It's not only changes in US law that affect taxpayers but also changes in laws of other countries. Examples: enforcement (treaties), whether tax is owed (Subpart F) and how much tax is owed to the US (foreign tax credits). https://t.co/ovoD240jtT
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) October 13, 2022
As long as the US continues to employ citizenship taxation any changes in US tax law will continue to have unintended consequences on Americans abroad. In March of 2022 I outlined how some of the tax changes proposed in the 2023 Biden Green book would impact US citizens who live outside the United States. As important as US tax changes are, Americans abroad must be aware of how changes in the laws of their country of residence may also impact their “tax relationship” with the United States.
The purpose of this post is provide five simple examples. Some of the examples are based on Canada’s tax laws and others are of a more general nature.
1. Enhancing US Criminal Enforcement – Extradition
An article that appeared on the Reuters site on October 6, 2022 by David Lawder began with:
WASHINGTON, Oct 6 (Reuters) – The Internal Revenue Service’s Criminal Investigation unit said on Thursday it has located 79 tax evasion fugitives in Mexico, Belize, El Salvador, Guatemala and Honduras in the first year of a new extradition initiative.
The effort was made possible by a change in Mexico’s tax laws in 2020 that made tax evasion a felony offense as part of a crackdown to improve weak tax collection. The reclassification paved the way for tax fugitives to be extradited to the United States.
(See the Appendix* for my interpretation of how this happened.)
It is likely that the number of extraditions for tax and other financial crimes will increase.
The use of extradition treaties demonstrates why the value of citizenship by investment programs is inversely correlated with the treaties (tax or other) the country has with the United States.
2. Legislating US Tax Law As Domestic Law – The FATCA IGAs
In 2014 Canada and many other countries entered into FATCA Intergovernmental Agreements with the United States. The purpose of the FATCA IGAs was for countries to legislate the US FATCA law (Internal Revenue Code 1471 – 1474) as the domestic law of those countries. Canada made specific amendments to the Income Tax Act of Canada to enact the US FATCA law on Canadian soil. A general description of the Canada US FATCA IGA and the constitutional challenge against it is here. FATCA has had the effect of expanding the US tax base into Canada and other countries.
3. Revealing US taxation – Enhancing The Payment of US Capital Gains Tax On The Sale Of A Principal Residence in Canada
In Canada (and many other countries) the tax free gain on the sale of a principal residence plays a significant role in retirement planning. In 2016 the Government of Canada amended its tax laws to require the reporting of the sale of a principal residence. Many US citizens living in Canada have their US tax returns prepared from their Canadian tax returns. The sale of the principal residence is reported on the Canadian tax return. This has the effect of alerting the US tax preparer to the sale of the Canadian principal residence and the need to pay US capital gains tax on the sale.
4. Creating Taxable Income For The US – Reducing The Tax Rate On Corporate Income May CREATE US Subpart F Income For US Citizens
It is common in non-US countries for individuals to run their businesses through small business corporations. When these businesses are organized by US citizens their small business may become “Controlled Foreign Corporations” (CFCs). CFC’s are subject to the US Subpart F rules found in Sections 951 – 965 of the Internal Revenue Code.
The purpose of the CFC rules is to attribute income earned by the CFC directly to the shareholder. CFC income includes both traditional Subpart F income and GILTI income. In each case a change in the corporation’s tax rate will impact whether the individual US shareholder will be required to include a portion of the corporation’s income in the shareholder’s personal income. To the extent that income earned in the corporation is taxed at a rate of at least 90% of the US corporate tax rate (currently 18.9%) the individual shareholder will NOT be subject to US Subpart F income inclusions. In this way, a reduction in the Canadian rates of taxation on income earned by those corporations may create US taxable income for the US citizen shareholder.
