A Defense of the United States Application and Interpretationof Tax Treaties

1|Chris Rinaldi – A Defense of the United States’
Interpretation and Application of Tax Treaties

I. INTRODUCTION

Tax law is a dynamic field of law that evolves quickly to meet practical problems and

create solutions to those problems. When problems are spotted from the domestic perspective

they receive a legal reaction. At the same time, a network of bilateral tax treaties has given rise to

an international legal aspect of tax law, which is both valuable and binding.

Oftentimes, the domestic realm of tax law has interacted uneasily with the international

obligations created under a tax treaty. 1 This has created dilemmas for every country in

administering tax treaties, but the United States is often pointed out as a culprit of elevating its

domestic taxation interests over its international obligations under tax treaties. Recent

scholarship argues that the United States often overrides its obligations under tax treaties through

the issuance of judicial opinions, executive treasury regulations and passage of subsequent

Congressional legislation which are contradictory to the terms of a tax treaty already in effect,

culminating in a treaty override.2

A treaty override occurs “when a contracting state intentionally applies domestic law or

regulation to accomplish specifically what the treaty forbids.” 3 It serves as a breach of

1
Michael Kirsch, The Limits of Administrative Guidance in the Interpretation of Tax Treaties, 87 Tex. L. Rev. 1063,
1092 (2009).
2
Richard L. Doernberg, Overriding Tax Treaties: The U.S. Perspective, 9 Emory Int'l L. Rev. 71, (1995); Timothy
Guenther, Tax Treaties and Overrides: The Multiple-Party Financing Dilemma, 16 Va. Tax Rev. 546 (1997);
Anthony Infanti, Curtailing Tax Treaty Overrides: A Call to Action, 62 U. Pitt. L. Rev. 677 (2001); Mark Wolff,
Congressional Unilateral Tax Treaty Overrides: The "Latter in Time Doctrine" is Out of Time!, 9 Fla. Tax. Rev. 699
(2009).
3
Doerenberg, supra note 3, at 74.


international law, substantively in regard to the defective provision, and of the customary

international law principal of pacta sunt servanda4

Tax treaties are negotiated with consideration shown towards implicit and explicit policy

considerations. These policy considerations reveal that the terms of a tax treaty create obligations

between the two contracting parties, but these obligations are held against the other party with a

certain latitude in mind.5 Tax treaties are purpose driven and this latitude is granted because of

the practical challenges that national taxing authorities face in administering and enforcing their

obligations under a tax treaty. The power to tax autonomously is a central element of state

sovereignty and when a state enters into a tax treaty it sacrifices some its autonomy to tax

income in order to facilitate commerce between countries.6 These obligations represent the

compromise of the right a state has to tax any income within their territorial jurisdiction, with the

goal to prevent incidents of double taxation. Each treaty partner relinquishes its taxing authority

over certain items of income and each treaty obligation entered into is well thought out to

accommodate certain legitimate economic actions.7

A dilemma is presented when these obligations are used in an abusive way by citizen and

non-citizen taxpayers, resulting in a contravention of the treaty’s purpose. Instead of facilitating
4
“…every treaty in force is binding upon the parties and must be performed by them in good faith” Reuven S. Avi-
Yonah, International Tax as International Law, 57 Tax. L. Rev. 483, 493 (2004).
5
Treaties, by their nature, are subject to different interpretations and their may be more than one right answer
depending on the interpretive context. They also have to interact with domestic laws. The European Court of
Human Rights has applied a “margin of appreciation” doctrine in certain contexts when a signatory to the European
Convention on Human Rights fails to conform domestic laws to the laws of the Convention. Alex Glasshauser,
Difference and Deference in Treaty Interpretation, 50 Vill. L. Rev. 25, at 31-33 (2005).
6
Doerenberg, supra note 4, at 71.
7 Id.


economic benefits for the residents of a treaty partner, it may facilitate sham transactions that

only result in an evasion of taxes and not an economic transaction of any substance. 8 Tax treaties

aim to prevent these sham transactions resulting in tax evasion as much as they seek to facilitate

commerce.9 The Office of Economic Development (OECD), comprised of 34 countries

including the United States, has developed the Model Tax Convention & Commentary to help

further these aims. It features model treaty articles and the commentary explains the intended

meaning, effects, and purpose of the Convention’s articles.10 Countries do not follow the OECD

Model Tax Convention verbatim, but US tax treaties, and most others, substantially comply with

the OECD Model.11

This paper argues that many provisions that some view as treaty overrides should be

viewed as reasonable action to perfect the purpose of the treaty and avoid abuses of a tax treaty

as contemplated by treaty partners and international practice. Additionally, US courts have often

ruled against the US tax authorities when they have attempted to administer the law in a manner

that conflicts with treaty obligations. From a comparative perspective, the US's behavior in

interpreting and administrating tax treaties is reflective of the experience that the US's treaty

partners and counterpart states have encountered in administering their tax treaties.

8
Anna A. Kornikova, Solving the Problems of Tax-Treaty Shopping Through The Use of Limitation of Benefits
Clause, 8 Rich. J. Global L. & Bus. 249, 251-252
9 Kirsch, supra note 1, at 1065

10
Kirsch, supra note 11, at 1065-66
11
John A. Townsend, Tax Treaty Interpretation, 55 Tax Law. 219, at Pt. II, B, 1 (2001)


Part II of this paper will discuss two Congressional acts that many point to as an

example of treaty overrides by the US. Part III of this paper will explore federal courts’

application of anti-abuse doctrines to deny taxpayers benefits under a treaty. Part IV will discuss

the role of treasury regulations and other executive interpretations of domestic tax laws and tax

treaties in effecting treaty overrides, along with how they are dealt with by US courts.

