Collecting Another Country's Taxes – Recent Experience In The Canada-U.S. Context

Co-authored by Sunita Doobay, Blaney McMurtry LLP

INTRODUCTION

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...