[Senate Executive Report 104-7]
[From the U.S. Government Publishing Office]



104th Congress                                              Exec. Rept.
                                 SENATE

 1st Session                                                      104-7
_______________________________________________________________________


 
             INCOME TAX CONVENTION WITH THE FRENCH REPUBLIC

                                _______


   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. 103-32, 103rd Congress, 2d 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 the French Republic for the 
Avoidance of Double Taxation and the Prevention of Fiscal 
Evasion with Respect to Taxes on Income and Capital, signed at 
Paris on August 31, 1994, together with two related exchanges 
of notes, having considered the same, reports favorably 
thereon, without amendment, and recommends that the Senate give 
its advice and consent to ratification thereof, subject to one 
declaration as set forth in this report and accompanying 
resolution of ratification.

                               I. Purpose

    The principal purposes of the proposed income tax treaty 
between the United States and the French Republic (``France'') 
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 income taxes of 
the two countries. The proposed treaty is intended to continue 
to promote close economic cooperation between the two countries 
and to eliminate possible barriers to trade caused by 
overlapping taxing jurisdictions of the two countries. It is 
also intended to enable the countries to cooperate in 
preventing avoidance and evasion of taxes.
                             II. Background

    The proposed treaty was signed on August 31, 1994. The 
proposed treaty was amplified by diplomatic notes signed the 
same day, and by additional notes signed on December 19, 1994 
and December 20, 1994. The proposed treaty replaces the 
existing income tax treaty between the two countries that was 
signed in 1967 and modified by protocols signed in 1970, 1978, 
1984, and 1988.
    The proposed treaty was transmitted to the Senate for 
advice and consent to its ratification on September 19, 1994 
(see Treaty Doc. 103-32). 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 
1 (the ``U.S. model''), and the model income tax treaty of 
the Organization for Economic Cooperation and Development (the 
``OECD model''). However, the proposed treaty contains some 
deviations from these documents. Among other modifications, the 
proposed treaty includes a number of revisions to accommodate 
aspects of the Tax Reform Act of 1986.
    \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 
proposed 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 proposed treaty provides that a treaty 
country may not tax business income derived from sources within 
that country by residents of the other country unless the 
business activities in the first country are substantial enough 
to constitute a permanent establishment or fixed base (Articles 
7 and 14). Similarly, the proposed treaty contains ``commercial 
visitor'' exemptions under which residents of one country 
performing personal services in the other country are not 
required to pay tax in that other country unless their contact 
with that country exceeds specified minimums (Articles 14-17). 
The proposed treaty provides that dividends, royalties, and 
certain gains derived by a resident of either country from 
sources within the other country generally are taxable by both 
countries (Articles 10, 12 and 13). Generally, however, 
dividends and royalties received by a resident of one country 
from sources within the other country are taxed by the source 
country on a restricted basis or not at all (Articles 10 and 
12). The proposed treaty provides that as a general rule, the 
source country may not tax interest received by a resident of 
the other treaty country (Article 11).
    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 requiring the other country 
either to grant a credit against its tax for the taxes paid to 
the source country or to exempt that income from its tax 
(Article 24).
    The proposed treaty contains a ``saving clause'' similar to 
that contained in other U.S. tax treaties (Article 29(2)). 
Under this provision, the United States generally retains the 
right to tax its citizens and residents as if the treaty had 
not come into effect. In addition, the proposed treaty contains 
the standard provision that it does not apply to deny a 
taxpayer any benefits that person is entitled to under the 
domestic law of the country or under any other agreement 
between the two countries (Article 29(1)); that is, the treaty 
applies to the benefit of taxpayers.
    The proposed treaty also contains a nondiscrimination 
provision (Article 25) and provides for administrative 
cooperation, exchange of information, and assistance in 
collection between the tax authorities of the two countries to 
avoid double taxation and to prevent fiscal evasion with 
respect to income taxes (Articles 26-28).
    The proposed treaty differs in certain respects from other 
U.S. income tax treaties, from the U.S. and OECD model 
treaties, and from the present treaty with France. A summary of 
the provisions of the proposed treaty, including some of these 
differences, follows:
    (1) The proposed treaty generally applies only to residents 
of the United States and to residents of France (Article 1). 
This follows other U.S. income tax treaties, the U.S. model 
treaty, and the OECD model treaty. Unlike most other U.S. 
income tax treaties and the model treaties, however, the 
nondiscrimination rules of the proposed treaty do not apply to 
citizens or nationals of a treaty country who are not residents 
of that treaty country (Article 25). Thus, for example, the 
proposed treaty offers no protection for a U.S. citizen 
resident in a third country in the unlikely event that France 
imposes discriminatory taxation on residents of that country.
    (2) Unlike the U.S. model and many U.S. income tax treaties 
in force, but like the present treaty, the proposed treaty does 
not affect the imposition by the United States of the 
accumulated earnings tax and the personal holding company tax. 
In addition, like the U.S. model and a number of other U.S. 
income tax treaties, the proposed treaty applies to the excise 
taxes imposed with respect to the investment income of private 
foundations and, subject to an ``anti-conduit rule,'' to the 
U.S. excise tax imposed on insurance premiums paid to foreign 
insurers (Article 2).
    (3) The definition of the term ``United States'' as 
contained in Article 3 of the proposed treaty generally 
conforms to the definition provided in the U.S. model. In both 
treaties the term generally is limited to the United States of 
America, thus excluding from the definition U.S. possessions 
and territories. The proposed treaty, however, makes it clear 
that the United States includes its territorial sea and the 
seabed and subsoil of the adjacent area over which the United 
States may exercise rights in accordance with international law 
and in which laws relating to U.S. tax are in force. The U.S. 
model is silent with respect to this point. The definition of 
the term ``France'' as contained in the proposed treaty 
similarly includes its territorial sea and the seabed and 
subsoil of the adjacent area.
    (4) A U.S. citizen who is not also a U.S. resident (i.e., 
does not have a substantial presence, permanent home, or 
habitual abode in the United States) generally is not covered 
by the proposed treaty (Article 4).2 The U.S. model does 
cover such U.S. citizens. The United States rarely has been 
able to negotiate coverage for nonresident citizens, however.
    \2\ Similarly, the treaty would not cover an alien who has been 
admitted for permanent U.S. residence (i.e., a ``green card'' holder) 
unless that person has a U.S. substantial presence, permanent home, or 
habitual abode.
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    (5) For purposes of qualifying for benefits under the 
proposed treaty, the term ``resident of a Contracting State'' 
specifically includes the governments of the two treaty 
countries, including their political subdivisions and local 
authorities, and any agencies or instrumentalities of those 
national or subnational governmental bodies. The term also 
covers a pension trust and any other organization established 
in the treaty country and maintained exclusively to administer 
or provide retirement or employee benefits that is established 
or sponsored by a person that is a treaty-country resident, and 
any not-for-profit organization established and maintained in 
the treaty country, provided that applicable local laws limit 
the use of the organization's assets, both currently and upon 
the dissolution or liquidation of such organization, to the 
accomplishment of the purposes that serve as the basis for such 
organization's exemption from income tax.
    (6) In the case of income derived or paid by a partnership 
or similar pass-through entity, estate, or trust, the term 
``resident of a Contracting State'' applies only to the extent 
that the income derived by such entity is subject to tax in 
that country as the income of a resident, either in the hands 
of the entity or in the hands of its partners, beneficiaries, 
or grantors. In a case where the partnership or other entity is 
subject to tax by a treaty country at the entity level, it 
would be treated as a resident of that country under the 
treaty. The proposed treaty specifies that a societe de 
personnel, a groupement d'interet economique (economic interest 
group), or a groupement europeen d'interet economique (European 
economic interest group) that is constituted in France and has 
its place of effective management in France and that is not 
subject to French company tax is treated as a partnership for 
purposes of U.S. tax benefits under the proposed treaty, and, 
as specified in diplomatic notes, for purposes of U.S. tax 
benefits under any other U.S. tax treaty.
    (7) The definition of a permanent establishment in Article 
5 of the proposed treaty follows the corresponding provision in 
the U.S. model.
    (8) The proposed treaty includes the usual provision 
assigning the primary right to tax income from real property to 
the situs country. However, 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.
    (9) Unlike the U.S. and OECD model treaties and most other 
U.S. treaties, Article 6(5) of the proposed treaty provides a 
special rule that allows the situs country to tax corporate 
shareholders on the imputed rental value of real property owned 
by the corporation that they, as shareholders, are entitled to 
use. Like the present treaty, however, the proposed treaty 
precludes income taxation on the basis of the imputed rental 
value of housing owned in the taxing country by an individual 
resident of the other treaty country (Article 29(5)). Only 
France currently imposes tax on such a basis.
    (10) Article 7 of the proposed treaty provides that 
business profits attributable to a permanent establishment in 
one treaty country may be taxed by that country even if the 
payments are deferred until after the permanent establishment 
has ceased to exist. This clarifies that Code section 864(c)(6) 
is not overridden by the proposed treaty.
    (11) Both the proposed treaty and the U.S. model treaty 
contain definitions of the term ``business profits.'' Under the 
U.S. model definition (as well as under the definition 
contained in many other U.S. income tax treaties), business 
profits include income from the rental of tangible personal 
property and from the rental or licensing of films and tapes. 
Thus, such rental income earned by a resident of one treaty 
country from sources in the other country would only be taxable 
in the source country if the income is attributable to a 
permanent establishment or fixed base of that taxpayer in that 
country. The proposed treaty, consistent with the OECD model 
treaty, treats payments for the rental or licensing of films 
and tapes as royalties, which generally are exempt from tax in 
the source country (under Article 12) unless they are 
attributable to a permanent establishment. Thus, though the 
language of the proposed treaty is different from that of the 
present treaty and the U.S. model treaty, the treatment of 
rental or licensing payments with respect to films and tapes is 
the same.
    (12) The proposed treaty, like the present treaty but 
unlike the U.S. model, provides that partners would be treated 
as realizing income and incurring losses in accordance with 
their shares of the partnership's profits and losses, taking 
into account any special allocations that have substantial 
economic effect. This rule, consistent with U.S. law, is also 
applicable to France.
    (13) Like the present treaty and some other existing U.S. 
income tax treaties, Article 8 of the proposed treaty does not 
provide protection from source country taxation of income from 
leases of containers used in international traffic to the same 
extent as the U.S. model treaty, which exempts such income from 
source country tax as income from the operation of ships or 
aircraft in international traffic. For example, the model 
provides for exemption from tax in the source country for a 
container lessor (such as a financial institution or a leasing 
company) that does not also operate ships or aircraft in 
international traffic, but that leases containers to others for 
use in international traffic. Under the proposed treaty, the 
