|Jim Fuller||David Forst|
The US Treasury has released its revised 2016 Model Income Tax Treaty, which is the baseline text Treasury will use when it negotiates future tax treaties.
The US model income tax convention was last updated in 2006. A draft version of these new model treaty provisions was released for public comment in May 2015 (draft treaty). As a result of comments and feedback from stakeholders and interested parties, Treasury made a number of significant revisions to the proposed model treaty provisions. We will address different portions of the treaty over the next few months.
In a new provision, the Model Treaty addresses preferential regimes that some countries have implemented to attract highly mobile income by allowing resident companies to pay no or very little tax on their net income. These are called 'special tax regimes' (STRs) in the Model Treaty. When the provision applies, reduced US withholding tax under the treaty will not be permitted.
The scope of when the STR provisions in the Model Treaty can apply was narrowed from the 2015 draft treaty to cases in which the resident benefits from an STR with respect to a particular related-party interest payment, royalty payment, or guarantee fee that is within the scope of Article 21 (addressing 'Other Income'). An exception applies if the preferential regime will result in a rate reduction that is at least 15%, or 60% of the statutory company rate in the source country – whichever is lower.
The definition of STR was tightened to provide an exclusive list of the circumstances in which a statute, regulation, or administrative practice will be treated as an STR. This preferential treatment must be in the form of either a preferential rate for the income, a permanent reduction in the tax base with respect to the income (as opposed to preferences that merely defer the taxation of income for a reasonable period of time), or a preferential regime for companies that do not engage in an active business in the residence state.
Regimes that provide notional interest deductions (NIDs) with respect to equity are no longer treated as STRs. Instead, Article 11 (Interest) includes a new rule that would allow a treaty partner to tax interest in accordance with its domestic law if the interest is beneficially owned by a related person that benefits from an NID.
A country seeking to invoke the STR provisions must consult with the other country first and then notify the other country of its intention through a diplomatic note and issue a written public notification.
In response to comments on how to determine when a payee that benefits from an STR is "related to the payor" of an item of income, the 2016 Model provides that the STR provisions will only apply when the payee is a 'connected person' with respect to the payor of the income and provides a definition of that term, which generally means at least 50% relation.
The exceptions from the STR provisions for collective investment vehicles such as US regulated investment companies and US real estate investment trusts that are designed to achieve a single level of current tax (at either the entity level or the shareholder level) were clarified.
In next month's update, we will discuss other new provisions in the Model Treaty.
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