[Senate Executive Report 105-7]
[From the U.S. Government Publishing Office]
105th Congress Exec. Rpt.
SENATE
1st Session 105-7
_______________________________________________________________________
TAXATION CONVENTION WITH AUSTRIA
_______
October 30, 1997.--Ordered to be printed
_______________________________________________________________________
Mr. Helms, from the Committee on Foreign Relations,
submitted the following
R E P O R T
[To accompany Treaty Doc. 104-31]
The Committee on Foreign Relations, to which was referred
the Convention between the United States of America and the
Republic of Austria for the Avoidance of Double Taxation and
the Prevention of Fiscal Evasion with Respect to Taxes on
Income, signed at Vienna on May 31, 1996, having considered the
same, reports favorably thereon, with one understanding, two
declarations, and one proviso, and recommends that the Senate
give its advice and consent to ratification thereof, as set
forth in this report and the accompanying resolution of
ratification.
CONTENTS
Page
I. Purpose..........................................................1
II. Background.......................................................2
III. Summary..........................................................2
IV. Entry Into Force and Termination.................................3
V. Committee Action.................................................3
VI. Committee Comments...............................................4
VII. Budget Impact...................................................19
VIII.Explanation of Proposed Treaty..................................19
IX. Text of of the Resolution of Ratification.......................67
I. Purpose
The principal purposes of the proposed income tax treaty
between the United States and Austria are to reduce or
eliminate double taxation of income earned by residents of
either country from sources within the other country and to
prevent avoidance or evasion of the income taxes of the two
countries. The proposed treaty is intended to continue to
promote close economic cooperation and facilitate trade and
investment between the two countries. It also is intended to
enable the two countries to cooperate in preventing avoidance
and evasion of taxes.
II. Background
The proposed treaty was signed on May 31, 1996. The United
States and Austria also exchanged notes, with an attached
Memorandum of Understanding (the ``MOU''), on May 31, 1996. The
proposed treaty would replace the existing income tax treaty
between the two countries that was signed in 1956.
The proposed treaty was transmitted to the Senate for
advice and consent to its ratification on September 4, 1996
(see Treaty Doc. 104-31). The Committee on Foreign Relations
held a public hearing on the proposed treaty on October 7,
1997.
III. Summary
The proposed treaty is similar to other recent U.S. income
tax treaties, the 1996 U.S. model income tax treaty (``U.S.
model''), 1 and the model income tax treaty of the
Organization for Economic Cooperation and Development (``OECD
model''). However, the proposed treaty contains certain
substantive deviations from those documents.
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\1\ The Treasury Department released the U.S. model on September
20, 1996. A 1981 U.S. model treaty was withdrawn by the Treasury
Department on July 17, 1992.
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As in other U.S. tax treaties, the proposed treaty's
objective of reducing or eliminating taxation principally is
achieved by each country agreeing to limit, in certain
specified situations, its right to tax income derived from its
territory by residents of the other country. For example, the
proposed treaty contains provisions under which neither country
generally will tax business income derived from sources within
that country by residents of the other country unless the
business activities in the taxing country are substantial
enough to constitute a permanent establishment or fixed base
(Articles 7 and 14). Similarly, the proposed treaty contains
``commercial visitor'' exemptions under which residents of one
country performing personal services in the other country will
not be required to pay tax in the other country unless their
contact with the other country exceeds specified minimums
(Articles 14, 15, and 17). The proposed treaty provides that
dividends and certain capital gains derived by a resident of
either country from sources within the other country may be
taxed by both countries (Articles 10 and 13); however, the rate
of tax that the source country may impose on a resident of the
other country on dividends generally will be limited by the
proposed treaty (Article 10). The proposed treaty also provides
that interest and royalties derived by a resident of either
country generally will be exempt from tax in the other country
(Articles 11 and 12).
In situations where the country of source retains the right
under the proposed treaty to tax income derived by residents of
the other country, the proposed treaty 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 (Article 22).
The proposed treaty contains the standard provision (the
``saving clause'') contained in U.S. tax treaties pursuant to
which each country retains the right to tax its citizens and
residents as if the proposed treaty had not come into effect
(Article 1). In addition, the proposed treaty contains the
standard provision that it may not be applied to deny any
taxpayer any benefits the taxpayer would be entitled to under
the domestic law of a country or under any other agreement
between the two countries (Article 1).
The proposed treaty also contains a detailed limitation on
benefits provision to prevent the inappropriate use of the
proposed treaty (Article 16).
IV. Entry Into Force and Termination
A. Entry into Force
The proposed treaty provides that the instruments of
ratification are to be exchanged as soon as possible. The
proposed treaty will enter into force on the first day of the
second month following the exchange of instruments of
ratification. The present treaty generally ceases to have
effect once the provisions of the proposed treaty take effect.
In the case of taxes payable at source, the proposed treaty
takes effect for payments made on or after the first day of the
second month following the entry into force (i.e., the first
day of the fourth month following the exchange of instruments
of ratification). In the case of other taxes, the proposed
treaty takes effect for taxable years and periods beginning on
or after the first of January following the entry into force.
Taxpayers may elect temporarily to continue to claim
benefits under the present treaty with respect to a period
after the proposed treaty takes effect. For such a taxpayer,
the present treaty continues to have effect in its entirety for
the first assessment period or taxable year from the date on
which the provisions of the proposed treaty would otherwise
take effect.
B. Termination
The proposed treaty will continue in force until terminated
by a treaty country. Either country may terminate it at any
time after five years from the date of its entry into force by
giving at least six months prior written notice through
diplomatic channels. With respect to taxes payable at source, a
termination will be effective for payments made after the end
of the calendar year in which such notice has been given. With
respect to other taxes, a termination will be effective for
taxable years and periods beginning after the end of the
calendar year in which the notice has been given.
V. Committee Action
The Committee on Foreign Relations held a public hearing on
the proposed treaty with Austria (Treaty Doc. 104-31), as well
as on other proposed tax treaties and protocols, on October 7,
1997. The hearing was chaired by Senator Hagel. The Committee
considered these proposed treaties and protocols on October 8,
1997, and ordered the proposed treaty with Austria favorably
reported by a voice vote, with the recommendation that the
Senate give its advice and consent to ratification of the
proposed treaty, subject to an understanding, two declarations
and a proviso.
VI. Committee Comments
On balance, the Committee on Foreign Relations believes
that the proposed treaty with Austria is in the interest of the
United States and urges that the Senate act promptly to give
advice and consent to ratification. The Committee has taken
note of certain issues raised by the proposed treaty, and
believes that the following comments may be useful to Treasury
Department officials in providing guidance on these matters
should they arise in the course of future treaty negotiations.
A. Treatment of REIT Dividends
REITs in general
Real Estate Investment Trusts (``REITs'') essentially are
treated as conduits for U.S. tax purposes. The income of a REIT
generally is not taxed at the entity level but is distributed
and taxed only at the investor level. This single level of tax
on REIT income is in contrast to other corporations, the income
of which is subject to tax at the corporate level and is taxed
again at the shareholder level upon distribution as a dividend.
Hence, a REIT is like a mutual fund that invests in qualified
real estate assets.
An entity that qualifies as a REIT is taxable as a
corporation. However, unlike other corporations, a REIT is
allowed a deduction for dividends paid to its shareholders.
Accordingly, income that is distributed by a REIT to its
shareholders is not subject to corporate tax at the REIT level.
A REIT is subject to corporate tax only on any income that it
does not distribute currently to its shareholders. As discussed
below, a REIT is required to distribute on a current basis the
bulk of its income each year.
In order to qualify as a REIT, an entity must satisfy, on a
year-by-year basis, specific requirements with respect to its
organizational structure, the nature of its assets, the source
of its income, and the distribution of its income. These
requirements are intended to ensure that the benefits of REIT
status are accorded only to pooling of investment arrangements,
the income of which is derived from passive investments in real
estate and is distributed to the investors on a current basis.
In order to satisfy the organizational structure
requirements for REIT status, a REIT must have at least 100
shareholders and not more than 50 percent (by value) of its
shares may be owned by five or fewer individuals. In addition,
shares of a REIT must be transferrable.
In order to satisfy the asset requirements for REIT status,
a REIT must have at least 75 percent of the value of its assets
invested in real estate, cash and cash items, and government
securities. In addition, diversification rules apply to the
REIT's investment in assets other than the foregoing qualifying
assets. Under these rules, not more than 5 percent of the value
of its assets may be invested in securities of a single issuer
and any such securities held may not represent more than 10
percent of the voting securities of the issuer.
In order to satisfy the source of income requirements, at
least 95 percent of the gross income of the REIT generally must
be from certain passive sources (e.g., dividends, interest, and
rents). In addition, at least 75 percent of its gross income
generally must be from certain real estate sources (e.g., real
property rents, mortgage interest, and real property gains).
Finally, in order to satisfy the distribution of income
requirement, the REIT generally is required to distribute to
its shareholders each year at least 95 percent of its taxable
income for the year (excluding net capital gains). A REIT may
retain 5 percent or less of its taxable income and all or part
of its net capital gain.
A REIT is subject to corporate-level tax only on any
taxable income and net capital gains that the REIT retains.
Under an available election, shareholders may be taxed
currently on the undistributed capital gains of a REIT, with
the shareholder entitled to a credit for the tax paid by the
REIT with respect to the undistributed capital gains such that
the gains are subject only to a single level of tax.
Distributions from a REIT of ordinary income are taxable to the
shareholders as a dividend, in the same manner as dividends
from an ordinary corporation. Accordingly, such dividends are
subject to tax at a maximum rate of 39.6 percent in the case of
individuals and 35 percent in the case of corporations. In
addition, capital gains of a REIT distributed as a capital gain
dividend are taxable to the shareholders as capital gain.
Capital gain dividends received by an individual will be
eligible for preferential capital gain tax rates if the
relevant holding period requirements are satisfied.
Foreign investors in REITs
Nonresident alien individuals and foreign corporations
(collectively, foreign persons) are subject to U.S. tax on
income that is effectively connected with the foreign person's
conduct of a trade or business in the United States, in the
same manner and at the same graduated tax rates as U.S.
persons. In addition, foreign persons generally are subject to
U.S. tax at a flat 30-percent rate on certain gross income that
is derived from U.S. sources and that is not effectively
connected with a U.S. trade or business. The 30-percent tax
applies on a gross basis to U.S.-source interest, dividends,
rents, royalties, and other similar types of income. This tax
generally is collected by means of withholding by the person
making the payment of such amounts to a foreign person.
Capital gains of a nonresident alien individual that are
not connected with a U.S. business generally are subject to the
30-percent withholding tax only if the individual is present in
the United States for 183 days or more during the year. The
United States generally does not tax foreign corporations on
capital gains that are not connected with a U.S. trade or
business. However, foreign persons generally are subject to
U.S. tax on any gain from a disposition of an interest in U.S.
real property at the same rates that apply to similar income
received by U.S. persons. Therefore, a foreign person that has
capital gains with respect to U.S. real estate is subject to
U.S. tax on such gains in the same manner as a U.S. person. For
this purpose, a distribution by a REIT to a foreign shareholder
that is attributable to gain from a disposition of U.S. real
property by the REIT is treated as gain recognized by such
shareholder from the disposition of U.S. real property.
U.S. income tax treaties contain provisions limiting the
amount of income tax that may be imposed by one country on
residents of the other country. Many treaties, like the
proposed treaty, generally allow the source country to impose
not more than a 15-percent withholding tax on dividends paid to
a resident of the other treaty country. In the case of real
estate income, most treaties, like the proposed treaty, specify
that income derived from, and gain from dispositions of, real
property in one country may be taxed by the country in which
the real property is situated without limitation. 2
Accordingly, U.S. real property rental income derived by a
resident of a treaty partner generally is subject to the U.S.
withholding tax at the full 30-percent rate (unless the net-
basis taxation election is made), and U.S. real property gains
of a treaty partner resident are subject to U.S. tax in the
manner and at the rates applicable to U.S. persons.
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\2\ The proposed treaty, like many treaties, allows the foreign
person to elect to be taxed in the source country on income derived
from real property on a net basis under the source country's domestic
laws.
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Although REITs are not subject to corporate-level taxation
like other corporations, distributions of a REIT's income to
its shareholders generally are treated as dividends in the same
manner as distributions from other corporations. Accordingly,
in cases where no treaty is applicable, a foreign shareholder
of a REIT is subject to the U.S. 30-percent withholding tax on
ordinary income distributions from the REIT. In addition, such
shareholders are subject to U.S. tax on U.S. real estate
capital gain distributions from a REIT in the same manner as a
U.S. person.
In cases where a treaty is applicable, this U.S. tax on
capital gain distributions from a REIT still applies. However,
absent special rules applicable to REIT dividends, treaty
provisions specifying reduced rates of tax on dividends apply
to ordinary income dividends from REITs as well as to dividends
from taxable corporations. As discussed above, the proposed
treaty, like many U.S. treaties, reduces the U.S. 30-percent
withholding tax to 15 percent in the case of dividends
generally. Prior to 1989, U.S. tax treaties contained no
special rules excluding dividends from REITs from these reduced
rates. Therefore, under pre-1989 treaties such as the present
treaty with Austria, REIT dividends are eligible for the same
reductions in the U.S. withholding tax that apply to other
corporate dividends.
Beginning in 1989, U.S. treaty negotiators began including
in treaties provisions excluding REIT dividends from the
reduced rates of withholding tax generally applicable to
dividends. Under treaties with these provisions such as the
proposed treaty, REIT dividends generally are subject to the
full U.S. 30-percent withholding tax. 3
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\3\ Many treaties, like the proposed treaty, provide a maximum tax
rate of 15 percent in the case of REIT dividends beneficially owned by
an individual who holds a less than 10 percent interest in the REIT.
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Analysis of treaty treatment of REIT dividends
The specific treaty provisions governing REIT dividends
were introduced beginning in 1989 because of concerns that the
reductions in withholding tax generally applicable to dividends
were inappropriate in the case of dividends from REITs. The
reductions in the rates of source-country tax on dividends
reflect the view that the full 30-percent withholding tax rate
may represent an excessive rate of source-country taxation
where the source country already has imposed a corporate-level
tax on the income prior to its distribution to the shareholders
in the form of a dividend. In the case of dividends from a
REIT, however, the income generally is not subject to
corporate-level taxation.
