Treasury Responds to Menendez on Tax Treaties

June 12, 2019

The Honorable Robert Menendez
United States Senate
Washington, DC 20510

Dear Senator Menendez:

Thank you for your longstanding and strong support for the tax treaties currently pending before the Senate Committee on Foreign Relations. I am writing in response to your letter of June 11, 2019.

As you know, tax treaties promote the fair, orderly, efficient taxation of income by the United States and our treaty partners. These treaties increase certainty for taxpayers, mitigate the risk of double taxation by clearly allocating taxing rights across jurisdictions, and help combat tax evasion through exchange of information and cooperation among tax administrations. It has been more than eight years since the Senate last gave its advice and consent to ratification of a tax treaty, and the Department of the Treasury deeply appreciates your efforts to advance the important agreements that are currently pending.

We share your disappointment that too many tax treaties have not yet entered into force. We also appreciate your interest in fully vetting the proposed reservation language. To that end, please find the responses to your questions below:

(1) Please explain why, in Treasury's view, a BEAT tax reservation is necessary in the Chile, Poland, and Hungary treaties. Please include an explanation of the June 5 version of the BEAT tax reservation and how that version will satisfy the perceived need for a BEAT tax reservation.

Each of these tax treaties was signed at least six years ago. Since that time, U.S. domestic tax law has changed, as have international standards. In particular, the new base erosion and anti-abuse tax (BEAT) under section 59A of the Code is a significant change since these agreements were signed. Treasury therefore recommends including a reservation that clarifies that nothing in any of these Conventions will affect application of the BEAT under U.S. law or, reciprocally, any similar tax under the domestic law of the foreign treaty party. The BEAT is intended to minimize erosion of the U.S. tax base associated with excessive tax deductible payments to foreign related parties (including related parties that are also residents of a foreign jurisdiction that has a treaty in effect with the United States.)

Treasury believes that it is important to clarify the interaction of the new BEAT with the three full tax conventions, in part to ensure that these agreements are modernized to reflect this new base erosion and anti-abuse provision. In addition, we believe it is important to have a common understanding of this interaction that is agreed to by our treaty partners to both provide certainty to taxpayers and to avoid any potential conflict surrounding this issue. The reservation as drafted applies on a reciprocal basis. This serves a dual purpose of reflecting the current international trend toward modernization in this area as well as making the reservation more acceptable to our treaty partners.

(2) Please explain why the BEAT tax reservation was altered between May 13 and June 5. Please explain the differences between the two versions and whether, despite the differences in text, the two versions would have the same legal effect. If the two versions would not have the same legal effect, please explain the difference and why the June 5 version is preferable.

No substantive change was intended between the May 13 and June 5 versions of the reservation; the two versions would have the same legal effect. The changes were intended only to provide additional clarity. The key change in the language, which was added in an abundance of caution, is to specify that nothing in the treaties will impact the applicability of the BEAT, rather than singling out specific provisions of the treaties as not impacting the BEAT'S applicability.

(3) Please indicate whether the proposed reservations will require renegotiation of the pending tax treaties with Chile, Poland, and Hungary and provide an explanation for the Department's position.

As an international law matter, a reservation modifies the obligations established by the treaty. Accordingly, Chile, Poland, and Hungary would need to accept the reservation at the time the respective treaties are brought into force.

(4) Please indicate whether the Administration has informed the governments of Chile, Poland, and Hungary of the proposed reservations. If yes, please indicate when those discussions occurred, whether and when the governments were presented with the June 5 version, and whether those governments have committed to bringing the respective treaties into force if the June 5 version is included in the Senate's resolutions of advice and consent.

Over the past 18 months, Treasury has been working with our treaty partners to ensure they understand the recent changes to domestic tax law, including the application of the BEAT to treaty residents. Over the past few weeks, Treasury has discussed the BEAT reservation with Chile, Poland, and Hungary and explained that the United States intends, in all future tax treaties it negotiates, to include a provision addressing the BEAT as a modernizing feature of our tax agreements to limit base erosion. Each of the three treaty partners understands the proposed reservation and the reasons for it. None of the three treaty partners has expressed opposition to the substance of the proposed reservation. None of the partners, however, has completed parliamentary or other necessary internal procedures that would be required for them to make a specific commitment at this stage regarding the reservation in connection with entry into force of the treaties.

