TC Holds That Tax Treaties Did Not Allow Foreign Tax Credit Against Net Investment Income Tax

The Tax Court has held in Toulouse, 157 TC No. 4 (8/16/2021), that neither article 24(2)(a) of the U.S. income tax treaty with France nor article 23(2)(a) of the U.S. income tax treaty with Italy, allows a taxpayer to use a foreign tax credit to offset IRC §1411 net investment income tax.

IRC 

§

27 

provides for a credit against "the amount of taxes imposed by foreign countries * * * against the tax imposed by this chapter." IRC §27 is in chapter 1 of the Code. This credit is often referred to as the foreign tax credit.

IRC §1411 provides for a tax on net investment income (NII). Code Sec. 1411 is in chapter 2A of the Code.

Article 24(2)(a) of the U.S.-France Tax Treaty provides: "In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a citizen * * * of the United States as a credit against the United States income tax: * * *the French income tax paid by or on behalf of such citizen." Similar language is found in article 23(2)(a) of the U.S.-Italy Tax Treaty. Both treaties are referred to below as the Tax Treaty.

Ms. Toulouse, a US citizen living in France, claimed a foreign tax credit on her US tax return for income taxes she paid in France and Italy. The credit was used to offset her net investment income tax (NIIT).

The IRS denied the credit.

The Tax Court agreed with the IRS that neither the Code nor the Tax Treaties allow a taxpayer to offset NIIT with foreign taxes paid.

First The Court Said That Clearly The Code Does Not Allow A IRC §27 Foreign Tax Credit To Be Used To Offset NIIT.

The foreign tax credit only applies to taxes impose in chapter 1. The NIIT is found in chapter 2A. Ms. Toulouse had argued that the placement of the NIIT in chapter 2A was mere happenstance and a clerical choice. But the Court said that the enactment the NIIT as part of chapter 2A is a clear expression of congressional intent that credits against section 1 will not apply against the NIIT.

Second, the Tax Treaties do not allow a credit against NIIT for foreign taxes paid. The terms of the Tax Treaties say that such a credit is only allowed "in accordance with the provisions... of [U.S.] law." The Court said that U.S. law, in this case the Code, doesn't allow a credit against NIIT for foreign taxes paid.

Ms. Toulouse questioned the purpose of the Tax Treaties if there is no independent, treaty-based credit and a credit is allowable only if it is provided in the Code. But the Court pointed out that other provisions of the Tax Treaties may well provide for credits that are unavailable under the Code. But the provisions cited by Toulouse, by their express terms, do not so provide.

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