It is a cliché to state today that the world has become smaller, that business has become international, and that individuals have become peripatetic. However, those are facts of life. People no longer remain where they were born, raised, or educated. The freedom of movement of workers is guaranteed without discrimination by the European Community,1 the United Nations Universal Declaration of Human Rights, articles 13(2) and 15(3), and the International Covenant on Civil and Political Rights, article 12(2). Some consequences of the constant change are reflected in the OECD Model Double Taxation Convention on Income and Capital (the OECD Model Treaty) and in the OECD Model Double Taxation Convention on Estates and Inheritances and on Gifts (1983) (the Model Estate Tax Treaty). The OECD Model Treaty sets out a framework of rules to be used in determining the residence of an individual who is a resident of two contracting states under internal law for the purpose of determining which of the two states has an unlimited right to tax the individual's income or capital.2 A similar provision appears in article 4 of the Model Estate Tax Treaty. Both treaties deal with the consequences of an existing set of circumstances giving rise to dual residence, but neither treaty covers the consequences of the change of residence of an individual who ceases to be a resident of one contracting state and becomes a resident of the other.3 This article will not cover the problem of currency gains, inflation adjustments, and similar issues facing an individual who changes residence, triangular problems of three or more interested tax jurisdictions, nor the significant problem of enforcement. Nor will it cover the more emotionally charged issues of a renunciation of citizenship4 and taxing corporate expatriates.5 It should be noted that this area of the tax law is developing, and many of the conclusions in this article reflect the best judgments of the authors in the presence of meager authority.

I. Taxation of Income

A. Coverage

Discontinuities in the taxation of expatriates are caused by the administrative difficulties and political realities of taxation.6 If all taxpayers in every country were taxed on all of their income on an annual economic basis, say, an accrual method of accounting, including an annual accrual of unrealized gain or loss from changes in the value of assets, then the discontinuities would be minimal.7 Most of the countries represented by the authors of this article tax individual taxpayers on significant items of income on a cash realization method of accounting. That is, no income or deduction or gain or loss is recognized until cash or the equivalent is received or paid. This is the easiest method of reporting for individual taxpayers. Similarly, these countries do not (except in certain cases) require or allow taxpayers to recognize gain on an increase, or loss on a decrease, in the value of property until that gain or loss is realized. There are four reasons for this: first, annual valuation is difficult, expensive, and inexact; second, until a taxpayer has sold the property, the taxpayer may not have the funds to pay the tax; third, taxing paper gains seems unfair; and, fourth, annual accounting without carryback of losses may tax gains that are temporary.8

Moreover, in many countries,9 profits or gains on sales are not always fully taxable on the date of sale. Also, the gain may be deferred by electing the installment method of reporting or other methods of deferral in order to correlate the obligation to pay with the ability to pay, until the receipt of cash or property. These variations from an annual accrual taxation scheme result in discontinuities when the assumption that the taxpayer will pay a tax later to his country of residence is defeated by a change of that residence.

There are four separate reasons given for imposing some tax consequences on expatriation. First, it may be an attempt to deny former residents any unintended benefits flowing from applying rules for the taxation of nonresidents to them. This is the best argument for such taxes. Second, there may be a desire to punish those who expatriate. Third, it may be an attempt to increase the progressivity of the tax system when circumstances suggest an ability to pay more. Fourth, such rules may represent a symbolic statement expressing disapproval.10 It is clearly not an attempt to preserve the estate or inheritance tax; otherwise a country would impose a tax on the value of unappreciated property.

The problem of how to tax expatriates on income and gain that has accrued or was earned prior to departure is currently being reviewed by a number of countries, including the United States and Spain. Once an individual departs, his tax status changes significantly. Prior untaxed income and appreciation may never be taxed. Notwithstanding that there may not be significant revenue involved, the issue is highly charged by emotions because of public resentment over tax-motivated expatriations, on the one hand, and a feeling that taxing expatriates violates the fundamental right of freedom of movement, on the other. In 1996, the president and the Treasury Department proposed a sweeping change in the United States tax treatment of expatriating individuals -- a broadly based exit tax on all assets that would have been subject to the United States estate tax if the individual had died immediately before expatriating. The Senate, after limited debate, agreed, though with some modifications. The House of Representatives disagreed and proposed a strengthening in the trailing tax11 on individuals who surrendered their citizenship, and proposed to extend it to long-time residents who were lawful permanent residents of the United States. The debate lasted for 18 months before the Congress passed and the president signed the legislation.

The debate in the U.S. may not be finished. The ranking Democratic member of the House Ways & Means Committee, where all tax legislation originates, introduced a bill this year that would impose an exit tax on all individuals that expatriate, both citizens and long-term resident aliens, whose assets exceed US $675,000. The proposed legislation is similar to the exit taxes of Australia and Canada, with one major addition. Unlike Australia and Canada, the United States has not repealed its estate tax. In order to protect the U.S. Treasury against those individuals who expatriate or who have expatriated in order to avoid the estate tax, any United States citizen or resident would be subject to an excise tax on any gift, bequest, or inheritance that the individual receives from an expatriate. Although the proposed legislation is not retroactive, it would apply regardless of when the donor or decedent expatriated. The Treasury has proposed similar action but would treat the receipt as income, subject to normal income taxation.

