The interpretation of US Tax Treaties: Domestic law, foreign law or the intent of the treaty

On August 5, 2016 the United States Court of Appeals for the District of Columbia Circuits issued it’s decision in the Esher case.

This important case is here:

FRENCH TAXES US COURT REVERSAL 5 AUG 2016 (1)

Information about the history of the case is here which includes:

DC Circ. Chides DOJ For Snub Of US Gov’t In French Tax Row

A D.C. Circuit panel grilled the Department of Justice’s Tax Division on Tuesday for arguing a foreign tax dispute with dual U.S. and French citizens without first seeking input from the U.S. government, saying the case requires the court to interpret international treaties and examine other policy issues.

The court’s decision, authored by Justice Millet concluded with:

“The Totalization Agreement is an international executive agreement that must be interpreted in light of its full text and the shared expectations of the contracting governments.

Because the tax court committed legal error in its analysis of those questions, we reverse the judgment of the tax court and
remand for further proceedings consistent with this opinion.”

This case is very significant. It stands for the legal proposition that International Tax Treaties (of which Totalization Agreements are one example) are NOT to be interpreted as though they are domestic statutes. This means that U.S. law does NOT control the interpretation of International Treaties.

Summary of the judgment …

MILLETT, Circuit Judge: As a general rule, workers in the United States are taxed to support the payment of social security benefits to the retired and to individuals with disabilities. The expectation is that, having contributed to the national economy while actively employed, those workers will later become eligible beneficiaries rather than supporters of the social security system. See Flemming v. Nestor, 363 U.S. 603, 608–610 (1960).

That system gets complicated, however, for Americans who work overseas for part of their careers and, during those years, are required to pay taxes into a foreign government’s social security system. Foreign workers temporarily employed within the United States can sometimes confront a similar problem.

With Congress’s blessing, Presidents have entered into so-called “totalization agreements” with foreign governments to limit social-security taxing rights to the country where the work is being done. The agreements also allow overseas workers from both countries to obtain social security benefits based on the periods for which they make social security contributions to foreign governments.

This case involves a totalization agreement between the United States and France. Specifically, the issue on appeal is whether or not two French taxes enacted into law after that totalization agreement was adopted “amend[] or supplement[]” the French social security laws covered by the agreement, and thus fall within the agreement’s ambit. The tax court declared the status of those French laws not by analyzing the text of the totalization agreement or the understanding of the parties, but by resorting to American dictionaries. That was legal error. Because insufficient consideration was given to the text and the official views of the United States and French governments, we reverse and remand.

For a primer on Social Security taxes applied to Americans abroad and “totalization agreements” providing relief against “self employment” taxes see the post here.

Income taxes and Social Security taxes are under different “Chapters” of SUBTITLE A of the Internal Revenue Code, as follows:

CHAPTER 1 – NORMAL TAXES AND SURTAXES (§§ 1 to 1400U–3)
CHAPTER 2 – TAX ON SELF-EMPLOYMENT INCOME (§§ 1401 to 1403)
CHAPTER 2A – UNEARNED INCOME MEDICARE CONTRIBUTION (§ 1411)
CHAPTER 3 – WITHHOLDING OF TAX ON NONRESIDENT ALIENS AND FOREIGN CORPORATIONS (§§ 1441 to 1465)
CHAPTER 4 – TAXES TO ENFORCE REPORTING ON CERTAIN FOREIGN ACCOUNTS (§§ 1471 to 1474)
CHAPTER 5 – REPEALED] (§§ 1491 to 1494)
CHAPTER 6 – CONSOLIDATED RETURNS (§§ 1501 to 1564)

Foreign Tax Credits are allowable against Chapter 1 Income Taxes if they are “income” taxes and NOT if they are Social Security taxes …

The United States generally taxes income earned by its citizens regardless of where the citizen resides, but a United States citizen may take a tax credit against his or her United States income tax liability for taxes paid to a foreign country. 26 U.S.C. §§ 901(a) & (b). That credit shields taxpayers from double taxation. In contrast, taxes paid to a foreign country in accordance with a social security totalization agreement are not eligible for such a tax credit:

“Notwithstanding any other provision of law, taxes paid by any individual to any foreign country with respect to any period of employment or self-employment which is covered under the social security system of such foreign country in accordance with the terms of an agreement entered into pursuant to section 233 of the Social Security Act [42 U.S.C. § 433] shall not, under the income tax laws of the United States, be deductible by, or creditable against the income tax of, any such individual.
26 U.S.C. § 1401 note.”

