Application of Tax Treaties to U.S. Citizens Residing Abroad

U.S. citizens and residents earning income abroad may find that their income is subject to tax in multiple jurisdictions.  Some of the effects of double taxation on foreign source wages, dividends, interest, royalties and other payments can be ameliorated through a network of income tax treaties which the U.S. has with other countries. The U.S. has income tax treaties with over 60 countries.  While the effect of these treaties may be to lower the combined tax rate, most of these treaties contain provisions which prevent a U.S. citizen or resident from using a treaty to avoid U.S. tax on U.S. source income.

The application of tax treaties to U.S. citizens can be a complex exercise. Therefore, our approach is to proceed in a series of steps.

First, it is important to make sure that all parties are aware that the starting point for any discussion is to realize that the U.S. domestic tax law applies to U.S. citizens no matter where they live, no matter where their assets are located, and no matter how they are taxed under foreign law.

It is also important to fully understand the extent of the U.S. reporting rules (which are different than the tax rules) for U.S. taxpayers with foreign financial assets.

Next, is to perform a review of the client’s holdings and their recent U.S. tax returns to make sure the tax liability as well as their information reporting has been handled properly.

Then it is time to review how a particular treaty may work.   On an initial reading of a treaty it often appears to provide enormous relief from U.S. taxation for someone who is living abroad. However, most (maybe all tax treaties) have a section in them referred to as a “limitation of benefits” provision. The net effect of such a provision is that the U.S. government retains the right to tax its citizens under the general rules of the US. In other words, a U.S. taxpayer can’t escape U.S. tax by living outside the U.S., or by holding foreign assets.  It is worth noting that the sourcing rules in a treaty do help preserve the ability of a U.S. citizen to avoid double taxation with strong tax credit provisions.

When a U.S. citizen or resident client believes that the actions of either the United States or a treaty country will cause a tax situation not intended under the treaty between those two countries, s/he may seek assistance from the U.S. competent authority.  The procedures for seeking that assistance are outlined in Revenue Procedure 98-21 for Canada and Revenue Procedure 2015-40 for all other countries.

It is important to make a request for competent authority as soon as you have been denied treaty benefits, or the actions of the United States or the treaty country result in double taxation or taxation not intended by the treaty.  Unless specified in the treaty, taxpayers have discretion as to the time to file a request for competent authority; however, delaying such requests may preclude effective relief.  It is important to also take note and follow through with the proper measures to seek relief from the treaty country as well.  It is highly recommended to seek the advice of a tax professional if you believe that you must request U.S. competent authority due to double taxation or taxation not intended by a treaty.