[Senate Executive Report 111-3]
[From the U.S. Government Publishing Office]
111th Congress Exec. Rept.
SENATE
2d Session 111-3
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TAX CONVENTION WITH MALTA
_______
June 30, 2010.--Ordered to be printed
_______
Mr. Kerry, from the Committee on Foreign Relations,
submitted the following
REPORT
[To accompany Treaty Doc. 111-1]
The Committee on Foreign Relations, to which was referred
the Convention between the Government of the United States of
America and the Government of Malta with respect to Taxes on
Income, signed on August 8, 2008, at Valletta (the
``Convention'') (Treaty Doc. 111-1), having considered the
same, reports favorably thereon with one declaration, as
indicated in the resolution of advice and consent, and
recommends that the Senate give its advice and consent to
ratification thereof, as set forth in this report and the
accompanying resolution of advice and consent.
CONTENTS
Page
I. Purpose..........................................................1
II. Background.......................................................2
III. Major Provisions.................................................2
IV. Entry Into Force.................................................4
V. Implementing Legislation.........................................4
VI. Committee Action.................................................4
VII. Committee Recommendation and Comments............................5
VIII.Text of Resolution of Advice and Consent to Ratification.........6
IX. Annex I--Technical Explanation...................................7
X. Annex II--Transcript of Hearing Held November 10, 2009..........97
I. Purpose
The purpose of the new Malta Convention is to promote and
facilitate trade and investment between the United States and
Malta. Principally, the Convention provides for reduced
withholding rates on cross-border payments of dividends,
interest, royalties, and other income, as well as the
elimination of withholding taxes on cross-border dividend
payments to pension funds. The Convention contains rigorous
protections designed to protect against ``treaty shopping,''
which is the inappropriate use of a tax treaty by third-country
residents, and provisions to ensure the exchange of information
between tax authorities in both countries. While the proposed
Convention generally follows the 2006 U.S. Model Income Tax
Treaty (the ``U.S. Model''), it deviates from the U.S. Model in
certain respects, including by providing enhanced protections
against treaty shopping.
II. Background
There is no income tax treaty currently in force between
the United States and Malta. The previous U.S.-Malta tax treaty
(signed on March 21, 1980) was terminated by the United States
on January 1, 1997, due to concerns that changes to Maltese tax
law provided an incentive for ``treaty shopping'' and that
Malta was unable to satisfactorily exchange tax information.
After Malta changed its tax law in an effort to address these
concerns, the United States negotiated and concluded the
Convention. While the changes to Malta's tax law were critical
to the Treasury Department's willingness to re-engage Malta in
a double taxation treaty, it was nonetheless deemed necessary
to include protections against ``treaty shopping'' that go
beyond those in the U.S. model. The Convention was signed on
August 8, 2008.
III. Major Provisions
A detailed article-by-article analysis of the Convention
may be found in the Technical Explanation Published by the
Department of the Treasury on November 10, 2009. In addition,
the staff of the Joint Committee on Taxation prepared an
analysis of the Convention, JCX-50-09 (November 6, 2009), which
was of great assistance to the committee in reviewing the
Convention. A summary of the key provisions of the Convention
is set forth below.
General Scope
Article 1 provides that the scope of the Convention would
generally apply only to ``residents'' of the United States and
Malta. It contains a standard ``saving clause'' pursuant to
which each country retains the right to tax its residents and
citizens as if the Treaty had not come into effect. This
article also contains a standard provision providing in general
that the Convention may not be applied to deny a taxpayer any
benefits to which the taxpayer would be entitled under the
domestic law of a country or under any other agreement between
the two countries.
Covered taxes
Pursuant to Article 2, the Convention would apply to all
taxes on income, including gains-irrespective of the manner in
which they are levied. Except with respect to the benefits
provided by Article 24 (Non-Discrimination), state and local
taxes, including property taxes, do not fall within the scope
of the proposed treaty.
Dividends
Articles 10 and 13 provide that dividends and certain gains
derived by a resident of either country from sources within the
other country (residence-country taxation) may be taxed by both
countries. However, the proposed treaty limits the rate of
taxation that the source country may impose on certain
dividends paid to a resident of the other country. The
withholding tax rates on dividends are generally consistent
with those contained in the U.S. Model Treaty, but they
represent a departure from the exemption from source-country
withholding tax provided by several recent U.S. treaties and
protocols thereto for dividends paid by subsidiaries to parent
corporations resident in the other treaty countries.
Interest and Royalties
Article 11 limits the rate of source-country tax that may
be imposed on interest arising in one treaty country (the
source country) and beneficially owned by a resident of the
other country so that it may not exceed 10 percent of the gross
amount of the interest. See Article 11(2). Similarly, Article
12 provides that a royalty payment arising in a treaty country
and beneficially owned by a resident of the other treaty
country may be subject to a source country tax of up to 10
percent of the gross amount of the royalty. See Article 12(2).
These provisions differ from the corresponding rules of the
U.S. Model Treaty, which provides an exemption from source-
country taxation for most interest and royalty payments
beneficially owned by a resident of the other country. Although
the U.S. Model Treaty eliminates source-country withholding tax
on most payments of interest, royalties or other income,
exemption from withholding tax was deemed not appropriate in
this case, in light of Malta's unique tax system. The
Convention therefore provides for withholding at a rate of 10
percent on interest, royalties, and other income.
Pensions and Similar Remuneration
Under Articles 17 and 18, pensions and similar remuneration
paid to a resident of one country may be taxed only by that
country and only at the time and to the extent that a pension
distribution is made. These articles are exceptions to the rule
permitting the residence country to tax cross-border pensions.
Under these provisions, the residence country may not tax any
amount of such a pension or similar remuneration that would be
exempt from taxation in the other country if the beneficial
owner was a resident of that other country. The other
remuneration covered by these articles includes social security
benefits, annuities, alimony, child support (Article 17) and
pension funds (Article 18). As noted previously, the Convention
would generally eliminate withholding tax on cross-border
dividend payments to pension funds. The Convention's treatment
of pensions differs from the U.S. Model Treaty in some
respects. Like the U.S. Model Treaty, the Convention provides
that pension distributions (or similar remuneration) owned by a
resident of a contracting country are only taxable in the
recipient's country of residence. See Article 17. In addition,
a pension beneficiary's country of residence must exempt from
taxation a pension amount that would be exempt from tax in the
other country where the pension fund is established. However,
the Convention differs from the U.S. Model Treaty in that it
does not contain certain provisions that deal with the tax
treatment of cross-border pension contributions. These
provisions typically cover, among other things, the tax
treatment of pension contributions (paid by an individual or an
individual's employer) when an individual is a participant or
beneficiary of a pension fund resident in one country, but
employed in another country.
Limitation on Benefits
Consistent with current U.S. treaty policy, Article 22
includes a ``Limitation on Benefits'' provision, which is
designed to avoid treaty-shopping by limiting the indirect use
of a treaty's benefits by persons who were not intended to take
advantage of those benefits. The limitation on benefits
provision states that in situations in which the country of
source retains the right under the Convention to tax income
derived by residents of the other country, the Convention
provides for relief from the potential double taxation through
allowance by the country of residence of a tax credit for
certain foreign taxes paid to the other country. This article's
limitation on benefits provision generally reflects the anti-
treaty-shopping provisions included in the U.S. Model Treaty
and more recent U.S. income tax treaties, but it is more
stringent in a number of respects to ensure that third-country
residents do not inappropriately benefit from the Convention.
Exchange of Information
The Convention provides that the United States and Malta
shall exchange certain tax information. Under Article 26, the
United States is allowed to obtain such information from Malta
regardless of whether Malta needs the information for its own
tax purposes. Changes to Maltese tax law since the previous
treaty was terminated, including at the request of the United
States during the negotiating process, will facilitate the
exchange of tax information and made it possible for Malta to
agree to comprehensive information exchange obligations in the
Convention. The exchange of information provision set out in
Article 26 is substantially similar to the provision found in
the U.S. Model Treaty.
IV. Entry into Force
The Convention will enter into force on the date of the
exchange of instruments of ratification, yet certain provisions
will not have effect immediately. See Article 28.
V. Implementing Legislation
As is the case generally with income tax treaties, the
Convention is self-executing and does not require implementing
legislation for the United States.
VI. Committee Action
The committee held a public hearing on the Convention on
November 10, 2009. Testimony was received from Manal Corwin,
International Tax Counsel, U.S. Department of Treasury, and
Thomas A. Barthold, Chief of Staff, Joint Committee on
Taxation. The transcript of this hearing can be found in Annex
II.
On April 13, 2010, the committee considered the Convention
and ordered it favorably reported by voice vote, with a quorum
present and without objection.
VII. Committee Comments
The Committee on Foreign Relations believes that the
Convention will stimulate increased trade and investment,
reduce treaty-shopping incentives, and promote closer co-
operation between the United States and Malta. The committee
therefore urges the Senate to act promptly to give advice and
consent to ratification of the Convention, as set forth in this
report and the accompanying resolution of advice and consent.
A. LIMITATION ON BENEFITS
As noted above, the previous U.S.-Malta tax treaty was
terminated by the United States on January 1, 1997, in large
part due to provisions of Maltese domestic law that created
strong incentives for treaty-shopping. Such abuses may
undermine the integrity of a bilateral tax relationship, and
the committee applauds the Treasury Department's significant
efforts to address treaty shopping both in this Convention and
in other bilateral tax treaties.
After careful examination of this Convention, as well as
testimony and responses to questions for the record from the
Treasury Department, the committee is of the view that the
Convention's protections against treaty-shopping are robust and
will substantially deny treaty shoppers the benefit of the
Convention. The limitation on benefits provision, Article 22,
is more restrictive than that in the 2006 U.S. Model tax treaty
or in any existing U.S. tax treaty. In conjunction with this
extensive limitation on benefits provision, the Convention
contains relatively high rates for source country taxation of
dividends, interest, and royalties, which will make the
Convention less attractive to treaty shoppers. These issues are
addressed in more detail in the Treasury Department's responses
to questions for the record, which are included in the hearing
record appended to this report beginning at page 131. The
committee believes that it is critical for the Treasury
Department to closely monitor and keep the committee informed
on the effectiveness of the above-mentioned provisions in
discouraging and eliminating treaty-shopping under the
Convention.
B. DECLARATION ON THE SELF-EXECUTING NATURE
OF THE CONVENTION
The committee has included one declaration in the
recommended resolution of advice and consent. The declaration
states that the Convention is self-executing, as is the case
generally with income tax treaties. Prior to the 110th
Congress, the committee generally included such statements in
the committee's report, but in light of the Supreme Court
decision in Medellin v. Texas, 128 S. Ct. 1346 (2008), the
committee determined that a clear statement in the Resolution
is warranted. A further discussion of the committee's views on
this matter can be found in Section VIII of Executive Report
110-12.
VIII. Text of Resolution of Advice and Consent to Ratification
Resolved (two-thirds of the Senators present concurring
therein),
SECTION 1. SENATE ADVICE AND CONSENT SUBJECT TO A DECLARATION
The Senate advises and consents to the ratification of the
Convention Between the Government of the United States of
America and the Government of Malta for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income, signed on August 8, 2008, at Valletta (the
``Convention'') (Treaty Doc. 111-1), subject to the declaration
of section 2.
SECTION 2. DECLARATION
The advice and consent of the Senate under section 1 is
subject to the following declaration:
The Convention is self-executing.
IX. Annex I--Technical Explanation
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Department of the Treasury Technical Explanation of the Convention
Between the Government of the United States of America and the
Government of Malta for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion With Respect to Taxes on Income Signed at
Valletta on August 8, 2008
This is a technical explanation of the Convention between
the Government of the United States and the Government of Malta
For the Avoidance Of Double Taxation and the Prevention of
Fiscal Evasion with Respect to Taxes on Income, signed on
August 8, 2008 (the ``Convention'').
Negotiations took into account the U.S. Treasury
Department's current tax treaty policy, and the Treasury
Department's Model Income Tax Convention. Negotiations also
took into account the Model Tax Convention on Income and on
Capital, published by the Organisation for Economic Cooperation
and Development (the ``OECD Model''), and recent tax treaties
concluded by both countries.
The Technical Explanation is an official guide to the
Convention. It reflects the policies behind particular
Convention provisions, as well as understandings reached during
the negotiations with respect to the application and
interpretation of the Convention. References in the Technical
Explanation to ``he'' or ``his'' should be read to mean ``he or
she'' or ``his and her.''
ARTICLE 1 (GENERAL SCOPE)
Paragraph 1
Paragraph 1 of Article 1 provides that the Convention
applies only to residents of the United States or Malta except
where the terms of the Convention provide otherwise. Under
Article 4 (Resident) a person is generally treated as a
resident of a Contracting State if that person is, under the
laws of that State, liable to tax therein by reason of his
domicile, citizenship, residence, or other similar criteria.
However, if a person is considered a resident of both
Contracting States, Article 4 provides rules for determining a
State of residence (or no State of residence). This
determination governs for all purposes of the Convention.
Certain provisions are applicable to persons who may not be
residents of either Contracting State. For example, paragraph 1
of Article 24 (Non-Discrimination) applies to nationals of the
Contracting States. Under Article 26 (Exchange of Information
and Administrative Assistance), information may be exchanged
with respect to residents of third states.
Paragraph 2
Paragraph 2 states the generally accepted relationship both
between the Convention and domestic law and between the
Convention and other agreements between the Contracting States.
That is, no provision in the Convention may restrict any
exclusion, exemption, deduction, credit or other benefit
accorded by the tax laws of the Contracting States, or by any
other agreement between the Contracting States. The
relationship between the non-discrimination provisions of the
Convention and the General Agreement on Trade in Services (the
``GATS'') is addressed in paragraph 3.
Under paragraph 2, for example, if a deduction would be
allowed under the U.S. Internal Revenue Code (the ``Code'') in
computing the U.S. taxable income of a resident of Malta, the
deduction also is allowed to that person in computing taxable
income under the Convention. Paragraph 2 also means that the
Convention may not increase the tax burden on a resident of a
Contracting States beyond the burden determined under domestic
law. Thus, a right to tax given by the Convention cannot be
exercised unless that right also exists under internal law.
It follows that, under the principle of paragraph 2, a
taxpayer's U.S. tax liability need not be determined under the
Convention if the Code would produce a more favorable result. A
taxpayer may not, however, choose among the provisions of the
Code and the Convention in an inconsistent manner in order to
minimize tax. Thus, a taxpayer may use the Convention to reduce
its taxable income, but may not use both treaty and Code rules
where doing so would thwart the intent of either set of rules.
For example, assume that a resident of Malta has three separate
businesses in the United States. One is a profitable permanent
establishment and the other two are trades or businesses that
would earn taxable income under the Code but that do not meet
the permanent establishment threshold tests of the Convention.
One is profitable and the other incurs a loss. Under the
Convention, the income of the permanent establishment is
taxable in the United States, and both the profit and loss of
the other two businesses are ignored. Under the Code, all three
would be subject to tax, but the loss would offset the profits
of the two profitable ventures. The taxpayer may not invoke the
Convention to exclude the profits of the profitable trade or
business and invoke the Code to claim the loss of the loss
trade or business against the profit of the permanent
establishment. (See Rev. Rul. 84-17, 1984-1 C.B. 308.) If,
however, the taxpayer invokes the Code for the taxation of all
three ventures, he would not be precluded from invoking the
Convention with respect, for example, to any dividend income he
may receive from the United States that is not effectively
connected with any of his business activities in the United
States.
Similarly, nothing in the Convention can be used to deny
any benefit granted by any other agreement between the United
States and Malta. For example, if certain benefits are provided
for military personnel or military contractors under a Status
of Forces Agreement between the United States and Malta, those
benefits or protections will be available to residents of the
Contracting States regardless of any provisions to the contrary
(or silence) in the Convention.
Paragraph 3
Paragraph 3 specifically relates to non-discrimination
obligations of the Contracting States under the GATS. The
provisions of paragraph 3 are an exception to the rule provided
in paragraph 2 of this Article under which the Convention shall
not restrict in any manner any benefit now or hereafter
accorded by any other agreement between the Contracting States.
Subparagraph (a) of paragraph 3 provides that, unless the
competent authorities determine that a taxation measure is not
within the scope of the Convention, the national treatment
obligations of the GATS shall not apply with respect to that
measure. Further, any question arising as to the interpretation
of the Convention, including in particular whether a measure is
within the scope of the Convention shall be considered only by
the competent authorities of the Contracting States, and the
procedures under the Convention exclusively shall apply to the
dispute. Thus, paragraph 3 of Article XXII (Consultation) of
the GATS may not be used to bring a dispute before the World
Trade Organization unless the competent authorities of both
Contracting States have determined that the relevant taxation
measure is not within the scope of Article 24 (Non-
Discrimination) of the Convention.
The term ``measure'' for these purposes is defined broadly
in subparagraph (b) of paragraph 3. It would include, for
example, a law, regulation, rule, procedure, decision,
administrative action or guidance, or any other form of
measure.
Paragraph 4
Paragraph 4 contains the traditional saving clause found in
all U.S. treaties. The Contracting States reserve their rights,
except as provided in paragraph 5, to tax their residents and
citizens as provided in their internal laws, notwithstanding
any provisions of the Convention to the contrary. For example,
if a resident of Malta 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 Malta 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 Malta. See paragraph 4 of Article 23 (Relief from Double
Taxation).
For purposes of the saving clause, ``residence'' is
determined under Article 4 (Resident). Thus, an individual who
is a resident of the United States under the Code (but not a
U.S. citizen) but who is determined to be a resident of the
other Contracting State 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
before June 17, 2008 if he fails to certify that he has
complied with U.S. tax laws during the 5 preceding years, or 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 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 in which the
individual is treated as a resident of Malta under this
Convention, or as a resident of any country other than the
United States under the provisions of any other U.S. tax
treaty, and the individual does not waive the benefits of the
relevant tax treaty.
Paragraph 5
Paragraph 5 sets forth certain exceptions to the saving
clause. The referenced provisions are intended to provide
benefits to citizens and residents even if such benefits do not
exist under internal law. Paragraph 5 thus preserves these
benefits for citizens and residents of the Contracting States.
Subparagraph (a) lists certain provisions of the Convention
that are applicable to all citizens and residents of a
Contracting State, despite the general saving clause rule of
paragraph 4:
(1) Paragraph 2 of Article 9 (Associated Enterprises)
grants the right to a correlative adjustment with
respect to income tax due on profits reallocated under
Article 9.
(2) Paragraphs 1(b), 2, and 5 of Article 17
(Pensions, Social Security, Annuities, Alimony and
Child Support) provide exemptions from source or
residence State taxation for certain pension
distributions, social security payments and child
support.
(3) Article 18 (Pensions Funds) provides an exemption
for certain investment income of pension funds located
in the other Contracting State.
(4) Article 23 (Relief from Double Taxation) confirms
to citizens and residents of one Contracting State the
benefit of a credit for income taxes paid to the other
or an exemption for income earned in the other State.
(5) Article 24 (Non-Discrimination) protects
residents and nationals of one Contracting State
against the adoption of certain discriminatory taxation
practices in the other Contracting State.
(6) Article 25 (Mutual Agreement Procedure) confers
certain benefits on citizens and residents of the
Contracting States in order to reach and implement
solutions to disputes between the two Contracting
States. For example, the competent authorities are
permitted to use a definition of a term that differs
from an internal law definition. The statute of
limitations may be waived for refunds, so that the
benefits of an agreement may be implemented.
Subparagraph (b) of paragraph 5 provides a different set of
exceptions to the saving clause. The benefits referred to are
all intended to be granted to temporary residents of a
Contracting State (for example, in the case of the United
States, holders of non-immigrant visas), but not to citizens or
to persons who have acquired permanent residence in that State.
If beneficiaries of these provisions travel from one of the
Contracting States to the other, and remain in the other long
enough to become residents under its internal law, but do not
acquire permanent residence status (i.e., in the U.S. context,
they do not become ``green card'' holders) and are not citizens
of that State, the host State will continue to grant these
benefits even if they conflict with the statutory rules. The
benefits preserved by this paragraph are the host country
exemptions for government service salaries and pensions under
Article 19 (Government Service), certain income of visiting
students and trainees under Article 20 (Students and Trainees),
and the income of diplomatic agents and consular officers under
Article 27 (Members of Diplomatic Missions and Consular Posts).
Paragraph 6
Paragraph 6 addresses special issues presented by fiscally
transparent entities such as partnerships and certain estates
and trusts. Because countries may take different views as to
when an entity is fiscally transparent, the risk of both double
taxation and double non-taxation is relatively high. The
intention of paragraph 6 is to eliminate a number of technical
problems that arguably would have prevented investors using
such entities from claiming treaty benefits, even though such
investors would be subject to tax on the income derived through
such entities. The provision also prevents the use of such
entities to claim treaty benefits in circumstances where the
person investing through such an entity is not subject to tax
on the income in its State of residence. The provision, and the
corresponding requirements of the substantive rules of Articles
6 through 21, should be read with those two goals in mind.
In general, paragraph 6 relates to entities that are not
subject to tax at the entity level, as distinct from entities
that are subject to tax, but with respect to which tax may be
relieved under an integrated system. This paragraph applies to
any resident of a Contracting State who is entitled to income
derived through an entity that is treated as fiscally
transparent under the laws of either Contracting State.
Entities falling under this description in the United States
include partnerships, common investment trusts under section
584, and grantor trusts. This paragraph also applies to U.S.
limited liability companies (``LLCs'') that are treated as
partnerships or as disregarded entities for U.S. tax purposes.
Under paragraph 6, an item of income, profit or gain
derived by such a fiscally transparent entity will be
considered to be derived by a resident of a Contracting State
if a resident is treated under the taxation laws of that State
as deriving the item of income. For example, if a company that
is a resident of Malta pays interest to an entity that is
treated as fiscally transparent for U.S. tax purposes, the
interest will be considered derived by a resident of the U.S.
only to the extent that the taxation laws of the United States
treats one or more U.S. residents (whose status as U.S.
residents is determined, for this purpose, under U.S. tax law)
as deriving the interest for U.S. tax purposes. In the case of
a partnership, the persons who are, under U.S. tax laws,
treated as partners of the entity would normally be the persons
whom the U.S. tax laws would treat as deriving the interest
income through the partnership. Also, it follows that persons
whom the United States treats as partners but who are not U.S.
residents for U.S. tax purposes may not claim a benefit for the
interest paid to the entity under the Convention, because they
are not residents of the United States for purposes of claiming
this treaty benefit. (If, however, the country in which they
are treated as resident for tax purposes, as determined under
the laws of that country, has an income tax convention with
Malta, they may be entitled to claim a benefit under that
convention.) In contrast, if, for example, an entity is
organized under U.S. laws and is classified as a corporation
for U.S. tax purposes, interest paid by a company that is a
resident of Malta to the U.S. entity will be considered derived
by a resident of the United States since the U.S. corporation
is treated under U.S. taxation laws as a resident of the United
States and as deriving the income.
The same result obtains even if the entity were viewed
differently under the tax laws of Malta (e.g., as not fiscally
transparent in the first example above where the entity is
treated as a partnership for U.S. tax purposes). Similarly, the
characterization of the entity in a third country is also
irrelevant, even if the entity is organized in that third
country. The results follow regardless of whether the entity is
disregarded as a separate entity under the laws of one
jurisdiction but not the other, such as a single owner entity
that is viewed as a branch for U.S. tax purposes and as a
corporation for tax purposes under the laws of Malta. These
results also obtain regardless of where the entity is organized
(i.e., in the United States, in Malta or, as noted above, in a
third country).
For example, income from U.S. sources received by an entity
organized under the laws of the United States, which is treated
for tax purposes under the laws of Malta as a corporation and
is owned by a shareholder who is a resident of Malta for its
tax purposes, is not considered derived by the shareholder of
that corporation even if, under the tax laws of the United
States, the entity is treated as fiscally transparent. Rather,
for purposes of the treaty, the income is treated as derived by
the U.S. entity.
These principles also apply to trusts to the extent that
they are fiscally transparent in either Contracting State. For
example, if X, a resident of Malta, creates a revocable trust
in the United States and names persons resident in a third
country as the beneficiaries of the trust, the trust's income
would be regarded as being derived by a resident of Malta only
to the extent that the laws of Malta treat X as deriving the
income for its tax purposes, perhaps through application of
rules similar to the U.S. ``grantor trust'' rules.
Paragraph 6 is not an exception to the saving clause of
paragraph 4. Accordingly, paragraph 6 does not prevent a
Contracting State from taxing an entity that is treated as a
resident of that State under its tax law. For example, if a
U.S. LLC with members who are residents of Malta elects to be
taxed as a corporation for U.S. tax purposes, the United States
will tax that LLC on its worldwide income on a net basis,
without regard to whether Malta views the LLC as fiscally
transparent.
ARTICLE 2 (TAXES COVERED)
This Article specifies the U.S. taxes and the taxes of
Malta to which the Convention applies. With two exceptions, the
taxes specified in Article 2 are the covered taxes for all
purposes of the Convention. A broader coverage applies,
however, for purposes of Articles 24 (Non-Discrimination) and
26 (Exchange of Information and Administrative Assistance).
Article 24 (Non-Discrimination) applies with respect to all
taxes, including those imposed by state and local governments.
Article 26 (Exchange of Information and Administrative
Assistance) applies with respect to all taxes imposed at the
national level.
Paragraph 1
Paragraph 1 identifies the category of taxes to which the
Convention applies. Paragraph 1 is based on the U.S. and OECD
Models and defines the scope of application of the Convention.
The Convention applies to taxes on income, including gains,
imposed on behalf of a Contracting State, irrespective of the
manner in which they are levied. Except with respect to Article
24 (Non-Discrimination), state and local taxes are not covered
by the Convention.
Paragraph 2
Paragraph 2 also is based on the U.S. and OECD Models and
provides a definition of taxes on income and on capital gains.
The Convention covers taxes on total income or any part of
income and includes tax on gains derived from the alienation of
property. The Convention does not apply, however, to social
security charges, or any other charges where there is a direct
connection between the levy and individual benefits. Nor does
it apply to property taxes, except with respect to Article 24
(Non-Discrimination).
Paragraph 3
Paragraph 3 lists the taxes in force at the time of
signature of the Convention to which the Convention applies.
The existing covered taxes of Malta are identified in
subparagraph 3(a) as the income tax.
Subparagraph 3(b) provides that the existing U.S. taxes
subject to the rules of the Convention are the Federal income
taxes imposed by the Code, together with the excise taxes
imposed with respect to private foundations (Code sections 4940
through 4948). Social security and unemployment taxes (Code
sections 1401, 3101, 3111 and 3301) are specifically excluded
from coverage.
Paragraph 4
Under paragraph 4, the Convention will apply to any taxes
that are identical, or substantially similar, to those
enumerated in paragraph 3, and which are imposed in addition
to, or in place of, the existing taxes after August 8, 2008,
the date of signature of the Convention. The paragraph also
provides that the competent authorities of the Contracting
States will notify each other of any changes that have been
made in their laws, whether tax laws or non-tax laws, that
affect significantly their obligations under the Convention.
Non-tax laws that may affect a Contracting State's obligations
under the Convention may include, for example, laws affecting
bank secrecy.
ARTICLE 3 (GENERAL DEFINITIONS)
Article 3 provides general definitions and rules of
interpretation applicable throughout the Convention. Certain
other terms are defined in other articles of the Convention.
For example, the term ``resident of a Contracting State'' is
defined in Article 4 (Resident). The term ``permanent
establishment'' is defined in Article 5 (Permanent
Establishment). These definitions are used consistently
throughout the Convention. Other terms, such as ``dividends,''
``interest'' and ``royalties'' are defined in specific articles
for purposes only of those articles.
Paragraph 1
Paragraph 1 defines a number of basic terms used in the
Convention. The introduction to paragraph 1 makes clear that
these definitions apply for all purposes of the Convention,
unless the context requires otherwise. This latter condition
allows flexibility in the interpretation of the treaty in order
to avoid results not intended by the treaty's negotiators.
Subparagraph 1(a) defines the term ``person'' to include an
individual, a trust, a partnership, a company and any other
body of persons. The definition is significant for a variety of
reasons. For example, under Article 4, only a ``person'' can be
a ``resident'' and therefore eligible for most benefits under
the treaty. Also, all ``persons'' are eligible to claim relief
under Article 25 (Mutual Agreement Procedure).
The term ``company'' is defined in subparagraph 1(b) as a
body corporate or an entity treated as a body corporate for tax
purposes in the state where it is organized. The definition
refers to the law of the state in which an entity is organized
in order to ensure that an entity that is treated as fiscally
transparent in its country of residence will not get
inappropriate benefits, such as the reduced withholding rate
provided by subparagraph 2(a)(i) of Article 10 (Dividends). It
also ensures that the Limitation on Benefits provisions of
Article 22 will be applied at the appropriate level.
The terms ``enterprise of a Contracting State'' and
``enterprise of the other Contracting State'' are defined in
subparagraph 1(c) as an enterprise carried on by a resident of
a Contracting State and an enterprise carried on by a resident
of the other Contracting State. An enterprise of a Contracting
State need not be carried on in that State. It may be carried
on in the other Contracting State or a third state (e.g., a
U.S. corporation doing all of its business in the other
Contracting State would still be a U.S. enterprise).
Subparagraph 1(c) further provides that these terms also
encompass an enterprise conducted through an entity (such as a
partnership) that is treated as fiscally transparent in the
Contracting State where the entity's owner is resident. The
definition makes this point explicitly to ensure that the
purpose of the Convention is not thwarted by an overly
technical application of the term ``enterprise of a Contracting
State'' to activities carried on through partnerships and
similar entities. In accordance with Article 4 (Resident),
entities that are fiscally transparent in the country in which
their owners are resident are not considered to be residents of
a Contracting State (although income derived by such entities
may be taxed as the income of a resident, if taxed in the hands
of resident partners or other owners). It could be argued that
an enterprise conducted by such an entity is not conducted by a
resident of a Contracting State, and therefore would not
benefit from provisions applicable to enterprises of a
Contracting State. The definition is intended to make clear
that an enterprise conducted by such an entity will be treated
as carried on by a resident of a Contracting State to the
extent its partners or other owners are residents. This
approach is consistent with the Code, which under section 875
attributes a trade or business conducted by a partnership to
its partners and a trade or business conducted by an estate or
trust to its beneficiaries.
Subparagraph (d) defines the term ``enterprise'' as any
activity or set of activities that constitutes the carrying on
of a business. The term ``business'' is not defined, but
subparagraph (e) provides that it includes the performance of
professional services and other activities of an independent
character. Both subparagraphs are identical to definitions
added to the OECD Model in connection with the deletion of
Article 14 (Independent Personal Services) from the OECD Model.
The inclusion of the two definitions is intended to clarify
that income from the performance of professional services or
other activities of an independent character is dealt with
under Article 7 (Business Profits) and not Article 21 (Other
Income).
Subparagraph 1(f) defines the term ``international
traffic.'' The term means any transport by a ship or aircraft
except when such transport is solely between places within a
Contracting State. This definition is applicable principally in
the context of Article 8 (Shipping and Air Transport). The
definition combines with paragraphs 2 and 3 of Article 8 to
exempt from tax by the source State income from the rental of
ships or aircraft that is earned both by lessors that are
operators of ships and aircraft and by those lessors that are
not (e.g., a bank or a container leasing company).
The exclusion from international traffic of transport
solely between places within a Contracting State means, for
example, that carriage of goods or passengers solely between
New York and Chicago would not be treated as international
traffic, whether carried by a U.S. or a foreign carrier. The
substantive taxing rules of the Convention relating to the
taxation of income from transport, principally Article 8
(Shipping and Air Transport), therefore, would not apply to
income from such carriage. Thus, if the carrier engaged in
internal U.S. traffic were a resident of Malta (assuming that
were possible under U.S. law), the United States would not be
required to exempt the income from that transport under Article
8. The income would, however, be treated as business profits
under Article 7 (Business Profits), and therefore would be
taxable in the United States only if attributable to a U.S.
permanent establishment of the foreign carrier, and then only
on a net basis. The gross basis U.S. tax imposed by section 887
would never apply under the circumstances described. If,
however, goods or passengers are carried by a carrier resident
in Malta from a non-U.S. port to, for example, New York, and
some of the goods or passengers continue on to Chicago, the
entire transport would be international traffic. This would be
true if the international carrier transferred the goods at the
U.S. port of entry from a ship to a land vehicle, from a ship
to a lighter, or even if the overland portion of the trip in
the United States was handled by an independent carrier under
contract with the original international carrier, so long as
both parts of the trip were reflected in original bills of
lading. For this reason, the Convention, following the U.S.
Model, refers, in the definition of ``international traffic,''
to ``such transport'' being solely between places in the other
Contracting State, while the OECD Model refers to the ship or
aircraft being operated solely between such places. The
formulation in the Convention is intended to make clear that,
as in the above example, even if the goods are carried on a
different aircraft for the internal portion of the
international voyage than is used for the overseas portion of
the trip, the definition applies to that internal portion as
well as the external portion.
Finally, a ``cruise to nowhere,'' i.e., a cruise beginning
and ending in a port in the same Contracting State with no
stops in a foreign port, would not constitute international
traffic.
Subparagraph 1(g) designates the ``competent authorities''
for the other Contracting State and the United States. The U.S.
competent authority is the Secretary of the Treasury or his
delegate. The Secretary of the Treasury has delegated the
competent authority function to the Commissioner of Internal
Revenue, who in turn has delegated the authority to the Deputy
Commissioner (International) LMSB. With respect to
interpretative issues, the Deputy Commissioner (International)
LMSB acts with the concurrence of the Associate Chief Counsel
(International) of the Internal Revenue Service. In the case of
Malta, the competent authority is the Minister responsible for
finance or his authorized representative.
The geographical scope of the Convention with respect to
the United States is set out in subparagraph 1(h). It
encompasses the United States of America, including the states,
the District of Columbia and the territorial sea of the United
States. The term does not include Puerto Rico, the Virgin
Islands, Guam or any other U.S. possession or territory. For
certain purposes, the term ``United States'' includes the sea
bed and subsoil of undersea areas adjacent to the territorial
sea of the United States. This extension applies to the extent
that the United States exercises sovereignty in accordance with
international law for the purpose of natural resource
exploration and exploitation of such areas. This extension of
the definition applies, however, only if the person, property
or activity to which the Convention is being applied is
connected with such natural resource exploration or
exploitation. Thus, it would not include any activity involving
the sea floor of an area over which the United States exercised
sovereignty for natural resource purposes if that activity was
unrelated to the exploration and exploitation of natural
resources. This result is consistent with the result that would
be obtained under Section 638, which treats the continental
shelf as part of the United States for purposes of natural
resource exploration and exploitation.
The geographical scope of the Convention with respect to
Malta is set out in subparagraph 1(i). The term ``Malta'' means
the Republic of Malta and, when used in a geographical sense,
means the island of Malta, the Island of Gozo, and the other
islands of the Maltese archipelago including the territorial
waters thereof as well as any area of the sea-bed, it's sub-
soil and the superjacent water column adjacent to the
territorial waters, where the Republic of Malta exercises
sovereign rights, jurisdiction or control in accordance with
international law and its national law, including its
legislation relating to the exploration of the Continental
Shelf and exploitation of its natural resources.
The term ``national,'' as it relates to the United States
and to Malta, is defined in subparagraph 1(j). This term is
relevant for purposes of Articles 19 (Government Service) and
24 (Non-Discrimination). A national of one of the Contracting
States is (1) an individual who is a citizen or national of
that State, and (2) any legal person, partnership or
association deriving its status, as such, from the law in force
in the State where it is established.
Subparagraph (k) defines the term ``pension fund'' to
include any person established in a Contracting State that, in
the case of the United States, is generally exempt from income
taxation, and in the case of Malta, is a licensed fund or
scheme subject to tax only on income derived from immovable
property situated in Malta, and that is operated principally to
provide pension or retirement benefits or to earn income for
the benefit of one or more such arrangements. In the case of
the United States, the term ``pension fund'' includes the
following: a trust providing pension or retirement benefits
under a Code section 401(a) qualified pension plan, profit
sharing or stock bonus plan, Code section 403(a) qualified
annuity plan, a Code section 403(b) plan, a trust that is an
individual retirement account under Code section 408, a Roth
individual retirement account under Code section 408A, or a
simple retirement account under Code section 408(p), a trust
providing pension or retirement benefits under a simplified
employee pension plan under Code section 408(k), a trust
described in section 457(g) providing pension or retirement
benefits under a Code section 457(b) plan, and the Thrift
Savings Fund (section 7701(j)). Section 401(k) plans and group
trusts described in Revenue Ruling 81-100 and meeting the
conditions of Revenue Ruling 2004-67 qualify as pension funds
to the extent that they are Code section 401(a) plans and other
pension funds.
Paragraph 2
Terms that are not defined in the Convention are dealt with
in paragraph 2.
Paragraph 2 provides that in the application of the
Convention, any term used but not defined in the Convention
will have the meaning that it has under the law of the
Contracting State whose tax is being applied, unless the
context requires otherwise, or the competent authorities have
agreed on a different meaning pursuant to Article 25 (Mutual
Agreement Procedure). If the term is defined under both the tax
and non-tax laws of a Contracting State, the definition in the
tax law will take precedence over the definition in the non-tax
laws. Finally, there also may be cases where the tax laws of a
State contain multiple definitions of the same term. In such a
case, the definition used for purposes of the particular
provision at issue, if any, should be used.
If the meaning of a term cannot be readily determined under
the law of a Contracting State, or if there is a conflict in
meaning under the laws of the two States that creates
difficulties in the application of the Convention, the
competent authorities, as indicated in paragraph 3(c)(iv) of
Article 25 (Mutual Agreement Procedure), may establish a common
meaning in order to prevent double taxation or to further any
other purpose of the Convention. This common meaning need not
conform to the meaning of the term under the laws of either
Contracting State.
The reference in paragraph 2 to the internal law of a
Contracting State means the law in effect at the time the
treaty is being applied, not the law as in effect at the time
the treaty was signed. The use of ``ambulatory'' definitions,
however, may lead to results that are at variance with the
intentions of the negotiators and of the Contracting States
when the treaty was negotiated and ratified. The reference in
both paragraphs 1 and 2 to the ``context otherwise
requir[ing]'' a definition different from the treaty
definition, in paragraph 1, or from the internal law definition
of the Contracting State whose tax is being imposed, under
paragraph 2, refers to a circumstance where the result intended
by the Contracting States is different from the result that
would obtain under either the paragraph 1 definition or the
statutory definition. Thus, flexibility in defining terms is
necessary and permitted.
ARTICLE 4 (RESIDENT)
This Article sets forth rules for determining whether a
person is a resident of a Contracting State for purposes of the
Convention. As a general matter only residents of the
Contracting States may claim the benefits of the Convention.
The treaty definition of residence is to be used only for
purposes of the Convention. The fact that a person is
determined to be a resident of a Contracting State under
Article 4 does not necessarily entitle that person to the
benefits of the Convention. In addition to being a resident, a
person also must qualify for benefits under Article 22
(Limitation on Benefits) in order to receive benefits conferred
on residents of a Contracting State.
The determination of residence for treaty purposes looks
first to a person's liability to tax as a resident under the
respective taxation laws of the Contracting States. As a
general matter, a person who, under those laws, is a resident
of one Contracting State and not of the other need look no
further. For purposes of the Convention, that person is a
resident of the State in which he is resident under internal
law. If, however, a person is resident in both Contracting
States under their respective taxation laws, the Article
proceeds, where possible, to use tie-breaker rules to assign a
single State of residence to such a person for purposes of the
Convention.
Paragraph 1
The term ``resident of a Contracting State'' is defined in
paragraph 1. In general, this definition incorporates the
definitions of residence in U.S. law and that of Malta by
referring to a resident as a person who, under the laws of a
Contracting State, is subject to tax there by reason of his
domicile, residence, citizenship, place of management, place of
incorporation or any other similar criterion. Thus, residents
of the United States include aliens who are considered U.S.
residents under Code section 7701(b). Paragraph 1 also
specifically includes the two Contracting States, and political
subdivisions and local authorities of the two States, as
residents for purposes of the Convention.
Certain entities that are nominally subject to tax but that
in practice are rarely required to pay tax also would generally
be treated as residents and therefore accorded treaty benefits.
For example, a U.S. Regulated Investment Company (RIC) and a
U.S. Real Estate Investment Trust (REIT) are residents of the
United States for purposes of the treaty. Although the income
earned by these entities normally is not subject to U.S. tax in
the hands of the entity, they are taxable to the extent that
they do not currently distribute their profits, and therefore
may be regarded as liable to tax. They also must satisfy a
number of requirements under the Code in order to be entitled
to special tax treatment.
A person who is liable to tax in a Contracting State only
in respect of income from sources within that State or capital
situated therein or of profits attributable to a permanent
establishment in that State will not be treated as a resident
of that Contracting State for purposes of the Convention. Thus,
a consular official of Malta who is posted in the United
States, who may be subject to U.S. tax on U.S. source
investment income, but is not taxable in the United States on
non-U.S. source income (see Code section 7701(b)(5)(B)), would
not be considered a resident of the United States for purposes
of the Convention. Similarly, an enterprise of Malta with a
permanent establishment in the United States is not, by virtue
of that permanent establishment, a resident of the United
States. The enterprise generally is subject to U.S. tax only
with respect to its income that is attributable to the U.S.
permanent establishment, not with respect to its worldwide
income, as it would be if it were a U.S. resident.
Paragraph 2
Paragraph 2 provides that certain tax-exempt entities such
as pension funds and charitable organizations will be regarded
as residents of a Contracting State regardless of whether they
are generally liable to income tax in the State where they are
established. The paragraph applies to legal persons organized
under the laws of a Contracting State and established and
maintained in that State to provide pensions or other similar
benefits pursuant to a plan, or exclusively for religious,
charitable, scientific, artistic, cultural, or educational
purposes. Thus, a section 501(c) organization organized in the
United States (such as a U.S. charity) that is generally exempt
from tax under U.S. law is a resident of the United States for
all purposes of the Convention. In the case of Malta, the
Exchange of Notes accompanying the Convention provides that
paragraph 2 applies to entities exempt from taxation under
Maltese law as philanthropic institutions, philharmonic
societies, or sports clubs.
Paragraph 3
If, under the laws of the two Contracting States, and,
thus, under paragraph 1, an individual is deemed to be a
resident of both Contracting States, a series of tie-breaker
rules are provided in paragraph 3 to determine a single State
of residence for that individual These tests are to be applied
in the order in which they are stated. The first test is based
on where the individual has a permanent home. If that test is
inconclusive because the individual has a permanent home
available to him in both States, he will be considered to be a
resident of the Contracting State where his personal and
economic relations are closest (i.e., the location of his
``center of vital interests''). If that test is also
inconclusive, or if he does not have a permanent home available
to him in either State, he will be treated as a resident of the
Contracting State where he maintains a habitual abode. If he
has a habitual abode in both States or in neither of them, he
will be treated as a resident of the Contracting State of which
he is a national. If he is a national of both States or of
neither, the matter will be considered by the competent
authorities, who will assign a single State of residence.
Paragraph 4
Paragraph 4 seeks to settle dual-residence issues for
companies. A company is treated as resident in the United
States if it is created or organized under the laws of the
United States or a political subdivision. Because a company can
be treated as a resident of Malta if it is either incorporated
or managed and controlled there, dual residence can arise in
the case of a U.S. company that is managed and controlled in
Malta. In other cases, a company may be a dual resident because
it was originally incorporated in one Contracting State but has
``continued'' into the other Contracting State. Paragraph 4
attempts to deal with each of these situations.
Under paragraph 4, the residence of a dual-resident company
will be in the Contracting State under the laws of which it is
created or organized if it is created or organized under the
laws of only one of the other Contracting States. Thus, if a
company is a resident of the United States because it is
incorporated under the laws of one of the states and is a
resident of Malta because its place of effective management is
in Malta, then it will be a resident only of the United States.
However, if the incorporation test does not resolve the
question because, for example, the company was incorporated in
one Contracting State and continued into the other Contracting
State, but the first-mentioned Contracting State does not
recognize the migration and continues to treat the company as a
resident, then the competent authorities will try to determine
a single State of residence for the company.
If the competent authorities do not reach an agreement on a
single State of residence, that company may not claim any
benefit accorded to residents of a Contracting State by the
Convention. The company may, however, claim any benefits that
are not limited to residents, such as those provided by
paragraph 1 of Article 24 (Non-Discrimination). Thus, for
example, a State cannot discriminate against a dual resident
company.
Dual resident companies also may be treated as a resident
of a Contracting State for purposes other than that of
obtaining benefits under the Convention. For example, if a dual
resident company pays a dividend to a resident of Malta, the
U.S. paying agent would withhold on that dividend at the
appropriate treaty rate because reduced withholding is a
benefit enjoyed by the resident of Malta, not by the dual
resident company. The dual resident company that paid the
dividend would, for this purpose, be treated as a resident of
the United States under the Convention. In addition,
information relating to dual resident companies can be
exchanged under the Convention because, by its terms, Article
26 (Exchange of Information and Administrative Assistance) is
not limited to residents of the Contracting States.
Paragraph 5
Dual residents other than individuals or companies (such as
trusts or estates) are addressed by paragraph 5. If such a
person is, under the rules of paragraph 1, resident in both
Contracting States, the competent authorities shall seek to
determine a single State of residence for that person for
purposes of the Convention.
