My name is Larry Pollak
Good morning, and welcome to the 13th annual
nyu KPMG tax lecture series
I'm a tax partner with KPMg a graduate of the llm program and
director of this Tax lecture Series is my
Pleasure to be here this morning to be the coordinator of this program by way of background this lecture series was created
Back in 2000 to create a forum that brings together high-level government officials
Tax Academics from Nyu law school's tax llm program
members of the bar and Fax partners from KPMg to explore various
issues that are of current interest in taxation
The title of today's symposium is tax planning for in inbound investment
Defining the boundaries in fact that's the theme for the program today
Where do we draw the line in the sand with respect to the us taxing jurisdiction over foreign persons both?
under domestic tax law and by application of us tax treaties
Through a variety of lectures panels and debates were going to explore various
aspects of inbound investment today along the lifecycle of an inbound investment
starting with an initial Portfolio investment in the United States
Acquiring financing
capitalizing a us business
Restructuring post acquisition a u.s. Group by a foreign multinational
Repatriation of the profits from the u.s.
Back to the home jurisdiction and ultimately final disposition or liquidation of the us operation
Our Keynote speaker today is going to be Danielle Rolf's Danielle is the international tax counsel for the us
Department of the Treasury
Following Danielle's comments of later this morning
Danielle graciously agreed to join a debate session where we're going to explore the the paradigm of
Domestic tax law Treaty overrides are we going against our word that is is it ever appropriate for the United States?
To conclude a bilateral tax treaty with another country
and later in time to enact domestic tax legislation that
Appears to override what we have agreed with our treaty partner that should prove to be a very lively debate
Our distinguished speakers today include representing nyu law school professor David rosenbloom
professor of Daniel Shapiro
adjunct Professor Willard Taylor and visiting Professor Carlo Garbarino
representing KPMg
Sean Foley
Fred Gander
Pat Jackman
Tom zolo
Marco Grundig
Case Vaughn Mayo and
Bastion was on
representing the bar
Richard Anderson of
Wilmer Cutler hale and door llp
Peter connors of
Auric Harrington and Sutcliffe llp
Patrick Fenn a bacon gump strauss hauer & Feld
Llp, Jeffrey Friedman of Sutherland, Asbill and Brennan
Peter Gans of King & Spalding A
meek Panda of Sullivan and Worcester
There'll be two breaks one in the morning one in the afternoon lunch is just after 12:00 noon
We will be resuming in the program directly following each of the breaks and lunch to keep the program on schedule
just a few administrative comments on CpE and
cle
in order to claim credit for both continuing professional education and continuing legal education
You need to have signed in at the registration desk this morning and have received your name badge
In order to actually get the credit for cle
when you depart the program at the end of the day there'll be a box where you'll submit your scannable there is a
Second ID card which you'll see here on the screen. This is the paper
Badge that you'll see it's inside your name badge and at the end of the day you just take that paper
From Nyu and just drop it in the box on the way out at the end of the day and while you will scan that
In and you'll you'll get your cle credits if you should need to leave
Throughout the day prior to the end of the program just see the registration desk
And they'll clock you in at the end nyu is going to email you the cle certificates in about a week
I believe for continuing professional education credits
All you need to do is have received your name badge
now at the end of the program as well for both Cle & Cpe you will have to fill out your
evaluation form
Evaluation forms which you'll drop in the box on the way out and one last final comment for Cpe
In addition to having just received your name badge and register this morning
There is a cpe form in your binder that you will need to fill out
And you'll hand out at the end of the program to get cpe so again in summary for cle
You have this paper name badge
Which is on the screen plus an evaluation form that's what you need for your cle credits for CpE credits
You just need to have received the name badge in a registration desk and fill out the evaluation form at the end of the program
as
a reminder please put your cell phones on silent
Ring and with that
I'd like to again welcome you to the 13th annual nyu KPMG tax lecture now
Let's get started our first topic this morning
Is going to be Led by Richard Anderson?
The topic is going to be an overview of the u.s. Taxation of inbound
Activities of foreign persons the opening segment is intended as a high-level primer for those who don't regularly
practice in this area and
They'll be focused on where and how does the us draw that line in the sand as to our taxing jurisdiction over?
foreign persons
Richard is a partner with wilmer cutler hale and door lLp and is a frequent speaker and author on
International tax Matters in particular Richard has co-authored or authored
treatises covering the foreign tax credit foreign investment in u.s. Real property and
us income tax treaties and also has authored being a portfolios dealing with Ferpa and
us withholding Tax on foreign persons
Richard has also been an adjunct professor at the NyU tax llM Program Richard
Thank you, larry and good morning
everyone and let me add to Larry's comments my welcome and my thanks to you for coming particularly at this ungodly hour of
8:30 in the morning
I will my principal obligation here in addition to providing the primer that larry described
Is not to put us behind on time
So I do promise that we will keep it brief
We will keep it on time, and we will keep it at a fairly high level
Larry mentioned boundaries is the theme for this conference, and I think that's a useful
link to this topic because the question of
inbound taxation at a high level of abstraction is really one of
Jurisdiction it is a matter of figuring out who out there in the world actually cares
that the
U.s. In fact has an inbound taxing regime
And what does that mean and who is affected by it and so rather than simply give a laundry list of the rules that?
Inform that regime although we will touch on those to make sure that we all have a common
foundation
My objective this morning is to try and set those rules in a little bit of context
Taking into account the theme of the conference which again as larry mentioned is boundaries
So what are these boundaries, and I guess the place to start is
Who in fact cares that we have an inbound tax regime and who can figure out? Who's subject to it?
And to do that, I thought it might be useful to start by trying to answer this question
What does it mean is a technical matter as a matter of the statute to say somebody's a tax payer that is a fundamental word?
Certainly when you're trying to think about who has obligations under the tax laws
And we don't stop and think very often about what that term actually means
But it has contact and so I thought we'd start there. I've set up five examples of
types of entities or types of
Of units if you will and the question on the table for us to begin with is which among these different?
Entities that I've listed here is in fact a taxpayer under the code some of these are going to be easy
I'm trying to get us a nice um easy runway to get started this morning
not a big surprise that the first item on the
Chart is a yes. The if you are a
U.s. Corporation, which is in fact an entity that owes tax and you are entirely domestic in what you do there, isn't a big
conceptual difficulty in concluding that the us tax law treats you as a
Taxpayer I don't think we have to stop very long on that category
But as a matter of analysis and policy once once you go past that it gets a little more interesting and a little more complicated
the us partnership is a tax payer under the code not much question about that and yet as
All of you in the room note partnerships don't pay tax so you've already got one of these many examples
We see of the internal revenue code being written with English words, but not being written in English
You have you have a taxpayer?
My mother says if I'm paying tax that makes me a tax payer. Well the code says not so fast not so simple a
U.s. Partnership has obligations under the tax law it is a tax payer even though in the ordinary course it never writes a check
Things get stranger as we go down this list a foreign grantor trust
Didn't have to be foreign here
But I was trying to make the point
a grantor trust many of you in the audience will know this is a
Trust that is not treated as owning the assets for tax purposes that it actually owns out in the real world
It's grantor whoever that may be under the Rules owns those assets
So in a very fundamental kind of way a grantor trust doesn't exist under the tax laws
it doesn't have
The the basic requisite of owning something whether it's income or an asset that
would make it you would think a tax payer and yet a
Foreign grantor trust is indeed a domestic grantor trust as a technical matter and we'll get to why in a minute
Is indeed a tax payer?
Going from that to more
exotic examples
The government of North Korea could be any government
the government of North Korea has sovereign immunity as all recognized governments of
The world do not only under us law international law public international law
But also under the laws of almost every other country, and I only say almost because I don't know for sure
And yet, I assure you and we'll talk about how in a second the government of North Korea is in fact a taxpayer
I'm pretty confident. It doesn't pay any taxes to the us
I'm prepared to make a make a small wager on that, but it is a taxpayer. There's no two ways about it
I'll show you why in a minute and
finally
You have a foreign corporation here a corporation not organized under the laws of the United states it has no
visible us Connection at all
Doesn't have us shareholders isn't managed here doesn't have assets or income here
Why on Earth would it be a taxpayer well?
We're going to talk a fair amount this morning about whether and why and how it pays tax?
But it's a taxpayer
So what have we learned from that what we've learned from that is that
essentially
Everybody's a taxpayer
And that is in fact the rule the statute in two different parts of section 7701 tells you that explicitly a person is
defined in 7701 is essentially anything you can think of and
A taxpayer is any person subject to any internal revenue tax
sorry any is actually any internal revenue tax or law and
so
The reason why all the answer to all of these questions is yes is tied up in those two definitions if you put them together
then any person that
Is subject to an internal revenue tax is?
in fact a taxpayer in quotes
If you don't believe me there are some places you can look just to some examples and there are more
section 509 8 deals with private foundations and the excise taxes on Private foundations
You look in the definition of a private foundation doesn't say domestic doesn't say has to have a charitable purpose in the us
It's a private foundation
wherever it may be
Section 892 a 3 specifically tells the government of North Korea that it's a taxpayer
It says that if you are a foreign government. You are treated for us tax purposes as a corporation
resident in that country
So if the government of North Korea or any other government for example owns a hundred shares of ge stock and gets a dividend?
