be no relief in instances where income taxable under section 877 is subject to double taxation.240 Application under the proposals A former citizen subject to the proposed departure tax would be in some respects in a similar situation with respect to double taxation as someone taxed under present law section 877. The situation would be exacerbated under the proposals because the gain from a disposition of the asset may not be realized until many years after the deemed U.S. sale. Such individuals generally would not be eligible for any specific relief from double taxation under existing U.S. tax treaties. c. Competent authority relief Application under present law A taxpayer may request competent authority assistance pursuant to the "Mutual Agreement Procedure" ("MAP") article of an income tax treaty if the actions of the United States, its treaty partner, or both countries result in taxation that is contrary to the provisions of the applicable tax treaty, including double taxation of the same income.241 The MAP articles of U.S. tax treaties generally grant the competent authorities broad authority to consult and resolve double taxation issues regardless of whether they are specifically covered by the treaty.242 Under this procedure, a case-by-case determination is made based on the specific facts and circumstances of a particular taxpayer's situation. A decision made by the competent authorities with respect to a particular taxpayer has no precedential effect with respect to any other taxpayers. Rev. Proc. 91-23, 1991-1 C.B. 534, sets forth the procedures with respect to requests for assistance of the U.S. competent authority in resolving instances of taxation in contravention of the provisions of an income, estate or gift tax treaty to which the United States is a party. To be eligible for U.S. competent authority relief, the taxpayer must be a U.S. person as defined in section 7701(b)(30).243 Consequently, a former citizen subject to tax under section 877 is not eligible for such relief. Instead, such an individual would request assistance from the competent authority of his or her country of residence. If the case is accepted, the foreign com 240 Treaty relief is available only in limited circumstances. An example of such relief is found in the Convention Between the Government of the United States of America and the Government of the United Mexican States for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (the "U.S.-Mexico Treaty"). Under Articles 13 and 24 of the Treaty gains derived by a resident of Mexico from the sale of the stock of a U.S. company may be taxable by both the United States and Mexico if the shareholder owned at least 25 percent of such company for the 12-month period preceding the sale. If the gain is taxed by the United States, then the amount would constitute U.S. source income and the taxes paid to the United States would be eligible for foreign tax credit relief under the Mexican laws. Therefore, if a former citizen resident in Mexico who is subject to section 877 satisfies the requirements set forth in the Articles, the gain from the disposition of the stock would be U.S. source income under the treaty (as under sec. 877(c)), and Mexico would be obligated to cede primary taxing jurisdiction on such income. 241 All existing comprehensive U.S. income tax treaties, with the exception of the treaty with Ireland, contain a MAP article. All existing comprehensive U.S. income tax treaties, with the exception of the treaty with Ireland, contain a MAP article. 242 Article 25(3) of the 1981 U.S. Model Treaty provides that the competent authorities shall endeavor to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the treaty. Additionally, the competent authorities may also consult on issuesnot expressly stated in the treaty for the purpose of eliminating double taxation. 243 Section 3.05 of Rev. Proc. 91-23. petent authority would contact its U.S. counterpart for consultation and to attempt to resolve the issue. Although the competent authorities are expected to reach a mutual agreement, it is possible that they reach an impasse in some cases. If that happens, the taxpayer would suffer a significant tax burden caused by double taxation. Even if the competent authorities agree to review the case, the process can be time consuming (and hence, costly) for the taxpayer.244 The Joint Committee staff has been advised that the U.S. competent authority has been presented with no cases regarding double taxation issues arising under section 877 or analogous issues. 245 Application under the proposals If the proposed departure tax is enacted, an individual subjected to the regime (e.g., someone who took a formal oath to renounce his citizenship after the effective date) who subsequently disposes of an asset subjected to the deemed sale provision essentially would be in the same position as a former citizen subjected to U.S. tax under section 877. In other words, such a taxpayer generally would suffer double taxation if his or her resident country taxes the same income notwithstanding the fact that the resident country has in force an income tax treaty with the United States.246 It appears that without specific relief under a treaty, a former citizen who disposes of his or her assets after becoming a resident of a treaty country may be subject to double taxation. It is uncertain whether double taxation relief would be obtained under the MAP article. For example, the United States may decide not to cede its taxing jurisdiction in these instances. If that happens, unless the taxpayer's country of residence provides unilateral relief, the individual would be subject to double taxation. To the extent the departure tax applies to an individual, the tax would be imposed when an individual is still a U.S. citizen; thus, the gain would constitute U.S. source income under section 865 and foreign tax credit relief would not be available.247 Commentators have suggested that it would be appropriate for the United States, in future treaty negotiations, to include provisions to address the double taxation issue.248 d. Experience of other countries that impose similar taxes on former citizens or residents Very few countries currently impose taxes on former citizens or residents.249 In the case of countries that tax former citizens or residents, the regimes are substantially less expansive than the 244 The letter dated May 23, 1995, from IRS Commissioner Margaret Milner Richardson, Exhibit A (included in Appendix G), shows that the average days for the processing time of "NonAllocation" cases (i.e., cases not involving transfer pricing disputes) from 1990 to 1994 range from 377 to 726 days. 245 See, letter dated May 23, 1995, from IRS Commissioner Margaret Milner Richardson (included in Appendix G). 246 It is uncertain if the proposed U.S. expatriation tax would constitute a creditable tax in a taxpayer's new country of residence. 247 The unrealized gain would not be taxable by a foreign country at the same time the U.S. expatriation tax is imposed. Consequently, the income would remain U.S. source under section 865(a) and the special rule of section 865(g) (to convert U.S. source income into foreign source income if at least a 10 percent foreign tax is paid) would not be applicable. 