[Senate Hearing 108-829]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-829
 
                                TREATIES

=======================================================================

                                HEARING



                               BEFORE THE



                     COMMITTEE ON FOREIGN RELATIONS
                          UNITED STATES SENATE



                      ONE HUNDRED EIGHTH CONGRESS



                             SECOND SESSION



                               __________

                           SEPTEMBER 24, 2004

                               __________



       Printed for the use of the Committee on Foreign Relations


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                     COMMITTEE ON FOREIGN RELATIONS

                  RICHARD G. LUGAR, Indiana, Chairman

CHUCK HAGEL, Nebraska                JOSEPH R. BIDEN, Jr., Delaware
LINCOLN D. CHAFEE, Rhode Island      PAUL S. SARBANES, Maryland
GEORGE ALLEN, Virginia               CHRISTOPHER J. DODD, Connecticut
SAM BROWNBACK, Kansas                JOHN F. KERRY, Massachusetts
MICHAEL B. ENZI, Wyoming             RUSSELL D. FEINGOLD, Wisconsin
GEORGE V. VOINOVICH, Ohio            BARBARA BOXER, California
LAMAR ALEXANDER, Tennessee           BILL NELSON, Florida
NORM COLEMAN, Minnesota              JOHN D. ROCKEFELLER IV, West 
JOHN E. SUNUNU, New Hampshire            Virginia
                                     JON S. CORZINE, New Jersey

                 Kenneth A. Myers, Jr., Staff Director
              Antony J. Blinken, Democratic Staff Director

                                  (ii)




                            C O N T E N T S

                              ----------                              
                                                                   Page

Angus, Barbara, International Tax Counsel, United States 
  Department of the Treasury, Washington, D.C....................     3

    Prepared statement...........................................     6

Lugar, Hon. Richard G., U.S. Senator From Indiana................     1

Reinsch, Hon. William A., President, National Foreign Trade 
  Council, Washington, D.C.......................................    25

    Prepared statement...........................................    28

Yin, George, Chief of Staff, Joint Committee on Taxation, United 
  States Congress................................................    12

    Prepared statement...........................................    14

Zelisko, Judith P., President, Tax Executives Institute, 
  Washington, D.C................................................    32

    Prepared statement...........................................    33


                                Appendix

Statement Submitted for the Record by Senator George Allen of 
  Virginia.......................................................    41

Technical Explanations of the Treaties

Department of the Treasury Technical Explanation of the Protocol 
  Signed at Washington on March 8, 2004, Amending the Convention 
  Between the United States of America and the Kingdom of the 
  Netherlands for the Avoidance of Double Taxation and the 
  Prevention of Fiscal Evasion With Respect to Taxes on Income, 
  Signed at Washington on December 18, 1992......................    42

Department of the Treasury Technical Explanation of the Second 
  Protocol Signed on July 14, 2004, Amending the Convention 
  Between the United States of America and Barbados for the 
  Avoidance of Double Taxation and the Prevention of Fiscal 
  Evasion With Respect to Taxes on Income, Signed on December 31, 
  1984...........................................................    70


                                 (iii)

  


                                TREATIES

                              ----------                              


                       Friday, September 24, 2004

                      United States Senate,
                    Committee on Foreign Relations,
                                            Washington, DC.
    The committee met at 9:34 a.m., in room SD-419, Dirksen 
Senate Office Building, Hon. Richard G. Lugar, Chairman of the 
committee, presiding.
    Present: Senator Lugar.

          OPENING STATEMENT OF HON. RICHARD G. LUGAR,
                   U.S. SENATOR FROM INDIANA

    The Chairman. This hearing of the Senate Foreign Relations 
Committee is called to order.
    It is a pleasure to welcome our witnesses this morning and 
our distinguished guests to this hearing on the protocols 
amending the existing tax treaties with the Netherlands and 
Barbados.
    As chairman of the Senate Foreign Relations Committee, I am 
committed to moving tax treaties as expeditiously as possible. 
Last year this committee and the full Senate approved treaties 
with Mexico, Australia, and the United Kingdom. Earlier this 
year, we finalized treaties with Japan and Sri Lanka. I have 
encouraged the administration to continue its successful 
pursuit of treaties that strengthen the American economy by 
providing incentives for foreign companies to expand their 
operations and, as a result, to create many more jobs right 
here in the United States. I also encouraged the administration 
to transmit tax treaties to the Senate on a timely basis for 
consideration so that the benefits may be fully realized, and 
today's hearing comes as a climax for two very important 
treaties that really fulfill those hopes.
    The protocols that we have before us will bolster the 
economic relationships between the United States and countries 
that are already good friends and important trade and 
investment partners. As the United States considers how to 
create jobs and maintain economic growth, it is important that 
we try to eliminate impediments that prevent our companies from 
fully accessing international markets. These impediment may 
come in the form of regulatory barriers, taxes, tariffs, or 
unfair treatment. In the case of taxes, we should work to 
ensure that companies pay their fair share, while not being 
unfairly taxed twice on the same revenue. Tax treaties are 
intended to prevent double taxation so that companies are not 
inhibited from doing business overseas.
    The existing tax treaty between the United States and the 
Netherlands was signed in 1992. The protocol before us today, 
which amends that treaty, was signed on March 8 of this year, 
and we received it from the administration on July 16. It 
includes several novel provisions designed to prevent the 
inappropriate use of treaty benefits by those who are not 
legitimate residents or entities of either country. The 
administration has indicated that these anti-treaty-shopping 
provisions will now serve as a model as new tax treaties are 
negotiated. The protocol before us also makes many improvements 
to the existing treaty, including solidifying provisions 
regarding information exchange between the United States and 
Dutch taxing authorities.
    As our Government endeavors to facilitate economic growth 
and to expand employment, international tax policies that 
promote foreign direct investment in the United States, such as 
this protocol, are really critically important. The Netherlands 
is the third largest foreign investor in the United States, 
with $155 billion in 2002. The Netherlands is a significant 
importer of United States goods and services, with imports of 
$18.3 billion in 2002. In fact, the United States has been 
running a trade surplus with the Netherlands of about $8.5 
billion per year. Meanwhile, more than 1,600 United States 
companies have a presence in the Netherlands, employing more 
than 150,000 people. Now, this protocol will strengthen the 
important relationship between the United States and the 
Netherlands and improve the competitiveness of both countries.
    The existing tax treaty with Barbados was signed in 1984. 
The protocol before us today was signed on July 14 of this 
year, and the primary objective of the protocol is updating the 
anti-treaty-shopping provisions and other elements that 
currently permit inappropriate exploitation of the treaty by 
companies that establish locations in Barbados simply to reap 
tax benefits. Thus, it closes a loophole that can shift 
economic benefits outside the United States, and this is 
important to both American workers and taxpayers.
    The United States is the leading trading partner of 
Barbados. In 2002, the United States exported $425 million in 
goods and services to Barbados. This represents 40 percent of 
Barbados' total imports. Barbados provides the United States 
investors with special incentive packages pertaining to the 
hotel, manufacturing, and business service industries, among 
others. Many of these incentives are the result of benefits 
conferred through the tax treaty.
    I am pleased especially to welcome our distinguished 
witnesses. On our first panel, we will hear from the chief 
negotiator of the protocols before us, Ms. Barbara Angus, the 
International Tax Counsel from the Department of the Treasury. 
Also on our first panel is Mr. George Yin, Chief of Staff to 
the Senate Joint Committee on Taxation. On our second panel, we 
will hear from witnesses representing the private sector. Mr. 
Bill Reinsch is President of the National Foreign Trade Council 
and Ms. Judy Zelisko is President of the Tax Executives 
Institute.
    The committee looks forward to the insights and analysis of 
our expert witnesses. I would like for you to proceed now, and 
I will ask for you to testify first, Ms. Angus. Let me say to 
both witnesses and both panels all of your statements will be 
published in full in the record so you need not ask that that 
be done. Proceed as you wish, either with the full statement or 
a summary. We are delighted to have you and please proceed.

    STATEMENT OF BARBARA ANGUS, INTERNATIONAL TAX COUNSEL, 
          DEPARTMENT OF THE TREASURY, WASHINGTON, D.C.

    Ms. Angus.  Thank you, Mr. Chairman. I appreciate the 
opportunity to appear today at this hearing to recommend, on 
behalf of the administration, favorable action on income tax 
agreements with the Netherlands and Barbados. We appreciate the 
committee's interest in these agreements and in the U.S. tax 
treaty network, as demonstrated by the scheduling of this 
hearing.
    We are committed to eliminating unnecessary barriers to 
cross-border trade and investment. The primary means for 
eliminating tax barriers are bilateral tax treaties. Tax 
treaties provide benefits to taxpayers and governments by 
setting out clear ground rules that will govern tax matters 
relating to trade and investment. A tax treaty is intended to 
mesh the two tax systems so that taxpayers do not end up caught 
in the middle of a dispute between two governments, both trying 
to tax the same income.
    Coupled with the goal of removing tax barriers that can 
discourage cross-border investment and distort investment 
structures and locations is the need to ensure that our 
treaties cannot be used inappropriately, as such inappropriate 
use also can distort investment choices. We monitor our network 
of treaties to make sure that each treaty continues to serve 
its intended purposes optimally and is not being exploited for 
unintended purposes. Both in setting our overall negotiation 
priorities and in negotiating individual agreements, our focus 
is on ensuring that our treaty network fulfills its goals of 
facilitating cross-border trade and investment and preventing 
fiscal evasion.
    We believe these agreements with the Netherlands and 
Barbados will serve to further the goals of our tax treaty 
network. Both of these agreements substantially improve 
longstanding treaty relationships.
    I would like to highlight a key element that is common to 
the two agreements. Each agreement reflects significant 
developments with respect to the limitation on benefits 
provision designed to ensure that the benefits of the treaties 
are appropriately directed. The U.S. commitment to including 
comprehensive limitation on benefits provisions designed to 
prevent treaty shopping in all our treaties is one of the keys 
to improving our treaty network. Our treaties are intended to 
provide benefits to residents of the U.S. and residents of the 
particular treaty partner on a reciprocal basis. The treaty's 
benefits are not intended to flow to residents of a third 
country. If third country residents are able to exploit one of 
our treaties to secure reductions in U.S. tax, the benefits 
would flow in only one direction. Preventing this exploitation 
of our treaties is critical to ensuring that the third country 
will sit down at the table with us to negotiate on a reciprocal 
basis so that we can secure for U.S. persons reductions in tax 
on their investments in that country.
    The anti-treaty-shopping approach used in U.S. treaties 
relies primarily on a series of objective tests rather than 
requiring an examination of motives. Of course, there is no 
one-size-fits-all objective test that covers all circumstances. 
Therefore, limitation on benefits provisions include a series 
of alternative tests, some common across treaties and others 
tailored to particular circumstances. These objective tests 
have been refined over the years as more experience has been 
gained in applying and administering the tests and as the 
cross-border business structures subject to the tests have 
evolved.
    The agreements with the Netherlands and Barbados reflect 
revisions to the limitation on benefits articles in the two 
treaties to modernize those rules. The agreements also reflect 
the reworking of one of the objective tests that has become a 
standard feature of our limitation on benefits provisions: the 
publicly traded company test.
    The protocol with Barbados was negotiated in order to 
prevent the potential for exploitation of the treaty by U.S. 
corporations to facilitate inappropriate U.S. tax reductions. 
In recent years, a small number of U.S. corporations have 
engaged in corporate inversion transactions which involve a 
complicated restructuring in which a new foreign corporation is 
interposed between the public shareholders and the existing 
U.S. parent. This restructuring can be used to reduce U.S. tax 
on income from the corporate group's U.S. operations and also 
to reduce U.S. tax on income from any foreign operations of the 
group. In some corporate inversions, the new foreign parent 
claimed to be a resident of Barbados so that the provisions of 
the U.S.-Barbados treaty could be used to reduce U.S. tax on 
payments out of the existing U.S. corporate group. The use of 
the treaty in connection with this sort of corporate inversion 
transaction is neither intended nor appropriate.
    The protocol with Barbados prevents this inappropriate 
exploitation of the treaty through modifications to the 
limitation on benefits provision. In particular, the protocol 
tightens the publicly traded company test to ensure that a 
company resident in Barbados must have a real nexus with 
Barbados in order to be eligible with the treaty benefits. With 
the protocol's changes, a Barbados company that is largely 
traded on a U.S. stock exchange, which is true of the 
corporations that have undertaken corporate inversions, will no 
longer qualify for treaty benefits.
    The protocol with the Netherlands includes a more complete 
overhaul of the limitation on benefits provision in the current 
U.S.-Netherlands treaty.
    The protocol with the Netherlands also reflects a new 
approach for the publicly traded company test designed to 
ensure the intended nexus between a public company and its 
country of residence, while recognizing the integration of the 
global financial markets. Under the protocol, a public company 
that does not have sufficient nexus to its residence country 
through trading on local stock exchanges must establish nexus 
through primary management or control there. Given developments 
in trading patterns, the new test better serves the intended 
purpose of limiting treaty shopping by third country residents. 
Moreover, the revisions were intended to be forward looking to 
prevent any potential for the U.S.-Netherlands treaty to be 
exploited by what really is a U.S. company in some future 
possible evolution of corporate inversion transactions.
    In sum, the refinements to the limitation on benefits 
provisions in these two agreements reflect a common goal to 
ensure that the provisions serve its underlying objectives of 
limiting treaty benefits to bona fide residents of the two 
treaty countries, while at the same time recognizing the need 
for certainty and clear, administrable rules.
    Let me turn briefly to other highlights of these 
agreements.
    The protocol with the Netherlands modifies the current 
treaty which entered into force in '93. In addition to the 
inclusion of the state-of-the-art anti-treaty-shopping 
provisions, the protocol with the Netherlands provides for the 
elimination of source company withholding taxes on dividends 
received by a company from an 80 percent owned subsidiary. We 
believe this provision is appropriate in light of our overall 
treaty policy of reducing tax barriers to cross-border 
investment and in the context of this treaty relationship which 
does include both comprehensive anti-treaty-shopping provisions 
and model exchange of information provisions. The elimination 
of source country withholding taxes on inter- company dividends 
provides reciprocal benefits because the Netherlands and the 
U.S. both have dividend withholding taxes and there are 
substantial dividend flows going in both directions.
    The protocol further coordinates the two countries' rules 
regarding pension plans which will allow individuals to take up 
employment opportunities in either country without concerns 
about unintended tax effects on their retirement benefits.
    And the protocol includes an update of the exchange of 
information provisions in the current treaty that fully 
reflects model standards in this area.
    The protocol with Barbados was negotiated to ensure that 
the U.S.-Barbados tax treaty cannot be used inappropriately to 
secure tax reductions in circumstances where there is no risk 
of double taxation.
    In addition to the changes to prevent exploitation of the 
treaty in connection with corporate inversions, the protocol 
adds a substantial further restriction in the case of entities 
that qualify for one of several special preferential tax 
regimes in Barbados. Under the protocol, the provisions of the 
treaty that provide for reductions in U.S. withholding taxes do 
not apply in the case of entities that are not subject to the 
generally applicable Barbados tax system and that benefit 
instead from a preferential regime. An entity that is subject 
to no or low taxation in Barbados under these preferential 
regimes does not have any real risk of double taxation that 
these treaty provisions are intended to address.
    We urge the committee to take prompt and favorable action 
on the agreements before you today. Such action will further 
strengthen the U.S. tax treaty network by eliminating 
weaknesses and ensuring that our treaties continue to serve 
their intended purposes of facilitating real cross-border trade 
and investment.
    Let me conclude by expressing our appreciation for the hard 
work of the staffs of this committee and the Joint Committee on 
Taxation in the tax treaty process. I would be happy to answer 
any questions. Thank you.

    [The prepared statement of Ms. Angus follows:]

  Prepared Statement of Barbara M. Angus, International Tax Counsel, 
                United States Department of the Treasury

    Mr. Chairman and distinguished Members of the committee, I 
appreciate the opportunity to appear today at this hearing to 
recommend, on behalf of the administration, favorable action on two 
income tax agreements that are pending before this committee. We 
appreciate the committee's interest in these agreements and.in the U.S. 
tax treaty network, as demonstrated by the scheduling of this hearing.
    This administration is dedicated to eliminating unnecessary 
barriers to cross-border trade and investment. The primary means for 
eliminating tax barriers to trade and investment are bilateral tax 
treaties. Tax treaties eliminate barriers by providing greater 
certainty to taxpayers regarding their potential liability to tax in 
the foreign jurisdiction; by allocating taxing rights between the two 
jurisdictions so that the taxpayer is not subject to double taxation; 
by reducing the risk of excessive taxation that may arise because of 
high gross-basis withholding taxes; and by ensuring that taxpayers will 
not be subject to discriminatory taxation in the foreign jurisdiction. 
The international network of over 2000 bilateral tax treaties has 
established a stable framework that allows international trade and 
investment to flourish. The success of this framework is evidenced by 
the fact that countless cross-border transactions, from investments in 
a few shares of a foreign company by an individual to multi-billion 
dollar purchases of operating companies in a foreign country, take 
place each year, with only a relatively few disputes regarding the--
allocation of tax revenues between governments.
    Coupled with the goal of removing tax barriers that can discourage 
cross-border investment and distort investment structures and locations 
is the need to ensure that our tax treaties cannot be used 
inappropriately, as such inappropriate use also can distort investment 
choices. We continually monitor our existing network of tax treaties to 
make sure that each treaty continues to serve its intended purposes 
optimally and is not being exploited for unintended purposes. A tax 
treaty reflects a balance of benefits that is struck when the treaty is 
negotiated and that can be affected by future developments. In some 
cases, changes in law or policy in one or both of thetreaty partners 
may make it possible to increase the benefits provided by the treaty; 
in these cases, negotiation of a new or revised agreement may be very 
beneficial. In other cases, developments in one or both countries, or 
international developments more generally, may require a revisiting of 
the agreement to prevent exploitation and eliminate unintended and 
inappropriate consequences; in these cases, it may be necessary to 
modify or even terminate the agreement. Both in setting our overall 
negotiation priorities and in negotiating individual agreements, our 
focus is on ensuring that our tax treaty network fulfills its goals of 
facilitating cross border trade and investment and preventing fiscal 
evasion.
    The administration believes that these agreements with the 
Netherlands and Barbados will serve to further the goals of our tax 
treaty network. Both of these agreements substantially improve long-
standing treaty relationships. We urge the committee and the Senate to 
take prompt and favorable action on both agreements.

                 PURPOSES AND BENEFITS OF TAX TREATIES

    Tax treaties provide benefits to both taxpayers and governments by 
setting out clear ground rules that will govern tax matters relating to 
trade and investment between the two countries. A tax treaty is 
intended to mesh the tax systems of the two countries in such a way 
that there is little potential for dispute regarding the amount of tax 
that should be paid to each country. The goal is to ensure that 
taxpayers do not end up caught in the middle between two governments, 
each of which claims taxing jurisdiction over the same income. A treaty 
with clear rules addressing the most likely areas of disagreement 
minimizes the time the two governments (and. taxpayers) spend in 
resolving individual disputes.
    One of the primary functions of tax treaties is to provide 
certainty to taxpayers regarding the threshold question with respect to 
international taxation: whether the taxpayer's cross-border activities 
will subject it to taxation by two or more countries. Treaties answer 
this question by establishing the minimum level of economic activity 
that must be engaged in within a country by a resident of the other 
country before the first country may tax any resulting business 
profits. In general terms, tax treaties provide that if the branch 
operations in a foreign country have sufficient substance and 
continuity, the country where those activities occur will have primary 
(but not exclusive) jurisdiction to tax. In other cases, where the 
operations in the foreign country are relatively minor, the home 
country retains the sole jurisdiction to tax its residents.
    Tax treaties protect taxpayers from potential double taxation 
through the allocation of taxing rights between the two countries, This 
allocation takes several forms. First, the treaty has a mechanism for 
resolving the issue of residence in the case of a taxpayer that 
otherwise would be considered to be a resident of both countries. 
Second, with respect to each category of income, the treaty assigns the 
``primary'' right to tax to one country, usually (but not always) the 
country in which the income arises (the ``source'' country), and the 
``residual'' right to tax to the other country, usually (but not 
always) the country of residence of the taxpayer. Third, the treaty 
provides rules for determining which country will be treated as the 
source country for each category of income. Finally, the treaty 
provides rules limiting the amount of tax that the source country can 
impose on each category of income and establishes the obligation of the 
residence country to eliminate double taxation that otherwise would 
arise from the exercise of concurrent taxing jurisdiction by the two 
countries.
    As a complement to these substantive rules regarding allocation of 
taxing rights, tax treaties provide a mechanism for dealing with 
disputes or questions of application that arise after the treaty enters 
into force. In such cases, designated tax authorities of the two 
governments--known as the ``competent authorities'' in tax treaty 
parlance--are 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 that might 
otherwise result. The U.S. competent authority under our tax treaties 
is the Secretary of the Treasury. That function has been delegated to 
the Director, International (LMSB) of the Internal Revenue Service.
    In addition to reducing potential double taxation, treaties also 
reduce potential ``excessive'' taxation by reducing withholding taxes 
that are imposed at source. Under U.S. domestic law, payments to non-
U.S. 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. Most of our trading partners impose similar levels 
of withholding tax on these types of income. This tax is imposed on a 
gross, rather than net, amount. Because the withholding tax does not 
take into account expenses incurred in generating the income, the 
taxpayer that bears the burden of withholding tax frequently will be 
subject to an effective rate of tax that is significantly higher than 
the tax rate that would be applicable to net income in either the 
source or residence country. The taxpayer may be viewed, therefore, as 
suffering ``excessive'' taxation. Tax treaties alleviate this burden by 
setting maximum levels for the withholding tax that the treaty partners 
may impose on these types of income or by providing for exclusive 
residence-country taxation of such income through the elimination of 
source-country withholding tax. Because of the excessive taxation that 
withholding taxes can represent, the United States seeks to include in 
tax treaties provisions that substantially reduce or eliminate source-
country withholding taxes.
    Tax treaties also include provisions intended to ensure that cross-
border investors do not suffer discrimination in the application of the 
tax laws of the other country. This is similar to a basic investor 
protection provided in other types of agreements, but the non-
discrimination provisions of tax treaties are specifically tailored to 
tax matters and therefore are the most effective means of addressing 
potential discrimination in the tax context. The relevant tax treaty 
provisions provide guidance about what ``national treatment'' means in 
the tax context by explicitly prohibiting types of discriminatory 
measures that once were common in some tax systems. At the same time, 
tax treaties clarify the manner in which possible discrimination is to 
be tested in the tax context. Particular rules are needed here, for 
example, to reflect the fact that foreign persons that are subject to 
tax in the host country only on certain income may not be in the same 
position as domestic taxpayers that may be subject to tax in such 
country on all their income.
    In addition to these core provisions, tax treaties include 
provisions dealing with more specialized situations, such as rules 
coordinating the pension rules of the tax systems of the two countries 
or addressing the treatment of Social Security benefits and alimony and 
child support payments in the cross-border context. These provisions 
are becoming increasingly important as the number of individuals who 
move between countries or otherwise are engaged in cross-border 
activities increases. While these matters may not involve substantial 
tax revenue from the perspective of the two governments, rules 
providing clear and appropriate treatment are very important to the 
individual taxpayers who are affected.
    Tax treaties also include provisions related to tax administration. 
A key element of U.S. tax treaties is the provision addressing the 
exchange of information between the tax authorities.
    Under tax treaties, the competent authority of one country may 
request from the other competent authority such information as may be 
relevant for the proper administration of the country's tax laws; the 
requested information will be provided subject to strict protections on 
the confidentiality of taxpayer information. Because access to 
information from other countries is critically important to the full 
and fair enforcement of the U.S. tax laws, information exchange is a 
priority for the United States in its tax treaty program. If a country 
has bank secrecy rules that would operate to prevent or seriously 
inhibit the appropriate exchange of information under a tax treaty, we 
will not conclude a treaty with that country. Indeed, the need for 
appropriate information exchange provisions is one of the treaty 
matters that we consider non-negotiable.

             TAX TREATY NEGOTIATING PRIORITIES AND PROCESS

    The United States has a network of 57 bilateral income tax treaties 
covering 65 countries. This network includes all 29 of our fellow 
members of the OECD and covers the vast majority of foreign trade and 
investment of U.S. businesses. The primary constraint on the size of 
our tax treaty network may be the complexity of the negotiations 
themselves. The various functions performed by tax treaties, and most 
particularly the need to mesh the particular tax systems of the two 
treaty partners, make the negotiation process exacting and time-
consuming.
    A country's tax policy reflects the sovereign choices made by that 
country. Numerous features of the treaty partner's particular tax 
legislation and its interaction with U.S. domestic tax rules must be 
considered in negotiating an appropriate treaty. Examples include 
whether the country eliminates double taxation through an exemption 
system or a credit system, the country's treatment of partnerships and 
other transparent entities; and how the country taxes contributions to 
pension funds, earnings of the funds, and distributions from the funds, 
A treaty negotiation must take into account all of these and many other 
aspects of the particular treaty partner's tax system in order to 
arrive at an agreement that accomplishes the United States' tax treaty 
objectives.
    A country's fundamental tax policy choices are reflected not only 
in its tax legislation but also in its tax treaty positions. The 
choices in this regard can and do differ significantly from country to 
country, with substantial variation even across countries that seem to 
have quite similar economic profiles. A treaty negotiation also must 
reconcile differences between the particular treaty partner's preferred 
treaty positions and those of the United States.
    Obtaining the agreement of our treaty partners on provisions of 
importance to the United States sometimes requires other concessions on 
our part. Similarly, the other country sometimes must make concessions 
to obtain our agreement on matters that are critical to it. In most 
cases, the process of give-and-take produces a document that is the 
best tax treaty that is possible with that other country. In other 
cases, we may reach a point where it is clear that it will not be 
possible to reach an acceptable agreement. In those cases, we simply 
stop negotiating with the understanding that negotiations might restart 
if circumstances change. Each treaty that we present to the Senate 
represents not only the best deal that we believe we can achieve with 
the particular country, but also constitutes an agreement that we 
believe is in the best interests of the United States.
    In some situations, the right result may be no tax treaty at all or 
may be a substantially curtailed form of tax agreement. With some 
countries a tax treaty may not be appropriate because of the regional 
markets, companies that are listed on a stock exchange in their home 
country nevertheless may have a substantial portion of their trading 
volume occur on another exchange in their region. Moreover, the 
international prominence of the U.S. stock exchanges means that many 
foreign companies are listed and substantially traded on U.S. 
exchanges. The fact that the publicly-traded company test has been 
structured to take into account both home-country trading and also U.S. 
and regional third-country trading reflects the realities of modern 
global financial markets. However, it has become clear that, in some 
circumstances, this test alone may not be sufficient to establish the 
nexus between the company and its country of residence that is the 
underlying objective of the limitations on benefits provision.
    The proposed Protocol with Barbados was negotiated in order to 
prevent the potential for exploitation of the U.S.-Barbados treaty by 
U.S. corporations to facilitate inappropriate U.S. tax reductions. In 
recent years, a small number of U.S. corporations have engaged in 
corporate inversion transactions, which involve a complicated 
restructuring in which a new foreign corporation is interposed between 
the public shareholders and the existing U.S. parent corporation. This 
restructuring can be used to take advantage of U.S. tax rules to reduce 
U.S. tax on income from the corporate group's U.S. operations and also 
to reduce U.S. tax on income from any foreign operations of the 
corporate group. In some corporate inversion transactions, the new 
foreign ``parent'' corporation claimed to be a resident of Barbados so 
that the provisions of the U.S.-Barbados treaty could be used to reduce 
U.S. tax on payments from the existing U.S. corporate group to the new 
Barbados company. The use of the treaty in connection with this sort of 
corporate inversion transaction was neither intended nor appropriate. 
More generally, the treaty was not intended to be used by companies 
that while technically resident in Barbados do not have sufficient 
nexus with Barbados.
    The proposed Protocol with Barbados prevents this inappropriate 
exploitation of the treaty through modifications to the limitation on 
benefits provision. In particular, the proposed Protocol tightens the 
publicly-traded company test to ensure that a company resident in 
Barbados must have a real nexus with Barbados in order to be eligible 
for treaty benefits. This nexus is established through the requirement 
that the company's stock not only be listed on the Barbados stock 
exchange but also be primarily traded on the Barbados stock exchange 
(or on the sister exchanges in Jamaica or Trinidad and Tobago). As a 
result of the proposed Protocol's changes to the limitation on benefits 
provision, a Barbados company that is largely traded on a U.S. stock 
exchange, which is true of the corporations that have undertaken 
corporate inversion transactions, will no longer qualify for treaty 
benefits.
    The proposed Protocol with the Netherlands includes a more complete 
overhaul of the limitation on benefits provision in the current U.S.-
Netherlands treaty. It is notable that the current U.S.-Netherlands 
treaty broke new ground in terms of comprehensive anti-treaty-shopping 
rules and the inclusion of the provision in that treaty was crucial to 
our success in negotiating such provisions with other countries. The 
refinements included in the proposed Protocol reflect experience gained 
both through the administration of the provision in the current treaty 
and through the crafting of similar provisions in more recent treaties.
    The proposed Protocol with the Netherlands also reflects a new 
approach for the publicly-traded company test designed to ensure the 
intended nexus between a publicly-traded company and its country of 
residence while recognizing the integration of the .global financial 
markets. With this new approach, a public company that does not have 
sufficient nexus to its residence country through trading on the stock 
exchanges in that country must establish nexus through primary 
management and control in its residence country in order to qualify for 
treaty benefits under the publicly-traded company test. Thus, for 
example, a Dutch company that has more trading on U.S. stock exchanges 
than on exchanges in the Netherlands and its economic region or that 
otherwise is overwhelmingly traded on exchanges outside the Netherlands 
will qualify for U.S. treaty benefits under this new test if the 
company's center of management and control is in the Netherlands (which 
establishes a real link between the company and the Netherlands). Given 
developments in trading patterns, the new publicly traded company test 
better serves the intended purpose of limiting treaty shopping by 
third-country residents. Moreover, the revisions to the test were 
intended to be forward looking, to prevent any potential for the U.S.-
Netherlands treaty to be exploited by what is really a U.S. company in 
some possible future evolution of corporate inversion type 
transactions.
    In sum, the refinements to the limitation on benefits provisions 
generally, and the publicly-traded company test in particular, that are 
included in the two pending agreements reflect a common goal: to ensure 
that the limitation on benefits provision serves its underlying 
objective of limiting treaty benefits to bona fide residents of our 
treaty partners. The specific approaches used in the two agreements to 
achieve this common' goal differ. As with many aspects of our 
limitation on benefits provisions, the differences are due to the 
differing economic and legal circumstances of the two treaty partners.
    We intend to continue to scrutinize the limitation on benefits 
provisions in all our tax treaties. In addition to our ongoing efforts 
to incorporate such provisions in the few remaining U.S. treaties that 
do .not yet include them, we also will continue to review our 
limitation on benefits provisions generally, and the publicly-traded 
company test in particular, to make sure that the rules work to 
establish the intended nexus in the particular circumstances. If we 
find inadequacies in any of our treaties, we will work to refine the 
provisions in those treaties. As in the case of these two agreements, 
the optimal approach may well vary from treaty to treaty depending on 
the particular circumstances; flexibility in approach will be needed in 
order to accomplish the underlying objective while recognizing the need 
for certainty and clear, administrable rules.

           DISCUSSION OF PROPOSED NEW TREATIES AND PROTOCOLS

    I now would like to discuss the two agreements that have been 
transmitted for the Senate's consideration. We have submitted Technical 
Explanations of each agreement that contain detailed discussions of the 
provisions of each treaty and protocol. These Technical Explanations 
serve as an official guide to each agreement.

