According to the tax committees’ summary and technical explanation released with the discussion draft, the benefits provided to ‘qualified residents’ of Taiwan (discussed below) would be similar to those provided in the 2016 United States Model Income Tax Convention (2016 US Model Treaty). The legislation provides that future regulations or other post-enactment guidance issued under new Section 894A shall, to the extent practical, be consistent with the provisions of the 2016 US Model Treaty.

Observation: Notwithstanding the reference to the 2016 US Model Treaty as the basis for the legislation, there are differences between the proposed rules and that model treaty. No US income tax treaty currently in force is based on the 2016 US Model Treaty, although the pending US-Croatia Tax Treaty is modeled after it. 

For more information on the 2016 US Model Treaty, see the PwC Tax Insight. For additional information on the pending US-Croatia Tax Treaty, see the PwC Tax Insight.

Reduction of withholding taxes

The legislation would reduce the statutory 30% rate of US federal income tax imposed on certain US source payments, including interest, dividends, and royalties, received by or paid to certain residents of Taiwan (each referred to as a ‘qualified resident of Taiwan,’ as further described below). 

The legislation provides that the reduced rate is 10% for interest and royalty payments, and 15% for dividends. For dividends, the rate may be further reduced to 10% (except for dividends paid by Regulated Investment Companies (RICs)), which can only benefit from the reduced 15% rate) if such dividends are paid to or received by a person that, at all times during the 12-month period ending on the date when the relevant stock becomes ex-dividend, (a) is treated as a qualified resident of Taiwan, and (b) has held directly at least 10% (by vote and value) of such stock. 

The legislation provides a number of exceptions whereby the reduced rates (i.e., 10% or 15%) would not apply. The exceptions include dividends paid by a real estate investment trust (REIT), any amount subject to tax under the Foreign Investment Real Property Tax Act (FIRPTA) rules of Section 897, any amount received from or paid by an ‘expatriated entity’ to a foreign related person, and certain amounts included in income with respect to interests in a Real Estate Mortgage Investment Conduit (REMIC).

Observation: The reduced 10% rate on US-source dividends is higher than the 5% rate under the 2016 US Model Treaty with respect to dividends received from corporations that were held during a similar 12-month holding period. In contrast, most US income tax treaties do not contain a 12-month holding period requirement for a 5% dividend rate. Other US income tax treaties, especially those with developing countries, do not provide for a 5% dividend rate. Furthermore, generally consistent with certain other currently in force US income tax treaties, the benefit under the proposed legislation with respect to US-source interest and royalty payments is limited to a reduced 10% rate.

Observation: The rule that would deny benefits with respect to certain payments made by expatriated entities to connected persons is broader than a similar rule in the 2016 US Model Treaty, which only applies with respect to payments of interest, dividends, royalties, and guarantee fees paid within 10 years of that entity’s expatriation event. In the legislation, the provision denying benefits with respect to certain payments would apply indefinitely (i.e., rather than within the 10-year period after the expatriation event, as in the provision in the 2016 US Model Treaty). 

Determination of qualified residents of Taiwan

To avail of the benefits of the legislation, a foreign person must qualify as a ‘qualified resident of Taiwan.’ Under the proposed rules, a person would be treated as a ‘qualified resident of Taiwan’ if such person (1) is liable for tax to Taiwan by reason of its domicile, residence, place of management, place of incorporation, or any similar criterion; (2) is not a US person; and (3) in the case of a corporation, meets one of three tests provided for in such rules, which resemble (with a few relevant differences) the following tests provided under the Limitation on Benefits (LOB) article of 2016 US Model Treaty: the Ownership-Base Erosion Test, the Publicly Traded Company Test, and the Subsidiary of a Publicly Traded Company Test. 

Observation: The legislation does not include a standard generally found in US income tax treaties that extends treaty benefits to a company that is engaged in the active conduct of a trade or business in its residence country, without regard to ownership. The legislation (and perhaps post-enactment guidance) might consider other forms of typical LOB provisions like the active conduct of a trade or business test or the derivative benefits test (which is also found in many US income tax treaties).

Ownership-Base Erosion Test

Under the Ownership-Base Erosion Test of the legislation, a Taiwanese corporation may qualify as a ‘qualified resident of Taiwan’ if an ownership prong and a base erosion prong are satisfied. 

Ownership prong

The ownership prong is satisfied if at least 50% (by vote and value) of the company is owned, directly or indirectly, by qualified residents of Taiwan. In the case of indirect ownership, each intermediate owner must be a ‘qualifying intermediate owner’‒i.e., a person that is (1) a qualified resident of Taiwan, or (2) a resident in a third country (other than a ‘foreign country of concern,’ as defined in the CHIPS Act of 2022) that has a tax treaty with the United States that includes provisions addressing special tax regimes and notional interest deductions.

Observation: Regarding the definition of a ‘qualifying intermediate owner,’ the legislation is as restrictive as the 2016 US Model Treaty and treats US residents owning interests in a Taiwan entity as ‘impermissible’ intermediate owners. Moreover, although the proposed rules would allow intermediate owners resident in third countries that have treaties with the United States to qualify as ‘good’ owners for purposes of these rules, such third-country treaty would have to include provisions addressing special tax regimes and notional interest deductions. Because no other US tax treaty currently includes such provisions, no intermediate owner currently would be able to meet the ‘qualifying intermediate owner’ standard of the legislation. 

