[Senate Executive Report 106-8]
[From the U.S. Government Publishing Office]



106th Congress                                               Exec. Rpt.
                                 SENATE
 1st Session                                                   106-8

======================================================================



 
                        TAX CONVENTION WITH ITALY

                                _______
                                

                November 3, 1999.--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. 106-11]

    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 Italian Republic for the 
Avoidance of Double Taxation with Respect to Taxes on Income 
and the Prevention of Fraud or Fiscal Evasion, signed at 
Washington on August 25, 1999, together with a Protocol, having 
considered the same, reports favorably thereon, with one 
reservation, one understanding, one declaration, and one 
proviso, and recommends that the Senate give its advice and 
consent to ratification thereof, as set forth in this report 
and the accompanying resolution of ratification.

                                CONTENTS

                                                                   Page

  I. Purpose..........................................................1
 II. Background.......................................................2
III. Summary..........................................................2
 IV. Entry Into Force and Termination.................................3
  V. Committee Action.................................................3
 VI. Committee Comments...............................................4
VII. Budget Impact...................................................16
VIII.Explanation of Proposed Treaty..................................16

 IX. Explanation of Proposed Protocol................................55
  X. Text of Resolution of Ratification..............................61

                               I. Purpose

    The principal purposes of the proposed income tax treaty 
between the United States and Italy 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 and proposed protocol both were signed 
on August 25, 1999. The United States and Italy also exchanged 
notes on the same day with an attached Memorandum of 
Understanding to provide clarification with respect to the 
application of the proposed treaty. The proposed treaty would 
replace the existing income tax treaty between the United 
States and Italy that was signed in 1984.
    The proposed treaty, together with the proposed protocol 
and the exchange of notes, were transmitted to the Senate for 
advice and consent to its ratification on September 21, 1999 
(see Treaty Doc. 106-11). The Committee on Foreign Relations 
held a public hearing on the proposed treaty on October 27, 
1999.

                              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''), 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 treaties and models.
    As in other U.S. tax treaties, these objectives principally 
are achieved through each country's agreement 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 
each country generally agrees not to tax business income 
derived from sources within that country by residents of the 
other country unless the business activities in the taxing 
country are substantial enough to constitute a permanent 
establishment or fixed base (Articles 7 and 14). Similarly, the 
proposed treaty contains ``commercial visitor'' exemptions 
under which residents of one country performing personal 
services in the other country will not be required to pay tax 
in the other country unless their contact with the other 
country exceeds specified minimums (Articles 14, 15, and 17). 
The proposed treaty provides that dividends, interest, 
royalties, 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, 11, 12, and 13); 
however, the rate of tax that the source country may impose on 
a resident of the other country on dividends, interest, and 
royalties generally will be limited by the proposed treaty 
(Articles 10, 11, and 12).
    In situations where the country of source retains the right 
under the proposed treaty to tax income derived by residents of 
the other country, the proposed treaty generally provides for 
relief from the potential double taxation through the allowance 
by the country of residence of a tax credit for certain foreign 
taxes paid to the other country (Article 23).
    The proposed treaty contains the standard provision (the 
``saving clause'') included in U.S. tax treaties pursuant to 
which each country retains the right to tax its residents and 
citizens as if the treaty had not come into effect (Article 1). 
In addition, the proposed protocol contains the standard 
provision providing that the treaty 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.
    The proposed treaty contains certain ``main purpose'' tests 
which operate to deny the benefits of the dividends article 
(Article 10), the interest article (Article 11), the royalties 
article (Article 12) and the other income article (Article 22) 
if the main purpose or one of the main purposes of a person is 
to take advantage of the benefits of the respective article 
through a creation or assignment of shares, debt claims, or 
rights that would give rise to income to which the respective 
article would apply.
    The proposed protocol also contains a detailed limitation 
on benefits provision to prevent the inappropriate use of the 
treaty by third-country residents.

                  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 ceases to 
have effect once the provisions of the proposed treaty take 
effect.
    In the case of taxes withheld at source, the proposed 
treaty takes effect for amounts paid or credited on or after 
the first day of the second month following the date on which 
the proposed treaty enters into force. In the case of other 
taxes, the proposed treaty takes effect for taxable periods 
beginning on or after the first day of January next following 
the date on which the proposed treaty enters into force.
    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 a twelve-
month period from the date on which the provisions of the 
proposed treaty would otherwise take effect.

                             B. TERMINATION

    The proposed treaty will continue in force until terminated 
by either country. Either country may terminate the proposed 
treaty at any time after five years from the date of entry into 
force, provided that at least six months prior notice of 
termination is given through diplomatic channels. With respect 
to taxes withheld at source, a termination will be effective 
for amounts paid or credited on or after the first of January 
following the expiration of the six-month period. With respect 
to other taxes, a termination will be effective for taxable 
periods beginning on or after the first of January following 
the expiration of the six-month period.

                          V. Committee Action

    The Committee on Foreign Relations held a public hearing on 
the proposed treaty with Italy (Treaty Doc. 106-11), as well as 
on other proposed treaties and protocols, on October 27, 1999. 
The hearing was chaired by Senator Hagel. The Committee 
considered these proposed treaties and protocols on November 3, 
1999, and ordered the proposed treaty with Italy 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, an understanding, a 
declaration, and a proviso.

                         VI. Committee Comments

    On balance, the Committee on Foreign Relations believes 
that the proposed treaty with Italy 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 the 
Treasury Department officials in providing guidance on these 
matters should they arise in the course of future treaty 
negotiations.

                         A. MAIN PURPOSE TESTS

In general

    The proposed treaty includes a series of ``main purpose'' 
tests that can operate to deny the benefits of the dividends 
article (Article 10), the interest article (Article 11), the 
royalties article (Article 12), and the other income article 
(Article 22). This series of main purpose tests is not found in 
any other U.S. treaty, and is not included in the U.S. model or 
the OECD model.\1\
---------------------------------------------------------------------------
    \1\ Although not included in the OECD model, paragraph 17 of the 
commentary to the dividends article of the OECD model suggests that the 
treaty partners may find it appropriate to adopt a rule to deny treaty 
benefits if the acquisition of stock was ``primarily for the purpose of 
taking advantage of this provision.''
---------------------------------------------------------------------------

Description of provisions

    Under the proposed treaty, the provisions of the dividends 
article (Article 10) will not apply if it was the main purpose 
or one of the main purposes of any person concerned with the 
creation or assignment of the shares or rights in respect of 
which the dividend is paid to take advantage of the dividends 
article by means of that creation or assignment. Similarly, the 
interest article (Article 11) provides that its provisions will 
not apply if it was the main purpose or one of the main 
purposes of any person concerned with the creation or 
assignment of the debt claim in respect of which the interest 
is paid to take advantage of the interest article by means of 
that creation or assignment. Substantially similar main purpose 
tests apply in the case of the royalties article (Article 12) 
and the other income article (Article 22).
    The Technical Explanation indicates that the main purpose 
tests are to be ``self-executing.'' The Technical Explanation 
further states that the tax authorities of one of the treaty 
countries may, on review, deny the benefits of the respective 
article if the conditions of the main purpose tests are 
satisfied. In addition, the proposed protocol provides that 
under the mutual agreement procedures article (Article 25) the 
competent authorities of the treaty countries may agree that 
the conditions for application of the main purpose tests are 
met. The Technical Explanation states that the competent 
authority agreement does not have to relate to a particular 
case. Rather, if the competent authorities agree that a type of 
transaction entered into by several taxpayers is entered into 
with a main purpose of taking advantage of the treaty, treaty 
benefits can be denied to all taxpayers who had entered into 
such a transaction. The Technical Explanation states that it is 
anticipated that the public would be notified of such generic 
agreements through the issuance of press releases.

Committee concerns with the ``main purpose'' tests

    The Committee has several concerns with the new main 
purpose tests. The inclusion of such tests in the specific 
articles of the proposed treaty represents a fundamental shift 
in U.S. treaty policy. As a general matter, such changes in 
policy should be made only after careful consideration of 
whether circumstances warrant such a change, and whether the 
proposed change is appropriate. The Treasury Department should 
engage in meaningful consultations with the Congress when 
proposing to make such a policy shift. The Committee is 
concerned that such consultations did not occur in this 
instance, and that the Committee has not been afforded an 
opportunity to weigh the relevant policy considerations 
(including whether a need for such a provision exists) and to 
evaluate alternative approaches with respect to the proposed 
new tests.
    The Treasury Department has acknowledged that the United 
States presently has the right to apply its domestic law 
(including anti-abuse principles such as the business purpose 
doctrine) in the treaty context; this is a broad authority that 
would allow treaty benefits to be denied in tax avoidance 
transactions. The Treasury Department has stated, however, that 
the proposed main purpose tests are intended to go beyond 
present U.S. domestic law. Although the Committee shares the 
Treasury Department's concern with abusive transactions, the 
Treasury Department has not convinced the Committee that a 
higher standard is necessary in U.S. treaties than that which 
applies under domestic law. In addition, the Committee is 
concerned that the Treasury Department has not adequately 
explained the potential implications of going beyond present 
U.S. law in the treaty context.
    The new main purpose tests in the proposed treaty are 
subjective, vague and add uncertainty to the treaty. It is 
unclear how the provisions are to be applied. In addition, the 
provisions lack conformity with other U.S. tax treaties. This 
uncertainty could create difficulties for legitimate business 
transactions, and can hinder a taxpayer's ability to rely on 
the treaty.
    In the past, the United States has determined that 
subjective tests are not appropriate in the treaty context. For 
example, older U.S. treaties containing limitation on benefits 
provisions (which address an abuse of a treaty whereby 
residents of third countries try to take advantage of the 
treaty provisions through what is known as treaty shopping) 
applied broad subjective tests looking to whether the 
acquisition, maintenance, or operation of an entity did not 
have ``as a principal purpose obtaining benefits under'' the 
treaty. These subjective tests have been replaced in recent 
treaties (including the proposed treaty) with limitation on 
benefits provisions that apply clear, bright-line objective 
tests (such as ownership and base erosion tests, public company 
tests, as well as active business tests). The reasons for 
moving away from subjective standards are illustrated by a 
statement in the Technical Explanation to the limitation on 
benefits provision of the proposed treaty that acknowledges in 
connection with a principal purpose test that a ``fundamental 
problem presented by this approach is that it is based on the 
taxpayer's motives in establishing an entity in a particular 
country, which a tax administrator is normally ill-equipped to 
identify.'' Although this criticism is specific to a principal 
purpose test with respect to an anti-treaty shopping provision, 
the same concern applies with respect to subjective tests in 
general.
    The main purpose standard in the relevant provisions of the 
proposed treaty is that ``the main purpose or one of the main 
purposes'' is to ``take advantage of'' the particular article 
in which the main purpose tests appear. This is a subjective 
standard, dependent upon the intent of the taxpayer, that is 
difficult to evaluate. Such a standard is inconsistent with 
present U.S. treaty policy. In addition, the Committee is 
concerned that a broad standard based on whether one of the 
main purposes of a taxpayer is to take advantage of a 
particular treaty provision does not adequately distinguish 
between legitimate business transactions and tax avoidance 
transactions. While it is true that under U.S. domestic law, 
``a principal purpose'' test is used as an anti-abuse rule in a 
variety of contexts, its use generally has been limited to 
circumscribed situations. The Committee is concerned that the 
circumstances for inclusion of a main purpose test in the 
proposed treaty are not well-defined and that the standard 
potentially has much broader implications in the treaty context 
then in its analogs under U.S. domestic law. The Committee 
believes that consideration should be given to alternative 
formulations of anti-abuse standards, including objective 
standards such as those contained in the limitation on benefits 
provisions of modern U.S. income tax treaties.
    It is also unclear how the proposed main purpose tests 
would be administered. The Technical Explanation indicates that 
the tests are intended to be self-executing. In the absence of 
a taxpayer applying the tests to itself, the tax authorities of 
one of the countries may, on review, deny the treaty benefits. 
The Committee is concerned that the Treasury Department has not 
provided adequate assurances that the tests will not be used by 
treaty partners to deny treaty benefits for legitimate business 
activity.
    A fairness question also may be raised insofar as the 
proposed treaty provides the competent authorities with the 
ability to declare an entire class of transactions as abusive 
and, accordingly, deny treaty benefits to that class without 
the necessity of evaluating the facts of each specific 
transaction. It is unclear what degree of deference would be 
accorded to such a competent authority agreement by responsible 
tax administrative authorities or by the courts. Moreover, 
because the main purpose tests do not appear in other U.S. 
treaties or with respect to other articles of this proposed 
treaty, an issue arises as to whether its inclusion in specific 
provisions of this proposed treaty creates a negative inference 
as to the United States' ability to raise its internal anti-
abuse rules in connection with other treaties (or other 
provisions of this proposed treaty) in which such main purpose 
tests do not appear. The Technical Explanation states that no 
such inference with respect to other treaties is intended. The 
Committee believes that further consideration and analysis of 
these issues are necessary.

Committee conclusions

    The Committee shares the Treasury Department's concerns 
with respect to abusive transactions that inappropriately take 
advantage of treaty benefits. The Committee does not believe, 
however, that the main purpose tests in the proposed treaty 
have been fully and adequately developed. The Committee 
believes that there are many issues, including the need for 
such tests and, if needed, what the appropriate tests should be 
as a matter of U.S. treaty policy, that must be addressed 
before it would be appropriate to include such provisions in 
any U.S. income tax treaty. Accordingly, the Committee has 
included in its recommended resolution of ratification a 
reservation requiring that the main purpose tests be stricken 
from the proposed treaty and proposed protocol.
    Notwithstanding the Committee's concerns with the main 
purpose tests in the proposed treaty and its recommendation of 
a reservation in this regard, on balance the Committee believes 
that the proposed treaty with Italy is in the interest of the 
United States and strongly urges the Treasury Department to 
pursue an exchange of instruments of ratification with the 
aforementioned reservation with the same zeal with which it 
negotiated the proposed treaty in the first instance.
    In addition, the Committee is committed to working with the 
Treasury Department to develop appropriate ways to address tax 
avoidance in the treaty context. The Committee requests that 
the Treasury Department provide it with a comprehensive 
analysis of (1) the need for a main purpose or similar test 
including specific examples of abusive transactions that cannot 
be adequately addressed under present U.S. law; (2) 
alternatives to such a test including alternatives that rely on 
objective standards; (3) the interaction of such a test with 
present domestic law and the corresponding rules under the 
relevant foreign law; (4) any potential inferences that may be 
created with respect to other U.S. treaties and other 
provisions of the specific treaty that do not contain such a 
test; (5) the expected standards of judicial review with 
respect to the application of such a test and the degree of 
deference that may be accorded to competent authority 
agreements with respect to such a test; (6) the experience of 
foreign countries that presently include such a test or similar 
tests in their income tax treaties; and (7) any other relevant 
considerations.
    Until these issues have been fully considered by both the 
Treasury Department and the Committee, the Committee strongly 
recommends that the Treasury Department not modify its model 
treaty to include these or similar main purpose tests and not 
include such main purpose tests or similar tests in future 
treaties.

                  B. CREDITABILITY OF ITALIAN IRAP TAX

    United States law, subject to certain limitations, allows a 
credit for income, war profits or excess profits taxes paid to 
a foreign country. In general, to be a creditable tax under 
U.S. law, the tax must be likely to reach net gain in the 
normal circumstances in which it applies.
    In addition to the individual income tax and the 
corporation income tax, the proposed treaty provides for 
creditability of a portion of the Italian regional tax on 
productive activities (l'imposta regionale sulle attivita 
produttive or ``IRAP''). Effective January 1, 1998, the IRAP 
replaced Italy's local income tax (l'imposta locale sul redditi 
or ``ILOR''), which is treated as a creditable tax under the 
present U.S.-Italy treaty. Unlike the ILOR, the IRAP is 
calculated without a deduction for labor costs and, for certain 
taxpayers, without a deduction for interest costs. As a result, 
the tax base is not similar enough to a U.S. income tax base 
such that it is not likely to reach net gain. The IRAP 
therefore is unlikely to be a creditable tax under U.S. law, 
absent a special treaty provision.
    In general, the proposed treaty provides a formula under 
which the amount of the IRAP that is considered to be a 
creditable income tax under the proposed treaty is determined 
by multiplying the amount of the IRAP actually paid or accrued 
by a fraction. The numerator of the fraction represents an 
amount approximating the taxpayer's business profits that would 
be subject to the IRAP if deductions for interest and labor 
costs were allowed. The denominator of the fraction equals the 
actual tax base upon which Italy imposes the IRAP. Thus, if the 
IRAP tax base is twice that which it would have been if it 
permitted deductions for interest and labor (and therefore more 
closely approximated net income), then only half of the amount 
paid would be treated as a creditable income tax under the 
proposed treaty. That amount then would be subject to the other 
limitations on foreign tax credits under U.S. law.
    The Committee believes that treaties should not be used to 
provide a credit for taxes that may not otherwise be creditable 
under U.S. law. It may be more appropriate for such results to 
be accomplished in the normal course of internal U.S. tax 
legislation. The tax credits allowed under the proposed treaty 
for IRAP taxes likely are larger than the credits otherwise 
allowed under the Code and Treasury regulations and, therefore, 
potentially would reduce the U.S. taxes collected from U.S. 
companies operating in Italy.
    In addition, the Committee is concerned with the proposed 
treaty's mechanism for determining the amount of the IRAP that 
is treated as a creditable income tax for U.S. foreign tax 
credit purposes. In essence, in order to claim a credit for a 
portion of the IRAP, the proposed treaty takes the unusual step 
of requiring a calculation of a hypothetical portion of tax 
actually imposed under the IRAP that would more likely resemble 
a creditable income tax under U.S. tax principles, and then 
guarantees that such portion is eligible for the U.S. foreign 
tax credit. Such a hypothetical calculation is not consistent 
with U.S. treaty policy. The Committee strongly recommends that 
such hypothetical calculations not be used in future treaties 
to address foreign tax credit issues with respect to otherwise 
noncreditable taxes, particularly with respect to taxes not 
designed to reach net gain such as value added taxes.
    The Committee recognizes that special circumstances exist 
with respect to the proposed treaty. The IRAP has recently 
replaced the ILOR, which is a creditable income tax under the 
present U.S.-Italy treaty. In these circumstances it could be 
viewed as unfair to disadvantage U.S. enterprises doing 
business in Italy because of a change in Italian law. The 
formula provided in the proposed treaty is designed to limit 
the amount of the creditable IRAP tax under the proposed treaty 
to an amount that could be considered to be creditable under 
U.S. internal law if the IRAP were designed (like the ILOR 
which it replaced) to reach net gain. The Committee believes 
that given these circumstances, it is justifiable to provide a 
credit for a portion of the IRAP in the manner provided under 
the proposed treaty. However, the Committee does not believe 
that this provision should be construed in any way as a 
precedent for future treaties to provide creditability for 
otherwise non-creditable taxes under U.S. domestic law such as 
value added taxes. The Committee expects the Treasury 
Department to closely monitor the application of this formulary 
approach to the IRAP and to promptly notify the Committee as to 
whether such approach is achieving its intended results.