II. SUBSEQUENT LEGISLATION AND TAX TREATIES

The US has applied the last-in-time rule in the case of conflicting treaty provisions and

subsequent legislation.12 The rule is a result of the long-standing interpretation of the US

Constitution’s Supremacy Clause.13 The clause states that federal statutes and validly enacted

treaties are supreme in regard to federal law, but does distinguish between the two as to each

other.14 Therefore, when a statute passed subsequent to a treaty conflicts with a treaty a

provision, such that the two cannot be administered simultaneously, or Congress expressly

intends to override the treaty, then such statute will trump the treaty provision. 15 Nevertheless,

courts will implement the Charming Betsy principle of statutory interpretation in the absence of a

clear or explicit Congressional intent to override the treaty provision. 16 In that case, the courts

12
Harry G. Gourevitch, Tax Treaties: The Legislative Override Problem, 93 Tax Notes International 172-15 (1993).
13
Whitney v. Robertson, 124 U.S. 190, 193-4 (1888).
14
United States Constitution, Art. VI, Cl. 2
15
Reid v. Covert, 345 U.S. 1, 18 (1957)
16
Cook v. United States, 288 US 102, 120 (1933); Kornikova, supra note 10, at 262.


will attempt to harmonize the statute and treaty provision. But, when harmonization is not

feasible, the court will result to the last-in-time rule.17

The United States is not without its international counter parts in applying the last-in-time

rule. Various international domestic courts apply the rule in a similar manner. 18 The application

of the rule creates a ripe environment for the occurrence of a treaty override by simply honoring

the latest law. This is particularly so in the context of tax treaties, which must interact with

domestic tax laws that are actively subject to interpretation and change, in comparison to the

somewhat static life of a tax treaty.19

One example of the application of the later in time rule is the Foreign Investment in Real

Property Act (FIRPTA), passed by the US Congress in 1980. 20 Generally, foreign residents are

exempt from paying capital gains tax on US investments. This included investment in US real

property through corporations. Congress set out to slice an exception to the capital gains tax

exemption with FIRPTA. They would begin subjecting capital gains realized through the sale of

stock to taxation if the corporation whose stock was being sold owned US real property. 21 This

was a way to put an end to foreign residents purchasing US real property through a corporate

17
Whitney, supra note 15
18
Austria, Italy, the United Kingdom, and Sweden all apply a later-in-time rule. Tax Treaties and Domestic Law,
EC and International Tax Law Series, Vol. 2, Ed. Gugliemo Maisto, IBFD Publications, Amsterdam, 2006. see
also, Tax Treaty Interpretation, Ed. Michael Lang, , Kluwers Law International, London, 2001.
19
Gourevitch, supra note 14; Kirsch, supra note 12 at 1090-1093; Reuven S. Avi-Yonah, supra note 5 at 494
20
Pub L. No. 96-499, 94 Stat. 2599, 2690-91 (1980)
21
Gourevitch, supra note 21


vehicle and then realizing tax free gain by selling the stock of such corporation. 22 There were tax

treaties in effect that contained provisions exempting these real property gains from US tax

liability.23 This was a clear override in relation to those tax treaties and it was one of the rare

instances in which Congress announced its explicit intention to override its treaty obligations.24

FIRPTA serves as a good illustration of the overriding application of the last-in-time rule.

However, not all Congressional legislation directly conflicts with treaty provisions, as much as it

relates to them, and Congress will not express an intention to override a treaty provision, or may

expresses an intention not to override a treaty provision. 163(j) of the Internal Revenue Code,

created in the 1989 Omnibus Budget Reconciliation Act, fits into that latter category of

Congressional legislation.25

Some point to this as one of the numerous examples of the United States overriding its

tax treaties.26 Essentially, 163(j) re-characterizes a US taxpayer’s interest payments in order to

prevent a related-foreign taxpayer from stripping down their taxable US earnings through

making loans to a related US taxpayer. 27 It is more commonly known as the Internal Revenue

Code’s “earnings-stripping” provision and aims to prevent tax avoidance and the abuse of tax

22
Id
23
Id
24
Id. However, the administration of FIRPTA’s provisions bring into question the true extent FIRPTA constituted a
treaty override, if there was an override at all. While the statute expressly overrode the US treaty obligation in
conflict with it, it also had a five-year prospective application date. Within that time, conflicting treaties were
subject to re-negotiation. see also Wolff, supra note 3, at ???.
25
Pub. L. No. 101-239, 7210, 103 Stat. 2106, 2339-42 (1989)
26
Doerenberg, supra note 8 at 92-105; Infanti, supra note 3 at 682; Wolff, supra note 26, at 742-44.
27
Avi-Yonah, supra note 21, at 495-6.


treaty provisions, which usually exempts the interest payments made from a US entity to a

related foreign taxpayer from taxation in the foreign country. 28

163(j) addresses the following factual scenario: FCo, a well-capitalized foreign business,

sells widgets. FCo decides to begin producing widgets in the US through a subsidiary, USCo.

FCo. creates USCo.and capitalizes it with little equity and assets, and makes a loan to USCo. to

fund the rest of their US operations. Then USCo. makes interest payments, likely tax exempt or

subject to a substantially reduced tax rate under a treaty, to FCo. This interest paid by USCo. to

FCo. is deductible against USCo.’s US source income for US tax purposes, therefore lowering

USCo’s US tax liability. And the interest payments to FCo. will be subject to a reduced tax (if

they are not tax exempt) in their home country under a treaty.

First, 163(j) only applies when a US entity makes an interest payment to a related tax-

exempt entity.29 Tax exempt entity may mean a US entity not subject to taxation, or an entity

outside the US’s taxing jurisdiction.30 Second, 163(j) also requires that the US party related to

the tax-exempt interest payee have a 1.5:1 debt/equity ratio, or greater, and third, the US party

related to the tax exempt entity must have “excess interest deductions.”31

For example, above, FCo. is not subject to US tax and they are receiving interest

payments from USCo., which they own wholly and therefore the two are related parties. If

USCo. has $1,000x in debt; $300x of basis in assets, and $200x of taxable income (before any
28
Avi-Yonah, supra note 30, at 495.
29
26 U.S.C. 163(j)
30
Id.
31
26 U.S.C. 163(j)(2)(A)


deductions are taken into account) they will easily fail the debt/equity ratio test, as they hold debt

to equity at a 2:1 ratio. From here, excess interest deductions are calculated.

163(j) limits USCo’s allowable interest deductions for payments to FCo. to 50% of

USCo.'s taxable income for the year.32 Therefore, if USCo. makes $400x in interest payments to

FCo., they will only be allowed to claim $100x in interest deductions, or 50% of $200x, their US

taxable income for the year. They will have $300x of disallowed excess interest deductions. This

$300x in excess deductions may be carried over to the following tax year and may be used if it’s

within the allowable amount of deductions for the following tax year.

The taxpayer is allowed to factor in these excess interest deductions when determining

the allowable amount of deductions the following year. 33 If, in the following year, USCo. has

$200x of taxable income again, they can add last year’s $300x of unclaimed interest deductions

from the year prior. In this tax year they can take $250x in interest deduction for amounts paid

to FCo, or half of $500x (taxable income from the year plus carryover of the excess interest

deduction in the year prior).

