Copyright 1999 Federal News Service, Inc.
Federal News Service
OCTOBER 27, 1999, WEDNESDAY
SECTION: IN THE NEWS
LENGTH:
3304 words
HEADLINE: PREPARED TESTIMONY OF
LINDY
PAUL
JOINT COMMITTEE ON TAXATION
BEFORE THE
SENATE COMMITTEE ON FOREIGN RELATIONS
SUBJECT - TAX
TREATIES AND PROTOCOLS WITH EIGHT COUNTRIES
BODY:
My name is Lindy Paull. I am chief of staff of the Joint Committee
on Taxation. It is my pleasure to present testimony of the staff of the Joint
Committee on Taxation ("Joint Committee staff') today concerning the proposed
income tax treaties with Denmark, Estonia, Italy, Latvia, Lithuania, Slovenia,
and Venezuela, and the proposed estate and girl tax protocol with Germany.
Overview
As in the past, the Joint Committee staff has prepared
pamphlets covering each of the proposed treaties and protocols. The pamphlets
contain detailed descriptions of the provisions of the proposed treaties and
protocols, including comparisons with the 1996 U.S. model treaty, which reflects
preferred U.S. treaty policy, and with other recent U.S. tax treaties. The
pamphlets also contain detailed discussions of issues raised by the proposed
treaties and protocols. We consulted extensively with the staff of your
Committee in analyzing the proposed treaties and protocols and preparing the
pamphlets.
Five of the eight agreements at issue today represent new tax
treaty relationships for the United States. The new agreements are with Estonia,
Latvia, Lithuania, Slovenia, and Venezuela. The remaining three agreements
modify existing treaty relationships. The proposed treaty with Denmark would
replace an existing treaty signed in 1948. The proposed protocol with Germany
would make several modifications to the existing estate, girl, and inheritance
tax treaty signed in 1980. The proposed treaty with Italy would replace an
existing treaty signed in 1984.
My testimony will highlight some of the key
features of these treaties and protocols and certain issues they raise.
Baltic Countries (Estonia, Latvia, and Lithuania)
The proposed treaties
with the three Baltic countries of Estonia, Latvia, and Lithuania represent new
tax treaty relationships for the United States. The terms of the three proposed
Baltic treaties are substantially similar to each other.
Under the proposed
treaties, each Baltic country agrees to reduce its taxes on the income that U.S.
residents earn from sources in that country and the United States agrees to
reciprocal reductions of its tax on U.S. income of Baltic country residents. The
United States and each Baltic country also agree that their tax administrators
will exchange tax information to carry out the provisions of the proposed
treaties and each country's tax laws, and will cooperate together to resolve
problems in the coordination of the tax rules of the countries that may arise in
individual cases.
The proposed treaties with Estonia, Latvia, and Lithuania
follow the U.S. model treaty in many respects. However, they differ from the
U.S. model treaty in certain respects, primarily by not reducing source- country
taxation to the same extent as many U.S. tax treaties. In this regard, the
proposed treaties are similar to other treaties that the United States has
entered into with developing countries.
The proposed treaties allow broader
source-country taxation of business activities of residents of the other country
than the U.S. model treaty. They also permit higher maximum rates of
source-country tax on royalties, and permit the imposition of source-country tax
on certain equipment rental income. The maximum rate of source-country tax on
royalties generally is 10 percent. The proposed treaties treat equipment rental
income as royalties subject to a maximum 5-percent source-country tax.
Under
the proposed treaties, as under certain other U.S. tax treaties, the reduced
rates of U.S. withholding tax applicable to dividends generally would not apply
to dividends from U.S. Real Estate Investment Trusts ("REITs"). Thus, REIT
dividends may be subject to U.S. withholding tax at the full statutory rate of
30 percent. In 1997, the Treasury Department modified its policy with respect to
the exclusion of REIT dividends from the reduced withholding tax rates
applicable to other dividends under the treaties. Under this policy, REIT
dividends paid to a resident of a treaty country will be eligible for the
reduced rate of withholding tax applicable to portfolio dividends (typically, 15
percent) in certain cases. The proposed treaties do not incorporate this new
policy with respect to the treatment of REIT dividends (i.e., the 30-percent
U.S. withholding tax for REIT dividends generally would not be reduced under the
proposed treaties).
