The original article was published by Thomas Reuter in the December 2023 Newsletter of Taxes and Wealth Management.

Historically, the Supreme Court of the United States (the “Supreme Court” or the “Court”) has proven to be reluctant to hear income tax cases. However, following on the heels of the Bittner decision [1] rendered in February 2023, the Supreme Court has agreed to hear yet another federal income tax case. On June 26, 2023, the Court agreed to hear the appeal [2] of the United States Court of Appeals for the Ninth Circuit (hereinafter referred to as the “Ninth Circuit”) decision in Charles G. Moore & Kathleen F. Moore v. United States of America. [3] The petitioners in the Moore case are challenging the constitutionality of the “mandatory repatriation tax” provided for in Internal Revenue Code (“IRC”) Section 965 (hereinafter referred to as the “MRT”). It is interesting to note that the Supreme Court agreed to hear the Moore case despite the fact that there was no “split” between Circuit Courts on the issue that is the subject matter of the appeal.

What is the MRT?

The MRT provisions were included in the Tax Cut & Jobs Act (“TCJA”) passed in late 2017. [4] In a nutshell, natural persons who were 10% or more US shareholders of controlled foreign corporations (“CFCs”) [5] were subject to federal income tax on the higher of the CFC’s accumulated post- 1986 earnings & profits (“E&P”) as of November 2, 2017 or December 31, 2017. [6] The enactment of the MRT provisions was part of the move from a “deferral” system of income taxation to a “quasi-territorial” or “participation exemption” system. [7] The MRT provisions were designed to establish a starting point for the application of the Global Intangible Low-Taxed Income (“GILTI”) provisions for the 2018 and subsequent tax years.

[1. See the June 2023 edition of Taxes & Wealth Management for my article on the Bittner case.

2. Docket. No. 22-800.

3. 36 F.4th 930 (9th Cir., 2022). On appeal from a decision of the U.S. District Court for the Western District of Washington. The

District Court decision is unreported but is available at 2020 WL 6799022 (W.D. Wash. Nov. 19, 2020).

4. See IRC Section 965.

5. The MRT provisions also apply to certain US shareholders of CFCs that are not natural persons.

6. The reference to the two different dates in 2017 was done in an attempt to prevent the creation and implementation of certain“tax avoidance” strategies between the date that the TCJA was enacted and December 31, 2017.

7. Prior to the enactment of the MRT and the GILTI provisions, US shareholders of CFCs were generally subject to US federal income tax only upon distribution of a CFC’s E&P. There were certain exceptions to this rule, the primary one being the current taxation of Subpart F income (generally “passive income”) of the CFC. ]

The MRT was a “one-time tax” and was payable irrespective of whether such income had, in fact, been distributed to the shareholder. The MRT applied in either the 2017 or 2018 tax year, depending upon whether the CFC was a calendar year or fiscal year taxpayer. The portion of accumulated post- 1986 E&P that was allocable to a US shareholder’s “aggregate foreign cash position” [8] was taxed at an effective federal tax rate of 15.5% and the portion of accumulated post-1986 E&P that was allocable to all other assets was taxed at an effective federal tax rate of 8.0%. [9] The reduced effective tax rates were achieved through the application of certain “deduction equivalent” amounts. For these purposes, a CFC’s “cash position” includes cash held by the CFC, the net accounts receivable of the CFC and certain liquid investments and short-term obligations held by the CFC. [10]

Recognizing that the tax payable by the application of the MRT provisions was, in effect, a tax payable on income which the shareholder had yet to receive, the MRT provisions permitted affected taxpayers to elect to pay their MRT liability in eight annual installments. [11]

[8. IRC Section 965(c)(3).

9. IRC Section 965(c)(1) & (2).] 

10. IRC Section 965(c)(3)(B).

11. IRC Section 965(h).]

Case Background

For several years, Charles and Kathleen Moore (hereinafter referred to as the “Taxpayers”) had been greater than 10% shareholders in an Indian corporation. The Indian corporation was a CFC. The Indian corporation was created as part of an effort to assist subsistence farmers in India. As of December 31, 2017, the Indian corporation had accumulated post-1986 E&P of approximately $508,000.

The Taxpayers had never received any actual distributions from the Indian corporation but were faced with a 2017 tax bill of approximately $15,000 due to the application of IRC Section 965.

The Ninth Circuit Decision

The US District Court for the Western District of Washington granted the government’s motion to dismiss the Taxpayers’ complaint. [12]

The issue in Moore basically resolves itself into whether the 16th Amendment to the Constitution authorizes Congress to tax unrealized sums without apportionment among the states.

