Ireland: The 1997 Ireland/USA Double Tax Treaty

Last Updated: 5 March 1998
The 28th July, 1997 saw the signing of the new Ireland/USA Double Tax Treaty ("the New Treaty") which is to replace the existing treaty ("the 1949 Treaty") of 1949. Instruments of ratification are expected to be exchanged before the end of 1997 with the New Treaty entering into effect on 1st January 1998.

The New Treaty is accompanied by a Protocol and a Memorandum of Understanding but the technical memorandum usually prepared by the US IRS has yet to issue.

The New Treaty contains many welcome changes but for some sectors, particularly certain sectors of the financial services industry, the New Treaty brings some unwelcome changes, principally, the limitation on benefits article, which is the first comprehensive limitation on benefits article in Ireland's network of approximately 30 double tax treaties. For the most part, US-based multinationals operating in Ireland's will not be affected by this article but certain structures and operations based in the Dublin International Financial Services Centre may be affected.

Other favourable tax treatments afforded by the 1949 Treaty which will be adversely affected by the new treaty include the ability of portfolio investors in Ireland receiving dividends from a US corporation to obtain credit for underlying corporation tax and the ability of Irish branch operations of foreign corporates to receive interest from a US corporation free of Irish tax.

The following is a brief overview of some of the more relevant changes in the New Treaty.

Residence

A "Resident of a Contracting State" for the purposes of the New Treaty will include persons liable to tax in a state by reason of their domicile, residence, place of management, place of incorporation or similar criterion, US citizens, qualified governmental entities of a state, pension schemes, US regulated investment companies and real estate investment trusts and Irish collective investment undertakings.

The ability of Irish collective investment undertakings to avail of benefits under the New Treaty is a welcome development for the mutual funds industry in the Dublin International Financial Services Centre.

The inability of a US citizen and of a United States corporation to be resident of Ireland under the 1949 Treaty is changed in the New Treaty.

Also, the New Treaty contains a tie-breaker clause where persons are resident in both Contracting States - this does not exist in the 1949 Treaty.

Business Profits

A significant change to this article is the restriction on the amount of profits taxable in the country where the permanent establishment is located. Under the 1949 Treaty, the existence of a permanent establishment in the other State being liable for tax in the other State on all sources of income in that other State. Under the New Treaty, the taxable profits in the other State is limited to so much of the profits as are attributable to the permanent establishment.

Associated Enterprises

While the 1949 Treaty contains a provision for the adjustment of profits of one company in the case of dealings between associated enterprises, it does not contain a provision for a corresponding adjustment to the tax liability of the enterprise in the other State. The New Treaty contains such a provision in line with most modern treaties and this is to be welcomed.

Dividends

The dividends article in the New Treaty is more in line with the dividends out of the US, the Treaty provides for a 15% withholding tax in the case of a portfolio investor and a 5% withholding in the case of a corporate investor holding more than 10% of the voting stock.

The US portfolio investor receiving dividends from an Irish resident company will be entitled to the benefit of the Irish tax credit, and will be able to reclaim from the Irish Revenue any amount of that credit which exceeds 15% of the aggregate of the dividend and credit.

One notable change in the New Treaty with respect to dividends is the cessation of the Irish portfolio investor's entitlement to a credit for underlying tax paid by the US corporation paying the dividend.

Irish tax law re-characterises interest paid by an Irish company to a non-resident 75% parent company as a distribution. The Protocol to the New Treaty makes it clear that such interest will be treated as a dividend for the purpose of the New Treaty only to the extent that it exceeds an arms length rate.

Interest

Relief from taxation in the country of source was not available under the 1949 Treaty unless the recipient of the interest was liable to tax on it in the country of residence. Nor was relief available if the paying company was more than 50% owned by the recipient company. The interest article in the New Treaty brings interest treatment more in line with that provided in the OECD model treaty and is to be welcomed.

Royalties

This article is likewise replaced by an article more in the form of the OECD model article.

Capital Gains

The new treaty contains an article in respect of capital gains. The 1949 Treaty did not cover capital gains tax in Ireland.

