Overview
On June 7, 2022, the Ninth Circuit Court of Appeals held in Moore v. United States that the Mandatory Repatriation Tax (MRT), a one-time tax added under the Tax Cuts and Jobs Act (TCJA), did not violate the US Constitution’s Apportionment Clause or the Fifth Amendment’s Due Process Clause.1 The TCJA created the MRT, which modified Subpart F, by classifying controlled foreign corporation (CFC) earnings after 1986 as income taxable in 2017. The Moores challenged the constitutionality of Subpart F’s ability to permit the taxation of CFC’s income after 1986 through the MRT.
Background and Procedural History
The Moores had invested in KisanKraft Ltd., an Indian company that provides small-scale farmers in India with affordable equipment. KisanKraft is a CFC. KisanKraft earned a profit each year since 2005, but the company never distributed any earnings to the Moores. Since KisanKraft’s income was never distributed, the income was never taxable to the Moores. That all changed with the passage of the TCJA.
Under the TCJA, the MRT modified Subpart F by classifying CFC earnings after 1986 as income taxable in 2017 – as if the income was distributed to the U.S. investor.2Under the revised version of Subpart F, US persons owning at least 10% of a CFC are taxed on the CFC’s profits after 1986 at either 15.5% for earnings held in cash or 8% otherwise.3In 2018 the Moores learned about the MRT, which resulted in an unexpected tax bill of $15,000 – taxes based on earnings retained and reinvested by KisanKraft, and never distributed to the Moores.
The Moores challenged the constitutionality of Subpart F’s ability to permit the taxation of a CFC’s income after 1986 through the MRT. The district court granted the Government’s motion to dismiss the Moores’ complaint for failure to state a claim and denied the Moores’ cross-motion for summary judgment.
On appeal, the Ninth Circuit affirmed the district court’s dismissal.
The MRT does not violate the Apportionment Clause
The Apportionment Clause provides that “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.”4 However, the Sixteenth Amendment5 exempts from the apportionment requirement the broad category of “income, from whatever source derived.”6 While courts have struggled to define “income”, courts have consistently held that taxes similar to the MRT are constitutional. Against this backdrop, the Moores argued that the MRT was an unapportioned direct tax. Specifically, they argued that under Macomber7 and Glenshaw Glass8 income must be realized before it can be taxed. The Moores argued that the CFC income was not “realized” because the Moores’ never received the income and did not have complete dominion over the income. The Ninth Circuit rejected this argument for three reasons. First, Macomber and Glenshaw Glass were limited in scope and did not make more than a passing reference to realization. Second, the Supreme Court has made clear that Macomber and Glenshaw Glass do not provide a universal definition of “income.” Third, the Ninth Circuit has not adopted the definition of income advocated by the Moores,9 stating that there is no set definition of “income” under the Sixteenth Amendment.10
The MRT does not violate the Fifth Amendment’s Due Process Clause
The court recognized that the MRT was a retroactive law, which may violate the Fifth Amendment’s Due Process Clause. However, retroactive tax legislation may be constitutional if the “retroactive application itself serves a legitimate purpose by rational means.”11The Court concluded that the MRT did not violate the Due Process Clause because it “served a legitimate purpose; it prevents CFC shareholders who had not yet received distributions from obtaining a windfall by never having to pay taxes on their offshore earnings that have not yet been distributed.” The Court rejected that Moores’ argument that they expected that their offshore income would remain deferred, stating that “Tax legislation is not a promise, and a taxpayer has no vested right in the Internal Revenue Code.”12 Lastly, the Court held that the MRT was not a “wholly new tax” because prior to the MRT, US shareholders were taxed on CFC earnings when they were distributed. Thus, the Moores had reason to believe that their offshore activities would eventually be taxed.
Endnotes
1 __ F.4th__, 2022 WL 2036388 (June 7, 2022)
2 See IRC § 965(a), (d).
3 See IRC § 965(c).
4 U.S. Const. art I, 9, cl. 4.
5 Nat’l Fed’n of Indep. Bus. V. Sebelius, 567 U.S. 519 (212).
6 U.S. Const. amend. XVI.
7 Eisner v. Macomber, 252 U.S. 189 (1920).
8 Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955).
9 United States v. James, 333 F.2d 748 (9thCir. 1964).
10 Id. at 752-753.
11 Quarty v. United States, 170 F.3d 961 (9thCir. 1999).
12 See United States v. Carlton, 512 U.S. 26, 33 (1994).