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TAX CLINIC

tax credit of Sec. 901 is not available to The Tax Court was also uncon- The language in the articles of the
offset non-Chapter 1 taxes. vinced by Toulouse’s argument that U.S.–France and U.S.–Italy treaties
Recognizing this statutory barrier, the placement of the net investment relied upon by Toulouse continues to be
Toulouse argued that both the U.S.– income tax in Chapter 2A of the Code part of model U.S. tax treaty language
Italy and U.S.–France treaties provide (instead of Chapter 1) was a clerical on relief from double taxation, includ-
an independent basis for applying a choice or happenstance and that the ing model years 2006 and 2016. In
foreign tax credit against her net invest- intention of the treaties to eliminate its final regulations related to the net
ment income. The relevant language of double taxation should prevail in the investment income tax, the IRS stated
each treaty is identical and provides a absence of evidence that Congress con- that all treaties with similar language
foreign tax credit “[i]n accordance with sidered whether to provide a foreign “would not provide an independent
the provisions and subject to the limita- tax credit against the net investment basis for a credit against the section
tions of the law of the United States (as income tax. The court found that con- 1411 tax.” In the same regulations, in
it may be amended from time to time gressional creation of an entirely new stating that treaties must be analyzed
without changing the general principle chapter of the Code when enacting the to determine whether the United States
hereof).” However, the Tax Court held net investment income tax evidenced a has to provide a credit (if they do not
that the plain text of the treaties neces- structural choice. The court also cited contain the model language), the IRS
sarily subjected any credit to being cases and a technical explanation as- left open the possibility that treaties
within the provisions and limitations of sociated with the U.S.–France treaty in currently exist or could exist to allow
the Code. noting that, while the general purpose such a credit.
In so holding, the court rejected of treaties is to preclude double taxa- However, given the proliferation of
several arguments from Toulouse. First, tion, treaties do not provide absolute use of the model treaty language, most
the court noted that the fact that the protection, as the terms of credits U.S. citizens living abroad will continue
net investment income tax of Sec. 1411 are determined by the limitations of to find a foreign tax credit unavailable
was instituted after the enactment of U.S. law. against their net investment income,
the treaties was not determinative. Both even when that income is taxed by
treaties state that they cover all federal Survival of the idea of other countries. In view of the IRS’s
income taxes imposed by the Code, and independent tax credits under position and the Toulouse case, the best
the addition of the net investment in- treaties? course of action for affected citizens
come tax to the Code was not a change Arguably, the most interesting aspect of seems to be to encourage legislative ac-
to the “general principles of U.S. tax this case is neither the holding nor the tion to amend Sec. 901 to include taxes
laws.” discussion but the opening expressly under Chapter 2A as creditable. Such
The Tax Court then addressed Tou- highlighted by the court for potential an amendment would bring a credit
louse’s arguments premised on the “sub- future argument. Multiple times in the against the net investment income tax
ject to the limitations of the law of the opinion, the court observed that while squarely within the existing model
United States” language in the treaties. Toulouse’s argument based on Article treaty language “in accordance with the
While Toulouse argued that the Code 24(a) of the U.S.–France treaty and provisions … of the law of the United
provided no limitation on a foreign Article 23(2)(a) of the U.S.–Italy treaty States.”
tax credit as applied to net investment was unpersuasive, tax treaties could From Sarah Paxson, J.D., M.Acc.,
income because the Code was simply potentially provide credits outside of Dallas (Washington National Tax Office)
silent on the matter, the court noted the Code:
that her argument ignored the other
treaty language that such credit must [Toulouse] questions the purpose of Gains & Losses
be “in accordance with the provisions” the Treaties if there is no indepen-
of the Code. Worldwide income of U.S. dent, treaty-based credit and a credit IRS rules on cancellation of
residents is taxable absent an express is allowable only if it is provided in debt of a disregarded entity
affirmative credit or deduction stated the Code. But we do not so hold. On Dec. 11, 2020, the IRS released Let-
in the Code. Thus, the court found that Other provisions of the Treaties ter Ruling 202050014, in which it ruled
it is immaterial that the Code does not may well provide for credits that are that a series of proposed transactions
state that a credit is unavailable or is unavailable under the Code. [Tou- pursuant to a bankruptcy plan would
merely silent on the matter; the Code louse], however, relies on provisions not result in gain or loss to a corpora-
must provide a credit for one to exist. that by their express terms do not. tion and that Sec. 61(a)(12) (before its

16 February 2022 The Tax Adviser