[Senate Executive Report 113-10]
[From the U.S. Government Publishing Office]


113th Congress                                              Exec. Rept.
                                 SENATE
 2d Session                                                      113-10

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



 
                       PROTOCOL AMENDING THE TAX 
                         CONVENTION WITH SPAIN

                                _______
                                

                  July 17, 2014.--Ordered to be printed

                                _______
                                

         Mr. Menendez, from the Committee on Foreign Relations,
                        submitted the following

                              R E P O R T

                    [To accompany Treaty Doc. 113-4]

    The Committee on Foreign Relations, to which was referred 
the Protocol Amending the Convention between the United States 
of America and the Kingdom of Spain for the Avoidance of Double 
Taxation and the Prevention of Fiscal Evasion with Respect to 
Taxes on Income and its Protocol, signed at Madrid on February 
22, 1990, and a related Memorandum of Understanding signed on 
January 14, 2013, at Madrid, together with correcting notes 
dated July 23, 2013, and January 31, 2014 (together the 
``Protocol'') (Treaty Doc. 113-4), 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.................................................3
  V. Implementing Legislation.........................................3
 VI. Committee Action.................................................3
VII. Committee Comments...............................................4
VIII.Text of Resolution of Advice and Consent to Ratification.........5

 IX. Annex 1.--Technical Explanation..................................8
  X. Annex 2.--Transcript of Hearing of June 19, 2014................67

                               I. Purpose

    The purpose of the Protocol, along with the underlying 
treaty, is to promote and facilitate trade and investment 
between the United States and Spain. The proposed Protocol 
provides an exemption from source-country withholding on 
certain direct dividend payments and limits source-country 
taxation on all other dividends and branch profits, consistent 
with the U.S. Model Tax Treaty. The proposed protocol also 
exempts from source-country withholding cross-border payments 
of interest, royalties, and capital gains in a manner 
consistent with the U.S. Model. The Protocol 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 
Protocol generally follows the 2006 U.S. Model Income Tax 
Treaty (the ``U.S. Model''), it deviates from the U.S. Model in 
certain respects discussed below.

                             II. Background

    The United States has a tax treaty with Spain that is 
currently in force, which was concluded in 1990 (Convention 
between the United States of America and the Kingdom of Spain 
for the Avoidance of Double Taxation and the Prevention of 
Fiscal Evasion with Respect to Taxes on Income and its 
Protocol, signed at Madrid on February 22, 1990). The proposed 
Protocol was negotiated to bring U.S.-Spain tax treaty 
relations into closer conformity with each country's current 
tax treaty policies. For example, the proposed Protocol 
contains updated provisions designed to address ``treaty-
shopping.'' The proposed Protocol also includes updated 
exchange of information articles and a mandatory binding 
arbitration provision to resolve disputes between the revenue 
authorities of the United States and Spain.

                         III. Major Provisions

    A detailed article-by-article analysis of the Protocol may 
be found in the Technical Explanation Published by the 
Department of the Treasury on June 19, 2014, which is included 
at Annex 1 to this report. In addition, the staff of the Joint 
Committee on Taxation prepared an analysis of the Protocol, 
JCX-67-14 (June 17, 2014), which was of great assistance to the 
committee in reviewing the Protocol. A summary of the key 
provisions of the Protocol is set forth below.

                         LIMITATION ON BENEFITS

    Consistent with current U.S. tax treaty policy, the 
proposed Protocol includes a ``Limitation on Benefits'' (LOB) 
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 of benefits provision states that a corporation or 
similar entity resident in a contracting state (i.e., the 
United States or Spain) is not entitled to the benefits of the 
treaty unless that entity meets certain tests, such as carrying 
on an active trade or business, or being a publicly-traded 
company on certain specified stock exchanges. The provision is 
designed to identify entities that have established residency 
for tax-abuse purposes.
    The Protocol's limitation of 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 
differs in a few respects that may permit some companies to 
qualify for treaty benefits under tests not found in the Model. 
For instance, the proposed Protocol contains a derivative 
benefits test under which a company could qualify for treaty 
benefits if at least 95 percent of the aggregate voting power 
and value of its shares (and at least 50 percent of any 
disproportionate class of shares) are held by seven or fewer 
``equivalent beneficiaries.'' The proposed Protocol also 
contains a headquarters company test, under which a resident 
company would qualify if it meets the criteria to be considered 
a headquarters company of a multinational group. The proposed 
Protocol would also restrict the discretionary grant of tax 
treaty benefits that allows companies that do not pass one of 
the LOB tests but demonstrate that they have no treaty shopping 
purpose to claim treaty benefits.

                        EXCHANGE OF INFORMATION

    The proposed Protocol provides authority for the two 
countries to exchange tax information that is foreseeably 
relevant to carrying out the provisions of the existing 
Convention. The proposed Protocol allows the United States is 
allowed to obtain information (including from financial 
institutions) from Spain regardless of whether Spain needs the 
information for its own tax purposes.

                         MANDATORY ARBITRATION

    The Protocol incorporates mandatory, binding arbitration 
for certain cases where the competent authorities of the United 
States and Spain have been unable to resolve after within two 
years under the mutual agreement procedure. A mandatory and 
binding arbitration procedure is not included in the U.S. Model 
treaty, but has recently been included in the U.S. income tax 
treaties with Belgium, Canada, Germany, France, and 
Switzerland.

                      MEMORANDUM OF UNDERSTANDING

    The Memorandum of Understanding commits the United States 
and Spain to initiate discussions within six months after the 
proposed Protocol enters into force to extend the benefits of 
the Protocol to investments between Puerto Rico and Spain.

                          IV. Entry Into Force

    Article XV states that the proposed Protocol shall enter 
into force three months after the United States and Spain have 
notified each other that they have completed all required 
internal procedures for entry into force. The Memorandum of 
Understanding enters into force on the same date as the 
proposed Protocol.

                      V. Implementing Legislation

    As is the case generally with income tax treaties, the 
Protocol 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 
June 19, 2014. Testimony was received from Robert Stack, Deputy 
Assistant Secretary (International Tax Affairs) at the U.S. 
Department of the Treasury; Thomas Barthold, Chief of Staff of 
the Joint Committee on Taxation; Mary Jean Riley, Vice 
President of North American Stainless; and Catherine Schultz, 
Vice President for Tax Policy of the National Foreign Trade 
Council. A transcript of the hearing is included in Annex 2.
    On July 16, 2014, the committee considered the Protocol 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 
Protocol will stimulate increased trade and investment, reduce 
treaty shopping incentives, and promote closer co-operation 
between the United States and Spain. The committee therefore 
urges the Senate to act promptly to give advice and consent to 
ratification of the Protocol, as set forth in this report and 
the accompanying resolution of advice and consent.

                       A. LIMITATION ON BENEFITS

    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 Protocol, 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 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. INFORMATION EXCHANGE

    The Protocol would replace the existing Convention's tax 
information exchange provisions with updated rules that are 
consistent with current U.S. tax treaty practice. The provision 
would allow the tax authorities of each country to exchange 
information relevant to carrying out the provisions of the 
Convention or the domestic tax laws of either country. It would 
also enable the United States to obtain information (including 
from financial institutions) from Spain whether or not Spain 
needs the information for its own tax purposes.
    After careful examination of this Protocol, as well as 
witness testimony and responses to questions for the record, 
the committee believes that the exchange of information 
provisions will substantially aid in the full and fair 
enforcement of United States tax laws. According to witness 
testimony, the ``foreseeably relevant'' standard used in the 
Protocol does not represent a lower threshold than the standard 
found in earlier U.S. tax treaties. Witnesses also testified 
that the ``foreseeably relevant'' standard has been extensively 
defined in internationally agreed guidance to which no country 
has expressed a dissenting opinion to date. The committee is 
also of the view that the Protocol provides adequate provisions 
to ensure that any information exchanged pursuant to the 
Convention is treated confidentially. In sum, the committee 
believes these provisions on information exchange are important 
to the administration of U.S. tax laws and the Protocol 
provides adequate protection against the misuse of information 
exchanged pursuant to the Convention.

     C. 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 
Protocol Amending the Convention between the United States of 
America and the Kingdom of Spain for the Avoidance of Double 
Taxation and the Prevention of Fiscal Evasion With Respect to 
Taxes on Income and its Protocol, signed at Madrid on February 
22, 1990, and a related Memorandum of Understanding signed on 
January 14, 2013, at Madrid, together with correcting notes 
dated July 23, 2013, and January 31, 2014 (the ``Protocol'') 
(Treaty Doc. 113-4), subject to the declaration of section 2 
and the conditions of section 3.

SECTION 2. DECLARATION

    The advice and consent of the Senate under section 1 is 
subject to the following declaration:
          The Protocol is self-executing.

SECTION 3. CONDITIONS

    The advice and consent of the Senate under section 1 is 
subject to the following conditions:
          (1) Not later than 2 years after the Protocol enters 
        into force and prior to the first arbitration conducted 
        pursuant to the binding arbitration mechanism provided 
        for in the Protocol, the Secretary of the Treasury 
        shall transmit to the Committees on Finance and Foreign 
        Relations of the Senate and the Joint Committee on 
        Taxation the text of the rules of procedure applicable 
        to arbitration panels, including conflict of interest 
        rules to be applied to members of the arbitration 
        panel.
          (2)(A) Not later than 60 days after a determination 
        has been reached by an arbitration panel in the tenth 
        arbitration proceeding conducted pursuant to the 
        Protocol or any of the treaties described in 
        subparagraph (B), the Secretary of the Treasury shall 
        prepare and submit to the Joint Committee on Taxation 
        and the Committee on Finance of the Senate, subject to 
        laws relating to taxpayer confidentiality, a detailed 
        report regarding the operation and application of the 
        arbitration mechanism contained in the Protocol and 
        such treaties. The report shall include the following 
        information:
                  (i) For the Protocol and each such treaty, 
                the aggregate number of cases pending on the 
                respective dates of entry into force of the 
                Protocol and each treaty, including the 
                following information:
                          (I) The number of such cases by 
                        treaty article or articles at issue.
                          (II) The number of such cases that 
                        have been resolved by the competent 
                        authorities through a mutual agreement 
                        as of the date of the report.
                          (III) The number of such cases for 
                        which arbitration proceedings have 
                        commenced as of the date of the report.
                  (ii) A list of every case presented to the 
                competent authorities after the entry into 
                force of the Protocol and each such treaty, 
                including the following information regarding 
                each case:
                          (I) The commencement date of the case 
                        for purposes of determining when 
                        arbitration is available.
                          (II) Whether the adjustment 
                        triggering the case, if any, was made 
                        by the United States or the relevant 
                        treaty partner.
                          (III) Which treaty the case relates 
                        to.
                          (IV) The treaty article or articles 
                        at issue in the case.
                          (V) The date the case was resolved by 
                        the competent authorities through a 
                        mutual agreement, if so resolved.
                          (VI) The date on which an arbitration 
                        proceeding commenced, if an arbitration 
                        proceeding commenced.
                          (VII) The date on which a 
                        determination was reached by the 
                        arbitration panel, if a determination 
                        was reached, and an indication as to 
                        whether the panel found in favor of the 
                        United States or the relevant treaty 
                        partner.
                  (iii) With respect to each dispute submitted 
                to arbitration and for which a determination 
                was reached by the arbitration panel pursuant 
                to the Protocol or any such treaty, the 
                following information:
                          (I) In the case of a dispute 
                        submitted under the Protocol, an 
                        indication as to whether the presenter 
                        of the case to the competent authority 
                        of a Contracting State submitted a 
                        Position Paper for consideration by the 
                        arbitration panel.
                          (II) An indication as to whether the 
                        determination of the arbitration panel 
                        was accepted by each concerned person.
                          (III) The amount of income, expense, 
                        or taxation at issue in the case as 
                        determined by reference to the filings 
                        that were sufficient to set the 
                        commencement date of the case for 
                        purposes of determining when 
                        arbitration is available.
                          (IV) The proposed resolutions 
                        (income, expense, or taxation) 
                        submitted by each competent authority 
                        to the arbitration panel.
          (B) The treaties referred to in subparagraph (A) 
        are--
                  (i) the 2006 Protocol Amending the Convention 
                between the United States of America and the 
                Federal Republic of Germany for the Avoidance 
                of Double Taxation and the Prevention of Fiscal 
                Evasion with Respect to Taxes on Income and 
                Capital and to Certain Other Taxes, done at 
                Berlin June 1, 2006 (Treaty Doc. 109-20) (the 
                ``2006 German Protocol'');
                  (ii) the Convention between the Government of 
                the United States of America and the Government 
                of the Kingdom of Belgium for the Avoidance of 
                Double Taxation and the Prevention of Fiscal 
                Evasion with Respect to Taxes on Income, and 
                accompanying protocol, done at Brussels July 9, 
                1970 (the ``Belgium Convention'') (Treaty Doc. 
                110-3);
                  (iii) the Protocol Amending the Convention 
                between the United States of America and Canada 
                with Respect to Taxes on Income and on Capital, 
                signed at Washington September 26, 1980 (the 
                ``2007 Canada Protocol'') (Treaty Doc. 110-15); 
                or
                  (iv) the Protocol Amending the Convention 
                between the Government of the United States of 
                America and the Government of the French 
                Republic for the Avoidance of Double Taxation 
                and the Prevention of Fiscal Evasion with 
                Respect to Taxes on Income and Capital, signed 
                at Paris August 31, 1994 (the ``2009 France 
                Protocol'') (Treaty Doc. 111-4).
          (3) The Secretary of the Treasury shall prepare and 
        submit the detailed report required under paragraph (2) 
        on March 1 of the year following the year in which the 
        first report is submitted to the Joint Committee on 
        Taxation and the Committee on Finance of the Senate, 
        and on an annual basis thereafter for a period of five 
        years. In each such report, disputes that were 
        resolved, either by a mutual agreement between the 
        relevant competent authorities or by a determination of 
        an arbitration panel, and noted as such in prior 
        reports may be omitted.
          (4) The reporting requirements referred to in 
        paragraphs (2) and (3) supersede the reporting 
        requirements contained in paragraphs (2) and (3) of 
        section 3 of the resolution of advice and consent to 
        ratification of the 2009 France Protocol, approved by 
        the Senate on December 3, 2009.
                  IX. Annex 1.--Technical Explanation


DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE PROTOCOL SIGNED 
 AT WASHINGTON ON JANUARY 14, 2013 AMENDING THE CONVENTION BETWEEN THE 
UNITED STATES OF AMERICA AND THE KINGDOM OF SPAIN FOR THE AVOIDANCE OF 
 DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO 
 TAXES ON INCOME AND ITS PROTOCOL, WHICH FORMS AN INTEGRAL PART OF THE 
           CONVENTION, SIGNED AT MADRID ON FEBRUARY 22, 1990

    This is a Technical Explanation of the Protocol signed at 
Washington on January 14, 2013, the related Memorandum of 
Understanding signed the same day, and a subsequent Exchange of 
Notes dated July 23, 2013 (hereinafter the ``Protocol'', 
``Memorandum of Understanding'' and ``Exchange of Notes'' 
respectively), amending the Convention between the United 
States of America and the Kingdom of Spain for the avoidance of 
double taxation and the prevention of fiscal evasion with 
respect to taxes on income, signed at Madrid on February 22, 
1990 (hereinafter the ``existing Convention'') and the 
Protocol, which forms an integral part of the existing 
Convention, signed at Washington on November 6, 2003 
(hereinafter the ``Protocol of 1990'').
    Negotiations took into account the U.S. Department of the 
Treasury's current tax treaty policy and the Treasury 
Department's Model Income Tax Convention, published on November 
15, 2006 (the ``U.S. Model''). 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.
    This Technical Explanation is an official guide to the 
Protocol, Memorandum of Understanding and Exchange of Notes. It 
explains policies behind particular provisions, as well as 
understandings reached during the negotiations with respect to 
the interpretation and application of the Protocol, Memorandum 
of Understanding and the Exchange of Notes.
    References to the existing Convention are intended to put 
various provisions of the Protocol into context. The Technical 
Explanation does not, however, provide a complete comparison 
between the provisions of the existing Convention and the 
amendments made by the Protocol, Memorandum of Understanding 
and Exchange of Notes. The Technical Explanation is not 
intended to provide a complete guide to the existing Convention 
as amended by the Protocol, Memorandum of Understanding and 
Exchange of Notes. To the extent that the existing Convention 
and Protocol of 1990 have not been amended by the Protocol, 
Memorandum of Understanding and Exchange of Notes, the 
technical explanation of the existing Convention and the 
Protocol of 1990 remains the official explanation. References 
in this Technical Explanation to ``he'' or ``his'' should be 
read to mean ``he or she'' or ``his or her.'' References to the 
``Code'' are to the Internal Revenue Code of 1986, as amended. 
References to a ``Treas. Reg.'' are to regulations issued by 
the Treasury Department.

                               ARTICLE I

    Article I of the Protocol revises Article 1 (General Scope) 
of the existing Convention by deleting references to Article 20 
of the existing Convention, by adding new paragraphs 5 and 6.

New Paragraph 5 of Article 1

    New paragraph 5 relates to non-discrimination obligations 
of the Contracting States under the GATS. The provisions of 
paragraph 5 are an exception to the rule provided in paragraph 
2 of Article 1 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 5(a) provides that, unless the competent 
authorities determine that a taxation measure is not within the 
scope of the Convention, the national treatment obligations of 
the GATS shall not apply with respect to that measure. Further, 
any question arising as to the interpretation or application 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 25 (Non-
Discrimination) of the Convention.
    The term ``measure'' for these purposes is defined broadly 
in subparagraph 5(b). It would include a law, regulation, rule, 
procedure, decision, administrative action or any other similar 
provision or action.

New Paragraph 6 of Article 1

    New paragraph 6 addresses special issues presented by the 
payment of items of income, profit or gain to entities that are 
either wholly or partly fiscally transparent, such as 
partnerships, estates and trusts. Because countries may take 
different views as to when an entity is wholly or partly 
fiscally transparent, the risk of both double taxation and 
double non-taxation is relatively high. The provision, and the 
corresponding requirements of the substantive rules of the 
other Articles of the Convention, should be read with two goals 
in mind. The intention of paragraph 6 is to eliminate a number 
of technical problems that could prevent investors using such 
entities from claiming treaty benefits, even though such 
investors would be subject to tax on the income derived through 
such entities. Paragraph 1 of the Memorandum of Understanding 
sets forth the understanding of the Contracting States that 
paragraph 6 applies to identify the person that derives an item 
of income, profit or gain paid to a fiscally transparent entity 
for purposes of applying the Convention to that first mention 
person. The provision also prevents a resident of a Contracting 
State from claiming treaty benefits in circumstances where the 
resident investing in the entity does not take into account the 
item of income paid to the entity because the entity is not 
fiscally transparent in its State of residence.
    In general, the principles incorporated in this paragraph 
reflect the regulations under Treas. Reg. 1.894-1(d). Treas. 
Reg. 1.894-1(d)(3)(iii) provides that an entity will be 
fiscally transparent under the laws of an interest holder's 
jurisdiction with respect to an item of income to the extent 
that the laws of that jurisdiction require the interest holder 
resident in that jurisdiction to separately take into account 
on a current basis the interest holder's respective share of 
the item of income paid to the entity, whether or not 
distributed to the interest holder, and the character and 
source of the item in the hands of the interest holder are 
determined as if such item were realized directly by the 
interest holder. Entities falling under this description in the 
United States include partnerships, corporations that have made 
a valid election to be taxed under Subchapter S of Chapter 1 of 
the Code (``S corporations''), common investment trusts under 
section 584, simple trusts and grantor trusts. This paragraph 
also applies to payments made to other entities, such as U.S. 
limited liability companies (``LLCs''), that may be treated as 
either partnerships or as disregarded entities for U.S. tax 
purposes.
    New paragraph 6 provides that, for purposes of applying the 
Convention, an item of income, profit or gain derived through 
an entity that is fiscally transparent under the laws of either 
Contracting State, and that is formed or organized in either 
Contracting State, or in a state that has an agreement in force 
containing a provision for the exchange of information on tax 
matters with the Contracting State from which the income, 
profit or gain is derived, shall be considered to be derived by 
a resident of a Contracting State to the extent that the item 
is treated for purposes of the taxation law of such Contracting 
State as the income, profit or gain of a resident. For example, 
if a company that is a resident of Spain pays interest to an 
entity that is formed or organized either in the United States 
or in a country with which Spain has an agreement in force 
containing a provision for the exchange of information on tax 
matters, and that entity is treated as fiscally transparent for 
U.S. tax purposes, the interest will be considered derived by a 
resident of the United States, but only to the extent that the 
taxation laws of the United States treat 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. Where the entity is 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 under the Convention 
for the interest paid to the partnership, because such third-
country partners are not residents of the United States for 
purposes of claiming this benefit. If, however, the country in 
which the third-country partners are treated as residents for 
tax purposes, as determined under the laws of that country, has 
an income tax convention with the other Contracting State, they 
may be entitled to claim a benefit under that convention (these 
results would also follow in the case of an entity that is 
disregarded as an entity separate from its owner 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 the other 
Contracting State). In contrast, where the 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 
Spain to the U.S. corporation 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 would be reached even if the tax laws of 
Spain would treat the entity differently (e.g., if the entity 
were not treated as fiscally transparent in Spain in the first 
example above where the entity is treated as a partnership for 
U.S. tax purposes). Similarly, the characterization of the 
entity by a third country is also irrelevant, even if the 
entity is organized in that third country, although in such 
cases, subparagraph 6(b) requires that an agreement containing 
a provision for the exchange of information be in force between 
the source State and the third country.
    These principles also apply to trusts to the extent that 
they are wholly or partly fiscally transparent in either 
Contracting State. For example, suppose that X, a resident of 
Spain, creates a revocable trust in the United States and names 
persons resident in a third country as the beneficiaries of the 
trust. If, under the laws of Spain, X is treated as taking the 
trust's income into account for tax purposes, the trust's 
income would be regarded as being derived by a resident of 
Spain. In contrast, since the determination of deriving an item 
of income, profit or gain is made on an item by item basis, it 
is possible that, in the case of a U.S. non-grantor trust, the 
trust itself may be able to claim benefits with respect to 
certain items of income, such as capital gains, so long as it 
is a resident liable to tax on such gains, but not with respect 
to other items of income that are treated as income of the 
trust's interest holders.
    As noted above, 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 Spain 
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 Spain views the LLC as 
fiscally transparent.
    Paragraph 1 of the Memorandum of Understanding sets forth 
the understanding of the Contracting States regarding the 
relationship of paragraph 6 with the other provisions of the 
Convention. In order to obtain the benefits of the Convention 
with respect to an item of income, the person who according to 
paragraph 6 derives an item of income must satisfy all 
applicable requirements specified in the Convention, including 
other applicable requirements of Article 1, the requirements of 
Article 4 (Residence), Article 17 (Limitation on Benefits) and 
the concepts of beneficial ownership found in Articles 10 
(Dividends), 11 (Interest) and 12 (Royalties).

                               ARTICLE II

    Article II of the Protocol amends Article 3 (General 
Definitions) of the existing Convention.

Paragraph 1

    Paragraph 1 adds a new subparagraph (j) to paragraph 1 of 
Article 3. Subparagraph 1(j) defines the term ``pension fund''. 
Clause 1(j)(i) provides that in the case of Spain, the term 
means any scheme, fund, mutual benefit institution or other 
entity established in Spain that satisfies two criteria. First, 
as provided in clause 1(j)(i)(A), the person must be operated 
principally to manage the right of its beneficiaries to receive 
income or capital upon retirement, survivorship, widowhood, 
orphanhood, or disability. Second, contributions to the pension 
fund must be deductible from the taxable base of personal 
taxes.
    Subparagraph 3(a) of the Memorandum of Understanding as 
corrected by the Exchange of Notes sets forth a non-exhaustive 
descriptive list of those U.S. entities that will be regarded 
as pension funds for purposes of the Convention. The list 
includes: a trust providing pension or retirement benefits 
under an Internal Revenue Code section 401(a) qualified pension 
plan (which includes a Code section 401(k) plan), a profit 
sharing or stock bonus plan, a 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, 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)). A group trust described in Revenue Ruling 81-100, as 
amended by Revenue Ruling 2004-67 and Revenue Ruling 2011-1, 
shall qualify as a pension fund only if it earns income 
principally for the benefit of one or more pension funds that 
are themselves entitled to benefits under the Convention as 
residents of the United States.
    Subparagraph 3(b) of the Memorandum of Understanding sets 
forth a non-exhaustive descriptive list of those Spanish 
entities that will be regarded as pension funds for purposes of 
the Convention. The list includes: 1) any fund regulated under 
the Amended Test of the Law on pension funds and pension 
schemes (Texto Refundido de la Ley sobre Fondos y Planes de 
Pensiones), passed by Legislative Royal Decree 1/2002 of 
November 29; 2) any entity defined under Article 64 of the 
Amended Text of the Law on the regulation and monitoring of 
private insurances (Texto Refundido de la Ley de Ordenacion y 
Supervision de los Seguros Privados) passed by Legislative 
Royal Decree 6/2004 of October 29, provided that in the case of 
mutual funds all participants are employees; promoters and 
sponsoring partners are the companies, institutions or 
individual entrepreneurs to which the employees are engaged; 
and benefits are exclusively derived from the social welfare 
agreement between both parties, as well as any other comparable 
entity regulated within the scope of the political subdivisions 
(Comunidades Autonomas); and 3) insurance companies regulated 
under the Amended Text of the Law on the regulation and 
monitoring of private insurances passed by Legislative Royal 
Decree 6/2004 of October 29 whose activity is the coverage of 
the contingencies provided for in the Amended Text of the Law 
on pension funds and pension schemes.
    Clause 1(j)(ii) of new subparagraph 1(j) of Article 3 
provides that in the case of the United States, the term 
``pension fund'' means any person established in the United 
States that is generally exempt from income taxation in the 
United States, and is operated principally either to administer 
or provide pension or retirement benefits, or to earn income 
principally for the benefit of one or more persons established 
in the same Contracting State that are generally exempt from 
income taxation in that Contracting State and are operated 
principally to administer or provide pension or retirement 
benefits.
    The definition, as it applies in the case of the United 
States, recognizes that pension funds sometimes administer or 
provide benefits other than pension or retirement benefits, 
such as death benefits. However, in order for the fund to be 
considered a pension fund for purposes of the Convention, the 
provision of any other such benefits must be merely incidental 
to the fund's principal activity of administering or providing 
pension or retirement benefits. The definition also ensures 
that if a fund is a collective fund that earns income for the 
benefit of other funds, then substantially all of the funds 
that participate in the collective fund must be residents of 
the same Contracting State as the collective fund and must be 
entitled to benefits under the Convention in their own right.

Paragraph 2

    Paragraph 2 replaces paragraph 2 of Article 3 of the 
existing Convention. Terms that are not defined in the existing 
Convention are dealt with in paragraph 2.
    New paragraph 2 of Article 3 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 
domestic law of the Contracting State applying the Convention, 
unless the context requires otherwise, and subject to the 
provisions of Article 26 (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.
    The reference in paragraph 2 to the domestic 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 inclusion in 
both paragraphs 1 and 2 of an exception to the generally 
applicable definitions where the ``context otherwise requires'' 
is intended to address this circumstance. Where reflecting the 
intent of the Contracting States requires the use of a 
definition that is different from a definition under paragraph 
1 or the law of the Contracting State applying the Convention, 
that definition will apply. Thus, flexibility in defining terms 
is necessary and permitted.

                              ARTICLE III

    Article III of the Protocol replaces paragraph 3 of Article 
5 (Permanent Establishment) of the existing Convention. 
Paragraph 3 of Article 5 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 (f) of 
paragraph 2 of Article 5. Thus, a drilling rig does not 
constitute a permanent establishment if a well is drilled in 
less than twelve months. However, the well becomes a permanent 
establishment as of the date that production begins.
    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 twelve months. For purposes of applying the 
twelve-month rule, time is measured from the first day the sub-
contractor is on the site until the last day. Thus, if a sub-
contractor is on a site intermittently, 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.

                               ARTICLE IV

    Article IV of the Protocol replaces Article 10 (Dividends) 
of the existing Convention. New 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 
limitations on (including, in some cases, a prohibition from) 
taxation by the source State. New 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 of New Article 10

    Paragraph 1 of new Article 10 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 23 
(Other Income) of the Convention grants the residence country 
exclusive taxing jurisdiction (other than for dividends 
attributable to a permanent establishment in the other State).