exemption for shipping profits does not apply to profits from 
container leasing unless those leasing activities are 
``accessory'' or incidental to international shipping 
activities of the lessor. Such profits are treated as business 
profits under the proposed treaty, and thus exempt from tax in 
the source country unless attributable to a permanent 
establishment in that country.3
    \3\ The OECD published a view that containers should be treated as 
they are in the proposed treaty. OECD Committee on Fiscal Affairs, 
``The Taxation of Income Derived From the Leasing of Containers,'' 
para. 15 (1985).
    (14) Similar to the OECD model treaty, the article on 
associated enterprises (Article 9) of the proposed treaty omits 
the provision found in the U.S. model treaty and in most other 
U.S. treaties, which clarifies that neither treaty country is 
precluded from (or limited in) the use of any domestic law 
which permits the distribution, apportionment, or allocation of 
income, deductions, credits, or allowances between persons, 
whether or not residents of one of the treaty countries, owned 
or controlled directly or indirectly by the same interests, 
where necessary in order to prevent evasion of taxes or clearly 
to reflect the income of any of such persons. However, the 
Treasury Department Explanation of the Convention Between the 
United States of America and the Government of the French 
Republic for the Avoidance of Double Taxation and the 
Prevention of Fiscal Evasion with Respect to Taxes on Income 
and Capital, Signed at Paris on August 31, 1994, May 1995 (the 
``Technical Explanation'') states that the omitted language 
serves merely as a clarification, and that the proposed treaty 
is intended to fully preserve the rights of each country to 
apply its internal laws relating to adjustments between related 
parties.
    (15) Under Article 10 of the proposed treaty, as under the 
U.S. model treaty, direct investment dividends (i.e., dividends 
paid to companies resident in the other country that own 
directly (in the case of a French owner of a U.S. payor) at 
least 10 percent of the voting power of the payor, or directly 
or indirectly (in the case of a U.S. owner of a French payor) 
at least 10 percent of the capital of the payor) generally are 
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. However, like 
recent U.S. treaties, the proposed treaty would apply a 
withholding tax rate of 15 percent on dividends if those 
dividends are paid by a U.S. regulated investment company (a 
``RIC'') or a French societe d'investissement a capital 
variable (SICAV), regardless of whether the RIC or SICAV 
dividends are paid to a direct or portfolio investor. The 
proposed treaty does not provide for a reduction of U.S. 
withholding tax on dividends paid by a real estate investment 
trust (a ``REIT''), unless the dividend is beneficially owned 
by an individual French resident holding a less than 10-percent 
interest in the REIT.
    (16) Generally, the proposed treaty, the U.S. model, and 
the OECD model all share a common definition of the term 
``dividends.'' 4 The proposed treaty further defines this 
term, however, to include income from arrangements, including 
debt obligations, carrying the right to participate in profits, 
to the extent so characterized under the local law on the 
treaty country in which the income arises. This clarifies that 
each country applies its domestic law, for example, in 
differentiating dividends from interest.
    \4\ That definition is income from shares or other rights, not 
being debt-claims, participating in profits, as well as income from 
other corporate rights which is subjected to the same taxation 
treatment as income from shares by the laws of the treaty country of 
which the company making the distribution is a resident.
    (17) The proposed treaty specifically treats as dividends 
any payments in lieu of dividends to holders of depository 
receipts representing beneficial ownership of shares.
    (18) The proposed treaty, like the present treaty, allows 
U.S. shareholders to receive the benefit of all or a portion of 
the dividend tax credit (avoir fiscal) that French resident 
shareholders receive with respect to dividends from French 
corporations as part of the imputation tax system employed in 
France (Article 10(4)). U.S. shareholders generally receive the 
same avoir fiscal that French shareholders receive, subject to 
a deduction of the applicable dividend withholding tax imposed 
on the gross amount of the dividend plus the credit. Under 
French law, the avoir fiscal is allowed in the amount of one-
half of the net dividend, which is equivalent to the entire 
corporation tax at the current French rate of 33.33 percent. 
For example, assume that a French corporation earns Ff300 of 
taxable income, pays corporate tax of Ff100, and distributes 
Ff200 to its U.S. portfolio shareholders as a dividend. The 
amount of the avoir fiscal will be half of the dividend, or 
Ff100. Withholding tax will be imposed at the treaty rate of 15 
percent on the full Ff300 of dividend plus avoir fiscal. The 
avoir fiscal credit of Ff100 against withholding tax of Ff45 
will result in a net refund of French tax to the U.S. 
shareholders (assuming all of them qualify) of Ff55, in 
addition to their net cash dividend of Ff200.
    The full avoir fiscal is available under the proposed 
treaty to a U.S. resident that is an individual, another person 
that is not a company, a company (other than a RIC) that does 
not own (directly or indirectly) 10 percent or more of the 
stock of the payor, or a RIC that does not own (directly or 
indirectly) 10 percent or more of the stock of the payor but 
only if non-U.S. persons own less than 20 percent of the RIC's 
shares.
    The avoir fiscal is available only to shareholders that are 
subject to U.S. income taxation of the dividend and the avoir 
fiscal payment. Dividends paid to pass-through entities are 
eligible to the extent of the eligibility of their partners or 
beneficiaries.
    A reduced avoir fiscal, in the amount of 30/85 of the full 
amount (less applicable withholding tax), is available under 
the proposed treaty to certain investments by certain U.S. 
pension plans (not including plans that own, directly or 
indirectly, 10 percent or more of the stock of the payor). The 
reduced avoir fiscal, which is not granted by France under the 
present treaty, is effective for distributions paid after 
December 31, 1990.
    In the case of dividends paid to U.S. recipients that are 
not eligible to receive the avoir fiscal, the proposed treaty 
allows a refund of the French corporate tax prepayment 
(precompte) which has been paid with respect to distributions 
of earnings that have not borne full French corporate tax. The 
precompte refund is treated as a dividend for purposes of the 
withholding taxes allowed by the proposed treaty. French 
statutory law imposes the precompte on dividends without regard 
to the qualification of the recipient for the avoir fiscal.
    (19) The proposed treaty, similar to the present treaty and 
other U.S. treaties negotiated since 1986, expressly permits 
imposition of the branch profits tax in certain cases (Article 
10(7)). The rate of that tax may not exceed 5 percent.
    The United States is allowed under the proposed treaty to 
impose the branch profits tax on a French corporation that 
either has a permanent establishment in the United States, or 
is subject to tax on a net basis in the United States on income 
from real property or gains from the disposition of interests 
in real property. The tax is imposed on the ``dividend 
equivalent amount,'' as defined in the Code. In cases where a 
French corporation conducts a trade or business in the United 
States but not through a permanent establishment, the proposed 
treaty completely eliminates the branch profits tax that the 
Code would otherwise impose on such corporation (unless the 
corporation earned income from real property as described 
above). France is allowed to impose its corresponding tax under 
quinquies, article 115 of the French tax code (code general des 
impots).
    The proposed treaty makes clear that nothing in the non-
discrimination article (Article 25) should be construed as 
preventing either country from imposing its branch profits tax.
    (20) Under Article 11 of the proposed treaty, like the 
present treaty and the U.S. model treaty, interest generally is 
exempt from source-country taxation. However, interest that is 
determined by reference to the profits of the issuer (or one of 
its associated enterprises) is subject to source-country 
taxation at a maximum rate of 15 percent. In addition, no 
exemption or reduction of U.S. withholding tax is granted under 
the proposed treaty to a French resident that is a holder of a 
residual interest in a U.S. real estate mortgage investment 
conduit (a ``REMIC'') with respect to any excess inclusion.
    Interest, for purposes of the proposed treaty, does not 
include any amount treated as a dividend under Article 10.
    (21) The proposed treaty generally exempts from source-
country taxation royalties for the use of a copyright (or the 
use of a neighboring right such as reproduction or performing 
rights) of literary, artistic, or scientific work, including 
films, sound or picture recordings, and software (Article 12). 
However, the proposed treaty, like the current treaty and some 
other U.S. treaties, allows source-country taxation of certain 
other types of royalties at a maximum rate of 5 percent. Both 
the U.S. and OECD model treaties exempt royalties from source-
country tax. The category of royalties which is subject to 
source-country tax includes payments of any kind received as a 
consideration for the use of, or the right to use any patent, 
trademark, design or model, plan, secret formula or process, or 
other like right or property, or for information concerning 
industrial, commercial, or scientific experience.
    (22) Although not found in the OECD model, the U.S. model, 
or many other U.S. treaties, Article 12(6) of the proposed 
treaty contains a special provision for determining the source 
of royalties. The special sourcing provision includes three 
separate rules. First, if the royalty is paid by a resident of 
the United States or France, the royalty is treated as arising 
in that country. Second, if the royalty is paid by a person, 
whether or not a resident of the United States or France, that 
has a permanent establishment or fixed base in one of the 
countries in connection with which the liability to pay the 
royalty arose, and if the royalty is actually borne (i.e., is 
deducted in computing taxable income) by that permanent 
establishment or fixed base, then the royalty is deemed to 
arise in the country in which the permanent establishment or 
fixed base is located. Third, notwithstanding the first and 
second rules, a royalty paid for the use of, or the right to 
use, property in the United States or France is deemed to arise 
in that country. The Committee understands that this provision 
applies both for purposes of determining whether royalties are 
taxable in the source country, and in determining the source of 
royalties for purposes of computing the foreign tax credit 
under the article on relief from double taxation (Article 24). 
This dual application of the special sourcing provision avoids 
a potential mis-match between jurisdiction to tax and 
obligation to relieve double taxation.
    By contrast, since the U.S. model does not specifically 
provide (for any purpose) a sourcing rule for royalties, the 
applicable rule of domestic law applies. With respect to the 
domestic law of the United States, royalties generally are 
sourced in the country where the property giving rise to the 
royalty is used (Code sec. 861(a)(4)).
    (23) Both the U.S. model treaty and the proposed treaty 
(Article 13) 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. Like most 
recent U.S. tax treaties, the proposed treaty also provides for 
source-country taxation of such gains where the payments are 
received after the permanent establishment has ceased to exist. 
In addition, the proposed treaty provides that in a case where 
the laws of one treaty country tax the removal of such property 
from that country as a deemed disposition of the property, that 
country is permitted to tax the gain that accrues up to the 
time of removal, and the other country is permitted to tax the 
gain that accrues after the time of removal. The Technical 
Explanation indicates that such divided tax jurisdiction is 
exclusive; the residence country is not permitted to tax gain 
accruing prior to removal, and the source country is not 
permitted to tax gain accruing subsequent to removal.
    The Committee understands that this provision represents a 
combination of the French custom of taxing accrued, but 
unrealized gains at the time the asset is removed from France, 
with the U.S. rules that generally permit the United States to 
tax the realization of gains from the disposition of property 
that formerly was part of a U.S. business. This rule of the 
proposed treaty is not subject to the saving clause.\5\
    \5\ The exception from the saving clause for this rule was omitted 
from the proposed treaty as signed (and as submitted to the Senate) 
(Article 29(3)). By exchange of diplomatic notes on the 19th and 20th 
of December, 1994, the United States and France added the exception for 
this rule. As corrected, Article 29(3) of the proposed treaty provides 
as follows (with the additional clause emphasized):

