For years people have asked the question: Can the United States enforce U.S. tax debts in foreign countries? If this is possible, how would this work. I sometimes answer questions on Quora. My answer to this question (comments invited) is here:
Part 1 of 3 – The 5th Protocol to the Canada U.S. Tax Treaty – U.S. Residents Moving To Canada With a ROTH
This is the another post describing an aspect of the September 21, 2007 5th Protocol to the Canada U.S. tax treaty. This post describes how the owner a Roth IRA can maintain significant advantages from a Roth IRA which has been funded prior to a move to Canada. In my next post I will argue that the same provisions should apply to a TFSA that was funded prior to a Canadian resident moving to the United States.
http://laws-lois.justice.gc.ca/eng/acts/I-3.3/FullText.html#h-82
Introduction – The United States taxes ONLY one thing! Everything!
The United States has one of the most (if not the most) comprehensive and complicated tax systems in the world.
1. Who is subject to U.S. taxation?
The United States is one of only two countries to impose taxation on its citizens who do NOT live in the United States. In practical terms, (in a world of dual citizenship), this means that the United States imposes taxation on the citizens and residents of other nations. This is to be contrasted with a system of “residence based taxation” – a system where only “residents of the nation” are subject to full taxation. A system of “residence based taxation” assumes that the purpose of taxes is so that the government can provide services to residents. A system of “citizenship-based taxation” assumes that the purpose of taxation is so that taxpayers can fund the activities of the government. (It’s interesting that the United States is (1) the only modern country with “citizenship” taxation and (2) a country that provides comparatively few services to its residents.
2. What is the source of the income that is subject to U.S. taxation?
The United States (along with Canada and most other countries) uses a system of “worldwide taxation”. In other words a U.S. citizen who is a tax-paying resident of France, is expected to pay taxes to the United States on income earned anywhere in the world. This is to be contrasted with “territorial taxation”. A country that uses a “territorial tax system” imposes taxes ONLY on income earned in the country.
3. What are the rules that determine how the tax owed is calculated?
The American citizen living in France as a French citizen is subject to exactly the same rules in the Internal Revenue Code that Homeland Americans are subject to. The problem is that the Internal Revenue imposes a different kind of tax regime on “foreign income” and “foreign property. In effect, this means that the United States imposes a separate and more punitive regime on people who live outside the United States. (This has the effect of making it very difficult for American citizens living outside the United States to engage in rational financial and retirement planning.)
The Impact of Tax Treaties in General and the “Pension Provisions” in Particular
4. What about tax treaties? How do they affect this situation?
In general (except in specific circumstances) U.S. tax treaties do NOT save Americans abroad from double taxation. In fact, the principal effect of most U.S. tax treaties is to guarantee that Americans abroad are subject to double taxation. This is achieved through a tax treaty provision known as the “savings clause“. Pursuant to the “savings clause”, the treaty partner country agrees that the United States can impose U.S. taxation, according to U.S. tax rules on the residents of the treaty partner countries who are (according to the USA) U.S. citizens.
In practice this means that the United States imposes “worldwide taxation” on residents of other countries. In fact, the United States imposes a separate and punitive tax system on those who reside in other countries.
5. The specific problem of pensions are recognized in many tax treaties
Many U.S. tax treaties address the issue of pensions. The Canada and U.K. tax treaties give strong protection to the rights of individuals to have pensions. The Australia tax treaty has very weak pension protection. The problem of how the Australian Superannuation interacts with the Internal Revenue Code has been the subject of much discussion. The “Pensions Provisions” are found in Article XVIII of the Canada U.S. Tax Treaty (as amended over the years).
The 5th Protocol – effective September 21, 2007 – made numerous changes to the pensions provisions (Article XVIII of the Canada U.S. Tax Treaty)
The discussion around the @USTransitionTax and it's possible applicability to #Americansabroad shows why U.S. @nonresidenttax must end – Dangerous to be American if you don't live in America! https://t.co/00Sm2xc8Kl pic.twitter.com/ub0cQz1SkY
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) March 9, 2018
Introduction
This is the third in my series of posts about the Sec. 965 Transition Tax and whether/how it applies to the small business corporations owned by tax paying residents of other countries (who may also have U.S. citizenship). These small business corporations are in no way “foreign”. They are certainly “local” to the resident of another country who just happens to have the misfortune of being a U.S. citizen.
The first two posts were:
Part 1: Responding to The Section 965 “transition tax”: “Resistance is futile” but “Compliance is impossible”
Part 2: Responding to The Section 965 “transition tax”: Is “resistance futile”? The possible use of the Canada U.S. tax treaty to defeat the “transition tax”
Those who fail to learn from history are doomed to repeat it
Immediately prior to the passing of President Obama’s “Affordable Care Act” (which was subsequently ruled to be constitutional BECAUSE it was a “tax”), legislators were faced with a comprehensive, complex and incomprehensible piece of legislation. Very few members of Congress understood the details and impact of what they were voting for.
