Let’s Make A Deal: Examining The Chile-U.S. Tax Treaty

Tax Notes reporters Cady Stanton and Michael Smith discuss the recently passed Chile-U.S. tax treaty and the importance of tax treaties on both a national and international scale.

This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: It’s been a while.

On June 22 the U.S. Senate voted to approve the tax treaty between the United States and Chile after a decade-long delay. First signed in 2010, the treaty has struggled to make its way through Congress, but this long-awaited approval may set the stage for the passage of other pending treaties.

So what can we expect from the treaty process in the future and why are tax treaties so important? Tax Notes Capitol Hill reporter Cady Stanton and Tax Notes legal reporter Michael Smith will talk more about. Cady, Michael, welcome to the podcast.

Cady Stanton: Thanks for having me.

Michael Smith: Thanks for having me.

David D. Stewart: So Cady, could you give us some background on why it took so long for the U.S.-Chile treaty to pass through Congress?

Cady Stanton: Starting off with a brief timeline, the U.S. and Chile initially signed a tax treaty in February of 2010. The treaty first came up for consideration in the Senate in 2012 but had been languishing in the chamber for over a decade because of one senator, Republican Rand Paul of Kentucky.

Paul has long opposed the way the U.S. goes about treaties with other countries, particularly on how they address taxpayer privacy. He’s constantly taken issue with these agreements because of concerns he has that they could allow other countries’ tax bureaus the ability to access information on U.S. citizens.

When I spoke to Senator Paul about the Chile tax treaty and why he had opposed it for so long, he said he had the same complaints he’s had about tax treaties for more than 10 years. His pushback to the Chile tax treaty has more to do with our treaty process in general than it does with our relationship with that country in particular.

The treaty made progress this month due in part because of Chile’s position as one of the world’s leading producers of lithium, a critical mineral component in emerging technologies, including rechargeable batteries for things like phones, laptops, and electric vehicles.

David D. Stewart: Now, what is the more general process for a treaty to get through Congress?

Cady Stanton: Something that’s important to note when we’re talking about the treaty process in the U.S. federal government is that the Senate doesn’t technically ratify treaties. Rather, it takes up a resolution of ratification, formally approving of and consenting to those treaties that are negotiated by the executive branch with other countries.

When the full Senate votes to approve that resolution, the president is then allowed to proceed with fully ratifying the treaty. So once the two countries signed the Chile-U.S. tax treaty, the president submitted it to the Senate for consideration for that resolution and first, the Senate Foreign Relations Committee considered and voted on the treaty before reporting it to the full Senate.

Fun fact, the committee actually voted to approve the resolution four times across multiple congressional sessions before it finally got to a floor vote this month. Once the committee voted to approve of the resolution by a vote of 20 to 1, that one vote being Rand Paul on June 1, the full Senate then voted 95 to 2 to approve of the treaty on June 22.

David D. Stewart: How was Rand Paul as one senator holding up this treaty for the last decade?

Cady Stanton: In order for these treaty resolution approvals to fully pass, the Senate needs a two-thirds supermajority to get it through full passage. And Rand Paul’s objection, related to taxpayer privacy, was also getting the interest of some other Republican senators until [the treaty] gained so much support and so much pressure because of the impact over 12 years on U.S. citizens in Chile and being under double taxation. Eventually the tide of opinion about the treaty led to having a supermajority despite his single opposition.

Rand Paul intended to introduce an amendment around taxpayer privacy for this treaty, but in the end, conceded, and himself and Sen. Josh Hawley of Missouri were the only senators to vote against the treaty in the final vote.

David D. Stewart: OK. What sort of things are in this treaty?

Cady Stanton: The final text of the treaty includes two reservations. One on the U.S. tax on base erosion payments of corporations with substantial gross receipts, and one on relief from double taxation.

But it’s also important to talk about how the treaty includes a declaration on the need for future tax treaties to reflect changes made to international tax provisions as part of the Tax Cuts and Jobs Act in 2017. That was something that had held up the treaty more recently in the past few weeks and months.

Once President Biden proceeds with ratification, which he’s expected to do, Chile would become the third Latin American country with [a] double tax treaty with the United States, along with Mexico and Venezuela.

David D. Stewart: Now I know there are other treaties out there and other agreements. What’s still out there that needs to be taken up by the Senate?

Cady Stanton: The next treaty the committee is likely to consider is actually a really interesting one because it’s not really fully a treaty. It would be a tax agreement with Taiwan. The Senate is working on a tax agreement, which is similar to a tax treaty, because the United States does not have formal diplomatic relations with Taiwan.

There’s some really complicated politics at play because a tax agreement with Taiwan could definitely heighten tensions with China, which sees Taiwan as part of its territory and has undermined Taiwan’s efforts towards independence.

But top taxwriters in the Senate Finance and House Ways and Means committees from both parties have all issued statements in support of a tax agreement with Taiwan. So the desire for a formal agreement is apparent, but while the common goal is clear, the logistics of how to finalize it are yet to be ironed out.

David D. Stewart: Is there any sense of when this might come up for a vote and is there a potential tide the way that Chile had to get it over that hurdle?

Cady Stanton: Absolutely. Given there’s bipartisan and bicameral support for a tax agreement with Taiwan, it seems to be a pretty top priority in terms of treaties and agreements for the Senate [Foreign] Relations Committee. But the Taiwan tax agreement has been on the agenda for that committee for its business meetings multiple times in recent weeks and has been either delayed or rescheduled week after week without much explanation.

It’s hard to say when the delicate politics of the agreement might find a resolution, and the agreement might not come up for a vote in the committee or the full Senate for weeks or months, depending on how long sorting through those politics might take.

