What is a Tax Treaty Benefit and how can it help you?

What are the objectives of income tax treaties?

The primary aim of an income tax treaty is to facilitate cross-border trade and investment by removing tax barriers hindering these transactions. This overarching objective is complemented by specific operational and ancillary goals, including:

• reducing or eliminating double taxation;
• combating tax evasion, avoidance, or instances of double non-taxation (ensuring that income is taxed once and only once);
• preventing discrimination against foreign nationals and non-residents;
• enhancing administrative cooperation between treaty countries through mechanisms such as information exchange, assistance in tax collection, and dispute resolution.

Income tax treaties ultimately provide certainty for taxpayers and allocate tax revenues arising from cross-border activities between the treaty countries. 

Do US income tax treaties benefit US taxpayers?

Treaty provisions are generally reciprocal, i.e. they apply to both treaty countries. Therefore, treaty provisions may affect the foreign tax that a US citizen or resident must pay on income sourced in the treaty country.

As the proof of entitlement to the treaty benefits, foreign taxing authorities sometimes require certification from the US government that an applicant filed an income tax return as a US citizen or resident. The applicant should use IRS Form 8802 (Application for United States Residency Certification) to request such certification. 

Do US income tax treaties reduce US tax for US taxpayers?

US income tax treaties reduce the US taxes for residents of foreign countries. With certain exceptions, they do not reduce the US taxes for US citizens or residents. US citizens and residents are subject to US income tax on their worldwide income. Income tax treaties, however, can reduce the foreign taxes for US citizens or residents. 

Can US income tax treaties increase tax?

In general, income tax treaties do not impose or increase tax. Tax is imposed by domestic tax law.

Income tax treaties limit the taxes otherwise imposed by a treaty country. The effect of income tax treaties is primarily relieving in nature. 

Do US income tax treaties apply to state and local taxes?

In general, income tax treaties apply to all income and capital taxes imposed by the treaty countries. US tax treaties, however, apply only to national taxes. Accordingly, taxes imposed by state (i.e. provincial), local, and other sub-national governments are not subject to US income tax treaties. 

Which countries have income tax treaties with the United States?

As of the time of this blog, the US income tax treaty network extends to approximately 65 countries worldwide, including: Armenia, Australia, Austria, Azerbaijan, Bangladesh, Barbados, Belarus, Bulgaria, Canada, China, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Georgia, Germany, Greece, Hungry (Terminated), Iceland, India, Indonesia, Ireland, Israel, Italy, Jamaica, Japan, Kazakhstan, Korea, Kyrgyzstan, Latvia, Lithuania, Luxembourg, Malta, Mexico, Moldova, Morocco, Netherlands, New Zealand, Norway, Pakistan, Philippines, Poland, Portugal, Romania, Russia, Slovak Republic, Slovenia, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Tajikistan, Thailand, Trinidad and Tobago, Tunisia, Turkey, Turkmenistan, Ukraine, Venezuela, United Kingdom, and Uzbekistan. 

Who is eligible for treaty benefits?

Taxpayers can claim income tax treaty benefits if they qualify as residents of the treaty country under the residence article of the treaty. Qualification under the “limitation on benefits” (LOB) article of the treaty is also required.

The LOB article is an anti-treaty shopping provision intended to ensure that only genuine residents, who have a substantial connection to the treaty country, can enjoy the benefits of the tax treaty, thereby preventing misuse of the treaty's provisions.  

What is the saving clause?

Most income tax treaties that the United States has concluded contain a “saving clause” that preserves the right of each country to tax its own citizens and treaty residents as if no tax treaty were in effect. As a result, the saving clause will, in many cases, prohibit US citizens and residents from reducing or eliminating their US tax based on treaty provisions.

Certain types of income are generally exempt from the application of the saving clause. Consequently, certain tax treaty benefits associated with these income types may be extended to a US citizen or resident. 

Which types of income are subject to income tax treaties?

U.S. tax treaties with other countries can lower or eliminate U.S. taxes on various types of income for foreign taxpayers like nonresident individuals or foreign businesses. This includes business profits, income from personal services, and certain other incomes such as dividends, interest, royalties, capital gains, pensions, social security, and educational grants, provided they're not considered wages. However, these treaties often set a time limit on how long you can receive these tax benefits, particularly for students, apprentices, trainees, teachers, professors, and researchers. If you exceed this limit, you may lose these benefits and, in some cases, might have to pay back taxes for the years you were over the limit.

What's the procedure for claiming treaty benefits?

If an income tax treaty between the United States and the foreign payee's country of residence provides an exemption from, or a reduced rate of, withholding for certain items of income, the payee should notify the payor of the income (i.e. the withholding agent) of the payee's foreign status to claim the benefits of the treaty.

Generally, the payee does this by furnishing the following forms to the withholding agent:

• for income earned from personal services - a fully completed IRS Form 8233 (Exemption from Withholding on Compensation for Independent (& Certain Dependent) Personal Service of a Nonresident Alien Individual with the withholding agent)); and
• for income that is not earned from personal services - a fully completed IRS Form W-8 BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding) or IRS Form W-8 BEN-E (Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)).

If the payee claims tax treaty benefits that override or modify any provision of the US Internal Revenue Code, potentially resulting in a reduction of their tax liability under the treaty, the payee generally must attach a fully completed IRS Form 8833 (Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)) to the payee's US income tax return. 

Generally, the beneficial owner of income is the person who is required under US tax principles to report the payment as part of their gross income on a tax return. A person is not a beneficial owner of income, however, if that person is receiving the income as a nominee, agent or custodian, or if the person is a conduit whose participation in a transaction is disregarded. In the case of payments that are not classified as income, beneficial ownership is determined as if the payment were income.

Is relief available when treaty benefits are denied?

Generally, US residents who are covered by a US income tax treaty can seek help from the US competent authority if they are been denied tax treaty benefits or face double taxation or taxation that is otherwise inconsistent with the treaty. However, the US competent authority cannot address issues involving countries without a tax treaty with the US.

The office of the US competent authority lies within the Large Business and International (LB&I) Division of the US Internal Revenue Service (IRS).