- BILATERAL TAX TREATIES AND PROTOCOL: ESTONIA

[Senate Hearing 106-356]
[From the U.S. Government Publishing Office]

S. Hrg. 106-356

BILATERAL TAX TREATIES AND PROTOCOL: ESTONIA--TREATY DOC. 105-55;
LATVIA--TREATY DOC. 105-57; VENEZUELA--TREATY DOC. 106-3; DENMARK--
TREATY DOC. 106-12; LITHUANIA--TREATY DOC. 105-56; SLOVENIA--TREATY
DOC. 106-9; ITALY--TREATY DOC. 106-11; GERMANY--TREATY DOC. 106-13

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

HEARING

BEFORE THE

COMMITTEE ON FOREIGN RELATIONS
UNITED STATES SENATE

ONE HUNDRED SIXTH CONGRESS

FIRST SESSION

__________

OCTOBER 27, 1999

__________

Printed for the use of the Committee on Foreign Relations

Available via the World Wide Web: http://www.access.gpo.gov/congress/senate

U.S. GOVERNMENT PRINTING OFFICE
62-509 CC WASHINGTON : 2000
------------------------------------------------------------------------------
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402

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
ROD GRAMS, Minnesota RUSSELL D. FEINGOLD, Wisconsin
SAM BROWNBACK, Kansas PAUL D. WELLSTONE, Minnesota
CRAIG THOMAS, Wyoming BARBARA BOXER, California
JOHN ASHCROFT, Missouri ROBERT G. TORRICELLI, New Jersey
BILL FRIST, Tennessee
Stephen E. Biegun, Staff Director
Edwin K. Hall, Minority Staff Director

(ii)

C O N T E N T S

----------
Page

Dorgan, Hon. Byron L., U.S. Senator from North Dakota............ 2
Prepared statement of........................................ 4
Murray, Fred F., vice president for tax policy, National Foreign
Trade Council, Washington, DC.................................. 52
Prepared statement of........................................ 55
Paull, Lindy L., chief of staff, Joint Committee on Taxation..... 31
Prepared statement of........................................ 35
Underwood, Hon. Robert A., U.S. Delegate from Guam, prepared
statement...................................................... 66
West, Philip R., International Tax Counsel, Department of the
Treasury....................................................... 8
Prepared statement of........................................ 12

Appendix

Additional questions for the record from Senator Hagel to Phil
West, Treasury International Tax Counsel:
Responses regarding additional issues on pending tax treaties 69
Responses regarding issues raised in JCT pamphlets on pending
tax treaties............................................... 75
Statements in support of the Treaty for the Avoidance of Double
Taxation between Venezuela and the United States:
D'Empaire Reyna Bermudez & Asociados, Caracas, Venezuela..... 93
Hoet, Pelaez, Castillo & Duque, Caracas, Venezuela........... 95
Venezuelan American Chamber of Commerce and Industry,
Caracas, Venezuela......................................... 97
Torres, Plaz & Araujo, Caracas, Venezuela.................... 98
Statement in support of the U.S.-Lithuanian Bilateral Tax Treaty:
Williams Companies, Washington, DC........................... 100
Website addresses for the Treasury Department Technical
Explanations of the tax treaties and protocol in this hearing.. 101

(iii)

----------

WEDNESDAY, OCTOBER 27, 1999

U.S. Senate,
Committee on Foreign Relations,
Washington, DC.
The committee met, pursuant to notice, at 3:05 p.m. in room
SD-419, Dirksen Senate Office Building, Hon. Chuck Hagel
presiding.
Present: Senators Hagel and Sarbanes.
Senator Hagel. Good afternoon.
The committee meets today to consider bilateral income tax
treaties between the United States and Estonia, Latvia,
Lithuania, Venezuela, Denmark, Italy, and Slovenia as well as
an estate tax protocol with Germany.\1\
---------------------------------------------------------------------------
\1\ The Department of the Treasury technical explanations for these
tax treaties and protocol are available via the World Wide Web. See
appendix, page 101, for the Website addresses.
---------------------------------------------------------------------------
The United States has tax treaties with 59 countries. This
global network of treaties is designed to protect U.S.
taxpayers from double taxation and to provide the IRS with
information and data to prevent tax evasion and avoidance.
The treaties prevent international double taxation by
setting down rules to determine what country will have the
primary right to tax income and at what rates. These bilateral
international tax treaties are important for America's economic
growth.
As we move into the next millennium, today's global economy
will be even more interconnected and more interdependent on
international tax treaties. The treaties pending before this
committee represent new treaty relationships between the United
States and Estonia, Latvia, Lithuania, Venezuela and Slovenia.
The treaties with Denmark and Italy would modernize
existing treaty relationships. These treaties generally track
with the U.S. tax treaty model, although some deviate to
various degrees from the U.S. model.
Additionally, some of the provisions in these treaties are
being seen by this committee for the first time. The treaties
with Italy and Slovenia contain main purpose tests that are not
usually contained in U.S. treaties. These provisions would
permit the denial of benefits under a treaty if one of the main
purposes of a transaction was to take improper advantage of the
treaty.
I hope our Treasury witness today will be able to expand on
those provisions and explain the intent and practicality of
including these provisions in the treaties.
A variety of other issues has been raised by the Joint
Committee on Taxation. I know our witnesses are fully aware of
these issues and will be prepared to discuss them. As usual,
the Joint Committee staff has prepared careful analysis of each
of the treaties.
We are pleased today to have with us three distinguished
panels of witnesses. The first panel consists of Senator Byron
Dorgan from North Dakota. Senator Dorgan has been a leader on
many important issues in the U.S. Senate, including
agriculture, trade, taxes, and telecommunications.
Senator Dorgan became the youngest constitutional officer
in North Dakota's history when he was appointed State Tax
Commissioner at the age of 26. He was later elected to that
office twice. Senator Dorgan served a total of 11 years as Tax
Commissioner for North Dakota, so I suspect he knows a little
bit about this issue.
And I hope he is very impressed that I know so much about
that.
The second panel includes Mr. Philip West, International
Tax Counsel for the U.S. Department of the Treasury, and Ms.
Lindy L. Paull, chief of staff of the Joint Committee on
Taxation.
Mr. West has served as International Tax Counsel for the
Treasury Department for nearly 2 years. Prior to becoming Tax
Counsel, Mr. West served as the Deputy International Tax
Counsel.
Ms. Paull has served as the chief of staff of the Joint
Committee on Taxation since February, 1998. Prior to her work
at the Joint Committee, she was staff director and chief
counsel for the U.S. Senate's Finance Committee.
On the third panel, we will hear from Mr. Fred Murray, vice
president for tax policy of the National Foreign Trade Council.
Prior to his work at the National Foreign Trade Council, Mr.
Murray was special counsel for legislation in the office of the
Chief Counsel at the Internal Revenue Service from 1992 to
1996.
My friend and counterpart on the subcommittee, Mr.
Sarbanes, will be here momentarily. I understand he has
requested that we proceed.
So, with that, Senator Dorgan we welcome you and are
pleased to have you.

STATEMENT OF HON. BYRON L. DORGAN, U.S. SENATOR FROM NORTH
DAKOTA

Senator Dorgan. Mr. Chairman, thank you very much. I also,
in addition to serving as State Tax Commissioner, served 10
years in the House Ways and Means Committee when I was in the
U.S. House. So I have an acquaintance with the tax issue.
I am here today because we are dealing with tax treaties
which spark very little public interest, and yet there are
significant considerations that must be weighed in my judgment
as we deal with these treaties. I hope that the representatives
from the Treasury Department and the Joint Tax Committee will
also weigh in on some of these issues. I don't know that they
will, but I hope they will.
My concern deals with what is traditionally article 9 and
article 7 of these treaties, dealing with associated
enterprises and business profits. They deal with transactions
between intracorporate operations, that is, a corporation that
owns another corporation and sells to itself, or buys from
itself.
To tell you a little about that, let me ask you to think
about a toothbrush that is priced at $171. My expectation is
that you have not purchased one of those lately. But that
toothbrush is an intra-company transaction, designed by one
part of a company wholly owned by the other to move income in
one direction or another. Or if not $171 for a toothbrush,
think of $38 for a pair of pantyhose, or a missile rocket
launcher for $13, or how about a radial tire for $5. All of
these are examples of transfer pricing.
There is, in my estimation, a substantial amount of lost
income from transfer pricing. The Internal Revenue Service has
done some studies and they predict that it is somewhere in the
$2 billion to $3 billion range. The studies done by Professors
Pak and Zdanowicz in Florida suggest that it is between $30
billion and $40 billion a year. The right number is perhaps
somewhere in between.
These treaties that we negotiate include an article 7 and
an article 9. These treaties are, in my judgment, going to
cause us more and more difficulty with respect to court
decisions that have been rendered recently about them. I wanted
to mention that to the committee and ask that you consider
taking some action.
First, let me say something about massive tax avoidance by
some of the largest, especially foreign-based firms, but
generally speaking large corporations that buy and sell to and
from themselves in wholly owned subsidiaries. Thirty percent of
the largest foreign based firms with at least $250 million in
assets in the U.S. and business receipts of at least $50
million in a recent year paid no Federal income tax at all--
zero, none--to this country. This is despite doing over $300
billion of business in America. That information comes from a
GAO study.
Now is this something that is reasonable? Would you expect
that to be the case? If you had a kind of main street
mentality, where you do business, make a profit, and have to
pay a tax, would you expect that companies doing $300 billion
worth of business in this country would actually be able to
tell the IRS that they suffered only losses--and, therefore,
should exercise opportunities in our marketplace but should not
exercise the opportunity to pay taxes on profits?
This is where the $171 for a toothbrush comes in. It is the
device by which profit is moved away from the United States tax
collecting service.
Now what has happened is this. The Treasury Department and
the IRS use an antiquated system, called the arms length
pricing approach, for dealing with intracompany transactions.
It is like taking two plates of spaghetti and deciding to try
to attach the ends of the spaghetti together. It is, of course,
patently absurd and unworkable in today's practice. The
Internal Revenue Service is literally drowning in complexity
and is totally and completely unable to deal with it.
They won't admit that, but I will help them do so in the
absence of their admission. I might also say that the way to do
this, as opposed to the current standard that is an antiquated
one, is to use formulary apportionment, which most large
enterprises do not want. This is an approach which,
incidentally, the current U.S. Treasury Secretary previously
embraced until he came to the Treasury Department. Using
formulary apportionment makes a lot of sense.
But I cannot force our Government to do that. I can,
however, come to you and say that when a judge interprets tax
treaties and articles 7 and 9 as absolutely prohibiting
formulary apportionment, when our country believes it is the
only approach by which we can accurately measure income, then
this committee and the Congress had better get serious about
evaluating what articles 9 and 7 mean.
We have for many years felt that it is a harmless enough
provision. And yet, recent court decisions show us this is not
the case. A judge in the U.S. Court of Federal Claims in the
case of National Westminster Bank ruled that an existing
Treasury regulation was overridden by language in the U.S.-U.K.
tax treaty. The language he refers to is exactly this language
that exists in all of these treaties.
I testified against the language previously when the
Congress had moved these treaties out, and I come today again
to say that we are running flat into trouble on these issues.
This case alone will likely amount to $180 million in lost
tax revenue to the Federal Government. But multiply that many
fold, incidentally, if this case stands.
I come here today to ask that the committee do two things.
First, I want the committee to declare unequivocally that our
tax treaties do not prohibit the United States from using
reasonable formula methods to deal with tax avoidance.
Second, the committee should make whatever changes it needs
to these pending income tax treaties to stop the kind of absurd
result that has recently been approved by a couple of Federal
court cases, one of which I have just mentioned.
So, Mr. Chairman, you have a number of expert witnesses. I
know you are anxious to hear them. I have a lot more that I
could say about this, but I think in my prepared testimony I
have set out a more complete story.
I thank you for your patience and courtesy in allowing me
to stop by and present testimony today.
[The prepared statement of Senator Dorgan follows:]

Prepared Statement of Senator Byron L. Dorgan

Mr. Chairman and members of the Senate Foreign Relations Committee,
I appreciate the opportunity to testify about an urgent matter
involving most of our bilateral income tax treaties including several
of those being reviewed by the Committee this afternoon.
Here are some facts that many Americans do not know. Sixty-seven
percent of the foreign multinational firms operating in this country
paid not one penny in federal income taxes despite having hundreds of
billions of dollars of sales here in 1995, which is the latest year the
IRS has statistics available. For many of the preceding years, this
percentage was even higher!
These facts, are of course, outrageous. This is an absolute affront
to our families, individuals and Main Street business owners who
diligently pay the taxes they owe, on time, every April 15th. It's
equally galling that several foreign firms have snookered some of our
federal courts into believing that tax treaties we have with other
countries prohibit the United States from doing much to put a stop to
this massive tax avoidance.
That's why I'm here to urge you to do two things as the Committee
considers the income tax treaties before it today. First, the Committee
should declare unequivocally that our tax treaties do not prohibit the
United States from using reasonable formula methods to deal with this
enormous tax avoidance. Second, the Committee should make whatever
changes it needs to these pending income tax treaties to stop the kind
of absurd results that have recently been approved by our federal
courts.
When I last testified before your Committee about the transfer
pricing problem and how our income tax treaties impact it, I shared
with you a growing body of evidence that multinational firms are
continuing to use a sophisticated tax scheme called ``transfer
pricing'' to avoid paying their fair share of U.S. income taxes. This
bookkeeping practice allows enormously profitable multinational firms
to shift their profits out of one taxing jurisdiction into another more
favorable taxing jurisdiction--or even nowhere at all--by the simple
stroke of a pen.
Since that time, we've made little progress in stopping the
hemorrhaging of revenues caused by transfer pricing that some experts
say is now draining our Treasury coffers by more than $30 billion
annually. To make matters worse, the Treasury Department is continuing
to negotiate language in our income tax treaties that the tax
practitioners of large, sophisticated multinational firms are using to
sidestep what may be our country's best tools for enforcing our tax
laws in the fast-changing global marketplace. In theory, our income tax
treaties are intended to prevent treaty countries from ``double''
taxing the profits of multinational firms that operate around the
globe, while also allowing such countries to take steps to ensure that
multinational firms pay the taxes they rightfully owe. Unfortunately,
several troubling federal court rulings show that a handful of well-
represented multinational, companies can convince our courts that
somehow the language in our tax treaties overrides reasonable U.S.
efforts to enforce our international tax laws.
But let me first step back and describe the nature of the tax
avoidance by many large multinational conglomerates and how our income
tax treaties impact it.
Many of today's globe-trotting businesses are involved in a
campaign of massive global tax avoidance. Far from being overtaxed,
these large multinational companies have devised an aggressive
accounting scam that allows them to avoid paying U.S. taxes with
virtual immunity. Under this scheme called ``transfer pricing,''
multinational companies can move U.S. profits out of this country by
simply manipulating the price they charge themselves for goods and
services they move between related parts of their business.
This ruse, for example, allows foreign-based corporations to
purchase goods and services from U.S. affiliates at artificially low
prices and to sell their foreign-produced goods and services to U.S.
affiliates at artificially high prices. With transfer pricing, some
foreign-based firms claimed their U.S.-based operations in 1998
purchased toothbrushes for $171 each and pantyhose for $38 a pair, and
sold missile and rocket launchers for $13 each and radial tires for $5
each. This is absurd.
It should, therefore, come as no surprise that the vast majority of
foreign-based corporations are doing hundreds of billions of dollars of
business in the United States without paying any U.S. income taxes,
according to General Accounting Office (GAO) studies. This virtual tax
holiday for many profitable multinational firms is not an aberration or
limited, perhaps, to start-up firms or small businesses. In fact, the
GAO's most recent review of IRS tax data shows that about 30-percent of
the largest foreign-based firms with at least $250 million in U.S.
assets or total U.S. business receipts of at least $50 million in 1995
paid no federal income taxes that year, despite doing over $300 billion
of business here. The results for large U.S.-based firms were no
better.
No one seriously disputes the dismal record that our tax
enforcement officials have had in transfer pricing adjustment cases of
international firms under audit. Even the Treasury Department
understands that the potential for abuse in this area makes it one of,
if not the most, important international tax issue we have to deal
with.
Now the income tax treaties being reviewed by your Committee today
may pose a significant threat to both our current and possible future
efforts to put a stop to transfer pricing abuses.
Let me explain. Tucked away in the pending income tax treaties with
Estonia, Slovenia, Latvia, Lithuania and Venezuela are the so-called
``Associated Enterprises'' and ``Business Profits'' articles which deal
with transactions between related companies--whether intercompany
transactions between a parent company and its subsidiaries or intra-
corporate transactions between business branches. These provisions,
which are frequently found in Article 9 and Article 7, respectively,
are common to most bilateral income tax treaties that exist between the
United States and other countries. The actual language in Articles 9
and 7 appears harmless enough. But in practice, it is being used to
undermine our ability to enforce our tax laws regarding the major
multinational firms that do business between these countries.
For years, U.S. tax officials have wrestled with the problem of how
to divide the overall income of a firm doing business in many different
jurisdictions. At first glance, the problem seems simple. If
corporation X has operations in Idaho, and North Dakota, and Mexico,
just audit the books of each.
Unfortunately, though, the problem is not that simple. Corporations
have multitudes of ways of shifting income around from one subsidiary
or another, or one branch to another, by arranging artificial
``transactions'' between them. There are literally thousands of paper
transitions between these entities. Untangling them is a bureaucracy
intensive and ultimately futile exercise. Frequently, the income
disappears into the black holes of the company's multinational balance
sheets and is reported to no jurisdiction at all.
In the beginning, state tax officials tried to deal with the
problem on what is called a ``separate accounting'' basis. They would
pretend that the subsidiaries of a multistate corporation really were
separate businesses, and tried to adjust the transactions between them
one by one, to what they would be if the subsidiaries really were
dealing at ``arm's length.''
But for companies doing business between the states, the
proliferation of commerce simply overwhelmed this system. One by one,
the states shifted to using a formula method, which drops the arcane
tax accounting and allocates the corporation's overall income through a
simple, 3-factor formula instead.
This formula method is now the norm between the states. And the
United States Supreme Court has repeatedly held that the formula method
as used by the states is reasonable and fair.
Stubbornly, however, the Treasury Department has persisted with--
and the IRS has been burdened with--trying to enforce our international
tax laws under the rubric of the antiquated, bureaucracy-intensive
``arms-length'' or ``separate-entity'' accounting method that is
embraced in current Treasury regulations and our income tax treaties.
Yet the Treasury Department understands that traditional ``comparable
pricing'' methods used by IRS examiners are often unworkable and
therefore they have issued regulations using formula approaches to
apportion profits of an international business in many cases.
Many parties affected by our income tax treaties are now
interpreting Articles 9 and 7 as prohibiting the use of any formulary
methods to apportion income or expenses at the federal tax level.
Although there is nothing in the language of our treaties, or past
Committee reports interpreting our treaties, that sensibly supports
this interpretation, some well-financed--and well-represented--
multinational firms are successfully convincing many of our federal
court judges otherwise. For example, this past July, a judge on the
U.S. Court of Federal Claims in the case of National Westminster Bank,
PLC (NatWest) ruled that an existing Treasury regulation--Section
1.882-5--was overridden by language in our U.S.-U.K. tax treaty merely
because it used a formula to determine a reasonable apportionment of
NatWest's true interest expense to its U.S. banking business.
Unfortunately the judge's decision in NatWest is not an isolated
case. This ruling, and others like it, have potentially exposed the
Treasury Department to billions of dollars of new refund claims solely
on a company's claim that any formula approach--however reasonable and
fair--is in violation of our bilateral income tax treaties.
Quite simply it is a mistake for companies, our treaty partners and
our courts to read this restriction on formulary methods into our
existing income tax treaties and those pending before the Committee
today. This is certainly not the result this Committee intended to
sanction.
The Senate Foreign Relation Committee's view on this issue has
remained basically unchanged for decades. This Committee's report
language describing comparable language in the U.S.-United Kingdom
treaty in 1977 went to great lengths to ensure that countries may
``apply apportionment formulas . . . as a method to achieve an arm's
length price for a transaction between related parties or to apportion
income between related entities if it is established the entities are
not dealing on an arm's-length basis.'' The Committee report expressed
this view despite the existence of unique treaty language that
attempted to limit the use of formula methods. This point was re-
emphasized in a 1993 colloquy between Senator Mitchell and Foreign
Relations Committee Chairman Pell on the Senate floor during the
consideration of income tax treaties. Senator Pell reiterated the
Senate's longstanding position that our income tax treaties do not
prevent the appropriate use of a formula method by the United States or
our treaty partners to apportion overall income among associated
enterprises.
I urge this Committee to take steps to ensure that these pending
treaties do not lock this nation into a tax enforcement system that
does not work and cannot work. Again, this costs us billions of dollars
in revenue that we cannot afford to lose. And frankly, it just makes no
sense for the federal government to sit idly by as high-powered
foreign-based multinational companies use our tax treaties or any other
international agreements as a tool to prevent this country from
enforcing its existing tax laws--or future alternatives--to end abusive
tax avoidance practices such as transfer pricing. I happen to believe
that our best chance to curtail this massive avoidance is for this
country to replace its current transfer pricing enforcement provisions
with the kind of formulary apportionment that the states have used to
divide business profits successfully for decades. But I'm not here
asking to impose this today.
However, the Committee should take positive, formal steps to
declare that the use of a reasonable and fair formula to reach the best
possible result in a given circumstance would be contemplated by these
treaties and any future treaties. Consequently, if a formula method to
apportion income among related parties, or among units of a single
party, renders a reasonable and fair result, then multinational
companies must no longer be allowed to use our tax treaties to
circumvent that result in order to avoid paying their fair share of
U.S. income taxes. Such a declaration has always been appropriate.
However, it's needed now more than ever to put a stop to the kind of
absurd results that have recently been sanctioned by our federal
courts.
Once again, I appreciate your extending me the opportunity to
testify before this Committee on this important issue. I urge you to
consider taking the steps needed to ensure that this nation's tax
enforcement laws can keep pace with the changing world of global
economics and international business operations.

Senator Hagel. Senator, thank you.
May I ask just a general question? I will pursue your
points in questions with our witnesses from Treasury and the
Joint Committee on Taxation, and this committee will take a
look. But you know this business about as well as anybody
around here.
What is your suggestion as to how we then would proceed if
we took your suggestions? We have tax treaties with 59
countries. How do you start unravelling this?
Senator Dorgan. Well, you start by not moving a treaty that
includes language in article 7 and article 9 that is now being
misinterpreted by the courts and make more explicit exactly
what these mean. But, in fact our representatives from the
Treasury Department overseas in the OECD and elsewhere are
representing this portion of a tax treaty absolutely prohibit
formulary apportionment, than that is wrong. This is a bad
interpretation and it is not consistent with what this
committee and the Congress have said previously.
So we have the Treasury Department misinterpreting it in
the OECD. We have the court misinterpreting it now. And to the
extent that the committee has a willingness to make certain it
is not misinterpreted in the future, perhaps we need some more
explicit language to say that nothing in these articles shall
prohibit our taxing authorities, when they believe it is
necessary and appropriate to find an accurate method of
measuring income apportionment, from using a formulary
approach. We perhaps need to be more explicit in doing that.
Senator Hagel. Do you believe that would require going back
and renegotiating all of the tax treaties?
Senator Dorgan. I do not believe that is the case.
There are several methods of doing that. One is a
reservation. There are other approaches that can also be used.
All I am doing today is asking the committee to evaluate
especially what our obligation is in light of the recent U.S.
Court of Federal Claims case. I don't think we ought to ignore
this. I hope Treasury will not ignore it in its testimony, and
I hope you will ask the Joint Taxation Committee people about
it as well.
This moves down the road a good, long way in furthering tax
avoidance on a massive scale.
Look, if I were running a multinational corporation, the
last thing I would want is formulary apportionment because you
are able, under the current circumstance, to create a great
deal of ``nowhere income'' and, therefore, avoid the tax
consequences of earning income in certain areas.
But good corporations--and there are plenty of them--do not
mind at all. They don't want to be overtaxed or double taxed,
and I agree with that. Formulary apportionment will prevent
double taxation and do so in a way that protect corporations
while, at the same time, making sure that our country is able
to collect a reasonable income tax on profits made in this
country--just as we do from domestic corporations and from
other taxpayers.
Senator Hagel. Senator, thank you. I know you have other
obligations. But I would say that you are welcome through any
part of this hearing today to come up here, sit next to me, and
ask questions or participate in any way you want. That
invitation is open at any point to you.
Senator Dorgan. Well, I will not wear out my welcome. But
thank you for the courtesy of allowing me to come today.
Senator Hagel. Thank you.
Now we would ask the second panel to come forward. We have
Mr. West and Ms. Paull.
In the interest of full disclosure, I should tell you that
this morning at our hearing on China--I don't know if it had
anything to do with this subject matter--about halfway through
the hearing all of the glasses with ice were immediately
retrieved. The reason for that, after I asked Cheryl why this
was done, is because there was glass in the ice. Again, in the
interest of full disclosure and what is good for your health, I
would tell you that I presume we have no glass in the ice
today.
So there you are. If you prefer something else, we will get
you whatever else you need.
Now, after I have given a sampling of your glittering
backgrounds and resumes, let me ask you to proceed.
Mr. West, we will begin with you. I thank you both for
coming.

STATEMENT OF PHILIP R. WEST, INTERNATIONAL TAX COUNSEL,
DEPARTMENT OF THE TREASURY

Mr. West. Thank you, Mr. Chairman. My name is Philip West
and I am the Treasury Department's International Tax Counsel.
I am pleased today to appear before the committee to
recommend 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, particularly our multinational businesses doing
business around the world as well as benefits to our treaty
partners. The Treasury appreciates the committee's interest in
these agreements and requests the committee and the Senate take
prompt and favorable action on all of these agreements.
Mr. Chairman, the United States can be proud of our efforts
in the tax treaty area. As you pointed out, we have a broad
treaty network, including treaties with all 28 of our fellow
members of the OECD. Our treaties cover the vast majority of
trade and investment by U.S. companies abroad, and we meet
regularly with members of the U.S. business community regarding
their priorities and the practical problems they face with
respect to particular countries.
We are expanding our treaty network and we are focused on
renegotiating our older treaties. Since the beginning of 1993,
we have replaced our oldest treaties with Sweden, The
Netherlands, Ireland and Switzerland, and the Denmark treaty,
which you have before you today, will replace what is currently
the oldest of our income tax treaties still in force.
The treaties and the protocol before the committee today
represent a cross section of our tax treaty program, as you
have observed. We have treaties with developing countries in
Latin America, Eastern Europe and the former Yugoslavia, as
well as treaties with the developed world.
These treaties, like all of our treaties, allocate taxing
rights between the United States and our treaty partners when
both might claim jurisdiction to tax the same item of income.
As such, they remove impediments to international trade and
investment by reducing the threat of double taxation. Although
the domestic tax legislation of the United States furthers
these same general objectives, a treaty goes beyond what
domestic legislation can achieve. A treaty can address the
unique aspects of other countries' laws and the way they
interact with ours. A treaty can also modify the domestic law
of each country as it applies to income flowing between the
treaty partners.
I would like to give you a few examples of how the treaties
can operate to provide these benefits. All of the treaties
contain mechanisms for resolving double tax problems, not
otherwise resolved on the face of our treaties. The transfer
pricing disputes that Senator Dorgan referred to are capable of
resolution under our competent authority mechanisms in our
treaties.
The proposed treaty with Italy, as a specific example, is
of great importance to the U.S. business community. It
addresses the creditability of a new Italian regional tax and
it generally lowers the withholding tax rates imposed by each
country.
Our proposed treaty with Venezuela also contains important
benefits. Among these are establishing and clarifying minimum
taxing threasholds, limiting the taxation of payments for
technical services, and insuring the deductibility of payments
by Venezuelan subsidiaries to their U.S. parents.
The proposed treaty with Venezuela is of special importance
because it represents a crucial step toward achieving our goal
of expanding our tax treaty network in Latin America.
I know that the committee has been alerted to a pending
change in Venezuela's income tax law through which Venezuela
will move to the U.S. standards for taxing international income
and begin taxing all of the worldwide income earned by its
residents, rather than only income determined under broad
sourcing rules to be connected with Venezuela.
The possibility that Venezuela would adopt this worldwide
approach was anticipated throughout our treaty negotiations and
we planned for it in drafting the treaty. After reading,
analyzing, and discussing drafts of the new law, we have
determined that the treaty will be at least as appropriate
under the new law as the old law.
The increased possibilities for double taxation that are
the natural result of this change in Venezuela's law will make
the treaty even more important than it would have been
previously.
Accordingly, we recommend that the committee approve the
treaty despite this change in Venezuela's law.
Our proposed treaty with Denmark also provides significant
benefits to taxpayers, for example, by providing certainty with
respect to the creditability of Denmark's hydrocarbons tax and
by reducing the threshold that taxpayers must meet in order to
qualify for a lower withholding tax on dividend payments.
Also in the Denmark treaty, we furthered our effort to curb
abuse of the treaty by adding important new treaty shopping
rules. The treaty shopping rules play a significant role in our
efforts to prevent tax avoidance and evasion and to insure that
treaty benefits flow only to the intended recipients.
Treasury shares the concerns expressed by this committee
and the Congress regarding treaty shopping, and we have taken a
leading role in developing anti-treaty shopping provisions and
encouraging other countries to adopt these provisions in their
treaties as well.
As we have pursued our goal of eliminating treaty shopping,
however, we have seen an increasing number of other
transactions that seek to use treaties to achieve inappropriate
results. Therefore, we have decided to include in two of the
treaties before you today, the most recently negotiated of all
the treaties before you, anti-abuse rules in addition to the
limitation on benefits provisions. These rules are found in our
proposed treaties with Italy and Slovenia, again, the most
recently negotiated.
Mr. Chairman, we can all agree on the need to curb abuse.
Therefore, any debate on the subject should center on what
measures are appropriate to that end. Although we understand
the concerns that have been raised regarding the measures
proposed here today, we believe that they represent an
appropriate step to curb abuse.
In this regard, it is important to keep in mind that our
tax treaties contain only benefits for taxpayers. They contain
no provisions that increase tax burdens and, as such, it is
appropriate to impose reasonable limits on those benefits to
curb abusive transactions that may be developed in the future.
These rules are being proposed as a result of several
concurrent developments in the international tax law. First,
although the overwhelming majority of taxpayers who avail
themselves of treaty benefits are entitled to those benefits
and are not engaged in abusive transactions, aggressive abuse
of treaties has increased.
Congress has twice in recent years taken the unusual step
of legislating against treaty abuse. Most recently, Congress
enacted section 894(c) to deny benefits in certain transactions
structured not only to eliminate double taxation, a legitimate
goal, but, if possible, to eliminate all taxation.
Several years earlier, Congress enacted section 7701(l),
providing Treasury with regulatory authority to curb treaty
abuse. This authority has been exercised to adopt a standard
very similar to that under consideration by the committee today
under which taxpayers have been operating for some years now,
apparently without significant difficulty.
The increase in treaty abuse has unfortunate results for
both Treasury and our taxpayers. It requires Treasury to devote
resources that otherwise could be spent expanding our treaty
benefits to curbing abuse.
The anti-abuse rules before you will address the abuse
problem while, at the same time, freeing up Treasury resources
to negotiate greater treaty benefits for our taxpayers.
We believe that the proposed rules will be more effective
than a narrower rule and we decided against a broader, more
subjective, anti-abuse rule both because it provides a less
certain standard against which taxpayers can evaluate their
transaction and because it is less consistent with
international norms.
We decided on these particular rules in our treaties
because, when we were considering what measures were
appropriate to curb treaty abuse, we observed that virtually
all of the other countries with which we were negotiating at
the time either had treaty anti-abuse precedents generally
consistent with the rules you have before you today, in the
case of the United Kingdom, Chile, and Korea, or, in the case
of Canada, it had already included in its treaty with the
United States an explicit recognition of the right to apply a
similar anti-abuse rules that was in force under its domestic
law.
In addition, other countries, such as Ireland and Mexico,
have agreed to a similar provision with each other, and the
rule has been included in more than 50 treaties, representing
approximately 40 different countries, including 10 OECD
members.
Therefore, because the proposed rule appears in a
significant number of treaties and promises to appear in more,
it will likely be the subject of more interpretive law than the
other standards and likely will provide greater certainty over
time than some of the alternatives.
We take additional comfort from the fact that the Internal
Revenue Code contains at least 2 dozen separate provisions that
use a very similar standard, whether one of the principal
purposes of a transaction is the avoidance of tax. Development
of the law under these code sections may also help provide
greater certainty regarding the rules proposed here today.
Finally, our competent authority process provides an
additional measure of comfort to U.S. businesses if these
provisions, which are included in treaties intended to last for
decades, are misused by our treaty partners. The long-lasting
nature of our treaties effectively prevents us from relying on
amendments to the treaties to eliminate abuses that will arise
in the future.
Moreover, relying on amendments to domestic law will invite
charges that our treaties are being over-ridden, such as were
made when section 894(c) was enacted.
For these reasons, the treaties should contain their own
mechanisms to combat abuse, such as the provision in the
treaties before you today.
Mr. Chairman, I would like to close by addressing Senator
Dorgan's comments. I want to address Senator Dorgan's comments
and clarify the Treasury position on these matters, as well as
some of the developments to which he has referred.
First of all, the NatWest case, to which he referred,
actually represents a favorable trend in the law compared to
the prior case that he was referring to, the NorthWest Life
case.
In the earlier case, there was a decision with which we
disagreed at the Treasury Department that had some broad
language that indicated that perhaps these sorts of formulas
that we include in our legislation and regulations on occasion
were inappropriate and improper under our treaties.
We believe a close reading of the more recent precedent,
the NatWest case, is narrower and would not lead to that
conclusion, and we are encouraged by the narrower scope of that
opinion.
We would also note that both opinions relied on
commentaries to the OECD model treaty. Those commentaries are
not, as Senator Dorgan suggested--that interpretation of those
commentaries is not something the Treasury Department supports.
The Treasury Department is working in this international forum
to modify those commentaries in an effort to achieve what we
believe is a more appropriate result under our treaties.
Finally, I would like to clarify that, in the Treasury
Department's view, nothing in our treaties would prohibit the
sort of formulas to which Senator Dorgan alluded. We do not
favor that approach currently and do not intend to pursue it,
but would like to make clear that, in our view, our treaties do
not prohibit those approaches.
In closing, Mr. Chairman, I would like to reiterate our
recommendation for favorable action on these agreements. I
respectfully request that my written statement be included in
the record and I would be glad to answer any questions that you
may have.
[The prepared statement of Mr. West follows:]

