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Branch Profits Tax: Compliance
and Planning from the Ground Up Navigating the Tax Landscape for Foreign Businesses Operating in the U.S.
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Presenting a live 110-minute teleconference with interactive Q&A
James Sams, Principal, KPMG, McLean, Va.
Robert J. Misey, Jr., Shareholder, Reinhart Boerner Van Deuren, Milwaukee
Douglas Holland, Senior Manager, KPMG, Washington, D.C.
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Branch Profits Tax: Compliance and Planning from the Ground Up
Douglas Holland, KPMG
May. 2, 2013
James Sams, KPMG
Robert J. Misey, Jr., Reinhart Boerner Van Deuren
Today’s Program
Mechanics Of The Branch Profits Tax
[Douglas Holland]
Mechanics Of The Branch Level Interest Tax
[Robert J. Misey, Jr.]
Branch Tax And Tax Treaty Issues
[James Sams]
Slide 8 – Slide 33
Slide 34 – Slide 61
Slide 62 – Slide 90
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
MECHANICS OF THE BRANCH PROFITS TAX
Douglas Holland, KPMG
© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 9
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED
OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED,
BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE
PURPOSE OF (i) AVOIDING
PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii)
PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER
PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons, without
limitation, the tax treatment or tax structure, or both, of any transaction described in the associated
materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax
analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are subject to
change. Applicability of the information to specific situations should be determined through
consultation with your tax adviser.
© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 10
Agenda: Branch Profits Tax
1. Overview
A. Purpose
B. Definitional Rules
C. Examples and Traps
2. Branch Transfers
A. Terminations
B. Liquidations and Reorganizations
C. Incorporations
3. Compliance
Note: References to IRC or Treas. Reg. are to the Internal Revenue Code of 1986, Title 26 of
the United States Code, as amended, or to the Regulations promulgated thereunder, at Title
26 of the Code of Federal Regulations.
Overview And Discussion
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member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 12
Branch Taxes: Purpose
• Purpose: Equal treatment of foreign corporations operating in the
United States through corporation or branch (e.g., generally, 30%
withholding tax on dividends and interest to foreign person)
$ dividend and interest payments
$ dividend and interest payments
Foreign
Parent
U.S. Branch
/LLC US
U.S. Subsidiary
US
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member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 13
Branch Profits Tax (BPT)
•Purpose: Treat U.S. branch as if it were U.S. subsidiary of foreign corporation -- Subject income earned to two levels of tax
•How: Impose 30% tax on income repatriated (or deemed repatriated) to foreign parent (
884(e)(3)) from the U.S. branch
•Tax: 30% BPT on “dividend equivalent amount” (DEA)
• Generally, foreign corporation’s E&P that are effectively connected with U.S. trade or business (
884(b))
• Certain adjustments to DEA
• If earnings are re-invested into U.S. branch assets, DEA is reduced, and BPT is reduced; conversely, removal or lowering of U.S. branch assets treated as deemed remittances to foreign owner of the U.S. branch
• Fluctuations taken into account as changes in ―U.S. net equity‖; increase in U.S. net equity reduces DEA while decrease in U.S. net equity increases DEA (tracking hypothetical distribution of branch assets)
© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 14
Example: Basic BPT Computation
ECI $ 100
ECEP (at 35% tax rate) (a) 65
12/31/08 U.S. Net Equity 500
1/1/08 U.S. Net Equity 500
Increase in U.S. Net Equity (b) 0
DEA ((a) – (b)) 65
BPT (65 x 30) 19.5
Combined U.S. tax burden on $100
of U.S. profits with full BPT (35 + 19.5) $ 54.5
© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 15
Branch Profits Tax: Basic Definitions
• DEA is the amount of the foreign corporation’s effectively connected
earnings & profits (“ECEP”) for the taxable year (1) reduced (not below
zero) by any increase in U.S. Net Equity during the year; or (2)
increased by any decrease in U.S. Net Equity during the year.
• ECEP is a foreign corporation’s earnings and profits (“E&P”)
determined under general U.S. tax principles that are attributable to its
ECI.
