[Senate Executive Report 110-3]
[From the U.S. Government Publishing Office]
110th Congress Exec. Rept.
SENATE
1st Session 110-3
======================================================================
PROTOCOL AMENDING TAX CONVENTION
WITH DENMARK
_______
November 14, 2007.--Ordered to be printed
_______
Mr. Biden, from the Committee on Foreign Relations,
submitted the following
REPORT
[To accompany Treaty Doc. 109-19]
The Committee on Foreign Relations, to which was referred
the Protocol Amending the Convention Between the Government of
the United States of America and the Government of the Kingdom
of Denmark for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income,
signed at Copenhagen on May 2, 2006 (the ``Protocol'') (Treaty
Doc. 109-19), having considered the same, reports favorably
thereon and recommends that the Senate give its advice and
consent to ratification thereof, as set forth in this report
and the accompanying resolution of advice and consent.
CONTENTS
Page
I. Purpose..........................................................1
II. Background.......................................................2
III. Major Provisions.................................................2
IV. Entry Into Force; Effective Dates................................3
V. Implementing Legislation.........................................4
VI. Committee Action.................................................4
VII. Committee Reccommendation and Comments...........................4
VIII.Resolution of Advice and Consent to Ratification.................4
IX. Annex.--Technical Explanation....................................5
I. Purpose
The proposed Protocol to the existing income tax treaty
between the United States and Denmark is intended to promote
closer cooperation and further facilitate trade and investment
between the United States and Denmark. The Protocol's principal
objectives are to eliminate the withholding tax on dividends
arising from certain direct investments and on certain
dividends paid to pension funds; strengthen the treaty's
provisions that prevent the inappropriate use of the treaty by
third-country residents; and generally modernize the existing
tax treaty with Denmark to bring it into closer conformity with
U.S. tax treaty law and policy.
II. Background
The Protocol was signed on May 2, 2006. On the same day,
the United States and the Kingdom of Denmark exchanged notes to
confirm certain understandings with respect to the application
of the Protocol. The Protocol, accompanied by an exchange of
notes, amends the Convention between the Government of the
United States of America and the Government of the Kingdom of
Denmark for the Avoidance of Double Taxation and the Prevention
of Fiscal Evasion with Respect to Taxes on Income, signed at
Washington on August 19, 1999, together with a Protocol (the
``1999 Convention'') (Treaty Doc. 106-12; Exec. Rept. 106-9).
The 1999 Convention replaced an older income tax treaty
concluded in 1948 between the United States and Denmark.
III. Major Provisions
A detailed article-by-article analysis of the Protocol may
be found in the Technical Explanation published by the
Department of the Treasury on July 17, 2007, which is reprinted
in the Annex. In addition, the staff of the Joint Committee on
Taxation prepared an analysis of the Protocol, Document JCX-46-
07 (July 17, 2007), which has been of great assistance to the
committee in reviewing the Protocol. A summary of the key
provisions of the Protocol is set forth below.
1. Taxation of Cross-border Dividend Payments
The Protocol replaces Article 10 of the 1999 Convention,
which provides rules for the taxation of dividends paid by a
company that is a resident of one treaty country to a
beneficial owner that is a resident of the other treaty
country. The new version of Article 10 generally allows full
residence-country taxation and limited source-country taxation
of dividends.
The Protocol retains both the generally applicable maximum
rate of withholding at source of 15 percent and the reduced
five percent maximum withholding rate for dividends received by
a company owning at least 10 percent of share capital of the
dividend-paying company. Additionally, with some restrictions
intended to prevent treaty shopping, dividends paid by a
subsidiary in one treaty country to its parent company in the
other treaty country will be exempt from withholding tax in the
subsidiary's home country if the parent company owns (directly
or indirectly through residents of the treaty countries) at
least 80 percent of the voting power of the subsidiary for the
12-month period ending on the date entitlement to the dividend
is determined. By contrast, the 1999 Convention provides for a
maximum withholding tax rate of five percent for such
dividends.
The Protocol provides that dividends beneficially owned by
a pension fund described in Article 22(2)(e) of the treaty may
not be taxed by the country in which the company paying the
dividends is a resident, unless such dividends are derived from
the carrying on of a business by the pension fund or through an
associated enterprise.
As in the 1999 Convention, special rules apply to dividends
received from U.S. Regulated Investment Companies (RICs) and
U.S. Real Estate Investment Trusts (REITs), with some new
modifications applicable to dividends from REITs, which are
similar to provisions included in other recently concluded tax
treaties. These rules will also apply with respect to dividends
from Danish corporations determined by agreement of the
competent authorities to be similar to U.S. RICs and REITs.
2. Limitation on Benefits
The 1999 Convention already contains a ``Limitation on
Benefits'' provision (Article 22), which is designed to avoid
treaty-shopping. The Protocol amends the Convention's
Limitation on Benefits provision so as to strengthen it against
abuse by third-country residents and bring it into line with
the 2006 U.S. Model Tax Treaty (the ``U.S. Model'') and other
more recent U.S. tax treaties. Among other changes, the new
provision includes a requirement to determine whether a
company's public trading or management constitutes an adequate
connection to its country of residence in either the United
States or Denmark, in order to prevent certain companies that
are not adequately connected from qualifying for treaty
benefits.
3. Scope
The Protocol updates Article 1 of the 1999 Convention
(General Scope) in order to reflect subsequent changes in U.S.
tax law. Paragraph 4 of Article 1 of the 1999 Convention
provides that, with the exception of certain benefits listed
under paragraph 5 of Article 1, either treaty country may
continue to tax its own citizens and residents as if the treaty
were not in force. The Protocol adds to this provision to make
it clear that, notwithstanding any other provision in the
treaty, either treaty country may also tax, in accordance with
its law, certain former citizens and long-term residents for
ten years following the loss of such status. This change is
consistent with section 877 of the Code, which provides special
rules for the imposition of U.S. income tax on former U.S.
citizens and long-term residents for a period of ten years
following the loss of citizenship or long-term resident status.
IV. Entry Into Force; Effective Dates
The United States and Denmark shall notify each other when
the requirements for entry into force have been complied with
and in accordance with Article V, the Protocol will enter into
force upon the date of the receipt of the later of such
notifications. The Protocol's provisions shall have effect with
respect to taxes withheld at source, on income derived on or
after the first day of the second month next following the date
on which the Protocol enters into force. The Protocol's
provisions shall have effect with respect to other covered
taxes for taxable periods beginning on or after the first day
of January next following the date on which the Protocol enters
into force.
