The U.S.’ tax treaty with the Netherlands has an unusual provision in its “saving clause”: taxes on former U.S. Persons in the Netherlands cannot be imposed on Dutch citizens, only on non-citizens. Unfortunately, today this provision makes little difference, because the expatriation tax occurs on the day before expatriation, when you are not yet a former U.S. Person.
However, back in 2004, the expatriation tax was imposed for ten years after expatriation, meaning this provision indeed shielded Dutch citizens from the U.S. expatriation tax. So when Washington and The Hague negotiated a new protocol to their tax treaty, Congress expressed unhappiness that this provision was retained. In response, Treasury pointed out to them:
The provision in the U.S.-Netherlands treaty is not expected to produce significantly different results than would be provided under section 877 in practice. As described above, the special tax treatment provided in section 877 applies only in the case of individuals whose relinquishment of U.S. citizenship or long-term resident status had a principal purpose of tax avoidance.
Because the Netherlands imposes substantial tax on individuals who are resident there (and only resident individuals who are subject to Netherlands tax are eligible for the benefits of the U.S.-Netherlands tax treaty, including the provision that limits the imposition of U.S. tax), individuals who are trying to avoid tax are unlikely to become residents of the Netherlands.
About ten years ago, Congress was — once again — pounding the drum about Americans abroad “fleeing the country” and “not paying their fair share”. As mentioned last time, this led to various attempts to tighten the expatriation tax provisions, including significant bipartisan support in the Senate (though not in the House) for banishment of former citizens who had tax compliance issues. It was against this background that the U.S. began negotiating its new protocol to the tax treaty with the Netherlands.
U.S. tax treaties normally result in the avoidance of double taxation (and sometimes even single taxation) for corporations, but the imposition of double taxation on human beings, thanks to the “saving clause” which says the U.S. may tax “its own” citizens (including non-resident dual citizens and even former citizens) as if the treaty did not exist. However, the Netherlands insisted in 1993 that former U.S. citizens who were Dutch residents and citizens be protected from the saving clause. For lack of a better name, I’ll call this “the Dutch saving clause”.
As far as I can see, the “Dutch saving clause” was not an object of controversy when it was first introduced in 1993. The State Department, in its letter of submittal to the president, did not consider it important enough to highlight. During the Senate Committee on Foreign Relations’ 1993 tax treaty hearings, nearly all of the testimony about the tax treaty with the Netherlands focused on corporate “treaty shopping”, and no one brought up individual taxation. There was the same lacuna in the academic discussions I found.
However, after the new negotiations in 2004 the Joint Committee on Taxation suddenly became unhappy with that Dutch saving clause, and then-Senator Joe Biden wrote to Treasury to tell them so. Barbara Angus at Treasury had the task of responding to Biden, and wrote the passage quoted above; she has since moved on to the private sector, where she keeps herself busy telling people how great FATCA is. Yet even a FATCA fanatic like her recognises that there’s nothing objectionable whatsoever about the Dutch saving clause.
Under Article 3, the U.S.–Netherlands tax treaty only applies to “the part of the Kingdom of the Netherlands that is situated in Europe”, not to Curaçao, Aruba, or the other territories making up what was known back in 2004 as the Netherlands Antilles. Despite that, I’d bet that at least some of the Joint Committee on Taxation members probably thought that the “Dutch saving clause” was a giant loophole through which thousands of American billionaires would slip out to Caribbean tax havens.
Why this provision exists
Later on in her letter to Biden, Angus mentioned why the Netherlands had insisted on this treaty provision:
Indeed, pursuant to section 877, the Internal Revenue Service has issued rulings in cases involving Netherlands nationals who relinquished U.S. citizenship or long-term resident status in order to return to the Netherlands, concluding that the individuals did not have a principal motive of tax avoidance and therefore were not subject to the special tax rules provided in section 877. Moreover, because section 877 requires the United States to provide a credit against U.S. tax for tax paid in the country of residence, the application of section 877 to a resident of the Netherlands is unlikely to result in significant U.S. tax (given the substantial tax imposed by the Netherlands on the income of individuals who are resident there).
