Income Tax Treaty Practice for Tax Counsel: Planning and Structuring Transactions to Maximize Treaty-Based Benefits

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Income Tax Treaty Practice for Tax Counsel: Planning and Structuring Transactions to Maximize Treaty-Based Benefits Understanding and Applying Key Tax Treaty Provisions and the Coming Changes WEDNESDAY, APRIL 26, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Bryan H. Kelly, Counsel, Venable, Los Angeles Javier Salinas, JD, MBA, LLM, Managing Director, International Tax, BPM, San Francisco The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10. NOTE: If you are seeking CPE credit, you must listen via your computer phone listening is no longer permitted.

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4 Income Tax Treaty Practice for Tax Counsel: Planning and Structuring Transactions to Maximize Treaty-Based Benefits l Understanding and Applying Key Tax Treaty Provisions and the Coming Changes April 26, 2017

5 5 Agenda Basic principles and objectives of income tax treaties Conditions to benefits under U.S. income tax treaties Treatment of personal services income Permanent establishment rules Taxation of dividends, interest, and royalties Recent developments o 2016 U.S. Model Tax Treaty new provisions o OECD BEPS Project and the multilateral instrument

6 6 Basic Principles and Objectives of Income Tax Treaties

7 Basic Principles and Objectives of Income Tax Treaties Taxable Presence Taxation of Non-U.S. Persons Taxation differs depending on type of income earned o Non-business (passive) income 30% tax on gross amount of certain U.S.-source income Generally collected through withholding at source o U.S. trade/business income Net basis tax on ECI (at the graduated rate) U.S. branch profits tax application o Tax treaties may alter treatment of both types of income 7

8 Basic Principles and Objectives of Income Tax Treaties Objectives Facilitate international trade and investment by preventing double taxation of cross-border transactions o Achieved primarily by assigning primary taxing jurisdiction to residence country and by lowering or eliminating taxes levied by the source country (i.e., state where the relevant income arises) Avoid discriminatory treatment of nonresidents Prevent tax avoidance o Limitation on benefits provision o Exchange of information provision Permit reciprocal assistance in administering and enforcing tax laws 8

9 Basic Principles and Objectives of Income Tax Treaties Legal Basis for U.S. Tax Treaties U.S. Constitution, Article II, Section 2: o [The President] shall have the Power, by and with the Advice and Consent of the Senate, to make Treaties, provided two thirds of the Senators present concur. 9

10 Basic Principles and Objectives of Income Tax Treaties Treaty Enactment Process; Current Treaty Network How does a tax treaty become effective? o U.S. Treasury negotiates; administration official signs. o Hearing before Senate Foreign Relations Committee precedes consideration by full Senate. o Senate must "advise and consent" to ratification, by a two-thirds vote. o Senate may give conditional consent by means of a reservation or understanding. o President signs and instruments of ratification exchanged; treaty goes into force and becomes effective as specified. Amendments to existing treaties, called protocols, are subject to the same approval procedures as full treaties. U.S. has income tax treaties in force with nearly 70 other countries. Several treaties under negotiation or signed, but awaiting Senate approval. Some treaties currently in force are being renegotiated, or have been renegotiated and are awaiting ratification. 10

11 Basic Principles and Objectives of Income Tax Treaties Pending Tax Treaties and Protocols Treaty / protocol Signed Luxembourg 20 May 09 Switzerland 23 Sept 09 Chile 4 Feb 10 Hungary 4 Feb 10 Spain 14 Jan 13 Status Protocol amended and approved by the Senate Foreign Relations Committee and referred to the full Senate for ratification on 1 April 2014 Protocol amended and approved by the Senate Foreign Relations Committee and referred to the full Senate for ratification on 1 April 2014 Treaty approved by the Senate Foreign Relations Committee and referred to the full Senate for ratification on 1 April 2014 Treaty approved by the Senate Foreign Relations Committee and referred to the full Senate for ratification on 1 April 2014 Protocol approved by the Senate Foreign Relations Committee and referred to the full Senate for ratification on 16 July 2014 Japan 24 Jan 13 Transmitted to the U.S. Senate on 13 April 2015 for advice and consent to ratification Poland 13 Feb 13 Treaty approved by the Senate Foreign Relations Committee and referred to the full Senate for ratification on 16 July 2014 Vietnam 7 Jul 15 Awaiting transmission by the President to the U.S. Senate Norway Not signed Agreement on the text of the revisions to the treaty has been reached Romania Not signed Agreement on the text of the treaty has been reached 11

12 Basic Principles and Objectives of Income Tax Treaties U.S. Tax Treaty Network Gaps Asia/Pacific (no treaty in force with Hong Kong, Singapore, Taiwan, Malaysia, or Myanmar) South America (no treaty in force with Brazil, Argentina, Chile, or Peru) 12 Africa (no treaty in force with Algeria, Liberia, Kenya, Gabon, or Nigeria) Middle East (no treaty in force with Saudi Arabia, Qatar, Jordan, Kuwait, or UAE)

