Section of Taxation Publications
  VOL. 59
NO. 2
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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.


Wright Schickli

*Executive Director, Ernst & Young International Tax Services, San Jose, California; Carleton College, B.A., 1979; William Mitchell College of Law, J.D., 1984; New York University, LL.M., 1985. All opinions expressed in this Article are those of the author, and not necessarily those of Ernst & Young.



Technological developments, especially those fueled by the internet, have significantly extended the international reach of small and large businesses alike. Accompanying these opportunities are potential pitfalls that include international tax exposure and a host of related disclosure and compliance requirements. The tax treaty policy of the United States and the Organisation for Economic Co-operation and Development (OECD) is still evolving, but some headway has been made at an international level regarding how countries will treat payments relating to cross-border transactions, including those that have been facilitated by the internet age. While the United States has a model income tax convention, it has not been updated since 1996. 1 Importantly, notwithstanding the existence of the U.S. Model Income Tax Convention (the “U.S. Model Tax Treaty”), the give and take of the treaty negotiation process sometimes requires the Treasury Department to make concessions and deviate from the U.S. Model Tax Treaty because of compromises reached during the treaty negotiation process. This Article focuses on one of those compromises—an unusual tax treaty clause contained in many U.S. tax treaties that characterizes as a withholdable royalty a payment for the use of certain equipment or tangible property. 2 These Equipment Fee Clauses are unusual from a U.S. perspective because the underlying transaction is generally characterized as a lease from a U.S. tax standpoint because it is not in form or substance a license under applicable U.S. law. In effect, an Equipment Fee Clause characterizes as a royalty income that would be treated as rental income from a U.S. tax perspective. In a nontax treaty context, U.S.-source rentals and royalties are generally subject to a gross withholding tax. 3 In a tax treaty context, however, equipment fees are subject to a reduced rate of gross withholding tax, while rentals that constitute “business profits” generally are exempt from tax unless the lessor has a “permanent establishment” in the lessee’s country (in which case the lessor is subject to local net income taxation).

The purpose of this Article is to analyze the existing Equipment Fee Clauses in U.S. tax treaties, including the history and policy behind the clauses, and the few authorities that address their application. After summarizing relevant background principles, the Article highlights inconsistencies among the U.S. Equipment Fee Clause treaties, and explains the potential adverse impact of these clauses on U.S. taxpayers through a series of examples that could apply to taxpayers in a variety of industries. In conclusion, this Article makes recommendations concerning how to mitigate the adverse impact of these provisions on U.S. taxpayers in future U.S. tax treaties, and reminds the Treasury Department of the Senate Foreign Relations Committee’s request that it (1) “closely monitor” the effect of Equipment Fee Clauses, and (2) “continue to seek provisions that conform more closely with the U.S. model.”



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


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