Introduction …
This post is largely motivated by two recent Facebook discussions.
First discussion:
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
Questions:
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?
Second discussion:
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.)
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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
on capital.
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.
“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”.”
Yes, but not a likely solution. Who has the more power?
If lawsuits prevented a nonUS nation from offering its dual citizens as tribute to the US, they’d likely find a way to force all their dual nationals to give up USCship to keep their local Cship. Those who can’t give up USCship would in some way be stripped of their second Cship.
Far fetched? Not any more so than nations agreeing to the savings clause and FATCA IGAs.
“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”?”
There’s no opportunity for Canada to agree a treaty with the US which would grant treaty benefits to US citizens. The US doesn’t do that.
I agree with Plaxy – the US just doesn’t sign treaties without the saving clause. We need to get our home governments to push back on this policy. I don’t think most governments really understood what they were agreeing to pre-FATCA. The Australian treaty was last amended in 2001. Treaties take years to negotiate and ratify (if the US Senate ever agrees to ratify another tax treaty). In the past, with the lack of enforcement of CBT, the saving clause may have sounded reasonable. After the FATCA IGAs, any country that agrees to a saving clause should be sued for treaty malpractice.
With increasing numbers of dual citizens, if the savings clause must be retained, it should be re-written to allow someone to be a “tax-citizen” in only one country at a time. Someone who obtains citizenship of their adopted country should be beyond the reach of the IRS (other than US-source income). In other words, the saving clause should not apply to nonresident US citizens who are citizens of their resident country. Citizenship should matter.
Of course, the simplest answer would be for the US to join the rest of the developed world and tax on the basis of residence only.
Karen:
“the US just doesn’t sign treaties without the saving clause. We need to get our home governments to push back on this policy.”
In what way? It’s a US policy, and not only a policy but a US citizen right (i.e., that in theory USCs should all be subject to US taxation in accordance with the US tax code, with tax credits for foreign tax paid).
I agree there are serious problems with the way treaties are routinely agreed with little or no scrutiny by the representatives of the electorate, but I think the articles to focus on are the mutual collection articles and the articles which allow personal information to be swapped between the countries at will, without the consent (or even knowledge) of the owner of the information.
See Allison Christian’s blog for interesting discussion of this subject.
Also:
“https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2780874”
“US citizen right ”
How in the hell is taxation a citizen right?
“How in the hell is taxation a citizen right?”
Being taxed on US-source income according to US law rather than residence-country law can result in lower tax. Most of the aggressive tax-avoidance stuff aims to exploit US tax loopholes. Besides which, the US tax code allows deductions which may not be available from the residence country; and the famous “free money” (child tax credits etc).
You might qualify for child tax credits for your children, if you were in a position to be able to file and claim. (Or you might not; I don’t know the riles.)
Well, I guess we all might as well quit and go home right? Fortunately this claim is simply wrong.
What we have seen consistently in both the Internal Revenue Code (example the Sec. 877A exit tax rules) and tax treaties (example refusal to collect if the tax debt is on a Canadian citizen) is different treatment for U.S. citizens who are also citizens of other countries.
There is no reason to believe that USA would insist on the “savings clause” if there were opposition to it. As Karen points out, these “savings clauses” were signed in a pre-FATCA era when the treaty negotiators had little or no appreciation that the “savings clause” would be interpreted to impose direct taxation on their own tax residents.
It seems to me that there are at least three ways to attack this problem in the tax treaties.
1. Get rid of the savings clause period.
2. Expand the scope of exemptions to the “savings clause” to the other activities including the definition of tax residence.
3. Change the treaty definition of “tax resident” to ensure that it included U.S. citizens who were tax residents of Canada would not also be tax residents of the USA.
There are certainly additional ways to attack this problem.
The point is to use the treaties to ensure that the U.S. cannot impose worldwide taxation on people who are tax residents of the country where they actually live.
Why not explore the possibilities instead of simply saying that it is not possible? As Henry Ford was fond of saying: “Whether you think you can do or you think you can’t do it, you are right.”
“You might qualify for child tax credits for your children, if you were in a position to be able to file and claim. (Or you might not; I don’t know the riles.)”
Yes, and eligable for other benies too, but those are not rights. And I have never filed for them, even when I was filing tax returns.
“There is no reason to believe that USA would insist on the “savings clause” if there were opposition to it. ”
Both parties have to agree to every provision of a treaty, else it’s not an agreement. And both parties can pull out or renegotiate. If you believe you can persuade Canada to pull out or try to renegotiate, go to it.
“Why not explore the possibilities instead of simply saying that it is not possible? ”
I don’t see any possibilities in trying to get rid of the saving clause. I do agree that the global acceptance of America’s unilateral designation of the US-born as US-tax-resident should be challenged. That’s down to the OECD, as they’re the ones who stuck it in their standard. I would definitely support a challenge to that, if anybody can figure out a way to do it.
“Yes, and eligable for other benies too, but those are not rights.”
A US citizen has the right under US law to claim whatever tax benefits are available to him/her, by filing a US tax return.
“And I have never filed for them, even when I was filing tax returns.”
A sensible decision, IMO.
