EXPLANATION OF PROPOSED PROTOCOL

TO THE INCOME TAX TREATY BETWEEN

THE UNITED STATES AND BARBADOS

Scheduled for a Hearing

Before the

COMMITTEE ON FOREIGN RELATIONS

UNITED STATES SENATE

On September 24, 2004

____________

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

September 16, 2004

JCX-55-04
ii

CONTENTS

Page

INTRODUCTION .......................................................................................................................... 1

I. SUMMARY................................................................................................................................. 2

II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL TRADE AND INVESTMENT 

AND U.S. TAX TREATIES........................................................................................................... 3

A. U.S. Tax Rules.................................................................................................................... 3

B. U.S. Tax Treaties................................................................................................................ 5

III. OVERVIEW OF BARBADOS TAX LAW ............................................................................. 7

A. National Income Taxes....................................................................................................... 7

B. International Aspects of Barbados Tax Law....................................................................... 8

C. Other Taxes....................................................................................................................... 10

IV. EXPLANATION OF PROPOSED PROTOCOL .................................................................. 11

Article 1. General Scope ........................................................................................................ 11

Article 2. Limitation on Benefits........................................................................................... 12

Article 3. Exchange of Information ....................................................................................... 20

Article 4. Entry Into Force..................................................................................................... 21

V. ISSUES.................................................................................................................................... 22

A. Potential Availability of Inappropriate Benefits Under Other U.S. Treaties.................... 22

B. Treatment of Special Tax Regimes Outside the Context of Withholding Taxes.............. 23

C. Qualification of Dividends Received by U.S. Residents From Barbados Corporations

for Reduced U.S. Tax Rates.............................................................................................. 25
1

INTRODUCTION

This pamphlet,1 prepared by the staff of the Joint Committee on Taxation, describes the 

proposed protocol to the existing income tax treaty between the United States and Barbados (the 

“proposed protocol”).2 The proposed protocol was signed on July 14, 2004. The Senate 

Committee on Foreign Relations has scheduled a public hearing on the proposed protocol for 

September 24, 2004.3

Part I of the pamphlet provides a summary of the proposed protocol. Part II provides a 

brief overview of U.S. tax laws relating to international trade and investment and of U.S. income 

tax treaties in general. Part III provides a brief overview of relevant Barbados tax laws. Part IV 

contains an article-by-article explanation of the proposed protocol. Part V contains a discussion 

of issues relating to the proposed protocol.

 

1

 This pamphlet may be cited as follows: Joint Committee on Taxation, Explanation of 

Proposed Protocol to the Income Tax Treaty Between the United States and Barbados (JCX-55-

04), September 16, 2004. References to “the Code” are to the U.S. Internal Revenue Code of 

1986, as amended.

2

 The proposed protocol is accompanied by official understandings implemented by an 

exchange of diplomatic notes (the “notes,” collectively).

3

 For a copy of the proposed protocol, see Senate Treaty Doc. 108-26.
2

I. SUMMARY

The principal purposes of the existing treaty between the United States and Barbados are 

to reduce or eliminate double taxation of income earned by residents of either country from 

sources within the other country and to prevent avoidance or evasion of the taxes of the two 

countries. The existing treaty also is intended to promote close economic cooperation between 

the two countries and to eliminate possible barriers to trade and investment caused by 

overlapping taxing jurisdictions of the two countries.

The existing treaty was signed in 1984 and was amended by a protocol signed in 1991. 

The treaty is broadly similar to other U.S. income tax treaties, the 1996 U.S. model income tax 

treaty (the “U.S. model”), and the 1992 model income tax treaty of the Organization for 

Economic Cooperation and Development, as updated (the “OECD model”), with some 

substantive deviations from these treaties and models. The proposed protocol amends three 

articles of the existing treaty.

The proposed protocol replaces Article 22 (Limitation on Benefits) of the existing treaty 

with a new article designed primarily to eliminate certain inappropriate benefits that are available 

under the existing treaty. Specifically, the existing treaty allows a company that is legally 

resident in Barbados to claim the benefits of reduced U.S. withholding tax rates by virtue of 

being publicly traded, even in cases in which the company has no meaningful economic presence 

in Barbados and is subject to only nominal levels of taxation there. This aspect of the existing 

treaty has been a key element in some recent “corporate inversion” transactions that have been 

used by U.S.-based multinational enterprises to erode the U.S. tax base. The proposed protocol 

modifies the limitation-on-benefits provision of the existing treaty to prevent this and similar 

abuses. The proposed protocol also updates the provision in several respects to reflect recent 

developments in U.S. treaty policy.

The proposed protocol amends Article 26 (Exchange of Information) of the existing 

treaty, to promote greater conformity with more recent U.S. income tax treaties in this regard.

In addition, the proposed protocol expands the “saving clause” provision in Article 1 

(General Scope) of the existing treaty to allow the United States to tax former long-term 

residents whose termination of residency has as one of its principal purposes the avoidance of 

tax. This provision allows the United States to apply amendments made in 1996 to the special 

tax rules under section 877 of the Code.
3

II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL TRADE

AND INVESTMENT AND U.S. TAX TREATIES

This overview briefly describes certain U.S. tax rules relating to foreign income and 

foreign persons that apply in the absence of a U.S. tax treaty. This overview also discusses the 

general objectives of U.S. tax treaties and describes some of the modifications to U.S. tax rules 

made by treaties.

A. U.S. Tax Rules

The United States taxes U.S. citizens, residents, and corporations on their worldwide 

income, whether derived in the United States or abroad. The United States generally taxes 

nonresident alien individuals and foreign corporations on all their income that is effectively 

connected with the conduct of a trade or business in the United States (sometimes referred to as 

“effectively connected income”). The United States also taxes nonresident alien individuals and 

foreign corporations on certain U.S.-source income that is not effectively connected with a U.S. 

trade or business.

Income of a nonresident alien individual or foreign corporation that is effectively 

connected with the conduct of a trade or business in the United States generally is subject to U.S. 

tax in the same manner and at the same rates as income of a U.S. person. Deductions are allowed 

to the extent that they are related to effectively connected income. A foreign corporation also is 

subject to a flat 30-percent branch profits tax on its “dividend equivalent amount,” which is a 

measure of the effectively connected earnings and profits of the corporation that are removed in 

any year from the conduct of its U.S. trade or business. In addition, a foreign corporation is 

subject to a flat 30-percent branch-level excess interest tax on the excess of the amount of 

interest that is deducted by the foreign corporation in computing its effectively connected income 

over the amount of interest that is paid by its U.S. trade or business.

U.S.-source fixed or determinable annual or periodical income of a nonresident alien 

individual or foreign corporation (including, for example, interest, dividends, rents, royalties, 

salaries, and annuities) that is not effectively connected with the conduct of a U.S. trade or 

business is subject to U.S. tax at a rate of 30 percent of the gross amount paid. Certain insurance 

premiums earned by a nonresident alien individual or foreign corporation are subject to U.S. tax 

at a rate of one or four percent of the premiums. These taxes generally are collected by means of 

withholding.

