Tax Treaties and Exempt Income

Share This Article

Tax Treaties and Exempt Income

Tax Treaties and Exempt Income

Most United States tax treaties provide an exemption for certain categories of employees, including teachers, students, and researchers.[1]

Nonresident alien teachers, students, and trainees who are entitled to treaty exemptions from U.S. tax on part or all of their salary for working in the United States are generally required to file Form 8233 in order to claim the exemption.[2]

A teacher or trainee is an individual, other than a student, who is temporarily in the United States under a “J” or “Q” visa and substantially complies with the requirements of that visa.  A person is considered to have substantially complied with the visa requirements if they have not engaged in activities that are prohibited by U.S. immigration laws and could result in the loss of their visa status.

Under the language generally contained in U.S. tax treaties, a non-resident “is temporarily present in the [United States] for the purpose of teaching or carrying on research at a school, college, university or other recognized educational or research institution” “shall be exempt from tax in the [United States] . . . on the remuneration received in consideration of teaching or carrying on research. . . .”

This Insight post looks at the meaning and scope of the phrase “other recognized educational . . . institution.”  It sets out several relevant treaty provisions below with the relevant tax analysis and authorities.  For future international tax topics, stay tuned for our International Tax Symposium.

Tax Treaties

The United States is a signatory to more than 60 income tax treaties. Our Freeman Law interactive tax treaty map provides a link to tax treaty materials for each U.S. treaty partner:

 

The U.S.-Czech-Republic Tax Treaty

As originally written, the United States-Czech-Republic tax treaty provides as follows:

  1. An individual who visits a Contracting State for the primary purpose of teaching or conducting research at a university, college, school or other accredited educational or research institution in the other Contracting State, and who is, or immediately before such visit was, a resident of the other Contracting State shall be exempt from tax in the first-mentioned Contracting State for a period not exceeding two years in respect of remuneration for such teaching or research. The benefits provided in this paragraph shall not be granted to an individual who, during the immediately preceding period enjoyed the benefits of one of the preceding paragraphs of this Article. An individual shall be entitled to the benefits of this paragraph only once.

Art. 21, para 5 Tax Convention with the Czech Republic (emphasis added).

One interpretive issue with respect to this provision is the meaning and scope of the phrase “other recognized educational . . . institution” for purposes of this exemption.

The phrase “recognized educational institution” is not defined in the Convention. In the instance (United States-Bulgaria treaty) of an undefined term, paragraph 2 of Article 3, General Definitions, of the Convention provides in relevant part:

Any . . .  term not defined [in the Convention] shall, unless the context otherwise requires or the competent authorities agree to a common meaning pursuant to the provisions of Article 26 (Mutual Agreement Procedure). . . have the meaning which it has at that time under the law of that State for the purposes of the taxes to which this Convention applies, any meaning under the applicable tax laws of that State [the United States] prevailing over a meaning given to the term under other laws of that State.

There is limited judicial guidance on the proper interpretation of the phrase “recognized educational institution.”  The Tax Court has, however, looked to section 170 in other similar cases in an effort to interpret the scope of the phrase, giving it a similar meaning.  Section 170(b)(1)(A)(ii) defines a similar phrase, “educational organization,” as an organization “which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.” Under Treas. Reg. § 1.170A–9(c)(1), an “educational organization does not include organizations engaged in both educational and noneducational activities unless the latter are merely incidental to the educational activities.”  Tax Court precedent has generally applied this definition in this context.

The Tax Court’s approach is in line with the IRS’s approach as well.  In rulings regarding the qualification of an educational organization under the treaty exemption provision, the IRS has fairly consistently applied the standard derived from § 170(b)(1)(A)(ii). Thus, under IRS guidance, the facility must maintain a regular faculty and curriculum and normally have a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.

