Double Taxation Relief Manual: Guidance by country: United States of America: Limitation on Benefits: cases of doubt
See DT19882 for the main provisions. In most cases, this will be sufficient to determine entitlement but in more difficult cases the following further explanation may be useful.
In broad terms, a “qualified person” is a UK or US resident who is either:
a qualified governmental entity (as defined in Article 3);
a publicly traded company (listed in the UK or US);
a 50%+ subsidiary of five or fewer publicly traded companies (that are listed in the UK or US);
a publicly traded trust (listed in the UK or US);
a trust 50%+ owned by publicly traded companies or by publicly traded trusts (that are listed in the UK or the US);
a pension scheme (where more than 50% of beneficiaries, members or participants are individuals who are UK or US resident);
a tax exempt employee benefit scheme (where more than 50% of beneficiaries, members or participants are individuals who are UK or US resident);
a religious, charitable, scientific, artistic, cultural or educational organisation;
a legal entity that satisfies an ownership and a “base erosion” test;
a trust, or trustee of a trust in their capacity as such, if the trust is more than 50% owned by certain “qualified persons” or by “equivalent beneficiaries” provided it satisfies a “base erosion” test.
These tests, which determine whether a particular category of UK or US resident is a “qualified person”, are all based on the concept that a substantial commercial and economic connection must exist between the taxpayer and the UK or the US to warrant entitlement to treaty benefits. If the standard set by any one of the tests in paragraph 2 is met, then entitlement to all treaty benefits is established (subject to conditions in the articles dealing with the type of income concerned being met).
How is the “base erosion” test satisfied?
The base erosion test is satisfied if less than 50% of the person’s gross income for the relevant taxable or chargeable period is paid or accrued, directly or indirectly, to persons who are not UK or US residents in the form of payments that are tax deductible for the purposes of the taxes covered by the treaty in the country in which the person is resident.
The “derivative benefits” test
Paragraph 3 of the article provides that, even if a company is not a “qualified person” as defined by the treaty, it shall nevertheless be entitled to the benefit of the treaty with respect to an item of income, profit or gain, if it satisfies any other specified condition for obtaining such benefit, and it is at least 95% owned by seven or fewer persons who are “equivalent beneficiaries” as defined by the treaty, and less than 50% of the company’s gross income for that period is paid to non-UK or non-US persons in the form of tax deductible payments. The conditions set out in paragraph 3 of the article are commonly known as the “derivative benefits” test, though this is not a term employed in the treaty.
As at January 2004 the provision has no effect because no EC or EEA country has a comprehensive double taxation treaty with the US that provides for zero US withholding tax on dividends.
The “active conduct of a trade or business” test
Paragraph 4 of the article provides that even if a UK resident is not a “qualified person” as defined by the treaty it shall nevertheless be entitled to the benefit of the treaty with respect to an item of income, profit or gain, if it satisfies any other specified condition for obtaining such benefit, and it is engaged in the active conduct of a trade or business in the UK.
Paragraph 4 (a), (b) and (c) set out the conditions for passing the “active conduct of a trade or business” test and guidance on the meaning of some of the specific terms used in the paragraph is provided in the Exchange of Notes to the treaty. Essentially however, there are three main conditions: the UK resident must be engaged in the active conduct of a trade or business in the UK; the income derived from the US must be derived in connection with or incidental to that trade or business; and the trade must be substantial in relation to the activity in the US.
Comment on the meaning of “trade or business”, “in connection with”, “incidental to” and “substantial” is given in the section entitled “Zero Withholding Tax on US Dividends - Articles 10 and 23” in the Special Edition Tax Bulletin.
Competent authority discretion
Paragraph 6 provides that a UK or US resident who is neither a “qualified person” nor entitled to treaty benefits with respect to an item of income, profit or gain under the “derivative benefits” test or the “active conduct of a trade or business” test shall nevertheless be granted treaty benefits by the competent authority of the other country if the competent authority determines that the establishment, acquisition or maintenance of the person claiming the benefit 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 detail, with reference to specific circumstances, how the competent authority will approach this task.