Recent
Developments In US Tax Treaties
In
August, 2003, the US and Swiss competent authorities
concluded an agreement regarding the Limitation on Benefits
Article of the income tax treaty and accompanying Revised
Memorandum of Understanding between the United States
and the Swiss Confederation. The agreement provides
guidance regarding application of the “derivative benefits”
provisions of the treaty, under which a Swiss company
may be entitled to treaty benefits based, in part, on
the residence of its ultimate beneficial owners. The
agreement provides that certain categories of US residents
will be taken into account for purposes of the derivative
benefits ownership tests, including individuals who
are residents of the United States and companies incorporated
in the United States whose principal class of shares
is primarily and regularly traded on a recognized stock
exchange.
In
February, 2004, the Treasury Department addressed issues
surrounding the administration and regulation of the
foreign tax credit rules whilst also forbidding transactions
designed to generate credits for foreign taxes paid
on gains that are not subject to tax in the United States.
Notice 2004-19 follows reconsideration by the authorities
of Notice 98-5. Notice 98-5 described an approach for
disallowing foreign tax credits based on a comparison
of economic profit to the claimed tax benefits and stated
that this approach would be implemented through regulations.
The Treasury decided not to issue regulations as described
in Notice 98-5. This decision was influenced by recent
court cases involving foreign tax credit transactions
that clearly produced results inconsistent with the
purpose of the foreign tax credit rules.
The courts held that the approach taken in Notice 98-5
did not support the IRS’s proposed disallowance of foreign
tax credits in those cases. Treasury and the IRS disagree
strongly with the result in those cases, but have concluded
that the approach described in Notice 98-5 is unlikely
to be an effective tool for addressing transactions
that abuse the foreign tax credit rules.
Accordingly, Notice 2004-19 withdraws Notice 98-5, and
describes the approaches Treasury and the IRS are using
to address transactions and arrangements structured
to give rise to inappropriate foreign tax credit results.
Notice 2004-20 halts a specific transaction designed
to generate credits for foreign taxes paid on gains
that are not subject to tax in the United States. The
claimed result of the transaction is a foreign tax credit
but no corresponding income and U.S. tax for the U.S.
taxpayer.
The transaction involves a purported acquisition of
stock of a foreign target corporation by a domestic
corporation, an accompanying election under section
338, and a prearranged plan to sell the target corporation’s
assets in a transaction that gives rise to foreign tax
without corresponding income for U.S. tax purposes.
Commenting on the notices, Treasury Assistant Secretary
for Tax Policy Pam Olson observed: “The foreign tax
credit serves the important purpose of eliminating potential
double taxation. It was never intended to eliminate
tax altogether.” “Transactions structured so the taxpayer
incurs foreign taxes without any corresponding U.S.
tax liability because the underlying income is not recognized
for U.S. tax purposes do not give rise to the double
taxation that is the economic basis for the foreign
tax credit. These types of transactions should not generate
foreign tax credits.”
She added: “The Treasury Department and the IRS will
continue to use all of the tools available to stem abusive
foreign tax credit transactions. In addition, we urge
Congress to pass the legislation proposed in the President’s
Budget to ensure the government has additional tools
to prevent abuse in this area.”
In
March, 2004, the United States and the Netherlands signed
a protocol amending their existing bilateral income
tax treaty. Then US Treasury Secretary, John Snow observed
that: "The new agreement that we are signing today is
just the latest chapter in a long history of close relations
between the United States and the Netherlands. It is
hard to imagine a country that is more outwardly-focused
than the Netherlands. As a result, the Netherlands has
been an international leader in bringing down barriers
to cross-border trade and investment. The first tax-related
agreement between our two countries was a shipping agreement
that entered into force in 1926. Since that time we
have entered into a series of tax treaties and protocols,
each of which has helped further improve the environment
for international trade and investment."
Going
on to draw attention to the fact that the original tax
treaty between the US and the Netherlands was one of
the first bilateral agreements to include provisions
preventing non-residents of either country from exploiting
the tax benefits of the agreement, the Treasury Secretary
outlined the ways in which the newly signed protocol
improves upon the existing agreement. These include:
- Modernising
the provisions preventing inappropriate exploitation
of the treaty to take into account economic developments
and changes in treaty practices over the past decade.
The new rules are simpler, clearer and more effective;
- Providing
for exclusive residence-country taxation of certain
intercompany dividends. This elimination of withholding
taxes removes a remaining barrier to investment between
our two countries in both directions;
- Providing
clear rules regarding the treatment of investments
made through partnerships, allowing flexibility in
business form; and
- Further
coordinating the two countries' tax rules relating
to pensions, allowing individuals to take up employment
opportunities in either country without concerns about
unintended tax effects on their retirement benefits.
After
some problems in the Senate, the new protocol came into
effect at the end of 2004.
