Tax Treaties and Anti Treaty Shopping Initiatives American Bar
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Document Sample
American Bar Association
Business Law Section
Tax Treaties and Anti-Treaty Shopping
Initiatives
Edward Tanenbaum, Alston & Bird LLP – Panel Chair
Peter Blessing, Shearman & Sterling LLP Dr. Klaus Sieker, Flick Gocke Schaumburg
John Harrington, International Tax Counsel, Diana Wessells, Alston & Bird LLP
U.S. Department of the Treasury
Frankfurt
May 30, 2008
Topics Covered
• Overview of U.S. taxation of foreign persons
• Overview of German domestic taxation of foreign investors in Germany
• Commentary to Article I of the OECD Treaty on anti-treaty shopping
initiatives
• U.S., German, and EU statutory anti-treaty shopping initiatives
• Overview of U.S. Limitation on Benefits treaty provisions and policy
considerations
• Overview of German Limitation on Benefits treaty provisions
• Related Treaty Provisions
• Proposed U.S. anti-treaty shopping provisions
• Effect of treaties on structuring international holding companies
2
Basic Treaty Shopping Example
A B
• A and B are individuals resident in a country
that does not have an income tax treaty with the
German United States
AG
• 30% U.S. withholding tax would apply to
US
payments made directly to A and B by U.S.
Corp. Corp.
• Absent an exception, anti-treaty shopping rules
prevent A and B from obtaining zero or a
reduced rate of U.S. withholding tax under U.S.
– Germany tax treaty.
3
Overview of U.S. Domestic Taxation of Foreign
Persons
4
Overview of U.S. International Tax Rules
• U.S. persons and foreign persons are taxed differently
• U.S. person includes:
– U.S. individual (citizen or tax resident)
– U.S. corporation (created or organized in the United States)
– U.S. partnership (created or organized in the United States)
– Any estate (other than a foreign estate – non-U.S. source income and not U.S.
trade or business income)
– Any trust (if U.S. court supervision and U.S. fiduciary)
• A foreign person is a foreign individual who is not a U.S. person (i.e., a
non-resident alien individual) or an entity that is formed under foreign law
5
Overview of U.S. International Tax Rules
• Two basic regimes apply to foreign persons:
– Effectively connected income regime:
• Income effectively connected with the conduct of a trade or business within the
United States by a foreign person is subject to U.S. tax on a net income basis (This
regime taxes U.S. source income and certain foreign source income as well)
• Gains from disposition of U.S. real property interests under the Foreign
Investment in Real Property Tax Act of 1980 (FIRPTA)
– Gross basis withholding regime:
• Certain types of U.S. source passive income and certain capital gains not
effectively connected with a U.S. trade or business are taxed at a flat rate of 30
percent, unless a specific Code exception or treaty benefit applies
– Passive income includes dividends, interest, rents, royalties, etc.
– Capital gains taxed if non-resident alien present in U.S. for 183 days or more during the
year
• No benefit of deductions or credits
6
Overview of U.S. International Tax Rules
• Sourcing rules determine if income is U.S. source or
foreign source
– U.S. source income includes: Dividends paid by U.S.
corporations; interest if obligor is a U.S. resident; income
from services performed in the United States
– Interest from a Swiss bank account is foreign source
income
7
Overview of U.S. International Tax Rules
Exemptions from gross withholding tax:
• Interest on U.S. bank deposits
• Short-term original issue discount
– Obligation payable 183 days or less from the date of original issue
• Portfolio Interest
– Obligation must be in either registered form or bearer form; detailed
requirements apply to each
– Interest cannot be paid to person owning 10% or more (vote) of obligor
– Certain types of contingent interest ineligible
– Interest cannot be received by a bank
• Treaty exemptions or reductions
– U.S. income tax treaties typically reduce or eliminate withholding tax on
interest, dividends, and royalties
8
Overview of U.S. International Tax Rules
Collection of Tax
• Taxpayers engaged in conduct of U.S. trade or business (or who have
U.S. source taxable capital gains ) must file income tax returns
• Taxpayers not engaged in a U.S. trade or business do not file if all tax is
collected by the withholding agent
• If no exemption applies, the withholding agent (typically, the payor) must
withhold the 30% tax and file an information return
• If an exemption or reduction applies, withholding agent must have
certification from payee:
– Form W-8 BEN: “beneficial owner” of income and/or entitlement to treaty
benefits
• Recipient must file “Treaty-Based Return Position Disclosure” with IRS
on Form 8833 (some exceptions)
9
Overview of U.S. International Tax Rules
Withholding under FIRPTA
• FIRPTA treats gains and losses from U.S. real property interests as effectively
connected income, but withholding applies. Includes sale of stock of U.S. Real
Property Holding Corporation
• Transferee of U.S. real property generally must withhold 10% tax
• Disclosure requirements apply
Withholding for partnerships
• Partnerships required to withhold tax on effectively connected taxable income of
foreign partners at highest marginal rate
• Foreign partner can claim credit for its share of withholding tax
10
Overview of U.S. International Tax Rules
German Individuals
GmbH
Sale
Div
100% 25% Interest
Unrelated
USRPHC US Co. US Bank
• Dividend subject to 5% withholding tax – U.S. company withholds tax and remits to IRS
• Portfolio interest from bank is exempt from tax if not effectively connected with U.S. trade or business
• Sale of USRPHC subject to tax at U.S. marginal rates
Transferee (buyer) withholds tax of 10% of purchase price
GmbH files tax return reporting receipt of all items of income and takes credit for 10% advance tax
withheld by transferee on sale of USRPHC
11
Overview of German Domestic Taxation of Foreign Investors
in Germany
12
Overview of German Domestic Taxation of Foreign Investors
in Germany
• Foreigners (i.e., non-residents) are subject to German tax on German source income
only.
