Copyright 1999 Federal Document Clearing House, Inc.
Federal Document Clearing House Congressional Testimony
October 27, 1999
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 24307 words
HEADLINE:
TESTIMONY October 27, 1999 PHILIP R. WEST TAX COUNSEL TREASURY INTERNATIONAL
SENATE FOREIGN RELATIONS TAX TREATIES AND PROTOCOLS
BODY:
October 27, 1999 TREASURY INTERNATIONAL TAX
COUNSEL PHILIP R. WEST SENATE COMMITTEE ON FOREIGN RELATIONS Mr. Chairman and
members of the Committee, I am pleased today to recommend, on behalf of the
Administration, favorable action on eight bilateral tax treaties and protocols
that the President has transmitted to the Senate and that are the subject of
this hearing. These agreements would provide significant benefits to the United
States, as well as to our treaty partners. Treasury appreciates the Committee's
interest in these agreements as demonstrated by the scheduling of this hearing,
and requests that the Committee and the Senate take prompt and favorable action
on all of these agreements. The treaties and protocols before the Committee
today represent a cross-section of the United States tax treaty program. There
are new agreements with three of our oldest treaty partners -- new income tax
treaties with Denmark and Italy and a protocol to our estate tax treaty with
Germany -- and five agreements -- with Estonia, Latvia, Lithuania, Slovenia and
Venezuela expand our treaty network in Latin America, Eastern Europe, and the
former Yugoslavia. An active treaty program is important to the overall
international economic policy of the United States, and tax treaties have a
substantial positive impact on the after-tax profitability of United States
businesses that enter a treaty partner's marketplace. This is an obvious
incentive to expand our treaty network to new treaty partners. However, it also
requires us to update our existing treaties. When President Clinton took office,
many important U.S. tax treaties were nearly half a century old. Since the
beginning of 1993, we have replaced our tax treaties with Sweden, which dated
from 1939, with the Netherlands, which dated from 1948, with Ireland, which
dated from 1949, and with Switzerland, which dated from 195 1. The Denmark
treaty, which you are considering today, will replace the oldest of our income
tax treaties still in force, which was signed in 1948. For these reasons,
negotiating new treaties and updating existing treaties take up a large amount
of my staff s time. We believe, however, that the investment of our resources is
worthwhile because of the benefits a modem treaty network brings both to
taxpayers and to the government. I'd like to speak now about these benefits.
Benefits to Taxpayers An income tax treaty removes impediments to international
trade and investment by reducing the threat of "double taxation" that can occur
when both countries impose tax on the same income. Four different aspects of
this general goal illustrate the point. First, an income tax- treaty generally
increases the extent to which exporters can engage in trading activity in the
other country without triggering tax. Second, when taxpayers do engage in a
sufficient amount of activity for tax to be imposed, the treaty establishes
rules that assign to one country or the other the primary right of taxation with
respect to an item of income, that help ensure the allowance of appropriate
deductions and that reduce withholding tax on payments of income to the treaty
beneficiary. Third, the treaty provides a dispute resolution mechanism to
prevent double taxation that sometimes can arise in spite of the treaty.
Finally, the treaty helps to create stability of tax rules that the private
sector needs if its member are to be confident in their projections of an
investment's return. Although the domestic tax legislation of the United States
and other countries in many ways is intended to further the same general
objectives as our treaty program, a treaty goes beyond what domestic legislation
can achieve. Legislation cannot easily take into account differences among other
countries' rules for the taxation of particular classes of income and how those
rules interact with United States law. Legislation also cannot reflect
variations in the United States' bilateral relations with our treaty partners. A
treaty, on the other hand, can make useful distinctions, and alter in an
appropriate manner the domestic statutory law of both countries as it applies to
income flowing between the treaty partners. Examples in the treaties before you
include reductions in statutory withholding tax rates and the creditability of
the Italian tax known as the IRAP. One of the principal ways in which double
taxation is eliminated is by assigning primary taxing jurisdiction in particular
factual settings to one treaty partner or the other. In the absence of a treaty,
a United States company operating a branch or division or providing services in
another country might be subject to income tax in both countries on the income
generated by such operations. The resulting double taxation can impose an
oppressive financial burden on the operation and might well make it economically
non- viable. For example, lesser developed countries frequently assert much
broader taxing jurisdiction than the United States does. In the absence of a
treaty, they might well tax a foreign
corporation on income from business activities even if the
activities conducted in the other country are relatively negligible or, in some
cases, if the payor of the income is a resident of the developing country
without regard to whether any activities take place within its territory. In
many cases, the country will not allow the foreign corporation to deduct
business expenses relating to such income. Finally, the foreign corporation may
not be able to plan its activities in such a way as to avoid the tax because the
rules that establish the taxation threshold under the country's domestic laws
may not be clear. If the economic activities that give rise to the income take
place in the United States, we would view the income as being from U.S. sources.
In cases where a foreign corporation taxes
income that we view as U.S.-source, the effect of the U.S. tax rules
may be to deny a foreign tax credit in whole or in part (depending on the U.S.
corporation's overall foreign tax credit situation). Tax treaties help to
resolve these situations by establishing the minimum level of economic activity
that a resident of one country must engage in within the other before the latter
country may tax the resulting business profits. The tax treaty lays out ground
rules providing that one country or the other, but not both, will have primary
taxing jurisdiction over branch operations and individuals performing services
in the other country. In general terms, the treaty provides that if the branch
operations have sufficient substance and continuity and, accordingly, sufficient
economic penetration, the country where the activities occur will have primary
(but not exclusive) jurisdiction to tax. In other cases, where the operations
are relatively minor, the home country retains the sole jurisdiction to tax.
Under these treaty rules, United States manufacturers may test a market by
establishing a foreign presence through which products are sold without
subjecting themselves to foreign tax, including compliance, rules. Generally, if
the market proves promising, the company will establish a more substantial
operation which would become subject to tax in the other country. Similarly,
United States residents generally may live and work abroad for short periods
without becoming subject to the other country's taxing jurisdiction; if they
stay longer, however, they would become subject to tax on the income derived in
the other country or, ultimately, might even become subject to taxation as
residents. These rules, the permanent establishment and business profits rules
and analogous provisions for individuals, not only eliminate in many cases the
difficult task of allocating income and tax between countries but also serve to
encourage desirable trade activities by eliminating or reducing what can often
be complex tax compliance requirements. High withholding taxes at source can be
an impediment to international economic activity. Under United States domestic
law, all payments to non-United States 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. Inasmuch as this tax is imposed on a gross
rather than net amount, it imposes a high cost on investors receiving such
payments. Indeed, in many cases the cost of such taxes can be prohibitive as a
30 percent tax on gross income often can exceed I 00 percent of the net income.
Most of our trading partners impose similar levels of withholding tax on these
types of income. Tax treaties alleviate this burden by reducing the levels of
withholding tax that the treaty partners may impose on these types of income. In
general, United States policy is to reduce the rate of withholding taxation on
interest and royalties to zero. Dividends normally are subject to tax at one of
two rates, 15 percent on portfolio investors and 5 percent on direct corporate
investors. The extent to which we realize our policy of reducing withholding
rates depends on a number of factors. Although Ceneralizations often are
difficult to make in the context of complex negotiations, it is fair to say that
we are more successful in reducing these rates with countries that are
relatively developed and where there are substantial reciprocal income flows. We
also achieve lesser but still significant reductions with countries where the
flows tend to be disproportionately in favor of the United States. The benefits
of tax treaties are not limited to business profits earned by companies.
Treaties remove tax impediments to desirable scientific, educational, cultural
and athletic interchanges, facilitating our ability to benefit from the skills
and talents of foreigners including world-renowned rock stars, symphony
orchestras, astrophysicists and Olympic athletes. In fact, treaty benefits are
not limited to profit-making enterprises but extend to pension plans, Social
Security benefits, charitable organizations, researchers and alimony and child
support recipients. The rules provided in the treaty frequently do not
explicitly address every future development. This may be because the
international community has not yet reached a consensus on the appropriate
standard for taxation. For example, the international community may take some
time to reach a consensus on the appropriate taxation standard with respect to
the area of communications technology. This is an area in which international
cooperation is vitally important. To address these issues, our proposed treaties
with Estonia, Latvia and Lithuania. require the parties to consult within five
years after the treaties enter into force concerning the taxation of income from
new technologies. This period was chosen because of the possibility that an
international standard might emerge within that time that both Contracting
States would want to consider adopting. In fact, the Organization for Economic
Cooperation and Development ("OECD"), recognized as the leading international
forum to consider developments such as these, is considering these issues today.