13 Basic Principles and Objectives of Income Tax Treaties Model Treaties U.S. Model Income Tax Convention ( U.S. Model Treaty ) o Starting point for U.S. negotiations o Treasury technical explanation is official U.S. interpretation of provisions o Updated periodically; most recent model released in 2016 o 2016 U.S. Model Treaty is similar to the prior model (published in 2006) in many respects, but there are key differences (discussed subsequently) Organisation for Economic Cooperation and Development (OECD) o Very useful commentary for interpreting treaty provisions o Updated periodically; most recent model released in 2014 UN Model Treaty o Written from the perspective of developing nations o Last updated in 2011; update planned for 2017 Note: Except as otherwise indicated, references to treaty articles herein are to the articles of the 2006 U.S. Model Treaty. Caution: Though most tax treaties in force are based on the above models, each treaty is separately negotiated and is unique. 13

14 Basic Principles and Objectives of Income Tax Treaties Taxes Covered by Income Tax Treaties U.S. taxes o Federal income taxes o Federal excise taxes on private foundations o Not Social Security taxes o Not state and local taxes Foreign taxes o As enumerated in each treaty U.S. Model Treaty, Art. 2 14

15 Basic Principles and Objectives of Income Tax Treaties Interplay between Tax Treaties and U.S. Domestic Law IRC 894(a) o Requires that due regard be given to treaty IRC 7852(d)(1) o Provides that neither the treaty nor the law shall have preferential status by reason of its being a treaty or law Case law o Indicates that precedence is usually given to the most recently enacted authority (later-in-time rule) Treaties cannot create taxation, only reduce it Unless the context requires otherwise, terms not defined by a treaty are generally defined under the domestic laws of the source state 15

16 Basic Principles and Objectives of Income Tax Treaties Treaty Analysis Outline Is there a Treaty in effect? Has it been amended by any protocols? Is the taxpayer a resident as defined by the Treaty? Is the resident entitled to Treaty benefits? o Limitation on Benefits (LOB) article of the Treaty o Treaty may not be available if U.S. perceives an abusive situation and will apply U.S. anti-abuse case law and legislative provisions How does the Treaty treat the specific type(s) of income at issue? o E.g., business profits o E.g., dividends, interest, or royalties 16

17 Basic Principles and Objectives of Income Tax Treaties Claiming Treaty Benefits Claim of benefits directed to source state by a resident of the other contracting state the state of residence United States as source state: o Treaty benefits claimed by providing appropriate Form W-8 to a payor prior to the payment of income for which treaty benefits are claimed U.S. persons claiming treaty benefits with respect to foreign source income: o Many U.S. treaty partners require U.S. citizens and U.S. residents to provide a U.S. Residency Certificate (Form 6166) in order to claim income tax treaty benefits; applied for on Form 8802, and certificate typically received within 45 days o In the case of a fiscally transparent entity, Form 6166 will certify that its owners/beneficiaries are tax residents of the United States o Some treaty partners permit reduction of tax by claiming benefits prior to payment, similar to the United States; others may require treaty-based tax reductions to be claimed via refund 17

18 Basic Principles and Objectives of Income Tax Treaties Mutual Agreement Procedures Articles 25(1) and 25(2) of the 2016 U.S. Model Tax Treaty provide as follows: o Where a person considers that the actions of one or both of the Contracting States result or will result for such person in taxation not in accordance with the provisions of this Convention, it may, irrespective of the remedies provided by the domestic law of those Contracting States, and the time limits prescribed in such laws for presenting claims for refund, present its case to the competent authority of one or both of the Contracting States. o The competent authority shall endeavor, if the objection appears to it to be justified and if it is not itself able to arrive at a satisfactory solution, to resolve the case by mutual agreement with the competent authority of the other Contracting State, with a view to the avoidance of taxation that is not in accordance with this Convention. Any agreement reached shall be implemented notwithstanding any time limits or other procedural limitations in the domestic law of the Contracting States. Assessment and collection procedures shall be suspended during the period that any mutual agreement proceeding is pending. U.S. Competent Authority ( CA ) manages Mutual Agreement Procedures ( MAP ) requests through the Advance Pricing and Mutual Agreement ( APMA ) Program; procedures for requesting CA assistance set out in Revenue Procedure

19 Basic Principles and Objectives of Income Tax Treaties Mutual Agreement Procedures (continued) Typical issues brought for resolution under AMPA include: o Transfer pricing adjustments o Residency determinations o Permanent establishment determinations o Allocation of expenses (e.g., to a permanent establishment) Salient features of the process: o CA has leeway to deny assistance; no judicial review of denial. See Yamaha Motor Corp., USA v. United States, 779 F. Supp. 610 (DC Cir. 1991). o No taxpayer right to participate directly (but can submit proposals and request participation) o Can be a long process; sometimes several years Arbitration: o Some existing U.S. tax treaties contain non-mandatory arbitration procedures that may be invoked if a MAP matter cannot be resolved by the competent authorities. o 2016 U.S. Model Treaty MAP article contains a mandatory binding arbitration provision. 19

