[Senate Executive Report 105-11]
[From the U.S. Government Publishing Office]



105th Congress                                              Exec. Rept.
                                 SENATE

 1st Session                                                     105-11
_______________________________________________________________________


 
                    TAX CONVENTION WITH SOUTH AFRICA

                                _______
                                

                October 30, 1997.--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. 105-9]

    The Committee on Foreign Relations, to which was referred 
the Convention between the United States of America and the 
Republic of South Africa for the Avoidance of Double Taxation 
and the Prevention of Fiscal Evasion with Respect to Taxes on 
Income and Capital Gains, signed at Cape Town February 17, 
1997, having considered the same, reports favorably thereon, 
with one declaration and one proviso, and recommends that the 
Senate give its advice and consent to ratification thereof, as 
set forth in this report and the accompanying resolution of 
ratification.


                                CONTENTS
                                                                   Page
  I. Purpose..........................................................1
 II. Background.......................................................2
III. Summary..........................................................2
 IV. Entry Into Force and Termination.................................3
  V. Committee Action.................................................3
 VI. Committee Comments...............................................4
VII. Budget Impact...................................................11
VIII.Explanation of Proposed Treaty..................................11

 IX. Text of the Resolution of Ratification..........................55

                               I. Purpose

    The principal purposes of the proposed income tax treaty 
between the United States and South Africa are to reduce or 
eliminate double taxation of income earned by residents of 
either country from sources within the other country and to 
prevent avoidance or evasion of the income taxes of the two 
countries. The proposed treaty is intended to promote close 
economic cooperation and facilitate trade and investment 
between the two countries. It also is intended to enable the 
two countries to cooperate in preventing avoidance and evasion 
of taxes.

                             II. Background

    The proposed treaty was signed on February 17, 1997. No 
income tax treaty between the United States and South Africa is 
in force at present. The income tax treaty between the United 
States and South Africa that was signed in 1946 was terminated 
on July 1, 1987.
    The proposed treaty was transmitted to the Senate for 
advice and consent to its ratification on June 26, 1997 (see 
Treaty Doc. 105-9). The Committee on Foreign Relations held a 
public hearing on the proposed treaty on October 7, 1997.

                              III. Summary

    The proposed treaty is similar to other recent U.S. income 
tax treaties, the 1996 U.S. model income tax treaty (``U.S. 
model"), 1 and the model income tax treaty of the 
Organization for Economic Cooperation and Development (``OECD 
model''). However, the proposed treaty contains certain 
substantive deviations from those documents.
---------------------------------------------------------------------------
    \1\ The Treasury Department released the U.S. model on September 
20, 1996. A 1981 U.S. model treaty was withdrawn by the Treasury 
Department on July 17, 1992.
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    As in other U.S. tax treaties, the proposed treaty's 
objective of reducing or eliminating double taxation 
principally is 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 country. For 
example, the proposed treaty contains provisions under which 
neither country generally will tax business income derived from 
sources within that country by residents of the other country 
unless the business activities in the taxing country are 
substantial enough to constitute a permanent establishment or 
fixed base (Articles 7 and 14). Similarly, the proposed treaty 
contains ``commercial visitor'' exemptions under which 
residents of one country performing personal services in the 
other country will not be required to pay tax in the other 
country unless their contact with the other country exceeds 
specified minimums (Articles 14, 15, and 17). The proposed 
treaty provides that dividends and certain capital gains 
derived by a resident of either country from sources within the 
other country generally may be taxed by both countries 
(Articles 10 and 13); however, the rate of tax that the source-
country may impose on a resident of the other country on 
dividends generally will be limited by the proposed treaty 
(Article 10). The proposed treaty also provides that interest 
and royalties derived by a resident of either country generally 
will be exempt from tax in the other country (Articles 11 and 
12).
    In situations where the country of source retains the right 
under the proposed treaty to tax income derived by residents of 
the other country, the proposed treaty generally provides for 
relief from the potential double taxation through the allowance 
by the country of residence of a tax credit for certain foreign 
taxes paid to the other country (Article 23).
    The proposed treaty includes the ``saving clause'' 
contained in U.S. tax treaties that allows the United States to 
retain the right to tax its citizens and residents as if the 
treaty had not come into effect (Article 1). In addition, the 
proposed treaty contains the standard provision that it may not 
be applied to deny any taxpayer any benefits the taxpayer would 
be entitled to under the domestic law of a country or under any 
other agreement between the two countries (Article 1).
    The proposed treaty also contains a detailed limitation on 
benefits provision to prevent the inappropriate use of the 
treaty (Article 22).

                  IV. Entry Into Force and Termination

                          A. Entry into Force

    The proposed treaty provides that the countries must notify 
each other that the constitutional requirements for the entry 
into force of the proposed treaty have been complied with.
    The proposed treaty will enter into force thirty days after 
the date on which the second of the two notifications of the 
completion of the constitutional requirements has been 
received. With respect to taxes payable at source, the proposed 
treaty will be effective for amounts paid or credited on or 
after the first of January following entry into force. With 
respect to other taxes, the proposed treaty will be effective 
for taxable periods beginning on or after such first of 
January.

                             B. Termination

    The proposed treaty will continue in force until terminated 
by either country. Either country may terminate the proposed 
treaty by giving notice through diplomatic channels at least 
six months before the end of any calendar year starting five 
years after the year the treaty has entered into force. With 
respect to taxes payable at source, a termination will be 
effective for amounts paid or credited on or after the first of 
January following the year in which notice of termination is 
given. With respect to other taxes, a termination will be 
effective for taxable periods beginning on or after the first 
of January following the year in which such notice of 
termination is given.

                          V. Committee Action

    The Committee on Foreign Relations held a public hearing on 
the proposed treaty with South Africa (Treaty Doc. 105-9), as 
well as on other proposed tax treaties and protocols, on 
October 7, 1997. The hearing was chaired by Senator Hagel. The 
Committee considered these proposed treaties and protocols on 
October 8, 1997, and ordered the proposed treaty with South 
Africa favorably reported by a voice vote, with the 
recommendation that the Senate give its advice and consent to 
ratification of the proposed treaty, subject to a declaration 
and a proviso.

                         VI. Committee Comments

    On balance, the Committee on Foreign Relations believes 
that the proposed treaty with South Africa is in the interest 
of the United States and urges that the Senate act promptly to 
give advice and consent to ratification. The Committee has 
taken note of certain issues raised by the proposed treaty, and 
believes that the following comments may be useful to Treasury 
Department officials in providing guidance on these matters 
should they arise in the course of future treaty negotiations.

                     A. Treatment of REIT Dividends

REITs in general

    Real Estate Investment Trusts (``REITs'') essentially are 
treated as conduits for U.S. tax purposes. The income of a REIT 
generally is not taxed at the entity level but is distributed 
and taxed only at the investor level. This single level of tax 
on REIT income is in contrast to other corporations, the income 
of which is subject to tax at the corporate level and is taxed 
again at the shareholder level upon distribution as a dividend. 
Hence, a REIT is like a mutual fund that invests in qualified 
real estate assets.
    An entity that qualifies as a REIT is taxable as a 
corporation. However, unlike other corporations, a REIT is 
allowed a deduction for dividends paid to its shareholders. 
Accordingly, income that is distributed by a REIT to its 
shareholders is not subject to corporate tax at the REIT level. 
A REIT is subject to corporate tax only on any income that it 
does not distribute currently to its shareholders. As discussed 
below, a REIT is required to distribute on a current basis the 
bulk of its income each year.
    In order to qualify as a REIT, an entity must satisfy, on a 
year-by-year basis, specific requirements with respect to its 
organizational structure, the nature of its assets, the source 
of its income, and the distribution of its income. These 
requirements are intended to ensure that the benefits of REIT 
status are accorded only to pooling of investment arrangements, 
the income of which is derived from passive investments in real 
estate and is distributed to the investors on a current basis.
    In order to satisfy the organizational structure 
requirements for REIT status, a REIT must have at least 100 
shareholders and not more than 50 percent (by value) of its 
shares may be owned by five or fewer individuals. In addition, 
shares of a REIT must be transferrable.
    In order to satisfy the asset requirements for REIT status, 
a REIT must have at least 75 percent of the value of its assets 
invested in real estate, cash and cash items, and government 
securities. In addition, diversification rules apply to the 
REIT's investment in assets other than the foregoing qualifying 
assets. Under these rules, not more than 5 percent of the value 
of its assets may be invested in securities of a single issuer 
and any such securities held may not represent more than 10 
percent of the voting securities of the issuer.
    In order to satisfy the source of income requirements, at 
least 95 percent of the gross income of the REIT generally must 
be from certain passive sources (e.g., dividends, interest, and 
rents). In addition, at least 75 percent of its gross income 
generally must be from certain real estate sources (e.g., real 
property rents, mortgage interest, and real property gains).
    Finally, in order to satisfy the distribution of income 
requirement, the REIT generally is required to distribute to 
its shareholders each year at least 95 percent of its taxable 
income for the year (excluding net capital gains). A REIT may 
retain 5 percent or less of its taxable income and all or part 
of its net capital gain.
    A REIT is subject to corporate-level tax only on any 
taxable income and net capital gains that the REIT retains. 
Under an available election, shareholders may be taxed 
currently on the undistributed capital gains of a REIT, with 
the shareholder entitled to a credit for the tax paid by the 
REIT with respect to the undistributed capital gains such that 
the gains are subject only to a single level of tax. 
Distributions from a REIT of ordinary income are taxable to the 
shareholders as a dividend, in the same manner as dividends 
from an ordinary corporation. Accordingly, such dividends are 
subject to tax at a maximum rate of 39.6 percent in the case of 
individuals and 35 percent in the case of corporations. In 
addition, capital gains of a REIT distributed as a capital gain 
dividend are taxable to the shareholders as capital gain. 
Capital gain dividends received by an individual will be 
eligible for preferential capital gain tax rates if the 
relevant holding period requirements are satisfied.

Foreign investors in REITs

    Nonresident alien individuals and foreign corporations 
(collectively, foreign persons) are subject to U.S. tax on 
income that is effectively connected with the foreign person's 
conduct of a trade or business in the United States, in the 
same manner and at the same graduated tax rates as U.S. 
persons. In addition, foreign persons generally are subject to 
U.S. tax at a flat 30-percent rate on certain gross income that 
is derived from U.S. sources and that is not effectively 
connected with a U.S. trade or business. The 30-percent tax 
applies on a gross basis to U.S.-source interest, dividends, 
rents, royalties, and other similar types of income. This tax 
generally is collected by means of withholding by the person 
making the payment of such amounts to a foreign person.
    Capital gains of a nonresident alien individual that are 
not connected with a U.S. business generally are subject to the 
30-percent withholding tax only if the individual is present in 
the United States for 183 days or more during the year. The 
United States generally does not tax foreign corporations on 
capital gains that are not connected with a U.S. trade or 
business. However, foreign persons generally are subject to 
U.S. tax on any gain from a disposition of an interest in U.S. 
real property at the same rates that apply to similar income 
received by U.S. persons. Therefore, a foreign person that has 
capital gains with respect to U.S. real estate is subject to 
U.S. tax on such gains in the same manner as a U.S. person. For 
this purpose, a distribution by a REIT to a foreign shareholder 
that is attributable to gain from a disposition of U.S. real 
property by the REIT is treated as gain recognized by such 
shareholder from the disposition of U.S. real property.
    U.S. income tax treaties contain provisions limiting the 
amount of income tax that may be imposed by one country on 
residents of the other country. Many treaties, like the 
proposed treaty, generally allow the source country to impose 
not more than a 15-percent withholding tax on dividends paid to 
a resident of the other treaty country. In the case of real 
estate income, most treaties, like the proposed treaty, specify 
that income derived from, and gain from dispositions of, real 
property in one country may be taxed by the country in which 
the real property is situated without limitation. 2 
Accordingly, U.S. real property rental income derived by a 
resident of a treaty partner generally is subject to the U.S. 
withholding tax at the full 30-percent rate (unless the net-
basis taxation election is made), and U.S. real property gains 
of a treaty partner resident are subject to U.S. tax in the 
manner and at the rates applicable to U.S. persons.
---------------------------------------------------------------------------
    \2\ Many treaties allow the foreign person to elect to be taxed in 
the source country on income derived from real property on a net basis 
under the source country's domestic laws.
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    Although REITs are not subject to corporate-level taxation 
like other corporations, distributions of a REIT's income to 
its shareholders generally are treated as dividends in the same 
manner as distributions from other corporations. Accordingly, 
in cases where no treaty is applicable, a foreign shareholder 
of a REIT is subject to the U.S. 30-percent withholding tax on 
ordinary income distributions from the REIT. In addition, such 
shareholders are subject to U.S. tax on U.S. real estate 
capital gain distributions from a REIT in the same manner as a 
U.S. person.
    In cases where a treaty is applicable, this U.S. tax on 
capital gain distributions from a REIT still applies. However, 
absent special rules applicable to REIT dividends, treaty 
provisions specifying reduced rates of tax on dividends apply 
to ordinary income dividends from REITs as well as to dividends 
from taxable corporations. As discussed above, the proposed 
treaty, like many U.S. treaties, reduces the U.S. 30-percent 
withholding tax to 15 percent in the case of dividends 
generally. Prior to 1989, U.S. tax treaties contained no 
special rules excluding dividends from REITs from these reduced 
rates. Therefore, under pre-1989 treaties, REIT dividends are 
eligible for the same reductions in the U.S. withholding tax 
that apply to other corporate dividends.
    Beginning in 1989, U.S. treaty negotiators began including 
in treaties provisions excluding REIT dividends from the 
reduced rates of withholding tax generally applicable to 
dividends. Under treaties with these provisions such as the 
proposed treaty, REIT dividends generally are subject to the 
full U.S. 30-percent withholding tax. 3
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    \3\ Many treaties, like the proposed treaty, provide a maximum tax 
rate of 15 percent in the case of REIT dividends beneficially owned by 
an individual who holds a less than 10 percent interest in the REIT.
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Analysis of treaty treatment of REIT dividends

    The specific treaty provisions governing REIT dividends 
were introduced beginning in 1989 because of concerns that the 
reductions in withholding tax generally applicable to dividends 
were inappropriate in the case of dividends from REITs. The 
reductions in the rates of source-country tax on dividends 
reflect the view that the full 30-percent withholding tax rate 
may represent an excessive rate of source-country taxation 
where the source country already has imposed a corporate-level 
tax on the income prior to its distribution to the shareholders 
in the form of a dividend. In the case of dividends from a 
REIT, however, the income generally is not subject to 
corporate-level taxation.
    REITs are required to distribute their income to their 
shareholders on a current basis. The assets of a REIT consist 
primarily of passive real estate investments and the REIT's 
income may consist principally of rentals from such real estate 
holdings. U.S.-source rental income generally is subject to the 
U.S. 30-percent withholding tax. Moreover, the United States's 
treaty policy is to preserve its right to tax real property 
income derived from the United States. Accordingly, the U.S. 
30-percent tax on rental income from U.S. real property is not 
reduced in U.S. tax treaties.
    If a foreign investor in a REIT were instead to invest in 
U.S. real estate directly, the foreign investor would be 
subject to the full 30-percent withholding tax on rental income 
earned on such property (unless the net-basis taxation election 
is made). However, when the investor makes such investments 
through a REIT instead of directly, the income earned by the 
investor is treated as dividend income. If the reduced rates of 
withholding tax for dividends apply to REIT dividends, the 
foreign investor in the REIT is accorded a reduction in U.S. 
withholding tax that is not available for direct investments in 
real estate.
    On the other hand, some argue that it is important to 
encourage foreign investment in U.S. real estate through REITs. 
In this regard, a higher withholding tax on REIT dividends 
(i.e., 30 percent instead of 15 percent) may not be fully 
creditable in the foreign investor's home country and the cost 
of the higher withholding tax therefore may discourage foreign 
investment in REITs. For this reason, some oppose the inclusion 
in U.S. treaties of the special provisions governing REIT 
dividends, arguing that dividends from REITs should be given 
the same treatment as dividends from other corporate entities. 
Accordingly, under this view, the 15-percent withholding tax 
rate generally applicable under treaties to dividends should 
apply to REIT dividends as well.
    This argument is premised on the view that investment in a 
REIT is not equivalent to direct investment in real property. 
From this perspective, an investment in a REIT should be viewed 
as comparable to other investments in corporate stock. In this 
regard, like other corporate shareholders, REIT investors are 
investing in the management of the REIT and not just its 
underlying assets. Moreover, because the interests in a REIT 
are widely held and the REIT itself typically holds a large and 
diversified asset portfolio, an investment in a REIT represents 
a very small investment in each of a large number of 
properties. Thus, the REIT investment provides diversification 
and risk reduction that are not easily replicated through 
direct investment in real estate.
    At the October 7, 1997 hearing on the proposed treaty (as 
well as other proposed treaties and protocols), the Treasury 
Department announced that it has modified its policy with 
respect to the exclusion of REIT dividends from the reduced 
withholding tax rates applicable to other dividends under 
treaties. The Treasury Department worked extensively with the 
staff of the Committee on Foreign Relations, the staff of the 
Joint Committee on Taxation, and representatives of the REIT 
industry in order to address the concern that the current 
treaty policy with respect to REIT dividends may discourage 
some foreign investment in REITs while maintaining a treaty 
policy that properly preserves the U.S. taxing jurisdiction 
over foreign direct investment in U.S. real property. The new 
policy is a result of significant cooperation among all parties 
to balance these competing considerations.
    Under this policy, REIT dividends paid to a resident of a 
treaty country will be eligible for the reduced rate of 
withholding tax applicable to portfolio dividends (typically, 
15 percent) in two cases. First, the reduced withholding tax 
rate will apply to REIT dividends if the treaty country 
resident beneficially holds an interest of 5 percent or less in 
each class of the REIT's stock and such dividends are paid with 
respect to a class of the REIT's stock that is publicly traded. 
Second, the reduced withholding tax rate will apply to REIT 
dividends if the treaty country resident beneficially holds an 
interest of 10 percent or less in the REIT and the REIT is 
diversified, regardless of whether the REIT's stock is publicly 
traded. In addition, the current treaty policy with respect to 
the application of the reduced withholding tax rate to REIT 
dividends paid to individuals holding less than a specified 
interest in the REIT will remain unchanged.
    For purposes of these rules, a REIT will be considered 
diversified if the value of no single interest in real property 
held by the REIT exceeds 10 percent of the value of the REIT's 
total interests in real property. An interest in real property 
will not include a mortgage, unless the mortgage has 
substantial equity components. An interest in real property 
also will not include foreclosure property. Accordingly, a REIT 
that holds exclusively mortgages will be considered to be 
diversified. The diversification rule will be applied by 
looking through a partnership interest held by a REIT to the 
underlying interests in real property held by the partnership. 
Finally, the reduced withholding tax rate will apply to a REIT 
dividend if the REIT's trustees or directors make a good faith 
determination that the diversification requirement is satisfied 
as of the date the dividend is declared.
    The Treasury Department will incorporate this new policy 
with respect to the treatment of REIT dividends in the U.S. 
model treaty and in future treaty negotiations.
    The Committee believes that the new policy with respect to 
the applicability of reduced withholding tax rates to REIT 
dividends appropriately reflects economic changes since the 
establishment of the current policy. The Committee further 
believes that the new policy fairly balances competing 
considerations by extending the reduced rate of withholding tax 
on dividends generally to dividends paid by REITs that are 
relatively widely-held and diversified. The Committee 
anticipates that incorporation of this new policy will be 
considered in connection with any future modification to the 
proposed treaty.

