- [Larry] Okay, thank
you Sean, David and Tom
for the opening panel discussion
which is the platform for
the rest of the symposium.
Our next panel is going to focus
on the evolving U.S. treaty policy
as reflected in the
2016 U.S. model treaty.
The U.S. model treaty
is the starting template
for U.S. Treasury to
use when it negotiates
or renegotiates income tax
treaties with other nations.
The 2016 U.S. model treaty
includes several novel changes
and to the extent adopted
in U.S. Income Tax Treaties,
may make it more difficult
for some business structures
to qualify for treaty
benefits as we move forward.
This panel is going to be moderated
by Professor David
Rosenbloom with panelists,
Peter Blessing, Jason
Connery and Queyen Huynh.
Peter Blessing is a member
of the Complex Transactions Group
of KPMG's Washington
National Tax Practice.
Peter is a past chair of the Tax Section
of the New York State Bar Association
and was recently appointed
President of the U.S. Branch
of the International Fiscal Association.
Prior to joining KPMG, Peter was a partner
with Shearman and Sterling
for over 25 years.
Jason Connery is a Principal
in the International Tax Group of KPMG's
Washington National Tax Practice
and is an alum of the
graduate tax program at NYU.
Jason is co-author of the "Current Status
of U.S.Tax Treaties and
International Tax Agreements",
which is published monthly
in the "Tax Management
International Journal".
Queyen Huynh is an Associate
International Tax Counsel
in the Office of International Tax Counsel
at the United States
Department of the Treasury.
At Treasury Queyen works on a variety
of international tax matters
with a particular focus
on income tax treaties,
withholding, information
reporting and FACTA.
Queyen has taught courses
as an adjunct professor
at Georgetown University Law Center
where she earned her LOM.
Professor Rosenbloom, over to you.
- All right, so we're gonna talk about
the new U.S. Model Treaty
and where the policies reflect in it,
if I can get this thing
to work, here we go.
So I'm gonna say a few words
about U.S. Treaty Policy,
very few words, and then
I'm gonna turn it over
to Peter Blessing and Jason
who are going to ask
some questions of Queyen.
First of all, broadly speaking the U.S.
has got three things in it's treaty policy
that set it apart from other countries.
We reduce tax at source in
our model more than anybody,
more than the OECD so we're more favorable
in the residence country
in the competition
between residence and source.
And as part and parcel of
that, and it's a long story
which I won't go into,
but it goes with that first policy
that we're also lot more
sensitive to treaty shopping
than most other countries.
Some other countries
are beginning to jump in
and adopt LOB articles,
but we've been there for
probably close to 30 years now.
And we're way out ahead of anything
that appeared in BEPS on this.
So that's the second big
highlight of U.S. policy.
And the third highlight of U.S. policy
is that we limit benefits for U.S. persons
using the saving clause
and we're very reluctant to use treaties
to benefit U.S. persons.
Those are the real
highlights of the U.S. policy
and we're going to talk
more about Federalism
and not covering state taxes.
But as I see it, those are the things
that have us stand out.
Now we now have the new treaty,
model treaty, 2016 model
which is, let's see we had one,
we started this business in 1975,
so we had '75, '76, '81, '96, 2006, 2016,
whatever number that is.
So now we got a new model, 2016 model.
One of the questions that we
probably won't get to today,
but which is interesting
is what exactly are we dealing with here?
Is this an ideal treaty?
Is this the treaty we
wanna sign with everybody?
Some would say yes.
Is this a source of
interpretative guidance
with respect to existing treaties?
Can one point to this model,
which of course hasn't been enacted
or gone through any legal process.
It's just a brain child of some people
in the Treasury who put is out.
Can we point to that
in terms of interpreting
existing treaties?
And there will be, I assume
Queyen will tell us about it,
a technical explanation that'll give us,
that just raises the same question.
Are we gonna have new material out there
for interpreting existing treaties?
Is this an expression of policy?
I would say probably it is
an expression of policy,
but is it more than that?
And then the question
that I'm interested in,
is whether this is a model
for the developed world only,
or whether we approach
the developing world
with a different perspective?
So those are the questions that I would,
let me just say very
broadly how I see this.
Peter and Jason are gonna focus largely
on the headline items in this new model,
particularly the changes to the limitation
on benefits clause and some of
the other special tax regime.
Some of the other big issues in the model.
I say that the model
maintains the U.S. preference
for residence basis taxation.
There is very little changes in that.
There's some anti-treaty
shopping rules in there,
which are I suppose an encouragement
to residence basis
taxation to some extent.
In other words, there's
somewhat more taxation
at source to curb treaty shopping.
And in the LOB article,
as the slide indicates,
I think there's some real creative
and emphatic effort to change
limitation on benefits clause,
which by the way, is in
all of our recent treaties.