Tax scholars and commentators have criticized 163(j) as a treaty override in relation to

the anti-discrimination provision held in tax treaties, guaranteeing that a resident of the treaty

partner is treated no worse than a resident of the United States.34 These scholars say that 163(j)

32
26 U.S.C. 163(j)(2)(B)(i)(II)
33
26 U.S.C. 163(j)(1)(B)
34
163(j) is an anti-abuse provision. It will apply to foreign taxpayers because they are able to setup their interest
payments in a manner that abuses the tax laws in a way that 163(j) aims to prevent. In practice, therefore, 163(j)
will apply foreign taxpayers, but it does not change that it will apply to US taxpayers who set up an identical
scheme. see also, Avi-Yonah, supra note 31, at 495-6.


adversely affects foreign taxpayers, in relation to US taxpayers, directly. 35 Although 163(j) may

often be invoked to re-characterize financing schemes used by foreign taxpayers, it applies to

any exempt organization receiving interest payments from a related US taxpayer, whether the

payee is a US resident or otherwise.36 Moreover, 163(j) filled an absence in US law which a

majority of the US treaty partners already have filled with existing earnings-stripping, or "thin-

capitalization", provisions of their own.37 163(j)’s biggest effect on tax treaty provisions is to

harmonize their effect and application by the treaty partners. In order for 163(j) to be considered

an override its critics would have to argue that a provision in a tax treaty should be interpreted to

close a loophole in one country, but disallow that closure in the US. This would be wrong

though. A country may allow a greater benefit under the treaty then contemplated, but they may

also trim that added benefit and apply the lesser, but intended, benefit defined in the treaty.

III. ANTI-ABUSE DOCTRINES AND TAX TREATIES

US courts, along with courts of international countries, have developed anti-abuse

doctrines to re-characterize transactions under tax law.38 These doctrines, as implied by their

35
See note 29.
36
26 U.S.C. 163(j)
37
Avi-Yonah, supra note 37
38
Guenther, supra note 3 at 649; Kornikova, supra note 18 at 259-60, 267-272 (discussing anti-abuse measures
implemented by Canada, India, and the EU); Brian J. Arnold and Stef van Weeghel, The relationship between tax
treaties and anti-abuse measures, in Maisto, supra note 20, at 81-114. Austria applies anti-abuse doctrines to deny
treaty benefits, Daiela Hohenwarter, Austria, in Maisto, supra note 20, at 193-206; Germany implements the
“economic substance” doctrine as well. Alexander Rust, Germany, in Maisto, supra note 20, at 243; Italy has
blacklisted some countries under its’ anti-tax haven legislation, Pietro Bracco, Italy, in Maisto, supra note 20, at
274-75; The UK also applies anti-abuse theories to negate treaty benefits. Ian Roxon, United Kingdom, in Maisto,
supra note 20, at 344-352.

10 | C h r i s R i n a l d i – A D e f e n s e o f t h e U n i t e d S t a t e s ’

name, exist to prevent tax avoidance through the abuse of tax laws and the perceived formality of

the application of their language. The US courts have developed these anti-abuse doctrines in

wholly domestic legal disputes, but have applied them in disputes involving tax treaties as well.

These anti-abuse doctrines operate under the general principle, “form over substance”, or,

in other words, look to re-characterize transactions to reflect their purpose if they are void of

“economic substance.”39 The Internal Revenue Code was recently amended to place the

“economic substance” doctrine, as developed under Common Law, into effect as a statutory

provision.40 (7701(o))

The Common Law has developed three relevant anti-abuse tests, or theories, which fall

under the umbrella of the “economic substance” doctrine. First, there is the “business purpose”

test which looks for some purpose to the transaction other than tax avoidance. 41 Therefore, if the

only economically substantial part of the transaction is the tax savings, then the transaction will

not be respected as presented by the taxpayer. Instead, the court will re-characterize the

transaction to reflect its economic substance in absence of a separate and independent business

purpose.42

Second, there is the step-transaction doctrine which will aggregate multiple transactions

into one transaction in order to reflect the series of transactions’ economic substance. 43 The step-

39
Guenther, supra note 41
40
26 U.S.C. 7701(o)
41
Gregory v. Helvering, 293 U.S. 465, 469-70 (1935).
42
Guenther, supra note 43.
43
Commissioner v. Court Holding Co., 324 U.S. 33,1 at 334 (1945).


transaction doctrine is implemented on one of two bases. The court will apply the end-result test

under the step transaction doctrine, which will aggregate a series of pre-arranged transactions

that seek to reach the singular end result of tax avoidance.44 Courts will aggregate transactions

under the mutual-interdependence test when any one of the transactions entered into would have

been fruitless without entering into the others.45

The step transaction has a third theory of the “economic substance” doctrine embedded

into. This is the conduit theory. The conduit theory calls for disregarding an intermediate entity

in a transaction if such entity has no business purpose, other than to facilitate tax avoidance. 46

The conduit theory is often invoked by the IRS to re-characterize international transactions

between related parties which seek to abuse tax treaties in an effort to avoid US tax liability.

7701(l) was placed into the Internal Revenue Code in 1993.47 It authorized the treasury

department to issue regulations regarding the re-characterization of “any multiple-party financing

transaction as a transaction directly among any 2 or more of such parties”, or “conduit

arrangements” in order to prevent tax avoidance. 48 This culminated in Treasury Regulation

1.881-3, which adopts the conduit theory. 49

44
Guenther, supra note 46 at 650
45
Id.
46
Court Holding Co. at 334. In essence, when one party is labeled as a conduit, such party's role in the transaction
will not be respected, which will lead to the step in the transaction which involves the conduit to be disregarded.
47
Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-66, 238, 107 Stat. 312, 508 (1993).
48
26 I.R.C. 7701(l).
49
26 U.S.C. 1.881-3(a)(1)


1.881-3 provides guidelines of when the IRS will re-characterize a multiple-party

financing (MPF) transaction, and the consequences of such re-characterization.50 First, the

consequences of re-characterization could result in a denial of treaty benefits and a violation of

1441 or 1442 of the Code due to a failure to withhold and pay the proper US tax liability. 51

Some scholarship has argued that the application of these anti-abuse theories by courts,

and their codification or use in the interpretation of the Code, may constitute a treaty override,

and in the case of 1.881-3, does constitute a treaty override.52 This position is questionable

though. It appears well within the right of a court to apply the same theory to a transaction

wholly falling under domestic tax law, to a transaction that implicates a US treaty as well. Tax

treaties suspend, or soften, the imposition of tax in certain factual scenarios. On the other hand,

they do not suspend the legal theories and methodology that reasonably characterize the factual

scenario to be evaluated under the treaty’s language. The application of anti-abuse theories by

US courts are within the purview of the treaty partners, and moreover US treaty partners are on

notice, as these theories have been long-standing in US tax law. This is particularly true when

considering tax treaties have the purpose to diminish tax avoidance, while preventing double

taxation.

