August 30th 2018
U.S.- P.R.C. Income Tax Treaty Alert.
Proposed Amendment to U.S.- P.R.C. Income Tax Treaty May Impact Chinese Investment in the U.S.
On August 21, 2018, Sen. Tammy Baldwin, D-Wis and Sen. Marco Rubio, R-Fla., introduced legislation that would disallow application of treaty reduced withholding rates for Chinese individuals and entities.
Internal Revenue Code (IRC) Sections 871(a)(1)(A) and 881(a)(1) impose a flat tax of 30% on the gross FDAP income of foreign individuals and entities, respectively. Sections 1441 and 1442 impose an obligation to withhold the 30% tax upon the payee of FDAP income. FDAP income is passive investment income, such as, royalties, interest, dividends, rents, salaries, wages, premiums, annuities, compensations, and remunerations.
The Agreement Between the Government of the United States of America and the Government of the People's Republic of China for the Avoidance of Double Taxation and the Prevention of Tax Evasion with Respect to Taxes on Income, Apr. 30, 1984, T.I.A.S. No. 12,065, provides for reduced rates of withholding as follows:
Dividends 10% Article 9, para. 2
Interest 10% Article 10, para. 2
Royalties 10% Article 11, para. 2
The proposed changes to IRC section 894 are in bold.
(a) Treaty provisions.
(1) Except as otherwise provided in this section, the provisions of this title shall be applied to any taxpayer with due regard to any treaty obligation of the United States which applies to such taxpayer.
. . . .
(d) Exception for People’s Republic of China.
(1) IN GENERAL.- The rates of tax imposed under sections 871 and 881, and the rates of withholding tax imposed under chapter 3, with respect to any resident of the People's Republic of China shall be determined without regard to any provision of the Agreement between the Government of the United States of America and the Government of the People's Republic of China for the Avoidance of Double Taxation and the Prevention of Tax Evasion with Respect to Taxes on Income, signed at Beijing on 18 April 30, 1984.
(2) REGULATIONS.-The Secretary shall promulgate regulations to prevent the avoidance of the purposes of this subsection through the use of foreign entities.''
If the legislation becomes law, all U.S. source FDAP income earned by Chinese individuals and entities will be taxed at 30% on the gross amount and withheld at the source. Fortunately, the exemption for portfolio interest under IRC sections 871(h) or 881(c) is still available for Chinese individuals and entities on qualifying debt investments. Under the portfolio interest exemption, U.S. source interest is exempt from the 30% flat tax on properly documented loan transactions.
Leticia Balcazar is a partner with Aliant, LLP in Los Angeles California. She assists foreign investors with their business transactions in the United States. She is an expert not only in structuring new debt investments for foreign lenders but also in restructuring existing debt investments to comply with the portfolio interest exemption rules.