The proposed treaty includes anti-conduit rules that can operate to deny the benefits of the dividends article (Article 10), the inter- est article (Article 11), the royalties article (Article 12), and the other income article (Article 21).49 These rules are similar to, but significantly narrower and more precise than, the ‘‘main purpose’’ rules that the Senate rejected in 1999 in connection with its consid- eration of the U.S.-Italy and U.S.-Slovenia treaties.50 These rules are not found in the U.S. or OECD models and were included in the proposed treaty at the request of Japan. The purpose of the rules, from the Japanese perspective, is to prevent residents of third countries from improperly obtaining the reduced rates of Jap- anese tax provided under the treaty by channeling payments to a third-country resident through a U.S. resident (acting as a ‘‘con- duit’’).
Unlike Japan, the United States provides detailed rules in its do- mestic law governing arrangements to reduce tax through the use of conduits.51 The Technical Explanation emphasizes that the in- clusion of narrow anti-conduit rules in the proposed treaty should create no inference that the generally broader anti-conduit rules (and other anti-abuse rules) of U.S. domestic law would not apply in a particular situation.
Description of provisions
Under the anti-conduit rules of the proposed treaty, the treaty’s provisions with respect to dividends will not apply to dividends paid pursuant to certain back-to-back preferred stock arrange- ments. Specifically, a resident of a contracting state will not be con- sidered the beneficial owner of dividends in respect of preferred stock or other similar interest if such preferred stock or other inter- est would not have been established or acquired unless a person that is not entitled to the same or more favorable treaty benefits and that is not a resident of either contracting state held equiva- lent preferred stock or other interest in the resident.
Similarly, for purposes of applying the interest article, a resident of a contracting state will not be considered the beneficial owner of interest in respect of a debt-claim if such debt-claim would not have been established unless a person that is not entitled to the same or more favorable treaty benefits and that is not a resident of either contracting state held an equivalent debt-claim against the resident. For purposes of applying the royalties article, a resi- dent of the United States or Japan shall not be considered the ben- eficial owner of royalties in respect of intangible property if such
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52See Joint Committee on Taxation, Explanation of Proposed Income Tax Treaty Between the United States and the United Kingdom (JCS–4–03), March 3, 2003, 76–78.
royalties would not have been paid unless the resident pays royal- ties in respect of the same intangible property to a person that is not entitled to the same or more favorable treaty benefits and that is not a resident of either the United States or Japan. Finally, for purposes of applying the other income article, a resident of a con- tracting state will not be considered the beneficial owner of other income in respect of a right or property if such other income would not have been paid to the resident unless the resident pays other income in respect of the same right or property to a person that is not entitled to the same or more favorable treaty benefits and that is not a resident of either contracting state.
Issues
In view of the existence of detailed anti-conduit rules under U.S. domestic law, the adoption of different anti-conduit rules in the proposed treaty may be a source of confusion for taxpayers. The Technical Explanation mitigates this potential confusion by making it clear that the anti-conduit rules and other anti-abuse rules of U.S. domestic law will still be applied, regardless of whether an ar- rangement may pass muster under the anti-conduit rules of the proposed treaty. The Committee may wish to satisfy itself that this measure adequately addresses the potential confusion and uncer- tainty that could arise from including anti-conduit rules in the pro- posed treaty.
The Committee also may ask why, if a perceived deficiency in Japanese tax law motivated the inclusion of anti-conduit rules in the proposed treaty, the rules were made applicable not only to ar- rangements involving a reduction in Japanese taxes, but also to ar- rangements involving a reduction in U.S. taxes. Although treaty provisions are usually ‘‘symmetrical,’’ some may argue that, in this case, confusion could have been avoided by adopting an ‘‘asymmet- rical’’ set of anti-conduit rules applicable only to arrangements to reduce Japanese taxes.
The Committee also may note that this same issue was encoun- tered in connection with a similar (but broader) anti-conduit provi- sion included in the U.S.-U.K. income tax treaty. That provision was without precedent in the U.S. treaty network, and it was un- derstood to be a concession to the specific needs of the United King- dom.52 Now that a similar provision has been included in the pro- posed treaty with Japan, the Committee may wish to satisfy itself that it understands the current state of U.S. treaty practice in this regard—i.e., whether the Committee should expect to encounter treaty-specific anti-conduit rules in the future, or whether the cir- cumstances surrounding the U.K. and Japan treaties were excep- tional and unlikely to be repeated.
53The proposed treaty incorporates an anti-conduit rule to prevent persons not entitled to
equivalent treaty benefits from obtaining the benefit of the insurance excise tax waiver under the proposed treaty. Under this anti-conduit rule, the waiver applies to the extent that the risks covered by such premiums are not reinsured with a person not entitled to the benefits of the proposed treaty or any other tax treaty entered into by the U.S. that provides exemption from the U.S. insurance excise tax. In contrast, in the U.S.-U.K. treaty, the insurance excise tax was waived with the application of a ‘‘main purpose’’ anti-conduit treaty provision, but the Technical Explanation to that treaty stated that in the context of the insurance excise tax waiver, the United States will interpret the anti-conduit provision of the treaty by analogy to the rules of domestic U.S. law as they may evolve over time. The anti-conduit rule in the proposed treaty with Japan, however, applies regardless of purpose, so that under the proposed treaty, the in- surance excise tax would be imposed whenever a risk is reinsured with a person that would not be entitled to equivalent benefits, even if the reinsurance occurs in the ordinary course of business. Issues relating to the application of anti-conduit rules outside the context of the insur- ance excise tax waiver are discussed in the preceding section of this pamphlet.
54See, e.g., U.S. Treasury Department, Report to Congress on the Effect on U.S. Reinsurance Corporations of the Waiver by Treaty of the Excise Tax on Certain Reinsurance Premiums (March
1990).