Technical Explanation (1978)

Technical Explanation (1978)

TECHNICAL EXPLANATION OF THE CONVENTION BETWEEN THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF THE UNITED KINGDOM OF GREAT BRITAIN AND NORTHERN IRELAND FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON ESTATES OF DECEASED PERSONS AND ON GIFTS SIGNED AT LONDON ON OCTOBER 19, 1978

Introduction

The proposed Estate and Gift Tax Convention with the United Kingdom is the first Convention negotiated since the United States modified its estate and gift tax law in the Tax Reform Act of 1976. The 1976 modifications include combining the separate estate and gift tax rates into a single cumulative rate schedule, substituting a unified credit for the previously separate estate and gift tax exemptions, and imposing a tax on generation-skipping transfers. The Convention will replace the existing estate tax convention between the two countries which has been in effect since July 25, 1946.

The Convention is similar in principle to the U.S. Estate Tax Convention with the Netherlands [1976-1 C.B. 471], which entered into force in 1971, and to the U.S. Model Estate and Gift Tax Convention, published by the Treasury Department on March 16, 1977. The Convention also is based, in part, on the provisions of the Model Estate Tax Convention (Draft Double Taxation Convention on Estates and Inheritances), published in 1966 by the Organization for Economic Cooperation and Development (OECD).

The general principle underlying the proposed Convention is that the country of domicile may tax an individual’s estate or other transfers on a worldwide basis with a credit for tax paid to the other State with respect to certain types of property located therein. Specifically, immovable property and certain business assets are taxable in the Contracting State where situated. The Convention also allows the country of citizenship the right to tax an individual’s worldwide estate or other transfers, with a credit for tax paid to the other State on either a domiciliary or a situs basis.

The Convention provides rules for determining which State has the right to tax on a domiciliary basis when a decedent or transferor is domiciled, under the laws of the respective countries, in both States at the time of death or transfer. It provides that a U.S. citizen, who at the time of death or transfer is considered under the Convention to be domiciled in both the United Kingdom and the United States, shall be deemed to be domiciled in the United States if he had not been resident in the United Kingdom in 7 or more of the 10 income tax years of assessment ending with the year in which the death or transfer occurs. The effect of this rule is that the United Kingdom may not subject the estate or other transfers of a U.S. citizen and domiciliary to tax on a worldwide basis if he has been resident in the United Kingdom for less than 7 out of the 10 years ending with the year in which the death or transfer occurs. The Convention also provides that a U.S. citizen shall be deemed to have a domicile in the United States if he had been domiciled in the United States at any time during the three years preceding the time of death or transfer. This rule enables the United States to consider a citizen and former resident as a domiciliary for treaty purposes for a three year period. Thus, except for property taxable on a situs basis under the treaty, the United States generally retains primary taxing jurisdiction for three years after a U.S. citizen abandons his U.S. domicile. These rules for determining domicile are reciprocal.

The Convention is subject to ratification by the two Governments. Once ratified, it will enter into force on the thirty-first day after instruments of ratification are exchanged and will have effect in the United States with respect to estates of individuals dying and transfers taking effect after that date.

The Convention shall remain in force until terminated by one of the Contracting States. It may not be terminated for five years after it enters into force.

Federal Estate, Gift, and Generation-Skipping Transfer Taxes

The Federal estate, gift, and generation-skipping transfer taxes are excise taxes imposed on the transfer of property by death, gift, and generation-skipping transfer, respectively. Citizens and residents of the United States are subject to taxation on the transfers of all their property, wherever located. For these purposes, a resident of the United States is a domiciliary thereof, i.e., an individual living in the United States who has the intention to remain in the United States indefinitely or an individual who has lived in the United States with such an intention and who subsequently left the United States without having the intention to remain indefinitely in the country of his new residence.

Nonresidents who are not citizens of the United States (referred to hereafter as nonresident aliens) are taxable only on transfers of property situated within the United States. Tangible personal property and real estate, for example, are situated within the United States if located in the United States. Corporate stock has a U.S. situs only if issued by a corporation organized in the United States. Nonresident aliens are, however, exempt from Federal gift tax on all transfers of intangible property, including corporate stock.

