[Senate Executive Report 110-16]
[From the U.S. Government Publishing Office]
110th Congress Exec. Rept.
SENATE
2d Session 110-16
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TAX CONVENTION AND PROTOCOL WITH BULGARIA
_______
September 11, 2008.--Ordered to be printed
_______
Mr. Dodd, from the Committee on Foreign Relations,
submitted the following
REPORT
[To accompany Treaty Doc. 110-18]
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 Republic of Bulgaria for the
Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with Respect to Taxes on Income, with accompanying
Protocol, signed at Washington on February 23, 2007, as well as
the Protocol Amending the Convention between the Government of
the United States of America and the Government of the Republic
of Bulgaria for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income,
signed at Sofia on February 26, 2008 (Treaty Doc. 110-18),
having considered the same, reports favorably thereon with one
declaration, as indicated in the resolution of advice and
consent, and recommends that the Senate give its advice and
consent to ratification thereof, as set forth in this report
and the accompanying resolution of advice and consent.
CONTENTS
Page
I. Purpose..........................................................1
II. Background.......................................................2
III. Major Provisions.................................................2
IV. Entry Into Force; Effective Dates................................6
V. Implementing Legislation.........................................6
VI. Committee Action.................................................6
VII. Committee Recommendation and Comments............................6
VIII.Resolution of Advice and Consent to Ratification.................7
IX. Annex I.--Technical Explanation..................................9
X. Annex II.--Responses to Additional Questions Submitted for the
Record.........................................................107
I. Purpose
The Convention, as amended by the 2008 Protocol, would
promote and facilitate trade and investment between the United
States and Bulgaria. In particular, the Convention is designed
principally to reduce tax barriers to cross-border investment,
provide for better exchange of tax information, and facilitate
cross-border tax administration more generally.
II. Background
The Convention, the first income tax treaty concluded
between the United States and Bulgaria, was signed on February
23, 2007. Before transmitting the Convention to the Senate,
however, the executive branch concluded a Protocol to amend the
Convention, which was signed just over a year later on February
26, 2008. The 2008 Protocol essentially contains technical
corrections to the 2007 Convention that would, as explained by
the Treasury Department, ``address features of the Bulgarian
tax system and treaty network that could result in a Bulgarian
tax exemption for U.S. source income attributable to offshore
branches of the Bulgarian company receiving the U.S. source
income.'' The 2008 Protocol would amend the Convention to
address this potential and unintended ``double exemption.''
With some notable exceptions discussed below, the Convention,
as amended by the 2008 Protocol, is generally consistent with
the 2006 U.S. Model Tax Treaty and with tax treaties that the
United States has with other countries.
III. Major Provisions
A detailed, article-by-article analysis of the Convention
may be found in the Technical Explanation published by the
Department of the Treasury on July 10, 2008, which is reprinted
in Annex I. In addition, the staff of the Joint Committee on
Taxation prepared an analysis of the Convention, Document JCX-
59-08 (July 8, 2008), which was of great assistance to the
committee in reviewing the Convention. A summary of the key
provisions of the Convention is set forth below.
1. Dividends
Under the Convention, withholding taxes on cross-border
portfolio dividend payments may be imposed at a maximum rate of
10 percent. See Article 10(2)(b). When the beneficial owner of
a cross-border dividend is a company that directly owns at
least 10 percent of the stock of the company paying the
dividend, a withholding tax may be imposed at a maximum rate of
five percent. See Article 10(2)(a). No withholding tax,
however, is permitted on dividends paid by a company resident
in one of the countries to a pension fund that is a resident in
the other country provided the dividend is not derived from the
carrying on of a trade or business by such pension fund. See
Article 10(4).
2. Royalties and Interest
Under the Convention, withholding taxes on cross-border
royalty payments would be imposed at a maximum rate of five
percent. See Article 12(2). Similarly, withholding taxes on
cross-border interest payments may be imposed at a maximum rate
of five percent. See Article 11(2). No withholding tax on a
cross-border interest payment is generally permitted, however,
when the interest is beneficially owned by the government of
the other country (or by a central bank or other institution
wholly owned by that government); a resident of the other
country with respect to debt-claims guaranteed, insured or
indirectly financed by the government of the other country (or
an institution controlled by that government); a pension fund
resident in the other country, provided the interest is not
derived from the carrying on of a trade or business by such
pension fund; or, with some exceptions, a financial institution
(including a bank or insurance company) resident in the other
country. See Article 11(3).
Under the 2007 Protocol signed on the same day as the
Convention, the United States and Bulgaria are to reconsider
source-country taxation of interest and royalties arising in
Bulgaria and beneficially owned by a resident of the United
States, at a time that is ``consistent with the conclusion of
the transition period'' under a European Union Council
Directive (``EU Directive'') applicable to interest and
royalties deemed to arise in Bulgaria and beneficially owned by
a resident of the European Union, which is due to occur on
December 31, 2014. See Paragraph 7 of the 2007 Protocol.
In response to Committee questions regarding this
commitment to consult, the Treasury Department indicated that:
At the conclusion of the transition period under the [EU
Directive], Bulgaria is expected to adopt rates of withholding
on cross-border interest and royalties for residents of
European Union member states that are lower than the rate
provided for in the proposed treaty. The provision of the 2007
Protocol is intended to memorialize the understanding between
Bulgaria and the United States that the United States will have
the opportunity at the conclusion of the transition period to
negotiate a further protocol to the proposed treaty with
Bulgaria that could reduce the maximum rate of withholding that
may be imposed on cross-border interest and royalties arising
in Bulgaria.
3. Permanent Establishment
In general, U.S. bilateral tax treaties attempt to ensure
that a person or entity is not subject to undue and overly
burdensome taxation in instances in which the taxpayer has
minimal contacts with the taxing jurisdiction. This is
accomplished in the Convention through 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. See Article 7(1). A permanent establishment is
generally defined as ``a fixed place of business through which
the business of an enterprise is wholly or partly carried on.''
See Article 5(1). Examples include a place of management,
offices, branches, and factories. See Article 5(2).
The Convention, however, includes a special rule that would
effectively expand the definition of a permanent establishment
in a way that would affect enterprises that provide services.
Specifically, an enterprise of one country would be deemed to
have a permanent establishment in the other country if either
a) services are performed by an individual who is present in
the other country for at least 183 days during any 12-month
period and more than 50 percent of the enterprise's gross
active business revenues during that time is income derived
from those services, or (b) the services are provided in the
other country for at least 183 days during any 12-month period
with respect to the same or a connected project for customers
who are residents of that country or who have a permanent
establishment there for which the services are provided. See
Article 5(8). Thus, an enterprise that met either of these
criteria would be deemed to have a permanent establishment in
the treaty partner country, even if it did not have a fixed
place of business in that country, and attributable business
profits would be subject to tax by that country.
This special rule presents a number of administrative and
compliance challenges. For example, a number of the terms used
in this rule, such as what constitutes ``presence'' or a
``connected project,'' are ambiguous and require further
clarification. In addition, when combined with Article 14 of
the Convention, further complexities arise. Article 14(1) of
the Convention, with certain exceptions, sets forth a general
rule that if an employee who is a resident of one treaty
country (the ``residence country'') is working in the other
treaty country (the ``employment country''), his or her
salaries, wages, and other remuneration derived from the
exercise of employment in that country may be taxed by that
country (the employment country). Notwithstanding this general
rule, Article 14(2) of the treaty provides that the
remuneration derived by the employee from the exercise of
employment in the employment country shall be taxed only by the
residence country (and not the employment country) if: 1) the
employee is present in the employment country for 183 days or
less in any 12-month period commencing or ending in the taxable
year concerned; 2) the remuneration is paid by, or on behalf
of, an employer who is not a resident of the employment
country; and 3) the remuneration is not ``borne'' by a
permanent establishment that the employer has in the employment
country. It is the final requirement, which states that the
remuneration must not be ``borne'' by a permanent establishment
that the employer has in the employment country, that interacts
with the special rule in Article 5(8) in a potentially
significant and negative way.
In other words, the salaries, wages, and other remuneration
derived by an employee performing services through a permanent
establishment arising under Article 5(8) of the Treaty would be
subject under Article 14 to being taxed by the employment
country, even if the other requirements of the test in Article
14(2) had been met. Thus, the interaction of these two
provisions increases the complexities associated with the
special rule. For example, such a scenario would mean that an
employer and the relevant employees would need to fulfill
several tax-related obligations, including obtaining tax
identification numbers and providing for the withholding of
income taxes and other taxes as appropriate that would cover
the period beginning on the first day such services were
performed by such employee during the affected year, despite
the fact that they may not know whether the enterprise will be
deemed to have a permanent establishment under the Treaty until
perhaps 6 months into the relevant 12-month period, and will
therefore be subject to various taxes, including employment
taxes, by the services country reaching back to the beginning
of the relevant 12-month period.
Another aspect of the rule that would appear to be
difficult to manage is that the 12-month period is not tied to
a fiscal or calendar year. Also, it is necessary to determine
whether customers in the source country are residents or have a
permanent establishment in that country. Moreover, an
enterprise with a deemed permanent establishment in another
country that is not an actual fixed base is unlikely to have
the infrastructure in that other country to do the things
necessary to comply with the rules of this provision. For
example, such an enterprise is unlikely to keep in the
employment country a full set of financial records or records
tracking employees' activities there.
The committee asked the Treasury Department a number of
questions regarding this provision in an attempt to gain
greater insight and clarity into its operation. These questions
and answers can be found in Annex II.
4. Limitation on Benefits
Consistent with current U.S. treaty policy, the Convention
includes a ``Limitation on Benefits'' provision, which is
designed to avoid treaty-shopping by limiting the indirect use
of a treaty's benefits by persons who were not intended to take
advantage of those benefits. Among other things, this provision
provides that a company resident in a treaty country whose
shares are regularly traded on a recognized stock exchange may
qualify for treaty benefits if the company satisfies one of two
tests: either the company must be primarily traded on a
recognized stock exchange in its country of residence or the
company's primary place of management and control must be in
its country of residence. See Article 21(2). This requirement
is intended to ensure that there is an adequate connection to
the company's claimed country of residence.
5. Exchange of Information
The Convention provides for an exchange of information
between the United States and Bulgaria, which will facilitate
the enforcement of U.S. domestic tax rules. Specifically, the
Convention would allow the United States to obtain information
(including bank information) for its own tax purposes. See
Article 25.
6. Fiscally Transparent Entities
The 2006 U.S. Model Tax Treaty allows recipients of
``income, gains, or profits'' through an entity that is
fiscally transparent under the tax laws of the recipient's
residence to enjoy the same treaty benefits on that income as
they would have if the ``income, gains, or profits'' had been
received by them directly. Fiscally-transparent entities (a
subset of which are called ``disregarded entities'') are
entities that act as a conduit, apportioning all income
received to those holding an interest in the entity. There is
no requirement that the income be currently distributed to the
interest holder, only that it be apportioned to them for tax
purposes. Common examples are partnerships and limited
liability companies (LLCs) that do not choose to be taxed as
corporations under the U.S. ``check the box'' provisions. The
Convention provision is consistent with the 2006 U.S. Model Tax
Treaty provision. See Article 1(6).
7. Pension and Pension Funds
The Convention provides that pensions and other similar
remuneration paid to a resident of one country may be taxed
only by that country and only at such time and to the extent
that a pension distribution is made. See Article 17. Moreover,
the Convention would eliminate withholding tax on cross-border
dividend payments to pension funds. See Article 10(4).
IV. Entry Into Force; Effective Dates
The United States and Bulgaria shall notify each other
through diplomatic channels when their respective requirements
for the entry into force of this Convention have been
satisfied. This Convention shall enter into force on the date
of receipt of the later of these notifications.
The provisions of the Convention shall have effect in both
countries with respect to taxes withheld at source, on income
paid or credited on or after the first day of January in the
calendar year next following the year in which this Convention
enters into force; and with respect to other taxes on income,
for any taxable period beginning on or after the first day of
January in the calendar year next following the year in which
this Convention enters into force.
V. Implementing Legislation
As is the case generally with income tax treaties, the
Convention is self-executing and does not require implementing
legislation for the United States.
VI. Committee Action
The committee held a public hearing on the Convention on
July 10, 2008. Testimony was received from Mr. Michael Mundaca,
Deputy Assistant Secretary (International), Office of Tax
Policy, U.S. Department of the Treasury and Emily S. McMahon,
Deputy Chief of Staff to the Joint Committee on Taxation. A
transcript of this hearing can be found in Annex II to
Executive Report 110-15.
On July 29, 2008, the committee considered the Convention
and ordered it favorably reported by voice vote, with a quorum
present and without objection.
VII. Committee Recommendation and Comments
The Committee on Foreign Relations believes that the
Convention, as amended by the 2008 Protocol, will stimulate
increased trade and investment, substantially deny treaty-
shoppers the benefits of this tax treaty, and promote closer
cooperation between the United States and Bulgaria. The
committee therefore urges the Senate to act promptly to give
advice and consent to ratification of the Convention and the
2008 Protocol, as set forth in this report and the accompanying
resolution of advice and consent.
A. SPECIAL PERMANENT ESTABLISHMENT RULE FOR SERVICES
As discussed in Section III, the Convention includes a
special rule that would effectively expand the standard
definition of a permanent establishment in a way that affects
enterprises that provide services. This provision also appears
in the Canada Tax Protocol currently under consideration and
presents a number of serious administrative and compliance
challenges to service enterprises that may be subject to the
rule. The Treasury Department has made clear in testimony
before the committee that the inclusion of this provision in
the Convention and the Canada Tax Protocol ``does not reflect a
change in U.S. tax treaty policy, and inclusion of such a
provision in the U.S. Model is not being considered.'' The
committee welcomes this statement and urges the Treasury
Department to avoid including such a provision in future tax
treaties.
Although the United States has included similar provisions
in some of its tax treaties with developing nations\1\ and a
rationale exists for providing for expanded source taxation in
treaties with developing countries that frequently rely on
service providers from wealthier nations that do not
necessarily have a fixed place of business in their country,
the inherent difficulties in implementing this rule are
substantial.
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\1\The United States has included similar provisions in the tax
treaties with, for example, Indonesia (Treaty Doc. 100-22; Article
5(2)), India (Treaty Doc. 101-5; Article 5(2)), and Thailand (Treaty
Doc. 105-2; Article 5(3)).
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Finally, the committee urges the Treasury Department to
engage in discussions not just with Canada, but also with
Bulgaria, regarding the interpretation and application of the
new rule concerning the taxation of services in an effort to
improve its implementation. Upon completion of such
discussions, the committee urges the Treasury Department to
produce guidance on its application and ways in which
enterprises might approach their compliance.
B. RESOLUTION
The proposed resolution of advice and consent for the
Convention includes a declaration.
Declaration
The committee has included a proposed declaration, which
states that the Convention is self-executing, as is the case
generally with income tax treaties. The committee has in the
past included such a statement in the committee's report but,
in light of the recent Supreme Court decision, Medellin v.
Texas, 128 S. Ct. 1346 (2008), the committee has determined
that a clear statement in the Resolution is warranted. A
further discussion of the committee's views on this matter can
be found in Section VIII of Executive Report 110-12.
VIII. Resolution of Advice and Consent to Ratification
TEXT OF RESOLUTION OF ADVICE AND CONSENT TO RATIFICATION OF THE TAX
CONVENTION AND PROTOCOL WITH BULGARIA
Resolved (two-thirds of the Senators present concurring
therein),
SECTION 1. SENATE ADVICE AND CONSENT SUBJECT TO A DECLARATION
The Senate advises and consents to the ratification of the
Convention between the Government of the United States of
America and the Government of the Republic of Bulgaria for the
Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with Respect to Taxes on Income, with accompanying
Protocol, signed at Washington on February 23, 2007, as well as
the Protocol Amending the Convention between the Government of
the United States of America and the Government of the Republic
of Bulgaria for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income,
signed at Sofia on February 26, 2008 (Treaty Doc. 110-18),
subject to the declaration of section 2.
SECTION 2. DECLARATION
The advice and consent of the Senate under section 1 is
subject to the following declaration:
This Convention is self-executing.
IX. Annex I.--Technical Explanation
TECHNICAL EXPLANATION OF THE CONVENTION BETWEEN THE UNITED STATES OF
AMERICA AND THE REPUBLIC OF BULGARIA FOR THE AVOIDANCE OF DOUBLE
TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON
INCOME, SIGNED AT WASHINGTON ON FEBRUARY 23, 2007
This is a technical explanation of the Convention between
the United States and Bulgaria for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income, signed on February 23, 2007, and the Protocol
between the United States and Bulgaria signed on the same date
(the ``Protocol''), as amended by the Protocol between the
United States and Bulgaria signed on February 26, 2008
(collectively, the ``Convention''). The Protocol is discussed
below in connection with the relevant articles of the
Convention.
Negotiations took into account the U.S. Treasury
Department's current tax treaty policy, and the Treasury
Department's Model Income Tax Convention, updated as of
November 15, 2006. Negotiations also took into account the
Model Tax Convention on Income and on Capital, published by the
Organisation for Economic Cooperation and Development (the
``OECD Model''), and recent tax treaties concluded by both
countries.
The Technical Explanation is an official guide to the
Convention. It reflects the policies behind particular
Convention provisions, as well as understandings reached during
the negotiations with respect to the application and
interpretation of the Convention. References in the Technical
Explanation to ``he'' or ``his'' should be read to mean ``he or
she'' or ``his and her.''
ARTICLE 1 (GENERAL SCOPE)
Paragraph 1
Paragraph 1 of Article 1 provides that the Convention
applies only to residents of the United States or Bulgaria
except where the terms of the Convention provide otherwise.
Under Article 4 (Resident) a person is generally treated as a
resident of a Contracting State if that person is, under the
laws of that State, liable to tax therein by reason of his
domicile, citizenship, residence, or other similar criteria.
However, if a person is considered a resident of both
Contracting States, Article 4 provides rules for determining a
State of residence (or no State of residence). This
determination governs for all purposes of the Convention.
Certain provisions are applicable to persons who may not be
residents of either Contracting State. For example, paragraph 1
of Article 23 (Non-Discrimination) applies to nationals of the
Contracting States. Under Article 25 (Exchange of Information
and Adminis-trative Assistance), information may be exchanged
with respect to residents of third states.
Paragraph 2
Paragraph 2 states the generally accepted relationship both
between the Convention and domestic law and between the
Convention and other agreements between the Contracting States.
That is, no provision in the Convention may restrict any
exclusion, exemption, deduction, credit or other benefit
accorded by the tax laws of the Contracting States, or by any
other agreement between the Contracting States. The
relationship between the non-discrimination provisions of the
Convention and other agreements is addressed not in paragraph 2
but in paragraph 3.
Under paragraph 2, for example, if a deduction would be
allowed under the U.S. Internal Revenue Code (the ``Code'') in
computing the U.S. taxable income of a resident of Bulgaria,
the deduction also is allowed to that person in computing
taxable income under the Convention. Paragraph 2 also means
that the Convention may not increase the tax burden on a
resident of a Contracting State beyond the burden determined
under domestic law. Thus, a right to tax given by the
Convention cannot be exercised unless that right also exists
under internal law.
It follows that, under the principle of paragraph 2, a
taxpayer's U.S. tax liability need not be determined under the
Convention if the Code would produce a more favorable result. A
taxpayer may not, however, choose among the provisions of the
Code and the Convention in an inconsistent manner in order to
minimize tax. A taxpayer may use the treaty to reduce its
taxable income, but may not use both treaty and Code rules
where doing so would thwart the intent of either set of rules.
For example, assume that a resident of Bulgaria has three
separate businesses in the United States. One is a profitable
permanent establishment and the other two are trades or
businesses that would earn taxable income under the Code but
that do not meet the permanent establishment threshold tests of
the Convention. One is profitable and the other incurs a loss.
Under the Convention, the income of the permanent establishment
is taxable in the United States, and both the profit and loss
of the other two businesses are ignored. Under the Code, all
three would be subject to tax, but the loss would offset the
profits of the two profitable ventures. The taxpayer may not
invoke the Convention to exclude the profits of the profitable
trade or business and invoke the Code to claim the loss of the
loss trade or business against the profit of the permanent
establishment. See Rev. Rul. 84-17, 1984-1 C.B. 308. If,
however, the taxpayer invokes the Code for the taxation of all
three ventures, he would not be precluded from invoking the
Convention with respect, for example, to any dividend income he
may receive from the United States that is not effectively
connected with any of his business activities in the United
States.
Similarly, nothing in the Convention can be used to deny
any benefit granted by any other agreement between the United
States and Bulgaria. For example, if certain benefits are
provided for military personnel or military contractors under a
Status of Forces Agreement between the United States and
Bulgaria, those benefits or protections will be available to
residents of the Contracting States regardless of any
provisions to the contrary (or silence) in the Convention.
Paragraph 3
Paragraph 3 specifically relates to non-discrimination
obligations of the Contracting States under the General
Agreement on Trade in Services (the ``GATS''). The provisions
of paragraph 3 are an exception to the rule provided in
paragraph 2 of this Article under which the Convention shall
not restrict in any manner any benefit now or hereafter
accorded by any other agreement between the Contracting
States.Subparagraph 3(a) provides that, unless the competent
authorities determine that a taxation measure is not within the
scope of the Convention, the national treatment obligations of
the GATS shall not apply with respect to that measure. Further,
any question arising as to the interpretation of the
Convention, including in particular whether a measure is within
the scope of the Convention shall be considered only by the
competent authorities of the Contracting States, and the
procedures under the Convention exclusively shall apply to the
dispute. Thus, paragraph 3 of Article XXII (Consultation) of
the GATS may not be used to bring a dispute before the World
Trade Organization unless the competent authorities of both
Contracting States have determined that the relevant taxation
measure is not within the scope of Article 23 (Non-
Discrimination) of the Convention.
The term ``taxation measure'' for these purposes is defined
broadly in subparagraph 3(b). It would include, for example, a
law, regulation, rule, procedure, decision, administrative
action or guidance, or any other form of measure relating to
taxation.
Paragraph 4
Paragraph 4 contains the traditional saving clause found in
all U.S. treaties. The Contracting States reserve their rights,
except as provided in paragraph 5, to tax their residents and
citizens as provided in their internal laws, notwithstanding
any provisions of the Convention to the contrary. For example,
if a resident of Bulgaria performs professional services in the
United States and the income from the services is not
attributable to a permanent establishment in the United States,
Article 7 (Business Profits) would by its terms prevent the
United States from taxing the income. If, however, the resident
of Bulgaria is also a citizen of the United States, the saving
clause permits the United States to include the remuneration in
the worldwide income of the citizen and subject it to tax under
the normal Code rules (i.e., without regard to Code section 8
94(a)). However, subparagraph 5(a) of Article 1 preserves the
benefits of special foreign tax credit rules applicable to the
U.S. taxation of certain U.S. income of its citizens resident
in Bulgaria. See paragraph 4 of Article 22 (Relief from Double
Taxation).
For purposes of the saving clause, ``residence'' is
determined under Article 4 (Resident). Thus, an individual who
is a resident of the United States under the Code (but not a
U.S. citizen) but who is determined to be a resident of
Bulgaria under the tie-breaker rules of Article 4 would be
subject to U.S. tax only to the extent permitted by the
Convention. The United States would not be permitted to apply
its statutory rules to that person to the extent the rules are
inconsistent with the treaty.
However, the person would be treated as a U.S. resident for
U.S. tax purposes other than determining the individual's U.S.
tax liability. For example, in determining under Code section
957 whether a foreign corporation is a controlled foreign
corporation, shares in that corporation held by the individual
would be considered to be held by a U.S. resident. As a result,
other U.S. citizens or residents might be deemed to be United
States shareholders of a controlled foreign corporation subject
to current inclusion of Subpart F income recognized by the
corporation. See Treas. Reg. section 301.7701 (b)-7(a)(3).
Under paragraph 4, the United States also reserves its
right to tax former citizens and former long-term residents for
a period of ten years following the loss of such status with
respect to income from sources within the United States
(including income deemed under the domestic law of the United
States to arise from such sources). Thus, paragraph 4 allows
the United States to tax former U.S. citizens and former U.S.
long-term residents in accordance with section 877 of the Code.
Section 877 generally applies to a former citizen or long-term
resident of the United States who relinquishes citizenship or
terminates long-term residency before June 17, 2008 if either
of the following criteria exceed established thresholds: (a)
the average annual net income tax of such individual for the
period of 5 taxable years ending before the date of the loss of
status, or (b) the net worth of such individual as of the date
of the loss of status. Paragraph 1 of the Protocol provides
that the term ``long-term resident'' means any individual who
is a lawful permanent resident of the United States in eight or
more taxable years during the preceding 15 taxable years. In
determining whether the eight-year threshold is met, one does
not count any year in which the individual is treated as a
resident of Bulgaria under the Convention (or as a resident of
any country other than the United States under the provisions
of any other U.S. tax treaty), and the individual does not
waive the benefits of such treaty applicable to residents of
the other country. This understanding is consistent with how
this provision is generally interpreted in U.S. tax treaties..
Paragraph 5
Paragraph 5 sets forth certain exceptions to the saving
clause. The referenced provisions are intended to provide
benefits to citizens and residents even if such benefits do not
exist under internal law. Paragraph 5 thus preserves these
benefits for citizens and residents of the Contracting
States.Subparagraph (a) lists certain provisions of the
Convention that are applicable to all citizens and residents of
a Contracting State, despite the general saving clause rule of
paragraph 4:
(1) Paragraph 2 of Article 9 (Associated Enterprises)
grants the right to a correlative adjustment with
respect to income tax due on profits reallocated under
Article 9.
(2) Paragraphs 2 and 5 of Article 17 (Pensions,
Social Security Payments, Annuities, Alimony, and Child
Support) provide exemptions from source or residence
State taxation for certain pension distributions and
social security payments.
(3) Article 22 (Relief from Double Taxation) confirms
to citizens and residents of one Contracting State the
benefit of a credit for income taxes paid to the other
or an exemption for income earned in the other State.
(4) Article 23 (Non-Discrimination) protects
residents and nationals of one Contracting State
against the adoption of certain discriminatory
practices in the other Contracting State.
(5) Article 24 (Mutual Agreement Procedure) confers
certain benefits on citizens and residents of the
Contracting States in order to reach and implement
solutions to disputes between the two Contracting
States. For example, the competent authorities are
permitted to use a definition of a term that differs
from an internal law definition. The statute of
limitations may be waived for refunds, so that the
benefits of an agreement may be implemented.
Subparagraph 5(b) provides a different set of exceptions to
the saving clause. The benefits referred to are all intended to
be granted to temporary residents of a Contracting State (for
example, in the case of the United States, holders of non-
immigrant visas), but not to citizens or to persons who have
acquired permanent residence in that State. If beneficiaries of
these provisions travel from one of the Contracting States to
the other, and remain in the other long enough to become
residents under its internal law, but do not acquire permanent
residence status (i.e., in the U.S. context, they do not become
``green card'' holders) and are not citizens of that State, the
host State will continue to grant these benefits even if they
conflict with the statutory rules. The benefits preserved by
this paragraph are: (1) the host country exemptions for
government service salaries and pensions under Article 18
(Government Service), certain income of visiting students,
trainees, teachers, and researchers under Article 19 (Students,
Trainees, Teachers and Researchers), and the income of
diplomatic agents and consular officers under Article 26
(Members of Diplomatic Missions and Consular Posts).
Paragraph 6
Paragraph 6 addresses special issues presented by fiscally
transparent entities such as partnerships and certain estates
and trusts. Because different countries frequently take
different views as to when an entity is fiscally transparent,
the risk of both double taxation and double non-taxation are
relatively high. The intention of paragraph 6 is to eliminate a
number of technical problems that arguably would have prevented
investors using such entities from claiming treaty benefits,
even though such investors would be subject to tax on the
income derived through such entities. The provision also
prevents the use of such entities to claim treaty benefits in
circumstances where the person investing through such an entity
is not subject to tax on the income in its State of residence.
The provision, and the corresponding requirements of the
substantive rules of Articles 6 through 20, should be read with
those two goals in mind.
In general, paragraph 6 relates to entities that are not
subject to tax at the entity level, as distinct from entities
that are subject to tax, but with respect to which tax may be
relieved under an integrated system. This paragraph applies to
any resident of a Contracting State who is entitled to income
derived through an entity that is treated as fiscally
transparent under the laws of either Contracting State.
Entities falling under this description in the United States
include partnerships, common investment trusts under section
584 and grantor trusts. This paragraph also applies to U.S.
limited liability companies (``LLCs'') that are treated as
partnerships or as disregarded entities for U.S. tax purposes.
Under paragraph 6, an item of income derived by such a
fiscally transparent entity will be considered to be derived by
a resident of a Contracting State if a resident is treated
under the taxation laws of that State as deriving the item of
income. For example, if a company that is a resident of
Bulgaria pays interest to an entity that is treated as fiscally
transparent for U.S. tax purposes, the interest will be
considered derived by a resident of the United States only to
the extent that the taxation laws of the United States treats
one or more U.S. residents (whose status as U.S. residents is
determined, for this purpose, under U.S. tax law) as deriving
the interest for U.S. tax purposes. In the case of a
partnership, the persons who are, under U.S. tax laws, treated
as partners of the entity would normally be the persons whom
the U.S. tax laws would treat as deriving the interest income
through the partnership. Also, it follows that persons whom the
United States treats as partners but who are not U.S. residents
for U.S. tax purposes may not claim a benefit for the interest
paid to the entity under the Convention, because they are not
residents of the United States for purposes of claiming this
treaty benefit. (If, however, the country in which they are
treated as resident for tax purposes, as determined under the
laws of that country, has an income tax convention with
Bulgaria, they may be entitled to claim a benefit under that
convention.) In contrast, if, for example, an entity is
organized under U.S. laws and is classified as a corporation
for U.S. tax purposes, interest paid by a company that is a
resident of Bulgaria to the U.S. entity will be considered
derived by a resident of the United States since the U.S.
corporation is treated under U.S. taxation laws as a resident
of the United States and as deriving the income.
The same result obtains even if the entity were viewed
differently under the tax laws of Bulgaria (e.g., as not
fiscally transparent in the first example above where the
entity is treated as a partnership for U.S. tax purposes).
Similarly, the characterization of the entity in a third
country is also irrelevant, even if the entity is organized in
that third country. The results follow regardless of whether
the entity is disregarded as a separate entity under the laws
of one jurisdiction but not the other, such as a single owner
entity that is viewed as a branch for U.S. tax purposes and as
a corporation for tax purposes under the laws of Bulgaria.
These results also obtain regardless of where the entity is
organized (i.e., in the United States, in Bulgaria or, as noted
above, in a third country).
For example, income from U.S. sources received by an entity
organized under the laws of the United States, which is treated
for tax purposes under the laws of Bulgaria as a corporation
and is owned by a shareholder who is a resident of Bulgaria for
its tax purposes, is not considered derived by the shareholder
of that corporation even if, under the tax laws of the United
States, the entity is treated as fiscally transparent. Rather,
for purposes of the treaty, the income is treated as derived by
the U.S. entity.
These principles also apply to trusts to the extent that
they are fiscally transparent in either Contracting State. For
example, if X, a resident of Bulgaria, creates a revocable
trust in the United States and names persons resident in a
third country as the beneficiaries of the trust, the trust's
income would be regarded as being derived by a resident of
Bulgaria only to the extent that the laws of Bulgaria treat X
as deriving the income for its tax purposes, perhaps through
application of rules similar to the U.S. ``grantor trust''
rules.
Paragraph 6 is not an exception to the saving clause of
paragraph 4. Accordingly, paragraph 6 does not prevent a
Contracting State from taxing an entity that is treated as a
resident of that State under its tax law. For example, if a
U.S. LLC with members who are residents of Bulgaria elects to
be taxed as a corporation for U.S. tax purposes, the United
States will tax that LLC on its worldwide income on a net
basis, without regard to whether Bulgaria views the LLC as
fiscally transparent.
ARTICLE 2 (TAXES COVERED)
This Article specifies the U.S. taxes and the taxes of
Bulgaria to which the Convention applies. With two exceptions,
the taxes specified in Article 2 are the covered taxes for all
purposes of the Convention. A broader coverage applies,
however, for purposes of Articles 23 (Non-Discrimination) and
25 (Exchange of Information and Administrative Assistance).
Article 23 (Non-Discrimination) applies with respect to all
taxes, including those imposed by state and local governments.
Article 25 (Exchange of Information and Administrative
Assistance) applies with respect to all taxes imposed at the
national level.
Paragraph 1
Paragraph 1 identifies the category of taxes to which the
Convention applies. Paragraph 1 is based on the U.S. and OECD
Models and defines the scope of application of the Convention.
The Convention applies to taxes on income, including gains,
imposed on behalf of a Contracting State, irrespective of the
manner in which they are levied. Except with respect to Article
23 (Non-Discrimination), state and local taxes are not covered
by the Convention.
Paragraph 2
Paragraph 2 also is based on the U.S. and OECD Models and
provides a definition of taxes on income and on capital gains.
The Convention covers taxes on total income or any part of
income and includes tax on gains derived from the alienation of
property. The Convention does not apply, however, to social
security charges, or any other charges where there is a direct
connection between the levy and individual benefits. Nor does
it apply to property taxes, except with respect to Article 23
(Non-Discrimination).
Paragraph 3
Paragraph 3 lists the taxes in force at the time of
signature of the Convention to which the Convention applies.
The existing covered taxes of Bulgaria are identified in
subparagraph 3(a), as the personal income tax and the corporate
income tax. Paragraph 2 of the Protocol clarifies that these
taxes include the patent tax, which is a tax imposed on certain
small business operations in lieu of a net basis income
tax.Subparagraph 3(b) provides that the existing U.S. taxes
subject to the rules of the Convention are the Federal income
taxes imposed by the Code, together with the excise taxes
imposed with respect to the investment income of foreign
private foundations (Code section 4940). Social security and
unemployment taxes (Code sections 1401, 3101, 3111 and 3301)
are excluded from coverage.
Paragraph 4
Under paragraph 4, the Convention will apply to any taxes
that are identical, or substantially similar, to those
enumerated in paragraph 3, and which are imposed in addition
to, or in place of, the existing taxes after February 23, 2007,
the date of signature of the Convention. The paragraph also
provides that the competent authorities of the Contracting
States will notify each other of any changes that have been
made in their laws, whether tax laws or non-tax laws, that
significantly affect their obligations under the Convention.
Non-tax laws that may affect a Contracting State's obligations
under the Convention may include, for example, laws affecting
bank secrecy.
ARTICLE 3 (GENERAL DEFINITIONS)
Article 3 provides general definitions and rules of
interpretation applicable throughout the Convention. Certain
other terms are defined in other articles of the Convention.
For example, the term ``resident of a Contracting State'' is
defined in Article 4 (Resident). The term ``permanent
establishment'' is defined in Article 5 (Permanent
Establishment). These definitions are used consistently
throughout the Convention. Other terms, such as ``dividends,''
``interest'' and ``royalties'' are defined in specific articles
for purposes only of those articles.
Paragraph 1
Paragraph 1 defines a number of basic terms used in the
Convention. The introduction to paragraph 1 makes clear that
these definitions apply for all purposes of the Convention,
unless the context requires otherwise. This latter condition
allows flexibility in the interpretation of the Convention in
order to avoid results not intended by the Convention's
negotiators.
The geographical scope of the Convention with respect to
Bulgaria is set out in subparagraph 1(a). The term ``Bulgaria''
encompasses the Republic of Bulgaria, including the territory
and the territorial sea over which it exercises its State
sovereignty, as well as the continental shelf and the exclusive
economic zone over which it exercises sovereign rights and
jurisdiction in conformity with international law.
The geographical scope of the Convention with respect to
the United States is set out in subparagraph 1(b). It
encompasses the United States of America, including the states,
the District of Columbia and the territorial sea of the United
States. The term does not include Puerto Rico, the Virgin
Islands, Guam or any other U.S. possession or territory. For
certain purposes, the term ``United States'' includes the sea
bed and subsoil of undersea areas adjacent to the territorial
sea of the United States. This extension applies to the extent
that the United States exercises sovereignty in accordance with
international law for the purpose of natural resource
exploration and exploitation of such areas. This extension of
the definition applies, however, only if the person, property
or activity to which the Convention is being applied is
connected with such natural resource exploration or
exploitation. Thus, it would not include any activityinvolving
the sea floor of an area over which the United States exercised
sovereignty for natural resource purposes if that activity was
unrelated to the exploration and exploitation of natural
resources. This result is consistent with the result that would
be obtained under Code section 638, which treats the
continental shelf as part of the United States for purposes of
natural resource exploration and exploitation.
Subparagraph 1(c) provides that the terms ``a Contracting
State'' and ``the other Contracting State'' shall mean Bulgaria
or the United States, as the context requires.
Subparagraph 1(d) defines the term ``person'' to include an
individual, a company and any other body of persons. Paragraph
3 of the Protocol clarifies that the term ``any other body of
persons'' includes partnerships, trusts, and estates. The
definition is significant for a variety of reasons. For
example, under Article 4, only a ``person'' can be a
``resident'' and therefore eligible for most benefits under the
Convention. Also, all ``persons'' are eligible to claim relief
under Article 24 (Mutual Agreement Procedure).
