What is a Treaty-Based Return and Why Shall I File It?

Treaty-Based Return

Canadian businesses and individuals who make sales or provide services to U.S.-based clients or customers are considered to have income that is “effectively connected with the conduct of a trade or business in the United States”.  Under U.S. domestic tax law non-residents who carry on a U.S. trade or business are subject to U.S. taxation at the federal and possibly state levels.

Articles V and VII of the Canada-U.S. Income Tax Convention (the “Treaty”) provide an exception from U.S. federal income tax as long as the income of a Canadian sales or service provider is not attributable to a U.S. permanent establishment (“PE”).  A PE is defined as a fixed place of business through which a non-resident carries on business and may include a place of management, a branch, an office, a factory or workshop, a place of extraction of natural resources (such as a mine), a building, construction or installation project lasting more than 12 months, use of an installation or drilling rig or ship for the exploration or exploitation of natural resources for more than 3 months in any 12 month period, or an independent contractor or employee acting regularly in the U.S. and possessing the authority to conclude contracts.  In addition, a PE may be considered to exist if a service provider or an employee is present in the U.S. for over 182 days in any 12-month period, and during such period more than 50% of the gross active business income is derived from the said services, or if a service provider spends in the U.S. over 182 days in any 12-month period with respect to the same or connected project for customers who are either residents of the U.S. or maintain a PE in the U.S. (and the services are performed in respect of that PE.)

To claim relief under the Treaty from U.S. federal taxation on U.S. income by reason of an absence of a U.S. PE, the service provider must timely file a Treaty-Based Position Disclose Under Section 6114 or 7701(b) with the Internal Revenue Service (“IRS”) using Form 8833 along with either personal or corporate U.S. income tax return for non-resident/foreign corporation on Forms 1040NR or 1120-F.  Failure to file a treaty-based position disclosure could result in the loss of a benefit of tax deductions to the filer, i.e. the filer becomes subject to taxation on U.S. gross revenue.

The deadline for a U.S. income tax return with a treaty-based position disclosure is the 15th day of the 6th month following the end of the fiscal or calendar year of the filer.  An additional 6-month extension of time to file is available for foreign corporate filers and a 4-month extension for foreign individual filers by filing of an extension request on or before the original due date.

Penalties for failure to file and disclose a treaty-based position vary from $1,000 to $10,000 per type of filer – individual or corporation – and are imposed on each non-disclosed type of income.

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Reed Amendment

Reed amendment

The “Reed Amendment” and Admissibility to the United States: Will I Be Barred From Reentry After Renunciation?

By Daniel P. Joyce on August 27, 2015 Posted in SmarterWaystoCross.com
A common concern about renunciation of U.S. citizenship is that of admissibility to the United States thereafter. Many people tell me that they have read about a permanent ban on reentry to the United States following renunciation.

There is no automatic ban on reentry following renunciation. (Renunciations must be made outside the United States, typically at a U.S. consulate.) There is a provision of the law that justifies the concern, but an understanding of that law will reveal why there is very little to worry about.

One of the consequences of renunciation of citizenship is the conversion of one’s immigration status from citizen to “alien.” Nowhere is the stark reality of that conversion more apparent than at the border during one’s first attempt to reenter as a visitor. Many former citizens continue to have friends, relative or even seasonal vacation property in the United States, and return visits are not unusual. Without U.S. citizenship, the alien no longer has the right to enter the U.S. and there are no presumptions in his/her favor. For the first time, the newly converted alien must prove that he/she is a legitimate visitor (not intending to live or work in the United States) and that he/she is admissible.

There are many grounds of inadmissibility to the United States contained in section 212 of the Immigration and Nationality Act (INA), ranging from criminal convictions, prior immigration violations, terrorism, public health concerns, and others. Tacked on to the end of section 212, in subsection 212(a)(10)(E), is a curious provision often referred to as the “Reed Amendment” after the congressman who proposed it. The measure was a legislative reaction (many would say overreaction) to a billionaire named Kenneth Dart, who renounced his U.S. citizenship in 1994 and moved to Belize. It was apparent that Mr. Dart was doing so to limit U.S. income tax liability. The case received media attention that happened to coincide with movements in Congress to strengthen the immigration laws regarding illegal immigration and the tax laws regarding treatment of “expatriates.”

