U.S. Income Tax Treaties — The Limitation on Benefits Article (Portfolio 936)

Tax Management Portfolio, U.S. Income Tax Treaties — The Limitation on Benefits Article, discusses in detail the limitation on benefits (LOB) article of U.S. income tax treaties.

To view this Portfolio, take a free trial to Bloomberg Tax

Bloomberg Tax

This Portfolio is available with a subscription to Bloomberg Tax, a comprehensive research solution including over 500 Tax Management Portfolios, practice tools, primary sources and timely news.


The United States is a party to numerous income tax treaties with foreign countries. In order to enjoy the benefits of a U.S. income tax treaty, a person must satisfy a number of requirements, including residence in one of the treaty countries. Residence alone, however, is not sufficient. The United States is very concerned about “treaty shopping,” and thus most U.S. income tax treaties, including all modern U.S. income tax treaties, include a “LOB” article. The purpose of the LOB article is to determine whether a resident of a treaty country has a sufficient connection with that country to justify entitlement to treaty benefits.


U.S. Income Tax Treaties — The Limitation on Benefits Article was authored by the following experts.
Howard J. Levine, Esq.

Howard J. Levine is a partner in the Washington D.C. office of Roberts & Holland LLP, the largest law firm in the United States that is devoted exclusively to tax and tax-related matters. He is a former Assistant Branch Chief, Litigation Division, Office of Chief Counsel, Internal Revenue Service (1972-1976). Mr. Levine has served as an Adjunct Professor at Georgetown University Law School (LL.M. Tax) and George Washington University Law School (LL.M. Tax). He is a Contributing Editor of The Journal of Real Estate Taxation and a Member of the Advisory Boards of the Tax Management International Journal and theCCH Journal of Taxation of Global Transactions. Mr. Levine is an author of over 100 articles and publications, including 567-3rd T.M., Taxfree Exchanges Under Section 1031. A frequent speaker at numerous tax institutes around the country, Mr. Levine is a member of the American Bar Association Tax Section (former Chair, Committee on Sales, Exchanges and Basis; former Subcommittee Chair, Coordination of Tax and Customs Law, Committee on U.S. Activities of Foreign Taxpayers and Tax Treaties), the New York Bar, the District of Columbia Bar, and the International Fiscal Association.

Michael J. Miller, Esq.

Michael J. Miller is a partner in the New York office of Roberts & Holland LLP. He counsels foreign-and-U.S. based multinationals regarding a wide range of tax issues pertaining to their cross-border activities. Michael co-authored 945 T.M., U.S. Taxation of International Shipping and Air Transport Activities, and has written numerous articles on international tax issues for the Tax Management International Journal, CCH Journal of Taxation of Global Transactions, and the Canadian Tax Journal. Michael is an active member of the U.S. Activities of Foreign Taxpayers and Tax Treaties Committee of the American Bar Association Tax Section. He received his B.A. cum laude from Columbia College in 1988 and his J.D. from New York University in 1991. He clerked on the U.S. Tax Court for the Honorable James S. Halpern from 1991-1993.