The term ``company'' is defined in subparagraph 1(e) as a
body corporate or an entity treated as a body corporate for tax
purposes in the state where it is organized. The definition
refers to the law of the state in which an entity is organized
in order to ensure that an entity that is treated as fiscally
transparent in its country of residence will not get
inappropriate benefits, such as the reduced withholding rate
provided by subparagraph 2(b) of Article 10 (Dividends). It
also ensures that the Limitation on Benefits provisions of
Article 21 will be applied at the appropriate level.
The terms ``enterprise of a Contracting State'' and
``enterprise of the other Contracting State'' are defined in
subparagraph 1(f) as an enterprise carried on by a resident of
a Contracting State and an enterprise carried on by a resident
of the other Contracting State. An enterprise of a Contracting
State need not be carried on in that State. It may be carried
on in the other Contracting State or a third state (e.g., a
U.S. corporation doing all of its business in Bulgaria would
still be a U.S. enterprise).
These terms also encompass an enterprise conducted through
an entity (such as a partnership) that is treated as fiscally
transparent in the Contracting State where the entity's owner
is resident. In accordance with Article 4 (Resident), entities
that are fiscally transparent in the Contracting State in which
their owners are resident are not considered to be residents of
that Contracting State (although income derived by such
entities may be taxed as the income of a resident, if taxed in
the hands of resident partners or other owners). An enterprise
conducted by such an entity will be treated as carried on by a
resident of a Contracting State to the extent its partners or
other owners are residents. This approach is consistent with
the Code, which under section 875 attributes a trade or
business conducted by a partnership to its partners and a trade
or business conducted by an estate or trust to its
beneficiaries.
Subparagraph (g) defines the term ``enterprise'' as any
activity or set of activities that constitutes the carrying on
of a business. The term ``business'' is not defined, but
subparagraph (h) provides that it includes the performance of
professional services and other activities of an independent
character. Both subparagraphs are identical to definitions
recently added to the OECD Model in connection with the
deletion of Article 14 (Independent Personal Services) from the
OECD Model. The inclusion of the two definitions is intended to
clarify that income from the performance of professional
services or other activities of an independent character is
dealt with under Article 7 (Business Profits) and not Article
20 (Other Income). Subparagraph (i) further clarifies, at the
request of Bulgaria, that ``business profits'' also include
income from the performance of professional services and other
activities of an independent character.
Subparagraph 1 (j) defines the term ``international
traffic.'' The term means any transport by a ship or aircraft
except when such transport is solely between places within a
Contracting State. The exclusion from international traffic of
transport solely between places within a Contracting State
means, for example, that carriage of goods or passengers solely
between New York and Chicago would not be treated as
international traffic, whether carried by a U.S. or a foreign
carrier. The substantive taxing rules of the Convention
relating to the taxation of income from transport, principally
Article 8 (International Traffic), therefore, would not apply
to income from such carriage. Thus, if the carrier engaged in
internal U.S. traffic were a resident of Bulgaria (assuming
that were possible under U.S. law), the United States would not
be required to exempt the income from that transport under
Article 8. The income would, however, be treated as business
profits under Article 7 (Business Profits), and therefore would
be taxable in the United States only if attributable to a U.S.
permanent establishment of the foreign carrier, and then only
on a net basis. The gross basis U.S. tax imposed by section 887
would never apply under the circumstances described. If,
however, goods or passengers are carried by a carrier resident
in Bulgaria from a non-U.S. port to, for example, New York, and
some of the goods or passengers continue on to Chicago, the
entire transport would be international traffic. This would be
true if the international carrier transferred the goods at the
U.S. port of entry from a ship to a land vehicle, from a ship
to a lighter, or even if the overland portion of the trip in
the United States was handled by an independent carrier under
contract with the original internation*al carrier, so long as
both parts of the trip were reflected in original bills of
lading. For this reason, the Convention, following the U.S.
Model refers, in the definition of ``international traffic,''
to ``such transport'' being solely between places in the other
Contracting State, while the OECD Model refers to the ship or
aircraft being operated solely between such places. The
formulation in the Convention is intended to make clear that,
as in the above example, even if the goods are carried on a
different aircraft for the internal portion of the
international voyage than is used for the overseas portion of
the trip, the definition applies to that internal portion as
well as the external portion.
Finally, a ``cruise to nowhere,'' i.e., a cruise beginning
and ending in a port in the same Contracting State with no
stops in a foreign port, would not constitute international
traffic.
Subparagraph 1(k) designates the ``competent authorities''
for Bulgaria and the United States. The Bulgarian competent
authority is the Minister of Finance or an authorized
representative. The U.S. competent authority is the Secretary
of the Treasury or his delegate. The Secretary of the Treasury
has delegated the competent authority function to the
Commissioner of Internal Revenue, who in turn has delegated the
authority to the Deputy Commissioner (International) LMSB. With
respect to interpretative issues, the Deputy Commissioner
(International) LMSB acts with the concurrence of the Associate
Chief Counsel (International) of the Internal Revenue Service.
The term ``national,'' as it relates to the United States
and to Bulgaria, is defined in subparagraph 1(l). This term is
relevant for purposes of Articles 18 (Government Service) and
23 (Non-Discrimination). A national of one of the Contracting
States is (1) an individual who is a citizen of that State, and
(2) any legal person, partnership or association deriving its
status, as such, from the law in force in the State where it is
established.
Subparagraph 1(m) defines the term ``pension fund'' to
include any person established in a Contracting State that is
generally exempt from income taxation in that State and that is
operated principally to administer or provide pension or
retirement benefits or to earn income for the benefit of one or
more such arrangements. In the case of the United States, the
term ``pension fund'' includes the following: a trust providing
pension or retirement benefits under a Code section 401(a)
qualified pension plan, profit sharing or stock bonus plan, a
trust providing pension or retirement benefits under a Code
section 403(b) plan, a trust that is an individual retirement
account under Code section 408, a Roth individual retirement
account under Code section 408A, or a simple retirement account
under Code section 408(p), a trust providing pension or
retirement benefits under a simplified employee pension plan
under Code section 408(k), a trust described in section 457(g)
providing pension or retirement benefits under a Code section
457(b) plan, and the Thrift Savings Fund (section 7701(j)).
Section 401(k) plans and group trusts described in Rev. Rul.
81-100, 1981-1 C.B. 326, and meeting the conditions of Rev.
Rul. 2004-67, 2204-2 C.B. 28, qualify as pension funds because
they are covered by Code section 401(a).
Paragraph 2
Terms that are not defined in the Convention are dealt with
in paragraph 2.
Paragraph 2 provides that in the application of the
Convention, any term used but not defined in the Convention
will have the meaning that it has under the law of the
Contracting State whose tax is being applied, unless the
context requires otherwise, or the competent authorities have
agreed on a different meaning pursuant to Article 24 (Mutual
Agreement Procedure). If the term is defined under both the tax
and non-tax laws of a Contracting State, the definition in the
tax law will take precedence over the definition in the non-tax
laws. Finally, there also may be cases where the tax laws of a
State contain multiple definitions of the same term. In such a
case, the definition used for purposes of the particular
provision at issue, if any, should be used.
If the meaning of a term cannot be readily determined under
the law of a Contracting State, or if there is a conflict in
meaning under the laws of the two States that creates
difficulties in the application of the Convention, the
competent authorities, as indicated in paragraph 3(f) of
Article 24 (Mutual Agreement Procedure), may establish a common
meaning in order to prevent double taxation or to further any
other purpose of the Convention. This common meaning need not
conform to the meaning of the term under the laws of either
Contracting State.
The reference in paragraph 2 to the internal law of a
Contracting State means the law in effect at the time the
Convention is being applied, not the law as in effect at the
time the Convention was signed. The use of ``ambulatory''
definitions, however, may lead to results that are at variance
with the intentions of the negotiators and of the Contracting
States when the Convention was negotiated and ratified. The
reference in both paragraphs 1 and 2 to the ``context otherwise
requir[ing]'' a definition different from the Convention
definition, in paragraph 1, or from the internal law definition
of the Contracting State whose tax is being imposed, under
paragraph 2, refers to a circumstance where the result intended
by the Contracting States is different from the result that
would obtain under either the paragraph 1 definition or the
statutory definition. Thus, flexibility in defining terms is
necessary and permitted.
ARTICLE 4 (RESIDENT)
This Article sets forth rules for determining whether a
person is a resident of a Contracting State for purposes of the
Convention. As a general matter only residents of the
Contracting States may claim the benefits of the Convention.
The treaty definition of residence is to be used only for
purposes of the Convention. The fact that a person is
determined to be a resident of a Contracting State under
Article 4 does not necessarily entitle that person to the
benefits of the Convention. In addition to being a resident, a
person also must qualify for benefits under Article 21
(Limitation on Benefits) in order to receive benefits conferred
on residents of a Contracting State.
The determination of residence for treaty purposes looks
first to a person's liability to tax as a resident under the
respective taxation laws of the Contracting States. As a
general matter, a person who, under those laws, is a resident
of one Contracting State and not of the other need look no
further. For purposes of the Convention, that person is a
resident of the State in which he is resident under internal
law. If, however, a person is resident in both Contracting
States under their respective taxation laws, the Article
proceeds, where possible, to use tie-breaker rules to assign a
single State of residence to such a person for purposes of the
Convention.
Paragraph 1
The term ``resident of a Contracting State'' is defined in
paragraph 1. In general, this definition incorporates the
definitions of residence in U.S. law and that of Bulgaria by
referring to a resident as a person who, under the laws of a
Contracting State, is subject to tax there by reason of his
domicile, residence, citizenship, place of management, place of
incorporation or any other similar criterion. Thus, residents
of the United States include aliens who are considered U.S.
residents under Code section 7701(b). Paragraph 1 also
specifically includes the two Contracting States, and political
subdivisions and local authorities of the two States, as
residents for purposes of the Convention.
Certain entities that are nominally subject to tax but that
in practice are rarely required to pay tax also would generally
be treated as residents and therefore accorded treaty benefits.
For example, a U.S. Regulated Investment Company (RIC) and a
U.S. Real Estate Investment Trust (REIT) are residents of the
United States for purposes of the treaty. Although the income
earned by these entities normally is not subject to U.S. tax in
the hands of the entity, they are taxable to the extent that
they do not currently distribute their profits, and therefore
may be regarded as ``liable to tax.'' They also must satisfy a
number of requirements under the Code in order to be entitled
to special tax treatment.
Under paragraph 1 of the Convention and paragraph 4 of the
Protocol, a person who is liable to tax in a Contracting State
only in respect of income from sources within that State or of
profits attributable to a permanent establishment in that State
will not be treated as a resident of that Contracting State for
purposes of the Convention. Thus, a consular official of
Bulgaria who is posted in the United States, who may be subject
to U.S. tax on U.S. source investment income, but is not
taxable in the United States on non-U.S. source income (see
Code section 7701 (b)(5)(B)), would not be considered a
resident of the United States for purposes of the Convention.
Similarly, an enterprise of Bulgaria with a permanent
establishment in the United States is not, by virtue of that
permanent establishment, a resident of the United States. The
enterprise generally is subject to U.S. tax only with respect
to its income that is attributable to the U.S. permanent
establishment, not with respect to its worldwide income, as it
would be if it were a U.S. resident.
Paragraph 4 of the Protocol also clarifies that if a
company is a resident of one of the Contracting States under
the domestic law of that State, but is treated as a resident of
a third state under a treaty between that State and the third
state, then it will not be treated as a resident of the
Contracting State for purposes of the Convention. For example,
if a company that is organized in Bulgaria is managed and
controlled in the United Kingdom, both countries would treat
the company as being a resident under its domestic laws.
However, if a treaty between Bulgaria and the United Kingdom
assigned residence in such a case to the country in which the
company's place of effective management is located, and the
place of effective management is the United Kingdom, the
company would not qualify for benefits under the U.S.-Bulgaria
treaty because it is not subject to tax in Bulgaria as a
resident of Bulgaria. This rule is consistent with the holding
of Rev. Rul. 2004-76, 2004-2 C.B. 111.
Paragraph 2
Paragraph 2 provides that certain tax-exempt entities such
as pension funds and charitable organizations will be regarded
as residents of a Contracting State regardless of whether they
are generally liable to income tax in the State where they are
established. The paragraph applies to legal persons organized
under the laws of a Contracting State and established and
maintained in that State to provide pensions or other similar
benefits pursuant to a plan, or exclusively for religious,
charitable, scientific, artistic, cultural, or educational
purposes. Thus, a section 501(c) organization organized in the
United States (such as a U.S. charity) that is generally exempt
from tax under U.S. law is a resident of the United States for
all purposes of the Convention.
Paragraph 3
If, under the laws of the two Contracting States, and,
thus, under paragraph 1, an individual is deemed to be a
resident of both Contracting States, a series of tie-breaker
rules are provided in paragraph 3 to determine a single State
of residence for that individual. These tests are to be applied
in the order in which they are stated. The first test is based
on where the individual has a permanent home. If that test is
inconclusive because the individual has a permanent home
available to him in both States, he will be considered to be a
resident of the Contracting State where his personal and
economic relations are closest (i.e., the location of his
``center of vital interests''). If that test is also
inconclusive, or if he does not have a permanent home available
to him in either State, he will be treated as a resident of the
Contracting State where he maintains a habitual abode. If he
has a habitual abode in both States or in neither of them, he
will be treated as a resident of the Contracting State of which
he is a national. If he is a national of both States or of
neither, the matter will be considered by the competent
authorities, who will assign a single State of residence.
Paragraph 4
Dual residents other than individuals (such as companies,
trusts, or estates) are addressed by paragraph 4. If such a
person is, under the rules of paragraph 1 or 2, resident in
both Contracting States, the competent authorities shall seek
to determine a single State of residence for that person for
purposes of the Convention. If the competent authorities do not
reach an agreement on a single State of residence, that dual
resident may not claim any benefit accorded to residents of a
Contracting State by the Convention. The dual resident may,
however, claim any benefits that are not limited to residents,
such as those provided by paragraph 1 of Article 23 (Non-
Discrimination). Thus, for example, a State cannot discriminate
against a dual resident company.
Dual residents also may be treated as a resident of a
Contracting State for purposes other than that of obtaining
benefits under the Convention. For example, if a dual resident
company pays a dividend to a resident of Bulgaria, the U.S.
paying agent would withhold on that dividend at the appropriate
treaty rate because reduced withholding is a benefit enjoyed by
the resident of Bulgaria, not by the dual resident company. The
dual resident company that paid the dividend would, for this
purpose, be treated as a resident of the United States under
the Convention. In addition, information relating to dual
residents can be exchanged under the Convention because, by its
terms, Article 26 (Exchange of Information and Administrative
Assistance) is not limited to residents of the Contracting
States.
ARTICLE 5 (PERMANENT ESTABLISHMENT)
This Article defines the term ``permanent establishment,''
a term that is significant for several articles of the
Convention. The existence of a permanent establishment in a
Contracting State is necessary under Article 7 (Business
Profits) for the taxation by that State of the business profits
of a resident of the other Contracting State. Articles 10, 11
and 12 (dealing with dividends, interest, and royalties,
respectively) provide for reduced rates of tax at source on
payments of these items of income to a resident of the other
State only when the income is not attributable to a permanent
establishment that the recipient has in the source State. The
concept is also relevant in determining which Contracting State
may tax certain gains under Article 13 (Capital Gains) and
certain ``other income'' under Article 20 (Other Income).
Paragraph 1
The basic definition of the term ``permanent
establishment'' is contained in paragraph 1. As used in the
Convention, the term means a fixed place of business through
which the business of an enterprise is wholly or partly carried
on. As indicated in the OECD Commentary to Article 5 (see
paragraphs 4 through 8), a general principle to be observed in
determining whether a permanent establishment exists is that
the place of business must be ``fixed'' in the sense that a
particular building or physical location is used by the
enterprise for the conduct of its business, and that it must be
foreseeable that the enterprise's use of this building or other
physical location will be more than temporary.
Paragraph 2
Paragraph 2 lists a number of types of fixed places of
business that constitute a permanent establishment. This list
is illustrative and non-exclusive. According to paragraph 2,
the term permanent establishment includes a place of
management, a branch, an office, a factory, a workshop, and a
mine, oil or gas well, quarry or other place of extraction of
natural resources.
Paragraph 3
This paragraph provides rules to determine whether a
building site or a construction, assembly or installation
project, or an installation or drilling rig or ship used for
the exploration of natural resources constitutes a permanent
establishment for the contractor, driller, etc. Such a site or
activity does not create a permanent establishment unless the
site, project, etc. lasts, or the exploration activity
continues, for more than six months. It is only necessary to
refer to ``exploration'' and not ``exploitation'' in this
context because exploitation activities are defined to
constitute a permanent establishment under subparagraph (f) of
paragraph 2. Thus, a drilling rig does not constitute a
permanent establishment if a well is drilled in only three
months, but if production begins in the following month the
well becomes a permanent establishment as of that date.
The six-month test applies separately to each site or
project. The six-month period begins when work (including
preparatory work carried on by the enterprise) physically
begins in a Contracting State. A series of contracts or
projects by a contractor that are interdependent both
commercially and geographically are to be treated as a single
project for purposes of applying the six-month threshold test.
For example, the construction of a housing development would be
considered as a single project even if each house were
constructed for a different purchaser.
In applying this paragraph, time spent by a sub-contractor
on a building site is counted as time spent by the general
contractor at the site for purposes of determining whether the
general contractor has a permanent establishment. However, for
the sub-contractor itself to be treated as having a permanent
establishment, the sub-contractor's activities at the site must
last for more than six months. If a sub-contractor is on a site
intermittently, then, for purposes of applying the six-month
rule, time is measured from the first day the sub-contractor is
on the site until the last day (i.e., intervening days that the
sub-contractor is not on the site are counted).
These interpretations of the Article are based on the
Commentary to paragraph 3 of Article 5 of the OECD Model, which
contains language that is substantially the same as that in the
Convention. These interpretations are consistent with the
generally accepted international interpretation of the relevant
language in paragraph 3 of Article 5 of the Convention.
If the six-month threshold is exceeded, the site or project
constitutes a permanent establishment from the first day of
activity.
Paragraph 4
This paragraph contains exceptions to the general rule of
paragraph 1, listing a number of activities that may be carried
on through a fixed place of business but which nevertheless do
not create a permanent establishment. The use of facilities
solely to store, display or deliver merchandise belonging to an
enterprise does not constitute a permanent establishment of
that enterprise. The maintenance of a stock of goods belonging
to an enterprise solely for the purpose of storage, display or
delivery, or solely for the purpose of processing by another
enterprise does not give rise to a permanent establishment of
the first-mentioned enterprise. The maintenance of a fixed
place of business solely for the purpose of purchasing goods or
merchandise, or for collecting information, for the enterprise,
or for other activities that have a preparatory or auxiliary
character for the enterprise, such as advertising, or the
supply of information, do not constitute a permanent
establishment of the enterprise. Moreover, subparagraph 4(f)
provides that a combination of the activities described in the
other subparagraphs of paragraph 4 will not give rise to a
permanent establishment if the combination results in an
overall activity that is of a preparatory or auxiliary
character.
Paragraph 5
Paragraphs 5 and 6 specify when activities carried on by an
agent or other person acting on behalf of an enterprise create
a permanent establishment of that enterprise. For example,
under subparagraph 5(a), a person is deemed to create a
permanent establishment of the enterprise if that person has
and habitually exercises an authority to conclude contracts in
the name of that enterprise. If, however, his activities are
limited to those activities specified in paragraph 4 which
would not constitute a permanent establishment if carried on by
the enterprise through a fixed place of business, the person
does not create a permanent establishment of the enterprise.
The Convention adopts the OECD Model language ``in the name
of that enterprise'' rather than the US Model language
``binding on the enterprise.'' This difference in language is
not intended to be a substantive difference. As indicated in
paragraph 32 to the OECD Commentaries on Article 5, paragraph 5
of the Article is intended to encompass persons who have
``sufficient authority to bind the enterprise's participation
in the business activity in the State concerned.''
The contracts referred to in paragraph 5 are those relating
to the essential business operations of the enterprise, rather
than ancillary activities. For example, if the person has no
authority to conclude contracts in the name of the enterprise
with its customers for, say, the sale of the goods produced by
the enterprise, but it can enter into service contracts in the
name of the enterprise for the enterprise's business equipment,
this contracting authority would not fall within the scope of
the paragraph, even if exercised regularly.
Under subparagraph 5(b), a person is also deemed to create
a permanent establishment of the enterprise if that person has
no authority to conclude contracts, but habitually maintains in
that State a stock of goods or merchandise belonging to the
enterprise from which the person regularly fills orders or
makes deliveries on behalf of the enterprise, and additional
activities conducted in that State on behalf of the enterprise
have contributed to the conclusion of the sale of such goods or
merchandise.
Paragraph 6
Under paragraph 6, an enterprise is not deemed to have a
permanent establishment in a Contracting State merely because
it carries on business in that State through an independent
agent, including a broker or general commission agent, if the
agent is acting in the ordinary course of his business as an
independent agent. Thus, there are two conditions that must be
satisfied: the agent must be both legally and economically
independent of the enterprise, and the agent must be acting in
the ordinary course of its business in carrying out activities
on behalf of the enterprise.
Whether the agent and the enterprise are independent is a
factual determination. Among the questions to be considered is
the extent to which the agent operates on the basis of
instructions from the enterprise. An agent that is subject to
detailed instructions regarding the conduct of its operations
or comprehensive control by the enterprise is not legally
independent.
In determining whether the agent is economically
independent, a relevant factor is the extent to which the agent
bears business risk. Business risk refers primarily to risk of
loss. An independent agent typically bears risk of loss from
its own activities. In the absence of other factors that would
establish dependence, an agent that shares business risk with
the enterprise, or has its own business risk, is economically
independent because its business activities are not integrated
with those of the principal. Conversely, an agent that bears
little or no risk from the activities it performs is not
economically independent and therefore is not described in
paragraph 6.
Another relevant factor in determining whether an agent is
economically independent is whether the agent acts exclusively
or nearly exclusively for the principal. Such a relationship
may indicate that the principal has economic control over the
agent. A number of principals acting in concert also may have
economic control over an agent. The limited scope of the
agent's activities and the agent's dependence on a single
source of income may indicate that the agent lacks economic
independence. It should be borne in mind, however, that
exclusivity is not in itself a conclusive test; an agent may be
economically independent notwithstanding an exclusive
relationship with the principal if it has the capacity to
diversify and acquire other clients without substantial
modifications to its current business and without substantial
harm to its business profits. Thus, exclusivity should be
viewed merely as a pointer to further investigation of the
relationship between the principal and the agent. Each case
must be addressed on the basis of its own facts and
circumstances.
Paragraph 7
This paragraph clarifies that a company that is a resident
of a Contracting State is not deemed to have a permanent
establishment in the other Contracting State merely because it
con-trols, or is controlled by, a company that is a resident of
that other Contracting State, or that carries on business in
that other Contracting State. The determination whether a
permanent establishment exists is made solely on the basis of
the factors described in paragraphs 1 through 6 of the Article.
Whether a company is a permanent establishment of a related
company, therefore, is based solely on those factors and not on
the ownership or control relationship between the companies.
Paragraph 8
Paragraph 8 provides a special rule (subject to the
provisions of paragraph 4) for an enterprise of a Contracting
State that provides services in the other Contracting State,
but that does not have a permanent establishment by virtue of
the preceding paragraphs of the Article. If (and only if) such
an enterprise meets either of two tests as provided in
subparagraphs 8(a) and 8(b), the enterprise will be deemed to
provide those services through a permanent establishment in the
other State.
The first test as provided in subparagraph 8(a) has two
parts. First, the services must be performed in the other State
by an individual who is present in that other State for a
period or periods aggregating 183 days or more in any twelve-
month period. Second, during that period or periods, more than
50 percent of the gross active business revenues of the
enterprise (including revenue from active business activities
unrelated to the provision of services) must consist of income
derived from the services performed in that State by that
individual. If the enterprise meets both of these tests, the
enterprise will be deemed to provide the services through a
permanent establishment. This test in subparagraph 8(a) is
employed to determine whether an enterprise is deemed to have a
permanent establishment by virtue of the presence of a single
individual (i.e. a natural person).
For the purposes of subparagraph 8(a), the term ``gross
active business revenues'' shall mean the gross revenues
attributable to active business activities that the enterprise
has charged or should charge for its active business
activities, regardless of when the actual billing will occur or
of domestic law rules concerning when such revenues should be
taken into account for tax purposes. Such active business
activities are not restricted to the activities related to the
provision of services. However, the term does not include
income from passive investment activities.
The second test as provided in subparagraph 8(b) provides
that an enterprise will have a permanent establishment if the
services are provided in the other State for an aggregate of
183 days or more in any twelve-month period with respect to the
same or connected projects for customers who either are
residents of the other State or maintain a permanent
establishment in the other State with respect to which the
services are provided. The various conditions that have to be
satisfied in order for subparagraph 8(b) to have application
are described in detail below.
In addition to meeting the 183-day threshold, the services
must be provided for customers who either are residents of the
other State or maintain a permanent establishment in that
State. The intent of this requirement is to reinforce the
concept that unless there is a customer in the other State,
such enterprise will not be deemed as participating
sufficiently in the economic life of that other State to
warrant being deemed to have a permanent establishment.
Paragraph 8 applies only to the provision of services, and
only to services provided by an enterprise to third parties.
Thus, the provision does not have the effect of deeming an
enterprise to have a permanent establishment merely because
services are provided to that enterprise.
Further, paragraph 8 only applies to services that are
performed or provided by an enterprise of a Contracting State
within the other Contracting State. It is therefore not
sufficient that the relevant services be merely furnished to a
resident of the other Contracting State. Where, for example, an
enterprise provides customer support or other services by
telephone or computer to customers located in the other State,
those would not be covered by paragraph 8 because they are not
performed or provided by that enterprise within the other
State. Another example would be that of an architect who is
hired to design blueprints for the construction of a building
in the other State. As part of completing the project, the
architect must make site visits to that other State, and his
days of presence there would be counted for purposes of
determining whether the 183-day threshold is satisfied.
However, the days that the architect spends working on the
blueprint in his home office shall not count for purposes of
the 183-day threshold, because the architect is not performing
or providing those services within the other State.
For purposes of determining whether the time threshold has
been met, subparagraph 8(b) permits the aggregation of services
that are provided with respect to connected projects. For
purposes of this test, projects shall be considered to be
connected if they constitute a coherent whole, commercially and
geographically. The determination of whether projects are
connected should be determined from the point of view of the
enterprise (not that of the customer), and will depend on the
facts and circumstances of each case. In determining the
existence of commercial coherence, factors that would be
relevant include: 1) whether the projects would, in the absence
of tax planning considerations, have been concluded pursuant to
a single contract; 2) whether the nature of the work involved
under different projects is the same; and 3) whether the same
individuals are providing the services under the different
projects. Whether the work provided is covered by one or
multiple contracts may be relevant, but is not determinative,
in finding that projects are commercially coherent.
The aggregation rule addresses, for example, potentially
abusive situations in which work has been artificially divided
into separate components in order to avoid meeting the 183-day
threshold. Assume for example, that a technology consultant has
been hired to install a new computer system for a company in
the other country. The work will take ten months to complete.
However, the consultant purports to divide the work into two
five-month projects with the intention of circumventing the
rule in paragraph 8. In such case, even if the two projects
were considered separate, they will be considered to be
commercially coherent. Accordingly, subject to the additional
requirement of geographic coherence, the two projects could be
considered to be connected, and could therefore be aggregated
for purposes of subparagraph 8(b). In contrast, assume that the
technology consultant is contracted to install a particular
computer system for a company, and is also hired by that same
company, pursuant to a separate contract, to train its
employees on the use of another computer software that is
unrelated to the first system. In this second case, even though
the contracts are both concluded between the same two parties,
there is no commercial coherence to the two projects, and the
time spent fulfilling the two contracts may not be aggregated
for purposes of subparagraph 8(b). Another example of projects
that do not have commercial coherence would be the case of a
law firm which, as one project provides tax advice to a
customer from one portion of its staff, and as another project
provides trade advice from another portion of its staff, both
to the same customer.
Additionally, projects, in order to be considered
connected, must also constitute a geographic whole. An example
of projects that lack geographic coherence would be a case in
which a consultant is hired to execute separate auditing
projects at different branches of a bank located in different
cities pursuant to a single contract. In such an example, while
the consultant's projects are commercially coherent, they are
not geographically coherent and accordingly the services
provided in the various branches shall not be aggregated for
purposes of applying subparagraph 8(b). The services provided
in each branch should be considered separately for purposes of
subparagraph 8(b).
The method of counting days for purposes of subparagraph
8(a) differs slightly from the method for subparagraph 8(b).
Subparagraph 8(a) refers to days in which an individual is
present in the other country. Accordingly, physical presence
during a day is sufficient. In contrast, subparagraph 8(b)
refers to days during which services are provided by the
enterprise in the other country. Accordingly, non-working days
such as weekends or holidays would not count for purposes of
subparagraph 8(b), as long as no services are actually being
provided while in the other country on those days. For the
purposes of both subparagraphs, even if the enterprise sends
many individuals simultaneously to the other country to provide
services, their collective presence during one calendar day
will count for only one day of the enterprise's presence in the
other country. For instance, if an enterprise sends 20
employees to the other country to provide services to a client
in the other country for 10 days, the enterprise will be
considered present in the other country only for 10 days, not
200 days (20 employees x 10 days).
By deeming the enterprise to provide services through a
permanent establishment in the other Contracting State,
paragraph 8 allows the application of Article 7 (Business
Profits), and accordingly, the taxation of the services shall
be on a net-basis. Such taxation is also limited to the profits
attributable to the activities carried on in performing the
relevant services. It will be important to ensure that only the
profits properly attributable to the functions performed and
risks assumed by provision of the services will be attributed
to the deemed permanent establishment.
Paragraph 8 applies subject to the provisions of paragraph
4. In no case will paragraph 8 apply to deem services to be
provided through a permanent establishment if the services are
limited to those mentioned in paragraph 4 which, if performed
through a fixed place of business, would not make the fixed
place of business a permanent establishment under the
provisions of that paragraph. Further, days spent on
preparatory or auxiliary activities shall not be taken into
account for purposes of applying subparagraph 8(b).
ARTICLE 6 (INCOME FROM IMMOVABLE PROPERTY (REAL PROPERTY))
This Article deals with the taxation of income from
immovable property (real property) situated in a Contracting
State (the ``situs State''). The Article does not grant an
exclusive taxing right to the situs State; the situs State is
merely given the primary right to tax. However, until such time
as Bulgaria provides, with respect to income taxable under this
Article, for an election to be subject to tax on a net basis as
though such income were business profits attributable to a
permanent establishment, the Bulgarian rate of tax may not
exceed 10 percent of the gross amount of income derived by a
U.S. resident from real property situated in Bulgaria.
Paragraph 1
The first paragraph of Article 6 states the general rule
that income of a resident of a Contracting State derived from
real property situated in the other Contracting State may be
taxed in the Contracting State in which the property is
situated. The paragraph specifies that income from real
property includes income from agriculture and forestry.
Paragraph 2
The term ``real property'' is defined in paragraph 2 by
reference to the internal law definition in the situs State. In
the case of the United States, the term has the meaning given
to it by Treas. Reg. section 1.897-1(b). In addition to the
statutory definitions in the two Contracting States, the
paragraph specifies certain additional classes of property
that, regardless of internal law definitions, are within the
scope of the term for purposes of the Convention. This expanded
definition conforms to that in the OECD Model. The definition
of ``real property'' for purposes of Article 6 is more limited
than the expansive definition of ``real property'' in paragraph
1 of Article 13 (Capital Gains). The Article 13 term includes
not only real property as defined in Article 6 but certain
other interests in real property.
Paragraph 3
Paragraph 3 makes clear that all forms of income derived
from the exploitation of real property are taxable in the
Contracting State in which the property is situated. This
includes income from any use of real property, including, but
not limited to, income from direct use by the owner (in which
case income may be imputed to the owner for tax purposes) and
rental income from the letting of real property.
Other income closely associated with real property is
covered by other Articles of the Convention, however, and not
Article 6. For example, income from the disposition of an
interest in real property is not considered ``derived'' from
real property; taxation of that income is addressed in Article
13 (Capital Gains). Interest paid on a mortgage on real
property would be covered by Article 11 (Interest).
Distributions by a U.S. Real Estate Investment Trust or certain
regulated investment companies would fall under Article 13
(Capital Gains) in the case of distributions of U.S. real
property gain or Article 10 (Dividends) in the case of
distributions treated as dividends. Finally, distributions from
a United States Real Property Holding Corporation are not
considered to be income from the exploitation of real property;
such payments would fall under Article 10 or 13.
Paragraph 4
This paragraph specifies that the basic rule of paragraph 1
(as elaborated in paragraph 3) applies to income from real
property of an enterprise. This clarifies that the situs
country may tax the real property income (including rental
income) of a resident of the other Contracting State in the
absence of attribution to a permanent establishment in the
situs State. This provision represents an exception to the
general rule under Article 7 (Business Profits) that income
must be attributable to a permanent establishment in order to
be taxable in the situs state. However, if a resident of a
Contracting State carries on a business in the other
Contracting State through a permanent establishment situated
therein and the real property is effectively connected with
such permanent establishment, the provisions of Article 7 apply
to the real property income. This rule is important in view of
the lack of an election to be subject to tax on a net basis
with respect to income taxable under this Article under
Bulgarian law and the Convention. Accordingly, if a U.S.
resident has a permanent establishment in Bulgaria through
which the real property income is earned, that income will be
taxed on a net basis using the rates and rules of taxation
generally applicable to residents of Bulgaria, as such rules
may be modified by the Convention.
Paragraph 5
This paragraph contains a special rule limiting the rate of
Bulgarian taxation to 10 percent of the gross amount of income
derived by a U.S. resident from real property situated in
Bulgaria. This special rule applies for as long as U.S.
residents are not entitled under Bulgarian law to make an
election to compute the tax on income from real property
situated in Bulgaria on a net basis as if such income were
business profits attributable to a permanent establishment in
Bulgaria.
ARTICLE 7 (BUSINESS PROFITS)
This Article provides rules for the taxation by a
Contracting State of the business profits of an enterprise of
the other Contracting State.
Paragraph 1
Paragraph 1 states the general rule that business profits
of an enterprise of one Contracting State may not be taxed by
the other Contracting State unless the enterprise carries on
business in that other Contracting State through a permanent
establishment (as defined in Article 5 (Permanent
Establishment)) situated there. When that condition is met, the
State in which the permanent establishment is situated may tax
the enterprise on the income that is attributable to the
permanent establishment.
Although the Convention does not include a definition of
``business profits,'' the term is intended to cover income
derived from any trade or business. In accordance with this
broad definition, the term ``business profits'' includes income
attributable to notional principal contracts and other
financial instruments to the extent that the income is
attributable to a trade or business of dealing in such
instruments or is otherwise related to a trade or business (as
in the case of a notional principal contract entered into for
the purpose of hedging currency risk arising from an active
trade or business). Any other income derived from such
instruments is, unless specifically covered in another article,
dealt with under Article 20 (Other Income).
The term ``business profits'' also includes income derived
by an enterprise from the rental of tangible personal property
(unless such tangible personal property consists of aircraft,
ships or containers, income from which is addressed by Article
8 (International Traffic)). The inclusion of income derived by
an enterprise from the rental of tangible personal property in
business profits means that such income earned by a resident of
a Contracting State can be taxed by the other Contracting State
only if the income is attributable to a permanent establishment
maintained by the resident in that other State, and, if the
income is taxable, it can be taxed only on a net basis. Income
from the rental of tangible personal property that is not
derived in connection with a trade or business is dealt with in
Article 20 (Other Income).
In addition, as a result of the definitions of
``enterprise'' and ``business'' in Article 3 (General
Definitions), the term includes income derived from the
furnishing of personal services. Thus, a consulting firm
resident in one State whose employees or partners perform
services in the other State through a permanent establishment
may be taxed in that other State on a net basis under Article
7, and not under Article 14 (Income from Employment), which
applies only to income of employees. With respect to the
enterprise's employees themselves, however, their salary
remains subject to Article 14.
Because this Article applies to income earned by an
enterprise from the furnishing of personal services, the
Article also applies to income derived by a partner resident in
a Contracting State that is attributable to personal services
performed in the other Contracting State through a partnership
with a permanent establishment in that other State. Income that
may be taxed under this Article includes all income
attributable to the permanent establishment in respect of the
performance of the personal services carried on by the
partnership (whether by the partner himself, other partners in
the partnership, or by employees assisting the partners) and
any income from activities ancillary to the performance of
those services (e.g., charges for facsimile services).
The application of Article 7 to a service partnership may
be illustrated by the following example: a partnership has five
partners (who agree to split profits equally), four of whom are
resident and perform personal services only in Bulgaria at
Office A, and one of whom performs personal services at Office
B, a permanent establishment in the United States. In this
case, the four partners of the partnership resident in Bulgaria
may be taxed in the United States in respect of their share of
the income attributable to the permanent establishment, Office
B. The services giving rise to income which may be attributed
to the permanent establishment would include not only the
services performed by the one resident partner, but also, for
example, if one of the four other partners came to the United
States and worked on an Office B matter there, the income in
respect of those services. Income from the services performed
by the visiting partner would be subject to tax in the United
States regardless of whether the visiting partner actually
visited or used Office B while performing services in the
United States.
