Tax treaties establish specific frameworks to identify which taxes are covered by their provisions. Generally, income tax treaties apply to certain types of income taxes imposed by the countries that are parties to the treaty. Please note that U.S. tax treaties typically apply only to taxes levied at the federal level. This means that U.S. income tax treaties may not cover taxes imposed by state, county, or municipal governments.
Understanding the types of taxes encompassed by these treaties is crucial for applying treaty benefits and determining the appropriate tax treatment for cross-border transactions. Let’s take a closer look at some of these taxes in detail:
This section explains how the U.S. taxes the business profits of foreign companies that are residents of countries with a tax treaty. Generally, under a tax treaty, a foreign company’s business profits are taxable in the U.S. if it has a “Permanent Establishment” (PE) in the United States. A PE typically means that the company has a fixed place of business or a dependent agent located in the United States. In this case, profits attributable to the PE are generally subject to U.S. taxation for 21% (2025).
If there is no PE, the U.S. generally may not tax those business profits attributable to the PE. This is also likely true even if the company has engaged in a U.S. Trade or Business (USTB) under domestic law. This topic is addressed in U.S. tax treaties with countries such as Finland, Denmark, and India. To learn more about Permanent Establishments, please refer to our article here.
Please note that in the absence of a tax treaty, U.S. domestic tax law applies. In this case, business profits are generally taxable if the foreign company is engaged in a U.S. Trade or Business (USTB). Any income effectively connected with the USTB is likely subject to a graduated tax rate, currently set at 21% for corporations (as of 2025).
For example, ABC, a Finland company, provides business services to clients in the United States.
Under U.S. domestic tax laws ABC may be considered to be engaged in a U.S. trade or business. Therefore, ABC’s profits that are effectively connected with that U.S. activity may be subject to U.S. tax at graduated corporate tax rates. However, under the U.S.–Finland tax treaty, ABC’s business profits are generally taxable in the United States only if the company operates through a permanent establishment in the U.S.
If ABC does not have a permanent establishment in the United States, its business profits are generally not subject to U.S. tax. However, if ABC has a permanent establishment in the U.S., then its profits attributable to the PE may be taxed at 21% rate.
This section explains how the United States taxes dividends paid by U.S. companies to residents of a treaty country. Generally, the U.S. withholds and impose 30% tax on dividend payments to non-residents. However, this withholding rate and the effective tax rate may be reduced under applicable tax treaties. This is covered under U.S. tax treaties with other countries such as Finland, Denmark, and India, etc.
For example, John is from Finland and is a shareholder of Microsoft Corporation in the United States. He received dividend income from the U.S. company. Generally, dividend income is subject to a 30% withholding and effective tax in the U.S. However, a tax treaty between the U.S. and Finland allows a reduced tax rate of 5-15%. Therefore, John will likely be responsible for the reduced withholding and effective tax of 5-15%.
This section explains how the United States taxes interest payments made by U.S. company or person to resident of a treaty country. Generally, the U.S. withholds and imposes a 30% tax on interest payments to non-residents. However, this withholding rate and the effective tax rate may be reduced under applicable tax treaties. This is covered under U.S. tax treaties with other countries such as Finland, Denmark, and India, etc.
For example, Siya is from India and provided a loan to a U.S.-based manufacturing company. She received interest income from the U.S. company. Generally, interest income is subject to a 30% withholding tax in the U.S. However, a tax treaty between the U.S. and India may allow a reduced withholding rate of 10-15%. Therefore, Siya will likely be responsible for the reduced tax rate of 10-15%.
This section explains how the United States taxes royalties paid by U.S. companies to residents of a treaty country. Generally, the U.S. withholds and imposes a 30% withholding tax on royalty payments to non-residents. However, this withholding rate and the effective tax rate may be reduced under applicable tax treaties. This is covered under U.S. tax treaties with other countries such as the UK, Germany, Canada, India, etc.
For example, Maria is from Finland and licensed his patented manufacturing process to a U.S. pharmaceutical company. She received royalty income from the U.S. company. Generally, royalty income is subject to a 30% withholding tax in the U.S. However, a tax treaty between the U.S. and Finland may allow a reduced withholding rate of up to 5%. Therefore, Maira will likely be responsible for the reduced tax rate of 5% under the treaty.
