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 U.S. 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 U.S. currently has income tax treaties with approximately 58 countries. This article discusses the implications of the United States- Ireland 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 United States 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- Ireland Income Tax Treaty is no different. The treaty has its own unique definitions. We will now review the key provisions of the United States- Ireland Income Tax Treaty and the implications to individuals attempting to make use of the treaty.
Definition of Resident
The determination of an individual’s country of residence is important because 1) the treaty only applies to residents of the United States and Ireland; 2) the treaty often addresses double taxation issues by specifying certain tax treatment based upon an individual’s country of residence; and 3) an individual may be a resident of both countries under their domestic income tax laws.
Under Article 4(a) of the United States- Ireland Income Tax Treaty, an individual is considered a resident of the United States or Ireland if the individual is subject to tax in such country by reason of domicile, residence, place of management, place of incorporation, or any criterion of a similar nature. However, the term “resident” does not include persons subject only to tax on income sourced in the United States or Ireland. Under the protocol to the United States- Ireland Income Tax Treaty, Ireland does not consider U.S. citizenship or “green card” status alone sufficient to establish U.S. residency; instead, such person must also have a “substantial presence” in the United States or must be a resident of the United States and not another country under the treaty’s tie-breaker rules.
Under Article 4(3) of the United States- Ireland Income Tax Treaty, if an individual would be a resident of both the United States and Ireland, then: 1) the individual is deemed a resident of the country in which he has a permanent home; or he has permanent homes in both countries, he is deemed a resident of the country in which his personal and economic relations are closer (the individual’s center of vital interests); 2) if the center of vital interests cannot be determined, or if he has no permanent home in either country, then he is deemed a resident of the country in which he has a habitual abode; 3) if he has a habitual abode in both countries or neither country, then he is deemed a resident of the country of his nationality; or 4) in any other case, the competent authorities will settle the question. In cases of companies, Article 4(4) provides that the competent authorities of both countries shall settle dual-residence issues for persons other than individuals (such as companies, trusts or estates).
According to Article 5 of the United States- Ireland Income Tax Treaty, an enterprise that is a resident of either the United States or Ireland is not taxable upon its business profits in the other country (i.e., its net income as opposed to gross receipts, asset value, etc) unless those profits are “attributable to” a “permanent establishment” in the other country. In general, under Article 5(2), a “permanent establishment” is defined as a “fixed place of business through which the business of an enterprise is wholly or partly carried on.” Under Article 5(2), the term specifically includes a place of management; a branch; an office; a factory; a workshop; or a place of extraction of natural resources. Article 5(3) also includes certain construction sites and natural resource exploration sites lasting more than twelve months in the term. Article 5(4) also provides that a nonresident may carry out certain designated activities without creating a permanent establishment. The use or maintenance of installations for storage or exhibition of goods; the use or maintenance of facilities for storage or exhibition of goods to be processed by another; the use of a place of business to buy goods or obtain information; the use of a facility to carry on preliminary or auxiliary activities.
Income from Immovable Property
The United States- Ireland Income Tax Treaty permits a Contracting State in which immovable property (such as real estate) is located to tax income derived from such property.
Article 7 of the United States- Ireland Income Tax Treaty prescribes the circumstances under which a Contracting State may tax the “business profits” of a nonresident (as opposed to imposing withholding tax on foreign-source income of a nonresident). Although the term “business profits” is not defined in the treaty, the treaty does provide that where “business profits” include items specifically addressed by other provisions of the treaty such other provisions will override the general rules for calculating “business profits.” Article 7(7) defines the term “profits” to mean income derived from any trade or business. In accordance with this broad definition, the term “profits” includes income attributable to notional principal contracts and other financial instruments to the extent that the income is attributable to a trade or business of dealing in such instruments, or is otherwise related to a trade or business (as in the case of a notional principal contract entered into for the purpose of hedging currency risk arising from an active trade or business). A Contracting State can only tax the “business profits” of a nonresident if the nonresident carries on business through a permanent establishment in the taxing country. Even then, the taxing country can tax only so much of the business profits of the nonresident as 1) are “attributable to” the permanent establishment itself or, 2) under a “force of attraction rule,” are attributable to sales of goods in a Contracting State of a like kind as those that are sold through the permanent establishment.
