CCA 1343019: Cypriot holding company can support qualified dividend treatment

Plain-English summary

Chief Counsel Advice considers whether dividends from a Cypriot holding company can receive the reduced tax rate for qualified dividend income when the company is not owned by Cypriot residents. It concludes that the company can qualify as a qualified foreign corporation under IRC section 1(h)(11) if it is eligible for the U.S.-Cyprus treaty and was established and maintained for reasons unrelated to obtaining treaty benefits. The advice applies the treaty's limitation-on-benefits provision and the principal-purpose test. If those facts are present, the U.S. shareholder's dividends can receive the applicable net capital gain rate.

Ruling snapshot

• Question: Can a Cypriot holding company with no Cypriot ownership qualify for treaty benefits and support the reduced rate for qualified dividends?
• Outcome: Advice given
• Key authorities: IRC §§ 1(h)(1), 1(h)(11); U.S.-Cyprus income tax treaty, Articles 3 and 26; Notice 2011-64

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 201343019
       Release Date: 10/25/2013
       CC:INTL:B01:RLLor
       POSTN-134729-13

UILC: 1.11-00, 9114.03-08

date: September 10, 2013

 to:   James C. Fee, Jr.
       Senior Level Counsel (Philadelphia)
       Global High Wealth Industry
       (Large Business & International)

from: David L. Lundy
Assistant to the Branch Chief
Branch 1
Office of Associate Chief Counsel
(International)

subject: Qualified Dividend Income from Cypriot Holding Company -- I.R.C. section 1(h)(11)

       This memorandum responds to your request for nontaxpayer-specific Chief Counsel
       Advice. This advice may not be used or cited as precedent.

                                                   ISSUE

              Whether a Cypriot holding company with no Cypriot ownership can qualify for
       benefits of the U.S.-Cyprus income tax treaty (the “Treaty”)1 for purposes of I.R.C.
       section 1(h)(11),2 which provides U.S. shareholders with a reduced rate of tax on
       dividends received from “qualified foreign corporations.”

                                               CONCLUSION

              A Cypriot holding company with no Cypriot ownership can qualify for benefits of
       the Treaty for purposes of section 1(h)(11) if the establishment, acquisition, and


       1
         CONVENTION BETWEEN THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF THE
       REPUBLIC OF CYPRUS FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION
       WITH RESPECT TO TAXES ON INCOME, SIGNED MAR. 19, 1984, reprinted in 2 Tax Treaties (CCH) ¶ 2303.
       2
         Section references are to the Internal Revenue Code of 1986, as amended.

POSTN-134729-13 2

maintenance of the company and the conduct of its operations did not have as a
principal purpose obtaining benefits under the Treaty. In this case, the company was
established in Cyprus, and is being maintained, for reasons unrelated to the Treaty.
The company qualifies for benefits under Article 26(2) of the Treaty because there was
no principal purpose of obtaining treaty benefits. Thus, the company is a “qualified
foreign corporation” for purposes of section 1(h)(11), and dividends received by the
company’s U.S. shareholder will qualify for a reduced rate of tax.

                                      FACTS

   HoldCo is a corporation organized under the laws of Cyprus. Taxpayer, a U.S.

resident, owns a portion of the outstanding shares of Holdco. The remaining shares are
owned by persons who are not residents of the United States or Cyprus. HoldCo, which
owns an operating company in a third country, was established in Cyprus for reasons
unrelated to the Treaty. HoldCo has never earned U.S.-source income or claimed any
benefit under the Treaty. On his Form 1040, Taxpayer treated dividends he received
from Holdco as “qualified dividend income.”

                               LAW AND ANALYSIS

   Under section 1(h)(11), dividends received from a ‘qualified foreign corporation’

are treated as ‘qualified dividend income’ eligible for a reduced rate of tax. Section
1(h)(1) sets forth the preferential tax rates applicable to “net capital gain.” According to
section 1(h)(11)(A), net capital gain includes “qualified dividend income.”

    Section 1(h)(11)(B)(i) defines qualified dividend income as “dividends received

during the taxable year from (I) domestic corporations, and (II) qualified foreign
corporations.” A qualified foreign corporation is “any foreign corporation if (I) such
corporation is incorporated in a possession of the United States, or (II) such corporation
is eligible for benefits of a comprehensive income tax treaty with the United States
which the Secretary determines is satisfactory for purposes of this paragraph and which
includes an exchange of information program.” Section 1(h)(11)(C)(i).

   Notice 2011-64, 2011-37 I.R.B. 231 (Sept. 12, 2011), contains a list of U.S.

income tax treaties that meet the requirements of section 1(h)(11)(C)(i)(II). Section 3 of
Notice 2011-64 provides:

           In order to be treated as a qualified foreign corporation under the
   treaty test, a foreign corporation must be eligible for benefits of one of the
   U.S. income tax treaties listed in the Appendix. Accordingly, the foreign
   corporation must be a resident within the meaning of such term under the
   relevant treaty and must satisfy any other requirements of that treaty,
   including the requirements under any applicable limitation on benefits
   provision. For purposes of determining whether it satisfies these
   requirements, a foreign corporation is treated as though it were claiming

POSTN-134729-13 3

  treaty benefits, even if it does not derive income from sources within the
  United States. See H.R. Conf. Rep. No. 108-126, at 42 (2003) (stating
  that a company will be treated as eligible for treaty benefits if it “would
  qualify” for benefits under the treaty).

