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“Saving Clause” In U.S. Mexico Tax Treaty Informs Meaning Of “Renounced U.S. Citizenship For The Purpose Avoiding Taxation By The United States (Reed Amendment)”

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Summary and purpose:

This post is a continuation of my posts about the “saving clause” in U.S. tax treaties. For an introduction to the “saving clause” see:

Croatia Agrees To Allow The US To Impose Tax, Forms And Penalties On Its US Citizen Residents

This post will also identify how the 2003 Protocol to the U.S. Mexico tax treaty makes expatriation with an “intention to avoid taxation”, relevant from BOTH a tax and immigration perspective.

Part A – Taxation: The tax treaty saving clause and expatriation with an intention to avoid U.S. taxation

The 1992 U.S. Mexico tax treaty “saving clause”

A basic “saving clause” appeared in the 1992 U.S. Mexico tax treaty. It gave either the country the right to tax its citizens as though the treaty did not exist. See Appendix A for the full text and Appendix B for the technical interpretation

The 1992 “saving clause” stated that:

“the term “citizen” shall include a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of 10 years following such loss.”

The 1992 “saving clause” made no mention of “Green Card” holder or of the specific principles to be used to determine whether the expatriation “had as one of its principal purposes the avoidance of tax:,

The 2003 U.S. Mexico tax treaty protocol

The 2003 protocol to the U.S. Mexico tax treaty included a “saving clause” that is unlike any I have seen elsewhere. The Mexico “saving clause” has four unusual features:

1. While continuing the principle that the United States always has the right to tax its citizens (the purpose of any “saving clause”) it defines “citizen” to include BOTH citizen or long term resident who expatriated for the purpose of avoiding U.S. taxation (Paragraph 6. a));

2. It defines the meaning of “long term resident” (Paragraph 6.b) – notably this follows the definitions in the U.S. Internal Revenue Code 877(e)(2) as it was in 2003 and continues to be);

3. It provides specific criteria (reiterated in the technical interpretation) to be used as factors to determine whether a citizen expatriated for the purpose of avoiding U.S. taxation (Paragraph 7). See Appendix C of this post.

Paragraph 7

7. In the case of an individual who is a former citizen of a Contracting State, the following factors shall be considered favorably in determining whether or not one of the principal purposes of that individual’s loss of citizenship of that Contracting State was the avoidance of tax:

a) at the time of the individual ceasing to be a citizen of that Contracting State or within a reasonable period thereafter, the individual is or becomes a resident fully liable to income tax in the other Contracting State, and

b) i) the individual was a citizen of both Contracting States at birth and has remained a citizen of the other Contracting State;
ii) at the time of the loss of such citizenship (or within a reasonable period thereafter), the individual was or became a citizen of the other Contracting State, and that other Contracting State was that individual’s country of birth, or the country of birth of that individual’s spouse or of either of that individual’s parents;
iii) in the 10 years preceding the loss of such citizenship, the individual was present in that Contracting State for no more than 30 days in each taxable year or year of assessment; or
iv) the loss of citizenship occurred before the individual attained the age of 18 and one half years.

Notice that “dual citizenship” from birth is identified as being a factor negating expatriation with the intention of avoiding U.S. taxation. This continues the U.S. obsession with both “citizenship taxation” and “citizenship non-taxation”!

Because “Accidental Americans” are more likely to have dual citizenship from birth it is unlikely that the treaty would be interpreted to allow them to be taxed by the USA after expatriation!!

4. It provides specific criteria in Paragraph 8 (reiterated in the technical interpretation) to be used as factors to determine whether a Green Card holder expatriated for the purposes of avoiding U.S. taxation. See Appendix D of this post.

Paragraph 8

In the case of an individual who is a former long-term resident of a Contracting State, a number of factors may be considered by that Contracting State in determining whether or not one of the principal purposes of that individual’s loss of long-term resident status (“expatriation”) was the avoidance of tax. Paragraph 8 sets forth the following factors which will be considered favorably for purposes of determining whether a former long-term resident had a tax avoidance purpose for expatriating: (1) at the time of the individual’s expatriation (or within a reasonable time thereafter) the individual is or becomes a resident fully liable to tax in the other Contracting State and that other Contracting State is the individual’s country of birth, the country of birth of that individual’s spouse, or the country of birth of either of that individual’s parents; (2) in the 10 years prior to expatriation, the individual was present in the Contracting State from which he expatriated for no more than 30 days in each taxable year or year of assessment; or (3) the individual expatriated before he reached the age of 18 ½ years. This provision is consistent with U.S. law.

Notice that moving back to the “country of birth” is identified as a factor to negate any presumption of tax avoidance. In addition, becoming a “tax resident” in the new country of residence is relevant.

The 2003 protocol to the U.S. Mexico tax treaty is consistent with the principle that the “saving clause” mirrors the expatriation provisions of the time of negotiating the tax treaty.

Part B – Immigration: The tax treaty saving clause, expatriation with an intention to avoid U.S. taxation and how the tax treaty may bear on the application of the Reed amendment

Expatriation with an intention to avoid U.S. taxation is theoretically relevant for immigration purposes. This is the provision of U.S. immigration law that makes individuals who renounced for tax reasons inadmissible to the United States. This is commonly known as the “Reed Amendment”.

INA 212(d)(10)(E) reads:

“Any alien who is a former citizen of the United States who officially renounces United States citizenship and who is determined by the Attorney General to have renounced United States citizenship for the purpose of avoiding taxation by the United States is inadmissible.”

An excellent discussion and history of the Reed amendment is here. A 2020 podcast with U.S. tax lawyer Virginia La Torre Jeker discussing the Reed Amendment is here.