V. Implementing Legislation
As is the case generally with income tax treaties, the
Protocol is self-executing and thus does not require
implementing legislation for the United States.
VI. Committee Action
The committee held a public hearing on the Protocol on July
17, 2007 (a hearing print of this session will be forthcoming).
Testimony was received by Mr. John Harrington, International
Tax Counsel, Office of the International Tax Counsel at the
Department of the Treasury; Thomas A. Barthold, Acting Chief of
Staff of the Joint Committee on Taxation; the Honorable William
A. Reinsch, President of the National Foreign Trade Council;
and Ms. Janice Lucchesi, Chairwoman of the Board, Organization
for International Development. On October 31, 2007, the
committee considered the Protocol, 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
Protocol will stimulate increased investment, further
strengthen the provision in the 1999 Convention that prevents
treaty shopping, and promote closer cooperation and facilitate
trade and investment between the United States and Denmark. The
committee therefore urges the Senate to act promptly to give
advice and consent to ratification of the Protocol, as set
forth in this report and the accompanying resolution of advice
and consent.
The Protocol was considered by the committee on October 31,
2007, along with three other tax treaties: (1) The Protocol
Amending Tax Convention with Finland (Treaty Doc. 109-18); (2)
The Protocol Amending Tax Convention with Germany (Treaty Doc.
109-20); and (3) The Tax Convention with Belgium (Treaty Doc.
110-3). In the committee's report regarding the Protocol
Amending Tax Convention with Finland, also filed this day, the
committee set forth comments on two issues, which are also
relevant here.
First, the committee suggested that the Treasury Department
consider sharing the Technical Explanation it develops with its
treaty partners, prior to its public release. Second, the
committee encouraged the Treasury Department to further
strengthen anti-treaty-shopping provisions in tax treaties
whenever possible, with a particular focus on closing the
loophole created by those U.S. tax treaties currently in force
that do not have an anti-treaty-shopping provision. A detailed
discussion regarding these issues can be found in Section VII
of the committee's report regarding the Protocol Amending Tax
Convention with Finland (Exec. Rept. 110-4).
VIII. Text of Resolution of Advice and Consent to Ratification
Resolved (two-thirds of the Senators present concurring
therein), The Senate advises and consents to the ratification
of the Protocol Amending the Convention between the Government
of the United States of America and the Government of the
Kingdom of Denmark for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income,
signed at Copenhagen on May 2, 2006 (Treaty Doc. 109-19).
IX. Annex.--Technical Explanation
DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE PROTOCOL SIGNED
AT COPENHAGEN ON MAY 2, 2006 AMENDING THE CONVENTION BETWEEN THE
GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF THE
KINGDOM OF DENMARK FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE
PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME SIGNED AT
WASHINGTON ON AUGUST 19, 1999
This is a technical explanation of the Protocol signed at
Copenhagen on May 2, 2006 (the ``Protocol''), amending the
Convention between the United States of America and the
Government of Denmark for the avoidance of double taxation and
the prevention of fiscal evasion with respect to taxes on
income, signed at Washington on August 19, 1999 (the
``Convention'').
Negotiations took into account the U.S. Department of the
Treasury's current tax treaty policy and Treasury's Model
Income Tax Convention, published on September 20, 1996 (the
``U.S. Model''). Negotiations also took into account the Model
Tax Convention on Income and on Capital, published by the
Organization for Economic Cooperation and Development (the
``OECD Model''), and recent tax treaties concluded by both
countries.
This Technical Explanation is an official guide to the
Protocol. It explains policies behind particular provisions, as
well as understandings reached during the negotiations with
respect to the interpretation and application of the Protocol.
This technical explanation is not intended to provide a
complete guide to the Convention as amended by the Protocol. To
the extent that the Convention has not been amended by the
Protocol, the Technical Explanation of the Convention remains
the official explanation. References in this technical
explanation to ``he'' or ``his'' should be read to mean ``he or
she'' or ``his or her.''
ARTICLE I
Article I of the Protocol replaces paragraph 4 of Article 1
(General Scope) of the Convention, which contains the
traditional saving clause found in U.S. tax 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
Denmark 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 Denmark 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 894(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
Denmark.
For purposes of the saving clause, ``residence'' is
determined under Article 4 (Residence). 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 Denmark
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, each Contracting State 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. 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 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. The average annual net income
tax threshold is adjusted annually for inflation. The United
States defines ``long-term resident'' as an individual (other
than a U.S. citizen) who is a lawful permanent resident of the
United States in at least 8 of the prior 15 taxable years. An
individual is not treated as a lawful permanent resident for
any taxable year if such individual is treated as a resident of
a foreign country under the provisions of a tax treaty between
the United States and the foreign country and the individual
does not waive the benefits of such treaty applicable to
residents of the foreign country.
ARTICLE II
Article II of the Protocol replaces Article 10 (Dividends)
of the Convention. 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.
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 21 (Other Income)
grants the residence country 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 3. 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 15 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 shares 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 a reduced rate of withholding 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 (a) of paragraph 2 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 24 (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 (Residence)) 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 interpretations are confirmed by paragraph 12 of the
Commentary to Article 10 of the OECD Model.
Companies holding shares through fiscally transparent
entities such as partnerships are considered for purposes of
this paragraph to hold their proportionate interest in the
shares held by the intermediate entity. 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
4(1)(d) (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 provides exclusive residence-country taxation
(i.e., an elimination of withholding tax) with respect to
certain dividends distributed by a company that is a resident
of one Contracting State to a resident of the other Contracting
State. As described further below, this elimination of
withholding tax is available with respect to certain inter-
company dividends, with respect to qualified governmental
entities, and with respect to pension funds.
Subparagraph (a) of paragraph 3 provides for the
elimination of withholding tax on dividends beneficially owned
by a company that has owned 80 percent or more of the voting
power of the company paying the dividend for the 12-month
period ending on the date entitlement to the dividend is
determined. The determination of whether the beneficial owner
of the dividends owns at least 80 percent of the voting power
of the paying company is made by taking into account stock
owned both directly and stock owned indirectly through one or
more residents of either Contracting State.