ARTICLE 5 (PERMANENT ESTABLISHMENT)
This Article defines the term ``permanent establishment,''
a term that is significant for several articles of the
Convention. The existence of a permanent establishment in a
Contracting State is necessary under Article 7 (Business
Profits) for the taxation by that State of the business profits
of a resident of the other Contracting State. Articles 10
(Dividends), 11 (Interest), and 12 (Royalties) provide for
reduced rates of tax at source on payments of these items of
income to a resident of the other State only when the income is
not attributable to a permanent establishment that the
recipient has in the source State. The concept is also relevant
in determining which Contracting State may tax certain gains
under Article 13 (Gains) and certain ``other income'' under
Article 21 (Other Income).
Paragraph 1
The basic definition of the term ``permanent
establishment'' is contained in paragraph 1. As used in the
Convention, the term means a fixed place of business through
which the business of an enterprise is wholly or partly carried
on. As indicated in the OECD Commentary to Article 5 (see
paragraphs 4 through 8), a general principle to be observed in
determining whether a permanent establishment exists is that
the place of business must be ``fixed'' in the sense that a
particular building or physical location is used by the
enterprise for the conduct of its business, and that it must be
foreseeable that the enterprise's use of this building or other
physical location will be more than temporary.
Paragraph 2
Paragraph 2 lists a number of types of fixed places of
business that constitute a permanent establishment. This list
is illustrative and non-exclusive. According to paragraph 2,
the term permanent establishment includes a place of
management, a branch, an office, a factory, a workshop, and a
mine, oil or gas well, quarry or other place of extraction of
natural resources.
Paragraph 3
This paragraph provides rules to determine whether a
building site or a construction, assembly or installation
project, or an installation or drilling rig or ship used for
the exploration of natural resources constitutes a permanent
establishment for the contractor, driller, etc. Such a site or
activity does not create a permanent establishment unless the
site, project, etc. lasts, or the exploration activity
continues, for more than twelve months. It is only necessary to
refer to ``exploration'' and not ``exploitation'' in this
context because exploitation activities are defined to
constitute a permanent establishment under subparagraph 2(f).
Thus, a drilling rig does not constitute a permanent
establishment if a well is drilled in only six months, but if
production begins in the following month the well becomes a
permanent establishment as of that date.
The twelve-month test applies separately to each site or
project. The twelve-month period begins when work (including
preparatory work carried on by the enterprise) physically
begins in a Contracting State. A series of contracts or
projects by a contractor that are interdependent both
commercially and geographically are to be treated as a single
project for purposes of applying the twelve-month threshold
test. For example, the construction of a housing development
would be considered as a single project even if each house were
constructed for a different purchaser.
In applying this paragraph, time spent by a sub-contractor
on a building site is counted as time spent by the general
contractor at the site for purposes of determining whether the
general contractor has a permanent establishment. However, for
the sub-contractor itself to be treated as having a permanent
establishment, the sub-contractor's activities at the site must
last for more than 12 months. If a sub-contractor is on a site
intermittently, then, for purposes of applying the 12-month
rule, time is measured from the first day the sub-contractor is
on the site until the last day (i.e., intervening days that the
sub-contractor is not on the site are counted).
These interpretations of the Article are based on the
Commentary to paragraph 3 of Article 5 of the OECD Model, which
contains language that is substantially the same as that in the
Convention. These interpretations are consistent with the
generally accepted international interpretation of the relevant
language in paragraph 3 of Article 5 of the Convention.
If the twelve-month threshold is exceeded, the site or
project constitutes a permanent establishment from the first
day of activity.
Paragraph 4
This paragraph contains exceptions to the general rule of
paragraph 1, listing a number of activities that may be carried
on through a fixed place of business but which nevertheless do
not create a permanent establishment. The use of facilities
solely to store, display or deliver merchandise belonging to an
enterprise does not constitute a permanent establishment of
that enterprise. The maintenance of a stock of goods belonging
to an enterprise solely for the purpose of storage, display or
delivery, or solely for the purpose of processing by another
enterprise does not give rise to a permanent establishment of
the first-mentioned enterprise. The maintenance of a fixed
place of business solely for the purpose of purchasing goods or
merchandise, or for collecting information, for the enterprise,
or for other activities that have a preparatory or auxiliary
character for the enterprise, such as advertising, or the
supply of information, do not constitute a permanent
establishment of the enterprise. Moreover, subparagraph 4(f)
provides that a combination of the activities described in the
other subparagraphs of paragraph 4 will not give rise to a
permanent establishment if the combination results in an
overall activity that is of a preparatory or auxiliary
character.
Paragraph 5
Paragraphs 5 and 6 specify when activities carried on by an
agent or other person acting on behalf of an enterprise create
a permanent establishment of that enterprise. Under paragraph
5, a person is deemed to create a permanent establishment of
the enterprise if that person has and habitually exercises an
authority to conclude contracts that are binding on the
enterprise. If, however, for example, his activities are
limited to those activities specified in paragraph 4 which
would not constitute a permanent establishment if carried on by
the enterprise through a fixed place of business, the person
does not create a permanent establishment of the enterprise.
The Convention uses the U.S. Model language ``binding on
the enterprise,'' rather than the OECD Model language ``in the
name of that enterprise.'' This difference in language is not
intended to be a substantive difference. As indicated in
paragraph 32 to the OECD Commentaries on Article 5, paragraph 5
of the Article is intended to encompass persons who have
``sufficient authority to bind the enterprise's participation
in the business activity in the State concerned.''
The contracts referred to in paragraph 5 are those relating
to the essential business operations of the enterprise, rather
than ancillary activities. For example, if the person has no
authority to conclude contracts in the name of the enterprise
with its customers for, say, the sale of the goods produced by
the enterprise, but it can enter into service contracts in the
name of the enterprise for the enterprise's business equipment,
this contracting authority would not fall within the scope of
the paragraph, even if exercised regularly.
Paragraph 6
Under paragraph 6, an enterprise is not deemed to have a
permanent establishment in a Contracting State merely because
it carries on business in that State through an independent
agent, including a broker or general commission agent, if the
agent is acting in the ordinary course of his business as an
independent agent. Thus, there are two conditions that must be
satisfied: the agent must be both legally and economically
independent of the enterprise, and the agent must be acting in
the ordinary course of its business in carrying out activities
on behalf of the enterprise.
Whether the agent and the enterprise are independent is a
factual determination. Among the questions to be considered are
the extent to which the agent operates on the basis of
instructions from the enterprise. An agent that is subject to
detailed instructions regarding the conduct of its operations
or comprehensive control by the enterprise is not legally
independent.
In determining whether the agent is economically
independent, a relevant factor is the extent to which the agent
bears business risk. Business risk refers primarily to risk of
loss. An independent agent typically bears risk of loss from
its own activities. In the absence of other factors that would
establish dependence, an agent that shares business risk with
the enterprise, or has its own business risk, is economically
independent because its business activities are not integrated
with those of the principal. Conversely, an agent that bears
little or no risk from the activities it performs is not
economically independent and therefore is not described in
paragraph 6.
Another relevant factor in determining whether an agent is
economically independent is whether the agent acts exclusively
or nearly exclusively for the principal. Such a relationship
may indicate that the principal has economic control over the
agent. A number of principals acting in concert also may have
economic control over an agent. The limited scope of the
agent's activities and the agent's dependence on a single
source of income may indicate that the agent lacks economic
independence. It should be borne in mind, however, that
exclusivity is not in itself a conclusive test; an agent may be
economically independent notwithstanding an exclusive
relationship with the principal if it has the capacity to
diversify and acquire other clients without substantial
modifications to its current business and without substantial
harm to its business profits. Thus, exclusivity should be
viewed merely as a pointer to further investigation of the
relationship between the principal and the agent. Each case
must be addressed on the basis of its own facts and
circumstances.
Paragraph 7
This paragraph clarifies that a company that is a resident
of a Contracting State is not deemed to have a permanent
establishment in the other Contracting State merely because it
controls, or is controlled by, a company that is a resident of
that other Contracting State, or that carries on business in
that other Contracting State. The determination whether a
permanent establishment exists is made solely on the basis of
the factors described in paragraphs 1 through 6 of the Article.
Whether a company is a permanent establishment of a related
company, therefore, is based solely on those factors and not on
the ownership or control relationship between the companies.
ARTICLE 6 (INCOME FROM REAL (IMMOVABLE) PROPERTY)
This article deals with the taxation of income from real
(immovable) property situated in a Contracting State (the
``situs State''). The Article does not grant an exclusive
taxing right to the situs State; the situs State is merely
given the primary right to tax. The Article does not impose any
limitation in terms of rate or form of tax imposed by the situs
State, except that, as provided in paragraph 5, the situs State
must allow the taxpayer an election to be taxed on a net basis.
Paragraph 1
The first paragraph of Article 6 states the general rule
that income of a resident of a Contracting State derived from
real (immovable) property situated in the other Contracting
State may be taxed in the Contracting State in which the
property is situated. The paragraph specifies that income from
real (immovable) property includes income from agriculture and
forestry. Given the availability of the net election in
paragraph 5, taxpayers generally should be able to obtain the
same tax treatment in the situs country regardless of whether
the income is treated as business profits or real (immovable)
property income.
Paragraph 2
The term ``real (immovable) property'' is defined in
paragraph 2 by reference to the internal law definition in the
situs State. In the case of the United States, the term has the
meaning given to it by Reg. Sec. 1.897-1(b). In addition to the
statutory definitions in the two Contracting States, the
paragraph specifies certain additional classes of property
that, regardless of internal law definitions, are within the
scope of the term for purposes of the Convention. This expanded
definition conforms to that in the OECD Model. The definition
of ``real (immovable) property'' for purposes of Article 6 is
more limited than the expansive definition of ``real
(immovable) property'' in paragraph 1 of Article 13 (Capital
Gains). The Article 13 term includes not only real (immovable)
property as defined in Article 6 but certain other interests in
real (immovable) property.
Paragraph 3
Paragraph 3 makes clear that all forms of income derived
from the exploitation of real (immovable) property are taxable
in the Contracting State in which the property is situated.
This includes income from any use of real (immovable) property,
including, but not limited to, income from direct use by the
owner (in which case income may be imputed to the owner for tax
purposes) and rental income from the letting of real
(immovable) property. In the case of a net lease of real
(immovable) property, if a net election pursuant to paragraph 5
has not been made, the gross rental payment (before deductible
expenses incurred by the lessee) is treated as income from the
property.
Other income closely associated with real (immovable)
property is covered by other Articles of the Convention,
however, and not Article 6. For example, income from the
disposition of an interest in real (immovable) property is not
considered ``derived'' from real (immovable) property; taxation
of that income is addressed in Article 13 (Gains). Interest
paid on a mortgage on real (immovable) property would be
covered by Article 11 (Interest). Distributions by a U.S. Real
Estate Investment Trust or certain regulated investment
companies would fall under Article 13 in the case of
distributions of U.S. real property gain or Article 10
(Dividends) in the case of distributions treated as dividends.
Finally, distributions from a United States Real Property
Holding Corporation are not considered to be income from the
exploitation of real (immovable) property; such payments would
fall under Article 10 or 13.
Paragraph 4
This paragraph specifies that the basic rule of paragraph 1
(as elaborated in paragraph 3) applies to income from real
(immovable) property of an enterprise. This clarifies that the
situs country may tax the real (immovable) property income
(including rental income) of a resident of the other
Contracting State in the absence of attribution to a permanent
establishment in the situs State. This provision represents an
exception to the general rule under Articles 7 (Business
Profits) that income must be attributable to a permanent
establishment in order to be taxable in the situs State.
Paragraph 5
The paragraph provides that a resident of one Contracting
State that derives real (immovable) property income from the
other may elect, for any taxable year, to be subject to tax in
that other State on a net basis, as though the income were
attributable to a permanent establishment in that other State.
In the case of real property situated in the United States, the
election may be terminated only with the consent of the
competent authority of the United States. Termination of such
election will be granted in accordance with the provisions of
Treas. Reg. Sec. 1.871-10(d)(2).
ARTICLE 7 (BUSINESS PROFITS)
This Article provides rules for the taxation by a
Contracting State of the business profits of an enterprise of
the other Contracting State.
Paragraph 1
Paragraph 1 states the general rule that business profits
of an enterprise of one Contracting State may not be taxed by
the other Contracting State unless the enterprise carries on
business in that other Contracting State through a permanent
establishment (as defined in Article 5 (Permanent
Establishment)) situated there. When that condition is met, the
State in which the permanent establishment is situated may tax
the enterprise on the income that is attributable to the
permanent establishment.
Although the Convention does not include a definition of
``business profits,'' the term is intended to cover income
derived from any trade or business. In accordance with this
broad definition, the term ``business profits'' includes income
attributable to notional principal contracts and other
financial instruments to the extent that the income is
attributable to a trade or business of dealing in such
instruments or is otherwise related to a trade or business (as
in the case of a notional principal contract entered into for
the purpose of hedging currency risk arising from an active
trade or business). Any other income derived from such
instruments is, unless specifically covered in another article,
dealt with under Article 21 (Other Income).
The term ``business profits'' also includes income derived
by an enterprise from the rental of tangible personal property
(unless such tangible personal property consists of aircraft,
ships or containers, income from which is addressed by Article
8 (Shipping and Air Transport)). The inclusion of income
derived by an enterprise from the rental of tangible personal
property in business profits means that such income earned by a
resident of a Contracting State can be taxed by the other
Contracting State only if the income is attributable to a
permanent establishment maintained by the resident in that
other State, and, if the income is taxable, it can be taxed
only on a net basis. Income from the rental of tangible
personal property that is not derived in connection with a
trade or business is dealt with in Article 21 (Other Income).
In addition, as a result of the definitions of
``enterprise'' and ``business'' in Article 3 (General
Definitions), the term includes income derived from the
furnishing of personal services. Thus, a consulting firm
resident in one State whose employees or partners perform
services in the other State through a permanent establishment
may be taxed in that other State on a net basis under Article
7, and not under Article 14 (Income from Employment), which
applies only to income of employees. With respect to the
enterprise's employees themselves, however, their salary
remains subject to Article 14.
Because this article applies to income earned by an
enterprise from the furnishing of personal services, the
article also applies to income derived by a partner resident in
a Contracting State that is attributable to personal services
performed in the other Contracting State through a partnership
with a permanent establishment in that other State. Income
which may be taxed under this article includes all income
attributable to the permanent establishment in respect of the
performance of the personal services carried on by the
partnership (whether by the partner himself, other partners in
the partnership, or by employees assisting the partners) and
any income from activities ancillary to the performance of
those services (e.g., charges for facsimile services).
The application of Article 7 to a service partnership may
be illustrated by the following example: a partnership formed
in Malta has five partners (who agree to split profits
equally), four of whom are resident and perform personal
services only in Malta at Office A, and one of whom performs
personal services at Office B, a permanent establishment in the
United States. In this case, the four partners of the
partnership resident in Malta may be taxed in the United States
in respect of their share of the income attributable to the
permanent establishment, Office B. The services giving rise to
income which may be attributed to the permanent establishment
would include not only the services performed by the one
resident partner, but also, for example, if one of the four
other partners came to the United States and worked on an
Office B matter there, the income in respect of those services.
Income from the services performed by the visiting partner
would be subject to tax in the United States regardless of
whether the visiting partner actually visited or used Office B
while performing services in the United States.
Paragraph 2
Paragraph 2 provides rules for the attribution of business
profits to a permanent establishment. The Contracting States
will attribute to a permanent establishment the profits that it
would have earned had it been a distinct and separate
enterprise engaged in the same or similar activities under the
same or similar conditions. This language incorporates the
arm's-length standard for purposes of determining the profits
attributable to a permanent establishment. The computation of
business profits attributable to a permanent establishment
under this paragraph is subject to the rules of paragraph 3 for
the allowance of expenses incurred for the purposes of earning
the profits.
The ``attributable to'' concept of paragraph 2 is analogous
but not entirely equivalent to the ``effectively connected''
concept in Code section 864(c). The profits attributable to a
permanent establishment may be from sources within or without a
Contracting State.
Paragraph 2 also provides that the business profits
attributed to a permanent establishment include only those
derived from the assets used, risks assumed and activities
performed by the permanent establishment. This rule is
consistent with the ``asset-use'' and ``business activities''
tests of Code section 864(c)(2).
Paragraph 3
Paragraph 3 provides that in determining the business
profits of a permanent establishment, deductions shall be
allowed for the expenses incurred for the purposes of the
permanent establishment, ensuring that business profits will be
taxed on a net basis. This rule is not limited to expenses
incurred exclusively for the purposes of the permanent
establishment, but includes expenses incurred for the purposes
of the enterprise as a whole, or that part of the enterprise
that includes the permanent establishment. Deductions are to be
allowed regardless of which accounting unit of the enterprise
books the expenses, so long as they are incurred for the
purposes of the permanent establishment. For example, a portion
of the interest expense recorded on the books of the home
office in one State may be deducted by a permanent
establishment in the other if properly allocable thereto. This
rule permits (but does not require) each Contracting State to
apply the type of expense allocation rules provided by U.S. law
(such as in Treas. Reg. sections 1.861-8 and 1.882-5).
Paragraph 3 does not permit a deduction for expenses
charged to a permanent establishment by another unit of the
enterprise. Thus, a permanent establishment may not deduct a
royalty deemed paid to the head office. Similarly, a permanent
establishment may not increase its business profits by the
amount of any notional fees for ancillary services performed
for another unit of the enterprise, but also should not receive
a deduction for the expense of providing such services, since
those expenses would be incurred for purposes of a business
unit other than the permanent establishment.
Paragraph 4
Paragraph 4 provides that no business profits can be
attributed to a permanent establishment merely because it
purchases goods or merchandise for the enterprise of which it
is a part. This paragraph is essentially identical to paragraph
5 of Article 7 of the OECD Model. This rule applies only to an
office that performs functions for the enterprise in addition
to purchasing. The income attribution issue does not arise if
the sole activity of the office is the purchase of goods or
merchandise because such activity does not give rise to a
permanent establishment under Article 5 (Permanent
Establishment). A common situation in which paragraph 4 is
relevant is one in which a permanent establishment purchases
raw materials for the enterprise's manufacturing operation
conducted outside the United States and sells the manufactured
product. While business profits may be attributable to the
permanent establishment with respect to its sales activities,
no profits are attributable to it with respect to its
purchasing activities.
Paragraph 5
Paragraph 5 provides that profits shall be determined by
the same method each year, unless there is good reason to
change the method used. This rule assures consistent tax
treatment over time for permanent establishments. It limits the
ability of both the Contracting State and the enterprise to
change accounting methods to be applied to the permanent
establishment. It does not, however, restrict a Contracting
State from imposing additional requirements, such as the rules
under Code section 481, to prevent amounts from being
duplicated or omitted following a change in accounting method.
Paragraph 6
Paragraph 6 coordinates the provisions of Article 7 and
other provisions of the Convention. Under this paragraph, when
business profits include items of income that are dealt with
separately under other articles of the Convention, the
provisions of those articles will, except when they
specifically provide to the contrary, take precedence over the
provisions of Article 7. For example, the taxation of dividends
will be determined by the rules of Article 10 (Dividends), and
not by Article 7, except where, as provided in paragraph 6 of
Article 10, the dividend is attributable to a permanent
establishment. In the latter case the provisions of Article 7
apply. Thus, an enterprise of one State deriving dividends from
the other State may not rely on Article 7 to exempt those
dividends from tax at source if they are not attributable to a
permanent establishment of the enterprise in the other State.
By the same token, if the dividends are attributable to a
permanent establishment in the other State, the dividends may
be taxed on a net income basis at the source State full
corporate tax rate, rather than on a gross basis under Article
10.
As provided in Article 8 (Shipping and Air Transport),
income derived from shipping and air transport activities in
international traffic described in that Article is taxable only
in the country of residence of the enterprise regardless of
whether it is attributable to a permanent establishment
situated in the source State.
Paragraph 7
Paragraph 7 incorporates into the Convention the rule of
Code section 864(c)(6). Like the Code section on which it is
based, paragraph 7 provides that any income or gain
attributable to a permanent establishment during its existence
is taxable in the Contracting State where the permanent
establishment is situated, even if the payment of that income
or gain is deferred until after the permanent establishment
ceases to exist. This rule applies with respect to this
Article, paragraph 6 of Article 10, paragraph 5 of Article 11
(Interest), paragraph 4 of Articles 12 (Royalties), paragraph 3
of Article 13 (Gains) and paragraph 2 of Article 21 (Other
Income).
The effect of this rule can be illustrated by the following
example. Assume a company that is a resident of the other
Contracting State and that maintains a permanent establishment
in the United States winds up the permanent establishment's
business and sells the permanent establishment's inventory and
assets to a U.S. buyer at the end of year 1 in exchange for an
interest-bearing installment obligation payable in full at the
end of year 3. Despite the fact that Article 13's threshold
requirement for U.S. taxation is not met in year 3 because the
company has no permanent establishment in the United States,
the United States may tax the deferred income payment
recognized by the company in year 3.
Relationship to Other Articles
This Article is subject to the saving clause of paragraph 4
of Article 1 (General Scope) of the Model. Thus, if a citizen
of the United States who is a resident of Malta under the
treaty derives business profits from the United States that are
not attributable to a permanent establishment in the United
States, the United States may, subject to the special foreign
tax credit rules of paragraph 4 of Article 23 (Relief from
Double Taxation), tax those profits, notwithstanding the
provision of paragraph 1 of this Article which would exempt the
income from U.S. tax.
The benefits of this Article are also subject to Article 22
(Limitation on Benefits). Thus, an enterprise of Malta and that
derives income effectively connected with a U.S. trade or
business may not claim the benefits of Article 7 unless the
resident carrying on the enterprise qualifies for such benefits
under Article 22.
ARTICLE 8 (SHIPPING AND AIR TRANSPORT)
This Article governs the taxation of profits from the
operation of ships and aircraft in international traffic. The
term ``international traffic'' is defined in subparagraph 1(f)
of Article 3 (General Definitions). The Exchange of Notes
accompanying the Convention provides that neither the
provisions of Article 8 nor any other provision of the
Convention shall affect the continued validity and application
of the provisions of the Agreement between the United States
and Malta regarding the Taxation of Shipping and Aircraft
effected by exchange of notes dated at Washington December 26,
1996, and March 11, 1997.
Paragraph 1
Paragraph 1 provides that profits derived by an enterprise
of a Contracting State from the operation in international
traffic of ships or aircraft are taxable only in that
Contracting State. Because paragraph 6 of Article 7 (Business
Profits) defers to Article 8 with respect to shipping income,
such income derived by a resident of one of the Contracting
States may not be taxed in the other State even if the
enterprise has a permanent establishment in that other State.
Thus, if a U.S. airline has a ticket office in Malta, Malta may
not tax the airline's profits attributable to that office under
Article 7. Since entities engaged in international
transportation activities normally will have many permanent
establishments in a number of countries, the rule avoids
difficulties that would be encountered in attributing income to
multiple permanent establishments if the income were covered by
Article 7.
Paragraph 2
The income from the operation of ships or aircraft in
international traffic that is exempt from tax under paragraph 1
is defined in paragraph 2.
In addition to income derived directly from the operation
of ships and aircraft in international traffic, this definition
also includes certain items of rental income. First, income of
an enterprise of a Contracting State from the rental of ships
or aircraft on a full basis (i.e., with crew) is income of the
lessor from the operation of ships and aircraft in
international traffic and, therefore, is exempt from tax in the
other Contracting State under paragraph 1. Also, paragraph 2
encompasses income from the lease of ships or aircraft on a
bareboat basis (i.e., without crew), either when the income is
incidental to other income of the lessor from the operation of
ships or aircraft in international traffic, or when the ships
or aircraft are operated in international traffic by the
lessee. If neither of those two conditions apply, income from
the bareboat rentals would constitute business profits. The
coverage of Article 8 is therefore broader than that of Article
8 of the OECD Model, which covers bareboat leasing only when it
is incidental to other income of the lessor from the operation
of ships of aircraft in international traffic.
Paragraph 2 also clarifies, consistent with the Commentary
to Article 8 of the OECD Model, that income earned by an
enterprise from the inland transport of property or passengers
within either Contracting State falls within Article 8 if the
transport is undertaken as part of the international transport
of property or passengers by the enterprise. Thus, if a U.S.
shipping company contracts to carry property from Malta to a
U.S. city and, as part of that contract, it transports the
property by truck from its point of origin to an airport in
Malta (or it contracts with a trucking company to carry the
property to the airport) the income earned by the U.S. shipping
company from the overland leg of the journey would be taxable
only in the United States. Similarly, Article 8 also would
apply to all of the income derived from a contract for the
international transport of goods, even if the goods were
transported to the port by a lighter, not by the vessel that
carried the goods in international waters.
Finally, certain non-transport activities that are an
integral part of the services performed by a transport company,
or are ancillary to the enterprise's operation of ships or
aircraft in international traffic, are understood to be covered
in paragraph 1, though they are not specified in paragraph 2.
These include, for example, the provision of goods and services
by engineers, ground and equipment maintenance and staff, cargo
handlers, catering staff and customer services personnel. Where
the enterprise provides such goods to, or performs services
for, other enterprises and such activities are directly
connected with or ancillary to the enterprise's operation of
ships or aircraft in international traffic, the profits from
the provision of such goods and services to other enterprises
will fall under this paragraph.
For example, enterprises engaged in the operation of ships
or aircraft in international traffic may enter into pooling
arrangements for the purposes of reducing the costs of
maintaining facilities needed for the operation of their ships
or aircraft in other countries. For instance, where an airline
enterprise agrees (for example, under an International Airlines
Technical Pool agreement) to provide spare parts or maintenance
services to other airlines landing at a particular location
(which allows it to benefit from these services at other
locations), activities carried on pursuant to that agreement
will be ancillary to the operation of aircraft in international
traffic by the enterprise.
Also, advertising that the enterprise may do for other
enterprises in magazines offered aboard ships or aircraft that
it operates in international traffic or at its business
locations, such as ticket offices, is ancillary to its
operation of these ships or aircraft. Profits generated by such
advertising fall within this paragraph. Income earned by
concessionaires, however, is not covered by Article 8. These
interpretations of paragraph 1 also are consistent with the
Commentary to Article 8 of the OECD Model.
Paragraph 3
Under this paragraph, profits of an enterprise of a
Contracting State from the use, maintenance or rental of
containers (including equipment for their transport) are exempt
from tax in the other Contracting State, unless those
containers are used for transport solely in the other
Contracting State. This result obtains under paragraph 3
regardless of whether the recipient of the income is engaged in
the operation of ships or aircraft in international traffic,
and regardless of whether the enterprise has a permanent
establishment in the other Contracting State. Only income from
the use, maintenance or rental of containers that is incidental
to other income from international traffic is covered by
Article 8 of the OECD Model.
Paragraph 4
This paragraph clarifies that the provisions of paragraphs
1 and 3 also apply to profits derived by an enterprise of a
Contracting State from participation in a pool, joint business
or international operating agency. This refers to various
arrangements for international cooperation by carriers in
shipping and air transport. For example, airlines from two
countries may agree to share the transport of passengers
between the two countries. They each will fly the same number
of flights per week and share the revenues from that route
equally, regardless of the number of passengers that each
airline actually transports. Paragraph 4 makes clear that with
respect to each carrier the income dealt with in the Article is
that carrier's share of the total transport, not the income
derived from the passengers actually carried by the airline.
This paragraph corresponds to paragraph 4 of Article 8 of the
OECD Model.
Relationship to Other Articles
The taxation of gains from the alienation of ships,
aircraft or containers is not dealt with in this Article but in
paragraph 4 of Article 13 (Gains).
As with other benefits of the Convention, the benefit of
exclusive residence country taxation under Article 8 is
available to an enterprise only if it is entitled to benefits
under Article 22 (Limitation on Benefits).
This Article also is subject to the saving clause of
paragraph 4 of Article 1 (General Scope) of the Model. Thus, if
a citizen of the United States who is a resident of Malta
derives profits from the operation of ships or aircraft in
international traffic, notwithstanding the exclusive residence
country taxation in paragraph 1 of Article 8, the United States
may, subject to the special foreign tax credit rules of
paragraph 4 of Article 23 (Relief from Double Taxation), tax
those profits as part of the worldwide income of the citizen.
(This is an unlikely situation, however, because non-tax
considerations (e.g., insurance) generally result in shipping
activities being carried on in corporate form.)
ARTICLE 9 (ASSOCIATED ENTERPRISES)
This Article incorporates in the Convention the arm's-
length principle reflected in the U.S. domestic transfer
pricing provisions, particularly Code section 482. It provides
that when related enterprises engage in a transaction on terms
that are not arm's-length, the Contracting States may make
appropriate adjustments to the taxable income and tax liability
of such related enterprises to reflect what the income and tax
of these enterprises with respect to the transaction would have
been had there been an arm's-length relationship between them.
Paragraph 1
This paragraph addresses the situation where an enterprise
of a Contracting State is related to an enterprise of the other
Contracting State, and there are arrangements or conditions
imposed between the enterprises in their commercial or
financial relations that are different from those that would
have existed in the absence of the relationship. Under these
circumstances, the Contracting States may adjust the income (or
loss) of the enterprise to reflect what it would have been in
the absence of such a relationship.
The paragraph identifies the relationships between
enterprises that serve as a prerequisite to application of the
Article. As the Commentary to the OECD Model makes clear, the
necessary element in these relationships is effective control,
which is also the standard for purposes of section 482. Thus,
the Article applies if an enterprise of one State participates
directly or indirectly in the management, control, or capital
of the enterprise of the other State. Also, the Article applies
if any third person or persons participate directly or
indirectly in the management, control, or capital of
enterprises of different States. For this purpose, all types of
control are included, i.e., whether or not legally enforceable
and however exercised or exercisable.
The fact that a transaction is entered into between such
related enterprises does not, in and of itself, mean that a
Contracting State may adjust the income (or loss) of one or
both of the enterprises under the provisions of this Article.
If the conditions of the transaction are consistent with those
that would be made between independent persons, the income
arising from that transaction should not be subject to
adjustment under this Article.
Similarly, the fact that associated enterprises may have
concluded arrangements, such as cost sharing arrangements or
general services agreements, is not in itself an indication
that the two enterprises have entered into a non-arm's-length
transaction that should give rise to an adjustment under
paragraph 1. Both related and unrelated parties enter into such
arrangements (e.g., joint venturers may share some development
costs). As with any other kind of transaction, when related
parties enter into an arrangement, the specific arrangement
must be examined to see whether or not it meets the arm's-
length standard. In the event that it does not, an appropriate
adjustment may be made, which may include modifying the terms
of the agreement or re-characterizing the transaction to
reflect its substance.
It is understood that the ``commensurate with income''
standard for determining appropriate transfer prices for
intangibles, added to Code section 482 by the Tax Reform Act of
1986, was designed to operate consistently with the arm's-
length standard. The implementation of this standard in the
section 482 regulations is in accordance with the general
principles of paragraph 1 of Article 9 of the Convention, as
interpreted by the OECD Transfer Pricing Guidelines.
This Article also permits tax authorities to deal with thin
capitalization issues. They may, in the context of Article 9,
scrutinize more than the rate of interest charged on a loan
between related persons. They also may examine the capital
structure of an enterprise, whether a payment in respect of
that loan should be treated as interest, and, if it is treated
as interest, under what circumstances interest deductions
should be allowed to the payor. Paragraph 2 of the Commentary
to Article 9 of the OECD Model, together with the U.S.
observation set forth in paragraph 15, sets forth a similar
understanding of the scope of Article 9 in the context of thin
capitalization.
Paragraph 2
When a Contracting State has made an adjustment that is
consistent with the provisions of paragraph 1, and the other
Contracting State agrees that the adjustment was appropriate to
reflect arm's-length conditions, that other Contracting State
is obligated to make a correlative adjustment (sometimes
referred to as a ``corresponding adjustment'') to the tax
liability of the related person in that other Contracting
State. Although the OECD Model does not specify that the other
Contracting State must agree with the initial adjustment before
it is obligated to make the correlative adjustment, the
Commentary makes clear that the paragraph is to be read that
way.
As explained in the Commentary to Article 9 of the OECD
Model, Article 9 leaves the treatment of ``secondary
adjustments'' to the laws of the Contracting States. When an
adjustment under Article 9 has been made, one of the parties
will have in its possession funds that it would not have had at
arm's length. The question arises as to how to treat these
funds. In the United States the general practice is to treat
such funds as a dividend or contribution to capital, depending
on the relationship between the parties. Under certain
circumstances, the parties may be permitted to restore the
funds to the party that would have the funds had the
transactions been entered into on arm's length terms, and to
establish an account payable pending restoration of the funds.
See Rev. Proc. 99-32, 1999-2 C.B. 296.
The Contracting State making a secondary adjustment will
take the other provisions of the Convention, where relevant,
into account. For example, if the effect of a secondary
adjustment is to treat a U.S. corporation as having made a
distribution of profits to its parent corporation in the other
Contracting State, the provisions of Article 10 (Dividends)
will apply, and the United States may impose a 5 percent
withholding tax on the dividend. Also, if under Article 23
(Relief from Double Taxation) the other State generally gives a
credit for taxes paid with respect to such dividends, it would
also be required to do so in this case.
The competent authorities are authorized by paragraph 3 of
Article 25 (Mutual Agreement Procedure) to consult, if
necessary, to resolve any differences in the application of
these provisions. For example, there may be a disagreement over
whether an adjustment made by a Contracting State under
paragraph 1 was appropriate.
If a correlative adjustment is made under paragraph 2, it
is to be implemented, pursuant to paragraph 2 of Article 25
(Mutual Agreement Procedure), notwithstanding any time limits
or other procedural limitations in the law of the Contracting
State making the adjustment. If a taxpayer has entered a
closing agreement (or other written settlement) with the United
States prior to bringing a case to the competent authorities,
the U.S. competent authority will endeavor only to obtain a
correlative adjustment from Malta. See, Rev. Proc. 2006-54,
2006-49 I.R.B. 1035, Section 7.05.
Relationship to Other Articles
The saving clause of paragraph 4 of Article 1 (General
Scope) does not apply to paragraph 2 of Article 9 by virtue of
an exception to the saving clause in subparagraph 5(a) of
Article 1. Thus, even if the statute of limitations has run, a
refund of tax can be made in order to implement a correlative
adjustment. Statutory or procedural limitations, however,
cannot be overridden to impose additional tax, because
paragraph 2 of Article 1 provides that the Convention cannot
restrict any statutory benefit.
ARTICLE 10 (DIVIDENDS)
Article 10 provides rules for the taxation of dividends
paid by a company that is a resident of one Contracting State
to a beneficial owner that is a resident of the other
Contracting State. The Article provides for full residence-
State taxation of such dividends and a limited source-State
right to tax. Article 10 also provides rules for the imposition
of a tax on branch profits by the State of source. Finally, the
article prohibits a State from imposing taxes on a company
resident in the other Contracting State, other than a branch
profits tax, on undistributed earnings.
Paragraph 1
The right of a shareholder's country of residence to tax
dividends arising in the source country is preserved by
paragraph 1, which permits a Contracting State to tax its
residents on dividends paid to them by a company that is a
resident of the other Contracting State. For dividends from any
other source paid to a resident, Article 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. With respect to dividends
paid by a company resident in the United States, paragraph 2(a)
generally limits the rate of U.S. withholding tax State to 15
percent of the gross amount of the dividend. If, however, the
beneficial owner of the dividend is a company resident in Malta
and owns directly shares representing at least 10 percent of
the voting power of the company paying the dividend, then the
rate of withholding tax in the United States 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. With
respect to dividends paid by a company resident in Malta to a
beneficial owner that is a resident of the United States,
subparagraph 2(b) limits the tax that may be charged by Malta
to the Maltese tax chargeable on the profits out of which the
dividends are paid.
The benefits of paragraph 2 may be granted at the time of
payment by means of reduced rate of withholding tax at source.
It also is consistent with the paragraph for tax to be withheld
at the time of payment at full statutory rates, and the treaty
benefit to be granted by means of a subsequent refund so long
as such procedures are applied in a reasonable manner.
The determination of whether the ownership threshold for
subparagraph 2(a)(i) 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, the
determination would generally 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 State granting treaty benefits (i.e., the source
State). The beneficial owner of the dividend for purposes of
Article 10 is the person to which the income is attributable
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 limitations are confirmed by paragraph 12 of the
Commentary to Article 10 of the OECD Model. See also paragraph
24 of the Commentary to Article 1 of the OECD Model.
Special rules, however, apply to shares that are held
through fiscally transparent entities. In that case, the rules
of paragraph 6 of Article 1 (General Scope) will apply to
determine whether the dividends should be treated as having
been derived by a resident of a Contracting State. Residence-
State principles shall be used to determine who derives the
dividend, to assure that the dividends for which the source
State grants benefits of the Convention will be taken into
account for tax purposes by a resident of the residence State.
Source State principles of beneficial ownership shall then
apply to determine whether the person who derives the
dividends, or another resident of the other Contracting State,
is the beneficial owner of the dividend. If the person who
derives the dividend under paragraph 6 of Article 1 would not
be treated a nominee, agent, custodian, conduit, etc. under the
source State's principles for determining beneficial ownership
as, that person will be treated as the beneficial owner of the
income, profits or gains for purposes of the Convention.
Assume for instance, that a company resident in Malta pays
a dividend to LLC, an entity that is treated as fiscally
transparent for U.S. tax purposes but is treated as a company
for Maltese tax purposes. USCo, a company incorporated in the
United States, is the sole interest holder in LLC. Paragraph 6
of Article 1 provides that USCo derives the dividend. Malta's
principles of beneficial ownership shall then be applied to
USCo. If under the laws of Malta USCo is found not to be the
beneficial owner of the dividend, USCo will not be entitled to
the benefits of Article 10 with respect to such dividend. The
payment may be entitled to benefits, however, if USCo is found
to be a nominee, agent, custodian, or conduit for another
person who is a resident of the United States.
Beyond identifying the person to whom the principles of
beneficial ownership shall be applied, the principles of
paragraph 6 of Article 1 will also apply when determining
whether other requirements, such as the ownership threshold of
subparagraph 2(a)(i) have been satisfied.
For example, assume that MCo, a company that is a resident
of Malta, owns all of the outstanding shares in ThirdDE, an
entity that is disregarded for U.S. tax purposes that is
resident in a third country. ThirdDE owns 100% of the stock of
USCo. Malta views ThirdDE as fiscally transparent under its
domestic law, and taxes MCo currently on the income derived by
ThirdDE. In this case, MCo is treated as deriving the dividends
paid by USCo under paragraph 6 of Article 1. Moreover, MCo is
treated as owning the shares of USCo directly. The Convention
does not address what constitutes direct ownership for purposes
of Article 10. As a result, whether ownership is direct is
determined under the internal law of the State granting treaty
benefits (i.e., the source State) unless the context otherwise
requires. Accordingly, a company that holds stock through such
an entity will generally be considered to directly own such
stock for purposes of Article 10.
This result may change, however, if ThirdDE is regarded as
non-fiscally transparent under the laws of Malta. Assuming that
ThirdDE is treated as non-fiscally transparent by Malta, the
income will not be treated as derived by a resident of Malta
for purposes of the Convention. However, ThirdDE may still be
entitled to the benefits of the U.S. tax treaty, if any, with
its country of residence.
The same principles would apply in determining whether
companies holding shares through fiscally transparent entities
such as partnerships, trusts, and estates would qualify for
benefits. As a result, companies holding shares through such
entities may be able to claim the benefits of subparagraph
(a)(i) 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 subparagraph 6 of Article 1
(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 that dividends beneficially owned by a
pension fund may not be taxed in the Contracting State of which
the company paying the tax is a resident, unless such dividends
are derived from the carrying on of a business, directly or
indirectly, by the pension fund or through an associated
enterprise. For these purposes, the term ``pension fund'' is
defined in subparagraph 1(k) of Article 3 (General
Definitions).
Paragraph 4
Paragraph 4 imposes limitations on the rate reductions
provided by paragraphs 2 and 3 in the case of dividends paid by
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)(i).
The second sentence of subparagraph 4(a) provides that the
15 percent maximum rate of withholding tax of subparagraph
2(a)(ii) applies to dividends paid by RICs and that the
elimination of source-country withholding tax of paragraph 3
applies to dividends paid by RICs and beneficially owned by 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 paragraph 3 applies to dividends paid by
REITs and beneficially owned by a pension fund, provided that
one of the three following conditions is met. First, the
beneficial owner of the dividend is an individual or a pension
fund, in either case holding an interest of not more than 10
percent in the REIT. Second, the dividend is paid with respect
to a class of stock that is publicly traded and the beneficial
owner of the dividend is a person holding an interest of not
more than 5 percent of any class of the REIT's shares. Third,
the beneficial owner of the dividend holds an interest in the
REIT of not more than 10 percent and the REIT is
``diversified.''
Subparagraph (b) provides a definition of the term
``diversified.'' A REIT is diversified if the gross value of no
single interest in real property held by the REIT exceeds 10
percent of the gross value of the REIT's total interest in real
property. Foreclosure property is not considered an interest in
real property, and a REIT holding a partnership interest is
treated as owning its proportionate share of any interest in
real property held by the partnership.
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 Malta 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 that in
turn held the portfolio. 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 on dividends paid to pension funds.
Similarly, a resident of Malta directly holding U.S. real
property would pay U.S. tax upon the sale of the property
either at a 30 percent rate of withholding tax on the gross
income or at graduated rates on the net income. As in the
preceding example, by placing the real property in a REIT, the
investor could, absent a special rule, transform income from
the sale of real estate into dividend income from the REIT,
taxable at the rates provided in Article 10, significantly
reducing the U.S. tax that otherwise would be imposed.
Paragraph 4 prevents this result and thereby avoids a disparity
between the taxation of direct real estate investments and real
estate investments made through REITs. 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.
Paragraph 5
Paragraph 5 defines the term dividends broadly and
flexibly. The definition is intended to cover all arrangements
that yield a return on an equity investment in a corporation as
determined under the tax law of the state of source, as well as
arrangements that might be developed in the future.
The term includes income from shares, or other corporate
rights that are not treated as debt under the law of the source
State, that participate in the profits of the company. The term
also includes income that is subjected to the same tax
treatment as income from shares by the law of the State of
source. Thus, a constructive dividend that results from a non-
arm's length transaction between a corporation and a related
party is a dividend. In the case of the United States the term
dividend includes amounts treated as a dividend under U.S. law
upon the sale or redemption of shares or upon a transfer of
shares in a reorganization. See, e.g., Rev. Rul. 92-85, 1992-2
C.B. 69 (sale of foreign subsidiary's stock to U.S. sister
company is a deemed dividend to extent of the subsidiary's and
sister company's earnings and profits). Further, a distribution
from a U.S. publicly traded limited partnership, which is taxed
as a corporation under U.S. law, is a dividend for purposes of
Article 10. However, a distribution by a limited liability
company is not taxable by the United States under Article 10,
provided the limited liability company is not characterized as
an association taxable as a corporation under U.S. law.
Finally, a payment denominated as interest that is made by
a thinly capitalized corporation may be treated as a dividend
to the extent that the debt is recharacterized as equity under
the laws of the source State.
Paragraph 6
Paragraph 6 provides a rule for taxing dividends paid with
respect to holdings that form part of the business property of
a permanent establishment. In such case, the rules of Article 7
(Business Profits) shall apply. Accordingly, the dividends will
be taxed on a net basis using the rates and rules of taxation
generally applicable to residents of the State in which the
permanent establishment is located, as such rules may be
modified by the Convention. An example of dividends paid with
respect to the business property of a permanent establishment
would be dividends derived by a dealer in stock or securities
from stock or securities that the dealer held for sale to
customers.
Paragraph 7
The right of a Contracting State to tax dividends paid by a
company that is a resident of the other Contracting State is
restricted by paragraph 7 to cases in which the dividends are
paid to a resident of that Contracting State or are
attributable to a permanent establishment 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.
The paragraph also restricts the right of a Contracting
State to impose corporate level taxes on undistributed profits,
other than a branch profits tax. The paragraph does not
restrict a State's right to tax its resident shareholders on
undistributed earnings of a corporation resident in the other
State. Thus, the authority of the United States to impose taxes
on subpart F income and on earnings deemed invested in U.S.
property, and its tax on income of a passive foreign investment
company that is a qualified electing fund is in no way
restricted by this provision.
Paragraph 8
Paragraph 8 permits a Contracting State to impose a branch
profits tax on a company resident in the other Contracting
State. The tax is in addition to other taxes permitted by the
Convention. The term ``company'' is defined in subparagraph
1(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 (immovable) property in that Contracting State that is
taxed on a net basis under Article 6 (Income from Real
(Immovable) Property), or realizes gains taxable in that State
under paragraph 1 of Article 13 (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
(Immovable) Property), 7 (Business Profits) or 13 (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. If Malta also imposes a branch profits tax,
the base of its tax must be limited to an amount that is
analogous to the dividend equivalent amount.
