Canadian Beef
In 2013 Eritrean consular officials were found to be harassing Eritreans living in Toronto. Those officials were demanding that Eritrean expats pay 2% of their wages every year to Eritrea as a “diaspora tax.”
The Canadian government found that the officials were using “threats, harassment and intimidation” and warned them to stop. The warning proved ineffective so the Canadian government expelled the Eritrean Toronto consul-general from Canada.
You might think that Canada’s beef with Eritrea was about taxing its citizens who were living abroad. That wasn’t exactly the problem. Rather, Canada listed two other objections. First, Canada saw such activities as inconsistent with the Vienna Convention on consular relations. Second, extortion as a tactic of tax collection is illegal in Canada.
Canada did not object to the principle of Eritrea taxing its expat citizens living in Canada. Which is surprising because very few countries tax their citizens abroad. In fact, Eritrea is one of only two countries that taxes on the basis of citizenship, not on the basis of residency.
So why was Canada so careful not to object to citizenship-based taxation? Canada taxes on the basis of residency in Canada. If a Canadian citizen moves abroad and has no Canadian income, no Canadian tax return needs to be filed.
Canada could have said, “These people live in Canada, not in Eritrea. We’ll tax them as almost every country does. Take a hike, Eritrea.” Why didn’t they take that obvious path? They would be insisting that Eritrea act as they do.
The elephant in the room
Canada’s closest neighbor and largest trading partner is the US. As many know, the two countries also share the longest undefended border in the world (8,800 km).
Despite that long border, there’s a big mismatch in the populations of the two countries. Canada’s population is roughly equal to that of California, and about 11% the population of the 🇺🇸.
The size mismatch, the intertwined economies, and proximity make US-Canada relations of crucial importance to Canada.
Pierre Trudeau, the wittiest of Canadian Prime Ministers (and father of the current PM), famously summarized the nature of the Canada-US relationship. In a speech to an audience of American press correspondents in 1969 he said:
“Living next to you is in some ways like sleeping with an elephant. No matter how friendly and even-tempered is the beast, if I can call it that, one is affected by every twitch and grunt.”
Had Canada objected to Eritrea’s citizenship-based tax collection, the US would’ve definitely grunted. Why? Because it is the other country that applies citizenship-based taxation.
Had Canada based its complaint to Eritrea on the inappropriateness of citizenship-based taxation, it would’ve been logically compelled to complain about the 🇺🇸 tax regime.
Had that happened the US would have used its many levers of power to convince Canada of the folly of its ways. As a result, the tax treaty between Canada and the US reflects the reality that the 🇺🇸 tax system is based on citizenship, not residency.
If you’re a US citizen who lives in the US, you deal with one tax system. If you live in another country, you deal with two, that country’s and the US’ system. How those two systems shake hands is usually determined by a tax treaty between that country and the 🇺🇸.
Some implications
As an American expat, you are governed by 🇺🇸 tax law everywhere and anywhere. In the eyes of the 🇺🇸 government, it doesn’t matter if you have spent decades abroad. Or if you have no income from 🇺🇸 sources. Or even if you’ve never been to the 🇺🇸, which is possible if you have American parents.
If you have very little income you may not have to file a 🇺🇸 tax return if your income is less than $10-15K from all sources (depending on age and filing status). However, that threshold is so low that almost all working adults would exceed it. You’ll probably have to file annually.
You may get credit for taxes you paid to your country of residence. In fact, many expats who file do not owe the 🇺🇸 any money because of such tax credits. It depends on the tax treaty between the 🇺🇸 and your home country. However, your tax preparation will be much more expensive than if you live in the 🇺🇸.
Owning some common types of investments will force you to file onerous extra tax forms to the IRS. To avoid very expensive tax preparation costs, you will have to avoid many popular types of non-🇺🇸 investments like index funds or ETFs.
You might think that you could put your money into 🇺🇸 investments. Alas, you probably won’t be able to open an investment account with a 🇺🇸 financial institution. Why? Because you won’t have a 🇺🇸 home address, which is required. That means it’ll be more difficult to buy and sell on 🇺🇸 markets even though you’re a 🇺🇸 citizen.
Do you have foreign (non-🇺🇸) financial accounts with more than $10,000 in total at any time during the year? If so, you must file a detailed report with the 🇺🇸 Treasury about the details of these accounts (numbers, institutions, addresses, maximum amount during the year). Every year.
There are additional tax and finance complexities for 🇺🇸 expats, but you get the idea.
Exceptional suspicion
Much of the above information is difficult to believe. To the best of my knowledge it’s true. I’ll go into more of the details in later newsletters.
But why does the US behave in this heavy-handed fashion? I have an opinion.
American attitudes towards its citizens who live abroad reflect a belief in the exceptional nature of the 🇺🇸. Decades of economic and military power have spiced that exceptionalist belief with an arrogance that rarely admits to error or weakness.
American citizens living abroad are viewed with suspicion, in part because it's difficult to understand why they don’t return. It couldn’t because they’re happier elsewhere. There must be a more sinister reason.
One of the primary justifications for punitive expat tax rules is that Americans who chose to live abroad do so to evade taxes. It’s not a big exceptionalist leap to believe that other countries do a poorer job of tax collection than the US.
To ensure that 🇺🇸 expats don’t somehow evade paying taxes, banking and tax rules are then designed to reveal and regulate expats’ financial activities. Americans living within US boundaries would not tolerate the rules and requirements that expat citizens face.