20 20 Conditions to Benefits Under U.S. Income Tax Treaties

21 Conditions to Benefits Under U.S. Income Tax Treaties Residence Resident is defined as: any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature, and also includes that State and any political subdivision or local authority thereof. Article 4, Paragraph 1 o But not if only based on source taxation A resident does not include a person who is subject to tax in the country with respect only to: Fiscal Domicile Income derived from sources within the country, or Profits attributable to a permanent establishment (PE) located in the country 21

22 Conditions to Benefits Under U.S. Income Tax Treaties Residence U.S. Model Treaty, Art. 4(1) o Individuals resident where subject to tax by reason of domicile, residence, or citizenship o Corporations resident where subject to tax by reason of place of management or place of incorporation o Certain tax-exempt entities (e.g., charities, pension plans) resident where established and maintained o Qualified governmental entities resident where established o Fiscally transparent entities (e.g., partnerships, disregarded entities) generally are not themselves residents 22

23 Conditions to Benefits Under U.S. Income Tax Treaties Residence Fiscally Transparent Entities Fiscally transparent entities (e.g., partnerships, disregarded entities) o Income item derived through an entity that is fiscally transparent under the laws of either country is considered derived by a resident of a country to the extent that the item is treated for purposes of the taxation law of such country as the income, profit, or gain of a resident (either the entity or its owners) 23

24 Conditions to Benefits Under U.S. Income Tax Treaties Residence Fiscally Transparent Entities Residency tested at ForCo 1 and ForCo 2 levels Residency tested at For. Hybrid level Residency tested at ForCo 1 and ForCo 2 level ForCo 1 ForCo2 ForCo 1 ForCo2 ForCo 1 ForCo2 For. PS For. Hybrid For. Rev. Hybrid dividend dividend dividend USCo USCo USCo 24

25 Conditions to Benefits Under U.S. Income Tax Treaties Tie Breaker Rules Individuals In Article 4, Paragraph 3 the U.S. Model Treaty provides tie breaker rules for individuals o These provisions are identical to the provisions in the OECD Model Treaty in Article 4, Paragraph 2 Provides for four (five) tests, applied in order: 1. Permanent home/center of vital interests 2. Habitual abode 3. Nationality 4. Competent authority 25

26 Conditions to Benefits Under U.S. Income Tax Treaties Tie Breaker Rules Individuals The first tie breaker provides: o He shall be deemed to be a resident only of the State in which he has a permanent home available to him; o If he has a permanent home available to him in both States, he shall be deemed to be a resident only of the State with which his personal and economic relations are closer (center of vital interests) o Center of vital interests is not defined in the treaty It is a facts and circumstances analysis examining the individual's family and social relations, his or her occupation(s), his or her political, cultural, or other activities, his or her place of business, and the place from which he or she administers his or her property 26

27 Conditions to Benefits Under U.S. Income Tax Treaties Tie Breaker Rules Individuals The second tie breaker provides: o If the center of vital interests cannot be determined, then residency is determined based on place of habitual abode Essentially where the most time is spent The third tie breaker provides: o If there is no place of habitual abode, the residency is determined based on where she is a national The fourth tie breaker provides: o If a national of both countries, or neither country, it is left to competent authorities to resolve 27

28 Conditions to Benefits Under U.S. Income Tax Treaties Tie Breaker Rules Corporations Article 4(4) of the 2006 U.S. Model Treaty breaks the tie based on country of incorporation: o Where by reason of the provisions of paragraph 1 a company is a resident of both Contracting States, then if it is created or organized under the laws of one of the Contracting States or a political subdivision thereof, but not under the laws of the other Contracting State or a political subdivision thereof, such company shall be deemed to be a resident of the first-mentioned Contracting State. Article 4(4) of the 2016 Model now provides that if a company is a resident of both the contracting states, such company shall not be treated as a resident of either contracting state for claiming treaty benefits 28

29 Conditions to Benefits Under U.S. Income Tax Treaties Tie Breaker Rules Corporations Article 4 Paragraph 3 of the OECD Model Treaty breaks the tie based on place of management and control: o Where by reason of the provision of paragraph I a person other than an individual is a resident of both Contracting States, then it shall be deemed to be a resident only of the State in which its place of effective management is situated. UN Model treaty consistent with OECD treaty 29

30 Conditions to Benefits Under U.S. Income Tax Treaties Savings Clause U.S. treaties include a savings clause. U.S. Model Treaty, Article 1, Paragraph 4: o... this Convention shall not affect the taxation by a Contracting State of its residents (as determined under Article 4 (Resident)) and its citizens. A U.S. citizen or resident alien cannot claim treaty benefits to reduce or avoid U.S. worldwide taxation o For example, a U.S. citizen or resident alien will be taxed by the United States on a dividend, regardless of source because, as a U.S. citizen or resident alien, such person is taxable on her worldwide income o If Country X also taxes her on the same dividend, Taxpayer will likely not qualify for a foreign tax credit to reduce her U.S. tax on the income since the dividend is U.S. source income (assuming paid by a U.S. corporation) and the foreign tax credit is limited to the U.S. tax on foreign source income 30