“A US citizen has the right under US law to claim whatever tax benefits are available to him/her, by filing a US tax return.”
Benefits are conditional, rights are not.
“Benefits are conditional, rights are not.”
Correct, the USC has the right to the tax benefits available to him/her under US law. Not all benefits are available to all USCs, and benefits may come and go as US law changes. Likewise taxes may come, and even, occasionally, go.
There are different reasons for the different treatment.
US tax law doesn’t apply to a person who is no longer a US citizen.
When it comes to the collection article in the US-Canada treaty, the interesting question IMO is not “why does Canada collect on non-citizens and refuse to collect on citizens“, but “why does Canada collect?”
Most treaty countries don’t.
I would assume that the reason Canada signed on to the collection agreement is that it’s reciprocal, and there are a lot of Canadians living and working in the US. I’ve not heard of specific collection cases but it’s an area I remain completely ignorant of.
“I would assume that the reason Canada signed on to the collection agreement is that it’s reciprocal, and there are a lot of Canadians living and working in the US.”
And there are a lot of Americans living and working in Canada. While other countries, which don’t share a long land border with the US, don’t have so many Americans and therefore reciprocal tax collection is not worth America’s while. (Or Canada’s)
That seems likely.
And the reason neither wants to collect from their citizens is because citizens have more legal rights and it’s more trouble than it’s worth. Especially for the IRS.
Also given higher Canadian tax rates, Canada would have an interest in Canadians working in the US who had not declared non-residency.
Interestingly, Mexico, where it all began, has a long land border and a treaty, but no collection article.
I bite my tongue.
@plaxy
“US tax law doesn’t apply to a person who is no longer a US citizen.”
That’s actually not true.
I had herd that people who automatically lost US citizenship many years ago by naturalizing in a foreign state, while no longer US citizen for immigration purposes, can actually still be considered US citizens for tax purposes IF they did not formally report their loss of citizenship and obtain a CLN.
This has happened to people before. I was reading some of the stories on the website of the ADCS and one of the people was a grandmother for whom this was the case. Here is the quote from the website ”
“I came to Canada in the early 1960s, met and married a Canadian, and raised three Canadian born children. In 1972,
I became a Canadian citizen. At that time, the U.S. Consulate in Toronto told me that by becoming a Canadian I was permanently and irrevocably giving up my U.S. Citizenship. My financial records are most definitely not the business of the IRS.””
Anyhow, the US doesn’t care if you actually aren’t a US citizen. If you don’t have a CLN then Uncle Sam still lays claim to you.
Aaron:
It actually is true.
If you have a US birthplace and haven’t documented loss of citizenship, you’re still able to claim US citizen privileges, such as applying for a passport, right of entry, and right to file US tax returns to claim US tax benefits. You need the CLN to prove you’ve lost citizenship.
The CLN is your visa to NRAland.
@Aaron
To the best of my knowledge, we have only heard this from condors, not from the U.S. government itself. And of course, there is the issue of the banks, who may turn one over without a CLN. But that is not the same as the US taking definitive steps towards laying claim to anyone.
@ Aaron,
Re, you wrote:
As Plaxy put it [emphasis in original]
the CLN being proof, not the cause, of citizenship loss.
If a person believed they were relinquishing their US citizenship by become a Canadian citizen in 1972 – and did not exercise US citizen privileges after that date (which they presumably would not have done, believing they’d given up the US citizenship) – they are not a US citizen and they can get a CLN indicating they ceased to be one in 1972. The CLN provides convenient (though very expensive) proof of non-citizenship and it’s never too late to get one for a relinquishing act.
(Almost no one seems to have got a CLN back in the 60s and 70s because the consulates, while telling you that naturalisation would cause loss of citizenship, never seemed to mention that there was such a document available.)
@ Patricia Moon,
Good point. We’ve been involved in this for seven years and I too am unaware of the IRS taking steps towards persons who relinquished back in the 60s and 70s (or at any time, as far as I recall). I mentioned in my earlier comment that it’s never too late to get a relinquishment-based CLN , but so far IRS has not bothered any relinquishers that I’m aware of, whether we had a CLN or not.
I’m very happy to have one — and they can be very useful if needed to prove lack of citizenship to a bank, which is a big issue in some countries — but it’s not necessary here in Canada for pre-4 June 2004 relinquishers where, per CRA guidance, if a financial institution alleges you are a USC based on place of birth, you can rebut the allegation without a CLN:
CRA Guidance on enhanced financial accounts information reporting
” If you have a US birthplace and haven’t documented loss of citizenship, you’re still able to claim US citizen privileges, such as applying for a passport, right of entry, and right to file US tax returns to claim US tax benefits. You need the CLN to prove you’ve lost citizenship.”
Are you saying that years ago when one lost their citzenship through clearly defined statutes and without any CLN requirement instituted at that time , you could have reestablished your citzenship just by simply reapplying for a passport . Seems a bit odd. I would think that such information as citzenship acquisition was and still is shared between governments and simply reapplying is no guarantee for acceptance.
As for the other citzenship rights ,you must be joking. The obligations outweigh any such rights. It’ s been a time since I’ve had the right or privilege to pay taxes, anywhere for that matter.