The Appendix to Notice 2011-64 includes Cyprus in the list of countries with which the
United States has income tax treaties that meet the applicable requirements.

   Paragraph 1(a)(i) of Article 3 (Fiscal Residence) of the Treaty provides that the

term “resident of Cyprus” includes a Cypriot corporation. Paragraphs 1 and 2 of Article
26 (Limitation on Benefits) of the Treaty provide as follows:

         (1) A person (other than an individual) which is a resident of a
  Contracting State shall not be entitled under this Convention to relief from
  taxation in the other Contracting State unless

               (a) more than 75 percent of the beneficial interest in
         such person (or in the case of a corporation, more than 75
         percent of the number of shares of each class of the
         corporation’s shares) is owned, directly or indirectly, by one
         or more individual residents of the first-mentioned
         Contracting State; and

                (b) the gross income of such person is not used in
         substantial part, directly or indirectly, to meet liabilities
         (including liabilities for interest or royalties) to persons who
         are residents of a State other than a Contracting State and
         who are not citizens of the United States.

  For the purposes of subparagraph (a), a corporation that has substantial
  trading in its stock on a recognized exchange in a Contracting State is
  presumed to be owned by individual residents of that Contracting State. A
  stock exchange shall be treated as a “recognized exchange” by
  agreement of the competent authorities of the Contracting States.

         (2) Paragraph 1 shall not apply if it is determined that the
  establishment, acquisition and maintenance of such person and the
  conduct of its operations did not have as a principal purpose obtaining
  benefits under the Convention.

    The Treasury Department Technical Explanation (the “TE”) of paragraph 2 of

Article 26 provides:

         Under paragraph (2), paragraph (1) will not apply, and benefits will
  not be denied, even if the conditions of paragraph (1) are not met, if it is

POSTN-134729-13 4

   determined that the establishment, acquisition and maintenance of the
   person claiming treaty benefits and the conduct of its operations did not
   have the obtaining of treaty benefits as a principal purpose. This test
   recognizes that there are bona fide business reasons for an entity in a
   Contracting State to be owned by residents of a third state. In many
   circumstances, the granting of treaty benefits to such a person is not
   inconsistent with the objectives of the treaty. This test would be met, for
   example, if a Cyprus company owned by residents of third countries
   conducts business operations in Cyprus and holds investments in the
   United States, or engages in business activities in the United States,
   which are related or incidental to those business activities. For example, if
   the Cyprus company lends money to a supplier in the United States in
   order to assure a source of supply, and thereby derives interest income
   from the United States, that income could be considered incidental to its
   business activities. The test of paragraph (2) would also be met if the
   aggregate Cypriot tax burden is equal to or greater than the tax reductions
   claimed under the Convention. The test could also be satisfied in other
   ways. It should be noted that a resident of Cyprus who, under paragraph
   6 of Article 4, fails to qualify for treaty benefits cannot have the benefits
   restored by virtue of paragraph 2 of this Article.

    Taxpayer will be eligible for the reduced rate of tax on dividends he received from

HoldCo if the company is a “qualified foreign corporation” under section
1(h)(11)(C)(i)(II). To be a qualified foreign corporation, HoldCo must be eligible for
benefits of the Treaty. As provided by Notice 2011-64, HoldCo is treated as though it
were claiming treaty benefits. HoldCo is a resident of Cyprus under Article 3(1)(a)(i) of
the Treaty because it is a corporation organized under the laws of Cyprus. HoldCo
cannot qualify for benefits of the Treaty under paragraph 1 of Article 26 because it is not
owned by individual residents of Cyprus. The issue, then, is whether HoldCo can
qualify for benefits under paragraph 2 of Article 26, which turns on whether there was a
‘principal purpose’ of obtaining benefits under the Treaty.

   The TE provides examples of how a Cypriot entity might satisfy the test in

paragraph 2 of Article 26. One of the examples describes a Cypriot company that
conducts business operations in Cyprus. The company qualifies under paragraph 2
because it did not have a principal purpose of obtaining benefits under the Treaty. In
addition to the specific examples described, the TE indicates that the test of paragraph
2 also could be satisfied in other ways.

   In this case, HoldCo was established in Cyprus, and is being maintained, for

reasons unrelated to the Treaty. HoldCo qualifies under paragraph 2 of Article 26
because there was no ‘principal purpose’ of obtaining benefits under the Treaty. Thus,
HoldCo is a “qualified foreign corporation” for purposes of section 1(h)(11), and dividend
income that Taxpayer received from HoldCo qualifies for the applicable net capital gain
tax rate set forth in section 1(h)(1).