50
"this section provides rules that permit the district director to disregard, for purposes of section 881, the
participation of one or more intermediate entities in a financing arrangement where such entities are acting as
conduit entities. For purposes of this section, any reference to tax imposed under section 881 includes, except as
otherwise provided and as the context may require, a reference to tax imposed under sections 871 or 884(f)(1)(A) or
required to be withheld under section 1441 or 1442." Id.
51
Id.
52
Guenther, supra note 1, at 668-670.


Moreover, any treasury regulations or revenue rulings adopting these theories as the

position of the Treasury Department and Internal Revenue Service simply adopt the long-

standing common law formulation of these theories. If the IRS purports to apply these theories

in factual scenarios beyond their intended scope as developed by US courts then that is simply

their misguided reading of the law and not law in itself.53 US courts have given little respect to

Revenue Rulings when they appear to be inconsistent with actual law, and they have not

accorded much deference or respect to Treasury Regulations when the interpretations set out in

such regulations are contrary to other non-US government interpretations.54 The treatment of

treasury regulations is addressed below in Pt. III, but is more thoroughly analyzed in in Pt. IV

Since 1.881-3 was put in effect in 1995 there have been four cases in federal courts in

which the IRS has attempted to re-characterize MPF transactions. These cases have adjudicated

matters involving transactions taking place prior to 1995, therefore 1.881-3 is inapplicable.55 But,

the IRS argues for re-characterization of these transactions under the same theory set out in

1.881-3, which is the conduit theory, in an attempt to reflect the real economic substance of MPF

treaty shopping transactions.56

Overall, there have been seven cases in US courts in which the IRS has tried to re-

characterize MPF transactions to deny treaty benefits to a taxpayer. Four have denied the

53
1.881-3 is a facts and circumstances analysis. It does not re-formulate the conduit theory, as much as it gives the
Treasury's interpretation of the theory as applied to international transactions invoking treaty benefits.
54
Kirsch, supra note 21, at 1091-92
55
The effective date was September 11, 1995. 26 C.F.R. 1.881-3(f)
56
The IRS has called the related entites "flow-throughs", amongst other things, as noted below, but they are making
the "conduit" argument regardless.


taxpayer benefits while three have denied the IRS’s re-characterization attempt under the

“economic substance” doctrine, which is usually based upon the conduit theory.57 The first time

the issue was addressed was in Aiken Industries v. Commissioner, in which case the court sided

with the IRS in re-characterizing the transaction under the conduit theory. The court continued

to rule this way until 1996, when they refused to deny treaty benefits to a taxpayer in SDI

Netherlands v. Commissioner of Internal Revenue. Since then, two other cases have followed

suit, most noticeably Northern Indiana Public Service Company v. Commissioner.

As noted above, Aiken Industries was the first time the Tax Court considered the

legitimacy of a MPF transaction implicating treaty benefits. 58 Aiken involved inter-corporate

loans between related corporations. The petitioner Aiken Co., owned a US subsidiary (USCo.).

Aiken Co. was owned by a Bermudian corporation (BCo). BCo. lent USCo. $2,250,000. In

return, USCo. gave BCo. a promissory note for the amount of $2,250,000 with 4% interest. 59 If

the transaction remained between these two parties, the 4% interest payments from the USCo. to

BCo. would be subject to a 30% withholding tax before being paid to BCo.

But, BCo. transferred the promissory note to a related Honduran corporation (HCo.),

which BCo. owned indirectly through an Ecuadorian corporation. HCo. returned nine $250,000

57
The following cases were decided in favor of the IRS: Aiken Industries, Inc. v. Commissioner, 56 T.C. 925 (1971);
Teong-Chaw Gaw v. Commissioner v. Commissioner, T.C.M 1995-531 (1995); Morgan Pacific Corp. v.
Commissioner, T.C. Memo 1995-418 (1995); Del Commercial Properties Inc. v. Commissioner, T.C. Memo 1999-
411 (1999), aff’d 251 F.3d 210 (2001), writ denied, 534 U.S. 1104 (2002). The following cases were decided in
favor of the IRS: SDI Netherlands B.V. v. Commissioner, 107 T.C. 161, (1996); Northern Indiana Public Service
Company v. Commissioner, 105 T.C. 341 (1995), aff'd, 115 F.3d 506, (7th Cir. 1997); Ambase Corporation v.
Commissioner, T.C. Memo 2001-122 (2001).
58
Aiken Industries, 56 T.C. 925
59
Aiken Industries, 56 T.C. 929-30


promissory notes (or $2,250,000) in return for the assignment of rights from the $2,250,000

promissory note to be paid by USCo. The notes transferred from HCo. to BCo. also had a 4%

interest rate.60

This debt structuring between the related corporations resulted in significant tax benefits.

USCo. would now pay interest to HCo, in the amount of 4% on $2,250,000. The US and

Honduras had a tax treaty that disallowed the US to impose a withholding tax on the interest

payments from USCo. to HCo. Then, HCo. would pay their interest payments due to BCo., also

in the amount of 4% on $2,250,000, using the funds from USCo.'s interest payments to satisfy

their obligation.61

The IRS looked to re-characterize the transaction by arguing that HCo. should be

disregarded as a corporate entity. The result would be to deem the interest payments by USCo.

to be paid directly to BCo., which would subject such payments to a 30% withholding tax.

Aiken, plaintiff as owner of USCo., argued that HCo. was a valid corporation under the US-

Honduras tax treaty and therefore disregarding it would be in violation of the treaty. 62

The court agreed with Aiken and respected the corporate existence of HCo., but they

disregarded HCo. due to its role in the transaction.63 The court studied Article IX of the US-

60
Id. at 930
61
Id
62 Id at 931

63
Id at 932 and 934


Honduras Tax Treaty, pertaining to interest payments. Article IX exempted interest payments of

US source "received by" a Honduran taxpayer from US withholding tax. 64

The court noted that "received by" was not defined within the treaty and that the treaty

called for undefined terms to be given the meaning that they would normally be given under

domestic law.65 Therefore, this transaction as a whole came under the analysis a US court would

give to a transaction involving only US taxpayers in order to determine who "received" the

payments under the law.66 In essence, the court initially went to the treaty; they then were

kicked back into domestic law by the treaty, and the domestic law analysis would determine if

the treaty was applicable.

