U.S. and UK Competent Authorities Sign Arrangements Providing Guidance on Certain Terms in the U.S.-UK Tax Treaty
On July 26, 2021, the U.S. and UK competent authorities signed two arrangements that address the definition of “equivalent beneficiary” for purposes of the 2001 income tax treaty (as amended by the Protocol signed July 2002). One of the arrangements clarifies the treatment of the UK as a member of the European Community following its withdrawal from the EU (“EU Arrangement”). The other arrangement clarifies the treatment of the U.S.-Mexico-Canada Agreement (USMCA) now that it supersedes the North American Fair Trade Agreement (NAFTA) (“USMCA Arrangement”).
U.S.-UK Treaty Derivative Benefits Test
The U.S.-UK tax treaty contains a derivative benefits test, under which residents that do not meet the definition of a “qualified resident” for purposes of the limitation on benefits (LOB) provision in article 23 still may qualify for benefits if the following criteria is satisfied:
- At least 95% of the vote and value of its shares is owned by seven or fewer persons who are equivalent beneficiaries; and
- Less than 50% of its gross income for the taxable year is paid or accrued, directly or indirectly, to persons who are not equivalent beneficiaries, in the form of payments that are deductible in the resident country.
An equivalent beneficiary, as outlined in article 23 (7)(d), is defined as: (1) a resident of an EU member state; (2) a resident of a European Economic Area state; or (3) a resident of a party to NAFTA. The resident must also satisfy the other tests outlined in article 23 to qualify.
Competent Authority Regarding the UK Withdrawal from the EU
As a result of the UK’s withdrawal from the EU, it was unclear whether a UK resident would continue to be considered a resident of an EU member state for purposes of applying the derivative benefits test. However, in the EU Arrangement, the U.S. and UK competent authorities agreed that, for purposes of defining equivalent beneficiary in the treaty, a UK resident will continue to be considered a resident of an EU member state. Therefore, UK residents should still be eligible to qualify as equivalent beneficiaries for purposes of the derivative benefits test.
Competent Authority Regarding the UK and the USMCA
On November 30, 2018, the U.S., Mexico and Canada signed the USMCA, which, effective July 1, 2020, supersedes NAFTA. While several U.S. income tax treaties specifically reference NAFTA in the derivative benefits test of the limitation on benefits provisions (including the U.S.-UK tax treaty, as outlined above), such treaties do not contain language referencing other agreements in the event NAFTA were to no longer be in force. Despite the U.S. Treasury Department (Treasury) releasing Announcement 2020-6 in May 2020 indicating that once the USMCA supersedes NAFTA, Treasury would interpret references to NAFTA in U.S. income tax treaties as references to the USMCA, uncertainty remained as to whether other jurisdictions, including the UK, would apply a similar interpretation.
However, in the USMCA Arrangement, the U.S. and UK competent authorities agreed that, pursuant to the mutual agreement procedure, for purposes of defining equivalent beneficiary in the U.S.-UK tax treaty, references to NAFTA will be treated as references to the USMCA.
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