TREASURY DEPARTMENT TECHNICAL EXPLANATION OF THE CONVENTION BETWEEN THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF THE REPUBLIC OF ITALY FOR THE AVOIDANCE OF DOUBLE TAXATION WITH RESPECT TO TAXES ON INCOME AND THE PREVENTION OF FRAUD OR FISCAL EVASION AND AN ACCOMPANYING PROTOCOL AND EXCHANGE OF NOTES SIGNED AT ROME ON APRIL 17, 1984
GENERAL EFFECTIVE DATE UNDER ARTICLE 28: 1 JANUARY 1985
This Convention, together with the accompanying Protocol and Exchange of Notes, signed at Rome, Italy on April 17, 1984, was negotiated on the basis of the U.S. Model Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital, published in May 1977, the revised U.S. Model published in draft form in June 1981 (also referred to as the "U.S. Model"), and the two models published by the Organization for Economic Cooperation and Development (OECD) in 1963 and 1977. References to "the Convention" or "the Treasury" in this explanation mean the Convention. Protocol and Exchange of Notes signed on April 17, 1984.
The technical explanation is an official guide to the Convention. It reflects policies behind particular Convention provisions, as well as understandings reached with respect to the interpretation and application of the Convention.
TABLE OF ARTICLES
Article 1--------------------------------- Personal Scope
Article 2--------------------------------- Taxes Covered
Article 3--------------------------------- General Definitions
Article 4--------------------------------- Resident
Article 5--------------------------------- Permanent Establishment
Article 6--------------------------------- Income from Immovable Property
Article 7--------------------------------- Business Profits
Article 8--------------------------------- Shipping and Air Transport
Article 9--------------------------------- Associated Enterprises
Article 10------------------------------- Dividends
Article 11------------------------------- Interest
Article 12------------------------------- Royalties
Article 13------------------------------- Capital Gains
Article 14------------------------------- Independent Personal Services
Article 15------------------------------- Dependent Personal Services
Article 16------------------------------- Directors' Fees
Article 17------------------------------- Artistes and Athletes
Article 18------------------------------- Pensions, Etc.
Article 19-------------------------------Government Service
Article 20-------------------------------Professors and Teachers
Article 21-------------------------------Students and Trainees
Article 22-------------------------------Other Income
Article 23-------------------------------Relief from Double Taxation
Article 24-------------------------------Non-Discrimination
Article 25-------------------------------Mutual Agreement Procedure
Article 26-------------------------------Exchange of Information
Article 27-------------------------------Diplomatic Agents and Consular Officials
Article 28-------------------------------Entry into Force
Article 29-------------------------------Termination
Protocol---------------------------------of 17 April, 1984
Exchange of Notes--------------------of 17 April, 1984
ARTICLE 1
Personal Scope
This Article identifies the persons who come within the scope of the Convention and establishes the relationship between it and domestic law.
Paragraph 1 states that the Convention applies to residents of the United States and/or Italy, except where the terms of the Convention provide otherwise. The term "resident" is defined in Article 4 (Resident). When a person who is a resident of both Contracting States under their respective laws is assigned a single State of residence under Article 4 (Resident), that definition governs for all provisions of the Convention. In certain cases, the Convention may apply to residents of third countries because of their relationship to a resident of a Contracting State or because they are citizens of a Contracting State. For example, paragraph 1 (a) of Article 19 (Government Service) and Article 26 (Exchange of Information) may affect residents of third countries.
The provision found in paragraph 2 of this Article in the U.S. Model, that the Convention does not restrict the benefits of domestic law or other agreements between the two countries, is found in Article 3 of the Protocol. If domestic law provides a more favorable treatment than the Convention, the taxpayer may apply the provisions of domestic law. For example, if certain interest income derived by nonresidents is exempt from tax by statute, but the Treaty authorizes a tax at source of not more than 15 percent, the statutory exemption will apply. A taxpayer, however, may not make inconsistent choices between the rules of the Internal Revenue Code (hereafter "the Code") and the Convention rules. (See, for example, Revenue Ruling 84-17.)
Paragraph 2 contains the traditional "saving clause" which preserves the right of each Contracting State to tax its residents and citizens under its domestic law. Residence is defined in Article 4 (Resident). Under paragraph 1 of Article 1 of the Protocol to the Convention, the United States also preserves its right to tax former U.S. citizens whose loss of citizenship had as one of its principal purposes the avoidance of tax. Such former citizens are taxable in accordance with section 877 of the Code for 10 years following the loss of citizenship.
Paragraph 3 sets forth certain exceptions to the application of the saving clause where other provisions of the Convention present overriding policies. The saving clause does not override the benefits provided under paragraph 3 of Article 18 (Pensions, Etc.), relating to alimony and child support payments. The benefits provided in Articles 23 (Relief from Double Taxation), 24 (Non-Discrimination), and 25 (Mutual Agreement Procedure), including agreements referred to in paragraph 7 of Article 1 of the Protocol, are also available to residents and citizens of the Contracting States, notwithstanding the saving clause. In addition, paragraph 2 of Article 1 of the Protocol provides that the saving clause does not override the exemption from tax of social security benefits provided in paragraph 14 of Article 1 of the Protocol for individuals who are citizens of the residence State even if they are citizens of both States; and it does not override the special rule of Article 4 of the Protocol relating to U.S. citizens resident in Italy who are partners of a U.S. partnership.
In some cases, the saving clause overrides benefits otherwise conferred by the Convention on citizens or persons having immigrant status in a Contracting State, but does not override those benefits conferred on residents who are not citizens and do not have immigrant status in that State. This second category of exceptions to the saving clause concerns the benefits provided under Articles 19 (Government Service), 20 (Professors and Teachers), 21 (Students and Trainees) and 27 (Diplomatic Agents and Consular Officials). For example, a teacher or student from Italy who qualifies for U.S. tax benefits under Article 20 or 21 will not lose those benefits by staying in the United States long enough to be considered a resident for tax purposes, provided that the individual does not become a U.S. citizen or immigrant. The term "immigrant status" for U.S. purposes means a person admitted to the United States as a permanent resident under U.S. immigration laws (i.e., holding a "green card").
ARTICLE 2
Taxes Covered
Paragraph 1 states that the Convention applies to income taxes imposed on behalf of either Contracting State.
Paragraph 2 enumerates the existing taxes to which the Convention applies in each Contracting State. In the United States these are the Federal income taxes imposed by the Code, but excluding the accumulated earnings tax and the personal holding company tax. The excise taxes on private foundations and on premiums paid to foreign insurers are also covered by the Convention, but in the latter case the Convention applies only to the extent that the Italian insurer does not reinsure those risks with a resident of a country with which the United States does not have an income tax convention providing an exemption from this tax. (See paragraph 3 of Article 1 of the Protocol.) Social security taxes are not covered by the Convention, nor are U.S. state and local income taxes.
In Italy, the Convention applies to the individual income tax, the corporation income tax, and the local income tax except to the extent that the local tax is imposed on “cadastral” income. “Cadastral” income is the imputed rental value of real property, based on the official register or “cadastre” of assessed property values. The local income tax applies to specified categories of realized income and, separately, to the imputed income of certain real property. The local income tax is covered in full for purposes of Article 24 (Non-Discrimination). Although the cadastral portion of the local income tax is not otherwise covered by the Convention, and thus may not be credited under Article 23 (Relief from Double Taxation), the Convention does not take a position as to whether the local income tax on cadastral income is an income tax under U.S. law for purposes of the U.S. foreign tax credit. The latter determination must be made in accordance with Code sections 901 and 903 and the regulations thereunder.
Paragraph 3 provides that taxes enacted after the date of signature of the Convention (April 17, 1984) are also covered if they are substantially similar to the taxes referred to in paragraph 2. The competent authorities agree to notify each other of significant changes in their tax laws and of significant official publications concerning the application of the Convention.
For the purposes of Article 24 (Non-Discrimination), the Convention also applies to other types of taxes and to all taxes imposed by political subdivisions. (See paragraph 5 of Article 24.) For the purposes of Article 26 (Exchange of Information), the Convention applies to all national taxes to the extent the information is relevant to the assessment of taxes covered in this Article. (See paragraph 16 of Article 1 of the Protocol.)
ARTICLE 3
General Definitions
Paragraph 1 defines some of the principal terms used throughout the Convention. Unless the context otherwise requires, the terms defined in this paragraph have a uniform meaning throughout the Convention. A number of other important terms are defined in other articles. For example, the term “resident” is defined in Article 4 (Resident), the term “permanent establishment” is defined in Article 5 (Permanent Establishment), and the terms "dividends," “interest,” and "royalties" are defined in Articles 10, 11, and 12, respectively.