The Netherlands
    The proposed Protocol with the Netherlands was signed in Washington 
on March 8, 2004. The proposed Protocol modifies the current U.S.-
Netherlands treaty, which entered into force in 1993, to take into 
account developments over the last decade, including changes in each 
country's tax laws and tax treaty policies.
    The proposed Protocol includes significant changes with respect to 
the limitation on benefits rules. Although the current treaty includes 
a comprehensive limitation on benefits article, the details of the 
rules differ from those in other U.S. tax treaties in some respects and 
the rules have proven somewhat cumbersome in application for both 
taxpayers and the governments. The proposed Protocol brings the 
limitation on benefits article into closer conformity with the 
provisions in more recent U.S. treaties, including most particularly 
the new treaty with the United Kingdom. At the same time, as discussed 
earlier, the proposed Protocol tightens the limitation on benefits 
rules applicable to publicly-traded companies to ensure real nexus 
between the company and its residence country, as evidenced either by 
trading in the company's stock on the stock exchanges of such country 
or by the company's being primarily managed and controlled there.
    The proposed Protocol modifies the current treaty's provisions 
setting maximum rates for source-country withholding taxes on cross-
border dividends by providing for exclusive residence-country tax on 
certain intercompany dividends. This provision of the proposed Protocol 
provides for the elimination of source-country withholding taxes on 
certain intercompany dividends where the dividend is received by a 
company that owns at least 80 percent of the voting stock of the 
company paying the dividend. In the case of other dividends, the 
proposed Protocol continues the current treaty's limits on source-
country withholding taxes, with a maximum rate of 5 percent applicable 
to direct dividends (where the recipient of the dividends is a company 
that owns at least 10 percent of the company paying the dividends) and 
15 percent otherwise. The dividend withholding tax provisions in the 
proposed Protocol closely follow the analogous provisions in the recent 
agreements with the United Kingdom, Australia and Mexico.
    Treasury believes that this provision eliminating source-country 
withholding taxes on certain intercompany dividends is appropriate in 
light of our overall treaty policy of reducing tax barriers to cross-
border investment and in the context of this important treaty 
relationship. As I have testified previously, the elimination of 
source-country taxation of dividends is something that is to be 
considered only on a case-by-case basis. It is not the U.S. model 
position because we do not believe that it is appropriate in every 
treaty. Consideration of such a provision in a treaty is appropriate 
only if the treaty contains anti-treaty-shopping rules and an 
information exchange provision that meet the highest standards. In 
addition to these prerequisites, the overall balance of the treaty must 
be considered.
    These conditions and considerations all are met in the case of the 
proposed Protocol with the Netherlands. The proposed Protocol includes 
both comprehensive anti-treaty-shopping provisions and model exchange 
of information provisions. The United States and U.S. taxpayers benefit 
significantly from the dividend withholding tax provision. The 
elimination of source-country withholding taxes on intercompany 
dividends provides reciprocal benefits because the Netherlands and the 
United States both have dividend withholding taxes and there are 
substantial dividend flows going in both directions.
    The proposed Protocol updates the provisions applicable to 
dividends paid by REITs (and comparable Dutch entities) to conform to 
current U.S. tax treaty policy. The proposed Protocol reflects the 
refinement of approach adopted in 1997, which is intended to prevent 
the use of these entities to obtain withholding rate reductions that 
would not otherwise be available while providing appropriate reductions 
in the case of portfolio investors in REITs.
    The proposed Protocol includes provisions intended to coordinate 
the two countries' rules regarding earnings and accretions of pension 
plans and contributions to pension plans in cross-border situations. 
For example, the proposed Protocol provides that in the case of a U.S. 
citizen who contributes to a U.S. qualified pension plan while working 
in the United States and subsequently establishes residence in the 
Netherlands, the Netherlands will not impose tax on the earnings and 
accretions of the pension plan with respect to that individual until 
distributions are made from the plan. In addition, the proposed 
Protocol extends the reach of provisions regarding cross=border pension 
contributions that are included in the current treaty to cover 
situations where a U.S. citizen residing in the Netherlands makes 
contributions to a Dutch pension plan.
    The proposed Protocol extends the provision in the current treaty 
which preserves the U.S. right to tax certain former citizens whose 
loss of citizenship had, as one of its principal purposes, the 
avoidance of tax to cover also certain former long-term residents whose 
loss of such status had, as one of its principal purposes, the 
avoidance of tax.
    The proposed Protocol includes a provision, similar to that in the 
U.S. model treaty and other recent treaties, which is intended to 
coordinate each country's obligations in situations in which a taxation 
measure falls within both the nondiscrimination provisions of the 
treaty and the national treatment obligations of the General Agreement 
on Trade in Services. The proposed Protocol also includes several other 
administrative and technical modifications, including an update of the 
exchange of information provisions in the current treaty that fully 
reflects U.S. model standards in this area.
    The Memorandum of Understanding accompanying the proposed Protocol 
provides additional explanations and guidance regarding the agreed 
interpretation of the current treaty and the proposed Protocol. The 
Memorandum of Understanding is an update of the understanding with 
respect to the current treaty and is intended to replace that document.

Barbados
    The proposed Protocol with Barbados was signed in Washington on 
July 14, 2004. The proposed Protocol was negotiated to ensure that the 
U.S.-Barbados tax treaty cannot be used inappropriately to secure tax 
reductions in circumstances where there is no risk of double taxation. 
The proposed Protocol also updates the current treaty to reflect 
changes in U.S. tax law and to bring the treaty into closer conformity 
with current U.S. tax treaty policy.
    The most significant provision in the proposed Protocol is the 
modification of the current treaty's limitation on benefits article. As 
discussed earlier, the proposed Protocol revises the limitation on 
benefits article, with a particular focus on the publicly-traded 
company test, to ensure that the article operates effectively to limit 
treaty benefits to bona fide residents. Under the proposed Protocol, a 
company that is a resident of Barbados qualifies for treaty benefits 
under the publicly-traded company test only if the stock of the company 
is primarily traded on the Barbados stock exchange (or on one of the 
sister exchanges in Jamaica or Trinidad and Tobago).
    The proposed Protocol adds a further restriction to the limitation 
on benefits article to address the treatment of entities that qualify 
for one of several special preferential tax regimes in Barbados. Under 
the proposed Protocol, the provisions of the treaty that provide for 
reductions in U.S. withholding taxes do not apply in the case of 
entities that are not subject to the generally applicable Barbados tax 
system and that benefit instead from a preferential tax regime. An 
entity that is subject to no or very low taxation in Barbados under 
these preferential regimes does not have any real risk of the double 
taxation that these treaty provisions are intended to address.
    The current treaty preserves the U.S. right to tax former citizens 
whose loss of citizenship had, as one of its principal purposes, the 
avoidance of tax. The proposed Protocol expands this right to include 
taxation of former long-term residents whose loss of such status had, 
as one of its principal purposes, the avoidance of tax. The proposed 
Protocol also includes a clarification of the operation of the treaty's 
provisions relating to tax information exchange consistent with U.S. 
model standards in this area.

                       TREATY PROGRAM PRIORITIES

    We continue to maintain a very active calendar of tax treaty 
negotiations. We currently are in ongoing negotiations with Canada, 
Chile, Hungary, Iceland, Korea and Norway. In addition, we are 
beginning negotiations with Germany. We also have substantially 
completed work with Bangladesh and France, and look forward to the 
conclusion of these new agreements.
    As I noted earlier, a key continuing priority is updating the few 
remaining U.S. tax treaties that provide for low withholding tax rates 
but do not include the limitation on benefits provisions needed to 
protect against the possibility of treaty shopping. Another continuing 
priority is entering into new tax treaties with the former Soviet 
republics that are still covered by the old U.S.S.R. treaty (which does 
not include an adequate exchange of information provision). We also are 
focused on continuing to expand our treaty network by entering into new 
tax treaty relationships with countries that have the potential to be 
important trading partners in the future.
    Following up on our discussion earlier this year, we have begun 
work on an update to the U.S. model tax treaty to reflect our 
negotiating experiences since 1996. We look forward to working with the 
staffs of the Senate Foreign Relations Committee and Joint Committee on 
Taxation on this project.

                               CONCLUSION

    Let me conclude by again thanking the committee for its continuing 
interest in the tax treaty program, and the Members and staff for 
devoting time and attention to the review of these new agreements. We 
greatly appreciate the assistance and cooperation of the staffs of this 
committee and of the Joint Committee on Taxation in the tax treaty 
process.
    We urge the committee to take prompt and favorable action on the 
agreements before you today. Such action will further strengthen the 
U.S. tax treaty network by eliminating weaknesses and ensuring that our 
treaties continue to serve their intended purpose of facilitating real 
cross-border trade and investment.

    The Chairman. Well, thank you very much, Ms. Angus. I would 
just echo your final comment about the important staff work 
done by Democratic and Republican staff members of this 
committee and the Joint Tax Committee. These folks have really 
made a difference in terms of moving forward these treaties. 
They are complex. They deserve public scrutiny, which you and 
your Department give, but likewise in the checks and balances 
of our constitutional system, we are obligated to give to have 
confidence. So I appreciate that tribute to our staffs, as 
likewise your own diligent work in this area. It is good to 
have you before the committee again.
    Likewise, Mr. Yin, good to see you again, and would you 
please proceed with your testimony.

  STATEMENT OF GEORGE YIN, CHIEF OF STAFF, JOINT COMMITTEE ON 
                            TAXATION

    Mr. Yin.  Thank you very much, Mr. Chairman. It is my 
pleasure to present the testimony of the staff of the Joint 
Committee on Taxation concerning the proposed protocols with 
Barbados and the Netherlands, which amend the existing treaties 
with those two countries. I am just going to very briefly 
identify a few issues about which the committee may wish to 
inquire.
    On the Barbados protocol, as Ms. Angus has said, the most 
significant change is the proposed substitution of a new 
limitation on benefits article that tightens the scope of the 
treaty's eligible beneficiaries. Use of the existing treaty by 
unintended beneficiaries has been a key element in some recent 
corporate inversion transactions, as Ms. Angus described. The 
joint committee staff believes that the proposed protocol 
should prove effective in curtailing this inappropriate use of 
the existing treaty. Nevertheless, there are three issues the 
committee might wish to raise with the Treasury Department in 
connection with this improvement.
    First, by rendering the Barbados treaty less suitable for 
use in tax-motivated transactions, the proposed protocol may 
cause certain taxpayers to look for second-best treaties in the 
United States network that may be still suitable for a similar 
use. Are there any other treaties that concern the Treasury 
Department in this regard, and if so, what measures are being 
taken to address those concerns?
    The second is the proposed protocol makes taxpayers that 
are subject to very favorable tax regimes in Barbados, such as 
the international business companies regime, ineligible for 
only certain benefits of the U.S.-Barbados treaty. A question 
the committee might want to ask is, is there a reason the 
Treasury Department did not make such taxpayers ineligible for 
all treaty benefits, given that there is no risk of meaningful 
double taxation in that case?
    Finally, as a result of the tax act that was passed by 
Congress last spring, as you know, dividends received by 
individual shareholders from domestic and certain foreign 
corporations are generally taxed at a 15 percent tax rate. 
Qualifying foreign corporations generally include those that 
are eligible for the benefits of a comprehensive income tax 
treaty with the United States which the Treasury Department 
determines is satisfactory and includes an exchange of 
information program. Consistent with the relevant legislative 
history, the Treasury Department has, up until now, not treated 
the Barbados treaty as a qualifying treaty. Once the 
modifications made by this protocol enter into force, does the 
Treasury Department intend to reverse that decision, and if 
they do, how will they treat companies that are taxed under 
favorable tax regimes in Barbados and that therefore are 
eligible for only certain benefits under the treaty?
    Let me now turn to the Netherlands protocol. There are also 
three areas in which the committee may want to inquire.
    First, the protocol reduces from 5 percent to 0 the 
withholding tax rate on cross-border dividends paid by one 
corporation to another that owns 80 percent or more of the 
stock of the dividend-paying corporation, provided certain 
conditions are met. Although this provision does not appear in 
the U.S. or OECD model treaties, it is an identical or similar 
provision included in recent U.S. treaties with the UK, 
Australia, Mexico, and Japan, as well as the EU's parent 
subsidiary directive, as well as many bilateral tax treaties to 
which the U.S. is not a party.
    The Treasury Department has previously stated and states 
again today that it would not consider a zero-rate provision in 
the absence of strong anti-treaty-shopping and exchange of 
information provisions, and that is clearly a sensible position 
for the Treasury to take. The real question, however, is that 
assuming those strong provisions are in place, are there any 
cases where the Treasury would not be willing to negotiate a 
zero rate on direct dividends? And under what further 
circumstances would Treasury be willing to permit a zero rate 
even where ownership of the dividend- paying corporation falls 
below the 80 percent threshold, such as the over 50 percent 
threshold that Treasury negotiated in the recent Japan treaty?
    Second, like the Barbados protocol, the Netherlands 
protocol also contains a new limitation on benefits provision 
which is designed to tighten the scope of the treaty's eligible 
beneficiaries. In general, as Ms. Angus has described, in order 
to qualify for treaty benefits, a public company will have to 
maintain a substantial presence in the residence country. A 
company must either have a sufficient amount of its stock 
traded in its primary economic zone or day-to-day management 
responsibility exercised in the country of residence. Does the 
Treasury Department consider this to be a model limitation on 
benefits provision, and if so, do they intend to amend the U.S. 
model treaty to reflect that intention?
    More generally, concerning limitation on benefits 
provisions with a member country of the European Union, some 
have speculated that developments in the EU might call into 
question certain bilateral arrangements between an EU country 
and a non-EU country such as tax treaty benefits that are 
subject to standard limitation on benefits clauses. Of course, 
EU bodies do not have the authority to require the United 
States to grant any treaty benefits that the U.S. has not 
specifically negotiated. However, in light of the importance of 
limitation on benefits provisions to U.S. treaty policy, the 
committee may wish to ask the Treasury Department for its views 
as to how the ongoing process of European integration might 
affect the operation and development of the U.S. network of 
bilateral tax treaties with EU member countries.
    Finally, one other unique feature of the Netherlands treaty 
and protocol is that it generally precludes U.S. tax 
jurisdiction over former U.S. citizens or long-term residents 
who are Dutch nationals. Current U.S. tax law preserves such 
jurisdiction in cases where the loss of citizenship or the 
termination of residency had, as one of its principal purposes, 
the avoidance of U.S. income tax. The committee might want to 
ask the Treasury why it agreed to this provision.
    One last point. The Treasury Department reiterates in its 
statement today the statement that it made before this 
committee back in February, that it plans to update the U.S. 
model treaty and to work with the staff of your committee, as 
well as our staff in doing so. The committee may wish to ask 
about the time table of this project.
    I ask that the staff report that was prepared in 
conjunction with this hearing also be included in the record as 
well as the full testimony.
    The Chairman. It will be included in full.

    [The prepared statement of Mr. Yin and the Joint Committee 
on Taxation follows:]

 TESTIMONY OF THE STAFF OF THE JOINT COMMITTEE ON TAXATION BEFORE THE 
   SENATE COMMITTEE ON FOREIGN RELATIONS HEARING ON THE PROPOSED TAX 
            PROTOCOLS WITH BARBADOS AND THE NETHERLANDS \1\
---------------------------------------------------------------------------

    \1\ This document may be cited as follows: Joint Committee on 
Taxation, Testimony of the Staff of the Joint Committee on Taxation 
Before the Senate Committee on Foreign Relations Hearing on the 
Proposed Tax Protocols with Barbados and the Netherlands (JCX-58-04), 
September 22, 2004.
---------------------------------------------------------------------------
                           SEPTEMBER 24, 2004

    My name is George Yin. 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 today concerning the proposed income 
tax protocols with Barbados and the Netherlands.

                                OVERVIEW

    As in the past, the Joint Committee staff has prepared pamphlets 
covering the proposed protocols. The pamphlets provide detailed 
descriptions of the proposed protocols, including comparisons with the 
1996 U.S. model income tax treaty, which reflects preferred U.S. tax 
treaty policy, and with other recent U.S. tax treaties. The pamphlets 
also provide detailed discussions of issues raised by the proposed 
protocols. We consulted with the Treasury Department and with the staff 
of your committee in analyzing the proposed protocols and in preparing 
the pamphlets.
    The proposed protocol with Barbados would amend an existing tax 
treaty that was signed in 1984 and was modified by a protocol signed in 
1991. The proposed protocol with the Netherlands would update the 
existing treaty signed in 1992 and modified by protocol in 1993. My 
testimony today will highlight some of the key features of the proposed 
protocols and certain issues that they raise.

                                BARBADOS

Elimination of certain inappropriate benefits available under the 
        existing treaty
    The most significant change made by the proposed protocol with 
Barbados is the replacement of the existing treaty's limitation-on-
benefits article with a new article designed to eliminate certain 
inappropriate benefits that are available under the existing treaty. 
Specifically, the.existing treaty allows a company that is legally 
resident in Barbados to claim the benefits of reduced U.S. withholding 
tax rates by virtue of being publicly traded, even in cases in which 
the company has no meaningful economic presence in Barbados and is 
subject to only nominal levels of taxation there, under a special tax 
regime such as the ``International Business Companies'' regime. This 
aspect of the existing treaty has been a key element in some recent 
``corporate inversion'' transactions that have been used by U.S.-based 
multinational enterprises to erode the U.S. tax base. The proposed 
protocol modifies the limitation-on-benefits provision of the existing 
treaty to eliminate inappropriate treaty benefits under these and 
similar circumstances, as explained in detail in our pamphlet.
    The Joint Committee staff believes that the proposed protocol 
should prove effective in curtailing the inappropriate benefits that 
are available under the existing treaty. Thus, the proposed protocol 
should be viewed as a significant improvement by those concerned about 
the use of the existing treaty to facilitate tax-motivated 
transactions. Nevertheless, we have identified three issues that the 
committee might wish to raise with the Treasury Department in 
connection with the proposed protocol.

Potential availability of inappropriate benefits under other U.S. 
        treaties
    First, by rendering the Barbados treaty less suitable for use in 
tax-motivated transactions, the proposed protocol may cause certain 
taxpayers to look for ``second-best'' treaties in the U.S. network that 
may be suitable for similar use. The committee may wish to ask the 
Treasury Department whether it has concerns about any other U.S. tax 
treaties in this regard, and if so, what measures are being taken to 
address these concerns.

Treatment of special tax regimes outside the context of withholding 
        taxes
    Second, while the proposed protocol disallows treaty benefits in 
most situations in which the recipient of a payment is entitled to the 
benefits of a special tax regime, such as the Barbados ``International 
Business Companies'' regime, the proposed protocol leaves open the 
possibility that such a person may qualify for some benefits of the 
treaty under some circumstances, even though there is no risk of 
meaningful double taxation in such a case. Some may argue that it would 
have been best to foreclose entirely the possibility that persons that 
enjoy tax-haven-type benefits under the laws of a treaty country could 
qualify for treaty benefits.

Interaction with U.S. rate preference for dividend income
    Third, under the Jobs and Growth Tax Relief Reconciliation Act of 
2003, dividends received by an individual shareholder from domestic 
corporations are generally taxed at the preferential rates that apply 
to certain capital gains. Dividends received from a foreign corporation 
also may be eligible for this rate preference in some cases. One way in 
which a dividend from a foreign corporation may qualify is if the 
foreign corporation is eligible for the benefits of a comprehensive 
income tax treaty with the United States which the Treasury Department 
determines to be satisfactory for purposes of the rate-preference 
provision, and which includes an exchange of information program. 
Consistent with a statement made in the relevant legislative history, 
the Treasury Department announced in a notice that the existing treaty 
with Barbados is not satisfactory for purposes of the rate-preference 
provision. In that same notice, the Treasury Department indicated that 
the amendment or renegotiation of existing tax treaties may be a factor 
in deciding whether to amend its list of qualifying treaties. The 
committee may wish to ask the Treasury Department whether it intends to 
amend its list of qualifying treaties to include the U.S.-Barbados 
treaty, once the modifications made by the proposed protocol enter into 
force. In addition, if the Treasury Department does intend to add this 
treaty to the list of qualifying treaties, the committee may wish to 
ask how companies that are eligible for the benefits of a special tax 
regime will be treated for these purposes.

                              NETHERLANDS

    The proposed protocol with the Netherlands modifies several 
important articles in the existing treaty; Many of the provisions of 
the proposed protocol are generally consistent with the U.S. model 
treaty; however, there are a few areas in which the committee may wish 
to inquire.

``Zero-rate'' dividend provision
    One area is the proposed ``zero rate'' of withholding tax on 
certain intercompany dividends. The provision would eliminate source-
country tax on cross-border dividends paid by one corporation to 
another corporation that owns 80 percent or more of the stock of the 
dividend-paying corporation, provided that certain conditions are met. 
Under the current treaty with the Netherlands, these dividends may be 
subject to withholding tax in the source country at a rate of five 
percent. The proposed elimination of the withholding tax is intended to 
further reduce tax bathers to direct investment.
    The principal immediate effects of the zero-rate provision on U.S. 
taxpayers and the U.S. fisc would be: (1) to relieve U.S. corporations 
of the burden of Dutch withholding taxes in connection with qualifying 
dividends received from Dutch subsidiaries; (2) to relieve the U.S. 
fisc of the requirement to allow foreign tax credits with respect to 
these dividends; and (3) to eliminate the withholding tax revenues 
currently collected by the U.S. fisc with respect to qualifying 
dividends received by Dutch corporations from U.S. subsidiaries.
    This provision does not appear in the U.S. or OECD model treaties. 
However, many bilateral tax treaties to which the United States is not 
a party eliminate withholding taxes in similar circumstances. The 
European Union has also eliminated withholding taxes in similar 
circumstances under its ``Parent Subsidiary Directive.'' In 2003, the 
Senate approved adding zero-rate provisions to the U.S. treaties with 
the United Kingdom, Australia, and Mexico, and earlier this year the 
Senate approved adding a zero-rate provision to the U.S. treaty with 
Japan. Those provisions are similar to the provision in the proposed 
protocol.
    The committee may wish to determine whether the inclusion of the 
zero-rate provision in the proposed protocol signals a broader shift in 
U.S. tax treaty policy. The committee also may wish to consider whether 
and under what circumstances the Treasury Department intends to pursue 
similar provisions in other treaties and whether the U.S. model will be 
updated to reflect these developments. In addition, the committee may 
wish to inquire further, as to the rationale for the October 1, 1998 
stock ownership testing date with respect to eligibility for the zero 
rate on dividends received by companies that satisfy the limitation-on-
benefits provision only under certain specific tests contained in that 
provision. While this limitation on the zero rate for direct dividends 
apparently is modeled after a similar limitation in the U.S.-UK treaty, 
it is unclear why the October 1, 1998 testing date that applies for 
purposes of the U.S.-UK treaty is relevant in the context of the 
proposed Netherlands protocol.

Anti-treaty-shopping provision
    The limitation-on-benefits provision in the proposed protocol is 
similar to the anti-treaty-shopping provisions in several recent U.S. 
income. tax treaties; however, the anti-treaty-shopping provisions in 
the proposed protocol include a new requirement that tests for 
``substantial presence'' in the residence country in order for a public 
company to qualify for treaty benefits.
    Under the U.S. model and more recent U.S. income tax treaties, a 
public company can qualify for treaty benefits if it is listed in one 
of the two treaty countries and regularly traded on a recognized stock 
exchange, thereby allowing a company to qualify for treaty benefits if 
all the trading takes place in the other country or a third country 
exchange. Under the proposed protocol, a company must establish 
substantial presence in the residence country in order to obtain treaty 
benefits. A company must establish substantial presence by meeting one 
of two requirements.
    The first requirement determines whether public trading constitutes 
an adequate connection to the residence country. To establish adequate 
connection, the stock of the company must have a greater volume of 
trading in its primary economic zone than in the other treaty country 
and at least 10 percent of its worldwide trading must occur within its 
primary economic zone. For the United States, the primary economic zone 
includes all NAFTA countries and for the Netherlands, the primary 
economic zone includes the European Economic Area and the European 
Union.
    If a company fails the first requirement, it can still establish 
substantial presence if it meets the second requirement. The second 
requirement determines whether the company's primary place of 
management and control is in the country where it is a resident. This 
test should be distinguished from the ``place of effective management'' 
test that is used by many countries to establish residence and by the 
OECD model as a tiebreaker. The primary place of management and control 
test under the proposed protocol looks to where day-to-day 
responsibility for the management of the company (and its subsidiaries) 
is exercised. This is based on where the executive officers and senior 
management employees exercise day-to-day hearing earlier this year, the 
Joint Committee staff believes that this model is becoming obsolete and 
is in need of an update. At that same hearing, the Treasury Department 
staled that it intended to update the model. The committee may wish to 
inquire of the Treasury Department as to the current status of this 
project.
    I would be happy to answer any questions that the committee may 
have at this time or in the future.