• German source income comprises, inter alia (in broad terms):
1. Dividends received from German corporations
2. Royalties from intangibles used in Germany
3. Interest on profit participating loans/silent partnerships
4. Interest if the principal is secured by mortgage of domestic real estate
5. Income from a trade or business for which a German permanent
establishment is maintained
6. Income from professional services and employment performed in
Germany
7. Income including capital gains from real estate situated in Germany
8. Capital gains earned on shares in German corporations (exceptions
apply)
13
Overview of German Domestic Taxation of Foreign Investors
in Germany
• Dividends, royalties and interest from profit participating loans/silent
partnerships are taxed on a gross basis (i.e., no deductions allowed), the other
items of income are taxed on a net basis.
• Tax on dividends, royalties and interest from profit participating loans/silent
partnerships is collected by way of withholding
– Dividends at a rate of 21.1%
– Royalties at a rate of 21.1% when earned by individuals and at a rate of 15.825%
when earned by corporations
– Interest from profit participating loans/silent partnerships at a rate of 26.375%
14
Overview of German Domestic Taxation of Foreign Investors
in Germany
• Tax on other items of income is collected by way of assessment (i.e. , non-
resident must file a German tax return)
– Individuals pay income tax at marginal rates ranging from 26.375%
to 47.5%
– Corporation tax rate is set at 15.825%
• Income earned through a German permanent establishment is further subject
to trade tax (Gewerbesteuer)
– Trade tax on individuals is creditable against their income tax
– Combined corporate tax/trade tax burden for corporations is about
30%
15
Treaty-based reduction/elimination of German tax on foreign
investors
• Tax treaties provide eligible foreign investors with benefits, i.e., reduction or
elimination of German tax
• Reduction of WHT on dividends to a rate of 0%, 5%, 15%
• Elimination of WHT on interest and royalties (sometimes reduction to a rate
of 10%)
• Elimination of German tax on capital gains earned on shares (sometimes
exceptions for shares in real estate companies)
16
EU directive-based elimination of German tax on foreign
investors
• EU Parent/Subsidiary Directive (dividends), EU Interest and Royalties
Directive
• Zero WHT on dividends paid to EU resident corporations
– Minimum participation of 15%
– Minimum holding period of 12 months
• Elimination of German tax on interest and royalties paid to an affiliated EU
resident corporation or to an affiliated Swiss corporation
17
Example for treaty/directive shopping by U.S.
investors (1)
“Simple” Structure
German Co is a real estate corporation
US Co Dividends paid by GCo to U.S. Co subject
to 5% WHT under U.S.-Germany tax
75 %
treaty
No protection of U.S. Co against German
German Co tax on capital gain under U.S.-Germany tax
treaty
18
Example for treaty/directive shopping by U.S. investors (2)
“Advanced” Structure
US Co
Zero WHT on dividends paid by GCo to Lux
100 %
Co under EU P/S Directive
Lux Co Zero Lux WHT on profit repatriation to U.S.
Co (e. g. CPECS)
75 %
Lux Co is protected against German tax on
capital gains under the Lux-Germany tax
German Co treaty
Result subject to anti-treaty/directive
shopping provisions
19
Commentary to Article 1 of OECD Model Treaty
20
Commentary to Article 1 of OECD Model Treaty
• Two fundamental questions re tax treaty abuse:
– (1) whether the benefits of tax treaties (conventions)
must be granted to abusive transactions; and
– (2) whether specific provisions of the domestic law of a
Contracting State that are intended to prevent tax abuse
conflict with tax treaties.
• Re (1), a proper construction of tax conventions can allow
disregard of treaty-abusive transactions.
– Conventions must be interpreted in good faith (see Article 31
of the Vienna Convention on the Law of Treaties).
21
Commentary to Article 1 of OECD Model Treaty
• Re (2), in many States, taxes are ultimately imposed through the
provisions of domestic law, as restricted (or occasionally
broadened) by the provisions of tax conventions.
– Thus, treaty abuse = an abuse of these domestic provisions.
– Domestic anti-avoidance rules are not affected by treaties;
thus, no conflict.
– Relevant rules include “substance-over-form”, “economic
substance” and general anti-abuse rules.
– Recharacterization of income or in a redetermination of the
taxpayer per these rules may be given effect for treaty
purposes.
