What was the 2017 tax act and what did it change for US corporations’ foreign affiliates and foreign investments?
In 2017, Congress passed the Tax Cuts and Jobs Act, which included provisions cutting the corporate tax rate and giving a tax cut to households in the top 1%. One significant aspect of the Act was section 965, known as the repatriation provision, which changed the taxation of foreign affiliates. Prior to the Act, the profits from the foreign affiliates of US corporations were only taxed on dividend payments from the foreign affiliate to the US parent. This allowed US companies and residents to defer taxes on foreign profits by holding them abroad or timing dividend payments strategically. The change was expected to generate $340 billion in tax revenue over the next ten years.
Why was the repatriation portion of the Act appealed?
In the case Charles G. Moore And Kathleen F. Moore v. United States Of America, an American couple challenged the Act after being subject to a $15,000 tax bill tied to their shares in a company in India. The Moores invested $40,000.00 in the company in 2006, and never received distributions. They argued that their stake in the corporation had never been realized, because the earnings were retained and reinvested. Consequently, they contended that the repatriation tax was not taxing actual income. Traditionally, courts have held that a realization event (such as selling shares or receiving dividends) is necessary for taxable income. The petitioners challenged the Act under the 16th Amendment, which authorizes Congress to collect taxes.
What did the Supreme Court decide?
The Supreme Court upheld the tax on foreign affiliates, ruling that Congress has the power to tax people and companies based on their share of undistributed corporate income. The court held that the income met the realization requirement because it was realized by the corporation. The decision was 7-2, with Thomas and Gorsuch dissenting.
What are the implications of upholding the tax?
The court’s ruling was limited to whether income is recognized when it comes from a foreign entity to US shareholders. While the decision does not have a major immediate impact on the US tax system, it could lead future courts to reconsider other parts of the tax code. This ruling may have significant consequences for undistributed profits from corporations and pass-through tax entities. Currently, companies can reinvest earnings instead of making distributions to delay taxes, and shareholders can postpone selling their shares to delay realizing taxable income. The decision could prompt changes in the tax code, altering how and when shareholders are taxed on investments in the US. Additionally, this may disincentivize investors from investing in foreign entities over US entities.
