FROM THE OFFICE OF PUBLIC AFFAIRS

The TreasuryDepartment today announced that Vice President Gore and SouthAfrican Deputy President Mbeki signed an income tax convention inCape Town. This Convention replaces the previous convention thatwas terminated in 1987 pursuant to the U.S. Anti-Apartheid Act,and represents and important step in Treasury’s goal ofexpanding the U.S. tax treaty network with important tradingpartners. The Convention will enter into force after thecountries have exchanged the instruments of ratification.

The proposed incometax Convention with South Africa generally follows the pattern ofthe U.S. Model treaty and the Model treaty issued by theOrganization for Economic Cooperation and Development (OECD),although a major portion of the negotiations pre-datedpublication of the U.S. Model. There are, however, as with allbilateral tax Conventions, some variations from these norms. Inthe proposed Convention, these differences reflect particularaspects of South African law and treaty policy, the interactionof U.S. and South African law, and U.S.-South African economicrelations.

Taxation ofInvestment Income

The proposedConvention establishes maximum rates of withholding at source oninvestment income that are the same as those in the U.S. Model.Dividends are subject to a maximum rate of tax at source of 15percent, except that the rate is limited to 5 percent fordividends paid by a 10-percent or more subsidiary in one countryto its parent in the other. In general, interest and royaltiesare both exempt from tax at source, and are, therefore, subjectto tax exclusively in the country of residence of the beneficialowner of the income.

The standard U.S.anti-abuse rules are provided for certain classes of investmentincome. Dividends paid by non-taxable conduit entities, such asU.S. RICs and REITs, are subject to

special rules toprevent the use of these entities to transform what is otherwisehigh-taxed income into lower-taxed income. Excess inclusions withrespect to residual interests in REMICs are

denied the benefitsof the reduced rate of tax at source on interest, and contingentinterest is subject to source tax at the 15 percent rate appliedto portfolio dividends.

The taxation ofcapital gains under the proposed Convention follows the patternof the U.S. Model. It provides that gains from real property(including a U.S. real property interest) are taxable in thesitus State. Gains from the alienation of personal property thatis part of a permanent establishment or fixed base may be taxedin the State where the permanent establishment or fixed base islocated. All other gains, including gains from the alienation ofships, aircraft and containers operated or used in internationaltraffic, are taxable exclusively in the State of residence of thealienator.

Taxation ofBusiness Income

As with recent U.S.treaties and the U.S. and OECD Models, the proposed Conventionprovides generally for the taxation by one State of the businessprofits of a resident of the other only when such profits areattributable to a permanent establishment located in that otherState. The proposed Convention, however, grants rights to taxbusiness profits that are somewhat broader in one respect thanthose found in the U.S. and OECD Models. Under the proposedConvention, an enterprise will have a permanent establishment ina Contracting State if its employees or other personnel provideservices within that State for 183 days or more within a 12-monthperiod in connection with the same or a connected project.

The proposedConvention preserves the right of both States to impose a branchtax on local branches of corporations of the other State. Theproposed Convention will also accommodate a provision of the 1986Tax Reform Act that attributes to a permanent establishmentincome that is earned during the life of the permanentestablishment, but is deferred, and not received until after thepermanent establishment no longer exists.

The proposedConvention, consistent with current U.S. treaty policy, providesexclusive residence-country taxation of profits frominternational carriage by ship or aircraft. This reciprocalexemption also extends to income from the rental of ships,aircraft and containers.

Taxation ofPersonal Services Income

As with thetreatment of business profits, personal service income, for bothdependent and independent services, is subject to rules thatessentially follow the U.S. Model rules. The 183-day personalservice rule in the definition of permanent establishment is,appropriately, also present in the definition of fixed base. Inthe proposed Convention, the dollar threshold for host-countrytaxation of income of entertainers and sportsmen is currently$7,500, rather than $20,000. The proposed Convention, however,contains a rule allowing the Contracting States to increase theamount through an exchange of diplomatic notes. This provisionrequires diplomatic notes to be exchanged to increase thethreshold, rather than the competent authority agreement found inmany U.S. treaties. The treatment of directors, social securityrecipients, Government employees and students follows the patternof the U.S. Model. The treatment of pensions differs from that inthe U.S. Model. Pensions will be subject to limitedsource-country tax. The residence country may also tax, subjectto a foreign tax credit, if the source country has taxed. Likethe U.S. Model, an individual employed in one country who belongsto a pension plan in the other, may, subject to certainconditions, be allowed in his country of employment to deductcontributions to his plan in the other country.

As in the U.S.Model, the proposed Convention provides that income of a residentof a Contracting State not dealt with in the other articles ofthe Convention is taxable only in the country of residence of therecipient.

Anti-Treaty-ShoppingProvisions

The proposedConvention contains significant rules designed to restrict thebenefits of the Convention to persons that are not engaged in"treaty shopping." The provisions are similar to thosefound in the U.S. Model and in all recent U.S. treaties.

Exchange ofInformation

The informationexchange provisions make clear that South Africa is obligated toprovide U.S. tax officials such information, including bankinformation, as is necessary to carry out the provisions of theConvention. Consistent with U.S. policy, South Africaninformation will be available to U.S. authorities whether or notSouth Africa has a tax interest in the information.

The proposedConvention allows the General Accounting Office and the taxwriting Committees of Congress to obtain access to certain taxinformation exchanged under the Convention for use in theiroversight of the administration of U.S. tax laws and treaties.

GeneralProvisions

The proposedConvention provides a U.S. foreign tax credit for the SouthAfrican income taxes covered by the Convention, including thenormal tax and the secondary tax on companies, and for a SouthAfrican foreign tax credit for the U.S. income taxes covered bythe Convention. The U.S. foreign tax credit is subject to normallimitations of U.S. law, including limitations relating to theamount of foreign source income of the U.S. taxpayer and denialof the credit for non-compulsory payments.

In addition, theproposed Convention provides for non-discriminatory treatment (i.e.,national treatment) by one country to residents and nationals ofthe other. Also included in the proposed Convention are rulesnecessary for administering the Convention, including rules forthe resolution of disputes under the Convention.

Entry Into Force

The proposedConvention is subject to ratification. It will enter into force30 days after each State has notified the other that itsratification procedures have been completed. It will have effect,with respect to taxes withheld at the source, for amounts paid orcredited on or after the first day of January following entryinto force. In other cases the Convention will have effect withrespect to taxable periods beginning on or after the first day ofJanuary following the date on which the Convention enters intoforce.

The Convention willremain in force indefinitely unless terminated by one of theContracting States. Either State will be able to terminate theConvention after 5 years from the date on which the Conventionenters into force by giving prior notice of at least six monthsthrough diplomatic channels.

Copies of the newConvention are available from the Office of Public Affairs,Treasury Department, Room 2315, Washington, D.C. 20220. Foradditional information regarding the treaty please call 622-2960.