Under Article 9, if related persons who are residents of a Contracting State participate in transactions that are not arm’s length, the treaty grants authority to the Contracting State to adjust the income and tax liability of the persons to reflect the economic reality of the transactions. In particular, a Contracting State is permitted to adjust the income or loss of a resident to reflect income that would have been taken into account had “associated enterprises” utilized arm’s-length terms for their commercial or financial relations. An “associated enterprise” is defined as: 1) an enterprise of a Contracting State participates directly or indirectly in the management, control, or capital of an enterprise of the other Contracting State; or 2) the same persons participate directly or indirectly in the management, control, or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State. Thus, on the U.S. side of a cross-border transaction, the Internal Revenue Service (“IRS”) will be able to apply its intercompany pricing rules under Section 482 of the Internal Revenue Code and its rules relating to the allocation of deductions.
Independent Personal Services
Under Article 14 of the United States- Ireland Income Tax Treaty, a contracting State may tax the income from personal services of a nonresident individual acting as an independent contractor (and not as an employee or “dependent agent”) only if the individual has a fixed base in the Contracting State that he uses regularly in performing the services, in which case the Contracting State may tax income attributable to such fixed base. However, it is not necessary that the individual actually use the fixed base. It is only necessary that the fixed base be regularly available to him. For example, if an individual has an office in the other State that he can use if he chooses when he is present in the other state, that fixed base will be considered to be regularly available to him regardless of whether he conducts his activities there.
Article 14 applies to income derived by a partner resident in the Contracting State that is attributable to personal services of an independent character performed in the other State through a partnership that has a fixed base in that other Contracting State. Income which may be taxed under Article 14 includes all income attributable to the fixed base in respect of the performance of the personal services carried on by the partnership (whether by the partner himself, other partners in the partnership, or by employees assisting the partners) and any income from activities ancillary to the performance of those services. “Personal services” for these purposes “includes especially scientific, literary, or artistic activities, educational or training activities, as well as independent activities of physicians, lawyers, engineers, architects, dentists, and accountants.,
Dependent Personal Services
Under Article 15, a Contracting State may tax employment income derived by a nonresident to the extent the employee services are performed in the Contracting State unless 1) the employee is present in the Contracting State less than 183 days during a twelve month period; 2) the wages are paid by, or on behalf of, an employer that is a nonresident of the Contracting State; and 3) the wages are not “borne by” a permanent establishment or fixed base of the non-resident employer in the Contracting State. The 183-day period is measured using the “days of physical presence” method. Under this method, the days that are counted include any days in which a part of the day is spent in the host country. See Rev. Rul. 56-24, 1956-1 C.B. 851. Thus, days that are counted include the days of arrival and departure; weekends and holidays on which the employee does not work but is present within the country; vacation days spent in the country before, during or after the employment period, unless the individual’s presence before or after the employment can be shown to be independent of his presence there for employment purposes; and time during periods of sickness, training periods, strikes, etc, when the individual is present but not working. If illness prevented the individual from leaving the country in sufficient time to qualify for the benefit, those days will not count. Also, any part of a day spent in the host country while in transit between two points outside the host country is not counted.
Article 10 of the United States- Ireland Income Tax Treaty provides rules for the taxation of dividends paid by a company that is a resident of one Contracting State to a beneficial owner that is a resident of the other Contracting State. The Article provides for full residence country taxation of such dividends and a limited source-State right to tax. Under Article 10(5), the term dividends are defined broadly and flexibly. The definition is intended to cover all arrangements that yield a return on an equity investment in a corporation as determined under the tax law of the state or source, as well as arrangements that might be developed in the future. The term dividends includes income from shares, or other rights that are not treated as debt under the law of the source State. The term also includes income that is subjected to the same tax treatment as income from shares by the law of the State of sources. Thus, a constructive dividend that results from a non-arm’s length transaction between a corporation and a related party is a dividend. In the case of the United States, the term dividend includes amounts treated as a dividend under U.S. law upon the sale or redemption of shares or upon a transfer of shares in a reorganization. In addition, the term “dividends” includes income from shares or other rights (not being debt-claims), participation in profits, and income from other corporate rights that is subject to the same tax treatment as income from shares under the laws of the Contracting State of which the company making the distribution is a resident. However, a distribution by a limited liability company is not characterized by the United States as a dividend and, therefore is not a dividend for purposes of Article 10, provided the limited liability company is not taxable as a corporation under U.S. law.