Prepared Statement of Philip R. West

Mr. Chairman and members of the Committee, I am pleased today to
recommend, on behalf of the Administration, favorable action on eight
bilateral tax treaties and protocols that the President has transmitted
to the Senate and that are the subject of this hearing. These
agreements would provide significant benefits to the United States, as
well as to our treaty partners. Treasury appreciates the Committee's
interest in these agreements as demonstrated by the scheduling of this
hearing, and requests that the Committee and the Senate take prompt and
favorable action on all of these agreements.
The treaties and protocols before the Committee today represent a
cross-section of the United States tax treaty program. There are new
agreements with three of our oldest treaty partners--new income tax
treaties with Denmark and Italy and a protocol to our estate tax treaty
with Germany--and five agreements--with Estonia, Latvia, Lithuania,
Slovenia and Venezuela--expand our treaty network in Latin America,
Eastern Europe, and the former Yugoslavia.
An active treaty program is important to the overall international
economic policy of the United States, and tax treaties have a
substantial positive impact on the after-tax profitability of United
States businesses that enter a treaty partners marketplace. This is an
obvious incentive to expand our treaty network to new treaty partners.
However, it also requires us to update our existing treaties. When
President Clinton took office, many important U.S. tax treaties were
nearly half a century old. Since the beginning of 1993, we have
replaced our tax treaties with Sweden, which dated from 1939, with The
Netherlands, which dated from 1948, with Ireland, which dated from
1949, and with Switzerland, which dated from 1951. The Denmark treaty,
which you are considering today, will replace the oldest of our income
tax treaties still in force, which was signed in 1948.
For these reasons, negotiating new treaties and updating existing
treaties take up a large amount of my staff's time. We believe,
however, that the investment of our resources is worthwhile because of
the benefits a modern treaty network brings both to taxpayers and to
the government. I'd like to speak now about these benefits.
benefits to taxpayers
An income tax treaty removes impediments to international trade and
investment by reducing the threat of ``double taxation'' that can occur
when both countries impose tax on the same income. Four different
aspects of this general goal illustrate the point. First, an income tax
treaty generally increases the extent to which exporters can engage in
trading activity in the other country without triggering tax. Second,
when taxpayers do engage in a sufficient amount of activity for tax to
be imposed, the treaty establishes rules that assign to one country or
the other the primary right of taxation with respect to an item of
income, that help ensure the allowance of appropriate deductions and
that reduce withholding tax on payments of income to the treaty
beneficiary. Third, the treaty provides a dispute resolution mechanism
to prevent double taxation that sometimes can arise in spite of the
treaty. Finally, the treaty helps to create stability of tax rules that
the private sector needs if its member are to be confident in their
projections of an investment's return.
Although the domestic tax legislation of the United States and
other countries in many ways is intended to further the same general
objectives as our treaty program, a treaty goes beyond what domestic
legislation can achieve. Legislation cannot easily take into account
differences among other countries' rules for the taxation of particular
classes of income and how those rules interact with United States law.
Legislation also cannot reflect variations in the United States'
bilateral relations with our treaty partners. A treaty, on the other
hand, can make useful distinctions, and alter in an appropriate manner
the domestic statutory law of both countries as it applies to income
flowing between the treaty partners. Examples in the treaties before
you include reductions in statutory withholding tax rates and the
creditability of the Italian tax known as the IRAP.
One of the principal ways in which double taxation is eliminated is
by assigning primary taxing jurisdiction in particular factual settings
to one treaty partner or the other. In the absence of a treaty, a
United States company operating a branch or division or providing
services in another country might be subject to income tax in both
countries on the income generated by such operations. The resulting
double taxation can impose an oppressive financial burden on the
operation and might well make it economically non-viable.
For example, lesser developed countries frequently assert much
broader taxing jurisdiction than the United States does. In the absence
of a treaty, they might well tax a foreign corporation on income from
business activities even if the activities conducted in the other
country are relatively negligible or, in some cases, if the payor of
the income is a resident of the developing country without regard to
whether any activities take place within its territory. In many cases,
the country will not allow the foreign corporation to deduct business
expenses relating to such income. Finally, the foreign corporation may
not be able to plan its activities in such a way as to avoid the tax
because the rules that establish the taxation threshold under the
country's domestic laws may not be clear. If the economic activities
that give rise to the income take place in the United States, we would
view the income as being from U.S. sources. In cases where a foreign
corporation taxes income that we view as U.S.-source, the effect of the
U.S. tax rules may be to deny a foreign tax credit in whole or in part
(depending on the U.S. corporation's overall foreign tax credit
situation).
Tax treaties help to resolve these situations by establishing the
minimum level of economic activity that a resident of one country must
engage in within the other before the latter country may tax the
resulting business profits. The tax treaty lays out ground rules
providing that one country or the other, but not both, will have
primary taxing jurisdiction over branch operations and individuals
performing services in the other country. In general terms, the treaty
provides that if the branch operations have sufficient substance and
continuity and, accordingly, sufficient economic penetration, the
country where the activities occur will have primary (but not
exclusive) jurisdiction to tax. In other cases, where the operations
are relatively minor, the home country retains the sole jurisdiction to
tax.
Under these treaty rules, United States manufacturers may test a
market by establishing a foreign presence through which products are
sold without subjecting themselves to foreign tax, including
compliance, rules. Generally, if the market proves promising, the
company will establish a more substantial operation which would become
subject to tax in the other country. Similarly, United States residents
generally may live and work abroad for short periods without becoming
subject to the other country's taxing jurisdiction; if they stay
longer, however, they would become subject to tax on the income derived
in the other country or, ultimately, might even become subject to
taxation as residents. These rules, the permanent establishment and
business profits rules and analogous provisions for individuals, not
only eliminate in many cases the difficult task of allocating income
and tax between countries but also serve to encourage desirable trade
activities by eliminating or reducing what can often be complex tax
compliance requirements.
High withholding taxes at source can be an impediment to
international economic activity. Under United States domestic law, all
payments to non-United States persons of dividends and royalties as
well as certain payments of interest are subject to withholding tax
equal to 30 percent of the gross amount paid. Inasmuch as this tax is
imposed on a gross rather than net amount, it imposes a high cost on
investors receiving such payments. Indeed, in many cases the cost of
such taxes can be prohibitive as a 30 percent tax on gross income often
can exceed 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 we
realize our policy of reducing withholding rates 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 significant reductions with countries
where the flows tend to be disproportionately in favor of the United
States.
The benefits of tax treaties are not limited to business profits
earned by companies. Treaties remove tax impediments to desirable
scientific, educational, cultural and athletic interchanges,
facilitating our ability to benefit from the skills and talents of
foreigners including world-renowned rock stars, symphony orchestras,
astrophysicists and Olympic athletes. In fact, treaty benefits are not
limited to profit-making enterprises but extend to pension plans,
Social Security benefits, charitable organizations, researchers and
alimony and child support recipients.
The rules provided in the treaty frequently do not explicitly
address every future development. This may be because the international
community has not yet reached a consensus on the appropriate standard
for taxation. For example, the international community may take some
time to reach a consensus on the appropriate taxation standard with
respect to the area of communications technology. This is an area in
which international cooperation is vitally important. To address these
issues, our proposed treaties with Estonia, Latvia and Lithuania,
require the parties to consult within five years after the treaties
enter into force concerning the taxation of income from new
technologies. This period was chosen because of the possibility that an
international standard might emerge within that time that both
Contracting States would want to consider adopting. In fact, the
Organization for Economic Cooperation and Development (``OECD''),
recognized as the leading international forum to consider developments
such as these, is considering these issues today. Until resolution is
reached, the treaties with the Baltic countries provide that income of
a resident of one country from transmission by satellite, cable, optic
fiber and similar technologies will not be taxable in the other country
unless the resident has a permanent establishment in the other country.
We rejected an approach that would have taxed this income like a
royalty, subject to withholding.
Even with constant monitoring, there will be cases in which double
taxation occurs in spite of the treaty. In such cases, the treaty
provides mechanisms enabling the tax authorities of the two
governments--known as the ``competent authorities'' in tax treaty
parlance--to consult and reach an agreement under which the taxpayer's
income is allocated between the two taxing jurisdictions on a
consistent basis, thereby preventing the double taxation. The U.S.
competent authority under our tax treaties is the Secretary of the
Treasury. Currently, that function is delegated to the Assistant
Commissioner (International) of the Internal Revenue Service.
One of the most common situations in which this type of agreement
may be necessary is in the area of ``transfer pricing.'' If a
multinational manipulates the prices charged in transactions between
its affiliates in different countries, the income reported for tax
purposes in one country may be artificially depressed, and the tax
administration of that country will collect less tax from the
enterprise than it should. In theory, the multinational would plan its
transactions to ensure that its income is reported in the jurisdiction
with the lowest effective tax rate. It is this possibility that makes
transfer pricing one of the most important international tax issues.
If this potential tax avoidance (and the potential for double
taxation) is to be avoided, it is necessary to have a benchmark by
which to evaluate the prices charged. The benchmark adopted by the
United States and all our major trading partners is the arm's-length
standard. Under the arm's-length standard, the price charged should be
the same as it would have been had the parties to the transaction been
unrelated to one another--in other words, the same as if they had
bargained at ``arm's-length.'' This requires an analysis of the
functions performed, resources employed and risks assumed by each
party, to make sure each party is adequately compensated for those
functions, resources and risks in light of the contractual terms and
other relevant economic circumstances of the transaction. If taxpayers
and tax administrators can find similar transactions that took place
between unrelated parties, they begin the inquiry by analyzing those
transactions to see whether the functions, resources and risks of each
party are comparable to those in the related party transaction.
In more and more cases, it is difficult or impossible to find a
uniquely comparable transaction. This may be because the transactions
between related parties are highly specialized or involve unique
intangibles, or, as in the case of certain kinds of global securities
trading, the functions are so highly integrated that there is a single
profit center and no transactions are ever booked between the separate
entities. In those cases, it will not be possible to apply
``traditional transactional methods.'' Instead, taxpayers and tax
administrators will have to perform the functional analysis required by
the arm's-length approach, but will use transactional profits methods,
such as the comparable profits method or the profit-split method, in
order to compensate the entities for the functions performed, resources
employed and risks assumed. The Internal Revenue Service developed
transactional profits methods in the 1980's because it saw that it
would not always be possible to use traditional transactional methods.
These methods, including the use of multi-factor formulas in
appropriate cases, were found by the OECD to be an acceptable
application of the arm's length standard, at least as a method of last
resort, in the Transfer Pricing Guidelines issued in 1995 and its
report on Global Trading of Financial Instruments in 1998. We have
seen, and expect to continue to see, increasing acceptance of these
profits-based approaches in the coming years, speeded by the increase
in globally-integrated businesses that will become possible as a result
of improvements in telecommunications technology.
Perhaps because of globalization, there has also been an increased
focus in recent years on the taxation of branches (known as ``permanent
establishments''). Treaties use the same arm's length standard to
determine the profits attributable to a permanent establishment. Many
of the legal developments that have occurred in the context of the
taxation of separate legal entities, however, have not yet been
extrapolated to the branch situation. Because the commentaries to the
relevant parts of the OECD model tax treaty have not yet been revised
to reflect current thinking regarding profit splits, taxpayers have
taken inconsistent approaches in the context of permanent
establishments. One recent court case suggests that it is not possible
to use profits-based methods in determining the business profits
attributable to a permanent establishment, and that the tax
administrator is required to respect the income shown on the books of
the branch, except in ``exceptional circumstances,'' a much higher
standard than applies when adjusting the income of separate legal
entities. A more recent case would allow the administrators to adjust
the branch books to reflect an arm's length result, but does not
provide any guidance on how that is to be accomplished.
We believe that an international consensus eventually will develop
around the proposition that any of the methods that are acceptable for
transfer pricing between related entities will also be acceptable in
the context of allocating income between branches of a single entity.
The United States has already adopted this approach in the context of
global dealing of financial instruments, both in advance pricing
agreements and by regulation, as has the OECD in its report on Global
Trading in Financial Instruments. It has done so by sanctioning the use
of multi-factor formulas to allocate income from global trading
activity under one common trading model--the ``functionally fully-
integrated'' model.
prevention of tax avoidance and evasion
The foregoing aspects of our tax treaties involve benefits to
taxpayers. While providing these benefits certainly is a major purpose
of any tax treaty, it is not the only purpose. The second major
objective of our income tax treaty program is to prevent tax avoidance
and evasion and to ensure that treaty benefits flow only to the
intended recipients. Tax treaties achieve this objective in several
ways. They provide for exchange of information between the tax
authorities. They contain provisions designed to ensure that treaty
benefits are limited to bona fide residents of the other treaty country
and not to ``treaty shoppers.'' And two of the treaties before you
reflect one version of an anti-abuse rule that set limits on aggressive
tax avoidance transactions using treaties.
Under the tax treaties, the competent authorities are authorized to
exchange information, including confidential taxpayer information, as
may be necessary for the proper administration of the countries' tax
laws. This aspect of our tax treaty program is one of the most
important features of a tax treaty from the standpoint of the United
States. The information that is exchanged may be used for a variety of
purposes. For instance, the information may be used to identify
unreported income or to investigate a transfer pricing case. In recent
years information exchange has become a priority for the United States
in its tax treaty program. If a country has bank secrecy rules that
prevent or seriously inhibit the exchange of information under the tax
treaty, we will not conclude a treaty with it. In fact, we generally do
not even negotiate with such countries. Information exchange is one of
the handful of issues that we discuss with the other country before
beginning formal negotiations because it is one of a very few issues
that we consider non-negotiable. This has, of course, prevented us from
entering into treaties with some countries with which we have
significant economic ties, but we believe that it is the right policy.
Recent technological developments which facilitate international,
and anonymous, communications and commercial and financial activities
can also encourage illegal activities. Over the past several years we
have experienced a marked and important sea change as many of the
industrialized nations have recognized the increasing importance of tax
information exchange; the absence thereof serves to encourage not only
tax avoidance and evasion, but also criminal tax fraud, money
laundering, illegal drug trafficking, and other criminal activity.
Treasury is proud of the role it has played in moving these issues
forward not only in our bilateral treaty negotiations but also in other
fora such as the OECD.
A second aspect of U.S. tax treaty policy to deal with avoidance
and evasion is to include in all treaties comprehensive provisions
designed to prevent ``treaty shopping.'' This abuse of the treaty can
take a number of forms, but it generally involves a resident of a third
state that has either no treaty with the United States or a relatively
unfavorable one establishing an entity in a treaty partner that has a
relatively favorable treaty with the United States. This entity is used
to hold title to the person's United States investments, which could
range from portfolio stock investments to major direct investments or
other treaty-favored assets in the United States. By placing the
investment in the treaty partner, the third-country person is able to
withdraw the returns from the United States investment subject to the
favorable rates provided in the tax treaty, rather than the higher
rates that would be imposed if the person had invested directly into
the United States. Of course, the tax imposed by the treaty partner on
the intermediate entity must be relatively low, or the structure will
not produce tax savings that justify the added transaction costs.
This Committee and the Congress have expressed strong concerns
about treaty shopping, and the Treasury Department shares those
concerns. Our treaty program is designed to give benefits to residents
and, if applicable, nationals of our treaty partner. Treaty shopping
represents an abusive attempt to siphon benefits to others. Moreover,
if treaty shopping is allowed to occur, then there is less incentive
for the third country with which the United States has no treaty to
negotiate a treaty with the United States. The third country can
maintain inappropriate barriers to United States investment and trade,
and yet its companies can obtain the benefits of lower U.S. tax by
organizing their United States transactions so that they flow through a
country with a favorable United States tax treaty.
For these reasons, the United States has taken a leading role in
developing anti-treaty-shopping provisions and encouraging other
countries to adopt the provisions in their treaties. The Department of
the Treasury has included in all its recent tax treaties comprehensive
``limitation on benefits'' provisions that limit the benefits of the
treaty to bona fide residents of the treaty partner. These provisions
are not uniform, as each country has its own characteristics that make
it more or less inviting to treaty shopping in particular ways.
Consequently, each provision must to some extent be tailored to fit the
facts and circumstances of the treaty partners' internal laws and
practices. Moreover, the provisions need to strike a balance that
avoids interfering with legitimate and desirable economic activity.
As we have pursued our goal of updating our existing treaties to
eliminate treaty-shopping abuses, however, we have seen an increasing
number of other types of transactions that seek to use treaties to
achieve inappropriate results. Therefore, we have decided to include in
our treaties relatively modest anti-abuse rules in addition to the
limitation on benefits provision. In the treaties before you, these
rules are found only in the treaties with Italy and Slovenia, because
the others were substantially negotiated before this change in our
policy.
As described above, anti-treaty shopping rules are now firmly
entrenched in our treaty policy, in part as a result of concerns raised
by the Committee. The anti-abuse rules before you are complementary to
these anti-treaty shopping rules. Anti-treaty shopping rules take the
broad approach of denying all treaty benefits to persons who are not
bona fide residents of the treaty country. Anti-abuse rules such as
those before you are more targeted in the sense that they are not
blanket exclusions from all treaty benefits; they deny specific treaty
benefits in abuse cases.
These rules have been included in our treaties because of several
concurrent developments in international tax law. First, although the
overwhelming majority of taxpayers who avail themselves of treaty
benefits are entitled to those benefits and are not engaged in abusive
transactions, aggressive abuse of treaties has increased. As evidence
of this trend one need only observe that Congress has twice in recent
years taken the unusual step of legislating against treaty abuse. Most
recently, Congress enacted section 894(c) to deny benefits to certain
taxpayers that are not excluded from our treaties under limitation on
benefits provisions. Congress also enacted section 7701(l), providing
the Treasury with a broad grant of regulatory authority to curb treaty
abuse. This authority has been exercised to adopt a standard very
similar to that under consideration by you today, under which taxpayers
have been operating for some years now, apparently without significant
difficulty. (The commentary to Article 1 of the OECD model tax treaty
and the OECD Report on Harmful Tax Competition make clear that
countries can impose their domestic anti-abuse rules to claims for
treaty benefits.)
A second development contributed to the decision to include these
rules in our treaties. We observed that Italy had just concluded a
treaty containing a broader but more subjective anti-abuse rule. We
then observed that virtually all of the other countries with which we
were negotiating at the time either had treaty anti-abuse precedents
generally consistent with the rule you have before you (the United
Kingdom, Chile and Korea) or, in the case of Canada, had already
included in its treaty with the United States an explicit recognition
of the right to apply a similar anti-abuse rule that was in force under
its domestic law. In addition, other countries such as Ireland and
Mexico had agreed to a similar provision with each other and other
countries such as Israel were consistently seeking even broader
provisions. The rule has been included in more than 50 treaties,
representing approximately 40 different countries (including 10 OECD
members). In fact, concerns about the adequacy of current treaty rules
to prevent abuses have stimulated work in the OECD on this subject. As
one of the more common approaches to achieving such an objective, rules
such as those before you today are obviously part of that work.
The increase in treaty abuse has unfortunate results for both
Treasury and our taxpayers: it requires Treasury to divert resources to
fighting abuse that it might otherwise devote to improving our treaty
network. The emergence internationally of anti-abuse rules such as
those before you provides a win-win solution. They help address the
abuse problem, while at the same time freeing up Treasury resources to
provide greater benefits for U.S. taxpayers. As such, the question
became not whether an anti-abuse rule was appropriate, but which anti-
abuse rule was appropriate. Treasury rejected a narrower anti-abuse
rule because of its ineffectiveness. Treasury also rejected a broader
more subjective anti-abuse rule for several reasons. First, it provided
a less certain standard against which a taxpayer could meaningfully
evaluate its transaction. Second, since the narrower rule before you
appears in a significant number of treaties around the world, and
promises to appear in more, it is more consistent with international
norms and will likely be the subject of more interpretive law than the
other standards.
As such, the proposed rule should provide greater certainty over
time than some of the alternatives. Nevertheless, we are aware of
concerns that the proposed anti-abuse rules will provide uncertainty
for taxpayers. The test incorporated in the rule does require taxpayers
and their advisors to make some judgements. This standard creates no
more uncertainty, however, than other U.S. tax doctrines that may also
apply to the transaction under consideration, such as the business
purpose and step transaction doctrines. And, as the commentary to the
OECD model treaty makes clear, even if our treaties are silent
regarding abuse, other countries may apply their own internal anti-
abuse doctrines to U.S. taxpayers' claims for treaty benefits, whether
we have explicitly agreed to those standards or not.
Our treaties are intended to last decades before re-negotiation.
Therefore, relying on treaty amendments to eliminate abuses that arise
in the future will invariably prove inadequate. Moreover, relying on
amendments to domestic law will invite charges that the treaty is being
overridden, as were made when section 894(c) was enacted. For these
reasons, the treaties should contain their own mechanisms to combat
abuse, such as the provisions in the treaties before you today. In this
regard, it is important to keep in mind that our tax treaties contain
only benefits for taxpayers, and no provisions that increase tax
burdens. As such, it is appropriate to impose reasonable limits on
those benefits to curb abusive transactions that may be developed in
the future.
treaty program and negotiation priorities
Given all of these benefits to taxpayers and the government, an
obvious question is why we do not have a tax treaty with every country.
The answer is slightly different for each potential treaty partner, but
there are some general themes. In establishing priorities, we keep in
mind the two principal objectives of tax treaties--to prevent both
double taxation and tax avoidance and evasion.
The United States has a network of 50 bilateral income tax
treaties, the first of which was negotiated in 1939. Although that
number is somewhat lower than the number of treaties that some other
countries have, it is important to note that the network includes all
28 of our fellow members of the OECD and covers the vast majority of
trade and investment by U.S. companies abroad. For the past decade, the
Treasury Department has given priority to renegotiating older treaties
to ensure that they reflect current United States treaty policy,
particularly with respect to anti-abuse provisions and information
exchange.
As demonstrated by the mix of treaties being considered today, the
progress we have made at updating old conventions has given us the
opportunity to focus on expanding our treaty network. In this, our
primary concern is to conclude treaties or protocols that are likely to
provide the greatest benefits to United States taxpayers, such as when
economic relations are hindered by substantial tax obstacles. We meet
regularly with members of the U.S. business community regarding their
priorities and the practical problems they face with respect to
particular countries. We are proud of our efforts in the treaty area,
and believe that our record of accomplishment here is as strong as that
of any other administration in recent memory.
Even when business identifies problems that could be resolved by
treaty, however, a treaty may not be appropriate for a variety of
reasons. Despite the protections of the limitation on benefits
provisions and anti-abuse rules, there may be countries with which we
choose not to have a tax treaty because of the possibility of abuse.
Other countries may not present us with sufficient tax problems that
are best resolved by treaty. For example, we generally do not conclude
tax treaties with jurisdictions that do not impose significant income
taxes, because there is little danger of double taxation of income in
such a case. In such cases, particularly with Caribbean Basin
countries, we have offered to enter into an agreement limited to the
exchange of tax information, which furthers the goal of reducing tax
avoidance and evasion without creating other opportunities for abuse.
However, the situation can become more complex when a country
adopts a special regime for certain parts of the economy while the rest
of its residents are subject to substantial taxation. It might be
considered inappropriate to grant treaty benefits to companies taking
advantage of such regimes, while a treaty relationship might be useful
and appropriate in order to avoid double taxation in the case of the
residents who are subject to substantial taxation. Accordingly, in some
cases we have devised treaties that carve out from the benefits of the
treaties certain residents and activities. The anti-treaty shopping
provisions in our treaty network prevent investors from enjoying the
benefits of a tax-haven regime or preferential tax regime in their home
country and, at the same time, the benefits of a treaty between the
United States and another country. The recent OECD report on Harmful
Tax Competition recommends that member countries adopt similar
policies, and not enter into tax treaties with tax havens. The report
also directed the group within the Committee on Fiscal Affairs that is
responsible for the OECD Model treaty to consider various additions to
the Model that are intended to prevent abuse of tax treaties.
Prospective treaty partners also have to indicate that they
understand their obligations under the treaty, including with respect
to information exchange, and demonstrate that they are able to comply
with those obligations. Sometimes they are unable to do so. In other
cases we may feel that a treaty is inappropriate because a treaty
partner may be unwilling to deal with the tax problems that have been
identified by business. Lesser developed and newly emerging economies,
where capital and trade flows are often disproportionate or virtually
one-way, may not be willing to reduce withholding taxes to a level that
will eliminate double taxation because they feel that they cannot give
up scarce tax revenues. None of the new treaties that we have asked you
to consider today are in that class. All are with countries that showed
a willingness to reduce or eliminate withholding taxes or other
impediments to investment.
Most of the emerging economies with which we have had successful
treaty discussions--including those whose treaties we present today--
have been active participants in the training and outreach programs run
by the Treasury Department, the Internal Revenue Service and the OECD.
These programs are a wise investment as they help to ensure that all
parties understand the international norms that are represented by
these agreements. We have every reason to believe that these programs
will continue to increase the number of countries--particularly in
Eastern Europe and Latin America--that are ready to enter into mutually
advantageous treaties with us. In many cases, the existence of a treaty
that lowers taxation of trade and investment will help to establish
economic ties that will contribute to the country's stability and
independence, as well as improve its political relationships with the
United States.
The primary constraint on the size of our treaty network, however,
may be the complexity of the negotiations themselves. The various
functions performed by tax treaties, and particularly the goal of
meshing two different tax systems, makes the process of negotiation
quite time-consuming.
A nation's tax policy, as reflected in its domestic tax legislation
as well as its tax treaty positions, reflects the sovereign choices
made by that country in the exercise of one of its most important
governmental functions, that of funding the government. Numerous
features of the treaty partner's unique tax legislation and its
interaction with United States legislation must be considered in
negotiating an appropriate treaty. Examples include whether the country
eliminates double taxation through an exemption or a credit system,
whether the country has bank secrecy legislation that needs to be
modified by treaty, the treatment of partnerships and other transparent
entities, and how the country taxes contributions to pension funds, the
funds themselves and distributions from the funds. A negotiated treaty
needs to take into account all of these and many other aspects of the
treaty partner's tax system in order to arrive at an acceptable treaty
from the perspective of the United States. Accordingly, a simple side-
by-side comparison of two actual treaties, or of a proposed treaty
against a model treaty, will not enable meaningful conclusions to be
drawn as to whether a proposed treaty reflects an appropriate balancing
of interests. In many cases the differences are of little substantive
importance, reflecting language problems, cultural obstacles or other
impediments to the use of particular U.S. or OECD language.
In addition to keeping in mind that each treaty must be adapted to
the individual facts and circumstances of each treaty partner, it also
is important to remember that each treaty is the result of a negotiated
bargain between two countries that often have conflicting objectives.
Each country has certain issues that it considers non-negotiable. The
United States, which insists on effective anti-abuse and exchange-of-
information provisions, and which must accommodate its uniquely complex
internal laws, probably has more non-negotiable issues than most
countries. For example, each of the full treaties before the Committee
today allows the United States to impose our branch profits tax and
branch-level interest tax at the rates applicable to direct dividends
and interest, respectively, paid to related parties. All of them also
reflect our new policy with respect to dividend distributions from real
estate investment trusts, except for the treaties with Estonia, Latvia
and Lithuania, which were fully negotiated before the change in policy.
They also include the ``saving clause,'' which permits the United
States to tax its citizens and residents as if the treaty had not come
into effect, and allow the United States to apply its rules dealing
with former citizens and long-term residents and with investments in
U.S. real property interests.
Obtaining the agreement of our treaty partners on these issues
sometimes requires other concessions on our part. Similarly, other
countries sometimes must make concessions to obtain our agreement on
issues that are critical to them. Eventually, the process of give-and-
take produces a document that is the best treaty that is possible with
that other country. In many cases, the process ends there, as the
Administration decides that the treaty does not further the interests
of the United States enough to justify the necessary compromises. These
treaties never make it to this Committee. Accordingly, each treaty that
we present here represents not only the best deal that we believe we
can achieve with the particular country at this time, but also
constitutes an agreement that we believe is in the best interests of
the United States. The technical explanations which accompany our
treaty, the discussions with the staffs of this Committee and its
members, and the staffs of the tax-writing Committees, and most
importantly, hearings such as this, will provide the Senate with the
assurance that a particular treaty is, overall, in the best interests
of the United States.
discussion of treaties and protocols
Each of the treaties before you today reflects the basic principles
of current United States treaty policy. The provisions in each treaty
borrow heavily from recent treaties approved by the Senate and the U.S.
model and are generally consistent with the 1992 OECD Model Income Tax
Convention, as subsequently amended. The United States was and
continues to be an active participant in the development of the OECD
Model, and we are generally able to use most of its provisions as a
basis for negotiations.
The U.S. model was published in September 1996. A model treaty is a
useful device if used properly and kept current. In the course of the
negotiation of these treaties, we discovered that certain provisions of
our model treaty could be improved upon, and we did so in these
agreements. Many of these improvements have become part of the document
that we use to begin negotiations and we expect that they will be
reflected in a new version of the U.S. model that will be published in
the future.
There are no major inconsistencies between the U.S. and OECD
models, but rather the U.S. model elaborates on issues in which the
United States may have a greater interest or which result from
particular aspects of United States law and policy. For example, our
limitation of benefits provisions are generally not found in typical
tax treaties of other OECD countries. We have also found it useful to
expand on treaty coverage and treatment of pass-through entities such
as our limited liability companies. Despite the importance we attach to
the OECD model and our continuing efforts with our colleagues to
improve it and keep it current, most countries cannot accede to all of
the provisions of that model, nor do we expect that all of our
prospective treaty partners will agree with all of the provisions of
our model. The primary benefit of the U.S. Model is that it enables all
interested parties, including this Committee and the Congress and its
staffs, the American business community, and our prospective treaty
partners, to know and understand our treaty positions. We do not
anticipate that the United States will ever sign a tax convention
identical to the model; there are too many variables.
Nevertheless, there are some basic provisions that are found in all
of the treaties. These include provisions designed to improve the
administration both of the treaty and of the underlying tax systems,
including rules concerning exchange of information, mutual
administrative assistance, dispute resolution and nondiscrimination.
Each treaty permits the General Accounting Office and the tax-writing
committees of Congress to obtain access to certain tax information
exchanged under treaty for use in their oversight of the administration
of United States tax laws and treaties. Each treaty also contains a
now-standard provision ensuring that tax discrimination disputes
between the two nations generally will be resolved within the ambit of
the tax treaty, and not under any other dispute resolution mechanisms,
including the World Trade Organization (WTO).
Finally, some treaties will have special provisions not found in
other agreements. These provisions account for unique or unusual
aspects of the treaty partner's internal laws or circumstances. For
example, many well-known Danish multinational companies are owned in
part by ``taxable non-stock corporations.'' If the treaty had not
included special rules for taxable non-stock corporations, the
multinationals might not have qualified for full treaty benefits, even
though they clearly are not treaty-shopping. These rules had to be
tailored to the Danish law and the specific manner in which the taxable
non-stock corporations operate, without violating any of the basic
principles underlying our limitation on benefits provisions. The
flexibility we bring to the table should be regarded as a strength
rather than a weakness of the tax treaty program, since it is these
differences in the treaties which enable us to reach agreement and
thereby reduce taxation at source, prevent double taxation and increase
tax cooperation.
I would like to discuss the importance and purposes of each
agreement that you have been asked to consider. We have submitted
Technical Explanations of each agreement that contain detailed
discussions of each treaty and protocol. These Technical Explanations
serve as an official guide to each agreement. We have furnished our
treaty partners with a copy of the relevant technical explanation and
offered them the opportunity to submit their comments and suggestions.
The Baltic Treaties--Estonia, Latvia and Lithuania
I would now like to turn to the three treaties colloquially known
as the ``Baltic Treaties.'' Since gaining independence from the Soviet
Union at the beginning of this decade, the three Baltic States--
Estonia, Latvia and Lithuania--have actively pursued reforms aimed at
economic stabilization and market strengthening. These reforms have
placed Estonia in the first wave of Central and East European
applicants to the European Union, while Latvia and Lithuania are
currently under consideration by the EU for promotion to this first
wave. Economic performance in all three countries over the past several
years has been among the best in the region.
Entering into these treaties is an important element in our current
tax treaty program and is a high priority with the U.S. business
community. Without the current treaty, U.S. businesses are at a
competitive disadvantage in the Baltics, since many of their
competitors are from countries that have concluded a tax treaty with
them. Under the proposed Conventions, the Baltic States taxation of
U.S. operations would decrease on direct investment dividends,
copyright royalties (including software), royalties on the right to use
equipment, and interest paid on loans guaranteed by the U.S. Export-
Import Bank. In addition, the proposed Convention would provide U.S.
business a greater degree of certainty, protection against
discriminatory tax practices and the ability to resolve potential
double taxation cases and other disputes.
Although these Conventions were largely negotiated at joint
sessions, these are, of course, three separate treaties with three
separate, sovereign nations. I will, therefore, deal with each of the
three separately. In general, however, it should be noted that none of
the three deviates substantially from any of our more recent treaties.
Estonia
Let me first deal with Estonia. The treaty does differ from other
recent U.S. treaties in a number of respects. I will now highlight some
of these differences as well as other important provisions of the
treaty.
First, in respect of the taxation of investment income. The
withholding rates under the treaty are in some respects higher than
those in the U.S. Model and in many recent U.S. treaties with OECD
countries. The rates are the same as in many Estonian treaties. Under
the treaty dividends are subject to taxation at source in the same
manner as under the U.S. Model. Direct investment dividends are subject
to withholding tax at source at a maximum 5 percent rate, and portfolio
dividends are taxable at a maximum 15 percent rate. The treaty requires
a 10 percent ownership threshold for application of the 5 percent tax
rate.
The treaty provides for a maximum 10 percent rate of tax at source
on most interest payments. Interest earned on trade credits, and on
government debt, including debt guaranteed by government agencies
(e.g., the U.S. Export-Import Bank) is exempt from tax at source.
Royalties for the use of industrial, commercial or scientific
equipment are subject to a 5 percent tax at source. All other royalties
(including payments for the use of software, other than off-the-shelf
software) are taxed at a maximum rate of 10 percent.
In relation to the taxation of business income, consistent with the
U.S. and OECD Models, the treaty provides generally for the taxation by
one State of the business profits of a resident of the other only when
such profits are attributable to a permanent establishment located in
that other State. The treaty, however, includes an anti-abuse rule that
would allow the source state to tax sales or activities performed by
the enterprise outside the United States as if they were performed by a
permanent establishment if it is ascertained that such activities were
structured with the intention to avoid taxation in the State where the
permanent establishment is situated.
The treaty, consistent with current U.S. treaty policy, provides
for exclusive residence-country taxation of profits from international
carriage by aircraft and ships. This reciprocal exemption also extends
to income from the rental of aircraft, ships and containers if the
rental activity is incidental to the operation of aircraft and ships by
the lessor in international traffic. However, income from the
international rental of ships and aircraft that is non-incidental to
operation of ships and aircrafts is taxed at a 5 percent rate as a
royalty paid for the rental of equipment.
Income from the use or rental of containers that is non-incidental
to the operation of ships or aircraft in international traffic is
treated as other income. Therefore, non-incidental leasing of
containers by U.S. businesses is taxable only in the United States.
With regard to the taxation of personal services income, the
taxation of income from the performance of personal services under the
treaty is generally similar to that under the U.S. Model, but, like
some U.S. treaties with developing countries, it grants a taxing right
to the host country with respect to certain categories of personal
services income that is somewhat broader than in the OECD or U.S.
Model.
The limitation on benefits provisions are similar to those found in
the U.S. Model and in all recent U.S. treaties.
The exchange of information provisions generally follow the U.S.
Model and make clear that Estonia is obligated to provide U.S. tax
officials such information as is necessary to carry out the provisions
of the treaty.
The treaty provides a U.S. foreign tax credit for the Estonian
income taxes covered by the treaty, and a Estonian foreign tax credit
for the U.S. income taxes covered by the treaty.
The treaty will enter into force after each State has notified the
other that it has completed its ratification requirements. It will have
effect, with respect to taxes withheld at the source, for amounts paid
or credited on or after the first day of January of the calendar year
next following the year in which the treaty enters into force. In other
cases the treaty will have effect with respect to taxable years
beginning on or after the first day of January of the calendar year
next following the year in which the treaty enters into force. The
treaty will remain in force indefinitely unless terminated by one of
the Contracting States. Either State will be able to terminate the
treaty at the end of any calendar year by giving written notice at
least six months before the end of that calendar year.
Unique to the treaty and the treaties with Latvia and Lithuania is
an agreement that there will be a five-year period within which the
appropriate authorities of the two States will meet to discuss the
application of the treaty to income derived from new technologies (such
as payments received for transmission by satellite, cable, optic fibre
or similar technology). The meeting may result in a protocol that
specifically addresses the treaty's application to income from new
technologies.
Latvia
Next I will turn to Latvia. This treaty also differs in some
respects from other recent U.S. tax treaties. I will again highlight
some of these differences as well as other important provisions of the
treaty.
In respect of the taxation of investment income, the withholding
rates under the treaty are, again, in some respects higher than those
in the U.S. Model and in many recent U.S. treaties with OECD countries.
The proposed rates are the same as in many Latvian treaties.
Under the treaty dividends are subject to taxation at source in the
same manner as under the U.S. Model. Direct investment dividends are
subject to withholding tax at source at a maximum 5 percent rate, and
portfolio dividends are taxable at a maximum 15 percent rate. The
treaty requires a 10 percent ownership threshold for application of the
5 percent tax rate.
The treaty provides for a maximum 10 percent rate of tax at source
on most interest payments. Interest earned on trade credits, and on
government debt, including debt guaranteed by government agencies
(e.g., the U.S. Export-Import Bank) is exempt from tax at source.
Royalties for the use of industrial, commercial or scientific
equipment are subject to a 5 percent tax at source. All other royalties
(including payments for the use of software, other than off-the-shelf
software) are taxed at a maximum rate of 10 percent.
In relation to the taxation of business income, consistent with the
U.S. and OECD Models, the treaty provides generally for the taxation by
one State of the business profits of a resident of the other only when
such profits are attributable to a permanent establishment located in
that other State. The treaty, however, includes an anti-abuse rule that
would allow the source state to tax sales or activities performed by
the enterprise outside the United States as if they were performed by a
permanent establishment if it is ascertained that such activities were
structured with the intention to avoid taxation in the State where the
permanent establishment is situated.
The treaty, consistent with current U.S. treaty policy, provides
for exclusive residence-country taxation of profits from international
carriage by aircraft and ships. This reciprocal exemption also extends
to income from the rental of aircraft, ships and containers if the
rental activity is incidental to the operation of aircraft and ships by
the lessor in international traffic. However, income from the
international rental of ships and aircraft that is non-incidental to
operation of ships and aircrafts is taxed at a 5 percent rate as a
royalty paid for the rental of equipment.
Income from the use or rental of containers that is non-incidental
to the operation of ships or aircraft in international traffic is
treated as other income. Therefore, non-incidental leasing of
containers by U.S. businesses is taxable only in the United States.
With regard to the taxation of offshore activities, the treaty
contains a reciprocal agreement, found in several U.S. treaties,
particularly those with our North Sea partners, that the income from
the exploration or exploitation of the seabed and sub-soil is taxable
by the source State if the activities are carried on for more than 30
days in any twelve month period. Wages, salaries and similar
remuneration paid to those whose employment is derived from such
activities can be taxed in the state where the offshore activities
occur if such activities exceed the 30 day threshold. However, that
same remuneration can be taxed only in the non-source State if the
period of activity does not exceed 30 days and the employer is not a
resident of the source State. If the wages, salaries or other
remuneration are derived from the transportation of supplies or from
other activities (such as tugboats) auxiliary to the exploration and
exploitation then that remuneration can be taxed only in the country of
which the employer is resident.
The taxation of income from the performance of personal services
under the treaty is generally similar to that under the U.S. Model,
but, like some U.S. treaties with developing countries, it grants a
taxing right to the host country with respect to certain categories of
personal services income that is somewhat broader than in the OECD or
U.S. Model.
The limitation on benefits rules of the treaty are similar to those
found in the U.S. Model and in all recent U.S. treaties.
The exchange of information provisions generally follow the U.S.
Model and make clear that Latvia is obligated to provide U.S. tax
officials such information as is necessary to carry out the provisions
of the treaty.
The treaty provides a U.S. foreign tax credit for the Latvian
income taxes covered by the treaty, and a Latvian foreign tax credit
for the U.S. income taxes covered by the treaty.
The treaty will enter into force after each State has notified the
other that it has completed its ratification requirements. It will have
effect, with respect to taxes withheld at the source, for amounts paid
or credited on or after the first day of January of the calendar year
next following the year in which the treaty enters into force. In other
cases the treaty will have effect with respect to taxable years
beginning on or after the first day of January of the calendar year
next following the year in which the treaty enters into force.
The treaty will remain in force indefinitely unless terminated by
one of the Contracting States. Either State will be able to terminate
the treaty at the end of any calendar year by giving written notice at
least six months before the end of that calendar year.
Unique to the treaty and the treaties with Estonia and Lithuania is
an agreement that there will be a five-year period within which the
appropriate authorities of the two States will meet to discuss the
application of the treaty to income derived from new technologies (such
as payments received for transmission by satellite, cable, optic fibre
or similar technology). The meeting may result in a protocol that
specifically addresses the treaty's application to income from new
technologies.
Lithuania
Finally, let me turn to Lithuania. As with the other two Baltic
treaties, this treaty differs in some respects from other recent U.S.
tax treaties. I will again highlight some of these differences as well
as other important provisions of the treaty.
Once again, the withholding rates under the treaty are, in some
respects higher than those in the U.S. Model and in many recent U.S.
treaties with OECD countries. The proposed rates are the same as in
many Lithuanian treaties.
Under the treaty, dividends are subject to taxation at source in
the same manner as under the U.S. Model. Direct investment dividends
are subject to withholding tax at source at a maximum 5 percent rate,
and portfolio dividends are taxable at a maximum 15 percent rate. The
treaty requires a 10 percent ownership threshold for application of the
5 percent tax rate.
The treaty provides for a maximum 10 percent rate of tax at source
on most interest payments. Interest earned on trade credits, and on
government debt, including debt guaranteed by government agencies
(e.g., the U.S. Export-Import Bank) is exempt from tax at source.
Royalties for the use of industrial, commercial or scientific
equipment are subject to a 5 percent tax at source. All other royalties
(including payments for the use of software, other than off-the-shelf
software) are taxed at a maximum rate of 10 percent.
Consistent with the U.S. and OECD Models, the treaty provides
generally for the taxation by one State of the business profits of a
resident of the other only when such profits are attributable to a
permanent establishment located in that other State. The treaty,
however, includes an anti-abuse rule that would allow the source state
to tax sales or activities performed by the enterprise outside the
United States as if they were performed by a permanent establishment if
it is ascertained that such activities were structured with the
intention to avoid taxation in the State where the permanent
establishment is situated.
The treaty, consistent with current U.S. treaty policy, provides
for exclusive residence-country taxation of profits from international
carriage by aircraft and ships. This reciprocal exemption also extends
to income from the rental of aircraft, ships and containers if the
rental activity is incidental to the operation of aircraft and ships by
the lessor in international traffic. However, income from the
international rental of ships and aircraft that are non-incidental to
operation of ships and aircrafts is taxed at a 5 percent rate as a
royalty paid for the rental of equipment.
Income from the use or rental of containers that is non-incidental
to the operation of ships or aircraft in international traffic is
treated as other income. Therefore, non-incidental leasing of
containers by U.S. businesses is taxable only in the United States.
The treaty contains a reciprocal agreement, found in several U.S.
treaties, particularly those with our North Sea partners, that the
income from the exploration or exploitation of the seabed and sub-soil
is taxable by the source State if the activities are carried on for
more than 30 days in any twelve month period. Wages, salaries and
similar remuneration paid to those whose employment is derived from
such activities can be taxed in the state where the offshore activities
occur if such activities exceed the 30 day threshold. However, that
same remuneration can be taxed only in the non-source State if the
period of activity does not exceed 30 days and the employer is not a
resident of the source State. If the wages, salaries or other
remuneration are derived from the transportation of supplies or from
other activities (such as tugboats) auxiliary to the exploration and
exploitation then that remuneration can be taxed only in the country of
which the employer is resident.
The taxation of income from the performance of personal services
under the treaty is generally similar to that under the U.S. Model,
but, like some U.S. treaties with developing countries, it grants a
taxing right to the host country with respect to certain categories of
personal services income that is somewhat broader than in the OECD or
U.S. Model.
The limitation on benefits rules of the treaty are similar to those
found in the U.S. Model and in all recent U.S. treaties.
The information exchange provisions generally follow the U.S. Model
and make clear that Lithuania is obligated to provide U.S. tax
officials such information as is necessary to carry out the provisions
of the treaty.
The treaty provides a U.S. foreign tax credit for the Lithuanian
income taxes covered by the treaty, and a Lithuanian foreign tax credit
for the U.S. income taxes covered by the treaty.
The treaty will enter into force after each State has notified the
other that it has completed its ratification requirements. It will have
effect, with respect to taxes withheld at the source, for amounts paid
or credited on or after the first day of January of the calendar year
next following the year in which the treaty enters into force. In other
cases the treaty will have effect with respect to taxable years
beginning on or after the first day of January of the calendar year
next following the year in which the treaty enters into force.
The treaty will remain in force indefinitely unless terminated by
one of the Contracting States. Either State will be able to terminate
the treaty at the end of any calendar year by giving written notice at
least six months before the end of that calendar year.
Unique to this treaty and the treaties with Estonia and Latvia is
an agreement that there will be a five-year period within which the
appropriate authorities of the two States will meet to discuss the
application of the treaty to income derived from new technologies (such
as payments received for transmission by satellite, cable, optic fibre
or similar technology). The meeting may result in a protocol that
specifically addresses the treaty's application to income from new
technologies.
This concludes my remarks on the three Baltic treaties.
Venezuela
Next, I would like to tell you about the proposed treaty with
Venezuela. This treaty is of special importance because it represents a
crucial step towards achieving our goal of expanding our tax treaty
network in Latin America. If ratified, this agreement would be the
United States' only tax treaty in force with a South American nation.
The proposed treaty with Venezuela generally follows the pattern of
the 1996 U.S. Model, while incorporating some provisions found in
recent U.S. treaties with other developing countries and in the OECD
Model. The treaty's rules on the taxation of investment income are an
example. Although the withholding rates under the proposed treaty are
generally higher than those in the U.S. Model, the rates are comparable
to those found in other U.S. tax treaties with developing countries and
those in other tax treaties of Venezuela. Also, the withholding rates
reflect Venezuela's territorial system of taxation and the policy
objective of establishing an adequate single level of tax on cross-
border investment income.
Under the proposed treaty, as in the U.S. Model, direct investment
dividends are taxable at source at a 5 percent rate, and portfolio
dividends are taxable at source at a 15 percent rate. The proposed
treaty requires a 10 percent ownership threshold for application of the
5 percent direct investment tax rate. Also similar to the U.S. Model,
dividends paid to a Contracting State or a governmental entity
constituted and operated exclusively to administer or provide pension
benefits, are exempt from withholding in the source State.
The proposed treaty provides for a 10 percent rate of tax at source
on most interest payments. Interest that is received by a financial
institution (including an insurance company) is subject to a lower 4.95
percent rate of tax. Interest earned on government debt, including debt
guaranteed by government agencies (e.g., the U.S. Export-Import Bank,
the Federal Reserve Banks and the Overseas Private Investment
Corporation) is exempt from tax at source. These provisions are, in
effect, a melding of the U.S. and OECD Models.
Royalties for the right to use copyrights, patents or trademarks
are subject to a 10 percent tax at source. Royalties for the right to
use industrial, commercial or scientific equipment are subject to a
lower 5 percent rate of tax at source. Under the proposed treaty, fees
for the provision of technical services and fees for technical
assistance are considered business profits or personal services income,
and are taxed as such, rather than as royalty payments. These latter
important provisions thereby mitigate double taxation and generally
limit any taxation to net rather than gross income, and then only to
when a permanent establishment is created.
The taxation of capital gains under the proposed treaty follows the
format of the U.S. Model. Gains and income derived from the sale of
real property and from real property interests may be taxed by the
State in which the property is located. Likewise, gains or income from
the sale of personal property, if attributable to a fixed base or
permanent establishment situated in a Contracting State, may be taxed
in that State. All other gains, including gains from the sale of ships,
aircraft and containers, and gains from the sale of stock in a
corporation, are taxable only in the State of residence of the seller.
Regarding the taxation of business income, as with the U.S. and
OECD Models, the proposed treaty provides generally for the taxation by
one State of the business profits of a resident of the other only when
such profits are attributable to a permanent establishment located in
that other State. Under the proposed treaty, the taxation of income
from the operation of ships and aircraft in international traffic and
from the use, maintenance or rental of containers used in international
traffic is fully consistent with the U.S. Model.
The taxation of income from the performance of personal services
under the proposed treaty is similar to that under some U.S. treaties
with developing countries, but grants a taxing right to the host
country with respect to such income that is broader than in the OECD or
U.S. Model.
The limitation on benefits provisions of the proposed treaty are
similar to those found in the U.S. Model and in all recent U.S.
treaties, with minor modifications necessary because of Venezuela's
territorial tax system.
The information exchange provisions generally follow the U.S. Model
and make clear that Venezuela is obligated to provide U.S. tax
officials such information as is necessary to carry out the provisions
of the treaty.
The proposed treaty provides a U.S. foreign tax credit for
Venezuelan income taxes subject to the limitations imposed by U.S.
internal law on the granting of foreign tax credits. Similarly,
Venezuela shall, under the proposed Convention, provide relief against
double taxation to Venezuelan taxpayers who are also subject to U.S.
income tax, subject to the limitations imposed by Venezuelan law.
The proposed treaty will enter into force when each Contracting
State has notified the other that the domestic requirements needed for
entry into force have been completed. It will have effect, with respect
to taxes withheld at source, for amounts paid or credited on or after
January 1 of the year following the date on which the treaty enters
into force. In other cases the treaty will have effect with respect to
taxable periods beginning on or after January 1 of the year following
the date on which the treaty enters into force.
I know that the Committee has been alerted to a pending change in
Venezuela's income tax law, through which Venezuela will begin taxing
all of the income received by its residents, rather than only that
income that was determined, under broad ``sourcing'' rules, to be
connected to Venezuela. The possibility that Venezuela would adopt this
``worldwide'' system was present throughout our treaty negotiations,
and we planned for it in drafting the treaty. And while more time with
the new law may provide us with more opportunity to analyze its
provisions, we belIeve that the analysis we have performed is adequate
to allow us to determine that the treaty is at least as appropriate
under the new law as it would have been under the old law, and likely
more so. We believe that the treaty works appropriately, in large part
because this change from ``territorial'' to ``worldwide'' taxation
brings Venezuela's domestic laws into closer conformity with
international norms. The increased possibilities for double taxation
that are the natural result of this change make the treaty that much
more important than it was when Venezuela had a territorial system. And
the vestiges of Venezuela's territorial system are also addressed by
special provisions in the treaty included to deal with that system. On
balance, we believe we can recommend that the Committee approve the
treaty despite this change in Venezuela's law.
Slovenia
The United States does not currently have an income tax treaty with
Slovenia. Slovenia will be the first country in the area of the former
Yugoslavia with which we will have concluded a tax treaty. It is the
most economically advanced country in the former Yugoslavia and is in
the first wave of applicants to the European Union from Central and
Eastern Europe. We expect that the conclusion of the tax treaty will be
an important element in expanding trade and investment between the
United States and Slovenia.
The proposed income tax treaty with the Republic of Slovenia
generally follows the pattern of the U.S. Model, while incorporating
some provisions found in the OECD Model. The proposed treaty
establishes maximum rates of source country tax on cross-border
payments of dividends, interest, and royalties. The withholding rates
on investment income in the proposed treaty are generally consistent
with those found in U.S. treaties with OECD member countries.
Dividends may be subject to tax at source at a maximum rate of 15
percent, except when paid to a corporation in the other country that
owns at least 25 percent of the paying corporation, in which case the
maximum rate is 5 percent.
The maximum rate of withholding tax at source on interest under the
proposed treaty is 5 percent. However, interest received, guaranteed,
or insured by the Government of either Contracting State or the central
bank of either Contracting State and interest with respect to a
deferred payment for personal property or services is exempt from
withholding at source.
Royalties are generally subject to tax at source at a rate not to
exceed 5 percent.
The taxation of capital gains under the proposed treaty follows the
format of the U.S. Model. Gains and income derived from the sale of
real property and from real property interests may be taxed in the
State in which the property is located. Likewise, gains or income from
the sale of personal property, if attributable to a fixed base or
permanent establishment situated in a Contracting State, may be taxed
in that State. All other gains, including gains from the sale of ships,
aircraft and containers, and stock in a corporation, are taxable only
in the State of residence of the seller.
As with the U.S. and OECD Models, the proposed treaty provides
generally for the taxation by one State of the business profits of a
resident of the other only when such profits are attributable to a
permanent establishment located in that other State. Under the proposed
treaty, the taxation of income from the operation of ships and aircraft
in international traffic and from the use, maintenance or rental of
containers used in international traffic is fully consistent with the
U.S. Model.
The taxation of income from the performance of personal services
under the proposed treaty generally follows standard U.S. treaty
policy. The taxation of income from dependent personal services or of
income derived by corporate directors, by athletes, or by entertainers
is essentially the same as in other recent U.S. treaties. The dollar
threshold for the taxation of athletes and entertainers is slightly
lower than in the U.S. Model to reflect the lower average income level
in Slovenia.
The treaty provides for host-country exemption for students for up
to five years with respect to certain types of income. These exempted
categories of income include support payments from abroad, grants and
awards, and up to $5,000 of annual income from personal services in the
host state. Business trainees temporarily present in the host State are
exempted from tax for up to 12 months with respect to income from
personal services not exceeding $8,000. Visiting professors and
researchers at recognized educational or research institutions are
exempt from host-country taxation for a period not exceeding two years
from the date of first arrival.
The proposed treaty contains comprehensive rules in its
``Limitation on Benefits'' article, designed to deny ``treaty-
shoppers'' the benefits of the treaty. In addition, the treaty contains
new provisions aimed at preventing abuse with respect to specific
transactions. Under these provisions, a person otherwise entitled to
treaty benefits will be denied those benefits if the main purpose, or
one of the main purposes, of the creation or assignment of the rights
giving rise to the income was to take advantage of the treaty. These
provisions apply with respect to the Articles regarding Dividends,
Interest, Royalties, and Other Income. It is expected that the United
States will incorporate these new anti-abuse provisions into its Model.
The information exchange provisions generally follow the U.S. Model
and make clear that each State is obligated to provide tax officials of
the other State such information as is necessary to carry out the
provisions of the treaty. Slovenia has confirmed to us that it has no
bank secrecy or other rules that would prevent such exchange from
taking place.
The proposed treaty provides a U.S. foreign tax credit for
Slovenian income taxes subject to the limitations imposed by U.S.
internal law on the granting of foreign tax credits. Similarly,
Slovenia shall, under the proposed treaty, provide relief against
double taxation to Slovenian taxpayers who are also subject to U.S.
income tax, subject to the limitations imposed by Slovenian law.
Also included in the proposed treaty are rules necessary for
administering the treaty, including rules for the resolution of
disputes under the treaty.
The proposed treaty will enter into force upon the exchange of
instruments of ratification. It will have effect with respect to taxes
withheld at source for payments made or credited on or after the first
day of the third month next following the date the treaty enters into
force, and with respect to other taxes, for taxable years beginning on
or after the first day of January next following the date of entry into
force.
Denmark
I'd like to turn now to the proposed treaty and protocol with
Denmark. This proposed treaty would replace the existing convention,
our oldest income tax treaty, which was signed in 1948. The new treaty
generally follows the pattern of the OECD Model and of recent U.S.
treaties with other developed countries.
First, with regard to the taxation of investment income, the
withholding tax rates under the proposed treaty are the same as those
in the U.S. Model. Direct investment dividends are subject to
withholding tax at source at a maximum 5 percent rate and portfolio
dividends are taxable at a maximum 15 percent rate. The proposed treaty
requires a 10 percent ownership threshold for application of the 5
percent tax rate. This ownership threshold is reduced from the 95
percent threshold required under the existing treaty. As under the
existing treaty, interest and royalty payments are generally exempt
from tax in the source country under the proposed treaty. These
limitations on taxation by the source country do not apply if the
beneficial owner of the income is a resident of a Contracting State
that carries on business in the other Contracting State in which the
income arises and, in the case of business profits, the income is
attributable to a permanent establishment or, in the case of
independent personal services, to a fixed base in that other State.
The taxation of capital gains under the proposed treaty generally
follows the format of the U.S. Model. Gains from the sale of real
property and from real property interests may be taxed by the country
in which the property is located. Likewise, gains from the sale of
personal property forming part of a fixed base or permanent
establishment situated in a contracting State may be taxed in that
State. All other gains, including gains from the alienation of ships,
boats, aircraft and containers used in international traffic and gains
from the sale of corporate stock are taxable only in the seller's
residence State. As a variation from the rules under the current treaty
and the U.S. Model, gains of an enterprise of one Contracting State
from the deemed alienation of an installation, drilling rig or ship
used in the other State for the exploration or exploitation of oil and
gas resources may be taxed in that other State in accordance with its
law, but only to the extent of any depreciation taken in that other
State. In order to minimize possible double taxation that could
otherwise arise, the treaty allows adjustments to the timing of the
taxation of capital gains.
As with the existing treaty, recent U.S. treaties and the OECD
Model, the proposed treaty provides generally for the taxation by one
State of the business profits of a resident of the other only when such
profits are attributable to a permanent establishment located in that
other State.
In addition, the proposed treaty preserves the U.S. right to impose
its branch tax on U.S. branches of Danish corporations. This tax is not
imposed under the existing treaty.
Consistent with the U.S. Model, the proposed treaty permits only
the country of residence to tax profits from the international
operation of ships or aircraft and income from the use, maintenance or
rental of containers used in international traffic. This reciprocal
exemption extends to income from the rental on a full basis of ships
and aircraft and, if the ships or aircraft are operated in
international traffic by the lessee or the income is incidental to
income from the operation of ships or aircraft in international
traffic, to income from the rental on a bareboat basis of ships and
aircraft. The exemption under the proposed treaty is broader in scope
than under the existing treaty.
The proposed treaty clarifies the treatment of the profits of the
Scandinavian Airlines System (SAS) by treating it as a consortium that
is eligible for the exemption from taxation in the source State to the
extent of the participation of the Danish member of SAS, SAS Danmark A/
S.
The taxation of income from the performance of personal services
under the proposed treaty generally follows U.S. standard treaty
policy. The rules for the taxation of pension income vary from the
rules found in the existing treaty and the U.S. Model by providing for
taxation only in the source State, subject to an exception for persons
currently receiving pensions, who will continue to be taxed only in the
country of residence.
The limitation on benefits provisions of the proposed treaty are
similar to those found in the U.S. Model and recent U.S. treaties, with
modifications to take account of certain types of entities found only
in Denmark.
The proposed treaty provides a foreign tax credit for certain taxes
imposed under the Danish Hydrocarbon Tax Act, subject to the same type
of limitation that is found in other tax treaties with countries on the
North Sea.
Also included in the proposed treaty are the rules necessary for
administering the treaty, including rules for the resolution of
disputes under the treaty and the exchange of information. The exchange
of information provisions of the proposed treaty generally follow the
U.S. Model. Our experience on exchange of information with Denmark is
positive. As under the existing treaty, the proposed treaty contains a
provision for assistance in the collection of taxes.
The proposed treaty will enter into force when the Governments
notify each other that their requirements for entry into force have
been met. It will have effect, with respect to taxes withheld at
source, for amounts paid or credited on or after the first day of the
second month next following the date on which the treaty enters into
force; with respect to other taxes, the treaty will take effect for
taxable periods beginning on or after the first day of January next
following the date on which the treaty enters into force. Where the
existing treaty would have provided greater relief from tax than the
proposed treaty, the existing treaty will continue to have affect for
an additional year at the election of any person that was entitled to
benefits under the current treaty. The proposed treaty will remain in
force indefinitely unless terminated by one of the Contracting States
by giving prior notice through diplomatic channels.
Italy
The proposed new treaty and protocol with Italy would replace the
existing treaty, which was signed in 1984. The proposed treaty
generally follows the pattern of the OECD Model and other recent United
States treaties with developed countries. The proposed treaty is of
great importance to the U.S. business community because it addresses a
new Italian regional tax on productive activities and generally lowers
the withholding rates imposed by each country on passive investment
income.
The proposed treaty addresses the replacement of the Italian local
income tax by the new Italian regional tax on productive activities
(IRAP). Because IRAP is calculated without an allowance for labor costs
and, for certain taxpayers, without an allowance for interest costs, it
raises the issue of potential double taxation. By providing a U.S. tax
credit for a portion of IRAP, the proposed treaty resolves this issue.
A formula is provided in the proposed treaty for calculating the
creditable portion. Only the creditable portion of IRAP is considered
to be a covered tax under the proposed treaty.
The proposed treaty establishes maximum rates of source country tax
on cross-border payments of dividends, interest, and royalties that are
generally lower than those in the existing treaty.
Under the proposed treaty, dividends may be subject to tax at
source at a maximum rate of 15 percent, except when paid to a
corporation in the other country that owns at least 25 percent of the
paying corporation, in which case the maximum rate is 5 percent. Under
the existing treaty, the 5 percent rate is available only if the
receiving corporation owns more than 50 percent of the stock or capital
of the paying corporation, while a 10 percent rate applies if the
receiving corporation owns between 10 and 50 percent of the paying
corporation, and a 15 percent maximum rate applies in all other cases.
While the maximum rate applicable to those corporate taxpayers owning
at least 10 percent and less than 25 percent of the paying corporation
will increase from 10 percent to 15 percent under the proposed treaty,
the maximum rate for those owning between 25 percent and 50 percent of
the paying corporation, including the significant group of taxpayers
who own exactly 50 percent, will decrease from 10 percent to 5 percent.
The proposed treaty lowers the maximum rate of withholding tax at
source on interest to 10 percent from the 15 percent rate in the
existing treaty. As in the existing treaty, the proposed treaty
provides an exemption from withholding at source for interest received,
guaranteed, or insured by the Government of either Contracting State
(although, in order for interest received by a qualified governmental
entity to be eligible for this exemption, the qualified governmental
entity must hold less than 25 percent of the capital of the person
paying the interest). The proposed treaty also exempts from withholding
at source interest with respect to credit sales between enterprises and
credit sales of industrial, commercial, or scientific equipment.
The proposed treaty lowers the maximum rates of withholding tax at
source for royalty payments compared to the rates in the existing
treaty. Under the proposed treaty, royalties for literary copyrights
are exempt from tax at source. The maximum rate for royalties for the
use of computer software or for the rental of industrial, commercial,
or scientific equipment is 5 percent, and the maximum rate for all
other royalties is 8 percent. In contrast, under the existing treaty
the maximum rate for royalties for literary copyrights is 5 percent,
the maximum rate for royalties for the rental of tangible personal
property is 7 percent, the maximum rate for royalties for motion
pictures and films is 8 percent, and the maximum rate for all other
royalties is 10 percent. Thus, although the proposed treaty does not
reflect the U.S. Model position of exemption at source for software and
rentals of tangible personal property, the proposed treaty reduces the
rates of withholding as compared to the existing treaty.
The taxation of capital gains under the proposed treaty follows the
format of the existing treaty. Gains and income derived from the sale
of real property and from real property interests may be taxed in the
State in which the property is located. Likewise, gains or income from
the sale of personal property, if attributable to a fixed base or
permanent establishment situated in a Contracting State, may be taxed
in that State. As in the existing treaty, but unlike the U.S. Model,
non-incidental gains from the alienation of ships and aircraft rented
on a bareboat basis and attributable to a permanent establishment
situated in a Contracting State may be taxed in that State. All other
gains, including gains from the alienation of containers, gains from
the alienation of ships and aircraft rented on a full basis, incidental
gains from the alienation of ships and aircraft rented on a bareboat
basis, and gains from the sale of stock in a corporation, are taxable
only in the State of residence of the seller.
As with the U.S. and OECD Models, the proposed treaty provides
generally for the taxation by one State of the business profits of a
resident of the other only when such profits are attributable to a
permanent establishment located in that other State.
As under the U.S. Model, all income from the use, maintenance or
rental of containers used in international traffic is exempt from
source-country taxation under the proposed treaty. Also, the proposed
treaty provides for exclusive residence-country taxation of profits
from the international operation of ships or aircraft, including the
rental of ships and aircraft on a full basis and, when the rental is
incidental to the operation of ships or aircraft by the lessor, rentals
of ships and aircraft on a bareboat basis. Like the existing treaty,
but unlike the U.S. Model, income from the rental of ships and aircraft
on a bareboat basis that is not incidental to the operation of ships or
aircraft by the lessor and that is attributable to a permanent
establishment situated in a Contracting State may be taxed in that
State.
Unlike the existing treaty, the taxation of income from the
performance of personal services under the proposed treaty generally
follows standard U.S. treaty policy. Consistent with the U.S. Model,
the proposed treaty eliminates a provision of the existing treaty that
allows the source State to tax an individual performing independent
personal services if that individual has been present in that State for
more than 183 days during the year, even if that person does not have a
fixed base regularly available to him.
The limitation on benefits provisions of the proposed treaty are
similar to those found in the U.S. Model and in all recent U.S.
treaties, and are more comprehensive than those found in the existing
treaty.
In addition, the treaty contains new provisions aimed at preventing
abuse with respect to specific transactions. Under these provisions, a
person otherwise entitled to treaty benefits will be denied those
benefits if the main purpose, or one of the main purposes, of the
creation or assignment of the rights giving rise to the income was to
take advantage of the treaty. These provisions apply with respect to
the Articles regarding Dividends, Interest, Royalties, and Other
Income. It is expected that the United States will incorporate these
new anti-abuse provisions into its Model.
The information exchange provisions are similar to those in the
existing treaty and make clear that each State is obligated to provide
tax officials of the other State such information as is necessary to
carry out the provisions of the treaty. Italy has confirmed to us that
it has no bank secrecy or other rules that would prevent such exchange
from taking place.
Finally, the proposed treaty includes modernized rules necessary
for administering the treaty, including rules for the resolution of
disputes under the treaty. These provisions now conform to the OECD
Model, which should improve the functioning of the mutual agreement
process. They include the use of arbitration to resolve disputes that
may arise between the Contracting States. However, the arbitration
process may be implemented under the treaty only after the two
Contracting State have agreed to do so through an exchange of
diplomatic notes. Once implemented, a particular case may be assigned
to an arbitration panel only with the consent of all the parties to the
case.
The proposed treaty will enter into force upon the exchange of
instruments of ratification. It will have effect with respect to taxes
withheld at source for payments made or credited on or after the first
day of the second month next following the date the treaty enters into
force, and with respect to other taxes, for taxable years beginning on
or after the first day of January next following the date of entry into
force. In the event that a person would have been entitled to greater
relief under the existing treaty, that person may elect to continue to
apply the existing treaty for a twelve-month period from the date on
which the proposed treaty would otherwise have effect. The proposed
treaty will remain in force indefinitely unless terminated by one of
the Contracting States. Either State may terminate the proposed treaty
at any time after 5 years from the date on which the proposed treaty
enters into force by giving at least six months prior notice through
diplomatic channels.
Estate Tax Protocol with Germany
The proposed protocol amends the estate, inheritance and gift tax
treaty between the United States and Germany, which was signed in 1980
and entered into force in 1986. In 1988, the United States amended its
estate tax law in a way that increased estate taxes in the case of
deceased U.S. citizens who were married to non-citizens.
Although the U.S. rejected claims by estate tax treaty partners
that the 1988 change violated treaty nondiscrimination clauses, we
indicated our willingness to amend our estate tax treaties with certain
treaty partners to provide relief to surviving noncitizen spouses in
appropriate cases. In particular, the proposed protocol eases the
impact of the 1988 provisions upon certain estates of limited value.
The United States, in a 1995 protocol to the U.S.-Canada income tax
treaty, provided similar relief to certain estates of limited value
involving Canadians. The United States' willingness to enter into the
proposed protocol was a significant factor in Germany's ratification of
the current U.S.-Germany income tax treaty, which was signed in 1989.
The proposed protocol also provides a pro rata unified credit to
the estate of a German domiciliary for purposes of computing the U.S.
estate tax. Under this provision, a German domiciliary is allowed a
credit against U.S. estate tax ranging from the amount ordinarily
allowed to the estate of a nonresident under the Code ($13,000) to the
amount of credit allowed to the estate of a U.S. citizen under the Code
($202,050 in 1998), based on the extent to which the assets of the
estate are situated in the United States. Congress anticipated the
negotiation of such pro rata unified credits in Internal Revenue Code
section 2102(c)(3)(A), and a similar credit was included in the 1995
U.S.-Canada income tax protocol.
The proposed protocol also makes other changes to the Convention to
reflect more closely current U.S. treaty policy. For example, the
proposed protocol extends the period of time during which a citizen of
one country can be domiciled in the other country without becoming
subject to the primary taxing jurisdiction of the other country. Such a
provision is increasingly important to peripatetic business executives.
The proposed protocol also extends the United States' ability to tax
former citizens and long-term residents to conform with 1996
legislative changes to the Internal Revenue Code.
agreements dealing with taxation of dividends from reits
In 1997, the Senate approved three treaties, with Austria, Ireland
and Switzerland, subject to the understanding that the Treasury
Department would use its best efforts to negotiate agreements that
would modify those treaties' treatment of dividends paid by Real Estate
Investment Trusts. The agreements with Austria and Switzerland are in
an advanced stage of negotiation, but have not yet been completed.
However, the agreement with Ireland was signed on September 24, 1999.
Although it is not yet pending before the Committee, we hope that, if
the President transmits it to the Senate in time, the Committee will
consider it at the same time as the rest of the treaties as the
agreement does nothing other than respond to the Senate's 1997
understanding.
treaties under negotiation
We continue to maintain an active calendar of tax treaty
negotiations. We are in active negotiations with Canada, Korea, the
United Kingdom and Chile. We expect to announce the start of
negotiations with several other countries soon. In accordance with the
treaty program priorities noted earlier, we continue to seek
appropriate opportunities for tax treaty discussions and negotiations
with several countries in Latin America and in the developing world
generally.
conclusion
Let me conclude by again thanking the Committee for its continuing
interest in the tax treaty program, and for devoting the time of
Members and staff to undertake a meaningful review of the agreements
that are pending before you. We appreciate your efforts this year and
in past years to bring the treaties before this Committee and then to
the full Senate for its advice and consent to ratification. We also
appreciate the assistance and cooperation of the staffs of this
Committee and of the Joint Committee on Taxation in the tax treaty
process. With your and their help, we have, since the beginning of
1993, brought into force 22 new treaties and protocols, not counting
the eight agreements presently being considered.
We urge the Committee to take prompt and favorable action on all of
the Conventions and Protocols before you today. Such action will send
an important message to our trading partners and our business
community. It will demonstrate our desire to expand the United States
treaty network with income tax treaties formulated to enhance the
worldwide competitiveness of United States companies. It will
strengthen and expand our economic relations with countries that have
seen significant economic and political changes in recent years. It
will make clear our intention to deal bilaterally in a forceful and
realistic way with treaty abuse. Finally, it will enable us to improve
the administration of our tax laws both domestically and
internationally.
I will be glad to answer any questions you might have.