Paragraph 2 of New Article 10

    The State of source also may tax dividends beneficially 
owned by a resident of the other State, subject to the 
limitations of paragraphs 2, 3 and 4. Paragraph 2 of new 
Article 10 generally limits the rate of withholding tax in the 
State of source on dividends paid by a company resident in that 
State to 15 percent of the gross amount of the dividend. If, 
however, the beneficial owner of the dividend is a company 
resident in the other State and owns directly shares 
representing at least 10 percent of the voting power of the 
company paying the dividend, then the rate of withholding tax 
in the State of source is limited to 5 percent of the gross 
amount of the dividend. For application of this paragraph by 
the United States, shares are considered voting stock if they 
provide the power to elect, appoint or replace any person 
vested with the powers ordinarily exercised by the board of 
directors of a U.S. corporation.
    The determination of whether the ownership threshold for 
subparagraph 2(a) is met for purposes of the 5 percent maximum 
rate of withholding tax is made on the date on which 
entitlement to the dividend is determined. Thus, in the case of 
a dividend from a U.S. company, the determination of whether 
the ownership threshold is met generally would be made on the 
dividend record date.
    Paragraph 2 does not affect the taxation of the profits out 
of which the dividends are paid. The taxation by a Contracting 
State of the income of its resident companies is governed by 
the domestic law of the Contracting State, subject to the 
provisions of paragraph 4 of Article 25 (Non-Discrimination).
    The term ``beneficial owner'' is not defined in the 
Convention, and is, therefore, generally defined under the 
domestic law of the country imposing tax (i.e., the source 
country). The beneficial owner of the dividend for purposes of 
Article 10 is the person to which the 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 supported by paragraphs 12-12.2 of the 
Commentary to Article 10 of the OECD Model.
    Special rules apply to shares held through fiscally 
transparent entities both for purposes of determining whether 
the ownership threshold has been met and for purposes of 
determining the beneficial owner of the dividend.
    A company that is a resident of a Contracting State shall 
be considered to own directly the voting stock owned by an 
entity that is considered fiscally transparent under the laws 
of that State and that is not a resident of the other 
Contracting State of which the company paying the dividends is 
a resident, in proportion to the company's ownership interest 
in that entity. This is consistent with the rules of paragraph 
6 of Article 1 (General Scope) as revised by Article I, which 
provides that residence State principles shall be used to 
determine who derives the dividends, to ensure 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.
    For example, assume that FCo, a company that is a resident 
of the Spain, owns a 50 percent interest in FP, a partnership 
that is organized in Spain. FP owns 100 percent of the sole 
class of stock of USCo, a company resident in the United 
States. Spain views FP as fiscally transparent under its 
domestic law, and taxes FCo currently on its distributive share 
of the income of FP and determines the character and source of 
the income received through FP in the hands of FCo as if such 
income were realized directly by FCo. In this case, FCo is 
treated as deriving 50 percent of the dividends paid by USCo 
under paragraph 6 of Article 1. Moreover, FCo is treated as 
owning 50 percent of the stock of USCo directly. The same 
result would be reached even if the tax laws of the United 
States would treat FP differently (e.g., if FP were not treated 
as fiscally transparent in the United States), or if FP were 
organized in a third state, provided that that state has an 
agreement in force containing a provision for the exchange of 
information on tax matters with Spain, which in this example is 
the Contracting State from which the dividend arises, and as 
long as FP were still treated as fiscally transparent under the 
laws of the United States.
    While residence State principles control who is treated as 
owning voting stock of the company paying dividends through a 
fiscally transparent entity and, consequently, who derives the 
dividends, source State principles of beneficial ownership 
apply to determine whether the person who derives the 
dividends, or another resident of the other Contracting State, 
is the beneficial owner of the dividends. If the person who 
derives the dividends under paragraph 6 of Article 1 would not 
be treated as a nominee, agent, custodian, conduit, etc. under 
the source State's principles for determining beneficial 
ownership, that person will be treated as the beneficial owner 
of the dividends for purposes of the Convention. In the example 
above, FCo is required to satisfy the beneficial ownership 
principles of the United States with respect to the dividends 
it derives. If under the beneficial ownership principles of the 
United States, FCo is found not to be the beneficial owner of 
the dividends, FCo will not be entitled to the benefits of 
Article 10 with respect to such dividends. If FCo is found to 
be a nominee, agent, custodian, or conduit for a person who is 
a resident of the other Contracting State, that person may be 
entitled to benefits with respect to the dividends.

Paragraph 3 of New Article 10

    Paragraph 3 of new Article 10 provides exclusive residence-
country taxation (i.e., an elimination of withholding tax) with 
respect to certain dividends distributed by a company that is a 
resident of one Contracting State to a resident of the other 
Contracting State. As described further below, this elimination 
of withholding tax is available with respect to certain inter-
company dividends and with respect to certain pension funds.
    Subparagraph 3(a) provides for the elimination of 
withholding tax on dividends beneficially owned by a company 
that has owned, directly or indirectly through one or more 
residents of either Contracting State, 80 percent or more of 
the voting power of the company paying the dividend for the 
twelve-month period ending on the date entitlement to the 
dividend is determined. The determination of whether the 
beneficial owner of the dividends owns at least 80 percent of 
the voting power of the company is made by taking into account 
stock owned both directly and indirectly through one or more 
residents of either Contracting State.
    Eligibility for the elimination of withholding tax provided 
by subparagraph 3(a) is subject to additional restrictions 
based on, and supplementing, the rules of Article 17 
(Limitation on Benefits) as that Article has been modified by 
Article IX. Accordingly, a company that meets the holding 
requirements described above will qualify for the benefits of 
paragraph 3 only if it also: (1) meets the ``publicly traded'' 
test of subparagraph 2(c) of Article 17, (2) meets the 
``ownership-base erosion'' and ``active trade or business'' 
tests described in subparagraph 2(e) and paragraph 4 of Article 
17, (3) meets the ``derivative benefits'' test of paragraph 3 
of Article 17, or (4) is granted the benefits of paragraph 3 of 
Article 10 at the discretion of the competent authority of the 
source State pursuant to paragraph 7 of Article 17.
    For example, assume that ThirdCo is a company resident in a 
third country that does not have a tax treaty with the United 
States providing for the elimination of withholding tax on 
inter-company dividends. ThirdCo owns directly 100 percent of 
the issued and outstanding voting stock of USCo, a U.S. 
company, and of SCo, a Spanish company. SCo is a substantial 
company that manufactures widgets. USCo distributes those 
widgets in the United States. If ThirdCo contributes to SCo all 
the stock of USCo, dividends paid by USCo to SCo would qualify 
for treaty benefits under the active trade or business test of 
paragraph 4 of Article 30. However, allowing ThirdCo to qualify 
for the elimination of withholding tax, which is not available 
to it under the third state's treaty with the United States (if 
any), would encourage treaty shopping.
    In order to prevent this type of treaty shopping, paragraph 
3 requires SCo to meet the ownership-base erosion requirements 
of subparagraph 2(e) of Article 17 as revised by Article IX in 
addition to the active trade or business test of paragraph 4 of 
Article 17. Because SCo is wholly owned by a third country 
resident, SCo could not qualify for the elimination of 
withholding tax on dividends from USCo under the combined 
ownership-base erosion and active trade or business tests of 
subparagraph 3(b). Consequently, SCo would need to qualify 
under another test in paragraph 3 or obtain discretionary 
relief from the competent authority under Article 17 paragraph 
7. For purpose of subparagraph 3(b), it is not sufficient for a 
company to qualify for treaty benefits generally under the 
active trade or business test or the ownership-base erosion 
test unless it qualifies for treaty benefits under both.
    Alternatively, companies that are publicly traded or 
subsidiaries of publicly-traded companies will generally 
qualify for the elimination of withholding tax. Thus, a company 
that is a resident of Spain and that meets the requirements of 
subparagraph 2(c) of Article 17 will be entitled to the 
elimination of withholding tax, subject to the ownership and 
holding period requirements.
    In addition, under subparagraph 3(c), a company that is a 
resident of a Contracting State may also qualify for the 
elimination of withholding tax on dividends if it satisfies the 
derivative benefits test of paragraph 3 of Article 17, subject 
to the ownership and holding period requirements. Thus, a 
Spanish company that has owned all of the stock of a U.S. 
corporation for the twelve-month period ending on the date on 
which entitlement to the dividend is determined may qualify for 
the elimination of withholding tax if it is wholly-owned by a 
company that falls within the definition of ``equivalent 
beneficiary'' in subparagraph 8(g) of Article 17.
    The derivative benefits test may also provide benefits to 
U.S. companies receiving dividends from Spanish subsidiaries 
because of the effect of the Parent-Subsidiary Directive in the 
European Union. Under that directive, inter-company dividends 
paid within the European Union are free of withholding tax. 
Under subparagraph 8(h) of Article 17 that directive will be 
taken into account in determining whether the owner of a U.S. 
company receiving dividends from a Spanish company is an 
equivalent beneficiary. Thus, a company that is a resident of a 
member state of the European Union will, by virtue of the 
Parent-Subsidiary Directive, satisfy the requirements of 
Article subparagraph 8(g)(i)(B) of Article 17 with respect to 
any dividends received by its U.S. subsidiary from a Spanish 
company. For example, assume USCo is a wholly-owned subsidiary 
of ICo, an Italian publicly-traded company. USCo owns all of 
the shares of SCo, a Spanish company. If SCo were to pay 
dividends directly to ICo, those dividends would be exempt from 
withholding tax in Spain by reason of the Parent-Subsidiary 
Directive. If ICo meets the other conditions to be an 
equivalent beneficiary under subparagraph 8(g) of Article 17, 
it will be treated as an equivalent beneficiary.
    A company also may qualify for the elimination of 
withholding tax pursuant to subparagraph 3(c) if it is owned by 
seven or fewer U.S. or Spanish residents who qualify as an 
``equivalent beneficiary'' and meet the other requirements of 
the derivative benefits provision. This rule may apply, for 
example, to certain Spanish corporate joint venture vehicles 
that are closely-held by a few Spanish resident individuals.
    Subparagraph 8(g) of Article 17 contains a specific rule of 
application intended to ensure that for purposes of applying 
paragraph 3, certain joint ventures, not just wholly-owned 
subsidiaries, can qualify for benefits. For example, assume 
that the United States were to enter into a treaty with Country 
X, a member of the European Union, that includes a provision 
identical to paragraph 3. USCo is 100 percent owned by SCo, a 
Spanish company, which in turn is owned 49 percent by PCo, a 
Spanish publicly-traded company, and 51 percent by XCo, a 
publicly-traded company that is resident in Country X. In the 
absence of a special rule for interpreting the derivative 
benefits provision, each of PCo and XCo would be treated as 
owning only their proportionate share of the shares held by SCo 
in USCo. If that rule were applied in this situation, neither 
PCo nor XCo would be an equivalent beneficiary, because neither 
would meet the 80 percent ownership test with respect to USCo. 
However, since both PCo and XCo are residents of countries that 
have treaties with the United States that provide for 
elimination of withholding tax on inter-company dividends, it 
is appropriate to provide benefits to SCo in this case.
    Accordingly, the definition of ``equivalent beneficiary'' 
includes a rule of application that is intended to ensure that 
such joint ventures qualify for the benefits of paragraph 3. 
Under that rule, each of the shareholders is treated as owning 
shares of USCo with the same percentage of voting power as the 
shares held by SCo for purposes of determining whether it would 
be entitled to an equivalent rate of withholding tax. This rule 
is necessary because of the high ownership threshold for 
qualification for the elimination of withholding tax on inter-
company dividends.
    If a company does not qualify for the elimination of 
withholding tax under any of the foregoing objective tests, it 
may request a determination from the relevant competent 
authority pursuant to paragraph 7 of Article 17.

Paragraph 4 of New Article 10

    Paragraph 4 of new Article 10 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 purposes of 
application of this paragraph by the United States, the term 
``trade or business'' shall be defined in accordance with Code 
section 513(c). The term ``pension fund'' is defined in 
subparagraph 1(j) of Article 3 (General Definitions) of the 
Convention, as amended by Article II of the Protocol.

Paragraph 5 of New Article 10

    Paragraph 5 of new Article 10 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, ``jouissance'' shares 
or ``jouissance'' rights, mining shares, founders' shares or 
other 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, including amounts treated as dividend equivalents under 
Code section 871(m). 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 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. Paragraph 5 also clarifies that the term 
``dividends'' does not include distributions that are treated 
as gain under the laws of the State of which the company making 
the distribution is a resident. In such case, the provisions of 
Article 13 (Gains) shall apply (for example, the United States 
shall apply Code Section 897(h) and the regulations 
thereunder).
    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 of New Article 10

    Paragraph 6 of new Article 10 provides a rule for taxing 
dividends paid with respect to holdings that form part of the 
business property of a permanent establishment or fixed base. 
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 or 
fixed base 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 of New Article 10

    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 of new Article 10 to cases in which 
the dividends are paid to a resident of that Contracting State 
or are effectively connected to a permanent establishment in 
that Contracting State. Thus, a Contracting State may not 
impose a ``secondary'' withholding tax on dividends paid by a 
nonresident company out of earnings and profits from that 
Contracting State.
    The paragraph also restricts the right of a Contracting 
State to impose corporate level taxes on undistributed profits, 
other than a branch profits tax. The paragraph does not 
restrict a State's right to tax its resident shareholders on 
undistributed earnings of a corporation resident in the other 
State. Thus, the authority of the United States to impose taxes 
on subpart F income and on earnings deemed invested in U.S. 
property, and its tax on income of a passive foreign investment 
company that is a qualified electing fund is in no way 
restricted by this provision.

Paragraph 8 of New Article 10

    Paragraph 8 of new Article 10 permits a Contracting State 
to impose a branch profits tax on a company resident in the 
other Contracting State. The tax is in addition to other taxes 
permitted by the Convention. The term ``company'' is defined in 
subparagraph 1(e) of Article 3 (General Definitions) of the 
Convention.
    A Contracting State may impose a branch profits tax on a 
company if the company has income attributable to a permanent 
establishment in that Contracting State, derives income from 
real property (immovable property) in that Contracting State 
that is taxed on a net basis under Article 6 (Income from Real 
Property (Immovable Property)), or realizes gains taxable in 
that State under paragraph 1 of Article 13 (Capital Gains). In 
the case of the United States, the imposition of such tax is 
limited, however, to the portion of the aforementioned items of 
income that represents the amount of such income that is the 
``dividend equivalent amount.'' 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. 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, 
7 (Business Profits) or 13, reduced for any increase in the 
branch's U.S. net equity during the year or increased for any 
reduction in its U.S. net equity during the year. U.S. net 
equity is U.S. assets less U.S. liabilities. See Treas. Reg. 
1.884-1. The amount analogous to the dividend equivalent amount 
in the case of Spain is the amount of income (Imposicion 
Complementaria) determined under the Spanish Non Residents 
Income Tax regulated by the Amended Text of Non Residents 
Income Tax Law, passed by Legislative Royal Decree 5/2004 of 
5th March, as it may be amended from time to time.
    As discussed in the Technical Explanation to paragraph 2 of 
Article 1 (General Scope), consistency principles prohibit a 
taxpayer from applying provisions of the Code and this 
Convention in an inconsistent manner in order to minimize tax. 
In the context of the branch profits tax, this consistency 
requirement means that if a company resident in Spain uses the 
principles of Article 7 to determine its U.S. taxable income, 
it must then also use those principles to determine its 
dividend equivalent amount. Similarly, if the 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 Spanish company, for example, does 
not from year to year consistently apply the Code or the 
Convention to determine its dividend equivalent amount, then 
the 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.

Paragraph 9 of New Article 10

    Paragraph 9 of new Article 10 limits the rate of the branch 
profits tax that may be imposed under paragraph 8 to 5 percent, 
as provided in subparagraph 2(a) of Article 10. Paragraph 9 
also provides that the branch profits tax shall not be imposed 
on a company in any case if certain requirements are met. In 
general, these requirements provide rules for a branch that 
parallel the rules for when a dividend paid by a subsidiary 
will be subject to exclusive residence-country taxation (i.e., 
the elimination of source-country withholding tax). 
Accordingly, the branch profits tax cannot be imposed in the 
case of a company that satisfies any of the following 
requirements set forth in Article 17 (Limitation on Benefits) 
as revised by Article IX: (1) the ``publicly traded'' test of 
subparagraph 2(c); (2) both the ``ownership-base erosion'' and 
``active trade or business'' tests described in subparagraph 
2(e) and paragraph 4; (3) the ``derivative benefits'' test of 
paragraph 3; or (4) paragraph 7. If the company did not meet 
any of those tests, but otherwise qualified for benefits under 
Article 17, then the branch profits tax would apply at a rate 
of 5 percent as provided in subparagraph 2(a).
    Paragraph 9 applies equally if a taxpayer determines its 
taxable income under the laws of a Contracting State or under 
the provisions of Article 7 (Business Profits). For example, as 
discussed above, consistency principles require a company 
resident in Spain that determines its U.S. taxable income under 
the Code to also determine its dividend equivalent amount under 
the Code. In that case, the withholding rate reduction provided 
in subparagraph 2(a) would apply even though the company did 
not determine its dividend equivalent amount using the 
principles of Article 7.

                               ARTICLE V

    Article V of the Protocol replaces Article 11 (Interest) of 
the existing Convention. New Article 11 specifies the taxing 
jurisdictions over interest income of the States of source and 
residence and defines the terms necessary to apply the Article.

Paragraph 1 of New Article 11

    Paragraph 1 of new Article 11 generally grants to the State 
of residence the 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 domestic law 
of the State of source. The beneficial owner of the interest 
for purposes of Article 11 is the person to which the income is 
attributable under the laws of the source State. Thus, if 
interest arising in a Contracting State is received by a 
nominee or agent that is a resident of the other State on 
behalf of a person that is not a resident of that other State, 
the interest is not entitled to the benefits of Article 11. 
However, interest received by a nominee on behalf of a resident 
of that other State would be entitled to benefits. These 
limitations are confirmed by paragraph 9 of the OECD Commentary 
to Article 11.
    Special rules apply to interest derived through fiscally 
transparent entities for purposes of determining the beneficial 
owner of the interest. In such cases, residence State 
principles shall be used to determine who derives the interest, 
to assure that the interest 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.
    For example, assume that FCo, a company that is a resident 
of Spain, owns a 50 percent interest in FP, a partnership that 
is organized in Spain. FP receives interest arising in the 
United States. Spain views FP as fiscally transparent under its 
domestic law, and taxes FCo currently on its distributive share 
of the income of FP and determines the character and source of 
the income received through FP in the hands of FCo as if such 
income were realized directly by FCo. In this case, FCo is 
treated as deriving 50 percent of the interest received by FP 
that arises in the United States under paragraph 6 of Article 
1. The same result would be reached even if the tax laws of the 
United States would treat FP differently (e.g., if FP were not 
treated as fiscally transparent in the United States), or if FP 
were organized in a third state, provided such state has an 
agreement in force containing a provision for the exchange of 
information on tax matters with Spain, which in this example is 
the Contracting State from which the interest arises, and as 
long as FP were still treated as fiscally transparent under the 
laws of the United States.
    While residence State principles control who is treated as 
deriving the interest, source State principles of beneficial 
ownership apply to determine whether the person who derives the 
interest, or another resident of the other Contracting State, 
is the beneficial owner of the interest. If the person who 
derives the interest under paragraph 6 of Article 1 would not 
be treated as a nominee, agent, custodian, conduit, etc. under 
the source State's principles for determining beneficial 
ownership, that person will be treated as the beneficial owner 
of the interest for purposes of the Convention. In the example 
above, FCo is required to satisfy the beneficial ownership 
principles of the United States with respect to the interest it 
derives. If under the beneficial ownership principles of the 
United States, FCo is found not to be the beneficial owner of 
the interest, FCo will not be entitled to the benefits of 
Article 11 with respect to such interest. If FCo is found to be 
a nominee, agent, custodian, or conduit for a person who is a 
resident of the other Contracting State, that person may be 
entitled to benefits with respect to the interest.

Paragraph 2 of New Article 11

    Paragraph 2 of new Article 11 provides anti-abuse 
exceptions to the source-country exemption in paragraph 1 for 
two classes of interest payments arising in the United States.
    The first class of interest, dealt with in subparagraph 
2(a) is so-called ``contingent interest'' that does not qualify 
as portfolio interest under U.S. domestic law as defined in 
Code section 871(h)(4). The exceptions of section 871(h)(4)(c) 
will be applicable. If the beneficial owner of the contingent 
interest is a resident of Spain, subparagraph 2(a) provides 
that the gross amount of the interest may be taxed at a rate 
not exceeding 10 percent.
    The second class of interest is dealt with in subparagraph 
2(b). 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 3 of New Article 11

    Paragraph 3 of new Article 11 provides a definition of the 
term ``interest'' for purposes of the Article that is 
essentially identical to that provided in paragraph 4 of 
Article 11 of the existing Convention. The term ``interest'' as 
used in Article 11 is defined in paragraph 3 to include, inter 
alia, income from debt claims of every kind, whether or not 
secured by a mortgage and whether or not carrying a right to 
participate in the debtor's profits. The term does not, 
however, include amounts that are treated as dividends under 
Article 10 (Dividends), nor does it include penalty charges for 
late payment.
    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 recharacterized as loans because of a 
``substantial non-periodic payment.''

Paragraph 4 of New Article 11

    Paragraph 4 of new Article 11 is identical in substance to 
paragraph 5 of Article 11 of the existing Convention. Paragraph 
4 provides an exception to the exclusive residence taxation 
rule of paragraph 1 and the source State gross taxation rule of 
paragraph 2 in cases where the beneficial owner of the interest 
carries on or has carried on business through a permanent 
establishment situated in that State, or performs or has 
performed independent personal services through a fixed base 
situated in that state, and the debt-claim in respect of which 
the interest is paid is effectively connected with such 
permanent establishment or fixed base. In such cases the 
provisions of Article 7 (Business Profits) or Article 15 
(Independent Personal Servicers), as the case may be, 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 or fixed base that 
once existed in a Contracting State but no longer exists, the 
provisions of this paragraph shall apply to interest paid with 
respect to a debt-claim that would be effectively connected to 
such a permanent establishment or fixed base if it did exist in 
the year of payment or accrual. Accordingly, such interest 
would remain taxable under the provisions of Article 7 or 15, 
as the case may be, and not under this Article.

Paragraph 5 of New Article 11

    Paragraph 5 of new Article 11 provides a source rule for 
interest that is identical in substance to the interest source 
rule of the existing Convention. Interest is considered to 
arise in a Contracting State if paid by a resident of that 
State. However, interest that is borne by a permanent 
establishment or fixed base in one of the Contracting States is 
considered to arise in that State. For this purpose, interest 
is considered to be borne by a permanent establishment or fixed 
base if it is allocable to taxable income of that permanent 
establishment or fixed base. If the actual amount of interest 
on the books of a U.S. branch of a resident of Spain exceeds 
the amount of interest allocated to the branch under Treas. 
Reg. 1.882-5, the amount of such excess will not be considered 
U.S. source interest for purposes of this Article.

Paragraph 6 of New Article 11

    Paragraph 6 of new Article 11 is identical to paragraph 7 
of Article 11 of the existing Convention. Paragraph 5 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 the other Contracting State, 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 Code section 482.
    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 3. The United States 
would apply Code section 482 or 7872 to determine the amount of 
imputed interest in those cases.
            Relation to Other Articles
    Notwithstanding the foregoing limitations on source country 
taxation of interest, the saving clause of subparagraph 3 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 3 of Article 24 (Relief from Double 
Taxation), as if the Convention had not come into force.
    The benefits of this Article are also subject to the 
provisions of Article 17 (Limitation on Benefits). Thus, if a 
resident of Spain is the beneficial owner of interest paid by a 
U.S. corporation, the resident must qualify for treaty benefits 
under at least one of the tests of Article 17 in order to 
receive the benefits of this Article.

                               ARTICLE VI

    Article VI of the Protocol replaces Article 12 (Royalties) 
of the existing Convention. New 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 of New Article 12

    Paragraph 1 of new Article 12 generally grants to the State 
of residence the 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 domestic law 
of the State of source. The beneficial owner of the royalties 
for purposes of Article 12 is the person to which the income is 
attributable under the laws of the source State. Thus, if 
royalties arising in a Contracting State are 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 royalties are not entitled to the benefits of Article 12. 
However, the royalties 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.
    Special rules apply to royalties derived through fiscally 
transparent entities for purposes of determining the beneficial 
owner of the royalties. In such cases, residence State 
principles shall be used to determine who derives the 
royalties, to assure that the royalties 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.For example, assume that FCo, a company that is a 
resident of Spain, owns a 50 percent interest in FP, a 
partnership that is organized in Spain. FP receives royalties 
arising in the United States. Spain views FP as fiscally 
transparent under its domestic law, and taxes FCo currently on 
its distributive share of the income of FP and determines the 
character and source of the income received through FP in the 
hands of FCo as if such income were realized directly by FCo. 
In this case, FCo is treated as deriving 50 percent of the 
royalties received by FP that arise in the United States under 
paragraph 6 of Article 1. The same result would be reached even 
if the tax laws of the United States would treat FP differently 
(e.g., if FP were not treated as fiscally transparent in the 
United States), or if FP were organized in a third state, 
provided that that state has an agreement in force containing a 
provision for the exchange of information on tax matters with 
Spain, which in this example is the the Contracting State from 
which the royalty arises, and as long as FP were still treated 
as fiscally transparent under the laws of the United States.
    While residence State principles control who is treated as 
deriving the royalties, source State principles of beneficial 
ownership apply to determine whether the person who derives the 
royalties, or another resident of Spain, is the beneficial 
owner of the royalties. If the person who derives the royalties 
under paragraph 6 of Article 1 would not be treated as a 
nominee, agent, custodian, conduit, etc. under the source 
State's principles for determining beneficial ownership, that 
person will be treated as the beneficial owner of the royalties 
for purposes of the Convention. In the example above, FCo is 
required to satisfy the beneficial ownership principles of the 
United States with respect to the royalties it derives. If 
under the beneficial ownership principles of the United States, 
FCo is found not to be the beneficial owner of the royalties, 
FCo will not be entitled to the benefits of Article 12 with 
respect to such royalties. If FCo is found to be a nominee, 
agent, custodian, or conduit for a person who is a resident of 
Spain, that person may be entitled to benefits with respect to 
the royalties.

Paragraph 2 of New Article 12

    Paragraph 2 of new Article 12 defines the term 
``royalties,'' as used in Article 12, to include any 
consideration for the use of, or the right to use, any 
copyright of literary, artistic scientific or other work 
(including cinematographic films, and films and recordings for 
radio or television broadcasting), any patent, trademark, 
design or model, plan, secret formula or process, or for 
information concerning industrial, commercial, or scientific 
experience. The term ``royalties'' 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 formula'' is found in the Code, 
and its meaning has been elaborated in the context of sections 
351 and 367. See Rev. Rul. 55-17, 1955-1 C.B. 388; Rev. Rul. 
64-56, 1964-1 C.B. 133; Rev. Proc. 69- 19, 1969-2 C.B. 301.
    Consideration for the use or right to use cinematographic 
films, or works on film, tape, or other means of reproduction 
in radio or television broadcasting is specifically included in 
the definition of royalties. It is intended that, with respect 
to any subsequent technological advances in the field of radio 
or television broadcasting, consideration received for the use 
of such technology will also be included in the definition of 
royalties.
    If an artist who is resident in one Contracting State 
records a performance in the other Contracting State, retains a 
copyrighted interest in a recording, and receives payments for 
the right to use the recording based on the sale or public 
playing of the recording, then the right of such other 
Contracting State to tax those payments is governed by Article 
12. See Boulez v. Commissioner, 83 T.C. 584 (1984), aff'd, 810 
F.2d 209 (D.C. Cir. 1986). By contrast, if the artist earns in 
the other Contracting State income covered by Article 19 
(Artistes and Athletes), 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 19 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. 1.861-18. The fact that 
the transaction is characterized as a license for copyright law 
purposes is not dispositive. For example, a typical retail sale 
of ``shrink wrap'' software generally will not be considered to 
give rise to royalty income, even though for copyright law 
purposes it may be characterized as a license.
    The means by which the computer software is transferred are 
not relevant for purposes of the analysis. Consequently, if 
software is electronically transferred but the rights obtained 
by the transferee are substantially equivalent to rights in a 
program copy, the payment will be considered business profits.
    The term ``industrial, commercial, or scientific 
experience'' (sometimes referred to as ``know-how'') has the 
meaning ascribed to it in paragraph 11 et seq. of the 
Commentary to Article 12 of the OECD Model. Consistent with 
that meaning, the term may include information that is 
ancillary to a right otherwise giving rise to royalties, such 
as a patent or secret process.
    Know-how also may include, in limited cases, technical 
information that is conveyed through technical or consultancy 
services. It does not include general educational training of 
the user's employees, nor does it include information developed 
especially for the user, such as a technical plan or design 
developed according to the user's specifications. Thus, as 
provided in paragraph 11.3 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 or 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 15 (Independent Personal Services) or Article 16 
(Dependent Personal Services) as applicable. 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 3 of New Article 12

    This paragraph provides an exception to the rule of 
paragraph 1 that gives the State of residence exclusive taxing 
jurisdiction in cases where the beneficial owner of the 
royalties carries on or has carried on a business through a 
permanent establishment or performs or has performed personal 
services from a fixed base in the state of source and the right 
or property in respect of which the royalties are paid is 
effectively connected with that permanent establishment or 
fixed base. In such cases the provisions of Article 7 (Business 
Profits) or Article 15 (Independent Personal Services) will 
apply.
    In the case of a permanent establishment that once existed 
in a Contracting State but that no longer exists, the 
provisions of this paragraph also apply to royalties paid with 
respect to rights or property that would be effectively 
connected to such permanent establishment if it did exist in 
the year of payment or accrual. Accordingly, such royalties 
would remain taxable under the provisions of Article 7, and not 
under this Article.

Paragraph 4 of New Article 12

    Paragraph 4 of new Article 12 provides that in cases 
involving special relation-ships 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 3 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 3 of Article 24 (Relief from Double 
Taxation), as if the Convention had not come into force.
    As with other benefits of the Convention, the benefits of 
exclusive residence State taxation of royalties under paragraph 
1 of Article 12 are available to a resident of the other State 
only if that resident is entitled to those benefits under 
Article 17 (Limitation on Benefits).

                              ARTICLE VII

    Article VII of the Protocol makes amendments to Article 13 
(Capital Gains) of the existing Convention.

Paragraph 1

    Paragraph 1 of Article VII replaces paragraph 4 of existing 
Article 13. Because of the deletion of paragraph 4 of the 
existing Article, gains from the alienation of stock, 
participations or other rights in the capital of a company 
shall be taxed in accordance with the general rules of the 
Article. Revised paragraph 4 reflects Spain's prevailing tax 
treaty policy. Under the paragraph, a Contracting State may tax 
the gain from the alienation of shares of other rights, which 
directly or indirectly entitled the owner of such shares or 
rights to the enjoyment of immovable property situated in such 
Contracting State.

Paragraph 2

    Paragraph 2 replaces paragraphs 6 and 7 of Article 13 of 
the existing Convention. New paragraph 6 of revised Article 13 
provides that gains from the alienation of any property other 
than property referred to in paragraph 1 through 5 will be 
taxable only in the state of residence of the person alienating 
the property.

                              ARTICLE VIII

    In a conforming change to the restatement of Article 10 
(Dividends) of the existing Convention under Article IV of the 
Protocol, Article VIII of the Protocol deletes Article 14 
(Branch Tax) of the existing Convention.

                               ARTICLE IX

    Article IX of the Protocol replaces Article 17 (Limitation 
on Benefits) of the existing Convention. New Article 17 
contains anti-treaty-shopping provisions that are intended to 
prevent residents of third countries from benefiting from what 
is intended to be a reciprocal agreement between two countries. 
In general, the provision does not rely on a determination of 
purpose or intention but instead sets forth a series of 
objective tests. A resident of a Contracting State that 
satisfies one of the tests will receive benefits regardless of 
its motivations in choosing its particular business structure.
    The structure of the revised 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 derivative 
benefits rule. 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 a test for headquarters companies. Paragraph 6 
provides a special rule for so-called ``triangular cases'' 
notwithstanding the other provisions of new Article 17. 
Paragraph 7 sets forth rules for the competent authorities of 
the Contracting States to apply to determine if a resident 
which cannot satisfy any of the tests in paragraphs 2, 3, 4 or 
5 should nevertheless be entitled to a benefits provided in the 
Convention. Paragraph 8 defines certain terms used in the 
Article.

