[Senate Executive Report 105-7]
[From the U.S. Government Publishing Office]



105th Congress                                               Exec. Rpt.
                                 SENATE

 1st Session                                                      105-7
_______________________________________________________________________


 
                    TAXATION CONVENTION WITH AUSTRIA

                                _______
                                

                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. 104-31]

    The Committee on Foreign Relations, to which was referred 
the Convention between the United States of America and the 
Republic of Austria for the Avoidance of Double Taxation and 
the Prevention of Fiscal Evasion with Respect to Taxes on 
Income, signed at Vienna on May 31, 1996, having considered the 
same, reports favorably thereon, with one understanding, two 
declarations, 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...................................................19
VIII.Explanation of Proposed Treaty..................................19

 IX. Text of of the Resolution of Ratification.......................67

                               I. Purpose

    The principal purposes of the proposed income tax treaty 
between the United States and Austria 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 continue 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 May 31, 1996. The United 
States and Austria also exchanged notes, with an attached 
Memorandum of Understanding (the ``MOU''), on May 31, 1996. The 
proposed treaty would replace the existing income tax treaty 
between the two countries that was signed in 1956.
    The proposed treaty was transmitted to the Senate for 
advice and consent to its ratification on September 4, 1996 
(see Treaty Doc. 104-31). 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.
---------------------------------------------------------------------------
    As in other U.S. tax treaties, the proposed treaty's 
objective of reducing or eliminating 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 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 22).
    The proposed treaty contains the standard provision (the 
``saving clause'') contained in U.S. tax treaties pursuant to 
which each country retains the right to tax its citizens and 
residents as if the proposed 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 
proposed treaty (Article 16).

                  IV. Entry Into Force and Termination

                          A. Entry into Force

    The proposed treaty provides that the instruments of 
ratification are to be exchanged as soon as possible. The 
proposed treaty will enter into force on the first day of the 
second month following the exchange of instruments of 
ratification. The present treaty generally ceases to have 
effect once the provisions of the proposed treaty take effect.
    In the case of taxes payable at source, the proposed treaty 
takes effect for payments made on or after the first day of the 
second month following the entry into force (i.e., the first 
day of the fourth month following the exchange of instruments 
of ratification). In the case of other taxes, the proposed 
treaty takes effect for taxable years and periods beginning on 
or after the first of January following the entry into force.
    Taxpayers may elect temporarily to continue to claim 
benefits under the present treaty with respect to a period 
after the proposed treaty takes effect. For such a taxpayer, 
the present treaty continues to have effect in its entirety for 
the first assessment period or taxable year from the date on 
which the provisions of the proposed treaty would otherwise 
take effect.

                             B. Termination

    The proposed treaty will continue in force until terminated 
by a treaty country. Either country may terminate it at any 
time after five years from the date of its entry into force by 
giving at least six months prior written notice through 
diplomatic channels. With respect to taxes payable at source, a 
termination will be effective for payments made after the end 
of the calendar year in which such notice has been given. With 
respect to other taxes, a termination will be effective for 
taxable years and periods beginning after the end of the 
calendar year in which the notice has been given.

                          V. Committee Action

    The Committee on Foreign Relations held a public hearing on 
the proposed treaty with Austria (Treaty Doc. 104-31), 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 Austria 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 an understanding, two declarations 
and a proviso.

                         VI. Committee Comments

    On balance, the Committee on Foreign Relations believes 
that the proposed treaty with Austria 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\ The proposed treaty, like many treaties, allows 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.
---------------------------------------------------------------------------
    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 such as the present 
treaty with Austria, 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
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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' 
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 investment 
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. In addition, 
the Treasury Department has committed to use its best efforts 
to negotiate a protocol with Austria to amend the proposed 
treaty to incorporate this policy.
    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 
encourages the Treasury Department to act expeditiously in 
meeting its commitment to negotiate a protocol with Austria 
that incorporates this new policy, and the Committee believes 
that negotiating such a protocol with Austria should take 
priority over negotiating similar protocols with other 
countries.

                             B. Stock Gains

    Under U.S. internal law, gains realized by a nonresident 
alien or a foreign corporation from the disposition of a 
capital asset, other than a U.S. real property interest, 
generally are not subject to U.S. tax unless the gain is 
effectively connected with a U.S. trade or business. The U.S. 
model and the OECD model reflect this policy. Under these model 
treaties, such gains derived by a resident of a treaty country 
from sources within the other country generally are taxed only 
by the recipient's country of residence (except gains connected 
with a real estate interest or a permanent establishment or a 
fixed base). In other words, a U.S. investor who realizes 
capital gain in a treaty country generally is taxable only by 
the United States.
    The proposed treaty provides an exception to the above 
general rule. Under the proposed treaty, if a U.S. resident 
transfers property to an Austrian company as a capital 
contribution and, pursuant to the Austrian Reorganization Act 
(``Umgrundungssteuergesetz''), the transfer is not subject to 
Austrian tax, a subsequent ``alienation'' of the shares in the 
Austrian company will be taxable in Austria if such alienation 
occurs through the year 2010. According to the Treasury 
Department's Technical Explanation of the proposed treaty 
(hereinafter referred to as the ``Technical Explanation''), 
this rule applies to the disposition of stock of an Austrian 
company that was received upon the incorporation of a permanent 
establishment in Austria if the capital gains inherent in the 
property transferred to the Austrian company were not taxed at 
the time of the incorporation.
    The term ``alienation'' is defined broadly for this purpose 
to include any transfer of property. 4 For example, 
a subsequent contribution of the stock of the Austrian company 
that is the transferee of the property (from the U.S. 
transferor) to the capital of another company would constitute 
an alienation, and the appreciation in the stock of the 
Austrian company would be subject to Austrian tax under the 
proposed treaty.
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    \4\ Thus, a transfer may qualify as an alienation for Austrian tax 
purposes even though such transfer qualifies as a nonrecognition 
transaction for U.S. tax purposes.
---------------------------------------------------------------------------
    This provision could be viewed as a one-sided concession by 
the United States that is inconsistent with the preferred U.S. 
tax treaty position which, as stated above, generally grants 
the residence country the exclusive right to tax non-business 
capital gains derived by its residents from the other country.
    In addition, the provision also creates a potential double 
taxation problem for the U.S. taxpayer that transferred 
property to an Austrian company as a capital contribution. In 
the event that a subsequent transfer of the stock of such an 
Austrian company is treated as an ``alienation'' for Austrian 
tax purposes, the transfer would be taxable in Austria. 
However, if the subsequent transfer qualifies as a tax-free 
transaction in the United States, it would not be taxable in 
the year of the transfer and the U.S. tax on the appreciation 
in the stock of the Austrian company would be deferred until a 
later year. Consequently, the Austrian tax paid with respect to 
this transfer may not be available to offset the U.S. tax on 
the gain in the stock of the Austrian company (imposed in a 
subsequent year when the gain on such stock is recognized in a 
taxable transaction for U.S. tax purposes). 5
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    \5\ However, the Austrian tax paid may be carried back two years or 
carried forward five years to offset U.S. tax imposed on a similar type 
of foreign-source income under U.S. internal law.
---------------------------------------------------------------------------
    In the event that the transfer is treated as an 
``alienation'' for Austrian tax purposes, and if the transfer 
is taxable in the United States and Austria in the same year, 
double taxation still may occur because the gain generally is 
treated as U.S.-source income. 6 Under the U.S. 
foreign tax credit rules, foreign taxes paid or accrued by a 
taxpayer are allowed to reduce only U.S. taxes on foreign-
source income. Consequently, the Austrian taxes paid on the 
transfer of the stock of the Austrian subsidiary would not be 
allowed to reduce the U.S. gain from the same transaction, 
resulting in double taxation of the same gain, unless other 
relief is available. 7
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    \6\ Under certain circumstances, such gain may, however, qualify as 
foreign-source income.
    \7\ The Technical Explanation states that it is expected that any 
such double taxation would be addressed by the competent authorities.
---------------------------------------------------------------------------
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the provision 
in the proposed treaty is appropriate as a matter of U.S. 
treaty policy. The relevant portion of the Treasury 
Department's October 8, 1997 letter 8 responding to 
this inquiry is reproduced below:
---------------------------------------------------------------------------
    \8\ Letter from Joseph H. Guttentag, International Tax Counsel, 
Treasury Department, to Senator Paul Sarbanes, Committee on Foreign 
Relations, October 8, 1997 (``October 8, 1997 Treasury Department 
letter'').

    [O]ur current tax convention with Austria (which dates from 
1957) has no provision reserving to the residence country the 
right to source gain from the disposition of shares. Therefore, 
Austria now has the right to tax such gain. In the proposed 
treaty, Austria was willing to adopt a provision that gives up 
its right to tax stock gains at source. In securing this 
concession from Austria, we agreed to a transition rule in the 
pending convention preserving Austria's right to tax gain 
through the year 2010--a rule covering a very limited number of 
cases. This transition rule is limited to the disposition of 
stock that was received on the incorporation of a permanent 
establishment in Austria if the capital gains were not taxed on 
the incorporation of the subsidiary.
    We do not consider this provision to be a one-sided 
concession. Rather we believe that accepting the limited 
transition rule in the treaty was necessary in order to move 
over the long run to a provision that is fully consistent with 
U.S. tax treaty policy. We believe that our acceptance of such 
a transition rule in this case will not be misconstrued as a 
retreat from our support for the position we take in the U.S. 
Model.

    Although the proposed treaty represents a limited departure 
from U.S. tax treaty policy, the Committee believes that the 
provision represents a substantial improvement from the present 
treaty. This provision should not stand as a model for other 
treaty negotiations, however. In negotiating future treaties, 
the Treasury Department should continue to seek provisions that 
conform more closely to the U.S. model in generally providing 
for exclusive residence-country taxation of stock gains.

                              C. Royalties

    The present treaty contains a two-tier limitation on 
source-country taxation of royalties: (1) royalty payments for 
motion picture film rentals may be taxed by the source country 
at a rate of 10 percent; and (2) all other royalty payments are 
exempt from source-country taxation. The proposed treaty 
maintains the two-tier limitation of the present treaty, but 
modifies the treatment of royalties in two ways.
    First, the proposed treaty modifies the definition of the 
term ``royalties'' to exclude rentals and like payments for the 
use of industrial, commercial or scientific equipment. Such 
payments generally are treated as business profits under the 
proposed treaty. 9 Consequently, a U.S. resident 
would not be subject to Austrian income tax on amounts paid for 
the use of industrial, commercial or scientific equipment in 
Austria unless such amounts are attributable to a permanent 
establishment that the U.S. resident has in Austria. If the 
amounts are attributable to an Austrian permanent 
establishment, then the U.S. resident would be subject to 
Austrian tax on such amounts in the same manner that an 
Austrian resident that derives the same income would be taxed.
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    \9\ See 1992 OECD Commentary on Article 12, paragraph 9.
---------------------------------------------------------------------------
    Second, the proposed treaty expands the class of royalty 
payments that are subject to the 10-percent source-country 
taxation. Under the present treaty, only motion picture film 
rentals are subject to source-country taxation. Under the 
proposed treaty, source-country taxation also applies to 
payments for the use of, or the right to use, tapes or other 
means of reproduction used for radio or television 
broadcasting. Consequently, a significantly expanded class of 
Austrian-source royalties beneficially owned by U.S. residents 
will be subject to a 10-percent Austrian withholding tax under 
the proposed treaty. Such withholding taxes generally may be 
allowed to reduce the U.S. income tax imposed on the same or 
similar income. Accordingly, this increased class of Austrian 
royalty payments that are subject to a creditable 10-percent 
Austrian tax represents an expansion of the instances in which 
the United States cedes its taxing jurisdiction to Austria.
    By contrast, U.S. treaty policy, as reflected in the U.S. 
model and in many U.S. treaties with developed nations, 
generally would eliminate the source-country tax on royalties. 
The Committee noted during its consideration of the present 
treaty in 1957 that the treaty ``differs from a number of other 
tax treaties which provide a complete exemption for film 
rentals.''
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the expansion 
under the proposed treaty of the 10-percent source-country tax 
on royalties is appropriate as a matter of U.S. treaty policy. 
The relevant portion of the October 8, 1997 Treasury Department 
letter responding to the inquiry is reproduced below:

    Because we had accepted the 10-percent rate at source on 
movie royalties under the current U.S.-Austria tax convention 
and because we wanted to improve the current tax treaty in 
several other respects, we concluded that the best approach 
under the circumstances was to continue to accept the provision 
on film royalties. Realistically, because of technological and 
economic developments, this meant extending the rule to include 
radio and television broadcasting royalties. For example, it 
would be administratively difficult to distinguish between 
royalties relating to different broadcasting rights. In 
addition, distinguishing among these sectors would have created 
an uneven playing field within the entertainment industry. In 
negotiating the provision, we not only took into account the 
royalty income flows between our two countries but recognized 
that many of Austria's treaties, including several with OECD 
member countries, retain some source-country tax rights for 
royalties.

Although the Committee understands the reasons for expanding 
source-country taxation for royalties in this case, the 
Committee remains concerned that this provision represents a 
significant step backward from the present treaty. Its effect 
will be to cede taxing jurisdiction from the United States to 
Austria. The Committee believes that in updating existing tax 
treaties the Treasury Department should reject changes that 
would lessen the treaty's overall benefit to the United States. 
The Committee also is concerned by the precedent this provision 
may present for future treaty partners that may seek provisions 
allowing source-country taxation of royalties. Although the 
Committee does not believe that the treatment of such royalties 
warrants a reservation to, or rejection of, the proposed 
treaty, such a provision could be cause for such action in 
future treaties, particularly treaties with OECD member 
countries. The Treasury Department should continue to seek 
provisions that conform more closely to the U.S. model in 
exempting royalties from source-country taxation.