This section explains how the U.S. taxes income derived from U.S. real property and earned by residents of a treaty country. Generally, under U.S. domestic tax law, income from U.S.-situated real property, such as rental income, is taxable in the U.S. This is because the property is located in the United States.
Most U.S. tax treaties follow the same principle and allocate the right to tax real property income to the country where the property is located. As a result, treaty provisions typically do not eliminate U.S. taxation on U.S. real estate income but instead confirm the U.S.’s primary right to tax such income. This treatment is reflected in many U.S. tax treaties, including those with the United Kingdom, Canada, Germany, and others.
For example, under the U.S.–UK tax treaty, income derived by a UK resident from real property situated in the United States may be taxed in the U.S. This is because the taxing right is determined by the location of the property. Accordingly, rental income from U.S. real estate earned by a UK resident remains subject to U.S. tax.
This section explains how the United States taxes income derived from the operation of ships or aircraft in international traffic by residents of a treaty country. First, let’s understand the concept of international traffic.
International Traffic
For treaty purposes, international traffic generally means trips that carry passengers or goods across borders and are not primarily for travel within a single country. In other words, international traffic rule generally applies if the transportation begins in the U.S. but does not end in the U.S., or if ends in the U.S. but does not begins in the United States.
Next, let’s understand how the U.S. taxes the shipping and air transportation income under its domestic law.
U.S. Domestic Law
Generally, under U.S. domestic tax law, income earned by foreign persons from transportation activities connected to the United States may be subject to U.S. tax. Transportation income from the operation of ships or aircraft that either begins or ends in the U.S. is treated as 50% U.S.-source income. Further, foreign persons are generally subject to a 4% tax on their U.S.-source gross transportation income.
Next, let’s clarify how foreigners are taxed on their transportation activities if they come from a non-treaty country with the United States.
Non-Treaty Countries
For residents of countries that do not have a tax treaty with the United States, the U.S. applies its domestic rules. In these cases, income from international transportation that either begins or ends in the United States is typically subject to the 4% tax on the U.S.-source portion.
Next, let’s clarify how foreigners are taxed on their transportation activities if they come from a treaty country with the United States.
Treaty Countries
In most U.S. tax treaties, there is a specific Article on Shipping and Air Transport that modifies this general rule.
Under these treaty provisions, profits from the operation of ships or aircraft in international traffic are generally taxable in the country of residence of the foreign operator. As a result, the United States generally relinquishes its right to tax such income when the operator is a resident of the other contracting state. This treatment appears in many U.S. tax treaties, such as those with Canada.
Under the U.S.–Canada tax treaty, profits derived by a Canadian resident from the operation of ships or aircraft in international traffic are exempt from U.S. taxation.
For example, let’s say John, a Canadian resident, operates flights from Canada to Europe that stop in the United States. The trips qualify as international traffic because the flights cross borders and are not solely between U.S. cities. As a result, the profits from operating those flights are likely exempt from U.S. tax, since the income is taxed in John’s country of residence, Canada.
This section explains how the United States taxes profits earned by foreign companies that are related to U.S. companies. Generally, related companies may structure prices or business terms differently than independent companies. However, under the Transfer Pricing regime, U.S. domestic law allows tax authorities to review and adjust such arrangements.
Most U.S. tax treaties include an Associated Enterprises article that also follows the same principle. They permit the United States to reallocate profits from related-party transactions when pricing does not follow arm’s-length standards. These rules are closely linked to transfer pricing principles, which require related parties to deal with each other as independent parties would.
For example, under the U.S.-Germany tax treaty (Article 9 – Associated Enterprises), the United States and Germany may adjust profits between related companies to reflect arm’s-length pricing.
Let’s say a German parent company sells goods to its U.S. subsidiary at prices higher than those charged by independent companies. This inflated pricing likely increases the U.S. subsidiary’s expenses, thereby reducing its taxable profits. Under the tax treaty, the IRS may adjust the selling price and increase the U.S. subsidiary’s income to reflect fair market value. This adjustment ensures that profits are taxed in the jurisdiction where the business activities take place.