Article 10(2) of the treaty provides for a tax rate of 5 percent of the gross amount of the dividends if the beneficial owner is a company that owns at least 10 percent of the voting stock of the company paying the dividends and a 15 percent of the gross amount of the dividends in all other cases. Generally, the source State’s tax is limited to 15 percent of the gross amount of the dividend paid. If, however, the beneficial owner of the dividends is a company resident in the other State that holds at least 10 percent of the voting shares of the company paying the dividend, then the source State’s tax is limited to 5 percent of the gross amount of the dividend. Indirect ownership of voting shares (through tiers of corporations) and direct ownership of non-voting shares are not taken into account for purposes of determining eligibility for the 5 percent direct dividend rate. Shares are considered voting shares if they provide the power to elect, appoint or replace any person vested with the powers ordinarily exercised by the board of directors.
The term “beneficial owner” is not defined in the treaty, and is, therefore, defined as under the internal law of the country imposing tax (i.e., the source country). The beneficial owner of the dividend for purposes of Article 10 is the person to whom the dividend income is attributable for tax purposes under the laws of the source State. Thus, if a dividend paid by a corporation that is a resident of one of the States (as determined under Article 4 (Residence)) is received by a nominee or agent that is a resident of the other State on behalf of a person that is not a resident of that other State, the dividend is not entitled to the benefits of this Article. However, a dividend received by a nominee on behalf of a resident of that other state would be entitled to benefits.
A special tax credit rule may apply under Irish law. The tax credit is allowed pursuant to Ireland’s system of integrating corporate and shareholder taxation. Under this system adopted by Ireland, “advance corporation tax” (“ACT”) is collected at the corporate level upon a distribution of dividends by the corporation. This tax is treated both as an advance payment of a portion of the corporate income tax, and also as a payment by an individual Irish resident shareholder in partial or complete satisfaction of his personal tax liability on the dividends. Article 10(3) provides a mechanism by which United States shareholders of an Irish corporation will receive the benefits of the shareholder credits which have therefore not been granted to United States residents.
In the case of United States shareholders other than corporations which control at least 10 percent of the voting stock of the Irish resident corporation, the Irish refund will equal the full credit payable to an individual resident in Ireland, less 15 percent of the aggregate amount of the dividend and the Irish credit. For United States tax purposes, the Irish credit shall be treated as additional gross income and the 15 percent withholding tax will be considered a tax on the shareholder. With respect to dividends paid by a corporation resident in Ireland to a United States corporation which either alone or together with one or more associated corporation controls, directly or indirectly, at least 10 percent of the voting stock of the Irish resident that is paying the dividend, the shareholder will not be entitled to a tax credit, but the dividend will be exempt from Irish taxation at the shareholder level. For these purposes, two companies shall be deemed to be associated if one is controlled directly or indirectly by the other or both are controlled directly or indirectly by a third company.
The treaty also modifies the application of the maximum withholding rates for distributions by U.S. Real Estate Investment Trusts (“REITSs”). Certain small individual investors in REITs who hold less than a 10 percent interest in a REIT may qualify for 15 percent treaty rate on dividends paid by such an entity.
Branch Profits Tax
The U.S. imposes a 30 percent branch profits tax on the “dividends equivalent amount” of a foreign corporation engaged in a trade or business in the U.S., where the “dividend equivalent amount” is roughly equal to the taxable income of the branch, less income of the branch, less income tax paid by the branch and less amounts retained in U.S. operations. The treaty generally permits the U.S. to impose a branch tax. However, the United States may not impose its branch profits tax on the business profits of a corporation resident in the other State that are effectively connected with a U.S. trade or business but that are not attributable to a permanent establishment and are not otherwise subject to U.S. taxation.
Article 11(1) and (2) of the United States- Ireland Income Tax Treaty permits a Contracting State to tax interest income received by its residents from nonresidents without restriction, but imposes no withholding rates. Article 11(1) grants to the State of residence the exclusive right, subject to exceptions the right to tax interest beneficially owned by its residents and arising in the other Contracting State. “Interest” for purposes of the treaty includes income from debt-claims of every kind, irrespectively of whether the debt is secured or carries a right of participation in profits. Penalty charges for late payments of taxes are excluded from the definition of interest. Article 11 provides anti-abuse exceptions to the source-country exemption for two classes of interest payments.