Denmark
The proposed treaty with Denmark is a
comprehensive update of the 1948 treaty. The provisions of the proposed treaty
generally are consistent with the U.S. model treaty.The proposed treaty includes
a comprehensive anti-treaty-shopping provision, which resembles the provisions
of the U.S. model treaty and other recent treaties. The proposed treaty includes
a "derivative benefits" provision under which treaty benefits generally would be
available to Danish companies owned by residents of countries that are members
of the European Union or the European Economic Area, or are parties to the North
American Free Trade Agreement.
The proposed treaty provides certainty to
U.S. taxpayers that taxes imposed under the Danish Hydrocarbon Tax Act are
creditable income taxes for purposes of the U.S.
foreign tax credit. It is not entirely clear whether such taxes
would be creditable under U.S. law. The proposed treaty subjects each tax
imposed under the Danish Hydrocarbon Tax Act to separate "per-country"
limitations. Such limitations do not otherwise exist under U.S. law. A prior
proposed U.S. income tax treaty with Denmark contained a similar provision
providing for the creditability of taxes imposed under the Danish Hydrocarbon
Tax Act. This Committee reported favorably the prior proposed treaty (and its
protocol) in 1984 and 1985. During Senate consideration of the proposed treaty
in 1985, objections were raised regarding the creditability under the treaty of
the Danish hydrocarbon tax. The Senate has not given its advice and consent to
ratification of that treaty.
Germany
The proposed protocol with Germany
modifies in several respects the estate, gift, and inheritance tax treaty
between the United States and Germany that was signed in 1980.
First, the
proposed protocol modifies certain tiebreaker rules in the existing treaty that
determine which country has the right to tax on a worldwide basis when a
decedent or donor is domiciled in both the United States and Germany at the time
of death or at the time of making a gift. In this regard, the proposed protocol
extends from five to ten years the period of time during which a citizen of one
country can be domiciled in the other country without being subject to the
primary taxing jurisdiction of the other country.
Second, the proposed
protocol modifies certain exemptions granted when property is transferred
between spouses. The existing treaty provides that interspousal transfers of
property are granted a 50-percent exemption.
The proposed protocol
permits the United States to deny this exemption if the decedent or donor was a
U.S. citizen, or was a former U.S. citizen or longterm resident who lost such
status principally to avoid tax.
Third, the proposed protocol provides a
pro-rata unified credit to an individual domiciled in Germany, who is not a U.S.
citizen, for purposes of computing the U.S. estate tax. Under this provision,
such an individual domiciled in Germany would be entitled to a credit against
U.S. estate tax with respect to assets of the estate that are located in the
United States.Fourth, the proposed protocol provides a limited U.S. estate tax
marital deduction when the surviving spouse is not a U.S. citizen.
Finally,
the proposed protocol expands the saving clause of the treaty to cover two
additional classes of individuals over which the United States would retain the
right to tax under U.S. law. These are individuals who, at the time of the
transfer of property, were either domiciled in the United States, or were former
long-term residents of the United States who lost such status principally to
avoid tax.
Italy
The proposed treaty with Italy would replace the 1984
treaty. The proposed treaty generally follows the U.S. model treaty. However,
the proposed treaty differs from the U.S. model treaty in certain respects, as
described below.
The proposed treaty contains certain "main purpose" tests
that do not appear in any other U.S. treaties or the U.S. model treaty. The main
purpose tests operate to deny the benefits of the dividends, interest,
royalties, and other income articles of the proposed treaty if the main purpose
or one of the main purposes of a person is to take advantage of the benefits of
the respective article through a creation or assignment of shares, debt claims,
or rights that would give rise to income to which the respective article would
otherwise apply. In addition, the proposed treaty provides that the competent
authorities of the treaty countries can agree as to when the conditions of the
main purpose tests have been met. While the main purpose tests are intended to
prevent inappropriate benefits under the treaty, such tests inject considerable
uncertainty into the treaty provisions because such tests are subjective and
vague. This uncertainty can create difficulties for legitimate business
transactions, and can hinder a taxpayer's ability to rely on the treaty.