The U.S. Mexico tax treaty as an aid to interpreting the “Reed Amendment”

Assuming that the criteria for “expatriation to avoid U.S. taxation” can be used to interpret the Reed amendment (found in the Immigration and Nationality Act) it is clear that

– dual citizens from birth (most Accidental Americans are dual citizens from birth) are unlikely to be deemed “excludable aliens” within the meaning of the Reed amendment.

– long term Americans abroad (because they are less likely to be dual citizens from birth) do NOT enjoy the benefits of dual citizens from birth. (Nevertheless, I have no reason to believe that their renunciations would be deemed to be for the purposes of avoiding U.S. taxation.)

In other words, the Reed amendment is almost certainly inapplicable to “Accidental Americans”. It is not likely to be applicable to the circumstances generally of Americans abroad who are renouncing U.S. citizenship.

The 2003 protocol to the U.S. Mexico tax treaty is consistent with the principle that the “saving clause” mirrors the expatriation provisions of the time of negotiating the tax treaty.

Conclusion

Dual citizenship from birth continues to matter!

John Richardson – Follow me on X.com/Expatriationlaw

Appendix A

The U.S. Mexico 1992 Tax Treaty – Article I

ARTICLE 1

General Scope

1. This Convention shall apply to persons who are residents of one or both of the Contracting States, except as otherwise provided in the Convention.

2. The Convention shall not restrict in any manner any exclusion, exemption, deduction, credit, or other allowance now or hereafter accorded:

a) by the laws of either Contracting State; or
b) by any other agreement between the Contracting States.

3. Notwithstanding any provision of the Convention except paragraph 4, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship may tax its citizens, as if the Convention had not come into effect. For this purpose, the term “citizen” shall include a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of 10 years following such loss.

4. The provisions of paragraph 3 shall not affect

a) the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises), under paragraphs 1(b) and 3 of Article 19 (Pensions, Annuities, Alimony, and Child Support), and under Articles 22 (Exempt Organizations), 24 (Relief from Double Taxation), 25 (Non-Discrimination), and 26 (Mutual Agreement Procedure); and
b) the benefits conferred by a Contracting State under Articles 20 (Government Service), 21 (Students), and 28 (Diplomatic Agents and Consular Officers), upon individuals who are neither citizens of, nor lawful permanent residents in, that State.

https://www.irs.gov/pub/irs-trty/mexico.pdf

Appendix B

Technical Interpretation To The 1992 Treaty

Paragraph 3 contains the traditional “saving” clause, which provides that each country may tax in accordance with its domestic law, without regard to the Convention, its residents, citizens, and former citizens whose loss of citizenship had tax avoidance as one of its principal purposes. Although the paragraph is drafted reciprocally, Mexico does not now tax the income on the basis of citizenship. The taxation of former citizens is limited to a period of ten years, as provided in section 877 of the Code. “Residence”, for the purpose of the saving clause, is determined under Article 4 (Residence). Thus, for example, if an individual who is not a U.S. citizen is a resident of the United States under the Code, e.g., a “green card” holder, and is also a resident of Mexico under Mexican law, and the tie-breaker rules of paragraph 2 of Article 4 determine that he is a resident of Mexico, he will be entitled to U.S. benefits under the Convention.

As a consequence of the saving clause, each Article should be read as not providing benefits with respect to the U.S. taxation of U.S. citizens (wherever resident) or residents or with respect to Mexico’s taxation of Mexican citizens or residents. However, paragraph 4 provides certain exceptions to the saving clause. Under subparagraph (a), for example, U.S. residents and citizens are entitled to certain U.S. benefits provided under the Convention. Those benefits are:
the correlative adjustments authorized by paragraph 2 of Article 9; the exemption of social security benefits paid by the other State and of child support and alimony paid by residents of the other State, that are provided in paragraphs 1(b) and 3 of Article 19; the deductibility of certain contributions to Mexican charities and the relief from expenditure responsibilities provided in Article 22; the guarantee of a foreign tax credit provided in Article 24; the non-discrimination protection of Article 25; and the competent authority procedures of Article 26. Mexican residents are entitled to the benefits provided by Mexico under the same Articles (and Mexican citizens or former citizens would be entitled to the same benefits, if relevant).

Under subparagraph (b) certain additional benefits are available to U.S. residents who are neither U.S. citizens nor “green card” holders; these are the U.S. benefits extended to employees of the Mexican Government under Article 20, to visiting students, under Article 21, and to members of diplomatic and consular missions under Article 28. This subparagraph also applies reciprocally.

https://www.irs.gov/pub/irs-trty/mexicotech.pdf

Appendix C

2003 Protocol to the U.S. Mexico Tax Treaty

ARTICLE I

Article 1 of the Convention is deleted and the following Article is substituted:

“ARTICLE 1

General Scope

1. This Convention shall apply to persons who are residents of one or both of the Contracting States, except as otherwise provided in the Convention.

2. This Convention shall not restrict in any manner any exclusion, exemption, deduction, credit or other allowance now or hereafter accorded:

a) by the laws of either Contracting State; or
b) by any other agreement between the Contracting States.

3. Notwithstanding the provisions of subparagraph b) of paragraph 2:

a) any question arising as to the interpretation or application of this Convention and, in particular, whether a taxation measure is within the scope of this Convention, shall be determined exclusively in accordance with the provisions of Article 26 (Mutual Agreement Procedure) of this Convention; and
b) the provisions of any other agreement shall not apply to a taxation measure unless the competent authorities agree that the measure is not within the scope of Article 25 (Non-Discrimination) of this Convention.

For the purposes of this paragraph, a “measure” is a law, regulation, rule, procedure, decision, administrative action, or any similar provision or action.

