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ARE NEW US PROFIT SOURCING RULES IMPACTING YOUR (CANADIAN) BUSINESS BOTTOM LINE?

PROFIT SOURCING RULES

Effective for tax years after December 31, 2017, as part of the Tax Cuts and Jobs Act, certain significant changes were made to profits recognition from sales derived from production activities in Canada and furnished to the US (and vice-versa).  Previously, the sales were generally sourced based on a 50/50 method. For Canadian businesses that manufactured inventory (wholly or partially) in Canada and sold to the US, 50% of the sales were sourced to the production location and 50% were sourced to where the sale occurred (i.e., where the title to the inventory passed).

Going forward, the new rule requires that sales be sourced entirely based on location of the production, regardless of where the title shifts from the seller to the buyer.

One would think that under the new law gains, profits and income from the inventory produced in Canada and sold to the US will be all sourced back to Canada and none of it would taxed in the US? Wrong!  When enacting the law, the Congress was focusing on US companies with domestic production and foreign sales.  If there is no permanent establishment in the foreign country where sales happen the US manufacturer would completely escape foreign taxation. Furthermore, even if the US manufacturer has an office in the foreign country which materially participates in sales, the new provision prevents income to be resourced to the foreign country.

The rules applicable to foreign manufacturers with sales to the US happen to work quite differently. For foreign (e.g., Canadian) producers selling to the US, if they have a US office and actively solicit sales in the US, all the income from the sales will be treated as US source despite of the newly enacted source-of-production rule.

This discriminatory treatment is due to an existing overriding section which was in effect under the old method and which was likely not considered given the speed at which the new law was advanced.  Hopefully, this oversight will soon be revised.  Meanwhile, Canadian companies with productions in Canada and sales to the US must revisit their operating strategy to minimize what is brought under the US taxing jurisdiction.

Please consult your Hanson Crossborder tax professional to assist with your tax strategy.

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July 2: IRS Announces Five Additional Compliance Campaigns

cryptocurrency

Virtual currency and the repatriation of foreign profits under Section 965 are the two out of five most recently added IRS compliance campaigns administered by the IRS Large Business and International (“LB&I”) Division. The objective of the narrowly defined campaigns is to “improve return selection, identify issues representing a risk of non-compliance, and make the greatest use of limited resources”.  The new campaigns added on July 2 represent the fourth batch introduced since January 2017 that currently amount to 40 initiatives in total.

Virtual Currency

Virtual currency taxation campaign is designed to focus on tax issues related to cryptocurrency by both educating the taxpayers and enforcing their compliance with reporting income from cryptocurrencies.  Since the IRS has not yet issued formal guidance and IRS practice units on this subject, it also hopes to receive feedback and learn issues associated with virtual currency, including recordkeeping and foreign-based wallets provided by virtual currency exchanges.

Currently the IRS has no intention to introduce an amnesty pertaining to delinquent reporting and taxation of cryptocurrency. Instead, taxpayers who failed to adequately disclose and pay tax, can use one of the existing voluntary disclosure program or procedures.

Section 965 Transition Tax

The transition tax, as introduced by the 2017 Tax Cuts and Jobs Act, is effectively a toll charge on previously untaxed earnings of a specific foreign corporation.  The government imposes this one-time tax on shareholders as part of the overhaul of the US international tax system transitioning from the worldwide to quasi territorial taxation. The current guidance on this tax has been limited to 3 IRS Notices, IRS Publications and a set of Frequently Asked Questions, addressing both filing and payment obligations.

Since the guidance supporting the transition tax has been fraught with complexity and ambiguity, the campaign is mostly targeting smaller shareholders who may be unaware of their filing obligations, such as individuals, S-corporations and partnerships.  The LB&I refers to Sec 965 campaign as a “heads-up” campaign.

If you receive a letter under any of the campaigns, whether an outreach or traditional examination, and require technical support, do not hesitate to contact us at Hanson Crossborder Tax Inc.

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