When Tax Professionals Disagree

Walter B. Wriston (former CEO of Citicorp): “All the Congress, all the accountants and tax lawyers, all the judges, and a convention of wizards all cannot tell for sure what the income tax law says.”

Applying US tax law to “foreign” legal structures is problematic.1 This is one of the great frustrations of trying to comply with the US system of citizenship based taxation (and one of the reasons why this extraterritorial application of US law should be carefully considered by all countries who negotiate tax treaties with the US). Inevitably there will be differences of opinion as to how US law applies to particular foreign income or taxes – and these differences will lead to different US tax treatment of the same or similar items. There may be no single “right” answer, and we (or the tax professional we have hired) will have to choose how to interpret US tax law to determine our US tax liability on our foreign (home) income. Understanding how our local law meshes with the structures defined in the US tax code is the first step.

In Australia, we have two advantages relative to much of the rest of the world (especially those which are not part of the Commonwealth). First, our laws are written in English. While there are several Aussie colloquialisms that differ in meaning from American English, our laws and other formal writing are written in language that is mostly the same as US English (with a few extra vowels here and there, and the occasional “zed” that has been replaced by an “s”). Second, our legal system is derived from the British system, so many of the underlying principles are at least similar between the two countries. Even so, there are differences.

In this post I’d like to explore two areas where the application of US tax law to Australian financial products is not completely clear: managed funds and superannuation. An understanding of these US tax issues is critical for determining how the tax treaty (either the current treaty or a new one) can be used to protect Australian residents (and the Australian economy) from extraterritorial taxation by the US of Australian income.

Retail managed funds are an essential savings tool for Australians. They provide diversification with a relatively low initial investment. Under Australian law, managed funds are required to distribute all income and realised gains annually – just like mutual funds in the US. However, Australian managed funds are toxic investments for US taxpayers because most are classified as Passive Foreign Investment Companies (PFICs)2.

PFICs entered the US Tax Code in 1986. At that time mutual funds in the US were just gaining popularity and would not have been found in the investment portfolio of many smaller individual investors.  The intent of the PFIC rules was to remove a planning opportunity where wealthy investors could invest via a foreign corporation that did not distribute income currently, thereby deferring tax on interest and dividend income. Australian retail managed funds do not allow for any income deferral, so why are they PFICs? Let’s start with the definition: PFICs are corporations organised outside of the US where most of the assets are passive investments. Australian managed funds are certainly organised outside of the US and own exclusively passive investments; but are they corporations? Most are organised as “unit trusts,” a structure that doesn’t have a strict parallel in US law.

In the early 2000s, I doubt there were many Australian managed fund investors reporting their funds as PFICs on their US returns. At some point, however, the idea of PFICs entered the collective consciousness of tax professionals working on US expat returns. (The earliest reference I can find to this treatment is in 2009.) The more conservative return preparers decided to start reporting all foreign mutual funds as PFICS, and started writing articles about how toxic PFIC investments were. As this treatment became more common, it became expected. Now, most US tax preparers who work on expat returns will classify all foreign mutual funds as PFICs, even though they are not at all like the foreign investments originally targeted by Congress in 1986. In some sense, conservative compliance choices have changed the way US tax law is applied to Australian investments.

Superannuation is another area where compliance choices may end up dictating the treatment expected by the IRS. There are several different ways that superannuation can be analysed in determining how (or whether) to report super on a US tax return. In some ways, super is similar to US Social Security:

  • employers are required by law to contribute an amount that is a percentage of salary,
  • benefits from super contributions are not available to the employee until a condition of release has been met (most frequently retirement after a specified age), and
  • “The primary objective of the superannuation system is to provide income in retirement to substitute or supplement the age pension.”3

In other ways, super is similar to a 401(k) account:

  • accounts are attached to individual employees
  • most are defined contribution plans over which employees have limited ability to direct the  underlying investment,
  • voluntary contributions can be made in addition to the required employer contributions (subject to limits),
  • “concessional” contributions are made with before-tax dollars, and
  • income inside the account is not taxable to the employee.

And in other ways, super is different from anything available in the US:

  • contributions are taxed inside the fund at 15% on the way in,
  • investment income is taxed inside the fund at 15% while funds are accumulating,
  • income is completely tax free once withdrawals begin, and withdrawals are completely tax free after age 60,
  • substantial non-concessional contributions can be made with after-tax dollars,
  • super funds are not necessarily connected to employers, some are run as non-profit entities catering to a specific industry, others are owned and operated by banks,
  • it is possible to transfer your balance into a self-managed fund while still keeping it inside the superannuation system, and
  • self-employed individuals are not required to contribute to superannuation, but may make contributions which are deductible from their taxable income.