Eligibility for the elimination of withholding tax provided
by subparagraph (a) is subject to additional restrictions based
on, but supplementing, the rules of Article 22 (Limitation of
Benefits). Accordingly, a company that meets the holding
requirements described above will qualify for the benefits of
paragraph 3 only if it also: (1) meets the ``publicly traded''
test of subparagraph 2(c) of Article 22 (Limitation of
Benefits), (2) meets the ``ownership-base erosion'' and
``active trade or business'' tests described in subparagraph
2(f) and paragraph 4 of Article 22 (Limitation of Benefits),
(3) meets the ``derivative benefits'' test of paragraph 3 of
Article 22 (Limitation of Benefits), or (4) is granted the
benefits of subparagraph 3(a) of Article 10 by the competent
authority of the source State pursuant to paragraph 7 of
Article 22 (Limitation of Benefits).
These restrictions are necessary because of the increased
pressure on the Limitation of Benefits tests resulting from the
fact that the United States has relatively few treaties that
provide for such elimination of withholding tax on inter-
company dividends. The additional restrictions are intended to
prevent companies from re-organizing in order to become
eligible for the elimination of withholding tax in
circumstances where the Limitation of Benefits provision does
not provide sufficient protection against treaty-shopping.
For example, assume that ThirdCo is a company resident in a
third country that does not have a tax treaty with the United
States providing for the elimination of withholding tax on
inter-company dividends. ThirdCo owns directly 100 percent of
the issued and outstanding voting stock of USCo, a U.S.
company, and of DCo, a Danish company. DCo is a substantial
company that manufactures widgets; USCo distributes those
widgets in the United States. If ThirdCo contributes to DCo all
the stock of USCo, dividends paid by USCo to DCo would qualify
for treaty benefits under the active trade or business test of
paragraph 4 of Article 22. However, allowing ThirdCo to qualify
for the elimination of withholding tax, which is not available
to it under the third state's treaty with the United States (if
any), would encourage treaty-shopping.
In order to prevent this type of treaty-shopping, paragraph
3 requires DCo to meet the ownership-base erosion requirements
of subparagraph 2(f) of Article 22 in addition to the active
trade or business test of paragraph 4 of Article 22. Thus, DCo
would not qualify for the exemption from withholding tax unless
(i) on at least half the days of the taxable year, at least 50
percent of each class of its shares was owned by persons that
are residents of Denmark and eligible for treaty benefits under
certain specified tests and (ii) less than 50 percent of DCo's
gross income is paid in deductible payments to persons that are
not residents of either Contracting State eligible for benefits
under those specified tests. Because DCo is wholly owned by a
third country resident, DCo could not qualify for the
elimination of withholding tax on dividends from USCo under the
ownership-base erosion test and the active trade or business
test. Consequently, DCo would need to qualify under another
test or obtain discretionary relief from the competent
authority under Article 22(7). For purposes of Article
10(3)(a)(ii), it is not sufficient for a company to qualify for
treaty benefits generally under the active trade or business
test or the ownership-base erosion test unless it qualifies for
treaty benefits under both.
Alternatively, companies that are publicly traded or
subsidiaries of publicly-traded companies will generally
qualify for the elimination of withholding tax. In the case of
companies resident in Denmark, this includes companies that are
more than 50 percent owned by one or more taxable nonstock
corporations entitled to benefits under Article 22(2)(g). Thus,
a company that is a resident of Denmark and that meets the
requirements of Article 22(2) (i), (ii) or (iii) will be
entitled to the elimination of withholding tax, subject to the
12-month holding period requirement of Article 10(3)(a).
In addition, under Article 10(3)(a)(iii), a company that is
a resident of a Contracting State may also qualify for the
elimination of withholding tax on dividends if it satisfies the
derivative benefits test of paragraph 3 of Article 22. Thus, a
Danish company that owns all of the stock of a U.S. corporation
may qualify for the elimination of withholding tax if it is
wholly-owned, for example, by a U.K., Dutch, Swedish, or
Mexican publicly-traded company and the other requirements of
the derivative benefits test are met. At this time, ownership
by companies that are residents of other European Union,
European Economic Area or North American Free Trade Agreement
countries would not qualify the Danish company for benefits
under this provision, as the United States does not have
treaties that eliminate the withholding tax on inter-company
dividends with any other of those countries. If the United
States were to enter into such treaties with more of those
countries, residents of those countries could then qualify as
equivalent beneficiaries for purposes of this provision.
The derivative benefits test may also provide benefits to
U.S. companies receiving dividends from Danish subsidiaries,
because of the effect of the Parent-Subsidiary Directive in the
European Union. Under that directive, inter-company dividends
paid within the European Union are free of withholding tax.
Under subparagraph (i) of paragraph 8 of Article 22, that
directive will also be taken into account in determining
whether the owner of a U.S. company receiving dividends from a
Danish company is an ``equivalent beneficiary.'' Thus, a
company that is a resident of a member state of the European
Union will, by definition, meet the requirements regarding
equivalent benefits with respect to any dividends received by
its U.S. subsidiary from a Danish company. For example, assume
USCo is a wholly-owned subsidiary of ICo, an Italian publicly-
traded company. USCo owns all of the shares of DCo, a Danish
company. If DCo were to pay dividends directly to ICo, those
dividends would be exempt from withholding tax in Denmark by
reason of the Parent-Subsidiary Directive. If ICo meets the
other conditions of subparagraph 8(h) of Article 22, it will be
treated as an equivalent beneficiary by reason of subparagraph
8(i) of that article.
A company also may qualify for the elimination of
withholding tax pursuant to Article 10(3)(a)(iii) if it is
owned by seven or fewer U.S. or Danish residents who qualify as
an ``equivalent beneficiary'' and meet the other requirements
of the derivative benefits provision. This rule may apply, for
example, to certain Danish corporate joint venture vehicles
that are closely-held by a few Danish resident individuals.
