FROM THE OFFICE OF PUBLIC AFFAIRS

INTERNATIONAL TAX COUNSEL BEFORE THE COMMITTEEON FOREIGNRELATIONS

UNITED STATES SENATE

Mr. Chairman and members of the Committee, I am pleased today to recommendon behalf of the Administration, favorable action on eight bilateral tax treaties andprotocols that the President has transmitted to the Senate and that are the subject ofthis hearing. These agreements would provide significant benefits to the United States, aswell as to our treaty partners. Treasury appreciates the Committee’s interest inthese agreements as demonstrated by the scheduling of this hearing. Treasury requests theCommittee and the Senate to take prompt and favorable action on all of these agreements.

The treaties and protocols before the Committee today represent across-section of the United States tax treaty program. There are new agreements with fiveof our oldest treaty partners, Austria, Luxembourg, Switzerland, Ireland, and Canada. Twoagreements are with new treaty partners of growing economic significance, Turkey andThailand. The eighth agreement before you, the treaty with South Africa, brings thatimportant country back into our tax treaty network after its change in government. The newagreements will generate substantial benefits for United States taxpayers and taxauthorities, and will serve to expedite and increase desirable international economicactivity. Tax conventions, as explained in greater detail below, do not represent a zerosum exercise. Not only do United States-based businesses benefit from exemption from, orreduction of, foreign taxes, but additional tools are provided to enforce our tax laws,particularly with respect to international tax crimes, often related to money launderingand illegal drug traffic. Mutual agreement procedures not only minimize the risk of doubletaxation of our multinationals, as well as assuring appropriate taxation of foreign basedcompanies, but also facilitate a fair allocation of tax revenues between our treatypartners and the United States.

To help frame our discussions of the pending agreements, I would like to describe in general terms the United States tax treaty program. The United States has anetwork of 48 bilateral income tax treaties, the first of which was negotiated in 1939. Wehave treaties with most of our significant trading partners. Approval of the treaty withTurkey, which is before you today, would achieve an important objective of having taxtreaty relationships with all of the members of the Organization for Economic Cooperationand Development, the OECD.

The Department of the Treasury receives regular and numerous requests toenter tax treaty negotiations. As a result it has been necessary for us to establishpriorities. These priorities are not new; they are reflected in our existing treatynetwork including the agreements the Senate approved last year as well as the treatiesthat you are considering today.

Consistent with both Administration and Congressional policies, the Treasury gives priority to renegotiating older treaties that lack effective anti-abuseclauses or otherwise fail to reflect current United States treaty policy. Examples in thiscategory are the agreements with Austria, Luxembourg, Switzerland, and Ireland. We havemade it clear to our treaty partners that we will not tolerate continuation of treatyrelationships that fail to reflect important United States treaty policies. This policywas underscored last year by the termination of our treaties with Malta and Aruba, and bythe termination protocol with respect to the Netherlands Antilles.

Another priority is to conclude treaties or protocols that are likely toprovide the greatest benefits to United States taxpayers, such as when economic relationsare hindered by tax obstacles. Such new agreements could include treaties with expandingeconomies with which we lack a treaty, or revised and improved treaties with existingtreaty partners. Examples in this category include the treaties with Turkey, Thailand, andSouth Africa. As we complete our renegotiation of outdated treaties, we are able toincrease the priority we place on negotiating tax treaties in countries and regions ofincreasing importance to the United States and United States business. Thus, a major focusof our tax treaty program in the next several years will be to continue and expand ourtreaty activities with countries in Latin America and Southeast Asia.

We also try to conclude treaties with countries that have the potential tobe significant trading partners. The list of such countries has always been a long one,and it has become even longer since the creation of many new market-oriented economies inthe former Soviet Union and eastern European countries. Treasury focuses its efforts inthis category on those countries that have developed stable tax systems and that have thegreatest potential for bilateral economic activities. We also take into account theconcerns and interests of other governmental agencies and the private sector. Theexistence of a treaty will help remove tax impediments to trade and investment in suchcountries and thereby help establish economic ties that will contribute to the country'sstability and independence, as well as improving its political relationships with theUnited States. In the past four years the Senate considered and approved treaties withfive countries that fit this description: the Russian Federation, the Czech Republic,Slovakia, Kazakstan, and Ukraine. Other treaties in this category that have been initialedbut not yet signed are with Estonia, Latvia, and Lithuania

In determining our country priorities as well as treaty positions, weconsult regularly and usefully with many constituencies. We meet with the staff of thisCommittee and its members as well as staffs of the tax writing committees. We hear frommany United States-based companies and trade associations which provide useful guidanceparticularly with respect to practical in-country problems they face. We are constantlyworking to ensure that new economic and commercial developments, such as the revolution incommunication technology, are appropriately dealt with in our tax conventions.

The OECD provides a useful forum to consider these developments with ourtreaty partners. The development of new technologies in particular increases the need forinternational cooperation with respect to many tax policy and administration issues.

Irrespective of the category in which a particular country may fall, weseek to achieve the same two basic objectives through the treaty. First, to reduce incometax-related barriers to international trade and investment. An active treaty program isimportant to the overall international economic policy of the United States, and taxtreaties have a substantial positive impact on the competitive position of United Statesbusinesses that enter a treaty partner's marketplace.

A second general objective of our tax treaty program is to combat taxavoidance and evasion. A treaty provides the tax administrations of both treaty partnerswith additional tools with which to improve international tax administration.

While the domestic tax legislation of the United States and othercountries in many ways is intended to further the same general objectives as our treatyprogram, a treaty network goes beyond what domestic legislation can achieve. Legislationis by its nature unilateral, and cannot easily distinguish among countries. It cannot takeinto account other countries' rules for the taxation of particular classes of income andhow those rules interact with United States statutory rules. Legislation also cannotreflect variations in the United States' bilateral relations with our treaty partners. Atreaty, on the other hand, can make useful distinctions, and alter in an appropriatemanner, domestic statutory law of both countries as it applies to income flowing betweenthe treaty partners.

For example, a basic concept found in all of our treaties establishes theminimum level of economic activity that a resident of one country must engage in withinthe other before the latter country may tax the resulting business profits. These rules,the permanent establishment and business profits provisions, not only eliminate in manycases the difficult task of allocating income and resulting tax between countries but alsoserve to encourage desirable trade activities by eliminating, or reducing, what can oftenbe complex tax compliance requirements.

An income tax treaty removes impediments to international trade andinvestment by reducing the threat of "double taxation" that can occur when bothcountries impose tax on the same income. I’d like to mention four different aspectsof this general goal. First, an income tax treaty generally increases the extent to whichexporters can engage in trading activity in the other country without triggering tax.Second, when that threshold is met and tax is imposed, it establishes rules that assign toone country or the other the primary right of taxation with respect to an item of income,it ensures appropriate deductions and reduces the withholding tax on flows of income.Third, the treaty provides a dispute resolution mechanism to prevent double taxation thatsometimes can arise in spite of the treaty. Finally, and often most importantly, thetreaty helps to create stability of tax rules thereby encouraging desirable economicactivity. These benefits are not limited to companies and business profits. Treatiesremove tax impediments to desirable scientific, educational, cultural and athleticinterchanges, facilitating our ability to benefit from the skills and talents offoreigners including world renowned rock stars, symphony orchestras, astrophysicists andOlympic athletes. You will note that treaty benefits are not limited to profit-makingenterprises as they deal with pension plans, Social Security benefits (as in the protocolwith Canada), charitable organizations, researchers and alimony and child supportrecipients. I would like to discuss some of these aspects of an income tax treaty.