    Mr. Yin.  Thank you very much. I would be happy to answer 
any questions, sir.
    The Chairman. Well, thank you very much, Mr. Yin. You have 
raised a great number of questions that are important to 
consider. Some of these perhaps Ms. Angus may wish to respond 
to.
    Let me begin the questioning by asking you a more general 
question. Ms. Angus, can you describe the general criteria used 
to determine what country is suitable for a tax treaty with the 
United States? And how have we determined in the past suitable 
candidates? Are those criteria changing? Are they becoming more 
stringent, more liberal, or can you give us some idea of how we 
get into this business?
    Ms. Angus.  Thank you, Mr. Chairman. We really look at a 
variety of things. The negotiation of a tax treaty is a fairly 
complicated process, so it requires a significant commitment of 
resources. That means that we necessarily have to prioritize 
potential tax treaties. In trying to set the priorities, the 
primary consideration is whether there are tax problems faced 
by investors in that country that can be corrected by a tax 
treaty. When those sorts of problems exist, potential double 
taxation, for example, because of the interaction of the two 
tax systems, or other ways in which the two tax systems 
interact to create a special impediment, we look at things like 
the extent of bilateral economic relations between the United 
States and that country and also the structure of the country's 
tax system. Some tax systems are structured in a way that 
better lend themselves to coordination through a tax treaty; 
others create greater complexity.
    It is important to note that in the case of the United 
States a tax treaty is an essential as the only means for 
eliminating double taxation because we have provisions in our 
domestic law that unilaterally address double taxation. 
However, there are double taxation issues that can arise 
between countries that are just the sort of thing that the tax 
treaties do address.
    A tax treaty necessarily has to be an individualized 
agreement because it has to mesh the specifics of our tax 
system and our tax system as it evolves with the specifics of 
the other country's tax system. So although I sometimes feel 
bad about saying this, because we are continually changing our 
own tax system, we do look to the stability of the tax system 
of the other country. If the other country is about to embark 
on a significant reform of their tax system, it may make more 
sense to wait instead of investing a lot of time in negotiating 
provisions that mesh the current system, but they will be out 
of date as soon as the system is reformed.
    Another thing that we look to is whether we believe that 
the country is able to assume the obligations that it has to 
assume under a tax treaty including, for example, its 
obligations and commitments with respect to exchange of 
information and with respect to the protection of the 
confidentiality of information. So it is a balancing.
    We are always looking to further balance between our 
efforts to extend our treaty network, to establish new 
relations with countries where we have not previously had a tax 
treaty. Our treaty that entered into force this summer with Sri 
Lanka is an example of that. It is our first tax treaty 
relationship with that country, with the need to keep our 
existing treaties up to date, and the treaties before us, as 
well as the new treaty that entered into force earlier this 
year with Japan, are examples of that part of our priorities.
    The Chairman. Well, certainly the treaty with Japan that we 
considered earlier in the year would fit the criteria of a 
country of extraordinarily important relationships. As we cited 
in our earlier testimony, the relationship with the Netherlands 
is very substantial, the third largest trading partner. So this 
fits certainly that criteria that you are up to date where a 
lot of the action is.
    Let me just mention the distinguished Ambassador of the 
Netherlands is with us today. Would you stand, sir, so you can 
be recognized? We are delighted that you are here and honored 
that you would come to our hearing. I understand the Ambassador 
from Barbados may be under way. He is here. Great. We are 
delighted to have you.
    Let me ask one of the questions that Mr. Yin raised which 
is intriguing, and that is, clearly with the Barbados treaty, 
we are attempting to correct a potential for tax evasion. But 
Mr. Yin correctly raises the question of having done the right 
thing vis-a-vis Barbados and the United States, what about 
other situations. Does this mean that those that have ulterior 
motives move on to some other weakness in the system? And if 
so, have you thought about that? Are we sort of pushing folks 
along the trail to do something unfortunate somewhere else?
    Ms. Angus.  That is exactly the issue and we have thought 
about it. The Barbados treaty is the one that was widely 
identified by tax planners as the path to use in a corporate 
inversion transaction. That is why we think it is critically 
important to shut down this inappropriate exploitation of the 
Barbados treaty and the protocol will do that.
    But at the same time, you are exactly right. We have got to 
look at our other treaties to make sure that with the Barbados 
path closed off, other avenues do not become more attractive. 
Even where we do not see inversions happening, it still make 
sense to foreclose even what may be a remote possibility. One 
example in this regard is the changes to the limitation on 
benefits provision reflected in the Netherlands protocol. Those 
changes were intended to be very forward- looking, to ensure 
that the Netherlands treaty cannot sometime in the future 
somehow be exploited for some future evolution of this kind of 
transaction, and at the same time, the changes in that protocol 
are intended to recognize the realities of the global financial 
markets and are structured so as not to adversely affect real 
companies doing business between the U.S. and the Netherlands, 
the real intended beneficiaries of the treaty. We have got to 
consider and will consider similar limitation on benefits 
changes in other treaties as appropriate.
    We also continue to be focused on adding limitation on 
benefits provisions to those treaties in our network that do 
not have these important anti-treaty-shopping protections. And 
in this regard, we are in ongoing negotiations to update our 
treaties with Hungary and Iceland, two treaties that do not 
currently contain comprehensive limitation on benefits 
provisions.
    The Chairman. Well, that is certainly reassuring.
    Just as a practical matter, today we are taking up two 
treaties that have been in force for quite a while, and these 
are amendments or revisions to the treaties. It would occur to 
me, just logically from what you are suggesting, that there may 
be a who raft of treaties that need some treatment, not overall 
revision perhaps, but as you come upon these inequities and you 
find the possibility that somebody might be shopping treaties 
again.
    Is there some way in a more wholesale fashion--and I am 
raising this without having the technical background to do so--
that you can bring before the committee sort of a list of these 
situations so that in fact sort of as a generic class, we sort 
of fix all the treaties that may be relevant?
    This is an interesting problem. There are a lot of very 
talented people in this country and around the world who I 
suspect look at this whole structure for weaknesses. And 
correspondingly, in the public interest, we are trying to make 
certain that there is fairness and, furthermore, confidence in 
the tax system.
    Without getting into the rhetoric of the Senate floor, I 
would just say with regard to the Barbados treaty, a good 
number of Senators would raise the question, what is going on 
there with regard to fairness in taxation with ordinary 
Americans? Are some extraordinary pieces of tax evasion 
occurring here wholesale? And without answering whether they 
are or not, you are attempting to say we better make certain we 
have equity here. We are trying to make sure that there are not 
gaps in the system.
    I would just be curious, Mr. Yin, about your judgment. How 
do we approach this situation that your question, which is very 
thoughtful, raises about treaty shopping or country shopping or 
so forth? What is a proper way as a technician as you have 
looked at this issue?
    Mr. Yin.  Thank you, Mr. Chairman.
    Well, I think that certainly we would concur with 
Treasury's approach in addressing the Barbados treaty first 
because that did seem to be the one that was most in need of 
some remedy in this area.
    Beyond that, I would suggest that, as the Treasury 
indicated, they are viewing the entire network of treaties. I 
think it would be useful to lay out, perhaps through their 
model treaty approach, perhaps different alternatives. They now 
have an interesting new proposal which, of course, they have 
proposed in the Netherlands protocol. Perhaps that will be a 
model for all future treaties or perhaps that does not work for 
certain ones and they might want to offer an alternative for 
countries in a different situation. But whatever their thinking 
is, it would seem that the more that they are laying out their 
thinking to the various stakeholders, as well as of course to 
Congress for its oversight function, that would potentially be 
an advance in this area.
    The Chairman. You raised another question, Mr. Yin, about 
this entire model treaty time table as to how that is going to 
progress. Ms. Angus, do you have any thoughts about that? What 
can you tell us about Treasury's activities with the model 
treaty time table?
    Ms. Angus.  We are actively working to update the model 
treaty. I think in particular with the entry into force in the 
last 2 years of comprehensive new tax treaties with two of our 
major partners, the UK and Japan--and those were both 
fundamental overhauls of those treaties--it seemed to us that 
now is a particularly good time to revisit the model, to 
reflect developments, to take into account our recent 
negotiating experiences, and I would add to that as well our 
experiences with respect to these two protocols and the need to 
look more closely at some of the limitation on benefits 
provisions. As I said, we are actively working on producing an 
update and we are hoping to have that work substantially 
complete by the end of the year.
    We agree with the joint committee that having an updated 
model out there is very valuable to those that follow treaty 
matters closely. It gives a clear picture of what our 
negotiating priorities are, of what our policies are, and it is 
important to have that information out there.
    At the same time, we do have to balance the work on 
updating the model with work on ongoing negotiations, both to 
update existing treaties and to establish new treaty 
relationships. Again, as I said, we are hoping to have the work 
on updating the model substantially complete by the end of the 
year.
    The Chairman. Well, we appreciate that and I thank you for 
that testimony because that is very encouraging. Our committee, 
as you can perceive, has taken quite an interest in this 
general area. It is extremely complex and perhaps sometimes 
does not have the drama of our hearings on Iraq, North Korea, 
Iran, or other subjects, but at the same time, in terms of 
American business, workers, tax equity, and what have you, it 
is tremendously important in terms of the public good, which 
you would recognize, and this is why you serve as you do.
    Let me just ask this question of you, Ms. Angus. In the 
Netherlands protocol specifically, there are changes to the 
provisions in the underlying treaty regarding worker pensions. 
Now, can you explain what impact these provisions will have on 
United States nationals working in the Netherlands?
    Ms. Angus.  The provisions are intended to improve worker 
mobility by better coordinating the two countries' rules on the 
treatment of pension contributions, earnings in pension funds, 
and then distributions received from pension funds so that 
individuals do not have to worry about unexpected foreign tax 
consequences or double tax consequences impacting what they 
have been intending to set aside for their retirement. The 
provisions in the protocol with the Netherlands build on 
provisions in the current treaty and are a significant 
improvement.
    Focusing on U.S. persons working in the Netherlands, there 
are several important provisions in the protocol. Where a U.S. 
person was making contributions to a U.S. pension plan before 
moving to the Netherlands to take a job there, the Netherlands 
will allow deductions for continuing contributions to that U.S. 
plan as if it were a Netherlands plan. Where a U.S. person that 
has an interest in a U.S. pension plan retires in the 
Netherlands, under the protocol the Netherlands will not impose 
tax on the earnings in the pension plan and will impose tax 
only when the retiree receives distributions, which is when the 
retiree was expecting to be subject to tax with respect to the 
pension.
    Then there are also provisions dealing with the situation 
where a U.S. person living in the Netherlands participates in a 
Dutch pension plan. So, for example, a U.S. person who is 
employed not by a Dutch subsidiary of a U.S. company but by a 
Dutch company, so he or she is participating in a Dutch pension 
plan. In that situation, the protocol provides that the U.S. 
will allow deductions for U.S. tax purposes for contributions 
to that Dutch plan.
    Provisions like this on cross-border pensions are becoming 
increasingly important as more and more individuals spend part 
of their career working in a different country or working in 
several different countries. So finding ways to coordinate the 
pension systems of two countries, such as we have done here, 
will become more and more important and a greater focus as we 
look to update some of our older treaties.
    The Chairman. All of these items that you have given very 
explicitly substantially benefit or offer assurances to 
American employees who are involved in this. Sometimes changes 
are criticized because they adversely affect persons and change 
the whole rules of the game. In essence, you are offering 
assurance to American employees, whether they are working for 
Dutch firms, American firms, have a Dutch pension plan, an 
American one, maybe both, that the double taxation situation 
does not ensue and, in fact, certain deductions are recognized, 
which is a very sophisticated but very important point for a 
lot of Americans who may be involved in this.
    Let me ask about the effect, for instance, of these so- 
called inversion problems that are trying to be cured in the 
Barbados treaty. What is the impact of this on the United 
States domestic economy? Why should Americans be concerned 
whether taxes are being paid or evaded or there is treaty 
shopping? What finally happens back here as a result of all of 
this business?
    Ms. Angus.  Well, a corporate inversion is a transaction 
that can be very complicated as a structural matter. 
Operationally it can be virtually transparent. The company can 
operate the same way the day before the transaction and the day 
after the transaction, but the transaction can be used to 
achieve a substantial reduction in taxes. And that sort of 
opportunity, a substantial reduction in taxes through a 
transaction that is complicated as a technical matter, but 
virtually transparent operationally, is a cause for concern as 
a policy matter.
    These transactions can provide opportunities for 
inappropriate shifting of income from U.S. companies in the 
corporate group to outside the U.S. That represents an erosion 
of the U.S. corporate tax base. The transactions can mean a 
competitive advantage to companies that choose to undergo an 
inversion. That means a corresponding competitive disadvantage 
for their U.S. competitors that chose not to invert and choose 
to continue to operate in a U.S.-based group. The possibility 
of these transactions and their exploitation of inappropriate 
opportunities for U.S. tax reductions as an overall matter can 
erode confidence in the fairness of the tax system.
    The Barbados protocol helps ensure that these transactions 
cannot be used to avoid paying one's fair share of taxes, and 
shutting down the transactions helps to restore the competitive 
balance, eliminating the distortions that can be caused when 
complex corporate transactions can be used to dramatically 
change tax results.
    As a bottom line, we want companies to continue to choose 
to be based in the United States. So we need to keep our focus 
in our treaty policy, in our tax policy, and elsewhere on the 
overarching goal of maintaining the attractiveness of the U.S. 
as the most desirable location in the world for incorporation, 
headquartering, foreign investment, business opportunities, and 
employment opportunities.
    The Chairman. Yes, Mr. Yin?
    Mr. Yin.  I might just reiterate that a corporate 
inversion, really in general terms, would have two potential 
effects. One would be a reduction in the U.S. tax on foreign 
source earnings, and the other would be potentially a reduction 
of the U.S. tax on U.S. source earnings. I think that there are 
reasonable policy disagreements in terms of to what extent the 
U.S. should continue to tax foreign source earnings of U.S. 
taxpayers. Different Members of Congress certainly disagree on 
that point, but I think there is little or no disagreement on 
the point that the U.S. tax should certainly continue to apply 
in full to U.S. source earnings of companies. And to the extent 
an inversion transaction would allow companies to escape that 
tax burden, that clearly would be an object that should be 
curtailed.
    The Chairman. Just in simple layman's terms, essentially 
you are saying activity, business, whatever occurs here in the 
United States of America, along with everybody's business here, 
it ought to be taxed in the same way, that there ought not to 
be ways in which all this activity occurs and has consequences, 
but suddenly it all disappears into some other country and no 
tax is paid. And in essence, this is clearly unfair. It is felt 
that way, I will tell you, out on the hustings. People become 
very angry about these issues and wonder why we in Government 
are unable to see what is going on and to bring about fairness. 
So you are striking a blow for fairness today. We hope to 
assist you.
    Let me just ask one more question. This is a technical 
question Mr. Yin raised, Ms. Angus. But the Japan treaty that 
we ratified earlier in the year spoke to this question of the 
zero tax rate if 50 percent ownership of a company was 
involved. The Dutch tax treaty, as I recall, has an 80 percent 
criteria. Can you explain the difference? Should we be going to 
50, 80, where? Or what do you have to say about this particular 
situation?
    Ms. Angus.  Well, the provision in the Dutch protocol 
closely mirrors the provision that was included in our new 
U.S.-UK tax treaty, and it provides for an elimination of 
dividend withholding taxes in case of a parent and subsidiary 
where there is an 80 percent ownership, significant identity of 
economic interests between the parent and the subsidiary. That 
is a conservative approach to this provision. We think it is 
appropriate to approach this conservatively, as it is something 
that we have included only in a few U.S. treaties thus far.
    There are particular benefits, in this case, of having a 
provision that is similar between the U.S. and UK treaty and 
the U.S. and the Netherlands treaty because there are several 
significant businesses that are operated through joint UK-
Netherlands structures, and by having the provisions operate in 
the same way, there are administrative and technical advantages 
to that.
    In the case of the treaty with Japan, we did provide for 
elimination of dividend withholding in a slightly broader range 
of cases in all situations where the dividend was paid to a 
parent that controlled the subsidiary, so it had a more than 50 
percent ownership. That was a provision that was important to 
Japan. It was an ownership threshold that was significantly 
higher than the threshold that Japan used in its other treaties 
for a similar provision. On balance, given the significant 
changes that were included in the Japan treaty, most 
particularly the first time that Japan had ever agreed to 
eliminate withholding taxes on royalties, which was an issue of 
great importance to the U.S. business community, we thought it 
was appropriate to consider the broader provision in that case. 
It also recognized particular issues in the Japanese capital 
markets and in the ownership structures that are prevalent in 
Japan where there is a greater incidence of situations where 
you have got a company that has a substantial interest in a 
subsidiary but not an 80 percent interest.
    And so it was a balancing in that treaty, and it is a 
balancing in this treaty as well. It is something that we think 
that we ought to continue to look at closely as we go forward.
    The Chairman. Just as a matter of personal curiosity, Mr. 
Yin has mentioned a number of items. In fact, he asked about 
the time table for the model treaty, as well as things that 
might be provided in it. Is the joint committee regularly in 
touch with Treasury? In other words, as you think of things 
that ought to be a part of a model treaty, probably Treasury 
has thought of them too, maybe some of our staff. But I am just 
curious what the communication is. Is there a working 
relationship so that as this model treaty is moving on toward 
conclusion, the very best ideas are happening before they come 
to a hearing such as this one in which we ask, have you thought 
of this? Can either of you give any comment about your 
communications?
    Ms. Angus.  I could start by saying that we certainly value 
the opportunity to work closely with the joint committee. The 
joint committee staff's review of our treaties always is of 
benefit to us. They identify questions and raise issues that 
are very important for us to focus on, and they also help find 
solutions to those issues.
    When I indicated that we hoped to have the model 
substantially complete by the end of the year, maybe I should 
have been clearer that as we go through that process, we want 
to have a first draft that we are in a position to be able to 
talk with the joint committee staff and get their thoughts on 
some of the harder questions.
    We have also benefitted from the joint committee's analysis 
of these protocols and of the last several treaties and 
protocols where they have, in their pamphlets and in their 
discussions with us, made particular note of deviations from 
the existing model and made a particular point of making sure 
that we were focused on whether this provision that was in a 
given treaty is one that ought to be in the model so that 
people know, going forward, that it is our policy, or is it one 
that was tailored to some particular circumstance and is not 
for the model. So, certainly we hope to be able to work very 
closely with the staffs as we go forward on the model.
    Mr. Yin.  Let me just echo that we certainly value very 
highly our relationship with the Treasury Department and we 
stand ready to assist the Treasury Department at whatever point 
it wishes to present a draft of a model treaty or really on any 
other treaty issues that might come to their attention.
    The Chairman. Well, that is very reassuring. And then as 
you have your joint product, I know you will share it with our 
staff members on both sides of the aisle so that as we come to 
these hearings and potential action, we have all tried to think 
in advance of the hypotheticals and tried to resolve those as 
best we can.
    Well, I appreciate very much the testimony of both of you 
today, and we look forward to continuing to work with you. The 
agenda is not yet complete as you have pointed out. You have 
more work for us to do, and hopefully early in the next 
session, we will be taking a look at perhaps the model treaty 
and/or other bilateral efforts that you have negotiated.
    Do either of you have further comment that you have not had 
a chance to say?
    Ms. Angus.  I do not want to take up too much of the 
committee's time, but I would like, if you would not mind, to 
take just a minute to comment on a matter that the joint 
committee noted in its report on the Netherlands treaty.
    The Chairman. Good.
    Ms. Angus.  And that was the speculation that some have 
engaged in regarding whether developments in the European Union 
in the years to come could have implications for tax treaty 
relationships between U.S. and EU member countries. There has 
been a fair amount of speculation about this recently, and I 
think there are a couple of important points to be made about 
it and I will be try to be quick about that.
    I think first and foremost, no matter what happens in the 
EU, the U.S.'s ability to apply limitation on benefits 
provisions contained in our treaties will not be affected. 
Nothing that may occur in the EU can affect in any way the 
U.S.'s ability to apply this treaty, the Netherlands treaty, 
and all our other treaties in accordance with their terms.
    More generally, it is important to reiterate that U.S. tax 
systems are intended to mesh the U.S. tax system with the 
particular tax system of the treaty partner, and tax treaties 
necessarily reflect a balancing of U.S. tax treaty policy with 
the tax treaty policy of the particular treaty partner. The EU 
does not now have a single tax system, and the EU also does not 
now have a single tax treaty policy. Indeed, there are 
significant variations in these areas across EU countries.
    As long as EU countries have different tax systems, there 
will be a need to have different provisions in U.S. treaties 
with those countries in order to ensure that the treaty meshes 
the systems properly, and as long as EU countries have 
different tax treaty policies, there will be potential 
differences as the treaties reflect that balancing of our 
treaty policies with each other country's treaty preferences.
    As long as there are those differences, we need to protect 
against treaty shopping. Some EU countries share the U.S. 
preference for reducing withholding taxes to the greatest 
extent possible. Other EU countries insist on relatively higher 
withholding taxes. That creates the potential for treaty 
shopping, and thus the need for our comprehensive limitation on 
benefits provisions.
    To the extent that in the future there is more EU 
integration with respect to tax and treaty policy, the U.S. 
limitation on benefits provisions already contain the mechanism 
that will recognize this. To the extent that there is 
convergence that is reflected in comparable treaties across EU 
countries, the so-called derivative benefits rule that is 
contained in U.S. treaties means that U.S. treaty benefits will 
apply in the case of cross investment through another EU 
country because the investor would have been entitled to the 
same benefits under its own treaty with the U.S.
    I guess just in sum, we believe that the treaty with the 
Netherlands, as improved by the proposed protocol, will well 
serve our two countries not only today but also as developments 
in the EU progress.
    The Chairman. I appreciate that. That was an important 
question raised by Mr. Yin, and I thank you for that very 
comprehensive response.
    Well, thanks to both of you and we will look forward to now 
our next panel, which will be the Honorable William Reinsch, 
President of the National Foreign Trade Council, and Ms. Judith 
Zelisko, the President of the Tax Executives Institute of 
Washington, D.C.
    Let me mention as a point of personal privilege that, as I 
note the distinguished Netherlands delegation is leaving, one 
of the persons with us today was Casper Veldkamp who formerly 
served in my office, first as a student intern and then as a 
staff member. We are very proud that he is now serving the 
Netherlands on the staff as Dutch political counselor and was 
at the hearing today. It was great to have you, Casper, and we 
are proud of you.
    Mr. Veldkamp.  Thank you, Senator. Some of our staff will 
stay here.
    The Chairman. Great.
    I would like for you to testify in the order that I 
introduced you. As perhaps you heard, your full statements will 
be made a part of the record. You may proceed with those in 
full or in summaries, and then please respond to our questions. 
Mr. Reinsch.

   STATEMENT OF HON. WILLIAM A. REINSCH, PRESIDENT, NATIONAL 
            FOREIGN TRADE COUNCIL, WASHINGTON, D.C.

    Mr. Reinsch.  Thank you, Mr. Chairman. I appreciate your 
comment about the full statements. Since I have ruthlessly 
tried to trim mine in order to fit within the time limit, I am 
glad you are going to put the whole thing in.
    The National Foreign Trade Council was pleased to recommend 
ratification of the proposals that you are considering today. 
We appreciate your actions in particular, Mr. Chairman, in 
scheduling the hearing, and we strongly urge the committee to 
reaffirm the United States' historic opposition to double 
taxation by giving its full support to the pending Netherlands 
and Barbados protocols.
    The NFTC, organized in 1914, is an association of some 300 
U.S. business enterprises engaged in all aspects of 
international trade and investment. Our membership covers the 
full spectrum of industrial, commercial, financial, and service 
activities, and we seek to foster an environment in which U.S. 
companies can be dynamic and effective competitors in the 
international business arena. 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 they be free from excessive foreign taxes or double 
taxation and impediments to the flow of capital that can serve 
as barriers to full participation in the international 
marketplace. Foreign trade is fundamental to the economic 
growth of U.S. companies. Tax treaties are a crucial component 
of the framework that is necessary to allow that growth.
    That is why the NFTC has long supported the expansion and 
strengthening of the U.S. tax treaty network and why we are 
here today to recommend ratification of the two protocols.
    Tax treaties are bilateral agreements between the U.S. and 
foreign countries that serve to harmonize the tax systems of 
the two countries with respect to persons involved in cross-
border investment and trade. Tax treaties eliminate this double 
taxation by allocating taxing jurisdiction over the income 
between the two countries. In the absence of tax treaties, 
income from international transactions or investment may be 
subject to double taxation, first by the country where the 
income arises and again by the country of the recipient's 
residence.
    In addition, the tax systems of most countries impose 
withholding taxes, frequently at high rates, on payments of 
dividends, interest, and royalties to foreigners, and treaties 
are the mechanism by which these taxes are lowered on a 
bilateral basis. If U.S. enterprises earning such income abroad 
cannot enjoy the reduced foreign withholding rates offered by a 
tax treaty, they are liable to suffer excessive and non-
creditable levels of foreign tax and to be at a competitive 
disadvantage relative to traders and investors from other 
countries that do have such benefits. Tax treaties serve to 
prevent this barrier to U.S. participation in international 
commerce.
    If U.S. businesses are going to maintain a competitive 
position around the world, we need a treaty policy that 
protects them from multiple or excessive levels of foreign tax 
on cross-border investments, particularly if their competitors 
already enjoy that advantage. The U.S. has lagged behind other 
developed countries in eliminating this withholding tax and 
leveling the playing field for cross-border investment. The EU 
eliminated the tax on intra-EU parent-subsidiary dividends over 
a decade ago, and dozens of bilateral treaties between foreign 
countries have followed that route. The majority of OECD 
countries now have bilateral treaties in place that provide for 
a zero rate on parent-subsidiary dividends.
    Taxpayers are not the only beneficiaries of tax treaties. 
Treaties protect the legitimate enforcement interests of the 
United States by providing for the administration of U.S. tax 
laws and the implementation of U.S. treaty policy. The article 
that provides for the exchange of information between tax 
authorities is an excellent example of the benefits that result 
from an expanded treaty network. Treaties also provide the 
possibility of administrative assistance in the collection of 
taxes between the relevant tax authorities.
    The Netherlands protocol that is before the committee today 
updates a decade-old agreement. Its ratification will enhance 
an already well-established trading relationship that is one of 
the oldest and most significant for the United States. This 
protocol makes an important contribution toward improving the 
economic competitiveness of U.S. companies, especially relative 
to their EU counterparts.
    The NFTC has for years urged adjustment of U.S. treaty 
policy to allow for a zero withholding rate on related-entity 
dividends, and we praise the Treasury for making further 
progress in this protocol with the Netherlands. The ownership 
threshold necessary to receive the benefit of the zero dividend 
withholding rate is 80 percent, as you have noted, which is in 
line with the corresponding provisions in the U.S.-UK treaty. 
Although we support a less stringent ownership requirement, 
preferring the 50 percent threshold in the U.S.-Japan 
agreement, we very much appreciate Treasury's commitment to 
eliminating this impediment to trade. We thank the committee 
for its prior support of this evolution in U.S. tax treaty 
policy and we strongly urge you to continue that support by 
approving the protocol to the Netherlands treaty.
    Another notable inclusion in the Netherlands protocol is a 
section that would give reciprocal treatment to qualifying 
pension plans, another one that you noted, Mr. Chairman, 
allowing for the deductibility of contributions and making the 
corresponding distribution payments taxable. Modern U.S. tax 
treaty policy regarding hybrid entities and the application of 
reduced U.S. withholding rates on dividends paid by regulated 
investment companies and real estate investment trusts are also 
reflected in the protocol.
    Important safeguards are included in the Netherlands 
protocol to prevent treaty shopping. For example, in order to 
qualify for the lowered rates specified by the agreement, 
companies must meet certain requirements so that foreigners, 
whose governments have not negotiated a tax treaty with the 
Netherlands or the United States, cannot free-ride on this 
agreement.
    The protocol with Barbados also contains these important 
treaty shopping measures. The protocol amends a 20-year-old 
agreement with strict rules that preserve the purpose of the 
tax treaty network by ensuring that the benefits of the treaty 
are received by the intended beneficiaries.
    The Senate's ratification of these agreements will help 
Treasury in its continuing effort to improve and enhance the 
U.S. tax treaty network by negotiating agreements with other 
countries. We are particularly hopeful that the Senate will be 
able to complete its ratification procedures before it adjourns 
this year so that these agreements become effective as soon as 
possible. Let me also say on that, Mr. Chairman, I am in the 
group of people who think there is not going to be a lame duck 
session. So I hope that you are going to act soon, even though 
I may be wrong about that.
    The NFTC also wishes to reaffirm its support for the 
existing procedure by which Treasury consults on a regular 
basis with this committee, also the tax-writing committees, and 
the appropriate congressional staffs concerning tax treaty 
issues and negotiations and the interaction between treaties 
and developing tax legislation. We encourage all participants 
in such consultations to give them a high priority. We also 
commend this committee for scheduling tax treaty hearings so 
soon after receiving the agreements from the executive branch. 
Doing so enables improvements in the treaty network to enter 
into effect as quickly as possible, and this committee's record 
under your chairmanship, Senator Lugar, has been exemplary.
    Finally, the NFTC is grateful to the chairman and the 
members of the committee for giving international economic 
relations prominence in the committee's agenda. In particular, 
we want to express our gratitude for making time for a hearing 
before the end of this session, especially when demands on the 
committee's time are so pressing. We would also like to express 
our appreciation for the efforts of both the majority and 
minority staff which have facilitated the holding of this 
hearing at this time.
    We commend the committee for its commitment to proceed with 
ratification of these important agreements as expeditiously as 
possible. Thank you, Mr. Chairman.

    [The prepared statement of Mr. Reinsch follows:]

                Prepared Statement of William A. Reinsch

    Mr. Chairman and members of the committee: The National Foreign 
Trade Council (NFTC) is pleased to recommend ratification of the 
protocols under consideration by the committee today. We appreciate the 
Chairman's actions in scheduling this hearing, and we strongly urge the 
committee to reaffirm the United States' historic opposition to double 
taxation by giving its full support to the pending Netherlands and 
Barbados Protocols.
    The NFTC, organized in 1914, is an association of some 300 U.S. 
business enterprises engaged in all aspects of international trade and 
investment. Our membership covers the full spectrum of industrial, 
commercial, financial, and service activities, and the NFTC therefore 
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. 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 they be free 
from excessive foreign taxes or double taxation and impediments to the 
flow of capital that can serve as barriers to full participation in the 
international marketplace. Foreign trade is fundamental to the economic 
growth of U.S. companies. Tax treaties are a crucial component of the 
framework that is necessary to allow that growth.
    This is why the NFTC has long supported the expansion and 
strengthening of the U.S. tax treaty network and why we are here today 
to recommend ratification of the Protocols with the Netherlands and 
Barbados.
         tax treaties and their importance to the united states
    Tax treaties are bilateral agreements between the United States and 
foreign countries that serve to harmonize the tax systems of the two 
countries with respect to persons involved in cross-border investment 
and trade. Tax treaties eliminate this double taxation by allocating 
taxing jurisdiction over the income between the two countries. In the 
absence of tax treaties, income from international transactions or 
investment may be subject to double taxation, first by the country 
where the income arises and again by the country of the recipient's 
residence.
    In addition, the tax systems of most countries impose withholding 
taxes, frequently at high rates, on payments of dividends, interest, 
and royalties to foreigners, and treaties are the mechanism by which 
these taxes are lowered on a bilateral basis. If U.S. enterprises 
earning such income abroad cannot enjoy the reduced foreign withholding 
rates offered by a tax treaty, they are liable to suffer excessive and 
non-creditable levels of foreign tax and to be at a competitive 
disadvantage relative to traders and investors from other countries 
that do have such benefits. Tax treaties serve to prevent this barrier 
to U.S. participation in international commerce.
    If U.S. businesses are going to maintain a competitive position 
around the world, we need a treaty policy that protects them from 
multiple or excessive levels of foreign tax on cross-border 
investments, particularly if their competitors already enjoy that 
advantage. The United States has lagged behind other developed 
countries in eliminating this withholding tax and leveling the playing 
field for cross-border investment. The European Union (ELT) eliminated 
the tax on intra-EU, parent-subsidiary dividends over a decade ago and 
dozens of bilateral treaties between foreign countries have also 
followed that route. The majority of OECD countries now have bilateral 
treaties in place that provide for a zero rate on parent-subsidiary 
dividends.
    Tax treaties also provide other features that are vital to the 
competitive position of U.S. businesses. For example, by prescribing 
internationally agreed thresholds for the imposition of taxation by 
foreign countries on inbound investment, and by requiring foreign tax 
laws to be applied in a nondiscriminatory manner to U.S. enterprises, 
treaties offer a significant measure of certainty to potential 
investors. Another extremely important benefit that is available 
exclusively under tax treaties is the mutual agreement procedure. This 
bilateral administrative mechanism avoids double taxation on cross-
border transactions.
    Taxpayers are not the only beneficiaries of tax treaties. Treaties 
protect the legitimate enforcement interests of the United States by 
providing for the administration of U.S. tax laws and the 
implementation of U.S. treaty policy. The article that provides for the 
exchange of information between tax authorities is an excellent example 
of the benefits that result from an expanded tax treaty network. 
Treaties also offer the possibility of administrative assistance in the 
collection of taxes between the relevant tax authorities.
    A framework for the resolution of disputes with respect to 
overlapping claims by the respective governments is also provided for 
in tax treaties. In particular, the practices of the Competent 
Authorities under the treaties have led to agreements, known as 
``Advance Pricing Agreements'' or ``APAs,'' through which tax 
authorities of the United States and other countries have been able to 
avoid costly and unproductive proceedings over appropriate transfer 
prices for the trade in goods and services between related entities. 
APAs, which are agreements jointly entered into between one or more 
countries and particular taxpayers, have become common and increasingly 
popular procedures for countries and taxpayers to settle their transfer 
pricing issues in advance of dispute. The clear trend is that treaties 
are becoming an increasingly important tool used by tax authorities and 
taxpayers alike in striving for fairer and more efficient application 
of the tax laws.

                    AGREEMENTS BEFORE THE COMMITTEE

    The Netherlands Protocol that is before the committee today updates 
a decade old agreement. Its ratification will enhance an already well 
established trading relationship that is one of the oldest and most 
significant for the United States. This Protocol makes an important 
contribution toward improving the economic competitiveness of U.S. 
companies, especially relative to their EU counterparts.
    The NFTC has for years urged adjustment of U.S. treaty policy to 
allow for a zero withholding rate on related-entity dividends, and we 
praise the Treasury for making further progress in this Protocol with 
the Netherlands. The ownership threshold necessary to receive the 
benefit of the zero dividend withholding rate is 80 percent, which is 
in line with the corresponding provision in the U.S.-UK treaty. 
Although we support a less stringent ownership requirement, preferring 
the 50 percent threshold in the U.S.-Japan Agreement, we very much 
appreciate Treasury's commitment to eliminating this impediment to 
trade. We thank the committee for its prior support of this evolution 
in U.S. tax treaty policy and we strongly urge you to continue that 
support by approving the Protocol to the Netherlands Treaty.
    The existence of a withholding tax on cross-border, parent-
subsidiary dividends, even at the 5 percent rate previously in the 
U.S.-Netherlands treaty has served as a tariff like barrier to cross-
border investment flows. Without a zero rate, the combination of the 
underlying corporate tax and the withholding tax on the dividend will 
often lead to unusable excess foreign tax credits in the parent's 
hands, resulting in a lower return from a cross-border investment than 
a comparable domestic investment. This sort of multiple taxation of 
profits within a corporate group leads to exactly the kind of 
distortion in investment decisions that tax treaties are meant to 
prevent.
    Another notable inclusion in the Netherlands Protocol is a section 
that would give reciprocal treatment to qualifying pension plans, 
allowing for the deductibility of contributions and making the 
corresponding distribution payments taxable. Modem U.S. tax treaty 
policy regarding hybrid entities and the application of reduced U.S. 
withholding rates on dividends paid by Regulated Investment Companies 
(RICs) and Real Estate Investment Trusts (REITs) are also reflected in 
the protocol.
    Important safeguards are included in the Netherlands Protocol to 
prevent treaty shopping. For example, in order to qualify for the 
lowered rates specified by the agreement, companies must meet certain 
requirements so that foreigners whose governments have not negotiated a 
tax treaty with the Netherlands or the United States cannot free-ride 
on this agreement.
    The protocol with Barbados also contains these important treaty 
shopping measures. The protocol amends a twenty year old agreement with 
strict rules that preserve the purpose of the tax treaty network by 
ensuring that the benefits of the treaty are received by the intended 
beneficiaries.
    The Senate's ratification of these agreements will help Treasury in 
its continuing effort to improve and enhance the U.S. tax treaty 
network by negotiating agreements with other countries. We are 
particularly hopeful that the Senate will be able to complete its 
ratification procedures by the end of this Congressional year so that 
these agreements become effective as soon as possible.

                 GENERAL COMMENTS ON TAX TREATY POLICY

    While we are not aware of any opposition to the treaties under 
consideration, the NFTC as it has done in the past as a general 
cautionary note, urges the committee to reject opposition to the 
agreements based on the presence or absence of a single provision. No 
process that is as laden with competing considerations as the 
negotiation of a full-scale tax treaty between sovereign states will be 
able to produce an agreement that will completely satisfy every 
possible constituency, and no such result should be expected. Virtually 
all treaty relationships arise from difficult and sometimes delicate 
negotiations aimed at resolving conflicts between the tax laws and 
policies of the negotiating countries. The resulting compromises always 
reflect a series of concessions by both countries from their preferred 
positions. Recognizing this, but also cognizant of the vital role tax 
treaties play in creating a level playing field for enterprises engaged 
in international commerce, the NFTC believes that treaties should be 
evaluated on the basis of their overall effect. In other words, 
agreements should be judged on whether they encourage international 
flows of trade and investment between the United States and the other 
country. An agreement that meets this standard will provide the 
guidance enterprises need in planning for the future, provide 
nondiscriminatory treatment for U.S. traders and investors as compared 
to those of other countries, and meet a minimum level of acceptability 
in comparison with the preferred U.S. position and expressed goals of 
the business community.
    Mechanical comparisons of a particular treaty's provisions with the 
U.S. Model or with treaties with other countries do not provide an 
appropriate basis for analyzing a treaty's value. U.S. negotiators are 
to be applauded for achieving agreements that reflect as well as these 
agreements do the positions of the U.S. Model and the views expressed 
by the U.S. business community.
    The NFTC also wishes to emphasize how important treaties are in 
creating, implementing, and preserving an international consensus on 
the desirability of avoiding double taxation, particularly with respect 
to transactions between related entities. The United States, together 
with many of its treaty partners, has worked long and hard through the 
OECD and other fora to promote acceptance of the arm's length standard 
for pricing transactions between related parties. The worldwide 
acceptance of this standard, which is reflected in the intricate treaty 
network covering the United States and dozens of other countries, is a 
tribute to governments' commitment to prevent conflicting income 
measurements from leading to double taxation and resulting distortions 
and barriers for healthy international trade. Treaties are a crucial 
element in achieving this goal, because they contain an expression of 
both governments' commitment to the arm's length standard and provide 
the only available bilateral mechanism, the competent authority 
procedure, to resolve any disputes about the application of the 
standard in practice.
    We recognize that determination of the appropriate arm's length 
transfer price for the exchange of goods and services between related 
entities is sometimes a complex task that can lead to good faith 
disagreements between well-intentioned parties. Nevertheless, the 
points of international agreement on the governing principles far 
outnumber any points of disagreement. Indeed, after decades of close 
examination, governments around the world agree that the arm's length 
principle is the best available standard for determining the 
appropriate transfer price, because of both its economic neutrality and 
its ability to be applied by taxpayers and revenue authorities alike by 
reference to verifiable data.
    The NFTC strongly supports the efforts of the Internal Revenue 
Service and the Treasury to promote continuing international consensus 
on the appropriate transfer pricing standards, as well as innovative 
procedures for implementing that consensus. We applaud the continued 
growth of the APA program, which is designed to achieve agreement 
between taxpayers and revenue authorities on the proper pricing 
methodology to be used before disputes arise. We commend the ongoing 
efforts of the IRS to refine and improve the operation of the competent 
authority process under treaties to make it a more efficient and 
reliable means of avoiding double taxation.
    The NFTC also wishes to reaffirm its support for the existing 
procedure by which Treasury consults on a regular basis with this 
committee, the tax-writing committees, and the appropriate 
Congressional staffs concerning tax treaty issues and negotiations and 
the interaction between treaties and developing tax legislation. We 
encourage all participants in such consultations to give them a high 
priority. We also commend this committee for scheduling tax treaty 
hearings so soon after receiving the agreements from the Executive 
Branch. Doing so enables improvements in the treaty network to enter 
into effect as quickly as possible.
    We would also like to reaffirm our view, frequently voiced in the 
past, that Congress should avoid occasions of overriding the U.S. tax 
treaty commitments that are approved by this committee by subsequent 
domestic legislation. We believe that consultation, negotiation, and 
mutual agreement upon changes, rather than unilateral legislative 
abrogation of treaty commitments, better supports the mutual goals of 
treaty partners.

                             IN CONCLUSION

    Finally, the NFTC is grateful to the Chairman and the members of 
the committee for giving international economic relations prominence in 
the committee's agenda. In particular, we want to express our gratitude 
for making time for a hearing before the end of this session, 
especially when the demands upon the committee's time are so pressing. 
We would also like to express our appreciation for the efforts of both 
majority and minority staff which have allowed this hearing to be 
scheduled and held at this time.
    We commend the committee for its commitment to proceed with 
ratification of these important agreements as expeditiously as 
possible.