U.S. statutory taxation rules for transfers of citizens and residents allow: (a) a tax credit of $38,000 at present, but which is scheduled to increase to $47,000 by 1981; (b) a marital deduction for gift tax purposes equal to the first $100,000 of gifts and 50 percent of the value of gifts in excess of $200,000; (c) a marital deduction for estate tax purposes equal to the greater of $250,000 or one-half the value of the adjusted gross estate, but reduced by any post-1976 gift tax marital deduction in excess of 50 percent of the value of the lifetime gifts to the spouse after 1976; and (d) deductions for charitable contributions, debts, funerals, and administrative expenses, and claims against, and losses of, the estate. Taxable transfers are taxed at rates ranging from 18 to 70 percent. Credits are allowed for foreign death taxes paid with respect to property which is considered under U.S. situs rules to be situated in the taxing foreign country and which is included in the gross estate for Federal estate tax purposes.

Nonresident aliens are allowed a $3,600 credit against the estate tax liability plus deductions for a portion of the debts, funeral and administrative expenses, claims, and losses, based on the proportion of the decedent’s worldwide estate which is located in the United States. Taxable estates are taxed at rates ranging from 6 to 30 percent. Gifts and generation-skipping transfers by nonresident aliens, however, are taxed at the normal citizen or resident rates of 18 to 70 percent.

United Kingdom Capital Transfer Tax

The U.K. capital transfer tax applies to transfers of property by gift and death, as well as to transfers of settled or trust property. Individuals domiciled in the United Kingdom are subject to taxation on transfers of all their property, wherever situated. Individuals not domiciled in the United Kingdom are taxable only on property having a U.K. situs. All inter-spousal transfers are exempt from taxation, except that only the first £ 25,000 is exempt if the transferor is domiciled in the United Kingdom but the recipient is not. The tax base is the amount of “loss” to the transferor, but deductions are allowed for debts, expenses, and liabilities chargeable against the property transferred.

The rate of tax depends on the cumulative total of chargeable transfers during life and at death. There are two rate schedules: one for transfers on death or within 3 years of death and another for lifetime transfers. Where the cumulative total is less than £ 110,000 the rate of tax on lifetime gifts is one-half that imposed on a transfer by death; the schedules then converge and above £ 310,000 the rates are the same. A married couple’s transfers are taxed separately. Nondomiciliaries are taxed according to the same rate schedule as domiciliaries. To lessen international double taxation, a credit against the capital transfer tax may be taken for similar taxes paid to another country on the same property.

Article 1. Scope

This Article states that the Convention applies to any person who is subject to a tax covered by the Convention. As set forth in Article 2 (Taxes Covered), the Convention applies in the United States to the Federal gift tax and the Federal estate tax, including the tax on generation-skipping transfers and to the capital transfer tax in the United Kingdom.

Existing U.S. estate tax treaties, as well as the U.S. Model Estate and Gifts Tax Convention, apply to domiciliaries of one or both of the Contracting States. This Convention has a broader application; its scope is not limited to domiciliaries of the two Contracting States.

Article 2. Taxes Covered

Paragraph (1) identifies the taxes covered by the Convention. The Convention does not apply to any state or local taxes imposed by either Contracting State.

Paragraph (2) provides that the Convention also applies to any substantially similar taxes which are subsequently enacted in addition to, or in place of, the existing taxes. The competent authorities of the Contracting States are to notify each other of any changes which have been made in their respective laws relating to the taxation of estates, gifts, and other transfers.

Article 3. General Definitions

Paragraph (1) defines the terms “United States,” “United Kingdom,” “enterprise,” “competent authority,” “nationals,” “tax,” and “Contracting State.”

The term “United States” does not include Puerto Rico, the Virgin Islands, Guam, or any other U.S. possession or territory. The term “nationals” means, in relation to the United States, U.S. citizens. According to paragraph 5 of Article 4 (Fiscal Domicile), however, an individual who was at the time of death or other transfer, a resident of a U.S. possession and who became a U.S. citizen solely by reason of (a) being a citizen of such a possession or (b) birth or residence within such possession, will not be considered a national of the U.S. under the Convention. This exclusion conforms with Sections 2209 and 2501(c) of the Internal Revenue Code. In relation to the United Kingdom, “nationals” refers to (a) any citizen of the United Kingdom and Colonies, or (b) any British subject not possessing such citizenship or the citizenship of any other Commonwealth country or territory, if the individual in either case had the right of abode in the United Kingdom at the time of death or transfer.

Paragraph (2) provides that any term which is not otherwise defined in the Convention is, unless the Convention otherwise requires and subject to the provisions of Article 11 (Mutual Agreement Procedure), to have the meaning which it has under the tax laws of the Contracting State whose tax is being determined.