22
Commentary to Article 1 of OECD Model Treaty
• Guiding principle: “the benefits of a double taxation convention
should not be available where a main purpose for entering into
certain transactions or arrangements was to secure a more
favorable tax position and obtaining that more favorable
treatment in these circumstances would be contrary to the object
and purpose of the relevant provisions.”
23
Commentary to Article 1 of OECD Model Treaty
• Some common forms of tax avoidance are expressly dealt with,
e.g. by
– the concept of “beneficial owner” (in the Dividends, Interest
and Royalties Articles),
– special provisions dealing with, e.g., so-called artiste-
companies, and
– provisions regarding related party dealings.
• Convention may include provisions that focus directly on the
relevant avoidance strategy
– where specific avoidance techniques have been identified, or
– domestic law lacks the necessary anti-avoidance rules.
24
Commentary to Article 1 of OECD Model Treaty
• The “treaty shopping” issue may be addressed in a
comprehensive by a detailed limitation-of-benefits provisions.
• More limited formulations that may deal with treaty shopping:
– Ownership provisions, which deny benefits to a company
that is a resident of a Contracting State if it is owned or
controlled directly or indirectly by persons who are not
residents of a Contracting State.
– General subject-to-tax provisions provide that treaty benefits
in the State of source are granted only if the income in
question is subject to tax in the State of residence.
25
Commentary to Article 1 of OECD Model Treaty
– Base erosion provisions, which deny benefits if more than
e.g. 50% of gross income is paid out via certain types of
deductible payments to ineligible persons.
– Provisions that deny benefits to income received or paid by a
company enjoying tax privileges or to income that is
preferentially taxed.
– Provisions which deny benefits if it was “the main purpose or
one of the main purposes” of any person concerned with the
creation or assignment of shares, debt-claims, licenses or
other rights to take advantage of reduced treaty withholding
rates.
26
U.S. Statutory Anti-Treaty Shopping Initiatives
27
U.S. initiatives: Section 894 and Treasury Regulations
• These rules apply if an entity is treated as fiscally transparent in
either the United States or the foreign jurisdiction (hybrid or
reverse hybrid)
• Rules determine eligibility for treaty benefits for payments made
or received by such an entity
• Treaty eligibility only if item of income is “derived by” a
foreign entity
• Rules apply only to U.S. source passive income
28
Meaning of “Derived By”
• Income is “derived by” an entity if entity is not fiscally transparent
• Income is “derived by” an interest holder in entity if interest holder is not
fiscally transparent and entity is fiscally transparent under laws of interest
holder’s jurisdiction
• Entity is fiscally transparent if interest holder required to take item of income
into account on a current basis and character and source of income are
determined as if realized directly from the source
• Determination made under principles of foreign law
• Entity specifically identified in a treaty
• Dual claims can be made by entity itself and on behalf of interest holders
(withholding agent option)
29
The Canadian Fact Pattern
Canada
US LLC
LOAN
US Sub
• Canadian parent with U.S. subsidiary sets up single member U.S. LLC to lend $ to U.S.
subsidiary
• Subsidiary pays interest (deductible) to U.S. LLC, which would be subject to current favorable
10% treaty withholding rate
• Canada treats the payment as exempt dividend income from U.S. LLC, which is regarded as
corporation
30
Example
A 50 B 50
Entity C
• In Country C, Entity C is treated as not fiscally transparent
• In Country A, Entity C is treated as fiscally transparent
• In Country B, Entity C is treated as not fiscally transparent
• Entity C receives royalty income and portfolio interest from unrelated U.S. corporations
• U.S.-Country A Treaty has 0% withholding on royalties
• U.S.-Country C Treaty has 5% withholding on royalties
– One-half of the royalty income is subject to 0% withholding; balance subject to 5%
withholding
– Entity C receives interest which qualifies as portfolio interest exempt from tax
31
Example
A
B
Entity
• In Country B, Entity B is treated as fiscally transparent US
• In Country A, Entity B is treated as not fiscally transparent Corp.
• Entity B receives royalty income from an unrelated U.S. corporation
• U.S.-Country A Treaty has 0% withholding on royalties
• U.S.-Country B Treaty has 5% withholding on royalties
• No treaty relief is available to either entity B or individual A because of section 894.