The definitions of the terms “person”, “company”, “enterprise of a Contracting State,” and "international traffic" are the same as the definitions in the U.S. Model, except that the word “partnership” was deleted from the definition of the term “person” at the request of Italy, to preserve greater conformity with other Italian treaties. A partnership is understood to be included within the reference to "any other body of persons".
The term “person” includes an individual, an estate, a trust, a partnership, a company, and any other body of persons. The term "person" is important because the Convention generally applies to "persons" who are residents of one of the Contracting States (Article 1) and residence is defined in terms of “persons” meeting certain criteria (Article 4). The Model does not attempt an exhaustive definition, but simply lists examples. The term is meant to be interpreted broadly.
The term "company" means any body corporate or any other entity treated for tax purposes as a body corporate.
The terms "enterprise of a Contracting State" and "enterprise of the other Contracting State" mean an enterprise carried on by a resident (as defined under Article 4) of the United States or the other Contracting State, as the case may be.
The definition of “international traffic” is relevant to Article 8 (Shipping and Air Transport). If an international voyage includes a domestic segment, income from transporting persons or cargo exclusively on the domestic segment does not qualify as income from international traffic. For example, if a ship's route is London - New York -Baltimore - London, any persons or cargo on board when the ship left London and those traveling from New York to Baltimore to London are considered to be in international traffic, but persons or cargo loaded in New York and unloaded in Baltimore are not in international traffic.
The “competent authority” of the United States is the Secretary of the Treasury or his delegate. In Italy the competent authority function is assigned to the Ministry of Finance.
The terms “United States” and “Italy” are defined to include the continental shelf areas of the two countries with respect to exploration and exploitation of their natural resources. For the United States, the definition of the continental shelf is interpreted in accordance with section 638 of the Code and the regulations thereunder. The term “United States” does not include Puerto Rico, the Virgin Islands, Guam, or any other United States possession. The reference to “customary” international law is intended to avoid any implication that the Law of the Sea Convention was binding on either State as of the date of signature.
The term “nationals” is defined to include legal entities as well as individuals. This term is used in Articles 19 (Government Service) and 24 (Non-Discrimination).
Paragraph 2 provides that a term not defined in the Convention shall have the meaning which it has under the domestic law of the Contracting State applying the Convention at the time the term is being interpreted, unless the context of the Convention requires a different interpretation. The term "context" includes the purpose and background of the provision in which the term appears. It is understood that the competent authorities may agree on a common definition under the mutual agreement procedure of Article 25.
ARTICLE 4
Resident
This Article identifies those persons who are residents of a Contracting State. The definition begins with the person's liability to tax under the respective taxation laws of the Contracting State. The Article also provides rules for determining a single residence for individuals who would be dual residents under domestic law. The Convention definition is exclusively for purposes of the Convention. A definition of residence is important because, for the most part, only residents of the Contracting States may claim the benefits of the Convention.
Paragraph 1 lists a number of criteria which may be used to determine residence under the domestic laws of a Contracting State. The reference to persons "liable to tax" is not meant to exclude organizations, such as charities, which are tax-exempt under domestic law. Residents of the United States include aliens who are considered U.S. residents under section 7701(b) of the Code, and resident U.S. citizens. U.S. citizens resident in third countries are not included as residents of the United States for purposes of the Convention. Whether a U.S. citizen is a resident of the United States is determined in accordance with section 871 of the Code and the regulations thereunder (as in effect prior to enactment of section 7701(b) in the 1984 Tax Reform Act).
A person will not be considered to be a resident of a Contracting State if he is liable to tax there only with respect to income from sources in that State or capital located there. For example, an Italian diplomat stationed in the United States will not be considered a resident of the United States for purposes of the Convention.
A partnership, estate, or trust will be considered a resident of a Contracting State only to the extent that the income it derives is subject to tax by that State, either at the entity level or in the hands of the partners or beneficiaries, as the income of a resident. For example, a U.S. partnership which derives income from Italy and which is comprised of two partners who are residents of the United States and two partners who are residents of a third country will be considered a U.S. resident only to the extent of the shares of such income attributable to the partners who are U.S. residents. Treaty benefits, such as reduced withholding rates on dividends and interest, need not be extended by Italy to the portion of the income derived by the U.S. partnership which is passed through to the nonresident partners.
Paragraph 2 provides a series of tie-breakers for assigning a single residence to an individual who, by the criteria of paragraph 1, would be a resident of both countries. The tie-breakers are taken from the OECD Model.
The first test is where the individual has a permanent home. If that test is inconclusive because the individual has a permanent home in both countries, the second test is where his personal and economic relations are closest. If that test does not provide a satisfactory answer, or if the individual does not have a permanent home in either country, the next test is where he has his habitual abode. If that test also fails to establish a single country of residence, because the individual has an habitual abode in both countries or in neither of them, he is deemed to be a resident of his country of nationality (citizenship). And, if he is a national of both countries or of neither of them, the question is left to the competent authorities, who are instructed to settle it by mutual agreement.
Paragraph 3 provides that, in the event that a person other than an individual or company is a resident of both Contracting States under the provisions of paragraph 1, the competent authorities of the two countries shall endeavor to resolve the question and determine how the Convention applies to such a person.
The Convention does not resolve the issue of potential double residence of companies, which can arise if a corporation created or organized under the laws of a state of the United States or the District of Columbia has its legal seat of management or principal business purpose in Italy. It was considered that the competent authorities would be unlikely to agree on a single residence in such a case. In fact, it would not be the policy of the U.S. competent authority to agree to treat an entity incorporated in the United States as not a U.S. resident. Consequently, it is left to the companies to avoid the situation of being residents of both Contracting States. No cases of corporate dual residence were known to exist at the time the Convention was signed.
ARTICLE 5
Permanent Establishment
The rules for taxation by a Contracting State of business income derived by a resident of the other State utilize the concept of a “permanent establishment.”
Paragraph 1 of this Article defines in general terms a permanent establishment as a fixed place of business through which an enterprise carries on business activities.
Paragraph 2 provides an illustrative list of fixed places of business which constitute a permanent establishment. A place of management, branch, office, factory, workshop and a place of extraction of natural resources, such as a well or quarry, are examples of a permanent establishment. Since a place of management would in most cases require an office, which is specifically listed in paragraph 2, the addition of that term will not generally cause a permanent establishment to exist if there would not otherwise be one. A building site or construction or assembly project will only be considered a permanent establishment if it lasts longer than twelve months. In such a case, the Site or project constitutes a permanent establishment from the first day on which work physically begins within the territory of the Contracting State. A series of contracts or projects which are interdependent both commercially and geographically are to be treated as a single project for the purpose of applying the twelve-month test.
Paragraph 4 of Article 1 of the Protocol provides that a drilling rig or ship used to explore for or develop natural resources constitutes a permanent establishment in a Contracting State only if it remains there longer than 180 days in a twelve-month period. A series of contracts or projects which are interdependent both commercially and geographically are to be treated as a single project for the purpose of applying the twelve-month test. In the absence of an explicit rule, Italy takes the position that such a rig or ship would be considered a permanent establishment under paragraph 2 (f) with no minimum presence requirement.
Paragraph 3 enumerates certain activities which may be undertaken through a fixed place of business without creating a permanent establishment. Subparagraphs (a) through (e) are the same as the corresponding provisions in the U.S. Model. The use of facilities solely to store, display, or deliver goods or merchandise belonging to an enterprise does not constitute a permanent establishment, nor does the maintenance of a stock of goods or merchandise belonging to an enterprise solely for the purpose of storage, display, or delivery or solely for the purpose of processing by another enterprise. The maintenance of a fixed place of business solely to purchase goods or merchandise, to collect information, or to carry on for the enterprise any other preparatory or auxiliary activity does not constitute a permanent establishment. Subparagraph (f) of the U.S. Model was deleted. Italy is unwilling to make a commitment that all or several of the activities enumerated in subparagraphs (a) through (e) may be undertaken in combination without constituting a permanent establishment. Nor do they accept the 1977 OECD Model on this point. Rather, they follow the 1963 OECD Model and judge actual cases on the relevant facts and circumstances as to whether the combination of activities constitutes a permanent establishment.
Paragraphs 4 and 5 consider the use of agents. Under paragraph 4, a dependent agent who habitually exercises an authority to conclude contracts in the name of an enterprise is deemed to be a permanent establishment of that enterprise unless his activities are limited to purchasing for the enterprise. Under paragraph 5, an enterprise of a Contracting State will not be considered to have a permanent establishment in the other State merely because it uses the services of an independent agent acting in the ordinary course of business in that other State.
Paragraph 6 states that control of one company by another does not of itself constitute either company a permanent establishment of the other. The determination as to whether a subsidiary is a permanent establishment of its parent corporation, or conversely, or whether two or more subsidiaries of the same corporation are permanent establishments of the parent or of each other, is made by reference to the tests set out in paragraphs 1 through 5.
