There have been many developments in income tax treaty legislation in the United States in the past year. In November 2015, U.S. tax treaties with Switzerland, Japan, Luxembourg, Chile, Hungary, Spain and Poland were approved by the Senate Foreign Relations committee, which was a big deal. Until then, the Senate had not ratified a tax treaty since 2010. Additionally, the Treasury Department released its new model income tax treaty in February 2016, which had not been updated since 2006.
Some Treaty Background
Tax treaties, also known as double tax treaties, help avoid double taxation across multiple jurisdictions. For example, in the absence of a tax treaty between the U.S. and France, a U.S. citizen working in France could potentially be taxed on their French-sourced income earned in France and in the U.S.
Usually negotiated on a bilateral basis between two governments, the treaties generally follow certain models. The U.S. usually relies on its model treaty or the model developed by the Organisation for Economic Co-operation and Development (OECD), founded in 1961 and based in Paris.
The U.S. model treaty has an extensive article on students and trainees as well as a lengthy article on pensions. The OECD’s latest model treaty was approved in July 2014 and includes the application of Article 17, which deals with “Artistes and Sportsmen” and the treatment of termination payments.
The U.S. and OECD treaty models are similar but the U.S. model is typically the default used.
As of today, the State Department lists 195 countries as sovereign nations. If every country had a bilateral treaty with the other countries, the number of possible bilateral treaties would be 18,915 (195 countries x 97 possible bilateral treaties). Because of the complication in learning how to apply regulations within one tax treaty, multinational employers and practitioners may find it difficult to learn the regulations of all those treaties. Nonetheless, countries continue to sign bilateral treaties at a steady rate.
Tax Treaty Elements
Income tax treaties that eliminate double taxation are critical components of administering international payrolls. Tax treaties typically have at least 25 articles, each addressing a different topic. Several of the articles generally deal with the treatment of expatriate workers:
--Dependent personal services. The term is used by the Internal Revenue Service to describe the income tax provisions in treaties that address payments most common to employment situations, such as wages, salaries and similar compensation.
--Independent personal services. The term is used by the IRS to describe how payments to independent contractors and the self-employed are treated in treaties. This can include income for sporting and artistic activities.
--Professors, teachers and researchers. A section covering payments most common to professors, teachers or those conducting research.
--Students and apprentices are considered as exempt from tax for certain payments in income tax treaties.
--Capital gains income from stock awards and transactions also can be addressed in treaties.
Future of Income Tax Treaties
Multilateral treaties are an alternative to bilateral tax treaties. While bilateral treaties often take years to negotiate, approve and implement, multilateral agreements may make the process more efficient by wrapping several treaties into one. However, there are challenges with multilateral treaties.
One major challenge is varying internal tax regulation—for example, no income taxes or special incentives for countries in a region. Such variations make it difficult to break from the status quo. There has been some acceptance among regional countries with similar legislative structures, such as the 2005 South Asian Association for Regional Cooperation Income Tax Agreement, but large-scale acceptance is unlikely in the short term.
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