[By Bhavana Sree Sagili]
The author is a student of Damodaram Sanjivayya National Law University.
Introduction
The US Supreme Court in Moore v. United States, addressed the constitutionality of the Mandatory Repatriation Tax (MRT) implemented under the 2017 Tax Cuts and Jobs Act. This case is pivotal because it will determine whether Congress can impose taxes on the “unrealized income” of American-controlled foreign companies. While the final judgment is crucial, the underlying rationale of the decision holds even greater significance. If the Court rules in favor of Moore, it could set a precedent affecting various aspects of income tax law, potentially leading to substantial changes in how taxes on foreign income are structured and enforced.
The United States is the third largest investor in India, with investments totalling $65.19 Bn from April 2000 to March 2024. This investment is crucial for the growth of Indian small-scale businesses, enabling them to expand and thrive (like Moore in KisanKraft). The Supreme Court judgment on Moore v. United States could significantly impact these investments and, by extension, the Indian economy. A ruling that affects the taxation of unrealized income may influence U.S. investors’ decisions, potentially altering the flow of investment into India.
The judgment has implications for the international taxation framework, as the OECD’s Pillar Two global minimum tax aims to ensure multinational enterprises (MNEs) pay at least a 15% tax rate on their global income, thereby reducing profit shifting and base erosion. It establishes rules for a minimum effective tax rate on large multinational groups. If the U.S. faces challenges in implementing these rules due to constitutional issues, it could complicate global efforts to standardize international tax practices, impacting countries like India that support these initiatives.
Background
Historically, Congress has treated certain business entities, such as corporations and partnerships, as pass-through entities for tax purposes, meaning the entity itself does not pay taxes on its income; instead, the income is attributed to the shareholders or partners, who then pay taxes on their share of the income, regardless of distribution. Since 1962, Congress has applied a similar approach to American-controlled foreign corporations under Subpart F of the Internal Revenue Code, taxing American shareholders on certain types of income, mostly passive, that the foreign corporation earned but did not distribute. The 2017 Tax Cuts and Jobs Act introduced the Mandatory Repatriation Tax (MRT), imposing a one-time tax on the accumulated, undistributed income of these foreign corporations to address the trillions of dollars that had accumulated without U.S. taxation, applying a tax rate of 8% to 15.5% on these earnings.
Moore Vs Us
Charles and Kathleen Moore invested $40,000 in KisanKraft, an American-controlled foreign corporation based in India, receiving a 13% ownership share. From 2006 to 2017, KisanKraft generated substantial income but did not distribute any of it to its American shareholders, including the Moores. With the enactment of the MRT, the Moores faced a tax bill of $14,729 on their share of KisanKraft’s accumulated earnings from 2006 to 2017, even though they had not received any actual income from these earnings. The Moores paid the tax but then sued for a refund, arguing that the MRT was an unconstitutional direct tax because it taxed unrealized income without apportionment among the states. They claimed this violated the Direct Tax Clause of the Constitution.
Judgment
The Supreme Court upheld the constitutionality of the Mandatory Repatriation Tax (MRT), emphasizing Congress’s broad authority to tax income, including undistributed income from American-controlled foreign corporations. The majority opinion, delivered by Justice Kavanaugh, reinforced this power by referencing historical precedents where similar taxes had been upheld, validating the MRT within the framework of existing tax laws. Central to the Court’s reasoning was the Sixteenth Amendment, which allows Congress to tax “income” from any source without apportionment among the states. The majority held that the MRT fits this framework, as it taxes income the Moores were deemed to have earned through their investment in KisanKraft. Historical examples, such as Subpart F provisions, supported the constitutionality of the MRT.
In his concurring opinion, Justice Jackson emphasized Congress’s “plenary power” over taxation and the long history of taxing undistributed income. Justices Barrett and Alito, while agreeing with the judgment, highlighted the need for future examination of income attribution nuances. In contrast, Justice Thomas, joined by Justice Gorsuch, dissented, arguing that the Sixteenth Amendment requires income realization before taxation, which the MRT violates. The ruling referenced cases like Burk-Waggoner Oil Assn. v. Hopkins and Burnet v. Leininger, supporting taxation of undistributed income. This decision clarifies Congress’s authority to tax undistributed income from foreign corporations, reinforcing the government’s ability to address multinational tax deferral strategies while noting potential future challenges on income definition and attribution.
