As regular readers of the American Expat Financial News Journal possibly know better than most, U.S. taxpayers who live abroad (as well as their tax advisers) are increasingly having to consider the potential interactions between U.S. and foreign laws when determining the U.S. tax consequences of a particular financial transaction.
U.S. tax expert Virginia La Torre Jeker explains it this way: "In today's world, it is no longer possible for practitioners to ignore the possible implications of another country’s laws."
Here, La Torre Jeker – who is based in Dubai, where Sharia law must often be taken into account – looks at this important, but often overlooked, area...
(Editor's note: This article is taken from La Torre Jeker's most recent blog posting, which may be read and downloaded in full by clicking here.)
The important questions that American expats, and their tax advisers, need to be asking are these: "Should a foreign country’s law to be taken into account when analyzing a U.S. tax issue?"
"What guidance do we have to date from the IRS or the courts about the relevance of foreign law to a U.S. tax query?" And finally, "how do we go about approaching a particular U.S. tax matter when another country's law is considered relevant to the analysis?"
The answers often aren't obvious. In the Middle East/North Africa region where I am based, for example, I frequently see Sharia law issues impacting the U.S. tax analysis of a particular case. And yet, guidance is often lacking as to exactly how such matters should best be resolved.
I looked at this topic in some depth a few years back, in an article for Tax Notes International, entitled "When Sharia and US Tax Law Collide".
Being confronted with Sharia law issues myself, when addressing U.S. tax matters for my clients, is what led me to research the subject at some length, in order to try to understand generally how to approach the impact of a foreign country’s law on a U.S. tax transaction.
Relevance of a foreign country’s
laws to individuals' U.S. tax obligations
It is well established that in various contexts, foreign law is relevant to the interpretation or application of U.S. tax rules, and for this reason, cannot be ignored. A few illustrative examples are given below (but there are many more).
Many civil law countries – which includes most of those in mainland Europe but not the U.S. nor the United Arab Emirates – embrace the legal concept of a “usufruct”. Generally, a usufruct is a right of one person (the “usufructuary”), in a property owned by another, normally for a limited period of time or until death of the usufructuary.
The usufructuary is granted the full right to use the property, enjoy its fruits and income, to the complete exclusion of the property's underlying owner.
U.S. tax professionals typically struggle with usufruct issues when they arise, as the proper way to classify usfructs in tax terms isn't normally obvious to them. Is an usufruct a "trust"? A “life estate”?
Depending on the answer, the tax results will differ greatly.
Similar issues arise with “foundations,” another civil law entity, which are commonly established in many European countries, but unheard of in the U.S.
Are foundations “trusts”, or are they “associations,” and thus taxable as corporations under U.S. law?
Being able to answer such questions properly requires a thorough understanding of the non-U.S. laws under which the financial entity in question was created, and continues to exist.
Other examples of situations in which non-U.S. laws can come into determining the way U.S. tax rules are enforced include those that involve joint ownership of foreign real properties (in which “partnership” interests may not be eligible for tax-free “like-kind” exchange treatment), or fractional co-ownership interests in real property (e.g., as tenants-in-common) – which are, in fact, eligible.
Then there's the issue as to whether employee contributions into a foreign social security system can qualify as “taxes” for U.S. federal income tax purposes; and whether foreign levies are eligible for the foreign tax credit under U.S. tax law principles.
No court or IRS guidance
Real life examples in case law, and certain key IRS rulings, amply demonstrate the importance of foreign law to the U.S. tax rules as they theoretically might apply in situations American expats often find themselves. Yet they don't, in fact, provide guidance on this issue.
Neither the courts nor the IRS have articulated any clear standard for determining when foreign law should be taken into account, and when it shouldn't. In fact, we have seen different courts disagreeing about the relevance of foreign law, even when the courts are examining what appears as the same US tax issue.
Since this area remains substantially unaddressed to date, with a resulting willy-nilly approach, the IRS and taxpayers have little choice but to continue to debate exactly how foreign laws should be taken into account, when addressing U.S. tax matters that straddle jurisdictions.
Still, as sovereign boundaries continue to melt away in today’s global economy, the need for more clarity is becoming increasingly vital...
To read more of La Torre Jeker's analysis of the way U.S. and non-U.S. laws interact, where the U.S. tax consequences of various financial transactions need to be determined on her website, US Tax Talk, and other of her weekly articles that provide clear and detailed explanations of some of the myriad tax rules that impact so many American expats' lives, click here.
La Torre Jeker is a long-time U.S. expat tax law practitioner, who has been a member of the New York State Bar since 1984. She has been based in Dubai since 2001, and lived and worked in Hong Kong for 15 years before her Dubai posting.
To listen to La Torre Jeker discuss U.S. citizenship renunciation issues with Toronto tax and citizenship lawyer John Richardson, in a podcast recorded in October, click here.
To read La Torre Jeker's analysis of a recent IRS announcement that U.S. taxpayers may now begin to claim a "reasonable cause" defense, in the event they were ever to find themselves hit with a penalty in connection with a tax matter for which they had, "reasonably and in good faith," relied upon any IRS-published FAQs (frequently-asked-questions) that has to do with new tax legislation, click here.
To listen to La Torre Jeker discuss Foreign Bank Account Reports with John Richardson, in a podcast recorded in 2018 and entitled "looking for Mr. FBAR," click here.
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