Until resolution is reached, the treaties with the Baltic countries provide that
income of a resident of one country from transmission by satellite, cable, optic
fiber and similar technologies will not be taxable in the other country unless
the resident has a permanent establishment in the other country. We rejected an
approach that would have taxed this income like a royalty, subject to
withholding. Even- with constant monitoring, there will be cases in which double
taxation occurs in spite of the treaty. In such cases, the treaty provides
mechanisms enabling the tax authorities of the two governments -- known as the
"competent authorities" in tax treaty parlance -- to consult and reach an
agreement under which the taxpayer's income is allocated between the two taxing
jurisdictions on a consistent basis, thereby preventing the double taxation. The
U.S. competent authority under our tax treaties is the Secretary of the
Treasury. Currently, that function is delegated to the Assistant Commissioner
(International) of the Internal Revenue Service. One of the most common
situations in which this type of agreement may be necessary is in the area of
"transfer pricing." If a multinational manipulates the prices charged in
transactions between its affiliates in different countries, the income reported
for tax purposes in one country may be artificially depressed, and the tax
administration of that country will collect less tax from the enterprise than it
should. In theory, the multinational would plan its transactions to ensure that
its income is reported in the jurisdiction with the lowest effective tax rate.
It is this possibility that makes transfer pricing one of the most important
international tax issues. If this potential tax avoidance (and the potential for
double taxation) is to be avoided, it is necessary to have a benchmark by which
to evaluate the prices charged. The benchmark adopted by the United States and
all our major trading partners is the arm's- length standard. Under the
arm's-length standard, the price charged should be the same as it would have
been had the parties to the transaction been unrelated to one another -- in
other words, the same as if they had bargained at "arm's-length." This requires
an analysis of the functions performed, resources employed and risks assumed by
each party, to make sure each party is adequately compensated for those
functions, resources and risks in light of the contractual terms and other
relevant economic circumstances of the transaction. If taxpayers and tax
administrators can find similar transactions that took place between unrelated
parties, they be-in the inquiry by analyzing those transactions to see whether
the functions, resources and risks of each party are comparable to those in the
related party transaction. In more and more cases, it is difficult or impossible
to find a uniquely comparable transaction. This may be because the transactions
between related parties are highly specialized or involve unique intangibles,
or, as in the case of certain kinds of global securities trading, the functions
are so highly integrated that there is a single profit center and no
transactions are ever booked between the separate entities. In those cases, it
will not be possible to apply "traditional transactional methods." Instead,
taxpayers and tax administrators will have to perform the functional analysis
required by the arm's-length approach, but will use transactional profits
methods, such as the comparable profits method or the profit- split method, in
order to compensate the entities for the functions performed, resources employed
and risks assumed. The Internal Revenue Service developed transactional profits
methods in the 1980's because it saw that it would not always be possible to use
traditional transactional methods. These methods, including the use of
multi-factor formulas in appropriate cases, were found by the OECD to be an
acceptable application of the arm's length standard, at least as a method of
last resort, in the Transfer Pricing Guidelines issued in 1995 and its report on
Global Trading of Financial Instruments in 1998. We have seen, and expect to
continue to see, increasing acceptance of these profits-based approaches in the
coming years, speeded by the increase in globally-integrated businesses that
will become possible as a result of improvements in telecommunications
technology. Perhaps because of globalization, there has also been an increased
focus in recent years on the taxation of branches (known as "permanent
establishments"). Treaties use the same arm's length standard to determine the
profits attributable to a permanent establishment. Many of the legal
developments that have occurred in the context of the taxation of separate legal
entities, however, have not yet been extrapolated to the branch situation.
Because the commentaries to the relevant parts of the OECD model tax treaty have
not yet been revised to reflect current thinking regarding profit splits,
taxpayers have taken inconsistent approaches in the context of permanent
establishments. One recent court case suggests that it is not possible to use
profits- based methods in determining the business profits attributable to a
permanent establishment, and that the tax administrator is required to respect
the income shown on the books of the branch, except in "exceptional
circumstances," a much higher standard than applies when adjusting the income of
separate legal entities. A more recent case would allow the administrators to
adjust the branch books to reflect an arm's length result, but does not provide
any guidance on how that is to be accomplished. We believe that an international
consensus eventually will develop around the proposition that any of the methods
that are acceptable for transfer pricing between related entities will also be
acceptable in the context of allocating income between branches of a single
entity. The United States has already adopted this approach in the context of
global dealing of financial instruments, both in advance pricing agreements and
by regulation, as has the OECD in its report on Global Trading in Financial
Instruments. It has done so by sanctioning the use of multi-factor formulas to
allocate income from global trading activity under one common trading model --
the "functionally fully-integrated" model. Prevention of Tax Avoidance and
Evasion The foregoing aspects of our tax treaties involve benefits to taxpayers.
While providing these benefits certainly is a major purpose of any tax treaty,
it is not the only purpose. The second major objective of our income tax treaty
program is to prevent tax avoidance and evasion and to ensure that treaty
benefits flow only to the intended recipients. Tax treaties achieve this
objective in several ways. They provide for exchange of information between the
tax authorities. They contain provisions designed to ensure that treaty benefits
are limited to bonafide residents of the other treaty country and not to "treaty
shoppers." And two of the treaties before you reflect one version of an
anti-abuse rule that set limits on aggressive tax avoidance transactions using
treaties. Under the tax treaties, the competent authorities are authorized to
exchange information, including confidential taxpayer information, as may be
necessary for the proper administration of the countries tax laws. This aspect
of our tax treaty program is one of the most important features of a tax treaty
from the standpoint of the United States. The information that is exchanged may
be used for a variety of purposes. For instance, the information may be used to
identify unreported income or to investigate a transfer pricing case. In recent
years information exchange has become a priority for the United States in its
tax treaty program. If a country has bank secrecy rules that prevent or
seriously inhibit the exchange of information under the tax treaty, we will not
conclude a treaty with it. In fact, we generally do not even negotiate with such
countries. Information exchange is one of the handful of issues that we discuss
with the other country before beginning formal negotiations because it is one of
a very few issues that we consider non-negotiable. This has, of course,
prevented us from entering into treaties with some countries with which we have
significant economic ties, but we believe that it is the right policy. Recent
technological developments which facilitate international, and anonymous,
communications and commercial and financial activities can also encourage
illegal activities. Over the past several years we have experienced a marked and
important sea change as many of the industrialized nations have recognized the
increasing importance of tax information exchange; the absence thereof serves to
encourage not only tax avoidance and evasion, but also criminal tax fraud, money
laundering, illegal drug trafficking, and other criminal activity. Treasury is
proud of the role it has played in moving these issues forward not only in our
bilateral treaty negotiations but also in other forms such as the OECD. A second
aspect of U.S. tax treaty policy to deal with avoidance and evasion is to
include' in all treaties comprehensive provisions designed to prevent "treaty
shopping." This abuse of the treaty can take a number of forms, but it generally
involves a resident of a third state that has either no treaty with the United
States or a relatively unfavorable one establishing an entity in a treaty
partner that has a relatively favorable treaty with the United States. This
entity is used to hold title to the person's United States investments, which
could range from portfolio stock investments to major direct investments or
other treaty-favored assets in the United States. By placing the investment in
the treaty partner, the third-country person is able to withdraw the returns
from the United States investment subject to the favorable rates provided in the
tax treaty, rather than the higher rates that would be imposed if the person had
invested directly into the United States. Of course, the tax imposed by the
treaty partner on the intermediate entity must be relatively low, or the
structure will not produce tax savings that Justify the added transaction costs.
This Committee and the Congress have expressed strong concerns about treaty
shopping, and the Treasury Department shares those concerns. Our treaty program
is designed to give benefits to residents and, if applicable, nationals of our
treaty partner. Treaty shopping represents an abusive attempt to siphon benefits
to others. Moreover, if treaty shopping is allowed to occur, then there is less
incentive for the third country with which the United States has no treaty to
negotiate a treaty with the United States. The third country can maintain
inappropriate barriers to United States investment and trade, and yet its
companies can obtain the benefits of lower U.S. tax by organizing their United
States transactions so that they flow through a country with a favorable United
States tax treaty. For these reasons, the United States has taken a leading role
in developing anti-treaty- shopping provisions and encouraging other countries
to adopt the provisions in their treaties. The Department of the Treasury has
included in all its recent tax treaties comprehensive "limitation on benefits"
provisions that limit the benefits of the treaty to bonafide residents of the
treaty partner. These provisions are not uniform, as each country has its own
characteristics that make it more or less inviting to treaty shopping in
particular ways. Consequently, each provision must to some extent be tailored to
fit the facts and circumstances of the treaty partners' internal laws and
practices. Moreover, the provisions need to strike a balance that avoids
interfering with legitimate and desirable economic activity. As we have pursued
our goal of updating our existing treaties to eliminate treaty- shopping abuses,
however, we have seen an increasing number of other types of transactions that
seek to use treaties to achieve inappropriate results. Therefore, we have
decided to include in our treaties relatively modest anti-abuse rules in
addition to the limitation on benefits provision. In the treaties before you,
these rules are found only in the treaties with Italy and Slovenia, because the
others were substantially negotiated before this change in our policy. As
described above, anti-treaty shopping rules are now firmly entrenched in our
treaty policy, in part as a result of concerns raised by the Committee. The
anti-abuse rules before you are complementary to these anti-treaty shopping
rules. Anti-treaty shopping rules take the broad approach of denying all treaty
benefits to persons who are not bona fide residents of the treaty country.