Although the Netherlands agreed to the application of the special rules of section 877 to residents of the Netherlands who are former U.S. citizens or long-term residents, for a period of 10 years when loss of U.S. citizenship or long-term resident status had as one of its principal purposes the avoidance of U.S. income tax, the exception for Netherlands nationals contained in the 1993 treaty (and continued in the proposed protocol) was important to the Netherlands. This position reflects the underlying view that the special tax rules applicable in the case of tax-avoidance motivated changes in citizenship or residence should not be applicable in cases where the move is to go home. As noted above, the rules of section 877 and the exceptions contained therein reflect a similar perspective.
Obviously, the Netherlands is not the only country whose citizens live in the U.S. temporarily before deciding to return home. Also, as I’ll explore in more detail below, the “Dutch saving clause” did not just protect native Dutch people returning home, but also American immigrants to the Netherlands. Many other countries accept American immigrants too, and nearly every country in the OECD has higher taxes than the United States. Yet none of the U.S.’ other treaty “partners” ever responded to these obvious facts by drawing a line in the sand to protect their citizens and the immigrants who came to their country in good faith with the intention of settlement and integration.
This is a disappointing moral failure all around. I can understand why, for example, my own home Hong Kong might have been unable to get a provision like this included if we’d negotiated a tax treaty with the United States back then, but why not Canada or France or the United Kingdom or Germany? And what possible basis could the United States have had to object if those countries had asked for such a provision?
The text of the provision
The treaty provision in question, Article 24(1), reads:
Notwithstanding any provision of the Convention except paragraph 2, each of the States may tax its residents and nationals as if the Convention had not come into effect. For this purpose, as regards the United States, the term national shall include a former citizen or long–term resident, not being a national of the Netherlands, whose loss of such United States status has as one of its principal purposes the avoidance of income tax, but only for a period of 10 years following such loss.
As mentioned above, the bolded portion — the cause of all the earlier controversy — doesn’t actually do what it was intended to anymore. The U.S. made sure of that a few years after they signed the treaty.
Back in 2004, the U.S. expatriation tax still consisted of 10 years of continued taxation on U.S.-source income, and so the part in bold actually had some effect. As Angus noted, Dutch/Americans who had been dual citizens at birth were already exempt from covered expatriate status under § 877. However, the Dutch saving clause also protected Americans who naturalised in the Netherlands, as well as Dutch green card holders moving back home (if they knew enough to explicitly abandon their green cards by filing Form I-407). Even if they met the asset, tax threshold, or missing paperwork tests of § 877(a)(2) and thus became covered expatriates, the U.S. could not impose tax on them after they gave up U.S. status, since they always were or had just become Dutch citizens.
Unfortunately, Washington outmanoeuvred The Hague — as well as all treaty partners who had not yet succumbed to the U.S.’ efforts to define the term “U.S. citizen” to include a former citizen — with the passage of the 2008 HEART Act. That act changed the timing of the expatriation tax from 10 years after the event of expatriation, to one big chunk the day before it — a day when the “Dutch saving clause” does not yet protect them from U.S. taxation, even if they are already Dutch citizens on that day.
The Dutch saving clause isn’t a totally dead letter — for example, it would have operated to protect American emigrants to the Netherlands from the tax consequences of Chuck Schumer’s Ex-PATRIOT Act. Unfortunately, I don’t believe it can protect them from immigration law consequences predicated on tax status. In simpler terms: covered expatriates are still covered expatriates even if the tax treaty protects them from the expatriation tax, and if the immigration law banishes covered expatriates, the tax treaty could not help them.
Bad faith treaty negotiations
The “Dutch saving clause” is part of a treaty. The general purpose of the treaty is the “prevention of double taxation”, and the specific purpose of that clause, as the U.S. government itself admitted, is that “the special tax rules applicable in the case of tax-avoidance motivated changes in citizenship or residence should not be applicable in cases where the move is to go home”. Subsequent to the treaty, the U.S. — by passing the HEART ACT — took an action explicitly aimed at defeating the object and purpose of the treaty: modifying an existing tax provision whose effect of double taxation had been ameliorated by the treaty, and replacing it with a new tax provision designed to cause double taxation in a way that the treaty could not mitigate.
This should have been a giant lesson to all countries seeking to negotiate tax treaties or non-treaty executive agreements with the U.S.: Washington comes to the table with bad faith firmly planted in its mind, particularly on the topic of taxation of U.S. Persons abroad. Unfortunately, it looks like the people who should have been paying attention weren’t — even in the Netherlands, let alone other countries.