February 17, 2016

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PREAMBLE TO 2016 U.S. MODEL INCOME TAX CONVENTION

On February 17, 2016, the Treasury Department released a revised 2016 U.S. Model Income Tax 

Convention (the 2016 Model), which is the baseline text the Treasury Department uses when it 

negotiates tax treaties. The U.S. Model Income Tax Convention was last updated in 2006 (the 

2006 Model). This preamble highlights the significant features of the 2016 Model.

Many of the 2016 Model updates reflect technical improvements developed in the context of 

bilateral tax treaty negotiations and do not represent substantive changes to the 2006 Model. The 

2016 Model also includes a number of new provisions intended to more clearly implement the 

Treasury Department’s longstanding policy that tax treaties should eliminate double taxation 

without creating opportunities for non-taxation or reduced taxation through tax evasion or 

avoidance. For example, to protect against treaty abuse, the 2016 Model contains rules that 

would deny treaty benefits on deductible payments of highly mobile income that are made to 

related persons that enjoy low or no taxation with respect to that income under a preferential tax 

regime. In addition, new Article 28 (Subsequent Changes in Law) obligates the treaty partners to 

consult with a view to amending the treaty as necessary when changes in the domestic law of a 

treaty partner draw into question the treaty’s original balance of negotiated benefits and the need 

for the treaty to reduce double taxation. The 2016 Model also includes provisions to reduce the 

tax benefits of corporate inversions by denying reduced withholding taxes on U.S. source 

payments made by expatriated entities to related foreign persons. 

In addition to these new provisions, the 2016 Model includes a number of technical 

improvements and certain policy changes to longstanding Article 22 (Limitation on Benefits), 

which is intended to prevent so-called “treaty shopping” by third-country residents that are not 

intended beneficiaries of the treaty. The 2016 Model also includes a rule (located in new 

paragraph 8 of Article 1 (General Scope)) that is a revised version of the so-called “triangular 

permanent establishment” rule that has been included in some of the United States’ income 

treaties since the 1990s. The new version of the rule addresses income treated by a residence 

country as attributable to a permanent establishment and subject to little or no tax, as well as 

income that is excluded from the tax base of the residence country and attributable to a 

permanent establishment located in a third country that does not have a tax treaty with the source 

country. 

Draft versions of these new model treaty provisions, as well as proposed changes to Article 22

(Limitation on Benefits), were released on May 20, 2015 (the May 2015 draft) for public 

comment. The Treasury Department carefully considered all the comments it received and made 

a number of significant modifications to the proposed model treaty provisions in response to 

those comments. This preamble discusses the most significant changes made in response to 

comments.

The 2016 Model also contains rules to make more efficient and effective dispute resolution 

mechanisms between tax authorities through the use of mandatory binding arbitration. 
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Special Tax Regimes

The Treasury Department received several comments on the proposed rules contained in the May 

2015 draft that would deny reductions to withholding taxes under the treaty for deductible

related-party payments when the beneficial owner of the payment pays little or no tax on the 

related income as a result of a “special tax regime” (STR). 

Purpose of the STR provisions

Some countries have implemented preferential regimes to attract highly mobile income—income 

that taxpayers can easily shift around the globe through deductible payments such as royalties

and interest expense—by allowing resident companies to pay no or very little tax on that income. 

Consistent with the G20-OECD Base Erosion and Profit Shifting (BEPS) initiative, the STR 

provisions are intended to mitigate instances of double non-taxation whereby a taxpayer uses 

provisions in the tax treaty, combined with special tax regimes, to pay no or very low tax in 

either treaty country. However, the new provisions also reflect the United States’ preference for 

addressing BEPS concerns through changes to objective rules that apply on a prospective basis, 

rather than introducing subjective standards that could call into question agreed treaty benefits or 

applying wholly new concepts to prior years.

It is inappropriate for tax treaties to reduce U.S. statutory withholding rates on deductible U.S. 

source payments when the related income is subject to no or very little tax. The current ability of 

foreign-parented companies to engage in these types of transactions creates strong incentives to 

erode the U.S. tax base and gives foreign-parented companies an advantage over U.S.-parented 

companies, which cannot use these regimes to avoid paying tax on their U.S. income. To 

address this unintended result, the 2016 Model would deny treaty benefits for payments of 

interest, royalties, and certain guarantee fees between related parties if the beneficial owner of 

the payment benefits from a special tax regime with respect to the payment. 

Changes to the STR provisions in response to comments 

Comments on the May 2015 draft expressed concern that the proposed definition of STR was too

broad and would result in uncertainty as to when treaty benefits would be denied. Comments 

also requested that tax administrators be required to provide a public notification before the 

provisions would apply to a particular STR in order to assist taxpayers in applying the treaty.

