New U.S. model income tax treaty (2016) is released

Revised U.S. model income tax treaty (2016)

The U.S. Treasury Department today announced the release of a newly revised “U.S. Model Income Tax Convention” that will serve as the baseline text that Treasury will use as it negotiates tax treaties. Today’s release is the first update to the U.S. model income tax treaty since 2006.

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Overview

According to a Treasury Department release, the 2016 model income tax treaty includes:
  • A number of provisions intended to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance; however, it does not reduce withholding taxes on payments of “highly mobile income”—income that taxpayers can easily shift around the globe through deductible payments such as royalties and interest—that are made to related persons that enjoy low or no taxation with respect to that income under a preferential tax regime.  
  • Updates reflecting technical improvements developed in the context of bilateral tax treaty negotiations and do not represent substantive changes to the prior model.
  • A new article that obligates treaty partners to consult with a view to amending the treaty as necessary when changes in the domestic law of a treaty partner draw into question the treaty’s original balance of negotiated benefits and the need for the treaty to reduce double taxation.
  • Measures to reduce the tax benefits of corporate inversions—it denies reduced withholding taxes on U.S. source payments made by companies that engage in inversions to related foreign persons.
  • Rules requiring that disputes between tax authorities regarding the application of tax treaties be resolved through mandatory binding arbitration—the “last best offer” approach to arbitration in the new model income tax treaty is substantively the same as the arbitration provision in four U.S. tax treaties in force and three U.S. tax treaties that are awaiting the advice and consent of the Senate. 

Treasury reports that the 2016 model income tax treaty reflects changes made in response to comments received to the proposed model treaty provisions released in May 2015. 

KPMG observation

The 2016 model income tax treaty also incorporates certain OECD base erosion and profit shifting (BEPS) recommendations including:

  • Preamble language clarifying that the purpose of a tax treaty is the elimination of double taxation without creating opportunities for non-taxation or reduced taxation
  • An anti-fragmentation rule in Article 5 intended to prevent contract-splitting to meet the 12-month permanent establishment threshold for building sites or construction or installation projects
  • A 12-month ownership and residency requirement for the 5% withholding rate for direct dividends under Article 10

Notably, the U.S. 2016 model income tax treaty does not adopt the other BEPS recommendations relating to the permanent establishment article including the revised rules related to dependent and independent agents and the exemption for preparatory and auxiliary activities. 

Technical explanation expected

The Treasury release states that Treasury is preparing a detailed technical explanation of the 2016 model income tax treaty to be release this spring. The preamble to the model income tax treaty invites comments regarding certain situations that need to be addressed in the technical explanation for the so-called “active trade or business” test of Article 22 (Limitation on Benefits).  The deadline for public comments on this subject is April 18, 2016.

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