ARTICLE 6
Income from Immovable Property
This Article provides that income from immovable (real) property, including income from agriculture and forestry, may be taxed by the Contracting State where the property is located. This rule does not confer an exclusive right of taxation on the State where the property is located. It simply provides that the situs State has the primary right to tax such income, whether or not the income is derived through a permanent establishment in that State. This Article is substantially the same as Article 6 of the OECD Model. The provision in the U.S. Model for a binding election to be taxed on a net basis was deleted. Such an election is available under U.S. law, and Italy taxes income from real estate on a net basis.
ARTICLE 7
Business Profits
This Article provides rules for the taxation by a Contracting State of income from business activity carried on by a resident of the other State.
Paragraph 1 provides that profits of an enterprise of one Contracting State shall be taxable only in that State except to the extent that such profits are attributable to a permanent establishment through which the enterprise carries on business activities in the other State.
Paragraph 2 provides that the profits to be attributed to a permanent establishment are those which it might be expected to make if it were a distinct enterprise engaged in similar activities under similar conditions and dealing independently with the home office and other related persons. The profits must reflect arm’s length prices. The profits so attributed may be from sources within or without the Contracting State. Thus, items of income described in section 864(c)(4)(B) of the Code which are attributable to a permanent establishment in the United States may be taxed by the United States. Under this paragraph Italy gives up its “force of attraction” approach of attributing all income derived from Italy by an enterprise having a permanent establishment in Italy to that permanent establishment. In addition, the limited “force of attraction” rule in Code section 864(c)(3) does not apply for U.S. tax purposes under the Convention.
Paragraph 3 provides that deductions shall be allowed for expenses incurred for the purposes of the permanent establishment, as determined under the laws of each country, including a reasonable allocation of executive and general administrative expenses. Although Italian law does not provide detailed rules comparable to the U.S. section 1.861-8 and 1.882-5 regulations, Italy accepts the principle of a reasonable allocation. It is understood that any issues which might arise in practice may be discussed through the competent authority mechanism.
Paragraph 4 states that no profits shall be attributed to a permanent establishment by reason of the mere purchase by it of goods or merchandise for the enterprise.
Paragraph 5 provides that, unless there is good and sufficient reason to the contrary, the same method of determining profits attributable to the permanent establishment shall be used each year.
Paragraph 6 provides that, where business profits include items of income dealt with in other articles of the Convention, the provisions of those other articles govern. For example, the taxation of income of international shipping and aircraft operations is governed by Article 8 (Shipping and Air Transport) and not by this Article. Similarly, the taxation of dividends, interest, and royalties is governed by Articles 10, 11, and 12, respectively; however, the terms of those Articles provide that, where the holding, debt-claim, property or right giving rise to dividends, interest, or royalties derived by a resident of a Contracting State is effectively connected with a permanent establishment in the other State, the provisions of this Article apply and the item of income is taxed as business profits. The concept of “effectively connected with” in those Articles and "attributable to" in this Article have the same meaning.
Unlike the U.S. Model, the Convention treats income from the rental of industrial, commercial or scientific equipment and from the rental of films as royalties covered by Article 12 (Royalties) rather than as profits covered by this Article.
ARTICLE 8
Shipping and Air Transport
This Article, as supplemented by paragraph 5 of Article 1 of the Protocol, provides rules governing the taxation of income from the operation of ships or aircraft in international traffic.
Under paragraph 1, each of the Contracting States agrees to exempt from tax profits derived by an enterprise of the other State from the operation of ships or aircraft in international traffic. The term “international traffic” is defined in Article 3 (General Definitions). Paragraph 5 of Article 1 of the Protocol explains that such profits include profits from the use, maintenance or rental of containers (and related equipment for their transport) used in international traffic. It also includes profits from the rental on a full basis of ships and aircraft operated in international traffic or if the rental income is incidental to income from such international operation, and income from rental on a bareboat basis of ships or aircraft provided that the rental income is incidental to income from operating ships or aircraft in international traffic.
For example, if a U.S. airline which operates internationally leases a plane on a bareboat basis to an Italian airline, the rental income derived by the U.S. company is exempt from Italian tax under this Article. However, if the U.S. airline otherwise operates only within the United States, or if a U.S. bank leases the plane to the Italian airline, that rental income is not exempt under this Article.
Income from the rental of ships, aircraft or containers which is not exempt from tax under this Article is taxable in accordance with Article 12 (Royalties). Under that Article, the rental income is considered to have its source in Italy if the payer of the rental is a resident of Italy or if the rental payment is for the use of the property in Italy. For example, if a U.S. bank leases a plane on a bareboat basis to an Italian airline, the rental payment is of Italian source. If the bank leases the plane to a U.S. airline for use between New York and Rome, the portion of the rental payment attributable to the use of the plane within Italian territory is of Italian source. The tax at source on such leasing income under Article 12 is limited under Article 12 to 7 percent of the gross rental. (See paragraph 10 of Article 1 of the Protocol.) The 7 percent rate in Italy's case results from the imposition of the 10 percent tax permitted under Article 12 to 70 percent of the gross rental; Italian law allows a presumed expense deduction equal to 30 percent of the gross amount.
Paragraph 2 states that the provisions of this Article apply to a share in the profits of a pool, joint venture, or international operating agency. Participants in such a joint operation who are residents of third countries are not affected by this Convention, but the share of the profits derived by an enterprise of Italy or the United States will be exempt from tax by the other State as provided in paragraph 1 of this Article and paragraph 5 of Article 1 of the Protocol.
Paragraph 6 of Article 1 of the Protocol preserves the reciprocal exemption provided in sections 872 and 883 of the Code. By agreeing to exempt U.S. citizens and corporations from tax with respect to their income from operating ships documented or aircraft registered under U.S. law. Italy meets the requirements of those Code sections and the United States, accordingly, will exempt from tax income derived from the operation of ships documented or aircraft registered under Italian law by anyone other than a U.S. citizen, resident, or corporation.
ARTICLE 9
Associated Enterprises
This article provides that, where related persons engage in transactions which are not at arm’s length, the Contracting States may make appropriate adjustments to their taxable income and tax liability.
The Article states the general rule that where an enterprise of one Contracting State and an enterprise of the other State are related through management, control, or capital and their commercial or financial relations differ from those which would prevail between independent enterprises, the profits of the enterprises may be adjusted to reflect the profits which would have accrued if the two enterprises had been independent.
Paragraph 7 of Article 1 of the Protocol provides that, where one of the Contracting States has increased the profits of an enterprise of that State to the amount that would have accrued to the enterprise had it been independent of an enterprise in the other State, that other State shall, to the extent it agrees that the redetermination accurately reflects arm’s length conditions, make an appropriate adjustment by decreasing the amount of its tax on those profits. Such adjustments are to be made through the competent authority procedures of Article 25 (Mutual Agreement Procedure) and may only be made prior to the time that the tax is finally determined. (See paragraph 15 of Article 1 of the Protocol.) Since Article 25 is excepted from the saving clause, the benefit of such correlative adjustments is also available to residents of a Contracting State and, in the case of the United States, to nonresident U.S. citizens.
In Italy, the competent authority may not make such a correlative adjustment once an assessment becomes final. An assessment becomes final if not protested within 60 days, and the mutual agreement procedure must be invoked within eighteen months of such assessment. However, if the United States tax is adjusted, the statute for invoking competent authority relief in Italy begins to run from the date of that adjustment rather than from the date of the assessment by Italy.
Under Italian law, if the two requirements (protesting the assessment and invoking the mutual agreement procedure) are satisfied within the time limits, the Italian competent authority can intervene in court proceedings to prevent an assessment from becoming final and will do so if it considers the taxpayer's case to have merit. Thus, to benefit from a correlative adjustment by Italy, a taxpayer must take the necessary steps under Italian law to prevent the Italian tax assessment from becoming final in addition to seeking relief from the competent authority.
Paragraph 8 of Article 1 of the Protocol clarifies that each Contracting State may apply its internal law in determining liability for its tax. For example, although paragraphs 1 and 2 of this Article refer to allocations of “profits”, it is understood that such term also includes the components of the tax base and of the tax liability, such as income, deductions, credits, and allowances. For example, the United States will apply its rules and procedures under section 482 of the Code.
ARTICLE 10
Dividends
This Article limits the rate of tax which may be imposed by either Contracting State on dividends paid by a company which is a resident of that State to a resident of the other State.
Paragraph 1 states that such dividends may be taxed in the State of residence of the recipient. This provision confirms the provision of paragraph 2 of Article 1 (Personal Scope) that each Contracting State reserves the right to tax its residents.
