U.S. Income Tax Treaties — Income Not Attributable to a Permanent Establishment (Portfolio 938)

Tax Management Portfolio, U.S. Income Tax Treaties – Income Not Attributable to a Permanent Establishment, No. 938, discusses aspects of U.S. income tax treaties that relate to income that is not attributable to a permanent establishment. To view this Portfolio, visit Bloomberg Tax for a free trial. 

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Description

Tax Management Portfolio, U.S. Income Tax Treaties – Income Not Attributable to a Permanent Establishment, No. 938, discusses aspects of U.S. income tax treaties that relate to income that is not attributable to a permanent establishment. The portfolio covers general U.S. tax treaty considerations, including background regarding the impact of tax treaties on the taxation of foreign persons, the relationship of tax treaty provisions to U.S. tax law, the conditions for obtaining treaty benefits, and certain anti-abuse rules embedded within U.S. income tax treaties and within U.S. tax law. Specific treaty articles that address specific types of income, including those on dividends, interest, royalties, capital gain, income from real property, and other income are described in detail. The portfolio includes a summary of certain relevant documentation and reporting requirements.

This Portfolio may be cited as Nauheim and Scott, 938 T.M., U.S. Income Tax Treaties – Income Not Attributable to a Permanent Establishment.

Authors

Steve Nauheim, Esq.

Steve Nauheim, B.S., University of North Carolina (Chapel Hill); JD, Georgetown University Law Center; LL.M. (Taxation), George Washington University Law School; formerly attorney/advisor in the Office of Chief Counsel of the U.S. Internal Revenue Service, where he was a principal drafter of the 1968 U.S. transfer pricing regulations; has represented the U.S. government in bilateral income tax treaty negotiations; has been professor of international tax law and lectured and written extensively on the subject; has held leadership positions in several professional associations.

Eileen Scott, Ph.D.

Eileen Scott, B.S., Skidmore College, with honors; M.A., University of Miami; Ph.D., University of Miami, with award of academic merit; MPA, Harvard University. Eileen is an international tax services director with PricewaterhouseCoopers's Washington National Tax Services office, where she is a member of the firm's national inbound team, focusing on cross-border activities of foreign multinationals, including inbound financing, income tax treaty analysis, U.S. withholding requirements, among others. Previously Eileen has conducted research in the area of international trade and finance at the University of Miami and Harvard University's Center for Business and Government.