    The Chairman. Well, thank you very much for your 
commendations of our efforts. Let me just say parenthetically 
we do take the time table seriously. Even though the Congress 
may be in recess, the rest of American working people are not, 
and the tax implications continue on whether we are here or 
not. So we appreciate this opportunity to have you testify 
today to fulfill our obligation for a full-fledged hearing and 
a committee record. My reason for interrogating the previous 
witnesses so thoroughly is just to make certain we do have that 
record. These questions have been raised and have been 
responded to. Likewise, we will do so with you.
    Now, let me again commend our staffs who have to be 
extremely talented and diligent at this point in the session 
because much that we do must now happen by unanimous consent or 
relatively unanimous consent and this requires bipartisanship 
and it requires thoughtfulness as Americans as opposed to 
partisans.
    So we have been active. Staff was last evening on the 
floor. We succeeded in passing a very important piece of 
committee legislation with regard to Sudan, for example, 
somewhat distant from our purview this morning, but 
nevertheless an example of legislation that is timely and 
required, as we feel these treaties are.
    So we thank you again for your participation.
    Now, Ms. Zelisko, we would love to hear from you and if you 
will proceed.

   STATEMENT OF JUDITH P. ZELISKO, PRESIDENT, TAX EXECUTIVES 
                  INSTITUTE, WASHINGTON, D.C.

    Ms. Zelisko.  Thank you, Mr. Chairman. Good morning. I am 
Judy Zelisko, Vice President of Tax for Brunswick Corporation. 
I am here today as President of Tax Executives Institute whose 
5,400 members work for 2,800 of the largest companies in North 
America and Europe. TEI appreciates the opportunity to present 
its views on these two important protocols.
    Tax Executives Institute was established in 1944 to serve 
the professional needs of in-house tax practitioners. Today the 
institute has 53 chapters in the United States, Canada, and 
Europe. Our 5,400 members are accountants, attorneys, and other 
business professionals who work for the 2,800 leading companies 
in North America and Europe. They are responsible for 
conducting the tax affairs of their companies and ensuring 
their compliance with the tax laws.
    The majority of TEI's members work for multinational 
companies with substantial international operations and sales. 
Members of TEI must contend daily with the provisions of the 
various tax laws relating to the operation of business 
enterprises. Consequently, TEI members have a special interest 
in the tax treaty between the United States and the 
Netherlands, as well as the one between the United States and 
Barbados.
    A fundamental purpose of America's income tax treaties is 
to eliminate double taxation, which constitutes a significant 
burden on international trade and investment and hence impedes 
economic growth. We are pleased that the United States has 
sought to update the Dutch treaty since the current treaty does 
not reflect recent advancements in U.S. policy. The Dutch 
protocol under consideration by the committee will eliminate 
barriers to trade and investment between the two countries, 
curtail abuse, and promote cooperation in international 
enforcement. Prompt ratification will promote closer ties with 
a longstanding ally and major trading partner, encourage growth 
of the U.S. economy and jobs, and enhance tax enforcement 
efforts.
    A principal benefit of the Dutch protocol for business is 
the elimination of the withholding tax on dividends. This will 
encourage U.S. multinationals to bring offshore earnings back 
to the United States, thereby aiding the domestic economy.
    Another benefit is the article modernizing the cross- 
border treatment of pension funding and benefits by 
coordinating the two countries' rules. This will permit 
citizens of each country to transfer between affiliated 
companies without jeopardizing the status of their retirement 
benefits. It will also encourage investment by Dutch companies 
in the United States, as well as enable U.S. companies to 
provide their U.S. citizen employees who transfer overseas, for 
example, on temporary assignment, with the same pension 
benefits as their U.S.-based colleagues.
    Finally, the Dutch protocol will improve the exchange of 
information between the U.S. and Dutch tax authorities. This 
will aid both countries' enforcement efforts against tax 
shelters and other abusive transactions. The new protocol will 
also enhance the ability of the competent authorities to 
minimize double taxation by improving the procedures for 
reaching mutual agreement on tax issues.
    TEI, therefore, urges the committee to approve the new 
agreement with the Netherlands.
    Turning to the second protocol of today, the U.S.- Barbados 
treaty, we note that like the Dutch protocol the Barbados' 
agreement is designed to bring the current treaty in line with 
U.S. policy and put adequate safeguards in place to prevent 
inappropriate use of the treaty. To accomplish these 
objectives, the protocol expands the existing limitation on 
benefits article to modernize the anti-treaty-shopping 
provisions. The Treasury Department believes that the more 
restrictive terms will address concerns about the unintended 
use of the treaty by companies to migrate their corporate 
structures offshore.
    Although TEI has some reservations about expanding 
limitation on benefits to U.S. treaties generally without 
thorough analysis, on balance we agree ratification of the 
Barbados protocol is in the best interest of the country and 
the business community.
    Tax Executives Institute commends the Foreign Relations 
Committee for holding this hearing. To enable the Internal 
Revenue Service and U.S. taxpayers to reap the benefits of the 
new agreements, we urge their prompt ratification.
    I would be pleased to respond to any questions you might 
have.

    [The prepared statement of Ms. Zelisko follows:]

                Prepared Statement of Judith P. Zelisko

    Good afternoon. I am Judy Zelisko, Vice President-Tax for Brunswick 
Corporation. I am here today as President of Tax Executives Institute, 
whose 5,400 members work for 2,800 of the largest companies in North 
America and Europe. TEI appreciates the opportunity to present its 
views on these two important protocols.
    Tax Executives Institute was established in 1944 to serve the 
professional needs of in-house tax practitioners. Today, the Institute 
has 53 chapters in the United States, Canada, and Europe. Our 5,400 
members are accountants, attorneys, and other business professionals 
who work for 2,800 of the leading companies in North America and 
Europe; they are responsible for conducting the tax affairs of their 
companies and ensuring their compliance with the tax laws.
    The majority of TEI's members work for multinational companies with 
substantial international operations and sales. Members of TEI are 
responsible for managing the tax affairs of their companies and must 
contend daily with the provisions of the various tax laws relating to 
the operation of business enterprises. Consequently, TEI members have a 
special interest in the tax treaty to bring off-shore earnings back to 
the United States, thereby aiding the domestic economy.
    Another benefit is the article modernizing the cross-border 
treatment of pension funding and benefits by coordinating the two 
countries' rules. This will permit citizens of each country to transfer 
between affiliated companies without jeopardizing the status of their 
retirement benefits. It will also encourage investment by Dutch 
companies in the United States, as well as enable U.S. companies to 
provide their U.S. citizen employees who transfer overseas, for 
example, on temporary assignment, with the same pension benefits as 
their U. S.-based colleagues.
    Finally, the Dutch Protocol will improve the exchange of 
information between U.S. and Dutch tax authorities. This will aid both 
countries' enforcement efforts against tax shelters or other abusive 
transactions. The new protocol will also enhance the ability of the 
Competent Authorities to minimize double taxation by improving the 
procedures for reaching mutual agreement on tax issues.
    TEI therefore urges the committee to approve the new agreement with 
the Netherlands.
    Turning to the Second Protocol to the U.S.-Barbados treaty, we note 
that--like the Dutch Protocol--the Barbados agreement is designed to 
bring the current treaty in line with U.S. policy and put adequate 
safeguards in place to prevent inappropriate use of the treaty. To 
accomplish these objectives, the Protocol expands the existing 
Limitation on Benefits article to modernize the treaty's anti-treaty-
shopping provision. The Treasury Department believes that the more 
restrictive terms will address concerns about the unintended use of the 
treaty by companies that purport to migrate their corporate structures 
off-shore.
    Although TEI has some reservations about the limiting effect that 
the Barbados Protocol may potentially have on legitimate tax planning, 
on balance we agree ratification is in the best interest of the country 
and the business community.
    Tax Executives Institute commends the Foreign Relations Committee 
for holding this public hearing. To enable the Internal Revenue Service 
and U.S. taxpayers to reap the benefits of the new agreements, we urge 
their prompt ratification. I would be pleased to respond to any 
questions you may have.

    The Chairman. Well, thank you very much for that testimony.
    Let me ask you, Ms. Zelisko, what would be the most 
significant impact of each of these two protocols--they are 
very different in a sense, different country size and 
situation--but the impact on tax planning for U.S. nationals? 
You are representing the tax practitioners in the largest firms 
in our country obviously involved in tax planning strategy for 
your company and representing others today. What is likely to 
be the most significant impact that you see as a tax planner or 
as a leader of those who are involved in that field?
    Ms. Zelisko.  Thank you, Mr. Chairman.
    With regard to the Netherlands, it is the third largest 
investor in the United States, and the United States is a 
significant investment in the Netherlands. This new protocol 
would eliminate the trade barrier by permitting companies to 
repatriate earnings without a withholding tax. So I think 
companies that have not traditionally paid dividends may 
reassess that policy and obviously impact the U.S. economy I 
think positively.
    It will also permit increased investment in the United 
States by Dutch companies by eliminating the branch profits 
tax.
    By limiting benefits to residents of both countries, the 
new protocol will also curb the inappropriate use of treaty 
shopping. So I think those are the major impacts that the two 
protocols will have.
    The Chairman. The dividend impact. Describe that just in 
layperson's terms if you will. What do companies do now? Do 
they accumulate the money in one place and do not pay it out to 
their stockholders because of tax implications? Or how will 
this affect income coming into the United States?
    Ms. Zelisko.  When companies are operating overseas and 
they are profitable, they are obviously having a positive cash 
flow and accumulating cash, and then when assessing whether or 
not you are going to bring those funds home, one of the factors 
that you have to consider is obviously the tax cost of that. 
And depending upon the tax position of the company, if they 
happen to be in an excess tax credit position, the fact that 
you would also have a withholding tax, obviously increases the 
amount of credits that that company would have to absorb. And 
if they are in an excess credit position, Mr. Chairman, that is 
a net cost because they would have to have paid an additional 
tax. They cannot currently then offset that against their 
income because of the limitation calculation that we have to go 
through. Then that is a net cost of bringing those funds home. 
So consequently, they would basically obviously, depending upon 
other factors of the economics of the company, keep those funds 
overseas.
    The Chairman. So, in essence, at least there is a more 
likely decision to bring some of that money back to the United 
States to shareholders here who then will reap the benefits of 
that. They would reap them anyway, but it would be somewhere 
else, sort of in the hereafter as opposed to as a part of 
immediate income to them and to our country.
    Ms. Zelisko.  Exactly. Again, like anything else, it is a 
business decision, but obviously cost of funds is an important 
one.
    The Chairman. Now, how do you gauge that enactment of these 
protocols will affect worker flow between the United States and 
the Netherlands or Barbados? Do you have any comment as to what 
is going to happen with regard to workers coming and going?
    Ms. Zelisko.  I think certainly with regard to the Dutch 
protocol that we are looking at here today, employees who 
transfer overseas can often be whipsawed by the divergent 
pension rules that I mentioned earlier, sometimes being taxed 
when the pensions are funded and then again when they are 
distributed. The Dutch protocol specifically addresses this 
issue and coordinates the two countries' rules on pension 
funding and benefits, which will therefore permit U.S. 
companies to more freely transfer their workers among their 
operations without jeopardizing the status of their pension 
benefits, which obviously is, therefore, going to increase the 
worker flow potentially for temporary assignments and again 
reduce the barrier to that flow.
    The Chairman. Now, both protocols before the committee 
attempt to strengthen the ability of each country's tax 
authorities to exchange information about taxpayers when 
necessary. How has that lack of ability to exchange information 
impacted your members?
    Ms. Zelisko.  Well, again, I think anytime there is an 
increased information flow, I think that is positive. More 
specifically, governments obviously are involved in the 
enforcement of their tax laws and to have that information 
available is important because the extent of those exchanges 
provide a more level playing field for all concerned, for all 
taxpayers. Companies that do not engage in those abusive 
transactions will benefit by being able to compete more 
effectively, Mr. Chairman.
    The Chairman. Just as a general question from your 
expertise, obviously the provisions of these treaties we 
generally see as advances, but what do you consider to be the 
most significant tax barriers that remain in cross-border 
investment? If we are talking about the model treaty or about 
additional treaties, what sort of considerations should 
Treasury or the relevant committees of the Congress be 
considering?
    Ms. Zelisko.  Well, not only with regard to, I think, tax 
treaties, Mr. Chairman, but also with regard to tax legislation 
I think have major implications with regard to competitiveness 
of U.S. businesses. The high U.S. tax rate on corporations may 
act as a barrier to cross-border investments. In addition, U.S. 
tax laws may make it more difficult for U.S. companies to 
compete effectively overseas. U.S. companies face double 
taxation because of U.S. tax laws that, for example, allocate 
U.S. interest and other expenses against foreign source income 
for purposes of the foreign tax credit. In addition, U.S. 
companies that experience losses domestically while earning 
income abroad suffer a reduction in the foreign tax credit 
limitations which is important when you are trying to bring 
funds home from overseas. Finally, the alternative minimum tax 
limits, the amount of foreign tax credits the company may use, 
is also a barrier. Many of these provisions are addressed in 
legislation currently pending before Congress.
    The Chairman. Yes, not necessarily in these treaties but 
more generally.
    Ms. Zelisko.  More generally.
    The Chairman. And perhaps will receive action. I raise it 
only in this context because sometimes constructive things have 
been occurring through the treaty provisions. This is not a 
substitute for wholesale tax reform, but sometimes that has 
been hard for the Congress to come to grips with. But I 
appreciate your comment. This is very helpful.
    Mr. Reinsch, let me just ask you for a general thought. You 
have appeared now before the committee on each of these 
occasions when we have been taking up tax treaties and 
commended the committee for doing so with the UK, Australia, 
Mexico, Japan, Sri Lanka. How has the enactment of these 
treaties, prior to our consideration today of the Netherlands 
and Barbados, affected the flow of trade between the United 
States and the companies that have been affected? Have you seen 
any changes?
    Mr. Reinsch.  We expect it will have a positive effect, Mr. 
Chairman, but the truth is it is too soon to say. As you know, 
most of them have a lag in effective date. I think the Japan 
treaty, for example, substantial parts of it, will not go into 
effect until January 1 I think.
    The Chairman. Next year.
    Mr. Reinsch.  In addition, there is a data lag particularly 
for investment of a year or more. The trade lag is a little bit 
less. And in some cases, Australia being the primary example, 
we will probably never be able to tell because we are 
implementing a free trade agreement with them at the same time 
and trying to sort out what is a consequence of what action 
would be impossible. But we are expecting a favorable result. 
One of the things that we can do as part of our annual survey 
of our members on this subject is to ask them that question.
    The Chairman. I would appreciate that. You do have a 
membership that is very sensitive to these issues and is likely 
to be prescient as to what the data that does have a lag, as 
you say, may show. So to the extent that you can forward that 
to the committee or make it general public knowledge, this is 
very helpful as we proceed in these considerations of tax 
treaties in this debate.
    Mr. Reinsch.  We would be pleased to.
    The Chairman. Now, can you estimate how many United States 
companies are currently doing business or have investments in 
the Netherlands? I cited maybe 1,600 as our best view right 
now, which is a lot of American companies. Maybe you have 
additional data on this. I am simply curious why so many 
American companies are in the Netherlands; likewise, vice 
versa, why the volume of trade and investment has been so 
large. This is the third largest situation that we have 
considered. What are the characteristics of this relationship 
that have led to this?
    Mr. Reinsch.  Well, I think first of all, Mr. Chairman, we 
do not have better data than you. This regularly shows up as a 
significant country, as I said, in the survey that we conduct. 
Approximately half our member companies have participated, and 
our tax committee survey indicated that this was a significant 
country as far as their business is concerned.
    I think the reasons for the extent of the depth and breadth 
of the trade relationship in what is a small country is largely 
historic. You have, first of all, a long-term positive 
relationship with the Netherlands that goes back hundreds of 
years. You have a country there that has been one of the 
foremost trading and investing outward nations in Europe for a 
long time. You have had substantial Dutch investment in the 
United States for years, probably second in Europe only to the 
UK. A lot of our companies locate either their headquarters or 
various planning facilities there for their European 
operations. These are not in every case large manufacturing 
establishments, but they are either corporate headquarters or 
various divisions that do planning. It is centrally located. 
Transportation is efficient. It is linguistically convenient, 
if you will. Virtually everybody speaks English, which is not 
true in some countries to the south. And as a result, it is 
just a very attractive location, and there has been a lot of, 
in a sense, reciprocation of that attractiveness, with Dutch 
investment coming here over the years.
    The Chairman. Well, thank you very much for that testimony. 
I would indicate that this committee--and I am sure I speak for 
our country--very much appreciates the relationship we have 
with the Netherlands in areas that are outside the purview that 
we are discussing today. But it is a very important 
relationship. It is very important we take seriously these tax 
provisions and the commercial possibility of the equity that 
may come from these revisions.
    Let me just ask you the same question that I asked Ms. 
Zelisko. As you review with your members particular concerns on 
the model treaty, are you regularly in touch with Treasury, the 
joint committee, with us, with anybody? In other words, can you 
give us some idea of how the communication goes so that we are 
all thinking along the same track, and when we come to 
conclusions, then actually draft a treaty for formal 
ratification, that we have got it right?
    Mr. Reinsch.  Yes, certainly Mr. Chairman. I have to say I 
was amused in the previous panel on this issue you asked the 
same question that you asked 6 months ago and you got the same 
answer. I hope that we continue to make progress. I am going to 
try not to give you quite the same answer. You have asked me a 
different question, so I know you will get a different answer.
    We have a very constructive and I think positive 
relationship with the Treasury, particularly with Ms. Angus. 
She has regularly visited with us virtually on request. Our tax 
committee has two big meetings a year, fall and spring. She has 
consistently been both a guest speaker at both meetings 
annually, as well as spending considerable time, both before 
and after her remarks, to stay in touch with our individual 
members. We have a very direct, very clear channel of 
communication, both with her and her colleagues at the 
Treasury, virtually at any moment, and my colleague, Judy 
Scarabello, who is our Vice President for Tax, has been known 
to call her evenings, weekends, at virtually any moment. We 
have shared our survey information with her and would like to 
think that the Treasury has used that as input, particularly in 
focusing on where they would like to go next because that is 
one of the key questions we ask our members, what countries are 
of interest to them.
    So we are very pleased with the two-way nature of the 
relationship. She and her colleagues have not been shy about 
asking our opinion of things and also telling us when things 
that we want are not going to happen. And that is a 
relationship that we respect and appreciate.
    The Chairman. Well, I thank you for that reassurance. The 
purpose of raising the question is really to make sure we all 
stay in touch.
    Mr. Reinsch.  I say the same thing, Mr. Chairman, with 
respect to the committee. We have had a very constructive 
working relationship with the staff on both sides of the aisle, 
and we look forward to continuing it.
    The Chairman. I would just underline the fact that clearly 
you and the companies that you represent are exhorted 
constantly by all Americans to do more. We have an enormous 
balance of trade deficit. The need for American companies to be 
more successful exporters and to engage more successfully in 
international business is obviously apparent. There are some 
alarmists on the scene that see these deficits and their 
accumulation as an impending source of genuine concern for our 
entire economy and for the incomes of Americans. So what we are 
talking about today is very serious in terms of our foreign 
policy and our national strength.
    But having said that, we appreciate especially the witness 
of both of you on the technical aspects of taxes because this 
affects numbers of decisions as to how aggressive Americans 
want to be in terms of their foreign trade aspect and in terms 
of looking at those markets and then the fairness to each of 
the firms you represent because you both have broad 
constituencies of companies involved in all sorts of business 
that you have to consider as you think of your testimony.
    I have no more questions, but I would ask either of you if 
you have additional testimony or thoughts that have arisen as 
you have listened to the testimony, why, please give us the 
benefit of that presently. Do you have anything further you 
would like to comment, Ms. Zelisko?
    Ms. Zelisko.  The only thing I would like to add, Mr. 
Chairman, is that we also have a very good relationship with 
Ms. Angus with regard to, obviously, free flow of communication 
and input and make comments regularly with regard to whether it 
is treaties or proposed legislation. So again, I think that is 
very helpful for both sides.
    The Chairman. Well, that is reassuring. Just out of 
curiosity, where are your headquarters? Located here in 
Washington?
    Ms. Zelisko.  Yes, we are, sir.
    The Chairman. And do you have regular board meetings, 
conventions, or how does the input of your members come to you?
    Ms. Zelisko.  Well, we are governed by an executive 
committee, but we have an annual conference and a mid-year 
conference, which the mid-year is held here in Washington every 
year. And people from the Treasury are regular speakers at our 
conferences. We have an annual liaison meeting with Treasury, 
usually in February, in which issues are raised by our members 
which we solicit through our various committees that we have, 
and given that we are global in nature, we also have a very 
robust European chapter that has over 200 members companies, so 
obviously many members in the Netherlands as well talking here 
today. Consequently, we have a broad breadth of input with 
regard to the issues that face basically companies not only in 
the United States but the impact of those laws on our 
counterparts outside the United States.
    The Chairman. Thus, in your deliberation of members with 
the Treasury, at least a portion of those meetings has an 
international content I suspect, both because you have the 
European chapters, but likewise because you are interested in 
the equities of the type of consideration we have here today.
    Ms. Zelisko.  Yes, exactly.
    The Chairman. Very good.
    Now, how do you interact with your members, Mr. Reinsch?
    Mr. Reinsch.  Well, as much as possible. We do a wide 
variety of things, in addition to taxes, as you well know from 
our other interactions.
    The Chairman. Yes.
    Mr. Reinsch.  In this particular area, we have a tax 
committee which has itself a steering committee. The steering 
committee meets every 6 weeks, and it is both a meeting to 
discuss our agenda and what matters to our members. Also, we 
usually have a guest speaker oftentimes someone from the 
Treasury, but not always, to get an update on a matter of 
interest.
    We do an annual survey, as I indicated, specifically on 
treaties, and that then becomes our working agenda for our 
treaty goals for the year.
    We have two large meetings for the general membership, one 
in the spring that is out of town, and one in the fall that is 
here in Washington.
    The Chairman. As you have considered future work by 
Treasury, yourselves, or us on treaties, are there certain 
countries that come to mind or certain categories or parts of 
the world? Can you give us any forecast of where your 
recommendations will be?
    Mr. Reinsch.  I am glad you asked that, Mr. Chairman. The 
big two are Canada and Brazil, neither of which have evidenced 
much interest in a negotiation unfortunately.
    The Chairman. It is unfortunate.
    Mr. Reinsch.  We give the Treasury a great deal of credit 
for its efforts, and they continue to beat on the door and try 
to make these things move forward. Those are both important 
economies where there is substantial U.S. business and 
significant tax problems that we would like to see addressed.
    Beyond that, I think there are other EU countries, Germany 
being an example, where it would be nice to update the treaty 
and put in the zero withholding provision as well. But the big 
two that are sort of lurking out there are Canada and Brazil.
    The Chairman. Well, you raise an important issue because 
even if we are eager to visit about reform, sometimes our 
partners are not. It is not axiomatic, that we get excited and 
suddenly it happens. I think that is an important point in 
foreign relations generally, as many of us have found in 
treaties on other sorts of issues. But at the same time, I 
appreciate your candid answer because it does focus at least 
some public attention on the fact that some progress could be 
made with our good friends in Canada and Brazil. We hope they 
might be more forthcoming and likewise others.
    Well, I thank both of you again for your expert testimony, 
for coming again to the committee, and for your ongoing 
cooperation as you have illuminated that today. We will do our 
best to move these treaties to conclusion during this session 
of the Congress, and we ask you to continue to help us and to 
follow these activities.
    Ms. Zelisko.  Thank you very much, Mr. Chairman.
    Mr. Reinsch.  Thank you.
    The Chairman. Having said that, the hearing is adjourned.

    [Whereupon, at 11:09 the hearing was adjourned.]


                            A P P E N D I X

                              ----------                              



 Statement Submitted for the Record by Senator George Allen of Virginia

    I want to thank you for your leadership in scheduling this hearing 
regarding mutually beneficial income tax protocols with close United 
States trading partners such as the Netherlands. On March 8, 2004, the 
US and the Netherlands signed a protocol to the existing U.S./Dutch 
income tax treaty, which among other matters, provides for the 
exemption from withholding tax on corporate dividends. By eliminating 
double taxation of international income, we will promote direct foreign 
investment which will encourage a growing US economy and increasing 
U.S. employment. Current Dutch law imposes a general withholding tax on 
U.S. based companies similar to that imposed by the U.S. Consequently 
an exemption from the withholding tax on dividends under the new 
protocol would also benefit U.S. based companies. The bottom line here 
is that the U.S./Dutch tax protocol is beneficial to both parties.
    The Netherlands is the third largest investor in the U.S., having 
invested $155 billion in the US in 2002. Additionally, the Netherlands 
is a significant importer of U.S. goods and services with imports of 
$18.3 billion in 2002. The US has been running a trade surplus with the 
Dutch of approximately $8.5 billion per year.
    The U.S. is the largest investor in the Netherlands and the 
Netherlands is the third largest recipient of U.S. direct investment 
behind only the U.K. and Canada.
    The timing is especially auspicious for Senate ratification of the 
U.S./Dutch protocol in light of the fact that the Netherlands, a 
staunch U.S. ally. We appreciate and applaud the Netherlands for 
sending troops to help in the transition to democracy and peace in Iraq 
and for their efforts to promote a productive transatlantic partnership 
between the U.S. and the E.U. The Dutch have had the oldest continuous 
trade relationship with the U.S., longer than any other trading 
partner. As I understand it, Senate ratification of the protocol is a 
high priority for both the U.S. and Dutch governments.
    The Dutch Parliament ratified the protocol in July and I hope that 
we can reciprocate by ensuring Senate ratification before we adjourn in 
October. Thank you again Mr. Chairman for moving forward on important 
tax protocols and on many other key foreign policy matters.

                               __________

                 TECHNICAL EXPLANATIONS OF THE TREATIES

        prepared by the united states department of the treasury
                               __________

DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE PROTOCOL SIGNED 
  AT WASHINGTON ON MARCH 8, 2004, AMENDING THE CONVENTION BETWEEN THE 
  UNITED STATES OF AMERICA AND THE KINGDOM OF THE NETHERLANDS FOR THE 
AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH 
 RESPECT TO TAXES ON INCOME, SIGNED AT WASHINGTON ON DECEMBER 18, 1992

    This is a technical explanation of the Protocol signed at 
Washington on March 8, 2004 (the ``Protocol''), amending the Convention 
between the United States of America and the Kingdom of the Netherlands 
for the avoidance of double taxation and the prevention of fiscal 
evasion with respect to taxes on income, signed at Washington on 
December 18, 1992 (the ``1992 Convention''), as amended by a protocol 
signed at Washington on October 13, 1993 (the ``1993 Protocol''). The 
term ``Convention'' refers to the 1992 Convention as modified by both 
the 1993 Protocol and the Protocol.

    Negotiations took into account the U.S. Treasury Department's 
current tax treaty policy and the Treasury Department's Model Income 
Tax Convention, published on September 20, 1996 (the ``U.S. Model''). 
Negotiations also took into account the Model Tax Convention on Income 
and on Capital, published by the Organization for Economic Cooperation 
and Development, as updated in January 2003 (the ``OECD Model''), and 
recent tax treaties concluded by both countries.

    The Technical Explanation is an official guide to the Protocol It 
reflects the policies behind particular Protocol provisions, as well as 
understandings reached with respect to the application and 
interpretation of the Protocol and the 1992 Convention. This Technical 
Explanation should be read together with the Technical Explanation to 
the 1992 Convention with respect to provisions that have not been 
modified.

    The Protocol was accompanied by a detailed Understanding, 
implemented through an exchange of notes, indicating the views of the 
negotiators and of the States with respect to a number of provisions of 
the Convention. The Understanding supersedes the Understanding 
accompanying the 1992 Convention and the related exchange of notes 
accompanying the 1993 Protocol. The portions of the Understanding that 
have been added (as opposed to being merely repeated) are discussed in 
connection with the relevant portions of the Protocol.

    Paragraph XXXVIII of the Understanding provides that the United 
States and the Netherlands will consult together at regular intervals 
regarding the terms, operation and application of the Convention to 
ensure that it continues to serve the purposes of avoiding double 
taxation and preventing fiscal evasion. The first such consultation 
will take place no later than December 31st of the fifth year following 
the date on which the Protocol enters into force in accordance with the 
provisions of Article 10 of the Protocol. Further consultations shall 
take place thereafter at intervals of no more than five years. The 
Understanding also provides that the United States and the Netherlands 
will conclude further protocols to amend the Convention, if 
appropriate.

    References in the Technical Explanation to ``he'' or ``his'' should 
be read to mean ``he or she'' or ``his or her.''

                               Article 1

    Article 1 of the Protocol modifies Article I (General Scope) of the 
Convention to add new paragraph 3. Paragraph 3 specifically relates to 
the application to the Convention of dispute-resolution procedures and 
non-discrimination provisions under other agreements. The provisions of 
paragraph 3 are an exception to the rule provided in subparagraph (b) 
of paragraph 2 of Article 1 under which the Convention shall not 
restrict in any manner any benefit now or hereafter accorded by any 
other agreement between the Contracting States.

    Clause (i) of subparagraph (a) of paragraph 3 provides that, 
notwithstanding any other agreement to which the Contracting States may 
be parties, a dispute concerning the interpretation or application of 
the Convention, including a dispute concerning whether a measure is 
within the scope of the Convention, shall. be considered only by the 
competent authorities of the Contracting States, and the procedures 
under Article 29 (Mutual Agreement Procedure) of the Convention 
exclusively shall apply to the dispute. Thus, dispute-resolution 
procedures that may be incorporated into trade, investment, or other 
agreements between the Contracting States shall not apply in 
determining the scope of the Convention.

    Clause (ii) of subparagraph (a) of paragraph 3 provides that the 
national treatment provisions of Article XVII of the General Agreement 
on Trade in Services (``GATS'') shall not apply to any ``measure'' 
unless the competent authorities agree that such measure is not within 
the scope of the non-discrimination provisions of Article 28 (Non-
Discrimination) of the Convention. Subparagraph (b) of paragraph 3 
defines the term ``measure'' to mean a law, regulation, rule, 
procedure, decision, administrative action, or any similar provision or 
action, as related to taxes of every kind and description imposed by a 
Contracting State. Accordingly, no national treatment obligation 
undertaken by a Contracting State pursuant to GATS shall apply to a 
measure, unless the competent authorities agree that it is not within 
the scope of the Convention. The provision does not provide any 
limitation on the application of the most favored nation obligation 
(``MFN'') of Article II of GATS. Because there is no MFN obligation in 
the Convention, there can be no conflict between the Convention and the 
MFN obligation of GATS.

    Unlike the analogous provision in the U.S. Model, paragraph 3. does 
not include limitations on the application of the national treatment 
and MFN obligations of other agreements. The U.S. Model provision 
states generally that national treatment or MFN obligations undertaken 
by the Contracting States under any agreement other than the tax treaty 
and the General Agreement on Tariffs and Trade as applicable to trade 
in goods do not apply to a taxation measure, unless the competent 
authorities otherwise agree. Except as discussed above with respect to 
GATS, subparagraph 2(b) of the Convention provides that if there were 
overlap between Article 28 of the Convention and the national treatment 
or MFN obligations of any agreement, benefits would be available under 
both the Convention and that agreement. In the event of such overlap, 
to the extent benefits are available under that agreement that are not 
available under Article 28 of the Convention, a resident of a 
Contracting State is entitled to the benefits provided under the 
overlapping agreement.

                               Article 2

    Article 2 of the Protocol modifies Article 4 (Resident) of the 1992 
Convention by eliminating a special rule regarding the residence of 
estates and trusts. This rule is no longer necessary as the Protocol 
adopts a more general rule regarding fiscally transparent entities, 
found in a new paragraph 4 of Article 24 (Basis of Taxation) of the 
Convention. The new paragraph is discussed below in the Technical 
Explanation to Article 6 of the Protocol.

    Although the general rule regarding the determination of residence 
has not been changed, subparagraph (b) of Paragraph I of the 
Understanding clarifies the application of the existing definition with 
respect to certain dual resident companies. If a company is a resident 
of one of the Contracting States under the domestic law of that State, 
but is treated as a resident of a third state under a treaty between 
that State and the third state, then it will not be treated as a 
resident of the Contracting State for purposes of the Convention. For 
example, if a company that is organized in the Netherlands is managed 
and controlled in the United Kingdom, both countries would treat the 
company as being a resident under its domestic laws. However, the 
treaty between the Netherlands and the United Kingdom assigns residence 
in such a case to the country in which the company's place of effective 
management is located. Assuming that, in this case, the place of 
effective management is the United Kingdom, the company would not 
qualify for benefits under the U.S.-Netherlands treaty because it is 
not subject to tax in the Netherlands as a resident of the Netherlands. 
The paragraph in the Understanding thus is consistent with the holding 
of Rev. Rul. 2004-76, 2004-31 I.R.B. 111.

