United States International Tax Treaties: A Guide for Early Career Tax Professionals

With increasing international trade and financial activities, United States taxpayers face the risk of double taxation, where two or more countries tax the same income. To mitigate this risk and foster international economic collaboration, US tax treaties play a vital role. These agreements minimize tax barriers, clarify rules, and mitigate double taxation.

This article covers the fundamental principles behind US international tax treaties, how they mitigate double taxation, and when they apply. We will explore income versus estate/gift tax treaties, domestic versus international law, anti-abuse measures, and nonconforming US states. Finally, a case study and example will provide insight into how tax treaties work in practice.

WHAT IS A US TAX TREATY?
A US tax treaty is a formal agreement between the US government and another country aimed at reducing tax-related barriers to international business and investment. These treaties are designed to prevent double taxation by assigning taxing rights between the US and the treaty country. In essence, tax treaties dictate which country has the right to tax different types of income—such as dividends, interest, or wages—and under what circumstances.

In practice, US tax treaties provide benefits like allocation of primary taxing rights, reduced withholding rates, and residency rules.

For example, a Canadian resident earning under $10,000 in the US would report this for tax in both countries under domestic laws. However, Article XV of the US-Canadian Double Tax Treaty allocates primary taxing right on the earnings to Canada and states that the US will not tax the earnings provided all criteria of paragraph 2 are met (i.e., the earnings are less than $10,000 USD and the recipient of those earnings is present in the US for less than 183 days in the calendar year).

WHEN DO US TAX TREATIES APPLY?
United States tax treaties come into effect when a US taxpayer earns income that is subject to taxation under both US domestic laws and the laws of a foreign country where the income originates. Conversely, they may also apply when a non-US taxpayer receives income from a US source. To benefit from the provisions of a tax treaty, the taxpayer must generally qualify as a resident of one of the countries involved in the treaty.

DEFINING A TREATY RESIDENT
A treaty resident is an individual or entity (like a corporation) considered a resident of a country for the purpose of applying the benefits of a tax treaty between that country and the US. The criteria for determining residency vary by treaty, but generally, a treaty resident is someone who:

• Is taxed in their home country based on residence, domicile, or similar factors.
• Is not a resident of a third country for treaty purposes, preventing treaty shopping.

For individuals, this typically means they are taxed on worldwide income because they live or spend significant time in the treaty country. For corporations, tax residency often depends on incorporation or meeting specific domestic criteria.

TIE-BREAKER RULES
Tie-breaker rules in treaties resolve dual residency based on factors like permanent home, vital interests, habitual abode, and nationality generally applied in the order shown below:

1. Permanent home
2. Center of vital interests
3. Habitual abode
4. Nationality
5. Competent authority

These rules are typically found in the “Resident” article of US tax treaties, often Article 4.

NOT ALL COUNTRIES HAVE A US TAX TREATY
It is important to note that not all countries have a tax treaty with the United States. The US has many tax treaties in place with countries such as the United Kingdom (UK), Canada, Germany, and Japan. However, several major economies—like Brazil and Singapore—do not have tax treaties with the US. In these cases, taxpayers must rely on domestic tax laws and other mechanisms, such as foreign tax credits, to avoid double taxation.

Without a tax treaty, US taxpayers living or earning income in Brazil or Singapore could face higher taxes, as both US tax and local tax might be imposed on the same income without the relief mechanisms provided by tax treaties.

HOW US TAX TREATIES RELIEVE DOUBLE TAXATION
The primary goal of a tax treaty is to prevent double taxation, meaning the taxpayer must have income that could be taxed by both the US and the foreign country. United States tax treaties are reciprocal in nature with other taxing jurisdictions with which they have a double tax agreement (DTA) in effect. As a result of these reciprocal treaties, typically, the following mechanisms are available as double tax relief:

• Foreign Tax Credit (FTC): A US taxpayer can claim a credit on his or her US tax return for taxes paid or accrued to a foreign country, reducing his or her US tax liability on the same income. Equally, a foreign country may offer foreign tax credits to allow relief on double taxed income according to a double tax treaty.
• Tax Exemptions or Reductions: Tax treaties can reduce or exempt taxes on certain income types. For example, while fixed, determinable, annual, or periodical (FDAP) income is typically subject to 30 percent withholding in the US, a treaty may allow a lower rate. Under the US-UK Tax Treaty, the withholding on dividends can be reduced from 30 percent to 15 percent if the conditions of Article 10 are met.
• Permanent Establishment (PE) Rules: Many treaties contain permanent establishment rules that determine when a business’s income is subject to tax in another country. A US business operating overseas may not be taxed by the foreign country unless it has a PE there, such as an office or a significant local presence.

COURT CASE: A BELGIUM NATIONAL WORKING IN THE UNITED STATES
Langroudi, Mehrdad Hamzeye v. Commissioner. T.C. Summ. Op. 2007-156

To better understand tax treaty applications, we examine a court case involving the misapplication of the US-Belgium Double Tax Treaty. The petitioner, a Belgian citizen, filed Form 1040NR for tax years 2002 and 2003, claiming that his income from medical residencies was exempt from US federal income tax under Article 20 of the treaty, which addresses income earned from teaching or research activities.