• U.S. Net Equity (“U.S. Net Equity”) is the excess of a foreign
corporation’s U.S. Assets over its U.S. Liabilities as of the
determination date.
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member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 16
Example: BPT Computation
Year 1 Year 2 Year 3
Reinvestment Repatriation Current Deficit
ECEP (a) $ 100 $ 100 $ (50)
12/31/10 U.S. Net Equity 100 150 50
1/1/10 U.S. Net Equity 0 100 150
Increase/(Decrease) in
U.S. Net Equity (b) 100 50 (100)
Non-previously taxed
Accumulated ECEP 0 100 50
DEA (a) – (b) 0 50 50
BPT DEA x 30% $ 0 $ 15 $ 15
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member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 17
Example: Nimble Dividend Rule
ECEP (a) $ 50
12/31/10 U.S. Net Equity 200
1/1/10 U.S. Net Equity 200
Increase in U.S. Net Equity (b) 0
Non-previously taxed accumulated ECEP (150)
DEA ((a) – (b)) 50
BPT DEA x 30% $ 15
This rule provides parity to distributions from a U.S. subsidiary.
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member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 18
Example: ECEP Adjustments
Affecting BPT
ECI $ 0
ECEP (Muni-interest) (a) 50
12/31/10 U.S. Net Equity 200
1/1/10 U.S. Net Equity 200
Increase in U.S. Net Equity (b) 0
DEA ((a) – (b)) 50
BPT $ 15
The same principle applies to other items that do not constitute ECI but increase the
foreign corporation’s ECEP.
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member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 19
Branch Profits Tax:
Definition Of U.S. Assets
• In determining U.S. Net Equity, U.S. Assets generally include the foreign corporation’s assets held on the determination date if (1) all income produced by the asset is, or would be, ECI; and (2) all gain from the disposition of the asset would be ECI.
• The amount of a U.S. Asset generally is measured by the adjusted basis used to compute U.S. E&P multiplied by the portion of the asset that is treated as a U.S. asset.
• Note: partnership interests are treated as U.S. Assets in proportion to the percentage of income flowing through that is ECI.
• Difficult issues arise in contexts of current-year losses, shifting asset mixes, and tiered structures.
© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 20
Branch Profits Tax:
U.S. Real Property Interest
• If USRPI is actually connected or treated as connected with the
conduct of a U.S. trade or business (e.g., if an IRC
882(d) election is
made), the real property is a U.S. Asset.
• If USRPI is not used in a U.S. trade or business, the USRPI is not a
U.S. Asset. But, any gain from the sale of the USRPI is generally
treated as ECI and, therefore, generates ECEP which is generally
subject to BPT unless the termination rules apply.
• Gain on the sale of the stock of a U.S. real property holding company
does not give rise to ECEP despite the fact the gain is taxed as ECI
under IRC
897.
© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 21
Branch Profits Tax:
Definition Of U.S. Liabilities
•U.S. liabilities based on computation of USCLs under
Reg.
1.882-5, using the foreign corporation’s assets and
liabilities on the relevant determination date (e.g., end of
taxable year).
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member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 22
Change In U.S. Net Equity:
A Trap For The Unwary
A U.S. branch has $100 of ECI, incurs $35 of income tax and reinvests
the $65 of ECEP in U.S. assets. The foreign corporation has elected to
use the 50% fixed ratio to compute its USCLs.
Branch Profits Tax
ECEP $ 65
Increase in USNE (32)
DEA 33
BPT ($33 * 30%) $ 10
1/1/10 12/31/10
E&P Basis in U.S. Assets 1,000 1,065
Less: USCLs (500) (533)
U.S. Net Equity 500 532
Increase in U.S. Net Equity 32
Change in USNE
Slide Intentionally Left Blank
BPT Implications For
Transfers Of Branch Assets
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member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 25
Branch Profits Tax: Terminations
• A foreign corporation is exempt from BPT with respect to its disinvestment
(including all accumulated ECEP) in the year of complete termination of all
business activity in the United States. Temp. Reg.