                               Article 3

    Paragraph (a) of Article 3 of the Protocol replaces Article 10 
(Dividends) of the Convention. Article 10 provides rules for the 
taxation of dividends paid by a company that is a resident of one 
Contracting State to a beneficial owner that is a resident of the other 
Contracting State. The Article provides for full residence country 
taxation of such dividends and a limited source-State right to tax. 
Finally, the Article prohibits a State from imposing taxes on a company 
resident in the other Contracting State, other than a branch profits 
tax, on undistributed earnings.
Paragraph 1

    The right of a shareholder's country of residence to tax dividends 
arising in the source country is preserved by paragraph 1, which 
permits a Contracting State to tax its residents on dividends paid to 
them by a company that is a resident of the other Contracting State.
Paragraph 2

    The State of source also may tax dividends beneficially owned by a 
resident of the other State, subject to the limitations of paragraphs 2 
and 3. Paragraph 2 generally limits the tax in the State of source on 
the dividend paid by a company resident in that State to 15 percent of 
the gross amount of the dividend. If, however, the beneficial owner of 
the dividend is a company that is a resident of the other State and 
that directly owns shares representing at least 10 percent of the 
voting power of the company paying the dividend, then the withholding 
tax in the State of source is limited to 5 percent of the gross amount 
of the dividend. Shares are considered voting shares if they provide 
the power to elect, appoint or replace any person vested with the 
powers ordinarily exercised by the board of directors of a U.S. 
corporation.

    The benefits of paragraph 2 may be granted at the time of payment 
by means of reduced withholding at source. It also is consistent with 
the paragraph for tax to be withheld at the time of payment at full 
statutory rates, and the treaty benefit to be granted by means of a 
subsequent refund so long as refund procedures are applied in a 
reasonable manner.

    The term ``beneficial owner'' is not defined in the Convention, and 
is, therefore, defined as under the internal law of the country 
imposing tax (i.e., the source country). The beneficial owner of the 
dividend for purposes of Article 10 is the person to which the dividend 
income is attributable for tax. purposes under the laws of the source 
State. Thus, if a dividend paid by a corporation that is a resident of 
one of the States (as determined under Article 4 (Resident)) is 
received by a nominee or agent that is a resident of the other State on 
behalf of a person that is not a resident of that other State, the 
dividend is not entitled to the benefits of this Article. However, a 
dividend received by a nominee on behalf of a resident of that other 
State would be entitled to benefits. These interpretations are 
confirmed by paragraph 12 of the Commentary to Article 10 of the OECD 
Model. See also paragraph 24 of the Commentary to Article 1 of the OECD 
Model.

    Companies holding shares through fiscally transparent entities such 
as partnerships are considered for purposes of this paragraph to hold 
their proportionate interest in the shares held by the intermediate 
entity. As a result, companies holding shares through such entities may 
be able to claim the benefits of subparagraph (a) under certain 
circumstances. The lower rate applies when the company's proportionate 
share of the shares held by the intermediate entity meets the 10 
percent threshold. Whether this ownership threshold is satisfied may be 
difficult to determine and often will require an analysis of the 
partnership or trust agreement.
Paragraph 3

    Paragraph 3 provides exclusive residence-country taxation (i.e. an 
elimination of withholding tax) with respect to certain dividends 
distributed by a company that is a resident of one Contracting State to 
a resident of the other Contracting State. As described further below, 
this elimination of withholding tax is available with respect to 
certain inter-company dividends.

    Subparagraph (a) of paragraph 3 provides for the elimination of 
withholding tax on dividends beneficially owned by a company that has 
owned directly 80 percent or more of the voting power of the company 
paying the dividend for the 12-month period ending on the date the 
dividend is declared.

    Eligibility for the elimination of withholding tax provided by 
subparagraph (a) is subject to additional restrictions based on, but 
supplementing, the rules of Article 26 (Limitation on Benefits). These 
restrictions are necessary because of the increased pressure on the 
Limitation on Benefits tests resulting from the fact that the United 
States has relatively few treaties that provide for such elimination of 
withholding tax on inter-company dividends. The additional restrictions 
are intended to prevent companies from re-organizing in order to become 
eligible for the elimination of withholding tax in circumstances where 
the Limitation on Benefits provision does not provide sufficient 
protection against treaty-shopping.

    For example, assume that ThirdCo. is a company resident in a third 
country that does not have a tax treaty with the United States 
providing for the elimination of withholding tax on inter-company 
dividends. ThirdCo owns directly 100 percent of the issued and 
outstanding voting stock of USCo, a U.S. company, and of DCo, a 
Netherlands company. DCo is a substantial company that manufactures 
widgets; USCo distributes those widgets in the United States. If 
ThirdCo contributes to DCo all the stock of USCo, dividends paid by 
USCo to DCo would qualify for treaty bene fits under the active trade 
or business test of Paragraph 4 of Article 26. However, allowing 
ThirdCo to qualify for the elimination of withholding tax, which is not 
available to it under the third state's treaty with the United States 
(if any), would encourage treaty-shopping.

    Accordingly, a company that meets the holding requirements 
described above still will qualify for the benefits of paragraph 3 only 
in certain circumstances. Under Article 10(3)(b), publicly traded 
companies and subsidiaries of publicly-traded companies will qualify 
for the elimination of withholding tax without meeting any additional 
requirements. Thus, a company that is a resident of the Netherlands and 
that meets the listing and trading requirements of Article 26(2)(c) 
will be entitled to the elimination of withholding tax, subject to the 
12-month holding period requirement of Article 10(3).

    In addition, under Article 10(3)(c), a company that is a resident 
of a Contracting State may also qualify for the elimination of 
withholding tax on dividends if it satisfies the derivative benefits 
test of paragraph 3 of Article 26. Thus, a Netherlands company that 
owns all of the stock of a U.S. corporation can qualify for the 
elimination ofwithholding tax if it is wholly-owned, for example, by a 
U.K. or a Mexican publicly-traded company that otherwise satisfies the 
requirements to be an ``equivalent beneficiary''. At this time, 
ownership by companies that are residents of other EU, EEA or NAFTA 
countries would not qualify the Netherlands company for benefits under 
this provision, as the United States does not have treaties that 
eliminate the withholding tax on inter-company dividends with any other 
of those countries. If the United States were to negotiate such 
treaties with more of those countries, residents of those countries 
could then qualify as equivalent beneficiaries for purposes of this 
provision.

    The derivative benefits test may also provide benefits to U.S. 
companies receiving dividends from Netherlands subsidiaries, because of 
the effect of the Parent-Subsidiary Directive in the European Union. 
Under that directive, inter-company dividends paid within the European 
Union are free of withholding tax. Under subparagraph (g) of paragraph 
8 of Article 26, that directive will also be taken into account in 
determining whether the owner of U.S. company receiving dividends from 
a Netherlands company is an ``equivalent beneficiary''. Thus, a. 
company that is a resident of a Member State of the European Union 
will, by definition, meet the requirements regarding equivalent 
benefits with respect to any dividends received by its U.S. subsidiary 
from a Netherlands company. For example, assume USCo is a wholly-owned 
subsidiary of ICo, an Italian publicly traded company. USCo owns all of 
the shares of DCo, a Netherlands company. If DCo were to pay dividends 
directly to ICo, those dividends would be exempt from withholding tax 
in the Netherlands by reason of the Parent-Subsidiary Directive, even 
though the tax treaty between Italy and the Netherlands otherwise would 
allow the Netherlands to impose a:withholding tax at the rate of 5 
percent. If ICo meets the other conditions of subparagraph 8(f) of 
Article 26, it will be treated as an equivalent beneficiary by reason 
of subparagraph 8(g) of that Article.

    A company also could qualify for the elimination of withholding tax 
pursuant to Article 10(3)(c) if it is owned by seven or fewer U.S. or 
Netherlands residents who fall within a limited category of ``qualified 
persons.'' This rule would apply; for example, to certain Netherlands 
corporations that are closely-held by a few Netherlands resident 
individuals or charities.

    The definition of ``equivalent beneficiary'' is also intended to 
ensure that certain joint ventures, not just wholly-owned subsidiaries, 
can qualify for benefits. For example, assume that the United States 
were to enter into a treaty with Country X, an EU, EEA or NAFTA 
country, that includes a provision identical to Article 10(3). USCo is 
100 percent owned by DCo, a Netherlands company, which in turn is owned 
49 percent by PCo, a Netherlands publicly-traded company, and 51 
percent by XCo, a publicly-traded company that is resident in Country X 
In the absence of a special rule for interpreting derivative benefits 
provisions, each of the shareholders would be treated as owning only 
their proportionate share of the shares held by DCo. If that rule were 
applied in this situation, neither shareholder would be an equivalent 
beneficiary, since neither would meet the 80 percent ownership test 
with respect to USCo. However, since both PCo and XCo are residents of 
countries that have treaties with the United States that provide for 
elimination of withholding tax on inter-company dividends, it is 
appropriate to provide benefits to DCo in this case.

    Accordingly, the definition of ``equivalent beneficiary'' includes 
a rule of application that is intended to ensure that such joint 
ventures qualify for the benefits of Article 10(3). Under that rule, 
each of the shareholders is treated as owning shares with the same 
percentage of voting power as the shares held by DCo for purposes of 
determining whether it would be entitled to an equivalent rate of 
withholding tax. This rule is necessary because of the. high ownership 
threshold for qualification for the elimination of withholding tax on 
inter-company dividends.

    A company that qualifies for the benefits of the Convention under a 
Limitation on Benefits provision other than the rules described above 
will qualify for the elimination of withholding tax on inter-company 
dividends only if it acquired shares representing 80 percent or more of 
the voting stock of the company paying the dividends prior to October 
1, 1998, or it receives a determination from the competent authority 
with respect to Article 10(3). Accordingly, in the first example above, 
DCo will not qualify for the elimination of withholding tax on 
dividends unless it owned USCo before October 1, 1998. If it did own. 
USCo before October I, 1998, then it will continue to qualify for the 
elimination of withholding tax on dividends so long as it qualifies for 
benefits under at least one of the tests of Article 26. So, for 
example, if ThirdCo decides to get out of the widget business and sells 
its. stock in DCo to FWCo, a company that is resident in a country with 
which the United States does not have a tax treaty, DCo would continue 
to qualify for the elimination of withholding tax on dividends so long 
as it continues to meet the requirements of the active trade or 
business test of Article 26(4) or, possibly, the competent authority 
discretionary test of Article 26(7).

    The result would be different under the ``ownership-base erosion'' 
test of Article 26(2)(f). For example, assume DCo is a passive holding 
company owned by Netherlands individuals, which was established in 1996 
to hold the shares of USCo. DCo qualifies for the benefits of the 
Convention only under the ownership-base erosion test of Article 
26(2)(0. If the Netherlands individuals sell their stock in DCo to 
FWCo, DCo would lose all the benefits accorded to residents of the 
Netherlands under the Convention (including the elimination .of 
withholding tax on dividends) because the company would no longer 
qualify for benefits under Article 26 (unless, of course, the U.S. 
competent authority were to grant benefits under Article 26(7)).

    If a company does not qualify for the elimination of withholding 
tax under any of the foregoing objective tests, it may request a 
determination from the relevant competent authority pursuant to 
paragraph 7 of Article 26. Benefits will be granted with respect to an 
item of income if the competent authority of the Contracting State in 
which the income arises determines that the establishment, acquisition 
or maintenance of such resident and the conduct of its operations did 
not have as one of its principal purposes the obtaining of benefits 
under the Convention.

    In making its determination under Article 26(7) with respect to 
income arising in the United States, the U.S. competent authority will 
consider the obligations imposed upon the Netherlands by its membership 
in the European Communities. In particular, the United States will have 
regard to any legal requirements for the facilitation of the free 
movement of capital among Member States of the European Communities. 
The competent authority will also consider the differing internal tax 
systems, tax incentive regimes and tax treaty practices of the relevant 
Member States.

    For example, in the case above where DCo ceased to qualify for the 
elimination of withholding tax because it was acquired by FWCo, the 
competent authority would consider whether FWCo were a resident of a 
Member State of the European Communities. If it were, that would be a 
factor in favor of a determination that DCo is entitled to the benefits 
of the elimination of withholding tax on dividends. This would be 
particularly true if the U.S. business was a relatively small portion 
of the business acquired. However, that positive factor could be 
outweighed by negative factors. One negative factor could be a 
determination by the U.S. competent authority that FWCo benefited from 
a tax incentive regime that eliminated any domestic taxation. The 
competent authority would also consider facts that might indicate that 
an acquisition was not undertaken ``under ordinary business 
conditions'' but instead was undertaken to acquire the Netherlands-U.S. 
``bridge.'' These might include the fact that the Netherlands company 
was acquired even though all or substantially all of the business 
activities acquired consisted of the U.S. business; the fact that 
existing U.S. operations were restructured in an attempt to benefit 
from the elimination of withholding tax on dividends; or the fact that 
FWCo was owned by residents of a country that is not a Member State of 
the European Communities. Finally, another significant negative factor 
would be if the U.S. competent authority faced difficulties in learning 
the identity of FWCo's owners, such as an uncooperative taxpayer or 
legal barriers such as ``economic espionage '' or other limitations on 
the effective exchange of information in the country of which FWCo is a 
resident.

    Paragraph VIII of the Understanding establishes a hierarchy with 
respect to these tests. Any company that acquired the shares of the 
paying company after September 30, 1998, may request a discretionary 
ruling from the competent authority, unless it would qualify for 
benefits under subparagraphs 3(b) or 3(c). Thus, the competent 
authority could agree that a company may qualify for the elimination of 
withholding tax even if it satisfies Limitation on Benefits under the 
active conduct of a trade or business or the headquarters company test, 
or even if it does not satisfy any of the objective tests in Article 
26. However, the competent authority will not give ``comfort rulings'' 
to companies that meet the requirements of another subparagraph of 
paragraph 3.
Paragraph 4

    Paragraph 4 modifies in particular cases the maximum rates of 
withholding tax at source provided for in paragraphs 2 and 3.

    Subparagraph (a) provides that dividends paid by a U.S. Regulated 
Investment Company (``RIC'') or U.S. Real Estate Investment Trust 
('REIT``) or a Dutch beleggingsinstelling are not eligible for the 5 
percent maximum rate of withholding tax in subparagraph (a) of 
paragraph 2 or the elimination of withholding tax of paragraph 
3.Subparagraph (b) of paragraph 4 provides that the 15 percent maximum 
rate of withholding tax in subparagraph (b) of paragraph (2) shall 
apply for dividends paid by a RIC or a Dutch beleggingsinstelling 
(subject to the rule in subparagraph (c) regarding 
beleggingsinstellings that invest primarily in real estate).

    Subparagraph (c) provides that the 15 percent withholding rate in 
subparagraph (b) of paragraph (2) shall apply for dividends paid by a 
REIT or a beleggingsinstelling that invests in real estate to the same 
extent as a REIT, provided certain conditions are met. First, the 
dividend may qualify for the 15 percent maximum rate if the person 
beneficially entitled to the dividend is an individual holding an 
interest of not more than 25 percent in the REIT or 
beleggingsinstelling. Second, the dividend may qualify for the 15 
percent maximum rate if it is paid with respect to a class of stock 
that is publicly traded and the person beneficially entitled to the 
dividend is a person holding an interest of not more than 5 percent of 
any class of stock of the REIT or beleggingsinstelling. Third, the 
dividend may qualify for the 15 percent maximum rate if the person 
beneficially entitled to the dividend holds an interest in the REIT or 
beleggingsinstelling of 10 percent or less and the REIT or 
beleggingsinstelling is ``diversified'' (i.e., the gross value of no 
single interest in real property held by the REIT or 
beleggingsinstelling exceeds 10 percent of the gross value of the 
REIT's or beleggingsinstelling's total interest in real property). For 
purposes of this diversification test, foreclosure property is not 
considered an interest in real property, and a REIT or 
beleggingsinstelling holding a partnership interest is treated as 
owning its proportionate share of any interest in real property held by 
the partnership. Finally, the 15 percent rate will apply with respect 
to dividends paid by a REIT to a beleggingsinstelling or by a 
beleggingsinstelling to a RIC or REIT.

    The restrictions set forth above are intended to prevent the use of 
these investment vehicles to gain inappropriate source-country tax 
benefits for certain shareholders resident in the other Contracting 
State. For example, a company resident in the Netherlands that wishes 
to hold a diversified portfolio of U.S. corporate shares could hold the 
portfolio directly and pay a U.S. withholding tax of 15 percent on all 
of the dividends that it receives. Alternatively, it could hold the 
same diversified portfolio by purchasing 10 percent or more of the 
interests in a RIC. If the RIC is a pure conduit, there may be no U.S. 
tax cost to interposing the RIC in the chain of ownership. Absent the 
special rule in paragraph 4, such use of the RIC could transform 
portfolio dividends, taxable in the United States under the Convention 
at 15 percent, into direct investment dividends subject to no or 5 
percent withholding tax.

    Similarly, a resident of the Netherlands directly holding U.S. real 
property would pay U.S. tax either at a 30 percent rate on the gross 
income or at graduated rates on the net income. As in the preceding 
example, by placing the real property in a REIT, the investor could 
transform real estate income into dividend income, taxable at the rates 
provided in Article 10, significantly reducing the U.S. tax that 
otherwise would be imposed. Paragraph 4 prevents this result and 
thereby avoids a disparity between the taxation of direct real estate 
investments and real estate investments made through REITconduits. In 
the cases where the rules provide for a maximum 15 percent rate of 
withholding tax, the holding in the REIT is not considered the 
equivalent of a direct holding in the underlying real property.
Paragraph 5

    Paragraph 5 clarifies that the restrictions on source country 
taxation provided by paragraphs 2, 3 and 4 do not affect the taxation 
of the profits out of which the dividends are paid. The taxation by a 
Contracting State of the income of its resident companies is governed 
by the internal law of the Contracting State, subject to the provisions 
of paragraph 5 of Article 28 (Non-Discrimination).
Paragraph 6

    Paragraph 6 provides a broad and flexible definition of the term 
``dividends.'' This paragraph has not been amended by the Protocol The 
definition is intended to cover all arrangements that yield a return on 
an equity investment in a corporation as determined under the tax law 
of the state of source, including types of arrangements that might be 
developed in the future.

    The term dividends includes income from shares, or other corporate 
rights that are not treated as debt under the law of the source State, 
that participate in the profits of the company. The term also includes 
income that is subjected. to the same tax treatment as income from 
shares by the law of the State of source. Thus, a constructive dividend 
that results from a non-arm's length transaction between a corporation 
and a related party is a dividend.

    In the case of the United States, the term dividends includes 
amounts treated as a dividend under U.S. law upon the sale or 
redemption of shares or upon a transfer of shares in a reorganization. 
See, e.g., Rev. Raul. 92-85, 1992-2 C.B. 69 (sale of foreign 
subsidiary's stock to U.S. sister company is a deemed dividend to 
extent of subsidiary's and sister's earnings and profits). Further, a 
distribution from a. U.S. publicly traded limited partnership, which is 
taxed as a corporation under U.S. law, is a dividend for purposes of 
Article 10. However, a distribution by a limited liability company is 
not characterized by the United States as a dividend and, therefore, is 
not a dividend for purposes of Article 10, provided the limited 
liability company is not taxable as a corporation under U.S. law.

    Finally, a payment denominated as interest that is made by a thinly 
capitalized corporation may be treated as a dividend to the extent that 
the debt is recharacterized as equity under the laws of the source 
State. In the case of the United States, these rules include section 
163(j) of the Internal Revenue Code of 1986 (the ``Code'').

    The term dividends also includes, in the case of the Netherlands, 
income from profit sharing bonds, and, in the case of the United 
States, income from debt obligations that carry the right to 
participate in profits.
Paragraph 7

    Paragraph 7 provides that the rules of paragraphs 1, 2, 3, and 4 do 
not apply with respect to dividends paid with respect to holdings that 
form part of the business property of a permanent establishment or 
fixed base situated in the source country. Such dividends will be taxed 
on a net basis using the rates and rules of taxation generally 
applicable to residents of the State in which the permanent 
establishment is located, as modified by the Convention. An example of 
dividends paid with respect to the business property of a permanent 
establishment would be dividends derived by a dealer in stock or 
securities from stock or securities that the dealer held for sale to 
customers. In such a case, Article 7 (Business Profits) applies with 
respect to business profits from a permanent establishment and Article 
15 (Independent Personal Services) applies to income from the 
performance of personal services in an independent capacity from a 
fixed base.

    In the case of a permanent establishment that once existed in the 
State but that no longer exists, the provisions of paragraph 7 also 
apply, by virtue of paragraph 3 of Article 24 (Basis of Taxation), as 
modified by paragraph (d) of Article 6 of this Protocol, to dividends 
that would be attributable to such a permanent establishment if it did 
exist in the year of payment or accrual.
Paragraph 8

    A State's right to tax dividends paid by a company that is a 
resident of the other State is restricted by paragraph 8 to cases in 
which the dividends are paid to a resident of that State or are 
attributable to a permanent establishment in that State. Thus, a State 
may not impose a ``secondary'' withholding tax on dividends paid by a 
nonresident company out of earnings and profits from that State. In the 
case of the United States, paragraph 8, therefore, overrides the 
ability to impose taxes under sections 871 and 882(a) on dividends paid 
by foreign corporations that have a U.S. source under section 
861(a)(2)(B).

    The paragraph also restricts a State's right to impose corporate 
level taxes on undistributed profits, other than a branch profits tax. 
The accumulated earnings tax and the personal holding company taxes are 
taxes covered in Article 2 (Taxes Covered). Accordingly, under the 
provisions of Article 7 (Business Profits), the United States may not 
impose those taxes on the income of a resident of the other State 
except to the extent that income is attributable to a permanent 
establishment in the United States. Paragraph 8 further confirms the 
restriction on the U.S. authority to impose those taxes. The paragraph 
does not restrict a State's right to tax its resident shareholders on 
undistributed earnings of a corporation resident in the other State. 
Thus, the U.S. authority to impose the foreign personal holding company 
tax, its taxes on subpart F income and on an increase in earnings 
invested in U.S. property, and its tax on income of a passive foreign 
investment company that is a qualified electing fund is in no way 
restricted by this provision.

    Paragraph (b) of Article 3 provides updated cross-references in 
Article 25 (Methods of Elimination of Double Taxation).
Relation to Other Articles

    Notwithstanding the foregoing limitations on source country 
taxation of dividends, the saving clause of paragraph 1 of Article 24 
(General Scope) permits the United States to tax dividends received by 
its residents and citizens, subject to the special foreign tax credit 
rules of paragraph 6 of Article 25 (Methods of Elimination of Double 
Taxation), as if the Convention had not come into effect.

    The benefits of this Article are also subject to the provisions of 
Article 26 (Limitation on Benefits). Thus, if a resident of the 
Netherlands is the beneficial owner of dividends paid by a U.S. 
company, the shareholder must qualify for treaty benefits under at 
least one of the tests of Article 26 in order to receive the benefits 
of this Article.

                               Article 4

    Article 4 of the Protocol amends Article 11 (Branch Tax) of the 
Convention by inserting a new sentence at the end of paragraph 3. 
Paragraph 1 of Article 11 permits a Contracting State to impose a 
branch tax on the dividend equivalent amount of a company resident in 
the other Contracting State which derives business profits attributable 
to a permanent establishment located in the first-mentioned State or 
which derives income subject to tax on a net basis in the first-
mentioned State under Article 6 (Income from Real Property) or Article 
14 (Capital Gains).

    Paragraph 3 of Article 11 of the 1992 Convention provides that the 
branch profits tax will not be imposed at a rate exceeding the five 
percent rate allowed by paragraph 2(a) of Article 10 (Dividends), 
ensuring parallel treatment for branches and subsidiaries. The new 
sentence added to paragraph 3 further ensures such parallel treatment 
by providing for an exemption from the branch profits tax under 
conditions that parallel those for the elimination of withholding tax 
on inter-company dividends. Pursuant to paragraph 3, the branch profits 
tax may not be imposed in the case of a company which, before October 
1, 1998, was engaged in activities giving rise to profits attributable 
to a permanent establishment (whether or not the permanent 
establishment was actually profitable during that period) or to income 
or gains that are of a type that would be subject to the provisions of 
Article 6 or paragraphs 1 or 4 of Article 13. In addition, the branch 
profits tax may not be imposed in the case of a company which is a 
qualified person by reason of subparagraph (c) of paragraph 2 of 
Article 26 (Limitation on Benefits) (i.e., a publicly-traded company) 
or a company that would be entitled to benefits with respect to 
dividends under paragraph 3 of Article 26. Finally, the branch profits 
tax does not apply to a company that has received a ruling from the 
competent authority pursuant to paragraph 7 of Article 26 with respect 
to the dividend equivalent amount.

    Thus, for example, if a Netherlands company would be subject to the 
branch profits tax with respect to profits attributable to a U.S. 
branch and not reinvested in that branch, paragraph 3 may apply to 
eliminate the branch profits tax if that branch was established in the 
United States before October 1, 1998 and the other requirements of the 
Convention (e.g., Limitation on Benefits) are met. If, by contrast, a 
Netherlands company that did not have a branch in the United States 
before October 1, 1998, takes over, after October 1, 1998, the 
activities of a branch belonging to a third party, then the branch 
profits tax would apply, unless the Netherlands company is a qualified 
person under subparagraph (c) of paragraph 2 of Article 26, or is 
entitled to benefits under paragraph 3, or paragraph 7 of that Article.

    Moreover, if a branch that satisfied the requirements of paragraph 
3 of Article 11 by reason of having been involved in activities in the 
other State before October 1, 1998 transfers assets to a newly- 
incorporated, wholly-owned company, the treaty shopping concerns 
described above do not exist. Accordingly, in that case, it is expected 
that the U.S. competent authority will exercise its discretion to treat 
the new parent-subsidiary group as qualified for the elimination of 
withholding tax as well, so long as the Netherlands parent meets the 
other ownership requirements of paragraph 3 of Article 10 with respect 
to the subsidiary.

                               Article 5

    Article 5 of the Protocol updates the Convention's rules regarding 
cross-border pension contributions by eliminating the current rule, 
found in paragraph 5 of Article 28 (Non-Discrimination) and replacing 
it with new paragraphs 7 through 11 of Article 19 (Pensions, Annuities, 
Alimony).
Paragraph 7

    New paragraph 7 of Article 19 of the Convention provides that if a 
resident of a Contracting State is a member or beneficiary of, or a 
participant in, an exempt pension trust established in the other 
Contracting State, the State of residence will not tax the income of 
the exempt pension trust with respect to that resident until a 
distribution is made. Thus, for example, if a U.S. citizen contributes 
to a U.S. qualified pension plan while working in the United States and 
then establishes residence in the Netherlands, paragraph 7 prevents the 
Netherlands from taxing currently the plan's earnings and accretions 
with respect to that individual. When the resident receives a 
distribution from the pension fund, that distribution may be subject to 
tax in the State of residence, subject to paragraphs 1, 2 and 3 of 
Article 19 (Pensions, Annuities, Alimony). The paragraph also makes 
clear that the U.S. citizen will not be subject to tax if he rolls over 
the balance in one exempt pension trust into another U.S. fund that 
qualifies as an exempt pension trust.
Paragraph 8

    New paragraph 8 of Article 19 of the Convention provides certain 
benefits with respect to cross-border contributions to an exempt 
pension trust, subject to the limitations of paragraph 9 of the 
Article. It is irrelevant for purposes of paragraph 8 whether the 
participant establishes residence in the State where the individual 
renders services (the ``host State''). The provisions of paragraph 8 
are similar to the provisions of the U.S. Model with respect to pension 
contributions.

    Subparagraph (a) of paragraph 8 allows an individual who exercises 
employment or self-employment in a Contracting State to deduct or 
exclude from income in that Contracting State contributions made by or 
on behalf of the individual during the period of employment or self-
employment to an exempt pension trust established in the other 
Contracting State. Thus, for example, if a participant in a U.S. 
qualified plan goes to work in the Netherlands, the participant may 
deduct or exclude from income in the Netherlands contributions to the 
U.S. qualified plan made while the participant works in the 
Netherlands. Subparagraph (a), however, applies only to the extent of 
the relief allowed by the host State (e.g., the Netherlands in the 
example) for contributions to an exempt pension trust established in 
that State.

    Subparagraph (b) of paragraph 8 provides that, in the case of 
employment, accrued benefits and contributions by or on behalf of the 
individual's employer, during the period of employment in the host 
State, will not be treated as taxable income to the employee in that 
State. Subparagraph (b) also allows the employer a deduction in 
computing business profits in the host State for contributions to the 
plan. For example, if a participant in a U.S. qualified plan goes to 
work in the Netherlands, the participant's employer may deduct from its 
business profits in the Netherlands contributions to the U.S. qualified 
plan for the benefit of the employee while the employee renders 
services in the Netherlands.

    As in the case of subparagraph (a), subparagraph (b) applies only 
to the extent of the relief allowed by the host State for contributions 
to pension funds established in that State. Therefore, where the United 
States is the host State, the exclusion of employee contributions from 
the employee's income under this paragraph is limited to elective 
contributions not in excess of the amount specified in section 402(g). 
Deduction of employer contributions is subject to the limitations of 
sections 415 and 404. The section 404 limitation on deductions is 
calculated as if the individual were the only employee covered by the 
plan.
Paragraph 9

    Paragraph 9 limits the availability of benefits under paragraph 8. 
Under subparagraph (a) of paragraph 9, paragraph 8 does not apply to 
contributions to an exempt pension trust unless the participant already 
was contributing to the trust, or his employer already was contributing 
to the trust with respect to that individual, before the individual 
began exercising employment in the State where the services are 
performed (the ``host State''). This condition would be met if either 
the employee or the employer was contributing to an exempt pension 
trust that was replaced by the exempt pension trust to which he is 
contributing. The rule regarding successor trusts would apply if, for 
example, the employer has been taken over by a company that replaces 
the existing pension plan with its own plan, rolling membership in the 
old plan and assets in the old trust over into the new plan and trust.

    In addition, under subparagraph (b) of paragraph 9, the competent 
authority of the host State must determine that the recognized plan to 
which a contribution is made in the other Contracting State generally 
corresponds to the plan in the host State. Paragraph XII of the 
Understanding provides that the term ``exempt pension trust'' includes 
those arrangements that are treated as exempt pension trusts for 
purposes of Article 35 (Exempt Pension Trusts). The United States and 
the Netherlands entered into a competent authority agreement regarding 
the types of plans in each jurisdiction that will qualify as exempt 
pension trusts. See Notice 2000-57, 2000-2 C.B 389, 2000-43 I.R.B. 389.
Paragraph 10

    Paragraph 10 generally provides U.S. tax treatment for certain 
contributions by or on behalf of U.S. citizens resident in the 
Netherlands to exempt pension trusts established in the Netherlands 
that is comparable to the treatment that would be provided for 
contributions to U.S. qualified plans . Under subparagraph (a) of 
paragraph 10, a U.S. citizen resident in the Netherlands may exclude or 
deduct for U.S. tax purposes certain contributions to an exempt pension 
trust established in the Netherlands. Qualifying contributions 
generally include contributions made during the period the U.S. citizen 
exercises an employment in the Netherlands if expenses of the 
employment are borne by a Netherlands employer or Netherlands permanent 
establishment. Similarly, with respect to the U.S. citizen's 
participation in the Netherlands pension plan, accrued benefits and 
contributions during that period generally are not treated as taxable 
income in the United States.

    The U.S. tax benefit allowed by paragraph 10, however, is limited 
to the lesser of the amount of relief allowed for contributions and 
benefits under a corresponding exempt pension trust established in the 
Netherlands and, under subparagraph (b), the amount of relief that 
would be allowed for contributions and benefits under a generally 
corresponding pension plan established in the United States.

    Subparagraph (c) provides that the benefits an individual obtains 
under paragraph 10 are taken into account when determining that 
individual's eligibility for benefits under a pension plan established 
in the United States. Thus, for example, contributions to a Netherlands 
exempt pension trust may be taken into account in determining whether 
the individual has exceeded the annual limitation on contributions to 
an individual retirement account.

    Under subparagraph (d), paragraph 10 does not apply to pension 
contributions and benefits unless the competent authority of the United 
States has agreed that' the pension plan established in the Netherlands 
generally corresponds to a pension plan established in the United 
States. As noted above, the United States and the Netherlands have 
agreedthat certain plans in each jurisdiction will qualify as exempt 
pension trusts. Since paragraph 10 applies only with respect to persons 
employed by a Netherlands employer or Netherlands permanent 
establishment, however, the relevant Netherlands plans are those that 
correspond to employer plans in the United States, and not those that 
correspond to individual plans.
Paragraph 11

    Paragraph 11 provides that the Netherlands will apply the rules of 
paragraphs 7, 8, 9 and 10 only with respect to U.S. exempt pension 
trusts that will provide information and surety to the Netherlands with 
respect to participants in the trust. Under Netherlands law, when a 
Netherlands resident ceases to be a resident of the Netherlands, the 
Netherlands makes a ``preserved assessment,'' which means a tax on the 
amount of the pension attributable to employment in the Netherlands is 
assessed but not collected. The assessment lasts for 10 years and the 
employee is required to give surety. If a lump sum distribution or 
premature withdrawal is made within that time period, the tax is 
collected.