REITs are required to distribute their income to their
shareholders on a current basis. The assets of a REIT consist
primarily of passive real estate investments and the REIT's
income may consist principally of rentals from such real estate
holdings. U.S.-source rental income generally is subject to the
U.S. 30-percent withholding tax. Moreover, the United States'
treaty policy is to preserve its right to tax real property
income derived from the United States. Accordingly, the U.S.
30-percent tax on rental income from U.S. real property is not
reduced in U.S. tax treaties.
If a foreign investor in a REIT were instead to invest in
U.S. real estate directly, the foreign investor would be
subject to the full 30-percent withholding tax on rental income
earned on such property (unless the net-basis taxation election
is made). However, when the investor makes such investment
through a REIT instead of directly, the income earned by the
investor is treated as dividend income. If the reduced rates of
withholding tax for dividends apply to REIT dividends, the
foreign investor in the REIT is accorded a reduction in U.S.
withholding tax that is not available for direct investments in
real estate.
On the other hand, some argue that it is important to
encourage foreign investment in U.S. real estate through REITs.
In this regard, a higher withholding tax on REIT dividends
(i.e., 30 percent instead of 15 percent) may not be fully
creditable in the foreign investor's home country and the cost
of the higher withholding tax therefore may discourage foreign
investment in REITs. For this reason, some oppose the inclusion
in U.S. treaties of the special provisions governing REIT
dividends, arguing that dividends from REITs should be given
the same treatment as dividends from other corporate entities.
Accordingly, under this view, the 15-percent withholding tax
rate generally applicable under treaties to dividends should
apply to REIT dividends as well.
This argument is premised on the view that investment in a
REIT is not equivalent to direct investment in real property.
From this perspective, an investment in a REIT should be viewed
as comparable to other investments in corporate stock. In this
regard, like other corporate shareholders, REIT investors are
investing in the management of the REIT and not just its
underlying assets. Moreover, because the interests in a REIT
are widely held and the REIT itself typically holds a large and
diversified asset portfolio, an investment in a REIT represents
a very small investment in each of a large number of
properties. Thus, the REIT investment provides diversification
and risk reduction that are not easily replicated through
direct investment in real estate.
At the October 7, 1997 hearing on the proposed treaty (as
well as other proposed treaties and protocols), the Treasury
Department announced that it has modified its policy with
respect to the exclusion of REIT dividends from the reduced
withholding tax rates applicable to other dividends under
treaties. The Treasury Department worked extensively with the
staff of the Committee on Foreign Relations, the staff of the
Joint Committee on Taxation, and representatives of the REIT
industry in order to address the concern that the current
treaty policy with respect to REIT dividends may discourage
some foreign investment in REITs while maintaining a treaty
policy that properly preserves the U.S. taxing jurisdiction
over foreign direct investment in U.S. real property. The new
policy is a result of significant cooperation among all parties
to balance these competing considerations.
Under this policy, REIT dividends paid to a resident of a
treaty country will be eligible for the reduced rate of
withholding tax applicable to portfolio dividends (typically,
15 percent) in two cases. First, the reduced withholding tax
rate will apply to REIT dividends if the treaty country
resident beneficially holds an interest of 5 percent or less in
each class of the REIT's stock and such dividends are paid with
respect to a class of the REIT's stock that is publicly traded.
Second, the reduced withholding tax rate will apply to REIT
dividends if the treaty country resident beneficially holds an
interest of 10 percent or less in the REIT and the REIT is
diversified, regardless of whether the REIT's stock is publicly
traded. In addition, the current treaty policy with respect to
the application of the reduced withholding tax rate to REIT
dividends paid to individuals holding less than a specified
interest in the REIT will remain unchanged.
For purposes of these rules, a REIT will be considered
diversified if the value of no single interest in real property
held by the REIT exceeds 10 percent of the value of the REIT's
total interests in real property. An interest in real property
will not include a mortgage, unless the mortgage has
substantial equity components. An interest in real property
also will not include foreclosure property. Accordingly, a REIT
that holds exclusively mortgages will be considered to be
diversified. The diversification rule will be applied by
looking through a partnership interest held by a REIT to the
underlying interests in real property held by the partnership.
Finally, the reduced withholding tax rate will apply to a REIT
dividend if the REIT's trustees or directors make a good faith
determination that the diversification requirement is satisfied
as of the date the dividend is declared.
The Treasury Department will incorporate this new policy
with respect to the treatment of REIT dividends in the U.S.
model treaty and in future treaty negotiations. In addition,
the Treasury Department has committed to use its best efforts
to negotiate a protocol with Austria to amend the proposed
treaty to incorporate this policy.
The Committee believes that the new policy with respect to
the applicability of reduced withholding tax rates to REIT
dividends appropriately reflects economic changes since the
establishment of the current policy. The Committee further
believes that the new policy fairly balances competing
considerations by extending the reduced rate of withholding tax
on dividends generally to dividends paid by REITs that are
relatively widely-held and diversified. The Committee
encourages the Treasury Department to act expeditiously in
meeting its commitment to negotiate a protocol with Austria
that incorporates this new policy, and the Committee believes
that negotiating such a protocol with Austria should take
priority over negotiating similar protocols with other
countries.
B. Stock Gains
Under U.S. internal law, gains realized by a nonresident
alien or a foreign corporation from the disposition of a
capital asset, other than a U.S. real property interest,
generally are not subject to U.S. tax unless the gain is
effectively connected with a U.S. trade or business. The U.S.
model and the OECD model reflect this policy. Under these model
treaties, such gains derived by a resident of a treaty country
from sources within the other country generally are taxed only
by the recipient's country of residence (except gains connected
with a real estate interest or a permanent establishment or a
fixed base). In other words, a U.S. investor who realizes
capital gain in a treaty country generally is taxable only by
the United States.
The proposed treaty provides an exception to the above
general rule. Under the proposed treaty, if a U.S. resident
transfers property to an Austrian company as a capital
contribution and, pursuant to the Austrian Reorganization Act
(``Umgrundungssteuergesetz''), the transfer is not subject to
Austrian tax, a subsequent ``alienation'' of the shares in the
Austrian company will be taxable in Austria if such alienation
occurs through the year 2010. According to the Treasury
Department's Technical Explanation of the proposed treaty
(hereinafter referred to as the ``Technical Explanation''),
this rule applies to the disposition of stock of an Austrian
company that was received upon the incorporation of a permanent
establishment in Austria if the capital gains inherent in the
property transferred to the Austrian company were not taxed at
the time of the incorporation.
The term ``alienation'' is defined broadly for this purpose
to include any transfer of property. 4 For example,
a subsequent contribution of the stock of the Austrian company
that is the transferee of the property (from the U.S.
transferor) to the capital of another company would constitute
an alienation, and the appreciation in the stock of the
Austrian company would be subject to Austrian tax under the
proposed treaty.
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\4\ Thus, a transfer may qualify as an alienation for Austrian tax
purposes even though such transfer qualifies as a nonrecognition
transaction for U.S. tax purposes.
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This provision could be viewed as a one-sided concession by
the United States that is inconsistent with the preferred U.S.
tax treaty position which, as stated above, generally grants
the residence country the exclusive right to tax non-business
capital gains derived by its residents from the other country.
In addition, the provision also creates a potential double
taxation problem for the U.S. taxpayer that transferred
property to an Austrian company as a capital contribution. In
the event that a subsequent transfer of the stock of such an
Austrian company is treated as an ``alienation'' for Austrian
tax purposes, the transfer would be taxable in Austria.
However, if the subsequent transfer qualifies as a tax-free
transaction in the United States, it would not be taxable in
the year of the transfer and the U.S. tax on the appreciation
in the stock of the Austrian company would be deferred until a
later year. Consequently, the Austrian tax paid with respect to
this transfer may not be available to offset the U.S. tax on
the gain in the stock of the Austrian company (imposed in a
subsequent year when the gain on such stock is recognized in a
taxable transaction for U.S. tax purposes). 5
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\5\ However, the Austrian tax paid may be carried back two years or
carried forward five years to offset U.S. tax imposed on a similar type
of foreign-source income under U.S. internal law.
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In the event that the transfer is treated as an
``alienation'' for Austrian tax purposes, and if the transfer
is taxable in the United States and Austria in the same year,
double taxation still may occur because the gain generally is
treated as U.S.-source income. 6 Under the U.S.
foreign tax credit rules, foreign taxes paid or accrued by a
taxpayer are allowed to reduce only U.S. taxes on foreign-
source income. Consequently, the Austrian taxes paid on the
transfer of the stock of the Austrian subsidiary would not be
allowed to reduce the U.S. gain from the same transaction,
resulting in double taxation of the same gain, unless other
relief is available. 7
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\6\ Under certain circumstances, such gain may, however, qualify as
foreign-source income.
\7\ The Technical Explanation states that it is expected that any
such double taxation would be addressed by the competent authorities.
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As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department whether the provision
in the proposed treaty is appropriate as a matter of U.S.
treaty policy. The relevant portion of the Treasury
Department's October 8, 1997 letter 8 responding to
this inquiry is reproduced below:
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\8\ Letter from Joseph H. Guttentag, International Tax Counsel,
Treasury Department, to Senator Paul Sarbanes, Committee on Foreign
Relations, October 8, 1997 (``October 8, 1997 Treasury Department
letter'').
[O]ur current tax convention with Austria (which dates from
1957) has no provision reserving to the residence country the
right to source gain from the disposition of shares. Therefore,
Austria now has the right to tax such gain. In the proposed
treaty, Austria was willing to adopt a provision that gives up
its right to tax stock gains at source. In securing this
concession from Austria, we agreed to a transition rule in the
pending convention preserving Austria's right to tax gain
through the year 2010--a rule covering a very limited number of
cases. This transition rule is limited to the disposition of
stock that was received on the incorporation of a permanent
establishment in Austria if the capital gains were not taxed on
the incorporation of the subsidiary.
We do not consider this provision to be a one-sided
concession. Rather we believe that accepting the limited
transition rule in the treaty was necessary in order to move
over the long run to a provision that is fully consistent with
U.S. tax treaty policy. We believe that our acceptance of such
a transition rule in this case will not be misconstrued as a
retreat from our support for the position we take in the U.S.
Model.
Although the proposed treaty represents a limited departure
from U.S. tax treaty policy, the Committee believes that the
provision represents a substantial improvement from the present
treaty. This provision should not stand as a model for other
treaty negotiations, however. In negotiating future treaties,
the Treasury Department should continue to seek provisions that
conform more closely to the U.S. model in generally providing
for exclusive residence-country taxation of stock gains.
C. Royalties
The present treaty contains a two-tier limitation on
source-country taxation of royalties: (1) royalty payments for
motion picture film rentals may be taxed by the source country
at a rate of 10 percent; and (2) all other royalty payments are
exempt from source-country taxation. The proposed treaty
maintains the two-tier limitation of the present treaty, but
modifies the treatment of royalties in two ways.
First, the proposed treaty modifies the definition of the
term ``royalties'' to exclude rentals and like payments for the
use of industrial, commercial or scientific equipment. Such
payments generally are treated as business profits under the
proposed treaty. 9 Consequently, a U.S. resident
would not be subject to Austrian income tax on amounts paid for
the use of industrial, commercial or scientific equipment in
Austria unless such amounts are attributable to a permanent
establishment that the U.S. resident has in Austria. If the
amounts are attributable to an Austrian permanent
establishment, then the U.S. resident would be subject to
Austrian tax on such amounts in the same manner that an
Austrian resident that derives the same income would be taxed.
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\9\ See 1992 OECD Commentary on Article 12, paragraph 9.
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Second, the proposed treaty expands the class of royalty
payments that are subject to the 10-percent source-country
taxation. Under the present treaty, only motion picture film
rentals are subject to source-country taxation. Under the
proposed treaty, source-country taxation also applies to
payments for the use of, or the right to use, tapes or other
means of reproduction used for radio or television
broadcasting. Consequently, a significantly expanded class of
Austrian-source royalties beneficially owned by U.S. residents
will be subject to a 10-percent Austrian withholding tax under
the proposed treaty. Such withholding taxes generally may be
allowed to reduce the U.S. income tax imposed on the same or
similar income. Accordingly, this increased class of Austrian
royalty payments that are subject to a creditable 10-percent
Austrian tax represents an expansion of the instances in which
the United States cedes its taxing jurisdiction to Austria.
By contrast, U.S. treaty policy, as reflected in the U.S.
model and in many U.S. treaties with developed nations,
generally would eliminate the source-country tax on royalties.
The Committee noted during its consideration of the present
treaty in 1957 that the treaty ``differs from a number of other
tax treaties which provide a complete exemption for film
rentals.''
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department whether the expansion
under the proposed treaty of the 10-percent source-country tax
on royalties is appropriate as a matter of U.S. treaty policy.
The relevant portion of the October 8, 1997 Treasury Department
letter responding to the inquiry is reproduced below:
Because we had accepted the 10-percent rate at source on
movie royalties under the current U.S.-Austria tax convention
and because we wanted to improve the current tax treaty in
several other respects, we concluded that the best approach
under the circumstances was to continue to accept the provision
on film royalties. Realistically, because of technological and
economic developments, this meant extending the rule to include
radio and television broadcasting royalties. For example, it
would be administratively difficult to distinguish between
royalties relating to different broadcasting rights. In
addition, distinguishing among these sectors would have created
an uneven playing field within the entertainment industry. In
negotiating the provision, we not only took into account the
royalty income flows between our two countries but recognized
that many of Austria's treaties, including several with OECD
member countries, retain some source-country tax rights for
royalties.
Although the Committee understands the reasons for expanding
source-country taxation for royalties in this case, the
Committee remains concerned that this provision represents a
significant step backward from the present treaty. Its effect
will be to cede taxing jurisdiction from the United States to
Austria. The Committee believes that in updating existing tax
treaties the Treasury Department should reject changes that
would lessen the treaty's overall benefit to the United States.
The Committee also is concerned by the precedent this provision
may present for future treaty partners that may seek provisions
allowing source-country taxation of royalties. Although the
Committee does not believe that the treatment of such royalties
warrants a reservation to, or rejection of, the proposed
treaty, such a provision could be cause for such action in
future treaties, particularly treaties with OECD member
countries. The Treasury Department should continue to seek
provisions that conform more closely to the U.S. model in
exempting royalties from source-country taxation.
D. Exchange of Information
One of the principal purposes of the proposed income tax
treaty between the United States and Austria is to prevent
avoidance or evasion of income taxes of the two countries. The
exchange of information article of the proposed treaty is one
of the primary vehicles used to achieve that purpose.
