U.S. tax treaties can offer powerful benefits to both individuals and businesses abroad, but none of them mean anything if they can't be accessed in the first place, according to Michael Miller, a partner at Roberts and Holland LLP, who spoke at the Foundation for Accounting Education's International Tax Conference Thursday.

 

Miller said that treaty access tends to be determined through a number of tests. The "most fundamental" is residency: Are you a resident of the country with which the United States has a treaty? The United States generally defines a resident as someone who, under the laws of the contracting state, is liable to pay taxes therein by reason of domicile, residence, citizenship, place of management, place of incorporation or any similar criterion.

 

This means that if, for example, some people who hold a U.S. green card do not spend most of their time in the country, tax authorities will still consider them residents for treaty purposes, just as they do U.S. citizens abroad. Specific treaties, he said, are shaped by negotiations between the two countries and so are unlikely to be totally consistent from nation to nation. Thus they will sometimes include additional ways to be treated as a resident, such as substantial presence.

 

It is possible, he said, for individuals to be residents of both countries under this general rule, and so there are also a number of "tiebreaker provisions" to determine which country gets the tax money. Depending on the treaty, it might depend on where the person's permanent home is, where the person's "center of vital interest" lies, or even something more prosaic like nationality or just mutual agreement.

 

He added the caveat that "most, if not all, U.S. income tax treaties" have what he called a "savings clause" meant to preserve the government's ability to tax its own citizens and, potentially, former citizens as if the treaty did not exist. While some have carve-outs that allow citizens to get some treaty benefits, such as double-taxation relief, this can't be assumed.

 

"If a citizen lives in a treaty country and clearly would tiebreak for the treaty country, be careful in presuming that an individual can claim treaty benefits against the U.S.," he said.

 

Another significant restriction is the "limit on benefits" provision, which appears on almost every U.S. tax treaty, the purpose of which is to discourage treaty shopping. For instance, a resident of the Cayman Islands—which has no U.S. income tax treaty—who wants to access a treaty anyway might try to form a U.K. corporation and operate through that.

 

Like other treaty provisions, the particulars can vary greatly from country to country due to "evolving treaty policy and give and take of negotiations," Miller said. But they do tend to follow certain patterns. One common one is the public company test. A public company can qualify for treaty benefits in a particular country if the principal class of its shares is regularly traded on one or more recognize exchanges within that country.

 

Some go further and say that the shares must be traded specifically in the resident state, meaning that "it's not good enough if [a foreign company's stock] is primarily traded in the U.S. It would need to be primarily traded in its own state," which he said might be difficult to comply with "because some of those countries have fairly modest exchanges compared with the U.S." Others dispense with where stocks are traded and go instead with requiring that the primary place of control or management be in the resident state.

 

Another potential pitfall is the base erosion test. Essentially, this test requires that certain residents of the same contracting state own, directly or indirectly, at least 50 percent aggregate voting power and value of an entity (and of any disproportionate class of shares) and, if ownership is indirect, that each intermediate owner is a qualifying intermediate owner. It also requires those who are not residents of the contracting states or those who are connected persons who benefit from a special tax regime or notional interest deductions be paid less than 50 percent of gross income.
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The United States may also use the requirement that one maintain an active trade or business in the state (so no holding companies) with income that emanates from the business (rather than is derived from it), and performs substantial activity in the resident state connected with the trade or business.

 

But what if an entity cannot meet any of the criteria? Miller said there are two more possible routes to pursue before determining that an entity cannot access treaty benefits. One is looking at who owns it. If most or all of the ownership is held by people who already have access to a U.S. tax treaty, than the entity is considered to have access too.

"The idea is that treaty shopping isn't present, and therefore treaty benefit should be allowed," he said.

 

The last resort, he said, is the competent authority test. Basically, the entity would explain the situation to the government and ask permission to access treaty benefits. What the United States is most concerned with is whether an entity is being structured specifically to access treaty benefits. If it can be demonstrated that this is not the case, despite not meeting any of the other test criteria, then the U.S. can just give the entity relief. Miller warned, however, that this be a difficult process.

 

"As a practical matter, the U.S. tends to be fairly strict in allowing treaty benefits," he said, adding that in these discussions, the government tends to pay particular attention to whether there is substantial non-tax nexus to the contracting state. "There may be situations which are perfectly innocent, where you don't have such a nexus but nonetheless didn't have a treaty-shopping purpose, but for many reasons U.S. authorities are not overly interested in hearing the explanations."