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US: Tax Court finds limits to treaty-based double tax relief

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Toulouse v. Commissioner addresses the limitations of double tax relief

Mark Martin and Thomas Bettge of KPMG in the US discuss the US Tax Court’s recent decision in Toulouse v. Commissioner and its ramifications.

On August 16 2021, the US Tax Court released an opinion in Toulouse v. Commissioner that addresses the limitations of double tax relief under the US income tax treaties with France and Italy. Although the case addressed individual income tax issues, it illustrates a broader point that is relevant to all taxpayers who rely on tax treaties to alleviate double tax.

The taxpayer is a US citizen who resided abroad but, under the US worldwide income tax system, remained subject to tax in the US. For 2013, the taxpayer filed a US tax return that, among other things, reported net investment income tax (NIIT) of $11,450, and claimed – in two lines that she added to the IRS form in question – a foreign tax credit in the same amount, resulting in no NIIT due. The NIIT is a 3.8% tax imposed by section 1411 of the Internal Revenue Code (Code) on certain income of individuals that was enacted as part of President Obama’s healthcare reform.

Under US domestic law, both the taxpayer and the IRS agreed that the NIIT is not eligible for offset by foreign tax credits, although the rationale for this choice is unclear, and the taxpayer suggested that it was a result of legislative oversight. Foreign tax credits apply to taxes imposed under Chapter 1 of Subtitle A of the Code, which includes the individual and corporate income taxes. The NIIT, on the other hand, is located in Chapter 2A – in fact, Section 1411 is the sole section in Chapter 2A. As a result of this structuring, no foreign tax credit is permitted to offset the NIIT under US domestic law.

The taxpayer took the position that, notwithstanding the lack of a credit under domestic law, the relief from double taxation articles of the US–France and US–Italy treaties provided an independent right to the credit. The IRS disagreed, and matter came before the Tax Court, which held that no credit was available. While the decision was limited to the US treaties with France and Italy, the same result can be expected under other treaties with materially similar relief from double taxation language.

While acknowledging that “treaties should generally be liberally construed” to effectuate their purpose, the court noted that the treaty inquiry begins with the plain meaning of the treaty language. In this case, the plain language was not helpful to the taxpayer, as Article 24 of the French treaty and Article 23 of the Italian treaty both qualify the obligation to provide a tax credit. Under both treaties, credits shall be allowed “in accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof)”.

This led the court back to the fact that the Code does not provide for a tax credit with respect to the NIIT. In the court’s view, this is consistent with the purpose of the treaties as well as with their language: “Their purpose is not to provide absolute protection. The general purpose of the Treaties is to reduce double taxation, but the specific provisions of each treaty must be applied as written. . . . There is nothing in either Article 24(2)(a) of the US–France treaty or Article 23(2)(a) of the US–Italy treaty that entitles US taxpayers to an elimination of all double taxation”.

The result in Toulouse echoes the Tax Court’s January 2021 decision in Adams Challenge v. Commissioner. Adams Challenge involved, among other things, the application of the business profits article of the US–UK treaty, which provides that “In determining the business profits of a permanent establishment, there shall be allowed as deductions expenses that are incurred for the purposes of the permanent establishment”. 

Even in the absence of plain qualifying language such as that at issue in Toulouse, the court inferred a similar qualification, holding that “shall be allowed” means “shall be allowed so long as certain conditions are met”, including the satisfaction of domestic return filing and timing requirements.

Toulouse and Adams Challenge illustrate some of the limitations of treaties. As the Tax Court’s opinion in Toulouse states, there is no guarantee of double tax relief, which may result in significant hardship for taxpayers. 

While treaties’ double tax crediting rules do not provide perfect coverage, the good news is that where a treaty does cover an issue, dispute resolution under the treaty is almost always effective, as shown in the mutual agreement procedure statistics published by the OECD.  


Mark Martin

Principal, KPMG



Thomas Bettge

Manager, KPMG



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