It's a taxPayer sovereign immunity notwithstanding
892 tells you how much tax it actually pays or not, but it's a taxpayer. It's subject to that rule
section 1461 tells it withholding agent
Don't make a mistake because if you owe me a payment of somebody else's tax and you fail to do it properly
I can come after you
For that tax for that under withheld or unwitting doesn't matter where you are
I may have some practical enforcement problems if I am the irs
But I have a basis in the statute for saying you're a taxpayer now
Wasn't even your tax originally, but you messed it up. So now it is
my personal favorite is section 47 no one you don't see this very often, but that is a
part of the rules governing when debt instruments have to be issued in registered form and
What that means and what happens to you when you don't?
that provision puts a 1 percent excise tax on the issuance of
a bond that is supposed to be in a registered form as we define it and isn't and
there again
It doesn't specify that it has to be a domestic issue or an issue or with any connection to the us?
So there's a whole bunch of governments out there issuing debt who owe is a 1 percent excise tax on their bond offerings and have?
No idea
One of the reasons they have no idea is that we're not out there trying to collect it
And we'll talk about that in the balance of this morning session
So I think I've made the point
Everybody's a tax payer including people you don't think are taxpayers and at a high level of simplicity
We could say okay that's going to be the rule
We're going to have a very simple tax return for everybody two lines first line. What's your gross income second line send it in
The question is can we run a system that way?
assuming you can
Assuming that the statute actually says what I said, it said and assuming
That's valid in some way or other do we really want to tax everybody on everything
everywhere all the Time I
Submit to you know for at least two reasons one is it's not so easy to do anybody here wants to call up
The leader of North Korea, and tell him that he owes us a big check you go right ahead
Just let me know ahead of time because I don't want to be standing next to you, and that when you make that call
and the other
question is
what would happen as a
Matter of public international law if we did that what would happen to us investors going overseas. There's 200 countries out there
We have people here trying to invest there
What do you think everybody else does if we start saying all of you who have no idea?
We're even here and couldn't find us on a map if your life depended on it
You owe us a whole bunch of money
I think it's fair to say that that is a system that wouldn't work terribly well
and we like to think about the tax law as being a
Handmaiden of our trade policy is something to try and make it easier and more sensible and predictable for us
businesses to compete globally
More even now even than before
So if you if you accept the premise that just because we can do it doesn't mean we should do it the question is
what do you then do how do you how do you draw the line there are those boundaries again between a time and in an
Occasion and a circumstance when it's appropriate to
Impose tax on somebody who doesn't live here, and when don't you
Well there are several
Highfalutin kinds of principles that the
economics
Departments will tell you are good places to start
One of them is capital
Neutrality there's two flavors of a capital export neutrality and capital import neutrality
It's not really important to for our purposes to get into the difference between the two the principle is really that
taxes are an impediment to the movement of capital and
so if you're going to have a tax
And we need taxes everybody does then you need to organize your taxes in a way doesn't
Overly restrict the movement of capital and the ability to get a yield on it, so one of the organizing principles of international
tax Generally and certainly one of the
organizing principles of our
inbound tax regime is
What is appropriate in terms of taxing capital without making it?
Overly difficult for owners of that capital to deploy it efficiently. How do we keep the tax law from being too much of an impediment?
Another set of principles is the equity principles both horizontal and vertical horizontal Akwa tea means that similarly situated
Taxpayers ought to be treated similarly
now
You can tell any rule that has the word similarly in it twice is going to have a problem
And it does the whole ball game here is to figure out
How do you recognize when two people are similar along what?
Lines but dimensions, are you going to analyze their similarity to decide whether you're going to tax them the same way?
And we're going to talk about that a fair bit as we go through the substantive rules of inbound
tax versus taxing us
investors
Vertical equity on the other hand is about the ability to pay and in a sense fairness in the ability to pay should
the amount of tax the extent of your tax obligations be tied in some way to
the amount of your connection to the taxing
Jurisdiction and to your ability to pay how much?
benefit do you pull out of your connection to the jurisdiction for which the tax is a quid pro quo and
Related to that are the questions of fairness
That do you have enough of a connection can also be viewed as a fairness question is it fair
to take a very very small connection to a country and make that the foundation on which you build a very large tax bill or
Is there some minimum amount of Connection below which you should not go?
Not surprisingly the answer is yes, but how do you figure out where that line is and we'll talk about that
those are all very academic and theoretical questions, the
the very
real Day-To-day question is
Whatever the principles are used choose to organize your tax system. How you gonna collect it. What is an administrable?
Tax system look like
if you have a system that taxes every entity and individual on the planet
how do you deal with the fact that the majority of those as I said before couldn't find the us on a map and
Have no idea what their obligations are there's there's suppose. It's six billion
Two-legged taxpayers in the world by the definition I gave you a few minutes ago
How do you make that work? How do you even tell them they're tax payers? Do you tell them the tax payers?
and
because every system that
Takes money from somebody needs an enforcement mechanism. I don't have to think about it very hard to figure out why that is
That's a resource and that's a cost
How many tax policemen can we afford and what kind of a system for enforcing the tax laws can we?
Legitimately put in place before it starts eating up the very tax. We're trying to collect
What's politically feasible this goes to the question of fairness and it goes to questions of diplomacy and so forth and finally?
from a larger point of view not just tax policy, but the fiscal and macroeconomic regimes that taxes are part of
What's the best answer what what are the answers and what are the lines you draw in the sand that?
Give that our most supportive of your broader fiscal and macroeconomic
Policies, so those are all the hard questions when you decide rightly, I think that we can't tax all the taxpayers out there
So then what do we do?
We have to decide two things then we have to decide who we're going to tax and we have to decide what we're going to
Tax once we've decided we're going to make distinctions. We have to answer those two questions
And so again putting the organizing principles down on a more concrete level
the questions on who we should tax go to questions of who is
the right counterparty to charge with the social contract of
public benefits
Versus paying for them in the form of taxes who benefits from public expenditure and therefore who is it fair to ask?
should contribute the funds
that those public expenditures are used for
well, we make a couple of
Decisions about that certainly in the case of individuals, we think that citizenship matters
I think if you are a national of this country
We'll talk in a minute about what that term means in the tax law if you are national of this country there are benefits
Burdens Perhaps as well
But benefits perceived or otherwise to being a national of Country x therefore
Asking you to contribute in the form of taxes to the public expenditure resources of country x doesn't seem like too big a stretch
interestingly
most countries don't use nationality at least of individuals as a basis for doing that we do but it's
Not hard to compose a sensible paragraph about why that's a legitimate basis
Then there's what I refer to here is embedded residents. That's not a term
You'll find in the code what I was trying to capture here is the notion that
Residency as a as a colloquial meaning and it also has a legal meaning in the immigration laws, we're not talking about that
residency in the tax law
means a degree of connection to
The us and to the us taxing system that makes it appropriate
To tax the resident more or less like a national
And we'll talk
Again in just a moment about what though in technical terms what the notion of an embedded resident actually looks like in the tax law
A
Transitory resident is basically anybody else somebody who has some physical connection here some presence if you will
But hasn't really put down roots in the way that a longer term resident
Has done and in that situation
we've drawn a line that says it's not appropriate to tax them on the same basis as
It is to tax either embedded residents or nationals, and then there's everybody else
People who have no personal connection and by people I include entities who have no
Connection by reason of their individual status to this country, but because what they do is connected here. They get income here
They have assets here that
supports a certain amount of taxation that is a certain amount of permissible connection and
The rules that we have are designed to try and make those fine distinctions about which one of those rules are appropriate for which
Category of person
Who can bear the tax that's the other question we asked we talked about vertical equity a moment ago?
This is is there a level of nexus that's so light that it is not appropriate to
Impose either the full level of tax or perhaps even any tax on a
non-us in quotes tax Payer the answer that is yes, and
where that line is drawn is all has a lot to do with what those rules are and
Are we treating the similarly situated taxpayer similarly is the other driver in trying to figure out?
What subset we're going to apply this to and in a very practical level?
Because it's one thing to have a rule. It's another thing to actually have the rule carried out
how do we
How do we go about enforcing a tax when it doesn't happen completely?
voluntarily we talk about the us and in fiscal policy terms as a
Voluntary Tax system or a self-assessment system I prefer self-Assessment because April 15th
Just came by and I didn't feel quite so voluntary about my taxes don't know about the rest of you
But it is true that we don't have people knocking at our doors every
April 15th with a gun in one hand and a an envelope and the other saying give me your money we tell the government what?
We owe we have the white pieces in the chess game
We start the process of reporting our income and paying the tax
Not everybody does it right?