Paragraph 1 of New Article 17

    Paragraph 1 of new Article 17 provides that a resident of a 
Contracting State will be entitled to the benefits otherwise 
accorded to residents of a Contracting State under the 
Convention only to the extent provided in the Article. The 
benefits otherwise accorded to residents under the Convention 
include all limitations on source-based taxation under Articles 
6 (Income from Real Property (Immovable Property) through 16 
(Dependent Personal Services) and 18 (Director's Fees) through 
23 (Other Income), the treaty-based relief from double taxation 
provided by Article 24 (Relief from Double Taxation), and the 
protection afforded to residents of a Contracting State under 
Article 25 (Non-Discrimination). Some provisions do not require 
that a person be a resident in order to enjoy the benefits of 
those provisions. For example, Article 26 (Mutual Agreement 
Procedure) is not limited to residents of the Contracting 
States, and Article 28 (Diplomatic Agents and Consular 
Officers) applies to diplomatic agents or consular officials 
regardless of residence. Article 17 accordingly does not limit 
the availability of treaty benefits under these provisions.
    Article 17 and the anti-abuse provisions of domestic law 
complement each other, as Article 17 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, domestic law principles of 
the source Contracting State may be applied to identify the 
beneficial owner of an item of income, and Article 17 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 of New Article 17

    Paragraph 2 of new Article 17 has five subparagraphs, each 
of which describes a category of residents that will be 
considered qualified persons.
    It is intended that the provisions of paragraph 2 will be 
self-executing. Unlike the provisions of paragraph 7 of the new 
Article, 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 considered qualified persons. If such 
an individual receives income as a nominee on behalf of a third 
country resident, benefits may be denied under the applicable 
Articles of the Convention by the requirement that the 
beneficial owner of the income be a resident of a Contracting 
State.
            Governments--Subparagraph 2(b)
    Subparagraph 2(b) provides that the Contracting States and 
any political subdivision or local authority or wholly-owned 
instrumentality thereof will be considered qualified persons.
            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 will be 
considered a qualified person under clause (i) of subparagraph 
(c) if the principal class of its shares, and any 
disproportionate class of shares, is regularly traded on one or 
more recognized stock exchanges and the company satisfies at 
least one of the following additional requirements. First, 
under clause A) in the case of a company resident in Spain, the 
company's principal class of shares must be primarily traded on 
one or more recognized stock exchanges located either in Spain 
or within the European Union, and in the case of a company 
resident in the United States, the company's principal class or 
shares must be primarily traded on a recognized stock exchange 
located either in the United States or in another state that is 
a party to the North American Free Trade Agreement. If the 
company's principal class of shares does not satisfy the 
trading requirement set forth in clause A), clause B) provides 
that the regularly-traded company can nevertheless satisfy the 
requirements of clause (i) if the company's primary place of 
management and control is in its State of residence.
    The term ``recognized stock exchange'' is defined in 
subparagraph 8(a) of revised Article 17. It includes (i) 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) any Spanish stock 
exchange controlled by the Comision Nacional del Mercado de 
Valores; (iii) the principal stock exchanges of Stuttgart, 
Hamburg, Dusseldorf, Frankfurt, Berlin, Hannover, Munich, 
London, Amsterdam, Milan, Budapest, Lisbon, Toronto, Mexico 
City and Buenos Aires, and (iv) 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''. Subparagraph 8(e) clarifies that the term 
``shares'' includes depository receipts thereof. 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 be 
considered a qualified person under subparagraph 2(c) if it has 
a disproportionate class of shares that is not regularly traded 
on a recognized stock exchange. The term ``disproportionate 
class of shares'' is defined in subparagraph 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 Spain the other Contracting State has a 
disproportionate class of shares if it has outstanding a class 
of ``tracking stock'' that pays dividends based upon a formula 
that approximates the company's return on its assets employed 
in the United States.
    The following example illustrates this result.
    Example. OCo is a corporation resident in Spain. OCo has 
two classes of shares: Common and Preferred. The Common shares 
are listed and regularly traded on a Spanish stock exchange 
controlled by the Comision Nacional del Mercado de Valores. The 
Preferred shares have no voting rights and are entitled to 
receive dividends equal in amount to interest payments that OCo 
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 OCo 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 OCo, the Preferred shares are a 
disproportionate class of shares. Because the Preferred shares 
are not regularly traded on a recognized stock exchange, OCo 
will not qualify for benefits under subparagraph (c) of 
paragraph 2.
    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, 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)(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 any recognized stock exchange. 
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 
(General Definitions), this term will have the meaning it has 
under the laws of the State concerning the taxes to which the 
Convention applies, generally the source State. In the case of 
the United States, this term is understood to have the meaning 
it has under Treas. Reg. 1.884-5(d)(3), relating to the branch 
tax provisions of the Code. Accordingly, stock of a corporation 
is ``primarily traded'' if the number of shares in the 
company's principal class of shares that are traded during the 
taxable year on all recognized stock exchanges in the 
Contracting State of which the company is a resident exceeds 
the number of shares in the company's principal class of shares 
that are traded during that year on established securities 
markets in any other single foreign country.
    A company whose principal class of shares is regularly 
traded on a recognized exchange but cannot meet the primarily 
traded test may claim treaty benefits if its primary place of 
management and control is in its country of residence. This 
test is distinct from the ``place of effective management'' 
test which is used in the OECD Model and by many other 
countries to establish residence. In some cases, the place of 
effective management test has been interpreted to mean the 
place where the board of directors meets. By contrast, the 
primary place of management and control test looks to where 
day-to-day responsibility for the management of the company 
(and its subsidiaries) is exercised. The company's primary 
place of management and control will be located in the State in 
which the company is a resident only if the executive officers 
and senior management employees exercise day-to-day 
responsibility for more of the strategic, financial and 
operational policy decision making for the company (including 
direct and indirect subsidiaries) in that State than in the 
other State or any third state, and the staff that support the 
management in making those decisions are also based in that 
State. Thus, the test looks to the overall activities of the 
relevant persons to see where those activities are conducted. 
In most cases, it will be a necessary, but not a sufficient, 
condition that the headquarters of the company (that is, the 
place at which the CEO and other top executives normally are 
based) be located in the Contracting State of which the company 
is a resident.
    To apply the test, it will be necessary to determine which 
persons are to be considered ``executive officers and senior 
management employees''. In most cases, it will not be necessary 
to look beyond the executives who are members of the Board of 
Directors (the ``inside directors'') in the case of a U.S. 
company. That will not always be the case, however; in fact, 
the relevant persons may be employees of subsidiaries if those 
persons make the strategic, financial and operational policy 
decisions. Moreover, it would be necessary to take into account 
any special voting arrangements that result in certain board 
members making certain decisions without the participation of 
other board members.
            Subsidiaries of Publicly-Traded Corporations--Subparagraph 
                    2(c)(ii)
    A company resident in a Contracting State is entitled to 
all the benefits of the Convention under clause (ii) of 
subparagraph (c) of paragraph 2 if five or fewer publicly 
traded companies described in clause (i) are the direct or 
indirect owners of at least 50 percent of the aggregate vote 
and value of the company's shares (and at least 50 percent of 
any disproportionate class of shares). If the publicly-traded 
companies are indirect owners, however, each of the 
intermediate companies must be a resident of one of the 
Contracting States.
    Thus, for example, a company that is a resident of Spain, 
all the shares of which are owned by another company that is a 
resident of Spain, would qualify for benefits under the 
Convention if the principal class of shares (and any 
disproportionate classes of shares) of the parent company are 
regularly and primarily traded on a recognized stock exchange 
in Spain (or within the European Union). However, such a 
subsidiary would not qualify for benefits under clause (ii) if 
the publicly traded parent company were a resident of a third 
state, for example, and not a resident of the United States or 
Spain. Furthermore, if a parent company in Spain indirectly 
owned the bottom-tier company through a chain of subsidiaries, 
each such subsidiary in the chain, as an intermediate owner, 
must be a resident of the United States or Spain in order for 
the subsidiary to meet the test in clause (ii).
            Tax Exempt Organizations--Subparagraph 2(d)
    Subparagraph 2(d) set forth a limitation on benefits rule 
for persons referred to in paragraph 4 of the Memorandum of 
Understanding, which provides that the United States and Spain 
follow the positions described in paragraph 8.6 of the 
Commentary to Article 4 (Resident) of the OECD Model. Under 
clause (i) of subparagraph 2(d), a tax-exempt organization 
other than a pension fund automatically shall be considered a 
qualified person without regard to the residence of its 
beneficiaries or members. 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.
    Clause (ii) of paragraph 2(d), sets forth a rule to 
determine when pension funds described in subparagraph 1(j) of 
Article 3 (General Definitions) will be considered qualified 
persons. Clause (A) provides that pension funds described in 
clauses (i) and (ii)(A) of subparagraph 1(j) of Article 3 will 
be considered qualified persons if more than fifty percent of 
the beneficiaries, members or participants of the organization 
are individuals resident in either Contracting State. For 
purposes of this provision, the term ``beneficiaries'' should 
be understood to refer to the persons receiving benefits from 
the organization. Pension funds described in clause (ii)(B) of 
subparagraph 1(j) will be qualified persons if all of the 
persons for which such pension fund earns income satisfy the 
requirements of clause (A) of subparagraph 2(d).
            Ownership/Base Erosion--Subparagraph 2(e)
    Subparagraph 2(e) provides an additional method to qualify 
for treaty benefits that applies to any form of legal entity 
that is a resident of a Contracting State. The test provided in 
subparagraph (e), the so-called ownership and base erosion 
test, is a two-part test. Both prongs of the test must be 
satisfied for the resident to be entitled to treaty benefits 
under subparagraph 2(e).
    The ownership prong of the test, under clause (i), requires 
that 50 percent or more of each class of shares or other 
beneficial interests in the person is owned, directly or 
indirectly, on at least half the days of the person's taxable 
year by persons who are residents of the Contracting State of 
which that person is a resident and that are themselves 
entitled to treaty benefits under subparagraphs (a), (b), (d) 
or clause (i) of subparagraph (c) of paragraph 2. In the case 
of indirect owners, however, each of the intermediate owners 
must be a resident of that Contracting State.
    Trusts may be entitled to benefits under this provision if 
they are treated as residents under Article 4 (Residence) and 
they otherwise satisfy the requirements of this subparagraph. 
For purposes of this subparagraph, the beneficial interests in 
a trust will be considered to be owned by its beneficiaries in 
proportion to each beneficiary's actuarial interest in the 
trust. The interest of a remainder beneficiary will be equal to 
100 percent less the aggregate percentages held by income 
beneficiaries. A beneficiary's interest in a trust will not be 
considered to be owned by a person entitled to benefits under 
the other provisions of paragraph 2 if it is not possible to 
determine the beneficiary's actuarial interest. Consequently, 
if it is not possible to determine the actuarial interest of 
the beneficiaries in a trust, the ownership test under clause 
i) cannot be satisfied, unless all possible beneficiaries are 
persons entitled to benefits under the other subparagraphs of 
paragraph 2.
    The base erosion prong of clause (ii) of subparagraph (e) 
is satisfied with respect to a person if less than 50 percent 
of the person's gross income for the taxable year, as 
determined under the tax law in the person's State of 
residence, is paid or accrued to persons who are not residents 
of either Contracting State entitled to benefits under 
subparagraphs (a), (b), (d) or clause (i) of subparagraph (c) 
of paragraph 2, in the form of payments deductible for tax 
purposes in the payer's State of residence. These amounts do 
not include arm's-length payments in the ordinary course of 
business for services or tangible property or payments in 
respect of financial obligations to a bank that is not related 
to the payer. To the extent they are deductible from the 
taxable base, trust distributions are deductible payments. 
However, depreciation and amortization deductions, which do not 
represent payments or accruals to other persons, are 
disregarded for this purpose.

Paragraph 3 of New Article 17

    Paragraph 3 of new Article 17 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 certain 
companies that are residents 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 3(a) sets forth the ownership test. Under this 
test, seven or fewer equivalent beneficiaries must own shares 
representing at least 95 percent of the aggregate voting power 
and value of the company and at least 50 percent of any 
disproportionate class of shares. Ownership may be direct or 
indirect, although in the case of indirect ownership, each 
intermediate owner must be a resident of a member state of the 
European Union or any party to the North American Free Trade 
Agreement.
    The term ``equivalent beneficiary'' is defined in 
subparagraph 8(g). This definition may be met in two 
alternative ways.
    Under the first alternative, a person may be an equivalent 
beneficiary because it is entitled to equivalent benefits under 
a tax treaty between the country of source and the country in 
which the person is a resident. This alternative has two 
requirements.
    The first requirement as set forth in clause (i) of 
subparagraph 8(g) is that the person must be a resident of a 
member state of the European Union or of a party to the North 
American Free Trade Agreement (collectively, ``qualifying 
States''). In addition, the person must be entitled to all the 
benefits of a comprehensive tax 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), or 2(d) of this 
Article. If the treaty in question does not have a 
comprehensive limitation on benefits article, this requirement 
is met only if the person would be entitled to treaty benefits 
under the tests in subparagraphs 2(a), 2(b), 2(c)(i), or 2(d) 
of this Article if the person were a resident of one of the 
Contracting States.
    Clause (i)(B) of subparagraph 8(g) requires that with 
respect to insurance premiums, dividends (including branch 
profits), interest, and royalties, 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 had received the income directly from 
the source State.
    Subparagraph 8(g) 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 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 and receives such payments from a 
Spanish company, 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 Spanish 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 Spanish company will not 
qualify such French company as an equivalent beneficiary. 
Further, the French company cannot be an equivalent beneficiary 
if it qualifies for benefits only with respect to certain 
income as a result of a ``derivative benefits'' provision in 
the U.S.-France treaty. However, because such French company is 
a resident of a qualifying state, 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 Spanish residents who are 
eligible for treaty benefits by reason of subparagraphs 2(a), 
2(b), 2(c)(i), or 2(d) are equivalent beneficiaries for 
purposes of the relevant tests in this Article. Thus, a Spanish 
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 Spanish company under this 
paragraph. Thus, for example, if 90 percent of a Spanish 
company is owned by five companies that are resident in member 
states of the European Union who satisfy the requirements of 
subparagraph 8(g)(i), and 10 percent of the Spanish company is 
owned by a U.S. or Spanish individual, then the Spanish company 
still can satisfy the requirements of subparagraph 3(a).
    Subparagraph 3(b) sets forth the base erosion test. A 
company meets this base erosion test if less than 50 percent of 
its gross income (as determined in the company's State of 
residence) for the taxable period is paid or accrued, directly 
or indirectly, to a person or persons who are not equivalent 
beneficiaries in the form of payments deductible for tax 
purposes in company's State of residence. These deductible 
payments do not include arm's-length payments in the ordinary 
course of business for services or tangible property or 
payments in respect of financial obligations to a bank that is 
not related to the payor. This test is qualitatively the same 
as the base erosion test in subparagraph 2(e)(ii), except that 
the test in paragraph 3(b) focuses on base-eroding payments to 
persons who are not equivalent beneficiaries.

Paragraph 4 of New Article 17

    Paragraph 4 of new Article 17 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.
    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.
    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 Spain is 
entitled to the benefits of the Convention under paragraph 3 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 Code 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 constitutes or 
could constitute an independent economic enterprise carried on 
for profit. Furthermore, a corporation generally will be 
considered to carry on a trade or business only if the officers 
and employees of the corporation conduct substantial managerial 
and operational activities.
    The business of making or managing investments for the 
resident's own account will be considered to be a trade or 
business only when part of banking, insurance or securities 
activities conducted by a bank, an insurance company, or a 
registered securities dealer respectively. Such activities 
conducted by a person other than a bank, insurance company or 
registered securities dealer will not be considered to be the 
conduct of an active trade or business, nor would they be 
considered to be the conduct of an active trade or business if 
conducted by a bank, insurance company or registered securities 
dealer but not as part of the company's banking, insurance or 
dealer business. Because a headquarters operation is in the 
business of managing investments, a company that functions 
solely as a headquarters company will not be considered to be 
engaged in an active trade or business for purposes of 
paragraph 4.
    An item of income is derived in connection with a trade or 
business if the income-producing activity in the State of 
source is a line of business that ``forms a part of'' or is 
``complementary'' to the trade or business conducted in the 
State of residence by the income recipient.
    A business activity generally will be considered to form 
part of a business activity conducted in the State of source if 
the two activities involve the design, manufacture or sale of 
the same products or type of products, or the provision of 
similar services. The line of business in the State of 
residence may be upstream, downstream, or parallel to the 
activity conducted in the State of source. Thus, the line of 
business may provide inputs for a manufacturing process that 
occurs in the State of source, may sell the output of that 
manufacturing process, or simply may sell the same sorts of 
products that are being sold by the trade or business carried 
on in the State of source.
    Example 1. USCo is a corporation resident in the United 
States. USCo is engaged in an active manufacturing business in 
the United States. USCo owns 100 percent of the shares of FCo, 
a corporation resident in Spain. FCo distributes USCo products 
in Spain. Since the business activities conducted by the two 
corporations involve the same products, FCo'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 FCo. FCo and other USCo affiliates then manufacture 
and market the USCo-designed products in their respective 
markets. Since the activities conducted by FCo 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. FSub is a 
wholly-owned subsidiary of Americair resident in Spain. FSub 
operates a chain of hotels in Spain that are located near 
airports served by Americair flights. Americair frequently 
sells tour packages that include air travel to Spain and 
lodging at FSub 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 FSub's business does 
not form a part of Americair's business. However, FSub'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 FSub owns an office building in Spain instead of a hotel 
chain. No part of Americair's business is conducted through the 
office building. FSub'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 
ForHolding, a corporation resident in Spain. ForHolding is a 
holding company that is not engaged in a trade or business. 
ForHolding owns all the shares of three corporations that are 
resident in Spain: ForFlower, ForLawn, and ForFish. ForFlower 
distributes USFlower flowers under the USFlower trademark in 
Spain. ForLawn markets a line of lawn care products in Spain 
under the USFlower trademark. In addition to being sold under 
the same trademark, ForLawn and ForFlower products are sold in 
the same stores and sales of each company's products tend to 
generate increased sales of the other's products. ForFish 
imports fish from the United States and distributes it to fish 
wholesalers in Spain. For purposes of paragraph 3, the business 
of ForFlower forms a part of the business of USFlower, the 
business of ForLawn is complementary to the business of 
USFlower, and the business of ForFish is neither part of nor 
complementary to that of USFlower.
    An item of income derived from the State of source is 
``incidental to'' the trade or business carried on in the State 
of residence if production of the item facilitates the conduct 
of the trade or business in the State of residence. An example 
of incidental income is the temporary investment of working 
capital of a person in the State of residence in securities 
issued by persons in the State of source.
    Subparagraph (b) of paragraph 4 states a further condition 
to the general rule in subparagraph (a) in cases where the 
trade or business generating the item of income in question is 
carried on either by the person deriving the income or by any 
associated enterprises. Subparagraph (b) states that the trade 
or business carried on in the State of residence, under these 
circumstances, must be substantial in relation to the activity 
in the State of source. The substantiality requirement is 
intended to prevent a narrow case of treaty-shopping abuses in 
which a company attempts to qualify for benefits by engaging in 
de minimis connected business activities in the treaty country 
in which it is resident (i.e., activities that have little 
economic cost or effect with respect to the company business as 
a whole). Paragraph 5 of the Memorandum of Understanding sets 
forth the understanding of the Contracting States that a person 
shall be deemed to be related to another person if either 
person participates directly or indirectly in the management, 
control or capital of the other, or the same persons 
participate directly or indirectly in the management, control 
or capital of both.
    The determination of substantiality is made based upon all 
the facts and circumstances and takes into account the 
comparative sizes of the trades or businesses in each 
Contracting State the nature of the activities performed in 
each Contracting State, and the relative contributions made to 
that trade or business in each Contracting State. In any case, 
in making each determination or comparison, due regard will be 
given to the relative sizes of the economies in the two 
Contracting States.
    The determination in subparagraph (b) also is made 
separately for each item of income derived from the State of 
source. It therefore is possible that a person would be 
entitled to the benefits of the Convention with respect to one 
item of income but not with respect to another. If a resident 
of a Contracting State is entitled to treaty benefits with 
respect to a particular item of income under paragraph 4, the 
resident is entitled to all benefits of the Convention insofar 
as they affect the taxation of that item of income in the State 
of source.
    The application of the substantiality requirement only to 
income from related parties focuses only on potential abuse 
cases, and does not hamper certain other kinds of non-abusive 
activities, even though the income recipient resident in a 
Contracting State may be very small in relation to the entity 
generating income in the other Contracting State. For example, 
if a small U.S. research firm develops a process that it 
licenses to a very large, unrelated, pharmaceutical 
manufacturer in Spain, 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 Spain would not have 
to pass a substantiality test to receive treaty benefits under 
paragraph 4.
    Subparagraph (c) of paragraph 3 provides special 
attribution rules for purposes of applying the substantive 
rules of subparagraphs (a) and (b). Thus, these rules apply for 
purposes of determining whether a person meets the requirement 
in subparagraph (a) that it be engaged in the active conduct of 
a trade or business and that the item of income is derived in 
connection with that active trade or business, and for making 
the comparison required by the ``substantiality'' requirement 
in subparagraph (b). Subparagraph (c) attributes to a person 
activities conducted by persons ``connected'' to such person. A 
person (``X'') is connected to another person (``Y'') if X 
possesses 50 percent or more of the beneficial interest in Y 
(or if Y possesses 50 percent or more of the beneficial 
interest in X). For this purpose, X is connected to a company 
if X owns shares representing fifty percent or more of the 
aggregate voting power and value of the company or fifty 
percent or more of the beneficial equity interest in the 
company. X also is connected to Y if a third person possesses 
fifty percent or more of the beneficial interest in both X and 
Y. For this purpose, if X or Y is a company, the threshold 
relationship with respect to such company or companies is fifty 
percent or more of the aggregate voting power and value or 
fifty percent or more of the beneficial equity interest. 
Finally, X is connected to Y if, based upon all the facts and 
circumstances, X controls Y, Y controls X, or X and Y are 
controlled by the same person or persons.

Paragraph 5 of Article 17

    Paragraph 5 of new Article 17 provides that a resident of 
one of the Contracting States is entitled to all the benefits 
of the Convention if that person functions as a recognized 
headquarters company for a multinational corporate group. The 
provisions of this paragraph are consistent with the other U.S. 
tax treaties where this provision has been adopted. For this 
purpose, the multinational corporate group includes all 
corporations that the headquarters company supervises, and 
excludes affiliated corporations not supervised by the 
headquarters company. The headquarters company does not have to 
own shares in the companies that it supervises. In order to be 
considered a headquarters company, the person must meet several 
requirements that are enumerated in paragraph 5. These 
requirements are discussed below.
            Overall Supervision and Administration
    Subparagraph 5(a) provides that the person must provide a 
substantial portion of the overall supervision and 
administration of the group. This activity may include group 
financing, but group financing may not be the principal 
activity of the person functioning as the headquarters company. 
A person only will be considered to engage in supervision and 
administration if it engages in a number of the following 
activities: group financing, pricing, marketing, internal 
auditing, internal communications, and management. Other 
activities also could be part of the function of supervision 
and administration.
    In determining whether a ``substantial portion'' of the 
overall supervision and administration of the group is provided 
by the headquarters company, its headquarters-related 
activities must be substantial in relation to the same 
activities for the same group performed by other entities. 
Subparagraph 5(a) does not require that the group that is 
supervised include persons in the other State. However, it is 
anticipated that in most cases the group will include such 
persons, due to the requirement in subparagraph 5(g), discussed 
below, that the income derived in the other Contracting State 
by the headquarters company be derived in connection with or be 
incidental to an active trade or business supervised by the 
headquarters company.
            Active Trade or Business
    Subparagraph 5(b) is the first of several requirements 
intended to ensure that the relevant group is truly 
``multinational.'' This subparagraph provides that the 
corporate group supervised by the headquarters company must 
consist of corporations resident in, and engaged in active 
trades or businesses in, at least five countries. Furthermore, 
at least five countries must each contribute substantially to 
the income generated by the group, as the rule requires that 
the business activities carried on in each of the five 
countries (or groupings of countries) generate at least 10 
percent of the gross income of the group. For purposes of the 
10 percent gross income requirement, the income from multiple 
countries may be aggregated into non-overlapping groupings, as 
long as there are at least five individual countries or 
groupings that each satisfies the 10 percent requirement. If 
the gross income requirement under this subparagraph is not met 
for a taxable year, the taxpayer may satisfy this requirement 
by applying the 10 percent gross income test to the average of 
the gross incomes for the four years preceding the taxable 
year.
    Example. SHQ is a corporation resident in Spain. SHQ 
functions as a headquarters company for a group of companies. 
These companies are resident in the United States, Canada, New 
Zealand, the United Kingdom, Malaysia, the Philippines, 
Singapore, and Indonesia. The gross income generated by each of 
these companies for 2012 and 2013 is as follows:

------------------------------------------------------------------------
             Country                     2012                2013
------------------------------------------------------------------------
United States                                   $40                 $45
Canada                                           25                  15
New Zealand                                      10                  20
United Kingdom                                   30                  35
Malaysia                                         10                  12
Philippines                                       7                  10
Singapore                                        10                   8
Indonesia                                         5                  10
------------------------------------------------------------------------
  Total                                        $137                $155
------------------------------------------------------------------------

    For 2012, 10 percent of the gross income of this group is 
equal to $13.70. Only the United States, Canada, and the United 
Kingdom satisfy this requirement for that year. The other 
countries may be aggregated to meet this requirement. Because 
New Zealand and Malaysia have a total gross income of $20, and 
the Philippines, Singapore, and Indonesia have a total gross 
income of $22, these two groupings of countries may be treated 
as the fourth and fifth members of the group for purposes of 
subparagraph 5(b).
    In the following year, 10 percent of the gross income is 
$15.50. Only the United States, New Zealand, and the United 
Kingdom satisfy this requirement. Because Canada and Malaysia 
have a total gross income of $27, and the Philippines, 
Singapore, and Indonesia have a total gross income of $28, 
these two groupings of countries may be treated as the fourth 
and fifth members of the group for purposes of subparagraph 
5(b). The fact that Canada replaced New Zealand in a group is 
not relevant for this purpose. The composition of the grouping 
may change from year to year.
            Single Country Limitation
    Subparagraph 5(c) provides that the business activities 
carried on in any one country other than the headquarters 
company's State of residence must generate less than 50 percent 
of the gross income of the group. If the gross income 
requirement under this subparagraph is not met for a taxable 
year, the taxpayer may satisfy this requirement by applying the 
50 percent gross income test to the average of the gross 
incomes for the four years preceding the taxable year. The 
following example illustrates the application of this clause.
    Example. SHQ is a corporation resident in Spain. SHQ 
functions as a headquarters company for a group of companies. 
SHQ derives dividend income from a United States subsidiary in 
the 2008 taxable year. The state of residence of each of these 
companies, the situs of their activities and the amounts of 
gross income attributable to each for the years 2008 through 
2012 are set forth below.

----------------------------------------------------------------------------------------------------------------
                    Country                               Situs            2012    2011    2010    2009    2008
----------------------------------------------------------------------------------------------------------------
United States                                    U.S.                       $100    $100     $95     $90     $85
Mexico                                           U.S.                         10       8       5       0       0
Canada                                           U.S.                         20      18      16      15      12
United Kingdom                                   U.K                          30      32      30      28      27
New Zealand                                      N.Z.                         35      42      38      36      35
Japan                                            Japan                        35      32      30      30      28
Singapore                                        Singapore                    30      25      24      22      20
----------------------------------------------------------------------------------------------------------------
  Total                                                                     $260    $257    $238    $221    $207
----------------------------------------------------------------------------------------------------------------

    Because the United States' total gross income of $130 in 
2012 is not less than 50 percent of the gross income of the 
group, subparagraph 5(c) is not satisfied with respect to 
dividends derived in 2012. However, the United States' average 
gross income for the preceding four years may be used in lieu 
of the preceding year's average. The United States' average 
gross income for the years 2008-11 is $111.00 ($444/4). The 
group's total average gross income for these years is $230.75 
($923/4). Because $111 represents 48.1 percent of the group's 
average gross income for the years 2008 through 2011, the 
requirement under subparagraph 5(c) is satisfied.
            Other State Gross Income Limitation
    Subparagraph 5(d) provides that no more than 25 percent of 
the headquarters company's gross income may be derived from the 
other Contracting State. Thus, if the headquarters company's 
gross income for the taxable year is $200, no more than $50 of 
this amount may be derived from the other Contracting State. If 
the gross income requirement under this subparagraph is not met 
for a taxable year, the taxpayer may satisfy this requirement 
by applying the 25 percent gross income test to the average of 
the gross incomes for the four years preceding the taxable 
year.
            Independent Discretionary Authority
    Subparagraph 5(e) requires that the headquarters company 
have and exercise independent discretionary authority to carry 
out the functions referred to in subparagraph 5(a). Thus, if 
the headquarters company was nominally responsible for group 
financing, pricing, marketing and other management functions, 
but merely implemented instructions received from another 
entity, the headquarters company would not be considered to 
have and exercise independent discretionary authority with 
respect to these functions. This determination is made 
individually for each function. For instance, a headquarters 
company could be nominally responsible for group financing, 
pricing, marketing and internal auditing functions, but another 
entity could be actually directing the headquarters company as 
to the group financing function. In such a case, the 
headquarters company would not be deemed to have independent 
discretionary authority for group financing, but it might have 
such authority for the other functions. Functions for which the 
headquarters company does not have and exercise independent 
discretionary authority are considered to be conducted by an 
entity other than the headquarters company for purposes of 
subparagraph 5(a).
            Income Taxation Rules
    Subparagraph 2(f) requires that the headquarters company be 
subject to the generally applicable income taxation rules in 
its country of residence. This reference should be understood 
to mean that the company must be subject to the income taxation 
rules to which a company engaged in the active conduct of a 
trade or business would be subject. Thus, if one of the 
Contracting States has or introduces special taxation 
legislation that imposes a lower rate of income tax on 
headquarters companies than is imposed on companies engaged in 
the active conduct of a trade or business, or provides for an 
artificially low taxable base for such companies, a 
headquarters company subject to these rules is not entitled to 
the benefits of the Convention under paragraph 5.
            In Connection With or Incidental to Trade or Business
    Subparagraph 5(g) requires that the income derived in the 
other Contracting State be derived in connection with or be 
incidental to the active business activities referred to 
subparagraph 5(b). This determination is made under the 
principles set forth in paragraph 3. For instance, assume that 
a Spanish company satisfies the other requirements in paragraph 
5 and acts as a headquarters company for a group that includes 
a U.S. corporation. If the group is engaged in the design and 
manufacture of computer software, but the U.S. corporation is 
also engaged in the design and manufacture of photocopying 
machines, the income that the Spanish company derives from the 
United States would have to be derived in connection with or be 
incidental to the income generated by the computer business in 
order to be entitled to the benefits of the Convention under 
paragraph 5. Interest income received from the U.S. corporation 
also would be entitled to the benefits of the Convention under 
this subparagraph as long as the interest was attributable to 
the computer business supervised by the headquarters company. 
Interest income derived from an unrelated party would normally 
not, however, satisfy the requirements of this clause.

