Brexit’s Potential Impact on Use of U.S. Income Tax Treaties
Three and a half years after the UK voted to leave the European Union (EU), British exit (Brexit) finally occurred as of the end of the day on January 31, 2020. One of the many significant impacts of Brexit is the potential loss of treaty benefits that were based upon UK residents being also considered EU residents. Companies may need to review whether treaty reliance may continue after Brexit.
Brexit from the EU will not cause the language of the U.S.-UK Tax Treaty or any other U.S. income tax treaty to change. However, the U.S.-UK Tax Treaty and most tax treaties with the U.S. have a limitation on benefits (LOB) article that must be met to rely on the treaty. Brexit will cause any UK person to no longer be a resident of a country that is part of the EU. That change may cause compliance with that LOB clause to be lost or harder to achieve when a UK person owns shares in a company formed in another country that has an income tax treaty with the U.S. (such as Ireland). If such cross-border ownership exists, a review of the continued reliance on a tax treaty may be in order to determine if treaty reliance is maintained or put in jeopardy.
The LOB clause is intended to stop treaty shopping, which occurs when a company formed in a country that has a U.S. income tax treaty is owned by persons not residing in that country. For example, a UK individual owns an Irish company that invests in the U.S. and wants to get benefits under the U.S.-Ireland Tax Treaty. Unless the company is engaged in an active trade or business, the LOB clause would not be met where an Irish or other treaty company is owned by non-treaty residents unless a special derivative benefits clause is met.
If seven or fewer people own 95% or more of the treaty company, the derivative benefits clause will usually allow the LOB clause to be met by looking through the company to determine whether its primary owners are eligible for comparable treaty benefits under the U.S. income tax treaty with their home country. This look through approach usually only applies where the shareholders are residents of a country that is part of the EU.
Before Brexit, a UK resident was also an EU resident and could be counted on to meet the derivative benefits clause. After Brexit, that UK resident is no longer an EU resident and thus, does not count as being part of the 95% stock ownership group. As a result, the derivative benefits clause may no longer be met. Companies relying on compliance with the derivative benefits clause that have UK shareholders may want to review if Brexit will affect them.
Authors: Michael Hirschfeld, Managing Director of Andersen Tax LLC, NY Office, Julian Nelberg, Managing Director of Andersen Tax LLP, London and Zoe Wyatt, Managing Director of Andersen Tax LLP, London