The Netherlands recently focused on the issue and introduced, in 1997, a contingent exit tax.12 Upon emigration, a resident individual who owns a substantial interest in a resident or nonresident company is deemed to have disposed of the shares at the time immediately preceding emigration. The tax is deferred, however, and is waived if within the 10 years following emigration, no tainted transactions (such as a sale of the shares) occur.

France has also joined this group and recently enacted an exit tax.13

Canada was the initiator of the exit tax, and Australia was an early convert. Canada has recently revisited and strengthened its exit tax, partially in response to a transfer of appreciated property by a Canadian trust to a former Canadian resident that had the alleged effect of avoiding significant Canadian capital gains tax on the unrealized capital gains on taxable Canadian property. Australia is looking at the issue again in the context of the Review of Business Taxation, whose final report was released in 1999.14Both countries, however, use a trailing tax system for certain qualified property that is not subject to the exit tax, although the recent Canadian amendments have broadened the scope of the exit tax and substantially narrowed the scope of the trailing tax.

Many countries have not enacted specific legislation to address the numerous issues in this area. In such countries, the answers to the questions discussed here are often unclear and expatriates in identical situations may be treated inconsistently. Examples of the issues are discussed infra.

B. Methods

In general, there are three methods by which countries have addressed expatriation. The most common method is to ignore it and permit the normal rules to apply, treating emigration as a nontaxable event. A second method is to treat the act of expatriation as a taxable event, resulting in the deemed disposition of all assets and the realization of all accrued income15 and gains. A third method is to determine the assets and income that should be taxed but to defer taxing these gains and income until the property is sold and the gain actually realized or the income collected (a trailing tax).

This article will not debate which system is the best. Suffice it to say that there are issues of tax policy purity, administrative convenience, collectability, enforcement, and ability to pay. The purpose of this article is to identify and analyze the problems that occur because of discontinuities between the country of departure and the country of arrival, and to discuss any treaty provisions that can be adopted to alleviate double taxation or double nontaxation (exemption) by those countries whose treaties are patterned after the OECD Model Treaty.16

Similarly, this article will not debate whether any system violates the European Community's Convention17 on free movement of individuals, or any nondiscrimination provision of a treaty.

II. Appreciated Assets

The most serious question presented by expatriation is whether to tax appreciation on the value of capital assets at that time, at some later time, or not at all on the assumption that the gain will be taxed later by the new country of residence. Perhaps an equally serious problem is the appropriate relief to be granted to relieve double taxation if both the country of former residence and the country of new residence tax the same income or gains.

It must be noted that not all countries tax capital gains in the same manner.18 Some exempt them completely. Some tax them in the same manner and at the same rates as ordinary income. Some tax them at special capital gains rates. Some permit indexing of the cost of the asset for inflation, therefore taxing a portion of the gain only. Some reduce the tax rate on the taxed portion of the gain depending on the length of time the asset has been held before sale. Some tax only the gain on real estate. Finally, some tax only the gain on the disposition of shares in a company when the seller owns or owned a substantial interest.19

Generally, no country requires or allows its taxpayers to value annually (mark to market) capital assets and, therefore, countries do not tax the gain or allow the loss on the annual changes in the fair market value of capital assets.20 This "realization requirement" leads to potential discontinuities when a taxpayer changes residence before disposing of assets with unrealized gains or losses.

A. Taxation of Emigrants

While all of the authors' countries acknowledge the right of their residents, and, in the case of the United States, its citizens, to emigrate (and in the U.S. renounce citizenship), their tax laws exhibit different views on the tax consequences that should result from the emigration. At one extreme is the position that all possible taxes that could have been imposed on any appreciation in the value of assets should be immediately imposed the day before emigration. Otherwise, it is felt the tax law provides an incentive for emigration to a country that will not tax (or tax at a lower rate) the gains when ultimately realized.21 An extreme example of this position is the former Soviet Union's emigration tax which was based, in part, on the value of the individual's future service which the Soviet Union was losing. At the other extreme is the position that emigration is an inherent right of all individuals and, therefore, no country should have the right to impede such right.22

There appears to be some trend toward the former position. Several countries have implemented regimes in this direction. These regimes generally take one of two forms: the exit tax and the trailing tax, both of which are described below. They are not mutually exclusive. A country may have a different regime for different assets.

1. Exit Tax

An exit tax is an immediate tax, sometimes combined with extended payment terms, on the unrealized appreciation of assets, wherever situated, on departure from the country of residence.

Exit taxes are generally not imposed on stock options, or on accrued, vested, or contingent compensation.23

Australia, Canada, France, and the Netherlands are the only countries represented by the authors of this article that impose a general exit tax. Canada permits an election to defer payment of the tax until the asset is actually disposed of at a later time. Prior to October 2, 1996, the Canadian exit tax provided for a number of important exceptions, in the case of an emigrating individual for property that is "taxable Canadian property,"24 property that is inventory of a business carried on in Canada, certain rights under pension plans, and employee stock option rights.25 The exit tax was not imposed on unrealized gain in such property. In respect of property subject to the exit tax, taxpayers emigrating from Canada could elect to provide security for the payment of the tax and to defer the tax until the actual disposition of the property. Amendments have been proposed, retroactive to emigrations after October 1, 1996. The amendments would extend the deemed disposition rule to taxable Canadian property, other than immovable property situated in Canada. The amendments would also continue the right of an individual to provide security for the payment of any tax liability arising as a result of a deemed disposition and to postpone the payment of tax.26 Although Canada usually exempts capital gains realized and deemed to be realized on taxable Canadian property, other than immovable property and resource property, from tax under its treaties, Canada, like the U.S., limits this exemption and will tax after- emigration gains on taxable Canadian property that Canada would not tax if the individual owner had never been a resident of Canada.

