This post is largely motivated by two recent Facebook discussions.
A recent discussion in the American Expatriates group explored the question of whether a U.S. citizen who was a “tax resident” of another country could use a “tax treaty tie breaker” to avoid U.S. taxation. The discussion began with:
Good Morning, does anyone know something about Tax treaty tiebreakers, Would that be a possible solution for Americans Abroad, Dual Citizens, Accidental Americans ?
Tax treaty tiebreakers are rules that are used to assign a person’s tax residency to one country when an individual is a tax resident of both countries. In the context of U.S. tax treaties, treaty tie breaker rules are used when an individual is both:
1. A U.S. person for tax purposes (U.S. citizen or U.S. resident); and
2. A tax resident of another country.
It is very common to use tax treaties to assign tax residency to a country when an individual is a tax resident of more than one country
1. Does this mean that without the “savings clause” that that U.S. citizens living permanently in Canada would no longer be (in a practical sense) subject to “citizenship-based taxation”?
2. If the answer is that: the “savings clause” (by not allowing a “tax treaty tiebreaker”) is responsible for “citizenship-based taxation” in Canada – then is Canada by agreeing to the “savings clause” responsible for imposing U.S. “citizenship-based taxation” in Canada?
A second discussion raised the question of whether Canadian residents could sue the Government of Canada for entering into a treaty which would subject them to U.S. worldwide taxation. (Although the ADCS FATCA lawsuit argues that the amendments to Canada’s Income Tax Act violate the Charter, one wonders whether one could argue that the IGA itself violates the Charter.)
Thinking about the first discussion – the “savings clause” and “tax treaty tiebreakers”
To what extent is the “savings clause” responsible for the problems faced by U.S. citizens in Canada?
The answer to this question may be very simple. It may be very complex. It may depend on the circumstances. The purpose of this post is (through your comments) to explore the extent to which removing the “savings clause” from the Canada U.S. tax treaty would diminish the ability of the United States to impose worldwide taxation on “tax residents” of other countries. Is Canada, by agreeing to the “savings clause”, actually imposing U.S. taxation on its citizens and residents? Is the problem Canada and NOT the United States?
The impact of the “savings clause” on “tax treaty tiebreaker”
You will find the Canada U.S. Tax Treaty here.
Note that Article IV paragraph 2 contains the “tax treaty tie breaker” provision. Specifically it reads:
2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:
(a) he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him; if he has a permanent home available to him in both States or in neither State, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests);
(b) if the Contracting State in which he has his centre of vital interests cannot be determined, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;
(c) if he has an habitual abode in both States or in neither State, he shall be deemed to be a resident of the Contracting State of which he is a citizen; and
(d) if he is a citizen of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.
Therefore, if we read ONLY Article IV paragraph 2 we understand that:
1. If a person is a “tax resident” of both Canada and the United States; and
2. He has a permanent home available to him ONLY in Canada
then he would be a “tax resident” ONLY of Canada.
This would mean that the U.S. citizen resident in Canada would pay (just like a nonresident alien) U.S. tax ONLY on U.S. source income.
Green Card holders living in Canada can (but it may not be advisable) take advantage of this treaty provision. U.S. citizens CANNOT take advantage of this treaty provision. Why not? The answer is that the “savings clause” (found in Article XXIX) which reads as follows:
2. Except as provided in paragraph 3, nothing in the Convention shall be construed as preventing a Contracting State from taxing its residents (as determined under Article IV (Residence)) and, in the case of the United States, its citizens (including a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of ten years following such loss) and companies electing to be treated as domestic corporations, as if there were no convention between the United States and Canada with respect to taxes on income and
Note that paragraph 3 of Article XXIX contains some exemptions to the “Savings Clause” – meaning that U.S. citizens can take advantage of paragraph 3 exemptions.
3. The provisions of paragraph 2 shall not affect the obligations undertaken by a Contracting State:
(a) under paragraphs 3 and 4 of Article IX (Related Persons), paragraphs 6 and 7 of Article XIII (Gains), paragraphs 1, 3, 4, 5, 6(b) and 7 of Article XVIII (Pensions and Annuities), paragraph 5 of Article XXIX (Miscellaneous Rules), paragraphs 1, 5 and 6 of Article XXIX B (Taxes Imposed by Reason of Death), paragraphs 2, 3, 4 and 7 of Article XXIX B (Taxes Imposed by Reason of Death) as applied to the estates of persons other than former citizens referred to in paragraph 2 of this Article, paragraphs 3 and 5 of Article XXX (Entry into Force), and Articles XIX (Government Service), XXI (Exempt Organizations), XXIV (Elimination of Double Taxation), XXV (Non-Discrimination) and XXVI (Mutual Agreement Procedure);
Thinking about the discussion
Can Canada really agree to a treaty that subjects Canadian citizens living in Canada to the full force of the Internal Revenue Code? Could this give rise to a separate lawsuit against the Government of Canada based on the same Charter breaches that are the subject of the current ADCS lawsuit?
Questions – thinking about the interaction between the first discussion and the second discussion
1. What are some other ways that the removal of the “savings clause” would change the taxation of U.S. citizens resident in Canada?
2. What are some ways to rewrite the “savings clause” so that it did NOT subject Canadian “tax residents” to the full force of the Internal Revenue Code?
3. Would it make sense for citizens in every country that has a “savings clause” in a U.S. tax treaty (basically all of them) to launch a lawsuit against their own government for “offering them as tribute to the United States”?
4. In other words,a possible solution may be to stop blaming U.S. tax policy and start blaming governments that agree to the “savings clause”.
I look forward to your comments.