Institute of International
Bankers
Tax Treaty Developments & The
New U.S. Model Income Tax
Treaty
Tuesday - June 19, 2007
10:45 - 11:45 AM
Daniel J. Raimondo
HSBC Securities (USA) Inc.
Benedetta Kissel
Internal Revenue Service
Peter Connors
Orrick, Herrington & Sutcliffe LLP
Willard Taylor
Sullivan & Cromwell LLP
Recent treaty developments
• Issuance of new Model treaty in November
of 2006, together with technical
explanation
• Replaces the 1996 Model, which in turn
had been preceded by Models going back
to 1977
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Recent treaty developments
• Pending
– protocols with Denmark, Finland, and
Germany
– Treaty with Belgium
• Announced agreements with Iceland,
Bulgaria
• Protocol to the Canadian treaty
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Recent treaty developments
• Protocols with Denmark, Finland, and Germany,
and new treaty with Belgium provide
– A zero rate on parent-subsidiary dividends, on
dividends paid to pension plans and of branch profits
– New limitation on benefits articles
• Agreements with Germany and Belgium also
provide
– Authorized OECD approach for attribution of profits to
a permanent establishment
– Binding arbitration
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Specific Issues under 2006 Model
Treaty – “Consistency”
• The “consistency” doctrine
– i.e., that a foreign taxpayer may not choose to
apply the business profits article of the treaty
to some US operations and the “effectively
connected” rules in the Code to others
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Specific Issues under 2006 Model
Treaty – “Consistency”
• For example, suppose that a foreign corporation has
– activities that amount to a trade or business in the US but not a
permanent establishment and
– separately, employees and an office in New York that actively
trade stocks and securities and commodities
• May the foreign corporation use the treaty to avoid US
tax on the activities but Section 864(b)(2 ) to avoid US
tax on the trading income?
• What’s the legal basis for requiring “consistency”?
– Is there something more than Rev. Rul. 84-17?
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Specific Issues under 2006 Model
Treaty – Attribution of Profits
• How do the Model’s rules for attributing profits to
a permanent establishment differ from the
determination of “effectively connected” income
under the Code?
– Suppose a foreign bank has employees in a New
York branch who, working hand and glove with
employees in a foreign branch enter into notional
principal contracts with customers
• Under the “material factor” rules in the Section 864
regulations, all of the income would be “effectively
connected”, absent an APA (or the adoption of the global
dealing regulations)
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Specific Issues under 2006 Model
Treaty – Attribution of Profits
• Under the OECD guidelines, which seem
to be incorporated in the Model treaty,
attribution would assume that the branch
was functionally a separate entity and
determine the income on the basis of an
arm’s length allocation
– Is this self-executing?
– Is there any need in such a case for an APA or
for the global dealing regulations?
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Specific Issues under 2006 Model
Treaty – “Risk weighting”
• The Model treaty contemplates that banks and
other financial institutions may elect to use “riskweighting” to determine US assets and thus
deductible interest expense and branch profits
– In a number of treaties today (e.g., UK, Japan) and
also in the German protocol
– Not in others – e.g., Switzerland, the Netherlands
– Is risk-weighting self-executing? Will there be
guidance?
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Specific Issues under 2006 Model
Treaty-Payments to Hybrids
•Section 894
–
Reduced rate of any withholding tax imposed will not be available “on
an item of income derived through an entity which is treated as a
partnership (or is otherwise treated as fiscally transparent) for
purposes of this title if….such item is not treated for purposes of the
taxation laws of such foreign country as an item of income of such
person”
•Article 1(6)
–
An item of income, profit or gain derived through an entity that is
fiscally transparent under the laws of either Contracting State shall be
considered to be derived by a resident of a State to the extent that the
item is treated for purposes of the taxation law of such Contracting
State as the income, profit or gain of a resident.
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Specific Issues under 2006 Model
Treaty-Payments to Hybrids
Country A Co
Transparent for US purposes,
but not for Country A purposes
LLC
USCO
Treaty benefits will not be available since LLC is not transparent for Country A purposes
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Specific Issues under 2006 Model
Treaty-Payments to Hybrids
Country A Co
Transparent for US
purposes, but not
for Country A
purposes
LLC
USCO
Assume LLC is engaged in a trade or business but has no PE, does the Article 1(6) limit application to nonFDAP Income?
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Specific Issues under 2006 Model
Treaty-Dividends to Hybrids
• Article 10: If the dividends are beneficially owned by a
resident of the other Contracting State, except as
otherwise provided, the tax so charged shall not exceed:
• a) 5 percent of the gross amount of the dividends if the
beneficial owner is a company that owns directly at
least 10 percent of the voting stock of the company
paying the dividends
• How do you determine application of beneficial owner
and direct test?
– See LTR 200712007 (application of direct ownership test under
UK treaty)
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Specific Issues under 2006 Model
Treaty-Dividends to Hybrids
Country A
(treaty)
Transparent for
Country A and US
purposes
Country B
Dividends
USCO
•Alternative: What if transparent for US purposes, but not for Country A purposes?
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Specific Issues under 2006 Model
Treaty-Article 10-Reverse Hybrid
Country A
(treaty)
Country B
(Non-treaty)
USCO
•Article 10 not satisfied
•Article 1(6) satisfied
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Specific Issues under 2006 Model
Treaty
• Other items
– Model does not offer a zero rate on parentsubsidiary dividends
– TE lists guarantee fees as a type of income
constituting “Other Income”
– Model does not contemplate binding
arbitration
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