If they don't do it right you like to think it's because the world is complicated and they made a mistake
Some people don't do it right for other reasons
But whatever that is the system has to protect itself and so there has to be some method of
Enforcement. Which is very easy when you're talking about us taxpayers not so easy when it's the government of North Korea
So that's a very germane
Consideration and figuring out how you know the list of people whom we are going to subject to tax?
The other question is what do we tax? What's the tax base? What is the appropriate tax base? I mean, how do we measure?
Nexxus
What what part of your tax base do we?
Staple to the us and say
this is income that we feel we can tax because of something we'll talk about too something for the balance of
the session this morning and
This income not this income we don't have enough of a connection to that income to get it
So there's that boundary concept again, and how much income is it do we tax gross income like the joke I made a moment ago
Probably not a good idea
And if it's net income is it the same net income for a non-us person as it is for a u.s. Person
Here's a hint. The answer's no and
Why well by now you're getting to the the theme here right the thread is that we've made decisions about
Administrability about fairness about collectability about all those things I talked about a few minutes ago that say there are things that are
both appropriate and possible
We're going to go after that and the rest of it at least in our judgment
We think it's not appropriate and we're not going to go
Is all income the same there are - the answer's no?
we we make policy decisions about encouraging some activities as opposed to others and
That ripples through the tax law generally and certainly in the international tax field and in the inbound field those
Questions create rules that standing alone is a technical matter
Don't seem at first blush to make a lot of sense
But when you've put them in a policy context you see aha, I understand why they're doing that it may not be completely
Coherent from A
Closed system point of view but in the broader question it makes sense
I'll give you an example when we get to interest in a minute and
Then and this is critically important in the international field what I refer to as no ability
it's as
A practical matter and obviously not an academic exercise to figure out what tax base and how much tax you?
Actually have to be able to figure it out in the real world
You look at your books you look at your pay stubs. You look at whatever
You look at and you have to figure out. What's the right number?
What are the right numbers and what do I do with those who's got the information and when?
Is a very germane question when you're looking at?
Taxpayers who are halfway around the world in some cases?
May just have found out five minutes ago that they are taxpayers and worse yet
they may be among the taxpayers who actually have a tax obligation and
The question is how do I comply assuming?
I want to how do I actually do the mechanics of
Doing it the system has to help the taxpayer that way and not ask the taxpayer to get blood out of a stone
if you don't know
How much income a particular what how much?
Income or gain is in a particular payment
then it's very hard to figure out what the tax ought to be so you have to avoid in a
Well-designed tax system running into situations where you're requiring
Taxpayers to do things they cannot do because with the best will in the world. They just don't have the data and
This is a this is a recurring theme in the inbound area because we always have to think about this
That's it's not like most of the people in this room most of the people in this room
I'll have very
Significant connections to the us and in a lot of cases a lot of the information is spoon-fed to us
In terms of what we need to know we get pay stubs
We get whatever we get we get 1099s we get forms that say you got this payment. You've got that payment
you got the other oh, and by the way we told the irs to so take whatever action you deem appropriate and
All those things make it easier to put the data together
And we're all sort of used to that or many of us are but if you are a quote tax payer who never comes here
But has some connection that requires a tax payment
That's a big challenge
And we have to make sure we don't put ourselves in a position
of having again too many tax payers required to do things that we haven't given them the tools to do so
with all of that
Where do we come out who do we tax and what?
We are in fact going to get the rules here. I promise
So the who there's really three categories of the who's nationals and by that I mean not only
Individuals who are citizens, but also entities that enjoy if that's the word u.s. Nationality? I'll talk about that in just a moment
We have that concept I gave you of embedded residents?
And I'm going to unpick that for you in a minute to talk about what the statute means
About long term type residents who have these?
obligations, and then there's everybody else and
What do you tax the what depends on who you are?
if you're a national or an embedded resident as a
Slight overstatement, but only slight you owe tax on everything earned everywhere
we have a worldwide system of taxation for
residents and citizens
there are
Things to avoid double taxation there are exceptions to the rule, but it's real that's really the guiding principle for everybody else
That's where the bulk of the rules in the inbound area are actually found these are people where we said all right?
We have to draw a line. It's less than everything and less than everywhere
So how do you decide where do you draw that boundary there's that word again?
Well there have been I guess it's there any number of ways of categorizing it for today. I've chosen five there's income has derived B
From a transaction where the rules say that it is the status of the recipient that
matters if the recipient has a
Relationship to the us. We will tax it if he doesn't we won't
The second Rule here is the reverse
Sometimes it's not about the recipient sometimes it's about to pay or if there's a connection between the payor in the us will tax it
not otherwise
Maybe it's not about the people. Maybe it's about the thing maybe there are transactions in which it's where you find the asset
That should govern
Then there's the stuff that hard as I tried I could not fit it into those three categories
So there are some special rules that will gloss over lightly that that deal with particular situations that don't respond well to that
Categorization and then as a special category and this will be a theme for the entire day
Treaties are special
Treaties are special because treaties or contracts
And it's really the one place where
The to some degree there'll be a debate at the end of this morning about what that degree is
You can change these rules sometimes in very dramatic way is simply by agreement of two sovereigns say simply
It's not that easy to do but those are those that's one way of organizing the different rules
So let's talk about the who
Nationals is pretty easy in the case of individuals. We essentially follow the immigration rules if you're a us citizen, presto
You're a us citizen for tax purposes as well
in the case of entities
Nationality really means where are you organized the the act of birth of a certainly of a commercial entity of a corporation or a partnership?
It's a creature of law
And it's something that happens at the level of a particular public authority you file a certificate of incorporation
Presto you exist before that you didn't
So as a consequence we of expanding the nationality
Connector to entities the the rules in the u.s.. Very straightforward in most cases
They're practical applications can be a lot harder. Is that if you're a corporation or a partnership and you organized here?
You're a us national in quotes partnership statute doesn't use that term so use the term domestic
But that's what it that is effectively what it means it puts you in the same tax category as a two-legged citizen
There are some exceptions to that as I mentioned
And we'll talk about them in some of the some of the debate questions will raise some of them but for ana for now
That's not a bad
General Rule
trusts are a little bit different trusts have sort of a
Semi entity semi contractual Nature to them and so after many years of not quite knowing. How you do
Nationality or residents of a trust we now have a statutory rule that says that you're a us trust if you have predominantly u.s.
Trustees, and you're governed by principally by a us
court
which is a little bit of a hodgepodge kind of
Of definition, it's not as clear as the one for commercial entities
That's the bad news the good news is it's a heck of a lot better than what we had before
What we had before is the rule we still have for Estates. Which is essentially
You sort of look at everything and then you figure out whether it's a domestic estate or not
So we're we're not done in
In making a lot of clarity on our definitions. I
Wanted to stop for a minute on the embedded residents because I've used that term a lot
But if you go looking in the statute you'll never find it. I was trying to capture two different
kinds of
residency
The statute actually refers to resident aliens and for income tax purposes there are only two ways you can do that
if you're a non citizen
The so-called green tart green card test which essentially says that if you spend one day in the us
Holding a green card your your ticket to lawful permanent residency in the us
You are a resident alien from that day forward whether you ever set foot in the us again or not unless and until you
formally lose that card either through revocation or
Abandonment, and there's a lot of immigration law about how you do that. It's actually not that easy
We've also in more recent years drawn an even finer distinction between Green card holders
Who've been here for a very long time so-called long term residents and those who may not have been
This is principally relevant for our anti expatriation rules. Which is a whole nother topic for a whole nother day
But those two universes together are the immigration-related if you will
Half of the definition of what it means to be a resident alien
For everybody else. It's the so-called substantial presence test. Are you here enough?
