Disclosure requirements for treaty-based return positions.by Leifer, Steven J.
The disclosure requirements apply if a taxpayer takes a return position that any treaty of the U.S. (including, but not limited to, an income tax treaty, estate and gift tax treaty, or friendship, commerce or navigation treaty) overrules or modifies any provision of the IRC and thereby effects (or potentially effects) a reduction of any tax incurred at any time. A taxpayer is considered to adopt a "return position" when the taxpayer determines its tax liability with respect to a particular item of income, deduction or credit. A taxpayer may be considered to adopt a return position whether or not a return is actually filed.
What is a Treaty-Based Return Position?
In determining whether a return position is a treaty-based return position," the regulations provide that disclosure is required if the tax liability (including credits, carrybacks, carryovers, and other tax consequences or attributes for the current year as well as for other affected years) to be reported on a return of the taxpayer is different from the tax liability (including such credits, carrybacks, carryovers, and other tax consequences or attributes) that would be reported if the taxpayer did not rely on the benefit provided by a tax treaty. A return position is a treaty-based return position even if the IRC expressly provides that a taxpayer may rely on a treaty provision in order to override a specific IRC provision. In addition, a return position is a treaty-based return position unless the taxpayer's conclusion that no disclosure is required has substantial probability of success if challenged.
Example. Taxpayer is a foreign corporation with a U.S. trade or business. In the absence of a treaty, taxpayer would be subject to U.S. tax on the income effectively connected with the U.S. trade or business. However, under the terms of the treaty between the U.S. and the country in which taxpayer is resident, if the taxpayer does not maintain a permanent establishment in the U.S., the taxpayer is not subject to U.S. tax on a net basis on the U.S. trade or business income. The taxpayer's reliance on the permanent establishment clause of the treaty is a treaty-based return position that must be disclosed on the taxpayer's return.
Exclusions from Disclosure Requirements
In general, a treaty-based return position is subject to the disclosure requirements unless it is specifically excluded by the regulations. For example, the regulations exclude from the disclosure requirements a return position for which a treaty provides a reduced rate of withholding tax on certain types of passive income, such as dividends, interests, rents, or royalties. Such income is generally referred to as fixed, or determinable, annual or periodical income and, in the absence of a treaty override, is subject to withholding tax under Secs. 1441 or 1442.
This exemption does not apply to withholding requirements arising from special rules, relating to the sourcing of interest or dividends paid by foreign corporations, or relating to the treatment of payments to certain related foreign entities, or relating to income that is effectively connected with a U.S. trade or business but is not attributable to a permanent establishment in the U.S.
In addition, if a partnership, trust, or estate that has the taxpayer as a partner or beneficiary discloses on its information return a position for which reporting is otherwise required by the taxpayer, the taxpayer (i.e. partner or beneficiary) is then excused from disclosing that position on a return. The reporting requirement does not apply to a withholding agent with respect to the performance of its withholding functions.
Reporting is also waived for an individual when the aggregate of payments or income items otherwise reportable and received by the individual during the course of the taxable year does not exceed $10,000.
Although disclosure may not be required under Sec. 6114, in many cases there are other requirements that may bring the treaty position to the attention of the IRS. For example, a foreign corporation involving a nondiscrimination clause in a treaty in order to be taxed as a U.S. corporation on dispositions of real property is required to file an election to be taxed as a U.S. corporation. Similarly, a taxpayer who would be a U.S. resident in the absence of a treaty override is required to file a U.S. return. In addition, taxpayers that would be subject to withholding tax at a rate of 30% in the absence of a treaty are ordinarily required to provide the withholding agent with some assurance that they are, in fact, exempt or subject to reduced withholding under the treaty.
Positions Specifically Subject to Disclosure
The regulations identify certain treaty-based return positions that must be disclosed. The list in the regulations' is not intended to be exclusive. Any treaty-based return position is subject to disclosure unless specifically excluded from disclosure, as discussed above.