The general rule is that gains from the alienation of property are taxable only in the country of residence. The following exceptions exist:

1. Immovable property;

2. A United States real property interest;

3. Unquoted shares deriving the greater part of their value directly or indirectly from Irish land; and

4. Business assets or a permanent establishment

Independent Personal Services

Under the 1949 Treaty an individual performing services in the other country was exempt from tax in that other country if his presence there did not exceed 183 days in a year and the services were performed for a person in his country of residence. The New Treaty restricts the charge to the country of residence unless the person performing the services has a fixed base readily available to him in the other country for the purpose of performing those activities. If so, the country where the fixed base is located may tax income attributable to that base.

Dependent Personal Services

Under the 1949 Treaty, dependent personal services were covered by the same rules as independent personal services. Under the New Treaty they get a separate article. It receives essentially the same treatment under the New Treaty, namely, that remuneration derived by a resident of one country in respect of employment exercised in the other country is taxable only in the country of residence if:

(i) the employee is present in the other country for not more than 183 days
(ii) the remuneration is borne by an employer who is not resident in the other country, and
(iii) the remuneration is not borne by a permanent establishment of fixed base of the employer in the other country.

Artistes and Sportsmen

The New Treaty contains an article dealing with the taxation of entertainers and sportsmen, who were not specifically covered in the 1949 Treaty. It permits a Contracting State to charge tax in that State if the activities are exercised but with an exemption from liability where the gross receipts of the entertainer or sportsman do not exceed US $ 20,000 in the tax year concerned.

Pension and Social Security Annuities

Broadly, this article provides exemption from tax in the country of source in respect of pensions and annuities received by residents of the other Contracting State. Similar treatment applies to alimony payments. The article also contains a provision whereby a person performing personal services in one Contracting State may obtain a tax deduction in that State in respect of contributions made to certain pension schemes in the other Contracting State.

Offshore Exploration and Exploitation

The 1949 Treaty did not specifically cover offshore exploration and exploitation.

The new Treaty provides that exploration or exploitation activities shall be deemed to be a permanent establishment except that where the activities are less than 120 days in any 12 month period, this will not apply. Associated enterprises count as one for the purpose of this time period.

These provisions are carried over into independent professional services and employment remuneration concerning exploration or exploitation activities. Independent personal services provided in respect of exploration or exploitation activities in the other country are deemed to be provided in respect of a fixed base, and therefore will be taxable in that other country, but only where the services exceed 120 days in any 12 month period.

Remuneration from employment in a permanent establishment which is deemed to exist with respect to exploration activities or exploitation activities may be taxed in that country.

Limitation on Benefits

As indicated, the limitation on benefits ("LOB") article is the first substantive LOB article in Ireland's network of double tax treaties.

In order for a resident of a Contracting State to be entitled to the benefits of the New Treaty, that person either must be a "qualified person" or satisfy one of the other tests in the article.

To be a "qualified person", a resident must be either:

a. an individual;
b. a qualified government entity;
c. a person other than an individual where at least 50% of such person is beneficially owned by a qualified person and where a "base erosion test" is satisfied;
d. a unit trust where either the principal class of units in the trust is listed and substantially and regularly traded on a recognised stock exchange or where at least 50% of the interests in the unit trust are owned either by unit trusts or by companies whose principal class of unit shares are substantially or regularly traded on one or more recognised stock exchanges.
e. A company satisfying a similar stock exchange test or a company owned 50% by companies satisfying the stock exchange test or by qualified governmental entities or by companies owned as to at least 50% by qualified governmental entities.
f. pension funds and trusts where more than 50% of the beneficiaries/members are qualified persons.

"Base Erosion Test"

This test will be satisfied if not more than 50% of the company's "gross income" is used directly or indirectly to make deductible payments to persons who are not qualified persons or US citizens/residents.

