The Supreme Court today decided to hear a case that could have far-reaching implications for US taxation of income earned overseas. The case challenges a key international provision of the Tax Cuts and Jobs Act: the Section 965 Bridging Tax. The case has attracted attention (including multiple Wall Street Journal comments) for its potential impact on Biden proposal impose a wealth tax on high-income Americans. But the case also affects the corporate tax community.
In Moore vs United States, a married couple made a $40,000 investment in a small Indian company that turned out to be very profitable. The company reinvested its earnings and the Moores never received any distribution from the company. As a result of Section 965, however, the Moores had to report an additional $132,512 in U.S. taxable income in 2017 and pay an additional $14,729 in taxes. Suing for a refund, they challenged the transition fee (also called the “compulsory repatriation fee” or “MRT”) under section 965 as unconstitutional. A federal district court and the Ninth Circuit ruled against the Moores and for the United States. The Supreme Court is now considering whether to uphold the case.
The transition fee under Section 965 is at the heart of the controversy. For fiscal year 2017, the provision treats the retained earnings of a controlled foreign corporation through 1986 as Subpart F income of certain U.S. shareholders as a proportion of their ownership interests in 2017. According to the Moores, these retained earnings they are not actually income because they are not yet accomplished by the US taxpayer.
The case raises the question of whether wealth must be realized to constitute income. At first glance, it might seem like the stuff of law school symposiums and arcane law review articles. But, if the Court were to side with the Moores, it is possible that a fundamental pillar of the US system of international taxation would fall. Of course, section 965 is not the only provision in Chapter F that treats the foreign earnings of a controlled foreign company as the taxable income of US owners. In their most recent brief, the Moores try to distinguish Section 965 from the rest of Subpart F,(1) but one could imagine that a broad Supreme Court ruling could upset other aspects of CFC taxation and perhaps even extend to corporate AMT.
It was unclear whether the Supreme Court would decide to hear the case. Although it has attracted publicity, the Court hears only a small fraction of the cases it hears each year. Many of these cases involve “splitting the circuit,” and, here, the Moores have identified no other circuit court that has addressed the constitutionality of the Section 965 tax. (They pointed to presumably conflicting jurisprudence on the definition of income.) The court’s decision to hear the case may suggest that some judges are interested in the extent of the government’s fiscal power.
(1) Specifically, they state: “Although this Court has not addressed the constitutionality of Chapter F, its pre-MRT provisions (in section 965) address all events in that Congress identified as exhibiting the constructive realization of corporate income by shareholders, while the MRT simply credits its shareholders with the income of a foreign company going back thirty years, regardless of realisation.