Eligibility for Treaty Benefits Under The U.K.-U.S. Income Tax Treaty

Eligibility for Treaty Benefits Under

U.K.-U.S. Income Tax Treaty

by John Venuti, Ron Dabrowski, Douglas Poms, and

Alexey Manasuev

Reprinted from Tax Notes Int’l, March 23, 2009, p. 1095

Volume 53, Number 12 March 23, 2009

Eligibility for Treaty Benefits Under U.K.-U.S. Income

Tax Treaty

by John Venuti, Ron Dabrowski, Douglas Poms, and Alexey Manasuev

o be entitled to benefits under income tax treaties,

companies must satisfy eligibility requirements.

This article includes flowcharts to help practitioners

navigate the eligibility requirements of the U.K.-U.S.

income tax treaty applicable to companies, in particu-

lar the eligibility requirements for a 0 percent withhold-

ing tax rate on dividends.

Income tax treaties may exempt business income

from source-country income taxes and may exempt

from tax, or reduce domestic withholding tax rates on,

some payments between residents of countries that are

parties to an income tax treaty. U.S. income tax treaties

contain eligibility requirements. A company claiming

benefits must not only be a resident of the tax treaty

partner, but must also satisfy at least one of the tests in

the limitation on benefits provision included in most

U.S. income tax treaties.

This article contains decision-making flowcharts that

focus on the eligibility of companies claiming benefits

from the United States under the U.K.-U.S. income tax

treaty.

However, this article does not address the eligi-

bility for treaty benefits of entities that are partnerships

or are otherwise transparent for U.S. or U.K. tax pur-

poses. The article is based on the provisions of the

U.K.-U.S. income tax treaty, the protocol to the treaty,

and the U.S. Treasury technical explanation to the

treaty.

This article is the fourth in a series of articles that

provide flowcharts to help practitioners determine a

company’s eligibility for tax treaty benefits under the

LOB provision of specific U.S. income tax treaties and,

when applicable, determine eligibility for a 0 percent

withholding tax rate on cross-border intercompany

dividend payments to the company. This article ad-

dresses the eligibility of companies for a 0 percent

withholding tax rate on dividends under article 10.3

and the LOB provision (article 23) of the U.K.-U.S.

income tax treaty. (For prior coverage, see Tax Notes

Int’l, Jan. 14, 2008, p. 181, Doc 2007-27516,or2008

WTD 12-10; Tax Notes Int’l, Feb. 11, 2008, p. 523, Doc

2008-773,or2008 WTD 33-10; and Tax Notes Int’l, July

21, 2008, p. 285, Doc 2008-14359,or2008 WTD 142-8.)

Convention Between the Government of the United King-

dom of Great Britain and Northern Ireland and the Government

of the United States of America for the Avoidance of Double

Taxation and the Prevention of Fiscal Evasion With Respect to

Taxes on Income and on Capital, signed July 24, 2001. (For the

income tax treaty, see Doc 2001-20046 or 2001 WTD 143-14.)

John Venuti and Ron Dabrowski are principals, Douglas Poms is a director, and Alexey Manasuev is a

manager in the International Corporate Services Group of KPMG’s Washington National Tax Practice.

The information contained herein is of a general nature and based on authorities that are subject to

change. Applicability of the information to specific situations should be determined through consultation

with your tax adviser. This article represents the views of the authors only, and does not necessarily rep-

resent the views or professional advice of KPMG LLP.

work of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights

reserved.

(Footnote continued in next column.)

TAX NOTES INTERNATIONAL MARCH 23, 2009 • 1095

The article contains eight flowcharts analyzing the

LOB provision as applied to companies. The flow-

charts may serve as a useful practice tool for practition-

ers. Although the flowcharts provide a comprehensive

review of applicable provisions in the U.K.-U.S. in-

come tax treaty, taxpayers and their tax advisers should

carefully evaluate each case and determine whether the

requirements of the treaty are met based on all facts

and circumstances. ◆

SPECIAL REPORTS

1096 • MARCH 23, 2009 TAX NOTES INTERNATIONAL

Is the beneficial owner

a resident of the United

Kingdom?

