DT19853 - Double Taxation Relief Manual: Guidance by country: United States of America: Notes

Fiscally transparent persons

Article 1(8) of the Convention provides that income derived through a person that is a fiscally transparent entity under the laws of either the US or the UK will be treated as the income of a resident of a contracting state, if the taxation laws of either country treat it as such. So, treaty benefits will be available to the resident of either the US or the UK, not the fiscally transparent entity.

The Exchange of Notes sets out rules for taxing income, profits or gains:

• preserving the right of both States to tax income, profits or gains derived through a fiscally transparent person under the respective domestic laws of each State
• providing that where both contracting states consider an item of income, profit or gain to have been derived by one of their residents, both States can tax that person in respect of the item of income, profit or gain
• (in the UK) treating some items of income, profit or gain arising to a person as falling within the paragraph where another person is charged to UK tax in respect of them under specific anti-avoidance legislation

The relevant UK domestic law is specified in the Notes.

US LLCs - relief for US tax {#}

Relief for underlying tax will only be available to a UK company which has at least a 10% interest in the US LLC (see Article 24(4)(b)).

This is because HMRC takes the view that for UK tax purposes LLCs should generally be regarded as taxable entities and not as fiscally transparent. Accordingly, the UK taxes a UK member of an LLC by reference to distributions of profits made by the LLC and not by reference to the income of the LLC as it arises. If tax is paid in the US on the profits of the LLC - and irrespective of by whom that tax is paid - the UK regards that tax as underlying tax. Credit is available for it if, and only if, the member is a UK company which controls, directly or indirectly, at least 10% of the voting power of the LLC.

It follows that relief for underlying tax is not available to an individual UK member of an LLC. Revenue and Customs Brief 15 (2015) further discusses HMRC’s approach to US LLCs.

Residence of individuals

The United States taxes its citizens on their world-wide income wherever they may be resident. United States citizens are not, however, necessarily ‘residents of the United States’ for the purposes of the convention.

Where an individual claims relief from UK tax on income arising in the UK on the grounds that he is a resident of the United States for the purposes of the agreement, the approach to be adopted in considering the claim will depend upon whether the individual concerned is a United States citizen.

Article 4(2) of the convention contains an exception to the general rule of Article 4(1) that residence under internal law also determines residence under the convention. The exception applies with respect to a US citizen or alien lawfully admitted for permanent residence (i.e., a “green card” holder). Under Article 4(1), a person is considered a resident of either the UK or the US for purposes of the convention if he is liable to tax in either country by reason of citizenship. Although this rule applies to both countries, only the US taxes its non-resident citizens in the same manner as its residents. In addition, aliens admitted to the US for permanent residence (“green card” holders) qualify as US residents under Article 4(1) because they are taxed by the United States as residents, regardless of where they physically reside.

However, under the exception of paragraph 2, a US citizen or green card holder will only be treated as a resident of the US for the purposes of the convention, and, thereby entitled to treaty benefits, if they meet the following two conditions.

First, they must have a substantial presence, permanent home or habitual abode in the United States. The rule requires that the US citizen or green card holder have a reasonably strong economic nexus with the US.

Second, they must not be treated as a resident of a state other than the UK under any treaty between the UK and a third state. This rule prevents a US citizen or green card holder who is a resident of a country other than the US or the UK from choosing the benefits of the Agreement over those provided by the treaty between the UK and his country of residence. If the US citizen or green card holder’s country of residence does not have a treaty with the UK, however, then they will be treated as a resident of the US if they meet the first requirement of an economic nexus. If such a person is a resident of both the US and the UK, whether they are to be treated as a resident of the US for purposes of the convention is determined by the tie-breaker rules of paragraph 4.

Any cases of doubt or difficulty should be submitted to Specialist Personal Tax International Technical Team.

Dual resident individuals

Where it is established that a UK-resident claimant is also a resident of the United States, residence for the purpose of the agreement is determined by considering the so-called ‘tie-breaker’ tests set out in Article 4 - see INTM154020 for further details. Points of doubt or difficulty should be submitted to Employment Income Technical after following the guidance at INTM154020.