Anti-abuse rules such as those before you are more targeted in the sense that
they are not blanket exclusions from all treaty benefits; they deny specific
treaty benefits in abuse cases. These rules have been included in our treaties
because of several concurrent developments in international tax law. First,
although the overwhelming majority of taxpayers who avail themselves of treaty
benefits are entitled to those benefits and are not engaged in abusive
transactions, aggressive abuse of treaties has increased. As evidence of this
trend one need only observe that Congress has twice in recent years taken the
unusual step of legislating against treaty abuse. Most recently, Congress
enacted section 894(c) to deny benefits to certain taxpayers that are not
excluded from our treaties under limitation on benefits provisions. Congress
also enacted section 7701 (I), providing the Treasury with a broad grant of
regulatory authority to curb treaty abuse. This authority has been exercised to
adopt a standard very similar to that under consideration by you today, under
which taxpayers have been operating for some years now, apparently without
significant difficulty. (The commentary to Article 1 of the OECD model tax
treaty and the OECD Report on Harmful Tax competition make clear that countries
can impose their domestic anti-abuse rules to claims for treaty benefits.) A
second development contributed to the decision to include these rules in our
treaties. We observed that Italy had just concluded a treaty containing a
broader but more subjective anti- abuse rule. We then observed that virtually
all of the other countries with which we were negotiating at the time either had
treaty anti- abuse precedents generally consistent with the rule you have before
you (the United Kingdom, Chile and Korea) or, in the case of Canada, had already
included in its treaty with the United States an explicit recognition of the
right to apply a similar anti-abuse rule that was in force under its domestic
law. In addition, other countries such as Ireland and Mexico had agreed to a
similar provision with each other and other countries such as Israel were
consistently seeking even broader provisions. The rule has been included in more
than 50 treaties, representing approximately 40 different countries (including
10 OECD members). In fact, concerns about the adequacy of current treaty rules
to prevent abuses have stimulated work in the OECD on this subject. As one of
the more common approaches to achieving such an objective, rules such as those
before you today are obviously part of that work. The increase in treaty abuse
has unfortunate results for both Treasury and our taxpayers: it requires
Treasury to divert resources to fighting abuse that it might otherwise devote to
improving our treaty network. The emergence internationally of anti-abuse rules
such as those before you provides a win-win solution. They help address the
abuse problem, while at the same time freeing up Treasury resources to provide
greater benefits for U.S. taxpayers. As such, the question became not whether an
anti-abuse rule was appropriate, but which anti-abuse rule was appropriate.
Treasury rejected a narrower anti-abuse rule because of its ineffectiveness.
Treasury also rejected a broader more subjective anti-abuse rule for several
reasons. First, it provided a less certain standard against which a taxpayer
could meaningfully evaluate its transaction. Second, since the narrower rule
before you appears in a significant number of treaties around the world, and
promises to appear in more, it is more consistent with international norms and
will likely be the subject of more interpretive law than the other standards. As
such, the proposed rule should provide greater certainty over time than some of
the alternatives. Nevertheless, we are aware of concerns that the proposed
anti-abuse rules will provide uncertainty for taxpayers. The test incorporated
in the rule does require taxpayers and their advisors to make some judgements.
This standard creates no more uncertainty, however, than other U.S. tax
doctrines that may also apply to the transaction under consideration, such as
the business purpose and step transaction doctrines. And, as the commentary to
the OECD model treaty makes clear, even if our treaties are silent regarding
abuse, other countries may apply their own internal anti-abuse doctrines to U.S.
taxpayers' claims for treaty benefits, whether we have explicitly agreed to
those standards or not. Our treaties are intended to last decades before
re-negotiation. Therefore, relying on treaty amendments to eliminate abuses that
arise in the future will invariably prove inadequate. Moreover, relying on
amendments to domestic law will invite charges that the treaty is being
overridden, as were made when section 894(c) was enacted. For these reasons, the
treaties should contain their own mechanisms to combat abuse, such as the
provisions in the treaties before you today. In this regard, it is important to
keep in mind that our tax treaties contain only benefits for taxpayers, and no
provisions that increase tax burdens. As such, it is appropriate to impose
reasonable limits on those benefits to curb abusive transactions that may be
developed in the future. Treaty Program and Negotiation Priorities Given all of
these benefits to taxpayers and the government, an obvious question is why we do
not have a tax treaty with every country. The answer is slightly different for
each potential treaty partner, but there are some general themes. In
establishing priorities, we keep in mind the two principal objectives of tax
treaties -- to prevent both double taxation and tax avoidance and evasion. The
United States has a network of 50 bilateral income tax treaties, the first of
which was negotiated in 1939. Although that number is somewhat lower than the
number of treaties that some other countries have, it is important to note that
the network includes all 28 of our fellow members of the OECD and covers the
vast majority of trade and investment by U.S. companies abroad. For the past
decade, the Treasury Department has given priority to renegotiating older
treaties to ensure that they reflect current United States treaty policy,
particularly with respect to anti-abuse provisions and information exchange. As
demonstrated by the mix of treaties being considered today, the progress we have
made at updating old conventions has given us the opportunity to focus on
expanding our treaty network. In this, our primary concern is to conclude
treaties or protocols that are likely to provide the greatest benefits to United
States taxpayers, such as when economic relations are hindered by substantial
tax obstacles. We meet regularly with members of the U.S. business community
regarding their priorities and the practical problems they face with respect to
particular countries. We are proud of our efforts in the treaty area, and
believe that our record of accomplishment here is as strong as that of any other
administration in recent memory. Even when business identifies problems that
could be resolved by treaty, however, a treaty may not be appropriate for a
variety of reasons. Despite the protections of the limitation on benefits
provisions and anti-abuse rules, there may be countries with which we choose not
to have a tax treaty because of the possibility of abuse. Other countries may
not present us with sufficient tax problems that are best resolved by treaty.
For example, we generally do not conclude tax treaties with jurisdictions that
do not impose significant income taxes, because there is little danger of double
taxation of income in such a case. In such cases, particularly with Caribbean
Basin countries, we have offered to enter into an agreement limited to the
exchange of tax information, which furthers the goal of reducing tax avoidance
and evasion without creating other opportunities for abuse. However, the
situation can become more complex when a country adopts- a special regime for
certain parts of the economy while the rest of its residents are subject to
substantial taxation. It might be considered inappropriate to grant treaty
benefits to companies taking advantage of such regimes, while a treaty
relationship might be useful and appropriate in order to avoid double taxation
in the case of the residents who are subject to substantial taxation.
Accordingly, in some cases we have devised treaties that carve out from the
benefits of the treaties certain residents and activities. The anti-treaty
shopping provisions in our treaty network prevent investors from enjoying the
benefits of a tax-haven regime or preferential tax regime in their home country
and, at the same time, the benefits of a treaty between the United States and
another country. The recent OECD report on Harmful Tax Competition recommends
that member countries adopt similar policies, and not enter into tax treaties
with tax havens. The report also directed the group within the Committee on
Fiscal Affairs that is responsible for the OECD Model treaty to consider various
additions to the Model that are intended to prevent abuse of tax treaties.
Prospective treaty partners also have to indicate that they understand their
obligations under the treaty, including with respect to information exchange,
and demonstrate that they are able to comply with those obligations. Sometimes
they are unable to do so. In other cases we may feel that a treaty is
inappropriate because a treaty partner may be unwilling to deal with the tax
problems that have been identified by business. Lesser developed and newly
emerging economies, where capital and trade flows are often disproportionate or
virtually one-way, may not be willing to reduce withholding taxes to a level
that will eliminate double taxation because they feel that they cannot give up
scarce tax revenues. None of the new treaties that we have asked you to consider
today are in that class. All are with countries that showed a willingness to
reduce or eliminate withholding taxes or other impediments to investment. Most
of the emerging economies with which we have had successful treaty discussions
including those whose treaties we present today -- have been active participants
in the training and outreach programs run by the Treasury Department, the
Internal Revenue Service and the OECD. These programs are a wise investment as
they help to ensure that all parties understand the international norms that are
represented by these agreements. We have every reason to believe that these
programs will continue to increase the number of countries -- particularly in
Eastern Europe and Latin America -- that are ready to enter into mutually
advantageous treaties with us. In many cases, the existence of a treaty that
lowers taxation of trade and investment will help to establish economic ties
that will contribute to the country's stability and independence, as well as
improve its political relationships with the United States. The primary
constraint on the size of our treaty network, however, may be the complexity of
the negotiations themselves. The various functions performed by tax treaties,
and particularly the goal of meshing two different tax systems, makes the
process of negotiation quite time-consuming. A nation's tax policy, as reflected
in its domestic tax legislation as well as its tax treaty positions, reflects
the sovereign choices made by that country in the exercise of one of its most
important governmental functions, that of funding the government. Numerous
features of the treaty partner's unique tax legislation and its interaction with
United States legislation must be considered in negotiating an appropriate
treaty. Examples include whether the country eliminates double taxation through
an exemption or a credit system, whether the country has bank secrecy
legislation that needs to be modified by treaty, the treatment of partnerships
and other transparent entities, and how the country taxes contributions to
pension funds, the funds themselves and distributions from the funds. A
negotiated treaty needs to take into account all of these and many other aspects
of the treaty partner's tax system in order to arrive at an acceptable treaty
from the perspective of the United States. Accordingly, a simple side-by-side
comparison of two actual treaties, or of a proposed treaty against a model
treaty, will not enable meaningful conclusions to be drawn as to whether a
proposed treaty reflects an appropriate balancing of interests. In many cases
the differences are of little substantive importance, reflecting language
problems, cultural obstacles or other impediments to the use of particular U.S.