In response to these comments, the STR provisions have been significantly revised to both limit 

and clarify their application: 

• The scope of when the STR provisions can apply has been narrowed to cases when the 

resident benefits from an STR with respect to a particular related-party interest payment,

royalty payment, or guarantee fee that is within the scope of Article 21 (Other Income).

• In contrast to the May 2015 draft, the definition of STR has been tightened to provide an

exclusive list of the circumstances in which a statute, regulation, or administrative 

practice will be treated as an STR. To qualify as an STR, the regime must provide 
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preferential treatment to interest, royalties, or guarantee fees as compared to income from 

sales of goods or services. Such preferential treatment must be in the form of either a 

preferential rate for such income, a permanent reduction in the tax base with respect to 

such income (as compared to preferences that merely defer the taxation of income for a 

reasonable period of time), or a preferential regime for companies that do not engage in

an active business in the residence state.

• Regimes that provide “notional interest deductions” (NIDs) with respect to equity are no 

longer treated as STRs. Instead, Article 11 (Interest) includes a new rule that would 

allow a treaty partner to tax interest arising in that country in accordance with domestic 

law if the interest is beneficially owned by a related person that benefits from a NID. 

This change represents a more focused approach to addressing the policy concern that

interest income that benefits from a NID is often subject to no or very little tax because

(i) a NID, in effect, allows for a deduction on equity with respect to the time value of 

money, which is a very significant component of interest income, and (ii) in the relatedparty context, the holder of the equity often benefits from a participation exemption with 

respect to any returns on that equity. 

• The 2016 Model requires a country invoking the STR provisions to, after consultation 

with the other country, notify the other country of its intention through a diplomatic note 

and issue a written public notification. 

• In response to comments on how to determine when a payee that benefits from an STR is

“related to the payor” of an item of income, the 2016 Model provides that the STR 

provisions will only apply when the payee is a “connected person” with respect to the 

payor of the income and provides a definition of that term.

• The exceptions from the STR provisions for collective investment vehicles such as U.S. 

regulated investment companies and U.S. real estate investment trusts that are designed to 

achieve a single level of current tax (at either the entity level or the shareholder level) 

have been clarified.

• The 2016 Model provides an exception for preferential regimes that are generally 

expected to result in a rate of taxation that is at least 15 percent, or 60 percent of the 

general statutory rate of company tax in the source country, whichever is lower. In order 

to provide additional clarity, the 2016 Model provides language that would be included in 

an instrument reflecting an agreed interpretation between the two treaty countries. Such 

instrument would provide that the rate of taxation generally would be calculated based on 

the income tax principles of the country that has implemented the regime in question. 

Payments by Expatriated Entities

The 2016 Model contains provisions that would reduce the benefits of corporate inversions by 

denying treaty benefits for U.S. withholding taxes on U.S. source dividends, interest, royalties, 

and certain guarantee fees paid by U.S. companies that are “expatriated entities,” as defined 

under the Internal Revenue Code. 
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In response to comments, the Treasury Department has made several revisions to the version of 

these provisions included in the May 2015 draft. First, the 2016 Model provisions will apply

only when the beneficial owner of a dividend, interest payment, royalty, or guarantee fee

characterized as other income is a connected person with respect to the expatriated entity. 

Second, to provide certainty about the scope of the rule notwithstanding any future changes to 

U.S. law, the 2016 Model fixes the definition of “expatriated entity” to the meaning it has under 

Internal Revenue Code section 7874(a)(2)(A) as of the date the bilateral tax treaty is signed. 

Third, the 2016 Model provides that, under certain circumstances, preexisting U.S. subsidiaries

of the foreign acquirer would not be considered expatriated entities for purposes of the treaty.

Revised Limitation on Benefits (LOB) Article

The May 2015 draft included a number of proposed changes to Article 22 (Limitation on 

Benefits). The 2016 Model contains significant revisions in response to comments received on

those proposals. 

A fundamental pillar of U.S. tax treaty policy for over two decades has been to include objective 

LOB rules to prevent a practice known as “treaty shopping,” in which an investor from a third 

country routes investment into the United States through a company resident in a treaty partner

that does not have sufficient nexus to that country with respect to the treaty-benefitted income. 

While protecting the U.S. tax treaty network from abuse is the overarching objective of Article 

22, the Treasury Department also recognizes that multinationals often have operations dispersed 

through many subsidiaries around the globe. Accordingly, the May 2015 draft proposed to 

include for the first time in a U.S. model a “derivative benefits” test as an additional method for 

satisfying LOB. As described below, the 2016 Model retains a modified version of this test that 

was developed in response to comments and adds a second new test, a “headquarters company”

test. In addition, a number of the preexisting LOB tests have been tightened to prevent abuse by 

third-country residents.