Without getting into the “nitty-gritty” of the respective majority of amicus curiae briefs submitted to the Court appear to support the position advocated by the Taxpayers.

Arguments of the Taxpayers and of the government, the gist of the Taxpayers’ argument was that the MRT was unconstitutional because it was a “direct tax” that had not been apportioned between the states and that they had never received or “realized” the amounts upon which they were being taxed under IRC Section 965.

In contrast, the gist of the government’s argument was that whether a taxpayer has actually “realized” income does not determine whether a tax is constitutional. In support of its position, the government referred to a number of existing tax provisions that tax income that has yet to be received or realized. [13] 

The Ninth Circuit affirmed the decision of the US District Court for the Western District of Washington and denied the Taxpayers’ motion for a rehearing of the case. [14] 

In finding for the government and holding that the Taxpayers were subject to the MRT, the Ninth Circuit found that there was no constitutional requirement that income taxed by the federal government must first be received or “realized” by a taxpayer. [15] In other words, the Ninth Circuit held that the Constitution does not prohibit a corporation’s income from being attributed to its shareholders on a pro-rata basis (and thereby becoming subject to current taxation in the hands of the shareholders). The Ninth Circuit also noted that a finding that the MRT was unconstitutional could result in a shareholders’ “windfall” in the form of accumulated post-1986 E&P earned through November 2 or December 31, 2017 [16] potentially never being taxed in the hands of the shareholders of the CFC.

Future Proceedings in the Supreme Court

Through October 23, 2023, a significant number of amicus curiae briefs [17] have been submitted to the Court. The vast Argument before the justices of the Court is scheduled for December 5, 2023. A decision is expected sometime after May 2024. 

[ 12 See footnote 3.

13 For example, the Subpart F provisions which generally subject US shareholders to current taxation on undistributed “passive

income” of CFCs and the inclusion of income by application of the GILTI provisions of IRC Section 951A.

14 Moore v. United States, 53 F.4th 507 (9th Cir., 2022). The decision to deny a rehearing of the case was by a 5-4 majority.

15 In support of it’s finding that the MRT was constitutional, the Ninth Circuit made specific reference to prior authorities that had

upheld the constitutionality of the Subpart F provisions of the IRC.

16 That is, before the GILTI provisions took effect on January 1, 2018.

17 An amicus curiae brief is a legal brief submitted to an appellate court by a person or group who is not a party to the particular case but who has an interest in its outcome. Amicus curiae briefs generally advocate for a particular position and are submitted in an attempt to influence the decision of the appellate court. ]

Potential Ramifications of the Court’s Decision for Taxpayers

There has been a great deal of speculation in the “tax press” regarding the potential far-reaching impact of a finding by the Supreme Court that the MRT is, in fact, unconstitutional. There appear to be three possible outcomes at the Supreme Court:

1. An outright ruling in favor of the government that the imposition of the MRT is constitutional;
2. A “narrow” ruling in favor of the Taxpayers (e.g., a ruling that IRC Section 965 should not apply to minority shareholders of CFCs who do not have the ability to compel the CFC to distribute its E&P to the shareholders of the CFC); or
3. A “broad” ruling that the MRT is “flat-out” unconstitutional.

Certain commentators have speculated that a “broad” determination by the Supreme Court that the MRT is “flat- out” unconstitutional could call into question certain other income imputation or accelerated income recognition provisions that are currently features of the tax law and that have been referred to earlier in this article. For example, a “broad” decision in favor of the Taxpayers could call into question the continued validity of the Subpart F and the GILTI provisions. 

Summary

It was almost inevitable that some taxpayer would challenge the validity of the MRT by seeking judicial review as to its constitutionality. It is extremely interesting to note that the Supreme Court, despite its historical aversion to hear income tax cases, decided to hear the Moore case despite there being no “split” between Circuit Courts on the issue in question. Clearly, the Court concluded that that the Moore case raised a significant enough issue to justify it agreeing to hear the case. As noted by several commentators, the ultimate decision of the Court could have a far-reaching and very significant impact on certain current provisions of the tax law. There is all kinds of speculation as to how the Court will ultimately rule.

Time will tell as to how the Supreme Court will decide the Moore case. The author will update this article subsequent to the release of the Court’s decision, which is expected sometime after May 2024.

Written By Paul Bercovici

Director of International Tax

Adeptus Partners