Senator Hagel. Mr. West, thank you.
Ms. Paull.

STATEMENT OF LINDY L. PAULL, CHIEF OF STAFF, JOINT COMMITTEE ON
TAXATION

Ms. Paull. Thank you, Mr. Chairman. It is a pleasure to be
here.
Our staff has worked closely with the staff of this
committee over the years on tax treaties, and we appreciate the
opportunity to testify today before you.
I, too, have submitted written testimony for the record and
I would just like to highlight some of the issues that we have
raised for which there is a lot more detail in our pamphlets
with respect to the eight treaties and protocol that are before
you today.
With respect to the Baltic countries--Estonia, Latvia, and
Lithuania--the proposed treaties are consistent with our
treaties with developing countries. I would just highlight one
issue which is that these treaties do not reduce withholding
taxes on real estate investment trust dividends, which is
contrary to a policy that was instituted in 1997.
With respect to the Denmark proposed treaty, this is a
major update of a 1948 treaty. Again, the proposed treaty is
generally consistent with the U.S. model treaty. I would
mention one issue here that Mr. West touched on and that is
that the treaty provides, as is present with a few other
treaties we have with North Sea countries, that a foreign tax
credit may be claimed under the U.S. law for the Danish
hydrocarbon tax. Also, there is a limitation that is placed on
it which is consistent with at least one other treaty.
With respect to the new protocol, the proposed protocol for
Germany, that modifies a 1980 treaty dealing with estate, gift,
and inheritance taxes. We are not aware of any particular
problems. We would just kind of note that this is somewhat of a
small modification, important to German residents. They are
principally directed at easing U.S. taxes on German heirs.
Again, we are unaware of any major issues involved in that
protocol.
With respect to the proposed treaty with the Italian
Republic, this is, again, an update of a treaty, an existing
treaty, that was in force since 1984. I would call to your
attention four items in that treaty.
The first item would be that there is a tax in that this
proposed treaty would allow a portion of the so-called IRAP
tax, the Italian Regional Tax on Productive Activities, to be
eligible for a U.S. foreign tax credit. It is a little bit of
an unusual provision in the sense that there is a hypothetical
computation that is made to try to replicate or turn this tax
into a proxy for an income tax. I think this is an unusual
provision.
However, because there is some history here that the IRAP
tax replaces a previously creditable tax under the existing
treaty and the Treasury Department worked closely with Congress
on this, we think it is an appropriate provision.
The proposed treaty also provides a limited exception for
Italian insurance companies who are insuring U.S. risks. This
has to do with, basically, a limited exception from the U.S.
excise taxes on insurance premiums and reinsurance premiums.
It is our understanding--and I don't think the prior
testimony covered this--that there have been assurances that
there is appropriate Italian tax being collected on any of that
type of income that would be generated from U.S. risks.
The proposed treaty also omits the U.S. model treaty
language addressing bank secrecy laws. It is our understanding
that there has been an exchange of letters on this subject so
that there would be adequate exchange of information under the
treaties between the two countries.
Finally, the fourth item is the major item, which Mr. West
discussed in his testimony. This is the new main purpose test,
so to speak, that exists in the articles dealing with
dividends, interest, royalty and other incomes, which reduces
withholding rates on those items. The main purpose test would
operate to deny the benefits of the treaty provisions, those
articles, in the case of somebody who has created or assigned
shares, debt claims rights, various things depending on the
type of income that is generated.
I highlight this for the committee because this is a new
policy for the United States. It was not something of which I
think the staff who worked on this diligently throughout the
years with the Treasury Department was aware, that there was
going to be this new policy in these two recent treaties for
which the negotiations were just finished.
The Treasury's testimony today indicates that this new
policy would be included, possibly in a revision to the U.S.
model treaty in the near future.
I would note that there is a little, I guess, anxiety on
the part of the staffs who work on treaties diligently with the
Treasury Department to say that there was no consultation with
respect to this change. Also, this change is very vague. It is
very unclear what this means, we would have to note to the
committee, especially the language that talks about one of the
main purposes.
One of the concerns certainly that we would have is that
treaties are supposed to provide certainty and to facilitate
investment between the two countries. I think our concern is
that this will add quite a bit of uncertainty to investments
between the two countries.
Let me just give a simple example of what I mean. For
example, a company is looking to make an investment in a region
and, when looking at that region, may want to make that
investment in a country that, if all things are equal, has a
treaty with the United States. So, yes, one of the main
purposes of making that investment in that country might be to
make sure that they get some of the treaty benefits which would
be a lower withholding rate on their interests, dividends, or
royalties generated by that investment.
What happens to that transaction under this language? We
don't know the answer to that. But it seems like a fairly
common transaction and it seems like something that the
committee ought to be concerned about when you are trying to
have a free flow of investment between two countries.
I think we have other concerns about this particular
language because it is inserted in some parts of the treaty and
not throughout the treaty. What does that mean in terms of
anti-abuse, the so-called anti-abuse provision? What does that
mean for the rest of the treaties?
Often courts will look to one provision and say well, you
knew how to negotiate over an anti-abuse rule in that area, so
you must not have been concerned or nothing applies there. We
have a question as to what is the inference as to our domestic
laws.
Mr. West indicated we have a lot of domestic laws
specifically targeting transactions that could be abusive. What
is the inference here with respect to our domestic laws? Does
the fact that these treaties have some test at some point in
these treaties and then our domestic law--we just don't know
how they interact with them and whether or not they would be
elevated to a higher level than our domestic law, or whether or
not the standard used here is at a higher level than our
domestic law.
Our domestic law would really look at an abusive
transaction, look at such factors as is there a business
purpose for the investment, or is there an economic substance
to it--things like that. But this does not seem to incorporate
any of those notions.
These are some of the concerns that we would raise about
these provisions.
We, on balance, recognize there have been abusive
transactions to abuse treaties like there are abusive
transactions to abuse our current Tax Code. Congress has
reacted to them in the past and can in the future. The question
is whether or not that is such a significant concern that you
would put a cloud on your investments under these treaties.
That would be our concern there.
The Slovenia treaty also has just two of the issues that I
highlighted for the Italian Republic treaty, and that is that
the main purpose test that I was just discussing is also
included in the dividends, interests, royalties and other
income articles. Also, that treaty does not include the U.S.
model treaty language addressing bank secrecy laws.
Finally, we have the treaty with Venezuela. This is a new
treaty that was sought out by the United States at a time when
the country had a territorial tax system. So it is a little bit
unusual to be seeking out a treaty with a country like that.
The country is in the process of moving to a worldwide tax
system which makes a treaty to alleviate double taxation much
more relevant, as Mr. West said.
We have been informed that the worldwide tax system law was
enacted yesterday in this country. We have not seen the final
language of that law. We have consulted with representatives of
Venezuela and have been told that the new law is generally
consistent with our style of a worldwide tax system.
We would just mention to the committee that the new law
should be reviewed to make sure that the treaty provisions are
not in need of some sort of modification. We have a concern
with respect to the title that deals with the branch profits
tax, that the language used in that title seems to be directed
toward the United States branch profits tax as there was none
in Venezuela at the time the treaty was negotiated. There is
likely to be one in this new law. So we believe that that
article should be looked at.
Finally, on the Venezuela treaty, this is a country that is
undergoing profound political changes. Right now, it could be
perceived--we are not experts in this by any means, not even
close--but it could be perceived that there are somewhat
dueling bodies responsible, having overlapping responsibilities
in Venezuela right now.
They have a National Constituent Assembly, which is
drafting a new constitution. I think it is imminent that a new
constitution is going to be put before the people of Venezuela,
which would also trigger some new elections. So that is just a
question for the committee to consider, as to whether or not
there is sufficient political stability in that country to
insure that Venezuela will live up to its treaty obligations.
This ends my brief highlights of the issues presented by
the proposed treaties. As I said, the issues are discussed in a
lot more detail in our pamphlets which were submitted to the
committee. I would be happy to answer any questions you may
have now or as you consider the treaties.
[The prepared statement of Ms. Paull follows:]