Dividends (Article 10)

Who is entitled to zero US withholding tax (“zero”) on dividends?

The provisions of Article 23 (Limitation on benefits) in relation to zero on dividends are more stringent than for other benefits. The following therefore describes the rules in relation to zero on dividends only.

UK resident companies that beneficially own the dividend and that have owned shares representing 80% or more of the voting power of the US company paying the dividend for a 12-month period ending on the date the dividend is declared will be entitled to zero (Article 10(3)(a)), provided that the UK company either:

• owned those shares, directly or indirectly, before 1 October 1998 (Article 10(3)(a)(i)) and it passes either an “ownership and base erosion” test (Article 23(2)(f)) or an “active conduct of a trade or business” test (Article 23(4));
• is a company whose principal class of shares is listed or admitted to dealings on a recognised UK or US stock exchange and whose shares are regularly traded on a recognised stock exchange (Article 23(2)(c)(i));
• is a company which is at least 50% owned (by reference to the aggregate voting power and value of its shares) directly or indirectly by five or fewer such companies (Article 23(2)(c)(ii));
• is a company at least 95% owned (by reference to the aggregate voting power and value of its shares) directly or indirectly by seven or fewer “equivalent beneficiaries” and which passes a “base erosion” test (Article 23(3)); or
• is accepted by the US competent authority as being entitled to the benefits of the treaty on the basis that the establishment, acquisition or maintenance of the company and the conduct of its operations did not have as one if its principal purposes the obtaining of treaty benefits (Article 23(6)).

UK tax exempt pension schemes will also be entitled to zero, provided that the dividends in question are not derived from the carrying on of a business, directly or indirectly, by the pension scheme and that more than 50% of the beneficiaries, members or participants of the scheme are individuals who are residents of either the UK or the US (Article 10(3)(b) and Article 23(2)(e)).

In summary therefore, in order to obtain zero a person must be a UK resident, must satisfy the conditions at Article 10(3)(a) or (b), must satisfy one of the relevant tests in the limitation on benefits article and must satisfy all the other specified conditions for obtaining the benefit.

The following material expands on how the conditions for the above tests apply. Any point of doubt or difficulty should be referred to BAI Tax Treaty Team. See also the section on Limitation on benefits – cases of doubt (Article 23).

The 1 October 1998 ownership test and the subsequent interposition of intermediate holding companies

In order to qualify for zero under Article 10(3)(a)(i) the beneficial owner of the US dividend must be a UK resident company that has owned shares representing 80% or more of the voting power of the US company paying the dividend for at least 12 months before the dividend is declared and must have owned shares representing, directly or indirectly, 80% or more of the voting power of the US company paying the dividend before 1 October 1998.

In the case of direct ownership, a UK company that owned the requisite shares before 1 October 1998 and continues to hold them will be entitled to zero when a dividend is declared by the US company.

In the case of indirect ownership, where before 1 October 1998 a UK ultimate group parent company owned the US subsidiary through an intermediate holding company and subsequently reorganises so that it assumes direct ownership of the US subsidiary, entitlement to zero is preserved because the UK ultimate parent company will be the beneficial owner of the dividend and it held the requisite shares in the US company, albeit indirectly, before 1 October 1998.

However, in the case where before 1 October 1998 a UK ultimate group parent company owned the US company directly, but subsequently reorganises so that a newly incorporated company is interposed between it and the US company paying the dividend, entitlement to zero (by virtue of this test) will not be preserved. This is because (in the case where the interposed intermediate holding company is a UK resident) although the new intermediate holding company will be the beneficial owner of a US dividend it did not hold the requisite shares in the US company before 1 October 1998, directly or indirectly, as they were held by the UK ultimate group parent company at that date.

In an alternative situation (where the interposed intermediate holding company is a US resident) the UK ultimate group parent company, whilst being the beneficial owner of a US dividend, did not hold the requisite shares in the US company paying the dividend at 1 October 1998 because this company did not exist at that date.

