Under the existing wording of Article 23 of the Treaty, UK shareholders would no longer be considered equivalent beneficiaries for the purposes of the derivative benefits test, as the definition of equivalent beneficiaries refers to residency of a ‘member state of the EU or EEA or party to the North American Free trade Agreement.
On 26 July 2021, the US Internal Revenue Service (IRS) issued in conjunction with HM Revenue & Customs (HMRC) a Competent Authority Arrangement to clarify that UK residents can continue to be treated as equivalent beneficiaries.
What is Article 23?
The purpose of Article 23 (Limitation of Benefits) within the Treaty is to deter ‘treaty shopping’. Treaty shopping involves individuals and companies indirectly accessing the benefits of a tax treaty between two jurisdictions without being a resident of one of those jurisdictions.
Article 23 seeks to deter this practice by only granting the benefits of the Treaty to ‘qualified residents’ of the two Contracting States, where certain provisions are met. One of these provisions is known as the derivative benefits test, which grants treaty benefits to a resident of a Contracting State if its owners would be granted the same benefits if the income flowed directly to them. If the owners qualify, they are known as equivalent beneficiaries. The derivatives benefits test is relied upon by many groups to qualify under Article 23 for reduced rates of withholding tax.
Why has paragraph 7(d) Article 23 been affected by Brexit?
Paragraph 7(d) of Article 23 details the requirements of an equivalent beneficiary, which include ‘a resident of a Member State of the European Community or of a European Economic Area state or of a party to the North American Free Trade Agreement’.
Following the departure from the EU, UK residents would fall ordinarily outside of this definition and therefore could potentially not pass the conditions of Article 23. This could have had a consequential impact that businesses which had previously qualified for treaty benefits would no longer qualify, negatively impacting groups even where there had been no change to the business or ownership or other tax avoidance motive.
What has happened?
The Competent Authority Arrangement published by the IRS on 26 July 2021 clarified this point in stating that: ‘A “resident of a Member State of the European Community” continues to include a resident of the United Kingdom’. This is positive news for UK individuals and companies as it offers clarity that UK residents should still be able to qualify as equivalent beneficiaries when applying Article 23.
It is important to note this only applies to the UK/US Treaty and therefore group structures involving other jurisdictions may still be impacted.
Separately, the application of Article 23 is very mechanical in nature and needs to be considered in light of each particular group’s facts and circumstances. We therefore recommend businesses undertake a review to confirm the application of the Treaty to particular group structures.
Would you like to know more?
If you would like to discuss the above, please get in touch with your usual Blick Rothenberg contact or James Dolan using the details on this page.