What s New in the 2016 US Model Treaty?

Transcription

1 What s New in the 2016 US Model Treaty? Panelists: Lori Hellkamp, Jones Day Danielle Rolfes, U.S. Treasury Department David G. Shapiro, Saul Ewing LLP Gretchen Sierra, Deloitte Tax LLP Jason Yen, U.S. Treasury Department Moderator: Patricia A. Brown, University of Miami

2 Significant Change in Emphasis Since the first draft U.S. Model was issued in 1976, new versions have appeared about once a decade 1996 and 2006 Models were mostly evolutionary, reflecting technical changes that already had been adopted in negotiated treaties 2016 Model is revolutionary, with new focus not just on preventing treaty-shopping, but regime shopping that results in double non-taxation Could have impact as significant as 1981 Model, which introduced Limitation on Benefits provisions However, many provisions have not yet been included in treaties that have entered into force 2

3 Change Signaled in May 2015 Proposals New policy direction was clear from May 20, 2015 release of proposed changes addressing: Special Tax Regimes A new Limitation on Benefits article Payments by Expatriated Entities Subsequent Changes in Law Exempt Permanent Establishments Intent was to affect discussions at OECD on BEPS Action 6 and the negotiation of the multilateral instrument Panel will focus on final version of these provisions, not differences from the 2015 proposals 3

4 Article 3(1)(l) Special tax regime Any statute, regulation, or administrative practice that satisfies 5 conditions: 1. Preferential tax rate or reduction in tax base for passive income or companies that do not engage in active trade or business 2. In the case of a preferential tax rate for royalties, not conditioned on R&D in the state granting favorable rate 3. Generally expected to result in tax rate equal to lesser of 15% or 60% of the general statutory rate in the state granting the favorable rate 4. Does not apply principally to pension funds, typical tax-exempt organizations, or RIC or REIT equivalents 5. Identified as problem regime through diplomatic channels and placed on formal list of special tax regimes 4

5 Special tax regime: Preferential tax rate Any one of the following: Preferential rate of taxation for interest, royalties, guarantees or any combination thereof Permanent reduction in tax base with respect to interest, royalties, guarantee fees or any combination thereof via any of: Exclusion from gross receipts Notional deduction Deduction for dividends paid or accrued Taxation inconsistent with principles of Article 7 (Business Profits ) or Article 9 (Associated Enterprises) of the treaty Preferential rate of taxation or permanent reduction in the tax base of the types above for all of a company s foreign source income if the company does not engage in the active conduct of a trade or business in the state 5

6 Special tax regime effects Certain related-party payments denied treaty benefits if they benefit from STR: Interest [Article 11(2)(a)] Royalties [Article 12(2)(a)] Guarantee fees [Article 21(2)(a)] Payments to unrelated parties are not subject to STR rules Relationship test: connected person [Art. 3(1)(m)] 50% parent-subsidiary or common ownership o corporations: vote and value o all other entities: beneficial interest facts and circumstances 6

7 Notional Interest on Equity No longer part of special tax regime However, no reduction in withholding rate on interest if: Paid to a connected person ; and That person benefits from notional deductions with respect to equity (from perspective of residence State) Are Belgium and Brazil equated (and should they be) for these purposes? 7

8 Changes to Resident Definition Carves out individuals who are taxed on fixed-fee, forfait or similar basis But remittance basis taxpayers can still get treaty benefits to extent income actually is remitted Eliminates ability of competent authorities to tiebreak in case of dual resident companies companies will always be denied all benefits View that such companies are always tax planning vehicles Probably only confirms existing practice 8

9 Changes to Limitation on Benefits (LOB) More robust base erosion test (public subsidiary, ownership/base erosion, derivative benefits, and headquarters company tests) Public subsidiary test New derivative benefits test New headquarters company test More limited active trade or business test 9

10 Existing Base Erosion Test Basic rule: Less than 50% of gross income must be paid or accrued to: Persons not entitled to treaty benefits as individuals, governmental entities, public companies (but not their subsidiaries), or pensions or tax-exempts; Connected persons benefitting from a Special Tax Regime with respect to the payment; With respect to interest, connected persons benefitting from a notional deduction regime. Exception for arm s-length payments for tangible property or services made in ordinary-course and intragroup transactions (and, in the case of the headquarters test, financial payments to unrelated banks). In 2016 Model, included in public subsidiary and headquarters company tests in addition to traditional ownership/base erosion and derivative benefits. 10

