[Senate Executive Report 105-8]
[From the U.S. Government Publishing Office]



105th Congress                                               Exec. Rpt.
                                 SENATE

 1st Session                                                      105-8
_______________________________________________________________________


 
                  TAXATION CONVENTION WITH LUXEMBOURG

                                _______
                                

                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. 104-33]

    The Committee on Foreign Relations, to which was referred 
the Convention between the Government of the United States of 
America and the Government of the Grand Duchy of Luxembourg for 
the Avoidance of Double Taxation and the Prevention of Fiscal 
Evasion with Respect to Taxes on Income and Capital, signed at 
Luxembourg on April 3, 1996, having considered the same, 
reports favorably thereon, with one reservation, 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...................................................17
VIII.Explanation of Proposed Treaty..................................17

 IX. Text of the Resolution of Ratification..........................68

                               I. Purpose

    The principal purposes of the proposed income tax treaty 
between the United States and Luxembourg 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 April 3, 1996. The United 
States and Luxembourg also exchanged diplomatic notes at the 
time the proposed treaty was signed. The proposed treaty would 
replace the existing income tax treaty between the United 
States and Luxembourg that was signed in 1962.
    The proposed treaty was transmitted to the Senate for 
advice and consent to its ratification on September 4, 1996 
(see Treaty Doc. 104-33). 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 double taxation 
principally is achieved by each country agreeing to limit, in 
certain specified situations, its right to tax income derived 
from its territory by residents of the other country. For 
example, the proposed treaty contains provisions under which 
neither country generally will tax business income derived from 
sources within that country by residents of the other country 
unless the business activities in the taxing country are 
substantial enough to constitute a permanent establishment or 
fixed base (Articles 7 and 15). 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 15, 16, and 18). The proposed 
treaty provides that dividends and certain capital gains 
derived by a resident of either country from sources within the 
other country generally may be taxed by both countries 
(Articles 10 and 14); 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 12 and 
13).
    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 25).
    The proposed treaty includes the ``saving clause'' 
contained in U.S. tax treaties that allows the United States to 
retain the right to tax its citizens and residents as if the 
treaty had not come into effect (Article 1). In addition, the 
proposed treaty contains the standard provision that it may not 
be applied to deny any taxpayer any benefits the taxpayer would 
be entitled to under the domestic law of a country or under any 
other agreement between the two countries (Article 1).
    The proposed treaty also contains a detailed limitation on 
benefits provision to prevent the inappropriate use of the 
proposed treaty (Article 24).

                  IV. Entry Into Force and Termination

                          A. Entry into Force

    The proposed treaty will enter into force upon the exchange 
of instruments of ratification. The 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 of January 
following the entry into force. In the case of other taxes, the 
proposed treaty takes effect for taxable years and periods 
beginning on or after that first of January.
    Where greater benefits would be available to a taxpayer 
under the present treaty than under the proposed treaty, the 
proposed treaty provides that the taxpayer may elect to be 
taxed under the present treaty (in its entirety) for the first 
assessment period or taxable year following the date 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 by giving 
notice through diplomatic channels at least six months before 
the end of any calendar year after the entry into force. With 
respect to taxes payable at source, a termination will be 
effective for payments made on or after the first of January 
following the expiration of the six-month period. With respect 
to other taxes, a termination will be effective for taxable 
years and periods beginning on or after the first of January 
following the expiration of the six-month period.

                          V. Committee Action

    The Committee on Foreign Relations held a public hearing on 
the proposed treaty with Luxembourg (Treaty Doc. 104-33), 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 
Luxembourg favorably reported by a voice vote, with the 
recommendation that the Senate give its advice and consent to 
ratification of the proposed treaty, subject to a reservation, 
two declarations, and a proviso.

                         VI. Committee Comments

    On balance, the Committee on Foreign Relations believes 
that the proposed treaty with Luxembourg 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 transferable.
    In order to satisfy the asset requirements for REIT status, 
a REIT must have at least 75 percent of the value of its assets 
invested in real estate, cash and cash items, and government 
securities. In addition, diversification rules apply to the 
REIT's investment in assets other than the foregoing qualifying 
assets. Under these rules, not more than 5 percent of the value 
of its assets may be invested in securities of a single issuer 
and any such securities held may not represent more than 10 
percent of the voting securities of the issuer.
    In order to satisfy the source of income requirements, at 
least 95 percent of the gross income of the REIT generally must 
be from certain passive sources (e.g., dividends, interest, and 
rents). In addition, at least 75 percent of its gross income 
generally must be from certain real estate sources (e.g., real 
property rents, mortgage interest, and real property gains).
    Finally, in order to satisfy the distribution of income 
requirement, the REIT generally is required to distribute to 
its shareholders each year at least 95 percent of its taxable 
income for the year (excluding net capital gains). A REIT may 
retain 5 percent or less of its taxable income and all or part 
of its net capital gain.
    A REIT is subject to corporate-level tax only on any 
taxable income and net capital gains that the REIT retains. 
Under an available election, shareholders may be taxed 
currently on the undistributed capital gains of a REIT, with 
the shareholder entitled to a credit for the tax paid by the 
REIT with respect to the undistributed capital gains such that 
the gains are subject only to a single level of tax. 
Distributions from a REIT of ordinary income are taxable to the 
shareholders as a dividend, in the same manner as dividends 
from an ordinary corporation. Accordingly, such dividends are 
subject to tax at a maximum rate of 39.6 percent in the case of 
individuals and 35 percent in the case of corporations. In 
addition, capital gains of a REIT distributed as a capital gain 
dividend are taxable to the shareholders as capital gain. 
Capital gain dividends received by an individual will be 
eligible for preferential capital gain tax rates if the 
relevant holding period requirements are satisfied.

Foreign investors in REITs

    Nonresident alien individuals and foreign corporations 
(collectively, foreign persons) are subject to U.S. tax on 
income that is effectively connected with the foreign person's 
conduct of a trade or business in the United States, in the 
same manner and at the same graduated tax rates as U.S. 
persons. In addition, foreign persons generally are subject to 
U.S. tax at a flat 30-percent rate on certain gross income that 
is derived from U.S. sources and that is not effectively 
connected with a U.S. trade or business. The 30-percent tax 
applies on a gross basis to U.S.-source interest, dividends, 
rents, royalties, and other similar types of income. This tax 
generally is collected by means of withholding by the person 
making the payment of such amounts to a foreign person.
    Capital gains of a nonresident alien individual that are 
not connected with a U.S. business generally are subject to the 
30-percent withholding tax only if the individual is present in 
the United States for 183 days or more during the year. The 
United States generally does not tax foreign corporations on 
capital gains that are not connected with a U.S. trade or 
business. However, foreign persons generally are subject to 
U.S. tax on any gain from a disposition of an interest in U.S. 
real property at the same rates that apply to similar income 
received by U.S. persons. Therefore, a foreign person that has 
capital gains with respect to U.S. real estate is subject to 
U.S. tax on such gains in the same manner as a U.S. person. For 
this purpose, a distribution by a REIT to a foreign shareholder 
that is attributable to gain from a disposition of U.S. real 
property by the REIT is treated as gain recognized by such 
shareholder from the disposition of U.S. real property.
    U.S. income tax treaties contain provisions limiting the 
amount of income tax that may be imposed by one country on 
residents of the other country. Many treaties, like the 
proposed treaty, generally allow the source country to impose 
not more than a 15-percent withholding tax on dividends paid to 
a resident of the other treaty country. In the case of real 
estate income, most treaties, like the proposed treaty, specify 
that income derived from, and gain from dispositions of, real 
property in one country may be taxed by the country in which 
the real property is situated without limitation. 2 
Accordingly, U.S. real property rental income derived by a 
resident of a treaty partner generally is subject to the U.S. 
withholding tax at the full 30-percent rate (unless the net-
basis taxation election is made), and U.S. real property gains 
of a treaty partner resident are subject to U.S. tax in the 
manner and at the rates applicable to U.S. persons.
---------------------------------------------------------------------------
    \2\ Many treaties, like the proposed treaty, allow the foreign 
person to elect to be taxed in the source country on income derived 
from real property on a net basis under the source country's domestic 
laws.
---------------------------------------------------------------------------
    Although REITs are not subject to corporate-level taxation 
like other corporations, distributions of a REIT's income to 
its shareholders generally are treated as dividends in the same 
manner as distributions from other corporations. Accordingly, 
in cases where no treaty is applicable, a foreign shareholder 
of a REIT is subject to the U.S. 30-percent withholding tax on 
ordinary income distributions from the REIT. In addition, such 
shareholders are subject to U.S. tax on U.S. real estate 
capital gain distributions from a REIT in the same manner as a 
U.S. person.
    In cases where a treaty is applicable, this U.S. tax on 
capital gain distributions from a REIT still applies. However, 
absent special rules applicable to REIT dividends, treaty 
provisions specifying reduced rates of tax on dividends apply 
to ordinary income dividends from REITs as well as to dividends 
from taxable corporations. As discussed above, the proposed 
treaty, like many U.S. treaties, reduces the U.S. 30-percent 
withholding tax to 15 percent in the case of dividends 
generally. Prior to 1989, U.S. tax treaties contained no 
special rules excluding dividends from REITs from these reduced 
rates. Therefore, under pre-1989 treaties, REIT dividends are 
eligible for the same reductions in the U.S. withholding tax 
that apply to other corporate dividends.
    Beginning in 1989, U.S. treaty negotiators began including 
in treaties provisions excluding REIT dividends from the 
reduced rates of withholding tax generally applicable to 
dividends. Under treaties with these provisions such as the 
proposed treaty, REIT dividends generally are subject to the 
full U.S. 30-percent withholding tax. 3
---------------------------------------------------------------------------
    \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's 
treaty policy is to preserve its right to tax real property 
income derived from the United States. Accordingly, the U.S. 
30-percent tax on rental income from U.S. real property is not 
reduced in U.S. tax treaties.
    If a foreign investor in a REIT were instead to invest in 
U.S. real estate directly, the foreign investor would be 
subject to the full 30-percent withholding tax on rental income 
earned on such property (unless the net-basis taxation election 
is made). However, when the investor makes such investments 
through a REIT instead of directly, the income earned by the 
investor is treated as dividend income. If the reduced rates of 
withholding tax for dividends apply to REIT dividends, the 
foreign investor in the REIT is accorded a reduction in U.S. 
withholding tax that is not available for direct investments in 
real estate.
    On the other hand, some argue that it is important to 
encourage foreign investment in U.S. real estate through REITs. 
In this regard, a higher withholding tax on REIT dividends 
(i.e., 30 percent instead of 15 percent) may not be fully 
creditable in the foreign investor's home country and the cost 
of the higher withholding tax therefore may discourage foreign 
investment in REITs. For this reason, some oppose the inclusion 
in U.S. treaties of the special provisions governing REIT 
dividends, arguing that dividends from REITs should be given 
the same treatment as dividends from other corporate entities. 
Accordingly, under this view, the 15-percent withholding tax 
rate generally applicable under treaties to dividends should 
apply to REIT dividends as well.
    This argument is premised on the view that investment in a 
REIT is not equivalent to direct investment in real property. 
From this perspective, an investment in a REIT should be viewed 
as comparable to other investments in corporate stock. In this 
regard, like other corporate shareholders, REIT investors are 
investing in the management of the REIT and not just its 
underlying assets. Moreover, because the interests in a REIT 
are widely held and the REIT itself typically holds a large and 
diversified asset portfolio, an investment in a REIT represents 
a very small investment in each of a large number of 
properties. Thus, the REIT investment provides diversification 
and risk reduction that are not easily replicated through 
direct investment in real estate.
    At the October 7, 1997 hearing on the proposed treaty (as 
well as other proposed treaties and protocols), the Treasury 
Department announced that it has modified its policy with 
respect to the exclusion of REIT dividends from the reduced 
withholding tax rates applicable to other dividends under 
treaties. The Treasury Department worked extensively with the 
staff of the Committee on Foreign Relations, the staff of the 
Joint Committee on Taxation, and representatives of the REIT 
industry in order to address the concern that the current 
treaty policy with respect to REIT dividends may discourage 
some foreign investment in REITs while maintaining a treaty 
policy that properly preserves the U.S. taxing jurisdiction 
over foreign direct investment in U.S. real property. The new 
policy is a result of significant cooperation among all parties 
to balance these competing considerations.
    Under this policy, REIT dividends paid to a resident of a 
treaty country will be eligible for the reduced rate of 
withholding tax applicable to portfolio dividends (typically, 
15 percent) in two cases. First, the reduced withholding tax 
rate will apply to REIT dividends if the treaty country 
resident beneficially holds an interest of 5 percent or less in 
each class of the REIT's stock and such dividends are paid with 
respect to a class of the REIT's stock that is publicly traded. 
Second, the reduced withholding tax rate will apply to REIT 
dividends if the treaty country resident beneficially holds an 
interest of 10 percent or less in the REIT and the REIT is 
diversified, regardless of whether the REIT's stock is publicly 
traded. In addition, the current treaty policy with respect to 
the application of the reduced withholding tax rate to REIT 
dividends paid to individuals holding less than a specified 
interest in the REIT will remain unchanged.
    For purposes of these rules, a REIT will be considered 
diversified if the value of no single interest in real property 
held by the REIT exceeds 10 percent of the value of the REIT's 
total interests in real property. An interest in real property 
will not include a mortgage, unless the mortgage has 
substantial equity components. An interest in real property 
also will not include foreclosure property. Accordingly, a REIT 
that holds exclusively mortgages will be considered to be 
diversified. The diversification rule will be applied by 
looking through a partnership interest held by a REIT to the 
underlying interests in real property held by the partnership. 
Finally, the reduced withholding tax rate will apply to a REIT 
dividend if the REIT's trustees or directors make a good faith 
determination that the diversification requirement is satisfied 
as of the date the dividend is declared.
    The Treasury Department will incorporate this new policy 
with respect to the treatment of REIT dividends in the U.S. 
model and in future treaty negotiations. The Committee believes 
that the new policy with respect to the applicability of 
reduced withholding tax rates to REIT dividends appropriately 
reflects economic changes since the establishment of the 
current policy. The Committee further believes that the new 
policy fairly balances competing considerations by extending 
the reduced rate of withholding tax on dividends generally to 
dividends paid by REITs that are relatively widely-held and 
diversified.
    Because of significant existing and potential investment in 
REITs by Luxembourg residents, the Committee believes that it 
is important that this new policy be incorporated into the 
proposed treaty with Luxembourg immediately. In addition, the 
Committee believes that the reduced rate of withholding tax 
provided under the present treaty with Luxembourg should 
continue to apply with respect to certain existing investments 
in REITs. Accordingly, the Committee has included in its 
recommended resolution of ratification, with the concurrence of 
the Treasury Department, a reservation requiring that the 
proposed treaty reflect both this new policy with respect to 
the treatment of REIT dividends generally and a special rule 
for dividends on certain existing REIT investments. Under this 
special rule, in the case of any resident of Luxembourg who 
beneficially held an interest in a diversified REIT as of June 
30, 1997, dividends paid to such resident with respect to that 
interest will be eligible for the reduced rate of withholding 
tax. However, this special rule will not apply to dividends 
paid after December 31, 1999, unless the stock of the REIT is 
publicly traded on December 31, 1999 and thereafter. The 
Committee and the Treasury Department have agreed that the 
special rule will apply to existing investment in a REIT as of 
June 30, 1997 and to reinvestment in the REIT of both ordinary 
and capital gain dividends paid with respect to that 
investment. In addition, the Committee and the Treasury 
Department have agreed that if a REIT in which there is a 
qualifying investment as of June 30, 1997 goes out of existence 
in a nonrecognition transaction, the special rule will continue 
to apply to the investment in the successor REIT if any.

