2. Introduction and Overview. Recent More Restrictive LOB ProvisionsKey Provisions in the Pending Canada/U.S. ProtocolOther U.S. Tax Treaty DevelopmentsAudit Activity Update on Form 1120-FForm W-8BEN Common Validation Issues and Proposed Changes. 3. Recent More Restrictive LOB Provisions. Base
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1. 1 U.S. Inbound Treaty Developments: Traps for the Unwary
2. 2 Introduction and Overview Recent More Restrictive LOB Provisions
Key Provisions in the Pending Canada/U.S. Protocol
Other U.S. Tax Treaty Developments
Audit Activity Update on Form 1120-F
Form W-8BEN – Common Validation Issues and Proposed Changes
3. 3 Recent More Restrictive LOB Provisions Based on recent U.S. treaties, there is a trend toward more restrictive limitation on benefits provisions, including those with respect to:
The Publicly Traded Test,
The Ownership-Base Erosion Test,
The Derivative Benefits Test,
The Active Trade or Business Test,
The Headquarters Company Test, and
The Triangular Rule.
These restrictions take on increased importance in light of the increasing takeover of publicly traded companies by private investment funds and companies inverting from their home jurisdiction.
4. 4 Recent More Restrictive LOB Provisions, continued The Publicly Traded Test
The company’s principal class of shares (and any disproportionate class of shares) must be regularly traded on one or more recognized stock exchanges and one of the following requirements must be met:
The company's principal class of shares is primarily traded on one or more recognized stock exchanges located in the Contracting State of which the company is a resident, or
The company's primary place of management and control is in its State of residence.
Under the subsidiary of a publicly traded company test, each intermediate owner must be a resident of one of the Contracting States.
5. 5 Recent More Restrictive LOB Provisions, continued The Ownership-Base Erosion Test
The test generally requires consideration of direct and indirect owners of the recipient of the income, and that at least 50 percent of these persons qualify for benefits of the treaty as individuals, government units, qualified pension plans or charities, or publicly traded companies.
However, recent treaties (e.g., U.S.-Belgium) also require the shares of the income recipient to be owned by residents of the Contracting State of which such income recipient is a resident.
For the base erosion part of the test, gross income must be determined based on the tax laws of the resident country.
6. 6 Recent More Restrictive LOB Provisions, continued The Derivative Benefits Test
An equivalent beneficiary includes a person who would be entitled to the same benefits under another treaty with a comprehensive LOB provision for the same item of income, but only if it would be treated as a qualified person under similar LOB treaty provisions applicable to individuals, governmental units, qualified pension plans or charities, or publicly-traded companies.
Ambiguity exists as to whether residents of the source country are good owners.
Although the test may be applied by looking at direct or indirect ownership, for purposes of determining whether a person is an equivalent beneficiary, only the status of the “person” in question is analyzed.
7. 7 Recent More Restrictive LOB Provisions, continued The Active Trade or Business Test
Recent treaties (e.g., U.S.-Belgium treaty) explicitly provide that whether a trade or business activity is substantial will be determined based on all the facts and circumstances (i.e., no safe harbor test is provided, as in the U.S.-Dutch treaty).
Activities conducted by persons "connected" to such person shall be deemed to be conducted by such person.
Persons are "connected" to one another if:
One possesses at least 50 percent of the beneficial interest (or, in the case of a company, 50 percent of the aggregate voting power and 50 percent of the aggregate value) in the other, or
8. 8 Recent More Restrictive LOB Provisions, continued The Active Trade or Business Test, continued
Another person possesses, directly or indirectly, at least 50 percent of the beneficial interest (or, in the case of a company, 50 percent of the aggregate voting power and 50 percent of the aggregate value in the company) in each person.
A person also is considered to be connected to another if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same person or persons.
Substantiality requirement for related party payments.
Qualification is analyzed for each item of income in respect of which treaty benefits are claimed.
9. 9 Recent More Restrictive LOB Provisions, continued The Headquarters Company Test
Often a difficult test to meet because the test generally requires that a treaty benefit claimant meet a number of requirements regarding active business operations and gross income.
10. 10 Recent More Restrictive LOB Provisions, continued The Triangular Rule
The Triangular Rule addresses fact patterns in which the income of a company resident in one of the Contracting States is attributable to a Permanent Establishment located in a third jurisdiction and, by virtue of its attribution to that PE is subject to reduced or no taxation in the home country.