Yes

The term “dividend” is defined “broadly and

flexibly.” The definition is intended to cover all

arrangements that yield a return on an equity

investment in a corporation as determined

under the tax law of the state of source (U.S.),

as well as arrangements that might be

developed in the future. As such, this term

includes income from shares, or other

corporate rights that are not treated as debt

under the law of the source state (U.S.) that

participate in the profits of the company. The

term also includes income that is subjected to

the same tax treatment as income from shares

by the law of the state of source (U.S.). Thus, a

constructive dividend that results from a non-

arm's-length transaction between a corporation

and a related party is a dividend. Finally, a

payment denominated as interest that is made

by a thinly capitalized corporation may be

treated as a dividend to the extent that the debt

is recharacterized as equity under the laws of

the source state (U.S.). In the case of the

United States, the term “dividend” includes

amounts treated as a dividend under U.S. law

upon the sale or redemption of shares or upon

a transfer of shares in a reorganization. See,

e.g., Rev. Rul. 92-85, 1992-2 C.B. 69. Further,

a distribution from a U.S. publicly traded limited

partnership, which is taxed as a corporation

under U.S. law, is a dividend for purposes of

article 10. However, a distribution by a limited

liability company is not characterized by the

United States as a dividend, provided the

limited liability company is not characterized as

an association taxable as a corporation under

U.S. law. Article 10.5; U.S. Treasury

Technical Explanation to the U.K.-U.S.

Treaty.

The term "beneficial owner" is not defined in

the Treaty and is defined as under the internal

law of the country imposing tax (i.e., the source

country, the U.S.). The beneficial owner of the

dividend for purposes of article 10 is the person

to which the dividend income is attributable for

tax purposes under the laws of the source state

(U.S.). Thus, if a dividend paid by a corporation

that is a resident of one of the states (as

determined under article 4 (residence)) is

received by a nominee or agent that is a

resident of the other state on behalf of a person

that is not a resident of that other state, the

dividend is not entitled to the benefits of this

article. However, a dividend received by a

nominee on behalf of a resident of that other

state would be entitled to benefits. These

limitations are consistent with paragraph 12 of

the OECD commentary to article 10. See also

paragraph 24 of the commentary to article 1 of

the OECD model. U.S. Treasury Technical

Explanation to the U.K.-U.S. Treaty.

Does the company

meet the specified LOB

test? (.)See Charts 2-8

Eligible to claim 0 percent

withholding tax rate on dividends.

Not eligible to claim

0 percent withholding

tax rate on dividends.

Should consider

discretionary

determination by the

competent authority

under article 23.6.

(.)See Chart 8.

“Resident of a contracting state” generally

means any person who, under the laws of that

state, is liable to tax therein by reason of his

domicile, residence, citizenship, place of

management, place of incorporation, or any

other criterion of a similar nature. This term

also includes certain pension funds, certain

charitable entities, and qualified governmental

entities. The term, however, does not include

any person who is liable to tax in that state

regarding only income from sources in that

state or of profits attributable to a permanent

establishment in that state. Articles 4.1 and

4.3 of the U.K.-U.S. Treaty.

Istheentityapensionfundthat

is a resident of the United

Kingdom, provided that such

dividends are not derived from

the carrying on of a business,

directly or indirectly, by such

pension fund? Article 10.3(b).

* Article references are to the articles of the U.K.-U.S. income tax treaty, as amended by protocol.

Yes

Is the company a

U.K. company?

Yes

The U.K.-U.S. Treaty provides for

certain exceptions and rules

regarding dividends paid by

pooled investment vehicles. See

articles 10.4 and 10.10(b), (c), for

more detail and relevant

definitions; U.S. Treasury

Technical Explanation to the

U.K.-U.S. Treaty.

Has the company owned sharesdirectly

representing 80 percent or more of the

voting power in the company paying the

dividends for a 12-month period ending on

the date the dividend is declared?

(“

80%/12-month requirement”) Article

10.3(a); U.S. Treasury Technical

Explanation to the U.K.-U.S. Treaty.

Chart 1. Eligibility for 0 Percent Withholding Tax Rate on Dividend

Under Article 10.3 of U.K.-U.S. Tax Treaty*

SPECIAL REPORTS

TAX NOTES INTERNATIONAL MARCH 23, 2009 • 1097

Is the company publicly

traded? ( .)See Chart 3

Yes

Is the company a

subsidiary of a publicly

traded company?

