[JPRT 106-9-99]
[From the U.S. Government Publishing Office]


                                                               JCS-9-99

                                     

                        [JOINT COMMITTEE PRINT]


 
                        EXPLANATION OF PROPOSED
                         INCOME TAX TREATY AND
                       PROPOSED PROTOCOL BETWEEN
                         THE UNITED STATES AND
                         THE ITALIAN REPUBLIC

                        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
                                 ------                                
               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

                              ----------                              
                                                                   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....................................8


        Article 1.  Personal Scope...............................     8
        Article 2.  Taxes Covered................................    10
        Article 3.  General Definitions..........................    11
        Article 4.  Resident.....................................    13
        Article 5.  Permanent Establishment......................    15
        Article 6.  GIncome from Immovable Property..............    17
        Article 7.  Business Profits.............................    18
        Article 8.  Shipping and Air Transport...................    20
        Article 9.  Associated Enterprises.......................    21
        Article 10. Dividends....................................    22
        Article 11. Interest.....................................    26
        Article 12. Royalties....................................    29
        Article 13. Capital Gains................................    31
        Article 14. Independent Personal Services................    33
        Article 15. Dependent Personal Services..................    33
        Article 16. Directors' Fees..............................    34
        Article 17. Artistes and Athletes........................    34
        Article 18. Pensions, Etc................................    35
        Article 19. Government Service...........................    37
        Article 20. Professors and Teachers......................    37
        Article 21. Students and Trainees........................    38
        Article 22. Other Income.................................    38
        Article 23. Relief from Double Taxation..................    39
        Article 24. Non-Discrimination...........................    41
        Article 25. Mutual Agreement Procedure...................    43
        Article 26. Exchange of Information......................    44
        Article 27. Diplomatic Agents and Consular 
            Officials............................................    45
        Article 28. Entry into Force.............................    45
        Article 29. Termination..................................    46
IV. Explanation of Proposed Protocol.................................47

        Article 1................................................    47
        Article 2................................................    47
        Article 3................................................    51
        Article 4................................................    51
        Article 5................................................    51
        Article 6................................................    52
        Article 7................................................    52
        Article 8................................................    52

 V. Issues...........................................................54

        A. Main Purpose Tests....................................    54

        B. Creditability of Italian IRAP Tax.....................    57

        C. Insurance Excise Tax..................................    59

        D. Shipping and Aircraft Income..........................    60

        E. Treaty Shopping.......................................    62

        F. Arbitration Under the Mutual Agreement Procedures....    63

        G. Exchange of Information...............................    63
                              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 Italian Republic (``Italy''). 
The proposed treaty and proposed protocol were signed on August 
25, 1999.2 The Senate Committee on Foreign Relations 
has scheduled a public hearing on the proposed treaty and 
proposed protocol on October 13, 1999.
---------------------------------------------------------------------------
    \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 Italian Republic (JCS-9-99), 
October 8, 1999.
    \2\ For a copy of the proposed treaty, see Senate Treaty Doc. 106-
11, September 21, 1999.
---------------------------------------------------------------------------
    Part I of the pamphlet provides a summary with respect to 
the proposed treaty and 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 certain provisions of the proposed protocol. Part IV 
contains an article-by-article explanation of the proposed 
protocol. Part V 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 Italy 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 protocol 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.
    The proposed treaty contains certain ``main purpose'' tests 
which operate to deny the benefits of the dividends article 
(Article 10), the interest article (Article 11), the royalties 
article (Article 12) and the other income article (Article 22) 
if the main purpose or one of the main purposes of a person is 
to take advantage of the benefits of the respective article 
through a creation or assignment of shares, debt claims, or 
rights that would give rise to income to which the respective 
article would apply. The proposed protocol also contains a 
detailed limitation on benefits provision to prevent the 
inappropriate use of the treaty by third-country residents.
    The United States and Italy have an income tax treaty 
currently in force (signed in 1984). 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.

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 
necessary 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