Active-trade-or-business test

The May 2015 draft proposed a new limitation on the ability of connected companies to 

aggregate their activities for purposes of satisfying the LOB test that grants benefits with respect 

to income that is derived by a company in connection with the active conduct of a trade or 

business in its country of residence (the active-trade-or-business test). The change would, for 

example, have prevented a holding company from relying on the activities of connected active 

companies in the same country to satisfy the active-trade-or-business test. 

The change to the active-trade-or-business test in the May 2015 draft was motivated by a 

concern that the existing active-trade-or-business test can, in certain circumstances, allow thirdcountry residents to treaty shop through an entity that has an active trade or business in a treaty 

partner with respect to income, in particular intra-group dividends and interest, that does not in 

fact have a nexus to the activities in the treaty partner. After further consideration, the Treasury 

Department has determined that the treaty-shopping concern is not driven by the division of 

activities among connected persons. Rather, the concern arises from the standard applied to 
February 17, 2016

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determine whether income is “derived in connection with” an active trade or business in the 

residence country, which was not addressed in the May 2015 draft. To more directly address this 

concern, the active-trade-or-business test of the 2016 Model has been changed to require a 

factual connection between an active trade or business in the residence country and the item of 

income for which benefits are sought. Specifically, the 2016 Model requires that the treatybenefitted income “emanates from, or is incidental to,” a trade or business that is actively 

conducted by the resident in the residence state. With this change, the 2016 Model also restores 

the provision that allows activities to be attributed from connected persons.

The technical explanation of the 2016 Model, which the Treasury Department plans to release 

this spring, will provide guidance on when an item of income, in particular an intra-group 

dividend or interest payment, is considered to emanate from the active conduct of a trade or 

business of a resident. This guidance is expected to differ from the 2006 Model technical 

explanation of the meaning of the term “derived in connection with.” An example that the 

Treasury Department is considering including in the technical explanation is dividends and 

interest paid by a commodity-supplying subsidiary that was acquired by a company whose 

business in the residence state depends on a reliable source for the commodity supplied by the 

subsidiary. Under this example, such dividends and interest would be considered to emanate 

from the active trade or business of the parent. Another possible example could involve 

dividends and interest paid by a subsidiary that distributes products that were manufactured by 

the parent company in its state of residence. In contrast, the mere fact that two companies are in 

similar lines of businesses would not be sufficient to establish that dividends or interest paid 

between them are related to the active conduct of a trade or business. 

The Treasury Department invites comments with additional examples for potential inclusion in 

the technical explanation that would illustrate dividend or interest income that should be 

considered to emanate from an active trade or business in the residence state. Comments should 

take into account the extent to which suggested interpretations could facilitate treaty shopping by 

third-country residents with large global operations, and the extent to which the new derivative 

benefits and headquarters company tests—including the treatment of a headquarters company as 

a potential equivalent beneficiary with respect to intra-group dividends and interest income for 

purposes of the derivative benefits test—provide the more appropriate LOB tests for dividends 

and interest income and supplant any role for the active-trade-or-business test with respect to 

such income. The deadline for public comments is April 18, 2016. 

Derivative benefits

The 2016 Model allows companies to qualify for treaty benefits under a “derivative benefits” 

test, which is based on a broader concept of the longstanding “ownership-and-base erosion” test 

(contained in paragraph 2(f) of Article 22 of the 2016 Model). While a form of derivative 

benefits is included in most existing U.S. tax treaties with countries in the European Union, those 

treaties limit third-country ownership to seven or fewer “equivalent beneficiaries,” which 

generally must be resident in a member country of the European Union or North American Free 

Trade Area trading blocs. In contrast, the derivative benefits rule in the 2016 Model contains no 

such geographic restriction, instead requiring only that 95 percent of the tested company’s shares 

be owned, directly or indirectly, by seven or fewer persons that are equivalent beneficiaries. 
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Additionally, in response to comments received on the May 2015 draft, the 2016 Model allows 

certain categories of qualified persons in the state of source to be treated as equivalent 

beneficiaries, provided that such persons in the aggregate do not own more than 25percent of the 

tested company. However, in contrast to the derivative benefits provisions in existing U.S. tax 

treaties, the 2016 Model would restrict intermediate ownership to companies resident in the same 

state as the company seeking benefits or in a country that has a comprehensive income tax treaty 

in force with the country of source that contains rules addressing STRs and NIDs that are 

analogous to the rules in the 2016 Model. 