                       D. Exchange of Information

    One of the principal purposes of the proposed income tax 
treaty between the United States and Austria is to prevent 
avoidance or evasion of income taxes of the two countries. The 
exchange of information article of the proposed treaty is one 
of the primary vehicles used to achieve that purpose.
    The exchange of information article contained in the 
proposed treaty generally conforms to the corresponding 
articles of the U.S. and OECD models. As is true under these 
model treaties and the present treaty, 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 discloses any trade, business, industrial, commercial, or 
professional secret or trade process, or information the 
disclosure of which is contrary to public policy. The MOU 
provides that provisions on bank secrecy do not constitute a 
professional, trade, business, industrial, or commercial 
secret.
    The Technical Explanation states that Austrian bank secrecy 
laws prohibit Austrian tax authorities from obtaining 
information from Austrian banks for their own non-penal tax 
investigations and proceedings. Consequently, the Austrian 
competent authority generally would not be able to provide such 
information upon the request of the U.S. competent authority in 
connection with a non-penal tax investigation or proceeding in 
the United States. However, the proposed treaty provides that 
the Austrian competent authority may obtain Austrian bank 
information in connection with a U.S. penal investigation. 
According to the MOU, the term ``penal investigations'' applies 
to proceedings carried out by either judicial or administrative 
bodies, such as the commencement of a criminal investigation by 
the Criminal Investigation Division of the Internal Revenue 
Service (the ``IRS''). Therefore, this special provision 
enables the United States to obtain Austrian bank information 
in connection with criminal investigations without violating 
Austrian internal law. However, as under the present treaty, 
because of Austrian internal law, the United States may not 
obtain Austrian bank information in situations that are not in 
connection with a criminal investigation.
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department about the adequacy of 
the exchange of information provisions in the proposed treaty. 
The relevant portion of the October 8, 1997 Treasury Department 
letter is reproduced below:

    [T]he proposed treaty improves the ability of the United 
States to obtain information for the enforcement of U.S. tax 
laws and the prevention of tax avoidance and evasion. We were 
able to obtain assurance from Austria that the commencement of 
a criminal investigation by the Criminal Investigation Division 
of the Internal Revenue Service constitutes a penal 
investigation under Austrian domestic law. The establishment of 
a clear point for obtaining account information at a stage that 
is early enough to be useful in key cases is a major step 
forward under our pending treaty. Further, under our pending 
treaty, Austria is undertaking to do something else that it has 
not done for any other treaty partner. Austria will use its 
power of search and seizure in connection with a penal 
proceeding to obtain information under our pending treaty in 
connection with a penal proceeding in the United States.

    Although broader exchange of information provisions are 
desirable, the Committee understands the difficulty in 
achieving broader provisions given the current constraints of 
Austrian law and practices. Moreover, the Committee understands 
that the information exchange provisions of the proposed treaty 
represent a significant improvement over those of the present 
treaty. However, the Committee does not believe that the 
proposed Austrian treaty should be construed in any way as a 
precedent for other negotiations. The exchange of information 
provisions in treaties are central to the purposes for which 
tax treaties are entered into, and significant limitations on 
their effect, relative to the preferred U.S. tax treaty 
position, should not be accepted in negotiations with other 
countries that seek to have or to maintain the benefits of a 
tax treaty relationship with the United States.

                           E. OECD Commentary

    The MOU includes a special provision with respect to the 
interpretation of the proposed treaty. Under this provision, 
the OECD Commentary is to apply in interpreting any provision 
of the proposed treaty that corresponds to a provision of the 
OECD model. However, this general rule does not apply if either 
the United States or Austria has entered into a reservation or 
has included an observation with respect to the OECD model or 
its Commentary. In addition, this rule also does not apply if a 
contrary interpretation is included in the MOU, or a published 
interpretation of the proposed treaty (e.g., the Technical 
Explanation) has been provided by one country to the competent 
authority of the other country before the proposed treaty 
enters into force, or has been agreed to by the competent 
authorities after the proposed treaty has entered into force. 
In other words, unless specifically stipulated by either or 
both countries, the relevant OECD Commentary generally is 
controlling in the interpretation of provisions of the proposed 
treaty.
    The proposed treaty contains the standard provision that 
unless the context otherwise requires or the competent 
authorities of the two countries establish a common meaning, 
all terms not defined in the treaty are to have the meanings 
which they have under the laws of the country applying the 
treaty (Article 3, paragraph 2 (General Definitions)). Because 
this standard provision is part of the text of the proposed 
treaty, it overrides the provisions of the MOU in the event of 
a conflict. Thus, for example, if a term of the proposed treaty 
is not defined in the treaty, but is defined in U.S. internal 
law, and the same term also is defined in the OECD Commentary, 
and the United States and Austria have not stipulated 
otherwise, the definition provided by U.S. internal law would 
control.
    Other U.S. income tax treaties and protocols occasionally 
have required that a specific provision of an income tax treaty 
be interpreted in accordance with the OECD Commentary to the 
corresponding provision of the OECD model. 10 
However, no U.S. treaty has ever required the treaty countries 
to interpret the provisions of the treaty broadly in accordance 
with the OECD Commentary.
---------------------------------------------------------------------------
    \10\ For example, Provision 19 of the Protocol to the 1990 U.S.-
Spain income tax treaty requires the two countries to interpret Article 
27 (Exchange of Information and Administrative Assistance) of that 
treaty in a manner consistent with the Commentary to the corresponding 
provision of the 1977 OECD model treaty.
---------------------------------------------------------------------------
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the self-
executing nature of this provision could have the effect of 
modifying the substantive rules of the proposed treaty without 
the usual ratification procedures of either country. The 
relevant portion of the October 8, 1997 Treasury Department 
letter responding to this inquiry is reproduced below:

    This provision cannot create a substantive amendment to the 
proposed convention as adopted by both countries under their 
usual ratification procedures. Rather the provision utilizes an 
additional tool (the OECD Commentary) in interpreting the 
provisions of the Convention. The OECD Commentary would be 
useful in interpreting most of the provisions of the proposed 
Convention to a greater or lesser extent. Of course, the MOU 
and the Treasury Technical Explanation have precedence over the 
OECD commentaries, now and in the future.
    Neither country is bound by OECD Commentary to the extent 
that its disagreement with the Commentary is indicated at any 
time by observation or reservation. Therefore, the United 
States is not required to interpret a provision in a manner 
inconsistent with U.S. law or U.S. tax treaty policy. However, 
the ability to enter a reservation or observation to the OECD 
Commentary does not give either party a unilateral right to 
override the treaty because one country's reservation or 
observation does not bind the other. If the OECD Commentary, 
because of observations, and other interpretive sources do not 
resolve an issue, the competent authorities may attempt to do 
so.

    The Committee understands that the proposed treaty, as 
interpreted by the MOU, does not permit either country to make 
substantive amendments to the proposed treaty without 
ratification. The Committee also understands that the provision 
does not permit the OECD Commentary to override U.S. law or 
U.S. tax treaty policy. In order to make this point clear, the 
Committee has included in its recommended resolution of 
ratification an understanding regarding the ability of the 
United States to enter a reservation or observation to the OECD 
model or its Commentary at any time.

       F. Income from Sleeping Partnerships (Stille Gesellschaft)

    The proposed treaty contains a special rule which treats 
income derived from an Austrian ``sleeping partnership'' 
(Stille Gesellschaft) by a U.S. ``sleeping partner'' as 
business profits attributable to the permanent establishment of 
the partnership in Austria. According to the Technical 
Explanation, there are two types of sleeping partnerships under 
Austrian tax law: the ``typical'' form and the ``non-typical'' 
form. The profits of a sleeping partner in a typical sleeping 
partnership generally are treated as income from investment 
activities for Austrian tax purposes. On the other hand, the 
profits of a sleeping partner of a non-typical sleeping 
partnership are treated as income from commercial activities 
for Austrian tax purposes. Whether a particular sleeping 
partnership should be characterized as typical or non-typical 
under Austrian tax law may not be clear.
    German internal law also provides for sleeping 
partnerships. The 1989 U.S.-Germany income tax treaty provides 
that income from a sleeping partnership may be taxed in 
accordance with internal German tax law, without regard to the 
reduction in the tax rate otherwise applicable to dividends 
provided by that treaty, if such amount is deductible in 
computing the profits of the sleeping partnership. 
11
---------------------------------------------------------------------------
    \11\ See Article 10(5) of the 1989 U.S.-Germany income tax treaty.
---------------------------------------------------------------------------
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the proposed 
treaty's characterization of the profits from an Austrian 
sleeping partnership as business profits is appropriate, given 
that the U.S.-Germany treaty provides for different treatment 
of profits from similar entities under German law. The relevant 
portion of the October 8, 1997 Treasury Department letter 
responding to this inquiry is reproduced below:

    The domestic laws of Germany and Austria differ in how they 
tax income from one form of silent or sleeping partnership--the 
typical sleeping partnership. Austria requires a nonresident 
sleeping partner to declare the income and imposes tax on the 
income on a net basis. Germany imposes a withholding tax in 
full and final settlement of the sleeping partner's tax 
liability. The German and the pending Austrian treaty reflect 
this difference in their treatment of income from a typical 
sleeping partnership.
    Under the proposed Austrian treaty, in the case of either 
type of sleeping partnership arrangement (typical or non-
typical), there is only one level of tax imposed on the income. 
In the typical sleeping partnership arrangement, the income of 
the silent partner is deductible to the other partner; and, in 
the non-typical sleeping partnership arrangement, the other 
partner is entitled to exclude from income the amounts 
allocable to the silent partner.

As described above, profits from Austrian sleeping partnerships 
generally are taxed on a net basis under Austrian law, similar 
to the treatment of business profits under the proposed treaty. 
Accordingly, the Committee believes that the treatment of 
profits from Austrian sleeping partnerships under the proposed 
treaty as business profits is appropriate.

                           G. Treaty Shopping

In general

    The proposed treaty, like a number of U.S. income tax 
treaties, generally limits treaty benefits for treaty country 
residents so that only those residents with a sufficient nexus 
to a treaty country will receive treaty benefits. Although the 
proposed treaty generally is intended to benefit residents of 
Austria 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 reduce the tax on interest on a loan to a 
U.S. person by lending money to the U.S. person indirectly 
through a country whose treaty with the United States provides 
for a lower rate of withholding tax on interest. The third-
country investor may attempt to do this by establishing in that 
treaty country a subsidiary, trust, or other entity which then 
makes the loan to the U.S. person and claims the treaty 
reduction for the interest it receives.
    The anti-treaty-shopping provision of the proposed treaty 
is similar to anti-treaty-shopping provisions in the Internal 
Revenue Code (the ``Code''), as interpreted by Treasury 
regulations, and in several recent treaties. Some aspects of 
the provision, however, differ from the anti-treaty-shopping 
provision in the U.S. model. In its details, the proposed 
treaty resembles the 1993 U.S. treaty with the Netherlands and 
the 1995 U.S. treaty with France. The degree of detail included 
in this provision is notable in itself. The proliferation of 
detail may reflect, in part, a diminution in the scope afforded 
the IRS and the courts in the anti-treaty-shopping provisions 
of most previous U.S. treaties to resolve interpretive issues 
adversely to a person attempting to claim the benefits of the 
treaty; this diminution represents a bilateral commitment, not 
alterable by developing internal U.S. tax policies, rules, and 
procedures, unless enacted as legislation that would override 
the treaty. (To the same extent as is provided under other 
treaties, the IRS generally is not limited under the proposed 
treaty in its discretion to allow treaty benefits under the 
anti-treaty-shopping rules.) The detail in the proposed treaty 
does represent added guidance and certainty for taxpayers that 
may be absent under other treaties, although in many other U.S. 
treaties the negotiators have chosen to forego such additional 
guidance in favor of somewhat simpler and more flexible 
provisions.

Analysis of provisions

    One provision of the anti-treaty-shopping article differs 
from the comparable rule of some earlier U.S. treaties, but the 
effect of the change is not completely clear. The general test 
applied by those earlier treaties for the allowance of benefits 
to an entity that does not meet the bright-line ownership and 
base erosion tests is a broadly subjective one, turning on 
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 denies the benefits of the treaty only 
in cases where the income is not derived in connection with, or 
incidental to, the active conduct of a trade or business. 
12 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.
---------------------------------------------------------------------------
    \12\ However, this active trade or business test does not apply 
with respect to a business of making or managing investments carried on 
by a person other than a bank or insurance company, so that treaty 
benefits may be denied with respect to such a business regardless of 
whether it is an active trade or business.
---------------------------------------------------------------------------
    Although the proposed treaty's active business test is 
similar to that of other U.S. tax treaties, the proposed treaty 
provides greater detail than other treaties. In some cases, the 
proposed treaty mirror provisions in the branch tax 
regulations, but may be more generous to taxpayers. In 
addition, like some recent U.S. treaties, the proposed treaty 
attributes to the treaty resident active trades or businesses 
conducted by other entities. The attribution rules in the 
proposed treaty may result in more taxpayers being eligible for 
treaty benefits, and permit certain third-country business 
operations to be treated as if they were carried on in Austria. 
These rules are similar to those in the U.S.-Netherlands treaty 
and the U.S.-France treaty.
    The proposed treaty includes a special rule designed to 
prevent the proposed treaty from reducing or eliminating U.S. 
tax on income of an Austrian resident in a case where no other 
substantial tax is imposed on that income (the so-called 
``triangular case''). This is necessary because an Austrian 
resident in some cases may be wholly or partially exempt from 
Austrian tax on foreign (i.e., non-Austrian) income. The 
special rule applies generally if the combined Austrian and 
third-country taxation of third-country income earned by an 
Austrian enterprise with a permanent establishment in the third 
country is less than 60 percent of the tax that would be 
imposed if the income were subject to tax in Austria.
    Under the special rule, the United States is permitted to 
tax U.S.-source interest and royalties paid to the third-
country permanent establishment in accordance with its internal 
law without regard to the treaty. There are several exceptions 
to this special rule. Under one of the exceptions, the special 
rule does not apply if the income is subject to U.S. taxation 
under the controlled foreign corporation rules. 13 
The special rule for triangular cases is not included in the 
U.S. model.
---------------------------------------------------------------------------
    \13\ These provisions are contained in sections 951-964 of the Code 
(referred to as the ``subpart F'' rules).
---------------------------------------------------------------------------
    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 October 8, 1997 Treasury Department 
letter responding to this inquiry is reproduced below:

    Unlike the existing Convention, the proposed Convention 
with Austria contains a comprehensive anti-treaty-shopping 
provision. A Memorandum of Understanding provides an 
interpretation of key terms. Austria's recent membership in the 
European Union and the special United States ties to Canada and 
Mexico under the North American Free Trade Agreement are an 
element in the determination by the competent authority of 
eligibility for benefits of certain Austrian and United States 
companies. Recognized headquarters companies of multinational 
corporate groups are entitled to benefits of the Convention 
under rules that are substantively identical to the parallel 
rule in the U.S.-France treaty reviewed by the Committee in 
1995.
    The proposed Convention also provides for the elimination 
of another potential abuse relating to the granting of United 
States treaty benefits in the so-called triangular cases to 
income of an Austrian resident attributable to third-country 
permanent establishments of Austrian corporations that are 
exempt from tax in Austria by operation of Austria's law or 
treaties. Under the proposed rule, full United States treaty 
benefits will be granted in these triangular cases only when 
the United States-source income is subject to a sufficient 
level of tax in Austria and in the third country. As in the 
U.S.-France treaty, this anti-abuse rule does not apply in 
certain circumstances, including when the United States taxes 
the profits of the Austrian enterprise under subpart F of the 
Internal Revenue Code.

Committee Conclusions

    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 further believes 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 Austria 
since third-country investors may be unwilling to share 
ownership of such investing entities on a less-than-50-percent 
basis with U.S. or Austrian 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 an Austrian 
conduit. Finally, Austria imposes significant taxes of its own; 
these taxes may deter third-country investors from seeking to 
use Austrian 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 Austria is 
presented below. The MOU agreed to by the negotiators, and 
other matters set forth in diplomatic notes exchanged at the 
time the proposed treaty was signed, are covered together with 
the relevant articles of the proposed treaty.