The first exception deals with so-called “contingent interest.” Under this provision interest arising in the United States is determined by reference to the profits of the issuer or to the profits of one of its associated enterprises, and paid to a resident of the other State may be taxed by the United States according to its domestic laws, but if the beneficial owner is a resident of the other Contracting State, the gross amount of the interest may be taxed at a rate not exceeding the rates for dividends under this treaty.
The second exception is consistent with the policy of Internal Revenue Code Sections 860E(e) and 860G(b) that excess inclusions with respect to a real estate mortgage investment conduit (“REMIC”) should bear full U.S. tax in all cases. Without a full tax at source foreign purchases of residual interests would have a competitive advantage over U.S. purchasers at the time these interests are initially offered.
Article 12(1) of the United States- Ireland Income Tax Treaty states that a Contracting State and beneficially owned by a resident of the other Contracting State may be taxed only in the other State. The provisions of Article 12(1) shall not apply if the “beneficial owner” of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the royalties are attributable to such permanent establishment or fixed base. The term “beneficial owner” of royalties is not defined in the treaty, and is, therefore, defined as under the internal law of the country imposing tax (i.e., the source country).
The term “royalties” as used in Article 12 is defined to include payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, scientific or other work; for the use of, or the right to use, 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. It does not include income from leasing personal property. Consideration for the use or right to use cinematographic films, or works on film, tape, or disks in radio or television broadcasting is specifically included in the definition of royalties. It is intended that subsequent technological advances in the field of radio and television broadcasting will not affect the inclusion of payments relating to the use of such means of reproduction in the definition of royalties. Computer software generally is protected by copyright laws around the world. While not explicitly stated, the technical explanations of the United States- Ireland Income Tax Treaty states that consideration received for the use or the right to use computer software is treated either as royalties or as business profits, depending on the facts and circumstances of the transaction giving rise to the payment. This also includes payments received in connection with the transfer of so-called “shrink-wrap” computer software is treated as business profits. The term “royalties” also includes gain derived from the alienation of any right or property that would give rise to royalties, to the extent the gain is contingent on the productivity or use of the know-how.
Article 12(5)(c) and (d) of the United States- Ireland Income Tax Treaty deals with taxation by one State of a royalty paid by a resident of the other State to a resident of a third State for the use of an intangible in the first-mentioned State. Article 12(5)(c) provides that the rate of tax imposed on a royalty may be limited by reference to the tax treaty, if any, in force between the taxing State and the third State. Thus, for example, if a new process is developed by a Canadian company and licensed for use in the United States by a U.S. permanent establishment of an Irish company, assuming that the royalties are paid by the branch, and deducted by it for U.S. tax purposes, then under U.S. law the Irish resident (i.e. the permanent establishment) is required to withhold U.S. tax on the royalty at a 10 percent rate, the rate applicable to royalties under the United States- Canada Income Tax Treaty. .
Under Internal Revenue Code Section 861(a)(4), and implicitly under the U.S. Model, any royalty paid for the use of an intangible in the United States, regardless of the residence of the payor, is U.S. source, which, subject to any limitations in the tax treaty. The United States- Ireland Income Tax Treaty provides addition circumstances when one State may tax a royalty paid by a resident of the other State if: 1) it is for the use of a property in the first-mentioned State; 2) it is not paid to a resident of that other State; 3) the payor of the royalty has also received a royalty in respect of the use of a property in the first-mentioned State, and that royalty is either paid by a resident of that first-mentioned State or borne by a permanent establishment or fixed base situated in that State; and 4) the use of the intangible is not a component part of or directly related to the active conduct of a trade or business in which the payor (i.e. the resident of the other State) is engaged.
