tax notes international - Tuck School of Business - Dartmouth College

Internal Revenue Code section 894(c) and Treas.
reg. section 1.894-1(d) deal with this issue in cases
when the United States is the source country. An investor
can claim benefits of the U.S./investor-country
treaty on the investor’s share of the fund’s income if
the fund is fiscally transparent in the investor country
and the investor is not fiscally transparent in the investor
country. The analysis in other countries can be different,
or unclear.
The CIV report is limited in scope to funds that are
both widely held and subject to investor protection
regulations, that is, are under the Investment Company
Act of 1940 in the United States, or the UCITS Directive
in the EU. It does not address the usual type of
hedge fund or private equity fund.
The report concludes that under existing treaties, a
fund that does not have legal personality under domestic
law, such as a fond commun de placement, most likely
is not a person for treaty purposes and therefore cannot
claim benefits under the source-country/fund-country
treaty in its own right. On the other hand, a fund organized
as a corporation or a trust should be regarded
as a person for treaty purposes, the report says.
It concludes that a fund that receives an exemption
for specific types of income should be viewed as subject
to tax for treaty purposes, as should a fund that
receives a deduction for dividends paid (as is the case
with U.S. mutual funds). But a fund that is fiscally
transparent (treated like a partnership) in the fund
country or is exempt from fund-country tax on all of
its income should not be subject to tax in the fund
country.
The majority view in the report, though not without
dissent, is that a fund that is a resident should be
viewed as the beneficial owner of its income for treaty
purposes. In any event, it is important that source
countries clarify their views as to whether CIVs are
entitled to benefits under current treaties.
The ICG also considered situations under existing
treaties in which a fund cannot claim benefits under
the source-country/fund-country treaty in its own right.
In those cases, the report concludes that in principle,
investors should be able to claim treaty benefits on
their share of the fund’s income under the sourcecountry/investor-country
treaties.
This approach — investor-level benefits under the
source-country/investor-country treaties — was viewed
as less desirable than fund-level benefits because of the
difficulty of allocating the fund’s income among the
investors in a widely held fund with investors coming
and going daily. It was also recognized that many investors
would not bother to file requests for relief under
the source-country/investor-country treaties for
small amounts of money. Thus, it was argued in these
cases that the fund should be able to file claims for
relief under the source-country/investor-country treaties
on behalf of the investors. However, a minority of
OECD
the ICG did not believe that investors resident outside
of the fund country should be able to claim treaty benefits
under the applicable source-country/investorcountry
treaty. This view would allow investor-level
claims only to residents of the fund country.
The CIV report suggests that future treaties should
address the issues raised by CIVs directly, and contains
draft language for revisions to the commentary to the
OECD model income tax treaty. The preferred approach
is that a fund should always be a treaty beneficiary
in its own right, although perhaps with relief cut
back proportionately to the extent that the investors are
not themselves entitled to benefits under a sourcecountry/investor-country
treaty with benefits comparable
to the source-country/fund-country treaty.
For example, if the fund was 80 percent owned by
treaty-protected investors and 20 percent owned by
non-treaty-protected investors, one might limit benefits
under the source-country/fund-country treaty to 80
percent of the fund’s income. (The issues regarding
how such a fund is to ascertain who owns it are discussed
in the procedures report.)
The ICG felt that allowing funds to claim treaty
benefits under the source-country/fund-country treaty
for the future is preferable to allowing an investor to
claim treaty benefits under the source-country/investorcountry
treaty on the investor’s share of the fund’s income.
But the latter alternative might be preferable if,
for example, a substantial number of investors in the
investor country are pension funds that are entitled to
special treaty benefits not available to ordinary investors.
This would allow pension funds to claim their
special treaty rates on their share of the fund’s income,
albeit at the cost of more complexity.
The Procedures Report
Under modern securities processing, interests in a
fund or any widely held or publicly traded security
might be owned through multiple levels of brokers,
banks, and other financial intermediaries. For example,
the investor of record might be a central securities depository
such as the Depository Trust Company in the
United States or Clearstream or Euroclear in Europe.
The depository holds investments for the account of
its participants, which typically are banks and brokerages.
The banks and brokerages in turn hold investments
on account of their customers, typically through
omnibus accounts that combine securities held on behalf
of multiple customers.
This system exists for reasons that have nothing to
do with tax. But as a result, the payers in the source
country might have no idea who the ultimate owners
of the income that they are paying are, and a fund
might not know who owns it. Obtaining this information
can be very difficult. This can be even more
troublesome if some of the intermediaries are subject
to bank secrecy rules.
TAX NOTES INTERNATIONAL FEBRUARY 2, 2009 • 403
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