Table of Contents

Detailed Analysis

I. Introduction

II. The LOB Article in the 2006 U.S. Model Treaty

A. Introduction

B. The General Rule

C. Persons Entitled to All Benefits of the Treaty

1. Individuals

2. Qualified Governmental Entities

3. Publicly Traded Companies and Certain Subsidiaries

a. Publicly Traded Companies

b. Public Company Subsidiaries

4. Tax-Exempt Organizations and Pension Funds

5. Entities Satisfying Ownership and Base Erosion Tests

D. Active Business Test

1. Active Conduct of a Trade or Business Requirement

2. "Derived in Connection with" or "Incidental to" Requirement

a. "Derived in Connection with" Test

(1) "Forms a Part of" or "Complementary to" Test

(2) Royalties, Dividends, and Interest

b. The "Incidental to" Test

3. Substantiality Requirement

4. Examples

E. Discretion Granted Competent Authority

III. Avoiding Disqualification Under an LOB Article

Introductory Material

A. Publicly Traded Companies

1. Corporate Inversions

2. Differences in Requirements

3. Base Erosion

4. Disproportionate Class of Shares

B. Qualified Subsidiary of a Public Company

1. Introduction

2. Indirect Ownership

3. 1996 U.S.-Luxembourg Tax Treaty

4. Use of Dutch Treaty Subsidiary Exemption - Dutch Licensing Company - to Avoid Secondary Withholding Tax on Royalties

C. Joint Ownership Between U.S. and/or Contracting State Residents

1. In General

2. 50% Ownership by Non-Qualified Residents Permitted

3. 49% Ownership by Non-Qualified Residents Permitted

4. Disproportionate Class of Shares

D. Derivative Benefits Provision

1. In General

2. Ownership by Shareholders Entitled to Equivalent or More Favorable Treaty Benefits

3. Ownership by Residents of a Contracting State

4. Comprehensive Income Tax Convention

5. Equivalent or More Favorable Treaty Benefits

6. Examples

E. Headquarters Company Provision

F. Active Business Test

G. Investment Entities

H. Exempt Organizations

I. Competent Authority Relief

J. Continued Use of Treaties Without LOB Articles

IV. Limitations Outside of a Treaty

Introductory Material

A. Case Law

1. Aiken


3. Del Commercial

a. Background of the Case

b. The Court of Appeals' Analysis

c. Comments on the Court's Analysis

B. Section 7701(l) and the Anti-Conduit Regulations

C. Section 894(c) and the Regulations Thereunder

D. Section 884(e): Qualified Resident Requirement

V. History of the LOB Article in U.S. Income Tax Treaties

A. "Arranged or Maintained" Test

B. Holding Companies

C. Retreat - 1962-1969

D. Trinidad and Tobago and Finland - 1970

E. Japan - 1971

F. United Kingdom - 1975

G. 1977 U.S. Model Treaty

H. French Protocol - 1978

1. Three New Concepts

2. Excise Tax on Insurance Premiums

3. Income from International Shipping and Air Transport

I. Hungary - 1979

J. Cyprus and Jamaica - 1980

1. 1980 Proposed U.S.-Cyprus Tax Treaty

a. Non-Corporate Persons Covered

b. New Public Company Test

2. 1984 U.S.-Cyprus Treaty

3. 1980 U.S.-Jamaica Tax Treaty

a. Ownership and Base Erosion Test

b. Public Company Test

c. Principal Purpose Test

(1) Incidental Income Safe Harbor

(2) Derivative Benefits Safe Harbor

K. Two Proposed Model LOB Articles - 1981

L. Australia and New Zealand Tax Treaties - 1982

1. Ownership Test

2. Public Company Test

3. Principal Purpose Test

4. Income Derived by a Trustee

M. Denmark and France - 1983-1984

N. Italy Protocol - 1984

1. Ownership Test

2. Public Company Test

3. Principal Purpose Test

4. No Base Erosion Test

O. Inconsistencies in the 1980s - Treaties with Tunisia and China

P. Germany - 1989

1. Automatic Qualification

2. Active Business Connection Test

a. Connection

(1) Downstream Connection

(2) Product Line

(3) Short-Term Investment of Working Capital

b. Substantiality

3. Discretionary Qualification

4. Derivative Benefits

Q. Finland, Spain, and Russia - 1989-1992

R. Barbados - 1991

S. Mexico - 1992

1. Public Company Tests

2. Ownership and Base Erosion Test

3. Derivative Benefits

a. NAFTA-Specific Ownership Requirements

(1) Ownership by U.S. or Mexican Residents - More Than 30%

(2) Ownership by NAFTA State Residents - More Than 60%

b. NAFTA-Specific Base Erosion Requirements

(1) Less Than 70% Gross Income Paid to non-Qualifying Owners

(2) Less Than 40% Gross Income Paid to Persons Non-Qualifying Owners and Non-NAFTA State Residents

T. The Netherlands - 1992: New Level of Complexity

1. Public Company Tests

a. Publicly Traded Company

b. Subsidiary of Publicly Traded Company

c. Conduit Company

2. Ownership and Base Erosion Test

3. Active Business Test

a. Active Trade or Business and Attribution Rules

b. "In Connection With" and Substantiality

(1) "In Connection With"

(2) Substantiality

c. "Incidental To"

