[JPRT 106-8-99]
[From the U.S. Government Publishing Office]
JCS-8-99
[JOINT COMMITTEE PRINT]
EXPLANATION OF PROPOSED
INCOME TAX TREATY AND
PROPOSED PROTOCOL BETWEEN
THE UNITED STATES AND
THE KINGDOM OF DENMARK
Scheduled for a Hearing
before the
COMMITTEE ON FOREIGN RELATIONS
UNITED STATES SENATE
ON OCTOBER 13, 1999
__________
Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION
[GRAPHIC] [TIFF OMITTED]
OCTOBER 8, 1999
JOINT COMMITTEE ON TAXATION
106th Congress, 1st Session
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HOUSE SENATE
BILL ARCHER, Texas, WILLIAM V. ROTH, Jr., Delaware,
Chairman Vice Chairman
PHILIP M. CRANE, Illinois JOHN H. CHAFEE, Rhode Island
WILLIAM M. THOMAS, California CHARLES GRASSLEY, Iowa
CHARLES B. RANGEL, New York DANIEL PATRICK MOYNIHAN, New York
FORTNEY PETE STARK, California MAX BAUCUS, Montana
Lindy L. Paull, Chief of Staff
Bernard A. Schmitt, Deputy Chief of Staff
Mary M. Schmitt, Deputy Chief of Staff
Richard A. Grafmeyer, Deputy Chief of Staff
C O N T E N T S
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Page
Introduction..................................................... 1
I. Summary...........................................................2
II. Overview of U.S. Taxation of International Trade and Investment and
U.S. Tax Treaties.................................................4
A. U.S. Tax Rules........................................ 4
B. U.S. Tax Treaties..................................... 5
III.Explanation of Proposed Treaty and Proposed Protocol..............8
Article 1. General Scope................................ 8
Article 2. Taxes Covered................................ 10
Article 3. General Definitions.......................... 11
Article 4. Residence.................................... 12
Article 5. Permanent Establishment...................... 14
Article 6. Income From Real Property.................... 16
Article 7. Business Profits............................. 17
Article 8. Shipping and Air Transport................... 19
Article 9. Associated Enterprises....................... 21
Article 10. Dividends.................................... 22
Article 11. Interest..................................... 25
Article 12. Royalties.................................... 27
Article 13. Capital Gains................................ 28
Article 14. Independent Personal Services................ 31
Article 15. Dependent Personal Services.................. 31
Article 16. Directors' Fees.............................. 32
Article 17. Artistes and Sportsmen....................... 32
Article 18. Pensions, Social Security, Annuities,
Alimony and Child Support Payments................... 33
Article 19. Government Service........................... 34
Article 20. Students and Trainees........................ 35
Article 21. Other Income................................. 35
Article 22. Limitation of Benefits....................... 36
Article 23. Relief from Double Taxation.................. 42
Article 24. Non-Discrimination........................... 45
Article 25. Mutual Agreement Procedure................... 47
Article 26. Exchange of Information...................... 48
Article 27. Administrative Assistance.................... 49
Article 28. Diplomatic Agents and Consular Officers..... 50
Article 29. Entry into Force............................. 50
Article 30. Termination.................................. 51
IV. Issues...........................................................52
A. Creditability of Danish Hydrocarbon Tax............... 52
B. Treaty Shopping....................................... 55
INTRODUCTION
This pamphlet,\1\ prepared by the staff of the Joint
Committee on Taxation, describes the proposed income tax
treaty, as supplemented by the proposed protocol, between the
United States of America and the Kingdom of Denmark
(``Denmark''). The proposed treaty and proposed protocol were
both signed on August 19, 1999.\2\ The Senate Committee on
Foreign Relations has scheduled a public hearing on the
proposed treaty and proposed protocol on October 13, 1999.
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\1\ This pamphlet may be cited as follows: Joint Committee on
Taxation, Explanation of Proposed Income Tax Treaty and Proposed
Protocol Between the United States and the Kingdom of Denmark (JCS-8-
99), October 8, 1999.
\2\ For a copy of the proposed treaty and proposed protocol, see
Senate Treaty Doc. 106-12, September 21, 1999.
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Part I of the pamphlet provides a summary with respect to
the proposed treaty and proposed protocol. Part II provides a
brief overview of U.S. tax laws relating to international trade
and investment and of U.S. income tax treaties in general. Part
III contains an article-by-article explanation of the proposed
treaty and proposed protocol. Part IV contains a discussion of
issues with respect to the proposed treaty and proposed
protocol.
I. SUMMARY
The principal purposes of the proposed income tax treaty
between the United States and Denmark are to reduce or
eliminate double taxation of income earned by residents of
either country from sources within the other country and to
prevent avoidance or evasion of the taxes of the two countries.
The proposed treaty also is intended to promote close economic
cooperation between the two countries and to eliminate possible
barriers to trade and investment caused by overlapping taxing
jurisdictions of the two countries.
As in other U.S. tax treaties, these objectives principally
are achieved through each country's agreement to limit, in
certain specified situations, its right to tax income derived
from its territory by residents of the other country. For
example, the proposed treaty contains provisions under which
each country generally agrees not to tax business income
derived from sources within that country by residents of the
other country unless the business activities in the taxing
country are substantial enough to constitute a permanent
establishment or fixed base (Articles 7 and 14). Similarly, the
proposed treaty contains ``commercial visitor'' exemptions
under which residents of one country performing personal
services in the other country will not be required to pay tax
in the other country unless their contact with the other
country exceeds specified minimums (Articles 14, 15, and 17).
The proposed treaty provides that dividends, interest,
royalties, and certain capital gains derived by a resident of
either country from sources within the other country generally
may be taxed by both countries (Articles 10, 11, 12, and 13);
however, the rate of tax that the source country may impose on
a resident of the other country on dividends, interest, and
royalties generally will be limited by the proposed treaty
(Articles 10, 11, and 12).
In situations where the country of source retains the right
under the proposed treaty to tax income derived by residents of
the other country, the proposed treaty generally provides for
relief from the potential double taxation through the allowance
by the country of residence of a tax credit for certain foreign
taxes paid to the other country (Article 23).
The proposed treaty contains the standard provision (the
``saving clause'') included in U.S. tax treaties pursuant to
which each country retains the right to tax its residents and
citizens as if the treaty had not come into effect (Article 1).
In addition, the proposed treaty contains the standard
provision providing that the treaty may not be applied to deny
any taxpayer any benefits the taxpayer would be entitled to
under the domestic law of a country or under any other
agreement between the two countries (Article 1). The proposed
treaty also contains a detailed limitation on benefits
provision to prevent the inappropriate use of the treaty by
third-country residents (Article 22).
The United States and Denmark have an income tax treaty
currently in force (signed in 1948).\3\ The proposed treaty is
similar to other recent U.S. income tax treaties, the 1996 U.S.
model income tax treaty (``U.S. model''), and the model income
tax treaty of the Organization for Economic Cooperation and
Development (``OECD model''). However, the proposed treaty
contains certain substantive deviations from those treaties and
models.
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\3\ A prior proposed U.S. income tax treaty with Denmark was signed
in 1980 with a related proposed protocol that was signed in 1983. The
Committee reported favorably on this proposed treaty (and protocol) in
1984. However, the Senate did not consider the treaty further in 1984.
The Committee also reported favorably on the treaty (and protocol) in
1985. During Senate consideration of the treaty in 1985, objections
were raised regarding the creditability under the treaty of the Danish
hydrocarbon tax. The Senate has not given its advice and consent to
ratification of this treaty.
II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL TRADE AND INVESTMENT AND
U.S. TAX TREATIES
This overview briefly describes certain U.S. tax rules
relating to foreign income and foreign persons that apply in
the absence of a U.S. tax treaty. This overview also discusses
the general objectives of U.S. tax treaties and describes some
of the modifications to U.S. tax rules made by treaties.
A. U.S. Tax Rules
The United States taxes U.S. citizens, residents, and
corporations on their worldwide income, whether derived in the
United States or abroad. The United States generally taxes
nonresident alien individuals and foreign corporations on all
their income that is effectively connected with the conduct of
a trade or business in the United States (sometimes referred to
as ``effectively connected income''). The United States also
taxes nonresident alien individuals and foreign corporations on
certain U.S.-source income that is not effectively connected
with a U.S. trade or business.
Income of a nonresident alien individual or foreign
corporation that is effectively connected with the conduct of a
trade or business in the United States generally is subject to
U.S. tax in the same manner and at the same rates as income of
a U.S. person. Deductions are allowed to the extent that they
are related to effectively connected income. A foreign
corporation also is subject to a flat 30-percent branch profits
tax on its ``dividend equivalent amount,'' which is a measure
of the effectively connected earnings and profits of the
corporation that are removed in any year from the conduct of
its U.S. trade or business. In addition, a foreign corporation
is subject to a flat 30-percent branch-level excess interest
tax on the excess of the amount of interest that is deducted by
the foreign corporation in computing its effectively connected
income over the amount of interest that is paid by its U.S.
trade or business.
U.S.-source fixed or determinable annual or periodical
income of a nonresident alien individual or foreign corporation
(including, for example, interest, dividends, rents, royalties,
salaries, and annuities) that is not effectively connected with
the conduct of a U.S. trade or business is subject to U.S. tax
at a rate of 30 percent of the gross amount paid. Certain
insurance premiums earned by a nonresident alien individual or
foreign corporation are subject to U.S. tax at a rate of 1 or 4
percent of the premiums. These taxes generally are collected by
means of withholding.
Specific statutory exemptions from the 30-percent
withholding tax are provided. For example, certain original
issue discount and certain interest on deposits with banks or
savings institutions are exempt from the 30-percent withholding
tax. An exemption also is provided for certain interest paid on
portfolio debt obligations. In addition, income of a foreign
government or international organization from investments in
U.S. securities is exempt from U.S. tax.
U.S.-source capital gains of a nonresident alien individual
or a foreign corporation that are not effectively connected
with a U.S. trade or business generally are exempt from U.S.
tax, with two exceptions: (1) gains realized by a nonresident
alien individual who is present in the United States for at
least 183 days during the taxable year, and (2) certain gains
from the disposition of interests in U.S. real property.
Rules are provided for the determination of the source of
income. For example, interest and dividends paid by a U.S.
citizen or resident or by a U.S. corporation generally are
considered U.S.-source income. Conversely, dividends and
interest paid by a foreign corporation generally are treated as
foreign-source income. Special rules apply to treat as foreign-
source income (in whole or in part) interest and dividends paid
by certain U.S. corporations with foreign businesses and to
treat as U.S.-source income (in whole or in part) dividends
paid by certain foreign corporations with U.S. businesses.
Rents and royalties paid for the use of property in the United
States are considered U.S.-source income.
Because the United States taxes U.S. citizens, residents,
and corporations on their worldwide income, double taxation of
income can arise when income earned abroad by a U.S. person is
taxed by the country in which the income is earned and also by
the United States. The United States seeks to mitigate this
double taxation generally by allowing U.S. persons to credit
foreign income taxes paid against the U.S. tax imposed on their
foreign-source income. A fundamental premise of the foreign tax
credit is that it may not offset the U.S. tax liability on
U.S.-source income. Therefore, the foreign tax credit
provisions contain a limitation that ensures that the foreign
tax credit offsets only the U.S. tax on foreign-source income.
The foreign tax credit limitation generally is computed on a
worldwide basis (as opposed to a ``per-country'' basis). The
limitation is applied separately for certain classifications of
income. In addition, a special limitation applies to the credit
for foreign taxes imposed on foreign oil and gas extraction
income.
For foreign tax credit purposes, a U.S. corporation that
owns 10 percent or more of the voting stock of a foreign
corporation and receives a dividend from the foreign
corporation (or is otherwise required to include in its income
earnings of the foreign corporation) is deemed to have paid a
portion of the foreign income taxes paid by the foreign
corporation on its accumulated earnings. The taxes deemed paid
by the U.S. corporation are included in its total foreign taxes
paid and its foreign tax credit limitation calculations for the
year the dividend is received (or an amount is included in
income).
B. U.S. Tax Treaties
The traditional objectives of U.S. tax treaties have been
the avoidance of international double taxation and the
prevention of tax avoidance and evasion. Another related
objective of U.S. tax treaties is the removal of the barriers
to trade, capital flows, and commercial travel that may be
caused by overlapping tax jurisdictions and by the burdens of
complying with the tax laws of a jurisdiction when a person's
contacts with, and income derived from, that jurisdiction are
minimal. To a large extent, the treaty provisions designed to
carry out these objectives supplement U.S. tax law provisions
having the same objectives; treaty provisions modify the
generally applicable statutory rules with provisions that take
into account the particular tax system of the treaty partner.
The objective of limiting double taxation generally is
accomplished in treaties through the agreement of each country
to limit, in specified situations, its right to tax income
earned from its territory by residents of the other country.
For the most part, the various rate reductions and exemptions
agreed to by the source country in treaties are premised on the
assumption that the country of residence will tax the income at
levels comparable to those imposed by the source country on its
residents. Treaties also provide for the elimination of double
taxation by requiring the residence country to allow a credit
for taxes that the source country retains the right to impose
under the treaty. In addition, in the case of certain types of
income, treaties may provide for exemption by the residence
country of income taxed by the source country.
Treaties define the term ``resident'' so that an individual
or corporation generally will not be subject to tax as a
resident by both the countries. Treaties generally provide that
neither country will tax business income derived by residents
of the other country unless the business activities in the
taxing jurisdiction are substantial enough to constitute a
permanent establishment or fixed base in that jurisdiction.
Treaties also contain commercial visitation exemptions under
which individual residents of one country performing personal
services in the other will not be required to pay tax in that
other country unless their contacts exceed certain specified
minimums (e.g., presence for a set number of days or earnings
in excess of a specified amount). Treaties address passive
income such as dividends, interest, and royalties from sources
within one country derived by residents of the other country
either by providing that such income is taxed only in the
recipient's country of residence or by reducing the rate of the
source country's withholding tax imposed on such income. In
this regard, the United States agrees in its tax treaties to
reduce its 30-percent withholding tax (or, in the case of some
income, to eliminate it entirely) in return for reciprocal
treatment by its treaty partner.
In its treaties, the United States, as a matter of policy,
generally retains the right to tax its citizens and residents
on their worldwide income as if the treaty had not come into
effect. The United States also provides in its treaties that it
will allow a credit against U.S. tax for income taxes paid to
the treaty partners, subject to the various limitations of U.S.
law.
The objective of preventing tax avoidance and evasion
generally is accomplished in treaties by the agreement of each
country to exchange tax-related information. Treaties generally
provide for the exchange of information between the tax
authorities of the two countries when such information is
relevant for carrying out provisions of the treaty or of their
domestic tax laws. The obligation to exchange information under
the treaties typically does not require either country to carry
out measures contrary to its laws or administrative practices
or to supply information that is not obtainable under its laws
or in the normal course of its administration or that would
reveal trade secrets or other information the disclosure of
which would be contrary to public policy. The Internal Revenue
Service (the ``IRS''), and the treaty partner's tax
authorities, also can request specific tax information from a
treaty partner. This can include information to be used in a
criminal investigation or prosecution.
Administrative cooperation between countries is enhanced
further under treaties by the inclusion of a ``competent
authority'' mechanism to resolve double taxation problems
arising in individual cases and, more generally, to facilitate
consultation between tax officials of the two governments.
Treaties generally provide that neither country may subject
nationals of the other country (or permanent establishments of
enterprises of the other country) to taxation more burdensome
than that it imposes on its own nationals (or on its own
enterprises). Similarly, in general, neither treaty country may
discriminate against enterprises owned by residents of the
other country.
At times, residents of countries that do not have income
tax treaties with the United States attempt to use a treaty
between the United States and another country to avoid U.S.
tax. To prevent third-country residents from obtaining treaty
benefits intended for treaty country residents only, U.S.
treaties generally contain an ``anti-treaty shopping''
provision that is designed to limit treaty benefits to bona
fide residents of the two countries.
III. EXPLANATION OF PROPOSED TREATY AND PROPOSED PROTOCOL
A detailed, article-by-article explanation of the proposed
income tax treaty between the United States and Denmark is set
forth below. The provisions of the proposed protocol are
covered together with the relevant articles of the proposed
treaty.
Article 1. General Scope
Overview
The general scope article describes the persons who may
claim the benefits of the proposed treaty. It also includes a
``saving clause'' provision similar to provisions found in most
U.S. income tax treaties.
The proposed treaty generally applies to residents of the
United States and to residents of Denmark, with specific
modifications to such scope provided in other articles (e.g.,
Article 19 (Government Service), Article 24 (Non-
Discrimination), and Article 26 (Exchange of Information)).
This scope is consistent with the scope of other U.S. income
tax treaties, the U.S. model, and the OECD model. For purposes
of the proposed treaty, residence is determined under Article 4
(Residence).
The proposed treaty provides that it does not restrict in
any manner any benefit (e.g., an exclusion, exemption,
deduction, credit, or other allowance) accorded by internal law
or by any other agreement between the United States and
Denmark. Thus, the proposed treaty will not apply to increase
the tax burden of a resident of either the United States or
Denmark. According to the Treasury Department's Technical
Explanation (hereinafter referred to as the ``Technical
Explanation''), the fact that the proposed treaty only applies
to a taxpayer's benefit does not mean that a taxpayer may
select inconsistently among treaty and internal law provisions
in order to minimize its overall tax burden. In this regard,
the Technical Explanation sets forth the following example.