4. Notwithstanding any provision of this Convention except paragraph 5, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship may tax its citizens, as if the Convention had not come into effect.

5. The provisions of paragraph 4 shall not affect:

a) the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises), under subparagraph b) of paragraph 1 and paragraph 3 of Article 19 (Pensions, Annuities, Alimony, and Child Support), and under Articles 22 (Exempt Organizations), 24 (Relief from Double Taxation), 25 (Non-Discrimination), and 26 (Mutual Agreement Procedure); and
b) the benefits conferred by a Contracting State under Articles 20 (Government Service), 21 (Students), and 28 (Diplomatic Agents and Consular Officers), upon individuals who are neither citizens of, nor lawful permanent residents in, that State.

6. a) A former citizen or long-term resident whose loss of citizenship or long-term resident status had as one of its principal purposes the avoidance of tax (as defined under the laws of the Contracting State of which the person was a citizen or long-term resident) shall be treated for purposes of paragraph 4 of this Article as a citizen of that Contracting State, but only for a period of 10 years following the loss of such status. This paragraph shall apply only in respect of income from sources within that Contracting State (including income deemed under the domestic law of that State to arise from such sources).
b) The term “long-term resident” shall mean any individual who is a lawful permanent resident of a Contracting State in 8 or more taxable years during the preceding 15 taxable years. In determining whether the threshold in the preceding sentence is met, there shall not count any year in which the individual is treated as a resident of the other Contracting State under this Convention, or as a resident of any country other than the first-mentioned Contracting State under the provisions of any other tax treaty of that Contracting State, and, in either case, the individual does not waive the benefits of such treaty applicable to residents of the other country.

7. In the case of an individual who is a former citizen of a Contracting State, the following factors shall be considered favorably in determining whether or not one of the principal purposes of that individual’s loss of citizenship of that Contracting State was the avoidance of tax:

a) at the time of the individual ceasing to be a citizen of that Contracting State or within a reasonable period thereafter, the individual is or becomes a resident fully liable to income tax in the other Contracting State, and

b) i) the individual was a citizen of both Contracting States at birth and has remained a citizen of the other Contracting State;
ii) at the time of the loss of such citizenship (or within a reasonable period thereafter), the individual was or became a citizen of the other Contracting State, and that other Contracting State was that individual’s country of birth, or the country of birth of that individual’s spouse or of either of that individual’s parents;
iii) in the 10 years preceding the loss of such citizenship, the individual was present in that Contracting State for no more than 30 days in each taxable year or year of assessment; or
iv) the loss of citizenship occurred before the individual attained the age of 18 and one half years.

8. In the case of an individual who is a former long-term resident of a Contracting State, the following factors shall be considered favorably in determining whether or not one of the principal purposes of that individual’s ceasing to be a long-term resident of that Contracting State was the avoidance of tax:
a) at the time of the individual ceasing to be a long-term resident of that Contracting State or within a reasonable period thereafter, the individual is or becomes a resident fully liable to income tax in the other Contracting State, and that other Contracting State is:
i) the country in which the individual was born;
ii) the country in which the individual’s spouse was born; or
iii) the country where either of the individual’s parents was born;
b) in the 10 years preceding the individual’s ceasing to be a long-term resident of that Contracting State, the individual was present in that Contracting State for no more than 30 days in each taxable year or year of assessment; or
c) the individual ceases to be a long-term resident of that Contracting State before reaching the age of 18 and one half years.”

https://home.treasury.gov/system/files/131/Treaty-Mexico-Pr2-10-26-2002.pdf

Appendix D

Technical Interpretation To The 2003 Protocol

Paragraph 4

Paragraph 4 contains the traditional saving clause found in U.S. tax treaties. The Contracting States reserve their rights, except as provided in paragraph 5, to tax their residents and citizens as provided in their internal laws, notwithstanding any provisions of the Convention to the contrary. For example, if a resident of Mexico performs professional services in the United States and the income from the services is not attributable to a permanent establishment in the United States, Article 7 (Business Profits) would by its terms prevent the United States from
taxing the income. If, however, the resident of Mexico is also a citizen of the United States, the saving clause permits the United States to include the remuneration in the worldwide income of the citizen and subject it to tax under the normal Code rules (i.e., without regard to Code section 894(a)). However, subparagraph 5(a) of this Article preserves the benefits of special foreign tax credit rules applicable to the U.S. taxation of certain U.S. income of its citizens resident in Mexico. See paragraph 4 of Article 24 (Relief from Double Taxation).

For purposes of the saving clause, “residence” is determined under Article 4 (Residence). Thus, an individual who is a U.S. resident under the Internal Revenue Code but who is deemed to be a resident of Mexico under the tie-breaker rules of Article 4 would be subject to U.S. tax only to the extent permitted by the Convention. For example, if an individual who is not a U.S. citizen is a resident of the United States under the Code, and is also a resident of Mexico under its law, and that individual has a permanent home available to him in Mexico and not in the United States, he would be treated as a resident of Mexico under Article 4 and for purposes of the saving clause. The United States would not be permitted to apply its statutory rules to that person if they are inconsistent with the treaty.

However, the person would be treated as a U.S. resident for U.S. tax purposes other than determining the individual’s U.S. tax liability. For example, in determining under Code section 957 whether a foreign corporation is a controlled foreign corporation, shares in that corporation held by the individual would be considered to be held by a U.S. resident. As a result, other U.S. citizens or residents might be deemed to be United States shareholders of a controlled foreign corporation subject to current inclusion of Subpart F income recognized by the corporation. See
Treas. Reg. section 301.7701(b)-7(a)(3). The application of the saving clause to former citizens and long-term residents is not addressed in paragraph 4, but in paragraphs 6, 7, and 8.