        3. The provisions of paragraph 2 shall not affect:
        (a) the benefits conferred under paragraph 2 of Article 9 
      (Associated Enterprises), under paragraph 3(a) of Article 
      13 (Capital Gains), under paragraph 1(b) of Article 18 
      (Pensions), and under Articles 24 (Relief from Double 
      Taxation), 25 (Non-Discrimination), and 26 (Mutual 
      Agreement Procedure); and
        (b) the benefits conferred under Articles 19 (Public 
      Remuneration), 20 (Teachers and Researchers), 21 (Students 
      and Trainees), and 31 (Diplomatic and Consular Officers), 
      upon individuals who are neither citizens of, nor have 
      immigrant status in, the United States.
    The Technical Explanation states that this provision will 
not affect the operation of U.S. law (Code sec. 987) regarding 
foreign currency gain or loss on remittances of property or 
currency, by a qualified business unit. The Technical 
Explanation also indicates that taxpayers would not receive a 
new basis in remitted property for all purposes, but rather 
would be required to keep records establishing the value of 
remitted property at the time of remittance. The United States 
would then tax only additional increments in value in the event 
of a sale of the property following a remittance.
    (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, including U.S. real property 
interests, regardless of whether the taxpayer is engaged in a 
trade or business in the source country. 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. 
France is permitted to tax similar real property interests 
situated in France. Look-through rules apply in the case of 
real property interests held by pass-through entities.
    (25) The U.S. model treaty exempts from source-country 
taxation gains from the alienation of ships, aircraft, or 
containers operated in international traffic. The proposed 
treaty limits the application of this exemption to enterprises 
that themselves operate ships or aircraft in international 
traffic, and expands the exemption to cover also movable 
property (such as containers) pertaining to the operation of 
the ships or aircraft.
    (26) The proposed treaty exempts all other gains from 
source-country taxation, including gains realized by 
enterprises that do not themselves operate ships or aircraft on 
the alienation of containers used in international traffic, 
except where attributable to a permanent establishment in the 
source country.
    (27) 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 is not taxable in the other treaty country 
unless the person has or had a fixed base in the other country 
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 as are attributable to the fixed base.
    (28) Unlike the U.S. model treaty but like the present 
treaty, Article 14(4) of the proposed treaty provides a special 
rule for the taxation of services performed through a 
partnership. Although look-through treatment generally applies, 
France is not obligated under the treaty, including under 
Article 24 (Relief from Double Taxation), to exempt more than 
half of the earned income of a partnership accruing to a 
resident of France. To the extent this rule applies, 
compensating adjustments would be made to the taxation by 
France of nonresident partners.
    (29) The dependent personal services article of the 
proposed treaty (Article 15) varies slightly from that article 
of the U.S. model. Under the U.S. model, 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. The proposed treaty contains a 
similar rule, but provides that the measurement period for the 
183-day test is not limited to the taxable year; rather, the 
source country may not tax the income if the individual is not 
present there for a period or periods exceeding in the 
aggregate 183 days in a 12-month period.
    (30) The proposed treaty allows directors' fees derived by 
a resident of one treaty country for services performed in the 
other country 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 
(Article 16). 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 (and the proposed treaty), 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 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 and the OECD model positions.
    (31) 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, if that income exceeds 
$10,000 in a taxable period. The $10,000 threshold is the same 
as in the present treaty, but is half of the threshold provided 
in the U.S. model treaty. U.S. income tax treaties generally 
follow the U.S. model rule, but often use a lower annual income 
threshold. Under the OECD model, entertainers and sportsmen may 
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 principally 
supported, directly or indirectly, 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.
    (32) The U.S. model treaty provides that pensions (other 
than those relating to government service) and other similar 
remuneration derived and beneficially owned by a resident of a 
treaty country in consideration of past employment are taxable 
only in the residence country. Article 18 of the proposed 
treaty similarly applies this rule to private pensions, and 
provides that the timing and extent of taxation of pension 
benefits is determined under the laws of the source country. 
Similar to the U.S. model treaty, the proposed treaty allows 
taxation of social security benefits and governmental pensions 
(including U.S. Tier 1 Railroad Retirement benefits) paid to 
treaty-country residents only by the paying country. Thus, the 
treaty specifies that only France would be permitted to tax 
French social security benefits received by a U.S. citizen who 
is resident in France. The proposed treaty also provides for 
mutual recognition of tax-favored retirement arrangements, as 
may be agreed by the competent authorities of the two 
countries.
    (33) Unlike the U.S. model treaty, the proposed treaty 
makes no special provision for the treatment of alimony or 
child-support payments. Taking into account the ``other 
income'' article, the result in the case of alimony is 
generally similar to that under the model; the result in the 
case of child support may not be.
    (34) Article 19 of the proposed treaty modifies the U.S. 
model rule, that compensation paid by a treaty country 
government to its citizen for services rendered to that 
government in the discharge of governmental functions may only 
be taxed by that government's country. The proposed treaty 
applies its corresponding rule to all compensation paid by a 
governmental entity for services rendered to that governmental 
entity, regardless of whether the services are rendered in the 
discharge of governmental functions, so long as the services 
are not rendered in connection with a business carried on by 
the governmental entity. Moreover, unlike the U.S. model 
treaty, the proposed treaty specifies that compensation by a 
governmental entity would be taxable only by the other country 
if the services are rendered in that other country, and the 
individual is a resident and citizen of that other country and 
not also a citizen of the paying country. This rule is similar 
to the corresponding rule in the OECD model treaty. A similar 
rule applies to governmental pensions.
    (35) Unlike the U.S. and OECD model treaties, but like the 
present treaty and a number of existing U.S. treaties with 
other countries, the proposed treaty generally prohibits host 
country tax on the teaching income of a resident of one country 
who visits the other (host) country for two years or less to 
teach at a recognized educational institution (Article 20). 
Also unlike the models, but like the present and some other 
existing treaties, this same rule also applies under the 
proposed treaty to income received as a researcher engaged in 
research for the public benefit.
    (36) The U.S. model, the OECD model, and the proposed 
treaty (Article 21) all provide a general exemption from host-
country taxation of certain payments from abroad received by 
students and trainees who are or were resident in one country 
and studying or training in the host country. Whereas the U.S. 
and OECD models permit this exemption without regard to any 
income threshold, the proposed treaty, in certain cases, allows 
it only for certain limited time periods. Unlike the models, 
the proposed treaty also exempts anywhere from $5,000 to $8,000 
per year (depending on the circumstances) of personal services 
income of persons who qualify for benefits under this article 
of the proposed treaty.
    (37) The proposed treaty, like the present treaty, contains 
the standard ``other income'' article, found in the U.S. and 
OECD 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 22).
    (38) Under Article 23 of the proposed treaty, as under the 
U.S. and OECD model treaties, capital may be taxed by the 
country in which located if it is real property owned by a 
resident of either country, or if it is personal property 
forming part of the business property of a permanent 
establishment or fixed base maintained by a resident of the 
other country. The owner's country of residence may also tax 
that property. The right to tax ships, aircraft, and related 
movable property (including containers) operated in 
international traffic belongs solely to the country in which 
the owner resides. The proposed treaty also allows a country to 
tax the capital represented by a substantial interest in a 
company that is a resident of that country. All other capital 
of a resident of a treaty country is taxable only in the 
residence country. The proposed treaty provides a special rule 
under which France may not impose its wealth tax on the foreign 
property of a U.S. citizen (not also a French citizen) resident 
in France for the first five years of French residency.
    The French wealth tax is the only capital tax imposed under 
present law by either the United States or France.
    (39) The relief from double taxation article of the 
proposed treaty (Article 24) is substantially the same as the 
corresponding article of the present treaty. It relieves double 
taxation by means of a foreign tax credit allowed by the United 
States, a combination of a credit and an exemption allowed by 
France, and rules of application generally specifying that the 
country obligated to offer the credit or exemption is the 
country other than the one to which the proposed treaty accords 
the primary right to tax the applicable category of income.
    The article provides special rules for U.S. citizens who 
reside in France. In this case, the proposed treaty provides 
that items of income which may be taxed by the United States 
solely by reason of citizenship (under the saving clause) are 
to be treated as French source income to the extent necessary 
to avoid double taxation. In no event, however, would the tax 
paid to the United States be less than the tax that would be 
paid if the individual were not a U.S. citizen. This rule is 
similar to corresponding rules in several recent U.S. treaties.
    (40) The proposed treaty contains a nondiscrimination 
article (Article 25) similar to the nondiscrimination articles 
contained in the U.S. and OECD model treaties and other recent 
U.S. treaties. As noted above, however, unlike most other U.S. 
income tax treaties and the model treaties, the 
nondiscrimination rules of the proposed treaty do not apply to 
citizens or nationals of a treaty country who are not residents 
of the other treaty country.
    The proposed treaty's nondiscrimination article explicitly 
permits France to impose its earnings stripping rules, so long 
as the application of those rules is consistent with the arm's 
length principles of the associated enterprises article. The 
Technical Explanation states that the treaty negotiators agreed 
not to include a similar explicit provision respecting the U.S. 
earnings-stripping rules, based on the fact that the U.S. 
earnings-stripping rules were designed to be consistent with 
such principles.
    (41) Under the proposed treaty's mutual agreement procedure 
rules (Article 26), a case must be presented for consideration 
to a competent authority within three years from the 
notification of the action resulting in taxation not in 
accordance with the provisions of the proposed treaty. The U.S. 
model does not specify any time limit for presentation of a 
case to a competent authority, whereas the OECD model provides 
an identical three-year time limit for this purpose. It is 
understood that the time limit is included in the interests of 
good tax administration.
    (42) The mutual agreement article of the proposed treaty 
also specifically permits competent authority agreements that 
cover future as well as past years. This clarifies that the 
French government may enter into bilateral advance pricing 
agreements (APAs).
    (43) 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 26(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.
    (44) The proposed treaty, in its exchange of information 
article (Article 27), provides authorization for 
representatives of one treaty country to enter the other treaty 
country for the purpose of interviewing taxpayers and examining 
books and records, but only with the consent of the affected 
taxpayers and of the competent authority of the second treaty 
country. 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.
    (45) The proposed treaty contains a provision requiring 
each country to undertake to lend administrative assistance to 
the other in collecting taxes covered by the treaty (Article 
28). This provision, carried over with minor modifications from 
the present treaty, is more detailed than the administrative 
assistance provision in the U.S. model treaty. Among other 
things, the proposed treaty provision specifies that one 
country's application to the other for assistance must include 
a certification that the taxes at issue have been ``finally 
determined.''
    (46) As a general rule, the proposed treaty would not 
restrict the availability of any benefit allowed by any other 
agreement (present or future) between the United States and 
France (Article 29(1)).
    (47) The proposed treaty provides that its dispute 
resolution procedures under the mutual agreement article take 
precedence over the corresponding provisions of any other 
agreement between the United States and France in determining 
whether a law or other measure is within the scope of the 
proposed treaty (Article 29(8)). Unless the competent 
authorities agree that the law or other measure is outside the 
scope of the proposed treaty, only the proposed treaty's 
nondiscrimination rules, and not the nondiscrimination rules of 
any other agreement in effect between the United States and 
France, generally apply to that law or other measure. The only 
exception to this general rule is that the nondiscrimination 
rules of the General Agreement on Tariffs and Trade would 
continue to apply with respect to trade in goods.
    (48) The proposed treaty contains a limitation on benefits, 
or ``anti-treaty shopping,'' article (Article 30) that retains 
in some respects the outline of the limitation on benefits 
provisions contained in recent U.S. treaties and in the branch 
tax provisions of the Internal Revenue Code and Treasury 
Regulations. However, the proposed treaty provision is more 
detailed, and in some respects may be more generous to foreign 
persons, than recently negotiated provisions in most other 
treaties. The proposed treaty provision is similar to the 
limitation on benefits articles contained in the recent U.S. 
income tax treaty and protocol with the Netherlands.