As discussed in the explanation of paragraph 2 of Article 1
(General Scope), consistency principles prohibit a taxpayer
from applying provisions of the Code and this Convention
inconsistently. In the context of the branch profits tax, this
consistency requirement means that if a Maltese company uses
the principles of Article 7 to determine its U.S. taxable
income then it must also use those principles to determine its
dividend equivalent amount. Similarly, if the Maltese company
instead uses the Code to determine its U.S. taxable income it
must also use the Code to determine its dividend equivalent
amount. As in the case of Article 7, if a Maltese company, for
example, does not from year to year consistently apply the Code
or the Convention to determine its dividend equivalent amount,
then the Maltese company must make appropriate adjustments or
recapture amounts that would otherwise be subject to U.S.
branch profits tax if it had consistently applied the Code or
the Convention to determine its dividend equivalent amount from
year to year.
Subparagraph (b) provides that the branch profits tax shall
not be imposed at a rate exceeding five percent. It is intended
that subparagraph (b) apply equally if a taxpayer determines
its taxable income under the laws of a Contracting State or
under the provisions of Article 7. For example, as discussed
above, consistency principles require a Maltese company that
determines its U.S. taxable income under the Code to also
determine its dividend equivalent amount under the Code. In
that case, subparagraph (b) would apply even though the Maltese
company did not determine its dividend equivalent amount using
the principles of Article 7.
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of dividends, the saving clause of paragraph 4 of
Article 1 permits the United States to tax dividends received
by its residents and citizens, subject to the special foreign
tax credit rules of paragraph 4 of Article 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 on Benefits). Thus, if a
resident of the other Contracting State is the beneficial owner
of dividends paid by a U.S. corporation, the shareholder must
qualify for treaty benefits under at least one of the tests of
Article 22 in order to receive the benefits of this Article.
ARTICLE 11 (INTEREST)
Article 11 provides rules for the taxation of interest
arising in one Contracting State and paid to a beneficial owner
that is a resident of the other Contracting State.
Paragraph 1
Paragraph 1 grants to the State of residence the non-
exclusive right to tax interest beneficially owned by its
residents and arising in the other Contracting State.
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined under the internal law
of the State granting treaty benefits (i.e., the source State).
The beneficial owner of the interest for purposes of Article 11
is the person to which the income is attributable under the
laws of the source State. Thus, if interest arising in a
Contracting State is received by a nominee or agent that is a
resident of the other State on behalf of a person that is not a
resident of that other State, the interest is not entitled to
the benefits of Article 11. However, interest received by a
nominee on behalf of a resident of that other State would be
entitled to benefits. These limitations are confirmed by
paragraph 9 of the OECD Commentary to Article 11.
Paragraph 2
Paragraph 2 provides that the State of source also may tax
interest beneficially owned by a resident of the other
Contracting State, but the rate of tax shall be limited to 10
percent of the gross amount of the interest.
Paragraph 3
Paragraph 3 provides anti-abuse exceptions to paragraphs 1
and 2 for two classes of interest payments.
The first class of interest, dealt with in subparagraph (a)
is U.S.-source contingent interest of a type that does not
qualify as portfolio interest under U.S. domestic law. The
cross-reference to the U.S. definition of contingent interest,
which is found in section 871(h)(4) of the Code, is intended to
ensure that the exceptions of section 871(h)(4)(c) will be
applicable. Any such interest may be taxed in the United States
according to U.S. domestic law. If the beneficial owner is a
resident of Malta, however, the gross amount of the interest
may be taxed at a rate not exceeding 15 percent.
The second class of interest is dealt with in subparagraph
c) of paragraph 2. This exception is consistent with the policy
of Code sections 860E(e) and 860G(b) that excess inclusions
with respect to a real estate mortgage investment conduit
(REMIC) should bear full U.S. tax in all cases. Without a full
tax at source foreign purchasers of residual interests would
have a competitive advantage over U.S. purchasers at the time
these interests are initially offered. Also, absent this rule,
the U.S. fisc would suffer a revenue loss with respect to
mortgages held in a REMIC because of opportunities for tax
avoidance created by differences in the timing of taxable and
economic income produced by these interests.
Paragraph 4
The term ``interest'' as used in Article 11 is defined in
paragraph 4 to include, inter alia, income from debt claims of
every kind, whether or not secured by a mortgage. Penalty
charges for late payment are excluded from the definition of
interest. Interest that is paid or accrued subject to a
contingency is within the ambit of Article 11. This includes
income from a debt obligation carrying the right to participate
in profits. The term does not, however, include amounts that
are treated as dividends under Article 10 (Dividends).
The term interest also includes amounts subject to the same
tax treatment as income from money lent under the law of the
State in which the income arises. Thus, for purposes of the
Convention, amounts that the United States will treat as
interest include (i) the difference between the issue price and
the stated redemption price at maturity of a debt instrument
(i.e., original issue discount (``OID'')), which may be wholly
or partially realized on the disposition of a debt instrument
(section 1273), (ii) amounts that are imputed interest on a
deferred sales contract (section 483), (iii) amounts treated as
interest or OID under the stripped bond rules (section 1286),
(iv) amounts treated as original issue discount under the
below-market interest rate rules (section 7872), (v) a
partner's distributive share of a partnership's interest income
(section 702), (vi) the interest portion of periodic payments
made under a ``finance lease'' or similar contractual
arrangement that in substance is a borrowing by the nominal
lessee to finance the acquisition of property, (vii) amounts
included in the income of a holder of a residual interest in a
REMIC (section 860E), because these amounts generally are
subject to the same taxation treatment as interest under U.S.
tax law, and (viii) interest with respect to notional principal
contracts that are re-characterized as loans because of a
``substantial non-periodic payment.''
Paragraph 5
Paragraph 5 provides a rule for taxing interest in cases
where the beneficial owner of the interest carries on business
through a permanent establishment in the State of source
situated in that State and the interest is attributable to that
permanent establishment. In such cases the provisions of
Article 7 (Business Profits) will apply and the State of source
will retain the right to impose tax on such interest income.
In the case of a permanent establishment that once existed
in the State of source but that no longer exists, the
provisions of paragraph 5 also apply, by virtue of paragraph 7
of Article 7, to interest that would be attributable to such a
permanent establishment or fixed base if it did exist in the
year of payment or accrual. See the Technical Explanation of
paragraph 7 of Article 7.
Paragraph 6
Paragraph 6 provides a source rule for interest that is
identical in substance to the interest source rule of the OECD
Model. Interest is considered to arise in a Contracting State
if paid by a resident of that State. As an exception, interest
on a debt incurred in connection with a permanent establishment
in one of the States and borne by the permanent establishment
is deemed to arise in that State. For this purpose, interest is
considered to be borne by a permanent establishment if it is
allocable to taxable income of that permanent establishment
Paragraph 7
Paragraph 7 provides that in cases involving special
relationships between the payor and the beneficial owner of
interest income, Article 11 applies only to that portion of the
total interest payments that would have been made absent such
special relationships (i.e., an arm's-length interest payment).
Any excess amount of interest paid remains taxable according to
the laws of the United States and Malta, respectively, with due
regard to the other provisions of the Convention. Thus, if the
excess amount would be treated under the source country's law
as a distribution of profits by a corporation, such amount
could be taxed as a dividend rather than as interest, but the
tax would be subject, if appropriate, to the rate limitations
of paragraph 2 of Article 10 (Dividends).
The term ``special relationship'' is not defined in the
Convention. In applying this paragraph the United States
considers the term to include the relationships described in
Article 9, which in turn corresponds to the definition of
``control'' for purposes of section 482 of the Code.
This paragraph does not address cases where, owing to a
special relationship between the payer and the beneficial owner
or between both of them and some other person, the amount of
the interest is less than an arm's-length amount. In those
cases a transaction may be characterized to reflect its
substance and interest may be imputed consistent with the
definition of interest in paragraph 4. The United States would
apply section 482 or 7872 of the Code to determine the amount
of imputed interest in those cases.
Paragraph 8
Paragraph 8 permits the United States to impose its branch
level interest tax on a corporation resident in Malta. The base
of this tax is the excess, if any, of the interest deductible
in the United States in computing the profits of the
corporation that are subject to tax in the United States and
either attributable to a permanent establishment in the United
States or subject to tax in the United States under Article 6
(Income from Real Property) or paragraph 1 of Article 13
(Alienation of Property) of the Convention over the interest
paid by the permanent establishment or trade or business in the
United States. Such excess interest may be taxed as if it were
interest arising in the United States and beneficially owned by
the corporation resident in Malta. Thus, such excess interest
may be taxed by the United States at a rate not to exceed the
10 percent rate provided for in paragraph 2.
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of interest, the saving clause of paragraph 4 of
Article 1 permits the United States to tax its residents and
citizens, subject to the special foreign tax credit rules of
paragraph 4 of Article 23 (Relief from Double Taxation), as if
the Convention had not come into force.
As with other benefits of the Convention, the benefits of
Article 11 are available to a resident of the other State only
if that resident is entitled to those benefits under the
provisions of Article 22 (Limitation on Benefits).
ARTICLE 12 (ROYALTIES)
Article 12 provides rules for the taxation of royalties
arising in one Contracting State and paid to a beneficial owner
that is a resident of the other Contracting State.
Paragraph 1
Paragraph 1 grants to the State of residence the non-
exclusive right to tax royalties beneficially owned by its
residents and arising in the other Contracting State.
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined under the internal law
of the State granting treaty benefits (i.e., the source State).
The beneficial owner of the royalty for purposes of Article 12
is the person to which the income is attributable under the
laws of the source State. Thus, if a royalty arising in a
Contracting State is received by a nominee or agent that is a
resident of the other State on behalf of a person that is not a
resident of that other State, the royalty is not entitled to
the benefits of Article 12. However, a royalty received by a
nominee on behalf of a resident of that other State would be
entitled to benefits. These limitations are confirmed by
paragraph 4 of the OECD Commentary to Article 12.
Paragraph 2
Paragraph 2 provides that the State of source also may tax
royalties beneficially owned by a resident of the other
Contracting State, but the rate of tax shall be limited to 10
percent of the gross amount of the royalties.
Paragraph 3
Paragraph 3 defines the term ``royalties,`` as used in
Article 12, to include any consideration for the use of, or the
right to use, any copyright of literary, artistic, scientific
or other work (such as cinematographic films), any patent,
trademark, design or model, plan, secret formula or process, or
for information concerning industrial, commercial, or
scientific experience. The term ``royalties'' also includes
gain derived from the alienation of any right or property that
would give rise to royalties, to the extent the gain is
contingent on the productivity, use, or further alienation
thereof. Gains that are not so contingent are dealt with under
Article 13 (Gains). The term ``royalties,'' however, does not
include income from leasing personal property.
The term royalties is defined in the Convention and
therefore is generally independent of domestic law. Certain
terms used in the definition are not defined in the Convention,
but these may be defined under domestic tax law. For example,
the term ``secret process or formulas'' is found in the Code,
and its meaning has been elaborated in the context of sections
351 and 367. See Rev. Rul. 55-17, 1955-1 C.B. 388; Rev. Rul.
64-56, 1964-1 C.B. 133; Rev. Proc. 69-19, 1969-2 C.B. 301.
Consideration for the use or right to use cinematographic
films, or works on film, tape, or other means of reproduction
in radio or television broadcasting is specifically included in
the definition of royalties. It is intended that, with respect
to any subsequent technological advances in the field of radio
or television broadcasting, consideration received for the use
of such technology will also be included in the definition of
royalties.
If an artist who is resident in one Contracting State
records a performance in the other Contracting State, retains a
copyrighted interest in a recording, and receives payments for
the right to use the recording based on the sale or public
playing of the recording, then the right of such other
Contracting State to tax those payments is governed by Article
12. See Boulez v. Commissioner, 83 T.C. 584 (1984), affd, 810
F.2d 209 (D.C. Cir. 1986). By contrast, if the artist earns in
the other Contracting State income covered by Article 16
(Entertainers and Sportsmen), for example, endorsement income
from the artist's attendance at a film screening, and if such
income also is attributable to one of the rights described in
Article 12 (e.g., the use of the artist's photograph in
promoting the screening), Article 16 and not Article 12 is
applicable to such income.
Computer software generally is protected by copyright laws
around the world. Under the Convention, consideration received
for the use, or the right to use, computer software is treated
either as royalties or as business profits, depending on the
facts and circumstances of the transaction giving rise to the
payment.
The primary factor in determining whether consideration
received for the use, or the right to use, computer software is
treated as royalties or as business profits is the nature of
the rights transferred. See Treas. Reg. section 1.861-18. The
fact that the transaction is characterized as a license for
copyright law purposes is not diapositive. For example, a
typical retail sale of ``shrink wrap'' software generally will
not be considered to give rise to royalty income, even though
for copyright law purposes it may be characterized as a
license.
The means by which the computer software is transferred are
not relevant for purposes of the analysis. Consequently, if
software is electronically transferred but the rights obtained
by the transferee are substantially equivalent to rights in a
program copy, the payment will be considered business profits.
The term ``industrial, commercial, or scientific
experience'' (sometimes referred to as ``know-how'') has the
meaning ascribed to it in paragraph 11 et seq. of the
Commentary to Article 12 of the OECD Model. Consistent with
that meaning, the term may include information that is
ancillary to a right otherwise giving rise to royalties, such
as a patent or secret process.
Know-how also may include, in limited cases, technical
information that is conveyed through technical or consultancy
services. It does not include general educational training of
the user's employees, nor does it include information developed
especially for the user, such as a technical plan or design
developed according to the user's specifications. Thus, as
provided in paragraph 11.3 of the Commentary to Article 12 of
the OECD Model, the term ``royalties'' does not include
payments received as consideration for after-sales service, for
services rendered by a seller to a purchaser under a warranty,
or for pure technical assistance.
The term ``royalties'' also does not include payments for
professional services (such as architectural, engineering,
legal, managerial, medical, software development services). For
example, income from the design of a refinery by an engineer
(even if the engineer employed know-how in the process of
rendering the design) or the production of a legal brief by a
lawyer is not income from the transfer of know-how taxable
under Article 12, but is income from services taxable under
either Article 7 (Business Profits) or Article 14 (Income from
Employment). Professional services may be embodied in property
that gives rise to royalties, however. Thus, if a professional
contracts to develop patentable property and retains rights in
the resulting property under the development contract,
subsequent license payments made for those rights would be
royalties.
Paragraph 4
This paragraph provides a rule for taxing royalties in
cases where the beneficial owner of the royalties carries on
business through a permanent establishment in the state of
source and the royalties are attributable to that permanent
establishment. In such cases the provisions of Article 7 will
apply.
The provisions of paragraph 7 of Article 7 apply to this
paragraph. For example, royalty income that is attributable to
a permanent establishment and that accrues during the existence
of the permanent establishment, but is received after the
permanent establishment no longer exists, remains taxable under
the provisions of Article 7, and not under this Article.
Paragraph 5
Paragraph 5 contains the source rule for royalties. Under
paragraph 5, royalties are treated as arising in a Contracting
State when they are in consideration for the use of, or the
right to use, property, information or experience in that
State. This source rule parallels the source rule in section
861(a)(4) of the Code.
Paragraph 6
Paragraph 6 provides that in cases involving special
relationships between the payor and beneficial owner of
royalties, Article 12 applies only to the extent the royalties
would have been paid absent such special relationships (i.e.,
an arm's-length royalty). Any excess amount of royalties paid
remains taxable according to the laws of the two Contracting
States, with due regard to the other provisions of the
Convention. If, for example, the excess amount is treated as a
distribution of corporate profits under domestic law, such
excess amount will be taxed as a dividend rather than as
royalties, but the tax imposed on the dividend payment will be
subject to the rate limitations of paragraph 2 of Article 10
(Dividends).
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of royalties, the saving clause of paragraph 4 of
Article 1 (General Scope) permits the United States to tax its
residents and citizens, subject to the special foreign tax
credit rules of paragraph 4 of Article 23 (Relief from Double
Taxation), as if the Convention had not come into force.
As with other benefits of the Convention, the benefits of
Article 12 are available to a resident of the other State only
if that resident is entitled to those benefits under Article 22
(Limitation on Benefits).
ARTICLE 13 (GAINS)
Article 13 assigns either primary or exclusive taxing
jurisdiction over gains from the alienation of property to the
State of residence or the State of source.
Paragraph 1
Paragraph 1 of Article 13 preserves the non-exclusive right
of the State of source to tax gains attributable to the
alienation of real property situated in that State. The
paragraph therefore permits the United States to apply section
897 of the Code to tax gains derived by a resident of Malta
that are attributable to the alienation of real property
situated in the United States (as defined in paragraph 2).
Gains attributable to the alienation of real property include
gains from any other property that is treated as a real
property interest within the meaning of paragraph 2.
Paragraph 1 refers to gains ``attributable to the
alienation of real (immovable) property'' rather than the OECD
Model phrase ``gains from the alienation'' to clarify that the
United States will look through distributions made by a REIT
and certain RICs. Accordingly, distributions made by a REIT or
certain RICs are taxable under paragraph 1 of Article 13 (not
under Article 10 (Dividends)) when they are attributable to
gains derived from the alienation of real property.
Paragraph 2
This paragraph defines the term ``real (immovable) property
situated in the other Contracting State.'' The term includes
real (immovable) property referred to in Article 6 (i.e., an
interest in the real (immovable) property itself), a ``United
States real property interest'' (when the United States is the
other Contracting State under paragraph 1), and an equivalent
interest in real (immovable) property situated in Malta (when
Malta is the other Contracting State under paragraph 1).
Under section 897(c) of the Code the term ``United States
real property interest'' includes shares in a U.S. corporation
that owns sufficient U.S. real property interests to satisfy an
asset-ratio test on certain testing dates. The term also
includes certain foreign corporations that have elected to be
treated as U.S. corporations for this purpose. Section 897(i).
Paragraph 3
Paragraph 3 of Article 13 deals with the taxation of
certain gains from the alienation of movable property forming
part of the business property of a permanent establishment that
an enterprise of a Contracting State has in the other
Contracting State. This also includes gains from the alienation
of such a permanent establishment (alone or with the whole
enterprise). Such gains may be taxed in the State in which the
permanent establishment is located.
A resident of Malta that is a partner in a partnership
doing business in the United States generally will have a
permanent establishment in the United States as a result of the
activities of the partnership, assuming that the activities of
the partnership rise to the level of a permanent establishment.
Rev. Rul. 91-32, 1991-1 C.B. 107. Further, under paragraph 3,
the United States generally may tax a partner's distributive
share of income realized by a partnership on the disposition of
movable property forming part of the business property of the
partnership in the United States.
The gains subject to paragraph 3 may be taxed in the State
in which the permanent establishment is located, regardless of
whether the permanent establishment exists at the time of the
alienation. This rule incorporates the rule of section
864(c)(6) of the Code. Accordingly, income that is attributable
to a permanent establishment, but that is deferred and received
after the permanent establishment no longer exists, may
nevertheless be taxed by the State in which the permanent
establishment was located.
Paragraph 4
This paragraph limits the taxing jurisdiction of the State
of source with respect to gains from the alienation of ships or
aircraft operated in international traffic by the enterprise
alienating the ship or aircraft and from property (other than
real (immovable) property) pertaining to the operation or use
of such ships, aircraft, or containers.
Under paragraph 4, such income is taxable only in the
Contracting State in which the alienator is resident.
Notwithstanding paragraph 3, the rules of this paragraph apply
even if the income is attributable to a permanent establishment
maintained by the enterprise in the other Contracting State.
This result is consistent with the allocation of taxing rights
under Article 8 (Shipping and Air Transport).
Paragraph 5
Paragraph 5 provides a rule similar to paragraph 4 with
respect to gains from the alienation of containers and related
personal property. Such gains derived by an enterprise of a
Contracting State shall be taxable only in that Contracting
State unless the containers were used for the transport of
goods or merchandise solely within the other Contracting State.
The other Contracting State may not tax the gain, even if the
gain is attributable to a permanent establishment maintained by
the enterprise in that other Contracting State.
Paragraph 6
Paragraph 6 grants to the State of residence of the
alienator the exclusive right to tax gains from the alienation
of property other than property referred to in paragraphs 1
through 5. For example, gain derived from shares, other than
shares described in paragraphs 2 or 3, debt instruments and
various financial instruments, may be taxed only in the State
of residence, to the extent such income is not otherwise
characterized as income taxable under another article (e.g.,
Article 10 (Dividends) or Article 11 (Interest)). Similarly
gain derived from the alienation of tangible personal property,
other than tangible personal property described in paragraph 3,
may be taxed only in the State of residence of the alienator.
Gain derived from the alienation of any property, such as a
patent or copyright, that produces income covered by Article 12
(Royalties) is governed by the rules of Article 12 and not by
this article, provided that such gain is of the type described
in paragraph 3(b) of Article 12 (i.e., it is contingent on the
productivity, use, or disposition of the property).
Gains derived by a resident of a Contracting State from
real (immovable) property located in a third state are not
taxable in the other Contracting State, even if the sale is
attributable to a permanent establishment located in the other
Contracting State.
Relationship to Other Articles
Notwithstanding the foregoing limitations on taxation of
certain gains by the State of source, the saving clause of
paragraph 4 of Article 1 (General Scope) permits the United
States to tax its citizens and residents as if the Convention
had not come into effect. Thus, any limitation in this Article
on the right of the United States to tax gains does not apply
to gains of a U.S. citizen or resident.
The benefits of this Article are also subject to the
provisions of Article 22 (Limitation on Benefits). Thus, only a
resident of a Contracting State that satisfies one of the
conditions in Article 22 is entitled to the benefits of this
Article.
ARTICLE 14 (INCOME FROM EMPLOYMENT)
Article 14 apportions taxing jurisdiction over remuneration
derived by a resident of a Contracting State as an employee
between the States of source and residence.
Paragraph 1
The general rule of Article 14 is contained in paragraph 1.
Remuneration derived by a resident of a Contracting State as an
employee may be taxed by the State of residence, and the
remuneration also may be taxed by the other Contracting State
to the extent derived from employment exercised (i.e., services
performed) in that other Contracting State. Paragraph 1 also
provides that the more specific rules of Articles 15
(Directors' Fees), 17 (Pensions, Social Security, Annuities,
Alimony and Child Support), and 19 (Government Service) apply
in the case of employment income described in one of those
articles. Thus, even though the State of source has a right to
tax employment income under Article 14, it may not have the
right to tax that income under the Convention if the income is
described, for example, in Article 17 and is not taxable in the
State of source under the provisions of that article.
Article 14 applies to any form of compensation for
employment, including payments in kind. Paragraph 1.1 of the
Commentary to Article 16 of the OECD Model confirms that
interpretation.
Consistent with section 864(c)(6) of the Code, Article 14
also applies regardless of the timing of actual payment for
services. Consequently, a person who receives the right to a
future payment in consideration for services rendered in a
Contracting State would be taxable in that State even if the
payment is received at a time when the recipient is a resident
of the other Contracting State. Thus, a bonus paid to a
resident of a Contracting State with respect to services
performed in the other Contracting State with respect to a
particular taxable year would be subject to Article 14 for that
year even if it was paid after the close of the year. An
annuity received for services performed in a taxable year could
be subject to Article 14 despite the fact that it was paid in
subsequent years. In that case, it would be necessary to
determine whether the payment constitutes deferred
compensation, taxable under Article 14, or a qualified pension
subject to the rules of Article 17. Article 14 also applies to
income derived from the exercise of stock options granted with
respect to services performed in the host State, even if those
stock options are exercised after the employee has left the
source country. If Article 14 is found to apply, whether such
payments were taxable in the State where the employment was
exercised would depend on whether the tests of paragraph 2 were
satisfied in the year in which the services to which the
payment relates were performed.
Paragraph 2
Paragraph 2 sets forth an exception to the general rule
that employment income may be taxed in the State where it is
exercised. Under paragraph 2, the State where the employment is
exercised may not tax the income from the employment if three
conditions are satisfied: (a) the individual is present in the
other Contracting State for a period or periods not exceeding
183 days in any 12-month period that begins or ends during the
relevant taxable year (i.e., in the United States, the calendar
year in which the services are performed); (b) the remuneration
is paid by, or on behalf of an employer who is not a resident
of that other Contracting State; and (c) the remuneration is
not borne as a deductible expense by a permanent establishment
that the employer has in that other State. In order for the
remuneration to be exempt from tax in the source State, all
three conditions must be satisfied. This exception is identical
to that set forth in the OECD Model.
The 183-day period in condition (a) is to be measured using
the ``days of physical presence'' method. Under this method,
the days that are counted include any day in which a part of
the day is spent in the host country. (Rev. Rul. 56-24, 1956-1
C.B. 851.) Thus, days that are counted include the days of
arrival and departure; weekends and holidays on which the
employee does not work but is present within the country;
vacation days spent in the country before, during or after the
employment period, unless the individual's presence before or
after the employment can be shown to be independent of his
presence there for employment purposes; and time during periods
of sickness, training periods, strikes, etc., when the
individual is present but not working. If illness prevented the
individual from leaving the country in sufficient time to
qualify for the benefit, those days will not count. Also, any
part of a day spent in the host country while in transit
between two points outside the host country is not counted. If
the individual is a resident of the host country for part of
the taxable year concerned and a nonresident for the remainder
of the year, the individual's days of presence as a resident do
not count for purposes of determining whether the 183-day
period is exceeded.
Conditions (b) and (c) are intended to ensure that a
Contracting State will not be required to allow a deduction to
the payor for compensation paid and at the same time to exempt
the employee on the amount received. Accordingly, if a foreign
person pays the salary of an employee who is employed in the
host State, but a host State corporation or permanent
establishment reimburses the payor with a payment that can be
identified as a reimbursement, neither condition (b) nor (c),
as the case may be, will be considered to have been fulfilled.
The reference to remuneration ``borne by'' a permanent
establishment is understood to encompass all expenses that
economically are incurred and not merely expenses that are
currently deductible for tax purposes. Accordingly, the
expenses referred to include expenses that are capitalizable as
well as those that are currently deductible. Further, salaries
paid by residents that are exempt from income taxation may be
considered to be borne by a permanent establishment
notwithstanding the fact that the expenses will be neither
deductible nor capitalizable since the payor is exempt from
tax.
Paragraph 3
Paragraph 3 contains a special rule applicable to
remuneration for services performed by a resident of a
Contracting State as an employee aboard a ship or aircraft
operated in international traffic. Such remuneration may be
taxed only in the State of residence of the employee if the
services are performed as a member of the regular complement of
the ship or aircraft. The ``regular complement'' includes the
crew. In the case of a cruise ship, for example, it may also
include others, such as entertainers, lecturers, etc., employed
by the shipping company to serve on the ship throughout its
voyage. The use of the term ``regular complement'' is intended
to clarify that a person who exercises his employment as, for
example, an insurance salesman while aboard a ship or aircraft
is not covered by this paragraph.
If a U.S. citizen who is resident in Malta performs
services as an employee in the United States and meets the
conditions of paragraph 2 for source country exemption, he
nevertheless is taxable in the United States by virtue of the
saving clause of paragraph 4 of Article 1 (General Scope),
subject to the special foreign tax credit rule of paragraph 4
of Article 23 (Relief from Double Taxation).
ARTICLE 15 (DIRECTORS' FEES)
This Article provides that a Contracting State may tax the
fees and other compensation paid by a company that is a
resident of that State for services performed in that State by
a resident of the other Contracting State in his capacity as a
director of the company. This rule is an exception to the more
general rules of Articles 7 (Business Profits) and 14 (Income
from Employment). Thus, for example, in determining whether a
director's fee paid to a non-employee director is subject to
tax in the country of residence of the corporation, it is not
relevant to establish whether the fee is attributable to a
permanent establishment in that State.
This Article is subject to the saving clause of paragraph 4
of Article 1 (General Scope). Thus, if a U.S. citizen who is a
resident of Malta is a director of a U.S. corporation, the
United States may tax his full remuneration regardless of where
he performs his services.
ARTICLE 16 (ENTERTAINERS AND SPORTSMEN)
This Article deals with the taxation in a Contracting State
of entertainers and sportsmen resident in the other Contracting
State from the performance of their services as such. The
Article applies both to the income of an entertainer or
sportsman who performs services on his own behalf and one who
performs services on behalf of another person, either as an
employee of that person, or pursuant to any other arrangement.
The rules of this Article take precedence, in some
circumstances, over those of Articles 7 (Business Profits) and
14 (Income from Employment).
This Article applies only with respect to the income of
entertainers and sportsmen. Others involved in a performance or
athletic event, such as producers, directors, technicians,
managers, coaches, etc., remain subject to the provisions of
Articles 7 and 14. In addition, except as provided in paragraph
2, income earned by juridical persons is not covered by Article
16.
Paragraph 1
Paragraph 1 describes the circumstances in which a
Contracting State may tax the performance income of an
entertainer or sportsman who is a resident of the other
Contracting State. Under the paragraph, income derived by an
individual resident of a Contracting State from activities as
an entertainer or sportsman exercised in the other Contracting
State may be taxed in that other State if the amount of the
gross receipts derived by the performer exceeds $20,000 (or its
equivalent in Euros) for the taxable year. The $20,000 includes
expenses reimbursed to the individual or borne on his behalf.
If the gross receipts exceed $20,000, the full amount, not just
the excess, may be taxed in the State of performance.
The Convention introduces this monetary threshold to
distinguish between two groups of entertainers and athletes--
those who are paid relatively large sums of money for very
short periods of service, and who would, therefore, normally be
exempt from host country tax under the standard personal
services income rules, and those who earn relatively modest
amounts and are, therefore, not easily distinguishable from
those who earn other types of personal service income.
Tax may be imposed under paragraph 1 even if the performer
would have been exempt from tax under Article 7 or 14. On the
other hand, if the performer would be exempt from host-country
tax under Article 16, but would be taxable under either Article
7 or 14, tax may be imposed under either of those Articles.
Thus, for example, if a performer derives remuneration from his
activities in an independent capacity, and the performer does
not have a permanent establishment in the host State, he may be
taxed by the host State in accordance with Article 16 if his
remuneration exceeds $20,000 annually, despite the fact that he
generally would be exempt from host State taxation under
Article 7. However, a performer who receives less than the
$20,000 threshold amount and therefore is not taxable under
Article 16 nevertheless may be subject to tax in the host
country under Article 7 or 14 if the tests for host-country
taxability under the relevant Article are met. For example, if
an entertainer who is an independent contractor earns $14,000
of income in a State for the calendar year, but the income is
attributable to his permanent establishment in the State of
performance, that State may tax his income under Article 7.
Since it frequently is not possible to know until year-end
whether the income an entertainer or sportsman derived from
performances in a Contracting State will exceed $20,000,
nothing in the Convention precludes that Contracting State from
withholding tax during the year and refunding it after the
close of the year if the taxability threshold has not been met.
As explained in paragraph 9 of the Commentary to Article 17
of the OECD Model, Article 16 of the Convention applies to all
income connected with a performance by the entertainer, such as
appearance fees, award or prize money, and a share of the gate
receipts. Income derived from a Contracting State by a
performer who is a resident of the other Contracting State from
other than actual performance, such as royalties from record
sales and payments for product endorsements, is not covered by
this Article, but by other articles of the Convention, such as
Article 12 (Royalties) or Article 7. For example, if an
entertainer receives royalty income from the sale of live
recordings, the royalty income would be subject to the
provisions of Article 12, even if the performance was conducted
in the source country, although the entertainer could be taxed
in the source country with respect to income from the
performance itself under Article 16 if the dollar threshold is
exceeded.
In determining whether income falls under Article 16 or
another article, the controlling factor will be whether the
income in question is predominantly attributable to the
performance itself or to other activities or property rights.
For instance, a fee paid to a performer for endorsement of a
performance in which the performer will participate would be
considered to be so closely associated with the performance
itself that it normally would fall within Article 16.
Similarly, a sponsorship fee paid by a business in return for
the right to attach its name to the performance would be so
closely associated with the performance that it would fall
under Article 16 as well. As indicated in paragraph 9 of the
Commentary to Article 17 of the OECD Model, however, a
cancellation fee would not be considered to fall within Article
16 but would be dealt with under Article 7 or 14.
As indicated in paragraph 4 of the Commentary to Article 17
of the OECD Model, where an individual fulfills a dual role as
performer and non-performer (such as a player-coach or an
actor-director), but his role in one of the two capacities is
negligible, the predominant character of the individual's
activities should control the characterization of those
activities. In other cases there should be an apportionment
between the performance-related compensation and other
compensation.
Consistent with Article 14, Article 16 also applies
regardless of the timing of actual payment for services. Thus,
a bonus paid to a resident of a Contracting State with respect
to a performance in the other Contracting State during a
particular taxable year would be subject to Article 16 for that
year even if it was paid after the close of the year. The
determination as to whether the $20,000 threshold has been
exceeded is determined separately with respect to each year of
payment. Accordingly, if an actor who is a resident of one
Contracting State receives residual payments over time with
respect to a movie that was filmed in the other Contracting
State, the payments do not have to be aggregated from one year
to another to determine whether the total payments have finally
exceeded $20,000. Otherwise, residual payments received many
years later could retroactively subject all earlier payments to
tax by the other Contracting State.
Paragraph 2
Paragraph 2 is intended to address the potential for
circumvention of the rule in paragraph 1 when a performer's
income does not accrue directly to the performer himself, but
to another person. Foreign performers frequently perform in the
United States as employees of, or under contract with, a
company or other person.
The relationship may truly be one of employee and employer,
with no circumvention of paragraph 1 either intended or
realized. On the other hand, the ``employer'' may, for example,
be a company established and owned by the performer, which is
merely acting as the nominal income recipient in respect of the
remuneration for the performance (a ``star company''). The
performer may act as an ``employee,'' receive a modest salary,
and arrange to receive the remainder of the income from his
performance from the company in another form or at a later
time. In such case, absent the provisions of paragraph 2, the
income arguably could escape host-country tax because the
company earns business profits but has no permanent
establishment in that country. The performer may largely or
entirely escape host-country tax by receiving only a small
salary, perhaps small enough to place him below the dollar
threshold in paragraph 1. The performer might arrange to
receive further payments in a later year, when he is not
subject to host-country tax, perhaps as dividends or
liquidating distributions.
Paragraph 2 seeks to prevent this type of abuse while at
the same time protecting the taxpayers' rights to the benefits
of the Convention when there is a legitimate employee-employer
relationship between the performer and the person providing his
services. Under paragraph 2, when the income accrues to a
person other than the performer, the income may be taxed in the
Contracting State where the performer's services are exercised,
without regard to the provisions of the Convention concerning
business profits (Article 7) or income from employment (Article
14), unless the contract pursuant to which the personal
activities are performed allows the person other than the
performer to designate the individual who is to perform the
personal activities. This rule is based on the U.S. domestic
law provision characterizing income from certain personal
service contracts as foreign personal holding company income in
the context of the foreign personal holding company provisions.
See Code section 954(c)(1)(H). The premise of this rule is
that, in a case where a performer is using another person in an
attempt to circumvent the provisions of paragraph 1, the
recipient of the services of the performer would contract with
a person other than that performer (i.e., a company employing
the performer) only if the recipient of the services were
certain that the performer himself would perform the services.
If instead the person is allowed to designate the individual
who is to perform the services, then likely the person is a
service company not formed to circumvent the provisions of
paragraph 1. The following example illustrates the operation of
this rule:
Example. Company M, a resident of Malta, is engaged in the
business of operating an orchestra. Company M enters into a
contract with Company A pursuant to which Company M agrees to
carry out two performances in the United States in
consideration of which Company A will pay Company M $200,000.
The contract designates two individuals, a conductor and a
flautist, that must perform as part of the orchestra, and
allows Company M to designate the other members of the
orchestra. Because the contract does not give Company M any
discretion to determine whether the conductor or the flautist
perform personal services under the contract, the portion of
the $200,000 which is attributable to the personal services of
the conductor and the flautist may be taxed by the United
States pursuant to paragraph 2. The remaining portion of the
$200,000, which is attributable to the personal services of
performers that Company M may designate, is not subject to tax
by the United States pursuant to paragraph 2.
In cases where paragraph 2 is applicable, the income of the
``employer'' may be subject to tax in the host Contracting
State even if it has no permanent establishment in the host
country. Taxation under paragraph 2 is on the person providing
the services of the performer. This paragraph does not affect
the rules of paragraph 1, which apply to the performer himself.
The income taxable by virtue of paragraph 2 is reduced to the
extent of salary payments to the performer, which fall under
paragraph 1.
For purposes of paragraph 2, income is deemed to accrue to
another person (i.e., the person providing the services of the
performer) if that other person has control over, or the right
to receive, gross income in respect of the services of the
performer.
Pursuant to Article 1 (General Scope) the Convention only
applies to persons who are residents of one of the Contracting
States. Thus, income of a star company that is not a resident
of one of the Contracting States would not be eligible for
benefits of the Convention.
Relationship to Other Articles
This Article is subject to the provisions of the saving
clause of paragraph 4 of Article 1 (General Scope). Thus, if an
entertainer or a sportsman who is resident in Malta is a
citizen of the United States, the United States may tax all of
his income from performances in the United States without
regard to the provisions of this Article (subject to the
special foreign tax credit provisions of paragraph 4 of Article
23 (Relief from Double Taxation)). In addition, benefits of
this Article are subject to the provisions of Article 22
(Limitation on Benefits).
ARTICLE 17 (PENSIONS, SOCIAL SECURITY, ANNUITIES, ALIMONY, AND CHILD
SUPPORT)
This Article deals with the taxation of private (i.e., non-
government service) pensions and annuities, social security
benefits, alimony and child support payments.
Paragraph 1
Paragraph 1 provides that distributions from pensions and
other similar remuneration beneficially owned by a resident of
a Contracting State in consideration of past employment are
taxable only in the State of residence of the beneficiary. The
term ``pensions and other similar remuneration'' includes both
periodic and single sum payments.
The phrase ``pensions and other similar remuneration'' is
intended to encompass payments made by qualified private
retirement plans. In the United States, the plans encompassed
by Paragraph 1 include: qualified plans under section 401(a),
individual retirement plans (including individual retirement
plans that are part of a simplified employee pension plan that
satisfies section 408(k), individual retirement accounts and
section 408(p) accounts), section 403(a) qualified annuity
plans, and section 403(b) plans. Distributions from section 457
plans may also fall under Paragraph 1 if they are not paid with
respect to government services covered by Article 19. The
competent authorities may agree that distributions from other
plans that generally meet similar criteria to those applicable
to the listed plans also qualify for the benefits of Paragraph
1.
Pensions in respect of government services covered by
Article 19 are not covered by this paragraph. They are covered
either by paragraph 2 of this Article, if they are in the form
of social security benefits, or by paragraph 2 of Article 19
(Government Service). Thus, Article 19 generally covers section
457(g), 401(a), 403(a), and 403(b) plans established for
government employees, including the Thrift Savings Plan
(section 7701(j)).
Subparagraph (b) contains an exception to the State of
residence's right to tax pensions and other similar
remuneration under subparagraph (a). Under subparagraph (b),
the State of residence must exempt from tax any amount of such
pensions or other similar remuneration that would be exempt
from tax in the Contracting State in which the pension fund is
established if the recipient were a resident of that State.
Thus, for example, a distribution from a U.S. ``Roth IRA'' to a
resident of Malta would be exempt from tax in Malta to the same
extent the distribution would be exempt from tax in the United
States if it were distributed to a U.S. resident. The same is
true with respect to distributions from a traditional IRA to
the extent that the distribution represents a return of non-
deductible contributions. Similarly, if the distribution were
not subject to tax when it was ``rolled over'' into another
U.S. IRA (but not, for example, to a pension fund in the other
Contracting State), then the distribution would be exempt from
tax in Malta.
Paragraph 2
The treatment of social security benefits is dealt with in
paragraph 2. This paragraph provides that, notwithstanding the
provision of paragraph 1 under which private pensions are
taxable exclusively in the State of residence of the beneficial
owner, payments made by one of the Contracting States under the
provisions of its social security or similar legislation to a
resident of the other Contracting State or to a citizen of the
United States will be taxable only in the Contracting State
making the payment. The reference to U.S. citizens is necessary
to ensure that a social security payment by Malta to a U.S.
citizen who is not resident in the United States will not be
taxable by the United States.
This paragraph applies to social security beneficiaries
whether they have contributed to the system as private sector
or Government employees. The phrase ``similar legislation'' is
intended to refer to United States tier 1 Railroad Retirement
benefits.
Paragraph 3
Under paragraph 3, annuities that are derived and
beneficially owned by a resident of a Contracting State are
taxable only in that State. An annuity, as the term is used in
this paragraph, means a stated sum paid periodically at stated
times during a specified number of years or for life, under an
obligation to make the payment in return for adequate and full
consideration (other than for services rendered). An annuity
received in consideration for services rendered would be
treated as either deferred compensation that is taxable in
accordance with Article 14 (Income from Employment) or a
pension that is subject to the rules of paragraph 1.
Paragraphs 4 and 5
Paragraphs 4 and 5 deal with alimony and child support
payments. Both alimony, under paragraph 4, and child support
payments, under paragraph 5, are defined as periodic payments
made pursuant to a written separation agreement or a decree of
divorce, separate maintenance, or compulsory support. Paragraph
4, however, deals only with payments of that type that are
taxable to the payee. Under that paragraph, alimony paid by a
resident of a Contracting State to a resident of the other
Contracting State is taxable under the Convention only in the
State of residence of the recipient. Paragraph 5 deals with
those periodic payments that are for the support of a child and
that are not covered by paragraph 4. These types of payments by
a resident of a Contracting State to a resident of the other
Contracting State are taxable in neither Contracting State.
Relationship to Other Articles
Paragraphs 1 (a), 3 and 4 of Article 17 are subject to the
saving clause of paragraph 4 of Article 1 (General Scope).
Thus, a U.S. citizen who is resident in Malta and receives
either a pension, annuity or alimony payment from the United
States, may be subject to U.S. tax on the payment,
notwithstanding the rules in those three paragraphs that give
the State of residence of the recipient the exclusive taxing
right. Paragraphs 1(b), 2 and 5 are excepted from the saving
clause by virtue of subparagraph 5(a) of Article 1. Thus, the
United States will not tax U.S. citizens and residents on the
income described in those paragraphs even if such amounts
otherwise would be subject to tax under U.S. law.
ARTICLE 18 (PENSION FUNDS)
This Article provides that, if a resident of a Contracting
State participates in a pension fund established in the other
Contracting State, the State of residence will not tax the
income of the pension fund with respect to that resident until
a distribution is made from the pension fund. Thus, for
example, if a U.S. citizen contributes to a U.S. qualified plan
while working in the United States and then establishes
residence in Malta, this Article prevents Malta from taxing
currently the plan's earnings and accretions with respect to
that individual. When the resident receives a distribution from
the pension fund, that distribution may be subject to tax in
Malta, subject to paragraph 1 of Article 17 (Pensions, Social
Security, Annuities, Alimony, and Child Support).
Relationship to other Articles
Article 18 is excepted from the saving clause of paragraph
4 of Article 1 by virtue of paragraph 5(a) of Article 1. Thus,
the United States will allow U.S. citizens and residents the
benefits of Article 18.
ARTICLE 19 (GOVERNMENT SERVICE)
Paragraph 1
Subparagraphs (a) and (b) of paragraph 1 deal with the
taxation of government compensation (other than a pension
addressed in paragraph 2). Subparagraph (a) provides that
remuneration paid to any individual who is rendering services
to a Contracting State, political subdivision or local
authority is exempt from tax by the other State. Under
subparagraph (b), such payments are, however, taxable
exclusively in the other State (i.e., the host State) if the
services are rendered in that other State and the individual is
a resident of that State who is either a national of that State
or a person who did not become resident of that State solely
for purposes of rendering the services. The paragraph applies
to anyone performing services for a government, whether as a
government employee, an independent contractor, or an employee
of an independent contractor.
Paragraph 2
Paragraph 2 deals with the taxation of pensions paid by, or
out of funds created by, one of the States, or a political
subdivision or a local authority thereof, to an individual in
respect of services rendered to that State or subdivision or
authority. Subparagraph (a) provides that such pensions are
taxable only in that State. Subparagraph (b) provides an
exception under which such pensions are taxable only in the
other State if the individual is a resident of, and a national
of, that other State.
Pensions paid to retired civilian and military employees of
a Government of either State are intended to be covered under
paragraph 2. When benefits paid by a State in respect of
services rendered to that State or a subdivision or authority
are in the form of social security benefits, however, those
payments are covered by paragraph 2 of Article 17 (Pensions,
Social Security, Annuities, Alimony, and Child Support). As a
general matter, the result will be the same whether Article 17
or 19 applies, since social security benefits are taxable
exclusively by the source country and so are government
pensions. The result will differ only when the payment is made
to a citizen and resident of the other Contracting State, who
is not also a citizen of the paying State. In such a case,
social security benefits continue to be taxable at source while
government pensions become taxable only in the residence
country.
Paragraph 3
Paragraph 3 provides that the remuneration described in
paragraph 1 will be subject to the rules of Articles 14 (Income
from Employment), 15 (Directors' Fees), 16 (Entertainers and
Sportsmen) or 17 (Pensions, Social Security, Annuities,
Alimony, and Child Support) if the recipient of the income is
employed by a business conducted by a government.
Relationship to Other Articles
Under subparagraph 5(b) of Article 1 (General Scope), the
saving clause of paragraph 4 of Article 1 does not apply to the
benefits conferred by one of the States under Article 19 if the
recipient of the benefits is neither a citizen of that State,
nor a person who has been admitted for permanent residence
there (i.e., in the United States, a ``green card'' holder).