Paragraph 5

Some provisions are intended to provide benefits to citizens and residents even if such benefits do not exist under internal law. Paragraph 5 sets forth certain exceptions to the saving clause that preserve these benefits for citizens and residents of the Contracting States.

Subparagraph (a) lists certain provisions of the Convention that are applicable to all citizens and residents of a Contracting State, despite the general saving clause rule of paragraph 4:

(1) Paragraph 2 of Article 9 (Associated Enterprises) grants the right to a correlative adjustment with respect to income tax due on profits reallocated under Article 9.
(2) Subparagraph 1(b) and paragraph 3 of Article 19 (Pensions, Annuities, Alimony, and Child Support) provide exemptions from source or residence State taxation for certain pension distributions, social security payments and child support.
(3) Article 22 (Exempt Organizations) provides for reciprocal recognition of tax-exempt, charitable organizations resident in a Contracting State and qualifying for benefits of the Convention under paragraph 1(e) or 2 of Article 17 (Limitation on Benefits).
(4) Article 24 (Relief from Double Taxation) confirms the benefit of a credit to citizensand residents of one Contracting State for income taxes paid to the other, even if such a credit may not be available under the Code.
(5) Article 25 (Non-Discrimination) requires one Contracting State to grant national treatment to nationals of the other Contracting State in certain circumstances. Excepting this Article from the saving clause requires, for example, that the United States give such benefits to a national of Mexico even if that person is a citizen of the United States.
(6) Article 26 (Mutual Agreement Procedure) may confer benefits on residents or nationals of the Contracting States. For example, the statute of limitations may be waived for refunds and the competent authorities are permitted to use a definition of a term that differs from the internal law definition. As with the foreign tax credit, these benefits are intended to be granted by a Contracting State to its citizens and residents.

Subparagraph (b) of paragraph 5 provides a different set of exceptions to the saving clause. The benefits referred to are all intended to be granted to temporary residents of a Contracting State (for example, in the case of the United States, holders of non- immigrant visas), but not to citizens or to persons who have acquired permanent residence in that State. If beneficiaries of these provisions travel from one of the Contracting States to the other, and
remain in the other long enough to become residents under its internal law, but do not acquire permanent residence status (i.e., in the U.S. context, they do not become “green card” holders) and are not citizens of that State, the host State will continue to grant these benefits even if they conflict with statutory rules. The benefits preserved by this paragraph are the host country exemptions for the following items: government service salaries and pensions under Article 20 (Government Service); certain income of visiting students or business apprentices under Article 21 (Students); and the income of diplomatic agents and consular officers under Article 28 (Diplomatic Agents and Consular Officers).

Paragraph 6

Under subparagraph (a) of paragraph 6, each Contracting State reserves for a period of ten years its right to tax former citizens and long-term residents whose loss of citizenship or long-term resident status had as one of its principal purposes the avoidance of tax. Thus, the saving clause in paragraph 4 applies to such persons for a period of ten years. In the case of the United States, section 877 of the Code applies to former citizens and long-term residents of the United States whose loss of citizenship or long-term resident status had as one of its principal purposes the avoidance of tax. Under section 877, the United States generally treats an individual as having a principal purpose to avoid tax if either of the following criteria exceed established thresholds: (a) the average annual net income tax of such individual for the period of 5 taxable years ending before the date of the loss of status, or (b) the net worth of such individual as of the date of the loss of status. The thresholds are adjusted annually for inflation. Section 877(c) provides certain exceptions to these presumptions of tax avoidance. Paragraphs 7 and 8 provide similar factors that will be considered in favor of the taxpayer for purposes of determining whether one of the principal purposes of a change in status of a former citizen or long-term resident is the avoidance of tax.
Subparagraph (b) of paragraph 6 defines the term “long-term resident” of a Contracting State as an individual (other than a citizen of that State) who is a lawful permanent resident of that State in at least 8 of the 15 taxable years ending with the taxable year in which the individual ceased to be a long-term resident. In determining whether this threshold is met, the Convention provides that an individual will not be treated as a lawful permanent resident for any year in which the individual is: (1) treated as a resident of the other Contracting State, or as a resident of
any country other than the first-mentioned State under the provisions of any other tax treaty of that Contracting State, and (2) the individual does not waive the benefits of such treaty applicable to residents of the other country. This test is consistent with U.S. law.

Paragraph 7

In the case of an individual who is a former citizen of a Contracting State, a number of factors may be considered by that Contracting State in determining whether or not one of the principal purposes of that individual’s loss of citizenship (“expatriation”) was the avoidance of tax. Paragraph 7 sets forth the following factors which will be considered in favor of the taxpayer for purposes of determining whether a former citizen had a tax avoidance purpose for expatriating: (1) the individual is, at the time of his expatriation, a resident fully liable to tax in the other Contracting State, or becomes a resident fully liable to tax within a reasonable period after his expatriation; and (2) the individual meets one of the following four additional requirements: (a) the individual was a citizen of both Contracting States at birth and has remained a citizen of the other Contracting State; (b) at the time of expatriation (or within a reasonable period thereafter), the individual was or became a citizen of the other Contracting State, and that other Contracting State is the individual’s country of birth, the country of birth of that individual’s spouse, or the country of birth of either of that individual’s parents; (c) in the 10 years prior to expatriation, the individual was present in the Contracting State from which heexpatriated for no more than 30 days in each taxable year or year of assessment; or (d) the individual expatriated before he reached the age of 18 ½ years. This provision is consistent with U.S. law.