                        C. INSURANCE EXCISE TAX

    The proposed protocol, like the protocol to the present 
treaty, waives the U.S. excise tax on insurance premiums paid 
to foreign insurers under certain circumstances. With the 
waiver of the excise tax on insurance premiums, for example, an 
Italian 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 Italian 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 concerns 
in the past. 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 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 granted by Treasury in its future 
treaty negotiations without prior consultations with the 
appropriate committees of Congress.\2\ 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 the treaty 
has been followed by a number of legislative efforts to redress 
the perceived competitive imbalance created by the waiver.
---------------------------------------------------------------------------
    \2\ Limited consultations took place in connection with the 
proposed treaty.
---------------------------------------------------------------------------
    The proposed treaty waives imposition of the excise tax on 
insurance and reinsurance premiums paid to residents of Italy. 
The Committee understands that, unlike Bermuda and Barbados, 
Italy imposes substantial tax on the income, including 
insurance income, of its residents. Moreover, unlike in the 
case of the U.K. treaty, the waiver in the proposed treaty 
contains the anti-conduit clause.
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the Italian 
income tax imposed on Italian insurance companies on 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 Treasury Department's October 29, 1999, memorandum \3\ 
responding to this inquiry is reproduced below:
---------------------------------------------------------------------------
    \3\ Memorandum from the Treasury Department for Senator Hagel, 
October 29, 1999 (``October 29, 1999 Treasury Department memorandum'').

          Treasury recognizes the policy concerns about the 
        competitiveness of U.S. insurance companies that serve 
        as the basis for the imposition of the excise tax on 
        foreign insurers insuring U.S. risks. Consistent with 
        these policy concerns, the Treasury Department will 
        only agree to cover this excise tax in an income tax 
        convention, and thereby grant an exemption from the 
        tax, if Treasury is satisfied that an insurer that is a 
        resident of the treaty partner and is insuring U.S. 
        risks would face a level of taxation that is 
        substantial relative to the level of taxation faced by 
        U.S. insurers.
          During the course of negotiations, Treasury conducted 
        a thorough review of Italian law and information on 
        Italian insurance company operations. This review 
        demonstrated that insurance companies that are resident 
        in Italy are subject to a substantial level of tax in 
        Italy. Accordingly, it was determined that U.S. 
        insurance companies would not be placed at a 
        competitive disadvantage by the retention of coverage 
        of the excise tax in the proposed treaty.

    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 
Italian insurers and U.S. insurers, the Committee believes that 
the waiver of the excise tax for Italian insurers is consistent 
with the criteria the Committee has articulated for such 
waivers. The Committee expects the Treasury Department to 
closely monitor and to promptly notify the Committee of any 
changes in law or business practices that would have an impact 
on the tax burden of Italian insurers relative to that of U.S. 
insurers.

                    D. SHIPPING AND AIRCRAFT INCOME

Income from the rental of ships and aircraft

    The proposed treaty, like the present treaty, includes a 
provision found in the U.S. model and many U.S. income tax 
treaties under which profits from an enterprise's operation of 
ships or aircraft in international traffic are taxable only in 
the enterprise's country of residence. For this purpose, the 
operation of ships or aircraft in international traffic 
includes profits derived from the rental of ships or aircraft 
on a full (time or voyage) basis. Like the present treaty, in 
the case of profits derived from the rental of ships and 
aircraft on a bareboat (without a crew) basis, the rule 
limiting the right to tax to the country of residence applies 
to such rental profits only if the bareboat rental profits are 
incidental to other profits of the lessor from the operation of 
ships and aircraft in international traffic. Such bareboat 
rental profits that are not incidental to other income from the 
international operation of ships and aircraft generally would 
be taxable by the source country as royalties at a 5-percent 
rate (or as business profits if such profits are attributable 
to a permanent establishment). The U.S. model and many other 
treaties provide that profits from the rental of ships and 
aircraft operated in international traffic are taxable only in 
the country of residence, without requiring that the rental 
profits be incidental to income of the recipient from the 
operation of ships or aircraft. Under the proposed treaty, 
unlike under the U.S. model, an enterprise that engages only in 
the rental of ships and aircraft on a bareboat basis, but does 
not engage in the operation of ships and aircraft, would not be 
eligible for the rule limiting the right to tax income from 
operations in international traffic to the enterprise's country 
of residence. It should be noted that under the proposed 
treaty, profits from the use, maintenance, or rental of 
containers used in international traffic are taxable only in 
the country of residence.

Gains from the sale of ships and aircraft

    The proposed treaty, like the present treaty, includes a 
provision found in the U.S. model and many U.S. income tax 
treaties under which gains derived by an enterprise from one of 
the treaty countries from the alienation of ships or aircraft 
operated in international traffic (or movable property 
pertaining to the operation or use of ships, aircraft or 
containers) are taxable only in the country of residence, 
regardless of the existence of a permanent establishment in the 
other country. For this purpose, the proposed protocol provides 
that this rule also applies to gains from the sale of 
containers used for the transport in international traffic of 
goods and merchandise, and gains from the sale of ships or 
aircraft rented on a full basis. Like the present treaty, in 
the case of gains from the sale of ships or aircraft rented on 
a bareboat basis, the rule limiting the right to tax to the 
country of residence applies to such gains only if the rental 
profits from such bareboat rentals are incidental to other 
profits of the lessor from the operation of ships or aircraft 
in international traffic. Such gains that are not incidental to 
other income from the operation of ships and aircraft generally 
would be taxable by the source country as business profits if 
such profits are attributable to a permanent establishment. The 
U.S. model and many other treaties provide that gains from the 
sale of ships and aircraft operated in international traffic 
are taxable only in the country of residence, without requiring 
that the rental profits from the use of such ships be 
incidental to income of the recipient from the operation of 
ships or aircraft. Under the proposed treaty, unlike under the 
U.S. model, an enterprise that engages only in the rental of 
ships and aircraft on a bareboat basis, but does not engage in 
the operation of ships and aircraft, would not be eligible for 
the rule limiting the right to tax income from operations in 
international traffic to the enterprise's country of residence. 
It should be noted that under the proposed treaty gains from 
the sale of containers used in international traffic are 
taxable only in the country of residence.

Committee conclusions

    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the proposed 
treaty's rules with respect to income derived from the rental 
of ships and aircraft, and gains from the sale of ships and 
aircraft, are appropriate. The relevant portion of the October 
29, 1999, Treasury Department memorandum responding to this 
inquiry is reproduced below:

          Although it is the preferred U.S. policy to extend 
        the source-country exemption to include non-incidental 
        income from the bareboat rental of ships and aircraft 
        (and gains from the disposition of such ships and 
        aircraft), Italy was unwilling to change the existing 
        treaty on this point because of its strong treaty 
        policy against such exemptions. Indeed, the inclusion 
        of a source-country exemption for rental income (and 
        gains) from containers used in international traffic 
        represents a significant departure for Italy from its 
        normal treaty policy.

    The provisions in the proposed treaty represent a departure 
from the U.S. model. The Committee believes that in negotiating 
future treaties, the Treasury Department should continue to 
seek provisions that conform more closely to the U.S. model.

                           E. TREATY SHOPPING

    The proposed treaty, like a number of U.S. income tax 
treaties, generally limits treaty benefits for treaty country 
residents so that only those residents with a sufficient nexus 
to a treaty country will receive treaty benefits. Although the 
proposed treaty generally is intended to benefit only residents 
of Italy and the United States, 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. 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 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.
    One provision of the anti-treaty shopping article differs 
from the comparable rule of some earlier U.S. treaties, but the 
effect of the change is not clear. The general test applied by 
those treaties to allow benefits to an entity that does not 
meet the bright-line ownership and base erosion tests is a 
broadly subjective one, looking to whether the acquisition, 
maintenance, or operation of an entity did not have ``as a 
principal purpose obtaining benefits under'' the treaty. By 
contrast, the proposed treaty contains a more precise test that 
allows denial of benefits only with respect to income not 
derived in connection with (or incidental to) the active 
conduct of a substantial trade or business. (However, this 
active trade or business test does not apply with respect to a 
business of making or managing investments carried on by a 
person other than a bank, insurance company, or registered 
securities dealer; so benefits may be denied with respect to 
such a business regardless of how actively it is conducted.) In 
addition, the proposed treaty (like all recent treaties) gives 
the competent authority of the country in which the income 
arises the authority to determine that the benefits of the 
treaty will be granted to a person even if the specified tests 
are not satisfied.
    The Committee believes that limitation on benefits 
provisions are important to protect against ``treaty shopping'' 
by limiting benefits of a treaty to bona fide residents of the 
treaty partner. The Committee further believes that the United 
States should maintain its policy of limiting treaty shopping 
opportunities whenever possible. The Committee continues to 
believe further that, in exercising any latitude the Treasury 
Department has to adjust the operation of the proposed treaty, 
the rules as applied should adequately deter treaty shopping 
abuses. The proposed anti-treaty-shopping provision may be 
effective in preventing third-country investors from obtaining 
treaty benefits by establishing investing entities in Italy 
because third-country investors may be unwilling to share 
ownership of such investing entities on a 50-50 basis with U.S. 
or Italian residents or other qualified owners in order to meet 
the ownership test of the anti-treaty-shopping provision. In 
addition, the base erosion test provides protection from 
certain potential abuses of an Italian conduit. Finally, Italy 
imposes significant taxes of its own; these taxes may deter 
third-country investors from seeking to use Italian entities to 
make U.S. investments. On the other hand, implementation of the 
tests for treaty shopping set forth in the treaty may raise 
factual, administrative, or other issues that cannot currently 
be foreseen. The Committee emphasizes that the proposed anti-
treaty-shopping provision must be implemented so as to serve as 
an adequate tool for preventing possible treaty shopping abuses 
in the future.

          F. ARBITRATION UNDER THE MUTUAL AGREEMENT PROCEDURES

    The proposed treaty would allow for a binding arbitration 
procedure, if agreed by both competent authorities and the 
taxpayer or taxpayers involved, for the resolution of disputes 
regarding individual cases of double taxation not in accordance 
with the proposed treaty. Several conditions would have to be 
satisfied before this arbitration procedure could be utilized. 
First, the two countries would have to exchange diplomatic 
notes implementing this arbitration procedure; until that 
occurs, the arbitration procedure is not in effect. Second, the 
affected taxpayer must present his or her case to the competent 
authority. Third, the competent authority must first attempt to 
resolve the issue by itself, and if it cannot, then it must 
attempt to do so by mutual agreement with the competent 
authority of the other country. The Memorandum of Understanding 
explicitly states that the two countries will exchange the 
requisite diplomatic notes when the experience of the two 
countries with respect to a similar provision in the treaty 
between the U.S. and Germany has proven to be satisfactory.
    The relevant portion of the Treasury Department's October 
29, 1999, memorandum discussing this issue is reproduced below:

          Treasury recognizes that there has been little 
        practical experience with arbitration of tax treaty 
        disputes and this creates some uncertainty about how 
        well arbitration would work. For this reason, Treasury 
        does not advocate the inclusion of arbitration 
        provisions in new treaties. However, if the treaty 
        partner is strongly interested in an arbitration 
        provision, we are willing to include such a provision 
        in a new treaty with the proviso that it cannot be 
        implemented until the treaty partners have exchanged 
        diplomatic notes to that effect. This provides the 
        opportunity to wait until more experience has been 
        gained with arbitration and with the treaty partner 
        before deciding whether the implementation of such a 
        provision is desirable. For the foregoing reasons, and 
        because Italy was strongly interested in the provision, 
        it was included in the proposed treaty.

    The Committee continues to believe that the tax system 
potentially has much to gain from use of a procedure, such as 
arbitration, in which independent experts can resolve disputes 
that otherwise may impede efficient administration of the tax 
laws. However, the Committee also believes that the 
appropriateness of such a clause in a future treaty depends 
strongly on the other party to the treaty, and on the 
experience that the competent authorities have under the 
arbitration provision in the German treaty. The Committee 
understands that to date there have been no arbitrations of 
competent authority cases under the German treaty, and few tax 
arbitrations outside the context of that treaty. The Committee 
believes that it is appropriate to have conditioned the 
effectiveness of the arbitration provision in the proposed 
treaty on subsequent action which should occur only after 
review of future developments in this evolving area of 
international tax administration.
    The Committee's willingness to accommodate this arbitration 
procedure is strongly influenced by the fact that the proposed 
treaty would allow for a binding arbitration procedure only if 
agreed by both competent authorities and the taxpayer or 
taxpayers involved. The Committee believes that it would be 
inappropriate for any future treaty to include an arbitration 
procedure that did not contain this provision, which allows for 
a binding arbitration procedure only if agreed by both 
competent authorities and the taxpayer or taxpayers involved.

                       G. EXCHANGE OF INFORMATION

    One of the principal purposes of the proposed treaty 
between the United States and Italy is to prevent avoidance or 
evasion of taxes of the two countries. The exchange of 
information article of the proposed treaty (Article 26) 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.\4\ As is true under these 
model treaties, 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 that is not obtainable under the laws or in 
the normal course of the administration of either country, or 
to supply information that discloses any trade, business, 
industrial, commercial, or professional secret or trade 
process, or information the disclosure of which is contrary to 
public policy.
---------------------------------------------------------------------------
    \4\ This takes into account Article 1, paragraph 20 of the proposed 
protocol (including authorities involved in the oversight of tax 
administration within the ambit of persons to whom information may be 
disclosed) and the Technical Explanation of Article 26 of the treaty 
(stating that ``necessary'' is to be interpreted equivalently to 
``relevant'' with respect to the scope of the exchange of information 
provision).
---------------------------------------------------------------------------
    The exchange of information article contained in the 
proposed treaty varies significantly from the U.S. model in one 
respect: the authority to obtain information from third parties 
(commonly referred to as the ``bank secrecy'' provision). This 
provision of the U.S. model provides that, notwithstanding the 
limitations described in the preceding paragraph, a country has 
the authority to obtain and provide information held by 
financial institutions, nominees, or persons acting in a 
fiduciary capacity. This information must be provided to the 
requesting country notwithstanding any laws or practices of the 
requested country that would otherwise preclude acquiring or 
disclosing such information.
    One issue the Committee has considered is the significance 
of the omission of this provision with respect to this proposed 
treaty. According to the Technical Explanation to Article 26, 
the United States has received assurances from the Italian 
Ministry of Finance concerning Italy's ability to exchange 
third-party information obtained from banks and other financial 
institutions. The Treasury Department has received a letter 
dated October 11, 1999, from the Ministry of Finance of the 
Republic of Italy containing these assurances. Because of the 
Committee's view as to the vital nature of these exchanges of 
third-party information, the Committee has conditioned 
ratification of the proposed treaty on the following 
understanding, which shall be included in the instrument of 
ratification, and shall be binding on the President:

        Exchange of Information.--The United States understands 
        that, pursuant to Article 26 of the Convention, both 
        the competent authority of the United States and the 
        competent authority of the Republic of Italy have the 
        authority to obtain and provide information held by 
        financial institutions, nominees or persons acting in 
        an agency or fiduciary capacity, or respecting 
        interests in a person.