    In addition to the surety provided by the employee who ceases to be 
a resident, Netherlands pension funds also are required to provide 
surety or otherwise ensure that the beneficiaries of the plan are not 
able to avoid taxation by the Netherlands. Under the 1992 Convention, 
contributions to U.S. pension funds are deductible only if the pension 
fund corresponds to a Netherlands exempt pension trust. Accordingly, 
the rules regarding surety already apply to U.S. pension plans to the 
extent that an employee or employer wishes to deduct pension 
contributions to the U.S. plan. An explicit rule is needed in the 
Protocol because Paragraph XII of the Understanding provides that the 
term ``exempt pension trust'' includes those arrangements that are 
treated as exempt pension trusts for purposes of Article 35 (Exempt 
Pension Trusts). Without the rule in Article 11, U.S. funds arguably no 
longer would have been subject to the types of surety obligations and 
information requirements that apply to Netherlands funds.

    The Netherlands recognizes that these rules, including in 
particular those that require surety from both the employee and the 
pension fund may be burdensome, however, and therefore has agreed, in 
Paragraph XIII of the Understanding, that the competent authorities 
should work together to develop less burdensome methods of complying 
with these rules.
Relation to other Articles

    Subparagraph (c) of Article 6 of the Protocol adds paragraphs 7, 8 
and 10 of Article 19 as exceptions to the saving clause of paragraph 1 
of Article 24 (Basis of Taxation). Accordingly, a U.S. resident who is 
a beneficiary of a Netherlands pension plan will not be subject to tax 
in the United States on the earnings and accretions of a Netherlands 
exempt pension trust with respect to that U.S. resident. In addition, a 
U.S. resident may claim the benefits of paragraph 8 if he meets its 
conditions. Finally, U.S. citizens who are residents of the Netherlands 
will receive the benefits provided by paragraph 10 with respect to 
contributions made to exempt pension trusts established in the 
Netherlands.

                               Article 6

    Article 6 of the Protocol makes several changes to Article 24 
(Basis of Taxation) of the Convention.

    The changes provided in paragraphs (a) and (b) modify paragraph 1 
of Article 24 of the Convention which permits the United States to 
continue to tax as U.S. citizens former citizens (other than 
Netherlands nationals) whose loss of citizenship had as one of its 
principal purposes the avoidance of tax. To reflect 1996 amendments to 
U.S. tax law in this area, the Protocol extends this treatment to 
former long term residents whose loss of such status had as one of its 
principal purposes the avoidance of tax.

    Section 877 of the Code applies to former citizens and long-term 
residents of the United States whose loss of citizenship or long-term 
resident status had as one of its principal purposes the avoidance of 
tax. Under section 877, the United States generally treats an 
individual as having a principal purpose to avoid tax if either of the 
following criteria exceed established thresholds: (a) the average 
annual net income tax of such individual for the period of 5 taxable 
years ending before the date of the loss of status, or (b) the net 
worth of such individual as of the date of the loss of status. The 
thresholds are adjusted annually for inflation. Section 877(c) provides 
certain exceptions to these presumptions of tax avoidance. The United 
States defines ``long-term resident'' as an individual (other than a 
U.S. citizen) who is a lawful permanent resident of the United States 
in at least 8 of the prior 15 taxable years. An individual is not 
treated as a lawful permanent resident for any taxable year if such 
individual is treated as a resident of a foreign country under the 
provisions of a tax treaty between the United States and the foreign 
country and the individual does not waive the benefits of such treaty 
applicable to residents of the foreign country.

    The changes made by paragraph (c) and paragraph (d) are discussed 
above in connection with Article 5 of the Protocol and Article 3 of the 
Protocol, respectively.

    As noted in the Technical Explanation of Article 2 of the Protocol, 
paragraph (e) of Article 6 updates the Convention's rules regarding 
fiscally transparent entities by adding a new paragraph 4 to Article 24 
of the Convention. In general, paragraph 4 relates to entities that are 
not subject to tax at the entity level, such as partnerships and 
certain estates and trusts, as distinct from entities that are subject 
to tax, but with respect to which tax may be relieved under an 
integrated system. This paragraph applies to any . resident of a 
Contracting State who is entitled to income derived through an entity 
that is treated as fiscally transparent under the laws of either 
Contracting State. Entities falling under this description in the 
United States include partnerships, common investment trusts under 
section 584 and grantor trusts. This paragraph also applies to U.S. 
limited liability companies (``LLCs'') that are treated as partnerships 
for U.S. tax purposes.

    Under paragraph 4, an item of income, profit or gain derived by 
such a fiscally transparent entity will be considered to be derived by 
a resident of a Contracting State if a resident is treated under the 
taxation laws of that State as deriving the item of income. For 
example, if a Netherlands company pays interest to an entity that is 
treated as fiscally transparent for U.S. tax purposes, the interest 
will be considered derived by a resident of the United States only to 
the extent that the taxation laws of the United States treats one or 
more U.S. residents (whose status as U.S. residents is determined, for 
this purpose, under U.S. tax law) as deriving the interest for U.S. tax 
purposes. In the case of a partnership, the persons who are, under U.S. 
tax laws, treated as partners of the entity would normally be the 
persons whom the U.S. tax laws would treat as deriving the interest 
income through the partnership. Also, it follows that persons whom the 
United States treats as partners but who are not U.S. residents for 
U.S. tax purposes may not claim a benefit for the interest paid to the 
entity under the Convention, because they are not residents of the 
United States for purposes of claiming this treaty benefit. (If, 
however, the country in which they are treated as resident for tax 
purposes, as determined under the laws of that country, has an income 
tax convention with the Netherlands, they may be entitled to claim a 
benefit under that convention.) In contrast, if, for example, an entity 
is organized under U.S. laws and is classified as a corporation for 
U.S. tax purposes, interest paid by a Netherlands company to the U.S. 
entity will be considered derived by a resident of the United States 
since the U.S. corporation is treated under U.S. taxation laws as a 
resident of the United States and as deriving the income.

    The same result obtains even if the entity is viewed differently 
under the tax laws of the Netherlands (e.g., as not fiscally 
transparent in the first example above where the entity is treated as a 
partnership for U.S. tax purposes). Similarly, the characterization of 
the entity in a third country is also irrelevant, even if the entity is 
organized in that third country. The results follow regardless of 
whether the entity is disregarded as a separate entity under the laws 
of one jurisdiction but not the other, such as a single owner entity 
that is viewed as a branch for U.S. tax purposes and as a corporation 
for Netherlands tax purposes. These results also obtain regardless of 
where the entity is organized (i.e., in the United States, in the 
Netherlands, or, as noted above, in a third country).

    For example, income from U.S. sources received by an entity 
organized under the laws of the United States, which is treated for 
Netherlands tax purposes as a corporation and is owned by a Netherlands 
shareholder who is a Netherlands resident for Netherlands tax purposes, 
is not considered derived by the shareholder of that corporation even 
if, under the tax laws of the United States, the entity is treated as 
fiscally transparent.

    These principles also apply to trusts to the extent that they are 
fiscally transparent in either Contracting State. For example, if X, a 
resident of the Netherlands, creates a revocable trust in the United 
States and names persons resident in a third country as the 
beneficiaries of the trust, X would be treated under U.S. law as the 
beneficial owner of income derived from the United States. In that 
case, the trust's income would be regarded as being derived by a 
resident of the Netherlands only to the extent that the laws of the 
Netherlands treat X as deriving the income for Netherlands tax 
purposes.

    Under subparagraph (b) of Paragraph XIV of the Understanding, the 
competent authorities may agree to deviate from this general principle 
in cases where the characterization by the residence country is 
irrelevant to the taxation of the resident of that country. The 
Understanding provides the example of an exempt pension trust that is a 
resident of the Netherlands and that invests in the United States 
through a U.S. LLC. In that case, the fact that the United States views 
the LLC as fiscally transparent and the Netherlands views it as non-
transparent is irrelevant to the taxation of the exempt pension trust, 
which would be exempt on the investment income that it receives through 
the LLC, even if the Netherlands viewed the LLC as fiscally 
transparent. The competent authorities reached such an agreement on 
March 23, 2003, as reported in Announcement 2003-21, 2003-17 I.R.B. 
846.

    Paragraph 4 is not an exception to the saving clause of paragraph 
1. Accordingly, as confirmed by subparagraph (a) of Paragraph XIV of 
the Understanding, paragraph 4 does not prevent a Contracting State 
from taxing an entity that is treated as a resident of that State under 
its tax law. For example, if a U.S. LLC with Netherlands members elects 
to be taxed as a corporation for U.S. tax purposes, the United States 
will tax that LLC on its worldwide income on a net basis, and will 
impose withholding tax, at the rate provided in Article 10, on 
dividends paid by the LLC, without regard to whether the Netherlands 
views the LLC as fiscally transparent.

                               Article 7

    Article 7 of the Protocol replaces Article 26 (Limitation on 
Benefits) of the Convention.
Structure of the Article

    Article 26 follows the form used in other recent U.S. income tax 
treaties. Paragraph 1 states the general rule that a resident of a 
Contracting State is entitled to benefits otherwise accorded to 
residents only to the extent that the resident satisfies the 
requirements of the Article and any other specified conditions for the 
obtaining of such benefits. Paragraph 2 lists a series of attributes of 
a resident of a Contracting State, any one of which suffices to make 
such resident a ``qualified person'' and thus entitled to all the 
benefits of the Convention. Paragraph 3 provides a so-called 
``derivative benefits'' test under which certain categories of income 
may qualify for benefits. Paragraph 4 sets forth the active trade or 
business test, under which a person not entitled to benefits under 
paragraph 2 may nonetheless be granted benefits with regard to certain 
types of income. Paragraph 5 provides that a resident of one of the 
Contracting States is entitled to all the benefits of the Convention if 
that person functions as a recognized headquarters company for a 
multinational corporate group. Paragraph 6 provides for limited 
``derivative benefits'' for shipping and air transport income. 
Paragraph 7 provides that benefits may also be granted if the competent 
authority of the State from which the benefits are claimed determines 
that it is appropriate to grant benefits in that case. Paragraph 8 
defines the terms used specifically in this Article.Each of the 
substantive provisions of Article 26 states that benefits shall be 
granted only if the resident of a Contracting State satisfies any other 
specified conditions for claiming benefits. This means, for example, 
that a publicly-traded company that satisfies the conditions of 
subparagraph 2(c) will be eligible for the elimination of withholding 
tax on dividends at source only if it also owns 80 percent or more of 
the voting power of the paying company and satisfies the 12-month 
holding period requirement of paragraph 3 of Article 10, and satisfies 
any other conditions specified in Article 10 or any other articles of 
the Convention.

Paragraph 1

    Paragraph 1 provides that, except as otherwise provided, a resident 
of a Contracting State will be entitled to all the benefits of the 
Convention otherwise accorded to residents of a Contracting State only 
if the resident is a ``qualified person'' as defined in paragraph 2 of 
Article 26.

    The benefits otherwise accorded to residents under the Convention 
include all limitations on source-based taxation under Articles 6 
through 23 and 27, the treaty based relief from double taxation 
provided by Article 25 (Methods of Elimination of Double Taxation), and 
the protection afforded to residents of a Contracting State under 
Article 28. (Non-Discrimination). Some provisions do not require that a 
person be a resident in order to enjoy the benefits of those 
provisions. Article 29 (Mutual Agreement Procedure) is not limited to 
residents of the Contracting States, and Article 33 (Diplomatic Agents 
and Consular Officers) applies to diplomatic agents or consular 
officials regardless of residence. Article 26 accordingly does not 
limit the availability of treaty benefits under these provisions.

    Article 26 and the anti-abuse provisions of domestic law complement 
each other, as Article 26 effectively determines whether an entity has 
a sufficient nexus to the Contracting State to be treated as a resident 
for treaty purposes, while domestic anti-abuse provisions (e.g., 
business purpose, substance-over-form, step transaction or conduit 
principles) determine whether a particular transaction should be recast 
in accordance with its substance. Thus, internal law principles of the 
source Contracting State may be applied to identify the beneficial 
owner of an item of income, and Article 26 then will be applied to the 
beneficial owner to determine if that person is entitled to the 
benefits of the Convention with respect to such income.
Paragraph 2

    Paragraph 2 has six subparagraphs, each of which describes a 
category of residents that constitute ``qualified persons'' and thus 
are entitled to all benefits of the Convention. It is intended that the 
provisions of paragraph 2 will be self-executing. Claiming benefits 
under paragraph 2 does not require advance competent authority ruling 
or approval. The tax authorities may, of course, on review, determine 
that the taxpayer has improperly interpreted the paragraph and is not 
entitled to the benefits claimed.

            Individuals--Subparagraph 2(a)

    Subparagraph (a) provides that individual residents of a 
Contracting State will be entitled to all the benefits of the 
Convention. If such an individual receives income as a nominee on 
behalf of a third country resident, benefits may be denied under the 
applicable articles of the Convention by the requirement that the 
beneficial owner of the income be a resident of a Contracting State.

            Governments--Subparagraph 2(b)

    Subparagraph (b) provides that the Contracting States and any 
political subdivision or local authority thereof will be entitled to 
all the benefits of the Convention.

            Publicly Traded Corporations--Subparagraph 2(c)

    Subparagraph (c) applies to two categories of companies: publicly 
traded companies and subsidiaries of publicly traded companies. A 
company resident in a Contracting State is entitled to all the benefits 
of the Convention under clause (i) of subparagraph (c) if the principal 
class of its shares, and any disproportionate class of shares, is 
listed on a recognized U.S. or Netherlands stock exchange and is 
regularly traded on one or more recognized stock exchanges, unless the 
company has no substantial presence in the State in which it is a 
resident, as described below.

    The term ``recognized stock exchange'' is defined in subparagraph 
(a) of paragraph 8. It includes the NASDAQ System and any stock 
exchange registered with the Securities and Exchange Commission as a 
national securities exchange for purposes of the Securities Exchange 
Act of 1934. It also includes the Amsterdam Stock Exchange and any 
other stock exchange subject to regulation by the Authority for the 
Financial Markets (or its successor) in the Netherlands. Paragraph 
XXVII of the Understanding specifies that, for these purposes, certain 
exchanges that are part of Euronext will be considered to be subject to 
regulation by the Authority for the Financial Markets. The term also 
includes the Irish Stock Exchange, the Swiss Stock Exchange, the stock 
exchanges of Brussels, Frankfurt, Hamburg, Johannesburg, London, 
Madrid, Milan, Paris, Stockholm, Sydney, Tokyo, Toronto, and Vienna, 
and any other stock exchange agreed upon by the competent authorities 
of the Contracting States.

    The term ``principal class of shares'' is defined in subparagraph 
(b) of paragraph 7. Clause (i) defines the term to mean the ordinary or 
common shares of the company representing the majority of the aggregate 
voting power and value of the company. If the company does not have a 
class of ordinary or common shares representing the majority of the 
aggregate voting power and value of the company, then the ``principal 
class of shares'' is that class or any combination of classes of shares 
that represents, in the aggregate, a majority of the voting power and 
value of the company. In addition, clause (ii) of subparagraph (b) 
defines the term ``shares'' to include depository receipts for shares 
or trust certificates for shares.

    The term ``disproportionate class of shares'' is defined in 
subparagraph (c) of paragraph 8. A company has a disproportionate class 
of shares if it has outstanding a class of shares which is subject to 
terms or other arrangements that entitle the holder to a larger portion 
of the company's income, profit, or gain in the other Contracting State 
than that to which the holder would be entitled in the absence of such 
terms or arrangements. Thus, for example, a company resident in the 
Netherlands meets the test of subparagraph (c) of paragraph 8 if it has 
outstanding a class of ``tracking stock'' that pays dividends based 
upon a formula that approximates the company's return on its assets 
employed in the United States.

    A company whose principal class of stock is publicly traded will 
nevertheless not qualify for benefits under subparagraph (c) of 
paragraph 2 if it has a disproportionate class of shares that is not 
publicly traded. The following example illustrates this result.

          Example. DCo is a corporation resident. in the Netherlands. 
        DCo has two classes of shares: Common and Preferred. The Common 
        shares are listed and regularly traded on the Amsterdam Stock 
        Exchange. The Preferred shares have no voting rights and are 
        entitled to receive dividends equal in amount to interest 
        payments that DCo receives from unrelated borrowers in the 
        United States. The Preferred shares are owned entirely by a 
        single investor that is a resident of a country with which the 
        United States does not have a tax treaty. The Common shares 
        account for more than 50 percent of the value of DCo and for 
        100 percent of the voting power. Because the owner of the 
        Preferred shares is entitled to receive payments corresponding 
        to the U.S. source interest income earned by DCo, the Preferred 
        shares are a disproportionate class of shares. Because the 
        Preferred shares are not regularly traded on a recognized stock 
        exchange, DCo will not qualify for benefits under subparagraph 
        (c) of paragraph 2.


    A class of shares will be ``regularly traded'' in a taxable year, 
under subparagraph (h) of paragraph 8, if the aggregate number of 
shares of that class traded on one or more recognized exchanges during 
the twelve months ending on the day before the beginning of that 
taxable year is at least six percent of the average number of shares 
outstanding in that class during that twelve-month period. For this 
purpose, Paragraph XXVII of the Understanding provides that, if a class 
of shares was not listed on a recognized stock exchange during this 
twelve-month period, the class of shares will be treated as regularly 
traded only if the class meets the aggregate trading requirements for 
the taxable period in which the income arises. Trading on one or more 
recognized stock exchanges may be aggregated for purposes of meeting 
the ``regularly traded'' standard of subparagraph (h). For example, a 
U.S. company could satisfy the definition of ``regularly traded'' 
through trading, in whole or in part, on a recognized stock exchange 
located in the Netherlands or certain third countries. Authorized but 
unissued shares are not considered for purposes of subparagraph (h).

    The Protocol adds a new requirement to the publicly-traded company 
test intended to ensure that there is an adequate connection between a 
public company and its State of residence. A company that is regularly 
traded on one or more recognized stock exchanges will not qualify for 
treaty benefits under the publicly-traded company test if it has no 
``substantial presence'' in its country of residence.

    There are two components to the ``no substantial presence'' test. 
The first component determines whether public trading establishes a 
sufficient nexus to the State of residence of the company. The second 
component provides companies with an alternative means for establishing 
that nexus, by determining whether the company's ``primary place of 
management and control'' is in the State of which the company is a 
resident.

    There are two elements to the public trading component of the ``no 
substantial presence'' test. The first element compares trading in the 
State of which the company is not a resident to trading in the 
company's primary economic zone. For the United States, the primary 
economic zone is the NAFTA countries and for the Netherlands, the 
primary economic zone is the European Economic Area and the European 
Union. Thus, in the case of a Netherlands company, if more trading in 
its stock takes place on recognized stock exchanges in the United 
States than on recognized stock exchanges in the EEA and the EU, it 
will fail the trading component. The second element of the trading 
component compares trading within the company's primary economic zone 
with worldwide trading. If the stock of a company is not traded in its 
primary economic zone at all, or if trading in its primary economic 
zone constitutes less than 10 percent of total worldwide trading, the 
company will fail the trading component. Accordingly, a Netherlands 
company that met the ``regularly traded'' requirement of the public 
company test primarily through trading on the Johannesburg, Sydney, 
Tokyo, or Toronto stock exchanges might fail tie trading component.

    However, even if a company fails the public trading component of 
the ``no substantial presence'' test, it may still qualify for benefits 
under subparagraph (c) of paragraph 2 if the company's primary place of 
management and control is in the country of which it is a resident. 
This test should be distinguished from the ``place of effective 
management'' test which is used in the OECD Model and by many other 
countries to establish residence. In some cases, the place of effective 
management test has been interpreted to mean the place where the board 
of directors meets. By contrast, the primary place of management and 
control test looks to where day-to-day responsibility for the 
management of the company (and its subsidiaries) is exercised. The 
company's primary place of management and control will be located in 
the State in which the company is a resident only if the executive 
officers and senior management employees exercise day-to-day 
responsibility for more of the strategic, financial and operational 
policy decision making for the company (including direct and indirect 
subsidiaries) in that State than in the other State or any third state, 
and the staffs that support the management in making those decisions 
are also based in that State.

    Paragraph XXVI of the Understanding provides guidance regarding the 
persons who are to be considered ``executive officers and senior 
management employees''. In most cases, it will not be necessary to look 
beyond the executive board in the case of a Netherlands company or the 
executives who are members of the board of directors (the ``inside 
directors'') in the case of a U.S. company. That will not always be the 
case, however, and the Understanding makes clear that the relevant 
persons may be employees of subsidiaries if they make the strategic, 
financial and operational policy decisions. Moreover, if there are 
special voting arrangements that result in certain board members making 
certain decisions without the participation of other board members, 
that fact would be taken into account as well.

    The following example illustrates the principles of Paragraph XXVI:

          Example. NCo is a publicly-traded Netherlands corporation 
        that, along with its subsidiaries, is engaged in the music 
        business. NCo has 50 subsidiaries located in countries around 
        the world, organized under regional holding companies. The 
        local subsidiaries and their regional holding companies are 
        responsible for developing local artists; in most cases, those 
        artists will sell recordings only in their local markets 
        although NCo will choose one or two artists each year to 
        promote globally. The exceptions to this are the U.S. and U.K. 
        subsidiaries of NCo, many of whose artists achieve success 
        worldwide. Because the subsidiaries are primarily responsible 
        for developing their local markets, NCo allows the managers of 
        the subsidiaries substantial autonomy to make significant 
        business decisions, such as the principal artists to sign and 
        how to market and promote them. NCo's substantial Asian 
        operations are managed by employees in its Japanese holding 
        company. Like many Netherlands companies, NCo has both an 
        executive board and a supervisory board. The supervisory board 
        does not participate in decisions before they are made but, 
        pursuant to statute, has oversight responsibilities with 
        respect to the executive board. The members of NCo's executive 
        board include the chief executive officer and chief operating 
        officer of NCo, and the chief executive officers of its U.S. 
        holding company, its U.K. holding company, and its Japanese 
        holding company. On these facts, therefore, the executives most 
        responsible for guiding NCo's global business are members of 
        the executive board. Accordingly, it will not be necessary to 
        look beyond the executive board in applying the management 
        factor.


    Paragraph XXVI also includes a special rule for dealing with 
integrated corporate groups, where staffs located in two different 
countries support the management of two publicly traded companies. The 
special rule only applies if the other state in which the staffs are 
located is in the primary economic zone of the Netherlands and has a 
tax treaty with the United States that would provide equivalent 
benefits as the Convention. Thus, at the moment, this rule is limited 
to integrated corporate groups consisting of a Netherlands publicly 
traded company and a UK publicly traded company and their direct and 
indirect subsidiaries.

    A company resident in a Contracting State is entitled to all the 
benefits of the Convention under clause (ii) of subparagraph (c) of 
paragraph 2 if five or fewer publicly-traded companies described in 
clause (i) are the direct or indirect owners of at least 50 percent of 
the aggregate vote and value of the company's shares (and at least 50 
percent of any disproportionate class of shares). If the publicly-
traded companies are indirect owners, however, each of the intermediate 
companies must be a resident of one of the Contracting States. Thus, 
for example, a Netherlands company, all the shares of which are owned 
by another Netherlands company, would qualify for benefits under the 
Convention if the principal class of shares of the Netherlands parent 
company were listed on the Amsterdam Stock Exchange and regularly 
traded on the London stock exchange. However, the Netherlands company 
would not qualify for benefits under clause (ii) if the publicly traded 
parent company were a resident of Ireland, not of the United States or 
the Netherlands. Furthermore, if the Netherlands parent indirectly 
owned the Netherlands company through a chain of subsidiaries, each 
such subsidiary in the chain, as an intermediate owner, must be a 
resident of the United States or the Netherlands for the Netherlands 
company to meet the test in clause (ii).

            Exempt Pension Trusts--Subparagraph 2(d)

    An exempt pension trust is entitled to all the benefits of the 
Convention if, as of the close of the end of the prior taxable year, 
more than 50 percent of the beneficiaries, members or participants of 
the exempt pension trust are individuals resident in either Contracting 
State or if the organization sponsoring the pension trust is a 
qualified person. For purposes of this provision, the term 
``beneficiaries'' should be understood to refer to the persons 
receiving benefits from the exempt pension trust.

            Tax Exempt Organizations--Subparagraph 2(e)

    A tax-exempt organization other than an exempt pension trust is 
entitled to all the benefits of the Convention, without regard to the 
residence of its beneficiaries or members. Entities qualifying under 
this subparagraph are those that generally are exempt from tax in their 
Contracting State of residence and that are organized and operated 
exclusively to fulfill religious, charitable, educational, scientific, 
artistic, cultural, or public purposes.

            Ownership/Base Erosion--Subparagraph 2(f)

    Subparagraph 2(f) provides an additional test that applies to any 
form of legal entity that is a resident of a Contracting State. The 
test provided in subparagraph (f), the so-called ownership and base 
erosion test, is a two-part test. Both prongs of the test must be 
satisfied for the resident to be entitled to benefits under 
subparagraph 2(f). A company that would be a qualified person under 
subparagraph 2(c) but for the fact that it has no substantial presence 
in its State of residence may not qualify for benefits under 
subparagraph 2(f).

    The ownership prong of the test, under clause. (i), requires that 
50 percent or more of the aggregate voting power and value of the 
person (and 50 percent or more of any disproportionate class of shares) 
be owned directly or indirectly on at least half the days of the 
person's taxable year by persons who are themselves qualified persons 
under certain other tests of paragraph 2--subparagraphs (a), (b), (d) 
or (e), or clause (i) of subparagraph (c).

    Trusts may be entitled to benefits under this provision if they are 
treated as residents under Article 4 (Resident) and they otherwise 
satisfy the requirements of this subparagraph. For purposes of this 
subparagraph, the beneficial interests in a trust will be considered to 
be owned by its beneficiaries in proportion to each beneficiary's 
actuarial interest in the trust. The interest of a remainder 
beneficiary will be equal to 100 percent less the aggregate percentages 
held by income beneficiaries. A beneficiary's interest in a trust will 
not be considered to be owned by a person entitled to benefits under 
the other provisions of paragraph 2 if it is not possible to determine 
the beneficiary's actuarial interest. Consequently, if it is not 
possible to determine the actuarial interest of the beneficiaries in a 
trust, the ownership test under clause i) cannot be satisfied, unless 
all possible beneficiaries are persons entitled to benefits under the 
other subparagraphs of paragraph 2.

    The base erosion prong of clause (ii) of subparagraph (f) is not 
satisfied with respect to a person if 50 percent or more of the 
person's gross income for the taxable year is paid or accrued to a 
person or persons who are not residents of either Contracting State, in 
the form of payments deductible for tax purposes in the payer's State 
of residence. For this purpose, Paragraph XV of the Understanding 
states that the term ``gross income'' means total revenues derived by a 
resident of a Contracting State from its principal operations, less the 
direct costs of obtaining such revenues. In the case of the United 
States, the term ``gross income'' has the same meaning as such term in 
section 61 of the Code and the regulations thereunder.

    To the extent they are deductible from the taxable base, trust 
distributions are deductible payments, However, depreciation and 
amortization deductions, which do not represent payments or accruals to 
other persons, are disregarded for this purpose. Deductible payments 
also do not include arm's length payments in the ordinary course of 
business for services or tangible property or with respect to financial 
obligations to banks that are residents of either Contracting State or 
that have a permanent establishment in either Contracting State to 
which the payment is attributable.
Paragraph 3

    Paragraph 3 sets forth a derivative benefits test that is 
potentially applicable to all treaty benefits, although the test is 
applied to individual items of income. In general, a derivative 
benefits test entitles the resident of a Contracting State to treaty 
benefits if the owner of the resident would have been entitled to the 
same benefit had the income in question flowed directly to that owner. 
To qualify under this paragraph, the company must meet an ownership 
test and a base erosion test.

    Subparagraph (a) sets forth the ownership test. Under this test, 
seven or fewer equivalent beneficiaries must own shares representing at 
least 95 percent of the aggregate voting power and value of the 
company. Ownership may be direct or indirect. The term ``equivalent 
beneficiary'' is defined in subparagraph (f) of paragraph 8. This 
definition may be met in two alternative ways, the first of which has 
two requirements.

    Under the first alternative, a person may be an equivalent 
beneficiary because it is entitled to equivalent benefits under a 
treaty between the country of source and the country in which the 
person is a resident. This alternative has two requirements.

    The first requirement is that the person must be a resident of a 
Member State of the European Community, a European Economic Area state, 
or a party to the North American Free Trade Agreement (collectively, 
``qualifying States'').

    The second requirement of the definition of ``equivalent 
beneficiary'' is that the person must be entitled to equivalent 
benefits under an applicable treaty. To satisfy the second requirement, 
the person must be entitled to all the benefits of a comprehensive 
treaty between the Contracting State from which benefits of the 
Convention are claimed and a qualifying State under provisions that are 
analogous to the rules in Paragraph 2 regarding individuals, qualified 
governmental entities, publicly-traded companies or entities, and tax-
exempt organizations. Moreover, if the treaty in question does not have 
a comprehensive limitation. on benefits article, this requirement only 
is met if the person would be a ``qualified person'' under the tests in 
Paragraph 2 applicable to individuals, qualified governmental entities, 
publicly-traded companies or entities, and tax-exempt organizations.

    In order to satisfy the additional requirement necessary to qualify 
as an ``equivalent beneficiary'' under paragraph 8(f)(i)(B) with 
respect to dividends, interest, royalties or branch tax, the person 
must be entitled to a rate of withholding tax that is at least as low 
as the withholding tax rate that would apply under the Convention to 
such income. Thus, the rates to be compared are: (1) the rate of 
withholding tax that the source State would have imposed if a qualified 
resident of the other Contracting State was the beneficial owner of the 
income; and (2) the rate of withholding tax that the source State would 
have imposed if the third State resident received the income directly 
from the source State. For example, USCo is a wholly owned subsidiary 
of DCo, a company resident in the Netherlands. DCo is wholly owned by 
ICo, a corporation resident in Italy. Assuming DCo satisfies the 
requirements of paragraph 3 of Article 10 (Dividends), DCo would be 
eligible for the elimination of dividend withholding tax. The dividend 
withholding tax rate in the treaty between the United States and Italy 
is 5 percent. Thus, if ICo received the dividend directly from USCo, 
ICo would have been subject to a 5 percent rate of withholding tax on 
the dividend. Because ICo would not be entitled to a rate of 
withholding tax that is at least as low as the rate that would apply 
under the Convention to such income (i.e., zero), ICo is not an 
equivalent beneficiary within the meaning of paragraph 8(f)(i) of 
Article 26 with respect to the elimination of withholding tax on 
dividends.

    Subparagraph 8(g) provides a special rule to take account of the 
fact that withholding taxes on many inter-company dividends, interest 
and royalties are exempt within the European Union by reason of various 
EU directives, rather than by tax treaty. If a U.S. company receives 
such payments from a Netherlands company, and that U.S. company is 
owned by a company resident in a Member State of the European Union 
that would have qualified for an exemption from withholding tax if it 
had received the income directly, the parent company will be treated as 
an equivalent beneficiary. This rule is necessary because many EU 
member countries have not re-negotiated their tax treaties to reflect 
the rates applicable under the directives.

    Paragraph XVII of the Understanding illustrates the ``all the 
benefits'' requirement. The requirement that a person be entitled to 
``all the benefits'' of a comprehensive tax treaty eliminates those 
persons that qualify for benefits with respect to only certain types of 
income. Accordingly, the fact that a French parent of a Netherlands 
company is engaged in the active conduct of a trade or business in 
France and therefore would be entitled to the benefits of the U.S.-
France treaty if it received dividends directly is not sufficient for 
purposes of this paragraph. Further, the French company cannot be an 
equivalent beneficiary if it qualifies for benefits only with respect 
to certain income as a result of a ``derivative benefits'' provision in 
the U.S.-France treaty. However, it would be possible to look through 
the French company to its parent company to determine whether the 
parent company is an equivalent beneficiary.

    The second alternative for satisfying the ``equivalent 
beneficiary'' test is available only to residents of one of the two 
Contracting States. U.S. or Netherlands residents who are qualified 
persons by reason of subparagraphs (a), (b), (c)(i), (d), or (e) of 
paragraph 2 are equivalent beneficiaries for purposes of the relevant 
tests in Article 26. Thus, a Netherlands individual will be an 
equivalent beneficiary without regard to whether the individual would 
have been entitled to receive the same benefits if it received the 
income directly. A resident of a third country cannot be a ``qualified 
person'' by reason of those paragraphs or any other rule of the treaty, 
and therefore do not qualify as equivalent beneficiaries under this 
alternative. Thus, a resident of a third country can be an equivalent 
beneficiary only if it would have been entitled to equivalent benefits 
had it received the income directly.