Paragraph 6 of Article 17

    Paragraph 6 of new Article 17 deals with the treatment of 
income in the context of a so-called ``triangular case.'' The 
term ``triangular case'' refers to the use of a structure like 
the one described in the following paragraph by a resident of 
the other Contracting State to earn income from the United 
States:
    A resident of Spain, who would, absent paragraph 6, qualify 
for benefits under one or more of the provisions of this 
Article, sets up a permanent establishment in a third state 
that imposes a low or zero rate of tax on the income of the 
permanent establishment. The resident of Spain lends funds into 
the United States through the permanent establishment. The 
permanent establishment, despite its third-jurisdiction 
location, is an integral part of the resident of Spain. 
Therefore, the income that it earns on those loans, absent the 
provisions of paragraph 6, is entitled to exemption from U.S. 
withholding tax under the Convention. Under a current income 
tax treaty between Spain and the host jurisdiction of the 
permanent establishment, the income of the permanent 
establishment is exempt from tax by Spain (alternatively, Spain 
may choose to exempt the income of the permanent establishment 
from income tax). Thus, the interest income, absent paragraph 
6, would be exempt from U.S. tax, subject to little or no tax 
in the host jurisdiction of the permanent establishment, and 
exempt from tax in Spain.
    Paragraph 6 provides that the tax benefits that would 
otherwise apply under the Convention will not apply to any item 
of income if the combined aggregate effective tax rate in the 
residence State and the third state is less than 60 percent of 
the general rate of company tax applicable in the residence 
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 6 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.
    Notwithstanding the level of tax on interest and royalty 
income of the permanent establishment, paragraph 6 will not 
apply under certain circumstances. In the case of royalties, 
paragraph 6 will not apply if the royalties are received as 
compensation for the use of, or the right to use, intangible 
property produced or developed by the permanent establishment 
itself. In the case of any other income, paragraph 6 will not 
apply if that income is derived in connection with, or is 
incidental to, the active conduct of a trade or business 
carried on by the permanent establishment in the third state. 
The business of making, managing or simply holding investments 
is not considered to be an active trade or business, unless 
these are securities activities carried on by a registered 
securities dealer.
    Paragraph 6 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 7 of New Article 17

    Paragraph 7 of new Article 17 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 may be granted 
benefits under the Convention at the discretion of the 
competent authority of the State from which benefits in certain 
circumstances. Such competent authority shall make the 
determination of whether the granting of benefits would be 
justified based on an evaluation of the extent to which such 
resident satisfies the requirements of paragraphs 2, 3, 4 or 5. 
Such competent authority shall also consider the opinion, if 
any of the competent authority of the other Contracting State 
as to whether under the circumstances it would be appropriate 
to grant such benefits.
    A competent authority 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 3. Further, the competent authority may establish 
conditions, such as setting time limits on the duration of any 
relief granted.
    For purposes of implementing paragraph 7, a taxpayer will 
be permitted to present his case to the relevant competent 
authority for an advance determination based on the facts. In 
these circumstances, it is also expected that, if the competent 
authority determines that benefits are to be allowed, they will 
be allowed retroactively to the time of entry into force of the 
relevant treaty provision or the establishment of the structure 
in question, whichever is later.
    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 treaty-based relief 
from double taxation under Article 24 (Relief from Double 
Taxation), but it does not meet any of the objective tests of 
paragraphs 2 through 5, it may apply to the U.S. competent 
authority for discretionary relief.

Paragraph 8 of New Article 17

    Paragraph 8 of new Article 17 defines several key terms for 
purposes of Article 17. Each of the defined terms is discussed 
above in the context in which it is used.

                               ARTICLE X

    Article X of the Protocol amends Article 20 (Pensions, 
Annuities, Alimony and Child Support) of the existing 
Convention by adding a new paragraph 5.

New Paragraph 5 of Article 20

    New paragraph 5 provides that, if a resident of a 
Contracting State participates in a pension fund established in 
the other Contracting State, the State of residence will not 
tax the income of the pension fund with respect to that 
resident until a distribution is made from the pension fund. 
Thus, for example, if a U.S. citizen contributes to a U.S. 
qualified plan while working in the United States and then 
establishes residence in Spain, paragraph 5 prevents Spain from 
taxing currently the plan's earnings and accretions with 
respect to that individual. When the resident receives a 
distribution from the pension fund, that distribution may be 
subject to tax in the State of residence, subject to paragraph 
1 of Article 20.

                               ARTICLE XI

    Article XI of the Protocol replaces paragraph 3 of Article 
25 (Non-Discrimination) of the existing Convention in order to 
conform to changes made by the deletion of Article 14 and the 
changes made to Article 10 dealing with the taxation of branch 
profits tax. It clarifies that nothing in Article 25 should be 
construed as preventing either Contracting State from imposing 
a tax described in paragraph 8 of Article 10 (Dividends) as 
revised by Article IV.

                              ARTICLE XII

    Article XII of the Protocol makes amendments to Article 26 
(Mutual Agreement Procedure) of the existing Convention, which 
deals with the mutual agreement procedure. In particular, 
Article XII of the Protocol incorporates into Article 26 rules 
that provide for mandatory binding arbitration to resolve 
certain cases that the competent authorities of the Contracting 
States have been unable to resolve after a reasonable amount of 
time.

New Paragraph 5 of Article 26

    New paragraph 5 provides that a case shall be resolved 
through mandatory binding arbitration when a ``concerned 
person'' as defined in subparagraph 6(a) has presented a case 
to the competent authority of either Contracting State on the 
basis that the actions of one or both of the Contracting States 
have resulted for that person in taxation not in accordance 
with the provisions of the Convention, and the competent 
authorities of the Contracting States have not been able to 
reach an agreement to resolve the case, and if the conditions 
specified in this paragraph and in paragraph 6 are satisfied. 
The mandatory binding arbitration provision is an extension of 
(as opposed to an alternative to) the interaction between the 
competent authorities as provided in the mutual agreement 
procedure. Accordingly, only cases that have first been 
negotiated by the competent authorities pursuant to Article 26 
shall be eligible for arbitration.
    An initial condition set forth in paragraph 5 is that a 
concerned person has presented a case to the competent 
authority of either Contracting State on the basis that the 
actions of one or both of the Contracting States have resulted 
for that person in taxation not in accordance with the 
provisions of the Convention. Such taxation should be 
considered to have resulted from the actions of one or both of 
the Contracting States as soon as, for example, tax has been 
paid, assessed, or otherwise determined, or even in cases where 
the taxpayer is officially notified by the tax authorities that 
they intend to tax him on a certain element of income. As 
provided in paragraph 18 of the Protocol of 1990 as revised by 
Article XIV of the Protocol, in the case of the United States, 
such notification would take the form of a notice of proposed 
adjustment, and in Spain, such notification would include a 
notification of the Administrative Act of Assessment.
    The additional conditions that must be satisfied before a 
case may be resolved through arbitration are set forth in 
subparagraphs 5(a) through 5(e). Subparagraph 5(a) provides 
that tax returns must be filed with at least one of the 
Contracting States with respect to the taxable years at issue 
in the case. Subparagraph 5(b) provides that the case may not 
be a case that the competent authorities have mutually agreed 
before the date on which arbitration proceedings would 
otherwise have begun, is not suitable for determination by 
arbitration. Subparagraph 5(c) provides that an unresolved case 
shall not be submitted to arbitration if a decision on such 
case has already been rendered by a court or administrative 
tribunal of either Contracting State. Subparagraph 5(d) 
provides that the case must not involve a determination under 
paragraph 3 of Article 4 (Residence) dealing with dual resident 
entities. Finally, subparagraph 5(e) provides that the 
provisions of subparagraph 6(c), described below, which sets 
forth the rule governing the date on which an arbitration 
proceeding shall commence, must be satisfied.

New paragraph 6 of Article 26

    New paragraph 6 sets forth additional rules and definitions 
to be used in applying the arbitration provisions. Subparagraph 
6(a) defines the term ``concerned person'' as the person that 
brought the case to competent authority for consideration under 
Article 26 and all other persons, if any, whose tax liability 
to either Contracting State may be directly affected by a 
mutual agreement arising from that consideration. For example, 
a concerned person would include a U.S. corporation that brings 
a transfer pricing case with respect to a transaction entered 
into with its subsidiary in Spain for resolution to the U.S. 
competent authority, as well as the subsidiary, which may seek 
a correlative adjustment as a result of the resolution of the 
case.
    Subparagraph 6(b) defines the term ``commencement date'' as 
the earliest date on which the information necessary to 
undertake substantive consideration for a mutual agreement has 
been received by the competent authorities of both Contracting 
States. The competent authority of the United States will be 
considered to have received the information necessary to 
undertake substantive consideration for a mutual agreement on 
the date that it has received the information that must be 
submitted pursuant to Rev Proc. 2006-54, 2006-2 C.B. 1035,' 
4.05 (or any similarly applicable or successor procedures). The 
competent authority of Spain will be considered to have 
received the information necessary to undertake substantive 
consideration for a mutual agreement on the date it has 
received the information that must be submitted pursuant to 
Article 6 of Royal Decree 1794/2008 of November 3 (or any 
similarly applicable or successor procedures). The information 
shall not be considered received until both competent 
authorities have received copies of all materials submitted to 
either Contracting State by the concerned person(s) in 
connection with the mutual agreement procedure.
    Subparagraph 6(c) provides that an arbitration proceeding 
shall begin on the latest of four dates: (i) two years from the 
commencement date of that case (unless both competent 
authorities have previously agreed to a different date), (ii) 
the date upon which the present of the case has submitted a 
written request to a competent authority for a resolution of 
the case through arbitration, (iii) the earliest date upon 
which all concerned persons have entered into a confidentiality 
agreement and the agreements have been received by both 
competent authorities, or (iv) the date on which all legal 
actions or suits pending before the courts of either 
Contracting State concerning any issue involved in the care are 
suspended or withdrawn (as applicable) under the laws of the 
Contracting State in which the legal actions or suits are 
pending.
    Clause (i) of this subparagraph permits the competent 
authorities of the Contracting States to mutually agree to 
initiate arbitration proceedings on a date other than two years 
after the commencement date. This could be the case, for 
instance, if the negotiation of a case between the competent 
authorities was nearing completion and could be expected to be 
resolved in an additional short period of time, thus avoiding 
the need for an arbitration proceeding. As another example, if 
under paragraphs 5 and 6 arbitration proceedings would be 
initiated on the same date for a large number of cases, clause 
(i) would allow the competent authorities of the Contracting 
States to agree to establish different dates (including 
accelerated dates) to initiate arbitration proceedings for such 
cases in order to avoid having multiple arbitration proceedings 
take place at the same time. Clause (i) requires that the 
competent authorities of the Contracting States notify the 
presenter of the case of any such agreements.
    Clause (ii) of this subparagraph provides that the 
presenter of the case must submit a written request to the 
competent authority for a resolution of the case through 
arbitration. However, the presenter of the case may not submit 
such written request prior to the completion of the two year 
period after the commencement date described in clause (i).
    Clause (iii) of this subparagraph requires that all 
concerned persons and their authorized representatives or 
agents agree in writing prior to the beginning of an 
arbitration proceeding not to disclose to any other person any 
information received during the course of the arbitration 
proceeding from either Contracting State or the arbitration 
panel, other than the determination of the panel. A 
confidentiality agreement may be executed by any concerned 
person that has the legal authority to bind any other concerned 
person on the matter. For example, a parent corporation with 
the legal authority to bind its subsidiary with respect to 
confidentiality may execute a comprehensive confidentiality 
agreement on its own behalf and that of its subsidiary.
    Clause (iv) of this subparagraph requires that in the event 
that any issue involved in the case that is potentially subject 
to arbitration is the subject of any legal actions or suits 
pending before the courts of either Contracting States, such 
legal action must be either suspended or withdrawn as 
applicable under the laws of the Contracting State in which 
such legal actions or suits are pending.
    Subparagraph 6(d) provides that the determination of the 
arbitration panel shall constitute a resolution by mutual 
agreement under Article 26 and thus shall be binding on the 
Contracting States. As is the case with any negotiated 
resolution between the competent authorities pursuant to the 
mutual agreement procedure, the presenter of the case preserves 
the right not to accept the determination of the arbitration 
panel.
    Subparagraph 6(e) provides that for purposes of an 
arbitration proceeding under paragraphs 5 and 6 of Article 26, 
the members of the arbitration panel and their staff shall be 
considered ``persons or authorities'' to whom information may 
be disclosed under Article 27 (Exchange of Information and 
Administrative Assistance) of the Convention as revised by 
Article XIII.
    Subparagraph 6(f) sets forth the confidentiality 
obligations of the competent authorities of the Contracting 
States as well as the members of the arbitration panel and 
their staffs regarding an arbitration proceeding. Subparagraph 
6(g) provides that no information relating to an arbitration 
proceeding (including the arbitration panel's determination) 
may be disclosed by the competent authorities of the 
Contracting States, except as permitted by this Convention and 
the domestic laws of the Contracting States. In addition, all 
material prepared in the course of, or relating to, an 
arbitration proceeding shall be considered to be information 
exchanged between the Contracting States. Subparagraph 6(f) 
requires that all members of the arbitration panel and their 
staff make statements in writing not to disclose any 
information relating to an arbitration proceeding (including 
the arbitration panel's determination), and to abide by and be 
subject to the confidentiality and nondisclosure provisions of 
Article 27 of this Convention and the applicable domestic laws 
of the Contracting States. In the event those provisions 
conflict, the most restrictive condition shall apply. These 
statements from the members of the arbitration panel shall also 
include confirmation of their appointment to the arbitration 
panel.
    Subparagraph 6(g) sets forth a non-exhaustive list of items 
related to the time periods and procedures related to 
conducting an arbitration proceeding that the competent 
authorities of the Contracting States must agree to in order to 
ensure the effective and timely implementation of the 
provisions of paragraph 5 and 6 of Article 26. Such agreement 
must be consistent with the provisions of paragraphs 5 and 6 of 
Article 25 and paragraph 21 of the Protocol of 1990 as amended 
by Article XIV, and shall take the form of published guidance 
before the date that the first arbitration proceeding 
commences. Subparagraph 6(g) lists the following items for 
which the competent authorities of the Contracting States shall 
agree on time frames and procedures for:

          i) notifying the presenter of the case of any 
        agreements pursuant to either subparagraph 5(b) that 
        the case is not suitable for resolution through 
        arbitration, or clause i) of subparagraph 5(c) to 
        change the date on which an arbitration proceeding 
        could begin;
          ii) obtaining the statements of each concerned 
        person, authorized representative or agent, and member 
        of the arbitration panel (including their staff), in 
        which each such person agrees not to disclose to any 
        other person any information received during the course 
        of the arbitration proceeding from the competent 
        authority of either Contracting State or the 
        arbitration panel, other than the determination of such 
        panel;
          iii) the appointment of the members of the 
        arbitration panel;
          iv) the submission of proposed resolutions, position 
        papers, and reply submissions by the competent 
        authorities of the Contracting States to the 
        arbitration panel;
          v) the submission by the presenter of the case of a 
        paper setting forth the presenter's views and analysis 
        of the case for consideration by the arbitration panel;
          vi) the delivery by the arbitration panel of its 
        determination to the competent authorities of the 
        Contracting States;
          vii) the acceptance or rejection by the presenter of 
        the case of the determination of the arbitration panel; 
        and
          vii) the adoption by the arbitration panel of any 
        additional procedures necessary for the conduct of its 
        business.

    Paragraph 6 also provides that the competent authorities of 
the Contracting States may agree in writing on such other 
rules, time periods or procedures as may be necessary for the 
effective and timely implementation of the provisions of 
paragraphs 5 and 6 of Article 26.

                              ARTICLE XIII

    Article XIII of the Protocol replaces Article 27 (Exchange 
of Information and Administrative Assistance) of the existing 
Convention. This Article provides for the exchange of 
information between the competent authorities of the 
Contracting States. While mutual agreement procedures are 
addressed in Article 26, exchanges of information for purposes 
of the mutual agreement procedures are governed by this 
Article.

Paragraph 1 of New Article 27

    The obligation to obtain and provide information to the 
other Contracting State is set out in paragraph 1 of new 
Article 27. The information to be exchanged is that which may 
be is foreseeably 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 of the OECD Model. The Contracting States intend for 
the phrase ``is foreseeably relevant'' to be interpreted to 
permit the exchange of information that ``may be relevant'' for 
purposes of 26 U.S.C. Section 7602 of the Code, 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. Thus, the language of paragraph 1 
is intended to provide for exchange of information in tax 
matters to the widest extent possible, while clarifying that 
Contracting States are not at liberty to engage in ``fishing 
expeditions'' or otherwise to request information that is 
unlikely to be relevant to the tax affairs of a given taxpayer.
    Consistent with the OECD Model, a request for information 
does not constitute a ``fishing expedition'' solely because it 
does not provide the name or address (or both) of the taxpayer 
under examination or investigation. In cases where the 
requesting State does not provide the name or address (or both) 
of the taxpayer under examination or investigation, the 
requesting State must provide other information sufficient to 
identify the taxpayer. Similarly, paragraph 1 does not 
necessarily require the request to include the name and/or 
address of the person believed to be in possession of the 
information.
    The standard of ``foreseeable relevance'' can be met in 
cases dealing with both one taxpayer (whether identified by 
name or otherwise) or several taxpayers (whether identified by 
name or otherwise). Where a Contracting State undertakes an 
investigation into an ascertainable group or category of 
persons in accordance with its laws, any request related to the 
investigation will typically serve the objective of carrying 
out the domestic tax laws of the requesting State 
administration or enforcement of its domestic laws and thus 
will comply with the requirements of paragraph 1, provided it 
meets the standard of ``foreseeable relevance.'' In such cases, 
the requesting State should provide, supported by a clear 
factual basis, a detailed description of the group or category 
of persons and of the specific facts and circumstances that 
have led to the request, as well as an explanation of the 
applicable law and why there is reason to believe that the 
taxpayers in the group or category of persons for whom 
information is requested have been non-compliant with that law 
supported by a clear factual basis. The requesting State should 
further show that the requested information would assist in 
determining compliance by the taxpayers in the group or 
category of persons.
    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 under this Article, 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 subparagraph 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, taxes of every kind imposed by a 
Contracting State at the national level. Accordingly, the 
competent authorities may request and provide information for 
cases under examination or criminal investigation, in 
collection, on appeals, or under prosecution, and information 
may be exchanged with respect to U.S. estate and gift taxes. In 
contrast, paragraph 7, which relates to collection assistance, 
applies only to those taxes covered for general purposes of the 
Convention as defined in Article 2 (Taxes Covered).
    Information exchange is not restricted by paragraph 1 of 
Article 1. 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 the other 
Contracting State, 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 the other 
Contracting State, 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 the other Contracting State 
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 or territories for most purposes of the Convention, 
section 7651 of the Code authorizes the Internal Revenue 
Service to utilize the administrative and enforcement 
provisions of the Code in the U.S. possessions or territories, 
including to obtain information 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 other U.S. possession or territory government 
agency), or a third party located in a U.S. possession or 
territory.
    The final sentence of paragraph 1 provides that the 
requesting Contracting State may specify the form in which 
information is to be provided (e.g., authenticated copies of 
original documents (including books, papers, statements, 
records, accounts, and writings)). 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 2 of New Article 27

    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. The confidentiality rules cover 
communications between the competent authorities (including the 
letter requesting information) as well as references to 
exchanged information that may occur in other documents, such 
as advice by government attorneys to their respective competent 
authorities. At the same time, it is understood that the 
requested State can disclose the minimum information contained 
in a competent authority letter (but not the letter itself) 
necessary for the requested State to be able to obtain or 
provide the requested information to the requesting State, 
without frustrating the efforts of the requesting State. If, 
however, court proceedings or the like under the domestic laws 
of the requested State necessitate the disclosure of the 
competent authority letter itself, the competent authority of 
the requested State may disclose such a letter unless the 
requesting State otherwise specifies.
    Information received may be disclosed only to persons or 
authorities, including courts and administrative bodies, 
involved in the assessment, collection, or administration of, 
the enforcement or prosecution in respect of, or the 
determination of appeals in relation to, the taxes referred to 
in paragraph 1. Under this standard, information may be 
communicated to the taxpayer or his proxy. The information must 
be used by these persons only for the purposes mentioned in 
paragraph 2. Information may also be disclosed to legislative 
bodies, such as the tax-writing committees of the U.S. Congress 
and the U.S. 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.
    In situations in which the requested State determines that 
the requesting State does not comply with its duties regarding 
the confidentiality of the information exchanged under this 
Article, the requested State may suspend assistance under this 
Article until such time as proper assurance is given by the 
requesting State that those duties will indeed be respected. If 
necessary, the competent authorities may enter into specific 
arrangements or memoranda of understanding regarding the 
confidentiality of the information exchanged under this 
Article.
    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 a mutual legal 
assistance treaty in force between the Contracting States that 
allows for the exchange of tax information.

Paragraph 3 of New Article 27

    Paragraph 3 of new Article 27 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 of New Article 27

    Paragraph 4 of new Article 27 provides that when 
information is requested by a Contracting State in accordance 
with this Article, the other Contracting State is obligated to 
obtain the requested information as if the tax in question were 
the tax of the requested State, even if that State has no 
direct tax interest in the case to which the request relates. 
In the absence of such a paragraph, some taxpayers have argued 
that subparagraph 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 of New Article 27

    Paragraph 5 of new Article 27 provides that a Contracting 
State may not decline to provide information because that 
information is held by banks, other financial institutions, 
nominees or persons acting in an agency or fiduciary capacity 
or because it relates to ownership interests in a person. 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.
    Subparagraphs 3 (a) and (b) do not permit the requested 
State to decline a request where paragraph 4 or 5 applies. 
Paragraph 5 would apply, for instance, in situations in which 
the requested State's inability to obtain the information was 
specifically related to the fact that the requested information 
was believed to be held by a bank or other financial 
institution. Thus, the application of paragraph 5 includes 
situations in which the tax authorities' information gathering 
powers with respect to information held by banks and other 
financial institutions are subject to different requirements 
than those that are generally applicable with respect to 
information held by persons other than banks or other financial 
institutions. This would, for example, be the case where the 
tax authorities can only exercise their information gathering 
powers with respect to information held by banks and other 
financial institutions in instances where specific information 
on the taxpayer under examination or investigation is 
available. This would also be the case where, for example, the 
use of information gathering measures with respect to 
information held by banks and other financial institutions 
requires a higher probability that the information requested is 
held by the person believed to be in possession of the 
requested information than the degree of probability required 
for the use of information gathering measures with respect to 
information believed to be held by persons other than banks or 
financial institutions.

Paragraph 6 of New Article 27

    Paragraph 6 of new Article 27 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 of New Article 27

    Paragraph 7 provides for assistance in collection of taxes 
to the extent necessary to ensure that treaty benefits are 
enjoyed only by persons entitled to those benefits under the 
terms of the Convention. Under paragraph 7, a Contracting State 
will endeavor to collect on behalf of the other State only 
those amounts necessary to ensure that any exemption or reduced 
rate of tax granted under the Convention by that other State is 
not enjoyed by persons not entitled to those benefits. For 
example, if the payer of a U.S.-source portfolio dividend 
receives a Form W-8BEN or other appropriate documentation from 
the payee, the withholding agent is permitted to withhold at 
the portfolio dividend rate of 15 percent. If, however, the 
addressee is merely acting as a nominee on behalf of a third-
country resident, paragraph 7 would obligate Spain to withhold 
and remit to the United States the additional tax that should 
have been collected by the U.S. withholding agent.
    This paragraph also makes clear that the Contracting State 
asked to collect the tax is not obligated, in the process of 
providing collection assistance, to carry out administrative 
measures that are different from the laws or administrative 
practice of either Contracting State from those used in the 
collection of its own taxes, or that would be contrary to its 
sovereignty, security, or public policy.

Paragraph 8 of New Article 27

    Paragraph 8 of new Article 27 states that the competent 
authorities of the Contracting States may develop an agreement 
concerning the mode of application of the Article. The Article 
authorizes the competent authorities to exchange information on 
an automatic 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.
            Effective dates and termination in relation to exchange of 
                    information
    Once the Protocol is in force, the competent authority may 
seek information under the Protocol with respect to a year 
prior to the entry into force of the Protocol. In that case, 
the competent authorities have available to them the full range 
of information exchange provisions afforded under this Article.
    In contrast, if the provisions of new Article 27 were to 
terminate in accordance with the provisions of Article 30 
(Termination) of the existing Convention, it would cease to 
authorize, as of the date of termination, any exchange of 
information, even with respect to a year for which the Protocol 
was in force. In such case, the tax administrations of the two 
countries would only be able to exchange information to the 
extent allowed under either domestic law or another 
international agreement or arrangement.

                              ARTICLE XIV

    This Article makes a number of amendments to the Protocol 
of 1990.

Paragraph 1

    Paragraph 1 amends paragraph 5 of the Protocol of 1990 by 
deleting subparagraph 5(b) and renaming subparagraph 5(c) as 
subparagraph 5(b). Existing subparagraph 5(b) was deleted 
because it is no longer necessary, given the inclusion into 
Article 1 (General Scope) of the Convention of new paragraph 6, 
pursuant to Article 1 of this Protocol.

Paragraph 2

    Paragraph 2 replaces paragraph 7 of the Protocol of 1990. 
In the case of Spain, new subparagraph 7(a) provides special 
rules regarding dividend withholding on dividends paid by 
certain Spanish entities. Clause (i) provides that the 5 
percent withholding limitation provided in subparagraph 2(a) of 
Article 10 (Dividends) shall not apply in the case of dividends 
paid by an entity regulated under the law 11/2009 of 26th 
October on Sociedades Anonimas Cotizadas de Inversion en el 
Mercado Inmobiliario (SOCIMI) or successor statutes. Instead, 
the 15 percent withholding limitation provided in subparagraph 
2(b) of Article 10, or the exemption from withholding provided 
in paragraph 4 of Article 10 for dividends paid to pension 
funds, as the case may be, shall apply with respect to such 
dividends, but only if the beneficial owner of the dividends 
holds, directly or indirectly, capital that represents no more 
than 10 percent of all of the capital in the SOCIMI. Clause 
(ii) provides that the 5 percent withholding limitation shall 
also not apply in the case of dividends paid by a Spanish 
investment institution regulated under the law 35/2003 of 4th 
November on Instituciones de Inversion Colectiva or successor 
statutes. Instead, the 15 percent withholding limitation 
provided in subparagraph 2(b) of Article 10, or the exemption 
from withholding provided in paragraph 4 of Article 10 for 
dividends paid to pension funds, as the case may be, shall 
apply with respect to such dividends.
    In the case of the United States, new subparagraph 7(b) 
imposes limitations on the rate reductions provided by 
subparagraph 2(a) of revised Article 10 in the case of 
dividends paid by a regulated investment company (RIC) or a 
real estate investment trust (REIT). The first sentence of new 
subparagraph 7(b) provides that dividends paid by a RIC or REIT 
are not eligible for the 5 percent rate of withholding tax of 
subparagraph 2(a) of revised Article 10. The second sentence of 
new subparagraph 7(b) provides that the 15 percent maximum rate 
of withholding tax of subparagraph 2(b) of revised Article 10 
applies to dividends paid by RICs and that the elimination of 
source-country withholding tax of paragraph 4 of revised 
Article 10 applies to dividends paid by RICs and beneficially 
owned by a pension fund.
    The third sentence of new subparagraph 7(b) 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 4 of revised Article 10 
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.''
    New subparagraph 7(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. Section 856(e) 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.

Paragraph 3

    Paragraph 3 replaces paragraph 8 of the Protocol of 1990. 
New paragraph 8 provides a definition of the term ``real estate 
mortgage investment conduit (REMIC)'' for purposes of revised 
Article 11 (Interest) of the Convention as amended by Article 
V. The term means an entity that has in effect an election to 
be treated as a REMIC under Code Section 860D.

Paragraph 4

    Paragraph 4 deletes subparagraph 10(c) of the Protocol of 
1990 as a conforming change to the amendments made to Article 
13 (Capital Gains) of the Convention by Article VII.

Paragraph 5

    Paragraph 5 deletes paragraph 11 of the Protocol of 1990 as 
a conforming change to the deletion of Article 14 (Branch Tax) 
of the Convention by Article VIII.

Paragraph 6

    Paragraph 6 deletes paragraph 12 of the Protocol of 1990. 
Prior paragraph 12 referred to Commentary on Article 14 
(Independent Personal Services) of the 1977 Model Convention 
for the Avoidance of Double Taxation with Respect to Taxes on 
Income and on Capital of the Organisation for Economic 
Cooperation and Development, and of any guidelines which, for 
the application of such Article, may be developed in the 
future. The deletion of prior paragraph 12 ensures that the 
Contracting States can interpret Article 14 (Independent 
Personal Services) of the Convention in an ambulatory manner 
and consistently with the prevailing Commentaries of the OECD 
Model.

