U.S. Income Tax Treaties

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1 11th Annual International Estate Planning Institute New York State Bar Association March 13, 2015 Robert Dumont Deloitte Tax LLP Brian Rowbotham Rowbotham & Company Table of Contents Use of Treaty Benefits for Nonresidents 2 Worldwide Taxation of U.S. Citizens and Residents 3 Treaty Override 4 Claiming Benefits of Treaty with Dual Residence 5 U.S. China Income Tax Treaty 6 Treaty Qualification Period 7 Qualification Period Status at End of Year 8 Qualification: Definition 9 Foreign Disclosures 10 When to File Treaty Returns 11 Offshore Voluntary Disclosure Program (OVDP) Concerns 12 Expatriation for Tax Purposes 13 Expatriation for Tax Purposes: Treaty Based Returns 14 Expatriation Tax Reporting - IRS Notice IRS Notice IRS Form Filing Positions to Consider 18 Forfeiture of Green Card with Filing Nonresident Returns 19 Retention of Green Card 20 Green Card Status Legal Opinion 21 Totalization Agreements 22 Gift and Estate Tax Residence Planning 23 Other Treaty Challenges 24 Speakers Bios 25

2 Use of Treaty Benefits for Nonresidents Reduced rate of tax on U.S. source income At times, income can disappear Pensions distributions from U.S. qualified plans, Article 19 UK: foreign income from domestic taxation excluded Australia: step up in basis, similar exclusion 2 Worldwide Taxation of U.S. Citizens and Residents Definition of U.S. resident Section 7701(b) Lawful Permanent Resident Substantial presence test 3 year formula Closer connection exception 3

3 Treaty Override: Regulations permit individuals to calculate their tax as a nonresident Reg (a)(1) Statutory authority for treaty override Section 8949(a)(1) Section 7852(d) Substantial presence test Last in principle re: change in domestic law 4 Claiming Benefits of Treaty with Dual Residence Tie Breaker Tests: Article 4 OECD Model Tax Convention on Income and Capital, residency is determined based on the following factors: Permanent home Center of vital interests Habitual abode Citizenship 5

4 U.S. China Income Tax Treaty Article 4: Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then the competent authorities of the Contracting States shall determine through consultations the Contracting State of which that individual shall be deemed to be a resident for the purposes of this Agreement. Position of IRS: Dispute required for Competent Authority to intervene Tie Breaker Rules apply 6 Treaty Qualification Period What is the period when the treaty will apply to non U.S. source income? Only for period of dual residency: UK: April 5 year-end India: March 31 year-end Australia: June 30 year-end 7

5 Qualification Period Status at End of Year Assume treaty override for prior year Will taxpayer be a resident on January 1 of following year? Use of treaty for short initial absence in January? Domestic rules apply to definition Nonresident filing position at risk 8 Qualification: Definition Must be a full resident according to domestic rules Example: See paragraph 7 of UK-U.S. Treaty explanation re: UK Non Doms. Question: Must taxes be paid in foreign jurisdiction? 9

6 Foreign Disclosures All foreign disclosure rules apply: Generally, for purposes of the Internal Revenue Code other than the computation of the individual's United States income tax liability, the individual shall be treated as a United States resident. Reg (b)(7)(a)(3). Individuals are still residents for all other income tax rules. Reg (b)-1((b) Reporting required for: Form 926 Transfers to foreign corporations Form 3520 Distributions from foreign trusts Form 3520A Annual information return with U.S. Owner Form 5471 Reporting for certain foreign corporations Form 8858 Reporting for disregarded entities Form 8865 Reporting for foreign partnerships Form FinCEN 114 Foreign Bank Account Report (FBAR) 10 When to File Treaty Returns An alien individual described in paragraph (a) of this section who determines his or her U.S. tax liability as if he or she were a nonresident alien shall make a return on Form 1040NR on or before the date prescribed by law (including extensions) for making an income tax return as a nonresident. Reg (b)-7(b). Can Taxpayer file late, using the treaty, or file an amended return after due date? Amended returns 1040NR instructions permit amended returns Problem: Joint returns cannot be amended 11

7 Offshore Voluntary Disclosure Program (OVDP) Concerns IRS position: Treaty based return cannot be filed after due date. May impact application for Streamlined Processing. 12 Expatriation for Tax Purposes Administrative (forfeiture) Caution re: tax fraud cases Abandonment Removal Rescission Submission of USCIS Form I

8 Expatriation for Tax Purposes: Treaty Based Returns An individual shall cease to be treated as a lawful permanent resident if such individual commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, does not waive the benefits of such treaty applicable to resident of the foreign country, and notifies the Secretary of the commencement of such treatment. Section 7701(b)(6). Generally not an issue unless person is a covered expatriate. 14 Expatriation Tax Reporting - IRS Notice Same wording as statute Notice required Notice defined to be IRS Forms 8833 and 8854 IRS position (informal) clarification not forthcoming 15

