The United States has a "mirror code" system with certain of its territories -- including U.S. Virgin Islands, Guam and the Commonwealth of the Northern Mariana Islands (CNMI). The mirror code concept treats the U.S. tax code as the tax law of each jurisdiction -- U.S.,on the one hand, and the other jurisdiction,on the other. In effect, the two jurisdictions are treated as separate countries for purposes of the mirrored Code applied by each. Double taxation is generally avoided by requiring a single filing to the jurisdiction in which the taxpayer resides. If the U.S. citizen is a "bona fide resident." of the U.S. V.I., the U.S. resident reports and pays tax to the U.S. V.I. and not to the U.S.; If the U.S. taxpayer is resident anywhere else, he reports and pays his tax to the U.S. By contrast, if the U.S. V.I. citizen is resident in the U.S., he reports and pays tax to the U.S.; if he is resident anywhere else,he reports and pays tax to the U.S. V.I. In each of these cases, if the citizen pays tax in the noncitizenship country of residence -- i.e., U.S. citizens reports and pays tax in U.S. V.I. or U.S. V.I. citizen reports and pays tax in the U.S. -- the country receiving the tax will remit -- a process called "cover" -- the portion tax received that relates to income in the other country.
A pure mirror code system will result in the same tax regardless of where the return is filed and the tax paid. The territories are, however, allowed to give tax breaks with respect to taxes paid on income source in the territories under the system. Thus, if the reporting of U.S. V.I. sourced income is to U.S. V.I., the U.S. V.I. is permitted to give a tax break with respect to that tax. If the reporting of U.S. V.I. sourced income is to the U.S., then the U.S. should cover that portion of the tax to the U.S. V.I., whereupon, from the tax thus remitted, it can given any break it otherwise allows. Thus, at least in theory, wherever the return is filed, the same ultimate result should obtain.
The problem comes when, after the taxpayer has filed in good faith with the mirror code territory (e.g., the U.S. V.I.), the U.S. attempts to force the U.S. taxpayer to file in the U.S., despite being required under the treaty to make the single filing in U.S. V.I. The circumstances for double taxation are present if the U.S., through making a different sourcing determination, has no plan to cover the amount to the other country.
This battle was fought out in Appleton v. Commissioner, 140 T.C. ___, No. 14 (2013), here. The IRS took the position that the taxpayer was required to file in the U.S., he had filed in U.S. V.I. rather than the U.S., and that, as a result, the IRS had an unlimited statute of limitations to send a notice of deficiency with respect to the tax. The Court held that the single filing with the U.S. V.I. required under the mirror code scheme was a return filed under the Code and therefore the unlimited statute of limitations did not apply.