                           B. 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 
Luxembourg 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. The proposed treaty provision 
resembles the anti-treaty-shopping provisions contained in 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 Internal Revenue 
Service (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.) In 
addition, the detail in the proposed treaty represents 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 general provisions

    Anti-treaty-shopping articles in treaties often have a two-
part ``ownership and base erosion'' test. Many recent treaty 
provisions and the anti-treaty-shopping provision of the U.S. 
branch tax provisions in the Code generally have ownership 
requirements that limit benefits to a company residing in a 
treaty country unless more than 50 percent of all classes of 
its stock is held by individual residents of either treaty 
country. The proposed treaty lowers the qualifying percentage 
to at least 50 percent of the principal class of stock. Thus, 
the ownership requirement under the proposed treaty is more 
generous to taxpayers than the corresponding requirements in 
other recent treaties. The U.S. model requires that at least 50 
percent of all classes of the company's stock be owned by 
qualified persons for at least half the days during the 
company's taxable year. Because the ownership requirement in 
the U.S. model applies to all classes of the company's stock, 
and not just to the principal class of stock as in the proposed 
treaty, the proposed treaty generally is more favorable to 
taxpayers than the corresponding requirements in the U.S. 
model.
    The base erosion requirement in recent treaties denies 
treaty benefits if 50 percent or more of the resident's gross 
income is used, directly or indirectly, to meet liabilities 
(including liabilities for interest or royalties) to certain 
classes of persons not entitled to treaty benefits. A similar 
test applies under the branch tax rules under U.S. law. The 
base erosion test in the proposed treaty maintains the same 50-
percent-or-more threshold as in recent treaties. The proposed 
treaty may be more favorable to taxpayers than other recent 
treaties and the U.S. model because the test treats does not 
take into account amounts that reflect arm's-length payments in 
the ordinary course of business for services or for the 
purchase or rental of tangible property including immovable 
property. This exception is not included in the U.S. model.
    The proposed treaty is similar to other U.S. treaties and 
the branch tax rules in affording treaty benefits to certain 
publicly traded companies. In comparison with the U.S. branch 
tax rules, the proposed treaty is more lenient. The proposed 
treaty allows benefits to be afforded to a company that is 
controlled, directly or indirectly, by one or more qualifying 
publicly traded corporations while the branch tax rules allow 
benefits to be afforded only to a wholly-owned subsidiary of a 
publicly traded company. The Treasury Department's Technical 
Explanation of the proposed treaty (hereinafter referred to as 
the ``Technical Explanation'') provides that, for this purpose, 
the term control refers to the ability to influence the actions 
of the company, but does not require a majority (i.e., more 
than 50-percent) ownership. Thus, the proposed treaty's 
treatment of subsidiaries of publicly traded companies is more 
favorable relative to that in the corresponding provisions of 
other existing tax treaties. For example, in the U.S.-
Netherlands treaty, more than 50 percent of the aggregate vote 
and value of the stock of the subsidiary must be owned by five 
or fewer publicly traded companies. As another example, in the 
U.S.-France treaty, more than 50 percent of the aggregate vote 
and value of the stock of the subsidiary must be owned by any 
number of publicly traded companies.
    Under the active business test in the anti-treaty-shopping 
article, treaty benefits in the source country will be 
available under the proposed treaty to an entity that is a 
resident of one country, if it is engaged in the active conduct 
of a trade or business in its residence country, and if either 
the income derived from the source country is incidental to 
that trade or business in the residence country, or such income 
is derived in connection with that trade or business and the 
trade or business is substantial in relation to the income 
producing activity. (This active trade or business test 
generally does not apply with respect to a business of making 
or managing investments, unless these activities are carried on 
by a bank or an insurance company.) The proposed treaty's 
active business test is similar to those found in recent 
treaties. As in some recent U.S. treaties, the proposed treaty 
attributes to the treaty resident active trades or businesses 
conducted by other entities in a complementary line of 
business. The attribution rules in the proposed treaty may 
result in more taxpayers being eligible for treaty benefits, 
and permit in some cases the treatment of third-country 
business operations as if they were carried on in Luxembourg. 
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 a Luxembourg resident in a case where no other 
substantial tax is imposed on that income (the so-called 
``triangular case''). This is necessary because a Luxembourg 
resident may in some cases be wholly or partially exempt from 
Luxembourg tax on foreign (i.e., non-Luxembourg) income. The 
special rule applies generally if the combined Luxembourg and 
third-country taxation of U.S.-source income derived by a 
Luxembourg enterprise and attributable to a permanent 
establishment in the third country is less than 50 percent of 
the tax that would be imposed if the Luxembourg enterprise 
earned the income in Luxembourg.
    Under the special rule, the United States is permitted to 
tax dividends, interest, and royalties paid to the third-
country permanent establishment at the rate of 15 percent. In 
addition, under the special rule, the United States is 
permitted to tax other types of income without regard to the 
proposed treaty. The special rule generally does not apply if 
the U.S. income is derived in connection with, or is incidental 
to, an active trade or business in the third country. The 
special rule is similar to a provision of the 1993 protocol to 
the U.S.-Netherlands tax treaty and a provision of the U.S.-
France treaty. These special rules for triangular cases are not 
included in the U.S. model.
    The U.S.-France treaty provides a further exception from 
the application of the special rule for the triangular case if 
the third-country income is subject to taxation by either the 
United States or France under the controlled foreign 
corporation rules of either country. 4 Although the 
proposed treaty does not provide an explicit controlled foreign 
corporation exception, the Technical Explanation states that 
the U.S. competent authority would grant relief in a case where 
the U.S.-source income subject to the special rule ultimately 
is included in a U.S. shareholder's income under the subpart F 
rules.
---------------------------------------------------------------------------
    \4\ In the case of the United States, these provisions are 
contained in sections 951-964 of the Code and are referred to as the 
``subpart F'' rules.
---------------------------------------------------------------------------

Derivative benefits and discretionary competent authority relief

    The proposed treaty also provides mechanical rules under 
which so-called ``derivative benefits'' are afforded. 
5 Under these rules, a Luxembourg entity is afforded 
benefits based in part on its ultimate ownership of at least 95 
percent by seven or fewer residents of European Union (``EU'') 
or North American Free Trade Agreement (``NAFTA'') countries 
who would be entitled to U.S. treaty benefits that are as 
favorable under an existing treaty between the United States 
and the third country. The U.S. model does not contain a 
similar derivative benefits provision.
---------------------------------------------------------------------------
    \5\ The U.S. income tax treaties with the Netherlands, Jamaica, and 
Mexico also provide similar benefits.
---------------------------------------------------------------------------
    Taken as a whole, some may argue that the derivative 
benefits provision of the proposed treaty is more generous to 
taxpayers claiming U.S. treaty benefits than the derivative 
benefits provisions of any U.S. tax treaties currently in 
effect. For example, while most other treaties to which the 
United States is a party generally allow derivative benefits 
only with respect to certain income (e.g., interest, dividends 
or royalties), the proposed treaty allows a taxpayer to claim 
derivative benefits with respect to the entire treaty. 
6 In addition, unlike most existing treaties, the 
proposed treaty does not require any same-country ownership of 
a Luxembourg company claiming treaty benefits. 7 In 
other words, a Luxembourg entity that is 100-percent owned by 
certain third-country residents and that does not otherwise 
have a nexus with Luxembourg (e.g., by engaging in an active 
trade or business there), may be entitled to claim benefits 
under the proposed treaty.
---------------------------------------------------------------------------
    \6\ The U.S.-Jamaica tax treaty is the only other existing treaty 
that allows a taxpayer to claim derivative benefits with respect to the 
entire treaty.
    \7\ Article 26(4)(a) of the U.S.-Netherlands treaty, for example, 
requires more than 30-percent Dutch ownership of the entity claiming 
derivative benefits, and more than 70-percent EU ownership of such 
entity. On the other hand, the 1995 U.S.-Canada protocol permits a 
company to claim certain treaty benefits under the derivative benefits 
provision without any same country ownership; however, the benefits 
that may be so obtained are limited to reduced withholding rates for 
dividends, interest and royalties.
---------------------------------------------------------------------------
    Like other treaties and the branch tax rules, the proposed 
treaty permits the competent authority of the source country to 
allow benefits where the anti-treaty-shopping tests are not 
met. The Technical Explanation anticipates that the competent 
authority will base its determination on whether the 
establishment, acquisition, or maintenance of the person 
seeking benefits under the proposed treaty, or the conduct of 
such person's operations, has or had as one of its principal 
purposes the obtaining of benefits under the proposed treaty. 
This standard set forth in the Technical Explanation is similar 
to the standard of the U.S.-Netherlands treaty and other recent 
U.S. tax treaties.
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department about the adequacy of 
the anti-treaty-shopping provision in the proposed treaty. The 
relevant portion of the Treasury Department's October 8, 1997 
letter 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'').

    As each treaty's limitation on benefits provision reflects 
the policies and economies of each country, the limitation on 
benefits provisions will inevitably deviate from one another as 
well as from the U.S. model limitation on benefits provision.
    One of the primary ways in which the limitation on benefits 
provisions of the various treaties before the Committee differ 
is in the degree to which they provide ``bright line'' tests or 
leave issues open to interpretation. . . . As with the 
Netherlands and French treaties, the Luxembourg treaty grants 
benefits to companies that meet a clearly stated active 
business test. These rules create greater certainty than rules 
that require a subjective evaluation of whether the business is 
substantial. The same bright line rules apply in Luxembourg, 
France, and the Netherlands, indicating that the competent 
authority will be able to use experience gained in one country 
when evaluating issues arising in another country.
    The derivative benefits provision of the proposed treaty 
with Luxembourg took into account the small size of the 
Luxembourg stock market. Relative to the United States, France, 
and the Netherlands, there are very few publicly-traded 
Luxembourg companies. Thus, the derivative benefits provision 
of the proposed treaty does not require any Luxembourg 
ownership (while the Netherlands and France both require at 
least 30% ownership by one of the Contracting States). However, 
the treaty does increase the EU ownership requirement to 95 
percent (from 70 percent in the Netherlands and France) and 
imposes two additional conditions. First, the company must be 
owned by seven or fewer residents of the EU or NAFTA and 
second, there must be a comprehensive treaty in place that 
would grant benefits that are at least equivalent to the 
benefits under the Luxembourg treaty. This restriction on the 
number of shareholders, as well as the requirement that the 
third-country treaty provide equivalent or better withholding 
rates, means that companies are not likely to use this 
provision to route income for purposes of treaty shopping. 
Finally, the treaty contains a base erosion test that ensures 
that the treaty benefit is not being diverted to another 
country through earnings stripping.

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 continues to believe that the 
United States should maintain its policy of limiting treaty 
shopping opportunities whenever possible. The Committee 
continues to believe further that, in exercising any latitude 
Treasury has to adjust the operation of the proposed treaty, 
the rules as applied should adequately deter treaty shopping 
abuses. 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.

                        C. Insurance Excise Tax

    The proposed treaty, unlike the present treaty, covers the 
U.S. excise tax on insurance premiums paid to foreign insurers. 
However, in a departure from all existing U.S. tax treaties 
that cover the excise tax on insurance premiums, the excise tax 
on reinsurance premiums is not covered by the proposed treaty.
    With the waiver of the excise tax on insurance premiums, 
for example, a Luxembourg insurer without a permanent 
establishment in the United States can collect premiums on 
policies covering a U.S. risk or a U.S. person free of the 
excise tax on insurance premiums. However, the tax is imposed 
to the extent that the risk is reinsured by the Luxembourg 
insurer with a person not entitled to the benefits of an income 
tax treaty providing exemption from the tax. This latter rule 
is known as the ``anti-conduit'' clause.
    Such waivers of the excise tax have raised serious 
congressional concerns. For example, concern has been expressed 
over the possibility that such waivers may place U.S. insurers 
at a competitive disadvantage with respect to foreign 
competitors in U.S. markets if a substantial tax is not 
otherwise imposed (e.g., by the treaty partner country) on the 
insurance income of the foreign insurer (or, if the risk is 
reinsured, the reinsurer). Moreover, in such a case, a waiver 
of the tax does not serve the primary purpose of treaties to 
prevent double taxation, but instead has the undesirable effect 
of eliminating all tax on such income.
    The U.S.-Barbados and U.S.-Bermuda tax treaties each 
contained such a waiver as originally signed. In its report on 
the Bermuda treaty, the Committee expressed the view that those 
waivers should not have been included. The Committee stated 
that waivers should not be given by Treasury in its future 
treaty negotiations without prior consultations with the 
appropriate committees of Congress. 9 Congress 
subsequently enacted legislation to ensure the sunset of the 
waivers in the two treaties. The insurance excise tax also is 
waived in the treaty with the United Kingdom (without the so-
called ``anti-conduit rule''). The inclusion of such a waiver 
in that treaty has been followed by a number of legislative 
efforts to redress the perceived competitive imbalance created 
by the waiver.
---------------------------------------------------------------------------
    \9\ Limited consultations took place in connection with the 
proposed treaty.
---------------------------------------------------------------------------
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the Luxembourg 
income tax imposed on Luxembourg insurance companies with 
respect to insurance premiums results in a burden that is 
substantial in relation to the U.S. tax on U.S. insurance 
companies. The relevant portion of the October 8, 1997 Treasury 
Department letter responding to this inquiry is reproduced 
below:

    [T]reasury agrees to cover the federal excise tax imposed 
on premiums paid to foreign insurers only if we are satisfied 
that the foreign country imposes a sufficient level of tax on 
insurance premiums. Our analysis of Luxembourg's taxation of 
insurance premiums satisfies us that Luxembourg insurance 
companies pay a tax sufficient to maintain a competitive 
balance for U.S. companies in the insurance market. 
Consultations were held with Senate and House Committee staff 
members before a final decision was made. . . [W]e were not 
satisfied that this is true with respect to the Luxembourg 
taxation of reinsurance premiums. As a result, the treaty does 
not cover the excise taxes imposed on premiums paid to 
Luxembourg insurers for reinsurance. Accordingly, this 
exemption does not alter the competitive position of our 
insurance companies.

    In light of the inclusion in the proposed treaty of the 
anti-conduit clause and based on the assessment provided by the 
Treasury Department regarding the relative tax burdens of 
Luxembourg insurers and U.S. insurers, the Committee believes 
that the waiver of the excise tax for Luxembourg insurers is 
consistent with the criteria the Committee has articulated for 
such waivers. However, the Committee instructs the Treasury 
Department promptly to notify the Committee of any changes in 
laws or business practices that would have an impact on the tax 
burden of Luxembourg insurers relative to that of U.S. 
insurers.

                       D. Exchange of Information

    One of the principal purposes of the proposed income tax 
treaty between the United States and Luxembourg 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 article 
of the OECD model and the U.S. model. 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 practice 
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 Technical Explanation states that Luxembourg bank 
secrecy laws prohibit Luxembourg tax authorities from obtaining 
information from Luxembourg financial institutions for their 
own tax investigations and proceedings. Consequently, the 
Luxembourg competent authority would not be able to provide 
such information upon the request of the U.S. competent 
authority. However, the Notes provide that such information may 
be provided to the U.S. competent authority in accordance with 
the terms of the proposed Treaty between the United States of 
America and the Grand Duchy of Luxembourg on Mutual Legal 
Assistance in Criminal Matters (``MLAT''). MLATs are negotiated 
and administered by the U.S. Justice Department and are used 
for the exchange of information in criminal matters. Because 
the provisions of the MLAT would apply only to criminal 
investigations, the United States may not obtain financial 
institution information from Luxembourg in cases involving non-
criminal matters.
    With regard to criminal tax offenses, the proposed MLAT 
generally requires that assistance be provided only with 
respect to offenses concerning specifically enumerated taxes 
(e.g., value added taxes, sales taxes, excise taxes and custom 
duties). 10 The proposed MLAT imposes a higher 
standard before assistance can be provided with respect to 
offenses concerning other taxes (e.g., income taxes): 
assistance will not be available unless the facts establish a 
reasonable suspicion of ``fiscal fraud.'' This is defined to be 
a criminal offense in which the tax involved (either as an 
absolute amount or in relation to an annual amount due) is 
significant, and in which the conduct involved constituted a 
systematic effort or pattern of activity tending to conceal 
facts from, or provide inaccurate facts to, the tax 
authorities. Thus, with respect to income taxes covered under 
the proposed treaty, assistance under the proposed MLAT would 
not be available if this threshold inquiry were not satisfied.
---------------------------------------------------------------------------
    \10\ Under the proposed MLAT, this rule would also apply to any 
other taxes hereinafter agreed to by both countries through an exchange 
of diplomatic notes.
---------------------------------------------------------------------------
    Some have argued that the imposition under the proposed 
MLAT of a higher standard before assistance can be provided 
with respect to income taxes may disadvantage the United States 
in obtaining assistance with respect to its principal form of 
taxation, in comparison with the lower standard for assistance 
with respect to value added taxes, which are imposed by 
Luxembourg and not the United States. Others have responded 
that requiring reasonable suspicion of fiscal fraud before 
assistance can be provided with respect to income taxes may not 
be a significant impediment in most U.S. criminal income tax 
cases. This is so because, first, U.S. criminal income tax 
cases generally do involve an amount of tax that is 
significant, and second, systematic concealment or the 
provision of inaccurate facts is a common element of many U.S. 
criminal income tax cases.
    As stated earlier, the exchange of information provisions 
are used to achieve one of the principal purposes of the 
proposed treaty and, thus, are a vital part of the proposed 
treaty. The proposed treaty does not cover exchanges of all 
types of information (e.g., information of financial 
institutions is excluded). In this regard, the proposed treaty 
is supplemented by the proposed MLAT. However, the rights of 
each country to obtain tax information under the proposed MLAT 
also are limited.
    As is part of its consideration of the proposed treaty, the 
Committee asked if the Treasury Department considers the 
exchange of information provisions of the proposed treaty to be 
adequate to carry out the tax-avoidance purposes for which 
income tax treaties are entered into by the United States. The 
relevant portion of the October 8, 1997 Treasury Department 
letter responding to this inquiry is reproduced below:

    The treaty allows the United States to obtain information, 
other than information of Luxembourg financial institutions, 
for a broad range of matters. In the case of financial 
institutions, Luxembourg's internal law does not allow 
Luxembourg's tax authorities to obtain information from these 
institutions. Thus, a new approach was followed to obtain this 
information. The exchange of notes to the treaty makes it clear 
that this information is to be obtained through the Mutual 
Legal Assistance Treaty which was being negotiated at the same 
time as the tax treaty. . . .
    The Luxembourg treaty also contains a provision that 
requires Luxembourg to grant to us any improved access to 
information that it grants to other countries. For example, if 
the European Union requires its Member States to provide more 
information to one another, the United States will gain the 
same access to such information. This provision is beneficial 
to our tax authorities as it allows us to benefit from any 
liberalization that Luxembourg may adopt as part of its EU 
obligations.