Specific statutory exemptions from the 30-percent withholding tax are provided. For 

example, certain original issue discount and certain interest on deposits with banks or savings 

institutions are exempt from the 30-percent withholding tax. An exemption also is provided for 

certain interest paid on portfolio debt obligations. In addition, income of a foreign government 

or international organization from investments in U.S. securities is exempt from U.S. tax.
4

U.S.-source capital gains of a nonresident alien individual or a foreign corporation that 

are not effectively connected with a U.S. trade or business generally are exempt from U.S. tax, 

with two exceptions: (1) gains realized by a nonresident alien individual who is present in the 

United States for at least 183 days during the taxable year, and (2) certain gains from the 

disposition of interests in U.S. real property.

Rules are provided for the determination of the source of income. For example, interest 

and dividends paid by a U.S. citizen or resident or by a U.S. corporation generally are considered 

U.S.-source income. Conversely, dividends and interest paid by a foreign corporation generally 

are treated as foreign-source income. Special rules apply to treat as foreign-source income (in 

whole or in part) interest paid by certain U.S. corporations with foreign businesses and to treat as 

U.S.-source income (in whole or in part) dividends paid by certain foreign corporations with U.S. 

businesses. Rents and royalties paid for the use of property in the United States are considered 

U.S.-source income.

Because the United States taxes U.S. citizens, residents, and corporations on their 

worldwide income, double taxation of income can arise when income earned abroad by a U.S. 

person is taxed by the country in which the income is earned and also by the United States. The 

United States seeks to mitigate this double taxation generally by allowing U.S. persons to credit 

foreign income taxes paid against the U.S. tax imposed on their foreign-source income. A 

fundamental premise of the foreign tax credit is that it may not offset the U.S. tax liability on 

U.S.-source income. Therefore, the foreign tax credit provisions contain a limitation that ensures 

that the foreign tax credit offsets only the U.S. tax on foreign-source income. The foreign tax

credit limitation generally is computed on a worldwide basis (as opposed to a “per-country” 

basis). The limitation is applied separately for certain classifications of income. In addition, a 

special limitation applies to the credit for foreign taxes imposed on foreign oil and gas extraction 

income.

For foreign tax credit purposes, a U.S. corporation that owns 10 percent or more of the 

voting stock of a foreign corporation and receives a dividend from the foreign corporation (or is 

otherwise required to include in its income earnings of the foreign corporation) is deemed to 

have paid a portion of the foreign income taxes paid by the foreign corporation on its 

accumulated earnings. The taxes deemed paid by the U.S. corporation are included in its total 

foreign taxes paid and its foreign tax credit limitation calculations for the year in which the 

dividend is received.
5

B. U.S. Tax Treaties

The traditional objectives of U.S. tax treaties have been the avoidance of international 

double taxation and the prevention of tax avoidance and evasion. Another related objective of 

U.S. tax treaties is the removal of the barriers to trade, capital flows, and commercial travel that 

may be caused by overlapping tax jurisdictions and by the burdens of complying with the tax 

laws of a jurisdiction when a person's contacts with, and income derived from, that jurisdiction 

are minimal. To a large extent, the treaty provisions designed to carry out these objectives 

supplement U.S. tax law provisions having the same objectives; treaty provisions modify the 

generally applicable statutory rules with provisions that take into account the particular tax 

system of the treaty partner.

The objective of limiting double taxation generally is accomplished in treaties through 

the agreement of each country to limit, in specified situations, its right to tax income earned from 

its territory by residents of the other country. For the most part, the various rate reductions and 

exemptions agreed to by the source country in treaties are premised on the assumption that the 

country of residence will tax the income at levels comparable to those imposed by the source 

country on its residents. Treaties also provide for the elimination of double taxation by requiring 

the residence country to allow a credit for taxes that the source country retains the right to 

impose under the treaty. In addition, in the case of certain types of income, treaties may provide 

for exemption by the residence country of income taxed by the source country.

Treaties define the term “resident” so that an individual or corporation generally will not 

be subject to tax as a resident by both treaty countries. Treaties generally provide that neither 

country will tax business income derived by residents of the other country unless the business 

activities in the taxing jurisdiction are substantial enough to constitute a permanent establishment 

or fixed base in that jurisdiction. Treaties also contain commercial visitation exemptions under 

which individual residents of one country performing personal services in the other will not be 

required to pay tax in that other country unless their contacts exceed certain specified minimums 

(e.g., presence for a set number of days or earnings in excess of a specified amount). Treaties 

address passive income such as dividends, interest, and royalties from sources within one 

country derived by residents of the other country either by providing that such income is taxed 

only in the recipient's country of residence or by reducing the rate of the source country's 

withholding tax imposed on such income. In this regard, the United States agrees in its tax 

treaties to reduce its 30-percent withholding tax (or, in the case of some income, to eliminate it 

entirely) in return for reciprocal treatment by its treaty partner.

In its treaties, the United States, as a matter of policy, generally retains the right to tax its 

citizens and residents on their worldwide income as if the treaty had not come into effect. The 

United States also provides in its treaties that it will allow a credit against U.S. tax for income 

taxes paid to the treaty partners, subject to the various limitations of U.S. law.

The objective of preventing tax avoidance and evasion generally is accomplished in 

treaties by the agreement of each country to exchange tax-related information. Treaties generally 

provide for the exchange of information between the tax authorities of the two countries when 

such information is necessary for carrying out provisions of the treaty or of their domestic tax 

laws. The obligation to exchange information under the treaties typically does not require either 
6

country to carry out measures contrary to its laws or administrative practices or to supply 

information that is not obtainable under its laws or in the normal course of its administration or 

that would reveal trade secrets or other information the disclosure of which would be contrary to 

public policy. The Internal Revenue Service (the “IRS”), and the treaty partner's tax authorities, 

also can request specific tax information from a treaty partner. This can include information to 

be used in a criminal investigation or prosecution.

Administrative cooperation between countries is enhanced further under treaties by the 

inclusion of a “competent authority” mechanism to resolve double taxation problems arising in 

individual cases and, more generally, to facilitate consultation between tax officials of the two 

governments.

Treaties generally provide that neither country may subject nationals of the other country 

(or permanent establishments of enterprises of the other country) to taxation more burdensome 

than the taxation it imposes on its own nationals (or on its own enterprises). Similarly, in 

general, neither treaty country may discriminate against enterprises owned by residents of the 

other country.

At times, residents of countries that do not have income tax treaties with the United 

States attempt to use a treaty between the United States and another country to avoid U.S. tax. 

To prevent third-country residents from obtaining treaty benefits intended for treaty country 

residents only, treaties generally contain an “anti-treaty-shopping” provision that is designed to 

limit treaty benefits to bona fide residents of the two countries.
7

III. OVERVIEW OF BARBADOS TAX LAW4

A. National Income Taxes

Overview

Barbados imposes federal income tax on net taxable income under the Income Tax Act of 

1996 (the “Income Tax Act”). Barbados has a unitary income tax system under which income of 

all kinds is aggregated and subject to a single tax. The types of income subject to tax include 

business income, income from the holding of an office, and income from employment, as well as 

interest, dividends, and royalties. There is no income tax on capital gains.