    A detailed, article-by-article explanation of the proposed 
income tax treaty between the United States and Italy, as 
supplemented by the proposed protocol, is set forth below. The 
United States and Italy also agreed upon a Memorandum of 
Understanding to provide clarification with respect to the 
application of the proposed treaty. In the explanation below, 
the understandings and interpretations reflected in the 
Memorandum of Understanding are covered together with the 
relevant articles of the proposed treaty and certain aspects of 
the proposed protocol. A separate description of the proposed 
protocol is contained in Part IV.
Article 1. Personal Scope
            Overview
    The personal 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 Italy, 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 
(Resident).
    The proposed protocol provides that the proposed treaty 
does not restrict in any manner any exclusion, exemption, 
deduction, credit, or other allowance accorded by internal law 
or by any other agreement between the United States and Italy. 
Thus, the proposed treaty will not apply to increase the tax 
burden of a resident of either the United States or Italy. 
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 Italy 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.3
---------------------------------------------------------------------------
    \3\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
---------------------------------------------------------------------------
    The proposed protocol 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 Italy are parties in determining 
whether a measure is within the scope of the proposed treaty. 
The proposed protocol also provides that, 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 
Italy, 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 Italy 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 (Resident), 
includes corporations and other entities as well as 
individuals.
    The proposed protocol 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 (whether 
or not treated as such under Article 4 (Resident)), whose loss 
of citizenship or resident status, respectively, had as one of 
its principal purposes the avoidance of tax; such application 
is limited to the ten-year period following the loss of 
citizenship or resident status. 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; 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 exemption from source-country tax for certain 
alimony, child support, and pension payments (Article 18, 
paragraphs 5 and 6); 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 Italy to obtain such benefits of the proposed treaty 
with respect to their country of residence or citizenship. In 
addition, the proposed protocol provides that the saving clause 
does not override the exemption from source country tax of 
social security benefits (Article 18) for individuals who are 
citizens of the residence country even if they are citizens of 
both countries. The proposed protocol also provides that the 
saving clause does not override the special rule of Article 4 
of the proposed protocol relating to a credit against Italian 
taxes for U.S. citizens resident in Italy who are partners of a 
U.S. partnership. The exception to the saving clause with 
respect to social security benefits means that if the United 
States makes a social security payment to a resident of Italy 
who is a citizen of both countries, only Italy can tax that 
payment.
    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, an Italian 
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 
professors or teachers (Article 20), certain income received by 
students or trainees (Article 21), and certain income of 
diplomats and consular officials (Article 27).
Article 2. Taxes Covered
    The proposed treaty generally applies to the income taxes 
of the United States and Italy. 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, but 
excludes social security taxes. In addition, like the present 
treaty, the proposed treaty applies to the U.S. excise taxes 
imposed on insurance premiums paid to foreign insurers and with 
respect to private foundations. Unlike the present treaty, but 
like the U.S. model, the proposed treaty applies to the 
accumulated earnings tax and the personal holding company tax.
    The proposed protocol, like the protocol to the present 
treaty, provides that the proposed treaty applies to the excise 
taxes on insurance premiums paid to foreign insurers only to 
the extent that the risks covered by such premiums are not 
reinsured with a person that is not entitled to an exemption 
from such taxes under the proposed treaty or any other treaty. 
Because the insurance excise taxes are covered taxes under the 
proposed treaty, Italian insurers generally are not subject to 
the U.S. excise taxes on insurance premiums for insuring U.S. 
risks. The excise taxes continue to apply, however, when an 
Italian insurer reinsures a policy it has written on a U.S. 
risk with a foreign insurer that is not entitled to a similar 
exemption under this or a different tax treaty.
    In the case of Italy, the proposed treaty applies to the 
individual income tax (l'imposta sul reddito delle persone 
fisiche); the corporation income tax (l'imposta sul reddito 
delle persone giuridiche); and the regional tax on productive 
activities (l'imposta regionale sulle attivita produttive) (the 
so-called ``IRAP'' tax), but only that portion of the IRAP tax 
that is considered to be an income tax under Article 23 (Relief 
from Double Taxation). The present treaty covers a local tax 
rather than this regional tax. Such taxes include those that 
are collected by means of withholding.
    The proposed treaty also contains a rule generally found in 
U.S. income tax treaties (including the present treaty) which 
provides that the proposed treaty applies to any identical or 
substantially similar taxes that may be 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 of any 
significant official published materials concerning the 
application of the proposed 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, a company, an 
estate, a trust, a partnership, 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.
    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 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 the other treaty country. 
Accordingly, with respect to an Italian 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 Italian ``competent authority'' is the Ministry 
of Finance.
    The term ``United States'' means the United States of 
America (including the States thereof 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 any area beyond the territorial sea that is 
designated as an area within which the United States, in 
compliance with its legislation and in conformity with 
international law, exercises sovereign rights in respect of the 
exploration and exploitation of the natural resources of the 
seabed, the subsoil, and the superjacent waters. The Technical 
Explanation states that the extension of the term to such areas 
applies only if the person, property, or activity to which the 
proposed treaty is being applied is connected with such natural 
resource exploration or exploitation.
    The term ``Italy'' means the Italian Republic and includes 
any area beyond the territorial sea that is designated as an 
area within which Italy, in compliance with its legislation and 
in conformity with international law, exercises sovereign 
rights in respect of the exploration and exploitation of the 
natural resources of the seabed, the subsoil and the 
superjacent waters.
    The term ``nationals'' means (1) all individuals possessing 
the citizenship of a treaty country; and (2) all legal persons, 
partnerships, and associations deriving their status as such 
from the laws in force in a treaty country.
    The proposed treaty defines the term ``qualified 
governmental entity'' as any person or body of persons that 
constitutes a governing body of a treaty country, or of a 
political or administrative subdivision or local authority of a 
treaty country. Also defined as a qualified governmental entity 
is a person that is wholly owned (directly or indirectly) by a 
treaty country or a political or administrative subdivision or 
local authority thereof, provided it is organized under the 
laws of a treaty country, its earnings are credited to its own 
account with no portion of its income inuring to the benefit of 
any private person, and its assets vest in the treaty country, 
political or administrative subdivision or local authority upon 
dissolution. A qualified governmental entity is also defined to 
include a pension trust or fund of a person previously 
described in this paragraph that is constituted and operated 
exclusively to administer or provide pension benefits described 
in Article 19 (Government Service). The definitions described 
in the previous two sentences only apply if the entity does not 
carry on commercial activities. These definitions are the same 
as those in the U.S. model. The proposed protocol provides that 
in the case of the United States, a qualified governmental 
entity includes the Federal Reserve Banks, the Export-Import 
Bank, and the Overseas Private Investment Corporation. In the 
case of Italy, the proposed protocol provides that a qualified 
governmental entity includes La Banca d'Italia (the Central 
Bank), L'Istituto per il Commercio con l'Estero (the Foreign 
Trade Institute), and L'Istituto per l'Assicurazione del 
Credito all'Esportazione (the Official Insurance Institute for 
Export Credits). The proposed protocol also provides that a 
qualified governmental entity includes financial institutions, 
the capital of which is wholly owned by a treaty country or any 
state or political or administrative subdivision or local 
authority as may be agreed from time to time between the 
competent authorities of both treaty countries.
    The proposed treaty also contains the standard provision 
that, unless the context otherwise requires, all terms not 
defined in the treaty have the meaning pursuant to the 
respective tax laws of the country that is applying the treaty.
Article 4. Resident
    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.
Italy
    Under Italian law, residents are subject to tax on their 
worldwide income, while nonresident individuals are subject to 
tax only on income arising in Italy. Individuals are considered 
to be residents of Italy if their habitual abode is in Italy, 
if the center of their vital interests is in Italy, or if they 
are registered for the greater part of the tax period with the 
Office of Records of the Resident Population.
    Companies that are resident in Italy are subject to 
taxation on their worldwide income. A company that for the 
greater part of the tax year has its legal seat, place of 
effective management, or main business purpose in Italy is 
considered to be resident in Italy. Nonresident companies are 
subject to corporate income tax on income derived from Italy.
            Proposed treaty rules
    The proposed treaty specifies rules to determine whether a 
person is a resident of the United States or Italy for purposes 
of the proposed treaty. The rules generally are consistent with 
the rules of the U.S. model.
    Like the present treaty, 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 in that 
country by reason of the person's domicile, residence, 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. The 
proposed protocol provides that Italy will treat an individual 
who is a U.S. citizen or lawful permanent resident of the 
United States (i.e., a ``green card'' holder) as a resident of 
the United States 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 Italy is made based on the 
principles of the treaty tie-breaker rules described below.
    The proposed protocol provides special rules to treat as 
residents of a treaty country certain organizations that 
generally are exempt from tax in that country. Under these 
rules, 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 
either (1) exclusively for a religious, charitable, 
educational, scientific, or other similar purpose; or (2) to 
provide pensions or other similar benefits to employees 
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.
    The proposed protocol also provides that a qualified 
governmental entity is a resident of the country where it is 
established.
    The proposed treaty and proposed protocol contain special 
rules for fiscally transparent entities. Under these rules, the 
income of a partnership, estate, or trust (or according to the 
proposed protocol, a fiscally transparent entity) is considered 
to be the income of a resident of one of the treaty countries 
only to the extent that such income is subject to tax in that 
country as the income of a resident, either in its hands or in 
the hands of its partners or beneficiaries. For example, if a 
corporation resident in Italy 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.
    The Technical Explanation states that these rules for 
income derived through fiscally transparent entities apply 
regardless of where the entity is organized (i.e., in the 
United States, Italy, or a third country). The Technical 
Explanation also states that these rules apply even if the 
entity is viewed differently under the tax laws of the other 
country. As an example, the Technical Explanation states that 
income from Italian sources received by an entity organized 
under the laws of Italy, which is treated for U.S. tax purposes 
as a corporation and is owned by a U.S. shareholder who is a 
U.S. resident for U.S. tax purposes, is not considered derived 
by the shareholder of that corporation, even if under the tax 
laws of Italy the entity is treated as fiscally transparent. 
Rather, for purposes of the proposed treaty, the income is 
treated as derived by the Italian entity.
    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.
    In the case of any person other than an individual that 
would be a resident of both countries, the proposed treaty 
requires the competent authorities to endeavor to settle the 
issue of residence by mutual agreement and to determine the 
mode of application of the proposed 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 in 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, a quarry, or 
other place of extraction of natural resources. It also 
includes a building site or construction or assembly project 
that continues for more than twelve months. The proposed 
protocol provides that it also includes a drilling rig or ship 
used for the exploration or development of natural resources 
only if it continues for more than twelve months. The present 
treaty, on the other hand, treats such drilling rigs and ships 
as permanent establishments if the activity continues for more 
than 180 days in a twelve month period. 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, as under the present 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 for the enterprise 
solely for the purpose of advertising, for the supply of 
information, for scientific research, or for similar activities 
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. The 
Treasury Explanation states that Italy is unwilling to commit 
that all or several of the activities described above may be 
undertaken in combination without constituting a permanent 
establishment.
    Under the proposed treaty, as under the present 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 in such first country, 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 for 
that enterprise. This rule does not apply where the activities 
are limited to the purchase of goods or merchandise for the 
enterprise.
    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, relevant 
factors of which include the extent to which the agent bears 
business risk and whether the agent has an exclusive or nearly 
exclusive relationship with the principal.
    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 Immovable 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 immovable 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 immovable property 
includes income from agriculture or forestry.
    The term ``immovable property'' (``real property'') has the 
meaning which it has under the law of the country in which the 
property in question is situated.4 The proposed 
treaty specifies that the term in any case includes property 
accessory to immovable property; livestock and equipment used 
in agriculture and forestry; rights to which the provisions of 
general law respecting landed property apply; usufructs of 
immovable 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 immovable property.
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    \4\ 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 immovable 
property. The rules of Article 6, permitting source country 
taxation, also apply to the income from immovable property of 
an enterprise and to income from immovable property used for 
the performance of independent personal services.
    Unlike the U.S. model, the proposed treaty does not provide 
that residents of a treaty country that are liable for tax in 
the other treaty country on income from immovable property 
situated in such other treaty country may elect to compute the 
tax on such income on a net basis. However, U.S. internal law 
provides for such a net basis election in the case of income of 
a foreign person from real property (Code secs. 871(d) and 
882(d)). The Technical Explanation states that Italian internal 
law contains a provision that approximates net basis taxation 
for income from real property.
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)).
Italy
    Foreign corporations and nonresident individuals generally 
are subject to Italian tax only on income derived in Italy. 
Business income derived in Italy by a foreign corporation or 
nonresident individual generally is taxed in the same manner as 
the income of an Italian corporation or resident individual.
            Proposed treaty limitations on internal law
    Under the proposed 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 proposed 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 separate 
enterprise engaged in the same or similar activities under the 
same or similar conditions and dealing wholly independently 
with the enterprise of which it is a permanent establishment 
and other associated enterprises. The Technical Explanation 
states that this rule 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.
    In computing taxable business profits of a permanent 
establishment, the proposed treaty provides that deductions are 
allowed for expenses, wherever incurred, which are attributable 
to the activities of the permanent establishment. These 
deductions include a reasonable allocation of executive and 
general administrative expenses. The Technical Explanation 
states that as in the present treaty, but unlike the U.S. 
