What is Limitation on Benefits (LOB)?

How it works

LOB clauses appear in nearly every modern US tax treaty. They restrict treaty benefits — reduced WHT rates, treaty residency claims, capital-gains exemptions — to entities that pass at least one of several objective tests. The point is to block tax treaty shopping: an offshore investor inserting a Cypriot or Dutch holding company purely to access US treaty rates can fail the LOB and lose the treaty benefit.

The standard tests in a US treaty LOB article (modelled on the 2016 US Model Convention):

1. Individual — natural persons resident in the treaty state automatically qualify.
2. Government / pension fund / charitable organisation — qualifies.
3. Public company test — entity whose principal class of shares is regularly traded on a recognised stock exchange in the treaty state. Subsidiary of a publicly traded company may also qualify.
4. Ownership and base-erosion test — at least 50% of the entity's beneficial ownership is held by qualifying persons (residents of the treaty state who themselves qualify), AND less than 50% of gross income is paid out as deductible payments to non-residents (preventing base erosion through related-party charges).
5. Active trade or business test — entity carries on an active trade or business in the treaty state, the treaty income is connected with that business, and the activity is substantial relative to the income.
6. Derivative benefits test (in some treaties, especially with EU partners) — beneficial owners include "equivalent beneficiaries" who would have been entitled to similar treaty benefits had they invested directly.
7. Headquarters company test — narrow carve-out for genuine multinational headquarters.

Fail all of the above? Discretionary determination route: the entity can apply to the competent authority of the source country (US: IRS) for a one-off LOB determination based on facts and circumstances. Granted sparingly.

Why US treaties use LOB instead of PPT

The US has historically preferred objective tests over subjective intent tests. LOB criteria are mechanical: either the entity passes the public-company test or it doesn't. The Principal Purpose Test (PPT) introduced by the BEPS MLI is a subjective test — denying treaty benefits if obtaining them was one of the principal purposes of an arrangement.

Modern US treaties (post-2016) often combine both: an LOB clause for the structural test, plus a "main purpose" anti-abuse clause that mirrors PPT.

Examples

• Foreign individual UK-resident receives US dividends. Individual test → automatic LOB pass. UK-US treaty 5% / 15% portfolio dividend WHT applies.
• Cypriot SPV owned by a Russian beneficial owner receives US dividends. Public company test: fail (private). Ownership test: fail (Cypriot SPV not owned by Cypriot residents). Active trade or business: fail (passive holding). Derivative benefits: fail (Russia treaty currently suspended; Russian beneficial owner not an "equivalent beneficiary"). LOB denied → US-Cyprus treaty 0% on dividends not available; default 30% WHT applies.
• Genuine French operating subsidiary of a French parent group. Active trade or business test: pass (operating activity in France). LOB granted; France-US 5% / 15% portfolio dividend WHT applies on US-source dividends to the French sub.

Common mistakes

• Treating LOB as automatic. Treaty benefit claims via W-8BEN-E require the entity to confirm LOB qualification. The form has a specific section for which LOB test applies. Filing without identifying a passed test invalidates the form.
• Assuming derivative benefits = open access. Derivative benefits requires the ultimate beneficial owners to be "equivalent beneficiaries" — typically residents of EU/EFTA/NAFTA partners with similar treaty rates. Russian, Brazilian, or Argentine beneficial owners typically don't qualify even through an EU sub.
• Forgetting active-trade-or-business connection requirement. The active TB test requires the treaty income to be connected with the active business — not just the entity to have any business. A French operating company's US dividend portfolio income may fail this connection test.
• Skipping LOB analysis on holding structures. A pure holding company without commercial substance fails most LOB tests — and its treaty benefits are lost.