US RIC’s - Tax treaty benefits

The Norwegian Tax Appeal Board issued a decision 4 November 2020 (published 19 April 2021) in which tax treaty benefits for US Regulated Investment Companies (“RIC”) were discussed. 

In contrast to previous practice the Tax Appeal Board found that RICs in principle were entitled to treaty benefits. However, the RIC in question failed to pass the Limitation of Benefit clause (LOB) in the tax treaty and was not granted a reduced withholding tax rate.

The decision could be of great interest to RICs investing in Norway.

RICs 

A RIC is a US investment vehicle subject to special regulation and favourable taxation in the US. A RIC must derive a minimum of 90% of its income from capital gains, interest or dividends earned on investments. In addition the RIC must distribute a minimum of 90% of its net investment income to its shareholders in order to avoid taxation of its so-called Investment Company Taxable Income (“ICTI”). 

Withholding tax on dividends in the Norway/US tax treaty 

The general requirements for applying the reduced withholding tax rate in the tax treaty is that: 

• The RIC is tax resident in the US
• The RIC is the beneficial owner of the dividend;

In addition the RIC must pass the LOB clause. This require that:  

• The tax imposed on the RIC with respect to the dividend is not substantially less than the tax generally imposed on corporate income, and;
• More than 75% of the capital of the RIC is owned directly or indirectly by individual residents of the US

The Tax Appeal Board decision

In the specific case, a US RIC had received a dividend distribution from a Norwegian limited company and claimed the reduced withholding tax rate of 15%. The Central Tax Office for Foreign Affairs denied such reduction, as a RIC in their opinion was not eligible for tax treaty protection according to administrative practise, which in particular was based on a statement from the Ministry of Finance dated 9 May 2008. 

The RIC had provided a confirmation of residence stating that it was tax resident in the US (Form 6166) This had been accepted by the Central Tax Office and is also in line with the statement from the Ministry of Finance. 

The main issue was whether the RIC was the beneficial owner of the dividend.  

Is a RIC the beneficial owner of the dividend?

In the statement from the Ministry of Finance it was stated that where a dividend recipient redistributes the dividend directly without being taxed, the recipient will not be regarded as the beneficial owner of such dividend. Under reference to this a RIC that fulfills the requirements for tax exemption according to US domestic law, will not be regarded as the beneficial owner of the dividend. As the RIC was not taxed for its ICTI, the Ministry of Finance stated that RICs should be regarded as a conduit company. 

The Appeal Board however was of the opinion that this reason for not regarding a RIC as beneficial owner could no longer be valid as a result of the new comment in section 12.4 in the OECD commentary article 10 (article 8 in the Norway/US treaty). The commentary accepts that  entities such as pension funds and other Collective Investment Vehicles can have discretionary power over its income, even if such entities could have a general duty to distribute its income to the owners. The taxation of the RIC as described and the requirement to pass on at least 90%  of the ICTI to obtain the tax benefit, would therefore not result in it being regarded as a conduit company. Based on this, the Appeal Board concluded that the RIC fulfils the requirement for being regarded as the beneficial owner of the dividend. 

LOB issue 1 - Is the tax imposed on the RIC with respect to the dividend substantially less than the tax generally imposed on corporate income?

As the RIC can distribute at least 90% of its ICTI and therefore either be exempt from federal corporate income tax or only taxable for the part of the ICTI not distributed, the Appeal Board concluded that the tax the company pays is substantially less than tax generally imposed on corporate income. 

LOB issue 2 - Is more than 75% of the capital of the RIC owned directly or indirectly by individual residents of the US?

The RIC argued that it, according to practical or legal restrictions, was not able to document the share of capital owned by individuals tax resident in the US and that the competent authorities must decide whether the ownership requirement is fulfilled or not. If the ownership share is not decided by the competent authorities the LOB clause in article 20 will not apply. 

The Appeal Board stated that in situations where the competent authorities had not decided on the ownership requirement it was up to the RIC to provide documentation for the distribution of ownership stakes, and document that at least 75% of the capital of the RIC were owned directly or indirectly by individual residents of the US. 

The Appeal Board referred to the overview provided by the RIC, and stated that the ownership part owned by corporate persons tax resident in the US which the RIC considered as beneficial owners, is too big for the RIC to fulfil the ownership requirement. 

The Appeal board therefore concluded that the LOB clause in article 20 applied, and the RIC was not eligible for a reduced withholding tax rate. 

Summing up

The decision softens the restrictive practice applied so far by the Norwegian tax authorities and opens up for treaty protection / reduced withholding tax for RICs that can document that at least 75% of its direct or indirect owners are US tax resident individuals.