[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.]