                           B. Treaty Shopping

    The proposed treaty, like a number of U.S. income tax 
treaties, generally limits treaty benefits for treaty country 
residents so that only those residents with a sufficient nexus 
to a treaty country will receive treaty benefits. Although the 
proposed treaty is intended to benefit residents of South 
Africa and the United States only, residents of third countries 
sometimes attempt to use a treaty to obtain treaty benefits. 
This is known as ``treaty shopping.'' Investors from countries 
that do not have tax treaties with the United States, or from 
countries that have not agreed in their tax treaties with the 
United States to limit source-country taxation to the same 
extent that it is limited in another treaty may, for example, 
attempt to secure a lower rate of tax by lending money to a 
U.S. person indirectly through a country whose treaty with the 
United States provides for a lower rate. The third-country 
investor may do this by establishing in that treaty country a 
subsidiary, trust, or other investing entity which then makes 
the loan to the U.S. person and claims the treaty reduction for 
the interest it receives.
    The anti-treaty-shopping provision of the proposed treaty 
is similar to an anti-treaty-shopping provision in the Internal 
Revenue Code (the ``Code''), as interpreted by Treasury 
regulations, and in several newer treaties. Some aspects of the 
provision, however, differ from an anti-treaty-shopping 
provision in the U.S. model treaty.
    One provision of the anti-treaty-shopping article differs 
from the comparable rule in some earlier U.S. treaties, but the 
effect of the change is not completely clear. The general test 
applied by those earlier treaties for the allowance of 
benefits, short of satisfaction of a bright-line ownership and 
base erosion test, is a broadly subjective one, looking to 
whether the acquisition, maintenance, or operation of an entity 
did not have ``as a principal purpose obtaining benefits'' 
under the treaty. By contrast, the proposed treaty contains a 
more precise test that allows denial of benefits only with 
respect to income not derived in connection with the active 
conduct of a trade or business. (However, this active trade or 
business test generally does not apply with respect to a 
business of making or managing investments, so benefits can be 
denied with respect to such a business regardless of how 
actively it is conducted.) In addition, the proposed treaty 
gives the competent authority of the source country the ability 
to override this standard and to allow benefits if it so 
determines in its discretion.
    The practical difference between the proposed treaty tests 
and the earlier tests will depend upon how they are interpreted 
and applied. The principal purpose test may be applied 
leniently (so that any colorable business purpose suffices to 
preserve treaty benefits), or it may be applied strictly (so 
that any significant intent to obtain treaty benefits suffices 
to deny them). Similarly, the standards in the proposed treaty 
could be interpreted to require, for example, a more active or 
a less active trade or business (though the range of 
interpretation is far narrower). Thus, a narrow reading of the 
principal purpose test could theoretically be stricter than a 
broad reading of the proposed treaty test (i.e., would operate 
to deny benefits in potentially abusive situations more often).
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department about the adequacy of 
the anti-treaty-shopping provision in the proposed treaty. The 
relevant portion of the Treasury Department's October 8, 1997 
letter 4 responding to this inquiry is reproduced 
below:
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    \4\ Letter from Joseph H. Guttentag, International Tax Counsel, 
Treasury Department, to Senator Paul Sarbanes, Committee on Foreign 
Relations, October 8, 1997.

    The limitation on benefits article in the South African 
treaty is very close to that in the U.S. model. It differs in 
two principal respects related to the tax laws and policies of 
each country, both of which tighten the provision. Accordingly, 
we believe that it deals more than adequately with possible 
treaty-shopping abuses.
    The first difference is that it contains a provision, 
included at South Africa's request, under which trusts will be 
granted benefits under the ownership/base erosion tests only if 
they meet stricter standards than those applicable to entities 
other than trusts. The other principal difference from the 
Model provision is the inclusion of a so-called triangular case 
provision, which is included in all cases in which the treaty 
partner does not tax the earnings of a resident that are earned 
through a branch in a third country. The triangular case 
provision in the South African treaty is nearly identical to 
the provision in all of our other treaties with exemption 
countries. It provides that a South African entity that 
establishes a branch in a third country generally will not be 
entitled to benefits under the convention with respect to any 
item of income unless the combined tax imposed by both South 
Africa and the third country on that income totals at least 50% 
of the tax that would be imposed by South Africa if the income 
were not earned through the third country branch. This is a 
significant limitation on benefits, included in new treaties 
with countries that have an exemption system, under which the 
income of a resident earned through a third country branch 
generally is not taxed. The provision embodies the view that if 
the third country imposes low or no taxes, treaty benefits 
generally are inappropriate.

    The Committee believes that limitation on benefits 
provisions are important to protect against ``treaty shopping'' 
by limiting benefits of a treaty to bona fide residents of the 
treaty partner. The Committee continues to believe that the 
United States should maintain its policy of limiting treaty 
shopping opportunities whenever possible. The Committee 
continues to believe further that, in exercising any latitude 
Treasury has to adjust the operation of the proposed treaty, 
the rules as applied should adequately deter treaty shopping 
abuses. The anti-treaty-shopping provision in the proposed 
treaty may be effective in preventing third-country investors 
from obtaining treaty benefits by establishing investing 
entities in South Africa since third-country investors may be 
unwilling to share ownership of such investing entities on a 
50-50 basis with U.S. or South African residents or other 
qualified owners to meet the ownership test of the anti-treaty-
shopping provision. In addition, the base erosion test provides 
protection from certain potential abuses of a South African 
conduit. Moreover, the proposed treaty includes an anti-abuse 
rule covering the so-called ``triangular case.'' This rule 
generally permits the United States to impose a 15 percent tax 
on interest and royalties paid to a low-taxed third-country 
branch of a South African company and to tax other payments to 
such branch in accordance with U.S. internal law. An exception 
from this rule is provided if the third-country income is 
subject to taxation by the United States under the subpart F 
controlled foreign corporation provisions of the Code. Finally, 
South Africa imposes significant taxes of its own; these taxes 
may deter third-country investors from seeking to use South 
African entities to make U.S. investments. On the other hand, 
implementation of the detailed tests for treaty shopping set 
forth in the proposed treaty may raise factual, administrative, 
or other issues that cannot currently be foreseen. The 
Committee emphasizes that the proposed anti-treaty-shopping 
provision must be implemented so as to serve as an adequate 
tool for preventing possible treaty-shopping abuses in the 
future.

                           VII. Budget Impact

    The Committee has been informed by the staff of the Joint 
Committee on Taxation that the proposed treaty is estimated to 
cause a negligible change in fiscal year Federal budget 
receipts during the 1998-2007 period.

                  VIII. Explanation of Proposed Treaty

    A detailed, article-by-article explanation of the proposed 
income tax treaty between the United States and South Africa is 
presented below.

Article 1. General Scope

    The proposed treaty generally applies to residents of the 
United States and to residents of South Africa, with 
modifications to such scope provided in other articles (e.g., 
Article 19 (Government Service), Article 24 (Non-
discrimination) and Article 26 (Exchange of Information and 
Administrative Assistance)).
    The proposed treaty provides that it generally does not 
restrict any benefits accorded by internal law or by any other 
agreement between the United States and South Africa. Thus, the 
proposed treaty applies only where it benefits taxpayers. As 
discussed in the Treasury Department's Technical Explanation of 
the proposed treaty (hereinafter referred to as the ``Technical 
Explanation''), the fact that the proposed treaty only applies 
to a taxpayer's benefit does not mean that a taxpayer could 
inconsistently select among treaty and internal law provisions 
in order to minimize its overall tax burden. The Technical 
Explanation sets forth the following example. Assume a resident 
of South Africa has three separate businesses in the United 
States. One business is profitable, and constitutes a U.S. 
permanent establishment. The other two are trades or businesses 
that would generate effectively connected income as determined 
under the Code, but that do not constitute permanent 
establishments as determined under the proposed treaty; one 
trade or business is profitable and the other generates a net 
loss. Under the Code, all three operations would be subject to 
U.S. income tax, in which case the losses from the unprofitable 
line of business could offset the taxable income from the other 
lines of business. On the other hand, only the income of the 
operation which gives rise to a permanent establishment would 
be taxable by the United States under the proposed treaty. The 
Technical Explanation makes clear that the taxpayer could not 
invoke the proposed treaty to exclude the profits of the 
profitable trade or business that does not constitute a 
permanent establishment and invoke U.S. internal law to claim 
the loss of the unprofitable trade or business that does not 
constitute a permanent establishment against the taxable income 
of the permanent establishment. 5
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    \5\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
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    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 South Africa in determining 
whether a law or other measure is within the scope of the 
proposed treaty. 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 South Africa, generally 
apply to that law or other measure. For these purposes, a 
``measure'' is a law, regulation, rule, procedure, decision, 
administrative action, or any other form of measure. The only 
exception to this general rule is that the national treatment 
or most-favored nation treatment of the General Agreement on 
Tariffs and Trade will continue to apply with respect to trade 
in goods.
    Like all U.S. income tax treaties, the proposed treaty is 
subject to a ``saving clause.'' The saving clause in the 
proposed treaty is drafted unilaterally to apply only to the 
United States. The Technical Explanation states that South 
Africa elected not to have the saving clause apply for purposes 
of its tax. Under this clause, with specific exceptions 
described below, the proposed treaty is not to affect the U.S. 
taxation of its residents or its citizens. By reason of this 
saving clause, unless otherwise specifically provided in the 
proposed treaty, the United States will continue to tax its 
citizens who are residents of South Africa as if the treaty 
were not in force. ``Residents'' for purposes of the proposed 
treaty (and, thus, for purposes of the saving clause) include 
corporations and other entities as well as individuals who are 
not treated as residents of the other country under the 
proposed treaty's tie-breaker provisions governing dual 
residents (as defined in Article 4 (Residence)).
    The proposed treaty contains a provision under which the 
saving clause (and therefore the U.S. jurisdiction to tax) 
applies to a former U.S. citizen or long-term resident whose 
loss of citizenship or resident status, respectively, had as 
one of its principal purposes the avoidance of tax; such 
application is limited to the ten-year period following the 
loss of citizenship or resident status. Section 877 of the Code 
provides special rules for the imposition of U.S. income tax on 
former U.S. citizens and long-term residents for a period of 
ten years following the loss of such citizenship or resident 
status; these special rules apply to a former citizen or long-
term resident only if his or her loss of citizenship or 
resident status had as one of its principal purposes the 
avoidance of U.S. income, estate, or gift taxes. For purposes 
of applying the special tax rules to former citizens and long-
term residents, individuals who meet a specified income tax 
liability threshold or a specified net worth threshold 
generally are considered to have lost citizenship or resident 
status for a principal purpose of U.S. tax avoidance.
    Exceptions to the saving clause are provided for the 
following benefits conferred by the proposed treaty: 
correlative adjustments to the income of enterprises associated 
with other enterprises the profits of which were adjusted by 
South Africa (Article 9, paragraph 2); exemption from U.S. tax 
on social security benefits paid by South Africa, alimony and 
child support payments made by a resident of South Africa, and 
cross-border contributions to a South African pension fund 
(Article 18, paragraphs 2, 4, 5, 6 and 7); relief from double 
taxation (Article 23); nondiscrimination (Article 24); and 
mutual agreement procedures (Article 25).
    In addition, the saving clause does not apply to certain 
benefits conferred by the United States with respect to an 
individual who neither is a U.S. citizen nor has been admitted 
as a U.S. permanent resident. Under this rule, the specified 
treaty benefits are available to a South African citizen who 
spends enough time in the United States to be taxed as a U.S. 
resident under Code section 7701(b) (see discussion below in 
connection with Article 4 (Residence)), provided that the 
individual has not acquired U.S. immigrant status (i.e., is not 
a green-card holder). The benefits that are subject to this 
rule are exemptions from U.S. tax for the following items of 
income: compensation and pensions for government service 
(Article 19); certain income received by temporary visitors who 
are students, apprentices or business trainees (Article 20); 
and certain fiscal privileges of diplomatic agents and consular 
officers referred to in the proposed treaty (Article 27).
    The exceptions to the saving clause in the proposed treaty 
generally are consistent with the U.S. model and recent U.S. 
treaties.

Article 2. Taxes Covered

    The proposed treaty generally applies to the income taxes 
of the United States and similar taxes of South Africa. 
However, for purposes of the non-discrimination article 
(Article 24), the proposed treaty applies to taxes of all kinds 
imposed by the countries, including any taxes imposed by their 
political subdivisions or local authorities. Moreover, Article 
26 (Exchange of Information and Administrative Assistance) 
generally is applicable to all national-level taxes, including, 
for example, estate and gift taxes.
    In the case of the United States, the proposed treaty 
applies to the Federal income taxes imposed by the Code, but 
excludes social security taxes. Unlike many U.S. income tax 
treaties in force, but like the U.S. model, the proposed treaty 
applies to the accumulated earnings tax and the personal 
holding company tax. In addition, the proposed treaty applies 
to the U.S. excise tax imposed with respect to private 
foundations.
    In the case of South Africa, the proposed treaty applies to 
the normal tax and the secondary tax on companies.
    The proposed treaty also contains a provision generally 
found in U.S. income tax treaties to the effect that it applies 
to any identical or substantially similar taxes that either 
country may subsequently impose. The proposed treaty obligates 
the competent authority of each country to notify the competent 
authority of the other country of any significant changes in 
its internal tax laws and of any official published material 
concerning the application of the proposed treaty, including 
explanations, regulations, rulings or judicial decisions. This 
provision is similar to the U.S. model.

