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How Not to Borrow a Treaty: Smith v. Commr.

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How Not to Borrow a Treaty: Smith v. Commr.

For individual entrepreneurs operating across the globe, generating profits in corporations based in tax favored jurisdictions is a key ingredient in making and keeping a substantial share of profits. However, when the entrepreneur is a U.S. citizen, bringing those profits home requires careful planning in order to take advantage of the qualified dividend rules. Having a structure that is on the right side of the rules reduces the income tax rate on dividends to 20%. Having a structure on the wrong side, leaves the top rate at 37%. Too many entrepreneurs wait until the last minute to plan and even then have difficulty in following a plan based on tax law and economic substance. Galia Antebi and Stanley C. Ruchelman discuss a case in which one taxpayer was addicted to cutting corners or did not appreciate the risk when deviating from a plan. Whatever the reason, the plan crafted by his tax advisers never made it to the implementation stage. On paper, the plan worked. In substance, nothing was done. Big tax resulted.

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Insights Vol. 3 No. 4: B.E.P.S. Around The World

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Under political pressure from N.G.O. watchdogs, governments are striving to demonstrate their support for the B.E.P.S. Action Plan on a national level. Kenneth Lobo and Stanley C. Ruchelman look at implementation issues around the world. Included are issues in Germany related to exchanges of information, treatment of C.I.V.’s for income tax treaty purposes, and U.K. tax penalties for aggressive tax planning.

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2016 Model Treaty – B.E.P.S. and Expatriated Entities

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On February 17, 2016, the Treasury Department released its 2016 Model Treaty. The model serves as the baseline from which the U.S. initiates treaty negotiations. Various provisions are discussed in detail in this month’s Insights.

The 2016 Model Treaty adopts certain B.E.P.S. provisions, including those that eliminate double non-taxation through a splintered operation which divides a long-term project among several related parties and each party maintains the project for a limited time. That type of planning no longer works. Other B.E.P.S.-related revisions are missing. Sheryl Shah and Elizabeth V. Zanet explain what is out and what is in. They also address the way payments from expatriated entities are treated. It is not all bad news.

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U.S. Treasury Announces New U.S. Model Income Tax Treaty

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On February 17, 2016, the Treasury Department released its 2016 Model Treaty. The model serves as the baseline from which the U.S. initiates treaty negotiations. Various provisions are discussed in detail in this month’s Insights.

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Follow-Up Draft of Report on Action 6 (Treaty Abuse) and Public Comments Released

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Comments on the O.E.C.D.’s public discussion draft to the follow-up work on B.E.P.S. Action 6 (the “Follow-Up Draft”) were released on January 12, 2015. Action 6 of the B.E.P.S. Action Plan focuses on preventing treaty abuse and treaty shopping, which the O.E.C.D. has identified as being one of the most important sources of B.E.P.S. concerns.

The Follow-Up Draft modifies the “Report on Action 6 (Prevent the granting of treaty benefits in appropriate circumstances)” and identifies 20 issues on which interested parties may provide comments. It focuses on matters related to the application of the limitation on benefits (“L.O.B.”) rule and principal purpose test (“P.P.T.”) as well as the treaty entitlement of collective investment vehicles (“C.I.V.’s”) and non-C.I.V. funds. The 20 issues identified by the Follow-Up Draft and addressed in the comments are as follows:

Issues Related to the L.O.B. Provision

  • C.I.V.’s: application of the L.O.B. and treaty entitlement,
  • Non-C.I.V. funds: application of the L.O.B. and treaty entitlement,
  • Commentary on the discretionary relief provision of the L.O.B. rule,
  • Alternative L.O.B. provisions for E.U. countries,
  • Requirement that each intermediate owner be a resident of either Contracting State,
  • Issues related to the derivative benefit provision,
  • Provisions dealing with “dual-listed company arrangements,”
  • Timing issues related to the various provisions of the L.O.B. rule,
  • Conditions for the application of the provision on publicly-listed entities, and
  • Clarification of the “active business” provision.