Individuals

Individuals resident and domiciled in Barbados are subject to tax on their worldwide 

income. Taxable income includes remuneration from an office or employment, director’s fees, 

taxable profits from a trade or business, interest, dividends, royalties, trust income (whether or 

not received), partnership income, and the benefit of below-market loans. Dividends received by 

individuals from resident companies carry a tax credit and are grossed up accordingly, subjecting 

dividends to a final tax at a rate of 12.5 percent. The income tax generally applies at a rate of 20 

percent on the first BBD5 24,200 and 40 percent thereafter. Gross assessable income up to BBD 

17,500 is not subject to tax. Specially qualified individuals working in the international business 

and financial services sector may qualify to exempt up to 35 percent of their income from 

taxation. No tax is levied on capital gains.

Corporations

Under the Income Tax Act, Barbados generally imposes a corporation tax on the net 

taxable income of companies incorporated or registered in Barbados, as well as any foreign 

companies carrying on business or having an office or place of business in Barbados. Resident 

companies (companies managed and controlled from Barbados) are subject to tax on their 

worldwide income. Double taxation is generally avoided if a double taxation treaty is in force, 

which allows a credit against Barbados tax for foreign taxes paid on overseas income. The 

standard corporation tax rate for 2004 is 33 percent. Branches or subsidiaries pay an additional 

10 percent of corporation tax if profits have been remitted. However, if profits are reinvested in 

Barbados, other than for replacement of fixed assets, the additional tax is not imposed. Profits 

from business and trading operations are calculated according to standard accounting principles 

and include interest, royalties, and rents. Foreign-source dividends are included in profits for tax 

purposes. Dividends distributed from one resident company to another are exempt from tax. 

Losses may be carried forward 10 years; there are no loss carry-back provisions.

 

4

 The information in this section relates to Barbados law and is based on the Joint 

Committee staff’s review of publicly available sources. The description is intended to serve as a 

general overview; it may not be fully accurate in all respects, as many details have been omitted 

and simplifying generalizations made for ease of exposition.

5

 Barbados maintains a fixed exchange rate with the U.S. dollar (BBD 1.98 = USD 1.00).
8

B. International Aspects of Barbados Tax Law

Residency

Individuals domiciled and resident in Barbados are subject to tax on their worldwide 

income, whether or not remitted in Barbados. The Income Tax Act does not define domicile, but 

it is usually acquired by birth or by a conscious decision to reside permanently in the country. 

Residence is defined as presence in a country for more than 182 days in a calendar year. 

Nondomiciliary residents are taxed on income from sources in Barbados and income remitted to 

Barbados, whereas nondomiciliary nonresidents are taxed only on income from sources in 

Barbados.

Barbados imposes a corporation tax on companies, including companies incorporated or 

registered in Barbados, and foreign companies carrying on business or having an office or place 

of business in Barbados. Resident companies are taxed on their worldwide income. A resident 

company is one that is incorporated in or managed and controlled from Barbados. Nonresident 

companies are taxed only on income derived from business actually conducted in Barbados. 

Nonresident companies are taxed at a flat rate of 15 percent on dividends, interest, royalties, and 

management fees derived from a Barbados source. Barbados resident companies apply a 

withholding tax of 12.5 percent and 15 percent on interest and dividend payments to residents 

and nonresidents, respectively, subject to reduction by treaty.

Offshore Operations

Barbados has enacted several special tax regimes to make the country an attractive 

jurisdiction for the incorporation or registration of international businesses. Offshore companies 

are taxed at a rate significantly lower than the standard rate for local companies. 

International Business Companies

The International Business Company (“IBC”) is the most widely used vehicle for 

offshore operations in Barbados. The International Business Companies Act of 1991 defines an 

IBC as a company that carries on business in international manufacturing or international trade 

or commerce from within Barbados. A company wishing to operate as an IBC must obtain a 

license from the Ministry of Economic Development. The law limits the issue of an IBC license 

to companies that are incorporated or registered in Barbados. In addition, no more than 10 

percent of a company’s assets may accrue on liquidation to shareholders or lenders resident in 

the CARICOM region,6 and no more than 10 percent of the interest and dividend payments made 

by a company may go to individuals resident in the CARICOM region. IBCs pay income tax at 

rates ranging from one to 2.5 percent and enjoy an exemption from all withholding taxes.

 

6

 The Caribbean Common Market and Community (CARICOM) was established by the 

Treaty of Chaguramas in 1973. Member countries include Antigua and Barbuda, The Bahamas, 

Barbados, Belize, Dominica, Grenada, Guyana, Haiti, Jamaica, Montserrat, St.Lucia, St. Kitts 

and Nevis, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago.
9

International Banks

The activities of international banks are regulated by the International Financial Services 

Act of 2002. This act, which repealed the Offshore Banking Act of 1980, provides tax and other 

incentives for international banking business conducted from Barbados. In order to engage in 

international banking, companies must obtain the consent of the Minister of Finance, incorporate 

under the Barbados Companies Act of 1982, restrict business activities to offshore banking from 

within Barbados, and include among its directors at least one resident citizen of Barbados. 

International banks pay tax on banking profits at rates ranging from one to 2.5 percent. No other 

direct tax or capital gains tax is imposed on the profits or gains of the bank. 

Exempt Insurance Companies

The Barbados Exempt Insurance Act was passed in 1983 to create a regime for 

establishing Barbados as a location for international insurance businesses. In order to be eligible 

for exempt status, the company’s equity must be owned by persons resident outside the 

CARICOM region, and the company must insure against risks located outside Barbados. 

Exempt insurance companies are not taxed during their first 15 years of existence. Thereafter, 

they are taxed at a rate of two percent on their first $250,000 (U.S.) of profits.

Qualifying Insurance Companies

A 1998 law allows international insurance companies owned by Barbados residents or 

which insure a certain amount of local risk to register as qualifying insurance companies 

(“QICs”). A QIC is entitled to tax concessions if at least 90 percent of its premiums originated, 

and at least 90 percent of its risks are insured, outside the CARICOM region. A QIC’s profits 

are taxed at an effective rate of no more than 2.8 percent.

Societies with Restricted Liabilities

The Societies with Restricted Liabilities Act of 1995 was passed to position Barbados 

favorably in the international financial services market. An entity formed under the act (an 

“SRL”) enjoys limited liability and may be treated as a corporation, partnership, or a disregarded 

entity for U.S. tax purposes. SRLs are mainly used for international transactions and are 

prohibited from acquiring or holding land leased for business purposes. SRLs must be organized 

in Barbados and continuously maintain a registered office and agent in Barbados. SRLs pay tax 

on income at rates ranging from one to 2.5 percent. SRLs are exempt from withholding taxes on 

dividends and interest payments.
10

C. Other Taxes

In addition to the income taxes described above, other taxes are levied upon transactions, 

including a value added tax at a standard 15 percent rate (financial services are exempt), customs 

and excise duties, a stamp tax, and a property transfer tax. Barbados does not have gift or 

inheritance taxes. Land taxes are imposed upon land value at rates from 0.4 percent to one 

percent, depending upon whether land is improved or unimproved. If the landowner is foreign, 

the rate is three percent for unimproved land and two percent for improved land. Payroll taxes 

fund Barbados’s national insurance and social security systems. Many imported and locally 

produced items are subject to a consumption tax with rates ranging from six percent to 30 

percent.
11

IV. EXPLANATION OF PROPOSED PROTOCOL

Article 1. General Scope

The proposed protocol expands the “saving clause” provision in Article 1 (General 

Scope) of the existing treaty to include former long-term residents whose termination of 

residency had as one of its principal purposes the avoidance of tax.