    Although broader exchange of information provisions are 
desirable, the Committee understands the difficulty in 
achieving broader provisions given the constraints of 
Luxembourg law. Additionally, the Committee notes that the 
exchange of information provisions of the proposed treaty are 
improved in some respects over the comparable provisions of the 
present treaty. However, the Committee does not believe that 
the proposed Luxembourg 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 of 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.
    The Committee is particularly concerned about the fact that 
some exchanges of information will occur only under the MLAT 
and not under the proposed treaty itself. The Committee 
believes that given the significance of information exchange as 
a principal purpose for entering into a tax treaty, the 
exchange of information provisions should be contained in the 
tax treaty and not in a separate agreement such as the MLAT. In 
order to prevent the proposed treaty from entering into force 
until the information exchange provisions of the MLAT are 
effective, the Committee in its recommended resolution of 
ratification has conditioned U.S. ratification of the proposed 
treaty on ratification of the U.S.-Luxembourg MLAT.

                           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 Luxembourg is 
presented below. The provisions set forth in the diplomatic 
notes (the ``Notes'') exchanged at the time the proposed treaty 
was signed are covered together with the relevant articles of 
the proposed treaty. 11
---------------------------------------------------------------------------
    \11\ The Notes state that the negotiators developed and agreed upon 
a common understanding and interpretation of certain provisions of the 
proposed treaty, intending to give guidance both to the taxpayers and 
the tax authorities of the two countries in interpreting various 
provisions contained in the proposed treaty.
---------------------------------------------------------------------------

Article 1. General Scope

    The general 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 Luxembourg, with 
modifications to such scope provided in other articles (e.g., 
Article 26 (Non-discrimination) and Article 28 (Exchange of 
Information)). As discussed below, the proposed treaty also 
contains a ``saving clause'' under which the United States 
generally remains free to tax its own residents and citizens 
without regard to the treaty.
    The proposed treaty provides that it generally does not 
restrict any benefits accorded by internal law or by any other 
agreement between the United States and Luxembourg. Thus, the 
proposed treaty applies only where it benefits taxpayers. As 
discussed 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 Luxembourg has three separate 
businesses in the United States. One business is profitable, 
and constitutes a U.S. permanent establishment. The other two 
are trades or businesses that would generate effectively 
connected income as determined under the Code, but that do not 
constitute permanent establishments as determined under the 
proposed treaty; one trade or business is profitable and the 
other generates a net loss. Under the Code, all three 
operations would be subject to U.S. income tax, in which case 
the losses from the unprofitable line of business could offset 
the taxable income from the other lines of business. On the 
other hand, only the income of the operation which gives rise 
to a permanent establishment would be taxable by the United 
States under the proposed treaty. The Technical Explanation 
makes clear that the taxpayer could not invoke the proposed 
treaty to exclude the profits of the profitable trade or 
business that does not constitute a permanent establishment and 
invoke U.S. internal law to claim the loss of the unprofitable 
trade or business that does not constitute a permanent 
establishment against the taxable income of the permanent 
establishment. 12
---------------------------------------------------------------------------
    \12\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
---------------------------------------------------------------------------
            Saving clause
    Like all U.S. income tax treaties, the proposed treaty is 
subject to a ``saving clause.'' The saving clause in the 
proposed treaty is drafted unilaterally to apply only to the 
United States. Under this clause, with specific exceptions 
described below, the proposed treaty is not to affect the U.S. 
taxation of its residents or its citizens. By reason of this 
saving clause, unless otherwise specifically provided in the 
proposed treaty, the United States will continue to tax its 
citizens who are residents of Luxembourg as if the treaty were 
not in force. ``Residents'' for purposes of the proposed treaty 
(and, thus, for purposes of the saving clause) include 
corporations and other entities as well as individuals who are 
not treated as residents of the other country under the 
proposed treaty's tie-breaker provisions governing dual 
residents (as defined in Article 4 (Residence)).
    The proposed treaty contains a provision under which the 
saving clause (and therefore the U.S. jurisdiction to tax) 
applies to a former U.S. citizen 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 
Luxembourg (Article 9, paragraph 2); exemption from U.S. tax on 
pensions, social security benefits and annuities paid by 
Luxembourg (Article 19, paragraph 1(b)); relief from double 
taxation (Article 25); nondiscrimination (Article 26); and 
mutual agreement procedures (Article 27).
    In addition, the saving clause does not apply to the 
following benefits conferred by the United States with respect 
to an individual who neither is a U.S. citizen nor has been 
admitted to the United States as a permanent resident. Under 
this rule, the specified treaty benefits are available to a 
Luxembourg 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 (i.e., is not a green-card holder). The benefits that 
are subject to this rule are exemption from tax on compensation 
from government service to Luxembourg (Article 20); exemption 
from U.S. tax on certain income received by temporary visitors 
who are students, trainees, teachers or researchers (Article 
21); and certain fiscal privileges of diplomatic agents and 
consular officers referred to in the proposed treaty (Article 
29).
    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 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 two exceptions. The first exception applies to the 
governmental employment income derived by a resident of the 
other country. The second exception applies to the 
nondiscrimination provisions of the treaty. Under the present 
treaty, no exception to the saving clause is provided for the 
double taxation provisions.
            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 Luxembourg 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 Luxembourg, 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 will 
continue to apply with respect to trade in goods.

Article 2. Taxes Covered

    The proposed treaty generally applies to the income taxes 
of the United States and Luxembourg. It also applies to certain 
insurance excise taxes.
            United States

In general

    In the case of the United States, the proposed treaty 
applies to the Federal income taxes imposed by the Code, but 
excludes social security taxes. Unlike many U.S. income tax 
treaties in force, but like the present treaty, the proposed 
treaty applies to the accumulated earnings tax and the personal 
holding company tax. In addition, as discussed below, the 
proposed treaty applies to the U.S. excise tax imposed on 
insurance premiums paid to foreign insurers; however, the 
proposed treaty does not apply to the U.S. excise tax imposed 
on reinsurance premiums paid to foreign insurers. The present 
treaty does not apply to any excise taxes. The proposed treaty 
does not apply to any U.S. State or local income taxes.

Tax on insurance premiums

    Code rules--The United States imposes an excise tax on 
certain insurance and reinsurance premiums received by a 
foreign insurer from insuring a U.S. risk or a U.S. person 
(Code secs. 4371-4374). Unless waived by treaty, the excise tax 
applies to those premiums which are exempt from U.S. net-basis 
income tax. Under the Code, a foreign insurer is subject to 
U.S. net-basis income tax on income in situations where that 
insurance income is effectively connected with a U.S. trade or 
business. However, a foreign insurer ordinarily is not viewed 
as conducting a U.S. trade or business if it has no U.S. office 
or dependent agent and operates in the United States solely 
through independent brokers. In these situations, the insurance 
excise tax generally is imposed on the premiums paid for that 
insurance. 13
---------------------------------------------------------------------------
    \13\ The excise tax is currently imposed at a rate of 4 percent of 
the premiums paid on casualty insurance and indemnity bonds and 1 
percent of the premiums paid on life, sickness, and accident insurance, 
annuity contracts, and reinsurance (Code secs. 4371-4374).
---------------------------------------------------------------------------
    The treatment of insurance income of foreign insurers is 
further complicated in situations where, as is often the case, 
some portion of the risk is reinsured with other insurers in 
order to spread the risk. In situations where the foreign 
insurer is engaged in a U.S. trade or business (and, thus, is 
subject to the U.S. income tax), reinsurance premiums, whether 
paid to a U.S. or foreign reinsurer, are allowed as deductions. 
Accordingly, the foreign insurer is taxable only on the income 
attributable to the portion of the risk it retains. However, 
while generally no excise tax is imposed on insurance policies 
issued by a foreign insurer doing business in the United 
States, the one-percent excise tax on reinsurance is imposed if 
the insurer reinsures that U.S. risk with a foreign insurer 
that is not subject to U.S. net-basis income tax.
    Proposed treaty--The excise tax on insurance premiums is 
covered by the proposed treaty, but only to the extent that the 
foreign insurer does not reinsure the risks in question with a 
person not entitled to relief from this tax under an income tax 
treaty. However, in a departure from all existing U.S. tax 
treaties that cover the excise tax on insurance premiums, the 
excise tax on reinsurance premiums is not covered by the 
proposed treaty.
    Under the proposed treaty, Luxembourg insurers generally 
are no longer subject to the insurance excise tax on insurance 
premiums. The insurance excise tax on insurance premiums 
continues to apply, however, when a Luxembourg insurer with no 
U.S. trade or business reinsures a policy it has written on a 
U.S. risk with a foreign reinsurer, other than another insurer 
entitled to a similar exemption under a different tax treaty 
(such as the U.S.-France treaty). In addition, the insurance 
excise tax on reinsurance premiums also continues to apply 
under the proposed treaty. This treatment is a departure from 
the present treaty.
            Luxembourg
    In the case of Luxembourg, the proposed treaty applies to 
the income tax on individuals, including the surcharge for the 
benefit of the employment fund (l'impot sur le revenu des 
personnes physiques, y compris la contribution au fonds pour 
l'emploi). The proposed treaty also applies to the corporation 
tax, including the surcharge for the benefit of the employment 
fund (l'impot sur le revenu des collectivites, y compris la 
contribution au fonds pour l'emploi); the tax on fees of 
directors of companies (l'impot special sur les tantiemes); the 
capital tax (l'impot sur la fortune); and the communal trade 
tax ((l'impot commercial communal).
            Other rules
    For purposes of the nondiscrimination article (Article 26), 
the proposed treaty applies to taxes of all kinds imposed by 
the countries, including any taxes imposed by their political 
subdivisions or local authorities.
    The proposed treaty also contains a provision generally 
found in U.S. income tax treaties (including the present 
treaty) to the effect that it applies to any identical or 
substantially similar taxes that either country may 
subsequently impose. The proposed treaty obligates the 
competent authority of each country to notify the competent 
authority of the other country of any significant changes in 
its internal tax laws and of any official published material 
concerning the application of the treaty, including 
explanations, regulations, rulings or judicial decisions. 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 ``Luxembourg'' means the Grand Duchy of 
Luxembourg.
    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.
    The term ``person'' includes an individual, an estate, a 
trust, a partnership, a company, and any other body of persons. 
A ``company'' is any body corporate or any entity which is 
treated as a body corporate for tax purposes.
    An ``enterprise of a Contracting State'' 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 or citizenship of that 
country or a legal person, partnership, or association deriving 
its status as such from the laws in force in that country.
    The Luxembourg competent authority is the Minister of 
Finance or his authorized representative. The U.S. competent 
authority is the Secretary of the Treasury or his delegate. The 
U.S. competent authority function has been delegated to the 
Commissioner of Internal Revenue, who has redelegated the 
authority to the Assistant Commissioner (International) of the 
IRS. On interpretative issues, the latter acts with the 
concurrence of the Associate Chief Counsel (International) of 
the IRS.
    The proposed treaty defines the term ``beneficial owner'' 
in the case of a company that is treated as a partnership, or 
other pass-thru entity, under the laws of the ``other 
Contracting State'' as the persons that are subject to tax on 
the income of such company under the laws of the ``other 
Contracting State.'' The term ``other Contracting State'' is 
undefined. The Technical Explanation provides that the term 
``other Contracting State'' refers to the residence country of 
the person claiming benefits under the proposed treaty. The 
proposed treaty uses the term ``beneficial owner'' in the 
following articles: Dividends (Article 10), Interest (Article 
12), Other Income (Article 22), and Limitation on Benefits 
(Article 24) articles. The model treaties and other existing 
U.S. treaties do not contain a definition of a ``beneficial 
owner.''
    The proposed treaty also contains the standard provision 
that, unless the context otherwise requires or the competent 
authorities of the two countries agree to a common meaning, all 
terms not defined in the proposed treaty are to have the 
meanings which they have under the laws of the country 
concerning the taxes to which the proposed treaty applies.

Article 4. Residence

            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 proposed 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, like many recent U.S. tax treaties, 
generally defines ``resident of a Contracting State'' to mean 
any person who, under the laws of that country, is liable to 
tax therein 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 Luxembourg 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. 14 Thus, 
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. 
``Substantial presence'' is a defined term under the Code 
definition of residence in section 7701(b); ``permanent home'' 
and ``habitual abode'' are terms frequently used in treaty 
``tie-breaker'' rules, as described below.
---------------------------------------------------------------------------
    \14\ The present treaty does not define who is a U.S. resident. 
Thus, such a definition is determined under U.S. internal law. The 
Treasury Department has stated that a U.S. citizen is treated as a 
resident for purposes of the present treaty if the individual is taxed 
as a resident of the United States. Statement of Treasury Department 
Concerning Proposed Tax Convention Between The United States and The 
Grand Duchy Of Luxembourg With Respect To Taxes On Income and Property, 
as printed in Sen. Exec. Rep. No. 10, 88th Cong., 2d Sess. (1964). 
Consequently, a U.S. citizen who is resident in a country other than 
the United States may be treated as a U.S. resident, and hence, 
eligible for benefits under the present treaty.
---------------------------------------------------------------------------
    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 or of 
capital situated in that country. In the case of income derived 
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, Luxembourg would be required to 
reduce its withholding tax pursuant to the proposed treaty on 
only one-half of the Luxembourg source income paid to the 
trust.
    For purposes of this rule, the government of a treaty 
country, or of one of its political subdivisions or local 
authorities, is to be considered a resident of that country. An 
organization that is a resident of a country under that 
country's internal law and is wholly or partially tax exempt 
because it is organized and operated exclusively (1) for a 
religious, charitable, educational, scientific, or other public 
purpose, or (2) to provide pensions or other benefits to 
employees pursuant to a plan is treated as a resident of a 
treaty country. The Technical Explanation provides that a 
pension that is also organized as a trust is subject to the 
rules for tax-exempt entities in determining the residence of a 
pension.
    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 is deemed to be a 
resident of the country in which he or she has a permanent home 
available. If this permanent home test is inconclusive because 
the individual has a permanent home in both countries, the 
individual's residence is deemed to be the country with which 
his or her personal and economic relations are closer (i.e., 
the ``center of vital interests''). If the country in which the 
individual has his or her center of vital interests cannot be 
determined, or if the individual does not have a permanent home 
available in either country, such individual is deemed to be a 
resident of the country in which he or she has an habitual 
abode. If the individual has an habitual abode in both 
countries or in neither country, the individual is deemed to be 
a resident of the country of which he or she is a national. If 
the individual is a national of both countries or neither 
country, the competent authorities of the countries are to 
settle the question of residence by mutual agreement.

Entities

    In the case of an entity that is resident in both countries 
under the basic treaty definition, the proposed treaty requires 
the competent authorities to determine the residence of such 
person by mutual agreement, having regard to the entity's place 
of effective management, the place where it is incorporated or 
constituted, and any other relevant factors. If they are unable 
to reach such an agreement, the entity generally will be 
ineligible for benefits under the proposed treaty. In this 
regard, the proposed treaty is similar to some existing U.S. 
treaties, but dissimilar to the U.S. model, which does not 
specify that treaty benefits will be denied in cases where the 
competent authorities cannot agree. The Technical Explanation 
indicates that a dual resident corporation denied the benefits 
of the proposed treaty still may be treated as a resident of 
either country where its residence is relevant to benefits 
claimed by another person under the proposed treaty. For 
example, a Luxembourg resident may claim the benefits of 
reduced U.S. withholding tax on a dividend paid by a dual 
resident corporation.

