double taxation by assuming that a foreign country has a tax system that mirrors the U.S. system. The United States unilaterally relieves double taxation on net foreign source income because not to do so would case double taxation in the "mirror" case. However, it would be inconsistent with the legitimate exercise of our jurisdiction not to tax income generated in the United States to relieve double taxation in the case of inconsistent treatment of services described above. We should not simply cede our taxing right in such a case. Treaties are the appropriate mechanism to resolve double taxation arising when jurisdictions disagree over which country has the primary right to tax. The expatriation proposal is such a case where the United States should not cede its taxing right. In computing the tax on expatriation, the Administration's proposal provided most incoming residents with a fair market value basis in their property when they entered the United States. S. 700 provides that all individuals who enter the United States received a fair market value basis in property at the time they enter the United States for all dispositions-not just in computing the tax on expatriation. Thus, the United States would tax only the gains accrued while citizens or long-term residents were subject to U.S. taxing jurisdiction. If other countries mirrored the U.S. rules there would be no double taxation and, therefore, the U.S. should not cede its taxing jurisdiction unilaterally. Consequently, the potential double taxation (if any in fact were to occur) ought to be resolved by agreement between the countries. C. Limited Circumstances in Which Double Taxation is Tolerable The desire to avoid double taxation is but one consideration that is taken into account with other tax policy concerns. The Internal Revenue Code contains numerous provisions in which concerns about possible double taxation were outweighed by other factors. In particular, existing section 877 can cause double taxation. If an expatriate sells assets_within ten years after he renounces U.S. citizenship, double taxation can occur. Both the United States and the new country of residence may tax the gains. A similar situation exists under section 7701(b)(10), which taxes certain aliens on gains while nonresidents of the United States if they return to the United States within three years of prior U.S. residence. Congress has determined in other cases in which the risk of double taxation does not override tax policy objectives such as fairness. For example, double taxation may result from the application of section 864(c)(6) (taxing nonresidents on deferred payments attributable to U.S. activities), section 864(c)(7) (taxing the disposition of property that was used in a U.S. trade or business if the property is disposed of within ten years of the cessation of the trade or business), section 367(a) (taxing certain transfers of appreciated property to foreign corporations), and section 367(d) (taxing a U.S. person on deemed royalty payments as a result of transfers of intangible property to foreign corporations). In sum, the problems of double taxation are more likely in theory than in practice. In addition, the expatriation proposal would not cause double taxation if other countries had similar laws. Finally, the potential for double taxation is only one tax policy issue to be taken into account in reviewing proposals, such as the expatriation proposal; other tax policy objectives, such as perceived and actual fairness, can outweigh a remote risk of double taxation. II. THE PROPOSAL IS SUPERIOR TO EXISTING LAW WITH REGARD TO TAX TREATIES A. Tax Treaties May Limit the Effectiveness of Existing Section 877 In Crow v. Comm'r, 85 T.C. 376 (1985), the Tax Court held that the prior tax treaty between the United States and Canada prevents the IRS from applying section 877 to an expatriate individual who resides in Canada. This treaty allowed the United States to continue to tax U.S. citizens, but did not explicitly give the United States the right to tax former citizens. Although the Canadian treaty has since been renegotiated, practitioners advise that other tax treaties may give an expatriate the opportunity to avoid section 877. See, e.g., Ness, "Federal Tax Treatment of Expatriates Entitled to Treaty Protection," 21 Tax Lawyer 393 (1968); Association of the Bar of the City of New York, "Report on the Effect of Changes in the Type of United States Tax Jurisdiction over Individuals and Corporations," Tax Notes, Nov. 1, 1993 (1991); Langer, The Tax Exile, at 110-15 (1993-94) (citing treaties with Austria, Denmark, Greece, Ireland, Luxembourg, Pakistan, Sweden, and Switzerland). Therefore, the effectiveness of existing section 877 may be seriously hindered by certain tax treaties. B. Tax Treaties Will Not Limit the Effectiveness of Proposed Section 877a One of the benefits of the Administration proposal is that it does not conflict with our tax treaties. The proposal assesses tax while the individual is still a U.S. citizen. The United States would be able to impose this tax consistent with all of our treaties because all U.S. tax treaties reserve the right of the United States to tax its citizens as if the treaty had not come into effect. The Administration proposal includes an amendment to the Code to ensure that there is no gap between when an individual terminates U.S. citizenship and when the tax on expatriation is imposed. See proposed section 7701(a)(47). It is possible that there could be a difference between the time that citizenship is terminated for tax purposes and the time that the Department of State considers citizenship terminated. This potential difference should not, however, give rise to tax treaty problems. Tax treaties will use domestic tax rules to determine when individuals terminate U.S. citizenship. "United States Citizenship" is not defined in our treaties. Tax treaties contain a rule which determines how to define terms that are not otherwise defined in the treaty. The language on