Introduction and summary
In brief some of you may have heard that the United States “Net Investment Income Tax” (“NIIT”) found in Chapter 2A of Subtitle A (Income taxes) of the Internal Revenue Code (Chapter 26) cannot be offset by foreign tax credits based on Canadian taxes paid on the same income. Yes, this does subject some Canadians (and others) to double taxation (at a rate of 3.8%) on investment income.
From the perspective of the average individual “investment income” should be understood to be dividends, interest and capital gains including the capital gain on the sale of a principal residence!
(The “NIIT” is more widely referred to as the Obamacare surtax. Obviously Americans abroad cannot benefit from Obamacare.)
Interestingly, the “Net Investment Income Tax” is:
- a tax in addition to the normal income taxes in the Internal Revenue Code
- operates in a way that is very similar to Eritrea’s citizenship based tax on foreign income
- is one more expression of the U.S. hatred of all things foreign (the Internal Revenue Code punishes all things foreign)
- creates an extra tax (double taxation) on non-U.S. investments (in this way it is similar to the Trump tariffs which is essentially a sales tax on foreign imports)
The question of whether the Canada/U.S. tax treaty obligates the United States to allow a foreign tax credit (minimizing double taxation) is currently being litigated in the Bruyea case.
The purpose of this post is to explain the issue, the litigation and highlight a very important amicus brief written by two U.S. law professors in support of Mr. Bruyea. To better understand the problem, you are invited to read further. For those interesting only in listening to a podcast about the amicus brief, here you go …
An outline of this post is as follows …
Part 1 – Guaranteed double taxation on certain investment income for U.S. Citizens in Canada!!
Part 2 – The Net Investment Income Tax and the Internal Revenue Code denial of foreign tax credits
Part 3 – Does the Canada/U.S. tax treaty provide a tax credit when the Internal Revenue Code does not?
Part 4 – Conclusion
Appendix A – How the Internal Revenue Code is structured and why the Internal Revenue Code does not allow for a foreign tax credit to offset the NIIT
Appendix B – A deeper dive
Part 1 – Guaranteed double taxation on certain investment income for U.S. Citizens in Canada!!
Explaining the problem …
Your accountant may tell you that there is no “double taxation” of U.S. citizens living in Canada.
Your accountant will justify this claim by saying:
– Double taxation is prevented by the use of foreign tax credits.
– Double taxation is prevented by the Canada U.S. tax treaty.
This is a completely false statement. Double taxation can occur because of timing differences in the recognition of income. (Think Transition Tax, GILTI, Subpart F, Possibly PFIC.) An accurate statement would be:
U.S. citizens living in Canada (or anywhere else outside the USA) are because and only because of citizenship taxation subject to taxation by the United States.
U.S. citizens living in Canada are subject to taxation in Canada because they live in Canada.
Therefore, U.S. citizens in Canada are taxed by BOTH Canada and the United States on the same income and are therefore subject to double taxation. Some of the U.S. tax is paid to the United States by using the tax paid to Canada as a tax credit against U.S. taxes owed.
Part 2 – The Net Investment Income Tax and the Internal Revenue Code denial of foreign tax credits
What happens when income is realized at exactly the same time and neither foreign tax credits nor the treaty prevent the double taxation of income?
Unfortunately, the position of the IRS and United States Treasury is that Americans abroad ARE subject to double taxation on “foreign source” income that is subject to the Net Investment Income Tax (“NIIT”) found in Chapter 2A (and not Chapter 1) of the Internal Revenue Code.
Let’s take an example …
Assumptions: For simplicity I will assume that the U.S. dollar and the Canadian dollar are on par and that they have always been on par. Therefore, we need not consider any variations in the exchange rate. I am also assuming a simplified (and therefore not completely accurate) view that the NIIT is calculated by simply multiplying the investment income by .038. Finally, I am assuming that the sale will be taxed at the highest long term capital gains rate (20%) in the United States.
Facts: Mr Paul is a U.S. citizen who lives in Canada and is therefore a tax resident of BOTH Canada and the United States. He owned a small apartment building that he purchased for $100,000 in 1975. He sold the building for $3,100,000 in 2025. This would generate a taxable capital gain in each of Canada and the United States of $3,100,000 less $100,000 which is $3,000,000. Because the apartment building in in Canada, the first right of taxation belongs to Canada.
Step 1 – Canada will impose a tax of 50% of the gain which is $1,500,000. Let’s assume Mr. Paul is in the 50% tax bracket in Canada and will therefore pay a tax in Canada of $750,000.
Step 2 – The United States will tax the gain in two ways with two separate taxes:
First, there will be a U.S. capital gains tax of 20% of the total gain which will $600,000 (20% of $3,000,000.00)
Second, there will be a second U.S. “Net Investment Income Tax” which is a 3.8% additional tax. To keep it simple I will assume the tax is on the complete gain. The result is an additional $3,000,000 times .0038 which is an additional $114,000.00
The total United States tax would be $600,000 + $114,000 = $714,000.