Subparagraph (h) of paragraph 8 of Article 22 contains a
specific rule of application intended to ensure that for
purposes of applying Article 10(3) certain joint ventures, not
just wholly-owned subsidiaries, can qualify for benefits. For
example, assume that the United States were to enter into a
treaty with Country X, a member of the European Union, that
includes a provision identical to Article 10(3). USCo is 100
percent owned by DCo, a Danish company, which in turn is owned
49 percent by PCo, a Danish publicly-traded company, and 51
percent by XCo, a publicly-traded company that is resident in
Country X. In the absence of a special rule for interpreting
the derivative benefits provision, each of the shareholders
would be treated as owning only its proportionate share of the
shares held by DCo. If that rule were applied in this
situation, neither shareholder would be an equivalent
beneficiary, because neither would meet the 80 percent
ownership test with respect to USCo. However, since both PCo
and XCo are residents of countries that have treaties with the
United States that provide for elimination of withholding tax
on inter-company dividends, it is appropriate to provide
benefits to DCo in this case.
Consequently, when determining whether a person is an
equivalent beneficiary under paragraph 8 of Article 22, each of
the shareholders is treated as owning shares with the same
percentage of voting power as the shares held by DCo for
purposes of determining whether it would be entitled to an
equivalent rate of withholding tax. This rule is necessary
because of the high ownership threshold for qualification for
the elimination of withholding tax on inter-company dividends.
If a company does not qualify for the elimination of
withholding tax under any of the foregoing objective tests, it
may request a determination from the relevant competent
authority pursuant to paragraph 7 of Article 22. Benefits will
be granted with respect to an item of income if the competent
authority of the Contracting State in which the income arises
determines that the establishment, acquisition or maintenance
of such resident and the conduct of its operations did not have
as one of its principal purposes the obtaining of benefits
under the Convention. The Notes provide that the U.S. competent
authority generally will exercise its discretion to grant
benefits under this paragraph to a company that is a resident
of Denmark if (1) the company meets the requirements of
paragraph 4 of Article 22 (Limitation of Benefits) regarding
the active conduct of a trade or business in Denmark, (2) the
company meets the base erosion test of clause (f)(ii) of
paragraph 2 of Article 22, and (3) more than 80 percent of the
voting power and the value of the shares in the company is
owned by one or more taxable nonstock corporations that meet
the requirements of subparagraph (g) of paragraph 2 of Article
22. However, the competent authority may choose not to grant
benefits under this paragraph if it determines that a
significant percentage or amount of the income qualifying for
benefits under this paragraph will inure to the benefit of a
private person who is not a resident of Denmark.
Subparagraph (b) of paragraph 3 of Article 10 of the
Convention provides for exemption from tax in the state of
source for dividends paid to qualified governmental entities.
This exemption is analogous to that provided to foreign
governments under section 892 of the Code. Subparagraph (b) of
paragraph 3 makes that exemption reciprocal. A qualified
governmental entity is defined in paragraph 1(i) of Article 3
(General Definitions) of the Convention. The definition does
not include a governmental entity that carries on commercial
activity. Further, a dividend paid by a company engaged in
commercial activity that is controlled (within the meaning of
Treas. Reg. section 1.892-5T) by a qualified governmental
entity that is the beneficial owner of the dividend is not
exempt at source under paragraph 4 because ownership of a
controlled company is viewed as a substitute for carrying on a
business activity.
Subparagraph (c) of paragraph 3 of Article 10 of the
Convention provides that dividends beneficially owned by a
pension fund described in subparagraph (e) of paragraph 2 of
Article 22 (Limitation of Benefits) may not be taxed in the
Contracting State of which the company paying the dividends is
a resident, unless such dividends are derived from the carrying
on of a business, directly by the pension fund or indirectly,
through an associated enterprise.
This rule is necessary 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 4
Article 10 generally applies to distributions made by a RIC
or a REIT. However, distributions made by a REIT or certain
RICs that are attributable to gains derived from the alienation
of U.S. real property interests and treated as gain recognized
under section 897(h)(1) are taxable under paragraph 1 of
Article 13 instead of Article 10. In the case of RIC or REIT
distributions to which Article 10 applies, paragraph 4 imposes
limitations on the rate reductions provided by paragraphs 2 and
3 in the case of dividends paid by a RIC or a REIT.
The first sentence of subparagraph 4(a) provides that
dividends paid by a RIC or REIT are not eligible for the 5
percent rate of withholding tax of subparagraph 2(a) or the
elimination of source-country withholding tax of subparagraph
3(a).
The second sentence of subparagraph 4(a) provides that the
15 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 subparagraphs 3 (b) and (c)
applies to dividends paid by RICs and beneficially owned by a
qualified governmental entity or a pension fund.
The third sentence of subparagraph 4(a) provides that the
15 percent rate of withholding tax also applies to dividends
paid by a REIT and that the elimination of source-country
withholding tax of subparagraphs 3 (b) and (c) applies to
dividends paid by REITs and beneficially owned by a qualified
governmental entity or 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.''
Subparagraph (b) provides a definition of the term
``diversified,'' which is necessary because the term is not
defined in the Code. 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.
The restrictions set out above are intended to prevent the
use of these entities to gain inappropriate U.S. tax benefits.
For example, a company resident in Denmark 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 15
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 4, such use of the RIC could
transform portfolio dividends, taxable in the United States
under the Convention at a 15 percent maximum rate of
withholding tax, into direct investment dividends taxable at a
5 percent maximum rate of withholding tax or eligible for the
elimination of source-country withholding tax.
Similarly, a resident of Denmark directly holding U.S. real
property would pay U.S. tax on rental income 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 rental income 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 4 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 4 allows a dividend
from a REIT to be eligible for the 15 percent rate of
withholding tax, the holding in the REIT is not considered the
equivalent of a direct holding in the underlying real property.
The final sentence of paragraph 4(a) provides that the
rules of paragraph 4 apply also to dividends paid by companies
resident in Denmark that are similar to U.S. RICs and REITs.
Whether a Danish company is similar to a U.S. RIC or REIT will
be determined by mutual agreement of the competent authorities.
The Notes provide that for purposes of paragraph 4, a Danish
undertaking for collective investment in transferable
securities that is required to currently distribute its income
will be treated as a company similar to a U.S. RIC, while such
an undertaking that is permitted to accumulate its income will
not be so treated.
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, including
types of 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
dividends 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 subsidiary's and
sister'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, 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 that the general source country
limitations under paragraph 2 and 3 on dividends do not apply
if the beneficial owner of the dividends carries on business
through a permanent establishment situated in the source
country, or performs in the source country independent personal
services from a fixed base situated therein, and the dividends
are attributable to such permanent establishment or fixed base.
