Making use of a tax treaty is a bit trickier than expected. You would think that you could open up a treaty between the U.S. and a specific country, hop right to the section you have questions on, read that section of the treaty, and reasonably believe that you could apply what you’ve read to your tax return. You would be wrong.
Turns out that most of the text in all of our tax treaties isn’t worth the paper it’s printed on. The majority of every U.S. tax treaty is not applicable to U.S. citizens. This is even true when the U.S. citizen is living in a foreign country.
Treaty interpretation always has to begin with a review of the savings clause. Weird name for a component of a treaty, I know. The savings clause is the part of the treaty that basically says - if you are a U.S. person, you can ignore this treaty, it won’t help you - More literally, the savings clause saves the United States’ ability to apply its tax code to its citizens and residents.
The savings clause appears in different places in different treaties, generally, but not always, it is in Article 1. The best way to find the savings clause in most treaties, assuming you are viewing the treaty online, is to press ctrl+f to open a text search and type in “may tax”(exclude the quotation marks in the search). This will almost always bring you directly to the savings clause.
Here is a sample savings clause from the U.S. - U.K. tax treaty:
Notwithstanding any provision of this Convention except paragraph 5 of this Article, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship may tax its citizens, as if this Convention had not come into effect
As you can see, the take home point from the savings clause is generally that if you are a U.S. person you can pretend that the treaty doesn’t exist, but you’ll note that there is a section of the treaty that the savings clause doesn’t apply to. This excepted paragraph, which we often refer to as the clawback, lists the portion of the treaty that aren’t subject to the savings clause. The clawback does occasionally include entire articles of the treaty, but often it will list specific paragraphs of articles.
For example, let’s take a look at the clawback section from the U.S. - Australian tax treaty. In this treaty Article 1 paragraph 3 is the savings clause and Article 1 paragraph 4 has the clawback provisions:
(4) The provisions of paragraph (3) shall not affect: (a) the benefits conferred by a Contracting State under paragraph (2) of Article 9 (Associated Enterprises), paragraph (2) or (6) of Article 18 (Pensions, Annuities, Alimony and Child Support), Article 22 (Relief from Double Taxation), 23 (Non-Discrimination), 24 (Mutual Agreement Procedure) or paragraph (1) of Article 27 (Miscellaneous); or
(b) the benefits conferred by a Contracting State under Article 19 (Governmental Remuneration), 20 (Students) or 26 (Diplomatic and Consular Privileges) upon individuals who are neither citizens of, nor have immigrant status in, that State (in the case of benefits conferred by the United States), or who are not ordinarily resident in that State (in the case of benefits conferred by Australia).
This clawback provision is often broken into two sections, the first section which claws back treaty segments for all U.S. persons (paragraph 4(a) in the above example) and the second section which claws back treaty segments for a specially defined subset of individuals (paragraph (b) in the above example). In the Australian tax treaty, the U.S. subset of individuals is individuals who are neither citizens nor have immigrant status in the U.S. This subset will often specify that it applies to individuals who are not citizens or permanent residents (green card holders) and, despite the ambiguous wording of ‘immigrant status’, that is precisely what is meant here as well. To be more clear, if you are in the U.S. on a visa and subject to U.S. taxation based on your residency here but you are not a citizen or green card holder, you can utilize the sections of the treaty noted in paragraph (b) (highlighted in yellow).
To recap, any time you are consulting a treaty to determine if it offers you any potential tax relief you will start with the savings clause. To determine how the savings clause applies to you if you aren’t a citizen or green card holder, you may have to take a detour into the residency article (usually article 4 but it varies treaty to treaty) to determine if you are considered a U.S. resident (article coming soon reviewing how to determine if you are a U.S. resident under a tax treaty). Once you have determined that the savings clause applies to you, look at the clawback. If the article you were hoping to utilize for a tax benefit isn’t listed in the clawback, the treaty won’t be helping you.
Let’s walk through an example. Let’s assume you are a U.S. citizen and a Canadian resident who is living and working in Canada. You have made $1000 of contributions to a retirement plan in Canada and you want to know if you will be able to exclude or deduct those retirement contributions from your income on your U.S. return.
You hop over to the U.S. - Canada tax treaty and try to find the savings clause. Here the ‘may tax’ approach will fail you (it works in most treaties, but shouldn’t be viewed as confirmation of the absence of a savings clause), so you continue to read through the treaty and find the savings clause in Article 29 (XXIX):
2. Except as provided in paragraph 3, nothing in the Convention shall be construed as preventing a Contracting State from taxing its residents (as determined under Article IV (Residence)) and, in the case of the United States, its citizens (including a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of income tax, but only for a period of ten years following such loss) and companies electing to be treated as domestic corporations, as if there were no convention between the United States and Canada with respect to taxes on income and on capital.
And here is the text of the clawback:
3. The provisions of paragraph 2 shall not affect the obligations undertaken by a Contracting State: (a) Under paragraphs 3 and 4 of Article IX (Related Persons), paragraphs 6 and 7 of Article XIII (Gains), paragraph 5 of Article XXIX (Miscellaneous Rules), paragraphs 3 and 5 of Article XXX (Entry into Force), and Articles XVIII (Pensions and Annuities), XIX (Government Service), XXI (Exempt Organizations), XXIV (Elimination of Double Taxation), XXV (Non-Discrimination) and XXVI (Mutual Agreement Procedure); and (b) Under Article XX (Students), toward individuals who are neither citizens of, nor have immigrant status in, that State.
Looking at the clawback, you conclude that there is a good chance that the relevant article is Article 18 Pensions and Annuities. You jump over to Article 18 and find that your contributions are excludible from your income if you meet a number of requirements listed in Article 18 paragraph 8.
I would also like to quickly point out that if you, like most people, are using the treaty on the IRS’ website, you might be in for a few surprises. Following our above example, if you open the most recent CA-U.S. tax treaty (from 1980) on the IRS’ site, you won’t find a paragraph 8 in Article 18. This is because this paragraph was added in a ‘Protocol’ from 2007. The IRS does not make an effort to maintain updated/integrated versions of tax treaties, which means to correctly interpret a treaty you will have to read through both the treaty and any subsequent protocols, because some extra tail-chasing was exactly what this convoluted treaty application needed.