[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
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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
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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\
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\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.
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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.