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 
of natural resources, if the site or project lasts for more 
than 12 months. The Technical Explanation provides 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 
present treaty provides that a permanent establishment exists 
if the site or project lasts for more than six months.
    The general definition of a permanent establishment is 
modified to provide that a fixed place of business that is used 
for any of a number of specified activities does not constitute 
a permanent establishment. These activities include the use of 
facilities solely for storing, displaying, or delivering 
merchandise belonging to the enterprise and the maintenance of 
a stock of goods 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 merchandise or the collection of information for 
the enterprise. These activities include as well the 
maintenance of a fixed place of business solely for the purpose 
of carrying on, for the enterprise, any other activity of a 
preparatory or auxiliary character. Unlike the present treaty, 
the proposed treaty makes no reference to such activities as 
advertising, the supply of information, or scientific research. 
However, the Technical Explanation mentions advertising and the 
supply of information as activities that are preparatory or 
auxiliary. The proposed treaty, like the U.S. model, provides 
that the maintenance of a fixed place of business solely for 
any combination of these activities does not constitute a 
permanent establishment. This clause does not appear in the 
present treaty.
    If a person, other than an independent agent, is acting on 
behalf of an enterprise and has and habitually exercises the 
authority to conclude contracts in a country on behalf of an 
enterprise of the other country, the enterprise generally will 
be deemed to have a permanent establishment in the first 
country in respect of any activities that person undertakes for 
the enterprise. Consistent with the U.S. model and the OECD 
model, this rule does not apply where the contracting authority 
is limited to those activities described above, such as 
storage, display, or delivery of merchandise, which are 
excluded from the definition of a permanent establishment. 
Under the present treaty, where an agent's authority is limited 
to the purchase of merchandise for the account of the 
enterprise, such enterprise is not considered to have a 
permanent establishment.
    The proposed treaty contains the usual provision that no 
permanent establishment is deemed to arise based on an agent's 
activities if the agent is a broker, general commission agent, 
or any other agent of independent status acting in the ordinary 
course of its business. The Technical Explanation provides that 
an independent agent is one that is legally and economically 
independent of the enterprise. Whether an agent and an 
enterprise are independent depends on the facts and 
circumstances of the particular case.
    The fact that a company that is resident in one country is 
related to a company that is a resident of the other country or 
to a company that engages in business in that other country 
does not of itself cause either company to be a permanent 
establishment of the other.

Article 6. Income from Real Property (Immovable 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 14 (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. 15
---------------------------------------------------------------------------
    \15\ In the case of the United States, the term ``real property'' 
is defined in Treas. Reg. sec. 1.897-1(b).
---------------------------------------------------------------------------
    The proposed treaty specifies that the country in which 
property is situated may tax income derived from the direct 
use, letting, or use in any other form of such real property. 
The rules of this article allowing source-country taxation also 
apply to income from real property of an enterprise and to 
income from real property used for the performance of 
independent personal services.
    The present treaty permits the source country to tax 
interest on debts (other than bonds) secured by mortgages on 
real property under this article. The proposed treaty 
eliminates this rule and treats such interest in the same 
manner as other types of interest, which generally is free from 
source-country tax (see Article 12).
    Like the U.S. model and certain other U.S. income tax 
treaties, the proposed treaty provides residents of a country 
with an election to be taxed on a net basis by the other 
country on income from real property in that other country. The 
Technical Explanation provides that the election may be 
terminated with the consent of the competent authority of the 
country where the real property is located. U.S. internal law 
provides such a net-basis election in the case of income 
derived by a foreign person from U.S. real property (Code secs. 
871(d) and 882(d)).

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 the 
business is effectively connected with the conduct of a trade 
or business within the United States is made as if the sale or 
exchange occurred immediately before the cessation of the 
business. (Code sec. 864(c)(7).
            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. 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.
    The present treaty contains a force of attraction rule 
similar to that in the Code as described above. The proposed 
treaty eliminates this rule, providing instead that the 
business profits to be attributed to the permanent 
establishment shall include only the profits derived from the 
assets or activities of the permanent establishment. The 
proposed treaty is consistent with the U.S. model 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 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, a Luxembourg 
company which has a branch office in the United States but 
which has its head office in Luxembourg 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 Luxembourg 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 are not attributed to a permanent 
establishment merely by reason of the purchase of merchandise 
by a permanent establishment for the enterprise. Thus, where a 
permanent establishment purchases goods for its head office, 
the business profits attributed to the permanent establishment 
with respect to its other activities are not increased by the 
profit element with respect to its purchasing activities.
    The amount of profits attributable to a permanent 
establishment must be determined by the same method each year 
unless there is good and sufficient reason to change the 
method. Where business profits include items of income which 
are dealt with separately in other articles of the proposed 
treaty, those other articles, and not the business profits 
article, govern the treatment of such items of income. Thus, 
for example, profits attributable to a U.S. ticket office of a 
Luxembourg airline are generally exempt from U.S. Federal 
income tax under the provisions of Article 8 (Shipping and Air 
Transport).
    Like the present Luxembourg treaty, but unlike the U.S. 
model, the proposed treaty contains no definition of ``business 
profits.'' Under the U.S. model, the term means income derived 
from any trade or business, including income derived by an 
enterprise from the performance of personal services, and from 
the rental of tangible personal property. The Technical 
Explanation provides that it is understood that under the 
proposed treaty the term ``business profits'' includes income 
from the performance of personal services by an enterprise and 
income from the rental of tangible personal property. Income 
from the rental or licensing of cinematographic films is 
treated as royalties under the present and the proposed treaty.
    The proposed treaty incorporates the rule of Code section 
864(c)(6) and provides that any income or gain attributable to 
a permanent establishment or a fixed base during its existence 
is taxable in the country where the permanent establishment or 
fixed base is located even though payments are deferred until 
after the permanent establishment or fixed base has ceased to 
exist. This rule applies with respect to business profits 
(Article 7, paragraphs 1 and 2), dividends (Article 10, 
paragraph 4), interest (Article 12, paragraph 3), royalties 
(Article 13, paragraph 3), capital gains (Article 14, paragraph 
3), independent personal services income (Article 15) and other 
income (Article 22, 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 14 
(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 
Luxembourg, 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. ``International 
traffic'' means any transport by a ship or aircraft except when 
such transport is operated solely between places in a treaty 
country (Article 3(1)(d) (General Definitions)). Unlike the 
exemption provided in the present treaty, the exemption in the 
proposed treaty applies whether or not the ships or aircraft 
are registered in the first country.
    For purposes of the proposed treaty, shipping profits 
include income from the rental of ships or aircraft on a full 
basis. Shipping profits also include profits from 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. In addition, profits derived by 
an enterprise from the inland transport of property or 
passengers within a country are treated as shipping profits 
eligible for exemption if such transport is undertaken as part 
of international traffic by the enterprise. These rules are 
similar to the rules in the U.S. model.
    Like the U.S. model, the proposed treaty provides that 
income derived by an enterprise of one country from the use, 
maintenance, or rental of containers (including trailers, 
barges, and related equipment for the transport of containers) 
used in international traffic is taxable only in that country.
    The shipping and air transport provisions of the proposed 
treaty also apply to profits from participation in a pool, 
joint business, or international operating agency. This refers 
to various arrangements for international cooperation by 
carriers in shipping and air transport.

Article 9. Associated Enterprises

    The proposed treaty, like most other U.S. tax treaties, 
contains an arm's-length pricing provision. The proposed treaty 
recognizes the right of each country to 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.
    For purposes of the proposed treaty, an enterprise of one 
country is related to an enterprise of the other country if one 
of the enterprises participates directly or indirectly in the 
management, control, or capital of the other enterprise. 
Enterprises also are related if the same persons participate 
directly or indirectly in the management, control, or capital 
of such enterprises.
    Like the present Luxembourg 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 it is understood that the respective countries 
will apply their internal intercompany pricing rules (e.g., 
Code sec. 482, in the case of the United States). The Technical 
Explanation also clarifies that the U.S. ``commensurate with 
income'' standard for finding appropriate transfer prices for 
intangibles does not represent a departure in U.S. practice or 
policy from the arm's-length standard.
    When a redetermination of tax liability has been properly 
made by one country, the other country will make an appropriate 
adjustment to the amount of tax charged in that country on the 
redetermined income. 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 proposed treaty, and the competent authorities of the two 
countries will consult with each other if necessary. For 
example, under the mutual agreement article (Article 27), 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 (General Scope)) does 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.
            Internal dividend taxation rules

United States

    The United States generally imposes a 30-percent tax on the 
gross amount of U.S.-source dividends paid to nonresident alien 
individuals and foreign corporations. The 30-percent tax does 
not apply if the foreign recipient is engaged in a trade or 
business in the United States and the dividends are effectively 
connected with that trade or business. In such a case, the 
foreign recipient is subject to U.S. tax on such dividends on a 
net basis at graduated rates in the same manner that a U.S. 
person would be taxed.
    Under U.S. law, the term dividend generally means any 
distribution of property made by a corporation to its 
shareholders, either from accumulated earnings and profits or 
current earnings and profits. However, liquidating 
distributions generally are treated as payments in exchange for 
stock and thus are not subject to the 30-percent withholding 
tax described above (see discussion of capital gains in 
connection with Article 14 below).
    Dividends paid by a U.S. corporation generally are U.S.-
source. Also treated as U.S.-source dividends for this purpose 
are portions of certain dividends paid by a foreign corporation 
that conducts a U.S. trade or business. The U.S. 30-percent 
withholding tax imposed on the U.S.-source portion of the 
dividends paid by a foreign corporation is referred to as the 
``second-level'' withholding tax. This second-level withholding 
tax is imposed only if a treaty prevents application of the 
statutory branch profits tax.
    In general, corporations are not entitled under U.S. law to 
a deduction for dividends paid. Thus, the withholding tax on 
dividends theoretically represents imposition of a second level 
of tax on corporate taxable income. Treaty reductions of this 
tax reflect the view that where the United States already 
imposes corporate level tax on the earnings of a U.S. 
corporation, a 30-percent withholding rate may represent an 
excessive level of source-country taxation. Moreover, the 
reduced rate of tax often applied by treaty to dividends paid 
to direct investors reflects the view that the source-country 
tax on payments of profits to a substantial foreign corporate 
shareholder may properly be reduced further to avoid double 
corporate-level taxation and to facilitate international 
investment.
    A REIT is a corporation, trust, or association that is 
subject to the regular corporate income tax, but that receives 
a deduction for dividends paid to its shareholders if certain 
conditions are met. In order to qualify for the deduction for 
dividends paid, a REIT must distribute most of its income. 
Thus, a REIT is treated, in essence, as a conduit for federal 
income tax purposes. Because a REIT is taxable as a U.S. 
corporation, a distribution of its earnings is treated as a 
dividend rather than income of the same type as the underlying 
earnings. Such distributions are subject to the U.S. 30-percent 
withholding tax when paid to foreign owners.
    A REIT is organized to allow persons to diversify ownership 
in primarily passive real estate investments. As such, the 
principal income of a REIT often is rentals from real estate 
holdings. Like dividends, U.S.-source rental income of foreign 
persons generally is subject to the 30-percent withholding tax 
(unless the recipient makes an election to have such rental 
income taxed in the United States on a net basis at the regular 
graduated rates). Unlike the withholding tax on dividends, 
however, the withholding tax on rental income generally is not 
reduced in U.S. income tax treaties.
    U.S. internal law also generally treats a 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.

Luxembourg

    Luxembourg generally imposes a 25-percent withholding tax 
on certain Luxembourg-source dividend payments, including 
distributions from profit-sharing bonds and certain liquidation 
proceeds. 16 The dividend tax generally applies to 
Luxembourg-source proceeds, whether paid to individual or 
corporate residents or nonresidents. 17 The dividend 
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 Luxembourg tax law provisions enacted in 
response to the so-called ``parent-subsidiary directive'' 
approved by the EU Council of Ministers on July 23, 1990. 
18 Moreover, the dividend tax does not apply (or 
applies at a reduced rate) to an amount paid to a nonresident 
eligible for the elimination or reduction of the dividend tax 
by treaty.
---------------------------------------------------------------------------
    \16\ Under U.S. law, by contrast, liquidation proceeds generally 
are treated as capital gains, and are thus not subject to the 
corresponding U.S. 30-percent withholding tax. The Luxembourg dividend 
tax, therefore, may apply to Luxembourg-source income paid to a U.S. 
resident in a case where a corresponding U.S.-source item of income 
paid to a Luxembourg resident might not be subject to U.S. withholding 
tax under the Code.
    \17\ An exemption applies to certain dividends paid to Luxembourg 
corporations holding at least 10 percent of the stock of the payor. 
This exemption mirrors the so-called ``participation exemption'' under 
which Luxembourg corporations are exempt from tax on dividends paid by 
corporations (Luxembourg or foreign) in which the recipient owns at 
least a 10-percent interest.
    \18\ 90/435/EEC.
---------------------------------------------------------------------------
    The dividend tax is creditable against the Luxembourg 
income or company tax imposed on a Luxembourg resident 
shareholder receiving the taxable amount (or, in some cases, a 
nonresident shareholder that is subject to Luxembourg income or 
corporate tax). An excess of the dividend tax over those taxes 
generally is refundable.
    Like U.S. corporate tax law, Luxembourg 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, 
without a mechanism such as an imputation credit or a dividends 
paid deduction to integrate the two levels of tax. Since 1994, 
Luxembourg permits a 50-percent dividend received deduction for 
dividends paid by Luxembourg companies to a Luxembourg resident 
shareholder or to a permanent establishment of a nonresident 
shareholder.
            Proposed treaty limitations on internal law

Reduction of withholding tax

    Under the present treaty, the source-country dividend 
withholding tax generally may not exceed a 15-percent rate. 
However, because the present treaty limits the rate of 
withholding on dividends to half of the statutory rate in 
effect at the time the treaty went into force, the Luxembourg 
withholding tax is actually imposed at 7.5 percent for 
dividends paid to U.S. persons. On the other hand, portfolio 
dividends paid by a U.S. person to a Luxembourg recipient are 
subject to a 15-percent withholding tax. Under the present 
treaty, a 5-percent rate applies if a higher ownership 
threshold is met. Such threshold is met if 50 percent of the 
stock of the payor corporation is owned either by a corporate 
recipient residing in the other country or by a group of four 
(or fewer) corporations resident in the other country each of 
which is at least a 10-percent shareholder; the ownership test 
must be met for the period beginning at the start of the paying 
corporation's previous taxable year and ending on the date the 
dividend is paid.
    Under the proposed treaty, dividends paid by a company that 
is resident of a country to a resident of the other country may 
be taxed in the source country. However, source-country 
taxation is limited to 5 percent of the gross amount of the 
dividends if the beneficial owner of the dividends is a company 
which holds directly at least 10 percent of the voting stock of 
the payor company. The source-country dividend withholding tax 
generally is limited to 15 percent of the gross amount of the 
dividends in all other cases.
    The proposed treaty eliminates Luxembourg withholding tax 
in the case of dividends paid by a Luxembourg company if the 
beneficial owner of the dividend is a U.S. company that meets 
certain ownership requirements. In order to meet the ownership 
requirements, the U.S. company must own directly at least 25 
percent of the voting stock of the Luxembourg payor for an 
uninterrupted period of two years preceding the date of payment 
of the dividends. In addition, the dividend must be derived 
from the active conduct of a trade or business by the payor in 
Luxembourg (other than the business of making or managing 
investments, unless the payor is a banking or insurance 
company). The Technical Explanation provides that dividends 
paid out of profits generated in a subsidiary or branch outside 
of Luxembourg will not qualify for the exemption. If the U.S. 
recipient has different holding periods for the stock of the 
Luxembourg payor, the proposed treaty provides that the 
Luxembourg withholding tax is eliminated only with respect to 
the dividends attributable to that part of the shareholding 
that satisfies such ownership requirements.
    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 for the prior taxable year consisted of interest 
and dividends. The proposed treaty eliminates this rule, and 
replaces it with rules similar to those adopted in recent 
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 a Luxembourg 
resident, if the beneficial owner of the dividend is either an 
individual holding a 10 percent or greater interest in the REIT 
or is not an individual. Thus, such a dividend is taxable at 
the 30-percent United States statutory rate.

Definition of dividends

    Unlike the U.S. model and the OECD model, the present 
treaty provides no express definition of the term dividend. 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. The proposed treaty generally defines 
``dividends'' as income from shares, ``jouissance'' shares or 
``jouissance'' rights, mining shares, founders' shares, or 
other rights, not being debt-claims participating in profits. 
Dividends also include income treated as a distribution by the 
taxation law of the country in which the distributing company 
is resident. The proposed treaty provides that a beneficial 
owner of dividends who holds depository receipts evidencing 
ownership of the shares in lieu of the shares themselves also 
is entitled to the reduced dividend withholding rates. The 
proposed treaty also provides that the term dividends includes 
income from arrangements, including debt obligations, carrying 
the right to participate in, or determined with reference to, 
profits of the issuer or one of its associated enterprises, to 
the extent such income is characterized as a dividend 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 beneficial owner of the dividend carries on 
business through a permanent establishment (or a fixed base, in 
the case of an individual who performs independent personal 
services) in the source country and the dividends are 
attributable to the permanent establishment (or fixed base). 
Such dividends are taxed as business profits (Article 7) or as 
income from the performance of independent personal services 
(Article 15). In addition, dividends attributable to a 
permanent establishment or fixed base, but received after the 
permanent establishment or fixed base is no longer in existence 
are taxable in the country where the permanent establishment or 
fixed base existed (Article 7, paragraph 7).
    The proposed treaty 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 a Luxembourg 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 the case where the holding in respect of 
which the dividends are paid forms part of the business 
property of a U.S. permanent establishment or pertains to 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 a Luxembourg corporation are 
exempt from U.S. tax in any case where the recipient is not a 
U.S. citizen, resident, or corporation.
    Finally, the dividend article of the proposed treaty 
prohibits any tax by one treaty country on the undistributed 
profits of a company resident in the other treaty country, 
except as provided in the branch tax article (Article 11).

