[Senate Executive Report 104-34]
[From the U.S. Government Publishing Office]
104th Congress Exec. Rept.
SENATE
2d Session 104-34
_______________________________________________________________________
INCOME TAX CONVENTION WITH KAZAKHSTAN
_______
September 25, 1996.--Ordered to be printed
_______________________________________________________________________
Mr. Helms, from the Committee on Foreign Relations, submitted the
following
R E P O R T
[To accompany Treaty Doc. 103-33, Treaty Doc. 104-15, and Exchange of
Notes dated June 16 and 23, 1995 (EC-1431)]
The Committee on Foreign Relations, to which was referred
the Convention Between the Government of the United States of
America and the Government of the Republic of Kazakhstan for
the Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with Respect to Taxes on Income and Capital, with
Protocol, signed at Almaty on October 24, 1993, and two related
exchanges of notes dated August 1 and September 7, 1994, and
August 15 and September 7, 1994; an exchange of notes dated at
Washington July 10, 1995 relating to such convention and
protocol; and an exchange of notes dated June 16 and 23, 1995,
having considered the same, reports favorably thereon, without
amendment, and recommends that the Senate give its advice and
consent to ratification thereof, subject to a proviso.
I. Purpose
The principal purposes of the proposed income tax treaty
between the United States and Kazakhstan 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 income taxes of the two
countries. The proposed treaty is intended to promote close
economic cooperation and facilitate trade and investment
between the two countries. It also is intended to enable the
two countries to cooperate in preventing avoidance and evasion
of taxes.
II. Background
The proposed treaty and the proposed protocol were both
signed on October 24, 1993. Two related exchanges of notes were
dated August 1 and September 7, 1994 and August 15 and
September 7, 1994. In addition, there was an exchange of notes
dated July 10, 1995, and an exchange of notes dated June 16 and
23, 1995. Currently, the United States and Kazakhstan adhere to
the provisions of a tax treaty signed June 20, 1973 between the
Soviet Union and the United States (the ``USSR treaty''). The
proposed treaty replaces the USSR treaty with respect to
Kazakhstan.
The proposed treaty, together with the related protocol and
the two related exchanges of notes, was transmitted to the
Senate for advice and consent to its ratification on September
19, 1994 (see Treaty Doc. 103-33). The exchange of notes dated
July 10, 1995 was transmitted to the Senate for advice and
consent to its ratification on August 3, 1995 (see Treaty Doc.
104-15). The exchange of notes dated June 16 and 23, 1995 was
transmitted to the Senate on September 18, 1995 (see EC-1431).
The Committee on Foreign Relations held a public hearing on the
proposed treaty on June 13, 1995.
III. Summary
In general
As in other U.S. tax treaties, the principal objectives of
the proposed income tax treaty generally are achieved by each
country agreeing to limit, in certain specified situations, its
right to tax income derived from its territory by residents of
the other. For example, the treaty contains the standard treaty
provisions that neither country will 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 6 and 14). Similarly, the
treaty contains the standard ``commercial visitor'' exemptions
under which residents of one country performing personal
services in the other will not be required to pay tax in the
other unless their contact with the other exceeds specified
minimums (Articles 14-16). The proposed treaty provides that
dividends, interest, and royalties derived by a resident of
either country from sources within the other country generally
may be taxed by both countries (Articles 10-12). Generally,
however, dividends, interest, and royalties received by a
resident of one country from sources within the other country
are to be taxed by the source country on a restricted basis
(Articles 10-12).
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 treaty generally provides for the relief
of the potential double taxation by the country of residence
allowing a foreign tax credit (Article 23).
The treaty contains the standard provision (the ``saving
clause'') contained in U.S. tax treaties that each country
retains the right to tax its citizens and residents as if the
treaty had not come into effect (Article 1). In addition, the
treaty contains the standard provision that the treaty will not
be applied to deny any taxpayer any benefits he would be
entitled to under the domestic law of the country or under any
other agreement between the two countries (Article 1); that is,
the treaty will only be applied to the benefit of taxpayers.
Summary of treaty provisions
The proposed treaty is similar to other U.S. income tax
treaties, the 1981 U.S. model treaty (the ``U.S.
model''),1 and the model income tax treaty of the
Organization for Economic Development (the ``OECD model'').
However, the proposed treaty contains certain deviations from
those models. It also differs in significant respects from the
USSR treaty. (That treaty predates the 1981 U.S. model treaty
and was not representative of U.S. treaty policy.) A summary of
the provisions of the proposed treaty and the proposed
protocol, including some of these differences, follows:
---------------------------------------------------------------------------
\1\ The Treasury Department has withdrawn the U.S. model from use
as a model treaty. Accordingly, its provisions may no longer represent
the preferred position for U.S. treaty negotiations. Comparison of the
provisions of the proposed treaty against the provisions of the U.S.
model should be considered in the context of the provisions of
comparable recent U.S. treaties with other countries. The Treasury
Department's new model, released on September 20, 1996, was released
too late for consideration by the Committee in connection with the
proposed treaty.
---------------------------------------------------------------------------
(1) Like all treaties, the proposed treaty is limited by a
``saving clause'' (Article 1(3)), under which the treaty is not
to affect (subject to specific exceptions) the taxation by
either treaty country of its residents or its nationals.
Exceptions to the saving clause are similar to those in the
U.S. model and other U.S. treaties; the USSR treaty, in
contrast, flatly states that it shall not restrict the right of
a treaty country to tax its own citizens.
(2) The U.S. excise tax on insurance premiums paid to a
foreign insurer is not a covered tax; that is, the proposed
treaty does not preclude the imposition of the tax on insurance
premiums paid to Kazakhstani insurers (Article 2). This is a
departure from the USSR treaty and the U.S. model tax treaty,
but one that is shared by many U.S. treaties, including recent
ones. In addition, the proposed treaty, like the model treaty
but unlike the USSR treaty, does not contain a general
prohibition on source country taxation of reinsurance premiums
derived by a resident of the other country. Nor does the
proposed treaty contain the provision of the USSR treaty under
which, if the income of a resident of one country is tax-exempt
in the other country, the transaction giving rise to that
income is exempt from any tax that is or may otherwise be
imposed on the transaction.
(3) Like the U.S. model but unlike the USSR treaty, the
proposed treaty generally does not cover U.S. taxes other than
income taxes, although it does cover taxes on property. Nor
does the proposed treaty cover the accumulated earnings tax,
the personal holding company tax, and social security taxes.
(4) The proposed treaty makes it clear that each country
includes its territorial sea, and also the economic zone and
continental shelf in which certain sovereign rights and
jurisdiction may be exercised in accordance with international
law (Article 3).
(5) By contrast with the USSR treaty, but like the U.S.
model, U.S. citizens are entitled to treaty benefits regardless
of actual residence in a third country. In addition, the
proposed treaty introduces rules for determining when a person
is a resident of either the United States or Kazakhstan, and
hence entitled to benefits under the treaty (Article 4). The
proposed treaty, like the model, provides tie-breaker rules for
determining the residence for treaty purposes of ``dual
residents,'' or persons having residence status under the
internal laws of each of the treaty countries.
(6) Article 5 of the proposed treaty introduces the
permanent establishment threshold for one country's imposition
of tax on the business profits of a resident of the other
country, in conformity with the U.S. and OECD model treaties.
This replaces the concept of a ``representation'' used in the
USSR treaty.
(7) Under the U.S. model treaty, a building site or
construction or installation project, or an installation or
drilling rig or ship used for the exploration or exploitation
of natural resources, constitutes a permanent establishment
only if it lasts more than 12 months. The corresponding rule in
the proposed treaty is the same. Under the USSR treaty, the
source country is prohibited from taxing the income of a
resident of the other country from furnishing engineering,
architectural, designing, and other technical services in
connection with an installation contract with a resident of the
source country and which are carried out in a period not longer
than 36 months at one location. The proposed treaty treats as a
permanent establishment the furnishing of services, including
consultancy services, within a country for a period of more
than 12 months.
(8) The USSR treaty in general imposes no restriction on
the taxation of income from real property by the country in
which the property is located. The proposed treaty contains a
provision similar to the corresponding model treaty provision
permitting taxation of such income by the country in which the
real property is located, including the U.S. model treaty
provision under which investors in real property in the country
not of their residence must be permitted to elect to be taxed
on those investments on a net basis (Article 9).
(9) The business profits article of the U.S. model treaty
omits the force of attraction rules contained in the Code,
providing instead that the business profits to be attributed to
the permanent establishment shall include only the profits
derived from the assets or activities of the permanent
establishment. The proposed treaty, on the other hand, contains
a limited force of attraction rule (Article 6) under which a
country (the first country) could tax sales in that country by
a resident of the other country of goods or merchandise of the
same or similar kind as the goods or merchandise that are sold
by that person through its permanent establishment in the first
country and other business activities in that country of the
same kind as those effected through its permanent
establishment. This rule is narrower in scope than the Code's
force of attraction rules.
(10) The proposed treaty clarifies that a country may tax
profits or income if the other-country resident carries on ``or
has carried on'' business, or has ``or had'' a fixed base, in
that country. Addition of the words ``or has carried on'' and
``or had'' clarifies that, for purposes of the treaty rules
stated above, any income attributable to a permanent
establishment (or fixed base) during its existence is taxable
in the country where the permanent establishment (or fixed
base) is situated even if the payments are deferred until after
the permanent establishment (or fixed base) has ceased to
exist.
(11) The proposed treaty provides that expenses incurred
for the purposes of the permanent establishment are to be
allowed as deductions from the taxable income of a permanent
establishment. However, the proposed treaty provides that no
deductions may be taken in respect of amounts paid by the
permanent establishment to the head office in the form of
royalties, fees, or other payments, to the extent that they
exceed reimbursements of costs incurred by the head office and
allocable to the permanent establishment.
(12) The proposed treaty, similar to the model treaty and
similar in some respects to the USSR treaty, provides that
income of a resident of one treaty country from the operation
of ships or aircraft in international traffic is taxable only
in that country (Article 8). Similar to the model treaty, the
proposed treaty includes bareboat leasing income in the
category of income to which this rule applies. Similar to the
model treaty and unlike the present treaty, the proposed treaty
provides that income of a treaty-country resident from the use
or rental of containers and related equipment used in
international traffic shall be taxable only in that country.
(13) Article 7 of the proposed treaty corresponds to the
associated enterprises article in the U.S. model treaty. In
particular, the proposed treaty contains a ``correlative
adjustment'' clause, providing that either treaty country must
correlatively adjust any tax liability it previously imposed on
a person for income reallocated to a related person by the
other treaty country. The USSR treaty contains no associated
enterprises article.
