The US Tax Treaty Saving Clause As A Vehicle To Tax Residents Of Other Countries On Non-US Income

April 1, 2024 - Participants include:

 

Dr. Karen Alpert - @FixTheTaxTreaty

 

John Richardson - @ExpatriationLaw

 

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Understanding what citizenship taxation really is ... Like the optical illusion where some people see an old woman and others see a young woman, citizenship taxation is viewed by different people in different ways. Some people (tax academics, politicians and many tax professionals) view citizenship taxation as simply the US taxing its nonresident citizens with no consciousness of the reality that those citizens live in and are taxed by other countries. Others (individuals who are actually subjected to citizenship taxation) view it as the U.S. imposing taxes, forms and penalties on the residents of other countries. Because of these two different perceptions, it is difficult to have a helpful discussion about citizenship taxation.

 

U.S. Citizenship Taxation

 

The U.S. is currently the only major country that treats all its citizens as tax residents. There has often been speculation as to what would happen if other major countries employed citizenship taxation. Because countries already tax based on residence and source, citizenship taxation would have practical meaning ONLY for a country’s nonresident citizens. This is because “citizenship taxation” would create dual “tax residency” for the nonresident citizens of a country. Generally, treaties allow dual tax residents to use a treaty to become a tax resident of ONLY one country. The exception is when a treaty includes a “saving clause”. A “saving clause” is when a treaty allows a country to tax its citizens (whether resident or nonresident) without regard to the treaty. In this way the “saving clause” prevents an individual with “dual tax residency” from using the treaty to become a treaty tax resident of ONLY one country. Practically speaking, the “saving clause,” by denying individuals the opportunity for “dual tax residents” to become tax residents of only one country, allows the country with the “saving clause” to impose worldwide taxation on the tax residents of another country! The effect of Country A (the United States) including a “saving clause” in its tax treaty with other country B means that U.S. citizens are always “dual tax residents” because the "saving clause" prevents them from becoming treaty nonresidents.. Therefore, because  dual tax residency cannot be prevented by treaty, the treaty allows for: Country A (the United States) to impose “worldwide taxation” on the tax residents of country B on non-US source income.