Article 3. General Definitions

    Certain of the standard definitions found in most U.S. 
income tax treaties are contained in the proposed treaty.
    The term ``South Africa'' means the Republic of South 
Africa. When used in a geographical sense, the term ``South 
Africa'' includes the territorial sea of South Africa as well 
as any area outside the territorial sea over which South Africa 
exercises sovereign rights or jurisdiction, in accordance with 
international and South African laws, with regard to the 
exploration or exploitation of natural resources.
    The term ``United States'' means the United States of 
America. The Technical Explanation states that it is understood 
that the term does not include Puerto Rico, the Virgin Islands, 
Guam, or any other U.S. possession or territory. When used in 
the geographic sense, the term ``United States'' means the 
States, the District of Columbia, and the territorial sea of 
the United States; it also includes the seabed and subsoil of 
underseas areas adjacent to the territorial sea over which the 
United States has sovereign rights in accordance with 
international law, for the purpose of exploration and 
exploitation of natural resources, but only to the extent that 
the person, property or activity to which the proposed treaty 
is being applied is connected with such exploration or 
exploitation.
    The term ``person'' includes an individual, an estate, a 
trust, a partnership, a company, and any other body of persons. 
A ``company'' is any body corporate or any entity which is 
treated as a body corporate for tax purposes according to the 
laws of the country in which the entity is organized.
    The terms ``enterprise of a Contracting State'' and 
``enterprise of the other Contracting State'' are defined, 
respectively, as an enterprise carried on by a resident of a 
country, and an enterprise carried on by a resident of the 
other country. The proposed treaty does not define the term 
``enterprise.'' The Technical Explanation states that the term 
``enterprise'' generally is understood to refer to any activity 
or set of activities that constitute a trade or business.
    Under the proposed treaty, a person is considered a 
``national'' of one of the treaty countries if the person is an 
individual who is a citizen of that country or a legal person, 
partnership, association or other entity deriving its status as 
such from the laws in force in that country.
    The South African competent authority is the Commissioner 
for Inland Revenue or his authorized representative. The U.S. 
competent authority is the Secretary of the Treasury or his 
delegate. The U.S. competent authority function has been 
delegated to the Commissioner of Internal Revenue, who has 
redelegated the authority to the Assistant Commissioner 
(International) of the IRS. On interpretative issues, the 
latter acts with the concurrence of the Associate Chief Counsel 
(International) of the IRS.
    The proposed treaty also contains the standard provision 
that, unless the context otherwise requires or the competent 
authorities of the two countries agree to a common meaning, all 
terms not defined in the proposed treaty are to have the 
meanings which they have under the laws of the country 
concerning the taxes to which the proposed treaty applies. For 
these purposes, the proposed treaty provides that the meaning 
of a term under the applicable tax laws of that country will 
prevail over any meaning given to the term under non-tax laws 
of that country.

Article 4. Residence

    The assignment of a country of residence is important 
because the benefits of the proposed treaty generally are 
available only to a resident of one of the treaty countries as 
that term is defined in the proposed treaty. Furthermore, 
double taxation often is avoided by the assignment of a single 
treaty country as the country of residence when, under the 
internal laws of the treaty countries, a person is a resident 
of both.
    Under U.S. law, residence of an individual is important 
because a resident alien is taxed on worldwide income, while a 
nonresident alien is taxed only on certain U.S.-source income 
and on income that is effectively connected with a U.S. trade 
or business. An individual who spends substantial time in the 
United States in any year or over a three-year period generally 
is treated as a U.S. resident (Code sec. 7701(b)). A permanent 
resident for immigration purposes (i.e., a green-card holder) 
also is treated as a U.S. resident. The standards for 
determining residence provided in the Code do not alone 
determine the residence of a U.S. citizen for the purpose of 
any U.S. tax treaty (such as a treaty that benefits residents, 
rather than citizens, of the United States). Under the Code, a 
company is domestic, and therefore taxable on its worldwide 
income, if it is organized in the United States or under the 
laws of the United States, a State, or the District of 
Columbia.
    Under the proposed treaty, the term ``resident of a 
Contracting State'' is defined separately for U.S. residents 
and South African residents. The definition of a U.S. resident 
is consistent with that contained in the U.S. model. The 
Technical Explanation states that the definition of a South 
African resident is intended to include only those persons over 
which South Africa exerts its broadest taxing jurisdiction.
    In the case of the United States, the proposed treaty 
defines the term ``resident of a Contracting State'' to mean 
any person who, under U.S. law, is liable to tax therein by 
reason of his or her domicile, residence, citizenship, place of 
incorporation, or any other criterion of a similar nature. The 
Technical Explanation states that the term also includes aliens 
who are considered U.S. residents under Code section 7701(b). 
The term does not include any person who is liable to tax in 
the U.S. in respect only of income from U.S. sources or of 
profits attributable to a permanent establishment in the United 
States. The term also includes a legal person organized under 
the laws of the United States that is generally exempt from 
U.S. tax and is established and maintained in the United States 
either (1) exclusively for a religious, charitable, 
educational, scientific, or other similar purpose, or (2) to 
provide pensions or other similar benefits to employees 
pursuant to a plan. The Technical Explanation states that the 
reference to an entity that is ``generally'' exempt from U.S. 
tax is intended to reflect the fact that under U.S. law, 
certain entities that generally are considered to be exempt 
from U.S. tax may be subject to certain excise taxes or to the 
income tax on unrelated business profits. The Technical 
Explanation also states that the term ``other similar 
benefits'' is intended to include employee benefits such as 
health and disability benefits.
    In the case of South Africa, the proposed treaty defines 
the term ``resident of a Contracting State'' to mean any 
individual who is ordinarily resident in South Africa, and any 
legal person which is incorporated or has its place of 
effective management in South Africa.
    The proposed treaty also defines ``resident of a 
Contracting State'' to include the United States or South 
Africa, or any of its political subdivisions or local 
authorities.
    In the case of income, profit or gain derived through an 
entity that is fiscally transparent under the laws of either 
country, the proposed treaty provides that the income is 
considered to be derived by a resident of a country to the 
extent that the income is treated for purposes of the tax laws 
of such country as the income, profit or gain of a resident. 
The Technical Explanation states that fiscally transparent 
entities include entities such as partnerships and certain 
estates and trusts. In the case of the United States, such 
entities include partnerships, common investment trusts under 
section 584 of the Code, grantor trusts, and U.S. limited 
liability companies treated as partnerships for U.S. tax 
purposes. Thus, for example, if the U.S. partners' share in the 
income of a U.S. limited liability company (treated as a 
partnership for U.S. tax purposes) is only one-half, South 
Africa would be required to reduce its withholding tax pursuant 
to the proposed treaty on only one-half of the South African-
source income paid to the partnership.
    The Technical Explanation states that the rules in the 
proposed treaty for income derived through fiscally transparent 
entities apply regardless of where the entity is organized 
(i.e., in the United States, South Africa or a third country). 
The Technical Explanation also states that these rules apply 
even if the entity is viewed differently under the tax laws of 
the other country. As an example, the Technical Explanation 
states that income from South African sources received by an 
entity organized under the laws of South Africa, which is 
treated for U.S. tax purposes as a corporation and is owned by 
a U.S. shareholder who is a U.S. resident for U.S. tax 
purposes, is not considered derived by the shareholder of that 
corporation, even if under the tax laws of South Africa, the 
entity is treated as fiscally transparent. Rather, for purposes 
of the proposed treaty, the income is treated as derived by the 
South African entity.
    A set of ``tie-breaker'' rules is provided to determine 
residence in the case of an individual who, under the basic 
residence rules, would be considered to be a resident of both 
countries. Such a dual resident individual is deemed to be a 
resident of the country in which he or she has a permanent home 
available. If this permanent home test is inconclusive because 
the individual has a permanent home in both countries, the 
individual's residence is deemed to be the country with which 
his or her personal and economic relations are closer (i.e., 
the ``centre of vital interests''). If the country in which the 
individual has his or her centre of vital interests cannot be 
determined, or if the individual does not have a permanent home 
available in either country, such individual is deemed to be a 
resident of the country in which he or she has an habitual 
abode. If the individual has an habitual abode in both 
countries or in neither country, the individual is deemed to be 
a resident of the country of which he or she is a national. If 
the individual is a national of both countries or neither 
country, the competent authorities of the countries are to 
settle the question of residence by mutual agreement.
    In the case of a company that is resident in both countries 
under the basic residence rules, the proposed treaty provides 
that the company is treated as a resident of the country in 
which it is incorporated.
    In the case of a person other than an individual or a 
company that is resident in both countries under the basic 
residence rules, the proposed treaty requires the competent 
authorities by mutual agreement to determine the residence of 
such person and the mode of application of the proposed treaty 
to such person.

Article 5. Permanent Establishment

    The proposed treaty contains a definition of the term 
``permanent establishment'' that generally follows the pattern 
of other recent U.S. income tax treaties, the U.S. model, and 
the OECD model.
    The permanent establishment concept is one of the basic 
devices used in income tax treaties to limit the taxing 
jurisdiction of the host country and thus to mitigate double 
taxation. Generally, an enterprise that is a resident of one 
country is not taxable by the other country on its business 
profits unless those profits are attributable to a permanent 
establishment of the resident in the other country. In 
addition, the permanent establishment concept is used to 
determine whether the reduced rates of, or exemptions from, tax 
provided for dividends, interest, and royalties apply or 
whether those amounts are taxed as business profits.
    In general, under the proposed treaty, a permanent 
establishment is a fixed place of business through which the 
business of an enterprise is carried on in whole or in part. A 
permanent establishment includes a place of management, a 
branch, an office, a factory, a workshop, a mine, an oil or gas 
well, a quarry, or other place of extraction of natural 
resources. It also includes a warehouse, in relation to a 
person providing storage facilities for others, and a store or 
premises used as a sales outlet. The term also includes a ship, 
drilling rig, installation or other structure used for the 
exploration or exploitation of natural resources, but only if 
it lasts for more than 12 months. The term also includes a 
building site or construction, installation or assembly 
project, or supervisory activities in connection with such site 
or project, where such site, project or activities last for 
more than 12 months. Unlike the U.S. and OECD models, the term 
also includes the furnishing of services, including consultancy 
services, within a country by an enterprise through employees 
or other personnel engaged by the enterprise for such purposes, 
but only if such activities continue (for the same or a 
connected project) in that country for a period or periods 
aggregating more than 183 days in any 12-month period 
commencing or ending in the taxable year concerned. The 
Technical Explanation states that projects that are 
commercially and geographically interdependent are to be 
treated as a single project for purposes of the 12-month test. 
This rule providing the 12-month period for establishing a 
permanent establishment in connection with a site or project is 
similar to the rules of the U.S. and OECD models.
    The general definition of a permanent establishment is 
modified to provide that a fixed place of business that is used 
for any of a number of specified activities does not constitute 
a permanent establishment. These activities include the use of 
facilities solely for storing, displaying, or delivering goods 
or merchandise belonging to the enterprise and the maintenance 
of a stock of goods or merchandise belonging to the enterprise 
solely for storage, display, or delivery or solely for 
processing by another enterprise. These activities also include 
the maintenance of a fixed place of business solely for the 
purchase of goods or merchandise or the collection of 
information for the enterprise. These activities include as 
well the maintenance of a fixed place of business solely for 
the purpose of carrying on, for the enterprise, any other 
activity of a preparatory or auxiliary character. The Technical 
Explanation states that advertising and the supply of 
information qualify as activities that are preparatory or 
auxiliary. The proposed treaty, like the U.S. model, provides 
that the maintenance of a fixed place of business solely for 
any combination of these activities does not constitute a 
permanent establishment.
    If a person, other than an independent agent, is acting on 
behalf of an enterprise and has and habitually exercises the 
authority in a country to conclude contracts in the name of an 
enterprise of the other country, the enterprise generally will 
be deemed to have a permanent establishment in the first 
country in respect of any activities that person undertakes for 
the enterprise. Consistent with the U.S. model and the OECD 
model, this rule does not apply where the contracting authority 
is limited to those activities described above, such as 
storage, display, or delivery of merchandise, which are 
excluded from the definition of a permanent establishment.
    The proposed treaty contains the usual provision that no 
permanent establishment is deemed to arise based on an agent's 
activities if the agent is a broker, general commission agent, 
or any other agent of independent status acting in the ordinary 
course of its business. The Technical Explanation provides that 
an independent agent is one that is legally and economically 
independent of the enterprise, and that is acting in the 
ordinary course of business in carrying out activities on 
behalf of the enterprise. Whether an agent and an enterprise 
are independent depends on the facts and circumstances of the 
particular case.
    The fact that a company that is resident in one country is 
related to a company that is a resident of the other country or 
to a company that engages in business in that other country 
does not of itself cause either company to be a permanent 
establishment of the other.

Article 6. Income from Immovable Property (Real Property)

    This article covers income, but not gains, from real 
property. The rules covering gains from the sale of real 
property are contained in Article 13 (Capital Gains).
    Under the proposed treaty, income derived by a resident of 
one country from immovable property (real property) situated in 
the other country may be taxed in the country where the real 
property is located. This rule is consistent with the rules in 
the U.S. and OECD models. For this purpose, income from 
immovable property includes income from agriculture or 
forestry.
    The term ``immovable property (real property)'' has the 
meaning which it has under the law of the country in which the 
property in question is situated. 6 The proposed 
treaty specifies that the term in any case includes property 
accessory to immovable property; livestock and equipment used 
in agriculture or forestry; rights to which the provisions of 
general law respecting landed property apply; usufruct of 
immovable property; and rights to variable or fixed payments as 
consideration for the working of, or the right to work, mineral 
deposits, sources and other natural resources. Ships, boats and 
aircraft are not considered to be real property.
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    \6\ In the case of the United States, the term ``real property'' is 
defined in Treas. Reg. sec. 1.897-1(b).
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    The proposed treaty provides that the country in which real 
property is situated may tax income derived from the direct 
use, letting, or use in any other form of such real property. 
The rules of this article allowing source-country taxation also 
apply to income from real property of an enterprise and to 
income from real property used for the performance of 
independent personal services.

Article 7. Business Profits

            Internal taxation rules

United States

    U.S. law distinguishes between the U.S. business income and 
other U.S. income of a nonresident alien or foreign 
corporation. A nonresident alien or foreign corporation is 
subject to a flat 30-percent rate (or lower treaty rate) of tax 
on certain U.S.-source income if that income is not effectively 
connected with the conduct of a trade or business within the 
United States. The regular individual or corporate rates apply 
to income (from any source) which is effectively connected with 
the conduct of a trade or business within the United States.
    The treatment of income as effectively connected with a 
U.S. trade or business depends upon whether the source of the 
income is U.S. or foreign. In general, U.S.-source periodic 
income (such as interest, dividends, and rents), and U.S.-
source capital gains are effectively connected with the conduct 
of a trade or business within the United States if the asset 
generating the income is used in, or held for use in, the 
conduct of the trade or business or if the activities of the 
trade or business were a material factor in the realization of 
the income. All other U.S.-source income of a person engaged in 
a trade or business in the United States is treated as 
effectively connected with the conduct of a trade or business 
in the United States (referred to as a ``force of attraction'' 
rule).
    Foreign-source income generally is treated as effectively 
connected income only if the foreign person has an office or 
other fixed place of business in the United States and the 
income is attributable to that place of business. Only three 
types of foreign-source income are considered to be effectively 
connected income: rents and royalties for the use of certain 
intangible property derived from the active conduct of a U.S. 
business; certain dividends and interest either derived in the 
active conduct of a banking, financing or similar business in 
the United States or received by a corporation the principal 
business of which is trading in stocks or securities for its 
own account; and certain sales income attributable to a U.S. 
sales office. Special rules apply in the case of insurance 
companies.
    Any income or gain of a foreign person for any taxable year 
that is attributable to a transaction in another taxable year 
is treated as effectively connected with the conduct of a U.S. 
trade or business if it would have been so treated had it been 
taken into account in that other taxable year (Code sec. 
864(c)(6)). In addition, if any property ceases to be used or 
held for use in connection with the conduct of a trade or 
business within the United States, the determination of whether 
any income or gain attributable to a sale or exchange of that 
property occurring within ten years after the cessation of the 
business is effectively connected with the conduct of a trade 
or business within the United States is made as if the sale or 
exchange occurred immediately before the cessation of the 
business. (Code sec. 864(c)(7)).

