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.
General background
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.
@Ann1
“the banks are sure that no matter what they do to comply, the 30% will be withheld by the US”
For now, it is the expats who are suffering. When will the level of suffering affect so many many people, that they are willing to take a stand? First it is the expats who are fleeced, Then the banks. Then the general population because the treasuries of their countries are being diminished. It just goes on and on. And one wonders where does the money go? Who is actually helped by this? All into a big black hole of debt.
I think the whole world should have held together and not accepted FATCA. But only when they too feel the pain might they perhaps say no – and enough of this exploitation?
@Ann1
What’s really ironic is that FFIs who are deemed compliant under an IGA have nothing to fear. If they don’t report some “US persons” which, according to their regulations, should have been reported there will be absolutely no consequences for them. The IRS will have no idea that anything is missing (because the FFI didn’t report – duh!). Their behaviour is completely irrational.
@Shadow Raider
Well said. Thank you. Your statements enlightened me and clarified my reasoning. Very, very important to differentiate between the notion of benefit and right.
IMO this paints an incomplete picture. Canadian citizens abroad pay Canadian taxes on their world-wide income unless they sever tax residency. Part of severing tax residency means one must be subject to the “departure tax”. The Canadian “departure tax” is similar to the US “exit tax” with one difference being that the “departure tax” does not have an exclusion (AFAIK).
So, it is possible for Canadians abroad to not be subject to Canadian taxes on their world-wide income, but it does involve a one-time hit that can range from $0 to very large.
FWIW, I have an acquaintance who worked (and mainly lived) in the US for several years while his family remained in Canada. He filed both US and Canadian taxes.
[I’ve read that the US modelled it’s “exit tax” on Canada’s “departure tax”.]
tdott Sorry there is little to compare Canada’s departure tax to US exit tax.
Canada’s applies when you leave the country and take assets with you. Since capital gains on those assets were untaxed until that point, they are taxed as capital gains when you leave. This was to prevent the wealthiest families ( Bromfmans etc.) from earning a pile in Canada and then transferring assets tax free to the Bahamas.
The US tax applies if you give up citizenship even if not a nickel to buy the assets was earned in the US.
I don’t think Canada’s departure tax depends on whether one takes the assets out of Canada or even if there is an actual sale. It is a “deemed disposition” as of the date of departure and gains are taxed as of that date. If one chooses to not actually sell those assets they receive a new cost basis which is the valuation as of the date the departure tax is paid. This is simply a collection of tax which has been deferred up to the date of departure.
The Canadian tax code allows many ways to defer tax. If one remains a Canada taxpayer those taxes will eventually be paid some time in the future. If one wishes to exit the Canadian tax system, all the CRA is asking is that the deferred tax be paid up to the date of departure because that is the last chance the CRA will ever have to tax those accrued gains. Seems fair enough to me.
If one wishes to exit the Canadian system there is even a way to avoid paying the departure tax by “pledging” enough of the assets to cover the departure tax that would be owing. This might be useful for someone who wanted to leave Canada for a few years, not bother with Canadian filings, but intends to eventually return and reenter the Canadian system. The Canadian system allows plenty of flexibility.
For example, a taxpayer could choose to continue filing Canadian taxes for a year or two after leaving and pay that departure tax when they are in a lower tax bracket.
Canada’s system seems equitable and reasonable to me; the US exit tax, on the other hand, is punishment pure and simple.
@Duke of Devon
I disagree. IMO they are quite similar. Giving up US citizenship is how one severs tax residency with the US. Canada allows you to sever tax residency in a much more civilized manner. However, in both cases what you are doing is severing tax residency so that you are no longer subject to Canadian or US taxes. And, in both case, you are subject to a tax based on your unrealized capital gains (among other things).
Replace “give up citizenship” with “sever tax residency” and the same applies to Canada. E.g., Canadian Joe Blow moves from Canada to the US, does not sever tax residency (for whatever reason), buys stock (US or Canadian) with his US earned dollars. Stock doubles in value over the course of some years. Mr Blow finally decides to sever his tax residency with Canada. At that point, Joe Blow is subject to the “departure tax” and will pay Canada capital gains tax on the increase in value of the stock. If Joe Blow had maintained tax residency, Canada would have taxed the stock’s capital gains at the time of sale (perhaps after the US took the first bite). Since he is severing tax residency, Canada takes its last shot to recoup those deferred taxes.
One can certainly argue that Joe Blow should have severed tax residency at the time he made the move. But for whatever reason (ignorance, negligence, thought he would just stay for 6 months), he didn’t. And so, he’s subject to a tax on assets he bought with money he earned while living in the US.
That is my understanding of the Canadian departure tax. If that understanding is incorrect (IANAL, IANAA), I would actually welcome being shown why.
I suspect that should the CRA start really enforcing tax residency, we’ll see people finding themselves either owing back taxes (if they had not been filing, but want to maintain tax residency) or owing the departure tax. In this regard, FATCA/GATCA *could* as some point make a difference to Canadians abroad.
@maz57
Do you consider the US exit tax to be punishment because it requires one to give up their US citizenship in order to sever tax residency, or is it something else (more)?
If the former, the root of the evil is actually (as it seemingly always is) CBT, and you won’t get an argument from me. If the latter could you elaborate?
Ann#1 You have a fairly clear case for relinquishment. Canadiangirl403 just received her CLN based on government employment. Taking another citizenship is a very strong case, particularly when you do nothing afterward such as getting a US passport to make them think you did not relinquish. It is hard for them to argue intent and they have to look at the evidence of your actions since getting Canadian citizenship. Please think carefully, those lucky enough to have a pre dated relinquishment claim do not have to jump through the hoops to get a SSN, pay a fee to renounce or enter into the nasty US tax system.