Article 11. Branch Tax

    The proposed treaty expressly permits the United States to 
collect the branch profits tax from a Luxembourg company. 
Luxembourg does not impose a branch profits tax.
            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,'' which 
is a measure of the accumulated U.S. effectively connected 
earnings of the corporation that are removed in any year from 
its U.S. trade or business. The dividend equivalent amount is 
limited by (among other things) aggregate earnings and profits 
accumulated in taxable years beginning after December 31, 1986. 
The Code provides that no U.S. treaty shall exempt any foreign 
corporation from the branch profits tax (or reduce the amount 
thereof) unless the foreign corporation is a ``qualified 
resident'' of the treaty country. The definition of a 
``qualified resident'' under U.S. internal law is somewhat 
similar to the definition of a corporation eligible for 
benefits under the proposed treaty (discussed below in 
connection with Article 24 (Limitation on Benefits)).
            Proposed treaty limitations on internal law
    The proposed treaty allows the United States to impose the 
branch profits tax on a Luxembourg 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 would generally eliminate 
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 United States only on the 
business profits of the foreign corporation that are 
attributable to its U.S. permanent establishment or that are 
subject to tax on a net basis as income or gains from real 
property. The proposed treaty and the Notes permit the United 
States to impose its branch profits tax on the ``dividend 
equivalent amount'' as that term is defined under the Code and 
as it may be amended from time to time without changing the 
general principle thereof.
    None of the restrictions on the operation of the U.S. 
branch tax provisions apply, however, unless the corporation 
seeking treaty protection meets the conditions of the proposed 
treaty's limitation on benefits article (Article 24). As 
discussed below, the limitation on benefits requirements of the 
proposed treaty are similar in some respects to the analogous 
provisions of the branch profits tax provisions of the Code.

Article 12. 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 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.
            Luxembourg internal law
    Luxembourg generally does not impose tax on interest income 
of nonresidents, unless the interest income is earned in 
connection with a Luxembourg permanent establishment. However, 
Luxembourg imposes a 25-percent withholding tax on interest 
from profit-sharing bonds. In addition, a nonresident may be 
subject to Luxembourg tax on interest on loans secured by real 
property situated in Luxembourg.
            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 definition of 
that term) paid to Luxembourg residents. The proposed treaty 
also exempts from Luxembourg taxes, in those few cases where 
any such tax might otherwise be applicable, Luxembourg-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. The Committee understands that the proposed 
treaty also exempts Luxembourg corporations from the U.S. 
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 by the United States at a 30 percent 
rate under the proposed treaty.
    In addition, the exemptions do not apply if the beneficial 
owner of the interest carries on business through a permanent 
establishment (or a fixed base, in the case of an individual 
who performs independent personal services) in the source 
country and the interest paid is attributable to the permanent 
establishment (or fixed base). In that event, the interest is 
taxed as business profits (Article 7) or income from the 
performance of independent personal services (Article 15). In 
addition, interest attributable to a permanent establishment or 
fixed base, but received after the permanent establishment or 
fixed base is no longer in existence, is taxable in the country 
where the permanent establishment or fixed base existed 
(Article 7, paragraph 7).
    The proposed treaty addresses the issue of non-arm's-length 
interest charges between related parties (or parties having an 
otherwise special relationship) by stating that this article 
applies only to the amount of arm's-length interest. Any amount 
of interest paid in excess of the arm's-length interest is 
taxable according to the laws of each country, taking into 
account the other provisions of the proposed treaty. For 
example, excess interest paid to a parent corporation may be 
treated as a dividend under local law and, thus, entitled to 
the benefits of Article 10 (Dividends) of the proposed treaty.
    Unlike the present treaty, the proposed treaty allows the 
source country to impose a tax, at a rate not exceeding 15 
percent, on the interest arising from that country and 
determined with reference to the profits of the issuer or of 
one of its associated enterprises. Thus, the proposed treaty 
permits the United States to tax, at a 15-percent rate, the 
amount of U.S.-source contingent interest derived by a 
Luxembourg resident. The proposed treaty also permits 
Luxembourg to tax, at the same rate, the amount of Luxembourg-
source interest from profit-sharing bonds derived by a U.S. 
resident.

Definition of interest and source rules

    The proposed treaty defines interest generally as income 
from debt claims of every kind, whether or not secured by 
mortgage, and whether or not carrying a right to participate in 
the debtor's profits (unless described in the dividends article 
(Article 10)). In particular, it includes income from 
government securities and from bonds or debentures, including 
premiums or prizes attaching to such securities, bonds, or 
debentures. The proposed treaty also defines interest to 
include all other income that is treated as income from money 
lent by the taxation law of the source country. Penalty charges 
for late payment are not treated as interest.
    In general, under the proposed treaty, interest is deemed 
to arise in the residence country of the payor. However, if the 
payor (whether or not a resident of the United States or 
Luxembourg) has a permanent establishment or a fixed base in 
one of the treaty countries, the debt on which the interest is 
paid was incurred in connection with that permanent 
establishment or fixed base and the interest is borne by the 
permanent establishment or fixed base, the interest is deemed 
to arise in the country in which the permanent establishment or 
fixed base is located. For example, interest paid to a 
Luxembourg resident by the U.S. branch of a French company is 
considered U.S.-source under the proposed treaty and, 
therefore, is exempt from U.S. tax.

Article 13. 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. Luxembourg generally imposes a 10- or 12-percent 
tax on royalties derived by nonresidents.
            Proposed treaty limitations on internal law
    The proposed treaty provides that royalties arising in one 
treaty country and paid to a resident of the other country may 
be taxed only by the residence country. Thus, the proposed 
treaty generally continues the rule of the present treaty that 
exempts U.S.-source royalties paid to Luxembourg residents from 
the 30-percent U.S. tax. This exemption is similar to that 
provided in the U.S. model. 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 under the proposed treaty does not apply 
where the beneficial owner carries on business through a 
permanent establishment (or a fixed base, in the case of an 
individual who performs or performed independent personal 
services) in the source country and the royalties are 
attributable to the permanent establishment (or fixed base). In 
that event, such royalties are taxed as business profits 
(Article 7) or income from the performance of independent 
personal services (Article 15). In addition, royalties 
attributable to a permanent establishment or fixed base, but 
received after the permanent establishment or fixed base is no 
longer in existence, are taxable in the country where the 
permanent establishment or fixed base existed (Article 7, 
paragraph 7).
    Similar to the U.S. model and the OECD model, royalties are 
defined as payments of any kind received as consideration for 
the use of, or the right to use, any copyright of literary, 
artistic, or scientific work (including cinematographic films, 
and audio and video tapes and disks and other means of 
reproduction); for the use of, or the right to use, any patent, 
trademark, design or model, plan, secret formula or process, or 
other like right or property; or for information concerning 
industrial, commercial or scientific experience. The term 
``royalties'' also includes gains from the alienation of any 
property described above which are contingent on the 
productivity, use, or disposition of the property.
    The 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 the right to use, property, 
information or experience in the United States.
    The proposed treaty addresses the issue of non-arm's-length 
royalties between related parties (or parties having an 
otherwise special relationship) by stating that this article 
applies only to the amount of arm's-length royalties. Any 
amount of royalties paid in excess of the arm's-length royalty 
is taxable according to the laws of each country, taking into 
account the other provisions of the proposed treaty. For 
example, excess royalties paid to a parent corporation by its 
subsidiary may be treated as a dividend under local law and, 
thus, entitled to the benefits of Article 10 (Dividends) of the 
proposed treaty.

Article 14. 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. 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.
            Luxembourg internal law
    Under Luxembourg law, the taxation of capital gains, of 
both residents and nonresidents, generally is limited to 
certain gains that are business income or income from personal 
services. However, both a resident individual, and in some 
cases a nonresident, may be subject to a 20-percent Luxembourg 
tax on gain from the disposition of shares issued by a 
Luxembourg corporation, if the person is treated as having a 
substantial interest in the corporation. In addition, 
Luxembourg generally taxes the gain realized by a nonresident 
individual or foreign corporation on gain from the sale of real 
property located in Luxembourg.
            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 purposes of this 
article includes real property referred to in Article 6 (Income 
from Real Property) which is located in the other country and a 
United States real property interest, as defined under the Code 
(as of the date of signature and as it may be amended from time 
to time without changing the general principles thereof). The 
Technical Explanation clarifies that distributions by a REIT 
that are attributable to gains derived from a disposition of 
real property are taxable under this article (and such gains 
are not taxable under the dividends article (Article 10)). Real 
property also includes shares or comparable corporate rights in 
a company that is a resident of Luxembourg, the assets of which 
consist for the greater part of real property situated in 
Luxembourg. According to the Technical Explanation, a 
nonresident generally is subject to Luxembourg tax upon a sale 
of shares in a Luxembourg real estate corporation only if the 
nonresident owns more than 25 percent of the corporation and 
either (1) holds the shares for a period not exceeding six 
months or (2) had been a Luxembourg resident for more than 
fifteen years and became a nonresident for less than five years 
immediately prior to the sale.

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 is attributable to a permanent 
establishment or a fixed base located in that country. The 
proposed treaty generally does not permit the countries to tax 
any gains from the disposition of any property after such 
property ceases to be used in a U.S. trade or business. 
However, gains attributable to a permanent establishment or a 
fixed base, but received after the permanent establishment or 
fixed base is no longer in existence, are taxable in the 
country where the permanent establishment or fixed base existed 
(Article 7, paragraph 7).
    Gains of an enterprise of one of the treaty countries from 
the alienation of ships, aircraft or containers operated in 
international traffic, and gains from the alienation of 
personal property pertaining to the operation of such ships, 
aircraft and containers, are taxable only in that country.
    Generally, gains from the alienation of any property other 
than that discussed above are taxable under the proposed treaty 
only in the country where the alienator is a resident.

Article 15. Independent Personal Services

            U.S. internal law
    The United States taxes the income of a nonresident alien 
at the regular graduated rates if the income is effectively 
connected with the conduct of a trade or business in the United 
States by the individual. The performance of personal services 
within the United States may be a trade or business within the 
United States.
    Under the Code, the income of a nonresident alien from the 
performance of personal services in the United States is 
excluded from U.S.-source income, and therefore is not taxed by 
the United States in the absence of a U.S. trade or business, 
if: (1) the individual is not in the United States for over 90 
days during the taxable year; (2) the compensation does not 
exceed $3,000; and (3) the services are performed as an 
employee of, or under a contract with, a foreign person not 
engaged in a trade or business in the United States or are 
performed for a foreign office or place of business of a U.S. 
person.
            Proposed treaty limitations on internal law
    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 individual 
performing the services has a fixed base regularly available to 
him or her in the second country for the purpose of performing 
the activities. In that case, the nonresidence country may tax 
only that portion of the individual's income which is 
attributable to the fixed base.
    The present treaty does not provide an exemption from 
source-country tax for income from independent personal 
services. The exemption from source-country tax provided in the 
proposed treaty for independent personal services income 
generally is similar to that contained in the U.S. and OECD 
models. Under the U.S. and OECD models, the nonresidence 
country may tax income from services provided in the residence 
country, assuming that the fixed base requirement is otherwise 
met. By contrast, under some U.S. tax treaties, the 
nonresidence country may only tax income from independent 
personal services if the services are performed there.
    For purposes of this article in the proposed treaty, 
independent personal services include independent scientific, 
literary, artistic, educational, or teaching activities as well 
as the independent activities of physicians, lawyers, 
engineers, architects, dentists, and accountants.
    Under the proposed treaty, in determining taxable 
independent personal services income, the principles of 
paragraph 3 of Article 7 (Business Profits) are applicable to 
allow a taxpayer to deduct expenses that are incurred for 
purposes of the fixed base. According to the Technical 
Explanation, the taxpayer may deduct all relevant expenses, 
wherever incurred, in computing the net income from independent 
personal services subject to tax in the source country.

Article 16. 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 are taxable only in the country of residence 
if three requirements are met: (1) the individual is present in 
the source country for not more than 183 days in any twelve-
month period beginning or ending during the taxable year 
concerned; (2) the individual's employer is not a resident of 
the source country; and (3) the compensation is not borne by a 
permanent establishment or fixed base of the employer in the 
source country. These limitations on source-country taxation 
are generally consistent with the U.S. and OECD models. The 
present treaty limits the level of compensation that may be 
exempt from source-country taxation to $3,000.
    The proposed treaty provides that compensation derived from 
employment exercised continuously or predominately aboard a 
ship or aircraft operated in international traffic by an 
enterprise of one of the treaty countries may be taxed in the 
residence country of the enterprise. However, if the internal 
law of the residence country of the enterprise does not subject 
the income derived from such employment to tax, such income is 
taxable in the employee's country of residence. This provision 
was included at Luxembourg's request. U.S. internal law 
generally does not tax the compensation of a nonresident 
derived from employment exercised aboard a ship or aircraft 
operated in international traffic by a U.S. enterprise.
    This article is modified in some respects for directors' 
fees (Article 17), pensions, social security and annuities 
(Article 19), and government service (Article 20).

Article 17. Directors' Fees

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

Article 18. Artistes and Sportsmen

    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 sportsmen. These 
rules apply notwithstanding the other provisions dealing with 
the taxation of income from personal services (Articles 15 and 
16) and business profits (Article 7), and are intended, in 
part, to prevent entertainers and sportsmen from using the 
treaty to avoid paying any tax on their income earned in one of 
the countries.
    Under this article of the proposed treaty, one country may 
tax an entertainer or sportsman 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 by him or her from such activities, including 
reimbursed expenses, exceed $10,000 or its Luxembourg franc 
equivalent. Thus, if a Luxembourg 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 25 (Relief From 
Double Taxation), below.) The Technical Explanation clarifies 
that because it is not possible to know whether the $10,000 (or 
the Luxembourg franc equivalent) is exceeded until the end of 
the year, the source country may subject all payments to an 
artiste or sportsman to withholding and refund any excess 
amount withheld.
    According to the Technical Explanation, this article 
applies to all income directly connected with a performance by 
an entertainer or sportsman, such as appearance fees, award or 
prize money, and a share of the gate receipts. Income derived 
by an entertainer or sportsman from other than actual 
performance, such as royalties from record sales and payments 
for product endorsements, is not covered by this article; 
instead, these amounts are covered by other articles of the 
proposed treaty, such as Article 13 (Royalties) or Article 15 
(Independent Personal Services). For example, if a Luxembourg 
entertainer receives royalty income from the sale of recordings 
of a concert given in the United States, the royalty income 
will be exempt from U.S. withholding tax under Article 13, even 
if the remuneration from the concert itself may have been 
covered by this article.
    The proposed treaty provides that where income in respect 
of activities exercised by an entertainer or sportsman in his 
or her capacity as such accrues not to the entertainer or 
sportsman but to another person, that income of that person may 
be taxed by the country in which the activities are exercised, 
unless it is established that neither the entertainer or 
sportsman nor persons related to him or her participate 
directly or indirectly in the profits of that other person in 
any manner, including the receipt of deferred remuneration, 
bonuses, fees, dividends, partnership distributions or other 
income distributions. (This provision applies notwithstanding 
the business profits and independent personal service articles 
(Articles 7 and 15).) This provision prevents certain 
entertainers and sportsmen from avoiding tax in the country in 
which they perform by, for example, routing the compensation 
for their services through a third entity such as a personal 
holding company or a trust located in a country that would not 
tax the income.

Article 19. Pensions, Social Security, and Annuities

    Under the proposed treaty, pensions and other similar 
remuneration derived and beneficially owned 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 20 
(Government Service). Thus, for example, it generally does not 
apply to pensions paid to a resident of one treaty country 
attributable to services performed for government entities of 
the other country. 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 (including an individual retirement account).
    Social security payments and other payments made under 
similar legislation by one country to an individual who is a 
resident of the other country or to a U.S. citizen are taxable 
only in the paying country. 19 This rule, which is 
not subject to the saving clause, exempts U.S. citizens and 
residents from U.S. tax on Luxembourg social security payments. 
This rule is subject to the provisions of Article 20 
(Government Service). Under this rule, only the United States 
may tax U.S. social security payments to persons residing in 
Luxembourg. 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 
Luxembourg from double taxation.
---------------------------------------------------------------------------
    \19\ The Notes state that it is understood that the term ``other 
similar legislation'' is intended to refer to U.S. tier 1 Railroad 
Retirement benefits.
---------------------------------------------------------------------------
    The proposed treaty provides that annuities may be taxed 
only in the country of residence of the person who derives and 
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 (other than services 
rendered).

