This is the fourth in a series of posts about “treaty based” foreign tax credits. The purpose of this post is NOT to discuss how the foreign tax credit rules work. The purpose is to discuss when a later statute can override an earlier tax treaty. It just so happens that this principle will be discussed in the context of foreign tax credit issues.
(The three previous posts discussed the foreign tax credit rules in the context of the NIIT (“Net Investment Income Tax“). For a description of the first three posts, see the Appendix to this post.)
The governing principle for when a statute can override a tax treaty seems to be that:
1. Generally statutes and treaties are (if possible) to be interpreted to give effect to both.
2. A later statute will override an earlier treaty only when the the statute reflects a clear legislative intent to do override the treaty.
When Can A Statute Override A Tax Treaty?
The principle will be explored in the context of:
A. The Bruyea Case
B. The Section 2801 Regulations Governing Covered Gifts
A. The Bruyea Case
The following in an excerpt from pages 14 – 19 of Judge Solomson’s ruling in Bruyea.
a. The “last-in-time rule” does not apply here
A later-enacted statute controls over a directly conflicting treaty provision. Bell, 169 F.3d at 1386. This is known as the “last-in-time rule.” Kappus, 337 F.3d at 1057 (“When a statute conflicts with a treaty, the later of the two enactments prevails over the earlier under the last-in-time rule.” (discussing Whitney v. Robertson, 124 U.S. 190, 194-95 (1888)); Whitney, 124 U.S. at 195 (“The duty of the courts is to construe and give effect to the latest expression of the sovereign will.”). Moreover, Congress has codified, in 26 U.S.C. § 7852(d)(1), the “last-in-time principle as applied to tax treaties and statutes.” Kappus, 337 F.3d at 1057 (discussing 26 U.S.C. § 7852(d)(1)). Here, the parties do not dispute that the NIIT was enacted after the operative Treaty provisions on which Mr. Bruyea relies to support his claim. But the “last-in-time rule” only has significance if the NIIT indeed conflicts directly with the treaty. The government’s mere talismanic invocation of the “last-in-time rule” does not mean it is applicable or that it resolves the salient question.
Now, Mr. Bruyea concedes that if Congress had enacted a later statute that expressly precluded any foreign tax credit — or any Treaty-based credit — from being applied to the NIIT, such a provision would control over the Treaty, and he would not have a viable claim here. Pl. MSJ at 24 (“Later enacted statutes can override a treaty if Congress intends to do so, but . . . Congress did not intend an override when enacting the NIIT.”). In other words, such a hypothetical statute would control even if the Treaty lacked the U.S. Law Limitation (contained within Art. XXIV, ¶ 1, Clause [2]). That, of course, necessarily means that the U.S. Law Limitation is completely irrelevant to the “last-in-time rule,” which, again, is a background rule that would apply even if the Treaty did not contain the U.S. Law Limitation. We can thus put the U.S. Law Limitation to the side for now and concentrate solely on whether the “last-in-time rule” applies here in some dispositive way.
The first major problem for the government’s argument, according to Mr. Bruyea, is that “[b]ecause there has not been an explicit Congressional override, long-established case law requires that the NIIT and the Canada Treaty should be read harmoniously to give effect to both.” Pl. MSJ at 25. Mr. Bruyea is correct. This Court must attempt to harmonize Treaty and statutory provisions: “Where a treaty and a statute ‘relate to the same subject, the courts will always endeavor to construe them so as to give effect to both, if that can be done without violating the language of either.’” Kappus, 337 F.3d at 1056 (quoting Whitney, 124 U.S. at 194, and citing Xerox Corp., 41 F.3d at 658)).
In Kappus, the United States Court of Appeals for the District of Columbia Circuit declined to attempt to harmonize the Canada Tax Treaty with 26 U.S.C. § 59(a)(2), the statute at issue in that case. 337 F.3d at 1056. There, the D.C. Circuit acknowledged that “[t]he question of whether the Treaty and statute can be harmonized as the government suggests is an extremely close one.” The court concluded, however, that “[i]t is not . . . a question that [the court] need resolve” because the plaintiffs conceded that the Treaty and statute were in “irreconcilable conflict” — indeed, the plaintiffs “contend[ed] that harmonization is not possible” — and the D.C. Circuit found that the statute was last in time. Id.
