When Can You Actually Claim Treaty
Benefits? Navigating the Thornier Issues of
the Limitation on Benefits Article
Moderator:
Jeffrey Rubinger, Bilzin Sumberg Baena Price & Axelrod LLP, Miami, FL.
Panelists:
Patricia A. Brown, University of Miami School of Law, Miami, FL;
Philip Wagman, Clifford Chance US LLP, New York, NY;
Henry Louie, Deputy to the International Tax Counsel (Treaty Affairs), Department
of Treasury, Washington, DC;
Karen J. Cate, Competent Authority Analyst, Internal Revenue Service,
Washington, DC.
Qualification for Treaty Benefits
• Must be a resident of a Contracting State within the
meaning of the treaty
• Satisfy the treaty's "Limitation on Benefits" (LOB)
provision
LOB Tests Applicable to Entities
(in Preferred Order)
• Publicly-traded companies (including
subsidiaries of publicly-traded companies)
• Derivative benefits
• Headquarters companies
• Active conduct of a trade or business
• Ownership/base erosion
• Competent authority discretion
Publicly-Traded Companies Primary Place of Management and
Control
Publicly-Traded Company Rule
• Originally, ownership presumption that applied
under ownership/base erosion test
• Conceptually, difficult to understand, particularly
because 1990’s treaties often included multiple
third-country stock exchanges as “recognized stock
exchanges”
– ALI argued that publicly-traded companies were
unlikely to engage in treaty-shopping
• Best understood as a practical provision to ensure
that major multinational corporations automatically
qualify under LOB
Primary Place of Management and
Control
• Introduced in 2004 Protocol to U.S.-Netherlands
treaty as part of anti-inversion provisions
• A publicly-traded company that is not primarily
traded in its State of residence (or economic
community of residence) will qualify for benefits only
if its primary place of management and control is in
its State of residence
• Conscious effort to develop a test that is not as
subject to abuse as “place of effective management”
Derivative Benefits Provision
Derivative Benefits, in General
• A company that does not satisfy any of the other LOB
tests may qualify for treaty benefits if a specified
percentage (typically 95 percent) of its shares is
owned, directly or indirectly, by seven or fewer
"equivalent beneficiaries" and a base erosion test is
satisfied.
Equivalent Beneficiary
•
An "equivalent beneficiary" generally means any person that:
– In connection with certain European country treaties, is a resident of a
member state of the EU, any state of the European Economic Area, a party to
NAFTA, or, in some cases, Switzerland, or Australia (i.e., Malta-U.S. Treaty)
(each, a "Qualifying Country");
– Is entitled to the benefits of a comprehensive income tax treaty between such
Qualifying Country and the Contracting State from which treaty benefits are
claimed and satisfies certain LOB requirements (even if that treaty has no
LOB article); and
– In the case of dividends, interest, royalties, and possibly certain other items,
would be entitled, under the treaty between the Qualifying Country and the
Contracting State in which the income arises, to a rate of tax with respect to
the particular class of income for which benefits are claimed that is "at least as
low as" the rate provided for under the treaty between the Contracting States.
What if Fail "As Least as Low" Test?
French shareholder is not equivalent
beneficiary under U.S.-U.K. treaty
because rate of withholding on dividends
under U.S.-France treaty (5%) is not as least
as low as rate of withholding under U.S.-U.K.
treaty (0%).
France
5% rate of
withholding on
dividends under
U.S.-France treaty
Is dividend paid by U.S. to U.K. subject to 30 percent
withholding or 5 percent withholding?
U.K.
U.S.
0% rate of
withholding on
dividends under
U.S.-U.K. treaty
What if Fail "As Least as Low" Test? (cont.)
France
(Public Co.)
5% rate of
withholding on
dividends under
U.S.-France treaty
Germany
(ATOB)
Technical Explanation to U.S.-U.K. treaty concludes that
French company qualifies as equivalent
beneficiary with respect to 5% withholding, even though
it would not be entitled to 0% withholding under U.S.U.K. treaty (0%).
U.K.
Similar language appears in Memorandum of
Understanding agreed to by the U.S. and Netherlands in
connection with the 2004 protocol to U.S.-Dutch treaty.
U.S.
0% rate of
withholding on
dividends under
U.S.-U.K. treaty
Should this position be followed in other treaties?
Individual as Equivalent Beneficiary
Dividend from U.S. to Luxembourg will be eligible for
5% withholding tax rate, so long as both U.K. Public
Co. and U.K. individual are both equivalent
beneficiaries with respect to 5% rate.
U.K.
