Marc Quaghebeur

Introduction

When Belgian PM Verhofstadt and Finance Minister Reynders met President Bush in January 2006, the agenda had been clearly agreed in advance, and a new double tax treaty was not on the agenda. But then the Belgians proposed a new double tax treaty. The president did not show his surprise, but he quipped: “if that means we both pay less taxes, then that’s fantastic”.
 
In fact, the treaty may well qualify for the Guinness Book of Records as the fastest negotiation and ratification process of a double tax treaty ever.  Negotiations only started after Prime Minister Verhofstadt and Finance Minister Reynders met with President Bush in January 2006, and a completely revised treaty was signed within a year, together with a protocol which clarifies some technical details. On 28 December 2007, the ratification documents were exchanged so that the treaty entered into force on 1 January. 

General

The new income tax treaty: (http://www.ustreas.gov/press/releases/reports/treaty.doc) , and protocol: ( http://www.ustreas.gov/press/releases/reports/initialed protocol 11.20.06 final for printing.doc ) which will replace the 1970 double tax treaty, is based on the OECD Model (2005) as well as on the most recent treaties signed by both parties, in particular the US Model tax treaty published in November 2006. 

The most significant changes are the zero-rate withholding tax, the tightening of the limitation-on-benefits provision and the introduction of a mandatory binding arbitration, but there are a number of other important changes, generally in line with recent U.S. treaty practice. The treaty addresses cross-border pension issues and includes now-standard U.S. provisions dealing with hybrid entities, regulated investment companies (RICs), and real estate investment trusts (REITs) and exchange of information.  In particular the exchange of information provisions raised quite a few eyebrows in Belgium.

An official of the US Treasury recently explained that  the zero rate withholding provision for dividends has been significant in helping the US modernise its LOB provisions and improve information exchange.  The US Treasury prided itself that the United States was able to get the best information exchange article in the treaty, but also to ensure that Belgium provides the information in practice.

Entry into force

The new treaty entered into force on 28 December 2007. Its provisions apply for taxable periods beginning on or after January 1st 2008. As for withholding tax, the treaty entered into force on 1 February 2008. 

However, if a taxpayer was entitled to greater benefits under the old treaty, he can continue to claim the benefit of the prior treaty for twelve months.

Hybrid entities and residence

Article 1(6) of the new treaty provides that income, profit or gain derived though a fiscally transparent entity in either State will be deemed to be derived by a resident of a State to the extent that the item is treated for purposes of the taxation law of such Contracting State as the income, profit or gain of a resident.

If a U.S. LLC or LLP holds shares in a Belgian company and receives dividends, Belgium will acknowledge that the LLC or LLP is transparent and that the income is derived directly by a U.S. resident unless the income is not treated as income of a resident in the U.S.  This provision will ensure that Belgium grants the participation exemption for dividends derived from shares in a fiscally transparent entity in the United States. This has been a bone of contention for a very long time, as the Belgian Tax Authorities refused the benefit of the participation exemption because the dividends did not qualify under the condition that the dividends must have been subject to a tax of the same nature as the (Belgian) corporate income tax. (See also Article 22)

Business profits (Articles 5, 7 and 9)

The warehousing exemption in Article 5(3) has been brought into line with treaty practice, thereby ending the abnormality that the permanent establishment exemption was not available where goods held by a U.S. person in a Belgian warehouse are sold in Belgium (article 5(4) of the old treaty).

One of the provisions in the new Protocol requires that the principles of the OECD transfer pricing guidelines be used in determining the profits attributable to a permanent establishment. Given the consternation that has been caused by the OECD’s ongoing project on the attribution of profits to a permanent establishment, some taxpayers may find this provision a point of concern.

The new treaty introduces a correlative adjustment provision in Article 9(2).  When one State adjusts the taxable income and tax liability of an enterprise, and the other State agrees that the adjustment is appropriate, the latter is obliged to make a correlative adjustment to the tax liability of the related enterprise which is a resident of that State.

Dividends (Article 10)

The withholding tax on dividends is limited to 15 percent (5 percent in case of a parent company that owns directly at least 10 percent of the voting stock of the company paying the dividends). However the treaty introduces a zero rate, but under different conditions.

US dividends

The treaty provides a zero rate for dividends paid to a Belgian parent company that has owned directly or indirectly shares representing 80 percent of the voting power in the US subsidiary for the last twelve months with strict limitation of benefit conditions.   This threshold mirrors the one in the treaties and protocols which the U.S. has signed recently with the UK, the Netherlands, Sweden, or Germany.  This provision has to be read in conjunction with the limitation-on-benefits provision (Article 22) and the exchange of information provision (Article 25). 

The zero rate will be discontinued after five years, unless the U.S. Senate is satisfied that Belgium has satisfactorily complied with its obligations under Article 25. Moreover, the U.S. may terminate the convention if it finds that Belgium's actions with respect to Articles 24 (Mutual Agreement Procedure) and 25 have materially altered the balance of benefits of the Convention.

