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In The 21st Century The Most Important Thing About A Person Is Tax Residency



John Richardson- Residency Determines Tax

Green Card holders are deemed to be U.S. tax residents under the Internal Revenue Code. In most circumstances Green Card Holders are also treated as U.S. tax residents under U.S. tax treaties.

U.S. Green Card holders have traditionally been able to use tax treaties to sever “tax residence” with the United States. This decision carries both burdens and benefits and should never be undertaken without competent professional advice. (For Green Card holders who are “long term residents“, the use of a “tax treaty tie breaker” will result in expatriation. Expatriation may trigger the imposition of the Sec. 877A Expatriation Tax.)

The tax treaty tie breaker is available if and only if the individual is, according to the tax treaty, a tax resident of BOTH the United States and the treaty partner country.

Typically the tax treaty tie breaker is a mechanism where one uses the provisions of the tax treaty to assign tax residency to one and only one country according to the tax treaty.

To repeat: a condition precedent to the use of the tax treaty tie breaker is that the individual be a tax resident of both countries according to the tax treaty.

Most tax treaties provide that if an individual is a tax resident of Country A according to domestic law, then the individual is a resident of Country A under the treaty. In other words, tax residency under the terms of the treaty follows from tax residency under domestic law.

Prior to the U.S. UK Tax Treaty of July 24, 2001, tax residency for Green Card holders according to the tax treaty, followed from tax residency under domestic law.

The U.S. UK Tax Treaty of July 24, 2001 changed this basic rule. The July 24, 2001 tax treaty contains a provision that provides that tax residency under the U.S. UK tax treaty, does not necessarily follow from tax residency under U.S. domestic law. Specifically Article 4 Paragraph 2 states that Green Card holders will NOT be treated as U.S. tax residents under the U.S. UK Tax treaty except as follows:

  1. An individual who is a United States citizen or an alien admitted to the United States for permanent residence (a “green card” holder) is a resident of the United States only if the individual has a substantial presence, permanent home or habitual abode in the United Statesand if that individual is not a resident of a State other than the United Kingdom for the purposes of a double taxation convention between that State and the United Kingdom.

Paragraph 2 of Article 4 provides a presumption against U.S. tax residency for Green Card holders resulting in U.S. tax residency under the U.S. U.K. tax treaty.

The purpose of this post is to explore the implications of this unusual provision and how it impacts Green Card holders who are tax residents of the UK.

Part A – U.S. UK Tax Treaty – Prior to July 24, 2001 (1975)

Pursuant to the 1975 U.S. UK Tax Treaty, tax residency under the treaty followed from tax residency under domestic law. (Interestingly it was not until 1984 that the United States adopted a system of deemed tax residency for Green Card Holders.)

ARTICLE 4
Fiscal Residence

(1) For the purposes of this Convention:
(a) the term “resident of the United Kingdom” means:
(i) any person, other than a corporation, resident in the United Kingdom for the purposes of United Kingdom tax; but in the case of a partnership, estate, or trust, onlyto the extent that the income derived by such partnership, estate, or trust is subject to United Kingdom tax as the income of a resident, either in its hands or in the hands of its partners or beneficiaries; and
(ii) a corporation whose business is managed and controlled in the United Kingdom;
(b) the term “resident of the “United States” means:
(i) any person, other than a corporation, resident in the United States for the purposes of United States tax; but in the case of a partnership, estate, or trust, only to the extent that the income derived by such partnership, estate, or trust is subject to United States tax as the income of a resident, either in its hands or in the hands of its partners or beneficiaries; and
(ii) a United States corporation.
(2) Where by reason of the provisions of paragraph (1) an individual is a resident of both Contracting States, then the individual’s tax status shall be determined as follows:
(a) the individual shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him. If the individual has a permanent home available to him in both Contracting States or in either of the Contracting States, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closest (centre of vital interests);
(b) if the Contracting State in which the individual’s centre of vital interests is located cannot be determined, he shall be deemed to be a resident of that Contracting State in which he has an habitual abode;
(c) if the individual has an habitual abode in both Contracting States or in neither of them, he shall be deemed to be a resident of the Contracting State of which he is a national; and
(d) if the individual is a national of both Contracting States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.