(.)See Chart 3

Does the company

meet the ownership

and base erosion

test ( .)? See Chart 5

Yes

Does the company meet

the

active trade or

business test (

See

Chart 6

Does the company meet

the derivative benefits

test? (.)See Chart 7

Did the company own,

directly or indirectly, shares

representing at least 80

percent of the voting power

of the company paying the

dividends before October 1,

1998?

Yes

Not eligible to claim 0 percent

withholding tax rate on dividends.

Is the company a

resident of the

United Kingdom?

Yes

Eligible to claim

0 percent

withholding tax

rate on dividends,

provided the 80%

direct ownership

requirement

under article

10.3(a) is also

met.

Eligible to claim

0 percent

withholding tax rate

on dividends,

provided the

80%/12-month

requirement under

article 10.3(a) is

also met.

Competent authority

discretionary determination.

(.)See Chart 8

Yes

Chart 2. Eligibility for Treaty Benefits Under Article 23 (LOB) of U.K.-U.S.

Tax Treaty (for the Purposes of Article 10.3)

SPECIAL REPORTS

1098 • MARCH 23, 2009 TAX NOTES INTERNATIONAL

Is the U.K.

company publicly

traded?

Is the company’s principal class of

shares (this test considers those

classes of shares that account for a

majority of the company’s voting

power and value) listed or

admitted to dealings on a

recognized stock exchange?

Article 23.2(c)(i).

Is the company’s principal class of

shares regularly traded on one or

more recognized stock

exchanges .? Article 23.2(c)(i)

Eligible to claim 0

percent withholding tax

rate on dividends.

Not eligible to

claim 0 percent

withholding tax

rate on

dividends

under this LOB

test.

“Shares” include depository receipts for shares or trust certificates

for shares. Article 23.7(b)(ii).

“Principal class of shares” means the ordinary or common

shares of the company, provided that such class of shares

represents the majority of the voting power and value of the

company. If no single class of ordinary or common shares

represents the majority of the aggregate voting power and value of

the company, the "principal class of shares" is that class or those

classes that in the aggregate represent a majority of the aggregate

voting power and value of the company. Article 23.7(b)(1).

“Recognized stock exchange” includes: (a) the NASDAQ

System and any stock exchange registered with the Securities and

Exchange Commission as a national securities exchange for

purposes of the Securities Exchange Act of 1934; (b) the London

Stock Exchange and any other recognized investment exchange

within the meaning of the Financial Services Act 1986 or

the Financial Services and Markets Act 2000; the Irish(c)

Stock Exchange, the Swiss Stock Exchange, and the stock

exchanges of Amsterdam, Brussels, Frankfurt, Hamburg,

Johannesburg, Madrid, Milan, Paris, Stockholm, Sydney, Tokyo,

Toronto, and Vienna; and and other stock exchange that the(d)

competent authorities of the United States and the United Kingdom

agree to recognize for the purposes of article 23. Article 23.7(a).

The shares in a class of shares or the units in a class of units are

considered to be “regularly traded” on one or more recognized

stock exchanges in a chargeable or tax period if the aggregate

number of shares or units of that class traded on such stock

exchange or exchanges during the 12 months ending on the day

before the beginning of that tax or chargeable period is at least 6

percent of the average number of shares or units outstanding in that

class during that 12-month period. For this purpose, if a class of

shares was not listed on a recognized stock exchange during this

12-month period, the class of shares will be treated as regularly

traded only if the class meets the aggregate trading requirements for

the tax period in which the income arises. U.S. Treasury Technical

Explanation to the U.K.-U.S. Treaty; U.S. Treas. Reg. Section

1.884-5(d)(4)(i)(B).

Yes

Does the company meet the 80%/12-

month requirement under article

10.3(a)?

Yes

Note: The publicly traded company test is subject to article 23.5 of

the U.K.-U.S. Treaty that relates to certain arrangements under

which holders of a class of stock in a resident of a contracting

state (U.K.) receive a disproportionate share of the income arising

from the other contracting state (U.S.) (e.g., tracking stock).

Example. UKCo is a corporation resident in the United Kingdom.