The general scope article describes the persons who may claim the benefits of the 

existing treaty. The treaty generally applies to residents of the United States and Barbados, with 

specific modifications to such scope in other articles. Like all U.S. income tax treaties and the 

U.S. model, the treaty includes a “saving clause.” Under this clause, with specific exceptions, 

the treaty does not affect the taxation by either treaty country of its residents or its citizens. 

Thus, the United States may continue to tax its citizens who are residents of Barbados as if the 

treaty were not in force. 

The existing treaty contains a provision under which the saving clause (and therefore the 

U.S. jurisdiction to tax) applies for U.S. tax purposes to a former U.S. citizen whose loss of 

citizenship status had as one of its principal purposes the avoidance of U.S. tax; such application 

is limited to the 10-year period following the loss of citizenship status. 

The proposed protocol expands the saving clause provision in the existing treaty to 

include former long-term residents whose termination of residency had as one of its principal 

purposes the avoidance of tax. The expansion of this provision makes the treaty consistent with 

amendments to the U.S. tax rules under Code section 877 in 1996 related to former citizens and 

former long-term residents who relinquish citizenship or terminate residency.

Prior to the enactment of the Health Insurance Portability and Accountability Act of 

1996, section 877 of the Code provided special rules for the imposition of U.S. income tax on 

former U.S. citizens for a period of 10 years following the loss of citizenship; these special tax 

rules applied to a former citizen only if his or her loss of U.S. citizenship had as one of its 

principal purposes the avoidance of U.S. income, estate or gift taxes. The Health Insurance 

Portability and Accountability Act of 1996 expanded section 877 to apply also to certain former 

long-term residents of the United States. For purposes of applying the special tax rules to former 

citizens and long-term residents, individuals who meet a specified income tax liability threshold 

or a specified net worth threshold generally are considered to have lost citizenship or resident 

status for a principal purpose of U.S. tax avoidance. 

The proposed protocol updates the existing treaty to reflect the reach of U.S. taxing 

jurisdiction under section 877 as expanded in 1996. Accordingly, the saving clause in the 

proposed protocol permits the United States to impose the special tax rules on former U.S. longterm residents who terminate residency with a principal purpose of avoiding U.S. income, estate, 

or gift taxes.

The term “long-term resident” is defined under U.S. domestic laws. The United States 

defines “long-term resident” as an individual (other than a U.S. citizen) who is a lawful 

permanent resident of the United States in at least eight of the prior 15 taxable years. An 
12

individual is not treated as a lawful permanent resident for any taxable year if such individual is 

treated as a resident of a foreign country under the provisions of a tax treaty between the United 

States and the foreign country and the individual does not waive the benefits of such treaty 

applicable to residents of the foreign country. 

Article 2. Limitation on Benefits

In general

The existing treaty was intended to limit double taxation caused by the interaction of the 

tax systems of the United States and Barbados as they apply to residents of the two countries. At 

times, however, residents of third countries attempt to use a treaty. This use is known as “treaty 

shopping,” which refers to a situation in which a person who is not a resident of either treaty 

country seeks certain benefits under the income tax treaty between the two countries. Under 

certain circumstances, and without appropriate safeguards, the third-country resident may be able 

to secure these benefits indirectly by establishing a corporation or other entity in one of the treaty 

countries, which entity, as a resident of that country, is entitled to the benefits of the treaty. 

Limitation-on-benefits provisions seek to prevent this sort of treaty shopping and limit the 

benefits of the treaty to qualified residents of the two countries.

The proposed protocol replaces Article 22 (Limitation on Benefits) of the existing treaty 

with a new article that both generally updates the provision and addresses a particular problem 

that has arisen under that provision.

Inappropriate benefits available under the existing treaty

The existing treaty allows treaty benefits to be claimed in circumstances in which there is 

no possibility of meaningful double taxation arising as a result of the interaction of the U.S. and 

Barbados tax systems. Specifically, the existing treaty allows a company that is legally resident 

in Barbados to claim the benefits of reduced U.S. withholding tax rates by virtue of being 

publicly traded, even if the company’s stock is traded primarily on a U.S. stock exchange (as 

opposed to a Barbados stock exchange), and even in cases in which the Barbados-resident 

company has no meaningful economic presence in Barbados and is subject to only nominal 

levels of taxation there (e.g., as an IBC). 

This aspect of the existing treaty has been a key element in some recent “corporate 

inversion” transactions that have been used by U.S.-based multinational enterprises to erode the 

U.S. tax base. Simply stated, in an inversion transaction, a U.S. corporation effectively 

reincorporates as a foreign corporation in a low-tax jurisdiction, thereby replacing the U.S. 

parent corporation of a multinational corporate group with a foreign parent corporation.7 Such a

transaction places the group in a position to realize two main U.S. tax benefits: (1) removing 

 

7

 For more detailed description and analysis of inversion transactions, see, e.g., Joint 

Committee on Taxation, Background and Description of Present-Law Rules and Proposals 

Relating to Corporate Inversion Transactions (JCX-52-02), June 5, 2002; U.S. Treasury 

Department, Office of Tax Policy, Corporate Inversion Transactions: Tax Policy Implications, 

May 17, 2002.
13

some or all of the group’s foreign operations and income from the U.S. taxing jurisdiction; and 

(2) reducing the U.S. taxes that otherwise would be incurred on income from the group’s U.S. 

operations, through the use of various “earnings stripping” strategies (e.g., having a U.S. group 

member make large payments of deductible interest or royalties to the new foreign parent, which 

will be subject to little or no residence-country tax on such payments). The first benefit, 

removing the group’s foreign operations from the U.S. taxing jurisdiction, generally does not 

depend critically on the existence of a comprehensive income tax treaty between the United 

States and the jurisdiction in which the new foreign parent corporation is resident. The second 

benefit, however, involving erosion of the U.S. tax base on U.S.-source income through earnings 

stripping strategies, does depend critically on the existence of such a treaty.8 Without treatybased reductions of withholding tax rates on items such as interest and royalties, the tax benefits 

of the deduction for the U.S. company making the payment would be substantially offset by 

imposition of a 30-percent U.S. withholding tax.

