When a Foreign Company Holds Directors' Meetings in the U.S. – Tax Treaty Issues for U.S. Citizens and Resident Aliens

By Thomas St.G. Bissell, Esq.  

Celebration, FL

 

This author's prior two commentaries discussed the personal tax implications for nonresident alien individuals who attend directors' meetings that are held in the United States by a foreign corporation, where a tax treaty either does or does not apply.1 This commentary discusses the tax issues that can arise where a U.S. citizen or "resident alien" (as defined in §7701(b)) attends a board meeting that is held in the United States by a corporation that is resident in a tax treaty country. The reader may wish to refer to the discussion of certain rules in the two prior commentaries.

 

As previously discussed, there are four alternative rules that apply under U.S. income tax treaties in determining whether a (foreign) treaty country may tax directors' fees that are paid to individual directors of a company that is resident in the treaty country, but where a directors' meeting is held in the United States:

 

1. If the treaty is silent on the taxation of directors' fees, then the treaty country is generally not expressly permitted to tax fees paid to any individuals covered by the treaty for services rendered in the United States other than individuals who also happen to be residents of the treaty country. Thus, a U.S. citizen or §7701(b) resident alien who is also a "resident" of the United States for treaty purposes would be exempt from tax in the treaty country on his U.S.-source director's fees. However, if the U.S. citizen or resident alien were a "resident" of the treaty country under the "tie-breaker" rules of the treaty,2 he would usually be subject to the treaty country's tax on those fees, and if he were a U.S. citizen (i.e., not a §7701(b) resident alien), he would also be subject to U.S. tax on the same fees.3

 

2. If the treaty follows Article 15 of the 2006 U.S. Model Income Tax Treaty, then the treaty country may tax a U.S. "resident" (as defined in the treaty) on his director's fees only if the board meeting is held in the treaty country itself.  Thus, the treaty country could not tax a U.S. citizen or §7701(b) resident alien who was also a U.S. "resident" for treaty purposes on his U.S.-source director's fees. However, if he were a "resident" of the treaty country under the "tie-breaker" rules of the treaty, the rules described above in (1) would apply.

 

3. If the treaty follows the OECD Model Tax Convention - as do several important U.S. tax treaties, including the treaty with Switzerland - then the treaty country may tax individuals who are U.S. "residents" (as defined in the treaty) on director's fees for attending meetings anywhere in the world of a company that is a treaty country resident. Thus, the OECD Model would permit the treaty country to tax the U.S.-source director's fees of a U.S. citizen or §7701(b) resident alien who is classified either as a U.S. "resident" for treaty purposes, or as a resident of the treaty country (and takes no position if the individual is resident in a third country for treaty purposes). Whether the treaty country actually chooses to tax a U.S. "resident" who attends a board meeting in the United States or in a third country, however, would depend on the provisions of the treaty country's internal law.

 

4. If the treaty country follows the "hybrid" rule of certain U.S. treaties - for example, Article 16 of the Irish treaty or Article 16 of the Mexican treaty - then the treaty country may tax a U.S. citizen or §7701(b) resident alien who is a U.S. "resident" under the treaty only on director's fees for attending a board meeting of the treaty country corporation if the meeting is held in the treaty country itself, or in a third country. Thus, the treaty country may not tax a U.S. "resident" who attends a board meeting in the United States.

 

Therefore, if a U.S. citizen or §7701(b) resident alien is "resident" in the United States within the meaning of the particular tax treaty, only the OECD-type treaties permit the treaty country to tax director's fees paid to such an individual for attending board meetings of a treaty country corporation that are held in the United States.

 

Although Article 4 of the U.S. 2006 Model has always included a very broad definition of the term U.S. "resident" for treaty purposes so as to include within the definition all U.S. citizens (wherever they might live) and all noncitizens who are classified as "resident aliens" under §7701(b), a number of recent treaties, including the treaty with Switzerland, are more restrictive and classify a U.S. citizen or a §7701(b) resident alien as a U.S. "resident" for treaty purposes only if he has a "substantial presence, permanent home, or habitual abode in the United States."4 Thus, if a U.S. citizen or a §7701(b) resident alien receives director's fees for attending the U.S. board meeting of a Swiss company but the individual is not classified as a U.S. "resident" under this more restrictive definition - for example, because he lives in a third country - the Swiss treaty itself does not address this situation.5 If the U.S. citizen or the §7701(b) resident alien is resident in a third country, Switzerland's right to tax his U.S.-source director's fees would depend on the provisions of that country's treaty (if any) with Switzerland or, if no treaty applied, then the provisions of internal Swiss law.

 

If an "OECD-type" treaty country does exercise its right to tax a U.S. citizen or a §7701(b) resident alien who is a U.S. "resident" for treaty purposes on his fees for attending the U.S. board meeting of a treaty country corporation, an obvious double taxation issue will arise, because the fees will be classified as U.S.-source income under the Code and thus in theory treaty country income taxes cannot be credited against U.S. tax on the same income. Under Article 23(3) of the 2006 U.S. Model, however, double taxation is avoided by re-sourcing to the (foreign) treaty country income derived by a U.S. resident that is rightfully subject to taxation by the treaty country. This rule is included in several of the treaties that follow the expansive rule on directors' fees of the OECD Model,6 but it is not included in the Swiss treaty.7 Presumably, however, double taxation could be avoided even under the Swiss treaty under the general Competent Authority provisions of the Mutual Agreement Procedure (Article 25) of the treaty, although initiating a Competent Authority procedure would usually be beyond the resources of most individual taxpayers.

