By Anthony Diosdi
The major purpose of an income tax treaty is to mitigate international double taxation through tax reduction or exemptions on certain types of income derived by residents of one treaty country from sources within the other treaty country. Because tax treaties often substantially modify United States and foreign tax consequences, the relevant treaty must be considered in order to fully analyze the income tax consequences of any outbound or inbound transaction. The United States currently has income tax treaties with approximately 58 countries. This article discusses the United States- Philippines Income Tax Treaty.
There are several basic treaty provisions, such as permanent establishment provisions and reduced withholding tax rates, that are common to most of the income tax treaties to which the U.S. is a party. In many cases, these provisions are patterned after or similar to the United States Model Income Tax Convention, which reflects the traditional baseline negotiating position. However, each tax treaty is separately negotiated and therefore unique. As a consequence, to determine the impact of treaty provisions in any specific situation, the applicable treaty at issue must be analyzed. The United States- Philippines Income Tax Treaty is no different. The treaty has its own unique definitions. We will now review the key provisions of the United States- Philippines Income Tax Treaty and the implications to individuals attempting to make use of the treaty.
Definition of Resident
The tax exemptions and reductions that treaties provide are available only to a resident of one of the treaty countries. Income derived by a partnership or other pass-through entity is treated as derived by a resident of a treaty country to the extent that, under the domestic laws of that country, the income is treated as taxable to a person that qualifies as a resident of that treaty country. Under Article 3 of the United States- Philippines Income Tax Treaty, a resident is any person who, under a country’s internal laws, is subject to taxation by reason of domicile, residence, citizenship, place of management, place of incorporation, or other criterion of a similar nature. Because each country has its own unique definition of residency, a person may qualify as a resident in more than one country. Whether a person is a resident of the United States or Philippines for treaty purposes is determined by reference to the internal laws of each country.
The term “resident of the United States” means: 1) a business entity formed in the United States, or 2) any other person (except a corporation or any entity treated under United States law as a corporation) resident in the United States for purposes of United States tax, but in the case of an estate or trust only to the extent that the income derived by such person is subject to United States tax as the income of a resident. Section 7701(b) of the Internal Revenue Code treats an alien individual as a U.S. resident where such an individual is 1) lawfully admitted for permanent residence, (26 C.F.R. Section 301.7701(b)-1(b)(1)) “Green card test:” An alien is a resident alien with respect to a calendar year if the individual is a lawful permanent resident at any time during the calendar year. A lawful permanent resident is an individual who has been lawfully granted the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws. Resident status is deemed to continue unless it is rescinded or administratively or judicially determined to have been abandoned.”) (2) meets the substantial presence test, (An individual meets the substantial presence test with respect to any calendar year if i) such individual was present in the United States at least thirty-one days during the calendar year, and ii) the sum of the number of days on which such individual was present in the United States during the current year and the two preceding calendar year (when multiplied by the applicable multiplier: current year – 1, first preceding year – ⅓, second preceding year – ⅙) equals or exceeds 183 days) or iii) makes a first year election.
In contrast to the U.S. law, the term “resident of the Philippines” means 1) a Philippine corporation, and 2) any other person (except a corporation or any entity treated as a corporation for Philippine tax purposes) resident in the Philippines for purposes of Philippine tax, but in the case of a professional partnership, estate, or trust only to the extent that the income derived by such partnership, estate, or trust is subject to Philippines tax as the income of a resident either in the hands of the respective entity or of its partners or beneficiaries.
An individual who is a resident of both Contracting States shall be deemed to be resident of that Contracting State in which he maintains his permanent home. If he has a permanent home in both Contracting States or in neither Contracting State, he or she shall be deemed to a resident of that Contracting State with which his or her personal and economic relations are closest (center of vital interests). While Article 3 of the treaty looks to each country’s laws to define the term “resident,” Because each country has its own unique definition of residency, a person may qualify as a resident in more than one country. Whether a person is a resident of the United States or Philippines for treaty purposes is determined by reference to the internal laws of each country.