31 Conditions to Benefits Under U.S. Income Tax Treaties Treaty Shopping Problem: Cross-border dividend subject to high taxes due to lack of treaty Potential solution: Route dividend through holding company based in country with favorable treaty network FCo US Subsidiary $ $0$ 30% statutory withholding tax rate FCo Treaty Holding Company US Subsidiary $ $0$ 0% treaty withholding tax rate $ $0$ 5% treaty withholding tax rate 31

32 Conditions to Benefits Under U.S. Income Tax Treaties U.S. Response to Treaty Shopping Tax Treaty limitation on benefits (LOB) provisions o See Article 22, U.S. Model Treaty Judicial doctrines o Business purpose and substance over form Anti-abuse provisions o Section 894(c), which denies treaty benefits to certain payments to hybrid entities o Section 7701(l), anti-conduit provision (Treas. Reg ) 32

33 Conditions to Benefits Under U.S. Income Tax Treaties Eligible Residents Under LOB provisions Article 22(1) of the U.S. Model provides the basic rule: One may not claim treaty benefits unless they are a qualified person as defined in paragraph 2 33

34 Conditions to Benefits Under U.S. Income Tax Treaties Eligible Residents Under LOB Provisions Individuals (no special restrictions) Publicly traded companies o Principal class of shares (and any disproportionate class) is regularly traded on a recognized stock exchange and primarily traded or management and control test met Subsidiaries of publicly traded companies o 50% owned, vote and value, by five or fewer publicly traded companies that are residents or qualifying intermediate owners Companies that meet both (i) stock ownership test and (ii) base erosion test Certain governmental and tax-exempt entities Companies that meet active trade or business test Competent authority relief 34

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36 Conditions to Benefits Under U.S. Income Tax Treaties LOB Publicly Traded Test Article 22(2)(c) provides that a company is a qualified person if its principal class of stock (and any disproportionate class of shares) is regularly traded on one or more recognized stock exchanges and either: o its principal class of stock is primarily traded on a stock exchange in its country of residence; or o the company s primary place of management and control is in its country of residence A corporation whose stock is publicly traded qualifies under the LOB provision because it is unlikely a publicly traded company would be used primarily for tax avoidance 36

37 Conditions to Benefits Under U.S. Income Tax Treaties LOB Publicly Traded Test The term recognized stock exchange is defined in Article 22(7)(a) The terms primarily traded and regularly traded are not defined in the Treaty o Article 3(2) says to look at local law where not otherwise defined o Treas. Reg (d)(3) defines regularly traded if trades are affected on at least 60 days during the year and the aggregate number of shares traded is at least 10% of the average number of shares outstanding during the year o Principally traded did the number of shares traded in Country X exceed the number of shares traded in any other single foreign country? Treasury Technical Explanation to Article 22 37

38 Conditions to Benefits Under U.S. Income Tax Treaties LOB Publicly Traded Test Management and control (Article 22(2)(c)(i)(B)) o For a company that cannot meet the primarily traded test for qualified person status o The tested company will be considered a qualified resident if its primary place of management and control is in the contracting state of which it is a resident Technical Explanation guidance o Requirement looks to where, more than any other State, the executive officers and senior management employees (in most cases, executives who are members of the board of directors) exercise, with support staff, the dayto-day responsibility for strategic, financial, and operational policy decision making for the company (including direct and indirect subsidiaries) o Indicates that, in most cases, the location of the company headquarters in the residence State is a necessary, but not sufficient, condition for satisfying this test 38

39 Conditions to Benefits Under U.S. Income Tax Treaties LOB Subsidiary of a Publicly Traded Company Test Under Article 22(2)(c)(ii) a corporation can be a qualified person if it is a subsidiary of a company which meets the test of Article 22(2)(c)(i) (i.e., publicly traded company test) Publicly traded company must own at least 50% of the vote and value of the tested subsidiary For indirectly owned companies, each intermediate corporation in the chain must be a resident of one of the treaty countries. Article 22(2)(c)(ii) 39

40 Conditions to Benefits Under U.S. Income Tax Treaties LOB Ownership and Base Erosion Test Stock ownership test Article 22(2)(e)(i) o Prong is designed to ensure that the ultimate beneficiaries of the income (e.g., the owners of a company) are primarily residents of the contracting states o Requires that at least 50% of the aggregate voting power and value be owned, directly or indirectly, for at least half the days of the taxable year by residents of the entity's contracting state who qualify for treaty benefits Applies to individuals, qualified governmental entities, publicly traded companies, charitable organizations, and pension funds Excludes subsidiaries of publicly traded companies 40

41 Conditions to Benefits Under U.S. Income Tax Treaties LOB Ownership and Base Erosion Test Base erosion test Article 22(2)(e)(ii) o Prong is designed to prevent the entity claiming treaty benefits from reducing its taxable income (i.e., eroding the tax base) through the use of deductible payments (for local law purposes) to persons that are not subject to the tax regime of either State o An entity generally fails the base erosion test if 50% or more of its gross income for the taxable year is paid or accrued, directly or indirectly, to persons who are not residents of either State entitled to treaty benefits and in the form of payments that are deductible for tax purposes in the entity s State of residence Arm s-length expenses incurred in the ordinary course of business for services or tangible property are not included in deductible expenses 41

