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Tax Treaties: United States And Sweden



Tax Treaties: United States And Sweden

Quick Summary.  Sweden taxes resident legal entities on their worldwide income, while non-resident entities are subject to tax derived from a Swedish source.  Sweden taxes non-residents based, in part upon whether they work for an employer with a permanent establishment in Sweden and based upon days of physical presence in Sweden.  Sweden implemented a pay-as-you-earn (PAYE) system in 2019 for individuals.

Sweden implemented new limitation rules and hybrid mismatch rules as of 2019 and 2020, respectively.  The hybrid mismatch rules, implemented in light of the EU ATAD directive and the BEPS project, provide that certain expenses that are related to hybrids due to a Permanent Establishment are not deductible.

The Swedish Tax Agency has historically emphasized enforcement of the arm’s-length rule and carried interest treatment with respect to owners of private equity companies.

Treaty

Currency.  Swedish Krona (SEK)

Common Legal Entities.  Private/public limited liability company (AB), partnership (KB and HB), sole proprietorship, and branches.

Tax Authorities.  Swedish Tax Agency

Tax Treaties.  Party to more than 100 income tax treaties.  Ratified the OECD MLI.

Corporate Income Tax Rate.  21.4%

Individual Tax Rate.  0% / 20%

Corporate Capital Gains Tax Rate.  0% / 21.4%

Individual Capital Gains Tax Rate.  30%

Residence.  Based upon concept of regularly residing in Sweden.  One who previously resided in Sweden is generally treated as a resident after departure if essential ties are retained.

Withholding Tax.

            Dividends.  30 % (company resident) / 0% (individual resident) / 30% (company nonresident / 0% (individual nonresident)

            Interest.  0%

            Royalties.  0%

Transfer Pricing.  OECD transfer pricing guidelines.

CFC Rules.  Swedish persons with an interest in certain foreign legal entities are subject to immediate taxation on certain income, subject to exemptions.

Hybrid Treatment.  Interest deduction limitation rules apply.  Anti-hybrid rules based upon EU Anti-Tax Avoidance Directive.

Inheritance/estate tax. No.


The principal purposes of the income tax treaty between the United States and Sweden are to reduce or eliminate double taxation of income earned by residents of either country from sources within the other country, and to prevent avoidance or evasion of the income taxes of the two countries.

As in other U.S. tax treaties these objectives are principally achieved by each country agreeing to limit, in certain specified situations, its right to tax income derived from its territory by residents of the other. For example, the treaty contains the standard treaty provisions that neither country will tax business income derived by residents of the other unless the business activities in the taxing country are substantial enough to constitute a permanent establishment or fixed base and the income is attributable to the permanent establishment or fixed base. Similarly, the treaty contains the standard “commercial visitor” exemptions under which residents of one country performing personal services in the other will not be required to pay tax in the other unless their contact with the other exceeds specified minimums. The treaty provides that dividends and certain capital gains derived by a resident of either country from sources within the other country generally may be taxed by both countries. Generally, however, dividends received by a resident of one country from sources within the other country are to be taxed by the source country on a restricted basis. The treaty also provides that, as a general rule, the source country may not tax interest and royalties received by a resident of the other treaty country.

In situations where the country of source retains the right under the treaty to tax income derived by residents of the other country, the treaty generally provides for the relief of the potential double taxation by requiring the country of residence either to grant a credit against its tax for the taxes paid to the second country or to exempt that income.

The treaty also contains the standard provision (the “saving clause”) contained in U.S. tax treaties that each country retains the right to tax its citizens and residents as if the treaty had not come into effect. In addition, the treaty contains the standard provision that the treaty will not be applied to deny any taxpayer any benefits he would be entitled to under the domestic law of the country or under any other agreement between the two countries; that is, the treaty will only be applied to the benefit of taxpayers.

The treaty differs in certain respects from other U.S. income tax treaties and from the U.S. model treaty.  A summary of the provisions of the treaty, including some of these differences, follows:

The U.S. excise tax on insurance premiums paid to a foreign insurer generally is covered; that is, the excise tax is treated as a tax that may be eliminated by treaty.  Similar coverage appears in other tax treaties (such as Germany, the Netherlands, and France), and under the U.S. model treaty.

The definition of the term “United States” as contained in the proposed treaty generally conforms to the definition provided in the U.S. model. In both treaties the term generally is limited to the United States of America, thus excluding from the definition U.S. possessions and territories. The treaty, however, makes it clear that the United States includes its territorial sea and the seabed and subsoil of the adjacent area over which the United States may exercise rights in accordance with international law and in which laws relating to U.S. tax are in force. The U.S. model is silent with respect to this point. The definition of the term “Sweden” as contained in the treaty similarly includes its territorial sea and other maritime areas over which Sweden, in accordance with international law, exercises sovereign rights or jurisdiction.

