Preventing Treaty Abuse

I. S. 187Introduction

A. Historical Background and Overview of the Limitation on Benefits Clause

The limitation on benefits (LOB) concept was pioneered by the United States in its tax treaties due to the significant abuse of its bilateral income tax treaty network with other countries. With the high income tax rates in the US, residents of third counties who want to invest in the US look for tax breaks by locating a country that has both a favorable income tax treaty with the US and attractive internal tax laws. For example, the US-Ireland treaty provides for a 30 % US tax withholding reduction on dividends, interests and royalties paid to non-residents from US sources. This encourages third-country residents to establish residence in Ireland. Also, US citizens, who are taxed on worldwide income, might invest indirectly in the US through a treaty partner in order to avoid paying tax. Thus, in order to address this problem – called treaty shopping – the US has included versions of an LOB provision in all of its treaties since its 1981 US Model Treaty; this has then been followed by other countries as well in their bilateral income tax agreements with other countries.

The term “treaty shoppin...