David D. Stewart: OK. Now Michael, Cady was talking a bit about these reservations to the Chile treaty. Could you tell us about what those mean for the implementation?

Michael Smith: Yeah, thanks, Dave. The reservations have to get sent back to Chile and then be approved by the Chilean Congress on their own afterwards. Historically, reservations haven’t really had the best track record. I think the last set of reservations we had was with Italy in 1999 when President Clinton signed it. That languished around for about a decade before it finally got passed through the Italian congress. It was also subject to two different sets of diplomatic notes before they finally implemented it.

David D. Stewart: OK. So is it possible that this would then have to bounce back and forth or is it just, this is what we have?

Michael Smith: It really depends how that negotiation goes between the United States and Chile. There’s a lot of speculation that these reservations are going to go through pretty quickly. The reservations for BEAT [base erosion and antiabuse tax] and relief from double taxation are just adjustments from the 2017 Tax Cuts and Jobs Act. They’re fairly straightforward in that sense.

Also, Chile has been providing some forms of tax relief for U.S. investors for the past several years in this instance. They’ve been providing relief for U.S. investors in the area and that just had to be re-upped every couple years.

So a lot of people are expecting this to pass through pretty quickly because that level of stability between the countries is important.

David D. Stewart: All right. Now, I understand that the U.S. maintains these model tax treaties that get updated periodically. What sort of new features will we find in this treaty?

Michael Smith: Yeah, in 2016, the U.S. put out its 2016 model tax treaty. It had a couple different changes to stop different forms of treaty shopping that the country believed was happening around that time.

One of the big ones was article 22 on the limitation on benefits to try and avoid these types of treaty shopping because it changed it from income “derived from a business” to “emanates from a business.”

This allowed some forms of aggregation to track and verify where income was coming from other countries and avoid different organizations using permanent establishments and profit shifting in order to avoid taxation and essentially have double nontaxation.

David D. Stewart: What other pending treaties are you watching out for and are there any unique issues to be watching for?

Michael Smith: One of the interesting treaties coming up is Croatia. The U.S. signed a treaty with Croatia this last December, and it includes one of the reservations that’s in the Chile treaty. It includes the reservation to preserve BEAT.

It’s interesting to see how that moves forward because it will give us more glimpses into how the U.S. is going to model its treaty negotiations moving forward, into whether these two reservations are going to become baseline policy for treaty negotiations moving forward.

There’s also several treaties that are in negotiation stages right now. Israel and Switzerland are two examples that we originally believed were going to be just protocols, but Treasury recently indicated that they’re going to need a new treaty with Israel.

It was originally signed in 1975 with amending protocols in the early ’80s and early ’90s. A lot of the treaty doesn’t reflect the changes in internationalization and how interconnected the world has [become] in that sense. So there’s a lot of updates that are needed for the treaty to include these kind[s] of aspects.

So that’s a new avenue to see where Treasury and where the United States goes with their treaty negotiations as well. I think those are interesting to look forward to to see how exactly all of this plays out and where those reservations come in or the model treaty comes in for these kind[s] of negotiations.

David D. Stewart: All right, so taking a bigger-picture view here about the idea of a tax treaty to begin with: What is the importance of a tax treaty at both the national and international scale?

Michael Smith: Money talks. Trade agreements are a big deal, but taxes are the underpinning for a lot of these kinds of trade. Tax agreements are able to create incentives for companies to trade both internally and internationally in these instances, and in this situation, it’s for getting these kinds of productions of resources that the United States needs and this kind of cooperation on larger matters.

Agreement to a tax treaty can mean just agreement for those single interactions, but it also develops a level of agreement between countries that shows willingness to continue operations between not just the countries, but also companies in those regions as well.

David D. Stewart: All right. These treaties have been held up and we haven’t seen a new one in over a decade. What is the consequence of these treaties just not being ratified by the United States?

Michael Smith: The treaties can have large consequences. I think that a lot of the tax credits that we’ve seen for things like electric vehicles are also a way to combat our inability to get these kinds of resources. Chile, for example, has the world’s largest reserve of lithium and [is the] second-largest producer. They recently went through a process to up their production in order to start exporting even more lithium.

I think the electric vehicle movement and a lot of clean energy movements have been greatly hindered by the inability to create these kinds of treaties throughout the world and specifically with the United States. I think that our production and ability to get these resources has been greatly hindered by our inability to have treaties with varying countries.

The delays in treaties also have large implications for individuals and corporations at large with the recent changes to the 2022 foreign tax credit regulations. They changed the sourcing rules for another country to be sufficiently similar to the U.S. tax rules.

In which case, it means that the sourcing rules have to follow the place-of-use standard rather than a residency-based standard. Residency-based standards are typically what’s used in the rest of the world, and the United States kind of has its own special place with a place-of-use standard. This changed the tax treatment of a lot of different payments that companies were making.

Originally they were getting a one-for-one tax credit for the taxes they were paying in other countries. And under the new sourcing rules, these would be disallowed in some instances.

While Treasury has provided so much needed relief in this area, it’s been more problematic because treaties operate as a primary means of backstopping from double taxation in these areas. Without a tax treaty, that means taxpayers have to go through the rigmarole of going through the foreign tax credit evaluation and going through all of the associated paperwork that’s involved in that kind of area.

This causes a lot of unnecessary work or unneeded work when we could just have tax treaties that provide a primary method of relief for taxpayers in this area.

David D. Stewart: Well, all right, now, this being the first treaty that has been approved since this podcast began, I hope that potentially we can have more discussions of future treaties. Cady, Michael, thanks for being here.

Cady Stanton: Thanks for having me.

Michael Smith: Thanks for having me, Dave.