SECTION 3. APPLICATION OF THE

CONVENTION AFTER THE REPEAL OF ACT

.01 Section 901 Credit for Tax With- held . A U.S. shareholder, whether a portfolio or direct investor, who invokes the provisions of paragraph (2)(a) of Article 10 of the Convention upon the receipt of a dividend or other qualifying distribution after April 5, 1999 from a U.K. corporation will continue to be entitled to receive a foreign tax credit under section 901, in accordance with Article 23, for the amount withheld pursuant to paragraph (2)(a) of Article 10. This amount is treated as a creditable withholding tax for U.S. tax purposes pursuant to paragraph (1)(b) of Article 23.

.02 Portfolio investors . A U.S. portfolio investor entitled to payment of a tax credit under Article 10 of the Convention upon receipt of a dividend or other qualifying distribution from a U.K. corporation may elect to be treated as receiving the amount due under the Convention without affirmatively making a claim to the United Kingdom. A portfolio investor may make this election by so indicating on Line 5 of Form 8833 (Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)) and filing the completed Form 8833 with the taxpayer’s income tax return for the relevant year.

A portfolio investor making this election will be treated as having received an additional dividend equal to the gross amount of the tax credit (unreduced by amounts withheld), and as having paid the

withholding tax due under Article 10, on the date of the distribution. Thus, the investor must include in income the gross payment deemed received, and may claim a foreign tax credit under Article 23 for the withholding tax treated as paid to the United Kingdom.

The withholding tax creditable under Article 23 cannot exceed the amount of the tax credit payable under the Convention. Since the tax permitted to be withheld under paragraph (2)(a)(ii) of Article 10 can only be withheld from the amount of the tax credit due to the U.S. portfolio investor, the United Kingdom is not permitted under the Convention to withhold an amount in excess of the tax credit. Accordingly, the tax is considered due and paid only to the extent of the tax credit.

For purposes of section 905(b) of the Code (relating to proof of credits), a U.S. portfolio investor who elects to be treated as receiving a payment and paying a tax under the Convention is not required to obtain a receipt or other evidence from the United Kingdom verifying the payment of the withholding tax, but may use secondary evidence to substantiate the amount of tax treated as paid. See Treas. Reg. § 1.905–2(b)(3).

.03 Direct Investors . A U.S. direct investor that claims a tax credit from the United Kingdom is entitled to a small payment net of withholding tax under paragraph (2)(a)(i) of Article 10. The amount of the withholding tax creditable under Article 23 will be equal to 5 percent of the sum of the dividend and the gross amount of the tax credit. The investor must include the gross amount of the tax credit in income as a dividend and satisfy all requirements under section 905(b) and the regulations thereunder relating to the verification and computation of the foreign tax credit. The investor must also file a Form 8833 (Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)) with the taxpayer’s income tax return for the relevant year disclosing the benefits claimed under Articles 10 and 23 of the Convention. .04 Section 902 or 960 Credit for Cor- porate-Level Tax . Under paragraph (1)(c) of Article 23 of the Convention, the portion of the tax credit to which a U.K. shareholder would be entitled upon a qualifying distribution, but which is not paid to a U.S. direct investor, is treated as an in

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distribution to a U.S. direct investor), out of which it paid the tax credit due under the Convention to its U.S. shareholder. See Treasury Explanation, reprinted in 1980–1 C.B. 455, 474 (prescribing this treatment under pre-1987 law).

