Explaining the Saving Clause III

This is Part 3 of our series explaining the Saving Clause in the Australia / US tax treaty. In Part 1 we saw how international tax works for 90% of the world’s population: income sourced in the country where you live is taxed only by that country. Income from elsewhere is governed by the treaty and generally taxed by the source country – with a tax credit in the resident country if it is also taxed there. In Part 2 we saw how the Saving Clause works in US tax treaties[1]: US citizens are subject to US tax wherever they live due to the unique practice of Citizenship Based Taxation; the Saving Clause allows the US tax its citizens as if most of the treaty did not exist, allowing the US to tax foreign-source income of foreign residents.  

The Saving Clause allows the US to reach into the Australian tax base and tax the Australian source income of Australian resident taxpayers. This erodes the ability of the affected US Persons to take advantage of Australian public policy and tax breaks encouraging retirement savings and local investment. The Saving Clause, and the US practice of CBT more generally, frustrates Australian domestic policy by allowing a foreign government to apply its own idiosyncratic tax rules to income earned on Australian soil by Australian residents. In the long run, this will disadvantage the affected US Persons and make them more likely to require Australian government assistance in the form of the Age Pension and other social safety net programs in Australia.

Clearly, the main problem is the US practice of taxing non-resident citizens on their worldwide income (CBT) – under CBT US citizens living outside the US are treated as tax-resident in TWO countries simultaneously: wherever they actually live and the US. Without CBT, the Saving Clause wouldn’t matter. The US would still have the right to tax Australian source income, but US tax law wouldn’t actually impose any tax on non-US source income of Australian residents. While Australia cannot change US law[2], it can stand up for its own interests when negotiating treaties and other international agreements with the US.

How can countries like Australia protect their tax base from this exceptional US practice of Citizenship Based Taxation? Until the US changes to the international norm of residence based taxation, there will always be a possibility of some Australian source income being taxed by the US and paid by tax-compliant US citizens resident in Australia. There are three ways that countries like Australia can mitigate this problem:

  1. Remove the Saving Clause from the treaty (or exclude citizenship from the Saving Clause).
  2. Add a Citizenship “Tie-breaker” Clause.
  3. Add a “Tax Base Preservation” Clause.

1. Removing the Saving Clause

This would allow Australian-resident US citizens to use some clauses of the treaty to exclude Australian source income from US taxation. This would not be perfect, as it would not change US law. Let’s look at a couple of examples of how it would work:

Salary / wages: These are dependent personal services. Article 15 of the treaty (currently unavailable to US citizens due to the Saving Clause) states (in part):

… salaries, wages and other similar remuneration derived by an individual who is a resident of one of the Contracting States in respect of an employment … shall be taxable only in that State unless the employment is exercised or the services performed in the other Contracting State. If the employment is so exercised or the services so performed, such remuneration as is derived from that exercise or performance may be taxed in that other State.

Article 15 denies the right of the non-resident country to tax wages that are not earned in that country. So, in the absence of a Saving Clause, wages paid to an Australian-resident US citizen would be taxable only in Australia unless the services were performed in the US.

Sale of real property: This is covered by Article 13 of the treaty which states (in part):

Income or gains derived by a resident of one of the Contracting States from the alienation or disposition of real property situated in the other Contracting state may be taxed in that other State.

In this case, the treaty doesn’t deny the right of the non-resident country to tax gains from the sale of property situated where the taxpayer is resident. So, without the Saving Clause, Article 13 would not prevent the US from taxing US citizens on gains from the sale of real property located in Australia.

The above are only two examples of how removing the Saving Clause would affect US citizens residing in Australia. Looking through the treaty, the following types of income might still be taxable in the US even if the Saving Clause did not exist:

  • Income from Real Property (this may be taxed at source, but no limitation on taxation by other country)
  • Dividends (arguably limited to 15% for dividends from US companies paid to Australian residents, but no limit on tax on non-US source dividends)
  • Interest (arguably limited to 10% for interest from US sources paid to Australian residents, but no limit on tax on non-US source interest)
  • Royalties (arguably limited to 5% for royalties from US sources paid to Australian residents, but no limit on tax on non-US source royalties)
  • Gain on sale of Real Property (this may be taxed at source, but no limitation on taxation by other country)
  • US Social Security and US public pensions (these are not taxable in Australia under the treaty). This provision is currently available to US citizens as it is one of the exceptions from the Saving Clause

As a general rule, without the Saving Clause business income and earned income would only be taxable by the country where the taxpayer is resident, unless the activity is sourced or connected with the other country. So earned income or active business income earned entirely within Australia would be taxable only by Australia.