32
Domestic Reverse Hybrids
Treated as corporation for US tax purposes and fiscally transparent for foreign purposes
Domestic reverse hybrid
•Income from the United States paid to domestic reverse hybrid not entitled to treaty
benefits
33
Domestic Reverse Hybrids
• Income paid by domestic reverse hybrid – treated as “derived”
by its interest holders (provided they are not fiscally transparent)
by treating and testing the income as if paid by a non-fiscally
transparent entity
– If interest holder “derives” at time of payment, then receive
treaty relief
– This is the case even if the item of income were characterized
differently or treated as having been received earlier under
foreign law
34
Domestic Reverse Hybrid Shutdown
Debt/Equity Interest
FC
Shut-down of
abusive transaction Domestic reverse hybrid
US
LLC Dividend
US Sub
• Capitalization with part debt, part equity
• U.S. corporation pays dividend and domestic reverse hybrid pays interest
• Foreign country treats entity as fiscally transparent and interest holder as receiving
dividends
• United States treats entity as receiving dividends but deducting interest
• Reduced withholding rate under treaty
• Deduction at U.S. level
35
Domestic Reverse Hybrid Shutdown
FC
Debt/Equity Interest
Domestic reverse hybrid
Dividend
US
Corporation
Cannot manipulate difference in entity classification rules to inappropriately reduce tax
• So, if:
– Payment from domestic entity to related (80%) domestic reverse hybrid is treated as dividend under
either United States or foreign jurisdiction (and interest holder treated as deriving his proportionate share
of the dividend) and
– Domestic reverse hybrid makes payment to related (80%) interest holder which is deductible in United
States and entitled to reduced withholding rate under a treaty, then
– Payment by domestic reverse hybrid to be treated as a dividend for all purposes (up to the interest
holder’s proportionate share of the dividend payment from the U.S. corporation to the related domestic
reverse hybrid). No interest deduction.
36
Bank Loan
FC
Bank
Equity 100%
Loan Domestic Reverse Hybrid
Interest
100%
US Corporation Dividend
• Bank Loan untouched by domestic reverse hybrid regulations
• Even if loan guaranteed by related foreign interest holder.
• Beware conduit financing anti-avoidance rule for unrelated parties
37
Conduit Financing Regulations
• IRS may disregard certain intermediate entities (i.e., conduit entities) in
“financing arrangements,” with the result that the conduit entity cannot claim
benefits of a tax treaty between its country and the United States
• Purpose is to disallow treaty benefits where conduit entities are interposed to
gain treaty benefits
• A financing arrangement is series of transactions by which the financing
entity advances money or other property (or rights to use property) to another
person, i.e., the financed entity, if advance and receipt are effected through
one or more intermediate entities (generally, conduit entities)
38
Grounds for Disallowing Treaty Benefits in Conduit
Financing
• Treaty benefits are disallowed if:
– Participation of the intermediate entity reduces gross basis withholding
tax in comparison to tax imposed absent intermediate entities;
– Participation of the intermediate entity is pursuant to tax avoidance plan;
and
– Either:
• The intermediate entity is related to the lender or the borrower; or
• The intermediate entity would not have engaged in the financing
arrangement on substantially the same terms but for the fact that
lender engaged in the transaction with the intermediate entity
39
Grounds for Disallowing Treaty Benefits in Conduit
Financing
Factors considered for tax avoidance purpose:
• Significant reduction in tax as compared to financing absent intermediate
entities;
• Whether intermediate entity was able to advance the funds on its own;
• Length of time between separate advances;
• If parties involved in the advance of funds to or from an intermediate entity
are related, whether advance occurs in ordinary course of business
Favorable (but rebuttable) presumption:
• Participation of intermediate entity in financing arrangement not pursuant to
tax avoidance plan if: (1) intermediate entity is related to either or both of
lender or borrower and (2) intermediate entity performs significant financing
activities in the financing arrangement
40
Example: Conduit Financing Regulations
U.S. Foreign
Borrower Parent
Loan
Interest German
Sub
• Foreign Parent is a bank organized in a country that does not have a tax treaty with the
United States.
• Foreign Parent establishes and capitalizes a German subsidiary with the sole purpose of
having the German subsidiary make a loan to U.S. Borrower.
• Zero withholding on interest under the U.S.-Germany treaty is unavailable because:
– Participation of the German subsidiary reduces (i.e., eliminates) the 30% withholding tax on
interest that would apply if loan made by Foreign Parent (because Foreign Parent is a bank,
the portfolio interest exemption would be unavailable);
– Participation of German subsidiary is pursuant to a tax avoidance plan (e.g., significant
reduction of tax; German subsidiary would be unable to make loan absent the plan);
– German subsidiary is related to the lender, Foreign Parent.
German domestic anti-treaty shopping provision:
§ 50 d (3) ITA (1)
• Current version applicable since 2007
• Foreign corporation (FCo) is denied relief from German tax provided for in a tax
treaty or in an EU Directive to the extent that the shareholders of FCo were not
entitled to tax relief if the shareholders (rather than FCo) would have earned the
income themselves
and
1. There are no sound reasons for interposing FCo or
2. FCo derives less than 10 % of its gross revenue in a given year from
its own economic activities or
3. FCo does not participate by means of a proper business operation in
the general economy.
