[Senate Hearing 105-354]
[From the U.S. Government Publishing Office]
S. Hrg. 105-354
BILATERAL TAX TREATIES AND PROTOCOL
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FOREIGN RELATIONS
UNITED STATES SENATE
ONE HUNDRED FIFTH CONGRESS
FIRST SESSION
__________
OCTOBER 7, 1997
__________
Printed for the use of the Committee on Foreign Relations
U.S. GOVERNMENT PRINTING OFFICE
44-110 CC WASHINGTON : 1998
COMMITTEE ON FOREIGN RELATIONS
JESSE HELMS, North Carolina, Chairman
RICHARD G. LUGAR, Indiana JOSEPH R. BIDEN, Jr., Delaware
PAUL COVERDELL, Georgia PAUL S. SARBANES, Maryland
CHUCK HAGEL, Nebraska CHRISTOPHER J. DODD, Connecticut
GORDON H. SMITH, Oregon JOHN F. KERRY, Massachusetts
CRAIG THOMAS, Wyoming CHARLES S. ROBB, Virginia
ROD GRAMS, Minnesota RUSSELL D. FEINGOLD, Wisconsin
JOHN ASHCROFT, Missouri DIANNE FEINSTEIN, California
BILL FRIST, Tennessee PAUL D. WELLSTONE, Minnesota
SAM BROWNBACK, Kansas
James W. Nance, Staff Director
Edwin K. Hall, Minority Staff Director
(ii)
C O N T E N T S
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Page
Guttentag, Joseph H., Deputy Assistant Secretary, International
Tax Affairs, Department of Treasury............................ 3
Prepared statement........................................... 7
Kies, Kenneth J., Chief of Staff, Joint Committee on Taxation.... 35
Prepared statement........................................... 39
Mattson, Robert N., Chief Tax Officer and Assistant Treasurer,
International Business Machines Corporation, on behalf of the
National Foreign Trade Council and the United States Council
for International Business..................................... 48
Prepared statement........................................... 49
Appendix
Responses of Mr. Guttentag to questions asked by Chairman Helms.. 55
Responses of Mr. Guttentag to questions asked by Senator Sarbanes 55
BILATERAL TAX TREATIES AND PROTOCOL
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TUESDAY, OCTOBER 7, 1997
U.S. Senate,
Committee on Foreign Relations,
Washington, DC.
The committee met, pursuant to notice, at 3:15 p.m., in
room SD-419, Dirksen Senate Office Building, Hon. Chuck Hagel
presiding.
Senator Hagel. Good afternoon, and welcome.
Before we get started this afternoon, I would like to thank
the panelists for taking part in this important discussion on
bilateral international income tax treaties. Thank you.
This is an issue that is vital to our economic growth not
only today but, as you all know, for the future. The main
purposes of these treaties are to prevent international double
taxation and tax evasion.
No one wants to be double taxed on their hard-earned
income. They have a hard enough time here in the United States,
dealing with unfair, complicated and restrictive tax codes. The
last thing we need to do is subject our businesses and people
to move taxation. These treaties accomplish that by setting
down rules to determine whether the income source country or
the resident's country will have the primary right to tax
income, restricting the ability of the source income country to
tax and reducing withholding tax rates on cross-border payments
of interests, dividends and royalties.
Also these treaties grant the procedural authority to each
country to agree to provide tax relief for a particular
taxpayer who can establish that he is being taxed in a manner
inconsistent with the treaties. Tax evasion is also dealt with
under these treaties. The treaties put limitations on benefits,
so that benefits are denied to unintended beneficiaries.
If we are to provide a level playing field in this global
economy, everyone must be following the same rules.
Unfortunately, in many areas of the world, U.S. companies are
at a disadvantage compared to many of their European
competitors. Today, the United States has income tax treaties
in force with 46 countries worldwide, while the United Kingdom,
for example, has 98, and France has 94. In fact, the average G-
7 country has 67 income tax treaties in effect today.
In front of the Foreign Relations Committee today, we have
seven treaties and one protocol to amend an existing treaty
with Canada. Of the seven treaties, three are with new
countries: South Africa, Thailand and Turkey. These three
treaties are particularly important, as they may serve as
examples for expanding our tax treaties with other new and
developing countries in East Asia, Central Asia and Africa.
The other four treaties are also important, as they will
modernize existing treaties with Austria, Ireland, Luxembourg,
and Switzerland. As we move forward into the next millennium,
the global economy that we now have today will even be more
interrelated. We cannot sit back and let the rest of the world
pass by the United States. We must give our businesses and
individuals a chance to thrive in this ever-changing global
economy. That is why it is so important that these
international tax treaties are passed in a swift manner.
I come at this tax treaties maybe from a little different
perspective than the rest of my colleagues. I come at this as a
former businessman. I have started businesses and created jobs
throughout the world and understand a little bit, from a
practical perspective, the effects of these treaties. I
understand what it takes to make sure that businesses will be
successful and thrive in an international and competitive way.
It is not easy, but it can and must be done in order for
their to be growth and prosperity in the United States. No
companies are more vulnerable to onerous double taxation than
new, small businesses, struggling to compete in today's global
marketplace. These tax treaties will help U.S. companies
expand, create jobs and keep the U.S. economy growing. These
bilateral international tax treaties are important to the
future of this Nation, its economy and our growth. Today, I
hope that we will shed some light on the importance of these
treaties and the impact they will have internationally and
domestically. They will be important to strengthen the United
States in the ever-growing global economy.
[The prepared statement of Senator Hagel follows:]
Prepared Statement of Senator Hagel
Before we get started this afternoon, I would like to thank the
panelists for taking part in this very important discussion on
bilateral international income tax treaties. This is an issue that is
vital to economic growth of the United States, not only today, but also
for the future.
The main purposes of these treaties are to prevent international
double taxation and tax evasion.
No one wants to be double taxed on their hard earned income. We
have a hard enough time here in the United States dealing with an
unfair, complicated, and restrictive tax code. The last thing we need
to do is subject our businesses and people to more taxation. These
treaties accomplish that by setting down rules to determine whether the
income source country or the residence country will have the primary
right to tax income, restricting the ability of the source income
country to tax, and reducing withholding tax rates on cross-border
payments of interest, dividends, and royalties. Also these treaties
grant the procedural authority to each country to agree to provide tax
relief for a particular taxpayer who can establish that he is being
taxed in a manner inconsistent with the treaties.
Tax evasion is also dealt with under these treaties. The treaties
put ``limitations on benefits'' provisions in so that benefits are
denied to unintended beneficiaries. If we are to provide a level
playing field in this global economy, everyone must be following the
same rules.
Unfortunately, in many areas of the world U.S. companies are at a
disadvantage compared to many of their European competitors. Today, the
United States has income tax treaties in force with 46 countries
worldwide while the United Kingdom has 98 and France has 94. In fact,
the average G-7 country has 67 income tax treaties in effect.
In front of the Foreign Relations Committee today, we have 7
treaties and 1 protocol to amend an existing treaty with Canada. Of the
7 treaties, three are with new countries, South Africa, Thailand, and
Turkey. These three treaties are particularly important, as they may
serve as examples for expanding our tax treaties with other new and
developing countries in East Asia, Central Asia and Africa. The other 4
treaties are also important, as they will modernize existing treaties
with Austria, Ireland, Luxembourg, and Switzerland.
As we move forward into the next millennium, the global economy
that we have today will be even more interrelated. We can't sit back
and let the rest of the world pass by the United States. We must give
our businesses and individuals a chance to thrive in this ever changing
global economy. That is why it is so important that these international
tax treaties are passed in a swift manner.
I come at these tax treaties from a little different angle that the
rest of my colleagues. I come at this as a businessman. I've started
many businesses and created hundreds of jobs throughout this world. I
understand what it takes to make sure that businesses will be
successful and thrive. It is not easy, but it can and must be done in
order for there to be growth and prosperity in the United States. No
companies are more vulnerable to onerous double taxation than new small
businesses struggling to compete in today's global marketplace. These
tax treaties will help U.S. companies expand, create jobs, and keep the
U.S. economy growing.
These bilateral international tax treaties are important to the
future of this nation, its economy and growth. Today, I hope that we
will shed some light on the importance of these treaties and the impact
they will have internationally and domestically. They will be important
to strengthen the United States in the ever growing global economy.
Before recognizing the first of our witnesses, I would like to
recognize the subcommittee's Ranking Member, Senator Sarbanes, for any
comments he may have.
Senator Hagel. Now, before recognizing our distinguished
panelists, I would like to recognize the subcommittee's ranking
member, Senator Sarbanes. Senator Sarbanes.
Senator Sarbanes. Well, Mr. Chairman, I will be very brief.
I am anxious to hear the presentation. I am curious why, in
some of these treaties, we seem to be making one-sided
concessions. I will be interested in exploring that.
Recently, the Treasury developed a model treaty which seems
to make some significant departures from the model treaty. I
wonder what is the rationale for that.
Finally, this committee in the past has expressed an
opinion on certain aspects of tax policy, in terms of
provisions in treaties. That seems to have been ignored in a
couple of instances here. So, when we get to the questioning
period, I want to explore all of these areas.
Thank you.
Senator Hagel. Senator Sarbanes, thank you.
Let me first introduce the three panels of witnesses, and
then ask our first witness to proceed.
First, the Hon. Joseph H. Guttentag, Deputy Assistant
Secretary, International Tax, Department of Treasury.
The second panel, Mr. Kenneth J. Kies, Chief of Staff,
Joint Committee on Taxation.
And the third panel, Mr. Robert Mattson, on behalf of the
National Foreign Trade Council and the U.S. Council for
International Business, and also Assistant Treasurer, IBM.
With that, Mr. Secretary, please proceed. Good to have you.
STATEMENT OF JOSEPH H. GUTTENTAG, DEPUTY ASSISTANT SECRETARY,
INTERNATIONAL TAX, DEPARTMENT OF TREASURY
Mr. Guttentag. Thank you, Mr. Chairman and Mr. Sarbanes.
I will summarize my written statement, which I have
submitted for the record, and request that my statement be
included in the record.
Senator Hagel. Without objection.
Mr. Guttentag. Thank you, Mr. Chairman.
I am pleased today to be able to recommend, on behalf of
the administration, favorable action on seven bilateral tax
treaties and a protocol to our Canada tax treaty that the
President has transmitted to the Senate and that are the
subject of this hearing.
These agreements would provide significant benefits to the
United States, as well as to our treaty partners, and Treasury
requests the committee and the Senate to take prompt and
favorable action on all of these agreements. We have submitted
new agreements with five of our oldest treaty partners:
Austria, Luxembourg, Switzerland, Ireland, and Canada; two
agreements with completely new countries of increasing
important significance to us: Turkey and Thailand; and the
eighth agreement before you, the treaty with South Africa,
brings that important country back into our tax treaty network
after its change in government.
The new agreements will generate substantial benefits for
U.S. taxpayers and the tax authorities, and will serve to
expedite increased desirable international economic activity as
an income tax treaty removes impediments to international trade
and investment in many ways. First, it generally increases the
extent to which exporters can engage in trading activity in the
other country without triggering tax. When tax is imposed, it
ensures appropriate deductions, and reduces the withholding tax
on flows of income.
Second, it establishes rules that assign to one country or
the other the primary right of taxation with respect to a
particular piece of income, helping to prevent the double
taxation that can occur if both countries impose tax on the
same income. Third, the treaty provides a dispute resolution
mechanism to prevent double taxation that sometimes can arise
in spite of the treaty provisions.
Finally, and often most importantly, the treaty helps to
create stability of tax rules, thereby encouraging this
desirable economic activity. The tax treaties alleviate the
burden of high source--based taxation by reducing the levels of
withholding tax that the treaty partners may impose on these
types of income. In general, United States policy is to reduce
the rate of withholding tax on interest and royalties to zero;
dividends normally are subject to tax at one of two rates: 15
percent with respect to portfolio investment, and 5 percent
with respect to direct corporate investors.
The extent to which this policy is realized depends on a
number of factors. Although generalizations are often difficult
to make in the context of complex negotiations, it is fair to
say that we are more successful in reducing these rates with
countries that are relatively developed and where there are
substantial and reciprocal income flows.
We also achieve lesser but still very significant
reductions with countries where the flows tend to be
disproportionately in favor of the United States. Lesser
developed and newly emerging economies, where capital and trade
flows are often disparate or sometimes completely one way,
create obstacles to achieving our desired level of withholding,
though we still find a treaty most desirable.
These rules are general guidelines, and they do not address
every conceivable situation. Consequently, there will still be
cases in which double taxation may occur. In such cases, the
treaty provides a mechanism through the tax authorities of the
two governments, known as the competent authorities, to consult
and reach an agreement in which the taxpayer's income is
allocated between the two taxing jurisdictions on a consistent
basis, thereby preventing the double taxation.
All the aspects of tax treaties that I have been discussing
so far involve benefits that the treaties provide to taxpayers,
especially multinational companies, big and small. While
providing these benefits certainly is a major purpose of any
tax treaty, it is not the only purpose. The second major
objective of our income tax treaty program is to prevent tax
evasion and to ensure that treaty benefits only flow to those
intended recipients.
Tax treaties ensure this in two ways. First, they provide
for exchange of information between the tax authorities.
Second, they contain provisions to limit the treaty benefits to
real residents of the country, and to prevent treaty shopping.
Our tax treaties must provide appropriate tax treatment for
categories of income which are specially treated under the
Internal Revenue Code. One important example of such provisions
are the REITs, the real estate investment trusts, created by
Congress to help investors achieve diversified ownership in
primarily passive real estate investments. In the case of
foreign investors, the Congress provided for a 30 percent
withholding tax, except for certain capital gain distributions.
These rules reflect U.S. tax policy, which is consistent
with that of most countries. That is, each country reserves the
right to impose a full tax on income from real property; and
the other country must, therefore, give a credit or an
exemption to prevent double taxation. Our existing treaty
policy provides for a 30 percent withholding tax on REIT
dividends, with a limited 15 percent exception. That is only
for payments to individuals who own 10 percent or less of the
REIT.
We have determined that reconsideration of our existing
policy is appropriate for the reasons described in greater
detail in our prepared testimony. Our new policy provides for a
15 percent withholding tax on shareholders of publicly traded
REITs who hold 5 percent or less. Even if the REIT is not
publicly traded, but its holdings are substantially
diversified, the foreigner can hold up to 10 percent of the
REIT. This new policy has been developed with, and has the
support of, the staffs of this committee, the joint committee
on taxation and the REIT industry. It will be reflected in our
model treaty and in future treaty negotiations.
Furthermore, we do not object to a reservation in the
Luxembourg treaty, pending before you, which would reflect this
new policy in that treaty, as well as providing certain limited
grandfathering. We are also going to use our best efforts to
secure agreement with our current treaty partners, Austria,
Ireland and Switzerland, to protocols to our new treaties to
reflect this new policy.
Further details with which we agree and support are also
set forth in Mr. Kies' written testimony.
The discussion of REIT taxation provides an example of why
our tax treaty policy cannot be static, and our model treaty
published last year, as well as the OECD model, are and will be
ambulatory documents. We work on a continuing basis with our
foreign colleagues to continually review our treaty policies
and interpretations. It is to our advantage to have universally
accepted policies and interpretations, and we work hard to
achieve such goals.
If, however, we believe that inconsistencies are created
with U.S. positions, we can, at any time, disavow our
adherence. We have, over the years, working with this committee
and the tax writing committees, achieved an appropriate balance
between the certainty required in order to receive Senate
advice and consent and the necessary flexibility to achieve our
treaty goals. We must take into account that our treaties
remain in place, unchanged sometimes for decades, and
reasonable flexibility in interpreting the treaty--not changing
it--is needed to deal with new and unanticipated developments.
For example, we are working internationally with our
multinational businesses and foreign governments to ensure that
tax laws do not impede the development of new technologies,
exemplified by the Internet. At the same time, we need to
ensure that we have the proper tools in place to prevent these
new technologies from encouraging tax avoidance or evasion.
I do not intend to discuss the details of each of the eight
agreements you have before you, but will of course be pleased
to answer any questions you may have. Each treaty must be
adapted to the individual facts and circumstances of the treaty
partner. It is also important to remember that each treaty is a
result of a negotiated bargain between two countries that often
have conflicting objectives.
We have submitted technical explanations of each agreement
that contain detailed discussions of each treaty and protocol.
These technical explanations serve as an official guide to each
agreement. We have furnished our treaty partners with a copy of
the relevant technical explanation, and offered them the
opportunity to submit their comments and suggestions.
Each of the treaties with Austria, Switzerland, Luxembourg,
and Ireland are over 30 years old, and some are approaching 50.
They all needed to be modernized to take into account the
numerous changes in our economic relationships and tax laws
over the past decade. All are very close to the current U.S.
model, and contain appropriate versions of our anti-treaty
shopping and information exchange provisions.
The treaty with Luxembourg was negotiated in tandem with a
mutual legal assistance treaty, which provides essential tax
information exchange provisions. We urge prompt approval of the
tax treaty with Luxembourg, with the understanding that the
treaty will not come into effect until the MLAT does.
The treaties with Turkey, Thailand and South Africa
demonstrate agreement with countries in different stages of
development. Although there are some developing country
concessions in these agreements, they also reflect the greater
awareness by many countries that United States principles of
low rates of taxation at source and a stable tax system may be
a better route toward encouraging foreign investment than
revenue-losing tax holidays, combined with high withholding
taxes.
The Canadian protocol reflects the need for continued
monitoring of our bilateral agreement because of the enormous
number, complexity and importance of our cross-border
transactions. The protocol deals primarily with treatment of
social security benefits, and reflects the need for review,
which has already begun, of our current policies in that regard
with this committee, the tax-writing committees, and the Social
Security Administration.
We are continuing to maintain an active calendar or tax
treaty negotiations. Early this summer, we initialed treaties
with Estonia, Latvia and Lithuania. We are nearing completion
of our negotiations with Bangladesh, Sri Lanka and Denmark, and
are continuing negotiations with Venezuela and Italy. We also
would like to extend our treaties to more countries,
particularly in Latin America and Southeast Asia.
Let me conclude by again thanking the committee for its
continued interest in the tax treaty program, and for devoting
the time of the members and the staff to undertaking a
meaningful review of the agreements that are pending before
you. We appreciate your efforts this year and in past years to
bring the treaties before this committee, and then to the full
Senate, for its advice and consent to ratification. With your
help over the past few years, we have brought into force 15 new
agreements, and we look forward to adding the eight presently
before you.
We urge the committee to take prompt and favorable action
on all of the conventions and the protocol. Such action will
send an important message to our trading partners and our
business community. It will demonstrate our desire to expand
the United States treaty network with income tax treaties,
formulated to enhance the worldwide competitiveness of U.S.
companies. It will strengthen and expand our economic relations
with countries that have seen significant economic and
political changes in recent years. It will make clear our
intention to deal bilaterally, in a forceful and realistic way,
with treaty abuse. Finally, it will enable us to improve the
administration of our tax laws, both domestically and
internationally.
I will be glad to answer any questions you might have.
Thank you.
[The prepared statement of Mr. Guttentag follows:]
Prepared Statement of Mr. Guttentag
Mr. Chairman and members of the Committee, I am pleased today to
recommend on behalf of the Administration, favorable action on eight
bilateral tax treaties and protocols that the President has transmitted
to the Senate and that are the subject of this hearing. These
agreements would provide significant benefits to the United States, as
well as to our treaty partners. Treasury appreciates the Committee's
interest in these agreements as demonstrated by the scheduling of this
hearing. Treasury requests the Committee and the Senate to take prompt
and favorable action on all of these agreements.
The treaties and protocols before the Committee today represent a
cross-section of the United States tax treaty program. There are new
agreements with five of our oldest treaty partners, Austria,
Luxembourg, Switzerland, Ireland, and Canada. Two agreements are with
new treaty partners of growing economic significance, Turkey and
Thailand. The eighth agreement before you, the treaty with South
Africa, brings that important country back into our tax treaty network
after its change in government. The new agreements will generate
substantial benefits for United States taxpayers and tax authorities,
and will serve to expedite and increase desirable international
economic activity. Tax conventions, as explained in greater detail
below, do not represent a zero sum exercise. Not only do United States-
based businesses benefit from exemption from, or reduction of, foreign
taxes, but additional tools are provided to enforce our tax laws,
particularly with respect to international tax crimes, often related to
money laundering and illegal drug traffic. Mutual agreement procedures
not only minimize the risk of double taxation of our multinationals, as
well as assuring appropriate taxation of foreign based companies, but
also facilitate a fair allocation of tax revenues between our treaty
partners and the United States.
To help frame our discussions of the pending agreements, I would
like to describe in general terms the United States tax treaty program.
The United States has a network of 48 bilateral income tax treaties,
the first of which was negotiated in 1939. We have treaties with most
of our significant trading partners. Approval of the treaty with
Turkey, which is before you today, would achieve an important objective
of having tax treaty relationships with all of the members of the
Organization for Economic Cooperation and Development, the OECD.
The Department of the Treasury receives regular and numerous
requests to enter tax treaty negotiations. As a result it has been
necessary for us to establish priorities. These priorities are not new;
they are reflected in our existing treaty network including the
agreements the Senate approved last year as well as the treaties that
you are considering today.
