The rules of taxation should follow changes in society. The ordering of society should NOT be hampered by the rules of taxation!
As the world has become more digital, companies can carry on business from any location. Individuals have become more mobile. Multiple citizenships, factual residences and legal tax residencies are not unusual. It has become clear that the rules of international tax as reflected in tax treaties (as they apply to both corporations and individuals) are in need of reform.
The purpose of this post is to identify two specific areas where US tax treaties are rooted in the world as it was one hundred years ago and NOT as it is today.
First: The “Permanent Establishment” clause found in US and OECD tax treaties
Citizenship And Worldwide Taxation: Is It Morally Justified Or Unjustified?
Date: Friday, May 17th 2019 (View Time On Worldwide Clock)
Host: TaxConnections Live Stream Online YouTube Event
Speaker: John Richardson, Lawyer, Citizenship Solutions
Speaker: Edward Zelinsky, Lawyer, Cardoza School of Law
Moderator: William Byrnes, Lawyer, Texas A&M
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Gaudreau and Civil Engineer highlight the resemblance between citizenship-based and residence-based taxation when residence is implicitly (as in Gaudreau) or explicitly (as in Civil Engineer) defined as domicile, the taxpayer’s permanent home. Both domicile and citizenship are measures of long-term permanent allegiance rather than short-term physical presence. Consequently, the outcomes in tax cases will often be the same whether in personam jurisdiction to tax on a worldwide basis is asserted in terms of an individual’s citizenship or in terms of her domiciliary residence.
Determining domicile – the taxpayer’s permanent home – is often a factually daunting challenge, as is demonstrated by Gaines- Cooper. Consequently, in tax cases, citizenship is an administrable proxy for domicile. From this vantage, the U.S. system of citizenship-based taxation is closer than is generally recognized to other nations’ residence-based tax systems: When residence is defined for tax purposes as the taxpayer’s domicile, citizenship-based and residence-based taxation converge, but citizenship based taxation reaches these similar results more efficiently by eliminating the need for factually intensive inquiries about domicile.
Administrability, Residence, And Citizenship – Overview
As noted earlier, tax mavens often invoke ability-to-pay considerations to justify the worldwide taxation of an individual’s income and assets by the nation in which she resides. The country in which an individual lives exercises in personam jurisdiction over that individual. In addition to such personal jurisdiction, the nation of her residence is often the country in which an individual works (at least in significant part), earns some (often much) of her investment income, and maintains some (often much) of her assets. By virtue of her presence in the country of her residence, that country, the argument goes, is best positioned to measure and tax an individual’s overall capacity to pay by aggregating her worldwide income and assets and by enforcing against this resident the taxation of her aggregate income and assets. These ability-to-pay considerations, combined with the substantial public benefits the nation of residence provides to its residents, underpin the near universal practice of worldwide income taxation by the nation in which an individual lives.
At first blush, this argument for residence-based taxation leaves no room for a defense of citizenship-based taxation. If residence-based taxation of worldwide income and assets is the proper way to measure and tax an individual’s overall abilityto- pay and if such residence-based taxation correctly reflects the governmental benefits bestowed on individuals by virtue of their respective residences, it is the nation in which a U.S. citizen lives which should tax her worldwide income and holdings. If a U.S. citizen lives abroad, it follows from this argument, the nation of residence, rather than the United States, is best positioned to assess such citizen’s ability to pay by aggregating and taxing her worldwide income and assets. Moreover, the nation in which an individual lives is also properly compensated for the public benefits it provides to its residents by taxing globally such residents’ income and assets.
- Citizenship-Based Taxation and Benefits
Against the background established in the last three Parts, we can now assess the merits of the United States’ practice of taxing on the basis of citizenship, with a particular focus on the United States’ policy of taxing its nonresident citizens on their respective worldwide incomes and assets. In this Part, I evaluate citizenship-based taxation in terms of the benefits associated with U.S. citizenship. Governmentally furnished benefits are a traditional consideration for tax policy and, as we have seen, 130 is the rationale of Cook. However, upon examination, the benefits rationale for citizenship-based taxation proves unpersuasive, both in theory and in practice. The most significant civil and social benefits extended by the U.S. polity are tied to U.S. residence, not to U.S. citizenship.
The strongest benefits argument for citizenship-based taxation is one with which citizenship mavens are most uncomfortable, namely, the Tiebout/purchase characterization of citizenship as a public service purchased through tax payments. However, even that approach cannot be squared with the current system, which in practice charges different tax prices (often radically different tax prices) for the identical benefits of U.S. citizenship, depending upon the level and kinds of taxes assessed by the nation in which a U.S. citizen resides and earns his income.
- Implementing Citizenship-Based Taxation
As a final preliminary to evaluating the United States’ citizenship-based taxation of individuals, we must explore the Code’s implementation of such taxation. Recall, in this context, that the Code currently prescribes three different income tax treatments for the foreign taxes paid by U.S. citizens and residents. Foreign income taxes levied against foreign-source income are fully creditable against U.S. income taxes to the extent such foreign taxes are equal to or less than the U.S. taxes assessed against such foreign-source income. 124 All foreign taxes paid in connection with trade, business, and investment activity are deductible for U.S. income tax purposes, as are foreign real property taxes. 125 Other foreign taxes, such as general sales taxes levied by foreign nations, are neither creditable nor deductible. 126 As a result of this disparate treatment of different foreign taxes, otherwise similarly situated U.S. citizens who reside abroad pay different U.S. taxes depending upon the types and amounts of the taxes levied by the countries in which they live and earn their incomes.
- Three Theories of Citizenship
In this Part, I identify three conceptions of U.S. citizenship that help to evaluate the propriety of citizenship-based taxation. Some commentators describe citizenship in terms different from those identified in these three models. 65 Whatever the value of these alternative conceptions of citizenship in other contexts, for the issue explored in this Article – the propriety of taxing on the basis of citizenship – these three models are the useful approaches to citizenship and the benefits defense of citizenship based taxation.
- The Minimalist Model
For Professor Bickel, a minimalist conception of U.S. citizenship both describes the reality of U.S. law and embodies a normatively desirable state of affairs: “Happily,” Professor Bickel wrote, “the concept of citizenship [*1304] plays only the most minimal role in the American constitutional scheme.” 66 Prior to the adoption of the post-Civil War Amendments, the U.S. Constitution “contained no definition of citizenship and precious few references to the concept altogether.” 67 Citing the First and Second Amendments, Professor Bickel noted that “the Bill of Rights throughout defines rights of people, not of citizens.” 68 Thus, “the original Constitution presented the edifying picture of a government that bestowed rights on people and persons, and held itself out as bound by certain standards of conduct in its relations with people and persons, not with some legal construct called citizen.” 69
1. An Overview of U.S. Citizenship-Based Taxation of Individuals
There are two bases on which nations may exercise the jurisdiction to tax: source and political allegiance. 4 Under the heading of source, a nation taxes in rem income or assets located (“sourced”) within its borders regardless of where the owner of such income or assets lives. On a theoretical level, source-based taxation reflects the claim of the nation in which income arises or assets are held that such nation provides the benefits [*1294] within its territory that protect such income or assets. 5 On a pragmatic level, source-based taxation reflects the practical ability of the nation in which income or an asset is located to impose tax before such income or asset is remitted to the owner abroad.