Article 1. Personal Scope

    The personal scope article describes the persons who may 
claim the benefits of the proposed treaty.
            Overview
    The proposed treaty generally applies to residents of the 
United States and to residents of Austria, with specific 
modifications to such scope in other articles (e.g., Articles 
23 (Non-discrimination) and Article 25 (Exchange of Information 
and Administrative Assistance)).
    The proposed treaty provides that it generally does not 
restrict any exclusion, exemption, deduction, credit or other 
allowance accorded by internal law or by any other agreement 
between the United States and Austria. Thus, the proposed 
treaty will apply only where it benefits taxpayers. As 
discussed below in 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 Austria 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 incurs 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. 
14
---------------------------------------------------------------------------
    \14\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
---------------------------------------------------------------------------
            Coordination with dispute resolution procedures of other 
                    agreements
    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 Austria 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 Austria, generally apply to that 
law or other 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 would continue to 
apply with respect to trade in goods. For purposes of this 
provision, the term ``measure'' means a law, regulation, rule, 
procedure, decision, administrative action, or any other form 
of measure.
            Saving clause
    Like all U.S. income tax treaties, the proposed treaty is 
subject to a ``saving clause.'' Under this clause, with 
specific exceptions described below, the proposed treaty is not 
to affect the taxation by either treaty country 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 Austria as if the proposed 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 
tie-breaker provisions governing dual residents (as defined in 
Article 4 (Resident)).
    Like the U.S. model, 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 whose 
loss of citizenship 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. Prior to the 
enactment of the Health Insurance Portability and 
Accountability Act of 1996, section 877 of the Code provided 
special rules for the imposition of U.S. income tax on former 
U.S. citizens for a period of ten years following the loss of 
citizenship; these special tax rules applied to a former 
citizen only if his or her loss of U.S. citizenship had as one 
of its principal purposes the avoidance of U.S. income, estate 
or gift taxes. The Health Insurance Portability and 
Accountability Act of 1996 expanded section 877 in several 
respects. Under these amendments, the special income tax rules 
of section 877 were extended to apply also to certain former 
long-term residents of the United States. 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. In 
addition, an expanded foreign tax credit is provided with 
respect to the U.S. tax imposed under these rules. The 
amendments to section 877 generally are applicable to 
individuals whose loss of U.S. citizenship or U.S. resident 
status occurred on or after February 6, 1995. The proposed 
treaty provision reflects the reach of the U.S. tax 
jurisdiction pursuant to section 877 prior to its expansion by 
the Health Insurance Portability and Accountability Act of 
1996. Accordingly, the saving clause in the proposed treaty 
does not permit the United States to impose tax on former U.S. 
long-term residents who otherwise would be subject to the 
special income tax rules contained in the Code.
    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 
the other country (Article 9, paragraph 2); exemption from 
residence-country tax (or in the case of the United States, 
citizenship country tax) on gain accrued from the disposition 
of certain business assets (Article 13, paragraph 4); exemption 
from residence-country tax (or in the case of the United 
States, citizenship country tax) on social security benefits 
and alimony (Article 18, paragraphs 1(b) and 3); relief from 
double taxation (Article 22); nondiscrimination (Article 23); 
and mutual agreement procedures (Article 24).
    In addition, the saving clause does not apply to certain 
benefits conferred by one of the countries with respect to an 
individual who is neither a citizen of the conferring country 
nor, in the case of the United States, someone who has 
``immigrant status.'' Under this rule, for example, such treaty 
benefits are available to an Austrian 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 (Resident)), provided that the individual has not 
acquired U.S. immigrant status. The benefits that are subject 
to this rule are exemption from tax on compensation from 
government service to the other country (Article 19), exemption 
from host-country tax on certain income received by temporary 
visitors who are students and trainees (Article 20), and 
certain fiscal privileges of diplomatic agents and consular 
officers referred to in the proposed treaty (Article 26). An 
individual who has been admitted to the United States as a 
permanent resident under U.S. immigration laws (i.e., a ``green 
card'' holder) is considered to have ``immigrant status'' under 
the proposed treaty.
    The exceptions to the saving clause in the proposed treaty 
generally are consistent with the U.S. model and recent U.S. 
treaties. By contrast, although the double taxation provisions 
in paragraph 1 of Article XV of the present treaty afford 
protection to citizens, residents and corporations with respect 
to tax imposed by their home country, the saving clause in the 
present treaty sets forth only three exceptions. The first 
exception applies to governmental employment income derived by 
a resident of the other country (Article XI, paragraph (1)). 
The second exception applies to remuneration for teachers 
(Article XII). The third exception applies to remittances and 
maintenance for students and trainees (Article XIII).

Article 2. Taxes Covered

    The proposed treaty generally applies to the income taxes 
of the United States and Austria.
    In the case of the United States, the proposed treaty 
applies to the Federal income taxes imposed by the Code, but 
excluding social security taxes. Unlike many U.S. income tax 
treaties in force, but like the present treaty, the proposed 
treaty applies to the accumulated earnings tax and the personal 
holding company tax. In the case of Austria, the proposed 
treaty applies to the income tax (die Einkommensteuer) and the 
corporation tax (die Koerperschaftsteuer).
    For purposes of the non-discrimination article (Article 
23), the proposed treaty applies to taxes of all kinds imposed 
by the countries, including any taxes imposed by their 
political subdivisions or local authorities. In addition, for 
purposes of paragraphs 1 to 5 of the exchange of information 
and administrative assistance article (Article 25), the 
proposed treaty applies to taxes of all kinds imposed by the 
countries at the federal level.
    The proposed treaty also contains a provision generally 
found in U.S. income tax treaties (including the present 
treaty) to the effect that it will apply 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. The competent authorities also are to 
notify each other of any official published material concerning 
the application of the treaty. This clause 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 ``Austria'' comprises the Republic of Austria.
    The term ``United States'' means the United States of 
America, but does not include Puerto Rico, the Virgin Islands, 
Guam or any other U.S. possession or territory. When used in a 
geographical sense, it means the States and the District of 
Columbia. It also includes the territorial waters of the United 
States and the seabed and subsoil of the submarine areas 
adjacent to the territorial waters and over which the United 
States has exclusive rights, in accordance with international 
law, with respect to the exploration and exploitation of 
natural resources. Under the proposed treaty, these same areas 
are considered part of the United States for treaty purposes, 
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 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.
    An enterprise of a country is defined as an enterprise 
carried on by a resident of that country. The proposed treaty 
does not define the term ``enterprise.''
    Under the proposed treaty, a person is considered a 
national of one of the treaty countries if the person is an 
individual possessing nationality of that country, or a legal 
person, partnership, or association deriving its status as such 
from the law in force in that country.
    The Austrian competent authority is the Federal Minister of 
Finance or his delegate. 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 establish a common meaning, 
all terms not defined in the treaty are to have the meanings 
which they have under the laws of the country applying the 
treaty. The MOU includes a special provision with respect to 
the interpretation of the proposed treaty. Generally, the OECD 
Commentary is to apply in interpreting any provision of the 
proposed treaty that corresponds to a provision of the OECD 
model. 15 However, this general rule does not apply 
if either the United States or Austria has entered a 
reservation or has included an observation with respect to the 
OECD model or its Commentary. In addition, this rule also does 
not apply if a contrary interpretation is included in the MOU 
or a published interpretation of the proposed treaty (e.g., the 
Technical Explanation) that has been provided to the competent 
authorities of both countries or has been agreed to by the 
competent authorities. The Technical Explanation clarifies that 
the Technical Explanation overrides a different interpretation 
in the OECD Commentary, even where the OECD Commentary is 
adopted subsequent to the issuance of the Technical 
Explanation.
---------------------------------------------------------------------------
    \15\ The applicability of the OECD Commentary to the proposed 
treaty is consistent with the Vienna Convention on the Law of Treaties 
of May 23, 1969 (the ``Vienna Convention''). The United States has not 
yet ratified the Vienna Convention.
---------------------------------------------------------------------------

Article 4. Resident

            In general
    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 treaty. Furthermore, double 
taxation is often 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.
    The proposed treaty generally defines ``resident of a 
Contracting State'' to mean any person who, under the laws of 
that country, is liable to tax in that country by reason of his 
or her domicile, residence, citizenship, place of management, 
place of incorporation, or any other criterion of a similar 
nature. A U.S. citizen or a green-card holder who is not a 
resident of Austria is treated as a U.S. resident under the 
proposed treaty only if the individual has a substantial 
presence, permanent home, or habitual abode in the United 
States. Consistent with most U.S. income tax treaties, 
citizenship alone does not establish residence. As a result, 
U.S. citizens residing overseas are not necessarily entitled to 
the benefits of the proposed treaty as U.S. residents. The 
Technical Explanation provides that the term ``substantial 
presence'' under the proposed treaty is a similar concept to 
``substantial presence'' under Code section 7701(b); 
``permanent home'' and ``habitual abode'' are terms frequently 
used in treaty ``tie-breaker'' rules, as described below.
    The term ``resident of a Contracting State'' does not 
include any person who is liable to tax in that country in 
respect only of income from sources in that country. In the 
case of income derived by, or paid by, a partnership, estate or 
trust, the term applies only to the extent that the income it 
derives is subject to that country's tax as the income of a 
resident, either in its hands or in the hands of its partners, 
beneficiaries or grantors. For example, if the U.S. 
beneficiaries' share in the income of a U.S. trust is only one-
half, Austria would have to reduce its withholding tax pursuant 
to the proposed treaty on only one-half of the Austrian-source 
income paid to the trust. The MOU provides that a similar test 
applies in determining the residence of other pass-through 
entities, such as limited liability companies.
    According to the Technical Explanation, it is understood 
that a tax-exempt organization, including a pension trust, that 
is established under the laws of the United States or Austria 
is treated as a resident of the country under the laws of which 
it is established for purposes of the proposed treaty.
    These provisions of the proposed treaty generally are based 
on the provisions of the U.S. and OECD models and are similar 
to the provisions found in other U.S. tax treaties.
            Dual residents

Individuals

    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 will be 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 
or in neither country, the individual's residence is deemed to 
be the country with which his or her personal and economic 
relations are closer (i.e., the ``center of vital interests''). 
The MOU provides that the center of vital interests may not be 
determinable solely by reviewing the circumstances prevailing 
in one single year; a longer period may have to be taken into 
consideration. If the country in which the individual has his 
or her center of vital interests cannot be determined, 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 of them, the competent authorities of 
the countries are to settle the question of residence by mutual 
agreement.

Entities

    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 under 
the laws of which the company was created. This rule conforms 
with U.S. internal law.
    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, like the U.S. model, 
requires the competent authorities of the two countries to 
determine by mutual agreement the residence of such person and 
the mode of application of the 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 an 
enterprise engages in business. 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 any other 
place of extraction of natural resources. It also includes any 
building site or construction or installation project or an 
installation or drilling rig or ship used for the exploration 
or development of natural resources if the site or project 
lasts for more than 12 months. 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. The 12-month period for 
establishing a permanent establishment in connection with a 
site or project corresponds to the rule of the U.S. model.
    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 will 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 further 
include 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 refers to advertising and supplying information as 
examples of activities that are of a preparatory or auxiliary 
character. 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 will not constitute a 
permanent establishment.
    If a person has, and habitually exercises, the authority to 
conclude contracts in a country on behalf of an enterprise of 
the other country, the enterprise generally is 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. and OECD models, 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 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 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 real property situated in the other country 
may be taxed in the country where the real property is located. 
Income from real property includes income from agriculture or 
forestry.
    The term ``real property'' generally has the meaning that 
it has under the law of the country in which the property in 
question is situated. The term in any case includes property 
accessory to real property; livestock and equipment used in 
agriculture and forestry; rights to which the provisions of 
general law respecting landed property apply; usufruct of real 
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. Thus, income 
from real property includes royalties and other payments in 
respect of the exploitation of natural resources (e.g., oil). 
Ships, boats and aircraft are not real property. This 
definition corresponds to the definition of real property in 
the OECD model.
    The proposed treaty specifies that the source country may 
tax income derived from the direct use, letting, or use in any 
other form of 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.
    The MOU clarifies that the source country may tax the 
income derived from the exploitation of rights in real 
property. For example, a U.S. person that is a lessee of real 
property situated in Austria is subject to Austrian tax on the 
income derived from any sublease of the same property, even 
though the U.S. person is not the owner of the real property.
    The present treaty permits the source country to tax 
interest on mortgages secured by real property under this 
article. The proposed treaty eliminates this rule and treats 
such interest in the same way as other types of interest, which 
generally is free from source-country tax (see Article 11).
    Like the U.S. model and certain other U.S. income tax 
treaties, the proposed treaty provides residents of one country 
with an election to be taxed on a net basis by the other 
country on income from real property in that other country. 
U.S. internal law provides such a net-basis election in the 
case of income of a foreign person from U.S. real property 
income (Code secs. 871(d) and 882(d)). The proposed treaty 
provides that any such election shall be binding for the 
taxable year of the election and all subsequent taxable years, 
unless the competent authorities of the treaty countries agree 
to terminate the election pursuant to a request by the taxpayer 
made to the competent authority of the country in which the 
taxpayer is resident.

