Background

“In 2006, Charles and Kathleen Moore made an investment to help launch an overseas company formed to empower India’s underserved rural farmers. Charles’s friend and former co-worker Ravindra “Ravi” Kumar Agrawal saw that farmers in India’s most impoverished regions lacked access to even the most basic tools available in American hardware stores. To improve their livelihoods, he founded an India-based corporation, KisanKraft Machine Tools Private Limited, to import, manufacture, and distribute affordable farming equipment. Moved by Mr Agrawal’s vision, the Moores invested USD 40,000 – for them, a significant sum – and received about 13% of KisanKraft’s common shares. Agrawal retained approximately 80% ownership and moved to India to manage the business. KisanKraft’s rapid growth confirmed that Agrawal had identified a genuine need. The venture was profitable almost from the start, and its revenues increased every year. True to Agrawal’s original business plan, he reinvested all of KisanKraft’s earnings to grow the business, which had expanded to serve farmers across India. By 2017, it employed over 350 representatives in 14 regional offices, serving 2,500 local dealers.

“The Moores received regular updates from Agrawal on KisanKraft’s activities, as well as annual financial statements. Mr Moore visited India several times and was impressed with the difference that KisanKraft was making in the lives of India’s rural poor. The Moores never received any distributions, dividends, or other payments from KisanKraft, and as minority shareholders without any role in KisanKraft’s management, they had no ability to force the company to issue a dividend. For the Moores, it was payment enough that they were able to support KisanKraft’s “noble purpose…to improve the lives of small and marginal farmers in India”, and see the good that it was doing.

“Then came the tax bill. In 2018, the Moores learned from Agrawal that, under the recently enacted Mandatory Repatriation Tax (MRT), they owed income tax on KisanKraft’s reinvested earnings going back to 2006. Specifically, the MRT deemed a portion of KisanKraft’s earnings for each year proportional to the Moores’ ownership stake in 2017 to be the Moores’ 2017 income – even though they hadn’t received a penny from the company and likely wouldn’t for some time, if ever. Ultimately, the Moores had to declare an additional USD 132,512 as taxable 2017 income, and pay an additional USD 14,729 in tax. The MRT was enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA). It targets US shareholders who own 10% or more (by value or voting power) of foreign corporations that are primarily owned or controlled by US persons. 26 U.S.C. § 965.

“Prior to the MRT, these shareholders were usually taxed when the foreign corporation distributed its earnings. The MRT, however, simply deems the corporations’ retained earnings going back to 1986 to be the 2017 income of their US shareholders in proportion to their ownership stakes in 2017. The MRT taxes shareholders irrespective of whether they owned shares at the time the corporation made the earnings on which they’re being taxed; the effective tax rates for individuals are 17.54% and 9.05%, respectively. All that matters is that a given shareholder owned the requisite number of shares in 2017. The principal legislative purpose of this one-time tax was to partially fund the TCJA’s shifting of US corporate taxation from a worldwide system toward a territorial one – that is one where US corporations are taxed only on their domestic-source income. To accomplish this shift, the statute prospectively relieved US corporations from paying taxes on most distributions received from foreign corporations, including subsidiaries. That change was limited to corporate taxpayers; individual taxpayers like the Moores remain liable for income tax on distributions they receive.”

Breakdown of the law

While reviewing the MRT rules, one can’t miss their questionable constitutional status. Income recognition, from a supreme court standpoint, has long recognised realisation principals to determine when income is realised for income tax purposes.

There have been several precedent cases which define when income is taxable. A couple of the most notable cases are Eisner v. Macomber, 252 U.S. 189 (1920)(“Eisner”) and Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955)(Glenshaw”).

The Sixteenth Amendment states: “The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration”.

Under US 26, section 61(a) the general definition: “gross income means all income from whatever source derived…” is the determining factor for whether income is taxable or not.

Eisner makes perfectly clear that the lynchpin for Sixteenth Amendment, “incomes” is realisation by the taxpayer. The case states that for “a gain” to be income, it must be “received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal”. Glenshaw makes clear that under section 61(a), “incomes” to be realised by a taxpayer must be amounts which are “instances of undeniable accessions to wealth, clearly realised, and over which the taxpayers have complete dominion”.

Depending on how the US Supreme Court rules on this case, it will determine if the “mark to market” tax regimes of the IRS will survive. There are also significant questions about how partnership and S Corporation taxation is affected by this case. It could be argued that both partnerships and S Corporations income is taxed before it is realised by partners and shareholders.

The final issue which this case could determine is whether a billionaire wealth tax would pass muster under the constitutional framework currently in place.

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Canada’s foreign home buyer ban explained

Moore v. United States