or OECD language. In addition to keeping in mind that each treaty must be
adapted to the individual facts and circumstances of each treaty partner, it
also is important to remember that each treaty is the result of a negotiated
bargain between two countries that often have conflicting objectives. Each
country has certain issues that it considers non-negotiable. The United States,
which insists on effective anti-abuse and exchange-of-information provisions,
and which must accommodate its uniquely complex internal laws, probably has more
non-negotiable issues than most countries. For example, each of the full
treaties before the Committee today allows the United States to impose our
branch profits tax and branch-level interest tax at the rates applicable to
direct dividends and interest, respectively, paid to related parties. All of
them also reflect our new policy with respect to dividend distributions from
real estate investment trusts, except for the treaties with Estonia, Latvia and
Lithuania, which were fully negotiated before the change in policy. They also
include the "saving clause", which permits the United States to tax its citizens
and residents as if the treaty had not come into effect, and allow the United
States to apply its rules dealing with former citizens and long-term residents
and with investments in U.S. real property interests. Obtaining the agreement of
our treaty partners on these issues sometimes requires other concessions on our
part. Similarly, other countries sometimes must make concessions to obtain our
agreement on issues that are critical to them. Eventually, the process of
give-and-take produces a document that is the best treaty that is possible with
that other country. In many cases, the process ends there, as the Administration
decides that the treaty does not further the interests of the United States
enough to justify the necessary compromises. These treaties never make it to
this Committee. Accordingly, each treaty that we present here represents not
only the best deal that we believe we can achieve with the particular country at
this time, but also constitutes an agreement that we believe is in the best
interests of the United States. The technical explanations which accompany our
treaty, the discussions with the staffs of this Committee and its members, and
the staffs of the tax-writing Committees, and most importantly, hearings such as
this, will provide the Senate with the assurance that a particular treaty is,
overall, in the best interests of the United States. Discussion of Treaties and
Protocols Each of the treaties before you today reflects the basic principles of
current United States treaty policy. The provisions in each treaty borrow
heavily from recent treaties approved by the Senate and the U.S. model and are
generally consistent with the 1992 OECD Model Income Tax Convention, as
subsequently amended. The United States was and continues to be an active
participant in the development of the OECD Model, and we are generally able to
use most of its provisions as a basis for negotiations. The U.S. model was
published in September 1996. A model treaty is a useful device if used properly
and kept current. In the course of the negotiation of these treaties, we
discovered that certain provisions of our model treaty could be improved upon,
and we did so in these agreements. Many of these improvements have become part
of the document that we use to begin negotiations and we expect that they will
be reflected in a new version of the U.S. model that will be published in the
future. There are no major inconsistencies between the U.S. and OECD models, but
rather the U.S. model elaborates on issues in which the United States may have a
greater interest or which result from particular aspects of United States law
and policy. For example, our limitation of benefits provisions are generally not
found in typical tax treaties of other OECD countries. We have also found it
useful to expand on treaty coverage and treatment of pass-through entities such
as our limited liability companies. Despite the importance we attach to the OECD
model and our continuing efforts with our colleagues to improve it and keep it
current, most countries cannot accede to all of the provisions of that model,
nor do we expect that all of our prospective treaty partners will agree with all
of the provisions of our model. The primary benefit of the U.S. Model is that it
enables all interested parties, including this Committee and the Congress and
its staffs, the American business community, and our prospective treaty
partners, to know and understand our treaty positions. We do not anticipate that
the United States will ever sign a tax convention identical to the model; there
are too many variables. Nevertheless. there are some basic provisions that are
found in all of the treaties. These include provisions designed to improve the
administration both of the treaty and of the underlying tax systems, including
rules concerning exchange of information, mutual administrative assistance,
dispute resolution and nondiscrimination. Each treaty permits the General
Accounting Office and the tax-writing committees of Congress to obtain access to
certain tax information exchanged under treaty for use in their oversight of the
administration of United States tax laws and treaties. Each treaty also contains
a now-standard provision ensuring that tax discrimination disputes between the
two nations generally will be resolved within the ambit of the tax treaty, and
not under any other dispute resolution mechanisms, including the World Trade
Organization (WTO). Finally, some treaties will have special provisions not
found in other agreements. These provisions account for unique or unusual
aspects of the treaty partner's internal laws or circumstances. For example,
many well-known Danish multinational companies are owned in part by "taxable
non-stock corporations". If the treaty had not included special rules for
taxable non-stock corporations, the multinationals might not have qualified for
full treaty benefits, even though they clearly are not treaty- shopping. These
rules had to be tailored to the Danish law and the specific manner in which the
taxable non-stock corporations operate, without violating any of the basic
principles underlying our limitation on benefits provisions. The flexibility we
bring to the table should be regarded as a strength rather than a weakness of
the tax treaty program, since it is these differences in the treaties which
enable us to reach agreement and thereby reduce taxation at source, prevent
double taxation and increase tax cooperation. I would like to discuss the
importance and purposes of each agreement that you have been asked to consider.
We have submitted Technical Explanations of each agreement that contain detailed
discussions of each treaty and protocol. These Technical Explanations serve as
an official guide to each agreement. We have furnished our treaty partners with
a copy of the relevant technical explanation and offered them the opportunity to
submit their comments and suggestions. The Baltic Treaties -- Estonia, Latvia
and Lithuania I would now like to turn to the three treaties colloquially known
as the "Baltic Treaties." Since gaining independence from the Soviet Union at
the beginning of this decade, the three Baltic States - Estonia, Latvia and
Lithuania - have actively pursued reforms aimed at economic stabilization and
market strengthening. These reforms have placed Estonia in the first wave of
Central and East European applicants to the European Union, while Latvia and
Lithuania are currently under consideration by the EU for promotion to this
first wave. Economic performance in all three countries over the past several
years has been among the best in the region. Entering into these treaties is an
important element in our current tax treaty program and is a high priority with
the U.S. business community. Without the current treaty, U.S. businesses are at
a competitive disadvantage in the Baltics, since many of their competitors are
from countries that have concluded a tax treaty with them. Under the proposed
Conventions, the Baltic States taxation of U.S. operations would decrease on
direct investment dividends, copyright royalties (including software), royalties
on the right to use equipment, and interest paid on loans guaranteed by the U.S.
Export-Import Bank. In addition, the proposed Convention would provide U.S.
business a greater degree of certainty, protection against discriminatory tax
practices and the ability to resolve potential double taxation cases and other
disputes. Although these Conventions were largely negotiated at joint sessions,
these are, of course, three separate treaties with three separate, sovereign
nations. I will, therefore, deal with each of the three separately. In general,
however, it should be noted that none of the three deviates substantially from
any of our more recent treaties. Estonia Let me first deal with Estonia. The
treaty does differ from other recent U.S. treaties in a number of respects. I
will now highlight some of these differences as well as other important
provisions of the treaty. First, in respect of the taxation of investment
income. The withholding rates under the treaty are in some respects higher than
those in the U.S. Model and in many recent U.S. treaties with OECD countries.
The rates are the same as in many Estonian treaties. Under the treaty dividends
are subject to taxation at source in the same manner as under the U.S. Model.
Direct investment dividends are subject to withholding tax at source at a
maximum 5 percent rate, and portfolio dividends are taxable at a maximum 15
percent rate. The treaty requires a 10 percent ownership threshold for
application of the 5 percent tax rate. The treaty provides for a maximum 10
percent rate of tax at source on most interest payments. Interest earned on
trade credits, and on government debt, including debt guaranteed by government
agencies (e.g., the U.S. Export-Import Bank) is exempt from tax at source.
Royalties for the use of industrial, commercial or scientific equipment are
subject to a 5 percent tax at source. All other royalties (including payments
for the use of software, other than off-the-shelf software) are taxed at a
maximum rate of 10 percent. In relation to the taxation of business income,
consistent with the U.S. and OECD Models, the treaty provides generally for the
taxation by one State of the business profits of a resident of the other only
when such profits are attributable to a permanent establishment located in that
other State. The treaty, however, includes an anti-abuse rule that would allow
the source state to tax sales or activities performed by the enterprise outside
the United States as if they were performed by a permanent establishment if it
is ascertained that such activities were structured with the intention to avoid
taxation in the State where the permanent establishment is situated. The treaty,
consistent with current U.S. treaty policy, provides for exclusive residence-
country taxation of profits from international carriage by aircraft and ships.
This reciprocal exemption also extends to income from the rental of aircraft,
ships and containers if the rental activity is incidental to the operation of
aircraft and ships by the lessor in international traffic. However, income from
the international rental of ships and aircraft that is non-incidental to
operation of ships and aircrafts is taxed at a 5 percent rate as a royalty paid
for the rental of equipment. Income from the use or rental of containers that is
non- incidental to the operation of ships or aircraft in international traffic
is treated as other income. Therefore, non-incidental leasing of containers by
U.S. businesses is taxable only in the United States. With regard to the
taxation of personal services income, the taxation of income from the
performance of personal services under the treaty is generally similar to that
under the U.S. Model, but, like some U.S. treaties with developing countries, it
grants a taxing right to the host country with respect to certain categories of
personal services income that is somewhat broader than in the OECD or U.S.
