[Senate Hearing 108-26]
[From the U.S. Government Publishing Office]
S. Hrg. 108-26
TAX CONVENTION WITH THE UNITED KINGDOM (T. DOC. 107-19) AND PROTOCOLS
AMENDING TAX CONVENTIONS WITH AUSTRALIA (T. DOC. 107-20) AND MEXICO (T.
DOC. 108-3)
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HEARING
BEFORE THE
COMMITTEE ON FOREIGN RELATIONS
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
MARCH 5, 2003
__________
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 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, Ms. Barbara M., International Tax Counsel, U.S. Department
of the Treasury, Washington, DC................................ 3
Prepared statement........................................... 7
Responses to additional questions for the record from Senator
Sarbanes................................................... 44
Hagel, Hon. Chuck, U.S. Senator from Nebraska, opening statement. 2
Lugar, Hon. Richard G., U.S. Senator from Indiana, prepared
statement...................................................... 2
Noren, Mr. David, Legislation Counsel, Joint Committee on
Taxation, U.S. Congress, Washington, DC........................ 21
Prepared statement by the staff of the Joint Committee on
Taxation................................................... 23
Response to an additional question for the record from
Senator Sarbanes........................................... 45
Reinsch, Hon. William A., president, National Foreign Trade
Council, Inc., Washington, DC.................................. 32
Prepared statement........................................... 35
(iii)
TAX CONVENTION WITH THE UNITED KINGDOM (T. DOC. 107-19) AND PROTOCOLS
AMENDING TAX CONVENTIONS WITH AUSTRALIA (T. DOC. 107-20) AND MEXICO (T.
DOC. 108-3)
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WEDNESDAY, MARCH 5, 2003
U.S. Senate,
Committee on Foreign Relations,
Washington, DC.
The committee met, pursuant to notice, at 3 p.m. in room
SD-419, Dirksen Senate Office Building, Hon. Chuck Hagel
presiding.
Present: Senators Hagel and Bill Nelson.
Senator Hagel. Good afternoon. The committee meets today to
consider a bilateral tax treaty between the United States and
the United Kingdom as well as tax protocols with Mexico and
Australia. The United States has established a network of tax
treaties to bring order to our business and investment
relationships with other nations. Agreements such as the three
before us are an important tool for U.S. companies doing
business abroad and for the U.S. Treasury. These treaties help
protect U.S. taxpayers from double taxation and establish a
framework to prevent individuals and companies from evading
their tax obligations.
Tax treaties create a vital incentive for encouraging
foreign trade and investment. We live in a world where
countries and cultures are interconnected as never before. As
we build on those relationships and expand trade, it is vital
that our international tax policy change in order to reflect
U.S. economic policies.
I am pleased to have before the committee three agreements
that do just that. The U.S.-U.K. tax treaty replaces the
existing agreement from 1975. While not setting a global
precedent, it represents the first time that a U.S. treaty has
contained a zero rate of withholding tax on dividends. The U.K.
treaty contains an anti-treaty-shopping provision which will
help ensure payment of taxes by multilateral corporations. It
will create incentives for other nations to come to the
negotiating table to work out similar agreements.
Under the treaty, citizens of the United States and United
Kingdom will also benefit from each country recognizing the
other's pension plans. The Mexico and Australia protocols amend
the treaties which the United States signed in 1992 and 1982
respectively. Each protocol incorporates this new zero
withholding provision into the underlying treaties, among other
things. There are many other facets to the treaty and protocols
before us. I look forward to hearing our witnesses discuss the
agreements in more detail.
We will hear first from Barbara Angus, international tax
counsel for the Department of Treasury's Office of Tax Policy.
Ms. Angus is responsible for negotiating tax treaties and
serves as principal legal advisor on all aspects of
international tax policy matters. We are very pleased to have
Ms. Angus with us this afternoon.
David Noren is legislative counsel specializing in
international tax issues of the Joint Committee on Taxation,
and David, we are glad you are with us as well, and an old
friend of this committee, and one who has presented testimony
and whose advice we have looked to many times over on many
occasions, William Reinsch, president of the National Foreign
Trade Counsel--finally he has got a real job, an honest job--
will testify on the treaties from a business perspective on the
second panel today, so to all of our witnesses, thank you. We
are grateful that you would give us some time today, so with
that, Ms. Angus, please begin.
[The opening statement of Senator Hagel follows:]
Opening Statement of Senator Chuck Hagel
Good afternoon. The committee meets today to consider a bilateral
tax treaty between the United States and United Kingdom, as well as tax
protocols with Mexico and Australia.
The United States has established a network of tax treaties to
bring order to our business and investment relationships with other
nations. Agreements such as the three before us are an important tool
for U.S. companies doing business abroad and for the U.S. Treasury.
These treaties help protect U.S. taxpayers from double taxation and
establish a framework to prevent individuals and companies from evading
their tax obligations. Tax treaties create a vital incentive for
encouraging foreign trade and investment.
We live in a world where countries and cultures are interconnected
as never before. As we build on those relationships and expand trade,
it is vital that our international tax policy change in order to
reflect U.S. economic policies.
I am pleased to have before the committee three agreements that do
just that. The U.S.-U.K. tax treaty replaces the existing agreement
from 1975. While not setting a global precedent, it represents the
first time that a U.S. treaty has contained a ``zero rate'' of
withholding tax on dividends.
The U.K. treaty contains an anti-treaty-shopping provision which
will help ensure payment of taxes by multilateral corporations. It will
create incentives for other nations to come to the negotiating table to
work out similar agreements. Under the treaty, citizens of the U.S. and
U.K. will also benefit from each country recognizing the other's
pension plans.
The Mexico and Australia Protocols amend the treaties which the
U.S. signed in 1992 and 1982, respectively. Each protocol incorporates
this new zero withholding provision into the underlying treaties, among
other things.
There are many other facets to the treaty and protocols before us.
I look forward to hearing our witnesses discuss the agreements in more
detail.
Senator Hagel. At this time I would ask that a statement
submitted by Senator Lugar be included in the record.
[The prepared statement of Senator Lugar follows:]
Prepared Statement of Senator Richard G. Lugar
I am delighted that we are holding this hearing this afternoon. I
thank the witnesses who have come before us today and Senator Hagel for
chairing the hearing in his role as Chairman of the International
Economic Policy, Export and Trade Promotion Subcommittee.
At a time when the committee is considering a number of monumental
foreign policy challenges, the more ordinary business of diplomacy goes
on. Tax treaties may not seem exciting to some observers, but at a time
when our country faces serious national security questions, we cannot
neglect the important business of promoting trade and closer economic
cooperation worldwide.
Earlier this year I wrote about five campaigns that the United
States must undertake if it hopes to win the war on terrorism. We must
strengthen U.S. diplomatic capabilities; expand and globalize the Nunn-
Lugar program; build alliances; reinvigorate our commitment to
democracy, the environment, energy and development; and promote free
trade. Trade is one of the essential components of winning the war
against terrorism because it strengthens the economic ties that bind
nations together and enhances the standard of living for people around
the world.
This goal will be accomplished through bold initiatives, like the
comprehensive round of negotiations taking place at the World Trade
Organization. But it also will be accomplished through painstaking
negotiations to lower barriers to trade and investment one country at a
time.
The tax treaties that we have before us today will bolster the
economic relationships between the United States and three countries
that are already good friends and critical trade and investment
partners. In 2001, cross border investment between the United States
and the United Kingdom stood at nearly half a trillion dollars.
Investment between the United States and Mexico and the United States
and Australia each stood at just under 60 billion dollars. By
integrating and simplifying our systems of taxation, we will create an
even better environment for trade and investment.
These treaties represent our most ambitious attempt yet to
integrate our systems. Eliminating withholding taxes on the payment of
dividends by an 80 percent owned corporation to its foreign parent
corporation should greatly facilitate the flow of capital to its most
beneficial uses. More than 2,500 U.S. companies have subsidiaries in
the United Kingdom, Mexico, or Australia that could benefit from this
change.
The reciprocal recognition of pension contributions provided for in
the UK treaty is particularly important in an increasingly globalized
world. This provision will allow employees to continue making tax-free
contributions to retirement plans while they are working overseas,
which removes a significant barrier to the cross-border provision of
services. The services sector is extremely important to the U.S.
economy, and it is one of the few sectors in which we hold a trade
surplus with the rest of the world. There are 300,000 Americans
crossing the Atlantic every year to work in the United Kingdom, and
this provision, I believe, will encourage even more.
In conclusion, reporting out these tax treaties would fulfill an
important role of the committee and would be an important step in
promoting free trade. The last time the committee reported out any tax
treaties was in 1999, over three years ago. The fact that we are facing
serious national security challenges makes it all the more important
that we devote energy to expanding trade and investment. I am pleased
that the committee is moving forward on these treaties, which should
build even stronger ties with countries that are among our closest
friends and trading partners.
Senator Hagel. We will hear first from Barbara Angus,
International Tax Counsel for the Department of the Treasury's
Office of Tax Policy. Ms. Angus is responsible for negotiating
tax treaties and serves as a principal legal advisor on all
aspects of international tax policy matters. David Noren is
Legislative Counsel specializing in international tax issues
for the Joint Committee on Taxation. William Reinsch, President
of the National Foreign Trade Council will testify on the
treaties from a business perspective on the second panel today.
STATEMENT OF BARBARA M. ANGUS, INTERNATIONAL TAX COUNSEL, U.S.
DEPARTMENT OF THE TREASURY, WASHINGTON, DC
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 the income tax
agreements with the U.K., Australia, and Mexico.
We are committed 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 provide benefits to both taxpayers
and governments by setting clear rules that will govern tax
matters related 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 the 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
would like to tax the same dollar of income. We believe these
three agreements, which update important treaty relationships
with the U.K., Australia, and Mexico, would provide significant
benefits to the United States and to our treaty partners as
well as our respective business communities.
Our treaty relationships with these three countries employ
a range of mechanisms to accomplish the objective of reducing
the instances where taxes stand as a barrier to cross-border
investment. These agreements provide certainty to taxpayers
with respect to the threshold question of when the taxpayer's
cross-border activities will subject it to taxation in the
other country. They protect taxpayers from potential double
taxation through the allocation of taxing rights between the
countries. They reduce excessive taxation by reducing
withholding taxes that are imposed on gross income rather than
net income.
Finally, these agreements include comprehensive provisions
addressing treaty shopping concerns. Preventing exploitation of
our treaties by residents of third countries is critical to
ensuring that the third country will sit down at the table with
us to negotiate benefits and reductions in tax on a reciprocal
basis, so that we can secure for U.S. persons the benefits of
reductions in the third country's tax for investments there.
Before briefly describing the key provisions of these
agreements with the U.K., Australia, and Mexico, I would like
to discuss a development common to all three agreements. U.S.
tax policy for many years has been to eliminate withholding
taxes on interest and royalties, providing for exclusive
residence country taxation of this income. By contrast, the
U.S. regularly reduces by treaty the withholding taxes on
dividends, but has never agreed in a treaty to eliminate
withholding taxes on intercompany dividends. These three
agreements each include provisions eliminating withholding
taxes and providing for exclusive residence country tax on
intercompany dividends if certain conditions are satisfied. The
Treasury believes that this is an appropriate development in
light of our overall treaty policy of reducing tax barriers to
cross-border investment, and in the context of these three
treaty relationships.
Reductions in foreign withholding taxes borne by U.S.
taxpayers result in a direct benefit to the U.S. fisc to the
extent that the U.S. taxpayer otherwise would have been able to
use the foreign tax credit associated with such foreign taxes
to offset its U.S. tax. Reductions in foreign withholding taxes
results in a direct benefit to the U.S. taxpayer to the extent
that the taxpayer could not have used the foreign tax credits
to reduce its U.S. tax because of applicable limits. In those
cases, a reduction in foreign withholding taxes represents a
dollar-for-dollar reduction in its overall tax burden. The
reduction in foreign withholding taxes thus represents a
reduction in costs for U.S. taxpayers, increasing their
competitiveness in connection with international business
opportunities.
On the other hand, the imposition of U.S. withholding taxes
on foreign taxpayers with investments in the U.S. represents a
cost that reduces the return on those U.S. investments.
Eliminating the U.S. withholding tax by treaty results in a
short-term reduction in U.S. tax revenues which is offset by
the increase in tax revenues associated with the reduction in
foreign withholding taxes imposed on U.S. taxpayers. However,
eliminating these U.S. withholding taxes on foreigners
encourages inbound investment. Increased investment in the
United States means more jobs, greater productivity, and higher
wage rates.
Eliminating withholding taxes on dividends by treaty can
serve to eliminate one of the remaining significant barriers to
cross-border investment. We believe it is in the interests of
the United States to consider this step in appropriate cases.
We do not intend this as a blanket change in policy, because it
may not be appropriate to agree to such reductions in every
treaty with every country. We should be flexible, and approach
each case individually.
Some key parameters apply across the board. We do not
believe it is appropriate to eliminate source country tax on
intercompany dividends by treaty unless the treaty contains
anti-treaty-shopping rules that meet the highest standards and
unless the information exchange provisions of the treaty are
sufficient to allow us to confirm that the requirements for
entitlement to this benefit are satisfied.
In addition to these conditions, we must be satisfied with
the overall balance of the treaty. The optimal treatment of
withholding taxes on intercompany dividends should be
considered in the context of each treaty relationship. Let me
touch briefly on the highlights of each of these three
agreements.
The proposed treaty with the U.K. replaces the existing
treaty, and generally follows the pattern of other recent U.S.
treaties. A significant impetus for renegotiation of the U.K.
tax treaty was the impact on the treaty of changes made by the
U.K. to its domestic laws regarding dividends. The current
treaty contains unusual rules intended to extend to U.S.
shareholders the benefit of the U.K.'s treatment of dividends
while dividing the cost of that benefit between the two
governments. Changes in the U.K.'s domestic system for taxing
dividends mean that the provisions no longer work as intended.
The proposed treaty thus eliminates the provision of the
existing treaty that obligates the U.S. to provide a foreign
tax credit for phantom dividend withholding taxes.
The start of negotiations also provided an opportunity to
bring the treaty into greater conformity with U.S. tax treaty
policy. The current treaty does not include an effective anti-
treaty-shopping provision, and it grants a waiver of the U.S.
insurance excise tax without the anti-abuse protection that has
become the standard in other U.S. treaties. The proposed treaty
has been improved through the inclusion of a comprehensive
limitation on benefits provision, and the addition of an anti-
abuse rule that will prevent companies in third countries that
do not benefit from a waiver of the U.S. insurance excise tax
from using the U.K. as a conduit to avoid that U.S. tax. There
were barriers to the operation of the information exchange
provisions of the current treaty, and these problems have been
resolved.
The maximum withholding tax rates on investment income in
the proposed treaty are the same or lower than those in the
existing treaty. Although the treaty continues the rule under
which the country of source may tax direct investment dividends
and portfolio dividends at maximum rates of 5 and 15 percent
respectively, the proposed treaty provides for the elimination
of withholding taxes on dividends from certain 80-percent-owned
corporate subsidiaries, and on dividends derived by pension
plans. The proposed treaty, like the existing treaty, provides
for the elimination of source country tax on interest and
royalties.
The proposed treaty also contains rules to coordinate the
two countries' regimes for the tax treatment of pensions and
pension contributions. These rules are more comprehensive than
those in recent U.S. treaties and in the existing U.S.-U.K.
treaty.
The proposed protocol to the treaty with Australia was
negotiated to bring that treaty, concluded in 1982, up to date
and into closer conformity with the current U.S. tax treaty
practice. The most important aspects of the proposed protocol
with Australia deal with the taxation of cross-border dividend
royalty, and interest payments. The current treaty provides for
levels of source country tax that are substantially higher than
the preferred U.S. position. We were able to negotiate
substantial reductions with respect to all three categories.
The proposed protocol reduces the maximum rate of tax on
dividends in certain cases from the 15 percent of the current
treaty to 10 percent. The proposed protocol also provides for
the elimination of withholding taxes on certain intercompany
dividends. Australia imposes a withholding tax on dividends
paid out of earnings that have not been subject to full
corporate tax, so this elimination of the withholding tax will
apply to certain dividends from Australian companies.
