Unsuccessful Constitutional Challenges to the Collection Treaty Provision in the Tax Treaty between Canada and the United States

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This summer I visited Canada twice, Montreal and Toronto. Canada and the United States have long seemed like best friends. I wondered if I would be treated any differently now that our government policies do not seem to treat Canada as our best friend. Happy to report the Canadians remain as friendly as ever on the personal level. They do, however, want to collect the taxes due to them and that results in the case of Retfalvi v. United States, No. 5:17-cv-00468 (E.D.N.C. Aug., 15, 2018).

I have written before about the collection language that exists in two of the five tax treaties that have this special language, France and Denmark. Canada, along with the Netherlands and Sweden, is one of the other three countries that have the collection provision in their tax treaty with the United States. The Canadians invoked the treaty to ask the Unites States, specifically the IRS, to collect some unpaid Canadian taxes from an individual who at one point was a Canadian citizen but who had become a citizen of the United States. The taxpayer raised a number of constitutional arguments regarding the treaty to collect taxes. Most individuals raising constitutional arguments bring the phrase ‘tax protestor’ to mind but these were legitimate and well-argued constitutional arguments. In the end, the taxpayer lost but we gain insight regarding the constitutional underpinnings of the collection treaty provisions.

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Mr. Retfalvi moved from Hungary to Canada and became a citizen in 1993. He later moved to the United States and obtained permanent resident status in 2005 followed by citizenship in 2010. In 2006 he sold a pair of condominiums he had purchased earlier in Vancouver before he knew he was moving to the United States. He and his wife reported the sales on their Canadian tax returns; however, the returns were selected for audit. The audit resulted in a proposed increase in tax of over $100,000. He did not petition the Canadian Tax Court to fight the assessment of this additional tax. After the assessment became final, Canada invoked the treaty to secure the assistance of the IRS in collecting the taxes.

As the treaty requires, the IRS sprang into action. In November of 2015 it sent to Mr. Retfalvi a “Final Notice – Notice of Intent to Levy” giving him a chance to pay the liability before the IRS took administrative collection action against him. He objected to the notice of intent to levy and let the IRS know that he did not owe the tax. The IRS let him know that he had no ability to contest the tax in the United States. He filed a Form 12153 seeking a Collection Due Process (CDP) or equivalent hearing. The IRS let him know that he could not use the CDP process but could seek a CAP appeal. The IRS subsequently denied his CAP appeal because he tried to use the CAP process to challenge the underlying liability.

After failing to obtain a CDP hearing and losing the CAP appeal, Mr. Retfalvi filed suit in the United States District Court for the Eastern District of North Carolina seeking declaratory and injunctive relief from the collection action. The IRS moved to dismiss for lack of subject matter jurisdiction and failure to state a claim. The court dismissed the case citing the anti-injunction statute. Mr. Retfalvi then paid the tax and filed a suit for refund. The IRS rejected his claim for refund and he filed this suit because of alleged constitutional infirmities with the collection treaty provisions. He cited to nine specific constitutional problems with the treaty:

  • Article 26A [the collection provision of the treaty] violates the Origination Clause because it is a bill to raise revenue that did not originate in the House of Representatives:
  • Article 26A is invalid because it is not self-executing;
  • Article 26A violates the Taxing Clause because Congress has the exclusive authority to lay and collect taxes;
  • Article 26A violates the Taxing Clause because Congress cannot use its taxing power to levy or collect taxes of a foreign country;
  • Article 26A violates the Taxing Clause because it purports to amend the Internal Revenue Code;
  • The IRS is not authorized to assess and collect taxes imposed by Canadian laws;
  • Article 26A denies taxpayers due process;
  • Article 26A denies taxpayer equal protection of the law that is available to taxpayers who have had taxes assessed under the Internal Revenue Code; and
  • Article 26A creates an impermissible sub-classification of United States taxpayers.

The court addressed each of the nine alleged grounds for striking the treaty provision. It found as to each that a basis existed for the provision to be deemed constitutional. As a result, it struck his refund suit. I do not know if he has the ability to bring a refund suit in Canada but that is where he must go next if he wants the return of his money.

I am not going to go through each of the separate reasons that the court found the treaty provision constitutional but anyone with an interest in treaties and in constitutional law may find the opinion interesting. It provides a fair amount of detail with respect to each of the claimed bases for unconstitutionality including case citations and, in some instances, analysis of the treaty language as it relates to the constitution. The case also provides a good discussion of what is a tax bill that must originate in the House of Representatives and what is not.

This case continues the general theme of the collection treaty cases both here and in the other treaty countries. That theme, succinctly stated, is that if you want relief you must seek it in the country in which the liability arose. The country to whom the liability is sent pursuant to the treaty provision simply goes out and collects the money with basically no questions asked about the correctness of its origins.

 

Comments

  1. Norman Diamond says:

    “The audit resulted in a proposed increase in tax of over $100,000. He did not petition the Canadian Tax Court to fight the assessment of this additional tax.”

    It sounds like he cooked his own goose. If he wanted to dispute the underlying tax, he knew how to do it.

    I wonder why he decided (belatedly) to try to dispute the underlying tax. To the best of my limited knowledge[*] if the spouses lived apart, one in each condominium, I think they could both claim exemptions on sales of principal residences. But if they rented out one condominium there’s no escaping capital gains tax on that one.

    To the best of my knowledge the few treaties that have collection assistance only provide that assistance if the person wasn’t a citizen of the requested state at the time the tax arose. It doesn’t matter if the person became a citizen of the requested state later. It also doesn’t matter if the person was ever a citizen of the requesting state or not.

    I wonder what would happen if they moved to US Virgin Islands, Puerto Rico, etc. US possessions have Residence Based Taxation like most of the world, instead of Citizenship Based Taxation which the US and Eritrea apply to their diaspora. I think there’s no tax treaty between a US possession and Canada, so there’s no mitigation of double taxation if they have income sourced in one place while they reside in the other place, but there’s no collection assistance either.

    [* I never owned real estate in Canada but observed how the treatment of ownership of principal residences results in double taxation, not mitigated by treaties which purport to mitigate double taxation.]

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