Australia closely follows the original Canadian position. It treats gains on assets as having been realized on emigration, except for gains on assets having a defined connection with Australia. There is no provision for postponing the tax by posting security.27

The Netherlands recently focused on the emigration of its residents and introduced in 1997 what could be termed a "contingent exit" tax. Upon emigration, a resident individual who owns a substantial interest in a resident or nonresident company is deemed to have disposed of the shares immediately preceding emigration at fair market value and will be assessed on the gain, if any, that they are deemed to realize.28 If adequate security29 is provided, this tax is not collected unless and until, in the 10 years following emigration, one or more of certain " tainted" transactions occur.30 A sale of the shares is a tainted transaction. If no such transactions occur within the 10-year period, the tax is waived.31 This procedure is called the "conserving assessment." Taxpayers emigrating before 1997 have not been subject to such a "conserving assessment."

In addition, nonresident individuals holding a substantial interest in a Dutch resident company are, under certain conditions, subject to Dutch income tax on the gain, if any, realized on disposal of these shares.32 This applies also to taxpayers that have emigrated. If a conserving assessment has been issued, the tax basis has been stepped up to the fair market value at the time of emigration.33

Taxpayers who have emigrated after 1997 and who sell their shares within 10 years after emigration, face two tax events: (1) the conserving assessment will come due immediately, and (2) they will receive a new assessment for the gain, if any, that accrued after emigration.

If the value has decreased, an unusable loss results. If the shareholding is in a nonresident company, value changes after emigration are not subject to tax.

The tax, if any, paid in the new country of residence is creditable against the conserving assessment, and is limited to the amount of the conserving assessment.34 Technically, it is not a tax credit, as the assessment is definite and final (it relates to an earlier year). It is a waiver of collection of tax that would otherwise have to be paid.

Germany has a more limited exit tax regime (as well as a trailing tax) for individuals who hold a substantial interest in a German resident company, irrespective of whether the individual emigrates to a tax haven or to another jurisdiction.35 A substantial interest is defined as a share interest of 10 percent or more in a German resident corporation. An individual who surrenders his German residence is taxed on the gain resulting from a deemed disposition of any interest of 10 percent or more in a German resident corporation.36 If the individual later actually sells such interest, and if at that time Germany is not prevented from taxing the capital gain under a tax treaty as it would be under article 13 of the OECD Model, then the excess of such gain over the gain imputed at the time of the change of residence will also be taxed by Germany.

Although there is no general exit charge on individuals in the United Kingdom, there are a few occasions where a change of residence may give rise to a capital gain. This arises with reliefs, under which the realization of a capital gain is deferred if the proceeds are reinvested in an enterprise investment scheme or a venture capital trust. If the person becomes a nonresident within five years of the reinvestment, the relief is brought back into charge. There are also certain occasions under which a gain is postponed on the making of a gift. If the transferee becomes a nonresident (except for an employment abroad not exceeding three years) the relief is ended and the gain is realized. This arises when the change of residence occurs within six years after the end of the year of assessment in which the gift is made, for a gift to an individual, or without time limit in the case of a gift to a trustee.37

France has now joined the list of countries that impose an exit tax with a limited scope and possible exemptions. It also is a contingent exit tax. A taxpayer may be subject to this tax if he was a tax resident of France for six of the 10 years preceding a transfer of his tax residence outside France. The exit tax is first imposed on potential capital gains on substantial participations, such as participations in (non-real estate) French or foreign entities subject to a corporation tax that exceed 25 percent or that exceeded 25 percent at any time in the previous five years. The exit tax is also due where a capital gain was realized upon an exchange of shares before the expatriation and the payment of tax was deferred until the disposal of shares received in exchange. If the taxpayer provides a satisfactory guarantee, the payment of tax on departure may be deferred until the participation in question is concluded. If the participation is not ended for five years after the departure, or if the emigrant comes back to France during this period, the exit tax ceases to be due, and is refunded in case it was paid upon the departure. Otherwise, the guarantees are released. If the participation is concluded during the same period of time, the tax becomes effectively due (in case guarantees were provided) up to the value of the participation at the time of departure or, with respect to the exit tax on substantial participations, up to the effective capital gain realized after the departure, if it is lower than the capital gain that was taxed upon departure. As discussed below, a credit can be claimed against the French tax, if the capital gain is taxed in the foreign country where the emigrant has taken up a new residence.

The U.S. has a similar deemed disposition provision under its proposed Treasury regulations for interests in a passive foreign investment company, although the provision is not part of the Internal Revenue Code.

Although Sweden does not normally impose an exit tax on departure, it will tax on departure gain that was deferred on an earlier exchange of shares. In addition, as discussed below, Sweden has a limited exit tax on stock options when an employee emigrates.