                  IV. Entry Into Force and Termination

                          A. Entry into Force

    The proposed treaty will enter into force upon the exchange 
of instruments of ratification. The proposed treaty provisions 
with respect to taxes collected by withholding and the Federal 
insurance excise tax generally apply to amounts paid on or 
after the first day of the second month following the date on 
which the treaty enters into force. With respect to other 
taxes, the proposed treaty will take effect for taxable periods 
beginning on or after the first day of January following the 
date on which the treaty enters into force. As discussed above, 
the reduced avoir fiscal and French withholding taxes on 
royalties will take effect for distributions and payments made 
after December 31, 1990.

                             B. Termination

    The proposed treaty will continue in force until terminated 
by a treaty country. Either country may terminate it 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.
    With respect to taxes withheld at source, a termination 
will be effective for amounts paid or credited on or after the 
first of January following the expiration of the six-month 
period. With respect to other taxes, a termination is to be 
effective for taxable years 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 French Republic treaty, and on other proposed tax 
treaties and protocols, on June 13, 1995. The hearing was 
chaired by Senator Thompson. The Committee considered the 
proposed French Republic treaty on July 11, 1995, and ordered 
the proposed treaty favorably reported by a voice vote, with 
the recommendation that the Senate give its advice and consent 
to the ratification of the proposed treaty.

                         VI. Committee Comments

    The Committee on Foreign Relations approved the proposed 
treaty with a declaration that certain interest payments made 
to French subsidiaries that are controlled foreign corporations 
(as defined in Code sec. 957) should be automatically exempt 
from U.S. tax to the extent the payments are taxable to the 
payor under the subpart F provisions of the Internal Revenue 
Code. On balance, the Committee believes that this treaty is in 
the interest of the United States and urges that the Senate act 
promptly to give its 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. Anti-abuse Provisions