(14) The USSR treaty generally imposes no restriction on
the source-country taxation of dividends. The proposed treaty,
similar to the U.S. model treaty, provides in Article 10 that
direct investment dividends (i.e., dividends paid to companies
resident in the other country that own directly at least 10
percent of the voting shares of the payor) generally will be
taxable by the source country at a rate no greater than 5
percent. Other dividends generally are taxable by the source
country at a rate no greater than 15 percent.
(15) Like recent U.S. treaties, the proposed protocol
provides that dividends paid by a U.S. regulated investment
company (a ``RIC'') are subject to source country taxation at
the 15-percent limit (paragraph 2(a)). In addition, like some
recent U.S. treaties, the proposed treaty and proposed protocol
impose no general restriction on the source country taxation of
dividends paid by a U.S. real estate investment trust (a
``REIT'').
(16) The USSR treaty generally imposes no restriction on
the U.S. branch profits tax. The proposed treaty, similar to
U.S. treaties negotiated since 1986, expressly permits the
United States and Kazakhstan to impose a branch profits tax,
but at a rate not exceeding 5 percent (Article 10(5)).
(17) The USSR treaty limits the source-country taxation of
interest only in the case of interest in connection with the
financing of trade between the United States and the Soviet
Union. Unlike the model treaties, the proposed treaty provides
that interest may be taxed by both treaty countries, rather
than by the residence country only. Taxation of interest by the
source country generally is limited by the proposed treaty to a
rate of 10 percent (Article 11). Certain governmental interest
is exempt from source-country taxation under the proposed
treaty. In addition, the proposed treaty provides that income
from any arrangement, including a debt obligation, carrying the
right to participate in profits and treated as a dividend by
the source country according to its internal laws, may be taxed
by the source country as a dividend. Thus, for example, the
country of source could withhold tax on deductible interest
paid under an ``equity kicker'' loan, at rates applicable to
dividends. There is no similar provision in the U.S. or OECD
models.
The proposed protocol (paragraph 3(a)) provides that any
lower rate of withholding tax on interest agreed to in a treaty
between Kazakhstan and another OECD country will be applicable
between the United States and Kazakhstan. The Memorandum of
Understanding (point 4) clarifies that this modification in the
applicable withholding-tax rate will be subject to the usual
ratification processes.
(18) The proposed treaty permits the United States to
impose its branch-level interest tax on a permanent
establishment's ``excess interest amount,'' as defined in U.S.
law (Article 11(7)). Kazakhstan is permitted under the proposed
treaty to impose a similar tax.
(19) The proposed protocol (paragraph 3(c)) provides that
the interest article in the proposed treaty does not interfere
with the jurisdiction of the United States to tax under its
internal law an excess inclusion with respect to a residual
interest in a real estate mortgage investment conduit (a
``REMIC''). Currently, internal U.S. law applies regardless of
treaties that were in force when the REMIC provisions were
enacted.
(20) Unlike the model treaties and the USSR treaty, the
proposed treaty provides that royalties may be taxed by both
treaty countries, rather than by the residence country only.
Taxation of royalties by the source country is limited by the
proposed treaty to a rate of 10 percent (Article 12). Royalties
generally are defined as payments for the use of certain
rights, property, or information. Unlike the model treaty, the
proposed treaty does not treat as royalties gains from the
alienation of rights or property which are contingent on the
productivity, use, or further alienation of such right or
property. The taxation of such gains is governed by the
proposed treaty's ``Gains'' article, which, in a manner similar
to the royalties article of the model treaties, generally
reserves taxing jurisdiction to the residence country (Article
13).
(21) Also included in the proposed treaty's definition of
royalties are payments for the use of, or the right to use,
industrial, commercial, or scientific equipment. However, the
proposed treaty provides an election for such equipment rentals
to be taxed on a net basis, as if attributable to a permanent
establishment (Article 12(2)).
(22) The proposed protocol expressly provides in paragraph
4 that where the treaty limits the right to collect taxes,
which taxes are nevertheless withheld at source at the rates
provided for under internal law, refunds will be made in a
timely manner on application by the taxpayer.
(23) Both the U.S. model treaty and the proposed treaty
provide for source-country taxation of capital gains from the
disposition of property used in the business of a permanent
establishment in the source country (Article 13(4)). Unlike
most recent U.S. tax treaties, however, the proposed treaty
does not specifically provide for source-country taxation of
such gains where the payments are received after the permanent
establishment has ceased to exist. The Treasury Department's
Technical Explanation (hereinafter referred to as the
``Technical Explanation'') states that, unlike the United
States, Kazakhstan does not impose tax in that circumstance.
(24) Both the U.S. model treaty and the proposed treaty
provide for source-country taxation of capital gains from the
disposition of real property regardless of whether the taxpayer
is engaged in a trade or business in the source country. The
proposed treaty expands the U.S. model treaty definition of
real property for these purposes to encompass U.S. real
property interests. This safeguards U.S. tax under the Foreign
Investment in Real Property Tax Act of 1980, which applies to
dispositions of U.S. real property interests by nonresident
aliens and foreign corporations.
(25) Article 13(3) of the proposed treaty permits a treaty
country (the first country) to impose its statutory tax on
gains from the disposition, by a resident of the other country,
of stock, participation, or other rights in the capital of a
company or other legal person which is a resident of the first
country if the recipient of the gain, during the 12-month
period preceding the disposition, had a direct or indirect
participation of at least 25 percent in the capital of that
company or other legal person. Such gains are treated as
arising in the first country to the extent necessary to avoid
double taxation. The Committee understands that Kazakhstan has
enacted such a tax. The proposed protocol provides for
competent authority consultations regarding the application of
appropriate rules respecting tax-free reorganizations.
(26) The proposed treaty exempts all other gains from
source-country taxation. This includes gains from the
alienation of ships, aircraft, or containers operated in
international traffic.
(27) Article 14 of the proposed treaty provides that income
derived by a resident of one of the treaty countries from the
performance of professional or other personal services in an
independent capacity generally is not taxable in the other
treaty country unless the services are or were performed in
that other country and the person either (a) has or had a fixed
base there regularly available for the performance of his or
her activities, or (b) is or was present there for more than
183 days in any 12-month period. In such a case, the other
country is permitted to tax the income from services performed
in that country as are attributable to the fixed base.
(28) The dependent personal services article of the
proposed treaty (Article 15) is similar to that article of the
U.S. model. Under the proposed treaty, salaries, wages, and
other similar remuneration derived by a resident of one treaty
country in respect of employment exercised in the other country
is taxable only in the residence country (i.e., is not taxable
in the other country) if the recipient is present in the other
country for a period or periods not exceeding in the aggregate
183 days in the taxable year concerned and certain other
conditions are satisfied.
(29) Article 16 of the proposed treaty allows directors'
fees and similar payments derived by a resident of one treaty
country for services performed in his or her capacity as a
member of the board of directors (or another similar organ) of
a company which is a resident of the other country to be taxed
in that other country. The U.S. model treaty, on the other
hand, generally treats directors' fees under other applicable
articles, such as those on personal service income. Under the
U.S. model, the country where the recipient resides generally
has primary taxing jurisdiction over personal service income
and the source country tax on directors' fees is limited. By
contrast, under the OECD model treaty (and the proposed
treaty), the country where the company is resident has full
taxing jurisdiction over directors' fees and other similar
payments the company makes to residents of the other treaty
country, regardless of where the services are performed.
(30) The proposed treaty omits the U.S. model treaty
reservation to the source country of jurisdiction to tax an
entertainer or athlete, residing in the other country, who
earns more than $20,000 in the source country during a taxable
year, without regard to the existence of a fixed base or other
contacts with the source country. Thus, under the proposed
treaty, the rules applicable to personal service income apply
to entertainers and athletes.
(31) The proposed treaty modifies the USSR treaty's rule,
similar to the U.S. model rule, that compensation paid by a
treaty country government to one of its citizens for services
rendered to that government in the discharge of governmental
functions may only be taxed by that government's country. Under
Article 17 of the proposed treaty, as under the OECD model
treaty and other U.S. treaties, such compensation generally may
only be taxed by the recipient's country of residence, if the
recipient is a citizen of that country, or (in the case of
remuneration other than a pension) did not become a resident of
that country solely for the purpose of rendering the services.
(32) The proposed treaty, like the U.S. model treaty and
unlike the USSR treaty, expressly provides for the taxation of
pensions in general only by the residence country, and for the
taxation of social security benefits and other public pensions
not arising from government service only in the source country
(Article 18). Also like the U.S. model, the proposed treaty
provides for taxation of annuities and alimony only by the
residence country, and taxation of child support payments only
by the source country.
(33) The USSR treaty, unlike the models, precludes each
country from taxing a resident of the other country who is
temporarily present in the first country as a journalist, media
correspondent, teacher, or researcher; or who is temporarily
present to participate in an exchange program for
intergovernmental cooperation in science and technology, or to
study or gain technical, professional, or commercial
experience. These exemptions generally extend only to income or
allowances connected with the purpose of the visit, and only
for such period as is required to effectuate the purpose of the
visit, and in no case more than two years in the case of
teachers and researchers, five years in the case of students,
and one year in other cases.
The proposed treaty contains a narrower set of limitations
on host-country taxation of temporary visitors (Article 19)
than does the USSR treaty. The limitations do not apply to
visits for teaching or for journalism. They also do not provide
an exemption for employment income. The proposed treaty
prohibits the host country from taxing certain payments from
abroad for the purpose of the individual's maintenance,
education, study, research, or training. Temporary presence in
the host country must be for the purpose of studying at an
educational institution; training as required to practice a
profession; or studying or doing research as a recipient of a
grant from a governmental, religious, charitable, scientific,
literary, or educational organization. In the last case, the
proposed treaty prohibits the host country from taxing the
grant. The exemptions apply no longer than the period of time
ordinarily necessary to complete the study, training or
research. Moreover, no exemption for training or research will
extend for a period exceeding five years. The exemption from
host country tax does not apply to income from research if the
research is undertaken for private benefit.
(34) The proposed treaty contains an ``other income''
article which differs fundamentally from the ``other income''
article of the U.S. model treaty and more recent U.S. treaties.
Under the U.S. model, income not dealt with in another treaty
article generally may be taxed only by the residence country.
By contrast, Article 20 of the proposed treaty, like, for
example, the recent U.S.-Mexico treaty, specifies that items of
income of a resident of a treaty country which are not dealt
with elsewhere in the treaty and which arise in the other
treaty country are taxable in the other country.
(35) The proposed treaty contains a limitation on benefits,
or ``anti-treaty shopping,'' article similar to the limitation
on benefits articles contained in recent U.S. treaties and
protocols and in the branch tax provisions of the Code (Article
21). The limitation on benefits article in the proposed treaty
is virtually identical to the corresponding provisions of the
recent U.S. income tax treaty with the Russian Federation.