Assume a resident of Denmark has three separate businesses in
the United States. One business is profitable and constitutes a
U.S. permanent establishment. The other two businesses generate
effectively connected income as determined under the Internal
Revenue Code (the ``Code''), but do not constitute permanent
establishments as determined under the proposed treaty; one
business is profitable and the other business generates a net
loss. Under the Code, all three businesses would be subject to
U.S. income tax, in which case the losses from the unprofitable
business could offset the taxable income from the other
businesses. On the other hand, only the income of the business
which gives rise to a permanent establishment is taxable by the
United States under the proposed treaty. The Technical
Explanation makes clear that the taxpayer may not invoke the
proposed treaty to exclude the profits of the profitable
business that does not constitute a permanent establishment and
invoke U.S. internal law to claim the loss of the unprofitable
business that does not constitute a permanent establishment to
offset the taxable income of the permanent establishment.\4\
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\4\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
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The proposed treaty provides that the dispute resolution
procedures under its mutual agreement article take precedence
over the corresponding provisions of any other agreement to
which the United States and Denmark are parties in determining
whether a measure is within the scope of the proposed treaty.
Unless the competent authorities agree that a taxation measure
is outside the scope of the proposed treaty, only the proposed
treaty's non-discrimination rules, and not the non-
discrimination rules of any other agreement in effect between
the United States and Denmark, generally apply to that measure.
The only exception to this general rule is such national
treatment or most favored nation obligations as may apply to
trade in goods under the General Agreement on Tariffs and
Trade. For purposes of this provision, the term ``measure''
means a law, regulation, rule, procedure, decision,
administrative action, or any similar provision or action.
Saving clause
Like all U.S. income tax treaties, the proposed treaty
includes a ``saving clause.'' Under this clause, with specific
exceptions described below, the proposed treaty does not affect
the taxation by a country of its residents or its citizens. By
reason of this saving clause, unless otherwise specifically
provided in the proposed treaty, the United States may continue
to tax its citizens who are residents of Denmark as if the
treaty were not in force. For purposes of the proposed treaty
(and, thus, for purposes of the saving clause), the term
``residents,'' which is defined in Article 4 (Residence),
includes corporations and other entities as well as
individuals.
The proposed treaty contains a provision under which the
saving clause (and therefore the U.S. jurisdiction to tax)
applies to a former U.S. citizen or long-term resident whose
loss of citizenship or resident status had as one of its
principal purposes the avoidance of tax (as defined under the
laws of the country of which the person was a citizen or long-
term resident); such application is limited to the ten-year
period following the loss of citizenship. Section 877 of the
Code provides special rules for the imposition of U.S. income
tax on former U.S. citizens and long-term residents for a
period of ten years following the loss of citizenship or
resident status; these special tax rules apply to a former
citizen or long-term resident only if his or her loss of U.S.
citizenship or resident status had as one of its principal
purposes the avoidance of U.S. income, estate or gift taxes.
For purposes of applying the special tax rules to former
citizens and long-term residents, individuals who meet a
specified income tax liability threshold or a specified net
worth threshold generally are considered to have lost
citizenship or resident status for a principal purpose of U.S.
tax avoidance.
Exceptions to the saving clause are provided for the
following benefits conferred by a treaty country: the allowance
of correlative adjustments when the profits of an associated
enterprise are adjusted by the other country (Article 9,
paragraph 2); the allowance of a special basis adjustment
election with respect to gains recognized in the other country,
and the ability to coordinate the timing of gain recognition
between countries (Article 13, paragraphs 7 and 8); the source
rule for pension distributions, the exemption from residence
country tax for social security benefits, and certain child
support payments (Article 18, paragraphs 1(c), 2, and 5);
relief from double taxation through the provision of a foreign
tax credit (Article 23); protection from discriminatory tax
treatment with respect to transactions with residents of the
other country (Article 24); and benefits under the mutual
agreement procedures (Article 25). These exceptions to the
saving clause permit residents or citizens of the United States
or Denmark to obtain such benefits of the proposed treaty with
respect to their country of residence or citizenship.
In addition, the saving clause does not apply to the
following benefits conferred by one of the countries upon
individuals who neither are citizens of that country nor have
been admitted for permanent residence in that country. Under
this set of exceptions to the saving clause, the specified
treaty benefits are available to, for example, a Danish citizen
who spends enough time in the United States to be taxed as a
U.S. resident but who has not acquired U.S. permanent residence
status (i.e., does not hold a ``green card''). The benefits
that are covered under this set of exceptions are the
exemptions from host country tax for certain compensation from
government service (Article 19), certain income received by
students or trainees (Article 20), and certain income of
diplomats and consular officers (Article 28).
Article 2. Taxes Covered
The proposed treaty generally applies to the income taxes
of the United States and Denmark. However, Article 24 (Non-
Discrimination) is applicable to all taxes imposed at all
levels of government, including State and local taxes.
Moreover, Article 26 (Exchange of Information) generally is
applicable to all national-level taxes, including, for example,
estate and gift taxes.
In the case of the United States, the proposed treaty
applies to the Federal income taxes imposed by the Code and the
excise taxes imposed with respect to private foundations, but
excludes social security taxes.
In the case of Denmark, the proposed treaty applies to (1)
Denmark's income tax (indkomstskatten til staten), (2) the
municipal income tax (den kommunale indkomstskat), (3) the
income tax to the county municipalities (den amtskommunale
indkomstskat), and (4) taxes imposed under the Hydrocarbon Tax
Act (skatter i henhold til kulbrinteskatteloven).
The proposed treaty also contains a rule generally found in
U.S. income tax treaties which provides that the proposed
treaty applies to any identical or substantially similar taxes
that are imposed subsequently in addition to, or in place of,
the taxes covered. The proposed treaty obligates the competent
authority of each country to notify the competent authority of
the other country of any significant changes in its internal
tax laws (or other laws) that affect its obligations under the
treaty or of any official published materials concerning the
application of the treaty (including explanations, regulations,
rulings, or judicial decisions). The Technical Explanation
states that this requirement relates to changes that are
significant to the operation of the proposed treaty.
Article 3. General Definitions
The proposed treaty provides definitions of a number of
terms for purposes of the proposed treaty. Certain of the
standard definitions found in most U.S. income tax treaties are
included in the proposed treaty.
The term ``person'' includes an individual, an estate, a
trust, a partnership, a company, and any other body of persons.
A ``company'' under the proposed treaty is any body
corporate or any entity which is treated as a body corporate
for tax purposes according to the laws of the state in which it
is organized.
The terms ``enterprise of a Contracting State'' and
``enterprise of the other Contracting State'' mean,
respectively, an enterprise carried on by a resident of a
treaty country and an enterprise carried on by a resident of
the other treaty country. The terms also include an enterprise
carried on by a resident of a treaty country through an entity
that is treated as fiscally transparent in such country. The
proposed treaty does not define the term ``enterprise.''
However, despite the absence of a clear, generally accepted
meaning, the Technical Explanation states that the term is
understood to refer to any activity or set of activities that
constitute a trade or business.
The proposed treaty defines ``international traffic'' as
any transport by a ship or aircraft, except when the transport
is solely between places in a treaty country. Accordingly, with
respect to a Danish enterprise, purely domestic transport
within the United States does not constitute ``international
traffic.''
The U.S. ``competent authority'' is the Secretary of the
Treasury or his delegate. The U.S. competent authority function
has been delegated to the Commissioner of Internal Revenue, who
has redelegated the authority to the Assistant Commissioner
(International). On interpretative issues, the latter acts with
the concurrence of the Associate Chief Counsel (International)
of the IRS. The Danish ``competent authority'' is the Minister
for Taxation or his authorized representative.
The term ``United States'' means the United States of
America (encompassing the States and the District of Columbia),
but does not include Puerto Rico, the Virgin Islands, Guam, or
any other U.S. possession or territory. The term ``United
States'' also includes the territorial sea of the United
States, and the sea bed and subsoil of the submarine areas
adjacent to the territorial sea of the United States over which
the United States exercises sovereignty in accordance with
international law. The Technical Explanation states that this
extension of the definition applies, however, only for the
purpose of natural resource exploration and exploitation of
such areas and only if the person, property, or activity to
which the proposed treaty is being applied is connected with
such natural resource exploration or exploitation. Thus, the
term ``United States'' would not include any activity involving
the sea floor of an area over which the United States exercised
sovereignty for natural resource purposes if that activity was
unrelated to the exploration and exploitation of natural
resources.
The term ``Denmark'' means the Kingdom of Denmark,
including any area outside the territorial sea of Denmark which
in accordance with international law has been or may be
designated under Danish laws as an area within which Denmark
may exercise sovereign rights with respect to the exploration
and exploitation of the natural resources of the sea-bed or its
subsoil and the superjacent waters and with respect to other
activities for the exploration and economic exploitation of the
area. The proposed treaty provides that the term ``Denmark''
does not comprise the Faroe Islands or Greenland. However, the
proposed protocol provides that the treaty may, through a
supplementary treaty, be extended in its entirety or with any
necessary modifications to the Faroe Islands or Greenland if
they impose taxes substantially similar in character to those
covered by the proposed treaty. The Technical Explanation
states that such an extension would be subject to ratification
in the case of the United States, and approval in accordance
with Denmark's constitutional procedures.
The term ``national of a Contracting State'' means (1) any
individual possessing the nationality or citizenship of a
treaty country; and (2) any legal person, partnership, or
association deriving its status as such from the laws in force
in a treaty country.
The term ``qualified governmental entity'' means: (1) the
governing body, political subdivision, or local authority of a
treaty country; (2) a person wholly owned (directly or
indirectly) by the treaty country or its political subdivisions
or local authorities, provided that it is organized under the
laws of such country, its earnings are credited to its own
account with no portion of its income inuring to the benefit of
a private person, and its assets vest in the country, political
subdivision or local authority upon dissolution; and (3) a
pension trust or fund of a person described in (1) or (2) above
that is constituted and operated exclusively to administer or
provide pension benefits described in Article 19 (Government
Service). A qualified governmental entity described in (2) and
(3) above cannot engage in any commercial activity. This
definition is the same as that contained in the U.S. model.
The proposed treaty also contains the standard provision
that, unless the context otherwise requires or the competent
authorities agree to a common meaning, all terms not defined in
the treaty have the meaning pursuant to the respective laws of
the country that is applying the treaty. Where a term is
defined both under a country's tax law and under a non-tax law,
the definition in the tax law is to be used in applying the
proposed treaty.
Article 4. Residence
The assignment of a country of residence is important
because the benefits of the proposed treaty generally are
available only to a resident of one of the treaty countries as
that term is defined in the proposed treaty. Furthermore,
issues arising because of dual residency, including situations
of double taxation, may be avoided by the assignment of one
treaty country as the country of residence when under the
internal laws of the treaty countries a person is a resident of
both countries.
Internal taxation rules
United States
Under U.S. law, the residence of an individual is important
because a resident alien, like a U.S. citizen, is taxed on his
or her worldwide income, while a nonresident alien is taxed
only on certain U.S.-source income and on income that is
effectively connected with a U.S. trade or business. An
individual who spends sufficient time in the United States in
any year or over a three-year period generally is treated as a
U.S. resident. A permanent resident for immigration purposes
(i.e., a ``green card'' holder) also is treated as a U.S.
resident.
Under U.S. law, a company is taxed on its worldwide income
if it is a ``domestic corporation.'' A domestic corporation is
one that is created or organized in the United States or under
the laws of the United States, a State, or the District of
Columbia.
Denmark
Under Danish law, resident individuals are subject to tax
on their worldwide income, while nonresident individuals are
subject to tax only on income earned in Denmark. Individuals
are considered to be residents of Denmark if they are present
in Denmark for more than six months or if their permanent place
of residence is in Denmark. Companies that are incorporated in
Denmark, or whose seat of management is in Denmark, are
considered as residents of Denmark and subject to tax on their
worldwide income.
Proposed treaty rules
The proposed treaty specifies rules to determine whether a
person is a resident of the United States or Denmark for
purposes of the proposed treaty. The rules generally are
consistent with the rules of the U.S. model.
The proposed treaty generally defines ``resident of a
Contracting State'' to mean any person who, under the laws of
that country, is liable to tax by reason of the person's
domicile, residence, citizenship, place of management, place of
incorporation, or any other criterion of a similar nature. The
term ``resident of a Contracting State'' does not include any
person that is liable to tax in that country only on income
from sources in that country or on profits attributable to a
permanent establishment in that country. A United States
citizen or an alien lawfully admitted for permanent residence
in the United States (i.e., a ``green card'' holder) is a U.S.
resident only if he or she has a substantial presence,
permanent home, or habitual abode in the United States. The
determination of whether a citizen or national is considered a
resident of the United States or Denmark is made based on the
principles of the treaty tie-breaker rules described below.
The proposed treaty also provides that a resident includes
a legal person organized under the laws of a treaty country and
that is generally exempt from tax in the treaty country because
it is established and maintained in that country either (1)
exclusively for a religious, charitable, educational,
scientific, or other similar purpose; or (2) to provide
pensions or other similar benefits to employees, including
self-employed individuals, pursuant to a plan. The Technical
Explanation states that the term ``similar benefits'' is
intended to encompass employee benefits such as health and
disability benefits.
A qualified governmental entity is also treated as a
resident of the country in which it is established.
The proposed treaty provides a special rule for fiscally
transparent entities. Under this rule, an item of income,
profit, or gain derived through an entity that is fiscally
transparent under the laws of either country will be considered
to be derived by a resident of a country to the extent that the
item is treated, for purposes of the tax laws of such country,
as the income, profit, or gain of a resident of such country.
The Technical Explanation states that in the case of the United
States, such fiscally transparent entities include
partnerships, common investment trusts under section 584 of the
Code, grantor trusts, and U.S. limited liability companies
treated as partnerships for U.S. tax purposes. For example, if
a corporation resident in Denmark distributes a dividend to an
entity treated as fiscally transparent for U.S. tax purposes,
the dividend will be considered to be derived by a resident of
the United States only to the extent that U.S. tax laws treat
one or more U.S. residents (whose status as U.S. residents is
determined under U.S. tax laws) as deriving the dividend income
for U.S. tax purposes.
A set of ``tie-breaker'' rules is provided to determine
residence in the case of an individual who, under the basic
residence definition, would be considered to be a resident of
both countries. Under these rules, an individual is deemed to
be a resident of the country in which he or she has a permanent
home available. If the individual has a permanent home in both
countries, the individual's residence is deemed to be the
country with which his or her personal and economic relations
are closer (i.e., his or her ``center of vital interests''). If
the country in which the individual has his or her center of
vital interests cannot be determined, or if he or she does not
have a permanent home available in either country, he or she is
deemed to be a resident of the country in which he or she has
an habitual abode. If the individual has an habitual abode in
both countries or in neither country, he or she is deemed to be
a resident of the country of which he or she is a national. If
the individual is a national of both countries or neither
country, the competent authorities of the countries will settle
the question of residence by mutual agreement.
If a company would be a resident of both countries under
the basic definition in the proposed treaty, the competent
authorities of the countries will attempt to settle the
question of residence by mutual agreement and to determine the
mode of application of the treaty to such person.
Article 5. Permanent Establishment
The proposed treaty contains a definition of the term
``permanent establishment'' that generally follows the pattern
of other recent U.S. income tax treaties, the U.S. model, and
the OECD model.
The permanent establishment concept is one of the basic
devices used in income tax treaties to limit the taxing
jurisdiction of the host country and thus to mitigate double
taxation. Generally, an enterprise that is a resident of one
country is not taxable by the other country on its business
profits unless those profits are attributable to a permanent
establishment of the resident in the other country. In
addition, the permanent establishment concept is used to
determine whether the reduced rates of, or exemptions from, tax
provided for dividends, interest, and royalties apply, or
whether those items of income will be taxed as business
profits.
In general, under the proposed treaty, a permanent
establishment is a fixed place of business through which the
business of an enterprise is wholly or partly carried on. A
permanent establishment includes a place of management, a
branch, an office, a factory, a workshop, a mine, an oil or gas
well, a quarry, or any other place of extraction of natural
resources. It also includes a building site or a construction
or installation project, or an installation or drilling rig or
ship used for the exploration of natural resources, but only if
the site, project, or activity continues for more than twelve
months. For these purposes, activities carried on by an
enterprise related to another enterprise, within the meaning of
Article 9 (Associated Enterprises), are treated as carried on
by the enterprise to which it is related if the activities in
question are substantially the same as those carried on by the
last-mentioned enterprise and are concerned with the same
project or operation (except to the extent that those
activities are carried on at the same time). The Technical
Explanation states that the twelve-month test applies
separately to each individual site or project, with a series of
contracts or projects that are interdependent both commercially
and geographically treated as a single project. The Technical
Explanation further states that if the twelve-month threshold
is exceeded, the site or project constitutes a permanent
establishment as of the first day that work in the country
began.
Under the proposed treaty, the following activities are
deemed not to constitute a permanent establishment: (1) the use
of facilities solely for storing, displaying, or delivering
goods or merchandise belonging to the enterprise; (2) the
maintenance of a stock of goods or merchandise belonging to the
enterprise solely for storage, display, or delivery or solely
for processing by another enterprise; (3) the maintenance of a
fixed place of business solely for the purchase of goods or
merchandise or for the collection of information for the
enterprise; and (4) the maintenance of a fixed place of
business solely for the purpose of carrying on for the
enterprise any other activity of a preparatory or auxiliary
character.
