U.S. citizens living in Canada face tax risk on investment income

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Photo by Geoff Robins / AFP via Getty ImagesWe independently select everything we recommend. Buying through us may earn us a commission, which supports our work.A pair of U.S. tax cases decided this week confirmed that high-income U.S. citizens living in Canada (including dual citizens) could face an effective marginal tax rate of more than 57 per cent on any investment income they earn. Both cases dealt with the ability of U.S. citizens to claim a foreign tax credit against the dreaded net investment income tax (NIIT). One of the cases involved a Canadian resident taxpayer.THIS CONTENT IS RESERVED FOR SUBSCRIBERS ONLYSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman, and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.SUBSCRIBE TO UNLOCK MORE ARTICLESSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.REGISTER / SIGN IN TO UNLOCK MORE ARTICLESCreate an account or sign in to continue with your reading experience.Access articles from across Canada with one account.Share your thoughts and join the conversation in the comments.Enjoy additional articles per month.Get email updates from your favourite authors.THIS ARTICLE IS FREE TO READ REGISTER TO UNLOCK.Create an account or sign in to continue with your reading experience.Access articles from across Canada with one accountShare your thoughts and join the conversation in the commentsEnjoy additional articles per monthGet email updates from your favourite authorsSign In or Create an AccountBefore delving into the details of these landmark decisions, a bit of background on U.S. tax law is in order. The NIIT took effect in 2013 under the Affordable Care Act, known informally as Obamacare. The NIIT applies to high-income U.S. tax filers making more than US$200,000 (for single filers) annually, and imposes a 3.8 per cent surtax on net investment income, including interest, dividends and capital gains.Get the latest headlines, breaking news and columns.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Top Stories will soon be in your inbox.We encountered an issue signing you up. Please try againThe problem is that it also applies to U.S. citizens resident in Canada who already face punitive combined top federal and provincial tax rates of more than 50 per cent (in eight out of ten provinces) on their investment income. That’s because, under U.S. law, citizens are required to file an income tax return reporting worldwide income no matter where they reside, which is why U.S. citizens living in Canada are required to file U.S. tax returns each year. By contrast, Canada, like most countries in the world, generally only taxes individuals based on residency.In the majority of cases, however, U.S. citizens don’t end up owing U.S. federal tax due to offsetting foreign tax credits. The problem for dual income tax filers since 2013 has been that, under U.S. domestic law, foreign tax credits are not available to offset the 3.8 per cent NIIT, meaning that high-income, dual-filers, have been paying an extra 3.8 per cent U.S. tax on their worldwide investment income. The lack of a foreign tax credit meant that investment income is punitively taxed since tax is paid on that income in a foreign jurisdiction (such as Canada) which is not being fully credited against the NIIT paid in the U.S.That’s why two taxpayers, one in France and one in Canada, each, separately, took the U.S. government to court, arguing that, regardless of the U.S. domestic law that restricts claiming a foreign tax credit against the NIIT, the respective tax treaties signed between their countries of residence and the U.S. should work to eliminate this double taxation of investment income.The first case involved a French couple who were U.S. citizens living in Paris in 2015 who sold shares of a French company, and paid tax in both France and the U.S., including $3,851 of NIIT. They sued the U.S. Internal Revenue Service, demanding a refund of the NIIT and arguing that the France-U.S treaty should eliminate this double tax.They were initially successful in their 2023 case at the U.S. Court of Federal Claims, which found that the treaty did allow a foreign tax credit against the NIIT. But the U.S. government appealed the decision, and on Aug. 31 the U.S. Court of Appeals for the Federal Circuit reversed the lower court’s decision, ruling that the NIIT is not covered by the treaty, so no foreign tax credit applies.This advertisement has not loaded yet.This advertisement has not loaded yet, but your article continues below.The second case involved a Canadian taxpayer, Paul Bruyea, who was a U.S. citizen who lived in B.C. (He died in June 2026, so his estate took over the case.) In 2015, he sold some Canadian real estate and paid Canadian capital gains tax on the sale.But because Mr. Bruyea was also a U.S. citizen, he ended up having to pay NIIT of US$263,523 on the same gain. He initially tried to offset this NIIT liability by claiming a foreign tax credit for the capital gains taxes already paid to Canada, relying on the Canada-U.S. tax treaty, but the IRS disallowed the credit, so Mr. Bruyea ended up paying the tax in full.Fast forward to 2023 when Mr. Bruyea filed for a refund of the NIIT in the Court of Federal Claims, alleging that the NIIT that he paid to the U.S. constituted a form of double taxation, which was in direct violation of the Canada-U.S. tax treaty. The judge agreed with Mr. Bruyea’s interpretation and, in a 2024 decision, held that the treaty created an independent foreign tax credit that could be applied against the NIIT.The government appealed that decision as well, which is why the matter ended up in court again. The issue came down to the interaction between the U.S. tax code and the treaties. While both the Canada-U.S. tax treaty and the France-U.S. tax treaty contain clauses establishing foreign tax credits, both also contain a critical condition. In the case of the Canada-U.S. treaty, it states that double taxation shall be avoided “(i)n accordance with the provisions and subject to the limitations of the law of the United States.” Similar wording appears in the France treaty.The Federal Circuit court concluded that this wording is intended to explicitly incorporate the limitation contained in the U.S. domestic law, which restricts foreign tax credits from being claimed against the NIIT. As a result, the court found that Mr. Bruyea was not entitled to claim the foreign tax credit and the lower court’s decision was reversed, meaning that the full NIIT was, indeed, payable.Kevyn Nightingale, an accountant certified in both Canada and the U.S. and the leader of cross-border tax planning at Levy Salis LLP, was “surprised and disappointed at the decision,” he said in an email. While the court decision notes that the “drafters of the (treaty) understood they were drafting its provisions against the backdrop of the Code, including how the Code may limit the treaty-created credits,” Nightingale said, in the case of the NIIT this is not entirely accurate.He was present in Washington when the NIIT legislation was being drafted as part of a committee of the American Institute of Certified Public Accountants. At that meeting, Nightingale said he asked government representatives from the Joint Committee on Taxation and the U.S. Treasury about the need for a foreign tax credit against the NIIT, to which they responded that they simply hadn’t considered it.“The fact is that the legislation was adopted in extreme haste near the end of the year, just prior to the Christmas break. It was sloppily written as a result,” said Nightingale.Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.If you liked this story, sign up for more in the FP Investor newsletter.Notice for the Postmedia NetworkThis website uses cookies to personalize your content (including ads), and allows us to analyze our traffic. Read more about cookies here. By continuing to use our site, you agree to our Terms of Use and Privacy Policy.