You're not a green card holder. You're not a us citizen, but you can be here enough
And you can be here regularly enough to become and this is my word embedded if you're substantially present here
We're going to treat. You like a resident alien and again like nationals will tax you on your worldwide income
there's a formula for
How you do substantial presents this is the best thing about it. Is that it's pretty objective
The worst thing about it. Is that whenever someone comes to you with this question they never have all the information you need
but in that
Magical place where it you actually do have people come to you with all the information that you need
It's a relatively straightforward piece of arithmetic there are some
Relaxations around the edges designed to let some people off the hook on
The theory that there are reasons you may be here that are different from a a conscious choice
To become an economic actor here, and we didn't want to lock you into a simple arithmetic test one of the easiest
rules examples of that is diplomats if you're if you become the ambassador to the United nations from Country x
You're probably not going to be here forever
You're probably not here because you want to americanize yourself
but you're here because for five years your country says you need to be here you need to sit at the un and
Under the substantial presence test in the absence of an exception that would make you a tax resident of the us for the time you
Were here that doesn't seem like such a good idea. So we have this concept of
exempt days
Days you are here in some kind of a status where we choose not to
Treat you like a resident and those don't go into the arithmetic so you can be a diplomat
You can be in some cases a student there are other categories like that where it's as though
You're not really here even though you are here for purposes of this test
You can also prove that
Yes, I was here a long time, and it looks like I'm over the test
But my real roots are someplace else, and I can prove it the so-called closer connection test and then once again
You're gonna be hearing this all day
Rules of this variety are often modified in fact. They're invariably modified by tax treaties to which the u.s.
is a party
If you are one of these people a national or an embedded resident if I can continue to use that term the general rule is
You are taxable on your worldwide gross income
That is going to be determined principally under us
rules
As I mentioned before long term residents have an extra-special
Kind of problem here under the expatriation rules that will we're not going to get into but just remember
They're they're a couple of exceptions to that
The there is a foreign earned income exclusion. You're a us person and you most
significant amount of your income is from performing personal services overseas
If you do it exactly right and only stand on your left leg on Tuesdays
You can actually get an exemption from us tax on some of that income, so that's a bit of an exception
We try and avoid double taxation through a credit system
so you may not wind up paying all the us tax here you might otherwise because you paid some of it to another country and
once again
Treaty's can change the rules for what is the taxable base, and I won't step on other people's
Presentations and going into more detail than that
so the general rule
At a high level of abstraction if you're a national or a real honest-to-goodness tax resident then you are
essentially taxable on your worldwide income
and if you're somebody else you're not and
The not goes to the question of everybody else and now we get to the meat of the international tax rules
This is the laundry list that I've been trying to avoid going through too much of
What is the subset of income that and everyone else is subject to tax on here in the us?
We have Drawn several
Category distinctions to do that and remember now. We're no longer talking about
Nationals or embedded residents, we're talking about non-resident alien individuals
Non-us people we're talking about foreign corporations and other foreign types of entities not the domestic ones we've left them behind
the
The statute Draws a distinction along the lines I mentioned before about nexus and connection and how much activity
Makes it fair to bring you inside the boundary of us taxation of a non-us person
By in one at one level draws the distinction between are you conducting a business activity here or not?
and if you are
Then you are in the words of the statute
engaged in the active conduct of a trade or business in the United states or as a famous faculty member here coined the
The abbreviation many years ago et. Be engaged in trade, or business
if
You are engaged in trade, or business, then you have consequences
Under this category of income to be engaged in trade, or business one of two things needs to be true
Either you are conducting some minimum level of regular continuous and substantial activity here
That generates or is intended to generate income it's an economic activity test
or
you're not
But the statute magically waves a wand and says we're going to - like your eTb even though you're not now
It's worth pausing here for a second because certainly the debate. This is going to come up
congress and to some extent the irs that implements the will of congress has a bit of a tick and
that tick is
when it wants to
Import a rule that applies to somebody else into a new area
Rather than rewrite the rule again. It will say we're gonna pretend that somebody who lives in this new Category
Actually lives in the old category so that way we sort of magically import all those rules
So you get into we're going to have an example in the debate of that where things that are manifestly not
Domestic corporations are said by statute to be domestic corporations. It's not that congress doesn't understand its own rule
These not all of it
it's not
intended really to
Change the definition of what it means to be a domestic corporation what it is a shorthand
It's an effort to bring in the tax
consequences of being a domestic
Corporation and applying them lock stock and barrel to an entity that is not a domestic corporation. The simple way to do that
It's not intellectually rigorous, but it's simple is simply to say presto
Even though you're a foreign corporation. We're going to treat
You like a domestic corporation, and then all these other things happen to you now
I raise that here because congress does the same thing in the concept of being engaged in trade
Or business in the us and being et. B. We will find places
I'm going to mention a couple of them in what's left for me this morning
we're gonna find places where congress says this thing this income you're
Conducting this activity rather that you are conducting is
going to be treated as
An activity that means being engaged in a trade or business in the United States not because it really is that
but because that way you can suck in the rules that go along with Etb taxpayers and apply them to this new entity and
So we'll talk about a particular example of that in a minute, but absent that
Being engaged in trade or business means doing something doing something pretty regular doing something that resembles
economic profit making activity
So the threshold question is do you have a us trade or business?
That's always a factual determination except in the odd places where the statute gives you an answer for example?
to the eternal glee of
Investment Traders everywhere
Trading in stocks and securities for your own account is not a trade or business in the United states no matter how much you do
It that's not an intuitive rule. It wasn't always the rule, but it's been in the statute for
Nearly 50 years and that is just a very well
Ensconced exception to what it means to be engaged in trade or business
Absent exceptions like that any regular continuous and substantial economic activity means you're engaged in trade
or business two things come from that conclusion one is that you owe a tax return and
In the real world sometimes that's the most important thing to a particular taxpayer the other thing it means is that
the income generated by that activity
Becomes subject to a specific tax regime that kind of income is called effectively connected income income
effectively connected to the conduct of a trade or business and
in a gross oversimplification
it is essentially taxable like the
income of anybody else of a national or an embedded resident if you have a universe of
Effectively connected income you file a return you'd take your deductions, and you pay the tax on the difference in
order to
be effectively connected here's a case where the English word actually means what it means there really does need to be a connection and
the
The statute and principally the regulations
Give you rules for figuring out whether income generated by a trade or business is properly connected to that trade or business
and it's properly taxable under these rules and
As I said once you have effectively connected income of a trade or business you've got a filing requirement you have tax to pay perhaps
There's reporting and you are subject to examination all those wonderful things
Then there's everything else
Remember these are not nationals. They're not embedded residents
These are the everything else people, and they're not engaged in a trade or business in the United States
Then you're taxed on
With very few additional categories only this remaining category fixed or determinable
Annual or periodical income from us sources
now this is really my favorite example of
English words used in the statute that aren't really English
fixed or determinable
Annual or periodical income
right I
will tell you
That the category of fixed or determinable annual or periodical income includes among other things
gambling winnings
If you stop and think about it if they were that fixed and determinable, I'm not so sure it would be gambling
and
A lump sum royalty payment just doesn't sound all that annual or periodical to me
and
yet, I'm here to tell you and I don't think I will be contradicted by any of my august co speakers today that both of
those
types of payments if they are from us sources are subject of tax under this so-called FD Ap
regime
So don't get wrapped up in the words don't think oh, I understand the English language, so I know what this means
There's a there's a faulty premise there congress isn't using the same language. You are this means other income
Other income from us sources is subject to this different non EcI taxing regime
in the real world
This means the categories of income that you see on the slide this this laundry list list will probably catch
80 85 90 percent of the things that happen out there that are
Fixed or determinable annual or periodical income
That regime is different if you don't have Eci you're not etb and this is all you have you don't file a return
usually and
You don't actually have to pay a tax somebody else pays the tax for you
We have a withholding system for that, and you're going to have
Part of your payment held back from you and paid over on your behalf as a final tax
to the us government by whoever's paying you and
That's the end of the story
So you have two very very different?
regimes that work here depending on who you are and
What kind of income you're earning, so this is all the way back to where we started right?
Not all income is the same
not all taxpayers are similarly situated and we have to draw a line somewhere and
questions of nexus and connectedness and fairness and
Horizontal equity and sometimes vertical equity are the engine for that line drawing exercise?
In the time I have left
I'm going to talk about
What these connections are is they actually apply concretely to many of the kinds of income you're going to run across?
This is the laundry list I got almost all the way through my session here without inflicting the laundry list on you
But you knew you weren't going to get away from it all together
Here it is. We'll try and make it as painless as possible
There are as I suggested there are three principle connection categories there's connections of the payee
There's connection to the payor and there's connection of the asset
There's a there's a hot spot of other things that don't fit in those categories, but they cover a lot
so in the universe of payee connections these are categories where the question of tax ability is driven by
What is the connection of the recipient of the income to the United States?
Well, we talked about this one five minutes ago effectively connected income the person earning it to the recipient is engaged in the us trade
Or business that generates income that under the connectedness rules are effectively connect is effectively connected to that trade or business I
Haven't said a thing about the payor in that sentence. It's all about the payee and its relationship to the us
this is an example of that first Category a
lot of sales game
This really knows other simple way of saying it a lot of sales game is driven by this principle
Inventory sales are not inventory sales are generally driven by where title passes. That's a administrability and convenience rule
Sales that are attributable to an office in the us will almost always be sourced here. That's a
Nexus
exception
There are a couple of other
exceptions at the Margins for Depreciable property and for intangibles
But if you take those special cases important though they are and put them to one side
gain is a is generally speaking a pe connection kind of category for tax purposes if the
Seller is resident in the us. It's going to be taxable in the u.s.. Oh he's not it won't
Bit of an oversimplification, but that's the general driver
Compensation income much compensation income is in fact treated as traded trader business income because performing personal service is a trade or business
but sometimes it's not
When it's not it can be fadap fix your determinable annual or periodical income
It's us source income if the services are performed in the us
Again services are performed by the recipient of the income, so this is a payee
Category
Title of ink um and at the Margins and for your sakes. I hope neither one of these categories applies to you very often
Foreign currency transactions and transactions and derivatives fascinating and mind exploding lis complicated at the same time are largely
residents of the Payee driven categories
There are fewer
Categories that are paid or connected but they have a very very big volume of transactions covered by them
interest and dividends are the two principal categories here if
Broadly speaking there are some exceptions to this, but broadly speaking a u.s. Debtor
Pays us source interest
its connection of the payor not the creditor the generator that Determines the source of the
Interest income interest is for that income so absent an exemption
It's taxable taxable at a 30 percent withholding rate
This is possibly the classic example of an exception swallowing a rule because the amount of u.s.