Article 7. Business Profits

            U.S. internal law
    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 
business is effectively connected with the conduct of a trade 
or business within the United States is made as if the sale or 
exchange occurred immediately before the cessation of business 
(Code sec. 864(c)(7)).
            Proposed treaty limitations on internal law
    Under the proposed treaty, business 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. 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. 16 
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.
---------------------------------------------------------------------------
    \16\ However, some articles of the proposed treaty use the phrase 
``effectively connected''; see, e.g., Article 10 (Dividends).
---------------------------------------------------------------------------
    The present treaty contains a force of attraction rule 
similar to that in the Code as described above. The proposed 
treaty eliminates this rule. The proposed treaty is consistent 
with the U.S. and OECD models and other existing U.S. treaties 
in this respect.
    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 reasonably be expected to have been derived by it 
if it were a distinct and separate entity engaged in the same 
or similar activities under the same or similar conditions and 
dealing wholly independently with the enterprise of which it is 
a permanent establishment. 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). According to the Technical Explanation, under 
this language, the United States is free to use its current 
expense allocation rules, including the rules for allocating 
deductible interest expense under Treas. Reg. sec. 1.882-5, in 
determining deductible amounts. Thus, for example, an Austrian 
company which has a branch office in the United States but 
which has its head office in Austria will, in computing the 
U.S. tax liability of the branch, be entitled to deduct a 
portion of the executive and general administrative expenses 
incurred in Austria by the head office for purposes of 
operating the U.S. branch, allocated and apportioned in 
accordance with Treas. Reg. sec. 1.861-8.
    Business profits will not be 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 will not be 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 and sufficient reason to change the 
method. Where business profits include items of income which 
are dealt with separately in other articles of the treaty, 
those other articles, and not the business profits article, 
will govern the treatment of such items of income. Thus, for 
example, dividends are taxed under the provisions of Article 10 
(Dividends), and not as business profits, except as provided in 
paragraph 6 of Article 10.
    Under the proposed treaty, the term ``business profits'' 
includes income from the rental of tangible personal property. 
Under the present treaty, income from the rental of certain 
tangible personal property is treated as royalties.
    The proposed treaty contains a special rule which treats 
income derived from an Austrian ``sleeping partnership'' 
(Stille Gesellschaft) by a U.S. ``sleeping partner'' as 
business profits attributable to the permanent establishment of 
the partnership in Austria. According to the Technical 
Explanation, a sleeping partnership is a contract concluded 
under commercial law by which an investor (the sleeping 
partner) contributes money or money's worth to the business of 
the contracting partner in exchange for a share in the profits 
of the business and the right to obtain specified information 
about the development of the business. The sleeping partner may 
agree under the contract to bear a portion of the losses of the 
business.
    The Technical Explanation states that there are two types 
of sleeping partnerships under Austrian tax law: the typical 
form and the non-typical form. In a typical sleeping 
partnership, a sleeping partner does not participate in the 
capital and assets of the business, and his rights upon 
withdrawal from the partnership are limited to the return of 
his investment. The profits of a sleeping partner in a typical 
sleeping partnership generally are treated as income from 
investment activities for Austrian tax purposes. In a non-
typical sleeping partnership, a sleeping partner is entitled to 
participate in the increase in net wealth of the business 
property as well as profits and losses of the business. Unlike 
profits in a typical sleeping partnership, the profits of a 
sleeping partner in a non-typical sleeping partnership are 
treated as income from commercial activities for Austrian tax 
purposes. Whether a particular sleeping partnership should be 
characterized as typical or non-typical under Austrian tax law 
may be unclear.
    Under the proposed treaty, any income earned during the 
existence of and attributable to a permanent establishment or 
fixed base is taxable in the country where that permanent 
establishment or fixed base is situated, even if the payments 
with respect to such income are deferred until such permanent 
establishment or fixed base has ceased to exist. Thus, the 
proposed treaty permits the United States to apply the 
principles of Code section 864(c)(6) to the profits that rely 
for their taxability upon a nexus with a permanent 
establishment or fixed base. The proposed treaty rule that 
corresponds to the rule of Code section 864(c)(7) is discussed 
below in connection with the taxation of capital gains (Article 
13). 17
---------------------------------------------------------------------------
    \17\ This rule applies to business profits (Article 7, paragraphs 1 
and 2), dividends (Article 10, paragraph 4), interest (Article 11, 
paragraph 3), royalties (Article 12, paragraph 4), capital gains 
(Article 13, paragraph 3), independent personal services (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. The United States has entered 
into agreements with a number of countries, including Austria, 
providing such reciprocal exemptions. Benefits accorded under 
such an agreement are not restricted by the proposed treaty.
    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. The proposed 
treaty defines ``international traffic'' as any transport by a 
ship or aircraft operated by an enterprise of one of the treaty 
countries, except when the ship or aircraft is operated solely 
between places in one of the treaty countries (Article 
3(1)(d)(General Definitions)). Accordingly, with respect to an 
Austrian enterprise, purely domestic transport in the United 
States is excluded. The present treaty exempts all profits 
derived by an enterprise from the operation of ships or 
aircraft from source-country tax.
    For purposes of the proposed treaty, shipping profits 
include rental income from full or bareboat leases 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. Thus, the exemption from source-
country tax for shipping profits applies to a bareboat lessor 
(such as a financial institution or a leasing company) that 
does not operate ships or aircraft in international traffic, 
but that leases ships or aircraft for use in international 
traffic.
    According to the Technical Explanation, exemption also is 
available for profits from the inland transport of property or 
passengers within a country if such transport is undertaken as 
part of international traffic. Like the U.S. model, the 
proposed treaty expressly provides that income derived by an 
enterprise of one country from the use, maintenance, or rental 
of containers (including trailers, barges, and related 
equipment for the transport of containers) used in 
international traffic is exempt from tax by the other country. 
The Technical Explanation states that the same rule applies to 
a such income derived by a resident of either country through a 
partnership or other pass-through entity.
    The shipping and air transport provisions of the proposed 
treaty, other than the foregoing provisions with respect to 
income from container leasing, 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. The Technical Explanation clarifies that container 
leasing profits, which are supplementary or incidental to the 
operation of international traffic of ships or aircraft, from 
the participation in a pool, a joint business or an 
international operating agency also are exempt from source-
country tax.

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 determine the profits 
taxable by that country in the case of transactions between 
related enterprises, if the profits of an enterprise do not 
reflect the conditions which would have been made between 
independent enterprises. The proposed treaty provides that it 
is understood, however, that the fact that associated 
enterprises have concluded arrangements, such as cost-sharing 
arrangements or general services agreements, for or based on 
the allocation of executive, general administrative, technical 
and commercial expenses, research and development expenses, and 
other similar expenses, is not in itself a condition giving 
rise to this right.
    For purposes of the proposed treaty, an enterprise of one 
country is related to an enterprise of the other country if one 
of the enterprises participates directly or indirectly in the 
management, control, or capital of the other enterprise. 
Enterprises are also related if the same persons participate 
directly or indirectly in the management, control, or capital 
of such enterprises.
    Like the present Austrian treaty and 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 
provides that the respective countries retain the right to 
apply their internal intercompany pricing rules (e.g., Code 
sec. 482, in the case of the United States).
    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. This ``correlative adjustment'' clause has 
no counterpart in the present treaty. In making that 
adjustment, due regard is to be given to other provisions of 
the treaty and the competent authorities of the two countries 
will consult with each other if necessary. For example, under 
the mutual agreement article (Article 24), 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 taxing jurisdiction in the country of 
residence or nationality (discussed above in connection with 
Article 1 (Personal Scope)) will not apply in the case of such 
adjustments.

Article 10. Dividends

            Overview
    The proposed treaty replaces the dividend article of the 
present treaty with a new article that makes several changes. 
First, the proposed treaty generally liberalizes the conditions 
under which the 5-percent direct dividend withholding rate 
limitation is imposed. Second, the proposed treaty permits 
exceptions to the general 5-percent and 15-percent source-
country tax rates on dividends from a regulated investment 
company (``RIC'') or a REIT. Third, the proposed treaty permits 
the application by the source country of the treaty's dividend 
tax rates to income from arrangements, including debt 
obligations, carrying the right to participate in profits. 
Finally, the proposed treaty expressly permits the United 
States to collect a 5-percent branch profits tax from an 
Austrian company.
            U.S. internal law

Dividends and second-level withholding tax

    The United States generally imposes a 30-percent tax on the 
gross amount of U.S.-source dividends paid to nonresident alien 
individuals and foreign corporations. The 30-percent tax does 
not apply if the foreign recipient is engaged in a trade or 
business in the United States and the dividends are effectively 
connected with that trade or business. In such a case, the 
foreign recipient is subject to U.S. tax on such dividends on a 
net basis at graduated rates in the same manner that a U.S. 
person would be taxed.
    Under U.S. law, the term dividend generally means any 
distribution of property made by a corporation to its 
shareholders, either from accumulated earnings and profits or 
current earnings and profits. However, liquidating 
distributions generally are treated as payments in exchange for 
stock and thus are not subject to the 30-percent withholding 
tax described above (see discussion of capital gains in 
connection with Article 13 below).
    Dividends paid by a U.S. corporation generally are U.S.-
source. 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 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.

U.S. branch profits tax rules

    A foreign corporation engaged in the conduct of a trade or 
business in the United States is subject to a flat 30-percent 
branch profits tax on its ``dividend equivalent amount.'' The 
dividend equivalent amount is the corporation's earnings and 
profits which are attributable to its income that is 
effectively connected with its U.S. trade or business, 
decreased by the amount of such earnings that are reinvested in 
business assets located in the United States (or used to reduce 
liabilities of the U.S. business), and increased by any such 
previously reinvested earnings that are withdrawn from 
investment in the U.S. business. The dividend equivalent amount 
is limited by (among other things) aggregate earnings and 
profits accumulated in taxable years beginning after December 
31, 1986.
            Austrian internal law
    Austria generally imposes a 25-percent withholding tax on 
certain Austrian-source payments that include dividends. The 
withholding tax generally applies to dividends, other corporate 
distributions, and interest on profit-sharing and convertible 
bonds by an Austrian corporation whether paid to individual or 
corporate residents or nonresidents. The withholding tax does 
not apply to a dividend paid to a foreign corporation residing 
in a European Union (``EU'') member country, if the dividend is 
subject to Austrian tax law provisions enacted in response to 
the so-called ``parent-subsidiary directive'' approved by the 
EC Council of Ministers on July 23, 1990.
    Like U.S. corporate tax law, Austrian tax law generally 
embodies the so-called ``classical system'' under which 
corporate income may be taxed at the corporate level, and then 
taxed again at the shareholder level upon a distribution. A 
participation exemption is available if the recipient company 
owns 25 percent or more of the share capital of the payor 
company directly and continuously for at least 12 months prior 
to the end of the taxable year in which the dividend is paid.
    Austria does not impose a branch profits tax.
            Proposed treaty limitations on internal law

Reduction of withholding tax

    Under the proposed treaty, each country may tax dividends 
paid by its resident companies, but the rate of tax is limited 
by the proposed treaty if the beneficial owner of the dividends 
is a resident of the other country. Source-country taxation 
generally is limited to 5 percent of the gross amount of the 
dividends if the beneficial owner of the dividends is a company 
(other than a partnership) which holds directly at least 10 
percent of the voting shares of the payor company. Under the 
proposed treaty, the tax generally is limited to 15 percent of 
the gross amount of the dividends paid to residents of the 
other country in all other cases. Under the present treaty, 
source-country tax may be imposed at a 15-percent rate, rather 
than only a 5-percent rate, unless a higher ownership threshold 
is met (95-percent stock ownership by one recipient corporation 
residing in the other country).
    Under the present treaty, the prohibition on source-country 
tax at a rate exceeding 5 percent does not apply in certain 
cases where more than 25 percent of the gross income of the 
dividend payor consisted of interest and dividends. The 
proposed treaty eliminates this rule, and replaces it with 
rules similar to those adopted in recent U.S. treaties that 
allow source-country tax in excess of 5 percent on direct 
investment dividends from a RIC or REIT.
    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 an Austrian 
resident, if the beneficial owner of the dividend is either an 
individual holding a 10-percent-or-greater interest in the REIT 
or if the beneficial owner is not an individual. The MOU makes 
clear that such a dividend is taxable at the 30-percent United 
States statutory rate.

Definition of dividends

    Unlike the U.S. and OECD models, the present treaty 
provides no express definition of the term ``dividends''. The 
proposed treaty provides a definition of dividends that is 
broader than the definition in the U.S. model and some other 
recent U.S. treaties. Similar to the U.S. model, the proposed 
treaty generally defines ``dividends'' as income from shares or 
other rights (not being debt claims) participating in profits. 
Dividends also include income from other corporate rights that 
is subjected to the same tax treatment as income from shares by 
the country in which the distributing company is resident. The 
proposed treaty also provides (unlike the U.S. model) that the 
term dividends includes income from arrangements, including 
debt obligations, carrying the right to participate in profits, 
to the extent such income is characterized as dividends under 
the law of the country in which the income arises.

Special rules and exceptions

    The proposed treaty's reduced rates of tax on dividends do 
not apply if the recipient 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 holding on which the dividends are 
paid is effectively connected with the permanent establishment 
(or fixed base). Dividends paid on such holdings of a permanent 
establishment or a fixed base is 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 9).
    The proposed treaty contains a general limitation on the 
taxation by one country of dividends paid by companies that are 
residents of the other country. Under this provision, the 
United States may not, except in two cases, impose any taxes on 
dividends paid by an Austrian resident company that derives 
profits or income from the United States. The first exception 
is the case where the dividends are paid to U.S. residents. The 
second exception is where the holding in respect of which the 
dividends are paid is effectively connected with a U.S. 
permanent establishment or a fixed base in the United States. 
This rule is somewhat less restrictive of the United States' 
taxing jurisdiction than the corresponding rule in the present 
treaty. The present treaty provides that dividends paid by an 
Austrian corporation are exempt from U.S. tax in any case where 
the recipient is not a U.S. citizen, resident, or corporation.

Branch profits tax

    The proposed treaty allows the United States to impose the 
branch profits tax (as opposed to the branch-level excess 
interest tax (Code sec. 884(f)), described below) on an 
Austrian resident corporation that either has a permanent 
establishment in the United States, or is subject to tax on a 
net basis in the United States on income from real property or 
gains from the disposition of real property interests. Like the 
U.S. model, the proposed treaty permits at most a 5-percent 
branch profits tax rate, and, in cases where a foreign 
corporation conducts a trade or business in the United States, 
but not through a permanent establishment, the proposed treaty 
completely eliminates the branch profits tax that the Code 
imposes on such corporation.
    In general, the proposed treaty provides that the branch 
profits tax may be imposed by the source country only on that 
portion of the business profits of the foreign corporation 
attributable to its source-country permanent establishment, or 
the corporation's real property income subject to tax on a net 
basis. In general, the branch profits tax also may be imposed 
by the source country on the foreign corporation's gains from 
the disposition of real property. The proposed treaty permits 
the United States to impose its branch profits tax on the 
``dividend equivalent amount'' (as that term is defined under 
the Code as it may be amended from time to time) to the extent 
that this definition is in conformity with the principles of 
the branch tax article.
    None of the restrictions on the operation of 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 16). 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 described 
above.

Article 11. Interest

            U.S. internal law
    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 also 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.
            Austrian internal law
    Austria generally does not impose any tax on interest 
income of nonresidents. As described above in connection with 
the dividend article (Article 10), the Austrian dividend tax 
applies to proceeds from profit sharing bonds, and under the 
proposed treaty, such proceeds are treated as dividends rather 
than interest for Austrian withholding purposes. In addition, a 
nonresident individual or corporation may be subject to 
Austrian tax with respect to interest on loans secured by 
Austrian-situs real property.
            Proposed treaty limitations on internal law

Elimination of withholding tax

    The proposed treaty generally exempts from the U.S. 30-
percent tax interest (within the proposed treaty's definition 
of that term) paid to Austrian residents. The proposed treaty 
also exempts from Austrian tax, where any such taxes are 
otherwise applicable, Austrian-source interest paid to U.S. 
residents. These reciprocal exemptions are similar to those in 
effect under the present treaty and in the U.S. model. 
According to the Technical Explanation, the proposed treaty 
also exempts Austrian corporations from imposition by the 
United States of the branch-level excess interest tax.
    The exemptions apply only if the interest is beneficially 
owned by a resident of one of the countries. Accordingly, they 
do not apply if the recipient of the interest is a nominee for 
a nonresident.
    No such exemption applies to an excess inclusion with 
respect to a residual interest in a REMIC. Thus, such 
inclusions may be taxed at 30 percent under the proposed 
treaty. In addition, the proposed treaty does not prevent the 
United States from imposing its withholding tax on contingent 
interest that does not qualify as portfolio interest under U.S. 
law and to analogous types of interest under Austrian law.
    Exemptions from source-country tax will not apply if the 
beneficial owner of the interest carries on a 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 obligation on which the interest is paid 
is effectively connected with 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 on an obligation that is effectively connected with a 
permanent establishment or fixed base which is 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 9).
    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 
will apply only to the amount of arm's-length interest. Any 
amount of interest paid in excess of the arm's-length interest 
will be taxable according to the laws of each country, taking 
into account the other provisions of the proposed treaty. For 
example, interest paid to a parent corporation in excess of an 
arm's-length amount may be treated as a dividend under local 
law and thus entitled to the benefits of Article 10 (Dividends) 
of the proposed treaty.

