Co-authored by Sunita Doobay, Blaney McMurtry LLP
When asking a U.S. tax adviser to describe the "revenue rule," it would not be surprising for the adviser to say that it refers to formal guidance issued by the I.R.S. that can be relied on by other taxpayers as authority for a position taken in a tax return.
However, the term has a much different meaning in a cross-border context. As explained by one author:
The revenue rule, a common law doctrine with origins in the eighteenth century, is a battleground in the twenty-first century . . . . In its modern form the revenue rule generally allows courts to decline entertaining suits or enforcing foreign tax judgments or foreign revenue laws . . . .1
In a U.S. Supreme Court case of this century, the revenue rule is described in the following language:
Since the late 19th and early 20th century, courts have treated the common-law revenue rule as a corollary of the rule that, as Chief Justice Marshall put it, '[t]he Courts of no country execute the penal laws of another.' . . . The rule against the enforcement of foreign penal statutes, in turn, tracked the common-law principle that crimes could only be prosecuted in the country in which they were committed. . . . The basis for inferring the revenue rule from the rule against foreign penal enforcement was an analogy between foreign revenue laws and penal laws [citations omitted].2
The revenue rule can be overridden by treaty, and where it has, the U.S. and Canadian tax authorities have, in recent years, collected the taxes due in the other country.
This article will explore (i) the general development of the revenue rule, (ii) the applicable provisions of the Canada-U.S. Income Tax Treaty (the "Treaty") allowing for assistance in collection and exchanges of information, (iii) one U.S. wire fraud case, and (iv) several recent cases in the U.S. where taxpayers raised creative arguments to attack the validity of the Treaty provisions but to no avail.
DEVELOPMENT OF THE COMMON LAW RULE
English Common Law
Under common law, a court will not enforce the revenue laws of other countries. In the English case King of the Hellenes v. Brostron,3 Rowlatt J. emphasized this revenue rule, stating:
It is perfectly elementary that a foreign government cannot come here – nor will the courts of other countries allow our Government to go there – and sue a person found in that jurisdiction for taxes levied and which he is declared to be liable in the country to which he belongs.
The Dutch government was also precluded from collecting Dutch succession duties levied on a Dutch estate with an English-resident beneficiary. Tomlin J. in re Visser, The Queen of Holland v. Drukker4 stated:
My own opinion is that there is a well-recognized rule, which has been enforced for at least 200 years or thereabouts, under which these courts will not collect the taxes of foreign States for the benefit of the sovereigns of those foreign States; and this is one of those actions which these courts will not entertain.
The reasons for not enforcing a foreign state's revenue laws was explained by the House of Lords in Government of India, Ministry of Finance (Revenue Division) v. Taylor:5
If one State could collect its taxes through the courts of another, it would have arisen through what is described, vaguely perhaps, as comity or the general practice of nations inter se. . . . Tax gathering is an administrative act, though in settling the quantum as well as in the final act of collection judicial process may be involved. Our courts will apply foreign law if it is the proper law of a contract, the subject of a suit. Tax gathering is not a matter of contract but of authority and administration between the State and those within its jurisdiction. If one considers the initial stages of the process, which may, as the records of your Lordships' House show, be intricate and prolonged, it would be remarkable comity if State B allowed the time of its court to be expended in assisting in this regard the tax gatherers of State A.
Adoption in Canadian Courts
Canadian common law followed the revenue rule as set out in the above English case law. The revenue rule was applied by the British Columbia Court of Appeal in United States v. Harden6 when it refused to enforce a U.S. judgment obtained against Mrs. Harden, who was a Canadian resident at the time the case was brought. In earlier years, she was a resident of the U.S. In an attempt to sidestep the revenue rule, the U.S. government obtained a judgment against Mrs. Harden in the U.S. District Court for the Southern District of California, Central Division. The judgment was for outstanding tax plus interest in the amount of $200,037.28 for the 1945 U.S. taxation year and $439,462.87 for the 1946 U.S. taxation year.