The court determined that HCo. never received the payments and therefore the treaty did

not apply under Article IX of the treaty. They determined that HCo.'s role in the transaction had

no economic substance.67 When BCo. transferred USCo.'s promissory note in return for HCo.'s

notes they exchanged notes which had a dollar for dollar value equivalent that operated as

conduit debt, allowing the interest payments from USCo. to HCo. to be transferred to BCo. under

the illusion of a legitimate debt.68 HCo. realized no benefit as their notes and USCo.'s notes had

no interest spread, and they were for the same value, yielding identical interest payments to the

64
Id at 933
65
Id at 933
66
Id at 933-34
67
Id at 934
68
Id


right holders respectively. 69 In addition, the funds HCo. used to pay interest to BCo. could be

directly traced as the same money USCo. used to pay interest to HCo. Under these facts, the

court agreed that the transaction should be re-characterized and HCo.'s role, not existence, should

be disregarded in the transaction.70

The court peppered its opinion with language about the importance of respecting tax

treaty obligations and the supremacy of treaty obligations over domestic tax law throughout the

opinion.71 They also emphasized that a tax avoidance purpose is of little consequence when the

transaction also has economic substance.72 In the end, the court came to a reasoned conclusion

based upon their application of US domestic tax law, which was directed to be applied by the

US-Honduras treaty in this context. This is far from a treaty override but instead, it is a

reasonable application of US anti-abuse rules as authorized by following the directives under a

tax treaty, not ignoring them.

On the other hand, SDI Netherlands represents the other side of the coin in evaluating

MPF transactions under a treaty using US anti-abuse theories. SDI involved the non-exclusive

licensing of worldwide intellectual property (computer software) from a Bermudian parent

corporation (BCo.) to its Dutch (Netherlands) subsidiary (NCo.), which then sublicensed the US

intellectual property rights to another subsidiary in the US (USCo.). In turn, USCo. paid NCo.

69
Id
70
Id at 934
71
Id at 932. At one point the court may overstate the binding power of tax treaty obligations, claiming that they
trump all federal laws. This is clearly wrong as it relates to statutes passed after the ratification of a treaty. Id at
931-32.
72
Id at 933-34


contingent royalties based upon the gross profits of USCo. earned in connection with the

exploitation of the intellectual property rights granted by NCo. In turn, NCo. would send a

portion of these royalties to BCo., pursuant to their separate licensing agreement. 73

In the end, this licensing structure achieved substantial tax benefits. The royalties paid

from USCo. to NCo. are not taxed in the US under the US-Netherlands Tax Treaty.74 The

payments are then exempted from tax in the Netherlands, to the extent they are paid to BCo.

pursuant to the licensing agreement between NCo. and BCo. 75 In Bermuda there is no direct

corporate income tax, therefore the profits virtually escape taxation.

The facts above are similar to those in Aiken, except this scenario involved licenses and

royalty payments, opposed to loans and interest payments. But, the IRS claimed that NCo. was a

mere conduit, and therefore the payments from USCo. to NCo. were not within the purview of

the US-Netherlands Tax Treaty. 76 When NCo. is taken as a conduit the payments are deemed to

be paid directly from USCo. to BCo. The US and Bermuda have no tax treaty, therefore the

standard 30% withholding rate would apply under the IRS’s theoretical re-characterization of the

transaction.77

73
SDI Netherlands, 107 T.C. 161, at 163-65.
74
Id at 170.
75
Id at 176.
76
The IRS didn't claim that SDI Netheralands served as a "conduit", but instead labeled it as a "flow-through". The
court did not see any distinction between the two, both factually and in terms of the legal analysis needed to
determine what constituted a "flow-through" in comparison to a "conduit". Id at 172
77
Id at 172.


The court rebuffed the IRS’s re-characterization attempt in this case, in an opinion

distinguishing SDI’s factual scenario from Aiken. The distinctions were not frivolous nor

contradictory, but instead they re-affirmed the proper place of anti-abuse theories in US tax law

by not applying the conduit theory. Here, the court concluded that there were factual distinctions

both in the licensing agreements between the related parties, as well as in the financial aspects of

the transactions, which lent this transaction, and the parties involved, a legitimate business

purpose apart from treaty shopping and tax avoidance.78

The court re-affirmed the Aiken court’s recitation that a tax avoidance purpose, or a

transaction structured to receive treaty benefits, will not lead to re-characterization when the

transaction also has a legitimate business purpose. 79 In this case, like in Aiken, they respected

each corporation's independent organization and existence. The court also upheld the legitimacy

of the license agreements as "bona fide". 80 Under these consideration the court determined,

unlike in Aiken, all the parties involved received an independent profit and economic benefit

from taking part in the licensing of the intellectual property, i.e., the transaction had economic

substance for each party involved and they all received a benefit for their role in adding value to

the intellectual property rights and making it profitable.81

78
The court noted economic factors, mainly focusing on the facts that each related party earned an independent
profit and, pertaining to SDI Netherlands, a merger of funds took place concerning the royalties received from SDI
USA and other sublicensees throughout the world. The payments from SDI Netherlands to SDI Bermuda were not
directly traceable to the funds SDI Netherlands received from SDI USA. Id at 175-76.
79
Id at 175-76.
80
Id at 175
81
Id at 175.


In Northern Indiana Public Services the Tax Court was affirmed by the Seventh Circuit

Federal Appeals Court in once again denying the IRS’s attempt to re-characterize a lending

transaction between related parties, in a factual scenario that more resembles that of Aiken.82 In

Northern Indiana, the plaintiff US taxpayer setup a subsidiary in the Netherlands Antilles (which

falls under the US-Netherlands Income Tax Treaty). The subsidiary (NACo.) would receive

loans from the EuroBond Market (wholly unrelated purchasers of debt and underwriters) in

return for promissory notes of NACo., which were guaranteed by the US taxpayer-parent of

NACo. (USCo.) and bore an interest rate of 17.25%. 83

In turn NACo. would lend the funds received on behalf of its promissory notes to its

parent, USCo., in return for promissory notes issued by USCo. bearing a 18.25% interest rate. 84

The interest payments made by USCo. to NACo. on the USCo. notes were exempt US

withholding tax under the US-Netherlands Tax Treaty.85

The IRS sought to re-characterize the transaction by treating NACo. as a conduit, or

agent, of USCo. Under their re-characterization, USCo. would be deemed to pay the holder of

