tions in wealth (i.e., a deemed sale rule generally governing all capital assets whenever there are changes in value but not necessarily any other events) were assumed to violate the Constitution, the question must be addressed whether the act of expatriation results in a sufficient change in the attributes of certain property owned by the expatriate such that a "disposition" of such property may be deemed to have occurred. There is no definitive answer to this question, because “realization" has remained a rather ill-defined concept. As discussed earlier, the Supreme Court clearly has abandoned the Macomber definition of "income" requiring a severance of profit from the underlying capital. This has led commentators to continue to struggle with realization's elusive "true" meaning. As Professor Shaviro recently observed: "Realization refers to the occurrence of a taxable event, but the term does not dictate, even as a matter of ordinary usage, what that occasion should be." 148 It is clear that the notion of “realization" is not confined by the Constitution to ordinary sales of property for cash or other consideration. See United States v. Davis, 370 U.S. 65 (1962)(upholding imposition of tax on taxpayer's transfer of appreciated stock to his former wife in settlement of her interest in the property, even though the taxpayer received only intangible benefit of release of former wife's interest that could not be accurately measured), 149 A flexible definition of "realization" could be supported as part of broad power of Congress to levy taxes and define the class of objects to be taxed. See Barclay & Co. v. Edwards, 267 U.S. 442, 450 (1924). However, even assuming that the constitutional realization notion is synonymous with the phrase "sale or other disposition" from Code section 1001, this phrase is also vague enough to lead to debate whether a "realization" always requires the transfer of the ownership of property from one entity to another. 150 Stated in a different way, must one or more of the "bundle of sticks" defining the ownership of property be transferred for a realization event to occur, or is it sufficient if there is a change in the character (or "color") of the sticks? Professor Shaviro notes that the realization concept could be defined broadly so that the receipt of loan proceeds could be treated as a kind of realization event, to the extent of any appreciation of the taxpayer's assets or to the extent the amount borrowed exceeds the basis of the taxpayer's noncash assets (perhaps limited to assets pledged as loan security),151 In a sense, this conceptualization underlies the Ninth Circuit's decision in Murphy, supra, where it was held that Congress could treat the a "settling up" on potential tax liabilities at the time of expatriation. See discussion infra of international law issues raised by the proposals. 148 Shaviro, supra, at 11-12. 149 In Davis, the Court stated that there was no doubt that Congress "intended that the economic growth of this stock be taxed" and that the issue "is simply when is such accretion to be taxed." 370 U.S. at 68. In response to the Davis decision, Congress enacted section 1041 (which shields divorce property settlements from tax liability) to provide nonrecognition treatment for otherwise realizable income. 150 See Helvering v. Griffiths, 318 U.S. at 393 (no exemption from taxation where economic gain is enjoyed by some event other than the taxpayer's personal receipt of money or other property). Commentators have noted that some of the nonrecognition provisions of the Code have allowed the architects of the Code to finesse difficult realization issues by postponing the question of whether income has been “realized” until it is no longer difficult. White, supra, at 2044, n. 24. 151 Shaviro, supra, at 12, 39-41. taxpayer as if he had constructively received the gains in his futures contracts because he was permitted to draw against such gains. 992 F.2d at 931. As another example, proposed regulations issued by the Treasury Department under Code section 1001 provide that a significant modification in the terms of a debt instrument will be treated as if the original instrument was exchanged for the modified instrument. 152 Thus, under the proposed regulations, a taxable exchange is deemed to have occurred if there is any significant alteration of a legal right or obligation of the issuer or holder of a debt instrument (including a change in collateral securing the note). Such a modification could be conceptually viewed as a change in the legal attributes (or "color") of the bundle of sticks even though the sticks do not change hands. So viewed, a parallel could be drawn to the deemed realization that would result under the expatriation proposals due to a change in the jurisdictional attributes of some assets owned by an individual at the time he or she renounces U.S. citizenship. The few commentators who view Macomber as having continuing constitutional validity acknowledge that the concept of realization is not entirely rigid. Arguing that the Supreme Court has never abandoned Macomber, Professor Ordower writes: [A]lteration of the taxpayer's aggregate rights with respect In addition, Ordower acknowledges that there apparently is an exception to any constitutional realization requirement in cases involving offshore operations and attempts by Congress to prevent tax evasion. 153 This view was previously expressed during the deliberations that led to Congress' passage of the controlled foreign corporation rules in 1962. See Memorandum to Secretary of the Treasury Douglas Dillon from Robert H. Knight, dated June 12, 1961 (concluding that proposal to include in gross income of U.S. shareholders undistributed profits of a controlled foreign corpora 152 Prop. Treas. Reg. sec. 1.1001-3. Some commentators view the Cottage Savings decision as supporting the validity of the proposed regulations, even though Cottage Savings involved an actual, rather than deemed exchange, of instruments, and the issue was whether the instruments exchanged were materially different. See Evans, "The Realization Doctrine After Cottage Savings," (December 1992) Taxes 897, at 902. 