In such case, the rules of Article 7 (Business Profits) or
Article 14 (Independent Personal Services) shall apply, as the
case may be. Accordingly, such dividends will be taxed on a net
basis using the rates and rules of taxation generally
applicable to residents of the Contracting State in which the
permanent establishment or fixed base is located, as such rules
may be modified by the Convention. An example of dividends
attributable to 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 or fixed base 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. In the case of the United States, the
secondary withholding tax was eliminated for payments made
after December 31, 2004 in the American Jobs Creation Act of
2004.
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.
Paragraphs 8 and 9
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(b) 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 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 Articles 6
(Income from Real Property), 7 (Business Profits) or 13
(Capital Gains), 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. Denmark currently does not impose a branch
profits tax. If in the future Denmark were to impose a branch
profits tax, paragraph 8 provides that the base of its tax must
be limited to an amount that is analogous to the dividend
equivalent amount.
Paragraph 9 limits the rate of the branch profits tax
allowed under paragraph 8 to 5 percent. Paragraph 9 also
provides, however, that the branch profits tax will not be
imposed if certain requirements are met. In general, these
requirements provide rules for a branch that parallel the rules
for when a dividend paid by a subsidiary will be subject to
exclusive residence-country taxation (i.e., the elimination of
source-country withholding tax). Accordingly, the branch
profits tax may not be imposed in the case of a company that:
(1) meets the ``publicly traded'' test of subparagraph 2(c) of
Article 22 (Limitation of Benefits), (2) meets the ``ownership-
base erosion'' and ``active trade or business'' tests described
subparagraph 2(f) and subparagraph 4 of Article 22, (3) meets
the ``derivative benefits'' test of paragraph 3 of Article 22,
or (4) is granted benefits with respect to the elimination of
the branch profits tax by the competent authority pursuant to
paragraph 7 of Article 22.
Thus, for example, if a Danish company would be subject to
the branch profits tax with respect to profits attributable to
a U.S. branch and not reinvested in that branch, paragraph 9
may apply to eliminate the branch profits tax if the company
either met the ``publicly traded'' test, met the combined
``ownership-base erosion'' and ``active trade or business''
test, or met the derivative benefits test. If, by contrast, a
Danish company did not meet those tests, but met the ownership-
base erosion test (and thus qualified for treaty benefits under
subparagraph 2(a)), then the branch profits tax would apply at
a rate of 5 percent, unless the Danish company is granted
benefits with respect to the elimination of the branch profits
tax by the competent authority pursuant to paragraph 7 of
Article 22.
Relation to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of dividends, the saving clause of paragraph 4 of
Article 1 (General Scope) permits the United States to tax
dividends received by its residents and citizens, subject to
the special foreign tax credit rules of paragraph 2 of Article
23 (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 22 (Limitation of Benefits). Thus, if a
resident of Denmark 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 22 in order
to receive the benefits of this Article.
ARTICLE III
Article III of the Protocol amends subparagraph (b) of
paragraph 2 of Article 19 (Government Service) of the
Convention to correct a drafting error. Paragraph 2(a) provides
a general rule that a pension paid from public funds of a
Contracting State or a political subdivision or local authority
thereof to an individual in respect of services rendered to
that State or subdivision or authority in the discharge of
governmental functions is taxable only in that State. Paragraph
2(b) provides an exception under which the pension is taxable
only in the other State if the individual is a resident of and
a national of that other State. Before this amendment,
paragraph 2(b) incorrectly referred to pensions paid to ``a
resident or a national'' rather than pensions paid to ``a
resident and a national.''
ARTICLE IV
Article IV of the Protocol replaces Article 22 (Limitation
of Benefits) of the Convention. Article 22 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 for limited derivative benefits for
shipping and air transport income. Paragraph 6 provides special
rules for so-called ``triangular cases'' notwithstanding
paragraphs 1 through 5 of Article 22. Paragraph 7 provides that
benefits may also be granted if the competent authority of the
State from which the benefits are claimed determines that it is
appropriate to grant benefits in that case. Paragraph 8 defines
certain terms used in the Article.
Paragraph 1
Paragraph 1 provides that a resident of a Contracting State
will be entitled to benefits of the Convention otherwise
accorded to residents of a Contracting State only to the extent
provided in this Article. The benefits otherwise accorded to
residents under the Convention include all limitations on
source-based taxation under Articles 6 through 21, the treaty-
based relief from double taxation provided by Article 23
(Relief From Double Taxation), and the protection afforded to
residents of a Contracting State under Article 24 (Non-
Discrimination). Some provisions do not require that a person
be a resident in order to enjoy the benefits of those
provisions. For example, Article 25 (Mutual Agreement
Procedure) is not limited to residents of the Contracting
States, and Article 27 (Diplomatic Agents and Consular
Officers) applies to diplomatic agents or consular officials
regardless of residence. Article 22 accordingly does not limit
the availability of treaty benefits under such provisions.
Article 22 and the anti-abuse provisions of domestic law
complement each other, as Article 22 effectively determines
whether an entity has a sufficient nexus to a 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 22 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 seven 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 the provisions of paragraph 7, 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 applicable 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, or an agency or instrumentality of
that State, subdivision, or authority will be entitled to all
the 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 a recognized stock exchange located in the
Contracting State of which the company is a resident, or, in
the case of a company resident in Denmark, on a recognized
stock exchange located within the European Union, any other
European Economic Area country, or, in the case of a company
resident in the United States, on a recognized stock exchange
located in another state that is a party to the North American
Free Trade Agreement; 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 (d) of paragraph 8. It includes the NASDAQ System,
any stock exchange registered with the Securities and Exchange
Commission as a national securities exchange for purposes of
the Securities Exchange Act of 1934, and the Copenhagen Stock
Exchange. The term also includes the stock exchanges of
Amsterdam, Brussels, Frankfurt, Hamburg, Helsinki, London,
Oslo, Paris, Stockholm, Sydney, Tokyo, and Toronto, and 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 (a) of paragraph 8 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. Subparagraph (c) of paragraph 8
defines the term ``shares'' to include depository receipts for
shares. 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 percent 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 (c) of paragraph 2 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
(b) of paragraph 8. 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 Denmark meets the test of
subparagraph (b) of paragraph 8 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.--DCo is a corporation resident in Denmark. DCo has
two classes of shares: Common and Preferred. The Common shares
are listed and regularly traded on the Stockholm Stock
Exchange. The Preferred shares have no voting rights and are
entitled to receive dividends equal in amount to interest
payments that DCo 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 DCo 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 DCo, the Preferred
shares are a disproportionate class of shares. Because the
Preferred shares are not regularly traded on a recognized stock
exchange, DCo will not qualify for benefits under subparagraph
(c) of paragraph 2.