Model. The limitation on benefits provisions are similar to those found in the
U.S. Model and in all recent U.S. treaties. The exchange of information
provisions generally follow the U.S. Model and make clear that Estonia is
obligated to provide U.S. tax officials such information as is necessary to
carry out the provisions of the treaty. The treaty provides a U.S.
foreign tax credit for the Estonian income
taxes covered by the Treaty, and a Estonian foreign tax credit
for the U.S. income taxes covered by the treaty. The treaty
will enter into force after each State has notified the other that it has
completed its ratification requirements. It will have effect, with respect to
taxes withheld at the source, for amounts paid or credited on or after the first
day of January of the calendar year next following the year in which the treaty
enters into force. In other cases the treaty will have effect with respect to
taxable years beginning on or after the first day of January of the calendar
year next following the year in which the treaty enters into force. The treaty
will remain in force indefinitely unless terminated by one of the Contracting
States. Either State will be able to terminate the treaty at the end of any
calendar year by giving written notice at least six months before the end of
that calendar year. Unique to the treaty and the treaties with Latvia and
Lithuania is an agreement that there will be a five-year period within which the
appropriate authorities of the two States will meet to discuss the application
of the treaty to income derived from new technologies (such as payments received
for transmission by satellite, cable, optic fibre or similar technology). The
meeting may result in a protocol that specifically addresses the treaty's
application to income from new technologies. Latvia Next I will turn to Latvia.
This treaty also differs in some respects from other recent U.S. tax treaties. I
will again highlight some of these differences as well as other important
provisions of the treaty. In respect of the taxation of investment income, the
withholding rates under the treaty are, again, in some respects higher than
those in the U.S. Model and in many recent U.S. treaties with OECD countries.
The proposed rates are the same as in many Latvian treaties. Under the treaty
dividends are subject to taxation at source in the same manner as under the U.S.
Model. Direct investment dividends are subject to withholding tax at source at a
maximum 5 percent rate, and portfolio dividends are taxable at a maximum 15
percent rate. The treaty requires a 10 percent ownership threshold for
application of the 5 percent tax rate. The treaty provides for a maximum 10
percent rate of tax at source on most interest payments. Interest earned on
trade credits, and on government debt, including debt guaranteed by government
agencies (e.cy., the U.S. Export-Import Bank) is exempt from tax at source.
Royalties for the use of industrial, commercial or scientific equipment are
subject to a 5 percent tax at source. All other royalties (including payments
for the use of software, other than off-the-shelf software) are taxed at a
maximum rate of 10 percent. In relation to the taxation of business income,
consistent with the U.S. and OECD Models, the treaty provides generally for the
taxation by one State of the business profits of a resident of the other only
when such profits are attributable to a permanent establishment located in that
other State. The treaty, however, includes an anti-abuse rule that would allow
the source state to tax sales or activities performed by the enterprise outside
the United States as if they were performed by a permanent establishment if it
is ascertained that such activities were structured with the intention to avoid
taxation in the State where the permanent establishment is situated. The treaty,
consistent with current U.S. treaty policy, provides for exclusive residence-
country taxation of profits from international carriage by aircraft and ships.
This reciprocal exemption also extends to income from the rental of aircraft,
ships and containers if the rental activity is incidental to the operation of
aircraft and ships by the lessor in international traffic. However, income from
the international rental of ships and aircraft that is non-incidental to
operation of ships and aircrafts is taxed at a 5 percent rate as a royalty paid
for the rental of equipment. Income from the use or rental of containers that is
non- incidental to the operation of ships or aircraft in international traffic
is treated as other income. Therefore, non-incidental leasing of containers by
U.S. businesses is taxable only in the United States. With regard to the
taxation of offshore activities, the treaty contains a reciprocal agreement,
found in several U.S. treaties, particularly those with our North Sea partners,
that the income from the exploration or exploitation of the seabed and sub-soil
is taxable by the source State if the activities are carried on for more than 30
days in any twelve month period. Wages, salaries, and similar remuneration paid
to those whose employment is derived from such activities can be taxed in the
state where the offshore activities occur if such activities exceed the 30 day
threshold. However, that same remuneration can be taxed only in the non-source
State if the period of activity does not exceed 30 days and the employer is not
a resident of the source State. If the wages, salaries or other remuneration are
derived from the transportation of supplies or from other activities (such as
tugboats) auxiliary to the exploration and exploitation then that remuneration
can be taxed only in the country of which the employer is resident. The taxation
of income from the performance of personal services under the treaty is
generally similar to that under the U.S. Model, but, like some U.S. treaties
with developing countries, it grants a taxing right to the host country with
respect to certain categories of personal services income that is somewhat
broader than in the OECD or U.S. Model. The limitation on benefits rules of the
treaty are similar to those found in the U.S. Model and in all recent U.S.
treaties. The exchange of information provisions generally follow the U.S. Model
and make clear that Latvia is obligated to provide U.S. tax officials such
information as is necessary to carry out the provisions of the treaty. The
treaty provides a U.S. foreign tax credit for the Latvian
income taxes covered by the treaty, and a Latvian
foreign tax credit for the U.S. income taxes
covered by the treaty. The treaty will enter into force after each State has
notified the other that it has completed its ratification requirements. It will
have effect, with respect to taxes withheld at the source, for amounts paid or
credited on or after the first day of January of the calendar year next
following the year in which the treaty enters into force. In other cases the
treaty will have effect with respect to taxable years beginning on or after the
first day of January of the calendar year next following the year in which the
treaty enters into force. The treaty will remain in force indefinitely unless
terminated by one of the Contracting States. Either State will be able to
terminate the treaty at the end of any calendar year by giving written notice at
least six months before the end of that calendar year. Unique to the treaty and
the treaties with Estonia and Lithuania is an agreement that there will be a
five-year period within which the appropriate authorities of the two States will
meet to discuss the application of the treaty to income derived from new
technologies (such as payments received for transmission by satellite, cable,
optic fibre or similar technology). The meeting may result in a protocol that
specifically addresses the treaty's application to income from new technologies.
Lithuania Finally, let me turn to Lithuania. As with the other two Baltic
treaties, this treaty differs in some respects from other recent U.S. tax
treaties. I will again highlight some of these differences as well as other
important provisions of the treaty. Once again, the withholding rates under the
treaty are, in some respects higher than those in the U.S. Model and in many
recent U.S. treaties with OECD countries. The proposed rates are the same as in
many Lithuanian treaties. Under the treaty, dividends are subject to taxation at
source in the same manner as under the U.S. Model. Direct investment dividends
are subject to withholding tax at source at a maximum 5 percent rate, and
portfolio dividends are taxable at a maximum 15 percent rate. The treaty
requires a 10 percent ownership threshold for application of the 5 percent tax
rate. The treaty provides for a maximum 10 percent rate of tax at source on most
interest payments. Interest earned on trade credits, and on government debt,
including debt guaranteed by government agencies (e.g., the U.S. Export-Import
Bank) is exempt from tax at source. Royalties for the use of industrial,
commercial or scientific equipment are subject to a 5 percent tax at source. All
other royalties (including payments for the use of software, other than
off-the-shelf software) are taxed at a maximum rate of 10 percent. Consistent
with the U.S. and OECD Models, the treaty provides generally for the taxation by
one State of the business profits of a resident of the other only when such
profits are attributable to a permanent establishment located in that other
State. The treaty, however, includes an anti-abuse rule that would allow the
source state to tax sales or activities performed by the enterprise outside the
United States as if they were performed by a permanent establishment if it is
ascertained that such activities were structured with the intention to avoid
taxation in the State where the permanent establishment is situated. The treaty,
consistent with current U.S. treaty policy, provides for exclusive residence-
country taxation of profits from international carriage by aircraft and ships.
This reciprocal exemption also extends to income from the rental of aircraft,
ships and containers if the rental activity is incidental to the operation of
aircraft and ships by the lessor in international traffic. However, income from
the international rental of ships and aircraft that are non-incidental to
operation of ships and aircrafts is taxed at a 5 percent rate as a royalty paid
for the rental of equipment. Income from the use or rental of containers that is
non- incidental to the operation of ships or aircraft in international traffic
is treated as other income. Therefore, non-incidental leasing of containers by
U.S. businesses is taxable only in the United States. The treaty contains a
reciprocal agreement, found in several U.S. treaties, particularly those with
our North Sea partners, that the income from the exploration or exploitation of
the seabed and sub-soil is taxable by the source State if the activities are
carried on for more than 30 days in any twelve month period. Wages, salaries and
similar remuneration paid to those whose employment is derived from such
activities can be taxed in the state where the offshore activities occur if such
activities exceed the 30 day threshold. However, that same remuneration can be
taxed only in the non-source State if the period of activity does not exceed 300
days and the employer is not a resident of the source State. If the wages,
salaries or other remuneration are derived from the transportation of supplies
or from other activities (such as tugboats) auxiliary to the exploration and
exploitation then that remuneration can be taxed only in the country of which
the employer is resident. The taxation of income from the performance of
personal services under the treaty is generally similar to that under the U.S.