It has become clear that the existing treaty has been used by inverted corporations to 

facilitate base-eroding earnings stripping strategies in the United States. The availability of 

special tax regimes under Barbados law (e.g., IBCs), combined with reduced, five-percent 

withholding tax rates on interest and royalties under the treaty, makes the treaty very attractive 

for this purpose. The existing limitation-on-benefits provision allows benefits to be extended to 

all publicly traded corporations that are resident in one of the two treaty countries, with no 

requirement that the public trading occur in the company’s country of legal residence. Thus, a 

U.S. corporation primarily traded on a U.S. stock exchange can execute an inversion transaction 

that results in a Barbados IBC winding up as the parent of the corporate group, and the group’s 

U.S. companies can make treaty-benefited payments to the parent, based on the fact that the 

parent’s stock continues to be publicly traded on U.S. markets.9 The U.S. deductions generally 

provide the benefit of reducing a 35-percent corporate income tax, and the combination of a 

treaty-reduced five-percent rate of U.S. withholding tax on the payment and a nominal rate of 

Barbados tax on the receipt of the payment leave the tax benefit of the deductions largely intact. 

Absent application of the treaty, U.S. withholding tax would be imposed at the full 30-percent 

rate, thus substantially eliminating the overall tax benefit of the earnings stripping arrangement.

Thus, in a situation presenting no risk of significant double taxation arising from the 

interaction of the U.S. and Barbados tax systems, treaty provisions that were designed to mitigate 

such double taxation are instead used to facilitate purely tax-motivated transactions that erode 

the U.S. tax on income earned from business operations conducted within the United States. As 

explained in detail below, the proposed protocol includes rules designed to prevent the use of the 

treaty for these purposes.

 

8

 In the case of interest, the strategy also relies on a taxpayer’s ability to avoid 

application of section 163(j) of the Code, which was designed to limit earnings stripping. In 

some cases, section 482 of the Code also may serve to limit stripping transactions.

9

 The parent company actually may be incorporated in a tax-haven jurisdiction that does 

not have a comprehensive income tax treaty with the United States, but the company can 

establish a registered office in Barbados for the purpose of taking advantage of the U.S.-

Barbados treaty.
14

General overview of proposed limitation-on-benefits provision

The proposed limitation-on-benefits article provides that a treaty-country resident is 

entitled to treaty benefits only if such resident is described in one of the following categories:

(1) an individual;

(2) one of the two governments or a political subdivision or local authority thereof;

(3) a company that satisfies a public company test, and certain subsidiaries of such 

companies;

(4) an entity that satisfies an ownership test and a base erosion test;

(5) a tax-exempt entity organized and operated exclusively for religious, charitable, 

scientific, literary, or educational purposes; or

(6) a tax-exempt pension plan or employee benefit arrangement that meets an 

ownership test.

Alternatively, a resident that does not fit into any of the above categories may claim 

treaty benefits under the active business test. In addition, a person that does not satisfy any of 

the above requirements may be entitled to the benefits of the proposed treaty if the source 

country’s competent authority so determines.

Even if a person would qualify for treaty benefits by reason of being included on the 

enumerated list above or satisfying the active business test, such person is not entitled to the 

treaty’s reduced rates of withholding taxes on dividends, interest, and royalties if such person is 

entitled to income tax benefits under a “special tax regime” (such as the Barbados IBC regime). 

As explained in detail below, this modification, as well as changes to the public company test 

listed as item (3) above, serve to curtail the inappropriate benefits available under the existing 

treaty.

Individuals

Under the proposed protocol, individual residents of the United States and Barbados are 

entitled to all treaty benefits. However, if such an individual receives income as a nominee on 

behalf of a third country resident, and thus is not the beneficial owner of such income, benefits 

may be denied.

Governmental entities

The proposed protocol provides that the governments of the United States and Barbados, 

and any political subdivision or local authority thereof, are entitled to all treaty benefits.
15

Publicly traded companies

The public company test of the proposed protocol allows treaty benefits to be claimed by 

two categories of companies: publicly traded companies and subsidiaries of publicly traded 

companies. 

A company is entitled to all the benefits of the treaty as a publicly traded company if its 

principal class of shares is: (1) listed on a recognized stock exchange located in the treaty 

country in which the company is resident; (2) primarily traded on a recognized stock exchange 

located in such treaty country; and (3) regularly traded on one or more recognized stock 

exchanges. In the case of a company resident in Barbados, the company also may satisfy the 

second requirement above if it is primarily traded on either the Jamaica Stock Exchange or the 

Trinidad Stock Exchange. 

The requirement that a company’s principal class of shares be primarily traded on a stock 

exchange in its country of residence (or, in the case of Barbados, in Jamaica or Trinidad) 

represents an important departure from the rule of the existing treaty, which allowed companies 

to qualify for treaty benefits on the basis of public trading in either treaty country. Thus, as 

described above, an inverted corporation now resident in Barbados, but continuing to be traded 

primarily on a U.S. stock exchange, could satisfy the rule of the existing treaty on the strength of 

that public trading in the United States. Under the new rule, such a corporation would not be 

able to qualify for treaty benefits under the public trading test, because its principal class of 

shares would not be primarily traded in its country of residence (or in Jamaica or Trinidad). This 

new rule should prove to be relatively robust, as companies will find place of trading to be much 

less manipulable than legal residence as a non-tax matter. Thus, this modification of the existing 

treaty should curtail the inappropriate benefits available under the treaty with respect to inverted 

corporations, as well as corporations that establish similar structures by means other than 

corporate inversion.10

A company is entitled to all the benefits of the treaty as a subsidiary of a publicly traded 

company if: (1) at least 50 percent of the company’s principal class of shares is owned directly or 

indirectly by companies that are publicly traded under the test described above; and (2) the 

company satisfies the requirements of the “base erosion” clause of the limitation-on-benefits 

article. In the case of indirect ownership, each intermediate owner must be a person entitled to 

treaty benefits under this same provision.

For purposes of these rules, the term “recognized stock exchange” includes the NASDAQ 

system and any stock exchange registered with the Securities and Exchange Commission as a 

national securities exchange for purposes of the Securities Exchange Act of 1934. The term also 

includes the Barbados Stock Exchange, the Jamaica Stock Exchange, and the Trinidad Stock 

Exchange. The competent authorities of the two treaty countries also can agree to extend the 

term to include other exchanges.

 

10 In addition, even if this rule should prove to be less robust than anticipated, it is 

reinforced by a separate rule denying certain treaty benefits to beneficiaries of special tax 

regimes such as the Barbados IBC regime, as described in further detail below.
16

The term “principal class of shares” is not defined in the proposed protocol or in the 

existing treaty. As described in the Treasury Department’s Technical Explanation (the 

“Technical Explanation”), under paragraph 2 of Article 3 (General Definitions) of the existing 

treaty, the term will be defined under the laws of the treaty country whose taxes are at issue in a 

particular case -- generally the source country. Under U.S. tax law, a company’s principal class 

of shares is generally considered to be the common shares of the company representing the 

majority of the aggregate voting power and value of the company. If the company does not have 

such a class of shares, then the principal class of shares is the class or any combination of classes 

of shares that represents, in the aggregate, a majority of the voting power and value of the 

company. The term “shares” for this purpose includes depositary receipts for shares (e.g., 

American Depositary Receipts (“ADRs”)) or trust certificates for shares.

