Section of Taxation Publications
  VOL. 53
NO. 3
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 Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
 What is Tax Treaty Abuse? (Is Treaty Shopping an Outdated Concept?)
Richard L. Reinhold*

* Partner, Willkie Farr & Gallagher, New York, New York. Cornell University, A.B., 1973; SUNY Buffalo, J.D., 1976. The author wishes to thank David Rosenbloom and Jeffrey Van Hove for their comments on an earlier draft, as well as Phil Garthe for his research assistance. The author presented this paper to the Tax Forum in January 2000. Errors are the author’s alone.


This paper represents an effort to re-examine the principal measures that have been developed to curb certain practices that have been labeled "tax treaty abuse." Much attention has been devoted to this subject— both on the part of government as well as the private sector—since the 1970s, when the problem first received significant attention. 1 However, the commercial landscape has changed dramatically in the intervening years, and the pertinent legal concepts, including those that have been adopted to combat treaty abuse, have also evolved. 2 This Article attempts to take stock of some of the current treaty abuse measures in light of these changes, and reaches the following conclusions:

1. The 1970s saw a proliferation of tax avoidance strategies involving third-country nationals’ use of tax-haven entities to gain advantages under tax treaties between the United States and the tax-haven jurisdictions. To curb this practice-referred to as "treaty shopping"-the United States insisted on inclusion of detailed "limitation on benefits" ("LOB") provisions in tax treaties; these LOB provisions generally restrict treaty benefits to entities (1) that are owned to a sufficient degree by residents of treaty jurisdictions and (2) that do not erode their residence country tax base through deductible payments to persons outside the treaty jurisdictions.

2. Significant changes in applicable tax rules and the general elimination of tax treaties between the United States and tax-haven jurisdictions call into question the need for LOB provisions: with relatively few exceptions, it seems unnecessary to restrict treaty benefits in the case of companies formed in the industrialized jurisdictions that are the main trading partners of the United States.

3. In recent years, treaty LOB provisions have become increasingly complex and detailed, and in some cases quite restrictive. At the same time, some features of the provisions-particularly the exemption for public companies and so-called "derivative benefits" provisions-create potential gaps in the coverage of LOB rules. In circumstances in which LOB provisions might properly apply, it would seem that their functioning could be improved.

4. Separately, the issue arises as to entitlement to tax treaty benefits resulting from particular transactions entered into for a principal purpose of obtaining such benefits. Recently-signed treaties with Italy and Slovenia contain so-called "main purpose" provisions targeted at these transactions. While the provisions may duplicate principles already present in U.S. common law-business purpose, step transaction, economic substance, etc.-there may be a benefit to including these provisions in tax treaties.

Part II of this Article considers two prototype cases of tax treaty abuse from the 1970s and contrasts the treatment of these structures under then-applicable law with the treatment the transactions would receive today. Part III offers a policy perspective on why tax treaties are entered into and indicates what might be expected of treaty anti-abuse measures. Part IV surveys briefly and selectively the history of LOB provisions that have been included U.S. tax treaties and concludes with an examination of the current state of the art, e.g., Article 22 of the 1996 U.S. Model Tax Treaty, and some recent developments. Part V considers the so-called "main purpose" provisions in the Italian and Slovenian treaties.



1 See, e.g., Internal Revenue Service, Tax Havens And Their Use By United States Taxpayers - An Overview (1981); Fred Feingold, Entitlement to Treaty Benefits: A Comparison of the Dutch and German Solutions (Sept. 13, 1994) (unpublished Tax Club paper); Richard O. Loengard, Jr., Foreign Investors and Nimble Capital: Another Look at the U.S. Policy Towards Treaty Shopping, Tax Forum No. 439, Jan. 4, 1988; H. David Rosenbloom, Tax Treaty Abuse: Policies and Issues, 15 Law & Pol’y Int’l Bus. 763 (1983) [hereinafter Rosenbloom, Tax Treaty Abuse]; Stef van Weeghel, The Improper Use of Tax Treaties, Kluwer Law Int’l, 1988; Note, Income Tax Treaty Shopping: An Overview of Prevention Techniques, 5 Nw. J. Int’l L. & Bus. 626 (1983). [Back to text.]

2 Among the issues that the literature has considered in some detail is the definition of tax treaty abuse. While the question is interesting, and the answer to the question may color one’s view of the measures adopted in response, I propose for the moment to use a utilitarian standard: tax treaty abuse represents the use of a tax treaty provision by a person, or in a way, not intended by the treaty drafters. [Back to text.]


Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


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