An example of these circumstances are as follows: let’s assume that a Canadian resident licenses a patent for a process used in the automotive industry to a resident of Ireland, who in turn sub-licenses the patent to an automobile producer in the United States. The U.S. producer pays a royalty to the resident of Ireland for the use of the patent in the United States, and the Irish resident, in turn, pays a royalty to the Canadian resident for that same U.S. use of the patent. The royalty paid by the Irish resident to the resident of Canada would be exempt from the U.S. under the provisions of Article 12(1) the United States- Ireland Income Tax Treaty. The royalty paid by the Irish resident to the resident of Canada, however, would be subject to U.S. tax under the treaty. The rate would be set at 10 percent, under the provisions of U.S.-Canada Income Tax Treaty. If, on the other hand, the Irish resident was also engaged in automobile production, the royalty paid by the Irish resident to the Canadian resident would not be subject to U.S. federal taxation.
Article 18(5) and (6) deals with cross-border pension contributions. Article 18(5) provides for deductions (or exclusions) from the taxable income of an individual in one State for contributions paid by that individual to a pension plan in the other State if certain conditions are satisfied. Article 18(5) also provides that payments made to such a plan by or on behalf of the individual’s employer are deductible from the profits of the employer in that State and are not considered part of the taxable income of the individual. Where the United States is the host country, the exclusion of employee contributions from the employee’s income is limited to elective contributions not in excess of the amount specified in Section 402(g). Deduction of employer contribution is subject to the limitations of Sections 415 and 404. The Section 404 limitation on deduction on deductions would be calculated as if the individual were the only employee covered by the plan.
Article 18(6) of the United States- Ireland Income Tax Treaty is included in the treaty because Ireland continues to maintain a remittance system of taxation for individuals who are residents but not domiciled in Ireland. Such persons are subject to tax in Ireland on non-Irish source income only to the extent the income or chargeable gains are remitted to the Irish resident. Article 18(6) limits the deductibility from an individual’s taxable income. In such a case, the deduction that would otherwise be permitted is reduced by a proportion equal to the proportion of the individual’s income that is untaxed in that State because it was not remitted to or received by the individual in that State.
Article 18 is subject to the savings clause of Article 1(4). Thus, a U.S. citizen who is a resident in Ireland, and receives a pension payment from the United States, may be subject to U.S. tax on the payment.
Limitation on Benefits
The United States- Ireland Income Tax Treaty contains detailed rules intended to limit its benefits to persons entitled to such benefits by reason of their residence in a Contracting State. The rules are specifically intended to eliminate “treaty shopping” whereby, for example, a third-country resident could establish an entity in a Contracting State and utilize the provisions of the treaty to repatriate funds under favorable terms. To eliminate this potential abuse, the full benefits of the treaty are available to only a specified class of persons, limited treaty benefits are provided to an additional class of persons, and a facts and circumstances test provides discretion to make the treaty provisions available to others.
Under Article 23(1) of the United States- Ireland Income Tax Treaty, the full benefits of the treaty are available to any individual who is a resident of a contracting state and to any entity satisfying one of four tests: the “active business test,” the “ownership base erosion test,” the “publicly-traded company test,” or the “derivative benefit test.” .
Under Article 23(3),treaty benefits are available to an entity that is a resident of a Contracting State if it is engaged in the active conduct of a trade or business in its country of residence and the income derived from the other country is connected with or incident to such trade or business. The assumption underlying the active trade or business test is that a third country resident that establishes a “substantial” operation in Ireland and that derives income from a similar activity in the United States would not do so primarily to avail itself of the benefits of the treaty; it is presumed in such a case that the investor had a valid business purpose for investing in Ireland, and that the link between that trade or business and the U.S. activity that generates the treaty-benefited income manifested a business purpose for placing the U.S. investment in the entity in Ireland.
Article 23(2)(c) provides the so-called ownership and base erosion test. This test applies to any form of legal entity that is a resident of a Contracting State. The “ownership test” prong of the test specifies that more than 50 percent of the beneficial interest in the company (including more than 50 percent of each class of stock) must be owned, directly or indirectly by publicly-traded companies or tax exempt organizations Second, the “base erosion rule” requires that less than 50 percent of the gross income of the company be used, directly, or indirectly, to meet liabilities to persons other than those named with regard to the ownership test.
A company that is a resident of a Contracting State and the principal class of stock of which is traded on a recognized securities exchange, or wholly owned subsidiary of such a publicly-traded company, will be entitled to the benefits of the treaty. A “recognized securities exchange” includes the NASDAQ system, national securities exchanges under the Securities Exchange Act of 1934, the Irish Stock Exchange and the stock exchanges of Amsterdam, Brussels, Frankfurt, Hamburg, Madrid, Paris, Stockholm, Sydney, Tokyo, Vienna, and Zurich; and any other stock exchange agreed upon by the competent authorities.