"Active Trade or Business" Test

A resident of the a Contracting State who is not a qualified person will nevertheless be entitled to the benefits of the New Treaty with respect to an item of income derived from the other state if that resident person is engaged in the active conduct of a trade or business in the state of residence and the item of income is either connected with or incidental to the trade or business. Where the item of income is connected with the trade or business in the state of residence and the resident of that state has an ownership interest in the activity in the other State that generated the income, the trade or business must be substantial in relation to that activity.

In addition to the subjective test in determining whether the "substantiality" test has been satisfied, the New Treaty provides a safe harbour standard. Under this safe harbour standard, an activity in a state will be deemed substantial in relation to the income producing activity in the other state if the ratios of the assets used in the first mentioned state, gross income derived from the active business in that state and payroll expense for services performed in that state to the assets, gross income and payroll expense for services performed in the other state each equals at least 7.5% and the average of the three ratios equals at least 10%.

Limited guidance is given in the Protocol as to what constitutes being engaged in the active conduct of a trade or business and safe harbour standards are provided in the case of certain banking and insurance activities. It is specifically provided that the carrying on of the business of making or managing investments will not be regarded as engaged in the active conduct of a trade or business unless such business is carried out by a bank or insurance company acting in the ordinary course of its business. Further guidance is given on this in the Protocol.

"EU or NAFTA" Test

A further test is provided whereby non-qualified persons may qualify for benefits under the New Treaty. This test provides that a resident of a Contracting State will be granted all the benefits of the Treaty if 7 or fewer residents of Member States or the EU or NAFTA own at least 95% of the company shares and the "Base Erosion Test" outlined above is satisfied but with a resident of the Member State of the EU or a party to NAFTA being treated as a qualified person for the purpose of applying that test.

Even if the above test is satisfied, a company resident in a Contracting State will not be entitled to the benefit of certain articles (eg dividends, interest) unless at least 95% of that company's shares are held by residents of Member States of the EU or of NAFTA and with the further requirement that that country and the country in which the income arises have a treaty with benefits under the New Treaty with respect so such income. It is understood that the countries which would not satisfy this test in the context of interest payments are Belgium, Canada, Italy, Mexico, Portugal and Spain.

"Motive" test

A further means by which a non-qualified person may be eligible for the benefits of the New Treaty is by satisfying the competent authority of the other contracting state that the establishment, acquisition or maintenance of such person and the conduct of its operations did not have as one of its principal purposes the obtaining of benefits under the New Treaty.

Relief From Double Taxation

One notable change in this article compared to the equivalent article in the 1949 Treaty is the absence for the Irish portfolio investor receiving a dividend from a US corporation of a credit for underlying tax paid by the corporation.

It is worth noting that because credit against Irish tax will be allowed in respect of US tax payable under the law of the United States and in accordance with the convention no credit may be granted for US tax that arises as a result of a treaty override.

It is also worth noting that a US domiciled Irish resident qualifying for the remittance basis of taxation in Ireland, will be eligible for the benefits of the New Treaty in respect of income only to the extent that it is remitted to Ireland.

Mutual Agreement Procedure

Such an article does not exist in the 1949 Treaty and therefore is to be welcomed.

Entry into force

It is expected that the New Treaty will be ratified in 1997 with it coming into effect on 1st January 1998.

Where a person entitled to the benefits of the New Treaty would be taxed more favourably under the 1949 Treaty, then that person can claim the benefits of that 1949 Treaty provision for a further 12 months.

The "comparable treaty benefits" test in respect of certain categories of income under the "EU or NAFTA" test is to be postponed for a period of 2 years with a postponement for a further 12 months if in the particular instance the 1949 Treaty would have provided a more beneficial result than the New Treaty.

A & L Goodbody is Ireland's largest legal firm providing a comprehensive range of corporate and commercial legal services. The firm has a dedicated taxation department comprising experienced specialists practising in corporate and commercial taxation matters. Working with specialists in our Corporate and other departments, we advise inward investors and domestic clients on the full range of taxation issues likely to arise in business transactions. For more information on the New Treaty and other taxation matters, please contact either John Hickson or Peter Maher.

This article was intended to provide general guidelines. Specialist advice should be sought about specific facts.

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