Paragraph 7

    Paragraph 7 amends paragraph 13 of the Protocol of 1990. 
Revised paragraph 13 describes in a non-exhaustive fashion 
those entities to which clause (ii) of subparagraph 2(d) of 
revised Article 17 (Limitation on Benefits) as restated by 
Article IX applies. Because under Spain's current domestic law, 
a number of the entities described, including pension funds 
established in Spain, are not exempt from tax, the words ``tax 
exempt'' have been deleted from paragraph 13.

Paragraph 8

    Paragraph 8 replaces paragraph 18 of the Protocol of 1990. 
New paragraph 8 defines the term ``first notification'' for the 
purposes of applying paragraph 1 of Article 26 (Mutual 
Agreement Procedure) of the Convention. The term means, in the 
case of the United States, the Notice of Proposed Adjustment, 
and in the case of Spain, the Notification of the 
Administrative Act of Assessment.
    With respect to paragraph 5 of Article 26 as amended by 
Article XII, paragraph 8 clarifies when taxation not in 
accordance with the Convention shall be considered to have 
resulted from the actions of one or both of the Contracting 
States. The Contracting States understand that an action of 
either Contracting State that has resulted in taxation not in 
accordance with the provisions of the Convention shall include 
a Notice of Proposed Adjustment, a Notification of the 
Administrative Act of Assessment or in the case of taxes at 
source, a payment or withholding of tax.

Paragraph 9

    Paragraph 9 deletes paragraph 19 of the Protocol of 1990. 
The deletion of prior paragraph 19 permits the Contracting 
States to interpret Article 27 (Exchange of Information and 
Administrative Assistance) of the Convention as amended by 
Article XIII, in an ambulatory manner and consistently with the 
prevailing Commentaries of the OECD Model.

Paragraph 10

    Paragraph 10 adds a new paragraph 21 to the Protocol of 
1990. New paragraph 21 sets forth a number of principles 
related to the implementation of the mandatory binding 
arbitration rules provided in new paragraphs 5 and 6 of Article 
26 (Mutual Agreement Procedure).
    New subparagraph 21(a) of the Protocol to 1990 sets forth 
rules that the competent authorities of the Contracting States 
shall follow for selecting the members of the arbitration 
panel. The arbitration panel shall consist of three individual 
members. The members appointed shall not be employees nor have 
been employees within the twelve-month period prior to the date 
on which the arbitration proceeding begins, of the tax 
administration, the Treasury Department or the Ministry of 
Finance of the Contracting State which identifies them. Each 
competent authority of the Contracting States shall select one 
member of the arbitration panel. The two members of the 
arbitration panel who have been selected shall select the third 
member, who shall serve as Chair of the arbitration panel. If 
the two initial members of the arbitration panel fail to select 
the third member in the manner and within the time periods 
prescribed by the competent authorities of the Contracting 
States pursuant to subparagraph 6(g)(iii) of Article 26 of the 
Convention, these members shall be dismissed, and each 
competent authority of the Contracting States shall select a 
new member of the arbitration panel. The Chair shall not be a 
national or lawful permanent resident of either Contracting 
State.
    New subparagraph 21(b) of the Protocol of 1990 provides 
that if at any time before the arbitration panel delivers a 
determination to the competent authorities certain events 
occur, notwithstanding the initiation of an arbitration 
proceeding, the arbitration proceeding and the mutual agreement 
procedure with respect to a case shall terminate.
    Clause (i) provides that the arbitration proceeding and the 
mutual agreement procedure with respect to a case shall 
terminate if the competent authorities of the Contracting 
States reach a mutual agreement to resolve the case. Clause 
(ii) provides that the arbitration proceeding and the mutual 
agreement procedure with respect to a case shall terminate if 
the presenter of the case withdraws the request for 
arbitration, as is the case for the mutual agreement procedure 
as a general matter. Clause (iii) provides that the arbitration 
proceeding and the mutual agreement procedure with respect to a 
case shall terminate if any concerned person, or any of their 
representatives or agents, willfully violates the written 
statement of nondisclosure referred to in clause (iii) of 
subparagraph (c) of paragraph 6, and the competent authorities 
of both Contracting States agree that such violation should 
result in the termination of the arbitration proceeding. 
Finally, clause (iv) provides that the arbitration proceeding 
and the mutual agreement procedure with respect to a case shall 
terminate if any concerned person initiates a legal action or 
suit before the courts of either Contracting State concerning 
any issue involved in the case, unless such legal action or 
suit is suspended according to the applicable laws of the 
Contracting State.
    New subparagraph 21(c) of the Protocol to 1990 sets forth 
the rule governing the submission of proposed resolutions for 
consideration by the arbitration panel. The competent authority 
of each of the Contracting States shall be permitted to submit 
a proposed resolution addressing each adjustment or similar 
issue raised in the case. Such proposed resolution shall be a 
resolution of the entire case and shall reflect without 
modification all matters in the case previously agreed between 
the competent authorities of both of the Contracting States. 
Such proposed resolution shall be limited to a disposition of 
specific monetary amounts (for example, of income, profit, gain 
or expense) or, where specified, the maximum rate of tax 
charged pursuant to the Convention for each adjustment or 
similar issue in the case. The competent authority of each of 
the Contracting States shall also be permitted to submit a 
supporting position paper for consideration by the arbitration 
panel.
    New subparagraph 21(d) of the Protocol of 1990 provides a 
special rule for proposed resolutions involving an initial 
determination of a threshold question (such as the existence of 
a permanent establishment). Subparagraph 21(d) provides that 
notwithstanding the provisions of subparagraph 21(c), it is 
understood that, in the case of an arbitration proceeding 
concerning: i) the tax liability of an individual with respect 
to whose State of residence the competent authorities have been 
unable to reach agreement; ii) the taxation of the business 
profits of an enterprise with respect to which the competent 
authorities have been unable to reach an agreement on whether a 
permanent establishment exists; or iii) such other issues the 
determination of which are contingent on resolution of similar 
threshold questions, the proposed resolutions and position 
papers may include positions regarding the relevant threshold 
questions in clause i), ii) or iii) above (for example, the 
question of whether a permanent establishment exists), in 
addition to proposed resolutions to the contingent 
determinations (for example, the determination of the amount of 
profit attributable to such permanent establishment). The 
determination of the arbitration panel regarding the initial 
threshold question may preclude the need for a further 
determination regarding contingent determinations.
    New subparagraph 21(e) of the Protocol of 1990 provides 
that where an arbitration proceeding concerns a case comprising 
multiple adjustments or issues each requiring a disposition of 
specific monetary amounts of income, profit, gain or expense 
or, where specified, the maximum rate of tax charged pursuant 
to the Convention, the proposed resolution may propose a 
separate disposition for each adjustment or similar issue. This 
flexibility permits each adjustment or issue to be resolved 
independently through the arbitration proceeding, such that the 
determination of the arbitration panel will constitute a mutual 
agreement of the entirety of the issues in the case.
    New subparagraph 21(f) of the Protocol of 1990 provides 
that each of the competent authorities of the Contracting 
States shall receive the proposed resolution and position paper 
submitted by the other competent authority, and shall be 
permitted to submit a reply submission to the arbitration 
panel. Each of the competent authorities of the Contracting 
States shall also receive the reply submission of the other 
competent authority.
    New subparagraph 21(g) of the Protocol of 1990 provides 
that the presenter of the case shall be permitted to submit for 
consideration by the arbitration panel a paper setting forth 
the presenter's analysis and views of the case. The submission 
by the presenter of the case is not a proposed resolution that 
the arbitration panel could select in making its determination. 
The submission by the presenter may not include any information 
not previously provided to the competent authorities prior to 
the initiation of an arbitration proceeding. The competent 
authorities should determine an appropriate time frame for 
submission of such paper by the presenter in order to ensure 
that the competent authorities have sufficient time to consider 
the information.
    New subparagraph 21(h) of the Protocol of 1990 provides 
that the arbitration panel shall deliver a determination in 
writing to the competent authorities of the Contracting States. 
The determination reached by the arbitration panel in the 
arbitration proceeding shall be limited to one of the proposed 
resolutions for the case submitted by one of the competent 
authorities of the Contracting States for each adjustment or 
similar issue and any threshold questions, and shall not 
include a rationale or any other explanation of the 
determination. The determination of the arbitration panel shall 
have no precedential value with respect to the application of 
the Convention in any other case.
    New subparagraph 21(i) of the Protocol of 1990 provides 
that unless the competent authorities of both Contracting 
States agree to a longer time period, the presenter of the case 
shall have 45 days from receiving the determination of the 
arbitration panel to notify, in writing, the competent 
authority of the Contracting State to whom the case was 
presented, his acceptance of the determination. In the event 
the case is pending in litigation, each concerned person who is 
a party to the litigation must also advise, within the same 
time frame, the relevant court of its acceptance of the 
determination of the arbitration panel as the resolution by 
mutual agreement and its intention to withdraw from the 
consideration of the court the issues resolved through the 
proceeding. If any concerned person fails to so advise the 
relevant competent authority and relevant court within this 
time frame, the determination of the arbitration panel shall be 
considered not to have been accepted by the presenter of the 
case. Where the determination of the arbitration panel is not 
accepted, the case will not be eligible for any subsequent 
further consideration by the competent authorities.
    New subparagraph 21(j) of the Protocol of 1990 provides 
that the fees and expenses of the members of the arbitration 
panel, as well as any costs incurred in connection with the 
proceeding by the Contracting States, shall be borne equitably 
by the competent authorities of Contracting States.

                               ARTICLE XV

    This Article contains rules for bringing the Protocol into 
force and giving effect to its provisions.

Paragraph 1

    Paragraph 1 obligates the governments of the Contracting 
States to notify each other through diplomatic channels when 
the internal procedures required by each Contracting State for 
the entry into force of the Protocol have been complied with. 
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 protocol or treaty, an instrument of 
ratification is drafted for the President's signature. The 
President's signature completes the process in the United 
States.

Paragraph 2

    Paragraph 2 provides that the Protocol will enter into 
force three months following the date of the later of the Notes 
referred to in paragraph 1. 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 subparagraph 2(a), the Protocol will have effect with 
respect to taxes withheld at source (principally dividends, 
interest and royalties) for amounts paid or credited on or 
after the date on which the Protocol enters into force. For 
example, if the later of the Notes referred to in paragraph 1 
is dated April 25 of a given year, the withholding rates 
specified in new Article 11 of the Convention as amended by 
Article V of the Protocol would be applicable to any interest 
paid or credited on or after July 25 of that year. This rule 
allows the benefits of the withholding reductions to be put 
into effect without waiting until the following year. The delay 
of three 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.
    Under subparagraph 2(b), the Protocol will have effect with 
respect to taxes determined with reference to a taxable period 
beginning on or after the date on which the Protocol enters 
into force.
    For all other taxes, subparagraph 2(c) specifies that the 
Protocol will have effect on or after the date on which the 
Protocol enters into force.

Paragraph 3

    Paragraph 3 sets forth additional rules regarding the 
applicability of the mandatory binding arbitration rules 
provided in paragraphs 5, 6 of revised Article 26 of the 
Convention as amended by Article XII of the Protocol.
    Under paragraph 3, paragraphs 5 and 6 of revised Article 26 
of the Convention are not effective for cases that are under 
consideration by the competent authorities as of the date on 
which the Protocol enters into force. For cases that come under 
such consideration after the Protocol enters into force, the 
provision of paragraphs 5 and 6 of revised Article 26 of the 
Convention shall have effect on the date on which the competent 
authorities agree in writing on a mode of application pursuant 
to subparagraph (g) of paragraph 6 of Article 26. In addition, 
the commencement date for cases that are under consideration by 
the competent authorities as of the date on or after which the 
Convention enters into force, but before such provisions have 
effect, is the date on which the competent authorities have 
agreed in writing on the mode of application.

                                 OTHER

    The various provisions in the Memorandum of Understanding 
are explained above in the relevant portions of the Technical 
Explanation with the exception of paragraph 2. Paragraph 2 
provides that with reference to paragraph 3 of the Protocol of 
1990, the Contracting States commit to initiate discussions as 
soon as possible, but no later than six months after entry into 
force of the Protocol, regarding the conclusion of an 
appropriate agreement to avoid double taxation on investments 
between Puerto Rico and Spain.
          X. Annex 2.--Transcript of Hearing of June 19, 2014












                                TREATIES

                              ----------                              


                        THURSDAY, JUNE 19, 2014

                                       U.S. Senate,
                            Committee on Foreign Relations,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 11:05 a.m., in 
room SD-419, Dirksen Senate Office Building, Hon. Robert 
Menendez (chairman of the committee) presiding.
    Present: Senators Menendez, Cardin, and Risch.

          OPENING STATEMENT OF HON. ROBERT MENENDEZ, 
                  U.S. SENATOR FROM NEW JERSEY

    The Chairman. Good morning. This hearing of the Senate 
Foreign Relations Committee will come to order.
    Today we will be discussing two important treaties pending 
before the Senate Foreign Relations Committee: A new bilateral 
income tax treaty between the United States and Poland 
replacing the existing tax treaty that was signed in 1974, and 
an amendment to the existing bilateral income tax treaty signed 
in 1990 between the United States and Spain.
    As most are aware, this committee has expended significant 
effort in recent months to obtain Senate confirmation of 
pending income tax treaties and protocols. In February, Senator 
Cardin chaired a hearing, together with Senator Barrasso, on 
five income tax treaties and protocols with Switzerland, 
Hungary, Luxembourg, Chile, and the OECD. The committee 
approved the five treaties on April the 1st, and over the last 
few months, Senators Cardin, Levin, and I have on separate 
occasions requested unanimous consent for the Swiss and Chile 
treaties.
    Traditionally, tax treaties have enjoyed strong bipartisan 
support, and I will continue to urge my colleagues in the 
Senate to ratify these crucial components of United States 
trade and tax policy.
    To quote the National Foreign Trade Council and other 
leading business organizations' recent letter to all Senators, 
``for over 80 years, income tax treaties have played a critical 
role in fostering U.S. bilateral trade and investment while 
protecting U.S. businesses, large and small, from double 
taxation.''
    Tax treaties also enhance our efforts to prevent tax 
evasion and avoidance. Some members of the committee have 
raised concerns about this aspect of tax treaties, and I intend 
to use today's hearing to shed some light on the mechanisms 
used for exchange of information and for protecting the rights 
of law-abiding Americans living abroad.
    Today we continue our consideration of tax treaties with 
the Spain protocol and Poland treaty, both signed in early 
2013. We have important and growing trade relationships with 
both countries. The United States is among the largest source 
of foreign direct investment for each country, and American 
businesses employ hundreds of thousands of people in both 
countries.
    But the real story in recent years has been the increasing 
interest in investment from Spain and Poland into the United 
States. Spanish investment in particular increased in the last 
10 years from $14 billion to over $50 billion, making Spain one 
of the fastest growing sources of foreign investment into this 
country. We have a representative of Spain's largest investment 
business group in the United States on our second panel today, 
and I am looking forward to hearing from her and other 
witnesses on how these two treaties will further bolster the 
important economic relationships the United States has 
developed with Spain and Poland.
    And at this time, seeing no other member, let me introduce 
our first panel. On our first panel today are Mr. Robert Stack, 
the Deputy Assistant Secretary for International Tax Affairs at 
the Department of the Treasury, and Mr. Thomas Barthold, the 
Chief of Staff of the Joint Committee on Taxation, who I 
normally get to see in my other role on the Senate Finance 
Committee. We are glad to have you over here today. Both of 
these gentlemen testified at the February hearing. They are 
well known here in the Senate as two experts with decades of 
experience on international tax treaties.
    Your full written statements will be included in the 
record, without objection. I would ask you to summarize them in 
about 5 minutes or so, so we can proceed to questions.
    And I understand that Senator Risch is sitting in for 
Senator Corker today who has other obligations. If you have any 
opening statement.
    Senator Risch. No, thank you, Mr. Chairman.
    The Chairman. Thank you.
    With that, Mr. Stack, we will recognize you first.

   STATEMENT OF ROBERT STACK, DEPUTY ASSISTANT SECRETARY FOR 
  INTERNATIONAL TAX AFFAIRS, U.S. DEPARTMENT OF THE TREASURY, 
                         WASHINGTON, DC

    Mr. Stack. Thank you, Chairman Menendez and Senator Risch. 
I appreciate the opportunity to appear here today to recommend 
on behalf of the administration favorable action on two tax 
treaties pending before this committee.
    The proposed agreements before the committee today with 
Poland and Spain serve to further the goals of our tax treaty 
network and in particular the goals of providing meaningful tax 
benefits to cross-border investors, as well as protecting U.S. 
tax treaties from abuse.
    Before addressing the treaties on today's agenda, I want to 
take the opportunity to thank the committee for reporting 
favorably to the full Senate the five tax treaties and 
protocols on which I testified in February. I would 
particularly like to thank Chairman Menendez for his 
leadership, including his recent statements on the Senate floor 
urging the Senate to provide advice and consent to ratification 
of these important agreements.
    It has now been almost 4 years since the full Senate last 
considered a tax treaty. This prolonged and unprecedented delay 
is inconsistent with the Senate's long history of bipartisan 
support for timely consideration and approval of tax treaties, 
and it is also detrimental to a number of important U.S. 
interests. It denies U.S. businesses important protections 
against double taxation. It denies our law enforcement 
community the tools they need to fight tax evasion. It 
jeopardizes U.S. leadership on issues of transparency and tax 
matters. It causes other countries to question the United 
States commitment to tax treaties and makes it harder to gain 
cooperation in other tax matters important to the United 
States.
    I would like to take the opportunity to briefly address a 
concern that has been expressed about the pending tax treaties 
and the agreements that are subject to today's hearing.
    As I understand it, specifically, the claim is that these 
treaties adopt a new and unacceptably low standard for 
exchanging information that departs from prior U.S. policy of 
exchanging information only in cases of suspicion of tax fraud. 
To the contrary, the standard in the pending treaties that 
permits exchange of information that may be relevant or is 
foreseeably relevant is not new. In fact, it has been the U.S. 
Model standard since 1996 and has subsequently been endorsed as 
the international standard for exchange of information under 
treaties.
    Of the 57 U.S. income tax treaties in force, all of which 
were approved by the Senate, only one of our treaties, the one 
with Switzerland, refers to exchanging information only in 
cases of tax fraud or the like. This standard is what allowed 
Switzerland to become a haven for tax cheats and is why that 
treaty must be updated. Moreover, the foreseeably relevant 
standard has been extensively described in internationally 
agreed guidance. It has safeguards that prevent so-called 
fishing expeditions and ensures that information that has been 
exchanged pursuant to a treaty is kept confidential and used 
only for tax administration purposes.
    The Treasury Department has for many years viewed the 
ability to exchange information under a tax treaty for both 
criminal and civil purposes as a nonnegotiable item because we 
strongly believe that it is a crucial tool for enhancing tax 
compliance and transparency.
    I further note that since 1999 the Senate has approved at 
least 14 bilateral tax treaties that provide for the exchange 
of information that is, or may be, relevant for carrying out 
the provisions of a treaty or the domestic laws of either 
country. For these reasons, the administration urges the Senate 
to take prompt and favorable action on all seven of the pending 
agreements as soon as possible.
    Because my written statement and the Treasury Department's 
technical explanations provide detailed explanations of the 
provisions of the two agreements, I would just like to describe 
briefly the most noteworthy aspects of each of the agreements.
    The proposed tax treaty with Poland brings the current 
convention concluded in 1974 into closer conformity with 
current U.S. tax treaty policy as reflected in the U.S. Model 
Tax Convention. The proposed treaty contains a comprehensive 
limitation-on-benefits article designed to address treaty 
shopping, which is the inappropriate use of a tax treaty by 
residents of a third country. The existing tax treaty with 
Poland does not contain treaty shopping protections, and for 
this reason, revising the existing treaty has been a top 
priority for the Treasury Department's tax treaty program. It 
is imperative to bring the new agreement with Poland, as well 
as the agreement with Hungary, into force as soon as possible 
in order to minimize the adverse revenue effects to the United 
States that result from the treaty shopping loopholes in the 
existing agreements.
    The proposed protocol with Spain and an accompanying 
memorandum of understanding and exchange of notes make a number 
of key amendments to the existing tax treaty with Spain, which 
was concluded in 1990. Many of the provisions in the proposed 
protocol bring the treaty into closer conformity with the U.S. 
Model. Modernizing this existing treaty has been a high tax 
priority for the business communities in both the United States 
and Spain.
    Importantly, the proposed protocol brings the existing 
treaty's rules for taxing cross-border payments of dividends, 
interest, royalties, and capital gains into conformity with a 
number of recent U.S. tax treaties with major trading partners. 
It does so by assigning the exclusive taxing rights on such 
payments to the country of residence of the recipient of the 
payment. Until the proposed protocol enters into force, U.S. 
companies will continue to pay higher rates of Spanish taxes 
than they would otherwise pay under the protocol. These higher 
taxes are detrimental both to the companies themselves and to 
the U.S. fisc which must provide a foreign tax credit for the 
high Spanish taxes.
    The proposed protocol also updates the provisions of the 
existing treaty with respect to the mutual agreement procedure 
by requiring mandatory binding arbitration of certain cases 
that the competent authorities of the United States and Spain 
have been unable to resolve after a reasonable period of time. 
The arbitration provisions in the proposed protocol are similar 
to other mandatory arbitration provisions that were recently 
incorporated into a number of other U.S. bilateral tax 
treaties, including the arbitration provision in the proposed 
protocol of the tax treaty with Switzerland that the committee 
favorably reported to the Senate in April.
    Let me repeat our appreciation for the committee's interest 
in these agreements. We are also grateful for the assistance 
and cooperation of the staffs of this committee on both sides 
of the aisle and of the Joint Committee on Taxation.
    I would also like to recognize the tireless work of the 
Treasury team.
    We urge the committee and Senate to take prompt and 
favorable action on both agreements, as well as the five other 
agreements pending before the Senate.
    And I would be happy to answer any questions you may have. 
Thank you.
    [The prepared statement of Mr. Stack follows:]