However, both the Internal Revenue Service (IRS) and the US Tax Court disagreed. The IRS asserted that Article 21 of the treaty applied instead, which limits the exemption to $2,000 of income. At trial, Dr. Ketan Shevde, chairman of anaesthesia at Maimonides Medical Center, testified that the petitioner’s role was for anaesthesiology training, not for teaching or research. Dr. Shevde emphasized that the primary focus was on training to become an anaesthesiologist, with only minor involvement in teaching or research.

The petitioner also listed his job title as “anaesthesia trainee” on his tax returns, supporting that his role did not meet the teaching or research requirements of Article 20. The court agreed with the IRS’s position, ruling that Article 20 did not apply, and the petitioner’s residency income was subject to federal tax, with Article 21 limiting the exemption to $2,000. This led to penalties and interest imposed on the petitioner.

INCOME TAX TREATIES VS. ESTATE AND GIFT TAX TREATIES
While income tax treaties are the most common type of agreement, the US also has specific treaties governing estate and gift taxes which may be an article for another issue. These treaties are designed to prevent double taxation on cross-border transfers of wealth, such as inheritances or large gifts.

THE RELATIONSHIP BETWEEN DOMESTIC LAW AND INTERNATIONAL TAX TREATIES
One of the more challenging aspects of international taxation is the interaction between domestic law and international tax treaties. Generally, a treaty cannot be inconsistent with the US Constitution and where an international tax treaty conflicts with US law it may be down to the courts to decide the prevailing tax law to be applied.

HOW DOMESTIC AND INTERNATIONAL LAW INTERACT
When it comes to taxes, US domestic laws and international tax treaties interact in a few key ways. Here is a quick overview of the most important points:

• Tax Treaty Supremacy: Ratified tax treaties are on equal footing with US tax laws. If the Internal Revenue Code (IRC) conflicts with a treaty, then the courts apply the last-in-time rule allowing the most recent law passed to prevail.
• Last-in-Time Rule: If a new law conflicts with an existing treaty, the newer law takes precedence unless Congress states otherwise.ⁱ
• Self-Executing Treaties: Some treaties automatically become law when ratified, while others need additional legislation to take effect.

Understanding these basics helps tax professionals navigate international tax obligations with confidence.

ANTI-AVOIDANCE RULES: TREATY SHOPPING AND ANTI-ABUSE PROVISIONS
While tax treaties offer valuable benefits, they can be misused through strategies like treaty shopping, where favorable terms are exploited using a third country’s treaty. To prevent this, the US includes anti-abuse measures such as:

• Specific anti-avoidance rules (SAAR) targeting treaty loopholes.
• General anti-avoidance rules (GAAR), which invalidate transactions aimed at tax avoidance.
• Limitation on benefits (LOB) clauses, ensuring only residents of treaty partner countries benefit.

These measures protect the integrity of tax treaties and ensure legitimate taxpayers’ benefit.

THE SAVINGS CLAUSE IN US TAX TREATIES
One of the most unique features of US tax treaties is the savings clause. This clause allows the US to tax its citizens, lawful permanent residents (green card holders), and tax residents, as if the treaty did not exist.

Essentially, the savings clause preserves the US government’s right to tax its citizens and lawful permanent residents on their worldwide income, even if they live abroad.

The savings clause reflects the US’s broad approach to taxing its citizens and lawful permanent residents, a concept that often surprises those unfamiliar with US international tax rules.

HOW THE FOREIGN AND US TAX RETURN INTERACT
When handling clients with international income, US tax professionals may want to coordinate with their client’s foreign tax professionals and obtain the foreign tax return, if available, when preparing their US clients’ tax return. Here is why:

• Foreign Tax Credit: Some countries operate a pay-as-you-earn (PAYE) system or withholding that means no foreign tax return is required. However, foreign tax withholding does not always equal the final tax liability, and a foreign tax return may be needed to ascertain the ultimate tax liability. Where credit is given on the US tax return for foreign taxes suffered, any amount of foreign tax refunded cannot be included when computing the foreign tax credit.
• Avoiding Double Taxation: Obtaining a foreign tax return could help clarify whether income is taxed overseas and ensures the correct US double tax treaty provisions apply.
• Compliance: Proper coordination between US and foreign tax filings ensures compliance with both countries’ tax laws, minimizing
  potential penalties or errors.

Challenges may arise if the foreign country’s tax year does not align with the US calendar year, as seen in the UK, Australia, or India.

CHALLENGES POSED BY NONCONFORMING US STATES
While US tax treaties apply at the federal level, individual US states are not bound by these treaties. This creates potential complications for international taxpayers, as some states do not conform to the provisions of US tax treaties.

Nonconforming states such as California, Pennsylvania, and New Jersey, may not honor federal treaty provisions. As a result, taxpayers could still face state taxes on income that is relieved from federal taxation under a double tax treaty.

Tax professionals must be aware of these state-specific rules and understand how they may differ from federal treaty provisions.

CONCLUSION
United States international tax treaties play a pivotal role in global tax planning by preventing double taxation and providing clarity on cross-border financial transactions. However, the complexity of these treaties—especially their interaction with domestic law, the savings clause, anti-abuse provisions, and nonconforming US states—requires a deep understanding to ensure compliance and optimize tax benefits.

Early career tax professionals must familiarize themselves with these essential tools to effectively navigate the intricacies of international tax. By mastering the principles and applications of US tax treaties, professionals can help their clients avoid double taxation, comply with international tax laws, and take full advantage of the protections and benefits that tax treaties offer.