Posted by The TaxAdvocate Group, LLC

Tax Treaties

Tax Treaties

The USA is a party to more than 60 bilateral tax treaties. Under its tax treaties, U.S. citizens and residents may be entitled to tax benefits, such as exemptions from certain income taxes, reduced rates, and other benefits. The global network of tax treaties generally aims to mitigate "double taxation," as well as to promote international trade and investment, reciprocal application of tax laws, and exchange of tax information. 

Residents of the U.S. are generally entitled to the benefits of the treaty. In addition, U.S. citizens living in treaty countries are generally entitled to certain benefits and guarantees in the treaty, such as anti-discrimination provisions. U.S. citizens living in a foreign country may also be eligible for tax benefits under a country's tax treaties with other countries.

What is a tax treaty?

A tax treaty is a legal operating agreement between nations that coordinates, to some extent, the tax systems of each of the countries that are party to the treaty. Article 2 of the Vienna Convention on the Law of Treaties provides:

A treaty is a global agreement concluded between states and governed by international law.

Vienna Convention on the Law of Treaties, May 23, 1969. Although "tax treaties" are often called or referred to as "agreements" or "conventions," the name given to the instrument is not particularly important. It is an agreement between sovereign countries on the taxation of the income of citizens and their residents. Generally speaking, treaties aim to reduce or eliminate double taxation of income for residents of one of the countries of origin of the other country and to prevent tax evasion or evasion by both countries.

Tax treaties can be "bilateral (involving two parties)" or "multilateral (participated in by three or more parties)" agreements. A bilateral treaty is a direct agreement between two countries, which confers rights and imposes obligations on both contracting states. More than 3,000 bilateral tax treaties are currently in force around the world. The vast majority of these conventions are based on two particularly influential tax treaty models: the United Nations and the OECD model convention.

Multilateral tax treaties are instruments or agreements between more than two countries, which all agree on the terms of the instrument. Although there have been relatively few multilateral income tax treaties historically, recent efforts by the OECD and its Base Erosion and Profit Shifting ("BEPS") project have made the instruments multilateral organizations in the fiscal context.

Base Erosion and Profit Shifting (BEPS) refer to tax planning strategies that exploit loopholes and incompatibilities in tax rules to artificially shift profits to low-tax or tax-exempt locations where there is little or no economic activity resulting in reduced or no tax activity at all to be paid.

Treaties are established on the principle of reciprocity. According to article 26 of the Vienna Convention, the treaties are binding on the signatory countries. In accordance with the Convention, each country must respect and apply the treaty in good faith. This is called the pacta-sunt-servanda principle, which means "agreements must be honored" in Latin.

The advantages of tax treaty

  • Nondiscrimination provisions: Most U.S. tax treaties prohibit the treaty country from discriminating against U.S. citizens living in the treaty country. For example, such provisions prohibit the taxation of U.S. citizens at a higher rate than the taxation of U.S. citizens under the same circumstances.

  • Pensions and annuities: Certain non-government pensions and annuities may be exempt from income tax in a treaty country in respect of a resident of the United States. Most U.S. tax treaties exempt certain government pensions and annuities from the treaty country's income tax.

  • Personal service income: Payments received for the provision of personal services in a treaty country may be exempt from income tax in that country for a resident of the United States. Present in a contracting country for a limited number of days in a fiscal year that meets certain other requirements.

  • Professors and Teachers: Certain payments received for teaching or conducting research in a treaty country may be exempt from that country's income tax for a resident of the United States.

  • Provisions on tax credits: Most United States tax treaties allow a taxpayer to use a country tax credit or deduction based on the United States income tax.

  • Return on investment: A resident of the United States may be exempt from treaty country income tax on investment income, such as interest and dividends, received from a treaty country. In other circumstances, this income may be taxed at a reduced rate. Some treaties also exempt certain capital gains if the specified conditions are met.

  • Saving clauses: A safe clause states that a treaty does not affect U.S. taxes on its citizens and residents. Therefore, U.S. citizens and residents generally cannot use a treaty to reduce their tax payable in the United States. However, as far as the United States is concerned, most treaties contain exceptions to the saving clauses. These exceptions allow U.S. citizens or residents to use certain provisions of the Treaty.

  • Trainees, Students, and apprentices: Certain amounts received by the United States for education, research, or business, vocational, and technical training may be exempt from a country's tax treaty for a resident of the United States. In certain circumstances, payments received by students, trainees, and apprentices may be exempt from income tax in a treaty country.

Competent Authority

A US citizen or resident alien may seek assistance from the U.S. "competent authority" where the actions of a treaty country or the United States may: 

(i) Give rise to double taxation or 

(ii) Taxes incompatible with the treaty. 

Taxpayers requesting an exemption from the U.S. competent authority should consult a competent lawyer, file a request for credit protection or reimbursement promptly, and take the necessary steps in accordance with foreign procedures to avoid losing the right to file a complaint or a review by the authority under the income tax laws of that country.



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