[Senate Hearing 105-354]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 105-354

 
                  BILATERAL TAX TREATIES AND PROTOCOL

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

                                HEARING

                               BEFORE THE

                     COMMITTEE ON FOREIGN RELATIONS
                          UNITED STATES SENATE

                       ONE HUNDRED FIFTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 7, 1997

                               __________

       Printed for the use of the Committee on Foreign Relations




                   U.S. GOVERNMENT PRINTING OFFICE
 44-110 CC               WASHINGTON : 1998




                     COMMITTEE ON FOREIGN RELATIONS

                 JESSE HELMS, North Carolina, Chairman
RICHARD G. LUGAR, Indiana            JOSEPH R. BIDEN, Jr., Delaware
PAUL COVERDELL, Georgia              PAUL S. SARBANES, Maryland
CHUCK HAGEL, Nebraska                CHRISTOPHER J. DODD, Connecticut
GORDON H. SMITH, Oregon              JOHN F. KERRY, Massachusetts
CRAIG THOMAS, Wyoming                CHARLES S. ROBB, Virginia
ROD GRAMS, Minnesota                 RUSSELL D. FEINGOLD, Wisconsin
JOHN ASHCROFT, Missouri              DIANNE FEINSTEIN, California
BILL FRIST, Tennessee                PAUL D. WELLSTONE, Minnesota
SAM BROWNBACK, Kansas
                     James W. Nance, Staff Director
                 Edwin K. Hall, Minority Staff Director

                                  (ii)




                            C O N T E N T S

                              ----------                              
                                                                   Page

Guttentag, Joseph H., Deputy Assistant Secretary, International 
  Tax Affairs, Department of Treasury............................     3
    Prepared statement...........................................     7
Kies, Kenneth J., Chief of Staff, Joint Committee on Taxation....    35
    Prepared statement...........................................    39
Mattson, Robert N., Chief Tax Officer and Assistant Treasurer, 
  International Business Machines Corporation, on behalf of the 
  National Foreign Trade Council and the United States Council 
  for International Business.....................................    48
    Prepared statement...........................................    49

                                Appendix

Responses of Mr. Guttentag to questions asked by Chairman Helms..    55
Responses of Mr. Guttentag to questions asked by Senator Sarbanes    55




                  BILATERAL TAX TREATIES AND PROTOCOL

                              ----------                              


                        TUESDAY, OCTOBER 7, 1997

                                       U.S. Senate,
                            Committee on Foreign Relations,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 3:15 p.m., in 
room SD-419, Dirksen Senate Office Building, Hon. Chuck Hagel 
presiding.
    Senator Hagel. Good afternoon, and welcome.
    Before we get started this afternoon, I would like to thank 
the panelists for taking part in this important discussion on 
bilateral international income tax treaties. Thank you.
    This is an issue that is vital to our economic growth not 
only today but, as you all know, for the future. The main 
purposes of these treaties are to prevent international double 
taxation and tax evasion.
    No one wants to be double taxed on their hard-earned 
income. They have a hard enough time here in the United States, 
dealing with unfair, complicated and restrictive tax codes. The 
last thing we need to do is subject our businesses and people 
to move taxation. These treaties accomplish that by setting 
down rules to determine whether the income source country or 
the resident's country will have the primary right to tax 
income, restricting the ability of the source income country to 
tax and reducing withholding tax rates on cross-border payments 
of interests, dividends and royalties.
    Also these treaties grant the procedural authority to each 
country to agree to provide tax relief for a particular 
taxpayer who can establish that he is being taxed in a manner 
inconsistent with the treaties. Tax evasion is also dealt with 
under these treaties. The treaties put limitations on benefits, 
so that benefits are denied to unintended beneficiaries.
    If we are to provide a level playing field in this global 
economy, everyone must be following the same rules. 
Unfortunately, in many areas of the world, U.S. companies are 
at a disadvantage compared to many of their European 
competitors. Today, the United States has income tax treaties 
in force with 46 countries worldwide, while the United Kingdom, 
for example, has 98, and France has 94. In fact, the average G-
7 country has 67 income tax treaties in effect today.
    In front of the Foreign Relations Committee today, we have 
seven treaties and one protocol to amend an existing treaty 
with Canada. Of the seven treaties, three are with new 
countries: South Africa, Thailand and Turkey. These three 
treaties are particularly important, as they may serve as 
examples for expanding our tax treaties with other new and 
developing countries in East Asia, Central Asia and Africa.
    The other four treaties are also important, as they will 
modernize existing treaties with Austria, Ireland, Luxembourg, 
and Switzerland. As we move forward into the next millennium, 
the global economy that we now have today will even be more 
interrelated. We cannot sit back and let the rest of the world 
pass by the United States. We must give our businesses and 
individuals a chance to thrive in this ever-changing global 
economy. That is why it is so important that these 
international tax treaties are passed in a swift manner.
    I come at this tax treaties maybe from a little different 
perspective than the rest of my colleagues. I come at this as a 
former businessman. I have started businesses and created jobs 
throughout the world and understand a little bit, from a 
practical perspective, the effects of these treaties. I 
understand what it takes to make sure that businesses will be 
successful and thrive in an international and competitive way.
    It is not easy, but it can and must be done in order for 
their to be growth and prosperity in the United States. No 
companies are more vulnerable to onerous double taxation than 
new, small businesses, struggling to compete in today's global 
marketplace. These tax treaties will help U.S. companies 
expand, create jobs and keep the U.S. economy growing. These 
bilateral international tax treaties are important to the 
future of this Nation, its economy and our growth. Today, I 
hope that we will shed some light on the importance of these 
treaties and the impact they will have internationally and 
domestically. They will be important to strengthen the United 
States in the ever-growing global economy.
    [The prepared statement of Senator Hagel follows:]
                  Prepared Statement of Senator Hagel
    Before we get started this afternoon, I would like to thank the 
panelists for taking part in this very important discussion on 
bilateral international income tax treaties. This is an issue that is 
vital to economic growth of the United States, not only today, but also 
for the future.
    The main purposes of these treaties are to prevent international 
double taxation and tax evasion.
    No one wants to be double taxed on their hard earned income. We 
have a hard enough time here in the United States dealing with an 
unfair, complicated, and restrictive tax code. The last thing we need 
to do is subject our businesses and people to more taxation. These 
treaties accomplish that by setting down rules to determine whether the 
income source country or the residence country will have the primary 
right to tax income, restricting the ability of the source income 
country to tax, and reducing withholding tax rates on cross-border 
payments of interest, dividends, and royalties. Also these treaties 
grant the procedural authority to each country to agree to provide tax 
relief for a particular taxpayer who can establish that he is being 
taxed in a manner inconsistent with the treaties.
    Tax evasion is also dealt with under these treaties. The treaties 
put ``limitations on benefits'' provisions in so that benefits are 
denied to unintended beneficiaries. If we are to provide a level 
playing field in this global economy, everyone must be following the 
same rules.
    Unfortunately, in many areas of the world U.S. companies are at a 
disadvantage compared to many of their European competitors. Today, the 
United States has income tax treaties in force with 46 countries 
worldwide while the United Kingdom has 98 and France has 94. In fact, 
the average G-7 country has 67 income tax treaties in effect.
    In front of the Foreign Relations Committee today, we have 7 
treaties and 1 protocol to amend an existing treaty with Canada. Of the 
7 treaties, three are with new countries, South Africa, Thailand, and 
Turkey. These three treaties are particularly important, as they may 
serve as examples for expanding our tax treaties with other new and 
developing countries in East Asia, Central Asia and Africa. The other 4 
treaties are also important, as they will modernize existing treaties 
with Austria, Ireland, Luxembourg, and Switzerland.
    As we move forward into the next millennium, the global economy 
that we have today will be even more interrelated. We can't sit back 
and let the rest of the world pass by the United States. We must give 
our businesses and individuals a chance to thrive in this ever changing 
global economy. That is why it is so important that these international 
tax treaties are passed in a swift manner.
    I come at these tax treaties from a little different angle that the 
rest of my colleagues. I come at this as a businessman. I've started 
many businesses and created hundreds of jobs throughout this world. I 
understand what it takes to make sure that businesses will be 
successful and thrive. It is not easy, but it can and must be done in 
order for there to be growth and prosperity in the United States. No 
companies are more vulnerable to onerous double taxation than new small 
businesses struggling to compete in today's global marketplace. These 
tax treaties will help U.S. companies expand, create jobs, and keep the 
U.S. economy growing.
    These bilateral international tax treaties are important to the 
future of this nation, its economy and growth. Today, I hope that we 
will shed some light on the importance of these treaties and the impact 
they will have internationally and domestically. They will be important 
to strengthen the United States in the ever growing global economy.
    Before recognizing the first of our witnesses, I would like to 
recognize the subcommittee's Ranking Member, Senator Sarbanes, for any 
comments he may have.

    Senator Hagel. Now, before recognizing our distinguished 
panelists, I would like to recognize the subcommittee's ranking 
member, Senator Sarbanes. Senator Sarbanes.
    Senator Sarbanes. Well, Mr. Chairman, I will be very brief. 
I am anxious to hear the presentation. I am curious why, in 
some of these treaties, we seem to be making one-sided 
concessions. I will be interested in exploring that.
    Recently, the Treasury developed a model treaty which seems 
to make some significant departures from the model treaty. I 
wonder what is the rationale for that.
    Finally, this committee in the past has expressed an 
opinion on certain aspects of tax policy, in terms of 
provisions in treaties. That seems to have been ignored in a 
couple of instances here. So, when we get to the questioning 
period, I want to explore all of these areas.
    Thank you.
    Senator Hagel. Senator Sarbanes, thank you.
    Let me first introduce the three panels of witnesses, and 
then ask our first witness to proceed.
    First, the Hon. Joseph H. Guttentag, Deputy Assistant 
Secretary, International Tax, Department of Treasury.
    The second panel, Mr. Kenneth J. Kies, Chief of Staff, 
Joint Committee on Taxation.
    And the third panel, Mr. Robert Mattson, on behalf of the 
National Foreign Trade Council and the U.S. Council for 
International Business, and also Assistant Treasurer, IBM.
    With that, Mr. Secretary, please proceed. Good to have you.