    Another issue the Committee has considered is the 
implications of the omission of this provision from this treaty 
with respect to future treaty negotiations. While some treaty 
partners do not object to this bank secrecy provision, other 
treaty partners have resisted its inclusion in tax treaties. 
The broader issue of transparency of transactions involving 
third parties is a significant issue internationally. The 
United States has attempted to advance greater transparency in 
its treaty negotiations. It is possible that the omission of 
the bank secrecy provision from this treaty may be interpreted 
by other treaty partners as a weakening of the U.S. commitment 
to greater transparency and may make other treaty negotiations 
with respect to this issue more difficult. The Committee 
intends that the omission of this provision from this treaty 
does not indicate in any way a lessening of the commitment of 
the United States to pursue broader exchanges of information in 
future treaty negotiations.
    The Committee would have serious concerns with respect to a 
proposed treaty if the other country restricted access to this 
information and were unwilling to change its internal laws to 
accommodate full exchanges of information. The exchange of 
information provisions in treaties are central to the purposes 
for which tax treaties are entered into, and significant 
limitations on their effect, relative to the preferred U.S. tax 
treaty position, should not be accepted in negotiations with 
other countries that seek to have or maintain the benefits of a 
tax treaty relationship with the United States.
    The Committee understands that the Treasury Department has 
stated that other countries have expressed ``diplomatic'' 
concerns regarding the bank secrecy provision in the current 
U.S. model. While the Committee is sensitive to these concerns, 
the Committee is at the same time fully committed to full 
exchanges of information with other treaty partners. The 
Committee understands that the Treasury Department may be 
considering removing this bank secrecy provision from the U.S. 
model. The Committee believes that, while revisions to that 
provision might be appropriate, it is vital that future tax 
treaties (as well as the U.S. model) retain explicit language 
providing for full exchanges of information, including 
exchanges of information held by third parties. The Committee 
expects that the Treasury Department will consult fully with 
the Committee prior to any modification of the U.S. model 
relating to this issue.

                           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 1999-2008 period.

                  VIII. Explanation of Proposed Treaty

    A detailed, article-by-article explanation of the proposed 
income tax treaty between the United States and Italy, as 
supplemented by the proposed protocol, is set forth below. The 
United States and Italy also agreed upon a Memorandum of 
Understanding to provide clarification with respect to the 
application of the proposed treaty. In the explanation below, 
the understandings and interpretations reflected in the 
Memorandum of Understanding are covered together with the 
relevant articles of the proposed treaty and certain aspects of 
the proposed protocol. A separate description of the proposed 
protocol is contained in Part IX.

Article 1. Personal Scope

            Overview
    The personal scope article describes the persons who may 
claim the benefits of the proposed treaty. It also includes a 
``saving clause'' provision similar to provisions found in most 
U.S. income tax treaties.
    The proposed treaty generally applies to residents of the 
United States and to residents of Italy, with specific 
modifications to such scope provided in other articles (e.g., 
Article 19 (Government Service), Article 24 (Non-
Discrimination), and Article 26 (Exchange of Information)). 
This scope is consistent with the scope of other U.S. income 
tax treaties, the U.S. model, and the OECD model. For purposes 
of the proposed treaty, residence is determined under Article 4 
(Resident).
    The proposed protocol provides that the proposed treaty 
does not restrict in any manner any exclusion, exemption, 
deduction, credit, or other allowance accorded by internal law 
or by any other agreement between the United States and Italy. 
Thus, the proposed treaty will not apply to increase the tax 
burden of a resident of either the United States or Italy. 
According to the Treasury Department's Technical Explanation 
(hereinafter referred to as the ``Technical Explanation''), the 
fact that the proposed treaty only applies to a taxpayer's 
benefit does not mean that a taxpayer may select inconsistently 
among treaty and internal law provisions in order to minimize 
its overall tax burden. In this regard, the Technical 
Explanation sets forth the following example. Assume a resident 
of Italy has three separate businesses in the United States. 
One business is profitable and constitutes a U.S. permanent 
establishment. The other two businesses generate effectively 
connected income as determined under the Internal Revenue Code 
(the ``Code''), but do not constitute permanent establishments 
as determined under the proposed treaty; one business is 
profitable and the other business generates a net loss. Under 
the Code, all three businesses would be subject to U.S. income 
tax, in which case the losses from the unprofitable business 
could offset the taxable income from the other businesses. On 
the other hand, only the income of the business which gives 
rise to a permanent establishment is taxable by the United 
States under the proposed treaty. The Technical Explanation 
makes clear that the taxpayer may not invoke the proposed 
treaty to exclude the profits of the profitable business that 
does not constitute a permanent establishment and invoke U.S. 
internal law to claim the loss of the unprofitable business 
that does not constitute a permanent establishment to offset 
the taxable income of the permanent establishment.\5\
---------------------------------------------------------------------------
    \5\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
---------------------------------------------------------------------------
    The proposed protocol provides that the dispute resolution 
procedures under its mutual agreement article take precedence 
over the corresponding provisions of any other agreement to 
which the United States and Italy are parties in determining 
whether a measure is within the scope of the proposed treaty. 
The proposed protocol also provides that, unless the competent 
authorities agree that a taxation measure is outside the scope 
of the proposed treaty, only the proposed treaty's non-
discrimination rules, and not the non-discrimination rules of 
any other agreement in effect between the United States and 
Italy, generally apply to that measure. The only exception to 
this general rule is such national treatment or most favored 
nation obligations as may apply to trade in goods under the 
General Agreement on Tariffs and Trade. For purposes of this 
provision, the term ``measure'' means a law, regulation, rule, 
procedure, decision, administrative action, or any similar 
provision or action.
            Saving clause
    Like all U.S. income tax treaties, the proposed treaty 
includes a ``saving clause.'' Under this clause, with specific 
exceptions described below, the proposed treaty does not affect 
the taxation by a country of its residents or its citizens. By 
reason of this saving clause, unless otherwise specifically 
provided in the proposed treaty, the United States may continue 
to tax its citizens who are residents of Italy as if the treaty 
were not in force. For purposes of the proposed treaty (and, 
thus, for purposes of the saving clause), the term 
``residents,'' which is defined in Article 4 (Resident), 
includes corporations and other entities as well as 
individuals.
    The proposed protocol contains a provision under which the 
saving clause (and therefore the U.S. jurisdiction to tax) 
applies to a former U.S. citizen or long-term resident (whether 
or not treated as such under Article 4 (Resident)), whose loss 
of citizenship or resident status, respectively, had as one of 
its principal purposes the avoidance of tax; such application 
is limited to the ten-year period following the loss of 
citizenship or resident status. Section 877 of the Code 
provides special rules for the imposition of U.S. income tax on 
former U.S. citizens and long-term residents for a period of 
ten years following the loss of citizenship or resident status; 
these special tax rules apply to a former citizen or long-term 
resident only if his or her loss of U.S. citizenship or 
resident status had as one of its principal purposes the 
avoidance of U.S. income, estate, or gift taxes. For purposes 
of applying the special tax rules to former citizens and long-
term residents, individuals who meet a specified income tax 
liability threshold or a specified net worth threshold 
generally are considered to have lost citizenship or resident 
status for a principal purpose of U.S. tax avoidance.
    Exceptions to the saving clause are provided for the 
following benefits conferred by a treaty country: the allowance 
of correlative adjustments when the profits of an associated 
enterprise are adjusted by the other country (Article 9, 
paragraph 2); the exemption from source-country tax for certain 
alimony, child support, and pension payments (Article 18, 
paragraphs 5 and 6); relief from double taxation through the 
provision of a foreign tax credit (Article 23); protection from 
discriminatory tax treatment with respect to transactions with 
residents of the other country (Article 24); and benefits under 
the mutual agreement procedures (Article 25). These exceptions 
to the saving clause permit residents or citizens of the United 
States or Italy to obtain such benefits of the proposed treaty 
with respect to their country of residence or citizenship. In 
addition, the proposed protocol provides that the saving clause 
does not override the exemption from source country tax of 
social security benefits (Article 18) for individuals who are 
citizens of the residence country even if they are citizens of 
both countries. The proposed protocol also provides that the 
saving clause does not override the special rule of Article 4 
of the proposed protocol relating to a credit against Italian 
taxes for U.S. citizens resident in Italy who are partners of a 
U.S. partnership. The exception to the saving clause with 
respect to social security benefits means that if the United 
States makes a social security payment to a resident of Italy 
who is a citizen of both countries, only Italy can tax that 
payment.
    In addition, the saving clause does not apply to the 
following benefits conferred by one of the countries upon 
individuals who neither are citizens of that country nor have 
been admitted for permanent residence in that country. Under 
this set of exceptions to the saving clause, the specified 
treaty benefits are available to, for example, an Italian 
citizen who spends enough time in the United States to be taxed 
as a U.S. resident but who has not acquired U.S. permanent 
residence status (i.e., does not hold a ``green card''). The 
benefits that are covered under this set of exceptions are the 
exemptions from host country tax for certain compensation from 
government service (Article 19), certain income received by 
professors or teachers (Article 20), certain income received by 
students or trainees (Article 21), and certain income of 
diplomats and consular officials (Article 27).

Article 2. Taxes Covered

    The proposed treaty generally applies to the income taxes 
of the United States and Italy. However, Article 24 (Non-
Discrimination) is applicable to all taxes imposed at all 
levels of government, including State and local taxes. 
Moreover, Article 26 (Exchange of Information) generally is 
applicable to all national-level taxes, including, for example, 
estate and gift taxes.
    In the case of the United States, the proposed treaty 
applies to the Federal income taxes imposed by the Code, but 
excludes social security taxes. In addition, like the present 
treaty, the proposed treaty applies to the U.S. excise taxes 
imposed on insurance premiums paid to foreign insurers and with 
respect to private foundations. Unlike the present treaty, but 
like the U.S. model, the proposed treaty applies to the 
accumulated earnings tax and the personal holding company tax.
    The proposed protocol, like the protocol to the present 
treaty, provides that the proposed treaty applies to the excise 
taxes on insurance premiums paid to foreign insurers only to 
the extent that the risks covered by such premiums are not 
reinsured with a person that is not entitled to an exemption 
from such taxes under the proposed treaty or any other treaty. 
Because the insurance excise taxes are covered taxes under the 
proposed treaty, Italian insurers generally are not subject to 
the U.S. excise taxes on insurance premiums for insuring U.S. 
risks. The excise taxes continue to apply, however, when an 
Italian insurer reinsures a policy it has written on a U.S. 
risk with a foreign insurer that is not entitled to a similar 
exemption under this or a different tax treaty.
    In the case of Italy, the proposed treaty applies to the 
individual income tax (l'imposta sul reddito delle persone 
fisiche); the corporation income tax (l'imposta sul reddito 
delle persone giuridiche); and the regional tax on productive 
activities (l'imposta regionale sulle attivita produttive) (the 
so-called ``IRAP'' tax), but only that portion of the IRAP tax 
that is considered to be an income tax under Article 23 (Relief 
from Double Taxation). The present treaty covers a local tax 
rather than this regional tax. Such taxes include those that 
are collected by means of withholding.
    The proposed treaty also contains a rule generally found in 
U.S. income tax treaties (including the present treaty) which 
provides that the proposed treaty applies to any identical or 
substantially similar taxes that may be imposed subsequently in 
addition to or in place of the taxes covered. 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 or of any 
significant official published materials concerning the 
application of the proposed treaty, including explanations, 
regulations, rulings, or judicial decisions. The Technical 
Explanation states that this requirement relates to changes 
that are significant to the operation of the proposed treaty.

Article 3. General Definitions

    The proposed treaty provides definitions of a number of 
terms for purposes of the proposed treaty. Certain of the 
standard definitions found in most U.S. income tax treaties are 
included in the proposed treaty.
    The term ``person'' includes an individual, a company, an 
estate, a trust, a partnership, and any other body of persons.
    A ``company'' under the proposed treaty is any body 
corporate or any entity which is treated as a body corporate 
for tax purposes.
    The terms ``enterprise of a Contracting State'' and 
``enterprise of the other Contracting State'' mean, 
respectively, an enterprise carried on by a resident of a 
treaty country and an enterprise carried on by a resident of 
the other treaty country. The proposed treaty does not define 
the term ``enterprise.'' However, despite the absence of a 
clear, generally accepted meaning, the Technical Explanation 
states that the term is understood to refer to any activity or 
set of activities that constitute a trade or business.
    The proposed treaty defines ``international traffic'' as 
any transport by a ship or aircraft, except when the transport 
is solely between places in the other treaty country. 
Accordingly, with respect to an Italian enterprise, purely 
domestic transport within the United States does not constitute 
``international traffic.''
    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). On interpretative issues, the latter acts with 
the concurrence of the Associate Chief Counsel (International) 
of the IRS. The Italian ``competent authority'' is the Ministry 
of Finance.
    The term ``United States'' means the United States of 
America (including the States thereof and the District of 
Columbia), but does not include Puerto Rico, the Virgin 
Islands, Guam, or any other U.S. possession or territory. The 
term ``United States'' also includes the territorial sea of the 
United States and any area beyond the territorial sea that is 
designated as an area within which the United States, in 
compliance with its legislation and in conformity with 
international law, exercises sovereign rights in respect of the 
exploration and exploitation of the natural resources of the 
seabed, the subsoil, and the superjacent waters. The Technical 
Explanation states that the extension of the term to such areas 
applies only if the person, property, or activity to which the 
proposed treaty is being applied is connected with such natural 
resource exploration or exploitation.
    The term ``Italy'' means the Italian Republic and includes 
any area beyond the territorial sea that is designated as an 
area within which Italy, in compliance with its legislation and 
in conformity with international law, exercises sovereign 
rights in respect of the exploration and exploitation of the 
natural resources of the seabed, the subsoil and the 
superjacent waters.
    The term ``nationals'' means (1) all individuals possessing 
the citizenship of a treaty country; and (2) all legal persons, 
partnerships, and associations deriving their status as such 
from the laws in force in a treaty country.
    The proposed treaty defines the term ``qualified 
governmental entity'' as any person or body of persons that 
constitutes a governing body of a treaty country, or of a 
political or administrative subdivision or local authority of a 
treaty country. Also defined as a qualified governmental entity 
is a person that is wholly owned (directly or indirectly) by a 
treaty country or a political or administrative subdivision or 
local authority thereof, provided it is organized under the 
laws of a treaty country, its earnings are credited to its own 
account with no portion of its income inuring to the benefit of 
any private person, and its assets vest in the treaty country, 
political or administrative subdivision or local authority upon 
dissolution. A qualified governmental entity is also defined to 
include a pension trust or fund of a person previously 
described in this paragraph that is constituted and operated 
exclusively to administer or provide pension benefits described 
in Article 19 (Government Service). The definitions described 
in the previous two sentences only apply if the entity does not 
carry on commercial activities. These definitions are the same 
as those in the U.S. model. The proposed protocol provides that 
in the case of the United States, a qualified governmental 
entity includes the Federal Reserve Banks, the Export-Import 
Bank, and the Overseas Private Investment Corporation. In the 
case of Italy, the proposed protocol provides that a qualified 
governmental entity includes La Banca d'Italia (the Central 
Bank), L'Istituto per il Commercio con l'Estero (the Foreign 
Trade Institute), and L'Istituto per l'Assicurazione del 
Credito all'Esportazione (the Official Insurance Institute for 
Export Credits). The proposed protocol also provides that a 
qualified governmental entity includes financial institutions, 
the capital of which is wholly owned by a treaty country or any 
state or political or administrative subdivision or local 
authority as may be agreed from time to time between the 
competent authorities of both treaty countries.
    The proposed treaty also contains the standard provision 
that, unless the context otherwise requires, all terms not 
defined in the treaty have the meaning pursuant to the 
respective tax laws of the country that is applying the treaty.

Article 4. Resident

    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, 
issues arising because of dual residency, including situations 
of double taxation, may be avoided by the assignment of one 
treaty country as the country of residence when under the 
internal laws of the treaty countries a person is a resident of 
both countries.
            Internal taxation rules

United States

    Under U.S. law, the residence of an individual is important 
because a resident alien, like a U.S. citizen, is taxed on his 
or her 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 sufficient time in the United States in 
any year or over a three-year period generally is treated as a 
U.S. resident. A permanent resident for immigration purposes 
(i.e., a ``green card'' holder) also is treated as a U.S. 
resident.
    Under U.S. law, a company is taxed on its worldwide income 
if it is a ``domestic corporation.'' A domestic corporation is 
one that is created or organized in the United States or under 
the laws of the United States, a State, or the District of 
Columbia.