Horse interest on which tax is actually paid is vanishingly small
Why is that because we have an exemption we have the so called Portfolio interest exemption?
which used to be narrower than it is now simply by the passage of time, but
broadly speaking if debt is issued the right way and
The Debtor has proof that it's being paid to a non-us person in in the vast majority of cases. There is no
withholding
Required on that income it is us source fadap income no question about it
But before you actually get the withholding agent to write you that 30 percent check congress raises its hand and says
Oh good news this fits the Portfolio interest exemption
Do not pass go don't collect $200, but we do not have to make you withhold here because we made a choice
We're gonna go back to the policy question for a minute
We made a choice here that although we have every right to tax this income
We actually like as a macroeconomic policy matter for non-us people to put their money here. We like to borrow their money
All you got to do is read the papers. It's perfectly obvious
We like to borrow their money and one of the ways
We make it easy to borrow their money is to make it cheap for Lenders
To lend to us and one of the ways we do that is say
If you get $100 of interest we will take exactly none of it as it goes back to you
There is no tax policy. I submit there is no tax policy reason for this rule. There is a macroeconomic
Policy reason for this rule, and that's why we have the rule, but it's Fadap and it's pay are connected
It's us source because the payor is here
These other categories the asset connected ones rents from real property royalties on intangible property gains from the sale of real property
under our
Notorious from one of a better word ferpa the statute
Be if to the extent that the property that throws off the income is treated as connected to the us
The income itself is treated as u.s.. Source got nothing to do with the payor of the payee. You can have a u.s.
source royalty paid by a non-us
licensee to a non-us license or happens all the time because
The license may say you have the right to exploit the intangible property in the United States bingo
And the story absolutely a treaty rule that turns that off. It's us source
Fadap income and taxable
Gains from the sale of real property this is a this is a very unusual and important Category. It's a
most
It's not Fadap
but it's
You as it's presumptively us source
Property and therefore the gain is presumptively us source because the statute says so and that even applies to stock of a corporation
If the Corporation owns principally us real estate assets. I
list a couple of special cases here at the end and
As once again because you got to be hearing this all all day not just all morning treaties can have a very
significant effect on these rules, but as a very quick cook store
Not so much of the rules although. I hope it gave you a foundation for what's going to follow today, but as a way of
Contextualizing them into the discussions today. That's the high-level
introduction to the
tax system to of inbound taxation for non-us people
I thank you for your attention once again early in the morning
Always always a pleasure to be the first person up and see a full house, so I'm grateful for that
And I hope you enjoyed the rest of the conference as much as I'm sure I will thank you very much
Thank you Richard for those insightful
Comments for the primer on us and bound taxation and and the discussion on F dap and effectively
Connected income
With that as a backdrop the next topic is income tax treaties as you know
Income tax treaties are intended to override
domestic tax law the laws that Richard has described in a way that can provide benefits to
Qualified residents of our treaty partners and the discussion this morning on treaties is going to be led
by professor David Rosenbloom
In addition to providing comments in general with respect to tax treaties and the benefits that might be available
Professor Rosenbloom is also going to be discussing certain trends and prospects for the future
as in in the context of income tax treaties
Professor Rosenblum is the James s eustace visiting professor of taxation and is the director of the tax?
international Tax llm Program Here at at Nyu
David is a member of Caplin & Drysdale
And served as international tax counsel and director of the office of international tax affairs
in the us Treasury department
from 1978 to 1981
a frequent speaker and author on tax topics
David has taught international taxation and related subjects at Stanford Columbia
The University of Pennsylvania and Harvard law school's and also other educational institutions around the globe
professor Rosenbloom
I
Thank you very much. Larry. That's very nice of you to introduce me like that and and thank you Richard for a very methodical
Presentation which I actually was able to follow quite closely on the statutory rules
I'm I don't think there's any way in the time allotted to approach treaties with anywhere near that degree of organization
And it's just not the way
I I would operate anyway so I'm going to I'm going to do approach the topic of treaties in a different way
I'm going to assume a certain degree of a knowledge of treaties, and I'm going to talk about
What I see is the most important
Items on the on the Horizon in connection with treaties and also I'm going to talk about some things that I see
Coming down the pike, so let's go let's start with
number one
In my view as someone who's worked in treaties now for close to 40 years I think the most important
Development in the area of Trees has been the advent of mandatory arbitration
Which we now have in in four of our of our treaty with four of our treaties
let me put all those up on the
Board
We have them with Germany and belgium those were the first two Canada and france
Those of you who?
Follow this know this
realized that with respect to
Germany Belgium and France
The advent of Mandatory Arbitration has had
The the desired effect namely that if you put it in the treaty you never have mandatory arbitration
because the competent authorities get serious about resolving cases, but
Canada didn't get the memo and
So we've had at least five
arbitrations with Canada and
Finding out about what's happened in those arbitrations on this side of the border?
You'd do better trying to find the new your secrets of the United States
But if you wander the streets for even five minutes in Toronto, you will at least hear
Unverified that the United States has won all five of those
Arbitrations I do think that it wouldn't be
highly desirable
On the us side for the internal revenue service to have some kind of a report on its experience
Because I think it would it would aid?
It really would help particularly with Canada
For people to know how these are coming out
I've been involved in in one of them, and so I have seen it from the inside
For those of you who don't know I can't resist comment making this comment that the United States did something
I think extremely intelligent in
adopting mandatory arbitration
Because we have baseball
Arbitration as opposed to the arbitration that you find in the European union and with baseball arbitration
It has all sorts of quite desirable effects the way it works
is that the two sides that is to say the two governments each proposed a solution to an issue and
the arbitration panel which is a three-person panel with each government choosing one person and the
The two arbitrator's chosen by the government's selecting a third person from a different country
the Panel's mandate is to choose between the two sides in other words the panel does not have the
The power to either develop its own solution to compromise or even to write an opinion?
Its solution is simply a number without any
presidential value this goes a long way toward making the process more streamlined and to
Undermining or at least addressing the principal objection to Mandatory arbitration?
They knew that it interferes somehow with the sovereignty of countries and put in their tax systems
So I'm a big fan of what we have done and as I say as far as I know the only
Arbitrations that have taken place so far have been with Canada
I do think that our betray ssin is a this is a today's program of course is on inbound taxation
I do think that the the arbitration has been probably been more important
Outbound partly that's because of of Canada
But because Canada is where the arbitrations have occurred and and partly?
Because there are simply more cases outbound and inbound in the united states and one of the things about an in an inbound conference
That's worth mentioning
just in passing is that I wouldn't rely on this but
irs enforcement on the inside on the inbound side
With the exception of certain particular industries like the banks
Is is a lot less seems at least to this observer a lot less
vigorous than the outbound
The second most important development that I think we'd have to mention in treaties is the continuing reduction of us taxes source
The United States uses treaties
To promote its own view of the world which is basically a capital
exporting view of the world we we can persist in seeing ourselves as a
Capital exporter even though we have been not by any means an overwhelming capital net capital exporter for quite a Few years
We now have zero rate on dividends at least in some instances in Eleven of our
treaties in Force and
I wouldn't be surprised to see that
That extended so you you that's quite remarkable that?
Movement Toward reduction of taxation its source now. I should make clear
I think larry said it that the treaties of course trumped the code and in an inbound
Context which is is what we are what we're dealing with today. We're dealing with investments into the United States
I would say some very very high percentage of investments in the United States
the treaties are
Directly relevant there are cases where you don't find treaties having having relevance?