9 IRS Notice Cessation of lawful permanent residency. Under section 7701(b)(6), as amended by the Act, a long-term resident ceases to be a lawful permanent resident if (A) the individual s status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with immigration laws has been revoked or has been administratively or judicially determined to have been abandoned, or if (B) the individual (1) commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, (2) does not waive the benefits of the treaty applicable to residents of the foreign country, and (3) notifies the Secretary of such treatment on Forms 8833 and Effective date October 15, What if a person files amended return, back several years? 16 IRS Form 8833 Instructions for Form Termination of U.S. Residency If you are a dual-resident taxpayer and a long-term resident (LTR) and you are filing this form to be treated as a resident of a foreign country for purposes of claiming benefits under an applicable U.S. income tax treaty, you will be deemed to have terminated your U.S. residency status for federal income tax purposes. Because you are terminating your U.S. residency status, you may be subject to tax under section 877A and you must file Form 8854, Initial and Annual Expatriation Statement. You are an LTR if you were a lawful permanent resident of the United States in at least 8 of the last 15 tax years ending with the year your status as an LTR ends. 17

10 Filing Positions to Consider File 1040NR Exclude Form 8854 Exclude Form 8833 (Also include Form 8275 disclosure?) Exposure under Section 6114 rules History of disclosure and purpose of Regulations Disclosure required of unsupported positions No disclosure: but no disallowance - No statutory disallowance of Treaty for nondisclosure - Potential penalty for not filing: $1,000 per treaty position If there is no choice, then consider options 18 Forfeiture of Green Card with Filing Nonresident Returns? Treasury: The filing of a Form 1040NR by an individual described in paragraph (a) of this section may affect the determination by the Immigration and Naturalization Service as to whether the individual qualifies to maintain a residency permit. Reg (b)(1)(b). Immigration Regs. An applicant who is a lawfully admitted permanent resident of the United States, but who voluntarily claims nonresident alien status to qualify for special exemptions from income tax liability, or fails to file either federal or state income tax returns because he considers himself or herself to be a nonresident alien, raises a rebuttable presumption that the applicant has relinquished the privileges of permanent resident status in the United States. See 8 CFR 316.5(c)(2). (1995). 19

11 Retention of Green Card Actual facts determine green card forfeiture Length of absence Time spent in U.S. versus abroad since immigrating Purpose of trip(s) Place of employment Place of primary residence Job in U.S. versus abroad Property in U.S. versus abroad Family in U.S. versus abroad 20 Green Card Status Legal Opinion The filing of a nonresident return will not, in and of itself, result in the forfeiture of the green card. That said, U.S. resident status and the green card can be lost through certain conduct. The U.S. Customs and Border Protection agency examines returning U.S. residents to determine if they have abandoned resident status. Failure to return to the U.S. on a regular basis, extended absences from the U.S., employment abroad, and other factors may result in the government challenging the individual s right to retain his green card. The filing of a nonresident income tax return creates a rebuttable presumption that the green card holder has abandoned resident immigration status. 21

12 Totalization Agreements Allows foreign affiliate to cover foreign nationals social security Agreements exist with 25 countries Provides both U.S. resident and U.S. employer with exemption from U.S. Social Security Certificate process: 22 Gift and Estate Tax Residence Planning Domicile Determines Residence: A person acquires a domicile in a place by living there, for even a brief period of time, with no definite present intention of later removing therefrom. Residence without the requisite intention to remain indefinitely will not suffice to constitute domicile, nor will intention to change domicile effect such a change unless accompanied by actual removal. Regs. Secs (b) and (b). Can a green card holder residing outside the US have a foreign domicile? Can a newly arrived foreign national and family with a work permit claim foreign domicile? 23

13 Other Treaty Challenges Foreign tax credit, excess taxes paid by resident disqualifies Article 16 provisions re: foreign assignment Dependent services Independent services 24 Speakers Bios Robert Dumont is a tax principal in the New York office of Deloitte Tax LLP. He is the leader of the firm's International Private Client group, which is devoted to international estate and income tax planning for high net worth individuals and family offices. Prior to joining Deloitte, Mr. Dumont was a partner in the law firm of Baker & McKenzie. Mr. Dumont advises on a broad range of tax and estate planning issues relating to the cross-border activities of private clients, including "in-bound" investments made by non-u.s. families, pre-immigration tax planning, the tax aspects of expatriation, tax planning with respect to foreign trusts and foreign estates, the tax aspects of crossborder investments made by U.S. persons, and the structuring of family offices for international families. Mr. Dumont is a regular speaker and writer on international tax and estate planning matters. Mr. Dumont is a member of the bars of the State of New York and of the United Kingdom and Wales (non-practicing solicitor). He is a graduate of Georgetown University Law Center (J.D.) and New York University School of Law (L.L.M. in Taxation). Brian Rowbotham is the partner in charge of the firm s international tax practice. Mr. Rowbotham has 35 years of experience in advising businesses and individuals on complex domestic and international income and estate tax planning. He is the founding partner of Rowbotham & Company LLP which is dedicated to businesses and investors needing domestic and international tax and accounting services. His clients include private and public companies, multinational families and executives and non-u.s. investors doing business in the U.S. Mr. Rowbotham has given presentations on cross border tax strategies in Bangalore, Delhi, Mumbai, and to professional organizations throughout Asia, Europe and the U.S. He is a frequent guest speaker at the Haas Business School, UC Berkeley on international tax where he received his bachelors and MBA degrees. In 2012 he was awarded the Distinguished Service Award by the California CPA Society for support of the profession and was featured on the cover of the California CPA for Doing Business in China. 25