The total Canadian tax would be $750,000.
Q. Shouldn’t the $750,000 tax paid in Canada generate a sufficient foreign tax credit to offset the total U.S. tax of $714,000?
A. No. Under U.S. domestic law (in the Internal Revenue Code), the $750,000 CDN would offset ONLY the $600,000 U.S. capital gains tax and NOT the $114,000 NIIT. This means that Mr. Paul cannot use the tax paid in Canada to offset the $114,000 NIIT. Mr. Paul will receive a bill from the IRS for $114,000.
Notably, under U.S. domestic law, only $600,000 of the actual $750,000 of Canadian tax paid may be used as a tax credit against the total U.S. tax owing.
To better understand why the Internal Revenue Code, does NOT allow the NIIT cannot be paid by foreign tax credits, see Appendix A of this post.
The issue is whether the Canada/U.S. Tax Treaty allows for the $150,000 of additional CDN tax paid to be used as a tax credit against the NIIT.
Part 3 – Does the Canada/U.S. tax treaty provide a tax credit when the Internal Revenue Code does not?
1. Is the NIIT an “income tax” within the meaning of the Canada/U.S. tax treaty?
A recent article at Tax Notes suggested that the NIIT is NOT an income tax and therefore is NOT within the scope of the Canada/U.S. Tax Treaty. The article did NOT specifically reference the Canada/U.S. treaty. The Canada US tax treaty specifically states in Article II that:
1. This Convention shall apply to taxes on income and on capital imposed on behalf of each Contracting State, irrespective of the manner in which they are levied.
2. Notwithstanding paragraph 1, the taxes existing on March 17, 1995 to which the Convention shall apply are:(a) in the case of Canada, the taxes imposed by the Government of Canada under the Income Tax Act; and
(b) in the case of the United States, the Federal income taxes imposed by the Internal Revenue Code of 1986. However, the Convention shall apply to:
- (i) the United States accumulated earnings tax and personal holding company tax, to the extent, and only to the extent, necessary to implement the provisions of paragraphs 5 and 8 of Article X (Dividends);
- (ii) the United States excise taxes imposed with respect to private foundations, to the extent, and only to the extent, necessary to implement the provisions of paragraph 4 of Article XXI (Exempt Organizations);
- (iii) the United States social security taxes, to the extent, and only to the extent, necessary to implement the provisions of paragraph 2 of Article XXIV (Elimination of Double Taxation) and paragraph 4 of Article XXIX (Miscellaneous Rules); and
- (iv) the United States estate taxes imposed by the Internal Revenue Code of 1986, to the extent, and only to the extent, necessary to implement the provisions of paragraph 3(g) of Article XXVI (Mutual Agreement Procedure) and Article XXIXB (Taxes Imposed by Reason of Death).
3. The Convention shall apply also to:(a) any taxes identical or substantially similar to those taxes to which the Convention applies under paragraph 2; and
(b) taxes on capital;
which are imposed after March 17, 1995 in addition to, or in place of, the taxes to which the Convention applies under paragraph 2.
Because Chapter 2A (the NIIT) is in the Income Tax Subtitle of the Internal Revenue Code it seems clear that the NIIT is an income tax which is therefore included within the purview of the treaty. Put another way: the express terms of the treaty compel the conclusion that the NIIT is an “income tax”.
Therefore, the question becomes:
Does the Canada U.S. tax treaty create a a credit against the NIIT for Canadian taxes paid on income subject to US tax under the NIIT?
Let’s look to Article XXIV of the treaty which includes in paragraphs 1 and 2:
1. In the case of the United States, subject to the provisions of paragraphs 4, 5 and 6, double taxation shall be avoided as follows: In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a citizen or resident of the United States, or to a company electing to be treated as a domestic corporation, as a credit against the United States tax on income the appropriate amount of income tax paid or accrued to Canada; and, in the case of a company which is a resident of the United States owning at least 10 per cent of the voting stock of a company which is a resident of Canada from which it receives dividends in any taxable year, the United States shall allow as a credit against the United States tax on income the appropriate amount of income tax paid or accrued to Canada by that company with respect to the profits out of which such dividends are paid.
2. In the case of Canada, subject to the provisions of paragraphs 4, 5 and 6, double taxation shall be avoided as follows:(a) subject to the provisions of the law of Canada regarding the deduction from tax payable in Canada of tax paid in a territory outside Canada and to any subsequent modification of those provisions (which shall not affect the general principle hereof)
(i) income tax paid or accrued to the United States on profits, income or gains arising in the United States, and
(ii) in the case of an individual, any social security taxes paid to the United States (other than taxes relating to unemployment insurance benefits) by the individual on such profits, income or gains
shall be deducted from any Canadian tax payable in respect of such profits, income or gains;
(b) in the case of a company which is a resident of Canada owning at least 10 percent of the voting stock of a company which is a resident of the United States from which it receives dividends in any taxable year, Canada shall allow as a credit against the Canadian tax on income the appropriate amount of income tax paid or accrued to the United States by the second company with respect to the profits out of which the dividends are paid; and
(c) notwithstanding the provisions of subparagraph (a), where Canada imposes a tax on gains from the alienation of property that, but for the provisions of paragraph 5 of Article XIII (Gains), would not be taxable in Canada, income tax paid or accrued to the United States on such gains shall be deducted from any Canadian tax payable in respect of such gains.