this point that appears in the 1981 U.S. proposed model tax convention also appears in most U.S. tax treaties: As regards the application of the Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires or the competent authorities agree to a common meaning pursuant to the provisions of Article 25 (Mutual Agreement Procedure), have the meaning which it has under the laws of that State concerning the taxes to which the Convention applies. Article 3(2). Under this language, undefined terms are defined by reference to domestic laws concerning the taxes to which the Convention applies. The proposed tax treaty with France contains language rephrasing this concept to make it more explicit that the tax law definition prevails over other possible legal definitions. The draft of the Treasury Technical Explanation indicates that the rephrasing was requested by France, and that the United States had no objection because "this is consistent with the U.S. position regarding interpretation of this provision." In addition, the 1995 version of the OECD Model treaty will be revised to make this point more explicit. The new version of Article 3(2) will state: As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning which it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State. The OECD Commentary will state that "paragraph 2 was amended in 1995 to conform its text more closely to the general and consistent understanding of Member states." In other contexts, our tax treaties should not be interpreted to look to nontax definitions of an undefined term instead of tax definitions. For example, for tax treaty purposes the term "real property" must be defined under section 897 of the Code, and not by reference to state law. Similarly, for tax treaty purposes the term “dividends" is defined under Subchapter C of the Code, and not by reference to Security and Exchange Act or state corporate law definitions. It is important to note that any difference between proposed section 7701(a)(47) and the Department of State interpretation of when citizenship is terminated is analogous to the difference that exists under current law regarding when an individual is deemed to have abandoned his status as a permanent resident for tax purposes as opposed to immigration law purposes. Under immigration law, a green card is only valid as long as an individual retains residence in the United States. Thus, if an individual permanently moves to another country, for immigration law purposes that individual is no longer a permanent resident of the United States. For tax purposes, however, the individual remains a U.S. permanent resident until that status is revoked or has been administratively or judicially determined to have been abandoned. Section 7701(b)(6)(B). The legislative history to section 877A should indicate that the expatriation provision is not intended to conflict with tax treaties, but if any such conflict is asserted the new statute should prevail. If there are other issues you would like us to address, or if you need additional information, please let me know. Sincerely, LESLIE B. SAMUELS, Assistant Secretary (Tax Policy). KENNETH J. KIES, Esq. DEPARTMENT OF THE TREASURY, Chief of Staff, Joint Committee on Taxation, DEAR MR. KIES: This is in response to your letter of May 5, 1995, addressed to Assistant Secretary Samuels and me, in which you requested certain additional information regarding the legislative proposals that would impose a tax on U.S. citizens and certain long-term permanent residents who expatriate. As with my response, dated April 26, 1995, to your earlier letters, this letter will address your inquiries from the perspective of the Internal Revenue Service. As before, I will follow the general format of your letter. Pursuant to section 6103(f)(2) and (f)(4)(A) of the Internal Revenue Code of 1986, this letter contains tax return information (which has been underlined). I emphasize again that some of the enclosed information contains sensitive data developed from taxpayer cases. Any disclosure of the information (even to the taxpayers involved) is subject to the limitations of section 6103 and could undermine the Government's position in these cases. INFORMATION RELATED TO THE APRIL 4 AND APRIL 7 REQUESTS AND THE RESPONSES THERETO 1. Identification of trust interests. In order to identify trust interest held by an expatriate, the IRS would rely on information obtained from relevant tax and information returns. Under the Administration's expatriation legislative proposal, an expatriate must file a tentative tax return within 90 days following the act of expatriation. It is contemplated that, on this return, the taxpayer would disclose the nature and value of his assets, including interest in any trust, in order to verify the calculation of the tax liability under section 877A. Also, the new and expanded reporting requirements for foreign trusts and their U.S. grantors and beneficiaries that are part of the Administration's foreign trust legislative initiative contained in H.R. 981 will, if enacted, significantly enhance the information available for identifying trust interest held by an expatriating U.S. citizen or resident. In addition, existing tax and information returns from which information could be obtained for purposes of identifying and verifying and expatriate's trust interested would include Form 1040 (schedule E for income distributed from a trust), Form 1041 (for domestic non-grantor trusts) and Form 1040NR (for foreign non-grantor trusts), and any associated Schedules K-1 identifying beneficiaries (by name and taxpayer identifying number). Further sources of such information would include Forms 3520 and 3520A, required to be filed under section 6048 by U.S. persons creating or transferring property to foreign trusts, and TDF Form 90-22.1, required to be filed by U.S. persons with signature authority over or financial interests in foreign financial accounts. As with the entire Federal income tax system, all the information sources described above rely principally on self-assessment and voluntary compliance by taxpayers of fiduciaries. However, the IRS possesses broad investigative powers to verify information provided by taxpayers as well as to detect omitted information and noncompliance. These powers include the authority to obtain taxpayer information from third party sources, such as banks and other third-party record keepers. Further, the IRS can obtain information from treaty partners through the exchange of information programs under tax treaties. 