CFC Rejects Government Interpretation of Canada Double Tax Treaty (12/12/24)

Tax treaty cases in U.S. courts are not that common. I am interested in tax treaty cases because, years ago, I wrote an article on tax treaty interpretation: Tax Treaty Interpretation, 55 Tax Law. 219 (2001), here, and have retained my interest since.

Bruyea v. United States (CFC 12/5/24), CFC here and GS here, is a tax treaty case with significant discussion of tax treaty interpretation. (Slip Op. pp. 4-7 under the outline heading “Principles of Treaty Interpretation.”) Bottom-line, the Court held that Bruyea is entitled to a refund arising from a credit to avoid double taxation under the U.S and Canada tax treaty (“Canada Tax Treaty”). The Canada Tax Treaty is titled the Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital; the treaty and relevant documents may be viewed or downloaded here. This type of treaty is often called a double tax treaty because a primary goal is to avoid the treaty partners’ double taxing the same quantum of income. The U.S. has similar double tax treaties with many other countries.

I report on Bruyea because the court throws out some glittering generalities about tax treaty interpretation.

First, of course are the relevant facts, which the court summarizes succinctly (Slip Op. p. 2, cleaned up and footnotes omitted):

          On November 7, 2016, Mr. Bruyea filed an amended tax return (Form 1040X) with the Internal Revenue Service claiming a refund of $263,523 by virtue of a foreign tax credit that offsets the NIIT [Net Investment Income Tax] In particular, Mr. Bruyea asserts he is entitled to a foreign tax credit based on the provisions of Article XXIV of the Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital. The IRS rejected the refund claim, concluding that the Canada Tax Treaty did not provide an independent basis for a foreign tax credit to offset the NIIT and that such a foreign tax credit is not allowed under U.S. statutory foreign tax credit rules.

          When Mr. Bruyea failed to convince the IRS, he invoked the Simultaneous Appeal Procedure pursuant to which he sought the opinions of the U.S. and Canadian competent authorities to resolve a situation in which double taxation is present (i.e.Canadian income tax and U.S. NIIT on the same items of income and gain with no foreign tax credit offset available). The Canadian tax authority agrees with Mr. Bruyea. ECF No. 18-6 (“The position of the Canadian competent authority in this regard is that Canada, as the country of source, has the right to tax the gain, while the US, [*3] as the country which has residual taxation rights, must provide relief in accordance with Article XXIV of the Convention.”). Following the IRS’s denial of his tax refund claim, Mr. Bruyea filed his complaint in this court, asserting that he is entitled to a refund of the NIIT that he paid in the amount of $263,523 for the 2015 tax year.

          On February 14, 2024, Mr. Bruyea moved for partial summary judgment, arguing that he is entitled to a foreign tax credit for his 2015 tax year under the terms of the Canada Tax Treaty. The government filed a cross-motion for summary judgment and response in opposition to plaintiff’s motion. Each party filed a reply brief.

The issue was thus an issue of interpreting the Canada Tax Treaty. The court thrashes around on the principles of treaty interpretation (Slip Op. 4-7, cleaned up and footnotes omitted):

          Interpreting a treaty is similar to interpreting a statute or a contract. Thus, the interpretation of a treaty, like the interpretation of a statute, begins with its text. The contract must be considered as a whole and interpreted to effectuate its spirit and purpose, giving reasonable meaning to all parts. * * *  *

          When it comes to a treaty, however, there is a notable difference from other legal instruments: courts are encouraged to consider a treaty’s purpose, as well as extrinsic evidence of the intent of the parties to the treaty. Because a treaty ratified by the United States is an agreement among sovereign powers, the Supreme Court has also considered as aids to its interpretation the negotiation and drafting history of the treaty as well as the postratification understanding of signatory nations. Particularly when a treaty provision is ambiguous, courts may look beyond the written words to the history of the treaty, the negotiations, and the practical construction adopted by the parties. Thus, the practice of treaty signatories counts as evidence of the treaty’s proper interpretation, since their conduct generally evinces their understanding of the agreement they signed. The ‘opinions of our sister  signatories are ‘entitled to considerable weight. 