Belgian dividends

A US parent company only needs a 10 percent participation in the capital of the Belgian subsidiary.   However, since 1 January 2007, Belgium has extended the nil rate under the EU Parent-Subsidiary Directive to parent companies established in a country that is a double tax treaty partner (see http://international.taxationweb.co.uk/index.php?id=445).  Under the EU Parent-Subsidiary Directive, the only limitation of benefits provision is that the parent company must be liable to corporate income tax and not enjoy a tax regime that substantially departs from the ordinary tax regime. 

Dividends received by Pension funds

The withholding tax rate for dividends paid to pension funds is zero rated.  Belgium was particularly keen on this provision because it attempts to attract pan-European pension funds.  When implementing the so-called IORP Directive (Directive 2003/41/EC of the European Parliament and of the Council on the activities and supervision of Institutions for Occupational Retirement Provision (IORPs) of 3 June 2003 for Occupational Retirement Provision (Belgian State Gazette, 10 November 2006), Belgium adopted a new and transparent flexible legal framework, which must promote Belgium as prime location for international and pan-European pension funds.  Part of this strategy is to offer pension funds a de facto exemption of Belgian corporate income tax and one of the most extensive networks of double taxation treaties. The double tax treaty with the U.S. figures prominently in the government’s promotion.

Dividends received by conduit companies

Conduit rules are included to prevent the use of a U.S. Regulated Investment Company (RIC) to transform portfolio dividends into direct investment dividends or the use of a U.S. REIT to transform income from the sale of real estate into dividend income from the REIT.   That is why dividends paid out by a RIC or a REIT are excluded from the 5 percent withholding tax rate.  The maximum withholding tax in the U.S. will be 15 percent except if a RIC pays out a dividend to a pension fund in which case, it is zero. 

The withholding tax on dividends paid out by a REIT are reduced from the standard 30 to 15 percent in three situations:

• the beneficial owner of the dividend is an individual holding an interest of not more than 10 percent in the REIT.
• the dividend is paid with respect to a class of stock that is publicly traded and the beneficial owner of the dividend is a person holding an interest of not more than 5 percent of any class of the REIT’s shares. 
• the beneficial owner of the dividend holds an interest of not more than 10 percent of a “diversified” REIT.  A REIT is diversified if the gross value of no single interest in real property held by the REIT exceeds 10 percent of the gross value of the REIT’s total interest in real property. Foreclosure property is not considered an interest in real property, and a REIT holding a partnership interest is treated as owning its proportionate share of any interest in real property held by the partnership.

Dividends paid by a REIT beneficially owned by a pension fund are zero rated if the pension fund holds an interest of not more than 10 percent in the REIT. 

U.S. branch profits tax

The treaty also introduces a U.S. “branch profits” provision. In addition to the tax imposed on the taxable income of a foreign corporation, a foreign corporation also pays a tax of 30 percent of the dividend equivalent amount for the taxable year. The new treaty limits this U.S. branch profits tax to 5 percent in accordance with the withholding tax rules. It may, however, be eliminated on investments in a U.S. branch or partnership provided it meets the necessary limitation-on-benefits requirements (see Article 21).

Interest (Article 11)

The withholding tax rate on interest is eliminated subject to the limitation-on-benefits test (see Article 21).  This follows the current practice to eliminate withholding tax on cross-border payments of interest.  Within Europe, Belgium is surrounded by countries that as a matter of domestic tax law, do not levy withholding tax on interest (the Netherlands, Germany, Luxembourg). Moreover, EU Directive 2003/49/EC (Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States,  O.J., L 157, 26 June 2003, p. 49) provides for a zero withholding tax rate on interest.  In recent income tax treaties, the United States has also called for a zero rate of withholding. 

There are, however, specific anti-abuse exceptions for contingent interest where the source state can withhold 15 percent tax and for excess inclusions with respect to a real estate mortgage investment conduit (REMIC) which the US can fully tax. The latter is a U.S. policy to prevent purchasers of residual interests who would have a competitive advantage over U.S. purchasers at the time these interests are initially offered. There are, indeed, opportunities for tax avoidance created by differences in the timing of taxable and economic income produced by these interests.

Contingent interest is defined from a U.S. point of view as interest that does not qualify as portfolio interest under U.S. domestic law. The definition is in section 871(h)(4) of the Code, it must ensure that the exceptions of section 871(h)(4)(c) will apply.  Belgium, on the other hand, could charge 15 percent on any interest arising in reference to the receipts, sales, income, profits or other cash flow of the debtor or a related person, to any change in the value of any property of the debtor or a related person or to any dividend, partnership distribution or similar payment made by the debtor or a related person.

Gains (Article 13)

Gains derived by a resident of a Contracting State that are attributable to the alienation of real property situated in the other Contracting State may be taxed in that other State.   By using the term "attributable to the alienation of real property" rather than "gains from the alienation" (see the OECD Model Treaty), the U.S. can look through distributions made by a REIT and certain RICs and tax the capital gain on the underlying real property on the basis of Article 13 rather than on the basis of Article 10 (dividends).

Moreover, the term real property includes "United States real property interest", which denotes shares in a U.S. corporation that owns sufficient U.S. real property interests to satisfy an asset-ratio test on certain testing dates (section 897(c)) and certain foreign corporations that have elected to be treated as U.S. corporations (Section 897(i)).

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