model, the proposed treaty does not explicitly state that the 
expenses that may be considered to be incurred for the purposes 
of the permanent establishment are expenses for research and 
development, interest, and other similar expenses. The 
Technical Explanation, however, states that Italy accepts the 
principle of a reasonable allocation of expenses (such as in 
Treas. Reg. sections 1.861-8 and 1.882-5). The Technical 
Explanation states 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.
    The proposed treaty provides that, for purposes of the 
taxation of business profits, income may be attributable to a 
permanent establishment (and therefore may be taxable in the 
source country) even if the payment of such income is deferred 
until after the permanent establishment or fixed base has 
ceased to exist. This rule incorporates into the proposed 
treaty the rule of Code section 864(c)(6) described above. This 
rule applies with respect to business profits (Article 7, 
paragraphs 1 and 2), dividends (Article 10, paragraph 4), 
interest (Article 11, paragraph 5), royalties (Article 12, 
paragraph 5), capital gains (Article 13, paragraph 2), 
independent personal services income (Article 14), and other 
income (Article 22, paragraph 2).
    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. 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.
Article 8. Shipping and Air Transport
    Article 8 of the proposed treaty covers income from the 
operation of ships and aircraft 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.
    Like the present treaty, the proposed treaty provides that 
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 the other treaty country.
    The proposed protocol provides that profits from the 
operation of ships or aircraft in international traffic include 
profits derived from the rental of ships or aircraft on a full 
(time or voyage) basis (i.e., with crew). Like the present 
treaty, it also includes profits from the rental of ships or 
aircraft on a bareboat basis (i.e., without crew) if such 
rental activities are incidental to the activities from the 
operation of ships or aircraft in international traffic. 
Although not provided for in the proposed treaty, the Technical 
Explanation states that 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.
    The proposed protocol 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 for the transport of 
goods or merchandise in international traffic is taxable only 
in that country.
    As under the U.S. model, the shipping and air transport 
provisions of the proposed treaty apply to profits derived 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.
    The Technical Explanation states that income from the 
rental of ships, aircraft, or containers which is not exempt 
from source country tax under this article is taxable as 
royalty income (Article 12) or as business profits if 
attributable to a permanent establishment (Article 7). Under 
the royalty article, the rental income is considered to have 
its source in Italy if the payer is a resident of Italy or if 
the rental payment is for the use of the property in Italy. The 
Technical Explanation also states that certain non-transport 
activities that are an integral part of the services performed 
by a transport company are understood to be covered by this 
article of the proposed treaty.
    The proposed protocol provides, like the present treaty, 
that profits which a U.S. national not resident in Italy or 
which a U.S. corporation derives from operating ships 
documented or aircraft registered under U.S. law will be exempt 
from tax in Italy. The Technical Explanation states that this 
exception applies regardless of whether the income was derived 
from the operation of ships or aircraft in international 
traffic.
    The proposed protocol provides that if a U.S. state or 
local government imposes tax on the profits of Italian 
enterprises from the operation of ships or aircraft in 
international traffic, Italy may impose its regional tax on 
productive activites (l'imposta regionale sulle attivita 
produttive) (i.e., the IRAP tax) on the profits of U.S. 
enterprises from such activities, notwithstanding the 
provisions of Article 2 (Taxes Covered) and this article of the 
proposed treaty.
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 make an appropriate 
adjustment to the amount of tax paid in that country on the 
redetermined income. In making such adjustment, due regard is 
to be given to other provisions of the proposed treaty and 
proposed protocol. Any such adjustment is to be made only in 
accordance with the mutual agreement procedures of the proposed 
treaty. 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 proposed protocol provides that the proposed treaty 
does not limit any provisions of either country's internal law 
which permit the distribution, apportionment, or allocation of 
income, deductions, credits, or allowances between persons 
owned or controlled directly or indirectly by the same interest 
when necessary in order to prevent evasion of taxes or to 
clearly reflect the income of any person. Any such adjustments 
are permitted even if they are different from, or go beyond, 
those specifically authorized by this article, as long as they 
are in accord with general arm's length principles.
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.
Italy
    Italy generally imposes a withholding tax on dividend 
payments to nonresidents at a rate of 27 percent. However, 
nonresident individuals may claim reimbursement of up to two-
thirds of the withholding tax and nonresident companies may 
claim reimbursement of up to four-ninths of the withholding 
tax, but only if the respective nonresident can show that 
residence-country tax was paid on the dividend income. There is 
no branch remittance tax.
            Proposed treaty limitations on internal law
    The present treaty provides that dividends derived from 
sources within one country by a resident of the other country 
may be taxed by the source country. The rate of source country 
tax generally is limited to 15 percent. However, the rate of 
tax is limited to 5 percent if the dividend recipient is a 
company that has owned more than 50 percent of the voting stock 
during the 12-month period ending on the date of dividend 
declaration. Furthermore, the rate of tax is limited to 10 
percent if the beneficial owner is a company that has owned at 
least 10 percent but not more than 50 percent of the voting 
stock during the 12-month period ending on the date of dividend 
declaration. In order for the 5 or 10 percent rates to apply 
under the present treaty, not more than 25 percent of the gross 
income of the payor corporation may be derived from interest or 
dividends (other than interest or dividends derived in the 
conduct of a banking or finance business and interest or 
dividends received from subsidiary companies).
    Under the proposed treaty, dividends paid by a resident of 
a treaty country and beneficially owned by 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 
company which owns at least 25 percent of the voting stock of 
the payor company for a twelve-month period ending on the date 
the dividend is declared. The source country dividend 
withholding tax generally is limited to 15 percent of the gross 
amount of the dividends beneficially owned by residents of the 
other country in all other cases. The proposed treaty provides 
that these limitations do not affect the taxation of the 
company on the profits out of which the dividends are paid.
    The proposed treaty defines a ``dividend'' to include 
income from shares, ``jouissance'' shares or ``jouissance'' 
rights, mining shares, founder's shares, or other rights, not 
being debt-claims, participating in profits, as well as income 
from other corporate rights which 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 source country tax 
on dividends do not apply if the dividend recipient carries on 
business through a permanent establishment (or fixed base, in 
the case of an individual who performs independent personal 
services) in the source country and the dividends are 
effectively connected to the permanent establishment (or fixed 
base). In such a case, such dividends are taxable in the source 
country according to its own laws. The proposed protocol 
provides that such dividends may be taxed as either business 
profits (Article 7) or as income from the performance of 
independent services (Article 14), as the case may be. 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.
    Where a company that is a resident of one country derives 
profits or income from the other treaty country, the proposed 
treaty provides that such other country cannot impose any tax 
on the dividends paid, or undistributed profits earned, by such 
resident. Thus, the United States cannot impose its 
``secondary'' withholding tax on dividends paid by an Italian 
company out of its earnings and profits from the United States. 
An exception to this provision is provided in cases where the 
dividends are paid to a resident of the other treaty country or 
are effectively connected to a permanent establishment or a 
fixed base situated in such other treaty country. This rule 
does not prevent a country from imposing a branch profits tax 
as provided below. This rule also applies even if the dividends 
paid or undistributed profits consist wholly or partly of 
profits arising in such other country.
    Unlike the present treaty, the proposed treaty permits the 
imposition of a branch profits tax, but limits the rate of such 
tax to 5 percent. 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 immovable 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 immovable property income 
or capital gains, that represents the ``dividend equivalent 
amount'' (in the case of the United States) or an analogous 
amount (in the case of Italy). 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 that the amendments are consistent with 
the purpose of the branch profits tax.
    The proposed treaty provides an exemption from source 
country tax for dividends paid by a corporation that is a 
resident of one country to a qualified governmental entity (as 
defined in Article 3(1)(i)) that is resident in the other 
country. This exemption from source country tax only applies if 
the governmental entity owns (directly or indirectly) less than 
25 percent of the voting stock of the company paying the 
dividends. This threshold is different than the corresponding 
rule in the U.S. model, which provides that the qualified 
governmental entity may not ``control'' the dividend paying 
company.
    Under the proposed treaty, dividends paid by a U.S. RIC are 
eligible only for 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 an individual beneficially owning 
the dividends holds no more than a 10-percent interest in the 
U.S. REIT; the dividends are paid with respect to a class of 
stock that is publicly traded and the beneficial owner of the 
dividends owns no more than 5 percent of any class of the 
REIT's stock; or the beneficial owner of the dividends owns no 
more than 10 percent of the REIT and such REIT is also 
diversified. Otherwise, dividends paid by a U.S. REIT are 
subject to U.S. taxation at the full 30-percent statutory rate. 
The Technical Explanation states that, for these purposes, a 
REIT is considered diversified if the value of no single 
interest in the REIT's real property exceeds 10 percent of the 
REIT's total interest in real property.
    The proposed treaty provides a ``main purpose'' test that 
is not specifically included in the dividends articles of the 
U.S. model or OECD model. Under this rule, the proposed 
treaty's reduced rates of tax on dividends do not apply if the 
main purpose, or one of the main purposes, for the creation or 
assignment of shares or other rights in respect of which 
dividends are paid is to take advantage of the dividends 
article of the proposed treaty. The Technical Explanation 
states that it is intended that the provisions of this article 
will be self-executing, but the tax authorities of one of the 
treaty countries, on review, may deny the benefits of the 
reduced rate of tax on dividends. In addition, the Technical 
Explanation states that the competent authorities of both of 
the treaty countries may together agree that this standard has 
been met in a particular case or with respect to a type of 
transaction entered into by a number of taxpayers.
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.
Italy
    Italian-source interest payments to nonresidents generally 
are subject to withholding tax at a rate of 27 percent. 
However, no withholding tax is assessed on interest paid to a 
U.S. resident with respect to: (1) public bonds; (2) private 
bonds issued by banks and listed companies; and (3) deposits or 
current accounts. Interest paid with respect to private bonds 
having at least an 18-month maturity that are issued by other 
than a bank or listed company is subject to withholding tax at 
a rate of 12.5 percent.
            Proposed treaty limitations on internal law
    The present treaty generally limits source country tax to a 
maximum rate of 15 percent on interest derived by a resident of 
the other country. The present treaty also provides for a 
compete withholding exemption for interest derived by a treaty 
country (or a wholly-owned instrumentality thereof), or a 
treaty country resident with respect to debt obligations 
guaranteed or insured by such country (or instrumentality).
    The proposed treaty provides that interest arising in one 
of the countries and beneficially owned by a resident of the 
other country generally may be taxed by both countries. This is 
contrary to the position of the U.S. model which provides for 
an exemption from source country tax for interest beneficially 
owned by a resident of the other country.
    The proposed treaty limits the rate of source country tax 
that may be imposed on interest income. Under the proposed 
treaty, if the beneficial owner of interest is a resident of 
the other country, the source country tax on such interest 
generally may not exceed 10 percent of the gross amount of such 
interest.
    The proposed treaty provides for a complete exemption from 
source country withholding tax in the case of interest arising 
in a treaty country if the interest is (1) beneficially owned 
by a resident of the other country that is a qualified 
governmental entity owning (directly or indirectly) less than 
25 percent of the capital of the person paying the interest, 
(2) paid with respect to debt obligations guaranteed or insured 
by a qualified governmental entity of that other country and 
beneficially owned by a resident of such other country, (3) 
paid or accrued with respect to a sale on credit of goods, 
merchandise, or services provided by one enterprise to another 
enterprise; or (4) paid or accrued in connection with the sale 
on credit of industrial, commercial, or scientific equipment.
    The proposed treaty defines the term ``interest'' as income 
from government securities, bonds, or debentures, whether or 
not secured by a mortgage and whether or not carrying a right 
to participate in profits. It also includes debt claims of 
every kind as well as all other income subject to the same tax 
treatment as income from money lent under the tax law of the 
source country. The proposed protocol provides that, in the 
case of the United States, an excess inclusion with respect to 
a residual interest in a U.S. REMIC may be taxed as interest in 
accordance with each country's respective internal laws. 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 (or fixed base, in the 
case of an individual who performs independent personal 
services) and the debt claim in respect of which the interest 
is paid is effectively connected to that permanent 
establishment (or fixed base). In such a case, such interest is 
taxable in the source country according to its own laws. The 
proposed protocol provides that such interest may be taxed as 
either business profits (Article 7) or as income from the 
performance of independent services (Article 14), as the case 
may be. 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 provides that interest is treated as 
arising in a treaty country if the payor is the treaty country 
or its political subdivisions or local authorities, or is a 
resident of that country. 5 If, however, the 
interest expense is borne by a permanent establishment or a 
fixed base, the interest will have as its source the country in 
which the permanent establishment or fixed base is located, 
regardless of the residence of the payor. Thus, for example, if 
a French resident has a permanent establishment in Italy and 
that French resident incurs indebtedness to a U.S. person, the 
interest on which is borne by the Italian permanent 
establishment, the interest would be treated as having its 
source in Italy.
---------------------------------------------------------------------------
    \5\ This is consistent with the source rules of U.S. law, which 
provide as a general rule that interest income has as its source the 
country in which the payor is resident.
---------------------------------------------------------------------------
    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).
    In the case of the United States, the proposed treaty 
permits the imposition of the U.S. branch level interest tax on 
an Italian corporation, but limits the rate of such tax to 10 
percent. The U.S. tax imposed on the Italian corporation is the 
excess, if any, of (1) the interest deductible in computing the 
profits of the Italian corporation that either are attributable 
to a permanent establishment or subject to tax under Article 6 
(Income from Immovable Property) or Article 13 (Capital Gains) 
over (2) the interest paid by the permanent establishment or 
trade or business.
    The proposed treaty also provides a main purpose test 
similar to that for dividends (Article 10) under which the 
provisions with respect to interest will not apply if the main 
purpose, or one of the main purposes, for the creation or 
assignment of the debt claim in respect of which interest is 
paid is to take advantage of the interest article of the 
proposed treaty.
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.
Italy
    Royalties paid to nonresidents are subject to a 30 percent 
withholding tax, which is generally applied to 75 percent of 
the gross royalty payment, resulting in an effective rate of 
22.5 percent.
            Proposed treaty limitations on internal law
    The present treaty provides that royalties derived from 
sources within one country by a resident of the other country 
may be taxed by the source country. The rate of source country 
tax generally is limited to 10 percent. However, the rate of 
tax is limited to 5 percent if the royalty is in respect of 
payments received as consideration for the use of, or the right 