Some states of the United States impose exit taxes when their residents move to other states or out of the country. Generally, the state statute provides that all forms of deferred gain on prior dispositions, such as gain deferred on installment sales and deferred payment sales, are accrued and taxed on departure.38 The treatment of such deferred items is considered further below.

2. Extended Limited Tax Liability -- Trailing Tax

A "trailing tax" is a tax imposed on nonresidents (or, in the United States, nonresident aliens) after emigration that extends beyond the scope of the tax applicable to ordinary nonresidents, but is limited to gains on the assets situated or deemed situated in the country of former residence. It is imposed at a later date, usually the year of actual disposition, on assets owned on the date of the change of residence, and, in the case of Sweden and the United States, also on assets acquired after the change of residence.

Several countries, including the United States, Germany, and Sweden, impose a trailing tax on their former citizens or residents, as the case may be, for some period of time after they expatriate or become nonresidents. In the United States, any former citizen who, for purposes of avoiding tax, has renounced United States citizenship and any person who was a lawful permanent resident for at least eight of the prior 15 taxable years and who has surrendered his or her lawful permanent residence for a tax-avoidance purpose, is subject to the trailing tax for 10 years following the date of expatriation. Expatriates who are subject to the trailing tax must pay the greater of the normal tax (generally 30 percent) imposed on nonresident aliens on their income from U.S. sources, or the normal progressive U.S. tax imposed on citizens and residents, but applied only to gross income from sources within the U.S. For this purpose, the source of income is determined under an expanded definition of U.S.-source income, under which the following items are also treated as having a U.S. source: (a) gains on the sale or exchange of property located in the United States, (b) gains on the sale or exchange of stock issued by a domestic corporation (such as, one incorporated under the laws of a state or those of the District of Columbia), and (c) any income or gain derived from property subject to a "gain recognition agreement." Such a "gain recognition agreement" must be executed with respect to any property that has built-in non-U.S.-source income or gain if such property was acquired in a nontaxable exchange for property that had built-in U.S.-source income or gain. To the extent provided in regulations, an event that shifts the source of built-in U.S.-source income or gain, causing it to be treated as non-U.S.-source income or gain, will be treated as a deemed exchange. A common example is non-inventory personal property located abroad, such as art and jewelry. Since gain on the sale of such property is sourced on the basis of the owner's residence, the act of expatriation is treated as a deemed exchange. If the property owner refuses to enter into a gain recognition agreement, then the gain must be recognized immediately upon expatriation.39

Special rules also apply to the deferred sale of property formerly connected with the conduct of a trade or business within the United States. If such property is disposed of within 10 years after it has been used in connection with the conduct of a trade or business in the United States, then the determination of whether any income or gain attributable to such disposition is taxable is made as if such sale or exchange occurred immediately before such cessation, and without regard to the requirement that the taxpayer be engaged in a trade or business within the United States during the taxable year in which disposition occurs.40

A peculiarity of the U.S. and Swedish systems is that they tax assets acquired after a change in residence. No other country has a similar tax.41 It provides a disincentive for expatriates to invest in the United States and Sweden.42

Germany has a similar tax regime for German citizens who emigrate to a tax haven country or who do not assume residence in any country (effectively similar to the United States tax avoidance purpose test) and who maintain substantial economic ties with Germany. Such persons retain a special status with respect to income taxes (and, in certain respects, for inheritance tax purposes, as well) during the first 10 years after their move. This special status is called Extended Limited Tax Liability. Whereas German residents are taxed on their worldwide income, and ordinary nonresidents are taxed (at a lower rate) only on income from German sources and capital gains from German real estate assets, persons who are subject to the Extended Limited Tax Liability are subject to tax (at regular progressive rates) on gains from all German situs assets under expanded source rules.

As discussed previously, the Netherlands recently enacted a contingent exit tax under which the emigration of a resident holding a substantial interest in a company triggers an "assessment" of the built-in-gain in the substantial interest, which assessment becomes payable only if the interest is sold within 10 years of emigration.43

In certain cases, countries that do not actually have a trailing tax under internal law may limit the treaty exemption for capital gains of nonresidents. For example, the United Kingdom does not tax former residents on capital gains, but many treaties permit the United Kingdom to tax former residents for a number of years.44 This is significant in the case of dual residents who are treated as non-U.K. residents under the treaty and for individuals who are subject to tax in the United Kingdom on the basis of being "ordinarily resident" if they are not actual residents of the United Kingdom. In both cases, the treaty would allow the individual to be taxed on assets which the OECD Model Treaty provides are taxable only in the other state.45

The United Kingdom has another unusual variation of a trailing tax. In order to prevent avoidance of capital gains tax by temporary nonresidents and non-ordinary residents, provisions were introduced in 1998 to tax such persons upon their return on dispositions of assets held at the time of their departure if they had been nonresident for less than five years.46 This is achieved not by treating them as still resident or ordinarily resident at the time of the disposition, but by imposing a tax charge in the year of return on gains made while nonresident. The charge is different from a trailing tax as it is not imposed if the person does not return within five years; nor is it limited to tax on United Kingdom assets. Normally, a treaty in OECD Model form will prevent this charge on assets other than land in the United Kingdom and assets of a permanent establishment, as the gain will be taxable only in the country of residence. As in the case of the U.K.-Netherlands treaty mentioned above, many treaties permit the United Kingdom to tax capital gains for five years after a United Kingdom resident becomes a nonresident, which therefore allows this charge to apply.47

Canada had a treaty policy effectively to impose a trailing tax with respect to taxable Canadian property. Such property is generally protected from tax by treaty, but Canada has historically reserved the right to tax expatriates on gains on the dispositions of such property under its treaties for 5 to 10 years and has continued to do so in very recent treaties that have been signed after the effective date of the changes to the Income Tax Act that tax gains on taxable Canadian property on departure. Such trailing taxes, therefore, are still imposed, even though the gain accrued to the date of emigration is taxed at the time of departure.