Mr. Bruyea does not concede the “irreconcilable conflict” point here and he is correct not to do so. Because neither the NIIT nor any other I.R.C. provision expressly precludes the application of the Treaty-based tax credit Mr. Bruyea claims, this Court further agrees with Mr. Bruyea that we can dispense with the “last-in-time rule” on that basis alone. Simply put, the fact that the I.R.C. provides for foreign tax credits only in Chapter 1 does not expressly preclude the Treaty’s serving as an independent source for such a credit against the NIIT (i.e., just because the NIIT is located elsewhere within the I.R.C.).
Again, if Congress, after the Treaty’s ratification, had enacted a provision mandating that “the NIIT shall not be subject to any foreign tax credit,” this case would be over (and decisively so, in favor of the government). But this Court cannot infer such a meaning or result — and read the I.R.C. as if such express language exists — merely because the NIIT was placed in a separate chapter of the IRC. See, e.g., Cook v. United States, 288 U.S. 102, 120 (1933) (“A treaty will not be deemed to have been abrogated or modified by a later statute, unless such purpose on the part of Congress has been clearly expressed.”); Trans World Airlines, Inc. v. Franklin Mint Corp., 466 U.S. 243, 252 (1984) (“There is, first, a firm and obviously sound canon of construction against finding implicit repeal of a treaty in ambiguous congressional action.” (citing Cook, 288 U.S. at 120, amongst other cases)); In re Rath, 402 F.3d 1207, 1219 (Fed. Cir. 2005) (Bryson, J., concurring) (applying Cook).
In Trans World Airlines, the Supreme Court explained that “[l]egislative silence is not sufficient to abrogate a treaty.” 466 U.S. at 252 (citing Weinberger v. Rossi, 456 U.S. 25, 32 (1982)). There, the Supreme Court concluded that “[n]either the legislative histories of the Par Value Modification Acts, the history of the repealing Act, nor the repealing Act itself, make any reference to the [treaty]” at issue in that case. Id. To the contrary, explained the Court, the legislation at issue “was unrelated to the [treaty].” Id. The same is true in this case. The government has pointed to no express textual or extrinsic evidence — literally, nothing — even remotely suggesting that Congress’s placement of the NIIT outside of Chapter 1 was intended to preclude a Treaty-based tax credit. See Def. MSJ at 23-24. Nor does any such evidence likely exist.15
In Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., the Supreme Court contrasted, in the context of a treaty, “an exception to arbitrability grounded in express congressional language” with “a judicially implied exception.” 473 U.S. 614, 639 n.21 (1985) (emphasis added). The Court reasoned that it was “[d]oubtless” that “Congress may specify categories of claims it wishes to reserve for decision by our own courts without contravening this Nation’s obligations under the Convention” at issue in that case. Id. The Court declined, however, “to subvert the spirit of the United States’ accession to the Convention by recognizing subject-matter exceptions where Congress has not expressly directed the courts to do so.” Id. (emphasis added). Here, as in Mitsubishi, there is no express direction for courts to disregard the Treaty-based tax credit Mr. Bruyea claims based on Congress’s having placed the NIIT in its own chapter within the I.R.C. (i.e., outside of Chapter 1).
In sum, there is nothing “expressly” (or even necessarily) inconsistent about the NIIT’s placement and the Treaty-based credit Mr. Bruyea claims in this case. Magone v. Heller, 150 U.S. 70, 74 (1893) (“the adverb ‘expressly,’ in its primary meaning, denotes precision of statement, as opposed to ambiguity, implication, or inference, and is equivalent to ‘in an express manner’ or ‘in direct terms[.]’”); Express, Black’s Law Dictionary (12th ed. 2024) (defining “Express” as “Clearly and unmistakably communicated; stated with directness and clarity.”).16 This Court rejects the government’s argument that “the placement [of the NIIT] is itself an express inconsistency” with the Treaty. Tr. 21:18–19.