Paragraph 2 provides that such dividends may also be taxed in the State of which the paying company is a resident, but such tax may not exceed certain limits when the beneficial owner of the dividends is a resident of the other State. The limits are 5 percent if the beneficial owner is a company which owned 50 percent or more of the voting stock of the paying company for the twelve months preceding the declaration of the dividend and 10 percent if the beneficial owner is a company which owned 10 to 50 percent of the voting stock of the paying company for the twelve months preceding the declaration of the dividend, provided in each case that not more than 25 percent of the gross income of the paying company during that same period is derived from dividends and interest other than from subsidiary companies or interest derived in the conduct of a financing business. The limit is 15 percent in other cases. Paragraph 9 of Article 1 of the Protocol defines the term "subsidiary company" for purposes of this paragraph as a corporation in which the company paying the dividends owns more than 50 percent of the voting stock.
Paragraph 3 defines dividends. It is the same definition as in the OECD Model and includes any income from corporate rights taxed the same as income from corporate shares under the domestic law of the Contracting State of which the paying corporation is a resident.
Paragraph 4 provides that, where the shares in respect of which the dividends are paid are effectively connected with (i.e., the dividends are attributable to) a permanent establishment or a fixed base which the beneficial owner of the divi¬dends maintains in the country of which the company paying the dividend is a resident, such dividends are not taxable in accordance with this Article, but in accordance with the law of the state in which the permanent establishment or fixed base is maintained. It is understood that in such a case the dividends will be taxed in accordance with the principles of Article 7 (Business Profits) or 14 (Independent Personal Services), as the case may be.
Paragraph 5 provides that a Contracting State may not impose tax on dividends paid by a company which is a resident of the other State except to the extent that the dividends are paid to a resident of the first State or to the extent that the shares in respect of which the dividends are paid are effectively connected with (i.e., the dividends are attributable to) a permanent establishment or fixed base of the beneficial owner in the first State. The United States may also tax dividends received by U.S. citizens pursuant to paragraph 2 of Article 1 (Personal Scope). The United States may not impose its “second withholding tax” on dividends paid by an Italian company which under section 861(a)(2)(B) of the Code are from sources within the United States when paid to shareholders who are not U.S. residents or citizens. Italy does not impose a comparable tax. This paragraph does not, however, prevent the United States from imposing its accumulated earnings tax and personal holding company tax.
ARTICLE 11
Interest
This Article limits the tax which may be imposed by either Contracting State on interest derived and beneficially owned by a resident of the other State.
Paragraph 1 states that such interest may be taxed in the State of residence of the beneficial owner. This provision confirms the provision of paragraph 2 of Article 1 (Personal Scope) that each Contracting State reserves the right to tax its residents.
Paragraph 2 provides that such interest may also be taxed by the State in which it arises, but if the beneficial owner is a resident of the other State, the tax is limited to 15 percent of the gross amount of the interest.
Paragraph 3 provides, as an exception to paragraph 2, that certain interest will be exempt from tax in the Contracting State where it arises. The exemption at source applies when the interest is derived and beneficially owned by the government of the other State or by a wholly-owned instrumentality of that other State. Interest derived by a political subdivision or local authority of a Contracting State is not exempt from tax at source under this provision. The exemption also applies when interest is derived and beneficially owned by a resident of the other State with respect to debt obligations guaranteed or insured by the government of that other State or by a wholly-owned instrumentality of that other State. For example, Italy will not tax interest derived by the U.S. government or by an instrumentality, such as the Export-Import Bank or Overseas Private Investment Corporation (OPIC). Interest derived by and beneficially owned by other U.S. residents, such as lending institutions, will be exempt from tax by Italy if the loan is guaranteed or insured by the U.S. government or by a government instrumentality, such as the Export-Import Bank or OPIC.
Paragraph 4 defines “interest”, using the definition from the 1963 OECD Model. Interest includes income from debt-claims of all kinds, including mortgage interest. Penalties for late payment are not considered interest. The definition permits the United States to apply its rules for distinguishing between interest and dividends.
Paragraph 5 provides that, where the debt-claim in respect of which the interest is paid is effectively connected (i.e., the interest is attributable) to a permanent establishment or fixed base which the beneficial owner of the interest maintains in the other Contracting State, that interest is not taxable in accordance with this Article but in accordance with the law of the State where the permanent establishment or fixed base is situated. It is understood that the tax in such cases will be imposed in accordance with the principles of Article 7 (Business Profits) or 14 (Independent Personal Services), as the case may be. Paragraph 5 applies only when the interest is attributable to a permanent establishment or fixed base in the State where the interest arises, as defined in paragraph 6. However, paragraph 2 of Article 22 (Other Income) provides the same result for interest attributable to a permanent establishment in the other State but which arises outside that State. Thus, interest derived by a resident of Italy which is attributable to a U.S. permanent establishment of that resident may be taxed by the United States either under this paragraph (if the interest arises in the United States) or under paragraph 2 of Article 22 (if the interest arises outside the United States).
Paragraph 6 defines the source of interest. Interest arises in a Contracting State if paid by that State, a political subdivision or local authority thereof, or a resident of that State. As an exception to this general rule, when the indebtedness is connected with a permanent establishment or fixed base of the payer in a Contracting State and the interest expense is borne (deducted in computing taxable income) by that permanent establishment or fixed base, the interest arises in the State where that permanent establishment or fixed base is located. Thus, interest paid by a resident of Italy or of a third country which is incurred in connection with a U.S. permanent establishment of the payer and deductible by that permanent establishment is considered to be of U.S. source. This rule limits the application of and is itself limited by section 861(a)(1)(C) of the Code insofar as the interest is beneficially owned by a resident of Italy. In such a case, the U.S. tax is limited in accordance with paragraph 2 or 3. Interest beneficially owned by residents of third countries is not affected by this Article and is taxable in accordance with U.S. law or another U.S. treaty, as applicable.
Paragraph 7 states that this Article shall not apply to interest payments between related persons in excess of the amount which would have been agreed upon at arm’s length. Such excess amount shall be taxed according to the laws of each Contracting State, with regard also to the other provisions of this Convention. For example, if the excess amount is treated as a dividend, the tax imposed will be subject to the limitations of Article 10 (Dividends).
It is to be noted that, in accordance with the "saving clause" of paragraph 2 of Article 1 (Personal Scope), the United States may in any event impose its tax on interest derived by U.S. citizens.
ARTICLE 12
Royalties
This Article limits the tax which may be imposed by either Contracting State on royalties derived and beneficially owned by a resident of the other State.
Paragraph 1 states that such royalties may be taxed in the State of residence of the beneficial owner. This provision confirms the provision of paragraph 2 of Article 1 (Personal Scope) that each Contracting State reserves the right to tax its residents.
Paragraph 2 provides that such royalties may also be taxed by the Contracting State in which they arise, but the tax is subject to specified limits when the beneficial owner of the royalties is a resident of the other State. The limits are:
5 percent of the gross royalties for the use of copyrighted literary, artistic, or scientific work;
7 percent of the gross royalties for the use of tangible personal property (see paragraph 10 of Article 1 of the Protocol);
8 percent of gross film rentals; and
10 percent of the gross amount of other royalties.
It is agreed that royalties for the use of, or the right to use, computer software will be considered "other" royalties subject to the 10 percent maximum tax at source under paragraph 2(c).
Paragraph 3 defines the term "royalties" for purposes of the Article. The definition, which is based on that of the OECD Model, is broader than the definition in the U.S. Model. For purposes of this Convention, film rentals and payments for the use of, or right to use, industrial, commercial or scientific equipment are also treated as royalties. The United States will also treat as royalties under this Article certain gains from the alienation of any such right or property which are contingent on the productivity, use, or disposition thereof, as described in internal law.
Paragraph 4 provides that, where the right or property giving rise to the royalties is effectively connected with (the royalties are attributable to) a permanent establishment or fixed base maintained by the beneficial owner of the royalties in the other Contracting State, the royalties are not taxable in accordance with this Article, but in accordance with the law of the State where the permanent establishment or fixed base is situated. It is understood that the tax in such cases will be imposed in accordance with the principles of Article 7 (Business Profits) or 14 (Independent Personal Services), as the case may be.
Paragraph 5 defines the source of royalties. In general, a royalty is considered to arise in a Contracting State if paid by the government or a resident of that State. However, if a permanent establishment or fixed base of the payer in one of the States incurs the liability to pay the royalties and bears the payment (deducts it in arriving at taxable income), the royalty is considered to arise in the State where the permanent establishment or fixed base is located. And, notwithstanding those two rules, if a royalty relates to the use of, or the right to use, property in a State, the royalty may be treated as arising in that State. Thus, for example, the United States will continue to consider as of U.S. source, in accordance with its domestic law, royalties paid by a resident of Italy to a resident of a third country for use of such a right or property within the United States. As the beneficial owner is not a resident of Italy, the limitations of paragraph 2 would not apply in this example.