Prepared Statement of the Staff of the Joint Committee on Taxation

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

Senator Hagel. Ms. Paull, thank you, and Mr. West, thank
you.
You each know the drill around here. As a matter of fact, I
recall that not too long ago, Ms. Paull, you were on the other
side developing the questions.
What I would like to do is this. Let's just back through
your testimony, Ms. Paull, because you raise some questions
that I know Mr. West would like to engage in. I know he would
like to clarify some of those points.
So, if I might, let's just take your testimony and proceed
right along our merry way and stay on Venezuela.
Mr. West, you heard some of the concerns and the questions
raised by Ms. Paull. Let's start with the current government.
Obviously, that was factored into the equation as you all
thought through this and negotiated. It is an unknown. We
appreciate that. But why don't you start there and work your
way through some of the questions that Ms. Paull raised.
Thank you.
Mr. West. I would be happy to, Mr. Chairman.
Starting with the last issue, which is the political
turmoil there, we have consulted closely with the State
Department and, as Ms. Paull said, this is not something that
the tax experts profess to be expert in. But what we understand
from the State Department is that the changes that are going on
in Venezuela--and there are changes--are in the nature of
healthy changes that are fully consistent with democratic
principles.
Again, this is our understanding from the State Department.
They are not seeing developments there inconsistent with a
popularly elected government and popular democracy being
exercised.
So, while any further questions on that subject I would be
happy to take back to the State Department so as to provide you
with additional answers, we have not heard anything to indicate
that there is any reason not to go forward. In fact, the one
tax related concern in that area would be whether or not a
treaty makes sense even if you assumed great instability. In
our view, a tax treaty is perhaps even more important in an
unstable environment than it is in a stable environment,
because it will give U.S. taxpayers a measure of predictability
and certainty when they do business in Venezuela, even if there
is some change going on down there.
But, again, we have not heard anything to indicate that
there is any change that would affect the ability of Venezuela
to bring the treaty into force, that would affect, would
adversely affect, any of the provisions of the treaty.
Senator Hagel. Of course, that all depends on whether a new
government would enforce that treaty.
Mr. West. We have asked that question. What we understand
is this. The legislature has approved this treaty already. The
question would then have to be whether any new government would
actually invalidate a prior action of the legislature. We hear
nothing to indicate that that is at all on the radar screen for
what is happening in Venezuela.
Senator Hagel. Have you had a chance to look at what was
done yesterday with the passage of the language that Ms. Paull
referenced? They have not had a chance to look at it. Is there
anything that you know of that would be of concern to this
committee?
Mr. West. We have been working long and hard to make sure
that everything we can find out about this new legislation we
are learning, studying, discussing, and analyzing. As I said
earlier, we are now comfortable with what we have seen so far
that the treaty is an appropriate measure.
Now that leaves the question of whether or not what
ultimately is reflected in the final legislative language is
consistent with what we know so far. And we have not seen that
final legislative language. I do not believe it is available
yet.
But we understand that it will be available at any time.
What we intend is, when that language is made available--
and, again, it ought to be at any time now--we want to make
sure that the final legislative language is consistent with our
understanding of what the drafts have said to date. I think
that is important.
We need to do that and intend to do that before the treaty
is brought into force, to make sure that what is finally
enacted is consistent with what our understanding is.
Senator Hagel. Of course, you both know what we will do.
Some of the areas that we do not cover today we will submit to
you in writing for you to deal with.
Are there other areas, Mr. West, that Ms. Paull brought up
to which you want to respond regarding Venezuela?
Mr. West. I would only reiterate, again, that the new tax
system seems to us to be a move in a direction that makes the
treaty make more sense even than it did before. We think that
is a logical development and that our businesses will be all
the more benefited by ratification of the treaty.
Ms. Paull. And we agree with that.
Senator Hagel. Before we leave our neighbors to the south,
is there anything that you want to add, Ms. Paull, regarding
Venezuela?
Ms. Paull. No, but I would just agree with the last
statement Mr. West made.
Senator Hagel. OK. Thank you.
We will submit some questions to further clarify some of
these issues.
Let's talk a little bit about Italy. There is an area that
Ms. Paull raised in questions, and maybe a good place to start,
one of the general areas we could work from is this. Maybe
there was some lack of complete consultation between Treasury
and Joint Tax Committee. I don't know that, but I pay attention
occasionally.
If I was listening to this correctly, I sensed that from
Ms. Paull's testimony.
Maybe you would like to reflect on that.
Mr. West. I would, Mr. Chairman.
Undoubtedly, we did not consult on this issue as much as we
might have, as much as we could have. I will say that there are
differing views as to the extent of the consultation that was
engaged in. But I don't think that is something that is
necessarily productive to go into.
But I will say that we could have done more and I would
like to undertake that in the future in areas like this we will
do more.
Senator Hagel. Ms. Paull brought out a couple of specific
areas. I think she talked about the anti-abuse provision where
there is some concern.
Would you like to put her fears to rest?
Mr. West. I would.
Senator Hagel. And you are fortunate that Senator Sarbanes
is now here as well. He brings a calmness and sereneness to the
effort, and a much needed dignity, I might add.
Is that good enough, Paul?
Senator Sarbanes. I thought that was just fine, yes.
Mr. West. Let me address some of the concerns that Ms.
Paull raised.
First, let me address the negative inference concern
regarding what this means for our other treaties and the other
parts of this treaty that do not contain this rule.
Our technical explanation, which serves as the first stop
after the committee reports and the congressional reports
regarding interpretation of this agreement, make clear that no
inference is intended; that our domestic law anti-abuse rules
that otherwise would apply will no longer apply after this rule
is in place.
So it is not the intent of the negotiators that otherwise
applicable rules will cease to apply after this rule comes into
force.
Senator Hagel. Are there any other areas on the Italy
treaty that Ms. Paull raised to which you want to respond?
Mr. West. Yes. Let me address the vagueness problem which I
know is a concern.
I tried to highlight in my testimony some of the reasons
why this standard was chosen over other standards. Again, let
me reiterate that there are broader standards--such as the one
Italy agreed to in its immediately preceding treaty--broader
standards, what we might call more subjective standards, that
Italy had recently agreed to. We reviewed those standards and
we rejected those. We thought that this produced a measure of
uncertainty with which we were not comfortable.
But we needed an effective standard, and we think this
standard will be an effective standard. Again, we took comfort
from the fact that it is contained in some 50 treaties around
the world, 40 treaty countries, 10 OECD members. We have
identified, as I said, over 2 dozen provisions of the Internal
Revenue Code that contain a very, very similar provision--one
of the main purposes is tax avoidance. The Internal Revenue
Code in many places refers to one of the principal purposes
being tax avoidance.
We discussed the differences in those words with some of
our treaty partners, and they viewed them as not being
different. They thought that there was greater certainty going
with the language that was already contained in many treaties
around the world.
So we agreed that that would actually enhance the certainty
of our rule. So we decided on that provision.
Senator Hagel. Does your reference to a standard mean that
you had prepared a comprehensive analysis of these main purpose
tests?
When you say standard, what do you mean? Let me put it
another way. Was there a comprehensive analysis done?
Mr. West. Mr. Chairman, we can always do more. This is no
doubt another example of a situation in which we could have
done more in identifying the exact contours of what the
ramifications of a rule like this would be.
There is relatively little, we will acknowledge, relatively
little interpretive authority on standards like this. The case
law is sparse on standards like this. We acknowledge that.
But, again, what we do believe is that, over time, the case
law will develop and the interpretive authorities will develop
in a way that will provide adequate certainty to our taxpayers.
Senator Hagel. One of the questions, and I think it is a
valid point, is the uncertainty issue--more uncertainty/less
uncertainty. Of course, as you know, investment depends, to
some extent, on certainty. Realizing that we cannot all be
certain, do you think that this treaty makes it better in that
area or not?
Mr. West. Well, it does not make it better, Mr. Chairman.
But, again, I would like to keep in mind that these treaties
only provide benefits. They do not restrict taxpayer benefits
in any way.
Because of this, we view it as reasonable to impose
reasonable limits.
Now in some situations, like our limitation on benefits
provisions, it is relatively easy to identify with bright line
standards when a person, an entity, a company is a bona fide
resident of a jurisdiction and when that company is not a bona
fide resident of that jurisdiction.
In the area of avoidance of tax, generalized tax avoidance,
that does not lend itself as easily to those kinds of bright
line standards. Again, we think the Internal Revenue Code
reflects that because, again, in over 2 dozen places there is a
very similar standard. It has been incorporated as recently as
a provision relating to active financing income for our
financial services businesses, which is included in the
extenders bill that is under consideration by the Congress now.
Even this provision contains language very similar--whether
one of the principal purposes is the avoidance of tax.
We have seen it elsewhere. It does not increase certainty.
But our view, again, is that it is a reasonable measure in
these circumstances where tax avoidance through treaty abuse is
increasing.
Senator Hagel. Thank you, Mr. West.
Senator Sarbanes.
Senator Sarbanes. Thank you very much, Mr. Chairman. I
appreciate your calling this hearing. I am not going to be able
to stay. But I do have some questions that I want to ask.
I am very much concerned by the fact that these tax
treaties come before us and then, all of a sudden, we are
confronted with new provisions that we have not dealt with
before. It is difficult to ascertain the rationale for this.
The main purpose test that you have just been talking
about, it seems to me, is one clear example of that. Has it
been incorporated in other U.S. tax treaties, the Italian and
Slovenian main purposes tests?
Mr. West. No other U.S. tax treaties, no.
Senator Sarbanes. This is the first time, right?
Mr. West. Yes, it is.
Senator Sarbanes. Is it in the U.S. model treaty?
Mr. West. No, it is not.
Senator Sarbanes. Is it in the OECD model treaty?
Mr. West. No, it is not.
Senator Sarbanes. I understand that the countries insisting
on such language internationally are the U.K., Ukraine,
Kazakhstan, Canada, Mexico, and Uzbekistan. Is that correct?
Mr. West. I would not say that was correct for the
following reason. These provisions, as I am sure you know,
Senator, the negotiations are frequently not a matter of one
country insisting on a provision. We have a few nonnegotiable
provisions we insist on. But many of these treaties are agreed
on by both parties to the negotiation because they believe they
are in the mutual interests of both parties.
The countries you mentioned do have this as part of their
policy. There are other countries that also have it as part of
their policy.
Senator Sarbanes. With respect to the countries I listed,
does the U.S. have bilateral tax treaties with those countries?
Mr. West. The U.S. has a tax treaty with the United
Kingdom, Senator. We have a tax treaty with the Ukraine that
has been signed and approved by the Senate but not yet brought
into force.
Senator Sarbanes. And Kazakhstan?
Mr. West. We have a tax treaty with Kazakhstan, yes.
Senator Sarbanes. Canada?
Mr. West. We have a tax treaty with Canada, yes.
Senator Sarbanes. Mexico?
Mr. West. We do, yes.
Senator Sarbanes. Uzbekistan?
Mr. West. Our treaty with the former Soviet Union continues
to apply.
Senator Sarbanes. Would they contain main purpose language?
Mr. West. Our treaty with Canada includes a provision that
allows Canada to apply a similar rule under its domestic law to
U.S. taxpayers. It is not the identical rule.
Senator Sarbanes. Why wouldn't applying U.S. domestic law
cover whatever problem you are concerned with?
Mr. West. We have actually reviewed U.S. domestic law on
that point. Actually, the standards are quite low.
The most recent significant authority in that regard is a
case called Northern Indiana Public Service Company. We look at
that case and see that the kind of tax treaty, what we view as
tax treaty abuse, that is allowed to go on under the standards
as articulated by some of the courts beyond that which we think
is appropriate.
Senator Sarbanes. Has Slovenia incorporated such language
in its previous tax treaties?
Mr. West. Not to my knowledge, Senator.
Senator Sarbanes. So it's the first time for Slovenia?
Mr. West. I believe so.
Senator Sarbanes. How about Italy?
Mr. West. Italy has broader language in some of its prior
treaties--more subjective, less certain standards in some of
its provisions.
Senator Sarbanes. In how many of its treaties?
Mr. West. I do not have a count for you, but I would be
happy to provide you with that number.
I am informed that it is in seven.
Senator Sarbanes. I am told that in five instances out of
70 tax treaties, Italy has language that approximates this main
purpose language. Would that be correct?
Mr. West. I am advised the number is seven, and I don't
know if it is the most recent seven.
Senator Sarbanes. Seven out of what?
Mr. West. Senator, it could be the most recent seven. It
could be all seven of its most recently negotiated treaties. I
do not have those numbers, though. I would be happy to get
those to you.
Senator Sarbanes. You don't know that it's seven out of how
many?
Mr. West. No, I don't know how many bilateral treaties
Italy has, Senator.
Senator Sarbanes. It's probably a fairly large number,
wouldn't you think?
Mr. West. We can surmise.
Senator Sarbanes. Where did this impetus come from to put
in this language?
Mr. West. Originally from looking at the Italian precedent
in its treaty with Israel, Senator. We looked at that precedent
and saw that some very broad anti-abuse rules were being
incorporated in treaties around the world. We considered the
broader Italian precedent when we sat down at the table with
Italy but decided against it. We decided it would not provide
enough certainty to our taxpayers.
Senator Sarbanes. Is it now our policy to request or
support such language? Is it your intention to amend or change
the U.S. model treaty?
Mr. West. The Treasury Department believes it is
appropriate policy, Senator. Whether it is our policy will, of
course, depend on the views of this committee and our
consultations and work with you.
Senator Sarbanes. I don't quite follow that answer.
Mr. West. It is the Treasury Department's view that it is
appropriate policy. Whether it goes in our future treaties
will, of course, be dependent on the views of this committee.
Senator Sarbanes. Well, ultimately that is quite true
because a treaty cannot go through if this committee and the
Senate do not accede to it. But what is the Treasury's
position?
Mr. West. As I said, Senator, the Treasury's view is that
this is appropriate treaty policy, yes.
Senator Sarbanes. So you intend to put this in all
succeeding tax treaties?
Ms. Paull. Let me show you your testimony.
Mr. West. Let me quote from my written testimony. ``It is
expected that the United States will incorporate these new
anti-abuse rules into its model.''
Senator Sarbanes. Is that your statement?
Mr. West. That is my written testimony.
Senator Sarbanes. Well, I had not gone through your written
testimony. But I am glad Ms. Paull helped us out. That seemed
to be a lot clearer than what you have been telling me in the
last few minutes.
Mr. West. Let me explain the ambiguity.
What is or is not our model position at any time is this.
We have a published model. But, again, what our model is for
our next negotiation is, in part, a function of developments
between the publication of our last model and that negotiation.
I hope that explains some of the ambiguity.
Senator Sarbanes. Now does this treaty with Italy waive the
excise tax on insurance premiums?
Mr. West. It does, Senator.
Senator Sarbanes. The Senate on numerous occasions has
specifically expressed its opposition to such a waiver, has it
not?
Mr. West. The Senate has expressed its opposition I believe
in cases in which there have been no assurance that there would
be adequate taxation to protect the domestic insurance industry
from unfair competition by foreign insurers who might compete
for U.S. risk business.
In the case of Italy, the Treasury Department is
comfortable that Italian law does provide for a substantial
level of taxation so that there would be no such unfair
competition with our domestic insurance industry.
Senator Sarbanes. So you're telling our people that you can
assure them that they will not be placed at a competitive
disadvantage?
Mr. West. No, I would not make so broad a statement.
Senator Sarbanes. Why shouldn't you be able to make that
statement?
Mr. West. It's a personal reticence about personal
advantage and disadvantage and my ability to assess what
competitive advantage and disadvantage is.
What I would say, Senator, is that we are comfortable that
Italy imposes a substantial domestic tax on the Italian
companies competing with U.S. businesses.
Senator Sarbanes. Do you have a view on that, Ms. Paull?
Ms. Paull. Well, I certainly have been in the throes of
this provision in my former capacity at the Senate Finance
Committee. I flagged that for the committee because of that. We
had inquired of the Treasury Department and they assured us
that there would be an adequate level of tax imposed by Italy
on the insurance companies who are insuring U.S. risks over
here.
If that is not the case, then certainly that would be an
issue that the committee would want to visit. We do not have
any independent way of judging.
Senator Sarbanes. Nor do we, I assume.
Ms. Paull. Yes.
Senator Sarbanes. I mean, if that happens, it will happen
after the fact, correct--after the treaty goes into effect?
Ms. Paull. This is one of those things that certainly we
are under an obligation, the Treasury Department is under an
obligation, I would believe, to monitor very carefully.
Senator Sarbanes. What would happen if you found out that
the Italians were not doing this?
Ms. Paull. Well, what happened in the past, of course,
though there were a lot different circumstances, is the
Congress overrode the treaty provision ultimately. That is not
a great position for the Senate to be in.
Senator Sarbanes. That's right. Everyone comes and tells us
we should not do that because we won't be able to negotiate any
treaties.
What happens if, in effect, your assurances turn out to be
empty?
Mr. West. Well, Senator, we can go and seek renegotiation
of that point and attempt to reach agreement on a protocol with
the Italians if the facts change in such a dramatic manner.
Senator Sarbanes. Let me ask about bank secrecy.
The model treaty contains a provision on bank secrecy
authorizing a country to obtain and provide information held by
financial institutions, notwithstanding any laws or practices
of the requested country that would otherwise preclude such
exchange of information. Both the Italian and the Slovenian
treaties are missing this provision, although both technical
explanations state that the omission of this section does not
relieve those countries of the obligation to provide this
information.
Why was the standard bank secrecy provision omitted from
these two treaties?
Mr. West. Senator, that language has proven problematic for
us not for any substantive reasons in a number of cases but,
really, for reasons that I will term diplomatic.
What the language does, in effect, is require our treaty
partner to declare in a rather open way that this treaty will
override provisions of its domestic law potentially if that is
the case; or, if it is not the case, they view this language as
unnecessary because their domestic law already provides for
full exchange of bank information.
Let me assure you that in the case of Italy and Slovenia,
we have obtained assurances in writing from both countries that
they can obtain such information and that the absence of that
language from our treaties does not in any way affect or alter
our ability to obtain the information from financial
institutions that is appropriate under our exchange of
information provisions.
Senator Sarbanes. That is not a very good precedent to be
setting, is it, in terms of negotiating treaties with other
countries that come along?
Mr. West. Senator, we are coming to believe that the bad
precedent is the language in our model treaty, and we are
reconsidering that language, not in any way to step back from
our full commitment to complete an open exchange of information
regarding financial institutions, but because the language
itself, the words, seem problematic to many of our treaty
partners.
Senator Sarbanes. What does that mean, ``problematic to our
treaty partners''? They don't want to supply the information?
Mr. West. Well, as I said, either it is unnecessary because
they provide this information or it is, again, what I can best
term diplomatically objectionable because it is an open
declaration that laws that might otherwise be on the books
would be overridden, or both, perhaps.
Senator Sarbanes. Then how do you handle that situation?
Mr. West. Well, what we do, again, Senator, is assure
ourselves.
Senator Sarbanes. Let's say a country has the laws on the
books that would not enable this information to be exchanged. I
think your phrase was ``it is diplomatically problematical'' to
have language in the treaty that would provide for the exchange
of information. So where are we, then?
Mr. West. Senator, that is not a treaty we would enter
into. In the facts you described, there is no ability to get
the information. But they find the language objectionable.
Senator Sarbanes. Presumably, the ability to get the
information is on a continuum. At one end of the continuum is:
you can't get anything; at the other end of the continuum is:
what we can get by the provision in the model treaty. So you
range across that landscape.
Mr. West. Senator, there is no continuum for us. It is full
and open exchange of information held by financial institutions
or we will not enter into a new treaty relationship.
Senator Sarbanes. But it should be in the treaty, then.
In how many treaties is such a provision found?
Mr. West. It is not a majority of our treaties. I will see
if I can get that information. If I cannot answer it now, I
will provide it to you.
Senator Sarbanes. Has it been in all the treaties since we
became increasingly concerned about this issue?
Mr. West. It is not in all the treaties, Senator Sarbanes.
We have 8 treaties that have been approved by the Senate since
1996 when our model treaty language appeared that do not have
this language.
Senator Sarbanes. And how many do?
Mr. West. Four do and most of the treaties before you today
do. But several of them do not.
Senator Sarbanes. Mr. Chairman, you have been very
generous. I have just a couple of more questions and then will
have to depart, which I regret.
Senator Hagel. Why don't you continue, then.
Senator Sarbanes. Thank you.
You stated earlier at the table that there were benefits in
all of these treaties for U.S. taxpayers, is that correct?
Mr. West. I believe so. Yes, sir.
Senator Sarbanes. And that it was just a question of
limiting them. What are the benefits in the German protocol?
Mr. West. One benefit in the German protocol is our ability
to apply our recent expanded expatriation rules in that
protocol, Senator.
Senator Sarbanes. In my reading and in the reading we have
done it seems to indicate that it works to the benefit of
German residents with assets in the United States.
Mr. West. There are a couple of things about that.
Senator Sarbanes. But, also, there are no reciprocal
benefits to U.S. residents with property in Germany.
Mr. West. Well, first of all, German internal law provides
many of those same benefits. So there was no need to obtain
them through a reciprocal agreement.
Senator Sarbanes. What happens if they change German
internal law?
Mr. West. We would, again, consider seeking renegotiation
if this agreement became nonreciprocal.
Senator Sarbanes. On what basis would we do that?
Mr. West. A change in the circumstances. We are in
discussions with Germany all the time.
Senator Sarbanes. What would happen if we changed U.S.
internal law to the disadvantage of German residents?
Ms. Paull. That did happen.
Mr. West. That is what happened, which engendered this
negotiation.
Senator Sarbanes. What?
Mr. West. That is what happened. In 1988, our domestic law
was amended. It adversely affected German decedents with
noncitizen spouses, and Germany sought negotiation of this
protocol to our estate and gift tax convention.
They also sought it, Senator, in the context of our income
tax treaty that was agreed to in the early 1990's. The way the
Treasury Department has viewed this agreement is hand-in-glove
with the benefits and agreements that were provided under our
income tax treaty with Germany. Again, that was concluded after
the 1988 changes in law that adversely affected the Germans,
but prior to the conclusion of this estate and gift tax
provision.
Senator Sarbanes. Are you telling me that the reach of this
protocol is only to the extent of altering our earlier treaty
with Germany to encompass the changes in U.S. domestic tax law?
Mr. West. The two main things it does is it addresses the
1988 change in law that adversely affected German decedents
with noncitizen spouses and also implements a congressional
directive to negotiate with treaty partners to provide a pro
rata unified credit to them more appropriate than the one
provided to them under prior law.
Senator Sarbanes. Ms. Paull, do you have any observations
on any of these issues that I covered with Mr. West?
Ms. Paull. Yes, I have a few observations. I could start
with this last one.
I think we were on notice that the issues rising from our
1988 change in our law, Germany was on notice, and I believe
their testimony indicates that we made some modifications for
Canada as well.
The process of negotiating an income tax treaty with
Germany was near its final stages when we changed the law. So I
think there were commitments made that we would revisit the
Estate, Gift, and Inheritance Tax Treaty, and that is what this
is. I think we have been aware of that all along, that it was
an obligation of the United States to go back and revisit that.
That is why it looks a little bit unusual, in the sense
that it is principally a one-sided modification of the 1980
treaty, which deals only with estate, gift, and inheritance
taxes.
With respect to the bank secrecy provisions of the U.S.
model treaty, I would have to say that our staff would have
concerns about the Treasury Department deleting that language
from the model treaty.
Certainly, some of the treaties that were concluded in the
last 5 years only have some partial exchanges of information,
and I imagine that this committee believed that that was a step
in the right direction considering the countries that were
involved.
One would hope that we would hold that standard as a high
standard so that we could, with all of our treaty partners, get
a full and adequate exchange of information. I think you know
the countries we are talking about here. So I would just simply
comment on that.
On the main purpose test, I would, again, say to the
committee that this test is very vague, very vague, and we have
serious concerns about it. There is nothing of the test that
appears in the treaties in their various articles that deals
with tax avoidance, to which Mr. West was pointing--a variety
of, a kind of similar, a principal purpose, or a main purpose
type motivation--to avoid taxes as in our anti-abuse rules.
I go back to my situation, a fairly straight-forward
situation, where, all things being equal, a company, a U.S.
company is going to make an investment in a region. They might
want to pick Slovenia, but they might not want to under this
treaty to get the benefits of the treaty, the lower withholding
on the income that is generated by their investment.
It puts a major cloud on investments that has nothing to do
with what is stated in the articles and in the test that there
is tax avoidance involved. Certainly, the technical explanation
goes into that. But, you know, courts tend to look right at the
language of the provision they are having to interpret first.
So it is troublesome language. I don't think we have a clue
what it really means, to be perfectly frank with the committee.
Senator Sarbanes. Thank you very much, Ms. Paull.
Thank you, Mr. Chairman.
Senator Hagel. Senator Sarbanes, thank you.
Let me move along to a couple of other areas that we have
not had an opportunity to talk about.
First is the Baltic states. In reading the general dynamics
of what you have here, it is my understanding that the treaties
with the Baltics, as well as the Venezuela treaty, all contain
developing country concessions. You know what that means
regarding permitting higher withholding rates, different source
rules, and so on.
I guess I have two general questions. One is what was the
criteria used to determine if a country is entitled to
developing country concessions? That is my first question.
Mr. West. Mr. Chairman, what we do in cases like these, in
consultation with the State Department, is make a determination
of whether in the administration's view it is in the overall
interest of the United States to embark on treaty negotiations
with a country that we'll call a developing country.
Once we make a decision to do that and sit down at the
table with them, the extent to which we make concessions from
the positions we take with developed countries is a dynamic,
and it is a function of factors that I would venture to say are
not subject to precise delineation of how a negotiating dynamic
proceeds.
We take into account the overall benefits to the United
States and we negotiate the best agreement that we can under
the circumstances. That is certainly true with these treaties.
They reflect long negotiations, detailed negotiations. They go
on for a number of rounds, over weeks and years from beginning
to end, and we make a judgment as to whether the overall
package is the best that could be obtained.
It is our view that these agreements before you are the
best agreements that could be obtained with these countries.
Senator Hagel. Who makes the final decision on this?
Mr. West. The final decision is made by the Senate in
determining passage.
Senator Hagel. No, no. You know what I mean.
Mr. West. In the Treasury Department?
Senator Hagel. That's where you're from.
Mr. West. Typically, the Assistant Secretary for Tax Policy
is involved in reviewing these agreements and is apprised of
the terms of the agreements, sometimes has a role in
negotiating the agreements, and all of these negotiations are
subject to his judgment as to whether they are appropriate.
They are, of course, reviewed and transmitted by the Secretary
of the Treasury. They are reviewed by his office to make a
determination as to whether the Office of Tax Policy has acted
appropriately. But the Assistant Secretary for Tax Policy is
generally the official that I would say is responsible for
those judgments.
Senator Hagel. Thank you.
Do you believe or can you quantify if there are any
effects, impacts on investment in the countries that were given
these kinds of concessions?
Mr. West. Those are very hard to quantify, Mr. Chairman. I
would not even venture a guess as to what the effects are. We
do not negotiate these agreements with an eye toward a short-
term boost to investments. These are agreements that we enter
into because they are in the overall interests of the United
States, in our overall economic interests.
Senator Hagel. Are you familiar with a letter that Senators
Helms, Biden, and I recently wrote to the Secretary of the
Treasury regarding the U.S.-Japan Tax Treaty?
Mr. West. I am.
Senator Hagel. So you know that the question we posed to
the Secretary was about these same kinds of concessions with
Japan?
Mr. West. As I read the letter, Mr. Chairman, it was a
request, or an expression of the view of the signing Senators
that the Treasury Department should do what it can to open
formal negotiations to renegotiate the Japanese treaty.
Senator Hagel. Does that treaty have similar developing
country provisions in it?
Mr. West. I would say this, that certain of the positions
held by the Japanese consistently in all their treaty
relationships, relatively few but certain of them are
inconsistent with international norms for developed countries.
There is really one in particular and that is their withholding
tax rate on royalties.
One of the other provisions that I know is of interest to
the U.S. business community is the withholding tax rate on
interest. In that case, the United States position is actually
lower than the international norm in that area. So, saying what
a developed country versus developing country standard is can
get a bit tricky because in some cases the United States
standard is actually more favorable to our business community
than the international norm. That is the case with the interest
withholding tax rate in the Japanese treaty.
But their royalties tax withholding rate is inconsistent
with the international norm.
Senator Hagel. Are we renegotiating that part of the
treaty?
Mr. West. Mr. Chairman, I am doing everything in my power
to open negotiations in a manner that would lead to a treaty
that would be acceptable to this committee, to our business
community, and to the Japanese, as well. We want very much to
renegotiate the existing agreement to arrive at something that
would be acceptable to all three of those constituencies at
this time.
I am doing everything in my power to work toward opening
those negotiations.
Senator Hagel. Does it not occur to you--and I suspect it
has--that we are dealing here with the second largest economy
in the world, that of Japan, but yet it has developing country
provisions in it? Are we not talking about a charade here and
wouldn't that subject all further treaties to an erosion of any
confidence or any standards?
Mr. West. I would only comment, Mr. Chairman, not by way of
justification but by way of context, that two of our three
largest trading partners--that is, Canada and Japan--both hold
that same position regarding interest withholding tax rates.
Senator Hagel. The Secretary probably will be getting
another letter.
I want you to know that there are a number of us on this
committee who would be very happy to work with you on this, Mr.
West, if you feel you are not getting the kind of support and
impetus you need. We would look forward to working with you on
this.
Mr. West. I very much appreciate that.
Senator Hagel. Ms. Paull, is there anything you would like
to add to what Mr. West has said in any of these areas, these
general areas--anything we have talked about this afternoon?
Ms. Paull. No. I think I probably have outstayed my
welcome.
Senator Hagel. Oh, you have been most helpful, as always.
We could spend the rest of the day with some of the more
specific areas that we have not gotten into. But, suffice it to
say we will submit in writing some questions for details of
some of the more specific areas we want to get into.
This committee has a business meeting on November 3.
Obviously, as is always the case, the more timely the response,
the more likely that we could turn some of this around.
As always, we are grateful that you could come up today,
Mr. West. We appreciate it very much.
Ms. Paull, it is always nice seeing you. Thank you very
much.
Are there any last comments?
Mr. West. I would just say, again, that we request all of
these treaties be favorably acted on. Thank you for your time.
Senator Hagel. Thank you.
Mr. Murray, are you still awake?
Please come forward to the table. We will give you some
coffee or water, whatever you need.
Mr. Murray, thank you. We are grateful that you are here
today and look forward to your testimony. Please proceed.

STATEMENT OF FRED F. MURRAY, VICE PRESIDENT FOR TAX POLICY,
NATIONAL FOREIGN TRADE COUNCIL, WASHINGTON, DC

Mr. Murray. Thank you, Mr. Chairman. I am very happy to be
here. As you have noted, my name is Fred Murray. I am vice
president for tax policy of the National Foreign Trade Council.
The NFTC is an association of businesses with some 500-plus
members founded in 1914. It is the oldest and largest U.S.
association of businesses devoted to international trade
matters.
Most of the largest U.S. manufacturing companies and most
of the 50 largest U.S. banks are members. They account for
approximately 70 percent of all U.S. nonagricultural exports
and 70 percent of U.S. private foreign investment.
We are here today to recommend ratification of these
treaties and protocols under consideration by the committee. We
appreciate the chairman's and the committee's actions in
scheduling this hearing and agreeing to receive both our
testimony and our written statement for the record.
Expanding U.S. foreign trade and investment and
incorporating the United States into an increasingly integrated
world economy is an evermore important concern. Foreign trade
is fundamental to our economic growth and our future standard
of living. Although the U.S. economy is still the largest
economy in the world, its growth rate represents a mature
market for many of our companies.
As such, U.S. employers must export in order to expand the
U.S. economy by taking full advantage of the opportunities in
overseas markets.
Today, some 96 percent of U.S. firms' potential customers
are outside the United States. In the 1990's, some 86 percent
of the gains in worldwide economic activity occurred outside
the United States.
In recent years, exports have accounted for as much as one-
third of total U.S. economic growth.
As global competition grows ever more intense, it is vital
to the health of the U.S. economy and to our enterprises that
they be free from excessive foreign taxes or double taxation
that can serve as a barrier to full participation in the
international marketplace.
Tax treaties are a crucial component of the framework that
is necessary to allow such balanced competition. The NFTC has
long supported the expansion and strengthening of the U.S. tax
treaty network.
As you noted, the United States has in force approximately
59 income tax treaties, depending on how you count certain of
the agreements with the former Soviet Union. It has taken more
than 60 years to negotiate, sign, and approve these treaties
that form the current network. And, although there has been
significant progress in recent years in expanding the treaty
network, the U.S. treaty network still covers considerably less
of the developing world compared to coverage by the networks of
Japan and leading European nations and is still considerably
smaller than some of our major trading partners.
This discrepancy has persisted for many years, even though
the United States relies on the developing world to buy a far
larger share of its exports than does Europe.
Five of the eight agreements before the committee today
represent new tax treaty relationships with the United States.
The remaining three agreements modify existing relationships.
Virtually all treaty relationships depend upon difficult, and
sometimes delicate, negotiations aimed at resolving conflicts
between the tax laws and policies of the negotiating countries.
The resulting compromises always reflect a series of
concessions by both countries from their preferred positions.
With one exception that I will later note, we believe that
the treaties and protocols presently under consideration
represent a good compromise and that they will contribute
significantly both to the economic competitiveness of U.S.
companies and to the proper administration of U.S. tax laws.
Though all of the treaties before the committee today are
important and serve to expand the tax treaty network of the
United States, two of the treaties before the committee are
especially important to U.S. business interests.
First, let me address the treaty with Venezuela. Venezuela
is a major destination for U.S. based foreign investment, and
the U.S. is a major recipient of Venezuelan foreign investment.
Venezuela is the second largest importer and exporter to the
U.S. in the Western Hemisphere outside of those countries in
NAFTA. Only Brazil exceeds Venezuela.
The U.S. is Venezuela's most important trading partner, and
many U.S. based companies have a significant stake in
Venezuela. In fact, I have been told that as many as 1,000
companies are members of the ``AMCHAM'' in Venezuela.
If the treaty is ratified and comes into force and effect,
U.S. companies will be put on the same competitive footing that
companies from other nations currently have in their
relationships with Venezuela. There are 12 other countries with
whom Venezuela currently has double taxation treaties.
The United States currently has no tax treaties in force
and effect with countries on the continent of South America.
This remark bears special emphasis.
South American countries, including Venezuela, consistently
rank at or near the top of NFTC surveys in their importance to
U.S. based companies. This treaty is extremely important, as
noted above, because of its importance to U.S. based companies
and their interests in Venezuela.
It is perhaps even more critically important because its
ratification would tend to encourage more cooperation between
the new Government of Venezuela and that of the United States.
Conversely, failure to ratify the treaty may have important
negative implications to that relationship.
It is difficult to overstate the importance of gaining a
foothold in our treaty network with South American countries,
particularly in light of some of the tensions that have
previously existed with some of our neighbors and friends to
the south.
We are concerned, or, we have been made aware of some of
the concerns that the committee has become aware of in regard
to the situation there. I must say that my members report to me
that they are cautiously optimistic about the situation in
Venezuela and support the treaty. They hope that the committee
will look upon it favorably.
In fact, the NFTC congratulates the Treasury for its
efforts to persevere through some difficult negotiations of
this treaty, and through the change in government, to make this
landmark treaty.
I would also note that I am informed by some of my
colleagues that the new law that has been the subject of some
discussion this afternoon is to be published in the ``Official
Gazette'' this afternoon, as we speak.
The Treasury Department is also to be commended for
modernizing tax treaties with our major trading partners and,
specifically, members of the European Union.
The new tax treaty with Italy updates the existing treaty
to reflect current tax policies in the United States and Italy.
In addition to its other important contributions, the new
treaty addresses the replacement of the ILOR, the local income
tax, by the new Italian regional tax on productive activities,
the IRAP. This provision is very important to our companies
and, in spite of the inclusion of the other provision that has
been the subject of much discussion this afternoon and which
has caused a lot of concerns not only within our membership but
certainly within the committee as we have discussed or heard
discussed, it is very important that the treaty, with or
without the offending provision, be ratified so that the
provision governing the creditability of the ILOR come into
force and effect.
Our economic relationship with the Italian Republic is one
of our most important and the changes made by the treaty are
beneficial and important to our companies and workers.
Ratification of the treaties and protocols before the
committee today continues the momentum that is needed to bring
other nations into the U.S. treaty network. It sends a
continuing signal that the U.S. wishes to reduce and eventually
eliminate existing impediments to global business.
Again, the Council is grateful to the chairman and to the
members of the committee for the opportunity to speak before
the committee. We respectfully urge the committee to proceed
with ratification of these treaties and protocols as
expeditiously as the committee finds it appropriate.
I would like, given the discussion this afternoon, to make
one additional comment before I close, Mr. Chairman. The two
agreements that have been mentioned in a number of the comments
and questions, those with Italy and Slovenia, contain this main
purpose test that has been much discussed. Although the NFTC
does not support inappropriate use of such treaties, the
wording of these tests is vague and unclear. The tests must be
applied in a subjective way under treaty language that may be
difficult to change if they do not work as intended.
The questions and answers have elicited a number of
comments about these types of subjective rules. We have found
in other circumstances where the principal purpose test has
been used, or tests like the business purpose test, that there
is a good deal of uncertainty and quite a bit of litigation. It
gives rise to some concern in respect of the inclusion of these
rules in this particular context.
The rules may cause considerable uncertainty to taxpayers
in the application of the otherwise available provisions of the
treaties. In that respect, we certainly adopt Ms. Paull's
concerns.
That concludes my oral remarks this afternoon. I would be
pleased to answer your questions.
[The prepared statement of Mr. Murray follows:]