The “active conduct of a trade or business” test

A UK resident company seeking to obtain zero under Article 10(3)(a)(i) must, in addition to satisfying the 1 October 1998 ownership condition, satisfy either the “base erosion” and ownership test at Article 23(2)(f) or the “active conduct of a trade or business” test at Article 23(4).

The “active conduct of a trade or business” test has three main conditions: the UK resident must be engaged in the active conduct of a trade or business in the UK; the dividend derived from the US must be derived in connection with or be incidental to that trade or business; and the trade in the UK must be substantial in relation to the activity in the US.

The meaning of a “trade or business”

In the context of entitlement to zero withholding on US dividends, the terms, not being defined in the treaty, have the meaning they have in US law, in accordance with Article 3(2) (General Definitions).

The meaning of “in connection” with

In accordance with the Exchange of Notes to the treaty a dividend is to be considered as derived “in connection” with an active trade or business in the UK if the US activity that produces the dividend is a line of business which forms a part of, or is complementary to, the trade or business conducted in the UK.

A US trade or business activity will generally be considered to “form part of” a UK trade or business activity if, for example, it provides inputs to a manufacturing process carried on in the UK or if it sells the output of UK manufacturing operations or if it sells in the US the same sorts of products that are being sold by the trade or business carried in the UK.

A US trade or business activity may be considered “complementary” to a UK trade or business if its activities are part of the same overall industry and the two activities are economically and commercially interdependent.

The meaning of “incidental to”

A US dividend would be considered “incidental” to a UK trade or business if the dividend, though not produced by a line of business which forms part of, or is complementary, to the UK trade or business, nevertheless facilitates the conduct of the UK trade or business.

The meaning of “substantial”

To pass the “active conduct of a trade or business” test, the UK trade or business must be substantial in relation to the trade or business activity in the US that gives rise to the dividend. Whether a trade or business activity is “substantial” will depend on all the facts and circumstances. Factors such as the nature of the activities carried on in each country and the comparative sizes of the trades or businesses carried on in each country will be considered.

Will a UK resident company that is owned by seven or fewer EC resident companies be entitled to zero?

A UK resident company that is at least 95% owned by seven or fewer “equivalent beneficiaries” will be entitled to zero if the company also meets a base erosion test (Article 23(3)) and satisfies any of the other specified conditions for obtaining zero.

Assuming it meets those other conditions, the question is whether EC resident companies are “equivalent beneficiaries” as defined by the treaty.

What is an “equivalent beneficiary”?

An “equivalent beneficiary” is defined in Article 23(7)(d) (as amended by Article IV of the protocol to the treaty) as a resident of a Member State of the European Community or of a European Economic Area state, but only if either:

a) that resident is entitled to all the benefits of a comprehensive convention for the avoidance of double taxation (which includes a comprehensive limitation on benefits article) between any Member State of the EC or an EEA state and the US and would, under that convention, be entitled to zero US withholding tax on dividends or,

b) that resident is a specified “qualified person”.

Following the UK’s exit from the EU, a UK resident is not a resident in a Member State of the European Community or of a European Economic Area State and so will not meet this definition.

Are unquoted UK companies entitled to zero?

Assuming an unquoted UK resident company is the beneficial owner of the dividend and has owned shares representing 80% or more of the voting power of the US company paying the dividend for at least 12 months before the declaration of the dividend it may be entitled to zero US withholding tax on the dividend if it is owned by seven or fewer “equivalent beneficiaries” and it passes a so-called “base erosion” test (Article 10(3)(a)(iii) and Article 23(3)).

The “base erosion” test requires that less than 50% of the unquoted UK resident company’s gross income for the taxable year or chargeable period in which the dividend arises is paid, directly or indirectly, to persons who are not “equivalent beneficiaries”, in the form of payments that are tax deductible.

The company must, of course, also satisfy the other conditions of the dividends article.

If the company did not qualify by this route it could apply to the US competent authority for the benefit of zero under Article 23(6).

On what basis will the US competent authority decide whether a UK resident company is entitled to zero?

Zero will be granted if the US competent authority is satisfied that the establishment, acquisition or maintenance of the UK resident company and the conduct of its operations did not have as one of its principal purposes the obtaining of benefits under the treaty.

