Denial of Treaty Benefits and Limitation of Benefits

Denial of Treaty Benefits and Limitation of Benefits

One of the hallmarks of international tax planning is the ability to obtain a tax ruling from a foreign revenue services that the taxpayer is a qualified resident for income tax treaty purposes. Such a ruling permits a taxpayer to proceed with certainty in establishing operations. It allows a taxpayer to understand what dividends and interest will flow free or withholding taxes.

Starr International (“Starr”) is an interesting case for a number of reasons. In early February of this year, the United States motioned the court to reconsider its prior ruling that the IRS “consult” with its Swiss counterparts prior to any final decision to grant treaty benefits. The government argues that separation-of-powers principles prevent the Court from forcing the IRS to consult with the Swiss authorities or dictating the outcome of any consultation because doing so would impinge on the Executive’s authority to conduct foreign relations.

In 2015, the U.S. District Court, District of Columbia held that Starr, a Panamanian company tax resident in Switzerland, was permitted to proceed with its case on the issue of whether the government abused its discretion in denying Starr’s application for a ruling that Starr was entitled to a treaty qualification ruling that it was a eligible for benefits under the U.S.- Swiss Treaty. In denying the request for a ruling, the government did not consult with its Swiss counterpart. Starr contended that this was an abuse of discretion.

The ruling

At stake was $38 million dollars that was withheld from a 2007 U.S. source dividend because Starr did not qualify for treaty benefits. Starr claimed that nearly all of the economic value of Starr was vested in non-voting common stock owned by a Swiss formed charity that was owned by a Swiss Foundation. The voting common and preferred was owned by individuals, all but two of which were U.S. citizens. Starr and the government agreed that Starr did not satisfy the mechanical tests for a ruling under the Limitation of Benefits (LOB) provisions of the treaty.

While the case will proceed on the basis that the government’s discretion is not reviewable, there are other significant points. First, the structure was designed to put more than 50% of the value in foreign ownership. Second, the voting common and preferred shares could not impair the value of the class of non-voting common without its consent. It is unclear whether the Starr was structured in 1943 to avoid U.S taxation and its reaction to the 1962 change in the law which introduced of Subpart F and the Controlled Foreign Corporation status.