 

If the U.S. citizen or the §7701(b) resident alien happens to be a "resident" of the (foreign) treaty country under Article 4 of the relevant treaty, the treaty country will usually have the right to tax the individual on his U.S.-source director's fees under its internal law under all four of the types of treaties described at the beginning of this commentary. However, the treaty will usually contain detailed rules to prevent double taxation.  Whether the treaty is a "credit" treaty (such as the Japanese treaty) or an "exemption with progression" treaty (such as the Swiss treaty), in practice the United States will have primary taxing rights if a hypothetical nonresident alien resident in the treaty country would be subject to U.S. tax under the treaty on the same U.S.-source director's fees, but the treaty country will have primary taxing rights if the United States would not have the right to tax in that hypothetical situation. Most or all tax treaties (regardless of what they provide either explicitly or implicitly concerning directors' fees) give the United States the right to tax U.S.-source directors' fees paid by a treaty country corporation only if the hypothetical nonresident alien has a U.S. "fixed base" or "permanent establishment" to which the U.S.-source director's fees are attributable. Thus, in many cases the United States will not have the right to tax and therefore the treaty country will have primary taxing rights.8 

 

Because U.S. citizens and §7701(b) resident aliens are subject to U.S. social security self-employment tax ("SECA" tax) on their worldwide self-employment income, director's fees for attending the U.S. board meetings would be subject to SECA, which is imposed on a self-assessed basis (i.e., not on a withholding tax basis).9 Depending on the particular facts, the same fees could be subject to foreign social security tax as well, but subject to the special rules of a social security "totalization" agreement (if applicable). Although these rules are beyond the scope of this commentary, they should always be carefully considered.

 

This commentary also will appear in the January 2012 issue of the  Tax Management International Journal.  For more information, in the Tax Management Portfolios, see Williamson, 943 T.M., U.S. Income Tax Treaties - Provisions Relating Only to Individuals, and in Tax Practice Series, see ¶7160, U.S. Income Tax Treaties.

 


1 See Bissell, "When a Foreign Company Holds Directors' Meetings in the United States," 40 Tax Mgmt. Int'l J. 528 (9/9/11), and Bissell, "When a Foreign Company Holds Directors' Meetings in the U.S. - Tax Treaty Issues for Nonresident Aliens," 40 Tax Mgmt. Int'l J. 673 (11/11/11). 

 2 See Article 4(3) of the U.S. Treasury's 2006 Model Income Tax Treaty. 

 3 As discussed below, the treaty rules would usually include special rules for the elimination of double taxation. 

 4 See, for example, Article 4(1) of the Swiss treaty. With respect to a noncitizen who is classified as a §7701(b) resident alien under the Code, this rule in the Swiss treaty applies only if the individual is a permanent resident (so-called "green card" holder) under §7701(b)(1)(A)(i) of the Code, and not if he is a non-immigrant alien classified as a §7701(b) resident alien under the "substantial presence" test of §7701(b)(3). 

 5 Of course, if the U.S. citizen or §7701(b) resident alien is resident in Switzerland under the "tie-breaker" rules of the Swiss treaty, then Switzerland would have the right to tax him - not under the directors' fees rule of the treaty, but because under internal Swiss law and under the treaty Switzerland may tax the worldwide income of its tax residents. 

 6 See, for example, Article 22(2)(a) of the Icelandic treaty, Article 23(3) of the Japanese treaty, Article 24(3) of the Latvian treaty, and Article 24(3) of the Lithuanian treaty. 

 7 Article 23(3) of the Swiss treaty does provide for re-sourcing in the case of U.S. citizens who are tax residents of Switzerland, but not with respect to U.S. "residents" who are not Swiss residents. Article 23(2) provides only that the United States "shall allow as a credit against the United States tax on income the appropriate amount of tax paid to Switzerland …" (emphasis added). The Treasury's Technical Explanation of the Swiss treaty does not elaborate further. 

 8 See the discussion in Bissell, "When a Foreign Company Holds Directors' Meetings in the U.S. - Tax Treaty Issues for Nonresident Aliens," 40 Tax Mgmt. Int'l J. 673 (11/11/11), cited in note 1, above. As discussed in that commentary, under all four types of treaties described at the beginning of this commentary, the United States would have the right to tax a nonresident alien resident in the treaty country on fees for attending U.S. board meetings of a treaty country corporation only if the individual had a "fixed base" or "permanent establishment" in the United States to which his director's fees were attributable. If his U.S.-source director's fees would be subject to U.S. tax under these rules if received by a hypothetical nonresident alien resident in the treaty country, then a U.S. citizen or §7701(b) resident alien who is a "resident" of the treaty country would be subject to U.S. tax on his U.S.-source director's fees, and the treaty country would have to provide double taxation relief to the individual in the form of either a foreign tax credit or an exemption (depending on the terms of the particular treaty). However, if the U.S.-source director's fees would not be subject to U.S. tax in the hands of the hypothetical nonresident alien, then the income would be "re-sourced" for U.S. tax purposes to the extent necessary to avoid double taxation. Note that these relief-from-double-taxation rules would usually apply only to U.S. citizens who were classified as residents of the treaty country, because a §7701(b) resident alien who was classified as a treaty country resident would thereby be re-classified for U.S. tax purposes as a nonresident alien with respect to calculation of his U.S. income tax. See Regs. §301.7701(b)-7(a)(1). 

 9If the director is a nonresident alien for U.S. tax purposes, worldwide self-employment income is exempt from SECA. See Bissell, "When a Foreign Company Holds Directors' Meetings in the United States," 40 Tax Mgmt. Int'l J. 528 (9/9/11), at 529.