In this regard, the IRS has stated that it will interpret the terms in question in accordance with the definition of the term ‘educational institution’ contained in section 151(e)(4) of the Internal Revenue Code of 1954 and section 1.151-3(c) of the Income Tax Regulations.[3] (IRS’s agreement with Japanese competent authorities that the United States would interpret the terms “educational establishments” and “other educational institutions” in accordance with the definition of the term “educational institution” contained in Code Section 1512(e)(4), which was eliminated by legislation in 1976 but language of which is contained in Section 170(b)(1)(A)(ii));  (1976 amendments to Section 151(e)(4)(a) did not affect the definition of “educational institution,” “educational establishment,” or “other educational institutions” as used in various treaties); (qualifying status of U.S. branch of Belgian university).

Thus, the IRS’s prior guidance with respect to section 151(e)(4) of the 1954 Code remains valid.  The relevant regulations with respect to that section, which are still part of the current Treasury Regulations, state as follows:

(c) Educational institution. For purposes of sections 151(e) and 152, and the regulations thereunder, the term “educational institution” means a school maintaining a regular faculty and established curriculum, and having an organized body of students in attendance. It includes primary and secondary schools, colleges, universities, normal schools, technical schools, mechanical schools, and similar institutions, but does not include noneducational institutions, on-the-job training, correspondence schools, night schools, and so forth.

26 C.F.R. § 1.151-3.  Notably, under this definition, the IRS has found certain organizations to be educational organizations.  Certain rulings are particularly helpful in elucidating the scope of the concept of an educational organization in this context.  For example, in one ruling, the IRS determined that an organization that taught people to survive in a natural environment was an educational organization. The organization conducted 12 courses annually, each term lasting 26 days. Courses were taught by a faculty of full-time instructors to regularly enrolled students. The instruction, which included lectures, demonstrations, and practical exercises, took place on an isolated island where most classes were conducted out of doors rather than in classrooms. The school was found to be an educational organization that presented a formal program of instruction and maintained a regular curriculum, faculty, and student body.

In another ruling, the IRS similarly found that an organization whose only function was conducting a summer training school with a curriculum built around a core of theological studies analogous to that of a theological seminary was an educational organization.  The IRS determined that “even though the organization . . . conducted classes for only eight weeks each summer, it [wa]s, nevertheless, an educational organization within the meaning of section 170(b)(1)(A)(ii) of the Code since, during the eight weeks of operation, (1) its primary function [wa]s the presentation of formal instruction, (2) it normally maintain[ed] a regular faculty and curriculum, and (3) it normally ha[d] a regularly enrolled body of pupils and students in attendance at the place where its educational activities [we]re regularly carried on.”

These rulings provide helpful precedent.  In addition to the regulations under § 1.151-3 (cited and quoted above) and the rulings interpreting it, Treasury Regulations under § 170 provide as follows:

An educational organization is described in section 170(b)(1)(A)(ii) if its primary function is the presentation of formal instruction and it normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. The term includes institutions such as primary, secondary, preparatory, or high schools, and colleges and universities. It includes Federal, State, and other public-supported schools which otherwise come within the definition. It does not include organizations engaged in both educational and noneducational activities unless the latter are merely incidental to the educational activities. A recognized university that incidentally operates a museum or sponsors concerts is an educational organization within the meaning of section 170(b)(1)(A)(ii). However, the operation of a school by a museum does not necessarily qualify the museum as an educational organization within the meaning of this subparagraph.

Treas. Reg. § 1.170A-9.

This definition focuses on the existence of a “regular faculty” and “established curriculum,” as well as an “organized body of students in attendance.”

Moreover, the regulation’s examples, which include “primary and secondary schools” and “similar institutions,” imply that its scope encompasses certain institutions, as the examples focus on organizations with a primary focus on educational endeavors.  And notably, the IRS has extended this treaty exemption to a similar context: non-resident aliens invited to teach or lecture at summer seminars in the United States.  The extension of the exemption to this context is particularly relevant for certain organizations, and the facts and analysis set forth in another IRS Ruling are instructive in this regard.  The facts at issue in that ruling were as follows:

B is a corporation engaged in the collection and preservation of coins and medals, the investigation of matters connected with numismatics, and the popularization of the science of Numismatology. To aid in accomplishing these objectives, B has conducted summer seminars in numismatics since 1952 and expects to continue these seminars as a regular feature of its educational program. In addition, B maintains a library and a museum and conducts lectures for the public.