 The term “primarily traded” also is not defined in the proposed protocol or in the 

existing treaty. Thus, as above, the term will be defined under the laws of the treaty country 

whose taxes are at issue in a particular case. In the case of the United States, the Technical 

Explanation states that the term is understood to have the meaning it has under Treas. reg. 

section 1.884-5(d)(3), relating to the branch tax provisions of the Code. Under these rules, stock 

of a corporation is primarily traded in a company’s residence country if the number of shares in 

the company’s principal class of shares that are traded during the taxable year on all recognized 

stock exchanges in the company’s residence country exceeds the number of shares in the 

company’s principal class of shares that are traded during that year on established securities 

markets in any other single country.

The term “regularly traded” also is not defined in the proposed protocol or in the existing 

treaty. Again, the term accordingly will be defined under the laws of the treaty country whose 

taxes are at issue in a particular case. In the case of the United States, the Technical Explanation 

states that the term is understood to have the meaning it has under Treas. reg. section 1.884-

5(d)(4)(i)(B), relating to the branch tax provisions of the Code. Under these regulations, a class 

of shares is considered to be regularly traded if: (1) trades in the class of shares are made in more 

than de minimis quantities on at least 60 days during the taxable year; and (2) the aggregate 

number of shares in the class traded during the year is at least 10 percent of the average number 

of shares outstanding during the year.11 The regular trading requirement can be met by trading 

on any recognized exchange or exchanges located in either treaty country. The Technical 

Explanation states that trading on one or more recognized stock exchanges may be aggregated 

for purposes of this requirement. The Technical Explanation also states that authorized but 

unissued shares are not considered for purposes of this test.

Ownership and base erosion tests

An entity that is a resident of one of the treaty countries is entitled to treaty benefits under 

the proposed protocol if it satisfies both an ownership test and a base erosion test.

 

11 The Technical Explanation states that Treas. reg. sec. 1.884-5(d)(4)(i)(A), (ii) and (iii) 

will not be taken into account for purposes of defining the term “regularly traded” under the 

proposed protocol. 
17

In order to satisfy the ownership test, on at least half the days of the taxable year, shares 

or other beneficial interests representing more than 50 percent of the beneficial interest in the 

entity must be owned (directly or indirectly) by certain persons qualifying for treaty benefits 

under other provisions of the limitation-on-benefits article (i.e., individuals, governmental 

entities, parent companies that meet the public company test, tax-exempt entities operating for 

charitable or other specified purposes, and tax-exempt employee benefit arrangements). All such 

persons and intermediate owners must be residents of the same treaty country as the entity in 

question. Persons eligible for the benefits of a special tax regime (such as the Barbados IBC 

regime) are not qualifying owners for these purposes.

The base erosion test is satisfied only if less than 50 percent of the entity’s gross income 

for the taxable year is paid or accrued, directly or indirectly, in the form of deductible payments 

to persons who are not qualifying persons as described in the preceding paragraph. The 

Technical Explanation states that for this purpose, where reductions in U.S. tax are sought, the 

term “gross income” has the same meaning as under domestic law (i.e., section 61 of the Code 

and the regulations thereunder). The Technical Explanation also states that, for purposes of this 

test, deductible payments include neither arm’s length payments in the ordinary course of 

business for services or tangible property, nor depreciation and amortization deductions.

Tax-exempt and charitable organizations

A tax-exempt entity resident in a treaty country and operated exclusively for religious, 

charitable, scientific, literary, or educational purposes is entitled to all the benefits of the treaty. 

There is no requirement that specified percentages of the beneficiaries of these organizations be 

residents of the United States or Barbados.

Exempt employee benefits organizations

A tax-exempt plan, scheme, fund, trust, company, or other arrangement established in a 

treaty country and operated exclusively to administer or provide employee benefits is entitled to 

all the benefits of the proposed protocol if, as of the close of the end of the prior taxable year, 

more than 50 percent of the beneficiaries, members, or participants of the organization are 

entitled to the benefits of the treaty. According to the Technical Explanation, for purposes of this 

provision, the term “beneficiaries” should be understood to refer to the persons receiving benefits 

from the organization. 

Active business test

Under the proposed protocol, a treaty-country resident that is not entitled to all benefits of 

the treaty nevertheless may receive benefits with respect to certain items of income that are 

connected to an active trade or business conducted in its residence country. 

Under the general rule, a resident of a treaty country engaged in the active conduct of a 

trade or business in that country may obtain treaty benefits with respect to an item of income 

derived in the other treaty country, provided that the item of income is derived in connection 

with, or is incidental to, that trade or business. 
18

In general, a trade or business comprises activities that constitute (or could constitute) an 

independent economic enterprise carried on for profit. To constitute a trade or business, the 

activities conducted by the resident ordinarily must include every operation which forms a part 

of, or a step in, a process by which an enterprise may earn income or profit. The determination 

of whether activities constitute an active trade or business is determined under all the facts and 

circumstances. A person actively conducts a trade or business if it regularly performs active and 

substantial management and operational functions through its own officers or employees. In this 

regard, one or more of such activities may be carried out by independent contractors under the 

direct control of the resident. However, in determining whether the corporation actively 

conducts a trade or business, the activities of independent contractors shall be disregarded.

The business of making or managing investments for the resident’s own account will be 

considered to be a trade or business only when part of banking, insurance or securities activities 

conducted by a bank or insurance company. Such activities conducted by a person other than a 

bank or an insurance company will not be considered to be the conduct of an active trade or 

business, nor would they be considered to be the conduct of an active trade or business if 

conducted by a bank or insurance company other than as part of the company’s banking or 

insurance business. 

For this purpose, a person will be treated as a bank only if: (1) it is licensed to accept 

deposits from residents of its residence country and to conduct, in that country, lending or other 

banking activities; (2) it regularly accepts deposits from customers who are residents of its 

residence country in the ordinary course of its business, and the amount of deposits shown on the 

company’s balance sheet is substantial; and (3) it regularly makes loans to customers in the 

ordinary course of its trade or business. A person will be treated as an insurance company only 

if: (1) it is licensed to insure risks of residents of its residence country; and (2) it regularly 

insures (not including reinsurance) risks of customers who are residents of its residence country. 

The Technical Explanation states that, because a headquarters operation is in the business 

of managing investments, a company that functions solely as a headquarters company will not be 

considered to be engaged in an active trade or business under the test described above.