11 Base Erosion Tests Comparison Under 2006 Model/Existing Treaties Gross income and deductible payments calculation necessary only for company. Base erosion payments in most treaties (though not the 2006 Model) carve out financial payments to banks. No special tax regime or notional interest deduction concepts. Derivative benefits base erosion component (in existing treaties, not the 2006 Model) restricts only payments to recipients that are not equivalent beneficiaries. Under 2016 Model Must be satisfied by both the company and the entire tested group. No exception for payments to commercial banks in the same State (except in the headquarters company test). An otherwise good payment will be considered base-eroding if made to a related recipient that benefits from a special tax regime or notional interest deductions. In the derivative benefits test, deductible payments are bad if made to persons other than equivalent beneficiaries but also bad if made to equivalent beneficiaries that are headquarters companies or benefit from a special tax regime or notional interest deductions. 11

12 Base Erosion & Tested Group Test 2006 Model Treaty vs US Model Treaty Loan FP (Non-treaty) 2006 US Model Treaty Base erosion test would not prevent FS2 from obtaining treaty benefits if it (as the tested company) does not pay or accrue 50% or more of its gross income to certain bad recipients (e.g., non-treaty residences) such as FC. Fiscal Unity Loan FS (Treaty) FS2 (Treaty) FC (Non-treaty) Deductible payment 2016 US Model Treaty The new base erosion test examines base eroding payments of the tested resident (e.g., to FC) and the tested group (e.g., to FP) when the tested resident participates in a fiscal unity or similar regime that requires members of the group to share profits or losses or a group relief or loss sharing regime. USS (US) Query: Why not test base erosion on a consolidated group basis entirely and abandon a single company test? analyzed. : Note Other potentially applicable rules, such as Treas. Reg , would also need to be

13 Public Subsidiary Test Basic rule: At least 50% of the vote and value of the company s shares must be owned (directly or indirectly) by five or fewer companies satisfying the publicly traded company test. If ownership is indirect, each intermediate owner must be a resident of the other Contracting State or a qualifying intermediate owner. Additionally, except with respect to dividends, the company and its tested group must satisfy the new base erosion test discussed above. 13

14 Public Subsidiary Test Example Satisfies LOB under the 2006 Model and current treaties, but may not satisfy LOB under the 2016 Model. Public Foreign Parent Foreign Subsidiary Interest US Subsidiary Commercial bank No base erosion component to the public subsidiary test in the 2006 Model. Now Foreign Subsidiary may not satisfy LOB if there is too much base-eroding interest paid (even if the tested group in the aggregate does not breach the 50% threshold). Regardless, Foreign Subsidiary should still qualify for treaty benefits with respect to dividends. 14

15 New Derivative Benefits Test Similar to derivative benefits tests found in current treaties (e.g., Belgium, France, U.K.), but equivalent beneficiaries not limited to EU, EEA, or NAFTA residents. Summary of rule: The company must be at least 95% directly or indirectly owned by 7 or fewer equivalent beneficiaries. If indirectly owned, each intermediate must be a qualifying intermediate owner. The company and the tested group must satisfy a 50% base erosion test discussed above. Tighter base erosion test than in current treaties (more bad recipients). In general, an equivalent beneficiary is a treaty beneficiary by virtue of being an individual, government, pension, tax-exempt, publicly traded company or, in some circumstances, a headquarters company, and which is entitled under the same treaty to benefits or under another treaty to benefits/rates that are at least as favorable as those being sought. 15

16 New Derivative Benefits Test Example UKCo would not satisfy the derivative benefits test in current treaties, but it would satisfy the test under the 2016 Model. Public (non-eu, non-nafta) Country A Parent Assume qualifying U.S.-Country A treaty in effect and Parent qualifies for treaty benefits as a publicly-traded company UKCo US Subsidiary Current treaties generally require equivalent beneficiaries to be residents of EU or NAFTA (or in some cases, EEA) States. Note, however, that no treaties currently in force have the requisite special tax regime or notional interest deduction provisions required of third-country qualifying intermediate owners. 16