Thus, a resident of the United States who in the course of
performing functions of a governmental nature becomes a
resident of Malta (but not a permanent resident), would be
entitled to the benefits of this Article. Similarly, an
individual who receives a pension paid by the Government of
Malta in respect of services rendered to the Government of
Malta shall be taxable on this pension only in Malta unless the
individual is a U.S. citizen or acquires a U.S. green card.
ARTICLE 20 (STUDENTS AND TRAINEES)
This Article provides rules for host-country taxation of
visiting students and business trainees. Persons who meet the
tests of the Article will be exempt from tax in the State that
they are visiting with respect to designated classes of income.
Several conditions must be satisfied in order for an individual
to be entitled to the benefits of this Article.
First, the visitor must have been, either at the time of
his arrival in the host State or immediately before, a resident
of the other Contracting State.
Second, the purpose of the visit must be the full-time
education or training of the visitor. Thus, if the visitor
comes principally to work in the host State but also is a part-
time student, he would not be entitled to the benefits of this
Article, even with respect to any payments he may receive from
abroad for his maintenance or education, and regardless of
whether or not he is in a degree program. Whether a student is
to be considered full-time will be determined by the rules of
the educational institution at which he is studying.
The host-country exemption applies to payments received by
the student or business trainee for the purpose of his
maintenance, education or training that arise outside the host
State. A payment will be considered to arise outside the host
State if the payer is located outside the host State. Thus, if
an employer from one of the Contracting States sends an
employee to the other Contracting State for full-time training,
the payments the trainee receives from abroad from his employer
for his maintenance or training while he is present in the host
State will be exempt from tax in the host State. Where
appropriate, substance prevails over form in determining the
identity of the payer. Thus, for example, payments made
directly or indirectly by a U.S. person with whom the visitor
is training, but which have been routed through a source
outside the United States (e.g., a foreign subsidiary), are not
treated as arising outside the United States for this purpose.
The Article also provides a limited exemption for
remuneration from personal services rendered in the host State
with a view to supplementing the resources available to him for
such purposes to the extent of $9,000 United States dollars (or
its equivalent in Euros) per taxable year. The specified amount
is intended to equalize the position of a U.S. resident who is
entitled to the standard deduction and the personal exemption
with that of a student who files as a nonresident alien and
therefore is not. Accordingly, the competent authorities are
instructed to adjust this amount every five years, if
necessary, to take into account changes in the amount of the
U.S. standard deduction and personal exemption and in the
Maltese personal tax rates.
In the case of a business trainee, the benefits of the
Article will extend only for a period of one year from the time
that the visitor first arrives in the host country. If,
however, a trainee remains in the host country for a second
year, thus losing the benefits of the Article, he would not
retroactively lose the benefits of the Article for the first
year. The term ``business trainee'' is defined as a person who
is in the country temporarily for the purpose of securing
training that is necessary to qualify to pursue a profession or
professional specialty. Moreover, the person must be employed
or under contract with a resident of the other Contracting
State and must be receiving the training from someone who is
not related to its employer. Thus, a business trainee might
include a lawyer employed by a law firm in one Contracting
State who works for one year as a stagiaire in an unrelated law
firm in the other Contracting State. However, the term would
not include a manager who normally is employed by a parent
company in one Contracting State who is sent to the other
Contracting State to run a factory owned by a subsidiary of the
parent company.
Relationship to Other Articles
The saving clause of paragraph 4 of Article 1 (General
Scope) does not apply to this Article with respect to an
individual who is neither a citizen of the host State nor has
been admitted for permanent residence there. The saving clause,
however, does apply with respect to citizens and permanent
residents of the host State. Thus, a U.S. citizen who is a
resident of Malta and who visits the United States as a full-
time student at an accredited university will not be exempt
from U.S. tax on remittances from abroad that otherwise
constitute U.S. taxable income. A person, however, who is not a
U.S. citizen, and who visits the United States as a student and
remains long enough to become a resident under U.S. law, but
does not become a permanent resident (i.e., does not acquire a
green card), will be entitled to the full benefits of the
Article.
ARTICLE 21 (OTHER INCOME)
Article 21 assigns taxing jurisdiction over income not
dealt with in the other articles (Articles 6 through 20) of the
Convention. In order for an item of income to be ``dealt with''
in another article it must be the type of income described in
the article and, in most cases, it must have its source in a
Contracting State. For example, all royalty income that arises
in a Contracting State and that is beneficially owned by a
resident of the other Contracting State is ``dealt with'' in
Article 12 (Royalties). However, profits derived in the conduct
of a business are ``dealt with'' in Article 7 (Business
Profits) whether or not they have their source in one of the
Contracting States.
Examples of items of income covered by Article 21 include
income from gambling, punitive (but not compensatory) damages
and covenants not to compete. The article would also apply to
income from a variety of financial transactions, where such
income does not arise in the course of the conduct of a trade
or business. For example, income from notional principal
contracts and other derivatives would fall within Article 21 if
derived by persons not engaged in the trade or business of
dealing in such instruments, unless such instruments were being
used to hedge risks arising in a trade or business. It would
also apply to securities lending fees derived by an
institutional investor. Further, in most cases guarantee fees
paid within an intercompany group would be covered by Article
21, unless the guarantor were engaged in the business of
providing such guarantees to unrelated parties.
Article 21 also applies to items of income that are not
dealt with in the other articles because of their source or
some other characteristic. For example, Article 11 (Interest)
addresses only the taxation of interest arising in a
Contracting State. Interest arising in a third State that is
not attributable to a permanent establishment, therefore, is
subject to Article 21.
Distributions from partnerships are not generally dealt
with under Article 21 because partnership distributions
generally do not constitute income. Under the Code, partners
include in income their distributive share of partnership
income annually, and partnership distributions themselves
generally do not give rise to income. This would also be the
case under U.S. law with respect to distributions from trusts.
Trust income and distributions that, under the Code, have the
character of the associated distributable net income would
generally be covered by another article of the Convention. See
Code section 641 et seq.
Paragraph 1
The general rule of Article 21 is contained in paragraph 1.
Items of income not dealt with in other articles and
beneficially owned by a resident of a Contracting State will be
taxable in the State of residence. This right of taxation
applies whether or not the residence State exercises its right
to tax the income covered by the Article. As discussed in
greater detail below, however, where such income arises in the
other Contracting State, paragraph 3 permits limited source-
State taxation.
The reference in this paragraph to ``items of income
beneficially owned by a resident of a Contracting State''
rather than simply ``items of income of a resident of a
Contracting State,'' as in the OECD Model, is intended merely
to make explicit the implicit understanding that the limits on
source-State taxation provided by paragraphs 1 and 3 apply only
when a resident of a Contracting State is the beneficial owner
of the income. Thus, source taxation of income not dealt with
in other articles of the Convention is not limited by
paragraphs 1 and 3 if it is nominally paid to a resident of the
other Contracting State, but is beneficially owned by a
resident of a third State. However, income received by a
nominee on behalf of a resident of that other State would be
entitled to benefits.
The term ``beneficially owned'' is not defined in the
Convention, and is, therefore, defined as under the internal
law of the State granting treaty benefits (i.e., the source
State). The person who beneficially owns the income for
purposes of Article 21 is the person to which the income is
attributable for tax purposes under the laws of the source
State.
Paragraph 2
This paragraph provides an exception to the general rule of
paragraph 1 for income that is attributable to a permanent
establishment maintained in a Contracting State by a resident
of the other Contracting State. The taxation of such income is
governed by the provisions of Article 7 (Business Profits).
Therefore, income arising outside the United States that is
attributable to a permanent establishment maintained in the
United States by a resident of Malta generally would be taxable
by the United States under the provisions of Article 7. This
would be true even if the income is sourced in a third State.
Paragraph 3
This paragraph provides for limited source-State taxation
of income not dealt with in the foregoing Articles of the
Convention. Such income of a resident of one of the Contracting
States from sources in the other State may be taxed in the
source State, but the rate may not exceed 10 percent of the
amount of such items.
Relationship to Other Articles
This Article is subject to the saving clause of paragraph 4
of Article 1 (General Scope). Thus, the United States may tax
the income of a resident of the other Contracting State that is
not dealt with elsewhere in the Convention, if that resident is
a citizen of the United States. The Article is also subject to
the provisions of Article 22 (Limitation on Benefits). Thus, if
a resident of the other Contracting State earns income that
falls within the scope of paragraph 1 of Article 21, but that
is taxable by the United States under U.S. law, the income
would be exempt from U.S. tax under the provisions of Article
21 only if the resident satisfies one of the tests of Article
22 for entitlement to benefits.
ARTICLE 22 (LIMITATION ON BENEFITS)
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. However, the Exchange of Notes accompanying
the Convention provides that a company resident in Malta that
is an ``international trading company,'' as defined in article
2 of the Income Tax Act of Malta, shall be entitled to receive
only the benefits of the Convention (subject to all applicable
conditions or limitations) other than the benefits of Articles
10 (Dividends), 11 (Interest), 12 (Royalties), and 21 (Other
Income) of the Convention.
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,
benefits may be granted to that person with regard to certain
income earned in the conduct of an active trade or business.
Paragraph 5 provides special rules for so-called ``triangular
cases,'' notwithstanding the other provisions of the Article.
Paragraph 6 provides that benefits also may be granted if the
competent authority of the State from which benefits are
claimed determines that it is appropriate to provide benefits
in that case. Paragraph 7 addresses the application of the
Convention where a remittance system of taxation is used.
Paragraph 8 defines certain terms used in the Article.
Paragraph 1
Paragraph 1 provides that, except as otherwise provided, a
resident of a Contracting State will be entitled to all the
benefits otherwise accorded to residents of a Contracting State
under the Convention only to the extent provided in the
Article.
The benefits otherwise accorded to residents under the
Convention include all limitations on source-based taxation
under Articles 6 through 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. Article 25 (Mutual
Agreement Procedure) is not limited to residents of the
Contracting States, and Article 27 (Members of Diplomatic
Missions and Consular Posts) applies to diplomatic agents or
consular officials regardless of residence. Article 22
accordingly does not limit the availability of treaty benefits
under these 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 the Contracting
State to be treated as a resident for treaty purposes, while
domestic anti-abuse provisions (e.g., business purpose,
substance-over-form, step transaction or conduit principles)
determine whether a particular transaction should be recast in
accordance with its substance. Thus, internal law principles of
the source Contracting State may be applied to identify the
beneficial owner of an item of income, and Article 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 six 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 6, discussed
below, claiming benefits under paragraph 2 does not require
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 2(a) provides that individual residents of a
Contracting State will be entitled to all treaty benefits. If
such an individual receives income as a nominee on behalf of a
third country resident, benefits may be denied under the
respective articles of the Convention by the requirement that
the beneficial owner of the income be a resident of a
Contracting State.
Governments--Subparagraph 2(b)
Subparagraph 2(b) provides that the Contracting States and
any political subdivision or local authority thereof will be
entitled to all benefits of the Convention.
Publicly-Traded Corporations--Subparagraph 2(c)(i)
Subparagraph 2(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
subparagraph 2(c)(i) if (a) the principal class of its shares,
and any disproportionate class of shares, is listed on a
recognized stock exchange located in the company's State of
residence, (b) the principal class of its shares, and any
disproportionate class of shares, regularly traded on one or
more recognized stock exchanges in the company's State of
residence, (c) the principal class of its shares is primarily
traded on one or more recognized stock exchanges located in
company's State of residence, and (d) and the company satisfies
the base erosion test of subparagraph 2(f)(ii).
The term ``recognized stock exchange'' is defined in
subparagraph (a) of paragraph 8. It includes (i) the NASDAQ
System and any stock exchange registered with the Securities
and Exchange Commission as a national securities exchange for
purposes of the Securities Exchange Act of 1934, (ii) the Malta
Stock Exchange, and (iii) any other stock exchange agreed upon
by the competent authorities of the Contracting States.
If a company has only one class of shares, it is only
necessary to consider whether the shares of that class meet the
relevant trading requirements. If the company has more than one
class of shares, it is necessary as an initial matter to
determine which class or classes constitute the ``principal
class of shares.'' The term ``principal class of shares'' is
defined in subparagraph 8(b) to mean the ordinary or common
shares of the company representing the majority of the
aggregate voting power and value of the company. If the company
does not have a class of ordinary or common shares representing
the majority of the aggregate voting power and value of the
company, then the ``principal class of shares'' is that class
or any combination of classes of shares that represents, in the
aggregate, a majority of the voting power and value of the
company. Although in a particular case involving a company with
several classes of shares it is conceivable that more than one
group of classes could be identified that account for more than
50% of the shares, it is only necessary for one such group to
satisfy the requirements of this subparagraph in order for the
company to be entitled to benefits. Benefits would not be
denied to the company even if a second, non-qualifying, group
of shares with more than half of the company's voting power and
value could be identified.
A company whose principal class of shares is regularly
traded on a recognized stock exchange will nevertheless not
qualify for benefits under subparagraph 2(c)(i) 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 8(c). A company
has a disproportionate class of shares if it has outstanding a
class of shares which 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 Malta meets the test of subparagraph 8(c) 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. MCo is a corporation resident in Malta. MCo has
two classes of shares: Common and Preferred. The Common shares
are listed and regularly traded on the Malta Stock Exchange.
The Preferred shares have no voting rights and are entitled to
receive dividends equal in amount to interest payments that MCo
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 MCo 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 MCo, the Preferred shares are a
disproportionate class of shares. Because the Preferred shares
are not regularly traded on a recognized stock exchange, MCo
will not qualify for benefits under subparagraph 2(c)(i).
The term ``regularly traded'' is not defined in the
Convention. In accordance with paragraph 2 of Article 3
(General Definitions), this term will be defined by reference
to the domestic tax laws of the State from which treaty
benefits are sought. 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)(4)(i)(B), relating to the branch tax
provisions of the Code. Under these regulations, a class of
shares is considered to be ``regularly traded'' if two
requirements are met: trades in the class of shares are made in
more than de minimis quantities on at least 60 days during the
taxable year, and the aggregate number of shares in the class
traded during the year is at least 10 percent of the average
number of shares outstanding during the year. Sections 1.884-
5(d)(4)(i)(A), (ii) and (iii) will not be taken into account
for purposes of defining the term ``regularly traded'' under
the Convention.
The regular trading requirement can be met by trading on
any recognized exchange or exchanges located in either State.
Trading on one or more recognized stock exchanges may be
aggregated for purposes of this requirement. Thus, a U.S.
company could satisfy the regularly traded requirement through
trading, in whole or in part, on a recognized stock exchange
located in Malta. Authorized but unissued shares are not
considered for purposes of this test.
The term ``primarily traded'' is not defined in the
Convention. In accordance with paragraph 2 of Article 3, 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.
Subsidiaries of Publicly-Traded Corporations--Subparagraph
2(c)(ii)
A company resident in a Contracting State is entitled to
all the benefits of the Convention under subparagraph 2(c)(ii)
if five or fewer publicly traded companies described in
subparagraph 2(c)(i) are the direct or indirect owners of at
least 75 percent of each class of the company's shares, and the
company satisfies the base erosion test of subparagraph
2(f)(ii). If the publicly-traded companies are indirect owners,
however, each of the intermediate companies must be a resident
of the same Contracting State that is also entitled to benefits
of the Convention under subparagraph 2(c)(ii).
Thus, for example, a company that is a resident of Malta,
all the shares of which are owned by another company that is a
resident of Malta, would qualify for benefits under
subparagraph 2(c) if the principal class of shares (and any
disproportionate classes of shares) of the parent company are
regularly and primarily traded on the Malta Stock Exchange, and
it satisfies the base erosion test of subparagraph 2(f)(ii).
However, such a subsidiary would not qualify for benefits under
clause (ii) if the publicly traded parent company were a
resident of a third state. Furthermore, if a parent company in
Malta indirectly owned the bottom-tier company through a chain
of subsidiaries, each such subsidiary in the chain, as an
intermediate owner, must be a resident of Malta entitled to the
benefits of the convention under subparagraph 2(c)(ii) in order
for the subsidiary to meet the test in clause (ii).
Tax Exempt Organizations--Subparagraph 2(d)
Subparagraph 2(d) provides rules by which the tax exempt
organizations described in subparagraph 2(b) of Article 4
(Resident) will be entitled to all the benefits of the
Convention. Entities qualifying under this rule generally are
those that are exempt from tax in their State of residence and
that are organized and operated exclusively to fulfill
religious, charitable, scientific, artistic, cultural, or
educational purposes.
Pension Funds--Subparagraph 2(e)
A pension fund will qualify for benefits under subparagraph
2(e) if more than 75 percent of the beneficiaries, members or
participants of the pension fund are individuals resident in
either Contracting State. For purposes of this provision, the
term ``beneficiaries'' should be understood to refer to the
persons receiving benefits from the organization.
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 (e), the so-called ownership and base erosion
test, is a two-part test. Both prongs of the test must be
satisfied for the resident to be entitled to treaty benefits
under subparagraph 2(e).
The ownership prong of the test, under clause (i), requires
that 75 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 2(a), 2(b),
2(c)(i), 2(d), or 2(e). In the case of indirect owners,
however, each of the intermediate owners must be a qualified
person that is also 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
subparagraphs 2(a), 2(b), 2(c)(i), 2(d), or 2(e) if it is not
possible to determine the beneficiary's actuarial interest.
Consequently, if it is not possible to determine the actuarial
interest of the beneficiaries in a trust, the ownership test
under clause i) cannot be satisfied, unless all possible
beneficiaries are persons entitled to benefits under
subparagraphs 2(a), 2(b), 2(c)(i), 2(d), or 2(e).
The base erosion prong of clause (ii) of subparagraph (f)
is satisfied with respect to a person if less than 25 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 2(a), 2(b), 2(c)(i),
2(d), or 2(e), other than in the form of arm's-length payments
in the ordinary course of business for services or tangible
property.
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 a company that is a resident
of a Contracting State to treaty benefits if the owner of the
company 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 at least 95 percent of each class of shares of the company
must be owned, directly or indirectly, by seven or fewer
persons who are equivalent beneficiaries. The term ``equivalent
beneficiary'' is defined in subparagraph 8(d). This definition
may be met in two alternative ways, the first of which has two
requirements.
Under the first alternative, a person may be an equivalent
beneficiary because it is entitled to equivalent benefits under
a treaty between the country of source and the country in which
the person is a resident. This alternative has two
requirements.
The first requirement is that the person must be a resident
of a member state of the European Union, or of a European
Economic Area state, or of Australia, or of a party to the
North American Free Trade Agreement (collectively, ``qualifying
States'').
The second requirement of the definition of ``equivalent
beneficiary'' is that the person must be entitled to equivalent
benefits under an applicable treaty. To satisfy the second
requirement, the person must be entitled to all the benefits of
a comprehensive treaty between the Contracting State from which
benefits of the Convention are claimed and a qualifying State
under provisions that are analogous to the rules in
subparagraphs 2(a), 2(b), 2(c)(i), 2(d), or 2(e) of this
Article. If the treaty in question does not have a
comprehensive limitation on benefits article, this requirement
is met only if the person would be entitled to treaty benefits
under the tests in subparagraphs 2(a), 2(b), 2(c)(i), 2(d), or
2(e) of this Article if the person were a resident of one of
the Contracting States.
In order to satisfy the second requirement necessary to
qualify as an ``equivalent beneficiary'' under subparagraph
8(d)(i)(B) with respect to dividends, interest, royalties or
branch tax, the person must be entitled to a rate of tax that
is at least as low as the tax rate that would apply under the
Convention to such income. Thus, the rates to be compared are:
(1) the rate of tax that the source State would have imposed if
a qualified resident of the other Contracting State was the
beneficial owner of the income; and (2) the rate of tax that
the source State would have imposed if the third State resident
received the income directly from the source State. For
example, USCo is a wholly owned subsidiary of MCo, a company
resident in Malta. MCo is wholly owned by ICo, a corporation
resident in Italy. Assuming MCo satisfied the requirements of
paragraph 2 of Article 10 (Dividends), MCo would be eligible
for a dividend withholding tax rate of 5 percent. 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 be subject to a 5 percent rate of
withholding tax on the dividend. Because ICo would 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, ICo
is treated as a resident of a member state of the European
Union or a party to the North American Free Trade Agreement
with respect to the withholding tax on dividends.
Subparagraph 8(e) 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
Maltese 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 Maltese 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 Maltese company is not
sufficient for purposes of this paragraph. Further, the French
company cannot be an equivalent beneficiary if it itself
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 Maltese residents who are
eligible for treaty benefits by reason of subparagraphs 2(a),
2(b), 2(c)(i), 2(d), or 2(e) are equivalent beneficiaries for
purposes of the relevant tests in this Article. Thus, a Maltese
individual will be an equivalent beneficiary without regard to
whether the individual would have been entitled to receive the
same benefits if it received the income directly. A resident of
a third country cannot qualify for treaty benefits under these
provisions by reason of those paragraphs or any other rule of
the treaty, and therefore does not qualify as an equivalent
beneficiary under this alternative. Thus, a resident of a third
country can be an equivalent beneficiary only if it would have
been entitled to equivalent benefits had it received the income
directly.
The second alternative was included in order to clarify
that ownership by certain residents of a Contracting State
would not disqualify a U.S. or Maltese company under this
paragraph. Thus, for example, if 90 percent of a Maltese
company is owned by five companies that are resident in member
states of the European Union who satisfy the requirements of
subparagraph 8(d)(i), and 10 percent of the Maltese company is
owned by a U.S. or Maltese individual, then the Maltese company
still can satisfy the requirements of subparagraph 3(a).
Subparagraph 3(b) sets forth the base erosion test. A
company meets this base erosion test if less than 25 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. These amounts do not include arm's-length
payments in the ordinary course of business for services or
tangible property. This test is the same as the base erosion
test in subparagraph 2(f)(ii), except that the test in
paragraph 3(b) focuses on base-eroding payments to persons who
are not equivalent beneficiaries.
Paragraph 4
Paragraph 4 sets forth an alternative test under which a
resident of a Contracting State may receive treaty benefits
with respect to certain items of income that are connected to
an active trade or business conducted in its State of
residence. A resident of a Contracting State may qualify for
benefits under paragraph 4 whether or not it also qualifies
under paragraph 2 or 3.
Subparagraph 4(a) sets forth the general rule that a
resident of a Contracting State engaged in the active conduct
of a trade or business in that State may obtain the benefits of
the Convention with respect to an item of income derived in the
other Contracting State. The item of income, however, must be
derived in connection with or incidental to that trade or
business. In addition, the resident must satisfy the base
erosion test of clause (ii) of subparagraph 2(f).
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 Malta 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 or insurance activities
conducted by a bank or an insurance company. Such activities
conducted by a person other than a bank or insurance company
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 or insurance
company but not as part of the company's banking or insurance
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 MCo,
a corporation resident in Malta. MCo distributes USCo products
in Malta. Since the business activities conducted by the two
corporations involve the same products, MCo'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 MCo. MCo and other USCo affiliates then manufacture
and market the USCo-designed products in their respective
markets. Since the activities conducted by MCo 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. MSub is a
wholly-owned subsidiary of Americair resident in Malta. MSub
operates a chain of hotels in Malta that are located near
airports served by Americair flights. Americair frequently
sells tour packages that include air travel to Malta and
lodging at MSub 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 MSub's business does
not form a part of Americair's business. However, MSub'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 MSub owns an office building in Malta instead of a hotel
chain. No part of Americair's business is conducted through the
office building. MSub's business is not considered to form a
part of or to be complementary to Americair's business. They
are engaged in distinct trades or businesses in separate
industries, and there is no economic dependence between the two
operations.
Example 5. USFlower is a corporation resident in the United
States. USFlower produces and sells flowers in the United
States and other countries. USFlower owns all the shares of
MHolding, a corporation resident in Malta. MHolding is a
holding company that is not engaged in a trade or business.
MHolding owns all the shares of three corporations that are
resident in Malta: MFlower, MLawn, and MFish. MFlower
distributes USFlower flowers under the USFlower trademark in
Malta. MLawn markets a line of lawn care products in Malta
under the USFlower trademark. In addition to being sold under
the same trademark, MLawn and MFlower products are sold in the
same stores and sales of each company's products tend to
generate increased sales of the other's products. MFish imports
fish from the United States and distributes it to fish
wholesalers in Malta. For purposes of paragraph 4, the business
of MFlower forms a part of the business of USFlower, the
business of MLawn is complementary to the business of USFlower,
and the business of MFish is neither part of nor complementary
to that of USFlower.
An item of income derived from the State of source is
``incidental to'' the trade or business carried on in the State
of residence if production of the item facilitates the conduct
of the trade or business in the State of residence. An example
of incidental income is the temporary investment of working
capital of a person in the State of residence in securities
issued by persons in the State of source.
Subparagraph 4(b) states a further condition to the general
rule in clause (i) of 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 4(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).
A trade or business will be deemed substantial if, for each
of the three preceding taxable years, the asset value, the
gross income, and the payroll expense that are related to the
trade or business in the first-mentioned Contracting State each
equals at least 10 percent of the resident's (and any related
parties') proportionate share of the asset value, gross income,
and payroll expense, respectively, related to the activity that
generated the income in the other Contracting State, and the
average of the three ratios in each such year exceeds 15
percent.
The determination in subparagraph 4(b) is made separately
for each item of income derived from the State of source. It
therefore is possible that a person would be entitled to the
benefits of the Convention with respect to one item of income
but not with respect to another. If a resident of a Contracting
State is entitled to treaty benefits with respect to a
particular item of income under paragraph 4, the resident is
entitled to all benefits of the Convention insofar as they
affect the taxation of that item of income in the State of
source.
The application of the substantiality requirement only to
income from related parties focuses only on potential abuse
cases, and does not hamper certain other kinds of non-abusive
activities, even though the income recipient resident in a
Contracting State may be very small in relation to the entity
generating income in the other Contracting State. For example,
if a small U.S. research firm develops a process that it
licenses to a very large, unrelated, pharmaceutical
manufacturer in Malta, the size of the U.S. research firm would
not have to be tested against the size of the manufacturer.
Similarly, a small U.S. bank that makes a loan to a very large
unrelated company operating a business in Malta would not have
to pass a substantiality test to receive treaty benefits under
Paragraph 4.
Subparagraph 4(c) provides special attribution rules for
purposes of applying the substantive rules of subparagraphs
4(a) and 4(b). Thus, these rules apply for purposes of
determining whether a person meets the requirement in
subparagraph 4(a)(i) 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 4(b). Subparagraph 4(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 deals with the treatment of income in the
context of a so-called ``triangular case.''
An example of a triangular case would be a structure under
which a resident of Malta earns interest income from the United
States. The resident of Malta, who is assumed to qualify for
benefits under one or more of the provisions of this Article,
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 Maltese 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 Maltese resident. Therefore the income that
it earns on those loans, absent the provisions of paragraph 5,
is entitled to a reduced rate of withholding tax under the
Convention. Under a current Maltese income tax treaty with the
host jurisdiction of the permanent establishment, the income of
the permanent establishment is exempt from Maltese tax
(alternatively, Malta may choose to exempt the income of the
permanent establishment from Maltese income tax by statute).
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 Maltese tax.
Paragraph 5 applies reciprocally. However, 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.
Paragraph 5 provides that the tax benefits that would
otherwise apply under the Convention will not apply to any item
of income if the combined tax actually paid in the residence
State and the third state is less than 60 percent of the tax
that would have been payable in the residence State if the
income were earned in that State by the enterprise and were not
attributable to the permanent establishment in the third state.
In the case of dividends, interest and royalties to which this
paragraph applies, the withholding tax rates under the
Convention are replaced with a 15 percent withholding tax. Any
other income to which the provisions of paragraph 5 apply is
subject to tax under the domestic law of the source State,
notwithstanding any other provisions of the Convention.
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.
Paragraph 6
Paragraph 6 provides that a resident of one of the States
that is not entitled to the benefits of the Convention as a
result of paragraphs 1 through 5 still may be granted benefits
under the Convention at the discretion of the competent
authority of the State from which benefits are claimed.
The competent authority's discretion is quite broad. It may
grant all of the benefits of the Convention to the taxpayer
making the request, or it may grant only certain benefits. For
instance, it may grant benefits only with respect to a
particular item of income in a manner similar to paragraph 4.
Further, the competent authority may establish conditions, such
as setting time limits on the duration of any relief granted.
For purposes of implementing paragraph 6, a taxpayer will
be permitted to present his case to the relevant competent
authority for an advance determination based on the facts. In
these circumstances, it is also expected that, if the competent
authority determines that benefits are to be allowed, they will
be allowed retroactively to the time of entry into force of the
relevant treaty provision or the establishment of the structure
in question, whichever is later.
Finally, there may be cases in which a resident of a
Contracting State may apply for discretionary relief to the
competent authority of his State of residence. This would
arise, for example, if the benefit it is claiming is provided
by the residence country, and not by the source country. So,
for example, if a company that is a resident of the United
States would like to claim the benefit of the re-sourcing rule
of paragraph 3 of Article 23, but it does not meet any of the
objective tests of paragraphs 2 through 4, it may apply to the
U.S. competent authority for discretionary relief.
Paragraph 7
Paragraph 7 is included in this Article because Malta
continues to maintain a remittance system of taxation for
individuals who are resident but not domiciled in Malta. Such
persons are subject to tax in Malta on non-Maltese source
income only to the extent that the income or gains are remitted
to Malta. Under paragraph 7, such persons are entitled to the
benefits of the Convention in order to reduce or eliminate tax
only to the extent that the relevant income is remitted to or
received in Malta. For example, if a Maltese resident who is
not domiciled in Malta maintains a brokerage account in a third
country into which is paid $100 in U.S.-source dividend income,
the U.S. may impose withholding tax at the statutory rate of 30
percent because the dividend income will not be taxed in Malta
as it has not been remitted to Malta. If the dividend income
instead is paid into a brokerage account in Malta, the Maltese
resident will be subject to tax in Malta and the United States
will reduce the rate of withholding tax to 15 percent.
Paragraph 8
Paragraph 5 defines several key terms for purposes of
Article 22. Each of the defined terms is discussed above in the
context in which it is used.
ARTICLE 23 (RELIEF FROM DOUBLE TAXATION)
This Article describes the manner in which each Contracting
State undertakes to relieve double taxation. The United States
uses the foreign tax credit method under its internal law, and
by treaty.
Paragraph 1
The United States agrees, in paragraph 1, to allow to its
citizens and residents a credit against U.S. tax for income
taxes paid or accrued to Malta. Paragraph 1 also provides that
Malta's covered taxes are income taxes for U.S. purposes. This
provision is based on the Treasury Department's review of
Malta's laws.
Subparagraph 1(b) provides for a deemed-paid credit,
consistent with section 902 of the Code, to a U.S. corporation
in respect of dividends received from a corporation resident in
Malta of which the U.S. corporation owns at least 10 percent of
the voting stock. This credit is for the tax paid by the
corporation to Malta on the profits out of which the dividends
are considered paid.
The credits allowed under paragraph 1 are allowed in
accordance with the provisions and subject to the limitations
of U.S. law, as that law may be amended over time, so long as
the general principle of the Article, that is, the allowance of
a credit, is retained. Thus, although the Convention provides
for a foreign tax credit, the terms of the credit are
determined by the provisions, at the time a credit is given, of
the U.S. statutory credit.
Therefore, the U.S. credit under the Convention is subject
to the various limitations of U.S. law (see, e.g., Code
sections 901-908). For example, the credit against U.S. tax
generally is limited to the amount of U.S. tax due with respect
to net foreign source income within the relevant foreign tax
credit limitation category (see Code section 904(a) and (d)),
and the dollar amount of the credit is determined in accordance
with U.S. currency translation rules (see, e.g., Code section
986). Similarly, U.S. law applies to determine carryover
periods for excess credits and other inter-year adjustments.
There is a typographical error in the flush language
following paragraph subparagraph 1(b), which describes the
taxes that will be considered income taxes for purposes of
paragraph 1.
The provision as drafted refers to subparagraph 3(a) of
Article 2 (Taxes Covered), which describes the U.S. taxes
covered by the Convention. It should refer instead to
subparagraph 3(b).
Paragraph 2
Paragraph 2 provides that Malta will provide relief from
double taxation through the credit method. Malta agrees in
subparagraph 2(a), in accordance with and subject to the
provisions of the law of Malta, to allow a credit against
Maltese tax for income taxes payable on U.S.-source income.
Subparagraph 2(b) applies where a Maltese company owns at
least 10 percent of the voting stock of a U.S. company from
which the Maltese company receives dividends that are included
in a Malta assessment in accordance with the Convention. In
such a case, the income tax paid or accrued to the United
States by or on behalf of the payer with respect to the profits
out of which the dividends are paid shall, if those profits are
included in a Malta assessment, be allowed as a credit against
the relative Malta tax payable thereon.
Paragraph 3
Paragraph 3 provides a re-sourcing rule for gross income
covered by paragraph 1. Paragraph 3 is intended to ensure that
a U.S. resident can obtain an appropriate amount of U.S.
foreign tax credit for income taxes paid to Malta when the
Convention assigns to Malta primary taxing rights over an item
of gross income.
Accordingly, if the Convention allows Malta to tax an item
of gross income (as defined under U.S. law) derived by a
resident of the United States, the United States will treat
that item of gross income as gross income from sources within
Malta for U.S. foreign tax credit purposes. In the case of a
U.S.-owned foreign corporation, however, section 904(g)(10) may
apply for purposes of determining the U.S. foreign tax credit
with respect to income subject to this re-sourcing rule.
Section 904(g)(10) generally applies the foreign tax credit
limitation separately to re-sourced income. Furthermore, the
paragraph 3 re-sourcing rule applies to gross income, not net
income. Accordingly, U.S. expense allocation and apportionment
rules, see, e.g., Treas. Reg. section 1.861-9, continue to
apply to income resourced under paragraph 3.
Paragraph 4
Paragraph 4 provides special rules for the tax treatment in
both States of certain types of income derived from U.S.
sources by U.S. citizens who are residents of Malta. Since U.S.
citizens, regardless of residence, are subject to United States
tax at ordinary progressive rates on their worldwide income,
the U.S. tax on the U.S. source income of a U.S. citizen
resident in Malta may exceed the U.S. tax that may be imposed
under the Convention on an item of U.S. source income derived
by a resident of Malta who is not a U.S. citizen. The
provisions of paragraph 4 ensure that Malta does not bear the
cost of U.S. taxation of its citizens who are residents of
Malta.
Subparagraph 4(a) provides, with respect to items of income
from sources within the United States, special credit rules for
Malta. These rules apply to items of U.S.-source income that
would be either exempt from U.S. tax or subject to reduced
rates of U.S. tax under the provisions of the Convention if
they had been received by a resident of Malta who is not a U.S.
citizen. The tax credit allowed under paragraph 4 with respect
to such items need not exceed the U.S. tax that may be imposed
under the Convention, other than tax imposed solely by reason
of the U.S. citizenship of the taxpayer under the provisions of
the saving clause of paragraph 4 of Article 1 (General Scope).
For example, if a U.S. citizen resident in Malta receives a
payment of royalties from sources within the United States, the
foreign tax credit granted by Malta would be limited to 10
percent of the gross amount of the royalties--the U.S. tax that
may be imposed under paragraph 2 of Article 12 (Royalties)--
even if the shareholder is subject to U.S. net income tax
because of his U.S. citizenship.
Subparagraph 4(b) eliminates the potential for double
taxation that can arise because subparagraph 4(a) provides that
Malta need not provide full relief for the U.S. tax imposed on
its citizens resident in Malta. Subparagraph 4(b) provides that
the United States will credit the income tax paid or accrued to
Malta, after the application of subparagraph 4(a). It further
provides that in allowing the credit, the United States will
not reduce its tax below the amount that is taken into account
in Malta in applying subparagraph 4(a).
Since the income described in subparagraph 4(a) generally
will be U.S. source income, special rules are required to re-
source some of the income to Malta in order for the United
States to be able to credit the tax paid to Malta. This re-
sourcing is provided for in subparagraph 4(c), which deems the
items of income referred to in subparagraph 4(a) to be from
foreign sources to the extent necessary to avoid double
taxation under paragraph 4(b). Clause (iii) of subparagraph
3(c) of Article 25 (Mutual Agreement Procedure) provides a
mechanism by which the competent authorities can resolve any
disputes regarding whether income is from sources within the
United States.
The following two examples illustrate the application of
paragraph 4 in the case of U.S.source royalties received by a
U.S. citizen resident in Malta. In both examples, the U.S. rate
of tax on residents of Malta, under paragraph 2 of Article 12
(Royalties) of the Convention, is 10 percent. In both examples,
the U.S. income tax rate on the U.S. citizen is 35 percent. In
example 1, the rate of income tax imposed in Malta on its
resident (the U.S. citizen) is 25 percent (below the U.S.
rate), and in example 2, the rate imposed on its resident is 40
percent (above the U.S. rate).
------------------------------------------------------------------------
Example 1 Example 2
------------------------------------------------------------------------
Subparagraph (a):
U.S.-source royalty payment......... $100.00 $100.00
Notional U.S. withholding tax 10.00 10.00
(Article 10(2)(a)).................
Taxable income in Malta............. 100.00 100.00
Maltese tax before credit........... 25.00 40.00
Less: tax credit for notional U.S. 10.00 10.00
withholding tax....................
Net post-credit tax paid to Malta... 15.00 30.00
Subparagraphs (b) and (c):
U.S. pre-tax income................. $100.00 $100.00
U.S. pre-credit citizenship tax..... 35.00 35.00
Notional U.S. withholding tax....... 10.00 10.00
U.S. tax eligible to be offset by 25.00 25.00
credit.............................
Tax paid to Malta................... 15.00 30.00
Income re-sourced from U.S. to 42.86 71.43
foreign source (see below).........
U.S. pre-credit tax on re-sourced 15.00 25.00
income.............................
U.S. credit for tax paid to Malta... 15.00 25.00
Net post-credit U.S. tax............ 10.00 0.00
Total U.S. tax...................... 20.00 10.00
------------------------------------------------------------------------
In both examples, in the application of subparagraph (a),
Malta credits a 10 percent U.S. tax against its residence tax
on the U.S. citizen. In the first example, the net tax paid to
Malta after the foreign tax credit is $15.00; in the second
example, it is $30.00. In the application of subparagraphs (b)
and (c), from the U.S. tax due before credit of $35.00, the
United States subtracts the amount of the U.S. source tax of
$10.00, against which no U.S. foreign tax credit is allowed.
This subtraction ensures that the United States collects the
tax that it is due under the Convention as the State of source.
In both examples, given the 35 percent U.S. tax rate, the
maximum amount of U.S. tax against which credit for the tax
paid to Malta may be claimed is $25 ($35 U.S. tax minus $10
U.S. withholding tax). Initially, all of the income in both
examples was from sources within the United States. For a U.S.
foreign tax credit to be allowed for the full amount of the tax
paid to Malta, an appropriate amount of the income must be
treated as foreign-source income under subparagraph (c).
The amount that must be re-sourced depends on the amount of
tax for which the U.S. citizen is claiming a U.S. foreign tax
credit. In example 1, the tax paid to Malta was $15. For this
amount to be creditable against U.S. tax, $42.86 ($15 tax
divided by 35 percent U.S. tax rate) must be resourced as
foreign-source income. When the tax is credited against the $15
of U.S. tax on this resourced income, there is a net U.S. tax
of $10 due after credit ($25 U.S. tax eligible to be offset by
credit, minus $15 tax paid to Malta). Thus, in example 1, there
is a total of $20 in U.S. tax ($10 U.S. withholding tax plus
$10 residual U.S. tax).
In example 2, the tax paid to Malta was $30, but, because
the United States subtracts the U.S. withholding tax of $10
from the total U.S. tax of $35, only $25 of U.S. taxes may be
offset by taxes paid to Malta. Accordingly, the amount that
must be resourced to Malta is limited to the amount necessary
to ensure a U.S. foreign tax credit for $25 of tax paid to
Malta, or $71.43 ($25 tax paid to the other Contracting State
divided by 35 percent U.S. tax rate). When the tax paid to
Malta is credited against the U.S. tax on this re-sourced
income, there is no residual U.S. tax ($25 U.S. tax minus $30
tax paid to Malta, subject to the U.S. limit of $25). Thus, in
example 2, there is a total of $10 in U.S. tax ($10 U.S.
withholding tax plus $0 residual U.S. tax). Because the tax
paid to Malta was $30 and the U.S. tax eligible to be offset by
credit was $25, there is $5 of excess foreign tax credit
available for carryover.
Relationship to Other Articles
By virtue of subparagraph (a) of paragraph 5 of Article 1
(General Scope), Article 23 is not subject to the saving clause
of paragraph 4 of Article 1. Thus, the United States will allow
a credit to its citizens and residents in accordance with the
Article, even if such credit were to provide a benefit not
available under the Code (such as the re-sourcing provided by
paragraph 3 and subparagraph 4(c)).
ARTICLE 24 (NON-DISCRIMINATION)
This Article ensures that nationals of a Contracting State,
in the case of paragraph 1, and residents of a Contracting
State, in the case of paragraphs 2 through 5, will not be
subject, directly or indirectly, to discriminatory taxation in
the other Contracting State. Not all differences in tax
treatment, either as between nationals of the two States, or
between residents of the two States, are violations of the
prohibition against discrimination. Rather, the
nondiscrimination obligations of this Article apply only if the
nationals or residents of the two States are comparably
situated.
Each of the relevant paragraphs of the Article provides
that two persons that are comparably situated must be treated
similarly. Although the actual words differ from paragraph to
paragraph (e.g., paragraph 1 refers to two nationals ``in the
same circumstances,'' paragraph 2 refers to two enterprises
``carrying on the same activities'' and paragraph 4 refers to
two enterprises that are ``similar''), the common underlying
premise is that if the difference in treatment is directly
related to a tax-relevant difference in the situations of the
domestic and foreign persons being compared, that difference is
not to be treated as discriminatory (i.e., if one person is
taxable in a Contracting State on worldwide income and the
other is not, or tax may be collectible from one person at a
later stage, but not from the other, distinctions in treatment
would be justified under paragraph 1). Other examples of such
factors that can lead to nondiscriminatory differences in
treatment are noted in the discussions of each paragraph.
The operative paragraphs of the Article also use different
language to identify the kinds of differences in taxation
treatment that will be considered discriminatory. For example,
paragraphs 1 and 4 speak of ``any taxation or any requirement
connected therewith that is more burdensome,'' while paragraph
2 specifies that a tax ``shall not be less favorably levied.''
Regardless of these differences in language, only differences
in tax treatment that materially disadvantage the foreign
person relative to the domestic person are properly the subject
of the Article.
Paragraph 1
Paragraph 1 provides that a national of one Contracting
State may not be subject to taxation or connected requirements
in the other Contracting State that are more burdensome than
the taxes and connected requirements imposed upon a national of
that other State in the same circumstances. The OECD Model
prohibits taxation that is ``other than or more burdensome''
than that imposed on U.S. persons. This Convention omits the
reference to taxation that is ``other than'' that imposed on
U.S. persons because the only relevant question under this
provision should be whether the requirement imposed on a
national of the other Contracting State is more burdensome. A
requirement may be different from the requirements imposed on
U.S. nationals without being more burdensome.
The term ``national'' in relation to a Contracting State is
defined in subparagraph 1(j) of Article 3 (General
Definitions). The term includes both individuals and juridical
persons. A national of a Contracting State is afforded
protection under this paragraph even if the national is not a
resident of either Contracting State. Thus, a U.S. citizen who
is resident in a third country is entitled, under this
paragraph, to the same treatment in Malta as a national of
Malta who is in similar circumstances (i.e., presumably one who
is resident in a third State).
As noted above, whether or not the two persons are both
taxable on worldwide income is a significant circumstance for
this purpose. For this reason, paragraph 1 specifically states
that the United States is not obligated to apply the same
taxing regime to a national of Malta who is not resident in the
United States as it applies to a U.S. national who is not
resident in the United States. United States citizens who are
not residents of the United States but who are, nevertheless,
subject to United States tax on their worldwide income are not
in the same circumstances with respect to United States
taxation as citizens of Malta who are not United States
residents. Thus, for example, Article 24 would not entitle a
national of Malta resident in a third country to taxation at
graduated rates on U.S. source dividends or other investment
income that applies to a U.S. citizen resident in the same
third country.
Paragraph 2
Paragraph 2 of the Article, provides that a Contracting
State may not tax a permanent establishment of an enterprise of
the other Contracting State less favorably than an enterprise
of that first-mentioned State that is carrying on the same
activities.
The fact that a U.S. permanent establishment of an
enterprise of Malta is subject to U.S. tax only on income that
is attributable to the permanent establishment, while a U.S.
corporation engaged in the same activities is taxable on its
worldwide income is not, in itself, a sufficient difference to
provide different treatment for the permanent establishment.
There are cases, however, where the two enterprises would not
be similarly situated and differences in treatment may be
warranted. For instance, it would not be a violation of the
non-discrimination protection of paragraph 2 to require the
foreign enterprise to provide information in a reasonable
manner that may be different from the information requirements
imposed on a resident enterprise, because information may not
be as readily available to the Internal Revenue Service from a
foreign as from a domestic enterprise. Similarly, it would not
be a violation of paragraph 2 to impose penalties on persons
who fail to comply with such a requirement (see, e.g., sections
874(a) and 882(c)(2)). Further, a determination that income and
expenses have been attributed or allocated to a permanent
establishment in conformity with the principles of Article 7
(Business Profits) implies that the attribution or allocation
was not discriminatory.