South Africa

    Foreign corporations and nonresident individuals generally 
are subject to the South African normal tax only on income 
derived from sources within, or deemed to be within, South 
Africa. Business income derived in South Africa by a foreign 
corporation or nonresident individual generally is taxed in the 
same manner as the income of a domestic company or resident 
individual.
            Proposed treaty limitations on internal law
    Under the proposed treaty, profits of an enterprise of one 
country are taxable in the other country only to the extent 
that they are attributable to a permanent establishment in the 
other country through which the enterprise carries on business. 
This is one of the basic limitations on a country's right to 
tax income of a resident of the other country. As described 
above, unlike the U.S. and OECD models, the proposed treaty 
defines a permanent establishment of a country to include cases 
in which employees or other personnel of an enterprise provide 
services in that country for more than 183 days within a 12-
month period in connection with the same or connected project. 
Thus, the rules of the proposed treaty granting the source 
country the right to tax business profits are somewhat broader 
than the corresponding rules in the U.S. and OECD models.
    The taxation of business profits under the proposed treaty 
differs from U.S. rules for taxing business profits primarily 
by requiring more than merely being engaged in a trade or 
business before a country can tax business profits and by 
substituting an ``attributable to'' standard for the Code's 
``effectively connected'' standard. Under the Code, all that is 
necessary for effectively connected business profits to be 
taxed is that a trade or business be carried on in the United 
States. Under the proposed treaty, a permanent establishment 
would have to be present and the business profits generally 
would have to be attributable to that permanent establishment.
    The Technical Explanation states that it is understood that 
the business profits attributed to a permanent establishment 
include only those profits derived from that permanent 
establishment's assets or activities. This is consistent with 
the U.S. and OECD models and other existing U.S. treaties.
    The business profits of a permanent establishment are 
determined on an arm's-length basis. Thus, there are to be 
attributed to a permanent establishment the business profits 
which would be expected to have been derived by it if it were a 
distinct and independent entity engaged in the same or similar 
activities under the same or similar conditions. For example, 
this arm's-length rule applies to transactions between the 
permanent establishment and a branch of the resident enterprise 
located in a third country. Amounts may be attributed to the 
permanent establishment whether they are from sources within or 
without the country in which the permanent establishment is 
located.
    In computing taxable business profits, the proposed treaty 
provides that deductions are allowed for expenses incurred for 
the purposes of the permanent establishment. These deductions 
include a reasonable allocation of executive and general 
administrative expenses, research and development expenses, 
interest, and other expenses incurred for the purposes of the 
enterprise as a whole (or, if not the enterprise as a whole, at 
least the part of the enterprise that includes the permanent 
establishment), whether incurred in the country in which the 
permanent establishment is located or elsewhere. According to 
the Technical Explanation, under this language, the United 
States is free to use its current expense allocation rules, 
including the rules under Treas. Reg. secs. 1.861-8 and 1.882-
5.
    The proposed treaty specifies that in computing taxable 
business profits, no deductions are allowed for certain amounts 
incurred by the permanent establishment to any office of the 
enterprise, other than reimbursements of actual expenses. Such 
amounts include royalties, fees or similar payments in return 
for the use of patents or other rights; commissions or other 
charges for specific services performed or for management; or 
interest on moneys lent to the permanent establishment. As an 
example, the Technical Explanation states that a permanent 
establishment may not deduct a royalty deemed paid to the head 
office. It may, however, deduct an actual reimbursement to its 
head office for costs it incurred in developing an intangible 
generating the royalty. Similarly, the proposed treaty 
specifies that in computing taxable business profits, a 
permanent establishment may not take into account certain 
amounts charged by the permanent establishment to any office of 
the enterprise, other than for reimbursement of actual 
expenses. Such amounts include royalties, fees or similar 
payments in return for the use of patents or other rights; 
commissions or other charges for specific services performed or 
for management; or interest on moneys lent by the permanent 
establishment to any office of the enterprise.
    Business profits are not attributed to a permanent 
establishment merely by reason of the purchase of merchandise 
by a permanent establishment for the enterprise. Thus, where a 
permanent establishment purchases goods for its head office, 
the business profits attributed to the permanent establishment 
with respect to its other activities are not increased by the 
profit element with respect to its purchasing activities.
    The amount of profits attributable to a permanent 
establishment must be determined by the same method each year 
unless there is good reason to change the method. Where 
business profits include items of income which are dealt with 
separately in other articles of the proposed treaty, those 
other articles, and not the business profits article, govern 
the treatment of such items of income. Thus, for example, 
profits attributable to a U.S. ticket office of a South African 
airline are generally exempt from U.S. Federal income tax under 
the provisions of Article 8 (Shipping and Air Transport).
    Unlike the U.S. model, the proposed treaty contains no 
definition of ``business profits.'' The Technical Explanation 
states that the term ``business profits'' generally is 
understood to mean income derived from any trade or business, 
including income derived by an enterprise from the performance 
of personal services, and income from the rental of tangible 
personal property. This definition is the same as that 
contained in the U.S. model.
    The proposed treaty incorporates the rule of Code section 
864(c)(6) and provides that any income or gain attributable to 
a permanent establishment or a fixed base during its existence 
is taxable in the country where the permanent establishment or 
fixed base is located even though payments are deferred until 
after the permanent establishment or fixed base has ceased to 
exist. This rule applies with respect to business profits 
(Article 7, paragraphs 1 and 2), dividends (Article 10, 
paragraphs 4 and 6), interest (Article 11, paragraph 3), 
royalties (Article 12, paragraph 3), capital gains (Article 13, 
paragraph 3), independent personal services income (Article 14) 
and other income (Article 21, paragraph 2).

Article 8. Shipping and Air Transport

    Article 8 of the proposed treaty covers income from the 
operation of ships and aircraft in international traffic. The 
rules governing income from the sale of ships and aircraft 
operated in international traffic are contained in Article 13 
(Capital Gains).
    Under the Code, the United States generally taxes the U.S.-
source income of a foreign person from the operation of ships 
or aircraft to or from the United States. An exemption from 
U.S. tax is provided if the income is earned by a corporation 
that is organized in, or an alien individual who is resident 
in, a foreign country that grants an equivalent exemption to 
U.S. corporations and residents.
    Under the proposed treaty, profits which are derived by an 
enterprise of one country from the operation in international 
traffic of ships or aircraft (``shipping profits'') are taxable 
only in that country, regardless of the existence of a 
permanent establishment in the other country. ``International 
traffic'' means any transport by a ship or aircraft except when 
such transport is operated solely between places in a treaty 
country (Article 3(1)(h) (General Definitions)).
    The proposed treaty provides that shipping profits include 
income from the rental of ships or aircraft if such ships or 
aircraft are operated in international traffic by the lessee, 
or if the rental income is incidental to profits from the 
operation of ships or aircraft in international traffic. The 
Technical Explanation states that income from the rental of 
ships or aircraft on a full basis (i.e., with crew) is 
considered to be income from the operation of ships and 
aircraft (and, thus, is covered under the general rule). This 
treatment is similar to the U.S. model.
    The Technical Explanation states that, although not 
specified in the proposed treaty, profits derived by an 
enterprise from the inland transport of property or passengers 
within a country are treated as shipping profits eligible for 
exemption if such transport is undertaken as part of 
international traffic by the enterprise. This treatment is 
similar to the U.S. model.
    Like the U.S. model, the proposed treaty provides that 
income derived by an enterprise of one country from the use or 
rental of containers (including trailers, barges, and related 
equipment for the transport of containers) used in 
international traffic is taxable only in that country.
    The shipping and air transport provisions of the proposed 
treaty also apply to profits from participation in a pool, 
joint business, or international operating agency. This refers 
to various arrangements for international cooperation by 
carriers in shipping and air transport.

Article 9. Associated Enterprises

    The proposed treaty, like most other U.S. tax treaties, 
contains an arm's length pricing provision. The proposed treaty 
recognizes the right of each country to make an allocation of 
profits to an enterprise of that country in the case of 
transactions between related enterprises, if conditions are 
made or imposed between the two enterprises in their commercial 
or financial relations which differ from those which would be 
made between independent enterprises. In such a case, a country 
may allocate to such an enterprise the profits which it would 
have accrued but for the conditions so imposed. This treatment 
is consistent with the U.S. model.
    For purposes of the proposed treaty, an enterprise of one 
country is related to an enterprise of the other country if one 
of the enterprises participates directly or indirectly in the 
management, control, or capital of the other enterprise. 
Enterprises also are related if the same persons participate 
directly or indirectly in the management, control, or capital 
of such enterprises.
    Like the U.S. and OECD models, the proposed treaty does not 
include the paragraph contained in many other U.S. tax treaties 
which provides that the rights of the treaty countries to apply 
internal law provisions relating to adjustments between related 
parties are fully preserved. Nevertheless, the Technical 
Explanation states that it is understood that the respective 
countries will apply their internal intercompany pricing rules 
(e.g., Code section 482, in the case of the United States). The 
Technical Explanation also states that the U.S. ``commensurate 
with income'' standard for determining appropriate transfer 
prices for intangibles is consistent with the arm's-length 
standard.
    When a redetermination of tax liability has been properly 
made by one country, the other country will make an appropriate 
adjustment to the amount of tax charged in that country on the 
redetermined income, if it agrees with the adjustment. In 
making that adjustment, due regard is to be given to other 
provisions of the proposed treaty, and the competent 
authorities of the two countries will consult with each other 
if necessary. For example, under the mutual agreement article 
(Article 25), a correlative adjustment cannot necessarily be 
denied on the ground that the time period set by internal law 
for claiming a refund has expired. To avoid double taxation, 
the proposed treaty's saving clause retaining full U.S. taxing 
jurisdiction with respect to its citizens and residents 
(discussed above in connection with Article 1 (General Scope)) 
does not apply in the case of such adjustments.

Article 10. Dividends

            Internal taxation rules

United States

    The United States generally imposes a 30-percent tax on the 
gross amount of U.S.-source dividends paid to nonresident alien 
individuals and foreign corporations. The 30-percent tax does 
not apply if the foreign recipient is engaged in a trade or 
business in the United States and the dividends are effectively 
connected with that trade or business. In such a case, the 
foreign recipient is subject to U.S. tax on such dividends on a 
net basis at graduated rates in the same manner that a U.S. 
person would be taxed.
    Under U.S. law, the term dividend generally means any 
distribution of property made by a corporation to its 
shareholders, either from accumulated earnings and profits or 
current earnings and profits. However, liquidating 
distributions generally are treated as payments in exchange for 
stock and thus are not subject to the 30-percent withholding 
tax described above (see discussion of capital gains in 
connection with Article 14 below).
    Dividends paid by a U.S. corporation generally are U.S.-
source. Also treated as U.S.-source dividends for this purpose 
are portions of certain dividends paid by a foreign corporation 
that conducts a U.S. trade or business. The U.S. 30-percent 
withholding tax imposed on the U.S.-source portion of the 
dividends paid by a foreign corporation is referred to as the 
``second-level'' withholding tax. This second-level withholding 
tax is imposed only if a treaty prevents application of the 
statutory branch profits tax.
    In general, corporations are not entitled under U.S. law to 
a deduction for dividends paid. Thus, the withholding tax on 
dividends theoretically represents imposition of a second level 
of tax on corporate taxable income. Treaty reductions of this 
tax reflect the view that where the United States already 
imposes corporate level tax on the earnings of a U.S. 
corporation, a 30-percent withholding rate may represent an 
excessive level of source-country taxation. Moreover, the 
reduced rate of tax often applied by treaty to dividends paid 
to direct investors reflects the view that the source-country 
tax on payments of profits to a substantial foreign corporate 
shareholder may properly be reduced further to avoid double 
corporate-level taxation and to facilitate international 
investment.
    A REIT is a corporation, trust, or association that is 
subject to the regular corporate income tax, but that receives 
a deduction for dividends paid to its shareholders if certain 
conditions are met. In order to qualify for the deduction for 
dividends paid, a REIT must distribute most of its income. 
Thus, a REIT is treated, in essence, as a conduit for federal 
income tax purposes. Because a REIT is taxable as a U.S. 
corporation, a distribution of its earnings is treated as a 
dividend rather than income of the same type as the underlying 
earnings. Such distributions are subject to the U.S. 30-percent 
withholding tax when paid to foreign owners.
    A REIT is organized to allow persons to diversify ownership 
in primarily passive real estate investments. As such, the 
principal income of a REIT often is rentals from real estate 
holdings. Like dividends, U.S.-source rental income of foreign 
persons generally is subject to the 30-percent withholding tax 
(unless the recipient makes an election to have such rental 
income taxed in the United States on a net basis at the regular 
graduated rates). Unlike the withholding tax on dividends, 
however, the withholding tax on rental income generally is not 
reduced in U.S. income tax treaties.
    U.S. internal law also generally treats a Regulated 
Investment Company (``RIC'') as both a corporation and a 
conduit for income tax purposes. The purpose of a RIC is to 
allow investors to hold a diversified portfolio of securities. 
Thus, the holder of stock in a RIC may be characterized as a 
portfolio investor in the stock held by the RIC, regardless of 
the proportion of the RIC's stock owned by the dividend 
recipient.
    A foreign corporation engaged in the conduct of a trade or 
business in the United States is subject to a flat 30-percent 
branch profits tax on its ``dividend equivalent amount,'' which 
is a measure of the accumulated U.S. effectively connected 
earnings of the corporation that are removed in any year from 
its U.S. trade or business. The dividend equivalent amount is 
limited by (among other things) aggregate earnings and profits 
accumulated in taxable years beginning after December 31, 1986. 
The Code provides that no U.S. treaty will exempt any foreign 
corporation from the branch profits tax (or reduce the amount 
thereof) unless the foreign corporation is a ``qualified 
resident'' of the treaty country. The definition of a 
``qualified resident'' under U.S. internal law is somewhat 
similar to the definition of a corporation eligible for 
benefits under the proposed treaty (discussed below in 
connection with Article 22 (Limitation on Benefits)).

South Africa

    Dividends received by resident or nonresident individuals 
or companies, whether from South African or foreign companies, 
generally are exempt from the South African normal tax. 
Dividends declared by a South African company are subject to a 
12.5 percent secondary tax on companies (``STC''). Dividends 
received by the corporation can be offset against the dividends 
declared in computing the STC.
    Dividends paid to nonresident individuals and foreign 
corporations by South African companies generally are not 
subject to a withholding tax.
    A corporation with a branch in South Africa but whose place 
of effective management is outside South Africa is taxed on 
profits derived in South Africa. Such profits generally are 
subject to tax at a rate equal to the normal corporate tax rate 
plus five percentage points. Such a corporation is, however, 
exempt from the payment of the STC.
            Proposed treaty limitations on internal law

Reduction of withholding tax

    Under the proposed treaty, dividends paid by a company that 
is a resident of a country to a resident of the other country 
may be taxed in such other country. Dividends may also be taxed 
by the country in which the payor is resident, but the rate of 
tax is limited if the beneficial owner of the dividends is a 
resident of the other country. Under the proposed treaty, 
source-country taxation (i.e., taxation by the country in which 
the payor is resident) is limited to 5 percent of the gross 
amount of the dividends if the beneficial owner of the dividend 
is a company which holds directly at least 10 percent of the 
voting stock of the payor company. The source-country dividend 
withholding tax generally is limited to 15 percent of the gross 
amount of the dividend in all other cases. The Technical 
Explanation states that the ``beneficial owner'' of a dividend 
is understood generally to refer to any person resident in a 
country to whom that country attributes the dividend for 
purposes of its tax.
    The proposed treaty provides that the 15-percent maximum 
tax rate applies to dividends paid by a RIC. The proposed 
treaty provides that the 15-percent maximum tax rate applies to 
dividends paid by a REIT to an individual owning less than 10 
percent of the REIT. There is no limitation in the proposed 
treaty on the tax that may be imposed by the United States on a 
REIT dividend that is beneficially owned by a South African 
resident, if the beneficial owner of the dividend is either an 
individual holding a 10 percent or greater interest in the REIT 
or is not an individual. Thus, such a dividend is taxable at 
the 30-percent United States statutory rate.

Definition of dividends

    The proposed treaty generally defines ``dividends'' as 
income from shares and other rights, not being debt-claims, 
which participate in profits. The term also includes income 
that is subjected to the same tax treatment as income from 
shares under the laws of the country in which the payor is 
resident. This rule is the same as the U.S. model. The 
Technical Explanation states that a distribution by a limited 
liability company is not treated by the United States as a 
dividend and, thus, is not a dividend for purposes of Article 
10 (Dividends), provided that the limited liability company is 
not characterized as an association taxable as a corporation 
under U.S. law.

Special rules and exceptions

    The proposed treaty's reduced rates of tax on dividends do 
not apply if the beneficial owner of the dividend carries on 
business through a permanent establishment (or a fixed base, in 
the case of an individual who performs independent personal 
services) in the source country and the dividends are 
attributable to the permanent establishment (or fixed base). 
Such dividends are taxed as business profits (Article 7) or as 
income from the performance of independent personal services 
(Article 14). In addition, dividends attributable to a 
permanent establishment or fixed base, but received after the 
permanent establishment or fixed base is no longer in existence 
are taxable in the country where the permanent establishment or 
fixed base existed (Article 7, paragraph 7).
    The proposed treaty exempts from source-country tax 
dividends in cases in which the beneficial owner is (1) the 
United States or South Africa, or any of its political 
subdivisions or local authorities, or (2) a governmental 
pension trust or fund that is constituted and operated 
exclusively to administer government pension benefits, and that 
does not control the payor of the dividend.
    The proposed treaty contains a general limitation on the 
taxation by a treaty country of dividends paid to a resident of 
the other country by a corporation that is not a resident of 
the first country (a so-called ``second-level withholding 
tax''). Under this provision, a treaty country may not impose 
any tax on dividends paid by a corporation that is resident in 
the other country except where the dividends are paid to a 
resident of the first country, or insofar as the dividends are 
attributable to a permanent establishment or fixed base located 
in the other country, even if the dividends paid consist wholly 
or partly of profits or income arising in such country.

Branch profits tax

    The proposed treaty permits the imposition of a branch 
profits tax on a company that is resident in a country and that 
either has a permanent establishment in the other country or, 
in the case of the United States, is subject to tax in the 
United States on a net basis on income from real property or 
gains from the disposition of real property interests. In cases 
where a South African company conducts a trade or business in 
the United States, but not through a permanent establishment, 
the proposed treaty would generally eliminate the U.S. branch 
profits tax otherwise imposed on such corporation.
    In the case of South Africa, the proposed treaty specifies 
that the branch profits tax would be imposed at a rate that 
does not exceed the normal tax on companies by more than 5 
percentage points. The Technical Explanation states that this 
tax is imposed in lieu of, and not in addition to, the normal 
tax on companies and the STC.
    In the case of the United States, the proposed treaty 
specifies that the branch profits tax may not exceed 5 percent 
of the portion of profits of the corporation subject to tax in 
the United States that represents the dividend equivalent 
amount of such profits. The proposed treaty provides that the 
term ``dividend equivalent amount'' refers to the portion of 
the business profits of a permanent establishment subject to 
tax under Article 7 (Business Profits), or the portion of 
income from real property or gains from U.S. real property 
interests that is subject to tax in the United States on a net 
basis, that is comparable to the amount that would be 
distributed as a dividend if such income were earned by a 
locally incorporated subsidiary. The proposed treaty provides 
that the term ``dividend equivalent amount'' has the same 
meaning it has under U.S. law at it may be amended from time to 
time without changing the general principles of this article of 
the proposed treaty.
    None of the restrictions on the operation of the U.S. 
branch tax provisions apply, however, unless the corporation 
seeking treaty protection meets the conditions of the proposed 
treaty's limitation on benefits article (Article 22). As 
discussed below, the limitation on benefits requirements of the 
proposed treaty are similar in some respects to the analogous 
provisions of the branch profits tax provisions of the Code.

