In Paul Bruyea v. United States,¹ the US Court of Federal Claims (Claims Court) granted an individual's motion for partial summary judgment, finding the individual was entitled to a treaty-based FTC under the US-Canada Income Tax Treaty to offset the NIIT paid to the United States under IRC Section 1411.

Facts

In 2015, Bruyea was a US citizen and resident of British Columbia, Canada. He reported $7 million in capital gains from the sale of real property in Canada and paid approximately $2 million in taxes to Canada. He also filed Form 1040, US Individual Income Tax Return, and claimed an FTC of approximately $1.4 million against his regular US income taxes imposed by Chapter 1 of the Internal Revenue Code (the Code). He did not claim an FTC to offset the NIIT, imposed by Chapter 2A of the Code, due on this return.

On November 7, 2016, Bruyea filed Form 1040X, Amended US Individual Income Tax Return,for tax year 2015, claiming a refund of the NIIT — $263,523 — based on the assertion that Article 24 of the US-Canada income tax treaty (Treaty) allows Bruyea to claim Canadian tax paid as an FTC that offsets the NIIT. The IRS rejected the refund claim, stating that the Treaty did not contain an independent basis for an FTC to offset the NIIT, and that the IRC did not allow the FTC.

Bruyea then invoked the Simultaneous Appeal Procedure and sought advisory opinions from the US and Canadian competent authorities to aid in the resolution of the double taxation issue resulting from the same items of income and gain being taxed by the Canadian income tax and US NIIT with no FTC offset available. The Canadian Competent Authority agreed with Bruyea, advising that Canada has a right to tax the gain, while the United States must provide relief under Article 24 of the Treaty. Bruyea also filed a complaint with the Claims Court, claiming he was entitled to the refund, and moved for partial summary judgment, asserting he was entitled to an FTC under the Treaty. The US government filed a cross-motion for summary judgment. The Claims Court heard oral arguments on September 19, 2024, before issuing its order on December 5, 2024. Following the decision, the parties still must resolve whether Bruyea properly computed his US FTC under the Treaty.

Interpreting the Treaty

In undertaking its analysis, the Claims Court outlined its view on Treaty interpretation by stating that it is encouraged to consider a treaty's purpose as well as extrinsic evidence of the intent of the parties to the treaty. When a treaty provision is ambiguous, a court "may look beyond the written words to the history of the treaty, the negotiations, and the practical considerations adopted by the parties," including the proposition that the "opinions of our sister signatories … are entitled to considerable weight." The Claims Court further relied on its precedent that a US government agency's interpretation of a treaty provision "merits less deference where an agency and another country disagree on the meaning of a treaty."

Article 24(1) of the Treaty generally relieves double taxation on US citizens by providing that "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 … " This provision is contextualized by language that narrows the scope of the credit such that it must be "in accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time) … " — the so-called US Law Limitation. For US citizens who are tax resident in Canada, Article 24(4) further provides that "the United States shall allow as a credit against United States tax the income paid or accrued to Canada … ." The Treaty contains limitations to ensure that FTCs are not doubly offset based on income-sourcing rules.

The government argued that Bruyea's refund claim must fail because the Code only allows an FTC for taxes within Chapter 1, and the NIIT is in Chapter 2A. To support its position, the government pointed out that (1) the "last-in-time rule" requires a later-enacted statute to control over a directly conflicting treaty provision, and (2) the US Law Limitation prohibits a treaty-based credit against NIIT. However, the Claims Court disagreed with both positions.

The Claims Court pointed out that the government "concedes that a treaty generally may provide a self-executing tax credit (i.e., even where the Code contains no implementing provisions or even where it is inconsistent with a treaty-based tax credit)." It rejected the government's argument that the placement of the NIIT in Chapter 2A, as opposed to Chapter 1, was sufficient grounds for denying the FTC because the Treaty "guarantees that any future amendment to United States law will not change the general principle" of the Treaty. The Claims Court reasoned that the Treaty will give way to the Code only where a later-enacted statutory provision "directly" conflicts with the Treaty or where the Treaty, by its terms, defers to the Code.

The Claims Court then considered the "the last-in-time rule" ² and determined it must harmonize the Treaty and the Code, ultimately concluding that nothing in the NIIT language was inconsistent with a treaty-based FTC. The Claims Court, thus, held that the last-in-time rule did not apply in this instance because the application of the treaty-based tax credit did not conflict with and, therefore, was not precluded by the NIIT or any other Code provision.

