[Senate Executive Report 104-5]
[From the U.S. Government Publishing Office]



104th Congress                                              Exec. Rept.
                                 SENATE

 1st Session                                                      104-5
_______________________________________________________________________


 
                   INCOME TAX CONVENTION WITH UKRAINE

                                _______


   August 10 (legislative day, July 10), 1995.--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. 103-30, 103d Congress, 2d Session, and Treaty 
             Document 104-11, 104th Congress, 1st Session]
    The Committee on Foreign Relations, to which was referred 
the Convention Between the Government of the United States of 
America and the Government of Ukraine for the Avoidance of 
Double Taxation and the Prevention of Fiscal Evasion with 
Respect to Taxes on Income and Capital, with Protocol, signed 
at Washington on March 4, 1994, and the exchange of notes dated 
at Washington May 26 and June 6, 1995 relating to such 
convention and protocol, having considered the same, reports 
favorably thereon, without amendment, and recommends that the 
Senate give its advice and consent to ratification thereof.

                               I. Purpose

    The principal purposes of the proposed income tax treaty 
between the United States and Ukraine 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 is also 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 March 4, 1994. The exchange of notes was dated May 26 
and June 6, 1995. Currently, the United States and Ukraine 
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 would replace the USSR treaty 
with respect to Ukraine.
    The proposed treaty, together with related protocol, was 
transmitted to the Senate for advice and consent to its 
ratification on September 14, 1994 (see Treaty Doc. 103-30). 
The exchange of notes was transmitted to the Senate for advice 
and consent to its ratification on June 28, 1995 (see Treaty 
Doc. 104-11). The Committee on Foreign Relations held a public 
hearing on the proposed treaty on June 13, 1995.