Article 11. Interest

            Internal taxation rules

United States

    Subject to numerous exceptions (such as those for portfolio 
interest, bank deposit interest, and short-term original issue 
discount), the United States imposes a 30-percent tax on U.S.-
source interest paid to foreign persons under the same rules 
that apply to dividends. U.S.-source interest, for purposes of 
the 30-percent tax, generally is interest on the debt 
obligations of a U.S. person, other than a U.S. person that 
meets specified foreign business requirements. Also subject to 
the 30-percent tax is interest paid to a foreign person by the 
U.S. trade or business of a foreign corporation. A foreign 
corporation is subject to a branch-level excess interest tax 
with respect to certain ``excess interest'' of a U.S. trade or 
business of such corporation; under this rule an amount equal 
to the excess of the interest deduction allowed with respect to 
the U.S. business over the interest paid by such business is 
treated as if paid by a U.S. corporation to a foreign parent 
and therefore is subject to a withholding tax.
    Portfolio interest generally is defined as any U.S.-source 
interest that is not effectively connected with the conduct of 
a trade or business and that (1) is paid on an obligation that 
satisfies certain registration requirements or specified 
exceptions thereto, and (2) is not received by a 10-percent 
owner of the issuer of the obligation, taking into account 
shares owned by attribution. However, the portfolio interest 
exemption is inapplicable to certain contingent interest 
income.
    If an investor holds an interest in a fixed pool of real 
estate mortgages that is a real estate mortgage interest 
conduit (``REMIC''), the REMIC is treated generally for U.S. 
tax purposes as a pass-through entity and the investor is 
subject to U.S. tax on a portion of the REMIC's income (which 
in turn generally is interest income). If the investor holds a 
so-called ``residual interest'' in the REMIC, the Code provides 
that a portion of the net income of the REMIC that is taxed in 
the hands of the investor--referred to as the investor's 
``excess inclusion''--may not be offset by any net operating 
losses of the investor, must be treated as unrelated business 
income if the investor is an organization subject to the 
unrelated business income tax and is not eligible for any 
reduction in the 30-percent rate of withholding tax (by treaty 
or otherwise) that would apply if the investor were otherwise 
eligible for such a rate reduction.

South Africa

    South Africa generally does not impose a withholding tax on 
South African-source interest paid to nonresident individuals 
or foreign corporations. In certain cases, South African-source 
interest paid to nonresident individuals or foreign 
corporations may be subject to the normal tax.
            Proposed treaty limitations on internal law

Elimination of withholding tax

    The proposed treaty provides that interest derived and 
beneficially owned by a resident of a country is taxable only 
in that country. Thus, the proposed treaty generally exempts 
U.S.-source interest paid to South African residents from the 
30-percent U.S. tax. This exemption from source-country 
taxation is consistent with the U.S. model. This exemption does 
not apply if the recipient of the interest is a nominee for a 
nonresident.
    The exemption does not apply if the beneficial owner of the 
interest carries on business through a permanent establishment 
(or a fixed base, in the case of an individual who performs 
independent personal services) in the source country and the 
interest paid is attributable to the permanent establishment 
(or fixed base). In that event, the interest is taxed as 
business profits (Article 7) or income from the performance of 
independent personal services (Article 14). In addition, 
interest attributable to a permanent establishment or fixed 
base, but received after the permanent establishment or fixed 
base is no longer in existence, is taxable in the country where 
the permanent establishment or fixed base existed (Article 7, 
paragraph 7).
    The proposed treaty addresses the issue of non-arm's-length 
interest charges between related parties (or parties having an 
otherwise special relationship) by stating that this article 
applies only to the amount of arm's-length interest. Any amount 
of interest paid in excess of the arm's-length interest is 
taxable according to the laws of each country, taking into 
account the other provisions of the proposed treaty. For 
example, excess interest paid to a parent corporation may be 
treated as a dividend under local law and thus entitled to the 
benefits of Article 10 (Dividends) of the proposed treaty.
    Under the proposed treaty, no exemption from source-country 
tax applies to an excess inclusion with respect to a residual 
interest in a REMIC. Thus, such inclusions may be taxed by the 
United States at a rate of 30 percent under the proposed 
treaty. In addition, the proposed treaty allows the source 
country to impose a tax, at a rate not exceeding 15 percent, on 
contingent interest that does not qualify as portfolio interest 
under U.S. law.

Definition of interest

    The proposed treaty defines interest generally as income 
from debt claims of every kind, whether or not secured by 
mortgage, and whether or not carrying a right to participate in 
the debtor's profits. In particular, it includes income from 
government securities and from bonds or debentures, including 
premiums or prizes attaching to such securities, bonds, or 
debentures. The proposed treaty also defines interest to 
include all other income that is treated as income from money 
lent by the taxation law of the source country. Income treated 
as dividends under Article 10 (Dividends) and penalty charges 
for late payment are not treated as interest. This treatment is 
similar to the U.S. model.

Article 12. Royalties

            Internal taxation rules
    Under the same system that applies to dividends and 
interest, the United States imposes a 30-percent tax on U.S.-
source royalties paid to foreign persons and on gains from the 
disposition of certain intangible property to the extent that 
such gains are from payments contingent on the productivity, 
use, or disposition of the intangible property. Royalties are 
from U.S. sources if they are for the use of property located 
in the United States. U.S.-source royalties include royalties 
for the use of, or the right to use, intangible property in the 
United States.
    South Africa generally imposes a withholding tax of 12 
percent on South African-source royalties paid to nonresident 
individuals and foreign corporations.
            Proposed treaty limitations on internal law
    The proposed treaty provides that royalties derived and 
beneficially owned by a resident of a country are taxable only 
in that country. Thus, the proposed treaty generally exempts 
U.S.-source royalties paid to South African residents from the 
30-percent U.S. tax. This exemption from source-country 
taxation is similar to that provided in the U.S. model. The 
exemption does not apply if the recipient of the royalty is a 
nominee for a nonresident.
    The exemption under the proposed treaty does not apply 
where the beneficial owner carries on business through a 
permanent establishment (or a fixed base, in the case of an 
individual who performs independent personal services) in the 
source country and the royalties are attributable to the 
permanent establishment (or fixed base). In that event, such 
royalties are taxed as business profits (Article 7) or income 
from the performance of independent personal services (Article 
14). In addition, royalties attributable to a permanent 
establishment or fixed base, but received after the permanent 
establishment or fixed base is no longer in existence, are 
taxable in the country where the permanent establishment or 
fixed base existed (Article 7, paragraph 7).
    Similar to the U.S. model and the OECD model, the proposed 
treaty defines ``royalties'' as any consideration for the use 
of, or the right to use, any copyright of literary, artistic, 
or scientific work (including computer software, 
cinematographic films, and audio or video tapes or disks and 
other means of image or sound reproduction); 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. The term ``royalties'' also includes gains from the 
alienation of any property described above which are contingent 
on the productivity, use, or disposition of the property. The 
Technical Explanation states that the term ``royalties'' does 
not include income from leasing personal property.
    The Technical Explanation states that income from the 
rental or licensing of computer programs may be treated as 
royalties or as income from the alienation of tangible personal 
property, depending on the facts and circumstances. The 
Technical Explanation states that a typical retail sale of a 
``shrink wrap'' computer program generally will not be 
considered to give rise to royalty income.
    The proposed treaty addresses the issue of non-arm's-length 
royalties between related parties (or parties having an 
otherwise special relationship) by stating that this article 
applies only to the amount of arm's-length royalties. Any 
amount of royalties paid in excess of the arm's-length royalty 
is taxable according to the laws of each country, taking into 
account the other provisions of the proposed treaty. For 
example, excess royalties paid to a parent corporation by its 
subsidiary may be treated as a dividend under local law and 
thus entitled to the benefits of Article 10 (Dividends) of the 
proposed treaty.

Article 13. Capital Gains

            Internal taxation rules
    In the case of the United States, gain realized by a 
nonresident alien or a foreign corporation from the sale of a 
capital asset generally is not subject to U.S. tax unless the 
gain is effectively connected with the conduct of a U.S. trade 
or business. A nonresident alien or foreign corporation is 
subject to U.S. tax on gain from the sale of a U.S. real 
property interest as if the gain were effectively connected 
with a trade or business conducted in the United States. ``U.S. 
real property interests'' include interests in certain 
corporations if at least 50 percent of the assets of the 
corporation consist of U.S. real property.
    South Africa does not impose a tax on capital gains derived 
by resident or nonresident individuals or companies.
            Proposed treaty limitations on internal law
    The proposed treaty specifies rules governing when a 
country may tax gains from the alienation of property by a 
resident of the other country. The rules generally are 
consistent with those contained in the U.S. model.

Real property

    Under the proposed treaty, gains derived by a treaty 
country resident from the disposition of real property situated 
in the other country may be taxed in the other country. For 
purposes of this article, real property situated in the other 
country includes (1) real property referred to in Article 6 
(Income from Immovable Property (Real Property)), (2) a U.S. 
real property interest, or (3) an equivalent interest in real 
property located in South Africa. The Technical Explanation 
clarifies that distributions by a REIT that are attributable to 
gains derived from a disposition of real property are taxable 
under this article (and such gains are not taxable under the 
dividends article (Article 10)).

Other capital gains

    Gains from the alienation of movable property that forms a 
part of the business property of a permanent establishment 
which an enterprise of one country has in the other country, 
gains from the alienation of movable property pertaining to a 
fixed base which is available to a resident of one country in 
the other country for the purpose of performing independent 
personal services, and gains from the alienation of such a 
permanent establishment (alone or with the whole enterprise) or 
such a fixed base, may be taxed in that other country. Under 
the proposed treaty, such gains attributable to a permanent 
establishment or fixed base, but received after the permanent 
establishment or fixed base is no longer in existence, are 
taxable in the country where the permanent establishment or 
fixed base existed (Article 7, paragraph 7).
    Gains of an enterprise of one of the treaty countries from 
the alienation of ships, aircraft or containers operated in 
international traffic, and gains from the alienation of movable 
property pertaining to the operation of such ships, aircraft 
and containers, are taxable only in that country.
    Generally, gains from the alienation of any property other 
than that discussed above are taxable under the proposed treaty 
only in the country where the alienator is a resident.

Article 14. Independent Personal Services

            U.S. internal law
    The United States taxes the income of a nonresident alien 
at the regular graduated rates if the income is effectively 
connected with the conduct of a trade or business in the United 
States by the individual. The performance of personal services 
within the United States may be a trade or business within the 
United States.
    Under the Code, the income of a nonresident alien from the 
performance of personal services in the United States is 
excluded from U.S.-source income, and therefore is not taxed by 
the United States in the absence of a U.S. trade or business, 
if: (1) the individual is not in the United States for over 90 
days during the taxable year; (2) the compensation does not 
exceed $3,000; and (3) the services are performed as an 
employee of, or under a contract with, a foreign person not 
engaged in a trade or business in the United States or are 
performed for a foreign office or place of business of a U.S. 
person.
            Proposed treaty limitations on internal law
    Under the proposed treaty, income in respect of 
professional services or other activities of an independent 
character performed in one country by a resident of the other 
country is exempt from tax in the country where the services 
are performed (the source country) unless the individual 
performing the services crosses either of two thresholds in the 
source country. 7 The individual may be taxed in the 
source country if he or she has a fixed base regularly 
available to him or her in that country for the purpose of 
performing the services. 8 In that case, the source 
country is permitted to tax only that portion of the 
individual's income which is attributable to the fixed base. In 
addition, if the individual is present in the source country 
for the purpose of performing the services for a period or 
periods exceeding 183 days within a twelve-month period, the 
individual is deemed to have a fixed base regularly available 
to him or her in the source country and the income derived from 
such activities performed in the source country is deemed to be 
attributable to that fixed base. In such latter case, the 
source country is permitted to tax the income derived from the 
performance of such services in the source country during that 
period. This latter rule represents a departure from the U.S. 
model, which would permit the source country to tax the income 
from independent personal services of a resident of the other 
country only if the income is attributable to a fixed base 
regularly available to the individual in the source country for 
the purpose of performing the activities.
---------------------------------------------------------------------------
    \7\ The Technical Explanation states that the term ``professional 
services or other activities of an independent character'' includes 
independent scientific, literary, artistic, educational, or teaching 
activities as well as the independent activities of physicians, 
lawyers, engineers, architects, dentists, and accountants.
    \8\ According to the Technical Explanation, it is understood that 
the concept of a fixed base is analogous to the concept of a permanent 
establishment.
---------------------------------------------------------------------------
    The Technical Explanation states that it is understood that 
in determining taxable independent personal services income, 
the principles of paragraph 3 of Article 7 (Business Profits) 
are applicable to allow a taxpayer to deduct expenses that are 
incurred for purposes of the fixed base. According to the 
Technical Explanation, the taxpayer may deduct all relevant 
expenses in computing the net income from independent personal 
services subject to tax in the source country.

Article 15. Dependent Personal Services

    Under the proposed treaty, salaries, wages, and other 
remuneration derived from services performed as an employee in 
one country (the source country) by a resident of the other 
country are taxable only in the country of residence if three 
requirements are met: (1) the individual is present in the 
source country for not more than 183 days in any twelve-month 
period beginning or ending during the taxable year concerned; 
(2) the individual's employer is not a resident of the source 
country; and (3) the compensation is not borne by a permanent 
establishment or fixed base of the employer in the source 
country. These limitations on source-country taxation are 
generally consistent with the U.S. and OECD models.
    The proposed treaty also provides that remuneration derived 
by a resident of one country in respect of employment as a 
member of the complement of a ship or aircraft operated in 
international traffic is taxed only in that country. The 
Technical Explanation states that the ``complement'' of a ship 
or aircraft includes the crew.
    This article is subject to the separate articles covering 
directors' fees (Article 16), pensions and annuities (Article 
18), and government service income (Article 19).

Article 16. Directors' Fees

    Under the proposed treaty, directors' fees and other 
similar remuneration derived by a resident of one country for 
services rendered in the other country as a member of the board 
of directors of a company which is a resident of that other 
country may be taxed in that other country. This rule is the 
same as the rule under the U.S. model.

Article 17. Entertainers and Sportsmen

    Similar to the U.S. and OECD models, the proposed treaty 
contains rules that apply to the taxation of income earned by 
entertainers (such as theater, motion picture, radio, or 
television ``artistes,'' or musicians) and sportsmen. These 
rules apply notwithstanding the other provisions dealing with 
the taxation of income from personal services (Articles 14 and 
15) and business profits (Article 7), and are intended, in 
part, to prevent entertainers and sportsmen from using the 
treaty to avoid paying any tax on their income earned in one of 
the countries.
    Under this article of the proposed treaty, income derived 
by an entertainer or sportsman who is a resident of one country 
from his or her personal activities as such in the other 
country may be taxed in the other country if the amount of the 
gross receipts derived by him or her from such activities 
(including reimbursed expenses) exceeds $7,500 or its 
equivalent in South African rand for the taxable year 
concerned. Under this rule, if a South African entertainer or 
sportsman maintains no fixed base in the United States and 
performs (as an independent contractor) for one day of a 
taxable year in the United States for gross receipts of $2,000, 
the United States could not tax that income. If, however, that 
entertainer's or sportsman's gross receipts were $30,000, the 
full $30,000 (less appropriate deductions) would be subject to 
U.S. tax.
    This provision does not bar the country of residence from 
also taxing that income (subject to a foreign tax credit). (See 
Article 23 (Elimination of Double Taxation), below.) The 
Technical Explanation states that because it is not possible to 
know whether the $7,500 (or the South African rand equivalent) 
threshold is exceeded until the end of the year, the source 
country may subject all payments to an entertainer or sportsman 
to withholding and refund any excess amount withheld.
    According to the Technical Explanation, this article 
applies to all income connected with a performance by an 
entertainer or sportsman, such as appearance fees, award or 
prize money, and a share of the gate receipts. Income derived 
by an entertainer or sportsman from other than actual 
performance, such as royalties from record sales and payments 
for product endorsements, is not covered by this article; 
instead, these amounts are covered by other articles of the 
proposed treaty, such as Article 12 (Royalties) or Article 14 
(Independent Personal Services). For example, if a South 
African entertainer receives royalty income from the sale of 
live recordings of a concert given in the United States, the 
royalty income will be exempt from U.S. withholding tax under 
Article 12 (Royalties), even if the remuneration from the 
concert itself may have been covered by this article.
    The proposed treaty provides that where income in respect 
of personal activities exercised by an entertainer or sportsman 
in his or her capacity as such accrues not to the entertainer 
or sportsman but to another person, that income of that person 
may be taxed by the country in which the activities are 
exercised, unless it is established that neither the 
entertainer or sportsman nor persons related to him or her 
participate directly or indirectly in the profits of that other 
person in any manner, including the receipt of deferred 
remuneration, bonuses, fees, dividends, partnership 
distributions or other distributions. (This provision applies 
notwithstanding the business profits and independent personal 
service articles (Articles 7 and 14).) This provision prevents 
certain entertainers and sportsmen from avoiding tax in the 
country in which they perform by, for example, routing the 
compensation for their services through a third entity such as 
a personal holding company or a trust located in a country that 
would not tax the income.
    The proposed treaty provides that income derived by 
entertainers or sportsmen resident in one country from 
activities performed in the other country will not be taxed by 
the source country if the visit of the entertainers or 
sportsmen is supported wholly or mainly from the public funds 
of the government of the residence country or of any of its 
political subdivisions or local authorities. This rule is not 
contained in the U.S. or OECD models.
    The proposed treaty provides that the countries may, 
through the exchange of diplomatic notes, agree to increase the 
$7,500 threshold (or its South African rand equivalent) 
referred to above to reflect economic or monetary developments. 
Under the U.S. model, such changes in monetary thresholds can 
be accomplished by mutual agreement by the competent 
authorities, without requiring diplomatic notes to be exchanged 
between the countries.