The government’s argument, however, is even more ambitious, rejecting the need for any specificity in the later-enacted provision to overrule the Treaty. According to the government, the general rule that “a Congressional intention to modify a treaty by statute must be clearly expressed” does not apply to tax cases; rather, the government asserts, “a different standard applies under the [Internal Revenue] Code.” Def. MSJ at 42 n.20. In particular, the government points to 26 U.S.C. § 7852(d)(1), which provides that “[f]or purposes of determining the relationship between a provision of a treaty and any law of the United States affecting revenue, neither the treaty nor the law shall have preferential status by reason of its being treaty or law.”17 The government thus asserts that “treaties have no preferential status over tax statutes, and there need be no explicit statement of Congressional intent that the Code will prevail in case of conflict with a treaty.” Def. MSJ at 42 n.20 (citing S. Rep. No. 100-445 at 325-26 (1988)).
The government cannot get the mileage out of 26 U.S.C. § 7852(d)(1) it desires. As the D.C. Circuit recognized — citing the same Senate Report as the government here — “this provision was intended to codify the last-in-time principle as applied to tax treaties and statutes.” Kappus, 337 F.3d at 1057. And, indeed, that is all the statute’s plain language accomplishes. The government is wrong; tax statutes aren’t different than other statutes vis-à-vis treaties.
To be clear, neither this Court nor Mr. Bruyea takes any issue with the “last-in- time” principle in general. The question is simply whether it applies here. The Court continues to answer that question in the negative. Because 26 U.S.C. § 7852(d)(1) does nothing more than codify the “last-in-time rule,” as the D.C. Circuit recognized, the statute itself does nothing more than beg the question whether there is, in fact, a necessary conflict between the NIIT statute, on the one hand, and the Treaty, on the other. The government answers that question in the affirmative based on the NIIT’s placement — and despite any textual evidence that its placement in Chapter 2A was intended to defeat the Treaty-based tax credit. Mr. Bruyea, in contrast, correctly points to the general rule that this Court should not manufacture a conflict between the statute and the Treaty by implication. That is precisely what this Court established infra, and 26 U.S.C. § 7852(d)(1) does not change this Court’s analysis.
Kappus further demonstrates why the government is flat wrong. In that case, I.R.C. § 59(a)(2) — the tax statute at issue that conflicted with the Treaty — was subject to yet another TAMRA provision that specified that § 59(a)(2) was “intended to apply notwithstanding any inconsistent treaty obligations[.]” 337 F.3d at 1057 (discussing TAMRA, § 1012(aa)(2), codified at 26 U.S.C. § 861 note, and citing S. Rep. No. 100-45 at 319). According to the D.C. Circuit, “TAMRA thus made it crystal clear that Congress intended [§ 59(a)(2)] to supercede any preexisting treaty obligation with which it conflict[s].” Id. at 1058. Here, in contrast, the Treaty and the NIIT statute may be harmonized and, relatedly, there is no similar “crystal clear” congressional language like that in Kappus, indicating that the NIIT’s placement was designed to “supercede” a Treaty-based tax credit.
Finally, if the government were correct that 26 U.S.C. § 7852(d)(1) somehow vitiates the Supreme Court’s instruction that “a Congressional intention to modify a treaty by statute must be clearly expressed[,]” Def. MSJ at 42 n.20, we would expect to see some clear authority to that effect. The government notably quotes no language from the Senate Report or any case law so holding. And that is because there is no support for the government’s assertion. To the contrary, the D.C. Circuit in Kappus recognized — as does this Court — the continued vitality of the Supreme Court’s general rule that “statutes and treaties should be harmonized if possible,” even in tax cases. Kappus, 337 F.3d at 1059 n.7 (citing Whitney, 124 U.S. at 194, and the Federal Circuit’s decision in Xerox Corp., 41 F.3d at 658). Indeed, the D.C. Circuit instructed that “[t]he best way to harmonize § 59(a)(2) with [later-enacted] protocols [amending the Treaty] is to assume the latter were not intended to repeal the former.” Id. (emphasis added). And that is precisely how this Court approaches the NIIT. Moreover, this Court again notes that, quite unlike the plaintiffs in Kappus, Mr. Bruyea does not concede a conflict between the Treaty and a statute. Nor, for that matter, does the government point to language — “crystal clear,” id. at 1058, or otherwise — making a conflict between the Treaty and the NIIT “irreconcilable,” id. at 1056, or making them “absolutely incompatible,” id. at 1059.
