Corporate Tax 2010 - BMR Advisors

Chapter 49
USA
Stephen L. Gordon
Cravath, Swaine & Moore LLP
Andrew W. Needham
1 General: Treaties
1.4 Do they generally incorporate anti-treaty shopping rules (or
“limitation of benefits” articles)
1.1 How many income tax treaties are currently in force in the
United States
The U.S. currently has 59 bilateral income tax treaties in force
covering 67 countries. These countries include nearly every
member of the European Union, Canada, Mexico, China, Japan,
Australia and New Zealand. Although the U.S. has a treaty with
Bermuda, the Bermuda treaty is available only to non-U.S.
insurance and reinsurance companies.
1.2 Do they generally follow the OECD or another model
The United States generally follows the U.S. model income tax treaty,
most recently modified in 2006, which is similar but not identical to
the OECD model treaty. There are several notable differences
between the U.S. model and the OECD model. For example, the U.S.
model includes a “limitation of benefits” article (see question 1.4)
and a “savings clause” that prevents U.S. citizens and residents from
using the treaty to avoid taxation of U.S. source income. Although
the United States uses the U.S. model rather than the OECD model
treaty as the basis for negotiating new or amended treaties with other
countries, the U.S. model technical explanation notes that the
development of the 2006 U.S. model took into account the OECD
model and deliberately adopted many OECD model provisions.
The U.S. model lags behind some of the current U.S. negotiating
positions on treaty articles. For example, although not reflected in
the U.S. model, a trend has developed in U.S. treaties in favour of
a zero rate of withholding on dividends paid by a U.S. affiliate to its
foreign parent, subject to certain stock ownership requirements.
1.3 Do treaties have to be incorporated into domestic law
before they take effect
No. Although not incorporated into domestic law, treaties have the
force of federal law, and preempt state and local law (see question
1.5). Under the U.S. Constitution, the President makes treaties, and
the Senate must advise and consent to their ratification by a twothirds
vote. In practice, tax treaties are negotiated by the Treasury
Department, signed by a representative of the executive branch
(usually the Secretary of State or a U.S. Ambassador), signed by the
President, and sent to the Senate for ratification. Once the other
Contracting State carries out its corresponding internal procedures,
instruments of ratification are exchanged between the Contracting
States.
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Yes. Most United States treaties incorporate a limitation of benefits
(“LOB”) article. The purpose of the LOB provision is to prevent
bilateral treaties from conferring benefits on persons that do not
have a sufficient relationship to one of the Contracting States, i.e.,
persons other than “qualified persons”. The definition of qualified
person varies widely among different treaties. In the U.S. model
treaty, a qualified person includes an individual, a publicly-traded
corporation and subsidiaries that meet certain trading and
ownership requirements, as well as certain tax-exempt
organisations, pension funds, trusts, estates, partnerships, and other
companies. In some treaties, a resident of a Contracting State that
is not a qualified person may be entitled to claim treaty benefits
with respect to certain items of income derived from one State if it
is derived in connection with the active conduct of a trade or
business in the other State. In general, LOB provisions in more
recent U.S. treaties are more restrictive than those negotiated in
earlier treaties.
In addition to the LOB articles included in U.S. treaties, the United
States has authority to limit treaty-shopping by statute and under the
common law. These include anti-conduit and hybrid entity
regulations, as well as certain case law anti-abuse doctrines.
1.5 Are treaties overridden by any rules of domestic law
(whether existing when the treaty takes effect or
introduced subsequently)
Yes. A treaty may be overridden by a domestic law enacted after a
treaty takes effect. Under the U.S. Constitution, and as restated in the
Internal Revenue Code, treaties and federal statutes have the equal
force of law; in general, therefore, the one enacted later in time will
prevail. When possible, a U.S. court will attempt to construe statutes
to avoid any conflict with the terms of ratified treaties and vice versa.
In the case of a direct conflict, however, a later-in-time federal statute
will override the provisions of a ratified treaty. For example, in 1980
the Foreign Investment in Real Property Tax Act (“FIRPTA”)
introduced a tax on dispositions of foreign-owned real estate, and
explicitly overrode existing treaty provisions. More recently, rules
adopted to prevent “earnings stripping”, or deductions for certain
interest paid by a corporation to a tax-exempt or partially tax-exempt
related person, arguably contradict the non-discrimination article of
previously-enacted U.S. treaties.
Treaties preempt any inconsistent provision of state or local law.
By their terms, however, most treaties apply only to U.S. federal
income taxes.
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