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By Peter Muto
Special to the Financial Independence Hub
Canada and the United States have very different tax regimes, and if you live and work in Canada but happen to be an American citizen, you better pay attention. It is estimated that up to two million Americans currently reside in Canada either as full-time or part-time residents. Full-timers who hold jobs in this country, effectively U.S. citizens and green card holders, sometimes start thinking of themselves as being Canadian. But as far as the IRS is concerned, that is a big mistake.
Unbeknownst to many, the IRS in the U.S. and the Canada Revenue Agency (CRA) in Canada can assist each other in collecting taxes from their respective citizens, and this also goes for those with dual citizenship. The fact is tax debts can be enforceable in a foreign jurisdiction. Canada currently has collection-assistance provisions in treaties with such countries as Germany, the Netherlands, Norway, New Zealand, the United Kingdom and Spain. And the United States.
A recent case concerning an American who was ordered to pay a big penalty in U.S. district court demonstrates this all too well.
How one Canadian resident fell afoul of the IRS
The man, Donald Dewees, teaches at the University of Toronto. He lives and works in Canada, and dutifully pays his Canadian income tax. But, as mentioned at the outset, Canada and the U.S. have very different tax regimes. The biggest difference is that in this country the federal government taxes people based on residency, but the U.S. imposes tax obligations on all its citizens regardless where they live, even if they have no U.S. income.
According to the rules, Dewees is supposed to file with the IRS a document called an FBAR: the Report of Foreign Bank and Financial Accounts, which is known as Form FinCEN 114. He has to do that annually. What is this for? One situation it applies in is when an American citizen or green card holder has financial interest in, or signature authority over, one or more foreign accounts as long as the aggregate value is more than US$10,000 at any time during the reporting period. So, even though the person may not hold an American bank account and may not even earn American source income, they still have to file this report with the IRS every year.
Voluntary Disclosure Programs
In this case, back in 2009 Dewees entered what is known as the Offshore Voluntary Disclosure Program (OVDP). He did that so he would be compliant with his U.S. tax obligations. So far, so good. This program is similar to Canada’s Voluntary Disclosure Program, which allows a taxpayer to pay fixed penalties. In this way you know right away how much you owe. Also, when you are in the U.S. OVDP, criminal charges will never be laid against you.
However, here is where DeWees veered off course. After entering the OVDP program, he wanted to know how much he owed in penalties and the amount was about US$185,000. So he withdrew from the OVDP program.
After that the IRS got involved. The IRS assessed a penalty for failing to file form 5471, which is required when you own a controlling interest in a foreign company; in this case a non-U.S. company. The minimum penalty is US$10,000 and that is for every year of non-compliance. For Dewees, that meant 12 years and 12 X $10,000 is US$120,000. That is the total for which he was assessed.
Article XXVI-A of the Canada-U.S. Treaty says both countries will assist each other in the collection of taxes, which includes GST/HST, Canadian provincial taxes and taxes arising due to Director’s liability. Unique to the Canada-U.S. agreement, assistance is not granted to the requesting state where the debtor is a citizen of the other state at the time the debt arose.
This means either country will assist in collections concerning a non-citizen. In the case of Dewees, the CRA in Canada had no problem collecting a tax debt from an American citizen on behalf of the IRS. It could do so because the person was not a Canadian citizen, and Dewees had never been a citizen of Canada. The CRA was going to withhold his refunds and remit to the IRS until his debt was taken care of.
Dewees promptly paid the penalty the IRS had assessed and then filed a suit in U.S. District Court since he felt the fines were too high, and further, he also felt he had been denied due process and equal protection. The case was promptly dismissed.
In today’s complicated tax landscape, one should be aware of any unforeseen consequences that can develop when tax obligations are not met, and if you’re not sure what those obligations are, it is wise to seek professional advice.
Peter Muto is an Associate at Morris Kepes Winters LLP, a leading tax boutique law firm. His practice focuses on dispute resolution at the audit stage with the CRA, and appeals to the Tax Court of Canada.