Twenty years ago, renunciations were less frequent than today. In the mid-1990’s there were only a few hundred renunciations annually worldwide. A New York Times article from 1995 estimated that “a dozen or more of those who [renounced annually] are multimillionaires.”

The Reed Amendment was aimed at those multimillionaires. It gained enough bipartisan support to be enacted as part of the Illegal Immigration Reform and Immigrant Responsibility Act of 1996. The measure in its entirety states:

Any alien who is a former citizen of the United States who officially renounces United States citizenship and who is determined by the Attorney General to have renounced United States citizenship for the purpose of avoiding taxation by the United States is inadmissible.

Passage of the measure was its high-water mark because its history since that time has been marked by ineffectiveness and disuse. The executive branch never issued implementing regulations, and in 2002, the attorney general’s authority to make the tax avoidance determination was transferred to the Department of Homeland Security (DHS). At that time, six years after the law’s enactment, not one person had ever been excluded from entry to the United States for renouncing citizenship for tax avoidance purposes. The same is true today. To our knowledge, the DHS has never made a formal determination of inadmissibility under INA §212(a)(10)(E).

In 2003, the Staff of the Joint Committee on Taxation issued a report to Congress on the “Tax and Immigration Treatment of Relinquishment of Citizenship and Termination of Long-Term Residency,” which explained the “operational complications” involved in implementing the Reed Amendment. At the heart of the problem was the need for the Internal Revenue Service (IRS) to share information with DHS and other agencies to facilitate a determination of tax avoidance. However, tax information is highly confidential. Internal Revenue Code (IRC) §6103(a)(3) prohibits IRS employees from disclosing “any return or return information” to any other person or agency unless permitted under the statute. There was, and still is, no such provision to allow the sharing of tax return information with DHS for Reed Amendment purposes, and neither the IRS or DHS has promulgated any implementing regulations to make it happen. Accordingly, there currently are no procedures in effect to implement the law.

In 2014, there were 3,415 renunciations worldwide, which was a 13 percent increase over the previous year and close to ten times the average number of annual renunciations in the mid-1990’s. And the trend is upward: There were more than 1,000 renunciations in the fourth calendar quarter of 2014 alone. There have been at least 15,000 renunciations since the passage of the Reed Amendment in 1996—many of whom can be presumed to be multimillionaires—but no reported case during that time of a finding of inadmissibility for tax avoidance purposes.

The consular officer does not collect any tax information at the renunciation appointment and does not make a determination, or even a recommendation, concerning future admissibility. The renunciation process does not require the applicant to state a reason for renouncing. Unless the applicant decides to volunteer such information, the application is devoid of any express statement regarding the person’s motivation for renouncing. We generally advise against making such a voluntary statement.

The prudent former citizen would be careful about making any inflammatory comments about the U.S. tax system or taxes in general, whether at the consulate or at the border. It is within the authority of the inspecting Customs and Border Protection officer at the border to make a finding of inadmissibility on any of the grounds contained in INA §212. During the inspection process, a person’s place of birth or prior U.S. citizenship may give rise to questions about nationality, because a U.S. citizen is required by statute to claim U.S. nationality and present a U.S. passport. Someone who has renounced citizenship need only present a copy of the Certificate of Loss of Nationality to confirm that he/she is no longer a U.S. citizen. No explanation or reason is required or recommended. Despite its disuse, the Reed Amendment is still a valid law and therefore has the potential for use and misuse, even in the absence of the formal determination contemplated by its terms. For obvious reasons, the inspection booth during entry to the U.S. is neither the time nor the place to make political statements or constructive criticisms of the U.S. tax system.

