SCOTUS Takes on Foreign Investment Tax Threatening Owners, Athletes
The U.S. Supreme Court recently agreed to hear Moore v. United Sates, a case about whether the IRS can lawfully tax an American couple that invested in a rural farming business in India which hasn’t paid the couple anything.
The case has far-reaching implications for Americans who take stakes in foreign teams and for a potential “wealth tax” that would impact owners, pro athletes and other affluent individuals.
More from Sportico.com
“Owners of teams overseas should be following Moore v. U.S. very closely,” Robert Raiola CPA, the director of the Sports and Entertainment Group at PKF O’Connor Davies and a Sportico contributor, said in an interview. “This case goes to how investing in a team or really any other business in another country can lead to unforeseen taxes, especially if the business is valued at high levels, as teams often are.”
In the mid 20-aughts Charles and Kathleen Moore paid $40,000 for 11% of the common shares of KisanKraft Machine Tools Private Limited, a friend’s startup that imports and distributes low-cost equipment to farmers in India and is mostly owned by Americans. The Moores have never participated in company operations or management.
KisanKraft has turned a profit every year but hasn’t distributed earnings to shareholders, including the Moores. Those earnings have been reinvested to grow the business.
The Moores, who as minority shareholders lack the legal authority to compel a dividend payment, say they’re fine with this arrangement. They only wanted to help a friend and advance the “noble purpose” of helping struggling farmers.
Until recently, the Moores weren’t taxed for their KisanKraft investment since it hasn’t paid them.
The Sixteenth Amendment allows the federal government to impose an income tax, but taxable income has ordinarily meant realized actualized gains, such as the profit a person enjoys when they sell something for more than they paid. Unrealized gains are only gains “on paper” and are subject to change; what seems profitable today could become a loss later.
To that point, the Supreme Court held in Eisner v. Macomber (1920) that a gain becomes taxable income if “received or drawn” by the taxpayer for “separate use, benefit and disposal.” The Moores haven’t “received or drawn” from KisanKraft.
Then the 2017 Tax Cuts and Jobs Act became law.
Although the Act cut some taxes it offset the accompanying loss of revenue by imposing new taxes. One is the one-time Mandatory Repatriation Act (MRT).
The MRT levies a tax on undistributed earnings for American shareholders of foreign-based, but mostly American-owned, companies when those shareholders have at least a 10% stake. The Moores’ accountant discovered in 2018 they owed $14,729 extra in taxes due to the MRT. This was based on the Moores’ pro rata share of KisanKraft’s retained earnings.
The Moores sued the government and demanded a refund, arguing a violation of due process and other claims. But a district court in Washington and the Ninth Circuit sided with the feds.
“Whether the taxpayer has realized income does not determine whether a tax is constitutional,” Ninth Circuit Judge Ronald Gould wrote last year on behalf of a unanimous three-judge panel.
Gould is “right” in the sense that nowhere in the Constitution is there a literal requirement that gains must be realized to be taxable. The Sixteenth Amendment doesn’t mention that. Neither do tax-related clauses in Article I, including Section 2, Clause 3, which says taxes must be appropriated among the states in relationship to their population.
But the Moores contend that, unless reversed by the Supreme Court, the Ninth Circuit will have “empowered Congress to impose practically any tax of any design” on Americans.
As the Moores see it, the Ninth Circuit’s decision is “enormously consequential.” It could, they warn, upset “long-settled expectations undergirding practically all capital investment across the economy” and represent “the most avulsive change to the law of federal taxation since the Sixteenth Amendment’s ratification.”
Others agree with the Moores.
Although the Moores’ petition to the Ninth Circuit to rehear the case came up short, Judge Patrick Bumatay dissented in their favor. He warned “without the guardrails of a realization component, the federal government has unfettered latitude to redefine ‘income’ and redraw the boundaries of its power to tax without apportionment.”
There is no shortage of American investors who buy sizable parts of foreign-based, but mostly American-owned businesses in sports, and who could have a stake in the case’s outcome.
Todd Boehly is co-owner and chairman of the Chelsea Football Club and owns most of French Ligue 1 club RC Strasbourg Alsace. Duncan Niederauer, who formerly served as CEO of the New York Stock Exchange, is the majority shareholder of Venezia FC. According to The Ringer, more than a quarter of the top-tier clubs in England and Italy were under American ownership as of last year, with many other clubs having substantial American investments.
Whether any of these American sports investors have been, or will be, impacted by MRT is unknown. It would depend on, among other factors, unrealized gains.
The Moores and policy groups authoring amicus briefs warn that once the door opens to the feds taxing unrealized gains for foreign investments, other taxes will follow.
President Biden has proposed taxes on unrealized capital gains, such as for holdings of stocks and bonds, when held by households worth more than $100 million. U.S. Senator Elizabeth Warren (D-Mass) has called for a wealth tax, where households would pay a 2% tax on every dollar of net worth above $50 million and a 6% tax on every dollar of net worth above $1 billion (in addition to applicable income taxes).
Some support these proposals to address wide disparities in wealth. Others view them as unsound given that they do not reflect realized gains. Since teams in the major leagues are worth at least hundreds of millions, and usually billions, of dollars, their owners would be susceptible to wealth-related taxes. So too would many pro athletes.
The Moores maintain that a ruling in their favor “would effectively rule a tax on property or unrealized gains in property out-of-bounds.”
Arguing for the government, the Justice Department insists the Moores are misrepresenting the situation. The DOJ emphasizes that the Sixteenth Amendment permits Congress to lay and collect taxes on income “from whatever source derived,” an expansive phrase that arguably ought to cover “deferred foreign income.”
The DOJ also downplays the relevance of a wealth tax to the case and intimates it is a scare tactic or red herring. The agency says the MRT doesn’t, as would a wealth tax, “tax the value of anything.” It simply taxes deferred foreign income.
A hearing at the Supreme Court for Moore v. United States will take place in the fall or next spring.
