The U.S. is one of the few countries that assesses taxes on worldwide income for its citizens no matter where they live.ehrlif/iStockPhoto / Getty Images
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Dual citizenship, with the freedom to live, work and invest in two countries, is a bonus for many people. However, it can also lead to complications when filing and paying taxes, including double taxation. The good news is there could eventually be some relief from a particular cross-border tax issue facing Canadians who are U.S. citizens.
The net investment income tax (NIIT), enacted in the U.S. in 2013, is a 3.8 per cent surtax that applies to U.S. citizens based on certain net investment income. As this tax can result in double taxation, there’s a growing effort to change it. Most recently, a court case involving a U.S. citizen residing in France may offer a glimmer of hope.
The U.S. is one of the few countries that assesses taxes on worldwide income for its citizens no matter where they live. Meanwhile, Canada, which also taxes worldwide income, does so for residents. That means U.S. citizens who live in Canada are required to file a tax return in both Canada and the U.S. that includes their worldwide income on both returns.
Generally, U.S. citizens receive a credit on their U.S. tax return for taxes paid in Canada on their Canadian income. That reduces or eliminates double taxation for income earned in Canada on the U.S. tax return. Most often, Canadian taxes paid would cover the U.S. taxes on that income, as Canada’s tax rate is higher than U.S. taxes payable on that same income.
The controversy related to the NIIT is that foreign (Canadian) taxes paid cannot be applied against this extra U.S. net investment income tax.
The NIIT’s 3.8 per cent surtax is applied in addition to standard income taxes if a person’s total income exceeds a certain threshold: US$200,000 for single or head of household, US$250,000 for a married couple filing jointly, or US$125,000 for a married person filing separately.
If that threshold is met, the NIIT is applied to all income earned in a given year from investments including capital gains, interest, dividends, rental properties and royalties, subtracting related expenses.
For example, a single U.S. citizen living in Canada has total Canadian source income of US$225,000. Part of that is interest income of US$100,000, to which the NIIT applies. The client would pay US$80,000 in Canadian taxes. Her U.S. taxes are approximately US$50,000 and she would receive a credit for the Canadian taxes paid, effectively covering her U.S. taxes. The NIIT of US$3,800 would be added to the US$80,000 taxes paid in Canada to total US$83,800 – effectively a double tax.
Recent court ruling could be a game-changer
A U.S. federal court decision handed down this past October involving a couple with U.S. citizenship living in France is challenging the application of the NIIT. In the case, Christensen v. United States, the couple argued the U.S.-France tax treaty allowed them to use their foreign taxes paid to offset their U.S. NIIT tax liability. The federal court agreed, effectively concurring that a foreign tax credit can be applied against the NIIT. The U.S. is appealing this case, recognizing its far-reaching implications.
The Canada-U.S. tax treaty is worded differently than the U.S.-France tax treaty, so any future court case using Canadian taxpayers may require a different approach to the treaty articles. Should a case involving similar facts but applying the Canada-U.S. treaty be decided in the taxpayer’s favour, that could mean Canadian taxes paid could be applied against the NIIT.
At this point, there is most likely a case working its way through the system, but it could take some time, even years, before it is heard and a decision is reached. That evolving cross-border tax issue with the NIIT will be one for dual citizens to watch.
Mark Feigenbaum is partner, family office, and sports and entertainment law lead, KPMG Law LLP at KPMG in Canada
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