So, how is super to be treated on a US tax return? Like the blind men and the elephant, the answer depends on which part of the system you focus on. Tax professionals have advanced several theories – see an extended discussion here, on the Isaac Brock Society website. Until there’s a definitive ruling by the IRS, no one knows for sure! So, which part of this elephant should you focus on?

You certainly have no obligation to choose the interpretation that maximises your tax liability. In fact, you have a right to use a reasonable interpretation of the law that minimises your liability. In some cases you should disclose this interpretation very carefully in your return (consult a professional).

And, if anyone tells you there’s ONE right answer – ask them where the IRS ruling is that backs up that assertion. Until that ruling exists, any position you take on your US return is just an educated guess as to how US law applies to Australian legal structures.

DISCLAIMER – this goes without saying (and I’ve said it on the About page already) – I am NOT a lawyer or a tax professional. While we endeavour to make sure the information on this site is correct, you should consult an adviser who can take your own personal facts and circumstances into account!


  1. This post is assuming that you have already determined that US tax law should reach into Australia and tax your Australian source income and savings. For those who are not yet caught in the US tax system and have minimal ties to the US (such as Accidental Americans), consider very carefully the implications of entering the US tax system and whether US law should have any bearing on your Australian life.
  2. For a clear technical explanation of why PFICs are toxic, see PFICs Gone Wild! by Monica Gianni.
  3. http://www.aph.gov.au/Parliamentary_Business/Bills_LEGislation/Bills_Search_Results/Result?bId=r5762

4 thoughts on “When Tax Professionals Disagree”

  1. Karen:

    Thanks for an interesting and thought provoking post. For a supplementary read on the problem of PFICs, I offer your readers a submission to the Senate Finance Committee that is found here:

    http://www.citizenshipsolutions.ca/2014/02/06/pfic-taxation-and-americans-abroad/

    But, on the main point of your post …

    I have long been of the opinion that (1) U.S. tax law is primarily enforced by the tax compliance community and (2) sooner or later the positions adopted by a “critical mass” of tax professionals WILL become the the law! This is why it’s extremely important that dual Australian/U.S. citizens in Australia understand that there ARE different perspectives on all of these issues including the Australian Superannuation issue. Dual Australian/U.S. citizens in Australia must “push back” against any treatment of the Australian Superannuation that has the effect of disabling Australian citizen/residents from using the Superannuation as a retirement savings vehicle. (I do understand that the application of the Treaty to the Superannuation is unclear.)

    That said, on the interpretation of the Treaty …

    There is no way that the Treaty can be be interpreted to mean that: “Australian citizens residing in Australia cannot save for retirement”!

    Such an absurdity could NEVER have been the expectation of Australia in signing the Treaty. Australia’s expectation matters. A recent court decision has confirmed that the “expectation of the parties to the treaty” is a relevant (actually the most relevant) consideration in the interpretation of the Treaty. See here:

    http://www.citizenshipsolutions.ca/2016/08/07/the-interpretation-of-us-tax-treaties-domestic-law-foreign-law-or-the-intent-of-the-treaty/

    To allow any other interpretation is to agree that the United States of American can dictate how and even whether Australians can save for retirement. No, ……….

    The important role played by the tax professionals …

    Mark Twain (yes a famous American writer) was (I believe) the first to use the phrase:

    “If you are a hammer, everything looks like a nail.”

    If you are a U.S. tax professional then everything is seen through the prism of the U.S. Internal Revenue Code. If it’s not immediately clear how the code applies, then we will make it apply!

    Two thoughts occur to me.

    1. The Internal Revenue Code doesn’t mention the Australian Superannuation. Therefore, the instinct of the U.S. tax professional is to figure out how to make the Internal Revenue Code apply to the Super. It’s actually kind of funny to watch. It’s like buying a piece of furniture that doesn’t fit in your house. Rather than return the piece of furniture (the Internal Revenue Code doesn’t apply because of the Treaty), you knock down a wall in your house (let’s force the Internal Revenue Code into Australia) to make the furniture fit. It’s almost as though they cannot imagine a world that is not run by the Internal Revenue Code! (Hmmm, this from the land of the free?)