Article 20. Government Service

    Under the proposed treaty, remuneration, other than a 
pension, paid by a country or one of its political subdivisions 
or local authorities to an individual for services rendered to 
the payor generally is taxable in that country only. However, 
such remuneration is taxable only in the other country (the 
country that is not the payor) if the services are rendered in 
that other country, and the individual either (1) is a national 
of that other country, or (2) did not become a resident of that 
country solely for the purpose of rendering the services. Thus, 
for example, Luxembourg will not tax the compensation of a U.S. 
citizen and resident who is in Luxembourg to perform services 
for the U.S. Government, and the United States will not tax the 
compensation of a Luxembourg citizen and resident who performs 
services for the U.S. Government in Luxembourg.
    Any pension paid by a country or one of its political 
subdivisions or local authorities, to an individual for 
services rendered to the payor generally is taxable only in 
that country. However, such pensions are taxable only in the 
other country if the individual is both a resident and a 
national of that other country.
    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 16 
(Dependent Personal Services), 17 (Directors' Fees), and 19 
(Pensions, Social Security, and Annuities) 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 4(b) of the proposed treaty. 
Consequently, the saving clause does not apply to benefits 
conferred by this article to an individual who is neither a 
U.S. citizen nor a U.S. green-card holder. Thus, for example, 
the United States would not tax the compensation of a 
Luxembourg citizen who is not a U.S. green-card holder but who 
resides in the United States to perform services for the 
Luxembourg Government.

Article 21. Students, Trainees, Teachers, and Researchers

    The treatment provided to students, trainees, teachers and 
researchers under the proposed treaty corresponds generally to 
the treatment provided under the present treaty. The U.S. and 
OECD models also provide some host-country exemptions for 
students and trainees, but do not contain corresponding 
language for teachers and researchers, although other U.S. 
treaties provide similar benefits.
    Under the proposed treaty, a student, apprentice, or 
business trainee who visits the other country (the host 
country) for the purpose of full-time education at a recognized 
educational institution, or for full-time training, and who 
immediately before that visit, is or was a resident of the 
other treaty country, generally is exempt from tax in the host 
country on payments that he or she receives for the purpose of 
maintenance, education, or training. The Technical Explanation 
provides that it is not necessary for the payments to arise 
outside the host country. In the case of an apprentice or 
business trainee, this treaty benefit applies only for a period 
not exceeding two years from the date the individual first 
visits the host country for the above purposes. If the visit 
exceeds two years, the host country may tax the individual 
under its internal law for the entire period of the visit, 
unless in a particular case the competent authorities of the 
two countries agree otherwise. In the case of a student, as 
under the present treaty, this treaty benefit applies 
regardless of the length of the stay.
    Under the proposed treaty, a resident of a country who 
visits the other country (the host country) at the invitation 
of a university, college, school, or other recognized 
educational institution for the purpose of teaching, or 
engaging in research, or both, generally is exempt from tax in 
the host country on his or her remuneration for such teaching 
or research activities. This treaty benefit applies only for a 
period not more than two years from the date the individual 
first visits the host country for the above purposes. If the 
visit exceeds two years, the host country may tax the 
individual under its internal law for the entire period of the 
visit, unless in a particular case the competent authorities of 
the two countries agree otherwise. This exemption does not 
apply to income from research carried on for the benefit of any 
person other than the educational institution that extended the 
invitation to the researcher.
    The Technical Explanation provides that the benefits 
accorded by this article are subject to anti-abuse provisions. 
Where a person visits for two years and leaves for a brief time 
and returns, an additional exemption is not available if the 
two visits are in substance treated as a single visit.
    This article is an exception to the saving clause, pursuant 
to Article 1, paragraph 4(b) of the proposed treaty. 
Consequently, the saving clause does not apply to benefits 
conferred by this article to an individual who is neither a 
U.S. citizen nor a U.S. green-card holder. Thus, for example, 
the United States would not tax the compensation of a 
Luxembourg citizen who is not a U.S. green-card holder but who 
resides in the United States to perform research for a 
recognized educational institution.

Article 22. 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 Luxembourg. This article is 
substantially similar to the corresponding article in the U.S. 
model.
    As a general rule, items of income not otherwise dealt with 
in the proposed treaty which are beneficially owned by 
residents of either country are taxable only in the country of 
residence. This rule, for example, gives the United States the 
sole right under the proposed treaty to tax income derived from 
sources in a third country and paid to a resident of the United 
States. This article is subject to the saving clause, so U.S. 
citizens who are Luxembourg residents would continue to be 
taxable by the United States on their third-country income, 
with a foreign tax credit provided for income taxes paid to 
Luxembourg.
    The general rule just stated does not apply to income 
(other than income from real property (as defined in Article 
6)) if the beneficial owner of the income is a resident of one 
country and carries on business in the other country through a 
permanent establishment or a fixed base to which the income is 
attributable. In such a case, the provisions of Article 7 
(Business Profits) or Article 15 (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 Luxembourg generally would be taxable by the 
United States under Article 7 (Business Profits), even if the 
income was sourced in a third country.
    The Technical Explanation provides that in cases in which a 
resident of a treaty country derives income from real property 
located outside the other treaty country (whether in the first 
treaty country or in a third country) that is attributable to 
the resident's permanent establishment or fixed base in the 
other treaty country, only the country of residence of the 
income recipient may tax that income. Thus, for example, if a 
U.S. resident has a Luxembourg permanent establishment and the 
resident derives income from real property located in a third 
country that is effectively connected with the Luxembourg 
permanent establishment, under the proposed treaty, only the 
United States may tax such income.
    In addition, other income attributable to a permanent 
establishment or fixed base, but received after the permanent 
establishment or fixed base is no longer in existence, is 
taxable in the country where the permanent establishment or 
fixed base existed (Article 7, paragraph 7).

Article 23. Capital

    Luxembourg imposes a 0.5-percent capital tax on net worth. 
For residents of Luxembourg (individuals and corporations), the 
tax base is worldwide net worth. For nonresidents, the tax base 
generally includes real property situated in Luxembourg, assets 
belonging to a permanent establishment or a fixed base in 
Luxembourg, certain other business assets, certain intangibles 
registered in Luxembourg, and debt claims secured by Luxembourg 
real property.
    The proposed treaty specifies the circumstances in which 
either treaty country may impose tax on capital owned by a 
resident of the country. Since the United States does not 
impose taxes on capital, the only capital taxes covered by the 
proposed treaty are those imposed by Luxembourg. Thus, although 
the article is drafted in a reciprocal manner, its provisions 
are relevant only for the imposition of Luxembourg tax. This 
article was included at Luxembourg's request. The present 
treaty does not contain a similar provision.
    The proposed treaty describes two situations under which 
Luxembourg may tax the capital of a U.S. resident. First, 
capital represented by real property (as defined in Article 6) 
which is owned by a U.S. resident and situated in Luxembourg 
may be taxed by Luxembourg. Second, capital represented by 
movable property forming part of the business property of a 
permanent establishment which a U.S. enterprise has in 
Luxembourg or pertaining to a fixed base available to a U.S. 
resident for the purpose of performing independent personal 
services may be taxed by Luxembourg.
    The proposed treaty provides that capital represented by 
ships, aircraft or containers operated in international traffic 
(as defined in Article 8 (Shipping and Air Transport)) by an 
enterprise of either country and other movable property 
pertaining to the operation of such ships, aircraft or 
containers is taxable only in the residence country of the 
enterprise. All other elements of capital of a resident of 
either country are taxable only in that country.

Article 24. Limitation on Benefits

            In general
    The proposed treaty contains a provision generally intended 
to limit indirect use of the treaty by persons who are not 
entitled to its benefits by reason of residence in the United 
States or Luxembourg, or in some cases, in another member 
country of the EU or NAFTA.
    The proposed treaty is intended to limit double taxation 
caused by the interaction of the tax systems of the United 
States and Luxembourg as they apply to residents of the two 
countries. At times, however, residents of third countries 
attempt to use a treaty. This use is known as ``treaty 
shopping'', which refers to the situation where a person who is 
not a resident of either country seeks certain benefits under 
the income tax treaty between the two countries. Under certain 
circumstances, and without appropriate safeguards, the 
nonresident may be able to secure these benefits indirectly by 
establishing a corporation (or other entity) in one of the 
countries, which entity, as a resident of that country, is 
entitled to the benefits of the treaty. Additionally, it may be 
possible for a third-country resident to reduce the income base 
of a treaty country resident by having the latter pay out 
interest, royalties, or other deductible amounts under 
favorable conditions either through relaxed tax provisions in 
the distributing country or by passing the funds through other 
treaty countries (essentially, continuing to treaty shop), 
until the funds can be repatriated under favorable terms.
            Summary of proposed treaty provisions
    The anti-treaty-shopping article in the proposed treaty 
provides that a treaty country resident is entitled to all 
treaty benefits in the other country only if it is a 
``qualified resident'' of the United States or Luxembourg. 
Alternatively, certain items of income of a treaty resident may 
qualify for treaty benefits if the resident satisfies one of 
several other tests of the proposed treaty. This provision of 
the proposed treaty is in some ways comparable to the U.S. 
Treasury regulation under the branch tax definition of a 
qualified resident. 20 However, the proposed treaty 
provides opportunities for treaty benefit eligibility which are 
not provided under the regulation.
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    \20\ 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, a political subdivision or 
            local authority thereof, or any agency or 
            instrumentality of any such government, subdivision 
            or authority;
  (3) A company that satisfies an ownership test and a base 
            erosion test;
  (4) A company that satisfies a public company test;
  (5) A company that is controlled by certain public companies 
            and also satisfies a base erosion test; or
  (6) A not-for-profit, tax-exempt organization that satisfies 
            an ownership test.

Alternatively, a resident that does not fit into any of the 
above categories may claim treaty benefits with respect to 
certain items of income under the active business test or the 
derivative benefits test. Moreover, a treaty country resident 
is entitled to treaty benefits if the resident is otherwise 
approved by the source country's competent authority, in the 
exercise of the latter's discretion.
    The proposed treaty, like the present treaty, denies treaty 
benefits to a resident that is a ``1929 Luxembourg holding 
company'' and other companies that enjoy a similar special 
fiscal treatment under Luxembourg laws. In addition, the 
proposed treaty denies benefits with respect to certain income 
of a company that is owned primarily by persons who are not 
residents of either a treaty country or an EU or NAFTA country, 
if the shareholders in such company disproportionately 
participate in income from the other country.
    Special rules apply to income derived by a resident of 
Luxembourg in certain ``triangular'' cases described below.
    The Notes provide that a taxpayer claiming benefits under 
the ownership and base erosion tests, the public company test, 
or the derivative benefits test of the proposed treaty may be 
denied treaty benefits unless such a taxpayer demonstrates that 
the required percentage of its shares (including bearer shares) 
is beneficially owned by qualified residents, or where 
relevant, residents of EU or NAFTA countries.
    The competent authorities shall consult together with a 
view to developing a commonly agreed application of the 
provisions of this article, including the publication of 
regulations or other public guidance. In addition, the 
competent authorities shall, in accordance with Article 28 
(Exchange of Information), exchange such information as is 
necessary for carrying out the provisions of this article.
            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 under this rule.

Ownership test

    To meet the ownership test, it is necessary that at least 
50 percent of the principal class of shares in the entity is 
ultimately owned by persons that qualify as treaty residents or 
U.S. citizens. The proposed treaty does not define the term 
``principal class of shares.'' According to the Technical 
Explanation, it is understood that the term generally refers to 
the ordinary or common shares of a company, provided that such 
class represents the majority of the voting power and value of 
the company. In a case where no single class represents the 
majority of the company's voting power and value, the principal 
class of shares will be those classes that in the aggregate 
possess more than 50 percent of the voting power and value. In 
a case where multiple groups of classes of stock exist that 
account for more than 50 percent of the voting power and value 
of the shares, it is necessary that only one such group 
satisfies this requirement.
    The proposed treaty does not define the term ``ultimate 
owners'' of a principal class of shares. The Technical 
Explanation provides that it is intended that an ultimate owner 
is the first person in the ownership chain that is a qualified 
resident of the proposed treaty determined without reference to 
its owners, and that intermediate owners of the company be 
disregarded. For this purpose, the category of qualified 
residents that may constitute ultimate owners are individuals, 
one of the treaty countries or a political subdivision or local 
authority thereof (or any agency or instrumentality), a company 
that satisfies the public company test, and a not-for-profit, 
tax-exempt organization where more than half of the 
beneficiaries, members or participants in such organization are 
qualified residents.

Base erosion test

    To meet the base erosion test, not more than 50 percent of 
the gross income of the company for the year may be paid or 
accrued by the company as deductible amounts (under the laws of 
the company's residence country) to persons other than 
qualified residents or U.S. citizens. For purposes of the base 
erosion test, arm's length payments in the ordinary course of 
business for services or purchase or rentals of tangible 
property including immovable property are not taken into 
account in determining the amount of deductible payments made 
by the company. This test is intended to prevent a corporation, 
for example, from distributing most of its income in the form 
of deductible payments such as interest, royalties, service 
fees, or other amounts to persons not entitled to benefits 
under the proposed treaty.
            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 Luxembourg 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. Thus, such a company is entitled to 
the benefits of the proposed treaty regardless of where its 
actual owners reside or the amount or destination of payments 
it makes.
    Under the proposed treaty, a company's shares are 
considered substantially and regularly traded on one or more 
recognized stock exchanges in a taxable year if the aggregate 
number of shares of that class traded in such stock exchange or 
exchanges during the immediately preceding taxable year is at 
least 6 percent of the average number of shares outstanding in 
that class during that taxable year. The Technical Explanation 
provides that the term ``principal class of shares'' has the 
same meaning as that term has for purposes of the ownership and 
base erosion tests above.

Subsidiaries of publicly traded companies

    A company that is a resident of Luxembourg or the United 
States is entitled to treaty benefits if (1) it is controlled, 
directly or indirectly, by one or more companies which are 
residents of either treaty country, the principal classes of 
the shares of which are traded as described above, and (2) it 
satisfies the base erosion test described above (in connection 
with the ownership test). The Technical Explanation provides 
that control, for this purpose, refers to the ability to 
influence the actions of the company, but does not require a 
majority ownership.

Other definitions

    For purposes of satisfying the public company tests, the 
term ``recognized stock exchange'' generally includes any stock 
exchange registered with the Securities and Exchange Commission 
as a national securities exchange for purposes of the 
Securities Exchange Act of 1934, the Luxembourg Stock Exchange, 
the NASDAQ System owned by the National Association of 
Securities Dealers, and any other stock exchange agreed upon by 
the competent authorities of the two countries. The Notes 
provide that stock exchanges to be treated as ``recognized'' by 
agreement of the competent authorities include the principal 
stock exchanges of Amsterdam, Brussels, Frankfurt, Hamburg, 
London, Madrid, Milan, Paris, Sydney, Tokyo, and Toronto.
    For purposes of satisfying the public company test for a 
``closely-held company'' the term ``recognized stock exchange'' 
is the same as described above except it excludes the 
Luxembourg Stock Exchange and the NASDAQ System. The competent 
authorities also may agree to exclude certain other stock 
exchanges with respect to closely-held companies. Under the 
proposed treaty, a company is a ``closely-held company'' if 50 
percent or more of its principal class of shares is owned by a 
specified category of persons each of whom beneficially owns, 
directly or indirectly, alone or together with related persons, 
more than 5 percent of such shares for more than 30 days during 
a taxable year. Under the proposed treaty, the specified 
category of persons are persons other than qualified residents 
of one of the treaty countries or residents of an EU or NAFTA 
country.
    This exception to the definition of a ``recognized stock 
exchange'' in the case of a closely-held company has a 
counterpart in the regulations under Code section 884(e) for 
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 is not treated as ``regularly traded.'' Thus, even 
though the proposed treaty has no special rule for closely-held 
companies in defining the term ``substantial and regular 
trading,'' the proposed treaty may, by excluding from the 
public company test those companies traded on certain otherwise 
recognized exchanges, achieve a result that is in some cases 
similar to that achieved under the regulation. The class of 
closely-held companies to which the regulatory rule applies, 
however, is defined somewhat differently than the term 
``closely-held company'' under the proposed treaty.
---------------------------------------------------------------------------
    \21\ Treas. Reg. sec. 1.884-5(d)(4)(iii).
---------------------------------------------------------------------------
    The rules for defining substantial and regular trading have 
a counterpart in the regulations under Code section 884(e). 
22 The proposed treaty rules generally are, however, 
easier to satisfy. For example, the regulations require that 
the company's stock trade (other than in de minimis amounts) on 
a recognized stock exchange for at least 60 days of the year. 
In addition, the regulations require at least 10 percent of the 
aggregate number of shares be traded during the year.
---------------------------------------------------------------------------
    \22\ Treas. Reg. sec. 1.884-5(d)(5).
---------------------------------------------------------------------------
            Non-profit organizations
    An entity also is 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 
country of residence, provided that more than half the 
beneficiaries, members, or participants in the organization are 
qualified residents.
            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 Luxembourg if 
it is engaged directly (or indirectly through an associated 
enterprise) in the active conduct of a trade or business in its 
residence country, and if the income derived from the source 
country is (1) derived in connection with that trade or 
business and the trade or business is substantial in relation 
to the proportionate interest in the activity carried on in the 
source country that generated the income, or (2) incidental to 
the trade or business in the residence country. The test is 
applied separately to each item of income.
    An entity does not meet the active business test (and 
therefore cannot claim treaty benefits under this rule) by 
virtue of being engaged in the business of making or managing 
investments, unless these activities are carried on by a bank 
or insurance company.

