Ninth Circuit Rejects Constitutional Challenges To Section 965 Tax

• Published date: 06 July 2022
• Subject Matter: Corporate/Commercial Law, Tax, Corporate and Company Law, Income Tax, Tax Authorities, Shareholders
• Law Firm: Freeman Law
• Author: Mr TL Fahring

In Moore v. United States, the U.S. Ninth Circuit Court of Appeals recently rejected arguments that the mandatory repatriation tax imposed under section 965 of the Internal Revenue Code violated the Constitution's Apportionment Clause and Fifth Amendment Due Process Clause.¹

Background

The case involved a U.S. couple ("Taxpayers") that invested in an Indian company that was a controlled foreign corporation ("CFC") under 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 U.S. shareholders.³ U.S. shareholders, in turn, are U.S. persons that own at least a 10% interest in a foreign corporation.⁴

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

Subpart F changes this result in limited circumstances, causing U.S. shareholders of CFCs to include in gross income certain categories of income earned by the CFC within a given taxable year.⁶ To the extent, however, that a CFC's income doesn't fall within these categories, it would remain untaxed in the United States until repatriation.

Then came section 965 as amended by the Tax Cuts and Jobs Act of 2017 ("TCJA"), which caused U.S. shareholders of a CFC to be subject to a one-time tax on accumulated deferred foreign income earned by the CFC after 1986 regardless of whether the CFC distributed such earnings. This was part of the TCJA's broader goal of excluding from tax dividends received by certain domestic corporation from certain foreign subsidiaries (thereby moving the U.S. tax system from what amounts to more of a worldwide tax system to something that is slightly more of a territorial tax system).⁷

The Decision

As noted above, Taxpayers challenged the section 965 tax on the grounds that it violated the Apportionment Clause and the Fifth Amendment of the U.S. Constitution.⁸

The Apportionment Clause provides that "[n]o Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be...