US Model Tax Convention Changes To Tackle Inversions

On May 20, 2015, the US Department of the Treasury released for public comment draft updates to the US Model Income Tax Convention, including provisions to deny treaty benefits to companies that change their tax residence via inversion transactions.

The Treasury said other changes are intended to ensure that the United States is able to maintain the balance of benefits negotiated under its treaty network as the tax laws of its treaty partners change over time.

Introducing the changes, Deputy Assistant Secretary for International Tax Affairs Robert B. Stack said: “The draft provisions we are releasing for comment today reflect the fact that the tax regimes of our treaty partners are more likely to change over time than they have in the past, and that they sometimes change in ways that encourage base erosion and profit shifting or base erosion and profit shifting (BEPS), by multinational firms. Treaties exist to eliminate double taxation, not to create opportunities for BEPS, and today’s updates fully take account of the new international tax environment. The draft provisions also articulate steps that would help prevent our treaty network from encouraging inversion transactions.”

One set of draft provisions addresses issues arising from “special tax regimes,” which provide very low rates of taxation in certain countries in particular to mobile income, such as royalties and interest. The Treasury identified that this income can easily be shifted around the globe through deductible payments that can erode the US tax base. The proposals are intended to avoid instances of “stateless income” or double non-taxation, whereby a taxpayer uses provisions in a US tax treaty, combined with special tax regimes, to pay no or very low tax in the treaty partner countries.

The second set of draft provisions is aimed at reducing the tax benefits from a corporate inversion by imposing full withholding taxes on key payments such as dividends and base stripping payments, including interest and royalties, made by US companies that are “expatriated entities” as defined under the Internal Revenue Code.

Last, revisions are proposed to prevent residents of third-countries from inappropriately obtaining the benefits of a bilateral tax treaty. These include more robust rules on the availability of treaty benefits for income that is not subject to tax by a treaty partner because it is attributable to a permanent establishment located outside the country, and the ability of a company to make “excessive base eroding payments.”

Recognizing that multinationals often have global operations dispersed through many subsidiaries around the globe, the Model Convention for the first time contains a so-called “derivative benefits” rule. The rule is an additional method of qualifying for treaty benefits based on a broader concept of ownership that includes certain third-country ownership.

While not among the draft treaty provisions released, the next US Model will include a new Article to resolve disputes between tax authorities through mandatory binding arbitration.

The Model Convention is the baseline text used by the Treasury when negotiating tax treaties and was last updated in 2006.