UKCo has two classes of shares: common and preferred. The

common shares are listed on the London Stock Exchange and are

substantially and regularly traded. The preferred shares have no

voting rights and are entitled to receive dividends equal in amount

to interest payments that UKCo receives from unrelated borrowers

in the United States. The preferred shares are owned entirely by a

single investor that is a resident of a country with which the United

States does not have a tax treaty. The common shares account for

more than 50 percent of the value of UKCo and for 100 percent of

the voting power. Because the owner of the preferred shares is

entitled to receive payments corresponding to the U.S.-source

interest income earned by UKCo, the preferred shares are subject

to article 23.5. Because the owner of the preferred share is not an

“equivalent beneficiary”

()see definition on Chart 7

, UKCo will

be denied benefits regarding a portion of the interest payments.

Benefits will be denied to the extent that the owner of the

preferred shares receives a greater proportion of the U.S.

income than the owner would have received had the owner owned

comparable common shares. U.S. Treasury Technical

Explanation to the U.K.-U.S. Treaty.

Chart 3. Publicly Traded Company Test Under

Article 23.2(c)(I) (LOB) of U.K.-U.S. Tax Treaty

SPECIAL REPORTS

TAX NOTES INTERNATIONAL MARCH 23, 2009 • 1099

Yes

Is the company a U.K.

subsidiary of a U.K. publicly

traded company?

(.)See Chart 3

Are five or fewer U.K. publicly traded companies the

direct or indirect owners of at least 50 percent of the

aggregate vote and value of the company's shares? This

test considers the ownership of every class of shares

outstanding. If the publicly traded companies are indirect

owners, however, each of the intermediate companies

must be a resident of either the United States or United

Kingdom. Article 23.2(c)(ii).

Note: The subsidiary of a publicly traded

company test is subject to article 23.5 of the

U.K.-U.S. Treaty that relates to some

arrangements under which holders of a

class of stock in a resident of a contracting state

(U.K.) receive a disproportionate share of the

income arising from the other contracting state

(U.S.). Refer to Chart 3 for an example. U.S.

Treasury Technical Explanation to the U.K.-

U.S. Treaty.

Does the company meet the

80%/12-month requirement

under article 10.3(a)?

Eligible to claim 0

percent withholding tax

rate on dividends.

Yes

Not eligible to

withholding tax

rate on

dividends

under this LOB

Chart 4. Subsidiary of a Publicly Traded Company Test Under

Article 23.2(c)(ii) (LOB) of U.K.-U.S. Tax Treaty

claim 0 percent

test.

SPECIAL REPORTS

1100 • MARCH 23, 2009 TAX NOTES INTERNATIONAL

Chart 5. Ownership and Base Erosion Test Under

Article 23.2(f) (LOB) of U.K.-U.S. Tax Treaty

Yes

Does the company

meet the

ownership and

base erosion test?

Ownership Test

Are shares or other beneficial interests in the company representing at

least 50 percent of its aggregate voting power and value owned,

directly or indirectly, on at least half the days of the company’s tax year

by persons who are qualified persons and entitled to the benefits of

the U.K.-U.S. Treaty under article 23.2(a) (individual residents of U.K.),

article 23.2(b)(i) (U.K. qualified governmental entities), article 23.2(c)(I)

(publicly traded companies), article 23.2( d) (U.K. publicly traded

persons and their subsidiaries), or article 23.2(e) (certain U.K. pension

funds and charitable entities)? In the case of indirect owners, each of

the intermediate owners must be a resident of the United States or

United Kingdom. Article 23.2(f)(i).

Eligible

withholding tax rate on

dividends.

Not eligible to

claim 0 percent

withholding tax

rate on

dividends

under this LOB

test.

Yes

Base Erosion Test

Is less than 50 percent of the company’s gross income for the tax year, as

determined under the tax law in the company’s state of residence (U.K.),

paid or accrued, directly or indirectly, to persons who are not residents of

either the United States or United Kingdom, in the form of payments

deductible for tax purposes in the company’s state of residence (U.K.) (but

not including arm’s-length payments in the ordinary course of business for

services or tangible property and payments regarding financial obligations

to a bank, provided that if the bank is not a resident of the United States or

United Kingdom such payment is attributable to a permanent establishment

of that bank located in the United Kingdom or the United States)?

