IRS: USMCA Replaces NAFTA in U.S. Tax Treaties

 In Tax News

Once it enters into force, the USMCA will replace NAFTA.  Since many U.S. tax treaties make reference to NAFTA, it was unknown if this would cause any issues with these provisions, and despite a recent IRS clarification, it is probably still a bit unknown.

References to NAFTA appear in treaties even outside the U.S., Mexico, and Canada.  For example, the IRS announcement references two treaties besides those with Mexico and Canada that mention NAFTA.  Both the treaty with Germany and France mention NAFTA in the limitation of benefits provision.  This is the rule that disallows treaty shopping where a taxpayer tries to use a tax treaty through a nominal tie to a treaty country.  Therefore, in these cases, these designations are extremely important.  Confusion on this issue not only causes a problem with a specific provision of the treaty, but with the entire treaty, which makes it very important for the clarification on the issue.

With this announcement, the IRS has stated that it and Treasury will consider all references to NAFTA in U.S. tax treaties to be replaced by USMCA.   This is the obvious approach and will make for a smooth transition.  The problem is that, in the treaty world it takes two to tango.  The IRS cannot speak for Germany or France that they will read it the same way.  While many professionals do not see the USMCA as a major change from NAFTA, even if foreign countries agree with that sentiment, they may want to use this as a new point for negotiation, especially since lately the U.S. has not been very friendly when it comes to allies or foreign agreements.  In the end, there is probably not much to gain from these countries not taking the same approach other than the headache of needing to renegotiate a treaty, therefore, it is likely they will agree to follow the IRS and Treasury.  The Treasury Department is reaching out to these countries to confirm they agree with the interpretation, but from the tone of the announcement it seems the IRS is not expecting any surprises.

IRS Announcement 2020-6

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