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The accelerating growth in global trade has occasioned the creation of new types of cooperative enterprises. For example, companies routinely form joint ventures or other partnership arrangements to engage in isolated projects or systematically to conduct business. Various forms of limited liability companies are also business and investment vehicles in the global arena. The application of treaties to these companies and vehicles gives rise to problems because tax treaties do not deal with attribution of income -- they only allocate items of income between the two treaty countries. To the extent a treaty allocates income to the residence country of the company or individual earning or receiving the income, the determination to whom this income is taxed (that is, which company or individual is considered to earn or receive the income), is made under the domestic law rules of each of the treaty states. If these rules differ in their application in a given case, conflicting attribution will result.

[3] These treaty application problems have always existed but have been exacerbated in recent years by the growth of elective entity classification in some countries. For example, under U.S. law an entity, whether foreign or domestic, in many cases is free to choose whether it will be treated as transparent or nontransparent for U.S. tax purposes. /1/ Consequently, an entity may be treated as transparent for U.S. tax purposes and as nontransparent for foreign tax purposes, or vice versa. Also, without such elective classification, inconsistencies result from different domestic entity classification rules. For purposes of discussion, an entity that is treated as transparent for tax purposes in one jurisdiction and as nontransparent in another is referred to as a "hybrid entity." /2/ When there is no classification conflict, a transparent entity may be referred to as a partnership for purposes of discussion.

[4] The problems resulting from a characterization difference between the two (and perhaps three) countries involved are threefold. In the first place, if the entity and the persons participating in the entity ("participants") are residents of different countries, it is possible that each of the two countries taxes the income to its resident(s), typically without any relief for the tax imposed by the other country (except perhaps to the extent it was sourced in the other country). Second, if the source country taxes the income to the participants, but the residence country of the entity and of the participants taxes the income to the entity (or vice versa), the individual income tax rate applied may be substantially higher than the corporate tax rate to which the entity is subject with respect to the income in its country of residence (again, or vice versa). Third, particularly if the residence country of the recipient of the income relieves double taxation through a foreign tax credit, if the source country taxes the entity for the income, and the residence country of the participants taxes these participants, the latter country may not grant double taxation relief because the foreign tax was not imposed on the participant but on the entity.

I. Article 4(1)(d) of 1996 U.S. Model and IRC Section

894(c) Regulations

[5] While the current OECD model tax treaty does not contain provisions to deal effectively with these issues, the 1996 U.S. model provides a solution, at least to the first of the issues mentioned above. This solution is provided through an addition to the OECD definition in article 4 of the term "resident." With respect to the residence of partnerships and partners, article 4(1)(d) of the 1996 U.S. model income tax treaty provides as follows:

An item of income, profit or gain derived through an entity that

is fiscally transparent under the laws of either Contracting

State shall be considered to be derived by a resident of a State

to the extent that the item is treated for purposes of the




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