42 Conditions to Benefits Under U.S. Income Tax Treaties Example of LOB Ownership and Base Erosion Test Can the Country X corporate parent of a U.S. subsidiary meet the ownership/base erosion LOB test of the applicable treaty which is identical to the U.S. Model treaty under the following facts? Country X corporate parent is owned by four individuals resident in Country X. The Parent projects the following for the current year: o Gross income = $100 million Deductible expenses: o Service Fees to Country Y providers = $65 million o Interest expense to Country Y subsidiary = $35 million 42

43 Conditions to Benefits Under U.S. Income Tax Treaties LOB Example Solution Yes o Country X corporate parent meets the ownership test 100% owned by individuals resident in Country X o Corporate parent also meets the base erosion test because its deductible expenses (not including arm s-length payments in the ordinary course of business for services or tangible property) represent less than 50% of its gross income o Note that the analysis is based on projections that must be completed at the end of the year 43

44 Conditions to Benefits Under U.S. Income Tax Treaties Exception for Income Derived from Active Trade or Business Ineligible resident may still qualify for treaty benefits with respect to an item of income if: o It engages in an active business in the country of residence o Income derived in the other country is connected with or incidental to that active business o If payment is from a related party, business in the residence country is substantial in relation to activity in the other country that generates income Rationale taxpayer would not incur cost of doing business in country of residence merely to obtain treaty benefits Facts and circumstances test 44

45 Conditions to Benefits Under U.S. Income Tax Treaties Derivative Benefits Many U.S. tax treaties (although not the 2006 U.S. Model Treaty) also contain a derivative benefits provision Policy: o See, e.g., U.S. tax treaties with the UK, Belgium, Switzerland, Canada, and others o If a treaty resident company is owned directly or indirectly by residents of another treaty country that would have been entitled to the same level of U.S. treaty benefits if they had received the U.S. income directly instead of through the treaty resident, there is little potential for treaty shopping, and the taxpayer in question should be entitled to the benefits of its treaty of residence Note requirement to be entitled to the same level of U.S. treaty benefits o In the case of dividends, interest, royalties, and possibly certain other items, would be entitled, under the treaty between the potential equivalent beneficiary and the contracting state in which the income arises, to a rate of tax with respect to the particular class of income for which benefits are claimed that is "at least as low as" the rate provided for under the treaty between the contracting states 45

46 Conditions to Benefits Under U.S. Income Tax Treaties Derivative Benefits Example of At Least as Low Test 5% rate of withholding on dividends under Country Y treaty Foreign Parent Y Foreign Sub X USCo 0% rate of withholding on dividends under Country X treaty Foreign Parent is not equivalent beneficiary under U.S.-Country X treaty because rate of withholding on dividends under U.S.-Country Y treaty (5%) is not at least as low as rate of withholding under U.S.-Country X treaty (0%). Derivative benefits LOB test should be failed. Always look to Technical Explanation or Memorandum of Understanding (if available) to confirm how rule is applied in the relevant treaty. 46

47 Conditions to Benefits Under U.S. Income Tax Treaties Derivative Benefits The general framework of most derivative benefits provisions contains four primary aspects: o A specified percentage of direct or indirect ownership (usually 95%); o That is concentrated in the hands of a limited number of owners - seven or fewer; o That themselves are equivalent treaty beneficiaries - usually from a country within a regional trading block (e.g., EU, EEA, NAFTA); and o Satisfaction of a base erosion test Requirements vary from treaty to treaty careful analysis required 47

48 U.S. Domestic Law Anti-Abuse Rules Section 894(c) Section 894(c) denies treaty reduction in withholding tax with respect to any item derived through an entity that, under U.S. law, is treated as fiscally transparent if: o the income is not treated, for purposes of the Country X tax laws, as income of the foreign person claiming the treaty benefits (i.e., the partners in a partnership), o the treaty contains no provision relating to the applicability of the treaty to income derived through a fiscally transparent entity, and o the treaty country does not impose tax on the distribution of the income from such entity to such person Treas. Reg (d) applies to all tax treaties unless the treaty indicates otherwise or competent authority agrees otherwise 48

49 U.S. Domestic Law Anti-Abuse Rules Section 894(c) Corporation for Canada; disregarded in U.S. CanCo U.S. LLC U.S. OpCo Interest U.S. View o Interest payment from OpCo to U.S. LLC is actually a payment to CanCo because U.S. LLC is disregarded entity o Interest payment qualifies for reduced withholding rate under U.S.-Canada treaty o U.S. OpCo gets interest deduction Canadian View o When interest paid to U.S. LLC, no Canada tax because of deferral rule o When interest repatriated by U.S. LLC to CanCo, it is a tax-free dividend But under U.S. rules (and now Canada treaty), treaty benefits denied and interest payment subject to 30% withholding 49