Consistent with both Administration and Congressional policies, the
Treasury gives priority to renegotiating older treaties that lack
effective anti-abuse clauses or otherwise fail to reflect current
United States treaty policy. Examples in this category are the
agreements with Austria, Luxembourg, Switzerland, and Ireland. We have
made it clear to our treaty partners that we will not tolerate
continuation of treaty relationships that fail to reflect important
United States treaty policies. This policy was underscored last year by
the termination of our treaties with Malta and Aruba, and by the
termination protocol with respect to the Netherlands Antilles.
Another priority is to conclude treaties or protocols that are
likely to provide the greatest benefits to United States taxpayers,
such as when economic relations are hindered by tax obstacles. Such new
agreements could include treaties with expanding economies with which
we lack a treaty, or revised and improved treaties with existing treaty
partners. Examples in this category include the treaties with Turkey,
Thailand, and South Africa. As we complete our renegotiation of
outdated treaties, we are able to increase the priority we place on
negotiating tax treaties in countries and regions of increasing
importance to the United States and United States business. Thus, a
major focus of our tax treaty program in the next several years will be
to continue and expand our treaty activities with countries in Latin
America and Southeast Asia.
We also try to conclude treaties with countries that have the
potential to be significant trading partners. The list of such
countries has always been a long one, and it has become even longer
since the creation of many new market-oriented economies in the former
Soviet Union and eastern European countries. Treasury focuses its
efforts in this category on those countries that have developed stable
tax systems and that have the greatest potential for bilateral economic
activities. We also take into account the concerns and interests of
other governmental agencies and the private sector. The existence of a
treaty will help remove tax impediments to trade and investment in such
countries and thereby help establish economic ties that will contribute
to the country's stability and independence, as well as improving its
political relationships with the United States. In the past four years
the Senate considered and approved treaties with five countries that
fit this description: the Russian Federation, the Czech Republic,
Slovakia, Kazakstan, and Ukraine. Other treaties in this category that
have been initialed but not yet signed are with Estonia, Latvia, and
Lithuania
In determining our country priorities as well as treaty positions,
we consult regularly and usefully with many constituencies. We meet
with the staff of this Committee and its members as well as staffs of
the tax writing committees. We hear from many United States-based
companies and trade associations which provide useful guidance
particularly with respect to practical in-country problems they face.
We are constantly working to ensure that new economic and commercial
developments, such as the revolution in communication technology, are
appropriately dealt with in our tax conventions.
The OECD provides a useful forum to consider these developments
with our treaty partners. The development of new technologies in
particular increases the need for international cooperation with
respect to many tax policy and administration issues.
Benefits Provided by Income Tax Treaties
Irrespective of the category in which a particular country may
fall, we seek to achieve the same two basic objectives through the
treaty. First, to reduce income tax-related barriers to international
trade and investment. An active treaty program is important to the
overall international economic policy of the United States, and tax
treaties have a substantial positive impact on the competitive position
of United States businesses that enter a treaty partner's marketplace.
A second general objective of our tax treaty program is to combat
tax avoidance and evasion. A treaty provides the tax administrations of
both treaty partners with additional tools with which to improve
international tax administration.
While the domestic tax legislation of the United States and other
countries in many ways is intended to further the same general
objectives as our treaty program, a treaty network goes beyond what
domestic legislation can achieve. Legislation is by its nature
unilateral, and cannot easily distinguish among countries. It cannot
take into account other countries' rules for the taxation of particular
classes of income and how those rules interact with United States
statutory rules. Legislation also cannot reflect variations in the
United States' bilateral relations with our treaty partners. A treaty,
on the other hand, can make useful distinctions, and alter in an
appropriate manner, domestic statutory law of both countries as it
applies to income flowing between the treaty partners.
For example, a basic concept found in all of our treaties
establishes the minimum level of economic activity that a resident of
one country must engage in within the other before the latter country
may tax the resulting business profits. These rules, the permanent
establishment and business profits provisions, not only eliminate in
many cases the difficult task of allocating income and resulting tax
between countries but also serve to encourage desirable trade
activities by eliminating, or reducing, what can often be complex tax
compliance requirements.
Benefits to Taxpayers
An income tax treaty removes impediments to international trade and
investment by reducing the threat of ``double taxation'' that can occur
when both countries impose tax on the same income. I'd like to mention
four different aspects of this general goal. First, an income tax
treaty generally increases the extent to which exporters can engage in
trading activity in the other country without triggering tax. Second,
when that threshold is met and tax is imposed, it establishes rules
that assign to one country or the other the primary right of taxation
with respect to an item of income, it ensures appropriate deductions
and reduces the withholding tax on flows of income. Third, the treaty
provides a dispute resolution mechanism to prevent double taxation that
sometimes can arise in spite of the treaty. Finally, and often most
importantly, the treaty helps to create stability of tax rules thereby
encouraging desirable economic activity. These benefits are not limited
to companies and business profits. Treaties remove tax impediments to
desirable scientific, educational, cultural and athletic interchanges,
facilitating our ability to benefit from the skills and talents of
foreigners including world renowned rock stars, symphony orchestras,
astrophysicists and Olympic athletes. You will note that treaty
benefits are not limited to profit-making enterprises as they deal with
pension plans, Social Security benefits (as in the protocol with
Canada), charitable organizations, researchers and alimony and child
support recipients. I would like to discuss some of these aspects of an
income tax treaty.
One of the principal ways in which double taxation is eliminated is
by assigning primary taxing jurisdiction in particular factual settings
to one treaty partner or the other. In the absence of a treaty, a
United States company operating a branch or division or providing
services in another country might be subject to income tax in both
countries on the income generated by such operations (perhaps because
of limitations on the foreign tax credit provided by the Code). The
resulting double taxation can impose an oppressive financial burden on
the operation and might well make it economically unfeasible.
The tax treaty lays out ground rules providing that one country or
the other, but not both, will have primary taxing jurisdiction over
branch operations and individuals performing services. In general
terms, the treaty provides that if the branch operations have
sufficient substance and continuity, and accordingly, sufficient
economic penetration, the country where the activities occur will have
primary (but not exclusive) jurisdiction to tax. In other cases, where
the operations are relatively minor, the home country retains the sole
jurisdiction to tax. These provisions are especially important in
treaties with lesser developed countries, which in the absence of a
treaty frequently will tax a branch operation even if the level of
activity conducted in the country is negligible or where the line is
not clear and frequently will not allow deductions for appropriate
expenses. Under the favorable treaty rules, United States manufacturers
may establish a significant foreign presence through which products are
sold without subjecting themselves to foreign tax or compliance rules.
Similarly, United States residents generally may live and work abroad
for short periods without becoming subject to the other country's
taxing jurisdiction.
High withholding taxes at source are an impediment to international
economic activity. Under United States domestic law, all payments to
non-United States persons of dividends and royalties as well as certain
payments of interest are subject to withholding tax equal to 30 percent
of the gross amount paid. Inasmuch as this tax is imposed on a gross
rather than net amount, it imposes a high cost on investors receiving
such payments. Indeed, in many cases the cost of such taxes can be
prohibitive as a 30 percent tax on gross income often can exceed 100
percent of the net income. Most of our trading partners impose similar
levels of withholding tax on these types of income.
Tax treaties alleviate this burden by reducing the levels of
withholding tax that the treaty partners may impose on these types of
income. In general, United States policy is to reduce the rate of
withholding taxation on interest and royalties to zero. Dividends
normally are subject to tax at one of two rates, 15 percent on
portfolio investors and 5 percent on direct corporate investors.
The extent to which this policy is realized depends on a number of
factors. Although generalizations often are difficult to make in the
context of complex negotiations, it is fair to say that we are more
successful in reducing these rates with countries that are relatively
developed and where there are substantial reciprocal income flows. We
also achieve lesser but still very significant reductions with
countries where the flows tend to be disproportionately in favor of the
United States. Lesser developed and newly emerging economies, where
capital and trade flows are often disparate or sometimes one-way,
create obstacles to achieving our desired level of withholding. These
countries frequently find themselves on the horns of a dilemma. They
know that they must reduce their high levels of taxation to attract
foreign capital but, at the same time, they are unwilling to give up
scarce revenues. Such prospective treaty partners may perceive that
they are making a concession in favor of the United States without
receiving a corresponding benefit when they reduce withholding rates.
In some such cases, we will look at the level of overall rates of tax
and avoid agreements which serve to transfer tax from a less developed
foreign fisc to the United States. For this reason and others, the
treaty withholding rates will vary. Furthermore, even if the treaty
does not serve to reduce existing rates, it provides limitations and
the certainty demanded by business decision-makers.
The rules provided in the treaty are general guidelines that do not
address every conceivable situation, particularly, new developments.
Consequently, there will be cases in which double taxation occurs in
spite of the treaty. In such cases, the treaty provides mechanisms
enabling the tax authorities of the two governments--known as the
``competent authorities'' in tax treaty parlance--to consult and reach
an agreement under which the taxpayer's income is allocated between the
two taxing jurisdictions on a consistent basis, thereby preventing the
double taxation.
Prevention of Tax Evasion
All the aspects of tax treaties that I have been discussing so far
involve benefits that the treaties provide to taxpayers, especially
multinational companies but also others I have described. While
providing these benefits certainly is a major purpose of any tax
treaty, it is not the only purpose. The second major objective of our
income tax treaty program is to prevent tax evasion and to ensure that
treaty benefits flow only to the intended recipients. Tax treaties
achieve this objective in at least two major ways. First, they provide
for exchange of information between the tax authorities. Second, they
contain provisions designed to ensure that treaty benefits are limited
to real residents of the other treaty country and not to ``treaty
shoppers.''
Under the tax treaties, the competent authorities are authorized to
exchange information, including confidential taxpayer information, as
may be necessary for the proper administration of the countries' tax
laws. This aspect of our tax treaty program is one of the most
important features of a tax treaty from the standpoint of the United
States. The information that is exchanged may be used for a variety of
purposes. For instance, the information may be used to identify
unreported income or to investigate a transfer pricing case. In recent
years information exchange has become a priority for the United States
in its tax treaty program.
Recent technological developments which facilitate international,
and anonymous, communications and commercial and financial activities
can also encourage illegal activities. Over the past several years we
have experienced a marked and important sea change as many of the
industrialized nations have recognized the increasing importance of tax
information exchange and that the absence thereof serves to encourage
not only tax avoidance and evasion, but also criminal tax fraud, money
laundering, illegal drug trafficking, and other criminal activity.
Treasury is proud of the role it has played in moving these issues
forward not only in our bilateral treaty negotiations but also in other
fora such as the OECD and the OAS. We have observed that within the
European Union there has been increasing recognition that the desired
political and economic unity requires full disclosure and transparency.
To emphasize the importance of this subject, the Department of
Justice has written a letter, in light of its obligations to enforce
the tax laws, expressing its support for these treaties. A copy of the
letter is appended to this testimony for the Committee's information.
A second major objective of U.S. tax treaty policy is to obtain
comprehensive provisions designed to prevent abuse of the treaty by
persons who are not bonafide residents of the treaty partner. This
abuse, which is known as ``treaty shopping,'' can take a number of
forms, but its general characteristic is that a resident of a third
state that has either no treaty with the United States or a relatively
unfavorable one establishes an entity in a treaty partner that has a
relatively favorable treaty with the United States. This entity is used
to hold title to the person's United States investments, which could
range from portfolio stock investments to major direct investments or
other treaty-favored activity in the United States. By placing the
investment in the treaty partner, the third-country person is able to
withdraw the returns from the United States investment subject to the
favorable rates provided in the tax treaty, rather than the higher
rates that would be imposed if the person had invested directly into
the United States. The United States treaty partner must of course
cooperate by providing favorable tax treatment to the third country
investor.
This Committee and the Congress have expressed strong concerns
about treaty shopping, and the Department of the Treasury shares those
concerns. If treaty shopping is allowed to occur, then there is less
incentive for the third country with which the United States has no
treaty to negotiate a treaty with the United States. The third country
can maintain inappropriate barriers to United States investment and
trade, and yet its companies can operate free of these barriers by
organizing their United States transactions so that they flow through a
country with a favorable United States tax treaty.
Although anti-treaty shopping provisions give us leverage in
negotiating with other countries, we do not necessarily need to have
tax treaties with every country in the world. There are usually very
good reasons why the United States has not concluded a treaty with a
particular country. For example, we generally do not conclude tax
treaties with jurisdictions that do not impose significant income
taxes, because there is little danger of double taxation of income in
such a case and it would be inappropriate to reduce United States
taxation on returns on inbound investment if the other country cannot
offer a corresponding benefit in exchange for favorable United States
treatment. The anti-treaty shopping provisions in our treaty network
support this goal by preventing investors from enjoying the benefits of
a tax-haven regime in their home country and, at the same time, the
benefits of a treaty between the United States and another country.
However, these situations often are not black or white. Some countries
have adopted favorable tax regimes applicable to limited sectors of
their economy and the United States believes that in many circumstances
it is inappropriate to grant treaty benefits to companies taking
advantage of such regimes. On the other hand there may be other
elements of the economy as well as other factors that would make a
treaty relationship useful and appropriate. Accordingly, in some cases
we have devised treaties that carve out from the benefits of the
treaties certain residents and activities. In other cases, we have
offered to enter into an agreement limited to the exchange of tax
information. We have a number of these agreements, particularly with
Caribbean countries.
The Department of the Treasury has included in all its recent tax
treaties comprehensive ``limitation on benefits'' provisions that limit
the benefits of the treaty to bonafide residents of the treaty partner.
These provisions are not uniform, as each country has its own
characteristics that make it more or less inviting to treaty shopping
in particular ways. Consequently, each provision must to some extent be
tailored to fit the facts and circumstances of the treaty partners'
internal laws and practices. Moreover, these provisions should be
crafted to avoid interfering with legitimate and desirable economic
activity. For example, we have begun to address directly in our
negotiations the issue of how open-end United States regulated
investment companies (RICS) should be treated under limitation on
benefits provisions in order to facilitate cross-border investments
from this important source of capital. Because these funds are required
to stand ready to redeem their shares on a daily basis, we believe they
generally should be entitled to treaty benefits to the same extent as
closed-end RICS, which qualify for benefits under standard limitation
on benefits provisions because they are publicly traded on stock
exchanges. However, the negotiators need to ensure that what may appear
to be similar funds established in the treaty partner cannot be used to
promote treaty shopping.
Transfer Pricing
Several of the aspects of income tax treaties that I have been
describing are highly relevant to the resolution of transfer pricing
issues. Transfer pricing relates to the division of the taxable income
of a multinational enterprise among the jurisdictions where it does
business. If a multinational manipulates the prices charged in
transactions between its affiliates in different countries, the income
reported for tax purposes in one country may be artificially depressed,
and the tax administration of that country will collect less tax from
the enterprise than it should. Accordingly, transfer pricing is an
important subject not only in this country but in most other countries
as well.
In analyzing the prices charged in any transaction between parties
that are commonly controlled, it is necessary to have a benchmark by
which to evaluate the prices charged. The benchmark adopted by the
United States and all our major trading partners is the arm's-length
standard. This standard is reflected in hundreds of existing tax
treaties. Under the arm's-length standard, the price charged should be
the same as it would have been had the parties to the transaction been
unrelated to one another--in other words, the same as if they had
bargained at ``arm's-length.''
Consistent with the domestic practice of all major trading nations,
all of our comprehensive income tax treaties adopt the arm's-length
standard as the agreed benchmark to be used in addressing a transfer
pricing case. Adoption of a common approach to these cases is another
benefit provided by tax treaties. A common approach consistently
applied is a sine qua non for preventing both tax avoidance and double
taxation. A common approach guarantees the possibility of achieving a
consistent allocation of income between the treaty partners. Without
such an assurance, it is possible that the two tax authorities would
determine inconsistent allocations of income to their respective
jurisdictions, resulting in either double taxation or under taxation.
Double taxation would occur when part of the multinational's income is
claimed by both jurisdictions. Under taxation would occur when part of
the multinational's income is claimed by neither jurisdiction.
By adopting a common standard, the risks of double taxation and
under taxation are minimized. Furthermore, when double taxation does
occur, the competent authorities of the two countries are empowered to
consult and agree on an equitable division of income based upon this
common reference point. Without this common reference point, reaching
mutual agreement would be difficult or impossible.
Distributions from Real Estate Investment Trusts (REITs)
Our tax treaties must provide appropriate tax treatment for
categories of income which are specially treated under the Code. One
important example of such provisions are the REITS, created by Congress
to help investors achieve diversified ownership in primarily passive
real estate investments. In the case of foreign investors, the Congress
provided for a 30% withholding tax except for certain capital gain
distributions. These rules reflected U.S. tax policy which is
consistent with those of most other countries: each country reserves
the right to impose a full tax on income from real property, leaving
the residence country to alleviate any resulting double taxation.
REITs are created as U.S. corporations and their distributions are
in the form of corporate dividends. Unlike corporations, however, they
generally are not subject to tax at the corporate level and, if their
distributions were not subject to full taxation, their income would not
be subject to full taxation at the entity level or the shareholder
level. Therefore, a decision must be made whether to characterize the
distributions as distributions of real property rental income subject
to at least one level of full U.S. taxation or as dividends subject to
a lower rate.
It is has been U.S. policy since 1988 to treat REIT distributions
as conduit distributions of real estate rental income. The policy
originated in a 1988 directive, with which the Department of the
Treasury agreed, from the Joint Committee on Taxation and the Senate
Committee on Foreign Relations. The purpose of excluding certain REIT
dividends from preferential dividend withholding tax rates under the
treaties is to prevent foreign investors from utilizing a REIT conduit
to convert high-taxed U.S. source rental income into lower taxed
dividend income by passing the rental income through a REIT. This
policy avoids a disparity between the taxation of direct real estate
investments and real estate investments made through REIT conduits.
Limited relief from this rule generally is provided in the case of REIT
dividends beneficially owned by individuals holding less than a 10-
percent interest in the REIT. Such REIT dividends qualify for the
reduced withholding tax rates generally available in respect of
dividends.
Economic changes since these policies were established ten years
ago require that we review our position in order to insure that our
treaty policies reflect the best interests of the United States. These
interests include not discouraging, through our tax rules, desirable
foreign investment. To that end we have consulted with representatives
of the REIT industry and we are now satisfied that our current treaty
policy should be modified. While the treaties before you represent
policies with which we all have agreed, we now believe that it is
appropriate to revise our treatment of REIT dividends under our
treaties.
Our new policy takes into account that portfolio investments in a
REIT whether by individuals or institutional investors may be
indistinguishable in intent and results from similar investments in
other corporate securities and should be afforded similar tax
consequences in appropriate circumstances. In carrying out such a
policy however, two other considerations are significant. First, we
should maintain a reasonable neutrality with respect to the taxation of
foreigners and U.S. citizens. A potential U.S. investor in a shopping
mall should not be out bid by a foreigner because we have, through out
treaty process, provided inappropriate tax benefits to the foreigner.
Second, we should not provide such generous REIT benefits that
foreigners choose to make economically distorted investments to our
disadvantage. For example, we do not want a foreigner that is
considering building a major job-producing new factory in the United
States to choose instead to buy an existing office building because of
inappropriately favorable tax treatment of the latter.
The proposal which we put before you today has been developed by
the staff of the Joint Committee on Taxation in consultation with the
staff of this Committee and Treasury and with the help of the REIT
industry. Our existing treaty policy provides for a 30% withholding tax
on REIT dividends with an exception for payments to individuals who
hold 10% or less of the REIT. Our new policy retains the current
treatment of individuals with 10% or smaller holdings of the REIT and,
in addition, provides for a 15% withholding tax on dividends paid by
(i) a publicly traded REIT to any shareholder who holds a 5% or smaller
interest in the REIT, and (ii) a publicly traded or non-publicly traded
REIT, the holdings of which are substantially diversified, to a
shareholder who holds a 10% or smaller interest in the REIT.
We are going to reflect this new policy in our model treaty and in
future treaty negotiations. Furthermore we support the proposal to
insert a reservation to the Senate's advice and consent to our pending
treaty with Luxembourg to reflect our new REIT policy in that treaty,
as well as assuring ``grandfathered'' benefits for certain current
investments. We are also going to use our best efforts to secure
agreement with Austria, Ireland and Switzerland to protocols to our new
treaties to reflect our new REIT policy.
We believe that the foregoing proposal goes as far as we can in
accommodating the changes in the REIT industry consistent with sound
tax policy designed to take into account the factors described above.
Representatives of the REIT industry have been most helpful in
providing us with information with respect to developments in the
industry and changes in investment patterns since adoption of our 1988
policy and have indicated their support for the new policy.
Basis for Negotiations
Each of these treaties before you today reflects the basic
principles of current United States treaty policy. The provisions in
each treaty borrow heavily from recent treaties approved by the Senate
and the U.S. model (which had not yet been published while most of the
treaties were negotiated, but was available to U.S. negotiators in
draft form) and are generally consistent with the 1992 OECD Model
Income Tax Convention. The United States was and continues to be an
active participant in the development of the OECD Model, and we are
generally able to use most of its provisions as a basis for
negotiations.
The U.S. model was published in September 1996. A model treaty is a
useful device if used properly and kept current.