 STATEMENT OF JOSEPH H. GUTTENTAG, DEPUTY ASSISTANT SECRETARY, 
           INTERNATIONAL TAX, DEPARTMENT OF TREASURY

    Mr. Guttentag. Thank you, Mr. Chairman and Mr. Sarbanes.
    I will summarize my written statement, which I have 
submitted for the record, and request that my statement be 
included in the record.
    Senator Hagel. Without objection.
    Mr. Guttentag. Thank you, Mr. Chairman.
    I am pleased today to be able to recommend, on behalf of 
the administration, favorable action on seven bilateral tax 
treaties and a protocol to our Canada tax treaty 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, and Treasury 
requests the committee and the Senate to take prompt and 
favorable action on all of these agreements. We have submitted 
new agreements with five of our oldest treaty partners: 
Austria, Luxembourg, Switzerland, Ireland, and Canada; two 
agreements with completely new countries of increasing 
important significance to us: Turkey and Thailand; and the 
eighth agreement before you, the treaty with South Africa, 
brings that important country back into our tax treaty network 
after its change in government.
    The new agreements will generate substantial benefits for 
U.S. taxpayers and the tax authorities, and will serve to 
expedite increased desirable international economic activity as 
an income tax treaty removes impediments to international trade 
and investment in many ways. First, it generally increases the 
extent to which exporters can engage in trading activity in the 
other country without triggering tax. When tax is imposed, it 
ensures appropriate deductions, and reduces the withholding tax 
on flows of income.
    Second, it establishes rules that assign to one country or 
the other the primary right of taxation with respect to a 
particular piece of income, helping to prevent the double 
taxation that can occur if both countries impose tax on the 
same income. Third, the treaty provides a dispute resolution 
mechanism to prevent double taxation that sometimes can arise 
in spite of the treaty provisions.
    Finally, and often most importantly, the treaty helps to 
create stability of tax rules, thereby encouraging this 
desirable economic activity. The tax treaties alleviate the 
burden of high source--based taxation 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 tax on interest and royalties to zero; 
dividends normally are subject to tax at one of two rates: 15 
percent with respect to portfolio investment, and 5 percent 
with respect to direct corporate investors.
    The extent to which this policy is realized depends on a 
number of factors. Although generalizations are often 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 and reciprocal income flows.
    We also achieve lesser but still very significant 
reductions with countries where the flows tend to be 
disproportionately in favor of the United States. Lesser 
developed and newly emerging economies, where capital and trade 
flows are often disparate or sometimes completely one way, 
create obstacles to achieving our desired level of withholding, 
though we still find a treaty most desirable.
    These rules are general guidelines, and they do not address 
every conceivable situation. Consequently, there will still be 
cases in which double taxation may occur. In such cases, the 
treaty provides a mechanism through the tax authorities of the 
two governments, known as the competent authorities, to consult 
and reach an agreement in which the taxpayer's income is 
allocated between the two taxing jurisdictions on a consistent 
basis, thereby preventing the double taxation.
    All the aspects of tax treaties that I have been discussing 
so far involve benefits that the treaties provide to taxpayers, 
especially multinational companies, big and small. 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 
evasion and to ensure that treaty benefits only flow to those 
intended recipients.
    Tax treaties ensure this in two ways. First, they provide 
for exchange of information between the tax authorities. 
Second, they contain provisions to limit the treaty benefits to 
real residents of the country, and to prevent treaty shopping.
    Our tax treaties must provide appropriate tax treatment for 
categories of income which are specially treated under the 
Internal Revenue Code. One important example of such provisions 
are the REITs, the real estate investment trusts, created by 
Congress to help investors achieve diversified ownership in 
primarily passive real estate investments. In the case of 
foreign investors, the Congress provided for a 30 percent 
withholding tax, except for certain capital gain distributions.
    These rules reflect U.S. tax policy, which is consistent 
with that of most countries. That is, each country reserves the 
right to impose a full tax on income from real property; and 
the other country must, therefore, give a credit or an 
exemption to prevent double taxation. Our existing treaty 
policy provides for a 30 percent withholding tax on REIT 
dividends, with a limited 15 percent exception. That is only 
for payments to individuals who own 10 percent or less of the 
REIT.
    We have determined that reconsideration of our existing 
policy is appropriate for the reasons described in greater 
detail in our prepared testimony. Our new policy provides for a 
15 percent withholding tax on shareholders of publicly traded 
REITs who hold 5 percent or less. Even if the REIT is not 
publicly traded, but its holdings are substantially 
diversified, the foreigner can hold up to 10 percent of the 
REIT. This new policy has been developed with, and has the 
support of, the staffs of this committee, the joint committee 
on taxation and the REIT industry. It will be reflected in our 
model treaty and in future treaty negotiations.
    Furthermore, we do not object to a reservation in the 
Luxembourg treaty, pending before you, which would reflect this 
new policy in that treaty, as well as providing certain limited 
grandfathering. We are also going to use our best efforts to 
secure agreement with our current treaty partners, Austria, 
Ireland and Switzerland, to protocols to our new treaties to 
reflect this new policy.
    Further details with which we agree and support are also 
set forth in Mr. Kies' written testimony.
    The discussion of REIT taxation provides an example of why 
our tax treaty policy cannot be static, and our model treaty 
published last year, as well as the OECD model, are and will be 
ambulatory documents. We work on a continuing basis with our 
foreign colleagues to continually review our treaty policies 
and interpretations. It is to our advantage to have universally 
accepted policies and interpretations, and we work hard to 
achieve such goals.
    If, however, we believe that inconsistencies are created 
with U.S. positions, we can, at any time, disavow our 
adherence. We have, over the years, working with this committee 
and the tax writing committees, achieved an appropriate balance 
between the certainty required in order to receive Senate 
advice and consent and the necessary flexibility to achieve our 
treaty goals. We must take into account that our treaties 
remain in place, unchanged sometimes for decades, and 
reasonable flexibility in interpreting the treaty--not changing 
it--is needed to deal with new and unanticipated developments.
    For example, we are working internationally with our 
multinational businesses and foreign governments to ensure that 
tax laws do not impede the development of new technologies, 
exemplified by the Internet. At the same time, we need to 
ensure that we have the proper tools in place to prevent these 
new technologies from encouraging tax avoidance or evasion.
    I do not intend to discuss the details of each of the eight 
agreements you have before you, but will of course be pleased 
to answer any questions you may have. Each treaty must be 
adapted to the individual facts and circumstances of the treaty 
partner. It is also important to remember that each treaty is a 
result of a negotiated bargain between two countries that often 
have conflicting objectives.
    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.
    Each of the treaties with Austria, Switzerland, Luxembourg, 
and Ireland are over 30 years old, and some are approaching 50. 
They all needed to be modernized to take into account the 
numerous changes in our economic relationships and tax laws 
over the past decade. All are very close to the current U.S. 
model, and contain appropriate versions of our anti-treaty 
shopping and information exchange provisions.
    The treaty with Luxembourg was negotiated in tandem with a 
mutual legal assistance treaty, which provides essential tax 
information exchange provisions. We urge prompt approval of the 
tax treaty with Luxembourg, with the understanding that the 
treaty will not come into effect until the MLAT does.
    The treaties with Turkey, Thailand and South Africa 
demonstrate agreement with countries in different stages of 
development. Although there are some developing country 
concessions in these agreements, they also reflect the greater 
awareness by many countries that United States principles of 
low rates of taxation at source and a stable tax system may be 
a better route toward encouraging foreign investment than 
revenue-losing tax holidays, combined with high withholding 
taxes.
    The Canadian protocol reflects the need for continued 
monitoring of our bilateral agreement because of the enormous 
number, complexity and importance of our cross-border 
transactions. The protocol deals primarily with treatment of 
social security benefits, and reflects the need for review, 
which has already begun, of our current policies in that regard 
with this committee, the tax-writing committees, and the Social 
Security Administration.
    We are continuing to maintain an active calendar or tax 
treaty negotiations. Early this summer, we initialed treaties 
with Estonia, Latvia and Lithuania. We are nearing completion 
of our negotiations with Bangladesh, Sri Lanka and Denmark, and 
are continuing negotiations with Venezuela and Italy. We also 
would like to extend our treaties to more countries, 
particularly in Latin America and Southeast Asia.
    Let me conclude by again thanking the committee for its 
continued interest in the tax treaty program, and for devoting 
the time of the members and the staff to undertaking 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. With your 
help over the past few years, we have brought into force 15 new 
agreements, and we look forward to adding the eight presently 
before you.
    We urge the committee to take prompt and favorable action 
on all of the conventions and the protocol. 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 U.S. 
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. 
Thank you.
    [The prepared statement of Mr. Guttentag follows:]
                  Prepared Statement of Mr. Guttentag
    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. Treasury requests the Committee and the Senate to 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 five of our oldest treaty partners, Austria, 
Luxembourg, Switzerland, Ireland, and Canada. Two agreements are with 
new treaty partners of growing economic significance, Turkey and 
Thailand. The eighth agreement before you, the treaty with South 
Africa, brings that important country back into our tax treaty network 
after its change in government. The new agreements will generate 
substantial benefits for United States taxpayers and tax authorities, 
and will serve to expedite and increase desirable international 
economic activity. Tax conventions, as explained in greater detail 
below, do not represent a zero sum exercise. Not only do United States-
based businesses benefit from exemption from, or reduction of, foreign 
taxes, but additional tools are provided to enforce our tax laws, 
particularly with respect to international tax crimes, often related to 
money laundering and illegal drug traffic. Mutual agreement procedures 
not only minimize the risk of double taxation of our multinationals, as 
well as assuring appropriate taxation of foreign based companies, but 
also facilitate a fair allocation of tax revenues between our treaty 
partners and the United States.
    To help frame our discussions of the pending agreements, I would 
like to describe in general terms the United States tax treaty program. 
The United States has a network of 48 bilateral income tax treaties, 
the first of which was negotiated in 1939. We have treaties with most 
of our significant trading partners. Approval of the treaty with 
Turkey, which is before you today, would achieve an important objective 
of having tax treaty relationships with all of the members of the 
Organization for Economic Cooperation and Development, the OECD.
    The Department of the Treasury receives regular and numerous 
requests to enter tax treaty negotiations. As a result it has been 
necessary for us to establish priorities. These priorities are not new; 
they are reflected in our existing treaty network including the 
agreements the Senate approved last year as well as the treaties that 
you are considering today.
    Consistent with both Administration and Congressional policies, the 
Treasury gives priority to renegotiating older treaties that lack 
effective anti-abuse clauses or otherwise fail to reflect current 
United States treaty policy. Examples in this category are the 
agreements with Austria, Luxembourg, Switzerland, and Ireland. We have 
made it clear to our treaty partners that we will not tolerate 
continuation of treaty relationships that fail to reflect important 
United States treaty policies. This policy was underscored last year by 
the termination of our treaties with Malta and Aruba, and by the 
termination protocol with respect to the Netherlands Antilles.
    Another priority 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 tax obstacles. Such new 
agreements could include treaties with expanding economies with which 
we lack a treaty, or revised and improved treaties with existing treaty 
partners. Examples in this category include the treaties with Turkey, 
Thailand, and South Africa. As we complete our renegotiation of 
outdated treaties, we are able to increase the priority we place on 
negotiating tax treaties in countries and regions of increasing 
importance to the United States and United States business. Thus, a 
major focus of our tax treaty program in the next several years will be 
to continue and expand our treaty activities with countries in Latin 
America and Southeast Asia.
    We also try to conclude treaties with countries that have the 
potential to be significant trading partners. The list of such 
countries has always been a long one, and it has become even longer 
since the creation of many new market-oriented economies in the former 
Soviet Union and eastern European countries. Treasury focuses its 
efforts in this category on those countries that have developed stable 
tax systems and that have the greatest potential for bilateral economic 
activities. We also take into account the concerns and interests of 
other governmental agencies and the private sector. The existence of a 
treaty will help remove tax impediments to trade and investment in such 
countries and thereby help establish economic ties that will contribute 
to the country's stability and independence, as well as improving its 
political relationships with the United States. In the past four years 
the Senate considered and approved treaties with five countries that 
fit this description: the Russian Federation, the Czech Republic, 
Slovakia, Kazakstan, and Ukraine. Other treaties in this category that 
have been initialed but not yet signed are with Estonia, Latvia, and 
Lithuania
    In determining our country priorities as well as treaty positions, 
we consult regularly and usefully with many constituencies. We meet 
with the staff of this Committee and its members as well as staffs of 
the tax writing committees. We hear from many United States-based 
companies and trade associations which provide useful guidance 
particularly with respect to practical in-country problems they face. 
We are constantly working to ensure that new economic and commercial 
developments, such as the revolution in communication technology, are 
appropriately dealt with in our tax conventions.
    The OECD provides a useful forum to consider these developments 
with our treaty partners. The development of new technologies in 
particular increases the need for international cooperation with 
respect to many tax policy and administration issues.
Benefits Provided by Income Tax Treaties
    Irrespective of the category in which a particular country may 
fall, we seek to achieve the same two basic objectives through the 
treaty. First, to reduce income tax-related barriers to international 
trade and investment. 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 competitive position 
of United States businesses that enter a treaty partner's marketplace.
    A second general objective of our tax treaty program is to combat 
tax avoidance and evasion. A treaty provides the tax administrations of 
both treaty partners with additional tools with which to improve 
international tax administration.
    While 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 network goes beyond what 
domestic legislation can achieve. Legislation is by its nature 
unilateral, and cannot easily distinguish among countries. It cannot 
take into account other countries' rules for the taxation of particular 
classes of income and how those rules interact with United States 
statutory rules. 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, domestic statutory law of both countries as it 
applies to income flowing between the treaty partners.
    For example, a basic concept found in all of our treaties 
establishes 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. These rules, the permanent 
establishment and business profits provisions, not only eliminate in 
many cases the difficult task of allocating income and resulting tax 
between countries but also serve to encourage desirable trade 
activities by eliminating, or reducing, what can often be complex tax 
compliance requirements.
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. I'd like to mention 
four different aspects of this general goal. 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 that threshold is met and tax is imposed, it establishes rules 
that assign to one country or the other the primary right of taxation 
with respect to an item of income, it ensures appropriate deductions 
and reduces the withholding tax on flows of income. Third, the treaty 
provides a dispute resolution mechanism to prevent double taxation that 
sometimes can arise in spite of the treaty. Finally, and often most 
importantly, the treaty helps to create stability of tax rules thereby 
encouraging desirable economic activity. These benefits are not limited 
to companies and business profits. 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. You will note that treaty 
benefits are not limited to profit-making enterprises as they deal with 
pension plans, Social Security benefits (as in the protocol with 
Canada), charitable organizations, researchers and alimony and child 
support recipients. I would like to discuss some of these aspects of an 
income tax treaty.
    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 (perhaps because 
of limitations on the foreign tax credit provided by the Code). The 
resulting double taxation can impose an oppressive financial burden on 
the operation and might well make it economically unfeasible.
    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 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. These provisions are especially important in 
treaties with lesser developed countries, which in the absence of a 
treaty frequently will tax a branch operation even if the level of 
activity conducted in the country is negligible or where the line is 
not clear and frequently will not allow deductions for appropriate 
expenses. Under the favorable treaty rules, United States manufacturers 
may establish a significant foreign presence through which products are 
sold without subjecting themselves to foreign tax or compliance rules. 
Similarly, United States residents generally may live and work abroad 
for short periods without becoming subject to the other country's 
taxing jurisdiction.
    High withholding taxes at source are 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 100 
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 this policy is realized depends on a number of 
factors. Although generalizations 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 very significant reductions with 
countries where the flows tend to be disproportionately in favor of the 
United States. Lesser developed and newly emerging economies, where 
capital and trade flows are often disparate or sometimes one-way, 
create obstacles to achieving our desired level of withholding. These 
countries frequently find themselves on the horns of a dilemma. They 
know that they must reduce their high levels of taxation to attract 
foreign capital but, at the same time, they are unwilling to give up 
scarce revenues. Such prospective treaty partners may perceive that 
they are making a concession in favor of the United States without 
receiving a corresponding benefit when they reduce withholding rates. 
In some such cases, we will look at the level of overall rates of tax 
and avoid agreements which serve to transfer tax from a less developed 
foreign fisc to the United States. For this reason and others, the 
treaty withholding rates will vary. Furthermore, even if the treaty 
does not serve to reduce existing rates, it provides limitations and 
the certainty demanded by business decision-makers.
    The rules provided in the treaty are general guidelines that do not 
address every conceivable situation, particularly, new developments. 
Consequently, 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.
Prevention of Tax Evasion
    All the aspects of tax treaties that I have been discussing so far 
involve benefits that the treaties provide to taxpayers, especially 
multinational companies but also others I have described. 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 evasion and to ensure that 
treaty benefits flow only to the intended recipients. Tax treaties 
achieve this objective in at least two major ways. First, they provide 
for exchange of information between the tax authorities. Second, they 
contain provisions designed to ensure that treaty benefits are limited 
to real residents of the other treaty country and not to ``treaty 
shoppers.''
    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.
    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 and that 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 
fora such as the OECD and the OAS. We have observed that within the 
European Union there has been increasing recognition that the desired 
political and economic unity requires full disclosure and transparency.
    To emphasize the importance of this subject, the Department of 
Justice has written a letter, in light of its obligations to enforce 
the tax laws, expressing its support for these treaties. A copy of the 
letter is appended to this testimony for the Committee's information.
    A second major objective of U.S. tax treaty policy is to obtain 
comprehensive provisions designed to prevent abuse of the treaty by 
persons who are not bonafide residents of the treaty partner. This 
abuse, which is known as ``treaty shopping,'' can take a number of 
forms, but its general characteristic is that a resident of a third 
state that has either no treaty with the United States or a relatively 
unfavorable one establishes 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 activity 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. The United States treaty partner must of course 
cooperate by providing favorable tax treatment to the third country 
investor.
    This Committee and the Congress have expressed strong concerns 
about treaty shopping, and the Department of the Treasury shares those 
concerns. 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 operate free of these barriers by 
organizing their United States transactions so that they flow through a 
country with a favorable United States tax treaty.
    Although anti-treaty shopping provisions give us leverage in 
negotiating with other countries, we do not necessarily need to have 
tax treaties with every country in the world. There are usually very 
good reasons why the United States has not concluded a treaty with a 
particular country. 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 and it would be inappropriate to reduce United States 
taxation on returns on inbound investment if the other country cannot 
offer a corresponding benefit in exchange for favorable United States 
treatment. The anti-treaty shopping provisions in our treaty network 
support this goal by preventing investors from enjoying the benefits of 
a tax-haven regime in their home country and, at the same time, the 
benefits of a treaty between the United States and another country. 
However, these situations often are not black or white. Some countries 
have adopted favorable tax regimes applicable to limited sectors of 
their economy and the United States believes that in many circumstances 
it is inappropriate to grant treaty benefits to companies taking 
advantage of such regimes. On the other hand there may be other 
elements of the economy as well as other factors that would make a 
treaty relationship useful and appropriate. Accordingly, in some cases 
we have devised treaties that carve out from the benefits of the 
treaties certain residents and activities. In other cases, we have 
offered to enter into an agreement limited to the exchange of tax 
information. We have a number of these agreements, particularly with 
Caribbean countries.
    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, these provisions should be 
crafted to avoid interfering with legitimate and desirable economic 
activity. For example, we have begun to address directly in our 
negotiations the issue of how open-end United States regulated 
investment companies (RICS) should be treated under limitation on 
benefits provisions in order to facilitate cross-border investments 
from this important source of capital. Because these funds are required 
to stand ready to redeem their shares on a daily basis, we believe they 
generally should be entitled to treaty benefits to the same extent as 
closed-end RICS, which qualify for benefits under standard limitation 
on benefits provisions because they are publicly traded on stock 
exchanges. However, the negotiators need to ensure that what may appear 
to be similar funds established in the treaty partner cannot be used to 
promote treaty shopping.
Transfer Pricing
    Several of the aspects of income tax treaties that I have been 
describing are highly relevant to the resolution of transfer pricing 
issues. Transfer pricing relates to the division of the taxable income 
of a multinational enterprise among the jurisdictions where it does 
business. 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. Accordingly, transfer pricing is an 
important subject not only in this country but in most other countries 
as well.
    In analyzing the prices charged in any transaction between parties 
that are commonly controlled, 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. This standard is reflected in hundreds of existing tax 
treaties. 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.''
    Consistent with the domestic practice of all major trading nations, 
all of our comprehensive income tax treaties adopt the arm's-length 
standard as the agreed benchmark to be used in addressing a transfer 
pricing case. Adoption of a common approach to these cases is another 
benefit provided by tax treaties. A common approach consistently 
applied is a sine qua non for preventing both tax avoidance and double 
taxation. A common approach guarantees the possibility of achieving a 
consistent allocation of income between the treaty partners. Without 
such an assurance, it is possible that the two tax authorities would 
determine inconsistent allocations of income to their respective 
jurisdictions, resulting in either double taxation or under taxation. 
Double taxation would occur when part of the multinational's income is 
claimed by both jurisdictions. Under taxation would occur when part of 
the multinational's income is claimed by neither jurisdiction.
    By adopting a common standard, the risks of double taxation and 
under taxation are minimized. Furthermore, when double taxation does 
occur, the competent authorities of the two countries are empowered to 
consult and agree on an equitable division of income based upon this 
common reference point. Without this common reference point, reaching 
mutual agreement would be difficult or impossible.
Distributions from Real Estate Investment Trusts (REITs)
    Our tax treaties must provide appropriate tax treatment for 
categories of income which are specially treated under the Code. One 
important example of such provisions are the REITS, created by Congress 
to help investors achieve diversified ownership in primarily passive 
real estate investments. In the case of foreign investors, the Congress 
provided for a 30% withholding tax except for certain capital gain 
distributions. These rules reflected U.S. tax policy which is 
consistent with those of most other countries: each country reserves 
the right to impose a full tax on income from real property, leaving 
the residence country to alleviate any resulting double taxation.
    REITs are created as U.S. corporations and their distributions are 
in the form of corporate dividends. Unlike corporations, however, they 
generally are not subject to tax at the corporate level and, if their 
distributions were not subject to full taxation, their income would not 
be subject to full taxation at the entity level or the shareholder 
level. Therefore, a decision must be made whether to characterize the 
distributions as distributions of real property rental income subject 
to at least one level of full U.S. taxation or as dividends subject to 
a lower rate.
    It is has been U.S. policy since 1988 to treat REIT distributions 
as conduit distributions of real estate rental income. The policy 
originated in a 1988 directive, with which the Department of the 
Treasury agreed, from the Joint Committee on Taxation and the Senate 
Committee on Foreign Relations. The purpose of excluding certain REIT 
dividends from preferential dividend withholding tax rates under the 
treaties is to prevent foreign investors from utilizing a REIT conduit 
to convert high-taxed U.S. source rental income into lower taxed 
dividend income by passing the rental income through a REIT. This 
policy avoids a disparity between the taxation of direct real estate 
investments and real estate investments made through REIT conduits. 
Limited relief from this rule generally is provided in the case of REIT 
dividends beneficially owned by individuals holding less than a 10-
percent interest in the REIT. Such REIT dividends qualify for the 
reduced withholding tax rates generally available in respect of 
dividends.
    Economic changes since these policies were established ten years 
ago require that we review our position in order to insure that our 
treaty policies reflect the best interests of the United States. These 
interests include not discouraging, through our tax rules, desirable 
foreign investment. To that end we have consulted with representatives 
of the REIT industry and we are now satisfied that our current treaty 
policy should be modified. While the treaties before you represent 
policies with which we all have agreed, we now believe that it is 
appropriate to revise our treatment of REIT dividends under our 
treaties.
    Our new policy takes into account that portfolio investments in a 
REIT whether by individuals or institutional investors may be 
indistinguishable in intent and results from similar investments in 
other corporate securities and should be afforded similar tax 
consequences in appropriate circumstances. In carrying out such a 
policy however, two other considerations are significant. First, we 
should maintain a reasonable neutrality with respect to the taxation of 
foreigners and U.S. citizens. A potential U.S. investor in a shopping 
mall should not be out bid by a foreigner because we have, through out 
treaty process, provided inappropriate tax benefits to the foreigner. 
Second, we should not provide such generous REIT benefits that 
foreigners choose to make economically distorted investments to our 
disadvantage. For example, we do not want a foreigner that is 
considering building a major job-producing new factory in the United 
States to choose instead to buy an existing office building because of 
inappropriately favorable tax treatment of the latter.
    The proposal which we put before you today has been developed by 
the staff of the Joint Committee on Taxation in consultation with the 
staff of this Committee and Treasury and with the help of the REIT 
industry. Our existing treaty policy provides for a 30% withholding tax 
on REIT dividends with an exception for payments to individuals who 
hold 10% or less of the REIT. Our new policy retains the current 
treatment of individuals with 10% or smaller holdings of the REIT and, 
in addition, provides for a 15% withholding tax on dividends paid by 
(i) a publicly traded REIT to any shareholder who holds a 5% or smaller 
interest in the REIT, and (ii) a publicly traded or non-publicly traded 
REIT, the holdings of which are substantially diversified, to a 
shareholder who holds a 10% or smaller interest in the REIT.
    We are going to reflect this new policy in our model treaty and in 
future treaty negotiations. Furthermore we support the proposal to 
insert a reservation to the Senate's advice and consent to our pending 
treaty with Luxembourg to reflect our new REIT policy in that treaty, 
as well as assuring ``grandfathered'' benefits for certain current 
investments. We are also going to use our best efforts to secure 
agreement with Austria, Ireland and Switzerland to protocols to our new 
treaties to reflect our new REIT policy.
    We believe that the foregoing proposal goes as far as we can in 
accommodating the changes in the REIT industry consistent with sound 
tax policy designed to take into account the factors described above. 
Representatives of the REIT industry have been most helpful in 
providing us with information with respect to developments in the 
industry and changes in investment patterns since adoption of our 1988 
policy and have indicated their support for the new policy.
Basis for Negotiations
    Each of these 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 (which had not yet been published while most of the 
treaties were negotiated, but was available to U.S. negotiators in 
draft form) and are generally consistent with the 1992 OECD Model 
Income Tax Convention. 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.
    Based on our experience we anticipate that the United States model, 
like the OECD model, will not be a static document but will be modified 
as required to reflect changes in United States tax law or policy, 
economic, technical and other changes that may require further 
elaboration, clarification or even reversals of prior policies. There 
are no major inconsistencies between the US and OECD model, but rather 
the US 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. The tax consequences resulting from the 
development of new financial instruments need to be internationally 
accepted and consistent. 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. We believe 
that our new model and its accompanying explanation will find its 
principal benefits to be enabling 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 anticipate that American companies will be 
able to use the model to suggest modifications that may be required in 
connection with negotiations with a particular country based on the 
interaction of our two tax systems. For example, in my discussions of 
our policies with respect to information exchange and treaty shopping I 
noted the need to tailor these provisions to the specific 
circumstances, which will differ from country to country. We have 
presented our model to the OECD with the intention of working together 
to create even greater consistency concerning the important issues 
covered. We do not anticipate that the United States will ever sign a 