The proposed protocol provides for the elimination of
withholding taxes on interest payments in two key cases;
interest derived by a financial institution and interest paid
to government entities. The proposed protocol also reduces the
maximum level of withholding tax on royalty payments from 10
percent, as in the current treaty, down to 5 percent. The
changes in the treatment of royalties represent a major
concession by Australia, which has never agreed in a treaty to
lower its withholding tax on royalties below 10 percent.
The proposed treaty brings the existing treaty's treatment
of income from the operation of ships, aircraft, and containers
in international traffic closer to that of the U.S. model. The
proposed protocol also contains an updated version of the
comprehensive limitation on benefits article designed to deny
treaty shoppers the benefits of the treaty.
And finally, let me touch briefly on Mexico. The proposed
protocol to the income tax treaty with Mexico also was
negotiated to bring the existing treaty into closer conformity
with current U.S. policy. The major feature of the proposed
protocol with Mexico is the treatment of intercompany
dividends. As in the two prior agreements, the proposed
protocol eliminates source country withholding taxes on
dividends from certain 80-percent-owned subsidiaries. Dividends
paid to qualified pension funds also will be exempt from
withholding tax at source. While Mexico does not currently
impose a withholding tax on dividends, it has enacted such a
tax and then repealed it since the existing treaty was
negotiated in the early 1990s. As a result, locking in this
elimination of withholding taxes on intercompany dividends will
provide greater certainty to U.S. taxpayers regarding the long-
term tax environment for their investments in Mexico.
We urge the committee to take prompt and favorable action
on these three agreements. These agreements are evidence of how
even good treaty relationships can be made better. These
agreements will strengthen and expand our economic relations
with countries that have been significant economic and
political partners for many years, and will help to further
reduce barriers to cross-border trade and investment.
Let me conclude by expressing our appreciation for the hard
work of the staffs of this committee and of the Joint Committee
on Taxation during the tax treaty process. Thank you.
[The prepared statement of Ms. Angus follows:]
Prepared Statement of Barbara 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 three
income tax agreements that are pending before this Committee. We
appreciate the Committee's interest in these agreements 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; 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 the millions of cross-border transactions that take place
around the world each year give rise to relatively few disputes
regarding the allocation of tax revenues between governments.
The Administration believes that these three agreements, which
update important treaty relationships with the United Kingdom,
Australia and Mexico, would provide significant benefits to the United
States and to our treaty partners, as well as our respective business
communities. We request the Committee and the Senate to take prompt and
favorable action on all three 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 would like to tax the same income. Once a treaty
relationship is in place and working as it should, governments need
expend little additional resources negotiating to resolve individual
cases because the general principles for taxation of cross-border
transactions and activities will have been agreed in the treaty.
One of the primary functions of tax treaties is to provide
certainty to taxpayers with respect to the ``threshold'' question--that
is, 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 a resident of
one country must engage in within the other country before the latter
country may tax any resulting business profits. In general terms, tax
treaties provide that if the branch operations have sufficient
substance and continuity, the country where the activities occur will
have primary (but not exclusive) jurisdiction to tax. In other cases,
when the operations are relatively minor, the home country retains the
sole jurisdiction to tax its residents. In the absence of a tax treaty,
a U.S. company operating a branch or division or providing services in
another country might be subject to income tax in both the United
States and the other country on the income generated by such
operations. Although the United States generally provides a credit
against U.S. tax liability for foreign taxes paid, there remains
potential for resulting double taxation that could make an otherwise
attractive investment opportunity unprofitable, depriving both
countries of the benefits of increased cross-border investment.
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
determining the residence of a taxpayer that otherwise would 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 establishes both limitations on the amount
of tax that the source country can impose on each category of income
and 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, 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 Acompetent 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 ``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 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 having suffered ``excessive'' taxation.
Tax treaties alleviate this burden by providing maximum levels of
withholding tax that the treaty partners may impose on these types of
income. In general, U.S. tax treaty policy is to reduce the rate of
withholding tax on interest and royalties to zero, so that such
payments are taxed exclusively in the country of residence and not in
the country of source. In contrast, U.S. tax treaties have allowed some
source-country taxation of dividends, with many U.S. treaties providing
for a maximum source-country withholding tax of 5 percent on dividends
paid to direct corporate investors and a maximum source-country
withholding tax of 15 percent on dividends paid to all other
shareholders. Over the years, U.S. treaty negotiators have considered
proposals to treat intercompany dividends in the same manner as
interest and royalties and therefore to provide for exclusive
residence-country taxation of intercompany dividends in some cases. The
three treaties before the Committee are the first U.S. tax treaties to
do so.
Our 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. While this is similar to a basic
investor protection provided in several types of agreements, the non-
discrimination provisions of tax treaties are more effective because
they are specifically tailored to tax concerns. They provide guidance
about what ``national treatment'' means in the tax context by
specifically prohibiting types of discriminatory measures that once
were common in some tax systems. At the same time, they clarify the
manner in which 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.
Treaties also include provisions dealing with more specialized
situations. Some of these provisions are becoming increasingly
important as the number of individuals engaged in cross-border
activities increases. For example, provisions coordinating the pension
rules of the tax systems of the two countries are needed to ensure that
individuals who are expecting in their retirement to be subject to a
certain manner and level of taxation do not find their pensions eaten
into by unexpected taxation by another country. Other quite specific
rules address the treatment of employee stock options, Social Security
benefits, and alimony and child support in the cross-border context.
While these subjects may not involve a lot of revenue from the
perspective of the two governments, rules providing clear and
appropriate treatment can be very important to each of the individual
taxpayers who are affected.
Other treaty provisions deal with the administration of the treaty
and, to a certain extent, the domestic tax law of the two countries.
One of the most important of these is the provision addressing the
exchange of information between the tax authorities. Under tax
treaties, the competent authority of one country may provide to the
other competent authority such information as may be necessary for the
proper administration of that country's tax laws, 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 prevent or seriously
inhibit the appropriate exchange of information under a tax treaty, we
will not conclude a treaty with that country. In fact, information
exchange is a matter we raise with the other country before
commencement of formal negotiations because it is one of a very few
matters that we consider non-negotiable.
treaty program and negotiation priorities
The United States has a network of 56 bilateral income tax
treaties, the oldest of which currently in force now dates from 1950.
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.
companies.
The Treasury Department is working to renegotiate our older tax
treaties to ensure that they reflect current U.S. tax treaty policy.
The treaties before you are evidence of how even good treaty
relationships can be made better. At the same time, we are actively
working to establish new treaty relationships that will fill gaps in
our treaty network.
In establishing priorities, our primary objective is the conclusion
of treaties or protocols that will provide the greatest benefits to the
United States and to U.S. taxpayers. We communicate regularly with the
U.S. business community, seeking input regarding the areas in which
treaty network expansion and improvement efforts should be focused and
information regarding practical problems they face with respect to the
application of particular treaties and the application of the tax
regimes of particular countries.
The U.S. commitment to including comprehensive provisions designed
to prevent ``treaty-shopping'' in all of our tax treaties is one of the
keys to improving our overall treaty network. Our tax treaties are
intended to provide benefits to residents of the United States and
residents of the particular treaty partner on a reciprocal basis. The
reductions in source-country taxes agreed to in a particular treaty
mean that U.S. persons pay less tax to that country on income from
their investments there and residents of that country pay less U.S. tax
on income from their investments in the United States. Those reductions
and benefits are not intended to flow to residents of a third country.
If third-country residents can exploit one of our treaties to secure
reductions in U.S. tax, the benefits would flow only in one direction.
Such use of treaties is not consistent with the balance of the deal
negotiated. Moreover, preventing this exploitation of our treaties is
critical to ensuring that the third country will sit down at the table
with us to negotiate benefits and reductions in tax on a reciprocal
basis, so that we can secure for U.S. persons the benefits of
reductions in source-country tax on their investments in that country.
Treaty-shopping can take a number of forms, but it generally
involves a resident of a third country that either has no treaty with
the United States or has a treaty that offers relatively less benefit.
The third-country resident establishes an entity in a treaty partner
that has a relatively more favorable treaty with the United States in
order to hold title to the resident's investments in the United States,
which could range from portfolio stock investments to substantial
operating subsidiaries. By interposing the new entity so that the U.S.
investment appears to be made through the treaty partner, the third-
country resident is able to withdraw the returns from the U.S.
investment subject to the favorable rates of tax provided in the tax
treaty, rather than the higher rates that would be imposed on such
returns if the person had held the U.S. investments directly.
If treaty-shopping is allowed to occur, then there is less
incentive for the third country with which the United States has no
treaty (or has a treaty that does not reflect our preferred positions
on reductions in source-country withholding taxes) to negotiate a tax
treaty with the United States. The third country could maintain
inappropriate barriers to investment and trade from the United States
and yet its companies could obtain the benefits of lower U.S. tax by
organizing their investment and trade in the United States so that they
flow through a country with a favorable tax treaty with the United
States.
For these reasons, all recent U.S. tax treaties contain
comprehensive ``limitation on benefits'' provisions that limit the
benefits of the treaty to bonafide residents of the treaty partner.
These provisions are not uniform, as each country has particular
characteristics that affect both its attractiveness as a country
through which to treaty shop and the mechanisms through which treaty
shopping may be attempted. Consequently, the specific limitation on
benefits provision in each treaty must to some extent be tailored to
fit the facts and circumstances of the treaty partner's internal laws
and practices. Moreover, the provisions need to strike a balance that
prevents the inappropriate exploitation of treaty benefits while
ensuring that the treaty benefits floss smoothly to the legitimate and
desirable economic activity for which the benefits were intended.
Despite the protections of the limitation on benefits provisions,
there may be countries with which we choose not to have a tax treaty
because of the possibility of abuse. With other countries there may not
be the type of cross-border tax issues that are best resolved by
treaty. For example, we generally do not conclude tax treaties with
jurisdictions that do not impose significant income taxes, because
there is little possibility of double taxation of income in such a
case. In such cases, an agreement focused on the exchange of tax
information can be very valuable in furthering the goal of reducing
U.S. tax evasion.
The situation is more complex when a country adopts a special
preferential regime for certain parts of the economy that is different
from the rules generally applicable to the country's residents. In
those cases, the residents benefiting from the preferential regime do
not face potential double taxation and so should not be entitled to
reductions in U.S. withholding taxes, while a treaty relationship might
be useful and appropriate in order to avoid double taxation in the case
of the residents who do not receive the benefit of the preferential
regime. Accordingly, in some cases we have treaty relationships that
carve out certain residents and activities from the benefits of the
treaty. In other cases, we have determined that economic relations with
the relevant country were such that the potential gains from a treaty
were not sufficient to outweigh the risk of abuse, and have therefore
decided against entering into a tax treaty relationship (or have
terminated an existing relationship).
Prospective treaty partners must indicate that they understand
their obligations under the treaty, including those with respect to
information exchange, and must demonstrate that they are able to comply
with those obligations. Sometimes a potential treaty partner is unable
to do so. In other cases we may feel that a treaty is inappropriate
because the potential treaty partner may be unwilling to address in the
treaty real tax problems identified by U.S. businesses operating there.
Lesser developed and newly emerging economies, for which capital and
trade flows with the United States are often disproportionate or
virtually one-way, may not be willing to reduce withholding taxes to a
level acceptable to the United States because of concerns about the
short-term effects on tax revenues.
The primary constraint on the size of our tax treaty network,
however, may be the complexity of the negotiations themselves. The
various functions performed by tax treaties, and particularly the goal
of meshing two different tax systems, make the negotiation process
exacting and time consuming. While the starting point for all U.S. tax
treaty negotiations is the U.S. Model Tax Convention, it is never the
ending point.
A country's tax policy, as reflected in its domestic tax
legislation as well as its tax treaty positions, reflects the sovereign
choices made by that country. Numerous features of the treaty partner's
unique 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 or a credit system, the country's treatment of partnerships
and other transparent entities, and how the country taxes contributions
to pension funds, the funds themselves, and distributions from the
funds. A treaty negotiation must take into account all of these and
many other aspects of the treaty partner's tax system in order to
arrive at an acceptable treaty from the perspective of the United
States. Accordingly, a simple side-by-side comparison of two treaties,
or of a proposed treaty against a model treaty, will not enable
meaningful conclusions to be drawn as to whether a proposed treaty
reflects an appropriate balance. Moreover, there may be differences
that are of little substantive importance, reflecting language issues,
cultural obstacles or other impediments to the use of particular U.S.
or other model text.
Each treaty is the result of a negotiated bargain between two
countries that often have conflicting objectives. Each country has
certain positions that it considers non-negotiable. The United States,
which insists on effective anti-treaty-shopping and exchange of
information provisions, and which must accommodate its uniquely complex
tax laws, probably has more non-negotiable positions than most
countries. For example, every U.S. treaty must contain the Asaving
clause@, which permits the United States to tax its citizens and
residents as if the treaty had not come into effect, and allow the
United States to apply its rules applicable to former citizens and
long-term residents. Other U.S. tax law provisions that may complicate
negotiations are the branch profits tax and the branch level interest
tax, rules regarding contingent interest, real estate mortgage
investment conduits, real estate investment trusts and regulated
investment companies, and the Foreign Investors in Real Property Tax
Act rules.
Obtaining the agreement of our treaty partners on provisions of
importance to the United States sometimes requires other concessions on
our part. Similarly, other countries sometimes must make concessions to
obtain our agreement on matters that are critical to them. In most
cases, the process of give-and-take produces a document that is the
best treaty that is possible with that other country. In others, 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. Accordingly, each treaty that we present here represents not
only the best deal that we believe we can achieve with the particular
country at this time, but also constitutes an agreement that we believe
is in the best interests of the United States.
discussion of treaties and protocols
I would now like to discuss the importance and purposes of each
agreement that has been transmitted for your 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 Treasury Department
guide to each agreement. Before discussing the individual treaties,
however, I would like to discuss a development common to all three
agreements.
Elimination of Source Country Tax on Certain Intercompany Dividends
As discussed above, U.S. tax treaty policy for many years has been
to eliminate (or when that is not possible, to substantially reduce)
source-country withholding taxes on interest and royalties. By
contrast, the United States regularly reduces by treaty the withholding
tax on intercompany dividends but has never agreed in a treaty to
eliminate source-country withholding taxes on intercompany dividends.
These three agreements each include provisions eliminating source-
country withholding taxes on intercompany dividends if certain
conditions are satisfied. Treasury believes that this is an appropriate
development in light of our overall treaty policy of reducing tax
barriers to cross-border investment and in the context of these three
treaty relationships.
Bilateral reductions in source-country withholding taxes have two
offsetting effects on U.S. tax revenues in the short term. Reductions
in the U.S. withholding taxes imposed on foreign persons with
investments in the United States represent a short-term static
reduction in U.S. tax revenues. On the other hand, reductions in
foreign withholding taxes imposed on U.S. persons with foreign
investments represent a short-term static increase in tax revenues for
the United States because the U.S. persons that pay less in foreign
withholding taxes therefore claim less in foreign tax credits to offset
their U.S. tax liability. When U.S. companies receive more in payments
from their foreign subsidiaries than U.S. subsidiaries make in payments
to their foreign parents, the reduction in foreign tax credit claims
will offset the reduction in withholding tax collections. This should
hold true with respect to dividends, as U.S. companies receive
significantly more direct dividends from abroad than foreign companies
receive from the United States.
Reductions in foreign withholding taxes borne by U.S. taxpayers
result in a direct benefit to the U.S. fisc to the extent that the U.S.
taxpayer otherwise would have been able to use the foreign tax credits
associated with such withholding taxes to offset its U.S. tax
liability. Reductions in foreign withholding taxes result in a direct
benefit to the U.S. taxpayer to the extent that the taxpayer could not
have used the foreign tax credits to offset its U.S. tax liability
because of applicable limitations of domestic law. In cases where the
U.S. taxpayer has excess foreign tax credits, a reduction in foreign
withholding taxes represents a dollar-for-dollar reduction in its
overall tax burden: The reduction in foreign withholding taxes thus
represents a reduction in costs that may increase competitiveness in
connection with international business opportunities.
