Ninth Circuit Rejects Constitutional Challenges to Section 965 Tax | law of the free man

In Moore v. United Statesthe United States Court of Appeals for the Ninth Circuit recently rejected arguments that the mandatory repatriation tax imposed under article 965 of the Tax Code violated the Constitution Distribution clause and Fifth Amendment Due Process Clause.[1]

Background

The case involved an American couple (“Taxpayers”) who invested in an Indian company that was a controlled foreign company (“CFCs“) below Subpart F of the Internal Revenue Code.[2] Under Subpart F, a CFC is a foreign corporation more than 50% of which is owned (directly, indirectly, or constructively) by US shareholders.[3] US shareholders, on the other hand, are US persons who hold at least a 10% stake in a foreign company.[4]

Foreign corporations are generally not subject to federal income tax except on US-source income and income that is actually connected with the conduct of a trade or business in the United States.[5] Thus, foreign income earned by a foreign corporation that is not effectively connected with the conduct of a trade or business in the United States is generally deferred from taxation in the United States unless or until that the foreign corporation distributes profits to a U.S. person or that person sells an interest in that foreign corporation.

Subpart F modifies this result in limited circumstances, requiring US shareholders of SECs to include in gross income certain categories of income earned by the SEC in a given taxation year.[6] However, to the extent that a CFC’s income does not fall into these categories, it would remain untaxed in the United States until repatriation.

Then came Article 965 as amended by the Tax Cuts and Jobs Act of 2017 (“TCJA”), which made U.S. shareholders of an SEC subject to a one-time tax on cumulative deferred foreign income earned by the SEC after 1986, whether or not the SEC distributed such income. This was part of the TCJA’s broader goal of exempting from tax dividends received by certain domestic corporations from certain foreign subsidiaries (thus shifting the US tax system from what amounts more to a global tax system to something something that is slightly more of a territorial tax system).[7]

decision

As noted above, the taxpayers challenged the Section 965 tax on the grounds that it violated the apportionment clause and the Fifth Amendment of the US Constitution.[8]

The distribution clause provides that “[n]o Poll tax, or other direct tax, will be imposed, unless it is proportional to the census or enumeration above indicated above.[9] According to the Ninth Circuit, the apportionment clause generally applies only to 1) taxes paid by each person, without regard to property, occupation, or other circumstances; and 2) property taxes.[10] The Court observed that although the Supreme Court of Pollock v. Farmers’ Loan & Tr. Co.[11] ruled that taxes on movable income were subject to the apportionment clause, this result was canceled by Sixteenth Amendmentwhich exempted from the requirement of apportionment “income from any source derived”.[12] The Ninth Circuit also noted that similar taxes—particularly those imposed under Subpart F and previous statutes—had been upheld as constitutional by other courts.[13]

Nevertheless, the taxpayers argued that the Section 965 tax was an unallocated direct tax, relying on the definitions of income advanced by the Supreme Court in Eisner v. Macomber[14] and Commissioner c. Glenshaw Glass Co.[15] In particular, the Taxpayers argued that these rulings required income to be realized before it could be taxed.[16]

The Ninth Circuit disagreed, stating that fulfillment was not a constitutional requirement but rather – citing the Supreme Court in Helvering versus Horst[17]— a matter of ‘administrative convenience’.[18] The Court also noted that a decision that the Section 965 tax was unconstitutional on such grounds would call into question a number of other tax provisions, which it declined to do.[19] Thus, the Court held that the Section 965 tax did not violate the apportionment clause.

The Ninth Circuit also concluded that the Section 965 tax did not violate the Due Process Clause of the Fifth Amendment due to the fact that it was retroactive legislation because its retroactive application itself served a legitimate objective by rational means.[20] The Court viewed the Section 965 tax as an integral part of the TCJA’s move toward a more territorial tax system.[21] In this light, the Section 965 tax “served a legitimate purpose by preventing” CFC shareholders who had not yet received distributions from getting a windfall by never having to pay tax on their offshore income. which have not yet been distributed”.[22] Further, the Ninth Circuit found that the Section 965 tax accomplishes this objective by rational means in that it “accelerates the date of effective repatriation of undistributed CFC income to a date following the enactment of the TCJA “, which the Court found to be “a rational administrative measure”. the solution.”[23]

[1] Moore vs. USANo. 20-36122 (9th Cir. June 7, 2022).

[2] Identifier. at 4-5.

[3] 26 USC § 957(a).

[4] Identifier. § 951(b).

[5] See id. §§ 11, 881, 882; 26 CFR §§ 1.11-1(a), 1.881-1(a), (b).

[6]See identifier. §§ 951(a), 952, 954.

[7] See id. § 245A. A global tax system is a system where nationals of a country are taxed on worldwide income, while a territorial tax system is a system where a country only taxes income earned within its borders physical. See Cong. Res. Serv., US International Corporation Taxation: Basic Concepts and Policy Issues at 1 (December 21, 2016).

[8] Moore, above note 1, to 7.

[9] const. art. I, § 9, cl. 4.

[10] Moore, above note 1, at 9 (quoting Nat’l Fed’n of Indep. Bus. against Sebelius567 US 519, 571 (2012)).

[11] 158 US 601, 618 (1895).

[12] Moore, above note 1, at 9-10.

[13] Identifier. at 10-11.

[14] 252 US 189 (1920).

[15] 348 US 426 (1955).

[16] Moore, above footnote 1, at 13.

[17] 311 US 112, 116 (1940).

[18] Moore, above footnote 1, at 14.

[19] Identifier. at 15.

[20] Identifier. at 16 years old.

[21] Identifier.

[22] Identifier.

[23] Identifier.

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