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By Thomas S. Bissell, CPA Celebration, Florida
Previous articles by this author have discussed situations in which most of the U.S.’s income tax treaties could be interpreted so as to override two particular Code provisions: the “anti-inversion” excise tax under §4985 (enacted in 2004), which can tax nonresident alien “insiders” on certain stock rights allocable to foreign-source services income, and the “net investment income tax” (NIIT) under §1411 (enacted in 2010), which can impose a 3.8% tax on foreign-source investment income of U.S. citizens and resident aliens but without any foreign tax credit relief.
As discussed in another related article, the §4985 excise tax clearly can be imposed on a nonresident alien “insider” who owns so-called specified stock compensation (SSC) rights on the date on which a U.S. company is reorganized into a foreign corporation pursuant to an “inversion,” provided that certain tests are met. The tax (which is imposed on a “mark-to-market” basis) may arguably be imposed even though all of the nonresident alien's services are rendered outside the United States, so that the SSC rights would not be subject to any U.S. personal income tax when the individual actually exercises his or her SSC rights at a later date. However, under most U.S. income tax treaties, a strong argument can be made that the §4985 excise tax is actually a federal “income tax,” and thus that the tax is overridden by the treaty provisions which prevent the United States from taxing foreign-source personal services income of a nonresident alien who is resident in the treaty country.
A different treaty issue arises in applying the NIIT, which is imposed only on U.S. citizens and resident aliens (and never on nonresident aliens). There are three principal situations in which an individual who is subject to the NIIT might benefit from claiming the benefits of a foreign tax credit, where a particular item of net investment income is subject to foreign income tax. Although the NIIT rules do not provide that a foreign tax credit may ever be claimed against the NIIT, it is arguable that the NIIT is a tax “covered” by most U.S. income tax treaties, and thus that a foreign tax credit may be claimed against it under the “Relief from Double Taxation” provisions of the same treaty.
The principal difficulty in assessing the tax treaty implications under both §4985 and §1411 is that both the Code (including the enabling legislation) and the legislative history of each section are silent on the issue. Resolving this problem is made even more difficult by the rule of §7852(d)(1) (enacted in 1988), which provides in effect that in “determining the relationship between a provision of a treaty and any [federal tax law], neither the treaty nor the law shall have preferential status …” Some commentators have suggested that this provision should be construed to mean that an automatic “later in time” rule should always be applied, with the result that if a statute is enacted that conflicts with a pre-existing tax treaty, the treaty will by definition be overridden — even if both the Code and the legislative history are silent on the conflict. In still another related article on the problem of “silence,” however, this author concluded on the basis of the legislative history of §7852 itself that while there is a slight presumption in favor of a “later in time” rule under §7852(d)(1), nevertheless it is necessary to consult other sources in order to determine how Congress would have resolved the issue if it had been aware of it. Such other sources include other Code sections, other treaties, court decisions, statements by individuals in the legislative and executive branch, and statements and articles by outside commentators.
In a previous article on this subject, therefore, it was concluded that when the anti-expatriation “inheritance tax” under §2801 was enacted in 2008, and where both the Code and the legislative history are silent on the clear conflict between §2801 and many pre-existing U.S. estate tax treaties, a strong argument can be made that Congress did not intend to override those treaties (or at least that it would not have taken additional steps to override them, if it had been made aware of the issue). That conclusion was based primarily on the fact that the related income tax provisions in the same law were careful to acknowledge the existence of a Code-treaty conflict, and to prescribe the extent to which an override would or would not occur in three specific instances.