The exchange of information article contained in the
proposed treaty generally conforms to the corresponding
articles of the U.S. and OECD models. As is true under these
model treaties and the present treaty, under the proposed
treaty a country is not required to carry out administrative
measures at variance with the laws and administrative practices
of either country, to supply information which is not
obtainable under the laws or in the normal course of the
administration of either country, or to supply information
which discloses any trade, business, industrial, commercial, or
professional secret or trade process, or information the
disclosure of which is contrary to public policy. The MOU
provides that provisions on bank secrecy do not constitute a
professional, trade, business, industrial, or commercial
secret.
The Technical Explanation states that Austrian bank secrecy
laws prohibit Austrian tax authorities from obtaining
information from Austrian banks for their own non-penal tax
investigations and proceedings. Consequently, the Austrian
competent authority generally would not be able to provide such
information upon the request of the U.S. competent authority in
connection with a non-penal tax investigation or proceeding in
the United States. However, the proposed treaty provides that
the Austrian competent authority may obtain Austrian bank
information in connection with a U.S. penal investigation.
According to the MOU, the term ``penal investigations'' applies
to proceedings carried out by either judicial or administrative
bodies, such as the commencement of a criminal investigation by
the Criminal Investigation Division of the Internal Revenue
Service (the ``IRS''). Therefore, this special provision
enables the United States to obtain Austrian bank information
in connection with criminal investigations without violating
Austrian internal law. However, as under the present treaty,
because of Austrian internal law, the United States may not
obtain Austrian bank information in situations that are not in
connection with a criminal investigation.
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department about the adequacy of
the exchange of information provisions in the proposed treaty.
The relevant portion of the October 8, 1997 Treasury Department
letter is reproduced below:
[T]he proposed treaty improves the ability of the United
States to obtain information for the enforcement of U.S. tax
laws and the prevention of tax avoidance and evasion. We were
able to obtain assurance from Austria that the commencement of
a criminal investigation by the Criminal Investigation Division
of the Internal Revenue Service constitutes a penal
investigation under Austrian domestic law. The establishment of
a clear point for obtaining account information at a stage that
is early enough to be useful in key cases is a major step
forward under our pending treaty. Further, under our pending
treaty, Austria is undertaking to do something else that it has
not done for any other treaty partner. Austria will use its
power of search and seizure in connection with a penal
proceeding to obtain information under our pending treaty in
connection with a penal proceeding in the United States.
Although broader exchange of information provisions are
desirable, the Committee understands the difficulty in
achieving broader provisions given the current constraints of
Austrian law and practices. Moreover, the Committee understands
that the information exchange provisions of the proposed treaty
represent a significant improvement over those of the present
treaty. However, the Committee does not believe that the
proposed Austrian treaty should be construed in any way as a
precedent for other negotiations. The exchange of information
provisions in treaties are central to the purposes for which
tax treaties are entered into, and significant limitations on
their effect, relative to the preferred U.S. tax treaty
position, should not be accepted in negotiations with other
countries that seek to have or to maintain the benefits of a
tax treaty relationship with the United States.
E. OECD Commentary
The MOU includes a special provision with respect to the
interpretation of the proposed treaty. Under this provision,
the OECD Commentary is to apply in interpreting any provision
of the proposed treaty that corresponds to a provision of the
OECD model. However, this general rule does not apply if either
the United States or Austria has entered into a reservation or
has included an observation with respect to the OECD model or
its Commentary. In addition, this rule also does not apply if a
contrary interpretation is included in the MOU, or a published
interpretation of the proposed treaty (e.g., the Technical
Explanation) has been provided by one country to the competent
authority of the other country before the proposed treaty
enters into force, or has been agreed to by the competent
authorities after the proposed treaty has entered into force.
In other words, unless specifically stipulated by either or
both countries, the relevant OECD Commentary generally is
controlling in the interpretation of provisions of the proposed
treaty.
The proposed treaty contains the standard provision that
unless the context otherwise requires or the competent
authorities of the two countries establish a common meaning,
all terms not defined in the treaty are to have the meanings
which they have under the laws of the country applying the
treaty (Article 3, paragraph 2 (General Definitions)). Because
this standard provision is part of the text of the proposed
treaty, it overrides the provisions of the MOU in the event of
a conflict. Thus, for example, if a term of the proposed treaty
is not defined in the treaty, but is defined in U.S. internal
law, and the same term also is defined in the OECD Commentary,
and the United States and Austria have not stipulated
otherwise, the definition provided by U.S. internal law would
control.
Other U.S. income tax treaties and protocols occasionally
have required that a specific provision of an income tax treaty
be interpreted in accordance with the OECD Commentary to the
corresponding provision of the OECD model. 10
However, no U.S. treaty has ever required the treaty countries
to interpret the provisions of the treaty broadly in accordance
with the OECD Commentary.
---------------------------------------------------------------------------
\10\ For example, Provision 19 of the Protocol to the 1990 U.S.-
Spain income tax treaty requires the two countries to interpret Article
27 (Exchange of Information and Administrative Assistance) of that
treaty in a manner consistent with the Commentary to the corresponding
provision of the 1977 OECD model treaty.
---------------------------------------------------------------------------
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department whether the self-
executing nature of this provision could have the effect of
modifying the substantive rules of the proposed treaty without
the usual ratification procedures of either country. The
relevant portion of the October 8, 1997 Treasury Department
letter responding to this inquiry is reproduced below:
This provision cannot create a substantive amendment to the
proposed convention as adopted by both countries under their
usual ratification procedures. Rather the provision utilizes an
additional tool (the OECD Commentary) in interpreting the
provisions of the Convention. The OECD Commentary would be
useful in interpreting most of the provisions of the proposed
Convention to a greater or lesser extent. Of course, the MOU
and the Treasury Technical Explanation have precedence over the
OECD commentaries, now and in the future.
Neither country is bound by OECD Commentary to the extent
that its disagreement with the Commentary is indicated at any
time by observation or reservation. Therefore, the United
States is not required to interpret a provision in a manner
inconsistent with U.S. law or U.S. tax treaty policy. However,
the ability to enter a reservation or observation to the OECD
Commentary does not give either party a unilateral right to
override the treaty because one country's reservation or
observation does not bind the other. If the OECD Commentary,
because of observations, and other interpretive sources do not
resolve an issue, the competent authorities may attempt to do
so.
The Committee understands that the proposed treaty, as
interpreted by the MOU, does not permit either country to make
substantive amendments to the proposed treaty without
ratification. The Committee also understands that the provision
does not permit the OECD Commentary to override U.S. law or
U.S. tax treaty policy. In order to make this point clear, the
Committee has included in its recommended resolution of
ratification an understanding regarding the ability of the
United States to enter a reservation or observation to the OECD
model or its Commentary at any time.
F. Income from Sleeping Partnerships (Stille Gesellschaft)
The proposed treaty contains a special rule which treats
income derived from an Austrian ``sleeping partnership''
(Stille Gesellschaft) by a U.S. ``sleeping partner'' as
business profits attributable to the permanent establishment of
the partnership in Austria. According to the Technical
Explanation, there are two types of sleeping partnerships under
Austrian tax law: the ``typical'' form and the ``non-typical''
form. The profits of a sleeping partner in a typical sleeping
partnership generally are treated as income from investment
activities for Austrian tax purposes. On the other hand, the
profits of a sleeping partner of a non-typical sleeping
partnership are treated as income from commercial activities
for Austrian tax purposes. Whether a particular sleeping
partnership should be characterized as typical or non-typical
under Austrian tax law may not be clear.
German internal law also provides for sleeping
partnerships. The 1989 U.S.-Germany income tax treaty provides
that income from a sleeping partnership may be taxed in
accordance with internal German tax law, without regard to the
reduction in the tax rate otherwise applicable to dividends
provided by that treaty, if such amount is deductible in
computing the profits of the sleeping partnership.
11
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\11\ See Article 10(5) of the 1989 U.S.-Germany income tax treaty.
---------------------------------------------------------------------------
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department whether the proposed
treaty's characterization of the profits from an Austrian
sleeping partnership as business profits is appropriate, given
that the U.S.-Germany treaty provides for different treatment
of profits from similar entities under German law. The relevant
portion of the October 8, 1997 Treasury Department letter
responding to this inquiry is reproduced below:
The domestic laws of Germany and Austria differ in how they
tax income from one form of silent or sleeping partnership--the
typical sleeping partnership. Austria requires a nonresident
sleeping partner to declare the income and imposes tax on the
income on a net basis. Germany imposes a withholding tax in
full and final settlement of the sleeping partner's tax
liability. The German and the pending Austrian treaty reflect
this difference in their treatment of income from a typical
sleeping partnership.
Under the proposed Austrian treaty, in the case of either
type of sleeping partnership arrangement (typical or non-
typical), there is only one level of tax imposed on the income.
In the typical sleeping partnership arrangement, the income of
the silent partner is deductible to the other partner; and, in
the non-typical sleeping partnership arrangement, the other
partner is entitled to exclude from income the amounts
allocable to the silent partner.
As described above, profits from Austrian sleeping partnerships
generally are taxed on a net basis under Austrian law, similar
to the treatment of business profits under the proposed treaty.
Accordingly, the Committee believes that the treatment of
profits from Austrian sleeping partnerships under the proposed
treaty as business profits is appropriate.
G. Treaty Shopping
In general
The proposed treaty, like a number of U.S. income tax
treaties, generally limits treaty benefits for treaty country
residents so that only those residents with a sufficient nexus
to a treaty country will receive treaty benefits. Although the
proposed treaty generally is intended to benefit residents of
Austria and the United States only, residents of third
countries sometimes attempt to use a treaty to obtain treaty
benefits. This is known as treaty shopping. Investors from
countries that do not have tax treaties with the United States,
or from countries that have not agreed in their tax treaties
with the United States to limit source-country taxation to the
same extent that it is limited in another treaty may, for
example, attempt to reduce the tax on interest on a loan to a
U.S. person by lending money to the U.S. person indirectly
through a country whose treaty with the United States provides
for a lower rate of withholding tax on interest. The third-
country investor may attempt to do this by establishing in that
treaty country a subsidiary, trust, or other entity which then
makes the loan to the U.S. person and claims the treaty
reduction for the interest it receives.
The anti-treaty-shopping provision of the proposed treaty
is similar to anti-treaty-shopping provisions in the Internal
Revenue Code (the ``Code''), as interpreted by Treasury
regulations, and in several recent treaties. Some aspects of
the provision, however, differ from the anti-treaty-shopping
provision in the U.S. model. In its details, the proposed
treaty resembles the 1993 U.S. treaty with the Netherlands and
the 1995 U.S. treaty with France. The degree of detail included
in this provision is notable in itself. The proliferation of
detail may reflect, in part, a diminution in the scope afforded
the IRS and the courts in the anti-treaty-shopping provisions
of most previous U.S. treaties to resolve interpretive issues
adversely to a person attempting to claim the benefits of the
treaty; this diminution represents a bilateral commitment, not
alterable by developing internal U.S. tax policies, rules, and
procedures, unless enacted as legislation that would override
the treaty. (To the same extent as is provided under other
treaties, the IRS generally is not limited under the proposed
treaty in its discretion to allow treaty benefits under the
anti-treaty-shopping rules.) The detail in the proposed treaty
does represent added guidance and certainty for taxpayers that
may be absent under other treaties, although in many other U.S.
treaties the negotiators have chosen to forego such additional
guidance in favor of somewhat simpler and more flexible
provisions.
Analysis of provisions
One provision of the anti-treaty-shopping article differs
from the comparable rule of some earlier U.S. treaties, but the
effect of the change is not completely clear. The general test
applied by those earlier treaties for the allowance of benefits
to an entity that does not meet the bright-line ownership and
base erosion tests is a broadly subjective one, turning on
whether the acquisition, maintenance, or operation of an entity
did not have ``as a principal purpose obtaining benefits
under'' the treaty. By contrast, the proposed treaty contains a
more precise test that denies the benefits of the treaty only
in cases where the income is not derived in connection with, or
incidental to, the active conduct of a trade or business.
12 In addition, the proposed treaty gives the
competent authority of the source country the ability to
override this standard and to allow benefits if it so
determines in its discretion.
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\12\ However, this active trade or business test does not apply
with respect to a business of making or managing investments carried on
by a person other than a bank or insurance company, so that treaty
benefits may be denied with respect to such a business regardless of
whether it is an active trade or business.
---------------------------------------------------------------------------
Although the proposed treaty's active business test is
similar to that of other U.S. tax treaties, the proposed treaty
provides greater detail than other treaties. In some cases, the
proposed treaty mirror provisions in the branch tax
regulations, but may be more generous to taxpayers. In
addition, like some recent U.S. treaties, the proposed treaty
attributes to the treaty resident active trades or businesses
conducted by other entities. The attribution rules in the
proposed treaty may result in more taxpayers being eligible for
treaty benefits, and permit certain third-country business
operations to be treated as if they were carried on in Austria.
These rules are similar to those in the U.S.-Netherlands treaty
and the U.S.-France treaty.
The proposed treaty includes a special rule designed to
prevent the proposed treaty from reducing or eliminating U.S.
tax on income of an Austrian resident in a case where no other
substantial tax is imposed on that income (the so-called
``triangular case''). This is necessary because an Austrian
resident in some cases may be wholly or partially exempt from
Austrian tax on foreign (i.e., non-Austrian) income. The
special rule applies generally if the combined Austrian and
third-country taxation of third-country income earned by an
Austrian enterprise with a permanent establishment in the third
country is less than 60 percent of the tax that would be
imposed if the income were subject to tax in Austria.
Under the special rule, the United States is permitted to
tax U.S.-source interest and royalties paid to the third-
country permanent establishment in accordance with its internal
law without regard to the treaty. There are several exceptions
to this special rule. Under one of the exceptions, the special
rule does not apply if the income is subject to U.S. taxation
under the controlled foreign corporation rules. 13
The special rule for triangular cases is not included in the
U.S. model.
---------------------------------------------------------------------------
\13\ These provisions are contained in sections 951-964 of the Code
(referred to as the ``subpart F'' rules).
---------------------------------------------------------------------------
The practical difference between the proposed treaty tests
and the earlier tests will depend upon how they are interpreted
and applied. The principal purpose test may be applied
leniently (so that any colorable business purpose suffices to
preserve treaty benefits), or it may be applied strictly (so
that any significant intent to obtain treaty benefits suffices
to deny them). Similarly, the standards in the proposed treaty
could be interpreted to require, for example, a more active or
a less active trade or business (though the range of
interpretation is far narrower). Thus, a narrow reading of the
principal purpose test could theoretically be stricter than a
broad reading of the proposed treaty test (i.e., would operate
to deny benefits in potentially abusive situations more often).