248 See testimony of Stephen E. Shay before the Subcommittee on Oversight of the House Committee on Ways and Means, March 27, 1995. 249 See Appendix B for a comparison of the different regimes. ones currently proposed. There is limited experience regarding the relief of double taxation caused by the operation of departure tax or similar taxes. The following is a description of instances in the U.S. treaties with Canada and Germany where provisions of those treaties are designed to alleviate double taxation. As the discussion reveals, the solutions offered by bilateral treaties are somewhat limited. Canada Canada imposes a departure tax upon the termination of Canadian residence, irrespective of citizenship, that is somewhat similar to the proposed U.S. tax on expatriation. The same issue of double taxation arises when an individual leaves Canada to become a resident in another country. Under U.S. internal law, if an individual left Canada to become a U.S. resident, the statutory basis provisions set forth in sections 1001 and 1011 would not permit the individual to obtain a step up in the basis of assets that were acquired prior to the time that he or she became a U.S. resident.250 Consequently, the individual could be subject to double taxation when the assets were later sold. The Convention Between the United States of America and Canada With Respect to Taxes on Income and on Capital ("U.S.-Canada Treaty"), however, provides limited relief to U.S. residents who are subject to the Canadian departure tax upon the termination of their Canadian residence. The U.S.-Canada Treaty contains rules to determine whether the resident or the source country may tax the gains realized by taxpayers upon the disposition of personal property. The country of residence generally has the sole right to tax such gains.251 An exception is available to preserve the right of either country (primarily Canada) to apply its departure tax to a U.S. resident.252 Under the internal law of Canada, a taxpayer is generally subject to the departure tax in the year of relinquishment of Canadian residence. Individual taxpayers may, however, elect to postpone the taxable event with respect to certain assets until the item is sold. A special election is available under the U.S.-Canada Treaty to render taxpayers as having sold and repurchased, for U.S. tax purposes, the same assets taxed under the Canadian deemed sale regime. The effect of the election is to achieve a basis step-up in the assets for U.S. tax purposes.253 The "Elimination of Double Taxation" article of the Treaty considers the gain from the deemed sale as U.S. source income.254 Consequently, the United States, as the source country, may assert primary taxing jurisdiction over the income, and Canada will credit any U.S. tax imposed on such gain against the Canadian departure tax (i.e., ceding primary taxing jurisdiction to the United States). From the taxpayer's perspective, double taxation is avoided. The same result is generally achieved by a taxpayer who postpones the taxable event for Canadian tax purposes. When such a taxpayer disposes of his or her assets, the 250 See G.C.M. 34572, August 3, 1971. gain also would constitute U.S. source income under the same provision of the Treaty. However, if the taxpayer fails to make the election under Article XIII(7) of the Treaty and there is no deferral of the Canadian departure tax, double taxation will occur. No step-up in basis will be available for the gain taxed by the Canadian regime (because the deemed Canadian sale does not give rise to a realization event under U.S. tax principles). Thus, if the taxpayer disposes of the asset in a taxable transaction in a subsequent year, he or she will be required to compute the gain or loss using the adjusted basis of the asset under U.S. tax principles. The gain realized generally will be U.S. source income under section 865(a)(1); as a result, the Canadian departure tax paid may not be credited against the U.S. income tax liability on such sale. If a U.S. resident pays the Canadian departure tax, he or she may use the amount as a credit to offset U.S. tax imposed on other similar foreign source income. The foreign tax credit may be carried back for two years or carried forward for five years.255 If there is no other foreign source income and the individual suffers a double tax burden, he or she may request relief from the competent authorities under the MAP article of the Treaty. Because competent authority relief is discretionary, there is no guarantee that relief would be available to eliminate the burden of double taxation. Germany Germany also taxes former citizens and residents under limited circumstances. Under Article 13(6) of the Convention Between the United States of America and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion With Respect to Taxes on Income and Capital and to Certain Other Taxes ("U.S.-Germany Treaty"), gains from the disposition of assets not otherwise dealt with by the Treaty are taxable in the country in which the taxpayer is a resident. An exception, however, exists to preserve the right of either country (primarily Germany) to tax certain gains from the disposition of stock by a former resident if the seller is a substantial shareholder (i.e., owns at least 25 percent of the stock of a German company) and he or she disposes of the stock within 10 years of giving up German residence. The gain taxable under this provision is limited to the amount that reflects appreciation in the stock while the taxpayer was a German resident. The Treaty generally requires the United States to provide a fair market value basis (as of the date on which the individual has ceased to be a resident of Germany) of the shares in calculating any gain on the disposition of the shares for U.S. tax purposes.256 In the absence of this special provision, the United States would require the taxpayer to compute the gain or loss from the disposition using the adjusted basis of the shares, as determined under section 1011. Thus, the effect of the provision is to preserve the right of Germany to impose its internal taxation on former resi 255 See section 904(c). 256 The treaty does not prevent the United States from taxing any gain accrued during the period that taxpayer was a German resident if such amount has not been subject to tax in Germany. dents (who are U.S. residents at the time of disposition) on certain stock gains accrued while the individual was a German resident. The United States may tax only the portion of the gain accrued after the individual has terminated his or her residence in Germany. Although the terms of the Treaty provision grant reciprocal taxation rights and obligations, the provision of Article 13(6) currently applies chiefly to German tax on U.S. residents, because internal U.S. tax law does not contain a similar rule. Hence, the German negotiators of the treaty essentially obtained a concession from the United States in ceding taxing jurisdiction to Germany with respect to the gain accrued during the period of an individual's residence in Germany. |