1.884-2T(a).
• Requirements:
a) As of the end of the year, corporations either has no U.S. assets or
shareholders have adopted an irrevocable resolution to dissolve the company
and terminate the U.S. business;
b) Three-year lock-out period that prohibits the terminating corporation, or a
related corporation, from using any of the former U.S. Assets in the conduct of
a U.S. trade or business;
c) Terminating foreign corporation has no ECI (other than through
864(c)(6) or
(7)) during the three years after the end of the taxable year; and
d) Terminating foreign corporation attaches a waiver (Form 8848) to extend
statute of limitations to six years following complete termination (i.e., three past
the three-year lock-out period).
© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 26
Branch Profits Tax: Liquidations
And Reorganizations •A foreign corporation may defer its BPT liability when it transfers its U.S. branch operations to another corporation in a
381(a)-eligible corporate liquidation or reorganization; in such a case, termination rules not applicable. Temp. Reg.
1.884-2T(c).
• Foreign-to-Foreign
• Transferee inherits U.S. business, ECEP and non-ECEP carry over as a
381(a) attribute, U.S. net equity of transferee increased to reflect transfer.
• Inbound
• Distributions of inherited E&P by domestic transferee to foreign shareholder(s) can only qualify for treaty benefits to the extent the transferor foreign corporation would have been eligible for a BPT treaty reduction.
• Limitations on selling/cashing out of foreign transferor or domestic transferee by certain large shareholders within 12 months prior to
381(a) transfer. If violated,
exception to branch termination not applicable and deemed withdrawal of all branch equity with corresponding increase to DEA, possibly resulting in BPT exposure.
• Must also execute Form 2045 (contained within Form 8848) to extend statute of limitations on transfer of branch assets for six years after close of year of transfer.
© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 27
Branch Profits Tax: Incorporation
•A foreign corporation also may defer its BPT liability if it incorporates its
branch into a U.S. subsidiary (e.g., in a
351 transfer). Temp. Reg.
1.884-
2T(d).
• U.S. subsidiary must make an election to increase its E&P by the amount of
ECEP associated with the contributed U.S. assets. Same rule as in prior slide
for limitation on treaty periods.
• Foreign shareholder that contributes the assets must also agree to recognize
as a DEA any gain on a subsequent sale of the U.S. subsidiary’s stock, to the
extent of the transferred earnings that have not yet been subject to U.S. tax
via repatriation to the foreign shareholder.
Procedural Aspects
© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 29
Section 884 Compliance: Branch
Profits Tax
• Section 884 Branch Profits Tax (BPT) Reported on Form 1120-F, Not
by Section 1441/1442 Withholding.
• Section III, Part I.
• Not subject to estimated tax payments – Treas. Reg.
1.884-1(a).
• Additional Information:
• Section III, Part III—asks if a termination, reorganization or incorporation
event has occurred.
• If 1120-F filer is eligible under a Treaty for a reduced rate of withholding,
then Form 8833 must be used to claim treaty benefits.
• Statutory (IRC section 6712) $10,000 penalty for failure to file this
form.
© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 30
Section 884 Compliance: Branch
Profits Tax And Tax On Excess Interest
© 2013 KPMG LLP, a Delaware limited liability partnership and
the U.S. member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative
(―KPMG International‖), a Swiss entity. All rights reserved.
NDPPS 114294
The KPMG name, logo and ―cutting through complexity‖ are
registered trademarks or trademarks of KPMG International.
Slide Intentionally Left Blank
MECHANICS OF THE BRANCH LEVEL INTEREST TAX
Robert J. Misey Jr., Reinhart Boerner Van Deuren
Incentive To Move Deductions
To A U.S. Branch
34
ForCo
U.S.