Article 4. Fiscal Domicile

This Article sets forth rules for resolving cases of double domicile. The determination of a single treaty domicile is important, since the country of domicile has the primary right to tax the worldwide estate and other transfers, with the exception of property covered by Articles 6 (Immovable Property (Real Property) and 7 (Business Property of a Permanent Establishment and Assets Pertaining to a Fixed Base Used for the Performance of Independent Personal Services).

Under paragraph (1), domicile is determined initially under the law of each Contracting State. An individual is domiciled in the United States (a) if he was a U.S. resident or (b) if he was a U.S. national, and had been a resident in the United States at any time during the preceding 3 years. The Convention uses the term “resident (domiciliary)” because U.S. domestic law equates the term “resident” with the term “domiciliary.” The 3 year rule parallels a provision in the U.K. capital transfer tax that a U.K. domiciliary will be deemed to be domiciled in the United Kingdom for a period of 3 years after a change of domicile is actually made.

Paragraph (1) also provides that an individual is domiciled in the United Kingdom if he is (a) a U.K. domiciliary under general principles of U.K. law, or (b) treated as a U.K. domiciliary for purposes of the capital transfer tax. An individual who is not considered domiciled in the United Kingdom under general law is nevertheless deemed to be domiciled there for purposes of the capital transfer tax if he:

(1) was domiciled in the United Kingdom on or after December 10, 1974 and within 3 years immediately preceding the taxable event; or

(2) was resident in the United Kingdom on or after December 10, 1974, in at least 17 of the 20 income tax years of assessment ending with the income tax year in which the taxable event occurs; or

(3) has, since December 10, 1974, become and remained domiciled in the Channel Islands or the Isle of Man and, immediately before becoming domiciled there, was domiciled in the United Kingdom.

For condition (2), “resident” is defined as for income tax purposes except that the availability of a dwelling-house in the United Kingdom is disregarded. An individual is a U.K. resident for income tax purposes for the entire year if he has been present in the United Kingdom for a single day in that year, provided he also has a dwelling-house in the United Kingdom. Thus, the dwelling-house limitation means that an individual whose principal home is not in the United Kingdom, but who comes to the United Kingdom on occasional visits and maintains a flat or house there, will not be subject to capital transfer tax under this deemed domicile provision. By virtue of these “deemed domicile” provisions, an individual who is a foreign domiciliary under general law may be treated as a U.K. domiciliary and subject to capital transfer tax on all his assets wherever situated.

Paragraphs (2), (3), and (4) of the Convention set forth rules for resolving cases where, under the definitions in paragraph (1), there is a double domicile. Paragraph (2) provides that a U.K. national domiciled in both Contracting States shall be deemed to be domiciled in the United Kingdom for purposes of the Convention if he had not been resident in the United States for Federal income tax purposes in 7 or more of the 10 taxable years ending with the year in which the death or transfer occurs. The effect of this rule is to restrict the right of the United States to tax the estate and other transfers of a U.K. national and domiciliary who has been resident in the United States for less than 7 out of 10 years to certain situs property. The rule is based upon the concept that a Contracting State should not tax the estate or other transfers of an individual on a domiciliary basis if the individual has not been present in that State for a significant period of time.

Paragraph (3) is the reciprocal of paragraph (2). It provides that a U.S. national domiciled in both Contracting States shall be deemed to be domiciled in the United States for purposes of the Convention if he had not been resident in the United Kingdom in 7 or more of the 10 income tax years of assessment ending with the year in which the death or transfer occurs. For these purposes, residence in the United Kingdom is determined under the income tax rules, but the fact that a person maintains a dwelling-house in the United Kingdom is disregarded. The dwelling-house limitation has the same effect as in the “deemed domicile” provisions of U.K. internal law; thus a casual visitor who maintains a dwelling-house in the United Kingdom will not be considered a U.K. resident.

Paragraph (4) is subordinate to paragraphs (2) and (3). It provides rules for resolving cases of dual domicile where the 7 of 10 year rules do not apply. Under paragraph (4), an individual’s domicile is determined as follows: (a) he will be deemed to be domiciled in the Contracting State in which he maintained his permanent home; if he had a permanent home in both Contracting States or in neither, his domicile will be deemed to be in the Contracting State with which his personal and economic relations were closest (in other words, the State in which his center of vital interests was located); (b) if the Contracting State in which the individual’s center of vital interests was located cannot be determined, his domicile will be deemed to be in the Contracting State in which he had an habitual abode; (c) if he had an habitual abode in both Contracting States or in neither, his domicile will be deemed to be in the Contracting State of which he was a national; and (d) if he was a national of both Contracting States or neither, the competent authorities of the Contracting States will settle the issue by mutual agreement. These rules are similar to the rules in the OECD Model Convention on Estates and Inheritances.