For example, an alien who qualifies as a U.S. resident under the substantial presence test pursuant to U.S. tax law may simultaneously qualify as a resident of the Philippines under its definition of resident. To resolve this issue, the United States has included tie-breaker provisions in the United States- Philippines Income Tax Treaty. The tie-breaker rules are hierarchical in nature, such that a subordinate rule is considered only if the superordinate rule fails to resolve the issue. Article 3(2) of the United States- Philippines Income Tax Treaty provides the following tie-breaker for individuals:
a) An individual shall be deemed to be a resident of that Contracting State in which he maintains his permanent home. If he has a permanent home in both Contracting States or in neither of the Contracting States, he shall be deemed to be a resident of that Contracting State with which hios personal and economic relations are closest (center of vital interests);
b) If the Contracting State in which he has his center of vital interests cannot be determined, he shall be deemed to be a resident of that Contracting State in which he has a habitual abode;
c) If he has a habitual abode in Both Contracting States or in neither of the Contracting States, he shall be deemed to be a resident of the Contracting State of which he is a citizen; and
d) If he is a citizen of both Contracting States or of neither Contracting States, the competent authorities of the Contracting States shall settle the question by mutual agreement.
Below, please see Illustration 1 which provides an example how a treaty-tie breaker can be analyzed and resolved.
Paul is a citizen and resident of the Philippines. Paul owns PhilCo, a company incorporated in the Philippines that is in the trade or business of taking over corporations. PhilCo is in the process of expanding to the much more lucrative U.S. market by opening a branch office in the United States. Paul is divorced and maintains an apartment in Manila, Philippines, where he spends every other weekend visiting his children. Paul’s first wife, who kept their house in their divorce, has never left the Philippines. Paul becomes a U.S. resident alien under the substantial presence test as he operates PhilCo’s U.S. branch. In the United States. Paul owns a luxury condominium in Miami, Florida where he lives with his second wife.
Because Paul is considered a resident of both the United States and the Philippines, the treaty tie-breaker procedures must be analyzed to determine which country has primary taxing jurisdiction. With an apartment in the Philippines and a condominium in the United States, Paul has a permanent home available in both countries. With Paul’s children and his home office in the Philippines as opposed to the lucrative portion of his business and his new wife in the United States, Paul does not have a center of vital interests in either country. Furthermore, Paul regularly spends time in both countries, he arguably has a habitual abode in both. As a result, under the treaty tie-breaker, Paul may be considered a resident of the Philippines because he is a citizen of the Philippines.
Business Profits and Permanent Establishment
A central issue for any company exporting its goods or services is whether it is subject to taxation by the importing country. Most countries assert jurisdiction over all the income from sources within their borders, regardless of the citizenship or residence of the person receiving that income. Under a permanent establishment provision, the business profits of a resident of one treaty country are exempt from taxation by the other treaty country unless those profits are attributable to a permanent establishment located within the host country. A permanent establishment includes a fixed place of business, such as a place of management, a branch, an office, a factory or workshop. A permanent establishment also exists if employees or other dependent agents habitually exercise in the host country an authority to conclude sales contracts in the taxpayer’s name.
Article 5 of the United States- Philippines Income Tax Treaty defines a permanent establishment as a fixed place of business through which a resident of one of the Contracting States engages in industrial or commercial activity. This includes the following: 1) a set of management; 2) a branch; 3) an office; 4) a store or other sales outlet; 5) a factory; 6) a workshop; 7) a warehouse; 8) a mine, quarry, or other place of extraction of natural resources; 9) a building site or construction or assembly project or supervisory activities in connection therewith, provided such site, project or activity continues for a period of more than 183 days; and 10) the furnishing of services, including consultancy services, by a resident of one of the Contracting States through employees or other personnel, provided activities of that nature continue (for the same or a connected project) within the other Contracting State for a period or periods aggregating more than 183 days.
A permanent establishment shall be deemed not to include any one of the following:
1) The use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the resident;
2) The maintenance of a stock of goods or merchandise belonging to the resident solely for the purpose of storage, display, or occasional delivery;
3) The maintenance of a stock of goods or merchandise belonging to the resident solely for the purpose of processing by another person;
4) The maintenance of a fixed place of business sol;ely for the purpose of purchasing goods or merchandise, or for collecting information, for the resident;
5) The maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research, or for similar activities which have a preparatory or auxiliary character, for the resident; or
6) The furnishing of services, including the provision of equipment, in one of the Contracting States by a resident of the other Contracting State, including consultancy firms, in accordance with, or in the implementation of, an agreement between the Contracting State regarding technical cooperation.
Marketing products in either the United States or the Philippines solely through independent brokers or distributors does not create a permanent establishment, regardless of whether these independent agents conclude sales contracts in the exporter’s name. In addition, the mere presence within the importing country does not create a permanent establishment. Please see Illustration 2 and Illustration 3.