In Canada, the U.S. conceded the application of the principle that no action will be pursued in Canadian courts by or on behalf of a foreign state to recover taxes payable under foreign revenue laws. However, the U.S. contended that the revenue rule does not apply once the foreign state has recovered judgment in its domestic courts and sues to enforce the judgment in Canada.7 In essence, the U.S. argued that the once the matter was adjudicated in the U.S. court, the judgment stood on its own merits without the need of any reference to the underlying claim. However, the British Columbia Court of Appeal refused to enforce the California judgment because it remained a claim on behalf of a foreign state to recover taxation due under its law. The underlying claim tainted the enforceability of the judgment.8
The Supreme Court of Canada unanimously upheld the decision of the British Columbia Court of Appeal.9 At page 371 of its decision, the Supreme Court cited to the Irish decision Peter Buchanan Ltd. & Macharg v. McVey,10 where Lord Sommervell of Harrow stated at page 515 that a foreign state could not circumvent the direct or indirect application of the revenue rule. The Supreme Court of Canada stated:
A foreign State cannot escape the application of this rule, which is one of public policy, by taking a judgment in its own courts and bringing suit here on that judgment. The claim asserted remains a claim for taxes. It has not, in our courts, merged in the judgment; enforcement of the judgment would be enforcement of the tax claim.11
THIRD PROTOCOL TO THE TREATY ADOPTS ASSISTANCE IN COLLECTION
Article XXVIA (Assistance in Collection) was adopted by Article 15 of the Third Protocol to the Treaty, which was signed on March 17, 1995. That protocol replaced an earlier proposed protocol that was signed on August 31, 1994, but never went into force and was later withdrawn. The text of Article XXVIA appears in Appendix I.
The introduction of Article XXVIA meant that a U.S. citizen would no longer be permitted to move to Canada in order to avoid his or her U.S. tax liabilities as in Harden.12 To that end, the Technical Explanation prepared by the Treasury Department at the time the Third Protocol was submitted to the U.S. Senate as part of the approval process described the purpose and workings of the provision in the following language:
Article 15 of the Protocol adds to the Convention a new Article XXVI A (Assistance in Collection). Collection assistance provisions are included in several other U.S. income tax treaties, including the recent treaty with the Netherlands, and in many U.S. estate treaties. U.S. negotiators initially raised with Canada the possibility of including collection assistance provisions in the Protocol, because the Internal Revenue Service has claims pending against persons in Canada that would be subject to collection under these provisions. However, the ultimate decision of the U.S. and Canadian negotiators to add the collection assistance article was attributable to the confluence of several unusual factors.
Of critical importance was the similarity between the laws of the United States and Canada. The Internal Revenue Service, the Justice Department, and other U.S. negotiators were reassured by the close similarity of the legal and procedural protections afforded by the Contracting States to their citizens and residents and by the fact that these protections apply to the tax collection procedures used by each State. In addition, the U.S. negotiators were confident, given their extensive experience in working with their Canadian counterparts, that the agreed procedures could be administered appropriately, effectively, and efficiently. Finally, given the close cooperation already developed between the United States and Canada in the exchange of tax information, the U.S. and Canadian negotiators concluded that the potential benefits to both countries of obtaining such assistance would be immediate and substantial and would far outweigh any cost involved.
However, the two countries were hesitant to allow the application of collection procedures to their respective citizens doing business in the other country. To that end, Paragraph 8 of the Article XXVIA provides:
No assistance shall be provided under this Article for a revenue claim in respect of a taxpayer to the extent that the taxpayer can demonstrate that . . . the revenue claim relates to a taxable period in which the taxpayer was a citizen of the requested state.
EXCHANGE OF INFORMATION
Article XXVII addresses exchanges of information between the tax authorities in the U.S. and Canada. Originally adopted in 1984, the provision was modified by the Fifth Protocol to the Treaty signed on September 21, 2007. The text of Article XXVII appears in Appendix II.