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New IRS Compliance Deadlines May Impact Your Filings

IRS Compliance Deadlines

On 31 July 2015 President Obama signed the bill into law (The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, H.R. 3236, also known as Highway or Stop-gap Bill) which amongst other measures sets new due dates for commonly filed US income tax returns and other disclosures. These changes to the filing deadlines are applicable to returns for tax years beginning after 31 December 2015 which means for calendar-year filers the new deadlines will first appear in 2017.

FinCen Form 114

The standalone June 30th due date for electronically filed form FinCen 114, Report of Foreign Bank and Financial Accounts, (also known as FBAR) is now almost history. Starting in 2017, FBARs will have to be submitted at the same time as income tax returns, whether on APRIL 15 or with a six-month extension. A provision for an automatic 2-months extension to June 15 similar to Treasury Regulations Section 1.6081-5 for Americans abroad shall also apply. This is a very welcome change which makes a lot of sense for taxpayers and tax practitioners.

FBAR is required if a taxpayer, whether an individual or an entity, has a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account, exceeding certain thresholds. For additional criteria on filing FBAR please see the following IRS link: https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Report-of-Foreign-Bank-and-Financial-Accounts-FBAR

Form 1065

U.S. Return of Partnership Income reported on Form 1065 and partner’s Schedule K-1, Partner’s Share of Income, will soon change its current deadline of APRIL 15 or on the 15th DAY of the FOURTH MONTH following the taxable year. Starting with 2017, the filing deadline will be MARCH 15 or on the 15th DAY of the THIRD MONTH following the taxable year. This change effectively aligns the due date of the partnership return with the deadline of another flow-through entity’s tax reporting – S corporation (Form 1120-S). The likely hope behind this switch is that Schedule K-1 reporting each partner’s share of the partnership tax items will be available in time for their inclusion into the partner’s individual or corporation tax return.

We are not so optimistic and think that the change will likely lead to a greater number of extensions of partnership returns in addition to the returns of their partners.

For instructions of filing Form 1065 see the following IRS link: https://www.irs.gov/uac/Form-1065,-U.S.-Return-of-Partnership-Income

Form 1120

The deadline for a U.S. Corporation Income Tax Return has been flipped to what used to be the partnership return’s deadline, or APRIL 15 for a calendar year taxpayers or on the 15th DAY of the FOURTH MONTH for fiscal year-end filers. This means that we now will be clogged even more with the matching personal and corporate deadlines! If it is not confusing enough, here is another twist. C corporations with tax year-ends of June 30 will continue filing their returns on September 15 until 2025 and on October 15 thereafter. https://www.irs.gov/uac/Form-1120,-U.S.-Corporation-Income-Tax-Return

It is yet known whether the filing deadline will change for treaty-protective Form 1120-F, U.S. Income Tax Return of a Foreign Corporation.

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ARE YOU STILL WAITING FOR YOUR U.S. REFUND? IT MAY STILL BE AWHILE

IRS

If you filed a Form 1040NR, U.S. Nonresident Alien Income Tax Return, in 2015 claiming a refund from an overwithholding of tax on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, and have not received the refund yet, you are not alone. The delay is due to a current policy adopted by the Service while it conducts an examination of withholding agents and intermediaries on payments to nonresident alien individuals, foreign entities and foreign governments. No refunds are released within the first 6 months from the later of either the original due date of Form 1040NR or the date when the return was actually filed. To put it into perspective, if you filed your 2014 1040NR by its statutory due date of June 15, 2015 with all the appropriate withholding attachments, you will only be able to collect a refund after December 15, 2015.

It is currently unknown whether the same compliance focus will be adopted by the Service in 2016. To avoid a potential and unnecessary delay in collection of an overwithheld tax we advise our clients and prospects to submit in advance accurately completed Forms W-8BEN, Certificate of Foreign Status of Beneficial Owner for U.S. Tax Withholding, W-8BEN-E or any similar W-8 category forms to enable a withholding agent or intermediary to hold back only the required rate of tax on U.S. source income.

For a reference to IRS W-8 forms please see here

1042-2-s

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