Nondiscrimination Under Article XXV of Canada-U.S Treaty

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testone
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Nondiscrimination Under Article XXV of Canada-U.S Treaty

Post by testone »

Let’s say that you have a single individual (“Georgeâ€￾) that lives in Canada, is a Canadian citizen, and becomes a U.S. citizen (with or without moving to the U.S.) on June 1, 2012.

Let’s also say that you have a single individual (“Henryâ€￾) that lives in Canada, is a Canadian citizen, and becomes a U.S. resident (with or without moving to the U.S.) on June 1, 2012.

Treas. Reg. §1.6012-1(b)(2)(ii)(a) provides:
“If an alien individual becomes a citizen or resident of the United States during the taxable year and is a citizen or resident of the United States on the last day of such year, he must make a return of Form 1040 for the taxable year. However, a separate schedule is required to be attached to this return to show the income tax computation for the part of the taxable year during which the alien was neither a citizen nor resident of the United States, unless an election under section 6013(g) or (h) is in effect for the alien. A Form 1040NR, clearly marked "Statement" across the top, may be used as such a separate schedule.â€￾

This regulation provides the rule that individuals who become U.S. citizens or U.S. residents during the year must file a “dual statusâ€￾ tax return. So, under U.S. domestic law, an individual that becomes a U.S. citizen during the year must file a “dual statusâ€￾ tax return. This is the same treatment as provided for individuals that become residents during the year.

George became a U.S. citizen during 2012. Under U.S. domestic law, George would be required to file a dual status tax return.

Henry became a U.S. resident during 2012. Under U.S. domestic law, Henry would be required to file a dual status tax return.

Treas. Reg. §1.871-13 provides:
“Income from sources without the United States which is not effectively connected with the conduct by the taxpayer of a trade or business in the United States is not taxable if received by an alien individual while he is not a resident of the United States even though he becomes a citizen or resident of the United States after its receipt and before the close of the taxable year. However, income from sources without the United States which is not effectively connected with the conduct by the taxpayer of a trade or business in the United States is taxable if received by an individual while he is a citizen or resident of the United States, even though he earns the income earlier in the taxable year while he is neither a citizen nor resident of the United States.â€￾

This regulation provides the rule that individuals who become U.S. citizens or U.S. residents during the year are not taxed on foreign income received prior to becoming U.S. citizens or U.S. residents, but they are taxed on all income received after becoming U.S. citizens or U.S. residents. So, under U.S. domestic law, an individual that is not a resident of the U.S. who becomes a U.S. citizen during the year is not taxed on foreign income received prior to becoming a U.S. citizen. This is the same treatment as provided for individuals that become residents during the year.

George became a U.S. citizen during 2012. Under U.S. domestic law, George would not be taxed on foreign income received prior to becoming a U.S. citizen.

Henry became a U.S. resident during 2012. Under U.S. domestic law, Henry would not be taxed on foreign income received prior to becoming a U.S. resident.

Paragraph 1 of Article XXV of the Canada-U.S. Income Tax Treaty (the “Treatyâ€￾) provides in part:
“Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith that is more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances, particularly with respect to taxation on worldwide income, are or may be subjected.â€￾

In other words, under the Treaty, Canadian citizens cannot be subjected in the U.S. to any taxation or requirement that is more burdensome than the taxation and requirements to which U.S. citizens are subjected.

If George, as a U.S. citizen, would need to file a dual status tax return in the year that he became a U.S. citizen, why would it be discriminatory under the Treaty to require Henry to file a dual status tax return in the year that he became a U.S. resident?

If it is not discriminatory under the Treaty, is it a flawed position to argue that Henry is allowed to file a full year Form 1040 as though he were a resident for the entire year?

One might argue that if George had been a U.S. citizen the whole time then he would not need to file a dual status tax return. However, the same could be said of Henry. If Henry had been a U.S. resident the whole time then he would not need to file a dual status tax return either. I don’t see any discrimination under the Treaty.

