US Tax law. The Limitation-on-Benefits-Clause and US national anti abuse rules

Table of Content

Table of Content

Abbreviations

1. Introduction

2. Purpose and basic operation of the LOB

3. Structure of the Article
3.1 Individuals and Contracting States
3.2 Publicly-Traded-Corporations
3.3 Tax-Exempt Organizations and Pension Funds
3.4 Other legal entities

4. National anti-abuse rules

5. Summary

Register of Literature

Register of legal sources

Register of jurisdictions

Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1. Introduction

Double Taxation Treaties (“DTT“) are treaties between two or more countries to avoid international double taxation of income and property of individuals or legal entities. The main purpose of DTT is to divide the right taxation between the involved countries, to avoid differences in taxation and to ensure taxpayers’ equal rights and security. International tax planning has become a serious concern and companies started to shift their income to low-taxed jurisdictions. Therefore, states with a higher taxation fear for their tax revenues.¹ That is the reason why the prevention of abusive use of tax treaty benefits became a central aspect in the tax treaty policy of most industrialized countries.²

In order to prevent tax avoidance and tax evasion, states came up with different approaches.³ While Germany, in its treaty policy seeks to avoid the abusive use of DTT by referring to national anti abuse rules,⁴ the USA always insisted on the conclusion of an anti abuse rule in the DTT, the so-called “Limitation of Benefits Clause“ (“LOB“).⁵

Over the years, the USA has implemented several other national abuse regulations that also need to be reviewed in order to benefit from specific tax reliefs, e.g. Conduit Principles or Economic Substance Doctrine.⁶

The aim of this paper is to provide an overview of the national and international anti­abuse regulations of the USA. In doing so, the basics of the LOB will be presented first and selected aspects will be discussed. This leads to particular attention to the tests as for example Base-Erosion-Tes t, Derivative-Benefit-Test and the Active­Business-Test. For clarification purposes and the scope of this paper, Art. 28 sec. 5 and 6 are not discussed.

Subsequently, the national anti abuse provisions of the USA are explained. Inclusion the paper summarizes the results of the work.

2. Purpose and basic operation of the LOB

The LOB is a highly complex and extensive anti-treaty shopping provision intended to prevent resident of third countries from obtaining benefits under a tax treaty that were not intended for them. Moreover, the LOB is permanently adapted to current tax developments, therefore becomes more slender and more detailed with every update.⁷ These updates generally impose tighter restrictions for the taxpayer to achieve the benefits.⁸ Furthermore, the LOB does not rely on a determination of purpose or intention of the taxpayer but instead sets a forth series of objective tests. That means, that a taxpayer who satisfies one of the tests included will benefit from the DTT, regardless of its motivation. The reason for this is the view that someone who passes one of the tests has a sufficient connection to the resident state, which is more extensive than mere residency.⁹ The burden of proof regularly bears on the resident.¹⁰

Moreover, the LOB is factually linked to the specific requirement of being resident in one of the Contracting States and constitutes one of the exceptions provided for in Article 1, paragraph 1 of the DTT („ ...except as otherwise provided in this Convention“).

3. Structure of the Article

Paragraph 1 provides for the principle that a resident of a Contracting State may only benefit from the DTT, if the resident defines additionally as a “qualified person“ within the meaning of paragraph 2.¹¹ Paragraph 2 includes six additional subparagraphs, each describing a different type of resident being entitled to all benefits of the DTT. At this point it should be noted that paragraph 2 applies to all income of the entitled resident. In contrast to that, a person that qualifies as an entitled person under paragraph 3,4 or 7 has to pass the tests for each type of income. The following subsections deal with the conditions under which an entitled person within the meaning of paragraph 2 is considered to exist. In particular, emphasis will be given to the tests included in respective paragraphs.

3.1 Individuals and Contracting States

Subparagraph 2(a) provides a resident individual in a Contracting State will be entitled to all benefits of the DTT without any further conditions to be satisfied.¹² Nevertheless, an individual must also be the beneficial owner of the income, otherwise benefits may be denied under respective articles of the DTT.¹³

Apart from that, subparagraph 2(b) provides that also the Contracting States Germany and USA and their regional and local authorities¹⁴ are entitled to benefit from all benefits of the DTT without any further conditions to be met.^{15 16} This appears to be reasonable due to their given residence by nature.