Italy

    Under Italian law, residents are subject to tax on their 
worldwide income, while nonresident individuals are subject to 
tax only on income arising in Italy. Individuals are considered 
to be residents of Italy if their habitual abode is in Italy, 
if the center of their vital interests is in Italy, or if they 
are registered for the greater part of the tax period with the 
Office of Records of the Resident Population.
    Companies that are resident in Italy are subject to 
taxation on their worldwide income. A company that for the 
greater part of the tax year has its legal seat, place of 
effective management, or main business purpose in Italy is 
considered to be resident in Italy. Nonresident companies are 
subject to corporate income tax on income derived from Italy.
            Proposed treaty rules
    The proposed treaty specifies rules to determine whether a 
person is a resident of the United States or Italy for purposes 
of the proposed treaty. The rules generally are consistent with 
the rules of the U.S. model.
    Like the present treaty, the proposed treaty generally 
defines ``resident of a Contracting State'' to mean any person 
who, under the laws of that country, is liable to tax in that 
country by reason of the person's domicile, residence, place of 
management, place of incorporation, or any other criterion of a 
similar nature. The term ``resident of a Contracting State'' 
does not include any person that is liable to tax in that 
country only on income from sources in that country. The 
proposed protocol provides that Italy will treat an individual 
who is a U.S. citizen or lawful permanent resident of the 
United States (i.e., a ``green card'' holder) as a resident of 
the United States only if he or she has a substantial presence, 
permanent home, or habitual abode in the United States. The 
determination of whether a citizen or national is considered a 
resident of the United States or Italy is made based on the 
principles of the treaty tie-breaker rules described below.
    The proposed protocol provides special rules to treat as 
residents of a treaty country certain organizations that 
generally are exempt from tax in that country. Under these 
rules, a resident includes a legal person organized under the 
laws of a treaty country and that is generally exempt from tax 
in the treaty country because it is established and maintained 
either (1) exclusively for a religious, charitable, 
educational, scientific, or other similar purpose; or (2) to 
provide pensions or other similar benefits to employees 
pursuant to a plan. The Technical Explanation states that the 
term ``similar benefits'' is intended to encompass employee 
benefits such as health and disability benefits.
    The proposed protocol also provides that a qualified 
governmental entity is a resident of the country where it is 
established.
    The proposed treaty and proposed protocol contain special 
rules for fiscally transparent entities. Under these rules, the 
income of a partnership, estate, or trust (or according to the 
proposed protocol, a fiscally transparent entity) is considered 
to be the income of a resident of one of the treaty countries 
only to the extent that such income is subject to tax in that 
country as the income of a resident, either in its hands or in 
the hands of its partners or beneficiaries. For example, if a 
corporation resident in Italy distributes a dividend to an 
entity treated as fiscally transparent for U.S. tax purposes, 
the dividend will be considered to be derived by a resident of 
the United States only to the extent that U.S. tax laws treat 
one or more U.S. residents (whose status as U.S. residents is 
determined under U.S. tax laws) as deriving the dividend income 
for U.S. tax purposes.
    The Technical Explanation states that these rules for 
income derived through fiscally transparent entities apply 
regardless of where the entity is organized (i.e., in the 
United States, Italy, or a third country). The Technical 
Explanation also states that these rules apply even if the 
entity is viewed differently under the tax laws of the other 
country. As an example, the Technical Explanation states that 
income from Italian sources received by an entity organized 
under the laws of Italy, which is treated for U.S. tax purposes 
as a corporation and is owned by a U.S. shareholder who is a 
U.S. resident for U.S. tax purposes, is not considered derived 
by the shareholder of that corporation, even if under the tax 
laws of Italy the entity is treated as fiscally transparent. 
Rather, for purposes of the proposed treaty, the income is 
treated as derived by the Italian entity.
    A set of ``tie-breaker'' rules is provided to determine 
residence in the case of an individual who, under the basic 
residence definition, would be considered to be a resident of 
both countries. Under these rules, an individual is deemed to 
be a resident of the country in which he or she has a permanent 
home available. If 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., his or her ``center of vital interests''). If 
the country in which the individual has his or her center of 
vital interests cannot be determined, or if he or she does not 
have a permanent home available in either country, he or she 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, he or she 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 will settle 
the question of residence by mutual agreement.
    In the case of any person other than an individual that 
would be a resident of both countries, the proposed treaty 
requires the competent authorities to endeavor to settle the 
issue of residence by mutual agreement and to determine the 
mode of application of the proposed treaty to such person.

Article 5. Permanent Establishment

    The proposed treaty contains a definition of the term 
``permanent establishment'' that generally follows the pattern 
of other recent U.S. income tax treaties, the U.S. model, and 
the OECD model.
    The permanent establishment concept is one of the basic 
devices used in income tax treaties to limit the taxing 
jurisdiction of the host country and thus to mitigate double 
taxation. Generally, an enterprise that is a resident of one 
country is not taxable by the other country on its business 
profits unless those profits are attributable to a permanent 
establishment of the resident in the other country. In 
addition, the permanent establishment concept is used to 
determine whether the reduced rates of, or exemptions from, tax 
provided for dividends, interest, and royalties apply, or 
whether those items of income will be taxed as business 
profits.
    In general, under the proposed treaty, a permanent 
establishment is a fixed place of business in which the 
business of an enterprise is wholly or partly carried on. A 
permanent establishment includes a place of management, a 
branch, an office, a factory, a workshop, a mine, a quarry, or 
other place of extraction of natural resources. It also 
includes a building site or construction or assembly project 
that continues for more than twelve months. The proposed 
protocol provides that it also includes a drilling rig or ship 
used for the exploration or development of natural resources 
only if it continues for more than twelve months. The present 
treaty, on the other hand, treats such drilling rigs and ships 
as permanent establishments if the activity continues for more 
than 180 days in a twelve month period. The Technical 
Explanation states that the twelve-month test applies 
separately to each individual site or project, with a series of 
contracts or projects that are interdependent both commercially 
and geographically treated as a single project. The Technical 
Explanation further states that if the twelve-month threshold 
is exceeded, the site or project constitutes a permanent 
establishment as of the first day that work in the country 
began.
    Under the proposed treaty, as under the present treaty, the 
following activities are deemed not to constitute a permanent 
establishment: (1) the use of facilities solely for storing, 
displaying, or delivering goods or merchandise belonging to the 
enterprise; (2) the maintenance of a stock of goods or 
merchandise belonging to the enterprise solely for storage, 
display, or delivery or solely for processing by another 
enterprise; (3) the maintenance of a fixed place of business 
solely for the purchase of goods or merchandise or for the 
collection of information for the enterprise; and (4) the 
maintenance of a fixed place of business for the enterprise 
solely for the purpose of advertising, for the supply of 
information, for scientific research, or for similar activities 
of a preparatory or auxiliary character.
    Under the U.S. model, the maintenance of a fixed place of 
business solely for any combination of the above-listed 
activities does not constitute a permanent establishment. The 
Treasury Explanation states that Italy is unwilling to commit 
that all or several of the activities described above may be 
undertaken in combination without constituting a permanent 
establishment.
    Under the proposed treaty, as under the present treaty, if 
a person, other than an independent agent, is acting in a 
treaty country on behalf of an enterprise of the other country 
and has, and habitually exercises in such first country, the 
authority to conclude contracts in the name of such enterprise, 
the enterprise is deemed to have a permanent establishment in 
the first country in respect of any activities undertaken for 
that enterprise. This rule does not apply where the activities 
are limited to the purchase of goods or merchandise for the 
enterprise.
    Under the proposed treaty, no permanent establishment is 
deemed to arise if the agent is a broker, general commission 
agent, or any other agent of independent status, provided that 
the agent is acting in the ordinary course of its business. The 
Technical Explanation states that whether an enterprise and an 
agent are independent is a factual determination, relevant 
factors of which include the extent to which the agent bears 
business risk and whether the agent has an exclusive or nearly 
exclusive relationship with the principal.
    The proposed treaty provides that the fact that a company 
that is a resident of one country controls or is controlled by 
a company that is a resident of the other country or that 
carries on business in the other country does not of itself 
cause either company to be a permanent establishment of the 
other.

Article 6. Income from Immovable Property

    This article covers income from real property. The rules 
covering gains from the sale of real property are in Article 13 
(Capital Gains).
    Under the proposed treaty, income derived by a resident of 
one country from immovable property situated in the other 
country may be taxed in the country where the property is 
located. This rule is consistent with the rules in the U.S. and 
OECD models. For this purpose, income from immovable property 
includes income from agriculture or forestry.
    The term ``immovable property'' (``real property'') has the 
meaning which it has under the law of the country in which the 
property in question is situated.\6\ The proposed treaty 
specifies that the term in any case includes property accessory 
to immovable property; livestock and equipment used in 
agriculture and forestry; rights to which the provisions of 
general law respecting landed property apply; usufructs of 
immovable property; and rights to variable or fixed payments as 
consideration for the working of, or the right to work, mineral 
deposits, sources, and other natural resources. Ships, boats, 
and aircraft are not considered to be immovable property.
---------------------------------------------------------------------------
    \6\ In the case of the United States, the term is defined in Treas. 
Reg. sec. 1.897-1(b).
---------------------------------------------------------------------------
    The proposed treaty specifies that the country in which the 
property is situated also may tax income derived from the 
direct use, letting, or use in any other form of immovable 
property. The rules of Article 6, permitting source country 
taxation, also apply to the income from immovable property of 
an enterprise and to income from immovable property used for 
the performance of independent personal services.
    Unlike the U.S. model, the proposed treaty does not provide 
that residents of a treaty country that are liable for tax in 
the other treaty country on income from immovable property 
situated in such other treaty country may elect to compute the 
tax on such income on a net basis. However, U.S. internal law 
provides for such a net basis election in the case of income of 
a foreign person from real property (Code secs. 871(d) and 
882(d)). The Technical Explanation states that Italian internal 
law contains a provision that approximates net basis taxation 
for income from real property.

Article 7. Business Profits

            Internal taxation rules

United States

    U.S. law distinguishes between the U.S. business income and 
the 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, rents, and wages) 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 (under what is referred to as a ``force of 
attraction'' rule).
    Foreign-source income generally is 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 for purposes of determining 
the foreign-source income that is effectively connected with a 
U.S. business of an insurance company.
    Any income or gain of a foreign person for any taxable year 
that is attributable to a transaction in another 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 year (Code sec. 864(c)(6)). In 
addition, if any property ceases to be used or held for use in 
connection with the conduct of a trade or business within the 
United States, the determination of whether any income or gain 
attributable to a sale or exchange of that property occurring 
within ten years after the cessation of business is effectively 
connected with the conduct of a trade or business within the 
United States is made as if the sale or exchange occurred 
immediately before the cessation of business (Code sec. 
864(c)(7)).

Italy

    Foreign corporations and nonresident individuals generally 
are subject to Italian tax only on income derived in Italy. 
Business income derived in Italy by a foreign corporation or 
nonresident individual generally is taxed in the same manner as 
the income of an Italian corporation or resident individual.
            Proposed treaty limitations on internal law
    Under the proposed treaty, business profits of an 
enterprise of one of the countries are taxable in the other 
country only to the extent that they are attributable to a 
permanent establishment in the other country through which the 
enterprise carries on business. This is one of the basic 
limitations on a country's right to tax income of a resident of 
the other country. The rule is similar to those contained in 
the U.S. and OECD models.
    The proposed treaty provides that there will be attributed 
to a permanent establishment the business profits which it 
might be expected to make if it were a distinct and separate 
enterprise 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 
and other associated enterprises. The Technical Explanation 
states that this rule permits the use of methods other than 
separate accounting to determine the arm's-length profits of a 
permanent establishment where it is necessary to do so for 
practical reasons, such as when the affairs of the permanent 
establishment are so closely bound up with those of the head 
office that it would be impossible to disentangle them on any 
strict basis of accounts.
    In computing taxable business profits of a permanent 
establishment, the proposed treaty provides that deductions are 
allowed for expenses, wherever incurred, which are attributable 
to the activities of the permanent establishment. These 
deductions include a reasonable allocation of executive and 
general administrative expenses. The Technical Explanation 
states that as in the present treaty, but unlike the U.S. 
model, the proposed treaty does not explicitly state that the 
expenses that may be considered to be incurred for the purposes 
of the permanent establishment are expenses for research and 
development, interest, and other similar expenses. The 
Technical Explanation, however, states that Italy accepts the 
principle of a reasonable allocation of expenses (such as in 
Treas. Reg. sections 1.861-8 and 1.882-5). The Committee 
believes that it is appropriate to apply reasonable allocation 
methods for these purposes.
    The Technical Explanation states that deductions will not 
be allowed for expenses charged to a permanent establishment by 
another unit of the enterprise. Thus, a permanent establishment 
may not deduct a royalty deemed paid to the head office.
    Business profits are not attributed to a permanent 
establishment merely by reason of the purchase of goods or 
merchandise by the 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 a profit element in its purchasing activities.
    The proposed treaty requires the determination of business 
profits of a permanent establishment to be made in accordance 
with the same method year by year unless a good and sufficient 
reason to the contrary exists.
    The proposed treaty provides that, for purposes of the 
taxation of business profits, income may be attributable to a 
permanent establishment (and therefore may be taxable in the 
source country) even if the payment of such income is deferred 
until after the permanent establishment or fixed base has 
ceased to exist. This rule incorporates into the proposed 
treaty the rule of Code section 864(c)(6) described above. This 
rule applies with respect to business profits (Article 7, 
paragraphs 1 and 2), dividends (Article 10, paragraph 4), 
interest (Article 11, paragraph 5), royalties (Article 12, 
paragraph 5), capital gains (Article 13, paragraph 2), 
independent personal services income (Article 14), and other 
income (Article 22, paragraph 2).
    Where business profits include items of income that are 
dealt with separately in other articles of the proposed treaty, 
those other articles, and not the business profits article, 
govern the treatment of those items of income. Thus, for 
example, dividends are taxed under the provisions of Article 10 
(Dividends), and not as business profits, except as 
specifically provided in Article 10.

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 disposition of ships, aircraft, 
and containers are in Article 13 (Capital Gains).
    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 providing such reciprocal exemptions.
    Like the present treaty, the proposed treaty provides that 
profits which are derived by an enterprise of one country from 
the operation in international traffic of ships or aircraft are 
taxable only in that country, regardless of the existence of a 
permanent establishment in the other country. ``International 
traffic'' is defined in Article 3(1)(d) (General Definitions) 
as any transport by a ship or aircraft, except when the 
transport is solely between places in the other treaty country.
    The proposed protocol provides that profits from the 
operation of ships or aircraft in international traffic include 
profits derived from the rental of ships or aircraft on a full 
(time or voyage) basis (i.e., with crew). Like the present 
treaty, it also includes profits from the rental of ships or 
aircraft on a bareboat basis (i.e., without crew) if such 
rental activities are incidental to the activities from the 
operation of ships or aircraft in international traffic. 
Although not provided for in the proposed treaty, the Technical 
Explanation states that profits derived by an enterprise from 
the inland transport of property or passengers within either 
treaty country are treated as profits from the operation of 
ships or aircraft in international traffic if such transport is 
undertaken as part of international traffic by the enterprise.
    As under the U.S. model, the proposed protocol provides 
that profits of an enterprise of a country from the use, 
maintenance, or rental of containers (including trailers, 
barges, and related equipment for the transport of containers) 
used for the transport of goods or merchandise in international 
traffic is taxable only in that country.
    As under the U.S. model, the shipping and air transport 
provisions of the proposed treaty apply to profits derived from 
participation in a pool, joint business, or international 
operating agency. This refers to various arrangements for 
international cooperation by carriers in shipping and air 
transport.
    The Technical Explanation states that income from the 
rental of ships, aircraft, or containers which is not exempt 
from source country tax under this article is taxable as 
royalty income (Article 12) or as business profits if 
attributable to a permanent establishment (Article 7). Under 
the royalty article, the rental income is considered to have 
its source in Italy if the payer is a resident of Italy or if 
the rental payment is for the use of the property in Italy. The 
Technical Explanation also states that certain non-transport 
activities that are an integral part of the services performed 
by a transport company are understood to be covered by this 
article of the proposed treaty.
    The proposed protocol provides, like the present treaty, 
that profits which a U.S. national not resident in Italy or 
which a U.S. corporation derives from operating ships 
documented or aircraft registered under U.S. law will be exempt 
from tax in Italy. The Technical Explanation states that this 
exception applies regardless of whether the income was derived 
from the operation of ships or aircraft in international 
traffic.
    The proposed protocol provides that if a U.S. state or 
local government imposes tax on the profits of Italian 
enterprises from the operation of ships or aircraft in 
international traffic, Italy may impose its regional tax on 
productive activites (l'imposta regionale sulle attivita 
produttive) (i.e., the IRAP tax) on the profits of U.S. 
enterprises from such activities, notwithstanding the 
provisions of Article 2 (Taxes Covered) and this article of the 
proposed treaty.

Article 9. Associated Enterprises

    The proposed treaty, like most other U.S. tax treaties, 
contains an arm's-length pricing provision. The proposed treaty 
recognizes the right of each country to make an allocation of 
profits to an enterprise of that country in the case of 
transactions between related enterprises, if conditions are 
made or imposed between the two enterprises in their commercial 
or financial relations which differ from those which would be 
made between independent enterprises. In such a case, a country 
may allocate to such an enterprise the profits which it would 
have accrued but for the conditions so imposed. This treatment 
is consistent with the U.S. model.
    For purposes of the proposed treaty, an enterprise of one 
country is related to an enterprise of the other country if one 
of the enterprises participates directly or indirectly in the 
management, control, or capital of the other enterprise. 
Enterprises are also related if the same persons participate 
directly or indirectly in their management, control, or 
capital.
    Under the proposed treaty, when a redetermination of tax 
liability has been made by one country under the provisions of 
this article, the other country will make an appropriate 
adjustment to the amount of tax paid in that country on the 
redetermined income. In making such adjustment, due regard is 
to be given to other provisions of the proposed treaty and 
proposed protocol. Any such adjustment is to be made only in 
accordance with the mutual agreement procedures of the proposed 
treaty. The proposed treaty's saving clause retaining full 
taxing jurisdiction in the country of residence or citizenship 
does not apply in the case of such adjustments. Accordingly, 
internal statute of limitations provisions do not prevent the 
allowance of appropriate correlative adjustments.
    The proposed protocol provides that the proposed treaty 
does not limit any provisions of either country's internal law 
which permit the distribution, apportionment, or allocation of 
income, deductions, credits, or allowances between persons 
owned or controlled directly or indirectly by the same interest 
when necessary in order to prevent evasion of taxes or to 
clearly reflect the income of any person. Any such adjustments 
are permitted even if they are different from, or go beyond, 
those specifically authorized by this article, as long as they 
are in accord with general arm's length principles.

