Supreme Court Upholds Constitutionality of the Repatriation Tax

In a landmark decision, the Supreme Court recently upheld a key provision of the Tax Cuts and Jobs Act (TCJA) of 2017 which applies to the earnings or foreign corporations with U.S. shareholders, also known as Mandatory Repatriation Tax (MRT) enacted under Internal Revenue Code Section 965.

Charles and Kathleen Moore, a couple from the State of Washington, challenged the constitutionality of the MRT. Specifically, they claimed that MRT violates the Constitution’s apportionment clause. The Sixteenth Amendment generally exempts income taxes from this apportionment requirement. However, the Moore’s claimed that their unrealized gains shouldn’t be classified as income.

In the majority’s opinion, Justice Brett Kavanaugh wrote “Congress has long taxed shareholders of an entity on the entity’s undistributed income, and it did the same with the MRT”. The MRT applies to income realized by the foreign corporation with the U.S. shareholders, and the question is whether Congress can attribute a company’s realized and undistributed income to its shareholders for taxation. Justin Kavanaugh wrote, “This court has long upheld taxes of that kind, and we do the same today with the MRT”. Continuing that “those tax provisions, if suddenly eliminated, would deprive the U.S. government and the American people of trillions in lost tax revenue”.

Before the TCJA, American multinational corporations operated under a deferral system, where they paid U.S. taxes on foreign earnings when those profits were brought back into the country with certain exceptions. This system incentivized companies to keep their earnings offshore to avoid high U.S. income tax rates. The TCJA’s international tax reform aimed to curb this practice by transitioning to a quasi-territorial system, intending to level the playing field for American businesses in the global market.

The one-time MRT applied to accumulated profits held overseas since 1986. It subjects these profits to a tax rate of 15.5 percent on liquid assets and 8 percent on illiquid assets. This move is designed to encourage U.S. companies to repatriate their earnings, thus generating significant revenue for the federal government and potentially stimulating domestic investment.

The Supreme Court’s decision to uphold the MRT underscores its significance in the broader context of tax reform. It represents a step towards modernizing the U.S. tax code, aligning it more closely with international norms, and reducing the incentive for American businesses to hold profits overseas. The long-term impact on the global strategies of U.S. multinational corporations remains to be seen, but it undoubtedly marks a pivotal shift in international taxation policy.