Paragraph 2
Paragraph 2 provides rules for the attribution of business
profits to a permanent establishment. The Contracting States
will attribute to a permanent establishment the profits that it
would have earned had it been 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.
The ``attributable to'' concept of paragraph 2 provides an
alternative to the analogous but somewhat different
``effectively connected'' concept in Code section 864(c).
Depending upon the circumstances, the amount of income
``attributable to'' a permanent establishment under Article 7
may be greater or less than the amount of income that would be
treated as ``effectively connected'' to a U.S. trade or
business under Code section 864. In particular, in the case of
financial institutions, the use of internal dealings to
allocate income within an enterprise may produce results under
Article 7 that are significantly different than the results
under the effectively connected income rules. For example,
income from interbranch notional principal contracts may be
taken into account under Article 7, notwithstanding that such
transactions may be ignored for purposes of U.S. domestic law.
The profits attributable to a permanent establishment may
be from sources within or without a Contracting State. However,
as stated in paragraph 5 of the Protocol, the business profits
attributable to a permanent establishment include only those
profits derived from the assets used, risks assumed, and
activities performed by, the permanent establishment.
Paragraph 5 of the Protocol confirms that the arm's length
method of paragraphs 2 and 3 consists of applying the OECD
Transfer Pricing Guidelines, but taking into account the
different economic and legal circumstances of a single legal
entity (as opposed to separate but associated enterprises).
Thus, any of the methods used in the Transfer Pricing
Guidelines, including profits methods, may be used as
appropriate and in accordance with the Transfer Pricing
Guidelines. However, the use of the Transfer Pricing Guidelines
applies only for purposes of attributing profits within the
legal entity. It does not create legal obligations or other tax
consequences that would result from transactions having
independent legal significance.
For example, an entity that operates through branches
rather than separate subsidiaries generally will have lower
capital requirements because all of the assets of the entity
are available to support all of the entity's liabilities (with
some exceptions attributable to local regulatory restrictions).
This is the reason that most commercial banks and some
insurance companies operate through branches rather than
subsidiaries. The benefit that comes from such lower capital
costs must be allocated among the branches in an appropriate
manner. This issue does not arise in the case of an enterprise
that operates through separate entities, since each entity will
have to be separately capitalized or will have to compensate
another entity for providing capital (usually through a
guarantee).
Under U.S. domestic regulations, internal ``transactions''
generally are not recognized because they do not have legal
significance. In contrast, the rule provided by the Convention
is that such internal dealings may be used to attribute income
to a permanent establishment in cases where the dealings
accurately reflect the allocation of risk within the
enterprise. One example is that of global trading in
securities. In many cases, banks use internal swap transactions
to transfer risk from one branch to a central location where
traders have the expertise to manage that particular type of
risk. Under the Convention, such a bank may also use such swap
transactions as a means of attributing income between the
branches, if use of that method is the ``best method'' within
the meaning of Treas. Reg. section 1.482-1(c). The books of a
branch will not be respected, however, when the results are
inconsistent with a functional analysis. So, for example,
income from a transaction that is booked in a particular branch
(or home office) will not be treated as attributable to that
location if the sales and risk management functions that
generate the income are performed in another location.
Because the use of profits methods is permissible under
paragraph 2, it is not necessary for the Convention to include
a provision corresponding to paragraph 4 of Article 7 of the
OECD Model.
Paragraph 3
Paragraph 3 provides that in determining the business
profits of a permanent establishment, deductions shall be
allowed for the expenses incurred for the purposes of the
permanent establishment, ensuring that business profits will be
taxed on a net basis. This rule is not limited to expenses
incurred exclusively for the purposes of the permanent
establishment, but includes expenses incurred for the purposes
of the enterprise as a whole, or that part of the enterprise
that includes the permanent establishment. Deductions are to be
allowed regardless of which accounting unit of the enterprise
books the expenses, so long as they are incurred for the
purposes of the permanent establishment. For example, a portion
of the interest expense recorded on the books of the home
office in one State may be deducted by a permanent
establishment in the other if properly allocable thereto. The
amount of expense that must be allowed as a deduction is
determined by applying the arm's length principle. As noted
above with respect to paragraph 2 of Article 1 (General Scope),
if a deduction would be allowed under the Code in computing the
U.S. taxable income, the deduction also is allowed in computing
taxable income under the Convention. However, except where the
Convention provides for more favorable treatment, a taxpayer
cannot take deductions for expenses in computing taxable income
under the Convention to a greater extent than would be allowed
under the Code where doing so would be inconsistent with the
intent of the Code. For example, assume that a Bulgarian
taxpayer with a permanent establishment in the United States
borrows $100 to purchase U.S. tax exempt bonds, and that the
$100 of tax-exempt bonds and the $100 of related debt would be
treated as assets and liabilities of the permanent
establishment. For purposes of computing the profits
attributable to the permanent establishment under the
Convention, both the tax exempt interest from the bonds and the
interest expense from the related debt would be excluded.
As noted above, paragraph 5 of the Protocol provides that
the OECD Transfer Pricing Guidelines apply, by analogy, in
determining the profits attributable to a permanent
establishment. Accordingly, a permanent establishment may
deduct payments made to its head office or another branch in
compensation for services performed for the benefit of the
branch. The method to be used in calculating that amount will
depend on the terms of the arrangements between the branches
and head office. For example, the enterprise could have a
policy, expressed in writing, under which each business unit
could use the services of lawyers employed by the head office.
At the end of each year, the costs of employing the lawyers
would be charged to each business unit according to the amount
of services used by that business unit during the year. Since
this appears to be a kind of cost-sharing arrangement and the
allocation of costs is based on the benefits received by each
business unit, such a cost allocation would be an acceptable
means of determining a permanent establishment's deduction for
legal expenses. Alternatively, the head office could agree to
employ lawyers at its own risk, and to charge an arm's length
price for legal services performed for a particular business
unit. If the lawyers were under-utilized, and the ``fees''
received from the business units were less than the cost of
employing the lawyers, then the head office would bear the
excess cost. If the ``fees'' exceeded the cost of employing the
lawyers, then the head office would keep the excess to
compensate it for assuming the risk of employing the lawyers.
If the enterprise acted in accordance with this agreement, this
method would be an acceptable alternative method for
calculating a permanent establishment's deduction for legal
expenses.
Paragraph 5 of the Protocol also makes clear that a
permanent establishment cannot be funded entirely with debt,
but must have sufficient capital to carry on its activities as
if it were a distinct and separate enterprise. To the extent
that the permanent establishment does not have such capital, a
Contracting State may, for profit attribution purposes,
attribute such capital to the permanent establishment in
accordance with the arm's length principle and deny an interest
deduction to the extent necessary to reflect that capital
attribution. The method prescribed by U.S. domestic law for
making this attribution is found in Treas. Reg. section 1.882-
5. Both section 1.882-5 and the method prescribed in the
Convention start from the premise that all of the capital of
the enterprise supports all of the assets and risks of the
enterprise, and therefore the entire capital of the enterprise
must be allocated to its various businesses and offices.
However, section 1.882-5 does not take into account the
fact that some assets create more risk for the enterprise than
do other assets. An independent enterprise would need less
capital to support a perfectly-hedged U.S. Treasury security
than it would need to support an equity security or other asset
with significant market and/or credit risk. Accordingly, in
some cases section 1.882-5 would require a taxpayer to allocate
more capital to the United States, and therefore would reduce
the taxpayer's interest deduction more, than is appropriate. To
address these cases, paragraph 5 of the Protocol allows a
taxpayer to apply a more flexible approach that takes into
account the relative risk of its assets in the various
jurisdictions in which it does business. In particular, in the
case of financial institutions other than insurance companies,
the amount of capital attributable to a permanent establishment
is determined by allocating the institution's total equity
between its various offices on the basis of the proportion of
the financial institution's risk-weighted assets attributable
to each of them. This recognizes the fact that financial
institutions are in many cases required to risk-weight their
assets for regulatory purposes and, in other cases, will do so
for business reasons even if not required to do so by
regulators. However, risk-weighting is more complicated than
the method prescribed by section 1.882-5. Accordingly, to ease
this administrative burden, taxpayers may choose to apply the
principles of Treas. Reg. section 1.882-5(c) to determine the
amount of capital allocable to its U.S. permanent
establishment, in lieu of determining its allocable capital
under the risk-weighted capital allocation method provided by
the Convention, even if it has otherwise chosen the principles
of Article 7 rather than the effectively connected income rules
of U.S. domestic law.
Paragraph 4
Paragraph 4 provides that no business profits can be
attributed to a permanent establishment merely because it
purchases goods or merchandise for the enterprise of which it
is a part. This paragraph is essentially identical to paragraph
5 of Article 7 of the OECD Model. This rule applies only to an
office that performs functions for the enterprise in addition
to purchasing. The income attribution issue does not arise if
the sole activity of the office is the purchase of goods or
merchandise because such activity does not give rise to a
permanent establishment under Article 5 (Permanent
Establishment). A common situation in which paragraph 4 is
relevant is one in which a permanent establishment purchases
raw materials for the enterprise's manufacturing operation
conducted outside the United States and sells the manu*factured
product. While business profits may be attributable to the
permanent establishment with respect to its sales activities,
no profits are attributable to it with respect to its
purchasing activities.
Paragraph 5
Paragraph 5 provides that profits shall be determined by
the same method each year, unless there is good reason to
change the method used. This rule assures consistent tax
treatment over time for permanent establishments. It limits the
ability of both the Contracting State and the enterprise to
change accounting methods to be applied to the permanent
establishment. It does not, however, restrict a Contracting
State from imposing additional requirements, such as the rules
under Code section 481, to prevent amounts from being
duplicated or omitted following a change in accounting method.
Such adjustments may be necessary, for example, if the taxpayer
switches from using the domestic rules under section 864 in one
year to using the rules of Article 7 in the next. Also, if the
taxpayer switches from Convention-based rules to U.S. domestic
rules, it may need to meet certain deadlines for making
elections that are not necessary when applying the rules of the
Convention.
Paragraph 6
Paragraph 6 coordinates the provisions of Article 7 and
other provisions of the Convention. Under this paragraph, when
business profits include items of income that are dealt with
separately under other articles of the Convention, the
provisions of those articles will, except when they
specifically provide to the contrary, take precedence over the
provisions of Article 7. For example, the taxation of dividends
will be determined by the rules of Article 10 (Dividends), and
not by Article 7, except where, as provided in paragraph 6 of
Article 10, the dividend is attributable to a permanent
establishment. In the latter case the provisions of Article 7
apply. Thus, an enterprise of one State deriving dividends from
the other State may not rely on Article 7 to exempt those
dividends from tax at source if they are not attributable to a
permanent establishment of the enterprise in the other State.
By the same token, if the dividends are attributable to a
permanent establishment in the other State, the dividends may
be taxed on a net income basis at the source State full
corporate tax rate, rather than on a gross basis under Article
10 (Dividends).
As provided in Article 8 (International Traffic), income
derived from shipping and air transport activities in
international traffic described in that Article is taxable only
in the country of residence of the enterprise regardless of
whether it is attributable to a permanent establishment
situated in the source State.
The Convention incorporates the rule of Code section
864(c)(6). Like the Code section on which it is based,
paragraph 5 of the Protocol provides that any income or gain
attributable to a permanent establishment during its existence
is taxable in the Contracting State where the permanent
establishment is situated, even if the payment of that income
or gain is deferred until after the permanent establishment
ceases to exist. This rule applies with respect to Article 7
(Business Profits), paragraph 4 of Article 6 (Income from
Immovable Property (Real Property)), paragraph 6 of Article 10
(Dividends), paragraph 5 of Article 11 (Interest), paragraph 4
of Article 12 (Royalties), paragraph 3 of Article 13 (Capital
Gains) and paragraph 2 of Article 20 (Other Income).
The effect of this rule can be illustrated by the following
example. Assume a company that is a resident of Bulgaria and
that maintains a permanent establishment in the United States
winds up the permanent establishment's business and sells the
permanent establishment's inventory and assets to a U.S. buyer
at the end of year 1 in exchange for an interest-bearing
installment obligation payable in full at the end of year 3.
Despite the fact that Article 13's threshold requirement for
U.S. taxation is not met in year 3 because the company has no
permanent establishment in the United States, the United States
may tax the deferred income payment recognized by the company
in year 3.
Relationship to other Articles
This Article is subject to the saving clause of paragraph 4
of Article 1 (General Scope). Thus, if a citizen of the United
States who is a resident of Bulgaria under the treaty derives
business profits from the United States that are not
attributable to a permanent establishment in the United States,
the United States may, subject to the special foreign tax
credit rules of paragraph 4 of Article 22 (Relief from Double
Taxation), tax those profits, notwithstanding paragraph 1 of
this Article, which would exempt the income from U.S. tax.
The benefits of this Article are also subject to Article 21
(Limitation on Benefits). Thus, an enterprise of Bulgaria and
that derives income effectively connected with a U.S. trade or
business may not claim the benefits of Article 7 unless the
resident carrying on the enterprise qualifies for such benefits
under Article 21.
ARTICLE 8 (INTERNATIONAL TRAFFIC)
This Article governs the taxation of profits from the
operation of ships and aircraft in international traffic. The
term ``international traffic'' is defined in subparagraph 1(j)
of Article 3 (General Definitions).
Paragraph 1
Paragraph 1 provides that profits derived by an enterprise
of a Contracting State from the operation in international
traffic of ships or aircraft are taxable only in that
Contracting State. Because paragraph 6 of Article 7 (Business
Profits) defers to Article 8 with respect to shipping income,
such income derived by a resident of one of the Contracting
States may not be taxed in the other State even if the
enterprise has a permanent establishment in that other State.
Thus, if a U.S. airline has a ticket office in Bulgaria,
Bulgaria may not tax the airline's profits attributable to that
office under Article 7. Since entities engaged in international
transportation activities normally will have many permanent
establishments in a number of countries, the rule avoids
difficulties that would be encountered in attributing income to
multiple permanent establish*ments if the income were covered
by Article 7 (Business Profits).
Paragraph 2
The income from the operation of ships or aircraft in
international traffic that is exempt from tax under paragraph 1
is defined in paragraph 2.
In addition to income derived directly from the operation
of ships and aircraft in international traffic, this definition
also includes certain items of rental income. First, income of
an enterprise of a Contracting State from the rental of ships
or aircraft on a full basis (i.e., with crew) is income of the
lessor from the operation of ships and aircraft in
international traffic and, therefore, is exempt from tax in the
other Contracting State under paragraph 1. Also, paragraph 2
encompasses income from the lease of ships or aircraft on a
bareboat basis (i.e., without crew) when the income is
incidental to other income of the lessor from the operation of
ships or aircraft in international traffic. If the income is
not incidental to other income of the lessor from the operation
of ships or aircraft in international traffic, income from
bareboat rentals would constitute business profits.
Paragraph 6 of the Protocol clarifies, consistent with the
U.S. Model and the Commentary to Article 8 of the OECD Model,
that profits derived by an enterprise from the inland transport
of tangible property or passengers within either Contracting
State is treated as profits from the operation of ships or
aircraft in international traffic if such transport is
undertaken as part of international traffic. Thus, if a U.S.
shipping company contracts to carry property from Bulgaria to a
U.S. city and, as part of that contract, it transports the
property by truck from its point of origin to an airport in
Bulgaria (or it contracts with a trucking company to carry the
property to the airport) the income earned by the U.S. shipping
company from the overland leg of the journey would be taxable
only in the United States. Similarly, Article 8 also would
apply to all of the income derived from a contract for the
international transport of goods, even if the goods were
transported to the port by a lighter, not by the vessel that
carried the goods in international waters.
Finally, certain non-transport activities that are an
integral part of the services performed by a transport company,
or are ancillary to the enterprise's operation of ships or
aircraft in international traffic, are understood to be covered
in paragraph 1, though they are not specified in paragraph 2.
These include, for example, the provision of goods and services
by engineers, ground and equipment maintenance and staff, cargo
handlers, catering staff and customer services personnel. Where
the enterprise provides such goods to, or performs services
for, other enterprises and such activities are directly
connected with or ancillary to the enterprise's operation of
ships or aircraft in international traffic, the profits from
the provision of such goods and services to other enterprises
will fall under this paragraph.
For example, enterprises engaged in the operation of ships
or aircraft in international traffic may enter into pooling
arrangements for the purposes of reducing the costs of
maintaining facilities needed for the operation of their ships
or aircraft in other countries. For instance, where an airline
enterprise agrees (for example, under an International Airlines
Technical Pool agreement) to provide spare parts or maintenance
services to other airlines landing at a particular location
(which allows it to benefit from these services at other
locations), activities carried on pursuant to that agreement
will be ancillary to the operation of aircraft in international
traffic by the enterprise.
Also, advertising that the enterprise may do for other
enterprises in magazines offered aboard ships or aircraft that
it operates in international traffic or at its business
locations, such as ticket offices, is ancillary to its
operation of these ships or aircraft. Profits generated by such
advertising fall within this paragraph. Income earned by
concessionaires, however, is not covered by Article 8. These
interpretations of paragraph 1 also are consistent with the
Commentary to Article 8 of the OECD Model.
Paragraph 3
Under this paragraph, profits of an enterprise of a
Contracting State from the use, maintenance or rental of
containers (including equipment for their transport) used for
the transport of goods or merchandise are exempt from tax in
the other Contracting State, unless those containers are used
for transport solely in the other Contracting State. This
result obtains under paragraph 3 regardless of whether the
recipient of the income is engaged in the operation of ships or
aircraft in international traffic, and regardless of whether
the enterprise has a permanent establishment in the other
Contracting State. Only income from the use, maintenance or
rental of containers that is incidental to other income from
international traffic is covered by Article 8 of the OECD
Model.
Paragraph 4
This paragraph clarifies that the provisions of paragraphs
1 and 3 also apply to profits derived by an enterprise of a
Contracting State 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. For example, airlines from two
countries may agree to share the transport of passengers
between the two countries. They each will fly the same number
of flights per week and share the revenues from that route
equally, regardless of the number of passengers that each
airline actually transports. Paragraph 4 makes clear that with
respect to each carrier the income dealt with in the Article is
that carrier's share of the total transport, not the income
derived from the passengers actually carried by the airline.
This paragraph corresponds to paragraph 4 of Article 8 of the
OECD Model.
Relationship to other Articles
The taxation of gains from the alienation of ships,
aircraft or containers is not dealt with in this Article but in
paragraphs 4 and 5 of Article 13 (Capital Gains).
As with other benefits of the Convention, the benefit of
exclusive residence country taxation under Article 8 is
available to an enterprise only if it is entitled to benefits
under Article 21 (Limitation on Benefits).
This Article also is subject to the saving clause of
paragraph 4 of Article 1 (General Scope) of the Model. Thus, if
a citizen of the United States who is a resident of Bulgaria
derives profits from the operation of ships or aircraft in
international traffic, notwithstanding the exclusive residence
country taxation in paragraph 1 of Article 8, the United States
may, subject to the special foreign tax credit rules of
paragraph 4 of Article 22 (Relief from Double Taxation), tax
those profits as part of the worldwide income of the citizen.
(This is an unlikely situation, however, because non-tax
considerations (e.g., insurance) generally result in shipping
activities being carried on in corporate form.)
ARTICLE 9 (ASSOCIATED ENTERPRISES)
This Article incorporates in the Convention the arm's-
length principle reflected in the U.S. domestic transfer
pricing provisions, particularly Code section 482. It provides
that when related enterprises engage in a transaction on terms
that are not arm's-length, the Contracting States may make
appropriate adjustments to the taxable income and tax liability
of such related enterprises to reflect what the income and tax
of these enterprises with respect to the transaction would have
been had there been an arm's-length relationship between them.
Paragraph 1
This paragraph is essentially the same as its counterpart
in the U.S. and OECD Models. It addresses the situation where
an enterprise of a Contracting State is related to an
enterprise of the other Contracting State, and there are
arrangements or conditions imposed between the enterprises in
their commercial or financial relations that are different from
those that would have existed in the absence of the
relationship. Under these circumstances, the Contracting States
may adjust the income (or loss) of the enterprise to reflect
what it would have been in the absence of such a relationship.
The paragraph identifies the relationships between
enterprises that serve as a prerequisite to application of the
Article. As the Commentary to the OECD Model makes clear, the
necessary element in these relationships is effective control,
which is also the standard for purposes of section 482. Thus,
the Article applies if an enterprise of one State participates
directly or indirectly in the management, control, or capital
of the enterprise of the other State. Also, the Article applies
if any third person or persons participate directly or
indirectly in the management, control, or capital of
enterprises of different States. For this purpose, all types of
control are included, i.e., whether or not legally enforceable
and however exercised or exercisable.
The fact that a transaction is entered into between such
related enterprises does not, in and of itself, mean that a
Contracting State may adjust the income (or loss) of one or
both of the enterprises under the provisions of this Article.
If the conditions of the transaction are consistent with those
that would be made between independent persons, the income
arising from that trans-action should not be subject to
adjustment under this Article.
Similarly, the fact that associated enterprises may have
concluded arrangements, such as cost sharing arrangements or
general services agreements, is not in itself an indication
that the two enterprises have entered into a non-arm's-length
transaction that should give rise to an adjustment under
paragraph 1. Both related and unrelated parties enter into such
arrangements (e.g., joint venturers may share some development
costs). As with any other kind of transaction, when related
parties enter into an arrangement, the specific arrangement
must be examined to see whether or not it meets the arm's-
length standard. In the event that it does not, an appropriate
adjustment may be made, which may include modifying the terms
of the agreement or re-characterizing the transaction to
reflect its substance.
It is understood that the ``commensurate with income''
standard for determining appropriate transfer prices for
intangibles, added to Code section 482 by the Tax Reform Act of
1986, was designed to operate consistently with the arm's-
length standard. The implementation of this standard in the
section 482 regulations is in accordance with the general
principles of paragraph 1 of Article 9 of the Convention, as
interpreted by the OECD Transfer Pricing Guidelines.
This Article also permits tax authorities to deal with thin
capitalization issues. They may, in the context of Article 9,
scrutinize more than the rate of interest charged on a loan
between related persons. They also may examine the capital
structure of an enterprise, whether a payment in respect of
that loan should be treated as interest, and, if it is treated
as interest, under what circumstances interest deductions
should be allowed to the payor. Paragraph 3 of the Commentary
to Article 9 of the OECD Model, together with the U.S.
observation set forth in paragraph 15, sets forth a similar
understanding of the scope of Article 9 in the context of thin
capitalization.
Paragraph 2
When a Contracting State has made an adjustment that is
consistent with the provisions of paragraph 1, and the other
Contracting State agrees that the adjustment was appropriate to
reflect arm's-length conditions, that other Contracting State
is obligated to make a correlative adjustment (sometimes
referred to as a ``corresponding adjustment'') to the tax
liability of the related person in that other Contracting
State. Although the OECD Model does not specify that the other
Contracting State must agree with the initial adjustment before
it is obligated to make the correlative adjustment, the
Commentary makes clear that the paragraph is to be read that
way.
As explained in the Commentary to Article 9 of the OECD
Model, Article 9 leaves the treatment of ``secondary
adjustments'' to the laws of the Contracting States. When an
adjustment under Article 9 has been made, one of the parties
will have in its possession funds that it would not have had at
arm's length. The question arises as to how to treat these
funds. In the United States the general practice is to treat
such funds as a dividend or contribution to capital, depending
on the relationship between the parties. Under certain
circumstances, the parties may be permitted to restore the
funds to the party that would have the funds had the
transactions been entered into on arm's length terms, and to
establish an account payable pending restoration of the funds.
See Rev. Proc. 99-32, 1999-2 C.B. 296.
The Contracting State making a secondary adjustment will
take the other provisions of the Convention, where relevant,
into account. For example, if the effect of a secondary
adjustment is to treat a U.S. corporation as having made a
distribution of profits to its parent corporation in Bulgaria,
the provisions of Article 10 (Dividends) will apply, and the
United States may impose a 5 percent withholding tax on the
dividend. Also, if under Article 22 (Relief from Double
Taxation) Bulgaria generally gives a credit for taxes paid with
respect to such dividends, it would also be required to do so
in this case.
The competent authorities are authorized by paragraph 3 of
Article 24 (Mutual Agreement Procedure) to consult, if
necessary, to resolve any differences in the application of
these provisions. For example, there may be a disagreement over
whether an adjustment made by a Contracting State under
paragraph 1 was appropriate.
If a correlative adjustment is made under paragraph 2, it
is to be implemented, pursuant to paragraph 2 of Article 24
(Mutual Agreement Procedure), notwithstanding any time limits
or other procedural limitations in the law of the Contracting
State making the adjustment. If a taxpayer has entered into a
closing agreement (or other written settlement) with the United
States prior to bringing a case to the competent authorities,
the U.S. competent authority will endeavor only to obtain a
correlative adjustment from Bulgaria. See, Rev. Proc. 2006-54,
2006-2 C.B. 1035, Section 7.05.
Relationship to other Articles
The saving clause of paragraph 4 of Article 1 (General
Scope) does not apply to paragraph 2 of Article 9 by virtue of
an exception to the saving clause in subparagraph 5(a) of
Article 1. Thus, even if the statute of limitations has run, a
refund of tax can be made in order to implement a correlative
adjustment. Statutory or procedural limitations, however,
cannot be overridden to impose additional tax, because
paragraph 2 of Article 1 provides that the Convention cannot
restrict any statutory benefit.
ARTICLE 10 (DIVIDENDS)
Article 10 provides rules for the taxation of dividends
paid by a company that is a resident of one Contracting State
to a beneficial owner that is a resident of the other
Contracting State. The Article provides for full residence
country taxation of such dividends and a limited source-State
right to tax. Article 10 also provides rules for the imposition
of a tax on branch profits by the State of source. Finally, the
Article prohibits a State from imposing taxes on a company
resident in the other Contracting State, other than a branch
profits tax, on undistributed earnings.
Paragraph 1
The right of a shareholder's country of residence to tax
dividends arising in the source country is preserved by
paragraph 1, which permits a Contracting State to tax its
residents on dividends paid to them by a company that is a
resident of the other Contracting State. For dividends from any
other source paid to a resident, Article 20 (Other Income)
grants the State of residence exclusive taxing jurisdiction
(other than for dividends attributable to a permanent
establishment in the other State).
Paragraph 2
The State of source also may tax dividends beneficially
owned by a resident of the other State, subject to the
limitations of paragraphs 2 and 4. Paragraph 2 generally limits
the rate of withholding tax in the State of source on dividends
paid by a company resident in that State to 10 percent of the
gross amount of the dividend. If, however, the beneficial owner
of the dividend is a company resident in the other State and
owns directly shares representing at least 10 percent of the
voting power of the company paying the dividend, then the rate
of withholding tax in the State of source is limited to 5
percent of the gross amount of the dividend. Shares are
considered voting shares if they provide the power to elect,
appoint or replace any person vested with the powers ordinarily
exercised by the board of directors of a U.S. corporation.
The benefits of paragraph 2 may be granted at the time of
payment by means of reduced rate of withholding tax at source.
It also is consistent with the paragraph for tax to be withheld
at the time of payment at full statutory rates, and the treaty
benefit to be granted by means of a subsequent refund so long
as such procedures are applied in a reasonable manner.
The determination of whether the ownership threshold for
subparagraph 2(a) is met for purposes of the 5 percent maximum
rate of withholding tax is made on the date on which
entitlement to the dividend is determined. Thus, in the case of
a dividend from a U.S. company, the determination of whether
the ownership threshold is met generally would be made on the
dividend record date.
Paragraph 2 does not affect the taxation of the profits out
of which the dividends are paid. The taxation by a Contracting
State of the income of its resident companies is governed by
the internal law of the Contracting State, subject to the
provisions of paragraph 4 of Article 23 (Non-Discrimination).
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined as under the internal
law of the country imposing tax (i.e., the source country). The
beneficial owner of the dividend for purposes of Article 10 is
the person to which the dividend income is attributable for tax
purposes under the laws of the source State. Thus, if a
dividend paid by a corporation that is a resident of one of the
States (as determined under Article 4 (Resident)) is received
by a nominee or agent that is a resident of the other State on
behalf of a person that is not a resident of that other State,
the dividend is not entitled to the benefits of this Article.
However, a dividend received by a nominee on behalf of a
resident of that other State would be entitled to benefits.
These limitations are confirmed by paragraph 12 of the
Commentary to Article 10 of the OECD Model.
Special rules, however, apply to shares that are held
through fiscally transparent entities. In that case, the rules
of paragraph 6 of Article 1 (General Scope) will apply to
determine whether the dividends should be treated as having
been derived by a resident of a Contracting State. Residence
State principles shall be used to determine who derives the
dividend, to assure that the dividends for which the source
State grants benefits of the Convention will be taken into
account for tax purposes by a resident of the residence State.
Source state principles of beneficial ownership shall then
apply to determine whether the person who derives the
dividends, or another resident of the other Contracting State,
is the beneficial owner of the dividend. The source State may
conclude that the person who derives the dividend in the
residence State is a mere nominee, agent, conduit, etc., for a
third country resident and deny benefits of the Convention. If
the person who derives the dividend under paragraph 6 of
Article 1 would not be treated under the source State's
principles for determining beneficial ownership as a nominee,
agent, custodian, conduit, etc., that person will be treated as
the beneficial owner of the income, profits or gains for
purposes of the Convention.
Assume, for instance, that a company resident in Bulgaria
pays a dividend to LLC, an entity which is treated as fiscally
transparent for U.S. tax purposes but is treated as a company
for Bulgarian tax purposes. USCo, a company incorporated in the
United States, is the sole interest holder in LLC. Paragraph 6
of Article 1 provides that USCo derives the dividend.
Bulgaria's principles of beneficial ownership shall then be
applied to USCo. If under the laws of Bulgaria USCo is found
not to be the beneficial owner of the dividend, USCo will not
be entitled to the benefits of Article 10 with respect to such
dividend. The payment may be entitled to benefits, however, if
USCo is found to be a nominee, agent, custodian or conduit for
a person who is a resident of the United States.
Beyond identifying the person to whom the principles of
beneficial ownership shall be applied, the principles of
paragraph 6 of Article 1 will also apply when determining
whether other requirements, such as the ownership threshold of
subparagraph 2(a) have been satisfied.
For example, assume that BulCo, a company that is a
resident of Bulgaria, owns all of the outstanding shares in
ThirdDE, an entity that is disregarded for U.S. tax purposes
that is resident in a third country. ThirdDE owns 100% of the
stock of USCo. Bulgaria views ThirdDE as fiscally transparent
under its domestic law, and taxes BulCo currently on the income
derived by ThirdDE. In this case, BulCo is treated as deriving
the dividends paid by USCo under paragraph 6 of Article 1.
Moreover, BulCo is treated as owning the shares of USCo
directly. The Convention does not address what constitutes
direct ownership for purposes of Article 10. As a result,
whether ownership is direct is determined under the internal
law of the country imposing tax (i.e., the source country)
unless the context otherwise requires. Accordingly, a company
that holds stock through such an entity will generally be
considered to directly own such stock for purposes of Article
10.
This result may change, however, if ThirdDE is regarded as
non-fiscally transparent under the laws of Bulgaria. Assuming
that ThirdDE is treated as non-fiscally transparent by
Bulgaria, the income will not be treated as derived by a
resident of Bulgaria for purposes of the Convention. However,
ThirdDE may still be entitled to the benefits of the U.S. tax
treaty, if any, with its country of residence.
The same principles would apply in determining whether
companies holding shares through fiscally transparent entities
such as partnerships, trusts, and estates would qualify for
benefits. As a result, companies holding shares through such
entities may be able to claim the benefits of subparagraph (a)
under certain circumstances. The lower rate applies when the
company's proportionate share of the shares held by the
intermediate entity meets the 10 percent threshold, and the
company meets the requirements of Article 1(6) (i.e., the
company's country of residence treats the intermediate entity
as fiscally transparent) with respect to the dividend. Whether
this ownership threshold is satisfied may be difficult to
determine and often will require an analysis of the partnership
or trust agreement.
Paragraph 3
Paragraph 3 imposes limitations on the rate reductions
provided by paragraphs 2 and 4 in the case of dividends paid by
a RIC or a REIT.
The first sentence of subparagraph 3(a) provides that
dividends paid by a RIC or a REIT are not eligible for the 5
percent rate of withholding tax of subparagraph 2(a).
The second sentence of subparagraph 3(a) provides that the
10 percent maximum rate of withholding tax of subparagraph 2(b)
applies to dividends paid by RICs and that the elimination of
source-country withholding tax of paragraph 4 applies to
dividends paid by RICs and beneficially owned by a pension
fund.The third sentence of subparagraph 3(a) provides that the
10 percent rate of withholding tax also applies to dividends
paid by a REIT, and that the elimination of source-country
withholding tax of paragraph 4 applies to dividends paid by
REITs and beneficially owned by a pension fund, provided that
one of the three following conditions is met. First, the
beneficial owner of the dividend is an individual or a pension
fund, in either case holding an interest of not more than 10
percent in the REIT. Second, the dividend is paid with respect
to a class of stock that is publicly traded and the beneficial
owner of the dividend is a person holding an interest of not
more than 5 percent of any class of the REIT's shares. Third,
the beneficial owner of the dividend holds an interest in the
REIT of not more than 10 percent and the REIT is
``diversified.''
A REIT is diversified if the gross value of no single
interest in real property held by the REIT exceeds 10 percent
of the gross value of the REIT's total interest in real
property. Foreclosure property is not considered an interest in
real property, and a REIT holding a partnership interest is
treated as owning its proportionate share of any interest in
real property held by the partnership.
Subparagraph (b) provides that the rules of subparagraph
(a) shall also apply to dividends paid by companies resident in
Bulgaria that are similar to a RIC or a REIT. Whether companies
that are residents of Bulgaria are similar to RICs or REITs
will be determined by mutual agreement of the competent
authorities.The restrictions set out above are intended to
prevent the use of these entities to gain inappropriate tax
benefits. For example, a company resident in Bulgaria that
wishes to hold a diversified portfolio of U.S. corporate shares
could hold the portfolio directly and would bear a U.S.
withholding tax of 10 percent on all of the dividends that it
receives. Alternatively, it could hold the same diversified
portfolio by purchasing 10 percent or more of the interests in
a RIC. If the RIC is a pure conduit, there may be no U.S. tax
cost to interposing the RIC in the chain of ownership. Absent
the special rule in paragraph 3, such use of the RIC could
transform portfolio dividends, taxable in the United States
under the Convention at a 10 percent maximum rate of
withholding tax, into direct investment dividends taxable at a
5 percent maximum rate of withholding tax.
Similarly, a resident of Bulgaria directly holding U.S.
real property would pay U.S. tax upon the sale of the property
either at a 30 percent rate of withholding tax on the gross
income or at graduated rates on the net income. As in the
preceding example, by placing the real property in a REIT, the
investor could, absent a special rule, transform income from
the sale of real estate into dividend income from the REIT,
taxable at the rates provided in Article 10, significantly
reducing the U.S. tax that otherwise would be imposed.
Paragraph 3 prevents this result and thereby avoids a disparity
between the taxation of direct real estate investments and real
estate investments made through REIT conduits. In the cases in
which paragraph 3 allows a dividend from a REIT to be eligible
for the 10 percent rate of withholding tax, the holding in the
REIT is not considered the equivalent of a direct holding in
the underlying real property.
Paragraph 4
Paragraph 4 provides that, notwithstanding paragraph 2, the
State of source will not tax dividends beneficially owned by a
pension fund resident in the other Contracting State, unless
such dividends are derived from the carrying on of a business
by the pension fund or from an associated enterprise that is
not itself a pension fund resident in the other Contracting
State. For these purposes, the term ``pension fund'' is defined
in subparagraph 1(m) of Article 3 (General Definitions).
The exemption is provided because pension funds normally do
not pay tax (either through a general exemption or because
reserves for future pension liabilities effectively offset all
of the fund's income), and therefore cannot benefit from a
foreign tax credit. Moreover, distributions from a pension fund
generally do not maintain the character of the underlying
income, so the beneficiaries of the pension are not in a
position to claim a foreign tax credit when they finally
receive the pension, in many cases years after the withholding
tax has been paid. Accordingly, in the absence of this rule,
the dividends would almost certainly be subject to unrelieved
double taxation.
Paragraph 5
Paragraph 5 defines the term dividends broadly and
flexibly. The definition is intended to cover all arrangements
that yield a return on an equity investment in a corporation as
determined under the tax law of the state of source, as well as
arrangements that might be developed in the future.
The term includes income from shares, or other corporate
rights that are not treated as debt under the law of the source
State, that participate in the profits of the company. The term
also includes income that is subjected to the same tax
treatment as income from shares by the law of the State of
source. Thus, a constructive dividend that results from a non-
arm's length transaction between a corporation and a related
party is a dividend. In the case of the United States the term
dividend includes amounts treated as a dividend under U.S. law
upon the sale or redemption of shares or upon a transfer of
shares in a reorganization. See, e.g., Rev. Rul. 92-85, 1992-2
C.B. 69 (sale of foreign subsidiary's stock to U.S. sister
company is a deemed dividend to extent of the subsidiary's and
sister company's earnings and profits). Further, a distribution
from a U.S. publicly traded limited partnership, which is taxed
as a corporation under U.S. law, is a dividend for purposes of
Article 10. However, a distribution by a limited liability
company is not taxable by the United States under Article 10,
provided the limited liability company is not characterized as
an association taxable as a corporation under U.S. law.