For example, if a U.S. company is considering an investment in a
foreign country, it of course must consider the after-tax cost of that
investment. If the potential investment is the purchase of an existing
business in a foreign country, the U.S. company likely will compete
against bidders from other countries. If the U.S. company is in an
excess foreign tax credit position, any withholding tax paid to the
host country will decrease the U.S company's expected return on the
foreign investment. If another bidder is not subject to the host
country withholding tax (perhaps because of its home country's treaty
relationship with the host country), it may be willing to pay a higher
price for the target.
Similarly, a foreign company that is in an excess foreign tax
credit position in its home country might be discouraged from investing
in the United States because of the five percent withholding tax that
the United States is permitted to impose on direct investment dividends
under most of its tax treaties. The same is true of a company that is
based in a country that relieves double taxation by exempting direct
investment dividends from taxation. In either case, the imposition of a
five percent U.S. withholding tax reduces the return on the investment
in the United States dollar-for-dollar. Eliminating the withholding tax
by treaty therefore may encourage inbound investment. Increased
investment in the United States means more jobs, greater productivity
and higher wage rates.
The historical U.S. position of not eliminating by treaty
withholding taxes on direct investment dividends was consistent with
general treaty practice throughout the world. When most major trading
partners imposed such a tax, then the tax would not create the
competitive advantages and disadvantages described above, since every
company would be subject to it. In addition, many of our treatys were
negotiated at a time when corporate tax rates in Europe tended to be
higher than those in the United States, making it less likely for
foreign companies to be in an excess foreign tax credit position. As a
result, a five percent U.S. withholding tax on direct investment may
not have been seen as a significant cost of doing business here.
However, more and more countries are eliminating their withholding
taxes on intercompany dividends. In this regard, it should be noted
that the Parent-Subsidiary Directive adopted by the European Union in
1990 eliminated all withholding taxes on dividends paid by a subsidiary
in one EU member country to a parent in another of the fifteen (soon to
be 25) members of the European Union. Moreover, corporate tax rates
have been falling around the world. In this climate, it was appropriate
for the United States to consider agreeing by treaty to eliminate
source-country withholding taxes on certain intercompany dividends.
We believe that it is in the interest of the United States to take
a flexible approach, agreeing to eliminate the withholding tax on
intercompany dividends in appropriate cases. This would not be a
blanket change in policy, and the Treasury Department does not
recommend a change to the U.S. negotiating position in this respect,
because it may not be appropriate to agree to such reductions in every
treaty with every country. Therefore, we would approach each case
individually.
Some key parameters apply across the board. We do not believe that
it is appropriate to eliminate source-country taxation of intercompany
dividends by treaty unless the treaty contains anti-treaty-shopping
rules that meet the highest standards and the information exchange
provision of the treaty is sufficient to allow us to confirm that the
requirements for entitlement to this benefit are satisfied. Strict
protections against treaty shopping are particularly important when the
elimination of withholding taxes on intercompany dividends is included
in relatively few U.S. treatys.
In addition to these conditions, we must be satisfied with the
overall balance of the treaty. This assessment will be relatively
simple in cases where the other country imposes a withholding tax on
dividends comparable to the U.S. withholding tax and the dividend flows
are roughly equal (or favor the United States). In other cases,
eliminating withholding taxes on intercompany dividends nevertheless
may be appropriate if the United States benefits from concessions made
by the other country with respect to other provisions of the treaty. As
with many treaty elements, it is a matter of balance. Finally, there
may be cases where the elimination of withholding taxes by treaty is
desirable from the U.S. perspective in order to lock in a treaty
partner whose domestic law regarding withholding taxes may be in flux
and to establish certainty and stability with respect to the tax
treatment of investments in a particular country. We do not believe
that we should attempt now to set all the parameters for when
elimination of source-country withholding taxes on intercompany
dividends is appropriate and when it is not. The optimal treatment of
source-country withholding taxes on intercompany dividends must be
considered in the context of each treaty relationship.
United Kingdom
The proposed Convention with the United Kingdom was signed in
London on July 24, 2001, and was amended by a Protocol, signed in
Washington on July 19, 2002. The Convention is accompanied by an
exchange of diplomatic notes, also dated July 24, 2001. The Convention,
Protocol and notes replace the existing Convention, which was signed in
London in 1975 and modified by subsequent notes and protocols. The
proposed Convention generally follows the pattern of other recent U.S.
treaties and the U.S. Model treaty.
A significant impetus for the re-negotiation of the U.S.-U.K. tax
treaty was the impact on the operation of the treaty of changes made by
the United Kingdom to its domestic laws regarding the treatment of
dividends. The dividend article of the current treaty (along with
corresponding provisions of the article regarding foreign tax credits)
contains unusual rules intended to extend to U.S. shareholders the
benefit of the United Kingdom's imputation system for the taxation of
dividends, while dividing the cost of that benefit between the United
States and the United Kingdom. Changes in the United Kingdom's domestic
system for taxing dividends mean that the provisions no longer work as
intended.
The start of negotiations also provided an opportunity to bring the
treaty into greater conformity with U.S. tax treaty policy. The current
treaty does not include an effective anti-treaty-shopping provision,
and it grants a waiver of the insurance excise tax without the anti-
abuse protection that has become standard in other U.S. tax treaties.
There were substantial problems under the information exchange
provisions of the current treaty because the United Kingdom could
obtain information for the United States only if it too needed the
information for its own domestic tax purposes. Moreover, because the
treaty was negotiated in the late 1970's, it did not include any of the
provisions that are included in modern treaties to reflect the changes
in U.S. domestic law made over the last 20 years.
The maximum withholding tax rates on investment income in the
proposed Convention are the same or lower than those in the existing
treaty. Although the Convention continues the rule under which the
country of source may tax direct investment dividends and portfolio
dividends at a maximum rate of 5 and 15 percent, respectively, the
proposed Convention provides for a withholding rate of zero percent on
dividends from certain 80-percent-owned corporate subsidiaries and
those derived by pension plans. The proposed Convention was the first
income tax treaty signed by the United States that contains this
elimination of source-country tax for intercompany dividends.
Dividends paid by non-taxable conduit entities, such as U.S.
regulated investment companies and real estate investment trusts, and
any comparable investment vehicles in the United Kingdom, are subject
to special rules to prevent the use of these entities to obtain
withholding rate reductions that would not otherwise be available.
The proposed Convention, like the existing treaty and the U.S.
Model, provides for the elimination of source-country tax on interest
and royalties. Excess inclusions with respect to residual interests in
U.S. real estate mortgage investment conduits may be taxed under U.S.
domestic rules, without regard to the rest of the provisions relating
to interest, and contingent interest may be taxed by the source country
at a maximum rate of 15 percent rate.
The proposed Convention confirms that the United States generally
will not impose the excise tax on insurance policies issued by foreign
insurers if the premiums on such policies are derived by a U.K.
enterprise. This rule is a continuation of the waiver of the excise tax
that applies under the existing Convention. However, the proposed
Convention has been improved through the addition of an anti-abuse rule
that will prevent companies in third countries that do not benefit from
a waiver of the insurance excise tax from using a U.K. insurance
company as a conduit to avoid imposition of the tax.
The proposed Convention provides for exclusive residence-country
taxation of profits from the operation in international traffic of
ships or aircraft, including profits from the rental of ships and
aircraft on a full basis, or on a bareboat basis if the rental income
is incidental to profits from the operation of ships or aircraft in
international traffic. All income from the use, maintenance or rental
of containers used in international traffic is likewise exempt from
source-country taxation under the proposed Convention.
The proposed Convention carries over from the existing treaty
special rules regarding offshore exploration and exploitation
activities. These rules were included at the request of the United
Kingdom. The proposed Convention reflects technical changes to avoid
some unintended consequences of the old rules and provides a slightly
higher threshold for taxation of employees working in the offshore oil
sector.
The proposed Convention contains rules to coordinate the two
countries' regimes for the tax treatment of pensions and pension
contributions. These rules are more comprehensive than those in recent
U.S. treaties and the existing Convention. Under the proposed
Convention, the United States and the United Kingdom each will treat
pension plans established in the other State the same way comparable
domestic plans are treated. A similar rule applies to earnings and
accretions of pension plans and to employer contributions to pension
plans. In addition, the proposed Convention provides for the exclusive
residence-based taxation of Social Security payments, which is
different from the U.S. Model but consistent with the existing
Convention.
The proposed Convention also deals with income earned by
entertainers and sportsmen, corporate directors, government employees
and students in a manner consistent with the rules of the U.S. Model.
The Convention continues a host-country exemption for income earned by
teachers that is found in the existing treaty, although not in the U.S.
Model.
The proposed Convention contains comprehensive rules in its
``Limitation on Benefits'' article, designed to deny ``treaty-
shoppers'' the benefits of the Convention. This article is essentially
the same as the limitation on benefits articles contained in recent
U.S. treaties.
At the request of the United Kingdom, the proposed Convention
includes an additional limit on the availability of certain treaty
benefits obtained in connection with ``conduit arrangements.'' The
conduit arrangement test may apply to deny treaty benefits in certain
tax avoidance cases involving the payment of insurance premiums,
dividends, interest, royalties, or other income. The conduit
arrangement test is not contained in the U.S. Model. The test is
designed primarily to allow the United Kingdom to address treaty
shopping transactions that would not be caught by the limitation on
benefits article of the proposed Convention. U.K. domestic law does not
provide sufficient protection against such abusive transactions, but
U.S. domestic law does. The tax authorities of the two countries have
agreed on an interpretation of the term ``conduit arrangement'' that is
consistent with existing tax avoidance doctrines and measures under
U.S. law.
The proposed Convention provides relief from double taxation in a
manner consistent with the U.S. Model and eliminates the provision of
the existing treaty that obligates the United States to provide a
foreign tax credit for ``phantom'' dividend withholding taxes. The
proposed Convention also contains a re-sourcing rule to ensure that a
U.S. resident can obtain a U.S. foreign tax credit for U.K. taxes paid
when the Convention assigns to the United Kingdom primary taxing rights
over an item of gross income. A comparable rule applies for purposes of
the U.K. foreign tax credit. Although the U.S. Model does not contain a
re-sourcing rule, the existing Convention contains a similar rule.
Like the existing treaty, the proposed Convention provides a credit
for the U.K. Petroleum Revenue Tax, limited to the amount of the tax
attributable to sources within the United Kingdom. The credit allowed
by the proposed Convention is somewhat broader than that allowed under
the existing Convention to account for intervening changes in U.S.
domestic law.
The proposed Convention provides for non-discriminatory treatment
(i.e., national treatment) by one country to residents and nationals of
the other. Also included in the proposed treaty are rules necessary for
administering the treaty, including rules for the resolution of
disputes under the Convention. The information exchange provisions
generally follow the U.S. Model and make clear that the United Kingdom
will provide U.S. tax officials such information as is relevant to
carry out the provisions of the Convention and the domestic tax laws of
the United States. Inclusion of this U.S. Model provision was made
possible by a recent change in U.K. law.
Australia
The proposed Protocol to the Income Tax Convention with Australia
was signed in Canberra on September 27, 2001. It was negotiated to
bring the current Convention, concluded in 1982, up to date and into
closer conformity with current U.S. tax treaty practice, while also
incorporating some provisions found in the Australian Model income tax
convention.
The most important aspects of the proposed Protocol deal with the
taxation of cross-border dividend, royalty and interest payments. The
current treaty provides for levels of source-country taxation that are
consistent with Australian treaty practice but substantially higher
than the preferred U.S. position. We were able to negotiate substantial
reductions with respect to all three categories of payments.
Whereas the existing Convention allows for taxation at source of 15
percent on all dividends, the proposed Protocol provides for a maximum
source-country withholding tax rate of 5 percent on direct dividends
that meet a 10 percent ownership threshold. The proposed Protocol also
provides for the elimination of the source-country withholding taxes
with respect to dividends from certain 80 percent owned corporate
subsidiaries. Portfolio dividends will continue to be subject to a 15
percent rate of withholding. Australia imposes a withholding tax on
dividends paid out of earnings that have not been subject to full
corporate tax (``unfranked dividends''), which will be eliminated under
the proposed Protocol.
Dividends paid by U.S. regulated investment companies and real
estate investment trusts are subject to special rules to prevent the
use of these entities to obtain withholding rate reductions that would
not otherwise be available. The provision was adapted to recognize the
special investment structure of Australian unit trusts and their
participation in the U.S. REIT industry.
The proposed Protocol provides for the elimination of source-
country withholding taxes on interest payments in two key cases.
Interest derived by a financial institution that is unrelated to the
payor and interest paid to governmental entities are exempt from
withholding tax at source.
All other types of interest (including interest received by
financial institutions in back-to-back loans or their economic
equivalent) continue to be subject to source-country withholding tax at
the 10 percent maximum rate prescribed in the existing Convention.
The proposed Protocol also reduces the maximum level of withholding
tax on royalty payments from the 10 percent limit prescribed in the
existing Convention to 5 percent. The existing Convention treats rental
payments for the use of or the right to use any industrial, commercial
or scientific equipment as royalties that may be taxed by the source
country at a maximum rate of 10 percent. The proposed Protocol
eliminates the source-country withholding tax on such income by
treating this category of income as business profits. These changes in
the treatment of royalties represent a major concession by Australia,
which has never agreed in a treaty to lower its withholding tax on
royalties below 10 percent.
The proposed Protocol brings the existing Convention's treatment of
income from the operation of ships, aircraft and containers in
international traffic closer to that of the U.S. Model. The proposed
Protocol provides for exclusive residence-country taxation of profits
from the rental of ships and aircraft on a bareboat basis when the
rental activity is incidental to the operation in international traffic
of ships or aircraft by the lessor. All income from the use,
maintenance or rental of containers used in international traffic is
likewise exempt from source-country taxation under the proposed
Protocol.
The proposed Protocol clarifies that Australia's tax on capital
gains will be a covered tax for purposes of the existing Convention.
This closes a gap in the existing Convention and increases the
likelihood that U.S. taxpayers subject to capital gains tax in
Australia will be able to claim a foreign tax credit with respect to
that tax thereby avoiding potential double taxation. The proposed
Protocol generally preserves the existing Convention's tax treatment of
capital gains, while incorporating some aspects of Australia's domestic
law regarding expatriation. The proposed Protocol also provides rules
that coordinate both countries' tax systems with respect to these
expatriation rules.
The proposed Protocol contains an updated version of a
comprehensive ``Limitation on Benefits'' article, designed to deny
``treaty-shoppers'' the benefits of the Convention. This article is
essentially the same as the limitation on benefits article contained in
recent U.S. treaties.
The current Convention 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 former long-term residents whose loss of such status had, as
one of its principal purposes, the avoidance of tax. Therefore, the
United States may fully apply the provisions of section 877 of the
Internal Revenue Code.
Mexico
The proposed Protocol to the Income Tax Convention with Mexico was
signed in Mexico City on November 26, 2002. It was negotiated to bring
the existing Convention, concluded in 1992, into closer conformity with
current U.S. tax treaty policy.
The major feature of the proposed Protocol is the treatment of
intercompany dividends. As in the agreements with the United Kingdom
and Australia, the proposed Protocol eliminates source-country
withholding taxes on certain types of cross-border direct dividends.
Under the existing Convention, dividends may be taxed by the country of
source at a maximum rate of 5 percent on direct dividends (where the
recipient of the dividends owns at least 10 percent of the company
paying the dividends) and 10 percent with respect to all other
dividends. The proposed Protocol eliminates withholding taxes with
respect to dividends from certain 80-percent owned corporate
subsidiaries. The other rules will remain in place with respect to
those dividends that do not qualify for the elimination of the source-
country withholding tax. Dividends paid to qualified pension funds also
will be exempt from withholding tax at source.
While Mexico does not currently impose a withholding tax on
dividends, it has enacted such a tax and then repealed it since the
existing treaty was negotiated in the early 1990's. As a result,
locking in the elimination of source-country withholding taxes on
intercompany dividends will provide greater certainty to U.S. taxpayers
regarding the long-term tax environments for their investments in
Mexico.
Dividends paid by U.S. regulated investment companies and real
estate investment trusts are subject to special rules to prevent the
use of these entities to obtain withholding rate reductions that would
not otherwise be available.
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
former long-term residents whose loss of such status had, as one of its
principal purposes, the avoidance of tax. Therefore, the United States
may fully apply the provisions of section 877 of the Internal Revenue
Code.
