International Tax Newsletter
Recent Income Tax Treaty Changes By Sandra M. Spector The U.S. is now participating in a new income tax treaty with Japan that replaces a treaty executed in 1971. In addition, the U.S. and Netherlands have executed a protocol to the existing 1992 income tax treaty and 1993 protocol. The highlights of both the new treaty with Japan and the Dutch protocol are set forth below. Japan-U.S. Income Tax Treaty The new treaty (the Treaty) substantially reduces withholding taxes on dividends, interest, and royalties in certain situations. These reductions went into effect on July 1, 2004. Please note that, to take advantage of the provisions in the new treaty, a U.S. person must submit certification of U.S. residency to the Japanese payor in addition to completing certain other applications depending on the type of income at issue. Dividends The Treaty reduces the general withholding tax rate on dividends paid from 15 percent to 10 percent. It also reduces the withholding tax rate for dividends paid to corporate shareholders resident in the other country to 5 percent. Further, dividends paid to corporate shareholders and pension funds that satisfy certain conditions are exempt from withholding tax. Corporate shareholders must satisfy a voting power requirement as well as certain limitation on benefits provisions to qualify for the exemption. In order to meet the voting power requirement, the beneficial owner of the dividend must, in all cases, own more than 50 percent of the voting stock of the payor for a 12-month period ending on the date to which the “entitlement” to the dividend is determined. This requirement may be satisfied through indirect ownership if all intermediate owners are residents of either the U.S. or Japan. In addition to satisfying the ownership test set forth above, a corporate shareholder must satisfy certain conditions described in Article 22, Limitations on Benefits. Thus, a company must meet either the “publicly traded” test, the “ownership” and “base erosion test,” or have been granted benefits by the competent authorities. As noted above, a corporate shareholder that does not qualify for exemption may qualify for the 5 percent rate if it is the beneficial owner of the dividend and it owns at least 10 percent of the voting stock of the company on the date on which the dividend is declared. As with other current U.S. treaties, special rules apply to dividends paid by regulated investment companies (RICs) and real estate investment trusts (REITS). The U.S. withholding rate on dividends paid by a RIC to a resident of Japan is 10 percent (unless the shareholder is a pension fund that is exempt from withholding tax). Dividends paid by a REIT are subject to a 10 percent withholding rate (or exempt if the shareholder is a pension fund) if certain conditions are satisfied. Interest The Treaty retains the 10 percent withholding tax on interest, but expands the category of persons entitled to exemption from withholding tax. The exemption generally applies to banks, investment banks, insurance companies, registered securities, and other bank-like entities that, for three taxable years before the taxable year in which the interest is paid, derive more than 50 percent of liabilities from issuing bonds in the financial markets or taking deposits, and have more than 50 percent of assets in debt claims of unrelated persons. Please note that interest on parent-subsidiary debt is generally subject to 10 percent withholding tax. Further, the Treaty continues to address payments of interest between related parties that are greater than an arm’s length amount. Withholding tax is imposed on the excess of the amount that would have been paid absent the relationship between the parties at a rate not to exceed 5 percent. Royalties The old treaty imposed a 10 percent withholding tax on cross-border royalty payments. Pursuant to the Treaty, withholding tax on royalties is generally eliminated. We note that a five percent withholding tax is imposed on non-arm’s length royalties paid to related parties. *Anticonduit Provisions* The Treaty also contains anticonduit provisions which limit the availability of reduced withholding under Articles 10 (Dividends), 11 (Interest), 12 (Royalties), and 21 (Other Income). These provisions deny treaty benefits to a resident when the resident is not viewed as the beneficial owner of the income. The new rules are significantly narrower than similar rules provided under U.S. domestic law and were included at the request of Japan to ensure that Japan can prevent residents of third countries from improperly obtaining benefits. For example, interest payments on back-to-back loans involving a third-country resident are not entitled to reduced withholding under the Treaty if the payments would have been subject to higher withholding tax rates if paid directly to the third-country resident. 