Found in U.S. treaties with in Germany, Iceland, Luxembourg, Sweden, Denmark, Finland, and Belgium.
Generally denies treaty benefits where, for example, U.S. source income derived by a German resident in respect of which treaty benefits are claimed is attributable to a PE of the German resident in a third country, but only if:
11. 11 Recent More Restrictive LOB Provisions, continued … continued
The combined rate of tax imposed on such income in Germany and the country in which the PE is located is less than 60% of the tax that would be imposed on such income in Germany if it were derived directly by the German resident (i.e., not through the third country PE).
For dividends, interest, and royalties, a 15% U.S. withholding tax applies.
Exceptions exist for:
Royalty income attributable to intangible property produced or developed by the PE itself; and
Other income, where the PE is engaged in the active conduct of a trade or business in the third country.
12. 12 Treaty with Brother-Sister Company (Example) Limitation on Benefits (e.g., Belgium/U.S.
Publicly Traded Test (Article 21(2)(c)).
Not met since US Sub is not publicly traded, and its publicly traded parent is not a resident of the United States or Belgium.
Active Trade or Business (Article 21(4)).
The Trade or Business must be conducted in the United States, and the income from Belgian Sub must be “connected.”
Derivative benefits/equivalent beneficiaries (Article 21(3)).
Might be met with respect to an item of income derived from Belgian Sub. The base erosion test must be met.
13. 13 Key Provisions in the Pending Canada/U.S. Protocol The Canadian government finalized legislation to implement the protocol to the Canada-U.S. income tax convention on December 14, 2007.
The next steps are for the U.S. Congress to approve it, and then for each of the two countries to formally notify each other that their approval processes are complete.
The Protocol makes major changes, both positive and negative, including:
Zero withholding on interest (for both related and unrelated party interest).
Phase-in period for exemption from withholding tax on interest.
Binding mandatory arbitration (similar to Germany and Belgium).
14. 14 Key Provisions in the Pending Canada/U.S. Protocol, continued Entirely new Limitation on Benefits Article:
Conversion to bi-lateral (now it only applies to Canadian companies claiming U.S. benefits);
Scope of competent authority power under Article XXIX A(7) (discretionary right to deny treaty benefits if it would result in an abuse of the treaty).
Controversial, precedent setting, denial of treaty benefits to certain hybrid and reverse hybrid structures.
Controversial deemed PE rule for companies performing services if employees are present in host country for 183 days.
15. 15 Key Provisions in the Pending Canada/U.S. Protocol, continued Deemed PE where either:
Services are performed in the other State by an individual who is present there for a period or periods aggregating at least 183 days in any 12-month period and, during that period, more than 50% of the gross active business revenues of the enterprise are attributable to services performed by that individual in that other State; OR
Services are provided in that other State for an aggregate of at least 183 days in any 12-month period with respect to the same or connected project for customers who are either residents of that other State or who maintain a PE there and the services are provided in respect of that PE.
16. 16 Key Provisions in the Pending Canada/U.S. Protocol, continued New provision inserted at Canada’s request because of the CRA’s loss in Dudney.
U.S. Treasury Department strongly opposed to such provisions, but conceded because of the elimination of withholding tax on interest.
Delayed 3-year effective date. Art. 27(3)(c) of Protocol.
Meaning of “connected project”?
Exchange of Notes provides that projects will be considered to be “connected” if “they constitute a coherent whole, commercially and geographically.”
2008 OECD Draft Model Tax Convention and existing commentary under Article 5 (¶¶ 5.3 - 5.4) may provide some guidance.
17. 17 Provision of Services – U.S. Investing into Canada Does USCo have a PE in Canada?
USCo’s employee is deemed to be a PE of USCo in Canada if:
The individual is present in Canada for at least 183 days in any 12-month period, and
During that period of time, more than 50% of USCo’s gross “active business revenues” relates to income derived from the services performed by the individual.
18. 18 Provision of Services – U.S. Investing into Canada Does USCo have a PE in Canada?
USCo’s employees will be deemed to be a PE of USCo in Canada if:
Services are being provided in Canada for at least 183 days in any 12-month period in respect of the “same or connected project,” and
The services are provided to customers who are residents of Canada or who have a PE in Canada.