As currently in effect, Article XXVII authorizes the competent authorities to exchange information as may be relevant for carrying out the provisions of the Treaty or domestic tax law, insofar as the taxation under domestic law is not contrary to the Treaty. The Technical Explanation of the Fifth Protocol prepared by the U.S. Treasury Department as party of the approval process in the U.S. explains that the phrase "may be relevant" expresses the intention to allow the I.R.S. to obtain items of potential relevance to an ongoing investigation, without reference to its admissibility. The phrase is not intended to support a request in which a Contracting State simply asks for information regarding all bank accounts in one state maintained by residents of the requesting state.
The authority to exchange information is not restricted to residents of one or both states. Information may be exchanged for use in all phases of the taxation process including assessment, collection, enforcement, or the determination of appeals. Any information received by a state is to be treated as secret in the same manner as information obtained under the tax laws of that state. Disclosure of the information is limited to authorities, including courts and administrative bodies, involved in
- the assessment or collection of tax,
- the administration and enforcement of tax, or
- the determination of appeals in relation to tax.
Information received in any of the three categories may be disclosed in public court proceedings or in judicial decisions.
If one state requests information, the other state is required to use its information gathering measures to obtain the requested information. The requested state is not permitted to decline to obtain and supply information simply because it has no domestic tax interest in such information. This provision is in Article XXVII. It is intended to preclude the taxpayer argument that the requested state is not authorized to obtain information from a bank or fiduciary that is not needed for its own tax purposes.
Article XXVII does not impose an obligation on the requested state to
- carry out administrative measures at variance with the laws and administrative practice of either state,
- supply information that is not obtainable under the laws or in the normal course of the administration of either state,
- supply information that would disclose any trade, business, industrial, commercial, or professional secret or trade process, or
- supply information the disclosure of which would be contrary to public policy.
Nonetheless, Article XXVII does not prevent a requested state from voluntarily complying with a request on a discretionary basis, provided its internal laws are not violated.
A requested state may not decline to provide information because that information is held by a financial institution, nominee, or person acting in an agency or fiduciary capacity. Thus, domestic bank secrecy laws (or similar legislation relating to disclosure of financial information by financial institutions or intermediaries) are overridden by the state's obligation to provide information under Article XXVII.
Finally, in a general note that accompanied the signing of the Fifth Protocol, Canada and the U.S. expressly agree that the standards and practices described for the exchange of information are to be in no respect less effective than those described in the Model Agreement on Exchange of Information on Tax Matters developed by the O.E.C.D. Global Forum Working Group on Effective Exchange of Information.
MULTILATERAL CONVENTION ON MUTUAL ADMINISTRATIVE ASSISTANCE IN TAX MATTERS
In negotiating income tax treaties, Canada has abstained from adopting provisions that enforce collection of a treaty partner's tax from its citizens. Along with the U.S., it refused to adopt the assistance in tax recovery provisions of the Multilateral Convention on Mutual Administrative Assistance in Tax Matters (the "Convention"). The Convention was designed to cover:
All possible forms of administrative co-operation between States in the assessment and collection of taxes . . . through exchange of information . . . to the recovery of taxes.13
The Convention was developed jointly by the O.E.C.D. and the Council of Europe. It was open for signature in 1988 and came into force on April 1, 1995. The Convention was amended by the 2010 Protocol. Although, Canada signed the Convention on April 28, 2004, it did not ratify the Convention until November 21, 2013. The Convention entered into force in Canada in 2014. The U.S. has not ratified the Protocol.14 Article 6 of the Convention forms the foundation for what is known as the Common Reporting Standard ("C.R.S."). Although only 26 countries signed the 1988 version of the Convention, 130 jurisdictions are signatories at this time.