                              III. Summary

    The proposed treaty is similar to other recent U.S. income 
tax treaties, the 1981 proposed U.S. model income tax treaty 
(the ``U.S. model''),\1\ and the model income tax treaty of the 
Organization for Economic Cooperation and Development (the 
``OECD model''). However, the proposed treaty contains certain 
deviations from those models.
    \1\ The U.S. model has been withdrawn from use as a model treaty by 
the Treasury Department. Accordingly, its provisions may no longer 
represent the preferred position of U.S. tax treaty negotiations. A new 
model has not yet been released by the Treasury Department. Pending the 
release of a new model, comparison of the provisions of the proposed 
treaty against the provisions of the former U.S. model should be 
considered in the context of the provisions of comparable recent U.S. 
treaties.
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    As in other U.S. tax treaties, the objectives of the treaty 
are principally 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 7 and 14). Similarly, the treaty contains the 
standard ``commercial visitor'' exemptions under which 
residents of one country performing personal services in the 
other country will not be required to pay tax in such other 
country unless their contact with the other exceeds specified 
minimums (Articles 14-17). The proposed treaty provides that 
dividends and royalties derived by a resident of either country 
from sources within the other country generally may be taxed by 
both countries (Articles 10 and 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, 
11, and 12).
    In situations where the country of source retains the right 
under the proposed treaty to tax income derived by residents of 
the other country, the proposed treaty generally provides for 
the relief of the potential double taxation by the country of 
residence allowing a foreign tax credit (Article 24).
    The proposed 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.
    The proposed treaty differs in certain respects from other 
U.S. income tax treaties and from the U.S. and OECD model 
treaties. 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, including some of these 
differences, follows:
    (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 would not preclude the imposition of the tax on 
insurance premiums paid to Ukrainian 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 and 
excise taxes with respect to private foundations. The proposed 
treaty does not 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, the proposed treaty provides that 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 the Ukraine, 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 shortens that time period to six months. 
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 represents a move past the U.S. model treaty, 
allowing source country taxation under some circumstances that 
the model would preclude.
    (8) The proposed treaty, unlike the model treaties or other 
U.S. treaties, provides in Article 5(2)(g) that a store or 
other premises used as a sales outlet constitutes a permanent 
establishment.
    (9) 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 
provisions similar to the corresponding model treaty provisions 
permitting taxation of income from real property 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. Unlike the U.S. 
model treaty and most U.S. treaties, but like the OECD model 
treaty and several recent U.S. treaties, Article 6 of the 
proposed treaty defines real property to include accessory 
property, as well as livestock and equipment used in 
agriculture and forestry.
    (10) The business profits article (Article 7) of the 
proposed treaty overrides the force of attraction rules 
contained in the Internal Revenue Code (``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. 
Paragraph 2 of the proposed protocol provides an expansive 
description of this rule. This is consistent with the U.S. 
model treaty.
     (11) 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.
     (12) 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.
     (13) 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.
    (14) Article 9 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.
    (15) 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.
     (16) Like recent U.S. treaties, the proposed protocol 
provides that dividends paid by a U.S. regulated investment 
company would be subject to source country taxation at the 15-
percent limit (paragraph 3). On the other hand, like some 
recent U.S. treaties, the proposed treaty and proposed protocol 
impose no restriction on the source country taxation of 
dividends paid by a U.S. real estate investment trust.
     (17) 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 to impose the branch profits tax, but at a rate 
not exceeding 5 percent (Article 10(5)).
     (18) 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. The proposed treaty, like the U.S. model and numerous 
U.S. treaties, generally prohibits source country taxation on 
interest (Article 11). However, 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 model treaties.
     (19) The proposed protocol (paragraph 4) 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 
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 rights 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) Both the U.S. model treaty and the proposed treaty 
provide for source-country taxation of capital gains from the 
disposition of personal property used in the business of a 
permanent establishment in the source country. 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.
     (22) 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.
    (23) The proposed treaty exempts all other gains from 
source-country taxation (Article 13(4)). This generally 
includes gains from the alienation of ships, aircraft, or 
containers operated in international traffic.
    (24) In a manner similar to the U.S. model treaty, 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 would not be taxable in the other treaty 
country unless the services are or were performed in that other 
country and the person has or had a fixed base there regularly 
available for the performance of his or her activities. In such 
a case, the other country would be permitted to tax the income 
from services performed in that country attributable to the 
fixed base.
    (25) 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.
    (26) Article 16 of the proposed treaty allows directors' 
fees and similar payments derived by a resident of one treaty 
country for services performed outside the residence country in 
his or her capacity as a member of the board of directors (or 
another similar body) of a company that 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 treaty (and the proposed 
treaty), the country where the recipient resides generally has 
primary taxing jurisdiction over personal services income and 
the source country tax on directors' fees is limited. By 
contrast, under the OECD model 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. Thus, the proposed treaty represents a 
compromise between the U.S. model treaty and the OECD model 
treaty positions.
    (27) Similar to the U.S. model treaty, Article 17 of the 
proposed treaty allows a source country to tax income derived 
by artistes and sportsmen from their activities as such, 