(36) Unlike most U.S. treaties and the model treaties, the
USSR treaty has no provision providing relief from double
taxation. In the general case this absence may have little or
no impact on a U.S. person, as the United States provides
relief from double taxation by internal law, through the
foreign tax credit. The proposed treaty provides that each
country shall allow its residents (and the United States its
citizens) a credit for income taxes imposed by the other
country (Article 23). However, such credits need only be in
accordance with the provisions and subject to the limitations
of internal law (as it may be amended from time to time without
changing the general principle that credits must be allowed).
Paragraph 8(a) of the proposed protocol provides an
additional credit rule for a U.S. citizen who is a resident of
Kazakhstan. To such a person Kazakhstan must allow credits even
for U.S. taxes imposed solely by reason of the person's
citizenship, but to no greater extent than the Kazakhstani tax
on income from sources outside Kazakhstan.
(37) U.S. law allows taxpayers credit for foreign taxes
only if the foreign taxes are directed at the taxpayer's net
gain. Thus the sufficiency of deductions allowed under foreign
law is relevant to the creditability of foreign tax against
U.S. tax liability. At times, Soviet and Kazakhstani law have
in effect placed significant restrictions on labor and interest
cost deductions. The Committee understands that the Kazakhstan
Tax Code permits the deduction of wage and interest expense. In
order to assist U.S. taxpayers' ability to take U.S. credits
for Kazakhstani taxes, Kazakhstan confirms under the proposed
protocol (paragraph 8) that its law permits certain Kazakhstani
entities deductions for actual wages paid and for interest
(whether paid to a bank or another person and without regard to
the term of the loan). The deductions are limited by
Kazakhstani law, but only to the extent that such limitation is
not less than an arm's-length rate (taking into account a
reasonable risk premium). This confirmation applies to U.S.-
owned entities, to joint ventures with U.S. ownership, and to
Kazakhstani permanent establishments of U.S. entities. On the
basis of these required deductions, the proposed protocol
treats Kazakhstan's taxes as income taxes that are eligible for
the U.S. foreign tax credit. The Technical Explanation states
that the United States is not obligated to treat the
Kazakhstani taxes as eligible for U.S. foreign tax credits in
the event that these required deductions are denied under
Kazakhstani law.
(38) The proposed treaty does not provide for ``tax
sparing'' or other fictitious credits for taxes forgiven by one
treaty country to residents of the other country under an
incentive program. Like some other U.S. treaties, however,
paragraph 8(d) of the proposed protocol indicates that the
United States and Kazakhstan will amend the proposed treaty
(subject to the usual ratification procedures) to provide such
credits in the event that the United States either amends its
internal laws to allow such credits or agrees to provide them
in a tax treaty with any other country.
(39) Article 24 of the proposed treaty greatly expands the
nondiscrimination rule in the USSR treaty, in some respects
conforming it to the U.S. model, and in other respects
providing additional benefits. The USSR treaty requires
``national treatment'' to the extent of prohibiting
discrimination under the laws of one country against citizens
of the other country resident in the first country. It requires
``most-favored-nation treatment'' to the extent of prohibiting
less favorable treatment, under the laws of one country, of
citizens of the other country resident in the first country, or
of local representations of residents of the other country,
than the treatment afforded to third-country citizens and
representations of third-country residents. The proposed treaty
also requires both ``national treatment'' to the extent
required in the U.S. model and a form of ``most-favored-nation
treatment'' (not taking into account special agreements, such
as bilateral income tax treaties, with third countries) to be
applied to citizens and residents of the treaty countries. The
proposed treaty affords these benefits to citizens of the other
country in the same circumstances as citizens of the first
country, regardless of residence; to the local permanent
establishments of residents of the other country, and to
enterprises owned by residents of the other country. In
addition, the proposed treaty prohibits discrimination against
the deductibility of amounts paid to residents of the other
country. The Technical Explanation states that, like the U.S.
model treaty, it was intended that the nondiscrimination rules
of the proposed treaty apply not only to all national-level
taxes, but also to all taxes imposed by each country's
political subdivisions and local authorities.
(40) Like the U.S. model treaty, and unlike the USSR
treaty, the proposed treaty makes express provision for the
competent authorities to mutually agree on topics that arise
under the proposed treaty, but are not mentioned in the present
treaty's mutual agreement article, such as the characterization
of particular items of income, the common meaning of a term,
the application of procedural aspects of internal law, and the
elimination of double taxation in cases not provided for in the
treaty (Article 25).
(41) Paragraph 9 of the proposed protocol provides for
competent authority consultations in the event of a change in
law (or the application thereof) that may eliminate or
significantly limit a benefit provided by the proposed treaty.
If the issue cannot be resolved by the competent authorities,
the proposed treaty is subject to termination under its
termination provisions, but without regard to the prohibition
on termination during the first five years after entry into
force.
(42) The proposed treaty, like the U.S. treaties with
Germany, Mexico, and the Netherlands, provides for a binding
arbitration procedure to be used to settle disagreements
between the two countries regarding the interpretation or
application of the treaty (Article 25(5)). The arbitration
procedure can only be invoked by the agreement of both
countries. The effective date of this provision is delayed
until the two countries have agreed that it will take effect,
to be evidenced by a future exchange of diplomatic notes.
(43) Unlike some other recent U.S. treaties, the proposed
treaty does not provide that its dispute resolution procedures
under the mutual agreement article takes precedence over the
corresponding provisions of any other agreement between the
United States and Kazakhstan in determining whether a law or
other rule is within the scope of the proposed treaty.
Therefore, under the treaty as proposed, if Kazakhstan accedes
to the General Agreement on Trade in Services (the ``GATS''),
tax issues between the United States and Kazakhstan may be
subject to the dispute resolution procedures of the World Trade
Organization. This issue is addressed in the exchange of notes
dated July 10, 1995 which constitutes an agreement that will
enter into force on the date the treaty enters into force. The
exchange of notes provides that, in the event the GATS applies
between the United States and Kazakhstan, the dispute
resolution procedures under the mutual agreement article of the
proposed treaty will take precedence.
(44) While the USSR treaty requires exchanges of
information only to the extent of providing information about
changes in internal law, the proposed treaty includes the
standard exchange of information article, similar to that in
the U.S. model, which contemplates that each competent
authority will assist the other in obtaining and transmitting
information that relates to the assessment, collection,
enforcement, and prosecution of tax claims against particular
taxpayers (Article 26). The proposed treaty, like some other
U.S. treaties, omits the U.S. model provision pledging
assistance in collecting such amounts as may be necessary to
ensure that treaty relief does not enure to the benefit of
persons not entitled thereto.
(45) The proposed treaty would enter into force on the date
of the exchange of instruments of ratification, and would be
effective for matters other than withholding tax on January 1
of the year the treaty enters into force. With respect to
withholding taxes, the proposed treaty will be effective on the
first day of the second month following entry into force
(Article 28). Paragraph 10 of the proposed protocol states
that, during the first taxable year in which the proposed
treaty is in effect, a taxpayer may elect to be taxed under the
USSR treaty in its entirety.
IV. Entry Into Force and Termination
a. entry into force
The proposed treaty is subject to ratification in
accordance with the applicable procedures of each country, and
instruments of ratification are to be exchanged as soon as
possible. In general, the proposed treaty will enter into force
when the instruments of ratification are exchanged. The
exchanges of notes will enter into force when the treaty enters
into force.
With respect to taxes withheld at source on dividends,
interest or royalties, the proposed treaty will be effective
for amounts paid or credited on or after the first day of the
second month following entry into force. With respect to other
taxes, the proposed treaty will be effective for taxable
periods beginning on or after the first of January of the year
the treaty enters into force.
Where greater benefits would have been available to a
taxpayer under the USSR treaty than under the proposed treaty,
the proposed protocol provides that a taxpayer may elect to be
taxed under the USSR treaty (in its entirety) for the first
taxable year with respect to which the proposed treaty would
otherwise have effect.
b. termination
The proposed treaty will continue in force until terminated
by either country. Either country may terminate the treaty at
any time after five years from the date of its entry into force
by giving at least six months prior written notice through
diplomatic channels. A termination will be effective with
respect to taxes withheld at source for amounts paid or
credited on or after the first of January following the
expiration of the six month period. A termination will be
effective with respect to other taxes for taxable periods
beginning on or after the first of January following the
expiration of the six-month period.
V. Committee Action
The Committee on Foreign Relations held a public hearing on
the proposed treaty with Kazakhstan, the related protocol, and
the two related exchanges of notes (Treaty Doc. 103-33), as
well as on other proposed tax treaties and protocols, on June
13, 1995. The hearing was chaired by Senator Thompson. The
Committee considered the proposed treaty with Kazakhstan on
September 25, 1996, and ordered the proposed treaty, the
protocol, and the two related exchanges of notes; the exchange
of notes dated July 10, 1995; and the exchange of notes dated
June 16 and 23, 1995 favorably reported by a voice vote, with
the recommendation that the Senate give its advice and consent
to ratification of the proposed treaty, the protocol, and the
exchanges of notes, subject to a proviso.
VI. Committee Comments
On balance, the Committee on Foreign Relations believes
that the proposed treaty with Kazakhstan is in the interest of
the United States and urges that the Senate act promptly to
give advice and consent to ratification. The Committee has
taken note of certain issues raised by the proposed treaty, and
believes that the following comments may be useful to U.S.
Treasury officials in providing guidance on these matters
should they arise in the course of future treaty negotiations.
a. relationship to uruguay round trade agreements
The multilateral trade agreements encompassed in the
Uruguay Round Final Act, which entered into force as of January
1, 1995, include the GATS. This agreement generally obligates
members and their political subdivisions to afford persons
resident in member countries (and related persons) ``national
treatment'' and ``most-favored-nation treatment'' in certain
cases relating to services. The GATS applies to ``measures''
affecting trade in services. A ``measure'' includes any law,
regulation, rule, procedure, decisions, administrative action,
or any other form. Therefore, the obligations of the GATS
extend to any type of measure, including taxation measures.
However, the application of the GATS to tax measures is
limited by certain exceptions under Article XIV and Article
XXII(3). Article XIV requires that a tax measure not be applied
in a manner that would constitute a means of arbitrary or
unjustifiable discrimination between countries where like
conditions prevail, or a disguised restriction on trade in
services. Article XIV(d) allows exceptions to the national
treatment otherwise required by the GATS, provided that the
difference in treatment is aimed at ensuring the equitable or
effective imposition or collection of direct taxes in respect
of services or service suppliers of other members. ``Direct
taxes'' under the GATS comprise all taxes on income or capital,
including taxes on gains from the alienation of property, taxes
on estates, inheritances and gifts, and taxes on the total
amounts of wages or salaries paid by enterprises as well as
taxes on capital appreciation.
