Tax Treaty
A tax treaty is a bilateral agreement between two countries that allocates taxing rights over cross-border income and capital, reduces or eliminates double taxation, and establishes rules for information exchange and dispute resolution between the two tax authorities.
The United States has income tax treaties with more than 60 countries. These treaties are negotiated by the Treasury Department and the IRS, ratified by the Senate as executive agreements, and given legal effect through IRC Section 894. The primary goals are to prevent the same income from being taxed in full by both the source country and the residence country, and to reduce withholding taxes on dividends, interest, and royalties paid across borders.
Withholding tax rates on dividends are a key treaty provision. Without a treaty, the US imposes a 30 percent withholding tax on dividends paid to non-resident aliens. A treaty with a country may reduce that rate to 15 percent for portfolio investors or even zero for qualifying parent-subsidiary structures. For US investors receiving dividends from foreign corporations, the foreign withholding tax paid may generate a foreign tax credit on the US return under IRC Section 901.
Treaties also contain tie-breaker rules for tax residency when an individual qualifies as a resident of both treaty countries under their domestic laws. The tie-breaker typically examines the location of the individual's permanent home, center of vital interests, habitual abode, and nationality in sequence. These provisions are critical for expatriates and individuals with significant ties to two countries.
US citizens face a notable limitation: the US taxes its citizens on worldwide income regardless of residence, which means treaty benefits are constrained by the saving clause present in virtually every US tax treaty. The saving clause reserves the US's right to tax its own citizens and residents as if the treaty did not exist, with specific exceptions for certain treaty articles such as pension provisions and the foreign earned income exclusion.