USAco, a domestic corporation, markets its products through the internet to Filipino customers. Under the United States- Philippines Income Tax Treaty, the mere solicitation of orders through the internet does not constitute a permanent establishment. Therefore, USAco’s export profits are not subject to income tax in the Philippines.
USAco decided to expand its Filipino marketing activities by leasing retail store space in Manila, Philippines in order to display its goods and keep an inventory from which to fill foreign orders. Under the United States- Philippines Income Tax Treaty, USAco’s business profits would still not be subject to Philippines income taxation as long as USAco does not conclude any sales through its foreign office. However, if USAco’s employees start concluding sales at the Manila office, USAco may have a permanent establishment in the Philippines.
Personal Services Income
United States- Philippines Income Tax Treaty provisions covering personal services compensation are similar to the permanent establishment clauses covering business profits in that they create a higher threshold of activity for host country taxation. Generally, when an employee who is a resident of one treaty country derives income from services performed in the other treaty country, that income is usually taxable by the host country. However, the employee’s income is typically exempted from taxation by the host country if the employee is present in the host country for 90 days or less.
Income from Real Property
Tax treaties typically do not provide tax exemptions or reductions for income from real property. Consequently, both the home and host country maintain the right to tax real property. Article 7 of the United States- Philippines Income Tax Treaty provides that income derived by a Philippines resident from U.S. real property may be taxed in the United states and vice-versa.
Dividends, Interest, and Royalties
Article 11 of the United States- Philippines Income Tax Treaty provides that dividends by a resident of a Contracting State may be taxed by both Contracting States. The term “dividends” as used in the treaty means income from shares, mining shares, founders’ shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights assimilated to income from shares by the taxation law of the State of which the corporation making the distribution is a resident. Under the treaty, the rate of tax imposed by one of the Contracting States on dividends from sources within the Contracting State by a resident of the other Contracting State shall not exceed:
a) 25 percent of the gross amount of the dividend; or
b) When the recipient is a corporation, 20 percent of the gross amount of the dividend if during the part of the paying corporation’s taxable year which precede the date of payment of the dividend and during the whole of its prior taxable year (if any), at least 10 percent of the outstanding shares of the voting stock of the paying corporation was owned by the recipient corporation.
Article 12 of the United States- Philippines Income Tax Treaty deals with the taxation by one Contracting State of interest derived by a resident of the other Contracting State.
Article 12(1) of the treaty provides that interest derived by a resident of one of the Contracting States from sources within the other Contracting State may be taxed by both Contracting States. The term “interest” as used in this treaty means income from debt-claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor’s profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds, or debentures, as well as income assimilated to income from money lent by the taxation law of the Contracting State in which income arises, including interest on deferred payment sales.
Under the treaty, interest derived by a resident of one of the Contracting States from sources within the other Contracting State shall not be taxed by the other Contracting State at a rate in excess of 15 percent of the gross amount of such interest.
Article 13 of the United States- Philippines Income Tax Treaty discusses the taxation of royalties arising in a Contracting State and paid to a resident of the other Contracting State. The term “royalties: as used in the treaty means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or films or tapes used for radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or other like right or property, or for information concerning industrial, commercial, or scientific experience. The term “royalties” also includes gains derived from the sale, exchange or other disposition of any such right or property which are contingent on the productivity, use, or disposition thereof.
Under the treaty, royalties derived by a resident of one of the Contracting States from sources within the other Contracting State may be taxed by both Contracting States. However, the tax imposed by that other Contracting State shall not exceed a) in the case on the United States, 15 percent of the gross amount of the royalties; and b) in the case of the Philippines, the least of i) 25 percent of the gross amount of the royalties; ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities; and iii) the lowest rate of Philippine tax that may be imposed on yalties of the same kind under similar circumstances to a resident of a third State.
Article 18 of the United States- Philippines Income Tax Treaty provides that pensions and similar remuneration beneficially derived by a resident of one Contracting State in consideration of past employment are rendered. The term “pensions and other similar remuneration,” as used in this article, includes periodic payments other than social security payments made: 1) by reason of retirement or death and in consideration for services rendered or 2) by way of compensation for injuries received in connection with past employment. The most common question we receive regarding the United States- Philippines income tax treaty is whether or not the treaty by the residents of the Philippines to avoid the U.S. tax on distributions from 401k plans or IRAs. Nonresidents may be subject to a 30 percent U.S. tax on distributions from a U.S. based retirement account. In certain cases, nonresidents may also be subject to a 10 percent early withdrawal penalty. In order to answer this question as to whether the U.S.-Philippines Tax Treaty can be used to reduce or eliminate these taxes we must discuss the underlying rules governing tax treaties and how tax treaties are interpreted.
