The recently passed U.S. tax law makes it more complicated for American citizens outside the United States to run businesses, because their income may be judged to be GILTI: global intangible low-taxed income.
As we’ve learned, the GILTI rules were enacted to ensure that companies do not try to shift all profits to foreign subsidiaries in low-tax countries, since those foreign profits can be repatriated tax-free. This regime makes it more difficult for U.S. citizens in Canada to use a foreign corporation to defer income from personal tax.
If you’re not familiar with GILTI, go here for a brief overview of the regime. In that article, we gave the example of Dr. Jones, an incorporated doctor who is a Canadian-resident U.S. citizen. She has earned profits of CA$500,000 and taken a salary of CA$100,000.
Under the GILTI regime, all profits earned by her company (CA$400,000) in excess of a 10% return on her laptop (CA$300) are taxed to her personally in the U.S. That significantly limits her ability to defer her medical income from personal tax, dramatically increasing the amount of tax she pays annually; she will pay personal tax on almost the full CA$500,000 she earns.
Dr. Jones has a number of options to try and maximize her tax deferral. We review a number of them below. Each has pros and cons.
1. Renouncing U.S. citizenship
Dr. Jones’s first option is to cease being a U.S. citizen, meaning she will no longer be subject to U.S. tax laws. A full discussion of the tax and immigration implications of renouncing U.S. citizenship can be found here. The rules on renunciation are largely unchanged under U.S. tax reform, but the new law does allow more people to renounce without paying taxes. In order to renounce without tax exposure, a U.S. citizen’s net worth has to be less than US$2 million. It is now possible to make gifts of up to US$11.2 million (up from US$5.49 million under the prior law) to reduce a citizen’s worth below the threshold.
With proper advice, it should be possible for Dr. Jones to renounce her American citizenship without paying taxes to renounce and without border risk. Renouncing U.S. citizenship will provide the maximum tax benefits to Dr. Jones, as she would no longer be subject to U.S. tax rules.
2. Convert her corporation to a ULC
If renouncing U.S. citizenship is not appealing, Dr. Jones’s second option is to convert her corporation into an unlimited liability company (ULC). This type of corporation is available under the laws of B.C., Alberta, and Nova Scotia. A ULC is considered a corporation under Canadian tax law, but not under U.S. tax law. As long as Dr. Jones’s corporation does not have unrealized gains, the conversion from a regular corporation to a ULC should not trigger much tax in the U.S. or Canada. Under the ULC option, some deferral of personal income tax is available, but not as much as if Dr. Jones had renounced her citizenship.
This option is more difficult to enact for Dr. Jones, however, if she lives outside the three provinces. Further, ULCs do not provide liability protection—a risk Dr. Jones would have to weigh.
3. Restructure ownership of the corporation
A third option is to restructure Dr. Jones’s corporation so she only owns voting shares that cannot receive dividends. Doing so would allow her to opt out of the GILTI regime. If Dr. Jones is married to a Canadian resident who is not a U.S. taxpayer, this type of restructuring can be done without income tax consequences in either Canada or the U.S. Dr. Jones would then draw a salary for her services (instead of dividends as she is currently doing).
This option offers the most deferral, but restructuring corporations is complex and expensive. Further, the newly enacted Canadian anti-income splitting rules may make this plan unattractive, because they make it more expensive to pay dividends to a person who is not involved in the business. (Read more about the rules here.)
4. Take advantage of the GILTI exception
A fourth option is to use a narrow, technical exception to the GILTI rules. Income is judged to be not GILTI if it is:
- a) classified as Subpart F income (a U.S. tax term for certain income earned by a foreign corporation), and
- b) subject to tax at the corporate level in Canada of at least 18.9%.
Not all types of income will meet this criteria, and it requires giving up the Canadian small business tax rate. This strategy will increase the overall tax cost in Canada and the U.S. of earning the money through a corporation, but will preserve some deferral.
5. Use the 962 election
A final option for Dr. Jones would be to rely on an election found in section 962 of the U.S. tax code, known as the 962 election. The mechanics of this election are complex, but in short, Dr. Jones can choose to be subject to U.S. tax as if she were a U.S. corporation. The GILTI rules provide a 50% deduction to U.S. corporations that have GILTI income. It is unclear whether this deduction applies to individual taxpayers who use the 962 election, so using it has significant risk. If the 50% deduction is not available, or Dr. Jones doesn’t want to take the risk, then the 962 election is not advantageous as it will result in a lot more tax owing than the other options.
GILTI is a problem for U.S. citizens who own Canadian corporations like Dr. Jones. Left unchecked, it can significantly prevent deferral of corporately earned income from personal tax.
Dr. Jones has a few different strategies to plead not GILTI. If she doesn’t value her U.S. citizenship, renouncing is probably the most effective solution from a tax perspective. But there are other options that will preserve some personal tax deferral. Choosing the best one will depend on her specific situation and her long-term plans.
Max Reed , LLB, BCL, is a cross-border tax lawyer at SKL Tax in Vancouver. firstname.lastname@example.org