Under the U.S. model, the maintenance of a fixed place of
business solely for any combination of the above-listed
activities does not constitute a permanent establishment. Under
the proposed treaty (as under the OECD Model), a fixed place of
business used solely for any combination of these activities
does not constitute a permanent establishment, provided that
the overall activity of the fixed place of business is of a
preparatory or auxiliary character. In this regard, the
Technical Explanation states that it is assumed that a
combination of preparatory or auxiliary activities generally
will also be of a character that is preparatory or auxiliary.
Under the proposed treaty, if a person, other than an
independent agent, is acting in a treaty country on behalf of
an enterprise of the other country and has, and habitually
exercises, the authority to conclude contracts in the name of
such enterprise, the enterprise is deemed to have a permanent
establishment in the first country in respect of any activities
undertaken by such person for that enterprise. This rule does
not apply where the activities of such person are limited to
the activities listed above, such as storage, display, or
delivery of merchandise, which are excluded from the definition
of a permanent establishment.
Under the proposed treaty, no permanent establishment is
deemed to arise if the agent is a broker, general commission
agent, or any other agent of independent status, provided that
the agent is acting in the ordinary course of its business. The
Technical Explanation states that whether an enterprise and an
agent are independent is a factual determination, a relevant
factor of which includes the extent to which the agent bears
business risk.
The proposed treaty provides that the fact that a company
that is a resident of one country controls or is controlled by
a company that is a resident of the other country or that
carries on business in the other country does not of itself
cause either company to be a permanent establishment of the
other.
Article 6. Income from Real Property
This article covers income from real property. The rules
covering gains from the sale of real property are in Article 13
(Capital Gains).
Under the proposed treaty, income derived by a resident of
one country from real property situated in the other country
may be taxed in the country where the property is located. This
rule is consistent with the rules in the U.S. and OECD models.
For this purpose, income from real property includes income
from agriculture or forestry.
The term ``real property'' has the meaning which it has
under the law of the country in which the property in question
is situated.\5\ The proposed treaty specifies that the term in
any case includes property accessory to real property;
livestock and equipment used in agriculture and forestry;
rights to which the provisions of general law respecting landed
property apply; usufruct of real property; and rights to
variable or fixed payments as consideration for the working of,
or the right to work, mineral deposits, sources, and other
natural resources. Ships, boats, and aircraft are not
considered to be real property.
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\5\ In the case of the United States, the term is defined in Treas.
Reg. sec. 1.897-1(b).
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The proposed treaty specifies that the country in which the
property is situated also may tax income derived from the
direct use, letting, or use in any other form of real property.
The rules of Article 6, permitting source country taxation,
also apply to the income from real property of an enterprise
and to income from real property used for the performance of
independent personal services.
The proposed treaty provides that residents of a treaty
country that are liable for tax in the other treaty country on
income from real property situated in such other treaty country
may elect to compute the tax on such income on a net basis.
Such an election will be binding for the taxable year of the
election and all subsequent taxable years unless the competent
authority of the country in which the property is situated
agrees to terminate the election. U.S. internal law provides
such a net-basis election in the case of income of a foreign
person from U.S. real property (Code secs. 871(d) and 882(d)).
Article 7. Business Profits
Internal taxation rules
United States
U.S. law distinguishes between the U.S. business income and
the other U.S. income of a nonresident alien or foreign
corporation. A nonresident alien or foreign corporation is
subject to a flat 30-percent rate (or lower treaty rate) of tax
on certain U.S.-source income if that income is not effectively
connected with the conduct of a trade or business within the
United States. The regular individual or corporate rates apply
to income (from any source) which is effectively connected with
the conduct of a trade or business within the United States.
The treatment of income as effectively connected with a
U.S. trade or business depends upon whether the source of the
income is U.S. or foreign. In general, U.S.-source periodic
income (such as interest, dividends, rents, and wages) and
U.S.-source capital gains are effectively connected with the
conduct of a trade or business within the United States if the
asset generating the income is used in (or held for use in) the
conduct of the trade or business or if the activities of the
trade or business were a material factor in the realization of
the income. All other U.S.-source income of a person engaged in
a trade or business in the United States is treated as
effectively connected with the conduct of a trade or business
in the United States (under what is referred to as a ``force of
attraction'' rule).
Foreign-source income generally is effectively connected
income only if the foreign person has an office or other fixed
place of business in the United States and the income is
attributable to that place of business. Only three types of
foreign-source income are considered to be effectively
connected income: rents and royalties for the use of certain
intangible property derived from the active conduct of a U.S.
business; certain dividends and interest either derived in the
active conduct of a banking, financing or similar business in
the United States or received by a corporation the principal
business of which is trading in stocks or securities for its
own account; and certain sales income attributable to a U.S.
sales office. Special rules apply for purposes of determining
the foreign-source income that is effectively connected with a
U.S. business of an insurance company.
Any income or gain of a foreign person for any taxable year
that is attributable to a transaction in another year is
treated as effectively connected with the conduct of a U.S.
trade or business if it would have been so treated had it been
taken into account in that other year (Code sec. 864(c)(6)). In
addition, if any property ceases to be used or held for use in
connection with the conduct of a trade or business within the
United States, the determination of whether any income or gain
attributable to a sale or exchange of that property occurring
within ten years after the cessation of business is effectively
connected with the conduct of a trade or business within the
United States is made as if the sale or exchange occurred
immediately before the cessation of business (Code sec.
864(c)(7)).
Denmark
Foreign corporations and nonresident individuals generally
are subject to Danish tax only on income derived in Denmark.
Business income derived in Denmark by a foreign corporation or
nonresident individual generally is taxed in the same manner as
the income of a Danish corporation or resident individual.
Proposed treaty limitations on internal law
Under the proposed treaty (and similar to the present
treaty), business profits of an enterprise of one of the
countries are taxable in the other country only to the extent
that they are attributable to a permanent establishment in the
other country through which the enterprise carries on business.
This is one of the basic limitations on a country's right to
tax income of a resident of the other country. The rule is
similar to those contained in the U.S. and OECD models.
The taxation of business profits under the proposed treaty
differs from U.S. internal law rules for taxing business
profits primarily by requiring more than merely being engaged
in a trade or business before a country can tax business
profits and by substituting an ``attributable to'' standard for
the Code's ``effectively connected'' standard. Under the
proposed treaty, some type of fixed place of business would
have to be present and the business profits generally would
have to be attributable to that fixed place of business.
The proposed treaty (similar to the present treaty)
provides that there will be attributed to a permanent
establishment the business profits which it might be expected
to make if it were a distinct and independent enterprise
engaged in the same or similar activities under the same or
similar conditions. For this purpose, the business profits to
be attributed to the permanent establishment include only the
profits derived from the assets or activities of the permanent
establishment. The Technical Explanation states that this
provision permits the use of methods other than separate
accounting to determine the arm's-length profits of a permanent
establishment where it is necessary to do so for practical
reasons, such as when the affairs of the permanent
establishment are so closely bound up with those of the head
office that it would be impossible to disentangle them on any
strict basis of accounts.
The proposed protocol provides that nothing in Article 7
(Business Profits) or 24 (Non-Discrimination) prevents either
treaty country from applying their special rules dealing with
the taxation of insurance companies. Thus, for example, the
proposed treaty will not prevent the United States from
continuing to tax permanent establishments of Danish insurance
companies in accordance with section 842(b) of the Code.
In computing taxable business profits, the proposed treaty
provides that deductions are allowed for expenses, wherever
incurred, which are incurred for the purposes of the permanent
establishment. These deductions include a reasonable allocation
of executive and general administrative expenses, research and
development expenses, interest, and other expenses incurred for
the purposes of the enterprise as a whole (or the part of the
enterprise which includes the permanent establishment). The
Technical Explanation states that this rule permits (but does
not require) each treaty country to apply the type of expense
allocation rules provided by U.S. law (such as in Treas. Reg.
secs. 1.861-8 and 1.882-5). The Technical Explanation clarifies
that deductions will not be allowed for expenses charged to a
permanent establishment by another unit of the enterprise.
Thus, a permanent establishment may not deduct a royalty deemed
paid to the head office.
Business profits are not attributed to a permanent
establishment merely by reason of the purchase of goods or
merchandise by the permanent establishment for the enterprise.
Thus, where a permanent establishment purchases goods for its
head office, the business profits attributed to the permanent
establishment with respect to its other activities are not
increased by a profit element in its purchasing activities.
The proposed treaty requires the determination of business
profits of a permanent establishment to be made in accordance
with the same method year by year unless a good and sufficient
reason to the contrary exists. Where business profits include
items of income that are dealt with separately in other
articles of the proposed treaty, those other articles, and not
the business profits article, govern the treatment of those
items of income (except where such other articles specifically
provide to the contrary). Thus, for example, dividends are
taxed under the provisions of Article 10 (Dividends), and not
as business profits, except as specifically provided in Article
10.
For purposes of the proposed treaty, the term ``business
profits'' means income derived from any trade or business,
including income derived by an enterprise from the performance
of personal services and from the rental of tangible personal
property.
The proposed treaty incorporates the rule of Code section
864(c)(6) and provides that any income or gain attributable to
a permanent establishment or a fixed base during its existence
is taxable in the country where the permanent establishment or
fixed base is located even though payments are deferred until
after the permanent establishment or fixed base has ceased to
exist. This rule applies with respect to business profits
(Article 7, paragraphs 1 and 2), dividends (Article 10,
paragraph 6), interest (Article 11, paragraph 3), royalties
(Article 12, paragraph 3), capital gains (Article 13, paragraph
3), independent personal services income (Article 14), and
other income (Article 21, paragraph 2).
Article 8. Shipping and Air Transport
Article 8 of the proposed treaty covers income from the
operation or rental of ships, aircraft, and containers in
international traffic. The rules governing income from the
disposition of ships, aircraft, and containers are in Article
13 (Capital Gains).
The United States generally taxes the U.S.-source income of
a foreign person from the operation of ships or aircraft to or
from the United States. An exemption from U.S. tax is provided
if the income is earned by a corporation that is organized in,
or an alien individual who is resident in, a foreign country
that grants an equivalent exemption to U.S. corporations and
residents. The United States has entered into agreements with a
number of countries providing such reciprocal exemptions.
Under the proposed treaty, profits which are derived by an
enterprise of one country from the operation in international
traffic of ships or aircraft are taxable only in that country,
regardless of the existence of a permanent establishment in the
other country. ``International traffic'' is defined in Article
3(1)(d) (General Definitions) as any transport by a ship or
aircraft, except when the transport is solely between places in
a treaty country.
For purposes of the proposed treaty, profits from the
operation of ships or aircraft include profits derived from the
rental of ships or aircraft on a full (time or voyage) basis
(i.e., with crew). It also includes profits from the rental of
ships or aircraft on a bareboat basis (i.e., without crew) if
such ships or aircraft are operated in international traffic by
the lessee or if such rental income is incidental to profits
from the operation of ships or aircraft in international
traffic. Profits derived by an enterprise from the inland
transport of property or passengers within either treaty
country are treated as profits from the operation of ships or
aircraft in international traffic if such transport is
undertaken as part of international traffic by the enterprise.
These rules are the same as the corresponding rules in the U.S.
model.
The proposed treaty provides that profits of an enterprise
of a country from the use, maintenance, or rental of containers
(including trailers, barges, and related equipment for the
transport of containers) used in international traffic are
taxable only in that country.
The shipping and air transport provisions of the proposed
treaty apply to profits from participation in a pool, joint
business, or international operating agency. This refers to
various arrangements for international cooperation by carriers
in shipping and air transport. According to the proposed
protocol, the Scandinavian Airlines System (SAS) is a
consortium within the meaning of this article; its
participating members being SAS Danmark A/S, SAS Norge ASA, and
SAS Sverige AB. In order to avoid the problems inherent in
operating in the United States through a consortium, the
members of the consortium in 1946 established a New York
corporation, Scandinavian Airlines System, Inc. (SAS, Inc.) to
act on their behalf in the United States pursuant to an agency
agreement dated September 18, 1946. A similar agreement was
entered into by SAS directly and SAS, Inc., on March 14, 1951.
Pursuant to the agency agreement, SAS, Inc., is authorized to
perform only such functions as SAS assigns to it, all in
connection with international air traffic. Under that
agreement, all revenues collected by SAS, Inc., are
automatically credited to SAS. Operation expenses incurred by
SAS, Inc., are debited to SAS in accordance with the terms of
the agency agreement. SAS is obligated under the terms of the
agency agreement to reimburse SAS, Inc. for all of its expenses
irrespective of the revenues of SAS, Inc. SAS, Inc., does not
perform any functions except those connected with or incidental
to the business of SAS as an operator of aircraft in
international traffic. According to the Technical Explanation,
the income share of SAS Danmark A/S from its participation in
the SAS consortium is taxable in accordance with this article
of the proposed treaty. In addition, the proposed protocol
provides that in view of the special nature of the SAS
consortium and the agency agreement as described above, for
purposes of this article, the United States will treat all of
the income earned by SAS, Inc. that is derived from the
operation in international traffic of aircraft as income of the
SAS consortium.
The profits of an enterprise of a treaty country from the
transport by ships or aircraft of supplies or personnel to a
location where offshore activities in connection with the
exploration or exploitation of natural resources are being
carried on in the other country, or from the operation of
tugboats and similar vessels in connection with such
activities, are taxable only in the first-mentioned country
(i.e., the residency country). This rule applies
notwithstanding provisions under the permanent establishment
article that would otherwise subject such activities to source
country taxation. This rule is not contained in the U.S. model.
Article 9. Associated Enterprises
The proposed treaty, like most other U.S. tax treaties,
contains an arm's-length pricing provision. The proposed treaty
recognizes the right of each country to make an allocation of
profits to an enterprise of that country in the case of
transactions between related enterprises, if conditions are
made or imposed between the two enterprises in their commercial
or financial relations which differ from those which would be
made between independent enterprises. In such a case, a country
may allocate to such an enterprise the profits which it would
have accrued but for the conditions so imposed. This treatment
is consistent with the U.S. model.
For purposes of the proposed treaty, an enterprise of one
country is related to an enterprise of the other country if one
of the enterprises participates directly or indirectly in the
management, control, or capital of the other enterprise.
Enterprises are also related if the same persons participate
directly or indirectly in their management, control, or
capital.
Under the proposed treaty, when a redetermination of tax
liability has been made by one country under the provisions of
this article, the other country will (after agreeing that the
adjustment was appropriate) make an appropriate adjustment to
the amount of tax paid in that country on the redetermined
income if it considers an adjustment justified. In making such
adjustment, due regard is to be given to other provisions of
the proposed treaty, and the competent authorities of the two
countries are to consult with each other if necessary. The
proposed treaty's saving clause retaining full taxing
jurisdiction in the country of residence or citizenship does
not apply in the case of such adjustments. Accordingly,
internal statute of limitations provisions do not prevent the
allowance of appropriate correlative adjustments.
The Technical Explanation states that the treaty countries
reserve their rights to apply internal law provisions that
permit adjustments between related parties. The Technical
Explanation also states that adjustments are permitted under
internal law provisions even if such adjustments are different
from, or go beyond, the adjustments authorized by this article,
provided that such adjustments are consistent with the general
principles of this article permitting adjustments to reflect
arm's-length terms.
Article 10. Dividends
Internal taxation rules
United States
The United States generally imposes a 30-percent tax on the
gross amount of U.S.-source dividends paid to nonresident alien
individuals and foreign corporations. The 30-percent tax does
not apply if the foreign recipient is engaged in a trade or
business in the United States and the dividends are effectively
connected with that trade or business. In such a case, the
foreign recipient is subject to U.S. tax on such dividends on a
net basis at graduated rates in the same manner that a U.S.
person would be taxed.
Under U.S. law, the term ``dividend'' generally means any
distribution of property made by a corporation to its
shareholders, either from accumulated earnings and profits or
current earnings and profits. However, liquidating
distributions generally are treated as payments in exchange for
stock and thus are not subject to the 30-percent withholding
tax described above (see discussion of capital gains in
connection with Article 13 below).
Dividends paid by a U.S. corporation generally are U.S.-
source income. Also treated as U.S.-source dividends for this
purpose are portions of certain dividends paid by a foreign
corporation that conducts a U.S. trade or business. The U.S.
30-percent withholding tax imposed on the U.S.-source portion
of the dividends paid by a foreign corporation is referred to
as the ``second-level'' withholding tax. This second-level
withholding tax is imposed only if a treaty prevents
application of the statutory branch profits tax.
In general, corporations are not entitled under U.S. law to
a deduction for dividends paid. Thus, the withholding tax on
dividends theoretically represents imposition of a second level
of tax on corporate taxable income. Treaty reductions of this
tax reflect the view that where the United States already
imposes corporate-level tax on the earnings of a U.S.
corporation, a 30-percent withholding rate may represent an
excessive level of source country taxation. Moreover, the
reduced rate of tax often applied by treaty to dividends paid
to direct investors reflects the view that the source country
tax on payments of profits to a substantial foreign corporate
shareholder may properly be reduced further to avoid double
corporate-level taxation and to facilitate international
investment.