The Exchange of Notes to the treaty sets out in some detail, with reference to specific circumstances, how the US competent authority will approach this task.

What is the purpose of the consultation requirement?

The US competent authority is required to consult the UK competent authority before refusing zero to a UK resident under Article 23(6). This requirement gives the UK competent authority the opportunity to provide any further facts, arguments or interpretations in favour of the claimant that might be material to the determination of the claim.

However, it is for the US competent authority to have the final say.

Entertainers and sportsmen (Article 16)

{#}An entertainer or sportsperson who is a resident of the United States and who exercises his profession in the UK will not be liable to UK tax for any year of assessment in which his UK gross earnings (including any reimbursed expenses) do not exceed US $20,000 or the sterling equivalent (Article 16(1)). If the entertainer or sportsperson is self-employed or receives income through a controlled entity, for example a personal service company, withholding tax may have been paid during the year. Where withholding tax has been deducted no repayment of that tax should be made without reference to the Foreign Entertainers Unit.

{#}Alimony and maintenance (Article 17)

{#} {#}The provision at Article 17(5) generally covers periodic payments made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support. It exempts from tax in both the UK and the US such payments made by a resident of one of the Contracting States to a resident of the other Contracting State, unless the payments are deductible in the payer’s State of residence. Therefore, child support payments from a resident of a Contracting State to a resident of the other Contracting State are taxable in neither Contracting State, if the payments are not deductible to the payer. By contrast, deductible alimony payments made by a resident of a Contracting State to a resident of the other Contracting State are taxable, exclusively, in the recipient’s State of residence.

Teachers (Article 20A)

{#} {#}Article 20A provides a two-year tax exemption for UK and US resident professors or teachers who visit the other country for not more than two years for the purpose of teaching or engaging in public interest research at a university, college or other recognised educational institution. The exemption relates only to remuneration derived from such teaching and public interest research.

One of the conditions for the exemption from UK tax for a period of up to two years of the remuneration of visiting teachers from the United States is that the visit is ‘for the purpose of’ teaching etc. Where an individual from the United States is transferred to the UK in the course of his or her employment or in the exercise of his or her professional activities and is accompanied by his or her spouse who then takes up employment in the UK as a teacher, any claim by the spouse to exemption under Article 20(1) should be refused on the grounds that the purpose of his or her visit was to accompany his or her spouse and not to teach.

If they stay longer than two years, they will be treated in the same way as any other group of employees, and tax will be payable for the full period, starting from the first day of the visit.

{#} {#}Pensions (Article 17)

Article 17 provides for the taxation of pensions and other similar remuneration only in the state of residence of the beneficial owner. For this purpose, a payment is treated as a pension or other similar remuneration if it is a payment under a pension scheme, as defined at Article 3(1)(o).

IRAs

Contrary to this general rule, the residence state, under paragraph 1(b), must exempt from tax any amount of such pensions or other similar remuneration that would be exempt from tax in the State in which the pension scheme is established if the recipient were a resident of that State. Thus, for example, a distribution from a US Individual Retirement Arrangement or “IRA” to a UK resident will be exempt from tax in the UK to the same extent that the distribution would be exempt from tax in the US.

Lump Sums

A lump-sum payment derived by a resident of one State from a pension scheme established in the other State shall be taxable only in that other State.

The provision preserves the exemption from income tax of a lump sum relevant benefit where it is paid by a UK approved pension scheme to a beneficial owner who is a US resident. However, Article 1(4) will apply in respect of US citizens as the provisions of Article 17(2) are not amongst those listed at Article 1(5). So, the US can tax lump sums received by US citizens from UK schemes.

US Social Security Act

Article 17(3) specifically provides for exclusive residence-country taxation of social security benefits. It provides that payments made by one of the Contracting States under the provisions of its social security or similar legislation to a resident of the other Contracting State will be taxable only in the other Contracting State. Pensions paid by the US government to former members of the US armed forces (or to their surviving spouses or dependent children) in respect of their period of service continue to be regarded as paid for services rendered to the United States. Such pensions therefore come within Article 19 (Government Service) of the convention and are exempt from UK tax unless, exceptionally, the recipient is both a national and a resident of the UK in which case the pension is taxable only in the UK.