    2. If you decide (the default position of the U.S. tax compliance community) that the purpose of the U.S. Australia Tax Treaty was to disable a group of Australian citizens (those with a U.S. birth place) from retirement planning, you still must decide how the Internal Revenue Code applies. Because there are many differing variants on the Super it simply cannot be a “one size fits all”.

    The correct question is NOT:

    “How does the Internal Revenue Code” apply to the Australian Superannuation?

    The correct question (if you agree it applies at all) is:

    “How does the “Internal Revenue Code” apply in different ways to the differing factual variants of the Super?

    In my humble opinion, the ONLY rational interpretation of the “Australian Super” issue (at least with respect to basic concessional contributions required by law) is that they are part of Australia’s Social Security system and that they be treated as “Social Security” under the provisions of the U.S. Australia Tax Treaty.

    That the Superannuation is Social Security is NOT currently the default position. It will take time to get there. The tax compliance community must do its part in promoting this interpretation. Individuals must also make it clear that this is their expectation and that this is what they want. A failure to treat the Australian Superannuation as Social Security means that the whole Superannuation system is subject to U.S. regulation.

    The attitude of Australian citizens, their government and the tax professionals must become:

    Get your hands off our Social Security system!!!!!

    1. John,
      Thanks for your excellent comments which make a worthy addition to Karen’s blog!! I couldn’t agree more with the points you make, particularly “There is no way that the Treaty can be be interpreted to mean that: “Australian citizens residing in Australia cannot save for retirement”!”. Yet this is exactly where we are now with perceived challenges to Super, PFICs, growing limitations on financial products offered to US Persons, etc.

      It is worrying trend to me when I see the ongoing “complexification” of unclear USG tax compliance and reporting obligations which is being led by the taxation compliance industry. Particularly now that FATCA is driving greater recognition of the USG CBT demands for US Persons living overseas, we are seeing more and more complex interpretations being put forward as “rules” by taxation professionals trying to merge two country’s tax systems that were never designed with this purpose in mind.

      I personally believe that all should take as simple and straight-forward approach to compliance as possible and leave it to the IRS to challenge this on an exemption basis. The current situation we find ourselves in is impossible and getting worse with one winner being increasing compliance industry revenue. You make a great point that, as customers, we should demand as straight-forward and simple process as possible.

    2. John,
      Thanks for another insightful comment.

      I’d like to pick up on this point in particular:

      There is no way that the Treaty can be be interpreted to mean that: “Australian citizens residing in Australia cannot save for retirement”!

      Such an absurdity could NEVER have been the expectation of Australia in signing the Treaty. Australia’s expectation matters. A recent court decision has confirmed that the “expectation of the parties to the treaty” is a relevant (actually the most relevant) consideration in the interpretation of the Treaty.

      While I suspect that the Australians negotiating the treaty did not fully understand the implications of US citizenship-based taxation or the saving clause, it’s clear from the ATO website that the Australian government believes that tax treaties “reduce or eliminate double taxation” and “allocat[e] taxing rights between countries”. If you consider this in the context of the recent debates in Australia about the changes to superannuation policy, it is clear that allowing any country to tax the superannuation savings of Australian residents is contrary to Australian public policy and US taxation of super would never have been an expectation of any Australian government in negotiating a tax treaty.

  2. As Australian residents learn about U.S. citizenship taxation, I think it’s important that they learn from the Canadian experience. The mistake made by money Canadians was to confuse a “tax problem” with a “citizenship problem” with a “compliance problem”. What many Canadians did (because they assumed that they had a “tax problem”) was to consult with “tax professionals”. Well, if you consult a “tax professional” they will simply help you file taxes. Many Canadians entered the U.S. tax system without any consideration of their “U.S. citizen” status. Furthermore, even if they were “U.S. citizens”, their problem was more a problem of “lack of compliance”. and less a problem of taxation.

    What this sad state of affairs resulted in was …

    1. Certain individuals entering the U.S. tax system even what they had long ago relinquished U.S. citizenship (or may not even have been a U.S. citizen in the first place); and

    2. A situation of “over compliance”. For example, why you back file “X number” of U.S. returns? Why would you treat something that is primarily a savings vehicle as a “foreign trust”, etc?

    3. Why would you enter a program like “Streamlined” or “OVDP”, etc?

    The lives of many people have been destroyed. You cannot change your U.S. place of birth. But, you can respond (as opposed to react) intelligently to this situation.

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