By Madison Barnett and Stephanie Do
Many foreign companies are surprised to learn that US states are not generally bound by income tax treaties entered into by the US with foreign countries. Under these treaties, for US federal income tax purposes, certain non-US corporations and residents of foreign countries may be exempt from tax or taxed at a reduced rate. Most US states, however, also impose income taxes on corporations and individuals, and US tax treaties are generally not binding on states. As a result, the applicability of US tax treaties to state income taxes must be determined on a state-by-state and treaty-by-treaty basis. Some states expressly respect US tax treaties, such as Florida, Massachusetts, South Carolina and Virginia. Other states do not expressly respect treaties, but may implicitly do so by tying the state tax base to the US federal tax base in a manner that effectively conforms to federal treaty protections.
Some states will only apply a treaty to their state income taxes if the treaty specifically limits state taxation. Consequently, foreign taxpayers that are protected from US federal income tax by an income tax treaty may nevertheless have a state income tax filing obligation and potential state tax liability in the US states in which they do business.
On March 13, 2017, the State of Arkansas Department of Finance and Administration (the Department) issued Legal Opinion No. 20170217 addressing the applicability of the US-Canada Income Tax Treaty to Arkansas personal income tax. The Department determined that the treaty applies only to US federal income taxes, such that “income taxes levied by individual states, such as Arkansas, do not fall within the treaty’s jurisdiction.” As a result, “the treaty’s provisions are generally not recognized by this state.”
The Department also determined that the Arkansas credit for personal income taxes paid to another US state does not extend to taxes paid to the Canadian government or a Canadian province. Non-US taxes may be deducted from gross income for Arkansas personal income tax purposes, but not credited.