Model, but, like some U.S. treaties with developing countries, it grants a
taxing right to the host country with respect to certain categories of personal
services income that is somewhat broader than in the OECD or U.S. Model. The
limitation on benefits rules of the treaty are similar to those found in the
U.S. Model and in all recent U.S. treaties. The information exchange provisions
generally follow the U.S. Model and make clear that Lithuania is obligated to
provide U.S. tax officials such information as is necessary to carry out the
provisions of the treaty. The treaty provides a U.S. foreign
tax credit for the Lithuanian income taxes covered by
the treaty, and a Lithuanian foreign tax credit for the U.S.
income taxes covered by the treaty. The treaty will enter into
force after each State has notified the other that it has completed its
ratification requirements. It will have effect, with respect to taxes withheld
at the source, for amounts paid or credited on or after the first day of January
of the calendar year next following the year in which the treaty enters into
force. In other cases the treaty will have effect with respect to taxable years
beginning on or after the first day of January of the calendar year next
following the year in which the treaty enters into force. The treaty will remain
in force indefinitely unless terminated by one of the Contracting States. Either
State will be able to terminate the treaty at the end of any calendar year by
giving written notice at least six months before the end of that calendar year.
Unique to this treaty and the treaties with Estonia and Latvia is an agreement
that there will be a five-year period within which the appropriate authorities
of the two States will meet to discuss the application of the treaty to income
derived from new technologies (such as payments received for transmission by
satellite, cable, optic fibre or similar technology). The meeting may result in
a protocol that specifically addresses the treaty's application to income from
new technologies. This concludes my remarks on the three Baltic treaties.
Venezuela Next, I would like to tell you about the proposed treaty with
Venezuela. This treaty is of special importance because it represents a crucial
step towards achieving our goal of expanding our tax treaty network in Latin
America. If ratified, this agreement would be the United States' only tax treaty
in force with a South American nation. The proposed treaty with Venezuela
generally follows the pattern of the 1996 U.S. Model, while incorporating some
provisions found in recent U.S. treaties with other developing countries and in
the OECD Model. The treaty's rules on the taxation of investment income are an
example. Although the withholding rates under the proposed treaty are generally
higher than those in the U.S. Model, the rates are comparable to those found in
other U.S. tax treaties with developing countries and those in other tax
treaties of Venezuela. Also, the withholding rates reflect Venezuela's
territorial system of taxation and the policy objective of establishing an
adequate single level of tax on cross-border investment income. Under the
proposed treaty, as in the U.S. Model, direct investment dividends are taxable
at source at a 5 percent rate, and portfolio dividends are taxable at source at
a 15 percent rate. The proposed treaty requires a 10 percent ownership threshold
for application of the 5 percent direct investment tax rate. Also similar to the
U.S. Model, dividends paid to a Contracting State or a governmental entity
constituted and operated exclusively to administer or provide pension benefits,
are exempt from withholding in the source State. The proposed treaty provides
for a 10 percent rate of tax at source on most interest payments. Interest that
is received by a financial institution (including an insurance company) is
subject to a lower 4.95 percent rate of tax. Interest earned on government debt,
including debt guaranteed by government agencies (e.g., the U.S. Export-Import
Bank, the Federal Reserve Banks and the Overseas Private Investment Corporation)
is exempt from tax at source. These provisions are, in effect, a melding of the
U.S. and OECD Models. Royalties for the right to use copyrights, patents or
trademarks are subject to a 10 percent tax at source. Royalties for the right to
use industrial, commercial or scientific equipment are subject to a lower 5
percent rate of tax at source. Under the proposed treaty, fees for the provision
of technical services and fees for technical assistance are considered business
profits or personal services income, and are taxed as such, rather than as
royalty payments. These latter important provisions thereby mitigate double
taxation and generally limit any taxation to net rather than gross income, and
then only to when a permanent establishment is created. The taxation of capital
gains under the proposed treaty follows the format of the U.S. Model. Gains and
income derived from the sale of real property and from real property interests
may be taxed by the State in which the property is located. Likewise, gains or
income from the sale of personal property, if attributable to a fixed base or
permanent establishment situated in a Contracting State, may be taxed in that
State. All other gains, including gains from the sale of ships, aircraft and
containers, and gains from the sale of stock in a corporation, are taxable only
in the State of residence of the seller. Regarding the taxation of business
income, as with the U.S. and OECD Models, the proposed treaty provides generally
for the taxation by one State of the business profits of a resident of the other
only when such profits are attributable to a permanent establishment located in
that other State. Under the proposed treaty, the taxation of income from the
operation of ships and aircraft in international traffic and from the use,
maintenance or rental of containers used in international traffic is fully
consistent with the U.S. Model. The taxation of income from the performance of
personal services under the proposed treaty is similar to that under some U.S.
treaties with developing countries, but grants a taxing right to the host
country with respect to such income that is broader than in the OECD or U.S.
Model. The limitation on benefits provisions of the proposed treaty are similar
to those found in the U.S. Model and in all recent U.S. treaties, with minor
modifications necessary because of Venezuela's territorial tax system. The
information exchange provisions generally follow the U.S. Model and make clear
that Venezuela is obligated to provide U.S. tax officials such information as is
necessary to carry out the provisions of the treaty. The proposed treaty
provides a U.S. foreign tax credit for Venezuelan
income taxes subject to the limitations imposed by U.S.
internal law on the granting of foreign tax credits. Similarly, Venezuela shall,
under the proposed Convention, provide relief against double taxation to
Venezuelan taxpayers who are also subject to U.S. income tax, subject to the
limitations imposed by Venezuelan law. The proposed treaty will enter into force
when each Contracting State has notified the other that the domestic
requirements needed for entry into force have been completed. It will have
effect, with respect to taxes withheld at source, for amounts paid or credited
on or after January 1 of the year following the date on which the treaty enters
into force. In other cases the treaty will have effect with respect to taxable
periods beginning on or after January I of the year following the date on which
the treaty enters into force. I know that the Committee has been alerted to a
pending change in Venezuela's income tax law, through which Venezuela will begin
taxing all of the income received by its residents, rather than only that income
that was determined, under broad "sourcing" rules, to be connected to Venezuela.
The possibility that Venezuela would adopt this "worldwide" system was present
throughout our treaty negotiations, and we planned for it in drafting the
treaty. And while more time with the new law may provide us with more
opportunity to analyze its provisions, we believe that the analysis we have
performed is adequate to allow us to determine that the treaty is at least as
appropriate under the new law as it would have been under the old law, and
likely more so. We believe that the treaty works appropriately, in large part
because this change from "territorial" to "worldwide" taxation brings
Venezuela's domestic laws into closer conformity with international norms. The
increased possibilities for double taxation that are the natural result of this
change make the treaty that much more important than it was when Venezuela had a
territorial system. And the vestiges of Venezuela's territorial system are also
addressed by special provisions in the treaty included to deal with that system.
On balance, we believe we can recommend that the Committee approve the treaty
despite this change in Venezuela's law. In Slovenia The United States does not
currently have an income tax treaty with Slovenia. Slovenia will be the first
country in the area of the former Yugoslavia with which we will have concluded a
tax treaty. It is the most economically advanced country in the former
Yugoslavia and is in the first wave of applicants to the European Union from
Central and Eastern Europe. We expect that the conclusion of the tax treaty will
be an important element in expanding trade and investment between the United
States and Slovenia. The proposed income tax treaty with the Republic of
Slovenia generally follows the pattern of the U.S. Model, while incorporating
some provisions found in the OECD Model. The proposed treaty establishes maximum
rates of source country tax on cross-border payments of dividends, interest, and
royalties. The withholding rates on investment income in the proposed treaty are
generally consistent with those found in U.S. treaties with OECD member
countries. Dividends may be subject to tax at source at a maximum rate of 15
percent, except when paid to a corporation in the other country that owns at
least 25 percent of the paying corporation, in which case the maximum rate is 5
percent. The maximum rate of withholding tax at source on interest under the
proposed treaty is 5 percent. However, interest received, guaranteed, or insured
by the Government of either Contracting State or the central bank of either
Contracting State and interest with respect to a deferred payment for personal
property or services is exempt from withholding at source. Royalties are
generally subject to tax at source at a rate not to exceed 5 percent. The
taxation of capital gains under the proposed treaty follows the format of the
U.S. Model. Gains and income derived from the sale of real property and from
real property interests may be taxed in the State in which the property is
located. Likewise, Gains or income from the sale of personal property, if
attributable to a fixed base or permanent establishment situated in a
Contracting State, may be taxed in that State. All other gains, including Gains
from the sale of ships, aircraft and containers, and stock in a corporation, are
taxable only in the State of residence of the seller. As with the U.S. and OECD
Models, the proposed treaty provides generally for the taxation by one State of
the business profits of a resident of the other only when such profits are
attributable to a permanent establishment located in that other State. Under the
proposed treaty, the taxation of income from the operation of ships and aircraft
in international traffic and from the use, maintenance or rental of containers
used in international traffic is fully consistent with the U.S. Model. The
taxation of income from the performance of personal services under the proposed
treaty generally follows standard U.S. treaty policy. The taxation of income
from dependent personal services or of income derived by corporate directors, by
athletes, or by entertainers is essentially the same as in other recent U.S.
treaties. The dollar threshold for the taxation of athletes and entertainers is
slightly lower than in the U.S. Model to reflect the lower average income level
in Slovenia. The treaty provides for host-country exemption for students for up
to five years with respect to certain types of income. These exempted categories
of income include support payments from abroad, grants and awards, and up to
$5,000 of annual income from personal services in the host state. Business
trainees temporarily present in the host State are exempted from tax for up to
12 months with respect to income from personal services not exceeding $8,000.
