What is a “Foreign Country” for Income Tax Purposes?

Our tax laws allow individual taxpayers to exclude income earned in certain foreign countries.  This begs the question as to whether a taxpayer working outside of the U.S. is in a foreign country if he is working in an area that is not governed by the equivalent of what we think of as a government.  The court addresses this in Arnett v. Commissioner, 06-1934 (7th Cir. 2007) in the context of whether Antarctica is a “foreign country” for tax purposes.

Facts & Procedural History

Arnett is a U.S. citizen.  He was stationed in and worked in Antarctica.  He was employed by a U.S.-based employer. 

Arnett filed his U.S. tax return and claimed a Section 911 foreign earned income exclusion for amounts that he earned while stationed in Antarctica.

The IRS assessed a deficiency for the excluded income, arguing that Antarctica is not a “foreign country”as defined in the regulations.  

What is a Foreign Country?

The regulation defines the phrase “foreign country” to mean a territory under the sovereignty of a foreign nation. ?But how do you determine if a territory is under the sovereignty of a foreign nation?  Who makes this determination?  

The U.S. Tax Court viewed this from the vantage point of the U.S.  It looked to U.S. law.  The United States does not recognize Antarctica to be the sovereign territory of any foreign government.  To the U.S. government, Antarctica is just ungoverned land.  Thus, the U.S. Tax Court concluded that Antarctica is not a “foreign county.”  

But What is a Foreign Country, Really?

On appeal, the Seventh Circuit Court of Appeal determined that the term “foreign country” was ambiguous in in Section 911.  Thus, it used statutory construction principles to discern the definition.  

The appeals court considered the regulation and whether its definition was reasonable.  In doing so, the court considered the purpose for Section 911.  The purpose is to allow U.S. companies to be able to deploy Americans overseas on a more competitive basis.  This is required given the higher taxes Americans pay while working overseas.  

This issue does not come up if an American worker is employed in a part of the country that does not collect or impose tax–such as Antarctica.  The appeals court sided with the U.S. Tax Court, holding that Antarctica is not a “foreign country.”