In cases in which the trade or business generating the item of income in question is 

carried on either by the person deriving the income or by any associated enterprises through 

activities in the source country, the trade or business carried on in the residence country must be 

substantial in relation to the activity in the source country. According to the Technical 

Explanation, this requirement is intended to prevent a company from qualifying for sourcecountry treaty benefits by engaging in relatively de minimis business activities in the residence 

country. The determination of substantiality is made based upon all facts and circumstances, 

and, according to the Technical Explanation, takes into account the relative sizes of the trades or 

businesses in each treaty country (measured by reference to asset values, income and payroll 

expenses), the nature of the activities performed in each treaty country, and the relative 

contributions made to that trade or business in each treaty country. The Technical Explanation 

further states that in making each determination or comparison, due regard will be given to the 

relative sizes of the U.S. and Barbados economies.
19

The proposed protocol also provides a safe harbor, under which a trade or business may 

be deemed substantial based on a comparison of the income recipient’s asset value, gross 

income, and payroll expense in the residence country with the corresponding amounts in the 

source country, with reference to either the preceding taxable year, or the average of the 

preceding three years. In order to qualify for the safe harbor, the average of these three ratios 

must exceed 10 percent, and each individual ratio must exceed 7.5 percent. In cases in which 

less than all of the activity of a trade or business is attributable to a particular resident, only a 

proportionate share of the relevant activities will be taken into account.

According to the Technical Explanation, the substantiality test, which applies only to 

income earned by related parties, is intended to focus only on potentially abusive cases, and 

should not apply to situations thought to be non-abusive, even though the income recipient 

resident in one treaty country may be very small in relation to the entity generating income in the 

source country. For example, the Technical Explanation states that a small Barbados bank that 

makes a loan to a very large unrelated U.S. business would not have to pass a substantiality test 

in order to receive treaty benefits.

In determining whether a person is engaged in an active trade or business, the activities of 

a partnership are attributed to each of its partners. In addition, activities conducted by persons 

“connected” to a person are attributed to such person. A person is connected to another if such 

person possesses 50 percent or more of the beneficial interest in the other (or if the other 

possesses 50 percent or more of the beneficial interest in such person). For this purpose, a 

person is connected to a company if such person owns shares representing 50 percent or more of 

the aggregate voting power and value of the company or 50 percent or more of the beneficial 

equity interest in the company. A person also is connected to another if a third person possesses 

50 percent or more of the beneficial interest in both such person and the other person. For this 

purpose, if either person is a company, the threshold relationship with respect to such company 

or companies is 50 percent or more of the aggregate voting power and value or 50 percent or 

more of the beneficial equity interest. Finally, a person is connected to another if, based upon all 

the facts and circumstances, one controls the other, or the two are under common control.

Grant of treaty benefits by competent authority

A person that is not entitled to treaty benefits under the other provisions of the limitationon-benefits article nevertheless may be granted benefits under the treaty at the discretion of the 

competent authority of the source country. 

The notes accompanying the proposed protocol provide specific guidance as to the 

exercise of this discretion in the case of an employee benefits organization that fails to satisfy the 

requirement that 50 percent or more of its beneficiaries, members, or participants be persons 

entitled to the benefits of the treaty. In such a case, the U.S. competent authority will favorably 

consider the following factors: (1) the organization is established in Barbados; (2) the sponsoring 

employer of the organization is a resident of Barbados entitled to the benefits of the treaty (other 

than a person eligible for a special tax regime); (3) more than 30 percent of the beneficiaries, 

members, or participants of the organization are persons entitled to the benefits of the treaty; and 

(4) more than 70 percent of the beneficiaries, members, or participants of the organization are 

individuals resident in a member of the Caribbean Community.
20

Denial of withholding tax reductions for beneficiaries of special tax regimes

The proposed protocol contains a separate rule that denies the benefits of Articles 10 

(Dividends), 11 (Interest) and 12 (Royalties) of the treaty to a person that is entitled to income 

tax benefits under the provisions of a special tax regime, even if such person otherwise would be 

entitled to treaty benefits under the general limitation-on-benefits rules.12 A special tax regime is 

defined as any legislation or administrative practice that provides for an effective tax rate 

substantially lower than the generally applicable tax rate for companies or individuals, as 

appropriate. 

The notes specify several regimes under Barbados law that are special tax regimes for 

these purposes: (1) the Exempt Insurance Act; (2) the International Financial Services Act; (3) 

the International Business Companies Act; (4) the Societies with Restricted Liability Act; and (5) 

the Insurance (Miscellaneous Provisions) Act.13 The notes further provide that any legislation or 

administrative practice enacted or adopted after the signing of the proposed protocol pursuant to 

which the income of a person is entitled to the same or substantially similar tax benefits to those 

granted under a regime mentioned in the previous sentence will constitute a special regime. The 

Technical Explanation states that, in determining whether a person is entitled to the same or 

substantially similar benefits to the tax regimes identified in the notes, consideration will be 

given to all facts and circumstances, including, for example, whether a tax regime imposes tax on 

an artificially low taxable base.

No aspect of current U.S. tax law was identified in the notes as constituting a special tax 

regime.

Like the modifications to the public trading rule described above, this modification 

should curtail inappropriate benefits that are available under the existing treaty. This rule 

represents a significant improvement on the existing treaty, in that it disallows some of the major 

benefits of the treaty in cases that do not involve any meaningful risk of double taxation. 

Nevertheless, as discussed in part V.B. of this pamphlet, some may question why this approach 

was limited to withholding tax reductions, instead of being extended to all benefits available 

under the treaty.

Article 3. Exchange of Information

 Article 3 of the proposed protocol clarifies that the information exchanged under Article 

26 (Exchange of Information) of the treaty includes information held by financial institutions, 

nominees, or persons acting in an agency or fiduciary capacity (but does not include information 

that would reveal confidential communications between a client and an attorney, solicitor or 

 

12 For purposes of this rule, a partnership, estate, or trust is treated as a person entitled to 

the benefits of a special tax regime to the extent that such partnership, estate, or trust is treated as 

a resident of a treaty country under paragraph 1 of Article 4 (Residence) by reason of income of 

such partnership, estate, or trust being subject to tax in the hands of a person or persons entitled 

to the benefits of a special tax regime. 

13

 See part III.B. of this pamphlet for a description of these regimes.
21

other legal representative, where the client seeks legal advice). The Technical Explanation states 

that, in the case of the United States, the scope of the privilege for such confidential 

communications is coextensive with the attorney-client privilege under U.S. law. The treaty 

countries also may obtain and exchange information relating to the ownership of legal persons.

Article 4. Entry Into Force

Article 4 of the proposed protocol relates to the entry into force of the modifications 

contained therein. The proposed protocol provides that it shall be subject to ratification by both 

treaty countries, and instruments of ratification shall be exchanged as soon as possible. The 

proposed protocol will enter into force upon the exchange of instruments of ratification. 

The proposed protocol will have effect with respect to taxes withheld at source for 

amounts paid or credited on or after the first day of the second month following the date on 

which the proposed protocol enters into force. For all other taxes, the proposed protocol will 

have effect for taxable years beginning on or after January first of the year following entry into 

force.
22

V. ISSUES

A. Potential Availability of Inappropriate Benefits

Under Other U.S. Treaties

As discussed in part IV of this pamphlet, the proposed protocol modifies the existing 

treaty to eliminate certain inappropriate benefits that are available under the treaty. The problem 

stems from the fact that the existing treaty allows a company that is legally resident in Barbados 

to claim the benefits of reduced U.S. withholding tax rates by virtue of being publicly traded, 

even in cases in which the company has no meaningful economic presence in Barbados and is 

subject to only nominal levels of taxation there, pursuant to a special tax regime such as the IBC 

regime. Thus, in a situation presenting no risk of significant double taxation arising from the 

interaction of the U.S. and Barbados tax systems, treaty provisions that were designed to mitigate 

such double taxation are instead used to facilitate purely tax-motivated transactions that erode 

the U.S. tax on income earned from business operations conducted within the United States. As 

described in detail above, the proposed protocol modifies the limitation-on-benefits provision of 

the existing treaty to prevent this and similar abuses. As amended, this treaty should prove much 

less suitable for use in tax-motivated structures that rely on inappropriate treaty benefits.