One of the principal ways in which double taxation is eliminated is byassigning primary taxing jurisdiction in particular factual settings to one treaty partneror the other. In the absence of a treaty, a United States company operating a branch ordivision or providing services in another country might be subject to income tax in bothcountries on the income generated by such operations (perhaps because of limitations onthe foreign tax credit provided by the Code). The resulting double taxation can impose anoppressive financial burden on the operation and might well make it economicallyunfeasible.

The tax treaty lays out ground rules providing that one country or theother, but not both, will have primary taxing jurisdiction over branch operations andindividuals performing services. In general terms, the treaty provides that if the branchoperations have sufficient substance and continuity, and accordingly, sufficient economicpenetration, the country where the activities occur will have primary (but not exclusive)jurisdiction to tax. In other cases, where the operations are relatively minor, the homecountry retains the sole jurisdiction to tax. These provisions are especially important intreaties with lesser developed countries, which in the absence of a treaty frequently willtax a branch operation even if the level of activity conducted in the country isnegligible or where the line is not clear and frequently will not allow deductions forappropriate expenses. Under the favorable treaty rules, United States manufacturers mayestablish a significant foreign presence through which products are sold withoutsubjecting themselves to foreign tax or compliance rules. Similarly, United Statesresidents generally may live and work abroad for short periods without becoming subject tothe other country's taxing jurisdiction.

High withholding taxes at source are an impediment to internationaleconomic activity. Under United States domestic law, all payments to non-United Statespersons of dividends and royalties as well as certain payments of interest are subject towithholding tax equal to 30 percent of the gross amount paid. Inasmuch as this tax isimposed on a gross rather than net amount, it imposes a high cost on investors receivingsuch payments. Indeed, in many cases the cost of such taxes can be prohibitive as a 30percent tax on gross income often can exceed 100 percent of the net income. Most of ourtrading partners impose similar levels of withholding tax on these types of income.

Tax treaties alleviate this burden by reducing the levels of withholdingtax that the treaty partners may impose on these types of income. In general, UnitedStates policy is to reduce the rate of withholding taxation on interest and royalties tozero. Dividends normally are subject to tax at one of two rates, 15 percent on portfolioinvestors and 5 percent on direct corporate investors.

The extent to which this policy is realized depends on a number offactors. Although generalizations often are difficult to make in the context of complexnegotiations, it is fair to say that we are more successful in reducing these rates withcountries that are relatively developed and where there are substantial reciprocal incomeflows. We also achieve lesser but still very significant reductions with countries wherethe flows tend to be disproportionately in favor of the United States. Lesser developedand newly emerging economies, where capital and trade flows are often disparate orsometimes one-way, create obstacles to achieving our desired level of withholding. Thesecountries frequently find themselves on the horns of a dilemma. They know that they mustreduce their high levels of taxation to attract foreign capital but, at the same time,they are unwilling to give up scarce revenues. Such prospective treaty partners mayperceive that they are making a concession in favor of the United States without receivinga corresponding benefit when they reduce withholding rates. In some such cases, we willlook at the level of overall rates of tax and avoid agreements which serve to transfer taxfrom a less developed foreign fisc to the United States. For this reason and others, thetreaty withholding rates will vary. Furthermore, even if the treaty does not serve toreduce existing rates, it provides limitations and the certainty demanded by businessdecision-makers.

The rules provided in the treaty are general guidelines that do notaddress every conceivable situation, particularly, new developments. Consequently, therewill be cases in which double taxation occurs in spite of the treaty. In such cases, thetreaty provides mechanisms enabling the tax authorities of the two governments -- known asthe "competent authorities" in tax treaty parlance -- to consult and reach anagreement under which the taxpayer's income is allocated between the two taxingjurisdictions on a consistent basis, thereby preventing the double taxation.

All the aspects of tax treaties that I have been discussing so far involvebenefits that the treaties provide to taxpayers, especially multinational companies butalso others I have described. While providing these benefits certainly is a major purposeof any tax treaty, it is not the only purpose. The second major objective of our incometax treaty program is to prevent tax evasion and to ensure that treaty benefits flow onlyto the intended recipients. Tax treaties achieve this objective in at least two majorways. First, they provide for exchange of information between the tax authorities. Second,they contain provisions designed to ensure that treaty benefits are limited to realresidents of the other treaty country and not to "treaty shoppers."

Under the tax treaties, the competent authorities are authorized toexchange information, including confidential taxpayer information, as may be necessary forthe proper administration of the countries' tax laws. This aspect of our tax treatyprogram is one of the most important features of a tax treaty from the standpoint of theUnited States. The information that is exchanged may be used for a variety of purposes.For instance, the information may be used to identify unreported income or to investigatea transfer pricing case. In recent years information exchange has become a priority forthe United States in its tax treaty program.

Recent technological developments which facilitate international, andanonymous, communications and commercial and financial activities can also encourageillegal activities.

Over the past several years we have experienced a marked and important seachange as many of the industrialized nations have recognized the increasing importance oftax information exchange and that the absence thereof serves to encourage not only taxavoidance and evasion, but also criminal tax fraud, money laundering, illegal drugtrafficking, and other criminal activity. Treasury is proud of the role it has played inmoving these issues forward not only in our bilateral treaty negotiations but also inother fora such as the OECD and the OAS. We have observed that within the European Unionthere has been increasing recognition that the desired political and economic unityrequires full disclosure and transparency.

To emphasize the importance of this subject, the Department of Justice haswritten a letter, in light of its obligations to enforce the tax laws, expressing itssupport for these treaties. A copy of the letter is appended to this testimony for theCommittee's information.

A second major objective of U.S. tax treaty policy is to obtaincomprehensive provisions designed to prevent abuse of the treaty by persons who are not bonafide residents of the treaty partner. This abuse, which is known as "treatyshopping," can take a number of forms, but its general characteristic is that aresident of a third state that has either no treaty with the United States or a relativelyunfavorable one establishes an entity in a treaty partner that has a relatively favorabletreaty with the United States. This entity is used to hold title to the person's UnitedStates investments, which could range from portfolio stock investments to major directinvestments or other treaty-favored activity in the United States. By placing theinvestment in the treaty partner, the third-country person is able to withdraw the returnsfrom the United States investment subject to the favorable rates provided in the taxtreaty, rather than the higher rates that would be imposed if the person had investeddirectly into the United States. The United States treaty partner must of course cooperateby providing favorable tax treatment to the third country investor.

This Committee and the Congress have expressed strong concerns abouttreaty shopping, and the Department of the Treasury shares those concerns. If treatyshopping is allowed to occur, then there is less incentive for the third country withwhich the United States has no treaty to negotiate a treaty with the United States. Thethird country can maintain inappropriate barriers to United States investment and trade,and yet its companies can operate free of these barriers by organizing their United Statestransactions so that they flow through a country with a favorable United States taxtreaty.