The
proposed treaty provides certainty to U.S. taxpayers that a portion of taxes
imposed with respect to the Italian regional tax on productive activities
(referred to as the "IRAP") are creditable income taxes for
purposes of the U.S. foreign tax credit. Effective January 1,
1998, the IRAP replaced Italy's local income tax (referred to as the "ILOR"),
which was a creditable tax under the present U.S.- Italy treaty. Unlike the
ILOR, the IRAP is calculated without a deduction for labor costs and, for
certain taxpayers, without a deduction for interest costs. Absent the proposed
treaty, the IRAP is unlikely to be a creditable tax under U.S. law. The proposed
treaty provides a formula to calculate a portion of the IRAP that is intended to
approximate an income tax under U.S. tax principles. Creditability is provided
for only that portion of the IRAP.
The proposed treaty provides an exemption
for Italian insurance companies from the U.S. excise tax on insurance and
reinsurance premiums paid to foreign insurers with respect to U.S. risks. This
exemption applies only to the extent that the U.S. risk is not reinsured by the
Italian insurer with a foreign person that is not entitled to the benefits of a
U.S. treaty providing a similar exemption from such tax.The proposed treaty
includes an arbitration provision that is similar to the provision that was
included in the 1989 U.S.-Germany treaty. However, like the provisions in
several other recent U.S. treaties, such as the treaties with Ireland and
Switzerland, the arbitration provision in the proposed treaty will take effect
only upon a future exchange of diplomatic notes. It is intended that this
arbitration approach be evaluated by taking into account experience arbitrating
cases under the U.S.-Germany treaty.
The exchange of information article
contained in the proposed treaty conforms in most respects to the corresponding
articles of the U.S. and OECD model treaties. As is true under these model
treaties, the proposed treaty requires the countries to exchange such
information as is necessary for carrying out the provisions of the proposed
treaty and the domestic tax laws of the countries. There is one significant
respect in which the exchange of information article does not conform to the
corresponding article of the U.S. model treaty. The proposed treaty omits the
provision in the U.S. model treaty that requires information to be provided to
the requesting country notwithstanding that such disclosure may be precluded
under bank secrecy laws or similar legislation.
Slovenia
The proposed
treaty with Slovenia is a new tax treaty relationship for the United States. The
provisions of the proposed treaty generally comport with the U.S. model treaty.
Under the proposed treaty, Slovenia agrees to reduce its taxes on the income
that U.S. residents earn from sources in Slovenia and the United States agrees
to a reciprocal reduction of its tax on U.S. income of Slovenian residents. Like
the proposed treaty with Italy, the proposed treaty with Slovenia contains
certain "main purpose" tests that do not appear in any other U.S. treaties or
the U.S. model treaty. The main purpose tests operate to deny the benefits of
the dividends, interest, royalties, and other income articles of the proposed
treaty if the main purpose or one of the main purposes of a person is to take
advantage of the benefits of the respective article through a creation or
assignment of shares, debt claims, or rights that would give rise to income to
which the respective article would otherwise apply. In addition, the proposed
treaty provides that the competent authorities of the treaty countries can agree
as to when the conditions of the main purpose tests have been met. While the
main purpose tests are intended to prevent inappropriate benefits under the
treaty, such tests inject considerable uncertainty into the treaty provisions
because such tests are subjective and vague. This uncertainty can create
difficulties for legitimate business transactions, and can hinder a taxpayer's
ability to rely on the treaty.
The exchange of information article contained
in the proposed treaty conforms in most respects to the corresponding articles
of the U.S. and OECD model treaties. As is true under these model treaties, the
proposed treaty requires the countries to exchange such information as is
relevant for carrying out the provisions of the proposed treaty and the domestic
tax laws of the countries. There is one significant respect in which the
exchange of information article does not conform to the corresponding article of
the U.S. model treaty. The proposed treaty omits the provision in the U.S. model
treaty that requires information to be provided to the requesting country
notwithstanding that such disclosure may be precluded under bank secrecy laws or
similar legislation.
Venezuela
The proposed treaty with Venezuela
represents a new tax treaty relationship for the United States.