Finally, a payment denominated as interest that is made by
a thinly capitalized corporation may be treated as a dividend
to the extent that the debt is recharacterized as equity under
the laws of the source State.
Paragraph 6
Paragraph 6 provides a rule for taxing dividends paid with
respect to holdings that form part of the business property of
a permanent establishment. In such case, the rules of Article 7
(Business Profits) shall apply. Accordingly, the dividends will
be taxed on a net basis using the rates and rules of taxation
generally applicable to residents of the State in which the
permanent establishment is located, as such rules may be
modified by the Convention. An example of dividends paid with
respect to the business property of a permanent establishment
would be dividends derived by a dealer in stock or securities
from stock or securities that the dealer held for sale to
customers.
Paragraph 7
The right of a Contracting State to tax dividends paid by a
company that is a resident of the other Contracting State is
restricted by paragraph 7 to cases in which the dividends are
paid to a resident of that Contracting State or are
attributable to a permanent establishment in that Contracting
State. Thus, a Contracting State may not impose a ``secondary''
withholding tax on dividends paid by a nonresident company out
of earnings and profits from that Contracting State.
The paragraph also restricts the right of a Contracting
State to impose corporate level taxes on undistributed profits,
other than a branch profits tax. The paragraph does not
restrict a State's right to tax its resident shareholders on
undistributed earnings of a corporation resident in the other
State. Thus, the authority of the United States to impose taxes
on subpart F income and on earnings deemed invested in U.S.
property, and its tax on income of a passive foreign investment
company that is a qualified electing fund is in no way
restricted by this provision.
Paragraph 8
Paragraph 8 permits a Contracting State to impose a branch
profits tax on a company resident in the other Contracting
State. The tax is in addition to other taxes permitted by the
Convention. The term ``company'' is defined in subparagraph
1(e) of Article 3 (General Definitions).
A Contracting State may impose a branch profits tax on a
company if the company has income attributable to a permanent
establishment in that Contracting State, derives income from
real property in that Contracting State that is taxed on a net
basis under Article 6 (Income from Immovable Property (Real
Property)), or realizes gains taxable in that State under
paragraph 1 of Article 13 (Capital Gains). In the case of the
United States, the imposition of such tax is limited, however,
to the portion of the aforementioned items of income that
represents the amount of such income that is the ``dividend
equivalent amount.'' This is consistent with the relevant rules
under the U.S. branch profits tax, and the term dividend
equivalent amount is defined under U.S. law. Section 884
defines the dividend equivalent amount as an amount for a
particular year that is equivalent to the income described
above that is included in the corporation's effectively
connected earnings and profits for that year, after payment of
the corporate tax under Article 6, Article 7, or Article 13,
reduced for any increase in the branch's U.S. net equity during
the year or increased for any reduction in its U.S. net equity
during the year. U.S. net equity is U.S. assets less U.S.
liabilities. See Treas. Reg. section 1.884-1.
The dividend equivalent amount for any year approximates
the dividend that a U.S. branch office would have paid during
the year if the branch had been operated as a separate U.S.
subsidiary company. If Bulgaria also imposes a branch profits
tax, the base of its tax must be limited to an amount that is
analogous to the dividend equivalent amount.
As discussed in the Technical Explanation to paragraph 2 of
Article 1, consistency principles require that a taxpayer may
not use both treaty and Code rules where doing so would thwart
the intent of either set of rules. In the context of the branch
profits tax, the consistency requirement means that an
enterprise that uses the principles of Article 7 to determine
its net taxable income also must use those principles in
determining the dividend equivalent amount. Similarly, an
enterprise that uses U.S. domestic law to determine its net
taxable income must also use U.S. domestic law in complying
with the branch profits tax. As in the case of Article 7, if an
enterprise switches between domestic law and treaty principles
from year to year, it will need to make appropriate adjustments
or recapture amounts that otherwise might go untaxed.
Subparagraph b) provides that the branch profits tax shall
not be imposed at a rate exceeding the direct investment
dividend withholding rate of five percent.
Relationship to other Articles
Notwithstanding the foregoing limitations on source country
taxation of dividends, the saving clause of paragraph 4 of
Article 1 permits the United States to tax dividends received
by its residents and citizens, subject to the special foreign
tax credit rules of paragraph 4 of Article 22 (Relief from
Double Taxation), as if the Convention had not come into
effect.
The benefits of this Article are also subject to the
provisions of Article 21 (Limitation on Benefits). Thus, if a
resident of the other Contracting State is the beneficial owner
of dividends paid by a U.S. corporation, the shareholder must
qualify for treaty benefits under at least one of the tests of
Article 21 in order to receive the benefits of this Article.
ARTICLE 11 (INTEREST)
Article 11 specifies the taxing jurisdictions over interest
arising in one Contracting State and paid to a resident of the
other Contracting State.
Paragraph 1
Paragraph 1 generally grants to the State of residence the
non-exclusive right to tax interest arising in the other
Contracting State and paid to its residents.
Paragraph 2
Paragraph 2 provides that the State of source also may tax
the interest, but if the interest is beneficially owned by a
resident of the other Contracting State, the rate of tax will
be limited to 5 percent of the gross amount of the interest.
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined under the internal law
of the State of source. The beneficial owner of the interest
for purposes of Article 11 is the person to which the income is
attributable under the laws of the source State. Thus, if
interest arising in a Contracting State is received by a
nominee or agent that is a resident of the other State on
behalf of a person that is not a resident of that other State,
the interest is not entitled to the benefits of Article 11.
However, interest received by a nominee on behalf of a resident
of that other State would be entitled to benefits. These
limitations are confirmed by paragraph 9 of the OECD Commentary
to Article 11.
Paragraph 3
Paragraph (3) provides for exclusive residence-based
taxation in certain cases.
Under subparagraph (a), interest beneficially owned by a
Contracting State, a political subdivision, or a local
authority thereof (i.e., in the United States, a State or local
government), the central bank of that Contracting State or any
institution wholly owned by that Contracting State is subject
to exclusive residence-based taxation.
Under subparagraph (b), interest beneficially owned by a
resident of a Contracting State with respect to debt-claims
guaranteed, insured or indirectly financed by the Contracting
State, a political subdivision or a local authority thereof,
the central bank of that Contracting State or any institution
wholly owned by that Contracting State is subject to exclusive
residence-based taxation.
Under subparagraph (c), interest beneficially owned by any
financial institution, including, for example, a bank or an
insurance company, is subject to exclusive residence-based
taxation, unless the interest is paid as a part of a back-to-
back loan or an arrangement that is economically similar to and
has the effect of a back-to-back loan. Paragraph 8 of the
Protocol clarifies that the term ``back-to-back loan'' as used
in subparagraph c) means a loan structured to obtain the
benefits of subparagraph c) in which the loan is made to a
financial institution that in turn lends the funds directly to
the intended borrower. By referencing arrangements that are
economically similar to, and that have the effect of, a back-
to-back loan, paragraph (3)(c) reaches transactions that would
not meet the legal requirements of a loan, but would
nevertheless serve that purpose economically. For example, the
term would encompass securities issued at a discount, or
certain swap arrangements intended to operate as the economic
equivalent of a back to-back loan. In addition, nothing in
Article 11 is intended to limit the ability of the Contracting
States to enforce their domestic anti-avoidance provisions.
Subparagraph (d) provides for exclusive residence-based
taxation of interest beneficially owned by a pension fund
resident in the other Contracting State, provided that the
interest is not derived from the carrying on of a business,
directly or indirectly, by the pension fund.
Paragraph 4
The term ``interest'' as used in Article 11 is defined in
paragraph 4 to include, inter alia, income from debt claims of
every kind, whether or not secured by a mortgage. Penalty
charges for late payment are excluded from the definition of
interest. Interest that is paid or accrued subject to a
contingency is within the ambit of Article 11. This includes
income from a debt obligation carrying the right to participate
in profits. The term does not, however, include amounts that
are treated as dividends under Article 10 (Dividends).
The term interest also includes amounts subject to the same
tax treatment as income from money lent under the law of the
State in which the income arises. Thus, for purposes of the
Convention, amounts that the United States will treat as
interest include (i) the difference between the issue price and
the stated redemption price at maturity of a debt instrument
(i.e., original issue discount (``OID'')), which may be wholly
or partially realized on the disposition of a debt instrument
(section 1273), (ii) amounts that are imputed interest on a
deferred sales contract (section 483), (iii) amounts treated as
interest or OID under the stripped bond rules (section 1286),
(iv) amounts treated as original issue discount under the
below-market interest rate rules (section 7872), (v) a
partner's distributive share of a partnership's interest income
(section 702), (vi) the interest portion of periodic payments
made under a ``finance lease'' or similar contractual
arrangement that in substance is a borrowing by the nominal
lessee to finance the acquisition of property, (vii) amounts
included in the income of a holder of a residual interest in a
REMIC (section 860E), because these amounts generally are
subject to the same taxation treatment as interest under U.S.
tax law, and (viii) interest with respect to notional principal
contracts that are re-characterized as loans because of a
``substantial non-periodic payment.''
Paragraph 5
Paragraph 5 provides an exception to the rules of
paragraphs 1, 2 and 3 in cases where the beneficial owner of
the interest carries on business through a permanent
establishment in the State of source and the interest is
attributable to that permanent establishment. In such cases the
provisions of Article 7 (Business Profits) will apply and the
State of source will retain the right to impose tax on such
interest income.
In the case of a permanent establishment that once existed
in the State but that no longer exists, the provisions of
paragraph 5 also apply to interest that would be attributable
to such a permanent establishment if it did exist in the year
of payment or accrual. See the Technical Explanation to Article
7.
Paragraph 6
Paragraph 6 provides a source rule for determining the
source of interest that is identical in substance to the
interest source rule of the OECD Model. Interest is considered
to arise in a Contracting State if paid by a resident of that
State. As an exception, interest on a debt incurred in
connection with a permanent establishment in one of the States
and borne by the permanent establishment is considered to arise
in that State. For this purpose, interest is considered to be
borne by a permanent establishment if it is allocable to
taxable income of that permanent establishment.
Paragraph 7
Paragraph 7 provides that in cases involving special
relationships between the payor and the beneficial owner of
interest income, Article 11 applies only to that portion of the
total interest payments that would have been made absent such
special relationships (i.e., an arm's-length interest payment).
Any excess amount of interest paid remains taxable according to
the laws of the United States and Bulgaria, respectively, with
due regard to the other provisions of the Convention. Thus, if
the excess amount would be treated under the source country's
law as a distribution of profits by a corporation, such amount
could be taxed as a dividend rather than as interest, but the
tax would be subject, if appropriate, to the rate limitations
of paragraph 2 of Article 10.
The term ``special relationship'' is not defined in the
Convention. In applying this paragraph the United States
considers the term to include the relationships described in
Article 9, which in turn corresponds to the definition of
``control'' for purposes of section 482 of the Code.
This paragraph does not address cases where, owing to a
special relationship between the payor and the beneficial owner
or between both of them and some other person, the amount of
the interest is less than an arm's-length amount. In those
cases a transaction may be characterized to reflect its
substance and interest may be imputed consistent with the
definition of interest in paragraph 4. The United States would
apply section 482 or 7872 of the Code to determine the amount
of imputed interest in those cases.
Paragraph 8
Paragraph 8 provides anti-abuse exceptions to the rules of
paragraphs 2 and 3 for two classes of interest payments.
The first class of interest, dealt with in subparagraphs
(a) and (b) is so-called ``contingent interest.'' With respect
to interest arising in the United States, subparagraph (a)
refers to contingent interest of a type that does not qualify
as portfolio interest under U.S. domestic law. The cross-
reference to the U.S. definition of contingent interest, which
is found in section 871 (h)(4) of the Code, is intended to
ensure that the exceptions of section 871 (h)(4)(c) will be
applicable. With respect to Bulgaria, such interest is defined
in subparagraph (b) as any interest arising in Bulgaria that is
determined by reference to the receipts, sales, income, profits
or other cash flow of the debtor or a related person, to any
change in the value of any property of the debtor or a related
person or to any dividend, partnership distribution or similar
payment made by the debtor or a related person. Any interest
dealt with in subparagraphs (a) and (b) may be taxed in the
source State at a rate not exceeding 10 percent of the gross
amount of the interest.
The second class of interest is dealt with in subparagraph
8(c). This exception is consistent with the policy of Code
sections 860E(e) and 860G(b) that excess inclusions with
respect to a real estate mortgage investment conduit (REMIC)
should bear full U.S. tax in all cases. Without a full tax at
source foreign purchasers of residual interests would have a
competitive advantage over U.S. purchasers at the time these
interests are initially offered. Also, absent this rule, the
U.S. fisc would suffer a revenue loss with respect to mortgages
held in a REMIC because of opportunities for tax avoidance
created by differences in the timing of taxable and economic
income produced by these interests.
Paragraph 9
Paragraph 9 permits a Contracting State to impose its
branch level interest tax on a corporation resident in the
other Contracting State. The base of this tax is the excess, if
any, of the interest deductible in the first-mentioned
Contracting State in computing the profits of the corporation
that are subject to tax in the first-mentioned Contracting
State and either attributable to a permanent establishment in
the first-mentioned Contracting State or subject to tax in the
first-mentioned Contracting State under Article 6 or Article 13
of the Convention over the interest paid by the permanent
establishment or trade or business in the first-mentioned
Contracting State. Such excess interest may be taxed as if it
were interest arising in the first-mentioned Contracting State
and beneficially owned by the corporation resident in the other
Contracting State. Thus, such excess interest may be taxed by
the Contracting State of source at a rate not to exceed the 5
percent rate provided for in paragraph 2, and shall be exempt
from tax by the Contracting State of source if the recipient is
described in paragraph 3.
Relationship to other Articles
Notwithstanding the foregoing limitations on source country
taxation of interest, the saving clause of paragraph 4 of
Article 1 (General Scope) permits the United States to tax its
residents and citizens, subject to the special foreign tax
credit rules of paragraph 4 of Article 22 (Relief from Double
Taxation), as if the Convention had not come into force.
As with other benefits of the Convention, the benefits of
this Article are available to a resident of the other State
only if that resident is entitled to those benefits under the
provisions of Article 21 (Limitation on Benefits).
Agreement to Reconsider Withholding Rates
The Convention permits positive rates of taxation on
interest and royalties. Paragraph 7 of the Protocol evidences
the agreement of the Contracting States to reconsider the
provisions of Article 11 and Article 12 with respect to
interest and royalties arising in Bulgaria where the beneficial
owner of the income is a U.S. resident. Such reconsideration is
permitted to occur at an appropriate time, consistent with the
December 31, 2014 conclusion of the transition period
applicable to interest and royalties deemed to arise in
Bulgaria that are beneficially owned by a resident of the
European Union pursuant to Council Directive 2003/49/EC of 3
June 2003, on a common system of taxation applicable to
interest and royalty payments made between associated companies
of different Member States.
ARTICLE 12 (ROYALTIES)
Article 12 provides rules for the taxation of royalties
arising in one Contracting State and paid to a resident of the
other Contracting State.
Paragraph 1
Paragraph 1 grants the State of residence the non-exclusive
right to tax a royalty arising in the other Contracting State
and paid to its residents.
Paragraph 2
Paragraph 2 allows the State of source to tax royalties
arising in that State. If, however, the beneficial owner of the
royalty is a resident of the other Contracting State, the tax
may not exceed 5 percent of the gross amount of the royalties.
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined under the internal law
of the State of source. The beneficial owner of the royalty for
purposes of Article 12 is the person to which the income is
attributable under the laws of the source State. Thus, if a
royalty arising in a Contracting State is received by a nominee
or agent that is a resident of the other State on behalf of a
person that is not a resident of that other State, the royalty
is not entitled to the benefits of Article 12. However, a
royalty received by a nominee on behalf of a resident of that
other State would be entitled to benefits. These limitations
are confirmed by paragraph 4 of the OECD Commentary to Article
12.
Paragraph 3
The term ``royalties'' as used in this Article means:
Paragraph 3 defines the term ``royalties,'' as used in
Article 12, to include any consideration for the use of, or the
right to use, any copyright of literary, artistic, scientific
or other work (including cinematographic films and films, tapes
or other means of image or sound reproduction for radio or
television broadcasting), any patent, trademark, design or
model, plan, secret formula or process, or for information
concerning industrial, commercial, or scientific experience.
The term ``royalties'' also includes gain derived from the
alienation of any right or property that would give rise to
royalties, to the extent the gain is contingent on the
productivity, use, or further alienation thereof. Gains that
are not so contingent are dealt with under Article 13 (Capital
Gains). The term ``royalties,'' however, does not include
income from leasing personal property.
The term royalties is defined in the Convention and
therefore is generally independent of domestic law. Certain
terms used in the definition are not defined in the Convention,
but these may be defined under domestic tax law. For example,
the term ``secret process or formulas'' is found in the Code,
and its meaning has been elaborated in the context of sections
351 and 367. See Rev. Rul. 55- 17, 1955-1 C.B. 388; Rev. Rul.
64-56, 1964-1 C.B. 133; Rev. Proc. 69- 19, 1969-2 C.B. 301.
Consideration for the use or right to use cinematographic
films, or works on film, tape, or other means of reproduction
in radio or television broadcasting is specifically included in
the definition of royalties. It is intended that, with respect
to any subsequent technological advances in the field of radio
or television broadcasting, consideration received for the use
of such technology will also be included in the definition of
royalties.
If an artist who is resident in one Contracting State
records a performance in the other Contracting State, retains a
copyrighted interest in a recording, and receives payments for
the right to use the recording based on the sale or public
playing of the recording, then the right of such other
Contracting State to tax those payments is governed by Article
12. See Boulez v. Commissioner, 83 T.C. 584 (1984), aff'd, 810
F.2d 209 (D.C. Cir. 1986). By contrast, if the artist earns in
the other Contracting State income covered by Article 16
(Entertainers and Sportsmen), for example, endorsement income
from the artist's attendance at a film screening, and if such
income also is attributable to one of the rights described in
Article 12 (e.g., the use of the artist's photograph in
promoting the screening), Article 16 and not Article 12 is
applicable to such income.
Computer software generally is protected by copyright laws
around the world. Under the Convention, consideration received
for the use, or the right to use, computer software is treated
either as royalties or as business profits, depending on the
facts and circumstances of the transaction giving rise to the
payment.
The primary factor in determining whether consideration
received for the use, or the right to use, computer software is
treated as royalties or as business profits is the nature of
the rights transferred. See Treas. Reg. section 1.861-18. The
fact that the transaction is characterized as a license for
copyright law purposes is not dispositive. For example, a
typical retail sale of ``shrink wrap'' software generally will
not be considered to give rise to royalty income, even though
for copyright law purposes it may be characterized as a
license.
The means by which the computer software is transferred are
not relevant for purposes of the analysis. Consequently, if
software is electronically transferred but the rights obtained
by the transferee are substantially equivalent to rights in a
program copy, the payment will be considered business
profits.The term ``industrial, commercial, or scientific
experience'' (sometimes referred to as ``know-how'') has the
meaning ascribed to it in paragraph 11 et seq. of the
Commentary to Article 12 of the OECD Model. Consistent with
that meaning, the term may include information that is
ancillary to a right otherwise giving rise to royalties, such
as a patent or secret process.
Know-how also may include, in limited cases, technical
information that is conveyed through technical or consultancy
services. It does not include general educational training of
the user's employees, nor does it include information developed
especially for the user, such as a technical plan or design
developed according to the user's specifications. Thus, as
provided in paragraph 11.4 of the Commentary to Article 12 of
the OECD Model, the term ``royalties'' does not include
payments received as consideration for after-sales service, for
services rendered by a seller to a purchaser under a warranty,
or for pure technical assistance.
The term ``royalties'' also does not include payments for
professional services (such as architectural, engineering,
legal, managerial, medical, software development services). For
example, income from the design of a refinery by an engineer
(even if the engineer employed know-how in the process of
rendering the design) or the production of a legal brief by a
lawyer is not income from the transfer of know-how taxable
under Article 12, but is income from services taxable under
either Article 7 (Business Profits) or Article 14 (Income from
Employment). Professional services may be embodied in property
that gives rise to royalties, however. Thus, if a professional
contracts to develop patentable property and retains rights in
the resulting property under the development contract,
subsequent license payments made for those rights would be
royalties.
Paragraph 4
This paragraph provides an exception to the manner of
allocating taxing rights specified in paragraphs 1 and 2 in
cases where the beneficial owner of the royalties carries on
business through a permanent establishment in the State of
source and the royalties are attributable to that permanent
establishment. In such cases the provisions of Article 7
(Business Profits) will apply.
The provisions of paragraph 5 of the Protocol, regarding
Article 7 (Business Profits), apply to this paragraph. For
example, royalty income that is attributable to a permanent
establishment and that accrues during the existence of the
permanent establishment, but is re-ceived after the permanent
establishment no longer exists, remains taxable under the
provisions of Article 7 (Business Profits), and not under this
Article.
Paragraph 5
Paragraph 5 contains a source rule for determining the
source of royalties. Under paragraph 5, royalties are treated
as arising in a Contracting State if paid by a resident of that
State. As an exception, royalties that are attributable to a
permanent establishment in a Contracting State and borne by the
permanent establishment are considered to arise in that State.
Where, however, the payor of the royalties is not a resident of
either Contracting State, and the royalties are not borne by a
permanent establishment in either Contracting State, but the
royalties relate to the use of, or the right to use, in one of
the Contracting States, any property or right described in
paragraph 3, the royalties are deemed to arise in that State.
Paragraph 6
Paragraph 6 provides that in cases involving special
relationships between the payor and beneficial owner of
royalties, Article 12 applies only to the extent the royalties
would have been paid absent such special relationships (i.e.,
an arm's-length royalty). Any excess amount of royalties paid
remains taxable according to the laws of the two Contracting
States, with due regard to the other provisions of the
Convention. If, for example, the excess amount is treated as a
distribution of corporate profits under domestic law, such
excess amount will be taxed as a dividend rather than as
royalties, but the tax imposed on the dividend payment will be
subject to the rate limitations of paragraph 2 of Article 10
(Dividends).
Relationship to other Articles
Notwithstanding the foregoing limitations on source country
taxation of royalties, the saving clause of paragraph 4 of
Article 1 (General Scope) permits the United States to tax its
residents and citizens, subject to the special foreign tax
credit rules of paragraph 4 of Article 22 (Relief from Double
Taxation), as if the Convention had not come into force.
As with other benefits of the Convention, the benefits of
Article 12 are available to a resident of the other State only
if that resident is entitled to those benefits under Article 21
(Limitation on Benefits).Agreement to Reconsider Withholding
Rates
The Convention permits positive rates of taxation on
interest and royalties. Paragraph 7 of the Protocol evidences
the agreement of the Contracting States to reconsider the
provisions of Article 11 and Article 12 with respect to
interest and royalties arising in Bulgaria where the beneficial
owner of the income is a U.S. resident. Such reconsideration is
permitted to occur at an appropriate time, consistent with the
December 31, 2014 conclusion of the transition period
applicable to interest and royalties deemed to arise in
Bulgaria that are beneficially owned by a resident of the
European Union pursuant to Council Directive 2003/49/EC of 3
June 2003, on a common system of taxation applicable to
interest and royalty payments made between associated companies
of different Member States.
ARTICLE 13 (CAPITAL GAINS)
Article 13 assigns either primary or exclusive taxing
jurisdiction over gains from the alienation of property to the
State of residence or the State of source.
Paragraph 1
Paragraph 1 of Article 13 preserves the non-exclusive right
of the State of source to tax gains attributable to the
alienation of real property situated in that State. The
paragraph therefore permits the United States to apply section
897 of the Code to tax gains derived by a resident of Bulgaria
that are attributable to the alienation of real property
situated in the United States (as defined in paragraph 2).
Gains attributable to the alienation of real property include
gains from any other property that is treated as a real
property interest within the meaning of paragraph 2.
Paragraph 1 refers to gains ``attributable to the
alienation of immovable property (real property)'' rather than
the OECD Model phrase ``gains from the alienation'' to clarify
that the United States will look through distributions made by
a REIT and certain RICs. Accordingly, distributions made by a
REIT or certain RICs are taxable under paragraph 1 of Article
13 (not under Article 10 (Dividends)) when they are
attributable to gains derived from the alienation of real
property.
Paragraph 2
This paragraph defines the term ``immovable property (real
property) situated in the other Contracting State.'' The term
includes real property referred to in Article 6 (i.e., an
interest in the real property itself), a ``United States real
property interest'' (when the United States is the other
Contracting State under paragraph 1), and, as specified in
paragraph 2(c), an equivalent interest in immovable property
(real property) situated in Bulgaria.
Under section 897(c) of the Code the term ``United States
real property interest'' includes shares in a U.S. corporation
that owns sufficient U.S. real property interests to satisfy an
asset-ratio test on certain testing dates. The term also
includes certain foreign corporations that have elected to be
treated as U.S. corporations for this purpose. Section 897(i).
Section 897(c)(3) provides that, in certain situations
stock regularly traded on an established securities market will
not be treated as a U.S. real property interest, even if the
stock derives its value primarily from U.S. real property. With
respect to Bulgaria, subparagraph 2(c)(i) of Article 13,
provides an analogous carve-out in the case of stock regularly
traded on an established securities market. The term
``established securities market'' is defined in paragraph 9 of
the Protocol to mean a national securities exchange which is
officially recognized, sanctioned, or supervised by a
governmental authority as well as an over the counter market.
An over the counter market is any market reflected by the
existence of an interdealer quotation system. An interdealer
quotation system is any system of general circulation to
brokers and dealers which regularly disseminates quotations of
stocks and securities by identified brokers or dealers, other
than by quotation sheets which are prepared and distributed by
a broker or dealer in the regular course of business and which
contain only quotations of such broker or dealer. This
definition is consistent with the regulations under section
897.
Paragraph 3
Paragraph 3 of Article 13 deals with the taxation of
certain gains from the alienation of movable property forming
part of the business property of a permanent establishment that
an enterprise of a Contracting State has in the other
Contracting State. This also includes gains from the alienation
of such a permanent establishment (alone or with the whole
enterprise). Such gains may be taxed in the State in which the
permanent establishment is located.
A resident of Bulgaria that is a partner in a partnership
doing business in the United States generally will have a
permanent establishment in the United States as a result of the
activities of the partnership, assuming that the activities of
the partnership rise to the level of a permanent establishment.
Rev. Rul. 91-32, 1991-1 C.B. 107. Further, under paragraph 3,
the United States generally may tax a partner's distributive
share of income realized by a partnership on the disposition of
movable property forming part of the business property of the
partnership in the United States.
The gains subject to paragraph 3 may be taxed in the State
in which the permanent establishment is located, regardless of
whether the permanent establishment exists at the time of the
alienation. This rule incorporates the rule of section
864(c)(6) of the Code. Accordingly, income that is attributable
to a permanent establishment, but that is deferred and received
after the permanent establishment no longer exists, may
nevertheless be taxed by the State in which the permanent
establishment was located.
Paragraph 4
This paragraph limits the taxing jurisdiction of the State
of source with respect to gains from the alienation of ships or
aircraft operated in international traffic by the enterprise
alienating the ship or aircraft and from property (other than
real property) pertaining to the operation or use of such ships
or aircraft.
Under paragraph 4, such income is taxable only in the
Contracting State in which the alienator is resident.
Notwithstanding paragraph 3, the rules of this paragraph apply
even if the income is attributable to a permanent establishment
maintained by the enterprise in the other Contracting State.
This result is consistent with the allocation of taxing rights
under Article 8 (International Traffic).
Paragraph 5
Paragraph 5 provides a rule similar to paragraph 4 with
respect to gains from the alienation of containers and related
personal property. Such gains derived by an enterprise of a
Contracting State shall be taxable only in that Contracting
State unless the containers were used for the transport of
goods or merchandise solely within the other Contracting State.
The other Contracting State may not tax such gain even if it is
attributable to a permanent establishment maintained by the
enterprise in that other Contracting State.
Paragraph 6
Paragraph 6 provides that, if certain conditions are met, a
Contracting State can tax gains from the alienation of shares
of a resident company that are derived by a resident of the
other Contracting State. This provision permits Bulgaria to
continue to impose its tax on the gain derived by U.S.
residents on the alienation of shares in Bulgarian companies in
a narrow set of cases. The first requirement is that the
alienation occurs within 12 months of the date that the shares
are acquired. The second requirement is that the recipient of
the gain must have owned, directly or indirectly, at least 25
percent of the capital of the company at some time within the
12-month period preceding the alienation. Finally, the
provision provides that a Contracting State may not in any case
tax gains derived by a resident of the other Contracting State
from the alienation of shares of stock of public companies
traded on an established securities market.
As described above, the term ``established securities
market'' is a national securities exchange which is officially
recognized, sanctioned, or supervised by a governmental
authority as well as an over the counter market. An over the
counter market is any market reflected by the existence of an
interdealer quotation system, and an interdealer quotation
system is any system of general circulation to brokers and
dealers which regularly disseminates quotations of stocks and
securities by identified brokers or dealers, other than by
quotation sheets which are prepared and distributed by a broker
or dealer in the regular course of business and which contain
only quotations of such broker or dealer.
The United States will treat gain taxed by Bulgaria under
this paragraph as of Bulgarian source to the extent necessary
to permit a credit for the Bulgarian tax, subject to the
limitations of U.S. law.
Paragraph 6 is reciprocal. If the United States were to
introduce such a tax, it could be imposed in accordance with
the rules of this paragraph.
Paragraph 7
Paragraph 7 clarifies the interrelationship between
Articles 12 (Royalties) and 13 with respect to certain gains
treated as royalties. Under subparagraph 3(b) of Article 12,
the term royalties includes gain derived from the alienation of
property that would give rise to royalties, to the extent the
gain is contingent on the productivity, use, or further
alienation thereof. Therefore, such royalties are governed by
the provisions of Article 12 and not by this Article.
Paragraph 8
Paragraph 8 grants to the State of residence of the
alienator the exclusive right to tax gains from the alienation
of property other than property referred to in paragraphs 1
through 7. For example, gain derived from shares, other than
shares described in paragraphs 2, 3, or 6, debt instruments and
various financial instruments, may be taxed only in the State
of residence, to the extent such income is not otherwise
characterized as income taxable under another article (e.g.,
Article 10 (Dividends) or Article 11 (Interest)). Similarly
gain derived from the alienation of tangible personal property,
other than tangible personal property described in paragraph 3,
may be taxed only in the State of residence of the alienator.
Gains derived by a resident of a Contracting State from
real property located in a third state are not taxable in the
other Contracting State, even if the sale is attributable to a
permanent establishment located in the other Contracting State.
Relationship to other Articles
Notwithstanding the foregoing limitations on taxation of
certain gains by the State of source, the saving clause of
paragraph 4 of Article 1 (General Scope) permits the United
States to tax its citizens and residents as if the Convention
had not come into effect. Thus, any limitation in this Article
on the right of the United States to tax gains does not apply
to gains of a U.S. citizen or resident.
The benefits of this Article are also subject to the
provisions of Article 21 (Limitation on Benefits). Thus, only a
resident of a Contracting State that satisfies one of the
conditions in Article 21 is entitled to the benefits of this
Article.
ARTICLE 14 (INCOME FROM EMPLOYMENT)
Article 14 apportions taxing jurisdiction over remuneration
derived by a resident of a Contracting State as an employee
between the States of source and residence.
Paragraph 1
The general rule of Article 14 is contained in paragraph 1.
Remuneration derived by a resident of a Contracting State as an
employee may be taxed by the State of residence, and the
remuneration also may be taxed by the other Contracting State
to the extent derived from employment exercised (i.e., services
performed) in that other Contracting State. Paragraph 1 also
provides that the more specific rules of Articles 15
(Directors' Fees), 17 (Pensions, Social Security Payments,
Annuities, Alimony, and Child Support), and 18 (Government
Service) apply in the case of employment income described in
one of those articles. Thus, even though the State of source
has a right to tax employment income under Article 14, it may
not have the right to tax that income under the Convention if
the income is described, for example, in Article 17 (Pensions,
Social Security Payments, Annuities, Alimony, and Child
Support) and is not taxable in the State of source under the
provisions of that article.
Article 14 applies to any form of compensation for
employment, including payments in kind. Paragraph 1.1 of the
Commentary to Article 16 of the OECD Model now confirms that
interpretation.
Consistent with section 864(c)(6) of the Code, Article 14
also applies regardless of the timing of actual payment for
services. Consequently, a person who receives the right to a
future payment in consideration for services rendered in a
Contracting State would be taxable in that State even if the
payment is received at a time when the recipient is a resident
of the other Contracting State. Thus, a bonus paid to a
resident of a Contracting State with respect to services
performed in the other Contracting State with respect to a
particular taxable year would be subject to Article 14 even if
it was paid after the close of the year. An annuity received
for services performed in a taxable year could be subject to
Article 14 despite the fact that it was paid in subsequent
years. In that case, it would be necessary to determine whether
the payment constitutes deferred compensation, taxable under
Article 14, or a qualified pension subject to the rules of
Article 17 (Pensions, Social Security Payments, Annuities,
Alimony, and Child Support). Article 14 also applies to income
derived from the exercise of stock options granted with respect
to services performed in the host State, even if those stock
options are exercised after the employee has left the source
country. If Article 14 is found to apply, whether such payments
were taxable in the State where the employment was exercised
would depend on whether the tests of paragraph 2 were satisfied
in the year in which the services to which the payment relates
were performed.
Paragraph 2
Paragraph 2 sets forth an exception to the general rule
that employment income may be taxed in the State where it is
exercised. Under paragraph 2, the State where the employment is
exercised may not tax the income from the employment if three
conditions are satisfied: (a) the individual is present in the
other Contracting State for a period or periods not exceeding
183 days in any 12-month period that begins or ends during the
relevant taxable year (i.e., in the United States, the calendar
year in which the services are performed); (b) the remuneration
is paid by, or on behalf of, an employer who is not a resident
of that other Contracting State; and (c) the remuneration is
not borne as a deductible expense by a permanent establishment
that the employer has in that other State. In order for the
remuneration to be exempt from tax in the source State, all
three conditions must be satisfied. This exception is identical
to that set forth in the OECD Model.
The 183-day period in condition (a) is to be measured using
the ``days of physical presence'' method. Under this method,
the days that are counted include any day in which a part of
the day is spent in the host country. (Rev. Rul. 56-24, 1956-1
C.B. 851.) Thus, days that are counted include the days of
arrival and departure; weekends and holidays on which the
employee does not work but is present within the country;
vacation days spent in the country before, during or after the
employment period, unless the individual's presence before or
after the employment can be shown to be independent of his
presence there for employment purposes; and time during periods
of sickness, training periods, strikes, etc., when the
individual is present but not working. If illness prevented the
individual from leaving the country in sufficient time to
qualify for the benefit, those days will not count. Also, any
part of a day spent in the host country while in transit
between two points outside the host country is not counted. If
the individual is a resident of the host country for part of
the taxable year concerned and a non-resident for the remainder
of the year, the individual's days of presence as a resident do
not count for purposes of determining whether the 183-day
period is exceeded.
Conditions (b) and (c) are intended to ensure that a
Contracting State will not be required to allow a deduction to
the payor for compensation paid and at the same time to exempt
the employee on the amount received. Accordingly, if a foreign
person pays the salary of an employee who is employed in the
host State, but a host State corporation or permanent
establishment reimburses the payor with a payment that can be
identified as a reimbursement, neither condition (b) nor (c),
as the case may be, will be considered to have been fulfilled.
The reference to remuneration ``borne by'' a permanent
establishment is understood to encompass all expenses that
economically are incurred and not merely expenses that are
currently deductible for tax purposes. Accordingly, the
expenses referred to include expenses that are capitalizable as
well as those that are currently deductible. Further, salaries
paid by residents that are exempt from income taxation may be
considered to be borne by a permanent establishment
notwithstanding the fact that the expenses will be neither
deductible nor capitalizable since the payor is exempt from
tax.
Paragraph 3
Paragraph 3 contains a special rule applicable to
remuneration for services performed by a resident of a
Contracting State as an employee aboard a ship or aircraft
operated in international traffic. Such remuneration may be
taxed only in the State of residence of the employee if the
services are performed as a member of the crew of the ship or
aircraft or as other personnel regularly employed to serve
aboard the ship or aircraft. In the case of a cruise ship, for
example, paragraph 3 applies to the crew and others, such as
entertainers, lecturers, etc., employed by the shipping company
to serve on the ship throughout its voyage. The use of the
phrase ``regularly employed to serve'' is intended to clarify
that a person who exercises his employment as, for example, an
insurance salesman while aboard a ship or aircraft is not
covered by this paragraph.