to use, any copyright of literary, artistic, or scientific 
work. In addition, the rate of tax is limited to 7 percent if 
the royalties are derived with respect to tangible personal 
property. Furthermore, the rate of tax is limited to 8 percent 
if the royalty is in respect of payments received as 
consideration for the use of, or the right to use, motion 
pictures and films, tapes or other means of reproduction used 
for radio or television broadcasting.
    The proposed treaty provides that royalties arising in a 
treaty country and beneficially owned by a resident of the 
other country may be taxed by that other country. In addition, 
the proposed treaty allows the country where the royalties 
arise (the ``source country'') to tax such royalties. However, 
if the beneficial owner of the royalties is a resident of the 
other country, the source country tax generally may not exceed 
8 percent of the gross royalties. This maximum 8-percent rate 
is higher than the rate permitted under most U.S. treaties and 
the U.S. and OECD models, but is generally lower than the 
maximum rate under the present treaty. The U.S. and OECD models 
generally exempt royalties from source country taxation. The 
proposed treaty further provides that the source country tax on 
certain amounts treated as royalties may not exceed 5 percent 
of the gross royalties. This 5-percent limitation applies to 
royalties for the use of (or the right to use) computer 
software or industrial, commercial, or scientific equipment. 
Like the present treaty, but unlike the U.S. model, such rental 
income is considered to be a royalty.
    Unlike the present treaty, the proposed treaty provides a 
complete exemption from source country tax for royalties 
beneficially owned by a resident of the other country for the 
use of (or right to use) a copyright of literary, artistic, or 
scientific work (excluding royalties for computer software, 
motion pictures, films, tapes, or other means of reproduction 
used for radio or television broadcasting) if such resident is 
the beneficial owner of the royalties.
    For purposes of the proposed treaty, the term ``royalties'' 
means payment of any kind received as consideration for the use 
of, or the right to use, copyrights of literary, artistic, or 
scientific work (including computer software, motion pictures, 
films, tapes, or other means of reproduction used for radio or 
television broadcasting), patents, trademarks, designs or 
models, plans, secret formulae, processes, or other like rights 
or properties. The term also includes consideration for the use 
of, or the right to use, industrial, commercial, or scientific 
equipment, or for information concerning industrial, 
commercial, or scientific experience. According to the 
Technical Explanation, it is understood that whether payments 
with respect to computer software are treated as royalties or 
as business profits will depend on the facts and circumstances 
of the particular transaction. The Technical Explanation states 
that it is understood that payments with respect to transfers 
of ``shrink wrap'' computer software will be treated as 
business profits and not as royalties. The Technical 
Explanation also states that, with respect to the United 
States, gains derived from the sale of any right or property 
that would give rise to royalties is also considered to be 
royalty income, but only to the extent that such gain is 
contingent on the productivity, use, or further disposition 
thereof.
    The reduced rates of source country tax do not apply where 
the recipient carries on business through a permanent 
establishment (or fixed base in the case of an individual who 
performs independent personal services) in the source country, 
and the royalties are effectively connected to the permanent 
establishment (or fixed base). In such a case, such royalties 
are taxable in the source country according to its own laws. 
The proposed protocol provides that such royalties may be taxed 
as either business profits (Article 7) or as income from the 
performance of independent services (Article 14), as the case 
may be. 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 provides source rules for royalties 
which differ, in part, from those provided under U.S. internal 
law. Royalties are deemed to arise within a country if the 
payor is a resident of that country, or is one of the treaty 
countries or its political subdivisions or local authorities. 
If, however, the royalty expense is borne by a permanent 
establishment or fixed base that the payor has in Italy or the 
United States, the royalty has as its source the country in 
which the permanent establishment or fixed base is located, 
regardless of the residence of the payor. Thus, for example, if 
a French resident has a permanent establishment in Italy and 
that French resident pays a royalty to a U.S. person which is 
attributable to the Italian permanent establishment, then the 
royalty would be treated as having its source in Italy. The 
proposed treaty provides that notwithstanding the foregoing 
rules, royalties with respect to the use of, or right to use, 
rights or property within a treaty county may be deemed to 
arise within that country. Thus, consistent with U.S. internal 
law, the United States may treat royalties with respect to the 
use of property in the United States as U.S. source income.
    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 would have been agreed upon by the payor and the 
beneficial owner 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).
    As in the case of dividends (Article 10) and interest 
(Article 11), the proposed treaty includes a main purpose test 
under which the royalty provision will not apply if the main 
purpose, or one of the main purposes, for the creation or 
assignment of rights in respect of which royalties are paid is 
to take advantage of the proposed treaty's royalty article.
Article 13. Capital Gains
            Internal taxation rules
United States
    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.
Italy
    Nonresident companies are subject to the corporate income 
tax (37 percent) on capital gains from immovable property, but 
only if held for 5 years or less. Capital gains recognized by 
nonresident companies from the sale of shares or other 
participations in Italian resident companies are generally 
subject to a 27 percent tax rate. However, if the amount of 
participations sold during a 12-month period does not exceed 
either (1) 2 percent of voting power or 5 percent of capital 
(in the case of listed companies) or (2) 20 percent of voting 
power or 25 percent of capital (in all other cases), then such 
gains are subject to a 12.5 percent tax rate.
            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 immovable property 
situated in the other country may be taxed in the country where 
the property is situated. The proposed protocol provides that 
with respect to the United States, the term ``immovable 
property'' includes a United States real property interest. 
Such property is deemed to be situated in the United States for 
purposes of this article. In the case of Italy, immovable 
property includes (1) immovable property referred to in Article 
6 (Income from Immovable Property), (2) shares (or comparable 
interests) in a company (or other body of persons) the assets 
of which consist wholly or principally of real property 
situated in Italy, and (3) an interest in an estate of a 
deceased individual, the assets of which consist wholly or 
principally of real property situated in Italy. Such property 
is deemed to be situated in Italy for purposes of this article.
    The proposed treaty contains a standard provision which 
permits a country to tax the gain from the alienation of 
movable property that forms a part of the business property of 
a permanent establishment located in that country, or that 
pertains to a fixed base in that country for the purpose of 
performing independent personal services. This rule also 
applies to gains from the alienation of such a permanent 
establishment (alone or with the whole enterprise) or such a 
fixed base. 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.
    The proposed treaty provides that gains derived by an 
enterprise of one of the treaty countries from the alienation 
of ships or aircraft operated in international traffic (or 
movable property pertaining to the operation or use of ships, 
aircraft, or containers) are taxable only in such country. The 
proposed protocol provides that this rule also applies to (1) 
gains from the sale of containers (including trailers, barges, 
and related equipment for the transport of containers) used for 
the transport in international traffic of goods or merchandise; 
and (2) gains from the sale of ships or aircraft rented on a 
full basis or gains from the sale of ships or aircraft rented 
on a bareboat basis if, in the latter case, the rental profits 
are incidental to other profits from the operation of ships or 
aircraft in international traffic.
    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.
Article 14. Independent Personal Services
            Internal taxation rules
United States
    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.
Italy
    Nonresident individuals are subject to a withholding tax of 
30 percent on self-employment income.
            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.
    Like the present treaty, the proposed treaty provides that 
income from the performance of professional services in an 
independent capacity by a resident of one 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 the 
source 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.
---------------------------------------------------------------------------
    \6\ The Technical Explanation states that it is understood that the 
concept of a fixed base is similar to the concept of a permanent 
establishment.
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    The term ``professional services in an independent 
capacity'' includes, but is not limited to, scientific, 
literary, artistic, educational, and teaching activities as 
well as independent activities of physicians, lawyers, 
engineers, architects, dentists, and accountants.
Article 15. Dependent Personal Services
    Under the proposed treaty, salaries, wages, and other 
similar 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 is present in 
the source country for not more than 183 days in the fiscal 
year; (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 is not 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.
    The proposed treaty contains a special rule that permits 
remuneration derived by a resident of one country in respect of 
employment regularly exercised as a member of the crew of a 
ship or aircraft operated in international traffic by an 
enterprise of the other country to be taxed in that other 
country. A similar rule is included in the OECD model. U.S. 
internal law does not impose tax on such income of a 
nonresident alien, even if such person is employed by a U.S. 
entity.
    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), government service income (Article 19), income of 
professors and teachers (Article 20), and income of students 
and trainees (Article 21).
Article 16. Directors' Fees
    Under the proposed treaty, directors' fees and other 
similar payments derived by a resident of one country in his or 
her capacity as a member of the board of directors of a company 
that is a resident of the other country is taxable in that 
other country. Like the U.S. model, the proposed protocol 
provides that the country of the company's residence may tax 
the remuneration of nonresident directors, but only with 
respect to remuneration for services performed in that country.
Article 17. Artistes and Athletes
    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 athletes. 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 athletes 
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 athlete who is a resident of one country from his or her 
personal activities as such 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 Italian currency, or such entertainer or 
athlete is present in the other country for more than 90 days 
during the fiscal year. The $20,000 threshold includes 
reimbursed expenses. Under this rule, if an Italian entertainer 
or athlete 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 athlete's total compensation 
were $30,000 (or if the individual was present in the United 
States for more than 90 days), 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 athlete in his or 
her capacity as such accrues not to the entertainer or athlete 
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 athlete 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 provisions of the business profits and 
personal service articles (Articles 7, 14, and 15). This 
provision prevents highly-paid entertainers and athletes 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, Etc.
    Under the proposed treaty, pensions and other similar 
remuneration derived and beneficially owned by a resident of 
either country in consideration of past employment is subject 
to tax only in the recipient's country of residence. The 
Technical Explanation states that the provision is intended to 
apply to both periodic or lump sum payments. This rule is 
subject to the provisions of Article 19 (Government Service) 
with respect to pensions. The Technical Explanation indicates 
that it is understood that the United States may require a U.S. 
resident who receives a distribution from an Italian pension 
plan to include the entire distribution in the recipient's 
taxable income under the general residence-based rule above 
regardless of the fact that Italy may have previously imposed a 
tax on the Italian pension plan with respect to earnings and 
accretions.
    Notwithstanding the general residence-based rule above, if 
a resident of one country becomes a resident of the other 
country, lump-sum payments or severance payments (indemnities) 
that are received after the change in residency are taxable 
only in the original country of residency. This exception only 
applies to amounts that are paid with respect to employment 
exercised in the original country of residence and only while 
such person was a resident thereof. The term ``severance 
payments (indemnities)'' includes any payment made by reason of 
the termination of any office or employment of a person. The 
Technical Explanation states that this provision is intended to 
prevent potential abuses of the general pension rule described 
above. The Technical Explanation states that, for example, 
Italian law requires Italian employers to make certain lump-sum 
retirement payments to employees upon their retirement. The 
Technical Explanation notes that absent this provision, an 
employee resident in Italy (or the United States) who 
anticipates receiving such a payment might establish residence 
in the United States (or in Italy) in order to obtain more 
favorable U.S. (Italian) tax treatment under the general rule.
    Like the present treaty, the proposed treaty provides that 
payments made by one of the countries under the provisions of 
the social security or similar legislation of the country to a 
resident of the other country are taxable only by the country 
of residence. In contrast, the U.S. model provides that social 
security payments may be taxed only in the source country. The 
Technical Explanation states that the term ``similar 
legislation'' is intended to include U.S. tier 1 Railroad 
Retirement benefits.
    The proposed treaty provides that annuities are taxed only 
in the country of residence of the individual who beneficially 
derives them. The term ``annuities'' is defined for purposes of 
this provision as a stated sum paid periodically at stated 
times during life or during a specified number of years, under 
an obligation to make the payments in return for adequate and 
full consideration in money or money's worth (other than 
services rendered).
    Under the proposed treaty, alimony and child support 
payments paid by a resident of one country to a resident of the 
other country will be taxable only in the country of residence 
of the recipient. However, if the person making such payments 
is not entitled to a deduction for such payments in his or her 
country of residence, such payments are not taxable in either 
treaty 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. The term ``child 
support'' means periodic payments for the support of a minor 
child made pursuant to a written separation agreement or a 
decree of divorce, separate maintenance, or compulsory support.
    The proposed treaty includes special rules addressing the 
treatment of cross-border pension contributions. Under the 
proposed treaty, if an individual who is a member of a pension 
plan established and recognized under the law of one country 
performs personal services in the other country, contributions 
made by the individual to the plan during the period he or she 
performs such personal services are deductible in computing his 
or her taxable income in the other country. Similarly, payments 
made to the plan by or on behalf of his or her employer during 
such period are not treated as part of his or her taxable 
income and are allowed as a deduction in computing the 
employer's profits in the other country. However, these rules 
apply only if (1) contributions were made by or on behalf of 
the individual to the plan (or to a similar plan for which this 
plan is substituted) immediately before he or she visited the 
other country, and (2) the competent authority of the other 
country has agreed that the plan generally corresponds to a 
pension plan recognized for tax purposes by that country. 
Moreover, the benefits provided under these rules will not 
exceed the benefits that would be allowed by the other country 
to its residents for contributions to a pension plan recognized 
for tax purposes by that country. The proposed protocol 
provides that in the case of Italy, the term ``pension plan'' 
means ``fondi pensione.''
Article 19. Government Service
    Under the proposed treaty, remuneration, other than a 
pension, paid by a treaty country or one of its political or 
administrative subdivisions or local authorities to an 
individual for services rendered to the payor generally is 
taxable only by that country. However, such remuneration is 
taxable only in the other country (the country that is not the 
payor) 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 only that country or (2) did not become a 
resident of that country solely for the purpose of rendering 
the services. Like the present treaty, if the spouse or 
dependent child of an individual who under this provision is 
taxable only in the paying country also performs government 
functions in the other country, the proposed treaty provides 
that remuneration for those functions is taxable only in the 
