The United States is a signatory to more than 60 income tax treaties with countries throughout the world. Each treaty offers unique planning opportunities. From permanent-establishment planning, subsidiary or branch formation, transfer-pricing considerations, anti-hybrid planning, and everything in between, our tax attorneys, CPAs, and experts provide insight and guidance that is custom-tailored to our clients and their unique circumstances.
International Tax Treaties
In addition to the U.S. and foreign statutory rules for the taxation of foreign income of U.S. persons and U.S. income of foreign persons, bilateral income tax treaties limit the amount of income tax that may be imposed by one treaty partner on residents of the other treaty partner. Treaties also contain provisions governing the creditability of taxes imposed by the treaty country in which income was earned in computing the amount of tax owed to the other country by its residents with respect to such income. Treaties further provide procedures under which inconsistent positions taken by the treaty countries with respect to a single item of income or deduction may be mutually resolved by the two countries.
The preferred tax treaty policies of the United States have been expressed from time to time in model treaties and agreements. The Organization for Economic Cooperation and Development (the “OECD”) also has published model tax treaties. In addition, the United Nations has published a model treaty for use between developed and developing countries. The Treasury Department, together with the State Department, is responsible for negotiating tax treaties. The United Nations has also published a model income tax treaty (“the U.N. model”).
Many U.S. income tax treaties currently in effect diverge in one or more respects from the U.S. model. These divergences may reflect the age of a particular treaty or the particular balance of interests between the United States and the treaty partner. Other countries’ preferred tax treaty policies may differ from those of the United States, depending on their internal tax laws and depending upon the balance of investment and trade flows between those countries and their potential treaty partners. For example, certain capital importing countries may be interested in imposing relatively high tax rates on interest, royalties, and personal property rents paid to residents of the other treaty country. Consequently, treaties with such countries may have higher withholding rates on dividends, interest, royalties, and personal property rents. As another example, the other country may demand other concessions in exchange for agreeing to requested U.S. terms. Countries that impose income tax on certain local business operations at a relatively low rate (or a zero rate) in order to attract manufacturing capital may seek to enter into “tax-sparing” treaties with capital-exporting countries. In other words, the country may seek to enter into treaties under which the capital-exporting country gives up its tax on the income of its residents derived from sources in the first country, regardless of the extent to which the first country has imposed tax with respect to that income. While other capital-exporting countries have agreed to such treaties, the United States has rejected proposals by certain foreign countries to enter into such tax-sparing arrangements.
The OECD, the U.N., and the U.S. models reflect a standardization of terms that serves as a useful starting point in treaty negotiations. However, issues may arise between the United States and a particular country that of necessity cannot be addressed with a model provision. Because a treaty functions as a bridge between two actual tax systems, one or both of the parties to the negotiations may seek to diverge from the models to account for specific features of a particular tax system.
Model Income Tax Treaty Provisions
The U.S. model generally treats as a resident of a treaty country any person who, under the laws of that country, is liable to tax therein by reason of its domicile, residence, citizenship, place of management, place of incorporation, or any other similar criterion. However, the concept of resident excludes any person who is liable to tax in a country solely in respect of income from sources in that country or of profits attributable to a permanent establishment in that country.
Business Profits Attributable to a Permanent Establishment
Under the U.S. model, one treaty country may not tax the business profits of an enterprise of a qualified resident of the other treaty country, unless the enterprise carries on business in the first country through a permanent establishment situated there. In that case, the business profits of the enterprise may be taxed in the first country on profits that are attributable to that permanent establishment. The U.S. model describes in detail the characteristics relevant to determine whether a place of business is a permanent establishment. The term includes a place of management, a branch, an office, a factory, a workshop, a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.
The U.S. model provides that the business profits to be attributed to the permanent establishment include only the profits derived from the assets or activities of the permanent establishment. The U.N. model adds a limited “force of attraction rule” which would allow the country in which the permanent establishment is located to attribute to the permanent establishment sales in that country of goods or merchandise of the same or similar kind as those sold through the permanent establishment, and to attribute to the permanent establishment other business activities carried on in that country of the same or similar kind as those effected through the permanent establishment.