Section 1446 of the Code imposes on any partnership with
income that is effectively connected with a U.S. trade or
business the obligation to withhold tax on amounts allocable to
a foreign partner. In the context of the Convention, this
obligation applies with respect to a share of the partnership
income of a partner resident in Malta, and attributable to a
U.S. permanent establishment. There is no similar obligation
with respect to the distributive shares of U.S. resident
partners. It is understood, however, that this distinction is
not a form of discrimination within the meaning of paragraph 2
of the Article. No distinction is made between U.S. and non-
U.S. partnerships, since the law requires that partnerships of
both U.S. and non-U.S. domicile withhold tax in respect of the
partnership shares of non-U.S. partners. Furthermore, in
distinguishing between U.S. and non-U.S. partners, the
requirement to withhold on the non-U.S. but not the U.S.
partner's share is not discriminatory taxation, but, like other
withholding on nonresident aliens, is merely a reasonable
method for the collection of tax from persons who are not
continually present in the United States, and as to whom it
otherwise may be difficult for the United States to enforce its
tax jurisdiction. If tax has been over-withheld, the partner
can, as in other cases of over-withholding, file for a refund.
Paragraph 3
Paragraph 3 makes clear that the provisions of paragraphs 1
and 2 do not obligate a Contracting State to grant to a
resident of the other Contracting State any tax allowances,
reliefs, etc., that it grants to its own residents on account
of their civil status or family responsibilities. Thus, if a
sole proprietor who is a resident of Malta has a permanent
establishment in the United States, in assessing income tax on
the profits attributable to the permanent establishment, the
United States is not obligated to allow to the resident of
Malta the personal allowances for himself and his family that
he would be permitted to take if the permanent establishment
were a sole proprietorship owned and operated by a U.S.
resident, despite the fact that the individual income tax rates
would apply.
Paragraph 4
Paragraph 4 prohibits discrimination in the allowance of
deductions. When a resident or an enterprise of a Contracting
State pays interest, royalties or other disbursements to a
resident of the other Contracting State, the first-mentioned
Contracting State must allow a deduction for those payments in
computing the taxable profits of the resident or enterprise as
if the payment had been made under the same conditions to a
resident of the first-mentioned Contracting State. Paragraph 4,
however, does not require a Contracting State to give
nonresidents more favorable treatment than it gives to its own
residents. Consequently, a Contracting State does not have to
allow nonresidents a deduction for items that are not
deductible under its domestic law (for example, expenses of a
capital nature).
The term ``other disbursements'' is understood to include a
reasonable allocation of executive and general administrative
expenses, research and development expenses and other expenses
incurred for the benefit of a group of related persons that
includes the person incurring the expense.
An exception to the rule of paragraph 4 is provided for
cases where the provisions of paragraph 1 of Article 9
(Associated Enterprises), paragraph 7 of Article 11 (Interest)
or paragraph 6 of Article 12 (Royalties) apply. All of these
provisions permit the denial of deductions in certain
circumstances in respect of transactions between related
persons. Neither State is forced to apply the non-
discrimination principle in such cases. The exception with
respect to paragraph 7 of Article 11 would include the denial
or deferral of certain interest deductions under Code section
163(j).
Paragraph 4 also provides that any debts of an enterprise
of a Contracting State to a resident of the other Contracting
State are deductible in the first-mentioned Contracting State
for purposes of computing the capital tax of the enterprise
under the same conditions as if the debt had been contracted to
a resident of the first-mentioned Contracting State. Even
though, for general purposes, the Convention covers only income
taxes, under paragraph 7 of this Article, the nondiscrimination
provisions apply to all taxes levied in both Contracting
States, at all levels of government. Thus, this provision may
be relevant for both States. The other Contracting State may
have capital taxes and in the United States such taxes
frequently are imposed by local governments.
Paragraph 5
Paragraph 5 requires that a Contracting State not impose
more burdensome taxation or connected requirements on an
enterprise of that State that is wholly or partly owned or
controlled, directly or indirectly, by one or more residents of
the other Contracting State than the taxation or connected
requirements that it imposes on other similar enterprises of
that first-mentioned Contracting State. For this purpose it is
understood that ``similar'' refers to similar activities or
ownership of the enterprise.
This rule, like all non-discrimination provisions, does not
prohibit differing treatment of entities that are in differing
circumstances. Rather, a protected enterprise is only required
to be treated in the same manner as other enterprises that,
from the point of view of the application of the tax law, are
in substantially similar circumstances both in law and in fact.
The taxation of a distributing corporation under section 367(e)
on an applicable distribution to foreign shareholders does not
violate paragraph 5 of the Article because a foreign-owned
corporation is not similar to a domestically-owned corporation
that is accorded non-recognition treatment under sections 337
and 355.
For the reasons given above in connection with the
discussion of paragraph 2 of the Article, it is also understood
that the provision in section 1446 of the Code for withholding
of tax on non-U.S. partners does not violate paragraph 5 of the
Article.
It is further understood that the ineligibility of a U.S.
corporation with nonresident alien shareholders to make an
election to be an ``S'' corporation does not violate paragraph
5 of the Article. If a corporation elects to be an S
corporation, it is generally not subject to income tax and the
shareholders take into account their pro rata shares of the
corporation's items of income, loss, deduction or credit. (The
purpose of the provision is to allow an individual or small
group of individuals the protections of conducting business in
corporate form while paying taxes at individual rates as if the
business were conducted directly.) A nonresident alien does not
pay U.S. tax on a net basis, and, thus, does not generally take
into account items of loss, deduction or credit. Thus, the S
corporation provisions do not exclude corporations with
nonresident alien shareholders because such shareholders are
foreign, but only because they are not net-basis taxpayers.
Similarly, the provisions exclude corporations with other types
of shareholders where the purpose of the provisions cannot be
fulfilled or their mechanics implemented. For example,
corporations with corporate shareholders are excluded because
the purpose of the provision to permit individuals to conduct a
business in corporate form at individual tax rates would not be
furthered by their inclusion.
Finally, it is understood that paragraph 5 does not require
a Contracting State to allow foreign corporations to join in
filing a consolidated return with a domestic corporation or to
allow similar benefits between domestic and foreign
enterprises.
Paragraph 6
Paragraph 6 of the Article confirms that no provision of
the Article will prevent either Contracting State from imposing
the branch profits tax described in paragraph 8 of Article 10
(Dividends).
Paragraph 7
As noted above, notwithstanding the specification of taxes
covered by the Convention in Article 2 (Taxes Covered) for
general purposes, for purposes of providing nondiscrimination
protection this Article applies to taxes of every kind and
description imposed by a Contracting State or a political
subdivision or local authority thereof. Customs duties are not
considered to be taxes for this purpose.
Relationship to Other Articles
The saving clause of paragraph 4 of Article 1 (General
Scope) does not apply to this Article by virtue of the
exceptions in paragraph 5(a) of Article 1. Thus, for example, a
U.S. citizen who is a resident of Malta may claim benefits in
the United States under this Article.
Nationals of a Contracting State may claim the benefits of
paragraph 1 regardless of whether they are entitled to benefits
under Article 22 (Limitation on Benefits), because that
paragraph applies to nationals and not residents. They may not
claim the benefits of the other paragraphs of this Article with
respect to an item of income unless they are generally entitled
to treaty benefits with respect to that income under a
provision of Article 22.
ARTICLE 25 (MUTUAL AGREEMENT PROCEDURE)
This Article provides the mechanism for taxpayers to bring
to the attention of competent authorities issues and problems
that may arise under the Convention. It also provides the
authority for cooperation between the competent authorities of
the Contracting States to resolve disputes and clarify issues
that may arise under the Convention and to resolve cases of
double taxation not provided for in the Convention. The
competent authorities of the two Contracting States are
identified in paragraph 1(g) of Article 3 (General
Definitions).
Paragraph 1
This paragraph provides that where a resident of a
Contracting State considers that the actions of one or both
Contracting States will result in taxation that is not in
accordance with the Convention he may present his case to the
competent authority of either Contracting State. This rule is
more generous than in most treaties, which generally allow
taxpayers to bring competent authority cases only to the
competent authority of their country of residence, or
citizenship/nationality. Under this more generous rule, a U.S.
permanent establishment of a corporation resident in Malta that
faces inconsistent treatment in the two countries would be able
to bring its request for assistance to the U.S. competent
authority. If the U.S. competent authority can resolve the
issue on its own, then the taxpayer need never involve the
Maltese competent authority. Thus, the rule provides
flexibility that might result in greater efficiency.
Although the typical cases brought under this paragraph
will involve economic double taxation arising from transfer
pricing adjustments, the scope of this paragraph is not limited
to such cases. For example, a taxpayer could request assistance
from the competent authority if one Contracting State
determines that the taxpayer has received deferred compensation
taxable at source under Article 14 (Income from Employment),
while the taxpayer believes that such income should be treated
as a pension that is taxable only in his country of residence
pursuant to Article 17 (Pensions, Social Security, Annuities,
Alimony, and Child Support).
It is not necessary for a person requesting assistance
first to have exhausted the remedies provided under the
national laws of the Contracting States before presenting a
case to the competent authorities, nor does the fact that the
statute of limitations may have passed for seeking a refund
preclude bringing a case to the competent authority. Unlike the
OECD Model, no time limit is provided within which a case must
be brought.
Paragraph 2
Paragraph 2 sets out the framework within which the
competent authorities will deal with cases brought by taxpayers
under paragraph 1. It provides that, if the competent authority
of the Contracting State to which the case is presented judges
the case to have merit, and cannot reach a unilateral solution,
it shall seek an agreement with the competent authority of the
other Contracting State pursuant to which taxation not in
accordance with the Convention will be avoided.
Any agreement is to be implemented even if such
implementation otherwise would be barred by the statute of
limitations or by some other procedural limitation, such as a
closing agreement. Paragraph 2, however, does not prevent the
application of domestic-law procedural limitations that give
effect to the agreement (e.g., a domestic-law requirement that
the taxpayer file a return reflecting the agreement within one
year of the date of the agreement).
Where the taxpayer has entered a closing agreement (or
other written settlement) with the United States before
bringing a case to the competent authorities, the U.S.
competent authority will endeavor only to obtain a correlative
adjustment from Malta. See Rev. Proc. 200654, 2006-49 I.R.B.
1035, Sec. 7.05. Because, as specified in paragraph 2 of
Article 1 (General Scope), the Convention cannot operate to
increase a taxpayer's liability, temporal or other procedural
limitations can be overridden only for the purpose of making
refunds and not to impose additional tax.
Paragraph 3
Paragraph 3 authorizes the competent authorities to resolve
difficulties or doubts that may arise as to the application or
interpretation of the Convention. The paragraph includes a non-
exhaustive list of examples of the kinds of matters about which
the competent authorities may reach agreement. This list is
purely illustrative; it does not grant any authority that is
not implicitly present as a result of the introductory sentence
of paragraph 3.
The competent authorities may, for example, agree to the
same allocation of income, deductions, credits or allowances
between an enterprise in one Contracting State and its
permanent establishment in the other or between related
persons. These allocations are to be made in accordance with
the arm's length principle underlying Article 7 (Business
Profits) and Article 9 (Associated Enterprises). Agreements
reached under these subparagraphs may include agreement on a
methodology for determining an appropriate transfer price, on
an acceptable range of results under that methodology, or on a
common treatment of a taxpayer's cost sharing arrangement.
As indicated in subparagraph 3(c), the competent
authorities also may agree to settle a variety of conflicting
applications of the Convention. They may agree to settle
conflicts regarding the characterization of particular items of
income, the characterization of persons, the application of
source rules to particular items of income, the meaning of a
term, or the timing of an item of income.
The competent authorities also may agree as to advance
pricing arrangements. They also may agree as to the application
of the provisions of domestic law regarding penalties, fines,
and interest in a manner consistent with the purposes of the
Convention.
Since the list under paragraph 3 is not exhaustive, the
competent authorities may reach agreement on issues not
enumerated in paragraph 3 if necessary to avoid double
taxation. For example, the competent authorities may seek
agreement on a uniform set of standards for the use of exchange
rates. Agreements reached by the competent authorities under
paragraph 3 need not conform to the internal law provisions of
either Contracting State.
Finally, paragraph 3 authorizes the competent authorities
to consult for the purpose of eliminating double taxation in
cases not provided for in the Convention and to resolve any
difficulties or doubts arising as to the interpretation or
application of the Convention. This provision is intended to
permit the competent authorities to implement the treaty in
particular cases in a manner that is consistent with its
expressed general purposes. It permits the competent
authorities to deal with cases that are within the spirit of
the provisions but that are not specifically covered. An
example of such a case might be double taxation arising from a
transfer pricing adjustment between two permanent
establishments of a third-country resident, one in the United
States and one in Malta. Since no resident of a Contracting
State is involved in the case, the Convention does not apply,
but the competent authorities nevertheless may use the
authority of this Article to prevent the double taxation of
income.
Paragraph 4
Paragraph 4 authorizes the competent authorities to
increase any dollar amounts referred to in the Convention to
reflect economic and monetary developments. This refers only to
Article 16 (Entertainers and Sportsmen); Article 20 (Students
and Trainees) separately instructs the competent authorities to
adjust the exemption amount for students and trainees in
accordance with specified guidelines. The rule under paragraph
4 is intended to operate as follows: if, for example, after the
Convention has been in force for some time, inflation rates
have been such as to make the $20,000 exemption threshold for
entertainers unrealistically low in terms of the original
objectives intended in setting the threshold, the competent
authorities may agree to a higher threshold without the need
for formal amendment to the treaty and ratification by the
Contracting States. This authority can be exercised, however,
only to the extent necessary to restore those original
objectives. This provision can be applied only to the benefit
of taxpayers (i.e., only to increase thresholds, not to reduce
them).
Paragraph 5
Paragraph 5 provides that the competent authorities may
communicate with each other for the purpose of reaching an
agreement. This makes clear that the competent authorities of
the two Contracting States may communicate without going
through diplomatic channels. Such communication may be in
various forms, including, where appropriate, through face-to-
face meetings of representatives of the competent authorities.
Treaty termination in relation to competent authority dispute
resolution
A case may be raised by a taxpayer after the Convention has
been terminated with respect to a year for which a treaty was
in force. In such a case the ability of the competent
authorities to act is limited. They may not exchange
confidential information, nor may they reach a solution that
varies from that specified in its law.
Triangular competent authority solutions
International tax cases may involve more than two taxing
jurisdictions (e.g., transactions among a parent corporation
resident in country A and its subsidiaries resident in
countries B and C). As long as there is a complete network of
treaties among the three countries, it should be possible,
under the full combination of bilateral authorities, for the
competent authorities of the three States to work together on a
three-sided solution. Although country A may not be able to
give information received under Article 26 (Exchange of
Information and Administrative Assistance) from country B to
the authorities of country C, if the competent authorities of
the three countries are working together, it should not be a
problem for them to arrange for the authorities of country B to
give the necessary information directly to the tax authorities
of country C, as well as to those of country A. Each bilateral
part of the trilateral solution must, of course, not exceed the
scope of the authority of the competent authorities under the
relevant bilateral treaty.
Relationship to Other Articles
This Article is not subject to the saving clause of
paragraph 4 of Article 1 (General Scope) by virtue of the
exceptions in subparagraph 5(a) of that Article. Thus, rules,
definitions, procedures, etc. that are agreed upon by the
competent authorities under this Article may be applied by the
United States with respect to its citizens and residents even
if they differ from the comparable Code provisions. Similarly,
as indicated above, U.S. law may be overridden to provide
refunds of tax to a U.S. citizen or resident under this
Article. A person may seek relief under Article 25 regardless
of whether he is generally entitled to benefits under Article
22 (Limitation on Benefits). As in all other cases, the
competent authority is vested with the discretion to decide
whether the claim for relief is justified.
ARTICLE 26 (EXCHANGE OF INFORMATION AND ADMINISTRATIVE ASSISTANCE)
This Article provides for the exchange of information and
administrative assistance between the competent authorities of
the Contracting States.
Paragraph 1
The obligation to obtain and provide information to the
other Contracting State is set out in Paragraph 1. The
information to be exchanged is that which may be relevant for
carrying out the provisions of the Convention or the domestic
laws of the United States or of the other Contracting State
concerning taxes of every kind applied at the national level.
This language incorporates the standard in 26 U.S.C. Section
7602 which authorizes the IRS to examine ``any books, papers,
records, or other data which may be relevant or material.''
(Emphasis added.) In United States v. Arthur Young & Co., 465
U.S. 805, 814 (1984), the Supreme Court stated that the
language ``may be'' reflects Congress's express intention to
allow the IRS to obtain ``items of even potential relevance to
an ongoing investigation, without reference to its
admissibility.'' (Emphasis in original.) However, the language
``may be'' would not support a request in which a Contracting
State simply asked for information regarding all bank accounts
maintained by residents of that Contracting State in the other
Contracting State, or even all accounts maintained by its
residents with respect to a particular bank.
Exchange of information with respect to each State's
domestic law is authorized to the extent that taxation under
domestic law is not contrary to the Convention. Thus, for
example, information may be exchanged with respect to a covered
tax, even if the transaction to which the information relates
is a purely domestic transaction in the requesting State and,
therefore, the exchange is not made to carry out the
Convention. An example of such a case is provided in paragraph
8(b) of the OECD Commentary: a company resident in one
Contracting State and a company resident in the other
Contracting State transact business between themselves through
a third-country resident company. Neither Contracting State has
a treaty with the third State. To enforce their internal laws
with respect to transactions of their residents with the third-
country company (since there is no relevant treaty in force),
the Contracting States may exchange information regarding the
prices that their residents paid in their transactions with the
third-country resident.
Paragraph 1 clarifies that information may be exchanged
that relates to the assessment or collection of, the
enforcement or prosecution in respect of, or the determination
of appeals in relation to, the taxes covered by the Convention.
Thus, the competent authorities may request and provide
information for cases under examination or criminal
investigation, in collection, on appeals, or under prosecution.
The taxes covered by the Convention for purposes of this
Article constitute a broader category of taxes than those
referred to in Article 2 (Taxes Covered). Exchange of
information is authorized with respect to taxes of every kind
imposed by a Contracting State at the national level.
Accordingly, information may be exchanged with respect to U.S.
estate and gift taxes, excise taxes or, with respect to Malta,
value added taxes.
Information exchange is not restricted by paragraph 1 of
Article 1 (General Scope). Accordingly, information may be
requested and provided under this article with respect to
persons who are not residents of either Contracting State. For
example, if a third-country resident has a permanent
establishment in Malta, and that permanent establishment
engages in transactions with a U.S. enterprise, the United
States could request information with respect to that permanent
establishment, even though the third-country resident is not a
resident of either Contracting State. Similarly, if a third-
country resident maintains a bank account in Malta, and the
Internal Revenue Service has reason to believe that funds in
that account should have been reported for U.S. tax purposes
but have not been so reported, information can be requested
from Malta with respect to that person's account, even though
that person is not the taxpayer under examination.
Although the term ``United States'' does not encompass U.S.
possessions for most purposes of the Convention, Section 7651
of the Code authorizes the Internal Revenue Service to utilize
the provisions of the Internal Revenue Code to obtain
information from the U.S. possessions pursuant to a proper
request made under Article 26. If necessary to obtain requested
information, the Internal Revenue Service could issue and
enforce an administrative summons to the taxpayer, a tax
authority (or a government agency in a U.S. possession), or a
third party located in a U.S. possession.
Paragraph 2
Paragraph 2 provides assurances that any information
exchanged will be treated as secret, subject to the same
disclosure constraints as information obtained under the laws
of the requesting State. Information received may be disclosed
only to persons, including courts and administrative bodies,
involved in the assessment, collection, or administration of,
the enforcement or prosecution in respect of, or the
determination of the of appeals in relation to, the taxes
covered by the Convention. The information must be used by
these persons in connection with the specified functions.
Information may also be disclosed to legislative bodies, such
as the tax-writing committees of Congress and the Government
Accountability Office, engaged in the oversight of the
preceding activities. Information received by these bodies must
be for use in the performance of their role in overseeing the
administration of U.S. tax laws. Information received may be
disclosed in public court proceedings or in judicial decisions.
Paragraph 2 also provides that the competent authority of
the Contracting State that receives information under this
Article may, with the written consent of the other Contracting
State, make that information available to be used for other
purposes allowed under the provisions of an existing mutual
legal assistance treaty between the Contracting States that
allows for the exchange of tax information.
Paragraph 3
Paragraph 3 provides that the obligations undertaken in
paragraphs 1 and 2 to exchange information do not require a
Contracting State to carry out administrative measures that are
at variance with the laws or administrative practice of either
State. Nor is a Contracting State required to supply
information not obtainable under the laws or administrative
practice of either State, or to disclose trade secrets or other
information, the disclosure of which would be contrary to
public policy.
Thus, a requesting State may be denied information from the
other State if the information would be obtained pursuant to
procedures or measures that are broader than those available in
the requesting State. However, the statute of limitations of
the Contracting State making the request for information should
govern a request for information. Thus, the Contracting State
of which the request is made should attempt to obtain the
information even if its own statute of limitations has passed.
In many cases, relevant information will still exist in the
business records of the taxpayer or a third party, even though
it is no longer required to be kept for domestic tax purposes.
While paragraph 3 states conditions under which a
Contracting State is not obligated to comply with a request
from the other Contracting State for information, the requested
State is not precluded from providing such information, and
may, at its discretion, do so subject to the limitations of its
internal law.
Paragraph 4
Paragraph 4 provides that when information is requested by
a Contracting State in accordance with this Article, the other
Contracting State is obligated to obtain the requested
information as if the tax in question were the tax of the
requested State, even if that State has no direct tax interest
in the case to which the request relates. In the absence of
such a paragraph, some taxpayers have argued that paragraph
3(a) prevents a Contracting State from requesting information
from a bank or fiduciary that the Contracting State does not
need for its own tax purposes. This paragraph clarifies that
paragraph 3 does not impose such a restriction and that a
Contracting State is not limited to providing only the
information that it already has in its own files.
Paragraph 5
Paragraph 5 provides that a Contracting State may not
decline to provide information because that information is held
by financial institutions, nominees or persons acting in an
agency or fiduciary capacity. Thus, paragraph 5 would
effectively prevent a Contracting State from relying on
paragraph 3 to argue that its domestic bank secrecy laws (or
similar legislation relating to disclosure of financial
information by financial institutions or intermediaries)
override its obligation to provide information under paragraph
1. This paragraph also requires the disclosure of information
regarding the beneficial owner of an interest in a person, such
as the identity of a beneficial owner of bearer shares.
Paragraph 6
Paragraph 6 provides that the requesting State may specify
the form in which information is to be provided (e.g.,
depositions of witnesses and authenticated copies of original
documents). The intention is to ensure that the information may
be introduced as evidence in the judicial proceedings of the
requesting State. The requested State should, if possible,
provide the information in the form requested to the same
extent that it can obtain information in that form under its
own laws and administrative practices with respect to its own
taxes.
Paragraph 7
Paragraph 7 provides that the requested State shall allow
representatives of the applicant State to enter the requested
State to interview individuals and examine books and records
with the consent of the persons subject to examination.
Paragraph 8
Paragraph 8 states that the competent authorities of the
Contracting States may develop an agreement upon the mode of
application of the Article. The article authorizes the
competent authorities to exchange information on a routine
basis, on request in relation to a specific case, or
spontaneously. It is contemplated that the Contracting States
will utilize this authority to engage in all of these forms of
information exchange, as appropriate.
The competent authorities may also agree on specific
procedures and timetables for the exchange of information. In
particular, the competent authorities may agree on minimum
thresholds regarding tax at stake or take other measures aimed
at ensuring some measure of reciprocity with respect to the
overall exchange of information between the Contracting States.
Treaty effective dates and termination in relation to exchange of
information
Once the Convention is in force, the competent authority
may seek information under the Convention with respect to a
year prior to the entry into force of the Convention. Even if
an earlier Convention with more restrictive provisions, or even
no Convention, was in effect during the years in which the
transaction at issue occurred, the exchange of information
provisions of the Convention apply. In that case, the competent
authorities have available to them the full range of
information exchange provisions afforded under this Article.
Paragraph 3 of Article 28 (Entry into Force) confirms this
understanding with respect to the effective date of the
Article.
A tax administration may also seek information with respect
to a year for which a treaty was in force after the treaty has
been terminated. In such a case the ability of the other tax
administration to act is limited. The treaty no longer provides
authority for the tax administrations to exchange confidential
information. They may only exchange information pursuant to
domestic law or other international agreement or arrangement.
ARTICLE 27 (MEMBERS OF DIPLOMATIC MISSIONS AND CONSULAR POSTS)
This Article confirms that any fiscal privileges to which
diplomatic or consular officials are entitled under general
provisions of international law or under special agreements
will apply notwithstanding any provisions to the contrary in
the Convention. The agreements referred to include any
bilateral agreements, such as consular conventions, that affect
the taxation of diplomats and consular officials and any
multilateral agreements dealing with these issues, such as the
Vienna Convention on Diplomatic Relations and the Vienna
Convention on Consular Relations. The U.S. generally adheres to
the latter because its terms are consistent with customary
international law.
The Article does not independently provide any benefits to
diplomatic agents and consular officers. Article 19 (Government
Service) does so, as do Code section 893 and a number of
bilateral and multilateral agreements. In the event that there
is a conflict between the Convention and international law or
such other treaties, under which the diplomatic agent or
consular official is entitled to greater benefits under the
latter, the latter laws or agreements shall have precedence.
Conversely, if the Convention confers a greater benefit than
another agreement, the affected person could claim the benefit
of the tax treaty.
Pursuant to subparagraph 5(b) of Article 1 (General Scope),
the saving clause of paragraph 4 of Article 1 does not apply to
override any benefits of this Article available to an
individual who is neither a citizen of the United States nor
has immigrant status in the United States.
ARTICLE 28 (ENTRY INTO FORCE)
This Article contains the rules for bringing the Convention
into force and giving effect to its provisions.
Paragraph 1
Paragraph 1 provides for the ratification of the Convention
by both Contracting States according to their constitutional
and statutory requirements. Instruments of ratification shall
be exchanged as soon as possible.
In the United States, the process leading to ratification
and entry into force is as follows: Once a treaty has been
signed by authorized representatives of the two Contracting
States, the Department of State sends the treaty to the
President who formally transmits it to the Senate for its
advice and consent to ratification, which requires approval by
two-thirds of the Senators present and voting. Prior to this
vote, however, it generally has been the practice for the
Senate Committee on Foreign Relations to hold hearings on the
treaty and make a recommendation regarding its approval to the
full Senate. Both Government and private sector witnesses may
testify at these hearings. After the Senate gives its advice
and consent to ratification of the treaty, an instrument of
ratification is drafted for the President's signature. The
President's signature completes the process in the United
States.
Paragraph 2
Paragraph 2 provides that the Convention will enter into
force upon the exchange of instruments of ratification. The
date on which a treaty enters into force is not necessarily the
date on which its provisions take effect. Paragraph 2,
therefore, also contains rules that determine when the
provisions of the treaty will have effect.
Under paragraph 2(a), the Convention will have effect with
respect to taxes withheld at source (principally dividends,
interest and royalties) for amounts paid or credited on or
after the first day of the second month following the date on
which the Convention enters into force. For example, if
instruments of ratification are exchanged on April 25 of a
given year, the withholding rates specified in paragraph 2 of
Article 10 (Dividends) would be applicable to any dividends
paid or credited on or after June 1 of that year. 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 the other Contracting
State may make a claim for refund pursuant to section 1464 of
the Code.
For all other taxes, paragraph 2(b) specifies that the
Convention will have effect for any taxable period beginning on
or after January 1 of the year following entry into force.
Paragraph 3
As discussed under Article 26 (Exchange of Information),
the powers afforded the competent authority under that article
apply from the date of entry into force of the Convention,
regardless of the taxable period to which the matter relates.
ARTICLE 29 (TERMINATION)
The Convention is to remain in effect indefinitely, unless
terminated by one of the Contracting States in accordance with
the provisions of Article 29. The Convention may be terminated
at any time after the year in which the Convention enters into
force. If notice of termination is given, the provisions of the
Convention with respect to withholding at source will cease to
have effect after the expiration of a period of 6 months
beginning with the delivery of notice of termination. For other
taxes, the Convention will cease to have effect as of taxable
periods beginning after the expiration of this 6 month period.
Article 29 relates only to unilateral termination of the
Convention by a Contracting State. Nothing in that Article
should be construed as preventing the Contracting States from
concluding a new bilateral agreement, subject to ratification,
that supersedes, amends or terminates provisions of the
Convention without the six-month notification period.
Customary international law observed by the United States
and other countries, as reflected in the Vienna Convention on
Treaties, allows termination by one Contracting State at any
time in the event of a ``material breach'' of the agreement by
the other Contracting State.
X. Annex II--Transcript of Hearing held November 10, 2009
TREATIES
----------
TUESDAY, NOVEMBER 10, 2009
U.S. Senate,
Committee on Foreign Relations,
Washington, DC.
The committee met, pursuant to notice, at 9 a.m., in room
SD-419, Dirksen Senate Office Building, Hon. Edward E. Kaufman,
presiding.
Present: Senator Kaufman.
OPENING STATEMENT OF HON. EDWARD E. KAUFMAN,
U.S. SENATOR FROM DELAWARE
Senator Kaufman. I'll say it again, good morning.
Voices. Good morning.
Senator Kaufman. Today the committee will take up five
treaties: two protocols that amend our existing tax treaties
with France and New Zealand, a new tax treaty with Malta, a
bilateral investment treaty with Rwanda, and an international
convention on plant genetic resources for food and agriculture.
The France and New Zealand tax protocols reflect our
ongoing efforts to modernize existing tax treaties to conform
to current United States policy. In addition to reducing or
eliminating source-country taxation on certain dividends and
royalties, both protocols update the existing antiabuse and
information exchange provisions enforced with France and New
Zealand.
These changes will help guard against nonresidents
improperly benefiting from the treaties, and will facilitate
the exchange of tax information, which will assist in detecting
tax evasion.
The France protocol also provides for mandatory
arbitration, similar in many respects to recent treaties with
Canada, Germany, and Belgium.
The proposed tax treaty with Malta recognizes the
significant changes that Malta has made to its domestic tax law
in response to United States concerns that led to the
termination of our original tax agreement with Malta in 1997.
This proposed convention, like the protocols, generally follows
the 2006 U.S. Model Tax Treaty; however, it deviates from the
model in certain areas, including where deemed necessary to
provide enhanced protection against treaty-shopping.
I would note that critical stakeholders, such as the U.S.
Chamber of Commerce, the National Association of Manufacturers,
the National Foreign Trade Council, are all on record in strong
support of early ratification of the three tax treaties before
us today.
Moving from tax policy to investment policy, the United
States-Rwanda Bilateral Investment Treaty is the first such
agreement concluded between the United States and a sub-Saharan
African country since 1998. Our negotiators engaged Rwanda in
this endeavor in recognition of the Rwanda Government's efforts
to open its economy, improve its business climate, and embrace
trade and investment as a means to boost economic development
and alleviate poverty.
In 2008 and 2009, less than two decades after the genocide
from which Rwanda still strives to recover, Rwanda led the
world in the World Bank's review of doing business reforms, a
first for a sub-Saharan economy. We anticipate that the Rwanda
BIT will reinforce the government's economic reform program and
facilitate continued progress in the rebuilding and recovery
that has taken place since the 1994 genocide. We would also
hope to see similar openness in the expansion of political
space in Rwanda.
Last, by joining the International Plant Genetic Resources
Treaty, the United States will ensure we continue to play a
leading role in the conservation of critical plant resources
for future generations. Recent experience with dramatic price
increases and global food scarcity demonstrate the need to
preserve and enhance access to these resources. By joining this
convention, the United States will secure access to valuable
plant genetic resources and information from other countries, a
service which the Department of Agriculture is already
authorized to provide at no cost. This treaty enjoys support
from a broad range of stakeholders, including the American Sea
Trade Association, the Biotechnology Industry Organization,
Intellectual Property Owners Association, and the National
Farms Unit.
We are fortunate to have four--and I really mean that--four
excellent witnesses today: Kerri-Ann Jones, the Assistant
Secretary of State for the Bureau of Oceans and International
Environmental and Scientific Affairs; Manal Corwin,
international tax counsel for the Treasury Department; Wes
Scholz, the Director of the Office of Investment Affairs at the
State Department; and Thomas Barthold, chief of staff of the
Joint Committee on Taxation. We will start with tax treaties,
so I'll turn first to Ms. Corwin and next to Mr. Barthold;
after that, we'll take up Rwanda, BIT, and the Plant Genetics
Treaty.
Ms. Corwin.
STATEMENT OF MANAL CORWIN, INTERNATIONAL TAX COUNSEL,
DEPARTMENT OF TREASURY
Ms. Corwin. Thank you, Senator Kaufman. I appreciate the
opportunity to appear today to recommend, on behalf of the
administration, favorable action on three tax treaties pending
before this committee. We appreciate the committee's interest
in these treaties and in the U.S. tax treaty program overall.
This administration is committed to eliminating barriers to
cross-border trade and investment and preventing offshore tax
evasion. Tax treaties play a vital role in supporting both of
these objectives. Tax treaties facilitate cross-border
investment and provide greater certainty to taxpayers regarding
their potential tax liability in foreign jurisdictions. They do
so by allocating taxing rights between jurisdictions,
minimizing incidences of double taxation, and ensuring that
U.S. taxpayers are not subject to discriminatory treatment.
Tax treaties also play an important role in preventing tax
evasion. A key element of U.S. tax treaties is exchange of
information between tax authorities. Because access to
information from other countries is critically important to the
full and fair enforcement of U.S. tax laws, information
exchange is a top priority for the United States tax treaty
program.
The treaties before the committee today--with France,
Malta, and New Zealand--serve to further our tax treaty program
goals of facilitating cross-border trade and investment and
preventing fiscal evasion. We urge the committee and the Senate
to take prompt and favorable action on these agreements, which
I will now describe very briefly.
The proposed protocol with France is the second protocol
amending the current tax convention with France signed in 1994.
The most significant provisions in this agreement relate to the
taxation of dividends and royalties, the adoption of mandatory
arbitration to facilitate the resolution of disputes between
the United States and French revenue authorities, and
provisions to prevent treaty abuse and provide for full
exchange of information for tax purposes.
More specifically, the proposed protocol eliminates the
source country withholding tax on certain intercompany
dividends and on all royalty payments. The proposed protocol
also makes a number of changes to the limitation on benefits
article of the current convention, which is designed to protect
against abuses of the treaty by third-country residents.
Finally, the proposed protocol provides for mandatory
binding arbitration of certain cases that have not been
resolved by the competent authorities within a specified
period. The mandatory binding arbitration provision included in
the protocol with France is similar to provisions in our
current treaties with Canada, Germany, and Belgium, which this
committee and the Senate approved over the last 3 years.
However, in recognition of the helpful comments offered by this
committee with respect to the arbitration provisions in the
prior agreements, the arbitration provision in the French
protocol differs from the prior provisions in three key
respects.
First, the proposed arbitration rule with France permits
the taxpayers whose tax liabilities are affected by the
arbitration proceeding to submit a position paper directly to
the arbitration panel.
Second, the proposed rule prohibits employees of the tax
administrations of either the United States or France from
being appointed as members to the arbitration panel.
Finally, the proposed rule does not establish a hierarchy
of legal authorities for treaty interpretation.
We are hopeful that these three modifications adequately
address the concerns previously raised by this committee. We
look forward to continuing to work with this committee to make
arbitration an effective tool in promoting fair and expeditious
resolution of tax treaty disputes.
The proposed income tax convention with Malta reestablishes
a prior tax treaty relationship between Malta and the United
States. In 1996, the United States terminated its tax treaty
with Malta, originally signed in 1980, because of concerns
related to abuses of the treaty by third-country residents and
inadequate exchange of information. Since 1996, Malta has made
important changes to its domestic law in order to make a treaty
possible again. Most notably, Malta repealed its bank secrecy
rules so that it could agree to a ``full exchange of
information'' provision in the proposed treaty.
The proposed convention with Malta is generally consistent
with the current U.S. Model Income Tax Treaty. To take into
account special features of Malta's domestic law, however, the
proposed treaty contains robust rules to prevent so-called
``treaty shopping.'' In particular, the proposed treaty
includes a strict and comprehensive ``limitation on benefits''
article and provides for a positive withholding tax rate on
dividends, royalties, and interest.
Finally, the proposed convention provides for the full
exchange of information.
The proposed protocol with New Zealand is the first
protocol amending our current tax treaty, which entered into
force in 1983. The proposed protocol makes a number of changes
to the current convention, including eliminating the source-
country withholding tax on certain dividends and on all
royalties. The proposed protocol also updates the ``limitation
on benefits'' article, bringing into line with the U.S. Model
Treaty.
Let me conclude by thanking you for the opportunity to
appear before the committee to discuss the administration's
efforts with respect to the three agreements under
consideration. We thank the committee members and staff for
devoting time and attention to the review of these agreements,
and we are grateful for the assistance and cooperation of the
staff of the Joint Committee on Taxation. I also would like to
acknowledge and express my appreciation for the work done on
the proposed treaties by the teams at Treasury, the Internal
Revenue Service, and the State Department.
On behalf of the administration, we urge the committee and
the Senate to take prompt and favorable action on the
agreements before you today. And I'm happy to respond to any
questions you may have.
[The prepared statement of Ms. Corwin follows:]
Prepared Statement of Manal Corwin, International Tax Counsel,
Department of Treasury, Washington, DC
Chairman Kerry, Ranking Member Lugar, and distinguished members of
the committee, I appreciate the opportunity to appear today to
recommend, on behalf of the administration, favorable action on three
tax treaties pending before this committee. We appreciate the
committee's interest in these treaties and in the U.S. tax treaty
network overall.
This administration is committed to eliminating barriers to cross-
border trade and investment, and tax treaties are the primary means for
eliminating tax barriers to such trade and investment. Tax treaties
provide greater certainty to taxpayers regarding their potential
liability to tax in foreign jurisdictions; they allocate taxing rights
between the two jurisdictions and include other provisions that reduce
the risk of double taxation, including provisions that reduce gross-
basis withholding taxes. Tax treaties also ensure that taxpayers are
not subject to discriminatory taxation in the foreign jurisdiction.
This administration is also committed to preventing tax evasion,
and our tax treaties play an important role in this area as well. A key
element of U.S. tax treaties is exchange of information between tax
authorities. Under tax treaties, one country may request from the other
such information as may be relevant for the proper administration of
the first country's tax laws. Because access to information from other
countries is critically important to the full and fair enforcement of
U.S. tax laws, information exchange is a top priority for the United
States in its tax treaty program.
A tax treaty reflects a balance of benefits that is agreed to when
the treaty is negotiated. In some cases, changes in law or policy in
one or both of the treaty partners make the partners more willing to
increase the benefits beyond those provided by the original treaty; in
these cases, negotiation of a revised treaty may be very beneficial. In
other cases, developments in one or both countries, or international
developments more generally, may make it desirable to revisit a treaty
to prevent exploitation of treaty provisions and eliminate unintended
and inappropriate consequences in the application of the treaty; in
these cases, it may be expedient to modify the agreement. Both in
setting our overall negotiation priorities and in negotiating
individual treaties, our focus is on ensuring that our tax treaty
network fulfills its goals of facilitating cross-border trade and
investment and preventing fiscal evasion.
The treaties before the committee today with France, Malta, and New
Zealand serve to further the goals of our tax treaty network. The
treaties with France and New Zealand would modify existing tax treaty
relationships, to increase benefits in some instances and to eliminate
inappropriate benefits in others. The tax treaty with Malta would
reestablish a tax treaty relationship between our two countries that
was interrupted when the United States terminated a prior tax treaty
with Malta signed in 1980. We urge the committee and the Senate to take
prompt and favorable action on all of these agreements.
Before talking about the pending treaties in more detail, I would
like to discuss some more general tax treaty matters.
PURPOSES AND BENEFITS OF TAX TREATIES
Tax treaties set out clear ground rules that govern tax matters
relating to trade and investment between the two countries.
One of the primary functions of tax treaties is to provide
certainty to taxpayers regarding the threshold question with respect to
international taxation: whether a taxpayer's cross-border activities
will subject it to taxation by two or more countries. Tax treaties
answer this question by establishing the minimum level of economic
activity that must be engaged in within a country by a resident of the
other before the first country may tax any resulting business profits.
In general terms, tax treaties provide that if branch operations in a
foreign country have sufficient substance and continuity, the country
where those activities occur will have primary (but not exclusive)
jurisdiction to tax. In other cases, where the operations in the
foreign country are relatively minor, the home country retains the sole
jurisdiction to tax.
Another primary function is relief of double taxation. Tax treaties
protect taxpayers from potential double taxation primarily through the
allocation of taxing rights between the two countries. This allocation
takes several forms. First, the treaty has a mechanism for resolving
the issue of residence in the case of a taxpayer that otherwise would
be considered to be a resident of both countries. Second, with respect
to each category of income, the treaty assigns primary taxing rights to
one country, usually (but not always) the country in which the income
arises (the ``source'' country), and the residual right to tax to the
other country, usually (but not always) the country of residence of the
taxpayer (the ``residence'' country). Third, the treaty provides rules
for determining the country of source for each category of income.
Finally, the treaty establishes the obligation of the residence country
to eliminate double taxation that otherwise would arise from the
exercise of concurrent taxing jurisdiction by the two countries.
In addition to reducing potential double taxation, tax treaties
also reduce potential ``excessive'' taxation by reducing withholding
taxes that are imposed at source. Under U.S. law, payments to non-U.S.
persons of dividends and royalties as well as certain payments of
interest are subject to withholding tax equal to 30 percent of the
gross amount paid. Most of our trading partners impose similar levels
of withholding tax on these types of income. This tax is imposed on a
gross, rather than net, amount. Because the withholding tax does not
take into account expenses incurred in generating the income, the
taxpayer that bears the burden of withholding tax frequently will be
subject to an effective rate of tax that is significantly higher than
the tax rate that would be applicable to net income in either the
source or residence country. The taxpayer may be viewed, therefore, as
suffering excessive taxation. Tax treaties alleviate this burden by
setting maximum levels for the withholding tax that the treaty partners
may impose on these types of income or by providing for exclusive
residence-country taxation of such income through the elimination of
source-country withholding tax. Because of the excessive taxation that
withholding taxes can represent, the United States seeks to include in
tax treaties provisions that substantially reduce or eliminate source-
country withholding taxes.
As a complement to these substantive rules regarding allocation of
taxing rights, tax treaties provide a mechanism for dealing with
disputes between the countries regarding the treaties, including
questions regarding the proper application of the treaties that arise
after the treaty enters into force. To resolve disputes, designated tax
authorities of the two governments--known as the ``competent
authorities'' in tax treaty parlance--are to consult and to endeavor to
reach agreement. Under many such agreements, the competent authorities
agree to allocate a taxpayer's income between the two taxing
jurisdictions on a consistent basis, thereby preventing the double
taxation that might otherwise result. The U.S. competent authority
under our tax treaties is the Secretary of the Treasury or his
delegate. That function has been delegated to the Deputy Commissioner
(International) of the Large and Mid-Size Business Division of the
Internal Revenue Service.
Tax treaties also include provisions intended to ensure that cross-
border investors do not suffer discrimination in the application of the
tax laws of the other country. This is similar to a basic investor
protection provided in other types of agreements, but the
nondiscrimination provisions of tax treaties are specifically tailored
to tax matters and, therefore, are the most effective means of
addressing potential discrimination in the tax context. The relevant
tax treaty provisions explicitly prohibit types of discriminatory
measures that once were common in some tax systems. At the same time,
tax treaties clarify the manner in which possible discrimination is to
be tested in the tax context.
In addition to these core provisions, tax treaties include
provisions dealing with more specialized situations, such as rules
coordinating the pension rules of the tax systems of the two countries
or addressing the treatment of Social Security benefits and alimony and
child-support payments in the cross-border context (the Social Security
Administration separately negotiates and administers bilateral
totalization agreements). These provisions are becoming increasingly
important as more individuals move between countries or otherwise are
engaged in cross-border activities. While these matters may not involve
substantial tax revenue from the perspective of the two governments,
rules providing clear and appropriate treatment are very important to
the affected taxpayers.
Tax treaties also include provisions related to tax administration.
A key element of U.S. tax treaties is the provision addressing the
exchange of information between the tax authorities. Under tax
treaties, the competent authority of one country may request from the
other competent authority such information as may be relevant for the
proper administration of the first country's tax laws; the information
provided pursuant to the request is subject to the strict
confidentiality protections that apply to taxpayer information. Because
access to information from other countries is critically important to
the full and fair enforcement of the U.S. tax laws, information
exchange is a priority for the United States in its tax treaty program.
If a country has bank secrecy rules that would operate to prevent or
seriously inhibit the appropriate exchange of information under a tax
treaty, we will not enter into a new tax treaty relationship with that
country. Indeed, the need for appropriate information exchange
provisions is one of the treaty matters that we consider nonnegotiable.