The treaty provides rules for determining when a person is a resident of either the United States or Sweden, and hence (subject to the limitation on benefits) entitled to benefits under the treaty. The treaty, like the U.S. model treaty, provides tie-breaker rules for determining the residence for treaty purposes of “dual residents,” or persons having residence status under the internal laws of each of these treaty countries. These rules differ in some respects from the rules in the U.S. model treaty. For example, under the treaty, as under many other U.S. treaties, Sweden need not treat U.S. citizens or green card holders as U.S. residents unless they have a substantial presence, permanent home, or habitual abode in the United States. The U.S. model, by contrast, provides for the other country to reduce taxes on all U.S. citizens, regardless of where they reside.

The treaty does not contain the U.S. model treaty provision under which investors in real property in the country not of their residence, and who make an election to be taxed on those investments on a net basis, are bound by that election for all subsequent years unless the Countries agree to allow the taxpayer to terminate it. Instead, the making of the election is controlled by internal law. Although U.S. and Swedish law independently provide for elective net basis taxation, the making of a second election under internal U.S. law is restricted once a first election has been revoked. Unlike the U.S. model treaty and most U.S. treaties, but like the OECD model treaty and several recent U.S. treaties, the treaty defines real property to include accessory property, as well as livestock and equipment used in agriculture and forestry.

By contrast to most other U.S. treaties, the proposed treaty treats a permanent establishment as if it were a “distinct and separate enterprise” (as in the OECD model treaty) rather than a “distinct and independent enterprise” (as in the U.S. model treaty). The language in other U.S. treaties is intended to make clear that, as described in the OECD Commentaries, a permanent establishment is to be treated as if it were a totally independent enterprise, i.e., one that deals independently with all related companies, not just its home office. The Technical Explanation of the treaty explains that in the course of the negotiations, the Swedish negotiators made clear that they subscribed to the interpretation in the OECD Commentaries, but preferred to retain the language from the OECD model. The explanation further states that there should be no difference in applications between paragraph 2 of Article 7 of the treaty and its analog in other U.S. treaties.

The business profits article of the treaty omits the force of attraction rules contained in the Code, providing instead that the business profits to be attributed to a permanent establishment shall include only the profits derived from the assets or activities of the permanent establishment. This is consistent with the U.S. model.

The treaty, like the present and model treaties, provides that profits of an enterprise of one treaty country from the operation of ships or aircraft in international traffic are taxable only in that country. Like the U.S. model treaty, but unlike the present treaty, the treaty provides that profits of a treaty-country enterprise from the use or rental of containers and related equipment used in international traffic shall be taxable only in that country.

The associated enterprise article of the treaty incorporates the general principles of section 482 of the Code.

Under the treaty, as well as the U.S. model, direct investment dividends (i.e., dividends paid to companies resident in the other country that own directly at least 10 percent of the voting shares of the payor) will generally be taxable by the source country at a rate no greater than 5 percent. Portfolio investment dividends (i.e., those paid to companies owning less than a 10 percent voting share interest in the payor, or to noncorporate residents of the other country) are generally taxable by the source country at a rate no greater than 15 percent ( Article 10).

Like the U.S. model treaty, the treaty generally defines “dividends” as income from shares or other rights which participate in profits and which are not debt claims. Unlike the U.S. model treaty, the treaty also provides that the term dividends includes income from arrangements, including debt obligations, carrying the right to participate in profits to the extent so characterized under the law of the source country. Thus, the treaty permits dividend treatment of an “equity kicker” amount that is paid on a loan.

The prohibition on source country tax in excess of 5 percent on direct investment dividends does not apply to a dividend from a regulated investment company (a “RIC”). These dividends are generally subject to a 15-percent tax. In addition, a dividend from a real estate investment trust (a “REIT”) is taxed at source at the 15- percent portfolio dividend rate if the beneficial owner of the dividend is a Swedish individual who owns less than a 10-percent interest in the REIT (dividends paid by a REIT are taxed at source at the full 30-percent statutory rate in other cases).

The treaty provides an exemption from U.S. excise taxes on private foundations in the case of a religious, scientific, literary, educational, or charitable organization which is resident in Sweden, but only if such organization has received substantially all of its support from persons other than citizens or residents of the United States. This provision is designed to ensure that the Nobel Foundation, a Swedish charitable organization, will not be subject to U.S. excise taxes ( Article 10).

