Smith v. Comm'r of Internal Revenue

Decision Date25 August 2022
Docket Number5191-20
PartiesCORY H. SMITH, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
CourtU.S. Tax Court

P entered into a closing agreement with R under I.R.C. § 7121 waiving his right to elect to exclude foreign earned income under I.R.C. § 911(a) for the taxable years 2016-18. After filing his 2016 and 2017 returns without making the election, P filed amended returns making the election for those years, and R issued refunds in due course. P then made the election on his 2018 return.

Consistent with the closing agreement, R issued a notice of deficiency to P for the taxable years 2016-18 disallowing the elections under I.R.C. § 911(a). P petitioned this Court for redetermination of the deficiencies.

On competing Motions for Partial Summary Judgment, the parties dispute the validity of P's closing agreement. R asks this Court to hold that the agreement is valid under I.R.C § 7121 and must be enforced. P, on the other hand claims the agreement is invalid because the IRS official who executed it - the Director, Treaty Administration, in the IRS Large Business and International Division - did not have the authority to do so. In the alternative, P argues the closing agreement should be set aside under I.R.C. § 7121(b) because R committed malfeasance by disclosing confidential taxpayer information under I.R.C. § 6103 and because R misrepresented material facts in the terms of the closing agreement.

Held The closing agreement is valid and enforceable.

Held, further, the Director, Treaty Administration, had authority to execute the closing agreement on behalf of the Secretary.

Held, further, the closing agreement may not be set aside under I.R.C. § 7121(b) because P has failed to show malfeasance or misrepresentation of fact.

Held, further, R is entitled to partial summary judgment.

Tiffany Michelle Hunt, for petitioner.

Hannah Kate Comfort, for respondent.

OPINION

TORO, JUDGE.

Petitioner, Cory H. Smith, entered into a closing agreement with the Commissioner pursuant to section 7121.[1] There, Mr. Smith agreed to "irrevocably waive[ ] and forego[ ] any right that he . . . may have to make any election under Code section 911(a) with respect to income paid or provided to [him] as consideration for services performed for [his] employer at [the Joint Defense Facility at Pine Gap] in Australia" for the taxable years 2016, 2017, and 2018. But, despite this undertaking and even though closing agreements are "final and conclusive" as to the matters agreed upon, I.R.C. § 7121(b), in an effort to avoid paying tax on this income either in the United States or in Australia, Mr. Smith filed federal income tax returns claiming the very benefits he had "irrevocably" waived and forgone. Seeking to hold Mr. Smith to the terms of the closing agreement, the Commissioner issued a notice of deficiency.

Mr. Smith challenges the notice of deficiency and asks us to ignore the closing agreement on two separate grounds. First, he claims that the agreement is invalid because the Director, Treaty Administration, at the IRS Large Business and International Division (LB&I), who signed it on behalf of the Commissioner, lacked the authority to do so. Second, he claims that, even if properly signed, the agreement should be set aside as contemplated by section 7121(b) because of malfeasance or misrepresentation of material fact by the Commissioner. The Commissioner resists Mr. Smith's claims and asks that we enforce the closing agreement. Both parties have moved for partial summary judgment.

After addressing some issues of first impression raised by Mr. Smith's claims, we conclude that his arguments lack merit and that the closing agreement must be enforced. Accordingly, we will grant the Commissioner's Motion for Partial Summary Judgment and deny Mr. Smith's competing Motion.

Background

To provide context for the issues before us, we begin with a brief introduction to the location where the controversy arose and an overview of the tax rules governing U.S citizens working at that location.

I. Pine Gap Facility

Seeking to expand their military intelligence capabilities during the Cold War, in 1966, the United States and Australia jointly established a surveillance facility located "where the scrubs and plains are wide," Henry Lawson, "Out Back," in In the Days When the World Was Wide and Other Verses 47 (1896) - that is, in the middle of the Australian Outback. The Joint Defense Facility at Pine Gap, Alice Springs, Northern Territory, Australia, as the facility is known today, is commonly referred to as "Pine Gap," and we will follow that convention.