The U.S., OECD, and U.N. models expressly provide for the allocation of worldwide executive and general administrative expenses in determining business profits attributable to a permanent establishment. The U.S. model also provides for the allocation of research and development expenhttps://freemanlaw.com/wp-admin/media-upload.php?post_id=2848&type=image&TB_iframe=1ses, interest, and other expenses incurred for the purposes of the enterprise as a whole (or the part of the enterprise that includes the permanent establishment).
The U.S. model permits taxation of dividends by the residence country of the payor but limits the rate of such tax in cases in which the dividends are beneficially owned by a resident of the other treaty country. In such cases, the U.S. model allows not more than a 5-percent gross-basis tax if the beneficial owner is a company that owns directly at least 10 percent of the payor’s voting stock, and not more than a 15-percent gross-basis tax in any other case. Under the OECD model, the 5-percent rate is not available unless the beneficial owner of the dividends is a company other than a partnership that holds directly at least 25 percent of the capital of the dividend payor. The U.N. model expressly leaves to case-by-case bilateral negotiation the particular percentage limit to be imposed on source-country taxation of dividends.
Interest and Royalties
The U.S. model generally allows no tax to be imposed by a treaty country on interest or royalties arising in that country and beneficially owned by a resident of the other treaty country. By contrast, the OECD model would permit up to 10-percent gross-basis taxation of interest by the treaty country in which the interest arises. The U.N. model expressly leaves to case-by-case bilateral negotiation the particular percentage limit to be imposed on source-country taxation of interest or royalties.
The U.S. model provides that items of income beneficially owned by a resident of a treaty country, wherever arising, that are not dealt with in the articles of the treaty are taxable only by the recipient’s country of residence. By contrast, the U.N. model states that items of income of a resident of a treaty country not dealt with in the other treaty articles and arising in the other treaty country may also be taxed in that other country.
Relief From Double Taxation
The U.S. model obligates the United States to allow its residents and citizens as a credit against U.S. income tax: (a) income taxes paid or accrued to the treaty country by the U.S. person, and (b) in the case of a U.S. company owning at least 10 percent of the voting stock of a company resident in the treaty country, and from which the U.S. company receives dividends, the treaty country income tax paid or accrued by or on behalf of the payor company with respect to the profits out of which the dividends are paid. However, the U.S. model preserves U.S. internal law by subjecting this right to the foreign tax credit to the provisions and limitations of U.S. law as it may be amended from time to time without changing the general principle of the model provision.
A standard article in treaties specifies the U.S. and foreign taxes covered by the treaty. The U.S. model provides that such covered taxes shall be considered income taxes for purposes of the credit article, and contemplates the possibility that such a tax might be creditable solely by reason of the treaty.
The U.S. model provides that nationals of a treaty country, wherever they may reside, shall not be subjected in the other country to any taxation (or any requirement connected therewith) that is more burdensome than the taxation and connected requirements to which nationals of that other country in the same circumstances, particularly with respect to taxation on worldwide income, are or may be subjected. Similarly, the taxation of a permanent establishment or fixed base that an enterprise or resident of a treaty country has in the other country generally shall not be less favorably levied in the source country than the taxation levied on enterprises or residents of the source country carrying on the same activities. Further, an enterprise of a source country, the capital of which is wholly or partly owned or controlled by one or more residents of the other country, shall not be subjected in the source country to any taxation (or any requirement connected therewith) that is more burdensome than the taxation and connected requirements to which other similar source-country enterprises are or may be subjected. Finally, the U.S. model generally provides (subject to certain arm’s length standards) that interest, royalties, and other disbursements paid by a treaty country resident to a resident of the other country shall, for the purposes of determining the taxable profits of the payor, be deductible under the same conditions as if they had been paid to a resident of the source country.
Mutual Agreement Procedures
The U.S. model provides for a treaty country resident or national to obtain relief, from the competent authority of either treaty country, from actions of either or both countries that are considered to result in taxation in violation of the treaty. The U.S. model requires the competent authorities to endeavor to resolve such a case by mutual agreement where the home country authority cannot do so unilaterally.
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