Tax Treaty Benefits for U.S. Investments

As expected, a foreigner investing in a U.S. business may be subject to U.S. taxes.  Sometimes, when receiving the profits, the investor may be surprised to discover that the source usually withholds a fraction of it to fulfill tax obligations.  The amount withheld, often exceeding what is eventually owed, can also come as a surprise.  If taxes are not withheld, the investor may be required to file a tax return and pay taxes.

Generally, citizens and resident aliens are required to file an annual return with the Internal Revenue Service to report their income for the year and pay any taxes owed.  When paying a foreign person, the U.S. tax code shifts collection to the source, and the foreign person must file with the Service for any refund.  This ensures payment of taxes on U.S. income, but the withholding rates can be very high.  Tax treaties ease this burden by providing for more favorable tax rates; however, it is the responsibility of the foreign investor to file a treaty position with the person withholding taxes.  For investors who do not have taxes withheld, treaties can also assist by providing favorable rates, or even providing exceptions to filing which may exempt the U.S. income, but again, it is the investor’s responsibility to claim this position on their tax return.

Tax treaties are bilateral agreements between two countries that provide guidelines for how taxes will be administered between the two nations when a resident of one country is earning income in the other country.  These agreements mitigate the same income from being taxed twice and address other tax situations.  For example, most treaties lower the withholding tax on passive income such as dividends, and also provide a rule that active income in the U.S. must have a permanent establishment. Each treaty will define permanent establishment and there may be differences between any two given treaties.  In general, a permanent establishment is a fixed place of business through which a foreign enterprise conducts business activities in a country.  These are only a few treaty benefits investors can use to limit tax exposure in the U.S.

To find the correct provision under a tax treaty, investors must: (1) identify which treaty applies and if there is one with the U.S.; (2) note applicable provisions and limits on benefits; and (3) see if they qualify based on their situation.  It is important to remember, it is always the burden of the foreign investor to take a treaty position.

The U.S. remains a very attractive market for investors.  Even with the current favorable tax rates, investors should consult with a professional to see if they are entitled to any benefits under a U.S. tax treaty.

Disclaimer: Hone Maxwell LLP articles and blogs are not intended as legal advice. Additional facts, facts specific to your situation or future developments may affect subjects contained herein. Seek the advice of an attorney before acting or relying upon any information herein.

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