The proposed Protocol incorporates a modernized provision regarding
the source of income that will be more effective in eliminating double
taxation. Under the new provision, income that may be taxed by one of
the parties to the Convention will generally be treated as arising in
that country. Thus, the other country generally will exempt that income
or provide a credit for the taxes paid with respect to such income.
treaties under negotiation
We continue to maintain an active calendar of tax treaty
negotiations. We are in active negotiations with Japan, the
Netherlands, Iceland, Hungary, Barbados, France, Bangladesh, Canada,
and Korea. We have also signed an agreement with Sri Lanka which we
expect will be ready for transmittal to the Senate soon. In accordance
with the treaty program priorities noted earlier, we continue to seek
appropriate opportunities for tax treaty discussions and negotiations
with several countries in Latin America and in the developing world
generally.
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 the time and attention to the review of the agreements that
are pending before you. We also appreciate the assistance and
cooperation of the staffs of this Committee and of the Joint Committee
on Taxation in the tax treaty process.
We urge the Committee to take prompt and favorable action on the
three agreements before you today. Such action will strengthen and
expand our economic relations with countries that have been significant
economic and political partners for many years and will help to further
reduce barriers to cross-border trade and investment.
[Attachments.]
Department of the Treasury,
Washington, DC, July 19, 2002.
Gabriel Makhlouf, Director
Inland Revenue, International
Victory House
30-34 Kingsway
London WC2B, United Kingdom
Dear Mr. Makhlouf:
As we have discussed, questions have been raised about the manner
in which our respective tax examiners will administer the rules in our
proposed income tax convention dealing with ``conduit arrangements''.
We hope that an exchange of letters will provide useful guidance
regarding the position in each country.
With respect to the United States, we intend to interpret the
conduit arrangement provisions of the Convention in accordance with
U.S. domestic law as it may evolve over time. The relevant law
currently includes in particular the rules of regulation section 1.881-
3 and other regulations adopted under the authority of section 7701(1)
of the Internal Revenue Code. Therefore, the inclusion of the conduit
arrangement rules in the Convention does not constitute an expansion
(or contraction) of U.S. domestic anti-abuse principles (except with
respect to the application of anti-conduit principles to the insurance
excise tax).
We understand that the United Kingdom does not have domestic law
provisions relating to conduit transactions. It has, however, entered
into a number of treaties which include provisions aimed at dealing
with conduit-type arrangements. We understand that the United Kingdom
will, subject to the limitations in Article 3(1)(n), interpret the
provisions in the proposed convention in a manner consistent with its
practice under those other treaties.
In practice, of course, such general principles and practice will
be applied to particular fact patterns in determining whether the anti-
conduit provisions will apply. In order to further develop our mutual
understanding of how we each propose to apply the language, I have set
out below a number of examples together with the U.S. view regarding
whether benefits would be denied in each case.
We would appreciate your views, including the reasoning behind your
conclusion, regarding the treatment that would apply to each of the
cases set out below if the situation were reversed and the United
Kingdom were the source of the payments.
I look forward to your response regarding the U.K. views of these
transactions (as reversed). I appreciate the opportunity for our teams
to work together on this important matter.
Very truly yours,
Barbara M. Angus,
International Tax Counsel.
Annex
Example 1. UKCo, a publicly traded company organized in the United
Kingdom, owns all of the outstanding stock of USCo. XCo, a company
organized in a country that does not have a tax treaty with the United
States, would like to purchase a minority interest in USCo, but
believes that the 30% U.S. domestic withholding tax on dividends would
make the investment uneconomic. UKCo proposes that USCo instead issue
preferred stock to UKCo, paying a fixed return of 4% plus a contingent
return of 20% of USCo's net profits. The maturity of the
preferedpreferred stock is 20 years. XCo will enter into a separate
contract with UKCo pursuant to which it pays to UKCo an amount equal to
the issue price of the preferred stock and will receive from UKCo after
20 years the redemption price of the stock. During the 20 years, UKCo
will pay to XCo 3\3/3\% plus 20% of USCo's net profits.
This arrangement constitutes a conduit arrangement because UKCo
participated in the transaction in order to achieve a reduction in U.S.
withholding tax for XCo.
Example 2. USCo has issued only one class of stock, common stock
that is 100% owned by UKCo, a company organized in the United Kingdom.
UKCo also has only one class of common stock outstanding, all of which
is owned by XCo, a company organized in a country that does not have a
tax treaty with the United States. UKCo is engaged in the manufacture
of electronics products, and USCo serves as UKCo's exclusive
distributor in the United States, Under paragraph 4 of Article 23
(Limitation on Benefits), UKCo will be entitled to benefits with
respect to dividends received from USCo, even though UKCo is owned by a
resident of a third country.
Because the common stock owned by UKCo and XCo does not represent a
``financing transaction'' within the meaning of regulation section
1.881-3 as currently in effect, on these facts, this will not
constitute a conduit arrangement.
Example 3. XCo, a company organized in a country that does not have
a tax treaty with the United States, loans $1,000,000 to USCo, its
wholly-owned U.S. subsidiary in exchange for a note issued by USCo. XCo
later realizes that it can avoid the U.S. withholding tax by assigning
the note to its wholly-owned subsidiary, UKCo. Accordingly, XCo assigns
the note to UKCo in exchange for a note issued by UKCo. The USCo note
pays 7% and the UKCo note pays 6\3/4\%.
The transaction constitutes a conduit arrangement because it was
structured to eliminate the U.S. withholding tax that XCo otherwise
would have paid.
Example 4. XCo, a company organized in Country X, which does not
have a tax treaty with the United States, owns all of the stock of
USCo, a company resident in the United States. XCo has for a long time
done all of its banking with UKCo, a company organized in the United
Kingdom, because the banking system in Country X is relatively
unsophisticated. As a result, XCo tends to maintain a large deposit
with UKCo. UKCo is unrelated to XCo and USCo. When USCo needs a loan to
fund an acquisition, XCo suggests that USCo deal with UKCo, which is
already familiar with the business conducted by XCo and USCo. USCo
discusses the loan with several different banks, all on terms similar
to those offered by UKCo, but eventually enters into the loan with
UKCo, in part because interest paid to UKCo would not be subject to
U.S. withholding tax, while interest paid to banks organized in Country
X would be.
The United States will consider the fact that UKCo is unrelated to
USCo and XCo in determining whether there is a conduit arrangement.
Accordingly, this will be treated as a conduit arrangement only if UKCo
would not have entered into the transaction on substantially the same
terms in the absence of the XCo deposit. Under these facts, there is no
conduit arrangement.
Example 5. UKCo, a publicly-traded company organized in the United
Kingdom, is the holding company for a manufacturing group in a highly
competitive technological field. The manufacturing group conducts
research in subsidiaries located around the world. Any patents
developed in a subsidiary are licensed by the subsidiary to UKCo, which
then licenses the technology to its subsidiaries that need it. UKCo
keeps only a small spread with respect to the royalties it receives, so
that most of the profit goes to the subsidiary that incurred the risk
with respect to developing the technology. XCo, a company located in a
country with which the United States does not have a tax treaty, has
developed a process that will substantially increase the profitability
of all of UKCo's subsidiaries, including USCo, a company organized in
the United States. According to its usual practice, UKCo licenses the
technology and sub-licenses the technology to its subsidiaries. USCo
pays a royalty to UKCo, substantially all of which is paid to XCo.
Because UKCo entered into these transactions in the ordinary course
of its business, and there is no indication that it established its
licensing business in order to reduce its U.S. withholding tax, the
arrangements among USCo, UKCo and XCo do not constitute a conduit
arrangement.
Example 6. XCo is a publicly traded company resident in Country X,
which does not have a tax treaty with the United States. XCo is the
parent of a world wide group of companies, including UKCo, a company
resident in the United Kingdom, and USCo, a company resident in the
United States. USCo is engaged in the active conduct of a trade or
business in the United States. UKCo is responsible for coordinating the
financing of all of the subsidiaries of XCo. UKCo maintains a
centralized cash management accounting system for XCo and its
subsidiaries in which it records all intercompany payables and
receivables. UKCo is responsible for disbursing or receiving any cash
payments required by transactions between its affiliates and unrelated
parties. UKCo enters into interest rate and foreign exchange contracts
as necessary to manage the risks arising from mismatches in incoming
and outgoing cash flows. The activities of UKCo are intended (and
reasonably can be expected) to reduce transaction costs and overhead
and other fixed costs. UKCo has 50 employees, including clerical and
other back office personnel, located in the United Kingdom.
XCo lends to UKCo DM 15 million (worth $10 million) in exchange for
a 10-year note that pays interest annually at a rate of 5% per annum.
On the same day, UKCo lends $10 million to USCo in exchange for a 10-
year note that pays interest annually at a rate of 8% per annum. UKCo
does not enter into a long-term hedging transaction with respect to
these financing transactions, but manages the interest rate and
currency risk arising from the transactions on a daily, weekly or
quarterly basis by entering into forward currency contracts.
Because UKCo performs significant activities with respect to the
transactions between USCo and XCo, the participation of UKCo is
presumed not to have as one of its main purposes the avoidance of U.S.
withholding tax. Accordingly, based upon the foregoing facts, the loan
from XCo to UKCo and the loan from UKCo to USCo do not constitute a
conduit arrangement under the Convention.
______
Inland Revenue International Division,
Victory House, 30-34 Kingsway,
London WC2B 6ES, 19 July 2002.
Ms. Barbara M. Angus
International Tax Counsel,
U.S. Department of the Treasury,
1500 Pennsylvania Avenue, NW,
Washington, DC.
Dear Barbara,
Thank you for your letter of 19 July. I am happy to confirm that
your understanding of the UK's position with regard to the application
of the rules in our proposed income tax treaty dealing with ``conduit
arrangements'' is correct.
I attach the examples, reversed to show the position where income
flows from the UK to the US, together with our views on how we would
apply the anti-conduit rules to the transactions described.
Annex
Example 1. USCo, a publicly traded company organised in the United
States, owns all of the outstanding stock of UKCo. XCo, a company
organised in a country that does not have a tax treaty with the United
Kingdom, would like to purchase a minority interest in UKCo. USCo
proposes that UKCo issue preferred stock to USCo, paying a fixed return
of 4% plus a contingent return of 20% of UKCo's net profits. The
maturity of the preferred stock is 20 years. XCo will enter into a
separate contract with USCo pursuant to which it pays to USCo an amount
equal to the issue price of the preferred stock and will receive from
USCo after 20 years the redemption price of the stock. During the 20
years, USCo will pay to XCo 3\3/4\% plus 20% of UKCo's net profits.
The U.K. considers this arrangement would meet the objective
definition of a conduit arrangement at Article 3(1)(n)(i) but because
the U.K. has no withholding tax on dividends the motive test at Article
3(1)(n)(ii) would not be met because no increased treaty benefit would
be obtained by the routing through the U.S. Therefore the arrangement
would not constitute a conduit arrangement as defined by the treaty.
Example 2. UKCo has issued only one class of stock, common stock
that is 100% owned by USCo, a company organized in the United States.
USCo also has only one class of common stock outstanding, all of which
is owned by XCo, a company organized in a country that does not have a
tax treaty with the United Kingdom. USCo is engaged in the manufacture
of electronics products, and UKCo serves as USCo's exclusive
distributor in the United Kingdom. Under paragraph 4 of Article 23
(Limitation on Benefits), USCo will be entitled to benefits with
respect to dividends received from UKCo, even though USCo is owned by a
resident of a third country.
This seems to be a perfectly acceptable and normal commercial
structure with real economic activity in both the U.S. and the U.K. The
payment of dividends by subsidiary companies is a normal feature of
commercial life. Accordingly, in the absence of evidence that dividends
were flowed through to XCo, these transactions would not constitute a
conduit arrangement.
Example 3. XCo, a company organized in a country that does not have
a tax treaty with the United Kingdom, loans $1,000,000 to UKCo, its
wholly-owned U.K. subsidiary in exchange for a note issued by UKCo. XCo
later realizes that it can avoid the U.K. withholding tax by assigning
the note to its wholly-owned subsidiary, USCo. Accordingly, XCo assigns
the note to USCo in exchange for a note issued by USCo. The UKCo note
pays 7% and the USCo note pays 6\3/4\%.
The loan note was assigned to avoid U.K income tax on the payment
of interest. The transaction constitutes a conduit arrangement as
defined in the treaty as both the objective definition and the motive
test at Article 3(1)(n)(i) and (ii) respectively are met.
Example 4. XCo, a company organized in Country X, which does not
have a tax treaty with the United Kingdom, owns all of the stock of
UKCo, a company resident in the United Kingdom. XCo has for a long time
done all of its banking with USCo, a company organized in the United
States, because the banking system in Country X is relatively
unsophisticated. As a result, XCo tends to maintain a large deposit
with USCo. USCo is unrelated to XCo and UKCo. When UKCo needs a loan to
fund an acquisition, XCo suggests that UKCo deal with USCo, which is
already familiar with the business conducted by XCo and UKCo. UKCo
discusses the loan with several different banks, all on terms similar
to those offered by USCo, but eventually enters into the loan with
USCo, in part because interest paid to USCo would not be subject to
U.K. withholding tax, while interest paid to banks organized in Country
X would be.
The fact that UK/US treaty benefits are available if UKCo borrows
from USCo, and that similar benefits might not be available if it
borrowed elsewhere, is clearly a factor in UKCo's decision (which may
be influenced by advice given to by its 100% shareholder). It may even
be a decisive factor, in the sense that, all else being equal, the
availability of treaty benefits may swing the balance in favour of
borrowing from USCo rather than from another lender. However, whether
the obtaining of treaty benefits was ``the main purpose or one of the
main purposes'' of the transaction would have to be determined by
reference to the particular facts and circumstances.
Similarly, for the anti-conduit provision to apply it would have to
be established that the interest paid by UKCo was ``flowing through''
USCo to XCo. The fact that XCo has historically maintained large
deposits with USCo might, if anything, be a counter-indication. Against
that, there is the question why a cash-rich company would want to
increase its overall debt exposure in this way. XCo could redirect its
balance with USCo and lend it to UKCo--in which case it would face U.K.
withholding tax. It chooses not to, so there is a possible argument
that the transactions were structured to avoid U.K. withholding tax by
obtaining benefits under the treaty.
On the specific facts as presented, the transactions would not
constitute a conduit arrangement as defined by the treaty.
However, if USCo's decision to lend to UKCo was dependent on XCo
providing a matching collateral deposit to secure the loan, the
indication would be that XCo was in substance lending to UKCo direct
but in form routing the loan through a bank with whom it has a close
relationship in order to obtain the benefit of the treaty. In such
circumstances the transactions would constitute a conduit arrangement
as defined by the treaty.
Example 5. USCo, a publicly-traded company organized in the United
States, is the holding company for a manufacturing group in a highly
competitive technological field. The manufacturing group conducts
research in subsidiaries located around the world. Any patents
developed in a subsidiary are licensed by the subsidiary to USCo, which
then licenses the technology to its subsidiaries that need it. USCo
keeps only a small spread with respect to the royalties it receives, so
that most of the profit goes to the subsidiary that incurred the risk
with respect to developing the technology. XCo, a company located in a
country with which the United Kingdom does not have a tax treaty, has
developed a process that will substantially increase the profitability
of all of USCo's subsidiaries, including UKCo, a company organized in
the United Kingdom. According to its usual practice, USCo licenses the
technology and sub-licenses the technology to its subsidiaries. UKCo
pays a royalty to USCo, substantially all of which is paid to XCo.
Because XCo is conforming to the standard commercial organisation
and behaviour of the group in the way that it structures its licensing
and sub-licensing activities and assuming the same structure is
employed with respect to other subsidiaries carrying out similar
activities in countries which have treaties which offer similar or more
favourable benefits, the inference would be that the absence of a
treaty between country X and the U.K. is not influencing the motive for
the transactions described.
Therefore even though the specific fact pattern, as presented,
meets the first part of the definition of a ``conduit arrangement'' at
Article 3(1)(n)(i), on balance the conclusion would be that ``the main
purpose or one of the main purposes'' of the transactions was not the
obtaining of UK/US treaty benefits. So the structure would not
constitute a conduit arrangement.