Although anti-treaty shopping provisions give us leverage in negotiatingwith other countries, we do not necessarily need to have tax treaties with every countryin the world. There are usually very good reasons why the United States has not concludeda treaty with a particular country. For example, we generally do not conclude tax treatieswith jurisdictions that do not impose significant income taxes, because there is littledanger of double taxation of income in such a case and it would be inappropriate to reduceUnited States taxation on returns on inbound investment if the other country cannot offera corresponding benefit in exchange for favorable United States treatment. The anti-treatyshopping provisions in our treaty network support this goal by preventing investors fromenjoying the benefits of a tax-haven regime in their home country and, at the same time,the benefits of a treaty between the United States and another country. However, thesesituations often are not black or white. Some countries have adopted favorable tax regimesapplicable to limited sectors of their economy and the United States believes that in manycircumstances it is inappropriate to grant treaty benefits to companies taking advantageof such regimes. On the other hand there may be other elements of the economy as well asother factors that would make a treaty relationship useful and appropriate. Accordingly,in some cases we have devised treaties that carve out from the benefits of the treatiescertain residents and activities. In other cases, we have offered to enter into anagreement limited to the exchange of tax information. We have a number of theseagreements, particularly with Caribbean countries.

The Department of the Treasury has included in all its recent tax treatiescomprehensive "limitation on benefits" provisions that limit the benefits of thetreaty to bona fide residents of the treaty partner. These provisions are notuniform, as each country has its own characteristics that make it more or less inviting totreaty shopping in particular ways. Consequently, each provision must to some extent betailored to fit the facts and circumstances of the treaty partners' internal laws andpractices. Moreover, these provisions should be crafted to avoid interfering withlegitimate and desirable economic activity. For example, we have begun to address directlyin our negotiations the issue of how open-end United States regulated investment companies(RICs) should be treated under limitation on benefits provisions in order to facilitatecross-border investments from this important source of capital. Because these funds arerequired to stand ready to redeem their shares on a daily basis, we believe they generallyshould be entitled to treaty benefits to the same extent as closed-end RICs, which qualifyfor benefits under standard limitation on benefits provisions because they are publiclytraded on stock exchanges. However, the negotiators need to ensure that what may appear tobe similar funds established in the treaty partner cannot be used to promote treatyshopping.

Several of the aspects of income tax treaties that I have been describingare highly relevant to the resolution of transfer pricing issues. Transfer pricing relatesto the division of the taxable income of a multinational enterprise among thejurisdictions where it does business. If a multinational manipulates the prices charged intransactions between its affiliates in different countries, the income reported for taxpurposes in one country may be artificially depressed, and the tax administration of thatcountry will collect less tax from the enterprise than it should. Accordingly, transferpricing is an important subject not only in this country but in most other countries aswell.

In analyzing the prices charged in any transaction between parties thatare commonly controlled, it is necessary to have a benchmark by which to evaluate theprices charged. The benchmark adopted by the United States and all our major tradingpartners is the arm's-length standard. This standard is reflected in hundreds of existingtax treaties. Under the arm's-length standard, the price charged should be the same as itwould have been had the parties to the transaction been unrelated to one another -- inother words, the same as if they had bargained at "arm's-length."

Consistent with the domestic practice of all major trading nations, all ofour comprehensive income tax treaties adopt the arm's-length standard as the agreedbenchmark to be used in addressing a transfer pricing case. Adoption of a common approachto these cases is another benefit provided by tax treaties. A common approach consistentlyapplied is a sine qua non for preventing both tax avoidance and double taxation. Acommon approach guarantees the possibility of achieving a consistent allocation of incomebetween the treaty partners. Without such an assurance, it is possible that the two taxauthorities would determine inconsistent allocations of income to their respectivejurisdictions, resulting in either double taxation or under taxation. Double taxationwould occur when part of the multinational's income is claimed by both jurisdictions.Under taxation would occur when part of the multinational's income is claimed by neitherjurisdiction.

By adopting a common standard, the risks of double taxation and undertaxation are minimized. Furthermore, when double taxation does occur, the competentauthorities of the two countries are empowered to consult and agree on an equitabledivision of income based upon this common reference point. Without this common referencepoint, reaching mutual agreement would be difficult or impossible.

Our tax treaties must provide appropriate tax treatment for categories ofincome which are specially treated under the Code. One important example of suchprovisions are the REITs, created by Congress to help investors achieve diversifiedownership in primarily passive real estate investments. In the case of foreign investors,the Congress provided for a 30% withholding tax except for certain capital gaindistributions. These rules reflected U.S. tax policy which is consistent with those ofmost other countries: each country reserves the right to impose a full tax on income fromreal property, leaving the residence country to alleviate any resulting double taxation.

REITs are created as U.S. corporations and their distributions are in theform of corporate dividends. Unlike corporations, however, they generally are not subjectto tax at the corporate level and, if their distributions were not subject to fulltaxation, their income would not be subject to full taxation at the entity level or theshareholder level. Therefore, a decision must be made whether to characterize thedistributions as distributions of real property rental income subject to at least onelevel of full U.S. taxation or as dividends subject to a lower rate.

It is has been U.S. policy since 1988 to treat REIT distributions asconduit distributions of real estate rental income. The policy originated in a 1988directive, with which the Department of the Treasury agreed, from the Joint Committee onTaxation and the Senate Committee on Foreign Relations. The purpose of excluding certainREIT dividends from preferential dividend withholding tax rates under the treaties is toprevent foreign investors from utilizing a REIT conduit to convert high-taxed U.S. sourcerental income into lower taxed dividend income by passing the rental income through aREIT. This policy avoids a disparity between the taxation of direct real estateinvestments and real estate investments made through REIT conduits. Limited relief fromthis rule generally is provided in the case of REIT dividends beneficially owned byindividuals holding less than a 10-percent interest in the REIT. Such REIT dividendsqualify for the reduced withholding tax rates generally available in respect of dividends.

Economic changes since these policies were established ten years agorequire that we review our position in order to insure that our treaty policies reflectthe best interests of the United States. These interests include not discouraging, throughour tax rules, desirable foreign investment. To that end we have consulted withrepresentatives of the REIT industry and we are now satisfied that our current treatypolicy should be modified. While the treaties before you represent policies with which weall have agreed, we now believe that it is appropriate to revise our treatment of REITdividends under our treaties.

Our new policy takes into account that portfolio investments in a REITwhether by individuals or institutional investors may be indistinguishable in intent andresults from similar investments in other corporate securities and should be affordedsimilar tax consequences in appropriate circumstances. In carrying out such a policyhowever, two other considerations are significant. First, we should maintain a reasonableneutrality with respect to the taxation of foreigners and U.S. citizens. A potential U.S.investor in a shopping mall should not be out bid by a foreigner because we have, throughout treaty process, provided inappropriate tax benefits to the foreigner. Second, weshould not provide such generous REIT benefits that foreigners choose to make economicallydistorted investments to our disadvantage. For example, we do not want a foreigner that isconsidering building a major job-producing new factory in the United States to chooseinstead to buy an existing office building because of inappropriately favorable taxtreatment of the latter.

The proposal which we put before you today has been developed by the staffof the Joint Committee on Taxation in consultation with the staff of this Committee andTreasury and with the help of the REIT industry. Our existing treaty policy provides for a30% withholding tax on REIT dividends with an exception for payments to individuals whohold 10% or less of the REIT. Our new policy retains the current treatment of individualswith 10% or smaller holdings of the REIT and, in addition, provides for a 15% withholdingtax on dividends paid by (i) a publicly traded REIT to any shareholder who holds a 5% orsmaller interest in the REIT, and (ii) a publicly traded or non-publicly traded REIT,the holdings of which are substantially diversified, to a shareholder who holds a 10% orsmaller interest in the REIT.

We are going to reflect this new policy in our model treaty and in futuretreaty negotiations. Furthermore we support the proposal to insert a reservation to theSenate’s advice and consent to our pending treaty with Luxembourg to reflect our newREIT policy in that treaty, as well as assuring "grandfathered" benefits forcertain current investments. We are also going to use our best efforts to secure agreementwith Austria, Ireland and Switzerland to protocols to our new treaties to reflect our newREIT policy.

We believe that the foregoing proposal goes as far as we can inaccommodating the changes in the REIT industry consistent with sound tax policy designedto take into account the factors described above. Representatives of the REIT industryhave been most helpful in providing us with information with respect to developments inthe industry and changes in investment patterns since adoption of our 1988 policy and haveindicated their support for the new policy.

Basis for Negotiations

Each of these treaties before you today reflects the basic principles ofcurrent United States treaty policy. The provisions in each treaty borrow heavily fromrecent treaties approved by the Senate and the U.S. model (which had not yet beenpublished while most of the treaties were negotiated, but was available to U.S.negotiators in draft form) and are generally consistent with the 1992 OECD Model IncomeTax Convention. The United States was and continues to be an active participant in thedevelopment of the OECD Model, and we are generally able to use most of its provisions asa basis for negotiations.

The U.S. model was published in September 1996. A model treaty is a usefuldevice if used properly and kept current.

Based on our experience, we anticipate that the United States model, likethe OECD model, will not be a static document but will be modified as required to reflectchanges in United States tax law or policy, economic, technical and other changes that mayrequire further elaboration, clarification or even reversals of prior policies. There areno major inconsistencies between the US and OECD model, but rather the US model elaborateson issues in which the United States may have a greater interest or which result fromparticular aspects of United States law and policy. For example, our limitation ofbenefits provisions are generally not found in typical tax treaties of other OECDcountries. We have also found it useful to expand on treaty coverage and treatment ofpass-through entities such as our limited liability companies. The tax consequencesresulting from the development of new financial instruments need to be internationallyaccepted and consistent. Despite the importance we attach to the OECD model and ourcontinuing efforts with our colleagues to improve it and keep it current, most countriescannot accede to all of the provisions of that model, nor do we expect that all of ourprospective treaty partners will agree with all of the provisions of our model. We believethat our new model and its accompanying explanation will find its principal benefits to beenabling all interested parties, including this Committee and the Congress and its staffs,the American business community, and our prospective treaty partners, to know andunderstand our treaty positions. We anticipate that American companies will be able to usethe model to suggest modifications that may be required in connection with negotiationswith a particular country based on the interaction of our two tax systems. For example, inmy discussions of our policies with respect to information exchange and treaty shopping Inoted the need to tailor these provisions to the specific circumstances, which will differfrom country to country. We have presented our model to the OECD with the intention ofworking together to create even greater consistency concerning the important issuescovered. We do not anticipate that the United States will ever sign a tax conventionidentical to the model; there are too many variables.

A nation’s tax policy, as reflected in its domestic tax legislationas well as its tax treaty positions, reflects the sovereign choices made by that countryin the exercise of one of its most important governmental functions, that of funding thegovernment. Numerous features of the treaty partner's unique tax legislation and itsinteraction with United States legislation must be considered in negotiating anappropriate treaty. Examples include the treatment of partnerships and other transparententities, whether the country eliminates double taxation through an exemption or a creditsystem, whether the country has bank secrecy legislation that needs to be modified bytreaty, and whether and to what extent the country imposes withholding taxes on outboundflows of investment income. Consequently, a negotiated treaty needs to take into accountall of these and other aspects of the treaty partner's tax system in order to arrive at anacceptable treaty from the perspective of the United States. Accordingly, a simpleside-by-side comparison of two actual treaties, or of a proposed treaty against a modeltreaty, will not enable meaningful conclusions to be drawn as to whether a proposed treatyreflects an appropriate balancing of interests. In many cases the differences are oflittle substantive importance, reflecting language problems, cultural obstacles or otherimpediments to the use of particular United States or OECD language. The technicalexplanations which accompany our treaty, the discussions with the staffs of this Committeeand its members, and the staffs of the tax law writing Committees, and most importantly,hearings such as this, will provide the Senate with the assurance that a particular treatyis, overall, in the best interests of the United States.

In addition to keeping in mind that each treaty must be adapted to theindividual facts and circumstances of each treaty partner, it also is important toremember that each treaty is the result of a negotiated bargain between two countries thatoften have conflicting objectives. Each country has certain issues that it considersnonnegotiable. The United States, which insists on effective anti-abuse andexchange-of-information provisions, and which must accommodate its uniquely complexinternal laws, probably has more nonnegotiable issues than most countries. Obtaining theagreement of our treaty partners on these critical issues sometimes requires otherconcessions on our part. Similarly, other countries sometimes must make concessions toobtain our agreement on issues that are critical to them. The give and take that isinherent in the negotiating process leading to a treaty is not unlike the process thatresults in legislation in this body. Treaties can each be different and yet represent anideal treaty from the United States perspective with a particular country because of thespecific economic relationships, domestic tax rules and other factors, and even though thetreaty does not completely adhere to a model, whether that of the United States, the OECDor the treaty partner.

Each of the full treaties before the Committee today allows the UnitedStates to impose our branch profits tax at the treaty's direct-dividend rate. In addition,in conformity with what has become standard United States treaty policy, excess inclusionswith respect to residual interests in real estate mortgage investment conduits (REMICs)are subject to the United States statutory withholding rate of 30 percent.

The proposed treaties also contain provisions designed to improve theadministration both of the treaty and of the underlying tax systems, including rulesconcerning exchange of information, mutual assistance, dispute resolution andnondiscrimination. Each treaty permits the General Accounting Office and the tax-writingcommittees of Congress to obtain access to certain tax information exchanged under treatyfor use in their oversight of the administration of United States tax laws and treaties.Each treaty also contains a now-standard provision ensuring that tax discriminationdisputes between the two nations generally will be resolved within the ambit of the taxtreaty, and not under any other dispute resolution mechanisms, including the World TradeOrganization (WTO).

Each treaty also contains a comprehensive limitation on benefits provisiondesigned to ensure that residents of each State may enjoy treaty benefits only if theyhave a substantial nexus with that State, or otherwise can establish a substantialnon-treaty-shopping motive for establishing themselves in their country of residence. Eachtreaty preserves the right of the United States to tax certain former citizens generallyconsistent with recently enacted amendments to the Code dealing with this issue.

Finally, some treaties will have special provisions not found in otheragreements. These provisions account for unique or unusual aspects of the treaty partner'sinternal laws or circumstances. For example, in order to achieve the desired reciprocaltaxation of business profits on a net basis, special provisions in the proposed treatywith Turkey, applicable only to Turkey, were required. Turkey also exemplifies a treatypartner in a significantly different level of economic development than the United Statesand many other OECD member countries. While the treaty is based on the OECD model itreflects various reservations made by Turkey to that model particularly with respect towithholding at source on interest, dividends and royalties. All of these features shouldbe regarded as a strength rather than weakness of the tax treaty program, since it isthese differences in the treaties which enable us to reach agreement and thereby reducetaxation at source, prevent double taxation and increase tax cooperation.

I would like to discuss the importance and purposes of each agreement thatyou have been asked to consider. We have submitted Technical Explanations of eachagreement that contain detailed discussions of each treaty and protocol. These TechnicalExplanations serve as an official guide to each agreement. We have furnished our treatypartners with a copy of the relevant technical explanation and offered them theopportunity to submit their comments and suggestions.

The proposed new Convention with Austria signed in Vienna on May 30,1996,along with the Memorandum of Understanding, replaces the existing Convention, which wassigned in 1956. The proposed Convention generally follows the pattern of other recentUnited States treaties and the OECD Model treaty. The proposed new Convention containschanges made in order to create a closer alignment with our current income tax treatypolicy.

First, the proposed Convention contains a new exchange of informationprovision which will allow each country greater access to information important to taxenforcement. These provisions are needed because the existing Convention is limited anddoes not provide an effective means for the United States to obtain relevant Austrian bankaccount information. As elaborated in the Memorandum of Understanding, the informationexchange provisions make clear that United States tax authorities will be given access toAustrian bank information in connection with any penal investigation. The MOU clarifiesthat the term penal investigation applies to proceedings carried out by either judicial oradministrative bodies and that the commencement of a criminal investigation by theCriminal Investigation Division of the Internal Revenue Service constitutes a penalinvestigation.

Also, as the existing Convention contains no provision dealing with gainson disposition of personal property, the proposed new convention contains an articledealing with the taxation of capital gains. This provision is generally similar to that inrecent United States treaties. Under the new Convention, however, and consistent withUnited States tax law, a Contracting State in which a permanent establishment or fixedbase is located may also tax gains from the alienation of personal property that isremoved from the permanent establishment or fixed base, to the extent that gains accruedwhile the asset formed part of a permanent establishment or fixed base. Double taxation isprevented because the residence State must exclude from its tax base any gain taxed in theother State.

The withholding rates on investment income in the proposed Convention areessentially the same as in the present treaty and are generally consistent with UnitedStates policy. Direct investment dividends are subject to taxation at source at a rate of5 percent, and portfolio dividends are taxable at 15 percent. The proposed Conventioncontains a change that conforms the threshold of ownership required to obtain the lowestdividend withholding rate with the threshold in our most recent income tax conventions.Interest and royalties are generally exempt from tax at source. However, in the proposedConvention, as in the existing one, a tax may be imposed at a maximum rate of 10 percenton royalties in respect of commercial motion pictures, films and tapes; and the proposedConvention redefines the category to include royalties in respect of rights to use similaritems used for radio and television broadcasting.

Consistent with current United States treaty policy, the proposed treatyprovides for exclusive residence country taxation of profits from international carriageby ships or airplanes. The proposed Convention expands the scope of this provision toinclude income from the use or rental of containers and from the rental of ships andaircraft. Under the present Convention, such rental income is treated as royalty income,which may be taxed by the source country only if the income is attributable to a permanentestablishment in that country.

Personal services income is taxed under the proposed Convention as underrecent United States treaties with OECD countries. In addition, in recognition of theincreasingly mobile nature of the work force, the proposed Convention provides for thedeductibility, under limited circumstances, of cross-border contributions by individualstemporarily in one country who contribute to recognized pension plans in the othercountry.

Unlike the existing Convention, the proposed Convention contains acomprehensive anti-treaty-shopping provision. A Memorandum of Understanding provides aninterpretation of key terms. Austria’s recent membership in the European Union andthe special United States ties to Canada and Mexico under the North American Free TradeAgreement are an element in the determination by the competent authority of eligibilityfor benefits of certain Austrian and United States companies. Recognized headquarterscompanies of multinational corporate groups are entitled to benefits of the Convention.

The proposed Convention also provides for the elimination of anotherpotential abuse relating to the granting of United States treaty benefits in the so-calledtriangular cases to income of an Austrian resident attributable to a third-countrypermanent establishments of Austrian corporations that are exempt from tax in Austria byoperation of Austria’s law or treaties. Under the proposed rule, full United Statestreaty benefits will be granted in these triangular cases only when the UnitedStates-source income is subject to a sufficient level of tax in Austria and in the thirdcountry. As in the United States-France treaty, this anti-abuse rule does not apply incertain circumstances, including when the United States taxes the profits of the Austrianenterprise under subpart F of the Internal Revenue Code.

Also included in the proposed Convention are the provisions necessary foradministering the Convention, including rules for the resolution of disputes under thetreaty and the exchange of information. With the exception of the more limited access tobank information, the exchange of information provision in the proposed Convention isconsistent with the U.S. Model.

The proposed new Convention with Luxembourg, signed in Luxembourg onApril3, 1996, replaces the existing Convention, which was signed in 1962. The proposedConvention generally follows the pattern of the OECD Model Convention and other recentUnited States treaties with developed countries.

A new treaty is necessary for many reasons. The existing Convention doesnot provide an effective means for the United States to obtain information from Luxembourgfinancial institutions as part of the exchange of tax information under the Convention. Italso does not contain adequate rules to prevent residents of third countries fromimproperly obtaining the benefits of the Convention by using companies resident in one ofthe treaty countries to invest in the other. Finally, as the present treaty entered intoforce more than three decades ago, it does not reflect the significant changes in UnitedStates tax and treaty policy that have developed since the present treaty entered intoforce.

To deal with the first issues, the fact that the present treaty does notcontain a comprehensive provision to prevent treaty shopping or to provide for effectiveinformation exchange can lead to abuse (the current treaty contains a narrow limitation onbenefits provision that denies treaty benefits to certain Luxembourg holding companies).The proposed Convention contains a comprehensive anti-treaty-shopping provision and, inconjunction with a new Mutual Legal Assistance Treaty which also is pending before thisCommittee, will allow the Internal Revenue Service significant access to Luxembourg bankinformation.

Regarding the changes in tax and treaty policy, the new Convention, forexample, allows the United States to impose its branch tax on United States branches ofLuxembourg corporations. Among other modernizations, it also eliminates the withholdingtax on debt secured by real property, permits the United States to impose withholding taxon contingent interest, and eliminates the out-dated force of attraction rule so that acountry can only tax the profits that are actually attributable to a permanentestablishment in that country.

In parallel with Luxembourg’s elimination of dividend withholdingtaxes for payments within the European Union, Luxembourg unilaterally eliminates thewithholding tax for certain dividend payments between a Luxembourg subsidiary and its U.S.parent company in the proposed Convention. This practice generally puts the payments fromLuxembourg subsidiaries to U.S. entities on the same footing as payments from Luxembourgsubsidiaries to EU entities and is a significant benefit to U.S. companies doing businessin Luxembourg. Apart from this exception, the withholding rates on investment income inthe proposed Convention are generally the same as those in the present treaty. Interestand royalties are generally exempt at source, as under the present treaty. All UnitedStates-source and most Luxembourg-source direct investment dividends are subject totaxation at 5 percent at source.

The proposed Convention provides another major benefit to certain U.S.companies by modifying the present Convention rules to reflect current United Statestreaty policy with respect to ships and aircraft and related activities. The proposedConvention provides for exclusive residence country taxation of profits from internationalcarriage by ships or aircraft. The reciprocal exemption from source country taxation alsoextends to income from the use or rental of containers and from the rental of ships andaircraft.

The proposed Convention also provides benefits to the U.S. fisc. It doesthis in two manners: First, it contains detailed rules that restrict the benefits of theConvention to persons that are not engaged in treaty shopping. Second, it expands theability to exchange information about financial accounts. These provisions are importantas they ensure that the Convention serves its second purpose of preventing fiscal evasion.

Under the limitations on benefits provision in the proposed Convention, aperson must meet the test to be a qualified resident of a treaty country to be entitled toall of the benefits of the treaty. For example, companies may be entitled to benefits ifthey meet certain listed conditions. For example, publicly-traded companies will generallybe entitled to treaty benefits if their principal class of shares is substantially andregularly traded on a recognized stock exchange. Other companies may be qualified toobtain benefits if they meet certain ownership and base erosion tests. In addition, theproposed Convention allows certain residents of the European Union or of the NorthAmerican Free Trade Area to obtain derivative benefits. These provisions parallel thosecontained in recent treaties between the United States and Member States of the EuropeanUnion. Consistent with U.S. treaty policy, individuals, governmental entities andnot-for-profit organizations (provided more than half of the beneficiaries, members orparticipants, if any, in such organization are qualified residents) are entitled to allthe benefits of the treaty.

The proposed Convention continues to carve out Luxembourg’s"1929" holding companies from treaty benefits. It expands this coverage toinclude other companies that enjoy similar fiscal treatment, such as the investmentcompanies defined in the Act of March 30, 1988. Headquarters companies are also notgranted treaty benefits.

The proposed Convention also provides for the elimination of anotherpotential abuse relating to the granting of United States treaty benefits in the so-calledtriangular cases to third-country permanent establishments of Luxembourg corporations thatare exempt from tax in Luxembourg by operation of Luxembourg’s law or treaties. Underthe proposed rule, full United States treaty benefits will be granted in these triangularcases only when the United States-source income is subject to a sufficient level of tax inLuxembourg and the third country.

Finally, the proposed treaty allows the competent authority to allowbenefits even if the conditions outlined in the limitation on benefits article are notmet. The competent authority has the ability to resolve unilaterally these cases and granttreaty benefits in other cases where the perceived abuses do not in fact exist. Thislatter situation may arise, for example, when the United States source income iseffectively subject to United States tax under subpart F of the Code.

The modifications to the exchange of information article are a criticalpiece of the proposed treaty. Under its internal law, Luxembourg tax authorities may notobtain certain information from Luxembourg financial institutions. As clarified in theexchange of notes, certain information of financial institutions may be obtained andprovided to certain United States authorities only in accordance with the terms of thetreaty between the United States and Luxembourg on Mutual Legal Assistance in CriminalMatters. That agreement sets forth the scope of that obligation. The ability to obtainthis information is critical and we will not proceed to bring the Convention into forceexcept in tandem with the Mutual Legal Assistance Treaty. We request that the Committeerecommend that the Senate give its advice and consent to ratification on the understandingthat instruments of ratification will not be exchanged until the exchange of instrumentswith respect to the Mutual Legal Assistance Treaty has occurred.

The proposed Convention waives the United States excise tax on certaininsurance premiums paid to Luxembourg insurance companies, but does so in a more limitedway that other United States tax treaties that waive the excise tax. This proposedConvention generally waives the excise tax on direct insurance premiums, but does notwaive the tax on reinsurance premiums. Treasury agrees to waive the federal excise taxonly if we are satisfied that the foreign country imposes a sufficient level of tax oninsurance companies. In this case, we are satisfied that Luxembourg imposes a sufficientlevel of tax on direct business, but we are not satisfied that the effective tax rate onreinsurers is sufficient to justify waiving the excise tax on reinsurance premiums.

The proposed treaty with Turkey, signed in Washington on March 28, 1996,will be the first income tax convention between the United States and Turkey and willcomplete the United States' network of income tax treaties with OECD member countries. Thetreaty represents a central component of the economic relationship between Turkey and theUnited States. The proposed treaty generally follows the pattern of the OECD ModelConvention and other recent United States treaties. There are, however, variations thatreflect particular aspects of Turkish law and treaty policy, their interaction with UnitedStates law, and the disparity in the Turkish and United States economies.

The treaty establishes maximum rates of source-country tax on cross-borderpayments of dividends, interest, and royalties. Dividends may be taxed at source at amaximum rate of 20 per cent, except when paid to a corporation in the other country thatowns at least 10 percent of the paying corporation, in which case the maximum rate is 15percent. The general maximum rate of withholding tax at source on interest under theproposed treaty is 15 percent, with lower rates applicable for certain classes ofinterest. Royalties generally are subject to tax at source at a maximum rate of 10percent. Rental payments for tangible personal property are treated under the proposedtreaty as royalties, but are subject to tax at a maximum rate of 5 percent at source.

The proposed treaty generally follows standard United States treaty policyby providing for exclusive residence country taxation of profits from internationalcarriage by ships or airplanes and of income from the use or rental of ships, aircraft andcontainers. In this treaty, however, the reciprocal exemption does not extend to incomefrom the non-incidental rental of ships or aircraft. Such income is treated as royaltiesand will be subject to a maximum tax at source of 5 percent.

The limitation of benefits provisions is consistent with other recentUnited States treaties. The proposed treaty contains administrative provisions consistentwith United States treaty policy.

The proposed Convention and Protocol with Switzerland, signed inWashington on October 2, 1996, replace the existing Convention, which was signed in 1951.Many of the terms used in the Convention and Protocol are further explained in aMemorandum of Understanding that was negotiated at the same time. The new Conventiongenerally follows the pattern of the OECD Model Convention, and of recent U.S. treatieswith other developed countries. The proposed Convention and Protocol modernize many of theprovisions of the existing convention and add new provisions that have become part of ourtreaty policy.

For example, under the proposed Convention, interest generally may be paidfree of withholding in the source country, rather than being subject to the five percentwithholding tax that may be levied under the existing treaty. Although the withholdingrates on dividend and royalty income are essentially unchanged in the proposed Convention,the thresholds for, and exceptions from, those rates have been made consistent with otherrecent U.S. treaties. The proposed Convention also recognizes the growing importance ofpooled capital, by providing that qualified pension funds may receive dividends fromcorporations resident in the other country free of source-country taxation.

The proposed Convention clarifies the treatment of capital gains andallows us to apply in full our rules regarding the taxation of gains from the dispositionof U.S. real property interests. The proposed treaty also contains rules, found in a fewother U.S. treaties, that allow adjustments to the taxation of certain classes of capitalgains in order to coordinate the timing of the taxation of gains. These rules serve tominimize possible double taxation that could otherwise result.

As with the recent U.S. treaties and the OECD Model, the proposedConvention provides generally for the taxation by one State of the business profits of aresident of the other only when such profits are attributable to a permanent establishmentlocated in that other State. The present Convention grants taxing rights that are in somerespects broader and in others narrower than those found in modern treaties. In addition,the proposed Convention preserves the U.S. right to impose its branch tax on U.S. branchesof Swiss corporations. This tax is not imposed under the present treaty.

The proposed Convention provides, consistent with current U.S. treatypolicy, for exclusive residence country taxation of profits from international carriage byships or airplanes. This reciprocal exemption also extends to income from the rental ofships and aircraft if the rental income is incidental to income from the operation ofships or aircraft in international traffic. Other income from the rental of ships oraircraft and income from the use of rental of containers, however, are treated as businessprofits under Article 7. As such, these classes of income are taxable only in the countryof resident of the beneficial owner of the income unless the income is attributable to apermanent establishment in the other Contracting State, in which case it is taxable inthat State on a net basis.

The taxation of income from the performance of personal services under theproposed Convention is essentially the same as that under recent U.S. treaties with OECDcountries. Unlike many U.S. treaties, the proposed Convention provides for thedeductibility of cross-border contributions by a temporary resident of one country tocertain pension plans in the other, under limited circumstances.

The proposed Convention contains significant rules to deny the benefits ofthe Convention to persons that are engaged in treaty shopping. The present Conventioncontains no such anti-treaty-shopping rules. Such provisions are found in all recent U.S.treaties. The Protocol and Memorandum of Understanding contain explanations and examplesof the application of the Limitation on Benefits provisions.

The Limitation on Benefits article of the proposed Convention alsoeliminates another potential abuse by denying U.S. benefits with respect to incomeattributable to third-country permanent establishments of Swiss corporations that areexempt from tax in Switzerland by operation of Swiss law (the so-called "triangularcases"). Under the proposed rule, full U.S. treaty benefits generally will be grantedin these triangular cases only when the U.S. source income is subject to a significantlevel of tax in Switzerland or in the country in which the permanent establishment islocated.

The proposed Convention provides a U.S. foreign tax credit for the Swissincome taxes covered by the Convention, and for Swiss relief from double taxation withrespect to the income of Swiss residents subject to U.S. taxation. Swiss relief may be inthe form of a deduction, credit or exemption. In the case of social security benefits, apartial Swiss exemption is provided, which, when combined with the reduction in U.S.source-basis tax results in the avoidance of potential double taxation. The proposedConvention also provides for non-discriminatory treatment (i.e., nationaltreatment) by one country of residents and nationals of the other.

Also included in the proposed Convention are the rules necessary foradministering the Convention, including rules for the resolution of disputes under thetreaty and the exchange of information. The information exchange provisions, as elaboratedin the Protocol and Memorandum of Understanding, make clear that U.S. tax authorities willbe given access to Swiss bank information in cases of tax fraud. The Protocol includes aclear and broad definition of tax fraud that should facilitate information exchange.Furthermore, the new treaty provides that, where possible, information will be provided ina form that will make it acceptable for use in court proceedings.

The proposed Convention allows for the use of arbitration to resolvedisputes that may arise between the Contracting States. However, the arbitration processmay be implemented under the Convention only after the two Contracting State have agreedto do so through an exchange of diplomatic notes. Once implemented, a particular case maybe assigned to an arbitration panel only with the consent of all the parties to the case.

The proposed Convention deals with cases where a Contracting State enactslegislation that is believed to modify the application of the Convention in a significantmanner. In such cases, either Contracting State may request consultations with the otherto determine whether an amendment to the Convention is appropriate in order to restore theoriginal balance of benefits.

The proposed treaty with Thailand, signed in Bangkok on November 26, 1996,will, if ratified, be the first tax treaty between the United States and Thailand to enterinto force. An income tax treaty with Thailand was signed in 1965 but was returned to thePresident at his request in 1981 never having been formally considered by the Senate. Thecurrent proposed treaty is a major step in our efforts to expand our tax treaty network inAsia and will facilitate negotiating tax treaties with other important countries in theregion. The proposed treaty generally follows the pattern of the U.S. Model treaty, withthe deviations from the Model found in many recent U.S. treaties with other developingcountries. There are also some further variations that reflect particular aspects of Thailaw and treaty policy, the interaction of U.S. and Thai law, and U.S.-Thai economicrelations.

The proposed treaty establishes maximum rates of source-country tax oncross-border payments of dividends, interest, and royalties. Direct investment dividendsare taxable at source at a 10-percent rate, and portfolio dividends are taxable at a15-percent rate. The proposed treaty provides for a 15-percent maximum rate of tax atsource on most interest payments. Copyright royalties (including software) are subject toa 5-percent tax at source. Royalties for the right to use equipment are subject to a8-percent tax at source. Royalties for patents and trademarks are subject to a 15-percenttax at source. These rates generally are lower than those in many tax treaties Thailandrecently has entered into.

The taxation of capital gains under the proposed Convention does notfollow the usual pattern. Like some other U.S. treaties, it allows gains to be taxed byboth Contracting States under the provisions of their internal law.

Consistent with recent U.S. treaties and the U.S. and OECD Models, theproposed Convention provides generally for the taxation by one State of the businessprofits of a resident of the other only when such profits are attributable to a permanentestablishment located in that other State. The proposed Convention, however, grants rightsto tax business profits that are somewhat broader than those found in the U.S. and OECDModels: It allows taxation of some income that is not attributable to a permanentestablishment, but only if it can be shown that the income was shifted away from thepermanent establishment to avoid tax. Thus this "limited force of attraction"rule is narrower than those found in the U.N. Model and section 864(c)(3) of the U.S.Internal Revenue Code.

The proposed Convention, consistent with current U.S. treaty policy,provides for exclusive residence-country taxation of profits from international carriageby aircraft. This reciprocal exemption also extends to income from the rental of aircraftif the rental activity is incidental to the operation of aircraft by the lessor ininternational traffic. However, income from the international operation of ships,including ship rental income that is incidental to such operations, is taxed at one-halfof the tax rate otherwise applicable. Income from the use or rental of containers that isincidental to the operation of ships or aircraft in international traffic is treated thesame as the income from the operation of the ships or aircraft in international traffic (i.e.,it is exempt if incidental to such aircraft operations, and taxed at half of the rateotherwise applicable if incidental to such operation of ships). Income from the rental ofships, aircraft or containers that is not incidental to the operation of ships or aircraftin international traffic is treated as business profits, and thus is taxable by the stateother than the income recipient's state of residence only on a net basis and only ifattributable to a permanent establishment in the state. The current treaty policy ofThailand is to treat such income as royalties subject to tax at a rate of 8 percent ofgross. Treatment as business profits was a concession gained by the United States.

The proposed Convention grants a taxing right to the host country withrespect to income from the performance of personal services that is broader than that inthe OECD or U.S. Model, but that is similar to that granted under other U.S. treaties withdeveloping countries.

The proposed Convention contains detailed rules designed to restrict thebenefits of the Convention to persons that are not engaged in treaty shopping. Theprovisions are similar to those found in the U.S. Model and in all recent U.S. treaties.

The information exchange provisions make clear that Thailand is obligatedto provide U.S. tax officials such information as is necessary to carry out the provisionsof the Convention. The U.S. negotiators are satisfied that, under this provision, Thailandis now able to provide adequate tax information, including bank information, to the UnitedStates whenever there is a Thai tax interest in the case. Under current Thai law, however,Thailand is not able to provide information under the tax treaty in non-criminal caseswhere there is no Thai tax interest. The proposed Convention contains an unusual provisiondesigned to deal with this "tax interest" problem. The proposed Conventionprovides that Thailand generally is required to treat a U.S. tax interest as a Thai taxinterest and the U.S. generally is required to treat a Thai tax interest as a U.S. taxinterest. However, the "tax interest" provision does not take effect withrespect to either country until the United States receives from Thailand a diplomatic noteindicating that Thailand is prepared and able to implement the provision, which will notbe possible until Thai law is changed. If the United States has not received such adiplomatic note by June 30 of the fifth year following the entry into force of theConvention, the entire Convention shall terminate on January 1 of the sixth year followingentry into force.

The Convention remains in force indefinitely, except in the instance justdescribed, but either State may terminate the Convention after 5 years from the date onwhich the Convention enters into force, with six-months' notice.

The proposed treaty with South Africa, signed February 17, 1997, renews atreaty relationship that was interrupted when the previous convention was terminated in1987 pursuant to the U.S. Anti-Apartheid Act. The proposed Convention with South Africagenerally follows the pattern of the OECD Model treaty and other recent United Statestreaties.

The proposed Convention establishes maximum rates of withholding at sourceon investment income that are the same as those in the U.S. Model. The taxation of capitalgains under the proposed Convention also follows the pattern of the U.S. Model.

As with recent U.S. treaties and the U.S. and OECD Models, the proposedConvention provides generally for the taxation by one State of the business profits of aresident of the other only when such profits are attributable to a permanent establishmentlocated in that other State. The proposed Convention, however, grants rights to taxbusiness profits that are somewhat broader in one respect than those found in the U.S. andOECD Models. Under the proposed Convention, an enterprise will have a permanentestablishment in a Contracting State if its employees or other personnel provide serviceswithin that State for 183 days or more within a 12-month period in connection with thesame or a connected project.

As with the treatment of business profits, personal service income issubject to rules that generally follow the U.S. Model rules. The 183-day personal servicerule in the definition of permanent establishment, however, is also present in thedefinition of fixed base.

The proposed Convention, consistent with current U.S. treaty policy,provides exclusive residence-country taxation of profits from international carriage byship or aircraft. This reciprocal exemption also extends to income from the rental ofships, aircraft and containers.

In the proposed Convention, the dollar threshold for host-country taxationof income of entertainers and sportsmen is $7,500, rather than $20,000, as in the U.S.Model. The proposed Convention, however, contains a rule allowing the Contracting Statesto increase the amount through an exchange of diplomatic notes.

The treatment of pensions differs, at the request of South Africa, fromthat in the U.S. Model. Pensions will be subject to limited source-country tax. Theresidence country may also tax, subject to a foreign tax credit if the source country hastaxed. Like the U.S. Model, an individual employed in one country who belongs to a pensionplan in the other may, subject to certain conditions, be allowed in his country ofemployment to deduct contributions to his plan in the other country.

As in the U.S. Model, the proposed Convention provides that income of aresident of a Contracting State not dealt with in the other articles of the Convention istaxable only in the country of residence of the recipient.

The proposed Convention contains significant limitation on benefits rulessimilar to those found in the U.S. Model and in all recent U.S. treaties. The informationexchange provisions make clear that South Africa is obligated to provide U.S. taxofficials such information, including bank information, as is necessary to carry out theprovisions of the Convention. Consistent with U.S. policy, South African information willbe available to U.S. authorities whether or not South Africa has a tax interest in theinformation.

The proposed Convention provides a U.S. foreign tax credit for the SouthAfrican income taxes covered by the Convention, including the normal tax and the secondarytax on companies, and for a South African foreign tax credit for the U.S. income taxescovered by the Convention. The U.S. foreign tax credit is subject to normal limitations ofU.S. law, including limitations relating to the amount of foreign source income of theU.S. taxpayer and denial of the credit for non-compulsory payments.

The proposed Convention, Protocol and exchange of diplomatic notes betweenthe United States and Ireland, which were signed in Dublin on July 28, 1997, would replacethe present treaty between the two countries. The present treaty is the oldest U.S. taxtreaty; it was signed in 1949. The proposed treaty updates the existing treaty to reflectthe current laws and tax treaty policies of both countries. It fills a major void in theexisting treaty by introducing a

comprehensive limitation on benefits provision and a dispute resolutionprocedure.

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

The proposed treaty maintains the existing treaty’s general exemptionat source for interest and royalty payments.

Unlike the existing treaty, the proposed treaty preserves the U.S. rightto impose its branch profits tax in addition to the basic corporate tax on a branch’sbusiness.

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

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

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

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

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

Finally, the proposed treaty covers the U.S. excise tax imposed oninsurance premiums paid to foreign insurers, but only where such insurance premiums aresubject to the generally applicable tax imposed on insurance companies in Ireland. Thisproviso means that the excise tax may be imposed on insurance premiums paid to companiesthat receive the tax benefits associated with Ireland’s International FinancialServices Center (which is sometimes referred to as the "Dublin Docks"). Thisprovision was included in the treaty after the Department of the Treasury determined thatinsurance companies subject to Ireland’s generally applicable insurance tax regimeface a substantial tax burden relative to the U.S. taxation of U.S. insurance companies,but companies benefiting from Ireland’s International Financial Services Center donot face such a substantial tax burden.

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

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

The 1995 Protocol to the US-Canada Tax Convention, which became effectiveJanuary 1, 1996, changed the taxation of social security benefits. Under the Conventionprior to amendment by the 1995 Protocol, the country of residence of the recipient taxedsocial security benefits paid by the other country on a net basis but exempted 50 percentof the benefit. Under the present regime, the benefits are taxed at source at a rate of25.5 percent by the US and 25 percent by Canada. However, Canada permits U.S. recipientsof Canadian benefits to file a Canadian tax return and pay tax at regular graduated rateson net income.

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

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

The proposed Protocol also denies each country the right to tax incomefrom the sale of the stock of foreign corporations whose assets primarily consist ofdomestic real estate (e.g., real property holding companies). Both countries currently taxforeign persons on the sale of both domestic real estate and the stock of domesticcorporations whose assets primarily consist of domestic real estate. The currentConvention permits this tax and also permits the taxation of income from the sale of stockof foreign companies whose assets primarily consist of domestic real estate but neithercountry currently imposes such a tax. We believe that it is inappropriate to tax suchsales, but a bill imposing such a tax was introduced in the last session of the CanadianParliament. Although the Canadian Parliament was dissolved before these amendments werepassed, they are expected to be re-introduced in the next session with the same effectivedate. The proposed Protocol amends the Convention to limit each country’s right totax gains from the sale of stock of real property holding companies to companies that areresident in that country. This provision will be retroactively effective to April 26,1995, the date the previous Canadian legislation was proposed to be effective.

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

Let me conclude by again thanking the Committee for its continuinginterest in the tax treaty program, and for devoting the time of Members and staff toundertake a meaningful review of the agreements that are pending before you. We appreciateyour efforts this year and in past years to bring the treaties before this Committee andthen to the full Senate for its advice and consent to ratification. We also appreciate theassistance and cooperation of the staffs of this Committee and of the Joint Committee onTaxation in the tax treaty process. With your and their help, we have, since the beginningof 1993, brought into force 15 new treaties and protocols, not counting the eightagreements presently being considered.

We urge the Committee to take prompt and favorable action on all of theConventions and Protocols before you today. Such action will send an important message toour trading partners and our business community. It will demonstrate our desire to expandthe United States treaty network with income tax treaties formulated to enhance theworldwide competitiveness of United States companies. It will strengthen and expand oureconomic relations with countries that have seen significant economic and politicalchanges in recent years. It will make clear our intention to deal bilaterally in aforceful and realistic way with treaty abuse. Finally, it will enable us to improve theadministration of our tax laws both domestically and internationally.

I will be glad to answer any questions you might have.