2004 Dutch Protocol The Netherlands and the U.S. signed a protocol (the Protocol) and memorandum of understanding (MoU) on March 8, 2004, to amend the 1992 Tax Treaty and Protocol of 1993. The Protocol substantially reduces withholding taxes on dividends. (Royalties and interest income were already exempt from withholding pursuant under the 1993 protocol.) The Protocol also addresses the taxation of income received through hybrid entities and simplifies the limitation on benefits article of the former treaty. The Protocol entered into force on January 1, 2005. Dividends The Protocol retains the maximum rate of withholding tax of 15 percent and provides a 5 percent maximum rated for dividends to 10-percent corporate shareholders resident in the other country. Further, dividends paid to corporate shareholders and pension funds that satisfy certain conditions are exempt from withholding tax. Pursuant to the Protocol, dividends are exempt from withholding tax if the payor company is beneficially and directly owned by a company that has owned at least 80 percent of the voting power for the 12-month period ending on the date the dividend is declared and certain other conditions set forth in the Limitation on Benefits (LOB) designed to prevent treaty shopping are satisfied. In cases in which a company satisfies the LOB article only through “ownership/base erosion,” “active trade or business,” “headquarters company,” and/or “shipping/air transport” tests, the exemption will only apply if the company receiving the dividend held at least 80 percent of the voting power of the payor company prior to October 1, 1998. However, companies that qualify for benefits under the LOB through the “public trading,” “derivative benefits,” or “competent authority” tests will not need to meet the October 1, 1998. holding requirement in order to claim the exemption from withholding tax on dividends. Elimination of Branch Profits Tax Under the 1992 treaty, the branch profits tax rate was reduced to 5 percent. The Protocol reduces this rate to zero if certain conditions are met. These conditions generally correspond with those that apply to the elimination of dividend withholding tax as set forth above. Hybrid Entities The Protocol also contains new provisions that address income received through a hybrid entity. (A hybrid entity is an entity that is treated as a corporation in one country but as a partnership or a fiscally transparent entity in the other). Generally, an item of income paid to a hybrid entity is considered to be derived by an owner of the entity only to the extent that the income would be treated as income of the owner in the owner’s country of residence. This provision is intended to allow each country flexibility in resolving problems presented by such entities by allowing each country to take into account the tax treatment of the entity at issue under its own law as well as the law of the other country. The most typical hybrid entity situation involves a CV BV structure where the CV is a hybrid entity (i.e., a corporation for U.S. purposes but a partnership for Dutch purposes) and payments such as dividends are made from the BV to the CV. The CV is usually not resident in either the Netherlands or the U.S. The Dutch authorities have indicated that treaty benefits, especially the ability to qualify for the zero rate of withholding on dividends, may be available so long as the BV has an active business in the Netherlands. *Limitation on Benefits* In addition the Protocol substantially simplifies the Limitation on Benefits (LOB) provisions of the 1992 treaty and expands the number of persons that may qualify for benefits. The LOB provisions are generally similar to the LOB provisions in other U.S. treaties. The provision differs, however, in that it addresses U.S. concerns regarding inversion transactions by requiring public companies to satisfy additional requirements in order to qualify for benefits. Publicly traded companies must now meet a substantial presences test that requires both a minimum amount of shares to be traded on a local stock exchange as well as active management within the treaty country of residence. For more information about these tax treaty issues, please contact Sandra M. Spector 650.833.2137 sandra.spector@dlapiper.com or your DLA Piper Tax attorney. Circular 230 Notice: In accordance with Treasury Regulations which became applicable to all tax practitioners as of June 20, 2005, please note that any tax advice given herein (and in any attachments) is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of (i) avoiding tax penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. This publication is intended to provide clients with information on recent legal developments. It should not be construed as legal advice or legal opinion on specific facts. Pursuant to applicable Rules of Professional Conduct, it may constitute advertising. Published by DLA Piper Rudnick Gray Cary US LLP 401 B Street, Suite 1700, San Diego, California 92101-4297, USA Copyright © 2005 DLA Piper Rudnick Gray Cary US LLP You are receiving this communication because you are a valued client or friend of DLA Piper Rudnick Gray Cary US LLP. To unsubscribe from this mailing list, reply to this message with REMOVE in the subject line. Written requests may be sent to the address above, attention Marketing Department, and may take ten business days to process.	June 2005 Global Web Site » US Offices » US International Tax Practice »