Example 6. XCo is a publicly traded company resident in Country X,
which does not have a tax treaty with the United Kingdom. XCo is the
parent of a worldwide group of companies, including USCo, a company
resident in the United States, and UKCo, a company resident in the
United Kingdom. UKCo is engaged in the active conduct of a trade or
business in the United Kingdom. USCo is responsible for coordinating
the financing of all of the subsidiaries of XCo. USCo maintains a
centralized cash management accounting system for XCo and its
subsidiaries in which it records all inter-company payables and
receivables. USCo is responsible for disbursing or receiving any cash
payments required by transactions between its affiliates and unrelated
parties. USCo enters into interest rate and foreign exchange contracts
as necessary to manage the risks arising from mismatches in incoming
and outgoing cash flows. The activities of USCo are intended (and
reasonably can be expected) to reduce transaction costs and overhead
and other fixed costs. USCo has 50 employees, including clerical and
other back office personnel, located in the United States.
XCo lends to USCo DM 15 million (worth $10 million) in exchange for
a 10-year note that pays interest annually at a rate of 5% per annum.
On the same day, USCo lends $10 million to UKCo in exchange for a 10-
year note that pays interest annually at a rate of 8% per annum. USCo
does not enter into a long-term hedging transaction with respect to
these financing transactions, but manages the interest rate and
currency risk arising from the transactions on a daily, weekly or
quarterly basis by entering into forward currency contracts.
UKCo appears to be a real business performing substantive economic
functions, using real assets and assuming real risks. USCo appears to
be bearing the interest rate and currency risk. It is assumed that the
transactions are typical of USCo's normal treasury business and that
that business was carried on in a commercial manner.
So, on the specific facts presented, the transactions would not
constitute a conduit arrangement as defined by the treaty.
Senator Hagel. Ms. Angus, thank you very much.
Mr. Noren.
STATEMENT OF DAVID NOREN, LEGISLATION COUNSEL, JOINT COMMITTEE
ON TAXATION, U.S. CONGRESS, WASHINGTON, DC
Mr. Noren. Thank you, Mr. Chairman. It is my pleasure to
present the testimony of the staff of the Joint Committee on
Taxation today concerning the proposed income tax treaty with
the United Kingdom and the proposed protocols to the existing
income tax treaties with Australia and Mexico.
As in the past, the Joint Committee staff has prepared
pamphlets covering the proposed treaty and protocols. The
pamphlets provide detailed descriptions of the provisions of
the proposed treaty and protocols, including comparisons with
the 1996 U.S. model income tax treaty, which reflects preferred
U.S. treaty policy, and with other recent U.S. tax treaties.
The pamphlets also provide detailed discussions of issues
raised by the proposed treaty and protocols.
We consulted with the Department of the Treasury and with
the staff of your committee in analyzing the proposed treaty
and protocols, and in preparing the pamphlets. My testimony
today will highlight some of the key features of the proposed
treaty and protocols and certain issues that they raise.
One new feature of the proposed treaty and protocols is the
zero rate of withholding tax on certain intercompany dividends
provided under all three instruments. These provisions do not
appear in the U.S. model treaty, or in any existing U.S.
treaty, and their inclusion in the proposed treaty and
protocols represents a significant development in U.S. tax
treaty practice.
These provisions would eliminate source country withholding
tax on cross-border dividends paid by one corporation to
another corporation that owns at least 80 percent of the stock
of the dividend-paying corporation, provided that certain
conditions are met. Under the current treaties with the United
Kingdom and Mexico, these dividends may be subject to
withholding tax at a rate of 5 percent. Under the current
treaty with Australia, these dividends may be subject to
withholding tax at a rate of 15 percent. The elimination of the
withholding tax under these circumstances is intended to
further reduce the tax barriers to direct investment between
the United States and these treaty partners.
Although no existing U.S. treaty provides for a complete
exemption from withholding tax under these circumstances, many
bilateral treaties to which the United States is not a party do
eliminate withholding taxes under similar circumstances. The
same result has been achieved within the European Union by E.U.
directive. Thus, although these zero-rate provisions are
unprecedented in U.S. treaty history, there is substantial
precedent for them in the experience of other countries.
Looking beyond the three treaty relationships directly at
issue, the committee may wish to determine whether the
inclusion of zero-rate provisions in the proposed treaty and
protocols signals a broader shift in U.S. tax treaty policy.
Specifically, the committee may want to know whether and under
what circumstances the Department of the Treasury intends to
pursue similar provisions in other treaties, and whether the
U.S. model treaty will be amended to reflect these
developments.
The proposed treaty with the United Kingdom is a
comprehensive update of the 1975 treaty. The provisions of the
proposed treaty are generally consistent with the U.S. model
treaty. While the zero-rate provision is of particular
interest, the proposed treaty includes several other key
features. The proposed treaty includes a comprehensive anti-
treaty-shopping provision which resembles the provisions of the
U.S. model treaty and other recent treaties. The existing
treaty with the United Kingdom, like other treaties of its era,
does not include a comprehensive anti-treaty-shopping
provision.
The proposed treaty also includes an extensive set of rules
designed to coordinate the pension plans and other retirement
arrangements provided under the laws of the two countries.
These rules would facilitate retirement planning using the tax-
favored vehicles available under U.S. and U.K. law in cases
involving individuals who live for some period of time in both
countries.
The proposed treaty includes a general anti-conduit rule
that can operate to deny the benefits of several articles of
the treaty. This rule is not found in any other U.S. treaty,
and it is not included in the U.S. model. The rule is similar
to, but significantly narrower and more precise than, the
``main purpose'' rules that the Senate rejected in 1999 in
connection with its consideration of the proposed U.S.-Italy
and U.S.-Slovenia treaties. The rule was included at the
request of the United Kingdom, which has similar provisions in
many of its tax treaties.
The purpose of the rule, from the U.K. perspective, is to
prevent residents of third countries from improperly obtaining
the reduced rates of U.K. tax provided under the treaty by
channeling payments to a third country resident through a U.S.
resident. From the U.S. perspective, the rule is generally
unnecessary, because U.S. domestic law provides detailed rules
governing arrangements to reduce U.S. tax through the use of
conduits.
The proposed treaty also raises issues with respect to the
waiver of the U.S. insurance excise tax, the treatment of
dividend substitute payments, the attribution of profits to
permanent establishments, the treatment of shipping income, the
creditability of the U.K. petroleum revenue tax for purposes of
the U.S. foreign tax credit, and the treatment of visiting
teachers, all of which are discussed in detail in the Joint
Committee staff pamphlet on the proposed treaty.
The proposed protocol with Australia makes several
modifications to the 1982 treaty. The provisions of the
proposed protocol are generally consistent with the U.S. model
treaty. The proposed protocol reduces source country
withholding tax rates under the existing treaty with respect to
dividends, interest, and royalties.
In addition to adopting the zero-rate provision for certain
intercompany dividends, the modified dividends provision also
provides a maximum withholding tax rate of 5 percent on
dividends meeting a 10-percent ownership threshold, consistent
with the U.S. model. In other cases, the 15-percent rate of the
existing treaty is maintained, also consistent with the U.S.
model.
With respect to interest, the proposed protocol continues
to allow source country withholding tax at a rate of 10
percent, but generally allows a zero rate for interest received
by financial institutions and governmental entities. The U.S.
model does not allow source country withholding tax with
respect to interest.
The proposed protocol also retains source country taxation
of royalties under the existing treaty, but reduces the maximum
level of withholding tax from 10 percent to 5 percent. In
addition, the proposed protocol amends the definition of
royalties to remove equipment leasing income, thus eliminating
the withholding tax on this income and rendering it taxable by
the source country only if the recipient has a permanent
establishment in that country. The U.S. model does not allow
source country withholding tax with respect to royalties.
The proposed protocol also amends the shipping income
provisions under the existing treaty to reflect more closely
the treatment of such income under the U.S. model treaty.
The proposed protocol with Mexico makes several
modifications to the 1992 treaty, but the adoption of the zero-
rate dividends provision is the principal change and was the
impetus behind the protocol. Under the existing treaty, if the
United States adopts a withholding tax rate on dividends lower
than 5 percent in another treaty, the United States and Mexico
have agreed to promptly amend their treaty to incorporate that
lower rate. The inclusion of zero-rate dividends provisions in
the proposed treaty with the United Kingdom and the proposed
protocol with Australia would trigger this obligation, and the
inclusion of the provision in the proposed protocol with Mexico
is responsive to it.
These provisions and issues are all discussed in more
detail in the Joint Committee staff pamphlets on the proposed
treaty and protocols.
I would be happy to answer any questions that the committee
may have at this time or in the future. Thank you.
[The prepared statement of the staff of the Joint Committee
on Taxation follows:]
Prepared Statement of the Staff of the Joint Committee on Taxation,\1\
Presented by David Noren, Legislation Counsel, Joint Committee on
Taxation
---------------------------------------------------------------------------
\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 a Proposed
Tax Treaty with the United Kingdom and Proposed Protocols to Tax
Treaties with Australia and Mexico (JCX-14-03), March 3, 2003.
---------------------------------------------------------------------------
My name is David Noren. I am Legislation Counsel to the Joint
Committee on Taxation. It is my pleasure to present the testimony of
the staff of the Joint Committee on Taxation (the ``Joint Committee
staff'') today concerning the proposed income tax treaty with the
United Kingdom and the proposed protocols to the existing income tax
treaties with Australia and Mexico.
overview
As in the past, the Joint Committee staff has prepared pamphlets
covering the proposed treaty and protocols. The pamphlets provide
detailed descriptions of the provisions of the proposed treaty and
protocols, including comparisons with the 1996 U.S. model income tax
treaty, which reflects preferred U.S. treaty policy, and with other
recent U.S. tax treaties. The pamphlets also provide detailed
discussions of issues raised by the proposed treaty and protocols. We
consulted with the Department of the Treasury and with the staff of
your Committee in analyzing the proposed treaty and protocols and in
preparing the pamphlets.
The proposed treaty with the United Kingdom would replace an
existing treaty signed in 1975. The proposed protocol with Australia
would make several modifications to an existing treaty signed in 1982.
The proposed protocol with Mexico would make several modifications to
an existing treaty signed in 1992.
My testimony will highlight some of the key features of the
proposed treaty and protocols and certain issues that they raise.
``zero-rate'' dividend provisions
One new feature of the proposed treaty and protocols is the ``zero
rate'' of withholding tax on certain intercompany dividends provided
under all three instruments. These provisions do not appear in the U.S.
model treaty or in any existing U.S. treaty, and their inclusion in the
proposed treaty and protocols represents a significant development in
U.S. tax treaty practice.
These provisions would eliminate source-country withholding tax on
cross-border dividends paid by one corporation to another corporation
that owns at least 80 percent of the stock of the dividend-paying
corporation, provided that certain conditions are met. Under the
current treaties with the United Kingdom and Mexico, these dividends
may be subject to withholding tax at a rate of 5 percent. Under the
current treaty with Australia, these dividends may be subject to
withholding tax at a rate of 15 percent. The elimination of the
withholding tax under these circumstances is intended to further reduce
the tax barriers to direct investment between the United States and
these treaty partners.
Although no existing U.S. treaty provides for a complete exemption
from withholding tax under these circumstances, many bilateral treaties
to which the United States is not a party eliminate withholding taxes
under similar circumstances. The same result has been achieved within
the European Union by E.U. directive. Thus, although these zero-rate
provisions are unprecedented in U.S. treaty history, there is
substantial precedent for them in the experience of other countries.
Looking beyond the three treaty relationships directly at issue,
the Committee may wish to determine whether the inclusion of zero-rate
provisions in the proposed treaty and protocols signals a broader shift
in U.S. tax treaty policy. Specifically, the Committee may want to know
whether and under what circumstances the Department of the Treasury
intends to pursue similar provisions in other treaties, and whether the
U.S. model treaty will be amended to reflect these developments.
united kingdom
The proposed treaty with the United Kingdom is a comprehensive
update of the 1975 treaty. The provisions of the proposed treaty are
generally consistent with the U.S. model treaty. While the zero-rate
provision is of particular interest, the proposed treaty includes
several other key features.
The proposed treaty includes a comprehensive anti-treaty-shopping
provision, which resembles the provisions of the U.S. model treaty and
other recent treaties. The existing treaty with the United Kingdom,
like other treaties of its era, does not include a comprehensive anti-
treaty-shopping provision.
The proposed treaty also includes an extensive set of rules
designed to coordinate the pension plans and other retirement
arrangements provided under the laws of the two countries. These rules
would facilitate retirement planning using the tax-favored vehicles
available under U.S. and U.K. law in cases involving individuals who
live for some period of time in both countries.
The proposed treaty includes a general ``anti-conduit'' rule that
can operate to deny the benefits of several articles of the treaty.
This rule is not found in any other U.S. treaty, and it is not included
in the U.S. model. The rule is similar to, but significantly narrower
and more precise than, the ``main purpose'' rules that the Senate
rejected in 1999 in connection with its consideration of the proposed
U.S.-Italy and U.S.-Slovenia treaties. The rule was included at the
request of the United Kingdom, which has similar provisions in many of
its tax treaties. The purpose of the rule, from the U.K. perspective,
is to prevent residents of third countries from improperly obtaining
the reduced rates of U.K. tax provided under the treaty by channeling
payments to a third-country resident through a U.S. resident. From the
U.S. perspective, the rule is generally unnecessary, because U.S.
domestic law provides detailed rules governing arrangements to reduce
U.S. tax through the use of conduits.
The proposed treaty also raises issues with respect to the waiver
of the U.S. insurance excise tax, the treatment of dividend substitute
payments, the attribution of profits to permanent establishments, the
treatment of shipping income, the creditability of the U.K. petroleum
revenue tax under the U.S. foreign tax credit rules, and the treatment
of visiting teachers, all of which are discussed in detail in the Joint
Committee staff pamphlet on the proposed treaty.
australia
The proposed protocol with Australia makes several modifications to
the 1982 treaty. The provisions of the proposed protocol are generally
consistent with the U.S. model treaty.
The proposed protocol reduces source-country withholding tax rates
under the existing treaty with respect to dividends, interest, and
royalties. In addition to adopting the zero-rate provision for certain
intercompany dividends, the modified dividends provision also provides
a maximum withholding tax rate of 5 percent on dividends meeting a 10-
percent ownership threshold, consistent with the U.S. model. In other
cases, the 15-percent rate of the existing treaty is maintained, also
consistent with the U.S. model.
With respect to interest, the proposed protocol continues to allow
source-country withholding tax at a rate of 10 percent, but generally
allows a zero rate for interest received by financial institutions and
governmental entities. The U.S. model does not allow source-country
withholding tax with respect to interest.
The proposed protocol also retains source-country taxation of
royalties under the existing treaty, but reduces the maximum level of
withholding tax from 10 percent to 5 percent. In addition, the proposed
protocol amends the definition of royalties to remove equipment leasing
income, thus eliminating the withholding tax on this income and
rendering it taxable by the source country only if the recipient has a
permanent establishment in that country. The U.S. model does not allow
source-country withholding tax with respect to royalties.
The proposed protocol also amends the shipping income provisions
under the existing treaty to reflect more closely the treatment of such
income under the U.S. model treaty.
mexico
The proposed protocol with Mexico makes several modifications to
the 1992 treaty, but the adoption of the zero-rate dividends provision
is the principal change and was the impetus behind the protocol. Under
the existing treaty, if the United States adopts a withholding tax rate
on dividends lower than 5 percent in another treaty, the United States
and Mexico have agreed to promptly amend their treaty to incorporate
that lower rate. The inclusion of zero-rate dividends provisions in the
proposed treaty with the United Kingdom and the proposed protocol with
Australia would trigger this obligation, and the inclusion of the
provision in the proposed protocol with Mexico is responsive to it.
conclusion
These provisions and issues are all discussed in more detail in the
Joint Committee staff pamphlets on the proposed treaty and protocols. I
would be happy to answer any questions that the Committee may have at
this time or in the future.
Senator Hagel. Mr. Noren, thank you. Again, thank you each
for your testimony.
Ms. Angus, your testimony is very complete, and we
appreciate that very much.
