US Taxation and Foreign Expropriation Without US Representation?

One justification sometimes advanced for the imposition of US income taxation on US citizens living abroad is that US citizenship provides certain legal protections for property rights, even for those US citizens who reside abroad.

For example, under the investor protection chapters of US free-trade agreements (FTAs)—such as the Dominican Republic–Central America Free Trade Agreement (DR-CAFTA) and the US-Colombia Trade Promotion Agreement—US citizens are generally entitled, through being a claimant in an arbitration panel proceeding, to obtain damages caused by direct or indirect expropriations by the respondent governmental counterparties.

However, US FTAs have denial of benefits (DOB) clauses. In some cases, a DOB clause can prevent US citizens with dual citizenship from availing themselves of FTA arbitration. The non-applicability or applicability of the DOB clauses to US citizens who are dual citizens of another country was the subject of arbitration panel awards in Aven v. Costa Rica, decided in 2018, and Carrizosa v. Colombia, decided in 2021.

Aven v. Costa Rica

Aven involved a claim for expropriation against Costa Rica under the DR-CAFTA agreement by a dual Italian-US citizen. DR-CAFTA generally permits US citizens to claim damages against Latin American government parties due to expropriations, but a DOB clause provides that a US citizen who is a dual citizen shall be deemed to be exclusively a citizen of the country of their “dominant and effective” nationality.

Costa Rica contended that, based on such factors as the claimant’s mentioning of his Italian citizenship but not US citizenship on various documents relating to his Costa Rica investment, the individual’s dominant and effective nationality was Italy, thereby preventing the US citizen from invoking jurisdiction under DR-CAFTA. Favorably to the dual US citizen claimant, the panel concluded that the dominant and effective nationality test could not be applied to potentially disqualify a US citizen claimant whose dual nationality was that of a third country (Italy in Aven), rather than that of the allegedly expropriating country (Costa Rica in Aven). The arbitration panel reasoned that the purpose of the DOB clause was to prevent an FTA arbitration panel from entertaining claims against an expropriating government by citizens of its own country, not citizens of a third country.

This holding of Aven may be viewed as an alternative holding because the panel also held that the claimant’s US nationality was dominant and effective over his Italian nationality and that Costa Rica had not improperly expropriated the claimant’s property. But commentators cite Aven for the proposition that US citizens living abroad, provided they are not dual nationals of the expropriating country itself, can indeed be entitled to damages for expropriations under DR-CAFTA and comparably drafted US FTAs.

Carrizosa v. Colombia

Carrizosa featured claimants against Colombia who were dual Colombian-US citizens. The DOB clause in the US-Colombia FTA, like the DOB clause in the DR-CAFTA construed in Aven, provides that a US citizen who is a dual national shall be deemed to be exclusively a national of the country of their dominant and effective nationality.

The arbitration panel determined that because Colombia, the allegedly offending country, was itself the country of dual citizenship of the claimant (unlike Italy in Aven), then it was necessary in Carrizosa to determine the dominant and effective nationality of the claimant US citizens. No doubt to the claimants’ chagrin, the US State Department, indirectly funded by the claimants’ US income tax dollars, filed a discretionary submission with the Carrizosa arbitration panel advocating legal positions adverse to the US citizen claimants.

Those positions were ultimately conceded by the claimants and applied by the panel to defeat the claimants. Specifically, the US contended that the claimants, not Colombia, had the burden of proof to establish continued dominant and effective US nationality on each of the three dates of the challenged foreign governmental action, the submission of a claim to arbitration, and the resolution of the claim.

The panel noted that the claimants were born in Colombia (though to a US citizen mother, accounting for their dual citizenship) and grew up in Colombia. After being educated or working in the US or elsewhere abroad, they returned to Colombia. There, they managed their Colombian businesses for several years until the loss related to their Colombian investment, and then the FTA arbitration claim. Accordingly, the Carrizosa panel, applying these objective criteria, determined that the US citizen claimants’ dominant and effective nationality was Colombian and not US. The panel dismissed their FTA claim for lack of jurisdiction.

The claimants in Carrizosa made much of the fact that they paid US income taxes on a worldwide basis and viewed this as an indication of dominant and effective US nationality. The Colombian government disagreed, viewing such worldwide taxation as merely an incidental aspect of the US tax code, a position apparently accepted by the panel.

Conclusion

Defenders of US income taxation of US citizens residing abroad may note that the US negotiates FTAs that can provide those US citizens the same rights to compensation from expropriating foreign countries as the rights of US citizens living in the US. Under Aven, those US citizens may have FTA claims for compensation, even if they are held to have “dominant and effective” dual nationality in a foreign country other than the expropriating foreign country.

However, under Carrizosa, where a US citizen also holds dual citizenship in an expropriating FTA foreign country, and such expatriating country citizenship may be viewed as their dominant and effective nationality, the DOB clause may defeat the FTA expatriation claim. This is true under Carrizosa, even if the individual continues to pay US income taxes. When facing expropriation by that foreign country, such an investor may understandably feel they suffer from US taxation without, or even with adverse, US FTA representation.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Alan S. Lederman is a shareholder at Gunster, Yoakley & Stewart, P.A. in Fort Lauderdale, Fla.