Qualifying for Treaty Benefits Under the Derivative Benefits Article

Foreign persons are generally subject to U.S. federal income tax on two types of income: passive income from the U.S. (like interest and dividends) and income connected to a U.S. business. Most income tax treaties reduce or eliminate the 30 percent withholding tax on these types of income. To qualify for treaty benefits, the taxpayer must be a resident of a treaty country and meet the treaty’s limitation on benefits (LOB) provision, which aims to prevent tax avoidance. One way to qualify for treaty benefits is through the derivative benefits provision, which allows an entity owned by nonresident shareholders to qualify for treaty benefits if it is clear that the entity was not used for tax avoidance. An “equivalent beneficiary” is a person who lives in certain European countries or other specific countries and meets certain requirements under income tax treaties. These treaties allow the person to receive tax benefits when they earn certain types of income, like dividends or interest. This applies to people from countries like Canada, Mexico, and Australia, among others. The “at least as low” requirement is in place to stop people from using a business in another country to get a better tax rate. Instead of investing in the US through a French company, French residents could set up a company in Switzerland and lend money from there, because Switzerland has lower taxes. This would also work because both the US-France and US-Switzerland tax treaties allow for 0% withholding on interest. So, the French residents would benefit from setting up a company in Switzerland to get better tax benefits. Different tax treaties have different rules for equivalent beneficiaries. For example, some treaties allow equivalent beneficiaries to be residents in certain countries, while others have specific requirements for what kind of entity can be considered an equivalent beneficiary. Some treaties also require the equivalent beneficiary to meet certain tests in order to qualify for treaty benefits. It’s important to understand the specific rules of each treaty to know if someone can qualify as an equivalent beneficiary for tax purposes. The United States has different tax treaties with different countries. For example, a company from Norway wouldn’t get any tax benefits under the treaty with Switzerland, but it could get benefits under the treaties with Luxembourg and Ireland if it has a business in those countries. This means it could pay less tax when doing business with the U.S. For example, if a company from the UK has a business in Luxembourg and licenses intellectual property to the U.S., it could get a lower tax rate on the money it makes from that. This can be a good opportunity for companies from other countries to use the tax rules in these treaties to their advantage. Can individuals and companies be treated the same when it comes to getting tax benefits on dividends from a U.S. company? For example, if a U.K. company and a U.K. individual both own part of a Luxembourg company that gets dividends from a U.S. company, should they both get the same tax rate on those dividends? The law isn’t clear, but it’s an interesting question. The Exchange of Notes says that when comparing tax rates for dividends, you have to look at the rate of tax for individuals who directly own shares, and compare that to the rate of tax for individuals who are residents of the country where the recipient is based and own shares. This rule applies to the U.S. treaties with Luxembourg and Ireland.

The question is whether this rule could also apply to other treaties where the withholding tax rate on dividends is reduced to zero. For example, if a person in Canada owns a company in the U.K., which owns a company in the U.S., and the U.S.-U.K. treaty allows for a 0 percent withholding tax rate, would this rule still apply? If a UK company owns a French company, and the UK company owns a US company, the UK company can get a 0 percent tax rate on dividends from the US. But if the French company owned the US company directly, it would only get a 5 percent tax rate on dividends. This means the French company is not eligible for the 0 percent tax rate on dividends from the US. The example is saying that a U.K. company can get a lower tax rate on dividends from a U.S. company because it is owned by a German company that meets certain requirements of a tax treaty. Even though the German company doesn’t qualify for all the benefits of the treaty, it’s still okay because the U.K. company is also owned by a French company that does meet the requirements for a lower tax rate. So, they can’t get the zero percent tax rate, but they can get a lower rate of 5 percent. The example shows that a French company W can get a lower tax rate in the US by investing through a UK company Y, even though it’s not entitled to the lowest tax rate. This shows that some tax treaties allow companies from other countries to get better tax rates. These provisions are meant to stop companies from avoiding taxes, but they can also help companies save on taxes when investing in the US. The treaty with Luxembourg and the U.S.-Canada treaty allow third parties from certain countries to qualify for tax benefits. However, the benefits are limited to specific types of income, such as interest, dividends, and royalties. Jeffrey L. Rubinger is a tax lawyer in Miami who specializes in international tax law. This article was written on behalf of the Tax Law Section. The Florida Bar aims to teach its members about duty and service to the public, improve the justice system, and advance the study of law.

Source: https://www.floridabar.org/the-florida-bar-journal/qualifying-for-treaty-benefits-under-the-derivative-benefits-article/