Category Archives: savings clause

Exception to the "savings clause" – How the Canada U.S. Tax Treaty prevents "double taxation" of certain self-employment income

Those responsible for negotiating tax treaties with the United States should remember that:


It’s worth remembering that:
1. The contents of the “savings clause” will vary from treaty to treaty; a
2. Not all sections of the treaty will be subject to the “savings clause”.
Example of the Canada U.S. Tax Treaty used to PREVENT Double Taxation …
The following example comes from Olivier Wagner of “1040 Abroad” (reproduced with permission). It is a very interesting example because it involves an analysis of the interaction among:
(1) The savings clause in Article XXIX
(2) the principle against double taxation in Article XXIV
(3) the “Foreign Tax Credit” provisions in S. 904 of the Internal Revenue Code.
The basic  factual scenario involves a U.S. citizen living outside the United States who receives payment for consulting work inside the United States. I will let Oliver pick it up from here:
 

Now, being a tax geek, the question that comes to mind is: if a Canadian tax accountant (Canadian resident, US citizen) prepares tax returns in the US, will he have tax owing for that US sourced income?
Foreign Earned Income Exclusion (FEIE):
No luck here. IRC 911(a) excludes from taxation “foreign earned income” whereas IRC 911(b)(1)(A)  states “The term “foreign earned income” with respect to any individual means the amount received by such individual from sources within a foreign country or countries which constitute earned income attributable to services performed by such individual during the period described in subparagraph (A) or (B) of subsection (d)(1), whichever is applicable.” As such, income earned in the United States is not to be excluded under the FEIE
Foreign Tax Credit (FTC):
The foreign tax credit can only offset taxes arising from foreign sourced income, so at first look, no luck.
But then, as we note, we have several categories of income, to subdivide how the foreign tax cedit is allocated: General, passive and resourced by treaty – IRC 904(d)(6)(a) bingo !!!
Income resourced by treaty …
(6) Separate application to items resourced under treaties
(A) In general
If—
(i) without regard to any treaty obligation of the United States, any item of income would be treated as derived from sources within the United States,
(ii) under a treaty obligation of the United States, such item would be treated as arising from sources outside the United States, and
(iii) the taxpayer chooses the benefits of such treaty obligation,
subsections (a), (b), and (c) of this section and sections 902907, and 960 shall be applied separately with respect to each such item.
Hence we have the “resourced by treaty” FTC basket. In this case, we’ll use the US-Canada tax treaty. The analysis is a little lengthy so I put it in another post here.