And I don't believe any two U.S. treaties
are exactly the same in the LOB article.
And this model has some
very significant changes,
which Peter and Jason will get into,
going from the 2006 model.
I think the most important thing,
you've already heard me on arbitration.
I think the most important thing here
is not simply that we are
doing our mandatory arbitration
because we've already done
that in four treaties in place
and a couple of others that
are pending in the Senate.
But by putting it in the
model, we're basically saying
we would do mandatory
arbitration with anybody.
And that's significant.
I had always thought we would be hesitant
to do mandatory arbitration with countries
with which we did not
have an existing process
for handling the MAP.
So if a country comes in and says,
we like mandatory arbitration,
even if we've never had competent
authority discussions with them,
we would be hard pressed
to deny that, I think
now that it's in the model.
I think there are lots of
little nuggets in the model,
which we won't get into, we
don't have time to get into.
But there's a lot of little
changes, word changes,
there's paragraphs inserted.
You know Article 13, the
capital gain articles,
you got an elective
realization that's taken
from some of our most recent treaties.
I'm familiar with it
in the Canadian treaty.
There's a number of other
nuggets of change in here.
I would say, there's not
much change in substance.
But my overriding thought
and I'll leave you with this thought,
is that this, to me, this model
is a much more U.S. centric
articulation of a model
than we've had.
The history of the models
in the United States
of treaty negotiation
in the United States,
was when we started
this business way back,
we tried to go the rest of the world
and negotiate on the basis of U.S. law.
That was a flop, because
explaining U.S. law
to countries on a one-by-one
basis took forever
and they were reluctant to sign on.
And so what we did, and I guess the,
I would have thought the take off
was probably the 1975 treaty
with the United Kingdom,
we said, the heck with it,
we'll buy into what the OECD has done.
So we adopted an awful
lot of things in the OECD
that we don't really totally understand.
'Cause it isn't our language.
And we've been living with
that now, for every since '75.
And this model still has
plenty of OECD language in it,
but there's a lot more U.S.
specific language in it
and my sense is that that's
gonna make it a harder document
from which to negotiate.
We're gonna have to spend
more time explaining
why something is in this model
to countries that aren't used to the OECD
and are not used to
our domestic law rules.
So that's all I got.
Peter, I'm gonna hand you the,
I'm gonna have Pete turn
it over to Peter and Jason
and I'm gonna observe
like the rest of you.
- Yeah, Jason's gonna say something.
First, he's gonna say
he's very happy that David
isn't so pessimistic in this session,
(laughing)
but go on.
- Yeah, two things.
So the 2016 model has grown
to 70 pages versus 43 in 2006.
And the other unique thing that happened
prior to the release of the 2016 model
is Treasury actually put
out a draft model in May
and asked for comments.
And they actually read the comments
and incorporated some of the
changes into the 2016 model,
which as we'll go through,
some are helpful to taxpayers.
- Maybe while we're on comments,
I'll ask Queyen whether
she got any comments
or whether the Treasury got any comments
since they were due
yesterday on the new model.
- Well as Peter indicated,
when we released the 2016 model
in February of this year,
along with that we also
released a preamble
to the model where we discuss
some of the highlights of changes,
based on the fact that we
had released in May of 2015
a draft of the proposed
sort of, new cloth provisions that we had.
And one of the big
changes that we had made
was to the active trade or business test.
And the fact that we are moving away
from allowing active trades or businesses
that are sort in the same
or substantially similar
lines of businesses to qualify
under active trigger business
and we had requested comments on the fact
that we are now requiring
a more factual connection
with respect to the activity.
Those comments were due yesterday,
and we did not receive any comments
describing fact patterns that
people felt should be covered
by an active trade or business test
that is not adequately covered
by any of the other LOB tests
and so maybe comments will come in late,
but as of yesterday we've
not received any comments.
- Everybody just loves it.
(laughing)
So we're gonna focus on the LOB article.
We're going to ignore all
the nuggets that David found,
'cause we weren't so sure
how golden they were.
But we're gonna focus on the LOB article
and so this new model has
some new provision entirely
and some pretty substantial revisions
to some of the existing provisions.
Because the headquarters test for example,
is in our experience so rarely usable,
we're not even gonna talk about it.
And it sort of interweaves in
some of the other provisions
and creates some complications,
but we'll leave that to the side.
The big news of course, is
the derivative benefits tests
being expanded, but they've
also made substantial changes
to the public trading test
and as Queyen just said,
the active trade test.
And so we're gonna focus
on basically those three provisions.
First thing though, I
guess I would ask Queyen
the question at the bottom of this screen
which is, given how
complicated the new LOB is
compared to the prior one and given,
or even the prior one
is fairly complicated,
but given the comments that we, Treasury
and everyone else received
in connection with BEPS.
Is this gonna be easily negotiable
in your view going forward?
