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IRS Denies Treaty Benefits to Prevent Double
Non-Taxation (March 25, 2005) The IRS is targeting transactions that use U.S. tax treaties to obtain unintended tax benefits, such as simultaneously avoiding tax in both treaty countries (“double non-taxation”). IRS Commissioner Everson identified the prevention of double non-taxation as a key enforcement concern. (Financial Times, Feb. 27, 2005). This warning preceded the IRS attack in TAM 200509023 (March 7, 2005) in which the IRS challenged a transaction that not only tried to use a treaty inappropriately to achieve double non-taxation, but did so by taking inconsistent positions under the Internal Revenue Code (“Code”) and the treaty. The TAM makes clear that the IRS will look past the literal terms of a tax treaty to give effect to the intent and assumptions of the treaty partners. The Transaction Challenged: The TAM denied treaty benefits to a U.S. corporation that tried to use (what appears to be) the Canadian treaty to avoid tax on the outbound transfer of an intangible by incorporating in Canada without giving up its U.S. state law corporate charter. The treaty would have treated the U.S. corporation as a resident of Canada and given Canada the exclusive right to tax the gain from the transfer, even though the gain would not have been taxable under Canadian law. The taxpayer simultaneously sought to claim foreign tax credits on its U.S. consolidated income tax return for taxes paid to Canada on other income. IRS’s Rationales: The IRS denied treaty benefits under several different rationales. Central to each rationale was the IRS’s willingness to interpret an ambiguity in treaty language or to look beyond the literal terms of the treaty in order to (a) avoid a result, i.e., double non-taxation, that is contrary to the purpose of the treaty; or (b) prevent a perceived abuse of the treaty, such as simultaneous and inconsistent positions under the Code and the treaty. Recommendation: Taxpayers should assess both current and planned treaty positions to determine whether they produce tax results that are at odds with what the treaty partners may have intended – though literally compliant with the language of a treaty. The IRS has an easy way to find such transactions, since treaty-based positions must be disclosed on Form 8833 (Treaty-Based Return Position Disclosure). Where a transaction results in double non-taxation or inconsistent claims under the Code and the treaty on the same payment, taxpayers should expect IRS scrutiny. Disclaimer: We call these "client letters" because we use them to keep our clients informed. We also send them to friends of the firm and other people who have asked to receive them. We have posted these items on our website so people can get an idea of what kind of firm we are. Your reading of these letters does not create an attorney-client relationship with us. Please contact us if you have any questions. |
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