Clearly, removing the Saving Clause would, on its own, fix only part of the problem of allowing the US to reach into the Australian tax base.

2. Citizenship tie-breaker clause

This was suggested by John Richardson in a post on his website:

Dual citizenship, the lack of definition of “citizen” in the “Savings Clause” of U.S. Tax Treaties and why these are important

In this post John makes the point that US citizenship has evolved over the years. When Saving Clauses were first introduced in US tax treaties in the early 20th century, there were few, if any, dual citizens. Until the middle of the 20th century almost all countries (including the US) had laws stating that citizens would lose their citizenship as a consequence of proclaiming allegiance to another country by naturalising. Near the end of the post, John says:

No country should enter into another treaty with the  United States that includes the “Savings Clause”. That said, if the “Savings Clause” is to be part of a treaty, the meaning of “citizens” should be defined by the treaty and must exclude those who are both citizens and residents of Canada (dual citizens)!

In other words, there should be a “tie-breaker” for citizenship just like there’s an article of the treaty with tie-breaker rules for residence. For the purposes of taxation, individuals should be treated as only citizens of one country. If they are dual citizens, then they should be treated as only citizens of the country where they live.

How would this provision affect the US tax liability of US citizens residing in Australia? Those US citizens who are NOT also Australian citizens would be double taxed (under the same rules as apply now). However, once an Australian-resident US citizen takes up Australian citizenship, they would be able to take advantage of the citizenship tie-breaker and be taxed as a non-resident alien (NRA) in the US. This treatment would have to be at the option of the individual, as NRA tax on certain types of US-source income could result in a higher overall tax bill than under the current CBT regime[3]. Essentially, US CBT would not apply to dual citizens because the treaty would provide that Australian citizens resident in Australia could not also be deemed US citizens under US tax law.

Including a Citizenship Tie-breaker Clause in the treaty would encourage US citizens residing in Australia to take up Australian citizenship in order to enjoy the protection of the tax treaty from double taxation by the US.

3. Tax Base Preservation Clause

Remember that in the first post in this series, we specified the principle that

The Australian Source income of Australian Residents should be taxable only by Australia.

So, why not add a clause to the treaty that explicitly states that income arising in the country of residence is taxable only in that country? For countries using residence based taxation, this principle is implicit in both their national tax laws and in the way they interpret their international tax treaties. In treaties with the US, however, this principle needs to be explicitly stated. The US can tax its citizens however it wants, as long as it is not taxing the Australian source income of Australian-resident US citizens. In order to have the intended effect, if a Saving Clause remains, the Tax Base Preservation clause must be among those excepted from the Saving Clause.

With a Tax Base Preservation clause in the treaty, US citizens might still have to file US returns, but the return would include only non-Australian source income plus a Form 8833 stating the treaty position that Australian-source income is not taxable in the US. Since FBAR is required not by the tax code, but by the Bank Secrecy Act, any exemption for FBAR filing on Australian accounts would need to be explicitly mentioned in the treaty.

Where to next?

These fixes would help US citizens resident in Australia – and help preserve the Australian tax base. All require re-negotiation of the  current tax treaty, and, therefore, will not happen overnight. There are urgent problems with the way the current treaty is being interpreted in practice (especially with regard to superannuation). These can be resolved without renegotiating the current treaty, and should be a priority.

If Australia does not address the problem with the Saving Clause, and allows the US to tax the Australian source income of Australian residents, then in any new treaty Australia needs to urgently address the treatment of superannuation by the US. They also need to address the punitive treatment of Australian managed investments under US tax law and US taxation of gains on the principal residence of Australian-resident US citizens. Finally, they need to clarify when Australia will assist the US in collecting taxes from Australian residents, especially dual citizens.

And, once the treaty is re-negotiated, the solutions above do not help Australian citizens (and former residents) who move to the US. For this reason, the Australian government should ensure that superannuation is properly covered in any new treaty – even if the effects of CBT are eliminated or mitigated.

Finally, this site is not written by legal or tax professionals. As I stated in the first post in this series, this post is just general information. If you have a real transaction worth real money, then consult with a real tax professional!


[1] While I have been told that there are non-US tax treaties that contain a saving clause, the only other Australian tax treaty with a saving clause is the 1980 treaty with the Philippines (which had citizenship based tax at the time the treaty was negotiated). The latest OECD model tax convention does not include a saving clause.

[2] With the new administration in Washington and a Republican Party platform that calls for the repeal of FATCA and CBT, many are hopeful that these US laws will soon be changed. This would clearly be the best solution.  There’s even a page on this website for links to US action advocating these changes. However, the US legislative process is long and the outcome uncertain. It would be foolish to do nothing here and simply wait for the US to act.