Please help me understand what I am missing.
nelsona
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Post by nelsona »

I don't understand why you are comparing 2 individuals who BECAME US citizens.
What you should be doing is comparing one individual who BECAME a citizen, with one who always was. The Cdn/US person should be allowed to file the same as a US citizen "in the same circumstances" (which covers whether he moves to US or not).

The reason that filing dual-status is discriminatory is becuase dual status can result in higher US tax, because of not permitting standard deduction, not permitting certain itemized deductions and -- in the case of married individuls -- not permitting joint filing. If it does not result in higher taxes, the dual person can simply avail himself of the IRS regulations rather than the treaty.

In this clause, "discrimination" does not mean being treated "differently", it means being treated "worse".

What it means is that Cdns, regardless of where they live, can file a full year 1040, whether they must or not.


The treaty protects how one country can tax the nationals of the OTHER country, not how one country can tax its own nationals.
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testone
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Post by testone »

Thank you for your comments. I am just trying to learn about this so please forgive me.

I am comparing one individual that became a U.S. citizen mid-year with one that became a U.S. resident mid-year. I am trying to compare two individuals in the same circumstances but for their nationality.

You say that I should be comparing “one individual who BECAME a citizen, with one who always was.â€￾ So if George became a U.S. citizen mid-year, he should be compared with someone who was a citizen all year? Is that a similar circumstance? Shouldn’t he be compared with someone who became a resident mid-year?

I started to get convinced of your position when I thought about a U.S. citizen who is Canadian resident and a Canadian citizen who is Canadian resident. If both of these individuals had the exact same income and the U.S. citizen/Canadian resident was required to file a Form 1040, why shouldn’t the Canadian citizen/Canadian resident be able to file a Form 1040?

Then I started to look at the nondiscrimination provisions of some other treaties.

The Treasury Technical Explanation to the China-U.S. Income Tax Treaty in discussing its nondiscrimination provision (Article 23) states:

“U.S. citizens who are not residents of the United States are not in the same circumstances as citizens of China who are not residents of the United States, because nonresident U.S. citizens generally are subject to U.S. tax on their worldwide income whereas nonresident aliens of the United States generally are subject to U.S. tax only on their U.S. income.â€￾

After reading this, I thought that if this same rule applies to the Canada-U.S. Income Tax Treaty then the U.S. could tax the U.S. citizen/Canadian resident different from the Canadian citizen/Canadian resident. Just in case China was an anomaly, I looked at other treaties.

The Treasury Technical Explanation to the Cyprus-U.S. Income Tax Treaty in discussing its nondiscrimination provision (Article 7) states:

“The citizen of the United States is subject to United States taxation on worldwide income, while the citizen of Cyprus is not, thus making their circumstances different.â€￾

The Treasury Technical Explanation to the Denmark-U.S. Income Tax Treaty in discussing its nondiscrimination provision (Article 24) states:

“[T]he common underlying premise is that if the difference in treatment is directly related to a tax-relevant difference in the situations of the domestic and foreign persons being compared, that difference is not to be treated as discriminatory (e.g., if one person is taxable in a Contracting State on worldwide income and the other is not * * * distinctions in treatment would be justified under paragraph 1). * * * Because the relevant circumstances referred to in the paragraph relate, among other things, to taxation on worldwide income, paragraph 1 does not obligate the United States to apply the same taxing regime to a national of Denmark who is not resident in the United States and a U.S. national who is not resident in the United States. United States citizens who are not residents of the United States but who are, nevertheless, subject to United States tax on their worldwide income are not in the same circumstances with respect to United States taxation as citizens of Denmark who are not United States residents.â€￾

I stopped when the Treasury Technical Explanation to the Estonia-U.S. Income Tax Treaty had similar language to the Denmark treaty.

Even the Commentary to the OECD Model Income Tax Treaty supports this distinction. See Paragraph 9 of the Commentary to Article 24 of the OECD Model Income Tax Treaty.