Based on our experience we anticipate that the United States model,
like the OECD model, will not be a static document but will be modified
as required to reflect changes in United States tax law or policy,
economic, technical and other changes that may require further
elaboration, clarification or even reversals of prior policies. There
are no major inconsistencies between the US and OECD model, but rather
the US model elaborates on issues in which the United States may have a
greater interest or which result from particular aspects of United
States law and policy. For example, our limitation of benefits
provisions are generally not found in typical tax treaties of other
OECD countries. We have also found it useful to expand on treaty
coverage and treatment of pass-through entities such as our limited
liability companies. The tax consequences resulting from the
development of new financial instruments need to be internationally
accepted and consistent. Despite the importance we attach to the OECD
model and our continuing efforts with our colleagues to improve it and
keep it current, most countries cannot accede to all of the provisions
of that model, nor do we expect that all of our prospective treaty
partners will agree with all of the provisions of our model. We believe
that our new model and its accompanying explanation will find its
principal benefits to be enabling all interested parties, including
this Committee and the Congress and its staffs, the American business
community, and our prospective treaty partners, to know and understand
our treaty positions. We anticipate that American companies will be
able to use the model to suggest modifications that may be required in
connection with negotiations with a particular country based on the
interaction of our two tax systems. For example, in my discussions of
our policies with respect to information exchange and treaty shopping I
noted the need to tailor these provisions to the specific
circumstances, which will differ from country to country. We have
presented our model to the OECD with the intention of working together
to create even greater consistency concerning the important issues
covered. We do not anticipate that the United States will ever sign a
tax convention identical to the model; there are too many variables.
A nation's tax policy, as reflected in its domestic tax legislation
as well as its tax treaty positions, reflects the sovereign choices
made by that country in the exercise of one of its most important
governmental functions, that of funding the government. Numerous
features of the treaty partner's unique tax legislation and its
interaction with United States legislation must be considered in
negotiating an appropriate treaty. Examples include the treatment of
partnerships and other transparent entities, whether the country
eliminates double taxation through an exemption or a credit system,
whether the country has bank secrecy legislation that needs to be
modified by treaty, and whether and to what extent the country imposes
withholding taxes on outbound flows of investment income. Consequently,
a negotiated treaty needs to take into account all of these and other
aspects of the treaty partner's tax system in order to arrive at an
acceptable treaty from the perspective of the United States.
Accordingly, a simple side-by-side comparison of two actual treaties,
or of a proposed treaty against a model treaty, will not enable
meaningful conclusions to be drawn as to whether a proposed treaty
reflects an appropriate balancing of interests. In many cases the
differences are of little substantive importance, reflecting language
problems, cultural obstacles or other impediments to the use of
particular United States or OECD language. The technical explanations
which accompany our treaty, the discussions with the staffs of this
Committee and its members, and the staffs of the tax law writing
Committees, and most importantly, hearings such as this, will provide
the Senate with the assurance that a particular treaty is, overall, in
the best interests of the United States.
Discussion of Treaties and Protocols--Austria, Luxembourg, Turkey,
Switzerland, Thailand, South Africa, Ireland, Canada
In addition to keeping in mind that each treaty must be adapted to
the individual facts and circumstances of each treaty partner, it also
is important to remember that each treaty is the result of a negotiated
bargain between two countries that often have conflicting objectives.
Each country has certain issues that it considers nonnegotiable. The
United States, which insists on effective anti-abuse and exchange-of-
information provisions, and which must accommodate its uniquely complex
internal laws, probably has more nonnegotiable issues than most
countries. Obtaining the agreement of our treaty partners on these
critical issues sometimes requires other concessions on our part.
Similarly, other countries sometimes must make concessions to obtain
our agreement on issues that are critical to them. The give and take
that is inherent in the negotiating process leading to a treaty is not
unlike the process that results in legislation in this body. Treaties
can each be different and yet represent an ideal treaty from the United
States perspective with a particular country because of the specific
economic relationships, domestic tax rules and other factors, and even
though the treaty does not completely adhere to a model, whether that
of the United States, the OECD or the treaty partner.
Each of the full treaties before the Committee today allows the
United States to impose our branch profits tax at the treaty's direct-
dividend rate. In addition, in conformity with what has become standard
United States treaty policy, excess inclusions with respect to residual
interests in real estate mortgage investment conduits (REMICS) are
subject to the United States statutory withholding rate of 30 percent.
The proposed treaties also contain provisions designed to improve
the administration both of the treaty and of the underlying tax
systems, including rules concerning exchange of information, mutual
assistance, dispute resolution and nondiscrimination. Each treaty
permits the G6neral Accounting Office and the tax-writing committees of
Congress to obtain access to certain tax information exchanged under
treaty for use in their oversight of the administration of United
States tax laws and treaties. Each treaty also contains a now-standard
provision ensuring that tax discrimination disputes between the two
nations generally will be resolved within the ambit of the tax treaty,
and not under any other dispute resolution mechanisms, including the
World Trade Organization (WTO).
Each treaty also contains a comprehensive limitation on benefits
provision designed to ensure that residents of each State may enjoy
treaty benefits only if they have a substantial nexus with that State,
or otherwise can establish a substantial non-treaty-shopping motive for
establishing themselves in their country of residence. Each treaty
preserves the right of the United States to tax certain former citizens
generally consistent with recently enacted amendments to the Code
dealing with this issue.
Finally, some treaties will have special provisions not found in
other agreements. These provisions account for unique or unusual
aspects of the treaty partner's internal laws or circumstances. For
example, in order to achieve the desired reciprocal taxation of
business profits on a net basis, special provisions in the proposed
treaty with Turkey, applicable only to Turkey, were required. Turkey
also exemplifies a treaty partner in a significantly different level of
economic development than the United States and many other OECD member
countries. While the treaty is based on the OECD model it reflects
various reservations made by Turkey to that model particularly with
respect to withholding at source on interest, dividends and royalties.
All of these features should be regarded as a strength rather than
weakness of the tax treaty program, since it is these differences in
the treaties which enable us to reach agreement and thereby reduce
taxation at source, prevent double taxation and increase tax
cooperation.
I would like to discuss the importance and purposes of each
agreement that you have been asked to consider. We have submitted
Technical Explanations of each agreement that contain detailed
discussions of each treaty and protocol. These Technical Explanations
serve as an official guide to each agreement. We have furnished our
treaty partners with a copy of the relevant technical explanation and
offered them the opportunity to submit their comments and suggestions.
Austria
The proposed new Convention with Austria signed in Vienna on May
30, 1996, along with the Memorandum of Understanding, replaces the
existing Convention, which was signed in 1956. The proposed Convention
generally follows the pattern of other recent United States treaties
and the OECD Model treaty. The proposed new Convention contains changes
made in order to create a closer alignment with our current income tax
treaty policy.
First, the proposed Convention contains a new exchange of
information provision which will allow each country greater access to
information important to tax enforcement. These provisions are needed
because the existing Convention is limited and does not provide an
effective means for the United States to obtain relevant Austrian bank
account information. As elaborated in the Memorandum of Understanding,
the information exchange provisions make clear that United States tax
authorities will be given access to Austrian bank information in
connection with any penal investigation. The MOU clarifies that the
term penal investigation applies to proceedings carried out by either
judicial or administrative bodies and that the commencement of a
criminal investigation by the C Investigation Division of the Internal
Revenue Service constitutes a penal investigation.
Also, as the existing Convention contains no provision dealing with
gains on disposition of personal property, the proposed new convention
contains an article dealing with the taxation of capital gains. This
provision is generally similar to that in recent United States
treaties. Under the new Convention, however, and consistent with United
States tax law, a Contracting State in which a permanent establishment
or fixed base is located may also tax gains from the alienation of
personal property that is removed from the permanent establishment or
fixed base, to the extent that gains accrued while the asset formed
part of a permanent establishment or fixed base. Double taxation is
prevented because the residence State must exclude from its tax base
any gain taxed in the other State.
The withholding rates on investment income in the proposed
Convention are essentially the same as in the present treaty and are
generally consistent with United States policy. Direct investment
dividends are subject to taxation at source at a rate of 5 percent, and
portfolio dividends are taxable at 15 percent. The proposed Convention
contains a change that conforms the threshold of ownership required to
obtain the lowest dividend withholding rate with the threshold in our
most recent income tax conventions. Interest and royalties are
generally exempt from tax at source. However, in the proposed
Convention, as in the existing one, a tax may be imposed at a maximum
rate of 10 percent on royalties in respect of commercial motion
pictures, films and tapes; and the proposed Convention redefines the
category to include royalties in respect of rights to use similar items
used for radio and television broadcasting.
Consistent with current United States treaty policy, the proposed
treaty provides for exclusive residence country taxation of profits
from international carriage by ships or airplanes. The proposed
Convention expands the scope of this provision to include income from
the use or rental of containers and from the rental of ships and
aircraft. Under the present Convention, such rental income is treated
as royalty income, which may be taxed by the source country only if the
income is attributable to a permanent establishment in that country.
Personal services income is taxed under the proposed Convention as
under recent United States treaties with OECD countries. In addition,
in recognition of the increasingly mobile nature of the work force, the
proposed Convention provides for the deductibility, under limited
circumstances, of cross-border contributions by individuals temporarily
in one country who contribute to recognized pension plans in the other
country.
Unlike the existing Convention, the proposed Convention contains a
comprehensive antitreaty-shopping provision. A Memorandum of
Understanding provides an interpretation of key terms. Austria's recent
membership in the European Union and the special United States ties to
Canada and Mexico under the North American Free Trade Agreement are an
element in the . determination by the competent authority of
eligibility for benefits of certain Austrian and United States
companies. Recognized headquarters companies of multinational corporate
groups are entitled to benefits of the Convention.
The proposed Convention also provides for the elimination of
another potential abuse relating to the granting of United States
treaty benefits in the so-called triangular cases to income of an
Austrian resident attributable to a third-country permanent
establishments of Austrian corporations that are exempt from tax in
Austria by operation of Austria's law or treaties. Under the proposed
rule, full United States treaty benefits will be granted in these
triangular cases only when the United States-source income is subject
to a sufficient level of tax in Austria and in the third country. As in
the United States-France treaty, this anti-abuse rule does not apply in
certain circumstances, including when the United States taxes the
profits of the Austrian enterprise under subpart F of the Internal
Revenue Code.
Also included in the proposed Convention are the provisions
necessary for administering the Convention, including rules for the
resolution of disputes under the treaty and the exchange of
information. With the exception of the more limited access to bank
information, the exchange of information provision in the proposed
Convention is consistent with the U.S. Model.
Luxembourg
The proposed new Convention with Luxembourg, signed in Luxembourg
on April 3, 1996, replaces the existing Convention, which was signed in
1962. The proposed Convention generally follows the pattern of the OECD
Model Convention and other recent United States treaties with developed
countries.
A new treaty is necessary for many reasons. The existing Convention
does not provide an effective means for the United States to obtain
information from Luxembourg financial institutions as part of the
exchange of tax information under the Convention. It also does not
contain adequate rules to prevent residents of third countries from
improperly obtaining the benefits of the Convention by using companies
resident in one of the treaty countries to invest in the other.
Finally, as the present treaty entered into force more than three
decades ago, it does not reflect the significant changes in United
States tax and treaty policy that have developed since the present
treaty entered into force.
To deal with the first issues, the fact that the present treaty
does not contain a comprehensive provision to prevent treaty shopping
or to provide for effective information exchange can lead to abuse (the
current treaty contains a narrow limitation on benefits provision that
denies treaty benefits to certain Luxembourg holding companies). The
proposed Convention contains a comprehensive anti-treaty-shopping
provision and, in conjunction with a new Mutual Legal Assistance Treaty
which also is pending before this Committee, will allow the Internal
Revenue Service significant access to Luxembourg bank information.
Regarding the changes in tax and treaty policy, the new Convention,
for example, allows the United States to impose its branch tax on
United States branches of Luxembourg corporations. Among other
modernizations, it also eliminates the withholding tax on debt secured
by real property, permits the United States to impose withholding tax
on contingent interest, and eliminates the out-dated force of
attraction rule so that a country can only tax the profits that are
actually attributable to a permanent establishment in that country.
In parallel with Luxembourg's elimination of dividend withholding
taxes for payments within the European Union, Luxembourg unilaterally
eliminates the withholding tax for certain dividend payments between a
Luxembourg subsidiary and its U.S. parent company in the proposed
Convention. This practice generally puts the payments from Luxembourg
subsidiaries to U.S. entities on the same footing as payments from
Luxembourg subsidiaries to EU entities and is a significant benefit to
U.S. companies doing business in Luxembourg. Apart from this exception,
the withholding rates on investment income in the proposed Convention
are generally the same as those in the present treaty. Interest and
royalties are generally exempt at source, as under the present treaty.
All United States-source and most Luxembourg-source direct investment
dividends are subject to taxation at 5 percent at source.
The proposed Convention provides another major benefit to certain
U.S. companies by modifying the present Convention rules to reflect
current United States treaty policy with respect to ships and aircraft
and related activities. The proposed Convention provides for exclusive
residence country taxation of profits from international carriage by
ships or aircraft. The reciprocal exemption from source country
taxation also extends to income from the use or rental of containers
and from the rental of ships and aircraft.
The proposed Convention also provides benefits to the U.S. fisc. It
does this in two manners: First, it contains detailed rules that
restrict the benefits of the Convention to persons that are not engaged
in treaty shopping. Second, it expands the ability to exchange
information about financial accounts. These provisions are important as
they ensure that the Convention serves its second purpose of preventing
fiscal evasion.
Under the limitations on benefits provision in the proposed
Convention, a person must meet the test to be a qualified resident of a
treaty country to be entitled to all of the benefits of the treaty. For
example, companies may be entitled to benefits if they meet certain
listed conditions. For example, publicly-traded companies will
generally be entitled to treaty benefits if their principal class of
shares is substantially and regularly traded on a recognized stock
exchange. Other companies may be qualified to obtain benefits if they
meet certain ownership and base erosion tests. In addition, the
proposed Convention allows certain residents of the European Union or
of the North American Free Trade Area to obtain derivative benefits.
These provisions parallel those contained in recent treaties between
the United States and Member States of the European Union. Consistent
with U.S. treaty policy, individuals, governmental entities and not-
for-profit organizations (provided more than half of the beneficiaries,
members or participants, if any, in such organization are qualified
residents) are entitled to all the benefits of the treaty.
The proposed Convention continues to carve out Luxembourg's
``1929'' holding companies from treaty benefits. It expands this
coverage to include other companies that enjoy similar fiscal
treatment, such as the investment companies defined in the Act of March
30, 1988. Headquarters companies are also not granted treaty benefits.
The proposed Convention also provides for the elimination of
another potential abuse relating to the granting of United States
treaty benefits in the so-called triangular cases to third country
permanent establishments of Luxembourg corporations that are exempt
from tax in Luxembourg by operation of Luxembourg's law or treaties.
Under the proposed rule, full United States treaty benefits will be
granted in these triangular cases only when the United States-source
income is subject to a sufficient level of tax in Luxembourg and the
third country.
Finally, the proposed treaty allows the competent authority to
allow benefits even if the conditions outlined in the limitation on
benefits article are not met. The competent authority has the ability
to resolve unilaterally these cases and grant treaty benefits in other
cases where the perceived abuses do not in fact exist. This latter
situation may arise, for example, when the United States source income
is effectively subject to United States tax under subpart F of the
Code.
The modifications to the exchange of information article are a
critical piece of the proposed treaty. Under its internal law,
Luxembourg tax authorities may not obtain certain information from
Luxembourg financial institutions. As clarified in the exchange of
notes, certain information of financial institutions may be obtained
and provided to certain United States authorities only in accordance
with the terms of the treaty between the United States and Luxembourg
on Mutual Legal Assistance in C Matters. That agreement sets forth the
scope of that obligation. The ability to obtain this information is
critical and we will not proceed to bring the Convention into force
except in tandem with the Mutual Legal Assistance Treaty. We request
that the Committee recommend that the Senate give its advice and
consent to ratification on the understanding that instruments of
ratification will not be exchanged until the exchange of instruments
with respect to the Mutual Legal Assistance Treaty has occurred.
The proposed Convention waives the United States excise tax on
certain insurance premiums paid to Luxembourg insurance companies, but
does so in a more limited way that other United States tax treaties
that waive the excise tax. This proposed Convention generally waives
the excise tax on direct insurance premiums, but does not waive the tax
on reinsurance premiums. Treasury agrees to waive the federal excise
tax only if we are satisfied that the foreign country imposes a
sufficient level of tax on insurance companies. In this case, we are
satisfied that Luxembourg imposes a sufficient level of tax on direct
business, but we are not satisfied that the effective tax rate on
reinsurers is sufficient to justify waiving the excise tax on
reinsurance premiums.
Turkey
The proposed treaty with Turkey, signed in Washington on March 28,
1996, will be the first income tax convention between the United States
and Turkey and will complete the United States' network of income tax
treaties with OECD member countries. The treaty represents a central
component of the economic relationship between Turkey and the United
States. The proposed treaty generally follows the pattern of the OECD
Model Convention and other recent United States treaties. There are,
however, variations that reflect particular aspects of Turkish law and
treaty policy, their interaction with United States law, and the
disparity in the Turkish and United States economies.
The treaty establishes maximum rates of source-country tax on
cross-border payments of dividends, interest, and royalties. Dividends
may be taxed at source at a maximum rate of 20 per cent, except when
paid to a corporation in the other country that owns at least 10
percent of the paying corporation, in which case the maximum rate is 15
percent. The general maximum rate of withholding tax at source on
interest under the proposed treaty is 15 percent, with lower rates
applicable for certain classes of interest. Royalties generally are
subject to tax at source at a maximum rate of 10 percent. Rental
payments for tangible personal property are treated under the proposed
treaty as royalties, but are subject to tax at a maximum rate of 5
percent at source.
The proposed treaty generally follows standard United States treaty
policy by providing for exclusive residence country taxation of profits
from international carriage by ships or airplanes and of income from
the use or rental of ships, aircraft and containers. In this treaty,
however, the reciprocal exemption does not extend to income from the
non-incidental rental of ships or aircraft. Such income is treated as
royalties and will be subject to a maximum tax at source of 5 percent.
The limitation of benefits provisions is consistent with other
recent United States treaties. The proposed treaty contains
administrative provisions consistent with United States treaty policy.
Switzerland
The proposed Convention and Protocol with Switzerland, signed in
Washington on October 2, 1996, replace the existing Convention, which
was signed in 1951. Many of the terms used in the Convention and
Protocol are further explained in a Memorandum of Understanding that
was negotiated at the same time. The new Convention generally follows
the pattern of the OECD Model Convention, and of recent U.S. treaties
with other developed countries. The proposed Convention and Protocol
modernize many of the provisions of the existing convention and add new
provisions that have become part of our treaty policy.
For example, under the proposed Convention, interest generally may
be paid free of withholding in the source country, rather than being
subject to the five percent withholding tax that may be levied under
the existing treaty. Although the withholding rates on dividend and
royalty income are essentially unchanged in the proposed Convention,
the thresholds for, and exceptions from, those rates have been made
consistent with other recent U.S. treaties. The proposed Convention
also recognizes the growing importance of pooled capital, by providing
that qualified pension funds may receive dividends from corporations
resident in the other country free of source-country taxation.
The proposed Convention clarifies the treatment of capital gains
and allows us to apply in full our rules regarding the taxation of
gains from the disposition of U.S. real property interests. The
proposed treaty also contains rules, found in a few other U.S.
treaties, that allow adjustments to the taxation of certain classes of
capital gains in order to coordinate the timing of the taxation of
gains. These rules serve to minimize possible double taxation that
could otherwise result.
As with the recent U.S. treaties and the OECD Model, the proposed
Convention provides generally for the taxation by one State of the
business profits of a resident of the other only when such profits are
attributable to a permanent establishment located in that other State.
The present Convention grants taxing rights that are in some respects
broader and in others narrower than those found in modern treaties. In
addition, the proposed Convention preserves the U.S. right to impose
its branch tax on U.S. branches of Swiss corporations. This tax is not
imposed under the present treaty.
The proposed Convention provides, consistent with current U.S.
treaty policy, for exclusive residence country taxation of profits from
international carriage by ships or airplanes. This reciprocal exemption
also extends to income from the rental of ships and aircraft if the
rental income is incidental to income from the operation of ships or
aircraft in international traffic. Other income from the rental of
ships or aircraft and income from the use of rental of containers,
however, are treated as business profits under Article 7. As such,
these classes of income are taxable only in the country of resident of
the beneficial owner of the income unless the income is attributable to
a permanent establishment in the other Contracting State, in which case
it is taxable in that State on a net basis.
The taxation of income from the performance of personal services
under the proposed Convention is essentially the same as that under
recent U.S. treaties with OECD countries. Unlike many U.S. treaties,
the proposed Convention provides for the deductibility of cross-border
contributions by a temporary resident of one country to certain pension
plans in the other, under limited circumstances.
The proposed Convention contains significant rules to deny the
benefits of the Convention to persons that are engaged in treaty
shopping. The present Convention contains no such anti-treaty-shopping
rules. Such provisions are found in all recent U.S. treaties. The
Protocol and Memorandum of Understanding contain explanations and
examples of the application of the Limitation on Benefits provisions.
The Limitation on Benefits article of the proposed Convention also
eliminates another potential abuse by denying U.S. benefits with
respect to income attributable to third-country permanent
establishments of Swiss corporations that are exempt from tax in
Switzerland by operation of Swiss law (the so-called ``triangular
cases''). Under the proposed rule, full U.S. treaty benefits generally
will be granted in these triangular cases only when the U.S. source
income is subject to a significant level of tax in Switzerland or in
the country in which the permanent establishment is located.