International Tax Newsletter

Recent Income Tax Treaty Changes

The U.S. is now participating in a new income tax treaty with Japan that replaces a treaty executed in 1971. In addition, the U.S. and Netherlands have executed a protocol to the existing 1992 income tax treaty and 1993 protocol. The highlights of both the new treaty with Japan and the Dutch protocol are set forth below.

Japan-U.S. Income Tax Treaty

The new treaty (the Treaty) substantially reduces withholding taxes on dividends, interest, and royalties in certain situations. These reductions went into effect on July 1, 2004. Please note that, to take advantage of the provisions in the new treaty, a U.S. person must submit certification of U.S. residency to the Japanese payor in addition to completing certain other applications depending on the type of income at issue.

Dividends

The Treaty reduces the general withholding tax rate on dividends paid from 15 percent to 10 percent. It also reduces the withholding tax rate for dividends paid to corporate shareholders resident in the other country to 5 percent. Further, dividends paid to corporate shareholders and pension funds that satisfy certain conditions are exempt from withholding tax. Corporate shareholders must satisfy a voting power requirement as well as certain limitation on benefits provisions to qualify for the exemption.

In order to meet the voting power requirement, the beneficial owner of the dividend must, in all cases, own more than 50 percent of the voting stock of the payor for a 12-month period ending on the date to which the “entitlement” to the dividend is determined. This requirement may be satisfied through indirect ownership if all intermediate owners are residents of either the U.S. or Japan. In addition to satisfying the ownership test set forth above, a corporate shareholder must satisfy certain conditions described in Article 22, Limitations on Benefits. Thus, a company must meet either the “publicly traded” test, the “ownership” and “base erosion test,” or have been granted benefits by the competent authorities. As noted above, a corporate shareholder that does not qualify for exemption may qualify for the 5 percent rate if it is the beneficial owner of the dividend and it owns at least 10 percent of the voting stock of the company on the date on which the dividend is declared.

As with other current U.S. treaties, special rules apply to dividends paid by regulated investment companies (RICs) and real estate investment trusts (REITS). The U.S. withholding rate on dividends paid by a RIC to a resident of Japan is 10 percent (unless the shareholder is a pension fund that is exempt from withholding tax). Dividends paid by a REIT are subject to a 10 percent withholding rate (or exempt if the shareholder is a pension fund) if certain conditions are satisfied.

Interest

The Treaty retains the 10 percent withholding tax on interest, but expands the category of persons entitled to exemption from withholding tax. The exemption generally applies to banks, investment banks, insurance companies, registered securities, and other bank-like entities that, for three taxable years before the taxable year in which the interest is paid, derive more than 50 percent of liabilities from issuing bonds in the financial markets or taking deposits, and have more than 50 percent of assets in debt claims of unrelated persons. Please note that interest on parent-subsidiary debt is generally subject to 10 percent withholding tax.

Further, the Treaty continues to address payments of interest between related parties that are greater than an arm’s length amount. Withholding tax is imposed on the excess of the amount that would have been paid absent the relationship between the parties at a rate not to exceed 5 percent.

Royalties

The old treaty imposed a 10 percent withholding tax on cross-border royalty payments. Pursuant to the Treaty, withholding tax on royalties is generally eliminated. We note that a five percent withholding tax is imposed on non-arm’s length royalties paid to related parties.

Anticonduit Provisions

The Treaty also contains anticonduit provisions which limit the availability of reduced withholding under Articles 10 (Dividends), 11 (Interest), 12 (Royalties), and 21 (Other Income). These provisions deny treaty benefits to a resident when the resident is not viewed as the beneficial owner of the income. The new rules are significantly narrower than similar rules provided under U.S. domestic law and were included at the request of Japan to ensure that Japan can prevent residents of third countries from improperly obtaining benefits. For example, interest payments on back-to-back loans involving a third-country resident are not entitled to reduced withholding under the Treaty if the payments would have been subject to higher withholding tax rates if paid directly to the third-country resident.