Paragraph 8

In the case of an individual who is a former long-term resident of a Contracting State, a number of factors may be considered by that Contracting State in determining whether or not oneof the principal purposes of that individual’s loss of long-term resident status (“expatriation”) was the avoidance of tax. Paragraph 8 sets forth the following factors which will be considered favorably for purposes of determining whether a former long-term resident had a tax avoidance purpose for expatriating: (1) at the time of the individual’s expatriation (or within a reasonable time thereafter) the individual is or becomes a resident fully liable to tax in the other Contracting State and that other Contracting State is the individual’s country of birth, the country of birth of that individual’s spouse, or the country of birth of either of that individual’s parents; (2) in the 10 years prior to expatriation, the individual was present in the Contracting State from which he expatriated for no more than 30 days in each taxable year or year of assessment; or (3) the individual expatriated before he reached the age of 18 ½ years. This provision is consistent with U.S. law.

https://home.treasury.gov/system/files/131/Treaty-Mexico-Pr2-TE-3-5-2003.pdf

The Issue Is Not @CitizenshipTax. The Issue Is Whether The US Can Claim The Tax Residents Of Other Countries As US Tax Residents!

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Introduction – The United States has the “sovereign right” to define who are its “tax residents, but …”

Prologue

There is presently heightened advocacy directed toward the goal of influencing the United States to take action to end (what is described as) U.S. citizenship taxation. Notably this goal is for the purpose of influencing the United States to take action.

Perhaps it would be equally useful to define a separate goal of:

Not allowing the United States to claim the residents of other countries as U.S. tax residents!

Notably this goal would be to engage the governments of other countries!

Ideally both Americans abroad and their countries of residence should seek to stop the United States from reaching into those other countries and claiming the residents of those countries as U.S. tax residents!

In FATCA related discussions it has been common for Government Officials to claim that the United States has the sole right to determine who are its tax residents. Although true, this cannot mean that the United States (or any country) has the right to claim the residents of another country as its tax residents. (The debate is illuminated here and here.)

(Interestingly when the European PETI delegation visited Washington in July of 2022 they made it clear that they did NOT question the right of the United States to define European residents as U.S. tax residents. Rather, they just wanted to find a way to make it easier for European residents to be permitted to have access to bank accounts in the European countries where they live.)

It is appropriate for other countries to accept that the United States has the right (like any country) to define who are U.S. tax residents. It is completely inappropriate for Europeans to accept that the United States has the right to treat European tax residents (who actually live and work in Europe) as U.S. tax residents. By protecting European residents from the United States, European countries would be acting in a manner that is consistent with the OECD tax treaty which anticipates situations of “dual tax residency”. In circumstances of dual tax residency, the model OECD tax treaty (Article 4) provides that the treaty “tie break” will be used to assign tax residency to the country that correlates with the “circumstances of life”. (See page 111 in the document linked to in the previous sentence.) Interestingly, citizenship which absent naturalization, is based on “circumstances of birth” is considered to be the least important criterion under the treaty “tie break”rules.

The treaty tie break rules presumptively assign tax residency based on the “circumstances of life” and not on the “circumstances of birth“.

The bottom line is that, it’s time for the world to simply say:

Of course the United States can define who are its tax residents. But, the United States will NOT be permitted to treat the tax residents of our country (who actually live in our country) to be treated by the U.S. as though they are the tax property of the United States! That is the simple message that must be conveyed!!

Let’s now analyze how the United States goes about claiming the residents of other countries as U.S. taxable property. It’s explained by Mr. Paolo Gentoloni as follows …

Continue reading →

How U.S. Citizenship Tax, The Treaty “Saving Clause” and FATCA Create A Fiscal Prison For Dual Tax Residents

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Introduction – The Problem Of Dual Tax Residency For U.S. Citizens

A “Hell greater than the sum of the parts”

There are people in the world who really don’t understand (or say they don’t) what exactly is the problem with U.S. citizenship based taxation. They claim to not understand why defining “tax residency” based on the “circumstances of birth” rather than the “circumstances of life” is a problem. They fail to consider how taxation based on “circumstances of birth”, interacts with U.S. tax treaties and FATCA to create a “hell that is greater than the sum of the parts”.

This is the third post in a series designed to explore and facilitate the understanding of the U.S. “citizenship based” extra-territorial tax regime. The first post explored the practical meaning of U.S. citizenship-based taxation (it’s primary effects are on people who live outside the U.S.). The second post explored the fact that tax residency based on “citizenship” is tax residency based on the “circumstances of one’s birth” rather than the “circumstances of one’s life” (its effects are primarily based on the circumstance of birth in the U.S.). The conclusion drawn from these first two posts was that the U.S. citizenship based extra-territorial tax regime is one in which:

The circumstance of a U.S. birthplace is used as a justification to regulate the lives of people with no connection to the United States and impose U.S. taxation on income that has no connection to the United States and is received by someone who does not live in the United States.

Citizenship taxation has practical and contextual meaning only its application to tax residents of non-US countries. The U.S. uses the circumstance of a “U.S. birthplace” to reach out and “claim” the tax residents of other countries as U.S. “tax residents”.

The purpose of this post is to explain how the interaction of U.S. citizenship taxation (claiming those with a U.S. birth place as U.S. tax residents when they are tax residents of other countries), the “saving clause” (not allowing U.S. citizens with dual tax residency to assign tax residency to the country where they actually live) and FATCA (the tool to hunt, find and enforce the extraterritorial U.S. tax and regulatory regime on the residents of other countries) creates a whole hell greater than the sum of the parts.

Many people understand the three components of “citizenship taxation”, the “saving clause” and “FATCA” as separate entities. Few appear to understand how those three components interact together to destroy the lives of U.S. citizens with dual tax residency. The U.S. has created a “fiscal prison” for its citizens. Seven video accounts of the impact of the U.S. citizenship tax regime are available here.