(Public)
50%
5% rate of
withholding on
dividends under
U.S.-Luxembourg
treaty
U.K.
Individual
50%
Lux
U.S.
According to example in the Technical Explanation
(and to language in the Exchange of Notes) to the U.S.Luxembourg treaty, the dividend paid from U.S. to
Luxembourg qualifies for 5% withholding tax rate
because the rate of withholding for individuals is the
same under both the U.S.-Luxembourg treaty, and the
U.S.-U.K. treaty (i.e., 15%).
15% rate of
withholding on This appears to be contrary to intent of the "at least as
dividends under low" requirement, which is to prevent residents of a
U.S.-U.K. treaty third state from using an entity that is a resident of
one of the Contracting States to obtain a more
favorable rate of withholding tax that would otherwise
be available to them.
Individual as Equivalent Beneficiary (cont.)
Is dividend paid from U.S. to Netherlands
Eligible for 0% withholding?
French
Individual
0% rate of
withholding on
dividends under
U.S.-Netherlands
If follow language from Exchange of Notes and
example from Technical Explanation in
U.S.-Luxembourg treaty it would be because
rates of withholding on dividends paid to
individuals of France and the Netherlands
are 15% in both situations.
Dutch
15% rate of withholding on
dividends paid to individuals under
U.S.-Dutch treaty, and U.S.-French treaty
U.S.
Attribution Rules
What is rate of withholding on dividend from
U.S. to U.K.?
Dutch
(Public)
94%
0% rate of
withholding on
dividends under
U.S.-U.K. treaty
German
(Public)
6%
Article 23(7)(d) of the U.S.-U.K. Treaty provides
that "...the equivalent beneficiary...shall be
deemed to hold the same voting power in the
company paying the dividend as the company
claiming the benefits holds in such company."
Are both Dutch Co. and German Co. deemed to
own 100% of U.S. Co, making them equivalent
beneficiaries with respect to 0% withholding?
U.K.
100%
U.S.
Or under attribution principles, is Dutch Co.
only deemed to own 94% and German Co. only
6%, and therefore, fail both 0% (need at least
95% ownership by equivalent beneficiaries)
and 5% rates (since need at least 10%
ownership to qualify for 5% withholding tax
rate).
Issues Relating to LOB Provisions and
Investment Funds
Public Trading and Active Business Tests
Cayman
Fund
common &
preferred
shares
Charitable
trust
shares
Personal property
generating US –
source rent or
royalties
Facts
• Country X has a comprehensive
income tax treaty with the US.
• Pub Co’s common shares are traded
common
on recognized stock exchanges.
shares
• Sub is an SPV formed as part of a
Pub Co
financing transaction. Pub Co (1) owns
(Country X)
an “E note,” which gives it virtually the
entire economic interest in Sub, and (2)
Active
has a contractual right to appoint a
E Note
business
majority of Sub’s directors, absent a
default by Sub on its debt.
Debt US and • Sub’s shares (which have nominal
Sub
non-US value) are owned by a charitable trust.
(Country X)
lenders • Sub owns a portfolio of assets
(personal property) generating rent or
royalties, some from US sources. Pub Co
manages the portfolio from its office in
Country X.
Public
investors
16
Public Trading and Active Business Tests
Cayman
Fund
common &
preferred
shares
Charitable
trust
Public
investors
common
shares
Pub Co
(Country X)
E Note
Active
business
shares
Sub
(Country X)
Personal property
generating US –
source rent or
royalties
Debt
US and
non-US
lenders
Questions
• For purposes of the LOB
article, does Pub Co own > 50%
by vote and value of the shares
of Sub?
• For purposes of the “public
trading” test, does it matter/
should it matter how much of
Pub Co’s stock is owned by
Cayman Fund?
• “Principal class of shares”:
What happens if Pub Co’s
common shares have a FMV >
50% of Pub Co’s total equity
value at the start of 2014, but
drop below 50% of total equity
value by the end of 2014?
17
Ownership/Base Erosion: Testing Ownership
Non-US
investors
US
investors
Bermuda
Fund
Charitable
trust
E Note
shares
Sub
(Country X)
Personal property
generating US –
source rent or
royalties
Facts
• Pub Co sells to Bermuda Fund the E Note of
Sub (and the contractual right to appoint the
directors of Sub).
Questions
• Ownership of E Note:
• Must/should the US investors in
Bermuda Fund be “qualified persons”? Or
just US citizens/residents?
• Should it matter that the US investors
hold their interests in Sub indirectly,
through Bermuda Fund?