TCJA passed very quickly and few legislators knew what was in it. In relation to Obamacare, Nancy Pelosi remarked that "we must pass the bill so that you can see what's in it". Would she think that the TCJA should be passed so that we can see what's on it? https://t.co/XubU0xBSH1
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) March 11, 2018
Nancy Pelosi secured her in place of history by suggesting that:
“We really need to pass the law so that you can see what’s in it!”
Ms. Pelosi meant (I think) that it’s one thing to know what a law says. It’s quite another to know how it actually impacts people.
Notwithstanding the April 15, 2018 deadline for the first “transition tax” payment, very few “tax professionals” understand what the Internal Revenue Code Sec. 965 “transition tax” says, (let alone what it actually might mean – assuming it applies).
What the application of the “transition tax” might actually mean in the life of an individual owner of a Canadian Controlled Private Corporation
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Beginning with the conclusion (for those who don’t want to read the post) …
For the reasons given in this post, I believe that there are grounds to argue that the imposition of the Sec. 965 “transition tax” on Canadian resident/citizens DOES violate the Canada U.S. tax treaty. It is my hope that this post will generate some badly needed discussion on this issue.
If you are an individual who believes you may be impacted by the “transition tax”, you should consider raising this issue with the Competent Authority. I would be happy to explore this with you.
Need some background on the Sec. 965 “U.S. transition tax”?
The following tweet references a 7 part video series about the Internal Revenue Code Sec. 965 “Transition Tax” created by John Richardson and Dr. Karen Alpert.
Understanding the @USTransitionTax – the possible implications for small for small business owners who do NOT reside in the United States – A 7 part video series with John Richardson and Dr. Karen Alpert https://t.co/MfsK7ArrcL
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) February 13, 2018
(Video 6 gives examples of what various approaches to “Transition Tax Compliance” might look like.)
A reminder of what the possible imposition of the “transition tax” would mean to certain Canadian residents
My comment to the article on the @USTransitionTax that appeared in today's Financial Times https://t.co/zBdXxk8nGz. The actual article is here https://t.co/Ch99owa1Ri pic.twitter.com/Bt0Vems8t2
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) February 5, 2018
Interesting article that demonstrates the impact of the U.S. tax policy of (1) exporting the Internal Revenue Code to other countries and (2) using the Internal Revenue Code to impose direct taxation on the “tax residents” of those other countries.
Some thoughts on this:
1. Different countries have different “cultures” of financial planning and carrying on businesses. The U.S. tax culture is such that an individual carrying on a business through a corporation is considered to be a “presumptive tax cheat”. This is NOT so in other countries. For example, in Canada (and other countries), it is normal for people to use small business corporations to both carry on business and create private pension plans. So, the first point that must be understood is that (if this tax applies) it is in effect a “tax” (actually it’s confiscation) of private pension plans!!! That’s what it actually is. The suggestion in one of the comments that these corporations were created to somehow avoid “self-employment” tax (although possibly true in countries that don’t have totalization agreements) is generally incorrect. I suspect that the largest number of people affected by this are in Canada and the U.K. which are countries which do have “totalization agreements”.
2. None of the people interviewed, made the point (or at least it was not reported) that this “tax” as applied to individuals is actually higher than the “tax” as applied to corporations. In the case of individuals the tax would be about 17.5% and not the 15.5% for corporations. (And individuals do not get the benefit of a transition to “territorial taxation”.)
3. As Mr. Bruce notes people will not easily be able to pay this. There is no realization event whatsoever. It’s just: (“Hey, we see there is some money there, let’s take it). Because there is no realization event, this should be viewed as an “asset confiscation” and not as a “tax”.
4. Understand that this is a pool of capital that was NEVER subject to U.S. taxation on the past. Therefore, if this is a tax at all, it should be viewed as a “retroactive tax”.
5. Under general principles of law, common sense and morality (does any of this matter?) the retained earnings of non-U.S. corporations are first subject to taxation by the country of incorporation. The U.S. “transition tax” is the creation of a “fictitious taxable event” which results in a preemptive “tax strike” against the tax base of other countries. If this is allowed under tax treaties, it’s only because when the treaties were signed, nobody could have imagined anything this outrageous.
6. It is obvious that this was NEVER INTENDED TO APPLY TO Americans abroad. Furthermore, no individual would even imagine that this could apply to them without “Education provided by the tax compliance industry”. Those in the industry should figure out how to argue that this was never intended to apply to Americans abroad, that there is no suggestion from the IRS that this applies to Americans abroad, that there is no legislative history suggesting that this applies to Americans abroad, and that this should not be applied to Americans abroad.
7. Finally, the title of this article refers to “Americans abroad”. This is a gross misstatement of the reality. The problem is that these (so called) “Americans abroad” are primarily the citizens and “tax residents” of other countries – that just happen to have been born in the United States. They have no connection to the USA. Are these citizen/residents of other countries (many who don’t even identify as Americans) expected to simply “turn over” their retirement plans to the IRS???? Come on!