19. 19 Key Provisions in the Pending Canada/U.S. Protocol, continued Fiscally Transparent Entities
Benefits Granted – New Article IV (6):
Intended to address the CRA’s long-standing position of denying treaty benefits for U.S. investors investing into Canada through a U.S. LLC.
Example: Income Is Derived by Resident of U.S. and Therefore Is Eligible for Treaty Benefits if Derived Through Non-Canadian Entity That U.S. Considers Fiscally Transparent.
Result: Canada Gives Treaty Benefits for Canadian Source Income Paid to Disregarded U.S. LLC Owned By U.S. Residents.
Effective Date: As to Withholding Taxes, 1st Day of Second Month Beginning After Date Treaty Enters into Force.
20. 20 Treaty Benefits Granted to U.S. LLCs – New Article IV (6) Current treaty
Even if U.S. LLC transparent for U.S. tax purposes, 25% Canadian WHT on dividends.
If U.S. LLC members are U.S. residents
15% on dividends (possibly 5% if owner is a company and indirect ownership >=10%). See Art. X(2)(a) (as amended by the Protocol).
21. 21 Pending Canada/U.S. Protocol: Residence Article, continued Fiscally Transparent Entities
Benefits Denied – New Article IV (7)(a):
Adopts principles similar to I.R.C. § 894(c) into the Treaty.
Possible application to U.S. trade or business income?
Example: Income Not Derived by Resident of U.S. and Not Eligible for Treaty Benefits if Derived Through Non-U.S. Entity That U.S. Considers non-Fiscally Transparent
Result: Canada Denies Treaty Benefits for Canadian Source Income Paid to Non-U.S. Entity Owned By U.S. Resident That Is Not Subject to Current U.S. Tax When Paid
Effective Date: Prospective - First Day of Third Calendar Year Ending After Date Treaty Enters into Force. Example: Effective January 1, 2010 If Treaty Enters into Force in 2008.
22. 22 Treaty Benefits Denied – New Article IV (7)(a) – Example Current Rules
Interest subject to 10% WHT.
Not currently taxable in U.S. as CanLP treated as Canadian corporation for U.S. tax law.
USCo derives interest through CanLP, which is not U.S. resident.
CanLP not fiscally transparent in U.S., so interest not taxed as if received by USCo directly (i.e., no current U.S. tax on interest).
Result ? 25% WHT on interest.
23. 23 Pending Canada/U.S. Protocol: Residence Article, continued Fiscally Transparent Entities
Benefits Denied – New Article IV (7)(b)
Example: Income Not Derived by Resident of U.S. and Not Eligible for Treaty Benefits if Derived Through Canadian Resident That U.S. Considers Fiscally Transparent
Result: Canada Denies Treaty Benefits for Canadian Source Income Paid to U.S. Resident By Canadian Corporation That Is Disregarded for U.S. Purposes Because Not Subject to Current U.S. Tax When Paid
Effective Date: Prospective - First Day of Third Calendar Year Ending After Date Treaty Enters into Force. Example: Effective January 1, 2010 If Treaty Enters into Force in 2008.
24. 24 Treaty Benefits Denied – New Article IV (7)(b) – Example 1 Current Rules
Interest paid by NSULC subject to 10% WHT.
Disregarded in U.S. as NSULC considered branch of USCo.
Under Canadian law, USCo considered to receive interest from a Canadian resident (NSULC).
U.S. treatment of interest different than if NSULC were not treated as fiscally transparent (in which case interest taxable to USCo).
Result ? 25% WHT on interest.
25. 25 Treaty Benefits Denied? – New Article IV (7)(b) – Example 2 Current Rules
Dividends paid by NSULC subject to 5% WHT.
Under Canadian law, USCo considered to receive the dividends from a Canadian resident (NSULC).
Treatment of dividends for U.S. tax purposes different than if NSULC were not treated as fiscally transparent (in which case dividends would be taxable to USCo instead of disregarded).
Result ? 25% WHT on dividends?
26. 26 Treaty Benefits Denied? – New Article IV (7)(b) – Example 3 Partnership distribution by US LP (treated as dividend for U.S. tax purposes) subject to 30% U.S. withholding tax.
Interest payment by US LP should not result in a 30% U.S. withholding tax.
27. 27 Pending Canada/U.S. Protocol: Hybrid Provisions Germany (Protocol), New Article 1(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.”