Paragraph 6 provides that, where royalties paid between related persons exceed the amount which would have been determined at arm’s length, the provisions of this Article shall apply only to the arm’s length amount and the excess shall be taxable according to the law of each Contracting State, taking into account other provisions of the Convention.
Notwithstanding the provisions of this Article, the United States may tax its citizens in accordance with the “saving clause” of paragraph 2 of Article 1 (Personal Scope).
ARTICLE 13
Capital Gains
This Article provides rules for the taxation of gains derived by a resident of a Contracting State. In general, it provides that:
(1) gains from the alienation of immovable (real) property or certain business property may be taxed where the real property or the business is located;
(2) gains derived from the alienation of ships or aircraft or related property may be taxed only by the State of which the enterprise is a resident;
(3) gains from the alienation of any other property may be taxed only in the State of residence of the alienator.
Paragraph 1 states the rule that gains derived from the alienation of immovable property situated in a Contracting State may be taxed by that State. Paragraph 11 of Article 1 of the Protocol explains that, in the case of the United States, immovable property includes a United States real property interest and that such an interest is deemed to be situated in the United States. A "United States real property interest" is defined under the Foreign Investment in Real Property Tax Act, as amended. Thus, the United States retains its full taxing right under that law. In the case of Italy, immovable property includes property referred to in Article 6 and shares or interests in a body of persons or an estate whose assets consist principally of real property located in Italy. Such immovable property, shares or interests are deemed to be situated in Italy.
Paragraph 2 provides that gains with respect to personal property forming part of a permanent establishment or a fixed base which a resident of one Contracting State has in the other State may be taxed in the State where the permanent establishment or fixed base is located.
Paragraph 3 provides that, when an enterprise of a Contracting State derives gains with respect to the alienation of ships or aircraft operated by it in international traffic or of movable property pertaining to the operation of such ships or aircraft, the gain shall be taxable only in the State of residence of the enterprise. Paragraph 12 of Article 1 of the Protocol provides that this rule also applies to gains from the sale of containers and related equipment for the transport of containers used in international traffic. It also applies to gains from the alienation of ships and aircraft leased on a full basis if used in international traffic or if the leasing income is incidental to income from the operation of ships and aircraft in international traffic, and to gains from the alienation of ships or aircraft leased on a bareboat basis if the leasing income is incidental to income from the operation of ships and aircraft in international traffic.
Paragraph 4 provides that gains from the alienation of any other property shall be taxable only in the State of residence of the alienator.
Notwithstanding the provisions of this Article, the United States may tax its citizens in accordance with the "saving clause" of paragraph 2 of Article 1 (Personal Scope).
ARTICLE 14
Independent Personal Services
This Article concerns the taxation of income derived by a resident of one of the Contracting States from independent personal services.
An individual who is a resident of one Contracting State may be taxed by the other State on remuneration for independent personal services only if the services are performed in that other State and either the individual is present in that other State for an aggregate of more than 183 days in the taxable year or has a fixed base regularly available to him in that other State for the purpose of performing his activities. In the latter case, the other State may tax only the income attributable to that fixed base with respect to the services performed in that State.
The term "fixed base" is analogous to the term “permanent establishment.” Thus, a fixed base means a fixed place of business used with some continuity for performing independent services. It would not include a hotel room unless used as an office or work site on a continuing basis. The rules of Article 7 (Business Profits) should also be applied in taxing the profits attributable to a fixed base, e.g., taxation on a net basis using arm’s length pricing. However, the taxing right conferred in this Article with respect to self-employment income is more limited than that provided in Article 7 (Business Profits) for the taxation of business profits in that, in addition to being attributable to a fixed base in the taxing State, the self-employment income must be attributable to services performed in that State.
"Personal services in an independent capacity" include all personal services performed by an individual for his own account, including services performed as a partner in a partnership, where the individual receives the income and bears the losses arising from such services.
Notwithstanding the provisions of this Article, the United States may tax its citizens in accordance with the “saving clause” of paragraph 2 of Article 1 (Personal Scope).
ARTICLE 15
Dependent Personal Services
This Article provides the general rule for the taxation of remuneration derived by residents of one of the Contracting States as employees. Directors' fees are covered by Article 16, and pensions, annuities and remuneration of government employees are covered by Articles 18 and 19. Special rules concerning the remuneration of entertainers are provided in Article 17.
Remuneration for employee services may be taxed only in the Contracting State of which the employee is a resident, unless the employment is exercised in the other State. If the employment is so exercised, that other State may tax the remuneration for the services performed there, subject to the conditions set forth in paragraph 2.
Paragraph 2 provides that, even where a resident of one Contracting State performs services in the other State, the other State may not tax the income for such services if three conditions are met: the recipient is present in that State for not more than 183 days in the taxable year concerned, the remuneration is paid by or on behalf of an employer who is not a resident of that State, and the remuneration is not borne by (deducted by) a permanent establishment or a fixed base of that employer in that State. If any one of these conditions is not met, e.g., if the employer is a resident of the State where the services are performed, the income may be taxed by that State.
Paragraph 3 provides that remuneration for services regularly exercised aboard a ship or aircraft operated in international traffic by an enterprise of a Contracting State may be taxed only by that State. This provision is based on the corresponding provision of the OECD Model, rather than on the 1981 U.S. Model which assigns primary taxing jurisdiction to the country of residence of the employee. The term “regularly exercised” is intended to have the same meaning as the term “regular complement” used in the U.S. Model, i.e., it refers to the crew and other full time employees on board the ship or aircraft. It does not include persons who perform occasional services, such as entertainers who perform on cruise ships while they are in port.
Notwithstanding the provisions of this Article, the United States may tax its citizens in accordance with the “saving clause” of paragraph 2 of Article 1 (Personal Scope).
ARTICLE 16
Directors' Fees
This Article provides the rule found in the OECD Model that fees paid to company directors may be taxed in the Contracting State of which the paying company is a resident. (The residence of a company is determined under the domestic law of the respective States.) However, as explained in paragraph 13 of Article 1 of the Protocol, this rule only applies to the extent that the fees are attributable to services rendered in that State. Fees paid by a company which is a resident of one State to a director who is a resident of the other State for services performed outside the first-mentioned State may be taxed only in the State of residence of the director. Remuneration of directors who are also company officers for their services as company officers is covered by Article 15 (Dependent Personal Services).
Notwithstanding the provisions of this Article, the United States may tax its citizens in accordance with the “saving clause” of paragraph 2 of Article 1 (Personal Scope).
ARTICLE 17
Artistes And Athletes
This Article provides certain exceptions to the rules otherwise governing income from personal services in the case of income derived by entertainers and athletes.
Paragraph 1 provides that a resident of a Contracting State who performs personal services in the other State as an entertainer or athlete may be taxed in that other State on the remuneration for those services if either the gross receipts derived from such services, including expenses reimbursed or paid on his behalf, exceed $12,000 (or the equivalent in Italian lire) for the fiscal (i.e., taxable) year concerned, or the individual is present in that other State for an aggre¬gate of more than 90 days in that taxable year. If the gross receipts for such services exceed $12,000 for the taxable year, the full amount may be taxed by that other State, subject to any deductions allowable under its law. This rule overrides the provisions of Articles 14 (Independent Personal Services) and 15 (Dependent Personal Services) by adding an additional monetary basis for taxation at source and a shorter time threshold. However, if this Article does not permit taxation at source, the income may nevertheless be taxed by the State where the services are performed if such taxation is in accordance with the provisions of Article 14 or 15.
Income derived from services rendered by producers, directors, technicians and others who are not artistes or athletes is taxable in accordance with Article 14 or 15, as appropriate.
Paragraph 2 is substantially the same as the corresponding provision in the U.S. Model. Where income for services performed by an entertainer or athlete accrues to another person, it may be taxed in the State where the activities are performed without regard to the provisions of the Convention concerning business profits or income from independent personal services, unless it is established by the entertainer or athlete that neither he nor any related person participates in the profits of the recipient of the income. The intent of this provision is to prevent abuse of the Convention by diverting income to a person other than the individual performing the services, for example, by having the remuneration paid to a corporation which does not have a permanent establishment in the State where the services are performed.
Foreign entertainers commonly perform services in the United States as employees of, or contractors for, a company or other person. That person may act as the nominal recipient of the income in respect of the entertainer's services and the entertainer may act as its “employee” or “contractor.” In such cases, the company may escape taxation in respect to those services under the provisions of Article 7 (Business Profits) because it does not have a permanent establishment in the United States. The entertainer may also escape taxation by receiving a small salary in the year the services were performed in the United States and then either receiving payment in a later year when the income is subject to little or no U.S. tax, or liquidating the company after the services are performed. Under paragraph 2, such other person could not claim the permanent establishment protection otherwise provided by Articles 5 (Permanent Establishment) and 7 (Business Profits) and the income would not be entitled to the benefits of Article 14 (Independent Personal Services) or 15 (Dependent Personal Services).