Depreciation and amortization deductions, which do not represent payments

or accruals to other persons, are disregarded for this purpose. Article

23.2(f)(ii); U.S. Treasury Technical Explanation to the U.K.-U.S. Treaty.

Does the company meet the 80%/12-

month requirement under article

10.3(a)?

Yes

Did the company own shares

representing, directly or indirectly, at

least 80 percent of the voting power

of the company paying the dividends

before ?October 1, 1988

Yes

Note: The ownership and base erosion test

is subject to article 23.5 of the U.K.-U.S.

Treaty that relates to some arrangements

under which holders of a class of stock

in a resident of a contracting state

(U.K.) receive a disproportionate share of

the income arising from the other

contracting state (U.S.).

Example. A group of U.K. resident

individuals established an investment club.

The investment club purchases stocks

through HoldCo, a U.K. company owned by

the U.K. resident individuals in proportion

to their contributions to the investment

club. The rules of the investment club

prevent the club from borrowing. One of

the club's investments was an 80 percent

interest in a U.S. biotech company, USCo,

which was purchased in early 1997. USCo

developed an unusual gene therapy,

resulting in a substantial increase in the

value of USCo stock. The members of the

club wanted to sell some of the shares of

USCo to diversify their holdings but did not

want to be subject to capital gains tax in

the United Kingdom. Instead, HoldCo

issued a class of preferred shares that

track the dividends paid by USCo to

HoldCo in exchange for a capital

contribution from Investor. Investor is an

individual resident in another EU member

country. HoldCo meets the test for eligibility

for the zero rate of withholding tax under

article 10.3(a) because it qualifies for

benefits under the ownership and base

erosion test and it has owned a direct 80

percent interest in USCo since before

October 1, 1998. However, HoldCo would

not be entitled to a zero rate of withholding

tax on a portion of the dividends paid by

USCo to the extent the preferred shares

result in Investor receiving its proportionate

share of the income of HoldCo because

Investor is not an “equivalent

beneficiary.” ( .)See definition on Chart 7.

U.S. Treasury Technical Explanation to

the U.K.-U.S. Treaty.

The term “gross income” means total

revenues derived by a resident of a

contracting state (U.K.) from its principal

operations, less the direct costs of

obtaining such revenues. In the case of the

United States, the term “gross income” has

the same meaning as such term in section

61 of the Internal Revenue Code and

associated Treasury regulations. U.S.

Treasury Technical Explanation to the

U.K.-U.S. Treaty.

to claim 0 perecent

SPECIAL REPORTS

TAX NOTES INTERNATIONAL MARCH 23, 2009 • 1101

Is the company engaged in the inactive conduct of a trade or business

the United Kingdom (other than the business of making or managing

investments for the company’s own account, unless these activities are

banking, insurance, or securities activities carried on by a bank, insurance

company, or registered securities dealer)? Article 23.4(a).

A business activity generally will be considered to form part of a business

activity if the two activities involve the design, manufacture, or sale of the

same products or type of products, or the provision of similar services. The

line of business in the state of residence (U.K.) may be upstream,

downstream, or parallel to the activity conducted in the state of source

(U.S.). U.S. Treasury Technical Explanation to the Treaty.

For two activities to be considered to be “complementary,” the activities

need not relate to the same types of products or services, but they should

be part of the same overall industry and be related in the sense that the

success or failure of one activity will tend to result in success or failure for

the other. When more than one trade or business is conducted in the state

of source (U.S.) and only one of the trades or businesses forms a part of

or is complementary to a trade or business conducted in the state of

residence (U.K.), it is necessary to identify the trade or business to which

an item of income is attributable. Dividends will be deemed to be derived

first out of earnings and profits of the treaty-benefited trade or business,

and then out of other earnings and profits. U.S. Treasury Technical

Explanation to the Treaty.

Is the item of income, profit, or gain the tradederived in connection with

or business in the United Kingdom and such trade or business is

substantial in relation to the company’s trade or business activity in the

United States? Article 23.4(a), (b).

Did the company own shares representing, directly or indirectly, at least 80

percent of the voting power of the company paying the dividends before

October 1, 1998?

