This post should be construed as an information bulletin. It is not to be construed as practical advice, legal advice, moral advice, retirement planning advice or any other kind of advice. If you feel that you need professional advice then you should go and get it. This post contains the following five parts:
Part 1 – A reminder of what the transition tax is and what it (according to the tax professionals) requires you to do
Part 2 – A statement of part of the Canada U.S. Tax Treaty that you might find to be of relevance
Part 3 – Confirmation from the Department of Finance that the Canada Revenue Agency will not assist the IRS in collecting the "transition tax" on Canadian citizens
Part 4 – It is likely that the same situation would also apply to citizens of France, Sweden, Netherlands and Denmark
Part 5 – Residents of countries other than France, Sweden, Netherlands, Denmark and Canada
Again, this post is an information bulletin and is NOT to be construed as providing any form or advice.
There have been a large number of Brock posts devoted to the "transition tax".
For example:
Part 1 – A reminder of what the transition tax is and what it (according to the tax professionals) requires you to do
This is written on the assumption that the transition tax applies to your situation and that there are no reasonable arguments (including tax treaty arguments) to the effect that the tax does NOT apply.
If you as a “U.S. citizen or Green Card Holder” own 10% or more of the shares of a non-U.S. corporation (Canadian Controlled Private Corporation for example) AND more than 50% of the shares of the corporation are owned collectively by “U.S. citizens or Green Card Holders” then you are required to pay the IRS approximately 17.5% of the undistributed/retained earnings of the corporation. This is at a rate of 17,500 per $100,000 of retained earnings. There are some additional “twists and turns”, but that is the idea.
Please note that these “undistributed earnings” were NOT subject to U.S. tax when they were earned. Furthermore, this 17.5% levy is triggered simply by having “undistributed earnings” and NOT by any kind of normal taxable event.
For many Canadians, the undistributed earnings in their Canadian Controlled Private Corporations are “in effect” their pension plans. Therefore, for many Canadians, the appropriate characterization of this tax is that:
The United States is confiscating your pensions that were earned in Canada and will be taxed a second time in Canada.
Furthermore, some people would not have the money to pay this “tax”. As a result, some people are both retired and are mortgaging their homes in order to turn their retirement savings over to the IRS.
A possible opportunity for “Green Card Holders”
Green Card Holders may want to discuss with their advisors whether there are any “elections” they could make which might allow them to avoid this tax.
Those who pay a first installment by June 15, 2018 will have the opportunity to pay this tax over an 8 year period.
Part 2 – A statement of part of the Canada U.S. Tax Treaty that you might find to be of relevance
Here is the link to the Canada U.S. Tax Treaty:
https://www.fin.gc.ca/treaties-conventions/unitedstates-etatunis-eng.asp
Paragraph 8 of Article XXVI A includes:
8. No assistance shall be provided under this Article for a revenue claim in respect of a taxpayer to the extent that the taxpayer can demonstrate that
(a) where the taxpayer is an individual, the revenue claim relates either to a taxable period in which the taxpayer was a citizen of the requested State or, if the taxpayer became a citizen of the requested State at any time before November 9, 1995 and is such a citizen at the time the applicant State applies for collection of the claim, to a taxable period that ended before November 9, 1995;
This means that pursuant to the clear language in the tax treaty, the Canada Revenue Agency will NOT assist the IRS in collecting this tax (provided that you meet the requirements of Canadian citizenship).
Please note that this does NOT mean that you don’t owe the U.S. tax. It’s just the IRS cannot ask Canada to assist in collecting this tax for the United States. Because you (may) owe this tax, it is possible that the IRS could collect the tax by seizing assets under U.S. jurisdiction (in the USA, etc.).
Furthermore, I repeat:
The fact that the Canada Revenue Agency “shall” not assist with collection does NOT mean that the tax is not owed – just that Canada will not collect.
Part 3 – Confirmation from the Department of Finance that the Canada Revenue Agency will not assist the IRS in collecting the “transition tax” on Canadian citizens
Today a Canadian Citizen living in Canada, who believes that he/she may be subject to the “transition tax”, received a letter from the Department of Finance confirming that Canada will NOT assist the IRS in collecting this tax.
