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Tax News
In Topsnik v. Commissioner the Tax Court Rejects Fiscal Avoidance Attempt in the Sale of Shares
September 24, 2014
Cases
Here is a case that came out yesterday where the taxpayer tried to have its cake and eat it too. While the case does not address expressly an investment fund or its LPs one can draw parallels to the fund industry. What was the issue? Many treaties have various mechanisms that are in a way designed to mitigate fiscal avoidance, i.e. situations where a particular person does not pay tax in any jurisdiction. This mechanism can take various forms but most generally it would manifest itself in some requirement affording treaty benefits only if the specific person pays income tax in one of the contract states. For example, the Swiss treaty has special provisions for forfeit tax, the U.K treaty has special provisions for remittance taxpayers, and the German treaty has special provisions for source taxation.  Clearly, the U.S. does not want to bestow treaty benefits upon an individual who claims to be a resident in a treaty country but is not necessarily subject to tax in that country.  That would lead to a situation where the income is not subject to tax anywhere and this does not jive with our Revenue authorities.

An interesting situation occurs when a taxpayer is a dual-resident for treaty purposes and claims a residency in a foreign country under a treaty tie-breaker rule. You can imagine an affluent LP who is a green card holder of the U.S. but has his center of vital interest in a different country, say Germany. This LP redeems its shares in the fund and takes a treaty position that he should not be subject to tax because he is a resident of Germany for tax purposes. While these are not exactly the facts in Topsnik v. Commr, 143 T.C. No. 12 (Sept 2014) there are not far from the above succinct description. In this case a dual-resident (U.S. green card holder and a German resident) sold shares in a U.S. corporation.  He basically claimed that because he had ties to Germany and he was informally abandoned his U.S. green card, the gain on the shares should not have been subject to tax in the U.S.

This case is great because paints a detailed picture how these residency issues will be analyzed by the court. The court of course looked at the taxpayer’s travel logs which showed only a few days in Germany, the fact that when he was coming back through U.S. immigration he was stating that he was returning home, the fact that he had a U.S. home and so on. Most importantly for purposes of this blog post, the U.S. Government obtained information from the German authorities under Competent Authority procedure. This information exchange revealed that (1) petitioner was registered with the German tax authority as a taxpayer with limited liability, taxable only on German source income, (2) petitioner failed to file even the tax returns required of a limited liability taxpayer despite the tax authority's repeated requests that he do so, and (3) the German tax authority had no record of his filing income tax returns in Germany. That sealed the taxpayer’s faith. Considering that the taxpayer was subject to German tax only on German source income, and considering that he didn’t even pay that, under the U.S.-German treaty he could not be a resident.

What is the moral of the story for itinerant LPs here?  The main moral of the story is that the U.S. government does not like fiscal avoidance.  Some LPs, lead by their desire to minimize taxes, may  choose residence jurisdictions based on the opportunity for fiscal avoidance. These jurisdictions may be jurisdictions that do not necessarily come to mind as tax havens. To those LPs that reside in such jurisdictions and are also U.S. residents with U.S. source income, it is advisable to closely look at the fiscal avoidance provisions in the applicable treaty. Also, it pays to actually comply with the tax laws of the foreign jurisdiction for which the taxpayer claims residency. These points may seem common sense but apparently some taxpayer still footfall on these.  The end result may be a large penalty due to the U.S. Treasury, just as in this Topsnik case.  Lastly, there aren’t too many U.S. cases that deal with this issue to begin with, which makes this case even more so notable.
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Tags: 7701(b), double-tax treaty, dual resident, fiscal avoidance, fiscal evasion, treaty tie breaker, U.S. residency