So far so good. But, now we need to understand how the Canada U.S. Tax Treaty actually works to “resource” the U.S. income.
Olivier continues on with his analysis of the Canada U.S. Tax Treaty:
Article XXIX – (Keeping the Savings Clause in mind)
Miscellaneous Rules
1. The provisions of this Convention shall not restrict in any manner any exclusion, exemption, deduction, credit or other allowance now or hereafter accorded by the laws of a Contracting State in the determination of the tax imposed by that State.
2. Except as provided in paragraph 3, nothing in the Convention shall be construed as preventing a Contracting State from taxing its residents (as determined under Article IV (Residence)) and, in the case of the United States, its citizens (including a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of ten years following such loss) and companies electing to be treated as domestic corporations, as if there were no convention between the United States and Canada with respect to taxes on income and on capital.
3. The provisions of paragraph 2 shall not affect the obligations undertaken by a Contracting State:
(a) under paragraphs 3 and 4 of Article IX (Related Persons), paragraphs 6 and 7 of Article XIII (Gains), paragraphs 1, 3, 4, 5, 6(b) and 7 of Article XVIII (Pensions and Annuities), paragraph 5 of Article XXIX (Miscellaneous Rules), paragraphs 1, 5 and 6 of Article XXIX B (Taxes Imposed by Reason of Death), paragraphs 2, 3, 4 and 7 of Article XXIX B (Taxes Imposed by Reason of Death) as applied to the estates of persons other than former citizens referred to in paragraph 2 of this Article, paragraphs 3 and 5 of Article XXX (Entry into Force), and Articles XIX (Government Service), XXI (Exempt Organizations), XXIV (Elimination of Double Taxation), XXV (Non-Discrimination) and XXVI (Mutual Agreement Procedure);
This is the savings clause in which they’re saying that if you’re a US citizen, much of the tax treaty might as well not exist, except for a few articles mentioned in paragraph 3(a), which includes article XXIV (Elimination of Double Taxation), so article XXIV still applies to US citizens.
Article XXIV – (Exempt from the Savings Clause)
Elimination of Double Taxation
1. In the case of the United States, subject to the provisions of paragraphs 4, 5 and 6, double taxation shall be avoided as follows: In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a citizen or resident of the United States, or to a company electing to be treated as a domestic corporation, as a credit against the United States tax on income the appropriate amount of income tax paid or accrued to Canada; and, in the case of a company which is a resident of the United States owning at least 10 per cent of the voting stock of a company which is a resident of Canada from which it receives dividends in any taxable year, the United States shall allow as a credit against the United States tax on income the appropriate amount of income tax paid or accrued to Canada by that company with respect to the profits out of which such dividends are paid.
2. In the case of Canada, subject to the provisions of paragraphs 4, 5 and 6, double taxation shall be avoided as follows:
(a) subject to the provisions of the law of Canada regarding the deduction from tax payable in Canada of tax paid in a territory outside Canada and to any subsequent modification of those provisions (which shall not affect the general principle hereof)
(i) income tax paid or accrued to the United States on profits, income or gains arising in the United States, and
(ii) in the case of an individual, any social security taxes paid to the United States (other than taxes relating to unemployment insurance benefits) by the individual on such profits, income or gains
shall be deducted from any Canadian tax payable in respect of such profits, income or gains;
(b) subject to the existing provisions of the law of Canada regarding the taxation of income from a foreign affiliate and to any subsequent modification of those provisions – which shall not affect the general principle hereof – for the purpose of computing Canadian tax, a company which is a resident of Canada shall be allowed to deduct in computing its taxable income any dividend received by it out of the exempt surplus of a foreign affiliate which is a resident of the United States; and
(c) notwithstanding the provisions of subparagraph (a), where Canada imposes a tax on gains from the alienation of property that, but for the provisions of paragraph 5 of Article XIII (Gains), would not be taxable in Canada, income tax paid or accrued to the United States on such gains shall be deducted from any Canadian tax payable in respect of such gains.
3. For the purposes of this Article:
(a) profits, income or gains (other than gains to which paragraph 5 of Article XIII (Gains) applies) of a resident of a Contracting State which may be taxed in the other Contracting State in accordance with the Convention (without regard to paragraph 2 of Article XXIX (Miscellaneous Rules)) shall be deemed to arise in that other State; and
(b) profits, income or gains of a resident of a Contracting State which may not be taxed in the other Contracting State in accordance with the Convention (without regard to paragraph 2 of Article XXIX (Miscellaneous Rules)) or to which paragraph 5 of Article XIII (Gains) applies shall be deemed to arise in the first-mentioned State.
4. Where a United States citizen is a resident of Canada, the following rules shall apply:
(a) Canada shall allow a deduction from the Canadian tax in respect of income tax paid or accrued to the United States in respect of profits, income or gains which arise (within the meaning of paragraph 3) in the United States, except that such deduction need not exceed the amount of the tax that would be paid to the United States if the resident were not a United States citizen; and
(b) for the purposes of computing the United States tax, the United States shall allow as a credit against United States tax the income tax paid or accrued to Canada after the deduction referred to in subparagraph (a). The credit so allowed shall not reduce that portion of the United States tax that is deductible from Canadian tax in accordance with subparagraph (a). …
Getting to the conclusion …
A. Here the paragraph 4(a) says that Canada should allow a credit for “income tax paid in respect of profits, income or gains which arise (within the meaning of paragraph 3) in the United States”
B. Paragraph 3 says that we can disregard the savings clause for this purpose and that if we have profits, income or gains of a resident of a contracting state (Canada) which may not be taxed in the other contracting state (United Sates) in accordance with the Convention (without regard to paragraph 2 of Article XXIX (Miscellaneous Rules) “savings clause”), such profits, income or gains shall be deemed to arise in the first-mentioned State (Canada).
C. By virtue of “Article VII – Business Profits”, business profits from an individual or corporation resident of Canada which does not have a permanent establishment in the United States shall indeed not be taxed in the United States and are taxed in Canada.

(Article VII
Business Profits
1. The business profits of a resident of a Contracting State shall be taxable only in that State unless the resident carries on business in the other Contracting State through a permanent establishment situated therein. If the resident carries on, or has carried on, business as aforesaid, the business profits of the resident may be taxed in the other State but only so much of them as are attributable to that permanent establishment.)

D. As such, going back to paragraph 4(a), Canada should not allow any foreign tax credit with respect to such income (the business profits are deemed to be taxable only in Canada).
E. Going to paragraph 4(b), the United States shall allow a tax credit for the Canadian taxes with respect to such income.
Conclusion: Practically speaking as long as taxpayer remains a resident of Canada (as defined by Article IV), the actual location where work is performed doesn’t matter, income will be sourced to Canada, taxes will be paid to Canada and the US will allow a foreign tax credit against taxes arising from such income – meaning that in most cases there wouldn’t be any US tax owed.