This problem can be solved ONLY by the United States redefining its rules for “tax residency” so that “citizenship” (the circumstances of one’s birth”) is not relevant to “tax residency” (the circumstances of one’s life).

This post is to identify the component “Part”(s) of the problem. It is organized in “Sections” and “Parts” as follows:

Section I – How The Problem Was Created

Part A – Tax, Residency and Tax Residency
Part B – The general problem of dual tax residency
Part C – Introducing the treaty tie break and how it can be used to end “dual tax residency” under a relevant Canadian tax treaty”
Part D – The general principles of the U.S. Canada “tax treaty tie break – How “circumstances of life” are used to assign tax residency
Part E – Food for thought – Citizenship the least important factor for the treaty tie break
Part F – Two possible examples of assigning residence to one country by using the “treaty tie break” – Green Card Edition
Part G – U.S. Citizens CANNOT Benefit From The “Tax Treaty Tie Break” – Hello “Saving Clause”
Part H – The “Saving Clause” And The Inability For U.S. Citizens To Use The “Treaty Tie Break” Is How The United States Captures The Residents Of The Treaty Partner Country And Claims Them As U.S. Tax Residents
Part I – The Tax Treaty Tie Break And Implications For U.S. Tax Compliance And For FATCA And The CRS Reporting

Section II – How Dual Tax Residents Experience The Extraterritorial Tax Regime

Part J – The U.S. exports a more punitive from of taxation to tax residents of other countries
Part K – The Problem Of Investing, Retirement planning and Retirement Planning – The Punitive Taxation And Reporting Requirements of PFICs and Foreign Trusts
Part L – The Problem Of Non-U.S. Pensions – How Are They Treated Under The Internal Revenue Code? – Different Rules For Different Countries
Part M – Discouraging U.S. Small Business Abroad – The Treatment Of Small Business Corporations Generally And On A Country By Country Basis
Part N – The “FBAR Marriage”: How Marriage To An Alien Results In Higher Taxation, More Reporting, Difficulties With Asset Transfers, Higher Divorce Costs And Possibly A Requirement To File A Tax Return With As Little As $5 Of Income

Section III – How The U.S. Extraterritorial Tax Regime Attacks The Sovereignty Of Other Countries

Part O – The U.S. taxation of residents of other countries attacks and erodes the tax base of those other countries

Section IV – Solving The Problem: Regulatory And Legislative Solutions

Part P – Regulatory Solution: “A Regulatory Fix For Citizenship Taxation
Part Q – Regulatory Solution: Amending The “Saving Clause” In U.S. Tax Treaties
Part R – Territorial Taxation For U.S. Citizen Individuals
Part S – Redefining U.S. Tax Residency To Move To Residence-based Taxation”

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The Road To Tax Reform For Americans Abroad: Part 2 – What Is US Citizenship Taxation?

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Prologue

In February of 2022, I began a series of posts discussing the problem of U.S. citizenship taxation. That post – The Road To Tax Reform For Americans Abroad: Part 1 – The Problem Is The System And Not The Party – concluded with:

As long as citizenship-based taxation continues and tax laws continue to evolve, whatever political party is in power will – by changing tax laws – continue to damage the lives and finances of Americans abroad.

Individual American Abroad Must Unite To Get This System Of Law Changed

Conclusion for today: The problem is the system! It’s not the political parties.

You have the right to vote. The question is not which party to vote for. The question is how can you most effectively use your vote to end US citizenship-based taxation and encourage FATCA repeal.

Who does citizenship taxation really impact? How does it impact people? What does it actually mean?

The term “citizenship tax” is abstract and meaningless without context. What does it really mean? In this short post I attempt to describe the defining aspect of US tax residency in simple terms.

Bottom line:

The ONLY contextual meaning of taxing based on citizenship is that it allows the US to impose tax on income earned outside the United States by people who live outside the United States.

Here is why …

What exactly is “citizenship taxation”? How/why does citizenship matter? It’s not what the “treaty partner” countries think!

1. Like all countries the United States imposes worldwide taxation on its residents. Individuals living in the United States will meet the “substantial presence” requirements and are therefore taxable on their worldwide income. Citizenship is irrelevant.

2. Like all countries the United States imposes taxation on income sourced in the United States. Generally the United States will have the first right of taxation and has the ability to withhold tax. Citizenship is irrelevant.

3. Like no other country (OK, sort of Eritrea) the United States imposes taxation on the non-US source income of people who do not live in the United States and do live in other countries. The US usually claims this right because those people were “Born In The USA” (making them US citizens). Therefore, the US imposes worldwide taxation on people who live in other countries. Citizenship is relevant because it is why the US claims the right to tax people who don’t live in the US and are residents of other countries.

4. Therefore, the practical meaning of “citizenship taxation” is the United States imposing taxation on the non-US source income earned by people who live in other countries. To be clear: citizenship taxation means that the United States is claiming the residents of OTHER countries as US residents for tax purposes!

5. This means that: Every country in the world who signs a tax treaty with the United States that includes a “saving clause” is agreeing that the United States has the right to tax income earned in the treaty partner country by residents of the treaty partner country. It is obvious that countries signing these treaties have no idea what they are signing. The problem has been further illuminated by the recent US Croatia tax treaty that allows the United States to imposes taxation on Croation residents who ARE and WERE US citizens.

Citizenship taxation is mostly taxation based on the circumstances of birth rather than the circumstances of life!