The letter also makes the following three assertions:
About U.S. tax jurisdiction
1. the United States has the right to impose taxes on U.S. citizens as a principle of U.S. tax policy;
2. Canada had agreed under the U.S. Canada Tax Treaty that the United States can impose U.S. taxation on Canadian residents who are U.S. citizens (this is a VERY revealing assertion – think of it Canada has agreed to allow the USA to impose taxation on Canadian resident/citizens);
About how to interpret U.S. tax law – way above their “pay grade”
3. That the U.S. transition tax does apply to those Canadian residents who the U.S. views as it citizens (I find this particularly offensive. It’s one thing to concede U.S. tax jurisdiction. It’s quite another to say that the “transition tax” should be interpreted to apply in the specific way that it does. But, hey with friends of like “Justin and Morneau”, who needs enemies?
The letter is here:
Part 4 – It is likely that the same situation would also apply to citizens of France, Sweden, Netherlands and Denmark
A recent post here on the Isaac Brock Society confirmed that France, Sweden, Netherlands and Denmark have the same kind of tax treaty that Canada has. Citizens of those countries may find this information to be helpful.
That said, you must read the express terms of the tax treaty in your country! I have NOT read your specific treaty! You must do that yourselves and determine what it says and does not say.
Part 5 – Residents of countries other than France, Sweden, Netherlands, Denmark and Canada
In all probability you would begin with the “revenue rule”, but see the comment here.
There is no reason to think that the IRS can seize assets located outside the United States. It’s just that the citizens of Canada, France, Sweden, Netherlands and Denmark seem to have better treaty protections.
In conclusion:
Again, this post does not constitute advice of any kind. It is for informational purposes only. I emphasize again:
This particular provision of the tax treaty has no bearing on whether you actually owe the “transition tax” to the United States.
Allie Chalke with Minister Morneau’s office can be reached here:
http://www.goc411.ca/en/154338/Allie-Chalke
“There is no reason to think that the IRS can seize assets located outside the United States. It’s just that the citizens of Canada, France, Sweden, Netherlands and Denmark seem to have better treaty protections.”
I think the difference may be that the treaties of those five countries have “Mutual assistance with collection” articles.
@Plaxy
Yes the difference is that those 5 countries have mutual assistance with collection provisions.
Basically, it starts with the Revenue Rule (which in general means that that one country one assist with enforcing the tax debts of another). See:
https://en.wikipedia.org/wiki/Rule_against_foreign_revenue_enforcement
Certain countries (including the United States) view the Revenue Rule as an impediment to tax enforcement.
As a result, the USA negotiated treaties with these 5 countries which:
1. Ended the Revenue Rule as a general principle (meaning that Canada would assist the U.S. with tax enforcement); but
2. Created an exception to this tax enforcement with respect to its own citizens.
Therefore, citizens of those 5 countries (actually 6 because U.S. citizens also would get the treaty protection) have explicit treaty protection.
Residents of “other countries” (whether citizens or not) would have to rely on the “revenue rule”. They would have to look to their individual tax treaties to see what kind of information sharing and mutual assistance provisions exist. In many cases there is no provision in these treaties that would obligate those “other countries” to collect for the IRS.
Interestingly the Dewees problem, which was widely discussed here at Brock was precisely because Mr. Dewees had NOT become a Canadian citizen and the tax treaty obligated Canada to assist the IRS with collection.
See for example the series of Brock posts about Mr. Dewees here:
https://isaacbrocksociety.ca/2017/08/21/dewees-3-lessons-about-the-oh-my-god-moment-and-dealing-with-the-problems-of-u-s-citizenship/comment-page-2/
On the general hostility toward the Revenue Rule and the assistance in collection provisions see:
http://procedurallytaxing.com/international-collection-efforts-by-the-irs-expanding-the-number-of-treaties-in-which-we-have-collection-language/
An excellent discussion of the rule of the Revenue Rule internationally is here:
http://citizenshiptaxation.ca/wp-content/uploads/2017/12/vkrishna_October-29-2004-Demise-of-the-revenue-rule-in-tax-law.pdf
USCitizenAbroad:
“Therefore, citizens of those 5 countries (actually 6 because U.S. citizens also would get the treaty protection) have explicit treaty protection.”
Yes, that’s the way I understand it, and yes, I agree it is 6 countries.
When I was first reading the US tax treaty with my country, I didn’t know about the Revenue Rule, but I concluded that since there’s no provision for the two countries to collect each other’s taxes, my local tax agency just wouldn’t have the authority to agree to help the IRS with collection.
It seems to me (non-lawyer obvs) that since the treaties with mutual collection articles have explicit protection for citizens, and the other treaties don’t include any provision for collecting, the result is that no country is bound by treaty to help the US collect CBT taxes from citizens.
But it also seems to me that if a person faced with the transition tax knows that they will not pay it, it would be best not to let it get as far as assessment.
