Eshel v. Comm, 118 AFTR 2d 2016-XXXX (CA Dist Col), 08/05/2016
U..S Court of Appeals for the District of Columbia Circuit
In many ways Eshel could be a Treaty Interpretation 101 class. The case focuses on the AGREEMENT ON SOCIAL SECURITY BETWEEN THE UNITED STATES OF AMERICA AND THE FRENCH REPUBLIC (treaty). We need to briefly review this type of treaty and a portion of the U.S. foreign tax credit system to provide context, so hopefully you can be a bit more patient than my teenagers.
You need to know what a Social Security Totalization Agreement is. Without going into too much detail, these treaties provide benefits to individuals who may work in more than one country, pay social taxes in each, but do not qualify for benefits in any particular country. As an example, suppose a U.S. citizen working in Atlanta for USCo gets transferred to FCo, the French subsidiary. If the employee’s time is split such that he/she doesn’t qualify for social security benefits in either country, the treaty can allow the time worked to be combined (totaled) to allow the individual to become eligible to receive benefits.
Another benefit is that the transferee to FCo can continue to pay only U.S. social security taxes provided the France assignment lasts fewer than five (5) years.
You should care about this case because the issues at play could materially impact your global after-tax cash flow. Generally, U.S. persons may claim a credit against U.S. income tax liability for foreign income taxes paid, ideally protecting taxpayers from double taxation. A taxpayer may deduct such taxes but the credit provides a greater benefit. Conversely, social taxes are ineligible for a foreign tax credit if the U.S. has a totalization agreement with that country covering such taxes.
The U.S. and France entered into the treaty in 1987. Most treaties of this type, including income tax treaties, provide both: (1) a list of the specific taxes covered; and (2) a provision providing flexibility for law changes, such as apply[ing] to legislation which amends or supplements the laws specified. (Article 2, paragraph 3.)
An issue arises because of two (2) French taxes implemented post 1987, the contribution sociale généralisée (CSG) in 1990 and contribution pour la remboursement de la dette sociale (CRDS) in 1996. The Eshels desired to claim a U.S. foreign tax credit (i.e., against income tax liability) for these two (2) taxes. The U.S. government believes these taxes are covered under the treaty and therefore ineligible for the foreign tax credit. While we could ramble on about the technical analysis, we’re more interested in the U.S. Court of Appeals for the District of Columbia Circuit’s statements on how to interpret not only this treaty but treaties in general.
The tax court (the court hearing the case prior to the appeal) correctly identified the issue as whether the laws adopting the CSG and CRDS “amend or supplement” the French laws enumerated in the relevant treaty provision. The tax court, however, looked to U.S. dictionaries for definitions and concluded the Totalization Agreement covers the two (2) taxes and therefore the Eshels could not claim a foreign tax credit for them. While the approach may have been appropriate for a domestic statute, the court of appeals concluded that tax court was asking the wrong question as this is a treaty. It should have looked to the treaty’s text and, if necessary, other documentation related to the countries’ shared understanding.
The court of appeals reminds the reader the treaty is an executive agreement with a foreign country. In essence it’s a contract between sovereign nations and needs to be read and interpreted in the context in which the parties intended. The court continues that it is inappropriate to make the United States’ maxims for statutory construction unilaterally dispositive.
The court of appeals reviews the treaty’s text and points to Article 1, which provides definitions for several terms but not specifically for amends or supplements. However, Article 1, paragraph 10 provides: Any term not defined in this Article shall have the meaning assigned to it in the laws which are being applied. The treaty defines Laws as those covered in Article 2. (Article 1, paragraph 3.) Article 2 focuses on the laws covered by the treaty, namely the U.S. laws, French laws and legislation which amends or supplements those laws. Since CSG and CRDS are French laws, the inquiry should be toward French laws. As the court of appeals says: For that reason, determining the “meaning” of “amend[ing] or supplement[ing]” the French laws should have at least in part been informed by French law.
There are other items the court of appeals disagrees with that we don’t go into here. Our takeaway is what we often tell our clients. First, for a general international tax issue, if an international tax issue seems to have an “easy” answer, take another look. Sometimes you have to take a step back and look at the bigger picture. Additionally, treaties are complex documents. Just because there is a treaty in place doesn’t mean one qualifies for benefits. Also, simply reading the treaty text doesn’t always provide the answer when applying the text to the facts. Often the Technical Explanation and other guidance is essential.
Here, the court of appeals seems to chastise the tax court, stating it should have consulted sources illuminating the “shared expectations of the contracting parties” such as “the negotiating and drafting history” and the postratification understanding of the contracting parties, quoting Zicherman, 516 U.S. at 223.
So, while there’s still no formal guidance on the creditability of these two (2) taxes, the court provides a how to. It has remanded the case for further proceedings – and for a more appropriate analysis.