50 U.S. Domestic Law Anti-Abuse Rules Anti-Conduit Rules Intended to combat treaty shopping by third-country residents Some financing structures may meet LOB tests but still must be analyzed under the anti-conduit regulations Anti-conduit financing regulations allow the IRS to recharacterize a multiple-party financing transaction for purposes of applying the 30% withholding tax on U.S.-source fixed or determinable annual or periodic income derived by a foreign person and not effectively connected with that person s conduct of a trade or business in the United States 50

51 U.S. Domestic Law Anti-Abuse Rules Anti-Conduit Rules Basic Example A lends money to B, for which B pays interest to A, and B turns around and lends that money to C, for which C pays interest to B The regulations give the IRS authority to collapse the loans and treat A as having lent money to C As a result, the IRS will treat A, rather than B, as having derived interest from C for purposes of the 30% withholding tax 51

52 52 Treatment of Personal Services Income

53 Treatment of Personal Services Income Independent Contractors 1996 U.S. Model Treaty, Article 14: Income derived by an individual who is a resident of a contracting state in respect of the performance of personal services of an independent character shall be taxable only in that state, unless the individual has a fixed base regularly available to him in the other contracting state for the purpose of performing his activities. If he has such a fixed base, the income attributable to the fixed base that is derived in respect of services performed in that other state may also be taxed in that other state. Employee v. independent contractor: To be an independent contractor, an individual must perform services for his or her own account and bear risk of loss Fixed base : intended to have a meaning similar, but not identical, to permanent establishment (discussed in detail below) o Example: an office that s available to a worker (whether it s used or not) 53

54 Treatment of Personal Services Income Independent Contractors Article governing treatment of independent contractors not included in 2006 model treaty; remuneration for independent services now subject to PE rules under Article 5 and business profits under Article 7 o Intended as a simplification rather than a material substantive change U.S. tax treaties in force tend to vary materially from the model provision; for example: o Many treaties provide that the host country can impose tax even if no fixed base, if worker has been present in the host country for a predetermined minimum number of days of a year (e.g., U.S.-Australia tax treaty) o U.S. tax treaty with the Russian Federation precludes host country tax unless income is attributable to a fixed base and worker has been in host country for more than 183 days 54

55 Treatment of Personal Services Income Employees U.S. model treaty, Art. 14, provides that, subject to certain exceptions, salaries, wages, and other remuneration, including certain deferred compensation, derived by a dependent worker (i.e., employee) who is a resident of a contracting state for services provided in the other contracting state (host state) may be taxed by the host state (i.e., no fixed base or PE attribution required) unless: o the employee is present in the host state for a period of not more than 183 days in any 12-month period commencing or ending in the taxable year; o the remuneration is paid by an employer who is not a resident of the host state; and o the remuneration is not borne by a PE or a fixed base which the employer maintains in the host state Much conformity with the model among treaties in force, but some variation; e.g., treaty with Egypt uses a 90-day period instead of a 183- day period; treaty with Canada exempts remuneration of USD 10,000 or less, even if other tests are not met 55

56 Treatment of Personal Services Income Employees Example 1: o FCorp, a resident of Country A, sends an employee to work in the United States for two months o Assume FCorp does not have a U.S. permanent establishment (as a result of the employee s activities or otherwise) o The income tax treaty between Country A and the United States includes a provision identical to Article 14 of the U.S. Model Treaty o Remuneration with respect to the employee s U.S. activities should be exempt from U.S. federal income tax under the treaty Example 2: o The facts are the same as in Example 1, except that the employee is seconded to a USCorp, U.S. subsidiary of Fcorp o Remuneration with respect to the employee s U.S. activities would not be exempt from U.S. tax under Article 14 of the treaty 56

57 Treatment of Personal Services Income Entertainers and Athletes See Art. 16 of the U.S. Model Tax Treaty General rule for income from employment (Article 14) does not apply Income derived from personal activities carried on in the host state as an entertainer such as a theatre, motion picture, radio or television artiste, or a musician or as a sportsman may be taxed in the host state, except where the gross receipts derived by such person from such activities does not exceed USD 20,000 (30,000 in the 2016 model) for the year concerned o Basic premise: artists and athletes should be exempt from host country tax (similar to other workers), but not to the same degree, because of the possibility that an artist or athlete may have the opportunity to earn a relatively large amount of income in a short period of time Article 16 applies to remuneration for performance, such as appearance fees, award or prize money, or a share of gate receipts; other income (e.g., royalties from record sales and payments for product endorsements) governed by general rules for employees/independent contractors Special rule for remuneration earned through loan-out companies 57