Table of Contents

Detailed Analysis
I. General Overview Regarding Bilateral U.S. Income Tax Treaties
Introductory Material
A. U.S. Taxation Regime in the Absence of Tax Treaty
B. Purpose of Tax Treaties
C. Relationship of Tax Treaty Provisions to U.S. Tax Law
1. Effect of Tax Treaty Provisions
2. Treaty Overrides
3. Electing Not to Apply Treaty Provisions
4. Application of Treaty Provisions to U.S. Persons
D. Ambulatory Construction of Treaties
E. Relationship to Other Agreements
II. Conditions for Treaty Benefits
A. Status as a Person
B. Residence
1. General Rules
2. Collective Investment Vehicles
3. Pension Funds and Charities
4. Governmental Entities
5. Fiscally Transparent Entities
6. Dual Residence or Non-Residence
C. Beneficial Ownership
1. General Concepts
2. Whose Law Applies to Identify the Beneficial Owner
3. Ownership in the Context of Certain Financial Transactions
4. Ownership in the Context of “Flow-Through” Entities
III. Anti-Abuse Rules
Introductory Material
A. Limitation on Benefits
1. Historical Perspective
2. The Modern Version of Anti-Treaty Shopping Provisions
B. Anti-Abuse Rules — Resident Must “Derive” the Income
1. The U.S. View — Regs. §1.894-1(d)
a. Treaty Benefits at the Entity Level
b. Treaty Benefits at the Interest Holders' Level
c. Benefits at Both the Entity and the Interest Holders' Level
d. Treaties to Which These Rules Apply
e. Special Rules for Domestic Entities
(1) Payments Made to a Domestic Entity
(2) Payments Made by a Domestic Entity
(3) Anti-Abuse Rules for Domestic Reverse Hybrids
f. Limitations Under §894(c)(1)
2. Views of OECD and Treaty Partners
C. Anti-Conduit Rules
D. Section 269
1. The Principal Purpose of Evasion or Avoidance of Federal Income Tax
2. Deduction, Credit, or “Other Allowance”
3. Tax Benefits Acquirer “Would Not Otherwise Enjoy”
E. Economic Substance
IV. Dividends
A. General Framework
1. U.S. Tax Rules
2. General U.S. Model Treaty Framework
B. Reduced Treaty Rate on Portfolio Dividends
1. General Rules
2. Beneficial Ownership
a. Beneficial Ownership of Dividends Versus Shares of Stock
b. Dividends on Shares Sold
3. Special Rules for RICs
4. Special Rules for REITs
C. Reduced Treaty Rate on Direct Investment Dividends
1. Ownership Requirements
2. Ownership Through a Fiscally Transparent Entity
3. Holding Period
4. Distributing Person and Shareholder Must Each Be a “Company” or “Corporation”
5. Elimination of Tax on Qualifying Parent/Subsidiary Dividends
a. History and Conditions for Qualifying
b. Definition of an Equivalent Beneficiary
c. Ownership of Shares by a Disregarded Entity
(1) The Private Letter Rulings
(2) Treasury Technical Explanations
6. Special Coordination with Corporate Integration Regimes
7. Targeted Anti-Abuse Provisions
D. Income Eligible for Relief Under Dividends Article
1. Definition of Dividend in Treaties
2. Deemed Dividends
a. Deemed Dividends Under §304
b. Amounts Treated as Dividends Under §356
c. Deemed Dividends Under §305
d. Deemed Dividends from Allocations Under §482
e. Securities Lending Transactions
(1) In General
(2) Character of Substitute Dividends Under Treaties
(3) Source of Substitute Dividends
E. Inconsistent Definitions and Use of Derivative Instruments
1. Inconsistent Income Classification — Debt Versus Equity
2. Inconsistent Beneficial Owner — Sale and Repurchase Transactions
3. Synthetic Ownership — Equity Swaps
F. Triangular Structure Provisions
G. “Second-Level” Tax on Dividends
1. U.S. Tax Rules
2. Treaty Relief from U.S. Tax Rules
3. Post-1986 Treaty Rules
H. Source Rules for Dividends
I. Accumulated Earnings and Personal Holding Company Taxes
V. Interest
A. General Treaty Relief for Interest Income
1. U.S. Tax Rules
2. General Treaty Framework
3. Applicable Rate of Tax on Interest Under Treaties
4. Conditions for General Treaty Relief
a. Residence
b. Beneficial Ownership
5. Triangular Provisions
6. Sourcing of Interest
7. Branch-Level Interest Tax
a. U.S. Sourcing Rules
b. Limitations Under Treaties
c. Conditions for Claiming the Benefit of a Treaty
8. Treaty Limitations on Interest Re-Sourced to a Foreign Permanent Establishment
9. Right to Impose Tax on Interest Paid by a Resident of the Other State
10. Interaction with Certain U.S. Tax Rules
a. Section 267(a)(2) and (3)
b. Section 163(e)(3)
c. Section 163(j)
B. Interest Income Eligible for Relief Under the Interest Article
1. General Definition
2. Deemed Interest Amounts
3. Participating Loans
4. Interest in Excess of Arm's-Length Amount
5. Derivative Financial Instruments and Other Transactions
a. Notional Principal Contracts
b. Securities Lending and Sale and Repurchase Transactions
(1) Securities Lending Transactions
(2) Sale and Repurchase Transactions
(a) Borrow Fees
(b) Substitute Payments
(c) Loan Rebate Fees
6. Guarantee Fees and Other Income Analogized to Interest
C. Anti-Abuse Rules: Financing Transactions and Companies