A class of shares will be ``regularly traded'' on one or
more recognized stock exchanges in a taxable year, under
subparagraph (f)(i) of paragraph 8, if two requirements are
met: (1) trades in the class of shares are effected on one or
more such exchanges in other than de minimis quantities during
every quarter, and (2) the aggregate number of shares of that
class traded on one or more such 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 (including shares held by taxable
nonstock corporations) during that twelve-month period. For
this purpose, if a class of shares was not listed on a
recognized stock exchange during this twelve-month period, the
class of shares will be treated as regularly traded only if the
class meets the aggregate trading requirements for the taxable
period in which the income arises. Trading on one or more
recognized stock exchanges may be aggregated for purposes of
meeting the ``regularly traded'' standard of subparagraph (f).
For example, a U.S. company could satisfy the definition of
``regularly traded'' through trading, in whole or in part, on a
recognized stock exchange located in Denmark or certain third
countries. Authorized but unissued shares are not considered
for purposes of subparagraph (f).
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 staffs 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 Danish Taxable Nonstock Corporations--
Subparagraph 2(c)(ii).--Clause (ii) of subparagraph 2(c)
provides a test under which certain companies that are
controlled by one or more taxable nonstock corporations
(``TNCs'') entitled to benefits under subparagraph (g) may meet
the publicly-traded test. This test is necessary because it is
common for a TNC to hold 100% of the ``Class A'' shares of
another company. The Class A shares have a disproportionate
amount of the voting power but have little or no rights to
dividends. The subsidiary company also issues ``Class B''
shares, which have preferential treatment as to dividends.
Class A shares held by TNCs are listed but not traded on the
Copenhagen stock exchange. Any class A shares that are not held
by TNCs and all Class B shares are both listed and traded on
the Copenhagen stock exchange. This rule is included to ensure
that a corporation whose voting shares are substantially owned
by a Danish TNC is not precluded from qualifying as a publicly-
traded company, so long as the rest of its shares satisfy a
public trading test.
A company will qualify under this test if one or more such
TNCs own shares representing more than 50 percent of the voting
power of the company and all other shares are listed on a
recognized stock exchange and are primarily traded on a
recognized stock exchange located within the European Union or
in any other European Economic Area state. Thus, all shares not
owned by TNCs, taken as a single class, must be traded more on
a recognized stock exchange located in a state within the
European Union or in any other European Economic Area state
than on established securities markets in any other single
foreign state.
Subsidiaries of Publicly-Traded Corporations--Subparagraph
2(c)(iii).--A company resident in a Contracting State is
entitled to all the benefits of the Convention under clause
(iii) of subparagraph (c) of paragraph 2 if five or fewer
companies entitled to benefits under clause (i) or (ii) (or any
combination thereof) 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 companies are
indirect owners, however, each of the intermediate companies
must be a resident of one of the Contracting States.
Thus, for example, a Danish company, all the shares of
which are owned by another Danish company, would qualify for
benefits under the Convention if the principal class of shares
(and any disproportionate classes of shares) of the Danish
parent company are regularly and primarily traded on the London
stock exchange. However, a Danish subsidiary would not qualify
for benefits under clause (iii) if the publicly traded parent
company were a resident of Ireland, for example, and not a
resident of the United States or Denmark. Furthermore, if a
Danish parent company indirectly owned a Danish 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 Denmark for the Danish subsidiary to meet the test in clause
(iii).
Tax-Exempt Organizations--Subparagraph 2(d).--Subparagraphs
2(d) and 2(e) provide rules by which tax-exempt organizations
described in Article 4(1)(b)(i) and pension funds will be
entitled to all of the benefits of the Convention. 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
subparagraph are those that are generally exempt from tax in
their Contracting State of residence and that are established
and maintained exclusively to fulfill religious, charitable,
educational, scientific, or other similar purposes.
Pensions--Subparagraph 2(e).--A legal person, whether tax-
exempt or not, that is organized under the laws of either
Contracting State to provide pension or similar benefits to
employees (including self-employed individuals) pursuant to a
plan will qualify for benefits if, as of the close of the end
of the prior taxable year, more than 50 percent of the
pension's beneficiaries, members or participants 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
pension fund.
Ownership/Base Erosion--Subparagraph 2(f).--Subparagraph
2(f) 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 (f), 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(f).
The ownership prong of the test, under clause (i), requires
that 50 percent or more of each class 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 (a), (b), (d),
(e), or clause (i) of subparagraph (c) of paragraph 2. In the
case of indirect owners, however, 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 (Residence) 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 the other subparagraphs of
paragraph 2.
The base erosion prong of clause (ii) of subparagraph (f)
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), (d), (e), or
clause (i) of subparagraph (c) of paragraph 2, in the form of
payments deductible for tax purposes in the payer's State of
residence. These amounts do not include arm's-length payments
in the ordinary course of business for services or tangible
property or payments in respect of financial obligations to a
bank that is not related to the payor. 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.
Danish Taxable Nonstock Corporations--Subparagraph 2(g).--
Paragraph 2(g) provides a special rule for a Danish Taxable
Nonstock Corporation (``TNC''), which is a vehicle to preserve
control of operating companies by the TNC through its control
of voting shares, with public shareholders receiving most
rights to dividends of the operating company. A TNC may qualify
for the benefits of the Convention if it meets specific
requirements under a two-part test.