58 Treatment of Personal Services Income Director s Fees See Art. 15 of the U.S. Model Tax Treaty Director s fees and other compensation derived by a resident of a contracting state for services rendered in the other contracting state in his capacity as a member of the BOD of a company that is a resident of the other contracting state may be taxed in that other contracting state Example: o o o o o o Individual A is a U.S. tax resident and a member of the board of directors of UKco, a company resident in the UK; A travels to UK, France and a non-treaty country to provide directorial services to UKco The UK and France follow the U.S. model on director s fees The United States may tax A on all director s fees The UK may tax director s fees for services rendered in the UK Unless A spent a large number of days in France or had a PE/fixed base there, A s director s fees should not be subject to French income tax The non-treaty country may tax the fees for services rendered there; taxes imposed by the UK and the nontreaty country generally would be creditable against A s U.S. tax liability Other common approaches: o o OECD model: resident of one contracting state who is a director of a company that is a resident of the other contracting state is subject to tax in the other state on director s fees, regardless of where the services are performed Earlier U.S. model treaties: did not include specific provisions for director s fees, so taxability was determined under general provisions governing the performance of personal services 58

59 Treatment of Personal Services Income Students/Trainees See Art. 20 of the U.S. Model Tax Treaty Two specific rules: 1. Payments received from outside the host country for maintenance, education, and training are exempt from tax by the host country, provided that the student/trainee (i) is a full-time student/trainee temporarily present in the host country and (ii) was, immediately before visiting the host state, a resident of the other contracting state Applies only for a 12-month period from the date of arrival 2. Student/trainee is exempt from host country tax on income from personal services rendered while temporarily present in the host country, in an aggregate amount equal to USD 10,000 per taxable year Most U.S. tax treaties include provisions for students/trainees similar to the U.S. model provision; a number of treaties extend similar benefits to teachers and researchers 59

60 Treatment of Personal Services Income Pensions and Social Security Pensions: Pension plan distributions and similar remuneration received by a resident of one country are taxable only by that country Any amount arising in the other contracting state which would be exempt from tax if the beneficial owner were a resident thereof is exempt from tax in the country of residence This provision is subject to the saving clause, so a U.S. citizen who is resident in another country cannot claim Social security: Social security benefits paid by a contracting state to a resident of the other contracting state (state of residence) are taxable only by the country making the payment (i.e., the source state) Savings clause does not apply to this benefit, so a U.S. citizen may claim Cross-border pension plan contributions (continued participation in home country plan): Where a participant in a pension plan established under the laws of one state performs services in the other state (host country), contributions to the plan and benefits accruing under the plan while the individual is working in the host country are exempt from tax and are deductible by the employer in the host country, to the same extent such relief is allowed by the host country to its residents, provided that: o The individual participated in the plan prior to working in the host country; and o The competent authority of the host country has agreed that the plan is sufficiently similar to plans recognized for tax purposes by that country. Savings clause does not apply for U.S. residents who are not citizens or green card holders 60

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62 62 Permanent Establishment Rules

63 Taxable Presence U.S. Trade or Business (Taxation of Business Profits) Statutory threshold for taxing foreign person s business profits o Engaged in trade or business within the United States (IRC 871 and 882) o Generally considered considerable, continuous, and regular activity in a jurisdiction o Typically a facts-and-circumstances test Jurisdiction to tax o A PE gives tax authorities the right to tax business profits attributable to the PE, and the existence of a PE may also bring with it additional tax and financial reporting requirements U.S. Model, Article 7 o The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. 63

64 Permanent Establishment (PE) U.S. Model, Article 5 General rule: Fixed place of business (e.g., office) Specific exclusions o Use facilities solely to store, display, or deliver goods belonging to enterprise o Maintain stock of goods solely for purpose of storage, display, or delivery, or processing by another enterprise o Maintain fixed place of business solely to purchase goods, collect information, or conduct other activity of a preparatory or auxiliary nature The activities of a dependent agent who has and regularly exercises the authority to contract on behalf of the principal can also create a PE 64

65 Permanent Establishment (PE) U.S. Model, Article 5 Construction sites o A building site or construction or installation project constitutes a PE if, but only if, it lasts more than 12 months Services PE provisions in some treaties o Where an enterprise does not otherwise have a PE in a Contracting State, that enterprise is deemed to have a PE in a Contracting State if and only if that enterprise provides services in such Contracting State for an aggregate of 183 days or more in any 12-month period with respect to the same or connected project for resident customers in such Contracting State (or for a Contracting State PE of non-resident customers) o E.g., Seconded Employees: Under U.S.- Canada Treaty, if USCo s employees are in fact under the supervision of (seconded to) the Canadian affiliates, then the services provided by these U.S. employees would not be counted in determining whether USCo itself has a PE in Canada 65

66 Proposed Changes under BEPS - Action 7 Preventing the Artificial Avoidance of PE status Parent company IP Holdco Principal Areas requiring risk assessment 1. Location of sales negotiation processes 2. Inventory ownership 3. Commissionaires/sales agent and toll manufacturing/warehouses 4. Preparatory and auxiliary nature of activities 5. Fragmentation of activities among related parties Manufacturer Distributor 66