Pension Contributions (Article 18)

Article 18 of the convention deals with pension contributions. It also touches on the taxation of the income, profits and gains accruing to pension schemes.

The term “pension scheme” is defined for the purposes of the treaty at Article 3(1)(o). This means that benefits are for approved schemes only.

Under the convention, contributions to the scheme by that member (or those paid on his behalf) will be tax-deductible in the state of residence. In the same way, benefits accrued under the scheme, or employer contributions to the scheme, will not be treated as part of his taxable income and those contributions will be tax-deductible for the employer. The reliefs available cannot exceed those allowed by the state of residence for contributions of the same amount to a scheme established in the state of residence.

The conditions for getting the relief are as follows:

• contributions were made by or on behalf of the individual or (in the case of an employee) his employer to the pension scheme (or to a similar scheme for which it was substituted) before the individual began to exercise an employment or self-employment in the other contracting state, and
• the competent authority of the other State agrees that the pension scheme generally corresponds to a pension scheme established in that other State.

Where someone comes to work in the UK, we will regard the first condition as having been met if the individual was a member of the US scheme before beginning to exercise an employment or self-employment in the UK.

The types of scheme that would be accepted as “generally corresponding” are those listed in the Exchange of Notes.

Relief will be restricted where contributions to a pension scheme are deductible or excludable in computing a person’s taxable income in the host country if he is subject to tax there not on his total income but only on amounts remitted to that country. Relief is available only on a corresponding proportion of the pension contributions.

Offshore activities (Article 21)

{#} {#}Article 21 contains provisions for the treatment of activities in connection with the exploration or exploitation of the sea bed and sub-soil and their natural resources.

The Article provides that:

• an enterprise of one country carrying on such activities in the other country is deemed to be carrying on a business in the other country through a permanent establishment and thus is taxable there in accordance with Article 7. While exploitation activities will always constitute a permanent establishment, exploration activities create a permanent establishment only if they continue for a period exceeding, in the aggregate, 30 days in a twelve-month period.
• in general, remuneration earned by a resident of one country in respect of employment in respect of exploration or exploitation activities carried on offshore in the other country may be taxed in that other country. The exception is if the employment in the other country does not exceed 30 days in any twelve-month period. Unlike the permanent establishment rule the 30-day limit applies to both exploration and exploitation activities or any combination of them.

Capital gains in respect of exploration or exploitation rights etc. are covered in Article 13 (Gains).

Limitation on Benefits (Article 23)

The limitation of benefits article provides that residents of the UK and the US are entitled to all the benefits of the treaty only if they are a “qualified person” (paragraph 2). If a resident is not a “qualified person” they may be entitled to benefits in respect of specific items of income, profits or gains under the “derivative benefits test” (paragraph 3), the “active conduct of a trade or business” test (paragraph 4) or at the discretion of the competent authority of the country that is giving up its taxing right under the treaty. (paragraph 6).

For most UK residents, the article will provide clear rules and certainty of treatment about entitlement to treaty benefits without recourse to either HMRC or the US Internal Revenue Service.

The following section DT19883 contains more detail on the various criteria in doubtful cases.

Limitation on Benefits: cases of doubt

In most cases, whether a person is entitled to benefits under the convention should be clear but in more difficult cases the following further explanation may be useful.

“Qualified persons”

In broad terms, a “qualified person” is a UK or US resident who is either:

• an individual
• a qualified governmental entity (as defined in Article 3)
• a publicly traded company (listed in the UK or US)
• a 50%+ subsidiary of five or fewer publicly traded companies (that are listed in the UK or US)
• a publicly traded trust (listed in the UK or US)
• a trust 50%+ owned by publicly traded companies or by publicly traded trusts (that are listed in the UK or the US)
• a pension scheme (where more than 50% of beneficiaries, members or participants are individuals who are UK or US resident)
• a tax-exempt employee benefit scheme (where more than 50% of beneficiaries, members or participants are individuals who are UK or US resident)
• a religious, charitable, scientific, artistic, cultural or educational organisation
• a legal entity that satisfies an ownership and a “base erosion” test
• a trust, or trustee of a trust in their capacity as such, if the trust is more than 50% owned by certain “qualified persons” or by “equivalent beneficiaries” provided it satisfies a “base erosion” test.