tax convention identical to the model; there are too many variables.
    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 the treatment of 
partnerships and other transparent entities, 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, and whether and to what extent the country imposes 
withholding taxes on outbound flows of investment income. Consequently, 
a negotiated treaty needs to take into account all of these and 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 United States or OECD language. The technical explanations 
which accompany our treaty, the discussions with the staffs of this 
Committee and its members, and the staffs of the tax law 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--Austria, Luxembourg, Turkey, 
        Switzerland, Thailand, South Africa, Ireland, Canada
    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 nonnegotiable. 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 nonnegotiable issues than most 
countries. Obtaining the agreement of our treaty partners on these 
critical 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. The give and take 
that is inherent in the negotiating process leading to a treaty is not 
unlike the process that results in legislation in this body. Treaties 
can each be different and yet represent an ideal treaty from the United 
States perspective with a particular country because of the specific 
economic relationships, domestic tax rules and other factors, and even 
though the treaty does not completely adhere to a model, whether that 
of the United States, the OECD or the treaty partner.
    Each of the full treaties before the Committee today allows the 
United States to impose our branch profits tax at the treaty's direct-
dividend rate. In addition, in conformity with what has become standard 
United States treaty policy, excess inclusions with respect to residual 
interests in real estate mortgage investment conduits (REMICS) are 
subject to the United States statutory withholding rate of 30 percent.
    The proposed treaties also contain provisions designed to improve 
the administration both of the treaty and of the underlying tax 
systems, including rules concerning exchange of information, mutual 
assistance, dispute resolution and nondiscrimination. Each treaty 
permits the G6neral 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).
    Each treaty also contains a comprehensive limitation on benefits 
provision designed to ensure that residents of each State may enjoy 
treaty benefits only if they have a substantial nexus with that State, 
or otherwise can establish a substantial non-treaty-shopping motive for 
establishing themselves in their country of residence. Each treaty 
preserves the right of the United States to tax certain former citizens 
generally consistent with recently enacted amendments to the Code 
dealing with this issue.
    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, in order to achieve the desired reciprocal taxation of 
business profits on a net basis, special provisions in the proposed 
treaty with Turkey, applicable only to Turkey, were required. Turkey 
also exemplifies a treaty partner in a significantly different level of 
economic development than the United States and many other OECD member 
countries. While the treaty is based on the OECD model it reflects 
various reservations made by Turkey to that model particularly with 
respect to withholding at source on interest, dividends and royalties. 
All of these features should be regarded as a strength rather than 
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.
Austria
    The proposed new Convention with Austria signed in Vienna on May 
30, 1996, along with the Memorandum of Understanding, replaces the 
existing Convention, which was signed in 1956. The proposed Convention 
generally follows the pattern of other recent United States treaties 
and the OECD Model treaty. The proposed new Convention contains changes 
made in order to create a closer alignment with our current income tax 
treaty policy.
    First, the proposed Convention contains a new exchange of 
information provision which will allow each country greater access to 
information important to tax enforcement. These provisions are needed 
because the existing Convention is limited and does not provide an 
effective means for the United States to obtain relevant Austrian bank 
account information. As elaborated in the Memorandum of Understanding, 
the information exchange provisions make clear that United States tax 
authorities will be given access to Austrian bank information in 
connection with any penal investigation. The MOU clarifies that the 
term penal investigation applies to proceedings carried out by either 
judicial or administrative bodies and that the commencement of a 
criminal investigation by the C Investigation Division of the Internal 
Revenue Service constitutes a penal investigation.
    Also, as the existing Convention contains no provision dealing with 
gains on disposition of personal property, the proposed new convention 
contains an article dealing with the taxation of capital gains. This 
provision is generally similar to that in recent United States 
treaties. Under the new Convention, however, and consistent with United 
States tax law, a Contracting State in which a permanent establishment 
or fixed base is located may also tax gains from the alienation of 
personal property that is removed from the permanent establishment or 
fixed base, to the extent that gains accrued while the asset formed 
part of a permanent establishment or fixed base. Double taxation is 
prevented because the residence State must exclude from its tax base 
any gain taxed in the other State.
    The withholding rates on investment income in the proposed 
Convention are essentially the same as in the present treaty and are 
generally consistent with United States policy. Direct investment 
dividends are subject to taxation at source at a rate of 5 percent, and 
portfolio dividends are taxable at 15 percent. The proposed Convention 
contains a change that conforms the threshold of ownership required to 
obtain the lowest dividend withholding rate with the threshold in our 
most recent income tax conventions. Interest and royalties are 
generally exempt from tax at source. However, in the proposed 
Convention, as in the existing one, a tax may be imposed at a maximum 
rate of 10 percent on royalties in respect of commercial motion 
pictures, films and tapes; and the proposed Convention redefines the 
category to include royalties in respect of rights to use similar items 
used for radio and television broadcasting.
    Consistent with current United States treaty policy, the proposed 
treaty provides for exclusive residence country taxation of profits 
from international carriage by ships or airplanes. The proposed 
Convention expands the scope of this provision to include income from 
the use or rental of containers and from the rental of ships and 
aircraft. Under the present Convention, such rental income is treated 
as royalty income, which may be taxed by the source country only if the 
income is attributable to a permanent establishment in that country.
    Personal services income is taxed under the proposed Convention as 
under recent United States treaties with OECD countries. In addition, 
in recognition of the increasingly mobile nature of the work force, the 
proposed Convention provides for the deductibility, under limited 
circumstances, of cross-border contributions by individuals temporarily 
in one country who contribute to recognized pension plans in the other 
country.
    Unlike the existing Convention, the proposed Convention contains a 
comprehensive antitreaty-shopping provision. A Memorandum of 
Understanding provides an interpretation of key terms. Austria's recent 
membership in the European Union and the special United States ties to 
Canada and Mexico under the North American Free Trade Agreement are an 
element in the . determination by the competent authority of 
eligibility for benefits of certain Austrian and United States 
companies. Recognized headquarters companies of multinational corporate 
groups are entitled to benefits of the Convention.
    The proposed Convention also provides for the elimination of 
another potential abuse relating to the granting of United States 
treaty benefits in the so-called triangular cases to income of an 
Austrian resident attributable to a third-country permanent 
establishments of Austrian corporations that are exempt from tax in 
Austria by operation of Austria's law or treaties. Under the proposed 
rule, full United States treaty benefits will be granted in these 
triangular cases only when the United States-source income is subject 
to a sufficient level of tax in Austria and in the third country. As in 
the United States-France treaty, this anti-abuse rule does not apply in 
certain circumstances, including when the United States taxes the 
profits of the Austrian enterprise under subpart F of the Internal 
Revenue Code.
    Also included in the proposed Convention are the provisions 
necessary for administering the Convention, including rules for the 
resolution of disputes under the treaty and the exchange of 
information. With the exception of the more limited access to bank 
information, the exchange of information provision in the proposed 
Convention is consistent with the U.S. Model.
Luxembourg
    The proposed new Convention with Luxembourg, signed in Luxembourg 
on April 3, 1996, replaces the existing Convention, which was signed in 
1962. The proposed Convention generally follows the pattern of the OECD 
Model Convention and other recent United States treaties with developed 
countries.
    A new treaty is necessary for many reasons. The existing Convention 
does not provide an effective means for the United States to obtain 
information from Luxembourg financial institutions as part of the 
exchange of tax information under the Convention. It also does not 
contain adequate rules to prevent residents of third countries from 
improperly obtaining the benefits of the Convention by using companies 
resident in one of the treaty countries to invest in the other. 
Finally, as the present treaty entered into force more than three 
decades ago, it does not reflect the significant changes in United 
States tax and treaty policy that have developed since the present 
treaty entered into force.
    To deal with the first issues, the fact that the present treaty 
does not contain a comprehensive provision to prevent treaty shopping 
or to provide for effective information exchange can lead to abuse (the 
current treaty contains a narrow limitation on benefits provision that 
denies treaty benefits to certain Luxembourg holding companies). The 
proposed Convention contains a comprehensive anti-treaty-shopping 
provision and, in conjunction with a new Mutual Legal Assistance Treaty 
which also is pending before this Committee, will allow the Internal 
Revenue Service significant access to Luxembourg bank information.
    Regarding the changes in tax and treaty policy, the new Convention, 
for example, allows the United States to impose its branch tax on 
United States branches of Luxembourg corporations. Among other 
modernizations, it also eliminates the withholding tax on debt secured 
by real property, permits the United States to impose withholding tax 
on contingent interest, and eliminates the out-dated force of 
attraction rule so that a country can only tax the profits that are 
actually attributable to a permanent establishment in that country.
    In parallel with Luxembourg's elimination of dividend withholding 
taxes for payments within the European Union, Luxembourg unilaterally 
eliminates the withholding tax for certain dividend payments between a 
Luxembourg subsidiary and its U.S. parent company in the proposed 
Convention. This practice generally puts the payments from Luxembourg 
subsidiaries to U.S. entities on the same footing as payments from 
Luxembourg subsidiaries to EU entities and is a significant benefit to 
U.S. companies doing business in Luxembourg. Apart from this exception, 
the withholding rates on investment income in the proposed Convention 
are generally the same as those in the present treaty. Interest and 
royalties are generally exempt at source, as under the present treaty. 
All United States-source and most Luxembourg-source direct investment 
dividends are subject to taxation at 5 percent at source.
    The proposed Convention provides another major benefit to certain 
U.S. companies by modifying the present Convention rules to reflect 
current United States treaty policy with respect to ships and aircraft 
and related activities. The proposed Convention provides for exclusive 
residence country taxation of profits from international carriage by 
ships or aircraft. The reciprocal exemption from source country 
taxation also extends to income from the use or rental of containers 
and from the rental of ships and aircraft.
    The proposed Convention also provides benefits to the U.S. fisc. It 
does this in two manners: First, it contains detailed rules that 
restrict the benefits of the Convention to persons that are not engaged 
in treaty shopping. Second, it expands the ability to exchange 
information about financial accounts. These provisions are important as 
they ensure that the Convention serves its second purpose of preventing 
fiscal evasion.
    Under the limitations on benefits provision in the proposed 
Convention, a person must meet the test to be a qualified resident of a 
treaty country to be entitled to all of the benefits of the treaty. For 
example, companies may be entitled to benefits if they meet certain 
listed conditions. For example, publicly-traded companies will 
generally be entitled to treaty benefits if their principal class of 
shares is substantially and regularly traded on a recognized stock 
exchange. Other companies may be qualified to obtain benefits if they 
meet certain ownership and base erosion tests. In addition, the 
proposed Convention allows certain residents of the European Union or 
of the North American Free Trade Area to obtain derivative benefits. 
These provisions parallel those contained in recent treaties between 
the United States and Member States of the European Union. Consistent 
with U.S. treaty policy, individuals, governmental entities and not-
for-profit organizations (provided more than half of the beneficiaries, 
members or participants, if any, in such organization are qualified 
residents) are entitled to all the benefits of the treaty.
    The proposed Convention continues to carve out Luxembourg's 
``1929'' holding companies from treaty benefits. It expands this 
coverage to include other companies that enjoy similar fiscal 
treatment, such as the investment companies defined in the Act of March 
30, 1988. Headquarters companies are also not granted treaty benefits.
    The proposed Convention also provides for the elimination of 
another potential abuse relating to the granting of United States 
treaty benefits in the so-called triangular cases to third country 
permanent establishments of Luxembourg corporations that are exempt 
from tax in Luxembourg by operation of Luxembourg's law or treaties. 
Under the proposed rule, full United States treaty benefits will be 
granted in these triangular cases only when the United States-source 
income is subject to a sufficient level of tax in Luxembourg and the 
third country.
    Finally, the proposed treaty allows the competent authority to 
allow benefits even if the conditions outlined in the limitation on 
benefits article are not met. The competent authority has the ability 
to resolve unilaterally these cases and grant treaty benefits in other 
cases where the perceived abuses do not in fact exist. This latter 
situation may arise, for example, when the United States source income 
is effectively subject to United States tax under subpart F of the 
Code.
    The modifications to the exchange of information article are a 
critical piece of the proposed treaty. Under its internal law, 
Luxembourg tax authorities may not obtain certain information from 
Luxembourg financial institutions. As clarified in the exchange of 
notes, certain information of financial institutions may be obtained 
and provided to certain United States authorities only in accordance 
with the terms of the treaty between the United States and Luxembourg 
on Mutual Legal Assistance in C Matters. That agreement sets forth the 
scope of that obligation. The ability to obtain this information is 
critical and we will not proceed to bring the Convention into force 
except in tandem with the Mutual Legal Assistance Treaty. We request 
that the Committee recommend that the Senate give its advice and 
consent to ratification on the understanding that instruments of 
ratification will not be exchanged until the exchange of instruments 
with respect to the Mutual Legal Assistance Treaty has occurred.
    The proposed Convention waives the United States excise tax on 
certain insurance premiums paid to Luxembourg insurance companies, but 
does so in a more limited way that other United States tax treaties 
that waive the excise tax. This proposed Convention generally waives 
the excise tax on direct insurance premiums, but does not waive the tax 
on reinsurance premiums. Treasury agrees to waive the federal excise 
tax only if we are satisfied that the foreign country imposes a 
sufficient level of tax on insurance companies. In this case, we are 
satisfied that Luxembourg imposes a sufficient level of tax on direct 
business, but we are not satisfied that the effective tax rate on 
reinsurers is sufficient to justify waiving the excise tax on 
reinsurance premiums.
Turkey
    The proposed treaty with Turkey, signed in Washington on March 28, 
1996, will be the first income tax convention between the United States 
and Turkey and will complete the United States' network of income tax 
treaties with OECD member countries. The treaty represents a central 
component of the economic relationship between Turkey and the United 
States. The proposed treaty generally follows the pattern of the OECD 
Model Convention and other recent United States treaties. There are, 
however, variations that reflect particular aspects of Turkish law and 
treaty policy, their interaction with United States law, and the 
disparity in the Turkish and United States economies.
    The treaty establishes maximum rates of source-country tax on 
cross-border payments of dividends, interest, and royalties. Dividends 
may be taxed at source at a maximum rate of 20 per cent, except when 
paid to a corporation in the other country that owns at least 10 
percent of the paying corporation, in which case the maximum rate is 15 
percent. The general maximum rate of withholding tax at source on 
interest under the proposed treaty is 15 percent, with lower rates 
applicable for certain classes of interest. Royalties generally are 
subject to tax at source at a maximum rate of 10 percent. Rental 
payments for tangible personal property are treated under the proposed 
treaty as royalties, but are subject to tax at a maximum rate of 5 
percent at source.
    The proposed treaty generally follows standard United States treaty 
policy by providing for exclusive residence country taxation of profits 
from international carriage by ships or airplanes and of income from 
the use or rental of ships, aircraft and containers. In this treaty, 
however, the reciprocal exemption does not extend to income from the 
non-incidental rental of ships or aircraft. Such income is treated as 
royalties and will be subject to a maximum tax at source of 5 percent.
    The limitation of benefits provisions is consistent with other 
recent United States treaties. The proposed treaty contains 
administrative provisions consistent with United States treaty policy.
Switzerland
    The proposed Convention and Protocol with Switzerland, signed in 
Washington on October 2, 1996, replace the existing Convention, which 
was signed in 1951. Many of the terms used in the Convention and 
Protocol are further explained in a Memorandum of Understanding that 
was negotiated at the same time. The new Convention generally follows 
the pattern of the OECD Model Convention, and of recent U.S. treaties 
with other developed countries. The proposed Convention and Protocol 
modernize many of the provisions of the existing convention and add new 
provisions that have become part of our treaty policy.
    For example, under the proposed Convention, interest generally may 
be paid free of withholding in the source country, rather than being 
subject to the five percent withholding tax that may be levied under 
the existing treaty. Although the withholding rates on dividend and 
royalty income are essentially unchanged in the proposed Convention, 
the thresholds for, and exceptions from, those rates have been made 
consistent with other recent U.S. treaties. The proposed Convention 
also recognizes the growing importance of pooled capital, by providing 
that qualified pension funds may receive dividends from corporations 
resident in the other country free of source-country taxation.
    The proposed Convention clarifies the treatment of capital gains 
and allows us to apply in full our rules regarding the taxation of 
gains from the disposition of U.S. real property interests. The 
proposed treaty also contains rules, found in a few other U.S. 
treaties, that allow adjustments to the taxation of certain classes of 
capital gains in order to coordinate the timing of the taxation of 
gains. These rules serve to minimize possible double taxation that 
could otherwise result.
    As with the recent U.S. treaties and the OECD Model, the proposed 
Convention 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 present Convention grants taxing rights that are in some respects 
broader and in others narrower than those found in modern treaties. In 
addition, the proposed Convention preserves the U.S. right to impose 
its branch tax on U.S. branches of Swiss corporations. This tax is not 
imposed under the present treaty.
    The proposed Convention provides, consistent with current U.S. 
treaty policy, for exclusive residence country taxation of profits from 
international carriage by ships or airplanes. This reciprocal exemption 
also extends to income from the rental of ships and aircraft if the 
rental income is incidental to income from the operation of ships or 
aircraft in international traffic. Other income from the rental of 
ships or aircraft and income from the use of rental of containers, 
however, are treated as business profits under Article 7. As such, 
these classes of income are taxable only in the country of resident of 
the beneficial owner of the income unless the income is attributable to 
a permanent establishment in the other Contracting State, in which case 
it is taxable in that State on a net basis.
    The taxation of income from the performance of personal services 
under the proposed Convention is essentially the same as that under 
recent U.S. treaties with OECD countries. Unlike many U.S. treaties, 
the proposed Convention provides for the deductibility of cross-border 
contributions by a temporary resident of one country to certain pension 
plans in the other, under limited circumstances.
    The proposed Convention contains significant rules to deny the 
benefits of the Convention to persons that are engaged in treaty 
shopping. The present Convention contains no such anti-treaty-shopping 
rules. Such provisions are found in all recent U.S. treaties. The 
Protocol and Memorandum of Understanding contain explanations and 
examples of the application of the Limitation on Benefits provisions.
    The Limitation on Benefits article of the proposed Convention also 
eliminates another potential abuse by denying U.S. benefits with 
respect to income attributable to third-country permanent 
establishments of Swiss corporations that are exempt from tax in 
Switzerland by operation of Swiss law (the so-called ``triangular 
cases''). Under the proposed rule, full U.S. treaty benefits generally 
will be granted in these triangular cases only when the U.S. source 
income is subject to a significant level of tax in Switzerland or in 
the country in which the permanent establishment is located.
    The proposed Convention provides a U.S. foreign tax credit for the 
Swiss income taxes covered by the Convention, and for Swiss relief from 
double taxation with respect to the income of Swiss residents subject 
to U.S. taxation. Swiss relief may be in the form of a deduction, 
credit or exemption. In the case of social security benefits, a partial 
Swiss exemption is provided, which, when combined with the reduction in 
U.S. source-basis tax results in the avoidance of potential double 
taxation. The proposed Convention also provides for non-discriminatory 
treatment (ie., national treatment) by one country of residents and 
nationals of the other.
    Also included in the proposed Convention are the rules necessary 
for administering the Convention, including rules for the resolution of 
disputes under the treaty and the exchange of information. The 
information exchange provisions, as elaborated in the Protocol and 
Memorandum of Understanding, make clear that U.S. tax authorities will 
be given access to Swiss bank information in cases of tax fraud. The 
Protocol includes a clear and broad definition of tax fraud that should 
facilitate information exchange. Furthermore, the new treaty provides 
that, where possible, information will be provided in a form that will 
make it acceptable for use in court proceedings.
    The proposed Convention allows for the use of arbitration to 
resolve disputes that may arise between the Contracting States. 
However, the arbitration process may be implemented under the 
Convention 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 Convention deals with cases where a Contracting State 
enacts legislation that is believed to modify the application of the 
Convention in a significant manner. In such cases, either Contracting 
State may request consultations with the other to determine whether an 
amendment to the Convention is appropriate in order to restore the 
original balance of benefits.
Thailand
    The proposed treaty with Thailand, signed in Bangkok on November 
26, 1996, will, if ratified, be the first tax treaty between the United 
States and Thailand to enter into force. An income tax treaty with 
Thailand was signed in 1965 but was returned to the President at his 
request in 1981 never having been formally considered by the Senate. 
The current proposed treaty is a major step in our efforts to expand 
our tax treaty network in Asia and will facilitate negotiating tax 
treaties with other important countries in the region. The proposed 
treaty generally follows the pattern of the U.S. Model treaty, with the 
deviations from the Model found in many recent U.S. treaties with other 
developing countries. There are also some further variations that 
reflect particular aspects of Thai law and treaty policy, the 
interaction of U.S. and Thai law, and U. S.-Thai economic relations.
    The proposed treaty establishes maximum rates of source-country tax 
on cross-border payments of dividends, interest, and royalties. Direct 
investment dividends are taxable at source at a 10-percent rate, and 
portfolio dividends are taxable at a 15-percent rate. The proposed 
treaty provides for a 15-percent maximum rate of tax at source on most 
interest payments. Copyright royalties (including software) are subject 
to a 5-percent tax at source. Royalties for, the right to use equipment 
are subject to a 8-percent tax at source. Royalties for patents and 
trademarks are subject to a 15-percent tax at source. These rates 
generally are lower than those in many tax treaties Thailand recently 
has entered into.
    The taxation of capital gains under the proposed Convention does 
not follow the usual pattern. Like some other U.S. treaties, it allows 
gains to be taxed by both Contracting States under the provisions of 
their internal law.
    Consistent with recent U.S. treaties and the U.S. and OECD Models, 
the proposed Convention 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 proposed Convention, however, grants rights to tax 
business profits that are somewhat broader than those found in the U.S. 
and OECD Models: It allows taxation of some income that is not 
attributable to a permanent establishment, but only if it can be shown 
that the income was shifted away from the permanent establishment to 
avoid tax. Thus this ``limited force of attraction'' rule is narrower 
than those found in the U.N. Model and section 864(c)(3) of the U.S. 
Internal Revenue Code.
    The proposed Convention, consistent with current U.S. treaty 
policy, provides for exclusive residence-country taxation of profits 
from international carriage by aircraft. This reciprocal exemption also 
extends to income from the rental of aircraft if the rental activity is 
incidental to the operation of aircraft by the lessor in international 
traffic. However, income from the international operation of ships, 
including ship rental income that is incidental to such operations, is 
taxed at one-half of the tax rate otherwise applicable. Income from the 
use or rental of containers that is incidental to the operation of 
ships or aircraft in international traffic is treated the same as the 
income from the operation of the ships or aircraft in international 
traffic i.e., it is exempt if incidental to such aircraft operations, 
and taxed at half of the rate otherwise applicable if incidental to 
such operation of ships). Income from the rental of ships, aircraft or 
containers that is not incidental to the operation of ships or aircraft 
in international traffic is treated as business profits, and thus is 
taxable by the state other than the income recipient's state of 
residence only on a net basis and only if attributable to a permanent 
establishment in the state. The current treaty policy of Thailand is to 
treat such income as royalties subject to tax at a rate of 8 percent of 
gross. Treatment as business profits was a concession gained by the 
United States.
    The proposed Convention grants a taxing right to the host country 
with respect to income from the performance of personal services that 
is broader than that in the OECD or U.S. Model, but that is similar to 
that granted under other U.S. treaties with developing countries.
    The proposed Convention contains detailed rules designed to 
restrict the benefits of the Convention to persons that are not engaged 
in treaty shopping. The provisions are similar to those found in the 
U.S. Model and in all recent U.S. treaties.
    The information exchange provisions make clear that Thailand is 
obligated to provide U.S. tax officials such information as is 
necessary to carry out the provisions of the Convention. The U.S. 
negotiators are satisfied that, under this provision, Thailand is now 
able to provide adequate tax information, including bank information, 
to the United States whenever there is a Thai tax interest in the case. 
Under current Thai law, however, Thailand is not able to provide 
information under the tax treaty in non-criminal cases where there is 
no Thai tax interest. The proposed Convention contains an unusual 
provision designed to deal with this ``tax interest'' problem. The 
proposed Convention provides that Thailand generally is required to 
treat a U.S. tax interest as a Thai tax interest and the U.S. generally 
is required to treat a Thai tax interest as a U.S. tax interest. 
However, the ``tax interest'' provision does not take effect with 
respect to either country until the United States receives from 
Thailand a diplomatic note indicating that Thailand is prepared and 
able to implement the provision, which will not be possible until Thai 
law is changed. If the United States has not received such a diplomatic 
note by June 30 of the fifth year following the entry into force of the 
Convention, the entire Convention shall terminate on January I of the 
sixth year following entry into force.
    The Convention remains in force indefinitely, except in the 
instance just described, but either State may terminate the Convention 
after 5 years from the date on which the Convention enters into force, 
with six-months' notice.
South Africa
    The proposed treaty with South Africa, signed February 17, 1997, 
renews a treaty relationship that was interrupted when the previous 
convention was terminated in 1987 pursuant to the U.S. Anti-Apartheid 
Act. The proposed Convention with South Africa generally follows the 
pattern of the OECD Model treaty and other recent United States 
treaties.
    The proposed Convention establishes maximum rates of withholding at 
source on investment income that are the same as those in the U.S. 
Model. The taxation of capital gains under the proposed Convention also 
follows the pattern of the U.S. Model.
    As with recent U.S. treaties and the U.S. and OECD Models, the 
proposed Convention 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 proposed Convention, however, grants rights to tax business 
profits that are somewhat broader in one respect than those found in 
the U.S. and OECD Models. Under the proposed Convention, an enterprise 
will have a permanent establishment in a Contracting State if its 
employees or other personnel provide services within that State for 183 
days or more within a 12-month period in connection with the same or a 
connected project.
    As with the treatment of business profits, personal service income 
is subject to rules that generally follow the U.S. Model rules. The 
183-day personal service rule in the definition of permanent 
establishment, however, is also present in the definition of fixed 
base.
    The proposed Convention, consistent with current U.S. treaty 
policy, provides exclusive residence-country taxation of profits from 
international carriage by ship or aircraft. This reciprocal exemption 
also extends to income from the rental of ships, aircraft and 
containers.
    In the proposed Convention, the dollar threshold for host-country 
taxation of income of entertainers and sportsmen is $7,500, rather than 
$20,000, as in the U.S. Model. The proposed Convention, however, 
contains a rule allowing the Contracting States to increase the amount 
through an exchange of diplomatic notes.
    The treatment of pensions differs, at the request of South Africa, 
from that in the U.S. Model. Pensions will be subject to limited 
source-country tax. The residence country may also tax, subject to a 
foreign tax credit if the source country has taxed. Like the U.S. 
Model, an individual employed in one country who belongs to a pension 
plan in the other may, subject to certain conditions, be allowed in his 
country of employment to deduct contributions to his plan in the other 
country.
    As in the U.S. Model, the proposed Convention provides that income 
of a resident of a Contracting State not dealt with in the other 
articles of the Convention is taxable only in the country of residence 
of the recipient.
    The proposed Convention contains significant Iiinitation on 
benefits rules similar to those found in the U.S. Model and in all 
recent U.S. treaties. The information exchange pro visions make clear 
that South Africa is obligated to provide U.S. tax officials such 
information, including bank information, as is necessary to carry out 
the provisions of the Convention. Consistent with U.S. policy, South 
African information will be available to U.S. authorities whether or 
not South Africa has a tax interest in the information.
    The proposed Convention provides a U.S. foreign tax credit for the 
South African income taxes covered by the Convention, including the 
normal tax and the secondary tax on companies, and for a South African 
foreign tax credit for the U.S. income taxes covered by the Convention. 
The U.S. foreign tax credit is subject to normal limitations of U.S. 
law, including limitations relating to the amount of foreign source 
income of the U.S. taxpayer and denial of the credit for non-compulsory 
payments.
Ireland
    The proposed Convention, Protocol and exchange of diplomatic notes 
between the United States and Ireland, which were signed in Dublin on 
July 28, 1997, would replace the present treaty between the two 
countries. The present treaty is the oldest U.S. tax treaty; it was 
signed in 1949. The proposed treaty updates the existing treaty to 
reflect the current laws and tax treaty policies of both countries. It 
fills a major void in the existing treaty by introducing a 
comprehensive limitation on benefits provision and a dispute resolution 
procedure.

