Yolande Bannister looks at the advantages of tax treaties, in particular the Barbados/US tax treaty.

The traditional purpose of a tax treaty is to ensure that a taxpayer is not taxed twice on the same income flows, and to determine an equitable split of the tax revenue derived between the participating countries, given situations where an investor in one country of residence conducts business through a permanent establishment in another country which acts as the host of the business enterprise.

Typically, important provisions in the tax treaty would deal with:

  • what taxes are covered;

  • how residence is determined for the purposes of tax and what the tie-breaking rules are;

  • how `permanent establishment' is defined in order to determine the right to tax. As a practical example of this, in a capital gains situation, Barbados would attempt to ensure that the entity which would be liable to a capital gains tax - for example, on the sale of shares - is resident in Barbados for the purposes of the tax treaty and liable to tax there. Barbados has no capital gains tax, which means that the entity, having been subject to tax in Barbados at a zero rate, would not be subject to a further tax in the country of origin;

  • the levels of withholding taxes on specified investment income;

  • whether the treaty allows third parties to benefit from the provisions to the treaty (i.e. treaty shopping); and

  • whether the treaty has tax sparing provisions.

    Barbados/US tax treaty

    There are certain implications for international business arising from the Barbados/US tax treaty.

    1. Limitation of Benefits Article

    Introduced by the Protocol, this Article contains some provisions valuable to the financial services sector, provided an active business is conducted. Banking and insurance are considered to be active businesses. The Article provides four alternative tests which allow a resident to benefit from the treaty:

  • the active business test. The active trade or business test affords treaty benefits to the residents of one treaty country that earn income in the other, if the resident carries on an active trade or business in its home country that is related to and substantial in relation to the income-producing activity in the other country. Excluded are the businesses of making or managing investments unless these activities are banking or insurance activities carried on by a bank or insurance company;

  • the shareholder test. Under the shareholder test, a company will qualify if more than 50% of its shares are held by persons entitled to benefits under the Convention who are US citizens, and at least 50% of the gross income is used to meet liabilities of persons entitled to the benefits of the Convention;

  • the listed stock test. To qualify under the listed stock test, the company's principal class of shares should be listed on a recognised stock exchange; and

  • the non-profit organisation test. A non-profit organisation may benefit if it is exempt from taxation in its state of residence once more than half its beneficiaries are entitled to the benefits of the Convention.

    2. Permanent establishment

    In Article 5 of the treaty, Barbados has reverted to the 1977 OECD model permanent establishment provisions in preference to the 1980 UN model provisions, with a view to attracting investment to its offshore sector. The UN model lowers the components that constitute a threshold, so that the source country is able to increase its potential jurisdiction to tax inbound investment on trade from persons in the treaty country.

    The accompanying memorandum of understanding recognises several examples to use the treaty for telemarketing and purchasing and selling by a Barbados company in relation to the US, joint venture investments and philanthropic organisations. As examples, the memorandum expressly recognises as eligible for treaty benefits:

  • a Barbadian resident company owned by three persons, each resident in a different third country, where the company is engaged in an active international marketing business in Barbados. It purchases goods in Asia and sells them through the Western hemisphere including the US, but has no permanent establishment in the US; and

  • a company owned by three persons, each resident in a different third country. The company is the worldwide headquarters and parent of an integrated international business carried on through subsidiaries in many countries including Barbados. The company's wholly-owned US and Barbados subsidiary manufacture, in their country of residence, different products, which form part of the group's product line.

    3. Withholding tax rates

    The rates of withholding taxes have been reduced in respect of dividends (except for portfolio income), interest and royalty income to 5%. This is attractive to foreign business. The lower rates would permit a multinational company investing in a third state through Barbados to pay some Barbados tax and still have a meaningful tax saving.

    4. Effect of the treaty on particular financial vehicles

    The US/Barbados treaty allows the use of Barbados as a holding company jurisdiction to make and manage investments in other countries. Particular advantages include low withholding tax on the repatriation of dividends, and the fact that the international investor can use international business companies (IBCs) to hold and manage investments in subsidiaries with certainty as to the tax and fees due and the ability to qualify for IBC status.

    Under the treaty, an IBC may perform a number of services such as repackaging operations in the host country, management, brokerage, construction and dredging services without incurring a permanent establishment. The treaty enables a Barbados IBC to assist an investor who wants to export or consolidate existing imports to the US. By establishing a Barbados IBC and having an active trade or business in Barbados relative to its US activities, the Barbados company can conduct activities related to marketing and selling goods into the US without the imposition of tax.

    The Barbados/US treaty exempts offshore banks from the application of the limitation on benefits provisions. This specific concession treats banking business as active business and therefore as an exception to the anti-treaty shopping provisions of the treaty. Offshore banks benefit from low withholding taxes for interest in the treaty of 5%.

    In addition, significant tax planning opportunities are available to ship owners participating in international traffic or any trading or related activities from Barbados. International traffic is defined as any transportation by ship except transportation solely within either Barbados or the US. The treaty exempts from tax in the US the profits of an enterprise carried out by a resident of Barbados from the operation of ships in such traffic, regardless of whether the profits are attributable to a permanent establishment in the US or the ship is registered in Barbados.

    Profits exempted under the treaty are:

  • operating profits;

  • profits from the rental of ships arising from the operation of the ships in international traffic by the lessee incidental rental profits, i.e. profits incident to the operating profits, rents from bareboat charters;

  • profits from maintenance, use or rental of containers used in the transport of merchandise in international traffic; and

  • profits from the participation in a pool, a joint business or an international operating agency.

    The lower withholding rates and favourable limitation of benefits provisions, as well as the P/E and business profits provisions in the 1992 Protocol to the treaty allow ship owners, especially multinational companies, to choose Barbados with confidence. Such a ship owner may use attractive provisions to conduct trading and other activities from Barbados.

    Barbados has concluded treaties with the UK, Canada, Norway, Finland, Cuba and Venezuela that offer excellent opportunities for trading and investment in selected countries using a Barbados entity, such as an IBC, captive insurance company or offshore bank.

    By Yolande Bannister

    Yolande Bannister is with The Alpha and Omega Group, Rua Bela Cintra 881, Bridgetown.