But on the inbound side the treaties are relevant in in most cases. We have treaties with something like 65
around the world and
there are most people those who go engage in any kind of planning have either come from treaty countries or
invested through treaty countries, which is a subject that I will get to in a second because
Planning through treaties to invest in the United States through treaties is a major a major subject
let me now say the third most important development is what's going on in the senate right now and
for those of you who haven't been following this
We have a hold on all treaties
progress of any treaties in the United States senate it has been put on by senator Paul from Kentucky I
Am not I've heard rumors, but I really don't know exactly why he's done this nor do
I know when if ever he would remove that hold but as a result of that
there are a bunch of treaties an
Accumulating bunch of treaties that are stalled in the senate
and I listed the ones that I know of I make no claim to being current with respect to everything, but the
Tax treaties that are up there are with treaties or protocols are with hungary which is very important
I'll say a word about that in a second luxembourg also quite important
convention on mutual
Administrative assistance in tax matters the new treaty with chile extremely important only our second treaty in South America
the protocol with switzerland Swiss can't understand why we can't get a treaty a protocol through that we
pounded them over their head to negotiate and
coming soon Spain Japan
poland who knows
So it really is
Suppose, it's unfortunate. It's a sort of striking that that one person
in the senate can can basically bring this program to a halt and
now let me just say about some of the ones that are that are they're
hungry of course
Which is a treaty that is near and dear to my heart personally since I actually negotiated it
hungry Lacks a limitation on benefits
provision and so it has been commonly used by investors from countries that
Don't have treaties with the United States for example Brazil
to invest through hungry now the
into the United States and Avoid
Take advantage of the provisions the lowering of tax under the us hungary treaty in my own defense who knew that
A treaty that was negotiated with people having those funny red stars on their hats and where some of them carrying submachine guns
would turn it that that country would turn itself years later into a tax haven, but that's precisely what happened and
So hungry has been reached out and attracted a lot of investment a lot of investment not only from non treaty countries
but also there's a fair amount into the united States through from Canada and that treaty is the
Treaty the protocol that's up there would put a stop to that, but again it's it's stalled
I want to mention chile because the only other treaty in South America that we have is
with
Venezuela it actually functions
reasonably well you'd be quite surprised notwithstanding in the newspapers, but the one with chile is important because
There was a lot of growing
Economic activity in South America and also a lot of attention being paid to the tax systems in South America
and it would be very good to get that that treaty in place the protocol with switzerland brings in a
Modern exchange of information provision which we've never been able to have previously with the swiss and
That that's of course a very important treaty in the context of the all the attention that's been paid to
Overseas accounts, and
attempting to
To get information out of the swiss financial
institutions, so in any event
I don't know where that's going
but I had the the current status of treaties in the senate has the rank is one of the
important items going on with respect to treaties
now
Looking to where. We are in the realm of treaties. I think that a
probably
the one doesn't have to have a crystal ball to
See that the whole question of treaty shopping or tax treaty abuse or borrowing treaties
Is a is a very it always has been a big issue
and
It's going to be a much bigger issue in the first place
We have a triumvirate of case decisions on
Treaty shopping
Quite apart from the limitation on benefits provisions that are in all modern u.s. Treaties
we also have three if you will common law of taxation cases cases that do not have a
specific statutory predicate for
Challenging treaty shopping, and they are akin industries
Northern Indiana public service company, which I like to refer to people referred to as nips Co and
Dell commercial and the history of this dell commercial is already already about 10 years old at least now
But the history is that akin of course?
was under the old treaty no longer in existence with Honduras and
Akin was because it relied on specific language in that treaty to deny the benefits of the treaty
it was not clear, whether akin was a
Statement of what would become a broad?
anti-treaty shopping principle
or whether it was a specific interpretation of the narrow language of a particular treaty contract and
We thought we had an answer to that when nips co came down which involved the antilles treaty
nips, Co
Which is a decision that I think is somewhat difficult to understand, but its result is not difficult to understand nips Co
Comes down saying that akin is basically a narrow decision
It upholds the use of netherlands antilles financed subsidiaries
And it looks after nips co as though
The Treaty shop in that was absolutely
Common very common in the multinational community
would continue to be
Accepted as legal on the basis of a fairly
Flimsy business purpose which looked looks to all intents to be saving us taxes as a business purpose
And even its go is a taxpayer favorable decision and after nips co I think those of us who follow this closely?
Thought that akin had been put to rest but no sooner then that had come down than just a few years later
the Dell commercial case came
decided by a judge at the appeals level by Judge Sentell and
Dell commercial is a situation with a canadian
investor an ultimate Canadian investor investing into the United States through a chain of
Netherlands and Netherlands antilles
intermediate entities claiming an interest deduction and zero rate of interest because under the u.s. Netherlands treaty and
under A
Step transaction analysis business purpose analysis, but really step transaction analysis. I think if you want to separate those two
concepts out
The court comes down saying that the government wins so all of a sudden. What looked to be a
fairly clear playing field for
Planning to borrow Trees and take advantage of treaty benefits all of a sudden was impeded by Dell commercial
now dell commercial like akin, but on like nips Co
Involves all related parties so perhaps. That's a ground for distinguishing
Dell commercial there has not been to my knowledge any
subsequent decision that has told us where we're going with this dell commercial case, but
What is happening?
Independently of Dell commercial is that and some of you may be aware this that the economic substance?
Doctrine has begun to eat the entire tax law so those of you. Who've been
Following what's been going on in the tax court lately and indeed in other courts, not just the tax court
We are we have entered into an era
When cases seem to be decided not on the basis of statutory?
Provisions or indeed as far as I can tell on the basis of law, but on the basis of something
Vaguely described as economic substance whatever that means and I have long
spoken from this podium and elsewhere about the
the
foreseeable
Train Collision between the economic substance doctrine which has had basically a domestic
birth and a domestic development
throughout ever since it came down with Gregory V helvering
and
Treaty shopping. It's as though you have these two lines of cases. Where you have
The international planning inbound planning which I think is still very very common and borrowing of treaties on the one hand
And you have some cases which suggest
The bass case there are a couple of cases that have been decided quite a few years ago which suggest that
Treaty shopping
Let's use a less pejorative term treaty borrowing is an acceptable practice
with fairly minimal
Presence in the intermediate countries on the one hand and on the other hand you have this rising Chorus brought on
Largely by the tax shelter domestic tax shelter
Litigation in the United States and not involving Cross-Border transactions involving mostly
deductions or credits but inside the United States
And you have this
Development of Economic substance well that I wouldn't I don't think those two lines have yet crossed
but they to my way of thinking they've been converging for some time and
There are a couple of straws in the wind that I would
signal to you one
in the recent very recent
Bank of New York Mellon case which is a foreign tax credit generator case involving so-called stars?
Transactions which are you know a Barclays bank generated?
Transaction that's being litigated in I think six different courts in the United States right now
In the bank of New York Mellon case which came down about problem about three weeks ago?
there is a piece toward the end of it where the
Court the tax court
Says that the treaty is this is the treaty with the united Kingdom
Is unavailable to resource income because the entire transaction lacked economic substance and treaties are not?
You're not entitled to treaty benefits if you have a transaction lacking economic substance
And I suppose at some degree of generality. That's true
What was interesting to me was?
mentioning the word treaties in the same sentence with the word economic substance strikes me as
sort of a harbinger of things to come
secondly in the
Even more recent case I think it came down within the past week of Barnes group
Which is a tax court memorandum case decided by judge Goki and which does not involve treaties
judge Goki Applies a step transaction analysis to
to find that a taxpayer
that thought it had made an investment in u.s. Property under section 956 and
But with a zero basis property and therefore had no
Inclusion that in fact all the intermediate steps in that plan could be factored out with the result that
instead of a 956 transaction we had a 301
dividend
now that in and of itself
It has nothing to do it is cross-border, but it has nothing to do with treaties, but in the con of that
Of discussing the step transaction doctrine I was interested to see judge go Keysight dell commercial
So Iii really do think that
There's much more to be to come here in this area that we're going to be seeing
Controversy and litigation and
in my experience a lot of the
inbound investment
Which borrows treaties?
In shall, we say has not got
robust presence in the intermedia in the intermediary countries
I don't think anybody investing in the united states through hungary is employing hundreds of employees in budapest
But I so, I I do think I do think we have we're gonna be seeing something along those lines
All right, let me go to a couple of other things that I want to talk about
Beneficial ownership
I don't know what's going on on this now, but I do think the law is somewhat confused
This is an area that I
Follow as best I can
We now have this has all been thrown up in the air insofar as the united States is concerned
by the
Rules which I think are pretty good rules by and large on
fiscally transparent entities we now have a provision in
The us model, it's a paragraph six of article one of the u.s.
Model and by the way, I would expect us to be seen a new us model in the not-Too-distant future
We have a fiscal transparency rule a fiscal transparency rule
tracts section
894 of the Code
And it's been made its presence felt in a number of negotiated us treaties
and it basically goes with the
Proposition that the decider as to what we're dealing with is the country of residence
so under fiscal transparency under 894
Residents country rules if the residence country sees its resident and taxes
The us as source country accepts at and that's basically the lesson of 894 it's also of course the animating
proposition in the oecd's partnership report which is very similar to and based on
section 894 but
Beneficial Ownership is different and
There is this confusion because under the treaty under paragraph 2 of article 3 of the u.s.
model as also under the oecd terms that are not otherwise defined are left of the source country and
if we end up in with
Treating letting the residents country have the call on who derives the income which is the is the proposition in the fiscal transparency
rule
Who derives the income being decided by the Country of Residence?