The proposed Convention provides a U.S. foreign tax credit for the
Swiss income taxes covered by the Convention, and for Swiss relief from
double taxation with respect to the income of Swiss residents subject
to U.S. taxation. Swiss relief may be in the form of a deduction,
credit or exemption. In the case of social security benefits, a partial
Swiss exemption is provided, which, when combined with the reduction in
U.S. source-basis tax results in the avoidance of potential double
taxation. The proposed Convention also provides for non-discriminatory
treatment (ie., national treatment) by one country of residents and
nationals of the other.
Also included in the proposed Convention are the rules necessary
for administering the Convention, including rules for the resolution of
disputes under the treaty and the exchange of information. The
information exchange provisions, as elaborated in the Protocol and
Memorandum of Understanding, make clear that U.S. tax authorities will
be given access to Swiss bank information in cases of tax fraud. The
Protocol includes a clear and broad definition of tax fraud that should
facilitate information exchange. Furthermore, the new treaty provides
that, where possible, information will be provided in a form that will
make it acceptable for use in court proceedings.
The proposed Convention allows for the use of arbitration to
resolve disputes that may arise between the Contracting States.
However, the arbitration process may be implemented under the
Convention only after the two Contracting State have agreed to do so
through an exchange of diplomatic notes. Once implemented, a particular
case may be assigned to an arbitration panel only with the consent of
all the parties to the case.
The proposed Convention deals with cases where a Contracting State
enacts legislation that is believed to modify the application of the
Convention in a significant manner. In such cases, either Contracting
State may request consultations with the other to determine whether an
amendment to the Convention is appropriate in order to restore the
original balance of benefits.
Thailand
The proposed treaty with Thailand, signed in Bangkok on November
26, 1996, will, if ratified, be the first tax treaty between the United
States and Thailand to enter into force. An income tax treaty with
Thailand was signed in 1965 but was returned to the President at his
request in 1981 never having been formally considered by the Senate.
The current proposed treaty is a major step in our efforts to expand
our tax treaty network in Asia and will facilitate negotiating tax
treaties with other important countries in the region. The proposed
treaty generally follows the pattern of the U.S. Model treaty, with the
deviations from the Model found in many recent U.S. treaties with other
developing countries. There are also some further variations that
reflect particular aspects of Thai law and treaty policy, the
interaction of U.S. and Thai law, and U. S.-Thai economic relations.
The proposed treaty establishes maximum rates of source-country tax
on cross-border payments of dividends, interest, and royalties. Direct
investment dividends are taxable at source at a 10-percent rate, and
portfolio dividends are taxable at a 15-percent rate. The proposed
treaty provides for a 15-percent maximum rate of tax at source on most
interest payments. Copyright royalties (including software) are subject
to a 5-percent tax at source. Royalties for, the right to use equipment
are subject to a 8-percent tax at source. Royalties for patents and
trademarks are subject to a 15-percent tax at source. These rates
generally are lower than those in many tax treaties Thailand recently
has entered into.
The taxation of capital gains under the proposed Convention does
not follow the usual pattern. Like some other U.S. treaties, it allows
gains to be taxed by both Contracting States under the provisions of
their internal law.
Consistent with recent U.S. treaties and the U.S. and OECD Models,
the proposed Convention provides generally for the taxation by one
State of the business profits of a resident of the other only when such
profits are attributable to a permanent establishment located in that
other State. The proposed Convention, however, grants rights to tax
business profits that are somewhat broader than those found in the U.S.
and OECD Models: It allows taxation of some income that is not
attributable to a permanent establishment, but only if it can be shown
that the income was shifted away from the permanent establishment to
avoid tax. Thus this ``limited force of attraction'' rule is narrower
than those found in the U.N. Model and section 864(c)(3) of the U.S.
Internal Revenue Code.
The proposed Convention, consistent with current U.S. treaty
policy, provides for exclusive residence-country taxation of profits
from international carriage by aircraft. This reciprocal exemption also
extends to income from the rental of aircraft if the rental activity is
incidental to the operation of aircraft by the lessor in international
traffic. However, income from the international operation of ships,
including ship rental income that is incidental to such operations, is
taxed at one-half of the tax rate otherwise applicable. Income from the
use or rental of containers that is incidental to the operation of
ships or aircraft in international traffic is treated the same as the
income from the operation of the ships or aircraft in international
traffic i.e., it is exempt if incidental to such aircraft operations,
and taxed at half of the rate otherwise applicable if incidental to
such operation of ships). Income from the rental of ships, aircraft or
containers that is not incidental to the operation of ships or aircraft
in international traffic is treated as business profits, and thus is
taxable by the state other than the income recipient's state of
residence only on a net basis and only if attributable to a permanent
establishment in the state. The current treaty policy of Thailand is to
treat such income as royalties subject to tax at a rate of 8 percent of
gross. Treatment as business profits was a concession gained by the
United States.
The proposed Convention grants a taxing right to the host country
with respect to income from the performance of personal services that
is broader than that in the OECD or U.S. Model, but that is similar to
that granted under other U.S. treaties with developing countries.
The proposed Convention contains detailed rules designed to
restrict the benefits of the Convention to persons that are not engaged
in treaty shopping. The provisions are similar to those found in the
U.S. Model and in all recent U.S. treaties.
The information exchange provisions make clear that Thailand is
obligated to provide U.S. tax officials such information as is
necessary to carry out the provisions of the Convention. The U.S.
negotiators are satisfied that, under this provision, Thailand is now
able to provide adequate tax information, including bank information,
to the United States whenever there is a Thai tax interest in the case.
Under current Thai law, however, Thailand is not able to provide
information under the tax treaty in non-criminal cases where there is
no Thai tax interest. The proposed Convention contains an unusual
provision designed to deal with this ``tax interest'' problem. The
proposed Convention provides that Thailand generally is required to
treat a U.S. tax interest as a Thai tax interest and the U.S. generally
is required to treat a Thai tax interest as a U.S. tax interest.
However, the ``tax interest'' provision does not take effect with
respect to either country until the United States receives from
Thailand a diplomatic note indicating that Thailand is prepared and
able to implement the provision, which will not be possible until Thai
law is changed. If the United States has not received such a diplomatic
note by June 30 of the fifth year following the entry into force of the
Convention, the entire Convention shall terminate on January I of the
sixth year following entry into force.
The Convention remains in force indefinitely, except in the
instance just described, but either State may terminate the Convention
after 5 years from the date on which the Convention enters into force,
with six-months' notice.
South Africa
The proposed treaty with South Africa, signed February 17, 1997,
renews a treaty relationship that was interrupted when the previous
convention was terminated in 1987 pursuant to the U.S. Anti-Apartheid
Act. The proposed Convention with South Africa generally follows the
pattern of the OECD Model treaty and other recent United States
treaties.
The proposed Convention establishes maximum rates of withholding at
source on investment income that are the same as those in the U.S.
Model. The taxation of capital gains under the proposed Convention also
follows the pattern of the U.S. Model.
As with recent U.S. treaties and the U.S. and OECD Models, the
proposed Convention provides generally for the taxation by one State of
the business profits of a resident of the other only when such profits
are attributable to a permanent establishment located in that other
State. The proposed Convention, however, grants rights to tax business
profits that are somewhat broader in one respect than those found in
the U.S. and OECD Models. Under the proposed Convention, an enterprise
will have a permanent establishment in a Contracting State if its
employees or other personnel provide services within that State for 183
days or more within a 12-month period in connection with the same or a
connected project.
As with the treatment of business profits, personal service income
is subject to rules that generally follow the U.S. Model rules. The
183-day personal service rule in the definition of permanent
establishment, however, is also present in the definition of fixed
base.
The proposed Convention, consistent with current U.S. treaty
policy, provides exclusive residence-country taxation of profits from
international carriage by ship or aircraft. This reciprocal exemption
also extends to income from the rental of ships, aircraft and
containers.
In the proposed Convention, the dollar threshold for host-country
taxation of income of entertainers and sportsmen is $7,500, rather than
$20,000, as in the U.S. Model. The proposed Convention, however,
contains a rule allowing the Contracting States to increase the amount
through an exchange of diplomatic notes.
The treatment of pensions differs, at the request of South Africa,
from that in the U.S. Model. Pensions will be subject to limited
source-country tax. The residence country may also tax, subject to a
foreign tax credit if the source country has taxed. Like the U.S.
Model, an individual employed in one country who belongs to a pension
plan in the other may, subject to certain conditions, be allowed in his
country of employment to deduct contributions to his plan in the other
country.
As in the U.S. Model, the proposed Convention provides that income
of a resident of a Contracting State not dealt with in the other
articles of the Convention is taxable only in the country of residence
of the recipient.
The proposed Convention contains significant Iiinitation on
benefits rules similar to those found in the U.S. Model and in all
recent U.S. treaties. The information exchange pro visions make clear
that South Africa is obligated to provide U.S. tax officials such
information, including bank information, as is necessary to carry out
the provisions of the Convention. Consistent with U.S. policy, South
African information will be available to U.S. authorities whether or
not South Africa has a tax interest in the information.
The proposed Convention provides a U.S. foreign tax credit for the
South African income taxes covered by the Convention, including the
normal tax and the secondary tax on companies, and for a South African
foreign tax credit for the U.S. income taxes covered by the Convention.
The U.S. foreign tax credit is subject to normal limitations of U.S.
law, including limitations relating to the amount of foreign source
income of the U.S. taxpayer and denial of the credit for non-compulsory
payments.
Ireland
The proposed Convention, Protocol and exchange of diplomatic notes
between the United States and Ireland, which were signed in Dublin on
July 28, 1997, would replace the present treaty between the two
countries. The present treaty is the oldest U.S. tax treaty; it was
signed in 1949. The proposed treaty updates the existing treaty to
reflect the current laws and tax treaty policies of both countries. It
fills a major void in the existing treaty by introducing a
comprehensive limitation on benefits provision and a dispute resolution
procedure.
The proposed treaty generally maintains the existing treaty's rates
of tax on direct and portfolio dividends, which are 5 and 15 percent,
respectively, Consistent with U.S. treaty policy, the threshold for
qualifying for the direct investment rate has been reduced from 95
percent of the ownership of the equity of a company to ten percent.
However, Ireland will exempt direct investment dividends paid to U.S.
residents from any withholding tax. Ireland also will allow U.S.
portfolio investors in Irish companies the tax credit provided to
individuals resident in Ireland for a portion of the Irish corporation
tax paid on distributed profits.
The proposed treaty maintains the existing treaty's general
exemption at source for interest and royalty payments.
Unlike the existing treaty, the proposed treaty preserves the U.S.
right to impose its branch profits tax in addition to the basic
corporate tax on a branch's business.
The proposed treaty provides special rules for the taxation of
activities associated with the offshore exploration for, and
exploitation of, natural resources. These rules provide for somewhat
shorter time thresholds than would otherwise apply for these activities
to give rise to a permanent establishment. They also permit taxation of
employee compensation associated with offshore activities. Other U.S.
treaties with countries in this geographical area (for example, Norway,
the United Kingdom, and the Netherlands) have similar provisions
dealing with offshore activities.
The proposed treaty includes a comprehensive limitation on benefits
provision to combat treaty shopping. The provision is broadly similar
to the corresponding provisions in other recent U.S. treaties, but it
has been tailored to accommodate the small size of the Irish economy
and the historically large share of foreign ownership of Irish
business. The limitation on benefits provision is most similar to the
corresponding provision in the proposed treaty with Luxembourg.
The proposed treaty closes another gap in the current treaty by
introducing a provision to resolve disputes by mutual agreement under
the treaty. Such a provision is necessary in some cases to avoid double
taxation.
The proposed treaty allows for the use of arbitration to resolve
disputes that may arise between Ireland and the United States over the
application of the treaty. However, the arbitration process may be
implemented only after the two States have agreed to do so through an
exchange of diplomatic notes. Once implemented, a case may be assigned
to arbitration only with the consent of all the parties to the case.
Also included in the proposed treaty are rules for the exchange of
information by the tax authorities of Ireland and the United States.
The treaty provides for extensive exchange of information necessary to
enforce tax laws and confirms that Ireland will obtain and provide any
information relevant to the investigation or prosecution of a criminal
tax matter.
Finally, the proposed treaty covers the U.S. excise tax imposed on
insurance premiums paid to foreign insurers, but only where such
insurance premiums are subject to the generally applicable tax imposed
on insurance companies in Ireland. This proviso means that the excise
tax may be imposed on insurance premiums paid to companies that receive
the tax benefits associated with Ireland's International Financial
Services Center (which is sometimes referred to as the ``Dublin
Docks''). This provision was included in the treaty after the
Department of the Treasury determined that insurance companies subject
to Ireland's generally applicable insurance tax regime face a
substantial tax burden relative to the U.S. taxation of U.S. insurance
companies, but companies benefiting from Ireland's International
Financial Services Center do not face such a substantial tax burden.
The treaty will enter into force on the date the instruments of
ratification are exchanged. The provisions with respect to taxes
withheld at source will have effect on or after the first day of
January following entry into force. With respect to other U.S. taxes,
the treaty generally will have effect for taxable years beginning on or
after that date. In the case of other Irish taxes, the treaty will have
effect for financial years (in the case of the corporation tax) or
years of assessment (in the case of the income and capital gains tax)
beginning on or after that date. Like many U.S. tax treaties that
replace existing treaties, a provision allows residents to choose to
apply the existing treaty for an additional year.
Canada
The proposed fourth Protocol to the Income Tax Convention between
the United States and Canada was signed in Ottawa on July 29, 1997. The
proposed Protocol is limited to two issues: the taxation of social
security benefits, and the taxation of foreign real property holding
companies.
The 1995 Protocol to the US-Canada Tax Convention, which became
effective January 1, 1996, changed the taxation of social security
benefits. Under the Convention prior to amendment by the 1995 Protocol,
the country of residence of the recipient taxed social security
benefits paid by the other country on a net basis but exempted 50
percent of the benefit. Under the present regime, the benefits are
taxed at source at a rate of 25.5 percent by the US and 25 percent by
Canada. However, Canada permits U.S. recipients of Canadian benefits to
file a Canadian tax return and pay tax at regular graduated rates on
net income.
This proposed Protocol returns to a system of residence-based
taxation in which social security benefits are taxable in the country
where the recipient lives. Therefore social security benefits will be
taxed on a net basis at graduated rates and low-income recipients will
not pay any tax. However, the taxation of benefits in the residence
country takes into account how the benefits would have been taxed in
the source country. For example, since the United States only includes
85 percent of the U.S. benefits in income, only 85 percent of U.S.
benefits received by Canadians will be subject to Canadian tax.
The proposed Protocol is retroactively effective to January 1,
1996, the date the prior rule took effect, so that social security
recipients will receive a refund of taxes previously paid although some
recipients may be required to pay additional taxes to their country of
residence. However, if as a result of the change, the residence-country
tax would exceed amount of the refund, there will be neither a refund
of source-country tax nor the imposition of additional residence-
country tax. Consequently, no one will be subject to a higher rate of
tax for the retroactive period. However, in the future some high-income
recipients of benefits will be subject to a higher rate of tax if their
average tax rate on these benefits in their country of residence is
higher than the current rate of source-country withholding tax.
The proposed Protocol also denies each country the right to tax
income from the sale of the stock of foreign corporations whose assets
primarily consist of domestic real estate (e.g., real property holding
companies). Both countries currently tax foreign persons on the sale of
both domestic real estate and the stock of domestic corporations whose
assets primarily consist of domestic real estate. The current
Convention permits this tax and also permits the taxation of income
from the sale of stock of foreign companies whose assets primarily
consist of domestic real estate but neither country currently imposes
such a tax. We believe that it is inappropriate to tax such sales, but
a bill imposing such a tax was introduced in the last session of the
Canadian Parliament. Although the Canadian Parliament was dissolved
before these amendments were passed, they are expected to be re-
introduced in the next session with the same effective date. The
proposed Protocol amends the Convention to limit each country's right
to tax gains from the sale of stock of real property holding companies
to companies that are resident in that country. This provision will be
retroactively effective to April 26, 1995, the date the previous
Canadian legislation was proposed to be effective.
Treaties under Negotiation
We are continuing to maintain an active calendar of tax treaty
negotiations. Early this summer we initialed treaties with Estonia,
Latvia, and Lithuania. We are nearing completion of our negotiations
with Bangladesh, Sri Lanka, and Denmark. We also are resuming
negotiations with Venezuela and Italy. In addition, in accordance with
the treaty program priority noted earlier, we continue to seek
opportunities for tax treaty discussions and negotiations with several
countries in Latin America and Southeast Asia.
Conclusion
Let me conclude by again thanking the Committee for its continuing
interest in the tax treaty program, and for devoting the time of
Members and staff to undertake a meaningful review of the agreements
that are pending before you. We appreciate your efforts this year and
in past years to bring the treaties before this Committee and then to
the full Senate for its advice and consent to ratification. We also
appreciate the assistance and cooperation of the staffs of this
Committee and of the Joint Committee on Taxation in the tax treaty
process. With your and their help, we have, since the beginning of
1993, brought into force 15 new treaties and protocols, not counting
the eight agreements presently being considered.
We urge the Committee to take prompt and favorable action on all of
the Conventions and Protocols before you today. Such action will send
an important message to our trading partners and our business
community. It will demonstrate our desire to expand the United States
treaty network with income tax treaties formulated to enhance the
worldwide competitiveness of United States companies. It will
strengthen and expand our economic relations with countries that have
seen significant economic and political changes in recent years. It
will make clear our intention to deal bilaterally in a forceful and
realistic way with treaty abuse. Finally, it will enable us to improve
the administration of our tax laws both domestically and
internationally.
I will be glad to answer any questions you might have.
__________
U.S. Department of Justice,
Office of Legislative Affairs,
Washington, D.C. 20530.
October 6, 1997
Hon. Jesse Helms,
Chairman,
Committee on Foreign Relations
U.S. Senate
Washington, D.C. 20510
Dear Mr. Chairman.
Seven income tax treaties and one protocol are pending before the
Foreign Relations Committee, namely treaties with Austria, Switzerland,
Ireland, Luxembourg, Turkey, South Africa, and Thailand, as well as a
protocol with Canada. The Department of Justice urges that the
Committee and the Senate approve these agreements at the earliest date
practicable.
The civil and criminal enforcement actions of the Tax Division of
the Justice Department are increasingly dependent on our ability to
obtain foreign evidence. Therefore, it is especially helpful to us that
the treaties forwarded by the President contain exchange of information
provisions that will significantly enhance the ability of federal
investigators and litigators to obtain foreign documents and testimony
to enforce U.S. tax laws. These provisions will also improve the
ability of federal authorities to obtain evidence in a form admissible
for U.S. court proceedings.
In particular, we believe that the proposed tax-treaties with
Austria, Switzerland, Ireland, and Luxembourg (in conjunction with the
proposed mutual legal assistance treaty (MLAT) with Luxembourg) \1\
will remove significant barriers currently facing U.S. tax enforcement.
The tax treaties with those countries, along with the Luxembourg MLAT,
have provisions that will assist U.S-tax authorities in obtaining
information held by financial institutions located in those countries,
which have very strict financial secrecy laws, for U.S. criminal tax
offenses. We have had a substantial number of criminal cases in the
past for which we needed financial information located in these
jurisdictions. Furthermore, the proposed tax treaties with Austria,
Switzerland, Ireland and Luxembourg provide for exchanging information,
other than that held by financial institutions in these four countries,
for both civil and criminal tax matters being investigated or enforced
in court by federal tax authorities in the United States.
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\1\ The proposed MLAT with Luxembourg is significant here because,
during the negotiations for the Luxembourg Tax Treaty, the Luxembourg
Tax Treaty Delegation, after thoroughly consulting with the principals
in Luxembourg, emphatically stated that Luxembourg law precluded
Luxembourg officials from obtaining and providing financial information
held by a Luxembourg institution through an administrative process such
as a tax treaty. On the other hand, the Luxembourg Delegation
emphasized that such assistance could be arranged through a judicial
process and suggested that we pursue the conclusion of an MLAT with
Luxembourg that would allow access by U.S. tax authorities to
Luxembourg financial information for criminal tax offenses.
Accordingly, the United States has negotiated an MLAT with Luxembourg
that covers most, if not all, U.S. criminal tax offenses and it is
understood that the U.S. would view a failure by Luxembourg to provide
assistance for criminal tax offenses under the MLAT as grounds for
termination of the tax treaty.
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The Department believes that all eight pacts will greatly enhance
the tax enforcement capabilities of the United States government.
The Office of Management and Budget has advised that there is no
objection to the submission of this report from the standpoint of the
Administration's program.
Sincerely,
Andrew Fois,
Assistant Attorney General.
Senator Hagel. Mr. Secretary, thank you.
Senator Sarbanes, would you like to begin? Whatever you
want to do.
Senator Sarbanes. Mr. Guttentag, have you had a chance to
review the work of the joint committee on taxation with respect
to these various tax treaties?
Mr. Guttentag. Yes, I have.
Senator Sarbanes. Have you prepared a memo or anything that
responds to some of the questions they raise? Has that been
done?
Mr. Guttentag. Well, the questions that were raised, I
believe we addressed those in our full statement, Mr. Sarbanes.