Income derived in connection with a substantial trade or business

    The proposed treaty specifies that an item of income is 
derived in connection with a trade or business if (1) the 
income accrues in the ordinary course of such trade or business 
and the beneficial owner owns, directly or indirectly, less 
than 5 percent of the shares (or other comparable rights) in 
the payor of the item of income, or (2) 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 Under the U.S. model, income is derived in 
connection with a trade or business only 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 accrued in 
the ordinary course of business where the beneficial owner owns 
less than 5 percent of the payor).
---------------------------------------------------------------------------
    \23\ Cf. Treas. Reg. sec. 1.884-5(e)(1). (To satisfy the active 
business test, the activities that give rise to the U.S. income must be 
part of a U.S. business and that business must be an integral part of 
an active trade or business conducted by the foreign corporation in its 
residence country.)
---------------------------------------------------------------------------
    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 based on all the facts and 
circumstances. According to the Technical Explanation, the 
factors to be considered include the proportionate share of the 
trade or business in the other country, the nature of the 
activities performed, and the relative contributions made to 
the conduct of the trade or business in both countries. 
24 However, the proposed treaty includes a safe 
harbor under which the trade or business of the income 
recipient is considered to be substantial if certain attributes 
of the residence-country business exceed a threshold fraction 
of the corresponding attributes of the trade or business 
located in the source country that produces the source-country 
income. Under this safe harbor, the attributes are assets, 
gross income, and payroll expense. 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 at least 10 percent, and each ratio 
separately is at least 7.5 percent. If any separate ratio is 
less than 7.5 percent for the prior year, the average of the 
corresponding ratios in the three prior years may be 
substituted. If a resident owns less than 100 percent of an 
activity in either country, the resident will only include its 
proportionate interest in such activity for purpose of 
computing the safe harbor percentages. These safe harbor 
percentages are similar to those contained in the U.S. model. 
The Technical Explanation clarifies that if the recipient and 
related persons of such recipient do not have any ownership 
interest in the person from whom the income is derived, the 
substantiality test also will be satisfied because the 
denominator in each factor is zero and the numerators are 
positive.

Income incidental to a trade or business

    Under the proposed treaty, income derived from one treaty 
country is incidental to a trade or business conducted in the 
other (residence) country if the income is not derived in 
connection with a trade or business as described above and the 
production of such income facilitates the conduct of the trade 
or business in the residence country. This definition is 
similar to that contained in the U.S. model. An example of such 
``incidental'' income is income from the investment of the 
working capital of the residence country trade or business.
            Derivative benefits test
    The proposed treaty contains a reciprocal derivative 
benefits rule. This rule effectively allows a Luxembourg 
company to receive ``derivative benefits'' in the sense that it 
derives its entitlement to U.S. tax reductions in part from the 
U.S. treaty benefits to which its owners would be entitled if 
they earned the income directly. In order for this rule to 
apply to a company that is resident in a treaty country, at 
least 95 percent of the shares of the company must be owned by 
seven or fewer residents of one or more countries each one of 
which is a party to NAFTA or is a member of the EU and is a 
country with which the other treaty country has a comprehensive 
income tax convention. In addition, the company must satisfy a 
special base erosion test. Moreover, income for which certain 
benefits are claimed must satisfy a rate comparison test. The 
U.S. model does not contain a similar derivative benefits 
provision.
    Under the special base erosion test, not more than 50 
percent of the gross income of the company for the year may be 
paid or accrued by the company as deductible amounts (under the 
laws of the company's residence country) to persons other than 
U.S. citizens or residents of a country that is a member of the 
EU or a party to NAFTA. For purposes of the base erosion test, 
arm's length payments in the ordinary course of business for 
services or purchases or rentals of tangible property are not 
taken into account in determining the amount of deductible 
payments made by the company.
    The proposed treaty imposes an additional condition for a 
company that is claiming benefits under the treaty with respect 
to certain types of income. Specifically, dividends, amounts 
subject to the branch tax, interest, or royalty payments in 
respect of which benefits are claimed under the proposed treaty 
must be subject to a rate of tax under the comprehensive treaty 
between the owner's residence country and the source country 
that is no less favorable than the rate of tax applicable to 
such company under the corresponding provisions of the proposed 
treaty. The Technical Explanation provides that if any of the 
owners accounting for the 95- percent interest in the company 
claiming benefits under the proposed treaty do not satisfy this 
test with respect to a payment, then no treaty benefit would be 
available for that payment.
    The Notes clarify that in applying the comparability 
requirement for dividends, the two tax rates that must be 
compared are the following:
    (1) The tax rate that each of the owners of the company 
would be entitled to if such owner directly held its 
proportionate share of the shares that gave rise to the 
dividends; and
    (2) The tax rate that each of the owners of the company, if 
such owner were a resident of the same country of which the 
recipient is a resident, would be entitled to under the 
proposed treaty if such owner directly held its proportionate 
share of the shares that gave rise to the dividends.

    For purposes of the ownership test described above, a 
person is considered to be a resident of an EU or NAFTA country 
only if that person would be entitled to the benefits of a 
comprehensive income tax treaty between a member country and 
the country from which the benefits of the proposed treaty are 
being claimed. If the applicable treaty between the owner's 
country of residence and the source country does not contain a 
comprehensive limitation on benefits article (including 
provisions similar to the ownership and base erosion tests, the 
publicly traded company test (but not the subsidiary of a 
publicly traded company test) and the active business test of 
the proposed treaty), then the owner itself must satisfy the 
definition of a ``qualified resident'' under the proposed 
treaty as if it were a resident of either the United States or 
Luxembourg, as the case may be. Alternatively, the owner of the 
company claiming benefits must satisfy the active business test 
of the proposed treaty, provided that the item of income with 
respect to which treaty benefits are claimed is derived in 
connection with an active trade or business conducted by such 
owner within its own country of residence.
            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 proposed treaty. 
Under this provision, such a person may be granted treaty 
benefits if the competent authority of the source country so 
determines.
    The Technical Explanation provides that the competent 
authority of a country will base its determination on whether 
the establishment, acquisition, or maintenance of the person 
seeking benefits under the proposed treaty, or the conduct of 
such person's operations, has or had as one of its principal 
purposes the obtaining of benefits under the proposed treaty. 
Thus, persons that establish operations in either the United 
States or Luxembourg with the principal purposes of obtaining 
benefits under the proposed treaty ordinarily will be denied 
such benefits. The Technical Explanation also provides that in 
determining whether to grant discretionary relief, the 
competent authorities will take into account all relevant facts 
and circumstances, including the existence of a clear business 
purpose for the structure and location of the income earning 
entity in question, the conduct of an active trade or business 
by such entity, a valid business nexus between that entity and 
the activity giving rise to the income, and the extent to which 
the entity 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 
shareholders. The competent authorities may determine to grant 
all, or partial, benefits of the proposed treaty.
    This provision of the proposed treaty is similar to a 
portion of the qualified resident definition under the Code 
branch 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 (sec. 884(d)(4)(D)).
            Triangular cases
    Under present laws and treaties that apply to Luxembourg 
residents, it is possible for profits of a permanent 
establishment maintained by a Luxembourg resident in a third 
country to be subject to a very low aggregate rate of 
Luxembourg and third-country income tax. The proposed treaty, 
in turn, eliminates the U.S. tax on several specified types of 
income of a Luxembourg resident. In a case where the U.S. 
income is earned by a third-country permanent establishment of 
a Luxembourg resident (the so-called ``triangular case'') the 
proposed treaty has the potential of helping Luxembourg 
residents to avoid all (or substantially all) taxation, rather 
than merely avoiding double taxation.
    The proposed treaty includes a special rule designed to 
prevent the proposed treaty from reducing or eliminating U.S. 
tax on income of a Luxembourg resident in a case where no other 
substantial tax is imposed on that income. Under the special 
rule, the United States is permitted to tax dividends, 
interest, and royalties paid to the third-country permanent 
establishment at the rate of 15 percent. In addition, under the 
special rule, the United States is permitted to tax other types 
of income without regard to the proposed treaty.
    The Technical Explanation provides that although the 
proposed treaty is drafted reciprocally with respect to this 
issue, these rules have no application to the United States 
because the United States does not exempt the profits of a U.S. 
company attributable to its third-country permanent 
establishment.
    In order for the special rule to apply, four conditions 
must be satisfied. First, a Luxembourg enterprise must derive 
income from the United States. Second, such income must be 
attributable to a permanent establishment that the Luxembourg 
enterprise has in a third country. Third, the Luxembourg 
enterprise must be exempt from Luxembourg tax on the profits 
attributable to the third-country permanent establishment. 
Fourth, the combined Luxembourg and third-country taxation of 
the item of U.S.-source income earned by the Luxembourg 
enterprise with the third-country permanent establishment must 
be less than 50 percent of the Luxembourg tax that would be 
imposed if the income were earned by the same enterprise in 
Luxembourg and were not attributable to the permanent 
establishment.
    The special rule does not apply if the U.S.-source income 
is derived in connection with, or is incidental to, the active 
conduct of a trade or business carried on by the permanent 
establishment in the third country (other than the business of 
making or managing investments unless these activities are 
banking or insurance activities carried on by a bank or 
insurance company). According to the Technical Explanation, the 
competent authority would grant relief in a case where the 
U.S.-source income subject to the special rule is ultimately 
included in a U.S. shareholder's income under the subpart F 
provisions of the Code. Such relief is also found in other 
recent U.S. income tax treaties (e.g., the 1995 U.S.-France 
income tax treaty).
            Denial of treaty benefits

Companies with disproportionate income participation

    Under the proposed treaty, treaty benefits are not 
available to the ``disproportionate part'' of the income 
derived from a treaty country by a company that is resident in 
the other country, if such company (or a company that controls 
it) has outstanding a class of shares (1) the terms of which, 
or arrangements with respect to which, entitle its holders to a 
portion of the income of the company derived from one treaty 
country that is larger than the portion such holders would 
receive absent such terms or arrangements, and (2) 50 percent 
or more of the vote and value of the company is owned by 
persons who are not qualified residents of either the United 
States, Luxembourg, or of another country that is a party to 
NAFTA or a member of the EU. The Technical Explanation provides 
that so-called alphabet stock that entitles the holders to 
earnings from the source country produced by a particular 
division or subsidiary of the company is included in the class 
of shares that entitle the holders to the disproportionate part 
of the company's income. The disproportionate part of the 
income is the part of the total income derived by the 
shareholder that is in excess of the amount that the 
shareholder would have derived absent any special terms that 
gave the shareholder a disproportionate entitlement to income 
derived from the source country.

1929 holding companies and similar entities

    Like the present treaty, the proposed treaty denies treaty 
benefits to a Luxembourg holding company within the meaning of 
the Act (loi) of July 31, 1929 and the Decree (arrete grand-
ducal) of December 17, 1938, or any subsequent revisions 
thereof. In addition, other companies that enjoy similar 
Luxembourg tax incentives also are not eligible for treaty 
benefits. The Notes state that investment companies within the 
meaning of the Act dated March 30, 1988 constitute companies 
that enjoy similar Luxembourg tax incentives for purposes of 
this article.

Article 25. 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.
            Luxembourg internal law
    Luxembourg unilaterally mitigates double taxation in 
several ways. First, the general rule of Luxembourg law that 
mitigates double corporate-level taxation--the so-called 
``participation exemption''--generally exempts a taxable 
Luxembourg company from corporate income tax on income 
(including dividends and stock gains) 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 10-percent or more shareholding in the entity 
in the case of dividends, and a 25-percent or more shareholding 
in the case of capital gains.
    Luxembourg grants a foreign tax credit for taxes paid to 
another country by a Luxembourg corporation. The credit is 
generally subject to a per-country limitation. However, a 
taxpayer may elect to compute its foreign tax credit for taxes 
on foreign-source interest and dividends using an overall 
limitation.
    In addition, under some of its treaties, Luxembourg exempts 
certain other types of foreign income of a Luxembourg resident 
(such as business profits derived through a foreign permanent 
establishment, income from employment abroad, or income from 
foreign real property) from its domestic tax on a pro rata 
basis. In other words, Luxembourg 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 Luxembourg tax that applies.
            Proposed treaty rules

Overview

    Unilateral efforts to limit double taxation are imperfect. 
Because of differences in rules as to when a person may be 
taxed on business income, a business may be taxed by two 
countries as if it is engaged in business in both countries. 
Also, a corporation or individual may be treated as a resident 
of more than one country and be taxed on a worldwide basis by 
both.
    The double tax issue is addressed in part in other articles 
of the proposed treaty that limit the right of a source country 
to tax income. This article provides further relief where both 
Luxembourg and the United States would otherwise still tax the 
same item of income. This article is not subject to the saving 
clause, so that the United States waives its overriding taxing 
jurisdiction to the extent that this article applies.
    The present treaty provides separate rules for relief from 
double taxation for the United States and Luxembourg. The 
present treaty generally provides for relief from double 
taxation of U.S. residents and citizens by requiring the United 
States to permit a credit against its tax for the appropriate 
amount of taxes paid to Luxembourg. The amount of Luxembourg 
taxes that are creditable is determined in accordance with U.S. 
law. The present treaty generally provides for relief from 
double taxation of Luxembourg residents by requiring Luxembourg 
to provide, in accordance with Luxembourg law, a deduction from 
Luxembourg tax with respect to U.S.-source income, in order to 
take into account U.S. federal income taxes paid.
    The present treaty contains a set of rules to determine the 
source of income under the treaty. These source rules apply in 
determining the foreign tax credit granted by either country to 
its residents or citizens under the treaty. For purposes of 
computing the U.S. foreign tax credit limitation, the source 
rules of the present treaty could result in a credit limitation 
which is different from that which would be arrived at in the 
absence of the treaty. The proposed treaty modifies this aspect 
of the present treaty by generally adopting the internal source 
rules of the country that allows the foreign tax credit. The 
modifications also include amending the rules applicable to 
U.S. citizens resident in Luxembourg.

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 Luxembourg. The proposed treaty 
also requires the United States to allow a deemed-paid credit, 
with respect to Luxembourg income tax, to any U.S. corporate 
shareholder of a Luxembourg company that receives dividends 
from such company if the U.S. company owns 10 percent or more 
of the voting stock of the Luxembourg company.
    The credit generally is to be computed in accordance with 
the provisions and subject to the limitations of U.S. law (as 
those provisions and limitations may change from time to time 
without changing the general principles of the treaty 
provisions). This provision is similar to those found in many 
U.S. income tax treaties.
    Luxembourg taxes covered by the proposed treaty (Article 2 
(Taxes Covered)), other than the capital tax and the portion of 
the communal trade tax that is computed on a basis other than 
profits, are 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 Luxembourg residents. Under the 
special rule, a U.S. citizen who is resident in Luxembourg 
will:
    (1) Compute the tentative U.S. income tax and the tentative 
Luxembourg income tax with respect to items of income that, 
under the proposed treaty, are subject to Luxembourg tax and 
are either exempt from U.S. tax or are subject to a reduced 
rate of tax when derived by a Luxembourg resident who is not a 
U.S. citizen.
    (2) Reduce the tentative Luxembourg tax by a hypothetical 
foreign tax credit for taxes imposed on his or her U.S.-source 
income. The amount of this credit is limited to the U.S. 
withholding tax that the citizen would have paid under the 
proposed treaty on such income if that person were a Luxembourg 
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 Luxembourg as computed 
in step (2) (i.e., after Luxembourg allowed the credit for U.S. 
taxes). The proposed treaty recharacterizes the income that is 
subject to Luxembourg taxation as foreign-source income for 
purposes of this computation.

The end result of this three-step formula is that the ultimate 
U.S. tax liability of a U.S. citizen who is a Luxembourg 
resident, with respect to an item of income, should not be less 
than the tax that would be paid if the individual were a 
Luxembourg resident and not a U.S. citizen.

Proposed treaty limitations on Luxembourg internal law

    In general, the proposed treaty requires Luxembourg to 
exempt from its internal tax income derived by one of its 
residents that is subject to U.S. tax under the proposed 
treaty. However, Luxembourg may employ its ``exemption with 
progression'' method with respect to such income by taking the 
exempt income into the tax base for purposes of determining the 
rate of Luxembourg tax applicable to the remainder of the 
nonexempt income. In the case of an item taxable as a dividend 
(under either Article 10 or Article 12(6)(b))), the proposed 
treaty requires Luxembourg to provide the equivalent of a 
foreign tax credit to the taxpayer by reducing the otherwise 
applicable Luxembourg tax by the amount of U.S. withholding tax 
paid. The reduction may not exceed that part of the Luxembourg 
tax (computed before the credit) that is attributable to the 
income that the United States may tax. A Luxembourg company 
that has held directly at least 10 percent of the capital of a 
U.S. company since the beginning of the Luxembourg company's 
accounting year is exempt from Luxembourg tax on U.S.-source 
dividends paid by such U.S. company, provided that the U.S. 
company is subject to U.S. tax that corresponds to the 
Luxembourg corporation tax. Moreover, such shares in the U.S. 
company also are exempt from the Luxembourg capital tax.