Citizenship is largely conferred by birth. Sometimes citizenship is conferred because of birth in a country (those born in the USA). Sometimes citizenship is conferred because of the citizenship of your parents (those born abroad to U.S. citizen parents). But, unless you are a naturalized citizen your citizenship is largely determined by the circumstances of your birth. Let’s consider this in the context of U.S. citizenship taxation:

1. Some (but not all) countries (like the USA) confer citizenship based on birth in the country.

2. There are ONLY two countries that make citizens (regardless of their residence) tax residents.

The United States is the ONLY country that does both!!

What is the definition of U.S. citizenship taxation?

US citizenship taxation means that the US can tax the non-US source income of residents of other countries! – because and ONLY because the person was born in the USA or born outside the U.S. to a U.S. citizen parent! You would be surprised how many people fit that definition.

(By the way, this is discrimination based on citizenship resulting from the “circumstances of birth”.)

For Americans abroad to every be free, U.S. citizenship can no longer be relevant to tax residency. The ONLY way that “citizenship taxation” can end is when citizenship is completely severed from tax residency! This means that citizenship is no longer relevant in deciding whether an individual is subject to income taxation.

John Richardson – Follow me on Twitter @Expatriationlaw

Croatia Agrees To Allow The US To Impose Tax, Forms And Penalties On Its US Citizen Residents

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Big News – December 2022

On December 7, 2022 a US Treasury Press Release included:

December 7, 2022

WASHINGTON — In a ceremony held at the U.S. Department of State today, Under Secretary of State for Economic Growth, Energy and the Environment Jose W. Fernandez and Croatia’s Minister of Finance Dr. Marko Primorac signed a comprehensive income tax treaty between the United States and Croatia. The new tax treaty is the first of its kind between the United States and Croatia.

“I am honored to sign the U.S.-Croatia income tax treaty with you today, Finance Minister Primorac,” said Under Secretary Fernandez. “We look forward to taking this monumental step towards further strengthening trade and commercial ties between the United States and Croatia.”

“The Treasury Department is pleased to conclude this new tax treaty with Croatia. It is the first comprehensive tax treaty that the United States has signed in over ten years and reflects our current tax treaty policies and is a milestone in the Treasury’s efforts to expand the U.S. tax treaty network. We appreciate the collaboration Croatia showed throughout the negotiations,” said Lily Batchelder, Assistant Secretary (Tax Policy).

The new tax treaty closely follows the U.S. Model income tax treaty. Key aspects of the new treaty include:

Elimination of withholding taxes on cross-border payments of dividends paid to pension funds and on payments of interest;

Reductions in withholding taxes on cross-border payments of dividends other than those paid to a pension fund, as well as royalties;

Modern anti-abuse provisions intended to prevent instances of non-taxation of income as well as treaty shopping;

Robust dispute resolution mechanisms including mandatory binding arbitration; and Standard provisions for the exchange of information to help the revenue authorities of both nations carry out their duties as tax administrators.

The new tax treaty will enter into force after the United States and Croatia have notified each other that they have completed their requisite domestic procedures, which in the case of the United States refers to the advice and consent to ratification by the U.S. Senate.

The text of the treaty document can be found at: https://home.treasury.gov/system/files/131/Treaty-Croatia-12-7-2022.pdf

Treaty-Croatia-12-7-2022

Of particular note in Treasury’s announcement is:

“The Treasury Department is pleased to conclude this new tax treaty with Croatia. It is the first comprehensive tax treaty that the United States has signed in over ten years and reflects our current tax treaty policies and is a milestone in the Treasury’s efforts to expand the U.S. tax treaty network. We appreciate the collaboration Croatia showed throughout the negotiations,” said Lily Batchelder, Assistant Secretary (Tax Policy).

The new tax treaty closely follows the U.S. Model income tax treaty.

Treasury’s announcement focuses on the mutually beneficial aspects of the US Croatia tax treaty. Notably Treasury’s announcement fails to comment on the inclusion of the enhanced “saving clause” which is identical to the following provision in the 2016 US Model tax treaty.

4. Except to the extent provided in paragraph 5 of this Article, this Convention shall not affect the taxation by a Contracting State of its residents (as determined under Article 4 (Resident)) and its citizens. Notwithstanding the other provisions of this Convention, a former citizen or former long-term resident of a Contracting State may be taxed in accordance with the laws of that Contracting State.

5. The provisions of paragraph 4 of this Article shall not affect:
a) the benefits conferred by a Contracting State under paragraph 3 of Article 7 (Business Profits), paragraph 2 of Article 9 (Associated Enterprises), paragraph 7 of Article 13 (Gains), subparagraph (b) of paragraph 1, paragraphs 2, 3 and 6 of Article 17 (Pensions, Social Security, Annuities, Alimony and Child Support), paragraph 3 of Article 18 (Contributions to Pension Funds), and Articles 23 (Relief From Double Taxation), 24 (Non-Discrimination) and 25 (Mutual Agreement Procedure); and
b) the benefits conferred by a Contracting State under paragraph 1 of Article 18 (Contributions to Pension Funds), and Articles 19 (Government Service), 20 (Students and Trainees) and 27 (Members of Diplomatic Missions and Consular Posts), upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that Contracting State.

This represents a significant expansion of the “saving clause” to allow the US to impose US taxation NOT only on its” residents (as determined under Article 4 (Resident)) and its citizens” but also on “a former citizen or former long-term resident” which are permitted to be subjected to any relevant future provisions of the Internal Revenue Code.

From the perspective of Croatia, the “saving clause” found in Paragraph 4 of Article 1 means:

4. Except to the extent provided in paragraph 5 of this Article, this Treaty shall not affect the taxation by the United States of its residents (as determined under Article 4 (Resident)) and residents of Croatia who happen to be US citizens. Notwithstanding the other provisions of this Convention, a former US citizen or former long-term US Green Card holder who is a resident of Croatia may be taxed by the United States according to the Internal Revenue Code.