Branch
Book Debt on Books
of U.S. Branch
Debt to 3P Bank Allocate S, G & A
Expenses
Taxation Of Effectively
Connected Income Deductions against effectively connected income of a U.S.
branch
Expenses, losses, and other deductions that are directly
related to effectively connected gross income (e.g., cost of goods sold), as well as a ratable portion of any deductions
that are not definitely related to any specific item of gross
income
35
Taxation Of Effectively
Connected Income (Cont.) The three-step approach for interest
1. Determine the value of the foreign corporation’s U.S. assets
2. Determine the total amount of the foreign corporation’s U.S. connected liabilities by multiplying the value of the foreign corporation’s U.S. assets by its worldwide debt-to-asset ratio for the year
3. Compare the amount of the foreign corporation’s U.S. connected liabilities to its U.S. booked liabilities
36
Taxation Of Effectively
Connected Income (Cont.) Comparison
a. If the foreign corporation’s U.S. booked liabilities exceed its U.S. connected liabilities, the foreign corporation’s U.S.
interest expense equals the interest accrued on U.S.
booked liabilities reduced by the percent of U.S.
connected liabilities to U.S. booked liabilities
37
Taxation Of Effectively
Connected Income (Cont.) Comparison (Cont.):
b. But if the foreign corporation’s U.S. booked liabilities are less than its U.S. connected liabilities, then the foreign
corporation may increase its interest expense deduction
by the excess amount of U.S. connected liabilities
multiplied times the effective interest rate on non U.S.-
booked liabilities
38
Example 1:
Interest Expense
39
ForCo
U.S. Branch
$5 million U.S. assets $1 million U.S. booked
liabilities @ 5%
F
.
$5 million U.S. assets $1 million U.S. booked
liabilities @ 5%
U.S.
foreign
parcel
U.S.
parcel
Taxation Of Effectively
Connected Income (Cont.)
40
Interest expense: Step 1
The total value of ForCo’s
U.S. assets is $5 million.
Taxation Of Effectively
Connected Income (Cont.) Interest expense: Step 2
The amount of ForCo’s U.S. connected liabilities is
determined by multiplying $5 million (the value of ForCo's
U.S. assets) by its debt-to-asset ratio. The debt-to-asset ratio is either: (a) the ratio of ForCo’s worldwide liabilities to its
worldwide assets or (b) a fixed rate of 50%. Assuming that
ForCo elects to use the fixed rate of 50%, its U.S. connected
liabilities are $2.5 million
41
Taxation Of Effectively
Connected Income (Cont.)
Interest expense: Step 3
Because ForCo’s U.S. connected liabilities ($2.5 million)
exceed its U.S. booked liabilities ($1 million), ForCo has "excess" interest expense of $75,000 (i.e., the $1.5 million
excess of U.S. connected liabilities multiplied by 5%), resulting
in a total interest expense of $125,000 (i.e., $50,000
attributable to the U.S. booked liabilities and $75,000 attributable to the excess U.S. connected liabilities)
42
Taxation Of Effectively
Connected Income (Cont.)
Branch profits tax
The branch profits tax is designed to equate the tax treatment of U.S. branch and U.S. subsidiary operations by
imposing a tax equal to 30% of a foreign corporation's
Dividend Equivalent Amount for the taxable year
43
Policy Behind The
Branch Interest Taxes
44
ForCo
F
US
F
US
ForCo
USSub
3PF
Bank
3PF
Bank
interest interest
Two Branch Interest Taxes
1. Branch interest withholding tax
2. Excess interest tax
45
Taxation Of Effectively
Connected Income (Cont.)
Branch interest withholding tax
1. Any interest paid by a foreign corporation's U.S. branch is
treated as if it were paid by a U.S. corporation
2. This rule subjects any interest paid by a U.S. branch to a foreign person to the 30% withholding tax
3. Interest is considered to be "paid by" a U.S. branch if the
underlying liability is booked by the foreign corporation as
a branch liability
46
Example 2:
Branch Interest Withholding Tax
47
ForCo
U.S. Branch
$50,000 interest paid
U.S.
F
Taxation Of Effectively
Connected Income (Cont.)