- Well I mean, I don't want to suggest
that any treaty negotiation is easy,
I mean even if you look at the 2006 model,
people have said our 2016 has
gotten a lot more complex,
a lot more complicated
and I would not disagree
that it's gone through some revisions.
But 2006, wasn't a--
- Cakewalk.
- Cakewalk either.
And obviously in a negotiation
you're sitting down
and you are talking about these provisions
and so a lot of the LOB
provisions fortunately
are not cut from new cloth unlike STR
or subsequent changes in law.
This is a provision that has been around.
We've been applying a
form of LOB since 1996.
We revamped it in 2006.
And the 2016 largely does build off
of the 2006 framework and
incorporates for example,
the derivative benefit and
headquarters provisions into it,
which have added to the length of pages.
So if people don't wanna
look at those LOB rules,
if the old rules work,
you don't have to read
derivative benefits and
headquarters company.
You know, so the length
of the treaty growing,
I don't think is indicative
of how much more complex it's grown.
I think it's because we've
actually added provisions
that people have asked us
to add for a number of years
into the model itself, with modifications,
you know based on what
we've currently done.
We have made that part of it potentially,
on some ways tighter, but in other ways
we've actually relaxed the 2006 model.
So I don't, you know whether
countries take it or not,
I mean when we sit down at the table,
the U.S. has already said that
we would not negotiate a PPT
in the context especially of
the multi-lateral instrument.
And so our approach will be
to sit down with jurisdictions
bilaterally probably, to
discuss a robust LOB approach.
- Okay, thanks.
So we're gonna start
with the public trading,
the subsidiary of the public trading test,
'cause that introduces
some of the concepts
and it's got a new base
erosion prong to it.
First we'll focus on the ownership test.
So basically this provision requires
a five or fewer within a 12 month period
of time the payment is made
and that it be a publicly
traded company owned by five
or fewer publicly traded company, sorry.
The subsidiary itself,
has to meet a qualifying ownership test
a qualifying intermediary owner test.
The qualifying, and I'll call
it QIO, 'cause it's shorter.
The QIO test has a sort
of a very simplistic way
to look at it.
So anything from any company
in the source country is okay.
And any company that's in
the residence country is okay
for purposes of public trading.
So mechanically the way that works
is the sub of the public
trading test says,
source state is okay,
QIO test, QIO is okay
and then QIO itself says residence is okay
and third country is okay
provided they meet the STR,
the Special Tax Regime Test
and the National Interest Deduction Test
And those provisions have to
actually be in the treaty.
And that last point is one
I want to come back to here.
So in this diagram, it's basically showing
an Irish subsidiary that's
trying to rely as a subsidiary
of a public traded Irish company.
So it's the Irish company,
is a tested company.
There's a UK company in between,
so that's the QIO issue,
whether that's a qualified
intermediary owner.
And for that purpose,
we have to not just look
at whether there is a special tax regime
or national interest deduction regime,
but we have to see that there's
a provision in the treaty.
And I guess, my first question
to Queyen is, first of all,
why is it so important
that we have a QIO test in this chain?
Got a public traded company, the QIO test
is only relevant to moving dividends up.
Is it so important that the tax,
whichever the tax, we've
already protected the tax
at the residence country.
It's moving up as a dividend.
There might be a CIV,
but that's not typical
in a public traded company
and in event we made
policy decision about that.
So we're moving up without,
I don't understand,
we could instead move it
down too for that matter
into a different jurisdiction.
So why is there the concern here?
So that's.
- I guess a little background is obviously
that the intermediate ownership
requirements themselves
are not neccesarily new in the 2016 model.
They had been there
even in '96 and in 2006.
And so this is not actually a
change in terms of limitation
and actually what we
did in 2016 was to allow
not only the source state
to be an intermediate owner
or the residence state,
we've also now expanded it
potentially to any other jurisdiction
that has the STR and the NID.
I mean, I think that when we go out there
and negotiate these treaties,
we do have an expectation
that the income is being benefited
and enjoyed by the treaty residence
to which the income is entitled.
The treaty benefits are entitled
and I think that we do have some concern
with respect to movements up the chain.
I mean, down the chain,
that's not something
that we've had in the
past and as I've said,
we're developing off the basis of 2006.
And so, it's an expansion
in fact actually,
of the 2006 model and so I
don't view this as narrowing
to the extent anyone was qualifying today.
This is not going to be the
reason why a new company
or a structure is going
to be disqualified.
- Yeah, so I'm not gonna
let Queyen off the hook
just by saying this is the
way it was in the last treaty.
We acknowledge that
and I meant to say that
in the beginning.
But we're sort of exploring the policy
and I still don't know what the policy is.
That, but let's take that as a given.
The provision does not
say like base erosion,
that it's a problem if
that intermediary owner
is actually benefiting
from a special tax regime.
