Tax-Expatriation

U.S. Enforcement/Collection of Taxes Overseas against USCs and LPRs – Legal Limitations

Posted on July 5, 2014 Updated on July 5, 2014

Maybe its a natural response for USCs and LPRs living overseas to ask:  “What is the chance I will get audited by the IRS?”  Sometimes, those individuals who either have less good faith (or are simply ignorant about how U.S. tax law functions) will also ask:  “How will the U.S. government ever know of my assets or income in my home country?”

A follow-up question is how does the U.S. federal government enforce tax obligations overseas?  This question often comes, of course, from individuals who reside in different countries outside the U.S. and typically have most (if not all) of their assets located in their country of residence.

A USC or LPR residing in Costa Rica, for instance, might have almost all of his business assets in Costa Rica and maybe financial investment assets in nearby regions such as Panama.  Similarly, a Chinese born dual national USC may have companies and business assets in both mainland China and Hong Kong.  If neither of these individuals have assets in the U.S., how can the U.S. federal government enforce tax liens, levies and the like against these individuals?

These questions are getting asked more and more now that FATCA has gone into force and financial information around the world is being collected regarding USC accounts in virtually all countries and financial institutions. See, FATCA Driven – New IRS Forms W-8BEN versus W-8BEN-E versus W-9 (etc. etc.) for USCs and LPRs Overseas – It’s All About Information and More Information

An excellent layman’s term summary of FATCA can be located on HSBC’s website here.

This overseas asset and income information will eventually be delivered, pursuant to the FATCA rules, to the U.S. Internal Revenue Service (IRS – revenue authority).

Hence, the collection of information under FATCA will be extensive. This, at least in part, answers the question of:  “How will they ever know of my assets or income in my home country?”  Admittedly, the complete answer to this question is far more complicated, when one considers the intricacies of FATCA and its regulations and other guidance from the IRS/Treasury.

However, that is a different question, than how that financial and income information will be used by the IRS to (a) make tax assessments, (b) assess and collect foreign bank account report (FBAR) penalties (See, Section 16 of the IRM), and (c) generally enforce and collect such tax assessments and penalties against USCs and LPRs residing outside the U.S.

1.  INFORMATION – The collection of asset and financial information under FATCA has a very “long arm” around the world.  Indeed, the image of the Uncle Sam octopus published in the June 28, 2014 article in the The Economist entitled  Taxing America’s diaspora: FATCA’s flaws captures well the idea of the reach of FATCA.

2.  INFORMATION VS COLLECTION – However, enforcing tax assessments and penalties and collecting against assets located outside the U.S. is a very different legal question, without such a “long arm”; simply because the reach and jurisdiction of U.S. law is necessarily limited and regularly in conflict with local laws of different countries.

To say it another way, Uncle Sam can indeed enforce the collection of financial and asset information under FATCA, due to the economic costs and ramifications to financial institutions and their investors if they did not comply with the automatic information exchange.  However, Uncle Same cannot simply enforce the collection of U.S. taxes and penalties through the worldwide financial institutional network, the same way it can in the U.S.

The U.S. has broad lien, levy and seizure powers under U.S. tax law.  The IRS can simply seize assets from U.S. bank accounts without going to a judge or court for final (or jeopardy) tax assessments provided they comply with various provisions of the law.  This is not a typical concept in the law for other creditors (other than the IRS) who must generally first take steps through the courts to get some type of judicial action (e.g., a court order) before simply seizing and taking assets from an individual.

The IRS’s broad lien and levy powers against assets, however, has significant limitations overseas.  See the 1998 Treasury Report  – Sometimes Old is as Good as New – 1998 Treasury Department Report on Citizens and LPRs, I have worked with IRS Revenue Officers who specialize in international collection matters who argue and assert they can merely exercise this lien and levy power overseas against foreign financial institutions.  However, this is where the power of the IRS comes to a screeching halt (or at least a major slowdown); when the collection of overseas assets is at stake.

The IRS is not without remedies to collect foreign assets, but it is not a simple process; if it can be done at all in any particular circumstance.

The IRS has no specific enforcement provisions negotiated in international treaties that will necessarily enable them to enforce and collect U.S. income taxes overseas with foreign government assistance.  The cornerstone 9th Circuit case of Her Majesty held in 1979 that the Canadian tax authorities could not enforce a tax judgment against U.S. taxpayers within the U.S. –

The basic facts were these, as reported in the case:

British Columbia then served a “Notice of Intention to Enforce Payment” on the defendants in the United States, and filed a certificate of assessment in the Vancouver Registry of the Supreme Court of British Columbia. This certificate was for $195,929.50 (a penalty and interest were included), and under the laws of British Columbia its filing gave it the same effect as a judgment of the court. British Columbia then instituted the present action in the United States. It was dismissed because the court below concluded that the Oregon courts would follow the “revenue rule.” Stated simply, the revenue rule merely provides that the courts of one jurisdiction do not recognize the revenue laws of another jurisdiction.¹

The U.S. 9th Circuit Court went on to say:

Although the Supreme Court has never had occasion to address the question of whether the revenue rule would prevent a foreign country from enforcing its tax judgment in the courts of the United States, the indications are strong that the Court would reach the same result as we reach in the present case. Both the majority and the dissenting opinion in Banco Nacional de Cuba v. Sabbatino, 376 U.S. 398, 84 S.Ct. 923, 11 L.Ed.2d 804 (1964), discussed the rule in a spirit which indicates a continued recognition of the revenue rule in the international sphere.¹⁰

This Majesty case specifically cited a Canadian Supreme Court case (Harden) which also applied the revenue rule in not enforcing a tax judgement in the U.S. courts for taxes against a Canadian resident:

Reciprocity would itself be a sufficient basis for denying British Columbia’s claim. The courts of British Columbia, relying upon the revenue rule, have refused to recognize the judgment of a United States court for taxes. United States v. Harden, 1963 Canada Law Reports 366 (Sup.Ct. of Canada, 1963, Affirming Court of Appeal for British Columbia).¹²

As a result of these cases and the Revenue Rule, the U.S. and Canada modified their income tax treaty to (at least in theory) allow for the international enforcement of taxes.  The U.S. now has five income treaties with “mutual assistance” provisions: Canada, Sweden, France, Denmark, and the Netherlands (with a clause in the newly negotiated, but yet to go into force, Swiss treaty).

The U.S. tax and international tax world has changed dramatically since 1979 and the 9th Circuit case of Her Majesty particularly with the advent of FATCA.  Nevertheless, there are serious legal limitations imposed on the IRS in collecting assets for U.S. tax liabilities and penalties owed by USCs and LPRs residing overseas.  Indeed, this is surely one of the principle reasons the IRS revised OVDP terms in June 2014 impose a 0% penalty against USCs and LPRs who participate in the so-called “streamlined process”.  See, More on the New 2014 “Streamlined” Process for USCs and LPRs Residing Overseas.

The follow-on post will discuss the very limited provisions that have been recently negotiated with these five different countries and explain in more detail the limits on the U.S. federal government on the collection of taxes.  It will also discuss the important differences of civil U.S. international tax enforcement/collection versus criminal tax enforcement; which are two very different beasts.

Finally, a dedicated post on the topic will discuss the steps the U.S. federal government is taking through the Department of Homeland Security and a database of information (TECS) to track and monitor people and their assets.  The government describes TECS as follows:  “The Treasury Enforcement Communications System (TECS) is a database maintained by the Department of Homeland Security (DHS), and it is used extensively by the law enforcement community. It contains information about individuals and businesses suspected of, or involved in, violations of federal law.”