    The proposed treaty generally maintains the existing treaty's rates 
of tax on direct and portfolio dividends, which are 5 and 15 percent, 
respectively, Consistent with U.S. treaty policy, the threshold for 
qualifying for the direct investment rate has been reduced from 95 
percent of the ownership of the equity of a company to ten percent. 
However, Ireland will exempt direct investment dividends paid to U.S. 
residents from any withholding tax. Ireland also will allow U.S. 
portfolio investors in Irish companies the tax credit provided to 
individuals resident in Ireland for a portion of the Irish corporation 
tax paid on distributed profits.

    The proposed treaty maintains the existing treaty's general 
exemption at source for interest and royalty payments.

    Unlike the existing treaty, the proposed treaty preserves the U.S. 
right to impose its branch profits tax in addition to the basic 
corporate tax on a branch's business.

    The proposed treaty provides special rules for the taxation of 
activities associated with the offshore exploration for, and 
exploitation of, natural resources. These rules provide for somewhat 
shorter time thresholds than would otherwise apply for these activities 
to give rise to a permanent establishment. They also permit taxation of 
employee compensation associated with offshore activities. Other U.S. 
treaties with countries in this geographical area (for example, Norway, 
the United Kingdom, and the Netherlands) have similar provisions 
dealing with offshore activities.

    The proposed treaty includes a comprehensive limitation on benefits 
provision to combat treaty shopping. The provision is broadly similar 
to the corresponding provisions in other recent U.S. treaties, but it 
has been tailored to accommodate the small size of the Irish economy 
and the historically large share of foreign ownership of Irish 
business. The limitation on benefits provision is most similar to the 
corresponding provision in the proposed treaty with Luxembourg.

    The proposed treaty closes another gap in the current treaty by 
introducing a provision to resolve disputes by mutual agreement under 
the treaty. Such a provision is necessary in some cases to avoid double 
taxation.

    The proposed treaty allows for the use of arbitration to resolve 
disputes that may arise between Ireland and the United States over the 
application of the treaty. However, the arbitration process may be 
implemented only after the two States have agreed to do so through an 
exchange of diplomatic notes. Once implemented, a case may be assigned 
to arbitration only with the consent of all the parties to the case.

    Also included in the proposed treaty are rules for the exchange of 
information by the tax authorities of Ireland and the United States. 
The treaty provides for extensive exchange of information necessary to 
enforce tax laws and confirms that Ireland will obtain and provide any 
information relevant to the investigation or prosecution of a criminal 
tax matter.

    Finally, the proposed treaty covers the U.S. excise tax imposed on 
insurance premiums paid to foreign insurers, but only where such 
insurance premiums are subject to the generally applicable tax imposed 
on insurance companies in Ireland. This proviso means that the excise 
tax may be imposed on insurance premiums paid to companies that receive 
the tax benefits associated with Ireland's International Financial 
Services Center (which is sometimes referred to as the ``Dublin 
Docks''). This provision was included in the treaty after the 
Department of the Treasury determined that insurance companies subject 
to Ireland's generally applicable insurance tax regime face a 
substantial tax burden relative to the U.S. taxation of U.S. insurance 
companies, but companies benefiting from Ireland's International 
Financial Services Center do not face such a substantial tax burden.

    The treaty will enter into force on the date the instruments of 
ratification are exchanged. The provisions with respect to taxes 
withheld at source will have effect on or after the first day of 
January following entry into force. With respect to other U.S. taxes, 
the treaty generally will have effect for taxable years beginning on or 
after that date. In the case of other Irish taxes, the treaty will have 
effect for financial years (in the case of the corporation tax) or 
years of assessment (in the case of the income and capital gains tax) 
beginning on or after that date. Like many U.S. tax treaties that 
replace existing treaties, a provision allows residents to choose to 
apply the existing treaty for an additional year.
Canada

    The proposed fourth Protocol to the Income Tax Convention between 
the United States and Canada was signed in Ottawa on July 29, 1997. The 
proposed Protocol is limited to two issues: the taxation of social 
security benefits, and the taxation of foreign real property holding 
companies.

    The 1995 Protocol to the US-Canada Tax Convention, which became 
effective January 1, 1996, changed the taxation of social security 
benefits. Under the Convention prior to amendment by the 1995 Protocol, 
the country of residence of the recipient taxed social security 
benefits paid by the other country on a net basis but exempted 50 
percent of the benefit. Under the present regime, the benefits are 
taxed at source at a rate of 25.5 percent by the US and 25 percent by 
Canada. However, Canada permits U.S. recipients of Canadian benefits to 
file a Canadian tax return and pay tax at regular graduated rates on 
net income.

    This proposed Protocol returns to a system of residence-based 
taxation in which social security benefits are taxable in the country 
where the recipient lives. Therefore social security benefits will be 
taxed on a net basis at graduated rates and low-income recipients will 
not pay any tax. However, the taxation of benefits in the residence 
country takes into account how the benefits would have been taxed in 
the source country. For example, since the United States only includes 
85 percent of the U.S. benefits in income, only 85 percent of U.S. 
benefits received by Canadians will be subject to Canadian tax.

    The proposed Protocol is retroactively effective to January 1, 
1996, the date the prior rule took effect, so that social security 
recipients will receive a refund of taxes previously paid although some 
recipients may be required to pay additional taxes to their country of 
residence. However, if as a result of the change, the residence-country 
tax would exceed amount of the refund, there will be neither a refund 
of source-country tax nor the imposition of additional residence-
country tax. Consequently, no one will be subject to a higher rate of 
tax for the retroactive period. However, in the future some high-income 
recipients of benefits will be subject to a higher rate of tax if their 
average tax rate on these benefits in their country of residence is 
higher than the current rate of source-country withholding tax.

    The proposed Protocol also denies each country the right to tax 
income from the sale of the stock of foreign corporations whose assets 
primarily consist of domestic real estate (e.g., real property holding 
companies). Both countries currently tax foreign persons on the sale of 
both domestic real estate and the stock of domestic corporations whose 
assets primarily consist of domestic real estate. The current 
Convention permits this tax and also permits the taxation of income 
from the sale of stock of foreign companies whose assets primarily 
consist of domestic real estate but neither country currently imposes 
such a tax. We believe that it is inappropriate to tax such sales, but 
a bill imposing such a tax was introduced in the last session of the 
Canadian Parliament. Although the Canadian Parliament was dissolved 
before these amendments were passed, they are expected to be re-
introduced in the next session with the same effective date. The 
proposed Protocol amends the Convention to limit each country's right 
to tax gains from the sale of stock of real property holding companies 
to companies that are resident in that country. This provision will be 
retroactively effective to April 26, 1995, the date the previous 
Canadian legislation was proposed to be effective.
Treaties under Negotiation

    We are continuing to maintain an active calendar of tax treaty 
negotiations. Early this summer we initialed treaties with Estonia, 
Latvia, and Lithuania. We are nearing completion of our negotiations 
with Bangladesh, Sri Lanka, and Denmark. We also are resuming 
negotiations with Venezuela and Italy. In addition, in accordance with 
the treaty program priority noted earlier, we continue to seek 
opportunities for tax treaty discussions and negotiations with several 
countries in Latin America and Southeast Asia.
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 15 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.

                               __________

                    U.S. Department of Justice,    
                     Office of Legislative Affairs,
                                    Washington, D.C. 20530.
                                                    October 6, 1997
Hon. Jesse Helms,
Chairman,
Committee on Foreign Relations
U.S. Senate
Washington, D.C. 20510

Dear Mr. Chairman.
    Seven income tax treaties and one protocol are pending before the 
Foreign Relations Committee, namely treaties with Austria, Switzerland, 
Ireland, Luxembourg, Turkey, South Africa, and Thailand, as well as a 
protocol with Canada. The Department of Justice urges that the 
Committee and the Senate approve these agreements at the earliest date 
practicable.
    The civil and criminal enforcement actions of the Tax Division of 
the Justice Department are increasingly dependent on our ability to 
obtain foreign evidence. Therefore, it is especially helpful to us that 
the treaties forwarded by the President contain exchange of information 
provisions that will significantly enhance the ability of federal 
investigators and litigators to obtain foreign documents and testimony 
to enforce U.S. tax laws. These provisions will also improve the 
ability of federal authorities to obtain evidence in a form admissible 
for U.S. court proceedings.
    In particular, we believe that the proposed tax-treaties with 
Austria, Switzerland, Ireland, and Luxembourg (in conjunction with the 
proposed mutual legal assistance treaty (MLAT) with Luxembourg) \1\ 
will remove significant barriers currently facing U.S. tax enforcement. 
The tax treaties with those countries, along with the Luxembourg MLAT, 
have provisions that will assist U.S-tax authorities in obtaining 
information held by financial institutions located in those countries, 
which have very strict financial secrecy laws, for U.S. criminal tax 
offenses. We have had a substantial number of criminal cases in the 
past for which we needed financial information located in these 
jurisdictions. Furthermore, the proposed tax treaties with Austria, 
Switzerland, Ireland and Luxembourg provide for exchanging information, 
other than that held by financial institutions in these four countries, 
for both civil and criminal tax matters being investigated or enforced 
in court by federal tax authorities in the United States.
---------------------------------------------------------------------------
    \1\ The proposed MLAT with Luxembourg is significant here because, 
during the negotiations for the Luxembourg Tax Treaty, the Luxembourg 
Tax Treaty Delegation, after thoroughly consulting with the principals 
in Luxembourg, emphatically stated that Luxembourg law precluded 
Luxembourg officials from obtaining and providing financial information 
held by a Luxembourg institution through an administrative process such 
as a tax treaty. On the other hand, the Luxembourg Delegation 
emphasized that such assistance could be arranged through a judicial 
process and suggested that we pursue the conclusion of an MLAT with 
Luxembourg that would allow access by U.S. tax authorities to 
Luxembourg financial information for criminal tax offenses. 
Accordingly, the United States has negotiated an MLAT with Luxembourg 
that covers most, if not all, U.S. criminal tax offenses and it is 
understood that the U.S. would view a failure by Luxembourg to provide 
assistance for criminal tax offenses under the MLAT as grounds for 
termination of the tax treaty.
---------------------------------------------------------------------------
    The Department believes that all eight pacts will greatly enhance 
the tax enforcement capabilities of the United States government.
    The Office of Management and Budget has advised that there is no 
objection to the submission of this report from the standpoint of the 
Administration's program.

      Sincerely,

                                       Andrew Fois,
                                Assistant Attorney General.

    Senator Hagel. Mr. Secretary, thank you.
    Senator Sarbanes, would you like to begin? Whatever you 
want to do.
    Senator Sarbanes. Mr. Guttentag, have you had a chance to 
review the work of the joint committee on taxation with respect 
to these various tax treaties?
    Mr. Guttentag. Yes, I have.
    Senator Sarbanes. Have you prepared a memo or anything that 
responds to some of the questions they raise? Has that been 
done?
    Mr. Guttentag. Well, the questions that were raised, I 
believe we addressed those in our full statement, Mr. Sarbanes. 
Some of those were addressed in my oral statement. Is there 
something specifically that I could address?
    Senator Sarbanes. Well, I have not had a chance to go 
through your full statement. So I am not in a position to make 
the judgment of whether it responds to the points raised by the 
staff of the joint committee on taxation. They do a very 
thorough and comprehensive review. I have a high opinion of 
their work.
    If it has not been answered, I think, Mr. Chairman, we 
ought to get that for the use of the committee.
    Mr. Guttentag. I would be glad to submit answers to the 
specific issues raised in each one of those cases.
    Senator Sarbanes. Well, let me take a few of them up with 
you.
    Mr. Guttentag. Certainly.
    Senator Sarbanes. Let me turn to the Austrian treaty first, 
and the stock gains. Apparently, we have made a one-sided 
concession, in which we allow Austria to impose a tax on stock 
gains through the year 2010 while the U.S. cannot impose a 
reciprocal tax. This may mean double taxation of capital gains 
for some U.S. investors. In fact, the Joint Tax Committee says:

    The committee may wish to consider whether the provision of 
the proposed treaty that permits Austria to tax capital gains 
from an alienation of the shares of certain Austrian companies 
through the year 2010 is appropriate as a matter of U.S. treaty 
policy. In this regard, the committee may wish to consider 
whether the inclusion of this provision in the proposed treaty 
will serve as a precedent for future treaties to permit similar 
one-side concessions, contrary to longstanding U.S. treaty 
policy.

    Now, what is your explanation for this?
    Mr. Guttentag. We do, in our treaty policy, we like to 
eliminate any capital gains of shares of stock or, generally, 
most movable property. We do not include real estate, which of 
course is subject to that kind of tax.
    Senator Sarbanes. Actually, our model treaty and the OECD 
model both reflect this policy, do they not?
    Mr. Guttentag. That is right. That is correct. In the 
Austrian treaty, which is presently in effect, permits Austria 
to tax capital gains. So our position when we negotiated with 
Austria was to provide for no taxation of capital gains. They 
pointed out to us that because under the current treaty they 
permitted taxpayers to establish corporations in Austria free 
of Austrian tax on the basis that when the stock in those 
corporations was later sold, they would be able to tax it.
    So their position was that they needed a type of 
grandfathering position which, until the year 2010, would allow 
them to tax those transactions. We believe that those are 
extremely few in number, and it is a very limited exception. We 
were able, thereby, by making this very limited exception, to 
achieve our overall policy. Because, generally, overall, there 
will be no Austrian taxes on capital gains, consistent with our 
model and the OECD model.
    Senator Sarbanes. So it is your position that you were, in 
effect, carrying through an existing provision in the current 
treaty?
    Mr. Guttentag. No; in the current treaty, there is no limit 
on Austrian capital gains. So we were able to put a provision 
in the new treaty which was consistent with our model--that 
there would not be any tax, with this limited exception.
    Senator Sarbanes. I see. Now, on the royalties, you went in 
the other direction. You expanded the exception, did you not, 
on royalties?
    Mr. Guttentag. Yes.
    Senator Sarbanes. Did you expand it?
    Mr. Guttentag. Yes. With respect to royalties, we do not 
consider we expanded that so much as we took into account new 
developments. The definition of movie and broadcast royalties 
that was put into the treaty 40 years ago or so did not take in 
account new technological developments, where we felt that it 
was appropriate--one, we do not believe it is appropriate--it 
is not our policy to provide for any tax in this area; but if 
there were to be a tax, we felt it was appropriate to include 
quite similar technologies to the radio and television 
broadcasting.
    Senator Sarbanes. Why would we do that if our objective is 
to eliminate source country tax on royalties? Why would you 
update it for the technology? We do not want to do that, do we?
    Mr. Guttentag. That was our bargaining. This was a bargain 
that we were able to reach with the Austrians. Taxation of 
royalties today means a lot more, I can tell you, Mr. Sarbanes, 
to American companies than it did at the time we negotiated 
this treaty. We do everything possible to make sure that those 
royalties flow into the U.S. free of any withholding tax. In 
order to do that, we have to make concessions. Because, in many 
cases, the flow of royalties into the United States from 
foreign countries is much greater than the flow in the other 
direction.
    And you will have the opportunity to hear Mr. Mattson, from 
IBM, in the next panel. I think he will support this position, 
not only of the importance, but of the efforts made by Treasury 
to maintain that position.
    Senator Sarbanes. Well, it does not matter to the company; 
they do not pay a larger tax bill, do they?
    Mr. Guttentag. Very often they do, Mr. Sarbanes, because it 
depends whether they are able to offset those foreign taxes 
against their U.S. taxes. That depends on the particular 
position of the company. That is one reason why we try to 
eliminate the tax at source to the fullest extent possible.
    Senator Sarbanes. Well, I am not getting an answer to my 
question.
    Mr. Guttentag. Yes.
    Senator Sarbanes. Is U.S. treaty policy generally to 
eliminate source country tax on royalties?
    Mr. Guttentag. It certainly is. You can look at Austrian 
treaties, Mr. Sarbanes. We did better than with most other 
countries. In many of their treaties, there is a 10 percent 
rate which is applied across the board to any royalties paid to 
a parent company.
    Senator Sarbanes. What is the existing provision in the 
Austrian treaty?
    Mr. Guttentag. The present position is that the tax is a 
nil rate of tax on royalties, with the exception of the movie 
royalties.
    Senator Sarbanes. And those are 10 percent?
    Mr. Guttentag. That is right.
    Senator Sarbanes. Now you have expanded it. So it is not 
only movie royalties, but also radio and television; is that 
correct?
    Mr. Guttentag. That is right.
    Senator Sarbanes. Well, isn't that moving in exactly the 
opposite direction from our general treaty policy?
    Mr. Guttentag. It is moving only in the sense of the 
particular items which are included. One, we are now reflecting 
in this treaty the technology which presently exists, which did 
not exist back then. So if we would have written that provision 
back then, it would have contained this language.
    Senator Sarbanes. What happens to radio and television 
broadcasting now under the current treaty?
    Mr. Guttentag. They are taxed at 10 percent. Those 
royalties are taxed at 10 percent.
    Senator Sarbanes. Under the existing treaty?
    Mr. Guttentag. Under the existing treaty.
    I think if you compare the withholding rates under the 
Austrian treaties with other countries and with the U.S., you 
will find that the U.S. rates are generally more favorable, 
including the royalty provisions. We did a good job in 
negotiating that treaty. It is fair. It is fair to Austria, but 
it is also fair to the U.S.
    Senator Sarbanes. Well, I am just trying to find out what 
you did at the moment, then we will evaluate it.
    Mr. Guttentag. OK.
    Senator Sarbanes. The Joint Tax Committee says the 
following:

    The proposed treaty expands the class of royalty payments 
that are subject to the 10 percent source country taxation. 
Under the present treaty, only motion picture film rentals are 
subject to source country taxation. Under the proposed treaty, 
source country taxation also applies to payments for the use of 
or the right to use tapes or other means of reproduction used 
for radio or television broadcasting. Consequently, a 
significantly expanded class of Austrian source royalties, 
beneficially owned by U.S. residents, will be subject to a 10 
percent Austrian withholding tax under the proposed treaty.