153 13 Va. Tax Rev. at 9, 18 ("The legislative history of the foreign personal holding company provisions justifies breaching the constitutional barrier to a shareholder level tax to prevent the proliferation of foreign 'incorporated pocketbooks' which lie beyond the taxing jurisdiction of the United States.") See also Norr, "Jurisdiction to Tax and International Income," 17 Tax L. Rev. 431, 453-54 (1962) (finding persuasive the contention that the CFC rules are constitutional under both Congress' taxing powers and its power to regulate foreign commerce). tion was a valid exercise of Congress' constitutional power to regulate foreign commerce; proposal can be supported on ground that income should be deemed to be constructively received in order to prevent tax avoidance or on broader ground that Macomber has been effectively overruled); Joint Committee on Internal Revenue Taxation, Comparison of Existing Law with President's Proposals on Taxation of Income from Foreign Subsidiaries (May 3, 1961) (noting that the foreign personal holding company rules are an exception to the general Macomber principle but have been held valid in Eder and such rules deal with a "relatively clear tax evasion area"). 154 Under this approach, even if there is a general constitutional realization requirement, this requirement-like most constitutional rules-is not absolute. Thus, it could be argued that the expatriation tax proposals are constitutionally valid because a deemed sale is provided for only when the taxpayer's (and Government's) relationship to property is altered due to a change in the jurisdictional attributes of the property for tax purposes and because the deemed sale rule would prevent tax evasion. Because every presumption favors the constitutional validity of a disputed tax statute, Mertens, Law of Federal Income Taxation, vol. 1, at sec. 4.01, there is a reasonable likelihood that the debate over whether a change of jurisdictional attributes of property is a sufficient realization event (and not merely a matter of form with little or no substantive effects as was found with the stock dividend in Macomber) would be resolved in favor of upholding the constitutionality of the statute. Cf. Helvering v. Griffiths, 318 U.S. at 393 (referring to the foreign personal holding company rules as a “practical necessity" and to the "inherent power" of the Government to protect itself from devices to avoid and evade its laws), 155 It is true that the expatriation tax proposals would tax the builtin gain of some assets that already are physically located offshore at the time that the taxpayer renounces U.S. citizenship. Indeed, the proposals could result in the imposition of tax in what could be considered to be "non-abusive" cases, because the assets in 154 In that publication, the staff of the Joint Committee on Internal Revenue Taxation suggested that, in contrast to the foreign personal holding company rules enacted in 1937, which dealt with a relatively clear_tax evasion area, there "may be some question as to whether all the provisions proposed [by President Kennedy in 1961] would be within the constitutional powers of the Congress." Another memorandum from Colin F. Stam, Chief of Staff of the Joint Committee on Internal Revenue Taxation to the Chairman of the Committee on Ways and Means, dated May 4, 1961, indicates that the basis for the Joint Committee's constitutional concern was that, while the foreign personal holding company rules were carefully tailored in 1937 to be no more drastic than required to prevent further use of one of the "most glaring loopholes" that led to tax evasion, the President's 1961 proposal was overbroad and would apply to some cases where it would be difficult or impossible to describe as involving the exploitation of a "glaring loophole." [1962 Act legislative history, vol 1, at 312]. See also Separate Views of the Republicans on H.R. 10650 [the 1962 Act] at B21 ("[C]ounsel for the Joint Committee on Internal Revenue Taxation has advised the committee that Congress cannot constitutionally tax shareholders on the undistributed income of foreign corporations, except in cases where such taxation is reasonably necessary to prevent evasion or avoidance of tax.") 155 In a letter to the Senate Finance Committee dated March 22, 1995, Professor Ordower writes that the expatriation tax proposals would "violate the constitutional limitation on the definition of income identified in Macomber," which the Supreme Court has yet to overrule. Ordower writes that, although "taxpayers have tolerated deviation from this constitutional limitation historically in certain types of transactions, including foreign personal holding companies, controlled foreign corporations, and the marking-to-market of commodities positions," the expatriation tax proposals would be a direct attack on Macomber: [S]uch taxation without realization raises far more fundamental issues than previous departures from the constitutional norm. It goes beyond earlier policy justifications such as tax avoidance through foreign personal holding companies and liquidity-based taxation of commodities positions. Here the proposed provision reaches the heart of unrealized gain. volved may never have been physically located in the United States. In such a case, it might seem anomalous to employ the legal fiction that gain is "realized" because the expatriate's assets are effectively being transferred offshore. However, the Supreme Court long ago upheld the validity under both the Constitution and principles of international law of deeming property that never was physically located in the United States to be within the tax jurisdiction of the United States for the sole reason that the owner is a United States citizen. Cook v. Tait, 265 U.S. 47 (1924)(upholding authority of United States Government to tax income from property located at the residence of a citizen residing abroad); United States v. Bennett, 232 U.S. 299 (1914)(upholding imposition of tax on the use of foreign-built yacht, owned or chartered by U.S. citizen, even if never used within geographic limits of the U.S.). The fact that certain property was never physically located within the geographic territory of the United States would not appear to be a bar to deeming such property to be transferred to a new legal situs due to the owner's act of expatriation. 