In October of 1962 the United States was almost dragged into a nuclear war with Russia because of Cuba. In response to the failed Bay of Pigs Invasion and the presence of American ballistic missiles within range of Moscow, Cuba requested nuclear ballistic missiles from Russia and Mr. Khrushchev complied. Our then president, John Kennedy recognized the threat and ordered a blockade on the nation of Cuba. The situation escalated to the point where the President ordered the United States Army and Navy to prepare to invade Cuba and the Air Force to get ready to carry our first round of nuclear preemptive attacks against Russia. The consequences for this world would have been absolutely devastating had the go-ahead been given.
What followed was a continuing cold war between NATO nations and The Warsaw Pact until 1991.
Because of the incident, Cuba was given the cold shoulder by America for 25 years even after the Cold War ended. The United States was so mad in fact, that foreign earned income from Cuba was made taxable under Subpart F income, by putting them on the Section 901 list (concepts discussed below). That put them on the wrong side of the IRS.
What is Subpart F Income?
Generally, income of controlled foreign countries or CFC’s is generally exempt from tax in the United States. Subpart F (Internal Revenue Code 952) was an attempt by Congress in 1962 to impose limits on deferral of foreign earned income. Within it, is Paragraph (a)(5) which includes into taxable United States income of which Section 901(j) applies.
IRC Section 952(a)(5) reads: the income of such corporation derived from any foreign country during any period during which section 901(j) applies to such foreign country. The payments referred to in paragraph (4) are payments which would be unlawful under the Foreign Corrupt Practices Act of 1977 if the payor were a United States person. For purposes of paragraph (5), the income described therein shall be reduced, under regulations prescribed by the Secretary, so as to take into account deductions (including taxes) properly allocable to such income.
And Code Section 901(j)(2)(A) reads: In general this subsection shall apply to any foreign country—
- the government of which the United States does not recognize, unless such government is otherwise eligible to purchase defense articles or services under the Arms Export Control Act,
- with respect to which the United States has severed diplomatic relations,
- with respect to which the United States has not severed diplomatic relations but does not conduct such relations, or
- which the Secretary of State has, pursuant to section 6(j) of the Export Administration Act of 1979, as amended, designated as a foreign country which repeatedly provides support for acts of international terrorisms.
Do you see the legal problem Cuba had with the IRS? There were only 5 countries on the Section 901 list as of December 31, 2015, which then included Cuba, Iran, North Korea, Sudan, and Syria (Internal Revenue Bulletin 2005-3). It had been over a half-century since the incident between once amicable neighbors.
Enter Revenue Ruling 2016-8.
In Revenue Ruling 2016-8, the IRS announced that Cuba is no longer one of the countries described in Section 901 of the Internal Revenue Code. It is retroactive to December 21, 2015. There are plenty of arguments, both for and against, thawing relations against Cuba. On the down side, a ruthless dictator is getting what he wants. On the up side America is safer and has another business partner in a close neighbor. The current Administration believes the adversity to the Cubans served neither nation.
Here at The Center we don’t get into politics. What will happen next, is a matter for politicians to process, for people to ponder. We do valuations and business succession planning and we do both well. We do not endorse nor condemn this revenue ruling. We want business people to know, this is a big event in the business tax world and there is quite possibly a new haven for business in North America. This is opportunity for American business. They are now on the right side of the IRS.
By: Roman Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors