New U.S.-U.K. income tax treaty's implications for U.S. businesses.

• Author: Packard, Pamela

The U.S. and the U.K. signed an income tax treaty on July 24, 2001 that will replace the current treaty signed in 1975. The new treaty will probably come into force for withholding taxes sometime in 2002 and fully into force on Jan. 1, 2003 (subject to ratification). It will be economically significant for both countries.

Dividend-Withholding Taxes

This is the first U.S. income tax treaty that, in certain circumstances, eliminates the dividend-withholding tax. This relief will apply if the dividend recipient is either a pension scheme or a company that has owned at least 80% of the payor for 12 months and it:

* Has owned at least 80% of the corporate payor before Oct. 1, 1998;

* Is a public company (under Article 23, par. 2(c));

* Is entitled to benefits under the derivative-benefits provision (Article 23, par. 3); or

* Is entitled to benefits under the competent-authority determination (Article 23, par. 6).

In general, the large number of at-least-80%-owned U.S. subsidiaries with a U.K. parent that have either existed before Oct. 1, 1998 or the parent is a public company will now be able to pay gross dividends.

When the exemptions noted do not apply, the dividend-withholding rate will be 5% if the beneficial owner is a company that owns more than 10% of the payor's voting power. It will be 15% in all other circumstances.

Branch-Profits Tax

The new treaty allows the imposition of a 5% branch-profits tax by the U.S., unless the U.K. company:

* Had a U.S. permanent establishment before Oct. 1, 1998;

* Is a public company (under Article 23, par. 2(c)); or

* Is entitled to benefits under either the derivative-benefits provision (Article 23, par. 3) or the competent-authority determination (Article 23, par. 6).

The current treaty does not allow the branch-profits tax to be imposed (Regs. Sec. 1.884-1(g)(3)).

Persons detrimentally affected by the new treaty can elect to apply the current treaty for an additional 12 months after the new treaty comes into force (Article 29, par. 3).

Interest- and Royalty-Withholding Taxes

Generally, the current withholding tax exemptions are continued, but with some definitional changes. For example, the new royalty provisions cover films; previously, they did not.

Conduit Arrangements

The new treaty's withholding tax provisions for dividends, interest and royalties will not apply if conduit arrangements exist. Generally, conduit arrangements are defined (in Article 3, par. 1 (n)) as arrangements entered into to...