The U.S. is one of the only nations that imposes income tax on its citizens who live abroad. The theory is that this taxation guarantees Americans worldwide pay their share for the privilege of U.S. citizenship and, perhaps more importantly, prevents them from hiding income by living overseas. Traditionally, the taxation policies of an expat’s country of residence have been viewed as an issue for the individual and have rarely influenced U.S. taxation in a broad way.

American citizens living abroad are subject to U.S. taxes, including the Net Investment Income Tax (NIIT), a 3.8 percent levy on certain net investment income of individuals, estates, and trusts with high earnings.

Historically, foreign tax credits (FTCs) from various countries have done little to offset the increasingly thorny NIIT liability. Americans claiming treaty-based foreign tax credits against the NIIT have rarely won in court; rulings have been against the taxpayer or narrowly applied to the specific language of a U.S. tax treaty with one country.

However, the U.S. Court of Federal Claims has decided in Paul Bruyea v. United States that FTCs may, in fact, be used to offset the NIIT according to U.S. tax treaties with more than a few nations.

Canada Treaty

The case stems from a tax refund complaint against the United States that Bruyea filed two years ago. He paid nearly $2 million in taxes to Canada and claimed a foreign tax credit of $1,398,683 to offset the regular U.S. tax liability for the 2015 tax year. At that time, Bruyea did not claim an FTC to offset the NIIT.

In November 2016, Bruyea filed a 1040X claiming a refund of $263,523 by virtue of offsetting the NIIT. Bruyea argued that he was entitled to an FTC based on Article XXIV of the Convention Between Canada and the United States with Respect to Taxes on Income and on Capital (aka the “Canada Tax Treaty”).

The IRS rejected the refund claim, concluding that “the Canada Tax Treaty did not provide an independent basis for a foreign tax credit to offset the NIIT and that such a foreign tax credit is not allowed under U.S. statutory foreign tax credit rules.”

Bruyea then invoked the Simultaneous Appeal Procedure to obtain the opinions of the U.S. and Canadian authorities to resolve the double taxation—Canadian income tax and U.S. NIIT—on the same items of income and gain with no FTC offset available.

The Canadian tax authority agreed with Bruyea: “Canada, as the country of source, has the right to tax the gain, while the U.S., as the country which has residual taxation rights, must provide relief in accordance with Article XXIV of the Convention.”

After the IRS denied his tax refund claim, Bruyea filed a complaint in the Court of Federal Claims, asserting that he was entitled to a refund of the NIIT that he paid, $263,523, for tax year 2015. On Feb. 14, 2024, he moved for partial summary judgment; the U.S. government filed a cross-motion for summary judgment and response.

‘Makes More Sense’

Despite the high drama of cross-border tax conflict, “interpreting a treaty is similar to interpreting a statute or a contract,” writes Federal Claims Judge Matthew H. Solomson in the Bruyea decision. “When it comes to a treaty, however, there is a notable difference from other legal instruments: Courts are encouraged to consider a treaty’s purpose, as well as extrinsic evidence of the intent of the parties to the treaty.”

In citing Article XXIV of the Canadian-American Convention, the opinion points out that in the case of the United States, double taxation shall be avoided, and “the United States shall allow to a citizen or resident of the United States … as a credit against the United States tax on income the appropriate amount of income tax paid or accrued to Canada.” The opinion also points out that paragraph four of the article specifies that “the United States shall allow as a credit against United States tax the income tax paid or accrued to Canada,” with some conditions.

The Court found that the U.S. government argument relied primarily on the U.S. Law Limitation clause of Article XXIV, that any Treaty-based credit must be “[i]n accordance with the provisions . . . of the law of the United States.”

“The government maintains that a treaty-based credit simply cannot exist independently of the [U.S. Internal Revenue Code, or IRC]—the ‘law of the United States,’” the Court writes. “The government contends that the NIIT … precludes the treaty-based tax credit Mr. Bruyea claims.”

The Court calls the basic interpretive problem “readily apparent. On the one hand, the Canada Tax Treaty plainly provides for a foreign tax credit in Mr. Bruyea’s favor … On the other hand, a literal reading of the U.S. Law Limitation arguably takes back what Article XXIV otherwise giveth (because the IRC, by its terms, certainly does not provide for the treaty-based tax credit Mr. Bruyea claims).”

The Court noted, though, that Bruyea agreed with the foundational axiom that the IRC does not provide the FTC he seeks to apply against the NIIT, arguing instead that the IRC cannot and does not answer the critical interpretative question posed by his complaint: “As the NIIT falls outside [C]hapter 1 [of the IRC], the parties agree that no credit is allowed under domestic law, but Plaintiff’s view is that the NIIT is covered by the foreign tax credit rules of the Canada Treaty.”

“The government’s interpretation has a glaring consistency problem: The government takes an ad hoc approach to the U.S. Law Limitation,” Solomson wrote. “The interpretative puzzle is complicated, but ultimately Mr. Bruyea’s approach makes more sense.”

More Treaties, Similar Risk

First, the federal government will have to do something about the NIIT, that darling of the tax-the-rich movement. Why is the NIIT not more nimble, given sticky inflation and the general rise of the stock market decade over decade? This tax and its increasingly unrealistic thresholds will eventually have to be indexed to inflation (as are many other important U.S. tax thresholds).

The Bruyea ruling concerns general language that applies to many tax treaties. And there’s the case’s potential impact, broadening what most recently culminated in the 2023 ruling in Christensen v. United States.

In Christensen, the U.S. Court of Federal Claims held that the U.S.-France income tax treaty permits the application of an FTC against NIIT for French income taxes paid on certain passive foreign-source income by an American couple who lived in France (essentially addressing that bane of U.S. expats, double income taxation).

The Claims Court combed the U.S.-France treaty and found two sections of Article 24 that refuted the Christensens’ claim for credit against the NIIT for French taxes they’d paid, echoing previous rulings from other courts in cases involving U.S. claims for tax credits in France, Italy, and South Korea.

Yet the Claims Court did support the Christensens, citing a separate sub-clause of the France Treaty’s Double Taxation article. Christensen, one observer noted, involved U.S. citizens who are residents in a foreign country whose income tax treaty with the U.S. does not specify that U.S. law limits FTCs claimed against American tax. Nonetheless,specific language deep in one tax treaty narrowly won the couple their credit.

Bruyea broadened the Christensen application of such language, what observers have called the court’s new “expansive perspective” on the ability to claim an FTC against NIIT. Suddenly, an expat American taxpayer might call upon this latest ruling to shield them from double taxation. 

Not so fast. In Bruyea, the Court found nothing in statutes forbidding using a foreign tax credit to offset the NIIT. While the ruling offers taxpayers—both individuals and businesses—a potentially more powerful and broadly applicable weapon than Christensen, the government is likely to appeal the Bruyea decision, opening the door for modification or even reversal.

Depending on it as precedent now to justify offsetting the NIIT is less of a risk than before—and may be worth it, depending on the size of the tax bill. Just remember that “encouraging” doesn’t mean “risk-free.”