C.R.S. is an automatic annual financial information exchange for tax authorities and allows a tax authority to inform another tax authority of the financial accounts held by tax residents of other signatory jurisdictions. Beginning July 1, 2017, Canada Revenue Agency ("C.R.A.") shares information with members of the C.R.S. Multilateral Agreement with which C.R.A. has formalized a C.R.S. partnership, including details of bank accounts held by their residents in Canada. In return, C.R.A. receives information on financial accounts held by Canadian residents outside of Canada from its C.R.S. partners. The information exchanged by C.R.A. comes from filings made to C.R.A. by Canadian financial institutions. Exchanged information includes the nonresident account holder's (i) name, (ii) address, (iii) date of birth, (iv) account balance or value at year end, and (v) certain amounts credited or paid into the account during the year. In comparison to F.A.T.C.A. reporting, C.R.S. has no de minimis amount for reporting purposes. The U.S. is not a signatory to C.R.S., as F.A.T.C.A. has been successful in uncovering accounts held outside the U.S. by U.S. persons. Nonetheless, the U.S. has automatic bank deposit exchange of information programs with more than 85 countries.15
CANADIAN EXPERIENCE WITH INFORMATION EXCHANGE OBLIGATIONS
The automatic exchange of information is permitted by Section 2 of the Canada-U.S. Enhanced Tax Information Exchange Agreement Implementation Act (the "Implementation Act"). It states that Article XXVII of the Treaty authorizes the exchange of information for tax purposes. It is this provision of the Treaty that authorizes the intergovernmental agreement ("I.G.A.") for purposes of exchange of information to enforce F.A.T.C.A.16
Hillis v. Canada
Article XXVIA prevents C.R.A. from collecting penalties imposed on its citizens by reason of F.A.T.C.A. or its global counterpart, C.R.S. In Hillis v. Canada,17 a motion for summary judgment was brought by two "accidental Americans" against C.R.A. seeking an injunction to prevent the supply of Canadian financial information to the I.R.S. Accidental American is a popular term in Canada for an individual who was born in the U.S. to Canadian citizens, moved to Canada as a child, and has never worked nor lived in the U.S. as an adult. It is the "accident" of birth in the U.S. that makes the individual a U.S. citizen.
In the Hillis case, the appellants argued that the Implementation Act was contrary to the provisions of Article XXVIA. The arguments of the appellants were similar to those who opposed the I.G.A. at the time of enactment. In broad terms, the arguments may be summarized as follows.
The provisions of the Implementation Act
- unduly harm the privacy rights and interests of all Canadians,
- unduly raise compliance costs to all Canadian financial institutions and Canadian taxpayers,
- impede Canada's efforts to enforce its own tax laws, and
- violate the spirit and potentially the letter of a number of Canadian laws and international treaties.
In sum, the appellants argued that by exchanging information under the Implementation Act, C.R.A. was effectively lending assistance to the I.R.S. in collecting tax from Canadian citizens, which is prohibited by Article XXVIA.
The Federal Court disagreed with the plaintiffs' assertions. The authority to exchange information obtained by Canada pursuant to the terms of the Implementation Act is derived from Article XXVII of the Treaty. As indicated above, the exchange of information provisions of the Treaty do not expressly prohibit disclosure. The words used in the Implementation Act are explicit and the intention of the two governments was found by the Federal Court to be clear. The intent was that each country agreed to would obtain and exchange, annually and on an automatic basis, all relevant information with respect to reportable accounts, subject to the confidentiality and other provisions of the Treaty.
In reaching its decision, the Federal Court relied on the assurances of C.R.A. that:
The IRS cannot use such information to administer non-tax laws (such as the US Bank Secrecy Act) or in its dealings with federal entities (such as the Financial Crimes Enforcement Network of the US Treasury Department) who are involved in money laundering repression. Indeed, the CRA will not assist the US in collecting non-tax related penalties such as penalties for failing to file the FBAR [Report of Foreign Bank and Financial Accounts]. Moreover, while the Canada-US treaty says that Canada may assist the US in collecting certain taxes, it also says that the Canadian authorities will not assist the US authorities in collecting a US tax liability if the person was a Canadian citizen when the liability arose. The Federal Court went on to state that, although the Treaty does not prevent the collection and the automatic disclosure of taxpayer information mentioned in Article 2 of the IGA with respect to US reportable accounts, the IRS cannot use such information to administer non-tax laws such as the Bank Secrecy Act in the US or in its operations directed to the suppression of money laundering, such as FinCEN. Consequently, CRA will not assist the U.S. in collecting penalties for failing to file FBAR forms.