Visiting professors and researchers at recognized educational or research
institutions are exempt from host-country taxation for a period not exceeding
two years from the date of first arrival. The proposed treaty contains
comprehensive rules in its "Limitation on Benefits" article, designed to deny
"treaty- shoppers" the benefits of the treaty. In addition, the treaty contains
new provisions aimed at preventing abuse with respect to specific transactions.
Under these provisions, a person otherwise entitled to treaty benefits will be
denied those benefits if the main purpose, or one of the main purposes, of the
creation or assignment of the rights giving rise to the income was to take
advantage of the treaty. These provisions apply with respect to the Articles
regarding Dividends, Interest, Royalties, and Other Income. It is expected that
the United States with incorporate these new anti-abuse provisions into its
Model. The information exchange provisions generally follow the U.S. Model and
make clear that each State is obligated to provide tax officials of the other
State such information as is necessary to carry out the provisions of the
treaty. Slovenia has confirmed to us that it has no bank secrecy or other rules
that would prevent such exchange from taking place. The proposed treaty provides
a U.S. foreign tax credit for Slovenian income
taxes subject to the limitations imposed by U.S. internal law on the granting of
foreign tax credits. Similarly, Slovenia shall, under the proposed treaty,
provide relief against double taxation to Slovenian taxpayers who are also
subject to U.S. income tax, subject to the limitations imposed by Slovenian law.
Also included in the proposed treaty are rules necessary for administering the
treaty, including rules for the resolution of disputes under the treaty. The
proposed treaty will enter into force upon the exchange of instruments of
ratification. It will have effect with respect to taxes withheld at source for
payments made or credited on or after the first day of the third month next
following the date the treaty enters 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. Denmark I'd like to turn now to the
proposed treaty and protocol with Denmark. This proposed treaty would replace
the existing convention, our oldest income tax treaty, which was signed in 1948.
The new treaty generally follows the pattern of the OECD Model and of recent
U.S. treaties with other developed countries. First, with regard to the taxation
of investment income, the withholding tax rates under the proposed treaty are
the same as those in the U.S. Model. Direct investment dividends are subject to
withholding tax at source at a maximum 5 percent rate and portfolio dividends
are taxable at a maximum 15 percent rate. The proposed treaty requires a 10
percent ownership threshold for application of the 5 percent tax rate. This
ownership threshold is reduced from the 95 percent threshold required under the
existing treaty. As under the existing treaty, interest and royalty payments are
generally exempt from tax in the source country under the proposed treaty. These
limitations on taxation by the source country do not apply if the beneficial
owner of the income is a resident of a Contracting State that carries on
business in the other Contracting State in which the income arises and, in the
case of business profits, the income is attributable to a permanent
establishment or, in the case of independent personal services, to a fixed base
in that other State. The taxation of capital gains under the proposed treaty
generally follows the format of the U.S. Model. Gains 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 fixed base or permanent establishment situated in a
contracting State may be taxed in that State. All other gains, including gains
from the alienation of ships, boats, aircraft and containers used in
international traffic and gains from the sale of corporate stock are taxable
only in the seller's residence State. As a variation from the rules under the
current treaty and the U.S. Model, gains of an enterprise of one Contracting
State from the deemed alienation of an installation, drilling rig or ship used
in the other State for the exploration or exploitation of oil and gas resources
may be taxed in that other State in accordance with its law, but only to the
extent of any depreciation taken in that other State. In order to minimize
possible double taxation that could otherwise arise, the treaty allows
adjustments to the timing of the taxation of capital gains. As with the existing
treaty, recent U.S. treaties and the OECD Model, the proposed treaty provides
generally for the taxation by one State of the business profits of a resident of
the other only when such profits are attributable to a permanent establishment
located in that other State. In addition, the proposed treaty preserves the U.S.
right to impose its branch tax on U.S. branches of Danish corporations. This tax
is not imposed under the existing treaty. Consistent with the U.S. Model, the
proposed treaty permits only the country of residence to tax profits from the
international operation of ships or aircraft and income from the use,
maintenance or rental of containers used in international traffic. This
reciprocal exemption extends to income from the rental on a full basis of ships
and aircraft and, if the ships or aircraft are operated in international traffic
by the lessee or the income is incidental to income from the operation of ships
or aircraft in international traffic, to income from the rental on a bareboat
basis of ships and aircraft. The exemption under the proposed treaty is broader
in scope than under the existing treaty. The proposed treaty clarifies the
treatment of the profits of the Scandinavian Airlines System (SAS) by treating
it as a consortium that is eligible for the exemption from taxation in the
source State to the extent of the participation of the Danish member of SAS, SAS
Danmark A/S. The taxation of income from the performance of personal services
under the proposed treaty generally follows U.S. standard treaty policy. The
rules for the taxation of pension income vary from the rules found in the
existing treaty and the U.S. Model by providing for taxation only in the source
State, subject to an exception for persons currently receiving pensions, who
will continue to be taxed only in the country of residence. The limitation on
benefits provisions of the proposed treaty are similar to those found in the
U.S. Model and recent U.S. treaties, with modifications to take account of
certain types of entities found only in Denmark. The proposed treaty provides a
foreign tax credit for certain taxes imposed under the Danish Hydrocarbon Tax
Act, subject to the same type of limitation that is found in other tax treaties
with countries on the North Sea. Also included in the proposed treaty are the
rules necessary for administering the treaty, including rules for the resolution
of disputes under the treaty and the exchange of information. The exchange of
information provisions of the proposed treaty generally follow the U.S. Model.
Our experience on exchange of information with Denmark is positive. As under the
existing treaty, the proposed treaty contains a provision for assistance in the
collection of taxes. The proposed treaty will enter into force when the
Governments notify each other that their requirements for entry into force have
been met. It will have effect, with respect to taxes withheld at source, for
amounts paid or credited on or after the first day of the second month next
following the date on which the treaty enters into force; with respect to other
taxes, the treaty will take effect for taxable periods beginning on or after the
first day of January next following the date on which the treaty enters into
force. Where the existing treaty would have provided greater relief from tax
than the proposed treaty, the existing treaty will continue to have affect for
an additional year at the election of any person that was entitled to benefits
under the current treaty. The proposed treaty will remain in force indefinitely
unless terminated by one of the Contracting States by giving prior notice
through diplomatic channels. Italy The proposed new treaty and protocol with
Italy would replace the existing treaty, which was signed in 1984. The proposed
treaty generally follows the pattern of the OECD Model and other recent United
States treaties with developed countries. The proposed treaty is of great
importance to the U.S. business community because it addresses a new Italian
regional tax on productive activities and generally lowers the withholding rates
imposed by each country on passive investment income. The proposed treaty
addresses the replacement of the Italian local income tax by the new Italian
regional tax on productive activities (IRAP). Because IRAP is calculated without
an allowance for labor costs and, for certain taxpayers, without an allowance
for interest costs, it raises the issue of potential double taxation. By
providing a U.S. tax credit for a portion of IRAP, the proposed treaty resolves
this issue. A formula is provided in the proposed treaty for calculating the
creditable portion. Only the creditable portion of IRAP is considered to be a
covered tax under the proposed treaty. The proposed treaty establishes maximum
rates of source country tax on cross-border payments of dividends, interest, and
royalties that are generally lower than those in the existing treaty. Under the
proposed treaty, dividends may be subject to tax at source at a maximum rate of
15 percent, except when paid to a corporation in the other country that owns at
least 25 percent of the paying corporation, in which case the maximum rate is 5
percent. Under the existing treaty, the 5 percent rate is available only if the
receiving corporation owns more than 50 percent of the stock or capital of the
paying corporation, while a 10 percent rate applies if the receiving corporation
owns between 10 and 50 percent of the paying corporation, and a 15 percent
maximum rate applies in all other cases. While the maximum rate applicable to
those corporate taxpayers owning at least 10 percent and less than 25 percent of
the paying corporation will increase from 10 percent to 15 percent under the
proposed treaty, the maximum rate for those owning between 25 percent and 50
percent of the paying corporation, including the significant group of taxpayers
who own exactly 50 percent, will decrease from 10 percent to 5 percent. The
proposed treaty lowers the maximum rate of withholding tax at source on interest
to 10 percent from the 15 percent rate in the existing treaty. As in the
existing treaty, the proposed treaty provides an exemption from withholding at
source for interest received, guaranteed, or insured by the Government of either
Contracting State (although, in order for interest received by a qualified
governmental entity to be eligible for this exemption, the qualified
governmental entity must hold less than 25 percent of the capital of the person
paying the interest). The proposed treaty also exempts from withholding at
source interest with respect to credit sales between enterprises and credit
sales of industrial, commercial, or scientific equipment. The proposed treaty
lowers the maximum rates of withholding tax at source for royalty payments
compared to the rates in the existing treaty. Under the proposed treaty,
royalties for literary copyrights are exempt from tax at source. The maximum
rate for royalties for the use of computer software or for the rental of
industrial, commercial, or scientific equipment is 5 percent, and the maximum
rate for all other royalties is 8 percent. In contrast, under the existing
treaty the maximum rate for royalties for literary copyrights is 5 percent, the
maximum rate for royalties for the rental of tangible personal property is 7
percent, the maximum rate for royalties for motion pictures and films is 8
percent, and the maximum rate for all other royalties is I 0 percent. Thus,
although the proposed treaty does not reflect the U.S. Model position of
exemption at source for software and rentals of tangible personal property, the
proposed treaty reduces the rates of withholding as compared to the existing
treaty. The taxation of capital gains under the proposed treaty follows the
format of the existing treaty. Gains and income derived from the sale of real
property and from real property interests may be taxed in the State in which the
property is located. Likewise, gains or income from the sale of personal
property, if attributable to a fixed base or permanent establishment situated in
a Contracting State, may be taxed in that State. As in the existing treaty, but
unlike the U.S. Model, non-incidental gains from the alienation of ships and
aircraft rented on a bareboat basis and attributable to a permanent
establishment situated in a Contracting State may be taxed in that State. All
other gains, including gains from the alienation of containers, gains from the
alienation of ships and aircraft rented on a full basis, incidental gains from
the alienation of ships and aircraft rented on a bareboat basis, and gains from
the sale of stock in a corporation, are taxable only in the State of residence
of the seller. As with the U.S. and OECD Models, the proposed treaty provides
generally for the taxation by one State of the business profits of a resident of
the other only when such profits are attributable to a permanent establishment
located in that other State. As under the U.S. Model, all income from the use,
maintenance or rental of containers used in international traffic is exempt from
source-country taxation under the proposed treaty. Also, the proposed treaty
provides for exclusive residence-country taxation of profits from the
international operation of ships or aircraft, including the rental of ships and
aircraft on a full basis and, when the rental is incidental to the operation of
ships or aircraft by the lessor, rentals of ships and aircraft on a bareboat
basis. Like the existing treaty, but unlike the U.S. Model, income from the
rental of ships and aircraft on a bareboat basis that is not incidental to the
operation of ships or aircraft by the lessor and that is attributable to a
permanent establishment situated in a Contracting State may be taxed in that
State. Unlike the existing treaty, the taxation of income from the performance
of personal services under the proposed treaty generally follows standard U.S.