For purposes of paragraph 2, income is considered to accrue to another person if that other person has control over, or the right to receive, gross income derived in respect of the services of an entertainer or athlete. This rule applies regardless of whether the other person is a “sham” or conduit. Income will not, however, be deemed to accrue to the benefit of another person where it is established to the satisfaction of the competent authority of the Contracting State in which the services are performed that neither the artiste or athlete, nor related persons, participate directly or indirectly in profits of such other person in any manner, including the receipt of deferred compensation, bonuses, fees, dividends, partnership distributions, or other distributions. Depending on the facts in a particular case, a person may be considered to be related to an artiste or athlete if he is an employee or agent of the artiste or athlete or if he is regularly employed by the artiste or athlete in an advisory capacity, such as his attorney, accountant, or investment advisor.
Notwithstanding the provisions of this Article, the United States may tax its citizens in accordance with the “saving clause” of paragraph 2 of Article 1 (Personal Scope).
ARTICLE 18
Pensions, Etc.
This Article deals with the taxation of pensions, annuities, alimony and child support payments and is supplemented by a provision in the Protocol dealing with social security payments.
Paragraph 1 provides that pensions derived and beneficially owned by a resident of a Contracting State in consideration of past employment shall be taxable only in that State. However, pensions in consideration of government employment are covered under Article 19 (Government Service). Paragraph 14 of Article 1 of the Protocol provides that social security benefits and similar public pensions not covered by Article 19 are covered by this paragraph. Thus, social security benefits derived by a resident of a Contracting State are taxable only in that State. The exemption from tax at source of social security benefits is preserved (i.e., excepted from the saving clause) for residents of the other country who are nationals of that country or dual nationals. However, a U.S. citizen resident in Italy who is not also an Italian citizen is not exempt from U.S. tax under this provision. (See paragraph 2 of Article 1 of the Protocol.)
Paragraph 2 provides that annuities beneficially owned by a resident of a Contracting State shall be taxable only in that State, and provides a definition of the term "annuities."
Paragraph 3 provides rules for the taxation of alimony and child support payments made by a resident of one Contracting State to a resident of the other State and defines the terms “alimony” and “child support”. The general rule is that such payments are taxable only in the country of residence of the recipient. However, if the payer is not entitled to a deduction in his country of residence, the amount will not be taxable to the recipient in either State. Thus, for example, since under present law alimony is deductible by the payer in each country, it is taxable to the recipient only in his country of residence, and since child support is not deductible by the payer in either country, it will not be taxable to the recipient in either country. The United States does not tax child support payments to the recipient; in the absence of the Convention, Italy would generally do so.
The reference to “entitled to” a deduction means permitted to claim a deduction under statutory rules. For example, a U.S. taxpayer who did not claim a deduction for alimony because he claimed the zero bracket amount or because he had a loss from other activities is nevertheless "entitled to" such a deduction if it is allowed by the Code. The provisions of this paragraph are excepted from the saving clause; thus a U.S. citizen resident in Italy will not be subject to U.S. tax on alimony or child support payments received from a U.S. resident if under this paragraph the exclusive right to tax is assigned to Italy as the country of residence.
ARTICLE 19
Government Service
This Article deals with the taxation of remuneration paid by a Contracting State for the performance of governmental functions for that State or a political or administrative subdivision.
Paragraph 1 provides that, as the general rule, such remuneration shall be taxable only in the paying State. However, if the services are rendered in the other State by an individual who is both a resident and a citizen of that other State, or who is a resident of that other State and did not become a resident solely for the purpose of rendering such services, then the income is taxable only in the State where the services are performed. If the spouse or dependent child of an individual who under this paragraph is taxable only in the paying state should also perform governmental functions in the other State, the remuneration for those functions is taxable only in the paying State, provided that the spouse or child is not a national of the other State. This rule is intended to benefit, for example, the spouse of a U.S. Embassy official in Rome who accepts employment at the U.S. Embassy after having become a resident of the host country.
Paragraph 2 provides that a pension paid to any individual by a Contracting State or a political subdivision or local authority as consideration for services rendered is taxable only in that State unless the recipient is both a resident and a national of the other State. In the latter case, such a pension is taxable only in that other State.
The exemption is limited to remuneration and pensions in respect of services of a governmental nature. Remuneration and pensions for services to a government-owned business are taxable under the provisions of Articles 14 (Independent Personal Services), 15 (Dependent Personal Services), 16 (Directors' Fees), 17 (Artistes and Athletes) and 18 (Pensions, Etc.), as the case may be. Whether functions are of a governmental nature is determined by reference to the concept of a governmental function in the State in which the income arises. It is understood that the Italian Government agencies, ICE, a state enterprise under the Ministry of Commerce which promotes Italian exports, and ENIT, a state agency which promotes tourism, perform governmental functions in the meaning of this Article. On the other hand, employment by a government-owned airline does not constitute employment of a governmental nature.
ARTICLE 20
Professors And Teachers
This Article provides that a professor or teacher who is a resident of one Contracting State and temporarily visits the other State to teach or conduct research at an educational institution in that other State or at a medical facility primarily financed by government funds will be exempt from tax in that other State on the remuneration for such teaching or research for two years. The exemption does not apply, however, if the research is conducted for private benefit rather than in the general public interest.
It is possible that an individual who meets the qualifications of this Article, including the requirement that the visit be “temporary” may remain in the other State longer than two years, in which case the exemption applies for the first two years of the visit.
The individual meets the residence test if he was a resident of the first-mentioned State immediately before visiting the other State, even if he should cease to be considered a resident of the first State during his absence. However, the benefits of this Article are not available to persons who acquire immigrant status in the other State or are citizens of that other State, in accordance with paragraph 3(b) of Article 1 (Personal Scope).
ARTICLE 21
Students And Trainees
This Article provides that a resident of a Contracting State who goes to the other State exclusively for the purpose of education or training shall be exempt from tax in that other State on payments received by the student or trainee which arise outside that State and which are for the purpose of his maintenance, education or training. Any remuneration for services performed in that other State is considered to arise in that State and is taxable in accordance with Article 14 (Independent Personal Services), 15 (Dependent Personal Services), 17 (Artistes and Athletes), or 19 (Government Service).
The individual meets the residence test if he was a resident of the first-mentioned State immediately before visiting the other State, even if he should cease to be considered a resident of the first State during his absence. However, the benefits of this Article are not available to persons who acquire immigrant status in the other State or are citizens of that other State, in accordance with paragraph 3 (b) of Article 1 (Personal Scope).
ARTICLE 22
Other Income
This Article provides that any income of a resident of a Contracting State which is not covered by the other articles of the Convention may be taxed only in that State. However, as noted above, the United States may in any event tax its citizens in accordance with paragraph 2 of Article 1 (Personal Scope).
Paragraph 2 provides an exception for income, other than income from real property, when the right or property giving rise to the income is effectively connected (the income is attributable to) a permanent establishment or fixed base maintained by the recipient in the other State. Such income, which includes dividends, interest, and royalties from third States which are attributable to a permanent establishment or fixed base in a Contracting State, is taxable under the provisions of Article 7 (Business Profits) or 14 (Independent Personal Services).
The exception for income from real property means that income of a resident of a Contracting State from real property situated in a third State may not be taxed by the other State.
Relatively few items of income, mainly of an occasional nature such as prizes, are expected to be covered by this Article.
ARTICLE 23
Relief from Double Taxation
This Article describes the manner in which the United States and Italy will undertake to avoid double taxation of their residents and, in the case of the United States, its citizens.
The United States agrees to give a foreign tax credit for income taxes paid to Italy, in accordance with the provisions and subject to the limitations of U.S. law. Credit is allowed for taxes paid directly by or on behalf of the income recipient. In addition, in the case of a U.S. company owning at least 10 percent of the voting stock of a company which is a resident of Italy from which it receives dividends, credit is allowed for the underlying corporate tax on the profits of the Italian company out of which the dividends are paid. This "indirect" credit is not allowed when the paying corporation is incorporated in the United States.
The Italian taxes referred to in paragraphs 2 (b) and 3 of Article 2 (Taxes Covered) are considered income taxes for purposes of the credit. As noted in that Article, the Italian local income tax is not covered to the extent that it is imposed on “cadastral” income (the imputed rental value of real property based on real estate assessments). To the extent that the local tax is imposed on such income, its creditability will be decided under the standards of the Code.
The Convention's guarantee of a foreign tax credit is independent of the statutory grant of a credit under the Code, but the amount of the credit to be allowed is determined in accordance with the limitations provided in the Code. (See, e.g., sections 904 (a) and (g).)
