M E M O R A N D U M

February 1, 2008

 

TO: Distribution

FROM: John Staples and Karan Mosley

RE: US Income Tax Treaties with Belgium, Denmark, Finland & Germany

On January 2, 2008, the Treasury Department announced the entry into force of Protocols amending existing income tax treaties with Germany, Denmark and Finland and a new income tax treaty and protocol with Belgium. The changes include the reduction of withholding rates on certain portfolio investment income, and will require U.S. withholding agents and Qualified Intermediaries to address documentation and systems' issues.

Summary of Portfolio Investment Income Withholding Rates

Dividends

• All the treaties retain the general rule that dividends are subject to withholding at 15%, or 5% if the beneficial owner directly owns at least 10% of the voting stock (Belgium, Finland, and Germany) or share capital (Denmark) of the distributing corporation.
• All the treaties add an exemption from withholding for dividends paid to pensions provided that the dividends are not derived from a trade or business carried on by the pension and, in the case of Belgium, Denmark, and Finland, by an associated enterprise. The Denmark treaty adds an exemption for dividends paid to a qualified governmental entity that does not control the payor of the dividend.
• The Belgium and Finland treaties have added RIC and REIT provisions. The Denmark and German treaties have modified their RIC and REIT provisions. The rules are:

  • RIC dividends cannot receive the 5% rate but can qualify for the 15% rate.
  •  All four treaties have added provisions that exempt RIC dividends paid to pensions provided the dividends are not derived from a trade or business carried on by the pension. The Denmark treaty adds an exemption for RIC dividends paid to a qualified governmental entity that does not control the RIC.
  • Under all four treaties, REIT dividends are entitled to a 15% rate (or the zero rate if the beneficial owner is a pension and, under the Denmark treaty only, a qualified governmental entity) only if (i) the beneficial owner is an individual or a pension fund owning not more than 10% of the REIT; (ii) the REIT dividends are paid on a class of stock that is publicly traded and the beneficial owner is an individual or entity owning an interest of not more than 5% of any class of REIT stock; or (iii) the beneficial owner is an individual or entity holding an interest of not more than 10% in the REIT and the REIT is diversified.
    • Previously, the treaties with Finland and Germany provided a 15% rate on REIT dividends only in the case of an individual owning less than a 10% interest in the REIT. The Denmark treaty REIT provisions are generally unchanged from the prior version except that it now applies a zero rate to pensions and qualified governmental entities. The REIT provisions are new in the Belgian treaty.
    • The RIC/REIT rules above do not apply to distributions made by a REIT and certain RICs that are attributable to gains derived from the alienation of a U.S. real property interest and treated as gain recognized under IRC §897(h)(1). Such distributions are subject to withholding under the Gains articles of the treaties and IRC §1445.

Interest

• The Belgian treaty now generally grants a zero rate on interest. Previously, the treaty generally imposed a 15% rate. The Denmark, Finland and German treaties retain their general zero rate on interest.
• The Belgium, Denmark and Finland treaties all have added provisions denying the zero rate for contingent interest (e.g., interest determined by receipts, sales, profits, or change in the value of property). Such interest is subject to a 15% rate. The German treaty did not add a new provision but already contained a provision in Article 10(6) (Dividends) stating that income from arrangements, including debt obligations, carrying the right to participate in profits may be taxed in the U.S. at 30%.
• The Belgium, Finland, and German treaties have added a provision under which an excess inclusion with respect to a REMIC residual interest is subject to 30% withholding. A similar provision was already in the Denmark treaty.
  

Effective Dates

The Belgium, Denmark and Finland treaty withholding rate provisions go into effect for amounts paid or credited on or after February 1, 2008. However, because the protocol with Finland entered into force prior to December 31, the Technical Explanation states that the zero rate under that treaty on dividends paid to pensions will have effect from January 1, 2007. The Germany treaty withholding rate provisions have effect retroactively as of January 1, 2007.

Recommendations: Withholding agents will need to obtain new Forms W-8BEN from beneficial owners to claim a zero rate on dividends paid to a pension and, in the case of Denmark, to a qualified governmental entity. Generally, new Forms W-8BEN with line 10 completed will also be necessary to claim a 15% rate on REIT dividends although other alternatives short of obtaining a new form may be available. Withholding agents will also have to change their withholding modules to reflect the new treaty rates. In the case of Belgium, Denmark and Finland (other than dividends paid to pensions), the systems will have to reflect the new rates only for payments made on or after February 1, 2008. All four treaties have modified limitation on benefits provisions to strengthen them. Generally, withholding agents should not have to request new withholding certificates because of the modified limitation on benefits provisions unless they have reason to know that a beneficial owner no longer qualifies under those provisions.

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