Article 10. Dividends

            Internal taxation rules

United States

    The United States generally imposes a 30-percent tax on the 
gross amount of U.S.-source dividends paid to nonresident alien 
individuals and foreign corporations. The 30-percent tax does 
not apply if the foreign recipient is engaged in a trade or 
business in the United States and the dividends are effectively 
connected with that trade or business. In such a case, the 
foreign recipient is subject to U.S. tax on such dividends on a 
net basis at graduated rates in the same manner that a U.S. 
person would be taxed.
    Under U.S. law, the term dividend generally means any 
distribution of property made by a corporation to its 
shareholders, either from accumulated earnings and profits or 
current earnings and profits. However, liquidating 
distributions generally are treated as payments in exchange for 
stock and thus are not subject to the 30-percent withholding 
tax described above (see discussion of capital gains in 
connection with Article 13 below).
    Dividends paid by a U.S. corporation generally are U.S.-
source income. 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 real estate investment trust (``REIT'') is a corporation, 
trust, or association that is subject to the regular corporate 
income tax, but that receives a deduction for dividends paid to 
its shareholders if certain conditions are met. In order to 
qualify for the deduction for dividends paid, a REIT must 
distribute most of its income. Thus, a REIT is treated, in 
essence, as a conduit for federal income tax purposes. Because 
a REIT is taxable as a U.S. corporation, a distribution of its 
earnings is treated as a dividend rather than income of the 
same type as the underlying earnings. Such distributions are 
subject to the U.S. 30-percent withholding tax when paid to 
foreign owners.
    A REIT is organized to allow persons to diversify ownership 
in primarily passive real estate investments. As such, the 
principal income of a REIT often is rentals from real estate 
holdings. Like dividends, U.S.-source rental income of foreign 
persons generally is subject to the 30-percent withholding tax 
(unless the recipient makes an election to have such rental 
income taxed in the United States on a net basis at the regular 
graduated rates). Unlike the withholding tax on dividends, 
however, the withholding tax on rental income generally is not 
reduced in U.S. income tax treaties.
    U.S. internal law also generally treats a regulated 
investment company (``RIC'') as both a corporation and a 
conduit for income tax purposes. The purpose of a RIC is to 
allow investors to hold a diversified portfolio of securities. 
Thus, the holder of stock in a RIC may be characterized as a 
portfolio investor in the stock held by the RIC, regardless of 
the proportion of the RIC's stock owned by the dividend 
recipient.
    A foreign corporation engaged in the conduct of a trade or 
business in the United States is subject to a flat 30-percent 
branch profits tax on its ``dividend equivalent amount.'' The 
dividend equivalent amount is the corporation's earnings and 
profits which are attributable to its income that is 
effectively connected with its U.S. trade or business, 
decreased by the amount of such earnings that are reinvested in 
business assets located in the United States (or used to reduce 
liabilities of the U.S. business), and increased by any such 
previously reinvested earnings that are withdrawn from 
investment in the U.S. business. The dividend equivalent amount 
is limited by (among other things) aggregate earnings and 
profits accumulated in taxable years beginning after December 
31, 1986.

Italy

    Italy generally imposes a withholding tax on dividend 
payments to nonresidents at a rate of 27 percent. However, 
nonresident individuals may claim reimbursement of up to two-
thirds of the withholding tax and nonresident companies may 
claim reimbursement of up to four-ninths of the withholding 
tax, but only if the respective nonresident can show that 
residence-country tax was paid on the dividend income. There is 
no branch remittance tax.
            Proposed treaty limitations on internal law
    The present treaty provides that dividends derived from 
sources within one country by a resident of the other country 
may be taxed by the source country. The rate of source country 
tax generally is limited to 15 percent. However, the rate of 
tax is limited to 5 percent if the dividend recipient is a 
company that has owned more than 50 percent of the voting stock 
during the 12-month period ending on the date of dividend 
declaration. Furthermore, the rate of tax is limited to 10 
percent if the beneficial owner is a company that has owned at 
least 10 percent but not more than 50 percent of the voting 
stock during the 12-month period ending on the date of the 
dividend declaration. In order for the 5 or 10 percent rates to 
apply under the present treaty, not more than 25 percent of the 
gross income of the payor corporation may be derived from 
interest or dividends (other than interest or dividends derived 
in the conduct of a banking or finance business and interest or 
dividends received from subsidiary companies).
    Under the proposed treaty, dividends paid by a resident of 
a treaty country and beneficially owned by a resident of the 
other country may be taxed in such other country. Dividends 
paid by a resident of a treaty country and beneficially owned 
by a resident of the other country may also be taxed by the 
country in which the payor is resident, but the rate of such 
tax is limited. Under the proposed treaty, source country 
taxation (i.e., taxation by the country in which the payor is 
resident) generally is limited to 5 percent of the gross amount 
of the dividend if the beneficial owner of the dividend is a 
company which owns at least 25 percent of the voting stock of 
the payor company for a twelve-month period ending on the date 
the dividend is declared. The source country dividend 
withholding tax generally is limited to 15 percent of the gross 
amount of the dividends beneficially owned by residents of the 
other country in all other cases. The proposed treaty provides 
that these limitations do not affect the taxation of the 
company on the profits out of which the dividends are paid.
    The proposed treaty defines a ``dividend'' to include 
income from shares, ``jouissance'' shares or ``jouissance'' 
rights, mining shares, founder's shares, or other rights, not 
being debt-claims, participating in profits, as well as income 
from other corporate rights which is subject to the same tax 
treatment as income from shares by the internal laws of the 
treaty country of which the company making the distribution is 
a resident.
    The proposed treaty's reduced rates of source country tax 
on dividends do not apply if the dividend recipient carries on 
business through a permanent establishment (or fixed base, in 
the case of an individual who performs independent personal 
services) in the source country and the dividends are 
effectively connected to the permanent establishment (or fixed 
base). In such a case, such dividends are taxable in the source 
country according to its own laws. The proposed protocol 
provides that such dividends may be taxed as either business 
profits (Article 7) or as income from the performance of 
independent services (Article 14), as the case may be. Under 
the proposed treaty, these rules also apply if the permanent 
establishment or fixed base no longer exists when the dividends 
are paid but such dividends are attributable to the former 
permanent establishment or fixed base.
    Where a company that is a resident of one country derives 
profits or income from the other treaty country, the proposed 
treaty provides that such other country cannot impose any tax 
on the dividends paid, or undistributed profits earned, by such 
resident. Thus, the United States cannot impose its 
``secondary'' withholding tax on dividends paid by an Italian 
company out of its earnings and profits from the United States. 
An exception to this provision is provided in cases where the 
dividends are paid to a resident of the other treaty country or 
are effectively connected to a permanent establishment or a 
fixed base situated in such other treaty country. This rule 
does not prevent a country from imposing a branch profits tax 
as provided below. This rule also applies even if the dividends 
paid or undistributed profits consist wholly or partly of 
profits arising in such other country.
    Unlike the present treaty, the proposed treaty permits the 
imposition of a branch profits tax, but limits the rate of such 
tax to 5 percent. The branch profits tax may be imposed on a 
company that is a resident of a treaty country and that has a 
permanent establishment in the other treaty country or is 
subject to tax in the other treaty country on a net basis on 
its income from immovable property (Article 6) or capital gains 
(Article 13). Such tax may be imposed only on the portion of 
the business profits attributable to such permanent 
establishment, or the portion of such immovable property income 
or capital gains, that represents the ``dividend equivalent 
amount'' (in the case of the United States) or an analogous 
amount (in the case of Italy). The Technical Explanation states 
that the term ``dividend equivalent amount'' has the same 
meaning that it has under Code section 884, as amended from 
time to time, provided that the amendments are consistent with 
the purpose of the branch profits tax.
    The proposed treaty provides an exemption from source 
country tax for dividends paid by a corporation that is a 
resident of one country to a qualified governmental entity (as 
defined in Article 3(1)(i)) that is resident in the other 
country. This exemption from source country tax only applies if 
the governmental entity owns (directly or indirectly) less than 
25 percent of the voting stock of the company paying the 
dividends. This threshold is different than the corresponding 
rule in the U.S. model, which provides that the qualified 
governmental entity may not ``control'' the dividend paying 
company.
    Under the proposed treaty, dividends paid by a U.S. RIC are 
eligible only for the 15-percent rate, regardless of the 
beneficial owner's percentage ownership in such entity. 
Dividends paid by a U.S. REIT are not eligible for the 5-
percent rate. Moreover, such REIT dividends are eligible for 
the 15-percent rate only if an individual beneficially owning 
the dividends holds no more than a 10-percent interest in the 
U.S. REIT; the dividends are paid with respect to a class of 
stock that is publicly traded and the beneficial owner of the 
dividends owns no more than 5 percent of any class of the 
REIT's stock; or the beneficial owner of the dividends owns no 
more than 10 percent of the REIT and such REIT is also 
diversified. Otherwise, dividends paid by a U.S. REIT are 
subject to U.S. taxation at the full 30-percent statutory rate. 
The Technical Explanation states that, for these purposes, a 
REIT is considered diversified if the value of no single 
interest in the REIT's real property exceeds 10 percent of the 
REIT's total interest in real property.
    The proposed treaty provides a ``main purpose'' test that 
is not specifically included in the dividends articles of the 
U.S. model or OECD model. Under this rule, the proposed 
treaty's reduced rates of tax on dividends do not apply if the 
main purpose, or one of the main purposes, for the creation or 
assignment of shares or other rights in respect of which 
dividends are paid is to take advantage of the dividends 
article of the proposed treaty. The Technical Explanation 
states that it is intended that the provisions of this article 
will be self-executing, but the tax authorities of one of the 
treaty countries, on review, may deny the benefits of the 
reduced rate of tax on dividends. In addition, the Technical 
Explanation states that the competent authorities of both of 
the treaty countries may together agree that this standard has 
been met in a particular case or with respect to a type of 
transaction entered into by a number of taxpayers.

Article 11. Interest

            Internal taxation rules

United States

    Subject to several exceptions (such as those for portfolio 
interest, bank deposit interest, and short-term original issue 
discount), the United States imposes a 30-percent withholding 
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 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 the 30-percent 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 if such interest (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 does not apply 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 generally is treated 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, 
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.

Italy

    Italian-source interest payments to nonresidents generally 
are subject to withholding tax at a rate of 27 percent. 
However, no withholding tax is assessed on interest paid to a 
U.S. resident with respect to: (1) public bonds; (2) private 
bonds issued by banks and listed companies; and (3) deposits or 
current accounts. Interest paid with respect to private bonds 
having at least an 18-month maturity that are issued by other 
than a bank or listed company is subject to withholding tax at 
a rate of 12.5 percent.
            Proposed treaty limitations on internal law
    The present treaty generally limits source country tax to a 
maximum rate of 15 percent on interest derived by a resident of 
the other country. The present treaty also provides for a 
compete withholding exemption for interest derived by a treaty 
country (or a wholly-owned instrumentality thereof), or a 
treaty country resident with respect to debt obligations 
guaranteed or insured by such country (or instrumentality).
    The proposed treaty provides that interest arising in one 
of the countries and beneficially owned by a resident of the 
other country generally may be taxed by both countries. This is 
contrary to the position of the U.S. model which provides for 
an exemption from source country tax for interest beneficially 
owned by a resident of the other country.
    The proposed treaty limits the rate of source country tax 
that may be imposed on interest income. Under the proposed 
treaty, if the beneficial owner of interest is a resident of 
the other country, the source country tax on such interest 
generally may not exceed 10 percent of the gross amount of such 
interest.
    The proposed treaty provides for a complete exemption from 
source country withholding tax in the case of interest arising 
in a treaty country if the interest is (1) beneficially owned 
by a resident of the other country that is a qualified 
governmental entity owning (directly or indirectly) less than 
25 percent of the capital of the person paying the interest, 
(2) paid with respect to debt obligations guaranteed or insured 
by a qualified governmental entity of that other country and 
beneficially owned by a resident of such other country, (3) 
paid or accrued with respect to a sale on credit of goods, 
merchandise, or services provided by one enterprise to another 
enterprise; or (4) paid or accrued in connection with the sale 
on credit of industrial, commercial, or scientific equipment.
    The proposed treaty defines the term ``interest'' as income 
from government securities, bonds, or debentures, whether or 
not secured by a mortgage and whether or not carrying a right 
to participate in profits. It also includes debt claims of 
every kind as well as all other income subject to the same tax 
treatment as income from money lent under the tax law of the 
source country. The proposed protocol provides that, in the 
case of the United States, an excess inclusion with respect to 
a residual interest in a U.S. REMIC may be taxed as interest in 
accordance with each country's respective internal laws. The 
proposed treaty provides that the term ``interest'' does not 
include amounts treated as dividends under Article 10 
(Dividends).
    The proposed treaty's reductions in source country tax on 
interest do not apply if the beneficial owner carries on 
business in the source country through a permanent 
establishment located in that country (or fixed base, in the 
case of an individual who performs independent personal 
services) and the debt claim in respect of which the interest 
is paid is effectively connected to that permanent 
establishment (or fixed base). In such a case, such interest is 
taxable in the source country according to its own laws. The 
proposed protocol provides that such interest may be taxed as 
either business profits (Article 7) or as income from the 
performance of independent services (Article 14), as the case 
may be. These rules also apply if the permanent establishment 
or fixed base no longer exists when the interest is paid but 
such interest is attributable to the former permanent 
establishment or fixed base.
    The proposed treaty provides that interest is treated as 
arising in a treaty country if the payor is the treaty country 
or its political subdivisions or local authorities, or is a 
resident of that country.\7\ If, however, the interest expense 
is borne by a permanent establishment or a fixed base, the 
interest will have as its source the country in which the 
permanent establishment or fixed base is located, regardless of 
the residence of the payor. Thus, for example, if a French 
resident has a permanent establishment in Italy and that French 
resident incurs indebtedness to a U.S. person, the interest on 
which is borne by the Italian permanent establishment, the 
interest would be treated as having its source in Italy.
---------------------------------------------------------------------------
    \7\ This is consistent with the source rules of U.S. law, which 
provide as a general rule that interest income has as its source the 
country in which the payor is resident.
---------------------------------------------------------------------------
    The proposed treaty addresses the issue of non-arm's-length 
interest charges between related parties (or parties otherwise 
having a special relationship) by providing that the amount of 
interest for purposes of applying this article is the amount of 
interest that would have been agreed upon by the payor and the 
beneficial owner in the absence of the special relationship. 
Any amount of interest paid in excess of such amount is taxable 
according to the laws of each country, taking into account the 
other provisions of the proposed treaty. For example, excess 
interest paid by a subsidiary corporation to its parent 
corporation may be treated as a dividend under local law and 
thus be subject to the provisions of Article 10 (Dividends).
    In the case of the United States, the proposed treaty 
permits the imposition of the U.S. branch level interest tax on 
an Italian corporation, but limits the rate of such tax to 10 
percent. The U.S. tax imposed on the Italian corporation is the 
excess, if any, of (1) the interest deductible in computing the 
profits of the Italian corporation that either are attributable 
to a permanent establishment or subject to tax under Article 6 
(Income from Immovable Property) or Article 13 (Capital Gains) 
over (2) the interest paid by the permanent establishment or 
trade or business.
    The proposed treaty also provides a main purpose test 
similar to that for dividends (Article 10) under which the 
provisions with respect to interest will not apply if the main 
purpose, or one of the main purposes, for the creation or 
assignment of the debt claim in respect of which interest is 
paid is to take advantage of the interest article of the 
proposed treaty.

Article 12. Royalties

            Internal taxation rules

United States

    Under the same system that applies to dividends and 
interest, the United States imposes a 30-percent withholding 
tax on U.S.-source royalties paid to foreign persons. U.S.-
source royalties include royalties for the use of or the right 
to use intangible property in the United States.