Under all derivative benefits provisions in existing U.S. tax treaties, in order to qualify as an 

equivalent beneficiary with respect to income referred to in Article 10 (Dividends), 11 (Interest), 

or 12 (Royalties), a third-country resident must be entitled, either under a comprehensive 

convention for the avoidance of double taxation between its country of residence and the source 

country or otherwise, to a rate of tax with respect to the particular category of income that is less 

than or equal to the rate applicable under the tax treaty pursuant to which benefits are being 

claimed. Companies that fail to satisfy this rate comparison test are not entitled to treaty 

benefits, and therefore are generally subject to 30-percent gross basis withholding tax on U.S. 

source payments of dividends, interest (other than interest of a portfolio nature), and royalties. 

The Treasury Department received comments requesting the elimination of this so-called “cliff 

effect.” In response to these comments, the 2016 Model would remove the cliff effect in these 

cases, and instead entitle a resident of the treaty partner to the highest rate of withholding to 

which its third-country resident owners would be entitled.

In crafting the LOB article in the 2016 Model, the Treasury Department revised the various tests 

to provide an appropriate scope of benefits. In particular, the May 2015 draft stated in a footnote 

that the Treasury Department believed that the new derivative benefits test was a more 

appropriate test than the active-trade-or-business test for holding companies. However, under 

existing treaties that include a derivative benefits test, subsidiaries of private companies are

unable to qualify for benefits with respect to dividends under the derivative benefits test because 

individual shareholders are only entitled to a 15-percent rate on dividends, and therefore the cliff 

effect described above would preclude any reduction in dividend withholding. The 2016 Model 

goes beyond solving this cliff effect by allowing certain companies relying on derivative benefits 

to qualify for the five-percent rate of withholding on dividends even if the company’s 

shareholders are individuals who would not be entitled to the five-percent rate. To achieve this,

the definition of equivalent beneficiary in the 2016 Model has been modified to allow individual 

shareholders to be treated as companies for purposes of the rate comparison test with respect to 

dividends, provided that the company seeking to qualify under derivative benefits has sufficient 

substance in its residence country to indicate that the individual shareholders are not simply 

routing income through a corporate entity in order to benefit from the lower company rate. 

Headquarters companies

Comments to the May 2015 draft requested that the LOB article include a rule that would entitle 

companies that serve as the active headquarters company of a multinational corporate group 

(“headquarters companies”) to treaty benefits. In response, the 2016 Model LOB includes a 

headquarters-company rule that is based on analogous tests found in some existing U.S. tax 
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treaties, but with important modifications. Most significantly, the 2016 Model requires a 

headquarters company to exercise primary management and control functions (and not just 

supervision and administration) in its residence country with respect to itself and its 

geographically diverse subsidiaries. The headquarters company rule in the 2016 Model also 

differs from existing headquarters company rules by including a base erosion test. Furthermore, 

a headquarters company is only entitled to benefits with respect to dividends and interest paid by 

members of its multinational corporate group; in the case of interest, this benefit is limited to a 

10-percent cap on withholding in the source state, which is consistent with the general rate of 

withholding on interest that is permitted under the OECD’s Model Income Tax Convention.

The new headquarters company test is analogous to the active-trade-or-business test in 

paragraph 3 of Article 22, which (as described above) generally entitles a company to treaty 

benefits without regard to the residence of its owners when the company derives income from 

the source state that emanates from, or is incidental to, such company’s trade or business in the 

residence country. The Treasury Department concluded that locating the strategic, financial, and 

operational policy decision-making for a multinational corporate group in a country establishes 

sufficient nexus to that country with respect to interest and dividends paid by members of the 

multinational corporate group for the company to be entitled to treaty benefits, as well as 

equivalent-beneficiary status for purposes of the derivative benefits test with respect to such 

dividend and interest income. The Treasury Department continues to believe that the activetrade-or-business test in paragraph 3 of Article 22 is the more appropriate test for other types of 

benefits provided under a treaty.

Rules for intermediate ownership

Comments requested that the rules for intermediate ownership contained in the various 

ownership-based LOB tests in the May 2015 draft be relaxed. In response to these comments,

the intermediate ownership rules in the LOB test for subsidiaries of publicly-traded companies

(paragraph 2(d) of Article 22) and the general ownership-base erosion test (paragraph 2(f) of 

Article 22) in the 2016 Model LOB have been revised to permit as an intermediate owner any 

company that is a resident of a country that has in effect a comprehensive tax treaty that contains 

rules addressing special tax regimes and notional interest deductions. 