Paragraph (5), as previously described, provides that an individual who was a resident of a U.S. possession and, who became a U.S. citizen solely by reason of citizenship, birth, or residence in that possession shall not be considered domiciled in or a national of the United States for purposes of this Convention.

Article 5. Taxing Rights

This Article establishes taxing rights for property taxable other than on a situs basis. Paragraph (1)(a) provides that property of a decedent or transferor domiciled in one of the Contracting States shall not be taxable in the other Contracting State unless it is property covered in Articles 6 (Immovable Property (Real Property)) or 7 (Business Property of a Permanent Establishment and Assets Pertaining to a Fixed Base Used for the Performance of Independent Personal Services). The effect of this provision is to give exclusive taxing rights to the country of domicile with respect to all property except that covered by Articles 6 and 7.

Paragraph (1)(b), however, provides that paragraph (1)(a) does not apply if the decedent or transferor was a national of the State in which he was not domiciled. In effect, this paragraph preserves residual taxation based on nationality.

Paragraph (2) provides that where the decedent or transferor was domiciled in neither Contracting State, but was a national of one, (but not both) of the Contracting States, property taxable in the Contracting State of nationality shall not be taxable in the other Contracting State. Thus, property owned by a third- country domiciliary that is taxable in the Contracting State of nationality is not taxable in the other Contracting State, even if it has a situs in that State, with the exception of property covered by Articles 6 (Immovable Property (Real Property)) and 7 (Business Property of a Permanent Establishment and Assets Pertaining to a Fixed Base Used for Independent Personal Services).

The rules of paragraphs (1) and (2) do not apply to property which is subject to the U.S. tax on generation-skipping transfers or which is comprised in a U.K. settlement. Paragraph (3), however, provides that property held in a generation-skipping trust or trust equivalent shall not be taxable by the United States on the occasion of a generation-skipping transfer if, at the time of the transfer, the deemed transferor was domiciled in the United Kingdom and was not a national of the United States. Paragraph (4) similarly precludes the United Kingdom from taxing property comprised in a settlement if at the time of settlement the settlor was domiciled in the United States and was not a national of the United Kingdom. Settled property includes property held in trust for successive beneficiaries or for anyone contingent on the occurrence of some event. The rules in paragraphs (3) and (4) do not apply to property covered by Articles 6 (Immovable Property (Real Property)) or 7 (Business Property of a Permanent Establishment and Assets Pertaining to a Fixed Base Used for the Performance of Independent Personal Services), which is taxable in the country of situs.

Paragraph (5) provides that the preceding paragraphs of Article 5 (Taxing Rights) shall not prevent a Contracting State from imposing tax where property, under the rules of paragraphs (1) through (4), is taxable only in the other Contracting State but tax, though chargeable, is not paid. A tax, however, shall be deemed paid where tax liability is reduced or eliminated by means of a specific exemption, deduction, exclusion, credit, or allowance.

Paragraph (6) allows the competent authorities to determine by mutual agreement the situs of property if, at the time of death or transfer, the decedent or transferor was not domiciled in either Contracting State and each State would regard the property as situated in its territory and therefore taxable under its laws. An example would be bearer bonds issued by a U.S. corporation held in a safe deposit box in a U.K. bank by a decedent domiciled in France. The United States would generally consider the bonds to be U.S. situs property because they are issued by a domestic corporation. The United Kingdom would consider the bonds to have a U.K. situs, since bearer bonds are situated where located.

Article 6. Immovable Property (Real Property)

This Article, which is similar to the immovable property article in the OECD Model Convention on Estates and Inheritances, and the United States-Netherlands Estate Tax Convention, provides that immovable property may be taxed in the Contracting State in which the property is situated. The term “immovable property” is defined in accordance with the law of the Contracting State in which the property is situated. The term generally includes, for example, property accessory to immovable property, livestock and equipment used in agriculture and forestry, and rights to payment for the working of mineral deposits and other natural resources. Debts secured by mortgage or otherwise are not considered immovable property, nor are ships, boats, and aircraft.

Article 7. Business Property of a Permanent Establishment and Assets Pertaining to a Fixed Base Used for the Performance of Independent Personal Services

Paragraph (1) establishes the general rule that, with the exception of assets referred to in Article 6 (Immovable Property (Real Property)), assets forming part of the business property of a permanent establishment of an enterprise may be taxed in the Contracting State in which the permanent establishment is situated.