Italy

    Royalties paid to nonresidents are subject to a 30 percent 
withholding tax, which is generally applied to 75 percent of 
the gross royalty payment, resulting in an effective rate of 
22.5 percent.
            Proposed treaty limitations on internal law
    The present treaty provides that royalties derived from 
sources within one country by a resident of the other country 
may be taxed by the source country. The rate of source country 
tax generally is limited to 10 percent. However, the rate of 
tax is limited to 5 percent if the royalty is in respect of 
payments received as consideration for the use of, or the right 
to use, any copyright of literary, artistic, or scientific 
work. In addition, the rate of tax is limited to 7 percent if 
the royalties are derived with respect to tangible personal 
property. Furthermore, the rate of tax is limited to 8 percent 
if the royalty is in respect of payments received as 
consideration for the use of, or the right to use, motion 
pictures and films, tapes or other means of reproduction used 
for radio or television broadcasting.
    The proposed treaty provides that royalties arising in a 
treaty country and beneficially owned by a resident of the 
other country may be taxed by that other country. In addition, 
the proposed treaty allows the country where the royalties 
arise (the ``source country'') to tax such royalties. However, 
if the beneficial owner of the royalties is a resident of the 
other country, the source country tax generally may not exceed 
8 percent of the gross royalties. This maximum 8-percent rate 
is higher than the rate permitted under most U.S. treaties and 
the U.S. and OECD models, but is generally lower than the 
maximum rate under the present treaty. The U.S. and OECD models 
generally exempt royalties from source country taxation. The 
proposed treaty further provides that the source country tax on 
certain amounts treated as royalties may not exceed 5 percent 
of the gross royalties. This 5-percent limitation applies to 
royalties for the use of (or the right to use) computer 
software or industrial, commercial, or scientific equipment. 
Like the present treaty, but unlike the U.S. model, such rental 
income is considered to be a royalty.
    Unlike the present treaty, the proposed treaty provides a 
complete exemption from source country tax for royalties 
beneficially owned by a resident of the other country for the 
use of (or right to use) a copyright of literary, artistic, or 
scientific work (excluding royalties for computer software, 
motion pictures, films, tapes, or other means of reproduction 
used for radio or television broadcasting) if such resident is 
the beneficial owner of the royalties.
    For purposes of the proposed treaty, the term ``royalties'' 
means payment of any kind received as consideration for the use 
of, or the right to use, copyrights of literary, artistic, or 
scientific work (including computer software, motion pictures, 
films, tapes, or other means of reproduction used for radio or 
television broadcasting), patents, trademarks, designs or 
models, plans, secret formulae, processes, or other like rights 
or properties. The term also includes consideration for the use 
of, or the right to use, industrial, commercial, or scientific 
equipment, or for information concerning industrial, 
commercial, or scientific experience. According to the 
Technical Explanation, it is understood that whether payments 
with respect to computer software are treated as royalties or 
as business profits will depend on the facts and circumstances 
of the particular transaction. The Technical Explanation states 
that it is understood that payments with respect to transfers 
of ``shrink wrap'' computer software will be treated as 
business profits and not as royalties. The Technical 
Explanation also states that, with respect to the United 
States, gains derived from the sale of any right or property 
that would give rise to royalties is also considered to be 
royalty income, but only to the extent that such gain is 
contingent on the productivity, use, or further disposition 
thereof.
    The reduced rates of source country tax do not apply where 
the recipient carries on business through a permanent 
establishment (or fixed base in the case of an individual who 
performs independent personal services) in the source country, 
and the royalties are effectively connected to the permanent 
establishment (or fixed base). In such a case, such royalties 
are taxable in the source country according to its own laws. 
The proposed protocol provides that such royalties may be taxed 
as either business profits (Article 7) or as income from the 
performance of independent services (Article 14), as the case 
may be. These rules also apply if the permanent establishment 
or fixed base no longer exists when the royalties are paid but 
such royalties are attributable to the former permanent 
establishment or fixed base.
    The proposed treaty provides source rules for royalties 
which differ, in part, from those provided under U.S. internal 
law. Royalties are deemed to arise within a country if the 
payor is a resident of that country, or is one of the treaty 
countries or its political subdivisions or local authorities. 
If, however, the royalty expense is borne by a permanent 
establishment or fixed base that the payor has in Italy or the 
United States, the royalty has as its source the country in 
which the permanent establishment or fixed base is located, 
regardless of the residence of the payor. Thus, for example, if 
a French resident has a permanent establishment in Italy and 
that French resident pays a royalty to a U.S. person which is 
attributable to the Italian permanent establishment, then the 
royalty would be treated as having its source in Italy. The 
proposed treaty provides that notwithstanding the foregoing 
rules, royalties with respect to the use of, or right to use, 
rights or property within a treaty county may be deemed to 
arise within that country. Thus, consistent with U.S. internal 
law, the United States may treat royalties with respect to the 
use of property in the United States as U.S. source income.
    The proposed treaty addresses the issue of non-arm's-length 
royalties between related parties (or parties otherwise having 
a special relationship) by providing that the amount of 
royalties for purposes of applying this article is the amount 
that would have been agreed upon by the payor and the 
beneficial owner in the absence of the special relationship. 
Any amount of royalties paid in excess of such amount is 
taxable according to the laws of each country, taking into 
account the other provisions of the proposed treaty. For 
example, excess royalties paid by a subsidiary corporation to 
its parent corporation may be treated as a dividend under local 
law and thus be subject to the provisions of Article 10 
(Dividends).
    As in the case of dividends (Article 10) and interest 
(Article 11), the proposed treaty includes a main purpose test 
under which the royalty provision will not apply if the main 
purpose, or one of the main purposes, for the creation or 
assignment of rights in respect of which royalties are paid is 
to take advantage of the proposed treaty's royalty article.

Article 13. Capital Gains

            Internal taxation rules

United States

    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 or, in the case of 
a nonresident alien, he or she is physically present in the 
United States for at least 183 days in the taxable year. 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.

Italy

    Nonresident companies are subject to the corporate income 
tax (37 percent) on capital gains from immovable property, but 
only if held for 5 years or less. Capital gains recognized by 
nonresident companies from the sale of shares or other 
participations in Italian resident companies are generally 
subject to a 27 percent tax rate. However, if the amount of 
participations sold during a 12-month period does not exceed 
either (1) 2 percent of voting power or 5 percent of capital 
(in the case of listed companies) or (2) 20 percent of voting 
power or 25 percent of capital (in all other cases), then such 
gains are subject to a 12.5 percent tax rate.
            Proposed treaty limitations on internal law
    The proposed treaty specifies rules governing when a 
country may tax gains from the alienation of property by a 
resident of the other country. The rules are generally 
consistent with those contained in the U.S. model.
    Under the proposed treaty, gains derived by a resident of 
one treaty country from the alienation of immovable property 
situated in the other country may be taxed in the country where 
the property is situated. The proposed protocol provides that 
with respect to the United States, the term ``immovable 
property'' includes a United States real property interest. 
Such property is deemed to be situated in the United States for 
purposes of this article. In the case of Italy, immovable 
property includes (1) immovable property referred to in Article 
6 (Income from Immovable Property), (2) shares (or comparable 
interests) in a company (or other body of persons) the assets 
of which consist wholly or principally of real property 
situated in Italy, and (3) an interest in an estate of a 
deceased individual, the assets of which consist wholly or 
principally of real property situated in Italy. Such property 
is deemed to be situated in Italy for purposes of this article.
    The proposed treaty contains a standard provision which 
permits a country to tax the gain from the alienation of 
movable property that forms a part of the business property of 
a permanent establishment located in that country, or that 
pertains to a fixed base in that country for the purpose of 
performing independent personal services. This rule also 
applies to gains from the alienation of such a permanent 
establishment (alone or with the whole enterprise) or such a 
fixed base. This rule also applies if the permanent 
establishment or fixed base no longer exists when the gains are 
recognized but such gains relate to the former permanent 
establishment or fixed base.
    The proposed treaty provides that gains derived by an 
enterprise of one of the treaty countries from the alienation 
of ships or aircraft operated in international traffic (or 
movable property pertaining to the operation or use of ships, 
aircraft, or containers) are taxable only in such country. The 
proposed protocol provides that this rule also applies to (1) 
gains from the sale of containers (including trailers, barges, 
and related equipment for the transport of containers) used for 
the transport in international traffic of goods or merchandise; 
and (2) gains from the sale of ships or aircraft rented on a 
full basis or gains from the sale of ships or aircraft rented 
on a bareboat basis if, in the latter case, the rental profits 
are incidental to other profits from the operation of ships or 
aircraft in international traffic.
    Gains from the alienation of any property other than that 
discussed above is taxable under the proposed treaty only in 
the country where the person disposing of the property is 
resident.

Article 14. Independent Personal Services

            Internal taxation rules

United States

    The United States taxes the income of a nonresident alien 
individual 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 constitute a 
trade or business within the United States.
    Under the Code, the income of a nonresident alien 
individual 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 the following criteria are met: (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.

Italy

    Nonresident individuals are subject to a withholding tax of 
30 percent on self-employment income.
            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, 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.
    Like the present treaty, the proposed treaty provides that 
income from the performance of professional services in an 
independent capacity by a resident of one country is exempt 
from tax in the country where the services are performed (the 
source country) unless the individual performing the services 
has a fixed base regularly available to him or her in the 
source country for the purpose of performing the services.\8\ 
In that case, the source country is permitted to tax only that 
portion of the individual's income which is attributable to the 
fixed base.
---------------------------------------------------------------------------
    \8\ The Technical Explanation states that it is understood that the 
concept of a fixed base is similar to the concept of a permanent 
establishment.
---------------------------------------------------------------------------
    The term ``professional services in an independent 
capacity'' includes, but is not limited to, scientific, 
literary, artistic, educational, and teaching activities as 
well as independent activities of physicians, lawyers, 
engineers, architects, dentists, and accountants.

Article 15. Dependent Personal Services

    Under the proposed treaty, salaries, wages, 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 by 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 the fiscal 
year; (2) the individual is paid by, or on behalf of, an 
employer who 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 the same as the 
rules of the U.S. model and the OECD model.
    The proposed treaty contains a special rule that permits 
remuneration derived by a resident of one country in respect of 
employment regularly exercised as a member of the crew of a 
ship or aircraft operated in international traffic by an 
enterprise of the other country to be taxed in that other 
country. A similar rule is included in the OECD model. U.S. 
internal law does not impose tax on such income of a 
nonresident alien, even if such person is employed by a U.S. 
entity.
    This article is subject to the provisions of the separate 
articles covering directors' fees (Article 16), pensions, 
social security, annuities, alimony, and child support payments 
(Article 18), government service income (Article 19), income of 
professors and teachers (Article 20), and income of students 
and trainees (Article 21).

Article 16. Directors' Fees

    Under the proposed treaty, directors' fees and other 
similar payments derived by a resident of one country in his or 
her capacity as a member of the board of directors of a company 
that is a resident of the other country is taxable in that 
other country. Like the U.S. model, the proposed protocol 
provides that the country of the company's residence may tax 
the remuneration of nonresident directors, but only with 
respect to remuneration for services performed in that country.

Article 17. Artistes and Athletes

    Like the U.S. and OECD models, the proposed treaty contains 
a separate set of rules that apply to the taxation of income 
earned by entertainers (such as theater, motion picture, radio, 
or television artistes or musicians) and athletes. These rules 
apply notwithstanding the other provisions dealing with the 
taxation of income from personal services (Articles 14 and 15) 
and are intended, in part, to prevent entertainers and athletes 
from using the treaty to avoid paying any tax on their income 
earned in one of the countries.
    Under the proposed treaty, income derived by an entertainer 
or athlete who is a resident of one country from his or her 
personal activities as such in the other country may be taxed 
in the other country if the amount of the gross receipts 
derived by him or her from such activities exceeds $20,000 or 
its equivalent in Italian currency, or such entertainer or 
athlete is present in the other country for more than 90 days 
during the fiscal year. The $20,000 threshold includes 
reimbursed expenses. Under this rule, if an Italian entertainer 
or athlete maintains no fixed base in the United States and 
performs (as an independent contractor) for one day of a 
taxable year in the United States for total compensation of 
$10,000, the United States could not tax that income. If, 
however, that entertainer's or athlete's total compensation 
were $30,000 (or if the individual was present in the United 
States for more than 90 days), the full amount would be subject 
to U.S. tax.
    The proposed treaty provides that where income in respect 
of activities exercised by an entertainer or athlete in his or 
her capacity as such accrues not to the entertainer or athlete 
but to another person, that income is taxable by the country in 
which the activities are exercised unless it is established 
that neither the entertainer or athlete nor persons related to 
him or her participated directly or indirectly in the profits 
of that other person in any manner, including the receipt of 
deferred remuneration, bonuses, fees, dividends, partnership 
distributions, or other distributions. This provision applies 
notwithstanding the provisions of the business profits and 
personal service articles (Articles 7, 14, and 15). This 
provision prevents highly-paid entertainers and athletes from 
avoiding tax in the country in which they perform by, for 
example, routing the compensation for their services through a 
third entity such as a personal holding company or a trust 
located in a country that would not tax the income.

Article 18. Pensions, Etc.

    Under the proposed treaty, pensions and other similar 
remuneration derived and beneficially owned by a resident of 
either country in consideration of past employment is subject 
to tax only in the recipient's country of residence. The 
Technical Explanation states that the provision is intended to 
apply to both periodic or lump sum payments. This rule is 
subject to the provisions of Article 19 (Government Service) 
with respect to pensions. The Technical Explanation indicates 
that it is understood that the United States may require a U.S. 
resident who receives a distribution from an Italian pension 
plan to include the entire distribution in the recipient's 
taxable income under the general residence-based rule above 
regardless of the fact that Italy may have previously imposed a 
tax on the Italian pension plan with respect to earnings and 
accretions.
    Notwithstanding the general residence-based rule above, if 
a resident of one country becomes a resident of the other 
country, lump-sum payments or severance payments (indemnities) 
that are received after the change in residency are taxable 
only in the original country of residency. This exception only 
applies to amounts that are paid with respect to employment 
exercised in the original country of residence and only while 
such person was a resident thereof. The term ``severance 
payments (indemnities)'' includes any payment made by reason of 
the termination of any office or employment of a person. The 
Technical Explanation states that this provision is intended to 
prevent potential abuses of the general pension rule described 
above. The Technical Explanation states that, for example, 
Italian law requires Italian employers to make certain lump-sum 
retirement payments to employees upon their retirement. The 
Technical Explanation notes that absent this provision, an 
employee resident in Italy (or the United States) who 
anticipates receiving such a payment might establish residence 
in the United States (or in Italy) in order to obtain more 
favorable U.S. (Italian) tax treatment under the general rule.
    Like the present treaty, the proposed treaty provides that 
payments made by one of the countries under the provisions of 
the social security or similar legislation of the country to a 
resident of the other country are taxable only by the country 
of residence. In contrast, the U.S. model provides that social 
security payments may be taxed only in the source country. The 
Technical Explanation states that the term ``similar 
legislation'' is intended to include U.S. tier 1 Railroad 
Retirement benefits.
    The proposed treaty provides that annuities are taxed only 
in the country of residence of the individual who beneficially 
derives them. The term ``annuities'' is defined for purposes of 
this provision as a stated sum paid periodically at stated 
times during life or during a specified number of years, under 
an obligation to make the payments in return for adequate and 
full consideration in money or money's worth (other than 
services rendered).
    Under the proposed treaty, alimony and child support 
payments paid by a resident of one country to a resident of the 
other country will be taxable only in the country of residence 
of the recipient. However, if the person making such payments 
is not entitled to a deduction for such payments in his or her 
country of residence, such payments are not taxable in either 
treaty country. For this purpose, the term ``alimony'' means 
periodic payments made pursuant to a written separation 
agreement or a decree of divorce, separate maintenance, or 
compulsory support, which payments are taxable to the recipient 
under the laws of the country of residence. The term ``child 
support'' means periodic payments for the support of a minor 
child made pursuant to a written separation agreement or a 
decree of divorce, separate maintenance, or compulsory support.
    The proposed treaty includes special rules addressing the 
treatment of cross-border pension contributions. Under the 
proposed treaty, if an individual who is a member of a pension 
plan established and recognized under the law of one country 
performs personal services in the other country, contributions 
made by the individual to the plan during the period he or she 
performs such personal services are deductible in computing his 
or her taxable income in the other country. Similarly, payments 
made to the plan by or on behalf of his or her employer during 
such period are not treated as part of his or her taxable 
income and are allowed as a deduction in computing the 
employer's profits in the other country. However, these rules 
apply only if (1) contributions were made by or on behalf of 
the individual to the plan (or to a similar plan for which this 
plan is substituted) immediately before he or she visited the 
other country, and (2) the competent authority of the other 
country has agreed that the plan generally corresponds to a 
pension plan recognized for tax purposes by that country. 
Moreover, the benefits provided under these rules will not 
exceed the benefits that would be allowed by the other country 
to its residents for contributions to a pension plan recognized 
for tax purposes by that country. The proposed protocol 
provides that in the case of Italy, the term ``pension plan'' 
means ``fondi pensione.''

Article 19. Government Service

    Under the proposed treaty, remuneration, other than a 
pension, paid by a treaty country or one of its political or 
administrative subdivisions or local authorities to an 
individual for services rendered to the payor generally is 
taxable only by that country. However, such remuneration is 
taxable only in the other country (the country that is not the 
payor) if the services are rendered in that other country by an 
individual who is a resident of that country and who (1) is 
also a national of only that country or (2) did not become a 
resident of that country solely for the purpose of rendering 
the services. Like the present treaty, if the spouse or 
dependent child of an individual who under this provision is 
taxable only in the paying country also performs government 
functions in the other country, the proposed treaty provides 
that remuneration for those functions is taxable only in the 
paying country, provided that the spouse or child is not a 
national of the other country.
    The proposed treaty provides that 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 by that country. Such a pension 
is taxable only by the other country, however, if the 
individual is a resident and national of that other country. 
Social security benefits in respect of government service are 
subject to Article 18 (Pensions, Etc.) and not this article.
    The proposed protocol provides that it is understood that 
the competent authorities of the treaty countries may, by 
mutual agreement, apply the rules described above to employees 
of organizations that perform functions of a governmental 
nature. The Technical Explanation states that it is anticipated 
that these rules will apply to, in the case of the United 
States, employees of the Federal Reserve Banks, the Export-
Import Bank, and the Overseas Private Investment Corporation 
and, in the case of Italy, employees of the Central Bank, the 
Foreign Trade Institute, and the Official Insurance Institute 
for Export Credits.
    If a country or one of its political subdivisions or local 
authorities is carrying on a business, the provisions of 
Articles 14 (Independent Personal Services), 15 (Dependent 
Personal Services), 16 (Directors' Fees), 17 (Artistes and 
Athletes), or 18 (Pensions, Etc.) will apply to remuneration 
and pensions for services rendered in connection with that 
business.

Article 20. Professors and Teachers

    The treatment provided to professors and teachers under the 
proposed treaty generally corresponds to the treatment provided 
under the present treaty.
    Under the proposed treaty, a professor or teacher who 
visits the other country (the host country) for a period not 
expected to exceed two years for the purpose of teaching or 
conducting research at a university, college, school, or other 
recognized educational institution, or at a medical facility 
primarily funded from governmental sources, and who immediately 
before that visit is, or was a resident of the other treaty 
country, generally is exempt from host country tax on his or 
her remuneration from such teaching or research activities. 
This treaty benefit applies for a period not exceeding two 
years. This exemption does not apply to income from research 
undertaken not in the general interest but primarily for the 
private benefit of a specific person or persons. The proposed 
protocol provides that for purposes of this article, the term 
``recognized educational institution'' means, in the case of 
the United States, an accredited educational institution. An 
educational institution is considered to be accredited if it is 
accredited by an authority that generally is responsible for 
the accreditation of institutions in the particular field of 
study.
    This article of the proposed treaty is an exception from 
the saving clause in the case of persons who are neither 
citizens nor lawful permanent residents of the host country.

