On Aug. 12, 2015, the IRS published Rev. Proc. 2015-40. The revenue procedure provides guidance on the process of requesting and obtaining assistance under U.S. tax treaties from the U.S. competent authority, acting through the Advance Pricing and Mutual Agreement Program and the Treaty Assistance and Interpretation Team (TAIT) of the IRS's Large Business & International Division.
Rev. Proc. 2015-40 supersedes Rev. Proc. 2006-54. This item highlights the changes to the general requirements for requesting a discretionary limitation-on-benefits (LOB) determination from the U.S. competent authority.
Compared to Rev. Proc. 2006-54, Rev. Proc. 2015-40 requires additional detail that taxpayers must provide when requesting a discretionary LOB determination. In addition, Rev. Proc. 2015-40 outlines certain conditions that must be met if a favorable determination is made. Importantly, Rev. Proc. 2015-40 identifies, by way of example, circumstances when the U.S. competent authority will not grant discretionary relief under a treaty. Finally, it announces an increase in the user fees for requesting discretionary LOB relief.
Rev. Proc. 2015-40 generally applies to requests filed on or after Oct. 30, 2015, although the triennial statement requirement, discussed below, is effective for discretionary LOB determinations issued on or after Aug. 31, 2015.
Consistent with Rev. Proc. 2006-54, Section 3.06(2)(a) of Rev. Proc. 2015-40 provides that the U.S. competent authority will not issue determinations regarding whether an applicant satisfies one of the objective LOB tests. In addition, Rev. Proc. 2015-40 provides that the U.S. competent authority will not accept a discretionary LOB request unless the applicant represents that, and explains why, it does not qualify under the objective tests of the LOB provisions.
In a departure from Rev. Proc. 2006-54, Sec. 3.06(2)(e) of Rev. Proc. 2015-40 outlines, by way of example but not limitation, circumstances when the U.S. competent authority typically will not exercise its discretion to grant relief:
- The applicant or any of its affiliates is subject to a special tax regime in its country of residence with respect to the class of income for which benefits are sought. An example of such a regime is a notional interest deduction for equity in the residence country.
- No tax or minimal tax would be imposed on the item of income in both the country of residence of the applicant and the country of source, taking into account both domestic law and the treaty provision (double nontaxation). The example provided is a hybrid instrument that is exempt from withholding and that generated a deduction in the country of source and that is exempt from tax in the resident country of the applicant.
- The applicant bases its request solely on the fact that it is a direct or indirect subsidiary of a publicly traded company resident in a third country, and the treaty withholding rate provided by the tax treaty between the United States and the country of the residence of the applicant is not lower than that provided by the tax treaty between the United States and the country of residence of the parent company or any intermediate owner.
Rev. Proc. 2015-40 also notes that U.S. competent authority will not accept a request based on hypothetical transactions and facts.
To obtain a favorable determination, the applicant must demonstrate that (1) it does not qualify under the relevant LOB provisions, (2) it has a substantial nontax nexus to the treaty country, and (3) neither the applicant nor its direct or indirect owners will use the treaty in a manner inconsistent with its purposes if benefits are granted. A substantial nontax nexus to the treaty country cannot be established by an intent to take advantage of favorable domestic laws of the treaty country, including the existence of a network of tax treaties. Rev. Proc. 2015-40 notes that the U.S. competent authority may grant all or only certain benefits.
In addition to the information already required by Rev. Proc. 2006-54, Rev. Proc. 2015-40 now requires that the applicant include the following with the request:
- The tax reasons for the use of any hybrid entities in the structure.
- In the case of a country that applies a territorial or exemption system for relieving double taxation on income or gain attributable to an office or branch in a third country, whether the applicant conducts business in the United States through such an office or branch, and if so, the name of the country in which the office or branch is located, the type of income or gain derived by the office or branch, and the applicable rate of tax applied to that income in that third jurisdiction.
- A chart stating:
- The name and country of tax residence or organization of the applicant and every entity or individual in its chain of ownership up to, and including, its ultimate beneficial owners.
- The classification of each entity under the tax law of the country in which it is organized and the United States (e.g., corporation, pension or other tax-exempt entity, or partnership).
- Whether each entity is fiscally transparent or opaque (i.e., nontransparent) under U.S. and foreign tax law.
- A description of the amount and type of ownership interests (e.g., preferred stock, common stock, or membership interests) held in each entity.
- An explanation of the nontax business reasons why the applicant was formed or maintained in the particular treaty country and an explanation for any recent changes in these reasons.
- A detailed description of the facts and circumstances that demonstrate that the applicant has a sufficient relationship or nexus to the treaty country.
- Analysis of any relevant factor for determining whether to grant a request for discretionary LOB relief, as indicated, for example, by the applicable U.S. tax treaty and Treasury Department Technical Explanation to the U.S. tax treaty.
