Last week the Federal Circuit heard oral argument in Bruyea v. United States, a tax case we have been following because it attracted an amicus brief. In this case, the United States is appealing a decision of the Court of Federal Claims allowing American citizens residing in Canada to claim a foreign tax credit. Judges Chen, Hughes, and Stark heard the oral argument. This is our argument recap.
Kathleen Lyon argued on behalf of the United States. She began by arguing the “U.S.-Canada tax treaty” allows a U.S. taxpayer to “claim a foreign tax credit” against U.S. income tax only “in accordance with the provisions and subject to the limitations of the law of the United States.” In the government’s view, Lyon explained, the lower court erred because it relied on a “narrow interpretation of the U.S. law limitation,” which “finds no support in the treaty’s text.”
A judge asked Lyon whether there are “any other income taxes” outside the category of taxes normally subject to the credit. Lyon answered by arguing that even within the ordinary category of income taxes, there are “taxes against which the foreign tax credit cannot be applied.”
Another judge questioned the implications of the trial court’s reasoning. Under that approach, the judge suggested, the treaty’s broad definition of “United States tax on income” might create an “independent right” to offset foreign taxes against anything fitting that definition. Lyon agreed that this would follow from the lower court’s view, and argued that such a reading has “no textual basis” in the treaty. Instead, she emphasized, the credit is conditioned on compliance with the “provisions and limitations” of U.S. law.
The panel asked about provisions in the treaty that modify the “general credit rule.” A judge asked whether treaty contains specific rules that “wouldn’t otherwise apply” under the domestic statutory scheme. Lyon agreed, arguing certain provisions show that, when the countries wanted to deviate from domestic law, “they wrote it into the agreement.”
Another judge asked how the treaty should be interpreted given the investment income tax “was enacted long after” the treaty was negotiated. Lyon answered by arguing nothing about the later enactment changed how the treaty’s credit provision operates. Also, nothing about the later enactment, she continued, “changed how the parties understood the paragraph” limiting the reach of the tax credit. Instead, she argued, the foreign tax credit has “always been restricted” consistently under U.S. law.
Stuart Horwich argued on behalf of Bruyea. Horwich began by framing the dispute as a straightforward case of double taxation. The taxpayer sold property in Canada, then paid Canadian and American taxes. Horwich argued that “paying the net investment income tax is in fact double taxation,” which, he said, the treaty meant to prevent.
A judge asked Horwich whether carryback or carryforward rules can help the taxpayer. Horwich acknowledged that credits can sometimes be carried back or forward, but argued that merely “mitigates to a degree double taxation” and does not eliminate the problem.
Turning to the treaty’s text, Horwich argued the phrase requiring compliance with U.S. law refers only to the rules used to determine the tax credit amount. In his view, those “provisions and limitations” concern only how the credit is calculated. Members of the panel repeatedly questioned that interpretation. One judge, for example, highlighted the phrase “in accordance with the provisions of and subject to the limitations of U.S. law.” This judge indicated the language “sounds a lot like” full compliance with domestic law rather than a limited impact related to calculation rules.
The panel raised other concerns with Bruyea’s interpretation. One judge suggested the taxpayer’s approach would allow for a wide range of foreign tax offsets. In response, Horwich pointed to the treaty’s broader purpose. He argued that, in interpreting the treaty, courts should consider the “shared expectations” of the countries and their goal of preventing double taxation.
In rebuttal, Lyon reiterated the credits in the treaty are “subject to the limitations” of U.S. law. She maintained the text alone resolves the dispute. According to Lyon, because the relevant U.S. tax falls outside the category of taxes eligible for the credit under domestic law, the taxpayer cannot claim the offset.
We will continue monitoring this case and report on developments.