5. Increasing The US Tax As The Share Of Total Tax Payable – Reducing Tax Paid To The Country Of Residence Reduces The Tax Credit To Offset US Tax Payable
Tax credits are designed to facilitate the use of payment of tax in one country to offset the tax owing in the second country. Generally tax credits result in the taxpayer paying total tax at a rate which is equal to the tax paid in the country which has the higher rate of tax. Imagine a situation where the United States has a tax rate of 30% and country B has a tax rate of 30%. If country B lowers its tax rate to 25%, US citizen residents of Country B will NOT receive the tax reduction that other residents enjoy. They will pay 25% tax to Country B and 5% tax to the United States.
Conclusion and general message
Tax changes in other countries (where a US citizen is “tax resident”) can have an impact on one’s “tax relationship” with the United States. Americans abroad who are continually subjected (because of citizenship taxation) to the unintended consequences of changes in US tax law, should also be conscious of changes in the laws of their country of residence. These changes may create changes in their “tax relationship” with the United States. Note that these changes may also impact the application of various kinds of treaties.
This reality increases the risk of for US citizens of living outside the United States as a tax residents of other countries! The description of how a change in Mexican tax law created an offense that triggered the US Mexico extradition treaty* is a visible and frightening example. But, there are many other examples which entrap even the most innocent of taxpayers.
*Appendix – The amendment of a Mexican tax law and how it triggered the US Mexico extradition treaty
1978 US Mexico Extradition Treaty
Article 2. EXTRADITABLE OFFENSES
1. Extradition shall take place, subject to this Treaty, for wilful acts which fall within any of the clauses of the Appendix and are punishable in accordance with the laws of both Contracting Parties by deprivation of liberty, the maximum of which shall not be less than one year.
2. If extradition is requested for the execution of a sentence, there shall be the additional requirement that the part of the sentence remaining to be served shall not be less than six months.
3. Extradition shall also be granted for wilful acts which, although not being included in the Appendix, are punishable, in accordance with the federal laws of both Contracting Parties, by a deprivation of liberty, the maximum of which shall not be less than one year.
4. Subject to the conditions established in paragraphs 1, 2 and 3, extradition shall also be granted:
(a) For the attempt to commit an offense; conspiracy to commit an offense; or the participation in the execution of an offense; or
(b) When, for the purpose of granting jurisdiction to the United States government, transportation of persons or property, the use of the mail or other means of carrying out interstate or foreign commerce is also an element of the offense.
JR Note: It appears that Mexico increased the prison time for certain tax crimes to the one year minimum required by the treaty.
Citizenship/Nationality can operate as a defence to an extradition request
Article 9. EXTRADITION OF NATIONALS
1. Neither Contracting Party shall be bound to deliver up its own nationals, but the executive authority of the requested Party shall, if not prevented by the laws of that Party, have the power to deliver them up if, in its discretion, it be deemed proper to do so.
2. If extradition is not granted pursuant to paragraph 1 of this article, the re quested Party shall submit the case to its competent authorities for the purpose of prosecution, provided that Party has jurisdiction over the offense.
JR Note: Many countries have a presumption of extraditing their own citizens. Assuming the presumption against extraditing their own nationals is a standard feature of Mexico’s extradition treaties, individuals moving to Mexico (who are not Mexican citizens) would we well advised to obtain Mexican citizenship as soon as possible.
The full text of the US Mexico extradition treaty is here …
Protocol – November 13, 1997
JR Note: The protocol to the treaty does NOT appear to change the range of offenses for which extradition is possible.
Commentary: Changes in Mexican tax law which triggered the application of the extradition treaty
Starting on Jan. 1, 2020, anyone accused of serious tax irregularities, such as the use of a fake invoice by the company or its counterparts – including suppliers and service providers – regardless of accepting the invoice in good faith, could now face prison without bail under this new provision. This new law effectively enables the government to enforce mandatory pre-trial detention for those accused of malfeasance with faking electronic invoices. During the investigation process, this could lead to asset seizures and the freezing of bank accounts. There is a risk of business owners losing control of their companies, even before being found guilty or being exonerated.
With these changes coming into effect in 2020, the Mexican government will have broad statutory authority to criminalize a company that makes a good faith invoicing error, including incarcerating executives in maximum security jails. Even if found not guilty at the end of the process, it is unlikely that the Mexican authorities compensate accused parties for lost assets.