As to the argument that the provision lends assistance in the collection of tax in a way this prohibited by Article XXVIA, the Federal Court disagreed, stating:
Article XXVI A applies only to cases in which tax liability has been determined and is enforceable, and does not apply to the assessment of tax payable, the verification of taxpayer compliance, or related exchanges of information. Accordingly, I find that the automatic exchange of information allowed by the IGA does not amount at the present time to providing assistance in collection, and is thus not captured under this Article. The plaintiffs have conflated the assessment of taxes, verification of compliance, and collection of penalties possibly due by US persons for non-reporting. The arguments made in this respect are not relevant and are premature in any event.
At Paragraph 76 of its decision, the Federal Court concluded that the I.G.A. was not contrary to the Treaty or the Income Tax Act and it was not up to the court to amend the law. The court stated:
True, a great number of Canadian taxpayers holding US reportable accounts are likely to be affected by a reporting system that in many quarters is considered unjust, costly and ineffective, considering that at the end of the day they are not likely to owe taxes to the US. In the absence of legislative provisions requiring all Canadian financial institutions (provincially and federally regulated) to automatically notify their account holders about reporting to the CRA under the IGA and Part XVIII of the ITA, these taxpayers may also be taken by surprise by any consequences that flow from such disclosure. The plaintiffs may find this deplorable, but apart from a constitutional invalidation of the impugned provisions or a change of heart by Parliament or Congress, or the governments of Canada or the US, there is nothing that this Court can judicially do today to change the situation. The impugned provisions have not been held to be ultra vires or inoperative. Judicial courage requires that judges uphold the Rule of Law.
Deegan v. Canada
A similar conclusion was reached in Deegan v. Canada.18 The provisions of the Implementation Act and Sections 263 to 269 of the Income Tax Act, R.S.C. 1985 (5th Supp.), were challenged by individuals who were accidental Americans.
The plaintiffs alleged that those provisions cause Canada to act as an intermediary between Canadian financial institutions and the I.R.S. Those institutions are required to provide C.R.A. with certain information concerning financial accounts belonging to customers whose account information suggests that they may be U.S. persons. C.R.A. then provides that information to the I.R.S. As a result, the plaintiffs alleged that the provisions of the Implementation Act violate the Canadian Constitution,19 asserting that they constitute an unreasonable seizure of financial information belonging to U.S. persons in Canada. The plaintiffs also alleged that the information exchange under the Implementation Act violated other provisions of the Canadian Constitution because they singled out individuals based on citizenship or national or ethnic origin.20 Finally, the plaintiffs alleged that the violations do not constitute reasonable limitations on the privacy and equality rights of affected individuals.21
The Federal Court disagreed with the allegations and held that the disputed provisions of the Implementation Act are not unreasonable and do not violate the Canadian Constitution.
The information that is obtained by C.R.A. from Canadian financial institutions is not an unreasonable search and seizure. Departing from the approach taken under the revenue rule, the Federal Court determined that an expectation of privacy is appropriate principally when a Canadian statute is criminal or quasi-criminal in nature. Reporting of tax information by Canadian financial institutions to C.R.A., and ultimately to the I.R.S., does not fit into that protected framework. Tax is essentially a regulatory statute, and the information relates to the manner in which income tax is calculated and collected. Hence, a lesser expectation of privacy exists.
The Federal Court also disagreed with the plaintiff's assertion that the information is not of a kind that is regularly obtained under the Income Tax Act and therefore should not be delivered to C.R.A. Following the holding in Hillis v. Canada, the banking information is foreseeably relevant to U.S. tax compliance and can be obtained by C.R.A. pursuant to a request from the I.R.S. under Article XXVII of the Treaty.
To the extent that the disputed provisions draw a distinction based on national origin and citizenship, they are not discriminatory. In reaching its decisions, the Federal Court took into account the detailed negotiations that were carried on by the Canadian government, attempting to negotiate a carve-out for Canada. When the Canadian government realized that a carve-out was not possible, it realized that entering into an I.G.A. was the only way to avoid a potentially devastating effect on the Canadian financial sector.