It's a problem if there's not
a provision in the treaty.
And I'm not sure why the difference
between the base erosion
test application of STR
and the ownership test.
- I am sure you're not gonna
like my answer here either,
but the reasons really for why we decided
to have that as a requirement in the QIO
in part was that we thought it was more
as a technical and administrative matter,
a lot easier for people
to know exactly what kinds
of intermediary owners will qualify,
by having it in the treaty.
Also the matter in which we
modify the STR rules themselves
to require jurisdictions
to provide a notification
and to talk to the other treaty partner.
We thought also made
more sense in the context
of putting it into that treaty
that we would have the framework
in which we could talk to
the other treaty partner
about sort of the
regimes that are in place
in that third country in
your example, in the UK.
So those were some of the reasons for why
we ultimately decided to
keep in the requirement
that the treaty itself
has to include the STR
and the NID provisions.
- So how do you plan to
deal with the transition
when a lot of treaties don't have it,
you're negotiating the first five.
- I mean I definitely will acknowledge
that as we get up there
and start negotiating this
it will be slow to start
in terms of putting in STR.
It is something that we've asked
to be put into the
multi-lateral instrument.
I mean, we'll see where that work goes.
But it will not, for
example, take away anything
that people were potentially
qualifying under 2006.
So this is a broadener to the rule
and it will be slow going
if countries are slow
to take onto STR.
But it is something that we've
proposed for the MOI work
and I don't know yet where
that will ultimately land.
- To be fair, Queyen
accept that you always say,
it's a broadener, which I
like that word by the way.
It's more generous maybe in some ways,
'cause we didn't, any third
country was a problem before.
But on the other hand, that's
why the whole provision
was a problem before,
because it was too strict
and it, you know it's,
but going onto the next--
- Which is on the timing issue,
you saw that in the UK
treaty, when the UK treaty
included a zero rate on dividends.
And one of the ways to qualify
was through the derivative benefits test.
And Treasury acknowledged
in the technical explanation
that at the time and it's
not really meaningful,
because no other treaty had a zero rate.
But over the next several years,
you saw Netherlands, Germany
and several other countries
include a zero rate.
And now the derivative benefits
for zero rate on dividends
is generally applicable.
- Okay.
So now just looking at
the base erosion prong
of the sub of public traded test,
of the publicly traded entity test.
We have some new additions here.
One of them is the, you'll
see in the second bullet
that the connected persons cannot benefit
from a special tax regime or
national interest deduction.
So that's why I just made reference to.
That helps to shore up the base erosion.
I grant you that's an important provision.
And the other which we'll
come to on a later slide
is a tested group concept
of prevent consolidation.
That's also a means of shoring up.
So that makes a lot of sense.
The notice though, that in
terms of who is a good payee
under this provision, these provisions,
and again I grant you
all the recent treaties
only refer as for purposes of
a good business entity payee
to a publicly traded company.
Not a sub of a publicly traded
company, no other company.
And we'll come to that
as to whether that's really appropriate.
Now base erosion test,
of course doesn't apply to dividends,
presumably because dividends
don't usually base erode.
And a publicly traded
entity context is unlikely.
There is a REIT, but there could be CIVs.
But there's special policy
concern, issues for that.
So let's go to the
gross income side of it.
Here there is a change from
the approach taken previously
as illustrated in the private ruling
where a participation exempted dividend
did count as good income for
purposes of base erosion.
Now this one I understand,
but I'll let Queyen
say why she thinks the
Treasury made this change.
- Well we made the change
to exclude dividends
from being included in gross
income when the company
is testing itself under
Articles 11 or 12 for example,
for interest or royalties.
Largely in part because when
you allow the exempt dividends
to be included in gross income,
it allows for more potential
for base erosion because the amount
that you can now base erode is increased
by your gross income because
it's normally capped at 50%
of the gross income.
And so with respect to
income and dividends
that were not subject to
tax and were in fact exempt
from the base, we decided
with respect to interest
and royalties for example,
that you should not be able
to include that to bump
up your gross income
which would allow you to
effectively base erode more than.
- Yeah.
- So that was the policy
reason for that change.
I mean it's fairly simplistic.
- Right, right.
So say, a company has a
dividend of 51 from the U.S.,
it has 39 of other taxable income
and then the U.S. company
also pays 10 of interest.
So essentially the
foreign company now has 49
of taxable income, 51 of non-taxed income
and it pays an interest deduction of 49
and magically it's eroded
100% of it's taxable income.
That sort of makes some sense.
- But, I mean there are
other backstops, right.
There's the conduit regs,
so you just can't freely
base erode to anyone.
It's gotta be to someone
who is otherwise eligible
for treaties at the equivalent rate
and then there's also
sort of the beneficial
ownership requirement.