Prepared Statement of Fred F. Murray

Mr. Chairman, and Members of the Committee:
The National Foreign Trade Council, Inc. (the ``NFTC'' or the
``Council'') is pleased to present its views on ratification of the
various income tax treaties and protocols before the Committee
today.\1\ We are here today to recommend ratification of the treaties
and protocols under consideration by the Committee. We appreciate the
Chairman's and the Committee's actions in scheduling this hearing and
agreeing to receive our testimony and written statement. We strongly
urge this Committee to reaffirm the United States' historic opposition
to double taxation by giving your full support to the pending treaties.
---------------------------------------------------------------------------
\1\ Convention Between the Government of the United States of
America and the Government of the Kingdom of Denmark for the Avoidance
of Double Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income Signed at Washington, D.C., on the 9th Day of August,
1999, Together with a Protocol Signed at the Same Time and Place;
Convention Between the United States of America and the Republic of
Estonia for the Avoidance of Double Taxation and the Prevention of
Fiscal Evasion With Respect to Taxes on Income, Signed at Washington,
D.C., on the 15th Day of January, 1998; Protocol Signed at Washington,
D.C., on the 14th Day of December, 1998, Amending the Convention
Between the United States of America and Federal Republic of Germany
For the Avoidance of Double Taxation with Respect to Taxes on Estates,
Inheritances, and Gifts, Signed at Bonn on December 3, 1980; Convention
Between the Government of the United States of America and the
Government of the Italian Republic for the Avoidance of Double Taxation
With Respect to Taxes on Income and the Prevention of Fraud or Fiscal
Evasion, Signed at Washington, D.C., on the 25th Day of August, 1999,
Together with a Protocol Signed at the Same Time and Place; Convention
Between the United States of America and the Republic of Latvia for the
Avoidance of Double Taxation and the Prevention of Fiscal Evasion With
Respect to Taxes on Income, Signed at Washington, D.C., on the 5th Day
of January, 1998; Convention Between the Government of the United
States of America and the Government of the Republic of Lithuania for
the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
with Respect to Taxes on Income, Signed at Washington, D.C., on the
15th Day of January, 1998; Convention Between the United States of
America and the Republic of Slovenia for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on
Income and Capital, Signed at Ljubljana, on the 21st Day of June, 1999;
And, Convention Between the Government of the United States of America
and The Government of the Republic of Venezuela for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income and Capital, Signed at Caracas on the 25th Day of
January, 1999, Together with a Protocol Signed at the Same Time and
Place.
---------------------------------------------------------------------------
The NFTC is an association of businesses with some 550 members,
originally founded in 1914 with the support of President Woodrow Wilson
and 341 business leaders from across the U.S. It is the oldest and
largest U.S. association of businesses devoted to international trade
matters. Its membership now consists primarily of U.S. firms engaged in
all aspects of international business, trade, and investment. Most of
the largest U.S. manufacturing companies and most of the 50 largest
U.S. banks are Council members. Council members account for at least
70% of all U.S. nonagricultural exports and 70% of U.S. private foreign
investment. A significant NFTC emphasis is to encourage policies that
will expand U.S. exports and enhance the competitiveness of U.S.
companies by eliminating major tax inequities and anomalies.
The founding of the Council was in recognition of the growing
importance of foreign trade and investment to the health of the
national economy. Since that time, expanding U.S. foreign trade and
investment, and incorporating the United States into an increasingly
integrated world economy, has become an even more vital concern of our
nation's leaders. The share of U.S. corporate earnings attributable to
foreign operations among many of our largest corporations now exceeds
50 percent of their total earnings. Even this fact in and of itself
does not convey the full importance of exports to our economy and to
American-based jobs, because it does not address the additional fact
that many of our smaller and medium-sized businesses do not consider
themselves to be exporters although much of their product is supplied
as inventory or components to other U.S.-based companies who do export.
Foreign trade is fundamental to our economic growth and our future
standard of living.\2\ Although the U.S. economy is still the largest
economy in the world, its growth rate represents a mature market for
many of our companies. As such, U.S. employers must export in order to
expand the U.S. economy by taking full advantage of the opportunities
in overseas markets. Today, some 96% of U.S. firms' potential customers
are outside the United States, and in the 1990's 86% of the gains in
worldwide economic activity occurred outside the United States. In
recent years, exports have accounted for as much as one-third of total
U.S. economic growth.\3\
---------------------------------------------------------------------------
\2\ ``Continued robust exports by U.S. firms in a wide variety of
manufactures and especially advanced technological products--such as
sophisticated computing and electronic products and cutting-edge
pharmaceuticals--are critical for maintaining satisfactory rates of GDP
growth and the international competitiveness of the U.S. economy.
Indeed, it is widely acknowledged that strong export performance ranks
among the primary forces behind the economic well-being that U.S.
workers and their families enjoy today, and expect to continue to enjoy
in the years ahead.'' Gary Hufbauer (Reginald Jones Senior Fellow,
Institute for International Economics) and Dean DeRosa (Principal
Economist, ADR International, Ltd.), ``Costs and Benefits of the Export
Source Rule, 1998-2002,'' A Report Prepared for the Export Source
Coalition, February 19, 1997. For an extensive discussion of the
importance of foreign operations and cross-border trade and investment
to the United States and the effects of globalization of the world
economy, see Ch. 5, ``The NFTC Foreign Income Project: International
Tax Policy for the 21st Century; Part One: A Reconsideration of Subpart
F,'' National Foreign Trade Council, Inc., Washington, D.C., March 25,
1999.
\3\ See, Fourth Annual Report of the Trade Promotion Coordinating
Committee (TPCC) on the National Export Strategy: ``Toward the Next
Century: A U.S. Strategic Response to Foreign Competitive Practices,''
October 1996, U.S. Department of Commerce, ISBN 0-16-048825-7; J. David
Richardson and Karin Rindal, ``Why Exports Matter: More!,'' Institute
for International Economics and the Manufacturing Institute,
Washington, D.C., February 1996.
---------------------------------------------------------------------------
tax treaties and their importance to the united states of america
Given the importance of the international economy to the United
States, the Council is grateful to the Committee for giving
international economic relations a prominent place on its agenda.
As noted, our membership is actively engaged in a broad spectrum of
industrial, commercial, financial, and service activities. The NFTC
therefore 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. As global competition grows ever more
intense, it is vital to the health of U.S. enterprises, and to their
continuing ability to contribute to the U.S. economy, that they be free
from excessive foreign taxes or double taxation that can serve as a
barrier to full participation in the international marketplace. Tax
treaties are a crucial component of the framework that is necessary to
allow such balanced competition. The NFTC has long supported the
expansion and strengthening of the U.S. tax treaty network.
Tax treaties are bilateral agreements between the United States and
foreign countries that serve to harmonize the tax systems of the two
countries. 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 double
taxation by allocating taxing jurisdiction between the two treaty
countries.
In addition, the tax systems of most countries impose withholding
taxes, frequently at high rates, on payments of dividends, interest,
and royalties to foreigners. These taxes can be reduced only by treaty.
If U.S. enterprises earning such income abroad cannot enjoy the reduced
foreign withholding rates offered by a tax treaty, they may suffer
double taxation and be unable to compete with business ventures from
other countries that do have such benefits. Thus, tax treaties serve to
prevent this barrier to U.S. participation in international commerce.
Tax treaties also provide other features which are vital to the
competitive position of U.S. businesses. For example, by prescribing
internationally agreed thresholds for the imposition of taxation by
foreign countries on inbound investment, and by requiring foreign tax
laws to be applied in a nondiscriminatory manner to U.S. enterprises,
treaties offer a significant measure of certainty to potential
investors. Another extremely important benefit, that is available
exclusively under tax treaties, is the mutual agreement procedure, a
bilateral administrative mechanism for avoiding double taxation.
The United States has in force some forty-nine \4\ Conventions for
the Avoidance of Double Taxation and the Prevention of Fiscal Evasion
With Respect to Taxes on Income (``income tax treaties'') with various
jurisdictions, not including other agreements affecting income taxes
and tax administration (e.g., Exchange of Tax Information Agreements or
Treaties of Friendship and Navigation that may include provisions that
deal with tax matters). It has taken more than sixty years to
negotiate, sign, and approve the treaties that form the current
network.\5\ A number of new agreements are being negotiated by the
Treasury Department. Nevertheless, the U.S. treaty network has never
been as extensive as the treaty networks of our principal competitors.
The U.S. treaty network still covers considerably less of the
developing world, compared to coverage by the networks of Japan and
leading European nations. This discrepancy has persisted for many
years, even though the United States relies on the developing world to
buy a far larger share of its exports than does Europe.
---------------------------------------------------------------------------
\4\ The count is somewhat imprecise--e.g., the effects of the
treaty with the former Union of Soviet Socialist Republics and its
effects on the former members of that Union are not considered (the
count may be increased by up to nine depending upon how such effects
are determined). Some treaties have been terminated in part, and there
are a number under active negotiation or renegotiation, or that have
been signed but not ratified.
\5\ The current international consensus favoring income tax
treaties is derived from sixty years of evolution, starting with the
model income tax treaty drafted by the League of Nations in 1927,
culminating in its ``London Model'' treaty in 1946, and carried on
later by the United Nations, and the Committee on Fiscal Affairs of the
Organization for Economic Cooperation and Development (``OECD''). The
U.S. first signed a bilateral tax treaty in 1932 with France, which
treaty never went into force. The first effective treaty, also with
France, was signed July 25, 1939, and came into force on January 1,
1945.
---------------------------------------------------------------------------
As noted above, the typical income tax treaty provides for the
elimination or at least mitigation of double taxation in a number of
ways: modification of sourcing rules, clarification of rules affecting
computation of foreign tax credits, specification of certain taxes that
may be considered income taxes for the purposes of the foreign tax
credit, rules allocating income to permanent establishments or
establishing transfer prices, rules establishing the competent
authority mechanism, and other rules in which jurisdiction to tax is
relinquished. The reciprocal reduction of withholding taxes imposed by
the respective contracting states on dividends, interest, royalties,
and certain other types of cross-border flows is the most important
form of mutually agreed relinquishment of jurisdiction to tax. The
treaties also provide a number of ``administrative'' mechanisms for
resolution of disputes as to state of residence, exchange of tax
information between tax authorities of the two contracting states,
nondiscrimination against nationals or other parties of one contracting
state by the other contracting state, and the like.
The principal function of an income tax treaty is to facilitate
international trade, investment, and commerce by removing or preventing
tax barriers to the free flow or exchange of goods and services and the
free movement of capital and persons. In making such an agreement, a
contracting state acts in two capacities.
First, as a country of residence, the contracting state imposes tax
on the income derived by resident individuals and legal entities (and,
in countries like the United States that tax their citizens on a world-
wide basis, its non-resident citizens and those legal entities
organized under its laws or otherwise subject to its jurisdiction). In
this capacity, the contracting state seeks to minimize the source-based
taxes imposed on these taxpayers by the other contracting state, its
treaty partner. If, like the United States, its system of world-wide
taxation is relieved by a foreign tax credit mechanism, it will have a
revenue interest in this result, but even in other circumstances, it
will have an interest in the reduction of source-based taxes as a means
of assuring fair treatment of its taxpayers and promoting their foreign
trade and commerce.
Second, the country of source may impose a tax on income derived by
individuals and entities resident in its treaty partner. In this role,
the contracting states have multiple and sometimes incongruent
interests. The source country may be interested in protecting its
revenues from unwarranted erosion. However, it is also concerned with
providing a hospitable environment for desirable inbound foreign
investment. As these bilateral treaties are reciprocal agreements,
contracting states must be willing to make concessions with respect to
taxing authority to gain similar reciprocal concessions from its treaty
partner.
The loss of revenue from withholding taxes, or other reductions of
source-based taxation has now, after these six decades, become
generally accepted as the price for obtaining for its taxpayers the
benefits of neutral tax treatment with respect to their international
trade, investment, and commerce. In fact, there has developed a
remarkably broad, general consensus among national governments, even
those who agree on few other principles, that it is in their interest
to enter into income tax treaties, and almost as broad consensus as to
the form of the mechanisms adopted.
Income tax treaties enable U.S. firms to compete in foreign
countries, and foreign firms to establish plants in the United States
and invest in U.S. securities. Without the tax treaty network and
complementary national legislation, double taxation would create an
enormous barrier to the international movement of capital and
technology. Likewise, a crippling of our treaty network could cause
world trade to shrink because so much of it depends upon cross-border
investment and open channels for movement of capital and technology.
A study, conducted under the auspices of the NFTC, illustrates the
possible consequences of abandoning all existing U.S. tax treaties,
and, in selective ways, changing U.S. tax laws to extract more revenue
from inward foreign investment:

Broadly speaking, the average foreign tax burden on income
flowing to the United States, which is predominantly from
direct investment and therefore subject to foreign corporate
tax as well as withholding taxes, would rise from about 16.0
percent (with a treaty network) to about 23.4 percent (without
a treaty network). The average U.S. tax burden on income
flowing to foreign investors would similarly rise from about
9.1 percent to about 14.1 percent.
In relative terms, the tax burdens on U.S. investment abroad
and foreign investment in the United States would thus escalate
by about the same amount. However, the absolute tax level is
lower on foreign investments in the United States because that
investment is concentrated in bank deposits and portfolio
securities, which are not immediately subject to the U.S.
corporate income tax.
As a consequence of higher tax rates, international
investment could implode. Using a conservative estimating
procedure, it was calculated that the stocks of U.S. investment
abroad and foreign investment in the United States would each
shrink by about $340 billion annually, without a treaty
network.
Reduced foreign investment in the United States would curb
competition in the U.S. marketplace and raise U.S. interest
rates. U.S. consumers would have to pay higher prices for a
smaller variety of goods, investment would be squeezed and,
ultimately, growth rates would be lower. In addition, the
smaller role of multinational firms would curtail U.S. exports
by some $21 billion annually, which would reduce the domestic
employment of those firms and their suppliers by an estimated
340,000 jobs.
In order for the U.S. Treasury to realize any revenue gain
from the non-treaty world, the Congress would need to impose a
new withholding tax on interest paid to foreign investors on
their U.S. bank deposits and Treasury securities. At a rate of
5 percent, the new tax would raise significant revenue, about
$6.4 billion annually. However, the larger tax revenues would
be more than offset by the inevitable rise in U.S. Treasury
interest payments (net of associated tax reflows) on Treasury
debt held by the public in this country and abroad. Higher
interest payments to the public (net of tax reflows) were
estimated by the model at $7.1 billion.
If the level of international investment imploded by twice
as much as the conservative estimating procedure might suggest,
the U.S. Treasury would lose $0.8 billion on U.S. income
payments to foreigners, and $3.2 billion on U.S. income
receipts from foreign sources In other words, the Treasury
could lose up to $40 billion from a policy that abandoned the
U.S. tax treaty network.
In any event, U.S. multinational enterpnses would be
substantially worse off. Their income flows before foreign tax
would contract from $279 billion to $240 billion. Their
combined tax burden, counting payments both to foreign
governments and the U.S. Treasury (after allowing for the U.S.
foreign tax credit), would rise by $9.4 billion. The loss of
income coupled with a rising tax burden would significantly
impair the competitive strength of U.S. multinational
enterpnses relative to rival firms based in Japan and Europe.
--G. Hufbauer, ``Tax Treaties and American Interests--A Report to the
National Foreign Trade Council, Inc.'' (1988).

While the preceding analysis is now somewhat out of date, world-
wide expansion of business enterprises and the increasing importance of
foreign investment flows and exports have served to increase the
importance of our treaty network. These conclusions nevertheless serve
to illustrate the importance of maintaining and expanding the treaty
network of which the United States is a member, and in a world in which
U.S. multinational enterprises must compete. Absent a ``level playing
field'' environment, taxes of all types on the income and capital flows
of U.S. multinational enterprises can easily escalate in proportion to
the economic activity involved. Particularly where more than two
junsdictions are involved, they can exceed one hundred percent.
Taxpayers are not the only beneficiaries of tax treaties. Treaties
protect the legitimate enforcement interests of the U.S. Treasury by
providing for the exchange of information between tax authorities.
Treaties have also provided a framework for the resolution of disputes
with respect to overlapping claims by the respective governments. In
particular, the practices of the Competent Authorities under the
treaties have led to agreements, known as ``Advance Pricing
Agreements'' or ``APAs'' within which tax authorities of the United
States and other countries, have been able to avoid costly and
unproductive disputes over appropriate transfer prices for the trade in
goods and services between related entities. APAs, which are agreements
jointly entered into between one or more countries and particular
taxpayers, have become common and increasingly popular procedures for
countries and taxpayers to settle their transfer pricing issues in
advance of dispute. The clear trend is that treaties are becoming an
increasingly important tool used by tax authorities and taxpayers alike
in striving for fairer and more efficient application of the tax laws.
treaties before the committee today
Five of the eight agreements before the Committee today represent
new tax treaty relationships for the United States: Estonia, Latvia,
Lithuania, Slovenia, and Venezuela. The remaining three agreements
modify existing relationships.
Virtually all treaty relationships depend upon difficult and
sometimes delicate negotiations aimed at resolving conflicts between
the tax laws and policies of the negotiating countries. The resulting
compromises always reflect a series of concessions by both countries
from their preferred positions. Recognizing this, but also cognizant of
the vital role tax treaties play in creating a level playing field for
enterprises engaged in international commerce, the NFTC believes that
treaties should be evaluated on the basis of their overall effects in
encouraging international flows of trade and investment between the
United States each of its treaty partners, in providing the guidance
enterprises need to plan for the future, in providing nondiscriminatory
treatment for U.S. traders and investors as compared to those of other
countries, and in meeting a minimum level of acceptability in
comparison with the preferred U.S. position and expressed goals of the
business community. Comparisons of a particular treaty's provisions
with the U.S. Model or with treaties with other countries may not in
some cases provide an appropriate basis for analyzing a treaty's value.
The treaties and protocols presently under consideration represent
a good illustration of the contribution of such agreements to the
economic competitiveness of U.S. companies and to the proper
administration of U.S. tax laws. Each of these treaties also includes
important advantages for the administration of U.S. tax laws. They
offer the possibility of administrative assistance between the relevant
tax authorities. The treaties also include modern safeguards against
treaty-shopping in accordance with established U.S. policy.
Moreover, each of the new treaties contains two very significant
provisions of great importance. First, each treaty contains a
nondiscrimination article which ensures even-handed treatment of
taxpayers by both contracting states. Second, they contain a mutual
agreement article which ensures that each country lives up to its
treaty obligations to avoid double taxation.
Likewise, these treaties set international norms for the conduct of
administrative audits of transactions between affiliates and provides a
mechanism to resolve tax disputes. Without these, U.S. companies could
not be assured of protections against arbitrary tax assessments. These
tax treaties help create the environment for predictable tax treatment
of cross-border business transactions so necessary to successful global
business enterprises. Transactions in tangible goods, 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 so that U.S.-based business
can be better prepared to compete in an global marketplace.
Though all of the treaties before the Committee today are important
and serve to expand the tax treaty network of the United States, two of
the treaties before the Committee are especially important to U.S.
business interests.
republic of venezuela
According to data received by NFTC, Venezuela is a major
destination for U.S.-based foreign investment, and the U.S. is a major
recipient of Venezuelan foreign investment. In fact, Venezuelan
companies and individuals have invested more than one-hundred billion
dollars in the United States. Venezuela exported more than $9.3 billion
in trade to the U.S. in 1998, and imported more that $6.5 billion that
year. Venezuela is the second largest importer and exporter to the U.S.
in the Western Hemisphere outside of those countries in the North
American Free Trade Agreement (Brazil is first).
The United States currently has no tax treaties in force and effect
with countries on the continent of South America. This remark bears
emphasis. South American countries, including Venezuela, consistently
rank at or near the top of NFTC surveys in their importance to U.S.-
based companies. The U.S. is Venezuela's most important trading
partner, and many U.S.-based companies have a significant stake in
Venezuela, its economy and its people. If the treaty is ratified and
comes into force and effect, U.S.-Venezuela business will be put onto
the same competitive footing that companies from other nations
currently have in their relationships in Venezuela. There are twelve
other countries with whom Venezuela currently has double taxation
treaties.\6\
---------------------------------------------------------------------------
\6\ Belgium, Czech Republic, France, Germany, Italy, Norway,
Portugal, Sweden, Switzerland, The Netherlands, Trinidad & Tobago, and
the United Kingdom. (A treaty with Mexico ratified by Venezuela is
pending ratification by Mexico.)
---------------------------------------------------------------------------
This treaty is extremely important, as noted above, because of its
importance to U.S.-based companies and their interests in Venezuela. It
is perhaps even more critically important because its ratification
would tend to encourage more cooperation between the government of
Venezuela and that of the United States. Conversely, failure to ratify
the treaty may have important negative implications to that
relationship. It is difficult to overstate the importance of gaining a
foothold in our treaty network with South American countries,
particularly in light of some of the tensions that have sometimes
existed between the U.S. and its neighbors and friends to the south.
The NFTC congratulates the Treasury for its efforts to persevere
through difficult negotiations and changes in governments in Venezuela
to make this landmark
treaty.
italian republic
The Treasury Department is to be commended for modernizing tax
treaties with our major trading partners and specifically members of
the European Union.
The new treaty with Italy updates the existing treaty to reflect
current tax policies in the United States and Italy. The new treaty
addresses the replacement of the Italian local income tax (l'imposta
locale sul redditi or ``ILOR'') by the new Italian regional tax on
productive activities (l'imposta regionale sulle attivat . . .
produttive or ``IRAP''), revises the withholding rates for passive
investment income for residents of each country, and strengthens the
administrative provisions. Our economic relationship with the Italian
Republic is one of our most important, and the changes made by the
treaty are beneficial and important to our companies and workers.
Ratification of the treaties and protocols before the Committee
today continues the momentum that is needed to bring other nations into
the U.S. treaty network. It sends a continuing signal that the U.S.
wishes to reduce and eventually eliminate 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 both the Executive Branch and the Congress have
given the tax treaties very high priority.
general comments on tax treaty policy
The NFTC also wishes to emphasize how important treaties are in
creating, preserving, and implementing an international consensus on
the desirability of avoiding double taxation, particularly with respect
to transactions between related entities. The United States, together
with many of its treaty partners, has worked long and hard to promote
acceptance of the arm's length standard for pricing transactions
between related parties. The worldwide acceptance of this standard,
which is reflected in the intricate treaty network covering the United
States and dozens of other countries, is a tribute to our government's
commitment to prevent conflicting income measurements from leading to
double taxation and the resulting distortions and barriers for healthy
international trade. Treaties are a crucial element in achieving this
goal, because they express both government's commitment to the arm's
length standard and provide the only available bilateral mechanism, the
competent authority procedure, to resolve overlapping claims.
The NFTC recognizes that determination of the appropriate arm's
length transfer price for the exchange of goods and services between
related entities is sometimes a complex task which can lead to good
faith disagreements between well-intentioned parties. Nevertheless, the
points of international agreement on the governing principles far
outnumber any points of disagreement. Indeed, after decades of close
examination, governments around the world agree that the arm's length
principle is the best available standard for determining the
appropriate transfer price, because of both its economic neutrality and
its ability to be applied by taxpayers and revenue authorities alike by
reference to verifiable data.
The NFTC strongly supports the efforts of the Internal Revenue
Service and Treasury to promote continuing international consensus on
the appropriate transfer pricing standards. We applaud the continuing
growth of the Advance Pricing Agreement (``APA'') program, which is
designed to achieve agreement between taxpayers and revenue authorities
on the proper pricing methodology to be used, before disputes arise. We
commend the Internal Revenue Services' efforts to refine and improve
the competent authority process under treaties, to make it a more
efficient and reliable means to avoid double taxation.
The NFTC supported the arbitration option in earlier treaties with
Germany, Mexico, and The Netherlands, and we urge that it be readily
available in those unusual cases where competent authority negotiations
prove unsuccessful.
These developments emphasize the international consensus behind the
arms-length standard. We cannot overemphasize the potential damage we
believe could result from any movement away from that consensus.
In fact, a recurring theme of our testimony is the importance of
considering the United States as a member of the world community of
nations, and the importance to United States business interests of
providing harmony between the tax system of the United States and that
of other nations where United States companies must conduct their
business. The same is true as well for foreign investors who invest
capital in the United States.
The NFTC also wishes to reaffirm its support for the existing
procedure by which Treasury consults on a regular basis with this
Committee, the tax-writing Committees, and the appropriate
Congressional Staffs concerning treaty issues and negotiations and the
interaction between treaties and developing tax legislation. We
encourage all participants in such consultations to give them a high
priority. We also respectfully encourage this Committee to schedule tax
treaty hearings, if possible at least once a year, to enable
improvements in the treaty network to enter into effect as quickly as
possible.
The NFTC also wishes to reaffirm its view, frequently voiced in the
past, that Congress should avoid occasions of overriding by subsequent
domestic legislation the U.S. treaty commitments that are approved by
this Committee. We believe that consultation, negotiation, and mutual
agreement upon changes, rather than unilateral legislative abrogation
of treaty commitments, better supports the mutual goals of treaty
partners.
Two of the agreements before the Committee today, those with Italy
and Slovenia, have provisions that contain ``main purpose'' tests that
do not appear in any other U.S. treaties or the U.S. Model Treaty.
Although NFTC does not support inappropriate use of such treaties, the
wording of these tests are vague and unclear. The tests must be applied
in a subjective way under treaty language that may be difficult to
change if they do not work as intended. The rules may cause
considerable uncertainty to taxpayers in the application of otherwise
available provisions of the treaties. The NFTC would hope that the
Treasury would not use its franchise to negotiate treaties as a way to
achieve new authority under new and untested general anti-avoidance
rules, particularly where the need for such rules has not been vetted
in the public discourse or has been refused by the Congress in other
contexts. NFTC strongly supports the immediate ratification of both
treaties, but finds the inclusion of these test provisions to be
troubling.
in conclusion
Again, the Council is grateful to the Chairman and the Members of
the Committee for giving international economic relations prominence in
the Committee's agenda. The NFTC appreciates the opportunity to submit
written comments on the treaties and protocols pending before the
Committee. We respectfully urge the Committee to proceed with
ratification of these treaties and the protocol as expeditiously as
possible.

Senator Hagel. Mr. Murray, thank you. We appreciate very
much what you have said and also what your organization does
for our country.
Mr. Murray. Thank you, Mr. Chairman.
Senator Hagel. You have been very important to this country
in our exports and our interests in the world. We recognize
that and appreciate it very much.
Mr. Murray. Thank you, Mr. Chairman.
Senator Hagel. Let me begin with your last comment. I think
you said regarding the main purpose test, the uncertainty, and
your paraphrasing of what Ms. Paull and Mr. West said, that you
tend to agree with Ms. Paull's concerns. Is that fair and
accurate?
Mr. Murray. Yes, Mr. Chairman, I believe it is.
Senator Hagel. What does that mean?
Mr. Murray. That is probably the hardest question you have
asked this afternoon in many respects.
As I noted in my testimony and as others have noted, all of
the treaties reflect a balancing of various concessions made by
both parties, and there are certainly provisions, as I
mentioned, in the Italy treaty that are very important to us.
So I have to preface my remark by consideration that my
membership really does want the Italian treaty, at least those
provisions that apply to the difficult transition issue that I
mentioned, to come into force and effect.
But I think it is also important to look at the policy
underlying some of the concerns that both Mr. West and Ms.
Paull have discussed this afternoon.
These provisions are new. We have not yet had a chance to
really parse through how they would work. The wording is fairly
vague.
I might also note, in addition to the other concerns that
have been expressed, that there is a general concern, I think,
in our jurisprudence about the use of general anti-avoidance
rules. Some of the countries mentioned this afternoon make more
prevalent use of such rules in their jurisprudence. But your
colleagues on the tax writing committees have been very
reluctant to make use of those rules in the past. In fact, as
Mr. West noted, there are only two other instances of which I
am aware that such a rule has been incorporated into our
Internal Revenue Code.
So I guess the bottom line, so to speak, is that we are
uncertain exactly what to make of these rules. But we are
troubled by them.
Senator Hagel. You noted that your members had given you
some sense of what they think is going on in Venezuela. I
believe your term was that they are cautiously optimistic.
Would you develop a little more what your members tell you
about what is going on and how this might have a consequence
and effect on the treaty and business?
Mr. Murray. I think probably the best place to start, Mr.
Chairman, in answer to that question is to sort of echo what
Mr. West said about what he had heard from the State Department
in this respect. I think it echoes to some degree what I have
heard from our member companies who are on the ground in
Venezuela.
I also had the occasion to have breakfast with Ambassador
Toro Hardy last week from Venezuela and to hear his view of how
some of these things were developing. I guess the proper way to
sum it up would be to say that, although I think there is a
good deal of transition--perhaps that is the best way to say
it--that is going on in Venezuela now, at least those on the
ground that have had discussion with me have indicated that, so
far, things seem to be proceeding in a direction that would
tend to support the thought that they are moving toward greater
development of their democracy and not the other way around.
Commercial interests seem to be, as I have said, cautiously
optimistic that things will continue to develop in that
direction.
It is certainly a situation that bears watching and there
have been enough developments this year that have probably
caused not only those who are citizens of Venezuela but also
those who have to do business in Venezuela to carefully watch
the situation.
Senator Hagel. So it is your analysis, your judgment, your
conclusion, based on the input you receive from members and
others, that the best thing we could do is to ratify this
treaty and move on, that that would be the most positive and,
hopefully, potentially beneficial for future trade with
Venezuela?
Mr. Murray. Mr. Chairman, while we certainly understand the
concerns that the committee has expressed, that members of the
committee have expressed, at least in some of our conversations
in recent weeks, I think our members believe that that is the
best course of action at this time.
Senator Hagel. Thank you.
Let's talk about the Baltic states treaties now. Give this
committee, if you would, your sense of how important that is.
Are we looking at a rather dramatic breakthrough or not? Does
it matter?
What do you think?
Mr. Murray. That is a hard question, also.
Senator Hagel. Oh, Senator Sarbanes asks all of the hard
questions.
Mr. Murray. You should be entitled also.
Senator Hagel. I'll tell him that.
Mr. Murray. I think, Mr. Chairman, those treaties are
important, not only because of the commercial relationships
that exist between the United States and those republics but
also because they represent an extension of our tax treaty
network. It is difficult for me to assess the commercial
importance of those treaties because they perhaps involve
relationships that are somewhat newer than the more established
relationships that we have in places like Italy and Venezuela,
where our companies have been present for many years.
Senator Hagel. What do your members say about it? Are they
excited about these treaties? Will they jump on the next plane
and go to the Baltics? What do your members think?
Mr. Murray. To be honest, I have not heard a great deal of
discussion from my members with respect to those particular
treaties. But I think I have found in previous discussions that
one of the reasons, in fact, why we spend so much time and
energy supporting the Treasury Department's extension of the
tax treaty network is because our members find that tax
treaties play an integral role in expanding investment in these
types of countries and help very much for our companies to, as
you say, develop the certainty they need to make those kinds of
investments.
So I would hope that it would lead to greater commercial
exports and investment.
Senator Hagel. I personally believe it will. I was in
Lithuania in December and I think there is great potential
there. The more of the uncertainty that we have talked about
this afternoon that we can remove from investment decisions,
obviously the better off we are. I do think the Baltic piece of
this is an important piece.
You heard the give and take regarding Japan. Would you care
to comment on the treaty with the Japanese, Third World
concessions, and some of the other areas that we got into here
today?
Mr. Murray. Mr. Chairman, we agree to the utmost with the
comments and questions that you raised in regard to the treaty.
We think that particular treaty relationship is out of kilter
with the rest of our network.
As you noted, the provisions of the treaty are almost
ancient by comparison to some of our other treaties. They are
approximately 30 years old now and they do not work very well
in the context of not only U.S. business operating in Japan,
but some of our members who are Japanese companies have also
expressed to us--in fact, I got a letter this morning from a
major Japanese company--an interest in our work in trying to
find a way to get that treaty renegotiated.
We understand Mr. West's concerns about some of the
negotiations. But, at the same time, we feel that if our
executive branch and the Congress make enough of an issue with
this, the Japanese will come to the table and, hopefully, will
be able to negotiate an arrangement that is satisfactory to
both governments.
Senator Hagel. Have you or your organization talked to Mr.
West or any of his colleagues about this particular
renegotiation?
Mr. Murray. Yes, Mr. Chairman. We had a dialog with the
Treasury actually over several years, going back a number of
years now, about this particular treaty. Most recently, six
CEO's of our companies went in with me to talk to Secretary
Summers about this particular treaty. It was our impression
from the meeting that the Secretary was interested in renewing
some of the internal discussions about how best to proceed
forward with the negotiations.
He seemed to be supportive and that was encouraging to us,
as well.
Senator Hagel. Well, you heard what I said about it. I
would be very happy to help, as I suspect some of my colleagues
would, as well. Maybe we could revisit that, all of us
together.
Mr. Murray. Thank you, Mr. Chairman. In doing our surveys
and some of our internal analysis of the treaty network, we
have found that that particular treaty is of concern to a great
number of our companies. In fact, there are over 60 companies
that presently are in our working group that are looking at
ways to try to advance this negotiation. The flows that are
involved in investment--for example, in some of our companies
the remittances from their Japanese subsidiaries account for as
much as 25 percent of their worldwide gross receipts.
Some of our companies, despite the popular press about a
U.S. presence in Japan, have significant presence in the
Japanese markets, and this treaty is very necessary to enable
those companies to effectively compete with their Japanese
counterparts.
Senator Hagel. Would this be one of the high priority, most
important next venues for Treasury to negotiate?
Mr. Murray. I would say in conducting our surveys, at least
since I have been the counsel, that the regions of East Asia
and Latin America are the two most prevalent regions in which
our companies express an interest in treaties. Within those two
regions, the Japanese treaty and the treaty with Brazil as well
as with Venezuela, come at the top of the list.
Senator Hagel. Thank you.
I was in Asia, Southeast Asia, in August, and one of the
countries I visited was Vietnam. Tell me a little bit about
where your members are on the Vietnam issue.
Mr. Murray. A number of our members are very interested in
Vietnam. In fact, some years ago, our council had a working
group on Vietnam, looking at the investment treaty with Vietnam
and some of the issues that were involved. Although I was not
personally involved in that effort, I know there is a
considerable interest within the membership in trying to expand
our commercial relations with Vietnam.
Senator Hagel. As you know, we are engaged up here on
normal trade relations, and I suspect that is not going to
happen before we lock the doors around here--who knows when?
But, nevertheless, I happen to believe as well that this is an
area we should pursue.
Have you talked to Treasury about it?
Mr. Murray. That is one particular area we have not really
had a real dialog about, although it is certainly something we
would want to discuss.
Senator Hagel. Is there an area here that we have not
talked about this afternoon that you would like to get on
record about?
Mr. Murray. No, Mr. Chairman. I think we have covered most
of the points that our membership has expressed some concern
about.
Again, I would ask that the committee give its prompt
consideration, as I believe you have indicated you will, to the
movement of the treaties within the remaining time of the
session.
I guess I would close by saying that we hope the committee
and also the Senate will give advice and consent to the effect
that these treaties should be ratified.
Senator Hagel. Mr. Murray, thank you.
Let me do just one piece of business here.
I understand that Delegate Underwood of Guam has asked that
his statement be included in the record. He wishes to note that
he is concerned that Guam and other U.S. territories are not
included in the treaty definition, of ``United States.'' I have
done that. His statement will be recorded.
[The statement referred to follows:]

Prepared Statement of Hon. Robert A. Underwood, U.S. Delegate from Guam

Mr. Chairman, I would like to express my concern over the manner in
which tax treaties like the ones being considered today by the Senate
Foreign Relations Committee are negotiated by the United States with
other countries. This hearing focuses on tax treaties which the United
States negotiated with the countries of Estonia, Latvia, Venezuela,
Denmark, Lithuania, Slovenia, Italy, and Germany.
What will not be brought up today is the fact that under these tax
treaties and many other tax treaties which the United States has
negotiated with other countries over the years, the definition of the
term ``United States'' generally excludes Guam and the other U.S
territories. The most commonly employed definition of the term ``United
States'' excludes Guam and the other territories by name like the
treaties with Estonia, Latvia, Venezuela, Lithuania, Italy, and
Germany. Some tax treaties explicitly includes the 50 states and the
District of Columbia in the definition of the term ``United States''
like the treaty with Slovenia. Some tax treaties employ the antiquated
definition of the term ``United States'' to mean ``only States, the
Territories of Alaska and Hawaii, and the District of Columbia'' like
the tax treaty with Denmark.
The point I wish to make, Mr. Chairman, is that if one of the goals
of tax treaties between the United States and other countries is to
provide for better foreign investment tax rates between the affected
countries, then I believe the current practice by U.S. negotiators has
been discriminatory against Guam and other U.S. territories because we
are unable to offer foreign investors the same tax treatment as the
fifty states. There also appears to be no justifiable reason why Guam
should not be included in tax treaties.
As background, under the U.S. tax code, there is a 30% withholding
tax rate on dividends, interest, and other forms of passive income
remitted to foreign investors. Since Guam's tax law ``mirror's'' the
rate established under the U.S. tax code, the standard rate for foreign
investors on Guam is 30%. As a result, only large and profitable
projects can absorb such high costs in Guam.
Lower withholding tax rates as negotiated under tax treaties
provides for a better foreign investment climate in the fifty states,
which often leads to the creation of new jobs and the stimulation of
the economy. These are goals which the people of Guam want just as much
as any other U.S. jurisdiction. Seventy-five percent of Guam's
commercial development is funded by foreign investors. Being excluded
from the definition of the term ``United States'' under tax treaties
makes Guam the single most expensive place under any state or
territorial jurisdiction in the United States for foreign investors.
To show how discriminatory the tax treaties being considered today
are toward Guam, the following chart shows the difference in tax rates
which the tax treaties would provide to the fifty states and the
District of Columbia, as compared to what would be available to foreign
investors in Guam.

Withholding Tax Rate Under Treaties
----------------------------------------------------------------------------------------------------------------
In Percent
Country -----------------------------------------------------------------
Dividends Interest
----------------------------------------------------------------------------------------------------------------
Estonia \1\................................... 15 0
Denmark \2\................................... 5, 15 0
Latvia \1\.................................... 10, 25 0
Venezuela \1\................................. 5, 15 4.95, 10
Lithuania \1\................................. 0 20
Slovenia \1\.................................. 15 0
Germany \2\................................... 5, 10, 15 0
Italy \2\..................................... 5, 15 15
----------------------------------------------------------------------------------------------------------------

Withholding Tax Rate Under Guam Law (Based on U.S. Code)

Guam.......................................... 30 30

----------------------------------------------------------------------------------------------------------------
\1\ Rates as quoted are from the general tax statutes of each country.
\2\ Rates as quoted are from the double tax treaties of each country.
Source: Deloitte & Touche LLP.

In looking at Guam's situation, one might wonder why Guam just
doesn't fix the problem by changing local law. Under current law, Guam
has no authority to change the withholding tax rate for foreign
investors. This is an issue that the federal government must resolve,
which is why the policy of U.S. negotiators for various treaties in
excluding Guam is so frustrating. Clearly, Guam cannot negotiate its
own treaties with other countries. So the easiest solution for Guam
would be for U.S. negotiators to include Guam in the definition of the
term ``United States'' for all tax treaties.
In the interim, however, I believe that there is no justification
for Guam's unfair treatment, which is why I have sought a legislative
solution under Guam's Organic Act. On July 1, 1999, I introduced H.R.
2462, legislation which includes the Guam Foreign Direct Investment
Equity Act. My bill seeks to amend Guam's Organic Act and allow Guam's
tax law to withhold taxes under foreign income provisions of the U.S.
tax code at the same rates available to states under U.S. tax treaties.
This does not create any tax advantage for Guam when compared to the
fifty states or any other U.S. territory. It simply levels the playing
field and provides for a more favorable foreign investment environment
on Guam by extending the same benefits foreign investors receive in the
fifty states to Guam.
Mr. Chairman, the underlying federal policy toward the U.S.
territories has always been to promote political and economic
development so that we can become more self-sufficient. There is no
reason why the federal government should impede Guam's efforts to
promote foreign investment in Guam. This is a benefit extended to all
fifty states and has been remedied for all other U.S. territories. Guam
is the only U.S. jurisdiction which is stymied with a 30% withholding
tax rate. It is bad for economic development for Guam and it is bad for
the United States.
I ask that the members of the Senate Foreign Relations Committee
consider reminding U.S. negotiators for future tax treaties with other
countries to do what is right for the people of Guam on foreign
investment opportunities by including Guam in the definition of the
term ``United States'' or by supporting my legislation, the Guam
Foreign Direct Investment Equity Act.

Senator Hagel. Is there any other business we need to do?
[Pause]
Senator Hagel. We will keep the record open for 3 days for
further comments and statements. That probably does not apply
to you, Mr. Murray, as much as it does to others. But I would
note that we still have representatives here from Treasury and
the Joint Tax Committee. You know how that works, anyway, all
of you.
Unless you have anything to add, Mr. Murray, again, I thank
you and your organization for your leadership.
Mr. Murray. Thank you, Mr. Chairman.
[Whereupon, at 4:58 p.m., the committee adjourned.]
A P P E N D I X

----------

Questions From Senator Hagel for Phil West, Treasury International Tax
Counsel, Regarding Pending Tax Treaties--October 27, 1999

Main Purpose Tests contained in the Italy and Slovenia Treaties
Question 1. Do the anti-abuse principles under current U.S. law,
such as the Business Purpose Doctrine, currently apply in the treaty
context?

Question 2. Are these ``main purpose'' tests intended to clarify
current domestic U.S. law or do they go beyond present U.S. law? If so,
how?

Question 3. How will you assure that the tests will not be used by
treaty partners to deny treaty benefits for legitimate business
transactions?

Question 4. During the hearing you indicated that the Treasury
Department has not prepared a comprehensive analysis of these ``main
purpose'' tests? Will you undertake such an analysis and provide it to
the Committee?

[Note. See Memorandum for Senator Hagel that follows for responses
to above questions.]

Other Issues
Question 1. Please provide the Committee with a response to all
issues raised in the Joint Committee pamphlets. (See page 75 for
response.)