Definition of interest

    The proposed treaty defines interest generally as income 
from debt claims of every kind, whether or not secured by a 
mortgage and whether or not carrying a right to participate in 
the debtor's profits. In particular, it includes income from 
government securities and bonds or debentures, including 
premiums or prizes attaching to such securities, bonds, or 
debentures. The proposed treaty also defines interest to 
include an excess inclusion with respect to a REMIC. However, 
the term does not include income dealt with in the dividend 
article (Article 10). Thus, the interest exemption does not 
prevent Austria from imposing the dividend tax on interest paid 
on profit-sharing bonds. Penalty charges for late payment are 
not considered interest for purposes of the proposed treaty.

Article 12. Royalties

            Internal law
    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. Austria generally imposes a 20-percent tax on 
royalties derived by nonresidents.
            Proposed treaty limitations on internal law

Reduction of withholding tax

    The U.S. model exempts royalties beneficially owned by a 
resident of one country from source-based taxation in the other 
country, and defines the term ``royalties'' to include payments 
for the right to use intangible property including 
cinematographic films, audio or video tapes or disks and other 
means of image or sound reproduction. The U.S. model does not 
include in that term rental payments for the use of tangible 
personal property.
    The present treaty differs from the U.S. model in that it 
permits source-country taxation of royalties. The present 
treaty covers rental payments for motion picture films and for 
the use of industrial, commercial or scientific equipment. The 
present treaty contains a two-tier limitation on source-country 
taxation of royalties. Only the residence country may tax 
royalties and similar payments in respect of the production or 
reproduction of literary, musical or other copyrights, artistic 
and scientific works, patents, designs, plans, secret processes 
and formulae, trademarks, and other like property and rights 
(including rentals and like payments for the use of industrial, 
commercial or scientific equipment). Motion picture film 
rentals may be taxed by the source country at a rate of 10 
percent.
    The proposed treaty maintains the two-tier limitation of 
the present treaty, but expands the class of payments that are 
subject to the 10-percent source-country tax. Under the 
proposed treaty, royalties that constitute consideration for 
the use of, or the right to use, cinematograph film or film, 
tapes or ``other means of reproduction'' used for radio or 
television broadcasting are subject to the 10-percent source-
country tax. The Technical Explanation indicates that the 
phrase ``other means of reproduction'' is intended to refer to 
use of means of reproduction that reflect future technological 
advances in the field of radio and television broadcasting. All 
other royalties arising in one treaty country and beneficially 
owned by a resident of the other country may be taxed only by 
the country of residence, and not by the country where the 
royalty arose. The exemption applies only if the royalty is 
beneficially owned by a resident of the other country; it does 
not apply if the recipient of the royalty is a nominee for a 
nonresident.
    The exemption and the 10-percent withholding rate under the 
proposed treaty do not apply where the recipient carries on a 
business through a permanent establishment (or a fixed base, in 
the case of an individual who performs or performed independent 
personal services) in the source country and the property with 
respect to which the royalties are paid is effectively 
connected with the permanent establishment (or fixed base). In 
that event, the royalties are taxed as business profits 
(Article 7) or income from the performance of independent 
personal services (Article 14). In addition, royalties paid 
with respect to property which is effectively connected with 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 9).
    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 
will apply only to the amount of arm's-length royalties. Any 
amount of royalties paid in excess of the arm's-length royalty 
will be 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.

Definition of royalties and source rules

    Under the proposed treaty, royalties are defined as 
payments of any kind received as a consideration for the use 
of, or the right to use, any copyright of literary, artistic, 
or scientific work (including cinematograph films or films or 
tapes used for radio or television broadcasting), 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 a 
right or property described above which are contingent on the 
productivity, use, or disposition of such right or property. 
The term ``industrial, commercial, or scientific experience'' 
is defined in paragraph 11 of the Commentary to Article 12 of 
the OECD Model. According to the Commentary, the term may 
include information that is ancillary to a right otherwise 
giving rise to royalties, such as a patent or secret process. 
According to the Technical Explanation, payments for the use, 
or the right to use, computer software may be considered 
royalties under the proposed treaty or may be considered 
business profits, depending on the facts and circumstances. 
However, payments received in connection with the transfer of 
so-called ``shrink-wrap'' computer software are treated as 
business profits.
    The proposed treaty conforms to the U.S. internal law 
source rules in treating royalties as arising from U.S. sources 
if they are for the use of, or right to use, property within 
the United States.

Article 13. Capital Gains

            U.S. internal law
    Generally, gain realized by a nonresident alien or a 
foreign corporation from the sale of a capital asset is not 
subject to U.S. tax unless the gain is effectively connected 
with the conduct of a U.S. trade or business. Under a special 
rule, gain from the disposition of any property within 10 years 
after such property ceased to be used in a U.S. trade or 
business is treated as effectively connected with the U.S. 
trade or business (Code sec. 864(c)(7)).
    In addition, 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.
            Austrian internal law
    Under Austrian law, the taxation of capital gains, of both 
residents and nonresidents, generally is limited to gains that 
are business income. However, a nonresident generally may be 
subject to Austrian tax (at ordinary rates) on gain from the 
disposition of shares issued by an Austrian corporation, if the 
person is treated as having a substantial interest (i.e, more 
than 10 percent) in the corporation. Under the present treaty, 
Austria retains the right to impose this tax in some limited 
cases on Austrian citizens who are U.S. residents.
    Austrian law also provides for nonrecognition of gain that 
is realized upon certain exchanges of property or stock in 
connection with contributions of property to corporations, 
liquidations of corporations, distributions of stock, and 
corporate reorganizations. Austrian and U.S. nonrecognition 
provisions are not identical. For example, if a U.S. company 
has a permanent establishment in Austria and the company 
transfers the assets of the Austrian permanent establishment to 
a subsidiary, Austria generally will tax the unrealized gain at 
the time of the transfer unless the shares of the subsidiary 
remains subject to Austrian tax.
            Proposed treaty limitations on internal law

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. Real property 
situated in the other country for the purposes of this article 
includes real property referred to in Article 6 (Income from 
Real Property) which is situated in the other country. With 
respect to the United States, the term real property situated 
in the other country includes a ``U.S. real property interest'' 
as defined under the Code, and an interest in a partnership, 
trust, or estate, to the extent that such interest is 
attributable to real property situated in the United States. 
The Committee understands 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)). With respect 
to Austria, the term includes shares or other comparable rights 
in a company the assets of which consist, directly or 
indirectly, mainly of real property situated in Austria.

Other capital gains

    The proposed treaty contains a standard provision which 
permits a country to tax the gain from the alienation of 
personal property that forms part of the business property of a 
permanent establishment or fixed base of a resident of the 
other country located in the first country.
    In addition, gains from the alienation of movable property 
previously used or held in connection with a permanent 
establishment or fixed base that a resident of one of the 
treaty countries has, or had, in the other country may be taxed 
by such other country, but only to the extent that the gain is 
attributable to the period in which the personal property in 
question formed part of the business property of the permanent 
establishment or fixed base. The residence country also may tax 
the gains associated with the same property; however, such 
country is required to exclude from its tax base any gain that 
is taxed by the source country. Thus, this provision is 
consistent with the internal Austrian rule that taxes the 
appreciation inherent in the business assets upon an 
incorporation of an Austrian permanent establishment. Although 
the provision is drafted reciprocally, the United States may 
not, under its domestic law, impose a tax on such an event. In 
addition, this provision is narrower than the rule of Code 
section 864(c)(7) because it limits the taxable gain to the 
amount accrued during the period the property was part of the 
permanent establishment or fixed base.
    Gains of an enterprise of one of the treaty countries from 
the alienation of ships, aircraft or containers operated in 
international traffic are taxable only in that country. Gains 
described in the royalties article (i.e., gains derived from 
alienation of certain intangible property that are contingent 
on productivity, use, or disposition) are taxable only in 
accordance with that article (Article 12). Thus, such gains are 
either exempt from source-country tax or are subject to a 10-
percent source-country tax.
    Generally, gains from the alienation of any property other 
than that discussed above will be taxable under the proposed 
treaty only in the country where the alienator is a resident.
    Under the proposed treaty, where a U.S. resident transfers 
property to an Austrian company as a capital contribution and 
the transfer is not subject to Austrian tax (i.e., due to the 
application of the Austrian Reorganization Tax Act 
(``Umgrundungssteuergesetz'')), a subsequent alienation of the 
shares in the Austrian company is taxable in Austria through 
the year 2010. The Technical Explanation states that it is 
expected that any double taxation that occurs as a result of 
treating a transfer of stock as an ``alienation'' for Austrian 
tax purposes would be addressed under the competent authority 
procedures.

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 a 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
    The proposed treaty limits the right of a country to tax 
income from the performance of personal services by a resident 
of the other country. Under the proposed treaty (unlike the 
present treaty), income from the performance of independent 
personal services (i.e., services performed as an independent 
contractor, not as an employee) is treated separately from 
income from the performance of dependent personal services.
    Under the proposed treaty, income from the performance of 
independent personal services by a resident of one country is 
exempt from tax in the other country, unless the services are 
performed in the other country and the income is attributable 
to a fixed base regularly available to the individual in the 
second country for the purpose of performing the activities.
    The proposed treaty generally provides a broader exemption 
from source-country tax for income from independent personal 
services than the present treaty. Under the present treaty, an 
exemption is generally available to a resident of a country 
only if his or her stay in the other country does not exceed 
183 days. The present treaty does not contain the fixed base 
limitation found in the proposed treaty.
    The Technical Explanation provides that it is understood 
that the term ``fixed base'' is similar in meaning to the term 
``permanent establishment'' of the proposed treaty. According 
to the Technical Explanation, the rules of Article 7 (Business 
Profits) for attributing income and expenses to a permanent 
establishment are generally relevant for attributing income to 
a fixed base. In addition, the Technical Explanation states 
that outside director fees are covered by this article.
    The exemption from source-country tax provided in the 
proposed treaty for independent personal services income is 
similar to that contained in the U.S. model.

Article 15. Dependent Personal Services

    Under the proposed treaty, wages, salaries, and other 
similar remuneration derived from services performed as an 
employee in one country (the source country) by a resident of 
the other country will be 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 consistent with the present treaty, as well as the U.S. and 
OECD models.
    The Technical Explanation provides that in determining the 
number of days for purposes of the 183-day rule, an individual 
is considered to be present for any day during which he or she 
is present in the source country (including part of the day), 
even if the individual does not work during that day. 
18
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    \18\ See Rev. Rul. 56-24, 1956-1 C.B. 851.
---------------------------------------------------------------------------
    The proposed treaty provides that compensation derived from 
employment as a member of the regular complement of a ship or 
aircraft operated in international traffic may be taxed only in 
the employee's country of residence.
    This article is modified by the provisions with respect to 
the treatment of pensions (Article 18) and government service 
(Article 19). In addition, the rules applicable to artistes and 
athletes (Article 17) apply notwithstanding the rules of this 
article.

Article 16. Limitation on Benefits

            In general
    The proposed treaty contains a provision, not found in the 
present treaty, 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 Austria.
    The proposed treaty is intended to limit double taxation 
caused by the interaction of the tax systems of the United 
States and Austria 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'' and 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 anti-treaty-shopping article in the proposed treaty 
provides that a treaty country resident is entitled to treaty 
benefits in the other country only if it fits into one of 
several categories or is otherwise approved by that country's 
competent authority, in the exercise of the latter's 
discretion. 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. 19 
However, the proposed treaty provides opportunities for treaty 
benefit eligibility which are not provided under the 
regulation.
---------------------------------------------------------------------------
    \19\ Treas. Reg. sec. 1.884-5.
---------------------------------------------------------------------------
    Generally, a resident of either country qualifies for all 
the benefits accorded by the proposed treaty if such resident 
is a ``qualified resident'' as defined in one of the following 
categories:

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

In addition, an item of income that is derived in connection 
with, or incidental to, an active trade or business conducted 
in the other country may qualify for treaty benefits under the 
active business test.
    Special rules apply to interest and royalty income derived 
by an Austrian company in certain ``triangular'' cases 
described below.
    The MOU provides that the provisions of the proposed 
treaty, such as those under this article, designed to prevent 
abusive transactions will not prevent the United States or 
Austria from applying its internal law ``substance over form'' 
rules.
    The competent authorities shall, pursuant to the authority 
provided in accordance with the provisions of Article 25 
(Exchange of Information and Administrative Assistance), 
exchange such information as is necessary for carrying out the 
provisions of this article and safeguarding the application of 
their internal laws.
            Ownership and base erosion tests
    Like 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 an 
entity is to qualify for treaty benefits.
    To meet the ownership test, more than 50 percent of the 
beneficial interest in the entity must be owned, directly or 
indirectly, by persons that qualify as treaty residents under 
certain tests of the proposed treaty or who are U.S. citizens. 
20 In the case of a company, qualified treaty 
residents or U.S. citizens must own, directly or indirectly, 
more than 50 percent of the number of shares of each class of 
the company's shares.
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    \20\ For this purpose, a qualified treaty resident is a person who 
is entitled to benefits under the proposed treaty as an individual 
resident of Austria or the United States, a public company or public 
company subsidiary (as described in the discussion of the public 
company tests below), one of the treaty countries or a political 
subdivision or local authority thereof, or a non-profit organization 
(as described in the discussion of qualifying organizations below).
---------------------------------------------------------------------------
    To meet the base erosion test, not more than 50 percent of 
the gross income of the entity may be used, directly or 
indirectly, to meet liabilities (including liabilities for 
interest or royalties) to persons or entities other than U.S. 
citizens or certain persons that qualify as treaty residents. 
This rule 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 treaty.
            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.

Publicly traded companies

    A company that is a resident of Austria or the United 
States is entitled to treaty benefits, if the principal class 
of its shares is substantially and regularly traded on one or 
more recognized stock exchanges. The Technical Explanation 
provides that the term ``principal class of shares'' is 
intended to be interpreted as the class of shares that 
represents the majority of the voting power and value of the 
company. When no single class of shares represents the majority 
of the voting power and value of the company, the term 
generally means those classes that in the aggregate possess 
more than 50 percent of the voting power and value of the 
company. The term ``shares'' includes depository receipts or 
trust certificates. In determining voting power, any shares or 
class of shares that are authorized but not issued shall not be 
counted; and in mutual agreement between the competent 
authorities, appropriate weight shall be given to any 
restrictions or limitations on voting rights of, or entitlement 
to disproportionately higher participation in, issued shares. 
Thus, such a company is entitled to the benefits of the treaty 
regardless of where its actual owners reside or the amount or 
destination of payments it makes.