The tax treaties advance a series of objectives, usually on a reciprocal basis. Their fundamental rationale is to prevent taxes from interfering with the free flow of international trade and investment. Their basic trust is the avoidance of double taxation of income from international transactions by limiting the jurisdiction that each treaty country may exercise to tax income from domestic sources realized by residents of the other country. Most provide clarification in certain respects of areas in which the application of the tax laws of the treaty partners may be ambiguous or unpredictable.
From time to time the Treasury Department will publish its Model Treaty. In general, the Model Treaty reflects the current position of U.S. representatives in negotiating treaty arrangements with other countries. It does not reflect the specific provisions of any treaty actually in force. The U.S. Model Treaty is not the only prototype that has been devised and used. The Organization for Economic Cooperation and Development (“OECD”) (whose members include virtually all of the major industrialized countries) has published a series of model treaties for the elimination of double taxation, together with particularly useful commentaries on the model treaty provisions.
Under the U.S.-Constitution, the U.S. Executive Branch has the exclusive province to negotiate all treaties (including tax treaties) as part of its authority to conduct U.S. foreign relations. Although the State Department has the primary jurisdiction over foreign relations within the Executive Branch, it is the Treasury Department, acting through its Assistant Secretary for Tax Policy and its International Tax Counsel, that actually negotiates tax treaties with the appropriate authorities of the foreign country. If agreement on the treaty is reached with the foreign country, the President signs the treaty on behalf of the United States and sends it to the U.S. Senate for its advice and consent. The Senate then refers the treaty to its Foreign Relations Committee which holds hearings on the matter. If the Senate Foreign Relations Committee approves the treaty, it sends the treaty to the full Senate for its consideration. Once the Senate approves the treaty by a two-thirds vote of its members, the treaty actually becomes effective only if and when the U.S. Executive Branch exchanges instruments of ratification with the foreign treaty country.
A U.S. tax treaty typically specifies the taxes of the foreign treaty partner to which the treaty applies. The treaty also typically provides that it applies only to federal income taxes and to certain federal taxes in the United States and to “identical or substantially similar taxes” of the foreign treaty partner or the United States that may be enacted after the treaty is signed.
It is important to understand that often terms of a U.S. tax treaty modify the tax results that one would otherwise obtain under the Internal Revenue Code. Internal Revenue Code Section 7852(d)(1) provides that “[f]or purposes of determining the relationship between a provision of a treaty and any law of the United States affecting revenue, neither the treaty nor the law shall have preferential status by reason of its being a treaty or law.” This rather enigmatic formulation is another (albeit convoluted) way of stating a basic principle of U.S. jurisprudence with respect to the posture of treaties: under the U.S. Constitution (art. VI, cl. 2), U.S. treaties and federal statutes have equal status as the supreme law of the land and, thus, whenever there is a conflict between the two, the later in time prevails. See Restatement (Third) of the Foreign Relations Law of the United States Section 115 (A.L.I. 1986). Thus, as long as a treaty does not conflict with the Constitution, laws passed by Congress and treaties ratified by the Senate will have equal weight. Consequently, if a tax treaty was ratified by the Senate after an Internal Revenue Code was enacted by Congress, any conflicted provisions of the Code will be superseded by the tax treaty. In other words, when an individual elects to apply the provisions of an income tax treaty, the income tax treaty may overrule the applicable provision of the Internal Revenue Code. The converse of the rule above is also true. If a U.S. statute is enacted that is inconsistent with an existing treaty provision, the statute, being later in time, will prevail and the benefits of the treaty will not be available.
As indicated above, tax treaties are often poorly worded and confusing. As a result, each tax tax treaty contains a Technical Explanation which reflects the policies behind each provision of the treaty. Technical Explanations also interpret tax treaties. When Technical Explanations do not explain the intent of a tax treaty, the OECD may be consulted to interpret the treaty. The OECD publishes commentary every four years to interpret terms of income tax treaties.