Relationship to other Articles
If a U.S. citizen who is resident in Bulgaria performs
services as an employee in the United States and meets the
conditions of paragraph 2 for source country exemption, he
nevertheless is taxable in the United States by virtue of the
saving clause of paragraph 4 of Article 1 (General Scope),
subject to the special foreign tax credit rule of paragraph 4
of Article 22 (Relief from Double Taxation).
ARTICLE 15 (DIRECTORS' FEES)
This Article provides that a Contracting State may tax the
fees and other compensation paid by a company that is a
resident of that State for services performed by a resident of
the other Contracting State in his capacity as a member of the
board of directors or a functionally similar body. This rule is
an exception to the more general rules of Articles 7 (Business
Profits) and 14 (Income from Employment). Thus, for example, in
determining whether a director's fee paid to a non-employee
director is subject to tax in the country of residence of the
corporation, it is not relevant to establish whether the fee is
attributable to a permanent establishment in that State.
Under this Article, a resident of one Contracting State who
is a director of a corporation that is resident in the other
Contracting State is subject to tax in that other State in
respect of his directors' fees regardless of where the services
are performed. This provision of the Convention is identical in
substance to the analogous provision in the OECD Model.
ARTICLE 16 (ENTERTAINERS AND SPORTSMEN)
This Article deals with the taxation in a Contracting State
of entertainers and sportsmen resident in the other Contracting
State from the performance of their services as such. The
Article applies both to the income of an entertainer or
sportsman who performs services on his own behalf and one who
performs services on behalf of another person, either as an
employee of that person, or pursuant to any other arrangement.
The rules of this Article take precedence, in some
circumstances, over those of Articles 7 (Business Profits) and
14 (Income from Employment).
This Article applies only with respect to the income of
entertainers and sportsmen. Others involved in a performance or
athletic event, such as producers, directors, technicians,
managers, coaches, etc., remain subject to the provisions of
Articles 7 and 14. In addition, except as provided in paragraph
2, income earned by juridical persons is not covered by Article
16.
Paragraph 1
Paragraph 1 describes the circumstances in which a
Contracting State may tax the performance income of an
entertainer or sportsman who is a resident of the other
Contracting State. Under the paragraph, income derived by an
individual resident of a Contracting State from activities as
an entertainer or sportsman exercised in the other Contracting
State may be taxed in that other State if the amount of the
gross receipts derived by the performer exceeds $15,000 (or its
equivalent in Bulgarian currency) for the taxable year. The
$15,000 includes expenses reimbursed to the individual or borne
on his behalf. If the gross receipts exceed $15,000, the full
amount, not just the excess, may be taxed in the State of
performance.
This Convention introduces a monetary threshold to
distinguish between two groups of entertainers and athletes--
those who are paid relatively large sums of money for very
short periods of service, and who would, therefore, normally be
exempt from host country tax under the standard personal
services income rules, and those who earn relatively modest
amounts and are, therefore, not easily distinguishable from
those who earn other types of personal service income.
Tax may be imposed under paragraph 1 even if the performer
would have been exempt from tax under Article 7 (Business
Profits) or 14 (Income from Employment). On the other hand, if
the performer would be exempt from host-country tax under
Article 16, but would be taxable under either Article 7 or 14,
tax may be imposed under either of those Articles. Thus, for
example, if a performer derives remuneration from his
activities in an independent capacity, and the performer does
not have a permanent establishment in the host State, he may be
taxed by the host State in accordance with Article 16 if his
remuneration exceeds $15,000 annually, despite the fact that he
generally would be exempt from host State taxation under
Article 7. However, a performer who receives less than the
$15,000 threshold amount and therefore is not taxable under
Article 16 nevertheless may be subject to tax in the host
country under Article 7 or 14 if the tests for host-country
taxability under the relevant Article are met. For example, if
an entertainer who is an independent contractor earns $14,000
of income in a State for the calendar year, but the income is
attributable to his permanent establishment in the State of
performance, that State may tax his income under Article 7.
Since it frequently is not possible to know until year-end
whether the income an entertainer or sportsman derived from
performances in a Contracting State will exceed $15,000,
nothing in the Convention precludes that Contracting State from
withholding tax during the year and refunding it after the
close of the year if the taxability threshold has not been met.
As explained in paragraph 9 of the Commentary to Article 17
of the OECD Model, Article 16 of the Convention applies to all
income connected with a performance by the entertainer, such as
appearance fees, award or prize money, and a share of the gate
receipts. Income derived from a Contracting State by a
performer who is a resident of the other Contracting State from
other than actual performance, such as royalties from record
sales and payments for product endorsements, is not covered by
this Article, but by other articles of the Convention, such as
Article 12 (Royalties) or Article 7 (Business Profits). For
example, if an entertainer receives royalty income from the
sale of live recordings, the royalty income would be subject to
the provisions of Article 12, even if the performance was
conducted in the source country, although the entertainer could
be taxed in the source country with respect to income from the
performance itself under Article 16 if the dollar threshold is
exceeded.
In determining whether income falls under Article 16 or
another article, the controlling factor will be whether the
income in question is predominantly attributable to the
performance itself or to other activities or property rights.
For instance, a fee paid to a performer for endorsement of a
performance in which the performer will participate would be
considered to be so closely associated with the performance
itself that it normally would fall within Article 16.
Similarly, a sponsorship fee paid by a business in return for
the right to attach its name to the performance would be so
closely associated with the performance that it would fall
under Article 16 as well. As indicated in paragraph 9 of the
Commentary to Article 17 of the OECD Model, however, a
cancellation fee would not be considered to fall within Article
16 but would be dealt with under Article 7 (Business Profits)
or 14 (Income from Employment).
As indicated in paragraph 4 of the Commentary to Article 17
of the OECD Model, where an individual fulfills a dual role as
performer and non-performer (such as a player-coach or an
actor-director), but his role in one of the two capacities is
negligible, the predominant character of the individual's
activities should control the characterization of those
activities. In other cases there should be an apportionment
between the performance-related compensation and other
compensation.
Consistent with Article 14 (Income from Employment),
Article 16 also applies regardless of the timing of actual
payment for services. Thus, a bonus paid to a resident of a
Contracting State with respect to a performance in the other
Contracting State during a particular taxable year would be
subject to Article 16 even if it was paid after the close of
the year. The determination as to whether the $15,000 threshold
has been exceeded is determined separately with respect to each
year of payment. Accordingly, if an actor who is a resident of
one Contracting State receives residual payments over time with
respect to a movie that was filmed in the other Contracting
State, the payments do not have to be aggregated from one year
to another to determine whether the total payments have finally
exceeded $15,000. Otherwise, residual payments received many
years later could retroactively subject all earlier payments to
tax by the other Contracting State.
Paragraph 2
Paragraph 2 is intended to address the potential for
circumvention of the rule in paragraph 1 when a performer's
income does not accrue directly to the performer himself, but
to another person. Foreign performers frequently perform in the
United States as employees of, or under contract with, a
company or other person.
The relationship may truly be one of employee and employer,
with no circumvention of paragraph 1 either intended or
realized. On the other hand, the ``employer'' may, for example,
be a company established and owned by the performer, which is
merely acting as the nominal income recipient in respect of the
remuneration for the performance (a ``star company''). The
performer may act as an ``employee,'' receive a modest salary,
and arrange to receive the remainder of the income from his
performance from the company in another form or at a later
time. In such case, absent the provisions of paragraph 2, the
income arguably could escape host-country tax because the
company earns business profits but has no permanent
establishment in that country. The performer may largely or
entirely escape host-country tax by receiving only a small
salary, perhaps small enough to place him below the dollar
threshold in paragraph 1. The performer might arrange to
receive further payments in a later year, when he is not
subject to host-country tax, perhaps as dividends or
liquidating distributions.
Paragraph 2 seeks to prevent this type of abuse while at
the same time protecting the taxpayers' rights to the benefits
of the Convention when there is a legitimate employee-employer
relationship between the performer and the person providing his
services. Under paragraph 2, when the income accrues to a
person other than the performer, the income may be taxed in the
Contracting State where the performer's services are exercised,
without regard to the provisions of the Convention concerning
business profits (Article 7) or income from employment (Article
14), but only if one of two conditions is met. The first
condition is that the contract pursuant to which the personal
activities are performed designates the entertainer or
sportsman (by name or description). The second condition is
that the contract allows the other party to the contract (or a
person other than the entertainer, sportsman or the person to
whom the income accrues) to designate the individual who is to
perform the personal activities. This rule is consistent with
the U.S. domestic law provision characterizing income from
certain personal service contracts as foreign personal holding
company income.
The premise of this rule is that, in a case where a
performer is using another person in an attempt to circumvent
the provisions of paragraph 1, the recipient of the services of
the performer would contract with a person other than that
performer (i.e., a company employing the performer) only if the
recipient of the services were certain that the performer
himself would perform the services (i.e., the contract
mentioned the performer by name or description or else allowed
the recipient of the services to designate who is to perform
the services). If instead the person to whom the income accrues
is allowed to designate the individual who is to perform the
services, then likely that person is a service company not
formed to circumvent the provisions of paragraph 1. The
following example illustrates the operation of this rule.
Example. Company O, a resident of Bulgaria, is engaged in
the business of operating an orchestra. Company O enters into a
contract with Company A pursuant to which Company O agrees to
carry out two performances in the United States in
consideration of which Company A will pay Company O $200,000.
The contract designates two individuals, a conductor and a
flutist, that must perform as part of the orchestra, and allows
Company O to designate the other members of the orchestra.
Because the contract mentions by name the conductor and the
flutist, the portion of the $200,000 that is attributable to
the personal services of the conductor and the flutist may be
taxed by the United States pursuant to paragraph 2. However,
because Company A is not allowed to designate the other
performers the remaining portion of the $200,000, is not
subject to tax by the United States pursuant to paragraph 2.
In cases where paragraph 2 is applicable, the income of the
``employer'' may be subject to tax in the host Contracting
State even if it has no permanent establishment in the host
country. Taxation under paragraph 2 is on the person providing
the services of the performer. This paragraph does not affect
the rules of paragraph 1, which apply to the performer himself.
The income taxable by virtue of paragraph 2 is reduced to the
extent of salary payments to the performer, which fall under
paragraph 1.
For purposes of paragraph 2, income is deemed to accrue to
another person (i.e., the person providing the services of the
performer) if that other person has control over, or the right
to receive, gross income in respect of the services of the
performer.
Pursuant to Article 1 (General Scope) the Convention only
applies to persons who are residents of one of the Contracting
States. Thus, income of a star company that is not a resident
of one of the Contracting States would not be eligible for the
benefits of the Convention.
Relationship to other Articles
This Article is subject to the provisions of the saving
clause of paragraph 4 of Article 1 (General Scope). Thus, if an
entertainer or a sportsman who is resident in Bulgaria is a
citizen of the United States, the United States may tax all of
his income from performances in the United States without
regard to the provisions of this Article, subject, however, to
the special foreign tax credit provisions of paragraph 4 of
Article 22 (Relief from Double Taxation). In addition, benefits
of this Article are subject to the provisions of Article 21
(Limitation on Benefits).
ARTICLE 17 (PENSIONS, SOCIAL SECURITY, ANNUITIES, ALIMONY, AND CHILD
SUPPORT)
This Article deals with the taxation of private (i.e., non-
government service) pensions and annuities, social security
benefits, alimony and child support payments.
Paragraph 1
Paragraph 1 provides that distributions from pensions and
other similar remuneration beneficially owned by a resident of
a Contracting State in consideration of past employment are
taxable only in the State of residence of the beneficiary. The
term ``pensions and other similar remuneration'' includes both
periodic and single sum payments.
The phrase ``pensions and other similar remuneration'' is
intended to encompass payments made by qualified private
retirement plans. In the United States, the plans encompassed
by paragraph 1 include: qualified plans under section 401(a),
individual retirement plans (including individual retirement
plans that are part of a simplified employee pension plan that
satisfies section 408(k), individual retirement accounts and
section 408(p) accounts), section 403(a) qualified annuity
plans, and section 403(b) plans. Distributions from section 457
plans may also fall under Paragraph 1 if they are not paid with
respect to government services covered by Article 18.
Pensions in respect of government services covered by
Article 18 are not covered by this paragraph. They are covered
either by paragraph 2 of this Article, if they are in the form
of social security benefits, or by paragraph 2 of Article 18
(Government Service). Thus, Article 18 generally covers section
457, 401(a), 403(b) plans established for government employees,
and the Thrift Savings Plan (section 7701(j)).
Paragraph 2
The treatment of social security benefits is dealt with in
paragraph 2. This paragraph provides that, notwithstanding the
provision of paragraph 1 under which private pensions are
taxable exclusively in the State of residence of the beneficial
owner, payments made by one of the Contracting States under the
provisions of its social security or similar legislation to a
resident of Bulgaria or to a citizen of the United States will
be taxable only in the Contracting State making the payment.
The reference to U.S. citizens is necessary to ensure that a
social security payment by Bulgaria to a U.S. citizen who is
not resident in the United States will not be taxable by the
United States.
This paragraph applies to social security beneficiaries
whether they have contributed to the system as private sector
or Government employees. The phrase ``similar legislation'' is
intended to refer to United States tier 1 Railroad Retirement
benefits.
Paragraph 3
Under paragraph 3, annuities that are derived and
beneficially owned by a resident of a Contracting State are
taxable only in that State. An annuity, as the term is used in
this paragraph, means a stated sum paid periodically at stated
times during a specified number of years, under an obligation
to make the payment in return for adequate and full
consideration (other than for services rendered). An annuity
received in consideration for services rendered would be
treated as either deferred compensation that is taxable in
accordance with Article 14 (Income from Employment) or a
pension that is subject to the rules of paragraph 1.
Paragraph 4
Paragraph 4 deals with alimony and child support payments.
Under paragraph 4, alimony and child support payments paid by a
resident of a Contracting State to a resident of the other
Contracting State are not taxable in the recipient's State of
residence. In addition, such payments are not taxable in the
payor's State of residence unless he is entitled to a deduction
for such payments in computing taxable income in his State of
residence. The term alimony is defined as periodic payments
made pursuant to a written separation agreement or a decree of
divorce, separate maintenance, or compulsory support.
Paragraph 5
Paragraph 5 provides that, if a resident of a Contracting
State participates in a pension fund established in the other
Contracting State, the State of residence will not tax the
income of the pension fund with respect to that resident until
a distribution is made from the pension fund. Thus, for
example, if a U.S. citizen contributes to a U.S. qualified plan
while working in the United States and then establishes
residence in Bulgaria, paragraph 5 prevents Bulgaria from
taxing currently the plan's earnings and accretions with
respect to that individual. When the resident receives a
distribution from the pension fund, that distribution may be
subject to tax in the State of residence under paragraph 1.
Relationship to other Articles
Paragraphs 1, 3, and 4 of Article 17 are subject to the
saving clause of paragraph 4 of Article 1 (General Scope).
Thus, a U.S. citizen who is resident in Bulgaria, and receives
a pension, annuity or alimony payment from the United States,
may be subject to U.S. tax on the payment, notwithstanding the
rules in paragraphs 1, 3 and 4. Paragraphs 2 and 5 are excepted
from the saving clause by virtue of subparagraph 5(a) of
Article 1. Thus, the United States will not tax U.S. citizens
and residents on the income described in paragraph 2, even if
such amounts otherwise would be subject to tax under U.S. law,
and the United States will allow U.S. citizens and residents
the benefits of paragraph 5.
ARTICLE 18 (GOVERNMENT SERVICE) PARAGRAPH 1
Paragraph 1 deals with the taxation of government
compensation (other than a pension addressed in paragraph 2).
Subparagraph (a) provides that remuneration paid to any
individual who is rendering services to that State, political
subdivision or local authority is exempt from tax by the other
State. Under subparagraph (b), such payments are, however,
taxable exclusively in the other State (i.e., the host State)
if the services are rendered in that other State and the
individual is a resident of that State who is either a national
of that State or a person who did not become resident of that
State solely for purposes of rendering the services. The
paragraph applies to anyone performing services for a
government, whether as a government employee, an independent
contractor, or an employee of an independent contractor.
Paragraph 2
Paragraph 2 deals with the taxation of pensions paid by, or
out of funds created by, one of the States, or a political
subdivision or a local authority thereof, to an individual in
respect of services rendered to that State or subdivision or
authority. Subparagraph (a) provides that such pensions are
taxable only in that State. Subparagraph (b) provides an
exception under which such pensions are taxable only in the
other State if the individual is a resident of, and a national
of, that other State.
Pensions paid to retired civilian and military employees of
a Government of either State are intended to be covered under
paragraph 2. When benefits paid by a State in respect of
services rendered to that State or a subdivision or authority
are in the form of social security benefits, however, those
payments are covered by paragraph 2 of Article 17 (Pensions,
Social Security Payments, Annuities, Alimony, and Child
Support). As a general matter, the result will be the same
whether Article 17 or 18 applies, since social security
benefits are taxable exclusively by the source country and so
are government pensions. The result will differ only when the
payment is made to a citizen and resident of the other
Contracting State, who is not also a citizen of the paying
State. In such a case, social security benefits continue to be
taxable at source while government pensions become taxable only
in the residence country.
Paragraph 3
Paragraph 3 provides that the remuneration described in
paragraph 1 will be subject to the rules of Articles 14 (Income
from Employment), 15 (Directors' Fees), 16 (Entertainers and
Sportsmen) or 17 (Pensions, Social Security Payments,
Annuities, Alimony, and Child Support) if the recipient of the
income is employed by a business conducted by a government.
Relationship to other Articles
Under paragraph 5(b) of Article 1 (General Scope), the
saving clause (paragraph 4 of Article 1) does not apply to the
benefits conferred by one of the States under Article 18 if the
recipient of the benefits is neither a citizen of that State,
nor a person who has been admitted for permanent residence
there (i.e., in the United States, a ``green card'' holder).
Thus, a resident of a Contracting State who in the course of
performing functions of a governmental nature becomes a
resident of the other State (but not a permanent resident),
would be entitled to the benefits of this Article. An
individual who receives a pension paid by the Government of
Bulgaria in respect of services rendered to the Government of
Bulgaria shall be taxable on this pension only in Bulgaria
unless the individual is a U.S. citizen or acquires a U.S.
green card.
ARTICLE 19 (STUDENTS, TRAINEES, TEACHERS AND RESEARCHERS)
This Article provides rules for host-country taxation of
visiting students, business trainees, teachers and researchers.
Persons who meet the tests of the Article will be exempt from
tax in the State that they are visiting with respect to
designated classes of income. Paragraph 1 addresses payments
received by a student or business trainee, while paragraph 2
addresses teachers and researchers temporarily present in the
host country.
Paragraph 1
Subparagraph (a) addresses the situation where a student or
business trainee that is a resident of a Contracting State
receives designated classes of payments while present in the
host State. Several conditions must be satisfied for such an
individual to be entitled to the benefits of paragraph 1.First,
the student or business trainee must have been, either at the
time of his arrival in the host State or immediately before, a
resident of the other Contracting State.
Second, the purpose of the visit must be the full-time
education (at a college, university, or other recognized
educational institution of a similar nature) or full-time
training of the visitor. Thus, if the visitor comes principally
to work in the host State but also is a part-time student, he
would not be entitled to the benefits of paragraph 1, even with
respect to any payments he may receive from abroad for his
maintenance or education, and regardless of whether or not he
is in a degree program. Whether a student is to be considered
full-time will be determined by the rules of the educational
institution at which he is studying.
The host-country exemption in paragraph 1 applies to
payments received by the student or business trainee for the
purpose of his maintenance, education or training that arise
outside the host State. A payment will be considered to arise
outside the host State if the payor is located outside the host
State. Thus, if an employer from one of the Contracting States
sends an employee to the other Contracting State for training,
the payments the trainee receives from abroad from his employer
for his maintenance or training while he is present in the host
State will be exempt from tax in the host State. Where
appropriate, substance prevails over form in determining the
identity of the payor. Thus, for example, payments made
directly or indirectly by a U.S. person with whom the visitor
is training, but which have been routed through a source
outside the United States (e.g., a foreign subsidiary), are not
treated as arising outside the United States for this purpose.
Paragraph 1 also provides a limited exemption for
remuneration from personal services rendered in the host State
with a view to supplementing the resources available to him for
such purposes to the extent of $9,000 United States dollars (or
its equivalent in the currency of Bulgaria) per taxable year.
The competent authorities are instructed to adjust this amount
every five years, if appropriate.
In the case of a business trainee, the benefits of
paragraph 1 will extend only for a period of two years from the
time that the visitor first arrives in the host country for the
purpose of training. If, however, a trainee remains in the host
country for a third year, thus losing the benefits of paragraph
1, he would not retroactively lose the benefits of the
paragraph 1 for the first two years. The term ``business
trainee'' is defined as a person who is in the country
temporarily either for the purpose of securing training that is
necessary to qualify to pursue a profession or professional
specialty, or as an employee of, or under contract with, a
resident of the other Contracting State, for the primary
purpose of acquiring technical, professional, or business
experience, from someone who is not his employer or related to
his employer. Thus, a business trainee might include a lawyer
employed by a law firm in one Contracting State who works for
one year as a stagiare in an unrelated law firm in the other
Contracting State. However, the term would not include a
manager who normally is employed by a parent company in one
Contracting State who is sent to the other Contracting State to
run a factory owned by a subsidiary of the parent company.
Paragraph 2
Paragraph 2 provides a limited exemption from host State
taxation for certain teachers and researchers temporarily
present in the host State for the purpose of teaching or
carrying on research at a school, college, university or other
recognized educational or research institution. The teacher or
researcher must be a resident of the other Contracting State at
the beginning of his visit to the host State. The income
eligible for exemption is the person's remuneration received in
consideration of teaching or carrying on research. The host-
country exemption will extend to payments received by a teacher
or researcher only for a period of two years from the time that
the visitor first arrives in the host country. A teacher or
researcher remaining in the host country for more than 2 years
becomes subject to tax on remuneration with respect to teaching
and researching, but does not retroactively lose the benefits
of paragraph 2 for the first two years. Paragraph 2 does not
apply to exempt income in consideration of carrying on research
if the research is primarily for the private benefit of a
specific person or persons rather than in the public interest.
Relationship to other Articles
The saving clause of paragraph 4 of Article 1 (General
Scope) does not apply to this Article with respect to an
individual who is neither a citizen of the host State nor has
been admitted for permanent residence there. The saving clause,
however, does apply with respect to citizens and permanent
residents of the host State. Thus, for example, a U.S. citizen
who is a resident of Bulgaria and who visits the United States
as a full-time student at an accredited university will not be
exempt from U.S. tax on remittances from abroad that otherwise
constitute U.S. taxable income. A person, however, who is not a
U.S. citizen, and who visits the United States as a student and
remains long enough to become a resident under U.S. law, but
does not become a permanent resident (i.e., does not acquire a
green card), will be entitled to the full benefits of the
Article.
ARTICLE 20 (OTHER INCOME)
Article 20 generally assigns taxing jurisdiction over
income not dealt with in the other articles (Articles 6 through
19) of the Convention to the State of residence of the
beneficial owner of the income. In order for an item of income
to be ``dealt with'' in another article it must be the type of
income described in the article and, in most cases, it must
have its source in a Contracting State. For example, all
royalty income that arises in a Contracting State and that is
beneficially owned by a resident of the other Contracting State
is ``dealt with'' in Article 12 (Royalties). However, profits
derived in the conduct of a business are ``dealt with'' in
Article 7 (Business Profits) whether or not they have their
source in one of the Contracting States.
Examples of items of income covered by Article 20 include
income from gambling, punitive (but not compensatory) damages
and covenants not to compete. The Article would also apply to
income from a variety of financial transactions, where such
income does not arise in the course of the conduct of a trade
or business. For example, income from notional principal
contracts and other derivatives would fall within Article 20 if
derived by persons not engaged in the trade or business of
dealing in such instruments, unless such instruments were being
used to hedge risks arising in a trade or business. It would
also apply to securities lending fees derived by an
institutional investor. Further, in most cases guarantee fees
paid within an intercompany group would be covered by Article
20, unless the guarantor were engaged in the business of
providing such guarantees to unrelated parties.
Article 20 also applies to items of income that are not
dealt with in the other articles because of their source or
some other characteristic. For example, Article 11 (Interest)
addresses only the taxation of interest arising in a
Contracting State. Interest arising in a third State that is
not attributable to a permanent establishment, therefore, is
subject to Article 20.
Distributions from partnerships are not generally dealt
with under Article 20 because partnership distributions
generally do not constitute income. Under the Code, partners
include in income their distributive share of partnership
income annually, and partnership distributions themselves
generally do not give rise to income. This would also be the
case under U.S. law with respect to distributions from trusts.
Trust income and distributions that, under the Code, have the
character of the associated distributable net income would
generally be covered by another article of the Convention. See
Code section 641 et seq.
Paragraph 1
The general rule of Article 20 is contained in paragraph 1.
Items of income not dealt with in other articles and
beneficially owned by a resident of a Contracting State will be
taxable only in the State of residence. This exclusive right of
taxation applies whether or not the residence State exercises
its right to tax the income covered by the Article.
The reference in this paragraph to ``items of income
beneficially owned by a resident of a Contracting State''
rather than simply ``items of income of a resident of a
Contracting State,'' as in the OECD Model, is intended merely
to make explicit the implicit understanding in other treaties
that the exclusive residence taxation provided by paragraph 1
applies only when a resident of a Contracting State is the
beneficial owner of the income. Thus, source taxation of income
not dealt with in other articles of the Convention is not
limited by paragraph 1 if it is nominally paid to a resident of
the other Contracting State, but is beneficially owned by a
resident of a third State. However, income received by a
nominee on behalf of a resident of that other State would be
entitled to benefits.
The term ``beneficially owned'' is not defined in the
Convention, and is, therefore, defined as under the internal
law of the country imposing tax (i.e., the source country). The
person who beneficially owns the income for purposes of Article
20 is the person to which the income is attributable for tax
purposes under the laws of the source State.
Paragraph 2
This paragraph provides an exception to the general rule of
paragraph 1 for income that is attributable to a permanent
establishment maintained in a Contracting State by a resident
of the other Contracting State. The taxation of such income is
governed by the provisions of Article 7 (Business Profits).
Therefore, income arising outside the United States that is
attributable to a permanent establishment maintained in the
United States by a resident of Bulgaria generally would be
taxable by the United States under the provisions of Article 7.
This would be true even if the income is sourced in a third
State.
Relationship to other Articles
This Article is subject to the saving clause of paragraph 4
of Article 1 (General Scope). Thus, the United States may tax
the income of a resident of Bulgaria that is not dealt with
elsewhere in the Convention, if that resident is a citizen of
the United States. The Article is also subject to the
provisions of Article 21 (Limitation on Benefits). Thus, if a
resident of Bulgaria earns income that falls within the scope
of paragraph 1 of Article 20, but that is taxable by the United
States under U.S. law, the income would be exempt from U.S. tax
under the provisions of Article 20 only if the resident
satisfies one of the tests of Article 21 for entitlement to
benefits.
ARTICLE 21 (LIMITATION ON BENEFITS)
Article 21 contains anti-treaty-shopping provisions that
are intended to prevent residents of third countries from
benefiting from what is intended to be a reciprocal agreement
between two countries. In general, the provision does not rely
on a determination of purpose or intention but instead sets
forth a series of objective tests. A resident of a Contracting
State that satisfies one of the tests will receive benefits
regardless of its motivations in choosing its particular
business structure.
The structure of the Article is as follows: Paragraph 1
states the general rule that residents are entitled to benefits
otherwise accorded to residents only to the extent provided in
the Article. Paragraph 2 lists a series of attributes of a
resident of a Contracting State, the presence of any one of
which will entitle that person to all the benefits of the
Convention. Paragraph 3 provides a so-called ``derivative
benefits'' test under which certain categories of income may
qualify for benefits. Paragraph 4 provides that, regardless of
whether a person qualifies for benefits under paragraph 2 or 3,
benefits may be granted to that person with regard to certain
income earned in the conduct of an active trade or business.
Paragraph 5 provides special rules for so-called ``triangular
cases'' notwithstanding paragraphs 1 through 4 of Article 21.
Paragraph 6 provides that benefits also may be granted if the
competent authority of the State from which benefits are
claimed determines that it is appropriate to provide benefits
in that case. Paragraph 7 defines certain terms used in the
Article.
Paragraph 1
Paragraph 1 provides that a resident of a Contracting State
will be entitled to the benefits otherwise accorded to
residents of a Contracting State under the Convention only to
the extent provided in the Article. The benefits otherwise
accorded to residents under the Convention include all
limitations on source-based taxation under Articles 6 through
20, the treaty-based relief from double taxation provided by
Article 22 (Relief from Double Taxation), and the protection
against discrimination afforded to residents of a Contracting
State under Article 23 (Non-Discrimination). Some provisions do
not require that a person be a resident in order to enjoy the
benefits of those provisions. Article 24 (Mutual Agreement
Procedure) is not limited to residents of the Contracting
States, and Article 26 applies to diplomatic agents or consular
officials regardless of residence. Article 21 accordingly does
not limit the availability of treaty benefits under these
provisions.
Article 21 and the anti-abuse provisions of domestic law
complement each other, as Article 21 effectively determines
whether an entity has a sufficient nexus to the Contracting
State to be treated as a resident for treaty purposes, while
domestic anti-abuse provisions (e.g., business purpose,
substance-over-form, step transaction or conduit principles)
determine whether a particular transaction should be recast in
accordance with its substance. Thus, internal law principles of
the source Contracting State may be applied to identify the
beneficial owner of an item of income, and Article 21 then will
be applied to the beneficial owner to determine if that person
is entitled to the benefits of the Convention with respect to
such income.
Paragraph 2
Paragraph 2 has five subparagraphs, each of which describes
a category of residents that are entitled to all benefits of
the Convention.
It is intended that the provisions of paragraph 2 will be
self executing. Unlike theprovisions of paragraph 6, discussed
below, claiming benefits under paragraph 2 does not require an
advance competent authority ruling or approval. The tax
authorities may, of course, on review, determine that the
taxpayer has improperly interpreted the paragraph and is not
entitled to the benefits claimed.
Individuals--Subparagraph 2(a)
Subparagraph (a) provides that individual residents of a
Contracting State will be entitled to all treaty benefits. If
such an individual receives income as a nominee on behalf of a
third country resident, benefits may be denied under the
respective articles of the Convention by the requirement that
the beneficial owner of the income be a resident of a
Contracting State.
Governments--Subparagraph 2(b)
Subparagraph (b) provides that the Contracting States and
any political subdivision or local authority thereof will be
entitled to all benefits of the Convention.
Publicly-Traded Corporations--Subparagraph 2(c)(i)
Subparagraph (c) applies to two categories of companies:
publicly traded companies and subsidiaries of publicly traded
companies. A company resident in a Contracting State is
entitled to all the benefits of the Convention under clause (i)
of subparagraph (c) if the principal class of its shares, and
any disproportionate class of shares, is regularly traded on
one or more recognized stock exchanges and the company
satisfies at least one of the following additional
requirements: first, the company's principal class of shares is
primarily traded on one or more recognized stock exchanges
located in the Contracting State of which the company is a
resident; or, second, the company's primary place of management
and control is in its State of residence.
The term ``recognized stock exchange'' is defined in
subparagraph 7(a). It includes (i) the NASDAQ System and any
stock exchange registered with the Securities and Exchange
Commission as a national securities exchange for purposes of
the Securities Exchange Act of 1934; (ii) the Bulgarian Stock
Exchange--Sofia, and any other stock exchange licensed to trade
securities and financial instruments under the Bulgarian law;
and (iii) any other stock exchange agreed upon by the competent
authorities of the Contracting States.
If a company has only one class of shares, it is only
necessary to consider whether the shares of that class meet the
relevant trading requirements. If the company has more than one
class of shares, it is necessary as an initial matter to
determine which class or classes constitute the ``principal
class of shares''. The term ``principal class of shares'' is
defined in subparagraph 7(b) to mean the ordinary or common
shares of the company representing the majority of the
aggregate voting power and value of the company. If the company
does not have a class of ordinary or common shares representing
the majority of the aggregate voting power and value of the
company, then the ``principal class of shares'' is that class
or any combination of classes of shares that represents, in the
aggregate, a majority of the voting power and value of the
company. Although in a particular case involving a company with
several classes of shares it is conceivable that more than one
group of classes could be identified that account for more than
50% of the shares, it is only necessary for one such group to
satisfy the requirements of this subparagraph in order for the
company to be entitled to benefits. Benefits would not be
denied to the company even if a second, non-qualifying, group
of shares with more than half of the company's voting power and
value could be identified.
A company whose principal class of shares is regularly
traded on a recognized stock exchange will nevertheless not
qualify for benefits under subparagraph 2(c) if it has a
disproportionate class of shares that is not regularly traded
on a recognized stock exchange. The term ``disproportionate
class of shares'' is defined in subparagraph 7(c). A company
has a disproportionate class of shares if it has outstanding a
class of shares that is subject to terms or other arrangements
that entitle the holder to a larger portion of the company's
income, profit, or gain in the other Contracting State than
that to which the holder would be entitled in the absence of
such terms or arrangements. Thus, for example, a company
resident in Bulgaria has a disproportionate class of shares if
it has outstanding a class of ``tracking stock'' that pays
dividends based upon a formula that approximates the company's
return on its assets employed in the United States.
The following example illustrates this result.
Example. BulCo is a corporation resident in Bulgaria. BulCo
has two classes of shares: Common and Preferred. The Common
shares are listed and regularly traded on the principal stock
exchange of Bulgaria. The Preferred shares have no voting
rights and are entitled to receive dividends equal in amount to
interest payments that BulCo receives from unrelated borrowers
in the United States. The Preferred shares are owned entirely
by a single investor that is a resident of a country with which
the United States does not have a tax treaty. The Common shares
account for more than 50 percent of the value of BulCo and for
100 percent of the voting power. Because the owner of the
Preferred shares is entitled to receive payments corresponding
to the U.S. source interest income earned by BulCo, the
Preferred shares are a disproportionate class of shares.
Because the Preferred shares are not regularly traded on a
recognized stock exchange, BulCo will not qualify for benefits
under subparagraph 2(c).
A class of shares will be ``regularly traded'' on one or
more recognized stock exchanges in a taxable year, under
subparagraph 7(g), if the aggregate number of shares of that
class traded on one or more recognized exchanges during the
twelve months ending on the day before the beginning of that
taxable year is at least six percent of the average number of
shares outstanding in that class during that twelve-month
period. The regular trading requirement can be met by trading
on any recognized exchange or exchanges located in either
State. Trading on one or more recognized stock exchanges may be
aggregated for purposes of this requirement. Thus, a U.S.
company could satisfy the regularly traded requirement through
trading, in whole or in part, on a recognized stock exchange
located in Bulgaria.
The term ``primarily traded'' is not defined in the
Convention. In accordance with paragraph 2 of Article 3
(General Definitions), this term will have the meaning it has
under the laws of the State concerning the taxes to which the
Convention applies, generally the source State. In the case of
the United States, this term is understood to have the meaning
it has under Treas. Reg. section 1. 884-5(d)(3), relating to
the branch tax provisions of the Code. Accordingly, stock of a
corporation is ``primarily traded'' if the number of shares in
the company's principal class of shares that are traded during
the taxable year on all recognized stock exchanges in the
Contracting State of which the company is a resident exceeds
the number of shares in the company's principal class of shares
that are traded during that year on established securities
markets in any other single foreign country.
A company whose principal class of shares is regularly
traded on a recognized exchange but cannot meet the primarily
traded test may claim treaty benefits if its primary place of
management and control is in its country of residence. This
test should be distinguished from the ``place of effective
management'' test which is used in the OECD Model and by many
other countries to establish residence. In some cases, the
place of effective management test has been interpreted to mean
the place where the board of directors meets. By contrast, the
primary place of management and control test looks to where
day-to-day responsibility for the management of the company
(and its subsidiaries) is exercised. The company's primary
place of management and control will be located in the State in
which the company is a resident only if the executive officers
and senior management employees exercise day-to-day
responsibility for more of the strategic, financial and
operational policy decision making for the company (including
direct and indirect subsidiaries) in that State than in the
other State or any third state, and the staff that support the
management in making those decisions are also based in that
State. Thus, the test looks to the overall activities of the
relevant persons to see where those activities are conducted.
In most cases, it will be a necessary, but not a sufficient,
condition that the headquarters of the company (that is, the
place at which the CEO and other top executives normally are
based) be located in the Contracting State of which the company
is a resident.
To apply the test, it will be necessary to determine which
persons are to be considered ``executive officers and senior
management employees''. In most cases, it will not be necessary
to look beyond the executives who are members of the Board of
Directors (the ``inside directors'') in the case of a U.S.
company. That will not always be the case, however; in fact,
the relevant persons may be employees of subsidiaries if those
persons make the strategic, financial and operational policy
decisions. Moreover, it would be necessary to take into account
any special voting arrangements that result in certain board
members making certain decisions without the participation of
other board members.
Subsidiaries of Publicly-Traded Corporations--Subparagraph
2(c)(ii)
A company resident in a Contracting State is entitled to
all the benefits of the Convention under clause (ii) of
subparagraph 2(c) if five or fewer publicly traded companies
described in clause (i) are the direct or indirect owners of at
least 50 percent of the aggregate vote and value of the
company's shares (and at least 50 percent of any
disproportionate class of shares). If the publicly-traded
companies are indirect owners, however, each of the
intermediate companies must be a resident of one of the
Contracting States.