Subsidiaries of publicly traded companies

    A company that is a resident of Austria or the United 
States is entitled to treaty benefits if it is at least 90-
percent owned, directly or indirectly, by five or fewer 
companies which are residents of either treaty country, the 
principal classes of the shares of which are publicly traded as 
described above, provided that the owner of any remaining 
portion of the company is an individual resident of Austria or 
the United States. The Technical Explanation provides that if 
the ownership of any remaining portion of the company belongs 
to more than one individual, each such individual must be a 
resident of either country.

Definitions

    The term ``recognized stock exchange'' includes the NASDAQ 
System, any stock exchange registered with the Securities and 
Exchange Commission as a national securities exchange for the 
purposes of the Securities Exchange Act of 1934, and the Vienna 
Stock Exchange. The term generally includes any other stock 
exchange agreed upon by the competent authorities of the two 
countries. U.S. internal law contains an exception to the 
definition of a ``recognized stock exchange'' in the case of a 
closely held company for purposes of identifying a ``qualified 
resident'' eligible for treaty protection from the U.S. branch 
tax. 21 The regulation provides that stock in 
certain closely held companies will not be treated as 
``regularly traded,'' The proposed treaty has no special rule 
for closely held companies in defining the term ``substantial 
and regular trading.'' Consequently, it will be easier for a 
closely held company to qualify as a resident of the United 
States or Austria under the proposed treaty than under the U.S. 
branch tax rules.
---------------------------------------------------------------------------
    \21\ Treas. Reg. sec. 1.884-5(d)(4)(iii).
---------------------------------------------------------------------------
    The proposed treaty does not define ``substantial'' and 
``regular'' trading. A definition for ``regular'' trading can 
be found in the regulations under Code section 884(e) for 
purposes of identifying a ``qualified resident'' eligible for 
treaty protection from the U.S. branch tax. 22
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    \22\ Treas. Reg. sec. 1.884-5(d)(4).
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            Non-profit organizations
    An entity also will be entitled to benefits under the 
proposed treaty if it is a not-for-profit organization which, 
by virtue of that status, generally is exempt from income 
taxation in its treaty country of residence, provided that more 
than half the beneficiaries, members, or participants, if any, 
in the organization are persons that are entitled to benefits 
under the proposed treaty. The not-for-profit organizations 
described include, but are not limited to, pension funds and 
private foundations.
            Headquarters companies
    A treaty country resident is entitled to all the benefits 
of the proposed treaty if that person functions as a 
headquarters company for a multinational corporate group. As 
set forth in the MOU, a company is considered to be a 
headquarters company for this purpose only if each of several 
criteria is satisfied. The person seeking such treatment must 
provide in its country of residence a substantial portion of 
the overall supervision and administration of the group, which 
may include, but cannot be principally, group financing. The 
person must have, and exercise, independent discretionary 
authority to carry out these functions. It must be subject to 
the same income taxation rules in its residence country as 
other persons entitled to the benefits of the proposed treaty. 
The group must consist of corporations resident in, and engaged 
in an active business in, at least five countries, and the 
income derived in the treaty country of which the headquarters 
company is not a resident must be derived in connection with, 
or be incidental to, those active business activities. The 
business activities carried on in each of the five countries 
(or five groupings of countries) must generate at least 10 
percent of the gross income of the group. The business 
activities carried on in any one country (other than the 
country where the headquarters company is resident) cannot 
generate 50 percent or more of the gross income of the group. 
Moreover, no more than 25 percent of the headquarters company's 
gross income may be derived from the treaty country of which it 
is not a resident.
    Other recent U.S. income tax treaties, such as the treaty 
with the Netherlands and the treaty with France, also contain a 
headquarters company provision in the limitation on benefits 
article.
            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 Austria if it 
is engaged in the active conduct of a trade or business in its 
residence country, the income derived from the source country 
is derived in connection with, or is incidental to, that trade 
or business, and, with respect to income derived in connection 
with that trade or business, the trade or business is 
substantial in relation to the activity carried on in the 
source country which provides the income with respect to which 
treaty benefits are claimed. According to the Technical 
Explanation, the test is applied separately to each item of 
income.
    An entity does not meet the active business test (and 
therefore is not eligible to claim treaty benefits under this 
rule) by virtue of being engaged in the business of making or 
managing investments, unless these activities are banking or 
insurance activities carried on by a bank or insurance company.
    The active trade or business rule is consistent with 
similar tests in recent U.S. treaties, and replaces a more 
general rule in some other U.S. income tax treaties that 
preserves benefits if an entity is not used ``for a principal 
purpose of obtaining benefits'' under a treaty. However, unlike 
other treaties, and to some extent like the regulations under 
Code section 884(e), the proposed treaty (in its text and as 
elucidated in the MOU) elaborates at length on the conditions 
under which the active business will, and will not, be 
considered to be met.
    The MOU provides several examples to illustrate the 
operation of the active trade or business test.

Income derived in connection with a substantial business

    The MOU specifies that income is derived in connection 
with, or is incidental to, 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 by the income 
recipient. 23 Alternatively, the income must be 
produced by assets that are part of the income recipient's 
business property. Under the U.S. model, 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 by the income recipient. The 
U.S. model does not contain the proposed treaty's alternative 
definition for income derived in connection with a trade or 
business (i.e., income produced by assets that are part of the 
income recipient's business property).
---------------------------------------------------------------------------
    \23\ Cf. Treas. Reg. sec. 1.884-5(e)(1) and (e)(4). (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 active trade or business conducted by the foreign corporation 
in its residence country; a business is an integral part if it 
comprises in principal part complementary and mutually interdependent 
steps in the production and sale or lease of goods or in the provision 
of services.)
---------------------------------------------------------------------------
    Under the proposed treaty, income derived in connection 
with a trade or business is eligible for treaty benefits if the 
trade or business conducted in the residence country is 
substantial in relationship to the income-generating activity 
in the other country. Under the U.S. model, the trade or 
business in the residence country must also be ``substantial'' 
in cases where the income derived by the source country is 
``incidental'' to the trade or business of the residence 
country. The proposed treaty does not apply a substantiality 
test to such incidental income.
    Whether the trade or business of the income recipient is 
substantial generally is determined by reference to its 
proportionate share of the trade or business in the source 
country, the nature of the activities performed, and the 
relative contributions made to the conduct of the trade or 
business in both countries. 24 The MOU provides a 
safe harbor for this purpose. Under the safe harbor, the trade 
or business of the income recipient will be deemed 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. The attributes 
are assets, gross income, and payroll expense. The level of 
each such attribute in the active conduct of the trade or 
business by the income recipient 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. For each separate attribute, the ratio of the 
residence country level to the source country level is 
computed.
---------------------------------------------------------------------------
    \24\ 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 the average of 
the three ratios is greater than 10 percent, and each ratio 
separately is greater than 7.5 percent. If any separate ratio 
is equal to or less than 7.5 percent for the prior year, the 
average of the corresponding ratios in the three prior years 
may be substituted. These safe harbor percentages are similar 
to those contained in the U.S. model.

Income incidental to a trade or business

    According to the MOU, income that is incidental to a trade 
or business is defined in the same manner as income that is 
derived in connection with a trade or business. Under that 
definition, income is incidental to 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, or the 
income is produced by assets that are part of the income 
recipient's business property. One of the examples contained in 
the MOU illustrates that income from the short-term investment 
of the working capital of the residence-country trade or 
business is treated as ``incidental income''. Unlike the 
proposed treaty, the U.S. model defines incidental income 
separately from income derived in connection with a trade or 
business. Under the U.S. model definition, income is incidental 
to a trade or business in the residence country if the 
production of such income facilitates the conduct of a trade or 
business in the other country.

Attribution rules

    As set forth in the MOU, the active business test takes 
into account the extent to which the person seeking treaty 
benefits either is itself engaged in business or is deemed to 
be so engaged through the activities of related persons. The 
MOU provides that under the proposed treaty, a treaty country 
resident is deemed to be engaged in the active conduct of a 
trade or business in its residence country (and is considered 
to carry on the proportionate share of such trade or business) 
if it is a partner in a partnership that is so engaged, or if 
it owns, either alone or as a member of a group of five or 
fewer persons that are qualified persons or residents of an 
``identified state,'' a controlling beneficial interest in a 
person that is engaged in the active conduct of a trade or 
business in the resident country of such owner. 25
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    \25\ An ``identified state'' means any third country, identified by 
agreement of the competent authorities, which has effective provisions 
for the exchange of information with the residence country of the 
person being test under these rules.
---------------------------------------------------------------------------
    A company resident in a treaty country is also deemed to be 
engaged in the active conduct of a trade or business in its 
residence country if it is a member of a group of companies 
that form or could form a consolidated group for tax purposes 
in the residence country and the group is engaged in the active 
conduct of a trade or business in that country. 26 A 
similar principle applies if a treaty country resident is under 
the common control with another person that is so engaged, 
provided that the control is held by five or fewer persons that 
are qualified persons or residents of an identified state.
---------------------------------------------------------------------------
    \26\ This rule is applied without regard to the residence of such 
companies.
---------------------------------------------------------------------------
    Finally, the activities of an owner of a treaty country 
resident may be attributed to such resident. Attribution to a 
treaty country resident applies if a controlling beneficial 
interest in the treaty country resident is held by a single 
person engaged in the active conduct of a trade or business in 
that same country. Attribution also applies if a controlling 
beneficial interest in the treaty country resident is held by a 
group of five or fewer persons, each of which is engaged in 
activity in that country which is a component part of or 
directly related to the trade or business in that country.
            Grant of treaty benefits by the competent authority
    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 treaty. Under this 
provision, such a person may be granted treaty benefits if the 
competent authority of the source country so determines. The 
MOU provides that in making this determination, the competent 
authority will take into account as its guideline whether the 
establishment, acquisition, or maintenance of the person, or 
the conduct of its operations, has or had as its principal 
purpose the obtaining of benefits under the proposed treaty. 
The competent authority of the source country will consult with 
the competent authority of the other country before denying the 
benefits of the treaty under this rule.
    This provision of the proposed treaty is similar to a 
portion of the qualified resident definition under the U.S. 
branch profits tax rules, under which the Secretary of the 
Treasury may, in his sole discretion, treat a foreign 
corporation as a qualified resident of a foreign country if the 
corporation establishes to the satisfaction of the Secretary 
that it meets such requirements as the Secretary may establish 
to ensure that individuals who are not residents of the foreign 
country do not use the treaty between the foreign country and 
the United States in a manner inconsistent with the purposes of 
the Code rule (Code sec. 884(d)(4)(D)).
    The MOU provides that in determining whether the 
establishment, acquisition, or maintenance of a corporation 
resident in one of the States has or had as its principal 
purpose the obtaining of benefits under the proposed treaty, 
the competent authorities may consider the following factors 
(among others):

  (1) the existence of a clear business purpose for the 
            structure and location of the income earning entity 
            in question;
  (2) the conduct of an active trade or business (as opposed to 
            a mere investment activity) by such entity;
  (3) a valid business nexus between that entity and the 
            activity giving rise to the income; and
  (4) the extent to which an entity which is a corporation 
            would be entitled to treaty benefits comparable to 
            those afforded by the proposed treaty if it had 
            been incorporated in the country of residence of 
            the majority of its shareholders.

The MOU contains an example that illustrates the application of 
these principles.
    The MOU provides that Austria's membership in the EU is a 
factor in the determination of eligibility for treaty benefits 
of an Austrian company with significant other EU member 
ownership or with significant business activities carried on in 
EU countries. Similar principles apply with respect to the 
special relationship between the United States, Canada, and 
Mexico under the North American Free Trade Agreement.
    The MOU provides that if the United States and Austria 
determine that it is desirable to amend Article 16 of the 
proposed treaty to reflect the closer relationship between 
Austria and its EU partners, the negotiators will promptly 
negotiate a Protocol in this regard.
            Triangular cases
    Under present laws and treaties that apply to Austrian 
residents, it is possible for profits of a permanent 
establishment maintained by an Austrian resident in a third 
country to be subject to a very low aggregate rate of Austrian 
and third-country income tax. The proposed treaty, in turn, 
eliminates the U.S. tax on several specified types of income of 
an Austrian resident. In a case where the U.S. income is earned 
by a third-country permanent establishment of an Austrian 
resident (the so-called ``triangular case'') the proposed 
treaty could have the potential of helping Austrian residents 
to avoid all (or substantially all) taxation, rather than 
merely avoiding double taxation.
    This article provides for an exception to the general rule 
in Articles 11 and 12 of the proposed treaty that eliminate or 
reduce the U.S. tax on interest and royalties. If the exception 
applies, the United States may tax the interest or royalty in 
accordance with its internal law (i.e., the United States 
generally may impose a 30-percent withholding tax on payments 
made to an Austrian resident).
    In order for this U.S. withholding tax to be imposed, two 
conditions must be met. First, the interest or royalty must be 
derived by an Austrian enterprise and must be attributable to a 
permanent establishment of that enterprise in a third 
jurisdiction. Second, combined Austrian and third country tax 
on the profits of the permanent establishment must be levied at 
an effective rate which is less than 60 percent of the general 
rate of company tax applicable in Austria.
    The special rule generally does not apply to interest 
income derived in connection with, or incidental to, an active 
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), royalties that are received as compensation for the 
use of, or the right to use, intangible property produced or 
developed by the permanent establishment, or if the income is 
subject to taxation by the United States under the subpart F 
controlled foreign corporation rules.