Whereas the beneficial ownership being decided by the country of Source
We are going to run into some serious technical problems
And I don't believe that has satisfactorily been worked out certainly it hasn't been worked out in the us Model
Or the model technical explanation, I would add that outside the United States
And this is sort of independent of my first point on beneficial ownership
Outside the United States beneficial ownership has come to take on a much broader
Meaning than we have ascribed to it in the united states. We have in our treaties the limitation on benefits
Provision which is designed to provide something of the defense due to treaty shopping
Most countries of the world this is a u.s. Originated idea most countries in the world
do not have that although I believe the
the Japanese with whom we negotiated fairly recently have begun to
Put something like it in their own treaties. I haven't followed that closely, but I'm so informed
But broadly we have limitation on benefits, and that allows us
Although we don't articulate it this way to
interpret beneficial ownership in a fairly narrow way as meaning something like
Whose income is really are we dealing with a nominee are we dealing with an agent or are we dealing with the real owner?
That's the way we look at it. It's not the rea the way the rest of the world is looking at it. They don't have
limitation on benefits so they are moving in the direction of
expanding beneficial ownership to test situations where for example
Income is received
And then immediately passed on to the owners of the the entity that receives the income we saw a case
Prevot car in Canada, which is a beneficial ownership case
Which I thought was correctly decided
Which said that just because income was passed on did not mean that it was not been officially owned by the original recipient
but we've seen a number of
other cases in Doe Foods in in the uk
that Royal bank of scotland in France
There have been several cases out there. There's a Spanish k there's a couple of Spanish cases all
questioning, whether
when a recipient passes on income that it receives from a source country that
The question is whether that recipient is in fact the beneficial owner?
And I think that is going to be an issue that us companies are going to encounter abroad
It probably is not as directly relevant to our topic today of inbound in bed where we have control over the issue
permanent establishment
This is there's an unending series of permanent establishment issues
As you many of you may know the oecd has put out a quite an interesting Pamphlet
identifying 25
No fewer than 25 permanent establishment issues under the oecd model
Convention that's a very interesting document
The ones that that I think that at least I see and that come up
With some degree of regularity I've listed three of them. I don't mean to be
be
Comprehensive in this these are just the ones that that that I've seen with some some frequency
seconding of employees, which is a practice which is
quite common many foreign companies
Frequently, send their employees into the United States
On some kind of a detail whether it's a formal secand menteur
Exactly the terms can vary from from assignment to assignment
But the point is that a foreign parent company may send employees to help its us subsidiary in one of Several ways
Those employees may stay for a while
they may they may for become employees of the of
The us subsidiary of course there are transfer pricing issues associated with this
But the one that I want to focus on is whether the parent company subjects itself to permanent establishment?
Status when it sends those employees in in the cases
I've seen there's very little doubt that for reasons that
Richard has already explained. There's very little doubt that there is a trade or business because you have people performing
personal services in the United States and the question whether
There is a fixed place of business available to these employees becomes
quite difficult and quite quite difficult to analyze
Personally I find the oecd
Of limited assistance in from the us perspective in in reaching those determinations
and I've recently had occasion to hear a discussion at the DC bar of
Of the seconding issue from IRs people at the national office
But I did not get a great deal of meat out of that. I think this is a troublesome area
The reason that it hasn't be gotten more attention is for some because of something I said
Right off the bat when I started speaking which is that I don't think irs
Enforcement has been all that vigilant on these on these issues, but I think this practice is common
And I think it is it is somewhat
about it
Ecommerce
I'm sure ecommerce is a
huge issue with
Probably more without bound than in bound
But it could be also with inbound the problem with e-Commerce that I've seen is whether a server
situated in in a particular jurisdiction
Constitutes a permanent establishment
and then one of the problems associated with that is simply identifying what kind of
income is being earned by the person operating that server and you have a
variety of
Candidates you have you have
Rental income you have services income
conceivably you even have royalty income
There's there's a lot of potential ways of looking at Ecommerce under are under the rules that that Richard outlined
We have in our in our law we have very little to deal with
the only case that that I know of that really helps at all and it's all of two paragraphs long is the
1942 case of Piedras Negras and look
Needless to say it's it's a little out of date for this. I don't I don't think there's been a really
sophisticated analysis certainly not in any court of how to treat ecommerce for purposes of the
permanent establishment rules
Agency issues are also
extremely
common
You have many situations. Where you have people doing things in the United states on behalf of
foreign persons and
although as I think we all know an agent whether
Dependent or independent can put a foreign person in a trader business under our statutory rules
I think that's reasonably clear
What is less clear?
Is how you deal with the treaty analysis because?
The way the treaties work agents all agents are
permanent establishments if they have the ability to
conclude contracts on behalf of or in the name of depending on your treaty the
Foreign person unless they are agents of an independent status
acting within the normal course of their business, so it's not
contrary to what people normally think of it's not a dichotomy between
Independent agents and dependent agents, it's a dichotomy between
Independent agents and all other agents except those who lack the ability to
contract on behalf of the foreign person and
that that issue
But the Independent agent issue
We do have guidance in the form of the tae-se opinion involving the uS-Japan treaty
but if you're not in an independent agent
situation
The question of what it means to conclude
Contracts in the name of the foreign person is very much of a live issue and very unclear
I had personal experience not in the United States
but but in Canada with a case that explored
That kind of issue, and that may actually be of help in in a us case. It's called Knights of Columbus
Where knights of Columbus had hundreds of agents knights of Columbus being basically a life insurance company?
I had hundreds of agents running around Canada
Selling life insurance
policies and
It was found in that case
And I think correctly so that they were they did not have the ability to conclude contracts in the name of the enterprise
I think there's some analysis there
Which could actually be relevant in the u.s.
Context so those are three types of issues that I see there are
Doubtless many more that I'm just not either not coming to mind or I haven't seen
But permanent establishment is all is a perennial issue under our treaty a treaties now
I wanted to talk a little bit about a couple more things
Arbitrage is of course the taking advantage of differences between two
two systems
tax arbitrage is two tax systems international tax arbitrage is tax systems in two different countries and
I
Speak and write a lot about arbitrage, but it arbitrage is mostly not a treaty subject. It's mostly
arises from differences in statutory law
under two countries of two countries and since
Taxpayers can always turn their back on a treaty and say I want to be taxed at least a u.s. Treaty
I want to be taxed under
under
statutory law
The treaties don't usually enter into it
but there are there is also arbitrage in a treaty context and
I don't think this is the only situation that this can arise in but I
Have seen it and I know it's fairly common with Luxembourg luxembourg is a very well
How should we say pliant jurisdiction it likes to help taxpayers?
and
Luxembourg's ruled is that you can have such a thing as a
deemed permanent establishment in another country, and you can have it for example if you have a
us partnership and that partnership
Could for example be engaged in an activity that is so minimal or so
singular in
One-time activity that it doesn't even arise to a trade or business for example a single loan
my understanding is that luxembourg would treat such a situation as
there being a permanent establishment in the United states and of course under their
Exemption provision they would exempt the permanent establishment from Tax
The United States on the other hand
Us Luxembourg treaty existing luxembourg treaty has a zero rate of tax on interest paid unless it's paid to a permanent establishment
so the question would be can something be a permanent establishment for Luxembourg purposes and
Not even be a permanent establishment
For us purposes and embedded in that question is the question whether it is possible to have
Something that is a permanent establishment without being a trader business under us law
I would have thought not but I don't I have not found anything conclusive on that
and I know that there's been a certain amount of planning to take advantage of what amounts to a double exemption no tax in the
United States because it's zero zero
Rate of interest and no permanent establishment in Luxembourg no tax in luxembourg because it's a permanent establishment
And they exempt beautiful isn't it?
All right, let me go let me go to another
Issue, which is slightly?
Again, this is slightly different from the inbound I I guess I exceeded my mandate in thinking about treaties
This is this is the question of what is a treaty benefit
This is a live issue
somewhat surprising to me
it is really not an inbound issue, so I probably not justified to spending too much time on it, but
the issue Involves section 1h 11 and the qualified dividends provision of the internal revenue code which
now gives a 20% tax allows a maximum 20 percent tax on on dividends from
Qualified foreign corporations in addition of course the domestic corporation used to be prior to December 31
It was 15% and the live issue here
Involves what does it mean to be a qualified foreign corporation?