2004 Dutch Protocol

The Netherlands and the U.S. signed a protocol (the Protocol) and memorandum of understanding (MoU) on March 8, 2004, to amend the 1992 Tax Treaty and Protocol of 1993. The Protocol substantially reduces withholding taxes on dividends. (Royalties and interest income were already exempt from withholding pursuant under the 1993 protocol.) The Protocol also addresses the taxation of income received through hybrid entities and simplifies the limitation on benefits article of the former treaty. The Protocol entered into force on January 1, 2005.

Dividends

The Protocol retains the maximum rate of withholding tax of 15 percent and provides a 5 percent maximum rated for dividends to 10-percent corporate shareholders resident in the other country. Further, dividends paid to corporate shareholders and pension funds that satisfy certain conditions are exempt from withholding tax.

Pursuant to the Protocol, dividends are exempt from withholding tax if the payor company is beneficially and directly owned by a company that has owned at least 80 percent of the voting power for the 12-month period ending on the date the dividend is declared and certain other conditions set forth in the Limitation on Benefits (LOB) designed to prevent treaty shopping are satisfied. In cases in which a company satisfies the LOB article only through “ownership/base erosion,” “active trade or business,” “headquarters company,” and/or “shipping/air transport” tests, the exemption will only apply if the company receiving the dividend held at least 80 percent of the voting power of the payor company prior to October 1, 1998. However, companies that qualify for benefits under the LOB through the “public trading,” “derivative benefits,” or “competent authority” tests will not need to meet the October 1, 1998. holding requirement in order to claim the exemption from withholding tax on dividends.

Elimination of Branch Profits Tax

Under the 1992 treaty, the branch profits tax rate was reduced to 5 percent. The Protocol reduces this rate to zero if certain conditions are met. These conditions generally correspond with those that apply to the elimination of dividend withholding tax as set forth above.

Hybrid Entities

The Protocol also contains new provisions that address income received through a hybrid entity. (A hybrid entity is an entity that is treated as a corporation in one country but as a partnership or a fiscally transparent entity in the other). Generally, an item of income paid to a hybrid entity is considered to be derived by an owner of the entity only to the extent that the income would be treated as income of the owner in the owner’s country of residence. This provision is intended to allow each country flexibility in resolving problems presented by such entities by allowing each country to take into account the tax treatment of the entity at issue under its own law as well as the law of the other country. The most typical hybrid entity situation involves a CV BV structure where the CV is a hybrid entity (i.e., a corporation for U.S. purposes but a partnership for Dutch purposes) and payments such as dividends are made from the BV to the CV. The CV is usually not resident in either the Netherlands or the U.S. The Dutch authorities have indicated that treaty benefits, especially the ability to qualify for the zero rate of withholding on dividends, may be available so long as the BV has an active business in the Netherlands.

Limitation on Benefits

In addition the Protocol substantially simplifies the Limitation on Benefits (LOB) provisions of the 1992 treaty and expands the number of persons that may qualify for benefits. The LOB provisions are generally similar to the LOB provisions in other U.S. treaties. The provision differs, however, in that it addresses U.S. concerns regarding inversion transactions by requiring public companies to satisfy additional requirements in order to qualify for benefits. Publicly traded companies must now meet a substantial presences test that requires both a minimum amount of shares to be traded on a local stock exchange as well as active management within the treaty country of residence.

For more information about these tax treaty issues, please contact

Sandra M. Spector
650.833.2137
sandra.spector@dlapiper.com

or your DLA Piper Tax attorney.

Circular 230 Notice: In accordance with Treasury Regulations which became applicable to all tax practitioners as of June 20, 2005, please note that any tax advice given herein (and in any attachments) is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of (i) avoiding tax penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

This publication is intended to provide clients with information on recent legal developments. It should not be construed as legal advice or legal opinion on specific facts. Pursuant to applicable Rules of Professional Conduct, it may constitute advertising.

Published by DLA Piper Rudnick Gray Cary US LLP
401 B Street, Suite 1700, San Diego, California 92101-4297, USA

You are receiving this communication because you are a valued client or friend of DLA Piper Rudnick Gray Cary US LLP.

To unsubscribe from this mailing list, reply to this message with REMOVE in the subject line. Written requests may be sent to the address above, attention Marketing Department, and may take ten business days to process.

June 2005

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