    The second alternative was included in order to clarify that 
ownership by certain residents of a Contracting State would not 
disqualify a U.S. or Netherlands company under this paragraph. Thus, 
for example, if 90 percent of a Netherlands company is owned by five 
companies that are resident in member states of the European Union who 
satisfy the requirements of clause (i), and 10 percent of the 
Netherlands company is owned by a U.S. or Netherlands individual, then 
the Netherlands company still can satisfy the requirements of 
subparagraph (a) of paragraph 3.

    Subparagraph (b) sets forth the base erosion test. A company meets 
this base erosion test if less than 50 percent of its gross income for 
the taxable period is paid or accrued, directly or indirectly, to a 
person or persons who are not equivalent beneficiaries in the form of 
payments deductible for tax purposes in company's State of residence. 
This test is the same as the base erosion test in clause (ii) of 
subparagraph (f) of paragraph 2, except that deductible payments made 
to equivalent beneficiaries, rather than amounts paid to residents of a 
Contracting State, are not counted against a company for purposes of 
determining whether the company exceeded the 50 percent limit.

    As in the case of base erosion test in subparagraph (f) of 
paragraph 2, deductible payments in subparagraph (b) of paragraph 3 
also do not include arm's length payments in the ordinary course of 
business for services or tangible property or with respect to financial 
obligations to banks that are residents of either Contracting State or 
that have a permanent establishment in either Contracting State to 
which the payment is attributable.

    Under the 1992 Convention, the derivative benefits provision had 
somewhat different requirements. The test required that 30 percent of 
the shares of the company claiming benefits be owned by Netherlands 
residents, but only 70 percent of the shares had to be owned by 
equivalent beneficiaries (including Netherlands residents). It is 
possible that some companies would qualify for benefits under the prior 
test, but not under the provisions of paragraph 3, and vice versa. 
Since satisfaction of the prior test demonstrates a close connection to 
the Netherlands, it remains a valid objective test. Accordingly, 
subparagraph (a) of Paragraph XXIV of the Understanding provides that a 
company will be granted the benefits of the Convention pursuant to the 
competent authority discretion provision in cases where more than 30 
percent of vote and value of the company's shares are owned by 
residents of a Contracting State that are described in subparagraph 
8(f)(ii) and more than 70 percent of the shares (and at least 50 
percent of any disproportionate class of shares) is owned by seven or 
fewer equivalent beneficiaries, provided that the base erosion test has 
been met.
Paragraph 4

    Paragraph 4 sets forth a test under which a resident of a 
Contracting State that is not a ``qualified person'' under paragraph 2 
may receive treaty benefits with respect to certain items of income 
that are connected to an active trade or business conducted in its 
State of residence.

    Subparagraph (a) sets forth the general rule that a resident of a 
Contracting State engaged in the active conduct of a trade or business 
in that State may obtain the benefits of the Convention with respect to 
an item of income, profit, or gain derived in the other Contracting 
State. The item of income, profit, or gain, however, must be derived in 
connection with or incidental to that trade or business.

    The term ``trade or business'' is not defined in the Convention. 
Pursuant to paragraph 2 of Article 3 (General Definitions), when 
determining whether a resident of the Netherlands is entitled to the 
benefits of the Convention under paragraph 4 of this Article with 
respect to an item of income derived from sources within the United 
States, the United States will ascribe to this term the meaning that it 
has under the law of the United States. Accordingly, the U.S. competent 
authority will refer to the regulations issued under section 367(a) for 
the definition of the term ``trade or business.'' In general, 
therefore, a trade or business will be considered to be a specific 
unified group of activities that constitute or could constitute an 
independent economic enterprise carried on for profit. Furthermore, a 
corporation generally will be considered to carry on a trade or 
business only if the officers and employees of the corporation conduct 
substantial managerial and operational activities.

    The business of making or managing investments for the resident's 
own account will be considered to be a trade or business only when part 
of banking, insurance or securities activities conducted by a bank, an 
insurance company, or a registered securities dealer. Such activities 
conducted by a person other than a bank, insurance company or 
registered securities dealer will not be considered to be the conduct 
of an active trade or business, nor would they be considered to be the 
conduct of an active trade or business if conducted by a bank, 
insurance company or registered securities dealer but not as part of 
the company's banking, insurance or dealer business.

    For this purpose, Paragraph XX of the Understanding states that a 
bank will be considered to be engaged in the active conduct of a trade 
or business only if it regularly accepts deposits from the public and 
makes loans to the public. Furthermore, an insurance company only is 
engaged in the active conduct of an insurance business if its gross 
income consists primarily of insurance or reinsurance premiums and 
investment income attributable to such premiums.

    Because a headquarters operation is in the business of managing 
investments, a company that functions solely as a headquarters company 
will not be considered to be engaged in an active trade or business for 
purposes of subparagraph (a). It may, however, qualify for benefits if 
it meets the requirements of paragraph 5.

    Paragraph XIX of the Understanding provides that an item of income 
is derived in connection with a trade or business if the income-
producing activity in the State of source is a line of business that 
``forms a part of'' or is ``complementary'' to the trade or business 
conducted in the State of residence by the income recipient.

    A business activity generally will be considered to form part of a 
business activity conducted in the State of source if the two 
activities involve the design, manufacture or sale of the same products 
or type of products, or the provision of similar services. The notes 
clarify that the line of business in the State of residence may be 
upstream, downstream, or parallel to the activity conducted in the 
State of source. Thus, the line of business may provide inputs for a 
manufacturing process that occurs in the State of source, may sell the 
output of that manufacturing process, or simply may sell the same sorts 
of products that are being sold by the trade or business carried on in 
the State of source.

          Example 1. USCo is a corporation resident in the United 
        States. USCo is engaged in an active manufacturing business in 
        the United States. USCo owns 100 percent of the shares of DCo, 
        a company resident in the Netherlands. DCo distributes USCo 
        products in the Netherlands. Because the business activities 
        conducted by the two corporations involve the same products, 
        DCo's distribution business is considered to form a part of 
        USCo's manufacturing business.

          Example 2. The facts are the same as in Example 1, except 
        that USCo does not manufacture. Rather, USCo operates a large 
        research and development facility in the United States that 
        licenses intellectual property to affiliates worldwide, 
        including DCo. DCo and other USCo affiliates then manufacture 
        and market the USCo-designed products in their respective 
        markets. Because the activities conducted by DCo and USCo 
        involve the same product lines, these activities are considered 
        to form a part of the same trade or business.


    For two activities to be considered to be ``complementary,'' the 
activities need not relate to the same types of products or services, 
but they should be part of the same overall industry and be related in 
the sense that the success or failure of one activity will tend to 
result in success or failure for the other. Where more than one trade 
or business is conducted in the State of source and only one of the 
trades or businesses forms a part. of or is complementary to a trade or 
business conducted in the State of residence, it is necessary to 
identify the trade or business to which an item of income is 
attributable. Royalties generally will be considered to be derived in 
connection with the trade or business to which the underlying 
intangible property is attributable. Dividends will be deemed to be 
derived first out of earnings and profits of the treaty benefited trade 
or business, and then out of other earnings and profits. Interest 
income may be allocated under any reasonable method consistently 
applied. A method that conforms to U.S. principles for expense 
allocation will be considered a reasonable method.

          Example 3. Americair is a corporation resident in the United 
        States that operates an international airline. DSub is a 
        wholly-owned subsidiary of Americair resident in the 
        Netherlands. DSub operates a chain of hotels in the Netherlands 
        that are located near airports served by Americair flights. 
        Americair frequently sells tour packages that include air 
        travel to the Netherlands and lodging at DSub hotels. Although 
        both companies are engaged in the active conduct of a trade or 
        business, the businesses of operating a chain of hotels and 
        operating an airline are distinct trades or businesses. 
        Therefore DSub's business does not form a part of Americair's 
        business. However, DSub's business is considered to be 
        complementary to Americair's business because they are part of 
        the same overall industry (travel), and the links between their 
        operations tend to make them interdependent.

          Example 4. The facts are the same as in Example 3, except 
        that DSub owns an office building in the Netherlands instead of 
        a hotel chain. No part of Americair's business is conducted 
        through the office building. DSub's business is not considered 
        to form a part of or to be complementary to Americair's 
        business. They are engaged in distinct trades or businesses in 
        separate industries, and there is no economic dependence 
        between the two operations.

          Example 5. USFlower is a company resident in the United 
        States. USFlower produces and sells flowers in the United 
        States and other countries. USFlower owns all the shares of 
        DHolding, a corporation resident in the Netherlands. DHolding 
        is a holding company that is not engaged in a trade or 
        business. DHolding owns all the shares of three corporations 
        that are resident in the Netherlands: DFlower, DLawn, and 
        DFish. DFlower distributes USFlower flowers under the USFlower 
        trademark in the Netherlands. DLawn markets a line of lawn care 
        products in the Netherlands under the USFlower trademark. In 
        addition to being sold under the same trademark, DLawn and 
        DFlower products are sold in the same stores and sales of each 
        company's products tend to generate increased sales of the 
        other's products. DFish imports fish from the United States and 
        distributes it to fish wholesalers in the Netherlands. For 
        purposes of paragraph 4, the business of DFlower forms a part 
        of the business of USFlower, the business of DLawn is 
        complementary to the business of USFlower, and the business of 
        DFish is neither part of nor complementary to that of USFlower.


    Paragraph XIX of the Understanding also provides that an item of 
income derived from the State of source is ``incidental to'' the trade 
or business carried on in the State of residence if production of the 
item facilitates the conduct of the trade or business in the State of 
residence. An example of incidental income is the temporary investment 
of working capital of a person in the State of residence in securities 
issued by persons in the State of source.

    Subparagraph (b) of paragraph 4 states a further condition to the 
general rule in subparagraph (a) in cases where the trade or business 
generating the item of income in question is carried on either by the 
person deriving the income or by any associated enterprises. 
Subparagraph (b) states that the trade or business carried on in the 
State of residence, under these circumstances, must be substantial in 
relation to the activity in the State of source. Paragraph XXII of the 
Understanding elaborates on the purpose and application of the 
substantiality requirement. The requirement is intended to prevent a 
narrow case of treaty-shopping abuses in which a company attempts to 
qualify for benefits by engaging in de minimis connected business 
activities in the treaty country in which it is resident (i.e., 
activities that have little economic cost or effect with respect to the 
company business as a whole).

    The determination of substantiality is made based upon all the 
facts and circumstances and takes into account the comparative sizes of 
fir trades or businesses in each Contracting State (measured by 
reference to asset values, income and payroll expenses), the nature of 
the activities performed in each Contracting State, and the relative 
contributions made to that trade or business in each Contracting State. 
In any case, in making each determination or comparison, due regard 
will be given to the relative sizes of the U.S. and Netherlands 
economies.

    In addition to this subjective rule, Paragraph XXII of the 
Understanding provides a safe harbor under which the trade or business 
of the income recipient may be deemed to be substantial based on three 
ratios that compare the size of the recipient's activities to those 
conducted in the other State with respect to the preceding taxable 
year, or the average of the preceding three years. The three ratios 
compare: (i) the value of the assets in the recipient's State to the 
assets used in the other State; (ii) the gross income derived in the 
recipient's State to the gross income derived in the other State; and 
(iii) the payroll expense in the recipient's State to the. payroll 
expense in the other State. The average of the three ratios must exceed 
10 percent, and each individual ratio must equal at least 7.5 percent. 
For purposes of this test, if the income recipient owns, directly or 
indirectly, less than 100 percent of the activity conducted in either 
State, only its proportionate share of the activity will be taken into 
account.

    The determination in subparagraph (b) also is made separately for 
each item of income derived from the State of source. It therefore is 
possible that a person would be entitled to the benefits of the 
Convention with respect to one item of income but not with respect to 
another. If a resident of a Contracting State is entitled to treaty 
benefits with respect to a particular item of income under paragraph 4, 
the resident is entitled to all benefits of the Convention insofar as 
they affect the taxation of that item of income in the State of source.

    The application of the substantiality test only to income from 
related parties focuses only on potential abuse cases, and does not 
hamper certain other kinds of non-abusive activities, even though the 
income recipient resident in a Contracting State may be very small in 
relation to the entity generating income in the other. Contracting 
State. For example, if a small U.S. research firm develops a process 
that it license to a very large, unrelated, Netherlands pharmaceutical 
manufacturer, the size of the U.S. research firm would not have to be 
tested against the size of the Netherlands manufacturer. Similarly, a 
small U.S. bank that makes a loan to a very large unrelated Netherlands 
business would not have to pass a substantiality test to receive treaty 
benefits under Paragraph 4.

    Subparagraph (c) of paragraph 4 provides special rules for 
determining whether a resident of a Contracting State is engaged in the 
active conduct of a trade or business within the meaning of 
subparagraph (a). Subparagraph (c) attributes the activities of a 
partnership to each of its partners. Subparagraph (c) also attributes 
to a person activities conducted by persons ``connected'' to such 
person. A person (``X'') is connected to another person (``Y'') if X 
possesses 50 percent or more of the beneficial interest in Y (or if Y 
possesses 50 percent or more of the beneficial interest in X). For this 
purpose, X is connected to a company if X owns shares representing 
fifty percent or more of the aggregate voting power and value of the 
company or fifty percent or more of the beneficial equity interest in 
the company. X also is connected to Y if a third person possesses fifty 
percent or more of the beneficial interest in both X and Y. For this 
purpose, if X or Y is a company, the threshold relationship with 
respect to such company or companies is fifty percent or more of the 
aggregate voting power and value or fifty percent or more of the 
beneficial equity interest. Finally, X is connected to Y if, based upon 
all the facts and circumstances, X controls Y, Y controls X, or X and Y 
are controlled by the same person or persons.

Paragraph 5

    Paragraph 5 provides that a resident of one of the Contracting 
States is entitled to all the benefits of the Convention if that person 
functions as a recognized headquarters company for a multinational 
corporate group. For this purpose, the multinational corporate group 
includes all corporations that the headquarters company supervises and 
excludes affiliated corporations not supervised by the headquarters 
company. The headquarters company does not have to own shares in the 
companies that it supervises. In order to be considered a headquarters 
company, the person must meet several requirements that are enumerated 
in Paragraph 5. These requirements are discussed below.
Overall Supervision and Administration

    Subparagraph (a) provides that the person must provide a 
substantial portion of the overall supervision and administration of 
the group. This activity may include group financing, but group 
financing may not be the principal activity of the person functioning 
as the headquarters company. A person only will be considered to engage 
in supervision and administration if it engages in a number of the 
following activities: group financing, pricing, marketing, internal 
auditing, internal communications, and management. Other activities 
also could be part of the function of supervision and administration.

    In determining whether a ``substantial portion'' of the overall 
supervision and administration of the group is provided by the 
headquarters company, its headquarters-related activities must be 
substantial in relation to the same activities for the same group 
performed by other entities.

    Subparagraph (a) does not require that the group that is supervised 
include persons in the other State. However, it is anticipated that in 
most cases the group will include such persons, due to the requirement 
discussed below that the income derived by the headquarters company be 
derived in connection with or be incidental to an active trade or 
business supervised by the headquarters company.

Active Trade or Business

    Subparagraph (b) is the first of several requirements intended to 
ensure that the relevant group is truly ``multinational.'' This sub-
paragraph provides that the corporate group supervised by the 
headquarters company must consist of corporations resident in, and 
engaged in active trades or businesses in, at least five countries. 
Furthermore, at least five countries must contribute substantially to 
the income generated by the group, as the rule requires that the 
business activities carried on in each of the five countries (or 
groupings of countries) generate at least 10 percent of the gross 
income of the group. For purposes of the 10 percent gross income 
requirement, the income from multiple countries may be aggregated, as 
long as there are at least five individual countries or groupings that 
each satisfy the 10 percent requirement. If the gross income 
requirement under this clause is not met for a taxable year, the 
taxpayer may satisfy this requirement by averaging the ratios for the 
four years preceding the taxable year.

          Example. DHQ is a corporation resident in the Netherlands. 
        DHQ functions as a headquarters company for a group of 
        companies. These companies are resident in the United States, 
        Canada, New Zealand, the United Kingdom, Malaysia, the 
        Philippines, Singapore, and Indonesia. The gross income 
        generated by each of these companies for 2004 and 2005 is as 
        follows:

                    Gross Income Generated in Example
------------------------------------------------------------------------
                        Country                           2004     2005
------------------------------------------------------------------------
United States.........................................      $40      $45
Canada................................................       25       15
New Zealand...........................................       10       20
United Kingdom........................................       30       35
Malaysia..............................................       10       12
Philippines...........................................        7       10
Singapore.............................................       10        8
Indonesia.............................................        5       10
                                                       -----------------
  Total...............................................     $137     $155
------------------------------------------------------------------------


          For 2004, 10 percent of the gross income of this group is 
        equal to $13.70. Only the United States, Canada, and the United 
        Kingdom satisfy this requirement for that year. The other 
        companies in the group may be aggregated to meet this 
        requirement. Because New Zealand and Malaysia have a total 
        gross income of $20, and the Philippines, Singapore, and 
        Indonesia have a total gross income of $22, these two groupings 
        of countries may be treated as the fourth and fifth members of 
        the group for purposes of clause (2)(h)(ii).
          In the following year, 10 percent of the gross income is 
        $15.50. Only the United States, New Zealand, and the United 
        Kingdom satisfy this requirement. Because Canada and Malaysia 
        have a total gross income of $27, and the Philippines, 
        Singapore, and Indonesia have a total gross income of $28, 
        these two groupings of countries may be treated as the fourth 
        and fifth members of the group for purposes of clause 
        (2)(h)(ii). The fact that Canada replaced New Zealand in a 
        group not relevant for this purpose. The composition of the 
        grouping may change from year to year.

Single Country Limitation

    Subparagraph (c) provides that the business activities carried on 
in any one country other than the headquarters company's state of 
residence must generate less than 50 percent of the gross income of the 
group. If the gross income requirement under this clause is not met for 
a taxable year, the taxpayer may satisfy this requirement by averaging 
the ratios for the four years preceding the taxable year. The following 
example illustrates the application of this subparagraph.

          Example. DHQ is a corporation resident in the Netherlands. 
        DHQ functions as a headquarters company for a group of 
        companies. DHQ derives dividend income from a United States 
        subsidiary in the 2004 taxable year. The state of residence of 
        each of these companies, the situs of their activities and the 
        amounts of gross income attributable to each for the years 2004 
        through 2008 are set forth below.

         State of Residence, Situs of Activities, and Gross Income Attributable to Companies in Example
----------------------------------------------------------------------------------------------------------------
                        Company                            Situs       2008     2007     2006     2005     2004
----------------------------------------------------------------------------------------------------------------
United States.........................................         U.S.     $100     $100      $95      $90      $85
United States.........................................       Mexico       10        8        5        0        0
United States.........................................       Canada       20       18       16       15       12
United Kingdom........................................           UK       30       32       30       28       27
New Zealand...........................................         N.Z.       40       42       38       36       35
Japan.................................................        Japan       35       32       30       30       28
Singapore.............................................    Singapore       25       25       24       22       20
                                                                    --------------------------------------------
  Totals..............................................                  $260     $257     $238     $221     $207
----------------------------------------------------------------------------------------------------------------



    Because the United States' total gross income of $130 in 2008 is 
not less than 50 percent of the gross income of the group, clause 
(2)(h)(iii) is not satisfied with respect to dividends derived in 2008. 
However, the United States' average gross income for the preceding four 
years may be used in lieu of the preceding year's average. The United 
States' average gross income for the years 2004-07 is $111.00 ($444/4). 
The group's total average gross income for these years is $230.75 
($923/4). Because $111.00 represents 48.1 percent of the group's 
average gross income for the years 2004 through 2007, the requirement 
under subparagraph (c) is satisfied.

Other State Gross Income Limitation

    Subparagraph (d) provides that no more than 25 percent of the 
headquarters company's gross income may be derived from the other 
Contracting State. Thus, if the headquarters company's gross income for 
the taxable year is $200, no more than $50 of this amount may be 
derived from the other Contracting State. If the gross income 
requirement under this clause is not met for a taxable year, the 
taxpayer may satisfy this requirement by averaging the ratios for the 
four years preceding the taxable year.
Independent Discretionary Authority

    Subparagraph (e) requires that the headquarters company have and 
exercise independent discretionary authority to carry out the functions 
referred to in subparagraph (a). Thus, if the headquarters company was 
nominally responsible for group financing, pricing, marketing and other 
management functions, but merely implemented instructions received from 
another entity, the headquarters company would not be considered to 
have and exercise independent discretionary authority with respect to 
these functions. This determination is made individually for each 
function. For instance, a headquarters company could be nominally 
responsible for group financing, pricing, marketing and internal 
auditing functions, but another entity could be actually directing the 
headquarters company as to the group financing function. In such a 
case, the headquarters company would not be deemed to have independent 
discretionary authority for group financing, but it might have such 
authority for the other functions. Functions for which the headquarters 
company does not have and exercise independent discretionary authority 
are considered to be conducted by an entity other than the headquarters 
company for purposes of subparagraph (a).

Income Taxation Rules

    Subparagraph (f) requires that the headquarters company be subject 
to the generally applicable income taxation rules in its country of 
residence. This reference should be understood to mean that the company 
must be subject to the income taxation rules to which a company engaged 
in the active conduct of a trade or business would be subject. Thus, if 
one of the Contracting States has or introduces special taxation 
legislation that impose a lower rate of income tax on headquarters 
companies than is imposed on companies engaged in the active conduct of 
a trade or business, or provides for an artificially low taxable base 
for such companies, a headquarters company subject to these rules is 
not entitled to the benefits of the Convention under Paragraph 5.

In Connection With or Incidental to Trade or Business

    Subparagraph (g) requires that the income derived in the other 
Contracting State be derived in connection with or be incidental to the 
active business activities referred to in subparagraph (b). This 
determination is made under the principles set forth in paragraph 4. 
For instance, if a Netherlands company that satisfied the other 
requirements in Paragraph 5 acted as a headquarters company for a group 
that included a United States corporation, and the group was engaged in 
the design and manufacture of computer software, but the U.S. company 
was also engaged in the design and manufacture of photocopying 
machines, the income that the Netherlands company derived from the 
United States would have to be derived in connection with or be 
incidental to the income generated by the computer business in order to 
be entitled to the benefits of the Convention under Paragraph 5. 
Interest income received from the U.S. company also would be entitled 
to the benefits of the Convention under this paragraph as long as the 
interest was attributable to a trade or business supervised by the 
headquarters company. Interest income derived from an unrelated party 
would normally not, however, satisfy the requirements of this clause.

Paragraph 6

    Paragraph 6 provides that a resident of one of the States that 
derives income from the other State described in Article 8 (Shipping 
and Air Transport) and that is not entitled to the benefits of the 
Convention under paragraphs 1 through 5, shall nonetheless be entitled 
to the benefits of the Convention with respect to income described in 
Article 8 if it meets one of two tests.

    First, a resident of one of the States will be entitled to the 
benefits of the Convention with respect to income described in Article 
8 if at least 50 percent of the beneficial interest in the person (in 
the case of a company, at least 50 percent of the aggregate vote and 
value of the stock of the company) is owned, directly or indirectly, by 
qualified persons or individuals who are residents of a third state 
that grants by law, common agreement, or convention an exemption under 
similar terms for profits as mentioned in Article 8 to citizens and 
corporations of the other State. This provision is analogous to the 
relief provided under Code section 883(c)(1).

    Alternatively, a resident of one of the States will be entitled to 
the benefits of the Convention with respect to income described in 
Article 8 if at least 50 percent of the beneficial interest in the 
person (in the case of a company, at least 50 percent of the aggregate 
vote and value of the stock of the company) is owned directly or 
indirectly by a company or combination of companies the stock of which 
is primarily and regularly traded on an established securities market 
in a third state, provided that the third state grants by law, common 
agreement or convention an exemption under similar terms for profits as 
mentioned in Article 8 to citizens and corporations of the other State. 
This provision is analogous to the relief provided under Code section 
883(c)(3). The term ``primarily and regularly traded on an established 
securities market'' is not defined in the Convention. In determining 
whether a resident of the Netherlands is entitled to benefits of the 
Convention under this paragraph, the United States will apply the 
principles of Code Section 883(c)(3)(A).

    A resident of a Contracting State that derives income from the 
other State described in Article 8 (Shipping and Air Transport) but 
that does not meet all the requirements of paragraph 5 will 
nevertheless qualify for treaty benefits if it meets the requirements 
of any other test under Article 26 (i.e., the publicly-traded test 
under paragraph 2(c) or the active trade or business test of paragraph 
4).

Paragraph 7

    Paragraph 7 provides that a resident of one of the States that is 
not entitled to the benefits of the Convention as a result of 
paragraphs 1 through 6 still may be granted benefits under the 
Convention at the discretion of the competent authority of the State 
from which benefits are claimed. In making determinations under 
paragraph 7, that competent authority will take into account as its 
guideline whether the establishment, acquisition, or maintenance of the 
person seeking benefits under the Convention, or the conduct of such 
person's operations, has or had as one of its principal purposes the 
obtaining of benefits under the Convention. Thus, persons that 
establish operations in one of the States with a principal purpose of 
obtaining the benefits of the Convention ordinarily will not be granted 
relief under paragraph, 7.

    The competent authority may determine to grant all benefits of the 
Convention, or it may determine to grant only certain benefits. For 
instance, it may determine to grant benefits only with respect to a 
particular item of income in a manner similar to paragraph 3. Further, 
the competent authority may set time limits on the duration of any 
relief granted.

    For purposes of implementing paragraph 7, a taxpayer will be 
permitted to present his case to the relevant competent authority for 
an advance determination based on the facts. In these circumstances, it 
is also expected that if the competent authority determines that 
benefits are to be allowed, they will be allowed retroactively to the 
time of entry into force of the relevant treaty provision or the 
establishment of the structure in question, whichever is later.

    A competent authority is required by paragraph 7 to consult the 
other competent authority before denying benefits under this paragraph. 
Subparagraph (b) of Paragraph XXIV of the Understanding includes two 
provisions intended to ensure that taxpayers receive determinations in 
a timely manner. First, the competent authorities agree to use 
reasonable efforts to make a determination pursuant to this paragraph 
within six months of receiving all of the necessary information from 
taxpayers. Second, they will meet semi-annually to discuss the status 
of outstanding cases.

    According to paragraph XXVIII of the Understanding, the competent 
authorities will consider the obligations of the Netherlands by virtue 
of its membership in the European Communities in making a determination 
under paragraph 7. In particular, the competent authorities will 
consider any legal requirements for the facilitation of the free 
movement of capital and persons, together with the differing internal 
tax systems, tax incentive regimes and existing tax treaty policies 
among Member States of the European Communities. As a result, where 
certain changes in circumstances otherwise might cause a person to 
cease to be a qualified person under paragraphs 2 and 3 of Article 26, 
such changes need not result in the denial of benefits.

    The changes in circumstances contemplated include, all under 
ordinary business conditions, a change in the State of residence of a 
major shareholder of a company; the sale of part of the stock of a 
Netherlands company to a resident in another Member State of the 
European Communities; or an expansion of a company's activities in 
other Member States of the European Communities. So long as the 
relevant competent authority is satisfied that those changed 
circumstances are not attributable to tax avoidance motives, they will 
count as a factor favoring the granting of benefits under paragraph 7, 
if consistent with existing treaty policies, such as the need for 
effective exchange of information. See the Technical Explanation to 
paragraph 3 of Article 10 for a discussion of the factors that the 
competent authority will consider in making these determinations. A 
company that wishes the relevant competent authority to take such legal 
requirements into account must request an advance determination, as 
described above.
Paragraph 8

    Paragraph 8 defines several key terms for purposes of Article 26. 
Each of the defined terms is discussed in the context in which it is 
used.

                               Article 8

    Article 8 restates Article 32 (Limitation of Articles 30 and 31) 
of' the Convention to make it consistent with the U.S. Model Tax 
Convention and international norms regarding information exchange and 
bank secrecy.

Paragraph 1

    Paragraph 1 provides that the obligations undertaken in Articles 30 
and 31 to exchange information do not require a Contracting State to 
carry out administrative measures that are at variance with the laws or 
administrative practice of either State. Moreover, a Contracting State 
is not required to supply information not obtainable under the laws or 
administrative practice of either State, or to disclose trade secrets 
or other information, the disclosure of which would be contrary to 
public policy. Thus, a requesting State may be denied information from 
the other State if the information would be obtained pursuant to 
procedures or measures that are broader than those available in the 
requesting State. Paragraph VIII confirms that the competent 
authorities will work together to ensure that the information to be 
provided will be in a form that facilitates its use in judicial 
proceedings in the requesting State.

Paragraph 2

    In paragraph 2, each Contracting State has confirmed that it will 
obtain and exchange certain information, notwithstanding the provisions 
of paragraph 1. The information that may be exchanged includes 
information held by financial institutions, nominees, or persons acting 
in an agency or fiduciary capacity. The Contracting States may also 
obtain and exchange information relating to the ownership of legal 
persons and, as described in paragraph XXXVI of the Understanding, will 
use all reasonable efforts to do so unless obtaining such information 
gives rise to disproportionate difficulties.

Paragraph 3

    Paragraph 3 confirms that the obligation to provide information 
held by persons acting in a fiduciary capacity does not extend to 
information that would reveal confidential communications between a 
client and an attorney, solicitor or other legal representative, where 
the client seeks legal advice or produced for the purposes of use in 
existing or contemplated legal proceedings. In the case of the United 
States, the scope of the privilege for such confidential communications 
is coextensive with the attorney-client privilege under U.S. law.

                               Article 9

    Article 9 updates several references in the Convention that have 
become outdated. Paragraph (a) updates the reference to the Netherlands 
Mining Act, which consolidated and restated the provisions of the 
Mining Act of 1810 and the Continental Shelf Mining Act of 1965. 
Paragraph (b) takes account of the fact that the euro has replaced 
Netherlands guilders as the currency of the Netherlands.

                               Article 10

    Article 10 contains the rules for bringing the Protocol into force 
and giving effect to its provisions.

    Paragraph 1 provides for the ratification of the Convention by both 
Contracting States according to their constitutional and statutory 
requirements. Each State must notify the other as soon as its 
requirements for ratification have been complied with. The Convention 
will enter into force on the date of the later of such notifications.

    In the United States, the process leading to ratification and entry 
into force is as follows: Once a protocol or treaty has been signed by 
authorized representatives of the two Contracting States, the 
Department of State sends the protocol or treaty to the President who 
formally transmits it to the Senate for its advice and consent to 
ratification, which requires approval by two-thirds of the Senators 
present and voting. Prior to this vote, however, it generally has been 
the practice of the Senate Committee on Foreign Relations to hold 
hearings on the protocol or treaty and make a recommendation regarding 
its approval to the full Senate. Both Government and private sector 
witnesses may testify at these hearings. After receiving the Senate's 
advice and consent to ratification, the protocol or treaty is returned 
to the President for his signature on the ratification document. The 
President's signature on the document completes the process in the 
United States.

    The date on which a treaty enters into force is not necessarily the 
date on which its provisions take effect. Paragraph 1 also contains 
rules that determine when the provisions of the treaty will have 
effect.

    Under subparagraph (a), the provisions of the Protocol relating to 
taxes withheld at source will have effect with respect to amounts paid 
or credited on or after the first day of the second month, following 
the date on which the Protocol enters into force. For example, if 
instruments of ratification are exchanged on April 25 of a given year, 
the withholding rates specified in paragraphs 2 and 3 of Article 10 
(Dividends) as provided in Article 3 would be applicable to any 
dividends paid or credited on or after June 1 of that year. Similarly, 
the revised Limitation on Benefits provisions of Article 7 would apply 
with respect to any payments of interest, royalties or other amounts on 
which withholding would apply under the Internal Revenue Code if those 
amounts are paid or credited on or after June 1.

    This rule allows the benefits of the withholding reductions to be 
put into effect as soon as possible, without waiting until the 
fallowing year. The delay of one to two months is required to allow 
sufficient time for withholding agents to be informed about the change 
in withholding rates. If for some reason a withholding agent withholds 
at a higher rate than that provided by the Convention (perhaps because 
it was not able to re-program its computers before the payment is 
made), a beneficial owner of the income that is a resident of the 
Netherlands may make a claim for refund pursuant to section 1464 of the 
Code.

    For all other taxes, subparagraph (b) specifies that the Protocol 
will have effect for any taxable period beginning on or after January 1 
of the year following entry into force.