https://www.irs.gov/pub/irs-trty/uk.pdf

Part B – The U.S. UK Tax Treaty – signed July 24, 2001

The 2001 Tax Treaty changed the rule that U.S. tax residency according to the Treaty automatically followed from U.S. tax residency under the Internal Revenue Code.

ARTICLE 1

General Scope
1. Except as specifically provided herein, this Convention is applicable only to persons who are residents of one or both of the Contracting States.
2. This Convention shall not restrict in any manner any benefit now or hereafter accorded:
a) by the laws of either Contracting State; or
b) by any other agreement between the Contracting States.
3. a) Notwithstanding the provisions of sub-paragraph b) of paragraph 2 of this Article:
(i) any question arising as to the interpretation or application of this Convention and, in particular, whether a taxation measure is within the scope of this Convention, shall be determined exclusively in accordance with the provisions of Article 26 (Mutual Agreement Procedure) of this Convention; and
(ii) the provisions of Article II and Article XVII of the General Agreement on Trade in Services shall not apply to a taxation measure unless the competent authorities agree that the measure is not within the scope of Article 25 (Non-discrimination) of this Convention.
b) For the purposes of this paragraph, a “measure” is a law, regulation, rule, procedure, decision, administrative action, or any similar provision or action.
4. Notwithstanding any provision of this Convention except paragraph 5 of this Article,a Contracting State may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship may tax its citizens, as if this Convention had not come into effect.
5. The provisions of paragraph 4 of this Article shall not affect:
a) the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises), sub-paragraph b) of paragraph 1 and paragraphs 3 and 5 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support),paragraph 1 of Article 18 (Pension Schemes) and Articles 24 (Relief From Double Taxation), 25 (Non-discrimination), and 26 (Mutual Agreement Procedure) of this
Convention; and
b) the benefits conferred by a Contracting State under paragraph 2 of Article 18 (Pension Schemes) and Articles 19 (Government Service), 20 (Students), and 28 (Diplomatic Agents and Consular Officers) of this Convention, upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State.
6. A former citizen or long-term resident whose loss of citizenship or long-term resident status had as one of its principal purposes the avoidance of tax (as defined under the laws of the Contracting State of which the person was a citizen or long-term resident) shall be treated for the purposes of paragraph 4 of this Article as a citizen of that Contracting State but only for a period of 10 years following the loss of such status. This paragraph shall apply only in respect of income from sources within that Contracting State (including income deemed under the domestic law of that State to arise from such sources). Paragraph 4 of this Article shall not apply in the case of any former citizen or long-term resident of a Contracting State who ceased to be a citizen or long-term resident of that State at any time before February 6th,1995.

ARTICLE 4
Residence
1. Except as provided in paragraphs 2 and 3 of this Article, the term “resident of a Contracting State” means, for the purposes of this Convention, any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or of profits attributable to a permanent establishment in that State.

  1. An individual who is a United States citizen or an alien admitted to the United States for permanent residence (a “green card” holder) is a resident of the United States only if the individual has a substantial presence, permanent home or habitual abode in the United States and if that individual is not a resident of a State other than the United Kingdom for the purposes of a double taxation convention between that State and the United Kingdom

https://www.treasury.gov/resource-center/tax-policy/treaties/documents/uktreaty.pdf

In order to be a U.S. tax resident under the U.S. UK tax treaty, a Green Card holder must now meet two conditions: (1) he must have a specified nexus to the USA and (2) he cannot, pursuant to a tax treaty between the UK and another country, be a tax resident of that other country.

