[Senate Executive Report 108-4]
[From the U.S. Government Publishing Office]
108th Congress Exec. Rpt.
SENATE
1st Session 108-4
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PROTOCOL AMENDING THE TAX CONVENTION
WITH MEXICO
_______
March 13, 2003.--Ordered to be printed
_______
Mr. Lugar from the Committee on Foreign Relations,
submitted the following
R E P O R T
[To accompany Treaty Doc. 108-3]
The Committee on Foreign Relations, to which was referred
the Second Additional Protocol That Modifies the Convention
Between the Government of the United States of America and the
Government of the United Mexican States for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income, signed at Mexico City on November
26, 2002, having considered the same, reports favorably thereon
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.................................2
V. Committee Action.................................................3
VI. Committee Comments...............................................3
VII. Budget Impact....................................................7
VIII.Explanation of Proposed Treaty...................................7
IX. Text of Resolution of Ratification...............................7
I. Purpose
The principal purposes of the existing income tax treaty
between the United States and Mexico and the proposed protocol
amending the existing treaty between the United States and
Mexico 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 taxes
of the two countries. The existing treaty and proposed protocol
also are intended to continue to promote close economic
cooperation between the two countries and to eliminate possible
barriers to trade and investment caused by overlapping taxing
jurisdictions of the two countries.
II. Background
The proposed protocol was signed on November 26, 2002. The
proposed protocol would amend the existing income tax treaty
between the United States and Mexico that was signed in 1992.
The proposed protocol was transmitted to the Senate for
advice and consent to its ratification on February 25, 2003
(see Treaty Doc. 108-3). The Committee on Foreign Relations
held a public hearing on the proposed protocol on March 5,
2003.
III. Summary
The proposed protocol includes provisions similar to those
of other recent U.S. income tax treaties, the 1996 U.S. model
income tax treaty (``U.S. model''), and the 1992 model income
tax treaty of the Organization for Economic Cooperation and
Development, as updated (``OECD model''). However, the proposed
protocol contains certain substantive deviations from these
treaties and models.
As in other U.S. tax treaties, the purposes of the protocol
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.
In the case of dividends, the proposed protocol contains
provisions that would eliminate source-country tax on certain
intercompany dividends in which certain ownership thresholds
and other requirements are satisfied. In addition, the proposed
protocol would provide a parallel exemption from the U.S.
branch profits tax (Articles 2 and 3 of the proposed protocol).
In situations in which the country of source retains the
right under the proposed treaty to tax income derived by
residents of the other country, the proposed protocol 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 (Articles 4 and
5 of the proposed protocol).
IV. Entry Into Force and Termination
A. ENTRY INTO FORCE
The proposed protocol will enter into force on the date on
which the second of the two notifications of the completion of
ratification requirements has been received. Each country must
notify the other through diplomatic channels when its
constitutional requirements for ratification have been
satisfied. The proposed protocol will be effective with respect
to dividends paid or credited on or after the first day of the
second month after the date on which the protocol enters into
force. All other provisions of the proposed protocol will be
effective for taxable periods beginning on or after the first
day of January of the year following the year in which the
proposed protocol enters into force.
B. TERMINATION
The existing treaty, as amended by the proposed protocol,
will remain in force until terminated by either country. Either
country may terminate the treaty by giving notice of
termination to the other country through diplomatic channels.
In such case, a termination is effective in respect of taxes
imposed in accordance with Articles 10 (Dividends), 11
(Interest) and 12 (Royalties) for amounts paid or credited on
or after the first day of the second month next following the
expiration of the six month period following notice of
termination. A termination is effective in respect of other
taxes for taxable periods beginning on or after first day of
January following the expiration of the 6 month period
following notice of termination.
V. Committee Action
The Committee on Foreign Relations held a public hearing on
the proposed protocol with Mexico (Treaty Doc. 108-3) on March
5, 2003. The hearing was chaired by Senator Hagel. \1\ The
Committee considered the proposed protocol on March 12, 2003,
and ordered the proposed protocol with Mexico favorably
reported by a vote
of 19 in favor and 0 against, with the recommendation that the
Senate give its advice and consent to ratification of the
proposed
treaty.
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\1\ The transcript of this hearing will be forthcoming as a
separate Committee print.
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VI. Committee Comments
On balance, the Committee on Foreign Relations believes
that the proposed protocol with Mexico 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 protocol
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. ZERO RATE OF WITHHOLDING TAX ON DIVIDENDS FROM 80-PERCENT-OWNED
SUBSIDIARIES
In general
The proposed protocol would eliminate withholding tax on
dividends paid by one corporation to another corporation that
owns at least 80 percent of the stock of the dividend-paying
corporation (often referred to as ``direct dividends''),
provided that certain conditions are met (subparagraph 3(a) of
Article 10 of the current treaty (Dividends)). The elimination
of withholding tax under these circumstances is intended to
reduce further the tax barriers to direct investment between
the two countries.