Article XXII(3) provides that a member may not invoke the
GATS national treatment provisions with respect to a measure of
another member that falls within the scope of an international
agreement between them relating to the avoidance of double
taxation. In case of disagreement between members as to whether
a measure falls within the scope of such an agreement between
them, either member may bring this matter before the Council
for Trade in Services. The Council is to refer the matter to
arbitration; the decision of the arbitrator is final and
binding on the members. However, with respect to agreements on
the avoidance of double taxation that are in force on January
1, 1995, such a matter may be brought before the Council for
Trade in Services only with the consent of both parties to the
tax agreement.
Article XIV(e) allows exceptions to the most-favored-nation
treatment otherwise required by the GATS, provided that the
difference in treatment is the result of an agreement on the
avoidance of double taxation or provisions on the avoidance of
double taxation in any other international agreement or
arrangement by which the member is bound.
The United States is a party to the GATS, but Kazakhstan is
not yet a party thereto. If Kazakhstan accedes to the GATS,
under the treaty as proposed, tax issues between the United
States and Kazakhstan could be subject to the dispute
resolution procedures of the World Trade Organization. At the
time of the June 13, 1995, hearing, the Committee understood
that the Treasury Department expected to address this issue in
an exchange of notes. Thus, as part of its consideration of the
proposed treaty, the Committee inquired of the Treasury
Department what assurance did the Committee have that the
exchange of notes addressing this issue would occur. The
relevant portion of the Treasury Department's July 5, 1995,
letter \2\ responding to this inquiry is reproduced below:
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\2\ Letter from then Assistant Secretary of the Treasury (Tax
Policy) Leslie B. Samuels to Senator Fred Thompson, Committee on
Foreign Relations, July 5, 1995 (``July 5, 1995 Treasury Department
letter'').
1. What assurances does this Committee have that an
exchange of notes will occur, and effectively permit
the treaty to preempt the dispute settlement procedures
under the GATS, should Kazakhstan accede to the GATS?
We have been advised that the Ministries of Finance
and Trade and Industry have approved the notes. We hope
to complete promptly the formalities associated with
the exchange.
The subsequent exchange of notes dated July 10, 1995,
addresses the relationship between the proposed treaty and the
GATS, in the event that the GATS applies between the United
States and Kazakhstan, and the relationship between the
proposed treaty and other agreements that apply between the two
countries. The exchange of notes dated July 10, 1995, provides
that, in the event the GATS applies between the United States
and Kazakhstan, a dispute concerning whether a measure is
within the scope of the proposed treaty is to be considered
only by the competent authorities under the dispute settlement
procedures of the proposed treaty. Moreover, the exchange of
notes dated July 10, 1995, provides that the nondiscrimination
provisions of the proposed treaty are the only
nondiscrimination provisions that may be applied to a taxation
measure unless the competent authorities determine that the
taxation measure is not within the scope of the proposed treaty
(with the exception of nondiscrimination obligations under the
General Agreement on Tariffs and Trade (``GATT'') with respect
to trade in goods, provided that GATT applies between the
United States and Kazakhstan).
The Committee believes that it is important that the
competent authorities are granted the sole authority to resolve
any potential dispute concerning whether a measure is within
the scope of the proposed treaty and that the nondiscrimination
provisions of the proposed treaty are the only appropriate
nondiscrimination provisions that may be applied to a tax
measure unless the competent authorities determine that the
proposed treaty does not apply to it (except nondiscrimination
obligations under GATT with respect to trade in goods, if it
applies between the United States and Kazakhstan). The
Committee also believes that the provision of the exchange of
notes dated July 10, 1995, is adequate to preclude the
preemption of the mutual agreement provisions of the proposed
treaty by the dispute settlement procedures under the GATS (in
the event that it applies between the United States and
Kazakhstan).
b. foreign tax credit for kazakhstani taxes
Tax policy
To be creditable under the limitations of U.S. law, a
foreign tax must be directed at the taxpayer's net gain. Like
any foreign taxes, the Kazakhstani tax on income (profits) of
enterprises and the income tax on individuals have been imposed
on a base that is not necessarily identical to the U.S. income
tax base. For example, the Committee understands that at the
time the proposed treaty was signed, Kazakhstani tax laws may
not have allowed full deductions for labor costs and interest
expense. However, the Committee understands that the Kazakhstan
Tax Code permits the deduction of wage and interest expense. In
order to assist U.S. taxpayers seeking eligibility of
Kazakhstani taxes for use as credits against U.S. tax, as
discussed above in Part III, the proposed protocol requires
Kazakhstan to provide interest and labor cost deductions in the
case of certain U.S. persons and U.S.-participating entities.
In addition, on the basis of those required deductions, the
proposed treaty provides that the Kazakhstani taxes will be
creditable for U.S. purposes.\3\
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\3\ The Committee understands that the proposed protocol will not
treat as creditable the Kazakhstani taxes imposed on a taxpayer that is
not eligible for the full deductions, as provided in the proposed
protocol.
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It generally has not been consistent with U.S. tax policy
for deductions from the U.S. tax base of a U.S. person to be
granted by treaty. Nor has it been consistent with U.S. tax
policy to guarantee by treaty the U.S. creditability of an
otherwise non-creditable foreign tax. It is believed that both
functions are generally more appropriately served in the normal
course of internal U.S. tax legislation. The proposed treaty
attempts to be consistent with these principles, while
accommodating the differences between Kazakhstan's and the
United States' internal constitutional processes. As a result,
the treaty commits Kazakhstan to providing special features of
its internal tax base with respect to foreign-owned
investments, in order to conform Kazakhstan's taxes to the
requirements of the U.S. foreign tax credit. However, the
proposed treaty takes the unusual additional step of
guaranteeing that the Kazakhstani tax, with the assurances
described in the proposed protocol, is eligible for the U.S.
foreign tax credit.
Stability of Kazakhstani tax law
The tax laws of Kazakhstan were adopted, by presidential
decree, in April 1995.\4\ The Committee understands that the
Kazakhstan Tax Code has been in place since 1995. A set of
technical amendments to the Tax Code were enacted in December
1995.
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\4\ The Decree of the President of the Republic of Kazakhstan,
Having the Force of a Law, ``On Taxes and Other Obligatory Payments to
the Budget'' (Almaty, April 24, 1995).
---------------------------------------------------------------------------
The 1992 U.S. income tax treaty with the Russian Federation
included a similar provision to the proposed protocol's special
deduction rules for the labor and interest expenses of certain
foreign-owned entities. However, despite allowing deductions
for all wages paid under the treaty, the Russian Federation
subsequently enacted an excess-wage tax that applies to wages
that exceed six times the minimum monthly wage. The package of
amendments to the Russian tax laws that took effect recently
continue the excess-wage tax at least through 1995.\5\ Under
the terms of the United States-Russia tax treaty, the United
States is not permitted to terminate the treaty until 1999.\6\
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\5\ Bureau of National Affairs, Daily Tax Report, May 1, 1995, p.
G-2.
\6\ The United States has rarely terminated a tax treaty in
response to changes in the tax laws of a treaty partner. Despite the
changes, it is usually desirable to continue the tax treaty
relationship for the sake of other treaty benefits until the treaty can
be renegotiated.
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The Committee understands that one of the December 1995
amendments to the Kazakhstan Tax Code resulted in the enactment
of an excess-wage tax. However, the Committee has been informed
that the Kazakhstani government has assured the Treasury
Department that the excess-wage tax will not be imposed on any
U.S.-owned businesses. In addition, unlike the United States-
Russia tax treaty, the proposed treaty includes a provision
that requires competent authority consultations in the event of
a change in law (or the application thereof) that may eliminate
or significantly limit a benefit provided by the proposed
treaty. If the issue cannot be resolved by the competent
authorities, the proposed treaty is subject to termination
under its termination provisions, but without regard to the
prohibition on termination during the first five years after
entry into force. Had such a provision been included in the
U.S.-Russia tax treaty, the Committee understands that the
United States would have been permitted to terminate the
treaty.
Most tax treaty partners of the United States have long-
established tax systems. The states of the former Soviet Union
generally have not yet had the opportunity fully to develop
their economies and tax systems. It is less common for the
United States to use a tax treaty as a device to stabilize the
economy or tax system of a country undergoing development or
transition. The Russian excess-wage tax is an example of how a
tax treaty alone may not be completely effective toward this
goal. Nonetheless, in such circumstances as those found in the
Russian Federation, the tax treaty may afford U.S. investors
and the U.S. Government a useful forum in which to air certain
grievances that may arise in the area of fiscal policy.
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department the reason for entering
into a treaty with a country whose government is not stable and
the precedent for bilateral tax treaties where the content of a
country's tax laws are not known in detail. The relevant
portion of the July 5, 1995 Treasury Department letter
responding to this inquiry is reproduced below:
2. Why should the United States enter into a treaty
with a country whose government is not stable?
Kazakhstan entered a period of political uncertainty
in March [1995], when a court ruling resulted in the
dissolution of Parliament. In April [1995], President
Nazarbayev held and won a national referendum on
extending his term in office until December 1, 2000.
Neither Treasury nor the State Department endorse this
development, which has been made known to Kazakhstan.
Both agencies, however, are convinced that proceeding
with the tax treaty is a prudent course and that the
treaty relationship will provide opportunities for the
United States to influence future developments within
Kazakhstan.
In particular, the treaty will cement our already
excellent relationship with our tax counterparts in the
Ministry of Finance. The treaty process has helped move
Kazakhstan's tax system in line with international
norms. The treaty also is important to U.S. investors
in Kazakhstan. In response to Kazakhstan's ``open
door'' policy to outside investment, Kazakhstan has
attracted two of the largest commitments of U.S.
investment in all of the former Soviet Union, including
the single largest, Chevron's project in the Tengiz oil
field. Kazakhstan received more long-term investment
commitments in 1994 than did Russia, and some 70 U.S.
firms have representative offices in Kazakhstan. By
supporting development of Kazakhstan's rich oil and
mineral reserves, the treaty will open the way for
entrepreneurial activities by other U.S. investors,
enhance the opportunity for reducing dependence on
Persian Gulf oil, and encourage continued development
of a stable economic system that is more compatible
with free markets and democratic reforms.
3. What precedent is there for bilateral tax treaties
where the content of [a country's] tax laws are not
known in detail?
The content of Kazakhstan's tax laws is actually
known in considerable detail. The United States side
extensively reviewed the relevant provisions of the
Kazakhstan tax code in effect at the time of the
negotiation. This review raised questions about whether
wage and interest expenses were fully deductible,
resulting in the Protocol provisions confirming that
these deductions would be available to U.S. investors
in Kazakhstan.
The U.S. side also has followed closely the
development of Kazakhstan's new law. This law was
drafted with the assistance of U.S. advisors familiar
to Treasury. It represents a significant step forward.
It regularizes and stabilizes the various contractual
arrangements for the taxation of royalties and profits,
and it eliminates more than 30 separate taxes,
mandatory ``contributions,'' and other Communist-era
levies. The rules in the new law are more comprehensive
than under the old law, reducing the need to rely on
easily-changed ``instructions'' (akin to regulations).
