Our firm, Moodys Tax Advisors, has proactively proposed legislation in Canada that will, if accepted and passed, allow a deduction against Canadian tax for the vast amount of professional fees paid to participate in the Internal Revenue Service's ("IRS's") 2011 Offshore Voluntary Disclosure Initiative ("OVDI"), the 2012 Offshore Voluntary Disclosure Program ("OVDP"), or the (traditional) Voluntary Disclosure procedure. For most Canadian taxpayers these fees are not deductible in Canada and we understand the Canada Revenue Agency ("CRA") has denied these deductions. Recently our firm submitted a proposal, and accompanying legislation, to the Department of Finance to amend the Canadian Income Tax Act to allow for such deductibility (you can read our submission here).
The Department of Finance has been very supportive of the plight of these individuals and their need to become compliant under US tax law in order to avoid potentially ruinous US penalties. In particular, Minister Flaherty has been very vocal of his support. We are hopeful that our proposal will result in additional relief for those unfortunate taxpayers who have been affected.
Background on IRS's voluntary disclosure programs
In 2011 and 2012 the IRS announced two important voluntary disclosure programs designed to allow those who have unfiled US tax returns to bring them current. Further, in 2012 the IRS announced a new "streamlined procedure" for certain "low risk" taxpayers to bring their tax filing current (you can read our analysis of this new procedure here). Approximately 33,000 individuals participated in the OVDI and a similar program in 2009, many of whom were Canadian residents who had, until recently, been unaware of their tax filing requirements and the associated penalties. In June 2012 the IRS announced that it had collected more than $5 billion from these programs (you can read the IRS's report on these programs here).
Most of these participants paid tens of thousands of dollars in professional and accounting fees to participate, even though they were fully compliant with their tax and reporting obligations in Canada and owed little or no additional US tax. For most taxpayers the professional fees incurred are deductible against US income tax, however they are generally not deductible against Canadian income taxes.
The IRS's Taxpayer Advocate Service is sympathetic to the tax compliance burden faced by US persons living in Canada
The Office of the Taxpayer Advocate (also called the Taxpayer Advocate Service or "TAS") is an independent office of the IRS and is charged with assisting taxpayers to resolve disputes with the IRS. TAS also identifies systemic problems that exist within the IRS and proposes solutions to these problems in an annual report to the US Congress.
The National Taxpayer Advocate 2011 Annual Report to Congress (which you can read in full here) addressed the plight of the tax compliance burden for US citizens residing abroad. The report was very critical of the IRS's treatment of these taxpayers. In its introduction to this topic the report states:
"The complexity of international tax law, combined with the administrative burden placed on these taxpayers, creates an environment where taxpayers who are trying their best to comply simply cannot. For some, this means paying more U.S. tax than is legally required, while others may be subject to steep civil and criminal penalties. For some U.S taxpayers abroad, the tax requirements are so confusing and the compliance burden so great that they give up their U.S. citizenship."1
The report continues to address more specific areas that are particularly challenging for US persons living abroad:
- The overwhelming complexity of international law;
- The complexity and administrative detail of often duplicative international reporting requirements;
- Steep penalties that may be disproportionate to tax liability;
- The IRS's focus on international tax enforcement without adequate coordination or a corresponding increase in service; and
- The lack of targeted taxpayer service for international taxpayers, which leads to confusion, errors, and higher compliance costs than for those in the US.2
Some Canadian residents knew of their US tax and filing obligations and, for whatever reason, fell behind. We believe these individuals comprise a very small minority of those who have not filed. Most individuals who need to catch up on US tax filings were simply unaware of these obligations and may not even have known they were US citizens. Only a miniscule fraction of individuals residing in Canada have not filed US tax returns based on malevolent intent, after all tax evaders can easily find jurisdictions with lower taxes than Canada.
We are therefore hopeful that our proposal to the Canadian Department of Finance will have an impact and provide relief to those who, because of ignorance, birth parents, or birthplace, are required to bear the cost of catching up on US tax filings.
1. National Taxpayer Advocate 2011 Annual Report to Congress at 129. Citing Memorandum for Secretary Geithner from J. Russell George, Treasury Inspector General for Tax Administration, Management and Performance Challenges Facing the Internal Revenue Service for Fiscal Year 2011 13 (October 15, 2010).
2. Ibid. at 130.
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