Article 21. Students and Trainees

    The treatment provided to students and trainees under the 
proposed treaty generally corresponds to the treatment provided 
under the present treaty.
    Under the proposed treaty, a student or business apprentice 
(trainee) who visits a country (the host country) for the 
purpose of his or her education at a recognized educational 
institution or for training, and who immediately before that 
visit is, or was a resident of the other treaty country, 
generally is exempt from host country tax on payments he or she 
receives for the purpose of such maintenance, education, or 
training; provided, however, that such payments arise outside 
the host country. The proposed protocol provides that for 
purposes of this article, the term ``recognized educational 
institution'' means, in the case of the United States, an 
accredited educational institution. An educational institution 
is considered to be accredited if it is accredited by an 
authority that generally is responsible for the accreditation 
of institutions in the particular field of study. The Technical 
Explanation states that a payment generally is considered to 
arise outside the host country if the payer is located outside 
the host country.
    This article of the proposed treaty is an exception from 
the saving clause in the case of persons who are neither 
citizens nor lawful permanent residents of the host country.

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 Italy. As a general rule, items of 
income not otherwise dealt with in the proposed treaty which 
are derived by residents of one of the countries are taxable 
only in the country of residence. This rule is similar to the 
rules in the U.S. and OECD models.
    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 U.S. resident. This 
article is subject to the saving clause, so U.S. citizens who 
are residents of Italy will continue to be taxable by the 
United States on their third-country income.
    The general rule just stated does not apply to income 
(other than income from immovable property as defined in 
Article 6) if the person deriving the income is a resident of 
one country and carries on business in the other country 
through a permanent establishment, or performs independent 
personal services in the other country from a fixed base, and 
the income is effectively connected to such permanent 
establishment or fixed base. In such a case, the income is 
taxable in the source country according to its laws. The 
proposed protocol states that the provisions of Article 7 
(Business Profits) or Article 14 (Independent Personal 
Services), as the case may be, may apply. Such exception also 
applies where the income is received after the permanent 
establishment or fixed base is no longer in existence, but the 
income is attributable to the former permanent establishment or 
fixed base.
    The proposed treaty contains a main purpose test similar to 
that provided with respect to the dividends, interest, and 
royalties articles (Articles 10, 11 and 12). The Technical 
Explanation states that, like those articles, the other income 
article is intended to be self-executing. However, the tax 
authorities, on review, may deny the benefits of the article in 
cases in which the main purpose, or one of the main purposes, 
for the creation or assignment of the rights in respect of 
which income is paid is to take advantage of the article.

Article 23. Relief From Double Taxation

            Internal taxation rules

United States

    The United States taxes the worldwide income of its 
citizens and residents. It attempts unilaterally to mitigate 
double taxation generally by allowing 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 that receives a dividend from the foreign 
corporation (or an inclusion of the foreign corporation's 
income) is deemed to have paid a portion of the foreign income 
taxes paid (or deemed paid) by the foreign corporation on its 
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.

Italy

    Italian double tax relief is allowed through a foreign tax 
credit. Italian foreign tax credits are limited to the lesser 
of the foreign tax paid or the Italian tax that relates (based 
on a ratio of foreign income to total income) to such amount of 
the income. Unlike the United States, the foreign tax credit 
limitation is determined on a per-country basis.
            Proposed treaty limitations on internal law
    One of the 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. 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 were engaged in business in both countries. 
Also, a corporation or individual may be treated as a resident 
of more than one country and be taxed on a worldwide basis by 
both.
    Part of the double tax problem is dealt with in other 
articles of the proposed treaty that limit the right of a 
source country to tax income. This article provides further 
relief where both Italy and the United States otherwise still 
tax the same item of income. This article is not subject to the 
saving clause, so that the country of citizenship or residence 
will waive its overriding taxing jurisdiction to the extent 
that this article applies.
    The proposed treaty generally provides that the United 
States will allow a U.S. citizen or resident a foreign tax 
credit for the income taxes imposed by Italy. The proposed 
treaty also requires the United States to allow a deemed-paid 
credit, with respect to Italian income tax, to any U.S. company 
that receives dividends from an Italian company if the U.S. 
company owns 10 percent or more of the voting stock of such 
Italian company. The credit generally is to be computed in 
accordance with the provisions and subject to the limitations 
of U.S. law (as such law may be amended from time to time 
without changing the general principles of the proposed treaty 
provisions). This provision is similar to those found in the 
U.S. model and many U.S. treaties.
    In the case of Italy, the proposed treaty provides that the 
individual income tax (l'imposta sul reddito delle persone 
fisiche); the corporation income tax (l'imposta sul reddito 
delle persone giuridiche); and a portion of the regional tax on 
productive activities (l'imposta regionale sulle attivita 
produttive) (the so-called ``IRAP'' tax) are income taxes 
available for credit against U.S. tax liabilities.
    The IRAP tax applies to Italian residents as well as 
nonresidents of Italy with a permanent establishment in Italy. 
The IRAP tax base is calculated without a deduction for labor 
costs and, for certain taxpayers, without a deduction for 
interest costs. With respect to manufacturing companies, for 
example, the IRAP tax base generally equals gross revenues from 
sales in Italy, with certain deductions for costs of goods 
sold, rent, and depreciation. No deduction is permitted for 
interest or labor expenses. With respect to banks and other 
financial institutions, the tax base generally equals interest 
and other income received, with certain deductions including 
interest paid, rent and depreciation (but with no deduction for 
labor expenses). The initial IRAP tax rate generally is 4.25 
percent (5.4 percent for banks and other financial 
institutions). Because the IRAP tax base does not permit 
deductions for labor and, in certain cases, interest, it is not 
likely to be a creditable tax under U.S. internal law.
    The proposed treaty provides that a portion of the taxes 
imposed under the IRAP will be considered to be a creditable 
income tax under this article. The proposed treaty provides a 
formula under which the creditable amount is calculated by 
multiplying the ``applicable ratio'' by the total amount of tax 
paid or accrued to Italy under the IRAP. The applicable ratio 
is a fraction, the numerator of which is the total IRAP tax 
base decreased (but not below zero) by labor expense and 
interest expense not otherwise taken into account in connection 
with the IRAP tax base. The denominator of the fraction is the 
actual tax base upon which Italy imposes the IRAP tax. The 
result of this calculation is an amount of the IRAP tax that 
approximates what the tax would have been had it been imposed 
on net income.
    The proposed treaty generally provides that in taxing its 
residents Italy may include in its tax base income that the 
United States may tax under the proposed treaty, but that if 
Italy does so, it must credit U.S. taxes paid by the Italian 
resident on that income that is taxable in the United States. 
This credit is not to exceed the amount of the tax that would 
be paid to the United States if the resident were not a U.S. 
citizen. That is, in the case of an Italian resident who is 
subject to U.S. tax on worldwide income as a U.S. citizen, 
Italy will credit only the U.S. tax to which the Italian 
resident would have been subject absent U.S. citizenship. Italy 
need not credit U.S. taxes if the relevant item of income is 
subject in Italy to a final withholding tax by request of the 
recipient in accordance with Italian law.
    The proposed treaty, like the U.S. model and other U.S. 
treaties, contains a special rule designed to provide relief 
from double taxation for U.S. citizens who are Italian 
residents. Under this rule, Italy will allow a foreign tax 
credit to a U.S. citizen who is resident in Italy by taking 
into account only the amount of U.S. taxes paid pursuant to the 
proposed treaty (other than taxes that may be imposed solely by 
reason of citizenship under the saving clause of Article 1 
(Personal Scope)) with respect to items of income that are 
either exempt from U.S. tax or are subject to a reduced rate of 
tax when derived by an Italian resident who is not a U.S. 
citizen. The United States will then credit the income tax 
actually paid to Italy, determined after application of the 
preceding sentence. The proposed treaty recharacterizes the 
income that is subject to Italian taxation as foreign source 
income for purposes of this computation, but only to the extent 
necessary to avoid double taxation of such income.
    The proposed treaty provides a resourcing rule for purposes 
of the U.S. foreign tax credit in the case of a person who is a 
dual national of the United States and Italy, and is taxable by 
Italy on income for services rendered to the Italian government 
(under Article 19(1)(a)), but is taxable by the United States 
under the saving clause. In such cases, the proposed treaty 
provides that such income is treated as Italian-source income 
for purposes of the U.S. foreign tax credit. The Technical 
Explanation states that this resourcing rule is provided in 
order to relieve potential double taxation. Thus, the United 
States may tax such income but must allow a credit for the 
Italian income tax, if any, in accordance with the other 
provisions of this article.
    This article is not subject to the saving clause, so that 
the country of citizenship or residence will waive its 
overriding taxing jurisdiction to the extent that this article 
applies.

Article 24. Non-Discrimination

    The proposed treaty contains a comprehensive non-
discrimination article relating to all taxes of every kind 
imposed at the national, state, or local level. It is similar 
to the non-discrimination article in the U.S. model, the 
present treaty, and to provisions that have been included in 
other recent U.S. income tax treaties.
    In general, under the proposed treaty, one country cannot 
discriminate by imposing other or more burdensome taxes (or 
requirements connected with taxes) on nationals of the other 
country than it would impose on its nationals in the same 
circumstances. This rule applies (notwithstanding the personal 
scope article (Article 1)) whether or not the nationals in 
question are residents of the United States or Italy. However, 
for purposes of U.S. tax, U.S. citizens subject to tax on a 
worldwide basis are not in the same circumstances as Italian 
nationals who are not U.S. residents.
    Under the proposed treaty, neither country may tax a 
permanent establishment of an enterprise of the other country 
less favorably than it taxes its own enterprises carrying on 
the same activities. Consistent with the U.S. model and the 
OECD model, however, 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 that are granted to its own 
residents.
    Each country is required (subject to the arm's-length 
pricing rules of paragraph 1 of Article 9 (Associated 
Enterprises), paragraph 7 of Article 11 (Interest), and 
paragraph 7 of Article 12 (Royalties)) to allow its residents 
to deduct interest, royalties, and other disbursements paid by 
them to residents of the other country under the same 
conditions that it allows deductions for such amounts paid to 
residents of the same country as the payor. The Technical 
Explanation states that the term ``other disbursements'' is 
understood to include a reasonable allocation of executive and 
general administrative expenses, research and development 
expenses, and other expenses incurred for the benefit of a 
group of related persons. The Technical Explanation further 
states that the rules of section 163(j) of the Code are not 
discriminatory within the meaning of this provision.
    The non-discrimination rules also apply 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 (or connected requirements) that 
the first country imposes or may impose on its similar 
enterprises. The Technical Explanation includes examples of 
Code provisions that are understood by the two countries not to 
violate this provision of the proposed treaty. Those examples 
include the rules that impose a withholding tax on non-U.S. 
partners of a partnership and the rules that prevent foreign 
persons from owning stock in Subchapter S corporations.
    Notwithstanding the definition of taxes covered in Article 
2, this article applies to taxes of every kind and description 
imposed by either country, or a political subdivision or local 
authority thereof. The proposed protocol provides that nothing 
in the non-discrimination article is to be construed as 
preventing either of the countries from imposing a branch 
profits tax or a branch-level interest tax.
    The saving clause (which allows the country of residence or 
citizenship to impose tax notwithstanding certain treaty 
provisions) does not apply to the non-discrimination article. 
Thus, a U.S. citizen resident in Italy may claim benefits with 
respect to the United States under this article.

Article 25. Mutual Agreement Procedure

    The proposed treaty contains the standard mutual agreement 
provision, with some variation, that authorizes the competent 
authorities of the two countries 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 might result in a waiver (otherwise 
mandated by the proposed treaty) of taxing jurisdiction by the 
country of citizenship or residence.
    Under this article, a resident of one country who considers 
that the action of one or both of the countries will cause him 
or her to be subject to tax which is not in accordance with the 
proposed treaty may (irrespective of internal law remedies) 
present his or her case to the competent authority of the 
country in which he or she is a resident, or if the case comes 
under the non-discrimination article (Article 24), to the 
competent authority of the country in which he or she is a 
national. Similar to the OECD model, and unlike the U.S. model, 
the proposed treaty provides that the case must be presented 
within three years from the first notification of the action 
resulting in taxation not in accordance with the provisions of 
the treaty. The competent authority will then make a 
determination as to whether the objection appears justified. If 
the objection appears to it to be justified and if it is not 
itself able to arrive at a satisfactory solution, that 
competent authority must 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.
    The competent authorities of the countries are to endeavor 
to resolve by mutual agreement any difficulties or doubts 
arising as to the interpretation or application of the proposed 
treaty. The competent authorities may also consult together for 
the elimination of double taxation regarding cases not provided 
for in the proposed treaty. This treatment is similar to the 
treatment under the U.S. model. The proposed protocol makes 
clear that the competent authorities can agree that the 
conditions for application of the main purpose provisions in 
Articles 10 (Dividends), 11 (Interest), 12 (Royalties), or 22 
(Other Income) have been met.
    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. The 
Technical Explanation states that 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. When it seems advisable in order to reach 
agreement to have an oral exchange of opinions, such exchange 
may take place through a Commission consisting of 
representatives of both country's competent authorities.
    Under the proposed treaty, if an agreement cannot be 
reached by the competent authorities pursuant to the rules 
described above, the case may, if agreed to by the taxpayer and 
each competent authority, be submitted to arbitration. The 
arbitration procedure does not become effective at the same 
time as the remainder of the treaty; instead, the arbitration 
procedure becomes effective on the date specified in a future 
exchange of diplomatic notes. The proposed protocol provides 
that within three years after entry into force of the proposed 
treaty, the competent authorities will consult to determine 
whether it is appropriate to exchange diplomatic notes 
implementing the arbitration procedure. The Memorandum of 
Understanding elaborates on the circumstances under which an 
exchange of diplomatic notes implementing the arbitration 
procedure will take place and also sets forth the procedures 
that will apply to arbitration proceedings if the provision is 
implemented.
    If the arbitration procedures become effective, the 
following rules apply. The taxpayer must agree in writing to be 
bound by the decision of the arbitration board. The competent 
authorities are permitted to release to the arbitration board 
such information as is necessary for carrying out the 
arbitration procedure. Any award of the arbitration board is 
binding on the taxpayer as well as each treaty country, with 
respect to the case at hand.

Article 26. Exchange of Information

    This article provides for the exchange of information 
between the two countries. Notwithstanding the provisions of 
Article 2 (Taxes Covered), the proposed protocol provides that 
the information exchange provisions apply to all taxes imposed 
in either country at the national level.
    The proposed treaty provides that the two competent 
authorities will exchange such information as is necessary to 
carry out the provisions of the proposed treaty, or the 
provisions of the domestic laws of the two countries concerning 
taxes to which the proposed treaty applies (provided that the 
taxation under those domestic laws is not contrary to the 
proposed treaty), and for the prevention of fraud and tax 
evasion. This exchange of information is not restricted by 
Article 1 (Personal Scope). Therefore, information with respect 
to third-country residents is covered by these procedures.
    Any information exchanged under the proposed treaty is 
treated as secret in the same manner as information obtained 
under the domestic laws of the country receiving the 
information. The exchanged information may be disclosed only to 
persons or authorities (including courts and administrative 
bodies) involved in the assessment or collection of, the 
enforcement or prosecution in respect of, or the determination 
of appeals in relation to, the taxes to which the proposed 
treaty applies. Such persons or authorities must use the 
information for such purposes only.\9\ The proposed protocol 
provides that information may also be disclosed to persons or 
authorities involved in the oversight of such activities. The 
Technical Explanation states that persons involved in the 
oversight of taxes include legislative bodies with oversight 
roles with respect to the administration of the tax laws, such 
as, for example, the tax-writing committees of Congress and the 
General Accounting Office. Information received by these bodies 
must be 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.
---------------------------------------------------------------------------
    \9\ 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 
the proposed treaty could not be used for these nontax purposes.
---------------------------------------------------------------------------
    As is true under the U.S. model and the OECD model, 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 that is not obtainable under the laws or in the 
normal course of the administration of either country, or to 
supply information that 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.
    Under the proposed protocol, a country may collect on 
behalf of the other country such amounts as may be necessary to 
ensure that relief granted under the treaty by the other 
country does not enure to the benefit of persons not entitled 
thereto. However, neither country is obligated, in the process 
of providing collection assistance, to carry out administrative 
measures that differ from those used in the collection of its 
own taxes, or that would be contrary to its sovereignty, 
security, or public policy.

Article 27. Diplomatic Agents and Consular Officials

    The proposed treaty contains the rule found in the U.S. 
model and other U.S. tax treaties that its provisions do not 
affect the fiscal privileges of members of diplomatic agents or 
consular officials under the general rules of international law 
or under 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 host country residents who are 
neither citizens nor lawful permanent residents of that 
country. Thus, for example, U.S. diplomats who are considered 
Italian residents may be protected from Italian tax.

Article 28. Entry into Force

    The proposed treaty provides that the treaty is subject to 
ratification in accordance with the applicable procedures of 
each country, and that instruments of ratification will be 
exchanged as soon as possible. The proposed treaty will enter 
into force upon the exchange of instruments of ratification.
    With respect to taxes withheld at source, the proposed 
treaty will be effective for amounts paid or credited on or 
after the first day of the second month following the date on 
which the proposed treaty enters into force. With respect to 
other taxes, the proposed treaty will be effective for taxable 
periods beginning on or after the first day of January next 
following the date on which the proposed treaty enters into 
force.
    Taxpayers may elect temporarily to continue to claim 
benefits under the present treaty with respect to a period 
after the proposed treaty takes effect. For such a taxpayer, 
the present treaty would continue to have effect in its 
entirety for a twelve-month period from the date on which the 
provisions of the proposed treaty would otherwise take effect. 
The present treaty ceases to have effect once the provisions of 
the proposed treaty take effect under the proposed treaty.