A real estate investment trust (``REIT'') is a corporation,
trust, or association that is subject to the regular corporate
income tax, but that receives a deduction for dividends paid to
its shareholders if certain conditions are met. In order to
qualify for the deduction for dividends paid, a REIT must
distribute most of its income. Thus, a REIT is treated, in
essence, as a conduit for federal income tax purposes. Because
a REIT is taxable as a U.S. corporation, a distribution of its
earnings is treated as a dividend rather than income of the
same type as the underlying earnings. Such distributions are
subject to the U.S. 30-percent withholding tax when paid to
foreign owners.
A REIT is organized to allow persons to diversify ownership
in primarily passive real estate investments. As such, the
principal income of a REIT often is rentals from real estate
holdings. Like dividends, U.S.-source rental income of foreign
persons generally is subject to the 30-percent withholding tax
(unless the recipient makes an election to have such rental
income taxed in the United States on a net basis at the regular
graduated rates). Unlike the withholding tax on dividends,
however, the withholding tax on rental income generally is not
reduced in U.S. income tax treaties.
U.S. internal law also generally treats a regulated
investment company (``RIC'') as both a corporation and a
conduit for income tax purposes. The purpose of a RIC is to
allow investors to hold a diversified portfolio of securities.
Thus, the holder of stock in a RIC may be characterized as a
portfolio investor in the stock held by the RIC, regardless of
the proportion of the RIC's stock owned by the dividend
recipient.
A foreign corporation engaged in the conduct of a trade or
business in the United States is subject to a flat 30-percent
branch profits tax on its ``dividend equivalent amount.'' The
dividend equivalent amount is the corporation's earnings and
profits which are attributable to its income that is
effectively connected with its U.S. trade or business,
decreased by the amount of such earnings that are reinvested in
business assets located in the United States (or used to reduce
liabilities of the U.S. business), and increased by any such
previously reinvested earnings that are withdrawn from
investment in the U.S. business. The dividend equivalent amount
is limited by (among other things) aggregate earnings and
profits accumulated in taxable years beginning after December
31, 1986.
Denmark
Denmark generally imposes a 25 percent withholding tax on
dividend payments to nonresidents that own less than 25 percent
of the paying corporation. However, there is no dividend
withholding tax in the case of shareholders that own 25 percent
or more of the paying corporation. Denmark does not impose a
branch tax on the repatriation of the after-tax profit of a
permanent establishment.
Proposed treaty limitations on internal law
Under the proposed treaty, dividends paid by a resident of
a treaty country to a resident of the other country may be
taxed in such other country. Dividends paid by a resident of a
treaty country and beneficially owned by a resident of the
other country may also be taxed by the country in which the
payor is resident, but the rate of such tax is limited. Under
the proposed treaty, source country taxation (i.e., taxation by
the country in which the payor is resident) generally is
limited to 5 percent of the gross amount of the dividend if the
beneficial owner of the dividend is a resident of the other
country and is a company that owns at least 10 percent of the
share capital of the payor company. The source country dividend
withholding tax generally is limited to 15 percent of the gross
amount of the dividends paid to residents of the other country
in all other cases. These provisions do not affect the taxation
of the company in respect of the profits out of which the
dividends are paid.
The present treaty provides for a similar dividend
withholding rate structure. However, in order to obtain the 5-
percent withholding rate under the present treaty, the
beneficial owner must control (directly or indirectly) at least
95 percent of the voting power of the paying corporation.
Furthermore, the paying corporation cannot derive more than 25
percent of its gross income from interest and dividends, other
than interest and dividends received from its own subsidiary
corporations. The 5-percent withholding rate does not apply
under the present treaty if the relationship of the two
corporations has been arranged or is maintained primarily with
the intention of securing such reduced rate.
Under the proposed treaty, dividends paid by a U.S. RIC are
eligible only for the limitation that applies the 15-percent
rate, regardless of the beneficial owner's percentage ownership
in such entity. Dividends paid by a U.S. REIT are not eligible
for the 5-percent rate. Moreover, such REIT dividends are
eligible for the 15-percent rate only if (1) the dividends are
beneficially owned by an individual who holds 10 percent or
less of the REIT; (2) the dividends are paid with respect to a
class of stock that is publicly traded and the beneficial owner
of the dividends is a person owning not more than 5 percent of
any class of the REIT's stock; or (3) the beneficial owner of
the dividends is a person owning not more than 10 percent of
the REIT and the REIT is diversified. Otherwise, dividends paid
by a U.S. REIT are subject to U.S. taxation at the full
statutory rate. For purposes of this provision, the Technical
Explanation states that a REIT will be considered to be
diversified if the value of no single interest in the REIT's
real property exceeds 10 percent of the REIT's total interests
in real property.
Notwithstanding the discussion above, dividends cannot be
taxed by the source country if the beneficial owner of the
dividends is a qualified governmental entity that does not
control the payor of the dividends. This rule is the same as
that contained in the U.S. model.
The proposed treaty defines a ``dividend'' to include
income from shares or other rights, not being debt-claims,
participating in profits, as well as income that is subject to
the same tax treatment as income from shares by the internal
laws of the treaty country of which the company making the
distribution is a resident.
The proposed treaty's reduced rates of tax on dividends do
not apply if the dividend recipient carries on business through
a permanent establishment in the source country and the
dividends are attributable to the permanent establishment.
Dividends attributable to a permanent establishment are taxed
as business profits (Article 7). The proposed treaty's reduced
rates of tax on dividends also do not apply if the dividend
recipient is a nonresident who performs independent personal
services from a fixed base located in a treaty country and such
dividends are attributable to the fixed base. In such a case,
the dividends attributable to the fixed base are taxed as
income from the performance of independent personal services
(Article 14). Under the proposed treaty, these rules also apply
if the permanent establishment or fixed base no longer exists
when the dividends are paid but such dividends are attributable
to the former permanent establishment or fixed base.
The proposed treaty provides that a country may not impose
any tax on dividends paid by a company that is a resident of
the other country, except to the extent that the dividends are
paid to a resident of the first country or the dividends are
attributable to a permanent establishment or fixed base
situated in that first country. Thus, this provision overrides
the ability of the United States to impose its second-level
withholding tax on the U.S.-source portion of dividends paid by
a Danish corporation. The proposed treaty also provides that a
country may not impose a tax on a corporation's undistributed
profits, except as provided below. These rules apply even if
the dividends paid or the undistributed profits consist wholly
or partially of profits arising in that country.
The proposed treaty permits the imposition of a branch
profits tax, but limits the rate of such tax to 5 percent
(i.e., the rate prescribed in paragraph 2(a) of this article).
The branch profits tax may be imposed on a company that is a
resident of a treaty country and that has a permanent
establishment in the other treaty country or is subject to tax
in the other treaty country on a net basis on its income from
real property (Article 6) or capital gains (Article 13). Such
tax may be imposed only on the portion of the business profits
attributable to such permanent establishment, or the portion of
such real property income or capital gains, that represents the
``dividend equivalent amount,'' and in the case of Denmark, an
amount that is analogous to the dividend equivalent amount. The
Technical Explanation states that the term ``dividend
equivalent amount'' has the same meaning that it has under Code
section 884, as amended from time to time, provided the
amendments are consistent with the purpose of the branch
profits tax.
Article 11. Interest
Internal taxation rules
United States
Subject to several exceptions (such as those for portfolio
interest, bank deposit interest, and short-term original issue
discount), the United States imposes a 30-percent withholding
tax on U.S.-source interest paid to foreign persons under the
same rules that apply to dividends. U.S.-source interest, for
purposes of the 30-percent tax, generally is interest on the
debt obligations of a U.S. person, other than a U.S. person
that meets specified foreign business requirements. Also
subject to the 30-percent tax is interest paid by the U.S.
trade or business of a foreign corporation. A foreign
corporation is subject to a branch-level excess interest tax
with respect to certain ``excess interest'' of a U.S. trade or
business of such corporation; under this rule, an amount equal
to the excess of the interest deduction allowed with respect to
the U.S. business over the interest paid by such business is
treated as if paid by a U.S. corporation to a foreign parent
and therefore is subject to the 30-percent withholding tax.
Portfolio interest generally is defined as any U.S.-source
interest that is not effectively connected with the conduct of
a trade or business if such interest (1) is paid on an
obligation that satisfies certain registration requirements or
specified exceptions thereto and (2) is not received by a 10-
percent owner of the issuer of the obligation, taking into
account shares owned by attribution. However, the portfolio
interest exemption does not apply to certain contingent
interest income.
If an investor holds an interest in a fixed pool of real
estate mortgages that is a real estate mortgage interest
conduit (``REMIC''), the REMIC generally is treated for U.S.
tax purposes as a pass-through entity and the investor is
subject to U.S. tax on a portion of the REMIC's income (which,
generally is interest income). If the investor holds a so-
called ``residual interest'' in the REMIC, the Code provides
that a portion of the net income of the REMIC that is taxed in
the hands of the investor--referred to as the investor's
``excess inclusion''--may not be offset by any net operating
losses of the investor, must be treated as unrelated business
income if the investor is an organization subject to the
unrelated business income tax, and is not eligible for any
reduction in the 30-percent rate of withholding tax (by treaty
or otherwise) that would apply if the investor were otherwise
eligible for such a rate reduction.
Denmark
Denmark generally does not impose a withholding tax on
interest paid to nonresidents.
Proposed treaty limitations on internal law
Like the U.S. model and the present treaty, the proposed
treaty exempts interest derived and beneficially owned by a
resident of one country from tax in the source country.
The proposed treaty defines the term ``interest'' as income
from debt claims of every kind, whether or not secured by a
mortgage and whether or not carrying a right to participate in
the debtor's profits. In particular, it includes income from
government securities and from bonds or debentures, including
premiums or prizes attaching to such securities, bonds, or
debentures. The proposed treaty includes in the definition of
interest any other income that is treated as interest by the
domestic law of the country in which the income arises. Penalty
charges for late payment are not regarded as interest for
purposes of this article. The proposed treaty provides that the
term ``interest'' does not include amounts treated as dividends
under Article 10 (Dividends).
The proposed treaty's reductions in source country tax on
interest do not apply if the beneficial owner carries on
business in the source country through a permanent
establishment located in that country and the interest is
attributable to that permanent establishment. In such an event,
the interest is taxed as business profits (Article 7). The
proposed treaty's reduced rates of tax on interest also do not
apply if the interest recipient is a treaty country resident
who performs independent personal services from a fixed base
located in the other treaty country and such interest is
attributable to the fixed base. In such a case, the interest
attributable to the fixed base is taxed as income from the
performance of independent personal services (Article 14).
These rules also apply if the permanent establishment or fixed
base no longer exists when the interest is paid but such
interest is attributable to the former permanent establishment
or fixed base.
The proposed treaty addresses the issue of non-arm's-length
interest charges between related parties (or parties otherwise
having a special relationship) by providing that the amount of
interest for purposes of applying this article is the amount of
interest that would have been agreed upon by the payor and the
beneficial owner in the absence of the special relationship.
Any amount of interest paid in excess of such amount is taxable
according to the laws of each country, taking into account the
other provisions of the proposed treaty. For example, excess
interest paid by a subsidiary corporation to its parent
corporation may be treated as a dividend under local law and
thus be subject to the provisions of Article 10 (Dividends).
The proposed treaty provides two anti-abuse exceptions to
the general source-country reduction in tax discussed above.
The first exception relates to ``contingent interest''
payments. If interest is paid by a source-country resident to a
resident of the other country and is determined with reference
(1) to receipts, sales, income, profits, or other cash flow of
the debtor or a related person, (2) to any change in the value
of any property of the debtor or a related person, or (3) to
any dividend, partnership distribution, or similar payment made
by the debtor to a related person, such interest may be taxed
in the source country in accordance with its internal laws.
However, if the beneficial owner is a resident of the other
country, such interest may not be taxed at a rate exceeding 15
percent (i.e., the rate prescribed in paragraph 2(b) of Article
10 (Dividends)). The second anti-abuse exception provides that
the reductions in and exemption from source country tax do not
apply to excess inclusions with respect to a residual interest
in a REMIC. Such income may be taxed in accordance with each
country's internal law.
Article 12. Royalties
Internal taxation rules
United States
Under the same system that applies to dividends and
interest, the United States imposes a 30-percent withholding
tax on U.S.-source royalties paid to foreign persons. U.S.-
source royalties include royalties for the use of or the right
to use intangible property in the United States.
Denmark
Denmark generally imposes a withholding tax on royalties
paid to nonresidents at a rate of 30 percent.
Proposed treaty limitations on internal law
The proposed treaty provides that royalties derived and
beneficially owned by a resident of a treaty country are
taxable only in that country. Thus, the proposed treaty
generally exempts U.S.-source royalties beneficially owned by
Danish residents from the 30-percent U.S. tax. This exemption
from source country taxation is similar to that provided in the
U.S. model and the present treaty.
The term ``royalties'' means any consideration for the use
of, the right to use, or the sale (which is contingent on the
productivity, use, or further disposition) of any copyright of
literary, artistic, scientific, or other work (including
computer software, cinematographic films, audio or video tapes
or disks, and other means of image or sound reproduction),
patent, trademark, design or model, plan, secret formula or
process, or other like right or property. The term also
includes consideration for the use of, or the right to use
information concerning industrial, commercial, or scientific
experience. The Technical Explanation states that it is
understood that payments with respect to transfers of ``shrink
wrap'' computer software will not be considered as royalty
income.
The reduced rates of source country taxation do not apply
where the beneficial owner carries on business through a
permanent establishment in the source country, and the
royalties are attributable to the permanent establishment. In
that event, the royalties are taxed as business profits
(Article 7). The proposed treaty's reduced rates of source
country tax on royalties also do not apply if the beneficial
owner is a treaty country resident who performs independent
personal services from a fixed base located in the other treaty
country and such royalties are attributable to the fixed base.
In such a case, the royalties attributable to the fixed base
are taxed as income from the performance of independent
personal services (Article 14). These rules also apply if the
permanent establishment or fixed base no longer exists when the
royalties are paid but such royalties are attributable to the
former permanent establishment or fixed base.
The proposed treaty addresses the issue of non-arm's-length
royalties between related parties (or parties otherwise having
a special relationship) by providing that the amount of
royalties for purposes of applying this article is the amount
that takes into account the use, right, or information for
which they are paid, in the absence of the special
relationship. Any amount of royalties paid in excess of such
amount is taxable according to the laws of each country, taking
into account the other provisions of the proposed treaty. For
example, excess royalties paid by a subsidiary corporation to
its parent corporation may be treated as a dividend under local
law and thus be subject to the provisions of Article 10
(Dividends).
Article 13. Capital Gains
U.S. internal law
Generally, gain realized by a nonresident alien or a
foreign corporation from the sale of a capital asset is not
subject to U.S. tax unless the gain is effectively connected
with the conduct of a U.S. trade or business or, in the case of
a nonresident alien, he or she is physically present in the
United States for at least 183 days in the taxable year. A
nonresident alien or foreign corporation is subject to U.S. tax
on gain from the sale of a U.S. real property interest as if
the gain were effectively connected with a trade or business
conducted in the United States. ``U.S. real property
interests'' include interests in certain corporations if at
least 50 percent of the assets of the corporation consist of
U.S. real property.
Proposed treaty limitations on internal law
The proposed treaty specifies rules governing when a
country may tax gains from the alienation of property by a
resident of the other country. The rules are generally
consistent with those contained in the U.S. model.
Under the proposed treaty, gains derived by a resident of
one treaty country from the alienation of real property
situated in the other country may be taxed in the country where
the property is situated. For the purposes of this article,
real property in the other country includes (1) real property
as defined in Article 6 (Income From Real Property), (2) a U.S.
real property interest, and (3) an equivalent interest in real
property situated in Denmark.
Gains from the alienation of personal property that are
attributable to a permanent establishment which an enterprise
of one country has in the other country, gains from the
alienation of personal property attributable to a fixed base
which is available to a resident of one country in the other
country for the purpose of performing independent personal
services, and gains from the alienation of such a permanent
establishment (alone or with the whole enterprise) or such a
fixed base, may be taxed in that other country. This rule also
applies if the permanent establishment or fixed base no longer
exists when the gains are recognized but such gains relate to
the former permanent establishment or fixed base.
Gains derived by an enterprise of a treaty country from the
alienation of ships, boats, aircraft, or containers operated or
used in international traffic (or personal property pertaining
to the operation or use of such ships, boats, aircraft, or
containers), are taxable only in such country.
Gains derived by an enterprise of a treaty country from the
deemed alienation of an installation, drilling rig, or ship
used in the other country for the exploration or exploitation
of oil and gas resources may be taxed by such other country in
accordance with its internal law, but only to the extent of any
depreciation taken in such other country. Thus, at the time of
deemed alienation of the property under the law of the host
country, an enterprise of the other treaty country may be
required to recapture the depreciation claimed in the host
country of an oil or gas exploration or exploitation
installation, drilling rig, or ship. Because the amount that
may be taxable is limited to the amount of any gain,
depreciation will be recaptured only to the extent it has
reduced the basis of the property below its fair market value.
This provision is not contained in the U.S. model. The
Technical Explanation states that the provision was included to
permit Denmark to impose its income tax at the same time an oil
or gas exploration or exploitation installation, drilling rig
or ship is deemed alienated under Denmark's income tax laws.
The Technical Explanation also states that other rules
(described below) were included in the proposed treaty in order
to prevent double taxation that might otherwise result from
this provision.