Some of those were addressed in my oral statement. Is there
something specifically that I could address?
Senator Sarbanes. Well, I have not had a chance to go
through your full statement. So I am not in a position to make
the judgment of whether it responds to the points raised by the
staff of the joint committee on taxation. They do a very
thorough and comprehensive review. I have a high opinion of
their work.
If it has not been answered, I think, Mr. Chairman, we
ought to get that for the use of the committee.
Mr. Guttentag. I would be glad to submit answers to the
specific issues raised in each one of those cases.
Senator Sarbanes. Well, let me take a few of them up with
you.
Mr. Guttentag. Certainly.
Senator Sarbanes. Let me turn to the Austrian treaty first,
and the stock gains. Apparently, we have made a one-sided
concession, in which we allow Austria to impose a tax on stock
gains through the year 2010 while the U.S. cannot impose a
reciprocal tax. This may mean double taxation of capital gains
for some U.S. investors. In fact, the Joint Tax Committee says:
The committee may wish to consider whether the provision of
the proposed treaty that permits Austria to tax capital gains
from an alienation of the shares of certain Austrian companies
through the year 2010 is appropriate as a matter of U.S. treaty
policy. In this regard, the committee may wish to consider
whether the inclusion of this provision in the proposed treaty
will serve as a precedent for future treaties to permit similar
one-side concessions, contrary to longstanding U.S. treaty
policy.
Now, what is your explanation for this?
Mr. Guttentag. We do, in our treaty policy, we like to
eliminate any capital gains of shares of stock or, generally,
most movable property. We do not include real estate, which of
course is subject to that kind of tax.
Senator Sarbanes. Actually, our model treaty and the OECD
model both reflect this policy, do they not?
Mr. Guttentag. That is right. That is correct. In the
Austrian treaty, which is presently in effect, permits Austria
to tax capital gains. So our position when we negotiated with
Austria was to provide for no taxation of capital gains. They
pointed out to us that because under the current treaty they
permitted taxpayers to establish corporations in Austria free
of Austrian tax on the basis that when the stock in those
corporations was later sold, they would be able to tax it.
So their position was that they needed a type of
grandfathering position which, until the year 2010, would allow
them to tax those transactions. We believe that those are
extremely few in number, and it is a very limited exception. We
were able, thereby, by making this very limited exception, to
achieve our overall policy. Because, generally, overall, there
will be no Austrian taxes on capital gains, consistent with our
model and the OECD model.
Senator Sarbanes. So it is your position that you were, in
effect, carrying through an existing provision in the current
treaty?
Mr. Guttentag. No; in the current treaty, there is no limit
on Austrian capital gains. So we were able to put a provision
in the new treaty which was consistent with our model--that
there would not be any tax, with this limited exception.
Senator Sarbanes. I see. Now, on the royalties, you went in
the other direction. You expanded the exception, did you not,
on royalties?
Mr. Guttentag. Yes.
Senator Sarbanes. Did you expand it?
Mr. Guttentag. Yes. With respect to royalties, we do not
consider we expanded that so much as we took into account new
developments. The definition of movie and broadcast royalties
that was put into the treaty 40 years ago or so did not take in
account new technological developments, where we felt that it
was appropriate--one, we do not believe it is appropriate--it
is not our policy to provide for any tax in this area; but if
there were to be a tax, we felt it was appropriate to include
quite similar technologies to the radio and television
broadcasting.
Senator Sarbanes. Why would we do that if our objective is
to eliminate source country tax on royalties? Why would you
update it for the technology? We do not want to do that, do we?
Mr. Guttentag. That was our bargaining. This was a bargain
that we were able to reach with the Austrians. Taxation of
royalties today means a lot more, I can tell you, Mr. Sarbanes,
to American companies than it did at the time we negotiated
this treaty. We do everything possible to make sure that those
royalties flow into the U.S. free of any withholding tax. In
order to do that, we have to make concessions. Because, in many
cases, the flow of royalties into the United States from
foreign countries is much greater than the flow in the other
direction.
And you will have the opportunity to hear Mr. Mattson, from
IBM, in the next panel. I think he will support this position,
not only of the importance, but of the efforts made by Treasury
to maintain that position.
Senator Sarbanes. Well, it does not matter to the company;
they do not pay a larger tax bill, do they?
Mr. Guttentag. Very often they do, Mr. Sarbanes, because it
depends whether they are able to offset those foreign taxes
against their U.S. taxes. That depends on the particular
position of the company. That is one reason why we try to
eliminate the tax at source to the fullest extent possible.
Senator Sarbanes. Well, I am not getting an answer to my
question.
Mr. Guttentag. Yes.
Senator Sarbanes. Is U.S. treaty policy generally to
eliminate source country tax on royalties?
Mr. Guttentag. It certainly is. You can look at Austrian
treaties, Mr. Sarbanes. We did better than with most other
countries. In many of their treaties, there is a 10 percent
rate which is applied across the board to any royalties paid to
a parent company.
Senator Sarbanes. What is the existing provision in the
Austrian treaty?
Mr. Guttentag. The present position is that the tax is a
nil rate of tax on royalties, with the exception of the movie
royalties.
Senator Sarbanes. And those are 10 percent?
Mr. Guttentag. That is right.
Senator Sarbanes. Now you have expanded it. So it is not
only movie royalties, but also radio and television; is that
correct?
Mr. Guttentag. That is right.
Senator Sarbanes. Well, isn't that moving in exactly the
opposite direction from our general treaty policy?
Mr. Guttentag. It is moving only in the sense of the
particular items which are included. One, we are now reflecting
in this treaty the technology which presently exists, which did
not exist back then. So if we would have written that provision
back then, it would have contained this language.
Senator Sarbanes. What happens to radio and television
broadcasting now under the current treaty?
Mr. Guttentag. They are taxed at 10 percent. Those
royalties are taxed at 10 percent.
Senator Sarbanes. Under the existing treaty?
Mr. Guttentag. Under the existing treaty.
I think if you compare the withholding rates under the
Austrian treaties with other countries and with the U.S., you
will find that the U.S. rates are generally more favorable,
including the royalty provisions. We did a good job in
negotiating that treaty. It is fair. It is fair to Austria, but
it is also fair to the U.S.
Senator Sarbanes. Well, I am just trying to find out what
you did at the moment, then we will evaluate it.
Mr. Guttentag. OK.
Senator Sarbanes. The Joint Tax Committee says the
following:
The proposed treaty expands the class of royalty payments
that are subject to the 10 percent source country taxation.
Under the present treaty, only motion picture film rentals are
subject to source country taxation. Under the proposed treaty,
source country taxation also applies to payments for the use of
or the right to use tapes or other means of reproduction used
for radio or television broadcasting. Consequently, a
significantly expanded class of Austrian source royalties,
beneficially owned by U.S. residents, will be subject to a 10
percent Austrian withholding tax under the proposed treaty.
Is that correct?
Mr. Guttentag. Yes, their statement is correct.
Senator Sarbanes. Well, I thought you just told me that
under the current treaty there was a 10 percent tax on radio
and television broadcasting.
Mr. Guttentag. I am sorry; that was only on movie
royalties. I do not believe we had television royalties to any
extent back in 1956.
Senator Sarbanes. Well, I was very careful in asking that
question.
Mr. Guttentag. Yes, I am sorry, Mr. Sarbanes.
Senator Sarbanes. Mr. Chairman, I have some more questions.
Maybe I had better yield to you, and then I will pick up on
these other questions later.
Senator Hagel. All right. I will ask a couple of questions,
then we will go back.
Mr. Secretary, can you give me a general range of the
Treasury's estimation of the effect of these treaties on
revenue flow to or from the Treasury?
Mr. Guttentag. Mr. Chairman, the Treasury does not provide
or make any revenue estimates on our tax treaties, as opposed
to tax legislation. We take into account, in general, the
amount of economic activity. This is an impossible task to do,
according to our experts in this area. General revenue
estimating concepts do not work well if you just try to apply
the rules that we would use in estimating revenue effects of
legislation internationally.
In many cases, there are secondary effects which are
extremely important--removing barriers--we cannot tell--for
example--Mr. Sarbanes asked whether, when we lower taxes, who
gets the benefit of that. Is it the company or is it the U.S.
Treasury? If we did not lower the tax, would they be able to
use it as a credit against their U.S. tax or would it just
lower their overall burden?
Well, we take the position that these treaties go beyond
just the tax revenue involved. As you suggested in your opening
statement, the impact on companies, encouraging these kinds of
desirable economic activity, is the real purpose of these
treaties. To avoid double tax is the real purpose of these
treaties. The revenue flows, we do not believe, are that
critical to making these decisions as to whether a treaty is
appropriate, even if we could do so.
Senator Hagel. Thank you.
Is the Treasury satisfied that all the treaties now under
consideration that we are talking about today are sound
structurally and without flaws?
Mr. Guttentag. Yes, we are, Mr. Chairman.
Senator Hagel. How does that work? How do you determine
that? Do you model that? Or how do you come to that conclusion?
Mr. Guttentag. Well, we go into the treaty negotiation with
our draft. We enter into a negotiation--I think it is quite
similar, Mr. Chairman, to the kinds of negotiations that you
have participated in, in the business world. If we make a
concession, we ask for an offsetting concession, which may be
in a completely different part of the agreement. We also take
into account special rules which apply in the U.S. or in the
foreign country. Then we look, before we initial any
convention, to determine whether we believe we have reached an
appropriate balance. We are satisfied, with each one of these
conventions, that we have done so.
Senator Hagel. Thank you.
I noted a recent GAO report had suggested that many foreign
corporations do not pay their fair share of taxes. You are
probably familiar with that report. Are you satisfied that what
we are doing here today deals with that issue?
Mr. Guttentag. Yes. One of the most important ways that our
treaties deal with that issue is providing for information
exchange. So that we can have direct contact between the tax
authorities of both countries. When a foreign corporation,
therefore, is engaged in business in the United States, we have
access to data as necessary in order to assure ourselves that
tax returns are accurate. Other provisions of the treaty are
enforced to make sure no unintended benefits go to foreign-
based companies or to U.S.-based companies.
So these treaties are most helpful in assuring, one, that
there are fair shares of taxes are paid to the U.S., but, at
the same time, avoiding any double tax.
Senator Hagel. What, in your opinion, are the major
distinctions between the limitations on benefits provisions of
these treaties? Are there differences?
Mr. Guttentag. Yes, there are differences. I do not think
any two are identical, nor are they identical to our model
treaty. Each country has its own internal laws dealing with
problems which we have to deal with in our limitations of
benefits articles. In some countries, these laws may seem to
encourage foreigners to use that country for treaty shopping
purposes. In other cases, the rules are closer to those of the
United States, which does not provide such encouragement.
Other countries have already adopted rules, long before we
did, to deal with this issue. Switzerland is one example that
you have before you today which, back in 1962, adopted
provisions to deal with treaty shopping, and which are
reflected in the treaty with Switzerland, where we provided a
meld of our limitations of benefits provisions and the Swiss
provisions.
Other countries, we take into account their membership in
economic units, membership in the European Union, membership in
NAFTA, to make sure that we do not discourage or interfere with
those economic relationships.
Senator Hagel. Thank you.
Senator Sarbanes.
Senator Sarbanes. Well, let me pursue the answer you just
gave on exchange of information and its importance in these tax
treaties as I understand it. In the light of that answer, I
want to ask about the treaty with Ireland. As I understand it,
the Irish protocol states that for the purposes of obtaining
information under the proposed treaties, the laws and practices
of Ireland do not permit its tax authorities to carry out
inquiries on behalf of another country where there is no Irish
liability for such tax.
Now, what that means is, in practice, the U.S. will not be
able to obtain information upon request from Ireland, but that
Ireland will be able to obtain information upon request from
the U.S. How could we have committed ourselves to language that
requires us to provide more information than Ireland must
provide, and prohibits us from withholding information because
they do? And I contrast this with the proposed treaty we have
with the Thailand.
The joint committee says here in their report:
The language of this provision in the proposed treaty does
not permit the U.S. to decline to obtain information that is
requested by Ireland solely because the United States is not
able to obtain information on a reciprocal basis from Ireland.
One issue is whether the committee views the exchange of
information provisions of the proposed treaty as sufficient to
carry out the tax-avoidance purposes for which income tax
treaties are entered into by the United States.
Some might consider the nonreciprocal nature of the
provision on obtaining information to be unusual. The committee
may wish to consider whether such a nonreciprocal provision is
appropriate in the context of the proposed treaty. Some might
also observe that other countries that have similar local law
impediments to obtaining information, such as Thailand, have
received less advantageous treatment with respect to U.S.
treaties than Ireland has as a consequence of these
impediments.
What is your response to that?
Mr. Guttentag. Well, yes, Ireland does have a prohibition
against providing information in a case in which they do not
have a particular Irish tax interest in getting that
information. That is true under the current treaty with
Ireland.
What we do when we go into a treaty with a country such as
Ireland with which we already have a treaty is we see how much
we can improve it. We negotiated long and hard on their tax
interest issue. What we have agreed to is that we are able to
get information, even if Ireland does not have a tax interest,
with respect to certain criminal cases; not civil cases,
however. That would be under another provision, as explained in
the diplomatic notes which are attached to the Irish treaty.
So we were able to make a step forward there that, while we
cannot get information on a civil case, we can get information
in criminal cases under the Irish Criminal Justice Act.
Now, on the issue of whether we should provide information,
there is a rule of comity which is applied internationally in
any treaty. That is, it should be applied equally. I believe
that, while this matter of information exchange is handled by
the Internal Revenue Service, not the Treasury, if it appeared
that there was a flow of information to Ireland on a regular
basis and difficulties in obtaining information from Ireland
because of this limitation, I think that we would then have to
reconsider whether we would be willing to provide information
in this nonreciprocal form.
But we prefer not to put this in a treaty to see what
happens in practice.
Senator Sarbanes. What did you do in the Thailand treaty?
There, in effect, you allow us not to provide information if
they do not provide information.
Mr. Guttentag. That is right. We made that reciprocal. But,
again, in Thailand, we have a couple of different situations.
One, Thailand is a new treaty country. We take the position
that when we are entering into a treaty with a new country, and
particularly if we think there are going to be difficulties and
problems with tax information exchange, we are liable to take a
much more stringent negotiating position. That we did in
Thailand.
While we made this reciprocal, we also put in Thailand a
provision that if Thailand is not able to eliminate their
requirement of a tax interest in order to provide information
within a period of 5 years, the treaty will terminate. No
action is required by the United States. No action is required
by the Senate.
So we have sent a clear message to Thailand that they must
eliminate this restriction in their law which prohibits their
giving us the information. They have indicated to us, the tax
authorities with whom we dealt, that they are interested in
eliminating this restriction. They were not able to do it
because of provisions of Thai law. We believe that putting it
in the treaty in this way, that the benefits of the treaty will
cause them to seriously consider enacting the legislation and
keeping the treaty in force.
So we do approach these, Mr. Sarbanes, differently when we
have an existing treaty relationship with a longstanding treaty
partner and a new country.
Senator Sarbanes. Well, now, the joint committee says that
the nonreciprocal nature of the provision on obtaining
information is unusual. Is that correct?
Mr. Guttentag. It may be unusual to have a provision in the
treaty under the tax interest provision like that. That may be
unusual.
Senator Sarbanes. How many tax treaties do we have?
Mr. Guttentag. Well, we have that in the U.K. treaty; it
also has a tax interest requirement.
Senator Sarbanes. How many tax treaties do we have
altogether?
Mr. Guttentag. We have 48.
Senator Sarbanes. Forty-eight. In how many of them would we
find this provision, the nonreciprocal nature of the exchange
of information? The reason I am picking up on this issue is
that you devoted one of your answers to the chairman at some
length on the importance of the exchange of information for
achieving the purpose of these tax treaties. Then we find that
one of the treaties that is here before us today, we really do
not seem to have met that standard.
Out of the 48 treaties, how many of them would have such a
provision, that is nonreciprocal in nature?
Mr. Guttentag. At least I know that Japan, the U.K. and
Ireland. Mr. Sarbanes, remember, while it is nonreciprocal, the
question is: Are we satisfied that we are doing the best we can
to get the required information that we are going to need,
taking into account the choice of having a treaty or not having
a treaty?
And we are satisfied that under the Irish treaty, having
negotiated long and hard with Ireland, knowing that we will be
able to get information dealing with the more important
criminal cases, regardless of the limitation, that we are
satisfied that we are doing the best we can. We are better off
getting that information under the current tax treaty than not
having a treaty at all.
Senator Sarbanes. Wouldn't you say that the reciprocal
exchange of information is probably one of the most important
objectives that we seek in any tax treaty?
Mr. Guttentag. I certainly believe so. Because we are
looking at this in two parts, as we said, Mr. Sarbanes. One is
to prevent double taxation; and the other is to prevent fiscal
evasion. We believe that this blending of these two purposes of
the treaty are both critical and, obviously, the exchange of
information is most important. The U.S. has been in the lead in
the world in encouraging further exchange of information and
breaking down barriers to exchange of information. We believe
we have been very successful and that we are going to push
further.
We have been working with the OECD, under its information
exchange article. The OECD article contains a commentary which
says that tax interest is not a valid reason not to give
information. As I said, we were able to persuade, we were able
to persuade the Irish Legislature to give us information
concerning criminal cases. So we have made a major improvement
over the existing treaty.
Senator Sarbanes. Now, as I understand it, the proposed
treaties with Luxembourg, Switzerland and Ireland waive the
U.S. excise tax on insurance premiums paid to foreign insurers.
Such waivers of the excise tax on reinsurance premiums may
place U.S. insurers at a competitive disadvantage with respect
to foreign competitors in U.S. markets if a substantial tax is
not otherwise imposed on the insurance income of the foreign
reinsurer.
Now, we heard about that from the insurance people
previously when we considered some tax treaties. In fact, in
this committee's report on the U.S.-Bermuda tax treaty, the
committee expressed its view that the waiver of the insurance
excise tax could have the undesirable effect of eliminating all
tax on insurance income and should not have been included in
the treaty. Congress subsequently enacted legislation to ensure
the sunset of that waiver, and has undertaken repeated efforts
to redress the competitive imbalance created by similar waivers
in the Barbados and the U.K. treaties.
Now, in light of this fairly strong congressional reaction,
why was this provision, then, included in the Luxembourg,
Switzerland and Ireland treaties?
Mr. Guttentag. Well, we listened very carefully, Mr.
Sarbanes. In negotiating these treaties, we took the positions,
as you have just expressed, very much to heart. We examined the
tax laws of Ireland, Luxembourg and Switzerland most carefully
to assure ourselves that any waiver we gave of the Federal
excise tax was accompanied by a reasonable tax imposed by the
country of residence of the insurance company to prevent any
inappropriate competitive advantage by the foreign insurance
company.
We determined that, in Switzerland, there was such a tax
imposed on insurance companies. In Luxembourg, we believe that
there was with respect to insurance, but not reinsurance. So,
therefore, reinsurance is carved out of the Luxembourg treaty.
With respect to Ireland, we believe that the insurance taxes
were appropriate; however, for companies operating in the
international financial service centers in Ireland, which
obtain certain tax benefits, we determined that those companies
should not be entitled to the benefits of our excise tax
exemption and they were not given that exemption.
Senator Sarbanes. Now, if those countries should repeal
those taxes, what would happen?
Mr. Guttentag. We would then go in to take away their
benefits of their exemption from the Federal excise tax.
Senator Sarbanes. That is provided for in the treaties?
Mr. Guttentag. Any change in the tax laws requires a
renegotiation of the treaty itself.
Senator Sarbanes. If they change their own tax policy with
respect to their own insurance companies?
Mr. Guttentag. Right. If we did that, we would then
immediately take steps to eliminate--if we believe that
resulted in a competitive disadvantage for the U.S. industry,
we would immediately take steps to renegotiate the treaty and
remove that exemption. The countries involved, I can tell you,
each one of the countries involved was subjected to such a
searching examination, they are fully aware of our policy in
this regard.
Senator Sarbanes. In 1974, Turkey invaded Cyprus, and since
then has occupied the north of Cyprus in the contrary to
repeated U.N. resolutions which the United States has
consistently supported, calling for the withdrawal of their
forces and so forth. I take it that this tax treaty with Turkey
would not provide any tax benefits for any U.S. or Turkish
permanent establishment in the north of Cyprus, that area now
occupied by Turkish forces; is that correct?
Mr. Guttentag. You are correct, Mr. Sarbanes. This treaty
only applies to Turkey as it is recognized by the United
States, which does not include northern Cyprus.
Senator Sarbanes. And I take it that Turkish Cypriots would
not be eligible for benefits under this treaty, as distinct
from Turkish citizens?
Mr. Guttentag. That is correct.
We do have a tax treaty with Cyprus. Any benefits for
residents of Cyprus would be controlled by that treaty.
Senator Sarbanes. Both the Turkish and Swiss treaties give
preferential treatment to profits from the operation of ships
and aircraft over profits from the rental of ships and
aircraft. In addition, the Swiss treaty fails to limit to the
country of residence the right to tax income from the use,
maintenance or rental of containers used in international
traffic. This is the container issue, with which I am sure you
are familiar.
Mr. Guttentag. Right.