The treaty expressly permits the United States to impose its branch profits tax. The United States may only apply its branch profits tax to the portion of the business profits of a Swedish company attributable to a permanent establishment or to certain income from real property. The amount of profits subject to the branch profits tax is limited to the amount representing the “dividend equivalent amount,” as defined under the Internal Revenue Code.

Like the U.S. model, the treaty generally provides that interest derived and beneficially owned by a resident of a country may be taxed only by that country. Thus, the treaty generally exempts from the U.S. 30-percent tax U.S. source interest paid to Swedish residents, and exempts from Swedish tax interest paid to U.S. residents. The treaty also provides that the exemption at source for interest does not apply to an excess inclusion of a U.S. real estate mortgage investment conduit (REMIC). The U.S. model (which was written before the enactment of the REMIC regime) does not exclude an excess inclusion of a REMIC from the exemption at source for interest.

The treaty provides that royalties derived and beneficially owned by a resident of a country generally may be taxed only by that country. Thus, the treaty generally exempts from the U.S. 30-percent tax all U.S. source royalties paid to Swedish residents, and exempts from Swedish tax royalties paid to U.S. residents. These reciprocal exemptions are similar to those provided in the U.S. and OECD model treaties. However, unlike the U.S. model treaty, payments for the use of, or the right to use, any motion pictures and works on film, tape or other means of reproduction used for radio or television broadcasting, are treated as royalties.

Both the U.S. model treaty and the treaty provide for source country taxation of capital gains from the disposition of real property regardless of whether the taxpayer is engaged in a trade or business in the source country. The treaty expands the present treaty (and U.S. model) definition of real property for these purposes to encompass “U.S. real property interests.” This Safeguards U.S. tax under the Foreign Investment in Real Property Tax Act of 1980 which applies to dispositions of U.S. real property interests by nonresident aliens and foreign corporations.

The treaty permits Sweden to impose its statutory tax on gains by an expatriate resident in the United States from any property derived by this individual during the ten years following the date on which the individual ceased to be a resident of Sweden. Under the treaty, the United States also retains a right to tax its former citizens for 10 years where their loss of citizenship had as one of its principal purposes the avoidance of tax.

The treaty generally conforms to the U.S. model treaty the provisions relating to independent personal services. Under the treaty, like the model treaty, independent personal services performed by a resident of one country in the other country can be taxed by the source country only if the income is attributable to a fixed base regularly available to the individual in the source country for the purpose of performing his or her activities.

The dependent services article of the treaty varies slightly from that article of the U.S. model. Under the U.S. model, salaries, wages and other similar remuneration derived by a resident of one treaty country in respect of employment exercised in the other country is taxable only in the residence country (i.e., is not taxable in the other country) if the recipient is present in the other country for a period or periods not exceeding in the aggregate 183 days in the taxable year concerned and certain other conditions are satisfied. The treaty contains a similar rule, but like the OECD model as revised in 1992, provides that the measurement period for the 183-day test is not limited to the taxable year; rather, the source country may not tax the income if the individual is not present there for a period or periods exceeding in the aggregate 183 days in a 12-month period.

The treaty prohibits source country tax on remuneration of a treaty country resident employed as a member of the regular complement of a ship or aircraft operating in international traffic.

The treaty allows directors’ fees made by a company resident in one country to a resident of the other country to be taxed in the first country if the fees are paid for services performed in that country. The U.S. model treaty, on the other hand, subject directors’ fees to the normal rules regarding the taxation of persons performing personal services. Under the U.S. model treaty, the country where the recipient resides generally has primary taxing jurisdiction over personal service income and the source country tax on directors’ fees is limited. By contrast, under the OECD model treaty the country where the company is resident has full taxing jurisdiction over directors’ fees and other similar payments the company makes to residents of the other treaty country, regardless of where the services are performed. Thus, the treaty represents a compromise between the U.S. model and the OECD model positions.

The treaty, contains a limitation on benefits, or “anti-treaty shopping,” article. This treaty provision retains in some respects the outline of the limitation on benefits provisions contained in recent U.S. treaties and in the branch tax provisions of the Internal Revenue Code and Treasury Regulations.