The Implications of NOT being a U.S. Tax Resident UnderThe U.S. UK Tax Treaty Are Two-Fold:

First: The Green Card holder will always be a U.S. tax resident under U.S. domestic law, but not under the tax treaty. If a Green Card holder is not a U.S. tax resident under the U.S. UK tax treaty, a Green Card Holder cannot use the tax treaty tie breaker provision to cease being a U.S. tax resident under that tax treaty. To put it simply: the provisions of the tax treaty tie breaker provision are not available.

Second: Because the tax treaty tie breaker provision is not available, the Green Card holder will always be treated/taxed as a U.S. tax resident under U.S. domestic law. (This is in effect the equivalent of the “saving clause” (applied to U.S. citizens) for Green Card holders. The Green Card holder will have treaty benefits (including the exclusions from the saving clause) because he is a UK tax resident.

Part C – The meaning of the two necessary conditions to qualify as a U.S. tax resident under the treaty: Joint Committee of Taxation Comments on Paragraph 2 of Article 4

Interestingly the JCT made no attempt to analyse this provision. An analysis of this issue is notably absent in their report and is addressed only in the following excerpt.

Proposed treaty rules

The proposed treaty specifies rules to determine whether a person is a resident of the United States or the United Kingdom for purposes of the proposed treaty. The rules generally are consistent with the rules of the U.S. model.

The proposed treaty generally defines ‘‘resident of a Contracting State’’ to mean any person who, under the laws of that country, is liable to tax in that country by reason of the person’s domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature. The term ‘‘resident of a Contracting State’’ does not include any person that is liable to tax in that country only on income from sources in that country or on profits attributable to a permanent establishment in that country. The proposed treaty provides that the United Kingdom will treat an individual who is a U.S. citizen or lawful permanent resident of the United States (i.e., a ‘‘green card’’ holder) as a resident of the United States only if he or she has a substantial presence, permanent home, or habitual abode in the United States and is not a resident of a third country for purposes of a tax treaty between such country and the United Kingdom. The determination of whether a citizen or national is considered a resident of the United States or the United Kingdom is made based on the principles of the treaty tie-breaker rules described below.

https://www.jct.gov/publications.html?func=startdown&id=1693

(Note that the JCT fails to acknowledge that this is a change from the previous treaty provision. It is impossible to tell whether the JCT appreciates the effect of this change.)

Part D – The meaning of the two necessary conditions to qualify as a U.S. tax resident under the treaty: U.S. Treasury Technical Interpretation

The technical interpretation does make an effort to “unpack this” as follows …

Paragraph 2

Paragraph 2 contains an exception to the general rule of paragraph 1 that residence under internal law also determines residence under the Convention. The exception applies with respect to a U.S. citizen or alien lawfully admitted for permanent residence (i.e., a “green card” holder).

Under paragraph 1, a person is considered a resident of a Contracting State for purposes of the Convention if he is liable to tax in that Contracting State by reason of citizenship. Although this rule applies to both Contracting States, only the United States taxes its non-resident citizens in the same manner as its residents. In addition, aliens admitted to the United States for permanent residence (“green card” holders) qualify as U.S. residents under the first sentence of paragraph 1 because they are taxed by the United States as residents, regardless of where they physically reside.

Under the exception of paragraph 2, a U.S. citizen or green card holder will be treated as a resident of the United States for purposes of the Convention, and, thereby entitled to treaty benefits, only if he meets two conditions. First, he must have a substantial presence (see section 7701(b)(3)), permanent home or habitual abode in the United States. This rule requires that the U.S. citizen or green card holder have a reasonably strong economic nexus with the United States. Second, he must not be treated as a resident of a state other than the United Kingdom under any treaty between the United Kingdom and a third state. This rule prevents a U.S. citizen or green card holder who is a resident of a country other than the United States or the United Kingdom from choosing the benefits of the Convention over those provided by the treaty between the United Kingdom and his country of residence. If the U.S. citizen or green card holder’s country of residence does not have a treaty with the United Kingdom, however, then he will be treated as a resident of the United States as long as he meets the first requirement of an economic nexus. If such a person is a resident of both the United States and the United Kingdom, whether or not he is to be treated as a resident of the United States for purposes of the Convention is determined by the tie-breaker rules of paragraph 4.

