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U.S.-Dutch agreement impedes treaty shopping.

Last December the United States and the Netherlands signed a new income tax treaty, effective for taxable years beginning (or for payments made, in the case of amounts subject to withholding tax) on or after January 1 of the year following ratification by both countries. Taxpayers, however, may elect to extend the benefits of the current treaty for an additional 12 months.

Significantly, the new treaty's "limitations on benefits" provision is intended to prevent "treaty shopping" (which occurs when a resident in a country that does not have a treaty with the United States forms a corporation in a country with a favorable U.S. treaty in order to obtain the benefits of that treaty).

The limitations-on-benefits provision generally allows a company resident in either the United States or the Netherlands to obtain the treaty's benefits if it satisfies one of four objective tests. The first applies when a corporation is regularly traded on a recognized stock exchange in either the Netherlands or the United States. The second focuses on whether the company shareholders are qualified residents of either country. The third applies where the company is engaged in active trade or business in its country of residence. The fourth allows a company to qualify for treaty benefits if it functions as a headquarters for a multinational group.

With regard to these tests, the new treaty broadens the typical anti-treaty-shopping provision by allowing Dutch companies to take into account certain activities in European Community countries. Additionally, if a taxpayer does not qualify under any of the objective tests, the treaty provides a subjective facts-and-circumstances test under which the competent authority of the country in which the income arises may grant treaty benefits if it determines that obtaining the benefits was not a principal purpose of establishing the entity.

The new anti-treaty-shopping provision will have its greatest impact on non-U.S. investors that conduct business in the United States through Dutch holding companies. Many such companies are formed for reasons other than to obtain treaty benefits. For example, many U. K. corporations establish Dutch holding companies to maximize their U.K. foreign tax credits. Such corporations would not ordinarily qualify under the objective tests because they lack the requisite ownership or activities. Nevertheless, they possibly could obtain relief under the facts-and-circumstances test.

Observation: The anti-treaty-shopping provision should generally prevent use of Dutch companies by foreign investors merely to obtain treaty benefits. However, although this provision is more liberal than similar provisions in other recently negotiated U.S. treaties, companies formed in the Netherlands for non-treaty-shopping purposes nevertheless may be prevented from obtaining benefits under the new treaty. It is uncertain whether the facts-and-circumstances test will be interpreted to provide them with relief.
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Publication:Journal of Accountancy
Date:Mar 1, 1993
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