These tests, which determine whether a particular category of UK or US resident is a “qualified person”, are all based on the concept that a substantial commercial and economic connection must exist between the taxpayer and the UK or the US to warrant entitlement to treaty benefits. If the standard set by any one of the tests in paragraph 2 is met, then entitlement to all treaty benefits is established (subject to conditions in the articles dealing with the type of income concerned being met).

How is the “base erosion” test satisfied?

The base erosion test is satisfied if less than 50% of the person’s gross income for the relevant taxable or chargeable period is paid or accrued, directly or indirectly, to persons who are not UK or US residents in the form of payments that are tax deductible for the purposes of the taxes covered by the treaty in the country in which the person is resident.

The “derivative benefits” test

Paragraph 3 of the article provides that, even if a company is not a “qualified person” as defined by the treaty, it shall nevertheless be entitled to the benefit of the treaty with respect to an item of income, profit or gain, if it satisfies any other specified condition for obtaining such benefit, and it is at least 95% owned by seven or fewer persons who are “equivalent beneficiaries” as defined by the treaty, and less than 50% of the company’s gross income for that period is paid to non-UK or non-US persons in the form of tax deductible payments. The conditions set out in paragraph 3 of the article are commonly known as the “derivative benefits” test, though this is not a term employed in the treaty.

As at January 2004 the provision has no effect because no EC or EEA country has a comprehensive double taxation treaty with the US that provides for zero US withholding tax on dividends.

The “active conduct of a trade or business” test

Paragraph 4 of the article provides that even if a UK resident is not a “qualified person” as defined by the treaty it shall nevertheless be entitled to the benefit of the treaty with respect to an item of income, profit or gain, if it satisfies any other specified condition for obtaining such benefit, and it is engaged in the active conduct of a trade or business in the UK.

Paragraph 4 (a), (b) and (c) set out the conditions for passing the “active conduct of a trade or business” test and guidance on the meaning of some of the specific terms used in the paragraph is provided in the Exchange of Notes to the treaty. Essentially however, there are three main conditions: the UK resident must be engaged in the active conduct of a trade or business in the UK; the income derived from the US must be derived in connection with or incidental to that trade or business; and the trade must be substantial in relation to the activity in the US.

Competent authority discretion

Paragraph 6 provides that a UK or US resident who is neither a “qualified person” nor entitled to treaty benefits with respect to an item of income, profit or gain under the “derivative benefits” test or the “active conduct of a trade or business” test shall nevertheless be granted treaty benefits by the competent authority of the other country if the competent authority determines that the establishment, acquisition or maintenance of the person claiming the benefit and the conduct of its operations did not have as one of its principal purposes the obtaining of benefits under the treaty.

The Exchange of Notes to the treaty sets out in detail, with reference to specific circumstances, how the competent authority will approach this task.

Conduit arrangements

Introduction

No enquiries should be opened in relation to this provision without reference to BAI Tax Treaty Team.

Bilateral double taxation treaties provide benefits for residents of the two contracting states. The “conduit arrangement” provision is designed to ensure that the benefits of the convention go only to those residents and not to residents of third countries who have deliberately arranged their transactions in such a way as to obtain treaty benefits to which they would not otherwise be entitled. The provision is therefore an anti-treaty abuse measure and like similar measures found in other UK double taxation treaties is transaction-based.

Whether the provision will apply in any given situation will depend on the particular facts and circumstances.

How will HMRC apply the “conduit arrangement” rule?

Every case will be considered on its particular facts and circumstances to determine whether the transaction or series of transactions meets the definition of a conduit arrangement. The definition contains an objective test (defining a conduit) and a subjective test (a motive test). Only if both tests are satisfied so that the transactions or series of transactions constitute a conduit arrangement will the relief provided by the relevant article be denied.

