How is a Foreign Tax Treaty Made?
Tax treaties can dictate which categories foreign source income must be reported for federal income tax purposes. Tax treaties do not directly cover your requirement to file an FBAR (Foreign Bank Account Report, FinCEN Form 114). Nonetheless,the discovery of unreported income in the environment of a tax treaty can impact on the IRS’ decision to assess penalties for non-filing of an FBAR.
In response to some of our clients questions on the topic of foreign tax treaty, we sifted through IRS training materials that we procured pursuant to a Freedom of Information Act (FOIA) Request to clarify this for you.
The Responsibility to Negotiate Tax Treaties (from the Office of the International Tax Counsel, Department of Treasury).
Once a tax treaty is drafted, diplomatic agents for each country must sign on. The tax treaty then goes to the desk of the President of the United States for his signature. Then a letter of transmittal goes to the Senate to request approval of the President’s ratification of the treaty.
The tax treaty is referred by the Senate to the Committee on Foreign Relations. They conduct tax treaty hearings before a committee. When the Committee is done deliberating, it has an opportunity to report on the Senate floor to either recommend that the treaty be approved as is, or that certain amendments, reservations, or understandings be considered before approval. The Committee could also decline to report the tax treaty favorably.
After the Committee action, the treaty is reported to the full Senate, which is charged with advising and consenting to the tax treaty’s ratification by a vote of two-thirds of the members of the Senate that are present. As of the end of 2014 several tax treaties have been held up by Senator Rand Paul under the Senate’s rules which permit one Senator to bring a motion for a vote to the floor. This is referred to as placing a “hold” on the treaty. No new tax treaties or treaty updates have been approved by the Senate since 2010, when Senator Paul was first elected.
If the tax treaty is approved without reservation or amendment, the President may then exchange instruments of ratification with the foreign government (assuming the foreign government has also completed its internal procedures to ratify the treaty). If the Senate approved the tax treaty but with a reservation or amendment, then renegotiations portions of the tax treaty may ensue before the foreign country will ratify it. If renegotiation is limited in scope, it will usually be completed in the form of a protocol by a two-thirds vote as if it were a separate tax treaty.