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At a public forum in April 2021, a Treasury official stated the United States desires to amend existing income tax treaties with Switzerland and Israel, and that the United States has opened tax treaty negotiations with Colombia, has completed tax treaty negotiations with Norway and Romania, and is engaged in ongoing tax treaty discussions with Croatia.
This treaty activity contrasts with recent US tax treaty history, where, in 2019, following a lengthy hiatus in the tax treaty approval process, four US tax treaty protocols, which had been negotiated and signed years before, entered into force. (For discussion of these protocols, see PwC Insight, US Senate approves four treaty protocols, July 18, 2019.) In addition, three additional pending US income tax treaties – with Chile, Hungary, and Poland – that also were negotiated and signed several years ago, remain pending. The timing for Senate action on those treaties remains uncertain and those treaties may require further renegotiation. (For discussion of these pending treaties, see PwC Insights, The US tax treaty landscape at the start of 2020: What US inbounds need to know, January 30, 2020.)
Action item: US income tax treaties significantly affect US inbound investment. Treaties provide global companies headquartered outside the US (‘inbound companies’) with opportunities to effectively manage their international tax burdens, but their access to favorable treaty benefits could present certain challenges in terms of eligibility, especially as tax treaties are updated. Inbound companies should evaluate the current state of play for tax treaties on which they currently rely, and how future tax treaty changes could impact their US inbound investments.
Pending new income US income tax treaties with Chile, Hungary, and Poland have not yet been resubmitted to the Senate for approval. Those treaties were submitted to the Senate for consideration during the previous Congress, but did not progress through the Senate ratification process due to Treasury concerns that these tax treaties could be viewed as overriding the Section 59A base erosion and anti-abuse tax (BEAT), which was enacted as part of the 2017 tax reform act. The Treasury Department proposed BEAT reservations to these tax treaties intended to make clear that the treaties do not override the BEAT rules, but those treaty reservations faced Senate resistance. As a result, the timing for Senate consideration of these pending treaties, which, in the case of Hungary and Poland, would replace existing US treaties with those countries, is uncertain; those tax treaties may require further renegotiation by the Treasury Department with those countries to address those BEAT concerns.
The US model tax income treaty is the baseline text Treasury uses in negotiating tax treaties. The pending tax treaties with Chile, Hungary, and Poland discussed above were negotiated based on the 2006 version of the US model income tax treaty. In 2016, the Treasury Department (under the Obama Administration) issued an updated US model income treaty (see PwC Insight, Final US Model Income Tax Treaty could significantly reduce access to treaty benefits, February 29, 2016).
Observation: The 2016 US model income tax treaty generally has been viewed as containing overly restrictive limitation on benefits provisions that limit access to treaties even in the case of some common business structures. Future treaty changes that incorporate these restrictive treaty policies could impact these structures.,
Since the 2016 US model income tax treaty was released, there have been several intervening events that may require this model tax treaty to be further updated, including the enactment of major U.S. tax reform in 2017 and changes in the Administration.
Observation: Given the significant impact of the 2017 tax reform act, we understand that the current Treasury Department continues to review the the 2016 US model tax treaty for necessary updates. (see PwC Insight, Tax reform readiness: Implications for US tax treaties, August 17, 2018).
Treaty eligibility for some companies may be affected by the United Kingdom’s withdrawal from the EU (Brexit). (See PwC Insights, The US tax treaty landscape at the start of 2020: What US inbounds need to know, January 30, 2020.) A resident of a country that is a party to a US tax treaty and wishes to avail itself of the benefits of the treaty generally must satisfy the treaty’s anti-treaty-shopping provisions in the limitation on benefits (LOB) article. Companies sometimes meet this test based on ultimate ownership by an owner that, under a US tax treaty with the owner’s country of residence, would qualify for an equivalent benefit if the US income were paid directly to that owner (an ‘equivalent beneficiary’), as well as by satisfying a base-erosion test. This is the ‘derivative benefits’ test. A qualifying owner for this purpose is described in several treaties by reference to a US, Mexican, or Canadian tax resident being a resident of a country that is a party to the North American Free Trade Agreement (NAFTA) or a European owner being a resident of an EU member state.
As of July 1, 2020, NAFTA was replaced by the United States-Mexico-Canada Agreement (USMCA). On May 19, 2020, in anticipation of the entry into force of the USMCA, Treasury and the IRS issued, on a unilateral basis, Announcement 2020-06, indicating that upon the USMCA's entering into effect, for the purpose of applying an applicable US income tax treaty, Treasury and the IRS, including the US Competent Authority, believe that any reference to the NAFTA in a US bilateral income tax treaty should be interpreted as a reference to the USMCA. (See PwC Insights, Treasury to interpret references to NAFTA as references to USMCA for certain tax treaty purposes, May 20, 2020.) Thus, companies satisfying the LOB requirements based on ownership by a US, Mexican, or Canadian owner under the derivative benefits test – e.g., US-based multinationals that have foreign subsidiaries relying on US treaty benefits based on the parent being a publicly traded US tax resident – can continue to be viewed as otherwise satisfying the test.
As discussed by a representative of the IRS at a public forum in May 2021, the issue related to Brexit poses more of a challenge and may not be resolved in a similar manner. In the absence of any unilateral guidance (such as an IRS notice) or bilateral agreement (such as a competent authority agreement), or a renegotiation of the relevant treaties – none of which has occurred to date – a UK company that has been an equivalent beneficiary with respect to a subsidiary resident in another jurisdiction with an applicable US tax treaty no longer may be deemed to meet that definition.
Observation: Companies relying on a UK company being a resident of an EU-member state for the purposes of the derivative benefits test of a treaty (either as an owner or as a recipient of a deductible payment) should evaluate the ability to claim treaty benefits.
Observation: An affected taxpayer potentially may seek a discretionary grant of treaty benefits from the US competent authority. However, this often is a lengthy process, and involves demonstrating to the satisfaction of the competent authority that the standards for such benefits are satisfied, which may be a detailed and time-consuming process.
Treasury is actively negotiating and/or renegotiating US income tax treaties. The timing of future changes to tax treaties is uncertain and affected taxpayers are encouraged to stay up to date on these developments.
Observation: Among the items under discussion with respect to a renegotiated treaty with Switzerland may be the possible elimination of tax withheld at source on certain parent/subsidiary dividends, consistent with certain other more recent US tax treaties. However, along with updating the treaty to be more in line with current US tax treaty policy, we expect that such items also would include the potential revision of the LOB article to tighten the requirements for eligibility.
The United States has an extensive global network of bilateral income tax treaties that has evolved over the years and continues to evolve. For about a decade, the treaty ratification process had been stalled. Although a few of the pending treaty protocols advanced through the process and entered into force in 2019, various factors have kept the pending treaties with Chile, Poland and Hungary from advancing toward ratification. There are several other treaty negotiations and discussions underway regarding potential new tax treaties (e.g., Colombia and Croatia), modernizing older treaties (e.g., those with Switzerland and Israel), and completion of renegotiations (e.g., Norway and Romania).
It appears that updating existing treaties and expansion of the US tax treaty network may be a priority (albeit one of many) for the Biden Administration. The greater certainty afforded by tax treaties for mitigation of excessive taxation or double taxation is an area of importance to global companies doing business in the United States and can be a critical determinant for non-US companies investing in the United States.