tax notes international - Tuck School of Business - Dartmouth College

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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 (C) Tax Analysts 2009. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
OECD Furthermore, a source country frequently will want some documentary proof that someone claiming treaty benefits is in fact entitled to them. Can the payers in the source country deal with a mountain of paperwork from all of the ultimate customers and investors, especially given that the fund or financial intermediary looks like one investor on the books of the sourcecountry payers? If some of the investors can benefit under an income tax treaty with the source country and others cannot, will the source country allow withholding on only a proportion of the payments? If relief at source is impossible, the investors might be able to request refunds from the source country. But what documentation will they need from the fund or financial intermediary that will be acceptable to the source country? Can the fund or financial intermediary generate the necessary documentation without undue burden? Will the investors bother to file claims for refunds of small amounts? These problems may not be too troublesome for funds with a small number of sophisticated investors, such as the pension pooling vehicles that are coming into use in Europe. But these issues are daunting for financial intermediaries with a large number of customers and for retail funds with a large number of small investors. The goal of the procedures report is to set forth best practices for how countries should handle claims for treaty relief when an investor that is entitled to treaty relief in its own right does not own the investment directly, but owns it through a CIV or through one or more levels of intermediaries. The ICG considered how to reduce costs and ensure that tax administrators’ rules were being followed. Its conclusions are as follows: • As much as possible, source countries should allow treaty relief at source, rather than requiring investors to file claims for refunds afterward. • Intermediaries that have been authorized by the source country should be allowed to make claims for treaty relief on behalf of their customers on a pooled basis, without having to provide detailed information on customers for each payment. 1 • Authorized intermediaries should be required to pass along detailed information about customers that have claimed treaty benefits to the source country after the fact so that the source country can verify that the treaty claims are proper. The source country would share this information with 1 This suggestion clearly bears a resemblance to the U.S. qualified intermediary system and the Irish qualifying intermediary system. the investor countries so that they can confirm that the income is being reported properly. 2 • Countries that do not use unique taxpayer identification numbers should do so, to allow information to be properly matched. 3 • Investors should be permitted to claim treaty benefits based on their own self-certification, rather than being required to obtain residence certificates, at least for small accounts. 4 Implications As stated earlier, the conclusions of these reports have not been accepted by the OECD, and the OECD does not make tax laws. But the OECD’s recommendations have been very influential on the treaty policies of developed countries. Thus, if these reports are adopted by the OECD, international treaty practice might move in the direction outlined in the reports. The Committee for Fiscal Affairs now is considering the reports, and has invited public comments on them. Comments are due by March 6. ♦ Matthew Blum, Ernst & Young LLP, Boston. The author appreciates the assistance of Alastair Campbell, a senior in Ernst & Young’s International Tax Services Group in Boston. 2 This is not like the U.S. qualified intermediary system because the U.S. system is designed to respect bank secrecy for non-U.S. investors. 3 Note that the United States does not require foreign persons claiming treaty benefits relating to publicly traded investments (and some other types of investments) to obtain U.S. taxpayer identification numbers. 4 As is the practice in the United States. 404 • FEBRUARY 2, 2009 TAX NOTES INTERNATIONAL (C) Tax Analysts 2009. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
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tax notes international - Tuck School of Business - Dartmouth College

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