TAX TREATY NEGOTIATING PRIORITIES AND PROCESS
The United States has a network of 59 income tax treaties covering
67 countries. This network covers the vast majority of foreign trade
and investment of U.S. businesses and investors. In establishing our
negotiating priorities, our primary objective is the conclusion of tax
treaties that will provide the greatest benefit to the United States
and to U.S. taxpayers. We communicate regularly with the U.S. business
community and the Internal Revenue Service, seeking their input
regarding the areas in which treaty network expansion and improvement
efforts should be focused and seeking information regarding practical
problems encountered under particular treaties and particular tax
regimes.
The primary constraint on the size of our tax treaty network may be
the complexity of the negotiations themselves. Ensuring that the
various functions to be performed by tax treaties are all properly
taken into account makes the negotiation process exacting and time
consuming.
Numerous features of a country's particular tax legislation and its
interaction with U.S. domestic tax rules are considered in negotiating
a tax treaty. Examples include whether the country eliminates double
taxation through an exemption system or a credit system, the country's
treatment of partnerships and other transparent entities, and how the
country taxes contributions to pension funds, earnings of the funds,
and distributions from the funds.
Moreover, a country's fundamental tax policy choices are reflected
not only in its tax legislation but also in its tax treaty positions.
These choices differ significantly from country to country, with
substantial variation even across countries that seem to have quite
similar economic profiles. A treaty negotiation must take into account
all of these aspects of the particular treaty partner's tax system and
treaty policies to arrive at an agreement that accomplishes the United
States tax treaty objectives.
Obtaining the agreement of our treaty partners on provisions of
importance to the United States sometimes requires concessions on our
part. Similarly, the other country sometimes must make concessions to
obtain our agreement on matters that are critical to it. Each tax
treaty that we present to the Senate represents not only the best deal
that we believe can be achieved with the particular country, but also
constitutes an agreement that we believe is in the best interests of
the United States.
In some situations, the right result may be no tax treaty at all.
Prospective treaty partners must evidence a clear understanding of what
their obligations would be under the treaty, especially those with
respect to information exchange, and must demonstrate that they would
be able to fulfill those obligations. Sometimes a tax treaty may not be
appropriate because a potential treaty partner is unable to do so.
In other cases, a tax treaty may be inappropriate because the
potential treaty partner is not willing to agree to particular treaty
provisions that are needed to address real tax problems that have been
identified by U.S. businesses operating there. If the potential treaty
partner is unwilling to provide meaningful benefits in a tax treaty,
investors would find no relief, and accordingly there would be no merit
to entering into such an agreement. The Treasury Department would not
enter into a tax treaty that did not provide benefits to investors or
which could be construed as an indication to future potential treaty
partners that we would settle for a tax treaty with inferior terms.
Sometimes a potential treaty partner insists on provisions the
United States will not agree to, such as providing a U.S. tax credit
for investment in the foreign country (so-called ``tax sparing''). With
other countries there simply may not be the type of cross-border tax
issues that are best resolved by treaty. For example, if a country does
not impose significant income taxes, there is little possibility of
double taxation of cross-border income, and an agreement that focuses
exclusively on the exchange of tax information (so called ``tax
information exchange agreements'' or TIEAs) may be the most appropriate
agreement.
A high priority for improving our overall treaty network is
continued focus on prevention of ``treaty shopping.'' The U.S.
commitment to including comprehensive limitation on benefits provisions
is one of the keys to improving our overall treaty network. Our tax
treaties are intended to provide benefits to residents of the United
States and residents of the particular treaty partner on a reciprocal
basis. The reductions in source-country taxes agreed to in a particular
treaty mean that U.S. persons pay less tax to that country on income
from their investments there and residents of that country pay less
U.S. tax on income from their investments in the United States. Those
reductions and benefits are not intended to flow to residents of a
third country. If third-country residents are able to exploit one of
our tax treaties to secure reductions in U.S. tax, such as through the
use of an entity resident in a treaty country that merely holds passive
U.S. assets, the benefits would flow only in one direction, as third-
country residents would enjoy U.S. tax reductions for their U.S.
investments, but U.S. residents would not enjoy reciprocal tax
reductions for their investments in that third country. Moreover, such
third-country residents may be securing benefits that are not
appropriate in the context of the interaction between their home
country's tax systems and policies and those of the United States. This
use of tax treaties is not consistent with the balance of the deal
negotiated in the underlying tax treaty. Preventing this exploitation
of our tax treaties is critical to ensuring that the third country will
sit down at the table with us to negotiate on a reciprocal basis, so we
can secure for U.S. persons the benefits of reductions in source-
country tax on their investments in that country.
CONSIDERATION OF ARBITRATION
Tax treaties cannot facilitate cross-border investment and provide
a more stable investment environment unless the treaty is effectively
implemented by the tax administrations of the two countries. Under our
tax treaties, when a U.S. taxpayer becomes concerned about
implementation of the treaty, the taxpayer can bring the matter to the
U.S. competent authority who will seek to resolve the matter with the
competent authority of the treaty partner. The competent authorities
will work cooperatively to resolve genuine disputes as to the
appropriate application of the treaty.
The U.S. competent authority has a good track record in resolving
disputes. Even in the most cooperative bilateral relationships,
however, there will be instances in which the competent authorities
will not be able to reach a timely and satisfactory resolution.
Moreover, as the number and complexity of cross-border transactions
increases, so does the number and complexity of cross-border tax
disputes. Accordingly, we have considered ways to equip the U.S.
competent authority with additional tools to resolve disputes promptly,
including the possible use of arbitration in the competent authority
mutual agreement process.
The first U.S. tax agreement that contemplated arbitration was the
United States-Germany income tax treaty signed in 1989. Tax treaties
with some other countries, including Mexico and the Netherlands,
incorporate authority for establishing voluntary binding arbitration
procedures based on the provision in the prior United States-Germany
treaty (although, these provisions have never been implemented).
Although we believe that the presence of these voluntary arbitration
provisions may have provided some limited incentive to reaching mutual
agreements, it has become clear that the ability to enter into
voluntary arbitration does not always provide sufficient incentive to
resolve problem cases in a timely fashion.
Over the past few years, we have carefully considered and studied
various types of mandatory arbitration procedures that could be used as
part of the competent authority mutual agreement process. In
particular, we examined the experience of countries that adopted
mandatory binding arbitration provisions with respect to tax matters.
Many of them report that the prospect of impending mandatory
arbitration creates a significant incentive to compromise before
commencement of the process. Based on our review of the U.S. experience
with arbitration in other areas of the law, the success of other
countries with arbitration in the tax area, and the overwhelming
support of the business community, we concluded that mandatory binding
arbitration as the final step in the competent authority process can be
an effective and appropriate tool to facilitate mutual agreement under
U.S. tax treaties.
One of the treaties before the committee, the Protocol with France,
includes a type of mandatory arbitration provision that in general
terms is similar to provisions in our current treaties with Canada,
Germany, and Belgium, which this committee and the Senate have approved
over the last 3 years.
In the typical competent authority mutual agreement process, a U.S.
taxpayer presents its problem to the U.S. competent authority and
participates in formulating the position the U.S. competent authority
will take in discussions with the treaty partner. Under the arbitration
provision proposed in the France protocol, as in the similar provisions
that are now part of our treaties with Canada, Germany, and Belgium, if
the competent authorities cannot resolve the issue within 2 years, the
competent authorities must present the issue to an arbitration board
for resolution, unless both competent authorities agree that the case
is not suitable for arbitration. The arbitration board must resolve the
issue by choosing the position of one of the competent authorities.
That position is adopted as the agreement of the competent authorities
and is treated like any other mutual agreement (i.e., one that has been
negotiated by the competent authorities) under the treaty.
Because the arbitration board can only choose between the positions
of each competent authority, the expectation is that the differences
between the positions of the competent authorities will tend to narrow
as the case moves closer to arbitration. In fact, if the arbitration
provision is successful, difficult issues will be resolved without
resort to arbitration. Thus, it is our expectation that these
arbitration provisions will be rarely utilized, but that their presence
will encourage the competent authorities to take approaches to their
negotiations that result in mutually agreeable conclusions in the first
place.
The arbitration process proposed in the agreement with France,
consistent with its predecessors, is mandatory and binding with respect
to the competent authorities. However, consistent with the negotiation
process under the mutual agreement procedure generally, the taxpayer
can terminate the arbitration at any time by withdrawing its request
for competent authority assistance. Moreover, the taxpayer retains the
right to litigate the matter (in the United States or the treaty
partner) in lieu of accepting the result of the arbitration, just as it
would be entitled to litigate in lieu of accepting the result of a
negotiation under the mutual agreement procedure.
In negotiating the arbitration rule in the proposed Protocol with
France, we took into account concerns expressed by this committee over
certain aspects of the arbitration rules with Canada, Germany, and
Belgium. Accordingly, the proposed arbitration rule with France differs
from its predecessors in three key respects. First, recognizing the
committee's instructions in its report on the Canada protocol that
future arbitration rules should provide a mechanism for taxpayer input
in the arbitration process, the proposed rule with France allows the
taxpayers who presented the original case that is subjected to
arbitration to submit a Position Paper directly to the arbitration
panel. Second, the rule on the proposed France Protocol disallows a
competent authority from appointing an employee from its own tax
administration to the arbitration board. Finally, the rule in the
proposed France Protocol does not prescribe a hierarchy of legal
authorities that the arbitration panel will use in making its decision.
Thus, customary international law rules on treaty interpretation will
apply. The new protocol amending our tax treaty with Switzerland,
signed in September 2009, also contains an arbitration rule that is
substantially the same as the rule in the proposed France Protocol. The
administration hopes to transmit the Switzerland protocol to the Senate
for its advice and consent as soon as possible.
Arbitration is a growing and developing field, and there are many
forms of arbitration from which to choose. We intend to continue to
study other arbitration provisions and to monitor the performance of
the provisions in the agreements with Canada, Belgium, and Germany, as
well as the performance of the provision in the agreement with France,
if ratified. As requested by the Senate in its approval of the protocol
with Canada in 2008, the Internal Revenue Service has published the
administrative procedures necessary to implement the arbitration rules
with Germany and Belgium, although to date no tax disputes with either
country has been submitted to arbitration. The development of
arbitration procedures are still under discussion with the Canadian tax
authorities.
We look forward to continuing to work with the committee to make
arbitration an effective tool in promoting the fair and expeditious
resolution of treaty disputes. The committee's comments made with
respect to the arbitration provisions with Canada, Germany, and Belgium
have been very helpful and will continue to inform future negotiations
of arbitration provisions.
DISCUSSION OF PROPOSED TREATIES
I now would like to discuss the three tax treaties that have been
transmitted for the Senate's consideration. We have submitted a
Technical Explanation of each treaty that contains detailed discussions
of the provisions of each treaty. These Technical Explanations serve as
the Treasury Department's official guide to each tax treaty.
France
The proposed Protocol with France was signed in Paris on January
13, 2009, and is the second protocol of amendment to the current tax
Convention with France, signed in 1994. The most significant provisions
in this agreement relate to the taxation of dividends and royalties,
the adoption of mandatory arbitration to facilitate the resolution of
disputes between the United States and French revenue authorities, and
provisions to prevent treaty abuse and provide for full exchange of
information for tax purposes. The Protocol also makes a number of
necessary updates to the current Convention to better reflect French
and U.S. domestic law.
The proposed Protocol makes a number of changes to the dividend
article of the current Convention. The proposed Protocol eliminates the
source-country withholding tax on many intercompany dividends. In
general, a company receiving a dividend must have a substantial
interest in the distributing corporation for a 12-month period and meet
special limitation on benefits provisions to qualify for the exemption
from withholding tax. The proposed Protocol also updates the dividend
article to incorporate policies reflected in the U.S. Model provision,
such as those regarding regulated investment companies (RICs) and real
estate investment trusts (REITs).
The proposed Protocol makes a significant change to the royalty
article of the current Convention. The current Convention allows the
source country to withhold on royalty payments to residents of the
other treaty partner with respect to certain types of property, but
limits the withholding rate to a maximum of 5 percent. The proposed
Protocol eliminates source-country withholding on all royalty payments,
bringing the Convention in line with the U.S. Model treaty.
The proposed Protocol makes a number of changes to the limitation
on benefits article of the current Convention. It tightens the
limitation on benefits rules applicable to publicly traded companies to
ensure a closer nexus between the company and its residence country
through regional trading of its shares or local management and control.
The proposed Protocol further tightens the limitation on benefits
provision by including a so-called ``triangular provision'' adopted in
many U.S. tax treaties. The rule is designed to prevent the use of
structures including third-country branches to avoid both source- and
residence-country taxation. Under the provision, the United States
needs not allow full treaty benefits to a French enterprise with
respect to certain income attributable to a permanent establishment of
the French enterprise located in a third country if the income is not
subject to a sufficient combined level of tax in both France and the
third country.
The proposed Protocol updates the provision in the current
Convention that preserves the U.S. right to tax certain former citizens
also to cover certain former long-term residents to reflect changes in
U.S. law.
As previously noted, the proposed Protocol provides for mandatory
arbitration of certain cases that have not been resolved by the
competent authority within a specified period, generally 2 years from
the commencement of the case. A Memorandum of Understanding
accompanying the Protocol sets forth rules and procedures for
arbitration. The arbitration board must deliver a determination within
6 months of the appointment of the chair of the arbitration board, and
the determination must either be the proposed resolution submitted by
the United States or the proposed resolution submitted by France. The
board's determination has no precedential value and that the board
shall not provide a rationale for its determination. As mentioned
above, in response to concerns expressed by the Senate in the approval
of prior agreements, the arbitration rule in the proposed Protocol
differs from earlier arbitration provisions in some key respects.
First, the proposed Protocol permits the concerned taxpayers to summit
written Position Papers to the arbitration board. Second, under the
proposed Protocol, the competent authority of a Contracting State may
not appoint an employee of its tax administration to be a member of the
arbitration board. Finally, the proposed protocol does not prescribe a
hierarchy of legal authorities to which the arbitration board must
adhere.
The proposed Protocol provides that the United States and France
shall notify each other in writing, through diplomatic channels, when
their respective constitutional and statutory requirements for entry
into force of the proposed Protocol have been satisfied. The proposed
Protocol will enter into force upon the date of receipt of the later of
such notifications. For taxes withheld at source, it will have effect
for amounts paid or credited on or after the first day of the January
of the year in which the proposed Protocol enters into force. With
respect to other taxes, the proposed Protocol will generally have
effect for taxable years that begin on or after the first day of
January next following the date on which the proposed Protocol enters
into force.
Malta
The proposed income tax Convention and accompanying exchange of
notes with Malta signed in Valletta on August 8, 2008, reestablishes a
previous tax treaty relationship between Malta and the United States.
The proposed Convention is generally consistent with the current U.S.
Model income tax treaty and with treaties that the United States has
with other countries, while incorporating special rules to take into
account special features of Malta's domestic tax law.
Under the proposed Convention, the United States may impose
withholding taxes on cross-border portfolio dividend payments at a
maximum rate of 15 percent. When the beneficial owner of the dividend
is a company that directly owns at least 10 percent of the stock of the
company paying the dividend, the United States may impose withholding
tax at a maximum rate of 5 percent. The proposed Convention also
incorporates rules provided in the U.S. Model tax treaty for certain
classes of investment income. For example, dividends paid by RICs and
REITs are subject to special rules to prevent the use of these entities
to transform what is otherwise higher taxed income into lower taxed
income.
The proposed Convention generally limits withholding taxes on
cross-border interest and royalty payments to a maximum rate of 10
percent. The interest article of the proposed Convention also contains
the U.S. Model rules regarding contingent interest and REMICs.
The proposed Convention limits the taxation by one country of the
business profits of a resident of the other country. The source
country's right to tax such profits is generally limited to cases in
which the profits are attributable to a permanent establishment located
in that country.
Consistent with current U.S. tax treaty policy, the proposed
Convention includes a comprehensive limitation on benefits article,
which takes into account unique features of Malta's tax system and is
designed to deny treaty shoppers the benefits of the Convention. The
proposed Convention provides for nondiscriminatory treatment by one
country to residents and nationals of the other country. In addition,
the proposed Convention provides for the full exchange between the tax
authorities of each country of information relevant to carrying out the
provisions of the agreement or the domestic tax laws of either country.
This will facilitate the enforcement of U.S. domestic tax rules. The
proposed Convention provides that information exchanged pursuant to the
Convention may, with the written consent of the country providing the
information, be used for certain nontax purposes as permitted under the
provisions of an existing mutual legal assistance treaty between the
two countries that allows for the exchange of tax information.
The proposed Convention provides that the United States and Malta
shall exchange instruments of ratification when their respective
applicable procedures for approval of the proposed Convention. The
proposed Convention will enter into force upon the exchange of
instruments of ratification. It will have effect, with respect to taxes
withheld at source, for amounts paid or credited on or after the first
day of the second month next following the date on which the proposed
Convention enters into force and, with respect to other taxes, for
taxable years beginning on or after the first day of January in the
year following the date upon which the proposed Convention enters into
force.
New Zealand
The proposed Protocol with New Zealand was signed in Washington on
December 1, 2008, and amends the current tax Convention with New
Zealand, which entered into force in 1983. The most significant
provisions in this agreement relate to dividends, interest, royalties,
taxation of income from personal services, antiabuse provisions, and
exchange of information for tax purposes. The proposed Protocol deletes
the current Convention's denial of treaty benefits to certain
categories of U.S. citizens. The Protocol also makes a number of
necessary updates to the current Convention to better reflect New
Zealand and U.S. domestic law.
The proposed Protocol makes a number of changes to the dividend
article of the current Convention. The proposed Protocol eliminates the
source-country withholding tax on many intercompany dividends. In
general, a company receiving a dividend must have a substantial
interest in the distributing corporation for a 12-month period and meet
special limitation on benefits provisions to qualify for the exemption
from withholding tax. The proposed Protocol also updates the dividend
article to incorporate policies reflected in the U.S. Model provision,
such as those regarding dividends paid by RICs and REITs.
The proposed Protocol amends the interest article of the current
Convention. The current Convention allows the source country to
withhold on interest payments to unrelated banks and certain financial
enterprises at a maximum of 10 percent. The proposed Protocol
eliminates source-country withholding on these payments, provided, in
the case of New Zealand, that the payer of the interest has paid New
Zealand's ``approved issuer levy'' with respect to the interest.
Moreover, the proposed Protocol secures the elimination of taxation by
New Zealand on interest payments to unrelated U.S. banks and financial
enterprises even if New Zealand changes the approved issuer levy regime
in the future.
The proposed Protocol makes significant changes to the royalty
article of the current Convention. The current Convention allows the
source country to withhold on royalty payments with respect to certain
types of property to residents of the other treaty partner, but limits
the withholding rate to a maximum of 10 percent. The proposed Protocol
lowers that maximum withholding rate on royalties to 5 percent.
Additionally, the proposed Protocol amends current Convention's
definition royalties by excluding from the definition payments for the
rental of equipment and other, tangible personal property.
As a result, these rental payments will be subject to the same tax
treatment as business income. These changes will bring the current tax
Convention into closer alignment with U.S. Model tax treaty policy.
The proposed Protocol makes important changes to the taxation of
individuals providing personal services. Under the current Convention,
income from independent personal services (such as accounting, legal or
consultancy services) may be taxed by the country in which the services
are performed if the individual providing the services is present in
that country for a period of 183 days or more. The proposed Protocol
replaces this taxing right based on days of presence with the U.S.
Model approach, which allows the country where the services are
performed to tax the income only if the service provider has a fixed
place of business in that country.
The proposed Protocol makes changes to the scope of benefits of the
current Convention available to U.S. citizens. Under the current
Convention, treaty benefits are only available to U.S. citizens who are
also resident in the United States. The proposed Protocol eliminates
the residency requirement and makes all U.S. citizens, wherever
resident, eligible for treaty benefits. This broader application, which
is consistent with the U.S. Model tax treaty, is appropriate policy,
because all U.S. citizens are subject to tax by the United States on
their worldwide income (and thus deserving of the benefits of U.S. tax
treaties) regardless of their place of residence.
The proposed Protocol replaces the limitation on benefits article
of the current Convention with a provision that closely tracks the U.S.
Model rule. It tightens the limitation on benefits rules applicable to
publicly traded companies to ensure a closer nexus between the company
and its residence country through trading of its shares on a local
stock exchange or through local management and control. The proposed
Protocol further tightens the limitation on benefits provision by
including a so-called ``triangular provision'' adopted in many U.S.
treaties. The rule is designed to prevent the use of structures
including third-country branches to avoid both source- and residence-
country taxation. Under the provision, the United States need not allow
full treaty benefits to a New Zealand enterprise with respect to
certain income attributable to a permanent establishment of the New
Zealand enterprise located in a third country if the income is not
subject to a sufficient combined level of tax in both New Zealand and
the third country.
The proposed Protocol includes other antiabuse rules. It extends
the provision in the current Convention that preserves the U.S. right
to tax certain former citizens also to cover certain former long-term
residents, and updates the provision to reflect changes in U.S. law.
The proposed Protocol conforms the interest article in the current
Convention to the U.S. Model treaty by including special contingent
interest and real estate mortgage investment--conduit exceptions to the
elimination of withholding tax on interest payments.
The proposed Protocol includes several other important
administrative and technical amendments. Significantly, it updates the
exchange of information provisions to specify the obligation to obtain
and provide information held by financial institutions, and to
otherwise reflect U.S. Model standards in this area.
The proposed Protocol provides that the United States and New
Zealand shall notify each other in writing, through diplomatic
channels, when their respective applicable procedures for ratification
have been satisfied. The proposed Protocol will enter into force upon
the date of the later of the required notifications. For taxes withheld
at source, the proposed Protocol will have effect on the first day of
the second month following the date of entry into force. With respect
to other taxes, the Protocol will have effect in the United States for
taxable periods starting on or after the first day of the January next
following the date of entry into force. In New Zealand, the proposed
Protocol will have effect with respect to other taxes for taxable
periods beginning on or after the first day of April next following the
date of entry into force.
TREATY PROGRAM PRIORITIES
A key continuing priority for the Treasury Department is updating
the few remaining U.S. tax treaties that provide for significant
withholding tax reductions but do not include the limitation on
benefits provisions needed to protect against the possibility of treaty
shopping. I am pleased to report that in this regard we have made
significant progress. Most notably, in June 2009 we announced the
conclusion of the negotiation of a new tax treaty with Hungary. The new
Hungary treaty, which we hope to sign, soon will contain a
comprehensive limitation on benefits provision that will ensure that
only residents of the United States and Hungary will enjoy the benefits
of the treaty. In addition, we recently concluded our second round of
negotiations with Poland and plan to hold additional negotiations early
next year.
Concluding agreements that provide for the full exchange of
information, including information held by banks and other financial
institutions, is another key priority of the Treasury Department. 2009
has been a year of fundamental change in transparency, as many secrecy
jurisdictions announced their intentions to comply with the
international standard of full information exchange. In this changing
environment, the Treasury has made many key achievements, including the
conclusion of protocols of amendment to the U.S. tax treaties with
Switzerland and Luxembourg that provide for full exchange of
information, including bank account information. The administration
hopes to transmit these agreements to the Senate for its consideration
as soon as possible. Moreover, in the near future we hope to commence
or reinvigorate tax treaty negotiations with a number of our other
trading partners with bank secrecy rules once those countries have
eliminated all domestic law impediments to full exchange of
information.
Beyond the two chief priorities of curbing treaty shopping and
expanding exchange of information relationships, the Treasury
Department continues to maintain a very active calendar of tax treaty
negotiations. We have recently held formal treaty negotiations with
Colombia and Korea, and later this month will open formal negotiations
with Israel.
CONCLUSION
Mr. Chairman and Ranking Member Lugar, let me conclude by thanking
you for the opportunity to appear before the committee to discuss the
administration's efforts with respect to the three agreements under
consideration. We appreciate the committee's continuing interest in the
tax treaty program, and we thank the members and staff for devoting
time and attention to the review of these new agreements. We are also
grateful for the assistance and cooperation of the staff of the Joint
Committee on Taxation.
On behalf of the administration, we urge the committee to take
prompt and favorable action on the agreements before you today.
Senator Kaufman. Thank you.
Mr. Barthold.
STATEMENT OF THOMAS A. BARTHOLD, CHIEF OF STAFF, JOINT
COMMITTEE ON TAXATION
Mr. Barthold. Thank you, Mr. Chairman.
My name is Thomas A. Barthold. I'm the Chief of Staff for
the Joint Committee on Taxation, and it's my pleasure to
present the testimony of the staff of the Joint Committee on
Taxation today concerning the proposed income tax treaty with
Malta and the proposed tax protocols with France and New
Zealand.
The Joint Committee Staff has prepared pamphlets covering
the proposed treaty and protocols, including detailed
descriptions of those documents, comparisons with the United
States Model Income Tax Treaty, and detailed discussions of
issues raised by the proposed treaty and protocols. I've
provided the committee with a more detailed written statement,
and I'll try to just briefly summarize a few high points from
that material.
The proposed treaty and protocols generally follow the U.S.
Model Treaty. However, there are some key differences, and I'd
like to just briefly address three: treaty-shopping and the
Malta treaty, about which Ms. Corwin spoke; binding arbitration
and the French protocol, also discussed by my friend and
colleague, Ms. Corwin; and the exchange of information provided
under each document.
As was noted, in 1997 the United States had terminated its
then-existing treaty with Malta, with the Treasury citing
concerns over potential for treaty-shopping under the old
treaty. Treaty-shopping is facilitated by a number of factors,
among them weak limitation on benefits provisions of a treaty
and certain favorable domestic law taxation of dividends,
interest, and capital-gain income.
At that time, in the mid-1990s, the Treasury had also noted
that Malta did not generally permit sharing of bank information
with foreign tax authorities. Now, subsequent to joining the
European Union, Malta has revised its law to permit sharing of
bank information with tax authorities, and the proposed treaty
would create a ``limitation on benefits'' provision more
stringent than that of the U.S. model. It would also, as was
noted, permit nonzero withholding rates on interest, dividends,
and royalties.
However, Malta's internal law, which was seen a decade ago
as potentially facilitating treaty-shopping, is largely
unchanged. And for that reason, it may be beneficial to ask the
Treasury Department more specifically what factors led it to
conclude that the concerns of a decade ago have been adequately
addressed by the overall balance of the proposed treaty and the
changes in internal law.
The proposed French protocol includes a requirement that
disputes that the competent authorities of the two treaty
countries are unable to resolve through consultation be settled
by arbitration. The arbitration method is referred to as
``last-best-offer arbitration,'' and, as was noted, the United
States currently has three tax treaties, those with Belgium,
Canada, and Germany, that have similar provisions for mandatory
arbitration. Nevertheless, this remains a unique feature of the
U.S. income tax treaty network, and there are some differences,
as were noted by Ms. Corwin, of the arbitration as proposed
under the French protocol and those of the three existing
treaties.
By contrast with the tax treaties with Canada and Germany,
but like that of the United States/Belgium treaty, the proposed
protocol with France permits arbitration of any case involving
the application of any article of the treaty, so long as the
competent authorities have not agreed that the case is not
suitable for arbitration. In the cases of Canada and Germany,
mandatory arbitration is more prescribed.
As noted by Ms. Corwin, a second and an important contrast
with the three existing treaties is that the proposed protocol
with France allows a taxpayer whose case is in mandatory
arbitration to submit a position paper to the arbitration
board. This is an important new development, and the committee
may wish to inquire both about the scope of mandatory
arbitration--the comparison of the four cases just noted--and
the opportunity for taxpayer participation. More broadly, as
arbitration was included in the French protocol, but not in the
protocol with New Zealand, for example, the committee might
inquire whether this is to become a standard feature of future
United States tax treaties, or if the Treasury Department has
particular goals in selectively choosing certain countries with
which it negotiates such provisions.
Also, I might note that, as the committee is aware, as a
condition of ratifying the United States protocol with Canada
just last year, the Senate required the Treasury Department to
submit a report describing operation of the mandatory
arbitration procedures under the Belgium, Canada, and Germany
treaties. The committee may wish to consider whether it should
require Treasury reporting to be expanded to encompass the
arbitration proceedings that are proposed in the protocol with
France.
Each of the proposed treaty and the protocols include
``exchange of information'' articles, again largely following
the U.S. model. There is a unique feature in the Malta treaty,
however. The proposed treaty permits the recipient of
information exchanged under the treaty to use that information
for purposes sanctioned by the United States/Malta treaty on
certain aspects of mutual legal assistance in criminal matters,
the so-called ``MLAT.''
The inclusion of a cross-reference to the MLAT in the
proposed treaty is unique among U.S. income tax treaties
providing for exchange of information. The committee may wish
to explore how this new rule will be reconciled with domestic
restrictions on disclosure of tax return information if Malta,
for example, were to request permission to use the information
for nontax purposes.
To the more general application of information exchange it
is perhaps worth noting that automatic and specific information
exchange, which are provided under the tax treaty and these
protocols, may not always be useful. There are problems with
automatic information exchange under existing U.S. tax treaties
and the tax treaties of other countries, and these have
included that information has not always been provided on a
timely basis, the different treaty partners' tax reporting
periods may differ from one another, the recipient country
sometimes has even had difficulty translating the information
into its own language, and then, sometimes the information is
so voluminous as to not be beneficial to the tax authority.
So, the committee may wish to explore with the Treasury
whether they foresee any practical impediments to the automatic
information exchange provided with France, Malta, and New
Zealand and the potential ease with which any impediments could
be removed, and the likelihood that they, in fact, would be
removed.
A specific problem with specific exchange of information
has been that some treaty countries have declined to exchange
information in response to specific requests intended to
identify limited classes of purposes. The committee may wish to
seek assurances, under the proposed treaty with Malta and the
proposed protocols with France and New Zealand, that the treaty
countries are required to exchange information in response to
specific requests that are comparable to John Doe summonses
under present law. This was an issue that has been in the news
over the last half year in our dealings under the Swiss Treaty
in the well-known UBS case.
I think those three main points are important highlights,
and I'll conclude my oral testimony with that.
As always, I and my staff are happy to answer any questions
that you or other members may have at this time or in the
future.
[The prepared statement of Mr. Barthold follows:]
Prepared Statement of the Staff of the Joint Committee on Taxation\1\
My name is Thomas A. Barthold. I am Chief of Staff of the Joint
Committee on Taxation. It is my pleasure to present the testimony of
the staff of the Joint Committee on Taxation today concerning the
proposed income tax treaty with Malta and the proposed tax protocols
with France and New Zealand.
---------------------------------------------------------------------------
\1\This document may be cited as follows: Joint Committee on
Taxation, Testimony of the Staff of the Joint Committee on Taxation
Before the Senate Committee on Foreign Relations Hearing on the
Proposed Tax Treaty with Malta and the Proposed Tax Protocols with
France and New Zealand (JCX 0954 0909), November 10, 2009. This
publication can also be found at http://www.jct.gov/.
---------------------------------------------------------------------------
OVERVIEW
As in the past, the Joint Committee staff has prepared pamphlets
covering the proposed treaty and protocols. The pamphlets provide
detailed descriptions of the proposed treaty and protocols, including
comparisons with the United States Model Income Tax Convention of
November 15, 2006 (``U.S. Model treaty''), which reflects preferred
U.S. tax treaty policy, and with other recent U.S. tax treaties.\2\ The
pamphlets also provide detailed discussions of issues raised by the
proposed treaty and protocols. We consulted with the Treasury
Department and with the staff of your committee in analyzing the
proposed treaty and protocols and in preparing the pamphlets.
---------------------------------------------------------------------------
\2\Joint Committee on Taxation,`` Explanation of Proposed Income
Tax Treaty Between the United States and Malta'' (JCX-50-09), November
6, 2009; Joint Committee on Taxation, ``Explanation of Proposed
Protocol to the Income Tax Treaty Between the United States and
France'' (JCX-49-09), November 6, 2009; Joint Committee on Taxation,
``Explanation of Proposed Protocol to the Income Tax Treaty Between the
United States and New Zealand'' (JCX-51-09), November 6, 2009.
---------------------------------------------------------------------------
The principal purposes of the treaty and protocols are to reduce or
eliminate double taxation of income earned by residents of either
country from sources within the other country and to prevent avoidance
or evasion of the taxes of the two countries. The proposed treaty and
protocols also are intended to promote close economic cooperation
between the treaty countries and to eliminate possible barriers to
trade and investment caused by overlapping taxing jurisdictions of the
treaty countries. As in other U.S. tax treaties, these objectives
principally are achieved through each country's agreement to limit, in
certain specified situations, its right to tax income derived from its
territory by residents of the other country.
The proposed treaty with Malta would restore an income tax treaty
relationship that the United States terminated with effect in 1997. The
proposed protocol with France would amend an existing tax treaty that
was signed in 1994 and that was amended by a previous protocol signed
in 2004. The proposed protocol with New Zealand would amend an existing
tax treaty that was signed in 1982.
My testimony today will highlight some of the key features of the
proposed treaty and protocols and certain issues that those agreements
raise.
U.S. MODEL TREATY
As a general matter, U.S. Model tax treaties provide a framework
for U.S. tax treaty policy and a starting point for tax treaty
negotiations with our treaty partners. These models provide helpful
information to taxpayers, the Congress, and foreign governments about
U.S. policies on tax treaty matters. The present U.S. Model treaty
incorporates important developments in U.S. income tax treaty policy
that had been reflected in U.S. income tax treaties signed in the years
immediately preceding the Model's publication in 2006. Treaties that
the United States has negotiated since 2006 in large part follow the
U.S. Model treaty. The proposed treaty and protocols that are the
subject of this hearing are, accordingly, generally consistent with the
provisions found in the U.S. Model treaty. There are, however, some key
differences from the U.S. Model treaty that I will discuss.
MALTA: TREATY SHOPPING
Limitation-on-benefits provisions
Like the U.S. Model treaty, the proposed protocols with France and
New Zealand and the proposed treaty with Malta include extensive
limitation-on-benefits rules. Limitation-on-benefits provisions are
intended to prevent third-country residents from benefiting
inappropriately from a treaty that generally grants benefits only to
residents of the two treaty countries. This practice is commonly
referred to as ``treaty shopping.'' A company may engage in treaty
shopping by, for example, organizing a related treaty-country resident
company that has no substantial presence in the treaty country. The
third-country company may arrange, among other transactions, to have
the related treaty-country company remove, or strip, income from the
treaty country in a manner that reduces the overall tax burden on that
income. Limitation-on-benefits rules may prevent these and other
transactions by requiring that an individual or a company seeking
treaty benefits have significant connections to a treaty country as a
condition of eligibility for benefits.
The limitation-on-benefits rules of the proposed protocols with
France and New Zealand are generally consistent with the rules of the
U.S. Model treaty. The limitation-on-benefits rules of the proposed
treaty with Malta, by contrast, depart in several significant respects
from parallel rules of the U.S. Model treaty. These departures
generally make the rules of the proposed treaty with Malta more
restrictive than the U.S. Model treaty's limitation-on-benefits
provision. For example, the departures include more restrictive tests,
first, for determining whether a publicly traded company qualifies for
treaty benefits and, second, for determining whether a nonpublicly
traded company is eligible for treaty benefits based on the extent to
which the company pays its gross income to persons who are not
residents of either treaty country.
Withholding tax rules
The proposed treaty with Malta also departs from the U.S. Model
treaty in its withholding tax rules for interest, royalties, and other
income not covered by particular articles of the treaty. The U.S. Model
treaty provides an exemption from source-country withholding tax on
most payments of interest, royalties, and other income to a resident of
the other treaty country. By contrast, the proposed treaty with Malta
permits withholding at a 10-percent rate on these payments.
The proposed treaty with Malta is consistent with the U.S. Model
treaty in its rules for dividend withholding tax, but these rules are
less favorable to taxpayers than the dividend provisions of other
recent U.S. tax treaties. Like the U.S. Model treaty, the proposed
treaty with Malta permits imposition of source-country withholding tax
at a 5-percent rate on dividends paid to a 10-percent-or-greater
shareholder resident in the other treaty country and at a 15-percent
rate on other dividends. The proposed protocol with France and many
other recent U.S. tax treaties eliminate source-country withholding tax
on dividends paid by an at least 80-percent-owned subsidiary to the
parent corporation in the other treaty jurisdiction.
Malta's domestic law
The strict limitation-on-benefits rules and the less taxpayer-
favorable withholding tax rules of the proposed treaty with Malta are
intended to restrict treaty shopping that might otherwise be attractive
because of features of Malta's internal tax laws. These features
include, among others: (1) An exemption from Maltese corporate taxation
for dividends received by a Malta corporation from certain foreign
subsidiaries; (2) a corresponding exemption from Maltese corporate tax
for gain from the sale of shares of these foreign subsidiaries; (3) the
absence of Maltese withholding tax on dividend and interest payments to
non-Maltese residents; and (4) an imputation system of corporate tax
that has the effect of eliminating a shareholder-level tax on corporate
profits.
Appropriateness of entering into new treaty with Malta
The previously mentioned U.S. termination of the prior income tax
treaty with Malta was due in part to the Treasury Department's concern
that Malta's internal tax law might have facilitated treaty shopping.
At the time, Malta also did not generally permit sharing of bank
information with foreign tax authorities. Malta has since joined the
European Union (``EU''), implemented EU directives assuring mutual
administrative assistance and compliance with international
transparency norms, and revised its domestic laws to allow Maltese tax
authorities to share bank information with foreign tax authorities. By
contrast, the Maltese internal taxation rules that might have
facilitated treaty shopping remain largely unchanged. To prevent
possible treaty shopping, however, the proposed treaty includes the
strict limitation-on-benefits and withholding tax provisions described
above.
In light of the prior treaty history, your committee may wish to
ask the Treasury Department about the factors that led it to conclude
that it was now appiopriate to enter into a new income tax treaty with
Malta. Your committee may also wish to inquire whether the provisions
of the proposed treaty and changes to Maltese domestic law, taken
together, assuage the concerns that led the Treasury Department to
terminate the prior treaty.
FRANCE: MANDATORY ARBITRATION
The proposed protocol with France broadly follows the U.S. Model
treaty. The proposed protocol does, however, differ from the U.S Model
treaty in several provisions, including its requirement that disputes
that the competent authorities of the two treaty countries are unable
to resolve through consultation be settled by arbitration.
U.S. income tax treaties provide mutual agreement procedures
authorizing the competent authorities of the treaty countries to
cooperate to resolve disputes, clarify issues, and address cases of
double taxation. The present tax treaty with France and other U.S.
income tax treaties permit the competent authorities and the affected
taxpayer to agree to voluntary arbitration of a case that the competent
authorities cannot resolve by mutual agreement. The proposed protocol
with France replaces this optional arbitration procedure with rules for
mandatory arbitration of some unresolved disputes. Three U.S. tax
treaties--those with Belgium, Canada, and Germany--now contain similar
rules for mandatory arbitration. These rules are a departure from the
U.S. Model treaty. The proposed treaty with Malta and the proposed
protocol with New Zealand do not include provisions for mandatory
arbitration of unresolved cases.
Although the mandatory arbitration provision of the proposed
protocol with France is similar to the corresponding provisions of the
U.S. tax treaties with Belgium, Canada, and Germany, there are two
significant differences. First, by contrast with the U.S. tax treaties
with Canada and Germany, but like the United States-Belgium treaty, the
proposed protocol with France permits arbitration of any case involving
the application of any article of the treaty so long as the competent
authorities have not agreed that the case is not suitable for
arbitration. The U.S. tax treaties with Canada and Germany provide
mandatory arbitration of cases involving the application of only
certain treaty articles. Second, by contrast with the treaties with
Belgium, Canada, and Germany, the proposed protocol with France allows
a taxpayer whose case is in mandatory arbitration to submit a position
paper to the arbitration board. Your committee may wish to inquire
about both the scope of mandatory arbitration and the opportunity for
taxpayer participation.
More broadly, your committee may wish to ask about the Treasury
Department's intentions for future U.S. income tax treaties and
protocols. Does the Treasury Department expect that mandatory
arbitration provisions following the proposed protocol and the treaties
with Belgium, Canada, and Germany will become a standard feature of
future U.S. tax treaties, or will the Treasury Department be selective
in choosing the countries with which it negotiates those provisions? If
the Treasury Department expects mandatory arbitration to become a
standard feature in future U.S. tax treaties, will the Treasury
Department revise the U.S. Model treaty to include mandatory
arbitration rules? If mandatory arbitration is not expected to be a
part of all or most future U.S. income tax treaties, it may be useful
to ask what criteria the Treasury Department will use to determine
whether a particular treaty should include mandatory arbitration.
Your committee also is aware that as a condition of ratifying the
U.S. protocol with Canada last year, the Senate required the Treasury
Department to submit to the Joint Committee on Taxation and the Senate
Finance Committee, among other information, a report describing the
operation of the mandatory arbitration procedures of the treaties with
Belgium, Canada, and Germany. This report must include information
about the size and subject matter of cases before arbitration and the
length of time of arbitration proceedings. This report must be provided
within 60 days after a determination is reached in the 10th arbitration
proceeding conducted under the U.S. treaty with Belgium, Canada, or
Germany, and similar reports must be submitted annually for 5 years
thereafter. These required reports will not include information about
the operation of the mandatory arbitration procedures of the proposed
protocol with France. Your committee may wish to consider wheither the
required Treasury reporting should be expanded to encompass arbitration
proceedings under the proposed protocol with France.
EXCHANGE OF INFORMATION
The U.S. Model treaty and U.S. income tax treaties generally
provide exchange of information rules requiring the competent
authorities of the two treaty countries to exchange information that
may be relevant for carrying out the treaties or the domestic laws of
the treaty countries concerning all taxes imposed by a treaty country.
The exchange of information article of the proposed protocol with New
Zealand closely follows the information exchange rules of the U.S.
Model treaty. The exchange of information articles of the proposed
treaty with Malta and the proposed protocol with France largely follow
the corresponding rules of the U.S. Model treaty but do differ in
certain respects. The Joint Committee staff's pamphlets describe these
differences and provide detailed overviews of the information exchange
articles of the two proposed protocols and the proposed treaty. Here I
wish to highlight issues related to the proposed treaty relationship
with Malta and related to the effectiveness of information exchange
under income tax treaties generally.
Information exchange with Malta
As described previously, the United States terminated its prior
income tax treaty with Malta with effect in 1997. At the time, Malta
did not generally permit sharing of bank information with foreign tax
authorities. Malta has since joined the European Union and implemented
EU directives concerning transparency and legal assistance. Last year,
Malta revised its banking law to grant Maltese tax authorities access
to bank information for the purpose of exchanging the information with
tax authorities of other countries under information exchange
agreements. Malta has entered into 45 agreements that require exchange
of information in compliance with standards set by the Organisation for
Economic Co-operation and Development (``OECD''). Malta is now
considered to have fully committed to the transparency standards of the
OECD.
To the extent that there were perceived deficiencies in the former
information exchange relationship with Malta that contributed to the
decision to terminate the prior treaty, and to the extent that the
United States may have little recent practical experience in
cooperating with Malta on tax matters, your committee may wish to seek
reassurances that any obstacles to effective information exchange have
been eliminated.
The information exchange article of the proposed treaty with Malta
includes one difference from the corresponding article of the U.S.
Model treaty. The proposed treaty permits the recipient of information
exchanged under the treaty to use that information for purposes
sanctioned by the United States-Malta Treaty on Certain Aspects of
Mutual Legal Assistance in Criminal Matters (``MLAT''). The Senate
ratified that treaty last year, but it has not yet entered into effect.
The extent to which this deviation from the U.S. Model treaty is
intended to expand the scope of permitted exchange of information is
not clear. The inclusion of a cross-reference to the MLAT in the
proposed treaty is unique among U.S. income tax treaties, although it
is consistent with both the OECD Convention on Mutual Assistance in Tax
Matters (in Article 4) and the 2005 OECD Model Convention on Income and
on Capital (in Article 26). Your committee may wish to explore how this
new rule is to be reconciled with domestic restrictions on disclosure
of return information if Malta requests permission to use the
information for nontax purposes.
Effectiveness of information exchange
The Joint Committee staff's pamphlets describe in detail several
practical issues related to information exchange under income tax
treaties. I will briefly note two issues here. First, automatic and
specific information exchange under tax treaties, two of three broad
methods of exchange of information, may not always be fully useful.\3\
Under automatic exchange, the parties to a tax treaty typically enter
into a memorandum of understanding to share, on an ongoing basis,
information that is deemed consistently relevant to the tax
administration of the other treaty country; the treaty countries are
not required to specifically request this information from one another.
The United States, for example, provides to its treaty partners
information about U.S.-source income received by residents of those
treaty countries. Specific exchange occurs when one treaty country
provides information to the other treaty country in response to a
request by the latter country for information that is relevant to an
ongoing investigation of a particular tax matter.
---------------------------------------------------------------------------
\3\The other method of information exchange is spontaneous
exchange. Spontaneous exchange occurs when one treaty country
determines that information in its possession may be relevant to the
other treaty country's tax administration and thus transmits the
information to the other country.
