Double Taxation Relief Manual: Guidance by country: United States of America: Dividends: from 1st May 2003
The United States tax deducted from a dividend paid by a United States corporation at the agreement rate of 15 per cent (5 per cent if the recipient is a company which is a resident of the United Kingdom and controls, directly or indirectly, at least 10 per cent of the voting stock in the United States company and doesn’t qualify for zero rate - see below) qualifies for credit as a direct tax (see INTM164010). The reductions to the above rates are not given if the dividends are effectively connected with (see INTM153110) a business carried on by the United Kingdom resident recipient through a permanent establishment in the United States or with a fixed base in the United States from which the recipient performs independent personal services.
Where the dividend is paid to a United Kingdom resident company controlling, directly or indirectly, at least 10 per cent of the voting power in the United States company, credit may also be given for the underlying tax (see INTM164010).
Withholding Tax on US Dividends - Articles 10 and 23
The treaty allows both the US and the UK to tax dividends paid to a resident of the other country but, subject to certain conditions, limits the tax the source country may impose to 5% or 15% of the gross amount of the dividend. In other circumstances, it removes entirely the right of the source country to tax dividends.
As the UK does not have a withholding tax on dividends, the limitations are only applicable to US dividends beneficially owned by and paid to UK residents.
The following considers the circumstances in which such UK residents may be entitled to receive US source dividends free of withholding tax. Reference is made to Article 1 (General Scope)], Article 10 (Dividends) and Article 23 (Limitation on Benefits).
Who will be entitled to zero US withholding tax (“zero”) on dividends?
It should be noted that the provisions of Article 23 (Limitation on benefits) in relation to zero on dividends are more stringent than for other benefits. The following therefore describes the rules in relation to zero on dividends only.
UK resident companies that beneficially own the dividend and that have owned shares representing 80% or more of the voting power of the US company paying the dividend for a 12 month period ending on the date the dividend is declared will be entitled to zero (Article 10(3)(a)), provided that the UK company either:
owned those shares, directly or indirectly, before 1 October 1998 (Article 10(3)(a)(i)) and it passes either an “ownership and base erosion” test (Article 23(2)(f)) or an “active conduct of a trade or business” test (Article 23(4));
is a company whose principal class of shares is listed or admitted to dealings on a recognised UK or US stock exchange and whose shares are regularly traded on a recognised stock exchange (Article 23(2)(c)(i));
is a company which is at least 50% owned (by reference to the aggregate voting power and value of its shares) directly or indirectly by five or fewer such companies (Article 23(2)(c)(ii));
is a company at least 95% owned (by reference to the aggregate voting power and value of its shares) directly or indirectly by seven or fewer “equivalent beneficiaries” and which passes a “base erosion” test (Article 23(3)); or
is accepted by the US competent authority as being entitled to the benefits of the treaty on the basis that the establishment, acquisition or maintenance of the company and the conduct of its operations did not have as one if its principal purposes the obtaining of treaty benefits (Article 23(6)).
UK tax exempt pension schemes will also be entitled to zero, provided that the dividends in question are not derived from the carrying on of a business, directly or indirectly, by the pension scheme and that more than 50% of the beneficiaries, members or participants of the scheme are individuals who are residents of either the UK or the US (Article 10(3)(b) and Article 23(2)(e)).
In summary therefore, in order to obtain zero a person must be a UK resident, must satisfy the conditions at Article 10(3)(a) or (b), must satisfy one of the relevant tests in the limitation on benefits article and must satisfy all the other specified conditions for obtaining the benefit.
The following material expands somewhat on the above. Any point of doubt or difficulty should be referred to CT & VAT, International CT. See also DT 19883 re Article 23 generally.
The 1 October 1998 ownership test and the subsequent interposition of intermediate holding companies
In order to qualify for zero under Article 10(3)(a)(i) the beneficial owner of the US dividend must be a UK resident company that has owned shares representing 80% or more of the voting power of the US company paying the dividend for at least 12 months before the dividend is declared and must have owned shares representing, directly or indirectly, 80% or more of the voting power of the US company paying the dividend before 1 October 1998.
In the case of direct ownership a UK company that owned the requisite shares before 1 October 1998 and continues to hold them will be entitled to zero when a dividend is declared by the US company.