All the above IMO. IANAL.
@Plaxy
Probably, maybe, who knows … A couple of thoughts:
1. Are prohibited from assisting: The Canada U.S. tax treaty uses the word “shall” not. This is mandatory and appears to leave little room for ambiguity. It says Canada shall not help collect.
2. Are not required to but can: The “Revenue Rule” thing is (I think) a bit different. I read the Revenue Rule as meaning that a country is NOT OBLIGATED TO HELP COLLECT. This may leave the possibility that a country could simply decide to help the U.S. collect, even though the revenue rule says that they are not obligated to do so.
This is difficult because, in most cases (historically) the “revenue rule” is discussed in the context of hiding criminal residents from an honest government. In this case, we are discussing the “revenue rule” in the context of shielding honest citizens from a criminal government.
Yes, I agree. It appears that no
country is bound by treaty to assist in collection, but only the countries with the Mutual Assistance with Collection” articles explicitly prohibit collection from citizens. And in the case of Canada, that assurance has been confirmed with specific reference to the transition tax, which is double good.
I don’t know about the Revenue Rule. Personally I wouldn’t want to rely on it, as I’m not aware of any local laws that give citizens/residents a right to rely on it. May be different elsewhere.
The government of Sweden has a tendency to do whatever they are asked to do. Or doing more than what they are I asked to do.
Perhaps it would be best for an owner of a Swedish business to move to Canada.
“ a country could simply decide to help the U.S. collect,”
Especially if the USC has accepted the liability by filing and including the required calculation of transition tax “due.”
If the USC doesn’t file, or files assuming exemption, it becomes tricky for the IRS to assess. Not impossible, because they do have the 5471 forms from previous years; but since they can’t rely on pre-emptive seizure of the assets (as they could with a USC actually resident in the US), it seems to me they would be forced to try to get a court to enforce production of the documents before they could assess. That would bring the whole issue of the legality of the transition tax before a court, which the IRS might prefer to avoid.
So if it was me I would not help them assess. IANAL
@Plaxy and all
Re: At least the Canada U.S. tax treaty
1. The USA can through information exchange get tax records on the individual but NOT on the Canadian Controlled Private Corporation. This would make it very difficult for the U.S. to get the information they are really looking for. (The whole reason for Subpart F is because the U.S. does not have the jurisdiction to tax the foreign corporation.)
2. Without that information it is hard to assess taxes.
Anyway, forget the theory. It’ obvious that some people will comply and some won’t.
I suspect that the result will be driven by the attitude of the advisors they use – meaning that those who use the best and most expensive tax advisors will comply.
“Without that information it is hard to assess taxes.”
Exactly.
Unless the tax is substantial, the IRS would be silly to waste its resources on ‘small fries.’ The situation is still the same, it’s expensive money to collect vs domestic tax where they resort to the IRS’ favour weapon, LIENS.
“Without that information it is hard to assess taxes.”
It’s only hard to assess the legally authorized amount. It’s not hard at all to assess. The IRS can fabricate a Substitute for Return alleging 1 billion dollars of retained earnings and assess 175 million in taxes. If the victim can’t pay 175 million then the victim can’t win a refund suit. Or if the victim is 100 times as rich as Dewees, the victim can pay 175 million and still not win a refund suit.
“Unless the tax is substantial, the IRS would be silly to waste its resources on ‘small fries.’”
OK, the IRS is silly. How do minnows obtain comfort from learning how silly the IRS is?
https://isaacbrocksociety.ca/2013/04/27/gao-report-reveals-ovd-minnows-paid-up-to-129x-more-in-penalties-than-in-tax-owed/
Minnows obtain comfort by ignoring the IRS, once they learn that the IRS cannot touch them, and that the only way they can be hurt is if they volunteer information or, worse, money to the IRS.
Figure that out and you are one comfortable minnow.
“It’s only hard to assess the legally authorized amount. It’s not hard at all to assess. The IRS can fabricate a Substitute for Return alleging 1 billion dollars of retained earnings and assess 175 million in taxes. If the victim can’t pay 175 million then the victim can’t win a refund suit.”
Surely post-Dewees there can’t be many owners of Canadian corporations who have USC citizenship but still haven’t bothered to become Canadian.
If any still exist, if they file assuming exemption the IRS can’t file a substitute return in their name. Even if they don’t file, it seems extremely unlikely that the IRS would choose to file a pretend return and then ask Canada for assistance in collecting US tax on imaginary income from an imaginary distribution of the undistributed earnings of a Canadian corporation.