Gains from the alienation of any property other than that
discussed above is taxable under the proposed treaty only in
the country where the person disposing of the property is
resident.
The proposed treaty coordinates U.S. and Danish taxation of
gains in circumstances where a treaty country resident is
subject to tax in both treaty countries and one country deems a
taxable disposition of property to have occurred, but the other
country does not currently tax such gains. In such a case, the
resident can elect in the annual return of income for the year
of disposition to be liable to tax in the residence country as
if he had sold and repurchased the property for an amount equal
to its fair market value at a time immediately prior to the
deemed disposition. This election applies to all property
disposed of during the taxable year for which the election is
made or at any time thereafter. The Technical Explanation
states that this provision might be useful in a case where a
U.S. corporation transfers a drilling rig, on which
depreciation was taken in Denmark, to its home office in the
United States. According to the Technical Explanation, Denmark
generally would tax any built-in gain upon the transfer,
limited to the amount of depreciation taken in Denmark, but the
United States would defer taxation until the rig actually was
sold. If the period for foreign tax credit carryovers had
expired at the time of actual disposition, the U.S. corporation
might not receive a foreign tax credit, resulting in double
taxation. The Technical Explanation states that if the U.S.
corporation elected the benefits of this provision, it would be
subject to U.S. tax currently on the built-in gain, and take a
new tax basis in the property.
The proposed treaty also provides coordination rules with
respect to gains from the alienation of property in a corporate
or other reorganization. Under the proposed treaty, if a
transaction is tax-deferred in the country of residence, then
the competent authority of the source country may agree, if
requested to do so by the person acquiring property in the
transaction, to enter into an agreement to defer tax to the
extent necessary to avoid double taxation. For this purpose, a
tax-deferred transaction includes a corporate or other
organization, reorganization, amalgamation, division, or
similar transaction in which profit, gain, or income is not
recognized for tax purposes. The Technical Explanation states
that one situation in which this provision might be useful is
the merger of two companies that are resident in one treaty
country, both of which have permanent establishments in the
other country. According to the Technical Explanation, if two
U.S. resident corporations, each with a permanent establishment
in Denmark, merged in a transaction that qualified as a tax-
free reorganization under Code section 368 but was taxable in
Denmark, Denmark could tax built-in gain on assets of the
permanent establishments. When those assets eventually were
sold, the United States might also tax the gain, but without a
foreign tax credit if the period for tax credit carryovers had
already expired. The Technical Explanation states that the
company surviving the merger could request that the Danish
competent authority defer recognition of the gain until actual
disposition of the assets, in order to assure a U.S. foreign
tax credit for the Danish tax. The Technical Explanation also
states that whether deferral should be granted is a matter to
be decided by the competent authority.
Article 14. Independent Personal Services
U.S. internal law
The United States taxes the income of a nonresident alien
individual at the regular graduated rates if the income is
effectively connected with the conduct of a trade or business
in the United States by the individual. The performance of
personal services within the United States may constitute a
trade or business within the United States.
Under the Code, the income of a nonresident alien
individual from the performance of personal services in the
United States is excluded from U.S.-source income, and
therefore is not taxed by the United States in the absence of a
U.S. trade or business, if the following criteria are met: (1)
the individual is not in the United States for over 90 days
during the taxable year, (2) the compensation does not exceed
$3,000, and (3) the services are performed as an employee of,
or under a contract with, a foreign person not engaged in a
trade or business in the United States, or are performed for a
foreign office or place of business of a U.S. person.
Proposed treaty limitations on internal law
The proposed treaty limits the right of a country to tax
income from the performance of personal services by a resident
of the other country. Under the proposed treaty, income from
the performance of independent personal services (i.e.,
services performed as an independent contractor, not as an
employee) is treated separately from income from the
performance of dependent personal services.
Under the proposed treaty, income in respect of personal
services of an independent character performed in one country
by a resident of the other country is exempt from tax in the
country where the services are performed (the source country)
unless the individual performing the services has a fixed base
regularly available to him or her in that country for the
purpose of performing the services.\6\ In that case, the source
country is permitted to tax only that portion of the
individual's income which is attributable to the fixed base.
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\6\ According to the Technical Explanation, it is understood that
the concept of a fixed base is similar, but not identical, to the
concept of a permanent establishment.
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Under the proposed treaty, income that is taxable in the
source country pursuant to this article will be determined
under the principles of Article 7 (Business Profits). Thus, all
relevant expenses, including expenses not incurred in the
source country, must be allowed as deductions in computing the
net income from services subject to tax in the source country.
Article 15. Dependent Personal Services
Under the proposed treaty, salaries, wages, and other
remuneration derived from services performed as an employee in
one country (the source country) by a resident of the other
country are taxable only by the country of residence if three
requirements are met: (1) the individual must be present in the
source country for not more than 183 days in any twelve-month
period; (2) the individual is paid by, or on behalf of, an
employer who is not a resident of the source country; and (3)
the compensation must not be borne by a permanent establishment
or fixed base of the employer in the source country. These
limitations on source country taxation are the same as the
rules of the U.S. model and the OECD model. If these three
requirements are not met and the employee's services are
performed in the other country, such other country may tax the
related compensation.
The proposed treaty provides that remuneration derived by a
resident of one country in respect of employment as a member of
the regular complement (including the crew) of a ship or
aircraft operated in international traffic is taxable only in
that country.
This article is subject to the provisions of the separate
articles covering directors' fees (Article 16), pensions,
social security, annuities, alimony, and child support payments
(Article 18), and government service income (Article 19).
Article 16. Directors' Fees
Under the proposed treaty, directors' fees and other
similar payments derived by a resident of one country as a
member of the board of directors of a company which is a
resident of that other country is taxable in that other
country. Under this rule, which is the same as the OECD model,
the country in which the company is resident may tax all of the
remuneration paid to nonresident board members, regardless of
where the services are performed. The U.S. model contains a
different rule, which provides that the country in which the
company is resident may tax nonresident directors, but only
with respect to compensation for services performed in that
country.
Article 17. Artistes and Sportsmen
Like the U.S. and OECD models, the proposed treaty contains
a separate set of rules that apply to the taxation of income
earned by entertainers (such as theater, motion picture, radio,
or television artistes, or musicians) and sportsmen. These
rules apply notwithstanding the other provisions dealing with
the taxation of income from personal services (Articles 14 and
15) and are intended, in part, to prevent entertainers and
sportsmen from using the treaty to avoid paying any tax on
their income earned in one of the countries.
Under the proposed treaty, income derived by an entertainer
or sportsman who is a resident of one country from his or her
personal activities as such exercised in the other country may
be taxed in the other country if the amount of the gross
receipts derived by him or her from such activities exceeds
$20,000 or its equivalent in Danish kroner. The $20,000
threshold includes reimbursed expenses. Under this rule, if a
Danish entertainer or sportsman maintains no fixed base in the
United States and performs (as an independent contractor) for
one day of a taxable year in the United States for total
compensation of $10,000, the United States could not tax that
income. If, however, that entertainer's or sportsman's total
compensation were $30,000, the full amount would be subject to
U.S. tax.
The proposed treaty provides that where income in respect
of activities exercised by an entertainer or sportsman in his
or her capacity as such accrues not to the entertainer or
sportsman but to another person, that income is taxable by the
country in which the activities are exercised unless it is
established that neither the entertainer or sportsman nor
persons related to him or her participated directly or
indirectly in the profits of that other person in any manner,
including the receipt of deferred remuneration, bonuses, fees,
dividends, partnership distributions, or other distributions.
This provision applies notwithstanding the business profits
(Article 7) and independent personal service (Article 14)
articles. This provision prevents highly-paid entertainers and
sportsmen from avoiding tax in the country in which they
perform by, for example, routing the compensation for their
services through a third entity such as a personal holding
company or a trust located in a country that would not tax the
income.
Article 18. Pensions, Social Security, Annuities, Alimony and Child
Support Payments
Under the proposed treaty, pension distributions arising in
a treaty country and beneficially owned by a resident of the
other country, whether paid periodically or in a single sum,
are taxable only in the country in which they arose. Under the
present treaty, on the other hand, pension distributions are
taxable only in the country of residence. The proposed treaty
provides that pension distributions will only be considered to
arise in a treaty country if paid by a pension scheme
established in such country. The proposed protocol provides
that a payment is treated as a pension distribution for these
purposes if paid under a pension scheme recognized for tax
purposes in the country in which the pension scheme is
established. For these purposes, pension schemes recognized for
tax purposes include, under U.S. law, qualified plans under
section 401(a), individual retirement plans (including
individual retirement plans that are part of a simplified
employee pension plan that satisfies section 408(k), individual
retirement accounts, individual retirement annuities, section
408(p) accounts, and Roth IRAs under section 408A), section
403(a) qualified annuity plans, and section 403(b) plans. Under
Danish law, pension schemes recognized for tax purposes include
pension schemes under Section 1 of the Act on Taxation of
Pension Schemes (pensionsbeskatningslovens afsnit I). The
proposed treaty includes a grandfather rule preserving taxation
only by the residence country if, prior to the entry into force
of the proposed treaty, a person was a resident of a treaty
country and was receiving pension distributions arising in the
other country.
Like the U.S. model, the proposed treaty provides that
payments made by one of the countries under the provisions of
the social security or similar legislation of a country to a
resident of the other country or to a U.S. citizen are taxable
only by the source country, and not by the country of
residence. The Technical Explanation states that the term
``similar legislation'' is intended to include U.S. tier 1
Railroad Retirement benefits. Consistent with the U.S. model,
this rule with respect to social security payments is an
exception to the proposed treaty's saving clause.
The proposed treaty provides that annuities are taxed only
in the country of residence of the individual who beneficially
owns and derives them. The term ``annuities'' is defined for
purposes of this provision as a stated sum paid periodically at
stated times during a specified number of years or for life
under an obligation to make the payments in return for adequate
and full consideration (other than services rendered).
Under the proposed treaty, alimony paid by a resident of
one country, and deductible therein, to a resident of the other
country is taxable only in the other country. For this purpose,
the term ``alimony'' means periodic payments made pursuant to a
written separation agreement or a decree of divorce, separate
maintenance, or compulsory support, which payments are taxable
to the recipient under the laws of the country of residence.
However, periodic payments (other than alimony) for the support
of a child made pursuant to a written separation agreement or a
decree of divorce, separate maintenance, or compulsory support,
paid by a resident of one country to a resident of the other
country, are taxable only in the payor's country of residence.
Article 19. Government Service
Under the proposed treaty, salaries, wages, and other
remuneration (other than a pension) paid from the public funds
of a treaty country or a political subdivision or local
authority thereof to an individual in respect of services
rendered to that country (or subdivision or authority) in the
discharge of functions of a governmental nature generally are
taxable only by that country. Such remuneration is taxable only
in the other country, however, if the services are rendered in
that other country by an individual who is a resident of that
country and who (1) is also a national of that country or (2)
did not become a resident of that country solely for the
purpose of rendering the services. This treatment is similar to
the rules under the U.S. and OECD models.
The proposed treaty further provides that any pension paid
from the public funds of one of the countries (or a political
subdivision or local authority thereof) to an individual in
respect of services rendered to that country (or subdivision or
authority) in the discharge of functions of a governmental
nature (other than social security payments described in
Article 18) is taxable only by that country. Such a pension is
taxable only by the other country, however, if the individual
is a resident and national of that other country. Social
security benefits in respect of government service are subject
to Article 18 (Pensions, Social Security, Annuities, Alimony
and Child Support Payments) and not this article.
The Technical Explanation states that the phrase
``functions of a governmental nature'' is generally understood
to encompass functions traditionally carried on by a
government. It generally would not include functions that
commonly are found in the private sector (e.g., education,
health care, utilities). Rather, it is limited to functions
that generally are carried on solely by the government (e.g.,
military, diplomatic service, tax administrators) and
activities that directly support the carrying out of those
functions.
The provisions of this article do not apply to remuneration
and pensions paid in respect of services rendered in connection
with a business carried on by a treaty country (or a political
subdivision or a local authority thereof). Rather, such
payments are subject to Articles 15 (Dependent Personal
Services), 16 (Directors' Fees), 17 (Artistes and Sportsmen),
and 18 (Pensions, Social Security, Annuities, Alimony and Child
Support Payments) as the case may be.
Article 20. Students and Trainees
Under the proposed treaty, payments received by a student,
apprentice, or business trainee who is, or was immediately
before visiting a country (the host country), a resident of the
other country, and who is present in the host country for the
purpose of his or her full-time education at an accredited
educational institution, or for his or her full-time training,
is not subject to tax in the host country. The exemption from
host country tax only applies to payments that arise outside of
the other country and are for the purpose of his or her
maintenance, education, or training. In the case of an
apprentice or business trainee, the exemption from host country
tax only applies for a period of no more than three years from
the date of first arrival for the purpose of his or her
training. The proposed treaty provides that this article does
not apply to income from research undertaken not in the public
interest, but primarily for the private benefit of a specific
person or persons.
This article of the proposed treaty is an exception from
the saving clause in the case of persons who are neither
citizens nor permanent residents of the host country. Thus, for
example, the United States would not tax such amounts paid to a
Danish citizen who is not a U.S. green-card holder but who
resides in the United States as a full-time student.
Article 21. Other Income
This article is a catch-all provision intended to cover
items of income not specifically covered in other articles, and
to assign the right to tax income from third countries to
either the United States or Denmark. As a general rule, items
of income not otherwise dealt with in the proposed treaty,
wherever arising, which are beneficially owned by residents of
one of the countries are taxable only in the country of
residence. This rule is similar to the rules in the U.S. and
OECD models.
This rule, for example, gives the United States the sole
right under the proposed treaty to tax income derived from
sources in a third country and paid to a U.S. resident. This
article is subject to the saving clause, so U.S. citizens who
are residents of Denmark will continue to be taxable by the
United States on their third-country income.
The general rule just stated does not apply to income
(other than income from real property as defined in Article 6)
if the beneficial owner of the income is a resident of one
country and carries on business in the other country through a
permanent establishment, or performs independent personal
services in the other country from a fixed base, and the income
is attributable to such permanent establishment or fixed base.
In such a case, the provisions of Article 7 (Business Profits)
or Article 14 (Independent Personal Services), as the case may
be, will apply. Such exception also applies where the income is
received after the permanent establishment or fixed base is no
longer in existence, but the income is attributable to the
former permanent establishment or fixed base.
Article 22. Limitation of Benefits
In general
The proposed treaty contains a provision generally intended
to limit the indirect use of the proposed treaty by persons who
are not entitled to its benefits by reason of residence in the
United States or Denmark.
The proposed treaty is intended to limit double taxation
caused by the interaction of the tax systems of the United
States and Denmark as they apply to residents of the two
countries. At times, however, residents of third countries
attempt to use a treaty. This use is known as ``treaty
shopping,'' which refers to the situation where a person who is
not a resident of either treaty country seeks certain benefits
under the income tax treaty between the two countries. Under
certain circumstances, and without appropriate safeguards, the
third-country resident may be able to secure these benefits
indirectly by establishing a corporation or other entity in one
of the treaty countries, which entity, as a resident of that
country, is entitled to the benefits of the treaty.
Additionally, it may be possible for the third-country resident
to reduce the income base of the treaty country resident by
having the latter pay out interest, royalties, or other amounts
under favorable conditions either through relaxed tax
provisions in the distributing country or by passing the funds
through other treaty countries until the funds can be
repatriated under favorable terms.
The proposed anti-treaty-shopping article provides that a
resident of either Denmark or the United States will be
entitled to the benefits of the proposed treaty only if the
resident is:
(1) an individual;
(2) a treaty country, a political subdivision or a
local authority thereof, or an agency or
instrumentality of such country, subdivision, or
authority;
(3) a company that satisfies one of three public
company tests;
(4) a charitable organization or other legal person
established and maintained exclusively for a religious,
charitable, educational, scientific, or other similar
purpose;
(5) a pension fund that satisfies an ownership test;
(6) an entity that satisfies both an ownership and
base erosion test; or
(7) in the case of Denmark, a taxable nonstock
corporation that satisfies a modified base erosion
test.
A resident that does not fit into any of the above
categories may claim treaty benefits with respect to certain
items of income under an active business test, or for shipping
and air transport income if certain conditions are satisfied. A
resident that does not fit into any of the above categories
also may claim treaty benefits if it satisfies a derivative
benefits test. Finally, in any case a resident of either
country may be entitled to the benefits of the proposed treaty
if the competent authority of the country in which the income
in question arises so determines.
Individuals
An individual resident of a treaty country is entitled to
the benefits of the proposed treaty.
Governments
Under the proposed treaty, the two countries, their
political subdivisions or local authorities, or agencies or
instrumentalities of the countries or their political
subdivisions or local authorities, are entitled to all treaty
benefits.
Public company tests
A company that is a resident of Denmark or the United
States is entitled to treaty benefits if more than 50 percent
of the vote and value of all classes of the shares in such
company are listed on a recognized stock exchange and are
substantially and regularly traded on one or more recognized
stock exchanges.
In addition, the company is entitled to treaty benefits if
more than 50 percent of the voting power of the company is
owned by one or more Danish taxable nonstock corporations
entitled to treaty benefits (described below), and all other
shares of the company are listed on a recognized stock exchange
and are substantially and regularly traded on one or more
recognized stock exchanges. The Technical Explanation states
that this rule is included to ensure that a corporation whose
voting shares are substantially owned by a Danish taxable
nonstock corporation is not precluded from qualifying as a
publicly traded company, so long as there is sufficient trading
in the remainder of its shares.