    Is that correct?
    Mr. Guttentag. Yes, their statement is correct.
    Senator Sarbanes. Well, I thought you just told me that 
under the current treaty there was a 10 percent tax on radio 
and television broadcasting.
    Mr. Guttentag. I am sorry; that was only on movie 
royalties. I do not believe we had television royalties to any 
extent back in 1956.
    Senator Sarbanes. Well, I was very careful in asking that 
question.
    Mr. Guttentag. Yes, I am sorry, Mr. Sarbanes.
    Senator Sarbanes. Mr. Chairman, I have some more questions. 
Maybe I had better yield to you, and then I will pick up on 
these other questions later.
    Senator Hagel. All right. I will ask a couple of questions, 
then we will go back.
    Mr. Secretary, can you give me a general range of the 
Treasury's estimation of the effect of these treaties on 
revenue flow to or from the Treasury?
    Mr. Guttentag. Mr. Chairman, the Treasury does not provide 
or make any revenue estimates on our tax treaties, as opposed 
to tax legislation. We take into account, in general, the 
amount of economic activity. This is an impossible task to do, 
according to our experts in this area. General revenue 
estimating concepts do not work well if you just try to apply 
the rules that we would use in estimating revenue effects of 
legislation internationally.
    In many cases, there are secondary effects which are 
extremely important--removing barriers--we cannot tell--for 
example--Mr. Sarbanes asked whether, when we lower taxes, who 
gets the benefit of that. Is it the company or is it the U.S. 
Treasury? If we did not lower the tax, would they be able to 
use it as a credit against their U.S. tax or would it just 
lower their overall burden?
    Well, we take the position that these treaties go beyond 
just the tax revenue involved. As you suggested in your opening 
statement, the impact on companies, encouraging these kinds of 
desirable economic activity, is the real purpose of these 
treaties. To avoid double tax is the real purpose of these 
treaties. The revenue flows, we do not believe, are that 
critical to making these decisions as to whether a treaty is 
appropriate, even if we could do so.
    Senator Hagel. Thank you.
    Is the Treasury satisfied that all the treaties now under 
consideration that we are talking about today are sound 
structurally and without flaws?
    Mr. Guttentag. Yes, we are, Mr. Chairman.
    Senator Hagel. How does that work? How do you determine 
that? Do you model that? Or how do you come to that conclusion?
    Mr. Guttentag. Well, we go into the treaty negotiation with 
our draft. We enter into a negotiation--I think it is quite 
similar, Mr. Chairman, to the kinds of negotiations that you 
have participated in, in the business world. If we make a 
concession, we ask for an offsetting concession, which may be 
in a completely different part of the agreement. We also take 
into account special rules which apply in the U.S. or in the 
foreign country. Then we look, before we initial any 
convention, to determine whether we believe we have reached an 
appropriate balance. We are satisfied, with each one of these 
conventions, that we have done so.
    Senator Hagel. Thank you.
    I noted a recent GAO report had suggested that many foreign 
corporations do not pay their fair share of taxes. You are 
probably familiar with that report. Are you satisfied that what 
we are doing here today deals with that issue?
    Mr. Guttentag. Yes. One of the most important ways that our 
treaties deal with that issue is providing for information 
exchange. So that we can have direct contact between the tax 
authorities of both countries. When a foreign corporation, 
therefore, is engaged in business in the United States, we have 
access to data as necessary in order to assure ourselves that 
tax returns are accurate. Other provisions of the treaty are 
enforced to make sure no unintended benefits go to foreign-
based companies or to U.S.-based companies.
    So these treaties are most helpful in assuring, one, that 
there are fair shares of taxes are paid to the U.S., but, at 
the same time, avoiding any double tax.
    Senator Hagel. What, in your opinion, are the major 
distinctions between the limitations on benefits provisions of 
these treaties? Are there differences?
    Mr. Guttentag. Yes, there are differences. I do not think 
any two are identical, nor are they identical to our model 
treaty. Each country has its own internal laws dealing with 
problems which we have to deal with in our limitations of 
benefits articles. In some countries, these laws may seem to 
encourage foreigners to use that country for treaty shopping 
purposes. In other cases, the rules are closer to those of the 
United States, which does not provide such encouragement.
    Other countries have already adopted rules, long before we 
did, to deal with this issue. Switzerland is one example that 
you have before you today which, back in 1962, adopted 
provisions to deal with treaty shopping, and which are 
reflected in the treaty with Switzerland, where we provided a 
meld of our limitations of benefits provisions and the Swiss 
provisions.
    Other countries, we take into account their membership in 
economic units, membership in the European Union, membership in 
NAFTA, to make sure that we do not discourage or interfere with 
those economic relationships.
    Senator Hagel. Thank you.
    Senator Sarbanes.
    Senator Sarbanes. Well, let me pursue the answer you just 
gave on exchange of information and its importance in these tax 
treaties as I understand it. In the light of that answer, I 
want to ask about the treaty with Ireland. As I understand it, 
the Irish protocol states that for the purposes of obtaining 
information under the proposed treaties, the laws and practices 
of Ireland do not permit its tax authorities to carry out 
inquiries on behalf of another country where there is no Irish 
liability for such tax.
    Now, what that means is, in practice, the U.S. will not be 
able to obtain information upon request from Ireland, but that 
Ireland will be able to obtain information upon request from 
the U.S. How could we have committed ourselves to language that 
requires us to provide more information than Ireland must 
provide, and prohibits us from withholding information because 
they do? And I contrast this with the proposed treaty we have 
with the Thailand.
    The joint committee says here in their report:

    The language of this provision in the proposed treaty does 
not permit the U.S. to decline to obtain information that is 
requested by Ireland solely because the United States is not 
able to obtain information on a reciprocal basis from Ireland. 
One issue is whether the committee views the exchange of 
information provisions of the proposed treaty as sufficient to 
carry out the tax-avoidance purposes for which income tax 
treaties are entered into by the United States.
    Some might consider the nonreciprocal nature of the 
provision on obtaining information to be unusual. The committee 
may wish to consider whether such a nonreciprocal provision is 
appropriate in the context of the proposed treaty. Some might 
also observe that other countries that have similar local law 
impediments to obtaining information, such as Thailand, have 
received less advantageous treatment with respect to U.S. 
treaties than Ireland has as a consequence of these 
impediments.

    What is your response to that?
    Mr. Guttentag. Well, yes, Ireland does have a prohibition 
against providing information in a case in which they do not 
have a particular Irish tax interest in getting that 
information. That is true under the current treaty with 
Ireland.
    What we do when we go into a treaty with a country such as 
Ireland with which we already have a treaty is we see how much 
we can improve it. We negotiated long and hard on their tax 
interest issue. What we have agreed to is that we are able to 
get information, even if Ireland does not have a tax interest, 
with respect to certain criminal cases; not civil cases, 
however. That would be under another provision, as explained in 
the diplomatic notes which are attached to the Irish treaty.
    So we were able to make a step forward there that, while we 
cannot get information on a civil case, we can get information 
in criminal cases under the Irish Criminal Justice Act.
    Now, on the issue of whether we should provide information, 
there is a rule of comity which is applied internationally in 
any treaty. That is, it should be applied equally. I believe 
that, while this matter of information exchange is handled by 
the Internal Revenue Service, not the Treasury, if it appeared 
that there was a flow of information to Ireland on a regular 
basis and difficulties in obtaining information from Ireland 
because of this limitation, I think that we would then have to 
reconsider whether we would be willing to provide information 
in this nonreciprocal form.
    But we prefer not to put this in a treaty to see what 
happens in practice.
    Senator Sarbanes. What did you do in the Thailand treaty? 
There, in effect, you allow us not to provide information if 
they do not provide information.
    Mr. Guttentag. That is right. We made that reciprocal. But, 
again, in Thailand, we have a couple of different situations. 
One, Thailand is a new treaty country. We take the position 
that when we are entering into a treaty with a new country, and 
particularly if we think there are going to be difficulties and 
problems with tax information exchange, we are liable to take a 
much more stringent negotiating position. That we did in 
Thailand.
    While we made this reciprocal, we also put in Thailand a 
provision that if Thailand is not able to eliminate their 
requirement of a tax interest in order to provide information 
within a period of 5 years, the treaty will terminate. No 
action is required by the United States. No action is required 
by the Senate.
    So we have sent a clear message to Thailand that they must 
eliminate this restriction in their law which prohibits their 
giving us the information. They have indicated to us, the tax 
authorities with whom we dealt, that they are interested in 
eliminating this restriction. They were not able to do it 
because of provisions of Thai law. We believe that putting it 
in the treaty in this way, that the benefits of the treaty will 
cause them to seriously consider enacting the legislation and 
keeping the treaty in force.
    So we do approach these, Mr. Sarbanes, differently when we 
have an existing treaty relationship with a longstanding treaty 
partner and a new country.
    Senator Sarbanes. Well, now, the joint committee says that 
the nonreciprocal nature of the provision on obtaining 
information is unusual. Is that correct?
    Mr. Guttentag. It may be unusual to have a provision in the 
treaty under the tax interest provision like that. That may be 
unusual.
    Senator Sarbanes. How many tax treaties do we have?
    Mr. Guttentag. Well, we have that in the U.K. treaty; it 
also has a tax interest requirement.
    Senator Sarbanes. How many tax treaties do we have 
altogether?
    Mr. Guttentag. We have 48.
    Senator Sarbanes. Forty-eight. In how many of them would we 
find this provision, the nonreciprocal nature of the exchange 
of information? The reason I am picking up on this issue is 
that you devoted one of your answers to the chairman at some 
length on the importance of the exchange of information for 
achieving the purpose of these tax treaties. Then we find that 
one of the treaties that is here before us today, we really do 
not seem to have met that standard.
    Out of the 48 treaties, how many of them would have such a 
provision, that is nonreciprocal in nature?
    Mr. Guttentag. At least I know that Japan, the U.K. and 
Ireland. Mr. Sarbanes, remember, while it is nonreciprocal, the 
question is: Are we satisfied that we are doing the best we can 
to get the required information that we are going to need, 
taking into account the choice of having a treaty or not having 
a treaty?
    And we are satisfied that under the Irish treaty, having 
negotiated long and hard with Ireland, knowing that we will be 
able to get information dealing with the more important 
criminal cases, regardless of the limitation, that we are 
satisfied that we are doing the best we can. We are better off 
getting that information under the current tax treaty than not 
having a treaty at all.
    Senator Sarbanes. Wouldn't you say that the reciprocal 
exchange of information is probably one of the most important 
objectives that we seek in any tax treaty?
    Mr. Guttentag. I certainly believe so. Because we are 
looking at this in two parts, as we said, Mr. Sarbanes. One is 
to prevent double taxation; and the other is to prevent fiscal 
evasion. We believe that this blending of these two purposes of 
the treaty are both critical and, obviously, the exchange of 
information is most important. The U.S. has been in the lead in 
the world in encouraging further exchange of information and 
breaking down barriers to exchange of information. We believe 
we have been very successful and that we are going to push 
further.
    We have been working with the OECD, under its information 
exchange article. The OECD article contains a commentary which 
says that tax interest is not a valid reason not to give 
information. As I said, we were able to persuade, we were able 
to persuade the Irish Legislature to give us information 
concerning criminal cases. So we have made a major improvement 
over the existing treaty.
    Senator Sarbanes. Now, as I understand it, the proposed 
treaties with Luxembourg, Switzerland and Ireland waive the 
U.S. excise tax on insurance premiums paid to foreign insurers. 
Such waivers of the excise tax on reinsurance premiums may 
place U.S. insurers at a competitive disadvantage with respect 
to foreign competitors in U.S. markets if a substantial tax is 
not otherwise imposed on the insurance income of the foreign 
reinsurer.
    Now, we heard about that from the insurance people 
previously when we considered some tax treaties. In fact, in 
this committee's report on the U.S.-Bermuda tax treaty, the 
committee expressed its view that the waiver of the insurance 
excise tax could have the undesirable effect of eliminating all 
tax on insurance income and should not have been included in 
the treaty. Congress subsequently enacted legislation to ensure 
the sunset of that waiver, and has undertaken repeated efforts 
to redress the competitive imbalance created by similar waivers 
in the Barbados and the U.K. treaties.
    Now, in light of this fairly strong congressional reaction, 
why was this provision, then, included in the Luxembourg, 
Switzerland and Ireland treaties?
    Mr. Guttentag. Well, we listened very carefully, Mr. 
Sarbanes. In negotiating these treaties, we took the positions, 
as you have just expressed, very much to heart. We examined the 
tax laws of Ireland, Luxembourg and Switzerland most carefully 
to assure ourselves that any waiver we gave of the Federal 
excise tax was accompanied by a reasonable tax imposed by the 
country of residence of the insurance company to prevent any 
inappropriate competitive advantage by the foreign insurance 
company.
    We determined that, in Switzerland, there was such a tax 
imposed on insurance companies. In Luxembourg, we believe that 
there was with respect to insurance, but not reinsurance. So, 
therefore, reinsurance is carved out of the Luxembourg treaty. 
With respect to Ireland, we believe that the insurance taxes 
were appropriate; however, for companies operating in the 
international financial service centers in Ireland, which 
obtain certain tax benefits, we determined that those companies 
should not be entitled to the benefits of our excise tax 
exemption and they were not given that exemption.
    Senator Sarbanes. Now, if those countries should repeal 
those taxes, what would happen?
    Mr. Guttentag. We would then go in to take away their 
benefits of their exemption from the Federal excise tax.
    Senator Sarbanes. That is provided for in the treaties?
    Mr. Guttentag. Any change in the tax laws requires a 
renegotiation of the treaty itself.
    Senator Sarbanes. If they change their own tax policy with 
respect to their own insurance companies?
    Mr. Guttentag. Right. If we did that, we would then 
immediately take steps to eliminate--if we believe that 
resulted in a competitive disadvantage for the U.S. industry, 
we would immediately take steps to renegotiate the treaty and 
remove that exemption. The countries involved, I can tell you, 
each one of the countries involved was subjected to such a 
searching examination, they are fully aware of our policy in 
this regard.
    Senator Sarbanes. In 1974, Turkey invaded Cyprus, and since 
then has occupied the north of Cyprus in the contrary to 
repeated U.N. resolutions which the United States has 
consistently supported, calling for the withdrawal of their 
forces and so forth. I take it that this tax treaty with Turkey 
would not provide any tax benefits for any U.S. or Turkish 
permanent establishment in the north of Cyprus, that area now 
occupied by Turkish forces; is that correct?
    Mr. Guttentag. You are correct, Mr. Sarbanes. This treaty 
only applies to Turkey as it is recognized by the United 
States, which does not include northern Cyprus.
    Senator Sarbanes. And I take it that Turkish Cypriots would 
not be eligible for benefits under this treaty, as distinct 
from Turkish citizens?
    Mr. Guttentag. That is correct.
    We do have a tax treaty with Cyprus. Any benefits for 
residents of Cyprus would be controlled by that treaty.
    Senator Sarbanes. Both the Turkish and Swiss treaties give 
preferential treatment to profits from the operation of ships 
and aircraft over profits from the rental of ships and 
aircraft. In addition, the Swiss treaty fails to limit to the 
country of residence the right to tax income from the use, 
maintenance or rental of containers used in international 
traffic. This is the container issue, with which I am sure you 
are familiar.
    Mr. Guttentag. Right.
    Senator Sarbanes. The 1990 committee report on the 
Indonesia tax treaty included the following comment:

    In 1983, the committee rejected the notion that a 
justifiable distinction could be made between container leasing 
income and income derived from other international 
transportation activities. The committee also questioned at 
that time the appropriateness of placing taxpayers primarily 
engaged in container leasing activities at a competitive 
disadvantage vis-a-vis companies engaged in international 
shipping and air transport activities. The committee also 
instructed the Treasury Department to include only the U.S. 
model provision on this matter in all future treaties.

    Well, I gather that has not been done and that the failure 
to cover container leasing once again puts this industry at a 
competitive disadvantage in these particular treaties; is that 
correct?
    Mr. Guttentag. We have come, I think, very close to 
providing exactly what the Senate has asked us to do in 
connection with the container leasing. The container leasing 
exemptions are provided in the treaties with Turkey, 
Luxembourg, Austria, South Africa, and Ireland. You mentioned 
Turkey, there is an exemption for containers in the Turkish 
treaty.
    In the treaty with Switzerland, income from containers are 
treated as business profits. What is the significance of that?
    That means that Switzerland cannot tax any of the income 
resulting from the use of containers unless the owner of those 
containers operates in Switzerland through a permanent 
establishment.
    Mr. Sarbanes, we have kept in close connection and close 
contact with the container industry with respect to all of 
those treaties since the Senate indicated its interest in this 
area. We believe that while we have not in every treaty here 
complied exactly with the model and been able to achieve our 
model result, that we have arrived at results which the 
container industry understands and which they find to be in a 
better position than if we had no treaty, and which they find 
to be satisfactory.
    Many of these countries have policies, Mr. Sarbanes, which 
are just as tough and as immovable as ours. If we were to try 
to have a treaty in which all of our model provisions and 
desires would be achieved, we would have far fewer than the 48 
treaties that we have now. I am sure that you understand that 
and did not mean to imply otherwise.
    Senator Sarbanes. Well, Mr. Chairman, I know we have to 
vote. I would like to make this suggestion. I would like to 
repeat what I said at the outset--that Mr. Guttentag take the 
questions raised by the joint committee on taxation and provide 
to the committee a response to the issues that they posed.
    Let me give you just an example of that, because I was told 
that their response is in the statement. But I am looking at 
your statement, and unless there is an appendix, which I have 
not seen, there is only a minor reference to Ireland on the 
question of exchange of information, about which we just had an 
extended discussion. Let me read it to you, because it is very 
brief:

    Also included in the proposed treaty are rules for the 
exchange of information by the tax authorities of Ireland and 
the United States. The treaty provides for extensive exchange 
of information necessary to enforce tax laws, and confirms that 
Ireland will obtain and provide any information relevant to the 
investigation or prosecution of a criminal tax matter.

