This is the third article in a series examining significant considerations in Moore v. United States, No. 22-800. The first article reviewed the history of the realization requirement (Tax Notes Int’l, Sept. 11, 2023, p. 1387). The second article examined how Congress has historically taxed foreign earnings (Tax Notes Int’l, Sept. 18, 2023, p. 1517).
This article is based on the facts laid out in the Moores’ filings, including declarations made by Ravindra Kumar Agrawal and Charles Moore to the U.S. District Court for the Western District of Washington dated May 15, 2019, and March 26, 2020, respectively, as well as the statutory financial reports of KisanKraft, which are public documents.
India is one of the most complex countries in which to invest, and its tax regime contributes significantly to that complexity. The U.S. international tax rules, meanwhile, are some of the most complicated parts of the Internal Revenue Code. Yet with apparently no thought for the tax implications in either country, Kathleen and Charles Moore went blithely into an area where many tread with trepidation, making — according to the court filings — an 11 percent direct investment in an Indian company in 2006. Only 10 years later did they begin to contemplate the tax costs, and even then they failed to take steps to prevent the imposition of a $15,000 section 965 tax liability from which they now ask the U.S. Supreme Court for relief.
The question presented in Moore is less constitutional than procedural: Should the Supreme Court be in the business of granting redress to taxpayers engaged in sophisticated cross-border transactions, who plan into structures with adverse tax consequences while failing to take advantage of the many opportunities provided by Congress to minimize or defer their associated U.S. tax liabilities?
The Knowns
Here’s what we know about the Moores’ investment (note that there are some inconsistencies between the Moores’ court filings and the KisanKraft Indian statutory filings):
Ravindra Kumar Agrawal (Ravi) founded KisanKraft as an Indian public limited company in 2005.
As of May 15, 2019, Ravi owned 80.138 percent of the shares of KisanKraft through a wholly owned domestic company, Washington Agrotech Ltd. He and his wife collectively owned about 2.6 percent of the shares of KisanKraft directly.
According to his 2020 declaration to the U.S. district court, signed under penalties of perjury, Charles Moore acquired about 11 percent of KisanKraft in 2006 for $40,000. (But note that in their February 21 petition for a writ of certiorari, the Moores said they received a stake of about 13 percent in 2006.) Although Ravi and his wife owned most of their shares of KisanKraft through a domestic limited company, the Moores owned their shares directly. Collectively, the Moores, Ravi, and Ravi’s wife contributed 99.5 percent of the company’s start-up capital.
According to Ravi’s 2019 declaration filed with the U.S. district court, as of May 15, 2019, Charles Moore owned 12.915 percent of the KisanKraft shares.
KisanKraft has grown every year since its founding.
According to Moore’s declaration, KisanKraft has not distributed any of its earnings to its shareholders, and all of its earnings have been reinvested in its business.
It follows from the fact that Washington Agrotech, a U.S. company, owned a stake of greater than 80 percent in KisanKraft that the company is a controlled foreign corporation (regardless of Ravi’s U.S. tax status).
According to the original complaint filed with the district court on September 26, 2019, Moore owned 12.937 percent of KisanKraft in 2017.
According to Moore’s declaration, the Moores’ share of KisanKraft’s retained earnings in 2017 was $508,000 and their taxable income increased in that year, as a result of the section 965 mandatory inclusion, by $132,512.
The statements in various court filings differ about the amount of tax paid by the Moores on their section 965 inclusion. The complaint says the additional tax paid was $15,130. The cert petition says the Moores paid about $14,729.
Based on the Moores’ share of KisanKraft’s income as reported in the court filings, the total amount of KisanKraft’s accumulated earnings in 2017 would have been about $6.5 million, which is corroborated by the Indian statutory filings.
The decrease in the Moores’ inclusion of KisanKraft’s accumulated earnings — from $508,000 to $132,512 of section 965 income — presumably resulted from the deduction provided by section 965(c), meaning that the Moores were only taxed on about 25 percent of their share of KisanKraft’s earnings.