U.S. courts will refer to OECD commentary as meaningful guidance and in divining the probable intent of the party-countries. However, U.S. courts are not bound by OECD commentaries (the only legally binding instruments are the Conventions signed by Member Countries). While a court will give deference to the consistent interpretation of a treaty advanced by the agencies of the United States charged with its administration, their interpretation is not conclusive and will not be adopted by the court if it is not supported by the treaty language or the intent of the party countries. See Nat’l Westminster v. U.S, 58 Fed Cl. 491 (2003). Nat’l Westminster states in relevant part, “for each of the Articles in the Convention there is a detailed Commentary which is designed to illustrate or interpret the provisions….Although the present Commentaries are not designed to be annexed in any manner to the Conventions to be signed by member countries, which alone constitute legally binding international instruments, they can nevertheless be of great assistance in the application of the Conventions and, in particular, in the settlement of eventual disputes.”
Nat’l Westminster indicates that if the U.S. and a treaty partner were members of the OECD at the time the treaty was enacted, the U.S. may apply the OECD definitions to interpret certain tax treaty terms. As long as the OECD terms are not contrary to the intent of the party-countries. The IRS has agreed with this interpretation in private letter rulings. Thus, unless an Internal Revenue Code (U.S. tax law) is enacted later in time from that of a tax treaty, U.S. tax law cannot supersede a tax treaty. Many tax treaties take a very broad approach as to what constitutes a “pension distribution” under international treaty law with which the IRS and U.S. courts may be legally bound to recognize.
To demonstrate how a tax treaty is interpreted and applied to a U.S. based retirement account, we will first examine the United States-Australia Income Tax Treaty in an example. For purposes of this example, Let’s assume that Tom is an Australian citizen that comes to the U.S. on an E-3 Visa for a short-term assignment. While working in the United States, Tom contributed money to an IRA. Tom has returned to Australia and would like to withdraw money from his U.S. based IRA. However, Tom is concerned about the U.S. federal 30 percent withholding tax and the 10 percent early withdrawal penalty.
Since Tom is a citizen of Australia, a country that the U.S. has a bilateral income tax treaty, Tom may utilize the U.S.- Australia Income Tax Treaty to potentially avoid the 30 percent withholding tax and the early withdrawal penalty. The U.S.- Australia Income Tax Treaty went into effect in 1983 with an amended protocol signed in 2001. The United States joined the OECD in 1961. Australia joined the OECD in 1971. Since both countries joined the OECD prior to the enactment of the U.S.- Australia Income Tax Treaty, U.S. courts can defer to the OECD with regard to interpreting treaty terms if the relevant term is not defined in the treaty or its Technical Explanations.
Article 18, Paragraph 1, of the United States- Australian Income Tax Treaty, states that “pensions and other similar remuneration paid to an individual who is a resident of one of the Contracting States in consideration of past employment shall be taxable only in that State.” The Technical Explanations to the treaty provides that “Article 18, Paragraph 1 means that pensions derived and beneficially owned by a resident of one of the Contracting States in consideration of past employment… shall be taxable only in that State [of residency].” Under the provisions of the U.S.- Australia Income Tax Treaty,” the country of residence has exclusive taxing rights over pension distributions. Residency for tax treaty purposes is determined under domestic law of each country. A tax resident is a person that is “liable to tax” in that country on the basis of residency or domicile. Since Tom is a resident of Australia, he can potentially take a treaty position that his U.S. IRA should be taxed according to the provisions of the U.S.- Australia Income Tax Treaty.
Next, we must determine if an IRA can be classified as a “pension or remuneration” under the treaty. The Technical Explanations to the U.S.- Australia Income Tax Treaty to Article 18, Paragraph 4, makes a reference to “periodic payments.” However, the terms “pensions and other remuneration” is not defined in the treaty or its Technical Explanations. Since these terms are not defined in the treaty or its Technical Explanations, the OECD commentary can be utilized to interpret the definitions of “pensions or other similar remuneration.” The OECD defines the word “pension” under the ordinary meaning of the word that covers periodic and non-periodic payments. The OECD also provides that a lump-sum payment in lieu of periodic pension payments that is made on or after cessation of employment may fall within the definition of Article 18 of the treaty. See OECD 2018 Commentary, Art 18. Assuming that Tom took a lump sum distribution from his IRA on or after the cessation of employment in the United States, Tom can take the position that his IRA distribution falls within the OECD’s definition of a “pension” and as a result, Tom’s U.S. based IRA distribution should fall under the scope of the treaty.
Now, let’s review the U.S.-Philippines Income Tax Treaty regarding the taxation of U.S. based retirement accounts. Let’s assume that Tom from our above example is a citizen of the Philippines and comes to the U.S. on an E-3 Visa for a short-term assignment. While working in the United States, Tom contributed money to an IRA. Tom has returned to the Philippines and would like to withdraw money from his U.S. based IRA. However, Tom is concerned about the U.S. federal 30 percent withholding tax and the 10 percent early withdrawal penalty.