- I mean the conduit point, it's fair.
I mean we had thought about that obviously
in the context of looking at the LOB
and sort of the update
to the model itself.
The conduit rules though
apply transactionally,
so you have to look
at every sort of back to
back financing arrangement.
And if you do find a conduit,
it's only with respect to those payments.
Whereas LOB certainly does
have a broader effect,
because it disqualifies the entire company
from treaty benefits, by just,
by taking away the qualified
person status and subsidiary.
- Let me just jump in with one point here.
You mentioned beneficial ownership.
Beneficial ownership is a
problem under the existing model.
And it's gonna be a problem
under this model too.
And I would hope the technical explanation
will deal with this more clearly
than the existing technical explanation.
The problem is that we have these concepts
floating around in the treaty.
We have derivation, which is
paragraph six of article one.
We have beneficial ownership,
which is in the investment articles.
We have, and the derivation,
the country that gets
to determine derivation
is the country of residence.
But beneficial ownership
is a non-defined term,
so that's determined by
the country of source.
So when you've got the
two different countries
determining the qualification
for treaty benefits,
that strikes me as a formula for problems.
And the technical explanation in the 2006,
tries to strong arm those two,
not I think, entirely satisfactorily.
It may be that that's possible
that it can be cleared up
by the technical explanation,
but it's a weird rule
that you get to get treaty benefits
if you derive the income
or the beneficial owner
of the income, but the
country of residence
tells you whether you derive it
and the country of source tells you
whether you're the beneficial owner.
That's a strange situation.
That's all I got for you.
- Yeah, I would say
the derived by concept,
allows the country of residence to apply
it's own beneficial ownership regime.
Essentially at the end of the day,
it's lookin' to whether
there's an agency or something.
We view beneficial ownership
as, it's one of your examples.
I think it's an example
what David just said
earlier today, on the session
that we have inherited these
terms from the OECD model
and then we try to say, well in our sense,
yeah, we agree it means
a nominee and agent,
but we also think it
means conduit situations
and we might even think it
means economic substance.
So getting back to the base erosion test,
this tested group concept
comes over in all of the,
it permeates all of the
base erosion provisions.
And like I said, it to me
it's very understandable.
We'll look at this example.
So it's covering not just
consolidation regimes,
but other fiscal unity regimes
and group relief regimes.
So they very carefully
referred to the specific things
they knew and then said
any similar regime.
If you're talking about
a disregarded entity
under the laws of the residence country
I don't you even think
get to this provision.
You just apply that rule
and disregarded entity
under the laws, a part
of the source country
aside the U.S. would not be relevant here.
So this is showing, let's
say that it's a Lux, owns Lux
and they have a fiscal unity, or it's UK,
in UK or in a group being
in the group relief.
They simply don't want to,
Treasury simply didn't want it
to be so easy to avoid
the base erosion test.
I think that's fair.
Active trade is sort of
an interesting situation,
because this provision,
and I'll say at the outset,
I'm, we're gonna have time for questions.
I'm sure lots of people are
going to have questions on this.
(chuckles)
This provision was supposed,
when it was first introduced
explained by Trisha Brown as
the essentially safety valve.
Don't worry about these other
provisions being too tight,
you can always relay on active trade.
And now it's sort of just the opposite.
We don't want you to rely on active trade,
we've got very nice things
like headquarters companies
and derivative benefits.
Which by the way are very hard to use,
but don't worry about that.
So this, the active trade
test is being changed
from what essentially was any connection.
I think it was any connection
upstream, downstream,
parallel businesses, not even so parallel
and not even so, not
even the same business,
but related businesses.
So it just had to complement
and you looked at the economic environment
to see if one sort of performed
in sync with the other
and if it didn't you looked to see
if it performed out of sync with the other
and that was a hedge,
maybe that was good too.
But it was very broad.
And now there is supposed
to be a direct connection.
It's not connected in
this it's a connection,
which to me sounds like dealings
and their examples are dealings.
It's, you know upstream or downstream.
I mean those are dealings
between the manufacturer
and the retailer or the distributor
and the retailer, and so forth.
And that's a big, big change.
So I'll let, I don't know if Quyen
you wanna say anything about it?
Maybe not.
- The evolution, I guess
of where we landed,
it sort of changed.
I mean in the May version as you recall,
one of the things that
we've been talking about
and discussing as part of the
OECD BEPS Project in Action 6,
was sort of highlighting
some of the problems
that other countries actually perceived
with our active trader business,
for example allowing
attribution or arrogation
for some of the substantiality tests
for active trader business.
And when we started looking
at the rules ourselves
more closely, we were wondering
to ourselves you know.
If you have a flower shop in
the Netherlands for example
and you have flower shops
in the United States,
what about the fact that
you have two similar lines
of businesses that don't have
anything to do with each other
except that you're both in the
sort of flower shop business
and maybe it's a Singaporean parent
that owns both flower shops.