Currently, no U.S. treaty provides for a complete exemption
from withholding tax under these circumstances, nor do the U.S.
or OECD models. However, many bilateral tax treaties to which
the United States is not a party eliminate withholding taxes
under similar circumstances, and the same result has been
achieved within the European Union under its ``Parent-
Subsidiary Directive.'' In addition, the United States has
signed a proposed treaty with the United Kingdom and a proposed
protocol with Australia that include zero-rate provisions
similar to the one in the proposed protocol.
Description of provision
Under the proposed protocol, the withholding tax rate is
reduced to zero on certain dividends beneficially owned by a
company that has owned at least 80 percent of the voting power
of the company paying the dividend for the 12-month period
ending on the date the dividend is declared (subparagraph 3(a)
of Article 10 of the current treaty (Dividends)). Under the
current U.S.-Mexico treaty, these dividends may be taxed at a
5-percent rate.
Benefits and costs of adopting a zero rate with Mexico
Tax treaties mitigate double taxation by resolving the
potentially conflicting claims of a residence country and a
source country to tax the same item of income. In the case of
dividends, standard international practice is for the source
country to yield mostly or entirely to the residence country.
Thus, the residence country preserves its right to tax the
dividend income of its residents, and the source country agrees
either to limit its withholding tax to a relatively low rate
(e.g., 5 percent) or to forgo it entirely.
Treaties that permit a positive rate of dividend
withholding tax allow some degree of double taxation to
persist. To the extent that the residence country allows a
foreign tax credit for the withholding tax, this remaining
double taxation may be mitigated or eliminated, but then the
priority of the residence country's claim to tax the dividend
income of its residents is not fully respected. Moreover, if a
residence country imposes limitations on its foreign tax
credit, withholding taxes may not be fully creditable as a
practical matter, thus leaving some double taxation in place.
For these reasons, dividend withholding taxes are commonly
viewed as barriers to cross-border investment. The principal
argument in favor of eliminating withholding taxes on certain
direct dividends in the proposed treaty is that it would remove
one such barrier.
Direct dividends arguably present a particularly
appropriate case in which to remove the barrier of a
withholding tax, in view of the close economic relationship
between the payor and the payee. Whether in the United States
or in Mexico, the dividend-paying corporation generally faces
full net-basis income taxation in the source country, and the
dividend-receiving corporation generally is taxed in the
residence country on the receipt of the dividend (subject to
allowable foreign tax credits). If the dividend-paying
corporation is at least 80-percent owned by the dividend-
receiving corporation, it is arguably appropriate to regard the
dividend-receiving corporation as a direct investor (and
taxpayer) in the source country in this respect, rather than
regarding the dividend-receiving corporation as having a more
remote investor-type interest warranting the imposition of a
second-level source-country tax.
Since Mexico does not currently impose a withholding tax on
these dividends under its internal law, the zero-rate provision
would principally benefit direct investment in the United
States by Mexican companies, as opposed to direct investment in
Mexico by U.S. companies. In other words, the potential
benefits of the provision would accrue mainly in situations in
which the United States is importing capital, as opposed to
exporting it.
However, it should be noted that, although Mexican internal
law currently does not impose a withholding tax on dividends
paid to foreign persons, there is no guarantee that this will
always be the case. Indeed, Mexican law has changed recently in
this regard--Mexico adopted a dividend withholding tax in 1999,
but then repealed it in 2001 (effective for dividends paid
after 2001). Thus, the inclusion of a zero-rate provision under
the proposed protocol would give U.S.-based enterprises
somewhat greater certainty as to the applicability of a zero
rate in Mexico, which arguably would facilitate long-range
business planning for U.S. companies in their capacities as
capital exporters. Along the same lines, the provision would
protect the U.S. fisc against increased foreign tax credit
claims in the event that Mexico were to change its internal law
in this regard.