Australia still follows the Canadian position and taxes former residents on later realization of assets having the necessary connection with Australia (a defined concept which is effectively a source-based tax). Departing residents may elect to treat other assets as belonging in this defined category and postpone taxation, with the effect that the Australian system then operates as a trailing tax for those assets. The deferral of tax on gains up until the time of departure is bought at the cost of taxation on the gain arising after departure also.48 Australia's treaties negotiated since the capital gains tax was introduced in 1985 generally preserve Australia's domestic tax rules. The situation under treaties negotiated before that time is controversial. The position of the tax administration is that the treaties permit imposition of a capital gains tax. The general view of the profession is that the treaties prohibit the taxation of capital gains under either the business profits article that excludes taxation in the absence of a PE or the other income article that, unlike the OECD Model Treaty, permits taxation only if the gain is sourced in Australia.49

Most countries that impose a trailing tax tax appreciation arising subsequent to a change of residence as well as appreciation accruing prior to departure.

3. Termination of Tax Jurisdiction

Belgium,50 Italy, Japan, Switzerland, the United Kingdom (except in the limited cases mentioned above), and the United States (in the absence of tax-motivated expatriation) do not impose any additional tax liability for a departing individual resident, and do not extend any tax jurisdiction over a departing resident, other than those taxes imposed on nonresidents in general.

B. Basis for Immigrants

The converse of a tax on accrued gains on departure is the exclusion from tax in the new country of residence of accrued gains on previously acquired assets in the hands of a new immigrant.51 This can be achieved by deeming the cost, referred to herein as basis, of such assets to be their values at that time for purposes of determining gain or loss on a future disposition.

Canada,52 Australia,53 the Netherlands (with some exceptions),54 and the recently defeated United States exit tax legislation, all grant an entering individual a new tax basis equal to the fair market value of the assets on the date of entry, instead of a carryover of his original tax basis.55 Australia grants a fair market value basis for assets that are not taxed in the hands of a nonresident (assets which are taxed to a nonresident, such as land in Australia, retain the original cost basis). Similarly, Canada does not grant a new fair market value basis for taxable Canadian property. This new basis eliminates the tax consequences of any pre-entry appreciation or depreciation in the assets' value. The U.S. has a similar rule with respect to the calculation of gain subject to its trailing tax. None of the other countries surveyed for this article, including those countries that have extended limited tax liability, grant a new tax basis in the absence of a treaty.56 Even Japan, where income accrued prior to immigration is not normally taxed when received, does not grant a new basis. The original acquisition cost remains the tax basis for determining gain on a future disposition of the assets and pre- immigration appreciation is taxed.

C. Discontinuities -- The Problem Areas

If an individual migrates from a country that imposes an exit tax or a trailing tax to a country with a different regime, a later disposition results in potential double taxation of the pre-emigration appreciation and, in most countries with a trailing tax, post-emigration appreciation. In the absence of a treaty, unless the taxpayer becomes a resident of a country that grants a new basis for his or her assets, or either the new country of residence or the former country of residence grants a credit for the foreign taxes, a subsequent disposition may also result in double taxation.

Conversely, when an individual migrates to a country that grants a date of entry tax basis from a country with no exit tax or trailing tax, or from a country like Belgium and Switzerland that exempt almost all capital gains realized by individuals, the pre-emigration appreciation may totally escape taxation, resulting in double nontaxation.

In order to facilitate the consideration of the issues, several examples of the possible factual patterns followed by the tax consequences under the alternate regimes are set forth. For purposes of exposition and simplicity, the examples assume that there are available tax credits and/or treaty benefits that may be applicable.

Example 1. An individual (A) residing in country X owns 100 shares of stock that he acquired at a cost of $100. A moves to country Y at a time when the shares have a value of $200. Three years later when the value is $300, A sells the shares. In the absence of a treaty, which country should tax the gain and how much should be taxed? At the time that A changed his residence, $100 of gain ($200 - $100) had accrued, but had not been realized. If country X has an exit tax regime, A would be treated as having realized a gain of $100 and would be subject to tax in country X on that unrealized gain, notwithstanding that A did not have (and may never realize) the funds to pay the tax. Unless country Y treats A as having acquired his stock for $200, A would be subject to a country Y tax on gain of $200 ($300 - $100) at the time of sale. In that case, A would have been subjected to a tax on $300 of gains ($200 in Y and $100 in X), notwithstanding that his economic gain was only $200. If country Y grants a new resident a fresh start and a fair market value basis for the shares, the true economic gain will have been taxed, partly by X and partly by Y, and multiple taxation of the same gain would have been avoided. However, if Y grants A a fresh start and X does not have an exit tax, then A will escape tax entirely on $100 of gain. If country X has a trailing tax regime, and if the gain on the sale is treated as having a source in country X (the shares were issued by a country X corporation) then A will be subject to tax in country X on the $200 of gain recognized at the time of sale. Here, A would be subject to complete double taxation on his $200 gain. In this example, double taxation would arise under both an exit tax and a trailing tax.