paying country, provided that the spouse or child is not a 
national of the other country.
    The proposed treaty provides that any pension paid by a 
country (or one of its political subdivisions or local 
authorities) to an individual for services rendered to the 
payor generally 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, Etc.) and not this article.
    The proposed protocol provides that it is understood that 
the competent authorities of the treaty countries may, by 
mutual agreement, apply the rules described above to employees 
of organizations that perform functions of a governmental 
nature. The Technical Explanation states that it is anticipated 
that these rules will apply to, in the case of the United 
States, employees of the Federal Reserve Banks, the Export-
Import Bank, and the Overseas Private Investment Corporation 
and, in the case of Italy, employees of the Central Bank, the 
Foreign Trade Institute, and the Official Insurance Institute 
for Export Credits.
    If a country or one of its political subdivisions or local 
authorities is carrying on a business, the provisions of 
Articles 14 (Independent Personal Services), 15 (Dependent 
Personal Services), 16 (Directors' Fees), 17 (Artistes and 
Athletes), or 18 (Pensions, Etc.) will apply to remuneration 
and pensions for services rendered in connection with that 
business.
Article 20. Professors and Teachers
    The treatment provided to professors and teachers under the 
proposed treaty generally corresponds to the treatment provided 
under the present treaty.
    Under the proposed treaty, a professor or teacher who 
visits the other country (the host country) for a period not 
expected to exceed two years for the purpose of teaching or 
conducting research at a university, college, school, or other 
recognized educational institution, or at a medical facility 
primarily funded from governmental sources, and who immediately 
before that visit is, or was a resident of the other treaty 
country, generally is exempt from host country tax on his or 
her remuneration from such teaching or research activities. 
This treaty benefit applies for a period not exceeding two 
years. This exemption does not apply to income from research 
undertaken not in the general interest but primarily for the 
private benefit of a specific person or persons. The proposed 
protocol provides that for purposes of this article, the term 
``recognized educational institution'' means, in the case of 
the United States, an accredited educational institution. An 
educational institution is considered to be accredited if it is 
accredited by an authority that generally is responsible for 
the accreditation of institutions in the particular field of 
study.
    This article of the proposed treaty is an exception from 
the saving clause in the case of persons who are neither 
citizens nor lawful permanent residents of the host country.
Article 21. Students and Trainees
    The treatment provided to students and trainees under the 
proposed treaty generally corresponds to the treatment provided 
under the present treaty.
    Under the proposed treaty, a student or business apprentice 
(trainee) who visits a country (the host country) for the 
purpose of his or her education at a recognized educational 
institution or for training, and who immediately before that 
visit is, or was a resident of the other treaty country, 
generally is exempt from host country tax on payments he or she 
receives for the purpose of such maintenance, education, or 
training; provided, however, that such payments arise outside 
the host country. The proposed protocol provides that for 
purposes of this article, the term ``recognized educational 
institution'' means, in the case of the United States, an 
accredited educational institution. An educational institution 
is considered to be accredited if it is accredited by an 
authority that generally is responsible for the accreditation 
of institutions in the particular field of study. The Technical 
Explanation states that a payment generally is considered to 
arise outside the host country if the payer is located outside 
the host country.
    This article of the proposed treaty is an exception from 
the saving clause in the case of persons who are neither 
citizens nor lawful permanent residents of the host country.
Article 22. 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 Italy. As a general rule, items of 
income not otherwise dealt with in the proposed treaty which 
are derived 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 Italy 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 immovable property as defined in 
Article 6) if the person deriving 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 effectively connected to such permanent 
establishment or fixed base. In such a case, the income is 
taxable in the source country according to its laws. The 
proposed protocol states that the provisions of Article 7 
(Business Profits) or Article 14 (Independent Personal 
Services), as the case may be, may 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.
    The proposed treaty contains a main purpose test similar to 
that provided with respect to the dividends, interest, and 
royalties articles (Articles 10, 11 and 12). The Technical 
Explanation states that, like those articles, the other income 
article is intended to be self-executing. However, the tax 
authorities, on review, may deny the benefits of the article in 
cases in which the main purpose, or one of the main purposes, 
for the creation or assignment of the rights in respect of 
which income is paid is to take advantage of the article.
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.
Italy
    Italian double tax relief is allowed through a foreign tax 
credit. Italian foreign tax credits are limited to the lesser 
of the foreign tax paid or the Italian tax that relates (based 
on a ratio of foreign income to total income) to such 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 Italy 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 proposed treaty generally provides that the United 
States will allow a U.S. citizen or resident a foreign tax 
credit for the income taxes imposed by Italy. The proposed 
treaty also requires the United States to allow a deemed-paid 
credit, with respect to Italian income tax, to any U.S. company 
that receives dividends from an Italian company if the U.S. 
company owns 10 percent or more of the voting stock of such 
Italian 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.
    In the case of Italy, the proposed treaty provides that the 
individual income tax (l'imposta sul reddito delle persone 
fisiche); the corporation income tax (l'imposta sul reddito 
delle persone giuridiche); and a portion of the regional tax on 
productive activities (l'imposta regionale sulle attivita 
produttive) (the so-called ``IRAP'' tax) are income taxes 
available for credit against U.S. tax liabilities.
    The IRAP tax applies to Italian residents as well as 
nonresidents of Italy with a permanent establishment in Italy. 
The IRAP tax base is calculated without a deduction for labor 
costs and, for certain taxpayers, without a deduction for 
interest costs. With respect to manufacturing companies, for 
example, the IRAP tax base generally equals gross revenues from 
sales in Italy, with certain deductions for costs of goods 
sold, rent, and depreciation. No deduction is permitted for 
interest or labor expenses. With respect to banks and other 
financial institutions, the tax base generally equals interest 
and other income received, with certain deductions including 
interest paid, rent and depreciation (but with no deduction for 
labor expenses). The initial IRAP tax rate generally is 4.25 
percent (5.4 percent for banks and other financial 
institutions). Because the IRAP tax base does not permit 
deductions for labor and, in certain cases, interest, it is not 
likely to be a creditable tax under U.S. internal law.
    The proposed treaty provides that a portion of the taxes 
imposed under the IRAP will be considered to be a creditable 
income tax under this article. The proposed treaty provides a 
formula under which the creditable amount is calculated by 
multiplying the ``applicable ratio'' by the total amount of tax 
paid or accrued to Italy under the IRAP. The applicable ratio 
is a fraction, the numerator of which is the total IRAP tax 
base decreased (but not below zero) by labor expense and 
interest expense not otherwise taken into account in connection 
with the IRAP tax base. The denominator of the fraction is the 
actual tax base upon which Italy imposes the IRAP tax. The 
result of this calculation is an amount of the IRAP tax that 
approximates what the tax would have been had it been imposed 
on net income.
    The proposed treaty generally provides that in taxing its 
residents Italy may include in its tax base income that the 
United States may tax under the proposed treaty, but that if 
Italy does so, it must credit U.S. taxes paid by the Italian 
resident on that income that is taxable in the United States. 
This credit is not to exceed the amount of the tax that would 
be paid to the United States if the resident were not a U.S. 
citizen. That is, in the case of an Italian resident who is 
subject to U.S. tax on worldwide income as a U.S. citizen, 
Italy will credit only the U.S. tax to which the Italian 
resident would have been subject absent U.S. citizenship. Italy 
need not credit U.S. taxes if the relevant item of income is 
subject in Italy to a final withholding tax by request of the 
recipient in accordance with Italian law.
    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 Italian 
residents. Under this rule, Italy will allow a foreign tax 
credit to a U.S. citizen who is resident in Italy 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 Article 1 
(Personal 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 an Italian resident who is not a U.S. 
citizen. The United States will then credit the income tax 
actually paid to Italy, determined after application of the 
preceding sentence. The proposed treaty recharacterizes the 
income that is subject to Italian 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 provides a resourcing rule for purposes 
of the U.S. foreign tax credit in the case of a person who is a 
dual national of the United States and Italy, and is taxable by 
Italy on income for services rendered to the Italian government 
(under Article 19(1)(a)), but is taxable by the United States 
under the saving clause. In such cases, the proposed treaty 
provides that such income is treated as Italian-source income 
for purposes of the U.S. foreign tax credit. The Technical 
Explanation states that this resourcing rule is provided in 
order to relieve potential double taxation. Thus, the United 
States may tax such income but must allow a credit for the 
Italian income tax, if any, in accordance with the other 
provisions of this article.
    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.
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, the 
present treaty, 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 other or more burdensome taxes (or 
requirements connected with taxes) on nationals of the other 
country than it would impose on its nationals in the same 
circumstances. This rule applies (notwithstanding the personal 
scope article (Article 1)) whether or not the nationals in 
question are residents of the United States or Italy. However, 
for purposes of U.S. tax, U.S. citizens subject to tax on a 
worldwide basis are not in the same circumstances as Italian 
nationals who are not U.S. residents.
    Under the proposed treaty, neither country may tax a 
permanent establishment of an enterprise 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 7 of Article 11 (Interest), and 
paragraph 7 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 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 other or 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.
    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 proposed protocol provides that nothing 
in the non-discrimination article is to be construed as 
preventing either of the countries from imposing a branch 
profits tax or a branch-level interest tax.
    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. 
Thus, a U.S. citizen resident in Italy 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 (irrespective of internal law remedies) 
present his or her case to the competent authority of the 
country in which he or she is a resident, or if the case comes 
under the non-discrimination article (Article 24), to the 
competent authority of the country in which he or she is a 
national. Similar to the OECD model, and unlike the U.S. model, 
the proposed treaty provides that the case must be presented 
within three years from the first notification of the action 
resulting in taxation not in accordance with the provisions of 
the treaty. The competent authority will then make a 
determination as to whether the objection appears justified. If 
the objection appears to it to be justified and if it is not 
itself able to arrive at a satisfactory solution, that 
competent authority must 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.
    The competent authorities of the countries are to endeavor 
to resolve by mutual agreement any difficulties or doubts 
arising as to the interpretation or application 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 protocol makes 
clear that the competent authorities can agree that the 
conditions for application of the main purpose provisions in 
Articles 10 (Dividends), 11 (Interest), 12 (Royalties), or 22 
(Other Income) have been met.
    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. When it seems advisable in order to reach 
agreement to have an oral exchange of opinions, such exchange 
may take place through a Commission consisting of 
representatives of both country's competent authorities.
    Under the proposed treaty, if an agreement cannot be 
reached by the competent authorities pursuant to the rules 
described above, the case may, if agreed to by the taxpayer and 
each competent authority, be submitted to arbitration. The 
arbitration procedure does not become effective at the same 
time as the remainder of the treaty; instead, the arbitration 
procedure becomes effective on the date specified in a future 
exchange of diplomatic notes. The proposed protocol provides 
that within three years after entry into force of the proposed 
treaty, the competent authorities will consult to determine 
whether it is appropriate to exchange diplomatic notes 
implementing the arbitration procedure. The Memorandum of 
Understanding elaborates on the circumstances under which an 
exchange of diplomatic notes implementing the arbitration 
procedure will take place and also sets forth the procedures 
that will apply to arbitration proceedings if the provision is 
implemented.
    If the arbitration procedures become effective, the 
following rules apply. The taxpayer must agree in writing to be 
bound by the decision of the arbitration board. The competent 
authorities are permitted to release to the arbitration board 
such information as is necessary for carrying out the 
arbitration procedure. Any award of the arbitration board is 
binding on the taxpayer as well as each treaty country, with 
respect to the case at hand.
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 protocol provides that 
the 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 necessary 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), and for the prevention of fraud and tax 
evasion. This exchange of information is not restricted by 
Article 1 (Personal Scope). Therefore, information with respect 
to third-country residents is covered by these procedures.
    Any information exchanged under the proposed treaty is 
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 or collection of, the 
enforcement or prosecution in respect of, or the determination 
of appeals in relation to, the taxes to which the proposed 
treaty applies. Such persons or authorities must use the 
information for such purposes only.7 The proposed 
protocol provides that information may also be disclosed to 
persons or authorities involved in the oversight of such 
activities. The Technical Explanation states that persons 
involved in the oversight 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 nontax purposes.
---------------------------------------------------------------------------
    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 either country, to supply 
information that is not obtainable under the laws or in the 
normal course of the administration of either 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.
    Under the proposed protocol, a country may collect on 
behalf of the other country such amounts as may be necessary to 
ensure that relief granted under the treaty by the other 
country does not enure to the benefit of persons not entitled 
thereto. However, neither country is obligated, in the process 
of providing collection assistance, to carry out administrative 
measures that differ from those used in the collection of its 
own taxes, or that would be contrary to its sovereignty, 
security, or public policy.
Article 27. Diplomatic Agents and Consular Officials
    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 members of diplomatic agents or 
consular officials 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 
Italian residents may be protected from Italian tax.
Article 28. Entry into Force
    The proposed treaty provides that the treaty is subject to 
ratification in accordance with the applicable procedures of 
each country, and that instruments of ratification will be 
exchanged as soon as possible. The proposed treaty will enter 
into force upon the exchange of instruments of ratification.
    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 following the date on 
which the proposed treaty enters into force. With respect to 
other taxes, the proposed treaty will be effective for taxable 
periods 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 a twelve-month period from 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 under the proposed treaty.
Article 29. Termination
    The proposed treaty will continue in force until terminated 
by either country. Either country may terminate the proposed 
treaty at any time after five years from the date of entry into 
force, provided that at least six months prior notice of 
termination is given through diplomatic channels. A termination 
is effective, with respect to taxes withheld at source for 
amounts paid or credited on or after the first day of January 
next following the expiration of the six-month period of 
notification. In the case of other taxes, a termination is 
effective for taxable periods beginning on or after the first 
day of January next following the expiration of the six-month 
notification period.

