Australian citizens and residents who are also taxable by the US are subject to double taxation that is not prevented by the Australia/US Tax treaty. In fact, the treaty guarantees unfair taxation by the US of some Australian source income, including superannuation. While the cause of this double taxation is the US practice of taxing based on citizenship rather than residence, the effect on Australian citizens and residents can be mitigated by updating the current tax treaty.
Double taxation stems from the mis-match between Australian tax law and the 74,000+ pages of US tax law and regulations. Those subject to both sets of tax law will pay the higher of the two tax rates on each type of income. To make things worse, US tax law treats many “foreign” investments as suspect and deserving of punitive taxation; for a US Person living in Australia, all of their local investments are “foreign” to the US.
The US has taxed based on citizenship rather than residence since the Civil War. However, until recently this was neither well communicated to US expatriates nor enforced. In 2014, Australia signed an inter-governmental agreement with the US, the FATCA IGA. Under this agreement, Australian banks must now hunt out US Persons and report their financial information to the ATO for transmission to the IRS.
The Australian government is one of two parties to both the Tax Treaty and the FATCA IGA. Those impacted by the inadequate coverage of these agreements are Australians living in Australia. The Australian government has an obligation to protect its citizens. In particular, the following areas need attention:
- Superannuation: Australia legislated mandatory retirement savings for employees with the Superannuation Guarantee (Administration) Act (1992) and the Superannuation Industry (Supervision) Act (1993). Unfortunately, the US does not recognise superannuation as a qualified tax-deferred retirement plan. While the US tax rules in this area are complex, the US will generally tax contributions and either current income inside super or a portion of withdrawals from super. The 2016 US Model Tax Treaty includes provisions under which the US will respect the tax deferral in super for Australian residents as well as for US residents who previously accumulated superannuation in Australia.
- Saving Clause: All US tax treaties include a “saving clause” that allows the US to tax US citizens as if the treaty did not exist (with the exception of a limited number of treaty provisions). The problems with this clause are discussed in this post by John Richardson at citizenshipsolutions.ca.
- PFICs (Passive Foreign Investment Companies): Australian managed funds, listed investment companies (LICs), real estate investment companies (A-REITs), and exchange traded funds (ETFs) are all treated as PFICs for US taxpayers. PFIC treatment results in punitive taxation of these investment vehicles. Part of the rationale behind this punitive treatment is to prevent US taxpayers from using “foreign” investments to defer taxable income. But, any of these investments that is registered for sale to retail investors will be required by Australian law to distribute all income and realised gains currently, just like the American equivalent. The treaty should include a clause that states that Australian investment structures that are sold to retail investors are not to be considered “foreign corporations” under the PFIC rules.
- NIIT (Net Investment Income Tax): Enacted as part of Obamacare, NIIT is a flat 3.8% tax on investment income for US taxpayers whose income exceeds a threshold determined by filing status. NIIT applies to all investment income, regardless of source, and cannot be offset by foreign tax credits. For those affected, this is a clear case of double taxation.
The end result of these deficiencies in the current treaty is that any Australian citizen or resident that is also taxed by the US (as a citizen or green-card holder) will end up paying tax to the US on their Australian superannuation, and will also find it difficult to effectively invest outside of super. These problems will affect middle class Australians more than high net worth Australians because a) the most effective investment vehicles for small savers are exactly those classified as PFICs and b) they are less able to afford the tax advice and compliance services needed to effectively plan for living under two very different tax regimes.
FATCA IGA: Under the IGA, the US agreed to provide reciprocal information. Article 10 of the IGA states that the parties will consult on the progress toward implementation of the IGA prior to 31 December 2016. This deadline in the IGA provides the Australian government a window of opportunity to re-examine the agreement to ascertain whether the US is actually providing the data promised in Article 6. Towards this end, the Australian government should disclose more information about the data sent TO the IRS in September 2015 and information about what NEW data has been received FROM the IRS under the FATCA IGA.
Citizenship Based Taxation: While the focus of this site is on actions the Australian government can take to protect its sovereignty and tax base, see the US Action page for updates on the fight against Citizenship Based Taxation in the US.