[3] NRAs may pay higher US tax on US-source income such as rental property and US source interest and dividends. There would be a credit for this tax against any Australian tax paid on the same income. Additionally, NRAs with US assets in excess of US$60,000 may be subject to US estate tax while US citizens have an estate tax exemption in excess of ~ US$5 million (but worldwide assets are considered, not just US assets).

9 thoughts on “Explaining the Saving Clause III”

  1. Interesting and insightful post. Although only marginally relevant to your points, here is what appears to be a “savings clause” type provision in the Australia Canada tax treaty (added in the 2002 protocol):

    https://www.fin.gc.ca/treaties-conventions/austral2-eng.asp

    “Article 26A[16]
    Various Interests of Canadian Residents

    Nothing in this Convention shall be construed as preventing Canada from imposing a tax on amounts included in the income of a resident of Canada with respect to a partnership, trust, or controlled foreign affiliate, in which that resident has an interest.”.”

  2. It strikes me that the existence of the “savings clause” also facilitates the United States “Expatriation Tax” (AKA “Exit Tax”) which is found in Internal Revenue Code S. 877A.

    The S. 877A Exit Tax includes (but is not limited to) the imposition of taxation on:

    1. The “pretend capital gain” on assets that are located in Australia (for example “real property” located in Australia); and

    2. Australian pensions that are located in Australia (is the Superannuation a pension?).

    See the series of posts here:

    http://www.citizenshipsolutions.ca/2015/04/01/renouncing-us-citizenship-how-the-s-877a-exit-tax-may-apply-to-your-canadian-assets-5-parts/

    To put it simply through the S. 877A Exit Tax the United States is claiming the right to confiscate assets that are sourced in Australia and that were most likely acquired while the owner resided in Australia. Under normal rules of International taxation (as you describe in the first post of your trilogy http://fixthetaxtreaty.org/2017/01/12/explaining-the-saving-clause-i/) Australia would have the first (and presumptive) right of taxation on both of these assets. But what happens via the S. 877A Exit is that:

    On the day before renouncing U.S. citizenship (while the person is still a U.S. citizen) the United States “swoops in” (steal it while we can) and claims the right to impose a preemptive tax on assets on which Australia clearly has the first right of taxation. In other words, the United States swoops in to impose taxation before Australia imposes taxation on the asset.

    To put it simply:

    This effect of the S. 877A Exit Tax is one of the most egregious examples of the United States “using it’s citizens” as “Trojan Horse Soldiers” to steal from the economies of other nations!

    As described by one commentator:

    “Although international tax law does not prohibit countries from imposing exit taxes
    on their residents, there could be situations in which the levy of a tax on capital gains by a legislative fiction in one country infringes on a bilateral tax treaty.

    In this respect, the Netherlands Supreme Court has ruled that the tax on a fictitious
    alienation in specific circumstances can be incompatible with treaty law. If a taxable event was allocated for tax purposes to one state, the other state cannot by a later legal fiction attribute taxing rights to itself regarding a purchase or alienation that did not actually occur.”

    Your post has proposed three possible solutions to the problem of the “Savings Clause”. How might each of these proposals defend Australia from the S. 877A Exit Tax? Interestingly the proposals operate differently.

    1. Removal of the savings clause – (Australia does NOT agree that the USA can impose taxation on any person who it deems to be a U.S. citizen):

    Th “Removal of the Savings Clause” does NOT mean the U.S. agrees that the U.S. WILL NOT unilaterally impose taxation on Australian assets. The United States might impose the taxation anyway. The precise effect of the removal of the “savings clause” would need to be considered on an “article by article” analysis of the treaty. If the savings clause were removed the individual treaty provisions would have to be strengthened to give Australia the exclusive right to impose taxation on Australian assets.

    2. Citizenship tie breaker – (if included in the treaty this would mean that the U.S. would agree to NOT impose taxation on any Australian citizen resident in Australia):

    This would ensure that the S. 877A Exit Tax could NOT be applied to dual U.S. Australian citizens living in Australia. It would protect the individual who is a “dual citizen”. It would NOT protect the U.S. citizen resident of Australia who was NOT an Australian citizen.

    3. Tax Base Preservation Clause – (if included this would mean that the U.S. would agree to not impose taxation on any Australian asset)

    This would protect both the individual (whether dual citizen or not) AND would protect the government and economy of Australia.

    It is abundantly clear that the United States is using it’s tax jurisdiction over U.S. citizens (a definition it can change at will) to attack the economies and sovereignty of other nations. In the event that this problem is NOT addressed, countries will no longer be able to afford the “fiscal risk” of accepting U.S. citizens as immigrants.