Except where the Convention requires otherwise, Italy may include in the tax base of its residents those items of income which the United States may tax under the Convention other than solely because the owner of the income is a U.S. citizen. In such a case, the U.S. taxes referred to in paragraphs 2 (a) and 3 of Article 2 (Taxes Covered) will be allowed as a credit against the Italian tax liability in an amount not to exceed the U.S. tax paid (other than by reason of citizenship) or the proportion of Italian tax which the U.S. income bears to the total income of the taxpayer.
The exemption method, rather than the credit method, is used by Italy to avoid double taxation where the Convention so requires, for example, with respect to payments of child support made by a U.S. resident to an Italian resident.
Italy will not give a foreign tax credit in cases where the taxpayer has elected under Italian law to pay a final withholding tax on an item of income, (e.g., dividends), thereby excluding that income from the tax base subject to the ordinary rates of tax.
Italy does not grant an indirect credit comparable to the credit authorized by section 902 of the Code. However, under Article 2359 of Italy's tax law, a portion of the dividends received by an Italian corporation from a foreign subsidiary (defined in terms of 10 percent ownership or a “controlling interest”) are excluded from the tax base.
Paragraph 4 provides source rules to be used by the United States in allowing relief from double taxation under this Article. Alternatively, taxpayers may use the foreign tax credit rules (including the source rules) of the Code. Subparagraph (a) provides in general that, for purposes of this Article, income derived by a resident of the United States which may be taxed by Italy under the Convention has its source in Italy, and income derived by a resident of Italy which may be taxed by the United States under the Convention has its source in the United States. However, subparagraph (b) provides, as an exception, that income taxed by the United States solely because it is derived by a U.S. citizen will be considered to have its source in Italy to the extent necessary to avoid double taxation. The amount of U.S. source income of U.S. citizens resident in Italy which is recharacterized as Italian source under this subparagraph may not be greater than the amount necessary to reduce the U.S. tax to the tax the United States may impose under the Convention on an Italian resident who is not a U.S. citizen. The income resourced in such cases is treated as foreign source income only for purposes of crediting the Italian income taxes designated in paragraph 2 (b) and 3 of Article 2 (Taxes Covered); other foreign income taxes may not be claimed as a credit against the U.S. tax on such resourced income.
ARTICLE 24
Non-Discrimination
This Article provides certain criteria of non-discriminatory application of the taxes covered by the Convention.
Paragraph 1 provides that nationals, as defined in Article 3 (General Definitions), of a Contracting State shall not be taxed less favorably in the other State than nationals of that other State who are in the same circumstances. For U.S. tax purposes, United States citizens, who are liable to U.S. tax on their worldwide income, are not in the same circumstances as Italian citizens who are not residents of the United States.
Paragraph 2 provides that a Contracting State may not impose more burdensome taxes on a permanent establishment of an enterprise of the other State than it imposes on its own enterprises carrying on the same activities. This rule does not require a State to extend to nonresidents personal tax relief granted to residents to reflect their civil status or family responsibilities.
Paragraph 3 prohibits discrimination in the matter of deductions, interest, royalties, and other disbursements by an enterprise of a Contracting State to a resident of the other State must be deductible for determining taxable profits under the same conditions as if they had been paid to a resident of the first-mentioned State. The term "other disbursements" is understood to include a reasonable allocation of executive and administrative expenses, research and development expenses, and other expenses incurred for a group of related enterprises.
Paragraph 4 requires that a Contracting State not impose more burdensome taxation on a subsidiary corporation owned by residents of the other State than it imposes on similar corporations which are locally owned.
Paragraph 5 states that, for purposes of this Article, the Convention applies to taxes of all kinds imposed by all political levels; it is not limited to the taxes specified in Article 2 (Taxes Covered).
ARTICLE 25
Mutual Agreement Procedure
This Article provides for cooperation between the competent authorities to resolve problems of double taxation.
Paragraph 1 provides that a taxpayer who considers that the actions of one or both of the Contracting States may result in taxation not in accordance with the Convention may present his case to the competent authority of the State of which he is a resident. If the case comes under Article 23 (Relief from Double Taxation) or paragraph 1 of Article 24 (Non-Discrimination) he may choose instead to present the case to the competent authority of the State of which he is a national. The OECD Model permits this option with respect to non-discrimination cases. The U.S. Model permits a taxpayer to seek relief from the competent authority of his state of residence or citizenship in all cases. The compromise adopted in the Convention adds to the OECD rule that a taxpayer also may seek relief from the competent authority of his country of citizenship in double taxation cases.
Paragraph 2 provides that the competent authority, if it considers the objection to be justified and if it is not able to arrive at a solution itself, shall endeavor to resolve the case by mutual agreement with the competent authority of the other Contracting State. The Convention does not include the rule of the U.S. Model that any agreement reached shall be implemented without regard to any statutory time limits of the States. However, provided that the taxpayer protests an Italian assessment within the required time period (60 days from the date of the assessment), the statute of limitations in Italy does not begin to run with respect to an adjustment of U.S. tax until the notification of such adjustment. And, provided that the tax due in Italy has not been finally determined at the time the competent authorities reach agreement, a refund of excess tax paid to Italy can be made even though the domestically applicable statute of limitations may have expired. However, as stated in paragraph 15 of Article 1 of the Protocol (discussed also under Article 9 (Associated Enterprises)), it is essential that the taxpayer protest the Italian assessment within the time limits prescribed by Italian law. Similarly, for U.S. tax purposes, a taxpayer may claim a refund only within the statute of limitations. In neither State will additional tax be imposed if the statute of limitations has expired.
Paragraph 3 provides that the competent authorities shall endeavor by mutual agreement to resolve any difficulties or doubt which may arise in the interpretation or application of the Convention. It is understood that the competent authorities may agree, for example, on the same allocation of income, deductions, credits or allowances; on the same characterization of items of income; on the same application of source rules with respect to particular items of income; and on a common meaning of a term. They may also discuss the application of the provisions of domestic law regarding penalties, fines and interest in a manner consistent with the purposes of the Convention. However, it is understood that this provision is not a broad grant of authority but is meant to allow the competent authorities to apply the principles of the Convention to settle difficulties or doubts which may arise in specific situations.
Paragraph 4 provides that the competent authorities may communicate with each other directly for the purpose of reaching agreements in accordance with this Article.
This Article is excepted from the “saving clause” of paragraph 2 of Article 1 (Personal Scope). Thus, the United States is required to extend the benefits of this Article to persons who are residents or citizens of the United States.
ARTICLE 26
Exchange Of Information
This Article provides for the exchange of information relevant to the assessment of taxes covered by the Convention.
Paragraph 1 provides that the competent authorities shall exchange such information as is necessary for carrying out the provisions of the Convention or of their domestic laws concerning taxes covered by the Convention. The information exchanged may concern any national level tax, provided that the information is relevant to assessing the taxes covered by the Convention. (See paragraph 16 of Article 1 of the Protocol.)
It also provides assurances that information so exchanged will be protected in the same manner as information obtained under domestic laws with respect to secrecy and disclosure. Persons involved in the administration of taxes covered by the Convention include legislative bodies involved in the administration of taxes and their agents such as, for example, the United States General Accounting Office. Therefore, information may be disclosed to them, subject to the limitations of this Article and the internal law of the respective Contracting State. (See paragraph 16 of Article 1 of the Protocol.)
Paragraph 2 explains that the obligation undertaken in paragraph 1 does not require a Contracting State to carry out measures contrary to the laws and administrative practice of either State, to supply information not obtainable under its laws or in the normal course of the administration of either State, or to supply information which would disclose trade secrets or other information the disclosure of which is contrary to public policy.
Article 6 of the Protocol provides that each Contracting State may collect on behalf of the other State such amounts as may be necessary to ensure that Treaty tax benefits do not improperly accrue to residents of third countries, for example, that reduced rates of withholding on dividends, interest or royalties under the Convention are not claimed by third country residents using an address in one of the States. Italy withholds tax on dividends, interest and royalties at the full rate and grants refunds to the extent necessary to reduce the tax to the limits authorized in its treaties on the basis of an official certification of residence of the claimant. The Italian competent authority is empowered to collect tax on behalf of the United States under this provision and will attempt to do so.
ARTICLE 27
Diplomatic Agents and Consular Officials
This Article corresponds to Article 27 of the U.S. Model. It provides that the Treaty shall not affect taxation privileges of diplomatic or consular officials under other special agreements or under international law.
ARTICLE 28
Entry into Force
The Convention is subject to ratification. Instruments of ratification will be exchanged at Washington.