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Eroding the tax base of other countries by imposing direct US taxation on the residents of those countries

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This is the fourth of a series of posts about international tax reform generally and how FATCA, CRS, citizenship-based taxation, GILTI, etc. work together.

The first three posts were:

US Tax Treaties Should Reflect The 21st Century And Not The World Of 100 Years Ago

The Pandora Papers, FATCA, CRS And How They Have Combined To Create Tax Haven USA

How The World Should Respond To The US FATCA Driven Attack On The Tax Base Of Other Countries

This fourth post continues where the third post – How The World Should Respond To The US FATCA Driven Attack On The Tax Base Of Other Countries – left off. That post described in a general way that FATCA facilitated the US taxation of residents of other countries. The purpose of this post is to give a small number of important examples. To repeat:

The imposition of FATCA on other countries means that …

The United States has effectively expanded its tax base into other countries by claiming residents of other countries as US tax residents. This is a direct attack on and the erosion of the tax base of those other countries.

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US Tax Treaties Should Reflect The 21st Century And Not The World Of 100 Years Ago

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Prologue

The rules of taxation should follow changes in society. The ordering of society should NOT be hampered by the rules of taxation!

As the world has become more digital, companies can carry on business from any location. Individuals have become more mobile. Multiple citizenships, factual residences and legal tax residencies are not unusual. It has become clear that the rules of international tax as reflected in tax treaties (as they apply to both corporations and individuals) are in need of reform.

The purpose of this post is to identify two specific areas where US tax treaties are rooted in the world as it was one hundred years ago and NOT as it is today.

First: The “Permanent Establishment” clause found in US and OECD tax treaties

Second: US Citizenship-based taxation which the US exports to other countries through the “saving clause” found in almost all US tax treaties

Each of these will be considered.

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Article 4 paragraph 2 of the U.S. U.K. Tax Treaty: A clause preventing the use of the tax treaty tie breaker for some Green Card holders

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Introduction – In The 21st Century The Most Important Thing About A Person Is His Tax Residency

Green Card holders are deemed to be U.S. tax residents under the Internal Revenue Code. In most circumstances, Green Card Holders are also treated as U.S. tax residents under U.S. tax treaties.

U.S. Green Card holders have traditionally been able to use tax treaties to sever “tax residence” with the United States. This decision carries both burdens and benefits and should never be undertaken without competent professional advice. (For Green Card holders who are “long term residents“, the use of a “tax treaty tie breaker” will result in expatriation. Expatriation may trigger the imposition of the Sec. 877A Expatriation Tax.)

The tax treaty tie breaker is available if and only if the individual is, according to the tax treaty, a tax resident of BOTH the United States and the treaty partner country.

Typically the tax treaty tie breaker is a mechanism where one uses the provisions of the tax treaty to assign tax residency to one and only one country according to the tax treaty.

To repeat: a condition precedent to the use of the tax treaty tie breaker is that the individual be a tax resident of both countries according to the tax treaty.

Most tax treaties provide that if an individual is a tax resident of Country A according to domestic law, then the individual is a resident of Country A under the treaty. In other words, tax residency under the terms of the treaty follows from tax residency under domestic law.

Prior to the U.S. U.K. Tax Treaty of July 24, 2001, tax residency for Green Card holders according to the tax treaty, followed from tax residency under domestic law.

The U.S. U.K. Tax Treaty of July 24, 2001 changed this basic rule. The July 24, 2001 tax treaty contains a provision that provides that tax residency under the U.S. U.K. tax treaty, does not necessarily follow from tax residency under U.S. domestic law. Specifically Article 4 Paragraph 2 states that Green Card holders will NOT be treated as U.S. tax residents under the U.S. U.K. Tax treaty except as follows:

2. An individual who is a United States citizen or an alien admitted to the United States
for permanent residence (a “green card” holder) is a resident of the United States only if the
individual has a substantial presence, permanent home or habitual abode in the United States and if that individual is not a resident of a State other than the United Kingdom for the purposes of a double taxation convention between that State and the United Kingdom.

Paragraph 2 of Article 4 provides a presumption against U.S. tax residency, under the tax treaty, for Green Card holders. This results in a situation where the Green Card holder is a U.S. tax resident under the U.S. Internal Revenue Code, but NOT a U.S. tax resident under the treaty.

The purpose of this post is to explore the implications of this unusual provision and how it impacts Green Card holders who are tax residents of the U.K. The post will be divided into the following six parts:

Part A – U.S. U.K. Tax Treaty – Prior to July 24, 2001 (1975)

Part B – The U.S. U.K. Tax Treaty – signed July 24, 2001

Part C – The meaning of the two necessary conditions to qualify as a U.S. tax resident under the treaty: Joint Committee of Taxation Comments on Paragraph 2 of Article 4

Part D – The meaning of the two necessary conditions to qualify as a U.S. tax resident under the treaty: U.S. Treasury Technical Interpretation

Part E – The meaning of Article 4(2) – A UK Perspective

Part F – IRS Commentary – July 3, 2018

Part G – What are the implications for Green Card Holders who are tax residents of the UK?

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Mr. Smyth Goes To Washington: Accidental Americans #FATCA – @ADCSovereignty – @RepHolding bill and More!

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Today I had an interesting conversation with veteran FATCA and citizenship-taxation activist Timothy Smyth. There are few people with his depth of knowledge and insight.
He will be in Washington this week. He is the man in above tweet who deserves your support and funding!
Enjoy the insight in his podcasts

"Savings clause" in US Tax Treaties guarantees US right of taxation on residents and citizens of other nations

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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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