The proposed
treaty raises unique issues because Venezuela currently has a territorial tax
system. Under this system, Venezuela taxes income of residents or nonresidents
only with respect to income from Venezuelan sources; accordingly, foreign-source
income is not taxed by Venezuela. This is unlike the U.S. tax system, which
taxes U.S. residents on worldwide income and generally taxes nonresidents only
on certain income from U.S. sources. The inconsistencies between the two tax
systems could result, in certain cases, in Venezuelan residents obtaining a
complete exemption from both U.S. and Venezuelan taxes under the proposed treaty
with respect to certain U.S. source income. In addition, under the proposed
treaty, the reduced rates of U.S. withholding tax on certain payments to
Venezuelan persons (such as for dividends, interest, and royalties) would
provide additional relief for such persons from taxation by both countries.
The Committee should be aware that Venezuela is in the process of moving
from a territorial tax system to a worldwide tax system. On April 26, 1999, an
enabling law authorized the President to take "extraordinary economic and
financial measures," including reforming Venezuela's income tax laws. Among
other things, the enabling law specifically authorizes the President to amend
Venezuela's tax laws to adopt a worldwide tax system (in lieu of Venezuela's
current territorial tax system) with a credit system to provide relief from
international double taxation. The enabling law authorizes the President to
publish a decree within six months of the authorization (i.e., no later than
October 26, 1999) which contains these and other changes to Venezuelan tax laws.
In September 1999, the Council of Ministers, with the President presiding,
approved a draft of a new income tax law which includes provisions adopting a
worldwide tax system.
1
In general, the new worldwide tax system is
similar to the U.S. system. Under the new worldwide tax system, Venezuelan
residents and domiciled entities would be taxable on worldwide income while
nonresidents and non-domiciled entities would be taxable only on certain income
from Venezuelan sources. Taxpayers generally would be permitted to claim a
credit against their Venezuelan tax liability for foreign taxes
paid on their foreign source income.
The
draft new tax law has not yet been published in Venezuela's
Official Gazette. For such law to take effect as provided by the enabling law,
this action must take place no later than October 26, 1999. Once officially
published, the new tax law generally would take effect for taxable years
beginning after the law is published. However, the new worldwide tax system
would take effect for taxable years beginning on or after January 1, 2001.
The proposed treaty differs from the U.S. model treaty in certain respects.
First, the proposed treaty does not reduce source-country taxation to the same
extent as many U.S. treaties. In this regard, the proposed treaty is similar to
other treaties that the United States has entered into with developing
countries.
Second, the proposed treaty would allow broader source-country
taxation of business activities of residents of the other country than the U.S.
model treaty. For example, the proposed treaty expands the definition of a
permanent establishment to include cases in which an enterprise provides
services through its employees in a country if the activities continue for more
than 183 days.
Third, the proposed treaty permits higher maximum rates of
source- country tax on royalties, and permits the imposition of source-country
tax on certain equipment rental income. The maximum rate of source- country tax
on royalties generally is 10 percent. The proposed treaty treats equipment
rental income as royalties subject to a maximum 5- percent source-country tax.
Venezuela currently is in a period of constitutional and institutional
change. In the past ten months, the Venezuelan people have elected a new
President, Hugo Chavez. In April, a new National Constituent Assembly was formed
to draft a new constitution. Among other things, conflicts have developed
between the new National Constituent Assembly and established political
institutions, such as the Venezuelan Congress. The Committee should consider the
implications of ongoing political changes in Venezuela as they relate to the
proposed treaty. For example, if there are competing claims as to who is
authorized to exercise legislative, executive, or judicial functions, it may be
difficult to identify the responsible competent authority with respect to the
proposed treaty. These uncertainties may make it difficult to administer the
treaty.
Conclusion
These issues are discussed in more detail in the
Joint Committee staff pamphlets on the proposed treaties and protocols. I would
be happy to answer any questions the Committee may have at this time and in the
future.
FOOTNOTES:
1 The draft new tax law also provides for several
fundamental changes in Venezuela's tax laws beyond the adoption of a worldwide
tax system, including the imposition of taxes on dividends, the adoption of
rules on transfer pricing, as well as general anti-abuse rules to allow the tax
authorities to disregard transactions entered into with a principal purpose to
evade, avoid, or otherwise reduce income taxes.
2 In general, laws are
enacted in Venezuela by means of publication in Venezuela's Official Gazette.
END
LOAD-DATE: October 29, 1999
