Note: Unless otherwise indicated, assume that the U.S. Model Income Tax Conventi

Question

Note: Unless otherwise indicated, assume that the U.S. Model Income Tax Convention of
November 15, 2006 (the “Model Treaty”).

USAco, a domestic corporation, is a wholly-owned subsidiary of HKco, a Hong Kong corporation. The U.S. does not have a tax treaty with Hong Kong, but both the U.S. and Hong Kong do have a treaty with country F that eliminates all withholding taxes. To avoid the 30% withholding tax that USAco must withhold on all interest payments to HKco, HKco forms FORco, a country F corporation, which will borrow the money from HKco and relend the money to USAco. This tax planning technique:

will work due to the Non-Discrimination Article of the Model Treaty.

will work because of the Relief from Double Taxation Article of the ModelTreaty.

will fail because of the Limitation on Benefits Article of the Model Treaty.

will fail because of the Permanent Establishment Article of the Model Treaty.

will work due to the Non-Discrimination Article of the Model Treaty.

will work because of the Relief from Double Taxation Article of the ModelTreaty.

will fail because of the Limitation on Benefits Article of the Model Treaty.

will fail because of the Permanent Establishment Article of the Model Treaty.

Explanation / Answer

The given scenario is called as " Treaty shopping"

Treaty shopping” generally refers to a situation where a person, who is resident in one country (say the “home” country) and who earns income or capital gains from another country (say the “source” country), is able to benefit from a tax treaty between the source country and yet another country  (say the “third” country). This situation often arises where a person is resident in the home country but the home country does not have a tax treaty with the source country.

USAco, a domestic corporation, is a wholly-owned subsidiary of HKco, a Hong Kong corporation. The U.S. does not have a tax treaty with Hong Kong, but both the U.S. and Hong Kong do have a treaty with country F that eliminates all withholding taxes. To avoid the 30% withholding tax that USAco must withhold on all interest payments to HKco, HKco forms FORco, a country F corporation, which will borrow the money from HKco and relend the money to USAco. This tax planning technique " will fail because of the Limitation on Benefits Article of the Model Treaty.

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