The Department of Treasury recently released an updated version of the U.S. Model Income Tax Convention, which is used to draft new and updated tax treaties between the U.S. and foreign countries. While the purpose of the new model convention remains the same, that is, to reduce instances of double taxation for multinational companies, the updated version contains a number of new provisions designed to prevent certain transactions that are perceived as abusive.
The new Model Treaty provided significant updates to the “Limitation on Benefits” provision. For the first time, the “derivative benefits test,” as seen in some more recent treaties, has now been added. Additionally, the definition of a “Permanent Establishment” has been modified to address situations where a third country is used to improperly obtain treaty benefits. A section was also added to attempt to further address the inversion issue as defined in IRC § 7874 by denial of certain withholding reductions on U.S.-sourced payments made by an expatriated entity.
Two new interesting provisions were included that could restrict treaty benefits by looking to the tax system of the treaty partner. First, Article 28 requires parties to the convention to consult with each other when a change in domestic law of one party shifts the balance of benefits originally negotiated between the parties. Secondly, benefits may be restricted if it is determined that the other party has instituted a “preferential tax regime.”
Treasury has released a preamble to the new Model Convention that discusses some of the changes between the 2006 Model Convention and the 2016 Model Convention, and is planning the updated Technical Explanation of the 2016 Model Convention.
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