General rule

    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 would receive treaty benefits. Although the 
proposed treaty generally is intended to benefit residents of 
France 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 attempt to 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 proposed treaty, like a number of U.S. income tax 
treaties, generally limits the class of treaty country 
residents eligible for benefits. Benefits are bestowed only 
upon those treaty country residents with a sufficient 
additional nexus, beyond simple residence, to the treaty 
country. In its outlines, the anti-treaty-shopping provision of 
the proposed treaty is somewhat similar to the anti-treaty-
shopping provision in the branch tax provisions of the Internal 
Revenue Code (as interpreted by Treasury regulations) and in 
several newer treaties. In its details, on the other hand, the 
proposed treaty resembles only the 1993 U.S. treaty with the 
Netherlands, which was in many ways unprecedented. The degree 
of detail included in this provision and in the Netherlands 
provision, relative to other treaties, is notable in itself. 
First, the proliferation of detail may reflect, in part, a 
diminution in the scope afforded the Internal Revenue Service 
(``IRS'') and the courts in the anti-treaty-shopping provisions 
of most previous U.S. treaties to resolve interpretive issues 
adversely to a person attempting to claim the benefits of the 
treaty; this diminution represents a bilateral commitment, not 
alterable by developing internal U.S. tax policies, rules, and 
procedures, unless enacted as legislation that would override 
the treaty. (To the same extent as is provided under other 
treaties, the IRS generally is not limited under the proposed 
treaty in its discretion to allow treaty benefits under the 
anti-treaty shopping rules.) In addition, the detail in the 
proposed treaty represents added guidance for taxpayers that 
may be absent under most other treaties, although the 
negotiators of most other U.S. treaties have chosen to forego 
such additional guidance in favor of somewhat simpler and more 
flexible provisions. In general, the provisions of the anti-
treaty shopping article of the proposed treaty tend to be at 
least somewhat more lenient than the comparable rules in the 
U.S. regulations under the branch tax, and other U.S. treaties, 
although every existing anti-treaty-shopping standard 
potentially may be satisfied through the exercise of more or 
less broad discretion of the Secretary of the Treasury. The 
proposed treaty is also one of the first to provide mechanical 
rules under which so-called ``derivative benefits'' are 
afforded.6 Under these rules, a French entity is afforded 
benefits based in part on its ultimate ownership by a third-
country resident who would be entitled to U.S. treaty benefits 
under an existing treaty between the United States and the 
third country.
    \6\ The U.S. income tax treaty with the Netherlands also provides 
for such benefits, as do, in a much more limited way, the U.S. tax 
treaties with Jamaica and Mexico.
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    Anti-treaty-shopping articles in treaties often have an 
``ownership/base erosion'' test. To qualify for benefits under 
such a test, an entity must meet two requirements, one 
concerning the connection of its owners to the treaty countries 
(the ``ownership'' requirement), the other concerning the 
destination of payments that it deducts from its income (the 
base reduction or ``erosion'' requirement). The ownership 
requirement in one anti-treaty-shopping provision proposed at 
the time the U.S. model treaty was proposed allows benefits to 
be denied to a company residing in a treaty country unless more 
than 75 percent of its stock is held by individual residents of 
the same country. The proposed treaty (like other U.S. treaties 
and an anti-treaty-shopping branch tax provision in the Code) 
lowers the qualifying percentage to 50, and broadens the class 
of qualifying shareholders to include entities and individuals 
resident in either treaty country (and citizens of the United 
States). For some purposes, the proposed treaty, unlike most 
previous treaties, broadens the class of qualifying 
shareholders to take into account also residents of member 
countries in the European Union (the ``EU'') with which the 
United States and France each has a bilateral income tax 
treaty. Thus, the ownership requirement under the proposed 
treaty is somewhat more generous to taxpayers than some 
predecessor requirements. 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. 
Counting for this purpose residents of EU member countries 
generally may also limit abuses in light of the treaties 
between the United States and those countries.
    The base erosion requirement in recent treaties allows 
benefits to be denied if 50 percent or more of the resident's 
gross income is used, directly or indirectly, to meet 
liabilities (including liabilities for interest or royalties) 
to certain classes of persons not entitled to treaty benefits. 
A similar test applies under the branch tax. The ``base 
reduction'' test in the proposed treaty modifies this test in 
several respects. First, the test does not take into account 
income used to meet an arm's-length liability, if the liability 
is incurred for (1) tangible property in the ordinary course of 
business, or (2) services performed in the payor's residence 
country. In some cases, payments to residents of EU member 
countries are also afforded favorable treatment. Thus, the 
base-reduction test in the proposed treaty, like the similar 
test in the U.S.-Netherlands treaty, is different, and may be 
more favorable to taxpayers, than most of its predecessors.
    Another provision of the anti-treaty-shopping article 
requires a source country to allow benefits with respect to 
income derived in connection with the active conduct of a trade 
or business in the residence country that is substantial in 
relation to the income-producing activity, or derived 
incidentally to that trade or business. (This active trade or 
business test generally does not apply with respect to a 
business of making or managing investments, except for banking 
or insurance activities conducted by a bank or an insurance 
company, so benefits can be denied with respect to such a 
business regardless of how actively it is conducted.) To the 
extent described above, the proposed treaty's active business 
test is similar to its predecessors'. In contrast to the 
practice followed in the drafting of other such treaty tests, 
however, the way in which the proposed treaty's active business 
test is to operate is laid out in great detail in the treaty. 
In some cases, the details mirror provisions in the branch tax 
regulations, but may be more generous to taxpayers. Like some 
recent U.S. treaties, the proposed treaty attributes to the 
treaty resident active trades or businesses conducted by other 
entities. The attribution rules in the proposed treaty may 
result in more taxpayers being eligible for treaty benefits, 
and permit in some cases the treatment of third country 
business operations as if they were carried on in France. These 
rules are similar to those in the U.S.-Netherlands treaty.
    The proposed treaty is similar to other U.S. treaties and 
the branch tax rules in affording treaty benefits to certain 
publicly traded companies. The treaty definition of ``publicly 
traded'' is explained in much greater detail in the proposed 
treaty than in most existing U.S. treaties. Again as in the 
case of the active business test, in some cases this 
elaboration mirrors the branch tax regulations, but is less 
rigorous. Also, like the branch tax rules, the proposed treaty 
allows benefits to be afforded to the wholly-owned subsidiary 
of a publicly traded company. Unlike most predecessors, the 
proposed treaty provides that benefits must be afforded to 
certain joint ventures of publicly traded companies, including 
in some cases joint ventures involving publicly traded 
companies resident in EU member countries other than France. 
Moreover, unlike the corresponding provision of the U.S.-
Netherlands tax treaty, upon which this joint-venture provision 
is modeled, the proposed treaty does not require that if 
benefits are to be afforded a company resident in a treaty 
country on the basis of public trading in the stock of the 
company's shareholder or shareholders, the company seeking 
treaty benefits also meet an anti-conduit test that measures 
base erosion.7 Thus, under the proposed treaty, a joint 
venture of two publicly traded companies could qualify for 
treaty benefits even if most of its gross income avoids 
taxation in France through base erosion. However, there may be 
significantly less potential for tax avoidance through base 
erosion under the tax laws of France than in the Netherlands.
    \7\ Under the U.S.-Netherlands treaty, the company either must not 
be a ``conduit company'' or, if it is a conduit company, the company 
must meet a ``conduit company base reduction test.'' A conduit company 
is one that pays out currently at least 90 percent of its aggregate 
receipts in deductible payments (including royalties and interest, but 
excluding those at arm's length for tangible property in the ordinary 
course of business or services performed in the payer's residence 
country). A conduit company meets the conduit base reduction test if 
less than a threshold fraction (generally 50 percent) of its gross 
income is paid to associated enterprises subject to a particularly low 
tax rate (relative to the tax rate normally applicable in the payer's 
residence country).
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    The proposed treaty also guarantees benefits to a resident 
that is a ``headquarter company'' of a multinational corporate 
group. A headquarter company is one that provides a group which 
is sufficiently geographically dispersed with substantial 
supervision and administration (including group financing if 
that is not its primary function). One requirement to qualify 
as a headquarter company in the proposed treaty is that the 
headquarter company must be subject to tax in its residence 
country on the same basis as a company conducting an active 
trade or business there. The Technical Explanation states that 
headquarter companies in France are not so taxed. Therefore, 
under present law, no French company is able to qualify as a 
headquarter company under the proposed treaty.
    Like other treaties and the branch tax rules, the proposed 
treaty gives the competent authority of the source country the 
power to allow benefits where the anti-treaty-shopping tests 
are not met. The proposed treaty states that benefits are to be 
allowed in a case where the competent authority of the country 
allowing the benefits determines that obtaining treaty benefits 
was not one of the principal purposes in establishing, 
acquiring, or maintaining the treaty-country person, or in 
conducting its operations. The proposed treaty also states that 
benefits are to be allowed in a case where the competent 
authority of the country allowing the benefits determines that 
it would not be appropriate, considering the purposes of the 
anti-treaty-shopping provision, to deny treaty benefits. The 
Technical Explanation anticipates that the competent 
authorities will take into account the principles and examples 
set forth in the Understanding accompanying the limitation-on-
benefits provision of the U.S.-Netherlands tax treaty. The 
proposed treaty requires each competent authority to consult 
the other before issuing an adverse ruling.
    The practical difference between the proposed treaty tests 
(and the similar tests in the U.S.-Netherlands treaty) and the 
corresponding tests in most predecessor treaties will depend 
upon how they are interpreted and applied. For example, the 
active business tests in other treaties theoretically might be 
applied leniently (so that any colorable business activity 
suffices to preserve treaty benefits), or they may be applied 
strictly (so that the absence of a relatively high level of 
activity suffices to deny them). Given the bright line rules 
provided in the proposed treaty, the range of interpretation 
under it may be narrower. It may be possible that a relatively 
narrow reading of the active business test in other treaties 
and the branch tax regulations could theoretically be stricter 
than the proposed treaty tests, and could 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 on how the United States would be able to ensure 
that the benefits of the proposed treaty would only be 
available to those who are entitled to receive them. Relevant 
portions of Treasury's letter responding to this and other 
inquiries, dated July 5, 1995, are reproduced below: \8\
    \8\ 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 letter'').
    2. Without a stronger information-sharing procedure, how 
will the United States be able to ensure under this treaty that 
the benefits of the treaty only go to those who are entitled to 
receive them?
    The provisions of the new treaty regarding information 
exchange with the French tax authorities are fully consistent 
with U.S. policy and are similar or identical to those in our 
recent treaties. Our experience with France under the current 
treaty has been very positive, and the proposed treaty expands 
the scope of information exchange in important respects. The 
French negotiators confirmed that information will continue to 
be exchanged between the tax authorities as in the past, 
despite the current disagreement concerning on-site audits. On-
site audits serve as a ``shortcut'' to the exchange of 
information between tax authorities under our treaties, but 
they are only one of numerous means of obtaining information. 
Therefore, we do not anticipate any particular problems in 
applying the limitation on benefits or other provisions of the 
treaty.
Triangular structures