Example 2. The same facts as in Example 1 except that the shares had a value of $60 at the time of emigration and a value of $200 at the time of sale. If country X imposes a trailing tax on the shares, then A will be subject to tax in country X on gain of $100 at the time of sale, notwithstanding the fact that all of the appreciation occurred after the date of emigration. On the other hand, if country X imposes an exit tax, then A would not owe any tax to country X.57 A will be subject to a tax on $100 of gain in country Y unless country Y gives A a fresh start basis in which case A's taxable gain would be $140. In this example, double tax is caused only by a trailing tax.

Example 3. The same facts as in Example 1, except that the shares had a value of $200 at the time of emigration and declined in value to $150 after emigration. If country X has an exit tax, then A would have been subject to tax in country X on $100 of gain, notwithstanding X actually realized only $50. If country X has a trailing tax, then A would be subject to tax on $50 of gain in country X. If country Y does not have a fresh start basis rule (or applies a fresh start basis rule for purposes of determining gain but not loss), then A would be subject to double tax on $50 of the gain. If country Y applies a fresh start basis, X could claim a loss of $50, however. In this example, the Canadian exit tax and a trailing tax could lead to double taxation. Australia, Canada, and the Netherlands, as new countries of residence, would allow such loss.

D. Internal Law Solutions

Countries may alleviate or ameliorate the foregoing cases of double taxation by allowing a tax credit for the other country's tax. Under the current rules in effect in most countries, with the exception of the United Kingdom, the availability of such credits is fairly limited.

In countries that limit the foreign tax credit based on the ratio of foreign income to worldwide income (a fairly common pattern), no foreign tax credit may be available to the taxpayer if he does not have foreign source income in the year of disposition, since the numerator of this limitation formula would be zero.58 Although the foreign tax credit may be carried forward in some countries, this may not provide adequate relief. The U.S. addresses this issue by providing for a special foreign tax credit applicable to expatriates. Although France does not generally grant a tax credit to taxpayers in the absence of a treaty, France in its new exit tax legislation specifically provides for a foreign tax credit where the capital gain is taxed in the country where an expatriate establishes residence.

Double taxation relief in the United Kingdom operates by identifying the foreign tax that has been charged on the same gain as is taxed by the United Kingdom. There is no requirement that the foreign tax arise at the same time or that it be charged to the same person, so long as the gain accrues in the other territory.59

Where an individual migrates from a country with an exit tax, none of the countries represented by the authors, except for the United Kingdom, would grant the individual a foreign tax credit. Canada proposes to allow a credit against its exit tax under draft legislation, not yet enacted, which also deals with the expanded exit tax.60

Similarly, where the country of former residence imposes a trailing tax, the new country will not grant a foreign tax credit unless it recognizes the expanded source rules of the former country or treats the gain as foreign sourced. Thus, the burden is generally on the country with the trailing tax to provide the credit. As indicated, some countries that have enacted trailing taxes have shown a willingness to allow a foreign tax credit in this situation.61

In the Netherlands, immigrating individuals will normally not receive a new basis for their substantial interest shareholdings in Dutch resident companies. However, if the individual can demonstrate that an exit tax was paid on the value of those shares, a step-up in basis will be granted. The immigrant's other assets, including shares in a foreign company,62 will receive a fair market value basis.

In addition, the Netherlands will waive collection of its contingent exit tax to the extent that the new country of residence imposes a tax on the gain.63

In Australia and Canada, the tax basis for assets owned by an immigrant is their fair market value on the date of immigration, eliminating the problem of multiple taxation.

FOOTNOTES

1Articles 39 and 43, the Treaty Establishing the European Community (Treaty of Rome/Amsterdam).

2OECD Model Treaty, article 4.

3See Betten, R., "Income Tax Aspects of Emigration and Immigration of Individuals," Amsterdam IBFD (1998).

4See PL 104-208 which permits the Attorney General (rather than the Secretary of the Treasury) to exclude nonresident aliens from the United States whose expatriation was principally tax motivated.

5Corporations also migrate and their tax issues have not been dealt with in the OECD Model Treaty. Their issues are similar but beyond the scope of this article. The tax effect and consequences have been generally well-considered. See "Transfer of Assets Into and Out of Taxing Jurisdiction," Vol. 71(a), Cahiers de Droit Fiscal International (1986), and Tax Management International Journal, Vol. 29, No. 1, p. 43 (2000) and The Fiscal Residence of Companies, Vol. 72(a), Cahiers de Droit Fiscal International (1987).

6"Administrative convenience underlies the realization requirement." Cottage Savings Ass'n v. Comm'r, 499 U.S. 554, 555 (Supreme Court, 1991).

7This would also be true if all countries taxed on a cash basis.