Since Tom is a citizen of the Philippines, a country that the U.S. has a bilateral income tax treaty, Tom may attempt to utilize the United States- Philippines Income Tax Treaty to potentially avoid the 30 percent withholding tax and the early withdrawal penalty.
The U.S.- Philippines Income Tax Treaty went into effect in 1977. The United States joined the OECD in 1961. The Philippines is not a member of the OECD. Since China is not a member of the OECD, U.S. courts cannot defer to the OECD to interpret the treaty terms. Article 18 of the U.S.- Philippines Tax Treaty defines the term “pension” as periodic payments other than social security payments 1) by reason of retirement or death and in consideration for services or 2) by way of compensation for injuries or sickness received in connection with past employment.
Next, we must determine if an IRA can be classified as a “pension” under the treaty. There are no Technical Explanations to the U.S.- Philippines Income Tax Treaty. Since the term “pension” is not defined in the treaty, it is uncertain if Tom can utilize the U.S.- Philippines Income Tax Treaty to shield him from U.S. tax once he receives a distribution from his IRA. Tom could take the position that it was the intent of the U.S.- Philippines Income Tax Treaty to exclude his IRA distribution from U.S. tax. Just because the term “pension” is not defined in the treaty should not prevent Tom from taking a treaty position. Thus, the IRS should define the term “pension” broadly and include an IRA in the definition of the term “pension.” Although Tom can take a treaty position that his U.S. based retirement account should not be subject to U.S. tax, at this point it is uncertain if the treaty can be used by Tom.
Lack of Anti-Treaty Shopping Provision (Limitation on Benefits)
Because tax treaties provide lower withholding tax rates on dividend, interest, and royalty income, a multinational corporation may be able to reduce its foreign withholding taxes by owning its subsidiaries throughout strategically located holding companies. This practice is known as “treaty shopping.” Anti-treaty shopping provisions are formally known as limitation on benefits (or “LOB”) provisions. The principal target of a LOB provision is a corporation that is organized in a treaty country by a resident of a non-treaty country merely to obtain the benefits of that country’s income tax treaty. Therefore, even if a corporation qualifies as a resident of the treaty country, that corporation is not entitled to treaty benefits unless it also satisfies the requirements of the treaty’s LOB provision. The U.S.-Philippines does not contain a LOB provision. The lack of a LOB provision may permit a resident of a non-treaty country to obtain the benefits of the U.S.-Philippines Income Tax Treaty.
Disclosure of Treaty-Based Return Positions
Any taxpayer that claims the benefits of a treaty by taking a tax return position that is in conflict with the Internal Revenue Code must disclose the position. See IRC Section 6114. A tax return position is considered to be in conflict with the Internal Revenue Code, and therefore treaty-based, if the U.S. tax liability under the treaty is different from the tax liability that would have to be reported in the absence of a treaty. A taxpayer reports treaty-based positions either by attaching a statement to its return or by using Form 8833. If a taxpayer fails to report a treaty-based return position, each such failure is subject to a penalty of $1,000, or a penalty of $10,000 in the case of a corporation. See IRC Section 6712.
The Income Tax Regulations describe the items to be disclosed on a Form 8833. The disclosure statement typically requires six items:
1. The name and employer identification number of both the recipient and payor of the income at issue;
2. The type of treaty benefited item and its amount;
3. The facts and an explanation supporting the return position taken;
4. The specific treaty provisions on which the taxpayer bases its claims;
5. The Internal Revenue Code provision exempted or reduced; and
6. An explanation of any applicable limitations on benefits provisions.
If an individual would like to take a treaty position (such as a claim that the U.S.-Philippines Tax Treaty exempts a U.S. based retirement plan from U.S. taxation), a detailed statement must be stated on the Form 8833.
The major purpose of an income tax treaty is to mitigate international double taxation through tax reductions or exemptions on certain types of income derived by residents of one treaty country from sources within the other treaty country. In the case of the U.S.-Philippines tax treaty, the treaty is outdated and when compared to other treaties, its provisions are not favorable. Anyone considering utilizing the U.S.-Philippines Income Tax Treaty to mitigate double taxation particularly in the case of U.S. based retirement accounts should consult with a qualified international tax attorney.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.
He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or firstname.lastname@example.org.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.