An Intelligence Site, A Tax Treaty, and a Closing Agreement

I am looking at a case involving IRS closing agreements and the U.S. Pine Gap facility in Australia.

It gives us a chance to talk about closing agreements, an uncommon topic.

It also gives a chance to talk about Pine Gap, which is a U.S. Intelligence-gathering facility in the Northern Territory of Australia. It started decades ago as a monitoring station for Soviet ballistic testing, and with the years it has acquired several new roles. Think of drone attacks in Pakistan, and you have an idea of what happens at Pine Gap.

FIRST ACT: we have a spooky intelligence site.

Let’s move on to a treaty.

Under general tax rules, Australia would be able to tax American workers at Pine Gap. They are - after all – working in Australia. This was not the desired result, so a treaty in the 1960s exempted American workers at Pine Gap from Australian tax. There was a requisite, though: to be exempt, the wages had to be taxed by the U.S.

Got it. There was a one-bite-at-the-apple rule. Australia would back off if the U.S. got the first bite.

But U.S. tax law also includes a foreign earned income exclusion, whereby an American worker overseas could exempt some (or all) of his/her wages from tax, if certain requirements were met.  

How could Australia be sure that the wages were being taxed by the U.S.? Mind you, the alternative was for Australia to apply the default rule, meaning that both Australia and the U.S. would tax the wages. Sure, the worker could claim a foreign tax credit on his/her U.S. tax return, but the tax consequences of working at Pine Gap would have escalated unappealingly.  

The treaty was revised in the 1980s to allow American workers at Pine Gap to relinquish their foreign earned income exclusion by entering into a closing agreement with the IRS.

SECOND ACT: we have an income tax treaty.

Cory was a U.S. Air Force veteran and engineer. In 2009 he received a job offer from Raytheon to work at Pine Gap. He was informed that Australia would not tax him, but to get there he would have to sign a closing agreement with the IRS. The agreement was straightforward: he would not claim the foreign earned income exclusion.

Mind you, he did not have to sign a closing agreement. Australia would then tax him, and his U.S. return would get a little more complicated.

Cory signed the agreement.

The point behind a closing agreement is finality. Both sides agree, settle, and move on. Excepting fraud or malfeasance, there are no “do-overs.” That is - as you would expect - the reason that one requests one. An example is the wrap-up of a taxable estate. The tax practitioner does not want that estate resurrecting later, causing headaches when all parties considered the matter closed.

Cory wanted out of his closing agreement.

Problem.

Closing agreements arise under a Code section. This means that the Court would be reviewing statutory law (that is, the Code as statute on the matter) and not just the general principles of contract law (offer, acceptance, and all that).

That Code section doesn’t let one off the hook without showing malfeasance or misrepresentation of a material fact.

Cory argued that he met that standard. Somebody somewhere at the IRS did not have appropriate signature authority; the IRS committed malfeasance by sharing information with his employer, Raytheon; he was induced to sign by false representations.

I think Cory was grasping at straws.

The Court apparently thought the same way. The Court decided Cory was stuck with the agreement. He signed it; he owned it.

THIRD ACT: we have a closing agreement.

This is a specialized case pulling-in several different areas of the Code.

I get Cory’s point. He wanted exemption both from Australian tax AND some/all U.S. tax.

Me too, Cory. Me too.

Our case this time was Cory H Smith v Commissioner, 159 T.C. No. 3 (Aug 25,2022).