As the global economy becomes more aligned, it is more common for businesses and individuals today to have income and tax compliance issues in more than one country. With the complexity of varying tax regimes and the difficulty in monitoring offshore tax compliance, governments and taxing authorities around the world are looking for ways to collaborate to ensure taxpayers are paying their fair share of tax in all required jurisdictions, wherever they may be.
Collaborative efforts among many countries have led to the formation of various Tax Information Exchange Agreements (TIEAs). A TIEA is a model information exchange agreement designed by the Organization for Economic Cooperation and Development (OECD). Per the OECD, in describing its agreement on exchange of information on tax matters model, “The purpose of this Agreement is to promote international co-operation in tax matters through the exchange of information.” The U.S. has TIEAs with countries throughout the world, and it has also instituted its own information sharing program via Intergovernmental Agreements (IGAs) under the Foreign Account Tax Compliance Act (FATCA). Although these agreements are primarily notorious for exchanging information regarding undisclosed foreign brokerage and bank accounts, a recent U.S. Tax Court case substantially reduced a taxpayer’s foreign tax credits claimed after the IRS discovered that virtually all of the foreign taxes originally paid, were refunded.
In Sotiropoulos v. Commissioner, the taxpayer, a U.S. citizen who resided and worked in London from 2002-2006 had U.K. compensation and taxes withheld that were reported on a U.K. tax return. As a U.S. citizen, the taxpayer was also required to file U.S. tax returns for the corresponding years, which reported her U.K. compensation and claimed foreign tax credits for the taxes withheld/paid to Her Majesty’s Revenue and Customs (HMRC), the U.K. taxing authority.
The taxpayer subsequently filed amended U.K. returns for the relevant years to report losses attributable to a U.K. film investments she made. The results of these losses produced significant overpayments of U.K. taxes, which the taxpayer elected to have refunded. The taxpayer however, did not notify the Secretary regarding the U.K. tax refunds as required by §905(c)(1)(C), since it was uncertain if the claimed losses would be sustained upon examination by HMRC.
Although the taxpayer had failed to disclose the U.K. refunds, the IRS was notified of the taxpayer’s U.K. refunds received under the terms of the U.S./U.K. information exchange agreement and the IRS consequently reduced the taxpayer’s claimed foreign tax credits, and issued the taxpayer a notice of deficiency for the years in question. The Tax Court concluded that the term “refund” does not connote finality or the final determination of a tax liability for U.S. federal income tax. Even though the taxpayer might have to repay the amounts originally refunded, it does not mean the taxpayer did not receive a refund reportable under §905(c)(1)(C).
Tax preparers dealing with international tax compliance issues should take notice of the Sotiropoulos opinion. With information exchange agreements becoming more prevalent among governments and taxing authorities, taxpayers must be aware that events which often went unnoticed, may now reveal themselves. As the enforcement of international tax compliance increases worldwide, preparers and taxpayers alike should be advised to consider the potential tax implications resulting from the open exchange of information.
Please contact an International Tax Services advisor for further information on this.