A U.S. District Court held that it isn’t unconstitutional under a provision of the United States–Canada tax treaty for Canada to offset Canadian tax refunds against unpaid U.S. tax liabilities.
The U.S. District Court for the District of Columbia stated that “the arm of the U.S. tax man is long, but in this case it needed extend only over our northern border to find” the taxpayer. The court dismissed the expat’s case, finding that he’d failed on his claims for relief under the Eighth Amendment and both the Due Process and Equal Protection Clauses of the Fifth Amendment.
Facts of the case
The taxpayer was a U.S. citizen living in Canada, where he operated a consulting business. The chronology of his case is as follows:
- In 2009, the taxpayer learned he’d failed to comply with the United States’ Report of Foreign Bank and Financial Accounts (FBAR) rules, which require U.S. taxpayers to file if money they control in a foreign financial account exceeds $10,000 at any time during a calendar year.
- In 2011, the IRS assessed a penalty of $120,000 against the taxpayer for failing to file Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” Because the taxpayer’s business was incorporated abroad, he was required to furnish certain annual information, which he’d neglected to do for 12 years.
- The taxpayer asked for an abatement of the penalty, which was denied.
- The Canadian tax agency (the Canada Revenue Agency) then withheld the taxpayer’s Canadian tax refund under terms of the United States–Canada Income Tax Convention.
- The taxpayer then paid the penalty, but challenged in court the relevant treaty provisions as unconstitutional under the Eighth Amendment and both the Due Process and Equal Protection Clauses of the Fifth Amendment.
The court held that the treaty didn’t violate the Eighth Amendment, which states that “excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.” The court said that it must first decide whether a penalty is a fine before determining if it is unconstitutionally excessive. A payment to the IRS is considered a fine under the Eighth Amendment only if the purpose of the penalty is “primarily retributive or deterrent rather than remedial,” the court wrote.
Remedial, not punitive
The court determined that tax penalties fulfill a remedial purpose and thus aren’t subject to the Excessive Fines Clause. The taxpayer argued that a smaller penalty would have achieved the same objective, but the court said that that’s beside the point. Because Congress authorized a $10,000 penalty for a “legitimate remedial purpose,” the taxpayer’s Eighth Amendment claim failed.
Regarding the due process claim, the taxpayer said that he’d had no opportunity to appeal the penalty “through administrative means or the U.S. Tax Court” before it was collected. But the court ruled that the absence of the taxpayer’s “requested avenue of relief doesn’t mean his due process rights have been violated.” The ability to challenge tax penalties in district courts fulfills the Fifth Amendment’s requirements. Accordingly, the court said, the taxpayer “failed to state a claim for relief under the Due Process Clause.”
Finally, the court held that the taxpayer didn’t have standing for his equal protection claim. The taxpayer based this claim on the contention that he wasn’t allowed to participate in the Streamlined Filing Compliance Procedures (SFCP), while other similarly situated taxpayers were. Thus, he claimed that he was denied the opportunity to have a lower penalty imposed. The SFCP is a federal program aimed at encouraging compliance with reporting requirements related to foreign assets, accounts and income.
The court said that the taxpayer’s equal protection argument suffered from a “fatal flaw” because the taxpayer didn’t plead that he’d sought entrance into the SFCP or that his application was denied. Because the taxpayer didn’t show, or attempt to show, that the IRS had ever denied him the opportunity to participate in the SFCP, he couldn’t establish that he’d suffered an actual injury. As a result, he lacked standing.