What Are Treaty Benefits and How Do You Claim Them?

A tax treaty is a formal agreement between two countries designed to address issues of double taxation and prevent tax evasion. It establishes clear rules for taxing income earned by a resident of one country from sources within the other. By coordinating tax claims, these agreements foster international trade and investment and ensure that taxpayers are not unfairly taxed on the same income by two different jurisdictions.

Determining Eligibility for Treaty Benefits

The primary requirement for accessing treaty benefits is establishing tax residency in one of the signatory countries. An individual or entity must be considered a resident under the domestic tax laws of that country, a determination based on factors like physical presence, the location of a primary home, or the country of incorporation for a business. Only after residency is established can one look to the treaty itself.

When an individual or company qualifies as a resident in both treaty countries, a “dual resident” status is created. In these cases, treaties contain “tie-breaker” rules to assign residency to a single country for treaty purposes. For an individual, these rules are applied sequentially and consider factors such as where the person has a permanent home, their center of vital interests (personal and economic ties), and their habitual abode. If these tests are inconclusive, the final determination may be based on citizenship or mutual agreement between the tax authorities.

The “Limitation on Benefits” (LOB) article is included in most modern U.S. tax treaties to prevent “treaty shopping.” This is a practice where residents of a third country invest through a company in a treaty country simply to gain access to that treaty’s benefits. To qualify, a resident must meet one of several objective tests outlined in the LOB article.

LOB tests include the “publicly traded company” test, which grants benefits to companies whose shares are regularly traded on a recognized stock exchange. Another is the “ownership and base erosion” test. This test requires that at least 50% of the company’s ownership is held by residents of the same treaty country and that less than 50% of its gross income is paid to non-residents as deductible payments like interest or royalties. These tests ensure a substantive economic connection exists between the entity and its country of residence.

Common Types of Treaty Benefits

One of the most frequent advantages of tax treaties is a reduction in withholding taxes. The standard U.S. statutory withholding tax rate on payments like dividends, interest, and royalties to foreign persons is 30%. A tax treaty can lower this rate, often to 15%, 5%, or even 0%. For example, a treaty might reduce the withholding on dividends paid by a U.S. corporation to a shareholder in a treaty country to 15%.

Treaties provide rules for taxing business profits, centered on the concept of a “Permanent Establishment” (PE). A PE is a fixed place of business, such as an office or factory, through which an enterprise of one country carries on business in the other. A country cannot tax the business profits of an enterprise from another country unless that enterprise has a PE within its borders. If a PE exists, only the profits attributable to it can be taxed by the host country.

Specific provisions apply to income from personal services. For independent personal services, such as consulting, income is taxable only in the individual’s country of residence unless they have a fixed base in the other country. For employment income, salary is taxable where the work is performed. However, treaties may provide an exemption if the employee is present in the host country for less than 183 days in a 12-month period, their employer is not a resident of the host country, and their salary is not borne by a PE in the host country.

Many treaties offer favorable treatment for capital gains, granting the exclusive right to tax the gain to the seller’s country of residence. An exception is for gains from the sale of real property, which are taxable in the country where the property is located. Special exemptions are also available for students, teachers, and researchers temporarily present in the other country for study or research, exempting certain income from tax for a limited period.

Information and Forms for Claiming Benefits

To claim treaty benefits, a foreign person must provide documentation to the U.S. entity paying the income, known as the withholding agent. The primary forms are Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals), and Form W-8BEN-E for entities.

When completing the appropriate form, you must provide your foreign tax identification number (FTIN). You also need to identify the specific tax treaty and the article that provides the benefit you are claiming. On Form W-8BEN, an individual certifies their country of residence and cites the specific treaty article to claim a reduced rate of withholding. For entities, Form W-8BEN-E requires a more detailed certification, including identifying which LOB provision the entity satisfies. If taking a treaty-based position on your tax return, you may need to file Form 8833, Treaty-Based Return Position Disclosure, to explain the position.

How to Submit Your Claim

The submission process depends on the form being used. A completed Form W-8BEN or W-8BEN-E is not sent to the IRS. Instead, you must provide it directly to the withholding agent—the U.S. company paying you the income. The agent uses this form to apply the correct, lower tax rate to your payment before you receive it, and retains the form for their records.

In contrast, Form 8833 is handled differently. This form is used to disclose a position that a U.S. tax liability is determined by a treaty in a manner inconsistent with the Internal Revenue Code. Form 8833 must be attached to the filer’s U.S. income tax return, such as a Form 1040-NR for a nonresident individual, and filed directly with the IRS.