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department about the adequacy of
the anti-treaty-shopping provision in the proposed treaty. The
relevant portion of the October 8, 1997 Treasury Department
letter responding to this inquiry is reproduced below:
Unlike the existing Convention, the proposed Convention
with Austria contains a comprehensive anti-treaty-shopping
provision. A Memorandum of Understanding provides an
interpretation of key terms. Austria's recent membership in the
European Union and the special United States ties to Canada and
Mexico under the North American Free Trade Agreement are an
element in the determination by the competent authority of
eligibility for benefits of certain Austrian and United States
companies. Recognized headquarters companies of multinational
corporate groups are entitled to benefits of the Convention
under rules that are substantively identical to the parallel
rule in the U.S.-France treaty reviewed by the Committee in
1995.
The proposed Convention also provides for the elimination
of another potential abuse relating to the granting of United
States treaty benefits in the so-called triangular cases to
income of an Austrian resident attributable to third-country
permanent establishments of Austrian corporations that are
exempt from tax in Austria by operation of Austria's law or
treaties. Under the proposed rule, full United States treaty
benefits will be granted in these triangular cases only when
the United States-source income is subject to a sufficient
level of tax in Austria and in the third country. As in the
U.S.-France treaty, this anti-abuse rule does not apply in
certain circumstances, including when the United States taxes
the profits of the Austrian enterprise under subpart F of the
Internal Revenue Code.
Committee Conclusions
The Committee believes that limitation on benefits
provisions are important to protect against ``treaty shopping''
by limiting benefits of a treaty to bona fide residents of the
treaty partner. The Committee further believes that the United
States should maintain its policy of limiting treaty shopping
opportunities whenever possible. The Committee continues to
believe further that, in exercising any latitude Treasury has
to adjust the operation of the proposed treaty, the rules as
applied should adequately deter treaty shopping abuses. The
anti-treaty-shopping provision in the proposed treaty may be
effective in preventing third-country investors from obtaining
treaty benefits by establishing investing entities in Austria
since third-country investors may be unwilling to share
ownership of such investing entities on a less-than-50-percent
basis with U.S. or Austrian residents or other qualified owners
to meet the ownership test of the anti-treaty-shopping
provision. In addition, the base erosion test provides
protection from certain potential abuses of an Austrian
conduit. Finally, Austria imposes significant taxes of its own;
these taxes may deter third-country investors from seeking to
use Austrian entities to make U.S. investments. On the other
hand, implementation of the detailed tests for treaty shopping
set forth in the proposed treaty may raise factual,
administrative, or other issues that cannot currently be
foreseen. The Committee emphasizes that the proposed anti-
treaty-shopping provision must be implemented so as to serve as
an adequate tool for preventing possible treaty-shopping abuses
in the future.
VII. Budget Impact
The Committee has been informed by the staff of the Joint
Committee on Taxation that the proposed treaty is estimated to
cause a negligible change in fiscal year Federal budget
receipts during the 1998-2007 period.
VIII. Explanation of Proposed Treaty
A detailed, article-by-article explanation of the proposed
income tax treaty between the United States and Austria is
presented below. The MOU agreed to by the negotiators, and
other matters set forth in diplomatic notes exchanged at the
time the proposed treaty was signed, are covered together with
the relevant articles of the proposed treaty.
Article 1. Personal Scope
The personal scope article describes the persons who may
claim the benefits of the proposed treaty.
Overview
The proposed treaty generally applies to residents of the
United States and to residents of Austria, with specific
modifications to such scope in other articles (e.g., Articles
23 (Non-discrimination) and Article 25 (Exchange of Information
and Administrative Assistance)).
The proposed treaty provides that it generally does not
restrict any exclusion, exemption, deduction, credit or other
allowance accorded by internal law or by any other agreement
between the United States and Austria. Thus, the proposed
treaty will apply only where it benefits taxpayers. As
discussed below in the Technical Explanation, the fact that the
proposed treaty only applies to a taxpayer's benefit does not
mean that a taxpayer could inconsistently select among treaty
and internal law provisions in order to minimize its overall
tax burden. The Technical Explanation sets forth the following
example. Assume a resident of Austria has three separate
businesses in the United States. One business is profitable,
and constitutes a U.S. permanent establishment. The other two
are trades or businesses that would generate effectively
connected income as determined under the Code, but that do not
constitute permanent establishments as determined under the
proposed treaty; one trade or business is profitable and the
other incurs a net loss. Under the Code, all three operations
would be subject to U.S. income tax, in which case the losses
from the unprofitable line of business could offset the taxable
income from the other lines of business. On the other hand,
only the income of the operation which gives rise to a
permanent establishment would be taxable by the United States
under the proposed treaty. The Technical Explanation makes
clear that the taxpayer could not invoke the proposed treaty to
exclude the profits of the profitable trade or business that
does not constitute a permanent establishment and invoke U.S.
internal law to claim the loss of the unprofitable trade or
business that does not constitute a permanent establishment
against the taxable income of the permanent establishment.
14
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\14\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
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Coordination with dispute resolution procedures of other
agreements
The proposed treaty provides that its dispute resolution
procedures under the mutual agreement article take precedence
over the corresponding provisions of any other agreement
between the United States and Austria in determining whether a
law or other measure is within the scope of the proposed
treaty. Unless the competent authorities agree that the law or
other measure is outside the scope of the proposed treaty, only
the proposed treaty's nondiscrimination rules, and not the
nondiscrimination rules of any other agreement in effect
between the United States and Austria, generally apply to that
law or other measure. The only exception to this general rule
is that the national treatment or most-favored nation treatment
of the General Agreement on Tariffs and Trade would continue to
apply with respect to trade in goods. For purposes of this
provision, the term ``measure'' means a law, regulation, rule,
procedure, decision, administrative action, or any other form
of measure.
Saving clause
Like all U.S. income tax treaties, the proposed treaty is
subject to a ``saving clause.'' Under this clause, with
specific exceptions described below, the proposed treaty is not
to affect the taxation by either treaty country of its
residents or its citizens. By reason of this saving clause,
unless otherwise specifically provided in the proposed treaty,
the United States will continue to tax its citizens who are
residents of Austria as if the proposed treaty were not in
force. ``Residents'' for purposes of the proposed treaty (and,
thus, for purposes of the saving clause) include corporations
and other entities as well as individuals who are not treated
as residents of the other country under the proposed treaty
tie-breaker provisions governing dual residents (as defined in
Article 4 (Resident)).
Like the U.S. model, the proposed treaty contains a
provision under which the saving clause (and therefore the U.S.
jurisdiction to tax) applies to a former U.S. citizen whose
loss of citizenship had as one of its principal purposes the
avoidance of tax; such application is limited to the ten-year
period following the loss of citizenship. Prior to the
enactment of the Health Insurance Portability and
Accountability Act of 1996, section 877 of the Code provided
special rules for the imposition of U.S. income tax on former
U.S. citizens for a period of ten years following the loss of
citizenship; these special tax rules applied to a former
citizen only if his or her loss of U.S. citizenship had as one
of its principal purposes the avoidance of U.S. income, estate
or gift taxes. The Health Insurance Portability and
Accountability Act of 1996 expanded section 877 in several
respects. Under these amendments, the special income tax rules
of section 877 were extended to apply also to certain former
long-term residents of the United States. For purposes of
applying the special tax rules to former citizens and long-term
residents, individuals who meet a specified income tax
liability threshold or a specified net worth threshold
generally are considered to have lost citizenship or resident
status for a principal purpose of U.S. tax avoidance. In
addition, an expanded foreign tax credit is provided with
respect to the U.S. tax imposed under these rules. The
amendments to section 877 generally are applicable to
individuals whose loss of U.S. citizenship or U.S. resident
status occurred on or after February 6, 1995. The proposed
treaty provision reflects the reach of the U.S. tax
jurisdiction pursuant to section 877 prior to its expansion by
the Health Insurance Portability and Accountability Act of
1996. Accordingly, the saving clause in the proposed treaty
does not permit the United States to impose tax on former U.S.
long-term residents who otherwise would be subject to the
special income tax rules contained in the Code.
Exceptions to the saving clause are provided for the
following benefits conferred by the proposed treaty:
correlative adjustments to the income of enterprises associated
with other enterprises the profits of which were adjusted by
the other country (Article 9, paragraph 2); exemption from
residence-country tax (or in the case of the United States,
citizenship country tax) on gain accrued from the disposition
of certain business assets (Article 13, paragraph 4); exemption
from residence-country tax (or in the case of the United
States, citizenship country tax) on social security benefits
and alimony (Article 18, paragraphs 1(b) and 3); relief from
double taxation (Article 22); nondiscrimination (Article 23);
and mutual agreement procedures (Article 24).
In addition, the saving clause does not apply to certain
benefits conferred by one of the countries with respect to an
individual who is neither a citizen of the conferring country
nor, in the case of the United States, someone who has
``immigrant status.'' Under this rule, for example, such treaty
benefits are available to an Austrian citizen who spends enough
time in the United States to be taxed as a U.S. resident under
Code section 7701(b) (see discussion below in connection with
Article 4 (Resident)), provided that the individual has not
acquired U.S. immigrant status. The benefits that are subject
to this rule are exemption from tax on compensation from
government service to the other country (Article 19), exemption
from host-country tax on certain income received by temporary
visitors who are students and trainees (Article 20), and
certain fiscal privileges of diplomatic agents and consular
officers referred to in the proposed treaty (Article 26). An
individual who has been admitted to the United States as a
permanent resident under U.S. immigration laws (i.e., a ``green
card'' holder) is considered to have ``immigrant status'' under
the proposed treaty.
The exceptions to the saving clause in the proposed treaty
generally are consistent with the U.S. model and recent U.S.
treaties. By contrast, although the double taxation provisions
in paragraph 1 of Article XV of the present treaty afford
protection to citizens, residents and corporations with respect
to tax imposed by their home country, the saving clause in the
present treaty sets forth only three exceptions. The first
exception applies to governmental employment income derived by
a resident of the other country (Article XI, paragraph (1)).
The second exception applies to remuneration for teachers
(Article XII). The third exception applies to remittances and
maintenance for students and trainees (Article XIII).
Article 2. Taxes Covered
The proposed treaty generally applies to the income taxes
of the United States and Austria.
In the case of the United States, the proposed treaty
applies to the Federal income taxes imposed by the Code, but
excluding social security taxes. Unlike many U.S. income tax
treaties in force, but like the present treaty, the proposed
treaty applies to the accumulated earnings tax and the personal
holding company tax. In the case of Austria, the proposed
treaty applies to the income tax (die Einkommensteuer) and the
corporation tax (die Koerperschaftsteuer).
For purposes of the non-discrimination article (Article
23), the proposed treaty applies to taxes of all kinds imposed
by the countries, including any taxes imposed by their
political subdivisions or local authorities. In addition, for
purposes of paragraphs 1 to 5 of the exchange of information
and administrative assistance article (Article 25), the
proposed treaty applies to taxes of all kinds imposed by the
countries at the federal level.
The proposed treaty also contains a provision generally
found in U.S. income tax treaties (including the present
treaty) to the effect that it will apply to any identical or
substantially similar taxes that either country may
subsequently impose. The proposed treaty obligates the
competent authority of each country to notify the competent
authority of the other country of any significant changes in
its internal tax laws. The competent authorities also are to
notify each other of any official published material concerning
the application of the treaty. This clause is similar to the
U.S. model.
Article 3. General Definitions
Certain of the standard definitions found in most U.S.
income tax treaties are contained in the proposed treaty.
The term ``Austria'' comprises the Republic of Austria.
The term ``United States'' means the United States of
America, but does not include Puerto Rico, the Virgin Islands,
Guam or any other U.S. possession or territory. When used in a
geographical sense, it means the States and the District of
Columbia. It also includes the territorial waters of the United
States and the seabed and subsoil of the submarine areas
adjacent to the territorial waters and over which the United
States has exclusive rights, in accordance with international
law, with respect to the exploration and exploitation of
natural resources. Under the proposed treaty, these same areas
are considered part of the United States for treaty purposes,
but only to the extent that the person, property, or activity
to which the proposed treaty is being applied is connected with
such exploration or exploitation.
The term ``person'' includes an individual, an estate, a
trust, a company, and any other body of persons. A ``company''
is any body corporate or any entity which is treated as a body
corporate for tax purposes.
An enterprise of a country is defined as an enterprise
carried on by a resident of that country. The proposed treaty
does not define the term ``enterprise.''
Under the proposed treaty, a person is considered a
national of one of the treaty countries if the person is an
individual possessing nationality of that country, or a legal
person, partnership, or association deriving its status as such
from the law in force in that country.
The Austrian competent authority is the Federal Minister of
Finance or his delegate. The U.S. competent authority is the
Secretary of the Treasury or his delegate. The U.S. competent
authority function has been delegated to the Commissioner of
Internal Revenue, who has redelegated the authority to the
Assistant Commissioner (International) of the IRS. On
interpretative issues, the latter acts with the concurrence of
the Associate Chief Counsel (International) of the IRS.
The proposed treaty also contains the standard provision
that, unless the context otherwise requires or the competent
authorities of the two countries establish a common meaning,
all terms not defined in the treaty are to have the meanings
which they have under the laws of the country applying the
treaty. The MOU includes a special provision with respect to
the interpretation of the proposed treaty. Generally, the OECD
Commentary is to apply in interpreting any provision of the
proposed treaty that corresponds to a provision of the OECD
model. 15 However, this general rule does not apply
if either the United States or Austria has entered a
reservation or has included an observation with respect to the
OECD model or its Commentary. In addition, this rule also does
not apply if a contrary interpretation is included in the MOU
or a published interpretation of the proposed treaty (e.g., the
Technical Explanation) that has been provided to the competent
authorities of both countries or has been agreed to by the
competent authorities. The Technical Explanation clarifies that
the Technical Explanation overrides a different interpretation
in the OECD Commentary, even where the OECD Commentary is
adopted subsequent to the issuance of the Technical
Explanation.
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\15\ The applicability of the OECD Commentary to the proposed
treaty is consistent with the Vienna Convention on the Law of Treaties
of May 23, 1969 (the ``Vienna Convention''). The United States has not
yet ratified the Vienna Convention.