Not All Tax Treaties Are Created Equal: US-French Social Security & Pension Treatment

This post, originally published on June 20, 2016 is reproduced with the kind permission of Patrick Hoza of U.S. Tax and Financial. Mr. Hoza is the author of the post and retains full copyright over the content.
The following tweet references the original post on the U.S. Tax and Financial website


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Not All Tax Treaties Are Created Equal: US-French Social Security & Pension Treatment
By Patrick Hoza 20 June 2016
While many US tax treaties have the same or similar language in them, one needs to pay USA French Flagsattention, as the devil is in the detail.
One such instance is how social security and pension distributions are treated in the US-French income tax treaty. For example, according to the Treaty (as amended by the 2004 and 2009 Protocols), payments under the social security legislation or similar legislation of a Contracting state to a resident of the other Contracting State or to a citizen of the United States shall be taxable only in the first-mentioned State. In English, social security income is taxed based on its source, a US social security payment made to a US citizen resident of France will be taxable only in the US and a French social security payment made to a US citizen resident of the US or France will only be taxable in France.
The same social security payment above, made to a US citizen resident of Switzerland would have a completely different treatment. In general, under the US-Swiss Income Tax Treaty, social security payments and other public pensions paid by a Contracting State to an individual who is a resident of the other Contracting State may be taxed in that other State. However, such payments may also be taxed in the first Contracting State according to the laws of that State (subject to a maximum 15% of the gross amount of the payment). So, a US citizen living in the US could be taxed up to 15% in Switzerland on Swiss social security payments (though Switzerland does not currently impose a tax on social security paid to non-residents of Switzerland), and Swiss citizens living in Switzerland would be taxed at 15% in the US on their US social security payments.
French pension distributions under the current US-French Income Tax Treaty (as revised by 2009 Protocol) are taxed based on a revised residency rule. If the US citizen resides in the US (or possibly France) and receives distributions from a French pension plan, that distribution is subject to tax only in France. A French resident who receives pension distributions from a US payor is subject to tax only in the US The reason that a US citizen resident in France is possibly only taxable in France on a French pension distribution is that there is some uncertainty if the treaty, as written, would be applicable due to the residency rules of the treaty. One should consult a tax professional when determining what position they are comfortable taking. However, based on the example prepared by the Joint Committee on Taxation the intention was that France would have sole right to tax French pension regardless of where the US citizen resides 1.
One must also be wary of the saving clause included in Tax Treaties. The saving clause is a clause included in all treaties which limits the use of the treaty by US citizens and residents. Due to the citizenship based tax system of the US, the saving clause is required to limit the ability of US persons to escape US tax based on the treaty. However, the saving clause is not uniform and can cover different aspects of a treaty based on the horse trading between the US and treaty country when concluding Tax Treaties and Protocols. The above social security and pension treatments are exempt from the saving clause under article 29 of the US-French Income Tax Treaty and thus open to US citizens to benefit from. However, the US-Swiss saving clause precludes a US citizen or resident from benefiting from the pension article of that treaty.
There are many differences between the various US Tax Treaties. One must make sure not to rely on past experience because, as the blog title indicates, not all treaties are created equal. Each has its own unique provisions and requires it’s own review and analysis.
Source material:
1. From page 16 of Explanation of Proposed Protocol to the Income Tax Treaty Between the United States and France: Under the proposed protocol, a U.S. citizen who resides in the United States (or France) and receives distributions from a French pension plan is subject to tax on that distribution only in France. A French resident who receives pension distributions from a U.S. payor is subject to tax only in the United States.

Dual citizenship, the lack of definition of "citizen" in the "Savings Clause" of U.S. Tax Treaties and why these are important


 
Introduction …
This is a “follow up” to my first post about the “Savings Clause” in the Canada U.S. Tax Treaty. The purpose of that first post was to demonstrate that pursuant to the “Savings Clause”, the Government of Canada has agreed to allow the United States to impose direct taxation on some Canadian citizens who are resident in Canada. The post generated a fascinating discussion about the “Savings Clause” and was widely discussed at the Isaac Brock Society. A subsequent post at the Isaac Brock Society provided greater detail about exactly how, and in what respects, the Government of Canada has agreed that the United States can impose direct U.S. taxation on some Canadian citizens and residents. One obvious conclusion from this discussion is reflected in the comment that:

Next time someone tells me that the tax treaty relieves double taxation, I’ll tell them that it causes it. We have RDSP’s and RESP’s to prove it.

