The U.S. has income tax treaties in force with over 60 countries. The purpose of tax treaties is to avoid double taxation on the classes of income covered by the treaty, which would otherwise be subject to income tax in both the U.S. and the treaty country. As a result, a tax treaty can provide an alternative for exemption from U.S. tax for business enterprises from a country which has a treaty with the U.S.
Tax treaties include provisions that reduce or eliminate taxes on passive income such as interest, dividends and royalties. Tax treaties also include a provision, the Business Profits Article, describing the threshold of activities that a foreign business enterprise must have in the U.S. before its business profits will be subject to U.S. income taxes. (Since tax treaties by their terms apply only to federal income taxes, state income taxes on business profits are not avoided by tax treaties, unless a particular state either explicitly or implicitly honors federal tax treaties.)
To be eligible for exemption from tax under a tax treaty, the income must be derived by an enterprise that is a resident of the treaty country. If the entity is a partnership or other flow-through entity, it must be recognized as the beneficial owner of the income for treaty purposes under the internal law of the treaty country. In addition, the ownership of the entity must meet the requirements of the Limitation on Benefits Article of the applicable treaty, if the treaty has such an article (most do). This article is designed to prevent businesses from claiming residency in the country merely for tax treaty purposes (called treaty shopping).