    Now, that is correct as far as it goes, but I do not think 
it goes very far in terms of addressing the issues that were 
raised by the Joint Tax Committee and the ones which we have 
just have discussed in some detail here. So I think there would 
be a benefit to receiving fuller responses. I understand you 
feel you have done a good job of negotiating these treaties, 
and I am not in a position now to say that is not the case.
    I am just raising some questions. But it seems to me that 
the legitimate concerns that have been raised by the staff of 
the Joint Tax Committee need to be responded to by the Treasury 
for the benefit of this committee. I think we should ask for 
that.
    Mr. Guttentag. Well, I have tried to do the best I can 
during this relatively short time with these complicated 
issues.
    Senator Sarbanes. I understand.
    Mr. Guttentag. But we will be glad to give you that in 
writing, Mr. Sarbanes.
    Senator Sarbanes. Good, that would be very helpful.
    Senator Hagel. Secretary Guttentag, thank you.
    I, too, have some additional questions that I would like to 
submit in writing for the record.
    Mr. Guttentag. Thank you.
    Senator Hagel. And we appreciate very much your time.
    The subcommittee will stand in recess for about 15 minutes 
in order for Senator Sarbanes and I to vote. Then we would like 
very much, if Mr. Kies is still available, to have him come up. 
Thank you.
    [Recess.]
    Senator Hagel. Mr. Kies, thank you for waiting. I do not 
know if you got a cup of coffee. In the old days, you said you 
would get a smoke, but we do not see that any more.
    Mr. Kies, please proceed, and thank you very much for 
coming today.

 STATEMENT OF KENNETH J. KIES, CHIEF OF STAFF, JOINT COMMITTEE 
                          ON TAXATION

    Mr. Kies. Thank you, Senator Hagel and Senator Sarbanes. 
Thank you for inviting the staff of the joint committee to be 
able to present testimony here today. I will be referring to my 
oral testimony. The committee also has written testimony that I 
would ask that you include in the record, as well.
    I am accompanied by Barbara Angus, Tom Barthold, Barry 
Wold, and Oren Penn, who all worked on the pamphlets and also 
the testimony for the joint committee.
    It is my pleasure to present our testimony at this hearing 
concerning the proposed income tax treaties with Austria, 
Ireland, Luxembourg, South Africa, Switzerland, Thailand, 
Turkey, and the proposed protocol amending the existing income 
tax treaty with Canada. As in the past, the staff of the joint 
committee 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. The pamphlets also contain detailed discussion of 
issues raised by the proposed agreements. We consulted 
extensively with your committee staff in analyzing the 
agreements and preparing the pamphlets.
    Five of the eight agreements at issue today would modify 
existing U.S. treaty relationships. Three of the agreements are 
with countries with which we have no treaty currently. Let me 
highlight some of the key features of the agreements.
    In connection with consideration of these agreements, an 
issue was raised regarding the U.S. treaty policy with respect 
to the treatment of dividends from U.S. real estate investment 
trusts, referred to commonly as REIT's. U.S. tax treaties 
generally limit the maximum rate of withholding tax that may be 
imposed by the source country on portfolio dividends paid by a 
corporation resident in one country to residents of the other 
country.
    Most commonly, the maximum rate of withholding tax on 
dividends is 15 percent. Treaties negotiated by the U.S. after 
1988 contain specific rules excluding REIT dividends from the 
reduced rates of withholding tax generally applicable to 
dividends. Accordingly, under such treaties, REIT dividends may 
be subject to U.S. withholding tax at the full statutory rate 
of 30 percent. The U.S. REIT industry expressed concern that 
the exclusion of REIT dividends from the reduced withholding 
tax rates applicable to other dividends may inappropriately 
discourage foreign investment in U.S. REIT's.
    The Treasury Department has worked extensively with the 
Joint Tax Committee and Foreign Relations Committee staffs, and 
representatives of the REIT industry to address this concern. 
As a result of significant cooperation among all parties, the 
U.S. treaty policy with respect to the treatment of REIT 
dividends has been modified. Under this new 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 two new cases.
    First, the reduced withholding tax rate will apply to REIT 
dividends if the treaty country resident beneficially holds an 
interest of 5 percent or less in each class of the REIT stock, 
and such dividends are paid with respect to a class of the REIT 
stock that is publicly traded. Second, the reduced withholding 
tax rate will apply to REIT dividends if the treaty country 
resident beneficially holds an interest of 10 percent or less 
in the REIT, and the REIT is diversified, regardless of whether 
the REIT stock is publicly traded.
    This new policy with respect to the treatment of REIT 
dividends will be incorporated into the U.S. model treaty, and 
the Treasury Department will use its best efforts to negotiate 
protocols to amend the proposed treaties with Austria, Ireland 
and Switzerland to incorporate this policy.
    In the case of Luxembourg, it is recommended that this 
policy be implemented by means of a reservation to the proposed 
treaty.
    The proposed protocol with Canada would modify the income 
tax treaty that was signed in 1980. The proposed protocol would 
replace the provision in the existing treaty that provides for 
exclusive source country taxation of social security benefits 
with a provision that provides for exclusive residence country 
taxation of social security benefits. This represents a return 
to the approach that applied prior to the 1995 protocol. The 
proposed protocol also would modify the provision in the 
existing treaty allowing situs country taxation of gains from 
real property.
    The proposed treaty with Austria is a comprehensive update 
of the 1956 treaty. The provisions of the proposed treaty 
generally comport with modern U.S. treaty policy. The proposed 
treaty includes a comprehensive anti-treaty-shopping provision, 
which resembles the provision in the U.S. model treaty and 
other recent treaties.
    The proposed treaty also includes an anti-abuse rule 
covering certain triangular cases which involve payments from 
the United States to the branch of an Austrian company located 
in a third country. Under this rule, the U.S. generally may 
tax, in accordance with its internal law, interest and 
royalties paid to a low-taxed, third country branch of an 
Austrian company.
    The proposed treaty expands the class of royalty payments 
that is subject to a 10-percent source country tax to include 
payments for the use of films, tapes or other means of 
reproduction used for radio or television broadcasting.
    The exchange of information provisions of the proposed 
treaty are substantially more useful than those of the current 
treaty. The information generally may be exchanged to carry out 
the purposes of the treaty or to carry out the domestic law of 
the countries concerning taxes covered by the information 
exchange article of the treaty. There are provisions in 
Austrian law that prohibit Austria from obtaining information 
from Austrian banks in non-penal investigations. However, bank 
information may be obtained for penal investigations. 
Accordingly, under the proposed treaty, bank information may be 
provided by Austria in connection with U.S. penal 
investigations, including the commencement of a criminal 
investigation by the IRS.
    The proposed treaty with Ireland is a comprehensive update 
of the 1949 treaty. The provisions of the proposed treaty 
generally are consistent with modern U.S. treaty policy.
    The proposed treaty includes a comprehensive anti-treaty 
shopping provision, which includes most of the elements of the 
anti-treaty-shopping provision found in the U.S. model treaty 
and other U.S. treaties. The proposed treaty includes a 
derivative benefits provision under which treaty benefits 
generally would be available to Irish companies that are owned 
by residents of countries that are members of the E.U. Or 
parties to NAFTA. Under this rule, the treaty benefits with 
respect to dividends, interest and royalties would be available 
only if the countries in which such owners are resident have 
treaties with the U.S. providing for benefits that are at least 
as favorable as those provided under the proposed treaty. 
However, this restriction on the availability of treaty 
benefits would take effect no earlier than 2 years after the 
proposed treaty takes effect. The proposed treaty also includes 
an anti-abuse rule, covering the so-called triangular case, 
similar to the provision in the Austrian treaty.
    The proposed treaty provides an exemption for Irish 
insurance companies from the U.S. excise tax on insurance and 
reinsurance premiums paid to foreign insurers with respect to 
U.S. risks, subject to certain limitations, which Mr. Guttentag 
discussed with Senator Sarbanes.
    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, under the proposed treaty, the countries 
are to exchange such information as is necessary for carrying 
out the provisions of the proposed treaty or the domestic 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. Again, Senator 
Sarbanes and Mr. Guttentag discussed that exception, which 
relates to the not completely evenhanded approach which the 
treaty takes in that regard.
    The proposed treaty with Luxembourg is a comprehensive 
update of the 1962 treaty. The provisions of the proposed 
treaty generally comport with modern U.S. treaty policy.
    The proposed treaty includes a comprehensive anti-treaty-
shopping provision which resembles the provisions in the U.S. 
model treaty. The proposed treaty includes a derivative 
benefits provision and an anti-abuse rule, covering the so-
called triangular case, similar to those in the Irish treaty.
    The proposed treaty provides an exemption for Luxembourg 
insurance companies from the U.S. excise tax on insurance 
premiums paid to foreign insurers with respect to U.S. risks, 
subject to certain limitations. However, unlike other U.S. tax 
treaties, the proposed treaty does not provide an exemption 
from the excise tax on reinsurance premiums paid to Luxembourg 
reinsurers. I believe Mr. Guttentag indicated the reason for 
that was that reinsurers are not taxed in a manner consistent 
with the way in which other insurers are taxed in Luxembourg.
    The exchange of information provisions of the proposed 
treaty are more useful than those of the current treaty. 
Information generally may be exchanged to carry out the 
purposes of the treaty or to carry out the domestic laws of the 
countries concerning taxes covered by the information exchange 
article of the treaty. There are provisions in Luxembourg law 
that generally prohibit Luxembourg from obtaining information 
from Luxembourg financial institutions either for their own 
purposes or for purposes of the proposed treaty. However, such 
bank information may be obtained under certain circumstances 
involving criminal tax matters, pursuant to the proposed mutual 
legal assistance treaty with Luxembourg.
    The proposed treaty with South Africa generally is 
consistent with other recent treaties that the U.S. has signed 
with developed countries. It is a straightforward reflection of 
current U.S. treaty policy, with only a few deviations. For 
example, the proposed treaty allows broader source-country 
taxation of business activities of residents of the other 
country by expanding 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.
    In addition, like many other U.S. treaties, the proposed 
treaty includes an anti-treaty-shopping provision, with an 
anti-abuse rule covering the so-called triangular case, as in 
the Irish and Luxembourg treaties.
    The proposed treaty with Switzerland is a comprehensive 
update of the 1951 treaty. The provisions of the proposed 
treaty generally are consistent with modern U.S. treaty policy.
    The proposed treaty includes a comprehensive anti-treaty-
shopping provision, with a derivative benefits provision and an 
anti-abuse rule dealing with the triangular case.
    The proposed treaty provides an exemption for Swiss 
insurance companies from the U.S. excise tax on insurance and 
reinsurance premiums paid to foreign insurers with respect to 
U.S. risks. The exchange of information provisions of the 
proposed treaty are somewhat more useful than those of the 
current treaty, but are nonetheless more restrictive than the 
comparable provisions in tax treaties with other countries. 
Information generally may be exchanged to carry out the 
purposes of the treaty, but it may not be exchanged to carry 
out the domestic laws of the countries concerning taxes covered 
by the information exchange article of the treaty. Information 
may also be exchanged to prevent tax fraud.
    The proposed treaty with Thailand would represent a new 
treaty relationship for the U.S. Under the proposed treaty, 
Thailand would agree to reduce its taxes on income that U.S. 
residents earn from sources in Thailand, The U.S. would agree 
to reciprocal reductions of its tax on U.S. income of Thai 
residents.
    The proposed treaty follows preferred U.S. treaty positions 
in many respects. However, it differs from preferred U.S. 
treaty positions in other respects, primarily by not reducing 
source country taxation to the same extent as many U.S. tax 
treaties. In this regard, the proposed treaty is similar to 
other treaties that the United States has entered into with 
developing countries.
    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, under the proposed treaty, the countries 
are to exchange such information as is necessary for carrying 
out the provisions of the proposed treaty or the domestic tax 
laws of the countries. However, the proposed treaty would 
suspend the application of this provision until the U.S. 
receives from Thailand a diplomatic note indicating that 
Thailand is prepared and able to implement this provision, 
which will require that Thailand enact enabling legislation. 
This means that neither country will obtain information for the 
other until this diplomatic note is provided. Mr. Guttentag 
indicated that it is anticipated Thailand will take that action 
in the next couple of years.
    Finally, the proposed treaty with Turkey would represent a 
new tax treaty relationship for the U.S. Turkey is the only 
OECD member country with which the U.S. has no tax treaty in 
force. Under the proposed treaty, Turkey would agree to reduce 
its tax on the income that U.S. residents earn from sources in 
Turkey, and the U.S. would agree to reciprocal reductions of 
its tax on U.S. income of Turkish residents.
    The U.S. and Turkey also would agree that their tax 
administrators will exchange tax information where necessary to 
carry out tax laws, and will cooperate together to resolve 
problems in the coordination of the tax rules of the two 
countries that may arise in individual cases.
    The proposed treaty follows preferred U.S. treaty positions 
in many respects. However, it differs from preferred U.S. 
treaty positions in other respects, primarily by not reducing 
source country taxation to the same extent as many U.S. tax 
treaties. In this regard, the proposed treaty is similar to the 
other treaties that the U.S. has entered into with developing 
countries.
    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 that the 
committee may have.
    [The prepared statement of Mr. Kies follows:]
                     Prepared Statement of Mr. Kies
    My name is Ken Kies. I am Chief of Staff of the Joint Committee on 
Taxation. It is my pleasure to present the testimony of the staff of 
the Joint Committee on Taxation (``Joint Committee staff'') at this 
hearing concerning the proposed income tax treaties with Austria, 
Ireland, Luxembourg, South Africa, Switzerland, Thailand, and Turkey 
and the proposed protocol amending the existing income tax treaty with 
Canada.
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 your Committee staff in analyzing the 
proposed treaties and protocols and preparing-the pamphlets.
    Five of the eight agreements at issue today would modify existing 
U.S. treaty relationships. The proposed protocol with Canada would make 
two modifications to the current treaty which was amended most recently 
in 1995. The proposed treaty with Austria would replace an existing 
treaty that has not been modified since 1956. The proposed treaty with 
Ireland would replace an existing treaty that has not been modified 
since 1949. The proposed treaty with Luxembourg would replace an 
existing treaty that has not been modified since 1962. The proposed 
treaty with Switzerland would replace an existing treaty that has not 
been modified since 1951. The other three treaties are with countries 
with which the United States does not currently have a treaty 
relationship. The proposed treaties with Thailand and Turkey would 
represent the entrance into tax treaty relationships where the United 
States has not previously had such a treaty. The final proposed treaty 
is with South Africa; the United States previously had a treaty with 
South Africa which was terminated in 1987, and no treaty currently is 
in force.
    I will highlight some of the key features of these treaties and 
protocols and the issues they raise.
Common Issue
    In connection with consideration of these treaties, an issue was 
raised regarding the U.S. treaty policy with respect to the treatment 
of dividends from U.S. Real Estate Investment Trusts (``REITs'').
    U.S. tax treaties generally limit the maximum rate of withholding 
tax that may be imposed by the source country on portfolio dividends 
paid by a corporation resident in one country to residents of the other 
country; most commonly, the maximum rate of withholding tax on 
dividends is 15 percent. Treaties negotiated by the United States after 
1988 contain specific rules excluding REIT dividends from the reduced 
rates of withholding tax generally applicable to dividends. 
Accordingly, under such treaties, REIT dividends may be subject to U.S. 
withholding tax at the full statutory rate of 30 percent. The exclusion 
of REIT dividends from the reduced rates of withholding tax generally 
applicable to dividends reflects the view that REIT dividends should be 
treated in a manner that generally is comparable to the treatment of 
rental income earned on a direct investment in real property.
    The REIT industry has expressed concern that the exclusion of REIT 
dividends from the reduced withholding tax rates applicable to other 
dividends may inappropriately discourage some foreign investment in 
REITS. The Treasury Department has worked extensively with your 
Committee staff, the Joint Committee staff, and representatives of the 
REIT industry in order to address this concern while maintaining a 
treaty policy that properly preserves the U.S. taxing jurisdiction over 
foreign direct investment in U.S. real property. As a result of 
significant cooperation among all parties to balance these competing 
considerations, the U.S. treaty policy with respect to the treatment of 
REIT dividends has been modified.
    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 two cases. 
First, the reduced withholding tax rate will apply to REIT dividends if 
the treaty country resident beneficially holds an interest of 5 percent 
or less in each class of the REIT's stock and such dividends are paid 
with respect to a class of the REIT's stock that is publicly traded. 
Second, the reduced withholding tax rate will apply to REIT dividends 
if the treaty country resident beneficially holds an interest of 10 
percent or less in the REIT and the REIT is diversified, regardless of 
whether the REIT's stock is publicly traded. In addition, the treaty 
policy with respect to the application of the reduced withholding tax 
rate to REIT dividends paid to individuals holding less than a 
specified interest in the REIT will remain unchanged.
    For purposes of these rules, a REIT will be considered diversified 
if the value of no single interest in real property held by the REIT 
exceeds 10 percent of the value of the REIT's total interests in real 
property. Any interest in real property will not include a mortgage, 
unless the mortgage has substantial equity components. An interest in 
real property also will not include foreclosure property. Accordingly, 
a REIT that holds exclusively mortgages will be considered to be 
diversified. The diversification rule will be applied by looking 
through a partnership interest held by a REIT to the underlying 
interests in real property held by the partnership. Finally, the 
reduced withholding tax rate will apply to a REIT dividend if the 
REIT's trustees or directors make a good faith determination that the 
diversification requirement is satisfied as of the date the dividend is 
declared.
    This new policy with respect to the treatment of REIT dividends 
will be incorporated into the U.S. model treaty. In addition, the 
Treasury Department will use its best efforts to negotiate protocols to 
amend the proposed treaties with Austria, Ireland, and Switzerland to 
incorporate this policy.
    In the case of Luxembourg, it is recommended that this policy be 
implemented by means of a reservation to the proposed treaty presently 
under consideration. In addition, it is recommended that this 
reservation include a special rule for existing investment in REITs by 
Luxembourg residents. Under this special rule, in the case of any 
resident of Luxembourg who held an interest in a diversified REIT as of 
June 30, 1997, dividends paid to such resident with respect to that 
interest would be eligible for the reduced rate of withholding tax. 
However, this special rule would not apply to dividends paid after 
December 31, 1999, unless the stock of the REIT is publicly traded on 
December 31, 1999 and thereafter. The special rule would apply to 
existing investment in a REIT as of June 30, 1997 and to reinvestment 
in the REIT of both ordinary and capital dividends paid with respect to 
that investment. In addition, if a REIT in which there is a qualifying 
investment as of June 30, 1997 goes out of existence in a 
nonrecognition transaction, the special rule would continue to apply to 
the investment in the successor REIT if any.
Canada
    The proposed protocol with Canada would modify the income tax 
treaty that was signed in 1980 and amended by protocols in 1983, 1984, 
and 1995.
    The proposed protocol would replace the provision in the existing 
treaty that provides for exclusive source-country taxation of social 
security benefits with a provision that provides for exclusive 
residence-country taxation of social security benefits. Under the 
proposed protocol, U.S. social security benefits paid to Canadian 
residents would be subject to tax only in Canada, and Canadian social 
security benefits paid to U.S. residents would be subject to tax only 
in the United States. This represents a return to the approach that 
applied prior to the 1995 protocol. The amendment made by the proposed 
protocol would take effect for social security benefits paid after 
1995, with a refund mechanism applying to taxes that have been paid 
with respect to post-1995 benefits.
    The proposed protocol also would modify the provision in the 
existing treaty allowing situs-country taxation of gains from real 
property; under this provision, the country in which real property is 
situated may tax gains with respect to corporate stock if a sufficient 
portion of the corporation's assets consists of such real property. The 
protocol would limit this rule so that it applies only to stock of 
domestic corporations and not to stock of foreign corporations. Such a 
limitation is consistent with U.S. internal law regarding the taxation 
of gains from stock of real property holding companies.
Austria
    The proposed treaty with Austria is a comprehensive update of the 
1956 treaty. The provisions of the proposed treaty generally comport 
with modern U.S. treaty policy.
    The proposed treaty includes a comprehensive anti-treaty-shopping 
provision, which resembles the provisions in the U.S. model treaty and 
other recent treaties. The proposed treaty also includes an anti-abuse 
rule covering certain ``triangular cases,'' which involve payments from 
the United States to a branch of an Austrian company located in a, 
third country. Under this rule, the United States generally may tax, in 
accordance with its internal law, interest and royalties paid to a low-
taxed third-country branch of an Austrian company.
    Under the proposed treaty, Austria may tax the disposition of stock 
of an Austrian company that was received upon the incorporation of a 
permanent establishment in Austria, if any inherent capital gains were 
not taxed at the time of the incorporation. This rule, which represents 
a unilateral concession by the United States, applies through the year 
2010.
    The proposed treaty expands the class of royalty payments that is 
subject to a 10-percent source-country tax. Under the existing treaty, 
only payments for the use of motion picture films are subject to 
source-country tax. Under the proposed treaty, source-country tax also 
applies to payments for the use of films, tapes or other means of 
reproduction used for radio or television broadcasting. The preferred 
U.S. treaty position is the elimination of source-country taxation of 
royalty income.
    The OECD Commentary, which reflects agreed interpretations of the 
OECD model treaty, is to apply in interpreting any provision of the 
proposed treaty that corresponds to a provision of the OECD model 
treaty. This rule does not apply where either the United States or 
Austria has entered a reservation, or has included an observation, with 
respect to the OECD model treaty or its Commentary. In addition, this 
rule generally does not apply where a contrary interpretation is 
included in the Memorandum of Understanding with respect to the 
proposed treaty or in a published interpretation of the proposed treaty 
(e.g., the Treasury Department's Technical Explanation).
    The exchange of information provisions of the proposed treaty are 
substantially more useful than those of the current treaty. Information 
generally may be exchanged to carry out the purposes of the proposed 
treaty or to carry out the domestic laws of the countries concerning 
taxes covered by the information exchange article of the proposed 
treaty. There are provisions in Austrian law that prohibit Austria from 
obtaining information from Austrian banks in non-penal investigations; 
however, bank information may be obtained for penal investigations. 
Accordingly, under the proposed treaty, bank information may be 
provided by Austria in connection with U.S. penal investigations, 
including the commencement of a criminal investigation by the Internal 
Revenue Service.
Ireland
    The proposed treaty with Ireland is a comprehensive update of the 
1949 treaty. The provisions of the proposed treaty generally are 
consistent with modern U.S. treaty policy.
    The proposed treaty includes a comprehensive anti-treaty-shopping 
provision, which includes most of the elements of the anti-treaty 
shopping-provisions found in the U.S. model treaty and other recent 
U.S. treaties. The proposed treaty includes a ``derivative benefits'' 
provision under which treaty benefits generally would be available to 
Irish companies that are owned by residents of countries that are 
members of the European Union (``EU'') or parties to the North American 
Free Trade Agreement (``NAFTA''). Under this rule, the treaty benefits 
with respect to dividends, interest, and royalties would be available 
only if the countries in which such owners are resident have treaties 
with the United States providing for benefits that are at least as 
favorable as those provided under the proposed treaty; however, this 
restriction on the availability of treaty benefits would take effect no 
earlier than two years after the proposed treaty takes effect. The 
proposed treaty also includes an anti-abuse rule covering the so-called 
``triangular case.'' This rule generally permits the United States to 
impose a 15-percent tax on dividends, interest, and royalties paid to a 
low-taxed third-country branch of an Irish company and to tax other 
payments to such a branch in accordance with U.S. internal law.
    The proposed treaty provides an exemption for Irish insurance 
companies from the U.S. excise tax on insurance and reinsurance 
premiums paid to foreign insurers with respect to U.S. risks. However, 
this exemption applies only to the extent that the U.S. risk is not 
reinsured by the Irish insurer with a person that is not entitled to 
the benefits of an income tax treaty that similarly provides an 
exemption from such tax. Moreover, the exemption does not apply if the 
premiums paid to the Irish insurance company are not subject to the 
generally applicable tax imposed on insurance corporations in Ireland.
    The proposed treaty includes an arbitration provision similar to 
the provision that was included in the 1989 U.S.-Germany tax treaty. 
However, like the provisions in several other recent treaties and the 
proposed treaty with 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 further once there has been some 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, 
under the proposed treaty the countries are to exchange such 
information as is necessary for carrying out the provisions of the 
proposed treaty or 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 includes the standard provision that upon request a 
country shall obtain information to which the request relates in the 
same manner and to the same extent as if the tax of the requesting 
country were imposed by the requested country. However, this provision 
cannot be fully implemented with respect to requests by the United 
States. Because of restrictions in Irish internal law, the United 
States may obtain limited information from Ireland with respect to 
criminal offenses, but may not obtain information from Ireland with 
respect to civil offenses. Ireland may, however, obtain information 
from the United States generally with respect to both criminal and 
civil offenses.
Luxembourg
    The proposed treaty with Luxembourg is a comprehensive update of 
the 1962 treaty. The provisions of the proposed treaty generally 
comport with modern U.S. treaty policy.
    The proposed treaty includes a comprehensive anti-treaty-shopping 
provision, which resembles the provisions in 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 Luxembourg companies that are owned by residents of 
countries that are members of the EU or parties to NAFTA. The proposed 
treaty also includes an anti-abuse rule covering the so-called 
``triangular case.'' This rule generally permits the United States to 
impose a 15-percent tax on dividends, interest, and royalties paid to a 
low-taxed third-country branch of a Luxembourg company and to tax other 
payments to such a branch in accordance with U.S. internal law.
    The proposed treaty provides an exemption for Luxembourg insurance 
companies for the U.S. excise tax on insurance 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 Luxembourg insurer 
with a person that is not entitled to the benefits of an income tax 
treaty that similarly provides an exemption from such tax. All existing 
U.S. tax treaties that provide exemptions from the U.S. excise tax on 
insurance premiums also provide exemptions from the U.S. excise tax on 
reinsurance premiums paid to foreign insurers. However, the proposed 
treaty does not provide an exemption from the excise tax on reinsurance 
premiums paid to Luxembourg reinsurers.
    The exchange of information provisions of the proposed treaty are 
more useful than those of the current treaty. Information generally may 
be exchanged to carry out the purposes of the proposed treaty or to 
carry out the domestic laws of the countries concerning taxes covered 
by the information exchange article of the proposed treaty. There are 
provisions in Luxembourg law that generally prohibit Luxembourg from 
obtaining information from Luxembourg financial institutions either for 
their own purposes or for purposes of the proposed treaty. However, 
such bank information may be obtained--under certain circumstances 
involving criminal tax matters pursuant to the proposed Mutual Legal 
Assistance Treaty with Luxembourg.
South Africa
    The proposed treaty with South Africa generally is consistent with 
other recent treaties that the United States has signed with developed 
countries. It is a straightforward reflection of current U.S. treaty 
policy, with only a few deviations. For example, the proposed treaty 
allows broader source-country taxation of business activities of 
residents of the other country by expanding 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.
    In addition, like many other U.S. treaties, the proposed treaty 
includes in the anti-treaty shopping provision an anti-abuse rule 
covering the so-called ``triangular case.'' This rule generally permits 
the United States to impose a 15-percent tax on interest and royalties 
paid to a low-taxed third-country branch of a South African company and 
to tax other payments to such branch in accordance with U.S. internal 
law.
Switzerland
    The proposed treaty with Switzerland is a comprehensive update of 
the 1951 treaty. The provisions of the proposed treaty generally are 
consistent with modern U.S. treaty policy.
    The proposed treaty includes a comprehensive anti-treaty-shopping 
provision, which resembles the provisions in 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 Swiss companies that are owned by residents of countries 
that are members of the EU or the European Economic Area or parties to 
NAFTA. The proposed treaty includes an anti abuse rule covering the so-
called ``triangular case.'' This rule generally permits the United 
States to impose a 15-percent tax on dividends, interest, and royalties 
paid to a low-taxed third-country branch of a Swiss company and to tax 
other payments to such a branch in accordance with U.S. internal law.
    The proposed treaty provides an exemption for Swiss insurance 
companies from the U.S. excise tax on insurance and reinsurance 
premiums paid to foreign insurers with respect to U.S. risks. However, 
this exemption applies only to the extent that the U.S. risk is not 
reinsured by the Swiss insurer with a foreign person that is not 
entitled to the benefits of an income tax treaty that similarly 
provides an exemption from such tax.
    The proposed treaty includes an arbitration provision similar to 
the provision that was included in the 1989 U.S.-Germany tax treaty. 
However, like the provisions in several other recent treaties and the 
proposed treaty with Ireland, 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 
future once there has been some experience arbitrating cases under the 
U.S.-Germany treaty.
    The exchange of information provisions of the proposed treaty are 
somewhat more useful than those of the current treaty, but are 
nonetheless more restrictive than the comparable provisions in tax 
treaties with other countries. Information generally may be exchanged 
to carry out the purposes of the proposed treaty, but it may not be 
exchanged to carry out the domestic laws of the countries concerning 
taxes covered by the information exchange article of the proposed 
treaty. Information may also be exchanged to prevent tax fraud. For 
example, in cases of tax fraud, Swiss banking secrecy provisions do not 
hinder the gathering of documentary evidence from banks or its being 
provided to the United States pursuant to the proposed treaty.
Thailand
    The proposed treaty with Thailand would represent a new tax treaty 
relationship for the United States.
    Under the proposed treaty, Thailand would agree to reduce its taxes 
on income that U.S. residents earn from sources in Thailand and the 
United States would agree to reciprocal reductions of its tax on U.S. 
income of Thai residents.
    The proposed treaty follows preferred U.S. treaty positions in many 
respects. However, it differs from preferred U.S. treaty positions in 
other respects, primarily by not reducing source country taxation to 
the same extent as many U.S. tax treaties. In this regard, the proposed 
treaty is similar to other treaties that the United States has entered 
into with developing countries.
    The proposed treaty would allow broader source-country taxation of 
business activities of residents of the other country. 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 90 
days.
    The proposed treaty also would permit higher maximum rates of 
source-country tax on dividends, interest and-royalties, and would 
permit the imposition of source-country tax on certain equipment rental 
income. These maximum rates of source-country tax generally range from 
10 to 15 percent in the case of dividends, 10 to 15 percent in the case 
of interest, and 5 to 15 percent in the case of royalties. The proposed 
treaty would treat equipment rental income as royalties subject to a 
maximum 8 percent source-country tax.
    In addition, the proposed treaty would allow Thailand to tax gains 
derived by U.S. residents from the alienation of property in accordance 
with its internal law. Although the proposed treaty would permit the 
United States to impose tax in the reverse situation, U.S. internal law 
generally does not tax such gains of foreign persons, other than gains 
with respect to a U.S. real property interest.
    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, 
under the proposed treaty the countries are to exchange such 
information as is necessary for carrying out the provisions of the 
proposed treaty or 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 includes the standard provision that upon request a 
country shall obtain information to which the request relates in the 
same manner and to the same extent as if the tax of the requesting 
country were imposed by the requested country. However, the proposed 
treaty also would suspend the application of this provision until the 
United States receives from Thailand a diplomatic note indicating that 
Thailand is prepared and able to implement this provision, which will 
require that Thailand enact enabling legislation. This means that 
neither country will obtain information for the other until this 
diplomatic note is provided.
    The provision by Thailand of this diplomatic note also is an 
important element in the termination article of the proposed treaty. 
There are two ways in which the proposed treaty may terminate. The 
first is a voluntary mechanism under which either country may terminate 
the proposed treaty at any time after five years after it enters into 
force, provided that appropriate notification is given. The second, 
which is much more unusual, is a mandatory termination on January 1 of 
the sixth year following the year the proposed treaty enters into 
force, unless this diplomatic note with respect to Thailand's ability 
to implement the information exchange provision is received by the 
previous June 30th.
Turkey
    The proposed treaty with Turkey would represent a new tax treaty 
relationship for the United States. Turkey is the only OECD member 
country with which the United States has no tax treaty in force.
    Under the proposed treaty, Turkey would agree to reduce its taxes 
on the income that U.S. residents earn from sources in Turkey and the 
United States would agree to reciprocal reductions of its tax on U.S. 
income of Turkish residents. The United States and Turkey also would 
agree that their tax administrators will exchange tax information where 
necessary to carry out tax laws and will cooperate together to resolve 
problems in the coordination of the tax rules of the two countries that 
may arise in individual cases.
    The proposed treaty follows preferred U.S. treaty positions in many 
respects. However, it differs from preferred U.S. treaty positions in 
other respects, primarily by not reducing source-country taxation to 
the same extent as many U.S. tax treaties. In this regard, the proposed 
treaty is similar to other treaties that the United States has entered 
into with developing countries.
    The proposed treaty would allow broader source-country taxation of 
business activities of residents of the other country. It also would 
permit higher maximum rates of source-country tax on dividends, 
interest, and royalties, and would permit the imposition of source-
country tax on certain equipment rental income. These maximum rates of 
source-country tax generally range from 15 to 20 percent in the case of 
dividends, 10 to 15 percent in the case of interest, and 5 to 10 
percent in the case of royalties. The proposed treaty would treat 
equipment rental income as royalties subject to a maximum 5 percent 
source-country tax.
    In addition, the proposed treaty would allow Turkey to tax gains 
derived by U.S. residents from shares and bonds of Turkish companies in 
certain cases. Although the proposed treaty would permit the United 
States to impose tax in the reverse situation, U.S. internal law does 
not tax such gains of foreign persons.
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.