In
July, 2004, the Treasury Department issued fresh guidance
relating to the determination of the applicable tax
treaty in cases where a foreign corporation is resident
in two foreign countries. According to the revenue ruling,
a foreign corporation will be treated as a resident
for US tax treaty purposes only of the country to which
residence has been assigned under the tax treaty between
the two foreign countries.
Accordingly, the foreign corporation will not be entitled
to claim the benefits of the tax treaty between the
United States and the country to which residence is
not assigned under the treaty between the two foreign
countries. However, the foreign corporation will be
entitled to claim the benefits of the tax treaty between
the United States and the country to which residence
is assigned, provided that it satisfies any limitation
on benefits provision and other applicable requirements
of the treaty.
In
September, 2004, a new income tax treaty between the
United States and the People's Republic of Bangladesh
was signed in Dhaka, the US government announced. The
treaty was signed by Ambassador Harry Thomas, on behalf
of the United States, and Khairruzzaman Chowdhury, Secretary
of the Internal Resources Division of the Ministry of
Finance and Chairman of the National Board of Revenue,
on behalf of Bangladesh.
According to the US Treasury, the treaty represents
another advance in its ongoing efforts to expand the
US tax treaty network by establishing new tax treaty
relationships with emerging economies. The new treaty
with Bangladesh generally follows the pattern of the
US model tax treaty and recent US tax treaties, including
recent agreements with other developing countries.
The treaty will be sent to the Senate for its advice
and consent to ratification. If the Senate acts favorably
and the treaty enters into force, it will represent
the first tax treaty in force between the two countries.
An
amended tax treaty between the United States and Barbados
was unanimously approved by the US Senate late in 2004.
The Second Protocol to the US/Barbados tax treaty, signed
by then US Treasury Secretary John Snow and Barbadian
Minister of Industry and International Business Dale
Marshall in July 2004, sought to strengthen anti-treaty
shopping provisions to ensure that the benefits of the
treaty go only to bona fide residents of each country.
In
February, 2005, the United States and New Zealand entered
into a mutual agreement to clarify the entitlement of
members of certain fiscally transparent entities to
benefits under their bilateral double taxation avoidance
convention.
The
move came after it emerged that entities may be treated
as fiscally transparent by the competent authorities
in one country, but not in the other.
In
a statement, the Internal Revenue Service explained
that: “Consistent with the approach taken in Article
4 (Residence) of the Convention, and pursuant to the
authority of Article 24 (Mutual Agreement Procedure)
of the Convention, the Competent Authorities agree that,
in applying the Convention, income paid to and through
such an entity is considered to be derived by a resident
of the Contracting State to the extent of the share
the resident has in the income.”
The
IRS went on to add that: “If a resident of the United
States is a partner or member of an entity created or
organized in the United States…and the entity is treated
for United States federal tax purposes as a partnership
or is disregarded as an entity separate from its owner
(e.g., a limited partnership; or a Limited Liability
Company, including one owned by a single member), the
resident of the United States would be afforded the
benefits of the treaty on the income that the resident
derives from New Zealand through the entity, even if
under its domestic law New Zealand does not treat the
entity as fiscally transparent.”
“Consistent
with the New Zealand/US treaty, the benefits extend
to the income received by the fiscally transparent entity
only to the extent of the resident’s share of that income.”
Also
in February, changes to the Internal Revenue Service’s
advance pricing agreement program looked to be on the
horizon. Hal
Hicks, the IRS's international associate chief counsel,
who presided over the public meeting, was said to be
“definitely interested” in a number of changes that
can be made to the program, which has been criticized
by tax practitioners for its inflexibility.
In
April, 2005, the governments of the United States and
Bulgaria announced that they plan to begin negotiations
on a bilateral income tax treaty, the first such agreement
between the two countries. The initial round of talks
was expected to take place in the autumn of 2005.
In
October, 2005. Assistant Secretary of State for Economic
and Business Affairs, E. Anthony Wayne and Swedish Ambassador,
Gunnar Lund signed a new Protocol to amend the existing
bilateral income tax treaty, concluded in 1994, between
the two countries.
The
Protocol significantly reduces tax-related barriers
to trade and investment flows between the United States
and Sweden. It also modernizes the treaty to take account
of changes in the laws and policies of both countries
since the current treaty was signed.
The
Protocol brings the tax treaty relationship with Sweden
into closer conformity with US treaty policy, with the
most important aspect of the agreement dealing with
the taxation of cross-border dividend payments.
The
Protocol is one of a few recent US tax agreements to
provide an elimination of the withholding tax on dividends
arising from certain direct investments. It also strengthens
the treaty's provisions preventing so-called treaty
shopping, which is the inappropriate use of a tax treaty
by third-country residents.