Form of Disclosure
The disclosure of a treaty-based return position should be made in a statement attached to the taxpayer's return. If the taxpayer is not otherwise required to file a return because, for example, the taxpayer has taken the position it does not have any income subject to U.S. tax, a return must be filed for the purpose of making the return position disclosure. Such return must be signed under penalties of perjury and need include only the taxpayer's name, address, and taxpayer identification number (TIN) if any, as well as the subject disclosure. The taxpayer's taxable year shall be deemed to be the calendar year (unless the taxpayer has previously established, or timely chooses for this purpose to establish, 'a different taxable year). The attachment to the return should be headed with the caption "Treaty-Based Return Position Disclosure under Section 6114" and provide the following information:
1. The taxpayer's name, employer identification number or social security number, TIN, if any, and address both in the country of residence and in the U.S.;
2. The name, TIN if available, and address in the U.S. of the payor of the income if the income is of the type that is FDAP, such as dividends, interest, rents and royalties;
3. A statement to indicate whether the taxpayer (if an individual) is a U.S. citizen or resident or (if a corporation) is incorporated in the U.S.
4. A separate statement of facts that the taxpayer relied upon to support each separate position taken, including for each position: 1) the nature and amount (or a reasonable estimate thereof) of gross receipts, each separate gross payment, each separate gross income item, or any other item (as applicable) for which the treaty benefit is claimed; 2) an explanation of the position taken along with a brief summary of the facts on which it is based; 3) the specific treaty provision(s) relied upon; 4) the code provision(s) overruled or modified; and 5) the provisions of the limitation on benefits article (if any) in the treaty that the taxpayer relies upon to prevent application of that article.
In a number of situations, separate reporting of related treaty positions or income items is not required.
1. If a taxpayer takes a position that it does not have a permanent establishment or fixed base in the U.S. and properly discloses that position, it need not separately report its payment of actual or deemed dividends or interest exempt from tax by reason of a treaty (or any liability for tax imposed by reason of Sec. 884 relating to the branch profits tax and branch interest tax).
2. A taxpayer may treat payments or income items of the same type (e.g., interest items) received from the same ultimate payor (e.g., the obligor on a note) as a single separate payment or income item.
3. If a taxpayer takes the return position that, under a treaty, income that is effectively connected with a U.S. trade or business is not subject to U.S. taxation because it is derived from sources outside the U.S., the taxpayer may treat payments or income items of the same type (e.g., interest items) as a single payment or income item.
4. Income from separate sales or services, whether or not made by an agent (independent or dependent), to different U.S. customers on behalf of a foreign corporation not having a permanent establishment in the U.S. may be treated as a single payment or income item.
Watch Out for Penalties
A taxpayer is subject to a $1,000 penalty ($10,000 for a C corporation) for each failure, in a material way, to disclose each treaty-based return position taken with respect to each separate payment or separate income item.
This penalty may be imposed more than once for a single taxable year if a taxpayer has failed to disclose one or more positions taken with respect to more than one separate payment or separate income item. For this purpose, separate payments or income items of the same type (e.g., interest payments) received from the same ultimate payor (e.g., the obligor on the note) will be treated as separate payments or income items (and not aggregated). However, the District Director has the discretion to aggregate separate payments or income items, in whole or in part, in accordance with the rules relating to aggregation of payments or income items for the purposes of the requirements for the reporting of treaty based return positions. The penalty may be imposed in addition to any other penalties. The penalty may be waived by the IRS if the taxpayer can show that the failure to provide the required information was not due to willful neglect.
When Do Disclosure Requirements Start?
The disclosure requirements apply to tax returns for which the original due date (without extensions) was after December 31, 1988. If the taxpayer filed a return before November 13, 1989 without complying with these provisions, or if the taxpayer was not otherwise required to file a return before November 13, 1989, the taxpayer was required to make the appropriate disclosures in a separate filing before june 12, 1990. In addition, with respect to any return due (without extensions) on or before march 10, 1990, the taxpayer is required to make the appropriate disclosures no later than June 12, 1990. However, if the taxpayer filed a return on or before November 13,1989 that included substantially the same information required above, an additional filing for that tax year is not required.
In the case of a foreign insurer or reinsurer that claimed an exemption from the Sec. 4371 excise tax in 1988 or 1989 on the basis of an annual filing of the Form 720, such filing deadline for 1988 and 1989 was August 15, 1990.
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