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Article 4. Resident
In general
The assignment of a country of residence is important
because the benefits of the proposed treaty generally are
available only to a resident of one of the treaty countries as
that term is defined in the treaty. Furthermore, double
taxation is often avoided by the assignment of a single treaty
country as the country of residence when, under the internal
laws of the treaty countries, a person is a resident of both.
Under U.S. law, residence of an individual is important
because a resident alien is taxed on worldwide income, while a
nonresident alien is taxed only on certain U.S.-source income
and on income that is effectively connected with a U.S. trade
or business. An individual who spends substantial time in the
United States in any year or over a three-year period generally
is treated as a U.S. resident (Code sec. 7701(b)). A permanent
resident for immigration purposes (i.e., a green-card holder)
also is treated as a U.S. resident. The standards for
determining residence provided in the Code do not alone
determine the residence of a U.S. citizen for the purpose of
any U.S. tax treaty (such as a treaty that benefits residents,
rather than citizens, of the United States.) Under the Code, a
company is domestic, and therefore taxable on its worldwide
income, if it is organized in the United States or under the
laws of the United States, a State, or the District of
Columbia.
The proposed treaty generally defines ``resident of a
Contracting State'' to mean any person who, under the laws of
that country, is liable to tax in that country by reason of his
or her domicile, residence, citizenship, place of management,
place of incorporation, or any other criterion of a similar
nature. A U.S. citizen or a green-card holder who is not a
resident of Austria is treated as a U.S. resident under the
proposed treaty only if the individual has a substantial
presence, permanent home, or habitual abode in the United
States. Consistent with most U.S. income tax treaties,
citizenship alone does not establish residence. As a result,
U.S. citizens residing overseas are not necessarily entitled to
the benefits of the proposed treaty as U.S. residents. The
Technical Explanation provides that the term ``substantial
presence'' under the proposed treaty is a similar concept to
``substantial presence'' under Code section 7701(b);
``permanent home'' and ``habitual abode'' are terms frequently
used in treaty ``tie-breaker'' rules, as described below.
The term ``resident of a Contracting State'' does not
include any person who is liable to tax in that country in
respect only of income from sources in that country. In the
case of income derived by, or paid by, a partnership, estate or
trust, the term applies only to the extent that the income it
derives is subject to that country's tax as the income of a
resident, either in its hands or in the hands of its partners,
beneficiaries or grantors. For example, if the U.S.
beneficiaries' share in the income of a U.S. trust is only one-
half, Austria would have to reduce its withholding tax pursuant
to the proposed treaty on only one-half of the Austrian-source
income paid to the trust. The MOU provides that a similar test
applies in determining the residence of other pass-through
entities, such as limited liability companies.
According to the Technical Explanation, it is understood
that a tax-exempt organization, including a pension trust, that
is established under the laws of the United States or Austria
is treated as a resident of the country under the laws of which
it is established for purposes of the proposed treaty.
These provisions of the proposed treaty generally are based
on the provisions of the U.S. and OECD models and are similar
to the provisions found in other U.S. tax treaties.
Dual residents
Individuals
A set of ``tie-breaker'' rules is provided to determine
residence in the case of an individual who, under the basic
residence rules, would be considered to be a resident of both
countries. Such a dual resident individual will be deemed to be
a resident of the country in which he or she has a permanent
home available. If this permanent home test is inconclusive
because the individual has a permanent home in both countries
or in neither country, the individual's residence is deemed to
be the country with which his or her personal and economic
relations are closer (i.e., the ``center of vital interests'').
The MOU provides that the center of vital interests may not be
determinable solely by reviewing the circumstances prevailing
in one single year; a longer period may have to be taken into
consideration. If the country in which the individual has his
or her center of vital interests cannot be determined, such
individual is deemed to be a resident of the country in which
he or she has an habitual abode. If the individual has an
habitual abode in both countries or in neither country, the
individual is deemed to be a resident of the country of which
he or she is a national. If the individual is a national of
both countries or neither of them, the competent authorities of
the countries are to settle the question of residence by mutual
agreement.
Entities
In the case of a company that is resident in both countries
under the basic residence rules, the proposed treaty provides
that the company is treated as a resident of the country under
the laws of which the company was created. This rule conforms
with U.S. internal law.
In the case of a person other than an individual or a
company that is resident in both countries under the basic
residence rules, the proposed treaty, like the U.S. model,
requires the competent authorities of the two countries to
determine by mutual agreement the residence of such person and
the mode of application of the treaty to such person.
Article 5. Permanent Establishment
The proposed treaty contains a definition of the term
``permanent establishment'' that generally follows the pattern
of other recent U.S. income tax treaties, the U.S. model and
the OECD model.
The permanent establishment concept is one of the basic
devices used in income tax treaties to limit the taxing
jurisdiction of the host country and thus to mitigate double
taxation. Generally, an enterprise that is a resident of one
country is not taxable by the other country on its business
profits unless those profits are attributable to a permanent
establishment of the resident in the other country. In
addition, the permanent establishment concept is used to
determine whether the reduced rates of, or exemptions from, tax
provided for dividends, interest, and royalties apply, or
whether those amounts are taxed as business profits.
In general, under the proposed treaty, a permanent
establishment is a fixed place of business through which an
enterprise engages in business. A permanent establishment
includes a place of management, a branch, an office, a factory,
a workshop, a mine, an oil or gas well, a quarry, or any other
place of extraction of natural resources. It also includes any
building site or construction or installation project or an
installation or drilling rig or ship used for the exploration
or development of natural resources if the site or project
lasts for more than 12 months. The Technical Explanation states
that projects that are commercially and geographically
interdependent are to be treated as a single project for
purposes of the 12-month test. The 12-month period for
establishing a permanent establishment in connection with a
site or project corresponds to the rule of the U.S. model.
The general definition of a permanent establishment is
modified to provide that a fixed place of business that is used
for any of a number of specified activities will not constitute
a permanent establishment. These activities include the use of
facilities solely for storing, displaying, or delivering goods
or merchandise belonging to the enterprise and the maintenance
of a stock of goods or merchandise belonging to the enterprise
solely for storage, display, or delivery or solely for
processing by another enterprise. These activities also include
the maintenance of a fixed place of business solely for the
purchase of goods or merchandise or the collection of
information for the enterprise. These activities further
include the maintenance of a fixed place of business solely for
the purpose of carrying on, for the enterprise, any other
activity of a preparatory or auxiliary character. The Technical
Explanation refers to advertising and supplying information as
examples of activities that are of a preparatory or auxiliary
character. The proposed treaty, like the U.S. model, provides
that the maintenance of a fixed place of business solely for
any combination of these activities will not constitute a
permanent establishment.
If a person has, and habitually exercises, the authority to
conclude contracts in a country on behalf of an enterprise of
the other country, the enterprise generally is deemed to have a
permanent establishment in the first country in respect of any
activities that person undertakes for the enterprise.
Consistent with the U.S. and OECD models, this rule does not
apply where the contracting authority is limited to those
activities described above, such as storage, display, or
delivery of merchandise, which are excluded from the definition
of a permanent establishment. The proposed treaty contains the
usual provision that no permanent establishment is deemed to
arise based on an agent's activities if the agent is a broker,
general commission agent, or any other agent of independent
status acting in the ordinary course of its business.
The fact that a company that is resident in one country is
related to a company that is a resident of the other country or
to a company that engages in business in that other country
does not of itself cause either company to be a permanent
establishment of the other.
Article 6. Income from Real Property
This article covers income, but not gains, from real
property. The rules covering gains from the sale of real
property are contained in Article 13 (Capital Gains).
Under the proposed treaty, income derived by a resident of
one country from real property situated in the other country
may be taxed in the country where the real property is located.
Income from real property includes income from agriculture or
forestry.
The term ``real property'' generally has the meaning that
it has under the law of the country in which the property in
question is situated. The term in any case includes property
accessory to real property; livestock and equipment used in
agriculture and forestry; rights to which the provisions of
general law respecting landed property apply; usufruct of real
property; and rights to variable or fixed payments as
consideration for the working of, or the right to work, mineral
deposits, sources, and other natural resources. Thus, income
from real property includes royalties and other payments in
respect of the exploitation of natural resources (e.g., oil).
Ships, boats and aircraft are not real property. This
definition corresponds to the definition of real property in
the OECD model.
The proposed treaty specifies that the source country may
tax income derived from the direct use, letting, or use in any
other form of real property. The rules of this article allowing
source-country taxation also apply to income from real property
of an enterprise and to income from real property used for the
performance of independent personal services.
The MOU clarifies that the source country may tax the
income derived from the exploitation of rights in real
property. For example, a U.S. person that is a lessee of real
property situated in Austria is subject to Austrian tax on the
income derived from any sublease of the same property, even
though the U.S. person is not the owner of the real property.
The present treaty permits the source country to tax
interest on mortgages secured by real property under this
article. The proposed treaty eliminates this rule and treats
such interest in the same way as other types of interest, which
generally is free from source-country tax (see Article 11).
Like the U.S. model and certain other U.S. income tax
treaties, the proposed treaty provides residents of one country
with an election to be taxed on a net basis by the other
country on income from real property in that other country.
U.S. internal law provides such a net-basis election in the
case of income of a foreign person from U.S. real property
income (Code secs. 871(d) and 882(d)). The proposed treaty
provides that any such election shall be binding for the
taxable year of the election and all subsequent taxable years,
unless the competent authorities of the treaty countries agree
to terminate the election pursuant to a request by the taxpayer
made to the competent authority of the country in which the
taxpayer is resident.
Article 7. Business Profits
U.S. internal law
U.S. law distinguishes between the U.S. business income and
other U.S. income of a nonresident alien or foreign
corporation. A nonresident alien or foreign corporation is
subject to a flat 30-percent rate (or lower treaty rate) of tax
on certain U.S.-source income if that income is not effectively
connected with the conduct of a trade or business within the
United States. The regular individual or corporate rates apply
to income (from any source) which is effectively connected with
the conduct of a trade or business within the United States.
The treatment of income as effectively connected with a
U.S. trade or business depends upon whether the source of the
income is U.S. or foreign. In general, U.S.-source periodic
income (such as interest, dividends, and rents), and U.S.-
source capital gains are effectively connected with the conduct
of a trade or business within the United States if the asset
generating the income is used in or held for use in the conduct
of the trade or business or if the activities of the trade or
business were a material factor in the realization of the
income. All other U.S.-source income of a person engaged in a
trade or business in the United States is treated as
effectively connected with the conduct of a trade or business
in the United States (referred to as a ``force of attraction''
rule).
Foreign-source income generally is treated as effectively
connected income only if the foreign person has an office or
other fixed place of business in the United States and the
income is attributable to that place of business. Only three
types of foreign-source income are considered to be effectively
connected income: rents and royalties for the use of certain
intangible property derived from the active conduct of a U.S.
business; certain dividends and interest either derived in the
active conduct of a banking, financing or similar business in
the United States or received by a corporation the principal
business of which is trading in stocks or securities for its
own account; and certain sales income attributable to a U.S.
sales office. Special rules apply in the case of insurance
companies.
Any income or gain of a foreign person for any taxable year
that is attributable to a transaction in another taxable year
is treated as effectively connected with the conduct of a U.S.
trade or business if it would have been so treated had it been
taken into account in that other taxable year (Code sec.
864(c)(6)). In addition, if any property ceases to be used or
held for use in connection with the conduct of a trade or
business within the United States, the determination of whether
any income or gain attributable to a sale or exchange of that
property occurring within ten years after the cessation of
business is effectively connected with the conduct of a trade
or business within the United States is made as if the sale or
exchange occurred immediately before the cessation of business
(Code sec. 864(c)(7)).
Proposed treaty limitations on internal law
Under the proposed treaty, business profits of an
enterprise of one country are taxable in the other country only
to the extent that they are attributable to a permanent
establishment in the other country through which the enterprise
carries on business. The taxation of business profits under the
proposed treaty differs from U.S. rules for taxing business
profits primarily by requiring more than merely being engaged
in a trade or business before a country can tax business
profits and by substituting an ``attributable to'' standard for
the Code's ``effectively connected'' standard. 16
Under the Code, all that is necessary for effectively connected
business profits to be taxed is that a trade or business be
carried on in the United States.
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\16\ However, some articles of the proposed treaty use the phrase
``effectively connected''; see, e.g., Article 10 (Dividends).
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The present treaty contains a force of attraction rule
similar to that in the Code as described above. The proposed
treaty eliminates this rule. The proposed treaty is consistent
with the U.S. and OECD models and other existing U.S. treaties
in this respect.
The business profits of a permanent establishment are
determined on an arm's-length basis. Thus, there are to be
attributed to a permanent establishment the business profits
which would reasonably be expected to have been derived by it
if it were a distinct and separate entity engaged in the same
or similar activities under the same or similar conditions and
dealing wholly independently with the enterprise of which it is
a permanent establishment. For example, this arm's-length rule
applies to transactions between the permanent establishment and
a branch of the resident enterprise located in a third country.
Amounts may be attributed to the permanent establishment
whether they are from sources within or without the country in
which the permanent establishment is located.
In computing taxable business profits, the proposed treaty
provides that deductions are allowed for expenses incurred for
the purposes of the permanent establishment. These deductions
include a reasonable allocation of executive and general
administrative expenses, research and development expenses,
interest, and other expenses incurred for the purposes of the
enterprise as a whole (or, if not the enterprise as a whole, at
least the part of the enterprise that includes the permanent
establishment). According to the Technical Explanation, under
this language, the United States is free to use its current
expense allocation rules, including the rules for allocating
deductible interest expense under Treas. Reg. sec. 1.882-5, in
determining deductible amounts. Thus, for example, an Austrian
company which has a branch office in the United States but
which has its head office in Austria will, in computing the
U.S. tax liability of the branch, be entitled to deduct a
portion of the executive and general administrative expenses
incurred in Austria by the head office for purposes of
operating the U.S. branch, allocated and apportioned in
accordance with Treas. Reg. sec. 1.861-8.
Business profits will not be attributed to a permanent
establishment merely by reason of the purchase of merchandise
by a permanent establishment for the enterprise. Thus, where a
permanent establishment purchases goods for its head office,
the business profits attributed to the permanent establishment
with respect to its other activities will not be increased by
the profit element with respect to its purchasing activities.
The amount of profits attributable to a permanent
establishment must be determined by the same method each year
unless there is good and sufficient reason to change the
method. Where business profits include items of income which
are dealt with separately in other articles of the treaty,
those other articles, and not the business profits article,
will govern the treatment of such items of income. Thus, for
example, dividends are taxed under the provisions of Article 10
(Dividends), and not as business profits, except as provided in
paragraph 6 of Article 10.
