Tax Treaties

The United States is a party to more than 60 bilateral income tax treaties.   Under its tax treaties, citizens and residents of the United States may be entitled to tax benefits, such as exemption from certain income taxation, reduced tax rates, and other benefits.  The global network of tax treaties is generally intended to mitigate “double taxation,” as well as to promote international trade and investment, the mutual enforcement of tax laws, and the exchange of tax-related information.  Freeman Law’s Treaty Resource Page provides an overview of every U.S. tax treaty and the tax system of each such country.

Residents of the United States are generally entitled to treaty benefits.  Likewise, U.S. citizens residing in treaty countries are generally entitled to certain treaty benefits and safeguards, such as nondiscrimination provisions. U.S. citizens residing in a foreign country may also be entitled to receive tax benefits under a treaty country’s tax treaties with other countries.

What is a Tax Treaty?

An income tax treaty is an operative legal agreement between or among nations that coordinates, to some degree, the tax systems of each respective country that is a party to the treaty.  Article 2 of the Vienna Convention on the Law of Treaties provides that:

A treaty is an international agreement (in one or more instruments, whatever called) concluded between States and governed by international law.

Convention on the Law of Treaties, Vienna, 23 May 1969. While “tax treaties” are often named or referred to as “agreements” or “conventions,” the name given to the instrument is not particularly important.  It represents an agreement between or among sovereign countries with respect to the taxation of the income of their respective citizens and residents.  Treaties are generally intended to reduce or eliminate double taxation of income earned by residents of either country from sources within the other country and to prevent avoidance or evasion of the taxes of the two countries.

Tax treaties can be “bilateral” or “multilateral” agreements.  A bilateral treaty is an agreement directly between two countries, conferring rights and imposing obligations on the two contracting States.   There are currently more than 3,000 bilateral income tax treaties in effect across the globe.  The vast majority of those treaties are based upon two particularly influential model tax conventions: the United Nations and OECD Model Conventions.

Multilateral tax treaties are instruments or agreements among more than two countries, all mutually agreeing to the terms of the instrument.  While there have historically been relatively few multilateral income tax treaties, recent efforts by the OECD and its Base Erosion and Profit Shifting (“BEPS”)[1] project have seen multilateral instruments grow in prominence in the international tax context.

Treaties are built upon the principle of reciprocity.  Under Article 26 of the Vienna Convention, treaties are binding on the signatory countries.  Each country must, under the Convention, abide by and execute the treaty in good faith. This is known as the pacta-sunt-servanda principle—Latin for “agreements must be kept.”

Common Tax Treaty Benefits

Personal service income. Payments received for performing personal services in a treaty country may be exempt from that country’s income tax with respect to a U.S. resident present in a treaty country for a limited number of days during a tax year who satisfies certain other requirements.

Professors and teachers. Certain payments received for teaching or performing research in a treaty country may be exempt from that country’s income tax with respect to a U.S. resident.

Students, trainees, and apprentices. Certain amounts received from the United States for study, research, or business, professional, and technical training may be exempt from a treaty country’s income tax with respect to a U.S. resident.  Under certain circumstances, pay received by students, trainees, and apprentices may be exempt from income tax in a treaty country.

Pensions and annuities. Certain nongovernment pensions and annuities may be exempt from income tax in a treaty country with respect to a U.S. resident.  Most U.S. tax treaties exempt certain government pensions and annuities from treaty country income tax.

Investment income. A U.S. resident may be exempted from a treaty country’s income tax with respect to investment income, such as interest and dividends, received from sources in a treaty country.  In other circumstances, such income may be taxed at a reduced rate.  Some treaties also exempt certain capital gains if specified requirements are met.

Tax credit provisions.  Most U.S. tax treaties allow a taxpayer to utilize a credit against or deduction from the treaty country’s taxes based on the U.S. tax on the income.

Nondiscrimination provisions. Most U.S. tax treaties prohibit the treaty country from discriminating against U.S. citizens who are residents of the treaty country.  For example, such provisions prohibit taxing U.S. citizens at a greater rate than the country taxes its own citizens in the same circumstances.

Saving clauses. A saving clause provides that a treaty does not affect the U.S.’s taxation of its own citizens and residents. Thus, U.S. citizens and residents generally cannot use a treaty to reduce their U.S. tax liability with respect to the U.S.

However, most treaties provide exceptions to saving clauses.  Those exceptions allow U.S. citizens or residents to utilize certain provisions of the treaty.

Competent Authority

A U.S. citizen or resident alien can request assistance from the U.S. “competent authority” where the actions of a treaty country or the United States would (i) cause double taxation or (ii) taxation that is inconsistent with the treaty.  Taxpayers seeking relief from the U.S. competent authority should consult competent legal counsel, along with filing a timely protective claim for credit or refund and taking any required actions that are necessary under the procedures of the foreign country to avoid losing the right to appeal or obtain competent authority review under that country’s income tax laws.

 

[1] Base erosion and profit shifting (BEPS) refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid.

 

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