1. Case Law
2. Administrative Guidance
3. The Anti-Conduit Regulations
4. Treaty Anti-Conduit Rules
VI. Royalties
A. General Treaty Relief for Royalty Income
B. Defining “Royalties” Under U.S. Tax Law
1. Royalties Distinguished from Proceeds of Sale or Disposition
2. Sales for Contingent Payments Treated as Giving Rise to Royalties
3. License Versus Partnership
C. U.S. Tax Law Rules on Sourcing of Royalties
1. Identifying the Place of Use of Commercial Intangibles
2. U.S.-Source Royalties Derived by Foreign Persons
D. General Treaty Framework for Royalties
1. Treaty Limitations on the Right to Tax Royalties
2. Applicable Rate of Tax
3. Treaty Definition of Types of Intellectual Property that Give Rise to Royalties
E. Payments Giving Rise to Royalties
1. Copyright Issues
a. Payments for Works of Art and Musical Performances
b. Payments for Theatrical Productions
c. Computer Software and Digital or Electronic Products
(1) Transfer of a Copyright Right
(2) Transfer of a Copyrighted Article
d. Provision of Services
e. Provision of Know-How
f. Copyright Rights: Sale or Disposition Versus License
2. Payments for Use of Cinematographic Films/Broadcasting Films or Tapes
3. Payments for Know-How
a. Technical Assistance Distinguished from Know-How
b. Technical Services Merely Ancillary to Transferring Know-How
4. Special Situations
a. Payments Attributable to Non-Usage
b. Damages for Infringement
c. Lump-Sum Payments
d. Contingent Payment Sales or Dispositions
5. Royalties Bundled with Other Types of Payments
6. Payments for Franchises
7. Royalties Attributable to Oil and Gas and Other Natural Resources
8. Rentals
F. U.S. Tax and Treaty Rules
1. Royalties Attributable to Third-Country PEs: Triangular Arrangements
2. Absence of Any Permanent Establishment in the Source State
3. Force-of-Attraction Principle
4. Royalties that Are Paid or Accrued
5. Deduction of Accrued but Unpaid Royalties Owed to Related Foreign Person
6. Imputation of Royalties
7. Absence of Royalties with Respect to Embedded Intangibles
8. Above-Market Royalties
9. Special Source Rules for Royalties
a. Cascading Royalties
b. Treatment Under Certain Treaties
c. U.S. Tax Law: Rev. Rul. 80-362 and SDI Netherlands B.V.
d. Anti-Conduit Rules
VII. Real Property Income
A. Introduction
B. General Treaty Framework — Relevant Treaty Articles
1. Article 6 — Income from Real Property Article
2. Article 13 — Gains
3. General Rules of Income from Real Property Article
a. Priority of Real Property Article
b. Definition of Real Property
c. Net Election
4. Operative Rules of the Gains Article
a. General Rule
b. Treaties with Canada and the Netherlands
C. U.S. Tax Treatment of Foreign Persons with U.S. Real Property Interests
1. Overview of FIRPTA
a. Legislative History and Purpose of the FIRPTA Rules
b. Coordination with U.S. Treaties
2. Mechanics of FIRPTA Rules
a. Definition of USRPI
b. Definition of USRPHC
D. Rentals of Real Property
E. Natural Resources Royalties
F. Livestock and Crops
VIII. Capital Gains
A. U.S. Tax Rules and Concepts
B. General Treaty Framework
1. General Rule of Exclusive Residence-State Taxation
2. Source-State Taxation of Gains Attributable to Real Property
3. Permanent Establishment Rules
4. Gains from Alienation of Shipping and Air Transport Property
C. Additional Instances of Source-State Taxation of Gains
1. Presence of Individual for 183 Days
2. Alienation of Substantial Interest in Corporation
D. Additional Provisions in Bilateral U.S. Tax Treaties
1. Nonrecognition Provisions
2. Relationship of Treaty Exemptions and Expatriation Provisions
3. Alienation of Intangible Assets
4. Specific Basis and Timing Provisions
IX. Other Income
A. Other Income — General
B. “Other Income” Articles
1. General Principles
2. Definition of Other Income
X. Documentation and Reporting
A. Introduction
B. General Concepts
1. FDAP and the 30% Tax Under §§871 and 881
2. Withholding Requirement
a. General Rule
b. Section 1441 Regulations
(1) Amounts Subject to Withholding
(2) Expansive Definition of FDAP
C. Documentation Requirements
1. Applicable Forms — General Overview
a. Form W-8BEN — Beneficial Owner Status and Treaty Claim
b. Intermediaries
c. Payments to Hybrid Entities
(1) Payments to Fiscally Transparent Entities
(2) Payments to Foreign Reverse Hybrid Entities
2. Other Documentation Requirements — Form W-8ECI
D. Reporting Required for Notional Principal Contracts
E. Reporting Required for Treaty-Based Return Positions
1. Section 6114 and Form 8833
2. Penalties If No Form 8833
F. Reporting — Returns
G. FATCA Rules

Working Papers

Table of Worksheets
Worksheet 1 United Nations Model Taxation Convention Between Developed and Developing Countries, Adopted January 2001
Worksheet 2 Testimony by Leslie B. Samuels, Assistant Secretary for Tax Policy, Senate Hearing 103-336, October 27, 1993
Worksheet 3 Zero Dividend Withholding