Income, profit, or gain is with a trade or business ifderived in connection

the income-producing activity in the state of source (U.S.) is a line of

business that “formsapartof”or is “complementary” to the trade or

business conducted in the company’s state of residence (U.K.).

Yes

In determining whether a person is engaged in the active conduct of a trade

or business in the United Kingdom (including satisfying the substantiality

requirement), activities conducted by a partnership in which that person is

a partner and activities conducted by persons connected to such person

would be deemed to be conducted by such person. Article 23.4(c).

Yes

Is the item of income derived from the United States incidental to that

trade or business in the United Kingdom? Article 23.4(a).

Yes

Does the U.K.

company meet the

active trade or

business test?

Not eligible to

withholding tax

rate on

dividends

under this LOB

test.

Yes

“Trade or business” — In general, U.S.

income tax principles, a trade or business

will be considered to be a specific unified

group of activities that constitute or could

constitute an independent economic

enterprise carried on for profit.

Furthermore, a corporation generally will

be considered to carry on a trade or

business only if the officers and

employees of the corporation conduct

substantial managerial and operational

activities. E.g., a company that functions

solely as a headquarters company will not

be considered to be engaged in an active

trade or business.

The business of making or managing

investments for the resident’s own

account will be considered to be a trade

or business only when part of banking,

insurance, or securities activities

conducted by a bank, an insurance

company, or a registered securities

dealer. Such activities conducted by a

person other than a bank, insurance

company, or registered securities dealer

will not be considered to be the conduct

of an active trade or business, nor would

they be considered to be the conduct of

an active trade or business if conducted

by a bank, insurance company, or

registered securities dealer but not as

part of the company's banking, insurance,

or dealer business. U.S. Treasury

Technical Explanation to the Treaty;

U.S. Treas. Reg. Section 1.367(a)-2T(b)(2).

“Incidental to” — An item of income,

profit, or gain derived from the state of

source (U.S.) is “incidental to” the trade or

business carried on in the state of

residence (U.K.) if production of the item

facilitates the conduct of the trade or

business in the state of residence (U.K.).

An example of incidental income is the

temporary investment of working capital

of a person in the state of residence

(U.K.) in securities issued by persons in

the state of source (U.S.). U.S. Treasury

Technical Explanation to the Treaty.

Eligible to claim 0 percent withholding tax rate on

dividends, provided that the 80%/12-month

requirement is also met.under article 10.3(a)

“Connected to” — A person will be

connected to another if one possesses at

least 50 percent of the beneficial interest

in the other (or, in the case of a company,

shares representing at least 50 percent of

the aggregate voting power and value of

the company or of the beneficial equity

interest in the company) or another

person possesses, directly or indirectly,

at least 50 percent of the beneficial

interest (or, in the case of a company,

shares representing at least 50 percent of

the aggregate voting power and value of

the company or of the beneficial equity

interest in the company) in each person.

In any case, a person will be considered

to be connected to another if, on the

basis of all the facts and circumstances,

one has control of the other or both are

under the control of the same person or

persons. Article 23.4(c).

“Substantiality

requirement” — The trade

or business carried on in

the state of residence (U.K.)

must be substantial in

relation to the activity in the

state of source (U.S.). This

determination is made

based on all the facts and

circumstances and takes

into account the

comparative sizes of the

trades or businesses in the

United States and United

Kingdom (measured by

reference to asset values,

income, and payroll

expenses), the nature of the

activities performed in the

United States and United

Kingdom, and the relative

contributions made to that

trade or business in the

United States and United

Kingdom. In making each

determination or

comparison, due regard will

be given to the relative

sizes of the U.S. and U.K.

economies. Article 23.4(b);

U.S. Treasury Technical

Explanation to the Treaty.

Yes

Chart 6. Active Trade or Business Test Under

Article 23.4 (LOB) of U.K.-U.S. Tax Treaty

(Only benefits regarding a particular item of income can be granted)

claim 0 percent

SPECIAL REPORTS

1102 • MARCH 23, 2009 TAX NOTES INTERNATIONAL

Derivative Ownership Test

Do seven or fewer “equivalent beneficiaries”

own shares representing at least 95 percent of

the aggregate voting power and value of the

company (ownership may be direct or indirect)?