Senator Sarbanes. The 1990 committee report on the
Indonesia tax treaty included the following comment:
In 1983, the committee rejected the notion that a
justifiable distinction could be made between container leasing
income and income derived from other international
transportation activities. The committee also questioned at
that time the appropriateness of placing taxpayers primarily
engaged in container leasing activities at a competitive
disadvantage vis-a-vis companies engaged in international
shipping and air transport activities. The committee also
instructed the Treasury Department to include only the U.S.
model provision on this matter in all future treaties.
Well, I gather that has not been done and that the failure
to cover container leasing once again puts this industry at a
competitive disadvantage in these particular treaties; is that
correct?
Mr. Guttentag. We have come, I think, very close to
providing exactly what the Senate has asked us to do in
connection with the container leasing. The container leasing
exemptions are provided in the treaties with Turkey,
Luxembourg, Austria, South Africa, and Ireland. You mentioned
Turkey, there is an exemption for containers in the Turkish
treaty.
In the treaty with Switzerland, income from containers are
treated as business profits. What is the significance of that?
That means that Switzerland cannot tax any of the income
resulting from the use of containers unless the owner of those
containers operates in Switzerland through a permanent
establishment.
Mr. Sarbanes, we have kept in close connection and close
contact with the container industry with respect to all of
those treaties since the Senate indicated its interest in this
area. We believe that while we have not in every treaty here
complied exactly with the model and been able to achieve our
model result, that we have arrived at results which the
container industry understands and which they find to be in a
better position than if we had no treaty, and which they find
to be satisfactory.
Many of these countries have policies, Mr. Sarbanes, which
are just as tough and as immovable as ours. If we were to try
to have a treaty in which all of our model provisions and
desires would be achieved, we would have far fewer than the 48
treaties that we have now. I am sure that you understand that
and did not mean to imply otherwise.
Senator Sarbanes. Well, Mr. Chairman, I know we have to
vote. I would like to make this suggestion. I would like to
repeat what I said at the outset--that Mr. Guttentag take the
questions raised by the joint committee on taxation and provide
to the committee a response to the issues that they posed.
Let me give you just an example of that, because I was told
that their response is in the statement. But I am looking at
your statement, and unless there is an appendix, which I have
not seen, there is only a minor reference to Ireland on the
question of exchange of information, about which we just had an
extended discussion. Let me read it to you, because it is very
brief:
Also included in the proposed treaty are rules for the
exchange of information by the tax authorities of Ireland and
the United States. The treaty provides for extensive exchange
of information necessary to enforce tax laws, and confirms that
Ireland will obtain and provide any information relevant to the
investigation or prosecution of a criminal tax matter.
Now, that is correct as far as it goes, but I do not think
it goes very far in terms of addressing the issues that were
raised by the Joint Tax Committee and the ones which we have
just have discussed in some detail here. So I think there would
be a benefit to receiving fuller responses. I understand you
feel you have done a good job of negotiating these treaties,
and I am not in a position now to say that is not the case.
I am just raising some questions. But it seems to me that
the legitimate concerns that have been raised by the staff of
the Joint Tax Committee need to be responded to by the Treasury
for the benefit of this committee. I think we should ask for
that.
Mr. Guttentag. Well, I have tried to do the best I can
during this relatively short time with these complicated
issues.
Senator Sarbanes. I understand.
Mr. Guttentag. But we will be glad to give you that in
writing, Mr. Sarbanes.
Senator Sarbanes. Good, that would be very helpful.
Senator Hagel. Secretary Guttentag, thank you.
I, too, have some additional questions that I would like to
submit in writing for the record.
Mr. Guttentag. Thank you.
Senator Hagel. And we appreciate very much your time.
The subcommittee will stand in recess for about 15 minutes
in order for Senator Sarbanes and I to vote. Then we would like
very much, if Mr. Kies is still available, to have him come up.
Thank you.
[Recess.]
Senator Hagel. Mr. Kies, thank you for waiting. I do not
know if you got a cup of coffee. In the old days, you said you
would get a smoke, but we do not see that any more.
Mr. Kies, please proceed, and thank you very much for
coming today.
STATEMENT OF KENNETH J. KIES, CHIEF OF STAFF, JOINT COMMITTEE
ON TAXATION
Mr. Kies. Thank you, Senator Hagel and Senator Sarbanes.
Thank you for inviting the staff of the joint committee to be
able to present testimony here today. I will be referring to my
oral testimony. The committee also has written testimony that I
would ask that you include in the record, as well.
I am accompanied by Barbara Angus, Tom Barthold, Barry
Wold, and Oren Penn, who all worked on the pamphlets and also
the testimony for the joint committee.
It is my pleasure to present our testimony at this hearing
concerning the proposed income tax treaties with Austria,
Ireland, Luxembourg, South Africa, Switzerland, Thailand,
Turkey, and the proposed protocol amending the existing income
tax treaty with Canada. As in the past, the staff of the joint
committee has prepared pamphlets covering each of the proposed
treaties and protocols. The pamphlets contain detailed
descriptions of the provisions of the proposed treaties and
protocols. The pamphlets also contain detailed discussion of
issues raised by the proposed agreements. We consulted
extensively with your committee staff in analyzing the
agreements and preparing the pamphlets.
Five of the eight agreements at issue today would modify
existing U.S. treaty relationships. Three of the agreements are
with countries with which we have no treaty currently. Let me
highlight some of the key features of the agreements.
In connection with consideration of these agreements, an
issue was raised regarding the U.S. treaty policy with respect
to the treatment of dividends from U.S. real estate investment
trusts, referred to commonly as REIT's. U.S. tax treaties
generally limit the maximum rate of withholding tax that may be
imposed by the source country on portfolio dividends paid by a
corporation resident in one country to residents of the other
country.
Most commonly, the maximum rate of withholding tax on
dividends is 15 percent. Treaties negotiated by the U.S. after
1988 contain specific rules excluding REIT dividends from the
reduced rates of withholding tax generally applicable to
dividends. Accordingly, under such treaties, REIT dividends may
be subject to U.S. withholding tax at the full statutory rate
of 30 percent. The U.S. REIT industry expressed concern that
the exclusion of REIT dividends from the reduced withholding
tax rates applicable to other dividends may inappropriately
discourage foreign investment in U.S. REIT's.
The Treasury Department has worked extensively with the
Joint Tax Committee and Foreign Relations Committee staffs, and
representatives of the REIT industry to address this concern.
As a result of significant cooperation among all parties, the
U.S. treaty policy with respect to the treatment of REIT
dividends has been modified. Under this new policy, REIT
dividends paid to a resident of a treaty country will be
eligible for the reduced rate of withholding tax applicable to
portfolio dividends--typically 15 percent--in two new cases.
First, the reduced withholding tax rate will apply to REIT
dividends if the treaty country resident beneficially holds an
interest of 5 percent or less in each class of the REIT stock,
and such dividends are paid with respect to a class of the REIT
stock that is publicly traded. Second, the reduced withholding
tax rate will apply to REIT dividends if the treaty country
resident beneficially holds an interest of 10 percent or less
in the REIT, and the REIT is diversified, regardless of whether
the REIT stock is publicly traded.
This new policy with respect to the treatment of REIT
dividends will be incorporated into the U.S. model treaty, and
the Treasury Department will use its best efforts to negotiate
protocols to amend the proposed treaties with Austria, Ireland
and Switzerland to incorporate this policy.
In the case of Luxembourg, it is recommended that this
policy be implemented by means of a reservation to the proposed
treaty.
The proposed protocol with Canada would modify the income
tax treaty that was signed in 1980. The proposed protocol would
replace the provision in the existing treaty that provides for
exclusive source country taxation of social security benefits
with a provision that provides for exclusive residence country
taxation of social security benefits. This represents a return
to the approach that applied prior to the 1995 protocol. The
proposed protocol also would modify the provision in the
existing treaty allowing situs country taxation of gains from
real property.
The proposed treaty with Austria is a comprehensive update
of the 1956 treaty. The provisions of the proposed treaty
generally comport with modern U.S. treaty policy. The proposed
treaty includes a comprehensive anti-treaty-shopping provision,
which resembles the provision in the U.S. model treaty and
other recent treaties.
The proposed treaty also includes an anti-abuse rule
covering certain triangular cases which involve payments from
the United States to the branch of an Austrian company located
in a third country. Under this rule, the U.S. generally may
tax, in accordance with its internal law, interest and
royalties paid to a low-taxed, third country branch of an
Austrian company.
The proposed treaty expands the class of royalty payments
that is subject to a 10-percent source country tax to include
payments for the use of films, tapes or other means of
reproduction used for radio or television broadcasting.
The exchange of information provisions of the proposed
treaty are substantially more useful than those of the current
treaty. The information generally may be exchanged to carry out
the purposes of the treaty or to carry out the domestic law of
the countries concerning taxes covered by the information
exchange article of the treaty. There are provisions in
Austrian law that prohibit Austria from obtaining information
from Austrian banks in non-penal investigations. However, bank
information may be obtained for penal investigations.
Accordingly, under the proposed treaty, bank information may be
provided by Austria in connection with U.S. penal
investigations, including the commencement of a criminal
investigation by the IRS.
The proposed treaty with Ireland is a comprehensive update
of the 1949 treaty. The provisions of the proposed treaty
generally are consistent with modern U.S. treaty policy.
The proposed treaty includes a comprehensive anti-treaty
shopping provision, which includes most of the elements of the
anti-treaty-shopping provision found in the U.S. model treaty
and other U.S. treaties. The proposed treaty includes a
derivative benefits provision under which treaty benefits
generally would be available to Irish companies that are owned
by residents of countries that are members of the E.U. Or
parties to NAFTA. Under this rule, the treaty benefits with
respect to dividends, interest and royalties would be available
only if the countries in which such owners are resident have
treaties with the U.S. providing for benefits that are at least
as favorable as those provided under the proposed treaty.
However, this restriction on the availability of treaty
benefits would take effect no earlier than 2 years after the
proposed treaty takes effect. The proposed treaty also includes
an anti-abuse rule, covering the so-called triangular case,
similar to the provision in the Austrian treaty.
The proposed treaty provides an exemption for Irish
insurance companies from the U.S. excise tax on insurance and
reinsurance premiums paid to foreign insurers with respect to
U.S. risks, subject to certain limitations, which Mr. Guttentag
discussed with Senator Sarbanes.
The exchange of information article contained in the
proposed treaty conforms in most respects to the corresponding
articles of the U.S. and OECD model treaties. As is true under
these model treaties, under the proposed treaty, the countries
are to exchange such information as is necessary for carrying
out the provisions of the proposed treaty or the domestic laws
of the countries. There is one significant respect in which the
exchange of information article does not conform to the
corresponding article of the U.S. model treaty. Again, Senator
Sarbanes and Mr. Guttentag discussed that exception, which
relates to the not completely evenhanded approach which the
treaty takes in that regard.
The proposed treaty with Luxembourg is a comprehensive
update of the 1962 treaty. The provisions of the proposed
treaty generally comport with modern U.S. treaty policy.
The proposed treaty includes a comprehensive anti-treaty-
shopping provision which resembles the provisions in the U.S.
model treaty. The proposed treaty includes a derivative
benefits provision and an anti-abuse rule, covering the so-
called triangular case, similar to those in the Irish treaty.
The proposed treaty provides an exemption for Luxembourg
insurance companies from the U.S. excise tax on insurance
premiums paid to foreign insurers with respect to U.S. risks,
subject to certain limitations. However, unlike other U.S. tax
treaties, the proposed treaty does not provide an exemption
from the excise tax on reinsurance premiums paid to Luxembourg
reinsurers. I believe Mr. Guttentag indicated the reason for
that was that reinsurers are not taxed in a manner consistent
with the way in which other insurers are taxed in Luxembourg.
The exchange of information provisions of the proposed
treaty are more useful than those of the current treaty.
Information generally may be exchanged to carry out the
purposes of the treaty or to carry out the domestic laws of the
countries concerning taxes covered by the information exchange
article of the treaty. There are provisions in Luxembourg law
that generally prohibit Luxembourg from obtaining information
from Luxembourg financial institutions either for their own
purposes or for purposes of the proposed treaty. However, such
bank information may be obtained under certain circumstances
involving criminal tax matters, pursuant to the proposed mutual
legal assistance treaty with Luxembourg.
The proposed treaty with South Africa generally is
consistent with other recent treaties that the U.S. has signed
with developed countries. It is a straightforward reflection of
current U.S. treaty policy, with only a few deviations. For
example, the proposed treaty allows broader source-country
taxation of business activities of residents of the other
country by expanding the definition of a permanent
establishment to include cases in which an enterprise provides
services through its employees in a country if the activities
continue for more than 183 days.
In addition, like many other U.S. treaties, the proposed
treaty includes an anti-treaty-shopping provision, with an
anti-abuse rule covering the so-called triangular case, as in
the Irish and Luxembourg treaties.
The proposed treaty with Switzerland is a comprehensive
update of the 1951 treaty. The provisions of the proposed
treaty generally are consistent with modern U.S. treaty policy.
The proposed treaty includes a comprehensive anti-treaty-
shopping provision, with a derivative benefits provision and an
anti-abuse rule dealing with the triangular case.
The proposed treaty provides an exemption for Swiss
insurance companies from the U.S. excise tax on insurance and
reinsurance premiums paid to foreign insurers with respect to
U.S. risks. The exchange of information provisions of the
proposed treaty are somewhat more useful than those of the
current treaty, but are nonetheless more restrictive than the
comparable provisions in tax treaties with other countries.
Information generally may be exchanged to carry out the
purposes of the treaty, but it may not be exchanged to carry
out the domestic laws of the countries concerning taxes covered
by the information exchange article of the treaty. Information
may also be exchanged to prevent tax fraud.
The proposed treaty with Thailand would represent a new
treaty relationship for the U.S. Under the proposed treaty,
Thailand would agree to reduce its taxes on income that U.S.
residents earn from sources in Thailand, The U.S. would agree
to reciprocal reductions of its tax on U.S. income of Thai
residents.
The proposed treaty follows preferred U.S. treaty positions
in many respects. However, it differs from preferred U.S.
treaty positions in other respects, primarily by not reducing
source country taxation to the same extent as many U.S. tax
treaties. In this regard, the proposed treaty is similar to
other treaties that the United States has entered into with
developing countries.
The exchange of information article contained in the
proposed treaty conforms in most respects to the corresponding
articles of the U.S. and OECD model treaties. As is true under
these model treaties, under the proposed treaty, the countries
are to exchange such information as is necessary for carrying
out the provisions of the proposed treaty or the domestic tax
laws of the countries. However, the proposed treaty would
suspend the application of this provision until the U.S.
receives from Thailand a diplomatic note indicating that
Thailand is prepared and able to implement this provision,
which will require that Thailand enact enabling legislation.
This means that neither country will obtain information for the
other until this diplomatic note is provided. Mr. Guttentag
indicated that it is anticipated Thailand will take that action
in the next couple of years.
Finally, the proposed treaty with Turkey would represent a
new tax treaty relationship for the U.S. Turkey is the only
OECD member country with which the U.S. has no tax treaty in
force. Under the proposed treaty, Turkey would agree to reduce
its tax on the income that U.S. residents earn from sources in
Turkey, and the U.S. would agree to reciprocal reductions of
its tax on U.S. income of Turkish residents.
The U.S. and Turkey also would agree that their tax
administrators will exchange tax information where necessary to
carry out tax laws, and will cooperate together to resolve
problems in the coordination of the tax rules of the two
countries that may arise in individual cases.
The proposed treaty follows preferred U.S. treaty positions
in many respects. However, it differs from preferred U.S.
treaty positions in other respects, primarily by not reducing
source country taxation to the same extent as many U.S. tax
treaties. In this regard, the proposed treaty is similar to the
other treaties that the U.S. has entered into with developing
countries.
These issues are discussed in more detail in the joint
committee staff pamphlets on the proposed treaties and
protocols. I would be happy to answer any questions that the
committee may have.
[The prepared statement of Mr. Kies follows:]
Prepared Statement of Mr. Kies
My name is Ken Kies. I am Chief of Staff of the Joint Committee on
Taxation. It is my pleasure to present the testimony of the staff of
the Joint Committee on Taxation (``Joint Committee staff'') at this
hearing concerning the proposed income tax treaties with Austria,
Ireland, Luxembourg, South Africa, Switzerland, Thailand, and Turkey
and the proposed protocol amending the existing income tax treaty with
Canada.
Overview
As in the past, the Joint Committee staff has prepared pamphlets
covering each of the proposed treaties and protocols. The pamphlets
contain detailed descriptions of the provisions of the proposed
treaties and protocols, including comparisons with the 1996 U.S. model
treaty, which reflects preferred U.S. treaty policy, and with other
recent U.S. tax treaties. The pamphlets also contain detailed
discussions of issues raised by the proposed treaties and protocols. We
consulted extensively with your Committee staff in analyzing the
proposed treaties and protocols and preparing-the pamphlets.
Five of the eight agreements at issue today would modify existing
U.S. treaty relationships. The proposed protocol with Canada would make
two modifications to the current treaty which was amended most recently
in 1995. The proposed treaty with Austria would replace an existing
treaty that has not been modified since 1956. The proposed treaty with
Ireland would replace an existing treaty that has not been modified
since 1949. The proposed treaty with Luxembourg would replace an
existing treaty that has not been modified since 1962. The proposed
treaty with Switzerland would replace an existing treaty that has not
been modified since 1951. The other three treaties are with countries
with which the United States does not currently have a treaty
relationship. The proposed treaties with Thailand and Turkey would
represent the entrance into tax treaty relationships where the United
States has not previously had such a treaty. The final proposed treaty
is with South Africa; the United States previously had a treaty with
South Africa which was terminated in 1987, and no treaty currently is
in force.
I will highlight some of the key features of these treaties and
protocols and the issues they raise.
Common Issue
In connection with consideration of these treaties, an issue was
raised regarding the U.S. treaty policy with respect to the treatment
of dividends from U.S. Real Estate Investment Trusts (``REITs'').
U.S. tax treaties generally limit the maximum rate of withholding
tax that may be imposed by the source country on portfolio dividends
paid by a corporation resident in one country to residents of the other
country; most commonly, the maximum rate of withholding tax on
dividends is 15 percent. Treaties negotiated by the United States after
1988 contain specific rules excluding REIT dividends from the reduced
rates of withholding tax generally applicable to dividends.
Accordingly, under such treaties, REIT dividends may be subject to U.S.
withholding tax at the full statutory rate of 30 percent. The exclusion
of REIT dividends from the reduced rates of withholding tax generally
applicable to dividends reflects the view that REIT dividends should be
treated in a manner that generally is comparable to the treatment of
rental income earned on a direct investment in real property.
The REIT industry has expressed concern that the exclusion of REIT
dividends from the reduced withholding tax rates applicable to other
dividends may inappropriately discourage some foreign investment in
REITS. The Treasury Department has worked extensively with your
Committee staff, the Joint Committee staff, and representatives of the
REIT industry in order to address this concern while maintaining a
treaty policy that properly preserves the U.S. taxing jurisdiction over
foreign direct investment in U.S. real property. As a result of
significant cooperation among all parties to balance these competing
considerations, the U.S. treaty policy with respect to the treatment of
REIT dividends has been modified.
Under this policy, REIT dividends paid to a resident of a treaty
country will be eligible for the reduced rate of withholding tax
applicable to portfolio dividends (typically, 15 percent) in two cases.
First, the reduced withholding tax rate will apply to REIT dividends if
the treaty country resident beneficially holds an interest of 5 percent
or less in each class of the REIT's stock and such dividends are paid
with respect to a class of the REIT's stock that is publicly traded.
Second, the reduced withholding tax rate will apply to REIT dividends
if the treaty country resident beneficially holds an interest of 10
percent or less in the REIT and the REIT is diversified, regardless of
whether the REIT's stock is publicly traded. In addition, the treaty
policy with respect to the application of the reduced withholding tax
rate to REIT dividends paid to individuals holding less than a
specified interest in the REIT will remain unchanged.
For purposes of these rules, a REIT will be considered diversified
if the value of no single interest in real property held by the REIT
exceeds 10 percent of the value of the REIT's total interests in real
property. Any interest in real property will not include a mortgage,
unless the mortgage has substantial equity components. An interest in
real property also will not include foreclosure property. Accordingly,
a REIT that holds exclusively mortgages will be considered to be
diversified. The diversification rule will be applied by looking
through a partnership interest held by a REIT to the underlying
interests in real property held by the partnership. Finally, the
reduced withholding tax rate will apply to a REIT dividend if the
REIT's trustees or directors make a good faith determination that the
diversification requirement is satisfied as of the date the dividend is
declared.
This new policy with respect to the treatment of REIT dividends
will be incorporated into the U.S. model treaty. In addition, the
Treasury Department will use its best efforts to negotiate protocols to
amend the proposed treaties with Austria, Ireland, and Switzerland to
incorporate this policy.
In the case of Luxembourg, it is recommended that this policy be
implemented by means of a reservation to the proposed treaty presently
under consideration. In addition, it is recommended that this
reservation include a special rule for existing investment in REITs by
Luxembourg residents. Under this special rule, in the case of any
resident of Luxembourg who held an interest in a diversified REIT as of
June 30, 1997, dividends paid to such resident with respect to that
interest would be eligible for the reduced rate of withholding tax.