The plaintiffs alleged that the purpose of the Implementation Act was to assist the U.S. government in implementing F.A.T.C.A. and finding U.S. tax evaders and cheats, a purpose that cannot be described as pressing and substantial for the Canadian government or Canadian residents. However, at the same time that Canada was negotiating its I.G.A. with the U.S. government, the O.E.C.D. was involved in developing and implementing a common standard for the automatic multilateral exchange of financial account information along the lines of the I.G.A. Hence, the Implementation Act could not be said to be out of line with global expectations of financial privacy.
Finally, the argument that the Implementation Agreement resulted in discrimination based on citizenship and national origin were misplaced. The Federal Court held that a classification based on national origin is a form of discrimination only where it perpetuates ongoing disadvantages or prejudice. That is not the case where compliance with laws of a country of citizenship are in issue.
The Charter does not require Canada to assist persons resident in this country in avoiding their obligations under duly-enacted laws of another democratic state, nor does it require this country to shelter those living in Canada from the reach of foreign laws. Indeed, as was noted earlier, insulating persons resident in this country from their obligations under duly-enacted laws of another democratic state is not a value that section 15 of the Charter was designed to foster.
Overall, the arguments raised by the plaintiffs paled in comparison to benefits that are derived by the banking industry in Canada. The I.G.A. was necessary for Canadian financial institutions to be deemed compliant with the requirements of F.A.T.C.A. and simplified the related data gathering obligations. In sum, the Implementation Act allowed Canadian financial institutions to avoid 30% withholding taxes on the receipt of capital payments on loans to U.S. residents and simplified the information gathering that would otherwise have been required under F.A.T.C.A.
1. Mallinak, "The Revenue Rule: A Common Law Doctrine for the Twenty-First Century," 16 Duke J. Comp. & Int'l L. 79 (2006)).
2. Pasquantino v. U.S., 544 U.S. 349, 360 et. seq, (2005).
3. (1923) 16 LI. L.Rep. 190, 193.
4.  Ch. 877, 884; 44 T.L.R. 692.
5.  A.C. 491. The factual background in this case is as follows. The government of India sought to enforce and collect capital gains tax from the sale of an English company that carried on business in India. The English company filed for voluntary liquidation and the Indian government brought its claim in the English bankruptcy proceeding. The House of Lords decision was unanimous.
6. (1962), 40 W.W.R. 428, 36 D.L.R. (2d) 602.
7. United States v. Harden, 36 D.L.R. (2d) 602 at p. 606.
8. Id. at p. 607.
9.  S.C.R. 366.
10.  A.C. 516.
11. Supra note 7 at p. 371.
12. Dianne Bennett, "Third Protocol to the Canada – U.S. Tax Treaty, " in Report of Proceedings of the Forty-Seventh Tax Conference, 1995 Conference Report (Toronto: Canadian Tax Foundation, 1996), 44:1-25, at 44:10. Harden was cited favorably by the Federal Court in 2015 F.C. 1082 at Paragraph 52 where the Federal Court stated that it was well settled that in no circumstances will a court directly or indirectly enforce the revenue laws of another country, unless expressly allowed to so in the home country of the person in question.
13. See O.E.C.D., "Convention on Mutual Administrative Assistance in Tax Matters," last updated October 2019.
14. See O.E.C.D. and Council Europe (2011), The Multilateral Convention on Mutual Administrative Assistance in Tax Matters: Amended by the 2010 Protocol, O.E.C.D. Publishing.
15. See Rev. Proc. 2019-23.
16. The Agreement Between the Government of Canada and the Government of the United States of America to Improve International Tax Compliance Through Enhanced Exchange of Information under the Convention Between Canada and the United States of America with Respect on Income and on Capital.
17. 2015 F.C. 1082 (September 16, 2015).
18. 2019 F.C. 960 (July 7, 2019).
19. Section 8 of the Canadian Charter of Rights and Freedoms (the "Charter"), Part I of the Constitution Act, 1982, being Schedule B to the Canada Act 1982 (U.K.), 1982, c. 11.
20. Section 15 of the Charter.
21. Section 1 of the Charter.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.