Article 26. 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 
Luxembourg. A U.S. national who is not a resident of the United 
States and a Luxembourg 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, 
or remuneration of an individual resident of a country 
attributable to a fixed base in the other country, less 
favorably than it taxes its own enterprise or resident carrying 
on the same activities. However, nothing in this article will 
be construed as preventing the United States from imposing a 
branch profits tax (Article 11). Consistent with the U.S. and 
OECD models, a country is not obligated to grant residents of 
the other country any personal allowances, reliefs, or 
reductions for tax purposes on account of civil status or 
family responsibilities which it grants to its own residents.
    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), 12 (Interest), and 13 
(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 
the term ``other disbursements'' is understood to include a 
reasonable allocation of executive and general administrative 
expenses, research and development expenses, and other expenses 
incurred for the benefit of a group of related enterprises. 
Similarly, any debts of an enterprise that is a resident of 
either country to a resident of the other country are 
deductible for the purposes of determining the taxable capital 
of the enterprise under the same conditions as if the debts had 
been contracted to a resident of the first country.
    The nondiscrimination rule also applies under the proposed 
treaty to enterprises of one country that are owned in whole or 
in part by residents of the other country. Enterprises resident 
in one country, the capital of which is wholly or partly owned 
or controlled, directly or indirectly, by one or more residents 
of the other country, will not be subjected in the first 
country to any taxation or any connected requirement which is 
other or more burdensome than the taxation and connected 
requirements that the first country imposes or may impose on 
its similar enterprises.
    U.S. internal law generally treats a corporation that 
distributes property in complete liquidation as realizing gain 
or loss as if the property had been sold to the distributee. 
If, however, 80 percent or more of the stock of the corporation 
is owned by another corporation, a nonrecognition rule applies 
and no gain or loss is recognized to the liquidating 
corporation. A special provision makes the nonrecognition 
provision inapplicable if the distributee is a foreign 
corporation (Code sec. 367(e)(2)). Even where the distributee 
is a foreign corporation resident in a treaty country, such 
treatment is not considered discriminatory, because absence of 
tax to the subsidiary in this case represents a complete 
elimination of U.S. tax jurisdiction over any appreciation, 
while a similar absence in the case of a domestic distributee 
simply shifts the appreciation into the hands of another U.S. 
taxpayer. 25 The Technical Explanation states that 
the application of Code section 367(e)(2) is consistent with 
the nondiscrimination article of the proposed treaty.
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    \25\ See Notice 87-66, 1987-2 C.B.376.
---------------------------------------------------------------------------
    U.S. internal law permits corporations that satisfy certain 
conditions to elect to be treated as a pass-through entity. If 
this so-called ``S corporation'' election is made, the 
corporation would not be subject to federal income tax on its 
profits at the entity level; instead, the individual 
shareholders of the corporation would be taxed directly on such 
profits. The election is only available if all of the 
shareholders of the corporation are U.S. citizens or residents. 
The Technical Explanation 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 Technical Explanation provides 
that it is understood that the withholding tax is a reasonable 
collection mechanism, and that it is not in conflict with the 
nondiscrimination provisions of the proposed treaty.
    The saving clause (which allows the United States to tax 
its citizens or residents notwithstanding certain treaty 
provisions) does not apply to the nondiscrimination article.

Article 27. 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 Luxembourg to consult 
together to attempt to alleviate individual cases of double 
taxation not in accordance with the proposed treaty. The saving 
clause of the proposed treaty does not apply to this article, 
so that the application of this article may result in a waiver 
(otherwise mandated by the proposed treaty) of U.S. taxing 
jurisdiction over its citizens or residents.
    Under this article, a resident of one country, who 
considers that the action of one or both of the countries 
results, or will result, in him or her paying a tax not in 
accordance with the proposed treaty, may present the case to 
the competent authority of 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 
authority is not itself able to arrive at a satisfactory 
solution, then the competent authority will endeavor to resolve 
the case by mutual agreement with the competent authority of 
the other country, with a view to the avoidance of taxation 
which is not in accordance with the proposed treaty. The 
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 proposed 
treaty. The proposed treaty makes express provision for the 
competent authorities to mutually agree on various issues 
including the attribution of income, deductions, credits, or 
allowances of a permanent establishment of an enterprise of a 
treaty country; the allocation of income, deductions, credits, 
or allowances; the characterization of particular items of 
income; the determination of the country in which the income 
arises; the common meaning of a term; and the elimination of 
double taxation in cases not provided for in the proposed 
treaty. The proposed treaty does not specify, as does the U.S. 
model, that the competent authorities may agree on the 
characterization of persons; advance pricing arrangements; 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 sportsmen 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 proposed treaty. It also 
removes any doubt as to restrictions that might otherwise arise 
by reason of the confidentiality rules of the United States or 
Luxembourg. 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 24 (Limitation on Benefits). The competent authorities 
are authorized to prescribe regulations to carry out the 
purposes of the proposed treaty.

Article 28. Exchange of Information

            Exchange of information

In general

    The proposed treaty contains a provision generally intended 
to prevent avoidance or evasion of taxes covered by the 
proposed treaty (principally income taxes), by providing for 
the exchange of information between the competent authorities 
of the treaty countries and for the provision of certain 
assistance in the collection of taxes. The proposed treaty does 
not cover exchanges of all types of information (e.g., 
information of financial institutions is excluded). In this 
regard, the proposed treaty is supplemented by a separate 
agreement, the proposed MLAT, described below. 26
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    \26\ The proposed MLAT was signed on March 13, 1997.
---------------------------------------------------------------------------

Summary of proposed treaty provisions

    The proposed treaty provides for the exchange of 
information necessary to carry out the provisions of the 
proposed treaty or of the specified tax laws of the two 
countries provided that taxation under those domestic laws is 
not contrary to the proposed treaty. The exchange of 
information is not restricted by Article 1 (General Scope). 
Therefore, third-country residents are covered. Unlike the U.S. 
model, the proposed treaty obligates the parties to exchange 
information only with respect to taxes that are listed under 
Article 2 (Taxes Covered).
    Any information exchanged is to be treated as secret in the 
same manner as information obtained under the domestic laws of 
the country receiving the information. The exchanged 
information may be disclosed only to persons or authorities 
(including courts and administrative bodies) involved in the 
assessment, collection, administration, enforcement, 
prosecution or determination of appeals with respect to the 
taxes covered by the proposed treaty. The information exchanged 
may be used only for such purposes. 27 The Technical 
Explanation states that the appropriate committees of the U.S. 
Congress and the U.S. General Accounting Office will be 
afforded access to information for use in the performance of 
their role in overseeing the administration of U.S. tax laws. 
Exchanged information may be disclosed in public court 
proceedings or in judicial decisions. The Notes provide that 
the proposed treaty requires each country to provide the 
broadest possible measure of assistance with respect to matters 
covered by the proposed treaty. The Notes provide that the 
authorities in each country, including judicial authorities to 
the extent that they become involved in executing a request, 
will use their best efforts to provide the assistance 
requested.
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    \27\ 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.
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    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 would disclose any trade, business, 
industrial, commercial, or professional secret or trade 
process, or information the disclosure of which would be 
contrary to public policy.
    Upon an appropriate request for information, the competent 
authority of the requested country is to obtain the information 
to which the request relates in the same manner and to the same 
extent as if the tax at issue were its own tax. Where 
specifically requested by the competent authority of one 
country, the competent authority of the other country shall 
provide information in the form of depositions of witnesses and 
authenticated copies of unedited original documents (including 
books, papers, statements, records, accounts, and writing) to 
the same extent that they can be obtained by such other 
competent authority under the laws and administrative practices 
of such other country.
    The Notes clarify that the competent authority of the 
requested country will obtain and provide information, other 
than information of financial institutions, for any matter 
relating to these functions only in the same manner and to the 
same extent as if the competent authority of the requested 
country were obtaining the information for an investigation or 
a public court proceeding, under its own law and practices. 
Upon request, the competent authority of the requested country 
is required to obtain and provide authenticated copies of 
third-party books and records located in the requested country 
for any tax investigation or proceeding in the requesting 
country, so long as the laws and practices of the requested 
country would allow its tax authorities to obtain such 
information for an investigation or a public court proceeding 
under its laws.
    The Technical Explanation states that the Luxembourg 
competent authority has adequate authority to compel the 
production of a wide variety of information, pursuant to a 
request from the U.S. competent authority. However, the 
Technical Explanation states that under Luxembourg internal 
law, Luxembourg tax authorities are prohibited from obtaining 
information from Luxembourg financial institutions for their 
own tax investigations and proceedings; thus, Luxembourg tax 
authorities are unable to obtain such information upon the 
request of U.S. tax authorities. The Notes further provide that 
information of Luxembourg financial institutions may be 
provided to U.S. authorities only in accordance with the terms 
of the proposed MLAT. The scope of the obligation is set forth 
in that agreement (as described below). The Notes provide that 
in the event that Luxembourg changes its laws and practices so 
that its tax authorities may obtain such information for 
purposes of enforcing and administering its own tax laws or the 
tax laws of member countries of the EU, such information will 
likewise be provided to the United States.

Summary of proposed MLAT provisions relating to taxes

    The proposed MLAT covers mutual legal assistance and 
exchange of information in criminal matters. The proposed MLAT 
and accompanying exchange of diplomatic notes (the ``MLAT 
Notes'') specify the scope of coverage regarding tax offenses. 
The requested country is required to provide assistance for 
offenses concerning value added taxes, sales taxes, excise 
taxes, custom duties and any other taxes that may be agreed to 
by the countries through an exchange of diplomatic notes. For 
offenses concerning other taxes (e.g., income taxes), the 
requested state must provide assistance only where the facts in 
a request establish a reasonable suspicion of ``fiscal fraud'' 
(``escroquerie fiscale''), as that term is defined in the 
proposed MLAT and the MLAT Notes. As used in the proposed MLAT, 
the term ``fiscal fraud'' means a criminal offense in which: 
(1) the tax involved, either as an absolute amount or in 
relation to an annual amount due, is significant, and (2) the 
conduct involved constitutes a systematic effort or a pattern 
of activity designed or tending to conceal pertinent facts from 
or provide inaccurate facts to the tax authorities. The 
requested country may not refuse assistance because its law 
does not impose the same kind of tax, or does not contain the 
same kind of tax regulations, as does the law of the requesting 
country.
    The MLAT Notes state that the description of the tax 
offenses defined in the proposed MLAT as fiscal fraud for which 
assistance is available is in accord with the concept of 
``fiscal fraud'' (``escroquerie fiscale'') under Luxembourg 
law. The MLAT Notes provide that the Luxembourg concept of 
``escroquerie fiscale'' is in accord with the concept of 
``fiscal fraud'' under the laws of the United States, where a 
pattern of affirmative willful misconduct (``manoeuvres 
frauduleuses'') exists, the likely effect of which would be to 
mislead tax authorities or conceal information from them. The 
MLAT Notes state that the United States and Luxembourg will 
consider that a pattern or combination of any one of the 
following activities designed or tending to conceal pertinent 
facts from, or provide inaccurate facts to, the tax authorities 
(``l'empoi systematique de manoeuvres frauduleuses'') would 
create a presumption of an offense for which assistance is 
available under the proposed MLAT: (1) keeping a double set of 
books; (2) making false entries or alterations or false 
invoices or documents; (3) destroying books or records; (4) 
concealing assets or covering up sources of income; and (5) 
handling one's affairs to avoid making the records usual in 
transactions of the kind. The MLAT Notes state that 
Luxembourg's concept of ``concealing pertinent facts from or 
providing inaccurate facts to the tax authorities'' is 
comparable to the United States concept of ``misleading tax 
authorities.''
    The proposed MLAT provides that information or evidence 
regarding a tax offense will be available for specified uses 
beyond the investigation or prosecution of the tax offense, 
including the assessment, collection, administration or 
enforcement in respect of taxes underlying that offense. Under 
the proposed MLAT, information or evidence which has been made 
public in the requesting country in the normal course of a 
proceeding for which it was provided may generally be used for 
any purpose. However, such information or evidence may not be 
used, among other things, for the prosecution of tax offenses 
for which assistance is not available under the proposed MLAT. 
For such offenses, information or evidence may not be used 
without the prior consent of the central authority of the 
requested country. The proposed MLAT also provides rules 
relating to the appearance of persons to assist in 
investigations or proceedings and the safe conduct of those 
persons, to the transfer of persons in custody, to the location 
or identification of persons or items, to the service of 
documents, and to search and seizure.
            Assistance in collection
    The proposed treaty also provides for administrative 
cooperation between the two countries in collecting taxes to 
the extent necessary to ensure that treaty benefits do not 
inure to the benefits of persons not entitled to such benefits. 
The provisions of the proposed treaty are more detailed than 
the corresponding provisions of the U.S. model provision.
    When one country applies to the other for assistance in the 
collection of taxes, its application must include a 
certification by its competent authority 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 referred 
to above will be rendered enforceable in accordance with the 
laws of the requested country. The tax covered by the accepted 
request will be collected by the accepting country as though 
the tax were that country's own tax that has been finally 
determined. However, the tax will not have, in the accepting 
country, any priority accorded to the taxes of that country 
(e.g., in the case of a bankruptcy).
    The proposed treaty provides that appeals concerning the 
existence or 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 treaty 
country the obligation to carry out administrative measures of 
a different nature from those used in the collection of its own 
taxes, or that would be contrary to its sovereignty, security, 
public policy or essential interests. The Technical Explanation 
states that the term ``essential interests'' is not defined in 
the proposed treaty; however, it is understood that bank 
secrecy is not an essential interest.

Article 29. 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 fiscal 
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 the application of this article to 
U.S. residents who are neither U.S. citizens nor green-card 
holders. Thus, Luxembourg diplomats who are considered U.S. 
residents generally may be protected from U.S. tax.

Article 30. Entry Into Force

    The proposed treaty will enter into force on the day of 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 takes effect for 
payments made on or after that first day of January.
    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 would continue to have effect in its 
entirety for the first assessment period or taxable year 
following 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.

Article 31. Termination

    The proposed treaty will continue in force until terminated 
by a treaty country. Either country may terminate it by giving 
notice through diplomatic channels at least six months before 
the end of any calendar year after the year the treaty has 
entered into force. Unlike many U.S. tax treaties, the proposed 
treaty does not contain the rule which provides that either 
country may terminate the treaty only after it has been in 
force for five years. A termination generally will be effective 
for taxable years and periods beginning on or after the first 
day of January following the expiration of the six month 
period. With respect to taxes payable at source, a termination 
will be effective for payments made on or after the first day 
of January following the expiration of the six month period.

               IX. Text of the Resolution of Ratification

    Resolved, (two-thirds of the Senators present concurring 
therein), That the Senate advise and consent to the 
ratification of the Convention between the Government of the 
United States of America and the Government of the Grand Duchy 
of Luxembourg for the Avoidance of Double Taxation and the 
Prevention of Fiscal Evasion with Respect to Taxes on Income 
and Capital, signed at Luxembourg on April 3, 1996 (Treaty Doc. 
104-33), subject to the reservation of subsection (a), the 
declarations of subsection (b), and the proviso of subsection 
(c).
    (a) RESERVATION.--The Senate's advice and consent is 
subject to the following reservation, which shall be included 
in the instrument of ratification, and shall be binding on the 
President:
          (1) REAL ESTATE INVESTMENT TRUSTS.--Subparagraph (a) 
        (ii) of paragraph 2 of Article 10 of the Convention 
        shall apply 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, (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, or (iii) the beneficial owner of the 
        dividends beneficially held an interest in the Real 
        Estate Investment Trust as of June 30, 1997, the 
        dividends are paid with respect to such interest, and 
        the Real Estate Investment Trust is diversified 
        (provided that such provision shall not apply to 
        dividends paid after December 31, 1999 unless the Real 
        Estate Investment Trust is publicly traded on December 
        31, 1999 and thereafter).
    (b) DECLARATIONS.--The Senate's advice and consent is 
subject to the following declaration, which shall be binding on 
the President:
          (1) SIMULTANEOUS EXCHANGE.--The United States shall 
        not exchange the instruments of ratification of this 
        Convention with the Government of the Grand Duchy of 
        Luxembourg until such time as it exchanges the 
        instruments of ratification with respect to the Treaty 
        Between the Government of the United States of America 
        and the Government of the Grand Duchy of Luxembourg on 
        Mutual Legal Assistance in Criminal Matters, signed at 
        Washington on March 13, 1997 (Treaty Doc. 105-11).
          (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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