                  IV. EXPLANATION OF PROPOSED PROTOCOL

    A detailed, article-by-article explanation of the proposed 
protocol, is set forth below. Certain provisions of the 
proposed protocol have been described in Part III. above in 
connection with the description of the proposed treaty.
Article 1.
    Article 1 of the proposed protocol modifies specific 
articles of the proposed treaty. Discussions of such 
modifications appear in the discussions of the affected 
articles, above.
Article 2.
    The proposed protocol 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 Italy. The present treaty 
contains a provision that is not as extensive.
    The proposed protocol is intended to limit double taxation 
caused by the interaction of the tax systems of the United 
States and Italy 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 Italy or the United States will be entitled 
to the benefits of the proposed treaty only if the resident:
          (1) is an individual;
          (2) is a qualified governmental entity;
          (3) is a company that satisfies a public company 
        test;
          (4) is a company that is owned by certain public 
        companies;
          (5) is a charitable organization or other legal 
        person established and maintained exclusively for a 
        religious, charitable, educational, scientific, or 
        other similar purpose;
          (6) is a pension fund that satisfies an ownership 
        test; or
          (7) is an entity that satisfies both an ownership 
        and base erosion test.
    Alternatively, a resident that does not fit into any of the 
above categories may claim treaty benefits with respect to 
certain items of income under the active business test. In 
addition, a person that does not satisfy any of the above 
requirements may be entitled to the benefits of the proposed 
treaty if the source country's competent authority so 
determines.
            Individuals
    An individual resident of a treaty country is entitled to 
the benefits of the proposed treaty.
            Qualified governmental entities
    Under the proposed protocol, a qualified governmental 
entity is entitled to all treaty benefits. Qualified 
governmental entities include the two countries, their 
political or administrative subdivisions, or their local 
authorities. Qualified governmental entities also include 
certain wholly-owned entities, the earnings of which are 
credited to the entity's own account, and certain pension 
trusts or funds providing government service pension benefits.
            Public company tests
    A company that is a resident of Italy 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 
regularly traded on a recognized stock exchange. In addition, a 
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 the test 
previously described, provided that each intermediate owner 
used to satisfy the control requirement is a resident of Italy 
or the United States. These rules follow the corresponding 
rules in the U.S. model.
    Under the proposed protocol, 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) any stock exchange constituted and 
organized according to Italian laws; and (3) any other stock 
exchange agreed upon by the competent authorities of both 
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 
that is 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 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 to the rule in the U.S. model.
            Ownership and base erosion tests
    Under the proposed protocol, 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 each class of the beneficial 
interests in an entity must be owned (directly or indirectly) 
by certain qualified residents described above (i.e., an 
individual; a qualified governmental entity; 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)). 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). 
This rule is intended to prevent a corporation, for example, 
from distributing most of its income, in the form of deductible 
items such as interest, royalties, service fees, or other 
amounts to persons not entitled to benefits under the proposed 
treaty. This treatment is similar to the corresponding rule in 
the U.S. model. The term ``gross income'' is not defined in the 
proposed treaty or proposed protocol and therefore will be 
defined according to the respective country's laws that is 
applying the treaty. The Technical Explanation states that for 
purposes of the base erosion test, in the case of the United 
States, ``gross income'' is defined as gross receipts less cost 
of goods sold.
            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 proposed protocol provides 
that 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.
    The proposed protocol provides that the determination of 
whether a trade or business is substantial is made based on all 
facts and circumstances. However, the proposed protocol 
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. The Technical Explanation provides that 
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 protocol 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 protocol, 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 or proposed protocol. 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.
            Grant of treaty benefits by the competent authority
    The proposed protocol 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 are to 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 3.
    This article of the proposed protocol contains the standard 
rule that the proposed treaty will not restrict in any manner 
any exclusion, exemption, deduction, credit, or other allowance 
accorded by internal law or by any other agreement between the 
United States and Italy. Thus, the proposed treaty will not 
apply to increase the tax burden of a resident of either the 
United States or Italy.
    This article also 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 Italy are parties in determining 
whether a measure is within the scope of the proposed treaty. 
It also provides that, 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 Italy, 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.
Article 4.
    This article provides that a U.S. citizen and Italian 
resident who is a partner in a U.S. partnership is entitled to 
a refundable credit against his or her Italian individual 
income tax (l'imposta sul reddito delle persone fisiche) for 
the taxable period that equals the portion of his Italian 
corporate tax (l'imposta sul reddito delle persone giuridiche) 
that is attributable to his or her share of the partnership 
income. In other words, Italy agrees to treat a U.S. 
partnership in the way that the United States treats it, as a 
flowthrough entity for tax purposes, when the partner whose tax 
is at issue is a U.S. citizen who is an Italian resident.
Article 5.
    This article provides for one method by which the competent 
authority of one of the two countries may allow the reduced 
withholding tax rates of the proposed treaty. The article 
establishes rules that will apply if either country establishes 
a refund system for withholding taxes whose rates the treaty 
reduces. In the case of such a refund system, the source 
country will withhold taxes at the regular rate, without regard 
to treaty reduction of that rate. Thereupon, the taxpayer 
receiving the income is to make to the source country a claim 
for refund (within the time fixed by law of the source country 
for claiming a refund) and to furnish with the claim an 
official certificate of his residence country that certifies 
the existence of the conditions allowing the reduced treaty 
rate to that taxpayer. The proposed treaty does not obligate 
the United States or Italy to establish a refund system. The 
United States does not presently use such a system, but rather, 
allows a payor to reduce withholding taxes at the source based 
on residence documentation provided by the beneficial owner of 
a U.S.-source payment.
Article 6.
    This article provides that each country may collect taxes 
for the other country to the extent necessary to insure that 
benefits of the treaty are not going to persons not entitled to 
those benefits. This treaty obligation does not oblige either 
country to use administrative measures that it does not use in 
collecting its own taxes or that are contrary to its 
sovereignty, security, or public policy.
Article 7.
    This article contains two provisions. The first states that 
either country may request consultations with the other country 
to determine whether amendment to the proposed treaty is 
appropriate to respond to changes in the law or policy of 
either country. If these consultations determine that the 
effect of the proposed treaty or its application have been 
changed by domestic legislation of either country resulting in 
an alteration to the balance of benefits provided by the 
proposed treaty, further consultations shall occur with a view 
toward amending the proposed treaty to restore an appropriate 
balance of benefits.
    The second provision in this article relates to the 
implementation of the mutual agreement procedures of the 
proposed treaty. This provision states that within three years 
of the entry into force of the proposed treaty, the competent 
authorities shall consult with respect to the implementation of 
the mutual agreement procedures. They shall take into account 
experience with respect to the mutual agreement procedures and 
shall determine whether modifications to that article of the 
proposed treaty would be appropriate. In addition, after taking 
into account experience with respect to arbitration of 
international tax disputes, they shall also determine whether 
it is appropriate to exchange the diplomatic notes that are 
prerequisite to the commencement of the arbitration procedures 
of the proposed treaty.
    The Memorandum of Understanding provides further detail 
regarding the arbitration proceedings. First, it states that 
the requisite diplomatic notes will be exchanged when the 
experience of the two countries with respect to similar 
provisions in other specified treaties has proven to be 
satisfactory. Second, if this condition is satisfied and the 
arbitration procedures become operative, the Memorandum of 
Understanding specifies that the results of the arbitration are 
to be binding. Third, it provides procedural rules for the 
arbitration, such as specifying time limits, appointment 
procedures for arbitrators, and rules for costs.
Article 8.
    Under this article of the proposed protocol, if a U.S. 
state or local government imposes tax on the profits of Italian 
enterprises from the operation of ships or aircraft in 
international traffic, Italy may impose its regional tax on 
productive activities (l'imposta regionale sulle attivita 
produttive) on the profits of U.S. enterprises from such 
activities, notwithstanding the provisions of Article 2 (Taxes 
Covered) and Article 8 (Shipping and Air Transport) of the 
proposed treaty.

                               V. ISSUES

    The proposed treaty with Italy presents the following 
specific issues.

                         A. Main Purpose Tests

            In general
    The proposed treaty includes a series of specific ``main 
purpose'' tests that can operate to deny the benefits of the 
dividends article (Article 10), the interest article (Article 
11), the royalties article (Article 12) and the other income 
article (Article 22). This series of main purpose tests is not 
found in any other U.S. treaty, and is not included in the U.S. 
model or the OECD model.8 The main purpose tests 
apparently are modeled after similar main purpose provisions 
found in treaties of other countries, such as many of the 
modern treaties of the United Kingdom.9
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    \8\ Although not included in the OECD model, paragraph 17 of the 
commentary to the dividends article of the OECD model suggests that the 
treaty partners may find it appropriate to adopt a rule to deny treaty 
benefits if the acquisition of stock was ``primarily for the purpose of 
taking advantage of this provision.''
    \9\ For example, the Convention Between the Government of the 
United Kingdom of Great Britain and Northern Ireland and the Government 
of the Republic of Korea for the Avoidance of Double Taxation and the 
Prevention of Fiscal Evasion with Respect to Taxes on Income and 
Capital Gains (Dec. 30, 1996) (``U.K.-Korea Treaty''), par. 6 of Art. 
10 (Dividends), provides that ``[t]he provisions of this Article 
[Article 10 (Dividends)] shall not apply if it was the main purpose or 
one of the main purposes of any person concerned with the creation or 
assignment of the shares or other rights in respect of which the 
dividend is paid to take advantage of this Article by means of that 
creation or assignment.'' See also par. 10 of Art. 11 (Interest), par. 
7 of Art. 12 (Royalties), and par. 4 of Art. 22 (Other Income) of the 
U.K.-Korea Treaty; Convention Between the Government of the United 
Kingdom of Great Britain and Northern Ireland and the Government of the 
Republic of Venezuela for the Avoidance of Double Taxation and the 
Prevention of Fiscal Evasion with Respect to Taxes on Income and 
Capital Gains, par. 7 of Art. 10 (Dividends), par. 9 of Art. 11 
(Interest), par. 7 of Art. 12 (Royalties), par. 5 of Art. 21 (Other 
Income) (Dec. 31, 1996); Convention Between the Government of the 
United Kingdom of Great Britain and Northern Ireland and the Government 
of the Republic of Argentina for the Avoidance of Double Taxation and 
the Prevention of Fiscal Evasion with Respect to Taxes on Income and 
Capital Gains, par. 9 of Art. 11 (Interest), par. 7 of Art. 12 
(Royalties), par. 4 of Art. 21 (Other Income) (Aug. 1, 1997).
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            Description of provisions
    Under the proposed treaty, the provisions of the dividends 
article (Article 10) will not apply if it was the main purpose 
or one of the main purposes of any person concerned with the 
creation or assignment of the shares or rights in respect of 
which the dividend is paid to take advantage of the dividends 
article by means of that creation or assignment. Similarly, the 
interest article (Article 11) provides that its provisions will 
not apply if it was the main purpose or one of the main 
purposes of any person concerned with the creation or 
assignment of the debt claim in respect of which the interest 
is paid to take advantage of the interest article by means of 
that creation or assignment. Substantially similar main purpose 
tests apply in the case of the royalties article (Article 12) 
and the other income article (Article 22).
    The Technical Explanation indicates that the main purpose 
tests are to be ``self-executing.'' The Technical Explanation 
further states that the tax authorities of one of the treaty 
countries may, on review, deny the benefits of the respective 
article if the conditions of the main purpose test are 
satisfied. In addition, the proposed protocol provides that 
under the mutual agreement procedures article (Article 25) the 
competent authorities of the treaty countries may agree that 
the conditions for application of the main purpose tests are 
met. The Technical Explanation states that the competent 
authority agreement does not have to relate to a particular 
case. Rather, if the competent authorities agree that a type of 
transaction entered into by several taxpayers is entered into 
with a main purpose of taking advantage of the treaty, treaty 
benefits can be denied to all taxpayers who had entered into 
such a transaction. The Technical Explanation states that it is 
anticipated that the public would be notified of such generic 
agreements through the issuance of press releases.
            Issues
    The new main purpose tests in the proposed treaty present 
several issues. The tests are subjective, vague and add 
uncertainty to the treaty. It is unclear how the provisions are 
to be applied. In addition, the provisions lack conformity with 
other U.S. tax treaties. This uncertainty can create planning 
difficulties for legitimate business transactions, and can 
hinder a taxpayer's ability to rely on the treaty. The 
Committee may wish to consider whether the benefits of such 
tests outweigh the uncertainty the main purpose tests would 
create.
    The main purpose standard in the relevant provisions of the 
proposed treaty is that the ``main purpose or one of the main 
purposes'' is to ``take advantage of'' the particular article 
in which the main purpose test appears. This is a subjective 
standard, dependent upon the intent of the taxpayer, that is 
difficult to evaluate.
    U.S. treaty policy has shifted away from subjective tests. 
In fact, the limitation on benefits provision (Article 2 of the 
proposed protocol), which addresses an abuse of the treaty 
whereby residents of third countries try to take advantage of 
the treaty provisions through what is known as ``treaty 
shopping'' (discussed below), is designed to avoid questions of 
taxpayer intent by providing a series of objective tests as to 
whether a person should be treated as a resident entitled to 
treaty benefits. The Technical Explanation to this article of 
the proposed protocol acknowledges in connection with a 
principal purpose test that a ``fundamental problem presented 
by this approach is that it is based on the taxpayer's motives 
in establishing an entity in a particular country, which a tax 
administrator is normally ill-equipped to identify.'' Although 
this criticism is specific to a principal purpose test with 
respect to a treaty shopping provision, the same criticism 
applies to subjective tests in general.
    It is also unclear how the rule would be administered. The 
Technical Explanation indicates that the provision is intended 
to be self-executing. In the absence of a taxpayer applying the 
rule to itself, the tax authorities of one of the countries 
may, on review, deny the treaty benefits. Thus, the Italian tax 
authorities apparently could apply Italian law to determine 
whether a U.S. company's main purpose, or one of its main 
purposes, was to take advantage of the specific article. If the 
U.S. company disagreed with the Italian tax authority, it could 
turn to the U.S. competent authority. In any event, it may be 
difficult for a U.S. company to evaluate whether its 
transaction may be subject to Italian main purpose standards. 
Again, this lack of clarity as to the application of the main 
purpose rule can impede reliance on the treaty.
    A fairness question also may be raised insofar as the 
proposed treaty provides the competent authorities with the 
ability to declare an entire class of transactions as abusive 
and, accordingly, deny treaty benefits to that class without 
the necessity of evaluating the facts of a specific 
transaction. It is unclear what degree of deference would be 
accorded to such a competent authority agreement.
    Many of the types of abusive transactions in which persons 
would be attempting to take advantage of the favorable treaty 
treatment with respect to dividends, interest, or royalties, 
involve persons who are not otherwise entitled to treaty 
benefits. The limitation on benefits provision (Article 2 of 
the proposed protocol) is designed to address such concerns. On 
the other hand, potentially abusive situations could arise in 
which the limitation on benefits provision would not apply. For 
example, a bank that is a resident of Italy and that can 
satisfy the tests under the limitation on benefits provision 
may decide to ``sell'' its treaty qualification to a customer 
that does not so qualify because it is a resident of a third 
country. The bank would agree to purchase immediately before a 
dividend record date shares in a U.S. company held by its 
customer. At the same time, the bank would enter into a 
``repurchase'' agreement under which it agrees to ``resell'' 
the shares to the customer on a certain date at a certain 
price. The repurchase agreement would be designed to eliminate 
the bank's exposure to any market risk in connection with 
holding the shares. The bank would collect the dividend and, on 
its face, would qualify for the reduced withholding rate under 
the treaty. The bank then would resell the shares to the 
customer pursuant to the repurchase agreement.10
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    \10\ See the Technical Explanation to Article 10 (Dividends).
---------------------------------------------------------------------------
    The favorable withholding rates provided under the proposed 
treaty if certain ownership requirements are satisfied also 
could invite potentially abusive activities. For example, the 
proposed treaty provides that there will be no source-country 
withholding on dividends if the beneficial owner of the 
dividends is a resident of the other country and is a qualified 
governmental entity that holds, directly or indirectly, less 
than 25 percent of the voting stock of the company paying the 
dividend. An Italian government pension fund with an ownership 
interest of more than 25 percent in a U.S. company, shortly 
before the dividends become payable, could enter into a 
transaction to decrease temporarily its holding to below the 
25-percent ownership threshold primarily for purposes of 
securing the exemption from dividend withholding under the 
treaty.11 Because the party or parties to this 
transaction are residents of a treaty country, the limitation 
on benefits provision (Article 2 of the proposed protocol) 
would not apply.
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    \11\ A similar example is provided in paragraph 17 of the 
Commentary to the dividends article of the OECD model.
---------------------------------------------------------------------------
    Although the limitation on benefits provision may not 
address all of the potential transactions in which a person can 
improperly take advantage of the treaty benefits, it would 
appear that residual abusive situations could be adequately 
addressed under U.S. internal law addressing issues such as 
beneficial ownership, conduit financing, economic substance, 
business purpose, and similar abuses, which should apply 
notwithstanding the treaty. Moreover, because this main purpose 
test does not appear in other U.S. treaties or with respect to 
other articles of this proposed treaty, some may assert that an 
issue arises as to whether its inclusion in specific provisions 
of this proposed treaty creates a negative inference as to the 
United States' ability to raise its internal anti-abuse rules 
in connection with other treaties (or provisions) in which such 
main purpose tests do not appear. The Technical Explanation 
states that no such inference with respect to other treaties is 
intended.