Under subparagraph 8(e), the term ``taxable nonstock
corporation'' as used in paragraph 2 means a foundation that is
taxable in accordance with paragraph 1 of Article 1 of the
Danish Act on Taxable Nonstock Corporations (fonde der
beskattes efter fondsbeskatningsloven). A TNC is a legal person
that is controlled by a professional board of directors, the
majority of which must be unrelated to the persons that founded
the TNC. As a foundation, a TNC must have a charter governing
the corporation's operations and identifying any TNC
beneficiaries and their entitlement to distributions from the
TNC. One TNC cannot own another. A TNC's capital is irrevocably
separated from the control of any person (``founder'')
contributing assets to the TNC at the time the TNC is
established. A TNC's assets can never be inherited nor can such
assets be paid out in liquidation except to creditors. TNCs are
subject to income tax at the same rate (32%) and in exactly the
same way as Danish corporations, except that a TNC can deduct
charitable contributions, whereas a regular Danish corporation
cannot deduct them, and a TNC, like any other foundation, can
deduct distributions to members of the founder's family
provided that these family members are resident in Denmark and
are taxable in Denmark at the full rate, which is from 45% to
59%. Distributions to other persons, e.g., Danish nonresidents,
are not deductible.
The two-part test in subparagraph (g) is a modification of
the ownership-base erosion test that is necessary because TNCs
do not have owners and thus cannot be subject to any ownership
test. This test was included for TNCs in order to treat them as
similarly as possible to other Danish corporations.
The first part of the test under subparagraph (g)(i) is
satisfied if no more than 50 percent of the amount of the TNC's
gross income (excluding its tax-exempt income) is paid or
accrued in the form of deductible payments (but not including
arms-length payments in the ordinary course of its activities
of a charitable nature and authorized by the Danish laws on
taxable non-stock companies for services or tangible property)
in the taxable year and in each of the preceding three taxable
years, directly or indirectly, to persons who are not entitled
to benefits under subparagraphs (a), (b), (d), (e), or clause
(i) of subparagraph (c). This means that no more than 50
percent of the amount of the TNC's gross income (excluding its
tax-exempt income) can be paid to persons other than residents
of either Contracting State that qualify for treaty benefits as
an individual (subparagraph (a)), a Contracting State, etc.
(subparagraph (b)), a company that is publicly traded
(subparagraph (c)(i)), a charitable organization, etc.
(subparagraph (d)), or a pension plan (subparagraph e).
The second part of the test under subparagraph (g)(ii) is
satisfied if no more than 50% of the amount of the total income
of the TNC (including its tax-exempt income) is paid or
accrued, in the form of deductible payments (but not including
arm's length payments in the ordinary course of its activities
of a charitable nature and authorized by the Danish laws on
taxable non-stock companies for services or tangible
properties) and non-deductible distributions, in the taxable
year and in each of the preceding three taxable years, directly
or indirectly, to persons who are not entitled to benefits
under subparagraphs (a), (b), (d), (e), or clause (i) of
subparagraph (c).
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 (h) of paragraph 8. 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, a European Economic
Area state, a party to the North American Free Trade Agreement,
or Switzerland (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
of this Article regarding individuals, governmental entities,
publicly-traded companies, tax-exempt organizations, and
pensions. 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 paragraph 2 of this Article applicable to
individuals, governmental entities, publicly-traded companies,
tax-exempt organizations, and pensions if the person were a
resident of one of the Contracting States.
In order to satisfy the second requirement to qualify as an
``equivalent beneficiary'' under paragraph 8(h)(i)(B) with
respect to dividends, interest, royalties, or branch tax, the
person must also be entitled to a rate of withholding or branch
tax that is at least as low as the withholding or branch 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. For example, USCo is a wholly
owned subsidiary of DCo, a company resident in Denmark. DCo is
wholly owned by ICo, a corporation resident in Italy. Assuming
DCo satisfies the requirements of paragraph 3 of Article 10
(Dividends), DCo would be eligible for the elimination of
dividend withholding tax. The dividend withholding tax rate in
the treaty between the United States and Italy is 5 percent.
Thus, if ICo received the dividend directly from USCo, ICo
would have been subject to a 5 percent rate of withholding tax
on the dividend. Because ICo would not be entitled to a rate of
withholding tax that is at least as low as the rate that would
apply under the Convention to such income (i.e., zero), ICo is
not an equivalent beneficiary within the meaning of paragraph
8(h)(i) of Article 22 with respect to the elimination of
withholding tax on dividends.
Subparagraph 8(i) 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
Danish 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 Danish 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 Danish 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 Danish residents who are
eligible for treaty benefits by reason of subparagraphs (a),
(b), (c)(i), (d), or (e) of paragraph 2 are equivalent
beneficiaries under the second alternative. Thus, a Danish
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 any of
those subparagraphs 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 Danish company under this
paragraph. Thus, for example, if 90 percent of a Danish company
is owned by five companies that are resident in member states
of the European Union who satisfy the requirements of clause
(i), and 10 percent of the Danish company is owned by a U.S. or
Danish individual, then the Danish company still can satisfy
the requirements of subparagraph (a) of paragraph 3.
Subparagraph (b) of paragraph 3 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 and payments in
respect of financial obligations to a bank that is not related
to the payor. This test is the same as the base erosion test in
clause (ii) of subparagraph (f) of paragraph 2, except that the
test in subparagraph 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 paragraphs 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 from
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 Denmark 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 DCo,
a company resident in Denmark. DCo distributes USCo products in
Denmark. Because the business activities conducted by the two
corporations involve the same products, DCo'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 DCo. DCo and other USCo affiliates then manufacture
and market the USCo-designed products in their respective
markets. Because the activities conducted by DCo 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. DSub is a
wholly-owned subsidiary of Americair resident in Denmark. DSub
operates a chain of hotels in Denmark that are located near
airports served by Americair flights. Americair frequently
sells tour packages that include air travel to Denmark and
lodging at DSub 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 DSub's business does
not form a part of Americair's business. However, DSub'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 DSub owns an office building in Denmark instead of a hotel
chain. No part of Americair's business is conducted through the
office building. DSub'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 company resident in the United
States. USFlower produces and sells flowers in the United
States and other countries. USFlower owns all the shares of
DHolding, a corporation resident in Denmark. DHolding is a
holding company that is not engaged in a trade or business.