treaty policy. Consistent with the U.S. Model, the proposed treaty eliminates a
provision of the existing treaty that allows the source State to tax an
individual performing independent personal services if that individual has been
present in that State for more than 1833 days during the year, even if that
person does not have a fixed base regularly available to him. The limitation on
benefits provisions of the proposed treaty are similar to those found in the
U.S. Model and in all recent U.S. treaties, and are more comprehensive than
those found in the existing treaty. In addition, the treaty contains new
provisions aimed at preventing abuse with respect to specific transactions.
Under these provisions, a person otherwise entitled to treaty benefits will be
denied those benefits if the main purpose, or one of the main purposes, of the
creation or assignment of the rights giving rise to the income was to take
advantage of the treaty. These provisions apply with respect to the Articles
regarding Dividends, Interest, Royalties, and Other Income. It is expected that
the United States will incorporate these new anti-abuse provisions into its
Model. The information exchange provisions are similar to those in the existing
treaty and make clear that each State is obligated to provide tax officials of
the other State such information as is necessary to carry out the provisions of
the treaty. Italy has confirmed to us that it has no bank secrecy or other rules
that would prevent such exchange from taking place. Finally, the proposed treaty
includes modernized rules necessary for administering the treaty, including
rules for the resolution of disputes under the treaty. These provisions now
conform to the OECD Model, which should improve the functioning of the mutual
agreement process. They include the use of arbitration to resolve disputes that
may arise between the Contracting States. However, the arbitration process may
be implemented under the treaty only' after the two Contracting State have
agreed to do so through an exchange of diplomatic notes. Once implemented, a
particular case may be assigned to an arbitration panel only with the consent of
all the parties to the case. The proposed treaty will enter into force upon the
exchange of instruments of ratification. It will have effect with respect to
taxes withheld at source for payments made or credited on or after the first day
of the second month next following the date the treaty enters 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. In the event that a
person would have been entitled to greater relief under the existing treaty,
that person may elect to continue to apply the existing treaty for a
twelve-month period from the date on which the proposed treaty would otherwise
have effect. The proposed treaty will remain in force indefinitely unless
terminated by one of the Contracting States. Either State may terminate the
proposed treaty at any time after 5 years from the date on which the proposed
treaty enters into force by giving at least six months prior notice through
diplomatic channels. Estate Tax Protocol with Germany The proposed protocol
amends the estate, inheritance and gift tax treaty between the United States and
Germany, which was signed in 1980 and entered into force in 1986. In 1988, the
United States amended its estate tax law in a way that increased estate taxes in
the case of deceased U.S. citizens who were married to non- citizens. Although
the U.S. rejected claims by estate tax treaty partners that the 1988 change
violated treaty nondiscrimination clauses, we indicated our willingness to amend
our estate tax treaties with certain treaty partners to provide relief to
surviving noncitizen spouses in appropriate cases. In particular, the proposed
protocol eases the impact of the 1988 provisions upon certain estates of limited
value. The United States, in a 1995 protocol to the U.S.-Canada income tax
treaty, provided similar relief to certain estates of limited value involving
Canadians. The United States' willingness to enter into the proposed protocol
was a significant factor in Germany's ratification of the current U.S.-Germany
income tax treaty, which was signed in 1989. The proposed protocol also provides
a pro rata unified credit to the estate of a German - domicilian, for purposes
of computing the U.S. estate tax. Under this provision, a German domiciliary is
allowed a credit against U.S. estate tax ranging from the amount ordinarily
allowed to the estate of a nonresident under the Code ($ 130,000) to the amount
of credit allowed to the estate of a U.S. citizen under the Code ($202,050 in
1998), based on the extent to which the assets of the estate are situated in the
United States. Congress anticipated the negotiation of such pro rata unified
credits in Internal Revenue Code section 2102(c)(3 ))(A), and a similar credit
was included in the 1995 U.S.-Canada income tax protocol. The proposed protocol
also makes other changes to the Convention to reflect more closely current U.S.
treaty policy. For example, the proposed protocol extends the period of time
during which a citizen of one country can be domiciled in the other country
without becoming subject to the primary taxing jurisdiction of the other
country. Such a provision is increasingly important to peripatetic business
executives. The proposed protocol also extends the United States' ability to tax
former citizens and long-term residents to conform with 1996 legislative changes
to the Internal Revenue Code. Agreements dealing with Taxation of Dividends from
REITS In 1997, the Senate approved three treaties, with Austria, Ireland and
Switzerland, subject to the understanding that the Treasury Department would use
its best efforts to negotiate agreements that would modify those treaties'
treatment of dividends paid by Real Estate Investment Trusts. The agreements
with Austria and Switzerland are in an advanced stage of negotiation, but have
not yet been completed. However, the agreement with Ireland was signed on
September 24, 1999. Although it is not yet pending before the Committee, we hope
that, if the President transmits it to the Senate in time, the Committee will
consider it at the same time as the rest of the treaties as the agreement does
nothing other than respond to the Senate's 1997 understanding. Treaties under
Negotiation We continue to maintain an active calendar of tax treaty
negotiations. We are in active negotiations with Canada, Korea, the United
Kingdom and Chile. We expect to announce the start of negotiations with several
other countries soon. In accordance with the treaty program priorities noted
earlier, we continue to seek appropriate opportunities for tax treaty
discussions and negotiations with several countries in Latin America and in the
developing world generally. Conclusion Let me conclude by again thanking the
Committee for its continuing interest in the tax treaty program, and for
devoting the time of Members and staff to undertake a meaningful review of the
agreements that are pending before you. We appreciate your efforts this year and
in past years to bring the treaties before this Committee and then to the full
Senate for its advice and consent to ratification. We also appreciate the
assistance and cooperation of the staffs of this Committee and of the Joint
Committee on Taxation in the tax treaty process. With your and their help, we
have, since the beginning of 1993, brought into force 22 new treaties and
protocols, not counting the eight agreements presently being considered. We urge
the Committee to take prompt and favorable action on all of the Conventions and
Protocols before you today. Such action will send an important message to our
trading partners and our business community. It will demonstrate our desire to
expand the United States treaty network with income tax treaties formulated to
enhance the worldwide competitiveness of United States companies. It will
strengthen and expand our economic relations with countries that have seen
significant economic and political changes in recent years. It will make clear
our intention to deal bilaterally in a forceful and realistic way with treaty
abuse. Finally, it will enable us to improve the administration of our tax laws
both domestically and internationally. I will be glad to answer any questions
you might have.
LOAD-DATE: November 2, 1999