With regard to the summer seminar program, B has a permanent location and facilities, maintains a regular faculty and established curriculum, and has a regularly organized body of students in attendance at the seminar. Participants in the program receive credit from their universities for their participation in the program.

. . .

Every summer, the regular faculty is supplemented by a visiting scholar. For the 1977 summer seminar, A of C was invited as the visiting lecturer. A is Professor of Ancient Numismatics at D and a recognized authority on Greek and Roman history. A is a resident of Switzerland and was present in the United States from May 30, 1977 to August 27, 1977 for the purpose of teaching at the summer seminar. A received remuneration in the amount of $3,000 for his participation in the summer seminar program, which consisted of delivering lectures and being available for consulation and discussion with the students participating in the seminar.

Article XII of the Convention provides that a professor or teacher, a resident of Switzerland, who temporarily visits the United States for the purpose of teaching for a period not exceeding two years at a university, college, school or other educational institution in the United States, shall be exempt from Federal income tax on his remuneration for teaching for such period.

Based on these facts and principles, the IRS went on to hold that:

the summer seminar program of B is an educational organization within the meaning of section 151(e)(4) of the Code and an educational institution within the meaning of Article XII of the Convention. Therefore, the $3000 remuneration paid to A by B will be exempt from Federal income tax.

 

The U.S.-Romania Tax Treaty

As originally written, the United States-Romania tax treaty provides as follows:

(1) Where a resident of one of the Contracting States is invited by the Government of the other Contracting State, a political subdivision, or a local authority thereof, or by a university or other recognized educational institution in that other Contracting State to come to that other Contracting State for a period not expected to exceed 2 years for the purpose of teaching or engaging in research, or both, at a university or other recognized educational institution and such resident comes to that other Contracting State primarily for such purpose, his income from personal services for teaching or research at such university for a period not exceeding 2 years from the date of his arrival in that other Contracting State.

(2) This article shall not apply to income from research if such research is undertaken not in the public interest but primarily for the private benefit of a specific person or persons.

Art. 19, para 1, Socialist Republic of Romania Double Taxation: Taxes on Income.

The definition set forth in the U.S.-Romania Treaty is almost identical to that of the Czech-Republic tax treaty—the primary difference being the use of “accredited” educational institution rather than “other recognized” educational institution.

Much as in the Czech-Republic treaty, the phrase “recognized educational institution” is not defined in the Convention. In the instance (United States-Romania treaty) of an undefined term, paragraph 2 of Article 2, General Definitions, of the Convention provides in relevant part:

Any other term used in this Convention and not defined in this Convention shall, unless the context otherwise requires, have the meaning which it has under the laws of the Contracting State whose tax is being determined. Notwithstanding the preceding sentence, if the meaning of such a term under the laws of one of the Contracting States is different from the meaning of the term under the laws of the other Contracting State, or if the meaning of such a term is not readily determinable under the laws of one of the Contracting States, the competent authorities of the Contracting States may, in order to prevent double taxation or to further any other purpose of this Convention, establish a common meaning of the term for purposes of this Convention.

Given that there is no definition of “recognized educational institution,” the IRS again looks to the section 170 definition, just like the Czech-Republic treaty.  (It’s rulings have found that “The term ‘re[c]ognized educational institution’ is construed to mean “accredited educational institution.”).