As is true of the U.S. and the OECD model treaties, the treaty contains a separate set of rules that apply to the taxation of income earned by entertainers (such as theater, motion picture, radio, or television “artistes” or musicians) and athletes. These rules apply notwithstanding the other provisions dealing with the taxation of income from personal services and business profits and are intended, in part to prevent entertainers and athletes from using the treaty to avoid paying any tax on their income earned in one of the countries. The dollar threshold for taxation under the treaty, however, is less than one-third of the threshold provided in the U.S. model. U.S. tax treaties generally follow the U.S. model rules, but often use a lower annual income threshold. Under the OECD model, entertainers and athletes may be taxed by the country of source, regardless of the amount of income they earn from artistic or sporting endeavors ( Article 18).

Under the treaty, pensions and other similar remuneration beneficially derived by a resident of either country in consideration of past employment generally are subject to tax only in the recipient’s country of residence. However, pensions and other payment made by one of the countries under the provisions of its social security system or similar legislation paid to a resident of the other country or to a citizen of the United States will be taxable only in the paying country.

As a general matter, employment compensation paid by a treaty country government may only be taxed by that country. If, however, the employee is a citizen of the other country, or did not become a resident of the other country solely for the purposes of his employment, the other country has the exclusive taxing right. A similar set of rules applies to pensions in respect of Government service. The treaty applies to all compensation paid by a governmental entity for services rendered to that governmental entity, regardless of whether the services are rendered in the discharge of governmental functions, so long as the services are not rendered in connection with a business carried on by the governmental entity.

The treaty, like the U.S. model, precludes a visited country from taxing certain compensation received by students, trainees, and certain other temporary visitors, when that compensation is for purposes of full time education or training and is received from abroad.

The treaty, contains the standard “other income” article, found in the model treaties, under which income not dealt with in another treaty article generally may be taxed only by the residence country.

The relief from double taxation article of the treaty, which generally ensures that each country allow foreign tax credits for the income taxes imposed by the other country, contains a special rule (contained in many other treaties) for U.S. citizens who reside in Sweden. Under this rule, Sweden will allow as a credit against Swedish tax the U.S. income taxes paid on U.S. source income. The credit, however, will not exceed the amount of tax that would have been paid to the United States if the resident were not a U.S. citizen.

The non-discrimination rule generally conforms to the U.S. model. The treaty prohibits discrimination under the laws of one country against nationals of the other country in the same circumstances as nationals of the first country. The treaty also prohibits discrimination under the laws of one country against permanent establishments of enterprises of the other country, against the deductibility of amounts paid to residents of the other country, or against enterprises owned by residents of the other country.

The treaty provides that its dispute resolution procedures under the mutual agreement article would take precedence over the corresponding provisions of any other agreement between the United States and Sweden in determining whether a law or other rule is within the scope of the proposed treaty. Unless the competent authorities agree that the law or other rule is outside the scope of the proposed treaty, only the treaty’s nondiscrimination rules, and not the most- favored-nation or national-treatment rules of any trade or investment agreement in effect between the United States and Sweden, generally would apply to that law or rule. The only exception is general rule is that the most-favored-nation and national-treatment rules of the General Agreement on Tariffs and Trade would continue to apply with respect to trade in goods.

The treaty contains a provision requiring each country to undertake to lend administrative assistance to the other in collecting taxes covered by the treaty. Among other things, the treaty provision specifies that one country’s application to the other for assistance must include a certification that the taxes at issue have been “finally determined.” A country is not required to lend assistance with respect to the country’s own citizens or entities, except as necessary to ensure that exemptions or reduced rates under the treaty will not be enjoyed by those not entitled to them. Neither country, however, is required to carry out administrative measures different from those used in the collection of its own taxes, or which would be contrary to its sovereignty, security, or public policy.

Transfer Pricing
The treaty, like most other U.S. tax treaties, contains an arm’s-length pricing provision. The treaty recognizes the right of each country to reallocate profits among related enterprises residing in each country, if a reallocation is necessary to reflect the conditions which would have been made between independent enterprises. In addition, the treaty requires each country to attribute to a permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise. The Code, under section 482, provides the Secretary of the Treasury the power to make reallocations wherever necessary in order to prevent evasion of taxes or clearly to reflect the income of related enterprises. Under regulations, the Treasury Department implements this authority using an arm’s-length standard. A significant function of this authority is to ensure that the United States asserts taxing jurisdiction over its fair share of the worldwide income of a multinational enterprise.

Have a question? Contact Jason Freeman, Freeman Law.

Jason Freeman

Mr. Freeman is the founding and managing member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney. Mr. Freeman has been recognized multiple times by D Magazine, a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service.
He was honored by the American Bar Association, receiving its “On the Rise – Top 40 Young Lawyers” in America award, and recognized as a Top 100 Up-And-Coming Attorney in Texas. He was also named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas” by AI.

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