8But see United States Internal Revenue Code (IRC) section 1291, permitting an annual mark-to-market accounting method for a publicly traded investment company; IRC section 475 mark-to-market accounting method for dealers in securities; IRC section 1256 mark-to-market futures and currency options; IRC section 1272 current taxation of original issue discount, sections 142.2 to 142.6 of the Canadian Income Tax Act for mark-to-market rules applicable to investments by investment dealers and other financial institutions, and the imposition of exit taxes imposed by Australia, Canada, France, and the Netherlands, discussed infra.

9For example, the United States, Japan, and Canada.

10Abreu, A., "Taxing Exits," 29 U.C. Davis L. Rev. 1087 (1996). This article contains an extensive discussion on the alleged reasons for imposing a tax on expatriation. A simpler explanation may be a desire to provide a final accounting for all deferred income or gains.

11The term "trailing tax" is used to describe a deferred tax imposed by the country of former residence on the later disposition of an asset owned, directly or indirectly, by an expatriate, or imposed when income is later received in cash or property. In the United States, a trailing tax is a source-based tax. However, it generally extends the usual taxation regime of nonresidents who are not taxed on all U.S. source gain. It also may change the source of gain, e.g., IRC sections 877, 865.

12See discussion at p. 647.

13See discussion at p. 648.

14Review of Business Taxation, A Tax System Redesigned, (Canberra, AGPS, 1999).

15In addition to a tax on the appreciation in assets, some countries tax income from prior services on a change in residence. Items of income are discussed separately in this article. Most countries with an exit tax do not accelerate or tax items of income.

16This article is a broad overview of the topic and does not deal with the detail and subtleties of any country's rules.

17See footnotes 25 and 29 arguing that the requirement of security is a violation of the Convention. But see Betten, R., Ibid. fn. 3 at p. 175 for a contrary view.

18Many nations generally tax the worldwide income of their individual residents, but only the domestic source income of nonresidents, whether citizens or aliens. Some countries tax resident individuals only on domestic source income. Exceptionally, only the United States, the Philippines, Liberia, and Eritrea tax their citizens, both resident and nonresident, on their worldwide income. With respect to such countries, the term "expatriation" as used herein, unless otherwise stated, refers to a surrender of both citizenship and residence.

19In general, Australia, Canada, France, Italy, Japan, Sweden, the United Kingdom, and the United States tax all capital gains. Belgium, Germany, and the Netherlands tax the gain on sales of shares of domestic companies in which the seller and his family owned a substantial interest. Switzerland does not tax capital gains on private assets at the federal level, except gains on real estate.

20See footnote 8 for some exceptions to this statement. Italian taxpayers may elect a "regime of managed savings" on portfolios managed by qualified intermediaries and pay a 12.5 percent substitute tax on the appreciation in value of the portfolio at the end of each year. United States taxpayers may elect to mark to market interests in a publicly traded passive foreign investment company. Australia taxes interests in foreign investment funds on a mark-to-market basis.

21Abreu, A., "Taxing Exits," 29 UC Davis Law Review 1087 (1996).

22See footnote 1.

23E.g., Canada (ITA 115(1)(a)(i) and the proposed definition of excluded right or interest in proposed section 128.1(10), para. (c)), Australia, and the Netherlands.

24Taxable Canadian property is, generally speaking, property in respect of which Canada, in the absence of contrary provisions in an income tax treaty, preserves its right to tax gains realized or deemed to be realized by nonresidents of Canada. Such property includes immovable property situated in Canada, shares in any corporation resident in Canada that is not listed on a prescribed stock exchange and a share in a nonresident corporation not listed on a prescribed stock exchange that at any time in the preceding 60-month period has more than 50 percent of the value of all its properties in taxable Canadian properties, Canadian resource properties, Canadian timber resource properties and similar properties, and any shares in a Canadian resident corporation listed on a prescribed stock exchange or in a nonresident corporation listed on a prescribed stock exchange deriving more than 50 percent of the value of its assets from taxable Canadian properties and similar properties if, during the five-year period preceding the disposition of the shares, the nonresident person and persons with whom the nonresident did not deal at arm's length owned 25 percent or more of the issued shares of any class of the corporation. Taxable Canadian properties can also include interests in partnerships and trusts where more than 50 percent (in value) of the properties of the partnership or the trust are taxable Canadian properties, Canadian resource properties, Canadian timber resource properties, or similar properties.

25An exception was also provided to an emigrating individual for property owned when the individual last became a resident of Canada if the individual was resident in Canada for no more than 60 months during the previous 10 years.

26A withholding tax would protect the government but would impose a burden on individuals who change their residence. Does a requirement of security impose an impediment on the freedom of movement?

27The categories of assets not subject to this treatment are similar to Canadian exempt property except that Australia does not look through entities in determining the category of asset and does not include pension rights or share options. There is an exception for shorter-term resident individuals similar to Canada. The Review of Business Taxation has proposed a look-through provision for nonresident entities that hold a substantial proportion of assets subject to Australian capital gains tax in the hands of nonresidents.

28Art. 20a(6)(i) ITA. By levying the exit tax at a time just prior to emigration, the Netherlands is taxing gains that, under virtually all its treaties, it could not tax if the gains did not materialize within five years after emigration. By pulling forward the time of (deemed) realization and imposing a 10-year time limit, the Netherlands is effectively overriding its treaties, replacing the five-year period with a 10-year period. In addition, under old treaties the new country of residence will not give a credit for the exit tax, whereas it would normally have given a credit for the tax paid to the Netherlands on realization within the five-year period.