---------------------------------------------------------------------------
Problems with automatic exchange under U.S. tax treaties and the
tax treaties of other countries have included that information has not
been provided on a timely basis; treaty countries' tax reporting
periods have differed from one another; the recipient country has had
difficulty translating information into its own language; and
information flows have been voluminous. Your committee may wish to
inquire about whether there are any practical impediments to automatic
information exchange with France, Malta, and New Zealand and the ease
with which any impediments could be removed and the likelihood that
they would be removed.
One problem with specific exchange has been that some treaty
countries have declined to exchange information in response to specific
requests intended to identify limited classes of persons.\4\ Your
committee may wish to seek assurances that, under the proposed treaty
with Malta and the proposed protocols with France and New Zealand,
treaty countries are required to exchange information in response to
specific requests that are comparable to John Doe summonses under
domestic law.\5\
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\4\For example, a petition to enforce a John Doe summons served by
the United States on UBS, AG was filed on February 21, 2009,
accompanied by an affidavit of Barry B. Shoff, the U.S. competent
authority for the United States-Switzerland income tax treaty.
Paragraph 16 of that affidavit notes that Switzerland had traditionally
taken the position that a specific request must identify the taxpayer.
See United States v. UBS AG, Civil No. 09-20423 (S.D. Fla.). On August
19, 2009, after extensive negotiations between the Swiss and U.S.
Governments, the United States and UBS announced that UBS had agreed to
provide information on over 4,000 U.S. persons with accounts at UBS.
\5\Under a John Doe summons, the U.S. Internal Revenue Service
(``IRS'') asks for information to identify unnamed ``John Doe''
taxpayers. The IRS may issue a John Doe summons only with judicial
approval, and judicial approval is given only if there is a reasonable
basis to believe that taxes have been avoided and that the information
sought pertains to an ascertainable group of taxpayers and is not
otherwise available.
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Second, the United States has been criticized for Federal and State
rules that may facilitate attempts by foreign persons to evade their
home country tax laws. One criticism is that the U.S. ``know your
customer'' rules for financial institutions may be less strict than
other countries in their requirements for the determination of
beneficial owners of financial accounts. A second criticism has been
that the entity formation laws of some U.S. States make it difficult
for government officials to ascertain the identities of owners of
entities. Your committee may wish to ask about the extent to which it
may be appropriate to consider policy changes to ensure that the United
States is able to respond effectively to information requests from its
treaty partners.
ARTICLE-BY-ARTICLE SUMMARIES
The Joint Committee staff's pamphlets provide detailed article-by-
article explanations of the proposed treaty and the two proposed
protocols. Below is a summary of significant features of each
agreement.
Malta
Like other U.S. tax treaties, the proposed treaty with Malta
includes rules that limit each country's right, in specified
situations, to tax income derived from its territory by residents of
the other country. For example, the proposed treaty contains provisions
under which each country generally agrees not to tax business income
derived from sources within that country by residents of the other
country unless the business activities in the taxing country are
substantial enough to constitute a permanent establishment (Article 7).
Similarly, the proposed treaty contains certain exemptions under which
residents of one country performing personal services in the other
country will not be required to pay tax in the other country unless
their contact with the other country exceeds specified minimums
(Articles 14 and 16). The proposed treaty also provides that pensions
and other similar remuneration paid to a resident of one country may be
taxed only by that country and only at the time and to the extent that
a pension distribution is made (Articles 17 and 18).
The proposed treaty provides that dividends and certain gains
derived by a resident of either country from sources within the other
country generally may be taxed by both countries (Articles 10 and 13);
however, the proposed treaty limits the rate of tax that the source
country may impose on certain dividends paid to a resident of the other
country. As described previously, these rules are consistent with the
corresponding provisions of the U.S. Model treaty, but they represent a
departure from the exemption from source-country withholding tax
provided by several recent U.S. treaties and protocols for dividends
paid by subsidiaries to parent corporations resident in the other
treaty countries.
The proposed treaty's rule for Maltese taxation of Malta-source
dividends paid to residents of the United States takes into account the
Maltese imputation system of corporate tax. The rule provides that the
tax that may be charged by Malta on dividends paid by a Maltese company
to a U.S. resident is limited to the Maltese tax chargeable on the
profits out of which the dividends are paid.
The proposed treaty generally limits the rate of source-country tax
that may be imposed on interest arising in one treaty country (the
source country) and beneficially owned by a resident of the other
treaty so that it may not exceed 10 percent of the gross amount of the
interest (Article 11). Similarly, the proposed treaty provides that a
royalty payment arising in a treaty country and beneficially owned by a
resident of the other treaty country may be subject to a source country
tax of up to 10 percent of the gross amount of the royalty (Article
12). As described previously, these provisions differ from the
corresponding rules of the U.S. Model treaty. The U.S. Model treaty
provides an exemption from source-country tax for most interest and
royalty payments beneficially owned by a resident of the other country.
Unlike the U.S. Model treaty, the proposed treaty permits limited
source-country taxation of income not dealt with in other articles of
the treaty. That income may be taxed by the source country at a rate
not greater than 10 percent (Article 21). As described previously, the
U.S. Model treaty, by contrast, exempts this income from source-country
taxation.
In situations in which the country of source retains the right
under the proposed treaty to tax income derived by residents of the
other country, the proposed treaty generally provides for relief from
the potential double taxation through the allowance by the country of
residence of a tax credit for certain foreign taxes paid to the other
country (Article 22).
The proposed treaty contains the standard provision (the ``saving
clause'') included in U.S. tax treaties pursuant to which each country
retains the right to tax its residents and citizens as if the treaty
had not come into effect (Article 1). In addition, the proposed treaty
contains the standard provision providing that the treaty may not be
applied to deny any taxpayer any benefits to which the taxpayer would
be entitled under the domestic law of a country or under any other
agreement between the two countries (Article 1).
The proposed treaty (Article 20) generally provides that students
and business trainees who are residents of one treaty country and who
visit the other treaty country (the host country) are exempt from host-
country taxation on certain types of payments received from sources in
their home country for their maintenance, education, or training.
The proposed treaty provides authority for the two countries to
resolve disputes (Article 25) and exchange information (Article 26) in
order to carry out the provisions of the proposed treaty. As noted
above, unlike the U.S. Model treaty exchange of information rules, the
proposed treaty permits the use of tax information received under the
tax treaty for purposes that are consistent with the scope of the MLAT
between the United States and Malta.
The proposed treaty also contains a detailed limitation-on-benefits
provision to prevent the inappropriate use of the treaty by third-
country residents (Article 22). This provision generally reflects the
anti-treaty-shopping provisions included in the U.S. Model treaty and
more recent U.S. income tax treaties, but, as was described previously,
is more stringent in a number of respects.
The provisions of the proposed treaty generally take effect on or
after the first day of January following the date that the proposed
treaty enters into force. With respect to withholding taxes
(principally on dividends, interest, and royalties), the provisions of
the proposed treaty take effect for amounts paid or credited on or
after the first day of the second month following the date on which the
proposed treaty enters into force.
France
The proposed protocol with France makes changes to Article 4
(Resident) of the present treaty that in general make the rules conform
more closely to the rules of other recent U.S. income tax treaties and
protocols. Among other changes, the proposed protocol provides a
special rule for French qualified partnerships and includes rules for
fiscally transparent entities, which are entities that are not subject
to tax at the entity level, that are similar to rules found in other
recent U.S. income tax treaties. One difference from recent U.S.
treaties is the addition of a requirement that, when a fiscally
transparent entity formed or organized outside the United States or
France derives an item of income, profit, or gain from U.S. or French
sources, the fiscally transparent entities rules apply only if the
country in which the entity is organized has concluded with the treaty
country from which the income, profit, or gain is derived an agreement
including an exchange of information provision intended to prevent tax
evasion.
The proposed protocol replaces Article 10 (Dividends) of the
present treaty. The new article generally allows full residence-country
taxation and limited source-country taxation of dividends. The proposed
protocol retains both the generally applicable 15-percent maximum
withholding rate and the reduced 5-percent maximum rate for dividends
received by a company owning at least 10 percent of the dividend-paying
company. As described previously, like several other recent treaties
and protocols, the proposed protocol provides for a zero rate of
withholding tax on certain dividends received by a parent company from
a subsidiary that is at least 80-percent owned by the parent. As in the
present treaty, special rules apply to dividends received from a
regulated investment company, a real estate investment trust, and a
societe d'investissement a capital variable; under the proposed
protocol, these rules are extended to a ``societe d'investissement
immobilier cotee'' and a ``societe de placement a preponderance
immobiliere a capital variable.''
Article 12 (Royalties) of the present treaty is revised to provide
that royalties arising in a treaty country (the source country) and
beneficially owned by a resident of the other treaty country are exempt
from taxation in the source country. Under the present treaty, the
source country may impose up to a 5-percent withholding tax on gross
royalty payments.
The proposed protocol makes conforming changes to Article 13
(Capital Gains) to reflect revisions made to Article 12 (Royalties). It
also updates Article 17 (Artistes and Sportsmen) to reflect the fact
that the French currency is now the euro.
The proposed protocol clarifies that the exclusive source-country
tax rule of Article 18 (Pensions) for payments arising under the social
security legislation or similar legislation of one of the treaty
countries to a resident of the other treaty country applies, in the
case of payments arising under France's social security legislation, to
payments made not only to residents of the United States, but also to
citizens of the United States who are residents of France. Accordingly,
notwithstanding the saving clause of paragraph 2 of Article 29
(Miscellaneous Provisions), the United States may not tax French social
security payments made to a U.S. citizen resident in France.
Article 22 (Other Income) of the present treaty is replaced with a
new article that conforms to the corresponding U.S. Model treaty
provision. The article generally assigns taxing jurisdiction over
income not dealt with in the other articles of the treaty to the
residence country of the beneficial owner of the income.
The proposed protocol switches the order of two paragraphs of
Article 24 (Relief from Double Taxation), clarifies that companies that
are French residents may elect to be taxed on a worldwide basis subject
to a credit in lieu of applying the general exemption system in France
to foreign business income, and makes several conforming changes.
The proposed protocol changes cross-references that Article 25
(Non-Discrimination) makes to provisions of Articles 10 (Dividends) and
12 (Royalties). These changes in cross-references reflect the proposed
protocol's renumbering of certain paragraphs of Articles 10 and 12.
As described previously, the proposed protocol changes the
voluntary arbitration procedure of Article 26 (Mutual Agreement
Procedure) of the treaty to a mandatory arbitration procedure that is
sometimes referred to as ``last best offer'' arbitration, in which each
of the competent authorities proposes one and only one figure for
settlement, and the arbitrator must select one of those figures as the
award. Under the proposed protocol, unless a taxpayer or other
``concerned person'' (in general, a person whose tax liability is
affected by the arbitration determination) does not accept the
arbitration determination, it is binding on the treaty countries with
respect to the case. A mandatory and binding arbitration procedure is
included in the U.S. income tax treaties with Belgium, Canada, and
Germany.
Mutual administrative assistance is modernized under the proposed
protocol. The proposed protocol replaces Article 27 (Exchange of
Information) of the present treaty with rules that conform closely to
the U.S. Model treaty. The proposed rules generally provide that the
two competent authorities will exchange such information as may be
relevant in carrying out the provisions of the domestic laws of the
United States and France concerning taxes imposed at a national level,
to the extent the taxation under those laws is not contrary to the
treaty. The proposed protocol's information exchange article deviates
from the U.S. Model treaty's article in its conditions under which
entry into a treaty country's sovereign territory is permitted. The
proposed protocol requires that a treaty country permit representatives
of the other treaty country enter its territory to interview a taxpayer
or to examine a taxpayer's books and records if the taxpayer has
consented. This rule is narrower than the corresponding rules of the
U.S. Model treaty because the proposed protocol's rule does not permit
entry for interviewing or examining the books and records of consenting
third parties.
Article 28 (Assistance in Collection) of the present treaty is
modified to remove an obsolete reference to former paragraph 4 of
Article 10 (Dividends).
The proposed protocol amends Article 29 (Miscellaneous Provisions)
of the present treaty, updating the saving clause to provide that
France may tax entities that have their place of effective management
in France, and which are subject to tax in France, notwithstanding the
new fiscally transparent entity provision in Article 4 (Resident). It
also updates the definition of former citizen and long-term residents
to conform with the changes to section 877 of the Code and makes
conforming changes to other paragraphs in Article 29. The proposed
protocol adds a new rule to Article 29 that payments made by French
Government agencies to lawful permanent residents of the United States
will be taxable only in the United States.
As described previously, Article 30 (Limitation on Benefits) of the
present treaty is replaced with a new article that reflects the anti-
treaty-shopping, provisions included in the U.S. Model treaty and more
recent U.S. income tax treaties. The new rules are intended to prevent
the indirect use of the treaty by persons who are not entitled to its
benefits solely by reason of residence in France or the United States.
The proposed protocol modifies Article 32 (Provisions for
Implementation) of the present treaty to delete obsolete references to
former paragraph 4(i) of Article 10 (Dividends) and former paragraph 8
of Article 30 (Limitation on Benefits).
Finally, Article XVI of the proposed protocol provides for the
entry into force of the proposed protocol. The treaty countries will
notify each other in writing when their respective constitutional and
statutory requirements for entry into force of the protocol have been
satisfied. The proposed protocol will enter into force on the date of
receipt of the latter of such notifications. For withholding taxes, the
proposed protocol has effect with respect to amounts paid or credited
on or after January 1st of the calendar year in which the proposed
protocol enters into force. For all other taxes, the proposed protocol
has effect for taxes imposed for tax periods beginning on or after
January 1st of the year immediately after the date on which the
proposed protocol enters into force. With respect to the binding
arbitration rules of Article 26 (Mutual Agreement Procedures), the
proposed protocol is effective for cases under consideration by the
competent authorities as of the date the proposed protocol enters into
force and cases that come under consideration thereafter.
New Zealand
Articles I (General Scope), II (Taxes Covered), III (General
Definitions) and X (Independent Personal Services) of the proposed
protocol with New Zealand generally update the provision of the present
treaty to conform to the U.S. Model treaty.
The proposed protocol replaces the definition of ``resident of a
Contracting State'' in Article 4 (Residence) of the present treaty with
one that is identical to the definition in the U.S. Model treaty. The
proposed protocol's definition of a resident of a Contracting State
reverses an exclusion from the definition in the present treaty for a
person who is subject to tax in a treaty country by reason of that
person's citizenship but who is not a resident of that country.
Consequently, under the proposed protocol, a nonresident citizen of the
United States may (subject to the article's other rules) be treated as
a resident of the United States. The proposed protocol also conforms to
the U.S. Model treaty's two tie-breaker rules for determining the
residence of an individual who otherwise would be a resident of both
treaty countries. Accordingly, residence under these tie-breaker rules
is determined based on the country of which the individual is a
national, rather than, as under the present treaty, on the individual's
country of citizenship.
The proposed protocol adds new paragraphs 8 and 9 to Article 7
(Business Profits) of the present treaty. New paragraph 8, like the
U.S. Model treaty, provides that business profits may be attributable
to a permanent establishment (and therefore may be taxable in the
source country) even if the payment of the income is deferred until
after the permanent establishment has ceased to exist. New paragraph 9
differs from the U.S. Model and OECD Model treaties, and specifically
addresses New Zealand law relating to trusts. It provides that (1) if a
fiscally transparent entity, or trustee, has a permanent establishment
in one treaty country, and (2) a resident of the other treaty country
is beneficially entitled to a share of profits from a business carried
on by the entity or trustee through a permanent establishment in the
first country, then the beneficial owner is treated as carrying on the
business through the permanent establishment.
The proposed protocol replaces Article 10 (Dividends) of the
present treaty with a new article that generally allows full residence-
country taxation and limited source-country taxation of dividends. The
proposed protocol retains the generally applicable maximum rate of
withholding at source of 15 percent, but also adds a reduced 5-percent
maximum rate for dividends received by a company owning at least 10
percent of the voting power of dividend-paying company. Like several
other recent treaties and protocols, the proposed protocol also
provides for a zero rate of withholding tax on certain dividends
received by a parent company from a subsidiary that is at least 80-
percent owned by the parent. The proposed protocol adds special rules
that apply to dividends received from regulated investment companies
and real estate investment trusts which are similar to provisions
included in other recent treaties and protocols.
The proposed protocol replaces Article 11 (Interest) of the present
treaty with a new article that retains source-country taxation, of
interest at a maximum withholding rate of 10 percent, but allows a
special zero rate of withholding for certain financial institutions and
governmental entities.
The proposed protocol revises Article 12 (Royalties) of the present
treaty. It provides that royalties arising in a treaty country (the
source country) and beneficially owned by a resident of the other
treaty country may be subject to a source country tax of up to 5
percent. This is a reduction from the 10-percent rate provided in the
present treaty, but any source-country taxation of royalties remains
above the exemption provided in the U.S. Model treaty.
The proposed protocol makes two modifications to Article 13
(Alienation of Property). The proposed protocol makes a conforming
change to reflect the elimination of Article 14 (Independent Personal
Services) of the present treaty in a manner consistent with the OECD
Model treaty. Additionally, to avoid double taxation, the proposed
protocol updates the present treaty to allow U.S. individuals who
expatriate to New Zealand (who are required to recognize taxable gain
on a deemed sale of all of their property under section 877A of the
Code) to get a step up in tax basis for New Zealand tax purposes by
treating the property deemed sold as immediately repurchased at its
fair market value.
The proposed protocol replaces Article 16 (Limitation on Benefits)
of the present treaty with a new article that reflects the anti-treaty-
shopping provisions included in the U.S. Model treaty and more recent
U.S. income tax treaties. The new rules are intended to prevent the
indirect use of the treaty by persons who are not entitled to its
benefits solely by reason of residence in New Zealand or the United
States.
The proposed protocol makes certain conforming changes to Article
22 (Relief from Double Taxation) of the present treaty to reflect
changes by the proposed protocol to Article 2 (Taxes Covered). The
proposed protocol also deletes the last sentence of paragraph 2 of
Article 22 of the present treaty. The deleted sentence provides that
dividends received from a U.S. company by a New Zealand company that
owns at least 10 percent of the paid-up share capital of the U.S.
company (being dividends that would be exempt from New Zealand tax
under New Zealand law at the time of the signing of the present treaty)
are exempt from New Zealand tax.
The proposed protocol replaces the nondiscrimination rules of
Article 23 of the present treaty with new rules that are similar to the
nondiscrimination provisions of the U.S. Model treaty and other recent
U.S. income tax treaties. These rules generally forbid each treaty
country from discriminating against nationals of the other country by
imposing on those nationals more burdensome taxes than it would impose
on its own comparably situated nationals in the same circumstances.
Similarly, neither treaty country may tax a permanent establishment of
an enterprise of the other country less favorably than it taxes its own
enterprises carrying on the same activities. The nondiscrimination
provision does not include the U.S. Model treaty rule which provides
that the nondiscrimination rules apply to taxes of every kind and
description imposed by a treaty country or by a political subdivision
or local authority of that treaty country. Accordingly, the
nondiscrimination rules apply only to taxes covered by the present
treaty (as modified by the proposed protocol) and not, for example, to
U.S. State and local taxes.
The proposed protocol does not change the provisions of Article 24
(Mutual Agreement Procedure) of the treaty. Thus, the treaty, as
modified by the proposed protocol, does not include a mandatory
arbitration procedure similar to the rules of the proposed protocol
with France and the treaties with Belgium, Canada, and Germany.
The proposed protocol replaces Article 25 (Exchange of Information)
of the present treaty with rules that conform closely to the U.S. Model
treaty. The proposed rules generally provide that the two competent
authorities will exchange such information as may be relevant in
carrying out the provisions of the domestic laws of the United States
and New Zealand concerning taxes imposed at a national level, to the
extent the taxation under those laws is not contrary to the treaty, as
modified by the proposed protocol. It provides--for the first time--for
mutual assistance in the collection of tax debts between the United
States and New Zealand. Such assistance is limited to tax debts that
arise from improperly granted treaty benefits.
The proposed protocol replaces paragraph 1 of the protocol to the
present treaty, which was signed on the same day as the treaty. Under
the proposed protocol, New Zealand is required to consult with the
United States for purposes of providing the same treatment on a
reciprocal basis if (1) it enters into a double taxation treaty with
any country (and not just with an OECD member) and (2) that treaty
limits the withholding tax rates on interest or royalties (but not
dividends) to a rate lower than the one provided for in the treaty with
the United States.
Under the provisions of Article XVI, the proposed protocol enters
into force on the date of the later of the notifications. The relevant
date is the date on the second of the notification documents, and not
the date on which the second notification is delivered to the other
treaty country. Generally, the proposed protocol is effective on a
prospective basis. However, the competent authority provisions under
Article 26 (Exchange of Information) are effective retroactively to
taxable periods preceding the entry into force of the proposed
protocol.
CONCLUSION
These provisions and issues are all discussed in more detail in the
Joint Committee staff pamphlets on the proposed treaty and protocols.
Senator Kaufman. Thank you.
Mr. Scholz.
STATEMENT OF WESLEY SCHOLZ, DIRECTOR, OFFICE OF INVESTMENT
AFFAIRS, BUREAU OF ECONOMIC, ENERGY, AND BUSINESS AFFAIRS,
DEPARTMENT OF STATE
Mr. Scholz. Thank you, Senator Kaufman. It's a privilege to
be here to testify before the Senate Foreign Relations
Committee as the administration seeks advice and consent of the
Senate to ratification of the United States-Rwanda Bilateral
Investment Treaty.
Foreign investment is an important source of economic
growth in the United States and around the globe. It improves
productivity, provides good jobs, and spurs healthy
competition. Foreign investment is a platform for U.S. exports.
In 2007, 22 percent of U.S. exports of goods were shipped to
foreign subsidiaries of U.S. firms.
Foreign investment can also be a powerful tool for economic
development. BITs play an important role by establishing rules
that protect the rights of investors abroad and provide market
access for future U.S. investment.
Since the inception of the U.S. Bilateral Investment Treaty
Program in the early 1980s, successive U.S. administrations
have negotiated BITs with the objective of protecting U.S.
investment abroad, encouraging the adoption of open,
transparent, and nondiscriminatory investment polices, and
supporting the development of international legal standards
consistent with these objectives.
The United States presently is a party to BITs with 40
countries. Five of these treaties are with sub-Saharan African
countries, although the BIT with Rwanda is the first such
treaty signed by the United States with a sub-Saharan African
country in almost a decade.
The United States chose to negotiate a BIT with Rwanda, in
part based on its strong economic reform program, which has
helped to rebuild the Rwandan economy since the 1994 genocide.
The Rwandan Government has opened its economy, improved its
business climate, and embraced trade and investment as a means
to boost economic development and help alleviate poverty.
In the World Bank's Doing Business 2010 Report, Rwanda was
the world's most improved country for its record of business-
related reforms, a first for a sub-Saharan African economy.
Rwanda also maintains a consistent policy of attempting to
combat corruption.
As the result of these reforms, foreign investors are
increasingly giving Rwanda serious consideration as a
destination for investment. According to our Embassy, United
States-led investment in Rwanda is poised to grow from less
than $50 million pre-2008 to more than $600 million in 3 to 5
years.
These improvements could increase access to energy
significantly for Rwandans and their regional neighbors, expand
the number of Rwandan university-educated students from the
thousands to the tens of thousands, and provide low-cost green
housing for middle-income Rwandans.
United States investment has the potential to change
Rwanda's economic landscape and play a significant role in
assisting Rwandan Government's efforts to become an economic
hub for central Africa.
The Department of State and the Office of U.S. Trade
Representative co-led the negotiation of this treaty, with the
participation of the Departments of Commerce and Treasury and
other U.S. Government agencies. The treaty, which was signed on
February 19, 2008, closely adheres to the text of the 2004 U.S.
model. The treaty will complement Rwanda's reform efforts, help
Rwanda attract more foreign investment that is vital to
economic prosperity, and deepen our economic relationship with
an important partner in Africa. It would also set a very
positive example for others in the region.
Looking ahead, the administration is interested in
exploring possibilities for new U.S. BITs in Africa. On August
5, at an event during the African Growth and Opportunity Act
Forum in Nairobi, Secretary of State Clinton and U.S. Trade
Representative Kirk announced that the United States would also
start negotiations toward a Bilateral Investment Treaty with
Mauritius. Mauritius is another partner in sub-Saharan Africa
that has taken serious steps to enact reforms and improve its
business climate. At that time, Secretary Clinton echoed
President Obama's call to do more to promote investment in
Africa and commented that the launch of negotiations with
Mauritius is in keeping with our broader interest in engaging
other potential partners in Africa.
In conclusion, the administration wishes to thank the
committee for its consideration of the treaty, and we urge you
to report it favorably to the full Senate for action.
I'd be happy to answer any of your questions.
[The prepared statement of Mr. Scholz follows:]
Prepared Statement of Wesley S. Scholz, Director, Office of Investment
Affairs, Department of State, Washington, DC
Mr. Chairman, thank you for the opportunity to testify before the
Foreign Relations Committee as the administration seeks advice and
consent of the Senate to ratification of the United States-Rwanda
Bilateral Investment Treaty (BIT).
Foreign investment is an important source of economic growth in the
United States and around the globe. It improves productivity, provides
good jobs, and spurs healthy competition. Foreign investment is a
platform for U.S. exports. In 2007, 22 percent of U.S. goods exports
were shipped to foreign subsidiaries of U.S. firms. Foreign investment
can also be a powerful tool for economic development. BITs play an
important role by establishing rules that protect the rights of U.S.
investors abroad and provide market access for future U.S. investment.
Since the inception of the U.S. BIT program in the early 1980s,
successive U.S. administrations have negotiated BITs with the objective
of protecting U.S. investment abroad, encouraging the adoption of open,
transparent, and nondiscriminatory investment policies, and supporting
the development of international legal standards consistent with these
objectives. U.S. BITs build on the principles contained in earlier U.S.
treaties of Friendship, Commerce, and Navigation. The United States
presently is a party to BITs with 40 countries. Five of these treaties
are with sub-Saharan African countries, although the BIT with Rwanda is
the first such treaty signed by the United States with a sub-Saharan
African country in almost a decade.\1\
---------------------------------------------------------------------------
\1\The other U.S. BITs with sub-Saharan African countries are with:
Cameroon, the Democratic Republic of Congo, Mozambique, the Republic of
Congo, and Senegal.
---------------------------------------------------------------------------
The United States chose to negotiate a BIT with Rwanda in part
based on its strong economic reform program, which has helped to
rebuild the Rwandan economy since the 1994 genocide. The Rwandan
Government has opened its economy, improved its business climate, and
embraced trade and investment as a means to boost economic development
and help alleviate poverty. In 2008-2009, Rwanda was the world's most
improved country in the World Bank's review of ``doing business''
reforms--a first for a sub-Saharan African country. The report cited
Rwanda's progress in areas such as reducing the time necessary to start
a business, making it easier to obtain credit, and providing rules to
facilitate trade and the registration of property. Rwanda also
maintains a consistent policy of combating corruption.
As the result of these reforms, foreign investors are increasingly
giving Rwanda serious consideration as a destination for investment.
According to our Embassy, U.S.-led investment in Rwanda is poised to
grow from less than $50 million pre-2008 to more than $600 million in 3
to 5 years. These investments could increase access to energy
significantly for Rwandans and their regional neighbors, expand the
number of Rwanda university-educated students from the thousands to the
tens of thousands, and provide low-cost ``green'' housing for middle-
income Rwandans. U.S. investment has the potential to change Rwanda's
economic landscape and play a significant role in assisting the Rwandan
Government's efforts to become an economic hub for Central Africa. The
BIT with Rwanda, once in force, would reinforce the Rwandan
Government's efforts to further reform its economy and promote a strong
business climate. It would also set a very positive example in the
region.
The Department of State and the Office of the U.S. Trade
Representative co-led the negotiation of this treaty, with the
participation of the Departments of Commerce, the Treasury, and other
U.S. Government agencies. The treaty, which was signed on February 19,
2008, adheres closely to the text of the 2004 U.S. Model BIT. As such,
it contains a set of core investor protections, which include:
--National treatment and most-favored-nation treatment for the full
life cycle of investment, including in the establishment,
acquisition, operation, management, and ultimate disposition of an
investment;
--The free transfer of investment-related funds;
--Prompt, adequate, and effective compensation in the event of an
expropriation;
--A minimum standard of treatment grounded in customary international
law;
--Freedom of investment from specified performance requirements;
--Prohibitions on nationality-based restrictions for the hiring of
senior managers; and
--Provisions on transparency in publication of investment-related laws,
regulations, and other measures, and the opportunity, to the extent
possible, for interested parties to comment on such proposed
measures.
The treaty also provides investors with the opportunity to resolve
investment disputes with a host government through international
arbitration.
This investment treaty is based on the 2004 U.S. Model BIT, which,
compared to earlier BITs, includes a number of provisions designed to
improve the operation of the treaty. These developments include greater
specificity with respect to key substantive provisions, and rules of
procedure designed to eliminate frivolous claims and to enhance
efficiency, transparency, and public participation in the arbitration
process. The Parties also recognize in the treaty that it would be
inappropriate to encourage investment by weakening or reducing the
protections afforded in domestic environmental and labor laws. Under
the Model, each Party may take limited exceptions to the core
obligations related to national treatment, most-favored-nation
treatment, performance requirements, and senior management and boards
of directors. In this area, Rwanda has taken only a few, narrow
exceptions; the treaty thus sends a powerful signal about Rwanda's
openness to foreign investment.
In sum, this treaty will complement Rwanda's reform efforts, help
Rwanda attract more foreign investment that is vital to economic
prosperity, and deepen our economic relationship with an important
partner in Africa.
Looking ahead, the administration is interested in exploring
possibilities for new U.S. BITs in Africa. On August 5, at an event
during the African Growth and Opportunity Act Forum in Nairobi,
Secretary of State Clinton and U.S. Trade Representative Kirk announced
that the United States would start negotiations toward a BIT with
Mauritius. Mauritius is another partner in sub-Saharan African that has
taken serious steps to enact reforms and improve its business climate.
At that time, Secretary Clinton echoed President Obama's call to do
more to promote investment in Africa, and commented that the launch of
negotiations with Mauritius is in keeping with our broader interest in
engaging other potential BIT partners in Africa.
In conclusion, the administration wishes to thank the committee for
its consideration of the treaty and we urge you to report it favorably
to the full Senate for action.
Senator Kaufman. Thank you.
Ms. Jones.
STATEMENT OF HON. KERRI-ANN JONES, ASSISTANT SECRETARY, BUREAU
OF OCEANS AND INTERNATIONAL ENVIRONMENTAL AND SCIENTIFIC
AFFAIRS, DEPARTMENT OF STATE
Dr. Jones. Mr. Chairman, thank you for the opportunity to
testify today in support of the International Treaty on Plant
Genetic Resources for Food and Agriculture.
The security of U.S. agriculture depends on the stability
and high yield of U.S. crops, which in turn is contingent on
the continued development of new crop varieties. The crops we
grow are always under threats from diseases, pests, drought,
and floods. Our food security will depend in part upon breeding
new crops with new traits.
To develop such varieties, breeders and researchers require
access to a broad spectrum of genetic raw material which
contains traits, such as resistance to virulent pests and
disease. Each nation, including the United States, is
interdependent on many other nations for access to that genetic
material. Consequently, protecting what is termed, ``plant
genetic resources for food and agriculture'' and facilitating
international access to such material are critical priorities
for the United States and the entire international community.
For the past 40 years, political and legal uncertainty has
characterized the environment for international exchanges of
agricultural plant genetic resources. During this period, U.S.
researchers found it increasingly difficult to gain access to
plant breeding materials in other countries. Meanwhile,
technological advances significantly improved our ability to
identify, characterize, and utilize agricultural genetic
resources, thereby increasing the importance of access to gene
pools outside of our borders.
By establishing a stable, legal framework for international
germplasm exchanges, the treaty benefits both research and
commercial interests in the United States. This treaty promotes
global food security through the conservation and sustainable
use of plant genetic resources for food and agriculture. It
creates a multilateral system for access to and benefit-sharing
regarding certain plant genetic resources to be used for
research, breeding, and training for food and agriculture.
The treaty currently covers the exchange of material for 64
food and feed crops. More may be added in the future through
the agreement of the parties.
The treaty entered into force in 2004 and now has a 120
parties. The United States signed the treaty in 2002. The
President forwarded it to the Senate for consideration in July
2008. Throughout the negotiating process, the United States was
firmly committed to creating a system that promotes U.S. and
global food security and protects U.S. access to genetic
resources held outside of our borders.
The United States also sought to protect the ability of the
international agricultural research centers, the centers that
were largely responsible for the Green Revolution, to continue
to genetically improve crops that underpin global food
security.
The treaty enjoys broad stakeholder support, as you have
already mentioned, including several prominent industrial
organizations, such as the ones you mentioned, but also the
American Soybean Association and the National Association of
Wheat Growers.
The treaty is consistent with existing U.S. practice and
may be implemented under existing U.S. authorities. No
statutory changes are needed.
The Agricultural Research Service, in their role as manager
of the National Plant Germplasm System, would play a major role
in domestic treaty implementation. For more than 50 years, the
U.S. National Plant Germplasm System has distributed samples of
germplasm to breeders and researchers worldwide and free of
charge, and thereby already contributes significantly to the
global effort to safeguard plant germplasm for food security
now and in the future.
Consequently, the United States is already in compliance
with key provisions of the treaty, so ratification would not
entail major policy or technical changes to the current
National Plant Germplasm System as it operates.
Mr. Chairman, the United States Department of Agriculture
has long been recognized as the world leader in plant germplasm
conservation and distribution. As a party to the treaty, U.S.
entities would gain guaranteed access to plant genetic
resources covered by the treaty. Ratification of the treaty
would underscore our continued leadership, and it would help
U.S. farmers and researchers sustain and improve their crops
and promote food security for future generations, not only in
the United States, but globally.
Thank you, Mr. Chairman, for this opportunity to convey our
support for ratification. I would be happy to answer any
questions.
[The prepared statement of Ms. Jones follows:]
Prepared Statement of Assistant Secretary Dr. Kerri-Ann Jones, Bureau
of Oceans and International Environmental and Scientific Affairs,
Department of State, Washington, DC
Mr. Chairman and members of the committee, thank you for the
opportunity to testify today in support of the International Treaty on
Plant Genetic Resources for Food and Agriculture (``the Treaty'').
Mr. Chairman, the security of U.S. agriculture depends on the
stability and high yield of U.S. crops which, in turn, is contingent on
the continual development of new crop varieties. The crops we grow are
always under threats from diseases, pests, droughts and floods.
Globalization has acted to bring continuous threats of new pests and
diseases into crop-producing areas, which can devastate crops or reduce
yields. Our food security will in part depend upon breeding new crops
that need less water but still produce high yields. To develop these
new crop varieties, breeders and researchers require access to a broad
spectrum of ``genetic raw material'' containing key traits such as
immunity to virulent pests and diseases. Each nation--including the
United States--is dependent on many other nations for access to that
genetic material. Consequently, facilitating international access to
what is termed ``plant genetic resources for is a critical priority for
the United States and the entire international community.
Over time, U.S researchers have found it increasingly difficult to
gain access to plant breeding materials in other countries. Meanwhile,
technological advances significantly improved our ability to identify,
characterize and utilize agricultural genetic resources, thereby
increasing the importance of access to gene pools outside of our
borders. By establishing a stable legal framework for international
germplasm exchanges, this Treaty benefits both research and commercial
interests in the United States. The Treaty also promotes global food
security through the conservation and sustainable use of plant genetic
resources for food and agriculture.
The centerpiece of the Treaty is the establishment of a
``Multilateral System'' for access to, and benefit-sharing regarding,
certain plant genetic resources to be used for research, breeding, and
training for food and agriculture. The scope of the Treaty's coverage
currently encompasses genetic resources of 64 crops and forages that
are maintained by International Agricultural Research Centers or that
are under the management and control of national governments and in the
public domain. Access to covered germplasm is granted through a
Standard Material Transfer Agreement, a contract that defines the terms
of access and benefit-sharing. Furthermore, the Treaty provides a
mechanism for enabling developing countries to acquire the capacities
needed to conserve and sustainably use plant germplasm essential for
food security, including facing the global challenges associated with
climate change.
The Treaty entered into force in 2004 and now has 120 Parties. The
United States signed the Treaty in 2002. The President forwarded it to
the Senate for consideration in July 2008, after negotiations of the
Standard Material Transfer Agreement were completed. Throughout the
Treaty negotiating process, the United States was firmly committed to
creating a system that promotes U.S. and global food security and
protects U.S. access to genetic resources held outside our borders. The
United States also sought to protect the ability of the International
Agricultural Research Centers--the institutions largely responsible for
the ``Green Revolution'' which saved billions of lives--to continue to
genetically improve crops that underpin global food security. The
Treaty enjoys broad stakeholder support, including support for U.S.
ratification from several prominent industry organizations such as the
American Seed Trade Association, the National Farmers Union, the
American Soybean Association, the National Association of Wheat
Growers, the National Corn Growers Association, the Biotechnology
Industry Organization and the Intellectual Property Owners of America.
Mr. Chairman, the Treaty is consistent with existing U.S. practice
and may be implemented under existing U.S. authorities. No statutory
changes are needed. The Agricultural Research Service, in its capacity
as manager of the National Plant Germplasm System, would play a major
role in domestic Treaty implementation. For more than 50 years, the
U.S. National Plant Germplasm System has distributed samples of
germplasm to plant breeders and researchers worldwide and free of
charge, thereby already contributing significantly to the global effort
to safeguard plant germplasm for food security, now and in the future.
Consequently, the United States is already in compliance with key
provisions of the Treaty, and ratification would not entail major
policy or technical changes to current National Plant Germplasm System
operations.
Mr. Chairman, the United States Department of Agriculture has long
been recognized as the world leader in plant germplasm conservation and
distribution. If the U.S. ratified the Treaty, U.S. entities would gain
guaranteed access to plant genetic resources covered by the Treaty. As
I have highlighted before, global access to plant genetic resources is
critical to the efforts of researchers and plant breeders to develop
new crop varieties that are more nutritious, are resistant to pests and
diseases, show improved yields, and are better able to tolerate
environmental stresses. The emergence of new biotechnology-based plant
breeding tools only heightens the importance of open access to plant
genetic resources.
Ratification of the Treaty would not only underscore our continued
leadership but it would also help U.S. farmers and researchers sustain
and improve their crops and promote food security for future
generations, not only in the United States but globally.
Senator Kaufman. Thank you very much.
Ms. Corwin, as has been pointed out, our existing treaties
with Belgium, Germany, and Canada have mandatory arbitration
requirements. How does Treasury decide whether treaties should
include mandatory arbitration?
Ms. Corwin. Thank you, Mr. Kaufman.
We look at arbitration as an appropriate extension of our
current competent authority process to resolve disputes, and we
think it is appropriate to resolve disputes in almost every
treaty. At the moment, we consider arbitration on a case-by-
case basis, looking to what the other treaty country thinks
about the provision, but also the history of disputes and the
difficulty of disputes we have with a particular jurisdiction--
you know, the historic aspects of it.
Senator Kaufman. Are you thinking about making it standard
for all treaties?
Ms. Corwin. It is something, again, we think is appropriate
as a dispute resolution mechanism. At the moment we are not
making it--going to make it part of our model, but we are going
to continue to study it as an effective tool and consider that
for the future.
Senator Kaufman. How do you feel about the idea of
reporting on these arbitration?
Ms. Corwin. I'm sorry?
Senator Kaufman. How do you feel about reporting more on
the arbitration process in these treaties?
Ms. Corwin. We are comfortable continuing to report on the
process and continue to work with this committee on refining
the effectiveness of it as a tool.
Senator Kaufman. And you feel pretty good about the Malta
treaty, that we've overcome the problems we've had in the past
and are ready to terminate the former treaty?
Ms. Corwin. Yes, we are comfortable. Since the treaty was
terminated, a number of significant changes have been made in
Malta. They, mostly importantly, as of 2008, repealed their
bank secrecy rules that were an impediment to information
exchange. Since 1996, they've also acceded to the EU, which has
caused them to implement a number of EU directives--like the
money laundering directive, the savings directive--that have
assured their participation in mutual assistance programs, and
also ensured that they would have to commit to international
transparency standards.
With regard to the treaty-shopping concerns, there are a
number of factors that make a jurisdiction an attractive target
for treaty-shoppers. As my colleague has mentioned, the
internal domestic laws of that jurisdiction are one of those
factors, but other factors include the attractiveness of the
treaty itself that's in existence in terms of the source-
country withholding rates, as well as the limitation on
benefits. In this treaty, we have not--unlike a lot of our
treaties, where we have gone to zero on withholding source-
country withholding with respect to dividends, interest, and
royalties, we have, in this treaty, included positive rates of
withholding, which makes it a less attractive target for
treaty-shoppers. But most importantly, we have included a very
robust ``limitation on benefits'' provision that makes it very
difficult for a third country to use Malta to strip income out
of the United States with a--and notably, a provision that
prevents payments out of a Maltese corporation to a third
country that would, we feel, ``alleve'' our treaty-shopping
concerns.
Senator Kaufman. Great.
Mr. Barthold, can you kind of summarize--you have a number
of concerns about the mandatory arbitration--can you talk a
little bit about that?
Mr. Barthold. Well, our concerns were more just questions
of direction and consistency. The one that I noted was, in two
cases now, we have that arbitration will be available with
respect to any aspect of the treaty. In two of the other
existing treaties, it's a narrower scope. So, our question was
really, ``Why the broader scope in some cases, the narrower
scope in others?'' Going forward, if it is the intent, as might
have been suggested, to use this as an additional tool to
resolve disputes, how broadly should it be applied, or should
it be applied in more narrow circumstances?
We also had some questions about the precise role of the
taxpayer position paper. I guess I would say that it's somewhat
unclear to us what benefit that necessarily brings to the
process, since the two parties would be, hopefully, fully--the
two countries--would hopefully be fully explaining the position
that they took. I guess it is conceivable the taxpayer could
provide some additional information, but one would think that
the taxpayer might have been working in concert with one of the
two contracting states to begin with.
Then there's also the issue related to the arbitration
proceedings and the results as to what sort of precedents they
might provide for future cases of dispute. Across the four
possible arbitration countries, that's left somewhat unclear,
in that, while each of the treaties said there's no
precedential value--at least in the case of the German Treaty,
it's--while there's no precedential value, if you get a similar
dispute, it's hoped that you get a similar outcome. And that's
stated as part of the explanation of how arbitration would
work.
So, I think our questions or our concerns are just a little
bit more of the unknown. How does Treasury think this will be
refined, going into the future.
Senator Kaufman. And do you think there should be some kind
of a standard arbitration provision?
Mr. Barthold. Well, if we think that this is an important
thing to do, an important part of providing for dispute
resolution, I think it would be important to outline that as
part of the model treaty.
Now, of course, in practice, when the Treasury negotiates
with other countries, you never get a result that looks exactly
like the model, because the other country has opposing goals. I
mean, the model lays out what we think is a good, reasonable
approach, and a lot of times we end up there, but I wouldn't
expect that we'd have uniformity across all provisions. But,
the model, in stating what we think would be a good, reasoned
approach, does also help guide us when we go forward in
negotiations. So, I think there would be some benefit to
thinking through what would be a good, reasoned approach.
Senator Kaufman. And you asked--you think we should ask
questions about additional reporting requirements. What would
be the objective of additional reporting requirements, in your
mind?
Mr. Barthold. The reporting requirements? I was just
pointing out that, technically, the requirement of the Senate
from last year only applies to the treaties with Belgium,
Canada, and Germany. So, you'd have to broaden that requirement
to bring in France.
Now, in practice, there really can't be any reporting until
there's arbitration. And I believe it's 10 cases. Right? And,
it's largely the hope, I believe, of the countries that have
negotiated arbitration as part of the treaties, that they may
never get to arbitration; that, in fact, arbitration itself
will be seen as either an embarrassment to the competent
authorities or an additional spur that helps the competent
authorities reach a resolution. And then, we don't actually get
to arbitration, in most cases, until after a 2-year clock has
started.
So, I don't imagine we're anywhere near to getting anybody
into arbitration quite yet, and it'll take a while to build up
10 cases. But, if we were to include reporting on possible
French arbitration cases, given the differences in scope across
the different treaties, given the fact that France will permit
taxpayer participation, a report would be very interesting,
just to see how the incomes matter, how the report of the
taxpayer matters, how the breadth or narrowness of the scope
matters. So, we think it would be a worthwhile thing for the
committee to request in regard to the mandatory arbitration in
the French protocol.
Senator Kaufman. Thanks.
Mr. Scholz, do you expect investment in Rwanda to increase
significantly once we enter into this treaty?
Mr. Scholz. As I mentioned in my testimony, our investment
in Rwanda in 2008 amounted to about $50 million, and the
Embassy has projected that that could go up as much as--up to
$600 million in the next few years.
There is interest on the part of United States investors in
the areas of green housing, education, infrastructure--
particularly energy infrastructure--in Rwanda. So, those are
important areas where we could see some actual growth in U.S.
investment flows.
Senator Kaufman. Again, what businesses do you think would
be going in there--what United States businesses will be
investing in Rwanda, do you think, after the treaty?
Mr. Scholz. Well, again, it would--it--there are firms in
those sectors that we've been told have been interested. I
can't give you specific companies at this point, but I'd be
happy to followup with more specifics.
Senator Kaufman. That'd be great.