Mechanics of the branch interest withholding tax
1. The branch interest withholding tax is not imposed on
interest that qualifies for an exemption from withholding
tax
2. The branch interest withholding tax is reported via
Form 1042 withholding, not on the Form 1120-F
48
Example 3:
Branch Tax On Excess Interest
49
ForCo
U.S. Branch
$125,000 interest deducted $75,000 s.t. branch interest withholding tax
U.S. Branch
U.S.
F
50
51
52
53
Exemptions From Branch
Interest Tax
1. Bank deposit interest
2. Portfolio interest
3. Reduction due to treaty
54
Example 4:
Interest Expense
55
ForCo
U.S. Branch
$5 million U.S. assets $5 million U.S. booked
liabilities @ 5%
F
.
$5 million U.S. assets
liabilities @ 5%
U.S.
foreign
parcel
U.S.
parcel
Taxation Of Effectively
Connected Income (Cont.)
56
Interest expense: Step 1
The total value of ForCo’s U.S.
assets is $5 million
Taxation Of Effectively
Connected Income (Cont.) Interest expense: Step 2
The amount of ForCo’s U.S. connected liabilities is
determined by multiplying $5 million (the value of ForCo's
U.S. assets) by its debt-to-asset ratio. The debt-to-asset ratio is either: (a) the ratio of ForCo’s worldwide liabilities to its
worldwide assets or (b) a fixed rate of 50%. Assuming that
ForCo elects to use the fixed rate of 50%, its U.S. connected
liabilities are $2.5 million
57
Taxation Of Effectively
Connected Income (Cont.)
Interest expense: Step 3
Because ForCo’s U.S. booked liabilities ($50 million) exceed
its U.S. connected liabilities ($2.5 million), ForCo's deductible interest is reduced from $50,000 by half to $25,000; $25,000 is
the branch interest withholding tax and there is not an
excess interest tax
58
Slide Intentionally Left Blank
BRANCH TAX AND TAX TREATY ISSUES
James Sams, KPMG
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member fi rms affiliated with
KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. Printed in the U.S.A.
FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied.
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT
INTENDED OR WRITTEN BY KPMG TO BE USED, AND
CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON
OR ENTITY FOR THE PURPOSE OF (i) AVOIDING
PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR
(ii) PROMOTING, MARKETING OR RECOMMENDING TO
ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction described in the
associated materials we provide to you, including, but not limited to, any tax opinions,
memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are subject
to change. Applicability of the information to specific situations should be determined through
consultation with your tax adviser.
© 2013 KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent
member firms affiliated with KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. 62
Agenda
• Treaty overview
• Tax treaty qualification (principal features)
• In general
• Hybrid entities
• Application to the BPT provisions
Treaty Overview
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member fi rms affiliated with
KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. Printed in the U.S.A.
FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 64
Tax Treaties: Overview
Common benefits of income tax treaties
− Reduced withholding taxes on investment income
E.g., rates ranging from 0% to 15% on dividends depending on
level of stock ownership
Reduced rates on BPT/BLIT
− No tax on business profits unless attributable to permanent
establishment
PE is a fixed place of business with exact forms creating PE
defined in treaty
Dependent agent may create PE while independent agent does
not create PE
− Competent authority procedures
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Tax Treaties: Overview (Cont.)
Each treaty is unique but contain common provisions
Weight of authority
− Generally same as IRC
− Where conflict exists, ―later in time‖ rule generally applies
Aids to treaty interpretation
− Treasury Department technical explanation
− Senate Foreign Relations Committee Report
− Model treaties and related commentary
2006 U.S. Model Treaty
2005 OECD Model Treaty
Treaty Qualification
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Treaty Qualification: General
Requirements
First, qualify under residence article
− Special rules for pass-through entities
Second, satisfy at least one of the tests in the LOB article
− ―Qualified persons‖ entitled to all treaty benefits
resident individuals, governments, publicly traded & subsidiary
of publicly traded corporations
Entities meeting ownership and base erosion tests
− Active Trade or Business Test
− Derivative Benefits Test (not all treaties)
− Headquarters company test (not common)
− Discretionary grant of treaty benefits
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LOB Provisions
General Form Of Ownership Tests
For companies, must be either:
− Regularly traded public company in the treaty jurisdiction
− More than 50% of its shares are owned by [5] or fewer companies
described above, or
− More than X% is owned by treaty residents, and X+Y% is owned by
U.S., EU or NAFTA residents
For companies and other persons:
− More than 50% is owned by treaty residents, and
− Base erosion test satisfied (i.e., earnings stripping may preclude
qualification).