Pine Gap's technical objectives are varied and complex and have evolved over time. For purposes of this Opinion, it suffices to note that the activities carried on there include the control of geosynchronous satellites to observe, collect, and process electronic signals data. See generally Anna Hood & Monique Cormier, Can Australia Join the Nuclear Ban Treaty Without Undermining ANZUS?, 44 Melb. U. L. Rev. 132, 138-41 (2020) (describing Pine Gap and collecting resources).

Staffing Pine Gap requires that a substantial number of U.S. citizens move to Australia. The facility was maintained by approximately 400 personnel when it was first established, a number that was expected to increase over time. See Evidence to Joint Standing Committee on Treaties, Parliament of Australia, Canberra, Aug. 9, 1999, at 1 (Desmond John Ball).

II. U.S. Taxation of Pine Gap Employees
A. General Principles

Complex issues of international taxation arise whenever a U.S. citizen lives and works abroad.[2] Unlike most countries, the United States taxes the worldwide income of its nonresident citizens. See, e.g., Cook v. Tait, 265 U.S. 47, 56 (1924); Huff v. Commissioner, 135 T.C. 222, 230 (2010). And this policy creates the potential for double taxation -  that is, the taxation of the same income by both the United States and another country. See AptarGroup Inc. v. Commissioner, No. 7218-20, 158 T.C., slip op. at 3 (Mar. 16, 2022).

Domestic law provides some relief from double taxation for U.S. citizens working abroad, for example by providing a credit for taxes paid abroad. See I.R.C. § 901. Of particular relevance to this case is another domestic law provision, section 911(a). It permits qualified individuals  to elect to exclude foreign earned income  from their gross incomes and treats that income as exempt from U.S. federal income taxation.[3]

In addition to providing relief through domestic law, the United States often addresses potential issues of double taxation through agreements with other countries. For example, acknowledging that issues of double taxation arise in the ordinary course of exchanges between the two countries, the governments of the United States and Australia entered into a treaty governing the general avoidance of double taxation a little more than a decade before Pine Gap was established. See Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Austl.-U.S., May 14, 1953, 4 U.S.T. 2274 (1953 Treaty).

B. Pine Gap Agreements

Despite the existence of the 1953 Treaty, concerns about double taxation received attention from the U.S. and Australian negotiators involved in establishing Pine Gap. The United States and Australia entered into two agreements governing the general operation of Pine Gap (Pine Gap Agreements), one in 1966 and another in 1969.[4]

As relevant to the issue of double taxation, the Pine Gap Agreements generally provide that the income U.S. citizens earn at Pine Gap will be deemed not earned in Australia, so long as it is actually taxed by the United States. Specifically, Article 9(1) of Pine Gap I provides that

[i]ncome derived wholly and exclusively from performance in Australia of any contract with the United States Government in connection with the [Pine Gap facility or station] by any person . . ., who is in . . . Australia solely for the purpose of such performance, shall be deemed not to have been derived in Australia, provided that it is not exempt, and is brought to tax, under the taxation laws of the United States.

17 U.S.T. at 2238. Pine Gap II contains a substantially identical provision. See Pine Gap II, art. X(1), 20 U.S.T. at 3100.[5] The undertakings reflected in the Pine Gap Agreements were incorporated into Australian domestic law.[6]

C. 1982 Treaty and Competent Authority Process

In 1982, the United States and Australia entered into a new income tax treaty that superseded the 1953 Treaty. Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Austl.-U.S., Aug. 6, 1982, 35 U.S.T. 1999 (1982 Treaty).[7]

As relevant here, Article 4 of the 1982 Treaty provides rules for determining an individual's residency, id. at 2008-11; see also 2001 Protocol, art. 3, T.I.A.S. No. 13,164, and Article 15 sets out rules for the taxation of employees,[8] 35 U.S.T at 2037-38. Article 15(1) states that, in general,

salaries, wages and other similar remuneration derived by an individual who is a resident of one of the Contracting States in respect of an employment . . . shall be taxable only in that State unless the employment is exercised . . . in the other Contracting State. If the employment is so exercised . . . such remuneration as is derived from that exercise . . . may be taxed in that other State.

35 U.S.T. at 2037. Article 15(2) limits the reach of Article 15(1) in certain circumstances that are not relevant here. In turn, Article 1(3) provides that, with exceptions that are not relevant here, "a Contracting State . . . may tax its citizens . . . as if this Convention had not...

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