In the case of indirect ownership, where before 1 October 1998 a UK ultimate group parent company owned the US subsidiary through an intermediate holding company and subsequently reorganises so that it assumes direct ownership of the US subsidiary, entitlement to zero is preserved because the UK ultimate parent company will be the beneficial owner of the dividend and it held the requisite shares in the US company, albeit indirectly, before 1 October 1998.
However, in the case where before 1 October 1998 a UK ultimate group parent company owned the US company directly, but subsequently reorganises so that a newly incorporated company is interposed between it and the US company paying the dividend, entitlement to zero (by virtue of this test) will not be preserved. This is because (in the case where the interposed intermediate holding company is a UK resident) although the new intermediate holding company will be the beneficial owner of a US dividend it did not hold the requisite shares in the US company before 1 October 1998, directly or indirectly, as they were held by the UK ultimate group parent company at that date.
In an alternative situation (where the interposed intermediate holding company is a US resident) the UK ultimate group parent company, whilst being the beneficial owner of a US dividend, did not hold the requisite shares in the US company paying the dividend at 1 October 1998 because this company did not exist at that date.
The “active conduct of a trade or business” test
A UK resident company seeking to obtain zero under Article 10(3)(a)(i) must, in addition to satisfying the 1 October 1998 ownership condition, satisfy either the “base erosion” and ownership test at Article 23(2)(f) or the “active conduct of a trade or business” test at Article 23(4).
The “active conduct of a trade or business” test has three main conditions: the UK resident must be engaged in the active conduct of a trade or business in the UK; the dividend derived from the US must be derived in connection with or be incidental to that trade or business; and the trade in the UK must be substantial in relation to the activity in the US.
The meaning of a “trade or business”
In the context of entitlement to zero withholding on US dividends, the terms, not being defined in the treaty, have the meaning they have in US law, in accordance with Article 3(2) (General Definitions).
The meaning of “in connection” with
In accordance with the Exchange of Notes to the treaty a dividend is to be considered as derived “in connection” with an active trade or business in the UK if the US activity that produces the dividend is a line of business which forms a part of, or is complementary to, the trade or business conducted in the UK.
A US trade or business activity will generally be considered to “form part of” a UK trade or business activity if, for example, it provides inputs to a manufacturing process carried on in the UK or if it sells the output of UK manufacturing operations or if it sells in the US the same sorts of products that are being sold by the trade or business carried in the UK.
A US trade or business activity may be considered “complementary” to a UK trade or business if its activities are part of the same overall industry and the two activities are economically and commercially interdependent.
The meaning of “incidental to”
A US dividend would be considered to be “incidental” to a UK trade or business if the dividend, though not produced by a line of business which forms part of, or is complementary, to the UK trade or business, nevertheless facilitates the conduct of the UK trade or business.
The meaning of “substantial”
To pass the “active conduct of a trade or business” test, the UK trade or business has to be substantial in relation to the trade or business activity in the US that gives rise to the dividend. Whether a trade or business activity is “substantial” will depend on all the facts and circumstances. Factors such as the nature of the activities carried on in each country and the comparative sizes of the trades or businesses carried on in each country will be taken into account.
Will a UK resident company that is owned by seven or fewer EC resident companies be entitled to zero?
A UK resident company that is at least 95% owned by seven or fewer “equivalent beneficiaries” will be entitled to zero if the company also meets a base erosion test (Article 23(3)) and satisfies any of the other specified conditions for obtaining zero.
Assuming it meets those other conditions the question is whether EC resident companies are “equivalent beneficiaries” as defined by the treaty.
What is an “equivalent beneficiary”?
An “equivalent beneficiary” is defined in Article 23(7)(d) (as amended by Article IV of the protocol to the treaty) as a resident of a Member State of the European Community or of a European Economic Area state, but only if either:
a) that resident is entitled to all the benefits of a comprehensive convention for the avoidance of double taxation (which includes a comprehensive limitation on benefits article) between any Member State of the EC or a EEA state and the US and would, under that convention, be entitled to zero US withholding tax on dividends or,
b) that resident is a specified “qualified person”.
