Hybrid Entities in Tax Treaty Law

S. 941. Background of the check-the-box regulations

When a business entity is incorporated in the United States of America (US), a determination must be made as to how this entity will be treated for USfederal income tax purposes. While some entities are treated as taxtransparent, having their income, losses and credits flowing-through their owners and being subject to tax at the owners level (irrespective of incomedistribution), other entities (such as corporations) are subject to income tax at the level of the entity and subsequently at the level of the owners when the income is actually distributed.

The current US entitytax classification system is the check-the-box (CTB) regime. The Internal Revenue Service (IRS) issued the CTB regulations under the Internal Revenue Code (IRC) Section (§) 7701 on December 17^th, 1996, with effect as fromJanuary 1^st, 1997.Under the CTB regime, the owners of domestic and foreign eligible entities are entitled to opt for how the business entity will be classified for US federal income tax purposes.

The election ofa foreign entity to be treated as flow-through under CTB regime may result in a potential mismatch betweenthe US tax treatmentvis-à-vis the tax t...