No derivative benefits unless explicitly prescribed in the treaty
68
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LOB Provisions
General Form Of Business Activities Tests
If fail ownership tests, may still qualify for some or all treaty
benefits if:
− Conduct ―active business‖ in treaty jurisdictions
Substantial in relation to business in other state
Similar or complementary businesses
In some cases, payroll, assets and gross income tests must be
satisfied; or, provided as safe harbors to gauge whether you are
―active‖
69
Treaties And Hybrids
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Hybrids
Having qualified under the treaty generally, must clear additional US domestic law hurdle governing payments to hybrid entities
− Applicable to payments to a non-US entity that is fiscally transparent under US and/or non-US law
− Relief available only if the item of income is treated as income of the treaty resident under the law of the treaty jurisdiction
− Special rule for payments to US ―reverse hybrids‖
Affects UK-US inbound financing structure using USGP
− US-UK Treaty Article 1(8) applies similar rules
− Consider payments to a US LLC
Must consider other nuances, special rules
− Proposed legislation may deny treaty benefits to a subsidiary which itself qualifies but whose parent company does not.
71
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Treaty Qualification For A DRE
US
Luxembourg
Bermuda
US
Residents
Is a Luxembourg DRE
eligible for the benefits of
the US-Luxembourg
Income Tax Treaty?
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Treaty Qualification For A DRE (Cont.)
The explanation to the 2006 U.S. model looks to domestic law:
− ―The determination of residence for treaty purposes looks first to a
person's liability to tax as a resident under the respective taxation
laws of the Contracting States. As a general matter, a person who,
under those laws, is a resident of one Contracting State and not of
the other need look no further. For purposes of the Convention, that
person is a resident of the State in which he is resident under
internal law.‖
The explanation goes on to say US will treat an otherwise fiscally
transparent US entity as a US resident if it is treated as a
corporation for US tax purposes.
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Treaty Qualification For A DRE (Cont.)
Second test: Is the Luxembourg DRE’s income “derived by” a resident of Luxembourg.
Paragraph 6 of Article 1 of 2006 US model provides:
− ―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.‖
If income is subject to tax in Luxembourg then the income is “derived by” the Luxembourg DRE. US
Luxembourg
Bermuda
US
Residents
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Treaty Qualification For A DRE (Cont.)
Third test: Beneficial owner of the income must be entitled to the benefits of the treaty.
The United States does not view a DRE as a beneficial owner.
Is the Luxembourg DRE denied treaty benefits because Bermuda is the “beneficial owner” of the income?
The commentary to the 2006 US Model states as follows:
− ―In the case of hybrid entities (that is, an entity that is treated as fiscally transparent under the laws of one State and non-fiscally transparent under the laws of the other, or of a third State), it may be that the person who "derives" the income under Article 1(6) is not the same person as the "beneficial owner" under Article 10 (Dividends). This will not prevent a claim for treaty benefits, so long as each of the requirements is met by one or more residents of the other Contracting State.‖
Applications Under The
BPT Provisions
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Treaty Qualification And The BPT
Does UK qualify for tax treaty relief in general?
If so, does BPT apply?
If so, at what rate?
US
Luxembourg
UK
Public
US Branch
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Treaty Qualification And The BPT (Cont.)
Article 10(7) of the UK Treaty permits the US to impose the BPT:
− A company that is a resident of a Contracting State and that has a
permanent establishment in the other Contracting State, or that is
subject to tax in that other State on a net basis on its income or
gains that may be taxed in that other State under Article 6 (Income
from Real Property) or under paragraph 1 of Article 13 (Gains) of
this Convention, may be subject in that other State to a tax in
addition to any tax that may be imposed by that other State in
accordance with the other provisions of this Convention.