Article 18. Pensions and Annuities

    The proposed treaty specifies rules for the taxation of 
private (i.e., non-governmental service) pensions and 
annuities, social security benefits, alimony and child support 
payments, as well as for the tax treatment of contributions to, 
and earnings by, pension plans. Some of the rules are in 
certain respects different from the rules in the U.S. model.
    Under the proposed treaty, pension distributions and other 
similar remuneration derived from sources within a country (the 
source country) and beneficially owned by a resident of the 
other country, whether paid periodically or as a single sum, 
may be taxed by the source country to a limited extent. This 
treatment is different from the U.S. model, which generally 
provides that pension distributions beneficially owned by a 
resident of a country are not taxable in the source country. 
The proposed treaty specifies that a pension or similar 
remuneration is deemed to arise from sources within a country 
to the extent that the service to which it relates is performed 
in that country. The Technical Explanation states that the term 
``pension distributions and other similar remuneration'' is 
intended to cover payments made by private retirement plans and 
arrangements in consideration of past employment, as well as 
U.S. tier 2 railroad retirement benefits.
    The proposed treaty specifies that in cases in which the 
United States is the source country, the tax imposed by the 
United States on pension distributions and similar remuneration 
beneficially owned by a resident of South Africa may not exceed 
15 percent of the gross amount of such pension and 
remuneration, provided that such amount is not subject to a 
penalty for early withdrawal. The Technical Explanation states 
that if the distribution is subject to the early withdrawal 
penalty, the reduced rate under the proposed treaty will not 
apply and the rules under the Code will apply.
    In cases in which South Africa is the source country, South 
Africa may tax pension distributions and similar remuneration 
beneficially owned by a U.S. resident, if the beneficial owner 
of such pension or remuneration: (1) has been employed in South 
Africa for a period or periods aggregating two years or more 
during the ten-year period immediately preceding the date from 
which the pension first became due, and (2) was employed in 
South Africa for a period or periods aggregating ten years or 
more. According to the Technical Explanation, a pension first 
becomes due for purposes of this rule on the first date on 
which the participant or beneficiary received a pension 
benefit, or if earlier, the first date such person could have 
received a payment if such person could have requested to have 
payment made at that earlier time. The Technical Explanation 
provides examples illustrating these rules.
    Although not specified in the proposed treaty, the 
Technical Explanation states that if these conditions are 
satisfied, a pro rata amount of a pension distribution 
corresponding to the amount of the gross pension distribution 
from South African sources will be taxed to a beneficiary who 
is a U.S. resident. The Technical Explanation states that the 
portion of a pension distribution treated as South African-
source income is equal to the total pension distribution 
multiplied by a fraction, the numerator of which is the 
employee's days of service for the employer in South Africa, 
and the denominator of which is the employee's total days of 
service for the employer.
    These pension rules are subject to the provisions of 
Article 19 (Government Service). Thus, for example, the rules 
generally do not apply to pensions paid to a resident of one 
treaty country attributable to services performed for 
government entities of the other country.
    The proposed treaty provides that social security payments 
and other similar public pensions paid by one country to a 
resident of the other country or to a U.S. citizen are taxable 
only in the paying country. This rule is similar to the rule in 
the U.S. model. The Technical Explanation states that it is 
understood that the term ``other similar public pensions'' is 
intended to refer to U.S. tier 1 railroad retirement benefits. 
This rule, which is not subject to the saving clause, exempts 
U.S. citizens and residents from U.S. tax on South African 
social security payments.
    The proposed treaty provides that annuities beneficially 
derived by a resident of a country are taxable only in that 
country. However, if the annuity was purchased in the other 
country while such person was a resident of that other country, 
the annuity may also be taxed by that other country. This 
latter rule is not contained in the U.S. model. An annuity is 
defined as a stated sum paid periodically at stated times 
during life or a specified number of years, under an obligation 
to make the payments in return for adequate and full 
consideration (other than services rendered).
    The proposed treaty provides that alimony paid by a 
resident of one country, and deductible in that country, to a 
resident of the other country, is taxable only in the payor's 
country of residence. However, if the alimony payment is not 
deductible in the payor's country of residence, the payment is 
exempt from tax in both countries. These rules are different 
from the U.S. model, which provides that alimony paid by a 
resident of a country, and deductible in that country, to a 
resident of the other country, is taxable only in the 
recipient's country of residence. For purposes of the proposed 
treaty, the term ``alimony'' means periodic payments made 
pursuant to a written separation agreement or a decree of 
divorce, separate maintenance or compulsory support.
    The proposed treaty provides that child support payments 
made by a resident of a country to a resident of the other 
country, and which are not deductible in the payor's country of 
residence, are exempt from tax in both countries. According to 
the Technical Explanation, in the event that the payor is 
allowed a deduction for a child support payment in his or her 
country of residence, the payment would be taxable to the payee 
by the other country under Article 21 (Other Income). For these 
purposes, child support payments are periodic payments, not 
treated as alimony payments, for the support of a minor child 
made pursuant to a written separation agreement, or a decree of 
divorce, separate maintenance or compulsory support.
    The proposed treaty provides special rules for individuals 
who are participants in a pension plan that is established and 
recognized under the legislation of one country (the plan 
country) and who perform personal services in the other country 
(the work country). These rules correspond to similar rules 
contained in the U.S. model. First, contributions paid by or on 
behalf of the individual to the plan during the period he or 
she performs such services in the work country are deductible 
(or excludible) in computing his or her taxable income in the 
work country. In addition, the proposed treaty provides that 
any benefits accrued under the plan or payments made to the 
plan by or on behalf of the individual's employer during that 
period are not treated as part of the employee's taxable 
income, and are allowed as a deduction in computing the 
employer's profits in the work country.
    Second, the proposed treaty provides that income earned but 
not distributed by the plan is not taxable in the work country 
until such time and to the extent that the earnings are 
distributed from the plan. Thus, the proposed treaty permits 
deferral of tax on undistributed earnings realized by the plan.
    Third, the proposed treaty provides that distributions from 
the plan to the individual are not subject to tax in the work 
country if the individual contributes such amounts to a similar 
plan established in the work country within a time period and 
in accordance with any other requirements imposed under the 
laws of the work country. Thus, the proposed treaty permits 
deferral of tax on rollovers of amounts from a pension plan in 
the plan country to a pension plan in the work country (subject 
to any restrictions on rollovers under the laws of the work 
country).
    The proposed treaty provides that the individual can 
receive these benefits only if (1) contributions by or on 
behalf of the individual to the plan (or to another similar 
plan for which this plan was substituted) were made before he 
or she arrived in the work country, and (2) the competent 
authority of the work country has agreed that the pension plan 
generally corresponds to a pension plan recognized for tax 
purposes by the work country. The proposed treaty further 
specifies that these benefits are limited to the benefits that 
would be allowed by the work country to its residents for 
contributions to, or benefits otherwise accrued under, a 
pension plan recognized for tax purposes by the work country. 
As an example, the Technical Explanation states that if the 
work country has a cap on contributions to a plan equal to five 
percent of remuneration, and the plan country has a seven 
percent cap, a deduction by the individual for contributions to 
a plan is limited to five percent.

Article 19. Government Service

    Under the proposed treaty, remuneration, other than a 
pension, paid by, or out of funds created by, a country or one 
of its political subdivisions or local authorities to an 
individual for services rendered to the payor, generally is 
taxable only in that country. However, such remuneration is 
taxable only in the other country (the country that is not the 
payor) if the services are rendered in that other country, and 
the individual is a resident of that other country who either 
(1) is a national of that other country, or (2) did not become 
a resident of that other country solely for the purpose of 
rendering the services. Thus, for example, South Africa 
generally will not tax the compensation of a U.S. citizen and 
resident who is in South Africa to perform services for the 
U.S. Government, and the United States generally will not tax 
the compensation of a South African citizen and resident who 
performs services for the U.S. Government in South Africa.
    Any pension paid by, or out of funds created by, a country 
or one of its political subdivisions or local authorities, to 
an individual for services rendered to the payor country 
generally is taxable only in that country. However, such 
pensions are taxable only in the other country if the 
individual is both a resident and a national of that other 
country. The Technical Explanation states that the phrase 
``paid by, or out of funds created by'' a country is intended 
to clarify that remuneration or pensions paid by entities such 
as government-owned corporations may also be covered by this 
article.
    The proposed treaty provides that this article does not 
apply to payments in respect of services rendered in connection 
with any trade or business carried on by either country or any 
of its political subdivisions or local authorities. This 
treatment is similar to the U.S. model, which limits the 
application of the corresponding article in the U.S. model to 
services rendered ``in the discharge of functions of a 
governmental nature.'' The Technical Explanation clarifies that 
remuneration excluded from this article because of this rule is 
subject to the provisions relating to personal services income 
(Articles 14 and 15), directors' fees (Article 16), income of 
entertainers and sportsmen (Article 17), and pensions and 
annuities (Article 18).
    This article is an exception to the saving clause, pursuant 
to Article 1, paragraph 5(b) of the proposed treaty. 
Consequently, the saving clause does not apply to benefits 
conferred by this article to an individual who is neither a 
U.S. citizen nor a U.S. green-card holder. Thus, for example, 
the United States would not tax the compensation of a South 
African citizen who is not a U.S. green-card holder but who 
resides in the United States to perform services for the South 
African Government.

Article 20. Students, Apprentices and Business Trainees

    Under the proposed treaty, a student, apprentice, or 
business trainee who visits the other country (the host 
country) for the purpose of full-time education or training, 
and who is, or immediately before that visit was, a resident of 
the other treaty country, generally is exempt from tax in the 
host country on payments that arise from sources outside the 
host country for the purposes of maintenance, education, or 
training. The Technical Explanation states that a payment is 
considered to arise from sources outside the host country if 
the payor is located outside the host country. In the case of 
an apprentice or trainee, this treaty benefit applies only for 
a period not exceeding one year from the date the individual 
first arrives in the host country for the purposes of his or 
her apprenticeship or training. In the case of a student, this 
treaty benefit applies regardless of the length of the stay. 
This treatment is similar to the U.S. model. The OECD model 
also provides some host-country exemptions for students and 
trainees; however, unlike the proposed treaty and the U.S. 
model, the OECD model does not contain a time limit on the 
exemption from host tax with respect to trainees.
    This article is an exception to the saving clause, pursuant 
to Article 1, paragraph 5(b) of the proposed treaty. 
Consequently, the saving clause does not apply to benefits 
conferred by this article to an individual who is neither a 
U.S. citizen nor a U.S. green-card holder. Thus, for example, 
the United States would not tax remittances from abroad of a 
South African citizen who is not a U.S. green-card holder but 
who visits the United States as a full-time student.

Article 21. Other Income

    This article is a catch-all provision intended to cover 
items of income not specifically covered in other articles, and 
to assign the right to tax income from third countries to 
either the United States or South Africa. This article is 
substantially similar to the corresponding article in the U.S. 
model.
    As a general rule, items of income not otherwise dealt with 
in the proposed treaty which are beneficially owned by 
residents of either country, wherever arising, are taxable only 
in the country of residence. This rule, for example, gives the 
United States the sole right under the proposed treaty to tax 
income derived from sources in a third country and paid to a 
resident of the United States. This article is subject to the 
saving clause, so U.S. citizens who are South African residents 
would continue to be taxable by the United States on their 
third-country income, with a foreign tax credit provided for 
income taxes paid to South Africa.
    The general rule just stated does not apply to income 
(other than income from immovable property (as defined in 
Article 6)) if the beneficial owner of the income is a resident 
of one country and carries on business in the other country 
through a permanent establishment or a fixed base to which the 
income is attributable. In such a case, the provisions of 
Article 7 (Business Profits) or Article 14 (Independent 
Personal Services), as the case may be, will apply. Thus, for 
example, income arising outside the United States that is 
attributable to a permanent establishment maintained in the 
United States by a resident of South Africa generally would be 
taxable by the United States under Article 7 (Business 
Profits), even if the income was sourced in a third country.
    In cases in which a resident of a treaty country derives 
income from real property located outside the other treaty 
country (whether in the first treaty country or in a third 
country) that is attributable to the resident's permanent 
establishment or fixed base in the other treaty country, only 
the country of residence of the income recipient may tax that 
income. Thus, for example, if a U.S. resident has a South 
African permanent establishment and the resident derives income 
from real property located in a third country that is 
effectively connected with the South African permanent 
establishment, only the United States may tax such income.
    Other income attributable to a permanent establishment or 
fixed base, but received after the permanent establishment or 
fixed base is no longer in existence, is taxable in the country 
where the permanent establishment or fixed base existed 
(Article 7, paragraph 7).

Article 22. Limitation on Benefits

            In general
    The proposed treaty contains a provision generally intended 
to limit indirect use of the treaty by persons who are not 
entitled to its benefits by reason of residence in the United 
States or South Africa. The proposed treaty is intended to 
limit double taxation caused by the interaction of the tax 
systems of the United States and South Africa as they apply to 
residents of the two countries. At times, however, residents of 
third countries attempt to use a treaty. This use is known as 
``treaty shopping,'' which refers to the situation where a 
person who is not a resident of either country seeks certain 
benefits under the income tax treaty between the two countries. 
Under certain circumstances, and without appropriate 
safeguards, the nonresident may be able to secure these 
benefits indirectly by establishing a corporation (or other 
entity) in one of the countries, which entity, as a resident of 
that country, is entitled to the benefits of the treaty. 
Additionally, it may be possible for a third-country resident 
to reduce the income base of a treaty country resident by 
having the latter pay out interest, royalties, or other 
deductible amounts under favorable conditions either through 
relaxed tax provisions in the distributing country or by 
passing the funds through other treaty countries (essentially, 
continuing to treaty shop), until the funds can be repatriated 
under favorable terms.
            Summary of proposed treaty provisions
    The proposed anti-treaty-shopping article provides that a 
resident of a country is entitled to all treaty benefits in the 
other country only to the extent provided in this article. 
Under this provision, certain persons are identified as 
qualifying as residents of a country. Alternatively, certain 
items of income of a treaty resident may qualify for treaty 
benefits if the resident satisfies one of several other tests 
of the proposed treaty. This provision of the proposed treaty 
is in some ways comparable to the U.S. Treasury regulation 
under the branch tax definition of a qualified resident. 
9 However, the proposed treaty provides 
opportunities for treaty benefit eligibility which are not 
provided for under the regulation.
---------------------------------------------------------------------------
    \9\ Treas. Reg. sec. 1.884-5.
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    The proposed treaty entitles a resident of either country 
to qualify for all the benefits accorded by the proposed treaty 
if such resident falls within one of the following categories:

  (1) An individual;
  (2) One of the treaty countries, a political subdivision or 
            local authority thereof;
  (3) A company that satisfies an ownership test and a base 
            erosion test;
  (4) A trust that satisfies an ownership test and a base 
            erosion test;
  (5) A company that satisfies a public company test;
  (6) A company that is owned by certain public companies;
  (7) A not-for-profit, tax-exempt organization; or
  (8) A tax-exempt pension fund

Such persons will be referred to as ``qualified residents.'' 
Alternatively, a resident that does not fit into any of the 
above categories may claim treaty benefits with respect to 
certain items of income under the active business test. 
Moreover, a treaty country resident is entitled to treaty 
benefits if the resident is otherwise approved by the source 
country's competent authority, in the exercise of the latter's 
discretion. Special rules apply to income derived by a resident 
of South Africa in certain ``triangular'' cases described 
below.
            Ownership and base erosion tests--companies
    Similar to many U.S. treaties that have a limitation on 
benefits article, the proposed treaty contains an ownership 
test and a base erosion payment test, both of which must be met 
if a company is to qualify for treaty benefits under this rule. 
The tests under the proposed treaty are similar, but not 
identical, to those contained in the U.S. model.