Under the proposed treaty, the term ``business profits''
includes income from the rental of tangible personal property.
Under the present treaty, income from the rental of certain
tangible personal property is treated as royalties.
The proposed treaty contains a special rule which treats
income derived from an Austrian ``sleeping partnership''
(Stille Gesellschaft) by a U.S. ``sleeping partner'' as
business profits attributable to the permanent establishment of
the partnership in Austria. According to the Technical
Explanation, a sleeping partnership is a contract concluded
under commercial law by which an investor (the sleeping
partner) contributes money or money's worth to the business of
the contracting partner in exchange for a share in the profits
of the business and the right to obtain specified information
about the development of the business. The sleeping partner may
agree under the contract to bear a portion of the losses of the
business.
The Technical Explanation states that there are two types
of sleeping partnerships under Austrian tax law: the typical
form and the non-typical form. In a typical sleeping
partnership, a sleeping partner does not participate in the
capital and assets of the business, and his rights upon
withdrawal from the partnership are limited to the return of
his investment. The profits of a sleeping partner in a typical
sleeping partnership generally are treated as income from
investment activities for Austrian tax purposes. In a non-
typical sleeping partnership, a sleeping partner is entitled to
participate in the increase in net wealth of the business
property as well as profits and losses of the business. Unlike
profits in a typical sleeping partnership, the profits of a
sleeping partner in a non-typical sleeping partnership are
treated as income from commercial activities for Austrian tax
purposes. Whether a particular sleeping partnership should be
characterized as typical or non-typical under Austrian tax law
may be unclear.
Under the proposed treaty, any income earned during the
existence of and attributable to a permanent establishment or
fixed base is taxable in the country where that permanent
establishment or fixed base is situated, even if the payments
with respect to such income are deferred until such permanent
establishment or fixed base has ceased to exist. Thus, the
proposed treaty permits the United States to apply the
principles of Code section 864(c)(6) to the profits that rely
for their taxability upon a nexus with a permanent
establishment or fixed base. The proposed treaty rule that
corresponds to the rule of Code section 864(c)(7) is discussed
below in connection with the taxation of capital gains (Article
13). 17
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\17\ This rule applies to business profits (Article 7, paragraphs 1
and 2), dividends (Article 10, paragraph 4), interest (Article 11,
paragraph 3), royalties (Article 12, paragraph 4), capital gains
(Article 13, paragraph 3), independent personal services (Article 14),
and other income (Article 21, paragraph 2).
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Article 8. Shipping and Air Transport
Article 8 of the proposed treaty covers income from the
operation of ships and aircraft in international traffic. The
rules governing income from the sale of ships and aircraft
operated in international traffic are contained in Article 13
(Capital Gains).
Under the Code, the United States generally taxes the U.S.-
source income of a foreign person from the operation of ships
or aircraft to or from the United States. An exemption from
U.S. tax is provided if the income is earned by a corporation
that is organized in, or an alien individual who is resident
in, a foreign country that grants an equivalent exemption to
U.S. corporations and residents. The United States has entered
into agreements with a number of countries, including Austria,
providing such reciprocal exemptions. Benefits accorded under
such an agreement are not restricted by the proposed treaty.
Under the proposed treaty, profits which are derived by an
enterprise of one country from the operation in international
traffic of ships or aircraft (``shipping profits'') are taxable
only in that country, regardless of the existence of a
permanent establishment in the other country. The proposed
treaty defines ``international traffic'' as any transport by a
ship or aircraft operated by an enterprise of one of the treaty
countries, except when the ship or aircraft is operated solely
between places in one of the treaty countries (Article
3(1)(d)(General Definitions)). Accordingly, with respect to an
Austrian enterprise, purely domestic transport in the United
States is excluded. The present treaty exempts all profits
derived by an enterprise from the operation of ships or
aircraft from source-country tax.
For purposes of the proposed treaty, shipping profits
include rental income from full or bareboat leases of ships or
aircraft, if such ships or aircraft are operated in
international traffic by the lessee or if the rental income is
incidental to profits from the operation of ships or aircraft
in international traffic. Thus, the exemption from source-
country tax for shipping profits applies to a bareboat lessor
(such as a financial institution or a leasing company) that
does not operate ships or aircraft in international traffic,
but that leases ships or aircraft for use in international
traffic.
According to the Technical Explanation, exemption also is
available for profits from the inland transport of property or
passengers within a country if such transport is undertaken as
part of international traffic. Like the U.S. model, the
proposed treaty expressly provides that income derived by an
enterprise of one country from the use, maintenance, or rental
of containers (including trailers, barges, and related
equipment for the transport of containers) used in
international traffic is exempt from tax by the other country.
The Technical Explanation states that the same rule applies to
a such income derived by a resident of either country through a
partnership or other pass-through entity.
The shipping and air transport provisions of the proposed
treaty, other than the foregoing provisions with respect to
income from container leasing, also apply to profits from
participation in a pool, joint business, or international
operating agency. This refers to various arrangements for
international cooperation by carriers in shipping and air
transport. The Technical Explanation clarifies that container
leasing profits, which are supplementary or incidental to the
operation of international traffic of ships or aircraft, from
the participation in a pool, a joint business or an
international operating agency also are exempt from source-
country tax.
Article 9. Associated Enterprises
The proposed treaty, like most other U.S. tax treaties,
contains an arm's-length pricing provision. The proposed treaty
recognizes the right of each country to determine the profits
taxable by that country in the case of transactions between
related enterprises, if the profits of an enterprise do not
reflect the conditions which would have been made between
independent enterprises. The proposed treaty provides that it
is understood, however, that the fact that associated
enterprises have concluded arrangements, such as cost-sharing
arrangements or general services agreements, for or based on
the allocation of executive, general administrative, technical
and commercial expenses, research and development expenses, and
other similar expenses, is not in itself a condition giving
rise to this right.
For purposes of the proposed treaty, an enterprise of one
country is related to an enterprise of the other country if one
of the enterprises participates directly or indirectly in the
management, control, or capital of the other enterprise.
Enterprises are also related if the same persons participate
directly or indirectly in the management, control, or capital
of such enterprises.
Like the present Austrian treaty and the U.S. and OECD
models, the proposed treaty does not include the paragraph
contained in many other U.S. tax treaties which provides that
the rights of the treaty countries to apply internal law
provisions relating to adjustments between related parties are
fully preserved. Nevertheless, the Technical Explanation
provides that the respective countries retain the right to
apply their internal intercompany pricing rules (e.g., Code
sec. 482, in the case of the United States).
When a redetermination of tax liability has been properly
made by one country, the other country will make an appropriate
adjustment to the amount of tax charged in that country on the
redetermined income. This ``correlative adjustment'' clause has
no counterpart in the present treaty. In making that
adjustment, due regard is to be given to other provisions of
the treaty and the competent authorities of the two countries
will consult with each other if necessary. For example, under
the mutual agreement article (Article 24), a correlative
adjustment cannot necessarily be denied on the ground that the
time period set by internal law for claiming a refund has
expired. To avoid double taxation, the proposed treaty's saving
clause retaining full taxing jurisdiction in the country of
residence or nationality (discussed above in connection with
Article 1 (Personal Scope)) will not apply in the case of such
adjustments.
Article 10. Dividends
Overview
The proposed treaty replaces the dividend article of the
present treaty with a new article that makes several changes.
First, the proposed treaty generally liberalizes the conditions
under which the 5-percent direct dividend withholding rate
limitation is imposed. Second, the proposed treaty permits
exceptions to the general 5-percent and 15-percent source-
country tax rates on dividends from a regulated investment
company (``RIC'') or a REIT. Third, the proposed treaty permits
the application by the source country of the treaty's dividend
tax rates to income from arrangements, including debt
obligations, carrying the right to participate in profits.
Finally, the proposed treaty expressly permits the United
States to collect a 5-percent branch profits tax from an
Austrian company.
U.S. internal law
Dividends and second-level withholding tax
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. 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 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 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.
U.S. branch profits tax rules
A foreign corporation engaged in the conduct of a trade or
business in the United States is subject to a flat 30-percent
branch profits tax on its ``dividend equivalent amount.'' The
dividend equivalent amount is the corporation's earnings and
profits which are attributable to its income that is
effectively connected with its U.S. trade or business,
decreased by the amount of such earnings that are reinvested in
business assets located in the United States (or used to reduce
liabilities of the U.S. business), and increased by any such
previously reinvested earnings that are withdrawn from
investment in the U.S. business. The dividend equivalent amount
is limited by (among other things) aggregate earnings and
profits accumulated in taxable years beginning after December
31, 1986.
Austrian internal law
Austria generally imposes a 25-percent withholding tax on
certain Austrian-source payments that include dividends. The
withholding tax generally applies to dividends, other corporate
distributions, and interest on profit-sharing and convertible
bonds by an Austrian corporation whether paid to individual or
corporate residents or nonresidents. The withholding tax does
not apply to a dividend paid to a foreign corporation residing
in a European Union (``EU'') member country, if the dividend is
subject to Austrian tax law provisions enacted in response to
the so-called ``parent-subsidiary directive'' approved by the
EC Council of Ministers on July 23, 1990.
Like U.S. corporate tax law, Austrian tax law generally
embodies the so-called ``classical system'' under which
corporate income may be taxed at the corporate level, and then
taxed again at the shareholder level upon a distribution. A
participation exemption is available if the recipient company
owns 25 percent or more of the share capital of the payor
company directly and continuously for at least 12 months prior
to the end of the taxable year in which the dividend is paid.
Austria does not impose a branch profits tax.
Proposed treaty limitations on internal law
Reduction of withholding tax
Under the proposed treaty, each country may tax dividends
paid by its resident companies, but the rate of tax is limited
by the proposed treaty if the beneficial owner of the dividends
is a resident of the other country. Source-country taxation
generally is limited to 5 percent of the gross amount of the
dividends if the beneficial owner of the dividends is a company
(other than a partnership) which holds directly at least 10
percent of the voting shares of the payor company. Under the
proposed treaty, the tax generally is limited to 15 percent of
the gross amount of the dividends paid to residents of the
other country in all other cases. Under the present treaty,
source-country tax may be imposed at a 15-percent rate, rather
than only a 5-percent rate, unless a higher ownership threshold
is met (95-percent stock ownership by one recipient corporation
residing in the other country).
Under the present treaty, the prohibition on source-country
tax at a rate exceeding 5 percent does not apply in certain
cases where more than 25 percent of the gross income of the
dividend payor consisted of interest and dividends. The
proposed treaty eliminates this rule, and replaces it with
rules similar to those adopted in recent U.S. treaties that
allow source-country tax in excess of 5 percent on direct
investment dividends from a RIC or REIT.
The proposed treaty provides that the 15-percent maximum
tax rate applies to dividends paid by a RIC. The proposed
treaty provides that the 15-percent maximum tax rate applies to
dividends paid by a REIT to an individual owning less than 10-
percent of the REIT. There is no limitation in the proposed
treaty on the tax that may be imposed by the United States on a
REIT dividend that is beneficially owned by an Austrian
resident, if the beneficial owner of the dividend is either an
individual holding a 10-percent-or-greater interest in the REIT
or if the beneficial owner is not an individual. The MOU makes
clear that such a dividend is taxable at the 30-percent United
States statutory rate.
Definition of dividends
Unlike the U.S. and OECD models, the present treaty
provides no express definition of the term ``dividends''. The
proposed treaty provides a definition of dividends that is
broader than the definition in the U.S. model and some other
recent U.S. treaties. Similar to the U.S. model, the proposed
treaty generally defines ``dividends'' as income from shares or
other rights (not being debt claims) participating in profits.
Dividends also include income from other corporate rights that
is subjected to the same tax treatment as income from shares by
the country in which the distributing company is resident. The
proposed treaty also provides (unlike the U.S. model) that the
term dividends includes income from arrangements, including
debt obligations, carrying the right to participate in profits,
to the extent such income is characterized as dividends under
the law of the country in which the income arises.
Special rules and exceptions
The proposed treaty's reduced rates of tax on dividends do
not apply if the recipient of the dividend carries on business
through a permanent establishment (or a fixed base, in the case
of an individual who performs independent personal services) in
the source country and the holding on which the dividends are
paid is effectively connected with the permanent establishment
(or fixed base). Dividends paid on such holdings of a permanent
establishment or a fixed base is taxed as business profits
(Article 7) or as income from the performance of independent
personal services (Article 14). In addition, dividends
attributable to a permanent establishment or fixed base, but
received after the permanent establishment or fixed base is no
longer in existence are taxable in the country where the
permanent establishment or fixed base existed (Article 7,
paragraph 9).
The proposed treaty contains a general limitation on the
taxation by one country of dividends paid by companies that are
residents of the other country. Under this provision, the
United States may not, except in two cases, impose any taxes on
dividends paid by an Austrian resident company that derives
profits or income from the United States. The first exception
is the case where the dividends are paid to U.S. residents. The
second exception is where the holding in respect of which the
dividends are paid is effectively connected with a U.S.
permanent establishment or a fixed base in the United States.
This rule is somewhat less restrictive of the United States'
taxing jurisdiction than the corresponding rule in the present
treaty. The present treaty provides that dividends paid by an
Austrian corporation are exempt from U.S. tax in any case where
the recipient is not a U.S. citizen, resident, or corporation.
Branch profits tax
The proposed treaty allows the United States to impose the
branch profits tax (as opposed to the branch-level excess
interest tax (Code sec. 884(f)), described below) on an
Austrian resident corporation that either has a permanent
establishment in the United States, or is subject to tax on a
net basis in the United States on income from real property or
gains from the disposition of real property interests. Like the
U.S. model, the proposed treaty permits at most a 5-percent
branch profits tax rate, and, in cases where a foreign
corporation conducts a trade or business in the United States,
but not through a permanent establishment, the proposed treaty
completely eliminates the branch profits tax that the Code
imposes on such corporation.
In general, the proposed treaty provides that the branch
profits tax may be imposed by the source country only on that
portion of the business profits of the foreign corporation
attributable to its source-country permanent establishment, or
the corporation's real property income subject to tax on a net
basis. In general, the branch profits tax also may be imposed
by the source country on the foreign corporation's gains from
the disposition of real property. The proposed treaty permits
the United States to impose its branch profits tax on the
``dividend equivalent amount'' (as that term is defined under
the Code as it may be amended from time to time) to the extent
that this definition is in conformity with the principles of
the branch tax article.