While ACT is no longer payable by U.K. corporations, the shareholder tax credit due under the Convention is still funded out of U.K. corporate tax revenues and is determined by reference to the amount of the dividend, which is a portion of the base used to compute the U.K. corporation’s tax. Thus, the payment of the shareholder tax credit gives rise to a refund or indirect subsidy for U.S. tax purposes. See section 901(i) and Treas. Reg. § 1.901–2(e)(3). These purposes include the computation of the corporation’s earnings and profits (E&P) and foreign income taxes and corresponding effects on the corporation’s U.S. shareholders, which may include the computation of the indirect credit under paragraph 1 of Article 23 (and pursuant to sections 902 and 960 of the Code) and the subpart F provisions under sections 951 through 964 of the Code. Accordingly, for distributions after April 5, 1999 with respect to which a U.S. direct investor applies for benefits under Article 10 of the Convention, the U.K. corporation will be treated as receiving a tax refund in an amount equivalent to the gross amount of the tax credit (unreduced by amounts withheld) payable to the U.S. shareholder under the Convention. This treatment ensures that the U.S. shareholder does not receive combined direct and indirect foreign tax credits in an amount exceeding the income taxes actually paid by the U.K. corporation.

The deemed refund of tax to the U.K. corporation is considered allocable to a separate limitation category in proportion to the ratio of post-1986 foreign income taxes in such category to the total amount of post-1986 foreign income taxes of the U.K. corporation, determined as of the close of the year in which the shareholder tax credit is paid or accrued and prior to accounting for the effect of distributions and deemed distributions during the year. To the extent the refund exceeds the U.K. corporation’s total post-1986 foreign income taxes, the refund is treated as attributable to foreign income taxes previously deemed paid on a last-in, first-out basis ( i.e., the refund reduces the foreign income taxes most recently deemed paid by

the U.S. shareholder). Thus, the U.K. corporation must, in the year the shareholder tax credit is paid or accrued, reduce its post-1986 foreign income taxes in the separate limitation category (or categories) to which the refund relates and correspondingly increase its post-1986 undistributed earnings in the same category (or categories) by the gross amount of the tax credit payable under the Convention. See Treas. Reg. sections 1.905–3T(a)(3) and (4). As explained in the Treasury Technical Explanation accompanying the Convention, where a U.S. direct investor owns less than all the stock of the distributing U.K. corporation, the indirect credit due under Article 23 and in accordance with sections 902 and 960 will be calculated with reference solely to the proportionate amount of E&P and foreign taxes attributable to that investor. Thus, the amount of the indirect credit will not vary according to the status of any other shareholder or the amount of distributions made, or payments of tax credits under the Convention, to any other shareholder. See Treasury Explanation, reprinted in 1980-1 C.B. 455, 473.

6. Procedures for Direct Investors To Claim a Tax Credit Payment Under the Convention . Prior to the repeal of ACT, the United Kingdom Inland Revenue could enter into arrangements with a U.K. corporation that paid a dividend or other qualifying distribution, authorizing it to pay the tax credit due under the Convention directly to its U.S. shareholders. The U.K. corporation could offset the amount of the tax credit paid against its ACT liability. Because U.K. corporations no longer pay ACT, this procedure is no longer available.

Because of the changes in U.K. law, all claims for payments of tax credits must be made on the appropriate United Kingdom form and filed directly with the United Kingdom Inland Revenue. The appropriate United Kingdom form is U.S./Corporation/Credit. In the United States, the forms may be obtained from the Internal Revenue Service, Office of Assistant Commissioner (International), Attn: Customer Service OP:IN:D:CS, 950 L’Enfant Plaza South, S.W., Washington, D.C. 20024. In the United Kingdom, the forms may be obtained from the Financial Intermediaries and Claims Office (“FICO”),

P.O. Box 46, Fitz Roy House, Nottingham NG2 1BD. The forms may be ordered from the United Kingdom by telephone on (011 44) 115 974 2000 or by fax on (011 44) 115 974 1863.

If a U.S. direct investor has never made a claim for a tax credit under the Convention, the investor should file a completed United Kingdom form (in duplicate) with the Philadelphia Service Center, Foreign Certification Unit, P.O. Box 16347, DP535B, Philadelphia, PA 19114. The Service Center will provide the required certification and transmit the form to the United Kingdom Inland Revenue. If a U.S. investor has previously filed a claim for a tax credit under the Convention, subsequent claims do not require certification by the Philadelphia Service Center. In such cases, the United Kingdom form should be filed directly with the United Kingdom Inland Revenue at the address shown above.