U.S. Proposes Changes to International Tax Treaty Model
The discord in legal tax practices has never been more evident than in the international tax practices of big multinationals. In an ongoing game of Tic-Tac-Toe between governments and big corps, it is glaringly obvious that the current score leaves regulatory bodies frustrated, angry and still trying to catch up.
In May 2015, the U.S. Treasury proposed new changes to the current U.S. Tax Treaty Model that will have an impact on how foreign corporations in the U.S. are taxed. This is the latest in an ongoing effort to eliminate tax avoidance by corporations. These changes will directly combat two tax strategies employed by corporations:
- Stateless Income
- Base Erosion and Profit Shifting (BEPS)
Stateless Income: In its basest form, the Stateless Income tax strategy is when profits derived by a multinational corporation in a jurisdiction other than the home country and taxed in a third country that has minimal to zero corporate tax. Google, Apple, and Starbucks are just some of the big names that have been smacked on the proverbial hand for employing this controversial strategy.
Google, for example, was accused of using the popular Irish double-dutch sandwich tax strategy to successfully decrease their tax obligations. Also, Apple was able to save over $30billion in income taxes since 2009 by having a unit incorporated in Ireland and managed from California (see our prior blogs and newsletters on Apple’s Ireland strategy).
Base Erosion and Profit Shifting (BEPS): This is a tax strategy used by multinational companies that take advantage of the gaps and in congruencies in the international tax platform to reduce corporate tax. This is done by shifting profits to low/no tax jurisdictions or just, as the IRS calls it, make profits disappear. The Organization for Economic Cooperation and Development (OECD) along with the G20 nations are working hard and fast to execute more standardized tax laws in addition to pushing the Beps Action Plan. According to the OECD website, the BEPS Project aims to provide governments with clear international solutions for fighting corporate tax planning strategies that exploit gaps and loopholes of
the current system to artificially shift profits to locations where they are subject to more favorable tax treatment.
For example, Amazon EU was accused of using a profit shifting tax strategy called ‘Hybrid Mismatch Arrangements’, where a company/entity is treated differently in different jurisdictions. The G20 defines this strategy as an arrangement that takes advantage of the differences in two or more jurisdictions by using ‘hybrid entities’. An entity could be treated in jurisdiction A as a taxable person and treated in Jurisdiction B as a taxable company, partnership etc. depending on the tax advantages the particular entity provides.
If the proposed amendments pass, multinationals may have to look into other tax strategies as international governing bodies are taking a more aggressive approach to tax avoidance.
The U.S. Treasury released proposals for amendments to combat the bi-products of international tax treaties put in place originally to avoid double taxation.
The first set of proposals addresses the issue of special tax regimes where multinationals take advantage of the inconsistencies in global taxation laws and shift profits to jurisdictions that have low tax rates especially for income such as interest or royalties. If passed, the new amendment would allow interest, royalties or other income to ‘related parties’ to be taxed in accordance with the domestic tax law of where the income was generated regardless of a no/low tax treaty that may be in place.
Corporate inversions may have been the number one thorn in the government’s shoe last year which is why it is not surprising that there is renewed global effort to curb this practice. Inversions make U.S. companies ‘Expatriated Entities’, which would allow them tax breaks including full benefits of their ‘adopted’ corporate country. However, under the new proposal, expatriated entities will be open to withholding taxes on dividends and even on interest and royalties. The new proposal stipulates that expatriated entities will have the same tax obligations in accordance with domestic tax laws, for up to ten years after filing expatriation.
In response to companies taking advantage of bilateral tax treaties, the proposals include new tools to combat Base Erosion and Profit Shifting (BEPS) by limiting treaty benefits and introducing qualifying criteria for companies claiming permanent establishment in a foreign jurisdiction. Permanent Establishment is a fixed place of business through which income is derived and to which certain tax benefits are available.
The draft proposals can be viewed on the U.S. Treasury website here.
It should be noted that these are suggested changes to the U.S. Model Tax Treaty, and will have no impact on treaties already in place, unless both parties to the treaty decide to modify the terms of the treaty. That is a very long-term process.
Klueger & Stein, LLP works with many cross-border businesses that may be affected by the proposed changes. We continue to advise our clients on their international tax needs.
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