Article 23.3(a).

Derivative Base Erosion Test

Was less than 50 percent of the company’s gross

income, as determined under U.K. tax law, for the

tax period paid or accrued, directly or indirectly, to

persons who are not equivalent beneficiaries in

the form of payments deductible for U.K. tax

purposes (but not including arm's-length payments

in the ordinary course of business for services or

tangible property and payments regarding

financial obligations to a bank, provided that if the

bank is not a resident of the United States or United

Kingdom, such payment is attributable to a

permanent establishment of that bank located in

either the United Kingdom or the United States)?

Article 23.3(b).

Eligible to claim 0 percent

withholding tax rate on

dividends.

Yes

Does the company meet the 80%/12-

month requirement under article

10.3(a)?

Does the U.K.

company meet the

derivative benefits

test?

Not eligible to

claim 0 percent

withholding tax

rate on

dividends

under this LOB

test.

“Equivalent beneficiary” is a resident of a member state

of the European Community or of a European Economic

Area state or of a party to the North American Free Trade

Agreement but only if that resident:

In order to determine whether a direct or indirect owner of

shares is an equivalent beneficiary, such owner will be

deemed to hold the same voting power in the company

paying the dividend as the company claiming the benefits

holds in such company.

Note: The derivative benefits test is subject to article 23.5

of the U.K.-U.S. Treaty that relates to some arrangements

under which holders of a class of stock in a resident

of a contracting state (U.K.) receive a disproportionate

share of the income arising from the other contracting state

(U.S.).

Example.. UKCo is a U.K. holding company, all the issued

and outstanding stock of which is owned 50 percent by a

privately held Danish company, DCo, and 50 percent by a

privately held French company, FCo. UKCo, in turn, owns

75 percent of the issued and outstanding stock of USCo, a

U.S. company engaged in the manufacture of wallpaper

and jet fuel. UKCo pays less than 50 percent of its gross

income to other persons in the form of payments

deductible under U.K. law. DCo and FCo are approached

by a Thai company, TCo, engaged in the business of

wallpaper manufacture in Southeast Asia. DCo, FCo, and

TCo arrange for UKCo to issue a class of preferred stock

to TCo, in exchange for a capital contribution. Payments

regarding this class of preferred stock will be set at a

fixed rate increased by the excess of the internal rate of

return on USCo's wallpaper business over the yield on 30-

year U.S. Treasury bonds. UKCo would be entitled, under

paragraph 3, to a 5 percent withholding rate regarding

distributions from USCo because DCo and FCo would

have been entitled to the same withholding rate on a direct

payment from USCo. However, UKCo will not be entitled to

a 5 percent withholding rate on a portion of the dividends

paid by USCo because of the preferred shares issued to

TCo. TCo is not an “equivalent beneficiary.” U.S.

Treasury Technical Explanation to the U.K. -U.S. Treaty.

Chart 7. Derivative Benefits Test Under Article 23.3 (LOB) of

U.K.-U.S. Tax Treaty

(i)(A) all

qualified person

and

(B)

(ii) qualified person

would be entitled to the benefits of a

comprehensive convention for the avoidance of

double taxation between any member state of the

European Community or an EEA state or any party to

NAFTA and the contracting state from which the

benefits of the U.K.-U.S. Treaty are claimed (U.S.),

provided that if such convention does not contain a

comprehensive LOB article, the person would be a

under article 23.2 of the U.K.-U.S.

Treaty if such person were a resident of the United

States or United Kingdom under article 4 (residence)

of the U.K.-U.S. Treaty;

regarding income referred to in article 10

(dividends), article 11 (interest), or article 12

(royalties) of this convention, would be entitled under

such convention to a rate of tax regarding the

particular class of income for which benefits are being

claimed under this convention that is at least as low

as the rate applicable under this convention;

is a by reason of article 23.2 (a)

(individual residents of U.K. and/or U.S.), article 23.2

(b)(i) (U.K. and/or U.S. qualified governmental entities),

article 23.2(c)(i) (publicly traded companies), article

23.2(d) (U.K. and/or U.S. publicly traded persons and

their subsidiaries), or article 23.2(e) (certain U.K. and/or

U.S. pension funds and charitable entities).