                  B. Creditability of Italian IRAP Tax

            Italian IRAP
    In addition to the individual income tax and the 
corporation income tax, the proposed treaty covers, in part, 
the Italian regional tax on productive activities (l'imposta 
regionale sulle attivita produttive or ``IRAP'') (paragraph 
2(b)(iii) of Article 2 (Taxes Covered)). Effective January 1, 
1998, the IRAP replaced Italy's local income tax (l'imposta 
locale sul redditi or ``ILOR''), which is covered under the 
present U.S.-Italy treaty. Paragraph (3) of Article 2 (Taxes 
Covered) of the present treaty provides that any identical or 
substantially similar tax that is imposed by one of the treaty 
countries after date of enactment of that treaty in addition 
to, or in place of, an existing tax is itself a covered tax. It 
is the Treasury Department's position that the IRAP is not 
identical to or substantially similar to the ILOR, which it 
replaced.12
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    \12\ See IR-INT-98-6 (March 31, 1998).
---------------------------------------------------------------------------
    The IRAP applies to Italian residents as well as 
nonresidents of Italy with a permanent establishment in Italy. 
Unlike the ILOR, the IRAP is calculated without a deduction for 
labor costs and, for certain taxpayers, without a deduction for 
interest costs. With respect to manufacturing companies, for 
example, the IRAP tax base generally equals gross revenues from 
sales in Italy, with certain deductions for costs of goods 
sold, rent, and depreciation. No deduction is permitted for 
interest or labor expenses. With respect to banks and other 
financial institutions, the tax base generally equals interest 
and other income received, with certain deductions including 
interest paid, rent and depreciation (but with no deduction for 
labor expenses). In general, the IRAP legislation refers to its 
tax base as ``added value produced in the territory of the 
region.'' The initial IRAP tax rate generally is 4.25 percent 
(5.4 percent for banks and other financial institutions).
    The Internal Revenue Service has stated that it does not 
consider IRAP to be an income tax or an ``in lieu of'' tax 
within the meaning of section 901 or section 903 of the 
Code.13 Hence, in order to provide temporary relief 
under the present treaty during 1998 while the United States 
and Italy negotiated the new proposed treaty, the competent 
authorities of the two countries agreed to treat a portion of 
the IRAP as an income tax under the present 
treaty.14
---------------------------------------------------------------------------
    \13\ Id.
    \14\ See Id.
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            Treatment under the proposed treaty
    The proposed treaty generally provides in Article 23 
(Relief from Double Taxation) that the United States agrees to 
allow its citizens and residents a credit against U.S. tax for 
income taxes paid to Italy. The amount of the credit is based 
on the amount of tax paid to Italy, but is subject to the 
limitations of the internal law of the United States, as that 
law may be amended over time, for purposes of limiting the 
credit to the U.S. tax on income from sources without the 
United States.
    With respect to taxes paid pursuant to the IRAP, the 
proposed treaty provides that only a portion of the taxes paid 
will be considered to be a creditable income tax under Article 
23. In general terms, the proposed treaty provides a formula 
under which the amount of the IRAP that is considered to be a 
creditable income tax is determined by multiplying the amount 
of the IRAP actually paid or accrued by a fraction. The 
numerator of the fraction represents an amount approximating 
the taxpayer's business profits that would be subject to the 
IRAP if deductions for interest and labor costs were allowed. 
The denominator of the fraction equals the actual tax base upon 
which Italy imposes the IRAP. Thus, if the IRAP tax base is 
twice that which it would have been if it permitted deductions 
for interest and labor (and therefore more closely approximated 
net income), then only half of the amount paid will be treated 
as a creditable income tax under the proposed treaty. That 
amount then would be subject to the other limitations on 
foreign tax credits under U.S. law.
            Issues
    U.S. law, subject to certain limitations, allows a credit 
for income, war profits or excess profits taxes paid to a 
foreign country. A foreign levy is an income tax only if it is 
a tax and the predominant character of that tax is that of an 
income tax in the U.S. sense.15 Treasury regulations 
provide that certain requirements must be satisfied in order 
for the predominant character of a tax to be considered an 
income tax in the U.S. sense. One such requirement is that the 
tax must be likely to reach net gain in the normal 
circumstances in which it applies.16 Among other 
things, the IRAP's failure to permit a deduction for labor 
costs and, in certain circumstances, interest costs calls into 
question whether the tax is likely to reach net gain. Hence, 
the tax is unlikely to be creditable under U.S. internal law. 
No specific determinations have been made administratively or 
judicially concerning the creditability of the IRAP under the 
Code.17
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    \15\ Treas. Reg. sec. 1.901-2(a)(1).
    \16\ Treas. Reg. sec. 1.901-2(a)(3) and -2(b).
    \17\ Although there has been no specific determinations, as stated 
above, Treasury (through the IRS Assistant Chief Counsel 
(International)) has publicly announced that the United States does not 
consider the IRAP to be an income tax or an ``in lieu of'' tax within 
the meaning of section 901 or section 903. IR-INT-98-6.
---------------------------------------------------------------------------
    The primary issue, therefore, is the extent to which 
treaties should be used to provide a credit for taxes that may 
not otherwise be fully creditable. In considering this issue, 
it is important for the Committee to be aware that the tax 
credits allowed under the proposed treaty for IRAP taxes could 
be larger than the credits otherwise allowed under the Code and 
Treasury regulations and, therefore, potentially could reduce 
the U.S. taxes collected from U.S. companies operating in 
Italy.
    In the past, it generally has not been considered 
consistent with U.S. policy for deductions from the U.S. tax 
base of a U.S. person to be granted by a treaty. Nor has it 
been considered consistent with U.S. tax policy to guarantee by 
treaty the U.S. creditability of what might be an otherwise 
noncreditable foreign tax. It may be more appropriate for both 
such functions to be accomplished in the normal course of 
internal U.S. tax legislation. In essence, in order to claim a 
credit for a portion of the IRAP, the proposed treaty requires 
a hypothetical calculation of taxes paid to Italy that would 
more likely resemble a creditable income tax in the U.S. sense, 
while taking the unusual additional step of guaranteeing that 
such portion of that tax is eligible for the U.S. foreign tax 
credit.18 On the other hand, the formula provided in 
the proposed treaty is designed to limit the amount of the 
creditable IRAP tax under the proposed treaty to an amount that 
could be considered to be creditable under U.S. internal law if 
the IRAP were designed (like the ILOR which it replaced) to 
reach net gain.
---------------------------------------------------------------------------
    \18\ Although the modification to Italian internal law in order for 
a portion of the IRAP tax to be creditable, and the corresponding 
guarantee of creditability under the proposed treaty, may be unusual 
and raise certain policy concerns, it is not unprecedented. The U.S. 
treaties with Kazakhstan and the pending treaty with the Ukraine (which 
was signed in 1994 and approved by the Senate in 1995, but for which 
the exchange of instruments of ratification has been delayed pending 
the resolution of issues relating to the newly enacted Ukrainian bank 
secrecy laws), for example, require Kazakhstan and the Ukraine, 
respectively, to modify their internal law to provide for deductions 
for interest and labor costs in the case of certain U.S. persons and 
U.S. participating entities, and provide for the creditability of such 
taxes as modified. The U.S. treaty with the Russian Federation also 
requires Russia to provide interest and labor cost deductions in order 
to assist U.S. taxpayers seeking eligibility of Russian taxes for use 
as credits against U.S. income; however, the Russian treaty does not 
guarantee that the Russian tax is creditable for U.S. purposes. 
Although these treaties provide some precedent for the proposed 
treaty's treatment of the IRAP, it is important to note that the 
proposed treaty does not require Italy to modify its internal law; 
rather it calculates a hypothetical tax that approximates what would 
have been imposed had Italy modified its internal law.
---------------------------------------------------------------------------
    The Committee may wish to consider (1) whether it is 
appropriate to use a treaty to guarantee creditability of a tax 
that otherwise is a noncreditable tax under U.S. law, and (2) 
whether it is appropriate to use a hypothetical tax calculation 
to approximate an income tax in order to achieve that result.

