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Congress Can't Tax Undistributed Earnings of US Firms' Foreign Subsidiaries

Congress Can't Tax Undistributed Earnings of US Firms' Foreign Subsidiaries
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Wednesday, 20 September 2017 08:27 AM Current | Bio | Archive

The United States does not tax a parent corporation on the earnings of its subsidiary until the subsidiary distributes the earnings to the parent as a dividend. This holds true for a U.S. corporation’s foreign subsidiary, provided the foreign subsidiary is not a “controlled foreign corporation,” which I am assuming is the case. If such foreign corporation does not do business in the U.S., and does not distribute its earnings, the earnings escape U.S. taxation.

Some have proposed that Congress simply tax the undistributed (“unrepatriated”) earnings of a U.S. corporation’s foreign subsidiary. But it cannot happen. Such a tax would be a “direct tax” upon ownership of property or income thereof which, under Article 1, Section 9 of the U.S. Constitution, must be apportioned among the States according to population. E.g., Eisner v. Macomber, 252 U.S. 189, 205-206, 40 S.Ct. 189, 64 L.Ed. 521 (1920); Pollock v. Farmers’ Loan & Trust Co., 158 U.S. 601, 637, 15 S.Ct. 912, 39 L.Ed. 1108 (1895).

The Sixteenth Amendment to the Constitution relieves income tax from the apportionment requirement. But the tax we are talking about, upon the undistributed earnings of a corporation, is not an income tax. It is more akin to a tax on real or personal property. A corporation’s undistributed earnings are a claim to its property, real or personal.

You could argue that a corporation’s undistributed earnings were once income. But nearly all of a corporation’s assets were originally realized by the corporation as income. A direct tax upon a corporation’s undistributed earnings without apportionment would require an amendment to the Constitution.

The only lawful way for the United States to tax the undistributed earnings of a U.S. corporation’s foreign subsidiary is to induce the subsidiary to distribute the earnings as a dividend to the U.S. parent. The Trump Administration has proposed doing this by means of a special, lower tax rate on such repatriations.

Congress could tax the current income of U.S. corporations’ foreign subsidiaries by, for example, broadening the “controlled foreign corporation” regime of Subpart F of the Internal Revenue Code.

Consistent with the U.S. Constitution’s Fifth Amendment Due Process Clause, such a law could have prospective effect only.

Stephen J. Dunn is a tax attorney in Troy, Michigan. He is the author of the treatise Foreign Accounts Compliance (Thomson Reuters 2017) and Foreign Accounts Compliance Blog.

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StephenJDunn
The only lawful way for the United States to tax the undistributed earnings of a U.S. corporation’s foreign subsidiary is to induce the subsidiary to distribute the earnings as a dividend to the U.S. parent.
congress, tax, earnings, foreign
391
2017-27-20
Wednesday, 20 September 2017 08:27 AM
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