Let me begin with part of Mr. Noren's testimony. In your
testimony, page 2, you ask specifically, ``the committee may
want to know whether and under what circumstances the
Department of the Treasury intends to pursue similar provisions
in other treaties,'' referencing zero-rate provisions, and I
noted in the last part of your testimony, Ms. Angus, that you
reference treaties currently under negotiation, which I want to
visit a little bit about.
That might be a good starting question to ask you to
respond to, and you I am sure were very attentive to Mr.
Noren's commentary this afternoon. Why don't we start there
with his question, because I had a similar question that I
wanted to ask as well, and I think you understand what his
point is, so have at it. Thank you.
Ms. Angus. Thank you, Mr. Chairman. We believe that
provisions that eliminate the withholding tax on dividends can
be very beneficial. In the case of intercompany dividends, such
provisions do serve to reduce what can be a significant barrier
to cross-border investment, and it is something that we believe
that we should consider.
Some years ago, most countries retained the right to impose
a withholding tax on dividends, but more and more countries are
eliminating their withholding taxes on dividends by treaty, and
as Mr. Noren pointed out, the European Union has done it as
well, so that dividends paid by a company in one European
country to a parent in another European country are not subject
to withholding tax. It is something that we believe we need to
consider in order to help to eliminate these cross-border
investment barriers between the U.S. and our trading partners.
That said, it is something that we need to look at very
carefully, and we believe that there are some clear parameters
that need to be included as we consider eliminating withholding
taxes on dividends. One is a strong and effective anti-treaty-
shopping provision. Also the information exchange provisions
that are needed to ensure that we have access to the
information to be able to test the anti-treaty-shopping
provision and determine that the dividend really is being paid
to someone who is resident of the other country.
That is critically important when we are talking about
beginning to include a benefit in our treaties that has not
traditionally been included in our treaties, because treaty
shopping will be a particular concern there. As we are only
beginning to include this provision, we need to be particularly
vigilant about treaty shopping.
In looking at considering this elimination, we really think
we need to look at the balance of benefits of the treaty, and
it is something that we should consider in our existing
relationships and our new treaty relationships as we go
forward.
Senator Hagel. The list of treaties under negotiation in
your testimony, can you tell the committee whether you are
currently looking at or intending to put zero-rate provisions
in any of these?
Ms. Angus. It is certainly something that we are
considering, and there has been significant interest from some
of our treaty partners. Some of our treaty partners have
policies of maintaining withholding taxes not just on
dividends, but in some cases, on interest and royalties as
well, and we work to try to reduce those withholding taxes. But
there are other countries that have long held policies of
eliminating withholding taxes on interest and royalties and
that are beginning to seek to reduce them in the case of
dividends as well, and so it is something that we are
discussing with our treaty partners in Europe, as well as some
of our other treaty partners.
There has been a great deal of interest in the inclusion of
this provision in the treaties that are pending before the
committee today. I know that not only are there many in the
business community that are eagerly waiting to see what the
reaction to these treaties is from the committee, but also
there are countries around the world that are waiting to see
what the reaction is.
Senator Hagel. But none specifically that you would point
out here in your list of treaties under negotiation that you
focused on?
Ms. Angus. I think it is really hard to point to a specific
country, since all of our negotiations are ongoing, and as I
said, we really think this is something that we need to look at
in the context of the whole balance of the treaty. As an
initial matter, we need to make sure that we are able to
include our preferred position on anti-treaty-shopping
provisions, but beyond that, we need to make sure that the
balance of benefits in the treaty is set at the optimal level.
And it is fair to say that when you are negotiating any deal,
no element of it is finished until it is all finished.
Senator Hagel. All right. Thank you.
Mr. Noren, do you have any comments on this?
Mr. Noren. The Joint Committee staff does not have a
general position on the appropriateness of zero-rate dividends
provisions. I think if you look at our pamphlets, we clearly
are of the view that there are potentially significant benefits
from doing this, arising from mitigating double taxation and
further reducing barriers to cross-border investment.
The benefit of doing this is arguably amplified, given that
many other countries seem to be doing it as well; conversely,
the competitive disadvantage to the country if we were not to
start doing this is arguably greater the more prevalent it
becomes generally. I would agree with everything that Ms. Angus
has said about the inability to develop a general position as
to whether it is appropriate in all cases, and I think that the
kinds of things she mentioned are exactly the kinds of things
that we have to think about: Do we have strong anti-treaty-
shopping rules with that treaty partner? Do we have strong
information exchange agreements? We might want to review the
tax system of the treaty partner. Does that treaty partner have
a comprehensive income tax system that imposes tax at rates
that are in the same ball park as the rates of our system?
So those are the kinds of things that I think we would have
to think about on a case-by-case basis.
Senator Hagel. Thank you. Staying with this flow, Ms.
Angus, something that Mr. Noren just said about significant
barriers created by tax systems that still remain in cross-
border investment, what would you say we all need to continue
to work on in that general area of significant barriers that
still remain, Mr. Noren referenced, within the tax structure
systems of countries?
Ms. Angus. Well, I think there are a number of things that
we need to look to. We certainly need to continue our policy of
seeking to reduce withholding taxes and seeking to get
provisions in our treaties in place that do everything that
they can to eliminate double taxation. There are some evolving
issues that I think we will need to pay continuing attention
to, and increasing attention to.
One area is the issues that arise because of developments
in technology. As technology develops and enables business to
further globalize their operations, more international tax
issues arise that need to be addressed in the tax treaty
context in order to ensure that double taxation on the
activities associated with that technology is avoided.
A lot of the tax treaty concepts that have developed over
the years were developed in a world that was looking at bricks-
and-mortar business. As we go to a more technology-based
economy and greater reliance on services, we need to make sure
that the rules that we have that assign taxing rights between
countries and that operate to prevent double taxation work
properly in the context of what some refer to as the new
economy.
Another issue that we are encountering increasingly is the
issue of individuals who will spend part of their career
working in one country and part working in another, or maybe in
several countries over the course of their career. The proposed
treaty with the U.K. includes a comprehensive set of provisions
dealing with coordinating the tax treatment of pensions, both
pension benefits and pension contributions, between the two
countries so that an individual who throughout his career has
been saving for his retirement does not find in his retirement
years that his pension is being eaten up by taxation from a
foreign country that he did not anticipate. We were able with
the U.K. to do a very comprehensive set of provisions
coordinating the pension rules because of some basic
similarities between our systems, but that is something that we
need to continue to look to with other countries so that taxes
not only are not a barrier to movements of capital, but also
are not a barrier to movements of people.
Senator Hagel. Mr. Noren, would you have any comment on
this?
Mr. Noren. I do not have anything to add to that.
Senator Hagel. OK, thank you.
Ms. Angus, what are your projections, and maybe you had
them in here, or do you have projections on the revenue impact
of the treaty and the protocols?
Ms. Angus. The purpose of the treaties, as we have talked
about here today, is to protect taxpayers from double taxation
by allocating taxing rights between the two countries, so
between the United States and between our treaty partner. We
also seek to avoid excessive taxation by reducing withholding
taxes, including the withholding taxes on dividends that we
have talked about here today.
Depending on the specific circumstances, the net effect of
all of the provisions in the treaty may be a short-term revenue
gain or loss when you look just in the short-term and just at
tax revenues. I think the key point is that a tax treaty is a
negotiated agreement under which both countries expect to be
better off in the long run. We believe that treaties provide
significant economic benefits to the United States, to our
treaty partner, and to both of our business communities, and so
we believe that the short-term revenue effects of a treaty can
pale in comparison to its long-term benefits.
The treaties provide greater certainty and a more stable
environment for foreign investment. They reduce tax-related
barriers to cross-border investment that will allow for a more
productive allocation of capital. This stability and enhanced
capital flow will have positive effects on the economies of
both countries.
Senator Hagel. Thank you, Ms. Angus. Mr. Noren, would you
like to respond?
Mr. Noren. I would echo everything that Ms. Angus said and
just note that traditionally Congress and the President and the
Treasury Department have treated treaties as being essentially
in a category of their own, as being not a part of the budget
process, and so it has been the custom not to provide detailed
revenue estimates of proposed treaties. As Ms. Angus says, they
are negotiated agreements in which two different countries each
agree to yield some of their taxing jurisdiction with a view
toward achieving these larger benefits.
Senator Hagel. Thank you. We have had some general
reference to future treaties and the protocols that will
continue to be required, as we are doing two of today, to
adjust to the new dynamics, new challenges and as you pointed
out, Ms. Angus, especially technology is changing things so
rapidly that we have to try to assure that our policies are at
least consistent with the reality of what the marketplace is,
and all the other challenges that we are dealing with.
In that regard, would you consider the U.S.-U.K. treaty in
today's 2003 terms, and maybe out a couple of years, a model
for what you can use as you negotiate out these treaties you
are working on now, and into the future?
Ms. Angus. I think in some senses it can be viewed as a
model. It reflects some important developments and a lot of
detailed work on dealing with some of these emerging issues,
the pension issue for one. It was the first treaty that the
United States signed that would eliminate the withholding tax
on intercompany dividends. But the U.K. treaty is a function of
the need to mesh the two particular tax systems, to mesh our
tax system with the particular tax system of the U.K.
We have some common features of our systems that allowed us
to mesh things sometimes more easily than may arise with other
countries. That said, even with our close history with the
United Kingdom, they have some aspects of their tax system that
are unique and that created particular issues, so there were
special rules we needed to deal with in order to mesh our
system with those elements of theirs.
To be fair, our own system certainly contains a lot of
rules that add to the complexity of this meshing of systems
process as well. I think there are many important things in the
U.K. treaty that we ought to be considering in other treaties,
while keeping in mind that each treaty is intended to serve the
purpose of meshing the systems of two particular countries, and
to foster the economic cooperation between those two economies,
and so there always will be unique provisions in any treaty
relationship.
Senator Hagel. Thank you. Mr. Noren, would you like to
respond?
Mr. Noren. The only thing I would add to that is that the
Joint Committee staff, in its tax simplification study, which
was released in the spring of 2001, made a recommendation that
the U.S. model treaty be updated more frequently than it is.
Our recommendation specifically was once per Congress, and I
think that with the existing model treaty now being 7 years
old, the tax treaty process might become somewhat more
transparent, and congressional involvement in the process
improved, with more frequent updates of the model.
Senator Hagel. So we are not paying attention well enough
up here, is your kind way to say it, Mr. Noren.
We have been joined by our friend from Florida, who knows a
little something about taxes, former insurance commissioner,
astronaut, all-around bon vivant, our friend the Senator from
Florida, Bill Nelson. Senator Nelson.
Senator Nelson. You go on. I am learning from you.
Senator Hagel. That is a frightening prospect, if the
Senator from Florida says he is learning from me.
I mentioned, Ms. Angus, I wanted to go back to the
additional treaties that you were looking at, and you mention
in your testimony the Sri Lanka treaty might well be ready for
transmittal to the Senate fairly soon. Is there a consistency
to the current treaties that you have under negotiation that we
could help you with up here, or be better prepared to deal with
some of these issues?
I think Mr. Noren's point is a good one, and our staff,
like any staff, is pulled in many directions here, and we never
have enough time and attention, but if there are things that
you could point us toward where we could be preparing ourselves
maybe more effectively than we have in the past, or to assist
you or just stay out of your way, then we would value that, so
take any piece of that that you like.
Ms. Angus. Well, thank you, Mr. Chairman, we very much
appreciate the assistance of this committee and the interest of
this committee in tax treaties, and we very much appreciate the
work of the staff of this committee. We who are focused on
taxes recognize that your committee and your staff has so many
other priorities and responsibilities beyond our world of taxes
and tax treaties.
On the issue of the model treaty, we certainly agree with
the comments about the need to make sure that we have a model
that provides the guidance that it ought to provide. It is
useful as a document on which to base discussions with this
committee and your staffs, and it also serves to provide
information to taxpayers as well, and so a model treaty is a
way to disseminate that sort of information, as treaty practice
evolves. Now, that said, we do need to balance the work in
publishing a model with the work in negotiating new treaties,
so that is always a balancing matter.
In terms of the treaties that we are negotiating currently,
we have a very active schedule, and we are dealing with a range
of situations, some renegotiations of existing treaties in
order to modernize and update those treaties, and some
situations where we are dealing with the need to address more
targeted issues within a treaty, and then we have some
agreements that will represent the first treaty relationship
with a country. The agreement that we were able to sign
recently with Sri Lanka is an example of that. That entire
relationship will be our first tax treaty relationship with
that country.
The issues that arise when we are looking at renegotiation
of a treaty sometimes are different than with a new treaty, but
in all cases, the goals are the same.
Senator Hagel. Mr. Noren, would you like to add anything to
that?
Mr. Noren. No, Senator.
Senator Hagel. Senator Nelson, I am going to submit some
specific, more technical questions to the Treasury, just to let
you know, and so I am not going to get into those now, but just
to make you aware of that, and I am going to ask Senator Nelson
now if he has questions or anything he would like to add.
Senator Nelson. May I ask a question?
Senator Hagel. Yes, sir.
Senator Nelson. We do a lot of business back and forth in
insurance, and I am curious, does the U.K. tax imposed on U.K.
insurers and reinsurers such as a lot of activities that spin
off from Lloyd's, does that U.K. tax on insurance premium
income result in a burden that is substantial in relationship
to the U.S. tax?
Ms. Angus. Senator, yes, it does. Our treaty, our current
treaty with the U.K. includes a provision that waives the U.S.
insurance excise tax on premiums paid to foreign insurers. The
provision in the existing treaty does not have the anti-abuse
rule that we prefer to see in our treaties, and that is
included in our recent treaties.
So one of the significant improvements we feel we were able
to make with the proposed treaty with the U.K. was to include
just that sort of anti-abuse rule, an anti-conduit provision
that would prevent the residents of third countries, including
countries that do not have significant taxation of insurance
operations, from being able to funnel their activities through
the U.K. in order to get the benefit of the agreement that we
have reached with the U.K.
In looking at this matter, in addition to wanting to ensure
that we were able to add to what is in the existing treaty in
order to have this anti-abuse rule, we also conducted a
thorough review of the U.K. tax law and of information about
the U.K. tax treatment of insurance, and that review
demonstrated that insurance companies that are resident in the
U.K. are subject to a substantial level of tax in the U.K. So
that was part of our review of this provision as well.
Senator Nelson. Would one of those third parties be an
example like Bermuda, that has very little taxation of any
income coming in from insurance?
Ms. Angus. That would be an example, and that is why we
thought, particularly with the size of the insurance market in
the U.K., that it was critically important to update our treaty
relationship to include this anti-abuse rule so that companies
in other countries that have the lower tax burdens on insurance
cannot take advantage of a provision in the U.K. treaty and get
a reduction in U.S. tax to which they should not be entitled.
Senator Nelson. Thank you, Mr. Chairman. I appreciate it.
Senator Hagel. Senator Nelson, thank you. Unless our two
witnesses have any further comments or additional
contributions, we are grateful for your testimony and your time
and, as I said, we will submit additional questions. Thank you
very much.
Mr. Reinsch. Well, I have introduced you once, but I will
take the opportunity to introduce you again. Those of you who
are familiar with this committee and economic issues, great
issues of our time, know our second witness, the Hon. William
Reinsch, president of the National Foreign Trade Council here
in Washington, who has had many senior-level positions with our
government, and we are grateful, Bill, that you would find time
to spend some of that time with us today, so please proceed
with your testimony.
STATEMENT OF HON. WILLIAM A. REINSCH, PRESIDENT, NATIONAL
FOREIGN TRADE COUNCIL, INC., WASHINGTON, DC
Mr. Reinsch. Thank you, Mr. Chairman. It is an honor to be
back. I recall the last time I was here when you were the
Chair, we were discussing the effect on the domestic and
commercial communications satellite industry of various
congressional actions with respect to exports. I believe this
is a less controversial topic, and I am pleased to be here.
Let me say I am also accompanied by Mary C. Bennett, of the
law firm of Baker and McKenzie, who is the National Foreign
Trade Council's [NFTC] counsel in this area, and she is going
to help me answer all the hard questions. I am going to deliver
an abbreviated statement in the hopes that you will put my
entire statement in the record.
Senator Hagel. Your complete statement will be in the
record.