If they put the U.S. underneath
the Dutch flower company,
they may be able to suddenly
get dividends, interest,
other income out of the United States
that would not have been
entitled to those benefits
had they been paid obviously to a country
to which we have no income tax treaty.
So I think we went back
and we started to wonder,
well what is it about that
dividend or interest income
coming out of the U.S.
to a Dutch flower company
that makes it connected
to the Netherlands?
Grant you there is a real
business in the Netherlands.
They are there.
There is Nexus in that country
with respect to that flower shop business.
What I think what we were concerned about,
really was the factual
connection for the income
that's coming out of the United States.
And so in our first
attempt actually in May,
what we did was we started
to remove sort of the ability
for different lines of
businesses to be attributed
to each other, thinking
that that would solve
the financing companies
shouldn't be able to get benefits
just because they have an
active trade or business
in a particular jurisdiction.
And what a lot of people
came back and told us
was that actually all you forced us to do
was reorganize and put the
U.S. directly underneath
the active company rather
than having a holding company
in the same jurisdiction.
And so, I mean it was both
over and under inclusive
on many levels, the
approach we had in May.
So ultimately where we landed
after having more discussions
at OECD and also internally
was that our real concern
was really with the fact that
the income that was being paid
out of the United States
was not factually connected
to any activity or any income
that was being generated
in the resident state.
And so we created a new word,
emanates for this purpose.
It looks very much like
the old 2006 model,
and so the moment we decided
that we were going to go after
and try to require more of a
Nexus with the resident state,
we also allowed attribution back
with respect to substantiality tests.
And so we realized that
wasn't our problem.
Our problem was just the
connection with respect
to the income out of the U.S.
And that's what we actually went out
and asked for comments on
and didn't get any as of yesterday.
- Yeah.
I would say on that last
point as Quyen said,
the substantiality test goes back,
hearkens back to the old test.
So it's the old test.
And I would say not
that you didn't need it,
that you recognized that
the new test was too strict
and it really didn't make
sense to extend it to that.
I have just a general problem
going back to the theory
of treaty shopping and the old genesis
of treaty shopping, going
back to the Aiken cases
and we had shell companies that were,
income was being run through them.
Here you have companies
that have very substantial presences
and I'm gonna assume substantial.
'Cause if you tell me you're worried
about ones that aren't
substantial, that's your issue.
But if it's substantial, you
got a substantial presence
in that country, why is that
company treaty shopping?
Why does it have to be
so tightly tied to that?
Maybe it's a rhetorical question,
'cause I know you've explained
and we've got to move on, but.
- I mean the other question
that's gonna come up
in practice is how much
of a factual connection
can I sell two percent
of my parent's products>
That's just something
we're gonna have to
grapple with over time.
Okay, so now we're gonna move
to the new derivative benefits test.
It's not neccesarily new.
Most of you have probably seen it
because it appears or
the 2016 model treaty
is somewhat patterned off the test
that appears in many of our
treaties with member states
of the EU, as well as Canada and Mexico
as members or parties to NAFTA.
Traditionally, it's
been a three prong test.
An ownership prong, a base erosion prong,
and a derivative prong.
The derivative prong,
the classic fact pattern
was you had a French parent,
Luxembourg subsidiary
with the Luxembourg subsidiary
lending into the U.S.
You ask, well if France
received interest directly,
we had a treaty that provided a zero rate.
If Luxembourg received it
directly there's a zero rate.
So the fact that EU member states
or members of EU member states
ought be able to freely move
their capital around the EU.
There's really no treaty
shopping necessarily going on,
just from an absolute rate perspective
or as least a source
state rate perspective.
And then people started saying,
"Well what if I have U.S. ownership
"along with my French parent?"
Well the U.S. doesn't
have a treaty with itself,
so how do I apply this derivative
prong, to (muffled) test.
And so I think it was
first in the UK treaty
where they started defining
and we'll talk about what an
equivalent beneficiary is.
To capture sort of the classic example.
France, Lux lending into the U.S. as,
to capture sort of U.S. ownership
and saying the U.S.
publicly traded company
would be a good owner for
purposes of the ownership prong.
And we'll see the 2016 model treaty says,
yeah, the U.S. can be a good owner.
The source state can be a good owner,
but only up to 25% in
my example of the LuxCo.
I don't know, Queyen, sort of the 25%,
when the original draft came
out, there was no tolerance
and so Treasury received comments saying,
"Hey, the source state
ought to be a good owner."
and Treasury modified to
say up to 25% is okay.
- Yeah, I mean I think you know again,
sort of looking at the
genesis of derivative benefits
and what it was trying to do.
It really was trying to find another way
for a third country owners
that would have qualified
under their respective
treaties with the United States
to be able to qualify a
derivative benefits company.