I absolutely agree. Although there are a few specific areas where the Tax Treaty mitigates against double taxation, for the most part, because of the Savings Clause, the U.S. Canada Tax Treaty, does NOT prevent double taxation. By ensuring U.S. taxation of Canadian residents and citizens, the U.S. Canada Tax Treaty guarantees double taxation!
It’s a myth that the tax treaty prevents double taxation. As John F. Kennedy said in his commencement address at Yale University on June 11, 1962:
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"Savings clause" in US Tax Treaties guarantees US right of taxation on residents and citizens of other nations


Introduction …


It is commonly believed that U.S. Tax Treaties are for the purpose of preventing “double taxation”. In general, US Tax Treaties do NOT prevent double taxation with respect to Americans abroad. For Americans abroad, double taxation is mitigated (but not prevented) by through Internal Revenue Code S. 901 (foreign tax credits) and Internal Revenue Code S. 911 (Foreign Earned Income Exclusion).
U.S. Tax Treaties include a “savings clause” (found in different sections of different treaties) that:
1. Guarantee the right of the United States to impose taxation on its citizens who are residing in other nations; and
2. Guarantee the right of the United States to impose taxation on its citizens as though the treaty didn’t exist.
Note that these “U.S. citizens” may (and in many cases are) citizens of their country of residence.
Those countries that have signed FATCA IGAs have effectively agreed to assist the United States in imposing taxation on their own citizens and residents. This will allow the United States to legally transfer capital out of the signatory country to the United States Treasury (for better use).
May 2016 – Elazar Cole and the “Savings Clause” …
On May 16, 2010, the U.S. Tax Court in the decision of – Elazar M. Cole v. Commissioner of Internal Revenue, T.C. Summary Opinion 2016-22 (May 2016) – confirmed the principle that a U.S. citizen cannot (as a general principle) use the Tax Treaty to prevent U.S. taxation.
The decision is here:
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Part 10 – The S. 877A "Exit Tax" and possible treaty relief under the Canada US Tax Treaty

Introduction – The Canada U.S. Tax Treaty Does Not Always Prevent Double Taxation


When countries independently make major changes in tax law, double taxation can occur
The following comment from 5thSwiss on the Isaac Brock Society site explains why and how double taxation can be a reality. It also underscores the dangers of a U.S. citizen leaving the United States.

It’s not obvious that renunciation of citizenship will cure failure to report in the past, or forgive unpaid tax. (“a ‘disposition’ of PFIC shares can occur by redeeming them, selling them, gifting them away, or even by giving up one’s US resident status or citizenship”)
The increasingly complex, expensive and draconian US tax law as applied to “accidental” US Persons might be considered by some a “good thing”. The more draconian – disproportionate – tax laws and penalties become, the more costly it is for ordinary families living abroad to report and pay tax on concessionary funds (such as for minors and disabled dependents, and retirement and tax-sparing funds not envisaged in the relevant bilateral tax treaty) the more impossible of enforcement and outrageous in principle such unilateral and exorbitant laws are seen to be.
And the less likely it is that the country of residence of a noncompliant person deemed to be a US person will assist the USG in collecting tax, prosecuting an individual and pursuing others on the basis of “transferee liability”.
Canadians who faced double taxation of their inheritance in that decade after Canada moved to capital gains taxation of estates based on deemed sale at death vs US imposition of estate duty (there is now a credit of one against the other under a tax Protocol) will understand that individuals are cannon fodder for Governments, who when they negotiate tax treaties are mainly concerned with the interests of multinational firms as represented by lobbyists. It is no wonder that of the 6 million Americans said to be resident abroad (the State Department knows of only half of those), an increasing number, unable to pay for tax advice or preparation, for renunciation of citizenship or the incremental US tax itself, are simply remaining underground. A series of GAO reports has looked at this and found no solution. And, by and large, legislators and bureaucrats (including diplomats) don’t care.
For the time being, the Lord Mansfield Dictum protects. But the hostility towards tax evasion abroad translates into hostility to expatriates generally. That is not a good sign.

5thSwiss describes the creation of  “double taxation” after one country (in this Canada) moved from an Estate Tax to a deemed disposition of assets on death. We now have a problem of the U.S. creating a deemed disposition of assets on expatriation when Canada has no such tax. This is what happens when one country makes a major change to its tax system and the other does not. (In this case there is at a minimum a “timing mismatch” in the taxable event.)

The S. 877A “Exit Tax” and the Canada U.S. Tax Treaty
The primary purpose of this post is to explore whether the Canada U.S. Tax Treaty can be used to mitigate some or all of the effects of the “Exit Tax”. I don’t know the answer. Therefore, this post will “raise an important question”, but not “answer the important question raised”.
U.S. Tax Treaties 101 – The outline
I am also going to use this post to outline some VERY basic aspects of U.S. tax treaties.   There will  four parts to this post:
Part 1 – Tax Treaties and the U.S. Constitution
Part 2 – Tax Treaties and the “Savings Clause”
Part 3 – The S. 877A “Exit Tax” and possible treaty relief
Part 4 – The “Savings Clause” as an argument against “citizenship taxation”
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