without regard to the existence of a fixed base or other 
contacts with the source country. The U.S. model treaty, 
however, allows such taxation by the source country only if 
that income exceeds $20,000 in a taxable year. U.S. income tax 
treaties generally follow the U.S. model treaty's rule, but 
often use a lower annual income threshold. Unlike the U.S. 
model treaty, but like the OECD model treaty, the proposed 
treaty allows entertainers and sportsmen to be taxed by the 
country of source, regardless of the amount of income that they 
earn from artistic or sporting endeavors.
    The proposed treaty includes an exception from source 
country taxation of artistes and sportsmen resident in the 
other country if the visit to the source country is 
substantially supported by public funds from the country of 
residence. Neither the U.S. model nor the OECD model contains 
such an exception, although it is found in some recent U.S. tax 
treaties.
    (28) The proposed treaty modifies the USSR treaty's rule, 
similar to the U.S. model treaty's 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 18 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 services are rendered in that country and 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.
    (29) 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 19).
    (30) Unlike the U.S. model treaty, the proposed treaty 
makes no special provision for the treatment of annuities, 
alimony, or child support payments. Taking into account the 
other income article which generally provides for taxation by 
the country of residence, the result in the case of annuities 
and alimony is generally similar to that under the U.S. model 
treaty; the result in the case of child support may not be.
    (31) The USSR treaty, unlike the model treaties, 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, but not more than 2 years in the case of teachers and 
researchers, 5 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 20) 
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.
    (32) The proposed treaty, unlike the USSR treaty, contains 
a version of the standard other income article, found in the 
model treaties and more recent U.S. treaties, under which 
income not dealt with in another treaty article generally may 
be taxed only by the residence country (Article 21).
    (33) 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 
22). 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.
    (34) 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 24). 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). 
In addition, unlike the U.S. model and other U.S. treaties, the 
proposed treaty does not include a specific provision for the 
operation of foreign tax credits in the case of a U.S. citizen 
resident in Ukraine.
    (35) 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 Ukrainian law have in 
effect placed significant restrictions on labor and interest 
cost deductions. In order to assist U.S. taxpayers' ability to 
take U.S. credits for Ukrainian taxes, Ukraine confirms under 
the proposed protocol (paragraph 7) that its law permits 
certain Ukrainian entities deductions for interest (whether 
paid to a bank or another person and without regard to the term 
of the loan) and for actual wages and other remuneration for 
personal services, regardless of its internal law, if U.S. 
residents beneficially own at least 20 percent of the entity, 
and the entity has total corporate capital of at least 
$100,000. This confirmation also applies to Ukrainian permanent 
establishments of U.S. entities, and individual U.S. citizens 
and residents pursuing entrepreneurial activities in Ukraine. 
On the basis of these required deductions, the proposed 
protocol treats Ukraine's taxes as income taxes that are 
eligible for the U.S. foreign tax credit.
    (36) 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 7(d) of the proposed protocol indicates that the 
United States and Ukraine will amend the proposed treaty 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.
    (37) Article 25 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. Like the U.S. model treaty, 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.
    (38) Like the U.S. model treaty, and unlike the USSR 
treaty, the proposed treaty makes express provision for the 
competent authorities mutually to agree on topics that would 
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, and the elimination of double taxation in 
cases not provided for in the treaty (Article 26).
    (39) Unlike some of the other pending treaties, the 
proposed treaty does not provide that its dispute resolution 
procedures under the mutual agreement article would take 
precedence over the corresponding provisions of any other 
agreement between the United States and Ukraine in determining 
whether a law or other rule is within the scope of the proposed 
treaty. Therefore, under the treaty as proposed, if Ukraine 
accedes to the General Agreement on Trade in Services (the 
``GATS''), tax issues between the United States and Ukraine may 
be subject to the dispute resolution procedures of the World 
Trade Organization. This issue is addressed in the exchange of 
notes dated May 26 and June 6, 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 Ukraine, 
the dispute resolution procedures under the mutual agreement 
article of the proposed treaty would take precedence.
    (40) 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 27). The proposed treaty 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.
    (41) Paragraph 5 of the proposed protocol expressly 
provides 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. 2
    \2\ The provision of the proposed protocol refers specifically to 
Article 14 (independent personal services) of the proposed treaty. The 
Committee understands that the reference to Article 14 was intended 
solely to emphasize that the refund provision applies to withholding 
taxes on payments for personal services as well as withholding taxes 
on, for example, dividends, interest, and royalties.
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                  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 at Kiev. In general, the proposed treaty will enter 
into force when the instruments of ratification are exchanged. 
The exchange of notes constitutes an agreement which will enter 
into force when the treaty enters into force. The USSR treaty 
generally ceases to have effect once the provisions of the 
proposed treaty take effect.
    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 is to be effective for taxable 
periods beginning on or after the first of January following 
entry into force.
    Where greater benefits would have been available to a 
taxpayer under the USSR treaty than under the proposed treaty, 
the 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. Moreover, in 
the case of a taxpayer claiming the benefits of Article 
III(1)(d) of the USSR Treaty (providing for taxation only by 
the source country of income from the furnishing of 
engineering, architectural, designing or other technical 
services in connection with an installation contract which are 
carried out in a period not exceeding 36 months at one 
location), the taxpayer may elect to be taxed under the USSR 
treaty (in its entirety) for the duration of the period of 
benefits provided by that subparagraph.