Focussing ONLY on the obligation of the United States to offer a tax credit from paragraph 1, let’s further parse the language:
1. In the case of the United States, … double taxation shall be avoided as follows: In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a citizen or resident of the United States, … as a credit against the United States tax on income the appropriate amount of income tax paid or accrued to Canada; …
The issue being litigated in the Bruyea case is how to interpret when the United States is required under the Treaty to allow a foreign tax credit against the NIIT on Canadian taxes paid on Canadian source investment income.
Interpretation 1 – The U.S. Treasury position:
Because the “law of the United States” (Internal Revenue Code) would NOT allow a credit against the NIIT, the treaty does NOT allow a credit against the NIIT for Canadian taxes paid on that income.
JR Commentary: Obviously this interpretation would render the meaning of paragraph 1 meaningless. It would mean that the a tax credit would be available ONLY if the Internal Revenue Code allows the credit. If this were the interpretation then the United States would be offering no treaty based foreign tax credit.
Interpretation 2 – The Position of Mr. Bruyea (the taxpayer)
Based on paragraph 1 of Article XXIV of the tax treaty, the United States is obligated to offer a foreign tax credit against U.S. income taxes (of which the NIIT is one). The language “subject to the limitations of the law of the United States” is NOT a denial of the credit, but is rather an expression of the U.S. rules governing the how the credit is calculated.
JR Commentary: This interpretation would give meaning to paragraph 1 of Article XXIV. It is the only interpretation that makes sense in the context of the tax treaty.
Unsurprisingly, the United States Treasury is seeking to deny the foreign tax credit to the taxpayer.
The Amicus brief filed by Professors Rosenbloom and Shaheen
It is great significance and assistance to Mr. Bruyea that these “heavyweight” professors have filed an amicus brief in support of the position that:
- Paragraph 1 of Article XXIV creates a foreign tax credit based on the treaty that is available even though the credit is denied under the Internal Revenue Code; and
- The language “subject to the limitations of the law of the United States” means only that United States law determines HOW the credit is calculated.
The amicus brief filed by Professors Rosenbloom and Shaheen (which is a great read) is here:
What follows is a podcast (it’s easier to listen to) describing the issues and the Rosenbloom Shaheen brief.
Part 4 – Conclusion
The addition of the amicus brief from Professors Rosenbloom and Shaheen adds very powerful weight to Mr. Bruyea’s position.
My prediction is that:
The court WILL rule that the Canada/U.S. tax treaty creates a treaty based foreign tax credit to offset the NIIT (even though the Internal Revenue Code does not allow the credit).
We will see! I expect this to be “done and dusted” in 2026.
Appendix A – How the Internal Revenue Code is structured and why the Internal Revenue Code does not allow for a foreign tax credit to offset the NIIT
The Internal Revenue Code is Title 26 of U.S. Laws. The Income Tax rules are found in Subtitle A of Title 26. Notice how the Subtitle A – Income Taxes – is divided into different Chapters.
Chapter 2A (creating the NIIT) is different from Chapter 1 (Normal Taxes And Surtaxes) which includes the foreign tax credit rules.
26 U.S. Code Subtitle A – Income Taxes
- CHAPTER 1—NORMAL TAXES AND SURTAXES (§§ 1 – 1400Z–2)
- CHAPTER 2—TAX ON SELF-EMPLOYMENT INCOME (§§ 1401 – 1403)
- CHAPTER 2A—UNEARNED INCOME MEDICARE CONTRIBUTION (§ 1411)
- CHAPTER 3—WITHHOLDING OF TAX ON NONRESIDENT ALIENS AND FOREIGN CORPORATIONS (§§ 1441 – 1465)
- CHAPTER 4—TAXES TO ENFORCE REPORTING ON CERTAIN FOREIGN ACCOUNTS (§§ 1471 – 1474)
- [CHAPTER 5—REPEALED] (§§ 1491 – 1494)
- CHAPTER 6—CONSOLIDATED RETURNS (§§ 1501 – 1564)
Subtitle A (consisting of Chapters 1 – 6) deals with “Income Taxes”
CHAPTER 1 is where the foreign tax credit rules live.
CHAPTER 2A is where the 3.8% Obamacare surtax on Net Investment Income lives.
CHAPTER 2A does NOT include a provision for foreign tax credits to offset the “NIIT”
This means that under purely domestic U.S. law NO foreign tax credit is allowed to offset the NIIT.
Appendix B – A deeper dive
The following post is Part 6 in a series of post at my Citizenship Solutions blog. This post links to all posts in the series.
Bonjour Part 6 – Rosenbloom and Shaheen Brief In Support Of Bruyea