It appears that the U.S. Treasury Department believes that an individual taxed on worldwide income is not in the same circumstances as an individual not taxed on worldwide income. Under this line of reasoning, I do not think that a Canadian citizen/Canadian resident who was not taxed in the U.S. on his/her worldwide income could file a Form 1040 by claiming discrimination under the Treaty.

Relating this back to my original hypothetical, it would seem appropriate to compare an individual that became a U.S. citizen mid-year with one that became a U.S. resident mid-year. If you were to compare, as you suggest, an individual who became a citizen, with one who always was a U.S. citizen, you would be comparing an individual who was NOT taxed on his worldwide income for the entire year with an individual who WAS taxed on his worldwide income for the entire year. I think that the U.S. Treasury Department would consider this a comparison of individuals in dissimilar circumstances, and therefore it would argue that it could treat the individuals differently (i.e., by requiring a dual status tax return in the first year of residency).
nelsona
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Post by nelsona »

The wording of that article was changed in the last protocol to make it more inline with OECD model. The old treaty had a broader clause, AND also granted the ability to use ANY treaty non-discrimaition clause that the US had with any other country, which made it unasailable.

There is no need to look any farther than the tech expalnation of the US-Canada protocol to realize that indeed -- in theory -- IRS now can refuse to accept a 1040 from anyone other than a US citzen or resident.

However, -- in practice -- since that time many Cdns (non US citizens and non-US GC holders) continue to file full year joint 1040's in order to collect such things as child tax credit, work tax credit, etc without issue from IRS.

These are ones that are NOT otherwise US taxpayers, but avail themselves of this article to file. This has always been the case.

However, in specific cases you mention, a married couple becoming a US citizen mid-year is ALWAYS allowed to file a full year 1040. That is the advantage I mentionned earlier.


So, since in paractice Cdn residents continue to file 1040's and mid-year married residents/citizens/GC are allowed by IRS reg to file full year, this leaves only single dual-statuses unaccounted for.

I would advise such a filer to file full 1040 -- if this benefits him -- and see what IRS says.

I have NEVER heard of IRS denying a 1040.
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testone
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Post by testone »

I hadn’t realized that the nondiscrimination article had changed with the 5th protocol to the Treaty. Thanks for pointing that out. I now see the language in the Technical Explanation that you refer to (“the United States is not obliged to apply the same taxing regime to a national of Canada who is not resident in the United States as it applies to a U.S. national who is not resident in the United States.â€￾).

Everything else you said makes sense. Now, onto my next question . . . if I may.

My next question relates to electing the section 911 foreign earned income exclusion in the first year of residency. Say a Canadian resident (single or married) became a U.S. citizen or a U.S. resident on June 1, 2012 and chose to file a Form 1040 for the full year. I don’t believe that the individual would technically be considered a “qualified individualâ€￾ under section 911(d)(1) because he/she would not have been a U.S. citizen or a U.S. resident during the period required for the bona fide residence test or for the 330 day physical presence test.

I recognize that from a practical perspective the I.R.S. may not reject a first year tax return where the taxpayer claims the foreign earned income exclusion with respect to the period prior to becoming a U.S. resident. However, from a technical perspective, I would think that the individual would not be able to rely on the nondiscrimination provision in Paragraph 1 of Article 23 of the Treaty to be treated as a “qualified individual.â€￾ Thus, from a technical perspective, I would think that the individual would not qualify for the foreign earned income exclusion for that first year. Do you agree?

Again, thanks for your comments.
nelsona
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Post by nelsona »

I've said what I have to say on this. Since in practice IRS is allowing first year residents (and last year residents) to use FEIE (and was obligated to in the pasttreaty, by the third country provision I mentionned at the outset), it doesn't really matter what technically is allowed or not.

One files, and IRS accepts or rejects.

Is there a point to this discussion?
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
nelsona
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Post by nelsona »

When IRS begins rejecting 1040 and 2555 submissions, let us know.
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testone
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Post by testone »

Understood. Thank you.
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