Observation: The recently signed US tax treaty with Croatia‒instead of requiring a third-country treaty to contain provisions addressing special tax regimes and notional interest deductions‒provides that an intermediate owner qualifies as a ‘qualifying intermediate owner’ if such owner does not actually benefit from a special tax regime or notional interest deduction. The discussion draft legislation does not follow this approach. 

Base erosion prong

The base erosion prong is satisfied if less than 50% of the corporation’s gross income (and in the case of a corporation that is a member of a tested group, less than 50% of the tested group’s gross income) is paid or accrued, directly or indirectly, in the form of deductible payments for Taiwanese tax purposes (not counting arm’s length payments for tangible property or services made in the ordinary course of business or, in the case of a tested group, intra-group transactions) to certain ‘impermissible’ recipients. Impermissible recipients of deductible payments are (1) persons who are not qualified residents of Taiwan, or (2) persons who are connected with respect to the tested company and benefit from a special tax regime with respect to the deductible payment (or, in the case of interest payments, benefit from notional interest deductions). As further described below, such base erosion prong also was included by the legislation as a requirement for a Taiwanese corporation to meet the Publicly Traded Company Test and Subsidiary of a Publicly Traded Company Test.

Observation: A base erosion prong is typically found, in current US income tax treaties, under the Ownership-Base Erosion Test and the Derivative Benefits Test (which is not included in the legislation). The 2016 US Model Treaty also includes a base erosion prong for purposes of the Subsidiary of a Publicly Traded Company Test. The legislation goes further and includes a base erosion prong for purposes of the Publicly Traded Company Test. This results in additional complexity for publicly traded companies seeking to qualify for benefits under the proposed rules. Also further restricting access to benefits when compared to the 2016 US Model Treaty (which treats residents of either Contracting State that qualify for treaty benefits under certain LOB tests as ‘good’ recipients of base eroding payments), the legislation treats payments to any persons other than qualified residents of Taiwan (thus including US residents) as ‘bad’ base eroding payments (not counting certain arm’s length payments and intra-group transactions, as indicated above). The legislation does not contain a provision excepting payments to banks from being base eroding payments, even though many currently in force US treaties contain such a provision. 

Publicly Traded Company Test

Under the Publicly Traded Company Test of the legislation, a Taiwanese corporation may qualify as a ‘qualified resident of Taiwan’ if, in addition to meeting the base erosion prong described above, it is primarily and regularly traded on an established securities market in Taiwan. 

Observation: Under most recent US income tax treaties, a foreign company is not required to have its stock traded in its country of residence; the company also can meet the Publicly Traded Company Test if its stock is traded on ‘any stock exchange registered with the US Securities and Exchange Commission as a national securities exchange’ (or any other stock exchange agreed upon by the competent authorities of the Contracting States) provided that its primary place of management and control is in its residence state. The legislation does not contain such an alternative substantial presence test, thus further restricting the ability of Taiwanese corporations to have access to the benefits of the proposed rules. Therefore, existing public groups with dual or multiple listings may fail this more restrictive test. It is not uncommon for a company to be listed on multiple exchanges, where the majority of its share trading does not take place on exchanges purely within its country of residence. This restriction not only affects companies that otherwise would qualify under the Publicly Traded Company Test but also may limit the ability of subsidiaries to qualify under the Subsidiary of a Publicly Traded Company Test, as discussed below. 

Subsidiary of a Publicly Traded Company Test

The legislation provides that any company resident in Taiwan may qualify for benefits if, in addition to meeting the base erosion prong described above, at least 50% (by vote and value) of the company is owned, directly or indirectly, by five or fewer companies that are resident in Taiwan and that satisfy the Publicly Traded Company Test described above, provided that, in the case of indirect ownership, each intermediate owner is a ‘qualifying intermediate owner,’ as described above. 

Observation: The Subsidiary of a Publicly Traded Company Test of the legislation is more restrictive than its counterpart in the 2016 US Model Treaty, which allows subsidiaries of publicly traded companies of either Contracting State (not only the residence State) to potentially meet such test. 

Dual Resident companies

Income tax treaties provide tiebreaker rules addressing where a person is treated by both treaty partners as a resident of each respective country under its domestic tax principles. The legislation provides tiebreaker rules for individuals that are consistent with most US income tax treaties. The proposed rules are silent regarding dual resident companies and do not contain any provision addressing such circumstances.

Observation: Under the 2016 US Model Treaty, if a company is treated as a resident of each of the treaty partners under its domestic laws, the company will not be eligible for benefits of the treaty at all; that is, there is no allowance of resolution of the dual residency by the applicable Competent Authorities, which is a provision found in many US income tax treaties that are currently in force. Although the legislation does not contain such a rule, the absence of a statutory provision resolving dual residency issues for companies, and the fact that any regulations addressing the legislation generally are to be consistent with the 2016 US Model Treaty, may result in companies that qualify as residents of both Taiwan and the United States not being eligible for benefits under the legislation.

Regulatory Authority

The legislation would give broad authority to the US Treasury to issue regulations providing more detailed (and needed) guidance, provided that the regulations are, to the extent practical, consistent with the 2016 US Model Treaty. 

Observation: In granting regulatory authority to Treasury, the legislation enumerates a number of specific issues that may be addressed by regulations or other guidance. Certain provisions that typically are found in the 2016 US Model Treaty and other US income tax treaties, such as the relief from double taxation article or the active trade or business LOB test, are not included in the legislation or in the list of issues to be potentially addressed by future guidance.

Observation: Most US income tax treaties are accompanied by a Treasury technical explanation of each treaty provision; thus, rather than providing broad regulatory authority, the relevant Congressional committees could draft legislative history language similar to a detailed technical explanation of the legislation.