Thus, for example, an individual resident of Mexico who is a U.S. citizen by birth, or who is a Mexican citizen and holds a U.S. green card, but who, in either case, has never lived in the United States, would not be entitled to benefits under the Convention. However, a U.S. citizen who is transferred to Mexico for two years would be entitled to benefits under the Convention if he maintains a permanent home or habitual abode in the United States and is not a resident of Mexico for purposes of the U.K.-Mexico tax treaty. If he were treated as a resident of Mexico under the U.K.-Mexico tax treaty, he could claim only the benefits of that treaty, even if the Convention would provide greater benefits.

The fact that a U.S. citizen who does not have close ties to the United States may not be treated as a U.S. resident under the Convention does not alter the application of the saving clause of paragraph 4 of Article 1 (General Scope) to that citizen. For example, a U.S. citizen who pursuant to the “citizen/green card holder” rule is not considered to be a resident of the United States still is taxable on his worldwide income under the generally applicable rules of the Code.

https://www.treasury.gov/resource-center/tax-policy/treaties/Documents/teus-uk.pdf

Part E – IRS Commentary – July 3, 2018

On July 3, 2018 the IRS completed a helpful document titled: “Determining an Individual’s Residency for Treaty Purposes“. The IRS procedural analysis was the subject of commentary here and here.

On page 16, the IRS offers useful commentary to alert individuals to the possibility that “tax residence” for domestic purposes, may not equate to “tax residence” for treaty purposes. Specifically, the IRS (consistent with Article 4 Paragraph 2 of the U.S. UK tax treaty) says:

Additional requirements:

Some treaties require that U.S. citizens or LPRs satisfy additional requirements to be residents of the United States for purposes of a treaty. For example, a treaty might provide that U.S. citizens or LPRs will not be treated as U.S. residents for treaty purposes unless—

  • They have a substantial presence, permanent home, or habitual abode in the United States
    and are not treated as residents of a third country under a treaty between the other
    Contracting State and that third country.
  • IRC 7701(b)(3)
    § They have a substantial presence in the United States or they would be a resident of the
    United States and not a resident of a third country under the principles of the tie-breaker
    rules.
    CAUTION: The substantial presence requirement appears in some treaties. The
    substantial presence requirement in these treaties is different from the substantial
    presence test (discussed earlier) in IRC 7701(b)(3), which applies to determine
    whether an individual is a resident alien under U.S. domestic law. Be sure to carefully
    read the text of the treaty you are applying and only refer to this Practice Unit as
    general guidance.

DECISION POINT: After determining that an individual is a resident for U.S. domestic
law purposes, determine whether the individual is a U.S. resident for treaty purposes
based on the text of the treaty before application of the tie-breaker rule (if the resident
claims residence in the treaty country).

(In the sidebar the IRS notes that the treaties with both the UK and France have provisions that may restrict circumstances under which a person who is a U.S. tax resident under U.S. law is NOT a U.S. tax resident under the treaty.

  • US-UK Treaty, Art. 4(2)
    § TE to US-UK Treaty, Art. 4(2)
    § US-France Treaty, Art. 4(2)
    § TE to US-France Treaty, Art. 4(2))

https://www.irs.gov/pub/irs-utl/tre_p_016_02_01_06.pdf

Part F – What are the implications for Green Card Holders who are tax residents of the UK?