And it wasn't so much
about U.S. companies,
U.S. publicly traded companies
being able to qualify
a foreign company in the
derivative benefits jurisdiction.
And so I do think that
when we modified it,
we relaxed, I don't want to say relaxed,
depending on the treaties
that you're basing it on.
Basing on the model, we did
decide that we should allow
some level of U.S. ownership
and 25% is where we landed.
I mean, under ownership and base erosion,
and I guess we allow up to a 50%
because we only require 50%
residence ownership test.
But the resident in the
case of the ownership
base erosion is in the same jurisdiction.
Whereas in derivative benefits,
the 95% could be across
any treaty jurisdiction
where we have a treaty with them.
- Right, so that's an important point.
The derivative benefits test
in the 2016 model treaty
is no longer geographically limited
to member states of the
EU and parties to NAFTA.
It's now gonna cover, the issues
typically comes up with
Japan and Australia
on that zero rate on dividends
since they're not parties to NAFTA
or member states of the EU.
The ownership prong requires seven
or fewer equivalent beneficiaries
own 95% or more of the tested company.
I'm not sure where the
seven or fewer came from,
but that's been around since
the derivative benefits
first appeared and nothing
changed in the 2016 model.
Sometimes that can be an
issue where you have a family
and the parents have children
and then grandchildren
and sort of the founder wants
to retain the voting power,
but for estate tax purposes
start moving some of the value
to his or her children and grandchildren.
And then as we mentioned,
the ownership prong
really limits the use of a
holding company structure
because it requires
each intermediate owner
in the chain be a QIO.
And as Peter mentioned that
definition is extremely limited.
There's a base erosion prong
similar to the ownership,
or the base erosion
prong of the subsidiary
of the publicly traded company
test that Peter mentioned,
except here bad payees are
non-equivalent beneficiaries
or equivalent beneficiaries that satisfy
the headquarters company test.
Or an equivalent
beneficiary that's connected
so a related person that's
benefiting from an STR
or initial interest deduction regime.
The complexity arises
in trying to figure out
how to define an equivalent beneficiary
and again, it sort of breaks
it up into three owners,
the classic third country owner,
which is outlined on this slide
and contains the derivative
test, the derivative prong test.
The 2016 model treaty is extremely helpful
under sort of the current
derivative benefits test.
If you flunk the derivative prong,
then the tested company
can't meet the test
and you have to go look for another test.
So the classic example is
Italy or Spain owns France.
France is lending it to the U.S.
Our treaties with Italy and
Spain provide for positive
withholding on interest,
as opposed to France where it's zero.
So my fact pattern, France
is giving a better answer
from a treaty perspective.
So under the current version of the test,
that appears in our existing treaties,
the French company would flunk
the derivative benefits test.
It's a little complicated
in the 2016 model
because you actually, it's
not in the LOB article itself
or paragraph four.
You have to go to the interest dividends
or royalties article to find it.
But now it's basically saying, all right,
we're gonna do away with the cliff affect
and, my tested company
so France in my example,
will be entitled to the
highest withholding tax rate
based on it's owners.
So in my example with
Italy, it would be 10%.
I have an example in the slides
where I have U.S. Pubco owning
30%, Japan 35% and UK 35%
of my DutchCo.
The U.S. Japan treaty
provides for a 10% rate.
My example was intended
for DutchCo to flunk,
because U.S. Pubco as a
resident of the source state
owns more than 25% of the
vote and value of DutchCo.
But if we were to change the facts
and shift some of U.S. Pubco's ownership
over to Japan and UK, by doing
away with the cliff affect,
the Dutch company I
believe now will qualify
for a 10% rate on interest.
I don't know, Quyen if you could comment
on the taxpayer favorable movement.
- Happy to.
I mean that was something
that the removable of the
so called cliff affect
for derivative benefits was
something that a lot of people
had come in on and had commented about.
And so we did ultimately
do it and as you said,
most of the questions I get
is, "Where did you do it?"
because they can't find it readily,
they're looking at the
LOB article to find it.
And so when we were
coming up with the rule,
actually at one point we had thought about
doing a blended rate among the
UK and Japan in your example.
And actually as we drafted the rule
and talked with our IRS colleague,
it turned out that it seemed
a lot more complicated
to sort of do a blending of rates
based on the differences of
the equivalent beneficiaries.
And so the highest rate among
the equivalent beneficiaries
was where we landed.
- Yeah, I think we have
more, there are more slides
in your materials, but I think we're,
our time is running short.
So we wanna open up the Q and A period.
So if anyone has particular
questions about the new model
that they'd like to
ask, we'll do our best.
Do we have any questions in the audience?
If there are no questions,
we'll revert to the slides.
- I'll prompt one.
Well I have a couple things.
Well one going back to active trade.