In
August 2006, the US Treasury Department announced that
the United States and the Federal Republic of Germany
had exchanged diplomatic notes correcting typographical
errors in the recently signed Protocol to the US-German
income tax treaty.
The corrected
text replaced the original text from the date on which
the Protocol was signed and will be incorporated into
the original text when the Protocol is printed in the
Treaties and Other International Acts Series (TIAS).
Deputy Treasury
Secretary, Robert M. Kimmitt, and Barbara Hendricks,
Parliamentary Secretary of State for the German Ministry
of Finance signed the new Protocol in June of that year
to amend the existing bilateral income tax treaty, concluded
in 1989, between the two countries.
The agreement
significantly reduces tax-related barriers to trade
and investment flows between the United States and Germany.
It also modernizes the treaty to take account of changes
in the laws and policies of both countries since the
current treaty was signed.
The most
important aspect of the Protocol deals with the taxation
of cross-border dividend payments. The Protocol is one
of a few recent US tax agreements to provide for the
elimination of the source-country withholding tax on
dividends arising from certain direct investments and
on dividends paid to pension funds.
The Protocol
also provides for mandatory arbitration of certain cases
that cannot be resolved by the competent authorities
within a specified period of time. This provision is
the first of its kind in a US tax treaty.
In addition,
the Protocol strengthens the treaty's provisions preventing
so-called treaty shopping, which is the inappropriate
use of a tax treaty by third-country residents. The
Protocol also modernizes the treaty relationship in
several ways and brings it into closer conformity with
current US tax treaty policy.
In
October 2006, HM Revenue and Customs and
the United States Internal Revenue Service signed an
agreement as competent authorities under the 2001 UK-US
double taxation convention.
Both the
UK and US rules deny relief for losses which have been
relieved in another territory. Both countries also deny
relief which could have been claimed in an overseas
territory but was denied in that territory under a dual
consolidated loss rule.
The interaction
of the UK and US rules for loss relief mean that it
is possible that the loss of a UK permanent establishment
cannot be offset either against the taxable income of
a US affiliate under the US Code or against the profits
of a UK affiliate under the UK rules for group relief.
Subject to
conditions set out in the agreement, the competent authorities
have agreed that the relevant taxpayer can make an election
to seek relief under one or other of the relevant relief
provisions, notwithstanding the existence of the elected
countries mirror rule.
The double
taxation convention between the UK and the US was signed
on 24 July 2001 and entered into force on 31 March 2003.
In
November 2006, the US Treasury announced that the Ambassador
to Belgium, Tom C. Korologos, and the Deputy Prime Minister
and Minister of Finance, Didier Reynders, had signed
a new Income Tax Treaty and Protocol to replace the
existing bilateral income tax treaty, concluded in 1970
(and amended in 1987) between the two countries.
The agreement
significantly reduces tax-related barriers to trade
and investment flows between the United States and Belgium.
It also modernizes the treaty to take account of changes
in the laws and policies of both countries since the
current treaty was signed.
According
to the US Treasury:
"The
most important aspect of the Treaty and Protocol deals
with the taxation of cross-border dividend payments.
The Treaty and Protocol provide for the elimination
of the source-country withholding tax on dividends arising
from certain direct investments and on dividends paid
to pension funds. The Treaty and Protocol also provide
for mandatory arbitration of certain cases that cannot
be resolved by the competent authorities within a specified
period of time."
"This
is only the second time that a US tax treaty has contained
such a provision. In addition, the Treaty and Protocol
also strengthen the Treaty's provisions preventing so-called
treaty shopping, which is the inappropriate use of a
tax treaty by third-country residents. The Treaty and
Protocol will also serve to improve the exchange of
information between the two countries, including bank
information."
With regard
to the signing, Ambassador Korologos observed that:
"This
is a win-win treaty. The signing today is a tribute
to the initiative of President Bush and Prime Minister
Verhofstadt both of whom became personally involved.
I congratulate the Finance Minister and the US Treasury
who worked out the details in record time. It is another
example of the close US-Belgian economic and political
ties."
Also
in November 2006, it emerged that the IRS had ended
uncertainty by adding Barbados to the list of countries
eligible for reduced tax rates on dividends paid by
foreign corporations under the 2003 Jobs and Growth
Tax Relief Reconciliation Act.
The
IRS confirmed that Barbados is a "satisfactory"
jurisdiction, able to enjoy the benefit of reduced withholding
rates of 15% on dividends paid to individual shareholders
from either a domestic corporation or a qualified foreign
corporation.
Although
dated October 30, 2006, the IRS Notice indicated that
with respect to Barbados, the effective date for the
accrual of this benefit was as of December 20, 2004.
The
Barbadian government said that the important reclassification
had come about as a direct result of the successful
conclusion of a Second Protocol to the 1984 Barbados-US
treaty. This Protocol was signed in July 2004 and entered
into force shortly thereafter, on December 20, 2004.
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