42
German domestic anti-treaty shopping provision:
§ 50 d (3) ITA (2)
• Scope of the provision is limited to items of income which are subject to withholding
tax (dividends, royalties, interest from profit participating loans/silent partnerships)
• Tax relief is not denied it there is a substantial and regular trade with the principal
class of shares in FCo on a recognized stock change (or if FCo falls under the
provisions of the Investment Tax Act)
• Provision is strictly enforced by German tax authorities
– FCo must provide the German payor of dividend/interest/royalty with a certificate issued by
the Federal Central Tax Office confirming FCo’s entitlement to treaty benefits
– Certificate is granted upon application and only if FCo demonstrates that there is no treaty
shopping (burden of proof is on FCo)
43
German domestic anti-treaty shopping provision:
§ 50 d (3) ITA (3)
• Own economic activity of FCo – the 10 % test
– At least 10 % of FCo’s gross revenue must be derived from its own economic activities
– Rendering services to group companies constitutes its own economic activity
– Economic activities carried out in a country other than the home state of FCo do not count
as own economic activity
– Passive investment income does not count. However, dividends, interest and royalties
earned by FCo from subsidiaries do count if these subsidiaries are managed by FCo (e.g.,
FCo operates as management holding company).
• Derivative benefits granted
44
Example - Denial of tax relief
Japan Co Dividends from GCo to Dutch Co
quality for zero WHT subject to § 50 d (3)
100 %
15 % WHT rate for dividends from GCo to
Japan Co
15 % WHT if Dutch Co is caught by § 50 d
Dutch Co (3) (i. e. Dutch Co has not sufficient
“substance”)
100 %
German Co
45
Example – Derivative Benefits
US Co Suppose that Dutch Co does not have
sufficient substance
100 % Is Lux Co entitled to zero WHT rate on
dividends from GCo?
Lux Co No, if Lux Co fails the § 50 d (3) test
unless Lux Co’s shareholder (e. g. U.S.
Co) qualifies for the zero rate which
100 %
depends on the U.S.-Germany tax treaty.
Dutch Co
100 %
German Co
46
Example – Denial of Derivative Benefits
US Co
Suppose that Lux Co does not have sufficient
100 %
substance
Bermuda Co is not entitled to treaty relief.
Bermuda Co
The fact that U.S. Co is entitled to treaty
relief under the U.S.-Germany tax treaty is
irrelevant for § 50 d (3).
100 %
If Lux Co fails the § 50 d (3) test, the
German domestic 21.1 % WHT rate
Lux Co
applies.
100 %
German Co
47
EU anti-treaty shopping provisions
• Art. 1 (2) EU P/S Directive and Art. 5 (1) Interest/Royalty Directive provide that the
Directive shall not preclude the application of domestic or agreement-based
provisions required for the prevention of fraud or abuse
• Even further, Art. 5 (2) Interest/Royalty Directive provides that member states may, in
the case of transactions for which the principal motive or one of the principal motives
is tax evasion, tax avoidance or abuse, withdraw the benefits of this Directive or
refuse to apply this Directive
• As per the ECJ, a national anti-abuse measure is compatible with EC law only if the
measure is proportionate and serves the specific purpose of preventing wholly
artificial arrangements
– Taxpayer must be given the opportunity to rebut a presumed abuse
– The objective of minimizing ones tax burden does in itself not constitute abuse
– § 50 d (3) ITA is thus not compatible with EC law in as far the benefits of the Directives are
denied to a foreign company not being a wholly artificial arrangement
48
Overview of U.S. Limitation on Benefits Provisions
and Policy Considerations
49
Overview of U.S. International Tax Rules
Qualification for treaty benefits (in general)
• Recipient must be the beneficial owner of the income
• Must be a resident of one of the treaty states (liable to tax)
– What if distributions to shareholders deductible and no tax paid by entity?
– What if country exempts income of investment company from taxation?
• Limitation on benefits (treaty shopping)
• U.S. Code overlay (e.g., section 894(c) and Treasury regulations)
50
Overview of LOB provisions in U.S.-Germany Treaty
LOB Tests
A resident must be a qualified person:
• Individual
• Contracting State
• Publicly traded company or subsidiary test
• Charitable, religious, etc. entity
• Pension entities meeting certain tests
• Company meeting base erosion and ownership test
• Derivative benefits test
• Active trade or business test
• Competent Authority ruling
51
Overview of LOB provisions in U.S.-Germany Treaty
LOB: Publicly Traded Company Test
• Substantial presence requirement for publicly traded company
(Art. 28(2)(c)(aa))
– Response in part to corporate inversions
– Requires, in addition to the company’s principal class of
shares (and any disproportionate class of shares) being
“regularly traded” on “recognized stock exchanges,” meeting
either of 2 different requirements
52
LOB: Publicly Traded Company Test (cont’d)
• Alternative Requirement 1: principal class of shares must be “primarily
traded” on exchange in contracting state of company’s residence
– In United States, test met if such trading exceeds trading on exchanges in
any other single country (§ 1.884-5(d)(3))
– Contrast protocols with Denmark, Finland and Sweden: exchanges could
be in EU, EEA and NAFTA.