Paragraph (2) defines the term “permanent establishment” as a fixed place of business through which the business of an enterprise is wholly or partly carried on. Illustrations of a permanent establishment are set forth in paragraph (2)(b). Paragraph (2)(c) states that a building site or construction or installation project constitutes a permanent establishment only if it lasts for more than twelve months. This twelve month period begins when work physically commences in the other Contracting State. A series of contracts or projects which are interdependent both commercially and geographically is to be treated as a single project for the purpose of applying the twelve months test.

Paragraph (2)(d) provides that a permanent establishment does not include: the use of facilities solely for the purpose of storage, display, or delivery of goods or merchandise belonging to an enterprise; the maintenance of a stock of goods or merchandise belonging to an enterprise solely for the purpose of storage, display or delivery; the maintenance of a stock of goods or merchandise belonging to an enterprise solely for the purpose of processing by another enterprise; the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for an enterprise; or the maintenance of a fixed place of business solely for the purpose of carrying on, for an enterprise, any other activity of a preparatory or auxiliary character. A fixed place of business used solely for one or more of these purposes will not be considered a permanent establishment under the Convention.

Under paragraph (2)(e), a person (other than an agent of an independent status to whom paragraph (2)(f) applies) will be deemed to constitute a permanent establishment if such person is acting in a Contracting State on behalf of an enterprise and habitually exercises in that State an authority to conclude contracts in the name of the enterprise, unless that person’s activities are limited to the activities described in paragraph (2)(d).

On the other hand, paragraph (2)(f) provides that an enterprise of one Contracting State will not be deemed to have a permanent establishment in the other Contracting State merely because such enterprise carries on business in the other Contracting State through a broker, general commission agent, or any other agent of an independent status, where the broker or agent is acting in the ordinary course of his business.

Under paragraph (2)(g), the fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State or which carries on business in that other State shall not of itself constitute either company a permanent establishment of the other.

Paragraph (3) provides that, except for assets described in Article 6 (Immovable Property (Real Property)), assets pertaining to a fixed base used for the performance of independent personal services may be taxed by a Contracting State if the fixed base is situated in that State. The concept of a “fixed base” is analogous to that of a “permanent establishment.”

Article 8. Deductions, Exemptions, etc.

Paragraph (1) states that deductions shall be allowed in accordance with the law in force in the Contracting State in which the tax is imposed. Section 2106(a)(1) of the Internal Revenue Code accords the estate of a nonresident alien a deduction for allowable expenses in the proportion which the value of the decedent’s gross estate situated in the United States bears to the value of his entire gross estate, wherever situated. The Code does not provide for any deductions, other than charitable or marital, for gift tax purposes. Since gifts are valued at their market value, however, any debt of the donor assumed by the donee constitutes a diminution in the total value of the transfer subject to tax. Deductions for generation-skipping tax purposes follow the relevant estate or gift tax rule.

The U.K. capital transfer tax provides that a liability secured by a particular property is deducted from the value of that property. Moreover, a liability to a person resident outside the United Kingdom which is neither payable in the United Kingdom nor an encumbrance on U.K. property is deductible from property outside the United Kingdom. In either case, if the debt exceeds the value of the property against which it is deductible, it may be deducted from the rest of the decedent’s or transferor’s property.

Paragraph (2) provides the benefits of the U.S. marital deduction for property which may be taxed in the United States and which passes to a spouse from a decedent or transferor who was domiciled in or a national of the United Kingdom. The benefit is given to the same extent as if (a) the decedent or transferor had been domiciled in the United States and (b) the decedent’s gross estate or the transferor’s transfers were limited to property which may be taxed by the United States.

The estate of a nonresident alien, who was domiciled in or a national of the United Kingdom, would thus be entitled to the full marital deduction provided by Section 2056 of the Code to the extent that the estate has property subject to estate tax in the United States. Thus, the deduction is limited to the greater of $250,000 or 50 percent of the value of the adjusted gross estate taxable in the United States. The marital deduction for gifts would be aggregated under the Convention in the same manner provided in Section 2523 of the Code: the first $100,000 of inter-spousal gifts taxable in the United States would be exempt, the second $100,000 would be fully taxable, and 50 percent of the amount of subsequent inter-spousal gifts would be taxable. All gifts by a transferor are cumulative regardless of whether the deduction has been made available by the Code or the Convention. Thus, if a transferor uses the full $100,000 deductions under the Code while domiciled in the United States and then becomes domiciled in the United Kingdom, the next $100,000 of gifts would be fully taxable under the Convention.

