Doing business in the United States: US tax treaties

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The United States has in place bilateral income tax treaties with more than 60 countries. The US government enters into such treaties for several reasons, including:

  • to encourage international trade and investment
  • to promote cooperation among countries in enforcing and administering tax laws
  • to promote information exchange
  • to reduce or eliminate double taxation and excessive taxation.
  • US income tax treaties typically cover various categories of income, including: 
    • business profits
    • passive income, such as dividends, interest, and royalties
    • income earned by teachers, trainees, artists, athletes, etc. 
    • gains from the sale of personal property
    • real property income
    • employment income
    • shipping and air transport income
    • income not otherwise expressly mentioned (i.e., other income).

The categories of income covered vary from treaty to treaty, and no two treaties are the same. Appendix A summarizes the benefits (reduced rates of tax collected through withholding) resulting from US tax treaties.

To be eligible for treaty benefits, it is necessary to satisfy the conditions of the residency article as well as certain other requirements including, importantly, when applicable, the limitation on benefits (LOB) article (discussed below). In general, an individual is treated as a resident of the country in which the individual is subject to tax by reason of domicile, residence, or citizenship. A corporation generally is treated as resident in the country in which it is subject to tax by reason of its place of management, place of incorporation, or similar criteria. US domestic rules contain provisions that address the treatment of the availability of treaty benefits to income received by fiscally transparent entities; some US treaties also address fiscally transparent entities.

The vast majority of US tax treaties contain LOB articles. LOB articles are anti-‘treaty-shopping’ provisions that are designed to deny treaty benefits when the party seeking the benefits does not have sufficient connection to the jurisdiction in which it is resident to support the application of the treaty. In recent years, the US Treasury has made it a priority to renegotiate the more commonly used treaties that did not have LOB articles. Two of those treaties — with Hungary and Poland — have been renegotiated but not yet ratified.

LOB articles provide objective tests (e.g., ownership-base erosion test, publicly traded company test) to determine whether an entity is appropriately claiming treaty benefits or was created merely to obtain treaty benefits. As new treaties are negotiated, the United States has been adding more restrictive provisions to the LOB tests; as a result, a company that is not engaged in treaty-shopping nonetheless may fail the tests. If objective tests are not met, a country’s competent authority may grant treaty benefits with respect to a specific item of income upon request by the taxpayer, if the competent authority determines that the establishment, acquisition, or maintenance of the entity and the conduct of its operations did not have as one of its principal purposes the obtaining of treaty benefits.

Inbound insight: In 2016, the US Treasury released a new version of the US Model Treaty, which is the starting point for US treaty negotiations. The 2016 Model Treaty reflects a shift in focus by the US Treasury in its treaty policy away from encouraging bilateral trade and investment and toward incorporating more restrictive provisions designed to prevent the use of income tax treaties to facilitate ‘stateless income.’ It is unclear whether treaty partners negotiating income tax treaties with the United States will be willing to accept such restrictive and complex LOB provisions, but residents of any country that is considering negotiating or renegotiating an income tax treaty with the United States should closely monitor the status of negotiations and analyze whether they could qualify for benefits under a treaty that incorporates the 2016 Model’s provisions.

The US tax treaty network includes treaties with most European countries and other major trading partners, including Mexico, Canada, Japan, China, Australia, and the former Soviet Union countries. There are many ‘gaps’ in the US tax treaty network, particularly in Africa, Asia, the Middle East, and South America. A new treaty with Chile was signed in 2010 but has yet to be ratified.

Inbound insight: Tax treaties reduce US tax collected through withholding to encourage foreign companies to invest in the United States. When both countries have the right to tax an item of income under the treaty, the treaty seeks to avoid double taxation by requiring one of the countries to allow a credit for the other country’s tax (or to exempt the income from its own tax).
Tax treaties help the US economy by allowing US companies to more efficiently conduct their businesses abroad and by making the United States more hospitable to foreign investment, which creates and sustains millions of American jobs.
No new US tax treaties or protocols have entered into force since 2010 due to objections raised by Senator Rand Paul (R-KY) about information-sharing agreements that are generally part of all US tax treaties. On October 29, 2015, the Senate held a hearing on eight treaties/protocols – those with Chile, Hungary, Poland, Japan, Luxembourg, Spain, and Switzerland, and a protocol to a multilateral treaty on mutual administrative assistance in tax matters – that were reported out favorably by the Senate Foreign Relations Committee on November 10, 2015, but have not yet been ratified by Congress. In addition, new treaties/protocols have been agreed to with Vietnam and Norway.

There are continued efforts to expand the network of countries that have adequate tax information exchange agreements with the United States. In addition to its bilateral income tax treaties, the United States currently is a party to over 30 tax information exchange agreements, which provide the legal basis for exchanges of information between tax administrations.

In addition, the US Treasury has signed many bilateral intergovernmental agreements (IGAs) related to the implementation of the FATCA information reporting and withholding provisions (discussed above).

On November 24, 2016, the OECD released the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). In brief, the MLI is an agreement among OECD member states to swiftly and cohesively amend each of their bilateral tax treaties to give effect to the OECD’s BEPS project. Although the United States participated in the discussion process, the United States has not signed the MLI.

Inbound insight: As noted in the state and local tax discussion above, states are not restricted in their taxing powers by federal limitations such as ‘engaging in a trade or business,’ having a ‘permanent establishment,’ or treaty restrictions.
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Christopher Kong

Leader, US Inbound Tax

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