None of the restrictions on the operation of U.S. branch
tax provisions apply, however, unless the corporation seeking
treaty protection meets the conditions of the proposed treaty's
limitation on benefits article (Article 16). As discussed
below, the limitation on benefits requirements of the proposed
treaty are similar in some respects to the analogous provisions
of the branch profits tax provisions of the Code described
above.
Article 11. Interest
U.S. internal law
Subject to numerous exceptions (such as those for portfolio
interest, bank deposit interest, and short-term original issue
discount), the United States imposes a 30-percent tax on U.S.-
source interest paid to foreign persons under the same rules
that apply to dividends. U.S.-source interest, for purposes of
the 30-percent tax, generally is interest on the debt
obligations of a U.S. person, other than a U.S. person that
meets specified foreign business requirements. Also subject to
the 30-percent tax is interest paid to a foreign person by the
U.S. trade or business of a foreign corporation. A foreign
corporation is also subject to a branch-level excess interest
tax with respect to certain ``excess interest'' of a U.S. trade
or business of such corporation; under this rule an amount
equal to the excess of the interest deduction allowed with
respect to the U.S. business over the interest paid by such
business is treated as if paid by a U.S. corporation to a
foreign parent and therefore is subject to a withholding tax.
Portfolio interest generally is defined as any U.S.-source
interest that is not effectively connected with the conduct of
a trade or business and that (1) is paid on an obligation that
satisfies certain registration requirements or specified
exceptions thereto, and (2) is not received by a 10-percent
owner of the issuer of the obligation, taking into account
shares owned by attribution. However, the portfolio interest
exemption is inapplicable to certain contingent interest
income.
If an investor holds an interest in a fixed pool of real
estate mortgages that is a real estate mortgage interest
conduit (``REMIC''), the REMIC is treated generally for U.S.
tax purposes as a pass-through entity and the investor is
subject to U.S. tax on a portion of the REMIC's income (which
in turn generally is interest income). If the investor holds a
so-called ``residual interest'' in the REMIC, the Code provides
that a portion of the net income of the REMIC that is taxed in
the hands of the investor--referred to as the investor's
``excess inclusion''--may not be offset by any net operating
losses of the investor, must be treated as unrelated business
income if the investor is an organization subject to the
unrelated business income tax, and is not eligible for any
reduction in the 30-percent rate of withholding tax (by treaty
or otherwise) that would apply if the investor were otherwise
eligible for such a rate reduction.
Austrian internal law
Austria generally does not impose any tax on interest
income of nonresidents. As described above in connection with
the dividend article (Article 10), the Austrian dividend tax
applies to proceeds from profit sharing bonds, and under the
proposed treaty, such proceeds are treated as dividends rather
than interest for Austrian withholding purposes. In addition, a
nonresident individual or corporation may be subject to
Austrian tax with respect to interest on loans secured by
Austrian-situs real property.
Proposed treaty limitations on internal law
Elimination of withholding tax
The proposed treaty generally exempts from the U.S. 30-
percent tax interest (within the proposed treaty's definition
of that term) paid to Austrian residents. The proposed treaty
also exempts from Austrian tax, where any such taxes are
otherwise applicable, Austrian-source interest paid to U.S.
residents. These reciprocal exemptions are similar to those in
effect under the present treaty and in the U.S. model.
According to the Technical Explanation, the proposed treaty
also exempts Austrian corporations from imposition by the
United States of the branch-level excess interest tax.
The exemptions apply only if the interest is beneficially
owned by a resident of one of the countries. Accordingly, they
do not apply if the recipient of the interest is a nominee for
a nonresident.
No such exemption applies to an excess inclusion with
respect to a residual interest in a REMIC. Thus, such
inclusions may be taxed at 30 percent under the proposed
treaty. In addition, the proposed treaty does not prevent the
United States from imposing its withholding tax on contingent
interest that does not qualify as portfolio interest under U.S.
law and to analogous types of interest under Austrian law.
Exemptions from source-country tax will not apply if the
beneficial owner of the interest carries on a business through
a permanent establishment (or a fixed base, in the case of an
individual who performs independent personal services) in the
source country and the obligation on which the interest is paid
is effectively connected with the permanent establishment (or
fixed base). In that event, the interest is taxed as business
profits (Article 7) or income from the performance of
independent personal services (Article 14). In addition,
interest on an obligation that is effectively connected with a
permanent establishment or fixed base which is received after
the permanent establishment or fixed base is no longer in
existence is taxable in the country where the permanent
establishment or fixed base existed (Article 7, paragraph 9).
The proposed treaty addresses the issue of non-arm's-length
interest charges between related parties (or parties having an
otherwise special relationship) by stating that this article
will apply only to the amount of arm's-length interest. Any
amount of interest paid in excess of the arm's-length interest
will be taxable according to the laws of each country, taking
into account the other provisions of the proposed treaty. For
example, interest paid to a parent corporation in excess of an
arm's-length amount may be treated as a dividend under local
law and thus entitled to the benefits of Article 10 (Dividends)
of the proposed treaty.
Definition of interest
The proposed treaty defines interest generally as income
from debt claims of every kind, whether or not secured by a
mortgage and whether or not carrying a right to participate in
the debtor's profits. In particular, it includes income from
government securities and bonds or debentures, including
premiums or prizes attaching to such securities, bonds, or
debentures. The proposed treaty also defines interest to
include an excess inclusion with respect to a REMIC. However,
the term does not include income dealt with in the dividend
article (Article 10). Thus, the interest exemption does not
prevent Austria from imposing the dividend tax on interest paid
on profit-sharing bonds. Penalty charges for late payment are
not considered interest for purposes of the proposed treaty.
Article 12. Royalties
Internal law
Under the same system that applies to dividends and
interest, the United States imposes a 30-percent tax on U.S.-
source royalties paid to foreign persons, and on gains from the
disposition of certain intangible property to the extent that
such gains are from payments contingent on the productivity,
use, or disposition of the intangible property. Royalties are
from U.S. sources if they are for the use of property located
in the United States. U.S.-source royalties include royalties
for the use of or the right to use intangible property in the
United States. Austria generally imposes a 20-percent tax on
royalties derived by nonresidents.
Proposed treaty limitations on internal law
Reduction of withholding tax
The U.S. model exempts royalties beneficially owned by a
resident of one country from source-based taxation in the other
country, and defines the term ``royalties'' to include payments
for the right to use intangible property including
cinematographic films, audio or video tapes or disks and other
means of image or sound reproduction. The U.S. model does not
include in that term rental payments for the use of tangible
personal property.
The present treaty differs from the U.S. model in that it
permits source-country taxation of royalties. The present
treaty covers rental payments for motion picture films and for
the use of industrial, commercial or scientific equipment. The
present treaty contains a two-tier limitation on source-country
taxation of royalties. Only the residence country may tax
royalties and similar payments in respect of the production or
reproduction of literary, musical or other copyrights, artistic
and scientific works, patents, designs, plans, secret processes
and formulae, trademarks, and other like property and rights
(including rentals and like payments for the use of industrial,
commercial or scientific equipment). Motion picture film
rentals may be taxed by the source country at a rate of 10
percent.
The proposed treaty maintains the two-tier limitation of
the present treaty, but expands the class of payments that are
subject to the 10-percent source-country tax. Under the
proposed treaty, royalties that constitute consideration for
the use of, or the right to use, cinematograph film or film,
tapes or ``other means of reproduction'' used for radio or
television broadcasting are subject to the 10-percent source-
country tax. The Technical Explanation indicates that the
phrase ``other means of reproduction'' is intended to refer to
use of means of reproduction that reflect future technological
advances in the field of radio and television broadcasting. All
other royalties arising in one treaty country and beneficially
owned by a resident of the other country may be taxed only by
the country of residence, and not by the country where the
royalty arose. The exemption applies only if the royalty is
beneficially owned by a resident of the other country; it does
not apply if the recipient of the royalty is a nominee for a
nonresident.
The exemption and the 10-percent withholding rate under the
proposed treaty do not apply where the recipient carries on a
business through a permanent establishment (or a fixed base, in
the case of an individual who performs or performed independent
personal services) in the source country and the property with
respect to which the royalties are paid is effectively
connected with the permanent establishment (or fixed base). In
that event, the royalties are taxed as business profits
(Article 7) or income from the performance of independent
personal services (Article 14). In addition, royalties paid
with respect to property which is effectively connected with a
permanent establishment or fixed base, but received after the
permanent establishment or fixed base is no longer in existence
are taxable in the country where the permanent establishment or
fixed base existed (Article 7, paragraph 9).
The proposed treaty addresses the issue of non-arm's-length
royalties between related parties (or parties having an
otherwise special relationship) by stating that this article
will apply only to the amount of arm's-length royalties. Any
amount of royalties paid in excess of the arm's-length royalty
will be taxable according to the laws of each country, taking
into account the other provisions of the proposed treaty. For
example, excess royalties paid to a parent corporation by its
subsidiary may be treated as a dividend under local law and
thus entitled to the benefits of Article 10 (Dividends) of the
proposed treaty.
Definition of royalties and source rules
Under the proposed treaty, royalties are defined as
payments of any kind received as a consideration for the use
of, or the right to use, any copyright of literary, artistic,
or scientific work (including cinematograph films or films or
tapes used for radio or television broadcasting), any patent,
trademark, design or model, plan, secret formula or process, or
other like right or property, or for information concerning
industrial, commercial or scientific experience. The term
``royalties'' also includes gains from the alienation of a
right or property described above which are contingent on the
productivity, use, or disposition of such right or property.
The term ``industrial, commercial, or scientific experience''
is defined in paragraph 11 of the Commentary to Article 12 of
the OECD Model. According to the Commentary, the term may
include information that is ancillary to a right otherwise
giving rise to royalties, such as a patent or secret process.
According to the Technical Explanation, payments for the use,
or the right to use, computer software may be considered
royalties under the proposed treaty or may be considered
business profits, depending on the facts and circumstances.
However, payments received in connection with the transfer of
so-called ``shrink-wrap'' computer software are treated as
business profits.
The proposed treaty conforms to the U.S. internal law
source rules in treating royalties as arising from U.S. sources
if they are for the use of, or right to use, property within
the United States.
Article 13. Capital Gains
U.S. internal law
Generally, gain realized by a nonresident alien or a
foreign corporation from the sale of a capital asset is not
subject to U.S. tax unless the gain is effectively connected
with the conduct of a U.S. trade or business. Under a special
rule, gain from the disposition of any property within 10 years
after such property ceased to be used in a U.S. trade or
business is treated as effectively connected with the U.S.
trade or business (Code sec. 864(c)(7)).
In addition, a nonresident alien or foreign corporation is
subject to U.S. tax on gain from the sale of a U.S. real
property interest as if the gain were effectively connected
with a trade or business conducted in the United States. ``U.S.
real property interests'' include interests in certain
corporations if at least 50 percent of the assets of the
corporation consist of U.S. real property.
Austrian internal law
Under Austrian law, the taxation of capital gains, of both
residents and nonresidents, generally is limited to gains that
are business income. However, a nonresident generally may be
subject to Austrian tax (at ordinary rates) on gain from the
disposition of shares issued by an Austrian corporation, if the
person is treated as having a substantial interest (i.e, more
than 10 percent) in the corporation. Under the present treaty,
Austria retains the right to impose this tax in some limited
cases on Austrian citizens who are U.S. residents.
Austrian law also provides for nonrecognition of gain that
is realized upon certain exchanges of property or stock in
connection with contributions of property to corporations,
liquidations of corporations, distributions of stock, and
corporate reorganizations. Austrian and U.S. nonrecognition
provisions are not identical. For example, if a U.S. company
has a permanent establishment in Austria and the company
transfers the assets of the Austrian permanent establishment to
a subsidiary, Austria generally will tax the unrealized gain at
the time of the transfer unless the shares of the subsidiary
remains subject to Austrian tax.
Proposed treaty limitations on internal law
Real property
Under the proposed treaty gains derived by a treaty country
resident from the disposition of real property situated in the
other country may be taxed in the other country. Real property
situated in the other country for the purposes of this article
includes real property referred to in Article 6 (Income from
Real Property) which is situated in the other country. With
respect to the United States, the term real property situated
in the other country includes a ``U.S. real property interest''
as defined under the Code, and an interest in a partnership,
trust, or estate, to the extent that such interest is
attributable to real property situated in the United States.
The Committee understands that distributions by a REIT that are
attributable to gains derived from a disposition of real
property are taxable under this article (and such gains are not
taxable under the dividends article (Article 10)). With respect
to Austria, the term includes shares or other comparable rights
in a company the assets of which consist, directly or
indirectly, mainly of real property situated in Austria.
Other capital gains
The proposed treaty contains a standard provision which
permits a country to tax the gain from the alienation of
personal property that forms part of the business property of a
permanent establishment or fixed base of a resident of the
other country located in the first country.
In addition, gains from the alienation of movable property
previously used or held in connection with a permanent
establishment or fixed base that a resident of one of the
treaty countries has, or had, in the other country may be taxed
by such other country, but only to the extent that the gain is
attributable to the period in which the personal property in
question formed part of the business property of the permanent
establishment or fixed base. The residence country also may tax
the gains associated with the same property; however, such
country is required to exclude from its tax base any gain that
is taxed by the source country. Thus, this provision is
consistent with the internal Austrian rule that taxes the
appreciation inherent in the business assets upon an
incorporation of an Austrian permanent establishment. Although
the provision is drafted reciprocally, the United States may
not, under its domestic law, impose a tax on such an event. In
addition, this provision is narrower than the rule of Code
section 864(c)(7) because it limits the taxable gain to the
amount accrued during the period the property was part of the
permanent establishment or fixed base.
Gains of an enterprise of one of the treaty countries from
the alienation of ships, aircraft or containers operated in
international traffic are taxable only in that country. Gains
described in the royalties article (i.e., gains derived from
alienation of certain intangible property that are contingent
on productivity, use, or disposition) are taxable only in
accordance with that article (Article 12). Thus, such gains are
either exempt from source-country tax or are subject to a 10-
percent source-country tax.
Generally, gains from the alienation of any property other
than that discussed above will be taxable under the proposed
treaty only in the country where the alienator is a resident.
Under the proposed treaty, where a U.S. resident transfers
property to an Austrian company as a capital contribution and
the transfer is not subject to Austrian tax (i.e., due to the
application of the Austrian Reorganization Tax Act
(``Umgrundungssteuergesetz'')), a subsequent alienation of the
shares in the Austrian company is taxable in Austria through
the year 2010. The Technical Explanation states that it is
expected that any double taxation that occurs as a result of
treating a transfer of stock as an ``alienation'' for Austrian
tax purposes would be addressed under the competent authority
procedures.