[The information provided by Mr. Scholz follows:]
I can provide a few examples of U.S. companies that have made or
are making significant investments in Rwanda. In March of this year,
U.S. firm ContourGlobal announced that it reached agreement with the
Government of Rwanda to invest $325 million in methane gas extraction
and power generation. U.S. firm Eco-Fuel and a British partner recently
announced they will undertake a $300 million renewable energy project
using jatropha to produce biofuel in Rwanda. Sorwathe, a U.S. tea
company that has invested Rwanda since 1978, recently opened a new $2
million tea factory in the country. Also this year, Starbucks Coffee
opened a ``Farmer Support Center'' in Kigali, the first such investment
by the company in Africa. We understand from our Embassy in Kigali that
a number of other U.S. firms are giving Rwanda a serious look as a
potential investment destination.
Of course, the existence of a BIT is one of many factors that
investors may consider in making their investment decisions, but
bringing the BIT into force would further improve the attractiveness of
Rwanda's investment climate.
Senator Kaufman. Thank you very much.
How does a treaty fit into our bilateral relations with
Rwanda on human rights?
Mr. Scholz. We've--Rwanda's made admirable advances over
the last decade in economic development and making significant
progress in adjudicating an enormous backlog of genocide cases.
Despite these advances, Rwanda continues to face significant
challenges regarding reconciliation, human rights,
democratization, as it continues its efforts to rebuild a
society torn asunder by war and genocide. The United States and
the international community continue to work toward the goal of
a stable, growing, democratic Rwanda with improved respect for
human rights. Specifically, the United States works with the
Government of Rwanda to open the political space, increase
civil liberties, and to strengthen the judiciary.
The treaty itself can promote economic development and
employment in Rwanda, as well as improve the rule of law and
transparency. These objectives are complementary to our efforts
to work with the Rwandan Government to improve human rights and
democracy in Rwanda.
We also continue to use other channels to raise our views
on issues of human rights and democratization. These include
our bilateral dialogues and other contacts and the Annual AGOA
Country Review and the Department's Annual Human Rights Report.
Senator Kaufman. Good. This is important, that we keep
talking to them about these human rights. I mean, they've--
civil society abuse, torture, you know, a number of things
going on there. Yes, they've come a long way, but they still
have a way to go.
Mr. Scholz. Yes----
Senator Kaufman. Thank you.
Mr. Scholz [continuing]. Well it's an important objective
for the Department.
Senator Kaufman. It is.
Ms. Jones, Plant Genetic Resources Treaty. Can you give us
some examples of a problem this treaty will help solve?
Dr. Jones. Yes, thank you, Mr. Chairman.
I think that the kind of problems that need to be solved,
from the sense of what's happening around the world regarding
crops being under stress, is the sort of thing that we're
seeing with wheat rust. This is a disease that has emerged--
reemerged recently, a virulent strain that is likely to affect
the U.S. wheat crops. Eighty percent of them are--look like
they are vulnerable to it.
It's the sort of thing where we would need to go outside of
our own genetic resource base to see if we can help ourselves,
as well as the world, to find resistance to this kind of
disease. And with this particular example, we're working with
two of the international agricultural research centers--the one
that deals with wheat and the one that deals with dryland
agriculture--looking at their genetic resources.
And so, having access to these resources is hugely
important, because we need to be able to look broadly for
traits that solve problems, as well as bring forward new
strains and varieties that could be more resistant and more
productive.
Senator Kaufman. Can you tell me a little bit about how
this will help global food security?
Dr. Jones. Certainly.
It helps global food security in that it stimulates
research and it allows important food crops to be researched in
a way that will help them be more productive, and also be able
to grow in areas that are more marginal and more stressed. And
that's likely--and we see it now, that's what's happening in
agriculture around the world. Lands are being affected by a
number of things, including climate change. And so, we will
need crops that have different kinds of resiliencies. And to
find that, we will have to look to genetic databases, genetic
resources around the world.
And so, it's an underpinning to food security, in that it's
a resource that will let us get to the crops that we will
eventually need worldwide.
Senator Kaufman. Good.
I want to thank the witnesses for their testimony and for
their questions.
Because tomorrow's a holiday, I'll leave the record open
until noon on Thursday.
That said, I understand the chairman will take up the
French--France protocol at a business meeting on November the
17th, so it'll be best to submit any questions on the record
for the treaty by close of business today, if possible.
Thank you very much.
[Whereupon, at 9:40 a.m., the hearing was adjourned.]
----------
Additional Questions and Answers Submitted for the Record
Responses of Manal Corwin to Questions Submitted by
Senator John F. Kerry
Question. Michael McIntyre, professor of law at Wayne State
University and Robert S. McIntyre, Director of Citizens for Tax
Justice, have criticized the information exchange provisions in the
France and New Zealand protocols and the Malta treaty as inadequate and
obsolete. They are concerned the provisions would only provide for an
exchange of information on specific request. They assert that the
emerging international standard for effective exchange of information
requires information not only on specific request but also automatic
and spontaneous exchanges. Why do the information exchange provisions
for these treaties not include automatic and spontaneous exchanges?
Answer. The provisions for exchange of information in the proposed
tax treaty with Malta and the proposed protocols with France and New
Zealand comply with the U.S. and international standards for full
exchange of information under income tax treaties. The treaty
provisions permit information exchange on request, on a routine (or
automatic) basis, and on a spontaneous basis. This level of information
exchange is consistent with international standards. The United States
is committed to robust information exchange for tax purposes and has
been a leader in efforts to improve information exchange worldwide. We
continue to work with colleagues in other jurisdictions to improve
mechanisms for information exchange, including with respect to
``routine'' or ``automatic'' exchange.
Question. The United States has automatic exchanges of information
under its tax treaties with Canada and Mexico. France is supporting
automatic exchanges of information with its EU partners. Why should the
treaty with France be different than the treaties with Canada and
Mexico?
Answer. As is the case with the U.S. Model tax treaty and all
modern U.S. tax treaties, the tax treaties with Canada and Mexico
permit, but do not require, the revenue authorities to exchange
information on an automatic basis. The provisions for exchange of
information in the proposed protocol with France similarly permit, but
do not require, the revenue authorities to exchange information on an
automatic basis. In this regard the treaty with France is fully
consistent with U.S. and international standards as they have existed
for a number of years. The Treasury Department is working with other
treaty countries to encourage and improve the mechanisms for effective
exchange of information, including mechanisms for routine or automatic
information exchange.
Question. Problems related to bank secrecy have been highlighted
recently by the UBS case. Do you think the Malta treaty and the France
and New Zealand protocols would improve the exchange of information in
a manner sufficient to prevent another UBS from happening?
Answer. The information exchange articles in the Malta treaty and
the France and New Zealand protocols conform with U.S. and
international standards for information exchange and thus override any
domestic bank secrecy provisions. However, even in countries with which
the United States has an effective comprehensive exchange of
information program that conforms to international standards,
uncooperative foreign banks can in some circumstances conceal overseas
investments by U.S. persons. Thus, in addition to focusing on
information exchange in bilateral negotiations, the Treasury Department
is pursuing a multipronged approach that includes legislative
proposals, multilateral initiatives to improve transparency and
information exchange in tax matters, and IRS enforcement actions. This
multipronged approach is intended to provide the IRS with the
information (from taxpayers, third parties, and other countries) and
the tools needed to tackle offshore tax evasion.
Question. One of the reasons the tax treaty was terminated with
Malta was concerns about the exchange of information. Why do you
believe now that there will be an adequate exchange of information?
Answer. Concerns about inadequate information exchange were among
the factors that led the United States to terminate the prior tax
treaty with Malta. The negotiations focused heavily on addressing this
concern. Since 1997, Malta has made key changes to its domestic law
regarding exchange of tax information. Most importantly, in 2008 Malta
changed its law to permit the exchange of information held by financial
institutions. This change made it possible for Malta to agree to
comprehensive information exchange obligations in the proposed treaty
that meet U.S. and international standards. As a member of the European
Union, Malta is also required to conform to international transparency
norms. Because of these recent developments in Malta, the Treasury
Department believes that Malta will be able to comply with its
information exchange obligations under the proposed treaty.
Question. Is the limitations on benefits article included in the
Malta treaty sufficient to prevent the use of the treaty by persons
that are not residents of the United States or Malta?
Answer. Yes. The features of Malta's tax system were taken into
account in negotiating the limitation on benefits provision of the
proposed treaty. As a result, the limitation on benefits article in the
proposed treaty with Malta is significantly more restrictive than the
limitation on benefits provisions in the 2006 U.S. Model tax treaty or
in any existing U.S. tax treaty. The Treasury Department believes that
this limitation on benefits article is sufficient to prevent abuse of
the treaty by third-country investors. In addition, the proposed treaty
also provides relatively high rates for source-country taxation of
dividends, royalties, and interest which make Malta unattractive as a
treaty shopping jurisdiction.
______
Responses of Manal Corwin to Questions Submitted by Senator Richard G.
Lugar Relating to the Tax Convention With Malta
treaty shopping
Question. November 16, 1995, the United States delivered a notice
of termination to Malta stating that the income tax treaty between the
two countries would cease to have effect as of January 1, 1997. The
termination of the treaty was due, at least in significant part, to
Treasury's concern with changes in prior Maltese law that might have
inappropriately facilitated the use of the treaty by persons who were
not residents of Malta or the United States.
In light of the prior treaty history, what considerations
were taken by Treasury to determine that it was appropriate to
enter into a new income tax treaty with Malta?
Answer. The United States terminated the prior tax treaty with
Malta because of concerns about the potential for treaty shopping and
because of Malta's inability to adequately exchange information with
the United States. Since 1997, significant changes in Malta's domestic
law relating to exchange of information have been enacted and Malta has
agreed to provisions in the proposed treaty that protect against treaty
shopping concerns. Most importantly, in 2008 Malta changed its law to
permit the exchange of information held by financial institutions. This
change made it possible for Malta to agree to include comprehensive
information exchange obligations in the proposed treaty that meet U.S.
and international standards. In addition, Malta acceded to the European
Union in 2004. As a member of the European Union, Malta is required to
conform to international transparency norms. Finally, Malta agreed to
antitreaty shopping rules in the proposed treaty designed to ensure
that treaty benefits would be restricted to bona fide residents of the
United States and Malta. The limitation on benefits article in the
proposed treaty is more restrictive than the limitation on benefits
article found in the 2006 U.S. Model tax treaty or in any existing U.S.
tax treaty. Moreover, the proposed treaty also provides relatively high
rates for source country taxation of dividends, royalties, and
interest. Taken together, these recent developments in Malta's domestic
law and the strong protections in the proposed limitation on benefits
article have lead Treasury to conclude that it is appropriate to enter
into the proposed treaty with Malta.
Question. Do the provisions of the proposed treaty, taken together,
alleviate all concerns that led the Treasury Department to terminate
the prior treaty?
Answer. Yes. The provisions of the proposed tax treaty differ from
the terms of the prior tax treaty with Malta in two key aspects. First,
the proposed tax treaty provides for a full exchange of information
that meets U.S. and international standards. This includes the
obligation to obtain and provide information held by banks. Second, the
proposed tax treaty contains a comprehensive limitation on benefits
provision that would restrict treaty benefits to residents of the
United States and Malta. The proposed treaty also provides relatively
high rates for source country taxation of dividends, royalties, and
interest.
Question. According to the Joint Committee on Taxation Explanation
on this proposed treaty, Maltese law still includes a number of
characteristics that are conducive to some of the concerns that led to
the termination of the previous treaty with Malta. For example, payment
of dividends and interest to foreign persons are not subject to
withholding tax in Malta. In addition, tax treatments of foreign
subsidiaries in Malta might contribute to tax treaty benefits being
extended to non-United States and Malta residents.
Considering these concerns, is the limitation-on-benefits
article sufficient to prevent the use of the proposed treaty by
persons that are not residents of the United States or Malta?
Answer. Yes. There are several factors that make a jurisdiction an
attractive location for treaty shopping. A favorable domestic tax
regime is only one of those factors. Other essential factors, however,
include favorable treaty rates on source country taxation and an
ability to access those rates by qualifying for treaty benefits. The
rates for source-country taxation of dividends, interest, and royalties
in the proposed treaty with Malta are higher than most U.S. income tax
treaties. In addition, the limitation on benefits provision in the
proposed treaty is significantly more restrictive than the limitation
on benefits provisions in the 2006 U.S. Model tax treaty, or in any
existing U.S. tax treaty making it very difficult for a non-resident
investing in the United States through Malta to qualify for the
benefits of the treaty. This limitation on benefits article is
sufficient to prevent abuse of the treaty by persons that are not
residents of the United States or Malta.
Question. Since the limitation-on-benefits article is a deviation
from the U.S. Model tax treaty, will legitimate persons be able to
qualify for benefits under the proposed treaty?
Answer. Yes. The objective tests in the proposed limitation on
benefits article are designed to allow residents of the United States
and Malta to enjoy the benefits of the tax treaty. In addition, as is
the case with all U.S. tax treaties containing modern limitation on
benefits provisions, legitimate investors who nevertheless fail to
satisfy any of the objective criteria may be granted treaty benefits at
the discretion of the revenue authorities of the relevant jurisdiction.
WITHHOLDING RATES
Question. Under the proposed treaty, the withholding rates are a
deviation from the U.S. Model tax treaty and may discourage non-United
States and Malta residents from receiving benefits. When does the
Treasury Department believe that is appropriate to deviate from the
withholding tax rates provided in the U.S. Model treaty?
Answer. The withholding rate reductions in income tax treaties are
negotiated on a case-by-case basis, taking into account several
factors, including the bilateral economic relationship with the
proposed treaty partner, the cross-border flows of income between the
two countries and the particular features of the tax system of the
proposed treaty partner. As a result, the withholding rate limitations
agreed to in a particular treaty will sometimes differ from the
withholding rate reductions provided in the U.S. Model tax treaty.
TRIANGULAR ARRANGEMENTS
Question. The proposed treaty includes special antiabuse rules
intended to deny treaty benefits in certain circumstances in which a
Malta-resident company earns U.S.-source income attributable to a
third-country permanent establishment and is subject to little or no
tax in the third jurisdiction and Malta.
What criteria will the Treasury Department consider in
determining when antiabuse rules applicable to triangular
arrangements will be included in future treaty negotiations?
Answer. Under prior policy, the Treasury Department sought to
include a limitation on benefits provision to address so-called
``triangular arrangements'' only when the treaty partner used an
exemption system to eliminate double taxation. However, in recent years
the Treasury Department has chosen to seek the inclusion of such a rule
in all new income tax treaties. A rule addressing triangular
arrangements will likely be included in the next revision of the U.S.
Model tax treaty.
______
Response of Manal Corwin to Question Submitted by Senator Richard G.
Lugar Relating to the Protocol Amending the Tax Convention With New
Zealand
Question. Why does the tax protocol with New Zealand not include an
arbitration provision such as has been included in recent tax treaties
with Canada, Germany, and Belgium along with the recently negotiated
protocol to the tax treaty with France?
Answer. The Treasury Department believes that mandatory binding
arbitration can be an effective tool to facilitate the resolution of
disputes between the revenue authorities of the two countries party to
a tax treaty. The Treasury intends to raise the inclusion of an
arbitration provision with our treaty partners on a case-by-case basis.
While we discussed with New Zealand the possibility of including an
arbitration provision, we ultimately decided not to do so, because we
have not had any difficulties or disputes with the New Zealand tax
authorities in the application of the existing tax treaty.
______
Responses of Manal Corwin to Questions Submitted by Senator Richard G.
Lugar Regarding the Protocol Amending the United States-France Tax
Treaty
ARBITRATION
Question. The France Protocol is the fourth tax treaty Treasury has
concluded that contains binding arbitration procedures for resolving
disputes between the competent authorities regarding the application of
the Convention. What criteria will the Treasury Department use to
determine whether a future treaty should include mandatory binding
arbitration?
Answer. The Treasury Department believes that mandatory binding
arbitration, as an extension of the competent authority negotiation
process, is an effective tool to strengthen the Mutual Agreement
Procedure and to achieve prompt and efficient settlement of disputes
between two tax authorities. The Treasury Department has been
discussing mandatory binding arbitration in general terms with our
treaty partners, and intends to continue to raise inclusion of a
mandatory binding arbitration provision with our treaty partners in
future negotiations. In considering a mandatory binding arbitration
provision with our treaty partners, the volume of cases, the nature of
the relationship between the two competent authorities, and the treaty
partner's views with respect to such a provision are important factors.
Mandatory binding arbitration remains a relatively new mechanism for
resolving disputes under our tax treaties, and going forward we will
study the effectiveness of the arbitration provisions we have concluded
so far. The Treasury Department welcomes input from the committee
concerning the factors that should be taken into account when
considering whether to include an arbitration provision in the context
of the negotiation of a particular agreement.
Question. The arbitration provision in the France Protocol permits
the arbitration of any case under any article of the treaty, unless the
competent authorities agree that the case is not suitable for
arbitration. Under the Canada and Germany treaties, similar arbitration
procedures apply only to disputes arising under specified articles of
the treaty. What factors did Treasury consider in deciding to adopt a
broader scope for arbitration of disputes under the France Protocol
than under the Canada and Germany treaties?
Answer. The Treasury Department believes that mandatory binding
arbitration can be beneficial in resolving all disputes that might
arise under an income tax convention. France agreed with the United
States in this regard. However, the scope of an arbitration provision
in a particular agreement is a matter that must be negotiated with the
treaty partner. As a first step, some countries may only be willing to
cover specific articles of a treaty. We believe it is important to make
that first step with appropriate treaty partners. Also, it should be
noted that while the mandatory binding arbitration provision in the
agreements with Canada and Germany are limited to certain articles,
other issues are eligible for arbitration if the competent authorities
agree that the particular case is suitable for arbitration.
Question. Describe Treasury's experience to date with the
arbitration provisions in the tax treaties with Belgium, Canada, and
Germany? Has the possibility of arbitration facilitated negotiated
resolution of disputes under these treaties? Does Treasury envision
significant numbers of cases being submitted to arbitration under these
treaties in the next 2 years?
Answer. With respect to the arbitration provision in the agreement
with Germany, on December 8, 2008, the U.S. and German competent
authorities entered into a memorandum of understanding and agreed on
arbitration guidelines concerning a number of procedural matters to
ensure the effective implementation of the arbitration provision.
Similarly, with respect to the Belgian arbitration provision, on May 6,
2009, the U.S. and Belgian competent authorities entered into a
memorandum of understandingand agreed on arbitration guidelines. In
compliance with the arbitration reporting requirements described in the
report of the Senate Foreign Relations Committee on the 2007 United
States-Canada protocol, the Treasury Department transmitted these
documents to the Committees on Finance and Foreign Relations of the
Senate and the Joint Committee on Taxation on November 9, 2009.
With respect to the arbitration provision in the agreement with
Canada, the U.S. competent authority began discussions with Canada
earlier this year to provide guidance on procedural aspects of the
arbitration provision.
The agreements with Belgium, Canada, and Germany have only been in
force for a short period of time. (The Germany and Belgium agreements
entered into force in December 2007, and the agreement with Canada
entered into force in December 2008.) No cases have yet been submitted
to arbitration under the agreements with Germany, Belgium, or Canada.
However, we believe that the prospect of impending mandatory binding
arbitration creates an incentive for the competent authorities to reach
agreement on a case before the arbitration process commences.
Consequently, we expect MAP negotiations to continue to resolve the
great majority of cases and do not anticipate a significant number of
cases to require resolution through arbitration. The Treasury
Department will monitor the performance of the provisions in the
agreements with Belgium, Canada, and Germany, as well as the
performance of the provision with France, if ratified.
Question. Describe the opportunities for taxpayer participation
under the arbitration provisions of the French Tax Protocol. What
issues will taxpayers have the opportunity to address in submissions to
the arbitration panel? Will taxpayers have the opportunity to address
the proposed resolutions submitted by the competent authorities?
Answer. The Treasury Department contemplates that if the proposed
protocol with France is approved, the U.S. competent authority will
work closely with the French competent authority to provide procedural
guidance on the application of the United States-French arbitration
provision, just as the U.S. competent authority has recently done with
the German and Belgian competent authorities and is doing with the
Canadian competent authority. The Treasury Department expects that such
guidance will include guidance on the provision permitting affected
persons to submit a position paper to the arbitration panel. Under the
Memorandum of Understanding with France, the taxpayer is permitted to
submit a position paper within 90 days of the appointment of the chair
of the arbitration panel. The Memorandum of Understanding does not
limit the issues that the taxpayer may address in its position paper,
nor does it prevent the taxpayer from addressing the proposed
resolutions submitted by the competent authorities. If the proposed
protocol is approved, the Treasury Department will monitor the
operation of the arbitration provision, including the rule allowing
affected persons to submit a position paper. The Treasury Department is
committed, in future discussions with our treaty partners concerning
the inclusion of an arbitration provision, to striking the appropriate
balance between allowing taxpayer input while maintaining the
efficiency and effectiveness of the competent authority process, and
the Treasury Department welcomes further input on this provision from
the committee.
automatic information exchange and john doe summonses
Question. Given language barriers and translation difficulties,
potentially vast amounts of information, and different tax reporting
periods, are there any practical impediments to automatic information
exchange with France?
Answer. The question identifies some of the impediments the IRS
faces in any automatic exchange process. A major practical impendent to
utilization of information received through automatic exchange is the
lack of a U.S. tax identification number (TIN) associated with the
information received.
Question. If the protocol to the French Tax Treaty goes into force,
what mechanisms are in place to facilitate the removal of any
impediments that have been identified in the previous question?
Answer. The IRS and Treasury are addressing the practical
impediments for effective automatic exchange of information, including
the lack of a TIN, by working with specific treaty partners, including
France, and also through OECD committees whose goal is to adopt tax
identification numbers as a tool and collect foreign tax identification
numbers when possible so that such identification numbers can be
included in automatic exchange.
Question. Does the Treasury Department expect any practical
impediments from existing Federal or State law or rules in fulfilling
obligations under the French Tax Protocol?
Answer. The United States fully complies with its exchange-of-
information obligations under its tax treaties.
Question. Under the French Tax Protocol, will France be required to
exchange information in response to specific requests that are
comparable to John Doe summonses under U.S. domestic law?
Answer. The protocol authorizes the competent authorities to
exchange information as may be relevant for carrying out the provisions
of the Convention or to the administration or enforcement of the
domestic laws concerning taxes imposed by the Contracting States,
insofar as the taxation under those domestic laws is not contrary to
the Convention. A specific request under the French tax treaty must
generally identify the taxpayer (or taxpayers) whose income tax
liability is in question and explain how the requested information may
be relevant for carrying out the provisions of the treaty or the tax
laws of the requesting state. A request may be possible in the case of
an unnamed taxpayer or taxpayers if the taxpayer or group can be
indentified through other means, such as by a specified account number
that the taxpayer is known to have used or some other identifying
characteristics.
______
Responses of Wesley Scholz to Questions Submitted by Senator Richard G.
Lugar Regarding the United States-Rwanda Bilateral Investment Treaty
Question. In its 2008 decision in Medellin v. Texas, 128 S.Ct. 1346
(2008), the Supreme Court concluded that the United States lacked the
authority in U.S. law to give effect to a judgment of the International
Court of Justice relating to U.S. obligations under the Vienna
Convention on Consular Relations. The Foreign Relations Committee has
previously stressed its view that it is important that the United
States comply with its treaty obligations, and has observed that the
committee generally does not recommend that the Senate give advice and
consent to treaties unless it is satisfied that the United States has
sufficient domestic legal authority to implement them. With these
considerations in mind, please indicate what authorities Federal and
State governments will rely on to implement the various obligations the
United States would assume upon becoming party to this treaty.
Answer. The United States is able to implement the proposed United
States-Rwanda Bilateral Investment Treaty (BIT) sufficiently under
existing legal authority and thus no further legal authority is
necessary to implement the treaty. The Convention on the Recognition
and Enforcement of Foreign Arbitral Awards, as codified in the Federal
Arbitration Act, 9 U.S.C. Sec. 201, and the Convention on the
Settlement of Investment Disputes Between States and Nationals of Other
States, as implemented domestically, 22 U.S.C. Sec. 1650a, would apply,
as relevant, in the context of enforcement of investor-State
arbitration awards rendered pursuant to the proposed BIT.
Question. Article 37 of the treaty provides for certain disputes
between the parties to the treaty concerning its interpretation or
application to be submitted to binding arbitration. What authorities
would the administration intend to rely upon to implement any state-to-
state arbitral decisions awarded against the United States pursuant to
this article?
Answer. State-to-State arbitrations are extremely rare. In fact, no
State-to-State arbitrations have taken place to date under U.S.
bilateral investment treaties. Nevertheless, there are various tools at
our disposal for implementing a State-to-State award should the
situation arise.
Articles 3 through 10 of the BIT and other provisions that qualify
or create exceptions to these Articles, such as Article 15, are self-
executing but do not confer a private right of action. All remaining
articles of the BIT are non-self-executing. As a result, should an
arbitral decision conclude that U.S. State law is inconsistent with the
BIT, the U.S. Government could, if necessary, choose to initiate a
legal action against the State to ensure compliance with a self-
executing provision of the BIT. To the extent an arbitral decision
determines that Federal law is inconsistent with the BIT and an award
addresses a self-executing provision of the BIT, then as long as the
statute in question predated the entry into force of the treaty, the
later-in-time self-executing BIT provision would prevail over the
earlier inconsistent statute.
To the extent an award addresses Article 11 of the BIT, which is a
non-self-executing provision of the BIT establishing investment
protections and subject to State-to-State arbitration, the U.S.
Government could seek legislation where no other existing authority
permitted it to comply with the award or take other appropriate steps,
such as seeking to interpret the statute in a manner that is consistent
with the arbitral decision. Under current U.S. law, however, existing
Federal authorities, for example, the Administrative Procedures Act, 5
U.S.C. Sec. 551 et. seq., along with comparable state-level
authorities, adequately ensure compliance with the transparency
standards established in Article 11 of the BIT.
Finally, were a State-to-State tribunal to award money damages
against the United States, funds to satisfy such an award could be
sought from appropriated funds, if any, or from the Judgment Fund (31
U.S.C. Sec. 1304) to the extent appropriate.
In brief, should a dispute between the Parties lead to arbitration
pursuant to the mechanism provided for in Article 37, there are a
number of options available for implementing State-to-State arbitral
decisions.
Question. What is the value of existing investments in the United
States by Rwandan investors? What are the most significant sectors in
which such investments occur?
Answer. According to the Department of Commerce's Bureau of
Economic Analysis, there is no direct investment in the United States
from Rwanda as a foreign parent.
Question. By how much does the administration expect Rwandan
investment in the United States to increase if the treaty enters into
force?
Answer. It is difficult to say with precision what impact a U.S.
bilateral investment treaty (BIT) may have on investment flows given
the wide range of factors that investors consider when making
investment decisions. There is presently no foreign direct investment
in the United States from Rwanda as a foreign parent, according to the
Department of Commerce's Bureau of Economic Analysis. According to
UNCTAD, Rwanda's outward foreign direct investment flows worldwide were
$14 million in 2008.
Question. What is the value of existing investments in Rwanda by
U.S. investors? What are the most significant sectors in which such
investments occur?
Answer. According to the Department of Commerce's Bureau of
Economic Analysis, U.S. direct investment in Rwanda on a historical
cost basis was $1 million in 2008, concentrated in the wholesale trade
sector. A number of new U.S. investments in Rwanda were undertaken or
announced in 2009. For example, in March 2009, U.S. firm ContourGlobal
announced that it reached agreement with the government of Rwanda to
invest $325 million in methane gas extraction and power generation.
U.S. firm Eco-Fuel and a British partner recently announced they will
undertake a $300 million renewable energy project growing jatropha to
produce biofuel in Rwanda. Sorwathe, a U.S. tea company that has
invested in Rwanda since 1978, recently opened a new $2 million tea
factory in the country. Also this year, Starbucks Coffee opened a
``Farmer Support Center'' in Kigali, the first such investment by the
company in Africa. We understand from our Embassy in Kigali that a
number of other U.S. firms are considering Rwanda as a potential
investment destination.
Question. By how much does the administration expect U.S.
investment in Rwanda to increase if the treaty enters into force?
Answer. U.S. bilateral investment treaties (BITs) play an important
role by establishing rules that protect the rights of U.S. investors
and providing market access for future U.S. investment. They also
promote transparency and the rule of law. In doing so, we believe the
BIT will assist Rwanda's efforts to improve its investment climate and
attract more foreign investment. It is difficult to say with precision
what effect a U.S. BIT may have on investment levels given the wide
range of factors that investors consider when making investment
decisions.
Question. As you mentioned in your recent testimony before the
committee, Bilateral Investment Treaties have been negotiated ``with
the objective of protecting U.S. investment abroad, encouraging the
adoption of open, transparent, and nondiscriminatory investment
policies, and supporting the development of international legal
standards consistent with these objectives.'' How will the Department
of State ensure that these and other objectives continue to be met and
developed in Rwanda?
Answer. Once in force, the treaty will provide a strong framework
of protections that support the objectives identified in my testimony.
In the event of an investment dispute, the treaty provides an investor-
State arbitration procedure that allows investors to bring claims
against the host government for alleged breaches of the treaty. The
treaty also contains a State-State dispute settlement mechanism.
The Department and other executive branch agencies will also
continue to use other channels to promote these objectives. These
efforts include our bilateral contacts with the Rwandan Government
generally, the United States-Rwanda Trade and Investment Council, led
by the Office of the U.S. Trade Representative, and the Overseas
Private Investment Corporation's programs in Rwanda (which are
authorized under a separate bilateral Investment Incentive Agreement
between the two governments).
Question. If this proposed treaty comes into force, what affect
does the Department of State estimate it will have on the region and
Rwanda's neighbors?
Answer. As the treaty embodies high standards of investor
protection, market access, and transparency, we believe it will set a
very positive example in the region. This is particularly the case as
countries in the region compete with one another to attract foreign
direct investment that supports economic growth and jobs.
Question. Besides the recently announced negotiations with
Mauritius, is the administration considering announcing the
commencement of other BIT negotiations before the review of the current
U.S. model BIT treaty is concluded?
Answer. Although we continue to work to identify candidates for
U.S. bilateral investment treaty (BIT) negotiations, we have no current
plans to announce any new BIT negotiations. The administration is
working to finalize the review of the model BIT as expeditiously as
possible.
______
Responses of Assistant Secretary Kerri-Ann Jones to Questions Submitted
by Senator Richard G. Lugar Regarding the Treaty on Plant Genetic
Resources for Food and Agriculture
Question. In its 2008 decision in Medellin v. Texas, 128 S.Ct. 1346
(2008), the Supreme Court concluded that the United States lacked the
authority in U.S. law to give effect to a judgment of the International
Court of Justice relating to U.S. obligations under the Vienna
Convention on Consular Relations. The Foreign Relations Committee has
previously stressed its view that it is important that the United
States comply with its treaty obligations, and has observed that the
committee generally does not recommend that the Senate give advice and
consent to treaties unless it is satisfied that the United States has
sufficient domestic legal authority to implement them. With these
considerations in mind, please indicate what authorities Federal and
State governments will rely on to implement the various obligations the
United States would assume upon becoming party to this treaty.
Answer. The United States currently has all necessary authority to
implement the Treaty. Please see pp. 2-8 of Treaty Transmittal package
for a description of such authorities. As described in that package,
the Treaty's core obligations are to be implemented primarily using
USDA and USAID authorities, such as the authority to operate the
National Germplasm System found in 7 U.S.C. Sec. 5841.
Question. Article 3 of the Treaty specifies that the Treaty relates
to plant genetic resources ``for food and agriculture.'' Are there
specific other uses for plant genetic resources that this scope was
intended to exclude? Would the Treaty's provisions apply to energy-
related uses of plant genetic resources?
Answer. Access to plant genetic resources via the Multilateral
System is to be ``provided solely for the purpose of utilization and
conservation for research, breeding, and training for food and
agriculture, provided that such purpose does not include chemical,
pharmaceutical and/or other nonfood/feed industrial uses.'' See Article
12.3(a). Energy-related uses of plant genetic resources are understood
to be a nonfood/feed industrial use, and the Multilateral System would
not provide for access to the plant genetic resource for research,
breeding and training for such an industrial use.
Question. Article 9 of the Treaty addresses ``Farmers Rights.''
Please indicate whether the administration interprets
Article 9 of the Treaty to require States Parties to afford
particular rights to farmers under their domestic laws.
Please indicate what steps the administration intends to
take to implement Article 9, and what authorities it would rely
upon.
Answer. No; the Treaty does not require States Parties to afford
any particular rights to farmers under domestic laws. Instead it
specifically envisions that each Party would define its own particular
measures in this regard. The United States already recognizes the
importance of consultation and recognition as contemplated by this
article, including in a variety of national and state laws,
regulations, and orders, including contract laws, unfair competition
laws, intellectual property laws, and Executive Order 13175 (November
6, 2000) ``Consultation and Coordination with Indian Tribal
Governments.'' Further, USDA has long conveyed extensive non-monetary
benefits to farmers through land grant universities and extension
services authorized under, inter alia, 7 U.S.C. Sec. Sec. 301 et. seq.,
322 et. seq. and 341 et seq. USDA also provides services specifically
to indigenous communities through, inter alia, Title V of P.L. 103-382
(Oct. 20, 1994); Title XVI, Sec. 1677, P.L. 101-64 (1990 Farm Bill); 7
U.S.C. Sec. 3241 and 20 U.S.C. Sec. 1059d.
Question. Please indicate whether the administration intends that
Article 9, or any other provision in the Treaty, would confer private
rights enforceable in U.S. courts if the United States became a party
to the Treaty.
Answer. Neither Article 9 nor any other provision of the Treaty
would confer directly enforceable rights in U.S. courts.
Question. The transmittal package for the Treaty indicates that the
United States interprets Article 12 of the Treaty as not diminishing
the availability or exercise of intellectual property rights under
national laws.
Is the administration aware of any instances in which
parties to the Treaty have expressed contrary interpretations
of Article 12?
Is the administration aware of any practice under the Treaty
that confirms or contradicts the interpretation of the United
States on this issue?
Answer. We are not aware of any instances in which Parties have
expressed contrary interpretations of Article 12 nor are we aware of
any practices under the Treaty that contradict our interpretation of
Article 12. Consistent with the United States interpretation of Article
12, a number of Parties have submitted declarations that plant genetic
resources for food and agriculture or their genetic parts or components
which have undergone innovation may be subject to intellectual property
rights, provided that the criteria relating to such rights are met.
Question. Article 11.2 of the Treaty provides that the Multilateral
System established under the Treaty ``shall include all plant genetic
resources for food and agriculture listed in Annex I that are under the
management and control of the Contracting Parties and in the public
domain.'' Please indicate to what extent, if any, this Article would
require the United States to make available plant genetic resources not
currently made available under the U.S. National Plant Germplasm
System.
Answer. There is no requirement to make any genetic resources
available beyond those already made available by the National Plant
Germplasm System.
Question. Article 13.2(a) of the Treaty provides for parties to the
Treaty to make available specified information about plant genetic
resources included in the Multilateral System established under the
Treaty. Please indicate whether these provisions would obligate the
United States to make publicly available information about plant
genetic resources that it does not currently make available in
connection with the operation of the U.S. National Plant Germplasm
System.
Answer. There are no requirements to make any information available
beyond that already freely distributed by the U.S. Department of
Agriculture and the National Plant Germplasm System. The Treaty
language exempts confidential information. The requirement to make
information available is also subject to national law, such as legal
privileges and the Trade Secrets Act 18 U.S.C. Sec. 1905.
Question. Please indicate what steps the administration intends to
take to implement the provisions of Article 13.2(b) of the Treaty
addressing access to and transfer of technology.
Answer. The U.S. Department of Agriculture's existing programs and
practices are consistent with Article 13.2(b) of the Treaty. The
National Plant Germplasm System and the Germplasm Resources Information
Network will continue to provide germplasm and related information
freely. Joint bilateral research projects between USDA and its
counterparts in Party countries will continue, as long as they continue
to address priorities of the United States and its counterparts, and if
funds continue to be available.
Question. Under Article 13.2(d) of the Treaty, the standard
Material Transfer Agreement (MTA) includes a requirement that a
recipient who commercializes a product that includes material accessed
under the Treaty must, under certain circumstances, pay to a Trust
Account established under the Treaty ``an equitable share of the
benefits arising from the commercialization of that product.''
According to the transmittal package for the Convention, the MTA
adopted by Treaty Governing Body ``includes a payment level of 1.1
percent of gross sales of a product incorporating material from the
Multilateral System minus a standard deduction of 30 percent.''
a. What factors went into the Governing Body's decision to
set the required payment at this level?
b. How does this required payment compare to the terms under
which U.S. entities accessed plant genetic resources from
foreign sources prior to the entry into force of the Treaty?
c. How much revenue has been generated for the Trust Account
to date from payments made pursuant to this provision of the
MTA? How much revenue does the administration expect such
payments to generate over the life of the Treaty?
Answer.
a. The payment level defined in the Treaty's standard material
transfer agreement (SMTA) was determined through a multilateral
negotiation process in which the United States participated. Article
13.2(d)(iii) of the Treaty requires the Governing Body to ``determine
the level, form, and manner of the payment, in line with commercial
practice.'' The payment level is considered by the U.S. seed industry
to be reasonable and consistent with existing commercial practice with
respect to current industry royalty rates. Joining the Convention would
give the United States a veto over any attempt to raise the payment
level established, which currently works out to be 0.77 percent of
gross sales.
b. Some materials under the control of Treaty Parties have not been
available to U.S. entities under any terms. The Treaty will guarantee
access to such materials that might not otherwise be available. Under
the terms of the SMTA, payment is not required for access. Payment is
required when a product is commercialized, but only if that product is
not freely available for further research and breeding. The SMTA grants
recipients the right to commercialize products under a fixed royalty
rate that the United States and other governments have prenegotiated.
U.S. entities may decide whether this rate is reasonable for a
particular product prior to accessing materials in the Multilateral
System. Moreover, U.S. ratification of the Treaty will not affect
whether U.S. entities accessing material from the Multilateral System
must pay such a rate, because foreign seed banks are already requiring
acceptance of the SMTA terms as a condition of access to such material.
In other words, the royalty payment would arise under private contracts
that are already in widespread use, and would not depend on whether the
United States has joined the Treaty.
c. To date, there have been no payments to the Trust Account. The
Treaty entered into force in June 2004. Scientific research and plant
breeding require years to accomplish their goals, and only a small
percentage of such efforts yields any commercial products. Thus, there
will likely be a lengthy ``lag time'' between the date of initial
access to plant genetic resources for food and agriculture from the
Multilateral System and the date of commercialization of any products
resulting from that research and development. Consequently, no revenue
has been generated to date for the Trust Account from payments made
pursuant to this provision of the MTA. We are uncertain how much
revenue such payments will generate, but forecast them to be in line
with what might be expected, based on current commercial practice, from
payments generated by licensing of unimproved genetic resources from
public-sector sources to U.S. private-sector companies. The Treaty
anticipates generating other revenues through voluntary contributions
to the Trust from both public and private sectors.
Question. Article 13.2(d)(ii) of the Treaty provides that the
Treaty's Governing Body ``may, from time to time, review the levels of
payment [provided for in the MTA] with a view to achieving a fair and
equitable sharing of benefits.''
a. Under what circumstances would the administration support
a decision by the Governing Body to change the payment level
referred to in Article 13.2(d)(ii)?
b. Does the administration intend to consult with the
Congress before supporting a decision by the Governing Body to
change the payment level referred to in Article 13.2(d)(ii)?
Answer.
a. If U.S. stakeholders supported a change in the payment level
referred to in Article 13.2(d)(ii), the United States would support a
change. To date, all indications are that the payment level is
consistent with existing commercial practice.
b. The U.S. would consult as appropriate with all interested
stakeholders, including Congress, on this matter.
Question. Please provide the amount of the annual budget for the
most recent year approved by the Treaty's Governing Body, and for the
immediate two previous years.
Answer. The approved operating budgets for 2008, 2009, 2010, and
2011 are $1,844,426; $2,826,885; $2,244,366; and $2,821,566
respectively.
Question. Article 13.3 of the Treaty provides that ``benefits
arising from the use of plant genetic resources for food and
agriculture that are shared under the multilateral system should flow
primarily, directly and indirectly, to farmers in all countries,
especially in developing countries, and countries with economies in
transition, who conserve and sustainably utilize plant genetic
resources for food and agriculture.'' Does the administration expect
that U.S. farmers will share in the benefits referred to in Article
13.3 of the Treaty? If so, how will such benefits be allocated and
distributed to U.S. farmers?
Answer. It is expected that plant genetic resources made available
under the Treaty's Multilateral System will be incorporated into U.S.
public and private-sector research and breeding programs. We do not
anticipate a need for an allocation or distribution scheme as the
benefits in question are general in nature. For example, U.S. farmers
will benefit by having access to improved varieties, developed by those
breeding programs, that are resistant to emerging diseases, to
environmental stresses such as drought, or which have increased product
value and/or nutritional content.
Question. To what purposes does the administration expect revenues
accruing to the Trust Account referred to in paragraph 19.3(f) of the
Treaty will be put? Given that decisions on the use of such funds
require consensus of the Treaty's Parties, and thus could not be
approved over U.S. objections, what considerations will guide the
administration's policy on the appropriate uses of such funds?
Answer. Revenues will be used primarily for capacity-building
activities that support the goals of conservation and sustainable use
of plant genetic resources that are critical for international food
security. The distribution of the funds in the Trust Account will be
subject to a funding strategy, which is reviewed and approved by the
Governing Body (i.e., by consensus of the Parties to the Treaty). The
administration's policy on the appropriate uses of the funds will
include consideration of consistency with the Treaty's objectives, as
well as efficiency, effectiveness, and accountability in the use of
funds.
Question. Article 18.4(d) of the Treaty provides that states
parties to the Treaty ``agree [] to undertake, and provide financial
resources for national activities for the conservation and sustainable
use of plant genetic resources for food and agriculture in accordance
with its national capabilities and financial resources. The financial
resources provided shall not be used to ends inconsistent with this
Treaty, in particular in areas related to international trade in
commodities.''
a. Does the administration interpret this Article to require
the United States to provide specific amounts of funding
available for the programs described?
b. What steps does the administration plan to take to
implement this Article?
c. What restrictions on existing U.S. programs would be
imposed by the Treaty's requirement that financial resources
``not be used to ends inconsistent with this Treaty, in
particular in areas related to international trade in
commodities?''
d. Would the Treaty's requirement that financial resources
``not be used to ends inconsistent with this Treaty, in
particular in areas related to international trade in
commodities'' apply to funding for programs implemented by
state or local governments in the United States? Are any such
state and local programs currently implemented in a manner
consistent with this requirement?
Answer.
a. No, Article 18.4(d) does not obligate Parties to contribute
specific amounts of financial resources for national activities for the
conservation and sustainable use of plant genetic resources. Further,
there are no assessed contributions from Parties to the Treaty.
b. Existing U.S. practice is consistent with Article 18.4(d).
c. Existing U.S. practice is consistent with Article 18.4(d).
d. No, 18.4(d) would not apply to funding for programs implemented
by state or local governments. Furthermore, the few state and local
programs devoted to conservation and sustainable use of plant genetic
resources, such as local crop genebanks, are currently implemented in a
manner consistent with the Treaty.
Question. Article 18.4(f) of the Treaty envisions that activities
undertaken pursuant to the Treaty will be funded, in part, by voluntary
contributions from States Parties to the Treaty. Please indicate
whether the administration would intend to provide any voluntary
contributions toward the Treaty's budget if the United States became
Party to the Treaty. Please indicate the amount of any such envisioned
contributions.
Answer. There are no plans to make voluntary financial
contributions toward the Treaty's budget at this time.
Question. Under Article 22 of the Treaty, Parties have the option
of accepting compulsory dispute settlement in the form of arbitration
or submission of disputes to the International Court of Justice. Please
indicate whether the executive branch recommends that the United States
submit to binding dispute resolution under either or both of these
mechanisms.
Answer. No; the administration does not make such a recommendation.
Question. Article 23 of the Treaty establishes rules applicable to
amending the Treaty and its annexes. What process does the executive
branch intend to follow with respect to considering any such
amendments? Does the executive branch intend to submit any such
amendments to the Senate for advice and consent?
Answer. While we would anticipate that ordinarily any amendment to
the main body of the Treaty would warrant the advice and consent of the
Senate, our expectation is that amendments to Annex I, which lists
crops and forages covered by the Multilateral System, would be
procedural and technical in nature and would not, in the normal course,
require the advice and consent of the Senate. If, however, a proposed
amendment to Annex I were to go beyond the current mandate of the Annex
and raise more substantive issues, the executive branch would consult
with the committee in a timely manner regarding the question of whether
advice and consent is warranted. In the case of Annex II, as noted in
an earlier question, the executive branch does not recommend that the
United States submit to binding dispute resolution under Article 22 of
the Treaty and thus it is anticipated that amendments to Part I of
Annex II would, even if accepted, have no legal effect on the United
States. An amendment to Part II of Annex II, which deals with
conciliation, could have an effect on the United States and the
executive branch would consult with the committee on whether such an
amendment would warrant the advice and consent of the Senate.