U.K. Tax Treaty, Article 1 (8)
“An item of income, profit or gain derived through a person that is fiscally transparent under the laws of either Contracting State shall be considered to be derived by a resident of a Contracting State to the extent that the item is treated for the purposes of the taxation law of such Contracting State as the income, profit or gain of a resident.”
Netherlands (Protocol), New Article 24 (4), similar to U.K. Treaty.
New Belgium Treaty, Article 1(6), similar to U.S. Model Treaty.
28. 28 Pending Canada/U.S. Protocol: Elimination of Interest WHT Canadian Protocol will eliminate withholding tax on arm’s length and non-arm’s length (related party) interest.
Major benefit for payments to Canadian banks and related Canadian lenders.
Phase-out for non-arm’s length (related party) interest.
Contingent interest (i.e., interest that varies with debtor’s financial performance or distributions) will be subject to 15% withholding tax (up from 10%).
29. 29 Pending Canada/U.S. Protocol: Limitation on Benefits Provisions LOB article is now fully reciprocal (previously applied only to treaty benefits sought from the United States).
Entitlement to all the benefits of the treaty generally requires a person to be a “qualifying person”:
Publicly traded test – only U.S. and Canadian stock exchanges are currently included (Article 29A(2)(c)).
Exchange of Notes state that anti-inversion language could be added as a future amendment to the publicly traded test.
Subsidiary of a publicly traded company (Article 29A(2)(d)), but only if:
5 or fewer persons that meet the publicly traded test own directly or indirectly more than 50% of the vote and value of the shares.
TRAP FOR THE UNWARY: In the case of indirect ownership, each company in the chain of ownership must be a qualifying person.
30. 30 Pending Canada/U.S. Protocol: Limitation on Benefits Provisions Ownership and base erosion test (Article 29A(2)(e)):
50% or more of the vote and value of the company is owned, directly or indirectly, by qualifying persons
All intermediate owners also must be qualifying persons (“not owned, directly or indirectly, by persons other than qualifying persons”); and
Less than 50% of its gross income is paid as deductible expenses (determined by state of residence) to non-qualifying persons.
No exclusion for arm’s length amounts paid for services or tangible personal property, as in some other U.S. tax treaties.
31. 31 Pending Canada/U.S. Protocol: Limitation on Benefits Provisions Active conduct of a trade or business test (Article 29A(3)):
Applies where the person claiming benefits is not a “qualifying person” but that person (or a related person) is engaged in the active conduct of a trade or business (“ACTB”) in its state of residence;
The income derived from the other state in respect of which treaty benefits are claimed (e.g., dividends from a U.S. subsidiary) must be derived in connection with, or be incidental to, the ACTB in the state of residence;
The trade or business in the residence state is “substantial” in relation to the trade or business activity carried on in the source state.
32. 32 Pending Canada/U.S. Protocol: Limitation on Benefits Provisions Derivative benefits test (Article 29A(4)):
Applies where person claiming treaty benefits is not a “qualifying person”;
If satisfied, provides treaty benefits but only in respect of dividends, interest, and royalties, and not, for example, for PE protection purposes.
More than 90% of the Canadian (or U.S.) company’s shares must be owned, directly or indirectly, by persons each of whom is a “qualifying person” or a person who:
Is a resident of a country with which the United States (or Canada) has a comprehensive income tax treaty and is entitled to all the benefits under such treaty;
33. 33 Pending Canada/U.S. Protocol: Limitation on Benefits Provisions Derivative benefits test, continued
Would qualify for benefits as a “qualifying person” or pursuant to the ACTB test under the U.S.-Canada treaty if such person were a Canadian (or a U.S.) resident;
Would be entitled to a rate of tax in the United States (or Canada) under the treaty between the United States (or Canada) and that person’s country of residence, with respect to the particular class of income for which benefits are being claimed, that is at least as low as the rate applicable under the U.S.-Canada treaty; and
A base erosion test is satisfied (less than 50% of gross income paid, directly or indirectly, to non-qualifying persons): No carve-out for arm’s length deductible payments.
34. 34 Pending Canada/U.S. Protocol: Limitation on Benefits Provisions Competent Authority relief. Art. 29(6).
Discretionary denial of treaty benefits. Art. 29(7).
Included in the 1995 protocol at Canada’s request so that Canada could apply its domestic anti-avoidance laws (GAAR).
Now applies bilaterally, apparently even if a person otherwise qualifies for treaty benefits under the LOB article.