SPECIAL REPORTS

TAX NOTES INTERNATIONAL MARCH 23, 2009 • 1103

Has discretionary

determination been

granted by the

competent authority

regarding the zero rate?

A resident of the United Kingdom that is neither a qualified person nor entitled to the

benefits of the U.K.-U.S. Treaty regarding an item of income, profit, or gain under

the derivative benefits test or the active trade or business test() (see Chart 7 see Chart

still may be granted benefits under the U.K.-U.S. Treaty at the discretion of the U.S.

competent authority. In making these determinations, the U.S. competent authority

will take into account as its guideline whether the establishment, acquisition, or

maintenance of the person seeking benefits under the Treaty, or the conduct of such

person's operations, has or had as one of its principal purposes the obtaining of

benefits under the U.K.-U.S. Treaty. Thus, persons that establish operations in one of

the states with a principal purpose of obtaining the benefits of the treaty ordinarily will

not be granted competent authority relief.

U.S. and U.K. competent authorities will consider the respective obligations of the

United Kingdom and the United States by virtue of their membership in the European

Community and the EEA on the one hand, and NAFTA on the other, in making a

determination. In particular, the competent authorities will consider any legal

requirements for the facilitation of the free movement of capital and persons, the

differing internal tax systems, tax incentive regimes, and existing tax treaty policies

among . As a result, when changes in circumstances otherwisequalifying states

might cause a person to cease to be a , such changes need notqualified person

result in the denial of benefits.

Eligible to claim

0 percent

withholding tax rate

on dividends.

Not eligible to

claim 0 percent

withholding tax

rate on dividends

under this LOB

test.

The competent authority’s discretion is quite broad. It may grant all of the benefits

of the U.K.-U.S. Treaty to the taxpayer making the request, or it may grant only

some benefits. For instance, it may grant benefits only regarding particular

item of income. Further, the competent authority may establish conditions,

such as setting time limits on the duration of any relief granted.

A taxpayer will be permitted to present its case to the relevant competent authority

for an advance determination based on the facts. In these circumstances, it is

also expected that, if the competent authority determines that benefits are to be

allowed, they will be allowed retroactively to the time of entry into force of the

relevant treaty provision or the establishment of the structure in question,

whichever is later. Before denying benefits of the U.K.-U.S. Treaty, the U.S.

competent authority will consult with the U.K. competent authority.

Yes

There is a US $15,000 user fee for

requesting a discretionary

If a request is submitted for more than

one entity, a separate user fee will be

charged for each entity. Rev. Proc.

2006-54 section 14.2.

The competent authorities will take into account the legal requirements for the free flow

of goods and services within the European Communities and within the North American

Free Trade Area. The changes in circumstances include, all under ordinary business

conditions, a change in the state of residence (U.K.) of a major participant in a

company; the sale of part of the ownership interests in a company to a resident of a

qualifying state; or an expansion of a company's activities in another qualifying state.

So long as the relevant competent authority is satisfied that those changed

circumstances are not attributable to tax avoidance motives, they will count as a factor

favoring the granting of benefits under article 23.6 of the U.K. -U.S. Treaty, if consistent

with existing treaty policies, such as the need for effective exchange of information. A

company that wishes the relevant competent authority to take such legal requirements

into account must request an advance determination. Article 23.6; U.S. Treasury

Technical Explanation to the U.K.-U.S. Treaty.

“Qualifying States” means member

states of the European Community or

European Economic Area States, or

parties to the North American Free Trade

Agreement.

Chart 8. Discretionary Determination by the Competent Authority

Under Article 23.6 (LOB) of the U.K.-U.S. Tax Treaty

Requesting competent authority

assistance — A taxpayer may request

the assistance of the U.S. competent

authority under Rev. Proc.

2006-54. The U.S. competent

authority may determine in its own

discretion that the taxpayer qualifies

for benefits under article 28

(LOB) of the U.K.-U.S. Treaty

(including the 0 percent withholding

tax rate on dividends; provided that

requirements under article 10.3(a) are

also met).

determination under the LOB provision.

SPECIAL REPORTS

1104 • MARCH 23, 2009 TAX NOTES INTERNATIONAL