2016 U.S. model income tax convention: What’s new?

On February 17, 2016, the Treasury Department released a revised 2016 U.S. Model Income Tax Convention (the 2016 Model), which is the baseline text the Treasury Department uses when it negotiates tax treaties. Here are the updates.

Special tax regimes

The 2016 Model denies treaty benefits for related party-interest payments, royalty payments, or guarantee fees within the scope of Article 21 if the beneficial owner of the payment benefits from a special tax regime with respect to the payment. The term “special tax regime” is defined as any legislation, regulation or administrative practice that provides a preferential effective rate of taxation on an item of income or profit.

Payments by expatriated entities (including inverted companies)

The 2016 Model denies treaty benefits for U.S. withholding taxes on U.S. source dividends, interest, royalties, and certain guarantee fees paid by U.S. companies that are expatriated entities. This provision applies only when the beneficial owner is a connected person with respect to the expatriated entity.

Revised limitation on benefits (LOB) article

The following tests have been modified/added to determine qualification under LOB:

• Active-trade-or-business: requires that the treaty benefitted income “emanates from, or is incidental to,” a trade or business that is actively conducted by the resident in the residence state
• Derivative benefits: requires 95 percent of the tested company’s shares to be owned, directly or indirectly, by seven or fewer persons that are equivalent beneficiaries
• Headquarters companies: requires a headquarters company to exercise primary management and control functions, and not just supervision and administration, in its residency country with respect to itself and foreign subsidiaries

Additional changes

• Requirement of mandatory binding arbitration to resolve certain disputes between tax authorities
• Requirement to evaluate if amendments to a treaty are necessary if a treaty partner’s general rate of company tax falls below the lesser of either 15 percent or 60 percent of the other country’s general statutory corporate rate
• Incorporation of certain base erosion and profit shifting (BEPS) recommendations such as imposition of a twelve-month ownership requirement