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Tax Treaty Tiebreaker And Taxation Of Subpart F And PFIC



John Richardson

Before a “Green Card” holder uses the “Treaty Tiebreaker” provision of a U.S. Tax Treaty, he/she must consider what is the effect of using the “Treaty Tiebreaker” on:

A. His/her immigration status under Title 8 (will he/she risk losing the Green Card?)

B. His/her status under Title 26 (will he expatriate himself under Internal Revenue Code S. 7701(b)) and subject himself to the S. 877A “Exit Tax” provisions?

Now, on to the post

The Internal Revenue Code of the United States imposes (1) requirements for taxation (determining how much tax is payable by various individuals) and (2) requirements for information reporting returns. For “U.S. Persons Abroad” the “information reporting requirements” are far more onerous.

Who is a U.S. Person?

“U.S. Persons” are defined in Internal Revenue Code S. 7701 (30) to include:

“(A) a citizen or resident of the United States”

The term “citizen” is defined in the Immigration and Nationality Act, but NOT in the Internal Revenue Code. The term “resident” is defined in S. 7701 (b) of the Internal Revenue Code. Specifically, an “alien” who who is a “lawful permanent resident of the United States at any time in the year” (Green Card holder) is a U.S. resident (but not the only kind) for tax purposes.

Therefore, the term “U.S. Person” includes Green Card Holders

U.S. Persons and the Subpart F rules for the attribution of income from “foreign” corporations to “U.S. Persons”

The basic idea is to punish “U.S. Persons” who use “foreign corporations” for “tax deferral”.

It is important to note that Internal Revenue Code Sections 951 – 965 (the Subpart F rules) appear in the section that includes income “without” the United States. This means that Subpart F income is “foreign source” income. “Non-residents” are taxable ONLY on U.S. source income.

What is a “Treaty Tie Breaker” rule?

It’s possible for a person to be treated as a “tax resident” of two countries. In this case a Tax Treaty can be used to determine in which country the person is a “tax resident”. For example Section 2 of Article IV of the Canada U.S. Tax Treaty says:

2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:

(a) he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him; if he has a permanent home available to him in both States or in neither State, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests);

(b) if the Contracting State in which he has his centre of vital interests cannot be determined, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;

(c) if he has an habitual abode in both States or in neither State, he shall be deemed to be a resident of the Contracting State of which he is a citizen; and

(d) if he is a citizen of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.

Q. What is the “effect” of using the “Treaty Tiebreaker” rule to deem a person to NOT be a U.S. resident (when he is still a “U.S. Person”?

A. He will taxable on ONLY U.S. source income

B. He will still be subject to the “information reporting requirements” in the Internal Revenue Code.

As explained by the IRS in Publication 519:

If you are treated as a resident of a foreign country under a tax treaty, you are treated as a nonresident alien in figuring your U.S. income tax. For purposes other than figuring your tax, you will be treated as a U.S. resident.

(Note that this means one would be treated as a “U.S. resident” for determining whether a “foreign corporation” is a “controlled corporation”.)

The effect of the “Treaty Tiebreaker” and the taxation of Subpart F income

A “nonresident” is NOT taxable on “non-U.S. income”. Therefore, a Green Card holder who uses the “Treaty Tiebreaker” to become a nonresident will NOT be taxable on Subpart F income!

The effect of the “Treaty Tiebreaker” and the taxation of PFIC income

A “nonresident” is NOT taxable on “non-U.S. income”. Therefore, a Green Card holder who uses the “Treaty Tiebreaker” to become a nonresident will NOT be taxable on PFIC income (which is income from a “foreign corporation”!

Who is eligible to make use of the “Treaty Tiebreaker” rules?

1. The treaty “savings clause” prevents U.S. citizens from being treated solely as a resident of Canada.

2. Note that the “Treaty Tie Breaker” rules are available to “Green Card” holders (but be very cautious). Before a “Green Card” holder uses the “Treaty Tiebreaker” he/she must consider what is the effect of using the “Treaty Tiebreaker” on:

A. His/her immigration status under Title 8 (will he/she risk losing the Green Card?)

B. His/her status under Title 26 (will he expatriate himself under Internal Revenue Code S. 7701(b)) and subject himself to the S. 877A “Exit Tax” provisions?

The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a Toronto based 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.”

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.

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One thought on “Tax Treaty Tiebreaker And Taxation Of Subpart F And PFIC

  1. Can you discuss how a dual citizen US & Canadian can use the treaty tiebreaker to their benefit when living permanently in Canada?

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