The United Kingdom’s departure from the European Union and the recently signed trade agreement between the United States, Mexico and Canada have significant international tax implications, particularly for multinational companies that rely on the “derivative benefits” provisions found in numerous U. S. income tax treaties.
The United States-Mexico-Canada Agreement (USMCA) has been ratified by Mexico and United States and will supersede the North American Free Trade Agreement (NAFTA) when ratified by Canada. The United Kingdom is currently in an 11-month transition period after leaving the European Union and will need new trade agreements. One the most significant tax implications of these developments revolves around “Limitation on Benefits” (LOB) clauses.
Entities that are residents of a country with an income tax treaty with the U.S. containing an LOB clause are generally eligible for treaty benefits only if they satisfy one of the objective tests under the LOB. Under the derivatives-benefits test, an equivalent tax treaty benefit could extend to the ultimate owner of a tax treaty recipient if the owner received the income directly and the recipient satisfies a base erosion test.
The derivative-benefits provisions of several U.S. tax treaties provide treaty benefits to resident entities that rely on their owners being both a U.K. resident and an EU member state, which would no longer apply after Brexit. Similarly, the repeal of NAFTA may now have the effect of limiting U.S. treaty access for multinationals from Canada, Mexico and other countries with U.S. tax treaties which provide access to other NAFTA member countries. In fact, these U.S. treaty references to residents of the NAFTA countries now may become void.
As a result of Brexit and the repeal of NAFTA, multinationals that rely on the derivative benefits clause of certain treaties may no longer be considered equivalent beneficiaries. This could mean a significantly increased tax burden and a U.S. withholding tax for many companies. Taxpayers impacted will need to revisit their wider tax profile, including treaty positions based on the derivative-benefit clause, and assess the need for restructuring.
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