                             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 Ukraine, the related protocol, and the 
exchange of notes, 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 Ukraine on July 11, 1995, and ordered the proposed treaty, 
the protocol, and the exchange of notes 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 exchange of notes.

                         VI. Committee Comments

    On balance, the Committee on Foreign Relations believes 
that the proposed treaty with Ukraine 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 the Ukraine 
is not yet a party thereto. However, the exchange of notes 
addresses the relationship between the proposed treaty and the 
GATS, in the event that the GATS applies between the United 
States and Ukraine, and the relationship between the proposed 
treaty and other agreements that apply between the two 
countries. The exchange of notes provides that, in the event 
the GATS applies between the United States and Ukraine, 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 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 Ukraine).
    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 Ukraine). The Committee 
also believes that the provision of the exchange of notes 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 Ukraine).

               B. Foreign Tax Credit for Ukrainian 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 Ukrainian 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, Ukrainian tax laws did not 
allow full deductions for labor costs. In order to assist U.S. 
taxpayers seeking eligibility of Ukrainian taxes for use as 
credits against U.S. tax, as discussed above in Part III, the 
proposed protocol requires Ukraine to provide interest and 
labor cost deductions in the case of certain U.S. persons and 
entities with U.S. ownership. In addition, on the basis of 
those required deductions, the proposed protocol provides that 
the Ukrainian taxes will be creditable for U.S. purposes. 
3
    \3\ The Committee understands that the proposed protocol would not 
treat as creditable the Ukrainian taxes imposed on a taxpayer that is 
not eligible for the full deductions, as provided in the proposed 
protocol.
---------------------------------------------------------------------------
    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 Ukraine's and the United 
States's internal constitutional processes. As a result, the 
treaty commits Ukraine to altering its internal tax base with 
respect to foreign-owned investments, in order to conform 
Ukraine'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 Ukrainian tax, with 
the assurances described in the proposed protocol, is eligible 
for the U.S. foreign tax credit.
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department to provide additional 
explanation regarding the precedential effect of the guarantee 
of creditability. The relevant portion of the Treasury 
Department's July 5, 1995 letter 4 responding to this 
inquiry is reproduced below:
    \4\ Letter from 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'').

          2. How will the guarantee of U.S. creditability in 
        the proposed treaty not set a precedent in this area? 
        Doesn't this section erode general tax treaty 
        principles?
          As of the date of signature of the treaty, the 
        Ukrainian income tax would have been a creditable tax 
        under U.S. regulations had wages and interest been 
        fully deductible. Therefore, given the guarantee of 
        interest and wage deductions in the treaty, the treaty 
        provisions stating that the Ukrainian tax is creditable 
        for U.S. tax purposes did not make an otherwise non-
        creditable tax creditable--given this modification of 
        Ukrainian law, the tax was fully creditable with or 
        without the treaty guarantee. This provision therefore 
        does not represent a meaningful concession by the 
        United States. It does however, provide additional 
        assurance to U.S. investors that they will not face 
        double taxation as a result of being denied foreign tax 
        credits for Ukrainian income taxes paid, and in that 
        sense is a useful provision.

Stability of Ukrainian tax law

    The Committee understands that Ukraine enacted one phase of 
its tax reform in April 1995. The Treasury Department has 
advised the Committee that the Ukrainian tax reform is changing 
the tax base generally from gross receipts to net income. In 
particular, it is understood that businesses are allowed 
deductions for wages, salaries and related expenses, interest 
and bank charges, and costs of production and depreciation 
charges.
    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 U.S.-Russia tax treaty, the United 
States is not permitted to terminate the treaty until 1999. 
6
    \5\  Bureau of National Affairs, Daily Tax Report, May 1, 1995, p. 
G-2. The Committee understands that the Russian Federation may intend 
to terminate the excess-wage tax as of 1996.
    \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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    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 to provide additional 
explanation regarding the role of a country's political 
situation in the decision to ratify a treaty with the country. 
The relevant portion of the July 5, 1995 Treasury Department 
letter responding to this inquiry is reproduced below:

          9. What role should a country's political situation 
        play, particularly in developing countries, in 
        determining whether to ratify these treaties?
          A country's political situation is a factor that is 
        considered in determining whether to build stronger 
        economic ties with that country. When consideration of 
        this and other factors leads to a policy of building 
        stronger economic ties with a particular country, a tax 
        treaty becomes a logical part of that policy. One of a 
        treaty's main purposes is to foster the competitiveness 
        of U.S. firms that enter the treaty partner's market 
        place. As long as it is U.S. policy to encourage U.S. 
        firms to compete in these market places, it is in the 
        interest of the United States to enter tax treaties.
          Moreover, in countries where an unstable political 
        climate may result in rapid and unforeseen changes in 
        economic and fiscal policy, a tax treaty can be 
        especially valuable to U.S. companies, as the tax 
        treaty may restrain the government from taking actions 
        that would adversely impact U.S. firms, and provide a 
        forum to air grievances that otherwise would be 
        unavailable.