Ownership test

    To meet the ownership test, at least 50 percent of each 
class of shares or other beneficial interests in the company 
must be owned, directly or indirectly, on at least half the 
days during the taxable year by: individual residents of South 
Africa or the United States; the countries themselves, 
political subdivisions or local authorities of the countries; 
certain publicly traded companies and companies owned by 
certain publicly traded companies (as described in the 
discussion of the public company tests below); or certain tax-
exempt organizations including charitable organizations and 
pension funds (as described in the discussion of tax-exempt 
entities below). The proposed treaty provides that in the case 
of indirect ownership, each person in the chain of ownership 
must be entitled to the benefits of the proposed treaty as one 
of the qualified residents referred to above.

Base erosion test

    The base erosion test is met only if less than 50 percent 
of the gross income of the company for the year is paid or 
accrued, directly or indirectly, to persons who are not 
residents of either country, in the form of payments that are 
deductible for income tax purposes in the company's country of 
residence. Under the proposed treaty, payments by the company 
to a resident of either country, or payments that are 
attributable to a permanent establishment in either country, 
are not considered base eroding payments for these purposes. 
This test is intended to prevent a corporation, for example, 
from distributing most of its income in the form of deductible 
payments such as interest, royalties, service fees, or other 
amounts to persons not entitled to benefits under the proposed 
treaty.
            Ownership and base erosion tests--trusts
    The proposed treaty provides a separate ownership test and 
base erosion test for trusts. These rules are similar to the 
ownership and base tests for companies described above; 
however, the proposed treaty provides more stringent ownership 
rules in the case of trusts. This is unlike the U.S. model, 
which generally applies the same ownership and base erosion 
tests to companies and trusts.

Ownership test

    Under the proposed treaty, the ownership test is met if at 
least 80 percent of the aggregate beneficial interests in the 
trust is owned, directly or indirectly, on at least 274 days 
during the taxable year by: individual residents of South 
Africa or the United States; the countries themselves, 
political subdivisions or local authorities of the countries; 
certain publicly traded companies and companies owned by 
certain publicly traded companies (as described in the 
discussion of the public company tests below); certain tax-
exempt organizations including charitable organizations and 
pension funds (as described in the discussion of tax-exempt 
entities below); or companies satisfying the ownership and base 
erosion tests. The at-least-80 percent ownership threshold for 
trusts is more stringent than the at-least-50 percent ownership 
threshold for companies, described above. The proposed treaty 
provides that in the case of indirect ownership, each person in 
the chain of ownership must be entitled to the benefits of the 
proposed treaty as one of the qualified residents referred to 
above.

Base erosion test

    The base erosion test under the proposed treaty is the same 
as the base erosion test for companies described above. This 
test requires that less than 50 percent of the trust's gross 
income be paid or accrued, directly or indirectly, to 
nonresidents of either country (unless the income is 
attributable to a permanent establishment located in either 
country), in the form of payments that are deductible for tax 
purposes in the trust's country of residence. The Technical 
Explanation states that trust distributions would be considered 
deductible payments to the extent that they are deductible from 
the tax base.
            Public company tests
    Like many other U.S. income tax treaties that have a 
limitation on benefits article, the proposed treaty contains a 
rule under which a company is entitled to treaty benefits if 
sufficient shares in the company are traded actively enough on 
a suitable stock exchange. This rule is similar to the branch 
profits tax rules in the Code under which a company is entitled 
to treaty protection from the branch tax if it meets such a 
test or if it is the wholly-owned subsidiary of certain 
publicly traded corporations resident in a treaty country. The 
rules under the proposed treaty are similar to those contained 
in the U.S. model.

Publicly traded companies

    A company that is a resident of South Africa or the United 
States is entitled to treaty benefits if all the shares in the 
class or classes of its shares representing more than 50 
percent of the voting power and value of the company are 
regularly traded on a recognized stock exchange. Thus, such a 
company is entitled to the benefits of the proposed treaty 
regardless of where its actual owners reside or the amount or 
destination of payments it makes. The Technical Explanation 
states that the requirement that ``all the shares'' in the 
principal class of shares be regularly traded makes clear that 
all shares in the principal class (or classes) of shares of the 
company must be regularly traded, as opposed to only a portion 
of such shares. This treatment is consistent with the U.S. 
model.
    Although the term ``regularly traded'' is not defined in 
the proposed treaty, the Technical Explanation states that the 
term will be defined by reference to the domestic laws of the 
country in which treaty benefits are sought. The Technical 
Explanation states that in the case of the United States, this 
term is understood to have the meaning it has under Treasury 
regulations relating to the branch profits tax provisions of 
section 884 of the Code.

Subsidiaries of publicly traded companies

    A company that is a resident of South Africa or the United 
States is entitled to treaty benefits if at least 50 percent of 
each class of shares in the company is owned, directly or 
indirectly, by companies that satisfy the public company tests 
described above. The proposed treaty provides that in the case 
of indirect ownership, each intermediate owner in the chain 
must be a person entitled to the benefits of the proposed 
treaty (as one of the qualified residents referred to above) 
under this article.

Other definitions

    For purposes of this article, the term ``recognized stock 
exchange'' means the NASDAQ System owned by the National 
Association of Securities Dealers, Inc.; any stock exchange 
registered with the Securities and Exchange Commission as a 
national securities exchange under the Securities Exchange Act 
of 1934; the Johannesburg Stock Exchange; and any other 
exchange agreed upon by the competent authorities of the two 
countries.
            Tax-exempt organizations

Charitable organizations

    An entity also is entitled to benefits under the proposed 
treaty if it is a legal person organized under the laws of a 
country and is generally exempt from tax in that country under 
laws relating to charitable and other similar organizations. 
The Technical Explanation clarifies that such organizations 
include entities organized and operated exclusively to fulfill 
religious, educational, scientific and other charitable 
purposes. Like the U.S. model, and unlike some recent treaties, 
there is no requirement that specified percentages of the 
beneficiaries of these organizations be residents of one of the 
countries.

Pension funds

    An entity also is entitled to the benefits under the 
proposed treaty if it is a legal person organized under the 
laws of a country, is generally exempt from tax in that 
country, and is established and maintained in that country to 
provide pensions or other similar benefits to employees 
pursuant to a plan; provided that more than 50 percent of the 
beneficiaries, members or participants are individuals resident 
in either country. This rule is similar to a rule contained in 
the U.S. model.
            Active business test

In general

    Under the active business test, treaty benefits in the 
source country are available under the proposed treaty to an 
entity that is a resident of the United States or South Africa 
if (1) it is engaged directly in the active conduct of a trade 
or business in its country of residence, (2) the income derived 
from the source country is derived in connection with, or is 
incidental to, that trade or business, and (3) the trade or 
business is substantial in relation to the activity of the 
resident (and any related parties) in the source country. These 
rules are generally similar to the rules in the U.S. model.
    The proposed treaty provides that the business of making or 
managing investments is not considered to be an active trade or 
business for purposes of these rules, unless the activity is a 
banking, insurance or securities activity conducted by a bank, 
insurance company or registered securities dealer, 
respectively. The Technical Explanation states that a 
headquarters operation will not be considered to be engaged in 
an active trade or business for purposes of these rules.

Income derived in connection with, or incidental to, a trade or 
        business

    The proposed treaty specifies that an item of income is 
derived in connection with a trade or business if the income-
producing activity in the source country is a line of business 
which forms a part of, or is complementary to, the trade or 
business conducted in the residence country. 10 This 
rule is similar to the rule in the U.S. model. The Technical 
Explanation states that it is intended that a business activity 
generally will be considered to ``form a part of'' a business 
activity conducted in the other country if the two activities 
involve the design, manufacture or sale of the same products or 
type of products, or the provision of similar services. The 
Technical Explanation further states that in order for 
activities to be ``complementary,'' the activities need not 
relate to the same types of products or services, but they 
should be part of the same overall industry and be related in 
the sense that success or failure of one activity will tend to 
result in the success or failure of the other activity. The 
Technical Explanation provides several examples illustrating 
these principles.
---------------------------------------------------------------------------
    \10\ Cf. Treas. Reg. sec. 1.884-5(e)(1). (To satisfy the active 
business test, the activities that give rise to the U.S. income must be 
part of a U.S. business and that business must be an integral part of 
an active trade or business conducted by the foreign corporation in its 
residence country.)
---------------------------------------------------------------------------
    The proposed treaty specifies that income is incidental to 
a trade or business if it facilitates the conduct of a trade or 
business in the other country. This rule is the same as the 
rule in the U.S. model.

Substantiality

    The proposed treaty provides that whether a trade or 
business of a resident is substantial is determined based on 
all the facts and circumstances. According to the Technical 
Explanation, the factors to be considered include the relative 
scale of the activities conducted in the two countries, and the 
relative contributions made to the conduct of the trade or 
business in both countries. 11 However, the proposed 
treaty includes a safe harbor under which the trade or business 
of the resident is considered to be substantial if certain 
attributes of the residence-country business exceed a threshold 
fraction of the corresponding attributes of the trade or 
business located in the source country that produces the 
source-country income. Under this safe harbor, the attributes 
are assets, gross income, and payroll expense. To satisfy the 
safe harbor, the level of each such attribute in the active 
conduct of the trade or business by the resident (and any 
related parties) in the residence country, and the level of 
each such attribute in the trade or business producing the 
income in the source country, is measured for the prior year or 
for the prior three years. For each separate attribute, the 
ratio of the residence country level to the source country 
level is computed.
---------------------------------------------------------------------------
    \11\ Cf. Treas. Reg. sec. 1.884-5(e)(3). (A foreign corporation 
engaged in business in its residence country has a substantial presence 
in that country if certain of the attributes of that business, 
physically located in its residence country, equal at least a threshold 
percentage of its worldwide attributes.)
---------------------------------------------------------------------------
    In general, the safe harbor is satisfied if, for the prior 
year or for the average of the three prior years, the average 
of the three ratios exceeds 10 percent, and each ratio 
separately is at least 7.5 percent. These rules are similar, 
but not identical, to those contained in the U.S. model. The 
Technical Explanation states that if a resident owns less than 
100 percent of an activity in either country, the resident will 
only include its proportionate interest in such activity for 
purpose of computing the safe harbor percentages.
            Grant of treaty benefits by the competent authority
    Finally, the proposed treaty provides a ``safety-valve'' 
for a treaty country resident that has not established that it 
meets one of the other more objective tests, but for which the 
allowance of treaty benefits would not give rise to abuse or 
otherwise be contrary to the purposes of the proposed treaty. 
Under this provision, such a person may be granted treaty 
benefits if the competent authority of the source country so 
determines.
    The Technical Explanation provides that the competent 
authority of a country will base its determination on whether 
the establishment, acquisition, or maintenance of the person 
seeking benefits under the proposed treaty, or the conduct of 
such person's operations, has or had as one of its principal 
purposes the obtaining of benefits under the proposed treaty. 
Thus, persons that establish operations in either the United 
States or South Africa with the principal purposes of obtaining 
benefits under the proposed treaty ordinarily will be denied 
such benefits.
            Triangular cases
    Under present laws and treaties that apply to South African 
residents, it is possible for profits of a permanent 
establishment maintained by a South African resident in a third 
country to be subject to a very low aggregate rate of South 
African and third-country income tax. The proposed treaty, in 
turn, eliminates the U.S. tax on several specified types of 
income of a South African resident. In a case where the U.S. 
income is earned by a third-country permanent establishment of 
a South African resident (the so-called ``triangular case'') 
the proposed treaty could have the potential of helping South 
African residents to avoid all (or substantially all) taxation, 
rather than merely avoiding double taxation. The proposed 
treaty is drafted unilaterally to apply only to income of a 
South African resident, because it has no application with 
respect to the United States--the United States does not exempt 
profits of a U.S. person attributable to a foreign permanent 
establishment.
    The proposed treaty includes a special rule designed to 
prevent the proposed treaty from reducing or eliminating U.S. 
tax on income of a South African resident in a case where no 
other substantial tax is imposed on that income. Under the 
special rule, the United States is permitted to tax 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 proposed treaty.
    In order for the special rule to apply, four conditions 
must be satisfied. First, a South African enterprise must 
derive income from the United States. Second, such income must 
be attributable to a permanent establishment that the South 
African enterprise has in a third country. Third, the South 
African enterprise must be exempt from South African tax on the 
profits attributable to the third-country permanent 
establishment. Fourth, the combined South African and third-
country taxation of the item of U.S.-source income earned by 
the South African enterprise and the third-country permanent 
establishment must be less than 50 percent of the South African 
tax that would be imposed if the income were earned by the same 
enterprise in South Africa and were not attributable to the 
permanent establishment.
    The special rule does not apply to interest derived in 
connection with, or incidental to, the active conduct of a 
trade or business carried on by the permanent establishment in 
the third country (other than the business of making or 
managing investments unless these activities are banking or 
insurance activities carried on by a bank or insurance company, 
respectively). The special rule also does not apply to 
royalties received as compensation for the use of, or the right 
to use, intangible property produced or developed by the third-
country permanent establishment. In addition, the special rule 
does not apply to income derived by a South African enterprise 
if the United States taxes the profits of that enterprise 
according to the subpart F controlled foreign corporation 
provisions of the Code (as it may be amended from time to time 
without changing the general principles thereof). 12
---------------------------------------------------------------------------
    \12\ Similar subpart F exceptions from this special rule also are 
found in other recent U.S. income tax treaties (e.g., the 1995 U.S.-
France income tax treaty).
---------------------------------------------------------------------------

Article 23. Elimination of Double Taxation

            Internal taxation rules

United States

    One of the two principal purposes for entering into an 
income tax treaty is to limit double taxation of income earned 
by a resident of one of the countries that may be taxed by the 
other country. The United States seeks unilaterally to mitigate 
double taxation by generally allowing U.S. taxpayers to credit 
the foreign income taxes that they pay against U.S. tax imposed 
on their foreign source income. An indirect or ``deemed-paid'' 
credit is also provided. Under this rule, a U.S. corporation 
that owns 10 percent or more of the voting stock of a foreign 
corporation and receives a dividend from the foreign 
corporation is deemed to have paid a portion of the foreign 
income taxes paid by the foreign corporation on its accumulated 
earnings. The taxes deemed paid by the U.S. corporation are 
included in its total foreign taxes paid for the year the 
dividend is received.
    A fundamental premise of the foreign tax credit is that it 
may not offset the U.S. tax on U.S.-source income. Therefore, 
the foreign tax credit provisions contain a limitation that 
ensures that the foreign tax credit only offsets U.S. tax on 
foreign source income. The foreign tax credit limitation 
generally is computed on a worldwide consolidated basis. Hence, 
all income taxes paid to all foreign countries are combined to 
offset U.S. taxes on all foreign income. The limitation is 
computed separately for certain classifications of income 
(e.g., passive income and financial services income) in order 
to prevent the crediting of foreign taxes on certain high-taxed 
foreign source income against the U.S. tax on certain types of 
traditionally low-taxed foreign source income. Other 
limitations may apply in determining the amount of foreign 
taxes that may be credited against the U.S. tax liability of a 
U.S. taxpayer.

South Africa

    In general, South African law allows resident individuals 
and domestic companies a credit for foreign taxes payable on 
income derived from non-South African sources if that income is 
also taxable by South Africa. The foreign tax credit cannot 
exceed the South African tax payable on the foreign income in 
question.
            Proposed treaty rules

Overview

    Unilateral efforts to limit double taxation are imperfect. 
Because of differences in rules as to when a person may be 
taxed on business income, a business may be taxed by two 
countries as if it is engaged in business in both countries. 
Also, a corporation or individual may be treated as a resident 
of more than one country and be taxed on a worldwide basis by 
both.
    The double tax issue is addressed in part in other articles 
of the proposed treaty that limit the right of a source country 
to tax income. This article provides further relief where both 
South Africa and the United States would otherwise still tax 
the same item of income. This article is not subject to the 
saving clause, so that the United States waives its overriding 
taxing jurisdiction to the extent that this article applies.