 

The U.S.-Bulgaria Tax Treaty

As amended, the United States-Bulgaria tax treaty provides as follows:

2. An individual who is a resident of a Contracting State at the beginning of his visit to the other Contracting State and who is temporarily present in the other Contracting State for the purpose of teaching or carrying on research at a school, college, university or other recognized educational or research institution shall be exempt from tax in the other Contracting State, for a period not exceeding two years from the date of the individual’s arrival in that other State on the remuneration received in consideration of teaching or carrying on research. This paragraph shall not apply to income from research if such research is undertaken not in the public interest but primarily for the private benefit of a specific person or persons.

Art. 19, para. 2, as amended by the Protocol Amending the Convention Between the Government of the United States of American and the Government of the Republic of Bulgaria, Art. III.

Much as in the Czech-Republic treaty, there is no definition of “other recognized educational institution” in the treaty.  In the instance of an undefined term, paragraph 2 of Article 3, General Definitions, of the Convention provides in relevant part:

As regards the application of this Convention at any time by a Contracting State any term not defined therein shall, unless the context otherwise requires, or the competent authorities agree to a common meaning pursuant to the provisions of Article 24 (Mutual Agreement Procedure), have the meaning which it has at that time under the law of that State for the purposes of the taxes to which this Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.

Given that there is no definition of “recognized educational institution, the IRS again looks to the section 170 definition, just like the US-Czech-Republic and US-Romania treaties.

 

The U.S.-Italy Tax Treaty

The United States-Italy tax treaty provides as follows:

A professor or teacher who makes a temporary visit to a Contracting State for a period that is not expected to exceed two years for the purpose of teaching or conducting research at a university, college, school, or other recognized educational institution, or at a medical facility primarily funded from governmental sources, and who is, or immediately before such visit was, a resident of the other Contracting State shall, for a period not exceeding two years, be exempt from tax in the first-mentioned Contracting State in respect of remuneration from such teaching or research.

Art. 20, para. 1 Convention Between the Government of the United States Of America and the Government of the Italian Republic for the Avoidance of Double Taxation With Respect to Taxes on Income and the Prevention of Fraud or Fiscal Evasion.

Just like the US-Romania treaty, there is no definition of “other recognized educational institution” in the treaty.  In the instance (United States-Italy treaty) of an undefined term, paragraph 2 of Article 3, General Definitions, of the Convention provides in relevant part:

As regards the application of this Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the laws of that State concerning the taxes to which this Convention applies.

Given that there is no definition of “recognized educational institution, the IRS again looks to the section 170 definition, just like the US-Czech-Republic and US-Romania treaties.

 

The U.S.-Poland Tax Treaty

The United States-Poland tax treaty provides as follows:

Where a resident of one of the Contracting States is invited by the Government of the other Contracting State, a political subdivision or a local authority thereof, or by a university or other recognized educational institution in that other Contracting State to come to that other Contracting State for a period not expected to exceed 2 years for the purpose of teaching or engaging in research, or both, at a university or other recognized educational institution and such resident comes to that other Contracting State primarily for such purpose, his income from personal services for teaching or research at such university or educational institution shall be exempt from tax by that other Contracting State for a period not exceeding 2 years from the date of his arrival in that other Contracting State.

Art. 17, para 1 United States – Poland Income Tax Convention.

Just like the US-Romania treaty, there is no definition of “other recognized educational institution” in the treaty.  In the instance (United States-Poland treaty) of an undefined term, paragraph 2 of Article 3, General Definitions, of the Convention provides in relevant part:

Any other term used in this Convention and not defined in this Convention shall, unless the context otherwise requires, have the meaning which it has under the laws of the Contracting State whose tax is being determined. Notwithstanding the preceding sentence, if the meaning of such a term under the laws of one of the Contracting States is different from the meaning of the term under the laws of the other Contracting State, or if the meaning of such a term is not readily determinable under the laws of one of the Contracting States, the competent authorities of the Contracting States may, in order to prevent double taxation or to further any other purpose of this Convention, establish a common meaning of the term for the purposes of this Convention.

Given that there is no definition of “recognized educational institution, the IRS again looks to the section 170 definition, just like the US-Czech-Republic and US-Romania treaties.