Some of these thoughts are explored in an earlier post: “U.S. Tax Reform and the “nonresident corporation owner”: Does the Section 965 “transition tax apply”?
And now, on to our “regularly scheduled programming”: The possible use of the U.S. Canada Tax Treaty to as a defense to the U.S. “transition tax”
In Part 1 of this series, I wrote: “Responding to the Section 965 “transition tax”: “Resistance is futile and compliance is impossible“. I ended that post with a reminder that the imposition of Section 965 “transition tax” on Canadian residents has (at least) four characteristics:
1.The U.S. Transition Tax is a U.S. tax on the “undistributed earnings” of a Canadian corporation; and
2. Absent deliberate and expensive mitigation provisions, the U.S. transition tax contemplates the “double taxation” of Canadian residents who hold U.S. citizenship.
3. The “transition tax” is a preemptive “tax strike” against a corporation in Canada. Historically Canada would have the first right of taxation over Canadian companies.
4. The U.S. Transition Tax creates a “fictitious” taxable event. It is not triggered by any action on the part of the shareholder.
The purpose of this post is to argue that the Canada U.S. tax treaty may be a defense to the application of the Section 965 “Transition Tax”
Part A – Exploring what a “Subpart F” inclusion really is
Part B – The Canada U.S. Tax Treaty: Relevant provisions
Part C – Impact of the “Savings Clause”
Part D – The Interpretation of the tax treaty: WHO interprets the treaty and HOW is the treaty to be interpreted
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Update August 6, 2018:
I have written a sequel to this post – “7 Habits Of Highly Effective Americans Abroad” which you may find of interest:
As Sir John Templeton said: The best time to invest is when you have the money – The 7 Habits Of Highly Effective #Americansabroad https://t.co/qbd3WKKUyK
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) August 6, 2018
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Has it become too much work to remain a U.S. citizen? Has the time come to renounce U.S. citizenship? Would you be a "covered expatriate" if you renounced? Subject to the "Exit Tax"? https://t.co/1sSX7ZQeX9 via @ExpatriationLaw
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) March 11, 2018
The reality of being a “DUAL” Canada U.S. tax filer is that you are a “DUEL” tax filer
“It’s not the taxes they take from you. It’s that the U.S. tax system leaves you with few opportunities for financial planning”.
I was recently asked “what exactly are the issues facing “Canada U.S. dual tax filers?” This is my attempt to condense this topic into a short answer. There are a number of “obvious issues facing U.S. citizens living in Canada.” There are a number of issues that are less obvious. Here goes …
There are (at least) five obvious issues facing “dual Canada U.S. tax filers in Canada”.
At the very least the issues include:
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Before you read this post!! Warning!! Warning!!
Before a “Green Card” holder uses the “Treaty Tiebreaker” provision of a U.S. Tax Treaty, he/she must consider what is the effect of using the “Treaty Tiebreaker” on:
A. His/her immigration status under Title 8 (will he/she risk losing the Green Card?)
B. His/her status under Title 26 (will he expatriate himself under Internal Revenue Code S. 7701(b)) and subject himself to the S. 877A “Exit Tax” provisions?
Now, on to the post.
The “Treaty Tiebreaker” and information reporting …
The Internal Revenue Code imposes on “U.S. Persons” (citizens or “residents”):
1. The requirement to pay U.S. taxes; and
2. The requirement to file U.S.forms.
All “U.S. Persons” (citizens or residents) are aware of the importance of “Information Returns” AKA “Forms” in their lives.
What is a U.S. resident for the purposes of taxation?
This question is answered by analyzing Internal Revenue Code S. 7701(b). If one is NOT a U.S. citizen, a physical connection to the United States (at some time or another) is normally required for one to be a “tax resident” of the United States..
What happens if one is a “tax resident” of more than one country?
The “savings clause” ensures that U.S. citizens are the only people in the world who have no defence to being deemed a tax resident of multiple countries. U.S. citizens (“membership has its privileges”) are ALWAYS tax residents of the United States. U.S. citizens who reside in other nations, may also be “tax residents” of their country of residence.
In some cases, a U.S. “resident” (which includes a Green Card holder) may be deemed to be a “nonresident” pursuant to the terms of a U.S. Tax Treaty. A Green Card holder “may” be able to use a “Treaty Tiebreaker” provision to be treated as a “nonresident”.
Warning!! Warning!!
Before a “Green Card” holder uses the “Treaty Tiebreaker” provision of a U.S. Tax Treaty, he/she must consider what is the effect of using the “Treaty Tiebreaker” on:
A. His/her immigration status under Title 8 (will he/she risk losing the Green Card?)
B. His/her status under Title 26 (will he expatriate himself under Internal Revenue Code S. 7701(b)) and subject himself to the S. 877A “Exit Tax” provisions?