If one adopts a similar approach and looks beyond §4985 itself to the rest of the “anti-inversion” legislation in 2004 — i.e., the enactment of the applicable corporate tax rules in new §7874 — it is clear that Congress was definitely aware of a Code-treaty conflict, because Congress provided specifically in new subsection (f) that “nothing in section 894 or 7852(d) … shall be construed as permitting an exemption, by reason of any treaty obligation of the United States heretofore or hereafter entered into, from the provisions of this section.” In effect, therefore, Congress clearly provided in the Code itself that the new corporate anti-inversion rules of §7854 were to prevail over not only all existing income tax treaties, but also over all subsequently ratified treaties. The fact that no similar provisions were included in the related anti-inversion rules of §4985 (or even mentioned in the legislative history of §4985) suggests strongly that to the extent that a Code-treaty conflict may exist under §4985, Congress did not intend any existing treaties to be overridden. This argument is strengthened by the fact that §4985 itself might well be construed by a court so as not to apply at all to the foreign-source compensation of nonresident alien individuals even in the absence of a tax treaty.
The analysis of the Code-treaty conflict under §1411 is different. In the first place, it probably cannot be argued under the Code itself that a foreign tax credit should be allowed against the NIIT, because nothing in the NIIT provisions or in the general foreign tax credit provisions (§§901 ff.) can be construed so as to allow the credit. This is in contrast with §4985, which arguably can be construed as never applying to the foreign-source compensation of a nonresident alien. However, it can clearly be argued that a foreign tax credit should be allowed against the NIIT under most income tax treaties. To the extent that a foreign tax credit is in fact available under the provisions of a particular treaty, therefore, the question must then be resolved whether the enactment of §1411 in 2010 had the effect of overriding all conflicting tax treaties — even though both the Code and the legislative history are silent on this question.
In considering this issue, it may be helpful to examine how the courts dealt with the Code-treaty conflict that came into being when Congress enacted the so-called “alternative minimum tax” (AMT) limitation on the foreign tax credit in 1986. That rule (contained in Code §59(a)(2), since repealed) provided that for AMT calculation purposes, no more than 90% of a taxpayer's AMT could be reduced by foreign tax credits. This limitation arguably conflicted with most income tax treaties, because the AMT is/was a tax “covered” by most treaties (since it is/was a tax on “income”), and because most treaties provide specifically that a foreign tax credit is allowed against U.S. income taxes with respect to income taxes imposed on the same income by the (foreign) treaty country. Although the 1986 legislation (and the related legislative history) were silent on the Code-treaty conflict, when Congress enacted “TAMRA” in 1988, it specifically provided that the AMT foreign tax credit limitation that had been enacted two years earlier was to apply “notwithstanding any treaty obligation of the United States.” This was the principal basis on which the Tax Court subsequently ruled in 1995 that §59(a)(2) had overridden the conflicting provisions in the U.S.-Canada income tax treaty.
Although the NIIT under §1411 is clearly different from the since-repealed provisions of §59(a)(2), there are obvious similarities. Both the NIIT and the AMT are imposed on specific elements of “income,” and while neither tax is specifically mentioned in any treaty as a tax that is “covered” by the treaty, both taxes are almost certainly covered by most treaties because they fit within the general treaty definition of “Federal income taxes imposed by the Internal Revenue Code.” Under the “Relief from Double Taxation” provisions of most U.S. income tax treaties, the United States agrees to allow “as a credit against the United States tax on income” the income taxes paid to the (foreign) treaty country. In 1988 Congress enacted §7852 to deal with conflicts between treaties and the Code, and as part of that legislation it specifically clarified how the conflict was to be resolved with respect to the recently enacted AMT foreign tax credit rules. One can certainly conclude from that history that if a similar foreign tax credit issue were to arise ever again under the U.S. income tax treaties, the treaties would be overridden only if Congress specifically mandated such an override, either in the legislation itself, or at least in the legislative history. Where both the Code (including the enabling legislation) and the legislative history are silent, therefore, it would appear that a strong argument can be made to the effect that no override has occurred. Congress can certainly provide for such an override at a later date, and perhaps even retroactively, but until that happens, it does not seem unreasonable to interpret Congressional “silence” to mean that when Congress enacted §1411 in 2010, it did not intend for an override to occur.
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