    The proposed treaty includes a special rule designed to 
prevent the proposed treaty from reducing or eliminating U.S. 
tax on income of a French resident in a case where no other 
substantial tax is imposed on that income (referred to as a 
``triangular structure''). This is necessary because a French 
resident may in some cases be wholly or partially exempt from 
French tax on foreign (i.e., non-French) income. The special 
rule applies generally if the combined French and third-country 
taxation of third-country income earned by a French enterprise 
with a permanent establishment in the third country is less 
than 60 percent of the tax that would be imposed if the French 
enterprise earned the income in France.
    In such a case, under the special rule, the United States 
is permitted to tax dividends, interest, and royalties paid to 
the third-country permanent establishment at the rate of 15 
percent. In addition, under the special rule, the United States 
is permitted to tax other types of income without regard to the 
treaty. The special rule generally does not apply if the U.S. 
income is in connection with or incidental to an active trade 
or business in the third country, or if the third-country 
income is subject to taxation by either the United States or 
France under the controlled foreign corporation (``CFC'') rules 
of either country. \9\ The special rule is similar to a 
provision of the 1993 protocol to the U.S.-Netherlands tax 
treaty.
    \9\ Article 30(5)(b) of the proposed treaty erroneously refers to 
subpart F of part II of subchapter N of chapter 1 of subtitle A of the 
Internal Revenue Code. The Technical Explanation confirms that the 
negotiators of the proposed treaty intended to refer to subpart F of 
part III of subchapter N of chapter 1 of subtitle A of the Internal 
Revenue Code.
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    The Committee commends efforts made by the Treasury 
Department to include effective anti-abuse shopping provisions 
in bilateral tax conventions, including the proposed treaty. 
Appropriate steps should be taken to ensure that U.S. taxes are 
properly paid by all corporations, both domestic and foreign, 
under U.S. income tax treaties. The Committee remains 
concerned, however, that the application of certain anti-abuse 
shopping provisions could, in some cases, deny the relief for 
double taxation from certain U.S. companies with overseas 
subsidiaries.
    The Committee believes that the exemptions allowed in 
paragraph 5(b) of Article 30 should be granted automatically to 
any CFCs resident in France to the extent the interest payments 
to such CFCs are includible in the income of their U.S. 
shareholders under the provisions of subpart F of the Code. If 
it is later determined that the payments do not constitute 
subpart F income and U.S. tax should have been withheld, then 
the U.S. withholding agent, including the U.S. shareholder of 
the CFC, should be held liable for penalties for failure to 
withhold, in addition to the withholding tax. Consequently, 
subjecting these businesses to additional administrative 
requirements to demonstrate that the income is taxable under 
the provisions of subpart F beyond regular audit procedures 
imposes onerous administrative requirements that are unduly 
burdensome.
    Because taxpayers with CFCs resident in the Netherlands 
have been subject to the same burdens, the Committee believes 
that the anti-abuse provision contained in Paragraph 8 of 
Article 12 of the U.S.-Netherlands tax treaty should be applied 
in the same manner as the relief available under paragraph 5(b) 
of Article 30 of the proposed treaty. The Committee further 
believes that any such relief should be available on a long-
term basis.
    As part of the consideration of this special rule under the 
proposed treaty, the Treasury Department was asked to discuss a 
similar provision contained in the U.S.-Netherlands treaty (as 
amended by the 1993 protocol), including reasons why permanent 
relief should not be granted in the case of Dutch finance 
subsidiaries whose profits are taxable under subpart F of the 
Code. The relevant portion of Treasury's response to these 
issues, as indicated in its July 6, 1995, letter to Senator 
Thompson, is reproduced below:
    1. Is it not true that since Competent Authority can grant 
temporary, case-by-case relief under paragraphs 1 and 3 of 
Article 29 of the Dutch Treaty, permanent Competent Authority 
relief could be granted and publicized on which affected 
taxpayers could rely, as was done in Notice 95-31, Revenue 
Ruling 80-304, Revenue Ruling 77-289, and Revenue Ruling 77-62?
    Competent authority relief can take different forms. The 
form that such relief will take will be dictated by the issue 
presented. In the authorities cited, the competent authorities 
either agreed on a common definition of a term that was not 
otherwise clearly defined, or agreed on a common interpretation 
of a provision that was unclear in some respect.
    Unlike the authorities cited, the agreement in this case 
does not relate to an ambiguity in the text of the treaty. It 
relates to a specific group of foreign taxpayers who, together 
with their current U.S. shareholders, may suffer double 
taxation of their U.S. source income. I have been informed by 
the Assistant Commissioner (International) that agreements 
between the competent authorities to eliminate double taxation 
invariably apply to specific taxpayers for a specific year or 
set of years. This long-standing administrative practice is 
consistent with the Internal Revenue Service's duty to ensure 
that the tax laws of the United States are administered 
appropriately. In a factually-based case involving individual 
foreign taxpayers it is impossible to anticipate every 
conceivable change in the relevant facts and circumstances that 
might occur. It is important for the IRS to be able to examine 
these structures in order to determine, for example, whether 
they are being used to evade foreign taxes, or the extent to 
which the income of the Dutch company is taxed currently as 
subpart F income.
    This approach is consistent with the approach taken to 
establishing entitlement to treaty benefits generally. For 
example, foreign taxpayers must file a Form 1001 in order to 
obtain reduced withholding rates under a tax treaty. This form 
must be resubmitted every three years.
    2. Does the Treasury Department have authority, under 
paragraph 3 of Article 34, to interpret the Dutch Treaty to 
carry out the intended purpose of that Treaty?
    Paragraph 3 of Article 34 gives Treasury the authority to 
issue regulations necessary to carry out provisions of the 
treaty other than those described in paragraphs 1 and 2 of that 
Article. Paragraph 1 provides that the competent authorities 
may, by mutual agreement, determine the ``mode of application'' 
of Article 12 (Interest) and certain other provisions of the 
treaty. Consequently, the authority granted by paragraph 3 of 
Article 34 does not extend to issues arising in connection with 
Article 12 of the treaty. The payments received by the Dutch 
taxpayers in these cases are interest payments that fall under 
paragraph 8 of Article 12 (Interest).
    3. Is it not true that beyond the Dutch Treaty itself, the 
Treasury Department's general authority to interpret the tax 
law is sufficient to support the issuance of policy guidance?
    Congress has historically been reluctant to grant wide 
discretion to the Treasury Department or the Internal Revenue 
Service to unilaterally modify the rate of taxation imposed on 
individual taxpayers, foreign or domestic. Indeed, we do not 
believe that the Internal Revenue Service has the authority to 
unilaterally reduce the rate of tax imposed on a particular 
foreign taxpayer. Tax rates are set by Congress and cannot be 
altered through unilateral administrative action.
    The treaty does, however, provide authority for the 
competent authorities to reach mutual agreements covering a 
number of issues that the Internal Revenue Service otherwise 
might not have authority to resolve, including issues relating 
to double taxation. All authority to reduce the U.S. tax rate 
to which these Dutch companies are subject derives from the 
treaty.
    4. If it were necessary to seek assent of the Netherlands 
in order to issue such published guidance, is it not highly 
likely that the Netherlands would accede to such guidance given 
their approval of relief for 1995?
    We have not discussed with the Dutch competent authority 
the possibility that an agreement to permanently reduce the 
rate of tax in the instant case be published. In any event, I 
understand that the Internal Revenue Service would have serious 
reservations with adopting such a solution. Although the 
Treasury Department has not been directly involved in any 
discussions between the affected taxpayers and the Internal 
Revenue Service, our general familiarity with these cases 
enables us to fully support the judgment of the Assistant 
Commissioner (International) in this regard.
    5. In the 1993 Protocol, did the Treasury Department cede 
authority to the Netherlands to resolve problems of U.S. 
taxpayers?
    Not at all. The Internal Revenue Service retains the 
ability it has under domestic law to resolve problems 
encountered by U.S. taxpayers, as well as the foreign taxpayers 
involved in these cases. A tax treaty only increases the IRS's 
ability to resolve problems. The IRS may use the mutual 
agreement procedures described in the treaty to resolve a 
variety of issues, including the issue faced by the Dutch 
companies that are subject to the 15 percent withholding tax 
under the Protocol. In these cases, this authority gives the 
IRS the possibility of reducing the rate of U.S. tax paid by 
these Dutch companies.
    6. Is there any specific reason that permanent relief 
should not be granted in the case of Dutch finance subsidiaries 
whose profits are subject to Subpart F of the Tax Code and who 
properly file annual tax returns?
    Ordinarily a foreign subsidiary of a U.S. corporation is 
not required to file an annual United States income tax return. 
The tax liability in these cases falls on the foreign 
corporation, while the correlative Subpart F issue and related 
IRS audits involve the U.S. parent--this distinction raises 
technical but important procedural issues.
    U.S. tax laws are designed to discourage structures such as 
those presented in these cases, as such structures were often 
used to inappropriately avoid U.S. tax. There may be non-U.S. 
tax reasons for such structures as well. Accordingly, under the 
Internal Revenue Code, foreign finance subsidiaries that 
receive related party U.S. source interest income are subject 
to 30 percent U.S. withholding tax, and the net income of the 
finance subsidiary is then subject to full U.S. corporate 
income taxation at the parent company level, with no 
possibility of a credit for the U.S. and foreign taxes paid at 
the subsidiary level. Double taxation is virtually inevitable 
in such cases. The companies involved in these cases 
effectively have asked that this policy be altered for them. 
While the treaty makes such a modification possible, we believe 
that administrative relief should be undertaken with caution 
when it involves an exception to a Congressionally-mandated 
policy.
    There are sound administrative reasons for not granting a 
permanent exemption in these cases. There are various ways in 
which taxpayers can manipulate the earnings and profits of a 
foreign subsidiary in order to reduce subpart F income. Under 
the Internal Revenue Code, a U.S. taxpayer is only required to 
include Subpart F income up to the amount of the foreign 
subsidiary's earnings and profits. Accordingly, it is possible 
that a foreign subsidiary could have substantial amounts of 
subpart F income but the U.S. parent corporation would be 
required to report little or no subpart F income due to the 
earnings and profits limitation. Therefore it is important that 
the IRS retain the ability to confirm that the taxpayer is not 
manipulating its earnings and profits accounts in order to 
depress its subpart F income inclusion. The IRS also has a 
responsibility to our treaty partners to decline to facilitate 
the evasion of their taxes.
    These concerns are especially acute with respect to foreign 
taxpayers asking for a reduction in their U.S. tax rate. 
Foreign taxpayers generally are beyond the reach of the U.S. 
tax collection system. Even a foreign company that is U.S.-
owned presents concerns, because the company may not be U.S.-
owned when its results are actually subject to audit.
    7. The inclusion [of a similar] provision in the French 
treaty indicates that, should French regulations change, you 
believe French subsidiaries should be treated differently. Why 
is this distinction appropriate?
    We have not concluded that French companies should be 
treated differently for this purpose than Dutch companies. We 
insisted on inclusion of a similar provision in the French 
treaty precisely because we were concerned that French law 
might change in the future in a way that would make these 
structures more feasible. If that occurred it was important 
that we have a provision in the treaty to prevent abuse.
    The French treaty relieves a French company from the U.S. 
withholding tax if the company's income is subject to Subpart 
F. The IRS has not determined what procedures it would adopt to 
implement this provision. The procedures eventually adopted 
could be comparable to those developed in connection with these 
cases.