• Alternative Requirement 2: “primary place of management and control” must
be in country of residence
– place where “executive officers and senior management employees
exercise day-to-day responsibility” for “the strategic, financial and
operational policy decision making” for the group
53
LOB: Publicly Traded Company Test (cont’d)
– such activity in company’s residence country must exceed
similar activity in any other country
– most of day-to-day activities of supporting staff also must be
there
– Note: under German domestic law, a German corporation
must have its primary place of management in Germany in
any event
54
LOB: Subsidiary of Publicly Traded Company Test
• New rule for subsidiaries of publicly traded companies
– At least 50% of voting power and value of shares owned
directly or indirectly by 5 or fewer companies meeting the
publicly traded company test
– If indirect, each intermediate owner must be resident of
either contracting state
55
LOB: 50% Ownership/Base Erosion Test
• First, at least 50% of each class of shares/interests of resident entity is owned
directly or indirectly by eligible residents that are (1) individuals, (2) publicly
traded companies (meeting the substantial presence test), (3) religious,
charitable, educational, etc. orgs., or (4) pension funds
– On at least half of days of year
– If indirect, each intermediate owner must be resident of same contracting
state
– Note that unlike U.S. treaties generally a U.S. “resident” individual does
not include all U.S. citizens and greencard holders; additional presence
requirement (art. XVI(2)(a))
56
LOB: 50% Ownership/Base Erosion Test (cont’d)
• Second, less than 50% of gross income paid as deductible
payments to noneligible persons
– does not provide for deduction of arm’s length ordinary
course payments for services or tangible property
– does not provide that gross income is as determined by
residence contracting state (contrast recent U.S. protocols
with Denmark, Finland and Sweden)
57
LOB – Active Trade or Business Test
• Resident is
1) engaged in active conduct of a trade or business (ATB) (other than an
investment business unless banking, insurance or securities by bank,
insurance company or registered securities dealer) in its country of
residence,
2) the item of income is derived in connection with or incidental to that
ATB, and
3) ATB activity in residence contracting state is “substantial” in relation to
the ATB activity in source contracting state
– Activities by persons “connected” to the resident (≥ 50% ownership
connection) are deemed performed by such resident
– No safe harbor for “substantial”
58
LOB: Derivative Benefits
• At least 95% of voting power and value of company’s shares
(and at least 50% of any disproportionate class of shares) is
owned by
– 7 or fewer persons who are residents of a country in the EU,
EEA or NAFTA and
– Entitled to all benefits under a comprehensive treaty between
such country and the source contracting state (or if such
treaty lacks a comprehensive LOB article, would be entitled
under the Protocol if residency were met) as an individual, a
contracting state or political subdivision, a publicly traded
company, a charitable org., or a pension fund,
59
LOB: Derivative Benefits (cont’d)
– Which, with respect to dividends, interest, royalties and
insurance premiums, provides no less favorable benefits in
respect of the relevant item of income (or an EU directive so
provides).
– Note: fact that owners may be publicly traded entities of
other treaty countries without meeting primary trading/place
of management tests) apparently is irrelevant
• Base erosion test must be satisfied with respect to equivalent
beneficiaries
• How to apply “equivalent beneficiary” requirement to dividends
where treaty with third country has no 0% rate?
60
LOB: Derivative Benefits (cont’d)
– MOU of U.S.-Netherlands Treaty at XVIII presents example of French
co. (qualifying for all benefits under U.S.-France Treaty) owning UK
company (qualifying only under active business provision of U.S.-UK
treaty) owning Dutch co. (potentially qualify under derivative benefits
provision of US-Netherlands treaty by reference to French owner) owning
US co. and concluding that the 5% dividend withholding is available.
– However, JCT Staff Explanation of U.S.-Netherlands Treaty states that
where Italian co. owns Dutch co. which owns U.S. co. and U.S. co. pays
dividend to Dutch co.; the Italian co. “is not an equivalent beneficiary”
for dividend withholding tax, which would imply 30% withholding.
61
LOB – Triangular Provision
• If income derived by an enterprise of a contracting state from
other contracting state
– is attributable to a PE in a third jurisdiction, and
– the combined tax paid in residence contracting state and 3rd
(PE) country is less than 60% of tax that would have been
payable in residence contracting state absent the PE,
– then, 15% source contracting state rate on any dividends,
interests and royalties attributable to such PE and
– other income from source contracting state is not eligible for
treaty relief
62
LOB – Competent Authority Relief
• If a resident is not entitled to some or all benefits under the
objective tests, CA of source CS may grant benefits
• Standard: “shall take into account” whether “one of [the
person’s] principal purposes” is obtaining benefits
• Must consult with other CA before denying benefits
63
Relationship of Art. 28 US-Germany tax treaty with § 50 d (3) ITA
ABC
Family
100 %
Dividends paid from GCo to U.S. HoldCo
US HoldCo would qualify for zero WHT under U.S.-
Germany tax treaty notwithstanding that U.S.
HoldCo is not engaged in an active trade since
100 % 100 % the active trade of the U.S. subs is attributed to
U.S. HoldCo.