156 The change in the jurisdictional attributes of property would not necessarily make valuation of such property any easier, but under Surrey's analysis (see footnote 134 supra) could provide the conceptual basis to statutorily deem that a "realization" has occurred. 157 The change in the taxpayer's and Government's relationship to such property, which would be viewed as being transferred to a new legal situs, would mark the end of the deferral of tax on built-in gains. In this way, the proposed taxing schemes could be viewed as providing an analog for personal property to the present-law rule contained in section 367, which ends tax deferral when business property is transferred to a foreign corporation (see Part II.A.4.d supra). Even though the rules of section 367 are referred to as exceptions to general "nonrecognition" treatment-as opposed to being special “realization" rules-the net effect of both section 367 and the expatriation tax proposals is to prevent tax deferral from being converted into permanent tax-free status. 158 As with the foreign personal holding company rules enacted in 1937 (which are viewed as remedying "tax evasion" by considering not only the tax otherwise escaped by the shareholder but the accumulated profits tax escaped by the foreign corporation), looking at the aggregate income, estate, and gift tax burden that is escaped when an individual renounces his citizenship may provide a sufficient "tax evasion" rationale that satisfies any surviving constitutional remnants of Macomber. 156 Consistent with this conceptual approach, the S. 700 and H.R. 1535 provide that with respect to those assets that a taxpayer elects to have remain within the jurisdiction of the U.S. tax system (by consenting to continue to be treated as a citizen with respect to such assets), a deemed realization event will not be statutorily mandated. 157 A comparison can be drawn to the significant alteration of legal attributes of assets that was found to have occurred in the 1920s reorganization cases of United States v. Phellis, 257 U.S. 156 (1921) and Marr v. United States, 268 U.S. 536 (1925)(both cases discussed by the Supreme Court in Cottage Savings), not because of an actual physical transfer of the assets but due to a change in their legal situs brought about when the corporations changed their State of incorporation. 158 See Prepared Statement of Professor Paul B. Stephan III, University of Virginia Law School, on Section 5 of H.R. 831, at 3 (“An analogous provision is section 367 of the Code, which denies nonrecognition treatment in certain corporate reorganizations if the recipient of appreciated property is a foreign corporation. I never have heard the argument that [this] provision imposes an impermissible burden on the right of a domestic corporation to export its capital.") Due process concerns In general.-Tax provisions must satisfy the requirements of constitutional provisions other than the Sixteenth Amendment. The Fifth Amendment to the Constitution forbids the Federal Government from depriving persons of property without due process of law. In the case of Brushaber v. Union Pacific R.R., 240 U.S. 1 (1916), the Supreme Court held that although the due process clause of the Fifth Amendment normally does not restrict Congress' taxing power or the classifications that may be used in a tax regime, the courts can intervene in extreme cases if the act complained of was so arbitrary as to constrain to Thus, in theory, the test under the due process clause for tax legislation generally is the same as for other economic regulation 159 : Did Congress act in an arbitrary or irrational manner? Bittker, supra, at 1-27; Mertens, supra, at sec. 401. In practice, however, it is extremely difficult to use the due process test to invalidate any economic regulation passed by Congress, but this is particularly so with respect to tax legislation. Economic regulation in general is given a presumption of validity by the judiciary; and the courts view Congress as having "especially broad latitude in creating classifications and distinctions in the tax statutes." Regan v. Taxation With Representation of Washington, 461 U.S. 540, 547 (1983). Because no Federal tax statute has ever been found to lack a rationale basis or to contain an improper classification under the due process clause (other than some early cases involving retroactive estate and gift taxation 160), it is difficult to describe the type of taxing scheme that could be found to violate the due process clause. It is clear, however, that much more is needed than a showing that a tax regime affects some persons more oppressively than others. In Brushaber, the Court rejected arguments that the income tax provisions of the Tariff Act of October 3, 1913, improperly discriminated against different types of entities and income. The Court held that a due process violation cannot be established merely because it is shown that the classification is "unwise" or results in "injustice." 240 U.S. at 26. In view of Brushaber and subsequent decisions, commentators uniformly agree that the proper focus under a due process analysis of a tax statute is whether the statute is so arbitrary and outside the zone of possible rationale debate that the only reasonable conclusion is that a "taking" has occurred. In applying this loose standard, Congress is accorded substantial flexibility and a presumption that it acted rationally. Mertens, 159 See, e.g., Usery v. Turner Elkhorn Mining Co., 428 U.S. 1 (1976)(upholding against due process challenge retroactive application of economic regulation, under which coal mine operators were made liable for benefits for former employees). 160 These early cases are now of questionable validity. United States v. Carlton, 114 S.Ct. 2018, 2024 (1994)(upholding retroactive change to estate tax provisions and noting that 1920s cases that invalidated retroactive tax changes on due process grounds were decided under a standard of review that "has long since been discarded"). |