Tax Treaty Doesn't Allow Foreign Tax Credit to Offset Net Investment Income Tax

(Parker Tax Publishing August 2021)

The Tax Court held that a taxpayer was not entitled to use a foreign tax credit to offset the Code Sec. 1411 net investment income tax (NIIT) under either the U.S. income tax treaty with France or the U.S. income tax treaty with Italy. The court found that under the plain text of the treaties, their terms are subject to the provisions and limitations of the Code and the Code does not allow for any credits against the NIIT. Toulouse v. Comm'r, 157 T.C. No. 4 (2021).

Background

Catherine Toulouse is a U.S. citizen who lives abroad. For 2013, Toulouse filed a U.S. federal income tax return claiming a carryover of her foreign tax credit for tax that she paid to France and Italy in prior years to offset the net investment income tax (NIIT) imposed by Code Sec. 1411.

The IRS assessed the NIIT, determined without the credit, and an addition to tax under Code Sec. 6651(a)(2) for failure to pay a tax shown on a return. Toulouse did not pay the assessed amount. The IRS issued to Toulouse notices of intent to levy and federal tax lien filing, and Toulouse filed a request for a collection due process hearing. After the hearing, the IRS issued a notice of determination sustaining only the levy notice. Toulouse took her case to the Tax Court.

Toulouse conceded that the Code does not provide for a foreign tax credit against the NIIT. However, she contended that Article 24(2)(a) of the U.S. income tax treaty with France and Article 23(2)(a) of the tax treaty with Italy provide a foreign tax credit independent of the Code. Those treaty provisions generally provide a credit against the U.S. federal income tax for the amount of French or Italian income tax paid by such citizen, in accordance with the provisions and subject to the limitations of the law of the United States. Toulouse argued that the NIIT, which was enacted in 2010 - after the execution of the treaties -- is not a "limitation" as that term is used in the treaties. Toulouse maintained that the treaties do not conflict with the Code because the Code is silent as to whether there is a foreign tax credit against the NIIT. She further argued that any limitation of a foreign tax credit as set forth in the treaties required some affirmative statement and should not be imposed on the basis of Congress' silence on the issue.

Analysis

The Tax Court held that Toulouse is not entitled to use a foreign tax credit to offset the NIIT under Article 24(2)(a) of the U.S.-France tax treaty or Article 23(2)(a) of the U.S.-Italy tax treaty.

The court found that under the express terms of the treaties that Toulouse relied on, any allowable foreign tax credit must be determined in accordance with the Code and is limited by the Code's provision of a credit. Thus, for Toulouse to prevail, the Code must provide the credit if one exists, and it was immaterial in the court's view that the Code does not affirmatively state that a foreign tax credit against the NIIT is disallowed. The court noted that Code Sec. 1411(c)(1)(B) expressly provides for deductions allowed by Subtitle A of the Code in the computation of net investment income, but there is no provision for any credits against the NIIT. The court said that the enactment of the NIIT as part of Chapter 2A of the Code was a clear expression of congressional intent that credits allowed against the individual income tax do not apply against the NIIT.

The court found that under Am. Air Liquide, Inc. & Subs. v. Comm'r, 116 T.C. 23 (2001) (quoting Menominee Tribe v. U.S., 391 U.S. 404, 413 (1968)), the intention to abrogate or modify a treaty is not to be lightly imputed to Congress. The court therefore reasoned that the fact that the NIIT was enacted after the execution of the treaties was not determinative. The court also found that the treaties recognize that that U.S. tax law may be subsequently amended "without changing the general principle hereof," and in the court's view, the imposition of the NIIT was not a change to the general principles of U.S. tax laws. The court further found that while the general purpose of tax treaties is to reduce double taxation, the specific treaties must be applied as written, and there is nothing in either of the relevant treaties that entitles U.S. taxpayers to an elimination of all double taxation.

For a discussion of calculating the NIIT on individuals, see Parker Tax ¶143,105.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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