Article 17. Artistes and Athletes

    Like 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 athletes. 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 athletes from using the 
treaty to avoid paying any tax on their income earned in one of 
the countries. However, an artiste or athlete not subject to 
host country tax under the provisions of this article may still 
be taxable by that country under the rules of Article 14 or 15.
    Under this article of the proposed treaty, one country may 
tax an entertainer or athlete who is a resident of the other 
country on the income from his or her personal services as such 
in the first country during any year in which the gross 
receipts derived from such activities, including reimbursed 
expenses, exceed $20,000 or its Austrian shillings equivalent. 
Thus, if an Austrian entertainer maintained no fixed base in 
the United States and performed (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 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 22 (Relief from Double Taxation), 
below.) The Technical Explanation clarifies that because it is 
not possible to know whether the $20,000 (or the Austrian 
shillings equivalent) is exceeded until the end of the year, 
the source country may subject all payments to an artiste or 
athlete to withholding and then refund any excess amount 
withheld.
    The Technical Explanation provides that in determining 
whether income is governed by this article, the controlling 
factor is whether the income in question is predominately 
attributable to the performance itself or other activities or 
property rights. In the case where an individual functions as a 
performer and non-performer, and the role in one of the 
capacities is negligible, the predominant character of the 
individual's activities should control the characterization of 
those activities. If the roles are not negligible, there should 
be an apportionment between the performance related 
compensation and the other compensation. 27
---------------------------------------------------------------------------
    \27\ See paragraph 4 of the Commentaries to Article 17 of the OECD 
model.
---------------------------------------------------------------------------
    The proposed treaty provides a standard provision that is 
intended to address potential abuses. Under this provision, 
where income in respect of activities exercised by an 
entertainer or athlete in his or her capacity as such accrues 
not to the entertainer or athlete, but to another person, that 
income may be taxed by the country in which the activities are 
exercised, unless it is established that neither the 
entertainer or athlete nor persons related to him or her 
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, independent personal 
service and dependent service articles (Articles 7, 14 and 
15).) This provision prevents certain performers and athletes 
from avoiding tax in the country in which they perform by, for 
example, routing the compensation for their services through a 
third entity such as a personal holding company or a trust 
located in a country that would not tax the income.
    In cases where payments are made to a person other than the 
entertainer or athlete who exercised the activities, but that 
do not involve routing payments to an entity to avoid source-
country tax as described above, the proposed treaty provides 
that such payments may be subject to source-country tax. Upon 
request of that person, the withholding tax may be refunded to 
the extent the amount exceeds the tax liability of the 
entertainer or the athlete. The Technical Explanation indicates 
that the refund claims must be accompanied by proper 
documentation. An example in the Technical Explanation 
illustrates that such a case may arise when a payment is made 
to an entertainer through a third-country promotor.
    The MOU clarifies that entities operating an orchestra 
generally are not subject to the provisions of this article. On 
the other hand, individual members of an orchestra may be 
subject to the provisions of this article if their annual 
remuneration received for the performance in the source country 
exceeds $20,000. In computing whether an individual satisfies 
this threshold, the MOU states that a monthly salary is 
allocated to the days spent in the source country; however, the 
entire amount of a performance-related global payment (e.g., a 
payment consisting of compensation for performance in Austria 
and for preparation outside of Austria) is taken into account.
    The foregoing provisions are generally similar to 
provisions in the U.S. and OECD models dealing with 
entertainers and athletes.

Article 18. Pensions

    This article contains rules applicable to the tax treatment 
of private pensions and annuities, social security benefits, 
alimony and child support payments, and cross-border pension 
contributions.
    Under the proposed treaty, as in the present treaty, 
pensions and other similar remuneration beneficially derived by 
a resident of either country in consideration of past 
employment generally are subject to tax only in the recipient's 
country of residence. This rule is subject to the provisions of 
Article 19 (Government Service). Thus, it generally does not 
apply, for example, in the case of pensions paid to a resident 
of one country attributable to services performed for 
government entities of the other. The Technical Explanation 
provides that this provision covers amounts paid by all private 
retirement plans and arrangements in consideration of past 
employment, regardless of whether they are considered qualified 
plans under the Code.
    Social Security payments and other public pensions 
28 paid by one country to an individual who is a 
resident of the other country or to a U.S. citizen will be 
taxable only by the paying country. (This rule also is subject 
to the provisions of Article 19 (Government Service).) This 
rule, which is not subject to the saving clause, exempts U.S. 
citizens and residents from U.S. tax on Austrian social 
security payments. Under this rule, only the United States may 
tax U.S. social security payments to residents of Austria. The 
rule thus safeguards the United States' right under the Social 
Security Amendments of 1983 to tax a portion of U.S. social 
security benefits received by nonresident individuals, while 
protecting any such individuals residing in Austria from double 
taxation.
---------------------------------------------------------------------------
    \28\ According to the MOU, the term ``other public pensions'' is 
intended to refer to U.S. tier 1 Railroad Retirement benefits. In 
addition, the term ``social security payments'' is not restricted to 
old age pensions but also refers to other types of social security 
benefits such as payments to compensate work-related diseases or 
accidents.
---------------------------------------------------------------------------
    The proposed treaty provides that annuities may be taxed 
only in the country of residence of the person who beneficially 
owns them. An annuity is defined as a stated sum payable 
periodically at stated times during a specified number of 
years, under an obligation to make the payments in return for 
adequate and full consideration.
    Unlike the present treaty, the proposed treaty provides for 
the treatment of alimony and child support payments. The 
proposed treaty grants exclusive taxing rights with respect to 
alimony to the treaty country of residence of the payor. This 
rule is different from the U.S. model, which provides that the 
recipient's country of residence has the exclusive taxing 
rights with respect to alimony payments. The term ``alimony'' 
as used in the article of the proposed treaty means periodic 
payments made pursuant to a written separation agreement or a 
decree of divorce, separate maintenance, or compulsory support. 
This rule is not subject to the saving clause; thus, alimony 
payments from an Austrian resident to a U.S. resident or 
citizen are taxable only in Austria.
    Under the proposed treaty, child support payments (made 
pursuant to a written separation agreement or a decree of 
divorce, separate maintenance, or compulsory support) are 
exempt from tax by both countries. This rule is the same as the 
rule in the U.S. model.
    The proposed treaty deals with the taxation of 
contributions borne by an individual who renders dependent 
personal services in one country (the host country) to a 
pension plan established in, and recognized for tax purposes, 
in the other country. In general, under the proposed treaty, in 
determining the individual's taxable income, the host country 
may be required to treat such contributions in the same way and 
subject them to the same conditions and limitations as 
contributions made to a pension plan established in the host 
country. Such treatment is provided only if the employee was 
not a resident of the host country and contributed to the 
pension plan immediately before exercising employment in the 
host country. In addition, the competent authority of the first 
country must agree that the pension plan corresponds to a 
pension plan recognized for tax purposes by that country.

Article 19. Government Service

    The proposed treaty generally exempts the wages of 
employees of one country from tax by the other country. Under 
the proposed treaty, remuneration, including pensions, 
annuities or similar benefits, paid by a country or one of its 
political subdivisions or local authorities to a citizen of 
such country for services rendered as an employee of that 
country (or subdivision or authority) generally is taxable only 
in that country.
    The proposed treaty states that the above rule also applies 
to remuneration paid to the Austrian Foreign Trade 
Representatives of the Austrian Federal Economic Chamber and to 
the staff members of the Austrian Foreign Trade Offices who are 
Austrian citizens to the extent they are discharging 
governmental functions in the United States. The MOU provides 
that employees of a government entity (such as an Embassy or 
Consulate) engaging in activities such as cleaning or driving 
are considered to be discharging governmental functions and, 
thus, are covered under this article.
    If a country or one of its political subdivisions or local 
authorities is carrying on a business (as opposed to functions 
of a governmental nature), the provisions of Articles 14 
(Independent Personal Services), 15 (Dependent Personal 
Services), 17 (Artistes and Athletes), and 18 (Pensions) will 
apply to remuneration and pensions for services rendered in 
connection with such business.
    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 with respect to an individual who is 
not a citizen of the country conferring such benefits, and, in 
the case where the United States is the conferring country, 
such individual is not a green-card holder. Thus, for example, 
the United States would not tax the compensation of an Austrian 
citizen who is not a U.S. green-card holder but who resides in 
the United States to perform services for the Austrian 
Government.

Article 20. Students and Trainees

    Like Article XII of the present treaty, the proposed treaty 
provides host country tax exemptions for a student, apprentice, 
or trainee, with respect to certain remittances from abroad for 
the purpose of the individual's maintenance, education or 
training. The U.S. and OECD models also provide for some host-
country exemptions for students and trainees; the proposed 
treaty and the U.S. model differ from the OECD model by 
providing a time limit for such exemption.
    Under the proposed treaty, an individual temporarily 
present in a treaty country for full-time education at a 
recognized educational institution, or for full-time training, 
and who, immediately before visiting the host country, is a 
resident of the other treaty country, is exempt from host 
country tax on certain payments he or she receives for a period 
of three years from the date the individual first arrives in 
the host country for the purpose of his or her training. Where 
this rule applies, the host country may not tax remittances 
from abroad for the purpose of maintenance, education, or 
training. The Technical Explanation provides that an individual 
who visits the host country to obtain business training and who 
also receives a salary from his or her employer for providing 
services would not be considered a trainee and would not be 
entitled to the benefits of this article.
    The present treaty exempts from host country tax a non-
profit sector grant, allowance, or award paid to a recipient of 
the other country. In addition, remuneration paid to a 
professor or teacher temporarily visiting the other country is 
also exempted from host country taxation. The proposed treaty 
does not contain these exemptions.
    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 with respect to an individual who is 
not a citizen of the country conferring such benefits, and, in 
the case where the United States is the conferring country, 
such individual is not a green-card holder. Thus, for example, 
an Austrian citizen who is not a U.S. green-card holder and who 
is residing in the United States for the purpose of full-time 
education would be entitled to the benefit of this article.

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 Austria. This article is 
substantially identical 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 derived by residents of either 
country will be 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 Austrian residents will continue to be taxable by the 
United States on their third-country income, with a foreign tax 
credit provided for income taxes paid to Austria (see 
discussion in connection with Article 22 (Relief From Double 
Taxation), below).
    The general rule just stated does not apply to income 
(other than income from real property (as defined in Article 
6)) if the recipient of the income is a resident of one country 
and carries on business in the other country through a 
permanent establishment or performs services from a fixed base, 
and property with respect to which the income is paid is 
effectively connected with the permanent establishment or fixed 
base. 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 
Austria generally would be taxable by the United States under 
Article 7 (Business Profits), even if the income was sourced in 
a third country.
    The prohibition on taxation by the country other than the 
residence country does apply, however, to income from real 
property that such country is not given permission to tax under 
Article 6. The Technical Explanation provides that even if real 
property is part of the property of a permanent establishment 
or fixed base in a treaty country, that country may not tax 
income from the property if neither the situs of the property 
nor the residence of the owner of the property is in that 
country. Thus, for example, if an Austrian resident derives 
income from real property located outside the United States 
that is effectively connected with the resident's permanent 
establishment or fixed base in the United States, only Austria 
may tax such income.

Article 22. Relief from Double Taxation

            U.S. internal law
    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.
    Foreign tax credits generally cannot exceed 90 percent of 
the pre-foreign tax credit alternative minimum tax (determined 
without regard to the net operating loss deduction). However, 
no such limitation will be imposed on a corporation if more 
than 50 percent of its stock is owned by U.S. persons, all of 
its operations are in one foreign country with which the United 
States has an income tax treaty with information exchange 
provisions, and certain other requirements are met. The 90-
percent alternative minimum tax foreign tax credit limitation, 
enacted in 1986, overrode contrary provisions of then-existing 
treaties.
            Austrian internal law
    Austria unilaterally mitigates double taxation in several 
ways. First, the general rule of Austrian law that mitigates 
double corporate-level taxation--the so-called ``participation 
exemption''--generally exempts a taxable Austrian company from 
corporate income tax on dividends derived in connection with a 
``participation'' in another entity, including in many cases a 
foreign company. A participation may be deemed to exist on the 
basis of a 25-percent or more shareholding in the entity. Where 
the entity is foreign, the entity must be subject to certain 
types of foreign tax law in order for the participation 
exemption to apply.
    Certain other types of foreign income of an Austrian 
resident may be unilaterally exempt from Austrian tax on a pro 
rata basis. That is, Austrian tax on worldwide income is 
reduced in the same proportion that exempt foreign income bears 
to worldwide income. This is also referred to as ``exemption 
with progression,'' in light of the fact that all worldwide 
income is included in the tax base for purposes of determining 
the marginal rate of Austrian tax that applies. Finally, 
foreign withholding taxes on certain dividends, interest, and 
royalties are in some limited cases (generally inapplicable to 
U.S.-source items) unilaterally creditable against Austrian 
tax.
            Proposed treaty rules
    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.
    Part of the double tax problem is dealt with in other 
articles of the proposed treaty that limit the right of a 
source country to tax income. This article provides further 
relief where both Austria 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 country of citizenship or 
residence waives its overriding taxing jurisdiction to the 
extent that this article applies.
    Under the present treaty, the United States, subject to the 
provisions of sections 901 through 905 of the Code, grants a 
foreign tax credit for the Austrian taxes specified in Article 
I. Austria likewise grants a credit against its tax for the 
amount of United States taxes specified in Article I with 
respect to income received from sources within the United 
States by its residents or corporations. However, the amount 
allowed as a credit is not in any case permitted to exceed the 
Austrian tax imposed on the income from sources within the 
United States. The proposed treaty modifies this system of the 
present treaty. The modifications include amending the rules 
applicable to U.S. citizens resident in Austria.

Proposed treaty limitations on U.S. internal law

    The proposed treaty generally provides that the United 
States will allow a citizen or resident a foreign tax credit 
for the income taxes imposed by Austria. The proposed treaty 
also requires the United States to allow the deemed-paid 
credit, with respect to Austrian income taxes, to any U.S. 
corporate shareholder of an Austrian company that receives 
dividends from such company if the U.S. company owns 10 percent 
or more of the voting stock of the Austrian 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 
provision). The MOU clarifies that this requirement refers to 
the laws in effect as of the date of entry of the proposed 
treaty, as they may be subsequently amended. The MOU provides 
that it is understood that, the 90-percent alternative minimum 
tax foreign tax credit limitation is consistent with the 
general U.S. commitment to provide a foreign tax credit. The 
MOU illustrates the calculation of the deemed-paid foreign tax 
credit and the dividend gross-up under U.S. tax principles.
    Austrian taxes covered by the proposed treaty (Article 2 
(Taxes Covered)) are to be considered income taxes for purposes 
of the U.S. foreign tax credit rules.
    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 Austrian residents. Under the special 
rule, a U.S. citizen who is resident in Austria will:
    (1) Compute the tentative U.S. income tax and the tentative 
Austrian income tax with respect to items of income that, under 
the proposed treaty, are subject to Austrian tax and either are 
exempt from U.S. tax or are subject to a reduced rate of tax 
when derived by an Austrian resident who is not a U.S. citizen.
    (2) Reduce the tentative Austrian 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 an Austrian 
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 Austria as computed in 
step (2) (i.e., after Austria allowed the credit for U.S. 
taxes). The proposed treaty recharacterizes the income that is 
subject to Austrian 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 U.S. citizen who is an Austrian 
resident with respect to an item of income should not be less 
than the tax that would be paid if the individual were not a 
U.S. citizen.
    The foregoing provisions are similar to those found in many 
U.S. income tax treaties.

Proposed treaty limitations on Austrian internal law

    In general, the proposed treaty requires Austria to 
continue to employ its ``exemption with progression'' method 
with respect to most U.S. income, as it does under the present 
treaty and internal Austrian law. As explained above, under the 
exemption with progression method the income, while exempt from 
tax, is taken into the tax base for purposes of determining the 
proportion by which Austrian tax is reduced.
    In addition, Austria also is required to permit an Austrian 
resident to claim a foreign tax credit for taxes paid to the 
United States in accordance with the rules of the proposed 
treaty. However, the amount of the credit shall not exceed the 
Austrian tax attributable to the income that may be taxed by 
the United States. For this purpose, the amount of U.S. branch 
profits tax (paragraph 6 of Article 10) is deemed to be 
attributable to the taxable income derived by the U.S. 
permanent establishment of an Austrian enterprise in the year 
that the tax is levied.