Mandatory Binding Arbitration to Facilitate the Resolution of Disputes Between the Tax 

Authorities

The Treasury Department is a strong proponent of developing ways to facilitate the resolution of 

disputes with treaty partners regarding the application of tax treaties. In this regard, Article 25 

(Mutual Agreement Procedure) of the 2016 Model contains rules requiring that certain disputes 

between tax authorities be resolved through mandatory binding arbitration. The “last-best offer” 

arbitration approach in the 2016 Model is substantively the same as the arbitration provision that 

is found in four U.S. tax treaties in force and three additional U.S. tax treaties that are awaiting 

the advice and consent of the Senate.
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New Article 28 (Subsequent Changes in Law)

Article 28 (Subsequent Changes in Law) has been added to the 2016 Model to address situations

in which, after a treaty is signed, one of the treaty partners changes its overall corporate tax 

system to no longer impose significant tax on cross-border income of resident companies. Such 

a fundamental change could call into question the original balance of negotiated benefits and the 

extent to which the tax treaty is needed to eliminate double taxation. The Treasury Department 

has made a number of changes to the version of Article 28 contained in the May 2015 draft in 

response to comments.

Comments raised questions regarding the application of Article 28 with respect to changes in the 

laws of a country governing the taxation of individuals. In response to these comments, the 

scope of Article 28 in the 2016 Model has been narrowed to address only changes in the laws 

governing the taxation of companies. To address concerns regarding individuals, the 2016 

Model contains discrete rules in other articles that address the availability of tax treaty benefits 

for individuals who are taxed on a remittance, fixed fee, “forfeit,” or similar basis. 

When implicated, Article 28 requires the treaty partners to consult to determine if amendments to 

the treaty are necessary to restore an appropriate allocation of taxing rights between the two 

countries, consistent with the purpose of the treaty to eliminate double taxation without creating 

opportunities for non-taxation. In contrast to the May 2015 draft, the 2016 Model explicitly 

provides that it is only after such consultations fail to progress that a treaty partner may issue a 

diplomatic note stating that it will cease to grant certain benefits under the treaty for payments to 

companies. The May 2015 draft provided that Article 28 would be triggered if the general rate of 

company tax fell below 15 percent. The Treasury Department did not intend for the use of a 

fixed rate to imply support for a floor on appropriate corporate tax rates, but rather only intended 

for the rate test to serve as a signal for when the original balance of negotiated benefits between 

the two countries had been significantly altered. However, if both the United States and its treaty 

partner substantially reduce their general rates of company tax, the fact that one country’s 

general rate falls below 15 percent may not be indicative of a shifting of the balance of benefits 

under the treaty. In order to better effectuate the policy underlying Article 28, the 2016 Model 

provides that Article 28 is triggered if a treaty partner’s general rate of company tax falls below 

the lesser of either 15 percent, or 60 percent of the other country’s general statutory rate of 

company tax. 

Incorporation of Select Other Measures Developed by the OECD-G20 BEPS Initiative

A number of the key recommendations regarding bilateral income tax treaties from the OECDG20 BEPS initiative have been fundamental parts of U.S. tax treaty policy for many years. For 

example, U.S. tax treaties have since the 1990s contained robust LOB provisions and rules that 

determine when treaty benefits should be available for payments through fiscally transparent 

entities. The 2016 Model incorporates certain other BEPS recommendations for the first time:

• A revised preamble for tax treaties that makes clear the intentions of the treaty partners 

that the purpose of a tax treaty is the elimination of double taxation with respect to taxes 
February 17, 2016

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on income without creating opportunities for non-taxation or reduced taxation through 

tax evasion or avoidance.

• A rule intended to protect against contract-splitting abuses of the twelve-month 

permanent establishment threshold for building sites or construction or installation 

projects.

• A twelve-month ownership requirement for the five-percent withholding rate for direct 

dividends, with refinements in the 2016 Model to impose a twelve-month residence 

requirement to prevent companies from circumventing the ownership period as well as to 

allow the payee company to take into account certain prior ownership.

The 2016 Model has not adopted the other BEPS recommendations regarding the permanent 

establishment threshold, notably the revised rules related to dependent and independent agents 

and the exemption for preparatory and auxiliary activities. It is important to ensure that the 

implications from any modifications to these treaty provisions are commonly understood and 

consistently administered by treaty partners. Accordingly, the Treasury Department is working 

with OECD and G20 member countries to create a common global understanding regarding 

profit attribution that will address the concerns raised by these BEPS permanent establishment 

recommendations. Furthermore, the Treasury Department is interested in developing ways to 

mitigate the compliance burdens on businesses and tax administrations that the new permanent 

establishment rules could create.