Thus, for example, a company that is a resident of
Bulgaria, all the shares of which are owned by another company
that is a resident of Bulgaria, would qualify for benefits
under the Convention if the principal class of shares (and any
disproportionate classes of shares) of the parent company are
regularly and primarily traded on a recognized stock exchange
in Bulgaria. However, such a subsidiary would not qualify for
benefits under clause (ii) if the publicly traded parent
company were a resident of a third state, for example, and not
a resident of the United States or Bulgaria. Furthermore, if a
parent company in Bulgaria indirectly owned the bottom-tier
company through a chain of subsidiaries, each such subsidiary
in the chain, as an intermediate owner, must be a resident of
the United States or Bulgaria in order for the subsidiary to
meet the test in clause (ii).
Tax Exempt Organizations--Subparagraph 2(d)
Subparagraph 2(d) provides rules by which the tax exempt
organizations described in paragraph 2 of Article 4 (Resident)
will be entitled to all the benefits of the Convention. A
pension fund will qualify for benefits if more than fifty
percent of the beneficiaries, members or participants of the
organization are individuals resident in either Contracting
State. For purposes of this provision, the term
``beneficiaries'' should be understood to refer to the persons
receiving benefits from the organization. On the other hand, a
tax-exempt organization other than a pension fund automatically
qualifies for benefits, without regard to the residence of its
beneficiaries or members. Entities qualifying under this rule
are those that are generally exempt from tax in their State of
residence and that are organized and operated exclusively to
fulfill religious, charitable, scientific, artistic, cultural,
or educational purposes.
Ownership/Base Erosion--Subparagraph 2(e)
Subparagraph 2(e) provides an additional method to qualify
for treaty benefits that applies to any form of legal entity
that is a resident of a Contracting State. The test provided in
subparagraph (e), the so-called ownership and base erosion
test, is a two-part test. Both prongs of the test must be
satisfied for the resident to be entitled to treaty benefits
under subparagraph 2(e).
The ownership prong of the test, under clause (i), requires
that at least 50 percent of the aggregate voting power and
value (and at least 50 percent of any disproportionate class of
shares) of shares or other beneficial interests in the person
is owned, directly or indirectly, on at least half the days of
the person's taxable year by persons who are residents of the
Contracting State of which that person is a resident and that
are themselves entitled to treaty benefits under subparagraphs
2(a), (b), (c)(i), or (d). In the case of indirect owners, each
of the intermediate owners must be a resident of that
Contracting State.
Trusts may be entitled to benefits under this provision if
they are treated as residents under Article 4 (Resident) and
they otherwise satisfy the requirements of this subparagraph.
For purposes of this subparagraph, the beneficial interests in
a trust will be considered to be owned by its beneficiaries in
proportion to each beneficiary's actuarial interest in the
trust. The interest of a remainder beneficiary will be equal to
100 percent less the aggregate percentages held by income
beneficiaries. A beneficiary's interest in a trust will not be
considered to be owned by a person entitled to benefits under
the other provisions of paragraph 2 if it is not possible to
determine the beneficiary's actuarial interest. Consequently,
if it is not possible to determine the actuarial interest of
the beneficiaries in a trust, the ownership test under clause
i) cannot be satisfied, unless all possible beneficiaries are
persons entitled to benefits under subparagraphs 2(a), (b),
(c)(i), or (d).
The base erosion prong of clause (ii) of subparagraph (e)
is satisfied with respect to a person if less than 50 percent
of the person's gross income for the taxable year, as
determined under the tax law in the person's State of
residence, is paid or accrued, directly or indirectly, to
persons who are not residents of either Contracting State
entitled to benefits under subparagraphs (a), (b), (c)(i), or
(d), in the form of payments deductible for tax purposes in the
payor's State of residence. These amounts do not include arm's-
length payments in the ordinary course of business for services
or tangible property. To the extent they are deductible from
the taxable base, trust distributions are deductible payments.
However, depreciation and amortization deductions, which do not
represent payments or accruals to other persons, are
disregarded for this purpose.
Paragraph 3
Paragraph 3 sets forth a derivative benefits test that is
potentially applicable to all treaty benefits, although the
test is applied to individual items of income. In general, a
derivative benefits test entitles the resident of a Contracting
State to treaty benefits if the owner of the resident would
have been entitled to the same benefit had the income in
question flowed directly to that owner. To qualify under this
paragraph, the company must meet an ownership test and a base
erosion test.
Subparagraph (a) sets forth the ownership test. Under this
test, seven or fewer equivalent beneficiaries must own shares
representing at least 95 percent of the aggregate voting power
and value of the company and at least 50 percent of any
disproportionate class of shares. Ownership may be direct or
indirect. The term ``equivalent beneficiary'' is defined in
subparagraph (e) of paragraph 7. This definition may be met in
two alternative ways, the first of which has two requirements.
Under the first alternative, a person may be an equivalent
beneficiary because it is entitled to equivalent benefits under
a treaty between the country of source and the country in which
the person is a resident. This alternative has two
requirements.
The first requirement is that the person must be a resident
of a member state of the European Union, or of a European
Economic Area state, or of a party to the North American Free
Trade Agreement (collectively, ``qualifying States'').
The second requirement of the definition of ``equivalent
beneficiary'' is that the person must be entitled to equivalent
benefits under an applicable treaty. To satisfy the second
requirement, the person must be entitled to all the benefits of
a comprehensive treaty between the Contracting State from which
benefits of the Convention are claimed and a qualifying State
under provisions that are analogous to the rules in paragraph 2
(a), (b), (c)(i), and (d) of this Article. If the treaty in
question does not have a comprehensive limitation on benefits
article, this requirement is met only if the person would be
entitled to treaty benefits under the tests in subparagraphs
2(a), (b), (c)(i), and (d) of this Article if the person were a
resident of one of the Contracting States.
In order to satisfy the second requirement necessary to
qualify as an ``equivalent beneficiary'' under subparagraph
7(e)(i)(B) with respect to dividends, interest, royalties or
branch tax, the person must be entitled to a rate of tax that
is at least as low as the tax rate that would apply under the
Convention to such income. Thus, the rates to be compared are:
(1) the rate of tax that the source State would have imposed if
a qualified resident of the other Contracting State was the
beneficial owner of the income; and (2) the rate of tax that
the source State would have imposed if the third State resident
received the income directly from the source State.
Subparagraph 7(f) provides a special rule to take account
of the fact that withholding taxes on many inter-company
dividends, interest and royalties are exempt within the
European Union by reason of various EU directives, rather than
by tax treaty. If a U.S. company receives such payments from a
Bulgarian company, and that U.S. company is owned by a company
resident in a member state of the European Union that would
have qualified for an exemption from withholding tax if it had
received the income directly, the parent company will be
treated as an equivalent beneficiary. This rule is necessary
because many European Union member countries have not re-
negotiated their tax treaties to reflect the exemptions
available under the directives.
The requirement that a person be entitled to ``all the
benefits'' of a comprehensive tax treaty eliminates those
persons that qualify for benefits with respect to only certain
types of income. Accordingly, the fact that a French parent of
a Bulgarian company is engaged in the active conduct of a trade
or business in France and therefore would be entitled to the
benefits of the U.S.-France treaty if it received dividends
directly from a U.S. subsidiary of the Bulgarian company is not
sufficient for purposes of this paragraph. Further, the French
company cannot be an equivalent beneficiary if it qualifies for
benefits only with respect to certain income as a result of a
``derivative benefits'' provision in the U.S.-France treaty.
However, it would be possible to look through the French
company to its parent company to determine whether the parent
company is an equivalent beneficiary.
The second alternative for satisfying the ``equivalent
beneficiary'' test is available only to residents of one of the
two Contracting States. U.S. or Bulgarian residents who are
eligible for treaty benefits by reason of subparagraphs 2(a),
(b), (c)(i), or (d) are equivalent beneficiaries for purposes
of the relevant tests in Article 21. Thus, a Bulgarian
individual will be an equivalent beneficiary without regard to
whether the individual would have been entitled to receive the
same benefits if it received the income directly. A resident of
a third country cannot qualify for treaty benefits under these
provisions by reason of those paragraphs or any other rule of
the treaty, and therefore does not qualify as an equivalent
beneficiary under this alternative. Thus, a resident of a third
country can be an equivalent beneficiary only if it would have
been entitled to equivalent benefits had it received the income
directly.
The second alternative was included in order to clarify
that ownership by certain residents of a Contracting State
would not disqualify a U.S. or Bulgarian company under this
paragraph. Thus, for example, if 90 percent of a Bulgarian
company is owned by five companies that are resident in member
states of the European Union who satisfy the requirements of
subparagraph 7(e)(i), and 10 percent of the Bulgarian company
is owned by a U.S. or Bulgarian individual, then the Bulgarian
company still can satisfy the requirements of subparagraph
3(a).
Subparagraph 3(b) sets forth the base erosion test. A
company meets this base erosion test if less than 50 percent of
its gross income (as determined in the company's State of
residence) for the taxable period is paid or accrued, directly
or indirectly, to a person or persons who are not equivalent
beneficiaries in the form of payments deductible for tax
purposes in company's State of residence. These amounts do not
include arm's-length payments in the ordinary course of
business for services or tangible property. This test is the
same as the base erosion test in subparagraph 2(e)(ii), except
that the test in paragraph 3(b) focuses on base-eroding
payments to persons who are not equivalent beneficiaries.
Paragraph 4
Paragraph 4 sets forth an alternative test under which a
resident of a Contracting State may receive treaty benefits
with respect to certain items of income that are connected to
an active trade or business conducted in its State of
residence. A resident of a Contracting State may qualify for
benefits under paragraph 4 whether or not it also qualifies
under paragraph 2 or 3.
Subparagraph (a) sets forth the general rule that a
resident of a Contracting State engaged in the active conduct
of a trade or business in that State may obtain the benefits of
the Convention with respect to an item of income derived in the
other Contracting State. The item of income, however, must be
derived in connection with or incidental to that trade or
business.
The term ``trade or business'' is not defined in the
Convention. Pursuant to paragraph 2 of Article 3 (General
Definitions), when determining whether a resident of Bulgaria
is entitled to the benefits of the Convention under paragraph 4
of this Article with respect to an item of income derived from
sources within the United States, the United States will
ascribe to this term the meaning that it has under the law of
the United States. Accordingly, the U.S. competent authority
will refer to the regulations issued under section 367(a) for
the definition of the term ``trade or business.'' In general,
therefore, a trade or business will be considered to be a
specific unified group of activities that constitute or could
constitute an independent economic enterprise carried on for
profit. Furthermore, a corporation generally will be considered
to carry on a trade or business only if the officers and
employees of the corporation conduct substantial managerial and
operational activities.
The business of making or managing investments for the
resident's own account will be considered to be a trade or
business only when part of banking, insurance or securities
activities conducted by a bank, an insurance company, or a
registered securities dealer. Such activities conducted by a
person other than a bank, insurance company or registered
securities dealer will not be considered to be the conduct of
an active trade or business, nor would they be considered to be
the conduct of an active trade or business if conducted by a
bank, insurance company or registered securities dealer but not
as part of the company's banking, insurance or dealer business.
Because a headquarters operation is in the business of managing
investments, a company that functions solely as a headquarters
company will not be considered to be engaged in an active trade
or business for purposes of paragraph 4.
An item of income is derived in connection with a trade or
business if the income-producing activity in the State of
source is a line of business that ``forms a part of'' or is
``complementary'' to the trade or business conducted in the
State of residence by the income recipient.
A business activity generally will be considered to form
part of a business activity conducted in the State of source 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 line of business in the State of
residence may be upstream, downstream, or parallel to the
activity conducted in the State of source. Thus, the line of
business may provide inputs for a manufacturing process that
occurs in the State of source, may sell the output of that
manufacturing process, or simply may sell the same sorts of
products that are being sold by the trade or business carried
on in the State of source.
Example 1. USCo is a corporation resident in the United
States. USCo is engaged in an active manufacturing business in
the United States. USCo owns 100 percent of the shares of
BulCo, a corporation resident in Bulgaria. BulCo distributes
USCo products in Bulgaria. Since the business activities
conducted by the two corporations involve the same products,
BulCo's distribution business is considered to form a part of
USCo's manufacturing business.
Example 2. The facts are the same as in Example 1, except
that USCo does not manufacture. Rather, USCo operates a large
research and development facility in the United States that
licenses intellectual property to affiliates worldwide,
including BulCo. BulCo and other USCo affiliates then
manufacture and market the USCo-designed products in their
respective markets. Since the activities conducted by BulCo and
USCo involve the same product lines, these activities are
considered to form a part of the same trade or business.
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. Where more than one trade or
business is conducted in the State of source and only one of
the trades or businesses forms a part of or is complementary to
a trade or business conducted in the State of residence, it is
necessary to identify the trade or business to which an item of
income is attributable. Royalties generally will be considered
to be derived in connection with the trade or business to which
the underlying intangible property is attributable. Dividends
will be deemed to be derived first out of earnings and profits
of the treaty-benefited trade or business, and then out of
other earnings and profits. Interest income may be allocated
under any reasonable method consistently applied. A method that
conforms to U.S. principles for expense allocation will be
considered a reasonable method.
Example 3. Americair is a corporation resident in the
United States that operates an international airline. BulSub is
a wholly-owned subsidiary of Americair resident in Bulgaria.
BulSub operates a chain of hotels in Bulgaria that are located
near airports served by Americair flights. Americair frequently
sells tour packages that include air travel to Bulgaria and
lodging at BulSub hotels. Although both companies are engaged
in the active conduct of a trade or business, the businesses of
operating a chain of hotels and operating an airline are
distinct trades or businesses. Therefore BulSub's business does
not form a part of Americair's business. However, BulSub's
business is considered to be complementary to Americair's
business because they are part of the same overall industry
(travel) and the links between their operations tend to make
them interdependent.
Example 4. The facts are the same as in Example 3, except
that BulSub owns an office building in Bulgaria instead of a
hotel chain. No part of Americair's business is conducted
through the office building. BulSub's business is not
considered to form a part of or to be complementary to
Americair's business. They are engaged in distinct trades or
businesses in separate industries, and there is no economic
dependence between the two operations.
Example 5. USFlower is a corporation resident in the United
States. USFlower produces and sells flowers in the United
States and other countries. USFlower owns all the shares of
BulHolding, a corporation resident in Bulgaria. BulHolding is a
holding company that is not engaged in a trade or business.
BulHolding owns all the shares of three corporations that are
resident in Bulgaria: BulFlower, BulLawn, and BulFish.
BulFlower distributes USFlower flowers under the USFlower
trademark in Bulgaria. BulLawn markets a line of lawn care
products in Bulgaria under the USFlower trademark. In addition
to being sold under the same trademark, BulLawn and BulFlower
products are sold in the same stores and sales of each
company's products tend to generate increased sales of the
other's products. BulFish imports fish from the United States
and distributes it to fish wholesalers in Bulgaria. For
purposes of paragraph 4, the business of BulFlower forms a part
of the business of USFlower, the business of BulLawn is
complementary to the business of USFlower, and the business of
BulFish is neither part of nor complementary to that of
USFlower.
An item of income derived from the State of source is
``incidental to'' the trade or business carried on in the State
of residence if production of the item facilitates the conduct
of the trade or business in the State of residence. An example
of incidental income is the temporary investment of working
capital of a person in the State of residence in securities
issued by persons in the State of source.
Subparagraph 4(b) states a further condition to the general
rule in subparagraph (a) in cases where the trade or business
generating the item of income in question is carried on either
by the person deriving the income or by any associated
enterprises. Subparagraph (b) states that the trade or business
carried on in the State of residence, under these
circumstances, must be substantial in relation to the activity
in the State of source. The substantiality requirement is
intended to prevent a narrow case of treaty-shopping abuses in
which a company attempts to qualify for benefits by engaging in
de minimis connected business activities in the treaty country
in which it is resident (i.e., activities that have little
economic cost or effect with respect to the company business as
a whole).
The determination of substantiality is made based upon all
the facts and circumstances and takes into account the
comparative sizes of the trades or businesses in each
Contracting State, the nature of the activities performed in
each Contracting State, and the relative contributions made to
that trade or business in each Contracting State.
The determination in subparagraph (b) also is made
separately for each item of income derived from the State of
source. It therefore is possible that a person would be
entitled to the benefits of the Convention with respect to one
item of income but not with respect to another. If a resident
of a Contracting State is entitled to treaty benefits with
respect to a particular item of income under paragraph 4, the
resident is entitled to all benefits of the Convention insofar
as they affect the taxation of that item of income in the State
of source.
The application of the substantiality requirement only to
income from related parties focuses only on potential abuse
cases, and does not hamper certain other kinds of non-abusive
activities, even though the income recipient resident in a
Contracting State may be very small in relation to the entity
generating income in the other Contracting State. For example,
if a small U.S. research firm develops a process that it
licenses to a very large, unrelated, pharmaceutical
manufacturer in Bulgaria, the size of the U.S. research firm
would not have to be tested against the size of the
manufacturer. Similarly, a small U.S. bank that makes a loan to
a very large unrelated company operating a business in Bulgaria
would not have to pass a substantiality test to receive treaty
benefits under paragraph 4.
Subparagraph 4(c) provides special attribution rules for
purposes of applying the substantive rules of subparagraphs (a)
and (b). These rules apply for purposes of determining whether
a person meets the requirement in subparagraph (a) that it be
engaged in the active conduct of a trade or business and that
the item of income is derived in connection with that active
trade or business, and for making the comparison required by
the ``substantiality'' requirement in subparagraph (b).
Subparagraph (c) attributes to a person activities conducted by
persons ``connected'' to such person. A person (``X'') is
connected to another person (``Y'') if X possesses 50 percent
or more of the beneficial interest in Y (or if Y possesses 50
percent or more of the beneficial interest in X). For this
purpose, X is connected to a company if X owns shares
representing fifty percent or more of the aggregate voting
power and value of the company or fifty percent or more of the
beneficial equity interest in the company. X also is connected
to Y if a third person possesses, directly or indirectly, fifty
percent or more of the beneficial interest in both X and Y. For
this purpose, if X or Y is a company, the threshold
relationship with respect to such company or companies is fifty
percent or more of the aggregate voting power and value or
fifty percent or more of the beneficial equity interest.
Finally, X is connected to Y if, based upon all the facts and
circumstances, X controls Y, Y controls X, or X and Y are
controlled by the same person or persons.
Paragraph 5
Paragraph 5 deals with the treatment of interest or royalty
income in the context of a so-called ``triangular case.'' The
paragraph provides special rules applicable to U.S. source
interest or royalties that are attributable to a permanent
establishment that a Bulgarian company has in a third state,
and that are otherwise exempt from taxation in Bulgaria.
The term ``triangular case'' refers to the use of the
following structure by a resident of Bulgaria to earn, in this
case, interest income from the United States. The resident of
Bulgaria, who is assumed to qualify for benefits under one or
more of the provisions of Article 21 (Limitation on Benefits),
sets up a permanent establishment in a third jurisdiction that
imposes only a low rate of tax on the income of the permanent
establishment. The Bulgarian resident lends funds into the
United States through the permanent establishment. The
permanent establishment, despite its third-jurisdiction
location, is an integral part of a Bulgarian resident.
Therefore, the income earned on those loans, absent the
provisions of paragraph 5, may be entitled to a reduced rate of
U.S. withholding tax under the Convention. Under a current
Bulgarian income tax treaty with the host jurisdiction of the
permanent establishment, the income of the permanent
establishment is exempt from Bulgarian tax. Alternatively,
Bulgaria may choose to exempt the income of the permanent
establishment from Bulgarian income tax. Thus, the interest
income is subject to a reduced rate of U.S. tax, is subject to
little tax in the host jurisdiction of the permanent
establishment, and is exempt from Bulgarian tax.
Because the United States does not exempt the profits of a
third-jurisdiction permanent establishment of a U.S. resident
from U.S. tax, either by statute or by treaty, the paragraph
only applies with respect to U.S. source interest or royalties
that are attributable to a third-jurisdiction permanent
establishment of a Bulgarian resident.
Paragraph 5 replaces the otherwise applicable rules in the
Convention for interest and royalties with a 15 percent
withholding tax for interest and royalties if the actual tax
paid on the income in the third state is less than 60 percent
of the tax that would have been payable in Bulgaria if the
income were earned in Bulgaria by the enterprise and were not
attributable to the permanent establishment in the third state.
In general, the principles employed under Code section
954(b) (4) will be employed to determine whether the profits
are subject to an effective rate of taxation that is above the
specified threshold. Notwithstanding the level of tax on
interest and royalty income of the permanent establishment,
paragraph 5 will not apply under certain circumstances. In the
case of interest (as defined in Article 11 (Interest)),
paragraph 5 will not apply if the interest is derived in
connection with, or is incidental to, the active conduct of a
trade or business carried on by the permanent establishment in
the third state. The business of making, managing or simply
holding investments is not considered to be an active trade or
business, unless these are banking or securities activities
carried on by a bank or registered securities dealer. In the
case of royalties (as defined in Article 12 (Royalties)),
paragraph 5 will not apply if the royalties are received as
compensation for the use of, or the right to use, intangible
property produced or developed by the permanent establishment
itself.
Paragraph 6
Paragraph 6 provides that a resident of one of the States
that is not entitled to the benefits of the Convention as a
result of paragraphs 2 through 4 still may be granted benefits
under the Convention at the discretion of the competent
authority of the State from which benefits are claimed. Under
paragraph 6, that competent authority will determine whether
the establishment, acquisition, or maintenance of the person
seeking benefits under the Convention, or the conduct of such
person's operations, has or had as one of its principal
purposes the obtaining of benefits under the Convention.
Benefits will not be granted, however, solely because a company
was established prior to the effective date of a treaty or
protocol. In that case a company would still be required to
establish to the satisfaction of the Competent Authority clear
non-tax business reasons for its formation in a Contracting
State, or that the allowance of benefits would not otherwise be
contrary to the purposes of the treaty. Thus, persons that
establish operations in one of the States with a principal
purpose of obtaining the benefits of the Convention ordinarily
will not be granted relief under paragraph 6.
The competent authority's discretion is quite broad. It may
grant all of the benefits of the Convention to the taxpayer
making the request, or it may grant only certain benefits. For
instance, it may grant benefits only with respect to a
particular item of income in a manner similar to paragraph 4.
Further, the competent authority may establish conditions, such
as setting time limits on the duration of any relief granted.
For purposes of implementing paragraph 6, a taxpayer will
be permitted to present his case to the relevant competent
authority for an advance determination based on the facts. In
these circumstances, it is also expected that, if the competent
authority determines that benefits are to be allowed, they will
be allowed retroactively to the time of entry into force of the
relevant treaty provision or the establishment of the structure
in question, whichever is later.
Finally, there may be cases in which a resident of a
Contracting State may apply for discretionary relief to the
competent authority of his State of residence. This would
arise, for example, if the benefit the resident is claiming is
provided by the residence country, and not by the source
country. So, for example, if a company that is a resident of
the United States would like to claim the benefit of the re-
sourcing rule of paragraph 3 of Article 22, but it does not
meet any of the objective tests of this Article, it may apply
to the U.S. competent authority for discretionary relief.
Paragraph 7
Paragraph 7 defines several key terms for purposes of
Article 21. Each of the defined terms is discussed above in the
context in which it is used.
ARTICLE 22 (RELIEF FROM DOUBLE TAXATION)
This Article describes the manner in which each Contracting
State undertakes to relieve double taxation. The United States
uses the foreign tax credit method under its internal law, and
by treaty.
Paragraph 1
Paragraph 1 provides that Bulgaria will provide relief from
double taxation through a mixture of the credit and exemption
methods.
Subparagraph 1(a) states the general rule that Bulgaria
will exempt income derived by a resident if the income may be
taxed in the United States in accordance with the Convention.
Subparagraph 1(c), permits Bulgaria to include the income
corresponding to the U.S. tax in the resident's tax base in
calculating the Bulgarian tax on the remaining income of the
resident. This rule provides for ``exemption with
progression.'' Under subparagraph 1(b), Bulgaria provides for a
tax credit rather than an exemption with respect to limited
classes of income. If the income may be taxed by the United
States under the provisions of Article 10 (Dividends), Article
11 (Interest), or Article 12 (Royalties), Bulgaria will relieve
double taxation by allowing a credit against Bulgarian tax in
an amount equal to the tax paid in the United States on such
income, but limited to the amount of Bulgarian tax attributable
to such dividends, interest, and royalty income.
Paragraph 2
The United States agrees, in paragraph 2, to allow to its
citizens and residents a credit against U.S. tax for income
taxes paid or accrued to Bulgaria. Paragraph 2 also provides
that Bulgaria's covered taxes are income taxes for U.S.
purposes. This provision is based on the Treasury Department's
review of Bulgaria's laws.
Subparagraph (b) provides for a deemed-paid credit,
consistent with section 902 of the Code, to a U.S. corporation
in respect of dividends received from a corporation resident in
Bulgaria of which the U.S. corporation owns at least 10 percent
of the voting stock. This credit is for the tax paid by the
corporation to Bulgaria on the profits out of which the
dividends are considered paid.
The credits allowed under paragraph 2 are allowed in
accordance with the provisions and subject to the limitations
of U.S. law, as that law may be amended over time, so long as
the general principle of the Article, that is, the allowance of
a credit, is retained. Thus, although the Convention provides
for a foreign tax credit, the terms of the credit are
determined by the provisions, at the time a credit is given, of
the U.S. statutory credit.
Therefore, the U.S. credit under the Convention is subject
to the various limitations of U.S. law (see, e.g., Code
sections 901-908). For example, the credit against U.S. tax
generally is limited to the amount of U.S. tax due with respect
to net foreign source income within the relevant foreign tax
credit limitation category (see Code section 904(a) and (d)),
and the dollar amount of the credit is determined in accordance
with U.S. currency translation rules (see, e.g., Code section
986). Similarly, U.S. law applies to determine carryover
periods for excess credits and other inter-year adjustments.
Paragraph 3
Paragraph 3 provides a re-sourcing rule for gross income
covered by paragraph 2. Paragraph 3 is intended to ensure that
a U.S. resident can obtain an appropriate amount of U.S.
foreign tax credit for income taxes paid to Bulgaria when the
Convention assigns to Bulgaria primary taxing rights over an
item of gross income.
Accordingly, if the Convention allows Bulgaria to tax an
item of gross income (as defined under U.S. law) derived by a
resident of the United States, the United States will treat
that item of gross income as gross income from sources within
Bulgaria for U.S. foreign tax credit purposes. In the case of a
U.S.-owned foreign corporation, however, section 904(h)(10) may
apply for purposes of determining the U.S. foreign tax credit
with respect to income subject to this re-sourcing rule.
Section 904(h)(10) generally applies the foreign tax credit
limitation separately to re-sourced income. Furthermore, the
paragraph 3 re-sourcing rule applies to gross income, not net
income. Accordingly, U.S. expense allocation and apportionment
rules, see, e.g., Treas. Reg. section 1.861-9, continue to
apply to income resourced under paragraph 3.
Paragraph 4
Paragraph 4 provides special rules for the tax treatment in
both States of certain types of income derived from U.S.
sources by U.S. citizens who are residents of Bulgaria. Since
U.S. citizens, regardless of residence, are subject to United
States tax at ordinary progressive rates on their worldwide
income, the U.S. tax on the U.S. source income of a U.S.
citizen resident in Bulgaria may exceed the U.S. tax that may
be imposed under the Convention on an item of U.S. source
income derived by a resident of Bulgaria who is not a U.S.
citizen. The provisions of paragraph 4 ensure that Bulgaria
does not bear the cost of U.S. taxation of its citizens who are
residents of Bulgaria.
Subparagraph (a) provides, with respect to items of income
from sources within the United States, special credit rules for
Bulgaria. These rules apply to items of U.S.-source income that
would be either exempt from U.S. tax or subject to reduced
rates of U.S. tax under the provisions of the Convention if
they had been received by a resident of Bulgaria who is not a
U.S. citizen. The tax credit allowed by Bulgaria under
paragraph 4 with respect to such items need not exceed the U.S.
tax that may be imposed under the Convention, other than tax
imposed solely by reason of the U.S. citizenship of the
taxpayer under the provisions of the saving clause of paragraph
4 of Article 1 (General Scope).
For example, if a U.S. citizen resident in Bulgaria
receives portfolio dividends from sources within the United
States, the foreign tax credit granted by Bulgaria would be
limited to 10 percent of the dividend--the U.S. tax that may be
imposed under subparagraph 2(b) of Article 10 (Dividends)--even
if the shareholder is subject to U.S. net income tax because of
his U.S. citizenship.
Subparagraph 4(b) eliminates the potential for double
taxation that can arise because subparagraph 4(a) provides that
Bulgaria need not provide full relief for the U.S. tax imposed
on its citizens resident in Bulgaria. The subparagraph provides
that the United States will credit the income tax paid or
accrued to Bulgaria, after the application of subparagraph
4(a). It further provides that in allowing the credit, the
United States will not reduce its tax below the amount that is
taken into account in Bulgaria in applying subparagraph 4(a).
Since the income described in paragraph 4(a) generally will
be U.S. source income, special rules are required to re-source
some of the income to Bulgaria in order for the United States
to be able to credit the tax paid to Bulgaria. This re-sourcing
is provided for in subparagraph 4(c), which deems the items of
income referred to in subparagraph 4(a) to be from foreign
sources to the extent necessary to avoid double taxation under
subparagraph 4(b). Subparagraph 3(e) of Article 24 (Mutual
Agreement Procedure) provides a mechanism by which the
competent authorities can resolve any disputes regarding
whether income is from sources within the United States.
The following two examples illustrate the application of
paragraph 4 in the case of aU.S.-source portfolio dividend
received by a U.S. citizen resident in Bulgaria. In both
examples, the U.S. rate of tax on residents of Bulgaria, under
subparagraph 2(b) of Article 10 (Dividends) of the Convention,
is 10 percent. In both examples, the U.S. income tax rate on
the U.S. citizen is 35 percent. In example 1, the rate of
income tax imposed in Bulgaria on its resident (the U.S.
citizen) is 25 percent (below the U.S. rate), and in example 2,
the rate imposed on its resident is 40 percent (above the U.S.
rate).
------------------------------------------------------------------------
Example 1 Example 2
------------------------------------------------------------------------
Subparagraph (a)
U.S. dividend declared...................... $100.00 $100.00
Notional U.S. withholding tax (Article 10.00 10.00
10(2)(b))..................................
Taxable income in Bulgaria.................. 100.00 100.00
Bulgaria tax before credit.................. 25.00 40.00
Less: tax credit for notional U.S. 10.00 10.00
withholding tax............................
Net post-credit tax paid to Bulgaria........ 15.00 30.00
------------------------------------------------------------------------
Subparagraphs (b) and (c)
U.S. pre-tax income......................... $100.00 $100.00
U.S. pre-credit citizenship tax............. 35.00 35.00
Notional U.S. withholding tax............... 10.00 10.00
U.S. tax eligible to be offset by credit.... 25.00 25.00
Tax paid to Bulgaria........................ 15.00 30.00
Income re-sourced from U.S. to foreign 42.86 71.43
source (see below).........................
U.S. pre-credit tax on re-sourced income.... 15.00 25.00
U.S. credit for tax paid to Bulgaria 15.00
25.00......................................
Net post-credit U.S. tax.................... 10.00 0.00
Total U.S. tax.............................. 20.00 10.00
------------------------------------------------------------------------
In both examples, in the application of subparagraph (a),
Bulgaria credits a 10 percent U.S. tax against its residence
tax on the U.S. citizen. In the first example, the net tax paid
to Bulgaria after the foreign tax credit is $15.00; in the
second example, it is $30.00. In the application of
subparagraphs (b) and (c), from the U.S. tax due before credit
of $35.00, the United States subtracts the amount of the U.S.
source tax of $10.00, against which no U.S. foreign tax credit
is allowed. This subtraction ensures that the United States
collects the tax that it is due under the Convention as the
State of source.
In both examples, given the 35 percent U.S. tax rate, the
maximum amount of U.S. tax against which credit for the tax
paid to Bulgaria may be claimed is $25 ($35 U.S. tax minus $10
U.S. withholding tax). Initially, all of the income in both
examples was from sources within the United States. For a U.S.
foreign tax credit to be allowed for the full amount of the tax
paid to Bulgaria, an appropriate amount of the income must be
re-sourced to Bulgaria under subparagraph (c).
The amount that must be re-sourced depends on the amount of
tax for which the U.S. citizen is claiming a U.S. foreign tax
credit. In example 1, the tax paid to Bulgaria was $15. For
this amount to be creditable against U.S. tax, $42.86 ($15 tax
divided by 35 percent U.S. tax rate) must be resourced to
Bulgaria. There is a net U.S. tax of $10 due after credit ($25
U.S. tax eligible to be offset by credit, minus $15 tax paid to
Bulgaria). Thus, in example 1, there is a total of $20 in U.S.
tax ($10 U.S. withholding tax plus $10 residual U.S. tax).
In example 2, the tax paid to Bulgaria was $30, but,
because the United States subtracts the U.S. withholding tax of
$10 from the total U.S. tax of $35, only $25 of U.S. taxes may
be offset by taxes paid to Bulgaria. Accordingly, the amount
that must be resourced to Bulgaria is limited to the amount
necessary to ensure a U.S. foreign tax credit for $25 of tax
paid to Bulgaria, or $71.43 ($25 tax paid to Bulgaria divided
by 35 percent U.S. tax rate). When the tax paid to Bulgaria is
credited against the U.S. tax on this re-sourced income, there
is no residual U.S. tax ($25 U.S. tax minus $30 tax paid to
Bulgaria, subject to the U.S. limit of $25). Thus, in example
2, there is a total of $10 in U.S. tax ($10 U.S. withholding
tax plus $0 residual U.S. tax). Because the tax paid to
Bulgaria was $30 and the U.S. tax eligible to be offset by
credit was $25, there is $5 of excess foreign tax credit
available for carryover.
Relationship to other Articles
By virtue of subparagraph 5(a) of Article 1 (General
Scope), Article 22 is not subject to the saving clause of
paragraph 4 of Article 1. Thus, the United States will allow a
credit to its citizens and residents in accordance with the
Article, even if such credit were to provide a benefit not
available under the Code (such as the re-sourcing provided by
paragraph 3 and subparagraph 4(c)).
ARTICLE 23 (NON-DISCRIMINATION)
This Article ensures that nationals of a Contracting State,
in the case of paragraph 1, and residents of a Contracting
State, in the case of paragraphs 2 through 5, will not be
subject, directly or indirectly, to discriminatory taxation in
the other Contracting State. Not all differences in tax
treatment, either as between nationals of the two States, or
between residents of the two States, are violations of the
prohibition against discrimination. Rather, the non-
discrimination obligations of this Article apply only if the
nationals or residents of the two States are comparably
situated.
Each of the relevant paragraphs of the Article provides
that two persons that are comparably situated must be treated
similarly. Although the actual words differ from paragraph to
paragraph (e.g., paragraph 1 refers to two nationals ``in the
same circumstances,'' paragraph 2 refers to two enterprises
``carrying on the same activities'' and paragraph 4 refers to
two enterprises that are ``similar''), the common underlying
premise is that if the difference in treatment is directly
related to a tax-relevant difference in the situations of the
domestic and foreign persons being compared, that difference is
not to be treated as discriminatory (i.e., if one person is
taxable in a Contracting State on worldwide income and the
other is not, or tax may be collectible from one person at a
later stage, but not from the other, distinctions in treatment
would be justified under paragraph 1). Other examples of such
factors that can lead to non-discriminatory differences in
treatment are noted in the discussions of each paragraph.The
operative paragraphs of the Article also use different language
to identify the kinds of differences in taxation treatment that
will be considered discriminatory. For example, paragraphs 1
and 4 speak of ``any taxation or any requirement connected
therewith that is more burdensome,'' while paragraph 2
specifies that a tax ``shall not be less favorably levied.''
Regardless of these differences in language, only differences
in tax treatment that materially disadvantage the foreign
person relative to the domestic person are properly the subject
of the Article.
Paragraph 1
Paragraph 1 provides that a national of one Contracting
State may not be subject to taxation or connected requirements
in the other Contracting State that are more burdensome than
the taxes and connected requirements imposed upon a national of
that other State in the same circumstances. The OECD Model
language would prohibit taxation that is ``other than or more
burdensome'' than that imposed on U.S. persons. This Convention
omits the reference to taxation that is ``other than'' that
imposed on U.S. persons because the only relevant question
under this provision should be whether the requirement imposed
on a national of the other Contracting State is more
burdensome. A requirement may be different from the
requirements imposed on U.S. nationals without being more
burdensome.
The term ``national'' in relation to a Contracting State is
defined in subparagraph 1(l) of Article 3 (General
Definitions). The term includes both individuals and juridical
persons. A national of a Contracting State is afforded
protection under this paragraph even if the national is not a
resident of either Contracting State. Thus, a U.S. citizen who
is resident in a third country is entitled, under this
paragraph, to the same treatment in Bulgaria as a national of
Bulgaria who is in similar circumstances (i.e., presumably one
who is resident in a third State).