At present the US has not entered into any other double taxation treaties with EC or EEC States which provide for zero US withholding tax on dividends. Therefore EC companies currently do not meet the first definition of “equivalent beneficiary”.
Neither do they meet the various specified definitions of “qualified person” (UK resident individuals, qualified UK governmental entities, UK resident UK or US listed companies whose shares are regularly traded on a recognised stock exchange, UK resident UK or US listed entities other than individuals or companies whose units are regularly traded on a recognised stock exchange, UK pension schemes, UK employee benefit funds or UK charities).
Therefore such a UK resident company would not automatically be entitled to the benefit of zero US withholding on dividends by virtue of Article 23(3).
However, assuming the UK resident company met all the other conditions for obtaining zero, it could apply to the US competent authority for the benefit of zero under Article 23(6).
Are unquoted UK companies entitled to zero?
Assuming an unquoted UK resident company is the beneficial owner of the dividend and has owned shares representing 80% or more of the voting power of the US company paying the dividend for at least 12 months before the declaration of the dividend it may be entitled to zero US withholding tax on the dividend if it is owned by seven or fewer “equivalent beneficiaries” and it passes a so-called “base erosion” test (Article 10(3)(a)(iii) and Article 23(3)).
The definition of “equivalent beneficiaries” includes UK resident individuals (Article 23(7)(d)(ii) (as amended by Article IV of the protocol to the treaty)).
The “base erosion” test requires that less that 50% of the unquoted UK resident company’s gross income for the taxable year or chargeable period in which the dividend arises is paid, directly or indirectly, to persons who are not “equivalent beneficiaries”, in the form of payments that are tax deductible.
The company must, of course, also satisfy the other conditions of the dividends article.
If the company did not qualify by this route it could apply to the US competent authority for the benefit of zero under Article 23(6).
What is the procedure for applying to the US competent authority for zero under Article 23(6) and how long will it take?
A taxpayer that is not otherwise entitled to benefits under Article 23 but believes it may be entitled to such benefits under the discretionary provision of Article 23(6) should submit that request to:
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224
For guidance in preparing requests for discretionary benefits, taxpayers should consult the U.S. Treasury Technical Explanation of Articles 10 and 23 of the Treaty (see https://www.treasury.gov/resource-center/tax-policy/treaties/Documents/teus-uk.pdf), and the U.S. Internal Revenue Service’s Revenue Procedure 2002-52, with particular reference to Sections 3.08 and 4 (see https://www.irs.gov/pub/irs-irbs/irb02-31.pdf pages 242 to 253). The IRS Internal Revenue Manual Exhibit 4.60.3-3, at Internal Revenue Manual - 4.60.3 Tax Treaty Related Matters, provides detailed guidance regarding information that should be submitted in connection with any request for a discretionary determination. The US has provided assurances that the competent authority office will consider any requests received as expeditiously as possible. In the case of a favourable determination, benefits will be allowed retrospectively to the later of the effective date of the relevant treaty provision or the time of establishment of the structure in question.
On what basis will the US competent authority decide whether a UK resident company is entitled to zero?
Zero will be granted if the US competent authority is satisfied that the establishment, acquisition or maintenance of the UK resident company and the conduct of its operations did not have as one of its principal purposes the obtaining of benefits under the treaty.
The Exchange of Notes to the treaty sets out in some detail, with reference to specific circumstances, how the US competent authority will approach this task.
What is the purpose of the consultation requirement?
The US competent authority is required to consult the UK competent authority before refusing zero to a UK resident under Article 23(6). This requirement gives the UK competent authority the opportunity to provide any further facts, arguments or interpretations in favour of the claimant that might be material to the determination of the claim.
However, it is for the US competent authority to have the final say.
Can a UK resident company that is treated as fiscally transparent for US tax purposes obtain zero?
Assuming all the other conditions for obtaining zero are met, a UK resident company which is treated for US tax purposes as fiscally transparent due to a “check the box” election will be entitled to zero in respect of a dividend paid by its wholly owned US company if, and to the extent that, the UK treats the dividend as the income of a UK resident.
The rule governing how the treaty applies to persons who are regarded as fiscally transparent by either the UK or the US is at Article 1(8).