The Convention enters into force on the date on which the instruments of ratification are exchanged. Its provisions with respect to withholding taxes will have effect for amounts paid or credited on or after the first day of the second month following the entry into force of the Convention. With respect to other taxes, the provisions will have effect for taxable periods beginning on or after January 1 of the year the Convention enters into force. Thus, for example, if instruments of ratification are exchanged in November 1985, the provisions of the Convention will take effect as of January 1, 1986, for withholding taxes and for taxable years beginning on or after January 1, 1985 for other taxes.
The 1956 Convention and the letters exchanged on December 13, 1974, relating to that Convention, will cease to have effect in relation to any tax in respect of which the Convention comes into effect. However, if the 1956 Convention would have afforded any greater relief from tax than the corresponding provision of this Convention, any such provision shall continue in effect for the first taxable year in which this Convention would otherwise have effect under paragraph 2 (i.e., in the case of taxes other than withholding taxes, for taxable years beginning before January 1, 1986).
The 1926 Exchange of Notes providing relief from double taxation of shipping profits is terminated. (However, see the discussion of Article 8 (Shipping and Air Transport).)
ARTICLE 29
Termination
The Convention shall remain in force indefinitely unless terminated by one of the Contracting States. Either State may terminate the Convention after five years from the date on which it enters into force by giving at least six months prior notice through diplomatic channels. In that event, the Convention will cease to have effect with respect to taxes withheld at the source for amounts paid or credited on or after January 1 following the termination date and, with respect to other taxes, for taxable periods beginning on or after January 1 following the termination date.
PROTOCOL
A Protocol to the Convention, signed on the same occasion and having equal force, amplifies the provisions of the Convention.
Article 1.
Article 1 of the Protocol contains sixteen paragraphs which modify or elaborate on certain provisions of Articles 1, 2, 5, 8, 9, 10, 12, 13, 16, 18, 25 and 26 of the Convention. Those provisions have been discussed above in connection with the relevant Article of the Convention.
Article 2.
The second Article of the Protocol limits the benefits of the Convention to bona fide residents of the Contracting States. It is intended to prevent residents of third countries from inappropriately using, for example, a company which is a resident of one of the States as a conduit or similar vehicle to obtain Treaty benefits. However, this Convention is not expected to be the subject of abuse, given the tax burden imposed by both countries, including source taxation on income of nonresidents, the retention of withholding taxes at source under the Convention that are not insignificant, and the shared interest of both countries in preventing tax fraud and evasion. Specifically, paragraph 1 provides that a person (other than an individual) which is a resident of one of the Contracting States is entitled to relief from taxation granted by the other State under Articles 7 (Business Profits), 10 (Dividends), 11 (Interest), 12 (Royalties), 13 (Capital Gains) or 22 (Other Income) only if certain conditions are met.
Treaty benefits will not be denied if either of two objective tests is met. The first test is met if more than 50 percent of the beneficial ownership of the person receiving the income (or, if a company, more than 50 percent of the number of each class of its shares) is owned, directly or indirectly, by any combination of individuals who are residents of either Contracting State, citizens of the United States, the States themselves, or publicly traded companies which are residents of a Contracting State. Under the second test, a publicly traded company that is a resident of the United States or Italy is entitled to Treaty benefits. Under this test, Treaty benefits are not denied if there is substantial and regular trading of the principal class of shares of such a company on a recognized stock exchange.
Paragraph 2 provides that, notwithstanding the tests of paragraph 1, Treaty benefits are allowed if the establishment, acquisition and maintenance of the person and the conduct of its operations did not have as a principal purpose the purpose of obtaining Treaty benefits. This provision recognizes that ownership of an entity that is a resident of the United States or Italy by persons resident in third countries is not uncommon, and that granting Treaty benefits to such an entity may be consistent with the goals of the Treaty. For example, this test would be met if an Italian company owned by third country residents conducts business operations in Italy and its U.S. investments are related or incidental to those business activities, or if the aggregate Italian tax burden equals or exceeds the tax reduction claimed under the Convention. It could also be met in other situations.
Paragraph 3 defines a “recognized stock exchange” for the purposes of paragraph 1(b). A recognized stock exchange includes U.S. stock exchanges registered with the Securities and Exchange Commission, the NASDAQ system, and stock exchanges constituted under the laws of Italy. In addition, the competent authorities may agree that an exchange other than those specifically mentioned is a recognized exchange.
This Article is not meant to impose any added burden on withholding agents, and withholding agents will not be required to verify a person's ownership or purposes.
In applying this Article the normal burden of proof rules apply. For example, under present U.S. procedures, an entity that is a resident of Italy and that believes it is entitled, under one of the alternative tests of this Article, to the 15 percent U.S. tax rate on royalties provided by Article 12 would file a U.S. Form 1001 with the appropriate withholding agent to claim the benefit. Of course, the Internal Revenue Service could, on audit, examine the transaction.
Article 3.
Article 3 of the Protocol provides the rule, discussed above in connection with Article 1 (Personal Scope) of the convention, that the Convention does not deprive a taxpayer of any benefit available under internal law or under any other agreement between the United States and Italy.
Article 4.
Article 4 provides special relief for U.S. citizens resident in Italy from an otherwise discriminatory feature of Italian law concerning the taxation of income from foreign partnerships. Under Italian law, the partners (whether or not residents of Italy) of an Italian partnership are taxed on their share of the partnership income under the individual income tax (IRPF). The local income tax (ILOR) applies at the partnership level, but the national corporation income tax (IRPG) is not imposed. In the case of non-Italian partnership, the partnership as such is subject to both the local income tax and the national corporation tax on the profits of its Italian operations and the partners are taxed individually on their share of the profits. A partnership is considered Italian under Italian law if it has its legal seat or principal place of business activity in Italy.
Resident partners are taxable on their share of partnership income from all sources while nonresident partners (e.g., those resident in the United States) would be taxed on their share of the after-tax profits of the Italian office.
Under the Treaty, Italy will continue to tax the income of a U.S. partnership attributable to its Italian permanent establishment. It will not subject to individual income tax the partners' shares of that partnership income. And under this Article, Italy agrees to avoid double taxation of the share of such partnership income of U.S. citizens who are residents of Italy by allowing them to credit against their liability for Italian individual income tax their pro rata portion of the corporation income tax imposed in that year on the income of the Italian office. If the corporation tax credit exceeds the applicable individual income tax, the excess is refundable. A U.S. partnership for this purpose is a U.S. national, defined (in Article 3 (General Definitions)) as a partnership deriving its status as such under the laws in force in the United States.
Article 5.
Article 5 confirms Italy's practice of granting reduced rates of tax in a Treaty by initially withholding tax at the statutory rate and providing refunds of the excess over the Treaty rate on the basis of an official certification that the claimant is a resident of the Treaty country entitled to such benefits. This Article simply confirms Italy's existing practice. It does not prevent either Contracting State from changing its method of implementing Treaty benefits.
Article 6.
Article 6 of the Protocol, as discussed in connection with Article 26 (Exchange of Information) of the Convention, provides for assistance in collecting taxes which have been reduced under the Treaty to the benefit of persons not entitled to such benefits.
Article 7.
Article 7 provides that the Protocol is subject to ratification and shall enter into force on the exchange of instruments of ratification, which is to take place in Washington. It will then have effect in accordance with the provisions of Article 28 (Entry into Force) of the Convention.
Article 8.
Article 8 provides that the Protocol shall remain in force as long as the Convention signed on this same date remains in force.
EXCHANGE OF NOTES
An Exchange of Notes, signed at the same time as the Convention and Protocol, expresses the concern of the Italian Government about the failure of the Convention to cover state and local income taxes imposed in the United States. Since the Convention does apply to the local income tax imposed in Italy, the Convention is not reciprocal in this respect.
It is the position of the Italian Government that the "unitary apportionment" method used by certain states of the United States to allocate income to United States offices or subsidiaries of Italian corporations is inequitable and administratively burdensome to Italian corporations doing business in those states. It is the Italian position that the income of the United States offices and subsidiaries of Italian corporations should be determined on an arm's length basis for state income tax purposes as it is for Federal income tax purposes. In the Note, Italy recognizes that the Senate rejected a proposed limitation on the use of "unitary apportionment" by the states in the United Kingdom income tax Treaty and has not consented to such a limitation in any tax Treaty. The United States agrees to reopen discussions with Italy on this subject should an acceptable provision be devised in future.
Further, Italy reserves the right to reopen discussions with the United States in the event that state taxation should change after the date of signature in a manner which has a substantial adverse effect on residents of Italy.
The final point in the note states that, if a U.S. state or local government should impose tax on the profits of Italian enterprises from the operation of ships or aircraft in international traffic, Italy may impose its local income tax on the profits of U.S. enterprises from such activities, notwithstanding Articles 2 (Taxes Covered) and 8 (Shipping and Air Transport) of the Convention.
July 30, 1985
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