Fourth Circuit Rejects Challenges to U.S.-Canada Tax Treaty

(Parker Tax Publishing August 2019)

The Fourth Circuit held that the treaty authorizing the United States to collect unpaid income taxes on behalf of Canada is not unconstitutional under the Origination Clause or the Taxing Clause and that the treaty is self-executing and thus does not require implementing legislation to validate it. The Fourth Circuit also held that the IRS is authorized under Code Sec. 6201 and Code Sec. 6301 to collect a foreign assessment on behalf of Canada. Retfalvi v. U.S., 2019 PTC 267 (4th Cir. 2019).

Background

In 1980, the United States and Canada executed the Convention Between the United States of America and Canada with Respect to Taxes on Income and on Capital (the Treaty). It was ratified by the U.S. Senate in 1984.

Article 26A was added to the Treaty and ratified by the Senate in 1995. Under Article 26A, the United States and Canada agreed to assist each other with the collection of unpaid taxes. To apply for collection assistance, the applicant State submits a revenue claim to the requested State. The applicant State must certify that the revenue claim has been "finally determined" under its laws. A revenue claim is finally determined when the applicant State has the right under its internal law to collect the revenue claim and all administrative and judicial rights of the taxpayer to restrain collection in the applicant State have lapsed or been exhausted.

If the requested State accepts the revenue claim, it must collect the claim as though it were its own finally determined tax debt. Therefore, a Canadian revenue claim accepted by the United States is treated by the United States as an assessment against the taxpayer as of the time the application is received. Any monies collected by the United States are forwarded to Canada. The taxpayer retains any rights of review otherwise available under the applicant State's laws. However, under Article 26A, the taxpayer cannot seek administrative or judicial review by the requested State of the revenue claim of the applicant State. The Supreme Court has held that Article 26A is self-executing. That is, Article 26A operates without the aid of any legislative provision.

Paul Retfalvi is a medical doctor and a Canadian citizen. In 1993, Retfalvi came to the United States to participate in a medical residency program. After completing his residency in 1997, he returned to Canada, then came back to the United States in 1998. To ensure that he would have a place to live if his visa was not renewed, Retfalvi purchased a condo in Vancouver, Canada, and signed a contract to purchase a second one. Through extensions of his visa, Retfalvi continued to reside in the United States and in 2005, was granted U.S. permanent resident status. As Retfalvi was no longer planning to reside in Canada, he sold both condos in 2006, and reported the income on his Canadian income tax return.

In 2007, the Canada Revenue Agency (CRA) audited Retfalvi's tax return, found that he had improperly reported the condo sales, and sent a Notice of Assessment. In response, Retfalvi filed an administrative appeal. In June 2010, Retfalvi became a U.S. citizen. In 2011, the CRA denied Retfalvi's appeal and notified him that he had 90 days to file an appeal with the Canadian Tax Court. However, Retfalvi did not challenge the proposed deficiency in time. As a result, his Canadian tax liability became final.

In October 2015, the CRA referred the assessment to the United States for collection pursuant to Article 26A. In November 2015, the IRS issued a Final Notice - Notice of Intent to Levy and of Your Right to a Hearing, instructing Retfalvi to pay $124,286 in U.S. currency to satisfy the Canadian revenue claim. The IRS Notice indicated that Retfalvi had 30 days to seek a hearing before the IRS Office of Appeals regarding the proposed levy. However, the Notice stated that the IRS had no authority to adjust the underlying Canadian tax liability. Retfalvi requested a hearing and was notified that he was entitled only to a limited hearing under the Collection Appeals Program. Retfalvi then filed for that hearing. In March 2016, the IRS denied Retfalvi's appeal because it determined that it did not have the authority to adjust a foreign tax liability. And, as noted, Retfalvi never challenged the existence or amount of the Canadian tax claim.

Retfalvi filed suit in a district court to seek a declaratory judgment and injunctive relief to enjoin the collection of the tax. The district court dismissed the case for lack of jurisdiction. Rather than appeal, Retfalvi paid the taxes and then filed a refund claim with the IRS, which was denied. Retfalvi then filed a refund suit in a district court in 2017. The district court dismissed the complaint, and Retfalvi appealed to the Fourth Circuit.

Retfalvi argued that Article 26A is invalid because it violates the Origination Clause of the Constitution, which requires that all bills for raising revenue originate in the House of Representatives. He also asserted that Article 26A violates the Taxing Clause of the Constitution which, according to Retfalvi, vests exclusive power in Congress to pay and collect taxes. In addition, Retfalvi contended that Article 26A is not self-executing and requires implementing language to validate it. Retfalvi also argued that the IRS lacked statutory authority to use its domestic enforcement authorities to collect a foreign assessment on behalf of Canada.

Fourth Circuit's Analysis

The Fourth Circuit rejected all of Retfalvi's arguments and affirmed the district court's dismissal. The Fourth Circuit noted that the Supreme Court has interpreted the Origination Clause to apply only to bills that levy taxes, in the strict sense of the word, and not to bills for other purposes which may incidentally create revenue. The Fourth Circuit found that Article 26A does not violate the Origination Clause because it does not levy taxes, nor does it impose a new tax or increase, decrease, or modify an existing one, but only assists in the collection of unpaid tax debts that have already been finally determined under their respective tax laws. The Fourth Circuit rejected Retfalvi's claim that Article 26A violates the Taxing Clause because it found that the Taxing Clause is not an exclusive grant of power to Congress. The Fourth Circuit also disagreed that Article 26A required implementing legislation because it found that Article 26A relies on each country's existing tax laws for assessment and thus requires no additional legislation to operate effectively.

The Fourth Circuit held that the IRS can use its domestic assessment authority in pursuit of the collection of a liability owed by a taxpayer to Canada. The court reasoned that Article 26A authorizes the IRS to employ the procedures in Code Sec. 6201 relating to assessments and Code Sec. 6301 relating to collection of taxes to pursue and collect Canadian revenue claims. The court noted that under Article 26A, if the United States accepts a request from Canada to collect a revenue claim, the United States must collect the revenue claim as if it were its own revenue claim. The court noted that other circuits have recognized the IRS's authority under other tax treaties to use domestic enforcement mechanisms to pursue foreign tax liabilities.

For a discussion of the general rules for assessments of tax, see Parker Tax ¶260,110.

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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