Mr. Reinsch. Thank you. The NFTC is honored to be here, and
pleased to recommend ratification of the treaty and protocols
under consideration by the committee today. We appreciate your
action, Mr. Chairman, in scheduling this hearing so promptly,
and we strongly urge the committee to reaffirm the United
States' historic opposition to double taxation by giving its
full support to the pending treaty and protocols.
You know who we are at the NFTC, and you know what our
goals are and what we stand for. We seek 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 that can serve
as a barrier to full participation in the international
marketplace. Tax treaties are a crucial component of the
framework that is necessary to allow such balanced competition.
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 tax convention
protocol with the U.K. and the protocols amending the tax
conventions with Australia and Mexico.
It is important to note that taxpayers are not the only
beneficiaries of tax treaties. Treaties protect the legitimate
enforcement interest of the U.S. Treasury by providing for the
exchange of information between tax authorities. Treaties have
also provided a framework for the resolution of disputes with
respect to overlapping claims by the respective governments.
In particular, the practices of the competent authorities
under the treaties have led to agreements known as advanced
pricing agreements, or APA's, through which tax authorities of
the United States and other countries have been able to avoid
costly and unproductive disputes over appropriate transfer
prices for the trade in goods and services between related
entities.
The treaty and protocols that are under your consideration
today, Mr. Chairman, are a good illustration of the
contribution such agreements can make to improving both the
economic competitiveness of U.S. companies and the proper
administration of U.S. tax laws in the international arena.
For example, the U.K., Australian, and Mexican agreements
contain a provision new to U.S. treaty policy which calls for a
zero rate of withholding tax on dividends paid to parent
corporations from their 80 percent or greater owned
subsidiaries. The existing of a withholding tax on cross-border
parent-subsidiary dividends, even at the 5 percent rate
previously typical in U.S. treaties, 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 from 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.
If U.S. businesses are going to maintain a competitive
position around the world, we need a treaty policy that
protects us from multiple or excessive levels of foreign tax on
our cross-border investments, particularly if our 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. For example, the
European Union eliminated this tax on intra-E.U. 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.
The NFTC has for years urged Treasury to change U.S. treaty
policy to allow for this zero rate on dividends, and we highly
commend Treasury for taking the first steps in that direction
by negotiating the agreements before the committee today. We
strongly urge you and the committee to promptly approve each of
these agreements, and we hope that subsequently the Senate's
ratification will help Treasury negotiate similar agreements
with many more countries.
We would also like to confirm to the committee our belief
that it is worthwhile to negotiate for the inclusion of this
provision even in treaties with countries whose domestic law
already provides for a zero rate on dividends, such as the
United Kingdom. Doing so has the effect of locking in the
benefit of the zero rate, protecting U.S. parent companies from
subsequent changes to the foreign tax regime.
The formal acceptance of the zero rate principle by treaty
also serves as a valuable precedent, confirming to other
prospective treaty partners the U.S. commitment to this policy.
These treaties are important to the U.S. business community
because of the actual and precedential effect of eliminating
the withholding tax on parent-subsidiary dividends, and because
of several other benefits they introduce. For example, the U.K.
treaty includes significant new provisions comparable to the
U.S. model guaranteeing reciprocal recognition of each
country's pension plans. That treaty also includes arrangements
aimed at eliminating double taxation of income and gains from
stock option plans. These provisions will eliminate substantial
difficulties that would otherwise be faced by migratory
employees as well as their employers.
In addition to its elimination of the withholding tax on
parent-subsidiary dividends, the Australian protocol includes
welcome deductions in the withholding tax rates on interest,
royalties, and equipment rentals, bringing the rates closer to
the U.S. model. The protocol to the U.S.-Mexico treaty includes
an amendment that clarifies the ability of the U.S. taxpayer to
treat income that may be taxed by Mexico under the treaty as
having its source in Mexico so as to allow the U.S. resident a
foreign tax credit for that Mexican tax. The zero rate on
dividends paid to pension funds under the U.K. and Mexico
agreements should attract investments from those funds into
U.S. stocks.
We are particularly hopeful that the Senate will be able to
complete its ratification procedures during the month of March
so that instruments of ratification will be exchanged before
April 1, 2003. This will prevent a year's delay in access to
the U.K. treaty's relief from U.K. corporate tax under
provisions such as the new pension rules, since that relief
goes into effect only for financial years beginning on or after
the April 1 immediately following the exchange of instruments
of ratification.
As it has done in the past, the NFTC urges you to reject
opposition to the treaty based on the presence or absence of a
single provision, not that we know of any opposition in this
case anyway. 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.
On the whole, we applaud the U.S. negotiators for achieving
agreements that reflect as well as these treaties do the
positions of the U.S. model and the views expressed by the U.S.
business community. The NFTC strongly supports the efforts of
the IRS 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 IRS' ongoing efforts 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 wants to reaffirm its support for the
existing procedure by which Treasury consults on a regular
basis with this committee, with the tax-writing committees, and
the appropriate congressional staffs concerning 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 respectfully encourage this committee to schedule
tax treaties with a minimum of delay after receiving the
agreements from the executive branch in order to enable
improvements in the treaty networks to enter into effect as
quickly as possible, precisely as you are doing in this case.
The NFTC also wishes to reaffirm its view, frequently
voiced in the past, that Congress should avoid occasions of
overriding by subsequent domestic legislation the U.S. treaty
commitments that are approved by this committee. We believe
that consultation and negotiation and mutual agreement upon
changes, rather than unilateral legislative abrogation of
treaty commitments, better supports the mutual goals of the
treaty partners.
Finally, we are grateful to the chairman and the other
members of the committee for giving international economic
relations prominence in the committee's agenda, not only with
respect to this issue, Mr. Chairman, but with respect to a
number of other issues that have been placed on the full
committee's agenda. We believe this is both important and
welcome, and very impressive, particularly so soon after the
new Congress, and when the demands on the committee's time in
so many other areas are pressing.
We would also like to express our appreciation for the
remarkable efforts of both the majority and the minority staffs
which have allowed this hearing to be scheduled and held so
efficiently. We respectfully urge the committee to proceed with
ratification of these agreements as expeditiously as possible.
Thank you.
[The prepared statement of Mr. Reinsch follows:]
Prepared Statement of Hon. William A. Reinsch, President, National
Foreign Trade Council, Inc.
Mr. Chairman and Members of the Committee:
The National Foreign Trade Council (NFTC) is pleased to recommend
ratification of the treaty and protocols under consideration by the
Committee today. We appreciate the Chairman's actions in scheduling
this hearing so promptly, and we strongly urge the Committee to
reaffirm the United States' historic opposition to double taxation by
giving its full support to the pending treaty and protocols.
The National Foreign Trade Council, organized in 1914, is an
association of some 350 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 that can serve as a barrier to full participation in
the international marketplace. Tax treaties are a crucial component of
the framework that is necessary to allow such balanced competition.
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 Tax Convention and Protocol with the
United Kingdom and the Protocols amending the Tax Conventions with
Australia and Mexico.
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 in respect of persons involved in cross-border investment and
trade. In the absence of tax treaties, income from international
transactions or investment may be subject to double taxation: once by
the country where the income arises and again by the country of the
income recipient's residence. Tax treaties eliminate this double
taxation by allocating taxing jurisdiction over the income between the
two countries.
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
noncreditable levels of foreign tax and to be at a competitive
disadvantage relative to traders and investors from other countries
that do have such benefits. Thus, tax treaties serve to prevent this
barrier to U.S. participation in international commerce.
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. Similarly, another extremely important benefit, which is
available exclusively under tax treaties, is the mutual agreement
procedure, a bilateral administrative mechanism for avoiding double
taxation on cross-border transactions.
Taxpayers are not the only beneficiaries of tax treaties. Treaties
protect the legitimate enforcement interests of the U.S. Treasury by
providing for the exchange of information between tax authorities.
Treaties have also provided a framework for the resolution of disputes
with respect to overlapping claims by the respective governments, 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 disputes 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.
Virtually all treaty relationships depend upon 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
encouraging international flows of trade and investment between the
United States and the other country, in providing the guidance
enterprises need in planning for the future, in providing
nondiscriminatory treatment for U.S. traders and investors as compared
to those of other countries, and in meeting a minimum level of
acceptability in comparison with the preferred U.S. position and
expressed goals of the business community. Slavish 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.
treaties before the committee today
The treaty and protocols presently under consideration are a good
illustration of the contribution such agreements can make to improving
both the economic competitiveness of U.S. companies and the proper
administration of U.S. tax laws in the international arena. For
example, the U.K., Australian, and Mexican agreements contain a
provision, new to U.S. treaty policy, which calls for a zero rate of
withholding tax on dividends paid to parent corporations from their 80
percent or greater owned subsidiaries. The existence of a withholding
tax on cross-border, parent-subsidiary dividends, even at the 5 percent
rate previously typical in U.S. treaties, 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. If U.S. businesses are going to maintain a competitive
position around the world, we need a treaty policy that protects us
from multiple or excessive levels of foreign tax on our cross-border
investments, particularly if our 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. For example, the European Union eliminated
this 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. The NFTC has for years urged Treasury to change U.S. treaty
policy to allow for this zero rate on dividends, and we highly commend
Treasury for taking the first steps in that direction by negotiating
the U.K., Australian, and Mexican agreements before the Committee
today. It is now up to this Committee to express its support for this
important new development in U.S. treaty policy, and we strongly urge
you to do that by your prompt approval of each of these agreements. We
hope the Senate's ratification of these agreements will help Treasury
negotiate similar agreements with many more countries.
We would also like to confirm to the Committee our belief that it
is worthwhile to negotiate for the inclusion of this provision even in
treaties with countries whose domestic law already provides for a zero
rate on dividends, such as the United Kingdom. Doing so has the effect
of locking in the benefit of the zero rate, protecting U.S. parent
companies from subsequent changes to the foreign tax regime. The formal
acceptance of the zero rate principle by treaty also serves as a
valuable precedent, confirming to other prospective treaty partners the
U.S. commitment to this policy. We would also note that the revenue
implications of eliminating the U.S. withholding tax on dividends paid
to U.K. parent companies is likely to be substantially affected by the
corresponding elimination of the notional 5 percent U.K. withholding
tax on dividends to U.S. parents under the current Treaty, thereby
eliminating any U.S. obligation to give foreign tax credits for those
amounts.
These treaties are important to the U.S. business community because
of the actual and precedential effect of eliminating the withholding
tax on parent-subsidiary dividends and because of several other
benefits they introduce. For example, the U.K. Treaty includes
significant new provisions, comparable to the U.S. Model, guaranteeing
reciprocal recognition of each country's pension plans. That Treaty
also includes arrangements aimed at eliminating double taxation of
income and gains from stock option plans. These provisions will
eliminate substantial difficulties that would otherwise be faced by
migratory employees and by their employers as well. In addition to its
elimination of the withholding tax on parent-subsidiary dividends, the
Australian Protocol includes welcome reductions in the withholding tax
rates on interest, royalties, and equipment rentals, bringing the rates
closer to the U.S. Model. The Protocol to the U.S.-Mexico Treaty
includes an amendment to the article on Relief from Double Taxation
that clarifies the ability of a U.S. taxpayer to treat income that may
be taxed by Mexico under the Treaty as having its source in Mexico, so
as to allow the U.S. resident a foreign tax credit for that Mexican
tax. The zero rate on dividends paid to pension funds under the U.K.
and Mexican agreements should attract investment from those funds into
U.S. stocks.
We are particularly hopeful that the Senate will be able to
complete its ratification procedures during the month of March so that
instruments of ratification will be exchanged before April 1, 2003.
This will prevent a year's delay in access to the U.K. Treaty's relief
from U.K. corporate tax under provisions such as the new pension rules,
since that relief goes into effect only for financial years beginning
on or after the April 1 immediately following the exchange of
instruments of ratification.
These agreements also include important advantages for the
administration of U.S. tax laws and the implementation of U.S. treaty
policy. They all offer the possibility of administrative assistance
between the relevant tax authorities. The agreements also include
modern safeguards against treaty-shopping in accordance with U.S.
policy. They reflect recent U.S. law changes aimed at preserving taxing
jurisdiction over certain individuals who terminate their long-term
residence within the United States. They also reflect modern U.S.
treaty policy on when reduced U.S. withholding rates will apply to
dividends paid by Regulated Investment Companies (RICs) and Real Estate
investment Trusts (REITs). Finally, the U.K. Treaty includes targeted
anti-abuse rules aimed at preventing inappropriate use of the benefits
provided by the Treaty.
general comments on tax treaty policy
As it has done in the past, the NFTC urges you to reject opposition
to a treaty 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. On the
whole, the U.S. negotiators are to be applauded for achieving
agreements that reflect as well as these treaties 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, preserving, and implementing 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 the 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.
The NFTC recognizes 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 lnternal Revenue
Service and 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 Internal
Revenue Service's ongoing efforts 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 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 respectfully encourage this Committee to schedule tax
treaty hearings with a minimum of delay after receiving the agreements
from the Executive Branch, in order to enable improvements in the
treaty network to enter into effect as quickly as possible, as you are
doing in this case.
The NFTC also wishes to reaffirm its view, frequently voiced in the
past, that Congress should avoid occasions of overriding by subsequent
domestic legislation the U.S. treaty commitments that are approved by
this Committee. 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 Council is grateful to the Chairman and the Members of
the Committee for giving international economic relations prominence in
the Committee's agenda, particularly so soon in a new Congress, and
when the demands upon the Committee's time are so pressing. We would
also like to express our appreciation for the remarkable efforts of
both Majority and Minority staff which have allowed this hearing to be
scheduled and held in such a short period of time.
We respectfully urge the Committee to proceed with ratification of
these agreements as expeditiously as possible.
Senator Hagel. Mr. Reinsch, thank you. As always, helpful,
and we are grateful you would take time to be with us. You were
here over the last hour, and listened to the previous
witnesses, their testimony and their response to questions and
I would like to go back onto a couple of those tracks, because
your perspective, the institutions that you represent,
essentially the consumers of the structure that we are dealing
with here, as always is critically important, and I would ask
you the question that I asked Ms. Angus about the treaty that
we are talking about today, the U.S.-U.K. treaty, on, from your
perspective, framing that up as a model for other treaties as
we negotiate those, realizing the variables and the dynamics
are always a little different, but generally, and you alluded
to this in your testimony, and I think your term was, generally
your organization is supportive of what has been negotiated
here.
Mr. Reinsch. I think my answer would be along the lines of
Barbara's, Mr. Chairman. We are very much supportive of the
treaty in general. There are some specific provisions that we
would like to see incorporated in other treaties. Zero
withholding is one, and I testified on that at some length, and
I think pension rules are also an important innovation.
We are comfortable with the other parts of the treaty. As
she noted, there are some aspects of the U.K. system that are,
if not unique, at least different than other cases. In
particular, with respect to the anti-conduit provisions that
are here, I am not sure that we would want to say are entirely
appropriate for either the U.S. model or for inclusion in every
treaty.
As you may know, Mr. Chairman, we shared this committee's
concern several years ago with much broader provisions that
were proposed and then ultimately rejected by the committee,
and we agreed with your action on that. These provisions do not
raise those issues, and that is why we can support them in this
treaty.
On the other hand, I think there are some characteristics
of the U.K. system that may make the provisions in that treaty
unique, and we would want to think a little bit about that
before we would say that that should be added either as part of
the model or included in other negotiations.
Senator Hagel. Thank you. Also, another question that I
posed to Ms. Angus, about--and I think Mr. Noren responded to
this as well, from your perspective, some of the most
significant barriers created by tax systems that you and your
companies have to deal with, that maybe we are not getting at
in these negotiations, or maybe we are.
Mr. Reinsch. She touched on two of them that I think are
big ones, and I will elaborate a little bit on one. I think in
general, the keeping-up problem is a serious one. We are in, as
you well know from your other work, an ever more rapidly
evolving global economic system. Things are changing very
quickly, and simply keeping up with new systems, new
relationships that are developed is a challenge; keeping up
with new technologies is a challenge; and we certainly agree
with Treasury's testimony that that is an issue that is very
important as far as barriers are concerned.
The other one that I would particularly flag, because it
relates so much to some other things that the NFTC is working
on, is the issue of mobility, which Ms. Angus mentioned. One of
the things that we have realized fairly recently is that
mobility is becoming a competitiveness issue in the same way
that market access and a whole bunch of other things are
issues. Our companies, our members' companies in particular,
are truly global companies, they operate everywhere, and they
need to be able to move their personnel around in order to
maximize the efficient allocation of their resources.