Alternatively, the company is entitled to treaty benefits
if at least 50 percent of each class of shares of the company
is owned (directly or indirectly) by five or fewer companies
that satisfy one of the two public company tests previously
described, provided that each intermediate owner used to
satisfy the control requirement is a resident of Denmark or the
United States.
For purposes of the above rules, the proposed treaty
provides that shares are considered to be substantially and
regularly traded on one or more recognized stock exchanges in a
taxable year if two conditions are satisfied. First, trades
must be effected other than in de minimis quantities during
every quarter. Second, the aggregate number of shares or units
traded during the previous taxable year must be at least 6
percent of the average number of shares or units outstanding
during that taxable year (including shares held by taxable
nonstock corporations).
A further test applies for a company in order to meet the
public company test described above through ownership by Danish
taxable nonstock corporations. Under this test, the
substantially and regularly traded requirement (described
above) is to be determined as if all the shares issued by the
company are one class of shares. Thus, shares held by Danish
taxable nonstock corporations in such company would be
considered outstanding for purposes of determining whether six
percent of the outstanding shares of the company are traded
during a taxable year. Without this rule, it might be possible
for a small class of shares to qualify a company as being
substantially and regularly traded.
Under the proposed treaty, the term ``recognized stock
exchange'' means (1) the NASDAQ System owned by the National
Association of Securities Dealers, Inc. and any stock exchange
registered with the U.S. Securities and Exchange Commission as
a national securities exchange under the U.S. Securities
Exchange Act of 1934; (2) the Copenhagen Stock Exchange and the
stock exchanges of Amsterdam, Brussels, Frankfurt, Hamburg,
London, Paris, Stockholm, Sydney, Tokyo, and Toronto; and (3)
any other stock exchange agreed upon by the competent
authorities of the countries.
Tax exempt organizations
An entity is entitled to the benefits under the proposed
treaty if it is a legal person organized under the laws of a
treaty country, generally exempt from tax in such country, and
established and maintained in such country exclusively for a
religious, charitable, educational, scientific, or other
similar purpose.
Pension funds
A legal person, whether or not exempt from tax, is entitled
to treaty benefits if (1) it is organized under the laws of a
treaty country to provide pension or other similar benefits to
employees, including self-employed individuals, pursuant to a
plan, and (2) more than 50 percent of the person's
beneficiaries, members, or participants are individuals
resident in either treaty country. This rule is similar but not
identical to the rule in the U.S. model. The Technical
Explanation states that since Denmark taxes pension funds, the
U.S. model rule was modified to allow such taxable entities to
qualify for treaty benefits.
Ownership and base erosion tests
Under the proposed treaty, an entity that is a resident of
one of the countries is entitled to treaty benefits if it
satisfies an ownership test and a base erosion test. Under the
ownership test, on at least half of the days during the taxable
year at least 50 percent of the beneficial interests in an
entity must be owned (directly or indirectly) by certain
qualified residents of the treaty country (i.e., an individual;
a treaty country, a political subdivision or a local authority
thereof, or its agencies or instrumentalities; a company that
satisfies one of the public company tests (described in the
discussion of public company tests above); a charitable
organization or other legal person established and maintained
exclusively for a religious, charitable, educational,
scientific, or other similar purpose; or a legal person that
satisfies the test for pension funds (described in the
discussion of pension funds above)). In the case of a company,
ownership is determined by reference to both the vote and value
of the company's shares. The Technical Explanation states that
trusts may be entitled to treaty benefits if they are treated
as residents of a treaty country and otherwise satisfy the
requirements under these provisions.
The base erosion test is satisfied only if less than 50
percent of the person's gross income for the taxable year is
paid or accrued (directly or indirectly), in the form of
deductible payments, to persons who are not residents of either
treaty country (unless the payment is attributable to a
permanent establishment situated in either treaty country). For
this purpose, deductible payments include payments for interest
or royalties, but do not include arm's length payments for the
purchase or use of or the right to use tangible property in the
ordinary course of business or arm's length remuneration for
services performed in the treaty country in which the person
making such payments is a resident. The competent authorities
may agree to add to, or eliminate from, the exceptions
mentioned in the preceding definition of ``deductible
payments.'' For purposes of measuring gross income, the term
means gross income for the first taxable period preceding the
current taxable period, provided that the amount of gross
income for such first taxable period is deemed to be no less
than the average of the annual amounts of gross income for the
four taxable periods preceding the current taxable period.
Danish taxable nonstock corporations
Under the proposed treaty, a Danish taxable nonstock
corporation is entitled to treaty benefits if it satisfies a
two-part modified base erosion test. The proposed treaty
provides that the term ``taxable nonstock corporation'' means a
foundation that is taxable in accordance with the Danish Act on
Taxable Nonstock Corporations (fonde der beskattes efter
fondsbeskatningsloven). The Technical Explanation states that a
Danish taxable nonstock corporation is a legal person that is
controlled by a professional board of directors, who must be
unrelated to the persons that formerly owned the operating
company controlled by the taxable nonstock corporation. The
Technical Explanation also states that a Danish taxable
nonstock corporation's capital is irrevocably separated from
the control of any founder that contributes assets at the time
such entity is established.
The modified base erosion test is satisfied if two
requirements are met. First, the amount paid or accrued by the
Danish taxable nonstock corporation in the form of deductible
payments in the taxable year and in each of the preceding three
taxable years (directly or indirectly) to persons who are not
generally qualified residents (excluding, for this purpose,
from the definition of qualified residents any companies that
satisfy the public company test through ownership by Danish
taxable nonstock corporations) of the proposed treaty under the
tests described above may not exceed 50 percent of its gross
income (excluding tax-exempt income).
Second, the amount paid or accrued, in the form of both
deductible payments and non-deductible distributions, in the
taxable year and in each of the preceding three taxable years
(directly or indirectly) to persons who are not generally
qualified residents of the proposed treaty under the tests
described above may not exceed 50 percent of its total income
(including tax-exempt income). For purposes of these rules,
deductible payments include deductible distributions made by a
Danish taxable nonstock corporation. This two-part test is a
modification of the ownership-base erosion test. The Technical
Explanation states that the ownership-base erosion test needed
to be modified because Danish taxable nonstock corporations do
not have owners and, thus, cannot be subject to any ownership
test. The Technical Explanation also states that the test
described above was included for Danish taxable nonstock
corporations in order to treat them as similarly as possible to
other Danish corporations.
Active business test
A resident satisfies the active business test if it is
engaged in the active conduct of a trade or business in its
country of residence; the income is connected with or
incidental to that trade or business; and the trade or business
is substantial in relation to the activity in the other country
generating the income. However, the business of making or
managing investments does not constitute an active trade or
business (and benefits therefore may be denied) unless such
activity is a banking, insurance, or securities activity
conducted by a bank, insurance company, or registered
securities dealer. Under the proposed treaty, the term
``engaged in the active conduct of a trade or business''
applies to a person that is directly engaged or to a partner in
a partnership that is so engaged, or is so engaged through one
or more associated enterprises, wherever resident.
The determination of whether a trade or business is
substantial is made based on all facts and circumstances.
However, the proposed treaty provides a safe harbor rule under
which a trade or business of the resident is considered to be
substantial if certain attributes of the residence-country
business exceed a threshold fraction of the corresponding
attributes of the trade or business located in the source
country that produces the source-country income. Under this
safe harbor, the attributes are assets, gross income, and
payroll expense. To satisfy the safe harbor, the level of each
such attribute in the active conduct of the trade or business
by the resident (and any related parties) in the residence
country, and the level of each such attribute in the trade or
business producing the income in the source country, is
measured for the prior year or for the prior three years. For
each separate attribute, the ratio of the residence country
level to the source country level is computed.
In general, the safe harbor is satisfied if, for the prior
year or for the average of the three prior years, the average
of the three ratios exceeds 10 percent, and each ratio
separately is at least 7.5 percent. These rules are similar to
those contained in the U.S. model. In determining these ratios,
only amounts to the extent of the resident's direct or indirect
ownership interest in the activity in the other treaty country
are taken into account. Under the proposed treaty, if neither
the resident nor any of its associated enterprises has an
ownership interest in the activity in the other country, the
resident's trade or business in its country of residence is
considered substantial in relation to such activity.
The proposed treaty provides that income is derived in
connection with a trade or business if the activity in the
other country generating the income is a line of business that
forms a part of or is complementary to the trade or business.
The Technical Explanation states that a business activity
generally is considered to ``form a part of'' a business
activity conducted in the other country if the two activities
involve the design, manufacture, or sale of the same products
or type of products, or the provision of similar services. The
Technical Explanation further provides that in order for two
activities to be considered to be ``complementary,'' the
activities need not relate to the same types of products or
services, but they should be part of the same overall industry
and be related in the sense that the success or failure of one
activity will tend to result in success or failure for the
other. Under the proposed treaty, income is incidental to a
trade or business if it facilitates the conduct of the trade or
business in the other country.
The term ``trade or business'' is not specifically defined
in the proposed treaty. However, as provided in Article 3
(General Definitions), undefined terms are to have the meaning
which they have under the laws of the country applying the
proposed treaty. In this regard, the Technical Explanation
states that the U.S. competent authority will refer to the
regulations issued under Code section 367(a) to define an
active trade or business.
Derivative benefits test
The proposed treaty contains a reciprocal derivative
benefits rule. This rule effectively allows a Danish company,
for example, to receive ``derivative benefits'' in the sense
that it derives its entitlement to U.S. tax reductions in part
from the U.S. treaty benefits to which its owners would be
entitled if they earned the income directly. If the
requirements of this rule are satisfied, a company that is
resident in one of the countries will be entitled to the
benefits of the treaty.
First, the company must satisfy an ownership test. Under
this test, at least 95 percent of the aggregate vote and value
of all of the company's shares must be owned (directly or
indirectly) by seven or fewer residents of the member states of
the European Union (``EU''), European Economic Area (``EEA''),
or parties to the North American Free Trade Agreement
(``NAFTA'').
Second, the company must satisfy a base erosion test. Under
this test, less than 50 percent of the gross income of the
company for the year may be paid or accrued by the company as
deductible amounts (directly or indirectly) to persons other
than residents of the member states of the EU, EEA, or parties
to the NAFTA.
A company will not be considered to have satisfied the
ownership or base erosion requirements above if it, or a
company that controls it, has an outstanding class of shares
(1) with terms (or other arrangements) that entitle its holders
to a portion of the company's income derived in the other
treaty country that is larger than the portion applicable in
the absence of such terms (or arrangements) and (2) which is
50-percent or more owned (based on vote or value) by persons
who are not residents of member states of the EU, the EEA, or
parties to the NAFTA .
For purposes of the rules described above, the proposed
treaty provides that a person is considered a resident of an
EU, EEA, or NAFTA country, only if such person would be
entitled to the benefits of a comprehensive income tax treaty
in force between any member state of the EU, EEA, or party to
the NAFTA and the country from which the benefits of such
treaty are being claimed; provided that, if the applicable
treaty between the owner's country of residence and the source
country does not contain a comprehensive limitation on benefits
article (including provisions similar to the public company
tests, the ownership and base erosion tests, and the active
business test, as described above), the owner itself would be a
qualified resident under the proposed treaty (under the rules
described above) if such person were a resident of the United
States or Denmark, as the case may be under Article 4
(Residence).
The proposed treaty imposes an additional condition for a
company that is claiming benefits under the treaty with respect
to certain types of income. Specifically, dividends, interest,
or royalties in respect of which benefits are claimed under the
proposed treaty must be subject to a rate of tax under such
other treaty that is at least as low as the rates applicable to
such company under the corresponding provisions of the proposed
treaty.
Shipping and air transport test
A resident of one country that derives shipping or aircraft
income from the other country is entitled to treaty benefits
with respect to such interest if at least 50 percent of the
beneficial interests in the resident (or in the case of a
company, at least 50 percent of the vote and value of such
company) is owned, directly or indirectly, by qualified persons
(as described above), U.S. citizens or residents, or
individuals who are residents of a third country, or a company
or companies the stock of which is primarily and regularly
traded on an established securities market in the third
country. However, this rule applies only if the third country
grants an exemption for shipping and aircraft income under
similar terms to citizens and corporations of the source
country either under its laws, in common agreement with the
other country, or under a treaty between the third country and
the other country.
Grant of treaty benefits by the competent authority
The proposed treaty provides a ``safety-valve'' for a
person that has not established that it meets one of the other
more objective tests, but for which the allowance of treaty
benefits would not give rise to abuse or otherwise be contrary
to the purposes of the treaty. Under this provision, such a
person may be granted treaty benefits if the competent
authority of the source country so determines. The
corresponding article in the U.S. model contains a similar
rule. The Technical Explanation states that for this purpose,
factors the competent authorities will take into account are
whether the establishment, acquisition, and maintenance of the
person, and the conduct of its operations, did not have as one
of its principal purposes the obtaining of treaty benefits.
Article 23. Relief from Double Taxation
Internal taxation rules
United States
The United States taxes the worldwide income of its
citizens and residents. It attempts unilaterally to mitigate
double taxation generally by allowing taxpayers to credit the
foreign income taxes that they pay against U.S. tax imposed on
their foreign-source income. An indirect or ``deemed-paid''
credit is also provided. Under this rule, a U.S. corporation
that owns 10 percent or more of the voting stock of a foreign
corporation and that receives a dividend from the foreign
corporation (or an inclusion of the foreign corporation's
income) is deemed to have paid a portion of the foreign income
taxes paid (or deemed paid) by the foreign corporation on its
earnings. The taxes deemed paid by the U.S. corporation are
included in its total foreign taxes paid for the year the
dividend is received.
Denmark
Danish double tax relief is allowed either through a
foreign tax credit or through an exemption with progression
(where tax-exempt income is considered for purposes of
determining the tax rate on taxable income, but is otherwise
not taxable income). Danish tax credits are, like in the United
States, limited to the lesser of the foreign tax paid or the
Danish tax that would have been imposed on the amount of the
income. Unlike the United States, the foreign tax credit
limitation is determined on a per-country basis.
Proposed treaty limitations on internal law
One of the principal purposes for entering into an income
tax treaty is to limit double taxation of income earned by a
resident of one of the countries that may be taxed by the other
country. Unilateral efforts to limit double taxation are
imperfect. Because of differences in rules as to when a person
may be taxed on business income, a business may be taxed by two
countries as if it were engaged in business in both countries.
Also, a corporation or individual may be treated as a resident
of more than one country and be taxed on a worldwide basis by
both.
Part of the double tax problem is dealt with in other
articles of the proposed treaty that limit the right of a
source country to tax income. This article provides further
relief where both Denmark and the United States otherwise still
tax the same item of income. This article is not subject to the
saving clause, so that the country of citizenship or residence
will waive its overriding taxing jurisdiction to the extent
that this article applies.
The present treaty provides separate rules for relief from
double taxation for the United States and Denmark. The present
treaty generally provides for relief from double taxation of
U.S. citizens, residents and corporations by requiring the
United States to permit a credit against its tax for taxes paid
to Denmark. The determination of this credit is made in
accordance with U.S. law. In the case of Denmark, the present
treaty generally provides for relief from double taxation for
taxes paid to the United States on the following types of
income: industrial or commercial profits, natural resource
royalties, certain government services income, student and
trainee income, teacher and professor income, and income earned
within the United States. However, the amount of relief granted
by Denmark cannot exceed the proportion of Danish taxes which
such income bears to the entire income subject to tax by
Denmark. Denmark also allows as a deduction from its taxes an
amount equal to 15 percent (5 percent in certain cases) of the
gross amount of U.S.-source dividends.
The proposed treaty generally provides that the United
States will allow a U.S. resident or citizen a foreign tax
credit for the income taxes imposed by Denmark. The proposed
treaty also requires the United States to allow a deemed-paid
credit, with respect to Danish income tax, to any U.S. company
that receives dividends from a Danish company if the U.S.
company owns 10 percent or more of the voting stock of such
Danish company. The credit generally is to be computed in
accordance with the provisions and subject to the limitations
of U.S. law (as such law may be amended from time to time
without changing the general principles of the proposed treaty
provisions). This provision is similar to those found in the
U.S. model and many U.S. treaties.
The proposed treaty provides that the taxes referred to in
paragraphs 1(b) and 2 of Article 2 (Taxes Covered) will be
considered creditable income taxes for purposes of the proposed
treaty, subject to all the provisions and limitations of
Article 23 (Relief from Double Taxation) of the proposed
treaty. This includes the Danish national income tax, the
Danish municipal income tax, the Danish income tax to the
county municipalities, and taxes imposed under the Danish
Hydrocarbon Tax Act.