    The Committee believes that the political and economic 
situation in countries with which the U.S. 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 Ukraine is making in democratic 
reforms. The current President, Leonid Kuchma, was freely 
elected and took office in a peaceful transfer of power. While 
the Ukrainian parliament (the Rada) is dominated by former 
Communists, it has been generally supportive of economic and 
democratic reforms and recently forfeited some of its Soviet-
era powers. The pace of economic reform in Ukraine has picked 
up with the election of President Kuchma. The Ukrainian 
government is operating under a tight budget and significant 
economic reform measures are being implemented.
    Ukraine holds great potential for U.S. investors and 
ratification of the proposed treaty would 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 would lock in a framework for U.S.-Ukraine economic 
relations that may be politically untenable later. The United 
States has a strong interest in the success of Ukraine's 
economic and democratic reform process. Recent Ukrainian 
actions support favorable consideration of the proposed treaty. 
Ultimately, a strong and independent Ukraine 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, 
would permit the country in which business activities are 
carried on to tax the activities sooner, in certain cases, than 
it would be able to under either of the model treaties. Under 
the proposed treaty, a building site or construction or 
installation project (or supervisory activities related to such 
projects) would create a permanent establishment if it exists 
in a country for more than six months; under the U.S. model, a 
building site, etc., must last for at least one year. Thus, for 
example, under the proposed treaty, a U.S. enterprise's 
business profits that are attributable to a construction 
project in Ukraine would be taxable by Ukraine if the project 
lasts for more than six months. Similarly, under the proposed 
treaty, the use of a drilling rig or ship for the exploration 
or exploitation of natural resources (or related supervisory 
activities) in a country for more than six months would create 
a permanent establishment there; under the U.S. model, drilling 
rigs or ships must be present in a country for at least one 
year. It should be noted that many tax treaties between the 
United States and developing countries provide a permanent 
establishment threshold of six months for building sites and 
drilling rigs. In addition, unlike under the model treaties or 
other U.S. tax treaties, a permanent establishment under the 
proposed treaty includes a store or other premises used as a 
sales outlet.
Source basis taxation

    Additional concessions to source basis taxation in the 
proposed treaty include a maximum rate of source country tax on 
royalties (10 percent) that is higher than that provided in the 
U.S. model treaty; and broader source country taxation of 
personal services income (especially directors' fees) and 
income of artistes and athletes than that allowed by the U.S. 
model treaty.

Taxation of business profits

    Unlike the U.S. model treaty, but similar to the United 
Nations model treaty, the proposed treaty would limit 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.

Committee conclusions

    One purpose of the proposed treaty is to reduce tax 
barriers to direct investment by U.S. firms in Ukraine. The 
practical effect of these developing country concessions could 
be greater Ukrainian taxation of future activities of U.S. 
firms in Ukraine 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 UN 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 
will necessarily 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 Ukraine 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 proposed at the time 
that the U.S. model treaty was proposed, 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 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 Ukraine 
since third-country investors may be unwilling to share 
ownership of such investing entities on a 50-50 basis with U.S. 
or Ukrainian 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 Ukrainian conduit. Finally, 
Ukraine imposes significant taxes of its own; these taxes may 
deter third-country investors from seeking to use Ukrainian 
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. 7 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.'' 8
    \7\ 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.
    \8\ 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. 9 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. 10
    \9\ 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'').
    \10\ ``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. 11 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. The Committee is concerned about whether 
the United States should enter into agreements that might 
conflict with a move to an alternative approach in the future, 
and if not, the degree to which U.S. obligations under the 
proposed treaty would in fact conflict with such a move.
    \11\ 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 
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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.
                           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 1995-2000 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 Ukraine for the Avoidance of Double 
Taxation and the Prevention of Fiscal Evasion with Respect to 
Taxes on Income and Capital Signed at Washington on March 4, 
1994.''

               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 Ukraine for the 
Avoidance of Double Taxation and the Prevention of Fiscal 
Evasion with Respect to Taxes on Income and Capital, with 
Protocol, signed at Washington on March 4, 1994 (Treaty Doc. 
103-30); and the Exchange of Notes Dated at Washington May 26 
and June 6, 1995, Relating to the Convention between the 
Government of the United States of America and the Government 
of Ukraine 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 
Washington on March 4, 1994 (Treaty Doc. 104-11).