17 Limitation on Benefits: Cliff Effect Country Y treaty: 15% w/h to individuals Country X treaty: 10% on all dividends dividend Owner (country Y) FP (country X) USS Typical derivative benefits provision: no benefit because Owner is not entitled to the same withholding rate as FP would receive (10% vs. 15%) New provisions in Articles 10, 11, and 12 states that withholding allowed at Owner s applicable withholding rate For dividends in particular, this provides some relief, but still can result in a higher treaty withholding rate for privately held companies 17

18 Limitation on Benefits: Intermediate Entities Ownership/base erosion and derivative benefits tests apply only if each intermediate company is a qualifying intermediate owner [defined in Art. 22(2)(f)]: Resident of country from which treaty benefits are being sought OR Resident of country with a treaty with the country from which benefits are being sought containing comparable anti-str and notional interest provisions 18

19 Intermediate Entity Example Interest Public Co (Country X) FS1 (Country Y) FS2 (Country X) OpCo (US) Country X has entered into treaty following new US model Treaty in force with Country Y follows old US model Country Y has a 30% corporate tax rate with no favorable tax treatment for dividends, interest, rent or royalties Country X taxes most income at 25% but taxes dividend and interest income at 20% FS2 does not satisfy ownership/base erosion test because Country Y does not have a treaty with STR provisions Should Country X have delayed treaty negotiations until other countries had adopted the STR provisions? 19

20 Active Trade or Business Test Summary of rule: If a company conducts an active trade or business in its residence state, it is eligible for treaty benefits on income derived from the source state that emanates from or is incidental to that trade or business. If the income is derived from a connected person or an activity conducted by the company in the source state, the company s trade/business in its residence state must be substantial in relation to the relevant trade/business carried on in the source state. Active trade or business for these purposes does not include: holding companies, group financing, group supervision and administration, and making or managing investments. Activities can be attributed by connected persons (generally requiring at least 50% ownership). 20

21 Active Trade or Business Test Emanates The relevant income must now emanate from or be incidental to the active trade/business. In the 2006 Model and current treaties, income must generally be derived in connection with or be incidental to the active trade or business (e.g., Canada, Germany, Belgium, France). Factual connection between the active trade or business in the residence country and the relevant item of income. The mere fact that two companies are in similar lines of business is not sufficient. 21

22 How Narrow is Active Conduct of a Trade or Business Now? The emanates from standard was not in 2015 proposed LOB. In the proposal, denied attribution of activities from entity to entity. Narrows the scope of the active trade or business test relative to current treaties (and the 2006 Model). Query whether this more factual analysis moves away from the general goal of objective tests. Treasury invited public comments on possible emanates from examples for inclusion in the Technical Explanation. 22

23 Old Active Conduct Test: Holding Companies and Finance Companies Both Spanish Holding Company and Spanish Finance Company would qualify for benefits because of attribution from Spanish Manufacturing Company 23

24 Active Trade or Business Test Example Emanates from Foreign Company s active trade or business May not emanate from Foreign Company s active trade or business Interest Foreign Company (Manufacturing) U.S. Company (Distributor) Sells manufactured products to U.S. Company on credit for distribution to U.S. customers Sells products manufactured by Foreign Company to U.S. customers Dividends or Interest Foreign Company (Distributor) U.S. Company (Distributor) Sells product X to foreign customers Sells product Y to U.S. customers 24

25 New Headquarters Company Test Summary of rule: The headquarters company s primary place of management and control must be in its country of residence. The multinational group must consist of entities resident and conducting an active trade/business in at least four countries and the trade/business carried out in each of at least four countries (or four non-overlapping groupings of countries) must each generate at least 10% of the group s income. No single jurisdiction (other than the headquarters company s country of residence) can generate 50% or more of the group s income. No more than 25% of the headquarters company s gross income can be derived from the source state. The headquarters company must be subject to tax in its residence country in the same manner as companies conducting active trades or businesses. The 50% base erosion test must be satisfied. 25