NACo. promissory notes in the EuroBond Market directly. This would mean that the interest

payments did not fall under the treaty and USCo. would be liable to pay the 30% withholding tax

that applied to the interest payments.86

82
Northern Indiana, 115 F.3d 506.
83
Id at 507-08.
84
Id at 508.
85
Id at 510
86
Id at 509


Again, the court focused on distinguishing facts that set Northern Indiana apart from

Aiken. First, the court noted that it was common practice for US companies to seek loans in the

EuroBond Market due to high interest rates in the US.87 It was also common practice for an

offshore financing company to act as an intermediary in securing funds from the EuroBond

Market.88 Second, the court emphasized that, unlike in Aiken, NACo. received a profit

attributable to the 1% spread between their promissory notes on the EuroBond Market and

USCo.'s promissory notes payable to them.89 Third, NACo. used these profits ($700,000) to

make independent investments un-related to USCo., which generated additional independent

profits for them.90

The court's opinion emphasized that a tax avoidance purpose in a transaction serves as a

non-factor when the transaction and entities involved all have a distinct and legitimate business

purpose on their own.91 Correctly, the court found that the facts supported the notion that the

related parties in the lending transaction served their own separate and legitimate business

purpose, beyond facilitating tax avoidance through treaty shopping. Therefore, the application

of the conduit theory and the re-characterization of the transaction was unnecessary and not

allowable.92

87
Id at 513-14.
88
Id
89
Id
90
Id at 513-14.
91
Id at 511-13
92
Id at 514.


A review of the case law reveals that the Tax Court has been reasonable and guarded in

applying anti-abuse theories to re-characterize transactions under the economic substance

doctrine. They have often disregarded the overreaching litigation positions of the IRS and has

granted minimal respect to administrative authority purporting to interpret a treaty, or a domestic

tax law directly affecting a treaty. Instead, they have independently analyzed each transaction

before applying any anti-abuse doctrines, and have set out a coherent list of distinguishing

factors between legitimate and sham MPF transactions. There rulings are in conformity with the

United States tax treaties, as the courts have validated MPF transaction between related parties

that have legitimate business purposes. They have also invalidated “sham” transactions that only

seek to achieve tax avoidance and serve no business purpose. In sum, they have used anti-abuse

doctrines to serve the dual purposes of a tax treaty--- avoid double taxation for the taxpayer and

prevent the taxpayer from abusing tax treaties to avoid taxes through transactions of no economic

substance. While doing so they have adhered to the texts of the tax treaties in question and have

expressed their high regard for fulfilling obligations under tax treaties.

IV. TREASURY REGULATIONS AND TAX TREATIES

The executive branch's interpretation of ambiguous tax laws through the treasury

department, known as Treasury Regulations, may lead the law to be applied in a manner that

violates a tax treaty. These interpretations have been cited as possible instances of treaty

overrides in such context.93 At the same, a Treasury Regulation may reasonably interpret a tax

law within the bounds of treaty obligations.

93
see note 3


Generally, congressionally authorized executive interpretations of ambiguous federal law

are given Chevron, or "great weight" deference by courts.94 In the context of treaty

interpretations, the executive opinion may be given "great weight" deference, but no deference

may be given if the executive opinion is not feasible in light of other interpretive evidence. 95

Executive interpretations of treaties seem, in practice, to be given Skidmore deference, which

determines that the deference given to the opinion should be proportional to its persuasiveness in

the interpretive context.96 Under these rules alone it is hard to ascertain how a Treasury

Regulation can become a treaty override in itself. It would take an improper application by a

court for a treaty override to take effect.

94
Chevron deference applies when: (1) “Congress has explicitly left a gap for the agency to fill”; (2) “there is an
express delegation of authority to the agency to elucidate a specific provision of the statute by regulation”. Chevron
v. National Resources Defense Council, 467 U.S. 837, at 843-44 (1984). Recently, the Supreme Court affirmed that
Chevron deference, and not another standard, would apply when evaluating treasury regulations. Mayo Foundation
for Medical Education and Research v. United States, 113 S.Ct. 704, at 713 (2011).
95
Sumitomo Shoji America v. Avagliano 457 U.S. 176, 184-85 (1982); Kolovrat v. Oregon 366 U.S. 187, 194
(1961). It is unclear where the term “great weight entered into play. All the prior cases cited to for this proposition
simply acknowledge the executive interpretation as something worth considering as interpretive evidence. Factor v.
Laubenheimer, 290 U.S. 276, at 295 (1933) (“And in resolving doubts the construction of a treaty by the political
department of the government, while not conclusive upon courts called upon to construe it, is nevertheless of
weight.”) Nielsen v. Johnson 279 U.S. 47, at 52 (1929) (“When their meaning is uncertain, recourse may be had to
the negotiations and diplomatic correspondence of the contracting parties relating to the subject matter and to their
own practical construction of it.” The court went on to rule against the government in denying treaty benefits under
a tax treaty) Charlton v. Kelly 229 U.S. 447, at 468 (1913) (“A construction of a treaty by the political department of
the Government, while not conclusive upon a court called upon to construe such a treaty in a matter involving
personal rights, is nevertheless of much weight.”)
96
“The rulings, interpretations, and opinions…while not controlling upon the courts by reason of their authority, do
constitute a body of experience and informed judgment to which courts and litigants may properly resort for
guidance. The weight of such a judgment in a particular case will depend upon the thoroughness evident in its
consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those
factors which give it power to persuade, if lacking power to control.” Skidmore v. Swift & Co., 323 U.S. 134, at 140
(1944).


US courts have taken cautious consideration of Treasury Regulations that appear to

conflict with the plain meaning and contextual meaning of a tax treaty obligation. They have

tended to treat the regulation as an indicator of US intent, but have not treated them as a decisive

indication of shared intent between the treaty partners. Instead, they are just one of many sources

considered by the court in their attempt to find the parties' intended meaning of treaty provisions

at the time of negotiating, signing, and ratifying the treaty.