When making such a determination the transaction or series of transactions must be put into their proper context.

It will be necessary to consider all the arrangements involving payments between UK and US taxpayers, and between US taxpayers and a taxpayer of a third country before the true pattern and purpose of the transaction or series of transactions can be established.

When this level of understanding has been achieved, HMRC will be able to determine whether the transaction or series of transactions meets the objective part of the conduit test and whether the obtaining of treaty benefits was a main purpose or merely an incidental consequence.

Given this, it is difficult to be prescriptive as to what type of transaction might constitute a conduit arrangement. But here are two examples of what might meet the definition:

1. A company resident in a country which does not have a tax treaty with the UK makes a loan to its UK subsidiary, but instead of lending the money direct it makes the loan indirectly via a wholly unconnected but accommodating US bank by providing a matching collateral deposit to the bank as security for the loan the bank then makes to the UK subsidiary company.

The objective test contained in the definition of a conduit would be satisfied as a US resident (the US bank) entitled to zero UK withholding tax on interest under the treaty receives interest arising in the UK and pays that interest to another person (the parent company) who is not resident in either the UK or the US but who is resident in a third country which doesn’t have a treaty with the UK that provides for zero UK withholding tax on interest.

The fact that treaty benefits are available if the UK subsidiary borrows from the US bank but would not be available if it borrowed from its parent suggests that a main purpose of the transactions might be to obtain the increased benefit of the treaty. So, the motive test might also be satisfied. This will have to be determined by reference to the particular facts and circumstances.

If examination of the facts supported this interpretation, then the series of transactions would be a conduit arrangement as defined in the treaty and the relief provided for by the Interest article would be denied. Full UK withholding tax on the interest paid by the UK subsidiary company would then be due.

1. A company organised in a country that does not have a tax treaty with the UK loans £1,000,000 to its wholly-owned UK subsidiary in exchange for a note issued by the UK company. The parent company later realises that it can avoid UK withholding tax by assigning the note to another wholly-owned subsidiary in the US. Accordingly, the parent assigns the note to its US subsidiary in exchange for a note issued by the US company. The UK company note pays 7% and the US company note pays 6 3/4%.

The loan note was assigned to avoid UK income tax on the payment of interest. The transaction constitutes a conduit arrangement as defined in the treaty as both the objective definition and the motive test at Article 3(1)(n)(i) and (ii) respectively are met.

How will HMRC interpret “substantially all”?

In determining whether “substantially all” of an item of income has been paid directly or indirectly to a resident of a third state the Revenue will consider all the relevant facts and circumstances of the case.

What does “at any time or in any form” mean?

An example might be US dividends received by a UK resident company in 2020 paid on to a resident of a third country in the form of interest in 2021. However, there is no presumption in the words “at any time” that the payment to the resident of the third country must take place after the payment from the source state.

Relief from double taxation: US Citizens and Other income

US Citizens resident in the UK

Article 24(6)(b) provides that the UK will not provide relief for the US tax imposed on its citizens resident in the UK if that tax is solely charged in accordance with the “saving clause” in Article 1(4). Consequently, Article 24(6)(c) eliminates the potential for double taxation that can arise by providing that the US will credit the income tax paid or accrued to the UK, after the application of Article 24(6)(b). It further provides that in allowing the credit, the US will not reduce its tax below the amount that is considered in the UK in applying Article 24(6)(b). This will mean, for instance:

• that the UK will not give relief for US tax paid in respect of US work days by US citizens, working for UK employers. Rather, the US will give relief for UK tax
• that US citizens can claim an exemption under Article 14(2) in the same way as a UK resident who is not a US citizen can providing that all the requirements set out in the paragraph are fulfilled

Any case of doubt or difficulty should be submitted to Employment Income Technical.

No credit to be given for third country income

Article 24(6)(a) provides that the UK is not required to give credit for United States tax charged on a United States national who is resident in the UK in respect of income which he derives from sources outside the United States as determined under UK laws.