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 followed 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 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 withdrew 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 halted 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 involved 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 represented
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 planned 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 reduced tax-related barriers
to trade and investment flows between the United States
and Sweden. It also modernized the treaty to take account
of changes in the laws and policies of both countries
since the current treaty was signed.
The
Protocol brought 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 was 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 reduced 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 dealt with the
taxation of cross-border dividend payments. As before,
the Protocol was 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 strengthened 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 modernized 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 reduced tax-related barriers
to trade and investment flows between the United States
and Belgium. It also modernized 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.
In
February 2007, it emerged that the talks between Bulgaria
and the United States had borne fruit, with Deputy Secretary
of the US Treasury, Robert M. Kimmitt and Bulgarian
Finance Minister Plamen Orescharski signing an income
tax treaty and protocol that month.
The
treaty aims to strengthen economic relations between
the United States and Bulgaria by generally reducing
the rates of taxation on cross-border dividend, interest
and royalty payments, and by providing for better exchange
of information between the two countries, including
bank information.
Bulgaria
on 1st January acceded to the European Union, a move
which has meant changes in many aspects of its relations
with third countries, including the United States.
The
US Treasury announced that on June 7, 2007 the United
States delivered to the Government of Sweden a notice
of termination of the tax treaty between the two countries
with respect to estates, inheritances, and gifts.
In
accordance with the provisions of the treaty, the notice
of termination provided that the treaty would cease
to have effect as of 1st January, 2008. At the time
the treaty was signed, Sweden maintained a tax on inheritances
and gifts. Sweden has since abolished this tax, and
as such, the treaty is no longer needed to prevent double
taxation with respect to taxes on estates, inheritances
and gifts.
In
September 2007, US Treasury Secretary Henry Paulson
and Canadian Finance Minister Jim Flaherty met in Quebec
to sign a protocol that would improve the US-Canada
income tax treaty for cross-border financing.
The
amendment was designed to eliminate the 10% withholding
tax on interest payments paid by borrowers in one country
to lenders in the other in arm's length arrangements.
The new protocol also phases out withholding tax on
interest payments in non-arm's-length arrangements,
or company subsidiaries, over three years.
Economists
believe that removing withholding tax on interest will
increase capital investment in Canada by as much as
C$18 billion, (US$17.9 billion).
It
is estimated by the Canadian government that the measure
would cost C$250 million in the two fiscal years following
the change.
In
October 2007, the Treasury Department announced that
Deputy Secretary Robert M. Kimmitt and Icelandic Finance
Minister Árni M. Mathiesen had signed a new income
tax treaty between the United States and Iceland.
In
a ceremony held at the Treasury Department, the two
officials signed a new tax treaty that brought the existing
agreement into closer conformity with current US tax
treaty policy.
For
example, the new treaty contains a comprehensive limitation
on benefits provision that is consistent with many recently
concluded US tax treaties.
The
agreement also maintains the existing treaty's withholding
tax exemption on cross-border interest payments, as
well as the existing treaty's reductions in withholding
taxes on cross-border dividend payments.
The
taxes to which the Convention applies in Iceland are
the income taxes to the state and the income tax to
the municipalities.
In
the United States, the taxes to which the Convention
applies are the Federal income taxes imposed by the
Internal Revenue Code, and the Federal excise taxes
imposed with respect to private foundations.
The
Convention also applies to any identical or substantially
similar taxes that are imposed after the date of signature
of the Convention in addition to, or in place of, the
existing taxes. The competent authorities of the Contracting
States shall notify each other of any significant changes
that have been made in their respective taxation or
other laws that significantly affect their obligations
under this Convention.
In
December 2007, it was announced that Canada had completed
the legislative steps required to give effect to the
fifth Protocol to the Canada-United States Income Tax
Convention.
The
Protocol was set to come into effect once it had been
ratified by the United States and the two countries
formally notified each other that their procedures are
complete.
In
January 2008, the Treasury revealed that three protocols
and one new tax treaty and protocol had entered into
force.
Protocols
amending existing tax treaties with Germany, Denmark
and Finland, along with a new income tax treaty and
protocol with Belgium entered into force December 28,
2007, following exchanges in Washington, DC of required
notifications and instruments of ratification.
All
generally apply to tax years beginning on or after January
1, 2008. Certain provisions of the protocols with both
Germany and Finland are retroactively effective, however,
on or after January 1, 2007.
In
April 2008, Tonio Fenech, Malta's Minister of Finance,
Economy and Investment initialled the text of a Treaty
for the Avoidance of Double Taxation between Malta and
the United States.
The
Malta/US DTA was signed in the presence of US Ambassador
Molly Bordonaro, on March 27th, 2008. Michael Mundaca
headed the US Treasury delegation in Malta, and initialled
the document on behalf of the United States.
The
signing of the tax agreement was the culmination of
a process which commenced with a meeting between Prime
Minister Lawrence Gonzi and President George Bush in
2005. It ends formal negotiations, and prepares the
treaty text agreed between the two countries for ratification
through a United States Senate for Foreign Relations
review.
The
treaty text was to be published on ratification as agreed
between both governments.
In 2009,
the US agreed protocols with a number of countries to
include the sharing of information on potential tax
evaders.
At
the G-20 Leaders' Summit in April, the US had strongly
supported efforts to ensure that all countries adhere
to international standards for exchange of tax information.
In the 2010 Budget, the US Administration delivered
a detailed reform agenda to reduce the amount of taxes
lost through unintended loopholes and the illegal use
of hidden accounts by well-off individuals.
Countries
signing such protocols with the US included Switzerland,
New Zealand and Luxembourg.
Many
countries also rushed to sign Tax Information Exchange
Agreements (TIEAs) with the US in 2009. Among them were
Gibraltar, Liechtenstein, Brazil, the Isle of Man, Aruba
and the Bahamas. TIEAs were signed in 2010 by Panama,
Chile and Hungary.
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