          There is yet another, meta-principle that applies to treaty interpretation. A tax treaty, in particular, should generally be construed liberally to give effect to the purpose which animates it and even where a provision of a treaty fairly admits of two constructions, one restricting, the other enlarging, rights which may be claimed under it, the more liberal interpretation is to be preferred. The Court of Appeals for the Federal Circuit, has synthesized the Supreme Court’s treaty interpretation principles as follows:

In construing a treaty, the terms thereof are given their ordinary meaning in the context of the treaty and are interpreted, in accordance with that meaning, in the way that best fulfills the purposes of the treaty. The judicial obligation is to satisfy the intention of both of the signatory parties, in construing the terms of a treaty.

Unless the treaty terms are unclear on their face, or unclear as applied to the situation that has arisen, it should rarely be necessary to rely on extrinsic evidence in order to construe a treaty, for it is rarely possible to reconstruct all of the considerations and compromises that led the signatories to the final document. However, extrinsic material is often helpful in understanding the treaty and its purposes, thus providing an enlightened framework for reviewing its terms. However, the ultimate question remains what was intended when the language actually employed was chosen, imperfect as that language may be.

In short, a Court must ‘examine not only the language, but the entire context of agreement. The Federal Circuit specifically noted that it had reviewed the [extrinsic] evidence.

          Although the Supreme Court has often given “great weight” to the Executive Branch’s interpretation of the treaty, more recently the Supreme Court has acknowledged that it has never provided a full explanation of the basis for our practice of giving weight to the Executive’s interpretation of a treaty. And, in any event, binding Federal Circuit authority instructs us that “an agency’s position merits less deference where an agency and another country disagree on the meaning of a treaty. Moreover, the Federal Circuit has declined to defer to Treasury’s contemporaneous interpretation where it conflicts with the contemporaneous intent of the Senate.

In the “Principles of Treaty Interpretation,” the court discusses the deference often accorded Executive Branch treaty interpretation. The deference described echoes Chevron deference which the Supreme Court rejected in Loper Bright Enterprises v. Raimondo, ___ U.S. ___, 144 S. Ct. 2244 (2024). However, deference to Executive Branch treaty interpretation is not the same as Chevron deference. The Executive Branch has special competence with regard to treaties, having negotiated the treaties and sponsored them in the Senate consent proceedings. I thus think this treaty interpretation deference survives Loper Bright. And, a Chevron Step Two-type analysis should apply to permit the court to reject unreasonable interpretations, as the court did in Buryea. (In other words, once it is concluded consistent with Loper Bright that deference to Executive Branch treaty interpretation can apply, a Chevron Step Two-type analysis police the boundaries of the deference.)

As an aside, the Bruyea opinion was written by CFC Judge Matthew H. Solomson (court bio here). The bio is impressive; as a former DOJ Tax attorney, I was impressed that Judge Solomson clerked for CFC Judge Fran Allegra, a DOJ Tax alum, who was a tax mensch. I open my Federal Tax Procedure book with the following quote from the Judge Allegra opinion in Principal Life Insurance Company v. United States, 95 Fed. Cl. 786, 788 (2010):

          The procedural aspects of the tax laws are of overriding importance in many controversies eclipsing or making moot substantive issues such as the allowance of deductions or credits, recognition or deferral of income, and methods of accounting. At times, the questions spawned by these procedures take on an almost metaphysical cast like “when is taxable income taxed?” The ontology needed to solve such abstruse inquiries comes not from philosophical tomes, but from Chapters 63 through 66 of the Internal Revenue Code of 1986, which supply interfused rules mapping the contours of commonly-used, but frequently-misunderstood, tax concepts such as assessment, deposit, and overpayment. 

Comments

I encourage readers to comment as they deem appropriate using the Comment feature, titled “Post a Comment” at the end of this blog entry. For Guides as to Comments, please see the page titled “Guides to Use and Posting of Comments (9/26/24)”),  here. (Note that, as with blog entries, the date in the parenthesis is the last date the item was changed.) Thank you.