- A statement whether the applicant received any tax rulings or tax concessions issued to the applicant by the country in which it is organized, a statement of whether the applicant otherwise benefits from a special tax regime in that country, and a description of the benefits.
- In the case of an applicant that is a hybrid entity, or that owns an interest in a hybrid entity through which it derives income, profit, or gain with respect to which it seeks treaty benefits, a detailed explanation of why the applicant derives the income in accordance with the relevant treaty provisions.
- A statement of the applicant's effective global tax rate.
- A statement of the extent to which deductible payments are made outside the ordinary course of the applicant's business.
- A detailed description of the tax treatment in the other contracting state if discretion is granted, including source and character.
A checklist of all of the information applicants are required to provide with a request for discretionary LOB relief is included in Section 3 of the Appendix of Rev. Proc. 2015-40.
Once an applicant obtains a favorable determination with respect to a discretionary LOB request, Rev. Proc. 2015-40 requires the applicant to notify TAIT within 90 days after becoming aware of any material change in fact or law with respect to the request. Unless TAIT indicates otherwise, a grant of discretionary LOB benefits will terminate upon the occurrence of a material change in law or fact. After notification of a material change, TAIT either will advise the applicant that the original determination is still in effect or will instruct the applicant to seek a supplemental determination. If a supplemental determination is required, no benefits will be allowed until TAIT has issued a supplemental determination. If a supplemental determination is issued, benefits may be granted retroactively.
In addition, Section 3.06(2)(h) of Rev. Proc. 2015-40 requires an applicant that receives a favorable discretionary LOB determination to file a triennial statement with TAIT to keep that determination in force. The statement must declare that:
- There has not been a material change with respect to any relevant fact.
- There has not been a material change in law relevant to the benefits being sought.
- The applicant is not claiming any benefits different from those granted.
The triennial statement must include a declaration under penalties of perjury that it is true, correct, and complete and must include any other representations or items as instructed by the U.S. competent authority. The applicant must file the first triennial statement no later than three years from the date of the letter notifying the applicant of the U.S. competent authority's determination to grant discretionary benefits, or by a date mutually agreed upon with the U.S. competent authority. The applicant must file each additional triennial statement with TAIT no later than three years after the most recent triennial statement, or by a date mutually agreed upon with the U.S. competent authority. The failure to timely file a triennial statement will result in a termination of the grant of discretionary benefits from the due date of the triennial statement.
Rev. Proc. 2015-40 generally applies to requests filed on or after Oct. 30, 2015, although the triennial statement requirement is effective for discretionary LOB determinations issued on or after Aug. 31, 2015.
Finally, Rev. Proc. 2015-40 announces an increase in user fees. The previous fee of $27,500 for requesting discretionary LOB relief increased to $32,500 for requests filed on or after Oct. 30, 2015, and before Sept. 30, 2016, and will be further increased to $37,000 for requests filed on or after Sept. 30, 2016.
Rev. Proc. 2015-40 updates the procedures for taxpayers requesting assistance from the U.S. competent authority and includes detailed guidance on discretionary LOB requests, simultaneous appeals procedures, and coordination with IRS examination, among other matters. Much of the documentation now explicitly required in Rev. Proc. 2015-40 has, in the past, been informally requested by the competent authority in the course of considering a discretionary LOB request. While greater transparency into the process is helpful, overall, it is clear that the process for requesting relief has become increasingly burdensome for taxpayers.
Interestingly, the examples of circumstances when the U.S. competent authority would not exercise its discretion to grant benefits under a tax treaty appear to be consistent with the tax treaty policy identified in the recently proposed changes to the U.S. Model Tax Convention and, perhaps, the Organisation for Economic Co-operation and Development base erosion and profit-shifting (BEPS) project more generally. For example, one of the changes proposes to deny treaty benefits in certain cases when the beneficial owner of the income benefits from a special tax regime. In this respect, "special tax regime" means any legislation, regulation, or administrative practice that provides a preferential effective rate of taxation to interest, royalties, or other income, including through reductions in the tax rate or tax base. According to the proposed Technical Explanation of the Model Tax Convention revisions, in the case of interest, this would include notional deductions with respect to equity. As noted above, Rev. Proc. 2015-40 indicates that discretion will typically not be exercised if the applicant or any of its affiliates is subject to a special tax regime, an example of which is a notional interest deduction with respect to equity. Moreover, Rev. Proc. 2015-40 also indicates that discretion would not be exercised in situations of double nontaxation, reflecting the work under the BEPS project.
Finally, it will be important to be mindful of the need to file the triennial statement and to notify the IRS of a material change in facts or law. In both cases, the failure to timely file the required notice terminates the ruling. Notably, no process is included to permit late filings, for example, upon a showing of reasonable cause.
A version of this item appeared in an EY International Tax Alert.
Michael Dell is a partner at Ernst & Young LLP in Washington.
For additional information about these items, contact Mr. Dell at 202-327-8788 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP.