In a recent memorandum (AM 2025-002, the general legal advice memorandum (GLAM)), the Internal Revenue Service (IRS) addressed whether treaty benefits are available to reduce the branch profits tax (BPT) for business profits earned through a reverse hybrid entity (an entity treated as a corporation for U.S. tax purposes but fiscally transparent under foreign law). In a taxpayer-favorable development, the GLAM concludes that treaty relief from BPT imposed on a reverse hybrid are determined on an owner-by-owner basis, taking into account residency and limitation-on-benefits requirements. As a result, the GLAM determined that treaty benefits were available to reduce BPT imposed on a reverse hybrid entity to the extent the owners of such entity met certain requirements for benefits under a U.S. tax treaty.

While not precedential, the GLAM articulates the IRS's view, which has not previously been addressed in regulations under section 894 or other U.S. guidance. The IRS's analysis in the GLAM may reassure taxpayers regarding the application of treaty relief from BPT to inbound structures involving reverse hybrids. Although the GLAM analyzes the specific terms of the 2016 United States Model Income Tax Convention, it observes that the same result would follow under the language of earlier treaties with narrower "fiscally transparent entity" provisions. The GLAM may signal that the IRS is willing to provide relief through informal guidance in appropriate circumstances.

The GLAM addresses a Country X entity (RFHX) classified as a corporation under U.S. law but fiscally transparent in Countries X, Y, and Z. The United States has a bilateral income tax treaty in force with Country Y but not with Countries X or Z. RFHX operates a U.S. trade or business giving rise to effectively connected income, which is subject to U.S. corporate income tax. RFHX distributes its income to its owners as earned, resulting in a dividend equivalent amount (DEA) equal to its net income. Absent relief under a treaty, section 884 would impose a 30 percent tax on the DEA. At issue is whether any relief from BPT is available under the Country Y treaty, notwithstanding that the BPT is imposed on the "company" (RFHX) rather than its owners, and RFHX is neither organized nor resident in a jurisdiction with a U.S. tax treaty.

The four owners of RFHX are: (i) an individual resident in Y, (ii) a publicly traded company resident in Y, (iii) a private Y company owned by Z residents, and (iv) an individual resident in Z. Under the GLAM, relief from BPT was available to the extent the DEA was treated as derived by Y residents that (1) were taxable in Country Y on their share of profits earned through RFHX, (2) met the Country Y treaty's 12-month residency requirement, and (3) satisfied the Country Y treaty's limitation-on-benefits article. The IRS concluded that the DEA treated as derived by the Country Y individual and Country Y public company qualified for relief from BPT. In contrast, the DEA treated as derived by the private Country Y company and the Country Z individual did not. The BPT was therefore reduced only on the portion of the DEA treated as derived by the qualifying Y owners. The GLAM observes that relief is determined under the BPT provision of the treaty that applies to each owner of a reverse hybrid. For this reason, even if RFHX were organized in a treaty jurisdiction, the results would remain the same. 

For more information, please contact:

Rocco V. Femia, rfemia@milchev.com, 202-626-5823

Layla J. Asali, lasali@milchev.com, 202-626-5866

Jeffrey M. Tebbs, jtebbs@milchev.com, 202-626-1480

Chadwick Rowland, crowland@milchev.com, 202-626-1589

The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.

This, and related communications, are protected by copyright laws and treaties. You may make a single copy for personal use. You may make copies for others, but not for commercial purposes. If you give a copy to anyone else, it must be in its original, unmodified form, and must include all attributions of authorship, copyright notices, and republication notices. Except as described above, it is unlawful to copy, republish, redistribute, and/or alter this presentation without prior written consent of the copyright holder.