There also is a greater consistency among different
parts of the law. This increased transparency not only
aids Treasury's review of Kazakhstani law, it will
greatly enhance investors' certainty as to the tax
results of their activities.
The English translation of the law indicates that it
is consistent with the treaty. The fact that there is
an English translation so soon is another indication of
Kazakhstan's interest in foreign investment. It usually
is as difficult to obtain English translations of
foreign tax laws as it is to obtain foreign language
translations of the Internal Revenue Code.
4. What is the current legal status of the USSR tax
treaty in Kazakhstan?
The United States considers the USSR tax treaty to
apply to Kazakhstan. Similarly, Kazakhstan publicly
undertook to honor the USSR's treaty obligations.
Kazakhstan has been applying the USSR treaty, and has
made known its intention to continue applying it until
the new treaty takes effect. Like the United States,
Kazakhstan is understandably eager to have a more
appropriate new treaty in place, and anticipates that
the new treaty will replace the USSR treaty as of
January 1, 1996.
Subsequent to the June 13, 1995 hearing, the Committee was
informed that Kazakhstan adopted a new law permitting the
creation of anonymous bank accounts. The Treasury Department
expressed concerns that the existence of such accounts would be
inconsistent with Kazakhstan's obligation to exchange
information under the proposed treaty. Consequently, the
Treasury Department requested the Committee to suspend its
consideration of the proposed treaty. The Committee has had
several communications with the Treasury Department concerning
the status of the Kazakhstani anonymous bank accounts. In a
letter to Senator Helms dated September 13, 1996, the Treasury
Department provided an update of the situation. The relevant
portion of the letter is reproduced below:
I am writing to update you with respect to the
pending income tax treaty between the United States and
Kazakhstan (the ``Convention''), which is under
consideration by the Senate Foreign Relations
Committee. Your Committee held a hearing on the
proposed treaty on June 13, 1995. At that time,
Kazakhstan had recently adopted a law permitting the
creation of anonymous bank accounts. We were concerned
that the existence of such accounts would be
inconsistent with Kazakhstan's obligation to exchange
information under the proposed Convention. At
Treasury's request, the Committee agreed to hold the
Convention until we received adequate assurances from
the Government of Kazakhstan regarding access to bank
account information.
During the past year, the U.S. and Kazakhstani
governments have had numerous discussions and exchanges
of correspondence regarding bank secrecy and its
implications for tax enforcement and tax treaties.
While this process has taken longer than we might have
liked, we believe that our efforts have been
successful. It appears that Kazakhstan now may go even
farther than simply ensuring access to anonymous bank
account information. The government of Kazakhstan has
prepared and sent to Parliament legislation that will
completely repeal the earlier law allowing anonymous
bank accounts to be established. The government of
Kazakhstan has provided Treasury with drafts of the
legislation, and, upon review, Treasury believes it
resolves the outstanding issues with respect to bank
account information. The legislation has been
designated ``urgent,'' and we therefore expect it to be
adopted within 30 days. We are advised by the
Kazakhstani government that there is no opposition to
the legislation. They also have assured us that no
anonymous accounts exist within Kazakhstan at present
and that no such accounts will be permitted to be
opened prior to adoption of the new legislation.
The Committee believes that the political and economic
situation in countries with which the United States is entering
into bilateral agreements is an important aspect in the
Senate's decision to advise and consent to ratification. The
Committee supports the progress that Kazakhstan is making in
democratic reforms.
Kazakhstan holds great potential for U.S. investors and
ratification of the proposed treaty will provide a more
predictable investment climate. Due to accelerating reforms it
is likely that, in the short term, related economic duress and
discontent will increase. Ratification of the proposed treaty
now will lock in a framework for United States-Kazakhstan
economic relations that may be politically untenable later. The
United States has a strong interest in the success of
Kazakhstan's economic and democratic reform process.
Ultimately, a strong and independent Kazakhstan is important to
the stability of Europe and to overall U.S. foreign policy
interests.
C. Developing Country Concessions
The proposed treaty contains a number of developing country
concessions, some of which are found in other U.S. income tax
treaties with developing countries. The most significant of
these concessions are listed below.
Definition of permanent establishment
The proposed treaty departs from the U.S. and OECD model
treaties by providing for broader source-basis taxation. The
proposed treaty's permanent establishment article, for example,
permits the country in which business activities are carried on
to tax the activities on a broader basis, in certain cases,
than it would be able to under either of the model treaties.
Under the proposed treaty, the furnishing of services,
including consultancy services, will create a permanent
establishment if it exists in a country for more than 12
months. Thus, for example, under the proposed treaty, a U.S.
enterprise's business profits that are attributable to
providing consultancy service without a fixed base in
Kazakhstan could be taxed by Kazakhstan.
Source basis taxation
Additional concessions to source basis taxation in the
proposed treaty include maximum rates of source country tax on
interest (10 percent) \7\ and royalties (10 percent) that are
higher than those provided in the U.S. model treaty, treatment
of certain equipment rentals as royalties, taxing jurisdiction
on the part of the source country as well as the residence
country with respect to income not otherwise specifically dealt
with by the proposed treaty, and broader source country
taxation of personal services income (especially directors'
fees) than that allowed by the U.S. model.
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\7\ The proposed protocol (paragraph 3(a)) provides that any lower
rate of withholding tax on interest agreed to in a treaty between
Kazakhstan and another OECD country would be applicable (subject to the
usual ratification processes, as clarified by point 4 of the Memorandum
of Understanding) between the United States and Kazakhstan.
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Taxation of business profits
Under the U.S. model and many other U.S. income tax
treaties, a country may only tax the business profits of a
resident of the other country to the extent those profits are
attributable to a permanent establishment situated within the
first country. The proposed treaty expands the definition of
business profits to include profits that are derived from
sources within the country where a permanent establishment
exists from sales of goods or merchandise of the same kind as
those sold through the permanent establishment or from other
business activities of the same kind as those effected through
the permanent establishment.
Also unlike the U.S. model treaty, the proposed treaty
limits certain deductions for expenses incurred on behalf of a
permanent establishment by the enterprise's head office. Unlike
some other U.S. tax treaties with developing countries (such as
Mexico and India), the proposed treaty's prohibition on
deductions for amounts paid by the permanent establishment to
its home office does not apply differently to interest payments
than to royalties or other fees.
Certain equipment leasing
In addition to containing the traditional definition of
royalties which is found in most U.S. tax treaties (including
the U.S. model), the proposed treaty provides that royalties
include payments for the use of, or the right to use,
industrial, commercial, or scientific equipment. These payments
are often considered rentals in other treaties, subject to
business profits rules which generally permit the source
country to tax such profits only if they are attributable to a
permanent establishment located in that country, and in such
case, the tax is computed on a net basis. By contrast, the
proposed treaty permits gross-basis source country taxation of
these payments, at a rate not to exceed 10 percent, with an
election for taxation on a net basis. The proposed treaty
permits source country taxation of these payments irrespective
of the existence of any permanent establishment.
Committee conclusions
One purpose of the proposed treaty is to reduce tax
barriers to direct investment by U.S. firms in Kazakhstan. The
practical effect of these developing country concessions could
be greater Kazakhstani taxation of future activities of U.S.
firms in Kazakhstan than would be the case under the rules of
either the U.S. or OECD model treaties.
There is a risk that the inclusion of these developing
country concessions in the proposed treaty could result in
additional pressure on the United States to include them in
future treaties negotiated with developing countries,
especially other nations of the former Soviet Union. However,
these precedents already exist in the U.N. model treaty, and a
number of existing U.S. income tax treaties with developing
countries already include similar concessions. Such concessions
arguably are necessary in order to obtain treaties with
developing countries. Tax treaties with developing countries
can be in the interest of the United States because they
provide developing country tax relief for U.S. investors and a
clearer framework within which the taxation of U.S. investors
will take place.
The Committee is concerned that developing country
concessions not be viewed as the starting point for future
negotiations with developing countries. It must be clearly
recognized that several of the rules of the proposed treaty
represent substantial concessions by the United States, and
that such concessions must be met with substantial concessions
by the treaty partner. Thus, future negotiations with
developing countries should not assume, for example, that the
definition of permanent establishment provided in this treaty
necessarily will be available in every case; rather, such a
definition will be only adopted in the context of an agreement
that satisfactorily addresses the concerns of the United
States.
D. 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 is intended to benefit residents of Kazakhstan
and the United States only, residents of third countries
sometimes attempt to use a treaty to obtain treaty benefits.
This is known as ``treaty shopping.'' Investors from countries
that do not have tax treaties with the United States, or from
countries that have not agreed in their tax treaties with the
United States to limit source country taxation to the same
extent that it is limited in another treaty may, for example,
attempt to secure a lower rate of tax by lending money to a
U.S. person indirectly through a country whose treaty with the
United States provides for a lower rate. The third-country
investor may do this by establishing in that treaty country a
subsidiary, trust, or other investing 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 an anti-treaty shopping provision in the Code (as
interpreted by Treasury regulations) and in several newer
treaties. Some aspects of the provision, however, differ either
from an anti-treaty-shopping provision in the U.S. model
treaty, or from the anti-treaty-shopping provisions sought by
the United States in some treaty negotiations since the model
was published in 1981. The issue is whether the anti-treaty-
shopping provision of the treaty effectively forestalls
potential treaty shopping abuses.
One provision of the anti-treaty-shopping article of the
proposed treaty is more lenient than the comparable rule in one
version proposed with the U.S. model. That U.S. model proposal
allows benefits to be denied if 75 percent or less of a
resident company's stock is held by individual residents of the
country of residence, while the proposed treaty (like several
newer treaties and an anti-treaty-shopping provision in the
Code) lowers the qualifying percentage to 50, and broadens the
class of qualifying shareholders to include residents of either
treaty country (and citizens of the United States). Thus, this
safe harbor is considerably easier to enter under the proposed
treaty. On the other hand, counting for this purpose
shareholders who are residents of either treaty country would
not appear to invite the type of abuse at which the provision
is aimed, since the targeted abuse is ownership by third-
country residents attempting to obtain treaty benefits.
Another provision of the anti-treaty-shopping article
differs from the comparable rule in some earlier U.S. treaties
and proposed model provisions, but the effect of the change is
less clear. The general test applied by those treaties to allow
benefits, short of meeting the bright-line ownership and base
erosion test, 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 the active conduct of
a trade or business. (However, this active trade or business
test does not apply with respect to a business of making or
managing investments, so benefits can be denied with respect to
such a business regardless of how actively it is conducted.) In
addition, the proposed treaty gives the competent authority of
the source country the ability to override this standard. The
Technical Explanation accompanying the treaty provides some
elaboration as to how these rules will be applied.