Scope of provision is unknown.
35. 35 Other U.S. Tax Treaty Developments Belgium, Germany, Denmark and Finland Ratification
Completed on December 28, 2007.
General entry into force date is January 1, 2008.
General entry into force for withholding tax is first day of second month (i.e., February 1, 2008).
Exception for Germany, which is retroactive for withholding tax purposes to amounts paid or credited on or after January 1, 2007.
Finnish Protocol is retroactive for parent/subsidiary dividends for dividends derived on or after January 1, 2007.
36. 36 Other U.S. Tax Treaty Developments, continued Common Themes
O% tax on dividends if 80% ownership and other criteria met.
More Restrictive Limitation on Benefits Article:
Publicly traded companies must also meet substantial presence test, based on where stock is traded or primary place of management.
Non-public companies must be 50% locally owned (plus meet base erosion test).
German and Belgian treaties contain binding arbitration provisions encouraging the tax authorities to resolve disputes over double taxation.
37. 37 Other U.S. Tax Treaty Developments, continued Treaties Without Limitation on Benefits Articles
Iceland: The Protocol was signed in October 2007 and will enter into force after ratification by both countries and exchange of instruments of ratification..
Hungary: A round of negotiations took place in February 2008 but there remains a long way to go, as the negotiators are working through an entirely new treaty.
Poland: Treasury claims it is a priority but has yet to hold a first round of negotiations.
Norway: The signing of a new agreement is expected “shortly” but additional change may be needed.
38. 38 Other U.S. Tax Treaty Developments, continued Other Updates
Bulgaria: New treaty expected to be sent to the Senate early this year to begin the ratification process.
Malta: Proposed income tax treaty has been initialed. It is awaiting signature.
Brazil, Chile, Singapore, and Vietnam: Exploratory discussions being conducted.
Italy: Treasury will be following up on the inaction by Italy on either accepting the new treaty signed in 1999 with the Senate Reservation or going back to the negotiation table.
France and New Zealand: Protocols to the treaties are in negotiation.
Spain: US-Spain AmCham is seeking to initiate changes to the current treaty.
39. 39 Form 1120-F Audit Update Two years ago the IRS initiated a project.
Conducted specialty training for LMSB and SB/SE international agents to examine “Protective forms 1120-F”.
120 returns were selected for examination by SB/SE and 40 returns by LMSB.
The IRS has not given up. They anticipate more 1120 activity next year due to e-filing of Forms 1120F.
Swallows Holding case was won on appeals.
40. 40 Common Validation Issues with Form W-8BEN U.S. address permanent resident and/or mailing address on form.
Withholding agent must obtain documentation to prove the beneficial owner is foreign (e.g., articles of incorporation).
Failure to provide a taxpayer identification number when beneficial owner is claiming a tax treaty benefit.
“Capacity in which acting” line on form:
Failure to complete line.
Entering a title that does not demonstrate sufficient authority to act on behalf of the beneficial owner.
Examples: manager, associate, secretary, authorized agent without a Power of Attorney being attached to form.
41. 41 When is a TIN Required on Form W-8BEN?
Generally, a TIN is not required on Form W-8BEN to:
Document the beneficial owner's status as foreign
Obtain a reduced rate of withholding on interest and dividends from actively traded securities.
Generally, a TIN is required to on Form W-8BEN to claim a reduced rate of withholding pursuant to an income tax treaty.
42. 42 Expiration of Form W-8BEN A Form W-8BEN without a TIN will be valid for the year in which the form is received plus 3 additional years, unless a change in circumstances occurs.
A Form W-8BEN with a TIN will remain valid indefinitely if a Form 1042-S is issued each year unless a change in circumstances occurs.
In practice, we recommend implementing the most stringent validation period because it will ensure consistent treatment and prevent errors that would subject the withholding agent to 30% withholding.
Re-solicit a new form every 3 years.
43. 43 Draft Form W-8BEN (July 2007) – Proposed Changes Foreign taxpayer identification number will be required.
Assists in validation of foreign status and sharing of information with other countries.
The IRS is working to provide guidance on the TIN format used by various countries.
Requires changes to systems and procedures.
Lines 4 and 5, the “do not abbreviate” language has been removed from the country section.
IRS has advised examiners to no longer reject forms because the country name has been abbreviated.
All forms in the Form W-8 series will be updated for this change.