If the company has more than one class of shares, it is necessary as an initial matter to determine whether one of the classes accounts for more than half of the voting power and value of the company. If so, then only those shares are considered for purposes of the test. If no single class of shares accounts for more than half of the company’s voting power and value, it is necessary to identify a group of two or more classes of the company’s shares that account for more than half of the company’s voting power and value, and then to determine whether each class of shares in this group satisfies the a test known as the regular trading requirement. Although in a particular case involving a company with several classes of shares it is conceivable that more than one group of classes could be identified that account for more than 50 percent of the shares, it is only necessary for one group to satisfy the requirement in order for the company to be entitled to benefits.
The principal class of shares must always include any disproportionate class of shares. A disproportionate class of shares means a class of shares in a company resident in one of the States that entitles the shareholder to a disproportionately higher share in the earnings generated in the other State by particular assets or activities of the company. Such a participation class of shares would include so-called alphabet stock that entitles the holder to earnings in the State produced by a particular division of the company.
The following examples illustrate this result.
EIRCo is a corporation resident in Ireland. EIRECo has two classes of shares: Common and Preferred. The Common shares are listed and regularly traded on a designated stock exchange in Ireland. The Preferred shares have no voting rights and are entitled to receive dividends equal in amount to interest payments that EIRECo receives from unrelated borrowers in the United States. The common shares account for more than 50 percent of the value of EIRECo and for 100 percent of the voting power. Because the owner of the Preferred shares is entitled to receive payments corresponding to the U.S. source interest income earned by EIRECo, the Preferred shares are considered to be a disproportionate class of shares.
EIRECo is a corporation resident in Ireland. EIRECo has two classes of shares: Common and Preferred. The Common shares are listed on the Irish Stock Exchange and are substantially and regularly traded. The Preferred shares have no voting rights and are entitled to receive dividends equal in amount to the income earned by EIRECo from selling widgets in Ireland. Because the Preferred shares do not entitle the owner to receive dividends or other payments corresponding to U.S.- source income received by EIRECo, the Preferred shares are not considered a disproportionate class of shares.
Finally, Article 23 sets forth the general rule that a resident of a Contracting State engaged in the active conduct of a trade or business in that State may obtain the benefits of the United States- Ireland Income Tax Treaty with respect to an item of income, profit, or gain derived in that other Contracting State. The item of income, profit, or gain, however, must be derived in connection with or incident of that trade or business.
The term “trade or business” is not defined in the treaty. Accordingly, the Internal Revenue Service (“IRS”) will refer to the regulations under Internal Revenue Code Section 367(a) for the definition of the term “trade or business.” In general, therefore, a trade or business will be considered to be a specific unified group of activities that constitute or could constitute an independent economy and an independent economic enterprise carried on for profit. Furthermore, a corporation generally will be considered to carry on a trade or business only if the officers and employees of the corporation conduct substantial managerial and operational activities. A business activity generally will be considered to form a business activity conducted in the State of source if the two activities involve the design, manufacture or sale of same products or types of products, or provisions of similar services.
Article 23(3)(b)(i) provides that income is derived in connection with a trade or business if the income-producing activity in the other State is a line of business that forms a part of or is complementary to the trade or business conducted in the State of residence by the income recipient. Although no definition of the term “forms a part of” or “complementary” is set forth in the treaty, it is intended that a business activity generally will be considered to “form a part of” a business activity conducted in the other State if the two activities involve the design, manufacture or sale of the same product or type of products, or the provision of similar services. In order for two activities to be considered to be “complementary,” the activities need not relate to the same types of products or services, but they should be part of the same overall industry and be related in the sense that the success or failure of one activity will tend to result in success or failure for the other. In cases in which more than one trade or business is conducted in the other State and only one of the trades or business forms a part of or is complementary to a trade or business conducted in the State of residence, it is necessary to identify the trade or business to which an item of income is attributable.
The following examples illustrate this rule.