29There is some doubt whether the "contingent exit tax" is consistent with the EC "freedom of movement" rules (there are no tax rules under the European Convention). One of the conditions for deferral is putting up security which, in the eyes of many, is an unacceptable hurdle to emigration.

30Art. 25(6) Tax Collection Act.

31Art. 26(2)(c) TCA.

32Art. 49(1)(b) ITA.

33Art. 20c(18) ITA.

34Art. 26(2)(b) TCA.

35The rules applicable to a German individual who moves to a tax haven are discussed at p. 650.

36Section 6 of the Foreign Tax Act -- Ausensteuergesetz (AStG). A pending bill will, if enacted, reduce the 10 percent threshold to 1 percent as of January 1, 2001, for all nonresidents of Germany.

37Taxation of Chargeable Gains Act 1992 (TCGA 1992), S.25(3)

38Other forms of income may also be subject to a trailing tax regime. For example, remuneration of an employee earned while a resident taxpayer is taxed only when the remuneration is received and the income from employee stock options is taxed when realized. Unrealized gains, such as appreciation, is not taxed and will escape future taxation. Pensions and annuities were formerly subject to tax when received, see NY Tax Law section 639; Cal. Rev. & Tax Code section 17554, but have recently been exempted by a federal statute. 4 USC section 114.

39IRC section 877.

40IRC section 864(c)(7).

41Canada follows the OECD Model, exempting capital gains of a nonresident alien, but retains in its treaties the right to tax its former residents on taxable Canadian property for 5 to 10 years. Under these treaties, Canada would tax gains on the disposition of taxable Canadian property acquired after emigration by a former Canadian resident and disposed of within the period set out in the treaty (normally 5 to 10 years) during which the former Canadian resident is not protected from full capital gains tax imposed by Canada. The provisions of article XIII(5) of the Canada-United States treaty that restrict the application of unlimited capital gains taxation to property owned by the former Canadian resident at the time of emigration are exceptions to the general treaty provisions.

42The Swedish trailing tax on financial instruments applies to financial instruments acquired after emigration.

43The Netherlands generally does not tax the capital gains realized by individuals. However, a resident of the Netherlands is subject to a 25 percent tax on the gain on the sale of a "substantial interest" in a company, whether the company is a Dutch company or a foreign company. Generally, a 5 percent or greater interest is considered substantial, and family ownership is taken into account. Nonresidents are also subject to Netherlands taxation in respect of a substantial interest in a Dutch company. Tax treaties generally restrict the taxing right of the Netherlands in respect of capital gains on such shares, to gains realized within a period of five years after emigration. Taxpayers who have emigrated to treaty countries would typically delay the realization of capital gains until this five-year period lapsed. The new contingent exit tax is designed to prevent such maneuvers, in addition to applying to companies not resident in the Netherlands. In addition, after January 1, 2001, the Netherlands will levy a contingent exit tax on annuities and pensions, discussed at p. 656.

44This occurs in about 40 percent of United Kingdom treaties; a further 30 percent do not limit the right of the United Kingdom to tax capital gains.

45The United Kingdom grants a foreign tax credit to individuals who are actually resident in the United Kingdom but does not allow the credit to individuals who are only "ordinarily resident."

46TCGA 1992 S 10 A. See Relief for tax on gains made while abroad [1999] BTR 325.

47The United Kingdom grants credit for tax paid in the country of residence in these circumstances only on assets situated in the country of residence. The United States has a similar tax for individuals who expatriate for less than three years, and grants a credit for tax paid in the country of residence without regard to the situs of the assets.

48The Review of Business Taxation recommended that the law require that security be provided for payment of this tax by the departing resident.

49Australia's pre-1985 treaties generally only have limited alienation of property articles that do not cover the field (only real estate and, in some cases, other assets of a PE) and do not refer to capital gains as such. Hence they are not applicable in many cases such as shares. There has been considerable tax planning around these treaties, e.g., FCT v. Lamesa, (1998) 36 ATR 589, but no case has yet dealt squarely with the position of capital gains generally.

50But see discussion under pensions infra.

51Voce, Mary F., "Basis of Foreign Property That Becomes Subject to United States Taxation," 4 Tax L. Rev. 341 (1996); "Anti-Domestic Taxing Jurisdictions Learning From Canada," 52 Tax Lawyer p. 275 (1999).

52Section 128.1 ITA.

53Income Tax Assessment Act (ITAA) 1997, section 136-40.

54For former residents returning within 10 years and for shares of Dutch resident companies (except if the country from which the immigrant comes has levied an exit tax).

55The Clinton Administration's Year 2000 Budget Plan provides a fresh start basis rule for individuals and companies immigrating to the United States.

56In Sweden, at least with respect to nonbusiness assets.

57A loss would not be allowed in this situation in Canada. The Netherlands and Australia would allow a capital loss in this case. ITAA 97, section 104-160(4).

58See e.g., IRC section 904.

59Statement of Practice 6/88.

60Proposed new section 126(2.21) Income Tax Act.

61E.g., United States and France. Australia does not allow a credit where it levies a trailing tax through an election. The United Kingdom's relief against the tax charges described above relates to assets situated in the prior country of residence.

62Art. 20c(7) ITA.

63Art. 26(2)(b) TCA.

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.