Question 2. Please provide a response to Senator Dorgan's
testimony, including your view on whether the treaties allow for
application of the formulary apportionment method in lieu of the arm's
length test if the United States were to change its policy. (See page
91 for response.)

Question 3. Please provide a response to Congressman Underwood's
testimony regarding the U.S. Treasury treaty policy excluding Guam and
other U.S. territories from the definition of the ``United States.''
(See page 92 for response.)

______

Memorandum for Senator Hagel

Re: Responses to Additional Issues Raised by Senator Hagel Regarding
Pending Tax Treaties, October 27, 1999

This memorandum provides responses to additional issues raised by
Senator Hagel in connection with the Senate Foreign Relations Committee
hearing on seven income tax treaties and an estate tax protocol held on
October 27, 1999. It also provides a response to the issues raised in
the pamphlets prepared by the Joint Committee on Taxation regarding the
``main purpose'' anti-abuse rules found in the treaties with Italy and
Slovenia.
``main purpose'' test
Issue Raised by the JCT Pamphlet: The issue raised by the JCT
pamphlet is whether the benefits of the anti-abuse rule outweigh the
uncertainties created for business.
Response: Because of the importance of preventing the abuse of our
tax treaties, we believe that the benefits of the anti-abuse provisions
outweigh any potential uncertainty.
The standard in the anti-abuse rule is substantively the same as
one found in several places in our tax code (including legislation
passed by the Senate this week), our tax regulations and our tax
treaties. Also, it is a developing international standard. Thus,
adopting this standard increases the likelihood that taxpayers will be
subject to one anti-abuse standard wherever they conduct their
business. These reasons for adopting the rules are discussed in greater
detail below.
Benefits of the Anti-Abuse Rules
The literature regarding anti-abuse rules and the place they hold
in U.S. tax jurisprudence, not to mention international tax
jurisprudence, is vast. Thoughtful commentators acknowledge that there
is a problem created by the self-assessment system, which creates an
incentive to play the ``audit lottery.'' Furthermore, the adversarial
system, which frequently results in settlements, rather than
litigation, may be seen as rewarding taxpayers who have taken
aggressive positions based on the words of a statute. The ``business
purpose,'' ``sham transaction'' and ``substance-over-form'' doctrines
alluded to in the question from Senator Hagel are themselves responses
to this problem. The Commentary to Article 1 of the OECD Model and the
OECD Report on Harmful Tax Competition make clear that countries can
impose their domestic anti-abuse rules to claims for treaty benefits.
Accordingly, these important common-law principles are incorporated
into our tax treaties, as confirmed by statements in the section of the
Technical Explanation to each treaty dealing with Limitation on
Benefits. The statements (found on page 94 of the Technical Explanation
to the treaty with Italy and pages 64-65 of the Technical Explanation
to the treaty with Slovenia) describe the interaction of the proposed
anti-abuse rules, domestic law and the limitation on benefits
provisions of our tax treaties. As stated in those paragraphs, the
limitation on benefits provisions of our treaties and the anti-abuse
provisions of domestic law complement each other, as the limitation on
benefits provisions effectively determine whether an entity has a
sufficient nexus to the Contracting State to be treated as a resident
for treaty purposes, while domestic anti-abuse provisions (e.g.,
business purpose, substance-over-form, step transaction or conduit
principles) determine whether a particular transaction should be recast
in accordance with its substance. Thus, internal law principles of the
source State may be applied to identify the beneficial owner of an item
of income, and the limitation on benefits provisions then will be
applied to the beneficial owner to determine if that person is entitled
to the benefits of the Convention with respect to such income.
The previous inclusion in treaties of an anti-abuse rule--the
limitation on benefits provision--was not seen as replacing domestic-
law anti-abuse rules. The treaties, of course, include a number of
anti-abuse rules, such as the ``star-company'' rule in the Artistes and
Sportsmen provision. This rule deals with the same types of abuses as
were present in United States v. Johansson, 336 F.2d 809 (5th Cir.
1964), where the court found that strictly applying the provisions of
the treaty to the ``star company'' would have produced a result not in
accordance with the rationale behind those provisions. No one has
suggested, however, that these rules, addressing abuses of particular
provisions, prevent us from applying our domestic anti-abuse rules.
Unfortunately, the domestic-law anti-abuse provisions have not been
working adequately to prevent treaty abuses. The main purpose tests of
the proposed treaty supplement these common-law doctrines to ensure
that treaties are not utilized for abusive purposes. The common-law
doctrines, such as economic substance, substance-over-form, and step-
transaction, focus on whether, in addition to the abusive purpose, the
transaction at issue has some colorable non-abusive purpose. In
contrast, the ``main purpose'' test focuses on whether a principal
purpose of the transaction is tax avoidance. This focus is justified
because of the increasing trend toward aggressive abuse of tax treaties
to obtain benefits that were not intended, such as the elimination of
all taxation (in contrast to the intended goal of eliminating double
taxation).
For example, in Northern Indiana Public Service Co. v.
Commissioner, 115 F.3d 506 (7th Cir. 1997), the taxpayer funneled
financing through a corporation established in a treaty country solely
for the purpose of obtaining the treaty's exemption from interest tax
withholding. The court conceded that it was ``undisputed'' that the
structure was set up for this tax-avoidance motive. Nonetheless, the
court permitted this abuse of the treaty because the IRS was unable to
prove that the corporation engaged ``in absolutely no business
activity.'' This court case bolstered the confidence of aggressive
taxpayers who had read very narrowly the seminal ``conduit'' case Aiken
Industries v. Commissioner of Internal Revenue, 56 T.C. 925 (1971). In
essence, many practitioners read a substantial business purpose test
out of Aiken Industries, and interpreted the case as holding that
treaty benefits could be denied only if the two legs of the conduit
transaction exactly matched in terms of principal, interest rates and
maturity dates.
Fortunately, by the time Northern Indiana was decided, Congress had
passed section 7701(1), providing Treasury with regulatory authority to
curb certain multi-party financing abuses, including certain treaty
abuses. This authority has been exercised to adopt a ``one of the
principal purposes'' standard very similar to that reflected in the
proposed anti-abuse rules, under which taxpayers have been operating
for some years now, apparently without significant difficulty.
Application of this test, rather than the ``business purpose'' test,
would reverse the result of Northern Indiana.
In addition to legislating on conduit transactions, Congress has
also as recently as 1997 legislated against another abuse of tax
treaties by enacting section 894(c) of the Code. The history of this
provision demonstrates the fact that taxpayers are relatively
indifferent as to whether they are engaged in the type of classic
``treaty-shopping'' addressed by the limitation on benefits provisions
or whether they participate in other transactions that produce the same
result. Until 1993, Canadian companies with U.S. subsidiaries
frequently used a financing structure that involved a Dutch corporation
with a Swiss branch. In 1993, a limitation on benefits provision was
added to the Netherlands tax treaty and the Canadian-U.S. groups
adopted U.S. limited liability company structures. These were closed
down in 1997 by the enactment of section 894(c). The companies then
explored moving the financing structures to Ireland for the three years
that remained before the limitation on benefits provision in that
treaty became fully effective, and settled on a structure in other
countries whose treaties with the United States do not have a
limitation on benefits provision. We intend to re-negotiate those
treaties in order to add a limitation on benefits provision, but we
expect that the Canadian companies will develop new structures
established with a main purpose to obtain treaty benefits.
The use of treaty amendments to eliminate specific abuses will
always be inadequate. Because our treaties are intended to last decades
before re-negotiation, and because of the difficulty involved with
negotiating a bilateral international treaty, it is not realistic to
update a treaty each time a new abusive transaction is discovered.
Moreover, such an approach would only encourage the search for new
techniques or unexplored opportunities under old treaties. For these
reasons, and because it is difficult to anticipate how various tax,
corporate and regulatory regimes will interact over long periods of
time, we should decide whether such anti-abuse provisions should be
included in our treaties not on the basis of any current abuses but
rather on the basis of patterns of abuses that we know tend to recur.
Similarly, the rifle-shot legislative approach to specific abuses is
not fully effective. Moreover, these post-ratification unilateral
legislative fixes have led to claims that our subsequently enacted
domestic anti-abuse rules constitute an override of our tax treaty
obligations. Adding an explicit provision to the treaty would lay such
arguments to rest in the future, and appropriate legislative history
would help to ensure that there is no negative inference regarding
existing treaties. Such a statement is included in the Treasury's
Technical Explanation to the proposed treaty.
These types of abusive transactions have become more prevalent as
more U.S. treaties have included effective limitation on benefits
provisions. Our treaty partners, which have even weaker anti-abuse
rules than we do, and who do not include limitation on benefits
provisions in their tax treaties, realized the necessity of these rules
before we did. In the case of Italy, for example, we understand that
this provision is necessary in order to combat the simplest of the
conduit cases that we address under section 7701(l). Other transactions
that would be addressed by this rule are more complicated. For example,
several years ago, U.S. taxpayers with U.K. subsidiaries developed a
scheme to inappropriately secure ``refunds'' of the advance corporation
tax from the U.K. government by engaging in transactions that, under
U.S. law, would be viewed as circular cash flows without economic
substance. However, U.K. law did not allow that country to reach the
U.S. result of ignoring the transaction entirely, and the current U.S.-
U.K. treaty did not permit the U.K. from denying these refunds because
it does not include the anti-abuse rules. These transactions became
very expensive for the United Kingdom and may have contributed to the
United Kingdom's decision effectively to eliminate these payments to
all U.S. taxpayers, whether they were abusing the system or not,
through changes in their domestic integration system.
It is therefore important to consider whether our treaty partner
(or potential treaty partner) believes it is in its interest to have
such rules in the treaty, in the same way that we consider the other
peculiar aspects of that country's law when drafting other provisions
of the treaty. Many countries do not have effective domestic anti-abuse
rules. This could be a function of the legal system or the fact that
their experience with sophisticated financial transactions is limited.
These countries increasingly rely on explicit anti-abuse provisions in
the treaty. It is difficult for the United States to tell such a
developing country that it will be required to provide benefits to all
U.S. taxpayers, without regard to whether they are participating in
abusive transactions, but that the United States will be able to apply
its panoply of anti-abuse rules in order to prevent many such abuses.
Slovenian tax authorities have informed us that Slovenia currently
has no domestic anti-abuse provisions. Although they are contemplating
the introduction of specific anti-abuse provisions with respect to
certain of the most basic types of abuses, these provisions would not
be broad enough to prevent the more sophisticated abuses that can occur
with treaties. Thus, the anti-abuse provisions would be necessary in
order for these tax authorities to effectively stop abuses of the
proposed treaties. Similarly, according to Italian tax authorities,
Italy currently does not have effective domestic anti-abuse doctrines
that could be used to deny treaty benefits in the case of abusive
transactions. As a result, Italy has increasingly included anti-abuse
provisions in its more recent treaties. For example, Italy's 1995
treaty with Israel has the following anti-abuse rule:

The competent authorities of the Contracting States, upon
their mutual agreement, may deny the benefits of this
Convention to any person, or with respect to any transaction,
if in their opinion the receipt of those benefits, under the
circumstances, would constitute an abuse of the Convention
according to its purposes.

Concerns about Uncertainty Interfering with Legitimate Business
Transaction Planning
As noted before, the drafting of any anti-abuse provision involves
the question of how to prevent the abuse without hindering legitimate
business transactions. Treasury rejected the broader, more subjective
anti-abuse rule found in the Italy-Israel treaty for several reasons.
First, it provided a less certain standard against which a taxpayer
could meaningfully evaluate its transaction. Second, since the narrower
rule before you appears in a significant number of treaties around the
world, and promises to appear in more, it is more consistent with
international norms and will likely be the subject of more interpretive
law than the other standards. Treasury rejected a narrower anti-abuse
rule because of its ineffectiveness.
In analyzing different approaches that have been taken over time,
we had the benefit of participating in work on anti-abuse rules
undertaken by Working Party 1 of the OECD's Committee on Fiscal Affairs
in response to a recommendation in the OECD's Report on Harmful Tax
Competition. The recommendation directs the Working Party to consider
different ways in which the entitlement to treaty benefits should be
restricted to prevent the abuse of tax treaties. As a result of that
process, we have a significant catalog of approaches taken by different
countries, and an idea of their views regarding how the law in this
area should develop. Needless to say, that process has informed our
thinking about the best ways to prevent treaty abuses.
We gravitated toward the ``main purpose'' standard of our proposed
rule because it corresponds to the U.S. ``a principal purpose''
standard which is applied in a number of our statutory provisions and
regulations. (A partial list of the relevant sections is attached.) In
fact, it is embedded in section 954(h) of the Code, which was enacted
in 1998 and passed by the Senate this week.
Judge Posner's ruling in Santa Fe Pacific Corporation v. Central
States, Southeast and Southwest Areas Pension Fund, 22 F.3d 725 (1994)
provides insight into the meaning of ``a principal purpose.'' This
standard is different from ``the principal purpose.'' A purpose can be
``a principal purpose'' if it is a major purpose for a transaction. The
standard is not met if a purpose was a minor, subordinate purpose. In
determining whether a purpose is major or minor, the question is
whether it ``weighed heavily in the [relevant party's] thinking.''
Other synonyms provided by Judge Posner include ``major, weighty,
salient, and important.'' The court acknowledges that, because the
determination of purpose involves inferring state of mind, the process
of determining whether the standard has been met may require the
examination of the relevant evidence.
Taxpayers, of course, are in the best position to know what
``weighed heavily'' on their minds when considering entering into a
transaction. Taxpayers are required to make subjective judgments under
all of the Code provisions in the attached list, and they can also look
to the principles developed under these statutes and regulations for
guidance. In essence, what the taxpayer is required to do is ask
whether it is entering into a transaction with a principal purpose of
tax avoidance. We think that requiring taxpayers to engage in this
basic analysis neither is overly burdensome nor introduces an
unacceptable level of uncertainty, but it does preserve our ability to
ensure that tax treaties do not become the tools of tax avoiders.
Moreover, the underlying policies of the provision provide
important guidance to taxpayers and limit its application. One
underlying policy is the concept that, as a general matter, a treaty
provision should not be exploited in a way that creates the opportunity
to avoid tax in both countries. This type of abuse was present in the
transactions that section 894(c) was intended to curb.
A second underlying policy is that treaty benefits are intended
only for certain persons (i.e., residents of the treaty countries and,
in certain circumstances, only particular residents of the treaty
countries). Although limitation on benefits provisions generally
prevent residents of third countries from obtaining treaty benefits,
Treasury's Technical Explanation to the proposed Italy and Slovenia
treaties contain examples of an abusive situation (i.e., ``dividend
washing'') where residents of third countries might nonetheless obtain
treaty benefits in the absence of an anti-abuse provision. The two
Technical Explanations also contain examples of abusive situations
where a resident of a treaty country might inappropriately obtain
benefits that are only intended for a narrow class of residents (i.e.,
dividend benefits that depend upon a specific ownership threshold).
The Technical Explanations to our treaties generally provide
rationales for the provisions found therein, and the Commentaries to
the OECD Model provide more. Taxpayers therefore should not have great
difficulty determining whether they were supposed to be entitled to
certain benefits.
Another benefit to taxpayers of adopting this standard is that the
rule appears to be broadly acceptable to other countries. The rule has
been included in more than 50 treaties, representing approximately 40
different countries (including 10 OECD members). Therefore, because the
proposed rule appears in a significant number of treaties around the
world, and promises to appear in more, it will likely be the subject of
more interpretive law than the other standards and likely will provide
greater certainty over time than some of the alternatives.
Concerns regarding Application
The JCT pamphlet also raises concerns regarding the application of
the proposed anti-abuse provisions, in particular the concern that the
provisions could be used by treaty partners to deny treaty benefits for
legitimate business transactions. As noted above, countries currently
can apply their own domestic anti-abuse rules to treaties. As a result,
a potential risk currently exists that a treaty partner could deny
treaty benefits to legitimate business transactions under domestic
anti-abuse rules (if any).
The explicit inclusion of ``main purpose'' tests in tax treaties
will bring a more uniform standard to this area. As noted above,
similar rules have been included in more than 50 treaties, representing
approximately 40 different countries (including 10 OECD members). The
expanding adoption and application of this standard will help ensure
that it will be applied in a reasonable and consistent way. While a
treaty partner's domestic anti-abuse rules (if any) could continue to
apply, it is anticipated that in practice treaty partners will look
primarily to the explicit standard in the treaty when they believe that
an abusive transaction has occurred.
As in other circumstances involving interpretation of the treaty, a
U.S. taxpayer who believes that the treaty partner has applied this
provision incorrectly may invoke the Mutual Agreement Procedure of
Article 25. Under that mechanism, the U.S. competent authority, if it
believes that the taxpayer's position is justified, will consult
directly with the treaty partner's competent authority in order to
resolve the issue. Article 25 explicitly authorizes the competent
authorities to reach agreement to avoid taxation that is not in
accordance with the treaty, and to resolve any doubts regarding the
interpretation or application of the convention. Arguably, it will be
easier for competent authorities' to reach a common understanding with
respect to the ``main purpose'' standard, which is explicitly included
in the treaty, than it would be to reach agreement with respect to an
anti-abuse provision of one country's domestic law. Of course, a
taxpayer who believes that the treaty partner has applied this
provision incorrectly could also invoke any other remedies available
under the domestic law of the treaty partner, such as judicial review.
As a practical matter, we believe that treaty partners will not
invoke this provision to deny treaty benefits for legitimate business
transactions. We have consulted with the tax authorities of the United
Kingdom, which has included a similar standard in more than 20 of its
tax treaties. According to those authorities, the United Kingdom has
not received any complaints from its taxpayers regarding the treaty
partner's inappropriate use of the provision. Furthermore, one of the
principal reasons that countries enter into tax treaties is to
facilitate legitimate business transactions, so it would be unlikely
that a treaty partner would invoke the main purpose provisions to
challenge such transactions.
We are also aware of concerns regarding the provision that allows
the competent authorities to agree that certain types of transactions
that are entered into by a broad number of taxpayers violate the anti-
abuse provisions. We believe that this provision is necessary to
effectively prevent the potentially widespread abuses that can occur
when a promoter develops and ``sells'' a treaty-abuse scheme to a
number of taxpayers. These schemes are not aimed at furthering the
specific business objectives of the ``purchasing'' taxpayers, but
instead are aimed merely at taking advantage of the treaty to avoid tax
liability. It is contemplated that the competent authorities will
provide the public with notice regarding such abusive schemes. The
published competent authority agreements would be subject to judicial
review.
Lack of Conformity with other U.S. Tax Treaties
The JCT pamphlet raises a slightly different issue regarding the
fact that these provisions are not included in other U.S. tax treaties.
In fact, a precursor to this provision can be found in the U.S. treaty
with Canada, which explicitly recognizes each country's right to apply
domestic anti-abuse rules, including Canada's right to apply a similar
anti-abuse rule that is in force under its domestic law.
We too were concerned about the possibility that our treaties would
not be uniform with respect to this provision, although the context was
slightly different. The countries other than Canada (whose position is
described above) with which we are currently negotiating (the United
Kingdom, Chile and Korea) include this provision in their standard
negotiating document. Because this rule is important to them, we were
considering adopting it in those treaties. Since the substantive
analysis described above suggested that it would be appropriate to
adopt it in those treaties, it also seemed that it would be appropriate
to adopt it in the treaties that were still under negotiation. This
decision was made rather late in the negotiating process, immediately
before the last round of negotiations with each of Italy and Slovenia,
which took place in late November and early December, 1998. At those
rounds, it was agreed to include the provision. Because it was an
unusual provision, in accordance with our usual procedure, we described
the rule and its purpose at a briefing with the Senate Foreign
Relations Committee and the staffs of the Joint Committee on Taxation
and the tax-writing committees which took place on December 16, 1998.
The treaty with Slovenia was signed on June 21, 1999 and the treaty
with Italy was signed on August 25, 1999.

Code provisions using ``a/one of the principal purposes'' anti-abuse
language

Sec. 170(f)(9)...................--Denial of ``charitable deductions''--
with a principal purpose of making
non-deductible lobbying
contribution.
Sec. 197(f)(9)(F)................ Denial of amortization for
intangibles acquired where one of
the principal purposes was to avoid
the churning or grandfather rule.
Sec. 302(c)(2)(B)(ii)............ Exception to attribution where one of
the principal purposes is tax
avoidance.
Sec. 306(b)(4)(B)................ Section 306 does not apply if it is
established to the satification of
the Secretary that tax avoidance is
not one of the principal purposes of
the transaction.
Sec. 336(d)(2)(B)(i)(II)......... Plan to recognize loss through
contribution/liquidation has a
principal purpose of tax avoidance.
Sec. 355(a)(1)(D)(ii)............ Retention of stock in controlling
corporation can't be in pursuance of
plan with tax avoidance as one of
its principal purposes.
Sec. 382(l)(1)(A)................ Capital contributions made with a
principal purpose of avoiding/
extending NOL limitations are
ignored.
Sec. 453(e)(7)................... Related person second distribution
rules waived if it is established to
the satisfaction of the Secretary
that tax avoidance is not one of the
principal purposes behind the
distributions.
Sec. 467(b)(4)(B)................ ``Disqualified leaseback'' must have
a principal tax avoidance purpose.
Sec. 614(e)(1)................... Aggregation of non-operating mining
interests allowable so long as a
principal purpose is not tax
avoidance.
Sec. 643(f)(2)................... Two or more trusts may be treated as
one if a principal purpose of such
trusts is the avoidance of tax.
Sec. 751(b)(3)(B)................ Property contributed to PRS with a
principal purpose of avoiding 120%
``substantial appreciation'' test is
ignored.
Sec. 860K(e)(2).................. FASITS supporting pass-thru interests
received differing treatment if a
tax avoidance is a principal purpose
of the transaction. 1996.
Sec. 877(a)(2)................... Expatriation tax (a principal purpose
but with objective unsafe harbor).
Test is referenced by Sec. Sec.
2107, 2501(a)(3).
Sec. 953(e)(7)(C)................ CFC insurance companies change of
reserve methods where a principal
purpose of the change is to claim
benefits under Sec. 953(f) or Sec.
954(f) is disregarded. 1998.
Sec. 954(h)(7)(A),(D)............ If a one of the principal purposes of
a transaction is to take advantage
of this subsection, that transaction
is disregared. 1997.
Sec. 1031(f)(2)(C)............... Like-kind exchanges between related
persons may still qualify for
nonrecognition where it is
established to the satisfaction of
the Secretary that one of the
principal purposes is not tax
avoidance. 1984.
Sec. 1272(a)(2)(E)(ii)........... Loans between natural persons with an
IP of less than $10,000 may still be
subject to OID by overzealous
auditors if one of the principal
purposes of the transaction is tax
avoidance. 1984.
Sec. 1298(d)(3)(B)............... Exception to leasing rules for PFIC
status if a principal purpose of
leasing property was to avoid PFIC
status. 1993.
Sec. 1298(e)(2)(B)(ii)........... Similar exception to intangible
regime where a principal purpose of
the license was to avoid PFIC
ststus. 1993.
Sec. 7872(c)(1)(D)............... Below market loan provision applies
to any below market loan one of the
principal purposes of which is tax
avoidance. 1984.
Sec. 9722........................ Transactions with a principal purpose
of tax avoidance are ignored.
------------------------------------------------------------------------

Recapping Responses to Written Questions From Senator Hagel

1. Do the anti-abuse principles under current U.S. law, such as the
Business Purpose Doctrine, currently apply in the treaty context?
--As noted above, such doctrines do apply in the treaty context.

2. Are these ``main purpose'' tests intended to clarify current
domestic U.S. law or do they go beyond present U.S. law? If so, how?
--This question is discussed above under ``Benefits of the Anti-
Abuse Rules.''

3. How will you assure that the tests will not be used by treaty
partners to deny treaty benefits for legitimate business transactions?
--This issue is discussed above under ``Concerns about
Application.''

4. During the hearing you indicated that the Treasury Department
has not prepared a comprehensive analysis of these ``main purpose''
tests? Will you undertake such an analysis and provide it to the
Committee?
--The requested analysis is provided above.

______

Memorandum for Senator Hagel

Re: Responses to Issues Raised in JCT Pamphlets on Pending Tax Treaties

This memorandum provides responses to issues raised by the Joint
Committee on Taxation in its pamphlets on the seven tax treaties
currently pending before the Senate Committee on Foreign Relations. No
issues were raised by the Joint Committee with respect to the pending
estate tax protocol with Germany. The other written questions submitted
after the hearing and the anti-abuse rules found in the treaties with
Italy and Slovenia will be discussed in a separate memorandum to follow
shortly. We apologize for this approach, as we would prefer to answer
all of the questions at the same time, but were asked by the Joint
Committee to provide these answers as quickly as possible in order to
facilitate its work on the Senate Foreign Relations Committee Reports.
proposed convention with denmark
Creditability of Danish Hydrocarbon Tax
Issue: The issue raised by the JCT pamphlet is the extent to which
treaties should be used to provide a credit for taxes that may not
otherwise be fully creditable and, in cases where a treaty does provide
creditability, to what extent the treaty should impose limitations not
contained in the Internal Revenue Code.
Response: The proposed Convention contains a limited credit with
respect to taxes on oil and gas extraction income and oil-related
income paid under Denmark's Hydrocarbon Tax Act. Various considerations
led to the decision to include such a credit provision in this
particular treaty.
First, taxpayers face uncertainty under our domestic laws regarding
the creditability of the taxes covered by this provision under domestic
law. In a 1995 decision interpreting temporary regulations under
section 901, the Tax Court determined that the Norwegian taxes on
offshore extraction activities was a fully creditable tax for U.S.
foreign tax credit purposes. The 1995 decision may be distinguishable,
however, and was not reviewed on appeal. A case is pending in the Tax
Court that will address the creditability of the U.K. Petroleum Revenue
Tax.
Second, our treaties with other North Sea countries provide that
similar taxes in those countries are creditable. Although those taxes
may be distinguishable from the Danish Hydrocarbons Tax, not providing
for the creditability of that tax here would raise questions regarding
the extent to which similarly-situated U.S. taxpayers are treated
similarly.
Third, we considered the treatment of Danish hydrocarbon taxes in
the context of the treaty as a whole. For Denmark, obtaining certainty
regarding the creditability of its hydrocarbon taxes similar to that
found in U.S. tax treaties with its North Sea petroleum competitors was
an important issue which we conceded in order to promptly conclude a
new treaty with an effective anti-treaty-shopping provision.
The pamphlet also questions the extent to which a tax treaty should
impose limitations not otherwise contained in the Code. If the Danish
tax were deemed to be noncreditable in the absence of a treaty,
taxpayers would obtain a higher foreign tax credit under the treaty
than they otherwise would. To limit the extent to which the treaty
might have this effect, the Treasury chose to incorporate, within the
treaty, an additional ``per-country'' limitation and restriction on the
use of carryovers that is similar in effect to the limitations imposed
by the other treaties in which this type of provision appears. Thus,
the treaty imposes restrictions that prevent that tax from offsetting
U.S. taxes on income earned in other countries or on Danish income that
falls within a different foreign tax credit basket. Of course, since
the treaty cannot put taxpayers in a worse position than domestic law,
if it were determined that the tax were fully creditable under domestic
law, these additional limitations would not apply. The Treasury
Department believes that the limitation on the use of credits is a fair
condition for the grant of the credit under the treaty.
Treaty Shopping
Issue: The issue raised by the JCT pamphlet is whether the
limitation on benefits provision of the proposed treaty is an adequate
tool for preventing possible treaty-shopping abuses in the future. The
pamphlet directs particular attention to the ``bright line rules''
under the active business test and to the so-called ``derivative
benefits'' rule.
Response: The United States is the international leader with
respect to treaty provisions to prevent treaty-shopping. Unlike the
existing treaty, the proposed treaty with Denmark contains a
comprehensive anti-treaty-shopping provision. We made every effort in
negotiating the proposed treaty with Denmark to ensure that the
limitation on benefits provisions adequately distinguished between
persons that legitimately should qualify for treaty benefits and
persons that may have a treaty shopping motive.
The provisions in this treaty do differ in some respects from those
in the U.S. Model and in other U.S. treaties, but this is not unusual.
Like our treaty with Ireland, there is more detail in the limitation on
benefits provision than is found in the U.S. Model. There is somewhat
less detail than in our treaties with Switzerland and The Netherlands.
Denmark wanted the added provisions in order to provide a measure of
certainty to taxpayers as to whether they would be entitled to treaty
benefits, but did not want the added complexity of the Swiss and
Netherlands treaties.
In addition, negotiation of these provisions requires that the
specific circumstances of the treaty partner be taken into account. As
a consequence, no two treaties have identical limitation on benefits
provisions. In Denmark's case, the provisions needed to accommodate the
fact that Denmark is a country with close economic ties to the rest of
Europe and the substantial foreign participation in its business
sector. The provisions do this without compromising their fundamental
objective.
The provision covering income from the operation of ships and
aircraft in international traffic essentially confirms the benefits
already provided by U.S. law under section 883 of the Code and
reciprocally requires Denmark to extend those benefits to U.S.
residents. As noted in the pamphlet, this provision was also included
in the conventions with The Netherlands and Ireland, which were
reviewed by the Committee in 1993 and 1997, respectively. Other rules
were added to address the treatment of taxable nonstock corporations,
whose ownership of some important Danish multinationals might have
disqualified those corporations from treaty benefits under an
unmodified limitation on benefits provision.
As noted in the JCT pamphlet, a company that satisfies the
derivative benefits provision will be entitled to all the benefits of
the treaty, just as in the U.S. treaties with France and Switzerland.
The derivative benefits provision of the proposed Convention was
crafted bearing in mind the openness of the Danish and U.S. economies
and their close integration with their European and North American
trading partners. Although the provision requires no Danish or U.S.
ownership of a company in order for it to be entitled to benefits, at
least 95 percent of the shares in the company must be owned by
residents of countries in the European Union, European Economic Area or
NAFTA. In addition, any third-country owners must be entitled to
benefits under a comprehensive income tax treaty between their country
of residence and the treaty partner (the United States or Denmark) from
which the benefits of the proposed treaty are sought. And, in order to
obtain the reduced withholding rates for an item of dividend, interest
or royalty income, the treaty with the third country must provide a
withholding rate on that item of income that is at least as low as the
rate provided in the proposed treaty. The requirement that the third-
country treaty provide at least equivalent withholding rates means that
this provision is unlikely to be exploited for treaty shopping
purposes, because the principal benefits of the treaty could be
obtained directly by the third-country resident. Finally, a base
erosion test ensures that treaty benefitted income is not being
diverted to another country through deductible payments.
proposed convention with estonia
Treatment of REIT Dividends
Issue: The issue raised by the JCT pamphlet is whether the
treatment of REIT dividends in the proposed treaty is appropriate.
Response: REITs are not generally subject to entity-level tax and
their predominant income is typically real estate rental income, which
is statutorily subject to a 30% rate of withholding tax that is not
generally reduced by treaties. Therefore, the JCT, the Senate Foreign
Relations Committee, and Treasury had, from 1988 to 1997, taken the
position that REIT dividends generally should be treated under U.S. tax
treaties as conduit distributions of real estate rental income and,
thus, as subject to 30% withholding tax except in very limited
circumstances. This is the policy currently embodied in the pending
treaty with Estonia.
In 1997, we re-considered that position in light of economic
changes since 1988. As a result of that re-consideration, we revised
our treatment of REIT dividends under our tax treaties. At that time,
we agreed to add the new rule in all ``future negotiations.'' However,
this treaty, like the treaties with Latvia and Lithuania, were fully
negotiated at the time that the new treatment of income from REITs was
developed. It would not have been appropriate to re-open negotiations
with the Baltic countries at that stage. We spoke to the REIT industry
at the time and they understood our position. As part of any future
revision of the Estonian treaty, we would seek to update the REIT rule.
Developing Country Concessions
Issue: The issue raised in the JCT pamphlet is whether the
developing country concessions represent appropriate U.S. treaty policy
and, if they do, whether Estonia is an appropriate recipient of these
concessions.
Response: Regarding whether Estonia is an appropriate recipient of
developing country concessions, it should be noted that for 1997,
Estonia's gross domestic product (GDP) was $9.3 billion and its per
capita GDP was $6,450. By contrast, the United States' 1997 GDP was
$8,100 billion and its per capita GDP $30,200.
With respect to the question of whether making developing country
concessions is appropriate, we believe that when a treaty is in the
interests of the United States we can agree to make such concessions
when the treaty partner believes that it is in its interest. The issue
is one of balancing the overall potential costs and benefits in the
treaty and the potential costs of moving away from our preferred
position against the potential benefits of having a treaty at all. With
respect to Estonia, we believe that the potential benefits outweigh the
potential costs.
For example, it generally is U.S. policy to reduce the rate of
withholding taxation on interest and royalties to zero, and to reduce
dividend withholding rates to 5 percent for direct investment dividends
and to 15 percent for portfolio dividends. 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 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 reducing their
high levels of taxation may help to attract foreign capital but, at the
same time, they are unwilling to give up scarce revenues. Such
prospective treaty partners may perceive that, by reducing withholding
tax rates, they would be making a tangible current concession in favor
of the United States while receiving at most a possible future benefit.
In some such cases, we will look at the overall level of tax and avoid
agreements which may have a significant adverse impact on the fisc of
the less developed partner. For this reason and others, the treaty
withholding rates will vary Estonia agreed to accept U.S. policy with
respect to dividend withholding, but not interest and royalty
withholding.
Businesses reinforce our view that frequently the treaty
relationship itself is more important than any one or more specific
benefits. For example, even if a treaty does not serve to reduce tax
rates to the levels that we prefer, it provides limitations, certainty,
and dispute resolution mechanisms that are important to business
decision-makers. We think the concessions are appropriate, both because
of the economic position of Estonia as a newly emerging economy and
because of the overall package of benefits that will accrue to the
United States under the treaty.
With respect to particular developing country concessions in the
proposed Estonian treaty, the JCT pamphlet identified the following:

the definition of ``permanent establishment'';
the taxation of business profits;
the taxation of certain equipment leasing; and
other taxation by the source country.

