Double Tax Treaties
Recent Developments In U.S. 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.
In March, 2010, as part of the Hiring Incentives to Restore Employment (HIRE) Act a further piece of legislation known as FATCA (Foreign Account Tax Compliance Act) was enacted and is intended to ensure that the US tax authorities obtain information on financial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold a substantial ownership interest, at foreign financial institutions (FFIs). Failure by an FFI to disclose information would result in a requirement to withhold 30% tax on US-source income.
Under the legislation, a participating FFI will have to enter into an agreement with the US Internal Revenue Service (IRS) to provide the name, address and taxpayer identification number (TIN) of each account holder who is a specified US person; and, in the case of any account holder which is a US-owned foreign entity, the name, address, and TIN of each substantial US owner of such entity. The account number is also required to be provided, together with the account balance or value, and the gross receipts and gross withdrawals or payments from the account.
While FATCA does not replace other tax information provisions already in existence, it will, in the eyes of the IRS, prevent US persons from hiding income and assets overseas. A US person within the framework of FATCA is described as:
- An individual who is a citizen or resident of the United States;
- A domestic partnership or corporation;
- A trust, if (1) a court within the US can exercise primary supervision over the administration of the trust; or (2) one or more US persons have the authority to control all substantial decisions of the trust;
- Any other person that is not a foreign person.
In this section:
» Table Of Tax Treaties A listing of the 54 countries with which the US has double tax treaties.
» Recent Developments In U.S. Tax Treaties New treaties; Changes and clarifications to existing treaties.
» Dividend Taxation Under 2003 Tax-Cutting Legislation Four US income tax treaties do not meet the requirements of the Act.
» Tax Information Exchange Agreements Many offshore jurisdictions don't want to or are not eligible to enter fully-fledged double tax treaties with their major trading partners.
» Transfer Pricing Most double tax benefits are linked to acceptable transfer pricing; few international transactions can now ignore it.