Impact on India
The United States, being the third-largest investor in India, has injected substantial capital into the Indian economy, with investments totaling $65.19 billion from April 2000 to March 2024. These investments have been crucial for the development of various sectors, particularly small and medium enterprises (SMEs). For instance, the investment by Charles and Kathleen Moore in KisanKraft, an American-controlled foreign corporation based in India, highlights how American capital supports the growth of Indian businesses. Kisan Kraft’s growth, fueled by foreign investment, has enabled it to enhance operations and reach broader markets, contributing significantly to the local economy.
The potential changes in U.S. tax laws, as highlighted by the Moore v. United States case, could have a profound impact on these investment dynamics. If the Supreme Court’s decision leads to broader taxation on unrealized income, U.S. investors may become more cautious about investing in foreign enterprises. This caution could result in reduced investment flows into India, potentially slowing down economic growth and innovation. The Mandatory Repatriation Tax (MRT), which imposes a one-time tax on accumulated, undistributed income of American-controlled foreign corporations, might prompt U.S. investors to repatriate their earnings more quickly. This could affect the long-term investments in Indian companies, impacting their sustainability and expansion plans.
India’s tax policy has traditionally been designed to attract foreign direct investment (FDI) by offering various incentives. In 2020 alone, India attracted FDI inflows worth $81.72 billion, demonstrating its appeal as an investment destination. However, if the U.S. tax regime becomes more stringent on unrealized foreign income, India might need to reassess and potentially enhance its tax incentives to retain and attract U.S. investments. The competitive landscape for attracting foreign investment could become more challenging, necessitating policy adjustments to maintain India’s investment-friendly image.
The broader economic implications of changes in U.S. investment behaviour are significant. The U.S. and India share a robust trade relationship, with bilateral trade reaching $146 billion in 2022. Any changes in investment patterns due to shifts in U.S. tax policies could alter trade dynamics, potentially impacting jobs, consumer prices, and overall economic stability. For instance, reduced U.S. investments could lead to slower growth in sectors that heavily rely on foreign capital, such as technology, manufacturing, and services. This, in turn, could affect employment rates and economic growth in these sectors.
India’s commitment to fostering a stable and attractive investment environment might require proactive adjustments in response to changes in U.S. tax laws. The Indian government has made significant strides in improving the ease of doing business, ranking 63rd in the World Bank’s Ease of Doing Business report in 2022, up from 77th in 2019. To maintain this positive trajectory, India may need to further align its tax policies with global standards while offering competitive incentives to foreign investors. Enhancing the ease of doing business and providing a stable regulatory environment will be crucial in ensuring that India remains a favorable destination for U.S. investments.
Conclusion
The Supreme Court case, Moore v. United States has significant implications for both U.S. tax policy and international investment, particularly concerning American investments in India. The Court upheld the constitutionality of the Mandatory Repatriation Tax (MRT), which taxes unrealized income from American-controlled foreign corporations. This ruling reinforces Congress’s authority to impose such taxes, potentially leading to more stringent taxation on unrealized income in the future. The decision is pivotal for U.S. investors, as it may influence their willingness to invest in foreign enterprises, including those in India. If U.S. tax laws become more restrictive regarding unrealized income, it could lead to a decrease in investment flows into India, affecting economic growth and innovation. Given that the U.S. is a major investor in India, any reduction in capital could have broader economic repercussions, impacting sectors reliant on foreign investment.
Moreover, India may need to reassess its tax incentives to maintain its attractiveness as an investment destination. The potential changes in U.S. tax policy could challenge India’s ability to attract foreign direct investment, necessitating adjustments to its regulatory and tax frameworks to ensure continued economic growth and stability. Overall, the Moore v. United States ruling not only clarifies the U.S. government’s taxing authority but also sets the stage for potential shifts in international investment dynamics, particularly between the U.S. and India.