[1] Reg. §1.1441-1(b)(7) imposes tax plus interest and penalties on the payor of U.S.-source income who does not obtain a timely Form 8233 from the foreign payee, even if the payment is clearly exempt from U.S. tax and thus would clearly be exempt from U.S. withholding tax if timely documentation were received. These rules clearly apply in the case of payments of U.S.-source compensation to nonresident aliens who are self-employed, but it is not clear from the §3401(a)(6) and §1441 regulations whether they also apply to nonresident alien employees who are supposed to follow the §1441 procedures in claiming a wage withholding exemption under Reg. §31.3401(a)(6)-1(f).

[2] Treas. Reg. § 1.1441-1(b)(7) provides, in relevant part, as follows:

1.1441-1(b)(7)(i) General Rule. —

A withholding agent that cannot reliably associate a payment with valid documentation on the date of payment and that does not withhold under this section, or withholds at less than the 30-percent rate prescribed under section 1441(a) and paragraph (b)(1) of this section, is liable under section 1461 for the tax required to be withheld under chapter 3 of the Code and the regulations thereunder, without the benefit of a reduced rate unless—

. . .

1.1441-1(b)(7)(i)(B) —

The withholding agent can demonstrate to the satisfaction of the district director or the Assistant Commissioner (International) that the proper amount of tax, if any, was in fact paid to the IRS;

. . .

1.1441-1(b)(7)(ii) Proof That Tax Liability Has Been Satisfied—

. . .

Proof that a reduced rate of withholding was, in fact, appropriate under the provisions of chapter 3 of the Code and the regulations thereunder may also be established after the date of payment by the withholding agent on the basis of a valid withholding certificate or other appropriate documentation received after that date that was effective as of the date of payment. A withholding certificate furnished after the date of payment will be considered effective as of the date of the payment if the certificate contains a signed affidavit (either at the bottom of the form or on an attached page) that states that the information and representations contained on the certificate were accurate as of the time of the payment. A withholding certificate received within 30 days after the date of the payment will not be considered to be unreliable solely because it does not contain the affidavit described in the preceding sentence. However, in the case of a withholding certificate of an individual received more than a year after the date of payment, the withholding agent will be required to obtain, in addition to the withholding certificate and affidavit, documentary evidence, as described in §1.1471-3(c)(5)(i), that supports the individual’s claim of foreign status or documentary evidence described in  §1.1441-6(c)(4)(i) to support any treaty claim made on the certificate. In the case of a withholding certificate of an entity received more than a year after the date of payment, the withholding agent will be required to obtain, in addition to the withholding certificate and affidavit, documentary evidence described in  §1.1471-3(c)(5)(i) that supports the entity’s claim of foreign status or documentary evidence described in  §1.1441-6(c)(4)(ii) to support any treaty claim made on the certificate. If documentation other than a withholding certificate is submitted from a payee more than a year after the date of payment, the withholding agent will be required to obtain from the payee a withholding certificate and affidavit supporting the claim of chapter 3 status as of the time of the payment.

[3] Notably, since that IRS ruling, Section 1901(a)(23) of the Tax Reform Act of 1976 amended that portion of section 151(e)(4) of the Code dealing with the definition of an ‘educational institution’ and redefines that term as an ‘educational organization’ described in section 170(b)(1)(A)(ii).  The 1976 amendment to section 151(e)(4), however, is not considered a substantive amendment. See S.Rep.No.94-938, 94th Cong., 2d Sess. 1 at 491 (1976), 1976-3 C.B. (Vol. 3), 49, 529.  Before its amendment in 1976, section 151(e)(4) provided that the term ‘educational institution’ means only an educational institution that normally maintains a regular faculty and curriculum, and normally has a regularly organized body of students in attendance at the place where its educational activities are carried on. Section 170(b)(1)(A)(ii) describes an educational organization that normally maintains a regular faculty and curriculum, and normally has a regularly enrolled body of students in attendance at the place where its educational activities are carried on.