First: Without satisfying the two part test, the Green Card holder will NOT be considered to be a U.S. tax resident under the tax treaty. This means that he cannot be a dual resident under the tax treaty. If he cannot be a dual tax resident under the treaty, he cannot cease to be a dual resident under the tax treaty. Because he cannot cease to be a dual resident under the treaty, the Green Card holder CANNOT cease to be a U.S. tax resident under the Tax Treaty. He will not secure the benefits of NOT being a U.S. tax resident. As a U.S. tax resident he will be subject to worldwide taxation (including CFC and PFIC income) on a properly filed 1040. In summary – he will continue to be subject to U.S. worldwide taxation and must file a 1040.

Second: The Green Card holder continues to be a tax resident of the UK according to the tax treaty. Therefore he continues to have the tax treaty benefits afforded to residents of the UK.

Third: The Green Card holder will continue to reduce his U.S. taxation through the use of Foreign Tax Credits and/or the FEIE (“Foreign Earned Income Exclusion”).

Fourth: Green Card holders should take care when using the Foreign Section 911 “Foreign Earned Income Exclusion”. The use of the Foreign Earned Income Exclusion may jeopardise the immigration requirement of intending to live permanently in the United States.

If the individual wishes to use the Section 911 Foreign Earned Income Exclusion is it suggested that:

– he should NOT use the bona fide resident test*; and

– should use the “physical presence” test

_______________________________________________________________________________________

*Interestingly the statutory language of Section 911 does NOT allow for a Green Card holder to use the bona fide resident test. As Virgina La Torre Jeker notes:

Bona Fide Residence Test and An Applicable Tax Treaty

A green card holder can also qualify for the FEIE under the BFR Test if the green card holder is a “bona fide resident” of a foreign country or countries for an uninterrupted period that includes an entire tax year, AND the individual is a citizen or national of a country with which the United States has an income tax treaty in effect. In particular, the tax treaty must have a nondiscrimination clause. See Publication 901, U.S. Tax Treaties, for a list of these countries. A nondiscrimination clause is a fundamental provision in every income tax treaty. Essentially, a nondiscrimination clause seeks to ensure that citizens/nationals and residents of one of the treaty partner jurisdictions are not discriminated against by the other treaty partner jurisdiction. Essentially, a signatory to the treaty, may not discriminate against the citizens / nationals, or residents of the other signatory. Absent a specific treaty provision or a provision of the reg­ulations under the treaty to the contrary, the non-discrimination article in a United States income tax treaty will be applied without regard to the saving clause in the treaty.

See Revenue Ruling 91-58 1991-2 C. B. 340 addressing the issue whether United Kingdom nationals who hold a green card can qualify for the FEIE under the BFR test enunciated in Internal Revenue Code Section 911. The Revenue Ruling stated: “Because citizens of the United States may be treated as qualified individuals for purposes of section 911(d) of the Code under either the bona fide resi­dence test or the physical presence test, requiring nationals of the United King­dom to satisfy the physical presence test subjects them to a requirement connected with section 911 which is more burden­some than the taxation and connected requirements to which citizens of the United States in the same circumstances are subjected. Accordingly, nationals of the United Kingdom must be treated as qualified individuals for purposes of sec­tion 911 if they satisfy the requirements of the bona fide residence test.”

If a green card holder decides to use the BFR, based on a Treaty containing a nondiscrimination clause, he should file Form 8833 treaty return position disclosure.

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The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a dual citizen. I am a lawyer – member of the Bar of Ontario. This means that, any counselling session you have with me will be governed by the rules of “lawyer client” privilege. This means that:

“What’s said in my office, stays in my office.”

I am also a member of the American Citizens Abroad Professional Tax Advisory Council (PTAC). This is an advisory panel focused on assisting American Citizens Abroad in an FBAR and FATCA world.

The U.S. imposes complex rules and life restrictions on its citizens wherever they live. These restrictions are becoming more and more difficult for those U.S. citizens who choose to live outside the United States.

FATCA is the mechanism to enforce those “complex rules and life restrictions” on Americans abroad. As a result, many U.S. citizens abroad are renouncing their U.S. citizenship. Although this is very sad. It is also the reality.