In the good old days we would talk about transferring
people from the plant in Savannah to the plant in Omaha. Now we
are talking--which I am sure it is something you would
welcome--about transferring them from the plant in Shanghai to
the plant in Los Angeles, or the research lab, more likely, or
vice versa, and that raises a whole bunch of issues.
We are currently struggling, as you may know, with a whole
bunch of visa issues and business travel issues that are the
product of September 11 and policy changes that we have been
unable to get the State Department and now the Department of
Homeland Security to surmount, that prevent customers from
coming to this country, that prevent people from coming to this
country to take possession of things they have already bought,
and prevent employees from coming to this country.
There are tax issues that become barriers, too, such as the
sorting out or mutual recognition of pension rules, and the
U.K. treaty is particularly important in this regard. As
companies struggle to move their talented people where they
need them, tax barriers and tax issues are going to become ever
more important. Frankly, if somebody is going to take a huge
bath if they move, that is a significant deterrent, and that,
in turn, affects the company's competitiveness.
So I think you will be hearing--this is kind of an
incipient--incipient is the wrong word, but this is a new issue
for us, one that you are going to be hearing more from us
about, but I think it has a place in the tax area as well,
because frankly the incentives or barriers that different tax
systems impose are significant obstacles to moving people
around, and we want to get over that.
Finally on this, Mr. Chairman--I apologize for the long
answer--we hear frequently from our members about particular
glitches in particular countries that they would like to see
corrected that would lend themselves to treaty negotiations. I
would not want to go into that here. Let me see if we can
provide you with some additional material after the fact, but
they really are not issues that rise to the level of general
principles, but particular problems that we have encountered in
individual cases.
Senator Hagel. Thank you. Do not concern yourself with long
answers. It is just you and me.
Mr. Reinsch. There are all of them back there listening,
too.
Senator Hagel. Well, they do not have anything else to do.
It is their bowling league night, obviously.
The provisions on the anti-treaty-shopping piece, how
effective can these tools be, in your opinion? How effective
should they be?
Mr. Reinsch. I was going to say, we will see. I think----
Senator Hagel. That is a good answer. That is a senatorial
answer.
Mr. Reinsch. Ms. Bennett thinks that they are tightly
drafted and will be effective. My experience in other
situations is, you know, this is a constant battle. For every
door you close, someone tries to open another one somewhere
else, another argument for periodic adjustments of the model
and periodic negotiation. We support what has been done here,
though, and we think they are tight and will be effective.
I will guarantee you that 3 or 4 years from now someone
will have found something, some problem, and we will have to
come back at them, but you can only learn those things by
experience.
Senator Hagel. So in your opinion they are worth the focus
we are placing on them to see if we can use them as effective
tools.
Mr. Reinsch. Yes.
Senator Hagel. Something, obviously, that you mentioned, in
general terms mentioned in Ms. Angus' testimony, the issue of
the exemption for a limited class of individuals on these tax
issues. She mentioned teachers and other specific categories,
and I think the U.S.-U.K. treaty addresses some of that.
Would you like to expand on that a little bit from the
perspective of, you just mentioned the competitiveness,
obviously, of having the right people in the right places at
the right time, the best people, and if we are not addressing
some of those human dynamics in these treaties and protocols,
then we are actually misplacing our emphasis here, and I would
be interested in your perspective on that general universe of
what we are trying to do in these tax treaties.
Mr. Reinsch. Well, I think this is an area that we are just
beginning to look at in greater depth. We believe that the
treaty addresses, by looking at the pension issues, the most
important issue and the most important problem. There may be
others, but I do not have anything else to offer for you on
that right now, Mr. Chairman.
Senator Hagel. Thank you. The general question that I posed
to Ms. Angus and Mr. Noren, areas where we could be, should be
more involved here, and I mentioned it a little earlier to you
as well, as trying to get out ahead of some of these dynamics
that we can anticipate, and you alluded to some extent to some
of this in your reference to getting your customers into the
country, and because of the security issue--and much of this is
related to the September 11, 2001 terrorist attack, and much of
our infrastructure, our government, our focus, our resources
are appropriately on that issue, but there must be some balance
and perspective applied to it as well.
It would be helpful to the committee for you to, if you
care to, share any thoughts from your perspective, your
vantagepoint from those you represent on this issue. You opened
it up in some of the things you said, and I wanted to explore
that a little more and give you a chance to develop that, if
you wish, a little more.
Mr. Reinsch. Well, I am glad you did, because it is an
opportunity, and I am glad to have the opportunity to take it.
You have used the right word, Mr. Chairman, balance, and I
think that is what we are looking for, the balance between
security concerns and commercial necessities, for lack of a
better term.
Some of this is human nature. If you look at the visa
issue, frankly, part of this is, nobody wants to be the guy out
in the embassy who stamps ``approved'' on the next terrorist
visa. The result is, larger numbers of them get sent back here,
they get thrown into the process, and, frankly, they get put
into a process with a lot of people reviewing the applications
whose mission is not a diplomatic, foreign policy, or a
commercial mission. Their mission is a security mission, and
from a security perspective, the way to achieve minimal risk is
not to let anybody in.
As you well know from the export control debate, the way to
achieve maximum safety there is not to let anything out, but we
both know that those are not viable solutions, that economic
considerations are important, particularly given the state of
the economy here these days, and elsewhere, for that matter,
and we have to try to strive for a balance in which we fully
address our security needs, but do not do it in such a way that
we are starting to put companies out of business here, and do
not do it in such a way that we cause good friends of ours and
allies to turn elsewhere not only for trade and commerce, but
to send their students elsewhere, and things like that.
I mean, the long-term consequences of some of these things
I believe are that we are going to break off relationships that
we have spent generations building, and which frankly have been
good for everybody. I mean, I think the views that you and I
have shared in the past, Senator, is that this country gains
enormously when foreigners come to this country, whether they
are students, whether they are engineers who work here for 3
months, whether they are visitors, or whether they are
immigrants.
We often get the best, and we often keep the best. They are
not all the best, but net, this country has been built on
immigrants. We have been built on different cultures and we are
stronger for it. The ones who go back benefit us as well,
because they take back some things from here, and we gain, and
greater global understanding gains.
And I worry as a general matter that we are cutting some of
those things off, and that over the long term, that is going to
decrease understanding of who and why we are, which will
complicate achieving our foreign policy goals among other
things, and our security goals. And in the short run, there are
very clearly commercial consequences that some companies, not
for the record, but privately are able to quantify in lost
sales, or lost income from training, from people who cannot
come here.
Talk to the--well, do not do it today, but in 6 months,
talk to the hotel people about the conferences that moved to
Vancouver because the organizers were not sure they could get
the paper presenters into San Francisco or Las Vegas or
wherever the conference is in time. The richness of global
dialog and discussion will be lost unless we address some of
these things.
I think you can do that without compromising security. We
are in the process of developing systems of access, too, that
will help us get over these humps, and some of these problems
are transition problems. One of the committee's tasks, I hope,
will be to ensure that the transition is as short as possible,
but some of the problems may be more fundamental than those,
and I would urge you to look at those as well.
We really are moving into an era where the rapidity, the
speed with which we can move money, move words through
communication, move people through transportation is such that
we simply have to keep our systems, our access systems and our
mobility systems up to speed. It is the same old thing. You
have got a global economy, and we are operating in a world of
nation States, and your committee and your subcommittee are
uniquely positioned to try to help lead everybody to see the
problems that that causes and how we can accelerate some
integrative factors in overcoming political barriers to allow
economic growth to occur.
Senator Hagel. Well, I am grateful for that answer, because
it leads us to one inescapable conclusion, that America's
competitiveness globally will determine our future, and if we
allow that to erode by not paying attention to all the various
components of positioning America in a continued high-ground
position of being competitive, then we will have failed.
I think of what the Chairman of the Federal Reserve said
before our Banking Committee a couple of weeks ago, when he was
asked about tax cuts, and it does play right into what you are
talking about. He talked about, what was critical in his
opinion was a flexible economy. The tax cuts, certain tax cuts
were good, he would support them, and you could argue it on a
fairness basis, equity basis, more private capital in private
hands, thus, investment and more productivity.
But his point was a fundamental point, and I think it cuts
right the way you are talking about here and what we have been
talking about. What is really the governing factor in these tax
treaties is for us to stay competitive in the world for the
future, that we are going to have to continue to keep a
flexible economy, and exports trade is a huge part of that, and
it becomes bigger and more important every day, which you
understand about as well as anyone.
Well, Mr. Reinsch, as always, we are grateful to have you
up here. On behalf of the committee I am going to instruct that
we will keep the record open until close of business tomorrow
for other Senators if they wish to present statements or they
have questions for the committee, or for the Treasury.
And on your point, Bill, about hoping that this committee
would move expeditiously on ratifying these protocols and
treaty, I have been told that Chairman Lugar intends to get
these up at our next business meeting. I think that will be
next week, and we will push hard to complete that work at the
business meeting, and if we can do that, then we can be in a
position to have it ready for floor action.
Mr. Reinsch. That is wonderful news, Mr. Chairman.
Senator Hagel. So, we will do everything we can. Any
additional comments before we go to the next hearing?
Mr. Reinsch. No, sir.
Senator Hagel. Thank you very much. We appreciate all of
you learning as much as you have from Mr. Reinsch and our
witnesses. The committee is recessed.
[Whereupon, at 4:20 p.m., the committee adjourned, to
reconvene subject to the call of the Chair.]
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Additional Questions Submitted for the Record
Responses of the Treasury Department to Additional Questions for the
Record Submitted by Senator Paul S. Sarbanes
Question. How will this zero rate of withholding tax provided for
dividends paid by a subsidiary in one treaty country to its 80 percent
or greater parent in the other country affect our future tax treaties?
How many upcoming treaties will include this provision? What would be
the revenue impact if additional countries and the United States push
for this inclusion? Will there be a new U.S. tax model treaty to
reflect this change?
Treasury Department Response. The Treasury Department believes that
the elimination by treaty of source-country withholding taxes on
intercompany dividends, as is provided in the proposed treaty with the
United Kingdom and the proposed protocols with Australia and Mexico now
before the Committee, can serve to further the key objective of tax
treaties to reduce barriers to cross-border trade and investment.
Historically, U.S. tax treaties have provided for limitations on
source-country withholding taxes on direct investment dividends but
have not provided for the elimination of such taxes. When this policy
was consistent with general treaty practice throughout the world, the
imposition of a limited withholding tax by the United States did not
present a relative barrier to investing in the United States. However,
in recent years more and more countries are eliminating withholding
taxes on intercompany dividends through their bilateral tax treaties.
In addition, the European Union has put in place a directive that
eliminates all withholding taxes on dividends paid by a subsidiary in
one EU member country to a parent in another EU member country. In the
context of this changing environment, the Treasury Department believes
it is in the United States' interest to consider, on a case by case
basis, agreeing by treaty to eliminate source-country withholding taxes
on certain intercompany dividends.
The proposed treaty with the United Kingdom and the proposed
protocols with Australia and Mexico include provisions eliminating the
source-country withholding tax on dividends received by a corporate
parent from an 80-percent-owned subsidiary, provided that certain
conditions are met. These conditions are intended to prevent third-
country residents from being able to exploit these provisions in order
to obtain reductions in U.S. tax to which they should not be entitled.
A necessary prerequisite to any treaty provision eliminating
withholding taxes on intercompany dividends is the inclusion in the
treaty of effective anti-treaty-shopping rules and information exchange
provisions that are sufficient to ensure that the benefits of these
source-country tax reductions are provided only to bona fide residents
of the treaty partners.
In every tax treaty negotiation, we must strike the appropriate
balance of benefits in the allocation of taxing rights under the
treaty. The agreed level of dividend withholding taxes is only one of
the many elements that make up this balance. With respect to dividends
in particular, we must consider the cross-border investment and
dividend flows in each direction and the treaty partner's domestic law
with respect to dividend withholding tax. We also must consider the
potential benefits to be secured through locking in the treatment of
dividends and providing stability regarding the future tax treatment of
cross-border investment. We must consider the benefits inuring to the
United States from other concessions the treaty partner may make. This
analysis must be done in the context of each existing or potential new
tax treaty relationship. We should not prejudge the outcome with any
particular country or countries.
In considering the impact of any elimination of withholding taxes
on intercompany dividends by treaty, it is appropriate to look to both
the short-term effects on tax revenues and the longer-term economic
implications of the overall tax treaty relationship. Because of the
reciprocal nature of tax treaties, treaty reductions in source-country
withholding taxes have offsetting effects on U.S. tax revenues in the
short-term. Reductions in U.S. withholding tax imposed on dividends
paid to foreign investors in the United States represent a short-term
static reduction in U.S. tax revenues. Reductions in foreign
withholding taxes imposed on dividends paid to U.S. investors abroad
represent an increase in U.S. tax revenues due to the corresponding
reduction in the foreign tax credits that otherwise would offset U.S.
tax liability. Because of these offsetting effects, the overall revenue
effect of tax treaties generally is viewed as negligible, with the
estimated effects slightly positive or slightly negative in some
particular cases.
Looking beyond the short-term effect on U.S. tax liabilities, an
income tax treaty is a negotiated agreement under which both countries
expect to be better off in the long run. These long-term economic
benefits outweigh any net short-term static effects on tax liabilities.
Securing the reduction or elimination of foreign dividend withholding
taxes imposed on U.S. investors abroad can reduce their costs and
improve their competitiveness in connection with international business
opportunities. Reduction or elimination of the U.S. dividend
withholding tax imposed on foreign investors in the United States may
encourage inbound investment, and increased investment in the United
States translates to more jobs, greater productivity and higher wage
rates. The tax treaty as a whole creates greater certainty and provides
a more stable environment for foreign investment. The agreed allocation
of taxing rights between the two countries reduces cross-border
impediments to the bilateral flow of capital, thereby allowing
companies and individuals to more effectively locate their operations
in such a way that their investments are as productive as possible.
This increased productivity will benefit both countries' economies. The
administrative provisions of the tax treaty provide for cooperation
between the two countries, which will help reduce the costs of tax
administration and improve tax compliance.
A flexible approach to the inclusion in tax treaties of provisions
eliminating source-country withholding taxes on certain intercompany
dividends is in order. In light of the range of factors that should be
considered, the Treasury Department does not view this as a blanket
change in the United States' tax treaty practice. Accordingly, we do
not envision a change to the U.S. model tax treaty provisions relating
to the allocation of taxing rights with respect to cross-border
dividends. The optimal treatment of intercompany dividends should
continue to be considered on a case-by-case basis in the context of
each individual tax treaty relationship.
Response of the Joint Committee on Taxation to an Additional Question
for the Record Submitted by Senator Paul S. Sarbanes
Question. In the draft report on the U.S.-U.K. treaty prepared by
the Joint Committee on Taxation, there is language that reads: ``the
Committee may wish to note that adopting a zero-rate provision in the
U.S.-U.K. tax treaty likely would result in a net revenue loss to the
United States.'' In the Committee's final report, the language was
changed to read: ``the Committee may wish to note that adopting a zero-
rate provision in the U.S.-U.K. tax treaty would have uncertain revenue
effects for the United States.''
What compelled the Committee to change the language?
Answer. This sentence in the Joint Committee staff's pamphlet on
the proposed treaty was changed to reflect analysis appearing further
in the relevant paragraph.\1\ The revenue loss mentioned in the draft
first sentence of the paragraph was a reference to the effect described
in the second sentence of the paragraph (i.e., the loss of the 5-
percent tax currently collected on dividends from U.S. subsidiaries to
U.K. parent companies). The third and fourth sentences of the
paragraph, which take into account reduced U.S. foreign tax credit
claims resulting from a change to the treaty in connection with the
U.K. advance corporation tax, as well as the final two sentences of the
paragraph, which note the uncertain longer-term effects of the zero-
rate provision on the domestic tax base, made it appropriate to amend
the first sentence of the paragraph to read as published.
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\1\ Joint Committee on Taxation, Explanation of Proposed Income Tax
Treaty Between the United States and the United Kingdom (JCS-4-03),
March 3, 2003, at 73-74.
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