US subs. Lux HoldCo § 50 d (3) excludes such attribution meaning
that U.S. HoldCo may not be entitled to the
100 % zero rate and in that case Lux HoldCo is denied
the zero rate as well (unless it passes the
substance-test)
German Co
64
LOB Provisions in Other German Treaties
• No comprehensive LOB provision in any other German treaty
– Former LOB provision in the Swiss-Germany treaty replaced with effect as of 2003 with a
provision allowing either country to apply its domestic anti-abuse provisions
• Numerous other provisions in German tax treaties limiting specific treaty benefits
– Excluding specific entities from treaty benefits (e.g., 1929 Luxembourg Holding Company)
– Excluding the applicability of the exemption method earned by a domestic taxpayer from
foreign sources (e.g., dividends received from a Swiss subsidiary earning passive
investment income)
– Remittance clause (e.g., a UK resident is entitled to relief from German withholding tax
only if and when the German source income is remitted and taxed in the UK)
65
Related Treaty Provisions
66
U.S.-Canada Treaty Example
• Article XXIX A of the US-Canada Income Tax Treaty provides:
It is understood that this [Limitation of Benefits] Article shall not be
construed as restricting in any manner the right of a Contracting State to
deny benefits under this Convention where it can reasonably be
concluded that to do otherwise would result in an abuse of the provisions
of this Convention.
• The LOB Article was originally unilateral, but was retained in the 2007 5th
Protocol that, when effective, would extend the Article to investment into
Canada.
67
U.S.-UK Treaty Example – Targeting Repo
Transactions
• Article 24(4)(c) of the US-UK income Tax Treaty provides:
c) United States tax shall not be taken into account under sub-paragraph (b) of this
paragraph for the purpose of allowing credit against United Kingdom tax in the
case of a dividend paid by a company which is a resident of the United States if
and to the extent that
(i) the United Kingdom treats the dividend as beneficially owned by a
resident of the United Kingdom; and
(ii) the United States treats the dividend as beneficially owned by a
resident of the United States; and
(iii) the United States has allowed a deduction to a resident of the United
states in respect of an amount determined by reference to that dividend.
• Above anti-arbitrage provision targeting certain “repo” transactions in which
e.g. USco sold stock to UKco with agreement to buy back in 5 years, which
were treated as stock purchases (followed by resales) for UK purposes and
secured loans for US tax purposes.
68
U.S.-UK Treaty Example – Targeting Conduit Arrangements
• Dividend, Interest and Royalty Articles deny protection to payments to
“conduit arrangements.”
n) The term “conduit arrangement” means a transaction or series of
transactions:
(i) which is structured in such a way that a resident of a
Contracting State entitled to the benefits of this Convention receives an
item of income arising in the other Contracting State but that resident
pays…all or substantially all of that income…to another person who is
not a resident of either Contracting State and who, if it received that item
of income direct from the other Contracting State, would not be
entitled…to benefits with respect to that item of income which are
equivalent to, or more favorable than, those available under this
Convention to a resident of a Contracting State; and
(ii) which has as its main purpose, or one of its main purposes,
obtaining such increased benefits as are available under this Convention.
69
Article 23(4) of the U.S.-Germany Tax Treaty – Switch Over
Provision (1)
• In principle, Germany applies the exemption method for income earned by a
German resident from a U.S. permanent establishment, U.S. real estate,
dependent services performed in the United States and from certain dividends
paid by U.S. corporations
• As an exception, Germany switches over from the exemption method to the
credit method
– where the United States (also) exempts the U.S. source income from its
tax
– where Germany has notified the United States that it wishes to apply the
credit method
70
Article 23(4) of the US-Germany Tax Treaty – Switch Over
Provision (2)
• Purpose: German residents should not escape foreign and German tax on
foreign source income
• Provision is applicable to German residents only
• Goes beyond article 28 (LOB) as it applies only to residents that have
overcome the LOB provision
• Provision is supplemented by domestic rules calling for a switch over
overriding treaty-based exemption from German income tax
71
Hybrids and Fiscally Transparent Entities in Treaties
U.S.-Germany Treaty
Article 1 (General Scope), paragraph 7:
“In the case of an item of income, profit or gain derived by or
through a person that is fiscally transparent under the laws of
either Contracting State, such item shall be considered to be
derived by a resident of a State to the extent that the item is
treated for the purposes of the taxation law of such State as the
income, profit or gain of a resident.”
•See also section 894 of the U.S. Code
72
Hybrids and Fiscally Transparent Entities in Treaties (cont’d)
U.S.-Netherlands Treaty
Article 24 (Basis of Taxation), paragraph 4:
“In the case of an item of income, profit or gain derived through
a person that is fiscally transparent under the laws of either
State, such item shall be considered to be derived by a resident
of a State to the extent that the item is treated for the purposes of
the taxation law of such State as the income, profit or gain of a
resident.”
73
Proposed U.S. Anti-Treaty Shopping Provisions
H.R. 3140 (DOGGETT BILL)
• Adds new Section 894(d)
• Withholding tax rate on deductible payments (interest, royalties)
by U.S. corporations to related (50%) foreign affiliates is higher
of:
-Rate applicable to payments made to foreign parent of the
affiliated group (taking into account any relevant treaty),
or
-Rate otherwise applicable on payment made to the foreign
affiliate
• Effect on existing treaties?