Article 23. 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 to 
provisions that have been embodied in other recent U.S. income 
tax treaties. It is broader than the nondiscrimination 
provision of the present treaty.
    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 or 
Austria. A U.S. national who is not a resident of the United 
States and an Austrian 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 of an enterprise of the other country 
less favorably than it taxes its own enterprise carrying on the 
same activities. Consistent with the U.S. and OECD models, 
however, a country is not obligated to grant residents of the 
other country any personal allowances, reliefs, or reductions 
for tax purposes granted to its own residents on account of 
civil status or family responsibilities. Under internal 
Austrian law, an Austrian enterprise may carry forward its 
losses for seven years to offset other income of that 
enterprise. The MOU extends this loss carryforward provision to 
losses incurred by an Austrian permanent establishment of a 
U.S. corporation.
    In a provision not contained in the present 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 indicates that 
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 rule of nondiscrimination 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. The nondiscrimination 
provisions do not prevent the imposition of the U.S. branch 
profits tax.
    U.S. internal law generally treats a corporation that 
distributes property in a 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. 29 The MOU states 
that the application of this rule is consistent with the 
nondiscrimination article of the proposed treaty.
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    \29\ See Notice 87-66, 1987-2 C.B. 376.
---------------------------------------------------------------------------
    U.S. internal law permits certain 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 MOU confirms 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 extend 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 MOU provides that it is 
understood that the withholding tax is a reasonable collection 
mechanism, and it is not in conflict with the nondiscrimination 
provisions of the proposed treaty.
    The saving clause (which allows the country of residence or 
citizenship to tax notwithstanding certain treaty provisions) 
does not apply to the nondiscrimination article.

Article 24. 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 Austria 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 
of taxing jurisdiction by the country of citizenship or 
residence.
    Under this article a resident of one country, who considers 
that the action of one or both of the countries results, or 
will result, in him or her to paying a tax not in accordance 
with the proposed treaty, may present the case to the competent 
authority of the country of which he or she is a resident or 
citizen. The competent authority will then make a determination 
as to whether the objection appears justified. If the objection 
appears to be justified and if the competent country is not 
itself able to arrive at a satisfactory solution, 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 treaty. The provision authorizes a waiver of the statute of 
limitations of either country so as to permit the issuance of a 
refund or credit notwithstanding the statute of limitations.
    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 treaty. 
They may also consult together for the elimination of double 
taxation in cases not provided for in the treaty.
    The proposed treaty makes express provision for the 
competent authorities to mutually agree on the attribution and 
allocation of income, deductions, credits, or allowances, the 
characterization of particular items of income, the 
determination of the country in which an item of income arises, 
the common meaning of a term and the elimination of double 
taxation in cases not provided for in the treaty. The proposed 
treaty does not provide, as does the U.S. model, that the 
competent authorities may agree on the same characterization of 
persons; advance pricing agreements; and the application of 
penalties, fines, and interest under internal law and increases 
(where appropriate in light of economic or monetary 
developments) in the dollar thresholds in provisions such as 
the artistes and athletes article and the students and trainees 
provisions.
    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 treaty. It also removes any 
doubt as to restrictions that might otherwise arise by reason 
of the confidentiality rules of the United States or Austria. 
The competent authorities shall consult together with a view to 
developing a commonly agreed application of the provisions of 
the proposed treaty, including the rules of Article 16 
(Limitation on Benefits). The competent authorities are 
authorized to prescribe regulations to carry out the purposes 
of the proposed treaty.
    The MOU clarifies that the mutual agreement procedure is 
not intended to create new treaty law but is intended to 
provide the possibility for the two countries to find an agreed 
position in their interpretation of the provisions of the 
proposed treaty.

Article 25. 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 tax laws of the two countries 
provided that taxation under those domestic laws is not 
contrary to the treaty. The carrying out of the provisions of 
the two countries concerning taxes includes ``penal 
investigations'' regarding fiscal offenses relating to taxes. 
According to the MOU, the term ``penal investigations'' applies 
to proceedings carried out by either judicial or administrative 
bodies, such as the commencement of a criminal investigation by 
the Criminal Investigation Division of the IRS. According to 
the Technical Explanation, it is understood that a U.S. penal 
investigation forms a basis for disclosure under the Austrian 
bank secrecy laws and practices.
    Any information exchanged is treated as secret in the same 
manner as information obtained under the domestic laws of the 
country receiving the information. The exchanged information 
may be disclosed only to persons or authorities (including 
courts and administrative bodies) involved in assessment, 
collection, administration, enforcement, prosecution or 
determination of appeals with respect to the taxes covered by 
this article. The information exchanged may be used only such 
purposes. 30 Exchanged information generally may be 
disclosed in public court proceedings or in judicial decisions.
---------------------------------------------------------------------------
    \30\ 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.
---------------------------------------------------------------------------
    The MOU provides that the appropriate committees of the 
U.S. Congress and the U.S. General Accounting Office shall be 
afforded access to information for use in the performance of 
their role in overseeing the administration of U.S. tax laws. 
31 The MOU also provides that such disclosure is 
permitted (with respect to Austria) to the Accounting Court 
(Rechnungshof) and the Committees of Parliament as is necessary 
to carry out their oversight responsibilities.
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    \31\ The MOU clarifies that this rule intends that the Senate 
Committee on Finance, the House Committee on Ways and Means and the 
Joint Committee on Taxation, as well as the U.S. General Accounting 
Office, will have access to all information received under the proposed 
treaty under the above-described conditions.
---------------------------------------------------------------------------
    Under the proposed treaty, information may be exchanged 
spontaneously or upon request and the competent authorities may 
agree on information which shall be furnished on a regular 
basis. The Technical Explanation states that the exchange of 
information in connection with simultaneous examinations is 
contemplated. In addition, the Technical Explanation permits 
the presence of tax examiners within the other country for 
purposes of conducting tax examinations, including interviewing 
taxpayers (with the consent of such taxpayers). In addition, 
the MOU provides that a request for information cannot be 
rejected by the requested state merely because the request was 
made for the purposes of pending judicial proceedings.
    As is true under the present treaty and 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 discloses any trade, business, 
industrial, commercial, or professional secret or trade 
process, or information the disclosure of which is contrary to 
public policy. The MOU provides, on the basis of paragraph 19 
of the OECD Commentary on Article 26 of the OECD model, 
provisions on bank secrecy do not constitute a professional, 
trade, business, industrial, or commercial secret. 
Consequently, according to the Technical Explanation, Austrian 
bank account information may be exchanged under this article 
upon commencement of a U.S. penal investigation.
    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 its tax 
were at issue. Where specifically requested by the competent 
authority of one country, the competent authority of the other 
country shall endeavor to provide the information in the form 
requested. Specifically, the competent authority of the other 
country will endeavor to provide depositions of witnesses and 
authenticated copies of unedited original documents (including 
books, papers, statements, accounts, and writings) to the same 
extent that they can be obtained by such other competent 
authority under the laws and administrative practices of such 
other country.
    The proposed treaty provides that the tax authorities may 
deliver documents to persons in the other country by using 
postal services. Each country shall determine in accordance 
with its domestic law the legal efficacy or sufficiency of the 
documents that are so delivered.
    The information exchange provisions of the proposed treaty 
apply to assistance carried out under penal investigation 
procedures. Accordingly, for an exchange of information in 
connection with a U.S. penal proceeding (as interpreted in the 
MOU), Austria has agreed to use its penal investigation 
procedures. However, the proposed treaty does not cover arrests 
of persons.
    The exchange of information provisions are not restricted 
by Article 1 (Personal Scope). Therefore, third-country 
residents are covered. For example, the Technical Explanation 
provides that the United States may request information with 
respect to an Austrian bank account of a third-country resident 
under the proposed treaty. In addition, like the U.S. model, 
the exchange of information article (except for the assistance 
in collection provision) is not restricted by Article 2 (Taxes 
Covered).
            Assistance in collection
    The proposed treaty generally provides that the countries 
are to undertake to assist and support each other in collecting 
the taxes enumerated in Article 2 of the proposed treaty to the 
extent necessary to ensure that treaty benefits are enjoyed 
only by persons entitled to those benefits under the proposed 
treaty. The MOU provides that the assistance extends to 
interest but not fines or other penalties.
    When one country applies to the other for assistance in 
enforcing a revenue claim, its application must include a 
certification by its competent authorities that the taxes are 
finally due and enforceable under its own laws. The Technical 
Explanation states that the concept of ``finally due and 
enforceable'' is to be applied under the same standard 
applicable to the U.S. income tax treaties with the Netherlands 
and Canada with respect to determining whether a claim is 
``finally determined'' under those treaties. Therefore, a tax 
is finally due and enforceable when the applicant country has 
the right under its internal law to collect the tax and all 
administrative and judicial rights of the taxpayer to restrain 
collection in the applicant country have lapsed or been 
exhausted.
    Under the proposed treaty, the certified document shall be 
rendered enforceable under the laws of the requested country. 
The proposed treaty provides that where Austria is the country 
requesting assistance, such document must be rendered 
enforceable by the Regional Finance Directorates 
(Finanzlandesdirektionen).
    Under the proposed treaty, an accepted request shall be 
collected by the accepting country as though the claim were 
that country's own revenue claim that has been finally 
determined. However, the claim will not have, in the accepting 
country, any priority accorded to the revenue claims of that 
country (e.g., in the case of a bankruptcy). In the event that 
judicial execution is necessary, the proposed treaty provides 
that a request from Austria shall be requested by the 
Finanzprokuratur or by the finance office delegated to act on 
his behalf. The proposed treaty provides that appeals 
concerning the existence or the amount of the debt shall lie 
only to the competent tribunal of the requesting country.
    Similar to the U.S. model, the collection provision does 
not impose on either country the obligation to carry out 
administrative measures of a different nature from those used 
in the collection of its own taxes, or that is contrary to its 
sovereignty, security, public policy or essential interest. 
According to the MOU, a country that has been requested to 
recover a tax on behalf of the other country may deny the 
request by invoking this ``essential interest'' clause and 
claim that the tax in question is not levied in accordance with 
the provisions of the proposed treaty.
    The MOU clarifies that the requested country shall be 
obligated to obtain the requested information according to its 
procedures at the time of the request (and not its procedures 
at the time the treaty enters into force). In addition, the MOU 
clarifies that the exchange of information and collection 
provisions are not confined to taxes levied, or information 
coming into existence, after the proposed treaty becomes 
effective.

Article 26. Diplomatic Agents and Consular Officers

    The proposed treaty contains the rule found in other U.S. 
tax treaties that its provisions are not to affect the 
privileges of diplomatic agents or consular officials 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 full to this article, so that, for 
example, U.S. diplomats who are considered Austrian residents 
generally may be protected from Austrian tax.

Article 27. Application of the Convention

    As a matter of internal law, the United States generally 
implements treaty reductions in taxes subject to withholding by 
reducing the amounts of tax withheld at the source. An 
alternative that the United States views as permissible under 
treaties is the refund of amounts withheld at the statutory 
rates. The proposed treaty contains express language confirming 
the validity of the latter method under this treaty. It 
provides that if a treaty country taxes an item by withholding 
at source, then the right to require withholding at the 
statutory rate is not affected by the treaty. The proposed 
treaty requires that the tax be refunded on application to the 
extent of the treaty reduction in accordance with the 
applicable procedures of the country under whose laws the 
withholding is made.

Article 28. Entry Into Force

    The proposed treaty will enter into force on the first day 
of the second month following the exchange of instruments of 
ratification. The provisions of the proposed treaty generally 
take effect for taxable years and periods beginning on or after 
the first day of January in the year following the date of 
entry into force. In the case of taxes payable at source, the 
proposed treaty generally takes effect for payments made on or 
after the first day of the second month following the date the 
treaty enters into force (i.e., the first day of the fourth 
month following the exchange of instrument of ratification). 
The MOU clarifies that the provisions of the exchange of 
information and administrative assistance article (Article 25) 
are not confined to taxes levied, or to information coming into 
existence after the date the proposed treaty enters into force.
    Taxpayers may elect temporarily to continue to claim 
benefits under the present treaty with respect to a period 
after the proposed treaty takes effect. For such a taxpayer, 
the present treaty continues to have effect in its entirety for 
the first assessment period or taxable year from the date on 
which the provisions of the proposed treaty would otherwise 
take effect. The present treaty ceases to have effect once the 
provisions of the proposed treaty take effect under the 
proposed treaty.

Article 29. Termination

    The proposed treaty will continue in force until terminated 
by a treaty country. Either country may terminate it at any 
time after five years from the date of its entry into force by 
giving at least six months prior written notice through 
diplomatic channels. A termination will be effective for 
taxable years and periods beginning after the end of the 
calendar year in which the notice has been given. With respect 
to taxes payable at source, a termination will be effective for 
payments made after the end of the calendar year in which the 
notice has been 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 Austria for the Avoidance of Double 
Taxation and the Prevention of Fiscal Evasion with Respect to 
Taxes on Income, signed at Vienna on May 31, 1996 (Treaty Doc. 
104-31), subject to the understanding of subsection (a), the 
declarations of subsection (b), and the proviso of subsection 
(c).
    (a) UNDERSTANDING.--The Senate's advice and consent is 
subject to the following understanding, which shall be included 
in the instrument of ratification, and shall be binding on the 
President:
          (1) OECD COMMENTARY.--Provisions of the Convention 
        that correspond to provisions of the Organization for 
        Economic Cooperation and Development (OECD) Model Tax 
        Convention on Income and on Capital generally shall be 
        expected to have the same meaning as expressed in the 
        OECD Commentary thereon. The United States understands, 
        however, that the foregoing will not apply with respect 
        to any reservations or observations it enters to the 
        OECD Model or its Commentary and that it may enter such 
        a reservation or observation at any time.
    (b) DECLARATIONS.--The Senate's advice and consent is 
subject to the following two declarations, which shall be 
binding on the President:
          (1) REAL ESTATE INVESTMENT TRUSTS.--The United States 
        shall use its best efforts to negotiate with the 
        Republic of Austria a protocol amending the Convention 
        to provide for the application of subparagraph (b) of 
        paragraph 2 of Article 10 of the Convention to 
        dividends paid by a Real Estate Investment Trust in 
        cases where (i) the beneficial owner of the dividends 
        beneficially holds an interest of 5 percent or less in 
        each class of the stock of the Real Estate Investment 
        Trust and the dividends are paid with respect to a 
        class of stock of the Real Estate Investment Trust that 
        is publicly traded or (ii) the beneficial owner of the 
        dividends beneficially holds an interest of 10 percent 
        or less in the Real Estate Investment Trust and the 
        Real Estate Investment Trust is diversified.
          (2) 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.
    (c) 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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