The practical difference between the proposed treaty tests
and the earlier tests will depend upon how they are interpreted
and applied. The principal purpose test may be applied
leniently (so that any colorable business purpose suffices to
preserve treaty benefits), or it may be applied strictly (so
that any significant intent to obtain treaty benefits suffices
to deny them). Similarly, the standards in the proposed treaty
could be interpreted to require, for example, a more active or
a less active trade or business (though the range of
interpretation is far narrower). Thus, a narrow reading of the
principal purpose test could theoretically be stricter than a
broad reading of the proposed treaty tests (i.e., would operate
to deny benefits in potentially abusive situations more often).
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department to provide additional
explanation regarding the sufficiency of the anti-treaty
shopping provisions in the proposed treaty and other treaties.
The relevant portion of the July 5, 1995 Treasury Department
letter responding to this inquiry is reproduced below:
7. Is Treasury confident that the anti-treaty
shopping provisions in these treaties will ensure full
payment of taxes by multinational corporations and
eliminate abuse of the treaties to lower taxes?
In conjunction with various domestic statutes and
regulations, the limitation on benefits provisions
should be very effective in preventing underpayment of
U.S. withholding taxes by non-residents, including
multinationals.
The Committee believes that limitation on benefits
provisions are important to protect against ``treaty shopping''
by limiting benefits of a treaty to bona fide residents of the
treaty partner. It also is important, however, for these
provisions to be crafted to avoid interfering with legitimate
and desirable economic activity. For example, the Committee
believes that U.S. open-end regulated investment companies
(``RICs'') generally should be eligible for treaty benefits
under limitation on benefits provisions in order to facilitate
cross-border investments from this important source of capital.
Because these funds are required to stand ready to redeem their
shares on a daily basis, the Committee believes they generally
should be entitled to treaty benefits to the same extent as
closed-end RICs, which qualify for benefits under standard
limitation on benefits provisions because they are publicly
traded on stock exchanges. While the Committee understands that
open-end RICs may be determined by the competent authority to
qualify for treaty benefits under limitation on benefits
provisions in existing treaties, the Committee believes that,
in future negotiations, the negotiators should address directly
the treatment of open-end RICs under limitation of benefits
provisions. The manner in which the eligibility of open-end
RICs for treaty benefits is addressed may vary from treaty to
treaty, for example, to permit the negotiators to ensure that
investment companies established in the treaty country are not
used to promote treaty shopping.
The Committee continues to believe that the United States
should maintain its policy of limiting treaty shopping
opportunities whenever possible. The Committee continues to
believe further that, in exercising any latitude Treasury has
to adjust the operation of the proposed treaty, the rules as
applied should adequately deter treaty shopping abuses. The
USSR treaty does not contain anti-treaty shopping rules.
Further, the proposed anti-treaty shopping provision may be
effective in preventing third-country investors from obtaining
treaty benefits by establishing investing entities in
Kazakhstan since third-country investors may be unwilling to
share ownership of such investing entities on a 50-50 basis
with U.S. or Kazakhstani residents or other qualified owners to
meet the ownership test of the anti-treaty shopping provision.
In addition, the base erosion test provides protection from
certain potential abuses of a Kazakhstani conduit. Finally,
Kazakhstan imposes significant taxes of its own; these taxes
may deter third-country investors from seeking to use
Kazakhstani 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. The Committee
emphasizes that the proposed provision must be implemented so
as to serve as an adequate tool for preventing possible treaty-
shopping abuses in the future.
E. Transfer Pricing
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 reallocate profits
among related enterprises residing in each country, if a
reallocation is necessary to reflect the conditions which would
have been made between independent enterprises. The Code, under
section 482, provides the Secretary of the Treasury the power
to make reallocations wherever necessary in order to prevent
evasion of taxes or clearly to reflect the income of related
enterprises. Under regulations, the Treasury Department
implements this authority using an arm's-length standard, and
has indicated its belief that the standard it applies is fully
consistent with the proposed treaty.\8\ A significant function
of this authority is to ensure that the United States asserts
taxing jurisdiction over its fair share of the worldwide income
of a multinational enterprise. The arm's-length standard has
been adopted uniformly by the leading industrialized countries
of the world, in order to secure the appropriate tax base in
each country and avoid double taxation, ``thereby minimizing
conflict between tax administrations and promoting
international trade and investment.'' \9\
---------------------------------------------------------------------------
\8\ The OECD report on transfer pricing generally approves the
methods that are incorporated in the current Treasury regulations under
section 482 as consistent with the arm's-length principles upon which
Article 9 of the proposed treaty is based. See ``Transfer Pricing
Guidelines for Multinational Enterprises and Tax Administrations,''
OECD, Paris 1995.
\9\ Id. (preface).
---------------------------------------------------------------------------
Some have argued in the recent past that the IRS has not
performed adequately in this area. Some have argued that the
IRS cannot be expected to do so using its current approach.
They argue that the approach now set forth in the regulations
is impracticable, and that the Treasury Department should adopt
a different approach, under the authority of section 482, for
measuring the U.S. share of multinational income.10 Some
prefer a so-called ``formulary apportionment'' approach, which
can take a variety of forms. The general thrust of formulary
apportionment is first to measure total profit of a person or
group of related persons without regard to geography, and only
then to apportion the total, using a mathematical formula,
among the tax jurisdictions that claim primary taxing rights
over portions of the whole. Some prefer an approach that is
based on the expectation that an investor generally will insist
on a minimum return on investment or sales.11
---------------------------------------------------------------------------
\10\ See generally The Breakdown of IRS Tax Enforcement Regarding
Multinational Corporations: Revenue Losses, Excessive Litigation, and
Unfair Burdens for U.S. Producers: Hearing before the Senate Committee
on Governmental Affairs, 103d Cong., 1st Sess. (1993) (hereinafter,
Hearing Before the Senate Committee on Governmental Affairs).
\11\ See Tax Underpayments by U.S. Subsidiaries of Foreign
Companies: Hearings Before the Subcommittee on Oversight of the House
Committee on Ways and Means, 101st Cong., 2d Sess. 360-61 (1990)
(statement of James E. Wheeler); H.R. 460, 461, and 500, 103d Cong.,
1st Sess. (1993); sec. 304 of H.R. 5270, 102d Cong., 2d Sess. (1992)
(introduced bills); see also Department of the Treasury's Report on
Issues Related to the Compliance with U.S. Tax Laws by Foreign Firms
Operating in the United States: Hearing Before the Subcommittee on
Oversight of the House Committee on Ways and Means, 102d Cong., 2d
Sess. (1992).
---------------------------------------------------------------------------
A debate exists whether an alternative to the Treasury
Department's current approach would violate the arm's-length
standard embodied in Article 9 of the proposed treaty, or the
nondiscrimination rules embodied in Article 25.12 Some,
who advocate a change in internal U.S. tax policy in favor of
an alternative method, fear that U.S. obligations under
treaties such as the proposed treaty would be cited as
obstacles to change.
---------------------------------------------------------------------------
\12\ Compare ``Tax Conventions with: The Russian Federation,''
Treaty Doc. 102-39; ``United Mexican States,'' Treaty Doc. 103-7; ``The
Czech Republic,'' Treaty Doc. 103-17; ``The Slovak Republic,'' Treaty
Doc. 103-18; and ``The Netherlands,'' Treaty Doc. 103-6. ``Protocols
Amending Tax Conventions with: Israel,'' Treaty Doc. 103-16; ``The
Netherlands,'' Treaty Doc. 103-19; and ``Barbados,'' Treaty Doc. 102-
41. Hearing Before the Committee on Foreign Relations, United States
Senate, 103d Cong., 1st Sess. 38 (1993) (``A proposal to use a
formulary method would be inconsistent with our existing treaties and
our new treaties.'') (oral testimony of Leslie B. Samuels, Assistant
Secretary for Tax Policy, U.S. Treasury Department); a statement
conveyed by foreign governments to the U.S. State Department that
``[worldwide unitary taxation is contrary to the internationally agreed
arm's-length principle embodied in the bilateral tax treaties of the
United States'' (letter dated 14 October 1993 from Robin Renwick, U.K.
Ambassador to the United States, to Warren Christopher, U.S. Secretary
of State); and ``American Law Institute Federal Income Tax Project:
International Aspects of United States Income Taxation II: Proposals on
United States Income Tax Treaties'' (1992), at 204 (n. 545) (``Use of a
world-wide combination unitary apportionment method to determine the
income of a corporation is inconsistent with the `Associated
Enterprises' article of U.S. tax treaties and the OECD model treaty'')
with Hearing Before the Senate Committee on Governmental Affairs at 26,
28 (``I do not believe that the apportionment method is barred by any
tax treaty that United States has now entered into.'') (statement of
Louis M. Kauder). See also Foreign Income Tax Rationalization and
Simplification Act of 1992: Hearings Before the House Committee on Ways
and Means, 102d Cong., 2d Sess. 224, 246 (1992) (written statement of
Fred T. Goldberg, Jr., Assistant Secretary for Tax Policy, U.S.
Treasury Department).
---------------------------------------------------------------------------
As part of its consideration of the proposed treaty, the
Committee requested the Treasury Department to provide
additional explanation regarding the Administration's current
policy with respect to transfer pricing issues, the use of the
arm's-length pricing method, and the application of treaties to
ensure full payment of required taxes by foreign corporations.
The relevant portions of the July 5, 1995, Treasury Department
letter responding to these inquiries are reproduced below:
1. Please describe the position of the U.S. Treasury
with regard to the transfer pricing issue.
While estimates of the magnitude of the problem vary,
Treasury regards transfer pricing as one of the most
important international tax issues that it faces.
Treasury believes that both foreign and U.S.-owned
multinationals have engaged in significant income
shifting through improper transfer pricing.
Treasury identified three problems that allowed these
abuses to occur: (1) lack of substantive guidance in
U.S. regulations for taxpayers and tax administrators
to apply in cases where the traditional approaches did
not work; (2) lack of an incentive for taxpayers to
attempt to set their transfer prices in accordance with
the substantive rules; and (3) lack of international
consensus on appropriate approaches. To resolve these
problems, Treasury has taken the following steps in the
last two years:
In July 1994, Treasury issued new final regulations
under section 482 of the Internal Revenue Code. These
regulations contain methods that were not reflected in
prior final regulations: the Comparable Profits and
Profit Split Methods. These methods are intended to be
used when the more traditional methods are unworkable
or do not provide a reliable basis for determining an
appropriate transfer price.
In August 1993, Congress enacted a Treasury proposal
to amend section 6662(e) of the Internal Revenue Code.
This provision penalizes taxpayers that both (1) are
subject to large transfer pricing adjustments and (2)
do not provide documentation indicating that they made
a reasonable effort to comply with the regulations
under section 482 in setting their transfer prices.
Treasury issued temporary regulations implementing the
statute in February 1994.
