Change Country

International Businesses

Global Income Tax Treaty Basics

Posted on November 19, 2021 by

Eric Lin

Eric Lin

Share This

Doing business globally requires knowledge of the benefits and requirements of income tax treaties between the countries on both sides of a cross-border transaction. Tax treaties are bilateral agreements made by two countries to reduce or eliminate double taxation for their residents.

The U.S. currently has income tax treaties with more than 50 countries to promote doing business around the world. It is very important for all U.S. companies conducting business with foreign companies to understand the U.S. income tax treaties and related tax filings. This includes foreign-owned U.S. subsidiaries with various ongoing transactions with affiliates of their global group.

Tax treaties contain key articles important in determining the specific tax rate applicable to the parties of the treaty. Here’s a short list of these key articles:

  • Residence: Identification of residents liable to tax and residency tiebreakers
  • Permanent Establishment: Determination of the activities which create a taxable presence in the other treaty country
  • Limitation of Benefits: Determination of eligibility for the treaty benefits
  • Business Profits: Determination of where and how business profits are taxed
  • Dividends, Interest and Royalties: There are separate articles which define these types of income and the applicable tax rate including any tax reductions or eliminations
  • Independent and Dependent Personal Services: Determination of which treaty country will tax income from services performed

Payments of fixed or determinable annual or periodical (FDAP) income such as interest, dividends and royalties from a U.S. company to a foreign company require 30% U.S. income tax withholding under the Internal Revenue Code. With an applicable treaty, this rate of income tax withholding may be reduced or eliminated.

For example:

  • When a U.S. company pays interest to a Chinese company, the U.S. income tax withholding rate is reduced to 10% under Article 10, Interest of the U.S. and China income tax treaty.
  • Article 12, Royalties of the U.S. and Germany income tax treaty provides that royalties will only be taxed in the country of the beneficial owner of the royalty, eliminating tax in country of the company paying the royalty. Therefore, the 30% U.S. income tax withholding required under U.S. tax law is eliminated.

As you can see from these examples, income tax treaties reflect different tax rates depending on the countries involved and types of income earned. A detailed treaty analysis may be required to determine the applicable withholding tax rate.

To claim treaty benefits, a company must meet various qualification tests described in the Limitation of Benefits article of the treaty. Generally, a taxpayer who takes tax treaty benefits should consider filing IRS Form 8833 to disclose the treaty position.

There are many filing requirements and exceptions to consider for Form 8833. Some of the most common requirements arise when FDAP income is not properly reported on Form 1042, if the FDAP income exceeds $500k, or if the treaty imposes additional conditions for the entitlement of treaty benefits. Form 8833 is an informational report that does not create tax liabilities; however, the noncompliance penalty is $10,000 per form in the case of a C corporation.

Contact Us

Understanding the requirements and benefits of an income tax treaty for your global business can be complex. As global expansion experts, we can help you realize the maximum benefit from an applicable treaty and meet all related filings. Contact us today to learn more.

Share This

Eric Lin

Senior Manager, International Tax

Fluent in Mandarin and part of the firm's international group, Eric supports Chinese companies with their tax and accounting needs.

Related Insights

Transfer Pricing Basics for International Companies

The concept of transfer pricing addresses the amounts that related parties under common control charge one another for goods, services, or intellectual property. For example, the price charged by a parent company when it sells goods to its subsidiary is referred to as the transfer price. The central issue regarding transfer pricing is the tax obligation that may arise around these kinds of transactions when they cross two or more tax jurisdictions. 

by Nina Wang

Branch or Subsidiary? Using an EOR to Bridge the Gap

If your company is in the early stages of planning a global expansion, it is important to consider how entity taxation and access to workforce outside your home country can be connected when deciding how and when to execute your growth strategy. Operating in a new market directly as a foreign company or a subsidiary of a foreign company has different tax consequences and compliance costs. Using an Employer of Record (EOR) can help.

by Teresa Gordon

Why US Manufacturers Should Consider Nearshoring to Mexico

For manufacturing and distribution businesses with operations in China or other faraway locations, nearshoring to Mexico is starting to look more attractive. Learn about the top drivers of nearshoring and why many businesses are choosing Mexico.

by Carlos Calderon

The Sound of Automation Podcast

Industrial automation businesses are the driving force behind Industry 4.0, and Clayton & McKervey is here to help.

Skip to content