Can Foreign Governments Obtain Taxpayer Information From State and Local Revenue Agencies?

By Jonathan Prokup

During a course that I taught about tax treaties at last week’s TEI Houston Tax School, one audience member asked whether the exchange-of-information provisions of U.S. tax treaties apply not only to the federal government but also to state and local governments.   I had to confess that I did not know the answer of the top of my head.  However, I took a quick look at the question later in the week.

By way of background, in each income tax treaty with foreign jurisdictions, the United States negotiates an “exchange of information and administrative assistance” provision.  This provision generally obligates the governments to share information with one another “as may be relevant for carrying out the provisions of this Convention or of the domestic laws of the Contracting States concerning taxes of every kind imposed by a Contracting State….”  United States Model Income Tax Convention (“Model Treaty”), art. 26, ¶ 1 (Nov. 15, 2006).

Thus, for example, if the IRS needs information about a U.S. company’s foreign operations to examine the correctness of the company’s subpart F inclusions, the IRS could seek that information from the governments of a treaty jurisdiction in which the foreign operations are located.  Conversely, if a foreign government requires information about a taxpayer’s U.S. operations, the exchange of information provision permits the IRS to provide such information to the foreign government.  This exchange of information is sanctioned domestically by Code section 6103(k)(4) (permitting disclosure of taxpayer information pursuant to tax treaties).

But do “taxes of every kind imposed by a Contracting State” include taxes imposed by state and local governments as well?  Treasury’s Technical Explanation of the Model Treaty states that Article 26 “applies with respect to all taxes imposed at the national level.” (emphasis added)  Furthermore, this statement immediately follows Treasury’s explanation that Article 24, relating to non-discrimination between residents of each treaty jurisdiction, “applies with respect to all taxes, including those imposed by state and local governments.”  The contrast between the two sentences tends to reinforce that Treasury chose its words carefully and that the exchange of information provisions do not apply to state or local governments.

Nevertheless, if a foreign government requests that the IRS provide certain taxpayer information, Article 26 requires the IRS to “use its information gathering measures to obtain the requested information, even though that other State may not need such information for its own purposes.”  Model Treaty, art. 26, ¶ 4.  At least one U.S. District Court has concluded that the IRS may use its summons power under Code section 7602 to obtain information from state departments of revenue.  Martini v. United States, 97 AFTR2d  2006-2592 (D. Nev. 2006).  Reasoning that the IRS’ summons power is analogous to the power of a federal grand jury to obtain information from state governments, the Martini court held that “[section] 7602 is not constitutionally infirm when used to recover records held by a state department of taxation.”

Thus, the reasoning of Martini, combined with the plain language of Article 26 of the Model Treaty, would seem to suggest that foreign governments could obtain taxpayer information from state and local governments by using the IRS as an intermediary.  Bear in mind, however, that the ultimate conclusion will also depend on the language in the treaty that applies to a given situation.

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