In July 1994, the Organization for Economic
Cooperation and Development issued a draft report on
transfer pricing. The United States is an active
participant in this body. The OECD transfer pricing
guidelines serve as the basis for the resolution of
transfer pricing cases between treaty partners and it
therefore is critical that any approach adopted in any
country be sanctioned in this report in order to reduce
the risk of double taxation. The draft report permits
the use of the new U.S. methods in appropriate cases.
2. Why shouldn't the United States interpret Article
9 of the tax treaties regarding transfer pricing as
permitting other methods of pricing such as the unitary
or formulary apportionment method?
If Treasury adopted such an interpretation, it would
send a signal to our treaty partners that we were
moving away from the arm's-length standard to a
different, more arbitrary approach. Sending such a
signal would be very destructive and, if implemented,
would inevitably result in double (and under) taxation
due to the fundamental inconsistency between the
approach used in the United States and that used
elsewhere. Further, adopting such an interpretation
would invite non-OECD countries to introduce their own
approaches that currently cannot be foreseen, but that
could inappropriately increase their tax bases at the
expense of the United States and other countries.
3. The consensus regarding transfer pricing methods
is currently the arm's-length standard. Will the U.S.
remain open to the possibility of better or alternative
methods without moving to such alternative methods
unilaterally?
If it appeared that another approach was superior to
the current approach, the U.S. would push for the
adoption of this new approach on a multilateral basis
so that there would be the necessary international
consensus in favor of the new approach.
4. Why does industry support the arm's-length pricing
method?
Most multinationals are willing to pay their fair
share of tax. Their primary concern is that they not be
subjected to double taxation. Because the arm's-length
standard is the universally adopted international norm
and the major countries of the world have adopted a
consensus interpretation of that standard within the
OECD, the risks of double taxation are infinitely
smaller under the arm's-length standard than under any
other approach.
5. A recent GAO report suggested that many foreign
corporations are not paying their fair share of taxes.
Is Treasury satisfied that these treaties ensure full
payment of required taxes?
A tax treaty by itself will not prevent transfer
pricing abuses. Rather, the treaty leaves it to the
internal rules and practices of the treaty partners to
deal with such issues. In the United States, Treasury
has taken the measures described above to ensure that
foreign--and domestic--corporations pay their fair
share of taxes. A tax treaty can make these internal
measures more effective, particularly through the
exchange of information provisions that enable the U.S.
tax authorities to obtain transfer pricing information
on transactions between related parties in the United
States and the treaty partner. The treaties also
facilitate Advance Pricing Agreements that preclude the
possibility of double taxation and at the same time
ensure that each country receives an appropriate share
of the taxes paid by a multinational.
F. Arbitration of Competent Authority Issues
In a step that has been taken only recently in U.S. income
tax treaties (i.e., beginning with the 1989 income tax treaty
between the United States and Germany), the proposed treaty
provides for a binding arbitration procedure, if both competent
authorities and the taxpayers involved agree, for the
resolution of those disputes in the interpretation or
application of the treaty that it is within the jurisdiction of
the competent authorities to resolve. This provision is
effective only after diplomatic notes are exchanged between
Kazakhstan and the United States. Consultation between the two
countries regarding whether such an exchange of notes should
occur will take place after a period of three years after the
proposed treaty has entered into force.
Generally, the jurisdiction of the competent authorities
under the proposed treaty is as broad as it is under any U.S.
income tax treaties. Specifically, the competent authorities
would be required to resolve by mutual agreement any
difficulties or doubts arising as to the interpretation or
application of the treaty. They could also consult together
regarding cases not provided for in the treaty.
As an initial matter, it is necessary to recognize that
there are appropriate limits to the competent authorities' own
scope of review.13 The competent authorities would not
properly agree to be bound by an arbitration decision that
purported to decide issues that the competent authorities would
not agree to decide themselves. Even within the bounds of the
competent authorities' decision-making power, there likely will
be issues that one or the other competent authority will not
agree to put in the hands of arbitrators. Consistent with these
principles, the Technical Explanation expects that the
arbitration procedures will ensure that the competent
authorities would not accede to arbitration with respect to
matters concerning the tax policy or domestic tax law of either
treaty country.
---------------------------------------------------------------------------
\13\ In discussing a clause permitting the competent authorities to
eliminate double taxation in cases not provided for in the treaty,
Representative Dan Rostenkowski, then Chairman of the House Committee
on Ways and Means, submitted the following testimony in 1981 hearings
before the Senate Committee on Foreign Relations:
Under a literal reading, this delegation could be
interpreted to include double taxation arising from any
source, even state unitary tax systems. Accordingly, the
scope of this delegation of authority must be clarified and
limited to include only noncontroversial technical matters,
---------------------------------------------------------------------------
not items of substance.
Tax Treaties: Hearings on Various Tax Treaties Before the Senate
Committee on Foreign Relations, 97th Cong., 1st Sess. 58 (1981).
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department whether the fact that
Kazakhstan has a new tax code meets the Committee's criteria
for arbitration provisions. The relevant portion of the July 5,
1995 Treasury Department letter responding to these inquiries
are reproduced below:
5. How does a treaty with a country that has a one-
month old tax code meet [the Committee's criteria for
arbitration provisions]?
The arbitration provision in the proposed treaty with
Kazakhstan was negotiated and drafted consistently with
our understanding of the Senate's views on arbitration
as expressed in the Report of the Senate Foreign
Relations Committee on the treaty between the United
States and Germany. The Committee recognized ``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 which
otherwise may impede efficient administration of the
tax laws'' and endorsed the ``experiment'' of
arbitration. In each treaty signed since the Senate's
consideration of the German treaty, Treasury has
included an arbitration provision only if the treaty
partner agrees to delay its implementation. The delay
affords us the opportunity to evaluate our experience
under the German treaty.
Thus, in the treaty with Kazakhstan we have agreed to
establish an arbitration mechanism only after an
exchange of diplomatic notes, which cannot occur until
after the Convention has been in force for three years
and then only after the Competent Authorities have
consulted and agreed that arbitration is an appropriate
means of resolving treaty disputes. Therefore the new
Kazakhstani tax law will be at least several years old
before this arbitration procedure could be initiated.
We do not believe that Kazakhstan's new tax code has
any bearing on the advisability of an arbitration
procedure. However, if some aspect of Kazakhstani law
made it unadvisable to initiate the procedure, the
United States would refrain from exchanging the
diplomatic notes necessary to initiate it.
As stated in recommending ratification of the U.S.-Germany
treaty and the United States-Netherlands treaty, the Committee
still believes 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 otherwise may
impede efficient administration of the tax laws. However, the
Committee believes that the appropriateness of such a clause in
a treaty depends strongly on the other party to the treaty, and
the experience that the competent authorities have under the
corresponding provision in the German and Netherlands treaties.
The Committee understands that to date there have been no
arbitrations of competent authority cases under the German
treaty or the Netherlands treaty, and few tax arbitrations
outside the context of those treaties. The Committee believes
that the negotiators acted appropriately in conditioning the
effectiveness of this provision on the outcome of future
developments in this evolving area of international tax
administration.
VII. Budget Impact
The Committee has been informed by the staff of the Joint
Committee on Taxation that the proposed treaty is estimated to
have a negligible effect on annual Federal budget receipts
during the fiscal year 1997-2003 period.
VIII. Explanation of Proposed Treaty
For a detailed article-by-article explanation of the
proposed tax treaty, see the ``Treasury Department Technical
Explanation of the Convention and Protocol Between the United
States of America and the Republic of Kazakhstan for the
Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with Respect to Taxes on Income and Capital Signed at
Almaty on October 24, 1993.''
IX. Text of the Resolution of Ratification
Resolved, (two-thirds of the Senators present concurring
therein), That the Senate advise and consent to the
ratification of the Convention Between the Government of the
United States of America and the Government of the Republic of
Kazakhstan for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income
and Capital, Together with the Protocol, signed at Almaty on
October 24, 1993, and Two Related Exchanges of Notes dated
August 1 and September 7, 1994 and dated August 15 and
September 7, 1994 (Treaty Doc. 103-33); an Exchange of Notes
dated at Washington July 10, 1995, Relating to the Convention
Between the Government of the United States of America and the
Government of the Republic of Kazakhstan for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income and Capital, Together With a Related
Protocol, signed at Almaty on October 24, 1993 (Treaty Doc.
104-15); and an Exchange of Notes dated June 16 and 23, 1995
(EC-1431). The Senate's advice and consent is subject to the
following proviso, which shall not be included in the
instrument of ratification to be signed by the President:
The United States shall not exchange the instruments
of ratification with the Government of the Republic of
Kazakhstan until such time as the Government of the
Republic of Kazakhstan has notified the Government of
the United States that its laws no longer permit
anonymous bank accounts to be established.
X. APPENDIX 1.--EXCHANGE OF NOTES (EC 1431)
----------
U.S. Department of State,
Washington, DC, September 5, 1995.
Hon. Al Gore,
President of the Senate
Washington, DC.
Dear Mr. President: In accordance with established State
Department practice regarding corrections to treaties, I am
enclosing authentic copies of an exchange of notes dated June
16 and 23, 1995, correcting the text of the Convention Between
the Government of the United States of America and the
Government of the Republic of Kazakhstan for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income and Capital, together with a related
Protocol, signed at Almaty on October 2,4 1993, and exchanges
of notes transmitted with the Convention. The Convention was
submitted to the Senate for advice and consent to ratification
on September 19, 1994, and is printed in Senate Treaty Document
103-33, 103d Congress, 2d Session.
These notes are being sent to the Committee on Foreign
Relations in order to correct the Convention. We would
appreciate it if the Committee on Foreign Relations and the
Senate would consider the text of this Convention as corrected.
Sincerely,
Wendy R. Sherman,
Assistant Secretary, Legislative Affairs.
Enclosures: As stated.
Embassy of the United States of America,
Almaty, June 16, 1995.
The Embassy of the United States of America presents its
compliments to the Ministry of Foreign Affairs of the Republic
of Kazakhstan and has the honor to refer to the Convention
Between the Government of the United States of America and the
Government of the Republic of Kazakhstan for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income and Capital, together with a related
Protocol, signed at Almaty on October 24, 1993, and Exchanges
of Notes (the ``Convention''):
The United States has discovered a discrepancy between the
English and Russian texts of paragraph 2 b) of Article 28
(Entry in Force) of the Convention. The Embassy proposes
correcting this discrepancy through an exchange of diplomatic
notes. The Ministry of Foreign Affairs is requested to correct
the signed Russian-language copies of the Convention that are
held in Kazakhstan so that the Russian-language text conforms
to the English-language text. The Kazakh-language version,
currently in process of conformation, will also reflect these
changes.