One can deduce from the amount of tax reported paid (about $15,000) that the Moores’ tax rate on their share of KisanKraft’s accumulated earnings was about 2.5 percent, meaning that they likely claimed a foreign tax credit available under section 965(g) to offset the section 965 inclusion of about $132,000.
The Indian statutory filings indicate that Charles Moore sold some of his shares in KisanKraft in 2019 to Ravi, Ravi’s wife, and other shareholders. In the fiscal year ending March 31, 2019, the Moores’ ownership stake in KisanKraft decreased from 12.973 percent to 12.195 percent.
According to the Moores, as of March 2020, they had never received a distribution or any other payment from KisanKraft.
The Indian statutory financials show that in the fiscal year ended March 31, 2020, the Moores sold some of their shares in KrisanKraft: a total of 5,21,000 shares in three tranches (using the Indian numbering system). The sale reduced their ownership stake in the company to 9.9 percent.
The Unknowns
Moore’s investment in KisanKraft raises questions of fact and questions regarding the couple’s failure to account for tax considerations when they made the investment and later. We highlight some of those below and expound further on a few:
Why did the Moores invest an amount that was just enough to trigger U.S. shareholder status for them under section 951(b)?
Why did the Moores not invest in KisanKraft through a U.S. entity — either the same entity as their friend, the company’s founder, or a wholly owned entity of their own (an S corporation)? This would have rendered the issue presented to the Court moot.
Did the Moores properly file their tax return in the year they became 10 percent shareholders, as Category 3 filers for Form 5471 purposes? If they did so, why did their return preparer not advise them of the adverse consequences of their structuring decisions? (If they did not properly file, the relevant years remain open.)
Did KisanKraft ever have subpart F income — or an investment in U.S. property within the meaning of section 956 — before 2017 that would have been taxable to the Moores?
What was KisanKraft’s Indian tax rate? What was its tax pool in 2018?
Why did the Moores sell shares in 2019 and 2020?
Why did the Moores not contribute the shares of KisanKraft to an S corporation after the tax changes enacted in 2017?
Should the Moores have reported their section 965 liability on their 2018 tax return, rather than the 2017 return?
The Initial Investment
Nonprofit Regrets?
According to his 2020 declaration filed with the district court, Charles Moore originally invested in KisanKraft because the company was being formed for a “noble purpose.” He thought it was unlikely that the company would be sold or that his shares would be monetized through a public offering.
Moore’s expectations regarding the likelihood of KisanKraft’s success raise the first set of questions about the structure of the investment. A contribution to a not-for-profit company could have generated a $40,000 deduction for the Moores on their 2006 tax return. Yet even though the company was formed primarily to serve the public good by selling low-cost tools to low-income farmers and Moore was not expecting any return from the investment, he apparently didn’t question the decision not to structure the investment in a way that could have saved him thousands of dollars on his tax bill.
There are many Indian organizations engaged in altruistic activities that are organized as nonprofits, rendering them exempt from Indian taxes. The website Global Giving lists over 400 Indian organizations that U.S. persons can contribute to and claim a tax deduction. Among those organizations are ones with goals similar to KisanKraft of helping to build the capacities of Indian farmers.
Direct Investment and Indian Tax
Because it is such a complicated place to do business, few foreigners invest into India directly; most do so through an investment entity organized in another jurisdiction. In addition to its high corporate tax rate (close to 35 percent during most of the relevant period), India imposes a capital gains tax on nonresident shareholders who dispose of their shares in an Indian company.
A simple Google search yields numerous websites providing words of caution for those considering investing into India, such as one that warns investors to “obtain tax advice early,” because “several fundamental aspects of tax imposition in India change frequently” (Rishab Kumar, “What Foreign Investors Should Know When Investing in India,” Cooleygo (Jan. 20, 2022)).