2. ( 3. ( ADDITIONAL INFORMATION REQUESTED BY THE MAY 5 LETTER (1)(a) Double taxation issues under section 877 Risks of potential double taxation arise each time a person or an asset moves across an international border. This systemic problem exists because of the lack of adequate coordination of tax regimes among different countries. Double taxation can result from inter alia discrepancies in rules governing the basis of assets for computing gain, loss, or depreciation, inconsistent source rules, or inconsistent residence determinations. Generally, tax treaties contain provisions designed to alleviate many of these double tax problems, either through substantive provisions or through the mutual agreement procedure. U.S. citizens residing abroad are routinely exposed to double taxation because the United States taxes its nationals on a worldwide basis and their income is also subject to taxation by their foreign country of residence. Because of the foreign tax credit limitation rules of section 904, a residence country tax imposed on the U.S. source income of a U.S. citizen resident abroad is not creditable against his U.S. tax liability on such income, resulting in double taxation. However, many U.S. income tax treaties include special relief provisions to reduce these potential double tax problems. For example, a U.S. citizen residing in France and earning U.S. source consulting fees would be taxed on such income in the United States and, presumably, in France as well. Under U.S. domestic tax rules, the French tax would not be creditable against the U.S. tax; depending upon the French domestic rules governing the source of income and unilateral relief from double tax, the U.S. tax also might not reduce the French tax liability. However, under Article 23.3 of the U.S.-French income tax treaty, relating to Relief from Double Taxation, the U.S. has agreed to resource the income, and both countries have agreed to grant special cross-credits to ensure that the income is fairly taxed in each country while avoiding double tax ation. Not all U.S. income tax treaties contain provisions similar to those contained in Article 23.3 of the U.S.-French income tax treaty. Compare, for example, the French treaty provision with Article 23(3) of the U.S.-U.K. income tax treaty and Article 23.3 of the U.S.-German income tax treaty. While most U.S. income tax treaties contain some provisions that protect U.S. citizens residing in the treaty country from double taxation, the extent of available relief depends in each case upon the provisions of the applicable treaty. Note that these provisions, when present, are self-executing and generally do not require the intervention of the competent authorities. A former U.S. citizen subject to tax on U.S. source income under section 877 is exposed to risks of double taxation similar to those of a U.S. citizen residing in a foreign country. Therefore, such a nonresident alien should generally be entitled to similar relief under income tax treaties to which a U.S. citizen is entitled. When an applicable tax treaty does not include adequate provisions relieving the double taxation of U.S. citizens residing in the treaty jurisdiction, taxpayers may consider seeking assistance from the competent authorities under the mutual agreement procedure of the treaty. The U.S. Competent Authority has had no cases requesting relief from double taxation resulting from the application of section 877 (or for that matter, section 7701(b)(10)). The approach that the U.S. Competent Authority would take in determining if, and the extent to which, the U.S. should grant relief from double taxation resulting from the application of section 877 would be governed by a consideration of iner alia, the terms of the applicable treaty, the facts of the specific case, and the willingness of the foreign competent authority to cede part or all of its tax jurisdiction to the U.S. However, as recent experience has shown, wealthy U.S. citizens who choose to expatriate typically either take up residence in low-tax countries or in high-tax countries which afford them special tax holidays. As a result, such individuals are unlikely to encounter double tax problems. (1)(b) Double taxation resulting from another country's departure tax regime Australia The U.S. Competent Authority has no record of a case requesting relief from double taxation resulting from the application of Australia's departure tax. Although the Australian departure tax is substantially similar in its application to that of Canada, unlike the U.S.-Canada income tax treaty (see below), the U.S.-Australian income tax treaty does not include a specially designed mechanism to relieve the potential double tax that may result from the imposition of the departure tax with respect to appreciated assets on which gain has not yet been realized. Canada The U.S.-Canada income tax treaty contains two special provisions that enable a taxpayer to avoid double taxation resulting from Canada's departure tax. Under Article XIII(5), Canada preserves its right to impose a departure tax on the post-departure disposition of certain property owned by a former long-term resident of Canada. However, under Article XXIV(3)(b), the gain arising from such a disposition is sourced in the United States, and under Article XXIV(2)(c), Canada allows a deduction for the U.S. tax imposed on such gain. This mechanism is helpful when the taxpayer upon departure from Canada has elected to defer the imposition of the Cana |