(5) Please explain why the Treasury Department originally requested BEAT tax reservations for all seven bilateral treaties but now asserts such reservations are not needed for the protocols with Spain, Switzerland, Luxembourg, and Japan. Please include an explanation of the analysis that led to Treasury's original position, as well as an explanation of the analysis that led to the current position.

Treasury learned on short notice of the possibility that the Senate might consider the seven pending bilateral tax treaties as early as the week of May 20. In an effort to prepare for such consideration, Treasury drafted a proposed reservation to address the BEAT. In light of the possibility of imminent Senate consideration of the treaties, and in an abundance of caution, Treasury initially proposed that the reservation be included in resolutions of advice and consent for each of the seven bilateral tax instruments. As events developed, Treasury had additional time to study the matter in more detail and to consult with treaty partners. Upon additional analysis and consultation, Treasury concluded that none of the specific treaty provisions modified by the four bilateral tax protocols would impact the applicability of the BEAT. Accordingly, Treasury concluded that the reservation was not needed with respect to any of the four protocols.

(6) Please provide Treasury's view of the likely effect if BEAT reservations are not included in the Senate's resolution of advice and consent in the Chile, Poland, and Hungary treaties, including on areas such as tax administration and taxpayer compliance, and any other area Treasury believes will be impacted by not including the reservation language. Please include an explanation of the analysis that led to this conclusion.

Treasury is concerned that, in the absence of a BEAT reservation, a newly enacted comprehensive tax agreement, such as the pending agreements with Chile, Poland, and Hungary, could lead to uncertainty about whether the BEAT applies to payments to residents of the treaty jurisdictions. Specifically, we believe some taxpayer may argue that, to the extent the BEAT is at odds with the terms of these treaties, the BEAT does not apply under the “later in time” principle. To provide tax certainty and to avoid unnecessary disputes of this kind, Treasury believes that it is necessary to clarify the status of the BEAT through a reservation to the Chile, Poland, and Hungary treaties.

(7) Please indicate whether U.S. tax administration would still benefit from ratification of the treaties with Chile, Poland, and Hungary, such as new limitation on benefits clauses, mutual agreement procedures, and exchange of information, if the reservation language was not included in the Senate's resolution of advice and consent.

The ratification of our revised tax agreements with Hungary and Poland would provide many benefits, including, significantly, the addition of new limitation on benefits articles to prevent treaty shopping abuse that would close an existing gap in our treaty network. The Chile tax treaty is a new relationship and taxpayers would benefit from reduction in tax rates for certain payments, relief from double taxation, and access to dispute resolution mechanisms under the treaty. Treasury remains concerned, however, that the ratification of these new comprehensive tax treaties without the BEAT reservation would increase tax uncertainty and potential disputes about the application of the BEAT with respect to payments to residents of these treaty jurisdictions. Treasury therefore urges the Senate to approve these agreements subject to a reservation that would provide clarity and certainty on this issue.

(8) I understand that the Treasury Department is revising the U.S. model tax treaty. Please indicate whether my understanding is accurate, and whether BEAT tax matters will be addressed in the revised model treaty such that BEAT tax reservations will not be needed for treaties negotiated based on the new model. Please confirm that you will keep the SFRC fully and currently informed with regard to the status, scope, and text of revisions to the model tax treaty, including by providing the Chair and Ranking Member with text of the new model or any revision contained therein prior to negotiation of a new treaty based on that model or a particular revision contained therein.

Treasury recognizes that it will need to revise the 2016 U.S. Model treaty in light of domestic and international law changes. At present, we have not yet made a determination of whether the 2016 U.S. Model will be revised in advance of any new negotiations or whether it will be revised after we resume negotiations and have gained more experience with treaty partners. In all future negotiations, however, Treasury will seek to ensure that a provision addressing the BEAT is included as a modernizing feature in our treaties to limit base erosion. We will keep the Committee fully informed with regard to the status and scope of textual revisions to our model treaty.

Please let us know if you have additional questions. We look forward to working with you further on the ratification of these treaties, and we thank you for your leadership on this issue.

Sincerely,

David Kautter
Assistant Secretary for Tax Policy

cc:
The Honorable Mitch McConnell
The Honorable Charles E. Schumer
The Honorable James E. Risch
The Honorable Charles E. Grassley
The Honorable Ron Wyden
The Honorable Mike Pompeo