Under that provision, a foreign tax will not be eligible for a tax credit if it is paid (i) with respect to a period of employment covered under the social security system of a foreign country, and (ii) “in accordance with” the terms of a totalization agreement. See Erlich v. United States, 104 Fed. Cl. 12, 17 (2012) (A tax is not creditable under this section when the “payment is consistent with the obligation of the taxpayer under the [totalization] agreement.”).

The factual dispute is whether two taxes paid by Americans abroad in France should be characterized as “income taxes” or as “social security” taxes …

To put it simply:

If the taxes are characterized as “social security taxes” then no tax credit against income taxes is available.

If the taxes are characterized as “income taxes” then a tax credit is available.

Justice Millet frames the issue as follows:

The issue in this case is whether CSG and CRDS “amend[] or supplement[]” the French laws enumerated in Article 2(1)(b), within the meaning of the Totalization Agreement. If they do, they are covered by the Totalization Agreement and the Eshels may not claim them as a credit on their United States tax returns. If they do not, they fall outside of the Agreement, and the Eshels may credit them against their United States income tax liability.

The issue: How should the determination of the character of the taxes (income tax or social security tax” be made?

There is a difference between interpreting an treaty (or other international executive agreement) and a domestic statute

Justice Millet writes …

or supplement[]” the designated French laws was the product of asking the wrong legal question. Rather than looking to the text of the Totalization Agreement or the signatory countries’ shared understanding, the tax court asked only what “amends or supplements” means in domestic dictionaries, as it might do if construing a purely domestic statute.
But the Totalization Agreement is not a domestic statute. It is an executive agreement with a foreign country: initiated by the State Department, negotiated by the Social Security Administration, signed by the President and a foreign government, and effective only after submission to Congress. See Allison Christians, Taxing the Global Worker: Three Spheres of International Social Security Coordination, 26 VA. TAX REV. 81, 90–91 (2006). Executive agreements must be interpreted under the same principles applicable to international treaties. See Air Canada v. United States Dep’t of Transportation, 843 F.2d 1483, 1486 (D.C. Cir. 1988); see also Kwan v. United States, 272 F.3d 1360, 1362 (Fed. Cir. 2001); Bank Melli Iran v. Pahlavi, 58 F.3d 1406, 1408 (9th Cir. 1995).

International executive agreements and treaties are primarily “compact[s] between independent nations,” Lozano v. Montoya Alvarez, 134 S. Ct. 1224, 1232 (2014) (quoting Medellín v. Texas, 552 U.S. 491, 505 (2008)), and it is “our responsibility to read [them] in a manner ‘consistent with the shared expectations of the contracting parties,’” Lozano, 134 S. Ct. at 1232 (emphasis in original) (quoting Olympic Airways v. Husain, 540 U.S. 644, 650 (2004)). Our goal is “to ascertain the intent of the parties by looking to the document’s text and context.” Lozano, 134 S. Ct. at 1232 (quoting United States v. Choctaw Nation, 179 U.S. 494, 535 (1900)). To that end, it is inappropriate to make the United States’ maxims for statutory construction unilaterally dispositive. “Even if a background principle is relevant to the interpretation of federal statutes, it has no proper role in the interpretation of treaties unless that principle is shared by the parties to ‘an agreement among sovereign powers.’” Lozano, 134 S. Ct. at 1232 (quoting Zicherman v. Korean Air Lines Co., 516 U.S. 217, 226 (1996)).
Instead, the tax court should have started with the Totalization Agreement’s plain text. “The interpretation of a treaty, like the interpretation of a statute, begins with its text.” Medellín, 552 U.S. at 506. The text of a treaty or executive agreement controls “unless ‘application of the words of the treaty according to their obvious meaning effects a result inconsistent with the intent or expectations of its signatories.’” United States v. Stuart, 489 U.S. 353, 365–366 (1989) (quoting Sumitomo Shoji America v. Avagliano, 457 U.S. 176, 180 (1982)).

All of which leads Justice Millet’s eventual conclusion that …

That extreme reading of the Totalization Agreement rests on nothing more than the Commissioner’s own say-so. It lacks any grounding in the Agreement’s text or in any principle governing the interpretation of international agreements. The tax court’s corresponding disregard of the Totalization Agreement’s textual direction concerning the role of French law in resolving undefined terms and in determining the content of the laws enumerated in Article 2(1)(b) was error and requires reversal.

Why this decision is important …

The court ruled that international tax treaties must be interpreted in the context of what were the expectations of the country when the treaty was signed. This may open up the possibility of reconsidering how various U.S. tax laws may affect the residents and citizens of other nations.

For example: To what extent was or is it the expectation of a country that it can be interpreted to allow the U.S. to impose punitive taxation on those who are primarily citizens of and factually residents of other nations?

Time will tell.

John Richardson