The End Game : The Zero-Tax Investor & Inbound US Investment with Old Treaties – John Bradshaw
We shall first sketch an effective but short-term inbound equity structure, from a zero-tax jurisdiction, into the United States, using Hungary in combination with Luxembourg. This should live thru at least 2005. Second, we shall outline improvements which can be made using a longer-life Polish/Cyprus inbound equity structure, once these countries join the European Union on May 1, 2004. In addition, we will consider what comes next (Romania?) and last, as most US treaties come to have LOB articles. Along the way, we shall address infusing the structure with substance, to blunt the impact of non-statutory business purpose tests.
If a zero-tax company, say in Bermuda, receives dividends directly from a US operating subsidiary, it suffers the 30% non-treaty rate of US withholding tax, up to the earnings and profits of the US company.
Zero-tax company – US operating company
We assume the zero-tax investor cannot avail himself of public company or headquarters companies or active business exceptions in LOB articles in recent US tax treaties. For now, we also assume the zero-tax investor is neither an EU resident nor a NAFTA resident. The implications of relaxing this residency assumption to circumvent US LOB clauses will be considered briefly at the end. Finally, we assume the zero-tax investor does not wish to consider a synthetic equity swap, perhaps because the tax result is uncertain or because of tax shelter disclosures.
There are a few remaining US tax treaties which do not contain LOB articles. These include those with Hungary, Romania, Poland, Greece, Pakistan, the Philippines and some former Soviet Socialist Republics. There are also a few US tax treaties which have antiquated holding company prohibitions, including those with Iceland, Norway, Egypt, Morocco, Trinidad & Tobago and Korea. We focus on EU countries on these lists, as typically dividends from operating subsidiaries can have favourable treatment under the relevant treaty and can be passed around the European Union tax free in virtue of the EU Parent/Subsidiary Directive. In addition, there are tax-effective techniques for repatriating profits out of the European Union to a zero-tax jurisdiction.
Hungary and Iceland provide short-term options for the zero-tax company to make an equity investment in a US operating subsidiary perhaps thru 2005 or even 2006. No treaty meetings have been held by the United States with Hungary or Iceland since 2002. The Hungary treaty negotiations never seem to make any progress. Some say the US Treasury is not in any rush, and will rely on court cases to deal with Hungary. If true, which I doubt, this would be an expensive and hazardous hit-and-miss approach to US policy. It would increase the importance of the substance discussed below. The US treaties with Korea, Pakistan, Trinidad & Tobago are also in renegotiation.
It is stated US Treasury policy to insert a limitation on benefits (“LOB”) article in all US income tax treaties. A country which refused in the long run to include such an article would find its US income tax treaty terminated. We are in the twilight zone. Nevertheless, there are still a few opportunities for a zero-tax investor, say in Bermuda, to access some third country US income tax treaties and make an inbound 100% equity investment into a US operating subsidiary in a tax effective manner, at least short term. Short term may even be thru the decade. For inbound investment into countries other than the United States, readers should consult The Holding Company and the Zero-tax Investor by Milton Grundy, ITPA Journal, May 2000 and the very helpful book of the same name. Our focus here, on the other hand, will be solely on structuring dividends from the US operating subsidiary since 2003, using old US tax treaties which do not as yet contain limitation on benefits (“LOB”) articles. (Shareholder interest-bearing debt financing US operations from a zero-tax jurisdiction will be addressed only in passing. This runs up against both thin capitalisation rules in Internal Revenue Code section 163(j) and anti-conduit back-to-back loan regulations.)