In National Westminster Bank PLC v. United States the Federal Circuit Court of Appeals

affirmed the Federal Claims Court in their refusal to yield to the IRS's application of Treasury

Regulation 1.882-5, in light of the US's obligations under the 1975 US-UK Tax Treaty.97 The

plaintiff (NatWest) sought a refund of taxes levied on them due to, what they claimed, was the

improper allocation of interest expenses under the formula the IRS was attempting to enforce

under 1.882-5.98 NatWest claimed that the formula implemented by the IRS violated the US-UK

Tax Treaty because it failed to treat NatWest's branch as an entity independent from NatWest. 99

NatWest, a UK bank, had unincorporated branches throughout the world. They would

lend money to their US branch from their home office in the UK, and from other branches

97
National Westminster Bank v. United States, 44 Fed. Cl. 120 (1999), aff'd, 512 F.3d 1347 (2008), rehearing
denied en banc, 2008 U.S. App. LEXIS 11124.
98
National Westminster Bank, supra note 104, 512 F.3d 1347 at 1349 (2008).
99
Id.


located throughout the world.100 These loans to the US branch were made in return for interest

on the loan, set at prevailing market rates.101

In turn, the US branch would lend these fund to US customers and in addition, the US

branch would lend to other NatWest branches at interest rates reflecting market value. 102 When

the US branch is taken as an independent entity it has interest income based on the loans made to

customers and other NatWest branches, while they take interest expense deductions for the

interest payments made to NatWest and its' branches based upon loans made to the US branch. 103

Generally, 1.882-5 provides a formula for a branch of a foreign enterprise to determine

how much interest expenses are allocable to the US branch. It requires that the US branch

establish a value of its total assets, based upon the books of the branch, but disregarding intra-

corporate loans, such as the ones that NatWest's US branch was receiving (and giving as well). 104

In the second step, the amount of liabilities allocable to the US branch is determined by

multiplying the value of the assets (determined in Step 1) by 95% or by a ratio of the foreign

corporation's worldwide liabilities to the total value of their worldwide assets. 105 Finally, the

100
National Westminster Bank, 44 Fed. Cl. 120 at 121.
101
Id
102
Id at 121
103
Id at 121-22
104
26 C.F.R. 1.882-5(b); (b)(1)(iv)
105
26 C.F.R. 1.882-5(c)


taxpayer can determine the amount of their deduction by using one of two methods proscribed in

1.882-5.106

The issue in this case arises from the first step in the formula, which disregards intra-

corporate debt.107 By ignoring this debt, the IRS treats the US branch of NatWest as related to

NatWest, whereas the treaty directs the US branch to be treated as "a distinct and separate

enterprise."108 NatWest, supported by the United Kingdom, argued that this was improper under

the treaty and that a formulaic interest expense allocation did not follow the separate enterprise

principle called for in Article VII of the treaty. 109

In order to resolve the question the court began with an interpretation of the plain

language of Article VII of the treaty. The court concluded that Article VII was clear in its plain

meaning and that NatWest's US branch should be treated as a separate and distinct entity. 110

Therefore, initially, 1.882-5 appears to violate the US-UK Tax Treaty. But, the court proceeds to

an investigation of the intended purpose behind the treaty. 111 However, the sources the court

went on to consider, and the weight they allotted to such sources, reveals something more about

106
26 C.F.R. 1.882-5(d)
107
Id at 123
108
Id. See also National Westminster Bank, 512 F.3d 1347, 1354
109
Id. See also National Westminster Bank, 512 F.3d 1347, 1357
110
Id at 123-24. See also, National Westminster Bank, 512 F.3d 1347, 1354-1355.
111
The plain meaning interpretation creates a presumption that such interpretation will control unless it “effects a
result inconsistent with the intent or expectations of its signatories.” Maximov v. United States, 373 U.S. 49, at 54
(1963)


how court's approach tax treaty interpretation and how they regard Treasury Regulations in such

context.

Both the Federal Court of Appeals and the Federal Claims Court rested their opinion on

the actions of the UK prior to the treaty taking effect, but after its ratification; the US Senate and

Treasury Department interpretation contemporaneous to the ratification of the treaty, and the

court leaned heavily on OECD Model Tax Convention & Commentaries.112 The OECD serves

as the international body which "provides a forum in which governments can work together to

share experiences and seek solutions to common problems", in addition to making "life harder

for...tax dodgers...whose actions undermine a fair and open society". 113 In fulfilling its mission

the OECD releases numerous "standards and models, for example in the application of bilateral

treaties on taxation".114 The Model Tax Convention sets out its main purpose, which is to

encourage tax conventions between states which provide relief from double taxation, while

preventing abuse of tax laws resulting in tax evasion. 115 The influence of the OECD model has

been recognized by Congress's joint committee on taxation. It stated the OECD model, in

112
National Westminster Bank 44 Fed Cl. 120, at 128. See also, National Westminster Bank, 512 F.3d 1347, at
1355-57, 1359-60
113
About OECD, OECD, (Accessed Apr. 20 2011, 3:11pm),
http://www.oecd.org/pages/0,3417,en_36734052_36734103_1_1_1_1_1,00.html
114
Id.
115
OECD 2010 Model Tax Convention on Income and Capital (Condensed Version), Commentary to Article 1, p.
59, July 22, 2010, http://browse.oecdbookshop.org/oecd/pdfs/browseit/2310081E.PDF


addition to the Treasury Department model, "reflect a standardization of terms that serve as a

useful starting point in treaty negotiations."116

Moreover, this standardization has resulted in tax treaties negotiated between individual

countries that are substantially the same to the OECD model and have developed international

norms in consummating bi-lateral tax treaties.117 The OECD is consistently used by international

courts when interpreting tax treaties. These courts view the OECD as a highly relevant source of

law, applicable in the context of tax treaties. 118 Unfortunately, US courts have not been

consistent in their consideration of the OECD commentaries. But, the commentaries have

received greater attention from US courts in the past fifteen years, at times being an instrumental

consideration for courts in reaching their decisions. 119 The NatWest decision serves as an

illustration of the latter.

The language the court uses to describe the OECD Model Convention & Commentaries

indicates that they hold a high level of respect for the rules and the interpretations held within.

They start by noting that the "entire context" of the US-UK Tax Treaty is "informed by, and

based on" the Model Convention. The court accepts the commentary to be what the OECD

states it is--- "great assistance...in the settlement of eventual disputes." 120 More importantly, the

116
The Joint Committee on Taxation, Description and Analysis of Present-Law Rules Relating to International
Taxation, June 28, 1999, JCX-40-99, at Pt. IV, C, 1.
117
Allison Christians, Hard Law, Soft Law, and International Taxation, 25 Wis. Int'l L.J. 325, 327-329 (2007).
118
see Maisto, supra note 40 and Lang, supra note 20.
119
Podd v. Commissioner, TCM 1998-418 (1998); American Air Liquide v. Commissioner, 116 TC 23, (2001);
Northwest Life Insurance v. Commissioner, 107 TC 363 (1996); Tasei Fire & Marine Insurance v. Commissioner,
104 TC 535 (1995).
120 Westminster Bank, 512 F.3d 1347, 1353-54.