The full text of paragraph 2 b) of Article 28 reads as
follows in the English:
b) in respect of other taxes, for taxable periods
beginning on or after the first day of January of the
year in which the Convention enters into force.
The Russian text of this paragraph should be corrected to
read as follows:
Following notification to the Embassy in Kazakhstan that
this correction is acceptable to Kazakhstan the United States
original will be corrected. The exchange of diplomatic notes
would be considered a correction of the Convention and would
become part of the official treaty record, but would not be
considered by the United States to be an amendment of the
Convention. The Convention will be printed in the United States
Treaties and Other International Acts Series as corrected.
The Embassy of the United States of America avails itself
of this occasion to renew to the Ministry of Foreign Affairs of
the Republic of Kazakhstan the assurances of its high
consideration.
------
Department of State,
Office of Language Services,
Translating Division.
Ministry of Foreign Affairs of the Republic of Kazakhstan:
The Ministry of Foreign Affairs of the Republic of
Kazakhstan presents its compliments to the Embassy of the
United States of America in the Republic of Kazakhstan and has
the honor to report that it received the note of June 16, 1995,
regarding the Convention between the Government of the Republic
of Kazakhstan and the Government of the United States of
America for the Avoidance of Double Taxation and Prevention of
Fiscal Evasion with Respect to Taxes on Income and Capital,
together with a related Protocol, signed at Almaty on October
24, 1993, and Exchanges of Notes (the ``Convention'').
The note stated:
[The Russian translation of the English note cited above
agrees in all substantive respects with the English original--
translator's note]
The Ministry of Foreign Affairs has the honor to advise
that the Republic of Kazakhstan agrees to this correction. This
correction will be regarded as a part of the official
Agreement.
The Ministry avails itself of the occasion to renew to the
Embassy the assurance of its high consideration.
Almaty, June 23, 1995.
Embassy of the United States of America.
XI. APPENDIX 2.--STATEMENT
----------
Written Statement of Joseph H. Guttentag, International Tax Counsel,
Department of the Treasury, Before the Committee on Foreign Relations,
U.S. Senate, September 24, 1996
Mr. Chairman and Members of the Committee:
I am pleased to submit this statement on behalf of the
Administration to recommend favorable action on the protocols
to two tax treaties, with Indonesia and with the Netherlands
with respect to the Netherlands Antilles, that are on the
Committee's business meeting agenda. Also on the agenda is the
tax treaty with Kazakhstan, on which the Administration
recommended favorable action in testimony before the Committee
on June 13, 1995. There are also three additional bilateral tax
treaties that the President has transmitted to the Senate, with
Austria, Luxembourg, and Turkey. All these agreements provide
significant benefits to the United States, as well as to our
treaty partners. Treasury appreciates the Committee's interest
in these agreements, and requests the Committee and the Senate
to take favorable action at this time on the three agreements
that are on the Committee's agenda, and on the remaining three
treaties as soon as possible.
The tax treaty program is designed to remove obstacles to
international trade and investment, such as double taxation,
and to prevent fiscal evasion, such as through treaty shopping
and information concealing. Accordingly, tax treaties provide
substantial benefits to taxpayers as well as to the fiscs of
both treaty partners.
For example, high withholding taxes at source are an
impediment to international economic activity. Under United
States domestic law, all payments to non-United States persons
of dividends and royalties as well as certain payments of
interest are subject to withholding tax equal to 30 percent of
the gross amount paid. Inasmuch as this tax is imposed on a
gross rather than net amount, it imposes a high cost on
investors receiving such payments. Indeed, in many cases the
cost of such taxes can be prohibitive. Most of our trading
partners impose similar levels of withholding tax on these
types of income.
Tax treaties alleviate this burden by reducing the levels
of withholding tax that the treaty partners may impose on these
types of income. In general, United States policy is to reduce
the rate of withholding taxation on interest and royalties to
zero. Dividends normally are subject to tax at one of two
rates, 15 percent on portfolio investors and 5 percent on
direct corporate investors, with certain exceptions.
The Treasury Department has included in all its recent tax
treaties comprehensive ``limitation on benefits'' provisions
that limit the benefits of the treaty to bona fide residents of
the treaty partner. These provisions are not uniform, as each
country has its own characteristics that make it more or less
inviting to treaty shopping in particular ways. Consequently,
each provision must to some extent be tailored to fit the facts
and circumstances of the treaty partners' internal laws and
practices. Moreover, these provisions should be crafted to
avoid interfering with legitimate and desirable economic
activity. For example, in the future we plan to address
directly in our negotiations the issue of how open-end United
States regulated investment companies (RICs) should be treated
under limitation on benefits provisions in order to facilitate
cross-border investments from this important source of capital.
Because these funds are required to stand ready to redeem their
shares on a daily basis, we believe they generally should be
entitled to treaty benefits to the same extent as closed-end
RICs, which qualify for benefits under standard limitation on
benefits provisions because they are publicly traded on stock
exchanges. However, the extent to which this goal may be
achieved is likely to vary from treaty to treaty, as the
negotiators need to ensure that mutual funds established in the
treaty partner cannot be used to promote treaty shopping.
Our tax treaties and treaty positions are subject to
continual review. We reexamine the appropriateness and
effectiveness of our treaty provisions, and receive comments
from both public and private sources. The release last week of
the new U.S. model income tax treaty, copies of which were
provided to the Committee, is an important step in this process
but does not represent its conclusion. The new model represents
our favored treaty positions at this time; we will reevaluate
and update the model over time as we evaluate model treaty
positions as employed in our recent tax treaties and receive
comments and further suggestions on the model itself.
Discussion of pending agreements--Indonesia, Netherlands Antilles, and
Kazakhstan
I would like to discuss the importance and purposes of each
agreement that the Committee has set for consideration. We have
submitted Technical Explanations of each agreement that contain
detailed discussions of each treaty and protocol. These
Technical Explanations serve as an official guide to each
agreement. We have furnished our treaty partners with a copy of
the relevant technical explanation and offered them the
opportunity to submit their comments, suggestions and
concurrence.
Indonesia
The proposed protocol with Indonesia, which was signed at
Jakarta on July 24, 1996, amends the income tax treaty with
Indonesia that was signed in 1988 and entered into force on
December 30, 1990. In many cases, the withholding tax rates
permitted under the existing tax treaty with Indonesia
significantly exceed those found in Indonesia's treaties with
other OECD countries. This places United States business at a
substantial competitive disadvantage in Indonesia relative to
competitors from other industrialized countries. Because
Indonesia is one of the world's most populous countries, with a
rapidly expanding market that is located in a region of dynamic
economic growth, it is especially important that United States
firms be able to compete there without this disadvantage.
The proposed protocol achieves this objective by reducing
the withholding tax rates permitted to bring them into line
with those in Indonesia's recent treaties with other OECD
countries. The protocol reduces the maximum rates of tax on
direct-investment dividends, interest, and royalty income,
which are generally 15 percent under the current treaty, to 10
percent.
Netherlands Antilles
Many years ago, the United States and the Netherlands
agreed to extend the then treaty between them to the
Netherlands Antilles. The extension became a contentious issue,
and in 1987 most of the provisons of the treaty as extended to
the Netherlands Antilles were terminated, except for the
taxation of interest at source and ancillary provisions. The
proposed protocol to the Netherlands treaty relates only to the
Netherlands Antilles and would complete the termination by
eliminating the exemption from United States withholding tax
for interest, except with respect to certain grandfathered debt
instruments.
The proposed protocol relating to the Netherlands Antilles
would eliminate ongoing treaty shopping through the Netherlands
Antilles by limiting the exemption from United States
withholding tax to certain debt instruments issued on or before
October 15, 1984. These debt instruments were issued in
connection with Eurobond offerings by Netherlands Antilles
subsidiaries of United States companies, generally before the
Deficit Reduction Act of 1984 allowed United States companies
to issue debt, free of United States withholding tax, directly
into the international capital markets. It is appropriate to
provide a continued exemption for these debt instruments
because the Eurobonds were issued in reasonable reliance on the
continued existence of the exemption and it is believed that
eliminating the exemption entirely would have an adverse effect
on international capital markets.
Kazakhstan
In addition to the five new treaties and protocols, the
Committee still has under consideration a treaty between the
United States and Kazakhstan. This treaty was the subject of a
hearing last year. At our request, the Committee delayed its
vote on this treaty until we received adequate assurances from
the Government of Kazakhstan regarding access to bank account
information. At the time of last year's hearing, Kazakhstan had
recently adopted laws permitting the opening of anonymous bank
accounts, and we wanted to be certain that the existence of
these accounts would not, as a legal or a practical matter,
impeded our access to bank account information in order to
enforce our tax laws.
I am pleased to report that Kazakhstan is now clearly
moving away from bank secrecy. The Government of Kazakhstan has
submitted legislation to the Kazakhstan Parliament to repeal
the earlier laws permitting the establishment of anonymous bank
accounts. We understand that the lower house of the Kazakhstan
Parliament has passed the legislation and that the Government
of Kazakhstan expects the law to be enacted without opposition
this week.
We appreciate the Committee's support on this very
important issue and hope that we can work cooperatively to move
this treaty forward while at the same time protecting the
integrity of the treaty's exchange of information provisions.
One alternative that we would support is for the Committee to
report the treaty recommending that the Senate give its advice
and consent to ratification assuming Kazakhstan's adoption of
the new law. The full Senate then could approve the
recommendation with appropriate conditions concerning the
elimination of anonymous bank accounts. We have provided the
committee with the latest information we have regarding the
status of this issue and will continue to keep the Committee
advised. If the Senate chooses to give its advice and consent
to the treaty at the present time, the Administration is
willing and able to accept the responsibility of not permitting
instruments of ratification to be exchanged until it is fully
satisfied that the conditions described above have been fully
satisfied. Absent this procedure, entry into force of the
treaty could be further substantially delayed. Based on
information we have received it would be in the interest of the
United States to have the treaty enter into force as promptly
as possible.
We will continue to work with the Committee and its staff
to bring this issue to a mutually satisfactory conclusion.
Conclusion
Let me conclude by again thanking the Committee for its
continuing interest in tax treaty program. We appreciate the
assistance and cooperation of the staffs of this Committee and
of the Joint Committee on Taxation in the tax treaty process.
With your and their help, we have over the past several years
brought into force 19 new treaties and protocols.
We urge the committee to take prompt and favorable action
on the three agreements before you at the business meeting. We
further urge the Committee to take favorable action as soon as
possible on the remaining three tax treaties that the President
has submitted to the Senate. Such action will send an important
message to our trading partners and our business community. It
will demonstrate our desire to expand the United States treaty
network with income tax treaties formulated to enhance the
worldwide competitiveness of United States companies. It will
strengthen and expand our economic relations with countries
that have seen significant economic and political changes in
recent years. Finally, it will make clear our intention to deal
bilaterally in a forceful and realistic way with treaty abuse.