Paragraphs (3) and (4) provide for special marital exemptions for purposes of the U.K. capital transfer tax. In the absence of the Convention, transfers between husband and wife are wholly exempt from such tax, whether they are lifetime gifts or transfers on death and whether the property is settled or not. But where the spouse making the transfer is domiciled in the United Kingdom for purposes of the tax and the other spouse is domiciled outside the United Kingdom, the exemption is limited to a cumulative total of £ 25,000.

Paragraph (3) provides for exemption to the extent of 50 percent of the value of property which passes to the spouse from a decedent or transferor who was domiciled in or a national of the United States and which may be taxed in the United Kingdom. The exemption is computed after taking into account all exemptions except those for transfers between spouses. The exemption is only available where the transfer would have been wholly exempt had the recipient spouse been domiciled in the United Kingdom and where no larger marital deduction is available under U.K. law, apart from the Convention. Property passing to a spouse domiciled in the United States from a decedent or transferor domiciled in the United States would be wholly exempt under the U.K. capital transfer tax. Thus, in this case, U.K. law provides greater relief than the treaty. On the other hand, the Convention would provide greater relief if the decedent or transferor was domiciled in the United Kingdom.

Paragraph (4)(a) provides for a marital deduction in the United Kingdom for qualifying transfers into a settlement or trust in which the recipient spouse has a life interest. The paragraph applies where property is comprised in a settlement on the death of a U.K. domiciliary and the surviving spouse was domiciled in or a national of the United States. The exemption is only available if: (i) the spouse is entitled to an immediate interest in possession under the settlement, (ii) the transfer would have been wholly exempt if the recipient spouse had been domiciled in the United Kingdom, and (iii) U.K. law apart from the Convention would not provide a larger marital exemption. The exemption consists of 50 percent of the value of the property transferred, calculated in the same manner as the exemption provided for in paragraph (3).

The exemption provided for in paragraph (4)(a) is only available if it is elected by the personal representatives and trustees of every settlement in which the deceased person had an interest in possession immediately before the decedent’s death. The personal representatives and trustees may be subsequently liable for capital transfer tax if, for example, the nondomiciled spouse eventually acquires the property outright. Paragraph (4)(b) provides, for example, that the election will be nullified and the settled property taxable as though given outright to the spouse if the spouse becomes absolutely and indefeasibly entitled to such property at any time after the decedent’s death. Accordingly, the purpose of the election is to protect the interests of the personal representatives and trustees.

Paragraph (5) provides that U.S. tax imposed on the estate of a national of the United Kingdom, who was neither domiciled in nor a national of the United States, will not be greater than the tax which would have been imposed if the decedent had been domiciled in the United States and taxed by the United States on his worldwide property. Paragraph (5) does not require a formal election; the appropriate information need only be included in an estate tax return, which is filed or amended within the applicable time period.

Article 9. Credits

This Article establishes rules for determining which Contracting State will credit the taxes of the other Contracting State where both States tax the same property.

Paragraph (1) applies where the United States imposes tax on the basis of the decedent’s or transferor’s domicile or nationality. Under paragraph (1)(a), the United States will credit tax paid to the United Kingdom with respect to property covered by Articles 6 (Immovable Property (Real Property)) and 7 (Business Property of a Permanent Establishment and Assets Pertaining to a Fixed Base Used for the Performance of Independent Personal Services). Paragraph (1)(b) requires the United States to credit taxes imposed in the United Kingdom on the basis of the decedent’s or transferor’s domicile against U.S. taxes imposed on the basis of nationality. This enables the United States to retain the residual right to tax the estate and other transfers of its citizens domiciled in the United Kingdom.

Paragraph (2) establishes reciprocal credit rules for the United Kingdom. Paragraphs (1) and (2) taken together thus grant the Contracting State where the decedent or transferor was domiciled the right to tax the estate or transfers on a worldwide basis, with a credit for tax paid to the other State with respect to property taxed in that State on the basis of situs. The Contracting State of nationality may tax the estate or transfers of its nationals, but must credit the tax paid to the other State on a domiciliary or situs basis. Unlike the United States, the United Kingdom does not tax the estates or transfers of its citizens on a worldwide basis. Under the Convention, however, it can apply its statutory source rules to its non-U.K. domiciled nationals. Thus, the United Kingdom could impose tax, with a credit for U.S. taxes, on registered shares in a U.K. corporation held by a U.K. national domiciled in the United States.

Paragraph (3) prescribes credit rules where the same event gives rise to tax on property held under the trust laws of the two countries. Paragraph (3)(a) requires a Contracting State to credit tax imposed in the other Contracting State on property covered under Articles 6 (Immovable Property (Real Property)) or 7 (Business Property of a Permanent Establishment and Assets Pertaining to a Fixed Base Used for the Performance of Independent Personal Services). Paragraph (3)(b) provides that the United Kingdom will credit the U.S. tax on other property where:

(i) the taxable event was a generation-skipping transfer and the deemed transferor was domiciled in the United States at the time of the deemed transfer;

(ii) the taxable event was the exercise or lapse of a power of appointment and the holder of the power was domiciled in the United States at the time of the exercise or lapse; or

(iii) in situations not covered by (i) or (ii), the settlor or grantor was domiciled in the United States at the time when the tax is imposed.

Paragraph (3)(c) provides that in all situations not covered by paragraph (3)(b), or where the United States may not tax on the basis of situs, the United States will credit the U.K. tax. Although paragraph (3) (c) is worded broadly, paragraph 3(b) preserves primary U.S. taxing jurisdiction in those situations where U.S. domiciliaries, as determined under the treaty, are taxable under the Federal estate, gift, and generation-skipping transfer tax laws of the United States.

Paragraph (4) establishes several general rules for computing the credit allowed under the Article. The credits allowed by a Contracting State shall not include taxes not levied in the other Contracting State because of a credit allowed by that other State. A tax is not creditable unless and until it is paid. In addition, the credit allowed by a Contracting State with respect to any property cannot exceed the portion of the tax paid in that State which is attributable to that property. In making this calculation, the tax paid shall be determined before the credit is given, but shall be reduced by any credit given for another tax.

Consider the estate of a decedent who was a U.S. national domiciled in the United Kingdom, which consisted of assets in the United Kingdom with a fair market value of $100 and U.S. real property with a fair market value of $20. The entire $120 estate would be taxable both in the United States and the United Kingdom. The United States would retain primary taxing jurisdiction over the U.S. real property and the United Kingdom over the other assets. If the U.K. capital transfer tax on the $120 estate were $24 and the U.S. estate tax were $30 before the allowance for any credits, the credits would be computed as follows. The United Kingdom would credit $4 of U.S. tax. Although $5 represents the portion of the U.S. tax of $30 attributable to U.S. real property, ($20/ $120) x ($30), the credit would be limited to $4, which is the portion the U.K. tax of $24 attributable to the U.S. real property. The United States would credit $20 of the U.K. tax, which represents the portion of the U.K. tax of $24 attributable to U.K. property, ($100/$120) x ($24). The net U.K. tax liability would be $20 ($24 less $4) and the U.S. tax liability would be $10 ($30$20).

Paragraph (5) provides that a claim for credit or refund under the Convention generally must be made within six years from the date of the event giving rise to the tax, or, where later, within one year from the last date on which the tax which is to be credited is due. The competent authority may, in appropriate circumstances, extend this time limit where the final determination of the taxes which are the subject of the claim is delayed.

Article 10. Non-Discrimination

Paragraph (1)(a) states that nationals of a Contracting State shall not be subjected in the other State to taxation or any other requirement connected therewith which is other or more burdensome than the taxation or requirements connected therewith to which nationals of the other Contracting State in the same circumstances are or may be subjected. Paragraph (1)(b), however, recognizes that a nonresident alien is not in the same circumstances as a U.S. national, who is taxed by the United States on a worldwide basis regardless of his domicile. Paragraph (1)(b) provides that paragraph (1)(a) shall not prevent the United States from taxing a national of the United Kingdom who is not domiciled in the United States as a nonresident alien in accordance with U.S. internal law. Paragraph (3) further points out that this Article does not require either Contracting State to grant to individuals not domiciled in that Contracting State any personal allowances, reliefs, or tax reductions which are granted to its domiciliaries. Paragraphs (1) and (3), however, must be read in conjunction with paragraph (5) of Article 8 (Deductions, Exemptions, Etc.) which specifically limits the U.S. tax imposed on the property of a U.K. national not domiciled in the United States to the tax that would have been imposed had the decedent been domiciled in the United States at the time of death.

Paragraph (2) provides that a permanent establishment which an enterprise of one Contracting State has in the other Contracting State will not be subject in that other Contracting State to less favorable taxation than an enterprise of the other Contracting State carrying on the same activities. Paragraph (4) extends similar protection to an enterprise of a Contracting State, the capital of which is wholly or partly owned or controlled by one or more residents of the other Contracting State.

Paragraph (5) limits the application of this Article to the taxes which are the subject of the Convention, i.e., the Federal gift tax and the Federal estate tax, including the tax on generation-skipping transfers in the United States and the capital transfer tax in the United Kingdom.

Article 11. Mutual Agreement Procedure

Under paragraph (1), if a person believes that the actions of one or both of the Contracting States result or will result in taxation which is not in accordance with the Convention, he may present his case to the competent authority of either Contracting State. Although a person need not exhaust any other administrative or judicial remedies prior to resorting to the mutual agreement procedure, it is anticipated that a person usually will do so.

Paragraph (2) provides that, if the competent authority considers the objection justified and cannot by itself arrive at an appropriate solution, it shall attempt to resolve the case by agreement with the competent authority of the other Contracting State. In cases in which the competent authorities reach an agreement, taxes will be imposed and refunds of taxes will be allowed, as appropriate, by the Contracting States. In the case of the United States, where an agreement is reached between the competent authorities which requires the United States to make a refund of tax or to extend any similar credit, the refund or credit will be made, assuming presentation of the case to the competent authority within a reasonable time, notwithstanding any procedural barriers existing under U.S. law, including any statute of limitations. In cases where an agreement cannot be reached between the competent authorities, the United States will not be required to provide any relief from double taxation on a unilateral basis.

Paragraph (3) permits the competent authorities of the Contracting States to endeavor to resolve any difficulties or doubts arising as to the application of the Convention, such as the meaning of terms not otherwise defined in the Convention.

Under paragraph (4), the competent authorities may communicate with each other directly and, when advisable, meet together for an oral exchange of opinions, for the purpose of reaching an agreement.

Article 12. Exchange of Information

This Article provides for a system of administrative cooperation between the competent authorities of the two Contracting States. It requires the exchange of available information necessary for carrying out the Convention and the domestic laws of the Contracting States concerning the taxes covered by the Convention. The competent authorities may exchange information in connection with tax compliance generally, not merely illegal acts or crimes.

The information exchanged must be treated as secret. However, the information may be disclosed to persons or authorities (including a court or administrative body) concerned with the assessment, collection, or enforcement of, or prosecution with respect to, the taxes which are the subject of the Convention. No information may be exchanged which would disclose any trade, business, industrial or professional secret or any trade process.

Article 13. Effect on Diplomatic and Consular Officials and Domestic Law

Paragraph (1) provides that nothing in the Convention shall affect the fiscal privileges of diplomatic and consular officials under the general rules of international law or under the provisions of special agreements.

Paragraph (2) provides that the Convention will not restrict in any manner any exclusion, exemption, deduction, credit, or other allowance now or hereafter accorded by the laws of either Contracting State.

This rule reflects the principle that a double taxation Convention should not increase the tax burden imposed by a Contracting State.

Article 14. Entry Into Force

Paragraph (1) provides that the Convention shall be ratified and that instruments of ratification shall be exchanged at Washington, D.C. as soon as possible after both States have ratified the Convention.

Paragraph (2) provides that the Convention will become effective on the thirty-first day following the date of exchange of instruments of ratification. The Convention shall apply in the United States with respect to the estates of individuals dying and transfers taking effect after the effective date. The Convention shall apply in the United Kingdom with respect to property by reference to which a tax liability arises after the effective date.

Paragraphs (3), (4), and (5) set forth transition rules for determining when the 1945 Estate Tax Convention will cease to have effect. These rules are important because of the transition rules contained in the U.K. capital transfer tax. Paragraph (3) states the general rule that the 1945 Convention shall cease to have effect for property to which the new Convention will apply under paragraph (2). Paragraph (4), however, provides that any provision of the 1945 Convention which would afford greater relief than the new Convention will continue to apply in the United Kingdom with respect to:

(a) any inter vivos gift made by a decedent before March 27, 1974, or

(b) any settled property in which the decedent had a beneficial interest in possession before March 27, 1974 but not at any time thereafter.

These exceptions relate to transition rules in the U.K. capital transfer tax which will cease to have effect with respect to deaths occurring on or after March 27, 1981. Paragraph (5) provides that the 1945 Convention will terminate on the last date on which, under the foregoing rules, it has effect.

Article 15. Termination

Paragraph (1) provides that the Convention shall remain in force until it is terminated by one of the Contracting States. A Contracting State may not terminate the Convention until after it has been in force at least 5 years. After the initial 5 year period, a Contracting State may terminate the Convention by providing the other State at least 6 months’ prior notice through diplomatic channels. If the Convention is terminated in accordance with these procedures, it will continue to apply to taxable events occurring between the time notice is given and the termination date specified in the notice.

Paragraph (2) provides that the termination of the Convention will not have the effect of reviving the 1945 Convention or other treaties previously abrogated.