Article 10(8) limits the tax to the dividend withholding tax rate of
5% specified in 10(2). That reduced rate applies to dividends paid
to a “company.”
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KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. Printed in the U.S.A.
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Treaty Qualification And
The BPT: Redux What if the US Branch qualifies as US
business nexus under the Code, but does NOT constitute a PE under an applicable US tax treaty?
Can the BPT apply? Consider the following language:
− Treas. Reg. section 1.884-1(f)(4), Ex.2: … The ECI is exempt from taxation under section 882(a) by reason of an income tax treaty and section 894(a). The income nevertheless gives rise to ECEP under this paragraph (f).‖
− UK treaty, Art. 10(7): ―…Such tax, however, may be imposed on only the portion of the business profits of the company attributable to the permanent establishment…‖
.
US
Luxembourg
Treaty
Country
Public
US ―Branch‖
[but not = PE]
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Treaty Qualification And The BLIT
Does UK qualify for tax treaty relief in general?
Does Spanish Bank qualify for tax treaty relief in general?
Which treaty (and rate) governs for purposes of the BLIT?
US
Luxembourg
UK
Public
US Branch
Spanish Bank
Interest
Excess Interest
(Deemed)
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Treaty Benefits For A Foreign
Reverse Hybrid (FRH)
UK
FRH
US Branch
UK
Individual
Saudi
Individual
Can the UK FRH
claim a reduced
rate of BPT under
the UK-US
Income Tax
Treaty?
German
Public Co.
UK Private
Co.
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Treaty Benefits For An FRH
Would US grant relief from BPT to FRH to extent of its UK
resident owners?
− Section 884(a) states this is a tax on the foreign corporation in
addition to the tax imposed under section 882.
Slide Intentionally Left Blank
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member fi rms affiliated with
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FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 84
Treaty Benefits For An FRH (Cont.)
Article 10(7) of the UK Treaty permits the US to impose the BPT:
− A company that is a resident of a Contracting State and that has a
permanent establishment in the other Contracting State, or that is
subject to tax in that other State on a net basis on its income or
gains that may be taxed in that other State under Article 6 (Income
from Real Property) or under paragraph 1 of Article 13 (Gains) of
this Convention, may be subject in that other State to a tax in
addition to any tax that may be imposed by that other State in
accordance with the other provisions of this Convention.
Article 10(8) limits the tax to the dividend withholding tax rate of
5% specified in 10(2). That reduced rate applies to dividends paid
to a “company.”
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member fi rms affiliated with
KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. Printed in the U.S.A.
FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 85
Treaty Benefits For An FRH (Cont.)
Article 3 provides:
− The term "company" means any body corporate or any entity that is
treated as a body corporate for tax purposes;
− Any term not defined therein shall, unless the context otherwise
requires, or the competent authorities agree on a common meaning
pursuant to the provisions of Article 26 (Mutual Agreement
Procedure) of this Convention, have the meaning which it has at
that time under the law of that State for the purposes of the taxes to
which this Convention applies, any meaning under the applicable
tax laws of that State prevailing over a meaning given to the term
under other laws of that State.
© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member fi rms affiliated with
KPMG International Cooperative (―KPMG International‖), a Swiss entity. All rights reserved. Printed in the U.S.A.
FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. 86
Treaty Benefits For An FRH (Cont.)
US views FRH as a corporation and imposes BPT.
FRH is fiscally transparent in the UK.
− Article 1(6) provides that income of FRH is income of a resident to the extent the UK treats it as income of a resident under its tax laws. Thus, partially income of a UK resident.
− Article 1(6) does not answer whether this is income of a UK company or UK resident individual.
− Article 3(2) suggests US law applies to determine whether FRH is a ―company‖ unless . . .
− Does the context otherwise require reference to UK law?
© 2012 KPMG LLP, a Delaware limited liability
partnership and the US member firm of the KPMG
network of independent member firms affiliated with
KPMG International Cooperative (―KPMG
International‖), a Swiss entity. All rights reserved.
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