The Indian capital gains tax on foreign persons’ disposition of shares in an Indian corporation would generally not be creditable in the United States because the gain on sale of the shares doesn’t give rise to foreign-source income — potentially leaving the Moores on the hook for multiple layers of tax imposed on their investment. A treaty resourcing rule may correct for that, but the treaty language is ambiguous, and taking that position would require the Moores to file Form 8833 on their tax return to claim a treaty-based position.
The Moores apparently invested in KisanKraft without doing the most rudimentary due diligence about the tax implications of their investment and without a care about the double taxes that could be imposed on the ongoing operations of the company and in the event of a subsequent disposition.
U.S. Tax Implications
By virtue of their greater-than-10-percent ownership in KisanKraft, the Moores immediately became classified as U.S. shareholders of a CFC.
While most Indian tax advisers would have warned Moore not to invest in KisanKraft directly, any U.S. tax adviser would have advised Moore to keep his investment below 10 percent if possible. Even before enactment of sections 965 and 951A, Moore’s greater-than-10-percent stake in KisanKraft rendered him taxable on any subpart F income earned by KisanKraft (under section 951) or all of KisanKraft’s accumulated earnings from its holding of U.S. property under section 956. At a minimum, the ownership stake implicated mandatory U.S. tax filings.
Given the close friendship between the Moores and Ravi described in the court filings and Moore’s declaration, it should have been relatively simple for the Moores to structure the investment to remain below the 10 percent threshold. Yet they went ahead with an investment structure that had serious U.S. tax consequences, even before section 965’s 2017 enactment.
Indian Taxes and Credits
Ravi’s declaration in support of the Moores’ district court filing includes a table of KisanKraft’s pretax revenues and after-tax profits from 2006 through the year ending March 31, 2019. The filings indicate that KisanKraft’s Indian tax rate averaged about 33 percent annually.
As individuals owning shares in a CFC, generally the Moores would not have been able to claim an FTC for any foreign taxes paid by KisanKraft. However, an election under section 962 would allow them to claim an FTC in the event of an inclusion of subpart F income, or — in the year of a section 965 inclusion — for that deemed dividend. The Moores’ initial complaint indicates that they claimed a credit for foreign taxes on their section 965 inclusion, thus reducing their U.S. tax liability on approximately $132,000 of taxable income (after the section 965(c) deduction) to about $15,000. The numbers suggest that KisanKraft’s tax rate on its accumulated earnings — as calculated for section 965 purposes — was about 25 percent.
The Section 965 Inclusion Year
For a foreign company with a March 31, 2018, year-end, the year of the section 965 inclusion generally should be the individual shareholder’s 2018 calendar year. Yet the Moores reported their section 965 inclusion in 2017, raising questions about whether the timing of their inclusion (and refund claim) are correct, whether they should have more appropriately reported the income in 2018, and why they elected not to do so.
The Section 965 Election
Section 965(i) provides that U.S. shareholders who owned shares of specified foreign corporations through an S corporation could elect to defer payment of their section 965 liability until the occurrence of a triggering event, defined to include the corporation ceasing to be an S corporation, liquidation or sale of substantially all the company’s assets, or a transfer of any share of stock in the S corporation by the taxpayer.
As noted, Washington Agrotech owned about 80 percent of the shares of KisanKraft. Ravi owned 100 percent of the shares of Washington Agrotech. Assuming Washington Agrotech was an S corporation, Ravi likely could defer the payment of tax on his section 965 liability indefinitely.
Yet Ravi — who encouraged his good friend Charles Moore to invest in his business alongside him, and who regularly spoke with Moore about the investment — apparently neglected to mention to his friend the potentially adverse consequences of holding a greater-than-10-percent interest in an Indian company directly, as well as the positive tax benefits associated with contributing his shares of KisanKraft to an S corporation in order to avail himself of the section 965(i) benefit of practically unlimited deferral.
