Tackling Taxes

On June 3, 2009, the IRS Large and Mid-Size Business (LMSB) Division designated tax withholding on U.S. source fixed or determinable annual or periodic (FDAP) income as a Tier 1 compliance issue. In enacting Section 894(c), Congress specifically stated that the law was intended to address a "tax avoidance opportunity for Canadian corporations with U.S. subsidiaries that arise because of the interaction between the U.S. tax law, the Canadian tax law, and the income tax treaty between the United States and Canada. To combat perceived abuses involving the use of hybrid entities in international tax planning, Section 894(c)(1 ) denies a foreign person treaty benefits of reduced withholding tax for an item of income derived through a partnership or other fiscally transparent entity, if the following three elements are present: 1. The item of income is not treated by the foreign country as an item of income of such foreign person. 2. The applicable treaty does not address the treatment of income derived through a partnership (or fiscally transparent entity). 3. The foreign country does not tax a distribution of such item of income from the partnership to the foreign person.