                 Prepared Statement of Robert B. Stack

    Chairman Menendez, Ranking Member Corker, and distinguished members 
of the committee, I appreciate the opportunity to appear today to 
recommend, on behalf of the administration, favorable action on two 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 one of the primary 
means for eliminating such tax barriers. Tax treaties provide greater 
certainty to taxpayers regarding their potential liability for tax in 
foreign jurisdictions, and they allocate taxing rights between 
jurisdictions to reduce the risk of double taxation. Tax treaties also 
ensure that taxpayers are not subject to discriminatory taxation in 
foreign jurisdictions.
    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 in an existing treaty; in 
these cases, revisions to a 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 an 
existing treaty to prevent improper exploitation of treaty provisions 
and eliminate unintended and inappropriate consequences in the 
application of the treaty. In yet other cases, the United States seeks 
to establish new income tax treaties with countries in which there is 
significant U.S. direct investment, and with respect to which U.S. 
companies are experiencing double taxation that is not otherwise 
relieved by domestic law remedies, such as the U.S. foreign tax credit. 
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 tax evasion.
    Before addressing the treaties on today's agenda, I want to take 
this opportunity to thank the committee for reporting favorably to the 
full Senate the five tax treaties and protocols on which I testified in 
February. I would particularly like to thank Chairman Menendez for his 
leadership, including his recent statements on the Senate floor urging 
the Senate to provide advice and consent to ratification of these 
important agreements.
    It has now been almost 4 years since the full Senate last 
considered a tax treaty. This prolonged delay is inconsistent with the 
Senate's long history of bipartisan support for timely consideration 
and approval of tax treaties and it is damaging to important U.S. 
interests. It denies U.S. businesses important protections against 
double taxation. It denies our law enforcement community the tools they 
need to fight tax evasion. It jeopardizes U.S. leadership on issues of 
transparency. It causes other countries to question our reliability as 
a treaty partner and makes it harder to gain cooperation in other 
matters important to the United States.
    The administration urges the Senate to act swiftly to approve the 
pending tax treaties and protocols with Switzerland, Luxembourg, 
Hungary, Chile, the Protocol amending the Multilateral Convention on 
Mutual Administrative Assistance in Tax Matters, as well as the 
agreements that are the subject of today's hearing.
    The proposed tax treaties before the committee today are with 
Poland and Spain, and each serves to further the goals of our tax 
treaty network. The proposed tax treaty with Poland would replace an 
existing treaty, the revision of which has been a top tax treaty 
priority for the Treasury Department. The proposed protocol with Spain 
makes a number of critical updates to our existing bilateral tax treaty 
with this important trading partner of the United States. We urge the 
committee and the Senate to take prompt and favorable action on both of 
these agreements.
    Before talking about the proposed treaties in more detail, I would 
like to discuss some 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 two countries. One of the 
primary functions of tax treaties is to provide certainty to taxpayers 
regarding a 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 
conducted within a country by a resident of the other country 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 of tax treaties 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, because 
residence is relevant to jurisdiction to tax, a tax 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, a tax 
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, a tax treaty provides rules for 
determining the country of source for each category of income. Fourth, 
a tax 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. Finally, a tax 
treaty provides for resolution of disputes between jurisdictions in a 
manner that avoids double taxation.
    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 the withholding tax frequently will 
be subject to an effective rate of tax that is significantly higher 
than the tax rate that would apply to net income in either the source 
or residence country. Tax treaties alleviate this burden by setting 
maximum rates of the withholding tax that the source country 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.
    As a complement to these substantive rules regarding the allocation 
of taxing rights, tax treaties provide a mechanism for dealing with 
disputes between countries regarding the proper application of a 
treaty. To resolve such disputes, designated tax authorities of the two 
governments--known as the ``competent authorities'' in tax treaty 
parlance--are required 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. The Secretary of the 
Treasury has delegated this function to the Deputy Commissioner 
(International) of the Large Business and International Division of the 
Internal Revenue Service.
    Another key element of U.S. tax treaties is the exchange of 
information between tax authorities. Under tax treaties, one country 
may request from the other such information that is foreseeably 
relevant for the proper administration of the first country's tax laws. 
Some have suggested that this standard is ambiguous and that it 
represents a lower threshold than the standard in earlier U.S. tax 
treaties. This is not the case. For at least 50 years, bilateral income 
tax treaties have permitted the revenue authorities to exchange 
information for tax administration purposes. Moreover, this standard 
has been extensively defined in internationally agreed guidance to 
which no country has expressed a dissenting opinion to date.
    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. As we establish exchange of information relationships, 
the administration places a high priority on ensuring that the 
exchanged information will not be misused by our treaty partners. The 
United States will not exchange tax information with a country unless 
it has adequate confidentiality laws that will protect the information 
we have provided, and it has demonstrated the foreseeable relevance of 
the requested information to a tax matter.
    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 and clarify the 
manner in which possible discrimination is to be evaluated in the tax 
context.
    In addition to these core provisions, tax treaties include 
provisions dealing with more specialized situations, such as rules 
addressing and coordinating the taxation of pensions, 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 treaty negotiating priorities and process
    The United States has a network of 57 comprehensive income tax 
treaties covering 66 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 to seek 
input regarding the areas on which we should focus our treaty network 
expansion and improve efforts, as well as regarding practical problems 
encountered under particular treaties or particular tax regimes.
    Numerous features of a country's 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 credit system, the country's 
treatment of partnerships and other transparent entities, and how the 
country taxes contributions to, earnings of, and distributions from, 
pension funds.
    Moreover, a country's fundamental tax policy choices are reflected 
not only in its tax laws, 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 tax treaty negotiation must take into account all 
of these aspects of the 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 tax 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 is presented 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 the Treasury Department's bilateral interactions with countries 
around the world, we commonly conclude that the right result may be no 
tax treaty at all. With certain countries there simply may not be the 
type of cross-border tax issues that are best resolved by a treaty. For 
example, if a country does not impose significant income taxes, there 
is little possibility of unresolved double taxation of cross-border 
income, given the fact that the United States provides foreign tax 
credits to its citizens and residents regardless of the existence of an 
income tax treaty. Under such circumstances, it would not be 
appropriate to enter into a bilateral tax treaty, because doing so 
would result in a unilateral concession of taxing rights by the United 
States. Absent instances of unrelieved double taxation, a bilateral 
agreement that focuses exclusively on the exchange of tax information 
(often referred to as a ``tax information exchange agreement'' or 
``TIEA'') may be appropriate.
    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 rules that address 
tax issues 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, such a treaty would provide little 
or no relief from double taxation to U.S. investors, and accordingly 
there would be no merit to entering into such an agreement. The 
Treasury Department will not conclude a tax treaty that does not 
provide meaningful benefits to U.S. investors or which may be construed 
by potential treaty partners as an indication that we would settle for 
a tax treaty with inferior terms.
           ensuring safeguards against abuse of tax treaties
    A high priority for improving our overall treaty network is a 
continued focus on prevention of ``treaty shopping.'' The U.S. 
commitment to including comprehensive ``limitation on benefits'' 
provisions is a key element 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 benefit 
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. That is, 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 countries' tax systems and policies and those of the 
United States. This use of tax treaties is not consistent with the 
balance of the agreement 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. Effective antitreaty shopping rules also ensure that the 
benefits of a U.S. tax treaty do not accrue to residents of countries 
with which the United States does not have a bilateral tax treaty 
because that country imposes little or no tax, and thus the potential 
of unrelieved double taxation is low.
    In this regard, the proposed tax treaty with Poland that is before 
the committee today includes a comprehensive limitation on benefits 
provision and represents a major step forward in protecting the U.S. 
tax treaty network from abuse. As was discussed in the Treasury 
Department's 2007 Report to the Congress on Earnings Stripping, 
Transfer Pricing and U.S. Income Tax Treaties, the existing income tax 
treaty with Poland, signed in 1974, is one of three U.S. tax treaties 
that, as of 2007, provided an exemption from source-country withholding 
on interest payments but contained no protections against treaty 
shopping. The other two agreements in this category were the 1975 tax 
treaty with Iceland and the 1979 tax treaty with Hungary. The revision 
of these three agreements has been a top priority for the Treasury 
Department's treaty program, and we have made significant progress. In 
2007, we signed a new tax treaty with Iceland which entered into force 
in 2008. In 2010, we concluded a new tax treaty with Hungary, which 
twice has been favorably reported out of this committee and is 
currently awaiting the advice and consent of the full Senate. These 
achievements demonstrate that the Treasury Department has been 
effective in addressing concerns about treaty shopping through 
bilateral negotiations and amendment of our existing tax treaties. We 
hope that the Senate will provide its advice and consent to the new tax 
treaties with Poland and Hungary, as well as the other tax treaties 
currently pending before the Senate, as soon as possible.
                      consideration of arbitration
    A tax treaty cannot provide a stable investment environment unless 
the tax administrations of the two countries implement the treaty 
effectively. Under the mutual agreement process provided under our tax 
treaties, a U.S. taxpayer that has a concern about the application of a 
treaty 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 are expected to work cooperatively 
to resolve 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 may be instances in which the competent authorities will 
not be able to reach timely and satisfactory resolutions. Moreover, as 
the number and complexity of cross-border transactions increases, so do 
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 assist in resolving disputes promptly, including 
the possible use of arbitration in the competent authority mutual 
agreement process.
    Over the past few years, we have carefully considered and studied 
various types of arbitration procedures that could be included in our 
treaties and 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 arbitration process. Based on our review of the 
merits of 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 proposed protocol 
with Spain, includes a type of mandatory arbitration provision. In 
general, this provision is similar to arbitration provisions in several 
of our recent treaties (Canada, Germany, Belgium, and France) that have 
been approved by the committee and ratified by the Senate over the last 
several years, as well as in the proposed protocol amending the 
existing bilateral tax treaty with Switzerland, which has been 
favorably reported out of this committee twice and is currently 
awaiting the advice and consent of the full Senate.
    In the typical competent authority mutual agreement process, a U.S. 
taxpayer presents its case 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 in the proposed protocol with Spain, as in the similar 
provisions that are now part of our treaties with Canada, Germany, 
Belgium, and France, as well as the proposed protocol with Switzerland, 
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 under the 
treaty (i.e., one that has been negotiated by the competent 
authorities).
    The arbitration process in the proposed protocol with Spain 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 provision in the proposed protocol 
with Spain, we took into account concerns expressed by this committee 
in its report on the 2007 protocol to the U.S.-Canada treaty over 
certain aspects of the arbitration rules in our treaties with Canada, 
Germany, and Belgium. Accordingly, the proposed arbitration rule with 
Spain (like the provisions in the treaty with France and the proposed 
protocol with Switzerland) differs from the provision in the treaties 
with Canada, Germany, and Belgium in three key respects. First, the 
proposed rule allows the taxpayer who presented the original case that 
is subjected to arbitration to submit its views on the case for 
consideration by the arbitration panel. Second, the proposed rule 
prohibits a competent authority from appointing an employee from its 
own tax administration to the arbitration board. Finally, the proposed 
rule does not prescribe a hierarchy of legal authorities that the 
arbitration panel must use in making its decision, thus ensuring that 
customary international law rules on treaty interpretation will apply.
    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 
resorting to arbitration. Thus, it is our objective that these 
arbitration provisions will rarely be utilized, but their presence will 
motivate the competent authorities to approach negotiations in ways 
that result in mutually agreeable conclusions without invoking the 
arbitration process.
    We are hopeful that our desired objectives for arbitration are 
being realized, even though we are still in the early stages in our 
experience with arbitration and at this time cannot report definitively 
on the effects of arbitration on our tax treaty relationships. Our 
observation is that, where mandatory arbitration has been included in 
the treaty, the competent authorities are negotiating with greater 
intent to reach principled and timely resolution of disputes. 
Therefore, under the mandatory arbitration provision, double taxation 
is being effectively eliminated in a timely and more expeditious 
manner.
    We will monitor the performance of the provisions in the agreements 
with Canada, Germany, Belgium, and France, as well as the performance 
of the provisions in the agreement with Spain and Switzerland, if 
ratified. The Internal Revenue Service has published the administrative 
procedures necessary to implement the arbitration rules with Canada, 
Germany, Belgium, and France. The administration looks forward to 
updating the committee on the arbitration process through the reports 
that are called for in the committee's report on the 2007 protocol to 
the U.S.-Canada treaty.
    In addition to the proposed protocol with Spain, we have also 
concluded a protocol to our bilateral tax treaty with Japan that 
incorporates mandatory binding arbitration. The administration hopes to 
transmit the new agreement with Japan to the Senate for its advice and 
consent soon. 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.
                    discussion of proposed treaties
    I would now like to discuss the two tax treaties that have been 
transmitted for the Senate's consideration. The two treaties are 
generally consistent with modern U.S. tax treaty practice as reflected 
in the Treasury Department's 2006 U.S. Model Income Tax Convention (the 
``U.S. Model''). As with all bilateral tax treaties, the treaties 
contain some minor variations that reflect particular aspects of the 
treaty policies and partner countries' domestic laws and economic 
relations with the United States. 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 explanation of each tax treaty.
Poland
    The proposed tax treaty with Poland was negotiated to bring the 
current convention, concluded in 1974, into closer conformity with 
current U.S. tax treaty policy as reflected in the U.S. Model. There 
are, as with all bilateral tax treaties, some variations from these 
norms. In the proposed treaty, these differences reflect particular 
aspects of Polish law and treaty policy, the interaction of U.S. and 
Polish law, and U.S.-Poland economic relations.
    The proposed treaty contains a comprehensive ``limitation on 
benefits'' article designed to address ``treaty shopping,'' which is 
the inappropriate use of a tax treaty by residents of a third country. 
The existing tax treaty with Poland does not contain treaty shopping 
protections and, for this reason, revising the existing treaty has been 
a top priority for the Treasury Department's tax treaty program. Beyond 
the standard provisions, the new limitation on benefits article 
includes a provision granting so-called ``derivative benefits'' similar 
to the provision included in all recent U.S. tax treaties with 
countries that are members of the European Union. The new limitation on 
benefits article also contains a special rule for so-called 
``headquarters companies'' that is identical to what the Treasury 
Department has agreed to with a number of other tax treaty partners.
    The proposed treaty incorporates updated rules that provide that a 
former citizen or long-term resident of the United States may, for the 
period of 10 years following the loss of such status, be taxed in 
accordance with the laws of the United States. The proposed Treaty also 
coordinates the U.S. and Polish tax rules to address the ``mark-to-
market'' provisions enacted by the United States in 2007 that apply to 
individuals who relinquish U.S. citizenship or terminate long-term 
residency.
    The withholding rates on investment income in the proposed treaty 
are in most cases the same as, or lower than, those in the current 
treaty. The proposed treaty provides for reduced source-country 
taxation of dividends distributed by a company resident in one 
Contracting State to a resident of the other Contracting State. The 
proposed treaty generally allows for taxation at source of 5 percent on 
direct dividends (i.e., where a 10-percent ownership threshold is met) 
and 15 percent on all other dividends. Additionally, the proposed 
treaty provides for an exemption from withholding tax on certain cross-
border dividend payments to pension funds.
    The proposed treaty updates the treatment of dividends paid by U.S. 
Regulated Investment Companies and Real Estate Investment Trusts to 
prevent the use of structures designed to inappropriately avoid U.S. 
tax.
    The proposed treaty provides for an exemption from source-country 
taxation for the following classes of interest: interest that is either 
paid by, or paid to, governments (including central banks); interest 
paid in respect of a loan made to or provided, guaranteed or insured by 
a government, statutory body or export financing agency; certain 
interest paid to a pension fund, interest paid to a bank or an 
insurance company; and interest paid to certain other financial 
enterprises that are unrelated to the payer of the interest. The 
proposed treaty provides for a limit of 5 percent on source-country 
withholding taxes on all other cross-border interest payments. In 
addition, consistent with the U.S. Model, source-country tax may be 
imposed on certain contingent interest and payments from a U.S. real 
estate mortgage investment conduit.
    The proposed treaty provides a limit of 5 percent on source-country 
withholding taxes on cross-border payments of royalties. The definition 
of the term ``royalty'' in the proposed treaty includes payments of any 
kind received as a consideration for the use of, or the right to use 
any industrial, commercial or scientific equipment.
    The taxation of capital gains under the proposed treaty generally 
follows the U.S. Model. Gains derived from the sale of real property 
and from real property interests may be taxed by the country in which 
the property is located. Likewise, gains from the sale of personal 
property forming part of a permanent establishment situated in either 
the United States or Poland may be taxed in that country. All other 
gains, including gains from the alienation of ships, boats, aircraft 
and containers used in international traffic and gains from the sale of 
stock in a corporation, are taxable only in the country of residence of 
the seller.
    Consistent with U.S. tax treaty policy, the proposed treaty employs 
the so-called ``Approved OECD Approach'' for attributing profits to a 
permanent establishment. 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. The proposed treaty 
defines a ``permanent establishment'' in a way that grants rights to 
tax business profits that are consistent with those found in the U.S. 
Model.
    The proposed treaty preserves the U.S. right to impose its branch 
profits tax on U.S. branches of Polish corporations. The proposed 
treaty also accommodates a provision of U.S. domestic law that 
attributes to a permanent establishment income that is earned during 
the life of the permanent establishment, but is deferred, and not 
received until after the permanent establishment no longer exists.
    Under the proposed treaty an enterprise performing services in the 
other country will become taxable in the other country only if the 
enterprise has a fixed place of business.
    The rules for the taxation of income from employment under the 
proposed treaty are consistent with the U.S. Model. The general rule is 
that employment income may be taxed in the country where the employment 
is exercised unless the conditions constituting a safe harbor are 
satisfied.
    The proposed treaty contains rules regarding the taxation of 
pensions, social security payments, annuities, alimony and child 
support that are generally consistent with the U.S. Model. Under the 
proposed treaty, pensions and annuities are taxable only in the country 
of residence of the beneficiary. The proposed treaty provides for 
exclusive source-country taxation of social security payments. Payments 
of alimony and child support are exempt from tax in both countries.
    Consistent with the U.S. Model and the international standard for 
tax information exchange, the proposed treaty provides for the exchange 
between the tax authorities of each country of information that is 
foreseeably relevant to carrying out the provisions of the proposed 
treaty or the domestic tax laws of either country. The proposed treaty 
allows the United States to obtain information (including from 
financial institutions) from Poland whether or not Poland needs the 
information for its own tax purposes, so long as the information to be 
exchanged is foreseeably relevant for carrying out the provisions of 
the treaty or the domestic tax laws of the United States or Poland.
    The proposed treaty will enter into force when both the United 
States and Poland have notified each other that they have completed all 
of the necessary procedures required for entry into force. The proposed 
treaty 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 of entry into force, and with respect to other 
taxes, for taxable years beginning on or after the first day of January 
next following the date of entry into force . The current treaty will, 
with respect to any tax, cease to have effect as of the date on which 
this proposed treaty has effect with respect to such tax.
    The proposed treaty provides that an individual who was entitled to 
the benefits under the provisions for teachers, students and trainees 
or government functions of the existing treaty at the time of entry 
into force of the proposed treaty shall continue to be entitled to such 
benefits until such time as the individual would cease to be entitled 
to such benefits if the existing treaty remained in force.
Spain
    The proposed protocol with Spain and an accompanying memorandum of 
understanding and exchange of notes make a number of key amendments to 
the existing tax treaty with Spain, concluded in 1990. Many of the 
provisions in the proposed protocol are intended to bring the existing 
treaty into closer conformity with the U.S. Model. The provisions in 
the proposed protocol also reflect particular aspects of Spanish law 
and tax treaty policy and U.S.-Spain economic relations. Modernizing 
the existing treaty has been a high tax treaty priority for the 
business communities in both the United States and Spain.
    The proposed protocol brings the existing tax treaty's rules for 
taxing payments of cross-border dividends into conformity with a number 
of recent U.S. tax treaties with major trading partners. The proposed 
protocol provides for an exemption from source-country withholding on 
certain direct dividends (i.e., dividends beneficially owned by a 
company that has owned, for a period of at least 12 months prior to the 
date on which the entitlement to the dividends is determined, at least 
80 percent of the voting stock of the company paying the dividends), as 
well as dividends beneficially owned by certain pension funds. 
Consistent with the U.S. Model, the proposed protocol limits to 5 
percent the rate of source-country withholding permitted on cross-
border dividends beneficially owned by a company that owns at least 10 
percent of the voting stock of the company paying the dividends, and 
limits to 15 percent the rate of source-country withholding permitted 
on all other dividends. The proposed protocol permits the imposition of 
source-country withholding on branch profits in a manner consistent 
with the U.S. Model.
    The proposed protocol brings the existing tax treaty's rules for 
taxation of cross-border interest payments largely into conformity with 
the U.S. Model by exempting such interest from source-country taxation. 
However, interest that is contingent interest may be subject to source-
country withholding tax at a rate of 10 percent (in contrast to 15 
percent under the U.S. Model). Consistent with the U.S. Model, full 
source-country tax may be imposed on payments from a U.S. real estate 
mortgage investment conduit.
    The proposed protocol exempts from source-country withholding 
cross-border payments of royalties and capital gains in a manner 
consistent with the U.S. Model.
    The proposed protocol updates the provisions of the existing treaty 
with respect to the mutual agreement procedure by requiring mandatory 
binding arbitration of certain cases that the competent authorities of 
the United States and Spain have been unable to resolve after a 
reasonable period of time. The arbitration provisions in the proposed 
protocol are similar to other mandatory arbitration provisions that 
were recently incorporated into a number of other U.S. bilateral tax 
treaties.
    The proposed protocol replaces the limitation on benefits 
provisions in the existing tax treaty with updated rules similar to 
those found in recent U.S. tax treaties with countries in the European 
Union.
    Consistent with the U.S. Model and the international standard for 
tax information exchange, the proposed protocol provides for the 
exchange between the tax authorities of each country of information 
that is foreseeably relevant to carrying out the provisions of the tax 
treaty or the domestic tax laws of either country. The proposed 
protocol allows the United States to obtain information (including from 
financial institutions) from Spain regardless of whether Spain needs 
the information for its own tax purposes, so long as the information to 
be exchanged is foreseeably relevant for carrying out the provisions of 
the treaty or the domestic tax laws of the United States or Spain.
    The proposed protocol will enter into force 3 months after both 
countries have notified each other that they have completed all 
required internal procedures for entry into force. The proposed 
protocol will have effect, with respect to taxes withheld at source, 
for amounts paid or credited on or after the date on which the proposed 
protocol enters into force, and with respect to other taxes, for 
taxable years beginning on or after the date on which the proposed 
protocol enters into force. Special rules apply for the entry into 
force of the mandatory binding arbitration provisions.
                       treaty program priorities
    In addition to our work described above to expand the U.S. tax 
treaty network, the Treasury Department also maintains an active 
negotiating calendar aimed at modernizing existing tax treaties with 
many of our key trading partners. In this regard, our recent efforts 
have borne much fruit. In 2013, we concluded a protocol with Japan 
that, if approved by the Senate, would make extensive changes to our 
bilateral tax treaty with that country.
    Another key continuing priority for the Treasury Department is 
updating those U.S. tax treaties that do not include the limitation on 
benefits provisions that protect against treaty shopping. I am pleased 
to report that in this regard we have made significant progress. In 
addition to the proposed tax treaty with Poland and the tax treaty with 
Hungary which is currently awaiting the advice and consent of the full 
Senate, we have initialed new tax treaties with Norway and Romania, 
both of which contain comprehensive limitation on benefits provisions. 
We are preparing the new Norway and Romania treaties for signature in 
the near future.
    Concluding agreements that provide for the full exchange of 
information, including information held by banks and other financial 
institutions, consistent with the international standard for tax 
information exchange, is another key priority of the Treasury 
Department. In this regard, we are in active negotiations with Austria 
to make a number of key amendments to the existing bilateral tax treaty 
to includ ing modern provisions for full exchange of information.
                               conclusion
    Chairman Menendez and Ranking Member Corker, let me conclude by 
thanking you for the opportunity to appear before the committee to 
discuss the administration's efforts with respect to the two treaties 
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. That 
concludes my testimony, and I would be happy to answer any questions.

    The Chairman. Thank you.
    Mr. Barthold.

    STATEMENT OF THOMAS A. BARTHOLD, CHIEF OF STAFF, JOINT 
             COMMITTEE ON TAXATION, WASHINGTON, DC

    Mr. Barthold. Thank you, Chairman Menendez, Senator Risch, 
Senator Cardin. I am Thomas Barthold. I am the chief of staff 
of the Joint Committee on Taxation, and it is my pleasure to 
present the testimony of the staff of the Joint Committee 
related to the protocol with Spain and the proposed treaty with 
Poland.
    As in the past, the Joint Committee staff and in particular 
my colleagues, Kristeen Witt, Kristine Roth, David Lenter, Paul 
Chen, Cecily Rock, and Natalie Tucker, provided for the 
committee detailed explanations of the treaty and the protocol, 
including comparisons with the U.S. Model Income Tax Convention 
and other recent U.S. treaties.
    I think for this hearing, it is important to remember that 
the principal purposes of these proposed income tax treaties 
and protocol are to reduce or eliminate the double taxation of 
income earned by residents of either country from sources 
within the other country and to prevent the avoidance or 
evasion of taxes of the two countries.
    Now, with both of these two countries, Spain and Poland, 
the United States already has an existing treaty relationship. 
So we are looking at updates rather than newly started treaty 
relationships. As Bob noted, the Spanish treaty dates to 1990, 
the Polish treaty to 1974.
    Let me highlight a few important achievements of the 
protocol and the treaty.
    First of all, both treaties would provide for reduced rates 
of withholding taxes on dividends, interest, and royalties. And 
I note in particular that the proposed protocol with Spain also 
provides a zero withholding tax rate on cross-border dividends 
paid by a subsidiary in one treaty country to a parent 
corporation in the other treaty country.
    In addition, both treaties provide rules similar to those 
of the U.S. Model for payments derived through entities that 
are fiscally transparent. These rules ensure that investors who 
derive payments through entities such as partnerships or 
limited liability companies are eligible in the appropriate 
circumstances to the benefits provided under the treaties.
    Both treaties provide definitions of pension funds. This is 
particularly important in the case of the protocol with Spain, 
which did not have such a special provision exempting dividends 
paid to a pension fund.
    Both treaties would conform to the U.S. Model treaty with 
respect to circumstances when a construction site, an 
installation project, drilling rig, or the like is not a 
permanent establishment.
    Both treaties include modern limitation-on-benefits 
provisions. As Mr. Stack noted, this closes a significant 
treaty shopping opportunity that was presented by the 1974 
treaty with Poland.
    And then a last highlight to note is the protocol with 
Spain provides for binding arbitration procedures.
    Now, the current model treaty for the United States dates 
to 2006. Since that time, a number of treaties have been 
negotiated, and as time evolves and as needs evolve, we see 
deviations in terms of where the Treasury in their negotiations 
ends up compared to the model treaty.
    As I noted, both agreements provide for Treasury's really 
most modern version of limitation-on-benefits provisions. 
However, both treaties also have deviations from the U.S. 
Model. The committee may wish to explore the rationale for some 
of these deviations. One that I will note is that both 
agreements allow full treaty benefits for an entity that 
functions as a headquarters company but does not satisfy the 
other categories of a person that would be entitled to full 
treaty benefits. The Treasury has negotiated headquarters 
companies provisions in several recent treaties, and as I note, 
this is not part of the U.S. Model.
    With regard to binding arbitration, I think the committee 
may wish to consider the extent to which the inclusion of the 
mandatory arbitration rules and the particular features of the 
provisions in the proposed protocol may represent an evolution 
of U.S. policy regarding binding arbitration. Several recent 
treaties negotiated have provided for binding arbitration, and 
so I think the committee may wish to inquire about the criteria 
on which the Treasury Department determines whether to include 
such a provision in any particular treaty and the scope to 
which it would apply.
    As noted, the Spanish treaty provides for a zero rate on 
certain dividends paid back to a parent corporation. This 
becomes the 13th treaty since 2003 which has provided for a 
zero rate. The committee may wish to explore Treasury's 
criteria for determining when a zero rate provision is 
appropriate.
    And lastly--and I recognize that I have run over time 
here-- 
I think note should be made of the memorandum of understanding 
that accompanies the Spanish protocol. The memorandum of 
understanding provides that, no later than 6 months after entry 
into force, there will be negotiations to bring to conclusion 
an appropriate agreement to avoid double taxation on 
investments between Puerto Rico and Spain. I note this for the 
Senators because U.S. income tax treaty policy does not apply 
treaties to United States territories, and so as a consequence, 
that can mean that a resident of Puerto Rico who derives income 
in Spain or a resident of Spain deriving income in Puerto Rico 
does not have the benefits of being exempted from source 
taxation on dividends, interest, or royalties that would be 
provided to a resident of the 50 States.
    Now, there are good policy reasons why U.S. income tax 
treaties do not cover the territories. This is not unique to 
Puerto Rico. All the other U.S. possessions are also not 
covered by U.S. income tax treaties. But if special provisions 
were to be made, the members may want to inquire of my 
colleague what Treasury thinks might be appropriate in this 
particular circumstance.
    With that, let me conclude my testimony, and I, too, am 
happy to answer any questions that the committee may have.
    [The prepared statement of Mr. Barthold follows:]

                Prepared Statement of Thomas A. Barthold

    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 protocol with Spain and proposed treaty with 
Poland.
                                overview
    As in the past, the Joint Committee staff has prepared pamphlets 
covering the proposed treaty and protocol. The pamphlets provide 
detailed descriptions of the proposed treaty and protocol, including 
comparisons with the United States Model Income Tax Convention of 
November 15, 2006 (``U.S. Model treaty'') and with other recent U.S. 
tax treaties. The pamphlets also provide detailed discussions of issues 
raised by the proposed treaty and protocol. We consulted with the 
Treasury Department and with the staff of the committee in analyzing 
the proposed treaty and protocol and in preparing these pamphlets.
    The principal purposes of the proposed income tax treaty and 
protocol 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 income tax treaty and protocol 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. income 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.
    My testimony today will first summarize several significant 
features of these agreements, followed by a more detailed discussion of 
two issues: first, the extent to which the deviations from the U.S. 
Model treaty in the proposed protocol and proposed treaty raise 
questions about possible U.S. positions in current and future income 
tax treaty negotiations, and, second, how the commitment in the 
proposed protocol with Spain to begin discussions toward an agreement 
to avoid double taxation of cross-border investment between Spain and 
Puerto Rico fits with broader U.S. tax and treaty policy related to 
Puerto Rico and the other U.S. territories.
    The U.S. Model treaty was published after the existing treaties 
with Spain and Poland entered into force. The proposed protocol with 
Spain would amend an existing tax treaty signed on February 22, 1990, 
its protocol. The proposed treaty with Poland would replace an existing 
income tax treaty signed on October 8, 1974. The proposed protocol with 
Spain and proposed treaty with Poland include a number of significant 
changes that, if entered into force, would conform the existing 
treaties to the U.S. Model treaty and to other recent U.S. treaties, 
including in the following areas:

   Both treaties would include rules similar to those of the 
        U.S. Model treaty for payments derived through entities that 
        are fiscally transparent. These rules are intended, on the one 
        hand, to ensure that investors who derive payments through 
        entities such as partnerships or limited liability companies 
        are eligible in appropriate circumstances for treaty benefits 
        such as reduced withholding and, on the other hand, to prevent 
        reductions in source-country taxation when a resident is not 
        subject to tax on payments derived through an entity because 
        the entity is not fiscally transparent in the residence 
        country.
   Both treaties would include definitions of pension funds. 
        The existing treaty with Spain did not have a special provision 
        exempting dividends paid to pension funds from withholding tax; 
        the proposed protocol includes a new paragraph 4 in Article 10 
        (Dividends), which exempts dividends from source-country tax if 
        the beneficial owner of the dividends is a pension fund and the 
        dividends are not derived in the carrying on of a trade or 
        business by the pension fund or through an associated 
        enterprise.
   Both treaties would conform to the U.S. Model treaty Article 
        5 (Permanent Establishment) in providing that a construction 
        site, installation project, drilling rig or exploration site is 
        not a permanent establishment unless it lasts more than 12 
        months, instead of the 6- and 18-month periods included in the 
        existing treaties with Spain and Poland, respectively.
   Both treaties would provide reduced rates of withholding 
        taxes for dividends, interest, and royalties. For Spain and 
        Poland, in conformity with the U.S. Model treaty, the generally 
        prevailing dividend withholding rates would be either 5 or 15 
        percent, depending on the level of ownership of the dividend-
        paying company, with special rules for dividends paid by 
        regulated investment companies and real estate investment 
        trusts. The proposed protocol with Spain also provides a zero 
        withholding rate on cross-border dividends paid by a subsidiary 
        in one treaty country to its parent corporation in the other 
        treaty country. In conformity with the U.S. Model treaty, the 
        proposed protocol with Spain eliminates source-country 
        withholding tax on many interest and royalty payments, while 
        the proposed treaty with Poland permits source-country taxation 
        of these payments at a 5-percent rate.
   Both treaties would include modern limitation-on-benefits 
        provisions (Poland, Article 22; Spain, Article IX of the 
        proposed protocol, amending Article 17 of the existing treaty), 
        closing a significant treaty-shopping opportunity presented by 
        the existing treaty with Poland, which is one of only two U.S. 
        income tax treaties that do not include any limitation-on-
        benefits rules (the other is the existing treaty with Hungary) 
        but provide for complete exemption from withholding on interest 
        payments from one treaty country to the other treaty country.
   Binding arbitration procedures would be mandatory in certain 
        cases presented to the U.S. and Spanish competent authorities 
        and unresolved under the mutual agreement procedures.
The extent to which the U.S. Model treaty continues to reflect U.S. tax 
        policy
    The current U.S. Model treaty was published in 2006 and provides a 
framework for U.S. income tax treaty policy and a starting point for 
income tax treaty negotiations with our treaty partners. A number of 
U.S. income tax treaties and protocols to earlier treaties have entered 
into force since then. Significant deviations from the U.S. Model 
treaty have, understandably, proliferated. This proliferation can be 
expected to continue as the U.S. State Department and Treasury 
Department negotiate new income tax treaties and protocols. Each of the 
agreements before the committee today differs from the U.S. Model 
treaty in several significant aspects: the limitation-on-benefits 
provisions proposed for both Spain and Poland (replacing a provision in 
the existing treaty with Spain and included for the first time in the 
proposed treaty with Poland); the extension of mandatory and binding 
arbitration to Spain; the zero-rate of dividend withholding for Spain; 
and the attribution of profits to a permanent establishment for Poland. 
The committee may wish to consider, among other questions described 
below, the extent to which these deviations represent actual U.S. 
income tax treaty policy notwithstanding that they differ from the 
policy as provided in the U.S. Model treaty. The committee also may 
wish to inquire whether the Treasury Department expects to publish a 
new model treaty in the near future and, if it does so expect, whether 
that new model would include provisions similar to the deviations 
described below.
            1. Limitations on benefits: Spain and Poland
    The committee may wish to inquire of the Treasury Department as to 
its plans to address the remaining U.S. income tax treaties that do not 
include limitation-on-benefits provisions, or include outdated versions 
of these provisions. In particular, you may wish to inquire about the 
rationale for several of the deviations, and to the extent that the 
provisions vary among recent treaties, whether one or another of the 
provisions reflects a preferred approach.
    The limitation-on-benefits rules in the proposed treaty and 
protocol with Poland and Spain, respectively, are similar to the rules 
in other recent and proposed U.S. income tax treaties and protocols and 
in the U.S. Model treaty, but they are not identical. The principal 
differences from the U.S. Model treaty are the inclusion of the 
headquarters company category of qualified person, the derivative 
benefits rule, and the antiabuse rule for triangular arrangements. In 
addition, the proposed protocol and proposed treaty differ slightly in 
formulating the derivative benefits rule. Finally, both the proposed 
protocol with Spain and the proposed treaty with Poland conform to the 
U.S. Model in permitting a treaty country the discretion to extend 
benefits to persons that do not otherwise qualify under the 
limitations-on-benefits provisions, but the proposed protocol with 
Spain differs in establishing the applicable standard for exercise of 
that discretion, as explained below.
    First, with respect to publicly traded companies, the committee may 
wish to explore the rationale underlying the identification of 
recognized stock exchanges for purposes of limitations of benefits and 
the criteria the Treasury Department considers when negotiating over 
the definition of a recognized stock exchange. Under both the proposed 
treaty with Poland and proposed protocol with Spain, a publicly traded 
company that is a resident of a treaty country is eligible for all the 
benefits of the proposed treaty if it satisfies a regular trading test, 
which requires that the company's principal class of shares is 
primarily traded on a recognized stock exchange, and also satisfies 
either a management and control test or a primary trading test. As in 
the U.S. Model treaty, in both the proposed treaty with Poland and the 
proposed protocol with Spain, a recognized stock exchange includes 
certain exchanges specified in the treaty as well as any other stock 
exchange agreed upon by the competent authorities of the treaty 
countries.
    With respect to the headquarters company rule, the committee may 
wish to explore the rationale for granting benefits to an entity that 
is not otherwise eligible for benefits. Both agreements also allow full 
treaty benefits for an entity that functions as a headquarters company, 
but does not satisfy the other categories of persons entitled to full 
treaty benefits. In doing so, they conform to U.S. income tax treaties 
in force with Austria, Australia, Belgium, the Netherlands, and 
Switzerland but not the U.S. Model treaty. The conditions for 
qualifying as a headquarters company include requirements intended to 
ensure that the headquarters company performs substantial supervisory 
and administrative functions for a group of companies, including its 
multinational nature, that the headquarters company is subject to the 
same income tax rules in its country of residence as would apply to a 
company engaged in the active conduct of a trade or business in that 
country; and that the headquarters company has independent authority in 
carrying out its supervisory and administrative functions.
    The derivative benefits rules may grant treaty benefits to a 
treaty-country resident company in circumstances in which the company 
itself would not qualify for treaty benefits under any of the other 
limitation-on-benefits provisions. Like other recent treaties, 
including those with Canada and Iceland as well as several European 
treaty countries, the proposed treaty with Poland and the proposed 
protocol with Spain include a derivative benefits rule. Under the 
derivative benefits rule, a treaty-country company receives treaty 
benefits for an item of income if the company's owners (referred to in 
the proposed treaty as equivalent beneficiaries) reside in a country 
that is in the same trading bloc as the treaty country and would have 
been entitled to the same benefits for the income had those owners 
derived the income directly. The definition of equivalent beneficiary 
differs in the proposed agreements. With respect to Spain, a party 
whose ownership interest is held indirectly is not an equivalent 
beneficiary unless the intermediate owner also qualifies as an 
equivalent beneficiary.
    Finally, the committee may wish to inquire whether it is 
appropriate to grant discretion to competent authorities to extend 
treaty benefits to persons not otherwise entitled to such benefits, 
and, if so, the standard for exercise of any such authority. As in the 
U.S. Model and other recently negotiated treaties with modern 
limitations on benefits articles, the proposed treaty with Poland 
includes a grant of discretion to the competent authority to extend 
otherwise unavailable treaty benefits to a party that is not otherwise 
entitled to treaty benefits if the competent authority determines that 
the organization or operation of the person claiming benefits did not 
have as a principal purpose the obtaining of treaty benefits. By 
contrast, the proposed protocol with Spain requires that the competent 
authority evaluate the extent to which the resident of the other 
country met any of the criteria under other provisions in the article, 
without regard to motivation.
    The committee may wish to inquire of the Treasury Department about 
the alternative formulations of the standard for discretion to extend 
tax treaty benefits that have been proposed as part of Action Plan on 
Base Erosion and Profit Shifting, undertaken by the Organisation for 
Economic Co-operation and Development (``OECD'') at the request of the 
G-20.\2\ Action Six in that plan is identifying ways to prevent 
inappropriate extension of treaty benefits. A discussion draft report 
on the issue includes two draft articles designed to stem treaty abuse.
            2. Mandatory arbitration: Spain
    Although U.S. tax treaties traditionally have not included a 
mechanism to ensure resolution of disputes, the addition of mandatory 
procedures for binding arbitration as part of the mutual agreement 
procedures has become increasingly frequent in recent years. If the 
proposed protocol enters into force, the U.S.-Spain treaty will be the 
fifth bilateral U.S. income tax treaty to require binding arbitration 
of unresolved cases. Mandatory binding arbitration is provided upon 
request of the taxpayer in paragraph 5 of Article 25 (Mutual Agreement 
Procedure) of the the 2010 Model Tax Convention on Income and on 
Capital of the Organisation for Economic Co-operation and Development 
(the ``OECD Model treaty''). Proponents of mandatory arbitration 
believe that incorporating into the mutual agreement process a 
mechanism that would ensure the resolution of disputes would impel the 
competent authorities to reach mutual agreement, so as to avoid any 
arbitration proceedings. As a result, these proponents hold the view 
that cases will be resolved more promptly and on more appropriate bases 
through the mutual agreement procedure than previously, although actual 
arbitration may be rare.
    In considering the proposed protocol, the committee may wish to 
consider the extent to which the inclusion of mandatory arbitration 
rules and the particular features of the arbitration provisions in the 
proposed protocol now represent the United States policy regarding 
mandatory binding arbitration. In particular, the committee may wish to 
inquire about the criteria on which the Treasury Department determines 
whether to include such provisions in a particular treaty, the 
appropriate scope of issues eligible for determination by binding 
arbitration, the absence of precedential value of arbitration 
determinations, the role of the taxpayer in an arbitration proceeding 
and how to ensure adequate oversight of the use of mandatory 
arbitration.
    Regardless of whether the Treasury Department expects mandatory 
arbitration to become a standard feature in all future U.S. tax 
treaties, the committee may wish to inquire whether the Treasury 
Department intends to develop and publish a standardized set of 
arbitration principles and procedures for inclusion in a revision to 
the U.S. Model treaty.
            3. Zero-rate of dividend withholding: Spain
    When certain conditions are satisfied, the proposed protocol with 
Spain eliminates withholding tax on dividends paid by a company that is 
resident in one treaty country to a company that is a resident of the 
other treaty country and that owns at least 80 percent of the stock of 
the dividend-paying company (often referred to as ``direct 
dividends''). The elimination of withholding tax on direct dividends is 
intended to reduce the tax barriers to direct investment between the 
two treaty countries.
    Until 2003, no U.S. income tax treaty provided for a complete 
exemption from dividend withholding tax, and the U.S. and OECD models 
do not provide an exemption. By contrast, many bilateral income tax 
treaties of other countries eliminate withholding taxes on direct 
dividends between treaty countries, and the European Union (``EU'') 
Parent-Subsidiary Directive repeals withholding taxes on intra-EU 
direct dividends. Recent U.S. income tax treaties and protocols with 
Australia, Japan, Mexico, the Netherlands, Sweden, the United Kingdom, 
Belgium, Denmark, Finland, Germany, France, and New Zealand include 
zero-rate provisions. The Senate ratified those treaties and protocols 
in 2003 (Australia, Mexico, United Kingdom), 2004 (Japan, Netherlands), 
2006 (Sweden), 2007 (Belgium, Denmark, Finland, and Germany), 2009 
(France), and 2010 (New Zealand). The proposed protocol with Spain 
therefore would bring to 13 the number of U.S. income tax treaties that 
provide a zero rate for direct dividends.
    Because zero-rate provisions are a relatively recent but now 
prominent development in U.S. income tax treaty practice, the committee 
may wish to consider possible costs and benefits of zero-rate 
provisions such as revenue considerations and diminishing of barriers 
to cross-border investment; the Treasury Department's criteria for 
determining when a zero-rate provision is appropriate; and certain 
specific features of zero-rate provisions such as ownership thresholds, 
holding-period requirements, the treatment of indirect ownership, and 
heightened limitation-on-benefits requirements. These issues have been 
described in detail in connection with the committee's previous 
consideration of proposed income tax treaties and protocols that have 
included zero-rate provisions.\3\
    Although zero-rate provisions for direct dividends have become a 
common feature of U.S. income tax treaties signed in the last decade, 
the U.S. Model treaty does not provide a zero-rate for direct 
dividends. In previous testimony before the committee, the Treasury 
Department has indicated that zero-rate provisions should be allowed 
only under treaties that have restrictive limitation-on-benefits rules 
and that provide comprehensive information exchange. Even in those 
treaties, according to previous Treasury Department statements, 
dividend withholding tax should be eliminated only on the basis of an 
evaluation of the overall balance of benefits under the treaty. Every 
recent U.S. income tax treaty or protocol has included restrictive 
limitation-on-benefits provisions and comprehensive information 
exchange provisions. The committee therefore may wish to inquire into 
whether there are other particular considerations that the Treasury 
Department will now take into account in deciding whether to negotiate 
for zero-rate direct dividend provisions in future income tax treaties 
and protocols. The committee also may wish to ask whether any new U.S 
model income tax treaty might eliminate withholding tax on direct 
dividends and, if it would not so provide, why it would not.
            4. Attribution of profits to a permanent establishment: 
                    Poland
    In the OECD and U.S. Model treaties, Article 7 (Business Profits) 
provides rules for the taxation by a treaty country of the business 
profits of an enterprise located in the other treaty country. The 
proposed treaty between the United States and Poland is the first to 
generally adopt the language of Article 7 (Business Profits) of the 
OECD Model treaty. Although the language used in the OECD Model treaty 
differs from the U.S. Model treaty, the policy toward, and 
implementation of, the business profits article under the two models 
are substantively similar. The committee may wish to ask the Treasury 
Department whether the use of the OECD Model treaty Article 7 in the 
Polish treaty represents a change in U.S. income tax treaty policy, or 
whether instead it achieves the same or a similar policy outcome.
    Article 7 in both the OECD and U.S. Model treaties sets forth the 
basic rule that the business profits cannot be taxed unless the 
enterprise carries on a business through a permanent establishment in 
the other treaty country. Although there are slight differences in the 
language, the provisions in the two models are identical in operation. 
This principle is based on the general international consensus that a 
country should not have taxing rights over the profits of an enterprise 
if the enterprise is not participating in the economic life of the 
country. Additionally, if an enterprise carries on business in the 
other treaty country through a permanent establishment, only the 
profits attributable to the permanent establishment determined under 
Article 7 are taxable in the country where the permanent establishment 
is located.
    The separate entity and arm's-length pricing principles are the 
basic principles upon which the attribution of profits rule in Article 
7 is based. The article does not allocate profits of the entire 
enterprise between the permanent establishment and the other parts of 
the enterprise; rather, it requires that the profits attributable to a 
permanent establishment be determined as if the permanent establishment 
were a separate enterprise operating at arm's length. These principles 
are incorporated into both the OECD and U.S. Model treaties.
    Both model treaties adopt the Authorized OECD Approach (the 
``AOA''), as set out under the OECD report, ``2010 Report on the 
Attribution of Profits to Permanent Establishments (the ``2010 OECD 
Report''). The AOA attributes profits to the permanent establishment 
from all its activities, including transactions with independent 
enterprises, transactions with associated enterprises, and dealings 
with other parts of the enterprise. Article 7 of the U.S. and OECD 
Model treaties specifically refers to the dealings between the 
permanent establishment and other parts of the enterprise in order to 
emphasize that the treatment of the permanent establishment requires 
that these dealings be treated the same way as similar transaction 
taking place between independent enterprises.
    The U.S. Model treaty includes, and, historically, the OECD Model 
treaty included, explicit language allowing expenses incurred for the 
purposes of the permanent establishment, including executive and 
general administrative expenses, whether in the treaty country where 
the permanent establishment is situated or elsewhere, to be deducted in 
determining the profits attributed to that permanent establishment. 
This language was intended to clarify that the determination of profit 
attributable to a permanent establishment required that expenses 
incurred directly or indirectly for the benefit of that permanent 
establishment be deducted. However, the paragraph was sometimes read as 
limiting the deduction of expenses to the actual amount of the expense 
rather than an arm's-length amount of expense. The OECD views its 
current Article 7 wording as requiring the recognition and arm's-length 
pricing of the dealings through which one part of the enterprise 
performs function for the benefit of the permanent establishment (e.g., 
through the provision of assistance in day-to-day management).\4\ The 
Technical Explanation of the U.S. Model treaty also clarifies that the 
U.S. Model treaty requires recognition and arm's-length pricing for 
functions performed for the benefit of the permanent establishment by 
another part of the enterprise. This requires that a deduction be 
allowed based on an arm's-length charge for these dealings, as opposed 
to a deduction limited to the actual amount of the expense. The 
committee may wish to inquire about the experience of the United States 
with its treaty partners related to the allowance and determination of 
the price for functions provided by one part of the enterprise for the 
benefit of the permanent establishment.
    The proposed treaty between the United States and Poland applies 
the principles of Article 7 only for purposes of attributing profits to 
a permanent establishment and does not affect the application of other 
articles. However, the OECD Model treaty applies the Article 7 
principles to attributing profits to a permanent establishment and for 
purposes of Article 23 (Elimination of Double Taxation). The OECD Model 
treaty requires that where an enterprise of one treaty country carries 
on business through a permanent establishment located in the other 
treaty country, the first country must either exempt the profits that 
are attributable to the permanent establishment (exemption system) or 
give a credit for the tax levied by the other country on the profits 
(foreign tax credit system).
    The significance of this difference relates to the computation of 
the foreign tax credit limitation. The United States does not apply the 
principles of Article 7 to the computation of the foreign tax credit 
limitation; rather, it applies the principles set forth by the Code. A 
taxpayer seeking to obtain additional foreign tax credit limitation to 
prevent double taxation must do so through the mutual agreement 
procedures. The taxpayer would have to prove that double taxation of 
the permanent establishment profits which resulted from the conflicting 
domestic law has been left unrelieved after applying mechanisms under 
domestic law. The committee may ask the Treasury Department about this 
difference as well as about the standard to be applied in determining 
whether a taxpayer meets the level of proof to show that double 
taxation was not relieved under the mechanisms of local law.
    The OECD Model treaty provides that where, in accordance with 
Article 7, one treaty country adjusts the profits attributable to a 
permanent establishment and taxes accordingly profits of the 
enterprises which have been charged to tax in the other treaty country, 
the other country will, to the extent necessary to eliminate double 
taxation on these profits, make an appropriate adjustment to the tax 
charged on those profits. In determining such adjustment, the competent 
authorities of the treaty countries will, if necessary, consult each 
other. The OECD acknowledges that some countries may prefer to resolve 
issues related to appropriate adjustments through the mutual agreement 
procedure if one treaty country does not unilaterally agree to make a 
corresponding adjustment, without any deference given to the adjusting 
treaty country's preferred position, and provides an alternative 
approach.\5\ The proposed treaty between the United States and Poland 
follows the alternative approach, providing that the appropriate 
adjustment be made by the other treaty country only if the other treaty 
country agrees with the adjustment made by the first treaty country. 
The alternative approach provides that where the other treaty country 
does not agree with the adjustment made by the first treaty country, 
the treaty countries will eliminate any double taxation through mutual 
agreement. The committee may wish to inquire about this alternative 
OECD approach, including the concerns raised by the Treasury Department 
related to the requirement to make appropriate adjustments as a result 
of an adjustment made by another treaty country.
Commitment to negotiate an agreement to avoid double taxation of 
        investments between Puerto Rico and Spain
    The committee may wish to consider the appropriate U.S. tax policy 
toward the Commonwealth of Puerto Rico in the context of the income tax 
treaty relationship between the United States and Spain. This 
consideration might include a broader evaluation of U.S. tax treaty 
policy in relation to the U.S. territories.
    The Memorandum of Understanding signed contemporaneously with the 
proposed protocol includes a paragraph (paragraph 3) under which the 
United States and Spain ``commit to initiate discussions as soon as 
possible, but no later than 6 months after the entry into force of the 
2013 Protocol, regarding the conclusion of an appropriate agreement to 
avoid double taxation on investments between Puerto Rico and Spain.''
    Paragraph 3 of the Memorandum of Understanding references paragraph 
3 of the 1990 protocol. Paragraph 3 of the 1990 protocol provides, 
``The Parties [the United States and Spain] agreed to initiate, as soon 
as possible, the negotiation of a Protocol to extend the application of 
this Convention to Puerto Rico, taking into account the special 
features of the taxes applied by Puerto Rico.''
    Following U.S. income tax treaty policy not to apply treaties to 
the U.S. territories, the existing treaty with Spain generally does not 
apply to Puerto Rico or the other U.S. territories, and the proposed 
protocol does not extend the application of the treaty to Puerto Rico 
or the other U.S. territories.\6\ Consequently, among other things, 
when a resident of Puerto Rico derives income in Spain or a resident of 
Spain derives income in Puerto Rico, the treaty's restrictions on 
source-basis taxation, such as reduced or zero withholding tax rates on 
dividends, interest, and royalties, are not available. Instead, the 
domestic tax laws of Puerto Rico and Spain apply to income from cross-
border investments between the two jurisdictions.
    It is understandable that U.S. income tax treaties do not cover 
Puerto Rico or the other U.S. territories: Individuals resident in the 
territories are generally taxed in the United States in a manner more 
similar to non-U.S. residents than to U.S. residents, and corporations 
organized in the territories likewise are subject to U.S. tax in a 
manner more similar to foreign corporations than to domestic 
corporations.\7\ Moreover, territory residents may benefit from 
favorable tax regimes in the territories, such as the U.S. Virgin 
Islands' economic development incentives and, more recently, Puerto 
Rico's tax incentives for individuals and businesses.\8\ If U.S. income 
tax treaty benefits were conferred on territory residents, 
consideration would need to be given to whether those benefits should 
be restricted in any way as a result of preferential tax regimes in the 
territories.\9\ Restrictions on treaty benefits as a result of 
territory tax preferences would be consistent with the long-standing 
U.S. treaty policy against tax sparing.
    On the other hand, the exclusion of territory residents from treaty 
benefits such as reductions in source country taxation may be in 
tension with the goals of some U.S. internal laws applicable to the 
territories. For example, the possession tax credit was intended to 
encourage economic activity in the territories. Economic activity might 
be discouraged, though, if, because they are not eligible for the 
benefits of U.S. income tax treaties, territory residents with cross-
border income must pay more in source country income taxes on that 
income than their peers in the United States or in foreign countries 
with similar treaty reductions in source taxation would face on the 
same income.
    If no agreement is reached to address taxation of cross-border 
investments between Spain and Puerto Rico, the Puerto Rican Government 
could, as one example, choose unilaterally to reduce Puerto Rican 
taxation of Puerto-Rico-source income derived by residents of Spain (or 
by residents of other countries with which the United States has income 
tax treaties in force).
    Even if Puerto Rico were to reduce or eliminate under its domestic 
tax law source-basis taxation of Puerto Rico source income derived by 
residents of Spain, Puerto Rican investors in Spain would be taxed 
under Spain's generally applicable internal tax laws unless Spain also 
were to grant unilateral relief to Puerto Rico residents.
    More broadly, assuming the existing treaty is not extended in 
application to Puerto Rico, resolution of bilateral legal questions 
otherwise addressed by the treaty would instead be governed by the 
domestic laws of Puerto Rico and Spain.
                               conclusion
    The matters that I have described in this testimony are addressed 
in more detail in the Joint Committee staff pamphlets on the proposed 
treaty and protocol. I am happy to answer any questions that the 
committee may have at this time or in the future.

----------------
End Notes

    \1\Joint Committee on Taxation, ``Explanation of Proposed Protocol 
to the Income Tax Treaty Between the United States and Spain'' (JCX-67-
14), June 17, 2014; Joint Committee on Taxation, ``Explanation of 
Proposed Income Tax Treaty Between the United States and Poland'' (JCX-
68-14), June 17, 2014. These publications can also be found at http://
www.jct.gov. The proposed protocol with Spain was signed on January 14, 
2013, and includes provisions amending the existing protocol (``1990 
protocol'') as well as a contemporaneous Memorandum of Understanding.
    \2\The full Action Plan, published July 19, 2013 is available at 
www.oecd.org/ctp/BEPSActionPlan.pdf.
    \3\See, for example, Joint Committee on Taxation, ``Explanation of 
Proposed Protocol to the Income Tax Treaty Between the United States 
and Germany'' (JCX-47-07), July 13, 2007, pp. 82-84.
    \4\See the Commentaries to the OECD Model Treaty, paragraphs 38-40.
    \5\See the Commentaries to the OECD Model Treaty, paragraph 68.
    \6\See Art. 3(1)(b) (defining ``United States,'' when used in a 
geographic sense, to include the 50 U.S. states and the District of 
Columbia but not the U.S. territories). Under U.S. internal law 
(section 7651), however, the IRS is permitted to obtain information 
from Puerto Rico and the other U.S. territories in response to a proper 
request for information made under Article 26 of the treaty. For more 
detail, see the description above of proposed protocol Article XIII.
    \7\We have described tax rules applicable to the U.S. territories 
in more detail in documents that we have published previously. See, for 
example, Joint Committee on Taxation, ``Federal Tax Law and Issues 
Related to the United States Territories'' (JCX-41-12), May 14, 2012.
    \8\For a description of recently enacted incentives, see Ivan 
Castano, ``Puerto Rico Moves to Encourage Profit Shifting, Boost 
Collections,'' Bloomberg BNA Daily Tax Report, May 28, 2014, p I-1.
    \9\In the context of the income tax treaty between the United 
States and Spain, the 1990 protocol's special provision related to 
Puerto Rico would require the United States and Spain to ``tak[e] into 
account the special features of the taxes applied by Puerto Rico.''

    The Chairman. Well, thank you both for your testimony.
    Let me start with you, Mr. Barthold. And first of all, 
thank you for the comprehensive pamphlets you issued yesterday 
addressing these treaties. I know they are very helpful to the 
staff and to all of us.
    A couple of basic questions. You touched upon this earlier, 
but I just want to try to synthesize. This is a field in which 
there is some degree of complexity, and I want to try to 
simplify it for the record as members consider their positions.
    Can you please describe how the treaty will lower the tax 
burden of U.S. firms operating abroad, as well as foreign firms 
with investments in the United States?
    Mr. Barthold. Absent the treaties, both countries, Spain 
and the United States, Poland and the United States, assert the 
right to tax certain income that is derived within their 
jurisdiction. In the case of the United States, dividends paid, 
royalties paid out by a foreign-owned enterprise can be subject 
to our gross withholding taxes which, under the Internal 
Revenue Code, have a default rate of 30 percent. The treaties 
negotiate those rates down. As I noted in the case of a parent 
corporation in Spain, it is to a rate of zero percent in the 
case of certain parent-subsidiary dividends. So that means that 
a Spanish investor who is investing into the United States is 
not subject to that 30-percent gross withholding tax. The 
enterprise in the United States will be subject to U.S. taxes 
such as the U.S. corporate income tax, but the dividend paid 
back out to the Spanish investor would not be subject to 
additional tax. It would be subject to whatever tax the Spanish 
Government imposes upon its residents. So by lowering that 
additional level of tax, it should encourage investment into 
the United States from Spain. And of course, since this is 
bilateral and it has agreed to do the same thing the other way, 
the same would be true for a United States investor investing 
into Spain.
    The Chairman. It is my understanding that both of the 
treaties we are discussing here today contain updated 
limitation-on-benefits provisions. Can you explain to the 
committee the purpose of those provisions?
    Mr. Barthold. Well, the simplest way to think of the 
limitation-on-benefits is to make sure that it is only a 
resident of Spain that qualifies for the benefit under the 
treaty and that it is not possible for a resident of a 
nontreaty country, for example, to--let me use the phrase--
masquerade as a resident of Spain to take advantage of the 
lower withholding rate on dividends or lower withholding rate 
on royalties.
    Mr. Stack can probably give you a very nice example of the 
issues that would arise under the existing Polish treaty in 
terms of one's ability to not be a Polish resident and get the 
benefits of a lower withholding rate on income paid out from 
the United States into Poland.
    The Chairman. Final question for you. The utility of the 
mandatory arbitration provision in the Spanish protocol.
    Mr. Barthold. The theory of binding arbitration is that it 
is really kind of the ultimate backstop. The first step under 
the treaties is that the competent authorities try to resolve 
disagreements. If the competent authorities cannot resolve it, 
it goes to binding arbitration. So that ensures both parties, 
the United States and Spain, that there will be a resolution, 
that any controversy will not be dragged on forever. By being 
ensured that there is a resolution and that there is an 
arbitration procedure, it gives some incentives to both sides 
to reach agreement prior to going to binding arbitration.
    Now, in practice the utility has not been greatly tested 
yet. As I noted, I think we have four binding arbitration 
agreements in place in prior treaties. The Treasury is to 
provide to the Senate Foreign Relations Committee, among 
others, a report on the outcome of binding arbitration, 
basically how it is working I think it is after we get to 10 
cases, and we have not yet reached the 10-case mark. So it is 
hard to make any judgment on how is this working out in 
practice at this time.
    The Chairman. Thank you.
    Mr. Stack, one of our colleagues has raised questions about 
these treaties on the Senate floor. So I would like to ask you 
a series of questions that hopefully can address and elucidate 
certain points.
    Number one, a concern has been expressed about the 
evolution of the information exchange provisions in our tax 
treaties over the years. You, I think, touched upon this in 
your opening statement. But can you please describe how the 
standards on information exchange in these treaties have 
changed from previous ones?
    Mr. Stack. Thank you, Senator.
    The two tax treaties before the committee, as well as the 
five that have come here before, reflect the same substantive 
standard information exchange that has been in our treaties for 
decades. Whether it is described, if you go back, exchange 
information as is necessary for tax administration or may be 
relevant to tax administration or foreseeably relevant as in 
the Spanish and Polish treaties, the standard requires that in 
order to exchange tax information, one partner has to 
demonstrate to the other that it is relevant to some tax 
proceeding going on in the other jurisdiction. This relevance 
link is very important because what it does is it ties the 
request to the legitimate purpose for the information sought in 
the treaty.
    Now, only one of the 57 treaties currently in force refers 
to exchanging information in cases of tax fraud and the like, 
and that is our treaty with Switzerland. And what is critical 
to understand is while the United States Government was seeking 
information from Swiss banks, it was the Swiss Government and 
the Swiss courts that were denying us access to that 
information about tax cheats based on the fraud and the like 
standard in the Swiss treaty. And so that is why we have been 
very anxious to have that standard changed in the Swiss treaty 
and conform it to the longstanding standard in our treaties of 
the relevance standard.
    The Chairman. Well, so as a followup to that, does the 
``may be relevant'' standard in the treaties before us today 
represent a new standard not used in previous tax treaties?
    Mr. Stack. No, Senator. What has happened in this space is 
the United States for a long time used ``may be relevant.'' The 
OECD has moved in its model work to foreseeably relevant,'' 
which is what we use in Poland and Spain. And they are 
substantively the same treaty. The difference is in the OECD 
sometimes you will have the groups of countries that want to 
maybe choose a different word, but the commentary in the OECD 
makes clear that this ties to the basic core relevance 
standard.
    The Chairman. Now, what is the basis for the standards on 
information exchange requests in these proposed treaties? Is 
this a standard used in U.S. domestic law? Can this type of 
information be obtained from U.S. citizens living in the United 
States who have bank accounts in the United States?
    Mr. Stack. Yes, Senator. This standard draws many of its 
origins from U.S. statutory law as elucidated in Supreme Court 
and other court rulings. It is, in fact, the same standard that 
the IRS must meet to examine the books and records of a 
taxpayer. And it comes from section 7602 of the Internal 
Revenue Code passed by Congress which authorizes the IRS to 
examine ``any books, papers, records, or other data that may be 
relevant or material'' to an inquiry into the taxpayer's tax 
liability. This is substantively the same standard as the 
``foreseeably relevant'' standard in Spanish and Polish 
treaties.
    I will just add the Supreme Court in 1964 in the Powell 
case made clear that in applying this relevance standard, it 
was not necessary for the IRS to show probable cause or 
anything more than meeting the requirement that the information 
may be relevant. And I will add that in 1984 in the Arthur 
Young case, the Supreme Court applied the standard and kind of 
explained how the relevance standard played out in a particular 
fact pattern involving accountant books and records. So we both 
have the statute and we have got elucidations by the Supreme 
Court on how the statute should apply, and that is the standard 
we have in the treaties.
    The Chairman. Now, in your view, is there any reason why 
people who have a foreign bank account should be treated any 
differently from U.S. citizens who have bank accounts in the 
United States?
    Mr. Stack. No, Senator, absolutely not. And these 
information exchange provisions that we are talking about put 
people with foreign bank accounts on an equal footing with U.S. 
citizens who have bank accounts here in the United States. As I 
just mentioned, under the code, the IRS has authority to seek 
information that ``may be relevant or material.'' The treaties 
before the committee today permit the IRS to request 
information that is foreseeably relevant. So in the tax treaty 
context, this standard and these provisions are critical to 
ensure that taxpayers cannot avoid their obligations by the 
simple device of shifting accounts overseas and getting better 
treatment than their U.S. resident counterparts.
    The Chairman. Now, how many U.S. tax treaties use the ``tax 
fraud or the like standard,'' a standard that is used in the 
Swiss treaty from 1996?
    Mr. Stack. Senator, there is only one treaty. The Swiss 
treaty uses this ``fraud and the like'' standard.
    The Chairman. And why did the Swiss treaty depart from the 
standard practice at the time?
    Mr. Stack. We do not know the specific circumstances 
surrounding the inclusion. We can only surmise that Switzerland 
insisted on it in light of their prior bank secrecy culture. 
But because of this language, as I mentioned, the Swiss banks 
were able to avoid having to turn information over to the 
United States.
    The Chairman. Now, does the information exchange provision 
in these treaties allow for bulk collection of information?
    Mr. Stack. Senator, without characterizing the transfers in 
any particular way, I thought the best way to answer this would 
be to describe the kinds of transfers that can take place under 
one of our treaties.
    Often this relevance standard is met when there is a 
specific request by our treaty partner about particular 
information for a particular tax matter that our treaty partner 
is investigating or looking at, and we provide that information 
that way.
    In other contexts, this relevant information may consist of 
greater quantities of information to be sure but still clearly 
tax-related pertaining to, let us say, a class of residents of 
one country that are receiving payments from the other country. 
So, for example, it may be that we will report interest, 
dividends, and other taxable income of the residents of another 
country from our country, and we have in the past entered into 
some reciprocal arrangements to exchange that type of 
information.
    The Chairman. Finally, a concern has been raised about the 
security of the information being exchanged pursuant to these 
treaties. Could you please describe the confidentiality 
protections that are built into the agreements before us, and 
what steps the U.S. Government takes to ensure that private 
information is not disclosed to the wrong parties?
    Mr. Stack. These confidentiality provisions of the treaties 
are central to establishing and maintaining our exchange of 
information treaty relationships around the world. Provisions 
requiring the protection are included in the treaties being 
considered by the Senate, and the United States importantly has 
authority, consistent with international law, not to exchange 
information in cases where a treaty partner does not protect 
the confidentiality of the information as required by the 
treaties.
    Specifically, the tax treaties before the Senate provide 
that information that is exchanged pursuant to the information 
exchange provisions be treated as secret in the other 
jurisdiction just as other secret information that that 
jurisdiction may have under its domestic laws is treated. And 
it can only be disclosed to individuals and bodies dealing with 
tax administration, not to others, with an exception for things 
being able to be disclosed in judicial proceedings and the 
like.
    It is also very important to emphasize that when 
negotiating a treaty, the Treasury and the IRS satisfy 
themselves that the foreign jurisdiction has the laws in place 
in order to maintain the confidentiality of this information. 
And the Treasury will agree to conclude a bilateral tax treaty 
or tax exchange only if it is satisfied that confidentiality 
laws are robust. If a treaty partner were to breach the 
relevant agreements confidentiality provisions, the United 
States would have the ability, consistent with international 
law, to suspend information exchange with that state pending 
resolution of the matter. And I will simply add for the 
committee that the IRS, which administers these provisions, has 
in the past suspended information exchange when it thought it 
was appropriate to do so.
    The Chairman. And then finally, on a question that I have 
personal interest in. Mr. Barthold referenced it. The proposed 
Spain protocol includes an accompanying memorandum of 
understanding that requires the United States and Spain to 
begin negotiations in 6 months after the protocol enters into 
force to conclude an agreement to avoid double taxation on 
investments between Puerto Rico and Spain. Given that Puerto 
Rico administers its own tax system but cannot enter into 
treaties, how is Treasury planning to work with its Spanish 
counterparts to extend the benefits of the protocol to Puerto 
Rico?
    Mr. Stack. Sure, Senator. I am happy to report that we 
began outreach with both Puerto Rico and Spain well in advance 
of the deadline in the protocol, which is 6 months after 
ratification.
    As Mr. Barthold pointed out, because Puerto Rico is a 
possession and because it has its own tax system, it raises 
some unique issues of how to treat them in a treaty 
relationship with Spain. For example, it would not be as easy 
as being able to say Puerto Rico will be treated as part of the 
United States for the treaty because we have got these two 
different tax systems.
    On the other hand, we think that one of Puerto Rico's main 
objectives is to be able to increase investment from Spain and 
giving Spanish investors a lower rate of withholding on the 
payments out of Puerto Rico back to Spain. And in our work on 
this area, we noted that when Guam had this similar concern, it 
was able, by its own statute, for example, to grant those 
reduced withholding rates to investors in Guam if those 
investor countries had treaty relationships with the United 
States. So we are looking at, for example, that idea, but we 
are looking at the full range of ideas. We are working with 
both Puerto Rico and Spain and the State Department, and we 
will keep the committee fully informed on our progress as we go 
along.
    The Chairman. Well, I appreciate that. I think one thing 
that we often forget is that but for the situs of where the 
residents of Puerto Rico reside, they are United States 
citizens. If they were to reside in the continental United 
States, they would be U.S. citizens. If they reside in Puerto 
Rico, at the same time they, for all intents and purposes, 
would be U.S. citizens except that they have the unique 
taxation system based upon their status.
    So we obviously have an interest in the economic well-being 
of Puerto Rico, and I hope that we can find a way that would be 
beneficial to seek foreign investment into Puerto Rico to help 
its economy, and I hope that we can find a way to successfully 
conclude that part of the negotiation.
    Let me thank both of you for your testimony. I hope that 
some of the very clear testimony, particularly about 
confidentiality and standards, has been helpful to members who 
have had some concerns, and that we will be able to move 
forward on these treaties before the Senate as a whole. And 
with the appreciation of the committee, this panel is excused. 
Thank you very much.
    As I excuse you, let me call up our next panel. On our 
second panel today we have Ms. Mary Jean Riley, the vice 
president of finance and administration, treasurer and member 
of the Board of Directors of North American Stainless, a member 
of Spain's Acerinox Group, one of the world's largest stainless 
steel producers. We also have Ms. Catherine Schultz, the vice 
president for tax policy at the National Foreign Trade Council, 
representing the largest U.S. companies dedicated to 
international tax and trade matters. Thank you both for being 
here.
    Your written statements will be fully included into the 
record, without objection. I would ask you to try to summarize 
them in around 5 minutes or so, so that we can enter into a bit 
of a dialogue. And we will start with you, Ms. Riley.

