The IRS recently released a generic legal advice memorandum (AM 2022-005) concluding that foreign shareholders are ineligible to claim a reduced U.S. tax rate under an applicable U.S. income tax treaty with respect to their domestic international sales corporation (DISC) distributions under Article 10 (Dividends) of an applicable U.S. income tax treaty. The IRS took the position that, pursuant to Article 5 (Permanent Establishment), their DISC distributions are not attributable to a permanent establishment within the U.S.
Section 996(g) requires foreign shareholders to treat DISC distributions as though they are effectively connected with the conduct of a trade or business conducted through a permanent establishment of such shareholders within the U.S. and that are derived from sources within the U.S.
In the memorandum, the IRS disagreed with the position that Article 5 of U.S. income tax treaties ratified after section 996(g) directly conflicts with, and thus overrides, Section 996(g). Instead, the IRS views Section 996(g) as a coordination rule governing the interaction between the Code — and specifically the DISC regime — with the overall U.S. income tax treaty network.
The memorandum concludes that because both the Code and U.S. income tax treaties prevent foreign shareholders of DISCs from claiming treaty benefits on DISC distributions, the “later-in-time” rule codified in Section 7852(d) is not applicable. Thus, foreign taxpayers are ineligible to claim treaty benefits regarding their DISC distributions and gains, regardless of when the treaty at issue entered into force.
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