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US-Canada Tax Treaty: Beware of Income Exemption Traps

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Are you a US taxpayer earning income in Canada? Do you rely upon the US-Canada tax treaty (officially known as, The Convention with Respect to Taxes on Income and on Capital, U.S.-Can., Sept. 26, 1980, T.I.A.S. No. 11,087) exemptions to claim deductions or limit reporting of income for US tax purposes?

If so, then you need to be aware that the tax treaty between the US and Canada does not always provide protections for US taxpayers- even if the treaty specifically states so. A recent example is the Jamieson v. Commissioner case.

In Jamieson v. Commissioner, 08-1253, the taxpayers were US citizens living, and earning income, in Canada in 2003. After paying their Canadian taxes, they claimed the foreign tax credit on their US tax returns, resulting in a net liability. They did not compute any AMT liability under the provisions of Internal Revenue Code (IRC) Section 55, taking the position that the Article XXIV of The US-Canada Treaty, limiting double taxation, precluded such a liability.

However, the IRS argued that under IRC Section 59(a)(2), enacted as part of the Tax Reform Act of 1986, which reduced the foreign tax for AMT purposes to 90% of a taxpayer’s AMT liability, an AMT liability existed. (Section 59(a)(2) was repealed in relevant part by the American Jobs Creation Act of 2004).

The US Tax Court ruled for the IRS. A Federal District Appeals Court affirmed, determining that Section 59(a)(2) superseded the US-Canadian Tax Treaty. The court held that the US Supreme Court case Whitney v. Robertson “last-in-time” rule governed in the case, in examining conflicts between treaties and statutes. The rule provides that when an inconsistency exists, whichever enactments came later in time will prevail over earlier ones.

Thus, the court determined that Section 59(a)(2) superseded the treaty, and was thus the last expression of the sovereign will. Furthermore, the court cited a DC Court of Appeals case in which it was determined that the IRS Technical and Miscellaneous Revenue Act of 1988, specifying that Section 59(a)(2) and other applicable sections was intended by Congress to supersede any conflicting treaty provisions.

This article is intended to give a brief summary of these issues, and should not be construed as legal or tax advice. Reporting foreign-earned income often necessitates an experienced understanding of complex regulations, IRC statutes, and case law, especially since the IRS penalties for failure to comply can be substantial.

If you have further questions regarding your own tax circumstances, Sherayzen Law Office offers professional advice for all of your cross-border, international, and other tax needs. Call (952) 500-8159 for a consultation today.

Tax Treaties

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Tax treaties are bilateral agreements between two countries that generally provide relief from taxation for individuals who are covered. The U.S. has tax treaties with more than 50 different countries. The U.S. has a formulated a Model Income Tax Treaty to assist in negotiations of future tax treaties. In general, treaties will grant one country primary taxing rights to items of income, and the other country will be required to give a credit for taxes paid.

Primary taxing rights typically depend on either the residency of taxpayers, or the presence of a permanent establishment in a treaty country. A permanent establishment generally is defined to be a branch, factory, office, workshop, mining site, warehouse, or other fixed places of business.

Under most tax treaties, residents (and sometimes, citizens or nationals) of foreign countries will be exempt from U.S. taxes on certain items of income, and taxed at a reduced rate on other specified items. For example, many U.S. tax treaties reduce the withholding tax rate on interest and dividends, and other certain kinds of investment income. The rates and items of taxation vary according to the terms of each treaty. If there is no tax treaty between the U.S. and another country, or a treaty does not cover a certain type of income, a resident (national or citizen, if applicable) of a country will be subject to U.S. taxes.

Under these same tax treaties, though U.S. residents or citizens are subject to U.S. income tax on their worldwide income, they will be exempt from tax, or taxed at a lower rate, in general on certain items of income sourced from another country subject to the tax treaty. Many treaties utilize savings clauses to prevent U.S. residents or citizens from using provisions of a treaty to avoid paying taxes on U.S. source income.

Do you have questions concerning international tax issues? Contact Sherayzen Law Office at (952) 500-8159 to discuss your tax situation with an experienced tax attorney.