If you have the very same
business as I read it,
you know your examples
right now are like I said,
they're upstream, downstream.
It's not the very same.
But if you have the very same,
wouldn't it be the most
natural thing in the world
for me to set up a holding company
that has a subsidiary
that's in the same business?
Isn't that absolutely the
only way I should do it?
And why wouldn't I want
to have them in a chain?
I guess I could have them side by side
and forego the treaty, but it seems odd.
That, I'll just note that.
I guess the other thing that,
just going to the equivalent beneficiary
or actually derivative
benefits in general.
The qualified intermediary
owner so is sort of weird
the way it applies there I think,
from the U.S. Policy standpoint
when you have a source country.
So if I had an Irish company
owning a U.S. company
owning a Dutch company, or no.
Let me say it this way.
I have an Irish company
owning a Dutch company
owning a U.S. company.
So my U.S. company is the source country.
This says, I think the
qualified intermediary owner
here for this purpose,
unlike public trading
says that I can't pay to the Netherlands
is not a good qualifying
intermediary owner
if it has a special tax regime,
unless there's a special
anti-special tax regime provision
in the treaty between the
U.S. and the Netherlands.
But why do we care?
Because that's only gonna
work against us I think.
'Cause we never have special tax regimes,
at least we claim we don't.
And so, we're just in that case,
not making the Dutch company
a good treaty resident.
I don't see the advantage
from our standpoint,
'cause I see it cutting
against us more often,
but there are I'll just say,
there are many things like that
in these provisions that
you have to think about
how they work in different context.
But maybe we have some questions now.
- I was gonna just note.
I guess part of the history
behind the derivative benefits
test also when we went back
and you know there is
a history to the fact
that previously in all of our
derivative benefits tests,
I think with the exception of Spain,
we don't have any limitations
on who can be an intermediate owner.
And so right now, it could be Caymans,
it could be UK, it could be Ireland,
it could be any jurisdiction.
One of the things that
we noted was that DB,
the derivative benefits test
really grew out of the
ownership base erosion test.
And ownership based erosion in 2006,
as we started to tighten
sort of who could be
an intermediate owner,
we found ourselves in
this awkward position
where we'd tightened it
in ownership base erosion
only to turn around and find
the same company qualifying
under derivative benefits,
because there was no limitation
on an intermediate owner in our DB rules.
And so when we were dealing with Spain,
one of the things that we did
try to do was sort of rein in
some of the intermediate
ownership by at least saying,
we should have some
parameters around this.
Because the way that intermediate
ownership is unbounded,
it was leading to some weird results
where the intermediate jurisdictions
would be in places where we would,
one maybe want to have a treaty with them
and the appropriate way for
the treaty benefited income
in that case, to go to Brazil
or to go to another
jurisdiction would be in fact
have a treaty directly
with the United States.
All that said, around the
same time that we were looking
at all this, the OECD came
around with their BEPS project
and we participated in that.
And a lot of countries
around the table said,
we want a derivative benefit test.
If you're going to have a robust LOB,
it must be a company with
a derivative benefits test
to which other jurisdictions said,
"Well we're not gonna agree
to a derivative benefits test
"if there aren't parameters around
"who can be an intermediate owner
"because we think that
treaty shopping happens
"when you have structures
"with intermediate owners in odd places."
And so the U.S. was not
alone, actually in worrying
about intermediate ownership
as reflected in the OECD report.
They came out and we came out
with initially a very tight rule.
We said the only intermediate owner,
I think in the 2014 draft
could be another equivalent beneficiary.
And we acknowledged that
after that report came out
a lot of comments came in
saying that's ridiculous,
because an equivalent
beneficiary is I think,
as Jason noted is limited.
It's a publicly traded company.
It's an individual.
It's a tax exempt to
another governmental entity.
They would be an EB and
not an intermediary.
So you haven't done any
broadening or tightening
of the rule, it's too tight.
And I think at the
OECD, when we went back,
you know the U.S. was
the first to acknowledge
that requiring an intermediate owner
to be an equivalent beneficiary
was definitely too tight.
And so we've sort of played around
and moderated with those rules
in the context of that work,
but also in the context of
looking at the U.S. model.
And so where we ultimately landed was,
you know again, in the May version
when we came out with the
QIO, it had a rate comparison,
it had lots more bells
and whistles to that rule.
And so we have backed off of it.
We haven't gotten rid of the requirement
for that particular jurisdiction
to have an STR or and NID.
But again, I think part
of the rationale there
was that we liked the idea
of having that framework
in place with another treaty jurisdiction
in order to facilitate conversations
about the FTR regime itself.
- Well thank you to the panelists
and thank you very much
for your attention.
I think this concludes this session.
Larry is gonna tell us our next step.
- [Larry] And thank you Quyen,
David and Peter and Jason.
(audience applause)