These are discussed below seriatim.
Permanent Establishment Definition
The Estonian treaty provides that the term ``permanent
establishment'' includes building sites, etc. and rigs, ships and
installations used for the exploration of natural resources when the
site or activity continues for more than six months. The U.S. Model
provides that these activities will constitute a ``permanent
establishment'' only when the site or activity continues for 12 months.
The lower threshold rule in the treaty reflects the fact that, as a
newly emerging economy, Estonia is more dependent upon tax revenues
from construction projects and similar activities than developed
countries whose physical and business infrastructure are more
established. This rule in the Estonian treaty is consistent both with
other Estonian treaties and with many other U.S. treaties with
developing countries.
Taxation of Business Profits
The proposed treaty provides that if an enterprise has a permanent
establishment in a country, that country may tax the portion of the
enterprise's business profits that is attributable to the permanent
establishment. As the JCT pamphlet points out, the proposed treaty
further provides that, under certain circumstances, the country in
which the permanent establishment exists may also tax income of the
enterprise attributable to sales in that country of goods or
merchandise of the same kind as those sold through the permanent
establishment or to other business transactions carried on in that
country that are of the same or similar kind as those effected through
the permanent establishment. These rules are of a type known as
``limited force of attraction'' rules. Such rules are found in the U.N.
Model, and are included in many treaties with developing countries.
Estonia requested that a limited force of attraction rule be
included in the proposed treaty. The United States agreed, but
negotiated a limited force of attraction rule that is narrower than the
rule found in the U.N. Model. The force of attraction rule in the
proposed treaty operates as an anti-abuse rule. Its application is
limited to situations in which it can be shown that the transaction
giving rise to the income was carried on outside the permanent
establishment and a principal purpose of the transaction is to avoid
taxation in the country in which the permanent establishment is
situated. We therefore concluded that the rule did not improperly
expand the taxation of business income.
Taxation of Certain Equipment Leasing
Under the U.S. Model Treaty, income from the rental of tangible
personal property is treated as business profits. Under the proposed
Estonian treaty, payments for the use of, or the right to use,
industrial, commercial, or scientific equipment will be treated as
royalties. Treatment of such income as royalties is consistent with the
position taken by many developing countries and with the former OECD
Model Treaty. It also represents the treaty policy of Estonia. Through
negotiation, we were able to reduce the withholding rate on this class
of royalties to 5 percent (from the general rate of 10 percent). As
with all royalty income, if the income from rentals of tangible
personal property are attributable to a permanent establishment or
fixed base in the source country, such income is taxed on a net basis
under Articles 7 or 14. As discussed below with respect to ships and
aircraft, there are exemptions from even the 5 percent withholding tax
in the case of income from the rental of containers, and from the
rental of ships and aircraft when such income is incidental to the
operation of the ships and aircraft in international traffic.
Other Taxation by Source Country
The JCT pamphlet also noted other areas in which the proposed
treaty provides for greater taxation by the source country than would
be permitted under the corresponding provisions of the U.S. Model. It
notes the fact that the withholding rate at source on royalties is
generally 10 percent, with a 5 percent rate on rentals of tangible
personal property, rather than the zero rate at source in the U.S.
Model. As noted above, developing countries are frequently unwilling to
lower their withholding rates to the levels in the U.S. Model, largely
because of their concerns over the potential loss of revenue. We were
able to get Estonia to agree to relatively low rates, similar to those
found in a number of other U.S. treaties with developing countries.
The JCT pamphlet also noted the fact that under the Estonia treaty
a fixed base is deemed to exist, thus allowing the host country to tax
income from independent personal services, when the visitor is present
in that country for 183 days in a 12-month period. This rule is not in
the U.S. Model. Estonia was concerned that, without this rule, a U.S.
resident would be able to spend longer than 183 days in Estonia
performing independent personal services, but would be able to do so
without using a fixed base (e.g., moving among clients' offices) and
would avoid Estonian tax. The addition of this rule will prevent this
result. This is standard Estonian treaty policy. A similar rule is
found in a number of other U.S. treaties with developing countries,
some (e.g., Thailand) with lower time thresholds.
It is pointed out in the JCT pamphlet that the ``Other Income''
provision in the Estonian treaty differs from the U.S. Model in that if
``other income'' is sourced in a Contracting State, that State is
allowed to tax the income. Under the U.S. Model all ``other income,''
regardless of source, may be taxed only in the State of residence of
the beneficial owner. The Estonian position is reflected in all of its
treaties, and is found in a number of U.S. treaties with developing
countries, as well as with several OECD partners. It is another aspect
of U.S. treaty policy that often is adjusted to reflect the economic
position of our treaty partners.
Royalty Source Rules
Issue: The issue raised by the JCT pamphlet is whether it is
appropriate to have royalty source rules in the treaty that are
different from the Internal Revenue Code rules regarding the source of
royalties.
Response: Under the proposed treaty, royalties are generally
sourced according to the residence of the payor or the location of the
permanent establishment or fixed base that incurs and bears the
royalty. That rule is consistent with the U.N. Model rule but is
different from the rule of U.S. internal law, which sources royalties
according to the place where the property is used. Estonia requested
the U.N. Model rule. The U.S. agreed, on the condition that the rule be
modified to provide that if the general rule, stated above, did not
source the royalty to either the United States or Estonia, the royalty
would be sourced according to the place of use of the property, which
is the general U.S. rule. A similar provision has been included in some
other U.S. treaties (e.g., the 1995 U.S.-Canada protocol and 1997
treaties with Thailand and Turkey). As noted in the JCT pamphlet, a
conflict between U.S. law and the rule under the proposed U.S.-Estonia
treaty would arise only in the circumstances where an Estonian resident
that does not have a permanent establishment or fixed base in the
United States pays a royalty to a U.S. resident for the right to use
property exclusively in the United States. The proposed royalty source
rule would treat such royalty as Estonian source (and therefore
potentially taxable in Estonia). However, U.S. internal law would treat
such royalty as U.S. source income. As noted in the JCT pamphlet, the
JCT staff recognizes that this situation would arise in relatively few
cases (as opposed to the more common situation in which an Estonian
resident using property in the United States would also have a
permanent establishment or fixed base in the United States to which the
royalty would be attributed, in which case it would be U.S. source). As
a consequence of a similar recognition by the Treasury staff, we
believe that this provision was an acceptable concession in the context
of the overall U.S.-Estonian tax treaty negotiation. A further
exception to the general source rule was included, at the insistence of
the United States, that sources royalties that are payments for the use
of containers as arising in neither Contracting State, and thus
taxable, as ``Other Income,'' only in the State of residence of the
income recipient. The result of this rule is consistent with the rule
in the U.S. Model, which, under Article 8, gives exclusive taxation
rights for such income to the State of residence of the beneficial
owner of the income.
Income from the Rental of Ships and Aircraft
Issue: The issue presented in the JCT pamphlet is whether the
proposed treaty's rules treating profits from certain rental of ships
and aircraft less favorably than profits from the operation of ships
and aircraft and the rental of containers are appropriate.
Response: The treatment of income from the rental of ships and
aircraft, where the rental is not incidental to the operation of ships
and aircraft in international traffic, was a difficult issue in the
negotiations. Although it is U.S. policy to include such income within
the scope of the source exemption in Article 8, Estonia was unwilling
to do so, although they were willing to exempt incidental rentals from
source country tax. The treaty permits Estonia to impose tax at source
on non-incidental ship and aircraft rentals, but at a rate limited to 5
percent of the gross rental. This is a common result in Estonian
treaties, and is also found in several other U.S. treaties.
Treaty Shopping
Issue: The issue raised by the JCT pamphlet is whether the
limitation on benefits provision of the proposed treaty is an adequate
tool for preventing possible treaty-shopping abuses in the future.
Response: The limitation on benefits provisions of the proposed
treaty adhere closely to those of the U.S. Model. We therefore believe
that they are adequate.
proposed convention with italy
``Main Purpose'' Anti-Abuse Test
As noted above, this issue will be addressed in a separate
memorandum.
Creditability of Italian IRAP Tax
Issue: The issue raised by the JCT pamphlet is the extent to which
treaties should be used to provide a foreign tax credit for taxes that
may not otherwise be fully creditable.
Response: One of the principal purposes for entering into an income
tax treaty is to limit double taxation of income earned by a resident
of one of the countries that may be taxed by the other country. One of
the common ways in which this is accomplished is through a foreign tax
credit, whereby the taxpayer's country of residence or citizenship,
which taxes the worldwide income of the taxpayer, allows a credit for
taxes paid to the other country on income that the other country is
allowed to tax under the treaty. This mechanism is provided for under
internal U.S. law, and is also a common feature of U.S. tax treaties.
The proposed treaty provides for this mechanism, allowing U.S.
residents or citizens a credit against U.S. income tax for the
appropriate amount of income tax paid to Italy. The proposed treaty
lists the specific Italian taxes that are considered creditable income
taxes, and, like other U.S. treaties, provides that any identical or
substantially similar taxes that are imposed by Italy after the date of
signature will be considered creditable income taxes.
The proposed treaty also addresses the creditability of the Italian
regional tax on productive activities (``IRAP''). This tax, which
became effective January 1, 1998, was enacted by Italy to replace the
local income tax (``ILOR''), as well as certain other taxes. This
enactment was part of a fundamental revision of the Italian system for
financing its regions and localities. In calculating the IRAP tax base,
taxpayers are allowed to deduct certain expenses, such as depreciation
and rental payments, but are not allowed to deduct labor expense or, in
the case of non-financial institutions, interest expense.
The Italian legislation implementing IRAP provides that IRAP is to
be considered substantially similar to ILOR for purposes of Italy's
international agreements ILOR, which was an income tax under U.S. law,
is explicitly listed as a creditable income tax in the existing treaty.
Accordingly, Italian tax authorities took the position that IRAP is
creditable in full under the existing treaty. In contrast, the Treasury
Department believes that IRAP is not substantially similar to ILOR for
purposes of the existing treaty. In particular, by disallowing
deductions for labor and interest expense, IRAP is not likely to reach
net gain in the normal circumstances in which it applies and,
accordingly, it does not satisfy one of the requirements for being an
income tax under U.S. law.
Because IRAP replaced a tax explicitly addressed by the existing
treaty, and because of the disagreement over the proper interpretation
of the existing treaty, the Treasury Department agreed to address the
creditability of IRAP in the context of a comprehensive renegotiation
of the existing treaty. The Treasury Department believed that such a
renegotiation would allow the existing treaty, which was signed in
1984, to be updated to more closely reflect current U.S. treaty policy.
In its economic effect, IRAP constitutes a tax not only on the net
income of a taxpayer, but also on labor and, in the case of non-
financial institutions, interest. Accordingly, U.S. negotiators refused
to permit a tax credit for the full amount of IRAP. However, because
one of the principal purposes of the treaty is to eliminate double
taxation of income, the negotiators believed it was appropriate to
allow limited relief for that portion of IRAP that was equivalent to a
tax on the net income of a U.S. taxpayer. Thus, the proposed treaty
provides a formula for determining the portion of IRAP that is
equivalent to an income tax for purposes of the foreign tax credit.
It is important to note that the portion of IRAP that is equivalent
to an income tax under the proposed treaty is subject to the same
limitations on creditability as the other Italian income taxes listed
in the treaty. In particular, in accordance with U.S. treaty policy,
the proposed treaty provides that an income tax is creditable only in
accordance with, and subject to the limitations of, U.S. law. Thus, for
example, the credit with respect to the relevant portion of IRAP is
subject to U.S. law rules governing ``basket limitations,'' currency
translation, and carryover periods.
As it has in the past, Treasury intends in its future negotiations
to continue its practice of reviewing its treaty partner's taxes
carefully to determine wehther their creditability should be provided
for in our treaty.
In summary, the proposed treaty's allowance of a foreign tax credit
for a portion of IRAP represents an appropriate response to a
particular set of circumstances arising in the context of an existing
treaty relationship. Moreover, the approach is narrowly tailored to
allow a credit only for that portion of IRAP that is equivalent to a
tax on the U.S. taxpayer's net income, thereby furthering the treaty
policy of eliminating double taxation on income. Under such
circumstances, the provision of a foreign tax credit by treaty is
appropriate.
Insurance Excise Tax
Issue: The issue raised by the JCT pamphlet is whether it is
appropriate to provide an exemption from the federal excise tax on
insurance premiums paid to foreign insurers in the proposed treaty with
Italy.
Response: The existing treaty, which was signed in 1984, provides
an exemption from the federal excise tax on insurance premiums paid to
Italian insurers, as long as certain requirements are satisfied. The
proposed treaty retains the existing treaty's coverage of this tax.
Treasury recognizes the policy concerns about the competitiveness
of U.S. insurance companies that serve as the basis for the imposition
of the excise tax on foreign insurers insuring U.S. risks. Consistent
with these policy concerns, the Treasury Department will only agree to
cover this excise tax in an income tax convention, and thereby grant an
exemption from the tax, if Treasury is satisfied that an insurer that
is a resident of the treaty partner and is insuring U.S. risks would
face a level of taxation that is substantial relative to the level of
taxation faced by U.S. insurers.
During the course of negotiations, Treasury conducted a thorough
review of Italian law and information on Italian insurance company
operations. This review demonstrated that insurance companies that are
resident in Italy are subject to a substantial level of tax in Italy.
Accordingly, it was determined that U.S. insurance companies would not
be placed at a competitive disadvantage by the retention of coverage of
the excise tax in the proposed treaty.
As further protection, the proposed treaty includes the ``anti-
conduit'' clause also found in the existing treaty. This provision
ensures that the excise, tax will apply if an Italian insurer reinsures
a policy it has written on a U.S. risk with a foreign insurer that is
not entitled to a similar exemption under this or a different tax
treaty.
Shipping and Aircraft Income
Issue: The issue raised by the JCT pamphlet is whether the proposed
treaty's rules with respect to income derived from the rental of ships
and aircraft, and gains from the sale of ships and aircraft, are
appropriate.
Response: The proposed treaty, with one favorable exception,
retains the existing treaty's treatment of income from the rental of
ships and aircraft, and gains from their sale. As in the existing
treaty, and consistent with U.S. policy, the proposed treaty provides
an exemption from source-country taxation for rental income (and gains)
from ships and aircraft rented on a full basis, as well as rental
income (and gains) from containers used in international traffic. As in
the existing treaty, the proposed treaty provides that income (and
gains) from ships and aircraft rented on a bareboat basis will be
exempt from source-country taxation only if the rentals are incidental
to the lessor's profits from the operation of ships or aircraft in
international traffic.
Although it is the preferred U.S. policy to extend the source-
country exemption to include non-incidental income from the bareboat
rental of ships and aircraft (and gains from the disposition of such
ships and aircraft), Italy was unwilling to change the existing treaty
on this point because of its strong treaty policy against such
exemptions. Indeed, the inclusion of a source-country exemption for
rental income (and gains) from containers used in international traffic
represents a significant departure for Italy from its normal treaty
policy.
Nonetheless, the proposed treaty does represent an improvement over
the existing treaty's treatment of rental income from the non-
incidental rental of ships and aircraft on a bareboat basis. Whereas
the existing treaty allows the source country to impose a 7 percent tax
rate on the gross amount of such rentals that are not attributable to a
permanent establishment in the source country, the proposed treaty
lowers that rate to 5 percent.
Treaty Shopping
Issue: The issue raised by the JCT pamphlet is whether the
limitation on benefits provision of the proposed treaty is an adequate
tool for preventing possible treaty-shopping abuses in the future.
Response: The limitation on benefits provision of the proposed
treaty is identical in all substantive respects to the provision
contemplated by the U.S. Model We therefore believe that it is
adequate.
Arbitration of Competent Authority Issues
Issue: The issue raised by the JCT pamphlet is whether the
provision allowing for the competent authorities to agree to
arbitration, with the consent of the affected taxpayer, is appropriate.
Response: Treasury recognizes that there has been little practical
experience with arbitration of tax treaty disputes and this creates
some uncertainty about how well arbitration would work. For this
reason, Treasury does not advocate the inclusion of arbitration
provisions in new treaties. However, if the treaty partner is strongly
interested in an arbitration provision, we are willing to include such
a provision in a new treaty with the proviso that it cannot be
implemented until the treaty partners have exchanged diplomatic notes
to that effect. This provides the opportunity to wait until more
experience has been gained with arbitration and with the treaty partner
before deciding whether the implementation of such a provision is
desirable. For the foregoing reasons, and because Italy was strongly
interested in the provision, it was included in the proposed treaty.
Exchange of Information
Issue: The issues raised by the JCT pamphlet are (1) whether the
information exchange provision, which does not include a sentence
regarding the ability to obtain information from financial
institutions, is sufficient and (2) whether a statement that the
omission of the provision regarding financial institutions does not
lessen the commitment of the United States to pursue broader exchanges
of information in future treaty negotiations would be beneficial.
Response: Adequate exchange of information with our treaty partners
is one of the key objectives of our tax treaty policy. The Treasury
Department remains strongly committed to this objective, including the
ability to exchange third-party information obtained from banks and
other financial institutions.
The Treasury Department believes that the exchange of information
provisions in the proposed treaty will enable the United States to
obtain this third-party information, and that the omission of paragraph
3 of Article 26 of the U.S. Model will have no adverse effect on this
ability. Treasury has received written assurances from the Italian
Ministry of Finance regarding Italy's ability to obtain bank
information under its internal laws in order to comply with the
information exchange provisions contained in the proposed treaty.
Moreover, Italy has been at the forefront of international efforts to
increase information exchange in order to prevent tax avoidance and
evasion. Indeed, Italy recently hosted a high-level OECD meeting
between tax and bank regulatory officials and the private sector in
order to discuss the problem of bank secrecy and explore the subject of
greater access to bank information for tax administration purposes.
It is important to note that the inclusion in a treaty of the first
sentence of paragraph 3 of Article 26 of the U.S. Model, which purports
to override a country's internal laws regarding bank secrecy, does not
guarantee that the United States will, in practice, actually receive
third-party bank information. For example, a country's internal laws
might not allow the exchange of such information notwithstanding the
purported override in the treaty. Accordingly, the most effective way
of protecting the United States' interest in this area is through due
diligence during negotiations to ensure that internal laws will, in
fact, enable the exchange.
In addition, some countries have viewed the request for this
provision as a diplomatic slight. This is particularly of concern to
those countries that have been affected by the United States' ``later-
in-time'' principle, which permits a subsequently enacted U.S. domestic
law to take precedence over the provisions of a previously ratified
treaty.
For these reasons, the Treasury Department plans to substantially
revise or eliminate this sentence in the U.S. Model. Of course, any
change in the sentence would not lessen the Treasury Department's
commitment to adequate information exchange, including third-party bank
information.
As to the second issue, as noted above, we believe that the effect
of the information exchange provision of this treaty is as broad as in
any of our tax treaties, and we do not believe that it would be
beneficial to suggest otherwise. However, we always welcome strong
statements from the Committee regarding the importance of information
exchange. Therefore, we believe that a statement from the Committee
that the omission of this statement in this treaty does not reflect any
lessening of our commitment to receiving information from banks and
other financial institutions would be beneficial.
proposed convention with latvia
Treatment of REIT Dividends
Issue: The issue raised by the JCT pamphlet is whether the
treatment of REIT dividends in the proposed treaty is appropriate.
Response: As noted with respect to Estonia above, this treaty was
fully negotiated at the time we decided to change our policy at the end
of 1997. It was not appropriate to re-open negotiations, in particular
because Latvia is not a significant source of investment in U.S. real
estate.
Developing Country Concessions
Issue: The issue raised in the JCT pamphlet is whether the
developing country concessions represent appropriate U.S. treaty policy
and, if they do, whether Latvia is an appropriate recipient of these
concessions.
Response: As noted above, developing country concessions may be
necessary in order to enter into treaties with developing countries.
Tax treaties with developing countries are in the interest of the
United States because they provide reductions in the taxation by such
countries of U.S. investors and a clearer framework for the taxation of
U.S. investors. Such treaties also provide dispute resolution and
nondiscrimination rules that benefit U.S. investors and exchange of
information procedures that benefit the tax authorities.
Regarding whether Estonia is an appropriate recipient of developing
country concessions, it should be noted that for 1997, the GDP of
Latvia was $10.4 billion (as compared to the U.S. GDP of $8,100
billion) and the per capita GDP was $4,260 (as compared to $30,200 per
capita GDP in the United States).
The Treasury Department believes that the developing country
concessions in the proposed treaty are in line with the concessions
granted by the United States to other developing countries and compare
favorably with developing country concessions granted to Latvia by
other OECD countries. These provisions are addressed individually
below.
With respect to particular developing country concessions in the
proposed Latvian treaty, the JCT pamphlet identified the following:

the definition of ``permanent establishment'';
the taxation of business profits;
the taxation of certain equipment leasing; and
other taxation by the source country.

These are discussed below seriatim.
Permanent Establishment Definition
The Latvian treaty provides that the term ``permanent
establishment'' includes building sites, etc. when the site or activity
continues for more than six months. A special article provides that
``offshore activities'' relating to the exploration for natural
resources will be taxed as a permanent establishment if such activities
continue for more than 30 days in any twelve-month period. The U.S.
Model provides that both building and oil exploration activities will
constitute a ``permanent establishment'' only when the site or activity
continues for 12 months. The lower threshold for building activities in
the treaty reflects the fact that, as a newly emerging economy, Latvia
is more dependent upon tax revenues from construction projects and
similar activities than developed countries whose physical and business
infrastructure are more established. This rule in the Latvian treaty is
consistent both with other Latvian treaties and with many other U.S.
treaties with developing countries. With respect to the offshore
activities rules, Latvia takes the same view as a number of North Sea
countries (and other countries whose tax laws have been influenced by
the North Sea countries) that the oil in their territorial waters is
part of their patrimony. They therefore want to make sure that they
have primary taxing jurisdiction with respect to all revenues generated
from the oil. The rule in the treaty is the same as that in our
treaties with Ireland, The Netherlands, Norway and the United Kingdom.
Taxation of Business Profits
The proposed treaty provides that if an enterprise has a permanent
establishment in a country, that country may tax the portion of the
enterprise's business profits that is attributable to the permanent
establishment. As in the treaty with Estonia, the treaty with Latvia
includes a ``limited force of attraction'' rule. The rule in the treaty
is narrower than the rule found in the U.N. Model and operates as an
anti-abuse rule. We therefore concluded that the rule did not
improperly expand the taxation of business income.
Taxation of Certain Equipment Leasing
Under the U.S. Model Treaty, income from the rental of tangible
personal property is treated as business profits. Under the proposed
Latvian treaty, payments for the use of or the right to use,
industrial, commercial, or scientific equipment will be treated as
royalties. Treatment of such income as royalties is consistent with the
position taken by many developing countries and with the former OECD
Model Treaty. It also represents the treaty policy of Latvia. Through
negotiation, we were able to reduce the withholding rate on this class
of royalties to 5 percent (from the general rate of 10 percent). As
with all royalty income, if the income from rentals of tangible
personal property are attributable to a permanent establishment or
fixed base in the source country, such income is taxed on a net basis
under Articles 7 or 14. As discussed below with respect to ships and
aircraft, there are exemptions from even the 5 percent withholding tax
in the case of income from the rental of containers used in
international traffic, and from the rental of ships and aircraft used
in international traffic on a full (time or voyage) basis, and on a
bareboat basis when such income is incidental to the operation of the
ships and aircraft in international traffic.
Other Taxation by Source Country
The JCT pamphlet also noted other areas in which the proposed
treaty provides for greater taxation by the source country than would
be permitted under the corresponding provisions of the U.S. Model. It
notes the fact that the withholding rate at source on royalties is
generally 10 percent, with a 5 percent rate on rentals of tangible
personal property, rather than the zero rate at source in the U.S.
Model. As noted above, developing countries are frequently unwilling to
lower their withholding rates to the levels in the U.S. Model, largely
because of their concerns over the potential loss of revenue. We were
able to get Latvia to agree to relatively low rates, similar to those
found in a number of other U.S. treaties with developing countries.
The JCT pamphlet also noted the fact that under the Latvia treaty a
fixed base is deemed to exist, thus allowing the host country to tax
income from independent personal services, when the visitor is present
in that country for 183 days in a 12-month period. This rule is not in
the U.S. Model. Latvia was concerned that, without this rule, a U.S.
resident would be able to spend longer than 183 days in Latvia
performing independent personal services, but would be able to do so
without using a fixed base (e.g., moving among clients' offices) and
would avoid Latvian tax.
The addition of this rule will prevent this result. This is
standard Latvian treaty policy. A similar rule is found in a number of
other U.S. treaties with developing countries, some (e.g., Thailand)
with lower time thresholds.
Royalty Source Rules
Issue: The issue raised by the JCT pamphlet is whether it is
appropriate to have royalty source rules in the treaty that are
different from the Internal Revenue Code rules regarding the source of
royalties.
Response: Under the proposed treaty, royalties are generally
sourced according to the residence of the payor or the location of the
permanent establishment or fixed base that incurs and bears the
royalty. That rule is consistent with the U.N. Model rule but is
different from the rule of U.S. internal law, which sources royalties
according to the place where the property is used. Latvia requested the
U.N. Model rule. The U.S. agreed, on the condition that the rule be
modified to provide that if the general rule, stated above, did not
source the royalty to either the United States or Latvia, the royalty
would be sourced according to the place of use of the property, which
is the general U.S. rule. This source provision has been included in
some other U.S. treaties (e.g., the 1995 U.S.-Canada protocol and 1997
treaties with Thailand and Turkey). As noted in the JCT pamphlet, a
conflict between U.S. law and the rule under the proposed U.S.-Latvia
treaty would arise only in the circumstances where a Latvian resident
that does not have a permanent establishment or fixed base in the
United States pays a royalty to a U.S. resident for the right to use
property exclusively in the United States. The proposed royalty source
rule would treat such royalty as Latvian source (and therefore
potentially taxable in Latvia) However, U.S. internal law would treat
such royalty as U.S. source income. As noted in the JCT pamphlet, the
JCT staff recognizes that this situation would arise in relatively few
cases (as opposed to the more common situation in which a Latvian
resident using property in the United States would also have a
permanent establishment or fixed base in the United States to which the
royalty would be attributed, in which case it would be U.S. source). As
a consequence of a similar recognition by the Treasury staff, we
believe that this provision was an acceptable concession in the context
of the overall U.S.-Latvian tax treaty negotiation. A further exception
to the general source rule was included, at the insistence of the
United States, that sources royalties that are payments for the use of
containers as arising in neither Contracting State, and thus taxable,
as ``Other Income,'' only in the State of residence of the income
recipient. The result of this rule is consistent with the rule in the
U.S. Model, which, under Article 8, gives exclusive taxation rights for
such income to the State of residence of the beneficial owner of the
income.
Income from the Rental of Ships and Aircraft
Issue: The issue presented in the JCT pamphlet is whether the
proposed treaty's rules treating profits from certain rental of ships
and aircraft less favorably than profits from the operation of ships
and aircraft and the rental of containers are appropriate.
Response: The treatment of income from the bareboat rental of ships
and aircraft, where the rental is not incidental to the operation of
ships and aircraft in international traffic, was a difficult issue in
the negotiations. Although it is U.S. policy to include such income
within the scope of the source exemption in Article 8, Latvia was
unwilling to do so, although they were willing to exempt incidental
rentals from source country tax. The treaty permits Latvia to impose
tax at source on non-incidental bareboat ship and aircraft rentals, but
at a rate limited to 5 percent of the gross rental. This is a common
result in Latvian treaties, and is also found in several other U.S.
treaties.
Treaty Shopping
Issue: The issue raised by the JCT pamphlet is whether the
limitation on benefits provision of the proposed treaty is an adequate
tool for preventing possible treaty-shopping abuses in the future.
Response: The limitation on benefits provisions of the proposed
treaty adhere closely to those of the U.S. Model. We therefore believe
that they are adequate.
proposed convention with lithuania
Treatment of REIT Dividends
Issue: The issue raised by the JCT pamphlet is whether the
treatment of REIT dividends in the proposed treaty is appropriate.
Response: As noted with respect to Estonia and Latvia above, this
treaty was fully negotiated at the time we decided to change our policy
at the end of 1997. It was not appropriate to re-open negotiations, in
particular because Lithuania is not a significant source of investment
in U.S. real estate.
Developing Country Concessions
Issue: The issue raised in the JCT pamphlet is whether the
developing country concessions represent appropriate U.S. treaty policy
and, if they do, whether Lithuania is an appropriate recipient of these
concessions.
Response: As noted above, developing country concessions may be
necessary in order to enter into treaties with developing countries.
Tax treaties with developing countries are in the interest of the
United States because they provide reductions in the taxation by such
countries of U.S. investors and a clearer framework for the taxation of
U.S. investors. Such treaties also provide dispute resolution and
nondiscrimination rules that benefit U.S. investors and exchange of
information procedures that benefit the tax authorities.
Regarding whether Lithuania is an appropriate recipient of
developing country concessions, it should be noted that for 1997, the
GDP of Lithuania was $15.4 billion (as compared to the U.S. GDP of
$8,100 billion) and the per capita GDP was $4,230 (as compared to
$30,200 per capita GDP in the United States).
The Treasury Department believes that the developing country
concessions in the proposed treaty are in line with the concessions
granted by the United States to other developing countries and compare
favorably with developing country concessions granted to Lithuania by
other OECD countries. With respect to particular developing country
concessions in the proposed Lithuanian treaty, the JCT pamphlet
identified the following:

the definition of ``permanent establishment'';
the taxation of business profits;
the taxation of certain equipment leasing; and
other taxation by the source country.

These are discussed below seriatim.
Permanent Establishment Definition
The Lithuanian treaty provides, that the term ``permanent
establishment'' includes building sites, etc. when the site or activity
continues for more than six months. A special article provides that
``offshore activities'' relating to the exploration for natural
resources will be taxed as a permanent establishment if such,
activities continue for more than 30 days in any twelve-month period.
The U.S. Model provides that both building and oil exploration
activities will constitute a ``permanent establishment'' only when the
site or activity continues for 12 months. The lower threshold for
building activities in the treaty reflects the fact that, as a newly
emerging economy, Lithuania is more dependent upon tax revenues from
construction projects and similar activities than developed countries
whose physical and business infrastructure are more established. This
rule in the Lithuanian treaty is consistent both with other Lithuanian
treaties and with many other U.S. treaties with developing countries.
With respect to the offshore activities rules, Lithuania takes the same
view as a number of North Sea countries (and other countries whose tax
laws have been influenced by the North Sea countries) that the oil in
their territorial waters is part of their patrimony. They therefore
want to make sure that they have primary taxing jurisdiction with
respect to all revenues generated from the oil. The rule in the treaty
is the same as that in our treaties with Ireland, The Netherlands,
Norway and the United Kingdom.
Taxation of Business Profits
The proposed treaty provides that if an enterprise has a permanent
establishment in a country, that country may tax the portion of the
enterprise's business profits that is attributable to the permanent
establishment. As in the treaties with Estonia and Latvia, the treaty
with Lithuania includes a ``limited force of attraction'' rule. The
rule in the treaty is narrower than the rule found in the U.N. Model
and operates as an anti-abuse rule. We therefore concluded that the
rule did not improperly expand the taxation of business income.
Taxation of Certain Equipment Leasing
Under the U.S. Model Treaty, income from the rental of tangible
personal property is treated as business profits. Under the proposed
Lithuanian treaty, payments for the use of, or the right to use,
industrial, commercial, or scientific equipment will be treated as
royalties. Treatment of such income as royalties is consistent with the
position taken by many developing countries and with the former OECD
Model Treaty. It also represents the treaty policy of Lithuania.
Through negotiation, we were able to reduce the withholding rate on
this class of royalties to 5 percent (from the general rate of 10
percent). As with all royalty income, if the income from rentals of
tangible personal property are attributable to a permanent
establishment or fixed base in the source country, such income is taxed
on a net basis under Article 7. As discussed below with respect to
ships and aircraft, there are exemptions from even the 5 percent
withholding tax in the case of income from the rental of containers
used in international traffic, and from the rental of ships and
aircraft used in international traffic on a full (time or voyage)
basis, and on a bareboat basis when such income is incidental to the
operation of the ships and aircraft in international traffic.
Other Taxation by Source Country
The JCT pamphlet also noted other areas in which the proposed
treaty provides for greater taxation by the source country than would
be permitted under the corresponding provisions of the U.S. Model. It
notes the fact that the withholding rate at source on royalties is
generally 10 percent, with a 5 percent rate on rentals of tangible
personal property, rather than the zero rate at source in the U.S.
Model. As noted above, developing countries are frequently unwilling to
lower their withholding rates to the levels in the U.S. Model, largely
because of their concerns over the potential loss of revenue. We were
able to get Lithuania to agree to relatively low rates, similar to
those found in a number of other U.S. treaties with developing
countries.
The JCT pamphlet also noted the fact that under the Lithuania
treaty a fixed base is deemed to exist, thus allowing the host country
to tax income from independent personal services, when the visitor is
present in that country for 183 days in a 12-month period. This rule is
not in the U.S. Model. Lithuania was concerned that, without this rule,
a U.S. resident would be able to spend longer than 183 days in Estonia
performing independent personal services, but would be able to do so
without using a fixed base (e.g., moving among clients' offices) and
would avoid Lithuanian tax. The addition of this rule will prevent this
result. This is standard Lithuanian treaty policy. A similar rule is
found in a number of other U.S. treaties with developing countries,
some (e.g., Thailand) with lower time thresholds.
Royalty Source Rules
Issue: The issue raised by the JCT pamphlet is whether it is
appropriate to have royalty source rules in the treaty that are
different from the Internal Revenue Code rules regarding the source of
royalties.
Response: Under the proposed treaty, royalties are generally
sourced according to the residence of the payor or the location of the
permanent establishment or fixed base that incurs and bears the
royalty. That rule is consistent with the U.N. Model rule but is
different from the rule of U.S. internal law, which sources royalties
according to the place where the property is used. Lithuania requested
the U.N. Model rule. The U.S. agreed, on the condition that the rule be
modified to provide that if the general rule, stated above, did not
source the royalty to either the United States or Lithuania, the
royalty would be sourced according to the place of use of the property,
which is the general U.S. rule. This source provision has been included
in some other U.S. treaties (e.g., the 1995 U.S.-Canada protocol and
1997 treaties with Thailand and Turkey). As noted in the JCT pamphlet,
a conflict between U.S. law and the rule under the proposed U.S.-
Lithuania treaty would arise only in the circumstances where a
Lithuanian resident that does not have a permanent establishment or
fixed base in the United States pays a royalty to a U.S. resident for
the right to use property exclusively in the United States. The
proposed royalty source rule would treat such royalty as Lithuanian
source (and therefore potentially taxable in Lithuania). However, U.S.
internal law would treat such royalty as U.S. source income. As noted
in the JCT pamphlet, the JCT staff recognizes that this situation would
arise in relatively few cases (as opposed to the more common situation
in which a Lithuanian resident using property in the United States
would also have a permanent establishment or fixed base in the United
States to which the royalty would be attributed, in which case it would
be U.S. source). As a consequence of a similar recognition by the
Treasury staff, we believe that this provision was an acceptable
concession in the context of the overall U.S.-Lithuanian tax treaty
negotiation. A further exception to the general source rule was
included, at the insistence of the United States, that sources
royalties that are payments for the use of containers as arising in
neither Contracting State, and thus taxable, as ``Other Income,'' only
in the State of residence of the income recipient. The result of this
rule is consistent with the rule in the U.S. Model, which, under
Article 8, gives exclusive taxation rights for such income to the State
of residence of the beneficial owner of the income.
Income from the Rental of Ships and Aircraft
Issue: The issue presented in the JCT pamphlet is whether the
proposed treaty's rules treating profits from certain rental of ships
and aircraft less favorably than profits from the operation of ships
and aircraft and the rental of containers are appropriate.
Response: The treatment of income from the bareboat rental of ships
and aircraft, where the rental is not incidental to the operation of
ships and aircraft in international traffic, was a difficult issue in
the negotiations. Although it is U.S. policy to include such income
within the scope of the source exemption in Article 8, Latvia was
unwilling to do so, although they were willing to exempt incidental
rentals from source country tax. The treaty permits Latvia to impose
tax af source on non-incidental bareboat ship and aircraft rentals, but
at a rate limited to 5 percent of the gross rental. This is a common
result in Latvian treaties, and is also found in several other U.S.
treaties.
Treaty Shopping
Issue: The issue raised by the JCT pamphlet is whether the
limitation on benefits provision of the proposed treaty is an adequate
tool for preventing possible treaty-shopping abuses in the future.
Response: The limitation on benefits provisions of the proposed
treaty adhere closely to those of the U.S. Model. We therefore believe
that they are adequate.
proposed convention with slovenia
``Main Purpose'' Anti-Abuse Test
As noted above, this issue will be addressed in a separate
memorandum.
Exchange of Information
Issue: The issues raised by the JCT pamphlet are (1) whether the
information exchange provision, which does not include a sentence
regarding the ability to obtain information from financial
institutions, is sufficient and (2) whether a statement that the
omission of the provision regarding financial institutions does not
lessen the commitment of the United States to pursue broader exchanges
of information in future treaty negotiations would be beneficial.
Response: Adequate exchange of information with our treaty partners
is one of the key objectives of our tax treaty policy. The Treasury
Department remains strongly committed to this objective, including the
ability to exchange third-party information obtained from banks and
other financial institutions.
The Treasury Department believes that the exchange of information
provisions in the proposed treaty will enable the United States to
obtain this third-party information, and that the omission of the first
sentence of paragraph 3 of Article 26 of the U.S. Model will have no
adverse effect on this ability. Treasury has received written
assurances from the Slovenian Ministry of Finance regarding Slovenia's
ability to obtain bank information under its internal laws in order to
comply with the information exchange provisions contained in the
proposed treaty. Moreover, the Slovenian Ministry of Finance has
confirmed that penalties exist under its internal law in order to
ensure that banks and other financial institutions comply with requests
for information.
It is important to note that the inclusion in a treaty of the first
sentence of paragraph 3 of Article 26 of the U.S. Model, which purports
to override a country s internal laws regarding bank secrecy, does not
guarantee that the United States will, in practice, actually receive
third-party bank information. For example, a country's internal laws
might not allow the exchange of such information notwithstanding the
purported override in the treaty. Accordingly, the most effective way
of protecting the United States' interest in this area is through due
diligence during negotiations to ensure that internal laws will, in
fact, enable the exchange.
In addition, some countries have viewed the request for this
provision as a diplomatic slight. This is particularly of concern to
those countries that have been affected by the United States' ``later-
in-time'' principle, which permits a subsequently enacted U.S. domestic
law to take precedence over the provisions of a previously ratified
treaty.
For these reasons, the Treasury Department plans to substantially
revise or eliminate this sentence in the U.S. Model. Of course, any
change in the sentence would not lessen the Treasury Department's
commitment to adequate information exchange, including third-party bank
information.
As to the second issue, as noted above, we believe that the effect
of the information exchange provision of this treaty is as broad as in
any of our tax treaties, and we do not believe that it would be
beneficial to suggest otherwise. However, we always welcome strong
statements from the Committee regarding the importance of information
exchange. Therefore, we believe that a statement from the Committee
that the omission of this statement in this treaty does not reflect any
lessening of our commitment to receiving information from banks and
other financial institutions would be beneficial.
Treaty Shopping
Issue: The issue raised by the JCT pamphlet is whether the
limitation on benefits provision of the proposed treaty is an adequate
tool for preventing possible treaty-shopping abuses in the future.
Response: The limitation on benefits provisions of the proposed
treaty adhere closely to those of the U.S. Model. We therefore believe
that they are adequate.
proposed convention with venezuela
Developing Country Concessions
Issue: The issue raised in the JCT pamphlet is whether the
developing country concessions represent appropriate U.S. treaty policy
and, if they do, whether Venezuela is an appropriate recipient of these
concessions.
Response: Regarding whether Venezuela is an appropriate recipient
of developing country concessions, it should be noted that for 1997,
Venezuela's gross domestic product (GDP) was $185 billion and its per
capita GDP was $8,300. By contrast, the United States' 1997 GDP was
$8.1 trillion and its per capita GDP $30,200.
With respect to particular developing country concessions in the
proposed Venezuela treaty, the JCT pamphlet identified the following:

the definition of ``permanent establishment'';
the taxation of certain equipment leasing;
other taxation by source country.