3.2 Publicly-Traded-Corporations

Subparagraph 2(a) and 2(b) appear to be very clear and straightforward, whereas subparagraph 2(c) provides for more complicated rules regarding publicly-traded- corporations (subparagraph 2(c) (aa)) and their subsidiaries (subparagraph 2(c) (bb)).16 A corporation is generally entitled to all benefits of the DTT, if their principal class of shares¹⁷ are regularly traded on one or more stock exchanges. Additionally, the resident¹⁸ corporation has to the satisfy at least one of the following tests.¹⁹ Thus it is ensured, that the benefits of the DTT are not solely granted by the fulfillment of formal regulations. Firstly, the company’s principal class of shares is primarily and regularly traded on a recognized stock exchange located in in a Contracting State (public trading test), where the corporations is defined to be resident according to Art. 4 of the DTT.²⁰ The term regularly indicates that a mere listing on the stock exchange is not regarded as sufficient.²¹ Secondly, the corporations primary place management and control is located in its state of residency. It should be emphasized, that the primary place of management and control does not correspond to the concept of the effective place of management as defined under art. 4 paragraph 3. Whereas the effective place of management is determined by the decisions of day-to-day business, the primary place of management and control is defined by the place where long term management policy decisions are made and controlled.²² The last mentioned test was introduced to include potential cases, in which too less public trading takes place (perhaps) due to the size of the stock exchange. Nevertheless, this test is of only minor importance, since there is generally sufficient regular trade on stock exchanges regarding German publicly traded corporations.²³

In addition, subsidiaries of an entitled corporation are qualified to benefit under subparagraph 2 (c) (aa) provided that further requirements are met. Subparagraph 2 (c) (bb) provides that a resident corporation is entitled to all benefits of the DTT, if at least 50 % of the corporation’s shares are held by a maximum of five publicly traded corporation as described under subparagraph 2 (c) (aa).²⁴ This requires that at least half of the voting rights and, in case of preferred shares, half of the value of the corporation (subsidiary test). The purpose is to prevent third country residents to benefit from the DTT by a joint venture vehicle.²⁵ In case, the publicly traded corporations are indirect shareholders, the intermediate corporation must additionally qualify as a resident of one of the Contracting States.

3.3 Tax-Exempt Organizations and Pension Funds

Subparagraph 2 (d) provides that certain tax-exempt organizations should be entitled to all benefits of the DTT, without regard to the residency of the beneficiaries or members.²⁶ Such tax-exempt organizations must be established under the law of the respective Contracting State.²⁷ From the reference to the respective national law it can be deduced that for Germany, Körperschaften, Personenvereinigungen and Stiftungen can be considered to be applicable.²⁸ For the USA, Corporations, Associations and Trusts are taken into consideration.²⁹ Since the subparagraph explicitly outlines that the tax-exempt entity must be established under the law of one of the Contracting States, it can be concluded that legal entities that were established in another than the Contracting States are not entitled to benefit from the DTT. This also applies, if the foreign corporations transfers its effective place of management to a Contracting State and is considered to be resident according to art. 4 sec. 3. At this it is irrespective whether to legal entity continues to pursue charitable business.³⁰

Furthermore the tax-exempt legal entity must maintained exclusively for a charitable purpose. The technical explanations to the DTT especially outline religious, educational, charitable or scientific purposes. By including similar purposes, it is clarified that slightly deviating charitable purposes are not harmful.³¹ Since such purposes are not specified in the DTA, the general national laws must be applied. In general, there are no significant difference from German law.³² Thus, subparagraph 2 (d) can be easily applied.

Apart from this, subparagraph 2 (e) states that a legal entity, established and maintained under the laws of the respective Contracting State,³³ that provides pension, pursuant to plan, or other similar benefits to employed or self-employed persons, is generally entitled to benefit to all benefits under the DTT, provided that one of the following requirements is met.³⁴

The pension fund is regarded as an entitled person, if more than 50 % of the beneficiaries³⁵ are resident in the Contracting States. It is not necessary, that the beneficiaries and the pension are both resident in the same Contracting State. Alternatively, independently from the residency of the beneficiaries, a pension fund can still be regarded as an entitled person, if the the parent company of the pension fund itself is entitled to benefit from the DTT due to another subparagraph of the LOB. For example, this would be the case if the parent company would be qualified as a publicly traded corporation. Thus, the residency of the beneficiaries would no longer be decisive.³⁶

3.4 Other legal entities

Subparagraph 2 (f) applies for any legal entity that is resident in one of the Contracting States, which cannot benefit from the DTT under the preceding subparagraphs described above. For that, the respective legal entity has to satisfy two highly complex tests.

The so-called ownership-test described in subparagraph 2 (f) requires that 50 % of the shares of the legal entity are held directly or indirectly by residents according to the preceding subparagraphs (a), (b), (d), (e) or clause (aa) of subparagraph (c) for at least half the days of the legal entity's taxable year.³⁷ At this point, it is important to outline that a temporary shortfall or excess has no negative nor positive consequences. This also applies, if the minimum participation level of 50 % has not been reached at the time of taking benefit from the DTT.³⁸

[...]

¹ Cf. Haarmann, W., IStR 2018, p. 1.

² Cf. Schnittker, H., IStR 2012, p. 720; Technical Explanations, US - German Protocol, p. 42.

³ Cf. Haarmann, W., IStR 2018, p. 1.

⁴ Cf. e.g. Sec. 50d, paragraph 3 GITA; Sec. 42 GTC.

⁵ Cf. Schnittker, H., IStR 2012, p. 720.