    Senator Hagel. Mr. Kies, thank you very much.
    Mr. Kies, does the Joint Tax Committee recommend that this 
committee support ratification of these proposed treaties?
    Mr. Kies. Senator Hagel, we have reviewed the treaties in 
great depth and, as Senator Sarbanes has pointed out, we have 
identified places where we think there are issues that the 
committee ought to look at. I guess our judgment is that, on 
balance, we have been persuaded, through the extensive 
discussions we have had with the Treasury Department about the 
negotiations that led to the provisions in the treaties, that 
these represent the best job that could be done given the 
negotiating pressures that the Treasury Department had to deal 
with.
    We do think that the resolution of the REIT issue was 
essential, and that the way in which it has been resolved, 
particularly as it relates to Luxembourg where there was 
immediate pressure concerning potential investors from 
Luxembourg, effectively deals with the issues raised by the 
U.S. REIT industry. That reservation--which we have been told 
by Treasury can be rather quickly addressed--will address the 
REIT problems adequately. So, on that basis, we think the 
treaties should proceed.
    Senator Hagel. Let me follow up for a minute on a general 
issue that Senator Sarbanes engaged in with Secretary 
Guttentag. I know Senator Sarbanes will move into some of the 
questioning with you.
    The current treaty with Ireland does not contain a 
limitation on benefits provision. Thus, if I understand this 
correctly, the proposed treaty greatly improves the current 
treaty relationship, and there are some other things. Are you 
concerned that certain treaty provisions here in this treaty 
will be abused during a period prior to its entry into force if 
we have no limitation on benefits provision?
    Mr. Kies. Yes, Senator Hagel, I think that that is one of 
the major improvements that has occurred in the negotiation of 
this treaty, and that the sooner the treaty gets into force, 
the better, in that regard. So, notwithstanding the fact that 
the information exchange piece is not particularly attractive 
in terms of where it ideally could have come out, the other 
improvements over the existing treaty, I think, are highly 
desirable.
    And I would say that the point that Mr. Guttentag made in 
comparing it to Thailand was an appropriate thing to bring to 
the committee's attention. Because, in the case of Thailand, we 
have no existing treaty; whereas in Ireland, there is an 
existing treaty over which this new treaty would make some 
significant improvements.
    Senator Hagel. The information exchange process, are there 
areas that we can improve in and in which you would make some 
suggestions to Treasury?
    Mr. Kies. I think that the area of information exchange is 
one in which there is always going to be a continuing struggle 
to get the most desirable position from the U.S. perspective, 
because many countries are not immediately willing to share 
information in the same way that we are. But I think that 
Treasury is going to have to continually negotiate aggressively 
to try and get the most open information exchange provisions we 
can.
    In the treaties before the committee, the provisions in the 
current treaties--for example, in Luxembourg, Austria and 
Switzerland--are quite limited. These treaties would make 
progress in that regard. The most significant progress is in 
Austria; the least significant probably is in Switzerland. But 
this is going to have to continue to be an area in which 
Treasury puts on as much pressure as they can to try and 
improve the information exchange provisions.
    Senator Hagel. Thank you.
    Senator Sarbanes.
    Senator Sarbanes. I wonder if the joint committee could, in 
effect, help to sharpen up for the Treasury some of the issues 
you raise, so that they can then submit to the committee their 
response on how they handled them. There are a couple of 
questions I put earlier to the Treasury Deputy Secretary that 
actually I thought the responses were quite to the point, in 
terms of what the negotiating situation was and what they were 
able to do.
    And it sounded as if, on the insurance issue, they had it 
pretty well covered. But there is very careful and thorough 
analysis of a number of important issues in these reports. I 
think we need a response to them from Treasury. I do not think 
we should just let these issues pass without addressing them, 
and then being able to make an informed judgment.
    Furthermore, the question is whether we should try to use 
any understandings, or maybe even just committee report 
language, on some of these issues to establish some kind of 
marker for the Treasury Department for the future. There is 
always a danger of getting on a slippery slope. I mean, 
Treasury departs from the model treaty, and then they say, 
well, we had to do this in order to negotiate a treaty.
    That may be quite true; I do not anticipate that we can 
take a cookie-cutter approach or that every country is simply 
going to take the model treaty. Obviously, they will not do 
that. But once you start down a path, then the next country 
points to what the previous country got and says, well, you did 
it for them, why can't you do that, plus perhaps a little more, 
for us? And then that unraveling process begins.
    And so I think one of the functions this committee can 
perform is to try to hold the Treasury within some parameters 
so that does not happen.
    Mr. Kies. Senator, I agree with you. I think there maybe 
are two ways in which we can be helpful in this regard. First 
is, throughout the preparation of the pamphlets, we did share 
those issues with Treasury representatives. But we would be 
happy to sit down with them and discuss even in more detail the 
issues we have raised there.
    The second thing that I think we can be helpful on is that, 
in developing committee reports, where there is a clear 
explanation of why the Treasury took a position--for example, 
in the reinsurance point and the insurance point, that they 
carefully looked at the treaty country's tax treatment of 
insurance companies--that should be reflected in the committee 
report, because it essentially sends a signal to other 
countries that unless their countries have comparable insurance 
taxation rules, they will not be able to expect to get a waiver 
of the insurance excise tax. That is the type of thing that we 
ought to reflect in the committee reports so that that is part 
of the legislative history which will be in place when future 
negotiations occur.
    So we will be happy to work with Treasury in both of those 
respects, and with the Foreign Relations staff.
    Senator Sarbanes. Thank you.
    Thank you, Mr. Chairman.
    Senator Hagel. In view, Mr. Kies, of the hour--it is 5 
o'clock--and in light of votes and other additions to our 
schedule, I would ask if Senator Sarbanes had any additional 
questions. I know we have another panel behind you.
    Senator Sarbanes. No, I do not have any more questions. I 
just want to thank the joint committee for their usual good 
work in preparing these studies.
    Mr. Kies. Thank you, Senator Sarbanes.
    Senator Sarbanes. They have been helpful.
    Senator Hagel. And I echo that, as well, Mr. Kies and your 
colleagues. Thank you very much for the time.
    Mr. Kies. Thank you, Senator Hagel.
    Senator Hagel. Mr. Mattson, please proceed whenever you are 
ready. Nice to have you. Welcome.