While evidence from recent corporate inversion transactions suggests that the U.S.-

Barbados treaty has been the preferred treaty for this sort of tax-motivated arrangement, it is not 

clear that this is the only treaty in the U.S. tax treaty network that may be suitable for these or 

similar inappropriate uses. The Committee may wish to ask the Treasury Department whether it 

has similar concerns about any other treaties in the U.S. network, and if so, what measures are 

being taken to address those concerns.
23

B. Treatment of Special Tax Regimes Outside

the Context of Withholding Taxes

The proposed protocol specifically denies the benefits of reduced withholding tax rates 

on dividends, interest, and royalties in cases in which the recipient of the payment is entitled to 

income tax benefits under the provisions of a special tax regime, such as the Barbados IBC 

regime. The denial of withholding tax reductions in cases involving special tax regimes is one 

way in which the proposed protocol seeks to eliminate inappropriate benefits that are available 

under the existing treaty.14

While this rule represents significant progress in eliminating inappropriate treaty benefits, 

some may question why the proposed protocol does not deny all tax reductions available under 

the treaty to beneficiaries of special tax regimes, instead of denying only the withholding tax 

reductions. For example, suppose a Barbados IBC that is generally entitled to treaty benefits 

conducts a trade or business in the United States. Under U.S. statutory tax law, the IBC would 

be subject to U.S. tax on the income effectively connected with that trade or business in a 

manner similar to that in which a domestic taxpayer would be taxed. However, under Article 7 

(Business Profits) of the existing treaty, the United States would not be allowed to tax the IBC on 

this income unless the trade or business also rose to the level of a “permanent establishment,” 

which generally requires a slightly higher level of presence and activity than the U.S. trade or 

business threshold. This is a standard source-country concession in income tax treaties 

worldwide, but some may question why the United States would make this concession in a case 

in which a special tax regime ensures that there is no risk of meaningful double taxation arising 

from the interaction of the two countries’ tax systems.15

To the extent that a special tax regime applies, the beneficiary of the regime enjoys tax 

benefits similar to those offered by tax havens. The same reasons that support the U.S. policy of 

not concluding comprehensive income tax treaties with tax havens arguably would support a 

similar policy of not extending the benefits of comprehensive income tax treaties to persons that 

enjoy tax-haven-type benefits under the laws of a treaty country.

 

14 As noted in part IV of this pamphlet, it is not the only way in which the proposed 

protocol curtails inappropriate treaty benefits. The modification of the public trading rule in the 

limitation-on benefits article is also an important measure in this regard, and that rule operates 

independently of the rule dealing specifically with special tax regimes.

15 In addition, even if the IBC’s business presence in the United States did rise to the 

level of a permanent establishment, thus allowing the United States to tax the profits attributable 

to the business, it appears that the IBC might be entitled to the benefits of Article 13A (Branch 

Tax) of the existing treaty. This would not affect the basic taxation of the business profits as 

they are earned, but it could allow a reduced rate of U.S. branch profits tax to apply when the 

profits are remitted back to the IBC, even though the branch profits tax is essentially a substitute 

for the dividend withholding tax that would apply if the business were conducted through a 

separate U.S. subsidiary.
24

On the other hand, the practical significance of not denying these other treaty benefits to 

beneficiaries of special tax regimes is not clear. At present, there is little reason to believe that 

this feature of the proposed protocol will leave open any important avenue of abuse, but some

may argue that it would have been best to foreclose this possibility entirely. It should be 

emphasized that the proposed protocol curtails the known inappropriate benefits that have been 

claimed under the existing treaty, through both the special tax regimes rule and the public 

company rule of the limitation-on-benefits article. As such, the proposed protocol should be 

viewed as a significant improvement by those concerned about these inappropriate benefits, even 

if some may argue that the proposed protocol is imperfect in minor respects.
25

C. Qualification of Dividends Received by U.S. Residents From

Barbados Corporations for Reduced U.S. Tax Rates

In the United States, under the Jobs and Growth Tax Relief Reconciliation Act of 2003 

(“JGTRRA”), dividends received by an individual shareholder from domestic corporations are 

generally taxed at the preferential rates that apply to certain capital gains. Dividends received 

from “qualified foreign corporations” are also eligible for this rate preference. The term

“qualified foreign corporation” includes a foreign corporation that is eligible for the benefits of a 

comprehensive income tax treaty with the United States which the Treasury Department 

determines to be satisfactory for purposes of the rate-preference provision, and which includes an 

exchange of information program.16 In legislative history to JGTRRA, the House and Senate 

conferees indicated that the existing treaty between the United States and Barbados was not 

satisfactory for this purpose: 

The conferees do not believe that the current income tax treaty between the 

United States and Barbados is satisfactory for this purpose because that treaty 

may operate to provide benefits that are intended for the purpose of mitigating or 

eliminating double taxation to corporations that are not at risk of double taxation. 

The conferees intend that, until the Treasury Department issues guidance 

regarding the determination of treaties as satisfactory for this purpose, a foreign 

corporation will be considered to be a qualified foreign corporation if it is eligible 

for the benefits of a comprehensive income tax treaty with the United States that 

includes an exchange of information program other than the current U.S.-

Barbados income tax treaty.17

Consistent with this legislative history, the Treasury Department announced in a notice 

that the existing treaty is not satisfactory for purposes of the rate-preference provision.18 In that 

same notice, the Treasury Department indicated that “the amendment or renegotiation of existing 

tax treaties” may be a factor in deciding whether to amend its list of qualifying treaties.19 The 

Committee may wish to ask the Treasury Department whether it intends to amend its list of 

qualifying treaties to include the U.S.-Barbados treaty, once the modifications made by the 

proposed protocol enter into force. In addition, if the Treasury Department does intend to add 

this treaty to the list of qualifying treaties, the Committee may wish to ask how companies that 

are eligible for the benefits of a special tax regime will be treated for these purposes, as such 

 

16 The term also effectively includes certain other corporations that are publicly traded in 

the United States. See Code sec. 1(h)(11)(C)(ii).

17 H.R. Conf. Rep. No. 108-126, 108th Cong., 1st Sess. 42 (2003).

18 Notice 2003-69, 2003-42 I.R.B. 851, Oct. 20, 2003.

19

 Id.
26

companies may be eligible for some, but not all, benefits of the treaty under the proposed 

protocol.20

 

20

 See part V.B of this pamphlet for a discussion of issues relating to the treatment of 

special tax regimes under the proposed protocol.