Article 29. Termination

    The proposed treaty will continue in force until terminated 
by either country. Either country may terminate the proposed 
treaty at any time after five years from the date of entry into 
force, provided that at least six months prior notice of 
termination is given through diplomatic channels. With respect 
to taxes withheld at source, a termination is effective for 
amounts paid or credited on or after the first day of January 
next following the expiration of the six-month period of 
notification. With respect to other taxes, a termination is 
effective for taxable periods beginning on or after the first 
day of January next following the expiration of the six-month 
notification period.

                  IX. Explanation of Proposed Protocol

    A detailed, article-by-article explanation of the proposed 
protocol, is set forth below. Certain provisions of the 
proposed protocol have been described in Part VIII. above in 
connection with the description of the proposed treaty.

Article 1

    Article 1 of the proposed protocol modifies specific 
articles of the proposed treaty. Discussions of such 
modifications appear in the discussions of the affected 
articles, above.

Article 2

    The proposed protocol contains a provision generally 
intended to limit the indirect use of the proposed treaty by 
persons who are not entitled to its benefits by reason of 
residence in the United States or Italy. The present treaty 
contains a provision that is not as extensive.
    The proposed protocol is intended to limit double taxation 
caused by the interaction of the tax systems of the United 
States and Italy 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 treaty country seeks certain benefits 
under the income tax treaty between the two countries. Under 
certain circumstances, and without appropriate safeguards, the 
third-country resident may be able to secure these benefits 
indirectly by establishing a corporation or other entity in one 
of the treaty countries, which entity, as a resident of that 
country, is entitled to the benefits of the treaty. 
Additionally, it may be possible for the third-country resident 
to reduce the income base of the treaty country resident by 
having the latter pay out interest, royalties, or other amounts 
under favorable conditions either through relaxed tax 
provisions in the distributing country or by passing the funds 
through other treaty countries until the funds can be 
repatriated under favorable terms.
    The proposed anti-treaty shopping article provides that a 
resident of either Italy or the United States will be entitled 
to the benefits of the proposed treaty only if the resident:

          (1) is an individual;
          (2) is a qualified governmental entity;
          (3) is a company that satisfies a public company 
        test;
          (4) is a company that is owned by certain public 
        companies;
          (5) is a charitable organization or other legal 
        person established and maintained exclusively for a 
        religious, charitable, educational, scientific, or 
        other similar purpose;
          (6) is a pension fund that satisfies an ownership 
        test; or
          (7) is an entity that satisfies both an ownership and 
        base erosion 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. In 
addition, a person that does not satisfy any of the above 
requirements may be entitled to the benefits of the proposed 
treaty if the source country's competent authority so 
determines.
            Individuals
    An individual resident of a treaty country is entitled to 
the benefits of the proposed treaty.
            Qualified governmental entities
    Under the proposed protocol, a qualified governmental 
entity is entitled to all treaty benefits. Qualified 
governmental entities include the two countries, their 
political or administrative subdivisions, or their local 
authorities. Qualified governmental entities also include 
certain wholly-owned entities, the earnings of which are 
credited to the entity's own account, and certain pension 
trusts or funds providing government service pension benefits.
            Public company tests
    A company that is a resident of Italy or the United States 
is entitled to treaty benefits if more than 50 percent of the 
vote and value of all classes of the shares in such company are 
regularly traded on a recognized stock exchange. In addition, a 
company is entitled to treaty benefits if at least 50 percent 
of each class of shares of the company is owned (directly or 
indirectly) by five or fewer companies that satisfy the test 
previously described, provided that each intermediate owner 
used to satisfy the control requirement is a resident of Italy 
or the United States. These rules follow the corresponding 
rules in the U.S. model.
    Under the proposed protocol, the term ``recognized stock 
exchange'' means (1) the NASDAQ System owned by the National 
Association of Securities Dealers, Inc. and any stock exchange 
registered with the U.S. Securities and Exchange Commission as 
a national securities exchange under the U.S. Securities 
Exchange Act of 1934; (2) any stock exchange constituted and 
organized according to Italian laws; and (3) any other stock 
exchange agreed upon by the competent authorities of both 
countries.
            Tax exempt organizations
    An entity is entitled to the benefits under the proposed 
treaty if it is a legal person organized under the laws of a 
treaty country, generally exempt from tax in such country, and 
that is established and maintained in such country exclusively 
for a religious, charitable, educational, scientific, or other 
similar purpose.
            Pension funds
    A legal person, whether or not exempt from tax, is entitled 
to treaty benefits if (1) it is organized under the laws of a 
treaty country to provide pension or other similar benefits to 
employees pursuant to a plan, and (2) more than 50 percent of 
the person's beneficiaries, members, or participants are 
individuals resident in either treaty country. This rule is 
similar to the rule in the U.S. model.
            Ownership and base erosion tests
    Under the proposed protocol, an entity that is a resident 
of one of the countries is entitled to treaty benefits if it 
satisfies an ownership test and a base erosion test. Under the 
ownership test, on at least half of the days during the taxable 
year at least 50 percent of each class of the beneficial 
interests in an entity must be owned (directly or indirectly) 
by certain qualified residents described above (i.e., an 
individual; a qualified governmental entity; a company that 
satisfies one of the public company tests (described in the 
discussion of public company tests above); a charitable 
organization or other legal person established and maintained 
exclusively for a religious, charitable, educational, 
scientific, or other similar purpose; or a legal person that 
satisfies the test for pension funds (described in the 
discussion of pension funds above)). The Technical Explanation 
states that trusts may be entitled to treaty benefits if they 
are treated as residents of a treaty country and otherwise 
satisfy the requirements under these provisions.
    The base erosion test is satisfied only if less than 50 
percent of the person's gross income for the taxable year is 
paid or accrued (directly or indirectly), in the form of 
deductible payments, to persons who are not residents of either 
treaty country (unless the payment is attributable to a 
permanent establishment situated in either treaty country). 
This rule is intended to prevent a corporation, for example, 
from distributing most of its income, in the form of deductible 
items such as interest, royalties, service fees, or other 
amounts to persons not entitled to benefits under the proposed 
treaty. This treatment is similar to the corresponding rule in 
the U.S. model. The term ``gross income'' is not defined in the 
proposed treaty or proposed protocol and therefore will be 
defined according to the respective country's laws that is 
applying the treaty. The Technical Explanation states that for 
purposes of the base erosion test, in the case of the United 
States, ``gross income'' is defined as gross receipts less cost 
of goods sold.
            Active business test
    A resident satisfies the active business test if it is 
engaged in the active conduct of a trade or business in its 
country of residence; the income is connected with or 
incidental to that trade or business; and the trade or business 
is substantial in relation to the activity in the other country 
generating the income. However, the proposed protocol provides 
that the business of making or managing investments does not 
constitute an active trade or business (and benefits therefore 
may be denied) unless such activity is a banking, insurance, or 
securities activity conducted by a bank, insurance company, or 
registered securities dealer.
    The proposed protocol provides that the determination of 
whether a trade or business is substantial is made based on all 
facts and circumstances. However, the proposed protocol 
provides a safe harbor rule under which a trade or business of 
the resident is considered to be substantial if certain 
attributes of the residence-country business exceed a threshold 
fraction of the corresponding attributes of the trade or 
business located in the source country that produces the 
source-country income. Under this safe harbor, the attributes 
are assets, gross income, and payroll expense. To satisfy the 
safe harbor, the level of each such attribute in the active 
conduct of the trade or business by the resident (and any 
related parties) in the residence country, and the level of 
each such attribute in the trade or business producing the 
income in the source country, is measured for the prior year or 
for the prior three years. For each separate attribute, the 
ratio of the residence country level to the source country 
level is computed.
    In general, the safe harbor is satisfied if, for the prior 
year or for the average of the three prior years, the average 
of the three ratios exceeds 10 percent, and each ratio 
separately is at least 7.5 percent. These rules are similar to 
those contained in the U.S. model. In determining these ratios, 
only amounts to the extent of the resident's direct or indirect 
ownership interest in the activity in the other treaty country 
are taken into account. The Technical Explanation provides that 
if neither the resident nor any of its associated enterprises 
has an ownership interest in the activity in the other country, 
the resident's trade or business in its country of residence is 
considered substantial in relation to such activity.
    The proposed protocol provides that income is derived in 
connection with a trade or business if the activity in the 
other country generating the income is a line of business that 
forms a part of or is complementary to the trade or business. 
The Technical Explanation states that a business activity 
generally is considered to ``form a part of'' a business 
activity conducted in the other country if the two activities 
involve the design, manufacture, or sale of the same products 
or type of products, or the provision of similar services. The 
Technical Explanation further provides that in order for two 
activities to be considered to be ``complementary,'' the 
activities need not relate to the same types of products or 
services, but they should be part of the same overall industry 
and be related in the sense that the success or failure of one 
activity will tend to result in success or failure for the 
other. Under the proposed protocol, income is incidental to a 
trade or business if it facilitates the conduct of the trade or 
business in the other country.
    The term ``trade or business'' is not specifically defined 
in the proposed treaty or proposed protocol. However, as 
provided in Article 3 (General Definitions), undefined terms 
are to have the meaning which they have under the laws of the 
country applying the proposed treaty. In this regard, the 
Technical Explanation states that the U.S. competent authority 
will refer to the regulations issued under Code section 367(a) 
to define an active trade or business.
            Grant of treaty benefits by the competent authority
    The proposed protocol provides a ``safety-valve'' for a 
person that has not established that it meets one of the other 
more objective tests, but for which the allowance of treaty 
benefits would not give rise to abuse or otherwise be contrary 
to the purposes of the treaty. Under this provision, such a 
person may be granted treaty benefits if the competent 
authority of the source country so determines. The 
corresponding article in the U.S. model contains a similar 
rule. The Technical Explanation states that for this purpose, 
factors the competent authorities are to take into account are 
whether the establishment, acquisition, and maintenance of the 
person, and the conduct of its operations, did not have as one 
of its principal purposes the obtaining of treaty benefits.

Article 3

    This article of the proposed protocol contains the standard 
rule that the proposed treaty will not restrict in any manner 
any exclusion, exemption, deduction, credit, or other allowance 
accorded by internal law or by any other agreement between the 
United States and Italy. Thus, the proposed treaty will not 
apply to increase the tax burden of a resident of either the 
United States or Italy.
    This article also provides that the dispute resolution 
procedures under the mutual agreement article take precedence 
over the corresponding provisions of any other agreement to 
which the United States and Italy are parties in determining 
whether a measure is within the scope of the proposed treaty. 
It also provides that, unless the competent authorities agree 
that a taxation measure is outside the scope of the proposed 
treaty, only the proposed treaty's non-discrimination rules, 
and not the non-discrimination rules of any other agreement in 
effect between the United States and Italy, generally apply to 
that measure. The only exception to this general rule is such 
national treatment or most favored nation obligations as may 
apply to trade in goods under the General Agreement on Tariffs 
and Trade. For purposes of this provision, the term ``measure'' 
means a law, regulation, rule, procedure, decision, 
administrative action, or any similar provision or action.

Article 4

    This article provides that a U.S. citizen and Italian 
resident who is a partner in a U.S. partnership is entitled to 
a refundable credit against his or her Italian individual 
income tax (l'imposta sul reddito delle persone fisiche) for 
the taxable period that equals the portion of his Italian 
corporate tax (l'imposta sul reddito delle persone giuridiche) 
that is attributable to his or her share of the partnership 
income. In other words, Italy agrees to treat a U.S. 
partnership in the way that the United States treats it, as a 
flowthrough entity for tax purposes, when the partner whose tax 
is at issue is a U.S. citizen who is an Italian resident.

Article 5

    This article provides for one method by which the competent 
authority of one of the two countries may allow the reduced 
withholding tax rates of the proposed treaty. The article 
establishes rules that will apply if either country establishes 
a refund system for withholding taxes whose rates the treaty 
reduces. In the case of such a refund system, the source 
country will withhold taxes at the regular rate, without regard 
to treaty reduction of that rate. Thereupon, the taxpayer 
receiving the income is to make to the source country a claim 
for refund (within the time fixed by law of the source country 
for claiming a refund) and to furnish with the claim an 
official certificate of his residence country that certifies 
the existence of the conditions allowing the reduced treaty 
rate to that taxpayer. The proposed treaty does not obligate 
the United States or Italy to establish a refund system. The 
United States does not presently use such a system, but rather, 
allows a payor to reduce withholding taxes at the source based 
on residence documentation provided by the beneficial owner of 
a U.S.-source payment.

Article 6

    This article provides that each country may collect taxes 
for the other country to the extent necessary to insure that 
benefits of the treaty are not going to persons not entitled to 
those benefits. This treaty obligation does not oblige either 
country to use administrative measures that it does not use in 
collecting its own taxes or that are contrary to its 
sovereignty, security, or public policy.

Article 7

    This article contains two provisions. The first states that 
either country may request consultations with the other country 
to determine whether amendment to the proposed treaty is 
appropriate to respond to changes in the law or policy of 
either country. If these consultations determine that the 
effect of the proposed treaty or its application have been 
changed by domestic legislation of either country resulting in 
an alteration to the balance of benefits provided by the 
proposed treaty, further consultations shall occur with a view 
toward amending the proposed treaty to restore an appropriate 
balance of benefits.
    The second provision in this article relates to the 
implementation of the mutual agreement procedures of the 
proposed treaty. This provision states that within three years 
of the entry into force of the proposed treaty, the competent 
authorities shall consult with respect to the implementation of 
the mutual agreement procedures. They shall take into account 
experience with respect to the mutual agreement procedures and 
shall determine whether modifications to that article of the 
proposed treaty would be appropriate. In addition, after taking 
into account experience with respect to arbitration of 
international tax disputes, they shall also determine whether 
it is appropriate to exchange the diplomatic notes that are 
prerequisite to the commencement of the arbitration procedures 
of the proposed treaty.
    The Memorandum of Understanding provides further detail 
regarding the arbitration proceedings. First, it states that 
the requisite diplomatic notes will be exchanged when the 
experience of the two countries with respect to similar 
provisions in other specified treaties has proven to be 
satisfactory. Second, if this condition is satisfied and the 
arbitration procedures become operative, the Memorandum of 
Understanding specifies that the results of the arbitration are 
to be binding. Third, it provides procedural rules for the 
arbitration, such as specifying time limits, appointment 
procedures for arbitrators, and rules for costs.

Article 8

    Under this article of the proposed protocol, if a U.S. 
state or local government imposes tax on the profits of Italian 
enterprises from the operation of ships or aircraft in 
international traffic, Italy may impose its regional tax on 
productive activities (l'imposta regionale sulle attivita 
produttive) on the profits of U.S. enterprises from such 
activities, notwithstanding the provisions of Article 2 (Taxes 
Covered) and Article 8 (Shipping and Air Transport) of the 
proposed treaty.

               X. Text of the Resolution of Ratification

    Resolved, (two-thirds of the Senators present concurring 
therein), That the Senate advise and consent to the 
ratification of the Convention between the Government of the 
United States of America and the Government of the Italian 
Republic for the Avoidance of Double Taxation with Respect to 
Taxes on Income and the Prevention of Fraud or Fiscal Evasion, 
signed at Washington on August 25, 1999, together with a 
Protocol (Treaty Doc. 106-11), subject to the reservation of 
subsection (a), the understanding of subsection (b), the 
declaration of subsection (c), and the proviso of subsection 
(d).
    (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) Main purpose tests.--Paragraph 10 of Article 10 
        (Dividends), paragraph 9 of Article 11 (Interest), 
        paragraph 8 of Article 12 (Royalties), and paragraph 3 
        of Article 22 (Other Income) of the Convention, and 
        paragraph 19 of Article 1 of the Protocol (dealing with 
        Article 25 (Mutual Agreement Procedure) of the 
        Convention) shall be stricken in their entirety, and 
        paragraph 20 of Article 1 of the Protocol shall be 
        renumbered as paragraph 19.
    (b) Understanding.--The Senate's advice and consent is 
subject to the following understanding, which shall be included 
in the instrument of ratification, and shall be binding on the 
President:
          (1) Exchange of information.--The United States 
        understands that, pursuant to Article 26 of the 
        Convention, both the competent authority of the United 
        States and the competent authority of the Republic of 
        Italy have the authority to obtain and provide 
        information held by financial institutions, nominees or 
        persons acting in an agency or fiduciary capacity, or 
        respecting interests in a person.
    (c) Declaration.--The Senate's advice and consent is 
subject to the following declaration, which shall be binding on 
the President:
          (1) Treaty interpretation.--The Senate affirms the 
        applicability to all treaties of the constitutionally 
        based principles of treaty interpretation set forth in 
        Condition (1) of the resolution of ratification of the 
        INF Treaty, approved by the Senate on May 27, 1988, and 
        Condition (8) of the resolution of ratification of the 
        Document Agreed Among the States Parties to the Treaty 
        on Conventional Armed Forces in Europe, approved by the 
        Senate on May 14, 1997.
    (d) Proviso.--The resolution of ratification is subject to 
the following proviso, which shall be binding on the President:
          (1) Supremacy of constitution.--Nothing in the 
        Convention 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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