    The Committee has recommended that the Senate give its 
advice and consent to the proposed treaty with a declaration 
regarding this issue to reflect its beliefs stated above.
Conclusion of the Committee

    The Committee believes, as it has stated in the past, that 
the United States should maintain its policy of limiting 
treaty-shopping opportunities whenever possible. The Committee 
is particularly concerned that, in exercising any latitude 
Treasury has to adjust the operation of a treaty, the treaty 
rules as applied should adequately deter treaty-shopping 
abuses. On the other hand, implementation of the tests for 
treaty shopping set forth in the treaty raise factual, 
administrative, and other issues. For example, as discussed 
above, the proposed treaty broadly allows treaty benefits to 
joint ventures of public companies. As another example, the 
proposed treaty allows the United States to impose higher 
levels of source tax in certain cases resulting in low overall 
tax; this is a stronger anti-abuse rule than is found in most 
recent U.S. treaties. By contrast, one limitation on benefits 
provision proposed at the time that the U.S. model treaty was 
proposed provides that any relief from tax provided by the 
United States to a resident of the other country under the 
treaty shall be inapplicable to the extent that, under the law 
in force in that other country, the income to which the relief 
relates bears significantly lower tax than similar income 
arising within that other country derived by residents of that 
other country. The Committee wishes to emphasize, however, that 
the new rules must be implemented so as to serve as an adequate 
tool for preventing possible treaty-shopping abuses in the 
future.

                          B. 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.10 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.'' 11
    \10\ 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 OECD Committee on Fiscal 
Affairs, ``Transfer Pricing Guidelines for Multinational Enterprises 
and Tax Administrators,'' OECD, Paris 1995.
    \11\ 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.12 Some 
prefer a so-called ``formulary apportionment'' approach, which 
can take a variety of forms. The general thrust of formulary 
apportionment is to first 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.13
    \12\ 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'').
    \13\ 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.\14\ 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 issue is 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.
    \14\ 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 information on the Administration's current policy 
with respect to transfer pricing issues. Among the information 
requested include a description of the Administration's general 
position on transfer pricing issues, an analysis of whether the 
United States should interpret Article 9 of tax treaties 
regarding transfer pricing as permitting other methods of 
pricing such as the unitary method or formulary apportionment 
method and the reasons for industry's support of the arm's-
length pricing method. In addition, the Committee also inquired 
whether the Treasury Department is satisfied that the proposed 
treaty, and other treaties that are the subject of the hearing, 
ensure foreign corporations are paying their share of U.S. 
taxes. Relevant portions of Treasury's response to these 
inquiries, in the July 5, 1995, Treasury letter, 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.
            c. relationship to other treaties and agreements

    The multilateral trade agreements encompassed in the 
Uruguay Round Final Act, which entered into force as of January 
1, 1995, include a General Agreement on Trade in Services 
(``GATS''). This agreement generally obligates members (such as 
the United States and France) 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 proposed treaty provides, in Article 29(8), that 
notwithstanding any other agreement to which the United States 
and France are parties, 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 proposed 
treaty 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).
    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). The 
Committee also believes that the provision of the proposed 
treaty is adequate to preclude the preemption of the mutual 
agreement provisions of the proposed treaty by the dispute 
settlement procedures under the GATS.
    The proposed treaty provides that, except as discussed 
above, it would not restrict any treaty benefits accorded by 
any other agreement between the United States and France. One 
existing treaty in force between the United States and France 
that includes tax-related provisions is the 1959 Convention of 
Establishment between the United States and France (the ``1959 
Convention'').
    Some have argued that one portion of the nondiscrimination 
provisions of the 1959 Convention (Article IX, Paragraph 4) may 
preclude application of a formulary method of taxation on a 
worldwide unitary basis either by the United States or by any 
State. That paragraph protects enterprises of one treaty 
country from taxation within the territories of the other 
treaty country ``upon capital, income, profits or any other 
basis, except by reason of the property which they possess 
within those territories, the income and profits derived from 
sources therein, the business in which they are there engaged, 
the transactions which they accomplish there, or any other 
bases of taxation directly related to their activities within 
those territories.'' On this basis, some have argued that the 
paragraph requires that taxation be imposed on a ``water's 
edge'' basis.
    Even if, as some have argued, the nondiscrimination 
provisions of the 1959 Convention may limit the scope or 
structure of U.S. taxation of French enterprises under present 
law, the Committee believes that Article 29(8) of the proposed 
treaty preclude any such limitation as discussed above.\15\
    \15\ Although some may argue that Article IX(4) of the 1959 
Convention is not a nondiscrimination provision because it addresses 
neither national treatment nor most-favored-nation treatment, and thus 
would be unaffected by the proposed treaty, a leading commentator on 
nondiscrimination provisions in tax treaties considers that provision 
to be a nondiscrimination provision. C. Van Raad, ``Nondiscrimination 
in International Tax Law'' (1986) at 240-241.
---------------------------------------------------------------------------

                        d. insurance excise tax

    The proposed treaty, like the present treaty, contains a 
waiver of the U.S. excise tax on insurance premiums paid to 
foreign insurers. Thus, for example, a French insurer or 
reinsurer without a permanent establishment in the United 
States can collect premiums on policies covering a U.S. risk or 
a U.S. person free of this tax. However, the tax is imposed to 
the extent that the risk is reinsured by the French insurer or 
reinsurer with a person not entitled to the benefits of the 
proposed treaty or another treaty providing exemption from the 
tax. This latter rule is known as the ``anti-conduit'' clause.
    Although waiver of the excise tax appears in the 1981 U.S. 
model treaty, waivers of the excise tax have raised serious 
Congressional concerns. For example, concern has been expressed 
over the possibility that they may place U.S. insurers at a 
competitive disadvantage to foreign competitors in U.S. 
markets, if a substantial tax is not otherwise imposed (e.g., 
by the treaty partner country) on the insurance income of the 
foreign insurer (or, if the risk is reinsured, the reinsurer). 
Moreover, in such a case waiver of the tax does not serve the 
purpose of treaties to avoid double taxation, but instead has 
the undesirable effect of eliminating all taxation.
    The U.S.-Barbados and U.S.-Bermuda tax treaties each 
contained such a waiver as originally signed. In its report on 
the Bermuda treaty, the Committee expressed the view that those 
waivers should not have been included. The Committee stated 
that waivers should not be given by Treasury in its future 
treaty negotiations without prior consultations with the 
appropriate committees of Congress.\16\ Congress subsequently 
enacted legislation to ensure the sunset of the waivers in the 
two treaties. The waiver of the tax in the treaty with the 
United Kingdom (where the tax was waived without the so-called 
``anti-conduit rule'') has been followed by a number of 
legislative efforts to redress perceived competitive imbalance 
created by the waiver.
    \16\ Such consultations took place in connection with the proposed 
treaty.
---------------------------------------------------------------------------
    However, French law may exempt low-taxed foreign income of 
a French resident from tax; if foreign laws that apply to the 
foreign insurance income of a French resident were changed in 
the future (or applied differently than they are now), the 
result might be a level of tax inconsistent with the criteria 
previously laid down by the Committee for waiver of the U.S. 
excise tax on premiums. While the Committee has no reason 
currently to expect that such foreign law changes will occur, 
the Committee instructs the Treasury Department promptly to 
inform the Committee of any changes in foreign laws or business 
practices that would have an impact on the tax burden of French 
insurers relative to that of U.S. insurers.
                       E. Exchange of Information