67 67 Action 7: Permanent Establishment Sales and Marketing Activities

68 Action 7: Sales and marketing activities Pre-BEPS PE standard 1. Marketing services arrangements have been routinely used to promote and sell product in local countries using a foreign principal trading company in order to effect the final sale to customers (see diagram on previous slide). 2. Model treaty Art. 5(5) - Dependent agent rule. No PE on the part of the foreign principal was deemed to arise unless dependent agents habitually concluded sales contracts in the name of the foreign principal. PE exposure in general was limited where local country personnel did not habitually conclude sales contracts with customers and it could be demonstrated that there was active participation in the sales process by the principal trading company. Post-BEPS changes 1. Principal trading companies may have local country PE exposure and be subject to tax on sales if dependent agents including affiliated marketing personnel are: Actively involved in generating sales locally and their efforts result in the successful conclusion of sales contracts without material modification of the contract; or They habitually conclude sales contracts on behalf of the foreign principal. 2. Proposed Article 5(5) PE rule. A foreign principal trading company will be deemed to have a PE when a person acting on its behalf (commissionaire, broker, or general commission agent) habitually concludes contracts or plays the principal role leading to the conclusion of sales contracts and no material modification of the contract is made by the principal, and these contracts are either in the name of the enterprise; or for the transfer of the ownership of, or the granting of the right to use, property owned by the enterprise or that the enterprise has the right to use; or for the provision of services by the enterprise. 68

69 Action 7: Permanent Establishment Commissioned Agent Parent company Principal (Company B) Commission payment Invoice for Commission payment Payment Invoice Commissioned agent (Company A) Initial customer inquiry Tangible property or digital content Customers (Company A) 69

70 Action 7: Independent Sales Agents, Commissionaires, and Brokers Pre-BEPS PE standard Post-BEPS changes Independent agents. Under pre-beps rules, sales agents that were economically and legally independent of a foreign principal did not create a PE. These included certain commissionaires, brokers, and general commission agents. 2. Model treaty Article 5(6) rule A PE is created where a person other than an agent of an independent status is acting on behalf of an enterprise and habitually concludes contracts in the name of the enterprise. 3. A foreign principal, in the past, could replace a local distributor with an independent agent (i.e., a commissionaire, broker, or general commission agent) without making substantive changes to the functions performed in that country. 1. The independent agent exception to PE afforded under Art. 5(6) of the U.S. model treaty will be narrowed in scope. Unrelated persons. The facts and circumstances must be closely evaluated in order to determine whether a person is economically and legally independent when selling on behalf of one or more unrelated persons. 2. Related parties. A person acting exclusively or almost exclusively on behalf of related parties shall not be considered an independent agent for purposes of asserting the independent agent exception. A person will be considered to be closely related to a company if the person possesses more than 50% ownership of the vote and value of the company s shares. 3. Sales activities described in revised Art. 5(5),where dependent agents habitually concluded sales contracts in the name of the foreign principal, will not result in a PE if performed by an independent agent that is economically and legally independent and not related to the foreign principal. Tax treaty provisions worldwide are in the process of being renegotiated in order to conform to post-beps changes.

71 Action 7: Commissionaire Arrangements Pre-BEPS PE standard 1. Commissionaires. Commissionaire selling arrangements are generally adopted by statute and allow the Commissionaire to sell on behalf of a foreign principal, either using their own name or their foreign principal s name, without creating a PE on the part of the foreign principal. Post-BEPS changes 1. Commissionaires will be subject to the same rules as dependent agents (and independent agents - see next slide). Principal trading companies having Commissionaire arrangements with affiliates or third parties may have local country PE exposure and be subject to tax on sales, where the Commissionaire habitually executes contracts on behalf of its foreign principal or in its own name without material modification of the contract by the foreign principal. 71

72 72 Taxation of Dividends, Interest, and Royalties

73 Dividends, interest, and royalties U.S. statutory withholding tax rates o 30% tax on U.S. source dividends, interest and royalties derived by foreign persons (IRC 871 and 881) U.S. Model, Art. 10 (dividends) o Tax rate is 5% for 10%-or-more corporate shareholder, and 15% for lessthan-10% corporate shareholder and individuals o Some newer treaties provide for 0% withholding on dividends if certain corporate ownership thresholds met (80% or more: UK, Netherlands, Australia, Mexico, Germany, Belgium, Finland, Denmark; Japan: more than 50%) U.S. Model, Art. 11 (interest) and Art. 12 (royalties) o Provide exemptions from U.S. withholding tax Note: Foreign residents must satisfy U.S. compliance requirements in order to obtain the benefit of this provision. 73

74 74 Recent Developments

75 Recent Developments Publication of revised U.S. Model Tax Convention in 2016 Release of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (typically referred to as the Multilateral Instrument or MLI ) 75

76 76 New U.S. Model Tax Treaty

77 Recent Developments New U.S. Model Tax Treaty On May 20, 2015, the Treasury Department released, for public comment, proposed changes to the 2006 U.S. Model Tax Treaty and the U.S. Model Technical Explanation According to Treasury officials, the proposed changes would: o Protect the U.S. tax base o Avoid instances of stateless income and double non-taxation o Make treaties more dynamic On February 17, 2016, the Treasury Department released a revised U.S. Model Tax Treaty, but did not release a technical explanation o Technical explanation was originally targeted for release in spring of 2016, but has still not been released Revisions to most articles; only significant ones discussed here 77