The proposed treaty provides special rules and limits to
determine the appropriate amount of creditable taxes paid or
accrued to Denmark by or on behalf of a U.S. national or
resident on income separately assessed under the Hydrocarbon
Tax Act. In connection with the special rules with respect to
the creditability of taxes imposed under the Hydrocarbon Tax
Act, the Technical Explanation states that the provisions in
some respects allow for greater foreign tax credits than under
U.S. statutory law. Specifically, the proposed treaty provides
that, in the case of a U.S. resident or national subject to
taxes imposed under the Hydrocarbon Tax Act, the United States
will allow as a credit against United States tax on income the
amount of tax paid or accrued to Denmark by the U.S. resident
or national pursuant to the Hydrocarbon Tax Act on oil and gas
extraction income from oil or gas wells in Denmark. The
proposed treaty limits the creditable amount, however, to the
product of (1) the maximum statutory U.S. rate applicable to
the U.S. resident or national for the taxable year and (2) the
amount of income separately assessed under the Hydrocarbon Tax
Act. The proposed treaty further provides that its special
rules on creditability apply separately, and in the same way,
to the amount of tax paid or accrued to Denmark pursuant to the
Hydrocarbon Tax Act on Danish-source oil related income and
other Danish-source income.
The proposed treaty also provides that for persons claiming
benefits under the treaty, the amount of any U.S. tax credit
with respect to taxes paid in connection with the Hydrocarbon
Tax Act is also subject to any other limitations imposed under
U.S. law, as it may be amended from time to time, that apply to
creditable taxes under section 901 or 903 of the Code.
Any taxes paid on income assessed separately under the
Hydrocarbon Tax Act in excess of the creditable amount after
application of the proposed treaty and Code limitations may be
used only as a credit in another taxable year (carried over to
those years specified under U.S. law--i.e., carried back two
years and carried forward five years), and only against United
States tax on income assessed separately under the Hydrocarbon
Tax Act.
Thus, the proposed treaty operates to create a separate
``per-country'' limitation with respect to each U.S. category
of extraction income or oil-related income on which tax is
separately assessed under the Hydrocarbon Tax Act. Accordingly,
the taxes paid pursuant to the Hydrocarbon Tax Act with respect
to oil and gas extraction income in Denmark cannot be used as a
credit to offset U.S. tax on (1) oil and gas extraction income
arising in another country, (2) Danish-source oil-related
income or other income on which tax is imposed under the
Hydrocarbon Tax Act, or (3) other Danish-source non-oil-related
income. The Technical Explanation states that if a person
earning income that is separately assessed under the
Hydrocarbon Tax Act chooses in a year not to rely on the
provisions of the proposed treaty to claim a foreign tax credit
for any amounts paid to Denmark, then the special ``per-
country'' limitation would not apply for that year. Instead,
the current overall foreign tax credit limitations of the Code
would apply, and the Danish taxes creditable under the Code
could be used, subject to the Code's limitations, to offset
U.S. tax on income from Danish and other foreign sources.
The proposed treaty, like the U.S. model and other U.S.
treaties, contains a special rule designed to provide relief
from double taxation for U.S. citizens who are Danish
residents. Under this rule, Denmark will allow a foreign tax
credit to a U.S. citizen who is resident in Denmark by taking
into account only the amount of U.S. taxes paid pursuant to the
proposed treaty (other than taxes that may be imposed solely by
reason of citizenship under the saving clause of paragraph 4 of
Article 1 (General Scope)) with respect to items of income that
are either exempt from U.S. tax or are subject to a reduced
rate of tax when derived by a Danish resident who is not a U.S.
citizen. The United States will then credit the income tax
actually paid to Denmark, determined after application of the
preceding sentence. The proposed treaty recharacterizes the
income that is subject to Danish taxation as foreign source
income for purposes of this computation, but only to the extent
necessary to avoid double taxation of such income.
The proposed treaty generally provides that Denmark will
allow its residents, who derive income that may be subject to
tax in the United States and Denmark, a deduction against
Danish income tax for the U.S. income taxes paid. The reduction
cannot exceed the pre-credit amount of Danish income tax
attributable to the income that may be taxed in the United
States. Under the proposed treaty, a Danish resident who
derives income which, in accordance with the proposed treaty,
is taxable only in the United States may be required to include
such income in its tax base for Danish tax purposes, but will
also be allowed a deduction from income tax for that part of
the income tax which is attributable to the income derived from
the United States.
Article 24. Non-Discrimination
The proposed treaty contains a comprehensive non-
discrimination article relating to all taxes of every kind
imposed at the national, state, or local level. It is similar
to the non-discrimination article in the U.S. model and to
provisions that have been included in other recent U.S. income
tax treaties.
In general, under the proposed treaty, one country cannot
discriminate by imposing more burdensome taxes (or requirements
connected with taxes) on nationals of the other country than it
would impose on its citizens in the same circumstances,
particularly with respect to taxation of worldwide income. This
provision applies whether or not the persons in question are
residents of the United States or Denmark.
Under the proposed treaty, neither country may tax a
permanent establishment of an enterprise (or a fixed base of a
resident) of the other country less favorably than it taxes its
own enterprises carrying on the same activities. Consistent
with the U.S. model and the OECD model, however, a country is
not obligated to grant residents of the other country any
personal allowances, reliefs, or reductions for tax purposes on
account of civil status or family responsibilities that are
granted to its own residents.
Each country is required (subject to the arm's-length
pricing rules of paragraph 1 of Article 9 (Associated
Enterprises), paragraph 4 of Article 11 (Interest), and
paragraph 4 of Article 12 (Royalties)) to allow its residents
to deduct interest, royalties, and other disbursements paid by
them to residents of the other country under the same
conditions that it allows deductions for such amounts paid to
residents of the same country as the payor. The Technical
Explanation states that the term ``other disbursements'' is
understood to include a reasonable allocation of executive and
general administrative expenses, research and development
expenses, and other expenses incurred for the benefit of a
group of related persons. The Technical Explanation further
states that the rules of section 163(j) of the Code are not
discriminatory within the meaning of this provision. The
proposed treaty further provides that any debts of an
enterprise of one country to a resident of the other country
are deductible for purposes of computing the capital tax of the
debtor's country of residence under the same conditions as if
the debt had been owed to a resident of the country imposing
such tax.
The non-discrimination rules also apply to enterprises of
one country that are owned in whole or in part by residents of
the other country. Enterprises resident in one country, the
capital of which is wholly or partly owned or controlled,
directly or indirectly, by one or more residents of the other
country, will not be subjected in the first country to any
taxation (or any connected requirement) which is more
burdensome than the taxation (or connected requirements) that
the first country imposes or may impose on its similar
enterprises. The Technical Explanation includes examples of
Code provisions that are understood by the two countries not to
violate this provision of the proposed treaty. Those examples
include the rules that impose a withholding tax on non-U.S.
partners of a partnership and the rules that prevent foreign
persons from owning stock in Subchapter S corporations.
The proposed treaty provides that nothing in the non-
discrimination article is to be construed as preventing either
of the countries from imposing a branch profits tax.
Notwithstanding the definition of taxes covered in Article 2,
this article applies to taxes of every kind and description
imposed by either country, or a political subdivision or local
authority thereof.
The saving clause (which allows the country of residence or
citizenship to impose tax notwithstanding certain treaty
provisions) does not apply to the non-discrimination article.
Therefore, a U.S. citizen resident in Denmark may claim
benefits with respect to the United States under this article.
Article 25. Mutual Agreement Procedure
The proposed treaty contains the standard mutual agreement
provision, with some variation, that authorizes the competent
authorities of the two countries to consult together to attempt
to alleviate individual cases of double taxation not in
accordance with the proposed treaty. The saving clause of the
proposed treaty does not apply to this article, so that the
application of this article might result in a waiver (otherwise
mandated by the proposed treaty) of taxing jurisdiction by the
country of citizenship or residence.
Under this article, a resident of one country who considers
that the action of one or both of the countries will cause him
or her to be subject to tax which is not in accordance with the
proposed treaty may present his or her case to the competent
authority of the country of which he or she is a resident or
national. A case may be presented to the competent authority
irrespective of the remedies provided by domestic law and the
time limits prescribed in such laws for presentation of claims
for refund.
If the objection appears to the competent authority to be
justified and if it is not itself able to arrive at a
satisfactory solution, that competent authority will endeavor
to resolve the case by mutual agreement with the competent
authority of the other country, with a view to the avoidance of
taxation which is not in accordance with the proposed treaty.
The provision authorizes a waiver of the statute of limitations
of either country. Any assessment and collection procedures are
suspended during the pendency of any mutual agreement
proceeding.
The competent authorities of the countries will endeavor to
resolve by mutual agreement any difficulties or doubts arising
as to the interpretation or application of the proposed treaty.
In particular, the competent authorities may agree to the
following: (1) the same attribution of income, deductions,
credits, or allowances of an enterprise of one treaty country
to the enterprise's permanent establishment situated in the
other country; (2) the same allocation of income, deductions,
credits, or allowances between persons; (3) the same
characterization of particular items of income; (4) the same
characterization of persons; (5) the same application of source
rules with respect to particular items of income; (6) a common
meaning of a term; (7) increases in any specific dollar amounts
referred to in the proposed treaty to reflect economic or
monetary developments; (8) advance pricing arrangements; and
(9) the application of the provisions of each country's
internal law regarding penalties, fines, and interest in a
manner consistent with the purposes of the proposed treaty. The
competent authorities may also consult together for the
elimination of double taxation regarding cases not provided for
in the proposed treaty. This treatment is similar to the
treatment under the U.S. model.
The proposed treaty authorizes the competent authorities to
communicate with each other directly for purposes of reaching
an agreement in the sense of this mutual agreement article. The
Technical Explanation states that this provision makes clear
that it is not necessary to go through diplomatic channels in
order to discuss problems arising in the application of the
proposed treaty.
Article 26. Exchange of Information
This article provides for the exchange of information
between the two countries. Notwithstanding the provisions of
Article 2 (Taxes Covered), the proposed treaty's information
exchange provisions apply to all taxes imposed in either
country at the national level.
The proposed treaty provides that the two competent
authorities will exchange such information as is relevant to
carry out the provisions of the proposed treaty or the
provisions of the domestic laws of the two countries concerning
taxes to which the proposed treaty applies (provided that the
taxation under those domestic laws is not contrary to the
proposed treaty). Such information may relate to the assessment
or collection of, the enforcement or prosecution in respect of,
or the determination of appeals in relation to, the taxes
covered by the proposed treaty. This exchange of information is
not restricted by Article 1 (General Scope). Therefore,
information with respect to third-country residents is covered
by these procedures.
Any information exchanged under the proposed treaty will be
treated as secret in the same manner as information obtained
under the domestic laws of the country receiving the
information. The exchanged information may be disclosed only to
persons or authorities (including courts and administrative
bodies) involved in the assessment, collection or
administration of, the enforcement or prosecution in respect
of, or the determination of appeals in relation to, the taxes
to which the proposed treaty would apply. Such persons or
authorities must use the information for such purposes only.\7\
The Technical Explanation states that persons involved in the
administration of taxes include legislative bodies with
oversight roles with respect to the administration of the tax
laws, such as, for example, the tax-writing committees of
Congress and the General Accounting Office. Information
received by these bodies must be for use in the performance of
their role in overseeing the administration of U.S. tax laws.
Exchanged information may be disclosed in public court
proceedings or in judicial decisions.
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\7\ Code section 6103 provides that otherwise confidential tax
information may be utilized for a number of specifically enumerated
non-tax purposes. Information obtained by the United States pursuant to
the proposed treaty could not be used for these non-tax purposes.
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As is true under the U.S. model and the OECD model, under
the proposed treaty, a country is not required to carry out
administrative measures at variance with the laws and
administrative practice of the other country, to supply
information that is not obtainable under the laws or in the
normal course of the administration of the other country, or to
supply information that would disclose any trade, business,
industrial, commercial, or professional secret or trade process
or information the disclosure of which would be contrary to
public policy.
Notwithstanding the preceding paragraph, a country has the
authority to obtain and provide information held by financial
institutions, nominees, or persons acting in an agency or
fiduciary capacity. It also has the authority to obtain
information respecting interests in a person. If information is
requested by a treaty country pursuant to this article, the
other country is obligated to obtain the requested information
in the same manner and to the same extent as if the tax in
question were the tax of the requested country, even if the
requested country has no direct tax interest in the case to
which the request relates. If specifically requested, the
competent authority of a country must provide information in
the form of depositions of witnesses and authenticated copies
of unedited original documents (including books, papers,
statements, records, accounts, and writings), to the same
extent such depositions and documents can be obtained under the
laws and administrative practices of the requested country with
respect to its own taxes.
Article 27. Administrative Assistance
The proposed treaty provides that the countries are to
undertake to lend assistance to each other in collecting all
categories of taxes (as described in Article 2) collected by or
on behalf of the government of each country, together with
interest, costs, additions to such taxes, and civil penalties
(referred to as a ``revenue claim''). The assistance provision
is substantially broader than the most nearly comparable
provision in the U.S. model, but similar in scope to the
existing U.S.-Denmark treaty. It is also similar to the
corresponding provisions in several U.S. treaties, including
the treaties with Canada and the Netherlands.
When one country applies to the other for assistance in
enforcing a revenue claim, its application must include a
certification that the taxes have been finally determined under
its own laws. For purposes of this article, a revenue claim is
finally determined when the applicant country has the right
under its internal law to collect the revenue claim and all
administrative and judicial rights of the taxpayer to restrain
collection in the applicant country have lapsed or been
exhausted.
The proposed treaty specifies that each country may accept
for collection a revenue claim of the other country which has
been finally determined. Consistent with this language, the
Technical Explanation states that each country has the
discretion whether to accept any particular application for
collection assistance. If the application for assistance is
accepted, generally the accepting country is to collect the
revenue claim as though it were its own revenue claim, finally
determined in accordance with the laws applicable to the
collection of its own taxes. However, a revenue claim of an
applicant country accepted for collection will not have, in the
requested country, any priority accorded to the revenue claims
of the requested country.
When a treaty country accepts a request for assistance in
collection, the claim will be treated by such country as an
assessment under its laws against the taxpayer as of the time
the application is received.
Nothing in this administrative assistance article is to be
construed as creating or providing any rights of administrative
or judicial review of the applicant country's finally
determined revenue claim by the requested country, based on any
such rights that may be available under the laws of either
country. On the other hand, if, at any time pending execution
of a request for assistance under this provision, the applicant
country loses the right under its internal law to collect the
revenue claim, its competent authority must promptly withdraw
the request for assistance in collection.
In general, amounts collected under this article by the
requested country must be forwarded to the competent authority
of the applicant country. Unless the competent authorities
otherwise agree, the ordinary costs incurred in providing
assistance are to be borne by the requested country, and any
extraordinary costs by the applicant country.
No assistance is required to be provided under this article
for a revenue claim with respect to an individual taxpayer to
the extent that the taxpayer can demonstrate that the claim
relates to a taxable period in which the taxpayer was a citizen
of the country from which assistance is requested. Similarly,
where the taxpayer is a company, estate, or trust, no
assistance is required to be provided under this article for a
revenue claim to the extent that the claim relates to a taxable
period in which the taxpayer derived its status as such an
entity from the laws in force in the requested country. The
only collection assistance required in such cases would be
assistance authorized under the proposed treaty's mutual
agreement procedure article.
Each treaty country will endeavor to collect on behalf of
the other country such amounts as may be necessary to ensure
that relief granted by the proposed treaty from taxation
imposed by the other country does not inure to the benefit of
persons not entitled thereto.
Nothing in this article is to be construed as requiring
either country to carry out administrative measures of a
different nature from those used in the collection of its own
taxes, or that would be contrary to its public policy. The
competent authorities shall agree upon the mode of application
of the article, including agreement to ensure comparable levels
of assistance to each country.
A requested country is not obligated to accede to the
request of the applicant country if the applicant country has
not pursued all appropriate collection action in its own
jurisdiction or in those cases where the administrative burden
for the requested country is disproportionate to the benefit to
be derived by the applicant country.
Article 28. Diplomatic Agents and Consular Officers
The proposed treaty contains the rule found in the U.S.
model and other U.S. tax treaties that its provisions do not
affect the fiscal privileges of diplomatic agents or consular
officers under the general rules of international law or under
the provisions of special agreements. Accordingly, the proposed
treaty will not defeat the exemption from tax which a host
country may grant to the salary of diplomatic officials of the
other country. The saving clause does not apply in the
application of this article to host country residents who are
neither citizens nor lawful permanent residents of that
country. Thus, for example, U.S. diplomats who are considered
Danish residents may be protected from Danish tax.
Article 29. Entry into Force
The proposed treaty will enter into force on the date on
which the second of the two notifications of the completion of
ratification requirements has been received. Each country must
notify the other when its requirements for ratification have
been satisfied.
With respect to taxes withheld at source, the proposed
treaty will be effective for amounts paid or credited on or
after the first day of the second month next following the date
on which the proposed treaty enters into force. With respect to
other taxes, the proposed treaty will be effective for taxable
years beginning on or after the first day of January next
following the date on which the proposed treaty enters into
force.
Taxpayers may elect temporarily to continue to claim
benefits under the present treaty with respect to a period
after the proposed treaty takes effect. For such a taxpayer,
the present treaty would continue to have effect in its
entirety for one year after the date on which the provisions of
the proposed treaty would otherwise take effect. The present
treaty ceases to have effect once the provisions of the
proposed treaty take effect, and will terminate on the last
date on which it has effect in accordance with the provisions
of this article.
Article 30. Termination
The proposed treaty will continue in force until terminated
by either country. Either country may terminate the proposed
treaty at any time by giving written notice of termination
through diplomatic channels. A termination is effective, with
respect to taxes withheld at source for amounts paid or
credited six months after the date on which notice of
termination was given. In the case of other taxes, a
termination is effective for taxable periods beginning on or
after six months from the date on which notice of termination
was given.
