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Edward Tanenbaum |
The affordable Health Choices Act of 2009 (HR 3200), promotes health care reform. Among the revenue provisions of the Act is one to restrict, in certain cases, the use of tax-treaty benefits by foreign firms with operations in the US. The proposal would amend section 894 of the Internal Revenue Code (code) relating to income affected by a treaty.
A foreign person that earns non-business US source income in the nature of interest, dividends, rents, royalties and certain similar types of income is subject to a flat 30% US withholding tax. However, in addition to certain statutory exemptions, the withholding tax can be reduced or eliminated under the provisions of a tax treaty between the US and the country of residence of the foreign person.
However, a foreign corporation, for example, may not benefit from a provision of a US tax treaty with a foreign country that eliminates or reduces US withholding tax unless the foreign corporation is both a resident of such foreign country and qualifies under a limitation-on-benefits provision contained in the US tax treaty with such foreign country.
Since the late 1970s, the US has attempted to curb so called treaty shopping, which is an arrangement whereby a foreign firm from a non-treaty jurisdiction attempts to benefit from a treaty by routing its US source income through an intermediate subsidiary in a third country that is a signatory to a tax-reducing treaty with the US. Most US treaties have significant anti-treaty-shopping provisions to curb this abuse.
New proposal
HR 3200 proposes to limit tax treaty benefits with respect to US withholding tax imposed on deductible related-party (for example, payee and payor share a related parent) payments.
Under the proposal, if a US subsidiary makes a deductible payment to a foreign corporation that has a common foreign parent, any withholding tax with respect to such payment would not be reduced under any treaty of the US unless the withholding tax would be reduced under a US treaty if such payment were made directly to the foreign parent corporation.
The provision would only apply to payments deductible under the US corporate income tax (such as interest and royalties). A payment is a deductible related-party payment if it is made directly or indirectly by any entity to any other entity, it is allowable as a deduction for US tax purposes and both entities are members of the same foreign controlled group of entities.
The degree of common ownership is based on a modified definition of "foreign controlled group of entities" requiring "more than 50%" common ownership. Thus, the provision would apply to payments to a foreign corporation where the US corporation and the payee corporation were linked to a common foreign parent by chains of more than 50% ownership.
The bill provides that the IRS may prescribe regulations providing for the treatment of two or more persons as members of a foreign controlled group of entities if such persons would be the common parent of such group if treated as one corporation. And also regulations providing for the treatment of any member of a foreign controlled group of entities as the common parent of that group if such treatment is appropriately taking into account the economic relationships among the group entities.
Supporters of the anti-treaty-shopping proposal cite tax revenue as their central concern; foreign firms that reduce their US withholding taxes with treaty shopping reduce the tax revenue the US collects on US-source income. Opponents of the measure have argued that the provision runs counter to US treaty policy and would increase the cost to US firms of doing business in the US and would, thus, harm US employment and wages.
It remains to be seen whether this provision will ultimately be enacted into law.
Edward Tanenbaum (edward.tanenbaum@alston.com) New York