As noted above, whether or not the two persons are both
taxable on worldwide income is a significant circumstance for
this purpose. For this reason, paragraph 1 specifically states
that the United States is not obligated to apply the same
taxing regime to a national of Bulgaria who is not resident in
the United States as it applies to a U.S. national who is not
resident in the United States. United States citizens who are
not residents of the United States but who are, nevertheless,
subject to United States tax on their worldwide income are not
in the same circumstances with respect to United States
taxation as citizens of Bulgaria who are not United States
residents. Thus, for example, Article 23 would not entitle a
national of Bulgaria resident in a third country to taxation at
graduated rates on U.S. source dividends or other investment
income that applies to a U.S. citizen resident in the same
third country.
Paragraph 2
Paragraph 2 of the Article, provides that a Contracting
State may not tax a permanent establishment of an enterprise of
the other Contracting State less favorably than an enterprise
of that first-mentioned State that is carrying on the same
activities.
The fact that a U.S. permanent establishment of an
enterprise of Bulgaria is subject to U.S. tax only on income
that is attributable to the permanent establishment, while a
U.S. corporation engaged in the same activities is taxable on
its worldwide income is not, in itself, a sufficient difference
to provide different treatment for the permanent establishment.
There are cases, however, where the two enterprises would not
be similarly situated and differences in treatment may be
warranted. For instance, it would not be a violation of the
non-discrimination protection of paragraph 2 to require the
foreign enterprise to provide information in a reasonable
manner that may be different from the information requirements
imposed on a resident enterprise, because information may not
be as readily available to the Internal Revenue Service from a
foreign as from a domestic enterprise. Similarly, it would not
be a violation of paragraph 2 to impose penalties on persons
who fail to comply with such a requirement (see, e.g., sections
874(a) and 882(c)(2)). Further, a determination that income and
expenses have been attributed or allocated to a permanent
establishment in conformity with the principles of Article 7
(Business Profits) implies that the attribution or allocation
was not discriminatory.
Section 1446 of the Code imposes on any partnership with
income that is effectively connected with a U.S. trade or
business the obligation to withhold tax on amounts allocable to
a foreign partner. In the context of the Convention, this
obligation applies with respect to a share of the partnership
income of a partner resident in Bulgaria, and attributable to a
U.S. permanent establishment. There is no similar obligation
with respect to the distributive shares of U.S. resident
partners. It is understood, however, that this distinction is
not a form of discrimination within the meaning of paragraph 2
of the Article. No distinction is made between U.S. and non-
U.S. partnerships, since the law requires that partnerships of
both U.S. and non-U.S. domicile withhold tax in respect of the
partnership shares of non-U.S. partners. Furthermore, in
distinguishing between U.S. and non-U.S. partners, the
requirement to withhold on the non-U.S. but not the U.S.
partner's share is not discriminatory taxation, but, like other
withholding on nonresident aliens, is merely a reasonable
method for the collection of tax from persons who are not
continually present in the United States, and as to whom it
otherwise may be difficult for the United States to enforce its
tax jurisdiction. If tax has been over-withheld, the partner
can, as in other cases of over-withholding, file for a refund.
Paragraph 3
Paragraph 3 makes clear that the provisions of paragraphs 1
and 2 do not obligate a Contracting State to grant to a
resident of the other Contracting State any tax allowances,
reliefs, etc., that it grants to its own residents on account
of their civil status or family responsibilities. Thus, if a
sole proprietor who is a resident of Bulgaria has a permanent
establishment in the United States, in assessing income tax on
the profits attributable to the permanent establishment, the
United States is not obligated to allow to the resident of
Bulgaria the personal allowances for himself and his family
that he would be permitted to take if the permanent
establishment were a sole proprietorship owned and operated by
a U.S. resident, despite the fact that the individual income
tax rates would apply.
Paragraph 4
Paragraph 4 prohibits discrimination in the allowance of
deductions. When a resident or an enterprise of a Contracting
State pays interest, royalties or other disbursements to a
resident of the other Contracting State, the first-mentioned
Contracting State must allow a deduction for those payments in
computing the taxable profits of the resident or enterprise as
if the payment had been made under the same conditions to a
resident of the first-mentioned Contracting State. Paragraph 4,
however, does not require a Contracting State to give non-
residents more favorable treatment than it gives to its own
residents. Consequently, a Contracting State does not have to
allow non-residents a deduction for items that are not
deductible under its domestic law (for example, expenses of a
capital nature).
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 that
includes the person incurring the expense.
An exception to the rule of paragraph 4 is provided for
cases where the provisions of paragraph 1 of Article 9
(Associated Enterprises), paragraph 7 of Article 11 (Interest)
or para-graph 6 of Article 12 (Royalties) apply. All of these
provisions permit the denial of deductions in certain
circumstances in respect of transactions between related
persons. Neither State is forced to apply the non-
discrimination principle in such cases. The exception with
respect to paragraph 7 of Article 11 would include the denial
or deferral of certain interest deductions under Code section
163(j).
Paragraph 4 also provides that any debts of an enterprise
of a Contracting State to a resident of the other Contracting
State are deductible in the first-mentioned Contracting State
for purposes of computing the capital tax of the enterprise
under the same conditions as if the debt had been contracted to
a resident of the first-mentioned Contracting State. Even
though, for general purposes, the Convention covers only income
taxes, under paragraph 7 of this Article, the nondiscrimination
provisions apply to all taxes levied in both Contracting
States, at all levels of government. Thus, this provision may
be relevant for both States. Bulgaria may have capital taxes
and in the United States such taxes frequently are imposed by
local governments.
Paragraph 5
Paragraph 5 requires that a Contracting State not impose
more burdensome taxation or connected requirements on an
enterprise of that State that is wholly or partly owned or
controlled, directly or indirectly, by one or more residents of
the other Contracting State than the taxation or connected
requirements that it imposes on other similar enterprises of
that first-mentioned Contracting State. For this purpose it is
understood that ``similar'' refers to similar activities or
ownership of the enterprise.
This rule, like all non-discrimination provisions, does not
prohibit differing treatment of entities that are in differing
circumstances. Rather, a protected enterprise is only required
to be treated in the same manner as other enterprises that,
from the point of view of the application of the tax law, are
in substantially similar circumstances both in law and in fact.
The taxation of a distributing corporation under section 367(e)
on an applicable distribution to foreign shareholders does not
violate paragraph 5 of the Article because a foreign-owned
corporation is not similar to a domestically-owned corporation
that is accorded non-recognition treatment under sections 337
and 355.
For the reasons given above in connection with the
discussion of paragraph 2 of the Article, it is also understood
that the provision in section 1446 of the Code for withholding
of tax on non-U.S. partners does not violate paragraph 5 of the
Article.
It is further understood that the ineligibility of a U.S.
corporation with nonresident alien shareholders to make an
election to be an ``S'' corporation does not violate paragraph
5 of the Article. If a corporation elects to be an S
corporation, it is generally not subject to income tax and the
shareholders take into account their pro rata shares of the
corporation's items of income, loss, deduction or credit. (The
purpose of the provision is to allow an individual or small
group of individuals the protections of conducting business in
corporate form while paying taxes at individual rates as if the
business were conducted directly.) A nonresident alien does not
pay U.S. tax on a net basis, and, thus, does not generally take
into account items of loss, deduction or credit. Thus, the S
corporation provisions do not exclude corporations with
nonresident alien shareholders because such shareholders are
foreign, but only because they are not net-basis taxpayers.
Similarly, the provisions exclude corporations with other types
of shareholders where the purpose of the provisions cannot be
fulfilled or their mechanics implemented. For example,
corporations with corporate shareholders are excluded because
the purpose of the provision to permit individuals to conduct a
business in corporate form at individual tax rates would not be
furthered by their inclusion.
Finally, it is understood that paragraph 5 does not require
a Contracting State to allow foreign corporations to join in
filing a consolidated return with a domestic corporation or to
allow similar benefits between domestic and foreign
enterprises.
Paragraph 6
Paragraph 6 of the Article confirms that no provision of
the Article will prevent either Contracting State from imposing
either the branch profits tax described in paragraph 8 of
Article 10 (Dividends) or the branch-level interest tax
described in paragraph 9 of Article 11 (Interest).
Paragraph 7
As noted above, notwithstanding the specification of taxes
covered by the Convention in Article 2 (Taxes Covered) for
general purposes, for purposes of providing nondiscrimination
protection this Article applies to taxes of every kind and
description imposed by a Contracting State or a political
subdivision or local authority thereof. Customs duties are not
considered to be taxes for this purpose.
Relationship to other Articles
The saving clause of paragraph 4 of Article 1 (General
Scope) does not apply to this Article by virtue of the
exceptions in paragraph 5(a) of Article 1. Thus, for example, a
U.S. citizen who is a resident of Bulgaria may claim benefits
in the United States under this Article.
Nationals of a Contracting State may claim the benefits of
paragraph 1 regardless of whether they are entitled to benefits
under Article 21 (Limitation on Benefits), because that
paragraph applies to nationals and not residents. They may not
claim the benefits of the other paragraphs of this Article with
respect to an item of income unless they are generally entitled
to treaty benefits with respect to that income under a
provision of Article 21.
ARTICLE 24 (MUTUAL AGREEMENT PROCEDURE)
This Article provides the mechanism for taxpayers to bring
to the attention of competent authorities issues and problems
that may arise under the Convention. It also provides the
authority for cooperation between the competent authorities of
the Contracting States to resolve disputes and clarify issues
that may arise under the Convention and to resolve cases of
double taxation not provided for in the Convention. The
competent authorities of the two Contracting States are
identified in paragraph 1(k) of Article 3 (General
Definitions).
Paragraph 1
This paragraph provides that where a resident of a
Contracting State considers that the actions of one or both
Contracting States will result in taxation that is not in
accordance with the Convention he may present his case to the
competent authority of either Contracting State. This rule is
more generous than in most treaties, which generally allow
taxpayers to bring competent authority cases only to the
competent authority of their country of residence, or citizen-
ship/nationality. Under this more generous rule, a U.S.
permanent establishment of a corporation resident in the treaty
partner that faces inconsistent treatment in the two countries
would be able to bring its request for assistance to the U.S.
competent authority. If the U.S. competent authority can
resolve the issue on its own, then the taxpayer need never
involve the Bulgarian competent authority. Thus, the rule
provides flexibility that might result in greater efficiency.
Although the typical cases brought under this paragraph
will involve economic double taxation arising from transfer
pricing adjustments, the scope of this paragraph is not limited
to such cases. For example, a taxpayer could request assistance
from the competent authority if one Contracting State
determines that the taxpayer has received deferred compensation
taxable at source under Article 14 (Income from Employment),
while the taxpayer believes that such income should be treated
as a pension that is taxable only in his country of residence
pursuant to Article 17 (Pensions, Social Security Payments,
Annuities, Alimony, and Child Support).
It is not necessary for a person requesting assistance
first to have exhausted the remedies provided under the
national laws of the Contracting States before presenting a
case to the competent authorities, nor does the fact that the
statute of limitations may have passed for seeking a refund
preclude bringing a case to the competent authority. Unlike the
OECD Model, no time limit is provided within which a case must
be brought.
Paragraph 2
Paragraph 2 sets out the framework within which the
competent authorities will deal with cases brought by taxpayers
under paragraph 1. It provides that, if the competent authority
of the Contracting State to which the case is presented judges
the case to have merit, and cannot reach a unilateral solution,
it shall seek an agreement with the competent authority of the
other Contracting State pursuant to which taxation not in
accordance with the Convention will be avoided.
Any agreement is to be implemented even if such
implementation otherwise would be barred by the statute of
limitations or by some other procedural limitation, such as a
closing agreement. Paragraph 2, however, does not prevent the
application of domestic-law procedural limitations that give
effect to the agreement (e.g., a domestic-law requirement that
the taxpayer file a return reflecting the agreement within one
year of the date of the agreement). Where the taxpayer has
entered a closing agreement (or other written settlement) with
the United States before bringing a case to the competent
authorities, the U.S. competent authority will endeavor only to
obtain a correlative adjustment from Bulgaria. See Rev. Proc.
2006-54, 2006-2 C.B. 1035, Section 7.05.
Because, as specified in paragraph 2 of Article 1 (General
Scope), the Convention cannot operate to increase a taxpayer's
liability, temporal or other procedural limitations can be
overridden only for the purpose of making refunds and not to
impose additional tax. Under Bulgarian law, a taxpayer may
secure payment of any tax due (for example, using a letter of
credit) and need not pay the entire amount of tax due until the
competent authorities resolve the case, while under U.S. law
with respect to U.S. initiated adjustments the United States
generally will postpone further administrative action with
respect to the issues under competent authority consideration.
See Rev. Proc. 2006-54, 2006-2 C.B. 1035, Section 7.01.
Paragraph 10 of the Protocol to the Convention sets forth
two additional clarifications to the application of paragraph 2
of Article 24. First, the Protocol notes that an agreement
reached would not affect any court proceedings or any final
court decisions or final tax assessment acts. This provision of
the paragraph is intended to address certain aspects of the
relationship of mutual agreement procedures and judicial or
assessment proceedings in Bulgaria.
Under Bulgarian law, a taxpayer may begin court proceedings
either before or after it has made a request for assistance
under this Article. The Protocol confirms that Bulgarian
judicial proceedings involving mutual agreement procedure
issues in question will not be inhibited merely by the
initiation of a request for competent authority assistance.
Moreover, any final judicial determination involving mutual
agreement procedure issues may be set aside only if the
requirements under Bulgarian law for revision or repeal of
final acts are fulfilled. Similarly, if the Bulgarian revenue
authority has finalized its tax assessment, irrespective of any
judicial activity, a mutual agreement procedure cannot change
that assessment unless the requirements under Bulgarian law for
revision or repeal of final acts are fulfilled.
Under the Bulgarian law for revision or repeal of final
acts, an assessment may be changed based on new information.
The Treasury Department understands that Bulgaria will
interpret broadly what constitutes ``new information.'' For
example, if an examination in Bulgaria is completed and closed,
the Bulgarian competent authority may nonetheless accept a
request for assistance based on new information, such as an
adjustment in the United States.
Second, paragraph 10 of the Protocol notes that if an
examination is completed and closed (and the subject of the
mutual agreement procedure request is not a matter pending
before a court or for which a settlement or court decision has
been reached) in a Contracting State, that Contracting State's
competent authority may nonetheless accept a request for
assistance if an adjustment causing double taxation is made in
the other Contracting State. This provision of the Protocol
confirms that the Bulgarian competent authority can accept a
mutual agreement procedure request based upon a US-initiated
adjustment and can subsequently implement any resulting
competent authority agreement, so long as the issue that is the
subject of the mutual agreement procedure request is neither an
issue presented to and pending before a Bulgarian court, nor
one for which a Bulgarian judicial decision or litigation
settlement has been concluded.
Paragraph 3
Paragraph 3 authorizes the competent authorities to resolve
difficulties or doubts that may arise as to the application or
interpretation of the Convention. The paragraph includes a non-
exhaustive list of examples of the kinds of matters about which
the competent authorities may reach agreement. This list is
purely illustrative; it does not grant any authority that is
not implicitly present as a result of the introductory sentence
of paragraph 3.
The competent authorities may, for example, agree to the
same allocation of income, deductions, credits or allowances
between an enterprise in one Contracting State and its
permanent establishment in the other or between related
persons. These allocations are to be made in accordance with
the arm's length principle underlying Article 7 (Business
Profits) and Article 9 (Associated Enterprises). Agreements
reached under these subparagraphs may include agreement on a
methodology for determining an appropriate transfer price, on
an acceptable range of results under that methodology, or on a
common treatment of a taxpayer's cost sharing arrangement.
The competent authorities also may agree to settle a
variety of conflicting applications of the Convention. They may
agree to settle conflicts regarding the characterization of
particular items of income, the characterization of persons,
the application of source rules to particular items of income,
or the meaning of a term. They also may agree as to advance
pricing arrangements.
Since the list under paragraph 3 is not exhaustive, the
competent authorities may reach agreement on issues not
enumerated in paragraph 3 if necessary to avoid double
taxation. For example, the competent authorities may seek
agreement on a uniform set of standards for the use of exchange
rates. Agreements reached by the competent authorities under
paragraph 3 need not conform to the internal law provisions of
either Contracting State.
Finally, paragraph 3 authorizes the competent authorities
to consult for the purpose of eliminating double taxation in
cases not provided for in the Convention and to resolve any
difficulties or doubts arising as to the interpretation or
application of the Convention. This provision is intended to
permit the competent authorities to implement the treaty in
particular cases in a manner that is consistent with its
expressed general purposes. It permits the competent
authorities to deal with cases that are within the spirit of
the provisions but that are not specifically covered. An
example of such a case might be double taxation arising from a
transfer pricing adjustment between two permanent
establishments of a third-country resident, one in the United
States and one in Bulgaria. Since no resident of a Contracting
State is involved in the case, the Convention does not apply,
but the competent authorities nevertheless may use the
authority of this Article to prevent the double taxation of
income.
Paragraph 4
Paragraph 4 authorizes the competent authorities to
increase any dollar amounts referred to in the Convention to
reflect economic and monetary developments. Under the
Convention, this refers only to Article 16 (Entertainers and
Sportsmen); Article 19 (Students, Trainees, Teachers and
Researchers) separately instructs the competent authorities to
adjust the exemption amount for students and trainees in
accordance with specified guidelines. The rule under paragraph
4 is intended to operate as follows: if, for example, after the
Convention has been in force for some time, inflation rates
have been such as to make the $15,000 exemption threshold for
entertainers unrealistically low in terms of the original
objectives intended in setting the threshold, the competent
authorities may agree to a higher threshold without the need
for formal amendment to the treaty and ratification by the
Contracting States. This authority can be exercised, however,
only to the extent necessary to restore those original
objectives. This provision can be applied only to the benefit
of taxpayers (i.e., only to increase thresholds, not to reduce
them).
Paragraph 5
Paragraph 5 provides that the competent authorities may
communicate with each other for the purpose of reaching an
agreement. This makes clear that the competent authorities of
the two Contracting States may communicate without going
through diplomatic channels. Such communication may be in
various forms, including, where appropriate, through face-to-
face meetings of representatives of the competent authorities.
Treaty termination in relation to competent authority dispute
resolution
A case may be raised by a taxpayer after the Convention has
been terminated with respect to a year for which the Convention
was in force. In such a case the ability of the competent
authorities to act is limited. They may not exchange
confidential information, nor may they reach a solution that
varies from that specified in its law.
Triangular competent authority solutions
International tax cases may involve more than two taxing
jurisdictions (e.g., transactions among a parent corporation
resident in country A and its subsidiaries resident in
countries B and C). As long as there is a complete network of
treaties among the three countries, it should be possible,
under the full combination of bilateral authorities, for the
competent authorities of the three States to work together on a
three-sided solution. Although country A may not be able to
give information received under Article 25 (Exchange of
Information and Administrative Assistance) from country B to
the authorities of country C, if the competent authorities of
the three countries are working together, it should not be a
problem for them to arrange for the authorities of country B to
give the necessary information directly to the tax authorities
of country C, as well as to those of country A. Each bilateral
part of the trilateral solution must, of course, not exceed the
scope of the authority of the competent authorities under the
relevant bilateral treaty.
Relationship to other Articles
This Article is not subject to the saving clause of
paragraph 4 of Article 1 (General Scope) by virtue of the
exceptions in paragraph 5(a) of that Article. Thus, rules,
definitions, procedures, etc. that are agreed upon by the
competent authorities under this Article may be applied by the
United States with respect to its citizens and residents even
if they differ from the comparable Code provisions. Similarly,
as indicated above, U.S. law may be overridden to provide
refunds of tax to a U.S. citizen or resident under this
Article. A person may seek relief under Article 24 regardless
of whether he is generally entitled to benefits under Article
21 (Limitation on Benefits). As in all other cases, the
competent authority is vested with the discretion to decide
whether the claim for relief is justified.
ARTICLE 25 (EXCHANGE OF INFORMATION AND ADMINISTRATIVE ASSISTANCE)
This Article provides for the exchange of information and
administrative assistance between the competent authorities of
the Contracting States.
Paragraph 1
The obligation to obtain and provide information to the
other Contracting State is set out in paragraph 1. The
information to be exchanged is that which may be relevant for
carrying out the provisions of the Convention or the domestic
laws of the United States or of Bulgaria concerning taxes of
every kind applied at the national level. This language
incorporates the standard in 26 U.S.C. section 7602 which
authorizes the IRS to examine ``any books, papers, records, or
other data which may be relevant or material.'' (Emphasis
added.) In United States v. Arthur Young & Co., 465 U.S. 805,
814 (1984), the Supreme Court stated that the language ``may
be'' reflects Congress's express intention to allow the IRS to
obtain ``items of even potential relevance to an ongoing
investigation, without reference to its admissibility.''
(Emphasis in original.) However, the language ``may be'' would
not support a request in which a Contracting State simply asked
for information regarding all bank accounts maintained by
residents of that Contracting State in the other Contracting
State, or even all accounts maintained by its residents with
respect to a particular bank.
Exchange of information with respect to each State's
domestic law is authorized to the extent that taxation under
domestic law is not contrary to the Convention. Thus, for
example, information may be exchanged with respect to a covered
tax, even if the transaction to which the information relates
is a purely domestic transaction in the requesting State and,
therefore, the exchange is not made to carry out the
Convention. An example of such a case is provided in the OECD
Commentary: a company resident in the United States and a
company resident in Bulgaria transact business between
themselves through a third-country resident company. Neither
Contracting State has a treaty with the third State. To enforce
their internal laws with respect to transactions of their
residents with the third-country company (since there is no
relevant treaty in force), the Contracting States may exchange
information regarding the prices that their residents paid in
their transactions with the third-country resident.
Paragraph 1 clarifies that information may be exchanged
that relates to the assessment or collection of, the
enforcement or prosecution in respect of, or the determination
of appeals in relation to, the taxes covered by the Convention.
Thus, the competent authorities may request and provide
information for cases under examination or criminal
investigation, in collection, on appeals, or under prosecution.
The taxes covered by the Convention for purposes of this
Article constitute a broader category of taxes than those
referred to in Article 2 (Taxes Covered). Exchange of
information is authorized with respect to taxes of every kind
imposed by a Contracting State at the national level.
Accordingly, information may be exchanged with respect to U.S.
estate and gift taxes, excise taxes or, with respect to
Bulgaria, value added taxes.
Information exchange is not restricted by paragraph 1 of
Article 1 (General Scope). Accordingly, information may be
requested and provided under this Article with respect to
persons who are not residents of either Contracting State. For
example, if a third-country resident has a permanent
establishment in Bulgaria, and that permanent establishment
engages in transactions with a U.S. enterprise, the United
States could request information with respect to that permanent
establishment, even though the third-country resident is not a
resident of either Contracting State. Similarly, if a third-
country resident maintains a bank account in Bulgaria, and the
Internal Revenue Service has reason to believe that funds in
that account should have been reported for U.S. tax purposes
but have not been so reported, information can be requested
from Bulgaria with respect to that person's account, even
though that person is not the taxpayer under examination.
Although the term ``United States'' does not encompass U.S.
possessions for most purposes of the Convention, section 7651
of the Code authorizes the Internal Revenue Service to utilize
the provisions of the Internal Revenue Code to obtain
information from the U.S. possessions pursuant to a proper
request made under Article 25. If necessary to obtain requested
information, the Internal Revenue Service could issue and
enforce an administrative summons to the taxpayer, a tax
authority (or a government agency in a U.S. possession), or a
third party located in a U.S. possession.
Paragraph 2
Paragraph 2 provides that the requesting State may specify
the form in which information is to be provided (e.g.,
depositions of witnesses and authenticated copies of original
documents). The intention is to ensure that the information may
be introduced as evidence in the judicial proceedings of the
requesting State. The requested State should, if possible,
provide the information in the form requested to the same
extent that it can obtain information in that form under its
own laws and administrative practices with respect to its own
taxes.
Paragraph 3
Paragraph 3 also provides assurances that any information
exchanged will be treated as secret, subject to the same
disclosure constraints as information obtained under the laws
of the requesting State. Information received may be disclosed
only to persons, including courts and administrative bodies,
involved in the assessment, collection, or administration of,
the enforcement or prosecution in respect of, or the
determination of appeals in relation to, the taxes covered by
the Convention. The information must be used by these persons
in connection with the specified functions. Information may
also be disclosed to legislative bodies, such as the tax-
writing committees of Congress and the Government
Accountability Office, engaged in the oversight of the
preceding activities. Information received by these bodies must
be for use in the performance of their role in overseeing the
administration of U.S. tax laws. Information received may be
disclosed in public court proceedings or in judicial decisions.
Paragraph 4
Paragraph 4 provides that the obligations undertaken in
paragraphs 1, 2, and 3 to exchange information do not require a
Contracting State to carry out administrative measures that are
at variance with the laws or administrative practice of either
State. Nor is a Contracting State required to supply
information not obtainable under the laws or administrative
practice of either State, or to disclose trade secrets or other
information, the disclosure of which would be contrary to
public policy.
Thus, a requesting State may be denied information from the
other State if the information would be obtained pursuant to
procedures or measures that are broader than those available in
the requesting State. However, the statute of limitations of
the Contracting State making the request for information should
govern a request for information. Thus, the Contracting State
of which the request is made should attempt to obtain the
information even if its own statute of limitations has passed.
In many cases, relevant information will still exist in the
business records of the taxpayer or a third party, even though
it is no longer required to be kept for domestic tax purposes.
While paragraph 4 states conditions under which a
Contracting State is not obligated to comply with a request
from the other Contracting State for information, the requested
State is not precluded from providing such information, and
may, at its discretion, do so subject to the limitations of its
internal law.
Paragraph 5
Paragraph 5 provides that when information is requested by
a Contracting State in accordance with this Article, the other
Contracting State is obligated to obtain the requested
information as if the tax in question were the tax of the
requested State, even if that State has no direct tax interest
in the case to which the request relates. In the absence of
such a paragraph, some taxpayers have argued that subparagraph
4(a) prevents a Contracting State from requesting information
from a bank or fiduciary that the Contracting State does not
need for its own tax purposes. This paragraph clarifies that
paragraph 4 does not impose such a restriction and that a
Contracting State is not limited to providing only the
information that it already has in its own files.
Paragraph 6
Paragraph 6 provides that a Contracting State may not
decline to provide information because that information is held
by financial institutions, nominees or persons acting in an
agency or fiduciary capacity. Thus, paragraph 6 would
effectively prevent a Contracting State from relying on
paragraph 4 to argue that its domestic bank secrecy laws (or
similar legislation relating to disclosure of financial
information by financial institutions or intermediaries)
override its obligation to provide information under paragraph
1. This paragraph also requires the disclosure of information
regarding the beneficial owner of an interest in a person, such
as the identity of a beneficial owner of bearer shares.
Treaty efective dates and termination in relation to exchange of
information
Once the Convention is in force, the competent authority
may seek information under the Convention with respect to a
year prior to the entry into force of the Convention. Even
though no Convention was in effect during the years in which
the transaction at issue occurred, the exchange of information
provisions of the Convention shall have effect from the date of
entry into force of the Convention without regard to the
taxable period to which the matter relates. In that case, the
competent authorities have available to them the full range of
information exchange provisions afforded under this Article.
Paragraph 11 of the Protocol, regarding Article 27 (Entry into
Force), confirms this understanding with respect to the
effective date of the Article.
A tax administration may also seek information with respect
to a year for which a treaty was in force after the treaty has
been terminated. In such a case the ability of the other tax
administration to act is limited. The treaty no longer provides
authority for the tax administrations to exchange confidential
information. They may only exchange information pursuant to
domestic law or other international agreement or arrangement.
ARTICLE 26 (MEMBERS OF DIPLOMATIC MISSIONS AND CONSULAR POSTS)
This Article confirms that any fiscal privileges to which
diplomatic or consular officials are entitled under general
provisions of international law or under special agreements
will apply notwithstanding any provisions to the contrary in
the Convention. The agreements referred to include any
bilateral agreements, such as consular conventions, that affect
the taxation of diplomats and consular officials and any
multilateral agreements dealing with these issues, such as the
Vienna Convention on Diplomatic Relations and the Vienna
Convention on Consular Relations. The U.S. generally adheres to
the latter because its terms are consistent with customary
international law.
The Article does not independently provide any benefits to
diplomatic agents and consular officers. Article 18 (Government
Service) does so, as do Code section 893 and a number of
bilateral and multilateral agreements. In the event that there
is a conflict between the Convention and international law or
such other treaties, under which the diplomatic agent or
consular official is entitled to greater benefits under the
latter, the latter laws or agreements shall have precedence.
Conversely, if the Convention confers a greater benefit than
another agreement, the affected person could claim the benefit
of the tax treaty.Pursuant to subparagraph 5(b) of Article 1,
the saving clause of paragraph 4 of Article 1 (General Scope)
does not apply to override any benefits of this Article
available to an individual who is neither a citizen of the
United States nor has immigrant status in the United States.
ARTICLE 27 (ENTRY INTO FORCE)
This Article contains the rules for bringing the Convention
into force and giving effect to its provisions.
Paragraph 1
Paragraph 1 provides that the Contracting States shall
notify each other, through diplomatic channels, when their
respective requirements for the entry into force of the
Convention have been satisfied. The Convention shall enter into
force on the date of receipt of the later of these
notifications.In the United States, the process leading to
ratification and entry into force is as follows: Once a treaty
has been signed by authorized representatives of the two
Contracting States, the Department of State sends the treaty to
the President who formally transmits it to the Senate for its
advice and consent to ratification, which requires approval by
two-thirds of the Senators present and voting. Prior to this
vote, however, it generally has been the practice for the
Senate Committee on Foreign Relations to hold hearings on the
treaty and make a recommendation regarding its approval to the
full Senate. Both Government and private sector witnesses may
testify at these hearings. After the Senate gives its advice
and consent to ratification of the treaty, an instrument of
ratification is drafted for the President's signature. The
President's signature completes the process in the United
States.
Paragraph 2
The date on which a Convention enters into force is not
necessarily the date on which its provisions take effect.
Paragraph 2 contains rules that determine when the provisions
of the Convention will have effect.
Under paragraph 2(a), the Convention will have effect with
respect to taxes withheld at source (principally dividends,
interest and royalties) for amounts paid or credited on or
after the first day of January in the calendar year following
the date on which the Convention enters into force. For
example, if instruments of ratification are exchanged on April
25th of year 1, the withholding rates specified in paragraph 2
of Article 10 (Dividends) would be applicable to any dividends
paid or credited on or after January 1 of year 2.
For all other taxes, paragraph 2(b) specifies that the
Convention will have effect for any taxable period beginning on
or after January 1 of the year following entry into force.
As discussed under Article 25 (Exchange of Information),
the powers afforded under that article apply retroactively to
taxable periods preceding entry into force.
ARTICLE 28 (TERMINATION)
The Convention is to remain in effect indefinitely, unless
terminated by one of the Contracting States in accordance with
the provisions of Article 28. For example, if written notice of
termination is given through the diplomatic channel not later
than June 30th of calendar year 1, the provisions of the
Convention will cease to have effect with respect to taxes
withheld at source on income paid or credited on or after
January 1st of calendar year 2. For other taxes, the Convention
will cease to have effect for any taxable period beginning on
or after January 1st of calendar year 2.
Article 28 relates only to unilateral termination of the
Convention by a Contracting State. Nothing in that Article
should be construed as preventing the Contracting States from
concluding a new bilateral agreement, subject to ratification,
that supersedes, amends or terminates provisions of the
Convention without the notification period.
Customary international law observed by the United States
and other countries, as reflected in the Vienna Convention on
Treaties, allows termination by one Contracting State at any
time in the event of a ``material breach'' of the agreement by
the other Contracting State.
X. Annex II.--Responses to Additional Questions
Submitted for the Record
Responses of Michael Mundaca, Deputy Assistant Secretary
(International), Office of Tax Policy, U.S. Department of the Treasury
to Questions for the Record From Senator Biden
Question 1. The President's Letter of Transmittal for the proposed
Iceland Tax Treaty notes that because the existing treaty with Iceland
from 1975 does not contain a Limitation on Benefits (``LOB'')
provision, which is intended to prevent so-called treaty shopping,
there has been ``substantial abuse of the existing Treaty's provisions
by third country investors.'' See Treaty Doc. 110-17 at III. Please
describe the evidence upon which this statement is based.
Answer. A Treasury Department report to Congress, ``Earning
Stripping, Transfer Pricing and U.S. Income Tax Treaties,'' released in
November 2007 (2007 Treasury Report), describes abuses of the U.S. tax
treaty network by third-country investors, particularly through
inappropriate reductions in withholding tax. The 2007 Treasury Report
presented data, gathered from U.S. tax returns, on deductible payments
such as interest made by U.S. companies to related foreign companies
located in treaty jurisdictions. The data suggested that tax treaties
that have no LOB provision and a zero rate of withholding tax on
deductible payments, such as our treaties with Iceland and Hungary, had
begun to be abused by third-country investors. In particular, the 2007
Treasury Report notes that while in 1996 almost no U.S.-source interest
was paid by foreign-controlled U.S. companies to related parties in
Iceland and Hungary, payments of such interest had increased by 2004 to
over $2 billion. In addition, publicly available information indicates
that many of those related parties were ultimately owned by
corporations from third countries. This evidence strongly suggests the
existence of treaty abuse by third-country residents.
Question 2. Please explain how the LOB provision will be enforced
against third-country investors that attempt to benefit from the
treaty's provisions, should the new treaty be ratified. In addition,
please describe specific enforcement challenges, if any, that the
United States has faced in the past when attempting to enforce LOB
provisions in other tax treaties.
Answer. The Internal Revenue Service has a multipronged approach to
enforcing compliance with treaty LOB provisions.
With respect to payments of amounts subject to withholding, such as
interest, royalties, and dividends, U.S. withholding agents (e.g.,
banks, brokers) are obligated to obtain, from each foreign payee,
documentation on which the withholding agents can rely to treat a
payment as made to a foreign person entitled to a reduced rate of
withholding tax under the treaty. Absent such documentation,
withholding at 30 percent is required. More specifically, foreign
taxpayers who derive and beneficially own the payment must complete a
Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for U.S.
Tax Withholding) to claim a reduced rate of withholding tax. Part II of
the W-8BEN is entitled ``Claim of Tax Treaty Benefits.'' On line 9 the
beneficial owner must identify its country of residence and, if the
person is not an individual, represent that it meets the LOB article of
the relevant treaty.
With respect to claiming treaty benefits other than withholding tax
reductions, such as a claim that a taxpayer does not have a permanent
establishment in the United States, the taxpayer must file Form 8833
(Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b))
attached to a Form 1120-F (U.S. Income Tax Return of a Foreign
Corporation) or Form 1040 NR (U.S. Nonresident Alien Income Tax
Return). Line 4 of Form 8833 requires the taxpayer to identify the LOB
provision that the taxpayer relies upon to be eligible to take the
treaty-based return position.
In addition, the Internal Revenue Service audits LOB compliance as
part of its general assessment of whether a foreign taxpayer is
eligible to claim treaty benefits. The Treasury Department understands
that the IRS' audit experience indicates that LOB issues most often
arise in the context of audits of U.S. corporations that makes payments
of interest, dividends, or royalties to related foreign persons.
In the end, however, the simple inclusion of a LOB article in a
treaty may by itself be largely responsible for limiting treaty
shopping. The 2007 Treasury Report provides evidence that the mere
inclusion of a comprehensive LOB provision is a deterrent against
treaty shopping.
Question 3. As set forth in Article 27(3) of the proposed treaty
with Iceland, an unusual year-long transition period is provided for
investors that are entitled to greater benefits under the 1975 treaty
than the new treaty, during which they can elect to continue to benefit
from the application of the 1975 treaty, rather than have the new
treaty's provisions applied to them. Why was this provision included?
How does this provision benefit the United States? Is this provision
one that might be included in future treaties?
Answer. The transition rule coordinating the entry into force of
the proposed Iceland treaty and the termination of benefits of the 1975
treaty is not an uncommon practice when an existing treaty is being
replaced by a new agreement or is being amended by a new protocol. For
instance, similar provisions were included in the U.S.-Belgium tax
treaty (signed November 27, 2006), the U.S.-Germany protocol (signed
June 1, 2006), the U.S.-U.K. tax treaty (signed July 24, 2001), and the
U.S.-Denmark tax treaty (signed August 19, 1999). In order to reach
agreement in 2007 with Iceland regarding inclusion of a LOB provision,
we agreed to this election.
Question 4. U.S. income tax treaties with Hungary and Poland
provide an exemption from withholding on cross-border interest payments
and, as in the case of the 1975 tax treaty with Iceland, these treaties
do not include an LOB provision. Is the Treasury Department negotiating
protocols with Hungary and Poland in order to rectify the omission of
an LOB provision? If not, why not? If so, please describe the status of
those negotiations.
Answer. Updating the agreements with Hungary and Poland is a key
part of the Treasury Department's effort to protect the U.S. tax treaty
network from abuse. The Treasury Department has had two rounds of
negotiations with Hungary already in 2008 with the aim of concluding a
new agreement as soon as possible. The next round of negotiations is
scheduled for September 2008, and an additional round is also
scheduled, if necessary, for December 2008.