    1. Thanks for your comments, John.

      I was focusing on the ongoing effect of taxing US citizens, but it is important to consider the effect of the treaty on the 877A Exit Tax. The Exit Tax is potentially the greatest threat to Australia’s tax base from the IRS, especially if superannuation is treated as a “foreign pension”. Of course, if the proposed changes make it easier to live a normal financial life as a US citizen in Australia, relinquishment of US citizenship may no longer be an important financial planning tool for US expats.

      Not only is the US using citizenship based taxation to plunder the tax base of other nations, but, as you note, they have sole power to determine who is still a US citizen. Furthermore, they have been using the exorbitant $2,350 renunciation fee and inordinate delays in granting renunciation appointments to both discourage US citizens from exiting the US tax system and to prolong the time period that victims are subject to US tax.

      One small point of clarification: about option 3 you say “(if included this would mean that the U.S. would agree to not impose taxation on any Australian asset)” — my intent was to carve out only the Australian assets (and other Australian-source income) owned by Australian residents. Australian assets owned by US residents, or US citizens living anywhere outside of Australia, would be fair game.

  3. If we take a step back and view the U.S. tax claim through the lens of the justification of tax, then once one is tax resident in Australia that should in itself, regardless of Australian citizenship, make U.S. tax claim of them unjustified. This is similar to thinking that if you live in New York and now move to Texas, is New York still justified in taxing you in Texas.

    Noted your mention of specific attention to superannuation and PFIC. I suggest this list should also include any U.S. nonresident/foreign penalties and reporting. One strong reason for including such a blanket statement is to future proof the treaty for anything new “foreign” asset/account/income penalties that the U.S. dreams up. The exemption needs to be more encompassing and future proof for changes in both the U.S. and Australian tax codes.

    The penalties for “foreign” should in itself be listed, yet listing also highlights the injustice and “out of whack” nature of U.S. extraterritorial tax.

    1. @JC – under international norms as practised by all countries except the US and Eritrea, becoming tax resident in a new country means you are no longer tax resident in your old country. Unfortunately, my understanding is that there is no international law that mandates this. When moving between countries, it is the tax treaty between the two countries that controls where you are considered resident for tax purposes. In all US tax treaties, the Saving Clause operates to make US citizens tax residents [1] in the US as well as where they live. My opinion is that there SHOULD be an international agreement that individuals can be tax resident in only one country at a time. Of course, the US will never agree to this while they practise Citizenship Based Taxation.

      The best way to “future-proof” the treaty is to make sure that it explicitly states that the Australian-source income of Australian residents is taxable ONLY in Australia. If that can’t be done, an exhaustive list of current anomalies will be out of date by the time the ink is dry on a new treaty.


      [1] Technically, the US tax code distinguishes between resident and non-resident taxpayers in some places, and non-resident citizens will be treated as non-residents under these provisions – but they are still taxed using the same tax rates as residents and most of the same rules (plus some pretty nasty rules that discriminate against their local investments). If you look at the regulations under CRS, US citizens are always treated as US tax-residents plus tax-residents of the country where they actually live.

  4. Does citizenship confer property rights of taxation to the country one is citizen of? Those arguing against CBT have suggested that no it does not. Even if one is not a citizen of Australia, and they are tax resident within Australia, then Australia is justified to tax them.

    Suggesting citizenship gives countries rights of taxation is already a compromise. The thinking goes like this: o.k. the U.S. shifts to residential based taxation. Then at what point does their citizenship tax rights now end (to help the U.S. agree to it all in the first place)? Let’s propose a compromise, instead of ending right of taxation with ending of actual residency – along the lines of RBT followed by all other countries – let’s let the U.S. continue in its claimed right to tax extraterritoriality yet only up to the point where the persons in question assume citizenship of a second country and are resident there.

  5. The savings clause is about claiming residency of the U.S. They don’t want to just claim citizenship as they want to claim Green card holders and other persons and entities to fit their definition of a U.S. person. The tie breaker forgets Green Card holders.

    1. @JC – for a discussion of the interaction of Green Card status and the Saving Clause, see this post at citizenshipsolutions:
      http://www.citizenshipsolutions.ca/2016/04/03/are-green-card-holders-resident-in-canada-us-persons-under-the-fatca-iga/

      Look at parts 4 and 5 of the discussion. Briefly, since Green Card holders are not citizens, the Saving Clause (as implemented in the Canadian and Australian tax treaties with the US) doesn’t prevent them from using the treaty tie-breaker rules.

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