    In most respects, the present treaty is similar to the U.S. 
model treaty and other U.S. treaties in its provisions on the 
exchange of information. The exchange of information provision 
serves the function of preventing fiscal evasion, one of the 
two principal reasons for which the United States enters into 
tax treaties. In one significant respect, however, the 
information-exchange provision of the proposed treaty provides 
narrower opportunities for obtaining tax information from the 
treaty partner than does the usual tax treaty relationship.
    The proposed treaty provides for representatives of one 
country to enter the other country to interview taxpayers and 
to examine and copy books and records, but only with the 
consent of the taxpayer and of the other competent authority. 
Moreover, this provision will not be effective until the United 
States and France agree to allow such interviews and 
examinations on a reciprocal basis, and signify that agreement 
in an exchange of diplomatic notes. That is, unless and until a 
subsequent agreement is reached, the United States has no 
authority under the treaty to enter France for audit purposes. 
After such agreement is reached, the authority to conduct such 
audits in France (as under some other U.S. treaties) would be 
available only with the consent of the taxpayer.
    However, the opportunities for obtaining tax information 
from France is significantly greater under the proposed treaty 
than under present law and practice. The Committee understands 
that French law precludes foreign government authorities, 
including agents of the United States and other treaty 
partners, from conducting on-site tax examinations in France 
even with consent of the taxpayer. There is no current 
limitation applicable to on-site tax examinations by French 
authorities in the United States. In fact, the Treasury 
Department has confirmed that France tax authorities do conduct 
such examinations from time to time. The proposed treaty would 
restore reciprocity to this relationship by limiting the 
ability of the French tax authorities to conduct on-site 
examinations in the United States until both countries agree to 
permit such examinations. The provision may serve to encourage 
France to modify its internal laws so that both countries could 
more effectively enforce their tax laws.
    As part of its consideration of the proposed treaty, the 
Committee raised the issue as to whether the United States can 
be assured that an exchange of notes regarding on-site audits 
will be forthcoming. The Committee also asked the Treasury 
Department whether the United States will be able to properly 
determine the tax obligations of French taxpayers who refuse to 
submit to the information sharing provisions. Relevant portions 
of Treasury's response to these inquiries, in the July 5, 1995, 
Treasury letter, are reproduced below:

    1. What assurance does the United States have from France 
that an exchange of notes [regarding on-site audits] will be 
forthcoming?
    We have not yet received assurances from the French 
negotiators regarding on-site audits. If the French tax 
officials had authority to resolve the issue, we would have 
insisted on doing so in the treaty itself. The problem is that 
on-site audits by foreign government officials are prohibited 
under French law. The treaty levels the playing field by 
introducing a similar prohibition against on-site audits by 
French officials in the United States until such time as their 
Government permits U.S. agents to conduct audits in France. The 
treaty, therefore, creates a strong incentive for France to 
change its current policy.
    3. How will the United States be able to properly determine 
the tax obligations of French taxpayers who refuse to submit to 
the information sharing provisions?
    The French Government routinely provides tax information to 
the Internal Revenue Service under the information exchange 
provisions of the current treaty without the taxpayer's 
consent. The provisions of the new treaty will not change this. 
Therefore, we do not anticipate any particular difficulty in 
determining the U.S. tax obligations of French taxpayers.
    The taxpayer's consent will be required only for an on-site 
audit, which as noted above are only one of several tools for 
obtaining information. This requirement is standard practice. 
Many other countries--including the United States--permit on-
site audits by foreign government officials only with the 
permission of the taxpayer.

    The Committee has considered the extent to which the 
limited examination opportunities under the proposed treaty 
would be adequate to allow the United States to properly 
determine the tax obligations of French persons, and to confine 
the benefits of the French treaty to those taxpayers entitled 
to receive them and has not recommended a reservation or 
understanding in this case. However, the Committee believes 
that the exchange of information provisions in treaties are 
central to the purposes for which tax treaties are entered 
into, and it does not believe that significant limitations on 
their effect, relative to the preferred U.S. tax treaty 
position, should be accepted by the Administration in its 
negotiations with other countries that seek to have or to 
maintain the benefits of a tax treaty relationship with the 
United States.
              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 and the 1992 income tax 
treaty between the United States and the Netherlands), the 
proposed treaty delegates to the executive branch the power to 
enter into, an agreement under which a binding arbitration 
procedure may be invoked, 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 with respect to this issue are exchanged between France 
and the United States. Consultation between the two countries 
regarding whether such an exchange of notes should occur will 
take place after there has been sufficient experience with 
other treaties containing a similar provision.
    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 
are 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.17 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 will not generally accede to arbitration with 
respect to matters concerning the tax policy or domestic tax 
law of either treaty country.
    \17\ 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, 
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      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 stated in recommending ratification of the U.S.-Germany 
treaty and the U.S. 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. Technical Clarifications
                      a. stock exchange excise tax
    Under the present treaty, the French tax on stock exchange 
transactions is a covered tax. That is, the tax could not be 
imposed on a resident of the United States. In the proposed 
treaty, however, the French tax on stock exchange transactions 
is not a covered tax, but Article 29(4) provides that any 
transaction in which an order for the purchase, sale, or 
exchange of stocks or securities originates in one treaty 
country and is executed through a stock exchange in the other 
treaty country is exempt in the first country from stamp or 
like tax otherwise arising with respect to such transaction. 
The apparent difference between these provisions is that the 
French tax on stock exchange transactions could be imposed, 
under the proposed treaty, on a U.S. resident who engages in a 
stock exchange transaction while in France on a temporary 
basis. However, the Committee understands that French law now 
exempts nonresident individuals and foreign legal persons from 
the tax on stock exchange transactions.
                      B. Treatment of Partnerships

    As noted above, the proposed treaty provides that a 
partnership or other entity that is subject to tax by a treaty 
country at the entity level would be treated as a resident of 
that country under the treaty. Article 4(2)(b)(iv) specifies 
that a societe de personnel, a groupement d'interet economique 
(economic interest group), or a groupement europeen d'interet 
economique (European economic interest group) that is 
constituted in France and has its place of effective management 
in France and that is not subject to French company tax would 
be treated as a partnership for purposes of U.S. tax benefits 
under the proposed treaty. Moreover, diplomatic notes exchanged 
between the United States and France on the date that the 
proposed treaty was signed specify also that such an entity, if 
so constituted, effectively managed, and not subject to tax, 
also would be treated as a partnership for purposes of U.S. tax 
benefits under any U.S. tax treaty with any third country. 
Although the effect of these diplomatic notes appears to pose a 
potential conflict with other tax treaties to which France is 
not a party, the Committee is assured by the Treasury 
Department that the treatment specified in the diplomatic notes 
is fully consistent with every other U.S. tax treaty.

                          VIII. 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.

                   IX. 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 Between the Government of the 
United States of America and the Government of the French 
Republic for the Avoidance of Double Taxation and the 
Prevention of Fiscal Evasion with Respect to Taxes on Income 
and Capital Signed at Paris on August 31, 1994.''

               X. 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 French 
Republic for the Avoidance of Double Taxation and the 
Prevention of Fiscal Evasion with Respect to Taxes on Income 
and Capital, signed at Paris on August 31, 1994, together with 
two related exchanges of notes (Treaty Doc. 103-32). The 
Senate's advice and consent is subject to the following 
declaration, which shall not be included in the instrument of 
ratification to be signed by the President:
    That it is the Sense of the Senate that the tax relief 
available under paragraph 5(b) of Article 30 of the proposed 
Convention, which exempts certain interest payments to French 
subsidiaries from United States tax to the extent that United 
States tax is imposed on such payments under subpart F of Part 
III of subchapter N of chapter 1 of subtitle A of the Internal 
Revenue Code (``subpart F''), should be automatically available 
to any French subsidiary that is a controlled foreign 
corporation under Section 957 of the Internal Revenue Code to 
the extent that such payments are taxed under subpart F. The 
Treasury Department and the Internal Revenue Service shall 
negotiate with their Dutch counterparts an application of 
Paragraph 8 of Article 12 of the U.S.-Netherlands Tax Treaty 
consistent with the French Treaty as described above and grant 
a long-term exemption from United States tax for interest paid 
to Dutch subsidiaries to the extent such interest is taxed 
under subpart F.