CONSTRUCCIÓN DEL SISTEMA WATER TRANSFER PRINTING.

Even if Congress were to exempt from U.S. tax a RIC’s foreign source income for treaty investors, such investors may still be economically worse off by investing through a RIC than investing directly if the RIC’s foreign source income is subject to source taxation. A RIC only distributes to a foreign shareholder its after-foreign-tax income.247 Assuming the investor’s country of residence does not permit a credit for source basis taxes levied on the RIC’s income, a foreign investor gets only the benefit of a deduction for source basis taxes paid by the RIC.

To illustrate, if a RIC earns $100 of foreign source dividend income on which $15 of taxes are withheld by the source country, the RIC will distribute only $85 to the foreign investor. Provided that there is no additional U.S. withholding tax, the foreign investor would be subject to residence basis tax on the $85 but would not receive a credit for the $15 source basis tax. Since the investor would only be taxed on $85, he or she

245 _{See supra PartIV.E.}

246 _{Taxable shareholders of a RIC that makes a section 853 election may be indifferent}

because they will merely have a larger foreign tax credit. Tax-exempt shareholders, such as pensions or 401(k) accounts, will be harmed because the RIC’s NAV will be reduced by the higher source country withholding taxes, which tax-exempt shareholders cannot use.

247 _{Under current law, foreign shareholders of a RIC that makes the foreign tax credit}

election under section 853 may also be subject to U.S. tax on the foreign taxes paid by the RIC. See infra Part III.B.

receives in essence the benefit of a deduction for the source taxes, and there is double taxation of the RIC’s income.

Under current law, when the RIC distributes $85, an additional 15% (or 30%) U.S. withholding tax is levied, and the $85 is subject to residence basis tax.248 Since the withholding tax is a direct tax, the foreign investor should be able to credit it against his or her residence tax liability. Thus, there is no double taxation of the $85 distributed, but again, the investor is only receiving a deduction and not a credit for the source basis taxes paid by the RIC.

Allowing a credit for source basis taxes may also be a possible mechanism to mitigate the double taxation of foreign source income earned through RICs. If the foreign investor were to receive a credit for source basis tax and any U.S. tax, double taxation would be mitigated, and the foreign investor would be in the same economic position as if the investor had directly earned the income.249 Using the same numbers in the above examples, the foreign investor would have $100 of income and a potential credit of $15 if the United States did not tax the RIC dividend and $27.75 if the United States taxed the $85 RIC dividend at 30%.250

A residence country could unilaterally implement such a rule, but it is not clear whether a residence country would permit its residents to credit the foreign taxes paid by a corporation of which they are shareholders.251 The United States permits its residents to credit foreign taxes paid by RICs, but generally does not permit taxes paid by a corporate entity to be credited by individual shareholders.252 In contrast, foreign taxes paid by lower-tier partnerships are passed through to a U.S. partner when the partner includes in income the distributive share of the lower-tier partnership’s income.

248 _{Since withholding taxes are direct taxes, it is assumed that a foreign investor is}

subject to residence basis taxation on the pre-tax amount of the dividend. If there were no residence basis taxes, the residence country would presumably not permit a credit for any foreign taxes.

249 _{Double tax would be mitigated but not eliminated unless the residence country gave}

an unlimited credit for the total foreign taxes. Under U.S. law, for instance, a U.S. taxpayer can only credit foreign taxes levied at a rate equal to or less than the U.S. rate on the foreign source income. See I.R.C. § 904. The foreign investor is also not exactly in the same position had he or she invested directly because of the additional layer of U.S. tax.

250 _{The $72.25 is grossed up by $12.75 U.S. tax and $15 foreign tax paid by the RIC.} 251 _{There would have to be some mechanism for the RIC to provide the information to}

foreign shareholders.

252 _{Certain corporate shareholders are permitted to credit taxes paid by other}

corporations when the corporate shareholder receives a dividend. See I.R.C. § 902 (indirect tax credit).

The OECD addressed this issue and suggested that it could be solved by including in the treaty between the CIV’s country of residence and the investor’s country of residence a provision that would require the investor’s country of residence to grant a credit for the source taxes imposed on the CIV’s income.253 After noting various possible objections — the measure would be an incomplete bilateral solution for a multilateral problem; reciprocal benefits may not be provided by the source country; the residence country could be required to grant relief greater than if an investor had directly invested — the OECD indicated that investors had not expressed an interest in making such claims.254 This could change if OECD proposals in the OECD become widely implemented. Resolving this issue will probably require a multilateral approach.

VI. CONCLUSION

The foreign RIC provisions mitigate tax inefficiencies to foreign shareholders for a RIC’s U.S. source income, but the failure to adopt look- through for foreign source income means that many RICs continue to be tax-inefficient investment vehicles for foreign investors. The current regime is thus inconsistent with the pass-through nature of RIC taxation, unnecessarily penalizes foreign investors in global RICs, and deprives the United States of tax revenue from RIC-related income, such as trading and management fees. Although treaty shopping may have been the primary rationale for not adopting pass-through for foreign source income, those concerns are largely illusory: a foreign investor potentially only benefits from a treaty between the United States and the source country if there is no residence taxation or the residence country does not credit U.S. taxes. By limiting look-through to treaty residents, a clearly second-best option, treaty shopping concerns should be entirely ameliorated and foreign investment in U.S. RICs facilitated.

253 _{OECD, Treaty Benefits CIVs, supra note 126 at paras. 41–47.}

254 _{Id. at paras. 46 and 47. For a discussion see Gijs Fibbe, The 2010 Update of the} OECD Commentary on Collective Investment Vehicles, in THE TAX TREATMENT OF CIVS AND REITS 67–71 (Hein Vermeulen ed., 2013).