To side with the government, this Court would have to disregard the FederalCircuit’s instruction in Xerox Corp. that “unless it is impossible to do so, treaty and law must stand together in harmony.” Kappus, 337 F.3d at 1059 n.6 (quoting Xerox Corp., 41 F.3d at 658). This Court has done its best to implement that instruction and the result favors Mr. Bruyea.
B. The Section 2801 Regulations Governing Covered Gifts
The proposed regulations do not address the effect of estate and gift tax treaties on the section 2801 tax, except to explicitly state in several examples that the covered expatriate in the example resides in a non-treaty country. Several comments request guidance on the application of estate and gift tax treaties to section 2801 when a gift or bequest is made by a covered expatriate domiciled in a treaty country. One comment requests that the final regulations provide that section 2801 does not apply to property transfers by covered expatriates domiciled in a treaty country.
Neither the statutory language nor the legislative history of section 2801 provides any indication of Congressional intent concerning the effect of existing estate and gift treaties on the application of section 2801. In the absence of specific language overriding treaties, statutes generally are to work in harmony with existing treaties but, with the exception of certain treaty obligations in effect on August 16, 1954, neither the treaty nor the statute has preferential status. See section 7852(d). The U.S. currently has estate and gift tax treaties with Australia, Austria, Denmark, France, Germany, Japan, and the United Kingdom and estate tax-only treaties with Finland, Greece, Ireland, Italy, the Netherlands, South Africa, and Switzerland. There are also estate tax provisions in the U.S.-Canada income tax treaty. The effect of a particular treaty on the application of section 2801 to a gift or bequest by a covered expatriate in a treaty country must be evaluated on a case-by-case basis when a particular transfer falls within the reach of both section 2801 and an estate or gift tax treaty. Any unresolved issue at that time as to the effect of a particular treaty may be elevated under the competent authority procedures. In view of the above, the final regulations do not include guidance on the effect of existing gift and estate tax treaties on the application of section 2801.
A PDF version of the 2801 Regulations is here:
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Appendix – The First Three Posts …
The first post detailed the provisions of the U.S. France tax treaty which created the “three bite rule”. By creating the “three bite rule” the U.S. France treaty was used to create a treaty based foreign tax credit.
The second post (also based on the U.S. France tax treaty) described how the U.S. France tax treaty was used to create an independent treaty based foreign tax credit. The purpose was to allow for a foreign tax credit against the NIIT (“Net Investment Income Tax”). Although a major breakthrough, it’s important to note that this case (Christensen):
1. Found that the treaty should be interpreted to create an a foreign tax credit that was independent of the credits allowed under the Internal Revenue Code;
2. Specifically ruled that the language “subject to the limitations of the law of the United States” (found in the opening paragraph of the double taxation clause) should be interpreted to preclude a foreign tax credit for payment of foreign tax on foreign investment income.
The third post continued the “NIIT Tax Treaty Chronicles”. Specifically, this post detailed how Judge Solomson, in the case of Paul Bruyea, determined that (contrary to Judge Blank’s ruling in Christensen) that the “subject to the limitations of the law of the United States”clause in Article XXIV, Paragraph 1:
1. Does NOT preclude the use of a foreign tax credit to offset the NIIT; and
2. That Article XXIV, Paragraph 1 allows a U.S. citizen or U.S. resident living in Canada to use taxes paid to Canada as a credit against the U.S. NIIT!
Judge Blank in Christensen and Judge Solomson in Bruyea reached opposite conclusions with respect to whether the following clause (as represented in the 2016 U.S. Model Tax Treaty) can be used to create a foreign tax credit which is independent of the foreign tax credit rules in the Internal Revenue Code (Sections 27, 901 and 904).
Article 23
RELIEF FROM DOUBLE TAXATION
1. In the case of __________, double taxation will be relieved as follows:
2. 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 resident or citizen of the United States as a credit against the United States tax on income applicable to residents and citizens:
a) the income tax paid or accrued to __________ by or on behalf of such resident or citizen; and
Therefore, I expect that this issue has NOT been fully resolved.
Judge Solomson’s decision in Bruyea is a very exciting decision. It goes FAR beyond the decision in Christensen and opens the door to arguing that many (if not all) U.S. treaties guarantee that the NIIT can be offset by foreign tax credits!!