Although the United States has never agreed bilaterally to
a zero rate of withholding tax on direct dividends, many other
countries have done so in one or more of their bilateral tax
treaties. These countries include OECD members Austria,
Denmark, France, Finland, Germany, Iceland, Ireland, Japan,
Luxembourg, Mexico, the Netherlands, Norway, Sweden,
Switzerland, and the United Kingdom, as well as non-OECD-
members Belarus, Brazil, Cyprus, Egypt, Estonia, Israel,
Latvia, Lithuania, Mauritius, Namibia, Pakistan, Singapore,
South Africa, Ukraine, and the United Arab Emirates. In
addition, a zero rate on direct dividends has been achieved
within the European Union under its ``Parent-Subsidiary
Directive.'' Finally, many countries have eliminated
withholding taxes on dividends as a matter of internal law
(e.g., the United Kingdom and Mexico). Thus, although the zero-
rate provision in the proposed protocol is unprecedented in
U.S. treaty history, there is substantial precedent for it in
the experience of other countries. It may be argued that this
experience constitutes an international trend toward
eliminating withholding taxes on direct dividends, and that the
United States would benefit by joining many of its treaty
partners in this trend and further reducing the tax barriers to
cross-border direct investment.
Committee conclusions
The Committee believes that every tax treaty must strike
the appropriate balance of benefits in the allocation of taxing
rights. The agreed level of dividend withholding for
intercompany dividends is one of the elements that make up that
balance, when considered in light of the benefits inuring to
the United States from other concessions the treaty partner may
make, the benefits of facilitating stable cross-border
investment between the treaty partners, and each partner's
domestic law with respect to dividend withholding tax.
In the case of this protocol, considered as a whole, the
Committee believes that the elimination of withholding tax on
intercompany dividends appropriately addresses a barrier to
cross-border investment. The Committee believes, however, that
the Treasury Department should only incorporate similar
provisions into future treaty or protocol negotiations on a
case-by-case basis, and it notes with approval Treasury's
statement that ``[i]n light of the range of facts that should
be considered, the Treasury Department does not view
[elimination of withholding tax on intercompany dividends] as a
blanket change in the United States' tax treaty practice.''
The Committee encourages the Treasury Department to develop
criteria for determining the circumstances under which the
elimination of withholding tax on intercompany dividends would
be appropriate in future negotiations with other countries. The
Committee expects the Treasury Department to consult with the
Committee with regards to these criteria and to the
consideration of elimination of the withholding tax on
intercompany dividends in future treaties.
B. MOST-FAVORED NATION PROVISION
Under the current U.S.-Mexico income tax treaty, dividends
beneficially owned by a company that owns at least 10 percent
of the voting stock of the dividend-paying company are subject
to a maximum withholding rate of 5 percent (paragraph 2(a) of
Article 10 of the current treaty), which is the lowest rate of
withholding tax on dividends currently available under U.S.
treaties. Under Protocol 1 to that treaty, the United States
and Mexico agreed that if the United States agreed in a treaty
with another country to impose a lower rate on dividends than
the 5% rate, ``both Contracting States shall apply that lower
rate instead of the [5%] rate.''
At the time the Committee considered the original Mexico
income tax treaty, the Committee was concerned with the self-
executing nature of the provision in the Mexico protocol. As a
result, the Senate provided its advice and consent to the
ratification of the treaty subject to an understanding ``that
the phrase `both Contracting States shall apply that lower
rate' . . . is understood to mean that both Contracting States
agree to promptly amend the Convention to incorporate that
lower rate.''
The adoption of a zero-rate provision in the U.S.-Australia
or the U.S.- U.K. treaty relationship would implicate this
commitment to amend the current treaty with Mexico.
Committee conclusions
The Committee remains concerned with the self-executing
nature of the provision in the original Mexico protocol. The
Committee believes that a subsequent amendment to any
previously ratified treaty should be subject to the advice and
consent of the Senate. The Committee is not persuaded by those
who have contended that the Senate would de facto approve the
amendment in giving its advice and consent to a subsequent
treaty that triggered the most favored nation clause. Such
provisions disrupt the delicate balance of power between the
legislative and executive branches of government.
It is the Committee's understanding that subsequent
treaties have not included such self-executing provisions. The
Committee notes its continuing concern regarding the effect of
such provisions and expects that the Treasury Department will
not include such provisions in future treaties.
VII. Budget Impact
The Committee has been informed by the staff of the Joint
Committee on Taxation that the proposed protocol is estimated
to cause a negligible change in Federal budget receipts during
the fiscal year 2003-2012 period.
VIII. Explanation of Proposed Treaty
A detailed, article-by-article explanation of the proposed
protocol between the United States and Mexico can be found in
the pamphlet of the Joint Committee on Taxation entitled
Explanation of Proposed Protocol to the Income Tax Treaty
Between the United States and Mexico (JCS-6-03), March 3, 2003.
IX. Text of Resolution of Ratification
Resolved (two-thirds of the Senators present concurring
therein), That the Senate advise and consent to the
ratification of the Second Additional Protocol That Modifies
the Convention Between the Government of the United States of
America and the Government of the United Mexican States for the
Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with Respect to Taxes on Income, signed at Mexico City
on November 26, 2002 (Treaty Doc. 108-3).