List of US income tax treaties meeting qualified dividend requirements updated

Executive summary:

Chile is added while Russia and Hungary are removed

On Dec. 28, 2023, the IRS and Treasury released Notice 2024-11, officially updating the list of U.S. income tax treaties that meet the requirements of section 1(h)(11)(C)(i)(II). The list is relevant in determining whether a corporation is a “qualified foreign corporation” and if a reduced capital gains rate on certain dividends can be applied.

The notice adds the treaty with Chile, which entered into force on Dec. 19, 2023, and removes the treaties with Russia and Hungary, because both have ceased to meet the requirements of section 1(h)(11) after the publication of Notice 2011-64, to the list.

Notice 2024-11 amplifies and supersedes Notice 2011-64.

List of US income tax treaties meeting qualified dividend requirements updated

Background

Under section 1(h)(11), dividends paid to an individual shareholder from either a domestic corporation or a "qualified foreign corporation" are generally subject to tax at reduced rates applicable to certain capital gains. Subject to certain exceptions, a “qualified foreign corporation” is any foreign corporation:

• That is incorporated in a possession of the United States;
• That is eligible for benefits of a comprehensive income tax treaty with the United States that the Secretary determines is satisfactory for purposes of this provision and that includes an exchange of information program (the treaty test); or
• Whose stock with respect to which such dividend is paid is readily tradable on an established securities market in the United States.

Passive foreign investment companies (“PFICs”) and surrogate foreign corporations that are not treated as domestic corporations are generally excluded from the definition of a qualified foreign corporation.

Analysis

Taxpayers receiving dividends from a qualified foreign corporation will be taxed at capital gain rates. Section 1(h)(1) generally provides that a taxpayer's "net capital gain" for any taxable year will be subject to a maximum tax rate of 20% (or 15% in the case of certain taxpayers). This rate does not include the 3.8% net investment income tax (“NIIT”) imposed under section 1411.

For individuals, the maximum federal income tax rate can reach 37%.

To be treated as a qualified foreign corporation under the treaty test, as described in Notice 2011-64, a foreign corporation must be eligible for benefits of one of the U.S. income tax treaties listed in the notice. This means that taxpayers must do more than just confirm a treaty is on the list. Further analysis is required. Accordingly, taxpayers must analyze if the foreign corporation:

• Is a resident within the meaning of such term under the relevant treaty; and
• Satisfies any other requirements of that treaty, including the requirements under any applicable limitation on benefits (“LOB”) provision.

For purposes of determining whether a foreign corporation satisfies these requirements, a foreign corporation is treated as though they were claiming treaty benefits, even if they do not derive income from sources within the United States. ¹

Taxpayers with foreign source qualified dividends or foreign source capital gains may be required to adjust their foreign source income for foreign tax credit (“FTC”) purposes. An adjustment under sections 1(h)(11)(C)(iv) and 904(b)(2)(B) may be required so as to not overstate the FTC due the dividend rate differential (i.e., capital gains are taxed at a lower rate than ordinary income).

Applicability date

The notice is effective for each U.S. income tax treaty as follows:

• Chile – for dividends paid on or after Dec. 19, 2023;
• Hungary – for dividends paid on or after Jan. 8, 2023; and
• Russia – for dividends paid on or after Jan. 1, 2023.

The notice does not make further changes to the list outlined in Notice 2011-64.

The IRS and Treasury intend to update the list, as appropriate.

Final reminders

Individual taxpayers receiving dividends from Chilean corporations may now be eligible for a reduced rate of tax on their “net capital gain.” Individual taxpayers receiving dividends from Hungarian and Russian corporations are no longer eligible for a reduced rate of tax on their “net capital gain.”

¹See 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).