Daily Tax Update - February 17, 2016: Treasury Issues 2016 U.S. Model Income Tax Treaty

Treasury Issues 2016 U.S. Model Income Tax Treaty:  Today the Treasury Department issued a newly revised U.S. Model Income Tax Convention and accompanying preamble (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 2016 Model reflects comments that the Treasury Department received in response to the proposed model treaty provisions it released on May 20, 2015.  

While many of the updates reflect technical improvements rather than substantive changes to the prior model, the 2016 Model includes a number of new provisions intended to more effectively 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.  Among other things, the 2016 Model (i) does not reduce withholding taxes on payments of highly mobile income—such as royalties and interest—that are made to related persons that enjoy low or no taxation with respect to that income under a preferential tax regime; (ii) 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; and (iii) denies reduced withholding taxes on U.S. source payments made by companies that engage in inversions to related foreign persons. 

Final Rules Released on Broker Reporting Obligations:  Today the IRS and the Treasury Department released final regulations (TD 9750), relating to information reporting by brokers for transactions involving debt instruments and options, including the reporting of original issue discount (OID) on tax-exempt obligations, the treatment of certain holder elections for reporting a taxpayer’s adjusted basis in a debt instrument, and transfer reporting for section 1256 options and debt instruments.  The final regulations generally adopt the provisions of temporary regulations released on April 18, 2013 (T.D. 9616) and March 13, 2015 (T.D. 9713).  

Specifically, the final regulations provide that for a debt instrument acquired on or after January 1, 2015, brokers are required to assume that a customer has elected to determine accrued market discount using a constant yield method unless the customer notifies the broker otherwise.  A customer that does not want to use a constant yield method to determine accrued market discount must, by the end of the calendar year in which the customer acquired the debt instrument in an account with the broker, notify the broker in writing that the customer wants the broker to use the ratable method to determine accrued market discount.  Additionally, the final regulations permit, but do not require, a broker to apply the default constant yield method to a debt instrument acquired on or after January 1, 2014, and before January 1, 2015, provided the broker was not informed that the customer had made a section 1278(b) election and there were no principal payments on the debt instrument during the 2014 calendar year.    

The final regulations also require a transferring broker to provide a transfer statement upon the transfer of a section 1256 option that occurs on or after January 1, 2016 to ensure that the receiving broker has all of the information required for purposes of section 6045. Additionally, to coordinate the reporting of OID under section 6049 with the reporting of basis for tax-exempt obligations under section 6045, the final regulations provide that a payor must report under section 6049 the daily portions of OID on a tax-exempt obligation acquired on or after January 1, 2017, and must also report amortized acquisition premium (which offsets OID) on such tax-exempt obligation.  A broker may report either a gross amount for both OID and amortized acquisition premium, or a net amount of OID that reflects the offset of the OID by the amount of amortized acquisition premium allocable to the OID.    

Lastly, the final regulations provide that a debt instrument issued by a non-U.S. issuer or a tax-exempt obligation issued before January 1, 2014, is treated as a noncovered security (and, therefore, is not subject to basis reporting under section 6045) if the terms of the debt instrument are not reasonably available to the broker within 90 days of the date the debt instrument was acquired by the customer.  The Treasury Department and the IRS agreed with commenters that a broker may not always be able to obtain the information required to be reported for such debt instruments.    

Final and Temporary Regulations Released Regarding USRPIs:  The IRS and the Treasury Department released final and temporary regulations (TD 9751) relating to the taxation of, and withholding on, foreign persons upon certain dispositions of, and distributions with respect to, United States real property interests (USRPIs).  The regulations reflect changes made by the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act).    

Among other things, the PATH Act increased the rate of withholding of tax on dispositions of USRPIs from 10% to 15% by amending section 1445 of the Internal Revenue Code (the Code), with an exception in the case of a disposition of property that is acquired by the transferee for his or her use as a residence with respect to which the amount realized is greater than $300,000 but does not exceed $1 million.  The PATH Act also provided that the so-called “cleansing exception” will not apply to dispositions on or after December 18, 2015 if the corporation or its predecessor was a real estate investment trust (REIT) or a regulated investment company at any time during the shorter of the period that the shareholder held the interest or the five-year period ending on the date of the disposition of the shareholder’s interest in the corporation.  The regulations reflect these changes.    

The Treasury Department and the IRS request comments regarding what regulations, if any, should be issued pursuant to section 897(l)(3).  The PATH Act added section 897(l) to the Code, providing that section 897 does not apply to USRPIs held directly (or indirectly through one or more partnerships) by, or to distributions received from a REIT by, a qualified foreign pension fund or entity wholly owned by a qualified foreign pension fund.  Section 897(l)(3) provides that the Treasury Secretary‎ shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of section 897(l).   

Miscellaneous Guidance: Revenue Ruling 2016-07 provides various prescribed rates for federal income tax purposes including the applicable federal interest rates, the adjusted applicable federal interest rates, the adjusted federal long-term rate, and the adjusted federal long-term tax-exempt rate.