The Sale of Shares
The Indian statutory financial records indicate that Charles Moore sold about one-fifth of his stake in KisanKraft in 2020 — reducing it from more than 12 percent to 9.9 percent. The decrease in ownership meant that he was no longer a U.S. shareholder of KisanKraft, and so should not have annual inclusions of KisanKraft earnings taxable as global intangible low-taxed income under section 951A.
The court filings do not provide any information about the tax consequences of the Moores’ sale of KisanKraft shares — including what consideration was received, or how much gain was reported. Any gain under Indian tax law would have been taxable in India at a 20 percent rate; it also would have been taxed in the United States at a 20 percent rate. Interpreting the India-U.S. tax treaty to allow for resourcing of the Indian capital gains tax would be a treaty-based position and would have required the Moores to file a Form 8833 with their 2019 and 2020 tax returns.
As the Moores’ decision to modify their ownership stake in KisanKraft indicates, when Congress changes the law regarding taxation of foreign income, taxpayers face a range of consequences for investments made under prior law.
The Moores’ Stake and the Control Test
The plaintiffs’ court filings represent the Moores as not in the group in control of KisanKraft. Yet the record is replete with indications that Charles Moore was an active investor in KisanKraft who could have urged Ravi to cause KisanKraft to repatriate some of its earnings. It suggests that when the Moores sought to minimize their U.S. tax liability from their ownership of KisanKraft, they were able to arrange a sale of the shares of this closely held company to its majority shareholders. And Moore served as a director of the company for five years, from 2012 until he resigned his position in early 2017, a fact that is inconsistent with his claim that he had no role in KisanKraft’s management. (Related coverage: p. 1776.)
Moore’s position as director raises questions about his assertion in his declaration that: “As a minority shareholder, I do not have the power to compel KisanKraft to make distributions to shareholders.”
In any case, 10 percent ownership is precisely the standard that Congress used in defining a U.S. shareholder — one subject to a mandatory subpart F inclusion — in 1962. The legislative history indicates that Congress recognized that “not all U.S. persons who are shareholders” in a CFC should be attributed subpart F income. It says that “this is to be done only in the case of those having . . . stock ownership of 10 percent or more of the combined voting power of all classes of stock, or of the total value of shares of all classes of stock.” Congress believed that the de minimis rule “prevents the attribution of the undistributed income back to the shareholders where their interest is small and their influence on the corporation’s policy is presumably negligible” (Legislative History of H.R. 10650, 87th Congress: The Revenue Act of 1962, Part 1).
The definition of U.S. shareholder has changed over time. But in one respect, it has remained constant — since 1962, a 10 percent shareholder of a CFC is considered to have enough sway over the business to merit an inclusion when required under different provisions of the subpart F regime, as well as recharacterization of gain from sale of shares under section 1248.
Taxpayers Similar to the Moores
Perhaps the most pernicious aspect of the relief the Moores are requesting from the Supreme Court — for a tax liability that results from their poor tax planning — is the fact that for many taxpayers similarly situated to the Moores, overturning section 965 would greatly increase their tax liability on repatriated earnings.
The Moores paid a tax rate of about 2.5 percent on earnings accumulated during years that might have been subject to rates exceeding 40 percent when earned. The Moores also say that KisanKraft has not repatriated any earnings — at least as of the date the cert petition was filed.
For U.S. taxpayers who owned shares in a foreign company and who were subject to tax on the inclusion mandated by section 965, a subsequent receipt of a dividend paid out of those earnings would be mostly tax free. In effect, paying a 2.5 percent tax in 2017 shielded U.S. taxpayers like the Moores from additional tax liability upon repatriation of the foreign company’s earnings.
If the Moores succeed in getting the Supreme Court to overturn section 965, those other taxpayers — who in good faith repatriated earnings, expecting zero additional tax liability — may be subject to significant additional tax owed. In the interest of protecting the Moores, the Court would be penalizing many other law-abiding citizens.
Mindy Herzfeld is professor of tax practice at University of Florida Levin College of Law, counsel at Potomac Law Group, and a contributor to Tax Notes International.
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