Debt US and
• How should Bermuda Fund document
non-US
lenders the status of its US investors? W-9s?
Certifications/ representations? (Cf. Regs.
1.884-5(b), 1.883-4(d).)
• Ownership of Sub’s debt:
• What if Sub’s debt is traded? Use
survey/sampling? (Cf. Rev. Proc. 2011-35.)
18
Ownership/Base Erosion: Tiered Entities
Non-US
investors
US
investors
Facts
• Bermuda Fund decides to hold the E
Note through Holdco. Bermuda owns
100% of Holdco’s shares, as well as an E
Note of Holdco.
Bermuda
Fund
Charitable
trust
shares
Personal property
generating US –
source rent or
royalties
Questions
• Sub will meet the ownership test, if
E Note
Holdco is a “qualified person.” To
determine Holdco’s status, apply the
Holdco
ownership/ base erosion test to Holdco:
(Country X)
• Does Holdco’s gross income include
Sub’s income?
E Note
• Do Holdco’s expenses include only
its own expenses? Should Holdco be
Debt US and
Sub
non-US
required to include Sub’s interest
(Country X)
lenders
expenses, in Holdco’s base erosion
calculation?
• Do/should the answers change, if
Holdco and Sub are consolidated for
Country X tax purposes?
19
Ownership/Base Erosion: Measurement of Income
Facts
• Under Country X’s tax laws, US Sub’s and
Non-US Sub’s dividends are excluded from
Holdco’s income.
• A substantial part of the interest on US
Sub’s and Country Y Sub’s notes accrues in
years prior to payment in cash. Under
Country X’s tax laws, Holdco must include
the interest in income as it accrues.
Non-US
investors
US
investors
Bermuda
Fund
Holdco
(Country X)
US Sub
Loan
Non-US Sub
(Country Y)
US and
non-US
lenders
Questions
• For purposes of the “base erosion” test:
• Should Holdco take into account
dividends received from US Sub and
Non-US Sub? (See PLR 200551016)
• Should Holdco take into account
interest from US Sub and Non-US Sub
in the year accrued, or received?
20
Ownership/Base Erosion: Measurement of Expenses
Facts
• Holdco’s ability to deduct interest
expense on its loan is subject to “thin
cap” or other limitations under
Country X’s tax laws.
Non-US
investors
US
investors
Bermuda
Fund
Holdco
(Country X)
US Sub
Loan
Non-US Sub
(Country Y)
US and
non-US
lenders
Questions
• For purposes of the “base erosion”
test, should Holdco take into account
its interest expense in the year (if any)
in which it is actually deductible? Or
the year in which it would generally be
deductible under Country X’s tax laws,
if no special limitations applied?
• What if the identity of the lenders
changes, between the year the
interest expense accrues and the year
the interest is actually deductible?
21
Competent Authority Discretion
Before Competent Authority
Discretion
• 1981 Protocol to 1980 U.S.-Jamaica treaty included
first modern LOB provision
– Objective tests – publicly-traded company, active
conduct of a trade or business, derivative benefits
– In addition, an entity would qualify for benefits if
the “acquisition, ownership or maintenance of
such person and the conduct of its operations did
not have as a principal purpose obtaining benefits
under this Convention.”
Role of Competent Authority
• In some mid-80’s treaties, competent authority required to
consult with other competent authority before denying
benefits under objective tests
• Starting with 1989 agreements with Germany, India and
Finland, clear that determination is within discretion of
competent authority
– However, competent authority was to consider “all the
facts”
– In particular, competent authority was to consider effects
of economic integration
– Frequently, competent authority required to consult
before denying discretionary benefits
Is Discretion limited to “Foot Faults”?
• In 2013 Protocol to 1990 U.S.-Spain treaty,
competent authority is to consider “if such grant of
benefits is justified based on an evaluation of the
extent to which such resident satisfies the
requirements of paragraphs 2, 3, 4 or 5 of this
Article” (as well as opinion of the other competent
authority)
• No longer directed to consider whether there is a tax
avoidance purpose for the structure
Procedural Requirements:
Notice 2013-78
• Mandatory Pre-filing Memoranda
• May be required to attend a pre-filing
conference, even if it did not request one
• Specifies additional information for LOB requests,
including information regarding the use of hybrid
entities, nominees and conduit companies, and
third country permanent establishments
• Notes that, if treaty requires consultation with
treaty partner, the competent authority “will
comply”
Contact Information
• Jeffrey Rubinger - 305-350-7261
([email protected])
• Patricia Brown - 305-284-5946
([email protected])
• Philip Wagman - 212-878-3133
([email protected])