U.S. Model Income Tax Treaty and the Concept of "Consistency"

Foreign coiporations generally conduct U.S. operations through U.S. subsidiaries. As a consequence, unless there is a misstep, tax treaty articles dealing with the attribution of income to a branch or other permanent establishment are largely relevant only to those foreign taxpayers, principally banks and insurance companies, that for nontax reasons operate through branches. For these taxpayers, however, one important change in the U.S. interpretation of tax treaties may be the expansion of the "consistency" rule in the Treasury Department's Technical Explanation of its 2006 Model Treaty.1

The "consistency" rule is the Treasury's view that a foreign person may elect to use either the treaty or the Internal Revenue Code to reduce U.S. taxes on business income, but may not use both, i.e., may not pick and choose between the business profits article of a treaty and the Internal Revenue Code's "effectively connected" rules. Prior to the release of the 2006 Model Treaty, the principal articulation of "consistency" was Rev. RuI. 84-17.2 That ruling held that a foreign corporation which carried on two separate U.S. activities that were not permanent establishments, and which resulted in income in one case and a loss in the other, could not...