74
Proposed U.S. Anti-Treaty Shopping Provisions
H.R. 3140 (DOGGETT BILL)
• Under the U.S.-Netherlands Treaty,
zero U.S. withholding tax applies.
Japanese Co.
• Under the U.S.-Japan treaty, 10% U.S.
withholding tax applies.
Dutch U.S. • Under the Doggett Bill, 10% rate
Co. Interest Co. would apply to the interest payment
from U.S. Co. to Dutch Co. No
reduction in U.S. withholding tax.
75
Proposed Anti-Treaty Shopping Provisions
H.R. 3970 (RANGEL BILL)
• Adds new Sections 894(d)
– Withholding tax on deductible related party payments may
not be reduced under a treaty unless it would be reduced
under a treaty if payments were made to foreign parent
– Takes into account treaty conflicts
• Both bills attempt to deal with stripping out payments not
“adequately” or “fairly” taxed
76
H.R. 3970 (RANGEL BILL) Example 1
• Under the U.S. - Netherlands Treaty,
Japanese Co. 0% U.S. withholding tax applies.
• Under the U.S. – Japan Treaty, 10%
U.S. withholding tax applies.
Dutch U.S. • Under the Rangel Bill, Dutch Co.
Co. Interest Co. receives benefit of 0% withholding
because a treaty reduction would have
been applicable if the payment were
made to the Japanese parent.
77
H.R. 3970 (RANGEL BILL) Example 2
• Under the U.S.-Portugal Treaty,
10% U.S. withholding applies.
Brazilian Co.
• No income tax treaty between
United States and Brazil.
• Under the Rangel Bill, the
Portuguese
U.S. Co. withholding tax rate is 30% on the
Co. Interest interest payment from the U.S. Co.
because there would be no
reduction if the payment were
made to Brazilian parent.
78
Effect of Treaty Provisions on Structuring
International Holding Companies
79
Prévost Car Case – Tax Court of Canada
Volvo Bussar A.B. Henlys Group PLC
(Volvo) (Henlys)
SWEDEN U.K.
51% 49%
Prévost Holding B.V.
(PHB.V.)
NETHERLANDS
100%
Prévost Car Inc.
(Prévost)
CANADA
• Prévost Car Inc. v. Her Majesty The Queen, 2008 TCC 231 (April 22, 2008).
• Question Addressed: “beneficial owner” of dividends under Article 10(2) of the
Canada-Netherlands Tax Treaty.
• Held for taxpayer. 80
Holding Company Structure for Multinational Group
US
Belgium
EU Opcos
• 0% w/h on dividends to Belgco and to USco.
• 95% participation exemption under CIT regime in Belgium on dividends received from EU Opcos (unless tax
haven or special regime), so 1.7% tax rate (33.99% on 5% of dividend, reduced by deduction).
• 100% participation exemption under CIT regime in Belgium on gains from sale of EU Opcos (unless tax haven
or special regime).
81
Holding Company Structures for MN Group or Private Equity
US
or
PE Fund (LLC/tax haven/nontreaty)
Cyprus
Netherlands
EU Opcos
• No dividend w/h tax on distributions from EU Opcos or from Dutch BV or from Cyprusco.
• 100% participation exemption from corporate income tax (CIT) on gains and dividends in
Dutchco (assuming EU Opcos are in active business or taxed at ≥ 10%) and in Cyprusco.
82
Holding Company Structures for MN Group or Private Equity
(Cont.)
US
or
PE Fund (LLC/tax haven/nontreaty)
Netherlands Cooperative
or Luxembourg
EU Opcos
• No dividend w/h tax on distributions from EU Opcos or from Dutch Cooperative or
(alternatively, from Luxco).
– In the case of Luxco, distributions are in legal form payment on convertible preferred equity certificates
(CPECs), which are debt for Lux purposes but equity for US tax purposes.
• 100% participation exemption from CIT on sale gains and dividends in Dutch Cooperative
(assuming EU Opcos are in active business or taxed at ≥ 10%) (and, alternatively, in Luxco
(assuming ≥ 12 month holding period)).
83
Holding Company Structure for Investment into China
US
Belgium
Hong Kong
China
• Sale by HKco is free of Chinese capital gains tax provided HKco holds 25% or less of Chinaco.
• Dividends from Chinaco are subject to 5% w/h tax.
• Dividends (net of expenses) is taxed in Belgium at 1.7% (95% participation exemption; 33.99%
rate on balance). Gains are fully exempt.
• No w/h tax on dividends from HKco or (assuming ≥ 10% USco ownership of voting stock)
Belgco.
84
Holding Company Structure for Investment into China
US
Ireland
China
• Sale by Irishco is free of Chinese Capital gains tax.
• Dividends from Chinaco are subject to 5% w/h tax.
• Dividends are taxable in Ireland at 12.5% rate, with a credit for taxes paid by Chinaco and for
the 5% w/h tax.
• Gain on sale of China shares are exempt under participation exemption.
• No dividend w/h tax from Irishco to USco.
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