4. Headquarters Companies - Seven Requirements

5. Derivative Benefits

6. 1993 Protocol: Triangular Cases

U. Czech Republic, Slovak Republic, and Kazakhstan - 1993-1994

V. France - 1994

W. Canada - 1995

X. Luxembourg - 1996: Expanded Derivative Benefits for EU and NAFTA Residents

1. Scope of Derivative Benefits Provision

2. Requirements of Derivative Benefits Provision

a. The Three Requirements

b. The Ownership Requirement

c. The Base Erosion Requirement

d. The Withholding Rate Requirement

3. Headquarters Companies

4. Other Provisions

a. Subsidiaries of Publicly Traded Companies

b. Triangular Arrangements

c. Tracking Stock

Y. Austria, Turkey, Thailand - 1996

Z. Switzerland - 1996: The Predominant Interest Test

1. The Predominant Interest Test

2. Other Provisions

a. Derivative Benefits

b. Triangular Arrangements

c. Headquarters Companies

3. Subsidiary of Public Company

4. Discretionary Safe Harbor

AA. The Baltics, Slovenia, and Italy - 1998-1999

1. The Main Purpose Test

2. Dividend Washing and Other Abuses

BB. United Kingdom - 2001: Wave of the Future?

1. Qualification of the Taxpayer Generally - Alternative Tests

a. Public Company Tests

b. Ownership/Base Erosion Test for Entities

c. Alternative Ownership/Base Erosion Test for Trusts

2. Qualification with Respect to a Particular Item of Income - Alternative Tests

a. Derivative Benefits Test

b. Active Business Test

c. Competent Authority Relief

d. Tracking Stock

3. Anti-Conduit Provision

a. Purpose and Effect

b. Application of Rule

CC. Australia Protocol - 2001

DD. Japan - 2003

1. Tracking Stock

2. Hybrid Entities

3. Anti-Conduit Provision

EE. Dutch Protocol - 2004

1. Publicly Traded Test

2. Public Company Subsidiary Test

3. Ownership and Base Erosion Test

4. Active Business Test

5. Broader Derivative Benefits Test

FF. Barbados Protocol - 2004

1. Stricter Public Company Test

2. Restrictive Ownership and Base Erosion Test

3. Active Business Test - Narrow Definition of Bank

4. Partial Denial of Treaty Benefits to Disqualified Residents

GG. Sweden - 2005

1. Publicly Traded Test

2. Public Company Subsidiary Test

3. Ownership and Base Erosion Test

4. Derivative Benefits Test

5. Triangular Arrangements

HH. Ongoing Negotiations with Hungary

II. Belgium - 2006

JJ. Iceland - 2007

KK. Bulgaria - 2007, 2008

VI. Future of the LOB Article

A. In General

B. What the Future May Bring

1. Simplification?

2. New U.S. Model?

3. Greater Influence of EU Law?

4. Modifications to the Derivative Benefits Provision?

5. More Burdensome Documentation Requirements?

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 United States Model Income Tax Convention of September 20, 1996, Article 22

Worksheet 1A United States Model Income Tax Convention of November 15, 2006, Article 22 and Technical Explanation

Worksheet 2 1989 United States-Germany Tax Treaty, Article 28 and Memorandum of Understanding

Worksheet 3 1992 United States-Netherlands Tax Treaty, Article 26 Memorandum of Understanding and 1993 Protocol to 1992 United States-Netherlands Tax Treaty, Article 5

Worksheet 4 2004 Protocol to 1992 United States-Netherlands Tax Treaty, Article 7

Worksheet 5 1996 United States-Luxembourg Tax Treaty, Article 24 and Exchange of Notes

Worksheet 6 1996 United States-Switzerland Tax Treaty, Article 22 Memorandum of Understanding and Protocol

Worksheet 7 1999 United States-Slovenia Tax Treaty

Worksheet 8 2001 United States-United Kingdom Tax Treaty, Article 23, Exchange of Notes and Protocol

Worksheet 9 United States-Barbados Tax Treaty, 2004 Protocol


Internal Revenue Code:

Foreign Statutes and Decrees:

Committee Reports/Public Laws:

Revenue Rulings and Procedures:

Tax Treatises:



Tax Articles: