<DOC>
[Joint Comm. on Taxation]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:85197.wais]
[JOINT COMMITTEE PRINT]
EXPLANATION OF PROPOSED PROTOCOL
TO THE INCOME TAX TREATY BETWEEN
THE UNITED STATES AND MEXICO
Scheduled for a Hearing
Before the
COMMITTEE ON FOREIGN RELATIONS
UNITED STATES SENATE
ON MARCH 5, 2003
__________
Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION
[GRAPHIC] [TIFF OMITTED]CONGRESS.#13
March 3, 2003
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U.S. GOVERNMENT PRINTING OFFICE
85-197 WASHINGTON : 2003 JCS-6-03
JOINT COMMITTEE ON TAXATION
108th Congress, 1st Session
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HOUSE SENATE
WILLIAM M. THOMAS, California, CHARLES E. GRASSLEY, Iowa,
Chairman Vice Chairman
PHILIP M. CRANE, Illinois ORRIN G. HATCH, Utah
E. CLAY SHAW, Jr., Florida DON NICKLES, Oklahoma
CHARLES B. RANGEL, New York MAX BAUCUS, Montana
FORTNEY PETE STARK, California JOHN D. ROCKEFELLER IV, West
Virginia
Mary M. Schmitt, Acting Chief of Staff
Bernard A. Schmitt, Deputy Chief of Staff
C O N T E N T S
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Page
Introduction..................................................... 1
I. Summary...........................................................2
II. Overview of U.S. Taxation of International Trade and Investment and
U.S. Tax Treaties.................................................3
A. U.S. Tax Rules........................................ 3
B. U.S. Tax Treaties..................................... 4
III.Explanation of Proposed Protocol..................................7
Article 1. General Scope................................. 7
Article 2. Dividends..................................... 8
Article 3. Branch Tax.................................... 14
Article 4. Capital Gains................................. 16
Article 5. Relief From Double Taxation................... 16
Article 6. Entry Into Force.............................. 17
Article 7. Remaining in Force............................ 18
IV. Issues...........................................................19
A. Zero Rate of Withholding Tax on Dividends from 80-
Percent-Owned Subsidiaries........................... 19
B. Visiting Teachers and Professors...................... 22
INTRODUCTION
This pamphlet,\1\ prepared by the staff of the Joint
Committee on Taxation, describes the proposed protocol to the
income tax treaty between the United States of America and
Mexico (``the proposed protocol''). The proposed protocol was
signed on November 26, 2002. The Senate Committee on Foreign
Relations has scheduled a public hearing on the proposed treaty
for March 5, 2003.
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\1\ This pamphlet may be cited as follows: Joint Committee on
Taxation, Explanation of Proposed Protocol to the Income Tax Treaty
Between the United States and Mexico (JCS-6-03), March 3, 2003.
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Part I of the pamphlet provides a summary of the proposed
protocol. Part II provides a brief overview of U.S. tax laws
relating to international trade and investment and of U.S.
income tax treaties in general. Part III contains an article-
by-article explanation of the proposed protocol. Part IV
contains a discussion of issues relating to the proposed
protocol.
I. SUMMARY
The principal purposes of the proposed protocol are to
reduce or eliminate the double taxation of income earned by
residents of either country from sources within the other
country and to prevent avoidance or evasion of the taxes of the
two countries. The proposed protocol also is intended to
promote close economic cooperation between the two countries
and to eliminate possible barriers to trade and investment
caused by overlapping taxing jurisdictions of the two
countries.
As in other U.S. tax treaties, these objectives principally
are achieved through each country's agreement to limit, in
certain specified situations, its right to tax income derived
from its territory by residents of the other country. In the
case of dividends, the proposed protocol contains provisions
that would eliminate source-country tax on certain intercompany
dividends in which certain ownership thresholds and other
requirements are satisfied. In addition, the proposed protocol
would provide a parallel exemption from the U.S. branch profits
tax (Articles 2 and 3 of the proposed protocol).
In situations in which the country of source retains the
right under the proposed treaty to tax income derived by
residents of the other country, the proposed protocol generally
provides for relief from the potential double taxation through
the allowance by the country of residence of a tax credit for
certain foreign taxes paid to the other country (Articles 4 and
5 of the proposed protocol).
The United States and Mexico have an income tax treaty
currently in force (signed September 18, 1992, together with a
protocol of the same date and a second protocol signed
September 8, 1994). The proposed protocol includes provisions
similar to those of other recent U.S. income tax treaties, the
1996 U.S. model income tax treaty (``U.S. model''), and the
1992 model income tax treaty of the Organization for Economic
Cooperation and Development, as updated (``OECD model'').
However, the proposed protocol contains certain substantive
deviations from these treaties and models.
II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL TRADE AND INVESTMENT AND
U.S. TAX TREATIES
This overview briefly describes certain U.S. tax rules
relating to foreign income and foreign persons that apply in
the absence of a U.S. tax treaty. This overview also discusses
the general objectives of U.S. tax treaties and describes some
of the modifications to U.S. tax rules made by treaties.
A. U.S. Tax Rules
The United States taxes U.S. citizens, residents, and
corporations on their worldwide income, whether derived in the
United States or abroad. The United States generally taxes
nonresident alien individuals and foreign corporations on all
their income that is effectively connected with the conduct of
a trade or business in the United States (sometimes referred to
as ``effectively connected income''). The United States also
taxes nonresident alien individuals and foreign corporations on
certain U.S.-source income that is not effectively connected
with a U.S. trade or business.
Income of a nonresident alien individual or foreign
corporation that is effectively connected with the conduct of a
trade or business in the United States generally is subject to
U.S. tax in the same manner and at the same rates as income of
a U.S. person. Deductions are allowed to the extent that they
are related to effectively connected income. A foreign
corporation also is subject to a flat 30-percent branch profits
tax on its ``dividend equivalent amount,'' which is a measure
of the effectively connected earnings and profits of the
corporation that are removed in any year from the conduct of
its U.S. trade or business. In addition, a foreign corporation
is subject to a flat 30-percent branch-level excess interest
tax on the excess of the amount of interest that is deducted by
the foreign corporation in computing its effectively connected
income over the amount of interest that is paid by its U.S.
trade or business.
U.S.-source fixed or determinable annual or periodical
income of a nonresident alien individual or foreign corporation
(including, for example, interest, dividends, rents, royalties,
salaries, and annuities) that is not effectively connected with
the conduct of a U.S. trade or business is subject to U.S. tax
at a rate of 30 percent of the gross amount paid. Certain
insurance premiums earned by a nonresident alien individual or
foreign corporation are subject to U.S. tax at a rate of 1 or 4
percent of the premiums. These taxes generally are collected by
means of withholding.
Specific statutory exemptions from the 30-percent
withholding tax are provided. For example, certain original
issue discount and certain interest on deposits with banks or
savings institutions are exempt from the 30-percent withholding
tax. An exemption also is provided for certain interest paid on
portfolio debt obligations. In addition, income of a foreign
government or international organization from investments in
U.S. securities is exempt from U.S. tax.
U.S.-source capital gains of a nonresident alien individual
or a foreign corporation that are not effectively connected
with a U.S. trade or business generally are exempt from U.S.
tax, with two exceptions: (1) gains realized by a nonresident
alien individual who is present in the United States for at
least 183 days during the taxable year, and (2) certain gains
from the disposition of interests in U.S. real property.
Rules are provided for the determination of the source of
income. For example, interest and dividends paid by a U.S.
citizen or resident or by a U.S. corporation generally are
considered U.S.-source income. Conversely, dividends and
interest paid by a foreign corporation generally are treated as
foreign-source income. Special rules apply to treat as foreign-
source income (in whole or in part) interest paid by certain
U.S. corporations with foreign businesses and to treat as U.S.-
source income (in whole or in part) dividends paid by certain
foreign corporations with U.S. businesses. Rents and royalties
paid for the use of property in the United States are
considered U.S.-source income.
Because the United States taxes U.S. citizens, residents,
and corporations on their worldwide income, double taxation of
income can arise when income earned abroad by a U.S. person is
taxed by the country in which the income is earned and also by
the United States. The United States seeks to mitigate this
double taxation generally by allowing U.S. persons to credit
foreign income taxes paid against the U.S. tax imposed on their
foreign-source income. A fundamental premise of the foreign tax
credit is that it may not offset the U.S. tax liability on
U.S.-source income. Therefore, the foreign tax credit
provisions contain a limitation that ensures that the foreign
tax credit offsets only the U.S. tax on foreign-source income.
The foreign tax credit limitation generally is computed on a
worldwide basis (as opposed to a ``per-country'' basis). The
limitation is applied separately for certain classifications of
income. In addition, a special limitation applies to the credit
for foreign taxes imposed on foreign oil and gas extraction
income.
For foreign tax credit purposes, a U.S. corporation that
owns 10 percent or more of the voting stock of a foreign
corporation and receives a dividend from the foreign
corporation (or is otherwise required to include in its income
earnings of the foreign corporation) is deemed to have paid a
portion of the foreign income taxes paid by the foreign
corporation on its accumulated earnings. The taxes deemed paid
by the U.S. corporation are included in its total foreign taxes
paid and its foreign tax credit limitation calculations for the
year in which the dividend is received.
B. U.S. Tax Treaties
The traditional objectives of U.S. tax treaties have been
the avoidance of international double taxation and the
prevention of tax avoidance and evasion. Another related
objective of U.S. tax treaties is the removal of the barriers
to trade, capital flows, and commercial travel that may be
caused by overlapping tax jurisdictions and by the burdens of
complying with the tax laws of a jurisdiction when a person's
contacts with, and income derived from, that jurisdiction are
minimal. To a large extent, the treaty provisions designed to
carry out these objectives supplement U.S. tax law provisions
having the same objectives; treaty provisions modify the
generally applicable statutory rules with provisions that take
into account the particular tax system of the treaty partner.
The objective of limiting double taxation generally is
accomplished in treaties through the agreement of each country
to limit, in specified situations, its right to tax income
earned from its territory by residents of the other country.
For the most part, the various rate reductions and exemptions
agreed to by the source country in treaties are premised on the
assumption that the country of residence will tax the income at
levels comparable to those imposed by the source country on its
residents. Treaties also provide for the elimination of double
taxation by requiring the residence country to allow a credit
for taxes that the source country retains the right to impose
under the treaty. In addition, in the case of certain types of
income, treaties may provide for exemption by the residence
country of income taxed by the source country.
Treaties define the term ``resident'' so that an individual
or corporation generally will not be subject to tax as a
resident by both the countries. Treaties generally provide that
neither country will tax business income derived by residents
of the other country unless the business activities in the
taxing jurisdiction are substantial enough to constitute a
permanent establishment or fixed base in that jurisdiction.
Treaties also contain commercial visitation exemptions under
which individual residents of one country performing personal
services in the other will not be required to pay tax in that
other country unless their contacts exceed certain specified
minimums (e.g., presence for a set number of days or earnings
in excess of a specified amount). Treaties address passive
income such as dividends, interest, and royalties from sources
within one country derived by residents of the other country
either by providing that such income is taxed only in the
recipient's country of residence or by reducing the rate of the
source country's withholding tax imposed on such income. In
this regard, the United States agrees in its tax treaties to
reduce its 30-percent withholding tax (or, in the case of some
income, to eliminate it entirely) in return for reciprocal
treatment by its treaty partner.
In its treaties, the United States, as a matter of policy,
generally retains the right to tax its citizens and residents
on their worldwide income as if the treaty had not come into
effect. The United States also provides in its treaties that it
will allow a credit against U.S. tax for income taxes paid to
the treaty partners, subject to the various limitations of U.S.
law.
The objective of preventing tax avoidance and evasion
generally is accomplished in treaties by the agreement of each
country to exchange tax-related information. Treaties generally
provide for the exchange of information between the tax
authorities of the two countries when such information is
necessary for carrying out provisions of the treaty or of their
domestic tax laws. The obligation to exchange information under
the treaties typically does not require either country to carry
out measures contrary to its laws or administrative practices
or to supply information that is not obtainable under its laws
or in the normal course of its administration or that would
reveal trade secrets or other information the disclosure of
which would be contrary to public policy. The Internal Revenue
Service (the ``IRS''), and the treaty partner's tax
authorities, also can request specific tax information from a
treaty partner. This can include information to be used in a
criminal investigation or prosecution.
Administrative cooperation between countries is enhanced
further under treaties by the inclusion of a ``competent
authority'' mechanism to resolve double taxation problems
arising in individual cases and, more generally, to facilitate
consultation between tax officials of the two governments.
Treaties generally provide that neither country may subject
nationals of the other country (or permanent establishments of
enterprises of the other country) to taxation more burdensome
than that it imposes on its own nationals (or on its own
enterprises). Similarly, in general, neither treaty country may
discriminate against enterprises owned by residents of the
other country.
At times, residents of countries that do not have income
tax treaties with the United States attempt to use a treaty
between the United States and another country to avoid U.S.
tax. To prevent third-country residents from obtaining treaty
benefits intended for treaty country residents only, treaties
generally contain an ``anti-treaty shopping'' provision that is
designed to limit treaty benefits to bona fide residents of the
two countries.
III. EXPLANATION OF PROPOSED PROTOCOL
Article 1. General Scope
Article 1 of the proposed protocol restates Article 1 of
the U.S.-Mexico treaty, with the exception of Paragraphs 3, 6,
7, and 8. Paragraph 3 relates to the interaction of the treaty
with other agreements. As amended by the proposed protocol,
Paragraph 3 provides two exceptions to the rule of Paragraph 2
that the treaty shall not restrict in any manner any exclusion,
exemption, deduction, credit or other allowance now or
hereafter accorded by the laws of either Contracting State or
by any other agreement between the Contracting States.
Paragraphs 6, 7, and 8 relate to the countries' rights to tax
certain former citizens and former long-term residents.
The treaty entered into force on December 28, 1993, before
the entry into force of certain other agreements to which the
Contracting States are parties (such as the General Agreement
on Trade in Services (``GATS'')). Consequently, the provisions
of Paragraph 3 serve to clarify and update the rules for
determining the interaction of the treaty with other agreements
with respect to the scope of the treaty. With respect to
taxation measures, the provisions of Paragraph 3 generally have
the effect of resolving which agreement applies in favor of the
treaty (not another agreement), except in cases in which the
competent authorities agree that the treaty should not be
applied.
Under the first provision of Paragraph 3, any question or
dispute concerning the interpretation or application of the
treaty, in particular whether a taxation measure is within the
scope of the treaty, is to be determined or resolved only as
provided by Article 26 of the treaty (Mutual Agreement
Procedure). Article 26 authorizes the competent authorities of
the United States and Mexico to consult together to attempt to
alleviate individual cases of double taxation not in accordance
with the treaty. The Technical Explanation notes that as a
result, dispute resolution procedures under other agreements do
not apply in determining the interpretation or application of
the treaty (including whether a taxation measure is within the
scope of the treaty).
Under the second provision of Paragraph 3, no other
agreement applies to a taxation measure unless the competent
authorities agree that the measure is not within the scope of
Article 25 of the treaty (Non-Discrimination). For this
purpose, a measure is defined inclusively to mean a law,
regulation, rule, procedure, decision, administrative action,
or any similar provision or action. Article 25 of the treaty
provides a comprehensive nondiscrimination provision relating
to all taxes of every kind imposed at the national, state, or
local level. The Technical Explanation notes that, under the
second provision of Paragraph 3 of the proposed protocol, if
the non-discrimination provisions of the treaty apply to a
taxation measure, then no national treatment or most-favored-
nation (``MFN'') obligations in another agreement of the
Contracting States applies to that taxation measure. The
Technical Explanation concludes that this provision, though it
differs from the equivalent provision in the U.S. model treaty,
has a similar effect. The provision does not explicitly provide
that the General Agreement on Tariffs and Trade (``GATT'') also
is applicable to taxation measures that are within the scope of
Article 25 of the treaty, but that article generally does not
relate to the treatment of trade in goods. Thus, if the
competent authorities agree that a taxation measure is not
within the scope of Article 25, the provisions of GATT would
apply to the measure, which is the same result as under the
U.S. model.
Under paragraph 6 of the proposed protocol, the United
States and Mexico reserve for a period of 10 years their right
to tax former citizens and former long-term residents whose
loss of citizenship or long-term resident status had, as one of
its principal purposes, the avoidance of tax. Consequently, the
saving clause of paragraph 4 applies to such individuals for a
period of 10 years. This provision expands on the comparable
provision of the current treaty, which applies only to former
citizens, and not to former long-term residents. The term
``long-term resident'' is defined to include an individual
(other than a citizen of either country) who is a lawful
permanent resident of the country in 8 or more taxable years of
the proceeding 15 taxable years. Paragraphs 7 and 8 of the
proposed protocol set forth factors similar to those set forth
in section 877 of the Code for use in determining whether one
of the principal purposes of a change in status of a former
citizen or long-term resident was the avoidance of tax.
Article 2. Dividends
Internal taxation rules
United States
The United States generally imposes a 30-percent tax on the
gross amount of U.S.-source dividends paid to nonresident alien
individuals and foreign corporations. The 30-percent tax does
not apply if the foreign recipient is engaged in a trade or
business in the United States and the dividends are effectively
connected with that trade or business. In such a case, the
foreign recipient is subject to U.S. tax on such dividends on a
net basis at graduated rates in the same manner that a U.S.
person would be taxed.
Under U.S. law, the term dividend generally means any
distribution of property made by a corporation to its
shareholders, either from accumulated earnings and profits or
current earnings and profits. However, liquidating
distributions generally are treated as payments in exchange for
stock and, thus, are not subject to the 30-percent withholding
tax described above (see discussion of capital gains in
connection with Article 13 below).
Dividends paid by a U.S. corporation generally are U.S.-
source income. Also treated as U.S.-source dividends for this
purpose are portions of certain dividends paid by a foreign
corporation that conducts a U.S. trade or business. The U.S.
30-percent withholding tax imposed on the U.S.-source portion
of the dividends paid by a foreign corporation is referred to
as the ``second-level'' withholding tax. This second-level
withholding tax is imposed only if a treaty prevents
application of the statutory branch profits tax.
In general, corporations are not entitled under U.S. law to
a deduction for dividends paid. Thus, the withholding tax on
dividends theoretically represents imposition of a second level
of tax on corporate taxable income. Treaty reductions of this
tax reflect the view that where the United States already
imposes corporate-level tax on the earnings of a U.S.
corporation, a 30-percent withholding rate may represent an
excessive level of source-country taxation. Moreover, the
reduced rate of tax often applied by treaty to dividends paid
to direct investors reflects the view that the source-country
tax on payments of profits to a substantial foreign corporate
shareholder may properly be reduced further to avoid double
corporate-level taxation and to facilitate international
investment.
A real estate investment trust (``REIT'') is a corporation,
trust, or association that is subject to the regular corporate
income tax, but that receives a deduction for dividends paid to
its shareholders if certain conditions are met. In order to
qualify for the deduction for dividends paid, a REIT must
distribute most of its income. Thus, a REIT is treated, in
essence, as a conduit for federal income tax purposes. Because
a REIT is taxable as a U.S. corporation, a distribution of its
earnings is treated as a dividend rather than income of the
same type as the underlying earnings. Such distributions are
subject to the U.S. 30-percent withholding tax when paid to
foreign owners.
A REIT is organized to allow persons to diversify ownership
in primarily passive real estate investments. As such, the
principal income of a REIT often is rentals from real estate
holdings. Like dividends, U.S.-source rental income of foreign
persons generally is subject to the 30-percent withholding tax
(unless the recipient makes an election to have such rental
income taxed in the United States on a net basis at the regular
graduated rates). Unlike the withholding tax on dividends,
however, the withholding tax on rental income generally is not
reduced in U.S. income tax treaties.
U.S. internal law also generally treats a regulated
investment company (``RIC'') as both a corporation and a
conduit for income tax purposes. The purpose of a RIC is to
allow investors to hold a diversified portfolio of securities.
Thus, the holder of stock in a RIC may be characterized as a
portfolio investor in the stock held by the RIC, regardless of
the proportion of the RIC's stock owned by the dividend
recipient.
Mexico
Mexico currently does not impose a withholding tax on
dividend payments to nonresidents.\2\
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\2\ Mexico adopted a dividend withholding tax in 1999, but then
repealed it in 2001 (effective for dividends paid after 2001).
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Proposed protocol limits on internal law
10-percent and 5-percent withholding rates
The proposed protocol generally limits dividend withholding
tax in the country of source to 10 percent of the gross amount
of the dividend. If the beneficial owner of the dividend is a
company resident in the other State and directly owns shares
representing at least 10 percent of the voting power of the
company paying the dividend, then the withholding tax in the
State of source is limited to 5 percent of the gross amount of
the dividend. The Technical Explanation states that shares are
considered voting shares if they provide the power to elect,
appoint, or replace any person vested with the powers
ordinarily exercised by the board of directors of a U.S.
corporation. The Technical Explanation states that the 5 and 10
percent rate benefits may be granted at the time of payment by
means of reduced withholding at the source; and that it is also
consistent with the protocol for tax to be withheld at the time
of payment at full statutory rates, and the treaty benefit to
be granted by means of a subsequent refund, so long as such
procedures are applied in a reasonable manner.
The Technical Explanation notes that the term ``beneficial
owner'' is not defined in the treaty, and is, therefore,
defined as under the internal law of the country imposing tax
(i.e., the source country). According to the Technical
Explanation, the beneficial owner of the dividend for purposes
of Article 10 is the person to which the dividend income is
attributable for tax purposes under the laws of the source
State. Thus, the Technical Explanation states that if a
dividend is paid by a corporation that is a resident of one of
the States (as determined under Article 4 (Residence)) is
received by a nominee or agent that is a resident of the other
State on behalf of a person that not a resident of that other
State, the dividend is not entitled to the benefits of this
Article. However, a dividend received by a nominee on behalf of
a resident of that other State would be entitled to
benefits.\3\
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\3\ The Technical Explanation states that these limitations are
confirmed by paragraph 12 of the OECD Commentaries to Article 10. The
Technical Explanation also refers to paragraph 24 of the Commentary to
Article 1 of the OECD model.
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The Technical Explanation states that companies holding
shares through fiscally transparent entities such as
partnerships are considered for purposes of this paragraph to
hold their proportionate interest in the shares. As a result,
companies holding shares through such entities may be able to
claim the benefits of the proposed protocol under certain
circumstances. The lower rate applies when the company's
proportionate share of the shares held by the intermediate
entity meets the 10 percent threshold. The Technical
Explanation notes that whether this ownership threshold is
satisfied may be difficult to determine and often will require
an analysis of the partnership or trust agreement.
Zero rate of withholding on certain dividends
The proposed protocol provides a zero rate of withholding
with respect to certain intercompany dividends where there is a
sufficiently high (80 percent of voting power) level of
ownership (often referred to as ``direct dividends''). The
proposed protocol also provides a zero rate of withholding with
respect to dividends received by tax-exempt pension funds.
Direct dividends
The proposed protocol reduces the withholding tax rate to
zero on certain dividends beneficially owned by a company that
has owned directly 80 percent or more of the voting stock of
the company paying the dividend for the 12-month period ending
on the date the dividend is declared.
In the case of a dividend-receiving company that satisfies
the Limitation on Benefits provision of the treaty only under
paragraphs 1(c), 1(d)(iii), or 1(f) of Article 17, the proposed
protocol imposes an additional requirement for qualification
for the zero rate, that the dividend be received from a company
with respect to which the dividend-receiving company owned,
directly or indirectly, 80 percent of the voting stock prior to
October 1, 1998.\4\ The October 1, 1998, date is intended to
prevent restructurings of corporate ownership in order to take
advantage of the zero-rate provision in circumstances where the
Limitation on Benefits provision does not provide sufficient
protection against treaty shopping.
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\4\ It is understood that this is the date on which the Treasury
Department announced that it was negotiating a zero rate of withholding
with the United Kingdom, the first instance in which the United States
was negotiating a zero rate. A similar restriction referring to this
date is contained in the proposed income tax treaty with the United
Kingdom.
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The proposed protocol also provides that, if the United
States agrees in another tax treaty to a zero-rate dividends
provision under conditions more beneficial than those of the
proposed protocol, the United States and Mexico shall, at
Mexico's request, consult with a view to incorporating a
similar provision into the U.S.-Mexico treaty.
Tax exempt pension plans
The proposed protocol also allows the zero withholding rate
for dividends beneficially owned by a trust, company, or other
organization constituted and operated exclusively to provide
benefits under a pension, retirement, or other employee benefit
plan. In order to qualify for the zero rate, the trust,
company, or other organization must be generally exempt from
tax in the Contracting State of which it is a resident, and the
dividends must not be derived from the carrying on of a
business, directly or indirectly, by such trust, company, or
organization. The Technical Explanation states that the
exemption is parallel to an existing exemption from the
withholding tax on interest available to pension funds under
Article 11(4)(c).
Dividends paid by RICs and REITs
The proposed protocol generally denies the 5 percent and
zero rates of withholding to dividends paid by a RIC or REIT.
In the case of a RIC, any such dividends are eligible for
the zero rate paid to tax exempt pension, retirement, or other
employee benefit plans. The 10 percent rate of withholding is
allowed for any dividends paid by a RIC.
In the case of a REIT, the 10 percent rate of withholding
or zero rate of withholding with respect to dividends paid to
tax exempt pension, retirement, or other employee benefit plans
is allowed for dividends paid by a REIT only if one of three
additional conditions is met. First, the person beneficially
entitled to the dividend is an individual holding an interest
of not more than 10 percent in the REIT. Second, the dividend
is paid with respect to a class of stock that is publicly
traded and the person beneficially entitled to the dividend is
a person holding an interest of not more than 5 percent of any
class of the REIT's stock. Third the person beneficially
entitled to the dividend holds an interest in the REIT of not
more than 10 percent and the REIT is ``diversified'' (i.e., the
gross value of no single interest in real property held by the
REIT exceeds 10 percent of the gross value of the REIT's total
interest in real property). For purposes of this
diversification test, the Technical Explanation indicates that
foreclosure property is not considered an interest in real
property, and a REIT holding a partnership interest is treated
as owning its proportionate share of any interest in real
property held by the partnership.
The Technical Explanation indicates that these restrictions
in availability of the different rates are intended to prevent
the use of RICs and REITs to gain unjustifiable source-country
benefits for certain shareholders resident in Mexico. For
example, a company resident in Mexico could directly own a
diversified portfolio of U.S. corporate shares and pay a U.S.
withholding tax of 10 percent on dividends on those shares.
There is a concern that such a company could purchase 10
percent or more of the interests in a RIC, which could even be
established as a mere conduit, and thus obtain a lower
withholding rate on a similar portfolio held by the RIC if the
5 percent rate were allowed to RIC dividends, or if the zero
rate were allowed for RIC dividends other than for dividends
paid to pension plans.
Similarly, the Technical Explanation gives an example of a
resident of Mexico directly holding real property and required
to pay U.S. tax either at a 30-percent rate on gross income or
at graduated rates on the net income. By placing the property
in a REIT, the investor could transform real estate income into
dividend income, taxable at the rates provided in the proposed
protocol. The limitations on REIT dividend benefits are
intended to protect against this result.
Dividends with respect to permanent establishment or fixed
base
The proposed protocol provides that dividends paid with
respect to holdings that form part of the business property of
a permanent establishment or fixed base situated in the source
country are taxed on a net basis, using the rules of taxation
generally applicable to residents of the State in which the
permanent establishment is located, as modified by the treaty.
The Technical Explanation gives as an example dividends derived
by a dealer in stock or securities from stock or securities
that the dealer held for sale to customers.
Definition of ``dividends''
Dividends are defined under the proposed protocol as
covering income from shares or other rights, not being debt-
claims, participating in profits, as well as income from other
corporate rights that is subjected to the same taxation
treatment as income from shares by the laws of the State of
which the company making the distribution is a resident.
The Technical Explanation states that this definition is
intended to cover all arrangements that yield a return on an
equity investment in a corporation as determined under the tax
law of the state of source, as well as arrangements that might
be developed in the future. The Technical Explanation gives as
examples of covered situations a constructive dividend that
results from a non-arm's length transaction between a
corporation and a related party; amounts treated as dividends
under U.S. law upon a sale or redemption of shares;
distributions from publicly traded limited partnerships that
are treated as corporations under U.S. law (but not from
limited liability companies, under U.S. law); and payments
denominated as interest but made by a thinly capitalized
corporation such that the debt is recharacterized as equity
under the laws of the source State.
The Technical Explanation states that under the existing
treaty and protocol, each Contracting State may apply its
statutory rules for distinguishing debt from equity or for
preventing thin capitalization in defining dividends for
purposes of this article. As under the existing Treaty, the
Technical Explanation gives an example of the U.S. rules of
Code section 163(f), denying a deduction for interest on
certain obligations not in registered form.
Company resident of one State deriving profits or income
from the other State
Under the proposed protocol, if a company that is a
resident of one Contracting State derives profits or income
from the other Contracting State, that other State may not
impose any tax on the dividends paid by a company which is not
a resident of that State, except insofar as such dividends are
paid to a resident of that other State or are attributable to a
permanent establishment or fixed base situated in that State.
The Technical Explanation states that in the case of the United
States, this provision overrides the ability to impose taxes
under section 871 and 882(a) on dividends paid by foreign
corporations that have a U.S. source under section
861(a)(2)(B).
Relation to other Articles
The Technical Explanation notes that the saving clause of
paragraph 4 of Article 1 (General Scope) permits the United
States to tax dividends received by its residents and citizens,
subject to the special foreign tax credit rules of paragraph 6
of Article 24 (Relief from Double Taxation), as if the Treaty
had not come into effect.
The benefits of the dividends article are also subject to
the provisions of Article 17 (Limitation on Benefits). Thus, if
a resident of Mexico is the beneficial owner of dividends paid
by a U.S. company, the shareholder must qualify for treaty
benefits under at least one of the tests of Article 17 in order
to receive the benefits of the Article 10 (Dividends).
Paragraph (b) of Article 2 of the protocol replaces
paragraph 8 of the treaty's existing protocol. The new
paragraph provides that if the United States agrees in a tax
treaty to a dividend exemption under conditions more beneficial
than those in paragraph 3 (which grants a zero rate of
withholding tax in certain circumstances), the Contracting
States shall, at Mexico's request, consult each other with a
view to concluding another protocol to incorporate a similar
provision into paragraph 3 of Article 10 (Dividends).
Paragraph (c) of Article 2 of the proposed protocol is a
technical correction to ensure that the provision of the
treaty's existing protocol paragraph 9 will continue to refer
to the definition of ``dividends'' which in the new Article 10
is found in paragraph 6.
Article 3. Branch Tax
Internal taxation rules
United States
U.S. persons are subject to U.S. tax on their worldwide
income. Foreign taxes may be credited against U.S. tax on
foreign-source income of the taxpayer. For purposes of
computing the foreign tax credit, the taxpayer's income from
U.S. sources and foreign sources must be determined.
Nonresident individuals who are not U.S. citizens and
foreign corporations (collectively, foreign persons) are
subject to U.S. tax on income that is effectively connected
with the conduct of a U.S. trade or business; the U.S. tax on
such income is calculated in the same manner and at the same
graduated rates as the tax on U.S. persons (secs. 871(b) and
882). Foreign persons also are subject to a 30-percent gross
basis tax, collected by withholding, on certain U.S.-source
passive income (e.g., interest and dividends) that is not
effectively connected with a U.S. trade or business. This 30-
percent withholding tax may be reduced or eliminated pursuant
to an applicable tax treaty. Foreign persons generally are not
subject to U.S. tax on foreign-source income that is not
effectively connected with a U.S. trade or business.
In general, dividends paid by a domestic corporation are
treated as being from U.S. sources and dividends paid by a
foreign corporation are treated as being from foreign sources.
Thus, dividends paid by foreign corporations to foreign persons
generally are not subject to withholding tax because such
income generally is treated as foreign-source income.
An exception from this general sourcing rule applies in the
case of dividends paid by certain foreign corporations. If a
foreign corporation derives 25 percent or more of its gross
income as income effectively connected with a U.S. trade or
business for the three-year period ending with the close of the
taxable year preceding the declaration of a dividend, then a
portion of any dividend paid by the foreign corporation to its
shareholders will be treated as U.S.-source income and, in the
case of dividends paid to foreign shareholders, will be subject
to the 30-percent withholding tax (sec. 861(a)(2)(B)). This
rule is sometimes referred to as the ``secondary withholding
tax.'' The portion of the dividend treated as U.S.-source
income is equal to the ratio of the gross income of the foreign
corporation that was effectively connected with its U.S. trade
or business over the total gross income of the foreign
corporation during the three-year period ending with the close
of the preceding taxable year. The U.S.-source portion of the
dividend paid by the foreign corporation to its foreign
shareholders is subject to the 30-percent withholding tax.
Under the branch profits tax provisions, the United States
taxes foreign corporations engaged in a U.S. trade or business
on amounts of U.S. earnings and profits that are shifted out of
the U.S. branch of the foreign corporation. The branch profits
tax is comparable to the second-level taxes imposed on
dividends paid by a domestic corporation to its foreign
shareholders. The branch profits tax is 30 percent of the
foreign corporation's ``dividend equivalent amount,'' which
generally is the earnings and profits of a U.S. branch of a
foreign corporation attributable to its income effectively
connected with a U.S. trade or business (secs. 884(a) and (b)).
In arriving at the dividend equivalent amount, a branch's
effectively connected earnings and profits are adjusted to
reflect changes in a branch's U.S. net equity (i.e., the excess
of the branch's assets over its liabilities, taking into
account only amounts treated as connected with its U.S. trade
or business) (sec. 884(b)). The first adjustment reduces the
dividend equivalent amount to the extent the branch's earnings
are reinvested in trade or business assets in the United States
(or reduce U.S. trade or business liabilities). The second
adjustment increases the dividend equivalent amount to the
extent prior reinvested earnings are considered remitted to the
home office of the foreign corporation.
If a foreign corporation is subject to the branch profits
tax, then no secondary withholding tax is imposed on dividends
paid by the foreign corporation to its shareholders (sec.
884(e)(3)(A)). If a foreign corporation is a qualified resident
of a tax treaty country and claims an exemption from the branch
profits tax pursuant to the treaty, the secondary withholding
tax could apply with respect to dividends it pays to its
shareholders. Several tax treaties (including treaties that
prevent imposition of the branch profits tax), however, exempt
dividends paid by the foreign corporation from the secondary
withholding tax.
Mexico
Mexico does not impose a branch profits tax.
Proposed treaty limitations on internal law
Article 3 of the proposed protocol provides an exemption
from the branch profits tax that parallels the provision of the
proposed protocol providing a zero rate of withholding on
dividends.\5\
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\5\ This provision is similar to the provision relating to branch
profits tax in the proposed U.S.-U.K. treaty. The October 1, 1998, date
in the proposed protocol follows the date set forth in the proposed
U.S.-U.K. treaty.
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The United States is allowed under the current treaty to
impose the branch profits tax (at a rate of 5 percent) on the
business profits of a Mexican corporation that are effectively
connected (or treated as effectively connected) with the
conduct of a trade or business in the United States, and are
either attributable to a permanent establishment in the United
States, or subject to tax on a net basis in the United States
on income subject to Article 6 (Income From Immovable Property
(Real Property)) or paragraphs 1 or 4 of Article 13 (Capital
Gains). The tax is imposed on the ``dividend equivalent
amount,'' as described above.
Under the proposed protocol, the branch profits tax will
not be imposed by the United States in cases in which a zero
rate of withholding on dividends would apply if the U.S. branch
business had been conducted by the Mexican company through a
separate U.S. subsidiary. Thus, the branch profits tax will not
be imposed in the case of a company that, before October 1,
1998, had a permanent establishment in the United States, or in
the case of income or gains subject to tax on a net basis in
the United States from real property or from the disposition of
interests in real property. In addition, the branch profits tax
will not apply to a Mexican company that is considered a
qualified person by reason of being a publicly-traded company,
or that is entitled to benefits with respect to the dividend
equivalent amount under the derivative benefits or competent-
authority discretion rules under Article 17 (Limitation on
Benefits).
Article 4. Capital Gains
Article 4 of the proposed protocol relates to the sourcing
rule for capital gains. The provision removes a sentence
relating to resourcing of capital gains from Article 13,
paragraph 4 of the treaty (Capital Gains) that is not
necessary, given the modification of the treaty's resourcing
rule made by Article V of the proposed protocol (described
below).
Article 5. Relief from Double Taxation
Internal taxation rules
United States
The United States taxes the worldwide income of its
citizens and residents. It attempts unilaterally to mitigate
double taxation generally by allowing taxpayers to credit the
foreign income taxes that they pay against U.S. tax imposed on
their foreign-source income. An indirect or ``deemed-paid''
credit is also provided. Under this rule, a U.S. corporation
that owns 10 percent or more of the voting stock of a foreign
corporation and that receives a dividend from the foreign
corporation (or an inclusion of the foreign corporation's
income) is deemed to have paid a portion of the foreign income
taxes paid (or deemed paid) by the foreign corporation on its
earnings. The taxes deemed paid by the U.S. corporation are
included in its total foreign taxes paid for the year the
dividend is received.
A fundamental premise of the foreign tax credit is that it
may not offset the U.S. tax on U.S.-source income. Therefore,
the foreign tax credit provisions contain a limitation that
ensures that the foreign tax credit only offsets U.S. tax on
foreign-source income. The foreign tax credit limitation
generally is computed on a worldwide consolidated basis. Hence,
all income taxes paid to all foreign countries are combined to
offset U.S. taxes on all foreign income. The limitation is
computed separately for certain classifications of income
(e.g., passive income and financial services income) in order
to prevent the crediting of foreign taxes on certain high-taxed
foreign-source income against the U.S. tax on certain types of
traditionally low-taxed foreign-source income. Other
limitations may apply in determining the amount of foreign
taxes that may be credited against the U.S. tax liability of a
U.S. taxpayer.
Mexico
Mexican residents are allowed a credit against their
Mexican income tax for foreign income taxes imposed on their
foreign-source income. The credit is limited to the Mexican tax
payable on the net foreign-source income. To the extent that
foreign taxes are not credited in a particular tax year, a
taxpayer may not deduct such foreign taxes. Excess foreign tax
credits, however, may be carried forward for a period of 10
years. Foreign tax credits may not be carried back.
Proposed treaty limitations on internal law
Article 5 of the proposed protocol revises the rule in the
current treaty for resourcing income taxed in accordance with
the treaty to relieve double taxation (paragraph 3 of Article
24, Relief from Double Taxation). The resourcing rule currently
in the treaty provides generally that income derived by a
resident of the United States that may be taxed in Mexico is
deemed to be Mexico-source income; however, such income
generally is subject to the source rules of U.S. domestic law
that apply for purposes of limiting the foreign tax credit
(except with respect to capital gains). Certain gains derived
by a U.S. resident from rights in the capital of a company or
person that is a resident of Mexico are deemed to be Mexico-
source income, to the extent necessary to avoid double taxation
(paragraph 4, Article 13 (Capital Gains)). Thus, in general,
under the current resourcing rule of the treaty, income taxed
in Mexico is subject to U.S. domestic foreign tax credit
limitation sourcing rules (except for certain capital gains).
The proposed protocol generally provides that the United
States will allow a U.S. citizen or resident a foreign tax
credit for the income taxes imposed by Mexico. The proposed
protocol contains a resourcing rule for this purpose. This rule
provides that an item of gross income (as defined under U.S.
law) that is derived by a U.S. resident that is taxed by Mexico
is deemed to be Mexico-source income. The proposed protocol
eliminates the rule of the current treaty that such income is
subject the source rules of U.S. domestic law that apply for
purposes of limiting the foreign tax credit. The provision of
the current treaty deeming certain capital gains as Mexico-
source income is eliminated as unnecessary, as the general
resourcing rule of the proposed protocol subsumes this
provision.
The Technical Explanation states that in the case in which
the treaty allows Mexico to tax an item of gross income (as
defined under U.S. law) derived by a U.S. resident, the United
States will treat that item of income as Mexico-source income
for purposes of the U.S. foreign tax credit. The Technical
Explanation further states that in such a case, however,
section 904(g)(10) may apply for purposes of determining the
U.S. foreign tax credit. Section 904(g)(10) generally provides
that the foreign tax credit limitation applies separately to
income resourced under a treaty. The Technical Explanation
points out that, because the resourcing rule of the proposed
protocol applies to gross income, not net income, U.S. expense
allocation and apportionment rules continue to apply to income
resourced under the rule of the proposed protocol.
Article 6. Entry into Force
The proposed protocol provides that the protocol is subject
to ratification in accordance with the applicable
constitutional and statutory requirements of each country. The
proposed protocol requires each State to notify the other as
soon as its requirements for ratification have been fulfilled;
the proposed protocol will enter into force upon the date of
the later of the two notifications.
The proposed protocol provides explicit effective dates for
each of the provisions of the proposed protocol. With respect
to Article 2, the proposed protocol will be effective with
respect to dividends paid or credited on or after the first day
of the second month after the date on which the protocol enters
into force. The Technical Explanation provides the following
example to illustrate the operation of this rule: if the second
notification of the fulfillment of the ratification
requirements is received on April 25, then the provisions of
Article 2 would take effect for dividends paid or credited on
or after June 1. All other provisions of the proposed protocol
will be effective for taxable periods beginning on or after the
first day of January of the year following the year in which
the proposed protocol enters into force.
The purpose of this bifurcated effective date is to permit
the benefits of the withholding reductions with respect to
dividends to be put into effect as soon as is administratively
feasible. A similar bifurcated effective date (permitting
reductions in withholding to occur sooner than other provisions
of the treaty) is included in the proposed income tax treaty
with the United Kingdom.
Article 7. Remaining in Force
The proposed protocol will remain in force as long as the
underlying convention to which this proposed protocol is an
amendment remains in force.
IV. ISSUES
A. Zero Rate of Withholding Tax on Dividends from 80-Percent-Owned
Subsidiaries
In general
The proposed protocol would eliminate withholding tax on
dividends paid by one corporation to another corporation that
owns at least 80 percent of the stock of the dividend-paying
corporation (often referred to as ``direct dividends''),
provided that certain conditions are met (subparagraph 3(a) of
Article 10 of the current treaty (Dividends)). The elimination
of withholding tax under these circumstances is intended to
reduce further the tax barriers to direct investment between
the two countries.
Currently, no U.S. treaty provides for a complete exemption
from withholding tax under these circumstances, nor do the U.S.
or OECD models. However, many bilateral tax treaties to which
the United States is not a party eliminate withholding taxes
under similar circumstances, and the same result has been
achieved within the European Union under its ``Parent-
Subsidiary Directive.'' In addition, the United States has
signed a proposed treaty with the United Kingdom and a proposed
protocol with Australia that include zero-rate provisions
similar to the one in the proposed protocol.
Description of provision
Under the proposed protocol, the withholding tax rate is
reduced to zero on certain dividends beneficially owned by a
company that has owned at least 80 percent of the voting power
of the company paying the dividend for the 12-month period
ending on the date the dividend is declared (subparagraph 3(a)
of Article 10 of the current treaty (Dividends)). Under the
current U.S.-Mexico treaty, these dividends may be taxed at a
5-percent rate.
Issues
In general
Given that the United States has never before agreed
bilaterally to a zero rate of withholding tax on direct
dividends, the Committee may wish to devote particular
attention to the benefits and costs of taking this step. The
Committee also may want to determine whether the inclusion of
the zero-rate provision in the proposed protocol (as well as in
the proposed treaty with the United Kingdom and the proposed
protocol with Australia) signals a broader shift in U.S. treaty
policy, and under what circumstances the United States may seek
to include similar provisions in other treaties. Finally, the
Committee may wish to be aware of the ``most favored nation''
provision relating to this subject in the current U.S.-Mexico
treaty, and the ramifications of this provision in light of the
proposed treaty with the United Kingdom and proposed protocol
with Australia.
Benefits and costs of adopting a zero rate with Mexico
Tax treaties mitigate double taxation by resolving the
potentially conflicting claims of a residence country and a
source country to tax the same item of income. In the case of
dividends, standard international practice is for the source
country to yield mostly or entirely to the residence country.
Thus, the residence country preserves its right to tax the
dividend income of its residents, and the source country agrees
either to limit its withholding tax to a relatively low rate
(e.g., 5 percent) or to forgo it entirely.
Treaties that permit a positive rate of dividend
withholding tax allow some degree of double taxation to
persist. To the extent that the residence country allows a
foreign tax credit for the withholding tax, this remaining
double taxation may be mitigated or eliminated, but then the
priority of the residence country's claim to tax the dividend
income of its residents is not fully respected. Moreover, if a
residence country imposes limitations on its foreign tax
credit,\6\ withholding taxes may not be fully creditable as a
practical matter, thus leaving some double taxation in place.
For these reasons, dividend withholding taxes are commonly
viewed as barriers to cross-border investment. The principal
argument in favor of eliminating withholding taxes on certain
direct dividends in the proposed treaty is that it would remove
one such barrier.
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\6\ See, e.g., Code sec. 904.
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Direct dividends arguably present a particularly
appropriate case in which to remove the barrier of a
withholding tax, in view of the close economic relationship
between the payor and the payee. Whether in the United States
or in Mexico, the dividend-paying corporation generally faces
full net-basis income taxation in the source country, and the
dividend-receiving corporation generally is taxed in the
residence country on the receipt of the dividend (subject to
allowable foreign tax credits). If the dividend-paying
corporation is at least 80-percent owned by the dividend-
receiving corporation, it is arguably appropriate to regard the
dividend-receiving corporation as a direct investor (and
taxpayer) in the source country in this respect, rather than
regarding the dividend-receiving corporation as having a more
remote investor-type interest warranting the imposition of a
second-level source-country tax.
Since Mexico does not currently impose a withholding tax on
these dividends under its internal law, the zero-rate provision
would principally benefit direct investment in the United
States by Mexican companies, as opposed to direct investment in
Mexico by U.S. companies. In other words, the potential
benefits of the provision would accrue mainly in situations in
which the United States is importing capital, as opposed to
exporting it.\7\
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\7\ In contrast, including a similar provision in a treaty with a
country that does impose withholding tax on some or all direct
dividends under its internal law (e.g., Australia) would provide more
immediate and direct benefits to the United States as both an importer
and an exporter of capital.
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However, it should be noted that, although Mexican internal
law currently does not impose a withholding tax on dividends
paid to foreign persons, there is no guarantee that this will
always be the case.\8\ Thus, the inclusion of a zero-rate
provision under the proposed protocol would give U.S.-based
enterprises somewhat greater certainty as to the applicability
of a zero rate in Mexico, which arguably would facilitate long-
range business planning for U.S. companies in their capacities
as capital exporters. Along the same lines, the provision would
protect the U.S. fisc against increased foreign tax credit
claims in the event that Mexico were to change its internal law
in this regard.
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\8\ Indeed, Mexican law has changed recently in this regard--Mexico
adopted a dividend withholding tax in 1999, but then repealed it in
2001 (effective for dividends paid after 2001).
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Although the United States has never agreed bilaterally to
a zero rate of withholding tax on direct dividends, many other
countries have done so in one or more of their bilateral tax
treaties. These countries include OECD members Austria,
Denmark, France, Finland, Germany, Iceland, Ireland, Japan,
Luxembourg, Mexico, the Netherlands, Norway, Sweden,
Switzerland, and the United Kingdom, as well as non-OECD-
members Belarus, Brazil, Cyprus, Egypt, Estonia, Israel,
Latvia, Lithuania, Mauritius, Namibia, Pakistan, Singapore,
South Africa, Ukraine, and the United Arab Emirates. In
addition, a zero rate on direct dividends has been achieved
within the European Union under its ``Parent-Subsidiary
Directive.'' Finally, many countries have eliminated
withholding taxes on dividends as a matter of internal law
(e.g., the United Kingdom and Mexico). Thus, although the zero-
rate provision in the proposed protocol is unprecedented in
U.S. treaty history, there is substantial precedent for it in
the experience of other countries. It may be argued that this
experience constitutes an international trend toward
eliminating withholding taxes on direct dividends, and that the
United States would benefit by joining many of its treaty
partners in this trend and further reducing the tax barriers to
cross-border direct investment.
General direction of U.S. tax treaty policy
Looking beyond the U.S.-Mexico treaty relationship, the
Committee may wish to determine whether the inclusion of the
zero-rate provision in the proposed protocol (as well as in the
proposed treaty with the United Kingdom and the proposed
protocol with Australia) signals a broader shift in U.S. tax
treaty policy. Specifically, the Committee may want to know
whether the Treasury Department: (1) intends to pursue similar
provisions in other proposed treaties in the future; (2)
proposes any particular criteria for determining the
circumstances under which a zero-rate provision may be
appropriate or inappropriate; (3) expects to seek terms and
conditions similar to those of the proposed treaty in
connection with any zero-rate provisions that it may negotiate
in the future; and (4) intends to amend the U.S. model to
reflect these developments.\9\
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\9\ More broadly, since the U.S. model has not been updated since
1996, the Committee may wish to ask whether the Treasury Department
intends to update the model to reflect all relevant developments that
have occurred in the intervening years. A thoroughly updated model
would provide a more meaningful and useful guide to current U.S. tax
treaty policy and would thereby increase transparency and facilitate
Congressional oversight in this important area. See Joint Committee on
Taxation, Study of the Overall State of the Federal Tax System and
Recommendations for Simplification, Pursuant to Section 8022(3)(B) of
the Internal Revenue Code of 1986 (JCS-3-01), April 2001, Vol. II, at
445-47 (recommending that the Treasury Department revise U.S. model tax
treaties once per Congress).
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``Most favored nation'' agreement
Under the current U.S.-Mexico income tax treaty, dividends
beneficially owned by a company that owns at least 10 percent
of the voting stock of the dividend-paying company are subject
to a maximum withholding rate of 5 percent (paragraph 2(a) of
Article 10 of the current treaty), which is the lowest rate of
withholding tax on dividends currently available under U.S.
treaties. Under Protocol 1 to that treaty, as modified by a
formal understanding subject to which the treaty and protocol
were ratified, the United States and Mexico have agreed, if the
United States adopts a rate on dividends lower than 5 percent
in a treaty with another country, ``to promptly amend [the
U.S.-Mexico treaty] to incorporate that lower rate.'' \10\
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\10\ This formal understanding was a response to an objection
raised by the Committee to the original language of the treaty
protocol, under which the ``most-favored nation'' provision would have
been self-executing--i.e., immediately upon U.S. agreement to a lower
rate with another treaty partner, the United States and Mexico would
have begun applying that lower rate in their treaty.
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The adoption of a zero-rate provision in the U.S.-Australia
or the U.S.-U.K. treaty relationship would trigger this
obligation to amend the current treaty with Mexico. The
proposed protocol with Mexico would amend that treaty to
incorporate a zero-rate provision substantially identical to
that of the proposed treaty with the United Kingdom, and
substantially similar to that of the proposed protocol with
Australia, and thus would seem to fulfill the U.S. obligation
under the ``most favored nation'' agreement. Thus, if the
Senate were to ratify the proposed protocol with Mexico along
with either the proposed treaty with the United Kingdom or the
proposed protocol with Australia (or both of them), no issues
of interaction between the two treaty relationships would need
to be confronted.
If, on the other hand, the Senate were to ratify either the
proposed treaty with the United Kingdom or the proposed
protocol with Australia, but not the proposed protocol with
Mexico, then the possibility would arise that the United States
eventually could be regarded as falling out of compliance with
its obligations under the U.S.-Mexico treaty. This would raise
difficult questions as to the exact nature of this obligation
and whether and how the United States would come into
compliance with it.
B. Visiting Teachers and Professors
The proposed protocol maintains the present treaty's
treatment of visiting teachers and professors, in which an
individual visiting in the host country to engage in teaching
or research at an educational institution is subject to income
tax in the host country on any remuneration received for his or
her teaching or research. The treatment of the present treaty
conforms to the U.S. model. While this is the position of the
U.S. model, an exemption for visiting teachers and professors
has been included in many bilateral tax treaties. Of the more
than 50 bilateral income tax treaties in force, 30 include
provisions exempting from host country taxation the income of a
visiting individual engaged in teaching or research at an
educational institution, and an additional 10 treaties provide
a more limited exemption from taxation in the host county for a
visiting individual engaged in research. Although the proposed
protocol with Australia would not include such a provision, the
proposed treaty with the United Kingdom does include such a
provision, and three of the most recently ratified income tax
treaties did contain such a provision.\11\ The Committee may
wish to satisfy itself that the inclusion of such an exemption
is not appropriate.
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\11\ The treaties with Italy, Slovenia, and Venezuela, each
considered in 1999, contain provisions exempting the remuneration of
visiting teachers and professors from host country income taxation. The
treaties with Denmark, Estonia, Latvia, and Lithuania, also considered
in 1999, did not contain such an exemption, but did contain a more
limited exemption for visiting researchers.
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<greek-d>