Federal Court of Claims made a presumption that the OECD Model and Commentaries are "in

the minds of the treaty negotiators."121

The court read the OECD commentary to affirm the separate enterprise principle, but not

without exceptions. First, when a branch and its head office do not keep separate accounts a

formulaic allocation of expenses may be necessary and is allowable.122 Second, some branch-

head office transactions may have to be adjusted to reflect an arms-length transaction if the

terms do not reflect those normally found in the market.123 Third, and most pertinent to this case,

is that the commentaries note that intra-corporate expenses, such as royalties or interest from a

branch to a home office should be disregarded in determining deductible expenses attributable to

the branch office.124 However, this third exception is subject to an exception of its own. The

commentary notes that "payments of interest made by different parts of a financial enterprise"

should not be disregarded as an expense of the branch office because "it is narrowly related to

the ordinary business of such enterprise."125

The court jumps on this language to support NatWest in this case, interpretating1.882-5

as incompatible with Article VII. 126 The commentary confirmed the court's plain meaning

121 National Westminster Bank, 44 Fed. Cl. 120 at 125.

122
Id at 126-27; See also National Westminster Bank, 512 F.3d 1347, at 1356.
123
Id
124
Id
125
Id
126
Id at 127-28


interpretation of Article VII, at least as it applies to interest payments "incurred by the permanent

establishment of an international financial enterprise" such as NatWest's US branch office. 127

After concluding that the OECD commentaries supported Article VII's plain meaning,

especially as applied to NatWest as a financial institution, the Federal Circuit Appeals Court had

a chance to address the government's contention that the Federal Claims Court failed to grant the

proper deference to the executive opinion that the 1.882-5 is consistent with Article VII of the

US-UK Tax Treaty.128 The court recognized that it is not improper to give the interpretation

deference, but they concluded that such deference should not be given to the executive

unbridled, moreover in some contexts it should not be given at all. 129 In the end, the court

concluded that the US interpretation that 1.882-5 was in conformity with Article VII did not

warrant deference. They noted that the circumstances in this case made deference

unwarranted.130

First, the treaty partners were in conflict over the meaning of the provision and the court's

objective is to find the shared intended meaning of the treaty partners, not a unilateral

meaning.131 In addition, prior to the treaty taking effect the UK calculated the interest expense

deduction for a UK branch of a foreign company using a similar formula to that of 1.882-5. In

1978, after signing the treaty, but before it took effect, the UK "abandoned its formula after

127
National Westminster Bank, 512 F.3d 1347, at 1356.
128
Id at 1358.
129
Id
130
Id
131
Id


concluding that the formula was inconsistent with the separate enterprise principle."132 The court

felt that, in this context, the UK's action was a conclusive sign of how they interpreted Article

VII.133

Second, the court did not accept the US interpretation, that 1.882-5 was consistent with

Article VII of the Treaty, as "long-standing".134 The court noted that the Senate ratification

history, along with Treasury Department statements contemporaneous to treaty negotiations, did

not show an intention that 1.882-5's interest allocation formula was consistent with the US's

interpretation at the time of signing the treaty in 1975.135 They noted that 1.882-5 was not

proposed until 1980, five years after the treaty was signed. 136 Additionally, the court was

unpersuaded by a 1984 OECD Report acknowledging the US's interpretation of Article VII to

allow for the application 1.882-5's interest allocation formula.137

Of course, these circumstances were considered in light of the Treaty and OECD analysis

above, which already revealed flaws in the Treasury’s interpretation. The pragmatic approach of

the federal courts in NatWest illustrates how US courts deal with executive opinions that are

contrary to the terms of a treaty. Although they will consider the executive opinion it is difficult

for the opinion to prevail in the face of evidence that puts its correctness and reasonableness in

132
Id at 1356-57
133
Id
134
Id at 1358-59
135
Id
136
Id
137
Id at 1358-59.


question. Therefore, a treaty override can't take place by the simple issuance of an executive

interpretation, through treasury regulations or otherwise.

V. CONCLUSION

The separate branches of the US government all have their input in creating and

administering tax laws. The US Congress has undoubtedly been guilty of the occasional treaty

override, but their behavior cannot be described as wholly disregarding tax treaty obligations.

Congress will often pass legislation to close loopholes that are created by tax treaties, but,

oftentimes these treaties do not demand these loopholes exist.

The treasury department has also attempted to close loopholes created by tax treaties

through interpreting the tax laws and the context of their application. Sometimes, the Treasury

Department oversteps the bounds of the law with their interpretations, but they have not gone

unchecked. US courts have been faithful to tax treaty obligation contracted for by the US and its

treaty partners. Courts have denied taxpayers benefits but only when they seek to undertake

transactions with the sole purpose of tax avoidance through treaty-shopping and abuse. On the

other hand, courts have disregarded unreasonable opinions of the executive branch in the face of

a contrary treaty obligation.

The US has not been fully faithful in administering its tax treaties, but it is difficult to

find a state that has been. The rapidly evolving nature of tax law makes it nearly impossible for

these broad and generally worded treaties to anticipate every scenario that will test their

application. However, the US has administered its tax treaties in a manner that serves their dual

purposes as established in the international community. The US is party to a network of bilateral


tax treaties that grants foreign taxpayers generous tax breaks, and oftentimes will give the

taxpayer more than the benefit of relief from double taxation. When these generous benefits are

taken advantage of a problem is created and the US has set out to fix these problems. The fix has

rarely been treaty overrides. Instead, the fix has come in the form of justified and reasonable

action to maintain a treaty network that allows generous benefits for actual economic activity,

while disallowing for abuse of those benefits by taxpayers with no other economic motive.

While one could question the US's international tax policy from an economic

perspective, it is hard to question the US practice from a legal perspective in light of counterpart

states' practice and the dual realities of tax law. In the young life of tax treaties the actions taken

to solve treaty shopping problems by the US government and other international governments

serve as the basis of international tax laws and principles that are becoming customary to follow.

While some may find this approach difficult to condone, it is a reality of tax law. Treaty

overrides are resorted to sparingly, and usually justifiably. This experimental system allows for

the perpetuation of the tax treaty network and allows treaty partners to feel more comfortable in

granting broader benefits under a treaty. It also trusts the courts to do their job when interpreting

tax treaties in order to prevent them from becoming hollow documents--- either by limiting their

benefits to render them meaningless or expanding them to grant benefits well beyond those

intended by the parties to the treaty.

A Defense of the United States Application and Interpretationof Tax Treaties

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