    As in many recent U.S. treaties, paragraph 2 provides an exception 
to the general rules of paragraph 1 regarding entry into force. Under 
paragraph 2, if any person who was entitled to the benefits of the 
Convention, before modification by the Protocol, would have received 
greater relief from tax than under the Convention as modified by the 
Protocol, the Convention as unmodified shall, at the election of any 
person that was entitled to benefits under the prior Convention, 
continue to have effect in its entirety for a twelve-month period from 
the date on which this Convention otherwise would have had effect with 
respect to such person.

    Thus, a taxpayer may elect to extend the benefits of the unmodified 
Convention for one year from the date on which the relevant provision 
of the modified Convention would first take effect. During the period 
in which tie election is in effect, the provisions of the unmodified 
Convention will continue to apply only insofar as they applied before 
the entry into force of the Protocol. If the grace period is elected, 
all of the provisions of the Convention as unmodified must be applied 
for that additional year. The taxpayer may not apply certain, more 
favorable provisions of the unmodified Convention and, at the same 
time, apply other, more favorable provisions of modified Convention. 
The taxpayer must choose one regime or fir other.

                               __________

DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE SECOND PROTOCOL 
  SIGNED ON JULY 14, 2004, AMENDING THE CONVENTION BETWEEN THE UNITED 
STATES OF AMERICA AND BARBADOS FOR THE AVOIDANCE OF DOUBLE TAXATION AND 
   THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME, 
                      SIGNED ON DECEMBER 31, 1984

    This is a technical explanation of the Second Protocol signed at 
Washington on July 14, 2004 (the ``Protocol''), amending the Convention 
between the United States of America and Barbados for the avoidance of 
double taxation and the prevention of fiscal evasion with respect to 
taxes on income, signed at Bridgetown on December 31, 1984 (the ``1984 
Convention''), as amended by a protocol signed at Washington, D.C. on 
December 18, 1991 (the ``1991 Protocol''). The term ``Convention'' 
refers to the 1984 Convention as modified by both the 1991 Protocol and 
the Protocol.

    Negotiations took into account the U.S. Treasury Department's 
current tax treaty policy and the Treasury Department's Model Income 
Tax Convention, published on September 20, 1996 (the ``U.S. Model''). 
Negotiations also took into account the Model Tax Convention on Income 
and on Capital, published by the Organization for Economic Cooperation 
and Development, as updated in January 2003 (the ``OECD Model''), and 
recent tax treaties concluded by both countries.

    The Protocol was accompanied by Understandings (the 
``Understandings''), implemented through an exchange of notes, 
indicating the views of the negotiators and of the States with respect 
to Article 22 (Limitation on Benefits) of the Convention. The 
Understandings also provided that the Understandings accompanying the 
1991 Protocol (the ``1991 Understandings'') continue to apply for 
purposes of applying Article 22 of the Convention, except to the extent 
that the 1991 Understandings are inconsistent with the provisions of 
Article 22 (as amended by the Protocol). The Understandings and the 
1991 Understandings are discussed in connection with the relevant 
portions of the Protocol.

    The Technical Explanation is an official guide to the Protocol. It 
reflects the policies behind particular Protocol provisions, as well as 
understandings reached with respect to the application and 
interpretation of the Protocol. This Technical Explanation should be 
read together with the Technical Explanations of the 1984 Convention 
and the 1991 Protocol.

    References in the Technical Explanation to ``he'' or ``his'' should 
be read to mean ``he or she'' or ``his or her.''

                               Article I

    Article I of the Protocol modifies paragraph 3 of Article 1 of the 
Convention which permits the United States to continue to tax as U.S. 
citizens former citizens whose loss of citizenship had as one of its 
principal purposes the avoidance of tax. To reflect 1996 amendments to 
U.S. tax law in this area, the Protocol extends this treatment to 
former long-term residents whose loss of such status had as one of its 
principal purposes the avoidance of tax.

    Section 877 of the Internal Revenue Code of 1986 (the ``Code'') 
applies to former citizens and long-term residents of the United States 
whose loss of citizenship or long-term resident status had as one of 
its principal purposes the avoidance of tax. Under section 877, the 
United States generally treats an individual as having a principal 
purpose to avoid tax if either of the following criteria exceed 
established thresholds: (a) the average annual net income tax of such 
individual for the period of 5 taxable years ending before the date of 
the loss of status, or (b) the net worth of such individual as of the 
date of the loss of status. The thresholds are adjusted annually for 
inflation. Section 877(c) provides certain exceptions to these 
presumptions of tax avoidance. The United States defines ``long-term 
resident'' as an individual (other than a U.S. citizen) who is a lawful 
permanent resident of the United States in at least 8 of the prior 15 
taxable years. An individual is not treated as a lawful permanent 
resident for any taxable year if such individual is treated as a 
resident of a foreign country under the provisions of a tax treaty 
between the United States and the foreign country and the individual 
does not waive the benefits of such treaty applicable to residents of 
the foreign country.

                               Article II

    Article II of the Protocol replaces Article 22 (Limitation on 
Benefits) of the Convention.
Structure of the Article

    Article 22 follows the form used in other recent U.S. income tax 
treaties. Paragraph 1 states the general rule that a resident of a 
Contracting State is entitled to benefits otherwise accorded to 
residents only to the extent that the resident satisfies the 
requirements of the Article and any other specified conditions for the 
obtaining of such benefits and lists a series of attributes of a 
resident of a Contracting State, any one of which suffices to make such 
resident entitled to all the benefits of the Convention. Paragraph 2 
sets forth the active trade or business test, under which a person not 
entitled to benefits under paragraph 1 may nonetheless be granted 
benefits with regard to certain types of income. Paragraph 3 provides 
that benefits also may be granted if the competent authority of the 
State from which the income arises determines that it is appropriate to 
grant benefits in that case. Paragraph 4 defines what constitutes a 
recognized stock exchange for purposes of paragraph I. Paragraph 5 
authorizes the competent authorities to develop agreed applications of 
the Article and to exchange information necessary for carrying out the 
provisions of the Article. Paragraph 6 excludes certain persons that 
are residents and that otherwise would qualify for the benefits of the 
Convention under paragraphs 1 or 2 of this Article from the benefits of 
Articles 10 (Dividends), 11 (Interest) and 12 (Royalties).

    Article 22 and the anti-abuse provisions of domestic law complement 
each other, as Article 22 effectively determines whether an entity has 
a sufficient nexus to the Contracting State to be treated as a resident 
for treaty purposes, while domestic anti-abuse provisions (e.g., 
business purpose, substance-over-form, step transaction or conduit 
principles) determine whether a particular transaction should be recast 
in accordance with its substance. Thus, internal law principles of the 
source Contracting State may be applied to identify the beneficial 
owner of an item of income, and Article 22 then will be applied to the 
beneficial owner to determine if that person is entitled to the 
benefits of the Convention with respect to such income.

Paragraph 1

    Paragraph 1 provides that, except as otherwise provided, a resident 
of a Contracting State will be entitled to all the benefits of the 
Convention otherwise accorded to residents of a Contracting State only 
if the resident is described in one of the subparagraphs of that 
paragraph 1.

    The benefits otherwise accorded to residents under the Convention 
include all limitations on source-based taxation under Articles 6 
through 21, the treaty-based relief from double taxation provided by 
Article 23 (Relief from Double Taxation), and the protection afforded 
to residents of a Contracting State under Article 24 (Non-
Discrimination). Some provisions do not require that a person be a 
resident in order to enjoy the benefits of those provisions. Article 25 
(Mutual Agreement Procedure) is not limited to residents of the 
Contracting States, and Article 27 (Diplomatic Agents and Consular 
Officers) applies to diplomatic agents or consular officials regardless 
of residence. Article 22 accordingly does not limit the availability of 
treaty benefits under these provisions.

    Paragraph 1 has six subparagraphs, each of which describes a 
category of residents that are entitled to all benefits of the 
Convention. It is intended that the provisions of paragraph 1 will be 
self-executing. Claiming benefits under paragraph 1 does not require 
advance competent authority ruling or approval. The tax authorities 
may, of course, on review, determine that the taxpayer has improperly 
interpreted the paragraph and is not entitled to the benefits claimed.

            Individuals--Subparagraph 1(a)

    Subparagraph (a) provides that individual residents of a 
Contracting State will be entitled to all the benefits of the 
Convention. If such an individual receives income as a nominee on 
behalf of a third country resident, benefits may be denied under the 
applicable articles of the Convention by the requirement that the 
beneficial owner of the income be a resident of a Contracting State.

            Governments--Subparagraph 1(b)

    Subparagraph (b) provides that the Contracting States and any 
political subdivision or local authority thereof will be entitled to 
all the benefits of the Convention.

            Publicly-Traded Corporations--Subparagraph 1(c)

    Subparagraph (c) applies to two categories of companies: publicly 
traded companies and subsidiaries of publicly traded companies. A 
company resident in a Contracting State is entitled to all the benefits 
of the Convention under clause (i) of subparagraph (c) if its principal 
class of shares is: (a) listed on a recognized stock exchange located 
in the Contracting State of which the company is a resident; (b) 
primarily traded on a recognized stock exchange located in the 
Contracting State of which the company is a resident; and (c) regularly 
traded on one or more recognized stock exchanges. In the case of a 
company that is resident in Barbados, the company alternatively may 
satisfy the second requirement if it is primarily traded on either the 
Jamaica Stock Exchange or the Trinidad Stock Exchange, each of which is 
a recognized stock exchange, as discussed below.

    The term ``recognized stock exchange'' is defined in paragraph 4. 
It includes the NASDAQ System and any stock exchange registered with 
the Securities and Exchange Commission as a national securities 
exchange for purposes of the Securities Exchange Act of 1934, as well 
as the Barbados Stock Exchange, the Jamaica Stock Exchange and the 
Trinidad Stock Exchange . The term also includes any other stock 
exchange agreed upon by the competent authorities of the Contracting 
States.

    The term ``principal class of shares'' is not defined in the 
Convention. In accordance with paragraph 2 of Article 3 (General 
Definitions), this term will have the meaning it has under the laws of 
the State concerning the taxes to which the Convention applies, 
generally the source State. Generally, under U.S. tax law, the 
``principal class of shares'' is defined as the common shares of the 
company representing the majority of the aggregate voting power and 
value of the company. If the company does not have a class of ordinary 
or common shares representing the majority of the aggregate voting 
power and value of the company, then the ``principal class of shares'' 
is that class or any combination of classes of shares that represents, 
in the aggregate, a majority of the voting power and value of the 
company. ``Shares'' include depository receipts for shares or trust 
certificates for shares.

    The term ``primarily traded'' is not defined in the Convention. In 
accordance with paragraph 2 of Article 3 (General Definitions), this 
term will have the meaning it has under the laws of the State 
concerning the taxes to which the Convention applies, generally the 
source State. In the case of the United States, this term is understood 
to have the meaning it has under Treas. Reg. section 1.884-5(d)(3), 
relating to the branch tax provisions of the Code. Accordingly, stock 
of a corporation is ``primarily traded'' on a recognized stock exchange 
in the Contracting State of which the company is a resident if the 
number of shares in the company's principal class of shares that are 
traded during the taxable year on all recognized stock exchanges in 
that Contracting State exceeds the number of shares in the company's 
principal class of shares that are traded during that year on 
established securities markets in any other single foreign country.

    The term ``regularly traded'' is not defined in the Convention. In 
accordance with paragraph 2 of Article 3 (General Definitions), this 
term will have the meaning it has under the laws of the State 
concerning the taxes to which the Convention applies, generally the 
source State. In the case of the United States, this term is understood 
to have the meaning it has under Treas. Reg. section 1.884-
5(d)(4)(i)(B), relating to the branch tax provisions of the Code. Under 
these regulations, a class of shares is considered to be ``regularly 
traded'' if two requirements are met: trades in the class of shares are 
made in more than de minimis quantities on at least 60 days during the 
taxable year, and the aggregate number of shares in the class traded 
during the year is at least 10 percent of the average number of shares 
outstanding during the year. Treas. Reg. section 1.884-5(d)(4)(i)(A), 
(ii) and (iii) will not be taken into account for purposes of defining 
the term ``regularly traded'' under the Convention.

    The regular trading requirement can be met by trading on any 
recognized exchange or exchanges. Trading on one or more recognized 
stock exchanges may be aggregated for purposes of this requirement. 
Authorized but unissued shares are not considered for purposes of this 
test.

    A company resident in a Contracting State is entitled to all the 
benefits of the Convention under clause (ii) of subparagraph (c) of 
paragraph 1 if: (a) at least 50 percent of the company's principal 
class of shares is owned directly or indirectly by companies that are 
publicly traded as provided above; and (b) the company satisfies the 
requirements of the base erosion clause of paragraph 1(d) of this 
Article. Furthermore, in the case of indirect ownership, each 
intermediate owner must be a person entitled to benefits of the 
Convention under this clause (ii). Thus, for example, a Barbados 
company, all the shares of which are owned by another Barbados company, 
would qualify for benefits under the Convention if the principal class 
of shares of the Barbados parent company were listed on the Barbados 
Stock Exchange, primarily traded on the Barbados Stock Exchange and 
regularly traded on the Barbados Stock Exchange and the New York Stock 
Exchange.

            Ownership/Base Erosion--Subparagraph 1(d)

    Subparagraph 1(d) provides an additional test that applies to any 
form of legal entity that is a resident of a Contracting State. The 
test provided in subparagraph (d), the so-called ownership and base 
erosion test, is a two-part test. Both prongs of the test must be 
satisfied for the resident to be entitled to benefits under 
subparagraph 1(d).

    The ownership prong of the test, under clause (i), requires that 
more than 50 percent of the beneficial interest in that person (or in 
the case of a company, more than 50 percent of the number of shares of 
each class of whose shares) is owned, directly or indirectly, on at 
least half the days of the taxable year by residents of that State that 
are entitled to the benefits of this Convention under subparagraphs 
(a), (b), (c)(i), (e) or (f) (other than a person described in 
paragraph 6 of this Article). Furthermore, in the case of indirect 
ownership, each intermediate owner must be a resident of that 
Contracting State.

    Trusts may be entitled to benefits under this provision if they are 
treated as residents under Article 4 (Resident) and they otherwise 
satisfy the requirements of this subparagraph. For purposes of this 
subparagraph, the beneficial interests in a trust will be considered to 
be owned by its beneficiaries in proportion to each beneficiary's 
actuarial interest in the trust. The interest of a remainder 
beneficiary will be equal to 100 percent less the aggregate percentages 
held by income beneficiaries. A beneficiary's interest in a trust will 
not be considered to be owned by a person entitled to benefits under 
the other provisions of paragraph 1 if it is not possible to determine 
the beneficiary's actuarial interest. Consequently, if it is not 
possible to determine the actuarial interest of any beneficiaries in a 
trust, the ownership test under clause (i) cannot be satisfied, unless 
all possible beneficiaries are persons entitled to benefits under the 
other subparagraphs of paragraph 1.

    The base erosion prong of clause (ii) of subparagraph (d) 
disqualifies a person if 50 percent or more of the person's gross 
income for the taxable. year is paid or accrued, directly or 
indirectly, to persons who are not residents of that same Contracting 
State entitled to the benefits of this Convention under subparagraphs 
(a), (b), (c)(i), (e) or (f) (other than a person described in 
paragraph 6 of this Article) in the form of payments that are 
deductible for the purposes of the taxes covered by this Convention in 
the State of which the person is a resident. The term ``gross income'' 
is not defined in the Convention. Thus, in accordance with paragraph 
(2) of Article 3 (General Definitions), in determining whether a person 
deriving income from United States sources is entitled to the benefits 
of the Convention, the United States will ascribe the meaning to the 
term that it has in the United States. In the case of the United 
States, the term ``gross income'' has the same meaning as such term in 
section 61 of the Code and the regulations thereunder.

    To the extent they are deductible from the taxable base, trust 
distributions are deductible payments. However, depreciation and 
amortization deductions, which do not represent payments or accruals to 
other persons, are disregarded for this purpose. Deductible payments 
also do not include arm's length payments in the ordinary course of 
business for services or tangible property.

            Tax Exempt Organizations--Subparagraph 1(e)

    A tax-exempt organization other than an exempt pension trust is 
entitled to all the benefits of the Convention, without regard to the 
residence of its beneficiaries or members. Entities qualifying under 
this subparagraph are those that are organized and operated exclusively 
for religious, charitable, scientific, literary or educational purposes 
and that, by virtue of that status, are generally exempt from income 
taxation in their Contracting State of residence.

            Exempt Employee Benefits Organizations--Subparagraph 1(f)

    A plan, scheme, fund, trust, company or other arrangement 
established in a Contracting State that is operated exclusively to 
administer or provide employee benefits and that, by reason of its 
nature as such, is generally exempt from income taxation in that State 
is entitled to all the benefits of the Convention if more than half of 
the beneficiaries, members or participants, if any, in such 
organization are persons that are entitled, under this Article, to the 
benefits of this Convention. For purposes of this provision, the term 
``beneficiaries'' should be understood to refer to the persons 
receiving benefits from the entity.

Paragraph 2

    Paragraph 2 sets forth a test under which a resident of a 
Contracting State that is not entitled to all benefits of the 
Convention may receive treaty benefits with respect to certain items of 
income that are connected to an active trade or business conducted in 
its State of residence.

    Subparagraph (a) sets forth the general rule that a resident of a 
Contracting State engaged in the active conduct of a trade or business 
in that State may obtain the benefits of the Convention with respect to 
an item of income derived in the other Contracting State. The item of 
income, however, must be derived in connection with or incidental to 
that trade or business.

    The term ``active trade or business'' is defined in clause (iii) of 
subparagraph 2(d). In general, a trade or business comprises activities 
that constitute (or could constitute) an independent economic 
enterprise carried on for profit. To constitute a trade or business, 
the activities conducted by the resident ordinarily must include every 
operation which forms a part of, or a step in, a process by which an 
enterprise may earn income or profit. The determination of whether the 
activities of a resident of a Contracting State constitute an active 
trade or business is determined under all the facts and circumstances. 
A resident of a Contracting State actively conducts a trade or business 
if it regularly performs active and substantial management and 
operational functions through its own officers or staff of employees. 
In this regard, one or more of such activities may be carried out by 
independent contractors under the direct control of the resident. 
However, in determining whether the corporation actively conducts a 
trade or business, the activities of independent contractors shall be 
disregarded.

    The business of making or managing investments for the resident's 
own account will be considered to be a trade or business only when part 
of banking or insurance activities conducted by a bank or an insurance 
company. Such activities conducted by a person other than a bank or an 
insurance company will not be considered to be the conduct of an active 
trade or business, nor would they be considered to be the conduct of an 
active trade or business if conducted by a bank or insurance company 
but not as part of the company's banking or insurance business.

    For this purpose, a resident will be treated as a bank only if: (a) 
it is licensed to accept deposits from residents of the Contracting 
State of which it is a resident and to conduct, in that State, lending 
or other banking activities; (b) it regularly accepts deposits from 
customers who are residents of the Contracting State of which it is a 
resident in the ordinary course of its business and the amount of 
deposits shown on the company's balance sheet is substantial; and (c) 
it regularly makes loans to customers in the ordinary course of its 
trade or business. Furthermore, a resident will be treated as an 
insurance company only if: (a) it is licensed to insure risks of 
residents of the Contracting State of which it is a resident; and (b) 
it regularly insures (not including reinsurance) risks of customers who 
are residents of the Contracting State of which it is a resident.

    Because a headquarters operation is in the business of managing 
investments, a company that functions solely as a headquarters company 
will not be considered to be engaged in an active trade or business for 
purposes of subparagraph (a).

    An item of income is derived in connection with a trade or business 
if the income-producing activity in the State of source is a line of 
business that ``forms a part of'' or is ``complementary'' to the trade 
or business conducted in the State of residence by the income 
recipient. A business activity generally will be considered to form 
part of a business activity conducted in the State of source if the two 
activities involve the design, manufacture or sale of the same products 
or type of products, or the provision of similar services. The notes 
clarify that the line of business in the State of residence may be 
upstream, downstream, or parallel to the activity conducted in the 
State of source. Thus, the line of business may provide inputs for a 
manufacturing process that occurs in the State of source, may sell the 
output of that manufacturing process, or simply may sell the same sorts 
of products that are being sold by the trade or business carried on in 
the State of source.

    For two activities to be considered to be ``complementary,'' the 
activities need not relate to the same types of products or services, 
but they should be part of the same overall industry and be related in 
the sense that the success or failure of one activity will tend to 
result in success or failure for the other. Where more than one trade 
or business is conducted in the State of source and only one of the 
trades or businesses forms a part of or is complementary to a trade or 
business conducted in the State of residence, it is necessary to 
identify the trade or business to which an item of income is 
attributable. Royalties generally will be considered to be derived in 
connection with the trade or business to which the underlying 
intangible property is attributable. Dividends will be deemed to be 
derived first out of earnings and profits of the treaty-benefited trade 
or business, and then out of other earnings and profits. Interest 
income may be allocated under any reasonable method consistently 
applied. A method that conforms to U.S. principles for expense 
allocation will be considered a reasonable method.

    An item of income derived from the State of source is ``incidental 
to'' the trade or business carried on in the State of residence if 
production of the item facilitates the conduct of the trade or business 
in the State of residence. An example of incidental income is the 
temporary investment of working capital of a person in the State of 
residence in securities issued by persons in the State of source.

    Subparagraph (b) of paragraph 2 states a further condition to the 
general rule in subparagraph (a) in cases where the trade or business 
generating the item of income in question is carried on either by the 
person deriving the income or by any associated enterprises. 
Subparagraph (b) states that the trade or business carried on in the 
State of residence, under these circumstances, must be substantial in 
relation to the activity in the State of source. The requirement is 
intended to prevent a narrow case of treaty-shopping abuses in which a 
company attempts to qualify for benefits by engaging in de minimis 
connected business activities in the treaty country in which it is 
resident (i.e., activities that have little economic cost or effect 
with respect to the company business as a whole).

    The determination of substantiality is made based upon all the 
facts and circumstances and takes into account the comparative sizes of 
the trades or businesses in each Contracting State (measured by 
reference to asset values, income and payroll expenses), the nature of 
the activities performed in each Contracting State, and the relative 
contributions made to that trade or business in each Contracting State. 
In any case, in making each determination or comparison, due regard 
will be given to the relative sizes of the U.S. and Barbados economies.

    In addition to this subjective rule, subparagraph (b) provides a 
safe harbor under which the trade or business of the income recipient 
may be deemed to be substantial based on three ratios that compare the 
size of the recipient's activities to those conducted in the other 
State with respect to the preceding taxable year, or the average of the 
preceding three years. The three ratios compare: (i) the value of the 
assets in the recipient's State to the assets used in the other State; 
(ii) the gross income derived in the recipient's State to the gross 
income derived in the other State; and (iii) the payroll expense in the 
recipient's State to the payroll expense in the other State. The 
average of the three ratios must exceed 10 percent, and each individual 
ratio must equal at least 7.5 percent. For purposes of this test, if 
the income recipient owns, directly or indirectly, less than 100 
percent of the activity conducted in either State, only its 
proportionate share of the activity will be taken into account.

    The determination in subparagraph (b) also is made separately for 
each item of income derived from the State of source. It therefore is 
possible that a person would be entitled to the benefits of the 
Convention with respect to one item of income but not with respect to 
another.

    If a resident of a Contracting State is entitled to treaty benefits 
with respect to a particular item of income under paragraph 2, the 
resident is entitled to all benefits of the Convention insofar as they 
affect the taxation of that item of income in the State of source.

    The application of the substantiality test only to income from 
related parties focuses only on potential abuse cases, and does not 
hamper certain other kinds of non-abusive activities, even though the 
income recipient resident in a Contracting State may be very small in 
relation to the entity generating income in the other Contracting 
State. For example, a small Barbados bank that makes a loan to a very 
large unrelated U.S. business would not have to pass a substantiality 
test to receive treaty benefits under Paragraph 2.

    As discussed above, paragraph 1 of the Understandings provides that 
the 1991 Understandings continue to apply for purposes of applying 
Article 22 of the Convention, except to the extent that the 1991 
Understandings are inconsistent with the provision of Article 22 (as 
amended by the Protocol). In this regard, the 1991 Understandings make 
clear that this provision is self executing; unlike the provisions of 
paragraph 3, discussed below, it does not require advance competent 
authority ruling or approval. The 1991 Understandings contain a number 
of examples illustrating the intention of the negotiators with respect 
to the interpretation of the active trade or business provisions in the 
1991 Protocol.

    Subparagraph (c) of paragraph 2 provides special rules for 
determining whether a resident of a Contracting State is engaged in the 
active conduct of a trade or business within the meaning of 
subparagraph (a). Subparagraph (c) attributes the activities of a 
partnership to each of its partners, Subparagraph (c) also attributes 
to a person activities conducted by persons ``connected'' to such 
person. A person (``X'') is connected to another person (``Y'') if X 
possesses 50 percent or more of the beneficial interest in Y (or if Y 
possesses 50 percent or more of the beneficial interest in X). For this 
purpose, X is connected to a company if X owns shares representing 50 
percent or more of the aggregate voting power and value of the company 
or fifty percent or more of the beneficial equity interest in the 
company. X also is connected to Y if a third person possesses 50 
percent or more of the beneficial interest in both X and Y. For this 
purpose, if X or Y is a company, the threshold relationship with 
respect to such company or companies is 50 percent or more of the 
aggregate voting power and value or 50 percent or more of the 
beneficial equity interest. Finally, X is connected to Y if, based upon 
all the facts and circumstances, X controls Y, Y controls X, or X and Y 
are controlled by the same person or persons.

Paragraph 3

    Paragraph 3 provides that a person that is not entitled to the 
benefits of this Convention pursuant to the provisions of paragraph 1 
may, nevertheless, be granted the benefits of the Convention at the 
discretion of the competent authority of the State in which the income 
in question arises. The paragraph itself provides no guidance to 
competent authorities or taxpayers as to how the discretionary 
authority is to be exercised. The 1991 Understandings, which generally 
continue to apply, as discussed above, provide that, for purposes of 
implementing paragraph 3, taxpayers will be permitted to present their 
cases to the competent authority for an advance determination based on 
the facts, and will not be required to wait until the tax authorities 
of one of the Contracting States have determined that benefits are 
denied. In these circumstances, it is also expected that if the 
competent authority determines that benefits are to be allowed, they 
will be allowed retroactively to the time of entry into force of the 
relevant treaty provision or the establishment of the structure in 
question, whichever is later.

    The 1991 Understandings further provide that, in making 
determinations under paragraph 3, the competent authorities will take 
into account all relevant facts and circumstances. The factual criteria 
that the competent authorities are expected to take into account 
include the existence of a clear business purpose for the structure and 
location of the income-earning entity in question; the conduct of an 
active trade or business (as opposed to a mere investment activity) by 
such entity; and a valid business nexus between that entity and the 
activity giving rise to the income.

    The 1991 Understandings also note that the discretionary authority 
granted to the competent authorities is particularly important in view 
of, and should be exercised with particular cognizance of, the 
developments in, and objectives of, international economic integration, 
such as that among the member countries of the CARICOM and under the 
North American Free Trade Agreement.

    In this regard, the Understandings provide specific guidance in the 
case of an employee benefits organization that fails to satisfy the 
requirements of subparagraph (f) of paragraph 2 solely because 50 
percent or less of its beneficiaries, members or participants are 
persons entitled to the benefits of the Convention. In such case, the 
U.S. Competent Authority will favorably consider the following factors: 
(a) the organization is established in Barbados; (b) the sponsoring 
employer of the organization is a resident of Barbados entitled to the 
benefits of the Convention (other than a person described in paragraph 
6 of Article 22); (c) more than 30 percent of the beneficiaries, 
members or participants of the organization are persons entitled to the 
benefits of this Convention; and (d) more than 70 percent of the 
beneficiaries, members or participants of the organization are 
individuals resident in a member of the Caribbean Community.

    The competent authority may determine to grant all benefits of the 
Convention, or it may determine to grant only certain benefits. For 
instance, it may determine to grant benefits only with respect to a 
particular item of income in a manner similar to paragraph 2. Further, 
the competent authority may set time limits on the duration of any 
relief granted.

Paragraph 4

    Paragraph 4 defines the term ``recognized stock exchange.'' See the 
paragraph 1 discussion above.

Paragraph 5

    Paragraph 5 of Article 22 authorizes the competent authorities both 
to develop procedures for the application of the Article, and to 
exchange information necessary to carry out its provisions. Thus, for 
example, if a Barbadian resident corporation claims benefits on the 
basis of having satisfied the ownership/base erosion tests of 
subparagraph 1(d), the U.S. competent authority may request information 
from the Barbados competent authority to confirm that these tests have, 
in fact, been satisfied.

Paragraph 6

    Paragraph 6 excludes certain persons that are residents and that 
otherwise would qualify for the benefits of the Convention under 
paragraphs 1 or 2 of this Article from the benefits of Articles 10 
(Dividends), 11 (Interest) and 12 (Royalties). Paragraph 6 denies these 
benefits in the case of a person that is entitled to income tax 
benefits under the provisions of a special tax regime. Paragraph 6 also 
treats a partnership, estate or trust as a person that is entitled to 
income tax benefits under the provisions of a special tax regime to the 
extent that such partnership, estate or trust is treated as a resident 
of a Contracting State under paragraph 1 of Article 4 (Residence) by 
reason of income of such partnership, estate or trust being subject to 
tax in the hands of one or more persons described in paragraph 6.

    The Understandings identify several regimes in Barbados that are 
special tax regimes. These regimes are as follows: (1) the Exempt 
Insurance Act, Cap. 308; (2) the International Financial Services Act, 
2002; (3) the International Business Companies Act, Cap. 77; (4) the 
Societies with Restricted Liability Act, Cap. 318B; or (5) the 
Insurance (Miscellaneous Provisions) Act, 1998. The Understandings 
further provide that any legislation or administrative practice enacted 
or adopted after the signing of this Protocol pursuant to which the 
income of a person is entitled to the same or substantially similar tax 
benefits to those granted under the legislation referred to in the 
previous sentence will constitute a special regime. In determining 
whether a person in entitled to the same or substantially similar 
benefits to those tax regimes identified in the understandings, 
consideration will be given to all facts and circumstances, including, 
for example, whether a tax regime imposes tax based on an artificially 
low taxable base.

                              Article III

    Article III of the Protocol amends Article 26 (Exchange of 
Information) of the Convention to add a new paragraph 4. Paragraph 4 
makes clear that information exchanged under Article 26 of the 
Convention includes information held by financial institutions, 
nominees, or persons acting in an agency or fiduciary capacity (but 
does not include information that would reveal confidential 
communications between a client and an attorney, solicitor or other 
legal representative, where the client seeks legal advice). In the case 
of the United States, the scope of the privilege for such confidential 
communications is coextensive with the attorney-client privilege under 
U.S. law. Paragraph 4 also makes clear that the Contracting States may 
obtain and exchange information relating to the ownership of legal 
persons.

                               Article IV

    Article IV relates to entry into force of the modifications made by 
the Protocol.

Paragraph 1

    Paragraph 1 provides that the Protocol shall be subject to 
ratification by both Contracting States according to their 
constitutional and statutory requirements. Instruments of ratification 
shall be exchanged as soon as possible.

    In the United States, the process leading to ratification and entry 
into force is as follows: once a protocol or treaty has been signed by 
authorized representatives of the two Contracting States, the 
Department of State sends the protocol or treaty to the President who 
formally transmits it to the Senate for its advice and consent to 
ratification, which requires approval by two-thirds of the Senators 
present and voting. Prior to this vote, however, it generally has been 
the practice of the Senate Committee on Foreign Relations to hold 
hearings on the protocol or treaty and make a recommendation regarding 
its approval to the full Senate. Both Government and private sector 
witnesses may testify at these hearings. After receiving the Senate's 
advice and consent to ratification, the protocol or treaty is returned 
to the President for his signature on the ratification document. The 
President's signature on the document completes the process in the 
United States.
Paragraph 2

    Paragraph 2 provides that the Protocol will enter into force upon 
the exchange of instruments of ratification. The date on which a treaty 
or protocol enters into force is not necessarily the date on which its 
provisions take effect. Paragraph 2, therefore, also contains rules 
that determine when the provisions of the. Protocol will have effect.

    Under paragraph 2(a), the Protocol will have effect with respect to 
taxes withheld at source (principally dividends, interest and 
royalties) for amounts paid or credited on or after the first day of 
the second month following the date on which the Protocol enters into 
force. For example, if instruments of ratification are exchanged on 
April 25 of a given year, the availability of benefits under Article 10 
(Dividends) of the Convention will be limited under Article 22, as 
amended by the Protocol, for any dividends paid or credited on or after 
June 1 of that year. The delay of one to two months is required to 
allow sufficient time for withholding agents to be informed about the 
change in withholding rates.

    For all other taxes, subparagraph (b) specifies that the Protocol 
will have effect for any taxable year beginning on or after January 1 
of the year following entry into force.

                                 
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