“If any still exist, if they file assuming exemption the IRS can’t file a substitute return in their name.”
I think they can. We already know that the IRS can refuse to file a return that is submitted electronically. We already know that the IRS can unfile a return that they previously filed, and next the IRS can destroy records of both the filing and unfiling. We already know that when the IRS receives returns in the mail the IRS can hide them in ceilings and other places in order to deny having received them.
Here’s part of a comment that I submitted to another site a few hours ago, where I don’t know yet if my comment will be “filed” or not:
The word “file” needs to be defined. When one kind of IRS administrative transcript (not Form 4340) shows that a return was filed but months later was not on file, and later a different kind of IRS administrative transcript (Form 4340) omits both the filing and subsequent unfiling, was the return filed? When a server mails a witness’s notarized declaration to a District Court and obtains a return receipt signed by a court employee, but the court denied receiving the declaration, was the declaration filed? When a party mails a collection of briefs to a District Court and the District Court files all except one brief but discards the brief whose exhibits included copies of the notarized declaration and USPS return receipt, and the weights of the filed briefs plus envelope add up to less than the shipping weight shown on the filing label and the missing weight is the missing brief, was the brief filed? When USPS’s web site shows that a post-trial brief was delivered to Tax Court but Tax Court discarded the brief, was the brief filed? When two spouses sign a return and one spouse mails it, and IRS records show that the spouse who didn’t mail it also didn’t file it, was the joint return really filed only by the spouse who mailed it? When a stockbroker sent information returns to the IRS but an IRS data entry clerk filed an altered Form 1099-B (for which she was jailed) and an IRS employee did something wrong with Form 1042-S (I haven’t seen TIGTA reports on this), were the information returns filed?
ND – I think you’re missing the point. The IRS isn’t going to try to get Canada (or other treaty partner) to help it steal the undistributed Canadian-source earnings of a Canadian corporation.
The IRS doesn’t in fact try to use made-up returns to try to get treaty partners to collect US tax on the non-US-source income of USCs who don’t live in the US, even when the income actually exists. They’re certainly not going to file a false return reporting vast sums of imaginary income and then ask the residence country to collect it for them.
This tax is a scam. The income being taxed does not exist, and if it did exist
would be taxable by the residence country, with the US obliged to give credit.
“The IRS isn’t going to try to get Canada (or other treaty partner) to help it steal the undistributed Canadian-source earnings of a Canadian corporation.”
The circumstances are going to start soon. We have no past evidence by which to guess if this is true or not.
“The IRS doesn’t in fact try to use made-up returns to try to get treaty partners to collect US tax on the non-US-source income of USCs who don’t live in the US, even when the income actually exists.”
I’ll take your word for it that the IRS hasn’t done so yet. However, the IRS can if it wishes. Had Dewees not volunteered, the IRS could have acted on their own if they wished.
“This tax is a scam.”
Yes. Since when would that stop the IRS?
“Had Dewees not volunteered, the IRS could have acted on their own if they wished.”
Apparently it doesn’t look that easy from the IRS’s point of view or they would already be filing phony returns on every non-filing non-dual USC living in Canada, Sweden, and the other mutual-collection countries. Yet they don’t.
I don’t think USC owners of Canadian corporations should panic themselves into capitulation by ruminating about the IRS. I do think they should all become Canadian citizens, if they haven’t already, and perhaps re-evaluate their US citizenship.
I think it matters quite a lot that this tax is a scam. The dishonesty of the pretext tends to evoke indignation in the individual being assaulted. A large percentage of those who eventually pay may do so resentfully, feeling (correctly) that the US Government has used their previous compliance as an instrument with which to abuse them.
The lesson will be learned, by some.
Although the US treaty with Canada provides for mutual assistance in collection (where the taxpayer is a citizen of the requesting country and is not a citizen of the requested country), the article also includes this provision:
It might be quite expensive for Canada to try to enforce collection of US taxes by forcing a distribution of the undistributed earnings of a Canadian corporation. Non-Canadian owners might want to explore possible legal defence they might have against such action by the CRA.
Likewise:
Would the CRA normally force a Canadian corporation owner to distribute the undistributed earnings of his/her Canadian corporation? This question also might be worth exploring.
Also it should be borne in mind that the treaty states:
Paragraph 7 says:
If I was a non-Canadian faced with the transition tax I think I would explore the feasibility of arguing that the CRA’s claim to taxation of the Canadian corporation’s earnings should have priority over the request for assistance in collecting US tax.
Just suggestions that might be worth thinking about. IANAL.