⁶ Please the chapter 4 for further explanations regarding the US national anti abuse rules.

⁷ Cf. DTT GER- USA, 1989, Article 28; DTT GER-USA, 2006, Article 28.

⁸ Cf. Jacob, F., IStR, 2011, pp. 45f.; e.g. for more detailed information regarding the Limitation-on- benefit clauses relating to investment funds, see Schnaufl, M., (PIStB 2011), pp. 335 ff.

⁹ Cf. Technical Explanations, US - German Protocol, Sec. 28, paragraph 1.

¹⁰ Cf. Linn, A., in Wassermeyer (publisher), DBA USA, Art. 28 rec. 21, supplement 147, 10/2019; G/K/G, DBA USA, Art. 28 rec. 12.

¹¹ Cf. Linn, A., in Wassermeyer (publisher), DBA USA, Art. 28 rec. 21, supplement 147, 10/2019.

¹² Cf. Kahlenberg, C., IStR 2020. p. 17; Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2(a); Linn, A., in Wassermeyer (publisher), DBA USA, Art. 28 rec. 21, supplement 147, 10/2019.

¹³ Cf. Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2(a); Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 38, supplement 147, 10/2019.

¹⁴ For Germany e.g. Länder, Kreis, Städte and Gemeinden; for USA States and Communities. Cf. Gohr, M., n: E/J/G/K, DBA USA, Art. 28 rec. 20.

¹⁵ Cf. Gohr, M., in: E/J/G/K, DBA USA, Art. 28 rec. 20; Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2 (a); Linn, A., in Wassermeyer (publisher), DBA USA, Art. 28 rec. 38, supplement 147, 10/2019.

¹⁶ Which is also reflected in the short technical explanations by the tax authorities and comments of the literature.

¹⁷ In case, a corporations has more than one class of shares (e.g. preferred shares and common shares), it is initially necessary to determine which class defines as principal class of shares; cf. Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2(c)(aa); Linn, A., in Wassermeyer (publisher), DBA USA, Art. 28 rec. 153, supplement 147, 10/2019.

¹⁸ Residency is determined by general rules of Article 4 of the DTT.

¹⁹ The additional tests were introduced in order to avoid so-called „corporate inversion transactions“,whereby US group’s parent corporations were moved outside the USA. For further information see e.g. Blöchle, D./ Dendorfer, W./ Kresge, T., IStR 2005, S. 700; Sheppard, L., TNI 2004, S. 387; § 7874 IRC.

²⁰ Cf. Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2(c) (aa); Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 44 ff, supplement 147, 10/2019; Cf. Schnittker, H., IStR 2012, p. 721.

²¹ Cf. Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 44 ff, supplement 147, 10/2019.

²² Cf. Wassermeyer, F./ Schönfeld, J., DB 2006, 1970; Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 162, supplement 147, 10/2019.

²³ Cf. Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 52 ff, supplement 147, 10/2019; Treasury Report to the Congress, p. 81.

²⁴ Cf. Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2(c) (bb); Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 53 ff, supplement 147, 10/2019; Schnittker, H., IStR 2012, p. 721.

²⁵ Cf. Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 56, supplement 147, 10/2019.

²⁶ Cf. Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2(d).

²⁷ The Technical Explanation to the DTT especially outline religious, educational and scientific purposes. Further purposes are explicitly conceivable (... other similar purposes). Cf. Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2 (d).

²⁸ Cf. §§ 51 Sec. 2 GTC i.c.w. 1 Sec. 1 GITA.

²⁹ Cf. IRC Sec. 501 (c) (3), (d).

³⁰ According to German Federal Fiscal Court this could be regarded as a violations of European fundamental freedoms rights, because foreign companies are treated differently than national (German) corporations. Nevertheless, since the USA are not bound to the European fundamental freedom rights, this does not apply. Finally, it could only be criticized, that Germany confirmed such DTT. Cf. ECJ 9 Sept. 2014, C-.386/04; Proff, M., IStR 2007, p. 269.

³¹ Cf. Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 61 rec. 56, supplement 147, 10/2019.

³² Cf. §§ 52-54 GTC; IRC Sec. 501 (c) (3).

³³ With regard to the terms established and maintained under the laws of the respective Contracting State the explanation related to tax-exempt organizations apply accordingly.

³⁴ Cf. Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2 (e); Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 66 ff, supplement 147, 10/2019; Schnittker, H., IStR 2012, p. 721.

³⁵ Beneficiaries should be understood as the persons received pensions (or similar benefits) from the pension fund. Cf. Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2 (e).

³⁶ Cf. Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 69 ff, supplement 147, 10/2019.

³⁷ Cf. Kahlenberg, C., IStR 2020, p. 18, Technical Explanations, US - German Protocol, Sec. 28, subparagraph 2 (f); Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 75 ff, supplement 147, 10/2019.

³⁸ Cf. Linn, A., in: Wassermeyer (publisher), DBA USA, Art. 28 rec. 75 ff, supplement 147, 10/2019.