                        C. Insurance Excise Tax

    The proposed protocol, like the protocol to the present 
treaty, covers the U.S. excise tax on insurance premiums paid 
to foreign insurers. Thus, for example, an Italian insurer or 
reinsurer without a permanent establishment in the United 
States can collect premiums on policies covering a U.S. risk or 
a U.S. person free of this tax. However, the tax is imposed to 
the extent that the risk is reinsured by the Italian insurer or 
reinsurer with a person not entitled to the benefits of the 
proposed treaty or another treaty providing exemption from the 
tax. This latter rule is known as the ``anti-conduit'' clause.
    Such waivers of the excise tax have raised serious 
congressional concerns. For example, concern has been expressed 
over the possibility that such waivers may place U.S. insurers 
at a competitive disadvantage with respect to foreign 
competitors in U.S. markets if a substantial tax is not 
otherwise imposed (e.g., by the treaty partner country) on the 
insurance income of the foreign insurer (or, if the risk is 
reinsured, the reinsurer). Moreover, in such case, a waiver of 
the tax does not serve the primary purpose of treaties to 
prevent double taxation, but instead has the undesirable effect 
of eliminating all tax on such income.
    The U.S.-Barbados and U.S.-Bermuda tax treaties each 
contained such a waiver as originally signed. In its report on 
the Bermuda treaty, the Committee expressed the view that those 
waivers should not have been included. The Committee stated 
that waivers should not be given by Treasury in its future 
treaty negotiations without prior consultations with the 
appropriate committees of Congress.19 Congress 
subsequently enacted legislation to ensure the sunset of the 
waivers in the two treaties. The insurance excise tax is waived 
in the treaty with the United Kingdom (without the so-called 
``anti-conduit rule''). The inclusion of such a waiver in the 
treaty has been followed by a number of legislative efforts to 
redress the perceived competitive imbalance created by the 
waiver.
---------------------------------------------------------------------------
    \19\ Limited consultations took place in connection with the 
proposed treaty.
---------------------------------------------------------------------------
    The issue is whether the waiver of the insurance excise tax 
in the proposed treaty is consistent with the Committee's view 
of sound tax treaty policy. Furthermore, the Committee may wish 
to satisfy itself that the Italian income tax imposed on 
Italian insurance companies on insurance premiums results in a 
burden that is substantial in relation to the U.S. tax on U.S. 
insurance companies.

                    D. Shipping and Aircraft Income

Income from the rental of ships and aircraft
    The proposed treaty, like the present treaty, includes a 
provision found in the U.S. model and many U.S. income tax 
treaties under which profits from an enterprise's operation of 
ships or aircraft in international traffic are taxable only in 
the enterprise's country of residence. For this purpose, the 
operation of ships or aircraft in international traffic 
includes profits derived from the rental of ships or aircraft 
on a full (time or voyage) basis. Like the present treaty, in 
the case of profits derived from the rental of ships and 
aircraft on a bareboat (without a crew) basis, the rule 
limiting the right to tax to the country of residence applies 
to such rental profits only if the bareboat rental profits are 
incidental to other profits of the lessor from the operation of 
ships and aircraft in international traffic. Such bareboat 
rental profits that are not incidental to other income from the 
international operation of ships and aircraft generally would 
be taxable by the source country as royalties at a 5-percent 
rate (or as business profits if such profits are attributable 
to a permanent establishment). The U.S. model and many other 
treaties provide that profits from the rental of ships and 
aircraft operated in international traffic are taxable only in 
the country of residence, without requiring that the rental 
profits be incidental to income of the recipient from the 
operation of ships or aircraft. Under the proposed treaty, 
unlike under the U.S. model, an enterprise that engages only in 
the rental of ships and aircraft on a bareboat basis, but does 
not engage in the operation of ships and aircraft, would not be 
eligible for the rule limiting the right to tax income from 
operations in international traffic to the enterprise's country 
of residence. It should be noted that under the proposed 
treaty, profits from the use, maintenance, or rental of 
containers used in international traffic are taxable only in 
the country of residence.
Gains from the sale of ships and aircraft
    The proposed treaty, like the present treaty, includes a 
provision found in the U.S. model and many U.S. income tax 
treaties under which gains derived by an enterprise from one of 
the treaty countries from the alienation of ships or aircraft 
operated in international traffic (or movable property 
pertaining to the operation or use of ships, aircraft or 
containers) are taxable only in the country of residence, 
regardless of the existence of a permanent establishment in the 
other country. For this purpose, the proposed protocol provides 
that this rule also applies to gains from the sale of 
containers used for the transport in international traffic of 
goods and merchandise, and gains from the sale of ships or 
aircraft rented on a full basis. Like the present treaty, in 
the case of gains from the sale of ships or aircraft rented on 
a bareboat basis, the rule limiting the right to tax to the 
country of residence applies to such gains only if the rental 
profits from such bareboat rentals are incidental to other 
profits of the lessor from the operation of ships or aircraft 
in international traffic. Such gains that are not incidental to 
other income from the operation of ships and aircraft generally 
would be taxable by the source country as business profits if 
such profits are attributable to a permanent establishment. The 
U.S. model and many other treaties provide that gains from the 
sale of ships and aircraft operated in international traffic 
are taxable only in the country of residence, without requiring 
that the rental profits from the use of such ships be 
incidental to income of the recipient from the operation of 
ships or aircraft. Under the proposed treaty, unlike under the 
U.S. model, an enterprise that engages only in the rental of 
ships and aircraft on a bareboat basis, but does not engage in 
the operation of ships and aircraft, would not be eligible for 
the rule limiting the right to tax income from operations in 
international traffic to the enterprise's country of residence. 
It should be noted that under the proposed treaty gains from 
the sale of containers used in international traffic are 
taxable only in the country of residence.
Issues
    The Committee may wish to consider whether the proposed 
treaty's rules with respect to income derived from the rental 
of ships and aircraft, and gains from the sale of ships and 
aircraft, are appropriate.

                           E. 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 only residents 
of Italy and the United States, 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. 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 several recent 
treaties. Some aspects of the provision, however, differ from 
the anti-treaty shopping provision in the U.S. model. The issue 
is whether the anti-treaty shopping provision of the proposed 
treaty will be effective in forestalling potential treaty 
shopping abuses.
    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, or 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 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 
the Treasury Department has to adjust the operation of the 
proposed treaty, it should satisfy itself that its rules as 
applied will adequately deter treaty shopping abuses. The 
proposed treaty's ownership test may be effective in preventing 
third-country investors from obtaining treaty benefits by 
establishing investing entities in Italy because third-country 
investors may be unwilling to share ownership of such investing 
entities on a 50-50 basis with U.S. or Italian residents or 
other qualified owners in order to meet the ownership test of 
the anti-treaty shopping provision. The base erosion test 
contained in the proposed treaty will provide protection from 
certain potential abuses of an Italian conduit. Finally, Italy 
imposes significant taxes of its own; these taxes may deter 
third-country investors from seeking to use Italian entities to 
make U.S. investments. On the other hand, implementation of the 
tests for treaty shopping set forth in the treaty may raise 
factual, administrative, or other issues that cannot currently 
be foreseen. Thus, the Committee may wish to satisfy itself 
that the provision as proposed is an adequate tool for 
preventing possible treaty-shopping abuses in the future.

          F. Arbitration Under the Mutual Agreement Procedures

    The proposed treaty would allow for a binding arbitration 
procedure, if agreed by both competent authorities and the 
taxpayer or taxpayers involved, for the resolution of disputes 
regarding individual cases of double taxation not in accordance 
with the proposed treaty. Several conditions would have to be 
satisfied before this arbitration procedure could be utilized. 
First, the two countries would have to exchange diplomatic 
notes implementing this arbitration procedure; until that 
occurs, the arbitration procedure is not in effect. Second, the 
affected taxpayer must present his or her case to the competent 
authority. Third, the competent authority must first attempt to 
resolve the issue by itself, and if it cannot, then it must 
attempt to do so by mutual agreement with the competent 
authority of the other country.
    The Memorandum of Understanding explicitly states that the 
two countries will exchange the requisite diplomatic notes when 
the experience of the two countries with respect to a similar 
provision in the treaty between the U.S. and Germany has proven 
to be satisfactory. In approving ratification of the U.S.-
Germany treaty, the Committee indicated a belief that the tax 
system potentially may have much to gain from use of a 
procedure, such as arbitration, in which independent experts 
can resolve disputes that may otherwise impede efficient 
administration of the tax laws. However, the Committee also 
believed that the appropriateness of such a clause in a future 
treaty depended strongly on the other party to the treaty and 
the experience that the competent authorities would have under 
the provision in the German treaty.
    The Committee may wish to consider whether this provision 
allowing for the future implementation of an arbitration 
procedure is appropriate.

                       G. Exchange of Information

    One of the principal purposes of the proposed treaty 
between the United States and Italy is to prevent avoidance or 
evasion of taxes of the two countries. The exchange of 
information article of the proposed treaty (Article 26) is one 
of the primary vehicles used to achieve that purpose.
    The exchange of information article contained in the 
proposed treaty generally conforms to the corresponding article 
of the OECD model and the U.S. model.20 As is true 
under these model treaties, under the proposed treaty a country 
is not required to carry out administrative measures at 
variance with the laws and administrative practice of either 
country, to supply information that is not obtainable under the 
laws or in the normal course of the administration of either 
country, or to supply information that discloses any trade, 
business, industrial, commercial, or professional secret or 
trade process, or information the disclosure of which is 
contrary to public policy.
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    \20\ This takes into account Article 1, paragraph 20 of the 
proposed protocol (including authorities involved in the oversight of 
tax administration within the ambit of persons to whom information may 
be disclosed) and the Technical Explanation of Article 26 of the treaty 
(stating that ``necessary'' is to be interpreted equivalently to 
``relevant'' with respect to the scope of the exchange of information 
provision).
---------------------------------------------------------------------------
    The exchange of information article contained in the 
proposed treaty varies significantly from the U.S. model in one 
respect: the authority to obtain information from third parties 
(commonly referred to as the ``bank secrecy'' provision). This 
provision of the U.S. model provides that, notwithstanding the 
limitations described in the preceding paragraph, a country has 
the authority to obtain and provide information held by 
financial institutions, nominees, or persons acting in a 
fiduciary capacity. This information must be provided to the 
requesting country notwithstanding any laws or practices of the 
requested country that would otherwise preclude acquiring or 
disclosing such information.
    One issue is the significance of the omission of this 
provision with respect to this proposed treaty. The omission of 
this provision from the proposed treaty may not be significant 
in that, according to the Treasury Department, Italian law 
permits exchanges of the types of information provided for 
under the U.S. model provision. On the other hand, if Italian 
law is not in conflict with the provision of the U.S. model, 
some may question why it was omitted. The Committee may wish to 
satisfy itself as to the sufficiency of this provision.
    Another issue is the implications of the omission of this 
provision from this treaty with respect to future treaty 
negotiations. While some treaty partners do not object to this 
bank secrecy provision, other treaty partners have resisted its 
inclusion in tax treaties. The broader issue of transparency of 
transactions involving third parties is a significant issue 
internationally, and in many respects the United States has 
attempted to advance greater transparency. It is possible that 
the omission of the bank secrecy provision from this treaty may 
be interpreted by other treaty partners as a weakening of the 
U.S. commitment to greater transparency and may make other 
treaty negotiations with respect to this issue more difficult. 
The Committee may wish to consider whether a statement that the 
omission of this provision from this treaty does not lessen the 
commitment of the United States to pursue broader exchanges of 
information in future treaty negotiations would be beneficial.

                                  
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