Jeffrey Tebbs and Caroline Reavesof Miller & Chevalier Chartered explain the substantive and procedural differences between a traditional treaty and a tax relief bill aiming to reduce obstacles to cross-border investment.
The United States-Taiwan Expedited Double-Tax Relief Act, which is advancing to the full Senate, would provide an array of tax benefits on certain income earned by qualified residents of Taiwan from US investments or activities.
These benefits include reduced US withholding taxes on dividends, interest, and royalties; a higher threshold for net basis taxation of business income; and preferential treatment of wages. This US tax relief would only take effect if Taiwan provides parallel relief to income earned by US residents from investments and activity in Taiwan. Together, these changes would reduce obstacles to cross-border investment with our ninth largest trading partner.
However, taxpayers should be aware of the substantive and procedural differences between this proposal and a traditional treaty.
First, the benefits of the legislation wouldn't take effect immediately after enactment. The Treasury Department must certify that Taiwan has afforded reciprocal relief to US residents. Based on similar rules for international operation of ships and aircraft, taxpayers should expect the certification process to delay the effective date.
In addition, eligibility for relief would be narrower than a treaty. Multinationals shouldn't assume the relief is available without analyzing their ownership structure and transactional flows.
Finally, the benefits provided, while substantial, also would be narrower than a comprehensive treaty—the legislation doesn't address transfer pricing, dispute resolution, or the creditability of certain taxes imposed by Taiwan.
Specific Relief Proposed
Under the proposal advanced by the Senate Finance Committee, the US would reduce withholding tax rates on interest and royalty income of qualified Taiwanese residents to 10% from 30%. Withholding tax rates on dividends would fall to 15% from 30%, with a special 10% rate available for corporate residents of Taiwan that satisfy an ownership threshold (10% of vote and value) and a holding period (one year prior to dividend).
Although the proposed withholding tax rates are higher than current US policy, it aligns with the withholding tax rates that Taiwan has negotiated in agreements with other major trading partners. The rules are otherwise intended to align with Articles 10 through 12 of the current US model treaty. Consistent with US policy, the reduced withholding rates wouldn't apply to dividends from real estate investment trusts or gains from sales of US real property interests.
The proposal further provides that the US would impose net income tax on the business income of a qualified resident of Taiwan that is effectively connected with a permanent establishment in the US—a significantly higher threshold for establishing taxable nexus than the existing standard of taxing income effectively connected with a US trade or business.
Finally, the proposal would exempt from taxation the compensation received by a qualified resident of Taiwan performing services in the US, unless paid by a US person or borne by a US permanent establishment. This rule should substantially reduce the compliance burden and costs of short- and intermediate-term business travelers between the US and Taiwan.
Restrictions on Relief
Similar to modern US treaties, the bill contains limitation-on-benefits rules to ensure that a corporate resident of Taiwan possesses sufficient nexus with Taiwan to justify application of benefits.
In general, entities taxed as corporations in Taiwan would be treated as qualified residents if they met an ownership and income test, a publicly traded in Taiwan test, or a qualified subsidiary test.
The current proposal now includes a rule allowing specific items of income to qualify for relief if emanating from (or incidental to) the conduct of an active trade or business in Taiwan, with restrictions consistent with US treaty policy. The active trade or business test isn't available if the company is controlled by residents of a "foreign country of concern," as defined in the CHIPS Act of 2022.
These limits are stricter than a typical treaty. The legislation wouldn't provide any mechanism for the two jurisdictions to offer discretionary relief. The proposal doesn't contain any "derivative benefits" test, which grants benefits to companies whose ultimate owner would be entitled to comparable tax relief if it earned the income directly (and the group satisfied a base erosion test).
Consequently, a Taiwanese company couldn't be considered a qualified resident if its ultimate owner was located in a third country, even if that third country has a tax treaty with the US that affords substantially similar benefits. While the addition of an active trade or business test mitigates the effect of omitting a derivative benefit test, it's limited to specific items of income.
Additional Differences
The benefits provided under the proposal are narrower than those provided under a comprehensive tax treaty. Critically, the bill wouldn't provide a common standard for pricing transactions between related parties or bilateral dispute resolution mechanisms to mitigate double taxation. In addition, the legislation doesn't identify the Taiwanese taxes that the US would consider eligible for its foreign tax credit.
Creditability of taxes under US treaties has grown in importance following 2022 regulations that tightened creditability standards (which have been partially suspended, but only through 2023). Some of these items may be addressed by the Treasury Department in regulations or when memorializing the reciprocal benefits—theproposal authorizes the release of regulations and guidance on a number of significant issues.
Such items may also be addressed by parallel legislation before the Senate Foreign Relations Committee, which would authorize the negotiation of a tax agreement between the American Institute in Taiwan and the Taipei Economic and Cultural Representative Office. Leadership of both the Senate Foreign Relations Committee and Senate Finance Committee have expressed optimism for a compromise, with hopes of completing legislation by the end of this year.
Originally published by Bloomberg Tax.
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