The statute seems to say says actually that as long as we have a treaty with the foreign country
And the treaty contains a an exchange of information
provision and the Taxpayer would qualify for the benefits under that treaty the
The entity is a qualified foreign corporation
The revenue service is in the process of challenging quite quite a number. I think of cases
involving
Whether an entity is a qualified foreign corporation a number of those I know involves
The tree treaty with cyprus which is which I'll come back to in a minute and which has got a a somewhat unique
Provision on on limitation on benefits, but I'm not going to talk about cyprus. I'm going to talk about Switzerland
Because I've also that there's also issues under switzerland the u.s. Swiss
limitation on benefits provision
has a
In addition to being a quite an elaborate provision. It's got what has come to be in a number of us treaties
It's got a special rule for a foreign branch of a third country branch of a of a swiss
Corporation and the Third Country Branch of the Swiss corporation
does not amounts paid to that do not qualify under the limitation on benefits unless the tax imposed by
a combination of switzerland and the third country amount to at least sixty percent of
What would have been paid if the amounts had been paid directly to switzerland? So there's a special rule
where you have let's call it a swiss corporation with a hungarian branch or a swiss corporation with a
Bahamas Branch or whatever you want a third Country Branch
now the problem arises because
the
in many of the cases that I have seen
there is no question of
Actually taking advantage of the treaty in the treaty that's being analyzed in other words the u.s.
person us individual is getting a dividend from a foreign corporation in claiming the
reduced rate of Tax on the dividend
and
The revenue service is saying well
we don't think that's a qualified foreign corporation because of the limitation on benefits provision and
The the reason that they're saying that as far as I can tell is that they have
adopted A
A
hypothetical test and they're not asking whether the
the
Entity has actually benefited from a treaty they're asking whether it would have benefited from the treaty and unfortunately the conference report
To the statute does use the word would although the statute does not and on the basis of the word would
The revenue service seems to have erected a test which
I'm not sure whether this is where they're going, but it could be as broad as could one conceive of
situations in which the limitation on benefits provision would
Would deny benefits and if you have a swiss corporation with a branch in a third country
One could conceive of that happening even though it may not be happening in the actual and the actual facts
Any event this has all gotten quite
confused and the reason I
situated here is because
The service in order to make this work at all
has to say that the benefit of the reduced rate attacks is a
Treaty benefit because that's what the statute is is aimed at the statute says
Would you be entitled to the benefits of a treaty under a treaty with another country?
I think the whole area is I mean, it's alice in Wonderland as far as I'm concerned, but I
Can't deny its existence. It is it is a live issue out there?
All right now in my I think this is my final
I've talked a lot already about limitation on benefits. I want to say two things in in wrapping up on it
one
We made a decision and I think we made it probably back in
1992 with the with the German Treaty on the
limitation on benefits provision which has got a
Lineage going all the way back to well all the way back to my time in the treasury in the late 70s
We started putting these provisions into our treaties and into our model treaty
You could trace. It actually back to the 1975 treaty with the united Kingdom where the the provision was pretty rudimentary
but
At a certain point and I do think it was 92
We made a decision
Between two paths one was to do something general facts and circumstances
You know touchy-feely?
That is this abusive
sort of
Abuse of law kind of a concept we know it when we see it if you like and that that kind of approach
We do find in the treaty with Cyprus cyprus
has got a
Limitation of benefits provision which I think is pretty unique in the u.s. In the u.s. Network although in Fairness all
All limitation on benefits provisions in the u.s. Network are unique. I don't think any two of them are exactly the same
The Cyprus provision has two
Ways out of limitation of benefits either you the cyprus entity is owned by cypriots
If anybody knows of any I'd be fascinated
Or or the competent authorities agree that the entity was not formed for the purpose of taking taking advantage of the treaty?
so there's a
Formed or availed of kind of a rule and there's a cyprus residence rules
And that's all there is so it's it's all based on discretion. It's all based on
individual facts and
the one thing I think we can say about the cyprus treaty as a
Vehicle for investing into the United States through treaty borrowing. Is that it is worked?
I I don't I don't see maybe I'm blind but I don't see many
people using cyprus as a as a
Jurisdiction to invest in the United states it goes the other way us people using cyprus to invest into Russia Eastern Europe Etc
But I don't I think the cyprus provision has been reasonably effective to me as far as I can tell
On the other hand with Germany and then with the netherlands where we got truly ridiculous?
We we began to try to do to write the internal revenue code into these treaties and so the dutch
limitation on benefits provision Occupies fully one-third of the text of the entire convention which seems a little excessive to me and
These very detailed
Rules in these conventions starting with Germany netherlands and and now pretty much found
It'll be found than hungry if hungry ever goes through a lot of our treaties today. Have got very detailed rules these tend to provide
roadmaps for how to avoid limitation on benefits and
My my guess is that they have limited effectiveness that they basically teach people
how to borrow treaties and invest in the United States
I could be wrong but my sense is that the cypress approach is a lot more effective now of course the the
The argument is that the cypress approach is not very does not give anybody any certainty there?
They're at the Mercy of the revenue service, and I understand that that concern
but that's the judgment we have made in terms of
Of which way to go we've gone in the direction of providing detailed rules
Switzerland is another case where?
We've provided a very very detailed
provision
We also have another a feature of our limitation on benefits provisions
And we've particularly needed this in the European union is the excuse me the derivative benefits clause
Where we give benefits under a treaty?
even though the
Recipient of the income coming from the United States the recipient entity would not be qualified under normal
Lob
Provisions for the treaty benefits as long as it can be shown that the owners of that
Entity would have qualified if they had invested
directly and
I understand. How we got there if we have a for example
We have a payment to a an entity in Germany all of whose shares are owned by French individuals. Let's say
the German
The German entity in a bilateral world treaties are a bilateral world the German entity will not qualify on its own
Let's say doesn't have a trader business in Germany doesn't qualify under any of the normal Lob
Criteria, but if can be shown that the French owners would have had
As good or better results if they'd invested directly
then we give the benefits to the German entity that's I
Find this kind of interesting because I think that the the idea that we should give
Benefits to that german entity because the French owners could have qualified
takes A
View of what we're doing with our taxes on foreign persons in the United States
which is quite different than we've taken for purposes of the
Fiscally transparent rules under section 894 if you think about it, why would we give benefits to a german entity?
when
When it's Wholly owned by a third country persons
On the basis that if they had invested directly they would have
They would have gotten the same benefits. We do that because we we say they haven't really gained anything
From the standpoint of us as a source country in other words
they haven't we are not giving up anything more to this german entity than we would have given up to the French and
owners if they'd invested directly that puts all the
The the Burden or the the pressure on whether to reduce tax on us as a source country
if on the other hand you take you look at section 894 which we do with
Transparent entities we take exactly the opposite view we say that we will only reverse taxes
We will only reduce taxes at source if we can be confident that the residents country is taxing
We say to ourself look the justification for reducing tax
For reducing our tax in a treaty is because the residents country is taxing
That's that's the basic deal in a treaty right a treaty is a contract the source country
Reduces or eliminates its tax the residents country undertakes to avoid double tax so we say we'll reduce
Now of course there are exceptions, but we will reduce our our source basis tax if the residents country's taxing
That's a clear. That's a clear position it seems to me
But I don't think it can easily be
Reconciled with the proposition that we will reduce our source country tax if it can be shown that
Somewhere up the chain some owner could have gotten as low attacks if they'd invested directly that that
disregards completely what's going on in the residence country so
those two policies are
inconsistent with one another and we have drifted into as we do we have drifted into each of them independently and
I
Don't I don't think there's anything
Much to be said about or thought about I just find it very interesting that we were sort of carrying water on
both hips and a shoulder I have come to the I've come to the end of of my
Comments, I thought there was one question did I see a question down there before I think you did yes?
You know rules like that
I think are adopted by each arbitration panel, but I think it probably is a majority what what tends to happen
Again, we don't have brought enough experience to make a generalization
But what tends to happen is that that third arbitrator has a lot of power? I didn't spend
The actual details I have 45 seconds to let me elaborate the actual details of developing that
Arbitration panel are quite interesting because it was never self-evident to me in the beginning
That that it wasn't that the two chosen arbitrators were chosen as essentially
Representatives of their countries and that they would choose a third person and that essentially you'd have a single arbitrator
That's the way I thought of it, but the revenue service and oh heavens. No that's not what we mean at all. We're Gonna
We're gonna choose somebody and they have to my knowledge. They've been choosing retired
U.s., tact. I don't know all the people have been chosen
But I I think they've made an effort not to simply choose people in a representative capacity however
I think it's inevitable that those people each of them being chosen by the
States in Canada because that's the real world
It's inevitable that you're going to end up with representation of the positions of those two countries, so that is a practical matter
You are gonna get to one and the decision is going to be decided by that by the third point person
Thank you very much for your attention
thank you, David for those insightful comments on tax treaties in particular your observations on the
prospects for the convergence of the economic substance doctrine and a tax treaty shopping or a treaty
Borrowing as David refers to it and also your insights on the u.s.. Hungarian treaty of which professor Rosenbloom has negotiated
Before you run off to the morning break just a few a few
Comments first of all the break is going to be located across the Hall in Greenburgh Lounge
I encourage you to come back in quickly because we the next panel is going to start at 10:30 with introductions at
10:25 that panel is Gonna be on the oecd
Application of attributing income to a permanent establishments finally we will be having a debate session as you know later this morning
together with Danielle ropes and other participants
And it will be summit audience interactive if you wish to participate in the polling aspect of the audience polling there will be 150
hand held polling devices available
by the entrance to the auditorium, so when you exit
Or come back in if you wish to participate in that just grab one of those and come back in. We'll see you shortly
Thank you