However, this special rule would not apply to dividends paid after
December 31, 1999, unless the stock of the REIT is publicly traded on
December 31, 1999 and thereafter. The special rule would apply to
existing investment in a REIT as of June 30, 1997 and to reinvestment
in the REIT of both ordinary and capital dividends paid with respect to
that investment. In addition, if a REIT in which there is a qualifying
investment as of June 30, 1997 goes out of existence in a
nonrecognition transaction, the special rule would continue to apply to
the investment in the successor REIT if any.
Canada
The proposed protocol with Canada would modify the income tax
treaty that was signed in 1980 and amended by protocols in 1983, 1984,
and 1995.
The proposed protocol would replace the provision in the existing
treaty that provides for exclusive source-country taxation of social
security benefits with a provision that provides for exclusive
residence-country taxation of social security benefits. Under the
proposed protocol, U.S. social security benefits paid to Canadian
residents would be subject to tax only in Canada, and Canadian social
security benefits paid to U.S. residents would be subject to tax only
in the United States. This represents a return to the approach that
applied prior to the 1995 protocol. The amendment made by the proposed
protocol would take effect for social security benefits paid after
1995, with a refund mechanism applying to taxes that have been paid
with respect to post-1995 benefits.
The proposed protocol also would modify the provision in the
existing treaty allowing situs-country taxation of gains from real
property; under this provision, the country in which real property is
situated may tax gains with respect to corporate stock if a sufficient
portion of the corporation's assets consists of such real property. The
protocol would limit this rule so that it applies only to stock of
domestic corporations and not to stock of foreign corporations. Such a
limitation is consistent with U.S. internal law regarding the taxation
of gains from stock of real property holding companies.
Austria
The proposed treaty with Austria is a comprehensive update of the
1956 treaty. The provisions of the proposed treaty generally comport
with modern U.S. treaty policy.
The proposed treaty includes a comprehensive anti-treaty-shopping
provision, which resembles the provisions in the U.S. model treaty and
other recent treaties. The proposed treaty also includes an anti-abuse
rule covering certain ``triangular cases,'' which involve payments from
the United States to a branch of an Austrian company located in a,
third country. Under this rule, the United States generally may tax, in
accordance with its internal law, interest and royalties paid to a low-
taxed third-country branch of an Austrian company.
Under the proposed treaty, Austria may tax the disposition of stock
of an Austrian company that was received upon the incorporation of a
permanent establishment in Austria, if any inherent capital gains were
not taxed at the time of the incorporation. This rule, which represents
a unilateral concession by the United States, applies through the year
2010.
The proposed treaty expands the class of royalty payments that is
subject to a 10-percent source-country tax. Under the existing treaty,
only payments for the use of motion picture films are subject to
source-country tax. Under the proposed treaty, source-country tax also
applies to payments for the use of films, tapes or other means of
reproduction used for radio or television broadcasting. The preferred
U.S. treaty position is the elimination of source-country taxation of
royalty income.
The OECD Commentary, which reflects agreed interpretations of the
OECD model treaty, is to apply in interpreting any provision of the
proposed treaty that corresponds to a provision of the OECD model
treaty. This rule does not apply where either the United States or
Austria has entered a reservation, or has included an observation, with
respect to the OECD model treaty or its Commentary. In addition, this
rule generally does not apply where a contrary interpretation is
included in the Memorandum of Understanding with respect to the
proposed treaty or in a published interpretation of the proposed treaty
(e.g., the Treasury Department's Technical Explanation).
The exchange of information provisions of the proposed treaty are
substantially more useful than those of the current treaty. Information
generally may be exchanged to carry out the purposes of the proposed
treaty or to carry out the domestic laws of the countries concerning
taxes covered by the information exchange article of the proposed
treaty. There are provisions in Austrian law that prohibit Austria from
obtaining information from Austrian banks in non-penal investigations;
however, bank information may be obtained for penal investigations.
Accordingly, under the proposed treaty, bank information may be
provided by Austria in connection with U.S. penal investigations,
including the commencement of a criminal investigation by the Internal
Revenue Service.
Ireland
The proposed treaty with Ireland is a comprehensive update of the
1949 treaty. The provisions of the proposed treaty generally are
consistent with modern U.S. treaty policy.
The proposed treaty includes a comprehensive anti-treaty-shopping
provision, which includes most of the elements of the anti-treaty
shopping-provisions found in the U.S. model treaty and other recent
U.S. treaties. The proposed treaty includes a ``derivative benefits''
provision under which treaty benefits generally would be available to
Irish companies that are owned by residents of countries that are
members of the European Union (``EU'') or parties to the North American
Free Trade Agreement (``NAFTA''). Under this rule, the treaty benefits
with respect to dividends, interest, and royalties would be available
only if the countries in which such owners are resident have treaties
with the United States providing for benefits that are at least as
favorable as those provided under the proposed treaty; however, this
restriction on the availability of treaty benefits would take effect no
earlier than two years after the proposed treaty takes effect. The
proposed treaty also includes an anti-abuse rule covering the so-called
``triangular case.'' This rule generally permits the United States to
impose a 15-percent tax on dividends, interest, and royalties paid to a
low-taxed third-country branch of an Irish company and to tax other
payments to such a branch in accordance with U.S. internal law.
The proposed treaty provides an exemption for Irish insurance
companies from the U.S. excise tax on insurance and reinsurance
premiums paid to foreign insurers with respect to U.S. risks. However,
this exemption applies only to the extent that the U.S. risk is not
reinsured by the Irish insurer with a person that is not entitled to
the benefits of an income tax treaty that similarly provides an
exemption from such tax. Moreover, the exemption does not apply if the
premiums paid to the Irish insurance company are not subject to the
generally applicable tax imposed on insurance corporations in Ireland.
The proposed treaty includes an arbitration provision similar to
the provision that was included in the 1989 U.S.-Germany tax treaty.
However, like the provisions in several other recent treaties and the
proposed treaty with Switzerland, the arbitration provision in the
proposed treaty will take effect only upon a future exchange of
diplomatic notes. It is intended that this arbitration approach be
evaluated further once there has been some experience arbitrating cases
under the U. S.-Germany treaty.
The exchange of information article contained in the proposed
treaty conforms in most respects to the corresponding articles of the
U.S. and OECD model treaties. As is true under these model treaties,
under the proposed treaty the countries are to exchange such
information as is necessary for carrying out the provisions of the
proposed treaty or the domestic tax laws of the countries. There is one
significant respect in which the exchange of information article does
not conform to the corresponding article of the U.S. model treaty. The
proposed treaty includes the standard provision that upon request a
country shall obtain information to which the request relates in the
same manner and to the same extent as if the tax of the requesting
country were imposed by the requested country. However, this provision
cannot be fully implemented with respect to requests by the United
States. Because of restrictions in Irish internal law, the United
States may obtain limited information from Ireland with respect to
criminal offenses, but may not obtain information from Ireland with
respect to civil offenses. Ireland may, however, obtain information
from the United States generally with respect to both criminal and
civil offenses.
Luxembourg
The proposed treaty with Luxembourg is a comprehensive update of
the 1962 treaty. The provisions of the proposed treaty generally
comport with modern U.S. treaty policy.
The proposed treaty includes a comprehensive anti-treaty-shopping
provision, which resembles the provisions in the U.S. model treaty and
other recent treaties. The proposed treaty includes a ``derivative
benefits'' provision under which treaty benefits generally would be
available to Luxembourg companies that are owned by residents of
countries that are members of the EU or parties to NAFTA. The proposed
treaty also includes an anti-abuse rule covering the so-called
``triangular case.'' This rule generally permits the United States to
impose a 15-percent tax on dividends, interest, and royalties paid to a
low-taxed third-country branch of a Luxembourg company and to tax other
payments to such a branch in accordance with U.S. internal law.
The proposed treaty provides an exemption for Luxembourg insurance
companies for the U.S. excise tax on insurance premiums paid to foreign
insurers with respect to U.S. risks. This exemption applies only to the
extent that the U.S. risk is not reinsured by the Luxembourg insurer
with a person that is not entitled to the benefits of an income tax
treaty that similarly provides an exemption from such tax. All existing
U.S. tax treaties that provide exemptions from the U.S. excise tax on
insurance premiums also provide exemptions from the U.S. excise tax on
reinsurance premiums paid to foreign insurers. However, the proposed
treaty does not provide an exemption from the excise tax on reinsurance
premiums paid to Luxembourg reinsurers.
The exchange of information provisions of the proposed treaty are
more useful than those of the current treaty. Information generally may
be exchanged to carry out the purposes of the proposed treaty or to
carry out the domestic laws of the countries concerning taxes covered
by the information exchange article of the proposed treaty. There are
provisions in Luxembourg law that generally prohibit Luxembourg from
obtaining information from Luxembourg financial institutions either for
their own purposes or for purposes of the proposed treaty. However,
such bank information may be obtained--under certain circumstances
involving criminal tax matters pursuant to the proposed Mutual Legal
Assistance Treaty with Luxembourg.
South Africa
The proposed treaty with South Africa generally is consistent with
other recent treaties that the United States has signed with developed
countries. It is a straightforward reflection of current U.S. treaty
policy, with only a few deviations. For example, the proposed treaty
allows broader source-country taxation of business activities of
residents of the other country by expanding the definition of a
permanent establishment to include cases in which an enterprise
provides services through its employees in a country if the activities
continue for more than 183 days.
In addition, like many other U.S. treaties, the proposed treaty
includes in the anti-treaty shopping provision an anti-abuse rule
covering the so-called ``triangular case.'' This rule generally permits
the United States to impose a 15-percent tax on interest and royalties
paid to a low-taxed third-country branch of a South African company and
to tax other payments to such branch in accordance with U.S. internal
law.
Switzerland
The proposed treaty with Switzerland is a comprehensive update of
the 1951 treaty. The provisions of the proposed treaty generally are
consistent with modern U.S. treaty policy.
The proposed treaty includes a comprehensive anti-treaty-shopping
provision, which resembles the provisions in the U.S. model treaty and
other recent treaties. The proposed treaty includes a ``derivative
benefits'' provision under which treaty benefits generally would be
available to Swiss companies that are owned by residents of countries
that are members of the EU or the European Economic Area or parties to
NAFTA. The proposed treaty includes an anti abuse rule covering the so-
called ``triangular case.'' This rule generally permits the United
States to impose a 15-percent tax on dividends, interest, and royalties
paid to a low-taxed third-country branch of a Swiss company and to tax
other payments to such a branch in accordance with U.S. internal law.
The proposed treaty provides an exemption for Swiss insurance
companies from the U.S. excise tax on insurance and reinsurance
premiums paid to foreign insurers with respect to U.S. risks. However,
this exemption applies only to the extent that the U.S. risk is not
reinsured by the Swiss insurer with a foreign person that is not
entitled to the benefits of an income tax treaty that similarly
provides an exemption from such tax.
The proposed treaty includes an arbitration provision similar to
the provision that was included in the 1989 U.S.-Germany tax treaty.
However, like the provisions in several other recent treaties and the
proposed treaty with Ireland, the arbitration provision in the proposed
treaty will take effect only upon a future exchange of diplomatic
notes. It is intended that this arbitration approach be evaluated
future once there has been some experience arbitrating cases under the
U.S.-Germany treaty.
The exchange of information provisions of the proposed treaty are
somewhat more useful than those of the current treaty, but are
nonetheless more restrictive than the comparable provisions in tax
treaties with other countries. Information generally may be exchanged
to carry out the purposes of the proposed treaty, but it may not be
exchanged to carry out the domestic laws of the countries concerning
taxes covered by the information exchange article of the proposed
treaty. Information may also be exchanged to prevent tax fraud. For
example, in cases of tax fraud, Swiss banking secrecy provisions do not
hinder the gathering of documentary evidence from banks or its being
provided to the United States pursuant to the proposed treaty.
Thailand
The proposed treaty with Thailand would represent a new tax treaty
relationship for the United States.
Under the proposed treaty, Thailand would agree to reduce its taxes
on income that U.S. residents earn from sources in Thailand and the
United States would agree to reciprocal reductions of its tax on U.S.
income of Thai residents.
The proposed treaty follows preferred U.S. treaty positions in many
respects. However, it differs from preferred U.S. treaty positions in
other respects, primarily by not reducing source country taxation to
the same extent as many U.S. tax treaties. In this regard, the proposed
treaty is similar to other treaties that the United States has entered
into with developing countries.
The proposed treaty would allow broader source-country taxation of
business activities of residents of the other country. For example, the
proposed treaty expands the definition of a permanent establishment to
include cases in which an enterprise provides services through its
employees in a country if the activities continue for more than 90
days.
The proposed treaty also would permit higher maximum rates of
source-country tax on dividends, interest and-royalties, and would
permit the imposition of source-country tax on certain equipment rental
income. These maximum rates of source-country tax generally range from
10 to 15 percent in the case of dividends, 10 to 15 percent in the case
of interest, and 5 to 15 percent in the case of royalties. The proposed
treaty would treat equipment rental income as royalties subject to a
maximum 8 percent source-country tax.
In addition, the proposed treaty would allow Thailand to tax gains
derived by U.S. residents from the alienation of property in accordance
with its internal law. Although the proposed treaty would permit the
United States to impose tax in the reverse situation, U.S. internal law
generally does not tax such gains of foreign persons, other than gains
with respect to a U.S. real property interest.
The exchange of information article contained in the proposed
treaty conforms in most respects to the corresponding articles of the
U.S. and OECD model treaties. As is true under these model treaties,
under the proposed treaty the countries are to exchange such
information as is necessary for carrying out the provisions of the
proposed treaty or the domestic tax laws of the countries. There is one
significant respect in which the exchange of information article does
not conform to the corresponding article of the U.S. model treaty. The
proposed treaty includes the standard provision that upon request a
country shall obtain information to which the request relates in the
same manner and to the same extent as if the tax of the requesting
country were imposed by the requested country. However, the proposed
treaty also would suspend the application of this provision until the
United States receives from Thailand a diplomatic note indicating that
Thailand is prepared and able to implement this provision, which will
require that Thailand enact enabling legislation. This means that
neither country will obtain information for the other until this
diplomatic note is provided.
The provision by Thailand of this diplomatic note also is an
important element in the termination article of the proposed treaty.
There are two ways in which the proposed treaty may terminate. The
first is a voluntary mechanism under which either country may terminate
the proposed treaty at any time after five years after it enters into
force, provided that appropriate notification is given. The second,
which is much more unusual, is a mandatory termination on January 1 of
the sixth year following the year the proposed treaty enters into
force, unless this diplomatic note with respect to Thailand's ability
to implement the information exchange provision is received by the
previous June 30th.
Turkey
The proposed treaty with Turkey would represent a new tax treaty
relationship for the United States. Turkey is the only OECD member
country with which the United States has no tax treaty in force.
Under the proposed treaty, Turkey would agree to reduce its taxes
on the income that U.S. residents earn from sources in Turkey and the
United States would agree to reciprocal reductions of its tax on U.S.
income of Turkish residents. The United States and Turkey also would
agree that their tax administrators will exchange tax information where
necessary to carry out tax laws and will cooperate together to resolve
problems in the coordination of the tax rules of the two countries that
may arise in individual cases.
The proposed treaty follows preferred U.S. treaty positions in many
respects. However, it differs from preferred U.S. treaty positions in
other respects, primarily by not reducing source-country taxation to
the same extent as many U.S. tax treaties. In this regard, the proposed
treaty is similar to other treaties that the United States has entered
into with developing countries.
The proposed treaty would allow broader source-country taxation of
business activities of residents of the other country. It also would
permit higher maximum rates of source-country tax on dividends,
interest, and royalties, and would permit the imposition of source-
country tax on certain equipment rental income. These maximum rates of
source-country tax generally range from 15 to 20 percent in the case of
dividends, 10 to 15 percent in the case of interest, and 5 to 10
percent in the case of royalties. The proposed treaty would treat
equipment rental income as royalties subject to a maximum 5 percent
source-country tax.
In addition, the proposed treaty would allow Turkey to tax gains
derived by U.S. residents from shares and bonds of Turkish companies in
certain cases. Although the proposed treaty would permit the United
States to impose tax in the reverse situation, U.S. internal law does
not tax such gains of foreign persons.
Conclusion
These issues are discussed in more detail in the Joint Committee
staff pamphlets on the proposed treaties and protocols. I would be
happy to answer any questions.
Senator Hagel. Mr. Kies, thank you very much.
Mr. Kies, does the Joint Tax Committee recommend that this
committee support ratification of these proposed treaties?
Mr. Kies. Senator Hagel, we have reviewed the treaties in
great depth and, as Senator Sarbanes has pointed out, we have
identified places where we think there are issues that the
committee ought to look at. I guess our judgment is that, on
balance, we have been persuaded, through the extensive
discussions we have had with the Treasury Department about the
negotiations that led to the provisions in the treaties, that
these represent the best job that could be done given the
negotiating pressures that the Treasury Department had to deal
with.
We do think that the resolution of the REIT issue was
essential, and that the way in which it has been resolved,
particularly as it relates to Luxembourg where there was
immediate pressure concerning potential investors from
Luxembourg, effectively deals with the issues raised by the
U.S. REIT industry. That reservation--which we have been told
by Treasury can be rather quickly addressed--will address the
REIT problems adequately. So, on that basis, we think the
treaties should proceed.
Senator Hagel. Let me follow up for a minute on a general
issue that Senator Sarbanes engaged in with Secretary
Guttentag. I know Senator Sarbanes will move into some of the
questioning with you.
The current treaty with Ireland does not contain a
limitation on benefits provision. Thus, if I understand this
correctly, the proposed treaty greatly improves the current
treaty relationship, and there are some other things. Are you
concerned that certain treaty provisions here in this treaty
will be abused during a period prior to its entry into force if
we have no limitation on benefits provision?
Mr. Kies. Yes, Senator Hagel, I think that that is one of
the major improvements that has occurred in the negotiation of
this treaty, and that the sooner the treaty gets into force,
the better, in that regard. So, notwithstanding the fact that
the information exchange piece is not particularly attractive
in terms of where it ideally could have come out, the other
improvements over the existing treaty, I think, are highly
desirable.
And I would say that the point that Mr. Guttentag made in
comparing it to Thailand was an appropriate thing to bring to
the committee's attention. Because, in the case of Thailand, we
have no existing treaty; whereas in Ireland, there is an
existing treaty over which this new treaty would make some
significant improvements.
Senator Hagel. The information exchange process, are there
areas that we can improve in and in which you would make some
suggestions to Treasury?
Mr. Kies. I think that the area of information exchange is
one in which there is always going to be a continuing struggle
to get the most desirable position from the U.S. perspective,
because many countries are not immediately willing to share
information in the same way that we are. But I think that
Treasury is going to have to continually negotiate aggressively
to try and get the most open information exchange provisions we
can.
In the treaties before the committee, the provisions in the
current treaties--for example, in Luxembourg, Austria and
Switzerland--are quite limited. These treaties would make
progress in that regard. The most significant progress is in
Austria; the least significant probably is in Switzerland. But
this is going to have to continue to be an area in which
Treasury puts on as much pressure as they can to try and
improve the information exchange provisions.
Senator Hagel. Thank you.
Senator Sarbanes.
Senator Sarbanes. I wonder if the joint committee could, in
effect, help to sharpen up for the Treasury some of the issues
you raise, so that they can then submit to the committee their
response on how they handled them. There are a couple of
questions I put earlier to the Treasury Deputy Secretary that
actually I thought the responses were quite to the point, in
terms of what the negotiating situation was and what they were
able to do.
And it sounded as if, on the insurance issue, they had it
pretty well covered. But there is very careful and thorough
analysis of a number of important issues in these reports. I
think we need a response to them from Treasury. I do not think
we should just let these issues pass without addressing them,
and then being able to make an informed judgment.
Furthermore, the question is whether we should try to use
any understandings, or maybe even just committee report
language, on some of these issues to establish some kind of
marker for the Treasury Department for the future. There is
always a danger of getting on a slippery slope. I mean,
Treasury departs from the model treaty, and then they say,
well, we had to do this in order to negotiate a treaty.
That may be quite true; I do not anticipate that we can
take a cookie-cutter approach or that every country is simply
going to take the model treaty. Obviously, they will not do
that. But once you start down a path, then the next country
points to what the previous country got and says, well, you did
it for them, why can't you do that, plus perhaps a little more,
for us? And then that unraveling process begins.
And so I think one of the functions this committee can
perform is to try to hold the Treasury within some parameters
so that does not happen.
Mr. Kies. Senator, I agree with you. I think there maybe
are two ways in which we can be helpful in this regard. First
is, throughout the preparation of the pamphlets, we did share
those issues with Treasury representatives. But we would be
happy to sit down with them and discuss even in more detail the
issues we have raised there.
The second thing that I think we can be helpful on is that,
in developing committee reports, where there is a clear
explanation of why the Treasury took a position--for example,
in the reinsurance point and the insurance point, that they
carefully looked at the treaty country's tax treatment of
insurance companies--that should be reflected in the committee
report, because it essentially sends a signal to other
countries that unless their countries have comparable insurance
taxation rules, they will not be able to expect to get a waiver
of the insurance excise tax. That is the type of thing that we
ought to reflect in the committee reports so that that is part
of the legislative history which will be in place when future
negotiations occur.
So we will be happy to work with Treasury in both of those
respects, and with the Foreign Relations staff.
Senator Sarbanes. Thank you.
Thank you, Mr. Chairman.
