On December 5, 2024, the U.S. Court of Federal Claims (“Court”) issued a partial summary judgment entitling a U.S. citizen residing in Canada to claim a treaty-based foreign tax credit (“FTC”) against his net investment income tax (“NIIT”) liability under Article XXIV of the U.S.–Canada income tax treaty (“Treaty”).1
There is one other taxpayer-favorable court ruling allowing U.S. citizens residing in a treaty country to offset their NIIT liabilities with a treaty-based FTC.2
Under U.S. domestic tax law, an FTC is not allowed against the NIIT. The ruling by the U.S. Court of Federal Claims offers a potential avenue for certain taxpayers to offset the NIIT with foreign income taxes assessed on the same income pursuant to the U.S.-Canada income tax treaty. This could eliminate or reduce the double tax imposed by the United States and Canada on income that is subject to both the U.S. NIIT and Canadian income tax. Further, this could reduce assignment costs for tax-equalized high-net-wealth employees.
The U.S. government is expected to appeal the decision. Thus, the U.S. Internal Revenue Service (“IRS”) could suspend the processing of refund claims filed on this basis until the appeals process is complete.
A U.S. citizen residing in Canada paid nearly US$2 million in taxes to Canada and claimed an FTC against his U.S. federal income tax liability for the 2015 tax year, but did not claim the FTC against the NIIT. In November 2016, the taxpayer filed an amended return claiming a refund of US$263,523, claiming a treaty-based FTC against his NIIT liability under Article XXIV of the Treaty. The IRS rejected the refund claim, concluding that the FTC cannot be used to offset the NIIT liability under the Internal Revenue Code (“Code”), and the Treaty does not provide an independent basis for the credit to offset the NIIT.
On May 25, 2023, the taxpayer filed a complaint against the United States in the Court and sought a refund of federal income tax paid for the 2015 tax year. The question presented to the Court was whether the taxpayer could offset his NIIT liability by claiming a treaty-based FTC, or whether the U.S. law limitation clause in paragraph 1 of Article XXIV precluded a treaty-based credit from being applied against the NIIT.
The taxpayer argued that the treaty-based FTC is applicable to NIIT under paragraphs 1 and 4 of Article XXIV because the Treaty provides a self-executing FTC, which is not subject to the domestic rule that prevents application of the FTC to NIIT. In contrast, the U.S. government argued that the treaty-based FTC is subject to the limitations of the U.S. law as provided in the U.S. law limitation clause in paragraph 1 of Article XXIV; thus, the NIIT cannot be offset by the treaty-based FTC as it is not allowed under the Code.
The Court rejected the government’s arguments and ruled in favor of the taxpayer. The Court held that the U.S. law limitation clause in paragraph 1 of Article XXIV is focused on how a treaty-based credit is computed, not whether such credit is applicable to the NIIT under the Treaty. In addition to citing to taxpayer-favorable interpretative evidence, the Court concluded that the purpose of the Treaty is to eliminate or avoid double taxation and parties to the Treaty contemplated a treaty-based credit, even if such credit may be inconsistent with the Code.
The parties have until January 16, 2025, to file a joint status-report regarding how the case should proceed.
KPMG LLP (U.S.) will follow the case and endeavor to provide further information as matters develop.
1 Bruyea v. United States, U.S. Court of Federal Claims (2024).
2 One previous case has reached the same conclusion in relation to a similar treaty provision in the U.S.- France income tax treaty: Christensen v. United States, 168 Fed. Cl. 263 (2023) (pending appealed in Fed. Cir.) (for prior coverage, see GMS Flash Alert 2024-007, January 10, 2024).
The above information is not intended to be "written advice concerning one or more Federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230 as the content of this document is issued for general informational purposes only.
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