The Tax Times: Tax Court - Taxpayer Was Not A Chinese Resident Pursuant to the US/China Tax Treaty

The Tax Court has ruled that a Chinese citizen who had lived in the U.S. and filed a 2005 U.S. return as a resident alien, then filed an amended 2005 return, then, in 2009, received a 2005 refund and interest on that refund, was neither a Chinese resident nor a nonresident alien in 2009 and therefore was subject to tax on the interest income at regular U.S. graduated rates.

Article 10.1 of the tax treaty between the U.S. and China (the treaty) provides that interest arising in a Contracting State (in this case, the U.S.) and paid to a resident of the other Contracting State (China) may be taxed in the other Contracting State (China). Article 10.2 provides that the interest may also be taxed in the Contracting State (U.S.) according to its laws—but if the recipient is the beneficial owner of the interest, the tax may not exceed 10% of the gross amount of the interest.

Article 4 of the treaty provides that the term "resident of a Contracting State" means any person who, under the laws of that Contracting State, is liable for tax therein by reason of his domicile, residence, place of head office, place of incorporation or any other criterion of a similar nature.

An alien individual is deemed a nonresident alien if she or he is neither a citizen of the U.S. nor considered a resident of the U.S.. (Code Sec. 7701(b)(1)(B)) An alien individual is treated as a resident of the U.S. with respect to any calendar year if such individual: (1) is a lawful permanent resident of the U.S. at any time during the calendar year, (2) meets a substantial presence test, or (3) makes a first-year election to be treated as a resident of the U.S. (Code Sec. 7701(b)(1)(A))

Resident aliens file U.S. returns on Form 1040, and nonresident aliens file U.S. returns on Form 1040NR, U.S. Nonresident Alien Income Tax Return.

Mr. Shi was a Chinese citizen.In 2005, he worked as a professor at a New York university and earned wages of $62,000, which he reported as income on Form 1040. From 2008-2012, he worked as a professor at the University of Wisconsin.

In 2008, Shi prepared Form 1040X, Amended U.S. Individual Income Tax Return, for his 2005 tax year. On it, he indicated that he was entitled to exclude all of his wages under a provision of the treaty. He disclosed that he was a resident alien because he met the substantial presence test in 2005; such status was a requirement to qualify for that treaty provision.

In 2009, Shi received a refund of 2005 taxes based on his amended return, plus interest. He filed Form 1040 for 2009 but did not report this interest on that return.

IRS issued a notice of deficiency with respect to this interest in 2011. In the latter part of 2012, Shi lost his job in the U.S. and returned to China. There was no record of Shi's having left the U.S. from his arrival in '99 up to the latter part of 2012.

Taxpayer doesn't qualify for the 10% tax rate in the treaty.
(No Surprise Here!)

Looking at the above mentioned treaty provisions, the Court concluded that, for Shi to benefit from the treaty, he must be considered a resident of China as defined by the treaty.

Shi argued that Article 4 residency is determined primarily by where an individual has his permanent home. Shi stated that his permanent home in 2009 was in Beijing, China and provided various exhibits substantiating that fact. He also said that he could not have been a resident of the U.S. in 2009 because he never owned a permanent home there. He concluded that he was a resident of China in 2009 under the treaty.

But, the Court ruled against him because Article 4 required that, in order to be considered a Chinese resident, he had to be considered a Chinese resident under Chinese law, and he provided no evidence as to what the relevant Chinese law was.

Taxpayer doesn't qualify to be taxed as a nonresident alien.

The question of whether Shi was a nonresident alien came down to the second of the three above tests under Code Sec. 7701(b)(1)(A), i.e., the substantial presence test.

The substantial presence test is an objective test: An individual meets the substantial presence test if he was present in the U.S. on at least 31 days during the calendar year, and for at least 183 days during the calendar year and the two preceding calendar years, calculated pursuant to a weighted formula. (Code Sec. 7701(b)(3)(A); Reg. § 301.7701(b)-1(c)(1))

IRS argued that Shi was physically present in the U.S. during all of the 2008-09 and 2009-10 academic years because he was employed as a professor in Wisconsin. Respondent asserted, therefore, that Shi was in the U.S. for more than 183 days in 2009 alone and met the substantial presence test.

Shi then pointed out that professors at the University of Wisconsin frequently take posts in international exchanges. He said that being employed as a professor at the University of Wisconsin is not proof and does not imply that Shi was physically present in the U.S. That is, even if Shi was employed as a professor at the University of Wisconsin during all of the 2008-2009 and 2009-2010 academic years, it does not guarantee that Shi was physically present in the U.S., at all, during all of the 2008-2009 and 2009-2010 academic years. Shi concluded that, without convincing evidence, the supposition that he met the substantial presence test was no more than an arbitrary statement.

The Court said that the preponderance of evidence offered was that Shi was present in the U.S. from '99 to sometime in 2012. Shi's speculations to the contrary were weak and suspect.

The Court said that the significance of his declarations in his 2005 tax return, to the issue at hand, was that once Shi became a resident of the U.S., he remained a resident until he actually departed from the U.S. in 2012. Shi's having filed Form 1040 instead of Form 1040NR for his 2009 tax year showed his understanding that he retained his resident status.

What if Mr. Shi Came To Teach at The
Same Universities Pursuant To a J-1 Visa?

Now had he come to the US pursuant to a J-1 visa he may not have been a US Resident Alien pursuant to the "Physical Presence Test," since he would be an "Exempt Individual" pursuant to IRC Sec. 7701(b)(5).

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