26 New Headquarters Company Test (cont d) New to the model treaty, but similar to headquarters company tests found in some current treaties (e.g., Switzerland, Belgium, pending Spain protocol). Some key differences in the 2016 Model headquarters company test compared to similar tests in current treaties: Added base erosion test Reduced active business presence requirement from 5 to 4 countries Applies only to related-party dividends and interest (and rate on interest can be reduced only to 10%) Heightened standard of primary place of management and control rather than overall supervision and administration (e.g., pending Spain protocol, Switzerland) This test is very rarely (ever?) used by taxpayers in the real world because companies could more easily satisfy the active trade or business test. 26

27 New Headquarters Company Test Examples Does not work under 2016 Model but may work under current treaties with a HQ test May work under the 2016 Model but does not work under current treaties with a HQ test Primary place of management and control in residence state Subject to full business taxation Foreign HQCo 20% Dividends Primary place of management and control in residence state Subject to full business taxation Foreign HQCo 25% Dividends OpCo A (Country A) 20% OpCo B (Country B) 20% OpCo C (Country C) 20% OpCo US (U.S.) 20% OpCo A (Country A) 25% OpCo B (Country B) 25% OpCo US (U.S.) 25% Too many bad base-eroding payments cause HQCo to fail the base erosion component. Most headquarters tests in current treaties require active presence in at least 5 countries. In general, the test is satisfied in such a narrow band of factual circumstances that it is unlikely the modifications will cause more taxpayers to qualify for treaty benefits as a HQ company. Query whether, in either example, the Foreign HQCo could (more easily) qualify for treaty benefits under the active trade or business test. 27

28 Overall Effect of Changes? Headquarters companies and finance companies may not qualify under active conduct of a trade or business Finance companies will have to satisfy derivative benefits, so probably held directly by parent Will holding companies meet new headquarters test? Can subsidiaries of publicly-traded companies meet base erosion test? Will ATB apply to any interest or dividends they receive? Can they satisfy derivative benefits because of wider pool of good recipients? 28

29 Anti-inversion rules Denial of treaty benefits to payments from expatriated entities for withholding taxes on payments for 10 years after inversion date to a connected person of: dividends [Article 10(5)(b)] interest [Article 11(2)(d)] royalties [Article 12(2)(b)] guarantee fees treated as other income [Article 21(2)(b)] Exclusion for pre-existing US subsidiaries of foreign group that were not connected persons of the expatriated entities immediately prior to an inversion Expressly ignores changes to 7874 but not to regulations or other administrative interpretations after the date of treaty 29

30 Exempt PE Rule Art. 1(8) Exempt PE Rule: FP (Treaty) Where an enterprise of a Contracting State derives income from the other Contracting State, and the residence state treats that income as attributable to a PE, treaty benefits denied if - a) the PE profits are subject to an aggregate effective rate of tax in the residence state and the PE state that is less than the lesser of (i) 15 percent or (ii) 60 percent of the company tax in residence state; or b) the PE is situated in a third state that does not have a tax treaty with the source state and the income is exempt in the residence state. -Competent authority may provide exceptions in certain instances. PE Interest US Loan The provision appears to only apply to source country treaty benefits. 30

31 Article 28 Subsequent Changes in Law Trigger: reduction in statutory tax rate of one contracting state below lesser of: 15% 60% of statutory rate in other contracting state Effect: Treaty amendment OR If negotiations don t progress, then after 6 months notice, terminate the following articles: o Dividends [Article 10] o Interest [Article 11] o Royalties [Article 12] o Other Income [Article 21] 31

32 Article 28 Special rules for determining statutory tax rate Statutory rate determined after deductions based on a percentage of otherwise allowable taxable income and similar mechanisms (e.g. notional interest deductions) A tax that applies to a company only upon a distribution by the company, or that applies to shareholders, is not taken into account. 32

33 Other Changes (or Not) Holding period requirement for direct dividend rate Addition of mandatory binding arbitration Not a surprise, but welcome Protocol provision on pension definition Is this enough, given aggressive expansion of qualified plans by Malta, for example? Still not including zero dividend rate on dividends Retreat, or just leverage? 33