United States

Swiss holding company not eligible for treaty benefits

INSIGHT ARTICLE  | 

In a recent ruling, see Starr Int'l Co. v. United States, the U.S. District Court for the District of Columbia sustained the IRS’s decision to deny Swiss-domiciled Starr International Co. (Starr) treaty benefits under the bilateral tax treaty between the United States and Switzerland (the “Treaty”).  Accordingly, Starr will not be entitled to the 5 percent or 15 percent favorable tax rates available under the Treaty on approximately $191 million in dividends it received during the year at issue.  Instead Starr will be subject to the full 30 percent gross basis tax applicable to U.S. source dividends.  While Starr was a Swiss corporation, the Court concluded that the facts supported the IRS’ judgement that Starr was formed with a principal purpose of tax avoidance and therefore the IRS was justified in its refusal to grant Starr benefits under the Treaty.

In this case Starr, a multinational enterprise, was domiciled in Switzerland during the year at issue – relocating from Ireland in the immediately preceding year.  Having failed to meet any of the objective criteria for benefits under the Treaty during that year, Starr petitioned the IRS for discretionary relief under a rare provision that allows the IRS, in its sole discretion, to grant benefits to taxpayers that do not satisfy any of the other tests contained in the Treaty.  However, after substantial discussions the IRS denied Starr’s request, stating that Starr’s historical domicile selection, including its recent move to Switzerland, were motivated equally by tax and independent business purposes.

The case is significant for a variety of reasons.  First, the court rejected Starr’s claim that the IRS should grant benefits whenever an entity is owned entirely by residents of the U.S. or Switzerland on the theory that no tax avoidance occurs in such cases.  In response the court concluded that no such standard existed in the Treaty and that even in such cases tax avoidance could exist where the entity requesting benefits lacked a sufficient economic presence in Switzerland to justify treating it as a resident.  Second, the court recognized the IRS’ wide discretion in determining whether to grant benefits under the discretionary test of the Treaty, noting that the IRS’ determining was arguable entirely unreviewable.  Third, the case arguably represents an example of the application of the standard for granting treaty benefits that the drafters of the Organisation for Economic Co-operation and Development  guidelines on base erosion and profit shifting (BEPS) have advocated in their final report, commonly known as the “principal purpose” test. 

Taxpayers claiming treaty benefits should review carefully whether they meet the rigorous standards of residence contained in a bilateral income tax treaty because losing treaty benefits could result in substantial increases in tax.  

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