   STATEMENT OF MARY JEAN RILEY, VICE PRESIDENT, FINANCE AND 
 ADMINISTRATION, TREASURER, NORTH AMERICAN STAINLESS, GHENT, KY

    Ms. Riley. Good morning.
    The Chairman. Good morning.
    Ms. Riley. My name is Mary Jean Riley, and I am vice 
president and treasurer of North American Stainless located in 
Ghent, Kentucky. Thank you for the opportunity to testify at 
today's hearing.
    In 1990, I walked from my CPA office to our courthouse lawn 
to witness the chairman of a Spanish company and our Governor 
announce that Carroll County, KY, had been selected as the site 
for a new stainless steel mill, North American Stainless. 
Little did I realize then that I would have the honor of 
testifying before this committee on this important issue to our 
community, the ratification of a tax treaty with Spain.
    The Spanish company I referred to is Acerinox, which is 
known worldwide as the world's largest and most competitive 
stainless steel producer. Acerinox correctly foresaw that the 
demand for stainless steel would increase in the United States 
and selected our community because of its location. NAS is 
located on the Ohio River and by interstate is within 600 miles 
of 60 percent of the Nation's population.
    Since 1990, Acerinox has invested more than $2.5 billion in 
NAS. This investment has been very beneficial to our community 
which was largely dependent on tobacco. Acerinox has not only 
provided the funds to build NAS, but just as or perhaps more 
importantly to our community has brought its technology to 
Kentucky and, through its emphasis on employee education and 
training, has created a workforce skilled in all the 
disciplines necessary for U.S. manufacturers to be competitive 
in the global market.
    NAS is the largest contributor to our high school STEM 
program. Additionally, we have established a program at our 
local community college which allows eligible employees to 
receive their full wages and benefits while receiving an 
associate degree in electrical technology at the full expense 
of North American Stainless. Many of our employees have 
received specialized training in Spain also.
    Thanks to the technology and training provided by Acerinox 
and the hard work of our employees, NAS is the only fully 
integrated stainless steel mill in the United States and is 
recognized as the most efficient stainless steel operation in 
the world. As we approach our 25th anniversary, our 1,360 
employees, earning on average a nonexempt wage and benefit 
package equaling $89,200 annually, are producing approximately 
40 percent of all stainless steel produced in the United 
States. And they are doing so in an environmentally responsible 
manner with NAS having achieved the Department of Environmental 
Protection's highest designation for environmental leadership. 
Additionally, Acerinox's investment has not only allowed us to 
expand in Kentucky, but we also have built finishing and 
distribution centers in Minooka, IL; Riverside, CA; 
Wrightsville, PA; and Pendergrass, GA.
    Our employees are very proud to be part of the Acerinox 
Group and to have built what we believe is the largest single 
Spanish investment in the United States. One of our fondest 
memories was the dedication of our hot mill by the Crown Prince 
of Spain, His Royal Highness Felipe de Borbon, Prince of 
Asturias. Another event which we all take pride from is the 
directive back at the beginning of the recession from Madrid in 
2008 that we would have no layoffs, even though NAS lost 40 
percent of our orders virtually overnight.
    I provide you with this background, Chairman, so you know 
what the men and women of NAS have accomplished with the 
support of our Acerinox Spanish parent and to seek your 
assistance in removing an impediment to our future growth by 
ratifying the proposed Spain protocol. As a member of the 
Acerinox Group, we compete for capital investment with our 
sister companies in the group. Acerinox has similar production 
facilities in Spain, South Africa, and recently has completed a 
$700 million mill in Malaysia.
    As the world economy continues to recover, Acerinox has 
choices to make and in the near future will decide where to 
invest next. An investment of $200 million to $300 million in 
Ghent to increase NAS's cold rolling, annealing, and finishing 
capacity will broaden our markets and could possibly add 50 to 
100 new highly skilled employees. However, without ratification 
of the protocol to remove the 10-percent withholding on 
dividends to Acerinox, our proposal may not be as attractive to 
Acerinox as those submitted by our sister companies. This is a 
major concern for us as we plan for our future on how to 
confront increased global competition.
    So again, I thank you for the opportunity to speak here 
today.
    [The prepared statement of Ms. Riley follows:]

                 Prepared Statement of Mary Jean Riley

    Good morning Chairman Menendez, Ranking Member Corker, and members 
of the Committee. My name is Mary Jean Riley and I am Vice President 
and Treasurer of North American Stainless, located in Ghent, KY. Thank 
you for the opportunity to testify at today's hearing. In 1990, I 
walked from my CPA office to our courthouse lawn to witness the 
chairman of a Spanish company and our Governor announce that Carroll 
County, Kentucky had been selected as the site for a new stainless 
steel mill, North American Stainless. Little did I realize then that I 
would have the honor of testifying before this committee on the 
importance to our community of the ratification of a tax treaty between 
our country and Spain.
    The Spanish company I referred to is Acerinox S.A., which is known 
worldwide as one of the world's largest and most competitive stainless 
steel producers. Acerinox correctly foresaw that demand for stainless 
steel would increase in the U.S. and selected our community because of 
its location. NAS is located on the Ohio River and by interstate is 
within 600 miles of 60 percent of our Nation's population. Since 1990 
Acerinox has invested more than $2.5 billion in NAS. This investment 
has been very beneficial for our community which was largely dependent 
on tobacco. Acerinox has not only provided the funds to build NAS but 
just as or perhaps more important to our community has brought its 
technology to Kentucky and through its emphasis on employee education 
and training has created a workforce skilled in all the disciplines 
necessary for U.S. manufacturing to compete globally. NAS is the 
largest contributor to our high school STEM program (science, 
technology, engineering, mathematics). Additionally, we have 
established a program at our local technical college which allows 
eligible employees to receive their full wages and benefits while 
pursuing an associate electrical tech degree at NAS's expense. Many of 
our employees have received specialized training in Spain. These 
Kentuckians came home not only with great respect for their new Spanish 
friends' technical skills but also in many instances for their skills 
on the basketball court.
    Thanks to the technology and training provided by Acerinox and the 
hard work of our employees, NAS is the only fully integrated stainless 
steel mill in the United States and is recognized as the most efficient 
stainless steel operation in the world. As we approach our 25th 
anniversary, our 1,360 employees, earning on average a nonexempt wage/
benefit of $89,200, are producing approximately 40 percent of all 
stainless produced in the USA and they are doing so in an 
environmentally responsible manner with NAS having achieved the 
Department of Environmental Protection's highest designation for 
environmental leadership. Additionally Acerinox's investment has not 
only allowed us to expand in Kentucky but we have also built finishing 
and distribution centers in Minooka, IL; Riverside, CA; Wrightsville, 
PA; and Pendergrass, GA.
    Our employees are very proud to be a part of the Acerinox Group and 
to have built what we believe is the largest single Spanish investment 
in the United States. One of our fondest memories is the dedication of 
our hot mill by the Crown Prince of Spain, His Royal Highness, D. 
Felipe de Borbon, Prince of Asturias. Another event in which we all 
take pride is the directive from Madrid in 2008 that there would be no 
``lay offs'' even though NAS lost 40 percent of our orders virtually 
overnight.
    I provide you with this background so you know what the men and 
women of NAS have accomplished with the support of Acerinox and to seek 
your assistance in removing an impediment to our future growth by 
ratifying the proposed Spain Protocol. As a member of the Acerinox 
Group, we compete for capital investment with our sister companies in 
the Group. Acerinox has similar production facilities in Spain, South 
Africa, and the recently completed $700,000,000 mill in Malaysia.
    As the world economy continues to recover, Acerinox has choices to 
make and in the near future will decide where to invest. An investment 
of $200,000,000 to 300,000,000 in Ghent to increase NAS's cold rolling, 
annealing and finishing capacity will broaden our markets and may add 
50 to a 100 new highly skilled employees. However, without ratification 
of the Protocol to remove the 10 percent withholding on dividends to 
Acerinox, our proposal may not be as attractive to Acerinox as those 
submitted by our sister companies in the Group. This is a major concern 
for us as we plan on how to confront increased global competition, so 
again I thank the committee for the opportunity to relate our concerns 
in person.

    The Chairman. Thank you very much. You will, I am sure, be 
pleased to know that the Crown Prince who attended your 
dedication is now the King of Spain.
    Ms. Schultz.

STATEMENT OF CATHERINE SCHULTZ, VICE PRESIDENT FOR TAX POLICY, 
         NATIONAL FOREIGN TRADE COUNCIL, WASHINGTON, DC

    Ms. Schultz. Good morning, Mr. Chairman. Thank you for the 
opportunity to testify at today's hearing. My name is Catherine 
Schultz, and I am vice president of tax policy for the National 
Foreign Trade Council.
    The National Foreign Trade Council was organized in 1914 
and we are celebrating our centennial anniversary this year. 
The NFTC is an association of some 250 U.S. enterprises engaged 
in all aspects of international trade and investment. We 
represent both U.S. multinationals and the U.S. subsidiaries of 
foreign multinationals. So we have both inbound and outbound 
companies as members. Our membership covers the full spectrum 
of industrial, financial, commercial, and service activities, 
and we seek to foster an environment in which the U.S. 
companies can be dynamic and effective competitors in the 
international business arena.
    To achieve that goal, American business must be able to 
participate fully in business activities throughout the world 
through the export of goods, services, technology, 
entertainment, and through direct investment in facilities 
abroad. As global competition grows ever more intense, it is 
vital to the health of U.S. enterprises and to their continuing 
ability to contribute to the U.S. economy that they be free 
from excessive foreign taxes or double taxation and impediments 
to the flow of capital that can serve as barriers to full 
participation in the international marketplace.
    Foreign trade is fundamental to the economic growth of U.S. 
companies. Ninety-five percent of the world's consumers are 
outside of the United States. Tax treaties are a crucial 
component of the framework that is necessary to allow that 
growth and balanced competition.
    The National Foreign Trade Council is pleased to recommend 
ratification of the treaty and protocol under consideration by 
the committee today. We appreciate the chairman's actions in 
scheduling this hearing and strongly urge the committee to 
reaffirm the U.S. historic opposition to double taxation by 
giving its full support as soon as possible to the pending 
protocol and tax treaties with Spain and Poland.
    The proposed tax treaty with Poland, signed in 2013, would 
update the 1974 treaty. The proposed treaty would lower 
withholding taxes on a bilateral basis and protect the 
interests of U.S. taxpayers in that country.
    Additionally, important safeguards included in the Poland 
tax treaty prevent treaty shopping. In order to qualify for the 
reduced rates specified by the treaties, companies must meet 
certain requirements so that foreigners whose governments have 
not negotiated a tax treaty with Poland or the United States 
cannot free ride on the treaty.
    Similarly, provisions in the section on dividends, 
interest, and royalties prevent arrangements by which a U.S. 
company is used as a conduit to do the same.
    Extensive provisions in the treaties are intended to ensure 
that the benefits of the treaty accrue only to those for which 
they are intended.
    For example, if the foreign investor from a country with 
which the United States does not have an income tax treaty 
wishes to invest in the United States by, for instance, 
purchasing shares in, or making a loan to, a U.S. company, that 
foreign investor will be subject to our statutory withholding 
rates of 30 percent on the U.S. source dividends and most 
interest that it receives. However, if that foreign investor 
instead chose to establish a Polish company, through which he 
would route his U.S. investment, the effect would be that the 
U.S. source dividends and interest would be reduced to the U.S. 
withholding provided in the Polish tax treaty.
    The LOB rule included in the tax treaty before you today 
would deny benefits to a Polish company that was owned by a 
third-country investor who did not have an active business in 
Poland, and thus stop abusive treaty shopping by those not 
entitled to treaty benefits.
    The Spanish protocol lowers withholding rates for interest, 
dividends, royalties and capital gains. We are pleased that the 
Spanish protocol provides for mandatory arbitration. The 
Spanish protocol mandatory arbitration provision makes sure 
that certain cases that cannot be resolved by the competent 
authorities within a specific period of time are resolved. 
Following the arbitration provisions already adopted in the 
Canadian, German, Belgian, French, and the pending Swiss tax 
treaty, the arbitration provisions help to resolve cases where 
the competent authorities are unable to reach agreement. NFTC 
member companies view tax treaty arbitration as a tool to 
strengthen, not replace existing treaty dispute resolution 
procedures conducted by the competent authorities. Although the 
existing mutual agreement procedures work well to resolve most 
of the disputes that arise in cases involving Spain in the 
United States, the inclusion of the arbitration provision in 
the Spanish tax protocol will expedite the resolution of 
disputes in all competent authority cases.
    In the recent past, some of the government-to-government 
negotiations that are intended to resolve double taxation for 
taxpayers have become bogged down when one party or the other 
refuses to work out the differences over the amount of income 
to be taxed in each jurisdiction. Mandatory arbitration 
provides a solution to this problem and ensures that tax 
disputes are resolved in a more timely manner, thereby saving 
companies millions of dollars that could be better spent 
elsewhere in their business.
    Finally, the NFTC is grateful to the chairman and members 
of the committee for giving international economic relations 
prominence in the committee's agenda, particularly with the 
demands of the committee that are so time-pressing. We would 
also like to express our appreciation for the efforts of both 
majority and minority staff which have enabled this hearing to 
be held at this time.
    We urge the committee to proceed with ratification of these 
important agreements as expeditiously as possible.
    Thank you, Mr. Chairman, for the opportunity to present the 
NFTC views on the tax treaties.
    [The prepared statement of Ms. Schultz follows:]

                Prepared Statement of Catherine Schultz

    Mr. Chairman and members of the committee, the National Foreign 
Trade Council (NFTC) is pleased to recommend ratification of the treaty 
and protocol under consideration by the committee today. We appreciate 
the chairman's actions in scheduling this hearing, and we strongly urge 
the committee to reaffirm the United States historic opposition to 
double taxation by giving its full support as soon as possible to the 
pending Protocol and Tax Treaty agreements with Spain and Poland.
    The NFTC, organized in 1914, is an association of some 250 U.S. 
business enterprises engaged in all aspects of international trade and 
investment. Our membership covers the full spectrum of industrial, 
commercial, financial, and service activities, and we seek to foster an 
environment in which U.S. companies can be dynamic and effective 
competitors in the international business arena. To achieve this goal, 
American businesses must be able to participate fully in business 
activities throughout the world through the export of goods, services, 
technology, and entertainment, and through direct investment in 
facilities abroad. As global competition grows ever more intense, it is 
vital to the health of U.S. enterprises and to their continuing ability 
to contribute to the U.S. economy that they be free from excessive 
foreign taxes or double taxation and impediments to the flow of capital 
that can serve as barriers to full participation in the international 
marketplace. Foreign trade is fundamental to the economic growth of 
U.S. companies. Ninety-five percent of the world's consumers are 
outside of the United States. Tax treaties are a crucial component of 
the framework that is necessary to allow that growth and balanced 
competition.
    This is why the NFTC has long supported the expansion and 
strengthening of the U.S. tax treaty network and why we recommend 
ratification of the items before you today.
                 general comments on tax treaty policy
    The NFTC, as it has done in the past as a general cautionary note, 
urges the committee to reject any opposition to the agreements based on 
the presence or absence of a single provision. No process as complex as 
the negotiation of a full-scale tax treaty will be able to produce an 
agreement that will completely satisfy every possible constituency, and 
no such result should be expected. Tax treaty relationships arise from 
difficult and sometimes delicate negotiations aimed at resolving 
conflicts between the tax laws and policies of the negotiating 
countries. The resulting compromises always reflect a series of 
concessions by both countries from their preferred positions. 
Recognizing this, but also cognizant of the vital role tax treaties 
play in creating a level playing field for enterprises engaged in 
international commerce, the NFTC believes that treaties should be 
evaluated on the basis of their overall effect. In other words, 
agreements should be judged on whether they encourage international 
flows of trade and investment between the United States and the other 
country. An agreement that meets this standard will provide the 
guidance enterprises need in planning for the future, provide 
nondiscriminatory treatment for U.S. traders and investors as compared 
to those of other countries, and meet an appropriate level of 
acceptability in comparison with the preferred U.S. position and 
expressed goals of the business community.
    The NFTC wishes to emphasize how important treaties are in 
creating, implementing, and preserving an international consensus on 
the desirability of avoiding double taxation, particularly with respect 
to transactions between related entities. The tax laws of most 
countries impose withholding taxes, frequently at high rates, on 
payments of dividends, interest, and royalties to foreigners, and 
treaties are the mechanism by which these taxes are lowered on a 
bilateral basis. If U.S. enterprises cannot enjoy the reduced foreign 
withholding rates offered by a tax treaty, noncreditable high levels of 
foreign withholding tax leave them at a competitive disadvantage 
relative to traders and investors from other countries that do enjoy 
the treaty benefits of reduced withholding taxes. Tax treaties serve to 
prevent this barrier to U.S. participation in international commerce.
    If U.S. businesses are going to maintain a competitive position 
around the world, treaty policy should prevent multiple or excessive 
levels of foreign tax on cross border investments, particularly if 
their foreign competitors already enjoy that advantage. The United 
States has lagged behind other developed countries in eliminating this 
withholding tax and leveling the playing field for cross-border 
investment. The European Union (EU) eliminated the tax on intra-EU, 
parent-subsidiary dividends over a decade ago, and dozens of bilateral 
treaties between foreign countries have also followed that route. The 
majority of OECD countries now have bilateral treaties in place that 
provide for a zero rate on parent-subsidiary dividends.
    Tax treaties also provide other features that are vital to the 
competitive position of U.S. businesses. For example, by prescribing 
internationally agreed thresholds for the imposition of taxation by 
foreign countries on inbound investment, and by requiring foreign tax 
laws to be applied in a nondiscriminatory manner to U.S. enterprises, 
treaties offer a significant measure of certainty to potential 
investors. Another extremely important benefit which is available 
exclusively under tax treaties is the mutual agreement procedure. This 
bilateral administrative mechanism avoids double taxation on cross-
border transactions.
    The NFTC also wishes to reaffirm its support for the existing 
procedure by which Treasury consults on a regular basis with this 
committee, the tax-writing committees, and the appropriate 
congressional staffs concerning tax treaty issues and negotiations and 
the interaction between treaties and developing tax legislation. We 
encourage all participants in such consultations to give them a high 
priority. Doing so enables improvements in the treaty network to enter 
into effect as quickly as possible.
                    agreements before the committee
    The Spain Protocol and the updated Tax Treaty with Poland that are 
before the committee today update agreements between the U.S. and these 
countries that were signed many years ago. The Spanish Protocol updates 
a Tax Treaty from 1990, and the Polish Tax Treaty replaces the treaty 
signed by the U.S. and Poland in 1974. The Protocol and Tax Treaty 
improve conventions that have stimulated increased investment, greater 
transparency, and a stronger economic relationship between our 
countries. The Spanish Protocol lowers the withholding rates for 
dividends, interest, and royalties. We are pleased that the Spanish 
Protocol provides for mandatory arbitration. The Polish Tax Treaty 
lowers the withholding rates for dividends, interest and royalties. The 
Polish Tax Treaty also includes a limitation on benefits (LOB) 
provision that will help stop treaty shopping through Poland. We thank 
the committee for its prior support of this evolution in U.S. tax 
treaty policy, and we strongly urge you to continue that support by 
approving the Tax Treaty and Protocol before you today.
    The proposed tax treaty with Poland, signed in 2013, would update 
the 1974 treaty. The proposed treaty would lower withholding taxes on a 
bilateral basis and protect the interests of U.S. taxpayers in that 
country. Additionally, important safeguards included in the Poland tax 
treaty prevent ``treaty shopping.'' In order to qualify for the reduced 
rates specified by the treaties, companies must meet certain 
requirements so that foreigners whose governments have not negotiated a 
tax treaty with Poland or the U.S. cannot free-ride on this treaty. 
Similarly, provisions in the sections on dividends, interest, and 
royalties prevent arrangements by which a U.S. company is used as a 
conduit to do the same. Extensive provisions in the treaties are 
intended to ensure that the benefits of the treaty accrue only to those 
for which they are intended.
    The Spanish Protocol provides for mandatory arbitration of certain 
cases that cannot be resolved by the competent authorities within a 
specified period of time. Following the arbitration provisions already 
adopted in the Canadian, German, Belgian and French tax treaties, the 
arbitration provision included in the Spanish Protocol will help to 
resolve cases where the competent authorities are unable to reach 
agreement. NFTC member companies view tax treaty arbitration as a tool 
to strengthen, not replace, the existing treaty dispute resolution 
procedures conducted by the competent authorities. Although the 
existing mutual agreement procedures work well to resolve most of the 
disputes that arise in cases involving Spain and the United States, the 
inclusion of the arbitration provisions in the Spanish Tax Protocol 
will expedite the resolution of disputes in all competent authority 
cases.
                             in conclusion
    Finally, the NFTC is grateful to the chairman and the members of 
the committee for giving international economic relations prominence in 
the committee's agenda, particularly when the demands upon the 
committee's time are so pressing. We would also like to express our 
appreciation for the efforts of both majority and minority staff which 
have enabled this hearing to be held at this time.
    We urge the committee to proceed with ratification of these 
important agreements as expeditiously as possible.

    The Chairman. Well, thank you both for your testimony. We 
believe--certainly I do as the chairman--that economic 
statecraft is an important function of the Senate Foreign 
Relations Committee, and while we face challenges in the world, 
as we see in Iraq today, as well as Syria and the Ukraine, we 
also believe that promoting U.S. economic interests abroad are 
very important. So I appreciate that recognition.
    Ms. Riley, let me first thank you for traveling to 
Washington today from Kentucky to testify in support of the 
United States-Spain treaty. And the concrete example you 
present of how the treaty could directly enhance investment in 
the United States, anywhere to potentially between $200 million 
and $300 million in Kentucky, and to create another 50 to 100 
new jobs for Americans, adding to--I think you said 1,300 or so 
jobs that exist already as a result of the investments that 
have been made, is pretty compelling.
    In your testimony, you discuss how North American Stainless 
competes with its sister companies, all subsidiaries of the 
Spanish parent company Acerinox, for investment. Could you 
elaborate a little bit on this process to explain to the 
committee how the reduced withholding tax on dividends may 
impact your parent company's decision on where to invest?
    Ms. Riley. Certainly, Mr. Chairman. Each year, our parent 
company asks each of the subsidiaries for capital projects that 
would either add to our efficiencies or broaden our product 
mix, increase our capacities, better utilize the facility that 
we have in place already. And so every year during the fourth 
quarter, each of us present proposals to our Spanish parent, 
and they are reviewed there. The types of things they look at 
are their internal rate of return, how quickly they are going 
to be able to--that we, the subsidiaries, can turn that project 
into a profit-making facility.
    And so we are coming up on the fourth quarter, and we will 
be making a presentation which would allow us to expand our 
product mix, a product that we do not manufacture here in the 
United States. We actually import it into the United States, 
and with us being able to manufacture it here, we can broaden 
our product mix here and increase our sales. That would be the 
project that would add 50 to 100 employees as we ramp that 
facility up to its full production capacity.
    And we will be competing with our sister companies in 
Spain, the one in Malaysia, and the one in South Africa also 
who have projects that are worthwhile in their markets.
    The Chairman. So in this competition the reduced 
withholding tax would give you an edge or at least another 
competitive advantage?
    Ms. Riley. Well, you know, it is certainly an added cost 
down the road for Acerinox wanting to get some of the 
investment back that they have made here to have an additional 
10 percent that they have to pay after NAS has already paid the 
Federal and State corporate income tax on those earnings before 
they are distributed out to the parent company. The withholding 
rates that Spain and Malaysia and Spain and South Africa have 
are less than the current 10-percent rate that we have here in 
the United States with our Spain treaty.
    The Chairman. So that clearly is part of their equation or 
their thinking at the end of the day.
    Ms. Riley. Yes, sir.
    The Chairman. What is roughly the timeframe in which this 
decisionmaking process gets done?
    Ms. Riley. End of the year, early 2015.
    The Chairman. Is it fair to say that if the treaty is not 
ratified that it increases the chances that your parent company 
will not necessarily make an investment in Kentucky?
    Ms. Riley. I cannot really speak for Acerinox, but they do 
have options. The U.S. market is a good market for them. So it 
is one piece of the puzzle. So I really cannot answer that. But 
it certainly is a strong consideration.
    The Chairman. Ms. Schultz, happy centennial.
    Ms. Schultz. Thank you.
    The Chairman. Not to you personally. The organization. 
[Laughter.]
    That is very obvious.
    I know your organization has for years represented the 
voice of business in supporting these treaties. Indeed, the 
president of your organization testified in support of the five 
treaties the committee considered in February, and we 
appreciate those insights.
    Can you describe what the members of your organization 
think about these treaties? What kind of support is there in 
the business community for ratification of these treaties?
    Ms. Schultz. The business community is unanimously 
supportive of these tax treaties. As you mentioned in your 
opening statement, we had sent a letter to all the Senators 
asking for floor consideration of the pending treaties that are 
already on the floor, plus these two when they get there. And 
that letter was signed not only by the NFTC but also by the 
Business Roundtable, the U.S. Chamber of Commerce, the National 
Association of Manufacturers, the Organization for 
International Investment, and many other organizations. So for 
the business community in general, they are very strongly in 
support of the tax treaties.
    For the NFTC members, we do a tax treaty survey of our 
members every year to find out what the priorities are for 
those members and where they are having difficulties around the 
world. And about 3 or 4 years ago, Spain was the number one 
choice because they were having the most problems with Spain 
and looking for reduced dividends. And quite honestly, there is 
a lot of pending tax cases with Spain right now, and the 
mandatory arbitration provision could really help remove the 
long-term disputes and make sure that they are resolved more 
quickly.
    What happens is if you have the mandatory arbitration 
provision, the disputes that are not resolved within 2 years 
can go into arbitration, and it really forces the competent 
authorities to come to the table and resolve these disputes 
quicker. For companies that have long-term disputes and have 
millions of dollars at stake, that money actually gets plowed 
back into the business for more economic growth and for job 
creation. It really can do more for the business than having 
everything tied up in just tax administration and for having to 
try these cases, which happens when these disputes are not 
easily resolved.
    So for the business community, having the lower withholding 
rates, the lower capital gains, and then having the dispute 
resolution provision and the mandatory arbitration is just 
critical for us.
    The Chairman. Now, your organization follows these treaties 
rather closely. What is your view on the standards on 
information exchange in these protocols?
    Ms. Schultz. The NFTC has always supported the information 
exchange provisions in the protocols. As Mr. Stack and Mr. 
Barthold already explained, the information that is being 
requested is the same information that has been requested in 
all of our treaties and is in our model tax treaty. And as Bob, 
I think, really explained very well about the fraud provision 
that is in the Swiss treaty. But really, the government 
collects information from domestic taxpayers, and we believe 
that any of the taxpayers that are abroad should be paying the 
same taxes and actually should be subjected to the same 
information withholding as U.S. taxpayers are. So we are 
strongly supportive of the information provisions that are 
included in the tax treaties.
    The Chairman. Well, thank you both for your testimony. I 
hope that these two panels gives any member who has had 
concerns about this a clear understanding that the information 
exchange standard is part of the normal course of events, that 
there are a series of protections, and that there are real 
consequences in terms of economic investment and opportunity 
for our companies by virtue of the ratification of the treaty.
    The problem is that if we have to bring up each treaty 
individually on the floor with full time for a debate, when 
these treaties used to go by what we call unanimous consent, it 
will negatively impact the time the Senate has to deal with the 
appropriation process to make sure that the fiscal year is 
fully appropriated, to address issues or current events that 
happen across the globe that sometimes rivet our attention, 
like Iraq, where many of our members are on the floor talking 
about what the United States should do, as well as nominations 
for the judges and ambassadorships we have not filled. It is 
going to be very difficult to get time on the Senate floor to 
go through an elaborate process of a debate, when I am sure 
virtually no one will come down to the floor to debate the 
treaties because there will be an almost unanimity of opinion 
in favor of the treaties.
    So I hope the hearing elucidates, for those who had a 
concern, that those concerns hopefully will be assuaged.
    And I appreciate the testimony of both of you to try to 
help us get to that point. Hopefully, we can achieve a 
ratification that will create greater economic opportunity for 
our companies here, and that obviously means jobs here at home 
as well.
    This hearing's record will remain open until the close of 
business tomorrow.
    And with the thanks of the committee, this hearing is 
adjourned.
    [Whereupon, at 12:05 p.m., the hearing was adjourned.]

                                  
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