The Claims Court also held that the US Law Limitation does not preclude Bruyea from claiming the treaty-based credit to offset the NIIT. In reaching this conclusion, the Claims Court considered various provisions of the Treaty, including clauses 2 and 3 of Article 24, paragraph 1, which reserve the right of the United States to amend its laws without changing the Treaty's general principle. The Claims Court found that those clauses refer to the "'general principle of eliminating or avoiding double taxation." The Claims Court also noted that paragraph 3(a) of Article 2 states that the Treaty applies to "taxes identical or substantively similar to taxes to which the Convention applies under paragraph 2" of Article 2, and that such language would cover the NIIT.

The Claims Court looked to the technical explanation of the Treaty for support and observed that "[p]aragraph 1 of Article [24] contains no suggestion that it was intended to limit in any way the type of United States tax to which a foreign tax credit might apply." Lastly, the Claims Court noted that the Treasury and IRS acknowledged in the final regulation implementing the NIIT that there is no "per se obstacle" to applying a treaty-based credit to the NIIT.

Ultimately, the Claims Court concluded that, "so long as the NIIT qualifies as a 'United States tax', the Treaty provides for the claimed credit." Therefore, the Claims Court ruled the Treaty allowed Bruyea to claim the credit to offset the NIIT. Accordingly, the Claims Court granted Bruyea's motion for partial summary judgment, finding that Bruyea was entitled to a treaty-based FTC against the NIIT for tax year 2015.

Toulouse, Christensen

The Claims Court's approach differed markedly from the approach taken by the United States Tax Court (Tax Court) in Toulouse v. Commissioner³ and by the Claims Court in Christensen v. United States.⁴

In Toulouse, the Tax Court rejected the taxpayer's claim that the US-France Income Tax Treaty (French Treaty) allows a credit against the NIIT as a result of taxes paid to France. The Tax Court relied primarily on the assertion that the NIIT resided in Chapter 2A of the Code — a chapter that was created exclusively for the NIIT deliberately and not by "happenstance and a clerical choice." The Tax Court held that the treaty credit provisions applied only to "regular taxes" found in Chapter 1, but it did not consider application of Article 24(2)(b) of the French Treaty because the petitioner did not argue that she was entitled to relief under that provision. The US District Court for the Central District of California in Kim v. United States⁵ applied similar reasoning as the Tax Court in Toulouse to deny a treaty-based FTC against the NIIT under the US-South Korea Income Tax Treaty.

In Christensen, the Claims Court held that the French Treaty allows an FTC to apply against NIIT because the French Treaty provided an independent basis for claiming the FTC (subject to income and FTC sourcing limitations) in Article 24(2)(b). Although Article 24(2)(a) of the French Treaty includes the US Law Limitation, the Claims Court in Christensen noted that Article 24(2)(b) does not include that language, so a treaty-based credit was available under Article 24(2)(b).

Implications

Bruyea demonstrated the Claims Court's expanded perspective on the ability to claim an FTC against the NIIT. In Bruyea, the Claims Court concluded that the US Law Limitation only informs how FTCs are computed for US tax purposes, while the same Claims Court (albeit a different judge) in Christensen concluded that the US Law Limitation could prevent a treaty-based FTC. Bruyea's holding is further contrasted by the Tax Court's conclusion in Toulouse, which concluded the US Law Limitation language allows treaty-based credits for taxes located in Chapter 1 only. Thus, a lack of clarity continues to exist, as:

• Toulouse strictly interprets a treaty as limited by US law
• Christensen identifies an exception in specific provisions under the relief from double taxation article
• Bruyea finds broader relief in various provisions under the relief from double taxation article

The Claims Court's treaty analysis in Bruyea raises the question whether a US individual who is not a resident of the treaty country (e.g., a US citizen who only resides in the United States) can potentially claim a treaty-based FTC against NIIT.

Taxpayers considering claiming a treaty-based FTC against NIIT under the relief from double taxation article of an applicable US income tax treaty should consult their tax advisors and proceed with caution. The competent authorities of Canada and the United States could not reach an agreement to alleviate the double tax that arises when the US denies any FTC to offset NIIT. Even though the Claims Court held against the US government in Bruyea, the Tax Court holding in Toulouse remains strong support for the IRS's position. If a taxpayer were to claim a treaty-based FTC against the NIIT, and the IRS were to subsequently deny the claim, the taxpayer may find it difficult to resolve the matter administratively — i.e., with IRS appeals or through competent authority. Taxpayers should consider the practical challenges on processing those claims, as well as the strong likelihood that the IRS will continue to deny claims for an FTC on a timely filed or amended return. The Forms 1040, 1116, Foreign Tax Credit, and 8960, Net Investment Income Tax Individuals, Estates, and Trusts, are not designed to allow an FTC against NIIT. Considering the decisions in favor of the US government in Toulouse and Kim, taxpayers should expect that the US government will appeal the Bruyea decision, just as it did with the Christensen decision. Taxpayers wishing to preserve their right to a refund may consider making protective refund claims.