At the same time, the treaty may permits Germany to make a corresponding adjustment to avoid double taxation, subject to agreement between the two tax authorities.
This section explains how the U.S. taxes income earned by foreign entertainers and athletes who perform or compete in the United States. Foreign entertainers or athletes may visit the U.S. temporarily and earn income from performances, competitions, or appearances. Generally, under U.S. domestic tax law, income earned by foreign entertainers and athletes from performing within the United States may be subject to U.S. tax.
Most U.S. income tax treaties contain a specific article governing the taxation of entertainers and athletes. Under these treaties, the United States is generally permitted to tax income earned from activities performed in the U.S.
Some treaties provide a limited exemption when the income does not exceed a specified threshold amount.
For example, under the U.S.-Estonia tax treaty, an Estonian entertainer performs in the U.S. and earns income exceeding the treaty threshold of $20,000. In that case, the income may be taxed in the U.S. This is because the income is attributable to activities physically performed in the United States and exceeds the exempt threshold.
However, if the income stays below the treaty threshold, the entertainer may be exempt from U.S. tax under the treaty.
This section explains how the United States taxes pension income and similar payments made from the U.S. to residents of a treaty country. Generally, pension income paid to non-residents may be subject to U.S. tax. However, the applicable tax rule may be limited or modified under U.S. tax treaties.
Most U.S. tax treaties provide that pensions and similar remuneration are primarily taxed in the recipient’s country of residence. This means that the country in which the individual is a tax resident generally has the first right to tax the pension income. This treatment is covered under U.S. tax treaties with countries such as Canada, the United Kingdom, and Germany, among others.
For example, under the U.S.-Canada tax treaty, a Canadian resident may receive pension payments from the United States. Under the treaty, Canada has the primary right to tax the pension income because the recipient is a Canadian tax resident. However, Canada’s tax on such income is subject to a limitation. The limitation is that it cannot exceed the amount of tax that the United States would impose on a U.S. resident receiving the same pension income. This prevents Canada from taxing cross-border pension income more heavily than it would be taxed in a purely domestic U.S. context.
Example:
Suppose John, a Canadian resident, receives an annual U.S. private pension of USD 50,000. If John were a U.S. resident, then he would be subject to a U.S. federal income tax on that pension income. Let’s assume John’s U.S. pension income tax would amount to approximately $7,500.
As per the U.S.-Canada tax treaty, Canada, as the residence state, has the primary right to tax the full USD 50,000 under Canadian income tax rules. However, Canada’s tax on this income may not exceed the U.S. tax liability on the same pension income. Here. U.S. tax liability on John amounts to $7,500.
Further, the United States may also tax such pension income as the source state, but the treaty limits the U.S. tax rate on such income to a maximum of 15 percent. This situation can be complicated and may lead to double taxation. If you find yourself in a similar situation, please contact us.
This section explains how the United States taxes income earned by students, trainees, teachers, and researchers who are residents of a treaty country and are temporarily present in the United States. Generally, under U.S. domestic tax law, income earned by such individuals while in the United States may be subject to U.S. tax.
For example, the taxable portions of scholarships or fellowships are generally subject to a 14% withholding if paid to a nonresident student on an F visa.
Most U.S. income tax treaties include special provisions that modify these domestic rules and provide exemptions or reduced tax rates for certain income earned by students, trainees, teachers, and researchers. These treaty provisions are intended to prevent double taxation and encourage educational and scientific exchanges.
For example, Article 22 of the U.S.-India tax treaty provides for exemption from U.S. tax for teachers, professors, and research scholars. Under the treaty, an individual is exempt from U.S. tax on teaching or research income if they were an Indian resident immediately before visiting the United States. Also, they should remain no longer than two years in the U.S.
The exemption applies only when teaching or research is performed at an accredited university or other recognized U.S. educational institution. If the individual’s stay in the United States exceeds two years, the exemption may be lost for the entire period of the visit.
The exemption does not apply to research conducted primarily for the private benefit of any person rather than in the public interest.