IV. ISSUES
The proposed treaty with Denmark, as supplemented by the
proposed protocol, presents the following specific issues.
A. Creditability of Danish Hydrocarbon Tax
Treatment under the proposed treaty
The proposed treaty extends coverage to taxes imposed under
the Danish Hydrocarbon Tax Act (paragraph 1(b)(iv) of Article 2
(Taxes Covered)). Article 23 of the proposed treaty (Relief
from Double Taxation) further provides, among other things,
that the taxes imposed under the Hydrocarbon Tax Act are to be
considered income taxes that are creditable against U.S. tax on
income, subject to the provisions and limitations of that
provision of the proposed treaty.
Specifically, the proposed treaty provides that, in the
case of a U.S. resident or national subject to taxes imposed
under the Hydrocarbon Tax Act, the United States will allow as
a credit against United States tax on income the amount of tax
paid or accrued to Denmark by the U.S. resident or national
pursuant to the Hydrocarbon Tax Act on oil and gas extraction
income from oil or gas wells in Denmark. The proposed treaty
limits the creditable amount, however, to the product of (1)
the maximum statutory U.S. rate applicable to the U.S. resident
or national for the taxable year and (2) the amount of income
separately assessed under the Hydrocarbon Tax Act. The proposed
treaty further provides that its special rules on creditability
apply separately, and in the same way, to the amount of tax
paid or accrued to Denmark pursuant to the Hydrocarbon Tax Act
on Danish-source oil related income and other Danish-source
income.
The proposed treaty also provides that for persons claiming
benefits under the treaty, the amount of any U.S. tax credit
with respect to taxes paid in connection with the Hydrocarbon
Tax Act is also subject to any other limitations imposed under
U.S. law, as it may be amended from time to time, that apply to
creditable taxes under section 901 or 903 of the Code.
Any taxes paid on income assessed separately under the
Hydrocarbon Tax Act in excess of the creditable amount after
application of the treaty and Code limitations may be used only
as a credit in another taxable year (carried over to those
years specified under U.S. law--i.e., carried back two years
and carried forward five years), and only against United States
tax on income assessed separately under the Hydrocarbon Tax
Act.
Thus, the proposed treaty operates to create a separate
``per-country'' limitation with respect to each U.S. category
of extraction income or oil-related income on which tax is
separately assessed under the Hydrocarbon Tax Act. Accordingly,
the taxes paid pursuant to the Hydrocarbon Tax Act with respect
to oil and gas extraction income in Denmark cannot be used as a
credit to offset U.S. tax on (1) oil and gas extraction income
arising in another country, (2) Danish-source oil-related
income or other income on which tax is imposed under the
Hydrocarbon Tax Act, or (3) other Danish-source non-oil-related
income.
To the extent that a taxpayer would obtain a more favorable
result with respect to the creditability of the Danish taxes
under the Code than under the proposed treaty, the taxpayer
could choose not to rely on the proposed treaty.\8\ The
Technical Explanation to Article 23 states that if a person
earning income that is separately assessed under the
Hydrocarbon Tax Act chooses in a year not to rely on the
provisions of the proposed treaty to claim a foreign tax credit
for any amounts paid to Denmark, then the special ``per-
country'' limitation of Article 23 would not apply for that
year. Instead, the current overall foreign tax credit
limitations of the Code would apply, and the Danish taxes
creditable under the Code could be used, subject to the Code's
limitations, to offset U.S. tax on income from Danish and other
foreign sources.
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\8\ See paragraph 2 of Article 1 of the proposed treaty (General
Scope), and accompanying description in the Technical Explanation.
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Danish internal law
The Danish Hydrocarbon Tax Act was introduced in 1982 to
tax income earned from certain activities in connection with
the surveying, exploration and extraction of hydrocarbons. The
Act extends the jurisdiction to tax under Danish internal law
in certain circumstances to areas beyond the Danish land
territory and the territorial sea.
Under the Hydrocarbon Tax Act, taxpayers with oil and gas
concessions are required to pay a company tax at the same rate
(currently 32 percent) as other companies, which is assessed
under ordinary rules, but with additional limitations. In
addition, a separate hydrocarbon tax is assessed at a rate of
70 percent of the aggregate taxable income of fields showing
profits. The Hydrocarbon Tax Act generally imposes a tax on
income in connection with preliminary surveys, exploration, and
extraction of hydrocarbons in Denmark, and any related
activity, including the installation of pipelines, supply
services and transport by ship and pipelines of hydrocarbons
extracted. Regular Danish corporate and income taxes are
deductible in computing taxable income subject to the separate
hydrocarbon tax. Losses arising from other activities may not
be set off against hydrocarbon income, but hydrocarbon losses
may be deducted from other profits. Other special deduction and
allowance rules also apply.
Issues
The proposed treaty treats the Danish hydrocarbon tax, and
any substantially similar tax, as a creditable tax for U.S.
foreign tax credit purposes. No specific determination has been
made administratively or judicially concerning the
creditability of the Danish hydrocarbon tax under the Code.\9\
It is unclear the extent to which the taxes imposed under the
Hydrocarbon Tax Act would be creditable under U.S. law. In
fact, the Technical Explanation to Article 23 states that in
connection with the Hydrocarbon Tax Act, the proposed treaty in
some respects allows for greater foreign tax credits than under
U.S. statutory law.
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\9\ Although there have been no specific determinations with
respect to the Danish hydrocarbon tax, the United States Tax Court has
recently addressed the issue of the creditability under the Code and
the prior temporary Treasury regulations under Code section 901 of
special charges imposed under Norway's Petroleum Tax Act in Phillips
Petroleum Co. v. Commissioner, 104 T.C. 256 (1995). The Norwegian
petroleum tax was found to be creditable; however, the court was not
applying the current final Treasury regulations under section 901. In
addition, such determinations are inherently factual; therefore, the
determination of the creditability of taxes imposed under the Danish
Hydrocarbon Tax Act under U.S. law is still an open issue.
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The primary issue is the extent to which treaties should be
used to provide a credit for taxes that may not otherwise be
fully creditable and, in cases where a treaty does provide
creditability, to what extent the treaty should impose
limitations not contained in the Code. A related issue is
whether a controversial matter in U.S. tax policy such as the
tax credits to be allowed U.S. oil companies on their foreign
extraction operations should be resolved through the treaty
process rather than the regular legislative process. In
considering these issues, it is important for the Committee to
be aware that the tax credits allowed under the proposed treaty
for Danish taxes could be somewhat larger than the credits
otherwise allowed under Treasury regulations and, therefore,
potentially could reduce somewhat the U.S. taxes collected from
U.S. oil companies operating in the Danish sector of the North
Sea. Because of the treaty's per-country limitation on the
treaty credit and the creditability of the regular Danish
income tax in the absence of the treaty, that reduction will be
limited. However, taxpayers are likely to rely upon the
proposed treaty only to the extent that it provides them with a
more favorable foreign tax credit result than would otherwise
result from the application of the Code.
Although it is no longer U.S. treaty policy generally to
provide a credit for foreign taxes on oil and gas extraction
income like the Danish hydrocarbon tax, similar provisions
making the United Kingdom's Petroleum Revenue Tax, Norway's
Submarine Petroleum Resource Tax, and the Netherlands' Profit
Share creditable are contained in the third protocol to the
U.S.-United Kingdom income tax treaty, the protocol to the
U.S.-Norway income tax treaty, and the U.S.-Netherlands income
tax treaty, respectively.\10\ Also at issue, therefore, is
whether Denmark should be denied a special treaty credit for
taxes on oil and gas extraction income when Norway, the
Netherlands, and the United Kingdom, its North Sea competitors,
now receive a similar treaty credit under the U.S. income tax
treaties with those countries currently in force. On the one
hand, it would appear fair to treat Denmark like Norway, the
Netherlands, and the United Kingdom. On the other hand, the
United States should not view any particular treaty concession
to one country as requiring identical or similar concessions to
other countries.
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\10\ In the case of the U.S.-United Kingdom treaty, there was a
threatened reservation on the provision. In response, the per-country
limitation was inserted in that protocol.
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A prior proposed U.S. income tax treaty with Denmark
contained a similar provision providing for the creditability
of taxes imposed under the Hydrocarbon Tax Act. The Committee
reported favorably on the treaty (and its protocol) in 1984 and
1985. During Senate consideration of the treaty in 1985,
objections were raised regarding the creditability under the
treaty of the Danish hydrocarbon tax. The Senate has not given
its advice and consent to ratification of that treaty. The
Committee may wish to consider whether the proposed treaty is
an appropriate vehicle for granting creditability of the Danish
hydrocarbon tax.
B. Treaty Shopping
The proposed treaty, like a number of U.S. income tax
treaties, generally limits treaty benefits for treaty country
residents so that only those residents with a sufficient nexus
to a treaty country will receive treaty benefits. Although the
proposed treaty generally is intended to benefit residents of
Denmark and the United States only, residents of third
countries sometimes attempt to use a treaty to obtain treaty
benefits. This is known as treaty shopping. Investors from
countries that do not have tax treaties with the United States,
or from countries that have not agreed in their tax treaties
with the United States to limit source country taxation to the
same extent that it is limited in another treaty may, for
example, attempt to reduce the tax on interest on a loan to a
U.S. person by lending money to the U.S. person indirectly
through a country whose treaty with the United States provides
for a lower rate of withholding tax on interest. The third-
country investor may attempt to do this by establishing in that
treaty country a subsidiary, trust, or other entity which then
makes the loan to the U.S. person and claims the treaty
reduction for the interest it receives.
The anti-treaty-shopping provision of the proposed treaty
is similar to anti-treaty-shopping provisions in the Code (as
interpreted by Treasury regulations) and in the U.S. model. The
provision also is similar to the anti-treaty-shopping provision
in several recent treaties. The degree of detail included in
these provisions is notable in itself. The proliferation of
detail may reflect, in part, a diminution in the scope afforded
the IRS and the courts to resolve interpretive issues adversely
to a person attempting to claim the benefits of a treaty; this
diminution represents a bilateral commitment, not alterable by
developing internal U.S. tax policies, rules, and procedures,
unless enacted as legislation that would override the treaty.
(In contrast, the IRS generally is not limited under the
proposed treaty in its discretion to allow treaty benefits
under the anti-treaty-shopping rules.) The detail in the
proposed treaty does represent added guidance and certainty for
taxpayers that may be absent under treaties that may have
somewhat simpler and more flexible provisions.
The anti-treaty-shopping provisions in the proposed treaty
differ from those in the Code and other treaties in a number of
respects. The proposed treaty contains a particularly broad
range of categories under which persons may qualify for
benefits under the treaty.
For example, the proposed treaty includes a special rule
under which income derived from the operation of ships or
aircraft in international traffic will be eligible for the
exemption from source country tax provided under the treaty.
Under this rule, a Danish resident that derives shipping or
aircraft income from the United States is entitled to exemption
from U.S. tax on such income if at least 50 percent of the
interests (in the case of a company, at least 50 percent of the
aggregate vote and value of the stock of such company) in the
resident is owned, directly or indirectly, by certain qualified
persons, U.S. citizens or residents, or individuals who are
residents of a third country or a company or companies the
stock of which is primarily and regularly traded on an
established securities market in a third country. This rule
applies as long as the third country grants an exemption to
shipping and aircraft income under similar terms to citizens
and corporations of the source country. Similar rules are
included in the treaties with the Netherlands and Ireland.
The proposed treaty also includes special rules relating to
Danish taxable nonstock corporations. The Technical Explanation
states that under Danish law, such corporations are foundations
that are taxable in a similar manner to other Danish
corporations. However, such corporations do not have owners per
se. As a foundation, the taxable nonstock corporation is
required to have a charter governing the corporation's
distributions and identifying the corporation's beneficiaries
and their entitlement to distributions. According to the
Technical Explanation, like any other foundation, taxable
nonstock corporations can deduct distributions to members of
the founder's family provided that these family members are
resident in Denmark and are fully taxable on such distributions
in Denmark. Under the proposed treaty, a Danish taxable
nonstock corporation is entitled to treaty benefits under a
modified base erosion test which provides that: (1) no more
than 50 percent of its gross income (excluding tax-exempt
income) may be paid by the taxable nonstock corporation in the
form of deductible payments (for the taxable year and the three
preceding years) to persons who are not qualified residents of
the treaty countries, and (2) no more than 50 percent of its
total income (including tax-exempt income) may be paid by the
taxable nonstock corporation, in the form of deductible
payments and non-deductible distributions (for the taxable year
and the three preceding years), to persons who are not
qualified residents of the treaty countries. In addition, under
the public company tests of the anti-treaty-shopping article, a
company is entitled to treaty benefits if more than 50 percent
of the voting power of the company is owned by one or more
taxable nonstock corporations entitled to treaty benefits (as
described above), and all of the other shares of the company
are listed on a recognized stock exchange and substantially and
regularly traded on one or more recognized stock exchanges. The
Technical Explanation states that this test is necessary
because it is common for Danish taxable nonstock corporations
to own all of a certain class of shares of another company that
provide disproportionate voting power but little or no rights
to dividends. The shares held by the taxable nonstock
corporation are listed but not traded on a stock exchange.
The proposed treaty is similar to other U.S. treaties and
the branch tax rules in affording treaty benefits to certain
publicly traded companies. In comparison with the U.S. branch
tax rules, the proposed treaty is more lenient. The proposed
treaty allows benefits to be afforded to a company that is at
least 50-percent owned, directly or indirectly, by five or
fewer qualifying publicly traded companies (including companies
owned by qualifying taxable nonstock corporations). The branch
tax rules allow benefits to be afforded only to a wholly-owned
subsidiary of a publicly traded company.
The proposed treaty also provides mechanical rules under
which so-called ``derivative benefits'' are afforded.\11\ Under
these rules, an entity is afforded treaty benefits based in
part on its ultimate ownership of at least 95 percent by seven
or fewer residents of EU, EEA or NAFTA countries. The U.S.
model does not contain a derivative benefits provision.
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\11\ The U.S. income tax treaties with Ireland, Jamaica, Mexico,
the Netherlands, and Switzerland provide similar benefits.
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Taken as a whole, some may argue that the derivative
benefits provisions of the proposed treaty are more generous to
taxpayers claiming U.S. treaty benefits than the derivative
benefits provisions of some other U.S. tax treaties currently
in effect. For example, while other treaties to which the
United States is a party generally allow derivative benefits
only with respect to certain income (e.g., dividends, interest,
or royalties), the proposed treaty allows a taxpayer to claim
derivative benefits with respect to the entire treaty.\12\ In
addition, unlike other treaties, the proposed treaty does not
require any same-country ownership of a Danish company claiming
treaty benefits.\13\ In other words, a Danish entity that is
100-percent owned by certain third-country residents and that
does not have a nexus with Denmark (e.g., by being engaged in
an active trade or business there), may be entitled to claim
benefits under the proposed treaty. Moreover, in order for
residents of third countries to be taken into account under
this rule, the proposed treaty generally requires that the
third country have a comprehensive income tax treaty with the
United States, and does not require that such treaty provide
benefits as favorable as those under the proposed treaty. The
latter requirement is imposed under the proposed treaty only in
order to qualify for benefits with respect to dividends,
interest, and royalties.
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\12\ The U.S. income tax treaties with Ireland, Jamaica, and
Switzerland allow a taxpayer to claim derivative benefits with respect
to the entire treaty.
\13\ Article 26(4) of the U.S.-Netherlands treaty, for example,
requires more than 30-percent Dutch ownership of the entity claiming
derivative benefits, and more than 70-percent EU ownership of such
entity.
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One provision of the anti-treaty shopping article differs
from the comparable rule of some earlier U.S. treaties, but the
effect of the change is not clear. The general test applied by
those treaties to allow benefits to an entity that does not
meet the bright-line ownership and base erosion tests is a
broadly subjective one, looking to whether the acquisition,
maintenance, operation of an entity did not have ``as a
principal purpose obtaining benefits under'' the treaty. By
contrast, the proposed treaty contains a more precise test that
allows denial of benefits only with respect to income not
derived in connection with (or incidental to) the active
conduct of a substantial trade or business. (However, this
active trade or business test does not apply with respect to a
business of making or managing investments carried on by a
person other than a bank, insurance company, or registered
securities dealer, so benefits may be denied with respect to
such a business regardless of how actively it is conducted). In
addition, the proposed treaty (like all recent treaties) gives
the competent authority of the country in which the income
arises the authority to determine that the benefits of the
treaty will be granted to a person even if the specified tests
are not satisfied.
The practical difference between the proposed treaty tests
and the corresponding tests in other treaties will depend upon
how they are interpreted and applied. Given the relatively
bright line rules provided in the proposed treaty, the range of
interpretation under it may be fairly narrow.
The Committee has in the past expressed its belief that the
United States should maintain its policy of limiting treaty-
shopping opportunities whenever possible. The Committee has
further expressed its belief that, in exercising any latitude
Treasury has with respect to the operation of a treaty, the
treaty rules should be applied to deter treaty-shopping abuses.
On the other hand, implementation of the tests for treaty
shopping set forth in the proposed treaty raise factual,
administrative, and other issues. The Committee may wish to
satisfy itself that the anti-treaty-shopping rules in the
proposed treaty are adequate under the circumstances.