These are discussed below seriatim.
The Definition of Permanent Establishment
The Venezuela treaty provides that the term ``permanent
establishment'' encompasses building sites and drilling rigs and ships
used for the exploration for natural resources when the site or
activity continues for periods aggregating more than 183 days within
any 12-month period. Under the U.S. Model, the site or activity would
have to last for more than 12 months. The Venezuela treaty also
includes a rule under which an enterprise that provides services in the
other country would be treated as having a permanent establishment if
its employees are in the other country and the activities continue for
a period or periods aggregating more than 183 days within a 12-month
period. The U.S. Model contains no provision treating the furnishing of
services as a permanent establishment.
The building-site rule reflects the recognition that Venezuela is a
developing nation and more dependent upon tax revenue from construction
projects than developed nations whose physical and business
infrastructure are more established. The building-site provision is
consistent with other income tax treaties of Venezuela. The rules
regarding the threshold for oil exploration were quite important to
Venezuela because of the importance of the oil sector to Venezuela's
economy. We also took into account the fact that the proximity of
Venezuela to the United States would make it easier for owners of
drilling rigs to move the rigs back and forth between the two countries
than would be the case with respect to other areas in which oil
exploration takes place. The rule in the treaty is the same as in our
treaty with Mexico and significantly longer than in our treaty with
Canada, which has a 3-month threshold.
Venezuela also requested the 183-day/12-month-period permanent
establishment rule with respect to the furnishing of services. As a
developing nation, Venezuela must import consultancy and other services
to a greater degree than developed nations and did not want to
surrender its right to tax such services. A similar rule is found in a
number of other U.S. treaties with developing countries, some (e.g.,
Thailand) with lower time thresholds.
Taxation of Certain Equipment Leasing
Under the U.S. Model Treaty, income from the rental of tangible
personal is treated as business profits. Under the proposed Venezuela
treaty, payments for the use of, or the right to use, industrial,
commercial, or scientific equipment will be treated as royalties.
Treatment of such income as royalties is consistent with the position
taken by many developing countries and with the former OECD Model
Treaty. It also represents the treaty policy of Venezuela. Through
negotiation, we were able to reduce the withholding rate on this class
of royalties to 5 percent (from the general rate of 10 percent), and to
carve out of the definition of ``royalties'' ship, aircraft and
container leasing income, whether or not such income is incidental to
the operation of such ships, aircraft or containers in international
traffic by the recipient of the income. Of course, payments for the use
of, or the right to use, industrial, commercial, or scientific
equipment that are attributable to a permanent establishment will be
taxed as business profits on a net, as opposed to a gross, basis.
Other Taxation by Source Country
The U.S. Model provides for an exemption from source-country
taxation for royalty payments. The Venezuela treaty provides that
royalties will be subject to withholding tax of 5 percent (in the case
of equipment leasing, as described above) or 10 percent with respect to
all other payments covered by the article. The Venezuela treaty also
provides that the source country may impose tax on ``other income'',
under the U.S. Model, income falling under the ``other income'' article
is taxable only by the country of residence of the beneficial owner. As
with interest, source country taxation was preserved in the treaty for
both royalties and other income to help ensure that under Venezuela's
territorial system, U.S.-source income paid to Venezuela would be
subject to a gross withholding tax that would approximate the results
if the income were actually subject to a net income tax in Venezuela.
We did not press for lower rates for these types of payments and do not
view the rates in this treaty as developing country concessions. Of
course, they are also in line with what Venezuela viewed as appropriate
withholding rates under this treaty.
The proposed treaty generally permits source country taxation of
artistes and sportsmen if the gross receipts derived by the individual
in the source country exceed $6,000 for the taxable year concerned. The
OECD and U.N. Models provide for taxation by the country of performance
of the remuneration of entertainers or sportsmen with no dollar or time
threshold. The United States introduces the dollar threshold test in
its treaties to distinguish between two groups of entertainers and
athletes--those who are paid very large sums of money for very short
periods of service, and who would, therefore, normally be exempt from
host country tax under the standard personal services income rules, and
those who earn relatively modest amounts and are, therefore, not easily
distinguishable from those who earn other types of personal service
income. The United States has entered a reservation to the OECD Model
on this point. Although the U.S. Model threshold is $20,000, we
frequently adopt a lower limit to reflect economic conditions in the
other country.
Treaty Shopping
Issue: The issue raised by the JCT pamphlet is whether the
limitation on benefits provision of the proposed treaty is an adequate
tool for preventing possible treaty-shopping abuses in the future.
Response: The limitation on benefits provisions of the proposed
treaty adhere closely to those of the U.S. Model. We therefore believe
that they are adequate.
Venezuelan Territorial Tax System
Issue: The issue raised by the JCT pamphlet is whether entering
into a treaty with a country that has a territorial system like that of
Venezuela is appropriate as a matter of U.S. treaty policy.
Response: As discussed extensively at the hearing, Venezuela is in
the process of changing its income tax law. Under the new system,
Venezuela will begin taxing all of the income received by its
residents, rather than only that income that was determined, under
broad ``sourcing'' rules, to be connected to Venezuela. The possibility
that Venezuela would adopt this ``worldwide'' system was present
throughout our treaty negotiations, and we planned for it in drafting
the treaty. After reading, analyzing and discussing drafts of the new
law, we have determined that the treaty will be at least as appropriate
under the new law as the old law. The increased possibilities for
double taxation that are the natural result of this change in law will
make the treaty even more important than under Venezuela's territorial
system. We believe that the treaty works appropriately, in large part
because this change from ``territorial'' to ``worldwide'' taxation
brings Venezuela's domestic laws into closer conformity with
international norms. Moreover, there are vestiges of Venezuela's
territorial system that are also addressed by special provisions in the
treaty included to deal with that system.
Although the pending change in Venezuela's law makes this issue
largely moot, we note that, in evaluating any tax treaty, it is
important to consider the benefits of the treaty to taxpayers and the
governments and weigh those benefits against any potential abuse that
might arise. Other countries with which we already have treaties have
certain aspects of territoriality in their tax codes, but we have
entered into treaties with them because the treaty was in our overall
interest. As with any prospective treaty partner, we analyzed
Venezuela's system to determine where double taxation could arise and
whether there were opportunities for double non-taxation and addressed
both problems. In most cases, the solutions arrived at in the Venezuela
treaty were based on principles established in other treaty contexts.
We believe that the treaty with Venezuela would have been appropriate
even without the change in law.
Stability of Venezuelan Law
Issue: The issues raised in the JCT pamphlet are whether the
constitutional and institutional changes in Venezuela will create
difficulties in administering the treaty, and whether the
confidentiality of taxpayer information exchanged under the treaty will
continue to be respected by any possible changes in local law.
Response: Potential constitutional and institutional changes in
Venezuela make the certainty and stability that the treaty would
provide especially important. The pamphlet suggests that there may be
uncertainty regarding the substantive law of Venezuela. The major
potential change in substantive tax law is the likely change in
Venezuela's system from territorial to worldwide taxation. Although
this issue is framed by a discussion of recent political developments,
the possibility that the law would change in this way existed during
the course of the negotiations and affected the negotiation of many of
the provisions of the treaty. The goal was to draft a treaty that would
protect taxpayers and the government whether Venezuela had a
territorial or a worldwide system. The treaty would benefit taxpayers
by providing general principles regarding the threshold for taxation,
the right to deductions for business expenses and non-discrimination.
With respect to tax administration, the provisions of the treaty
would eliminate ambiguity with respect to the identity of the competent
authority. The treaty clearly states that the Integrated National
Service of Tax Administration (SENIAT) is the competent authority at
this time, but Venezuela's Ministry of Finance also retains the
discretion to re-designate the competent authority, just as, in the
case of the United States, the Secretary of the Treasury retains the
discretion to name the competent authority for purposes of the treaty.
Maintaining the flexibility to change the designation of this authority
is a standard practice of tax treaties.
The Internal Revenue Service and the Treasury Department are
committed to ensuring that information exchanged under tax treaties is
used only for permitted purposes. The treaty provides that any
information exchanged in accordance with its provisions shall be used
exclusively for tax purposes. In the context of our review of
Venezuela, we consulted other government agencies, including agencies
experienced in exchanging information with many Latin American
countries. In this consultation we were not advised to anticipate
abuses of exchanged information on the part of Venezuela. It should
also be noted that moreover, we also understand that the new draft
constitution being written by the National Constituent Assembly
contains strong protections for civil and individual rights.

______

Response to Senator Dorgan's Testimony

The written questions from Senator Hagel request a response to
Senator Dorgan's testimony regarding the use of formulary apportionment
to allocate and apportion income between related business entities. In
particular, Senator Dorgan is concerned that certain provisions
contained in all seven of the double taxation treaties (but not the
German Estate Tax Protocol) pending before the Senate Foreign Relations
Committee would restrict the use of formulary apportionment based on
the interpretation of other U.S. treaties in two recent court cases.
Senator Dorgan's testimony raised concerns about the current
approach by the United States to allocating income between related
parties when those entities conduct business with one another. The
problem arises because related entities can adjust the prices at which
goods and services are purchased between each other without any non-tax
economic consequences to the group, as both entities involved are owned
or controlled by the same interests. Accordingly, other concerns such
as taxation may effectively control how prices are determined for these
related party transactions. For example, a multinational business can
manipulate the prices charged in transactions between its affiliates in
different countries, with the result that the income reported for tax
purposes in one country may be artificially depressed, and the tax
administration of that country collecting less tax from the enterprise
than it should. In theory, the multinational would plan its
transactions to ensure that its income is reported in the jurisdiction
with the lowest effective tax rate. It is this possibility that makes
transfer pricing one of the most important international tax issues.
If this potential tax avoidance (and the potential for double
taxation) is to be ameliorated, it is necessary to have a benchmark by
which to evaluate the prices charged. The benchmark adopted by the
United States and all our major trading partners is the arm's-length
standard. Under the arm's-length standard, the price charged should be
the same as it would have been had the parties to the transaction been
unrelated to one another--in other words, the same as if they had
bargained at ``arm's-length.'' This requires an analysis of the
functions performed and risks assumed by each party to the transaction,
to make sure each party is adequately compensated for those functions
and risks. If taxpayers and tax administrators can find similar
transactions that took place between unrelated parties, they begin the
inquiry by analyzing those transactions to see whether the functions
and risks performed by each party are comparable to those in the
related party transaction.
This approach has been reflected in all of our treaties to date,
including all seven treaties pending before the Committee. These
treaties also apply an analogous approach for allocating income to a
business conducted by a foreign corporation in the United States
through a branch. Two recent court decisions have addressed the
taxation of branch operations under a tax treaty and are the source of
Senator Dorgan's concern. The first case suggests that it is not
possible to use profits-based methods in determining the business
profits attributable to a permanent establishment, and that the tax
administrator is required to respect the income shown on the books of
the branch, except in ``exceptional circumstances,'' a much higher
standard than applies when adjusting the income of separate legal
entities. A more recent case provides that the tax administrators may
adjust the branch's books to reflect an arm's length. Thus, the trend
of the cases is in the right direction.
Moreover, the courts that decided these cases relied heavily on the
existing Commentary to Article 7 (Business Profits) of the OECD Model
Tax Convention. Without addressing the issue of whether the courts used
that Commentary in an appropriate manner, we can say that we believe
the Commentary itself needs to be changed in order to reflect recent
changes that have occurred with respect to transfer pricing between
related parties. These changes include the acceptance of transactional
profits methods, at least as a method of last resort, in the Transfer
Pricing Guidelines issued in 1995. In the OECD's report on Global
Trading of Financial Instruments in 1998, there is extensive discussion
of profit split methods, including the use of multi-factor formulas in
appropriate cases. We have seen, and expect to continue to see,
increasing acceptance of these profits-based approaches in the coming
years, speeded by the increase in globally-integrated businesses that
will become possible as a result of improvements in telecommunications
technology. If the Commentary to Article 7 had reflected these changes,
which have already taken place in the context of the treaty provision
dealing with related separate entities (as opposed to branches and
their home offices), the results in these cases might well have been
different.
Accordingly, in response to Senator Dorgan's specific concerns
regarding these cases, we do not believe that these recent cases limit
the United States ability to apply formulary apportionment under the
seven treaties before the Committee, or treaties currently in force.
There is an international consensus that the provisions of Article 9
require the application of the arm's length standard. For that reason,
the Treasury Department has testified in the past that ``unilateral''
adoption of a formulary apportionment system by the United States would
constitute an override of such provisions, and we have not advocated,
and do not advocate, that approach. However, if the major participants
in international trade were to reach a new consensus that formulaiy
methods are consistent with Article 9, adoption of such methods would
be acceptable within the scope of the current treaty provisions.
In the case of allocating income to the operations of a foreign
corporation's U.S. branch, we believe that an international consensus
eventually will develop around the proposition that any of the methods
that are acceptable for transfer pricing between related entities will
also be acceptable in the context of allocating income between branches
of a single entity. The United States has already adopted this approach
in the context of global dealing of financial instruments, both in
advance pricing agreements and by regulation, as has the OECD in its
report on Global Trading in Financial Instruments. It has done so by
sanctioning the use of multi-factor formulas to allocate income from
global trading activity under one common trading model--the
``functionally fully-integrated'' model.

______

Responses to Congressman Underwood's Testimony

The question Senator Hagel raised, in connection with Congressman
Underwood's testimony, is whether it is Treasury's policy to exclude
Guam and other U.S. territories from treaty coverage. Although the
State Department has concluded that the territories do not have the
constitutional authority to negotiate treaties with foreign
governments, the allocation of powers under the constitution is not
violated by the United States' signing a tax treaty that covers the
possessions of the United States. Thus, there is no legal bar to
extending treaty coverage to U.S. territories. Regarding the Treasury
Department's tax treaty policy with respect to the coverage of Guam and
other U.S. territories, the Treasury Department is willing to discuss
with Guamanian officials, or the officials of any other U.S.
possession, the implications of such coverage and the mechanisms
available to achieve appropriate tax results. We note that one
implication of treaty coverage may be a reduction in the possessions
tax collections. This and other implications must be carefully
considered by the appropriate parties before such coverage is extended.

______

D'Empaire Reyna Bermudez & Asociados
Caracas, Venezuela, October 11, 1999.

The Honorable Jesse Helms
Chairman, Senate Committee on Foreign Relations,
U.S. Senate,
Washington, DC.

Dear Mr. Chairman: On behalf of d'Empaire Reyna Bermudez &
Asociados, a law firm in Caracas, Venezuela which renders services to a
number of multinational corporations of the United States of America,
we submit the following statement, for its inclusion in the record of
your committee hearings on the proposed Treaty for the Avoidance of
Double Taxation Between Venezuela and The United States.
We thank you for this opportunity to express our views to you and
to your Committee.
Very truly yours,
Jose Rafael Bermudez,
Alberto I. Benshimol,
d'Empaire Reyna Bermudez & Asociados.

Statement to the Senate Committee on Foreign Relations--October 13,
1999

On behalf of the Law Office of d'Empaire Reyna Bermudez & Asociados
we wish to express our support to the ratification of the Treaty for
the Avoidance of Double Taxation Between Venezuela and The United
States (the ``Treaty'').
If the Treaty comes into effect next year,\1\ business with United
States, Venezuela's most important trading partner, will be put onto
the same competitive footing that Venezuela already has with the other
countries with whom it has bilateral comprehensive tax treaties based
on the OECD Model Tax Convention on Income and on Capital.\2\
---------------------------------------------------------------------------
\1\ Venezuela's Congress approved the Treaty last July 15.
\2\ Belgium, Czech Republic, France, Germany, Italy, Norway,
Portugal, Switzerland, The Netherlands, Trinidad & Tobago and the
United Kingdom. The Venezuelan Congress has also approved tax treaties
with Barbados, Denmark, Indonesia, Mexico and Sweden, which are not yet
in effect.
---------------------------------------------------------------------------
In line with the United States Model Income Tax Convention of
September 20, 1996 and the OECD Model Tax Convention, the Treaty
determines how each country will limit its taxing powers and
jurisdictions, so that double taxation is eliminated or mitigated.
The Treaty also has provisions aimed at preventing discriminatory
taxation (so that nationals of one state are not subject to a heavier
tax burden in the source state than that applicable to nationals of the
source state). Also, of particular importance to both the Internal
Revenue Service and the Venezuelan Tax Administration are standard
provisions aimed at providing cooperation between both contracting
States to combat tax evasion. These include the exchange of information
relevant to the collection of domestic taxes in each country, which may
come from sources other than the taxpayer (e.g. financial institutions,
agents and trustees).
Domestic tax laws change frequently, but tax treaties tend to have
a permanence which affords a higher level of security to taxpayers. The
Treaty will provide potential investors in each country with a level of
certainty about the maximum levels of taxation of their activities,
which is not currently available to them. It is this certainty that
makes investment, financing, trade and technology transfers between
both countries more attractive.
Some examples of how businesses operating in Venezuela can benefit
from the Treaty are:
Gains from the sale of shares. Currently, U.S. residents must pay
up to 34 percent income tax on the gains from the sale of their shares
in Venezuelan companies. But when shares of listed companies are sold
through a Venezuelan stock exchange, a flat income tax of one percent
of the total price is withheld. Once the Treaty comes into effect, U.S.
resident shareholders will not be subject to any income tax on the sale
of shares of Venezuelan companies.
Dividends. Because dividends are not taxed under Venezuela's
existing tax law, the IRS presently gets the full benefit of taxing all
dividends distributed by companies in Venezuela to U.S. residents.
However, since Venezuela's new income tax law would probably begin to
tax dividends at a flat tax of 34 percent, the Treaty will protect U.S.
investors from double taxation by limiting Venezuela's taxation of
dividends to a maximum of 15 percent. Furthermore, if the beneficial
owner of the dividend owns at least 10 percent of the company's voting
stock, the limit falls to 5 percent.
Interest. Interest payments currently made by Venezuelan entities
to U.S. creditors which are not financial institutions are subject up
to a 34 percent income tax withholding in Venezuela. Under the Treaty
this withholding will fall to 10 percent. Additionally, the 4.95
percent withholding applicable to payments to financial institutions is
guaranteed not to increase.
Capital goods and technology. Income earned by U.S. residents on
the leasing of equipment is currently subject to regular income tax in
Venezuela and the U.S. Under the Treaty, taxation of this income by
Venezuelan tax Administration is limited to five percent of the gross
amount of the lease payments. In addition, the current income tax law
levies a 10.2 percent withholding on technical assistance provided for
use in Venezuela by U.S companies without a permanent establishment in
Venezuela. Technical assistance provided on such a basis from the U.S.
will not be subject to income taxation in Venezuela once the Treaty
comes into effect. As a result, capital goods and technology sourced
out of the U.S. will be more attractive to Venezuelan businesses, as
the current general practice is to gross-up payments made to the
foreign supplier to take account of taxation.
There are many more areas covered by the Treaty than those
mentioned above. The Treaty will work to protect not only businesses
from double taxation, allowing corporations and individuals to plan
their taxes and the financial aspects of their projects with greater
certainty, but it will also benefit other cross border activities that
take place between the U.S. and Venezuela. For example, sportsmen and
women, government, diplomatic and consular officers, entertainers, as
well of overseas recipients of payments such as students, or recipients
of pensions and social security payments, will all benefit from the
Treaty.
The Treaty will facilitate access to the U.S. financial markets for
Venezuelan companies, aid the use of leased capital goods and the
contracting of U.S. technology and services. Moreover, the Treaty goes
much further than simply protecting taxpayers from overlapping taxation
by the two contracting States. The treaty can be seen as a guaranty of
certainty to U.S. investors relating to the impact of the Venezuelan
income tax on their investment in Venezuela.
For the aforementioned reasons we express our support to the
ratification of the Treaty for the Avoidance of Double Taxation Between
Venezuela and The United States.
We thank you again for this opportunity to express our views to you
on this matter.
Very truly yours,
Jose Rafael Bermudez,
Alberto I. Benshimol,
d'Empaire Reyna Bermudez & Asociados.

Additional Statement to the Senate Committee on Foreign Relations

On behalf of the Law Office of d'Empaire Reyna Bermudez & Asociados
and further to our statement dated October 13, 1999, in which expressed
our support to the ratification of the Treaty for the Avoidance of
Double Taxation Between Venezuela and The United State (the
``Treaty''), we wish to highlight the following issues:
At the request of the Venezuelan Executive Branch of Government,
the Venezuelan Congress issued on April 26, 1999 a special law
authorizing the President to pass and amend economic and financial
legislation (the ``Enabling Law'').\1\ Among other reforms, the
Enabling Law expressly authorized the President to amend the Venezuelan
income tax law (``ITL'') to introduce (i) a worldwide system of
taxation with a credit system to relieve international double taxation;
(ii) legal provisions authorizing the Tax Administration to disregard
the abuse of corporate forms in tax-oriented transactions; and (iii)
the taxation of dividends.
---------------------------------------------------------------------------
\1\ Ley Organica que Autoriza al Presidente de la Republica para,
Dictar Medidas Extraordinarias en Materia Economica y Financiera
Requeridas por el Inetres Publico, published in the Official Gazette
number 36.687, dated April 26, 1999.
---------------------------------------------------------------------------
Pursuant to the Enabling Law, a proposed draft of amendments to the
ITL (the ``Amended ITL'') was discussed by the President and his
Council of Ministers. The Amended ITL adapts the worldwide income
system of taxation applicable to Venezuelan resident individuals and
legal entities and permanent establishments of foreign entities. Note
that taxpayers would be generally allowed to credit against their
Venezuelan income tax liability income tax paid in other jurisdictions,
up to the amount resulting from applying the Amended ITL's rate to
foreign source income.
Pursuant to the Enabling Law, the Amended ITL, and all other
economic and financial legislation passed thereunder, must be enacted
no later than October 26, 1999.
Generally, laws are enacted in Venezuela by publication in
Venezuela's Official Gazette. We were informed, that the Amended ITL
will be enacted shortly by the President or the Ministry of the
Interior, who is currently acting as President of the Republic, while
the President is on an official trip to Asia. The Amended ITL will be
enforceable immediately after its enactment.
Under the Constitution of the Republic of Venezuela any amendment
to the current tax legislation may not be effective retroactively
(article 226). Therefore, the provisions of the Amended ITL would
generally be applicable to fiscal years beginning after their
enactment. Because the Tax Administration needs to prepare to
administer the Venezuela's new worldwide income system, the specific
provisions governing the system will be effective for tax years
beginning after December 31st, 2000.
We express our support to the ratification of the Treaty for the
Avoidance of Double Taxation Between Venezuela and the United States
and we thank you again for this opportunity to express our views on
this matter.
Very truly yours,
Jose Rafael Bermudez,
Alberto I. Benshimol,
d'Empaire Reyna Bermudez & Asociados.

______

Hoet, Pelaez, Castillo & Duque,
Caracas, Venezuela, October 11, 1999.

The Honorable Jesse Helms
Chairman, Senate Committee on Foreign Relations,
U.S. Senate,
Washington DC.

Dear Mr. Chairman: On behalf of Hoet Pelaez Castillo & Duque, an
international law firm located in Caracas, Venezuela, we submit the
following statement for inclusion in the record of your committee
hearings on the proposed Treaty For The Avoidance Of Double Taxation
Between Venezuela and The United States.
We thank you for this opportunity to express our views to you and
to your Committee.

Very truly yours,
Francisco M. Castillo, Senior Partner.

Statement to the Senate Committee on Foreign Relations--October 13,
1999

The law offices of Hoet, Pelaez, Castillo & Duque wishes to express
our support for the ratification of the Treaty for the Avoidance of
Double Taxation between Venezuela and the United States.
Hoet, Pelaez, Castillo & Duque has an extensive reputation and
experience in joint-venture negotiations, international financing,
including project financing of major projects, acting as Venezuelan
Counsel for major U.S. Corporations doing business in Venezuela. We
believe that a treaty to avoid double taxation between Venezuela and
the United States is of extreme necessity, in order to create a crucial
link between the tax systems of both nations. The treaty will allocate
the taxing authority between the U.S. and Venezuela and bring certainty
to the taxation of cross border transactions.
The absence of a tax treaty between the U.S. and Venezuela will
represent a disadvantage for U.S. investors, as Venezuela has already
entered into double taxation treaties with most European developed
nations, such as France, United Kingdom, Italy, Germany, Portugal, The
Netherlands and Switzerland, among others.
A double taxation treaty will never create or impose any tax, but
it will allocate taxing authority on an exclusive basis to one
contracting State or limit the taxing authority of one of the two
contracting States, in order to avoid double taxation with its negative
effects.
The need for such a treaty is nowadays even more urgent due to the
recent reform of the Venezuelan Income Tax.
The Venezuelan Congress enabled President Hugo Chavez to take
extraordinary economic and financial measures, including a reform of
the Income Tax Law. The President and the Cabinet have approved this
reform in the month of September, although the final text has not yet
been available to the general public, the main aspects of this reform
have been widely disclosed.
Following the world trend, Venezuela has shifted from a territorial
income tax to taxing global income.
According to the draft law which we have reviewed, all income
earned by natural persons or legal entities, who are residents or
domiciled in Venezuela, shall be subject to income tax, whether or not
said income is earned within Venezuela or abroad. In addition, as in
the present law, the income of natural persons or legal entities, who
are non-residents and not domiciled in Venezuela, shall be subject to
income tax, even though they do not have a permanent establishment or
fixed base within the country, when the source of said income is in or
occurs within the country.
Natural persons or legal entities domiciled or resident abroad and
who have a permanent establishment or fixed base in the country, shall
be subject to income tax exclusively on the income earned within
Venezuela or abroad which is attributable to their permanent
establishment or fixed base.
The law provides for a ``tax credit'' allowing deductions to be
made against the Venezuelan Income Tax, for income tax paid abroad for
income earned from extraterritorial sources. The draft law includes
definitions with respect to what is considered ``income tax'' and, in
case of any doubts, the Venezuelan Tax Administration should determine
the nature of the tax credit. In addition, the tax credit may not
exceed the income tax resulting from application of the provisions of
the Venezuelan Income Tax Law which would have been required to be paid
for said income.
On the other hand, to determine the income earned from a foreign
source, the norms of the Venezuelan law will be applicable as far as
income, costs and deductions of the income earned from an
extraterritorial source. That is, in order to establish the net income
the Venezuelan norms will be applied and not that of the country of
origin, so that theoretically, at least, some deductions could be
objected which in accordance to the Venezuelan law are not admissible,
although in the country of origin of the income they are admissible.
The new law includes an international tax transparency regime
applicable to all investment in low taxation jurisdiction.
Of particular importance are the rules on transfer pricing which
may be applicable to transactions bctween related parties and which are
included for the first time in Venezuelan tax legislation. These rules
may allow the Tax Authorities to disregard for tax purposes the prices
contained in import or export agreements if found different from those
they determine by one of the methods included in the law.
When the treaty was negotiated, Venezuela imposed no tax on
dividends under its internal laws. The new law will impose a
withholding tax on dividends, for the net income which exceeds the
taxable income, that is, those dividends which correspond to profits
that were not subject to income tax in Venezuela shall be subject to
the Dividend Tax.
The dividends will be subject to a proportional 34% tax, with the
exception of those dividends arising from companies dedicated to mining
activities, in which case the proportional dividend tax will be 60% or
for those dividends coming from companies dedicated to the exploitation
of hydrocarbons, the proportional dividend tax will be 67.7%.
Article 10 of the Treaty which limits tax on dividends will be a
clear advantage to U.S. business particularly in the field of
hydrocarbons.
Licensing of intellectual property is one of the most important
business relationship between U.S. and Venezuela. In the absence of the
Treaty, royalties would be subject to important withholding tax in both
countries. The concept of royalties in the Treaty is important to limit
the scope of the internal Venezuelan Income Tax Law that otherwise
would impose a higher tax than that provided in the Treaty.
As in the case of royalties, in the absence of the Treaty,
Venezuela would impose a higher withholding tax on interests paid to
lenders that are not financial institutions. The treatment in the
Treaty would assist such lenders taxing interests paid at a reviewed
rate of 10%, whereas financial institutions would be taxed under the
Venezuela internal laws at a 4.95% rate.
The Treaty would harmonize the taxation rules of both countries,
avoiding that the new rules may result in an adverse effect to U.S.
businesses investing in Venezuela.
The treaty closely follows recent U.S. income tax treaties and the
Model income tax treaty of the Organization for the Economic
Cooperation and Development.
Article 24 provides the rules for relief from double taxation. In
the case of Venezuela, it will be either an exemption or a tax credit.
As mentioned above, the new Venezuelan income tax law provides for a
tax credit. The U.S. will provide a direct or indirect credit for
Venezuelan taxes effectively paid.
The Government of President Hugo Chavez initiated the most
comprehensive legal reform of the Venezuelan democratic era, including
a new Constitution that should be approved this year.
The Venezuelan Congress has already ratified the Treaty in an
unprecedented decision confirming the Government's commitment to make
Venezuela more competitive and compatible with the global economy.
Ratification of the treaty with the U.S. is a key tool in giving U.S.
investors confidence in the stability of the Tax Regime in Venezuela.

______

VenAmCham,
Venezuelan American Chamber of Commerce and Industry,
Caracas, Venezuela, October 26, 1999.

The Honorable Jesse Helms
Chairman, Senate Committee on Foreign Relations,
United States Senate,
Washington DC.

Dear Mr. Chairman: On behalf of the Venezuelan American Chamber of
Commerce and industry (VenAmCham), we submit the following written
statement for inclusion in the record of your Committee Hearings on the
proposed Treaty for the Avoidance of Double Taxation Between Venezuela
and The United States of America.
We thank you for this opportunity to express our views to you and
to your Committee.
Yours very truly,
Jorge Redmond, President.
Antonio A. Herrera-Vaillant,
Vice President and General Manager.

Written Statement of the Venezuelan American Chamber of Commerce and
Industry--October 27, 1999

The following is submitted as a written statement of the views of
the Venezuelan American Chamber of Commerce and Industry (VenAmCham) in
reference to the proposed Treaty For The Avoidance of Double Taxation
Between Venezuela and The United States of America.
i. reasons for the need of a prompt ratification of the tax treaty
VenAmCham submits that the ratification of this treaty will be most
beneficial to both countries for the following three main reasons
which, not at the exclusion of others are:
First: The proposed treaty reduces or eliminates double taxation of
income earned by residents of either country from sources from the
other country in addition to preventing avoidance or evasion of the
taxes of the two countries and increasing transparency.
Second: The proposed treaty is also intended to promote close
economic cooperation between the two countries and to eliminate
possible barriers to trade and investment caused by overlapping taxing
jurisdictions of the two countries.
Third: The absence of a treaty between Venezuela and the U.S. is a
disadvantage for both Venezuelan and U.S. investors in either country,
because Venezuela has already in effect double taxation treaties with
most developed nations such as France, the United Kingdom, The
Netherlands, Germany, Italy, Portugal and Switzerland. The new treaty
will place on an equal competitive footing U.S. investments in
Venezuela ``vis-a-vis'' those of the above mentioned countries.
ii. who we are and what we do
VenAmCham, founded in 1950, is one of the largest overseas U.S.
Chambers of Commerce in the world with over 1,040 corporate and 6,000
individual members. Our membership includes all major U.S. corporations
and all U.S. oil companies doing business in Venezuela. We are a
private, non-government, non-profit institution. Our mission is to
foster, and improve business between the United States and Venezuela,
to promote and defend private enterprise, free trade and free markets
where member companies operating in Venezuela can prosper, support and
protect the general legitimate interests of our members.
VenAmCham has an active presence throughout Venezuela, as well as
in the capital city of Caracas. Accordingly, we have offices in the
cities of Maracaibo, Maturin, Barquisimeto and Valencia where we
conduct similar activities as in Caracas.
VenAmCham is represented in Washington DC by Ulrico A. Reale, in
order to maintain close contacts with the United States Congress, with
all departments of the U.S. Federal Government and its agencies in
addition with international lending institutions such as the IMF, the
World Bank and the IDB.
VenAmCham is associated with the U.S. Chamber of Commerce and with
the Association of the American Chambers of Commerce of which we are a
founding member. In 1998 VenAmCham became the contractual
representative in Venezuela of ``Enterprise Florida,'' an organization
jointly operated by business and the State of Florida, a state which is
Venezuela's top trading partner with the United States.
Among our U.S. related activities, VenAmCham hosted during the last
two years the chairmen of the Senate Energy Committee and of the House
Ways and Means Committee, who made working visits to Venezuela with
several members of their committees. On the U.S. Administration side,
VenAmCham has also recently hosted the President of the United States
of America, as well as the Secretaries of State, Commerce and Energy,
in addition to the Special Presidential Envoy to Latin America.
iii. facts about venezuela
Venezuela has had a new government since February of 1999. As a
presidential candidate, President Chavez chose to enter the Venezuelan
established process by running for president according to the standing
rules of 1998. He was freely elected by a decisive majority of the
Venezuelan people in an election process monitored by international
observers, such as the OAS and by U.S. Government representatives.
There has been no disruption of the Constitutional order in the
process leading to the establishment of the Constituent Assembly, this
opinion is shared by the majority of the standing Supreme Court and
most international observers. The Government has an overwhelming
majority in the Assembly. Dissent and minority opinions have been
expressed at all times and there has been no curtailment whatsoever of
personal freedoms.
The Assembly is completing its process of drafting a new
Constitution and the recent proposed drafts of the Constitution respect
and encourage private property and enterprise, granting, as a general
rule, equal treatment to national and foreign investments.
President Chavez has offered public and private assurances in
Venezuela and to foreign governments--including the United States and
international organizations such as the United Nations and the OAS--
that Venezuela will remain a democracy, intends to pursue a democratic
course of action, and a market oriented economy.
iv. conclusion
For the above reasons, although not to the exclusion of others,
VenAmCham strongly supports and endorses without reservations the
prompt ratification of the proposed Treaty for the Avoidance of Double
Taxation between Venezuela and The United States of America.
VenAmCham thanks the members of the Senate Foreign Relations
Committee for this opportunity to present its views and to be heard.

______

Torres, Plaz & Araujo,
Caracas, Venezuela, October 11, 1999.

The Honorable Jesse Helms
Chairman, Senate Committee on Foreign Relations,
U.S. Senate,
Washington, DC.

Dear Mr. Chairman: On behaif of Torres, Plaz & Araujo, an
Venezuelan firm active in international law areas, with its offices in
Caracas, Venezuela, which specializes in international taxation, we
submit the following statement, for inclusion in the record of your
committee hearings on the proposed Treaty For The Avoidance of Double
Taxation Between Venezuela and The United States.
We thank you for this opportunity to express our views to you and
to your Committee.
Very truly yours,
Federico Araujo Medina, Senior Partner.

Statement to the Senate Committee on Foreign Relations--October 13,
1999

The Law Offices of Torres, Plaz & Araujo wishes to express our
support for the ratification of the Treaty For The Avoidance of Double
Taxation Between Venezuela and The United States.
Our firm has been acting as legal counsel on corporate tax matters
for both U.S. and Venezuelan corporations engaged in trade and
investments in the most significant economical sectors of our Country,
namely petroleum, petrochemical, food sector, banking, among others,
for more than 25 years. Along said period of time we have realized and
event felt the need for the existence of a tax treaty between our
countries, settling grounds for certainty and thus with enhancing the
flow of business amount in our countries. We believe that in order to
compete fairly with other countries that have already agreed with
Venezuela Treaties in the Income Tax, we find that American investors
could be in an incompetitive position compared to investors from other
O.E.C.D. countries, which have concluded treaties previously with
Venezuela.
The approval of the Treaty and its entering into force becomes
critical in a moment when Venezuela has announced, through its
Executive Branch, a major amendment of the income tax regime--by
shifting from our traditional territorial tax principle, to the
worldwide system of taxation (i.e. adding domiciled/resident taxation
to source taxation) and by--furthermore--providing for taxation of
dividends, tax-free since 1991.
In addition, what we envisage as a need for certainty--through a
Tax Treaty--is enhanced since both taxpayer and Tax Administration will
be confronted with a whole new concept in tax law (from the Venezuelan
standpoint of view), having little or no experience in dealing with
such complex issues as (i) piercing corporate veil through; the
application of subtance over form rules; (ii) providing for a black-
listing or ``look-through'' scenario for investments in law tax
juridiction; (iii) including tax legislation (copies party from OECD
directives rules) on transfer pricing for international trade among
related parties; all of which even though bringing Venezuela's tax
system close to systems in place in the USA and other OECD countries,
is liable to end up in controversy between taxpayers and the Tax
Aministration, which may result in costly litigation and uncertainty,
in a moment when the latter cannot be afforded, at least for
investments in our Country, which, could--and perhaps will be likely
to--affect United States of American's individual and corporate
citizens investing in Venezuela (being the U.S.A. the most important
importing Country to Venezuela, of both investment and goods), as a
drawback via a vis investors from other OECD countries with treaties
already in force with Venezuela.
We sincerely believe that in view above mentioned of the facts and
under the current Treaty drafting (e.g. rules for avoidance of tax
treaty-shopping ``LOB'' provisions) ratification of the treaty could
not result in the creation of a tax treaty protected shelter, but
rather its approval would protect American investors in our country
from the income tax point of view further and would provide the same
with leverage in front of third country investors.
draft
The Committee should be aware that Venezuela may be moving from a
territorial tax system to a worldwide system. On April 26, 1999, the
Venezuela Congress authorized President Chavez under an enabling law to
take extraordinary economic and financial measures, including a reform
of Venezuela's income tax law. The enabling law specifically provide
that the changes must include the adoption of a worldwide tax system in
lieu of Venezuela's current territorial tax system as well as dividend
taxation, tax heaven's investments blacklisting a (look through) and
elaborate transfer pricing provisions, inter alia. Under the worldwide
tax system, similar to the U.S. system, Venezuelan residents and
domiciled entities are taxable on worldwide income while nonresident
and nondomiciled entities are taxable on certain income from Venezuela
sources. The enabling law authorized the President to publish a decree
within six months of the authorization (i.e., by October 26, 1999)
which contain these and other changes to Venezuelan tax laws. In
September 1999, the Cabinet approved a new income tax, which, among
other things, included provisions adopting a worldwide tax system. The
new tax law has not yet been signed by the President or published in
the Official Gazette. The Joint Committee staff has been told that
these actions are expected to be imminent. Once officially published,
the new laws generally will take effect for fiscal years beginning
after the law is published (with the law generally not being effective
later than January 1, 2000), even though a one (1) fiscal year tax
postponement on worldwide income and dividend taxation is expected to
be included in said income tax law transitional provisions.

______

Williams,
1627 Eye Street, NW., Suite 900,
Washington, DC, October 13, 1999.

Statement of the Williams Companies in Support of the U.S.-Lithuanian
Bilateral Tax Treaty--October 13, 1999

On behalf of The Williams Companies, I want to express our strong
support for the bilateral tax treaty between the United States and the
Government of Lithuania now pending before the Committee and urge its
ratification prior to adjournment of this session of Congress.
Williams is an $18 billion energy and communications company
headquartered in Tulsa, Oklahoma. Williams is active in most areas of
the oil and natural gas industry. Williams owns two refineries in the
United States, natural gas gathering and processing facilities, five
interstate natural gas pipeline systems, a large petroleum products
pipeline network, petroleum products terminals throughout the Midwest
and Southeast, and a large energy marketing and trading business. In
addition, we have numerous international investments through our
Williams International subsidiary. We also are leaders in the wholesale
transmission of voice, data and video communications.
The Government of Lithuania has selected Williams International to
be the strategic investor in the country's refining, transportation and
oil export industry. This selection has been confirmed by the
Parliament. While the terms of arrangement are still being discussed,
Williams is prepared to invest $150 million in the businesses and
manage a modernization program involving approximately $700 million.
Once completed, the refinery and related facilities, known as Mazeikiu
Nafta, will meet world class standards, including the more stringent
fuel quality standards that will apply in Europe after the year 2000.
Assuming our agreements with the Lithuanian Government are
concluded successfully, Williams will be the largest U.S. investor in
Lithuania by a large margin.
As a result of our investment, Williams will maintain considerable
staff in Lithuania. In addition to our direct investment, Williams will
operate the refinery and related facilities pursuant to a management
services agreement.
Ratification of the tax treaty is important for several reasons. It
will allow for the elimination of Lithuanian withholding tax at the
source on certain payments to U.S. legal entities, whose activities do
not rise to the level of a permanent establishment. Further, it will
reduce the withholding tax rates on payments of interest, dividends and
other types of income, which is paid from Lithuanian sources to U.S.
residents. This treaty will also benefit the competitive standing of
United States businesses operating in Lithuania. Currently, U.S.
businesses are at a severe disadvantage to businesses from countries
which have ratified double tax treaties with Lithuania.
In addition to the above tax savings, the treaty will provide
important relief from the double taxation of U.S. citizens and
residents in Lithuania, who may otherwise be subject to double taxation
of their income in both the United States and Lithuania.
In summary, we urge the Committee and the Senate to approve this
important treaty this year. If our agreement with the Lithuanian
Government is successfully concluded, we will begin making major
investments in the oil sector immediately. Williams to date has
expended considerable funds in studying the refinery and its operations
and has provided considerable assistance in the completion of the
Butinge oil export terminal on the Baltic. Any delay in ratifying the
treaty will have a negative impact on our investments to date and cloud
our future activities in the country.
We appreciate the Committee's desire to move this treaty forward
and urge its ratification by the full Senate.
Submitted by:
John C. Bumgamer, Jr.,
President, Williams International.

______

Website Addresses for the Treasury Department Technical Explanations

Estonia:
http://www.ustreas.gov/taxpolicy/documents.html#Estonia

Latvia:
http://www.ustreas.gov/taxpolicy/documents.html#Latvia

Lithuania:
http://www.ustreas.gov/taxpolicy/
documents.html#Lithuania

Venezuela:
http://www.ustreas.gov/taxpolicy/
documents.html#Venezuela

Denmark:
http://www.ustreas.gov/taxpolicy/documents.html#Denmark

Italy:
http://www.ustreas.gov/taxpolicy/documents.html#Italy

Slovenia:
http://www.ustreas.gov/taxpolicy/
documents.html#Slovenia

Germany:
http://www.ustreas.gov/taxpolicy/documents.html#Germany