DHolding owns all the shares of three corporations that are
resident in Denmark: DFlower, DLawn, and DFish. DFlower
distributes USFlower flowers under the USFlower trademark in
Denmark. DLawn markets a line of lawn care products in Denmark
under the USFlower trademark. In addition to being sold under
the same trademark, DLawn and DFlower products are sold in the
same stores and sales of each company's products tend to
generate increased sales of the other's products. DFish imports
fish from the United States and distributes it to fish
wholesalers in Denmark. For purposes of paragraph 4, the
business of DFlower forms a part of the business of USFlower,
the business of DLawn is complementary to the business of
USFlower, and the business of DFish 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 (b) of paragraph 4 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. In any case,
in making each determination or comparison, due regard will be
given to the relative sizes of the U.S. and Danish economies.
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, Danish pharmaceutical
manufacturer, the size of the U.S. research firm would not have
to be tested against the size of the Danish manufacturer.
Similarly, a small U.S. bank that makes a loan to a very large
unrelated Danish business would not have to pass a
substantiality test to receive treaty benefits under Paragraph
4.
Subparagraph (c) of paragraph 4 provides special
attribution rules for purposes of applying the substantive
rules of subparagraphs (a) and (b). Thus, 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
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 provides that a resident of one of the States
that derives income from the other State described in Article 8
(Shipping and Air Transport) and that is not entitled to the
benefits of the Convention under paragraphs 1 through 4, shall
nonetheless be entitled to the benefits of the Convention with
respect to income described in Article 8 if it meets one of two
tests. These tests in substance duplicate the rules set forth
under Code section 883 and therefore afford little additional
benefit beyond those provided by the Code. These tests are
described below.
First, a resident of one of the States that derives income
from the other State will be entitled to the benefits of the
Convention with respect to income described in Article 8 if at
least 50 percent of the beneficial interest in the person (in
the case of a company, at least 50 percent of the aggregate
vote and value of the stock of the company) is owned, directly
or indirectly, by persons entitled to benefits under
subparagraphs (a), (b), (c)(i), (d), or (e), paragraph 2,
citizens of the United States or individuals who are residents
of a third state that grants by law, common agreement, or
convention an exemption under similar terms for profits as
mentioned in Article 8 to citizens and corporations of the
other State. This provision is analogous to the relief provided
under Code section 883(c)(1).
Alternatively, a resident of one of the States that derives
income from the other State will be entitled to the benefits of
the Convention with respect to income described in Article 8 if
at least 50 percent of the beneficial interest in the person
(in the case of a company, at least 50 percent of the aggregate
vote and value of the stock of the company) is owned directly
or indirectly by a company or combination of companies the
stock of which is primarily and regularly traded on an
established securities market in a third state, provided that
the third state grants by law, common agreement or convention
an exemption under similar terms for profits as mentioned in
Article 8 to citizens and corporations of the other State. This
provision is analogous to the relief provided under Code
section 883(c)(3).
The provisions of paragraph 5 are intended to be self
executing. Unlike the provisions of paragraph 7, discussed
below, claiming benefits under paragraph 5 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.
Paragraph 6
Paragraph 6 deals with the treatment of royalties and
interest in the context of a so-called ``triangular case.''
The term ``triangular case'' refers to the use of the
following structure by a resident of Denmark to earn, in this
case, interest income from the United States. The resident of
Denmark, who is assumed to qualify for benefits under one or
more of the provisions of Article 22 (Limitation of 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 Danish 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 Danish resident. Therefore the income that
it earns on those loans, absent the provisions of paragraph 6,
is entitled to exemption from U.S. withholding tax under the
Convention. Under a current Danish income tax treaty with the
host jurisdiction of the permanent establishment, the income of
the permanent establishment is exempt from Danish tax. Thus,
the interest income is exempt from U.S. tax, is subject to
little tax in the host jurisdiction of the permanent
establishment, and is exempt from Danish 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 Danish resident.
Paragraph 6 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 Denmark if the
income were earned in Denmark 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 6 will not
apply under certain circumstances. In the case of interest (as
defined in Article 11 (Interest)), paragraph 6 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,
paragraph 6 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 7
Paragraph 7 provides that a resident of one of the States
that is not entitled to the benefits of the Convention as a
result of paragraphs 1 through 6 still may be granted benefits
under the Convention at the discretion of the competent
authority of the State from which benefits are claimed. In
making determinations under paragraph 7, that competent
authority will take into account as its guideline 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 the Convention
or the 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 Convention. 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 7.
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 7, 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.
A competent authority is required by paragraph 7 to consult
the other competent authority before denying benefits under
this paragraph.
Paragraph 8
Paragraph 8 defines several key terms for purposes of
Article 22. Each of the defined terms is discussed in the
context in which it is used.
ARTICLE V
Article V of the Protocol contains the rules for bringing
the Protocol into force and giving effect to its provisions.
Paragraph 1 provides that each State must notify the other
as soon as its requirements for ratification have been complied
with. The Protocol will enter into force upon the date of
receipt of the later of such notifications.
In the United States, the process leading to ratification
and entry into force is as follows: Once a protocol or treaty
has been signed by authorized representatives of the two
Contracting States, the Department of State sends the protocol
or 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 of the Senate Committee on Foreign Relations to hold
hearings on the protocol or 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
protocol or treaty, an instrument of ratification is drafted
for the President's signature. The President's signature
completes the process in the United States.
The date on which a treaty 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 treaty will have effect.
Under subparagraphs (a), the provisions of the Protocol
relating to taxes withheld at source will have effect with
respect to income derived on or after the first day of the
second month next following the date on which the Protocol
enters into force. For example, if instruments of ratification
are exchanged on April 25 of a given year, the withholding
rates specified in paragraphs 2 and 3 of Article 10 (Dividends)
would be applicable to any dividends paid or credited on or
after June 1 of that year. Similarly, the revised Limitation of
Benefits provisions of Article 5 of the Protocol would apply
with respect to any payments of interest, royalties or other
amounts on which withholding would apply under the Code if
those amounts are paid or credited on or after June 1.
This rule allows the benefits of the withholding reductions
to be put into effect as soon as possible, without waiting
until the following year. The delay of one to two months is
required to allow sufficient time for withholding agents to be
informed about the change in withholding rates. If for some
reason a withholding agent withholds at a higher rate than that
provided by the Convention (perhaps because it was not able to
re-program its computers before the payment is made), a
beneficial owner of the income that is a resident of Denmark
may make a claim for refund pursuant to section 1464 of the
Code.
For all other taxes, subparagraph (b) specifies that the
Protocol will have effect for any taxable period beginning on
or after January 1 of the year next following entry into force.