@BC_Doc, I think you mentioned that you had Canadian born kids who sadly are infected as USC even though you have RELINQUISHED.
If they have not yet been registered as Irish, let them register themselves as Irish when they are 18.
That will be a relinquishing act under 8 USC and 7 FAM.
They might not want to get a US CLN but they would have a legit relinquishing act just in case someone looked beyond their Canadian birthplace.
Cheers
@Brockers that are accidental Americans.
If you have an Irish grandparent you can register as Irish and that will be a relinquishing act.
@tdott. I don’t claim to be an expert on either the US exit tax or the Canadian departure tax but consider this: If a US person who has possibly never even lived in the US grows weary of filing US returns and US control over their financial life the only way they can get off the merry-go-round is to renounce US citizenship thereby exposing themselves to US exit tax. The US exit tax carries a special CG rate of (I believe) 30%. There is a large exemption (the first 600k of gain?) but for a wealthier person it could get expensive. Someone who owns a house in a major metropolitan area could be looking at substantial exit tax. That would be pretty punishing.
For a Canadian who has never lived in Canada the Canadian departure tax doesn’t apply because they have never been a Canadian taxpayer. For one who HAS lived in Canada the departure tax is calculated in normal fashion (only 50% of the gain is taxable at whatever marginal rate applies). A large gain on a personal residence doesn’t count. Either way, you keep Canadian citizenship.
@George I obtained Irish citizenship via my grandparents. While my kids can obtain it through me, I would have to apply before they turn age 18 so the US, I believe, wouldn’t consider it to be an expatriating act (too young at the time). Thank you for putting that out there though! All the best, BC_Doc
@Shadow Raider
I would take the “right” of voting one step further and say it’s an obligation. An obligation is not a benefit either, just as the obligation of a parent to feed one’s children could not be construed as a benefit. The State Department in its determination voting that disqualifies someone from the ability to relinquish is not because it benefits a citizen, but demonstrates that the citizen has accepted the responsibility of citizenship by voting.
@maz57
Fair enough. One question/quibble, I couldn’t find a reference to the special CG rate of 30%. Could you be thinking of the rate applied to “specified tax-deferred accounts”, “deferred compensation”, and “nongrantor trusts”? AFAICT, the usual tax rates apply to short- and long-term capital gains, with the maximum long-term rate being 23.8% (20% + 3.8% NIIT). [Not entirely sure if there is a max rate or it’s one-size-fits-all]
See Phil Hodgen’s “Exit Tax” book where he talks about this. See chapters (really sections, they’re tiny) 5,6,7,8 at
http://hodgen.com/httphodgen-comchapter-1-a-quf-the-exit-tax-%E2%80%8E/
At any rate, I totally agree that treatment is significantly different for the Canadian who never lived in Canada vs the USC who never lived in the US. This is a terrible side-effect of CBT. If the US didn’t have CBT (and if pigs could fly), then the treatment would be similar.
@ BC_Doc I was looking at the Irish citizenship site. My grandfather was Irish. I don’t think there is an age limit, the key is that you held the Irish citizenship before your children were born. They can apply anytime after they become adults, there is no age requirement that I can see. In fact you can keep the Irish citizenship by descent going by having every generation apply prior to the next generation being born.
http://www.citizensinformation.ie/en/moving_country/irish_citizenship/irish_citizenship_through_birth_or_descent.html
@heartsick– Thank you very much! I plan on helping my 19 year old daughter fill out the paperwork when she comes home from university this week. Again, for her, there is absolutely no down side to exercising her right to Irish citizenship. She’ll be welcome to work and live in the Republic should she choose to do so. By extension, she’ll also have a door open to the EU. Compare and contrast that with a Canadian holding US citizenship…
@ BC_Doc A citizenship that has benefits, imagine that. Certainly not like the toxic US one, that we are stuck with. Be sure to document her intention to give up the US citizenship. The costs have to be less than renouncing.
An American-German woman, who was falsely convicted of murdering her child and was on death row in Arizona for 22 years prior to having the conviction overturned last month, told Spiegel that she will be re-settling to Germany in August:
http://www.spiegel.de/panorama/justiz/debbie-milke-spricht-ueber-ihre-torturen-in-us-haft-in-arizona-a-1026995.html
Germany has higher taxes than the US so there must be other reasons for re-settling.
heartsick says
December 13, 2014 at 9:26 pm
@ BC_Doc I was looking at the Irish citizenship site. My grandfather was Irish. I don’t think there is an age limit, the key is that you held the Irish citizenship before your children were born. They can apply anytime after they become adults, there is no age requirement that I can see. In fact you can keep the Irish citizenship by descent going by having every generation apply prior to the next generation being born.
http://www.citizensinformation.ie/en/moving_country/irish_citizenship/irish_citizenship_through_birth_or_descent.html
@heartsick Four Irish citizenship certificates arrived in the mail today– one for each of my children, including my adult daughter. Thank you again!
@heartsick. Each of my four grandparents came off the boat from Ireland to America. I claimed my Irish citizenship through my grandfather back in 1990. Despite emmigrating to the US in his early 20s and naturalizing as a US citizen then living another 60+ years in the US, he was able to retain his Irish citizenship without the least bit of difficulty and them pass it on indirectly to his great grandchildren. Contrast this with the US– I was born and raised there but forced to nuke my nationality.