As shown in the 2007 Treasury Report, it does not appear that the
U.S.-Poland tax treaty has yet been extensively exploited by third-
country residents. Nevertheless, the Treasury Department has had
preliminary discussions with Poland and anticipates continuing those
discussions in 2008 with the goal of commencing negotiations to
conclude a new agreement to update the 1976 agreement. The United
States places a very high priority on bringing the proposed treaty with
Iceland into force and on concluding as soon as possible negotiations
with Hungary and Poland.
Beyond renegotiating the treaties with Hungary and Poland, the
Treasury Department reviews the current U.S. tax-treaty network on a
continuing basis to identify deficiencies in existing agreements and
areas where more beneficial terms for the United States and U.S.
taxpayers could be negotiated. As part of this process, antitreaty-
shopping provisions are given special scrutiny to ensure that they are
functioning appropriately. Those treaties with LOB provisions that are
out of date or need strengthening are given higher priority in the
Treasury Department's plan for negotiations.
Question 5. The proposed treaty with Iceland includes special
antiabuse rules intended to deny benefits in certain circumstances in
which an Icelandic-resident company earns U.S.-source income
attributable to a third-country permanent establishment and is subject
to little or no tax in the third jurisdiction and Iceland. Similar
antiabuse rules are included in other recent treaties, including the
proposed Convention with Bulgaria. The U.S. Model Tax Treaty, however,
does not include rules addressing so-called ``triangular
arrangements.'' Why? Is this a provision that might be added to the
U.S. Model Tax Treaty?
Answer. The Treasury Department's current policy is to incorporate
the so-called ``triangular rule'' into tax treaties in which the treaty
partner exempts from tax certain foreign source income such that a tax
treaty may be used inappropriately in conjunction with certain branch
structures to exempt fully from tax certain U.S.-source payments. The
Treasury Department is considering whether it is appropriate to include
such a rule in the next update of the U.S. Model tax treaty.
Question 6. The Committee on Taxation of Business Entities of the
New York City Bar has written to the Committee on Foreign Relations in
reference to the so-called ``derivative benefits'' test contained in,
for example, Article 21(3) of the LOB provision in the proposed treaty
with Iceland. In particular, the Bar's Committee on Taxation of
Business Entities has stated that they ``believe that there is a need
for guidance in determining the scope of the dividend payment relief
under such derivative provisions, due to the uncertainties involved in
calculating the relevant stock ownership.'' Has the Office of Tax
Policy considered whether it would be useful to publish guidance on
this topic?
Answer. The New York City Bar Association's Committee on Taxation
of Business Entities, in its May 2008 report (the NYCBA Report),
suggests that there is need for guidance clarifying how ownership is
calculated for purposes of the derivative-benefits rule in our recent
tax treaties. The Office of Tax Policy recognizes the importance of
providing published guidance with respect to income tax treaties
generally, and is currently considering this and other recommendations
made by the NYCBA Report.
Question 7. Under the U.S. Model Tax Treaty child support payments
paid to a resident of a treaty country is exempt from tax in either
country. The proposed treaty with Iceland, however, makes no mention of
the tax treatment of child support payments. Why is that?
Answer. The absence of a special rule governing the taxation of
child support payments in the proposed Iceland treaty means that the
taxation of such payments would be governed by Article 20 (Other
Income), which assigns the exclusive right to tax to the country of
residence of the recipient. During the course of the negotiations, the
Treasury Department learned that under Iceland's domestic law, most
child support payments are not subject to tax. Accordingly, leaving the
treatment of child support payments to Article 20 (Other Income)
achieves a tax result very similar to the result under the U.S. Model
rule; that is, the residence country will have the exclusive right to
tax child support, but such payments are in most cases exempt from tax
under the domestic laws of both the United States and Iceland.
Question 8. Why doesn't the proposed treaty with Iceland address
the tax treatment of cross-border pension contributions?
Answer. The proposed treaty with Iceland does not address the tax
treatment of cross-border pension contributions primarily for two
reasons. First, the U.S. Model pension funds provision provides for
deductibility in one State of contributions to a pension fund of the
other State only where the pension fund ``generally corresponds'' to a
pension fund in the first state. The provision is, therefore, only
appropriate if the two countries have pension systems that are similar.
During the course of negotiations, it became clear that Iceland and the
United States have very different pension systems. As a result, the
provision was not appropriate to include in the proposed treaty.
Second, Iceland had limited flexibility in changing by tax treaty its
rules for taxing pensions, because those rules are technically under
Iceland's pension law, not its tax law.
Question 9. Like the U.S. Model Tax Treaty, the Iceland Treaty
provides that pension distributions owned by a resident of a
contracting country are taxable in the recipient's country of
residence. The U.S. Model Tax treaty, however, contains an exception to
this provision under which a pension beneficiary's country of residence
must exempt from tax a pension amount or other similar remuneration
that would be exempt from tax in the other contracting country where
the pension fund is established, as if the beneficiary had been a
resident of that other country. Why doesn't the proposed treaty with
Iceland contain such an exception?
Answer. Like other departures from the U.S. Model, the omission in
the U.S.-Iceland tax treaty of the exemption from tax for pension
benefits that would be exempt from tax in the source country was the
result of the negotiation process. Moreover, Iceland had limited
flexibility in changing by tax treaty its rules for taxing pensions,
because those rules are technically under Iceland's pension law, not
its tax law.
Question 10. The U.S. Model Tax Treaty allows recipients of
``income, gains, or profits'' from an entity that is fiscally
transparent under the tax laws of the recipient's residence to enjoy
the same treaty benefits on that income as they would have if the
``income, gains, or profits'' had been received by them directly, so
long as the income coming to them through the entity is treated no
differently by their resident country than it would have been had it
been received directly by them. The provision in the Iceland Treaty for
fiscally transparent entities closely parallels the provision in the
U.S. Model Tax Treaty. Yet, rather than referring to such entities as
``fiscally transparent,'' the Iceland Treaty refers instead to entities
that are either ``a partnership, trust, or estate.'' See Article 1(6).
Treasury's Technical Explanation makes clear that this is intended to
include U.S. limited liability companies (``LLCs'') that are treated as
partnerships or as disregarded entities for U.S. tax purposes,
including LLCs with only one member. Although the meaning appears to be
equivalent, why wasn't the phrase ``fiscally transparent'' used in
Article 1(6)?
Answer. Paragraph 6 of Article 1 of the proposed treaty with
Iceland does not use the U.S. Model's phrase ``fiscally transparent''
because that term does not have meaning under the domestic law of
Iceland. During the course of the negotiations, the Treasury Department
obtained agreement in principle with Iceland over the intent and
application of paragraph 6 of Article 1. Accordingly, the Treasury
Department believes that the rule will be interpreted and applied by
Iceland consistent with the language in the U.S. Model Tax Treaty.
Question 11. The Convention Between the United States and the
Republic of Bulgaria for the avoidance of Double Taxation and the
Prevention of Fiscal Evasion With Respect to Taxes on Income, with
accompanying Protocol, was signed on February 23, 2007. Before
transmitting this treaty to the Senate, however, a Protocol amending
the 2007 treaty was negotiated with Bulgaria. This Protocol was signed
on February 26, 2008 and only after its completion, did the executive
branch transmit the original treaty to the Senate for advice and
consent. Why was the 2008 Protocol needed? What changed between
February 2007 and February 2008 to necessitate amending the 2007
treaty? What is the most important correction made by the 2008 Protocol
to the underlying treaty?
Answer. The 2008 Protocol made certain technical corrections to the
2007 Convention and accompanying Protocol, and addressed features of
the Bulgarian tax system and treaty network that could result in a
Bulgarian tax exemption for U.S. source income attributable to offshore
branches of the Bulgarian company receiving the U.S. source income. To
address the potential ``double exemption'' issue, the proposed 2008
Protocol would add a so-called ``triangular rule'' to the LOB provision
of the proposed treaty, which is the most important addition to be made
by the 2008 Protocol.
Question 12. Under the Bulgaria Convention, with limited
exceptions, the withholding tax on cross-border royalty and interest
payments would be imposed at a maximum rate of five percent. Under the
accompanying protocol, the United States and Bulgaria are to reconsider
source-taxation of interest and royalties arising in Bulgaria and
beneficially owned by a resident of the United States, at a time that
is ``consistent with the conclusion of the transition period'' under a
European Union Council Directive applicable to interest and royalties
deemed to arise in Bulgaria and beneficially owned by a resident of the
European Union. The conclusion of the transition period is due to occur
on December 31, 2014. Please explain the reason for including this
commitment to reconsider source-taxation of interest and royalties
arising in Bulgaria and beneficially owned by a resident of the United
States. Is it fair to say that when you consult, you expect to
negotiate an amendment to the Bulgaria Convention that would further
reduce the maximum rate of withholding that can be imposed on cross-
border interest and royalties arising in Bulgaria and beneficially
owned by a resident of the United States?
Answer. At the conclusion of the transition period under the
European Union Council Directive, Bulgaria is expected to adopt rates
of withholding on cross-border interest and royalties for residents of
European Union member states that are lower than the rate provided for
in the proposed treaty. The provision of the 2007 Protocol is intended
to memorialize the understanding between Bulgaria and the United States
that the United States will have the opportunity at the conclusion of
the transition period to negotiate a further protocol to the proposed
treaty with Bulgaria that could reduce the maximum rate of withholding
that may be imposed on cross-border interest and royalties arising in
Bulgaria.
Question 13. Both the Bulgaria Convention and the Canada Protocol
include a special rule that broadens the typical definition of a
``Permanent Establishment'' such that a service enterprise may still be
deemed to have a Permanent Establishment in a treaty country, even if
it does not have a fixed place of business in that country (the
``services country''). See Article 5(8) of the Bulgaria Convention and
Article 3(2) of the Canada Protocol.
13A. A number of the terms used in this rule are somewhat
ambiguous and although the Technical Explanations for the
Bulgaria Convention and the Canadian Protocol help to resolve
some of that ambiguity, there is still work to be done. Please
describe the steps you are taking with Canada, Bulgaria, and
internally to further clarify the application and operation of
this provision, including the specific terms you are focused on
clarifying. In particular, is work being done to further
clarify what constitutes ``presen[ce]'' in the services country
and what constitutes a ``connected project''? What about the
``provision of services''? Is this term, for example, intended
to include preparatory work or the collection of data from an
office in one country in order to provide services in the other
country?
Answer. In preparing the agreed Technical Explanation of the
proposed Protocol with Canada, the Treasury Department had many
discussions with Canada regarding the interpretation and application of
the new rule concerning the taxation of services.
If the proposed Protocol is approved by the Senate, the Treasury
Department will continue these discussions with Canada. The Treasury
Department's discussions with Canada to date have encompassed the
interpretation of a number of terms, including ``presen[ce]'' in the
services country, what constitutes ``connected projects,'' and the
meaning of ``provision of services.'' For example, the Technical
Explanation to the proposed Protocol clarifies that paragraph 6 of
Article V (Permanent Establishment) of the existing U.S.-Canada treaty
applies notwithstanding the new rule for taxation of services.
Paragraph 6 identifies activities with respect to which a fixed place
of business will not give rise to a permanent establishment, which
includes activities that have a preparatory or auxiliary character.
Accordingly, days spent on preparatory or auxiliary activities shall
not be taken into account for purposes of applying the services rule
described in subparagraph 9(b) of Article V.
The Treasury Department recognizes that additional guidance with
respect to the services rule included in both the proposed Canada
Protocol and the Bulgaria Convention is needed to provide more
certainty to taxpayers, and we welcome further input regarding
application of the rule.
13B. Article 14(1) of the Bulgaria Convention, with certain
exceptions, sets forth a general rule that if an employee who
is a resident of one treaty country (the ``residence country'')
is working in the other treaty country (the ``employment
country''), his or her salaries, wages, and other remuneration
derived from the exercise of employment in that country may be
taxed by that country--i.e., the employment country.
Notwithstanding this general rule, Article 14(2) of the treaty
provides that the remuneration derived by the employee from the
exercise of employment in the employment country shall be taxed
only by the residence country (and not the employment country)
if (1) the employee is present in the employment country for
183 days or less in any 12-month period commencing or ending in
the taxable year concerned; (2) the remuneration is paid by, or
on behalf of, an employer who is not a resident of the
employment country; and (3) the remuneration is not ``borne''
by a permanent establishment that the employer has in the
employment country. The Canada Protocol has a variation of this
provision in Article 10(2), which amends Article XV of the
Canada Tax Treaty. In both treaties, the final requirement
(i.e., that the remuneration is not ``borne'' by a permanent
establishment that the employer has in the employment country),
interacts with the special rule expanding the definition of a
permanent establishment in a potentially problematic way.
For example, in the case of the Bulgaria Convention, it appears
that the salaries, wages, and other remuneration derived by an employee
performing services through a permanent establishment arising under
Article 5(8) of the treaty would be subject under Article 14 to being
taxed by the employment country, even if the other requirements of the
test in Article 14(2) had been met (i.e., the employee had been present
in the employment country for less than 183 days during any 12-month
period commencing or ending in the taxable year concerned and the
employee's remuneration was paid by an employer who is a resident of
the other country). Is this correct? If so, the interaction of these
two provisions would increase the complexities associated with the
special rule contained in Article 5(8). For example, such a scenario
would mean that an employer and the relevant employees would need to
fulfill several tax-related obligations, including obtaining tax
identification numbers and providing for the withholding of income
taxes and other taxes as appropriate that would cover the period
beginning on the first day such services were performed by such
employee during the affected year. Please explain how the Department
intends to address the problems presented by this result for taxpayers
that may not know whether they will be deemed to have a permanent
establishment under the treaty until perhaps 6 months into the relevant
12-month period, and will therefore be subject to various taxes,
including employment taxes, by the services country reaching back to
the beginning of the relevant 12-month period.
Answer. It is correct that a permanent establishment arising under
Article 5(8) of the proposed Bulgaria Convention is a permanent
establishment for purposes of Article 14 of the Convention, and
therefore the salaries, wages, and other remuneration of an employee
borne by a permanent establishment of the employer arising under
Article 5(8) of the treaty would be subject under Article 14 to being
taxed by the source country, even if the other requirements of the test
in Article 14(2) had been met.
The Treasury Department recognizes that the rule for taxation of
services in the proposed Canada Protocol raises compliance and
administrative concerns for companies and their employees. The Treasury
Department and Internal Revenue Service have met with a number of U.S.
taxpayers, including professional services firms, to discuss the
interpretation and application of this rule, focusing on administrative
issues. The Treasury Department has discussed with Canada and, if the
proposed Protocol is approved by the Senate, will continue to discuss
with Canada, possible methods of easing the administrative burden on
businesses associated with complying with this new rule, the effective
date of which is delayed until the third taxable year ending after the
proposed Protocol enters into force. The Technical Explanation to the
proposed Canada Protocol, the contents of which the Government of
Canada has subscribed to, provides that ``[t]he competent authorities
are encouraged to consider adopting rules to reduce the potential for
excess withholding or estimated tax payments with respect to employee
wages that may result from the application of [the services rule].''
13C. A version of this special rule appears in the 2008 OECD
draft update to the OECD Model Tax Convention as an alternative
services permanent establishment provision. There are, however,
a few differences in language between the OECD rule and the one
used in the Bulgaria Convention and the Canada Protocol. In
particular, the OECD language clarifies that services performed
by an individual on behalf of an enterprise may be considered
as performed by that enterprise only if the enterprise
supervises, directs, or controls the manner in which the
services are performed by the individual. The language in the
text of the Bulgaria Convention and the Canada Protocol are
silent on this point, apparently leaving open the question of
whether, and if so, under what circumstances, the use of a
subcontractor might give rise to a permanent establishment of a
general contractor. Is it Treasury's view that services
performed by an individual on behalf of an enterprise may be
considered as performed by that enterprise only if the
enterprise supervises, directs, or controls the manner in which
the services are performed by the individual? Does Canada share
this view? Does Bulgaria?
Answer. For a number of years, the OECD has debated whether to
include an alternative rule for the taxation of services in the OECD
Model or its Commentary. The 2008 Update to the OECD Model, released on
July 18, 2008, includes a version of the services rule as an
alternative in the Model Commentary. The language of the OECD provision
does not match in all respects the language of provision included in
the proposed Bulgaria Convention and the Canada Protocol. For example,
the language of the Bulgarian and Canadian provision requires that the
services be provided ``for customers who are either residents of that
other State or who maintain a permanent establishment in that other
State.'' That language regarding the provision of services to customers
is not included in the OECD provision, and thus the issue of whether
the use of a subcontractor might give rise to a permanent establishment
is especially important in applying the OECD provision. If the Senate
approves the proposed the Bulgaria Convention and Canada Protocol, the
Treasury Department will continue to discuss with Bulgaria and Canada
the interpretation and application of the version of the rule for
taxation of services included in our agreements.
13D. One aspect of the rule in both the Bulgaria Convention
and the Canada Protocol that would appear to be difficult to
manage is the fact that the 12-month period isn't tied to a
fiscal year. Is this something you considered and rejected
during the course of negotiations? Is this something that might
be considered in the future, should you include this special
rule in future treaties?
Answer. The rule for taxation of services in the proposed
agreements with Bulgaria and Canada refers to an aggregate of 183 days
or more in ``any 12-month period'' as opposed to, for example, 183 days
or more in a fiscal or calendar year. The reference to ``any 12-month
period'' addresses potential situations in which, for example, work has
been artificially divided into two separate fiscal years in order to
avoid meeting the 183-day threshold. For instance, a taxpayer could
circumvent a threshold based on 183 days in a fiscal year by providing
services in the other state for the last 5 months of 1 fiscal year and
the first 5 months of the following fiscal year.
The Treasury Department recognizes the administrative and
compliance concerns of companies and their employees regarding the
rule's reference to ``any 12-month period.'' If the proposed agreements
with Bulgaria and Canada are approved by the Senate, the Treasury
Department will continue to discuss the interpretation and application
of this rule with Bulgaria and Canada in the context of exploring ways
to alleviate administrative and compliance burdens.
The inclusion of a rule for taxation of services in the proposed
agreements with Bulgaria and Canada does not reflect a change in U.S.
tax treaty policy, and inclusion of such a provision in the U.S. Model
is not being considered. However, it is a provision that the Treasury
Department will consider in the context of negotiating a particular
agreement in exchange for significant concessions in other areas, and
the inclusion of such a provision in the proposed agreements with
Bulgaria and Canada was a key element to achieving overall agreements
that provide benefits to the United States and to U.S. taxpayers. At
the same time, the Treasury Department recognizes the concerns raised
by the Joint Committee on Taxation's ``Explanation of Proposed Protocol
to the Income Tax Treaty between the United States and Canada'' about
the appropriateness of including a services rule in a tax treaty with a
developed country.
In the context of negotiating a particular agreement in the future,
the Treasury Department may consider referring to an alternative 12-
month period. The Treasury Department welcomes input concerning this
issue.
Question 14. Mandatory arbitration was included in the Protocol
with Canada, but not in the treaty with Iceland or Bulgaria. Please
explain why. In negotiating future treaties, what are the factors
considered by Treasury when deciding whether or not to include binding
arbitration in a new tax treaty or in an amendment to an existing tax
treaty? Are you currently negotiating mandatory arbitration mechanisms
with other countries? If so, which countries?
Answer. The Treasury Department believes that mandatory binding
arbitration, as an extension of the competent authority process, is an
effective tool to strengthen the Mutual Agreement Procedure in the U.S.
treaty network as a whole. Even in the best competent authority
relationships, there are, on occasion, difficult treaty interpretation
questions and disputes that arise. The Treasury Department believes
that the arbitration mechanism included in the proposed agreement with
Canada will help resolve cases in a timely manner and enhance the
working relationship of the competent authorities.
The Treasury Department has been discussing mandatory binding
arbitration in general terms with our treaty partners, and intends to
continue to raise inclusion of a mandatory binding arbitration
provision with our treaty partners in future negotiations. The Treasury
Department welcomes further input from the Committee concerning the
factors that should be taken into account when considering whether to
include an arbitration provision in the context of the negotiation of a
particular agreement, as well as ways that the arbitration provision in
future agreements might be improved or varied.
Question 15. When considering the mandatory arbitration provisions
in the Belgium and Germany tax treaties, which were approved by the
Senate last year, the committee focused on, among other things, the
selection of fair, objective, and independent arbiters. In answer to a
question for the record regarding your process for selecting arbiters,
it was noted that the Treasury Department ``expect[s] to have further
discussions with our treaty partners concerning the [selection of
arbiters], with a view toward achieving the best balance of the
concerns expressed and providing to taxpayers an efficient and
effective resolution of their double taxation.'' Please describe the
status of such discussions with Belgium and Germany. Does the
Department expect to have discussions with Canada on this topic as
well? Specifically, what work has been done to ensure that the United
States and all three treaty partners will select fair, objective, and
independent arbiters for service on arbitration boards constituted by
the mechanisms provided in these treaties?
Answer. The U.S. competent authority has formally begun discussions
with Belgium and Germany on a number of procedural matters to ensure
the effective implementation of the arbitration provision, including
regarding the qualifications for arbiters, especially those
qualifications required to ensure that arbiters are sufficiently
independent. In those discussions, the U.S. competent authority has
expressed the concerns raised by the committee in its considerations of
the Belgian and German agreements regarding the selection of Government
employees as arbiters. We hope that similar discussions with Canada
begin soon. While we do not yet have formal agreements with any of
these treaty partners, they understand and agree with the need for
fair, objective, and independent arbitration boards.
Question 16. The Canada Protocol, as in the case of the Belgium and
Germany tax treaties, does not identify the procedural rules that will
be used by arbitration boards constituted in accordance with the
mandatory arbitration provision included in each treaty. In answer to a
question for the record on this topic in relation to the Belgium and
Germany tax treaties, the Treasury Department noted that ``after
studying the details of the [procedural] rules commonly used in
commercial arbitration, we concluded that most of these rules relate to
evidentiary procedures not relevant to the simplified arbitration
format proposed in the agreements with Belgium and Germany, primarily
because the decision of the arbitration board is to be based upon a
record rather than a presentation of evidence.'' Has the Treasury
Department had discussions with Canada, Belgium, and Germany regarding
what procedural rules would be appropriate for the arbitration format
provided for in these treaties? In particular, has there been any
discussion regarding conflict of interest rules that might apply to
arbiters?
Answer. The U.S. competent authority has formally begun discussions
with Belgium and Germany, and informally with Canada, on a number of
procedural matters to ensure the effective implementation of the
arbitration provision. The objective of these discussions is to have
the procedures in place with respect to Belgium and Germany no later
than December 31, 2008. As part of the discussions with Belgium and
Germany, the U.S. competent authority has also begun discussing the
need for conflict-of-interest rules to govern arbiters. For example,
the U.S. competent authority has discussed whether safeguards might be
built into the necessary procurement arrangements between the United
States and the arbiter. While the U.S. competent authority does not yet
have formal agreements with any of these treaty partners, they
understand and agree with the need for fair, objective, and independent
arbitration boards.
Question 17. The Committee Report on the Germany and Belgium
treaties raised certain concerns regarding the mandatory arbitration
mechanism, including concerns regarding treaty interpretation and the
selection of arbiters. Other Members have indicated related concerns
regarding these provisions. None of these are addressed in the Canada
Protocol arbitration provision, but presumably that is because the
Canada Protocol was already negotiated when these concerns were raised.
Can you, however, confirm that these concerns will be considered and
addressed in future tax treaties with similar arbitration mechanisms?
Answer. The arbitration provision in the proposed Protocol with
Canada was already negotiated at the time the Senate considered the
agreements with Germany and Belgium in 2007. It is for this reason that
the concerns expressed by the Committee on the agreements with Germany
and Belgium are not reflected in the proposed Canada Protocol.
The Treasury Department greatly appreciates the input received from
the committee on several aspects of the German and Belgian arbitration
provisions, and similarly with the Canadian Protocol. The committee's
concerns have been and will continue to be considered in any
arbitration negotiations the Treasury Department conducts.
Question 18. The exchange of notes between the United States and
Canada that accompanies the Canada Protocol includes many of the
details that would govern the binding arbitration mechanism to be
included in the treaty. Among other things, the notes make clear that
the arbitration mechanism would only apply to certain articles in the
treaty, which are listed, unless otherwise agreed to by the parties.
18A. How were the articles to which arbitration applies,
selected?
Answer. The Treasury Department believes that mandatory binding
arbitration, as an extension of the competent authority process, is an
effective tool to strengthen the Mutual Agreement Procedure in the U.S.
treaty network as a whole. However, the scope of an arbitration
provision in a particular agreement is a matter that must be negotiated
with the treaty partner. Some countries may be willing to cover only
specific articles in the treaty. It should be noted that while the
mandatory binding arbitration provision in the proposed Canada Protocol
is limited to certain articles, other issues are eligible for
arbitration if the competent authorities agree that the particular case
is suitable for arbitration.
18B. Why isn't Article 3 (Definitions) among the articles
included in this list?
Answer. Article III of the existing Canada treaty provides
definitions and general rules of interpretation for the treaty.
Paragraph 1 of Article III defines a number of terms for purposes of
the treaty. Certain other terms are defined in other articles of the
treaty. Paragraph 2 of Article III provides that, in the case of a term
not defined in the treaty, the domestic tax law of the Contracting
State applying the treaty shall control, unless the context in which
the term is used requires a definition independent of domestic tax law
or the competent authorities reach agreement on a meaning.
To the extent that an issue concerning the definition of a term is
part of a case regarding the application of one or more articles
explicitly within the scope of the mandatory arbitration provision,
such definitional issue will be considered during the arbitration
process.
18C. If a dispute focuses on a term that is defined in
Article 3 and appears in another Article that is within the
scope of the arbitration mechanism, would such a dispute be
subject to arbitration under the Protocol?
Answer. To the extent that an issue concerning the definition of a
term defined in Article III is part of a case regarding the application
of one or more articles explicitly within the scope of the mandatory
arbitration provision, such definitional issue will be considered
during the arbitration process
Question 19. Article 2(1) of the proposed Canada Protocol addresses
the issue of so-called ``dual-resident corporations.'' It provides that
if such a company is created under the laws in force in a treaty
country but not under the laws in force in the other treaty country,
the company is deemed to be a resident only of the first treaty
country. Have you considered whether this rule is equitable, for
example, in circumstances in which a corporation was organized under
the laws of the United States many years ago and has long since ceased
to have significant contacts with the United States, but instead is
managed and controlled in Canada? Have you considered whether it might
be appropriate to provide discretion to the Competent Authorities in
such a case to determine, for example, that the company is in fact a
resident of Canada?
Answer. To address abuses of the existing treaty by U.S. companies
continuing into Canada, the proposed Protocol replaces the existing
treaty's rule for resolving dual-residency conflicts for corporations
with an updated rule that is similar to the rule in the U.S. Model. It
has been a longstanding treaty policy of the United States to place
significant weight on the place of incorporation when addressing
questions of dual corporate residence. However, we have included in
other agreements, for example in our agreement with the United Kingdom
and the proposed Bulgaria and Iceland agreements, provisions directing
the Competent Authorities to endeavor to determine for treaty purposes
the residence of dual resident corporations.
Question 20. Article 2(2) of the Canada Protocol would amend
Article IV of the Canada Tax Treaty to include a new paragraph 6 and 7,
setting forth specific rules for the treatment of certain income,
profit, or gain derived through or paid by fiscally transparent
entities. The new paragraph 6 would set forth a ``positive'' rule,
which identifies scenarios in which ``income, profit or gain shall be
considered to be derived by a person who is a resident of a Contracting
State.'' The new paragraph 7 would set forth a ``negative'' rule
intended to prevent the use of such entities to claim the benefits
where the investors are not subject to tax on the income in their state
of residence. In particular, paragraph 7 is aimed largely at curtailing
the use of certain legal entity structures that include hybrid fiscally
transparent entities, which, when combined with the selective use of
debt and equity, may facilitate the allowance of either (1) duplicated
interest deductions in the United States and Canada, or (2) a single,
internally generated, interest deduction in one country without
offsetting interest income in the other country. As noted by the Joint
Committee on Taxation in its explanation of the Canada Protocol,
commentators have raised a question as to whether subparagraph 7(b) is
too broad, because it could prevent legitimate business structures that
are not engaging in potentially abusive transactions from taking
advantage of benefits that would otherwise be available to them under
the treaty. Please explain whether you agree or disagree with the
assertion that subparagraph 7(b) is overbroad. If so, has there been
any discussion regarding what might be done to improve the situation?
In addition, does the Treasury Department expect to include such a rule
in future tax treaties? If so, has the Treasury Department considered
alternate versions that might provide for a narrower exception from the
rule in paragraph 6?
Answer. Subparagraph 7(b) essentially denies benefits in cases in
which the residence country treats a payment differently than the
source country and other conditions are met. The rule is broader than
an analogous rule in Treasury regulations issued pursuant to section
894 of the Internal Revenue Code. The Treasury Department is aware that
the scope of subparagraph 7(b) is potentially overbroad, especially in
the case of nondeductible payments. The Treasury Department has been
discussing, and will continue to discuss with Canada, whether to
address this issue. The Treasury Department does not contemplate
incorporating such a rule in future tax treaties.
Question 21. The Treasury Department's Technical Explanation
provides several examples of the application of subparagraph 7(b) to
certain legal entity structures. But, the Technical Explanation does
not provide an example of a payment made by a U.S. domestic reverse
hybrid entity that is treated as a partnership for Canadian tax
purposes to one of its owners. Although the partnership example in the
Technical Explanation should apply reciprocally to a payment treated as
a dividend for U.S. tax purposes and a partnership distribution for
Canadian tax purposes, the Technical Explanation does not state so
explicitly. Can you confirm that this is the case?
In addition, the Technical Explanation does not include examples
relating to a deductible interest (or royalty) payment from a hybrid
partnership entity to one of its owners. In the case of such a payment
from a Canadian hybrid partnership entity, the U.S. recipient of the
payment would generally treat it as a payment of interest (or
royalties) for U.S. tax purposes.\1\ One might expect that subparagraph
7(b) would not apply in this case because the fiscal transparency of
the partnership would generally not be relevant for residence-country
tax purposes, but there is no discussion of this case in the Technical
Explanation. Can you confirm that this is a reasonable reading of
subparagraph 7(b)? Also, please clarify whether subparagraph 7(b)
applies with respect to deductible payments by a domestic reverse
hybrid partnership entity to one of its Canadian owners.
---------------------------------------------------------------------------
\1\Under section 707(a) and Treas. Reg. section 1.707-1(a), if a
partner engages in a transaction with a partnership other than in the
capacity as a member of the partnership, the transaction is, in
general, considered as occurring between the partnership and one who is
not a partner. See Rev. Rul. 73-301, 1973-2 C.B. 215.
Answer. Page 10 of the agreed Technical Explanation provides an
example of the application of subparagraph 7(b):
``[Assume] in the above example, USCo (as well as other persons)
are owners of CanCo, a Canadian entity that is considered under
Canadian tax law to be a corporation that is resident in Canada but is
considered under U.S. tax law to be a partnership (as opposed to being
disregarded). Assume that USCo is considered under Canadian tax law to
have received a dividend from CanCo. Such payment is viewed under
Canadian tax law as a dividend, but under U.S. tax law is viewed as a
partnership distribution. In such a case, Canada views USCo as
receiving income (i.e., a dividend) from an entity that is a resident
of Canada (CanCo), CanCo is viewed as fiscally transparent under the
laws of the United States, the residence State, and by reason of CanCo
being treated as a partnership under U.S. tax law, the treatment under
U.S. tax law of the payment (as a partnership distribution) is not the
same as the treatment would be if CanCo were not fiscally transparent
under U.S. tax law (as a dividend). As a result, subparagraph 7(b)
would apply to provide that such amount is not considered paid to or
derived by the U.S. resident.''
The provisions of subparagraph 7(b) apply reciprocally. Assume, for
example, that CanCo (as well as other persons) are owners of USCo, a
U.S entity that is considered under U.S. tax law to be a corporation
resident in the United States, but is considered under Canadian tax law
to be a partnership (a so-called ``domestic reverse hybrid''). Assume
that CanCo is considered under U.S. tax law to have received a dividend
from USCo. Such payment is viewed under U.S. tax law as a dividend, but
under Canadian tax law is viewed as a partnership distribution. In such
a case, the United States views CanCo as receiving income (i.e., a
dividend) from an entity that is a resident of the United States
(USCo), USCo is viewed as fiscally transparent under the laws of
Canada, the residence State, and by reason of USCo being treated as a
partnership under Canadian tax law, the treatment under Canadian tax
law of the payment (as a partnership distribution) is not the same as
the treatment would be if USCo were not fiscally transparent under
Canadian tax law (as a dividend). As a result, subparagraph 7(b) would
apply to provide that such amount is not considered paid to or derived
by the Canadian resident.
As noted in the agreed Technical Explanation: ``Paragraphs 6 and 7
apply to determine whether an amount is considered to be derived by (or
paid to) a person who is a resident of Canada or the United States. If,
as a result of paragraph 7, a person is not considered to have derived
or received an amount of income, profit or gain, that person shall not
be entitled to the benefits of the Convention with respect to such
amount. Additionally, for purposes of application of the Convention by
the United States, the treatment of such payments under Code section
894(c) and the regulations thereunder would not be relevant.'' Thus,
subparagraph 7(b) applies with respect to deductible payments by a
domestic reverse hybrid to its Canadian owners.
Although not specifically addressed in the Technical Explanation,
the Treasury Department and Canada agree that subparagraph 7(b) does
not apply to deny benefits to interest and royalty payments by an
entity that is treated as a partnership by one country and a
corporation by the other if the treatment of such amount by the country
of the person deriving the income would be the same if such amount had
been derived directly by such person (interest or royalties).
Question 22. Does the Treasury Department intend to formally share
its Technical Explanation regarding the Bulgaria and Iceland Treaties
with each country, as a courtesy?
Answer. As a courtesy, the Treasury Department has sent copies of
its Technical Explanation to each country. Unlike the Technical
Explanation to the proposed Canada Protocol, however, the Technical
Explanations to the proposed Bulgaria and Iceland Conventions have not
been reviewed by or subscribed to by the relevant country.
______
Responses of Deputy Assistant Secretary Michael Mundaca to Questions
Submitted for the Record From Senator Lugar
Question 1. Please give an overview of current cases that have not
been resolved and the anticipated case load that would be addressed by
the Arbitration Provision in the Protocol with Canada, including number
of cases, length of time unresolved, and country of origin breakdowns.
Answer. There are currently 192 active cases with Canada. Of those,
approximately 90 percent are transfer-pricing cases, with the remainder
involving interpretive issues, such as residency and permanent-
establishment determinations. The Canadian tax authorities initiated
the adjustment in 85 percent of the cases caused by a transfer pricing
adjustment.
Fifty-three of the 192 total cases have been unresolved for over
two years. Of those 53 cases, the ``oldest'' case is 2,289 days old and
the ``youngest'' case is 762 days old. Four of the 53 cases involve
interpretive issues, the oldest of which is 1,657 days and the youngest
of which is 1085 days.
We should note that different countries track their outstanding
competent authority cases differently. For example, concepts such as
the definition of a case may vary by country. Thus, we have observed
that where a treaty partner has aggregate information regarding its
case load with the United States the numbers sometimes notably diverge
from the numbers used by the United States.
Question 2. Traditionally, tax treaties agreements have been seen
as facilitating cross-border trade and investment of multinational
businesses. However, increasing globalization also affects small
businesses. Is the current model for U.S. Tax Treaties clear,
understandable and usable for smaller businesses? Give examples of how
small business can take advantage of these treaties.
Answer. The current U.S. Model Tax Treaty and Technical Explanation
are available on the Treasury Department Web site. The Treaty and
especially the Technical Explanation are drafted to be as clear and
understandable as possible, but we recognize that technical
international tax rules and issues may appear opaque to many taxpayers.
IRS publications, especially Publication 901 on Tax Treaties, provide
international tax guidance in less technical terms and may be more
accessible to individuals who do not have significant tax experience.
We further recognize that in our increasingly global economy, small
businesses and individuals may, and perhaps must, address cross-border
tax issues. Because our tax treaties provide generally uniform and
clear rules regarding such important issues as withholding tax rates
and tax jurisdictional thresholds, we think they can be especially
useful to small businesses and individuals, who may not have access to
multinational advisors or foreign tax advice. More specifically, tax
treaties generally allow U.S. businesses to engage in trade in goods
and services of greater value and duration with foreign clients without
incurring foreign taxes than would be the case in the absence of
treaties. Treaties may also facilitate access to foreign skilled
workers and researchers, and to foreign capital via reduced withholding
rates.
We welcome further input from the committee regarding how best to
serve small businesses in this regard.
Question 3. Please describe the current U.S. position on reciprocal
elimination of withholding taxes on cross-border dividends paid between
a subsidiary and its parent company. Has there been a change in the
U.S. policy position?
Answer. The policy of the Treasury Department continues to be that
the elimination of source-country taxation of dividends should be
considered only on a case-by-case basis. Such a provision is not part
of the U.S. Model because we do not believe that it is appropriate to
include in every treaty. We must consider the interaction of our tax
system with our treaty partner's, as well as the overall balance of the
treaty before deciding whether inclusion is appropriate.