Proposed treaty limitations on U.S. internal law

    The proposed treaty generally provides that the United 
States will allow a U.S. citizen or resident a foreign tax 
credit for South African tax paid or accrued by or on behalf of 
such citizen or resident. The proposed treaty also provides 
that the United States will allow a deemed-paid credit, with 
respect to South African tax, to any U.S. corporate shareholder 
of a South African company that receives dividends from such 
company if the U.S. company owns 10 percent or more of the 
voting stock of the South African company.
    The credit generally is to be computed in accordance with 
the provisions and subject to the limitations of U.S. law (as 
those provisions and limitations may change from time to time 
without changing the general principles of the treaty 
provisions). This provision generally is similar to those found 
in the U.S. model and many U.S. income tax treaties.
    The Technical Explanation states that South African taxes 
covered by the proposed treaty (Article 2 (Taxes Covered)) 
generally are considered income taxes for purposes of the U.S. 
foreign tax credit rules. According to the Technical 
Explanation, certain portions of South Africa's STC might, in a 
given case, not be creditable for U.S. tax purposes.
    The proposed treaty, like other U.S. treaties, contains a 
special rule designed to provide relief from double taxation 
for U.S. citizens who are South African residents. Under the 
special rule, a U.S. citizen who is resident in South Africa 
will:
          (1) Compute the tentative U.S. income tax and the 
        tentative South African income tax with respect to 
        items of income that, under the proposed treaty, are 
        subject to South African tax and are either exempt from 
        U.S. tax or are subject to a reduced rate of tax when 
        derived by a South African resident who is not a U.S. 
        citizen.
          (2) Reduce the tentative South African tax by a 
        hypothetical foreign tax credit for taxes imposed on 
        his or her U.S.-source income. The amount of this 
        credit is limited to the U.S. withholding tax that the 
        citizen would have paid under the proposed treaty on 
        such income if that person were a South African 
        resident but not a U.S. citizen (e.g., 15 percent in 
        the case of portfolio dividends).
          (3) Reduce the tentative U.S. income tax by a foreign 
        tax credit for income tax actually paid to South Africa 
        as computed in step (2) (i.e., after South Africa 
        allowed the credit for U.S. taxes). The proposed treaty 
        recharacterizes the income that is subject to South 
        African taxation as foreign source income for purposes 
        of this computation.
The end result of this three-step formula is that the ultimate 
U.S. tax liability of a U.S. citizen who is a South African 
resident, with respect to an item of income, should not be less 
than the tax that would be paid if the individual were a South 
African resident and not a U.S. citizen.

Proposed treaty limitations on South African internal law

    Under the proposed treaty, United States taxes paid by 
South African residents in accordance with the proposed treaty 
will be allowed as a deduction against the South African taxes 
due under South African tax law. U.S. taxes imposed solely by 
reason of citizenship under the saving clause (Article 1, 
paragraph 4) are not covered by this rule. The proposed treaty 
specifies that the amount of the South African reduction from 
tax may not exceed an amount which bears to the total South 
African tax payable (before such reduction) the same ratio as 
the income concerned bears to the total income taxable in South 
Africa.

Article 24. Non-discrimination

    The proposed treaty contains a comprehensive 
nondiscrimination article relating to all taxes of every kind 
imposed at the national, state, or local level. It is similar 
to the nondiscrimination article in the U.S. model and other 
recent U.S. income tax treaties.
    In general, under the proposed treaty, one country cannot 
discriminate by imposing other or more burdensome taxes (or 
requirements connected with taxes) on nationals of the other 
country than it would impose on its nationals in the same 
circumstances. This provision applies whether or not the 
nationals in question are residents of the United States and/or 
South Africa. The proposed treaty specifies that a U.S. 
national who is subject to tax on a worldwide basis and a South 
African national who is not a resident of the United States are 
not deemed to be in the same circumstances for U.S. tax 
purposes.
    Under the proposed treaty, neither country may tax a 
permanent establishment or fixed base of an enterprise or 
resident of the other country less favorably than it taxes its 
own enterprise or resident carrying on the same activities. 
However, nothing in this article will be construed as 
preventing either country from imposing a branch profits tax 
(Article 10, paragraph 6). Consistent with the U.S. and OECD 
models, a country is not obligated to grant residents of the 
other country any personal allowances, reliefs, or reductions 
for tax purposes on account of civil status or family 
responsibilities which it grants to its own residents.
    Under the proposed treaty, each country is required 
(subject to the arm's-length pricing rules of Articles 9 
(Associated Enterprises), 11 (Interest), and 12 (Royalties)) to 
allow its residents to deduct interest, royalties, and other 
disbursements paid by them to residents of the other country 
under the same conditions that it allows deductions for such 
amounts paid to residents of the same country as the payor. The 
Technical Explanation states that the term ``other 
disbursements'' is understood to include a reasonable 
allocation of executive and general administrative expenses, 
research and development expenses, and other expenses incurred 
for the benefit of a group of related enterprises.
    The nondiscrimination rule also applies under the proposed 
treaty to enterprises of one country that are owned in whole or 
in part by residents of the other country. Enterprises resident 
in one country, the capital of which is wholly or partly owned 
or controlled, directly or indirectly, by one or more residents 
of the other country, will not be subjected in the first 
country to any taxation or any connected requirement which is 
other or more burdensome than the taxation and connected 
requirements that the first country imposes or may impose on 
its similar enterprises.
    U.S. internal law generally treats a corporation that 
distributes property in complete liquidation as realizing gain 
or loss as if the property had been sold to the distributee. 
If, however, 80 percent or more of the stock of the corporation 
is owned by another corporation, a nonrecognition rule applies 
and no gain or loss is recognized to the liquidating 
corporation. A special provision makes the nonrecognition 
provision inapplicable if the distributee is a foreign 
corporation (Code sec. 367(e)(2)). Even where the distributee 
is a foreign corporation resident in a treaty country, such 
treatment is not considered discriminatory, because absence of 
tax to the subsidiary in this case represents a complete 
elimination of U.S. tax jurisdiction over any appreciation, 
while a similar absence in the case of a domestic distributee 
simply shifts the appreciation into the hands of another U.S. 
taxpayer. 13 The Technical Explanation states that 
the application of Code section 367(e)(2) is consistent with 
the nondiscrimination article of the proposed treaty. The 
Technical Explanation states that a similar analysis applies to 
the treatment of section 355 distributions subject to section 
367(e)(1).
---------------------------------------------------------------------------
    \13\ See Notice 87-66, 1987-2 C.B. 376.
---------------------------------------------------------------------------
    U.S. internal law permits corporations that satisfy certain 
conditions to elect to be treated as a pass-through entity. If 
this so-called ``S corporation'' election is made, the 
corporation would not be subject to federal income tax on its 
profits at the entity level; instead, the individual 
shareholders of the corporation would be taxed directly on such 
profits. The election is only available if all of the 
shareholders of the corporation are U.S. citizens or residents. 
The Technical Explanation states that the S corporation 
provisions, including the rule that prevents a nonresident 
alien from being a shareholder of an S corporation, are not in 
conflict with the nondiscrimination provisions of the proposed 
treaty.
    U.S. internal law generally requires a partnership that 
engages in a U.S. trade or business to pay a withholding tax 
attributable to a foreign partner's share of the effectively-
connected income of the partnership. The withholding tax is not 
the final liability of the partner, but is a prepayment of tax 
which will be refunded to the extent it exceeds a partner's 
final U.S. tax liability. No withholding is required with 
respect to a U.S. partner's share of the effectively-connected 
income of the partnership. The Technical Explanation states 
that it is understood that the withholding tax is a reasonable 
collection mechanism, and that it is not in conflict with the 
nondiscrimination provisions of the proposed treaty.
    The saving clause (which allows the United States to tax 
its citizens or residents notwithstanding certain treaty 
provisions) does not apply to the nondiscrimination article.

Article 25. Mutual Agreement Procedure

    The proposed treaty contains the standard mutual agreement 
provision, with some variation, which authorizes the competent 
authorities of the United States and South Africa to consult 
together to attempt to alleviate individual cases of double 
taxation not in accordance with the proposed treaty. The saving 
clause of the proposed treaty does not apply to this article, 
so that the application of this article may result in a waiver 
(otherwise mandated by the proposed treaty) of U.S. taxing 
jurisdiction over its citizens or residents.
    Under this article, a resident of one country, who 
considers that the action of one or both of the countries 
results, or will result, in him or her paying a tax not in 
accordance with the proposed treaty, may present the case to 
the competent authority of either country. This provision is 
similar to the U.S. model, which also permits a person to bring 
his or her case to the competent authority of either country. 
Like the OECD model, the proposed treaty specifies that the 
case must be presented within three years from the first 
notification of the action giving rise to taxation not in 
accordance with the provisions of the proposed treaty. In the 
case of taxes withheld at source, the case must be brought 
within three years of the date of collection of the tax.
    The proposed treaty provides that a competent authority 
will make a determination as to whether the objection appears 
justified. If the objection appears to be justified and if the 
competent authority is not itself able to arrive at a 
satisfactory solution, then the competent authority will 
endeavor to resolve the case by mutual agreement with the 
competent authority of the other country, with a view to the 
avoidance of taxation which is not in accordance with the 
proposed treaty. The proposed treaty provides that any 
agreement is to be implemented even if such implementation 
would be barred by the statute of limitations or other 
procedural limitations, such as a closing agreement. The 
Technical Explanation states that in a case where a taxpayer 
has entered into a closing agreement or other written 
settlement with the United States prior to bringing a case to 
the competent authorities, the U.S. competent authority will 
endeavor only to obtain a correlative adjustment from South 
Africa and will not take any action that would otherwise change 
such agreements.
    The competent authorities of the countries are to endeavor 
to resolve by mutual agreement any difficulties or doubts 
arising as to the interpretation or application of the proposed 
treaty. The competent authorities of the countries may also 
consult together for the elimination of double taxation in 
cases not provided for in the proposed treaty.
    The proposed treaty authorizes the competent authorities to 
communicate with each other directly for purposes of reaching 
an agreement in the sense of this mutual agreement article. 
This provision makes clear that it is not necessary to go 
through diplomatic channels in order to discuss problems 
arising in the application of the proposed treaty. It also 
removes any doubt as to restrictions that might otherwise arise 
by reason of the confidentiality rules of the United States or 
South Africa. The proposed treaty specifies that the competent 
authorities, through consultations, will develop appropriate 
bilateral procedures, conditions, methods and techniques for 
the implementation of the mutual agreement procedures provided 
for in this article. The proposed treaty permits a competent 
authority to devise appropriate unilateral procedures, 
conditions, methods, and techniques to facilitate the bilateral 
actions taken by the competent authorities and the 
implementation of the mutual agreement procedures.
    The proposed treaty specifies that the competent 
authorities may agree on various issues including the 
attribution of income, deductions, credits, or allowances of a 
permanent establishment of an enterprise of a treaty country; 
the allocation of income, deductions, credits or allowances 
between persons; the characterization of particular items of 
income; the characterization of persons; the application of 
source rules with respect to particular items of income; and 
the common meaning of a term. The proposed treaty does not 
specify, as does the U.S. model, that the competent authorities 
may agree on advance pricing arrangements and the application 
of penalties, fines, and interest under internal law. However, 
the Technical Explanation states that the competent authorities 
may reach agreement on issues not enumerated in the proposed 
treaty if necessary to avoid double taxation.
    The saving clause (which allows the United States to tax 
its citizens or residents notwithstanding certain treaty 
provisions) does not apply to the mutual agreement article.

Article 26. Exchange of Information and Administrative Assistance

            Exchange of information
    The proposed treaty provides for the exchange of 
information necessary to carry out the provisions of the 
proposed treaty or of the specified tax laws of the two 
countries provided that taxation under those domestic laws is 
not contrary to the proposed treaty. The Technical Explanation 
states that the reference to information ``necessary'' to carry 
out the provisions of the proposed treaty is understood to be 
equivalent to the reference in the U.S. model to information 
that is ``relevant.'' Thus, a country requesting information 
should not be required to demonstrate that it would be disabled 
from enforcing its tax laws before it could obtain a particular 
item of information.
    The exchange of information is not restricted by Article 1 
(General Scope). Therefore, third-country residents are 
covered. Like the U.S. model, the proposed treaty permits 
information to be exchanged with respect to all taxes 
administered by the competent authorities of the countries. 
Thus, the taxes covered by the proposed treaty for purposes of 
the exchange of information article is broader than some other 
recent treaties, which limits the scope of the exchange of 
information provisions only to specified taxes covered under 
the treaty. The Committee understands that information to be 
exchanged under this article includes bank information. The 
proposed treaty explicitly excludes customs duties from the 
exchange of information provisions.
    Any information received by a country is to be treated as 
secret in the same manner as information obtained under the 
domestic laws of the country receiving the information. The 
exchanged information may be disclosed only to persons or 
authorities (including courts and administrative bodies) 
involved in the assessment, collection, administration, 
enforcement, prosecution or determination of appeals with 
respect to the taxes covered by the proposed treaty. The 
information exchanged may be used only for such purposes. 
14 The Technical Explanation states that the 
appropriate committees of the U.S. Congress and the U.S. 
General Accounting Office will be afforded access to 
information for use in the performance of their role in 
overseeing the administration of U.S. tax laws. Exchanged 
information may be disclosed in public court proceedings or in 
judicial decisions.
---------------------------------------------------------------------------
    \14\ Code section 6103 provides that otherwise confidential tax 
information may be utilized for a number of specifically enumerated 
non-tax purposes. Information obtained by the United States pursuant to 
this treaty could not be used for these non-tax purposes.
---------------------------------------------------------------------------
    As is true under the U.S. and OECD models, under the 
proposed treaty a country is not required to carry out 
administrative measures at variance with the laws and 
administrative practices of either country, to supply 
information which is not obtainable under the laws or in the 
normal course of the administration of either country, or to 
supply information which would disclose any trade, business, 
industrial, commercial, or professional secret or trade 
process, or information the disclosure of which would be 
contrary to public policy.
    Upon an appropriate request for information, the requested 
country is to obtain the information to which the request 
relates in the same manner and to the same extent as if the tax 
at issue were its own tax. Where specifically requested by the 
competent authority of one country, the competent authority of 
the other country will provide information in the form of 
depositions of witnesses and authenticated copies of unedited 
original documents (including books, papers, statements, 
records, accounts, and writing) to the same extent that they 
can be obtained under the laws and administrative practices of 
such other country with respect to its own taxes.
    The proposed treaty provides that the competent authority 
of a requested country will allow representatives of a 
requesting country to enter the requested country to interview 
individuals and examine books and records with the consent of 
the persons subject to the examination.
            Assistance in collection
    The proposed treaty provides for each of the countries to 
endeavor to collect taxes on behalf of the other country as may 
be necessary to ensure that treaty benefits do not inure to the 
benefits of persons not entitled to such benefits. Similar to 
the U.S. model, the collection provision does not impose on 
either treaty country the obligation to carry out 
administrative measures of a different nature from those used 
in the collection of its own taxes, or that would be contrary 
to its sovereignty, security, or public policy.

Article 27. Diplomatic Agents and Consular Officers

    The proposed treaty contains the rule found in the U.S. 
model and other U.S. tax treaties that its provisions are not 
to affect the fiscal privileges of members of diplomatic 
missions or consular posts under the general rules of 
international law or the provisions of special agreements. 
Accordingly, the proposed treaty will not defeat the exemption 
from tax which a host country may grant to the salary of 
diplomatic officials of the other country. The saving clause 
does not apply in the application of this article to U.S. 
residents who are neither U.S. citizens nor green-card holders. 
Thus, South African diplomats who are considered U.S. residents 
generally may be protected from U.S. tax.

Article 28. Entry Into Force

    The proposed treaty provides that the countries must notify 
each other that the constitutional requirements for the entry 
into force of the proposed treaty has been complied with. The 
Technical Explanation states that these constitutional 
requirements include ratification of the proposed treaty.
    The proposed treaty will enter into force thirty days after 
the date on which the second of the two notifications of the 
completion of the constitutional requirements have been 
received. With respect to taxes payable at source, the proposed 
treaty will be effective for amounts paid or credited on or 
after the first day of January in the year following the date 
of entry into force. With respect to other taxes, the proposed 
treaty will be effective for taxable periods beginning on or 
after that first day of January.

Article 29. Termination

    The proposed treaty will continue in force until terminated 
by a treaty country. Either country may terminate it through 
diplomatic channels by giving notice at least six months before 
the end of any calendar year starting five years after the year 
the treaty has entered into force. A similar termination rule 
is contained in many other U.S. tax treaties. With respect to 
taxes payable at source, a termination will be effective for 
amounts paid or credited on or after the first day of January 
following the year in which notice of termination is given. 
With respect to other taxes, a termination will be effective 
for taxable periods beginning on or after the first day of 
January following the year in which such notice of termination 
is given.

               IX. Text of the Resolution of Ratification

    Resolved, (two-thirds of the Senators present concurring 
therein), That the Senate advise and consent to the 
ratification of the Convention between the United States of 
America and the Republic of South Africa for the Avoidance of 
Double Taxation and the Prevention of Fiscal Evasion with 
Respect to Taxes on Income and Capital Gains, signed at Cape 
Town February 17, 1997 (Treaty Doc. 105-9), subject to the 
declaration of subsection (a), and the proviso of subsection 
(b).
    (a) DECLARATION.--The Senate's advice and consent is 
subject to the following declaration, which shall be binding on 
the President:
          (1) TREATY INTERPRETATION.--The Senate affirms the 
        applicability to all treaties of the constitutionally 
        based principles of treaty interpretation set forth in 
        Condition (1) of the resolution of ratification of the 
        INF Treaty, approved by the Senate on May 27, 1988, and 
        Condition (8) of the resolution of ratification of the 
        Document Agreed Among the States Parties to the Treaty 
        on Conventional Armed Forces in Europe, approved by the 
        Senate on May 14, 1997.
    (b) PROVISO.--The resolution of ratification is subject to 
the following proviso, which shall be binding on the President:
          (1) SUPREMACY OF THE CONSTITUTION.--Nothing in the 
        Treaty requires or authorizes legislation or other 
        action by the United States of America that is 
        prohibited by the Constitution of the United States as 
        interpreted by the United States.

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