EIRECo is a corporation resident in Ireland. EIRECo is engaged in an active manufacturing business in Ireland. EIRECo owns 100 percent of the shares of USCo, a corporation resident in the United States. USCo distributes EIRECo products in the United States. Since the business activities conducted by the two corporations involve the same products, USCo’s distribution business is considered to form a part of EIRECo’s manufacturing business
The facts are the same as in Example 1, except that EIRECo does not manufacture. Rather, EIRECo operates a large research and development facility in Ireland that licenses intellectual property to affiliates worldwide, including USCo. USCo and other EIRECo affiliates then manufacture and market the EIRECo-designed products in their respective markets. Since the activities conducted by USCo and EIRECo involve the same product lines, these activities are considered to form a part of the same trade or business.
For two activities to be considered to be “complementary,” the activities to be “complementary,” the activities need not relate to the same types of products or services, but they should be part of the same overall industry and be related in the sense that the success or failure of one activity will tend to result in success or failure for the other. Where more than one trade or business is conducted in the State of source and only one of the trades or businesses forms a part of or is complementary to a trade or business conducted in the State of residence, it is necessary to identify the trade or business to which an item of income is attributable.
Americair is a corporation resident in the United States that operates an international airline. FSub is a wholly-owned subsidiary of Americanair resident in Ireland. FSub operates a chain of hotels in Ireland that are located near airports served by Americair Flights. Americair frequently sells tour packages that include air travel to Ireland and lodging at FSub hotels. Although both companies are engaged in the active conduct of a trade or business. Therefore FSub business does not form a part of Americair’s business. However, FSub’s business is considered to be complementary to Americair’s business because they are part of the same overall industry (travel), and the links between their operation tend to make them interdependent.
The facts are the same as in Example 3, except that FSub owns an office building in Ireland instead of a hotel chain. No part of Americair’s business is conducted through the office building. FSub’s business is not considered to form a part of or to be complementary to Americair’s business. They are engaged in distinct trades or businesses in separate industries, and there is no economic dependence between the two operations.
Article 23(5)(a) sets forth an additional requirement that must be satisfied in order for a company that is a resident of a Contracting State to be entitled to the benefits of the treaty. To satisfy the second requirement, the person must be entitled to all the benefits of a comprehensive treaty between the Contracting State from which benefits of the treaty are claimed under a qualifying State. For this purpose, however, if the treaty in question does not have a comprehensive limitation on benefits article, this requirement only is met if the person would be a “qualified person” test discussed in Article 23 of the treaty. Thus, an Irish individual will be an equivalent beneficiary without regard to whether the individual would have been entitled to receive the same benefits if it received the income directly. A resident of a third country cannot qualify for treaty benefits. However, if certain ownership requirements are satisfied, the “equivalent beneficiary” test may be satisfied. Thus, for example, if 95 percent of an Irish company are residents in member states of the European Union or residents of NAFTA countries (i.e., Mexico, the U.S. or Canada) for which the rate (or rates) of withholding tax provided in the income tax treaty between the source state and such state is less than or equal to the rate or rates imposed under the United States- Ireland Income Tax Treaty, this test is satisfied.
The rates of tax to be compared are the rate of withholding tax that the source State would impose had the European Union or NAFTA resident directly received its proportionate share of the dividend, interest or royalty payment and the rate of withholding tax that the source State would have imposed had that person been a resident of the other State and the person’s proportionate share of the dividends, interest or royalty had been paid directly to that person. For example, assume that a U.S. company pays a dividend to EIRECo, a company resident in Ireland. EIRECo has two equal shareholders, a corporation resident in the United Kingdom and an individual resident in the United Kingdom. Both are residents of a member state of the European Union for purposes of this United States- Ireland Income Tax Treaty. Each person’s proportionate share of the dividend payment is 50 percent of the dividend. If the UK corporation had received this portion of the dividend directly, it would be subject to a withholding tax of 5 percent under the income tax treaty between the United States and the United Kingdom. If the individual had received his portion of the dividend directly, it would be subject to a withholding tax of 15 percent under the same treaty. These rates are the same rates that would have applied if the corporation and the individual had been residents of Ireland.
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.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. As a domestic tax attorney and international tax attorney, Anthony Diosdi provides international tax advice to individuals, closely held entities, and publicly traded corporations. Diosdi Ching & Liu, LLP has offices in San Francisco, California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in international tax matters throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: 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.