Senator Hagel. In view, Mr. Kies, of the hour--it is 5
o'clock--and in light of votes and other additions to our
schedule, I would ask if Senator Sarbanes had any additional
questions. I know we have another panel behind you.
Senator Sarbanes. No, I do not have any more questions. I
just want to thank the joint committee for their usual good
work in preparing these studies.
Mr. Kies. Thank you, Senator Sarbanes.
Senator Sarbanes. They have been helpful.
Senator Hagel. And I echo that, as well, Mr. Kies and your
colleagues. Thank you very much for the time.
Mr. Kies. Thank you, Senator Hagel.
Senator Hagel. Mr. Mattson, please proceed whenever you are
ready. Nice to have you. Welcome.
STATEMENT OF ROBERT N. MATTSON, CHIEF TAX OFFICER AND ASSISTANT
TREASURER, INTERNATIONAL BUSINESS MACHINES CORPORATION, ON
BEHALF OF THE NATIONAL FOREIGN TRADE COUNCIL AND THE UNITED
STATES COUNCIL FOR INTERNATIONAL BUSINESS
Mr. Mattson. Thank you, Senator Hagel and Senator Sarbanes.
My name is Bob Mattson. I am Chief Tax Officer and
Assistant Treasurer for the IBM Corporation. I appreciate the
opportunity to appear today before this committee on behalf of
the United States Council for International Business, as Vice
Chairman of its Tax Committee, and the National Foreign Trade
Council, as its former Tax Committee Chairman, which together
represent the international business community and the United
States' largest exporters. These trade associations work to
enhance the competitiveness of U.S.-owned business by promoting
sound and appropriate international tax policy and agreements.
I am accompanied today by Fred Murray, Vice President of
Tax Policy of the National Foreign Trade Council; and Tim
Sheehy, IBM's Manager of Government Affairs.
As global competition grows ever more intense, it is vital
to the health of the United States enterprises and to their
continuing ability to contribute to the United States economy
that the companies be free from excessive foreign taxes or
double taxation that can serve as a barrier to the full
participation of American companies in the international
marketplace. Bilateral tax treaties are a crucial component of
the framework necessary to allow such balanced competition.
It is for this reason that both the National Foreign Trade
Council and the United States United States Council on
International Business have long supported the expansion and
strengthening of the U.S. tax treaty network, and that we are
here today to recommend ratification of these treaties under
consideration by this committee. We appreciate the committee's
action in scheduling this hearing and agreeing to receiving our
testimony.
The treaties up for ratification should be ratified without
delay. For example, the revised treaty with Austria modernizes
an existing 40-year-old treaty, and eliminates a major
impediment to U.S. business restructuring in the European
Union. Austria joined the European Trading Union in 1995, and
it is essential that barriers be removed for U.S. business to
operate and restructure as required by the growing tendency
toward globalization. Businesses can no longer focus solely on
geographic borders, and many companies have increasingly
integrated their regional business activities. This is true in
Europe, and modernized tax treaties with Austria, Ireland,
Luxembourg, and Switzerland are essential.
We also strongly support and urge the prompt ratification
of the protocol with Canada and the new treaties with South
Africa, Thailand and Turkey.
The new treaty with Thailand advances U.S. business needs
for fairness and certainty in the Asian community. We commend
the Treasury Department for its efforts to include more
developing countries and Asian nations in our treaty network,
as this area is so vitally important to U.S. interests in the
global business arena. We trust that this committee will, Mr.
Chairman, support their endeavors to bring further treaties
with Asian and other developing countries for ratification to
your committee.
American global business enterprises, in the next century,
will be built around information networks, flexible work forces
and webs of strategic alliances. Without a refreshed and
expanding tax treaty network, IBM and other American-owned
businesses would find untenable barriers to the necessary free
flow of technology and investment which supports expanding
export jobs in the United States.
The emergence of a new set of technologically skilled
nations, which Thailand represents, necessitates that the U.S.
clarify the international rules applying to commerce with these
nations. These nations are linked to the U.S. by
telecommunications and information technologies, and will be
engaged in the conduct of electronic commerce. We would have
preferred that the Thai and the Turkish treaties totally
eliminated withholding taxes on the movement of technology
products, such as computer software. However, these treaties
are a realistic beginning in the right direction, and we
support their ratification.
While in the past business value-add was determined by
tangible goods, manufactured in plants located where
comparative advantage dictated, in the next century, know-how,
ideas and concepts--intangible goods--will drive economic value
and the competitive strength of American-owned business. Recent
trade agreements have brought down tariff barriers on high
technology tangible goods exports from the United States.
However, barriers on intangibles requires tax treaties which
eliminate withholding taxes on royalties, dividends and
interest flows.
These treaties set international norms for the conduct of
administrative audits of transactions between affiliates, and
provide a mechanism to resolve tax disputes. Otherwise,
American companies could not be assured of protection against
arbitrary tax assessments.
Tax treaties help create the environment for predictable
tax treatment of cross-border business transactions so
necessary to a successful global business. Ratification of
these treaties continues the momentum which is needed to bring
other nations into the U.S. treaty network. It sends a
continuing signal that the U.S. desires a lessening, and
eventual elimination, of the existing impediments to global
business.
Again, thank you for your patience by listening to my
statement today on this very important hearing to America's
global businesses. I would be happy to answer any questions you
might wish to ask.
[The prepared statement of Mr. Mattson follows:]
Prepared Statement of Mr. Mattson
Mr. Chairman, Members of the Committee:
My name is Bob Mattson and I am Chief Tax Officer and Assistant
Treasurer of the IBM Corporation. I appreciate the opportunity to
appear today before this Committee on behalf of the United States
Council for International Business, as vice chairman of its tax
committee, and the National Foreign Trade Council, as its former tax
committee chairman, which together represent the international business
community and the United States largest exporters. These trade
associations work to enhance the competitiveness of U.S.-owned business
by promoting sound and appropriate international tax policy and
agreements.
The National Foreign Trade Council, Inc. (NFTC) is an association
of over 500 U.S. business enterprises engaged in all aspects of
international trade and investment. The NFTC seeks to foster an
environment in which U.S. companies can be dynamic and effective
competitors in the international business arena. To achieve this goal,
American businesses must be able to participate fully in business
activities throughout the world, through the export of goods, services,
technology, and entertainment, and through direct investment in
facilities abroad.
The United States Council for International Business (USCIB) is the
American affiliate of the International Chamber of Commerce and the
Business and Industry Advisory Committee to the OECD. The USCIB
formulates its positions in committees composed of corporate and other
experts drawn from its membership of 300 multinational corporations,
service companies, law firms, and business associations. It advocates
these positions to the United States Government and to such
intergovernmental organizations as the OECD, the WTO, and other bodies
of the United Nations system with which its international affiliates
have official consultative status on behalf of world business.
As global competition grows ever more intense, it is vital to the
health of U.S. enterprises and to their continuing ability to
contribute to the U.S. economy that the companies be free from
excessive foreign taxes or double taxation that can serve as a barrier
to full participation in the international marketplace. Bilateral tax
treaties are a crucial component of the framework necessary to allow
such balanced competition.
It is for this reason that both the NFTC and USCIB have long
supported the expansion and strengthening of the U.S. tax treaty
network and that we are here today to recommend ratification of the
treaties under consideration by this Committee. We appreciate the
Committee's action in scheduling this hearing and agreeing to receive
our testimony.
Tax treaties are bilateral agreements between the United States and
foreign countries that serve to harmonize the tax systems of the two
countries in respect of persons involved in cross-border investment and
trade. In the absence of tax treaties, income from international
transactions or investment may be subject to double taxation: once by
the country where the income arises and again by the country of the
income recipient's residence. Tax treaties eliminate this exposure to
double taxation.
The treaties up for ratification should be ratified without delay.
In particular, the revised treaty with Austria modernizing the existing
40-year old treaty eliminates a major impediment to U.S. business
restructuring in the European Union. Austria joined the European
trading union in 1995 and it is essential that barriers be removed for
U.S. business to operate and restructure as required by the growing
tendency toward globalization. Businesses can no longer focus solely on
geographic borders and many companies have increasingly integrated
their regional business activities, This is true in Europe and
modernized tax treaties with Austria, Ireland, Luxembourg, and
Switzerland are essential. We also strongly support and urge the prompt
ratification of the protocol with Canada and the new treaties with
South Africa, Thailand and Turkey.
The new treaty with Thailand advances U.S. business needs for
fairness and certainty in the Asian community. We commend the Treasury
Department for its efforts to include more developing countries and
Asian nations in our treaty network as this area is so vitally
important to U.S. interests in the global business arena. We trust that
this committee will, Mr. Chairman, support their endeavors, to bring
further treaties with Asian and other developing countries for
ratification to this forum.
America's global business enterprises in the next century will be
built around information networks, flexible work forces and webs of
strategic alliances. Without a refreshed and expanding tax treaty
network, IBM and other American-owned businesses would find untenable
barriers to the necessary free flow of technology and investment which
supports expanding export jobs in the United States. The emergence of a
new set of technologically skilled nations which Thailand represents,
necessitates that the U.S. clarify the international rules applying to
commerce with these nations. These nations are linked to the U.S. by
telecommunications and information technologies and will be engaged in
the conduct of electronic commerce. We would have preferred that the
Thai and Turkey treaties totally eliminated withholding taxes on the
movement of technology products such as computer software, however,
these treaties are a realistic beginning in the right direction and we
support their ratification.
While in the past, business value-add was determined by tangible
goods manufactured in plants located where comparative advantage
dictated (such as our plants in North Carolina which export nearly 1-1/
2 billion dollars a year), in the next Century, know-how, ideas and
concepts - intangible goods - will drive economic value and the
competitive strength of American-owned business. Recent trade
agreements have brought down tariff barriers on high technology
tangible good exports from the United States. However, barriers on
intangibles require tax treaties which eliminate withholding taxes on
royalty, dividend and interest flows.
American business interests will be greatly served by the
recognition in these treaties that we now conduct a great portion of
our worldwide business in joint ventures and alliances with other
companies to gain greater access to foreign markets and technology.
These treaties contain substantial reductions in ownership thresholds
in qualifying for lower foreign withholding taxes on dividend
repatriations to the United States.
Likewise, these treaties set international norms for the conduct of
administrative audits of transactions between affiliates and provide a
mechanism to resolve tax disputes. Otherwise, American companies could
not be assured of protection against arbitrary tax assessments. Tax
treaties help create the environment for predictable tax treatment of
cross-border business transactions so necessary to a successful global
business. Transactions in intangible goods including computer software,
information and services are more viable if the tax rules applied are
consistent and avoid double taxation. It is vital that these treaties
be ratified to assist in that certainty so that American-owned business
can be better prepared to compete in a global marketplace.
Ratification of these treaties continues the momentum which is
needed to bring other nations into the U.S. treaty network. It sends a
continuing signal that the U.S. desires a lessening and eventual
elimination of the existing impediments to global business. The larger
business community hopes that side issues do not get in the way of a
treaty process that is working. We are extremely pleased that tax
treaties, these days, are negotiated and submitted to this Committee
promptly for your consideration.
Again, thank you for your patience by listening to my statement
today on this very important hearing to America's global businesses. I
would be happy to answer any questions you might wish to ask.
Senator Hagel. Mr. Mattson, thank you.
You mentioned in your statement that the Council supports
the ratification of these treaties that the committee will deal
with. Could you give me some examples of how these treaties
will in fact make a difference--add to productivity--not only
in your company, but other companies that you represent through
the Council, improved growth, more jobs here in the United
States?
Mr. Mattson. In one of your colleague's States, North
Carolina, we export some----
Senator Hagel. He is not just a colleague, he is the
chairman now.
Mr. Mattson. I understand that.
As well as Maryland, we export out of North Carolina over
$1.5 billion, and a number of those countries that are under
this treaty take that export.
You cannot export high technology good today without also
having agreements with regard to intangibles, as I mentioned.
Software, along with the personal computer exports out of our
North Carolina plants, are useless without the software that
accompanies them. These treaties help lower the foreign taxes
on those software products that move into those jurisdictions.
In the same way, other companies--drug companies, many of
our very highest technology companies and service companies--
would be in great competitive disadvantage if these treaties
did not lower the barriers on intangible products. For IBM, for
example, we would be in massive excessive foreign tax credit
situations. We would be paying very high foreign taxes without
the tax treaty network. We could not sustain our global
business posture without them, Senator.
Senator Hagel. As you know, the Treasury is continuing
negotiations on additional treaties--my understanding is
especially in Latin America and Southeast Asia. Are there other
areas, Mr. Mattson, that we should be looking at, or specific
areas within those two regions that Treasury is currently
negotiating treaties in?
Mr. Mattson. Well, again, I would say we ought to
strengthen our ties with Asia. That is very, very important. We
now, as we heard, have finally completed the ring of the OECD
countries, bringing in Turkey.
Latin America, it is vitally important to us that the Latin
American countries get the message. I note that Treasury has
been working with a number of them to bring them into the
treaty network. The problem is often on their side.
My colleagues remind me that Brazil is a difficult country
and very important to American business. The Japanese treaty
needs refreshing very extensively. It is one of our older
treaties, and you can understand the amount of trade and
impediments that the Japanese treaty throws up. Japan has the
highest withholding tax on intangibles in the entire OECD
network, and it is time that the U.S. Treasury begin to engage
the Japanese Government.
Senator Hagel. Thank you.
In reflecting on your members here and their feeling and
sense of this, are you generally pleased with the consultation
role of U.S. business with the Treasury Department on these
treaties?
Mr. Mattson. If it was not for the competent authority of
the Treasury Department, in the first instance, a number of
countries would take greater liberties than they would
otherwise in dealing with U.S. companies. Unfortunately, some
tax audit issues are zero-sum games. The U.S. becomes very
difficult with the foreign companies, and the foreign
governments then take on the U.S. companies to recover the same
am. If there were not these treaties in place, there could be
much more abuse in this area. We are very thankful that we can
go to the U.S. Government for assistance if we find these
problems.
Senator Hagel. Thank you.
Senator Sarbanes.
Senator Sarbanes. Well, I had a question, really, that just
follows along with what the chairman just asked. That is, what
more can be done on our side to help develop a system of tax
treaties? Or do you think everything is being done that can be
done?
Mr. Mattson. No, everything is not being done. It would be
hard for me right now to go through the various issues. But I
think the one thing I would say is that what happened with this
set of treaties should be replicated time and time again. That
is that this committee has brought before it the treaties for
ratification for consideration in a very prompt manner. We all
are very appreciative of that.
So, first and foremost is having a forum that treaties do
not just linger and sit after they have been signed, but can
come forth and be heard by this committee and examined, as you
have today. We are very appreciative of that factor. I think
that is a very important point that I would like to make.
Senator Sarbanes. Do you have any consultations with
Treasury about what countries should be given higher priority
in terms of either updating an existing tax treaty or
negotiating a tax treaty where none has heretofore existed? How
is the priority list set? How much involvement do you have in
helping to set that?
Mr. Mattson. Let me talk about the National Foreign Trade
Council, for example, which has over 500 U.S. business
enterprises engaged in all aspects of international trade and
investment. There is a tax committee, which many of these
members sit on. Once a year the National Foreign Trade Council
goes out and circularizes with its members what are their
needs, both new treaties, refreshed treaties or issues that are
pending.
We then accumulate that information, and the Treasury
Department has an annual meeting with the National Foreign
Trade Council and we submit this information to them. They have
been very receptive and very willing to work on these issues
that we bring before them. So, in that sense, business and
government has a very good relationship in the United States
with regard to the tax treaty network.
Senator Sarbanes. And to what extent, in your perception,
are the treaties worked out without cross-cutting of political
or security considerations? Or do you find situations in which
the United States is giving concessions to some country on a
tax treaty because it is working on a different track with
respect to some political or security matter with that country?
Mr. Mattson. It is hard for me to respond to that, because
while we do meet with Treasury and tell them our interests and
concerns, once they go into a treaty negotiation, that is
between the two countries. We do not have somebody sitting at
the table. So we hear about it after the fact.
And so all I can say is they know our interest; they have
generally accepted the importance of those issues, but once
they begin their own negotiations on government to government,
I think that you would have to ask the Assistant Secretary or
the Deputy Secretary those questions, sir.
Senator Sarbanes. OK. Well, thank you very much, sir, for
your testimony.
Senator Hagel. Mr. Mattson, once again, thank you. Thank
also your colleagues at the Council for not just helping
prepare the testimony today, but what you do every day to work
with us on these important issues. Thank you.
Mr. Mattson. Thank you, sir.
Senator Hagel. Thank you.
[Whereupon, at 5:20 p.m., the committee adjourned, to
reconvene subject to the call of the Chair.]
A P P E N D I X
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Responses of Mr. Guttentag to Questions Asked by Senator Helms
Question 1. I understand that the South African Government has
introduced legislation which will abrogate patent rights. Is there any
provision for protection of intellectual property in the South Africa
tax treaty?
Answer. The South African Parliament has just passed legislation
which is intended to reform South Africa's's health care system. The
stated object of the legislation is to make medicine more affordable.
One specific provision of the legislation invests in the Minister of
Health power which could severely restrict pharmaceutical patent owners
rights.
The United States Government has been actively discussing its
concerns about this legislation with the South African Government. Our
Embassy has been in frequent contact with the Ministry of Health, the
Department of Trade and Industry, and members of the Parliamentary
Portfolio Committee on Health. In Washington, USG officials have also
explained our views to South Africa's Ambassador, Franklin Sonn.
The U.S.-South Africa tax treaty provides for, among other things,
reduced tax rates on royalties received by U.S. pharmaceutical
companies from the exploitation of patents in South Africa. Because
intellectual property night protection does not fall under the purview
of bilateral tax treaties, the South African tax treaty does not
provide for the protection of intellectual property.
Question 2. South Africa has Joined the WTO and should therefore
abide by its intellectual property right protections. Is Treasury
concerned by South Africa's attempt to single out the U.S.
pharmaceutical industry for harsh treatment? Do you believe that Senate
action on this treaty will be construed as a green light for the South
African legislation?
Answer. The United States Government has reserved the right to
consider WTO action with respect to the legislation. Various interested
agencies currently are reviewing the legislation and considering a
course of action. The view of South African Government officials is
that the legislation is consistent with the South Africans' WTO
obligations.
It is unlikely that South Africa will single out the U.S.
pharmaceutical industry. All pharmaceutical patent holders in South
Africa, regardless of country of origin, could be affected by the
provision in the legislation regarding suspension of patents. As a
result, the European Union and several European countries have also
relayed their concerns to the South African Government.
Treasury does not believe the Senate action on the tax treaty will
be construed. as a green light for the South African legislation. The
South African Government is well aware of the views of the United
States Government on the legislation. Both Governments believe it is in
their interests for the tax treaty to be approved.
__________
Responses of Mr. Guttentag to Questions Asked by Senator Sarbanes
application of the turkish convention to northern cyprus
Question 1. Under the proposed U.S.-Turkey income tax convention,
would Turkish settlers on Cyprus be eligible for benefits?
Answer. The United States would not consider Turkish settlers on
Cyprus as residents of Turkey eligible for treaty benefits.
Question 2. Could Turkey unilaterally change its laws in such a way
as to make Turkish Cypriots eligible for benefits under the treaty?
Answer. The United States negotiated its tax treaty with Turkey on
the understanding that only those persons resident in Turkey (as
defined in the treaty, which does not include Cyprus) were residents of
Turkey for purposes of the tax treaty. Turkey could, theoretically, try
to make unilateral changes to its tax laws that would attempt to make
Turkish settlers in Cyprus eligible for benefits under the U.S.-Turkish
tax treaty. The United States would oppose any attempts by Turkey to
gain benefits under the tax treaty which had the effect of changing the
premise on which the treaty was negotiated or of undermining United
States policy toward Cyprus. If Turkey persisted with such changes,
Treasury would expect to take appropriate steps, possibly including
consultations or negotiations so as to specifically exclude benefits
for Cypriots, or termination of the treaty.
Question 3. Under the proposed treaty, could a resident of Turkey
avoid income taxes on an investment in the U.S. by routing that
investment through a branch in northern Cyprus?
Answer. A resident of Turkey cannot avoid income taxes on an
investment in the U.S. by routing that investment through a branch in
northern Cyprus. Under U.S. law, a resident of Turkey who made an
investment in the U.S - through a branch in Cyprus, or any other
jurisdiction, would be taxed under U.S. law and the U.S.-Turkey
Convention, as if the investment had been made directly from Turkey.
Furthermore, Turkey taxes the world-wide income of its residents as
does the United States so income earned in Cyprus by a branch of a
Turkish company would be subject to full Turkish tax.
Question 4. Would any treaty benefits accrue to a Turkish or U.S.
resident with a permanent establishment in northern Cyprus?
Answer. The location of a permanent establishment of a U.S. or
Turkish resident would be irrelevant for treaty purposes. Both Turkey
and the United States tax residents on their worldwide income.
Accordingly, both countries provide benefits to residents of the other
regardless of the existence or location of a permanent establishment of
the resident. Some countries provide special benefits for permanent
establishments and our treaties with those countries provide
appropriate limitation of benefits.
Question 5. If Turkey were to annex northern Cyprus, would any of
the above answers change?
Answer. We cannot speculate now about a hypothetical annexation
because we do not know what the circumstances would be. However,
assuming that the annexation were not recognized by the United States,
we would not expect the answers to change.