STATEMENT OF ROBERT N. MATTSON, CHIEF TAX OFFICER AND ASSISTANT 
  TREASURER, INTERNATIONAL BUSINESS MACHINES CORPORATION, ON 
  BEHALF OF THE NATIONAL FOREIGN TRADE COUNCIL AND THE UNITED 
           STATES COUNCIL FOR INTERNATIONAL BUSINESS

    Mr. Mattson. Thank you, Senator Hagel and Senator Sarbanes.
    My name is Bob Mattson. I am Chief Tax Officer and 
Assistant Treasurer for the IBM Corporation. I appreciate the 
opportunity to appear today before this committee on behalf of 
the United States Council for International Business, as Vice 
Chairman of its Tax Committee, and the National Foreign Trade 
Council, as its former Tax Committee Chairman, which together 
represent the international business community and the United 
States' largest exporters. These trade associations work to 
enhance the competitiveness of U.S.-owned business by promoting 
sound and appropriate international tax policy and agreements.
    I am accompanied today by Fred Murray, Vice President of 
Tax Policy of the National Foreign Trade Council; and Tim 
Sheehy, IBM's Manager of Government Affairs.
    As global competition grows ever more intense, it is vital 
to the health of the United States enterprises and to their 
continuing ability to contribute to the United States economy 
that the companies be free from excessive foreign taxes or 
double taxation that can serve as a barrier to the full 
participation of American companies in the international 
marketplace. Bilateral tax treaties are a crucial component of 
the framework necessary to allow such balanced competition.
    It is for this reason that both the National Foreign Trade 
Council and the United States United States Council on 
International Business have long supported the expansion and 
strengthening of the U.S. tax treaty network, and that we are 
here today to recommend ratification of these treaties under 
consideration by this committee. We appreciate the committee's 
action in scheduling this hearing and agreeing to receiving our 
testimony.
    The treaties up for ratification should be ratified without 
delay. For example, the revised treaty with Austria modernizes 
an existing 40-year-old treaty, and eliminates a major 
impediment to U.S. business restructuring in the European 
Union. Austria joined the European Trading Union in 1995, and 
it is essential that barriers be removed for U.S. business to 
operate and restructure as required by the growing tendency 
toward globalization. Businesses can no longer focus solely on 
geographic borders, and many companies have increasingly 
integrated their regional business activities. This is true in 
Europe, and modernized tax treaties with Austria, Ireland, 
Luxembourg, and Switzerland are essential.
    We also strongly support and urge the prompt ratification 
of the protocol with Canada and the new treaties with South 
Africa, Thailand and Turkey.
    The new treaty with Thailand advances U.S. business needs 
for fairness and certainty in the Asian community. We commend 
the Treasury Department for its efforts to include more 
developing countries and Asian nations in our treaty network, 
as this area is so vitally important to U.S. interests in the 
global business arena. We trust that this committee will, Mr. 
Chairman, support their endeavors to bring further treaties 
with Asian and other developing countries for ratification to 
your committee.
    American global business enterprises, in the next century, 
will be built around information networks, flexible work forces 
and webs of strategic alliances. Without a refreshed and 
expanding tax treaty network, IBM and other American-owned 
businesses would find untenable barriers to the necessary free 
flow of technology and investment which supports expanding 
export jobs in the United States.
    The emergence of a new set of technologically skilled 
nations, which Thailand represents, necessitates that the U.S. 
clarify the international rules applying to commerce with these 
nations. These nations are linked to the U.S. by 
telecommunications and information technologies, and will be 
engaged in the conduct of electronic commerce. We would have 
preferred that the Thai and the Turkish treaties totally 
eliminated withholding taxes on the movement of technology 
products, such as computer software. However, these treaties 
are a realistic beginning in the right direction, and we 
support their ratification.
    While in the past business value-add was determined by 
tangible goods, manufactured in plants located where 
comparative advantage dictated, in the next century, know-how, 
ideas and concepts--intangible goods--will drive economic value 
and the competitive strength of American-owned business. Recent 
trade agreements have brought down tariff barriers on high 
technology tangible goods exports from the United States. 
However, barriers on intangibles requires tax treaties which 
eliminate withholding taxes on royalties, dividends and 
interest flows.
    These treaties set international norms for the conduct of 
administrative audits of transactions between affiliates, and 
provide a mechanism to resolve tax disputes. Otherwise, 
American companies could not be assured of protection against 
arbitrary tax assessments.
    Tax treaties help create the environment for predictable 
tax treatment of cross-border business transactions so 
necessary to a successful global business. Ratification of 
these treaties continues the momentum which is needed to bring 
other nations into the U.S. treaty network. It sends a 
continuing signal that the U.S. desires a lessening, and 
eventual elimination, of the existing impediments to global 
business.
    Again, thank you for your patience by listening to my 
statement today on this very important hearing to America's 
global businesses. I would be happy to answer any questions you 
might wish to ask.
    [The prepared statement of Mr. Mattson follows:]
                   Prepared Statement of Mr. Mattson
    Mr. Chairman, Members of the Committee:
    My name is Bob Mattson and I am Chief Tax Officer and Assistant 
Treasurer of the IBM Corporation. I appreciate the opportunity to 
appear today before this Committee on behalf of the United States 
Council for International Business, as vice chairman of its tax 
committee, and the National Foreign Trade Council, as its former tax 
committee chairman, which together represent the international business 
community and the United States largest exporters. These trade 
associations work to enhance the competitiveness of U.S.-owned business 
by promoting sound and appropriate international tax policy and 
agreements.
    The National Foreign Trade Council, Inc. (NFTC) is an association 
of over 500 U.S. business enterprises engaged in all aspects of 
international trade and investment. The NFTC seeks to foster an 
environment in which U.S. companies can be dynamic and effective 
competitors in the international business arena. To achieve this goal, 
American businesses must be able to participate fully in business 
activities throughout the world, through the export of goods, services, 
technology, and entertainment, and through direct investment in 
facilities abroad.
    The United States Council for International Business (USCIB) is the 
American affiliate of the International Chamber of Commerce and the 
Business and Industry Advisory Committee to the OECD. The USCIB 
formulates its positions in committees composed of corporate and other 
experts drawn from its membership of 300 multinational corporations, 
service companies, law firms, and business associations. It advocates 
these positions to the United States Government and to such 
intergovernmental organizations as the OECD, the WTO, and other bodies 
of the United Nations system with which its international affiliates 
have official consultative status on behalf of world business.
    As global competition grows ever more intense, it is vital to the 
health of U.S. enterprises and to their continuing ability to 
contribute to the U.S. economy that the companies be free from 
excessive foreign taxes or double taxation that can serve as a barrier 
to full participation in the international marketplace. Bilateral tax 
treaties are a crucial component of the framework necessary to allow 
such balanced competition.
    It is for this reason that both the NFTC and USCIB have long 
supported the expansion and strengthening of the U.S. tax treaty 
network and that we are here today to recommend ratification of the 
treaties under consideration by this Committee. We appreciate the 
Committee's action in scheduling this hearing and agreeing to receive 
our testimony.
    Tax treaties are bilateral agreements between the United States and 
foreign countries that serve to harmonize the tax systems of the two 
countries in respect of persons involved in cross-border investment and 
trade. In the absence of tax treaties, income from international 
transactions or investment may be subject to double taxation: once by 
the country where the income arises and again by the country of the 
income recipient's residence. Tax treaties eliminate this exposure to 
double taxation.
    The treaties up for ratification should be ratified without delay. 
In particular, the revised treaty with Austria modernizing the existing 
40-year old treaty eliminates a major impediment to U.S. business 
restructuring in the European Union. Austria joined the European 
trading union in 1995 and it is essential that barriers be removed for 
U.S. business to operate and restructure as required by the growing 
tendency toward globalization. Businesses can no longer focus solely on 
geographic borders and many companies have increasingly integrated 
their regional business activities, This is true in Europe and 
modernized tax treaties with Austria, Ireland, Luxembourg, and 
Switzerland are essential. We also strongly support and urge the prompt 
ratification of the protocol with Canada and the new treaties with 
South Africa, Thailand and Turkey.
    The new treaty with Thailand advances U.S. business needs for 
fairness and certainty in the Asian community. We commend the Treasury 
Department for its efforts to include more developing countries and 
Asian nations in our treaty network as this area is so vitally 
important to U.S. interests in the global business arena. We trust that 
this committee will, Mr. Chairman, support their endeavors, to bring 
further treaties with Asian and other developing countries for 
ratification to this forum.
    America's global business enterprises in the next century will be 
built around information networks, flexible work forces and webs of 
strategic alliances. Without a refreshed and expanding tax treaty 
network, IBM and other American-owned businesses would find untenable 
barriers to the necessary free flow of technology and investment which 
supports expanding export jobs in the United States. The emergence of a 
new set of technologically skilled nations which Thailand represents, 
necessitates that the U.S. clarify the international rules applying to 
commerce with these nations. These nations are linked to the U.S. by 
telecommunications and information technologies and will be engaged in 
the conduct of electronic commerce. We would have preferred that the 
Thai and Turkey treaties totally eliminated withholding taxes on the 
movement of technology products such as computer software, however, 
these treaties are a realistic beginning in the right direction and we 
support their ratification.
    While in the past, business value-add was determined by tangible 
goods manufactured in plants located where comparative advantage 
dictated (such as our plants in North Carolina which export nearly 1-1/
2 billion dollars a year), in the next Century, know-how, ideas and 
concepts - intangible goods - will drive economic value and the 
competitive strength of American-owned business. Recent trade 
agreements have brought down tariff barriers on high technology 
tangible good exports from the United States. However, barriers on 
intangibles require tax treaties which eliminate withholding taxes on 
royalty, dividend and interest flows.
    American business interests will be greatly served by the 
recognition in these treaties that we now conduct a great portion of 
our worldwide business in joint ventures and alliances with other 
companies to gain greater access to foreign markets and technology. 
These treaties contain substantial reductions in ownership thresholds 
in qualifying for lower foreign withholding taxes on dividend 
repatriations to the United States.
    Likewise, these treaties set international norms for the conduct of 
administrative audits of transactions between affiliates and provide a 
mechanism to resolve tax disputes. Otherwise, American companies could 
not be assured of protection against arbitrary tax assessments. Tax 
treaties help create the environment for predictable tax treatment of 
cross-border business transactions so necessary to a successful global 
business. Transactions in intangible goods including computer software, 
information and services are more viable if the tax rules applied are 
consistent and avoid double taxation. It is vital that these treaties 
be ratified to assist in that certainty so that American-owned business 
can be better prepared to compete in a global marketplace.
    Ratification of these treaties continues the momentum which is 
needed to bring other nations into the U.S. treaty network. It sends a 
continuing signal that the U.S. desires a lessening and eventual 
elimination of the existing impediments to global business. The larger 
business community hopes that side issues do not get in the way of a 
treaty process that is working. We are extremely pleased that tax 
treaties, these days, are negotiated and submitted to this Committee 
promptly for your consideration.
    Again, thank you for your patience by listening to my statement 
today on this very important hearing to America's global businesses. I 
would be happy to answer any questions you might wish to ask.

    Senator Hagel. Mr. Mattson, thank you.
    You mentioned in your statement that the Council supports 
the ratification of these treaties that the committee will deal 
with. Could you give me some examples of how these treaties 
will in fact make a difference--add to productivity--not only 
in your company, but other companies that you represent through 
the Council, improved growth, more jobs here in the United 
States?
    Mr. Mattson. In one of your colleague's States, North 
Carolina, we export some----
    Senator Hagel. He is not just a colleague, he is the 
chairman now.
    Mr. Mattson. I understand that.
    As well as Maryland, we export out of North Carolina over 
$1.5 billion, and a number of those countries that are under 
this treaty take that export.
    You cannot export high technology good today without also 
having agreements with regard to intangibles, as I mentioned. 
Software, along with the personal computer exports out of our 
North Carolina plants, are useless without the software that 
accompanies them. These treaties help lower the foreign taxes 
on those software products that move into those jurisdictions.
    In the same way, other companies--drug companies, many of 
our very highest technology companies and service companies--
would be in great competitive disadvantage if these treaties 
did not lower the barriers on intangible products. For IBM, for 
example, we would be in massive excessive foreign tax credit 
situations. We would be paying very high foreign taxes without 
the tax treaty network. We could not sustain our global 
business posture without them, Senator.
    Senator Hagel. As you know, the Treasury is continuing 
negotiations on additional treaties--my understanding is 
especially in Latin America and Southeast Asia. Are there other 
areas, Mr. Mattson, that we should be looking at, or specific 
areas within those two regions that Treasury is currently 
negotiating treaties in?
    Mr. Mattson. Well, again, I would say we ought to 
strengthen our ties with Asia. That is very, very important. We 
now, as we heard, have finally completed the ring of the OECD 
countries, bringing in Turkey.
    Latin America, it is vitally important to us that the Latin 
American countries get the message. I note that Treasury has 
been working with a number of them to bring them into the 
treaty network. The problem is often on their side.
    My colleagues remind me that Brazil is a difficult country 
and very important to American business. The Japanese treaty 
needs refreshing very extensively. It is one of our older 
treaties, and you can understand the amount of trade and 
impediments that the Japanese treaty throws up. Japan has the 
highest withholding tax on intangibles in the entire OECD 
network, and it is time that the U.S. Treasury begin to engage 
the Japanese Government.
    Senator Hagel. Thank you.
    In reflecting on your members here and their feeling and 
sense of this, are you generally pleased with the consultation 
role of U.S. business with the Treasury Department on these 
treaties?
    Mr. Mattson. If it was not for the competent authority of 
the Treasury Department, in the first instance, a number of 
countries would take greater liberties than they would 
otherwise in dealing with U.S. companies. Unfortunately, some 
tax audit issues are zero-sum games. The U.S. becomes very 
difficult with the foreign companies, and the foreign 
governments then take on the U.S. companies to recover the same 
am. If there were not these treaties in place, there could be 
much more abuse in this area. We are very thankful that we can 
go to the U.S. Government for assistance if we find these 
problems.
    Senator Hagel. Thank you.
    Senator Sarbanes.
    Senator Sarbanes. Well, I had a question, really, that just 
follows along with what the chairman just asked. That is, what 
more can be done on our side to help develop a system of tax 
treaties? Or do you think everything is being done that can be 
done?
    Mr. Mattson. No, everything is not being done. It would be 
hard for me right now to go through the various issues. But I 
think the one thing I would say is that what happened with this 
set of treaties should be replicated time and time again. That 
is that this committee has brought before it the treaties for 
ratification for consideration in a very prompt manner. We all 
are very appreciative of that.
    So, first and foremost is having a forum that treaties do 
not just linger and sit after they have been signed, but can 
come forth and be heard by this committee and examined, as you 
have today. We are very appreciative of that factor. I think 
that is a very important point that I would like to make.
    Senator Sarbanes. Do you have any consultations with 
Treasury about what countries should be given higher priority 
in terms of either updating an existing tax treaty or 
negotiating a tax treaty where none has heretofore existed? How 
is the priority list set? How much involvement do you have in 
helping to set that?
    Mr. Mattson. Let me talk about the National Foreign Trade 
Council, for example, which has over 500 U.S. business 
enterprises engaged in all aspects of international trade and 
investment. There is a tax committee, which many of these 
members sit on. Once a year the National Foreign Trade Council 
goes out and circularizes with its members what are their 
needs, both new treaties, refreshed treaties or issues that are 
pending.
    We then accumulate that information, and the Treasury 
Department has an annual meeting with the National Foreign 
Trade Council and we submit this information to them. They have 
been very receptive and very willing to work on these issues 
that we bring before them. So, in that sense, business and 
government has a very good relationship in the United States 
with regard to the tax treaty network.
    Senator Sarbanes. And to what extent, in your perception, 
are the treaties worked out without cross-cutting of political 
or security considerations? Or do you find situations in which 
the United States is giving concessions to some country on a 
tax treaty because it is working on a different track with 
respect to some political or security matter with that country?
    Mr. Mattson. It is hard for me to respond to that, because 
while we do meet with Treasury and tell them our interests and 
concerns, once they go into a treaty negotiation, that is 
between the two countries. We do not have somebody sitting at 
the table. So we hear about it after the fact.
    And so all I can say is they know our interest; they have 
generally accepted the importance of those issues, but once 
they begin their own negotiations on government to government, 
I think that you would have to ask the Assistant Secretary or 
the Deputy Secretary those questions, sir.
    Senator Sarbanes. OK. Well, thank you very much, sir, for 
your testimony.
    Senator Hagel. Mr. Mattson, once again, thank you. Thank 
also your colleagues at the Council for not just helping 
prepare the testimony today, but what you do every day to work 
with us on these important issues. Thank you.
    Mr. Mattson. Thank you, sir.
    Senator Hagel. Thank you.
    [Whereupon, at 5:20 p.m., the committee adjourned, to 
reconvene subject to the call of the Chair.]


                            A P P E N D I X

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     Responses of Mr. Guttentag to Questions Asked by Senator Helms
    Question 1. I understand that the South African Government has 
introduced legislation which will abrogate patent rights. Is there any 
provision for protection of intellectual property in the South Africa 
tax treaty?
    Answer. The South African Parliament has just passed legislation 
which is intended to reform South Africa's's health care system. The 
stated object of the legislation is to make medicine more affordable. 
One specific provision of the legislation invests in the Minister of 
Health power which could severely restrict pharmaceutical patent owners 
rights.
    The United States Government has been actively discussing its 
concerns about this legislation with the South African Government. Our 
Embassy has been in frequent contact with the Ministry of Health, the 
Department of Trade and Industry, and members of the Parliamentary 
Portfolio Committee on Health. In Washington, USG officials have also 
explained our views to South Africa's Ambassador, Franklin Sonn.
    The U.S.-South Africa tax treaty provides for, among other things, 
reduced tax rates on royalties received by U.S. pharmaceutical 
companies from the exploitation of patents in South Africa. Because 
intellectual property night protection does not fall under the purview 
of bilateral tax treaties, the South African tax treaty does not 
provide for the protection of intellectual property.
    Question 2. South Africa has Joined the WTO and should therefore 
abide by its intellectual property right protections. Is Treasury 
concerned by South Africa's attempt to single out the U.S. 
pharmaceutical industry for harsh treatment? Do you believe that Senate 
action on this treaty will be construed as a green light for the South 
African legislation?
    Answer. The United States Government has reserved the right to 
consider WTO action with respect to the legislation. Various interested 
agencies currently are reviewing the legislation and considering a 
course of action. The view of South African Government officials is 
that the legislation is consistent with the South Africans' WTO 
obligations.
    It is unlikely that South Africa will single out the U.S. 
pharmaceutical industry. All pharmaceutical patent holders in South 
Africa, regardless of country of origin, could be affected by the 
provision in the legislation regarding suspension of patents. As a 
result, the European Union and several European countries have also 
relayed their concerns to the South African Government.
    Treasury does not believe the Senate action on the tax treaty will 
be construed. as a green light for the South African legislation. The 
South African Government is well aware of the views of the United 
States Government on the legislation. Both Governments believe it is in 
their interests for the tax treaty to be approved.

                               __________

   Responses of Mr. Guttentag to Questions Asked by Senator Sarbanes
        application of the turkish convention to northern cyprus
    Question 1. Under the proposed U.S.-Turkey income tax convention, 
would Turkish settlers on Cyprus be eligible for benefits?
    Answer. The United States would not consider Turkish settlers on 
Cyprus as residents of Turkey eligible for treaty benefits.
    Question 2. Could Turkey unilaterally change its laws in such a way 
as to make Turkish Cypriots eligible for benefits under the treaty?
    Answer. The United States negotiated its tax treaty with Turkey on 
the understanding that only those persons resident in Turkey (as 
defined in the treaty, which does not include Cyprus) were residents of 
Turkey for purposes of the tax treaty. Turkey could, theoretically, try 
to make unilateral changes to its tax laws that would attempt to make 
Turkish settlers in Cyprus eligible for benefits under the U.S.-Turkish 
tax treaty. The United States would oppose any attempts by Turkey to 
gain benefits under the tax treaty which had the effect of changing the 
premise on which the treaty was negotiated or of undermining United 
States policy toward Cyprus. If Turkey persisted with such changes, 
Treasury would expect to take appropriate steps, possibly including 
consultations or negotiations so as to specifically exclude benefits 
for Cypriots, or termination of the treaty.
    Question 3. Under the proposed treaty, could a resident of Turkey 
avoid income taxes on an investment in the U.S. by routing that 
investment through a branch in northern Cyprus?
    Answer. A resident of Turkey cannot avoid income taxes on an 
investment in the U.S. by routing that investment through a branch in 
northern Cyprus. Under U.S. law, a resident of Turkey who made an 
investment in the U.S - through a branch in Cyprus, or any other 
jurisdiction, would be taxed under U.S. law and the U.S.-Turkey 
Convention, as if the investment had been made directly from Turkey. 
Furthermore, Turkey taxes the world-wide income of its residents as 
does the United States so income earned in Cyprus by a branch of a 
Turkish company would be subject to full Turkish tax.
    Question 4. Would any treaty benefits accrue to a Turkish or U.S. 
resident with a permanent establishment in northern Cyprus?
    Answer. The location of a permanent establishment of a U.S. or 
Turkish resident would be irrelevant for treaty purposes. Both Turkey 
and the United States tax residents on their worldwide income. 
Accordingly, both countries provide benefits to residents of the other 
regardless of the existence or location of a permanent establishment of 
the resident. Some countries provide special benefits for permanent 
establishments and our treaties with those countries provide 
appropriate limitation of benefits.
    Question 5. If Turkey were to annex northern Cyprus, would any of 
the above answers change?
    Answer. We cannot speculate now about a hypothetical annexation 
because we do not know what the circumstances would be. However, 
assuming that the annexation were not recognized by the United States, 
we would not expect the answers to change.