Article 14. Independent Personal Services
U.S. internal law
The United States taxes the income of a nonresident alien
at the regular graduated rates if the income is effectively
connected with the conduct of a trade or business in the United
States by the individual. The performance of personal services
within the United States may be a trade or business within the
United States.
Under the Code, the income of a nonresident alien from the
performance of personal services in the United States is
excluded from U.S.-source income, and therefore is not taxed by
the United States in the absence of a U.S. trade or business,
if: (1) the individual is not in the United States for over 90
days during a taxable year; (2) the compensation does not
exceed $3,000; and (3) the services are performed as an
employee of, or under a contract with, a foreign person not
engaged in a trade or business in the United States or are
performed for a foreign office or place of business of a U.S.
person.
Proposed treaty limitations on internal law
The proposed treaty limits the right of a country to tax
income from the performance of personal services by a resident
of the other country. Under the proposed treaty (unlike the
present treaty), income from the performance of independent
personal services (i.e., services performed as an independent
contractor, not as an employee) is treated separately from
income from the performance of dependent personal services.
Under the proposed treaty, income from the performance of
independent personal services by a resident of one country is
exempt from tax in the other country, unless the services are
performed in the other country and the income is attributable
to a fixed base regularly available to the individual in the
second country for the purpose of performing the activities.
The proposed treaty generally provides a broader exemption
from source-country tax for income from independent personal
services than the present treaty. Under the present treaty, an
exemption is generally available to a resident of a country
only if his or her stay in the other country does not exceed
183 days. The present treaty does not contain the fixed base
limitation found in the proposed treaty.
The Technical Explanation provides that it is understood
that the term ``fixed base'' is similar in meaning to the term
``permanent establishment'' of the proposed treaty. According
to the Technical Explanation, the rules of Article 7 (Business
Profits) for attributing income and expenses to a permanent
establishment are generally relevant for attributing income to
a fixed base. In addition, the Technical Explanation states
that outside director fees are covered by this article.
The exemption from source-country tax provided in the
proposed treaty for independent personal services income is
similar to that contained in the U.S. model.
Article 15. Dependent Personal Services
Under the proposed treaty, wages, salaries, and other
similar remuneration derived from services performed as an
employee in one country (the source country) by a resident of
the other country will be taxable only in the country of
residence if three requirements are met: (1) the individual is
present in the source country for not more than 183 days in any
twelve-month period beginning or ending during the taxable year
concerned; (2) the individual's employer is not a resident of
the source country; and (3) the compensation is not borne by a
permanent establishment or fixed base of the employer in the
source country. These limitations on source-country taxation
are consistent with the present treaty, as well as the U.S. and
OECD models.
The Technical Explanation provides that in determining the
number of days for purposes of the 183-day rule, an individual
is considered to be present for any day during which he or she
is present in the source country (including part of the day),
even if the individual does not work during that day.
18
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\18\ See Rev. Rul. 56-24, 1956-1 C.B. 851.
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The proposed treaty provides that compensation derived from
employment as a member of the regular complement of a ship or
aircraft operated in international traffic may be taxed only in
the employee's country of residence.
This article is modified by the provisions with respect to
the treatment of pensions (Article 18) and government service
(Article 19). In addition, the rules applicable to artistes and
athletes (Article 17) apply notwithstanding the rules of this
article.
Article 16. Limitation on Benefits
In general
The proposed treaty contains a provision, not found in the
present treaty, generally intended to limit indirect use of the
treaty by persons who are not entitled to its benefits by
reason of residence in the United States or Austria.
The proposed treaty is intended to limit double taxation
caused by the interaction of the tax systems of the United
States and Austria as they apply to residents of the two
countries. At times, however, residents of third countries
attempt to use a treaty. This use is known as ``treaty
shopping'' and refers to the situation where a person who is
not a resident of either country seeks certain benefits under
the income tax treaty between the two countries. Under certain
circumstances, and without appropriate safeguards, the
nonresident may be able to secure these benefits indirectly by
establishing a corporation (or other entity) in one of the
countries, which entity, as a resident of that country, is
entitled to the benefits of the treaty. Additionally, it may be
possible for a third-country resident to reduce the income base
of a treaty country resident by having the latter pay out
interest, royalties, or other deductible amounts under
favorable conditions either through relaxed tax provisions in
the distributing country or by passing the funds through other
treaty countries (essentially, continuing to treaty shop),
until the funds can be repatriated under favorable terms.
Summary of proposed treaty provisions
The anti-treaty-shopping article in the proposed treaty
provides that a treaty country resident is entitled to treaty
benefits in the other country only if it fits into one of
several categories or is otherwise approved by that country's
competent authority, in the exercise of the latter's
discretion. This provision of the proposed treaty is in some
ways comparable to the U.S. Treasury regulation under the
branch tax definition of a qualified resident. 19
However, the proposed treaty provides opportunities for treaty
benefit eligibility which are not provided under the
regulation.
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\19\ Treas. Reg. sec. 1.884-5.
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Generally, a resident of either country qualifies for all
the benefits accorded by the proposed treaty if such resident
is a ``qualified resident'' as defined in one of the following
categories:
(1) An individual;
(2) One of the treaty countries or a political subdivision or
local authority thereof;
(3) A person that satisfies an ownership test and a base
erosion test;
(4) A company that satisfies a public company test;
(5) A company that is owned by certain public companies;
(6) A not-for-profit, tax-exempt organization that satisfies
an ownership test; or
(7) A headquarters company.
In addition, an item of income that is derived in connection
with, or incidental to, an active trade or business conducted
in the other country may qualify for treaty benefits under the
active business test.
Special rules apply to interest and royalty income derived
by an Austrian company in certain ``triangular'' cases
described below.
The MOU provides that the provisions of the proposed
treaty, such as those under this article, designed to prevent
abusive transactions will not prevent the United States or
Austria from applying its internal law ``substance over form''
rules.
The competent authorities shall, pursuant to the authority
provided in accordance with the provisions of Article 25
(Exchange of Information and Administrative Assistance),
exchange such information as is necessary for carrying out the
provisions of this article and safeguarding the application of
their internal laws.
Ownership and base erosion tests
Like many U.S. treaties that have a limitation on benefits
article, the proposed treaty contains an ownership test and a
base erosion payment test, both of which must be met if an
entity is to qualify for treaty benefits.
To meet the ownership test, more than 50 percent of the
beneficial interest in the entity must be owned, directly or
indirectly, by persons that qualify as treaty residents under
certain tests of the proposed treaty or who are U.S. citizens.
20 In the case of a company, qualified treaty
residents or U.S. citizens must own, directly or indirectly,
more than 50 percent of the number of shares of each class of
the company's shares.
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\20\ For this purpose, a qualified treaty resident is a person who
is entitled to benefits under the proposed treaty as an individual
resident of Austria or the United States, a public company or public
company subsidiary (as described in the discussion of the public
company tests below), one of the treaty countries or a political
subdivision or local authority thereof, or a non-profit organization
(as described in the discussion of qualifying organizations below).
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To meet the base erosion test, not more than 50 percent of
the gross income of the entity may be used, directly or
indirectly, to meet liabilities (including liabilities for
interest or royalties) to persons or entities other than U.S.
citizens or certain persons that qualify as treaty residents.
This rule is intended to prevent a corporation, for example,
from distributing most of its income in the form of deductible
payments (such as interest, royalties, service fees, or other
amounts) to persons not entitled to benefits under the treaty.
Public company tests
Like many other U.S. income tax treaties that have a
limitation on benefits article, the proposed treaty contains a
rule under which a company is entitled to treaty benefits if
sufficient shares in the company are traded actively enough on
a suitable stock exchange. This rule is similar to the branch
profits tax rules in the Code under which a company is entitled
to treaty protection from the branch tax if it meets such a
test or if it is the wholly-owned subsidiary of certain
publicly traded corporations resident in a treaty country.
Publicly traded companies
A company that is a resident of Austria or the United
States is entitled to treaty benefits, if the principal class
of its shares is substantially and regularly traded on one or
more recognized stock exchanges. The Technical Explanation
provides that the term ``principal class of shares'' is
intended to be interpreted as the class of shares that
represents the majority of the voting power and value of the
company. When no single class of shares represents the majority
of the voting power and value of the company, the term
generally means those classes that in the aggregate possess
more than 50 percent of the voting power and value of the
company. The term ``shares'' includes depository receipts or
trust certificates. In determining voting power, any shares or
class of shares that are authorized but not issued shall not be
counted; and in mutual agreement between the competent
authorities, appropriate weight shall be given to any
restrictions or limitations on voting rights of, or entitlement
to disproportionately higher participation in, issued shares.
Thus, such a company is entitled to the benefits of the treaty
regardless of where its actual owners reside or the amount or
destination of payments it makes.
Subsidiaries of publicly traded companies
A company that is a resident of Austria or the United
States is entitled to treaty benefits if it is at least 90-
percent owned, directly or indirectly, by five or fewer
companies which are residents of either treaty country, the
principal classes of the shares of which are publicly traded as
described above, provided that the owner of any remaining
portion of the company is an individual resident of Austria or
the United States. The Technical Explanation provides that if
the ownership of any remaining portion of the company belongs
to more than one individual, each such individual must be a
resident of either country.
Definitions
The term ``recognized stock exchange'' includes the NASDAQ
System, any stock exchange registered with the Securities and
Exchange Commission as a national securities exchange for the
purposes of the Securities Exchange Act of 1934, and the Vienna
Stock Exchange. The term generally includes any other stock
exchange agreed upon by the competent authorities of the two
countries. U.S. internal law contains an exception to the
definition of a ``recognized stock exchange'' in the case of a
closely held company for purposes of identifying a ``qualified
resident'' eligible for treaty protection from the U.S. branch
tax. 21 The regulation provides that stock in
certain closely held companies will not be treated as
``regularly traded,'' The proposed treaty has no special rule
for closely held companies in defining the term ``substantial
and regular trading.'' Consequently, it will be easier for a
closely held company to qualify as a resident of the United
States or Austria under the proposed treaty than under the U.S.
branch tax rules.
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\21\ Treas. Reg. sec. 1.884-5(d)(4)(iii).
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The proposed treaty does not define ``substantial'' and
``regular'' trading. A definition for ``regular'' trading can
be found in the regulations under Code section 884(e) for
purposes of identifying a ``qualified resident'' eligible for
treaty protection from the U.S. branch tax. 22
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\22\ Treas. Reg. sec. 1.884-5(d)(4).
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Non-profit organizations
An entity also will be entitled to benefits under the
proposed treaty if it is a not-for-profit organization which,
by virtue of that status, generally is exempt from income
taxation in its treaty country of residence, provided that more
than half the beneficiaries, members, or participants, if any,
in the organization are persons that are entitled to benefits
under the proposed treaty. The not-for-profit organizations
described include, but are not limited to, pension funds and
private foundations.
Headquarters companies
A treaty country resident is entitled to all the benefits
of the proposed treaty if that person functions as a
headquarters company for a multinational corporate group. As
set forth in the MOU, a company is considered to be a
headquarters company for this purpose only if each of several
criteria is satisfied. The person seeking such treatment must
provide in its country of residence a substantial portion of
the overall supervision and administration of the group, which
may include, but cannot be principally, group financing. The
person must have, and exercise, independent discretionary
authority to carry out these functions. It must be subject to
the same income taxation rules in its residence country as
other persons entitled to the benefits of the proposed treaty.
The group must consist of corporations resident in, and engaged
in an active business in, at least five countries, and the
income derived in the treaty country of which the headquarters
company is not a resident must be derived in connection with,
or be incidental to, those active business activities. The
business activities carried on in each of the five countries
(or five groupings of countries) must generate at least 10
percent of the gross income of the group. The business
activities carried on in any one country (other than the
country where the headquarters company is resident) cannot
generate 50 percent or more of the gross income of the group.
Moreover, no more than 25 percent of the headquarters company's
gross income may be derived from the treaty country of which it
is not a resident.
Other recent U.S. income tax treaties, such as the treaty
with the Netherlands and the treaty with France, also contain a
headquarters company provision in the limitation on benefits
article.
Active business test
In general
Under the active business test, treaty benefits in the
source country are available under the proposed treaty to an
entity that is a resident of the United States or Austria if it
is engaged in the active conduct of a trade or business in its
residence country, the income derived from the source country
is derived in connection with, or is incidental to, that trade
or business, and, with respect to income derived in connection
with that trade or business, the trade or business is
substantial in relation to the activity carried on in the
source country which provides the income with respect to which
treaty benefits are claimed. According to the Technical
Explanation, the test is applied separately to each item of
income.
An entity does not meet the active business test (and
therefore is not eligible to claim treaty benefits under this
rule) by virtue of being engaged in the business of making or
managing investments, unless these activities are banking or
insurance activities carried on by a bank or insurance company.
The active trade or business rule is consistent with
similar tests in recent U.S. treaties, and replaces a more
general rule in some other U.S. income tax treaties that
preserves benefits if an entity is not used ``for a principal
purpose of obtaining benefits'' under a treaty. However, unlike
other treaties, and to some extent like the regulations under
Code section 884(e), the proposed treaty (in its text and as
elucidated in the MOU) elaborates at length on the conditions
under which the active business will, and will not, be
considered to be met.
The MOU provides several examples to illustrate the
operation of the active trade or business test.
Income derived in connection with a substantial business
The MOU specifies that income is derived in connection
with, or is incidental to, a trade or business if the income-
producing activity in the source country is a line of business
which forms a part of, or is complementary to, the trade or
business conducted in the residence country by the income
recipient. 23 Alternatively, the income must be
produced by assets that are part of the income recipient's
business property. Under the U.S. model, income is derived in
connection with a trade or business if the income producing
activity in the source country is a line of business which
forms a part of, or is complementary to, the trade or business
conducted in the residence country by the income recipient. The
U.S. model does not contain the proposed treaty's alternative
definition for income derived in connection with a trade or
business (i.e., income produced by assets that are part of the
income recipient's business property).
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\23\ Cf. Treas. Reg. sec. 1.884-5(e)(1) and (e)(4). (To satisfy the
active business test, the activities that give rise to the U.S. income
must be part of a U.S. business and that business must be an integral
part of active trade or business conducted by the foreign corporation
in its residence country; a business is an integral part if it
comprises in principal part complementary and mutually interdependent
steps in the production and sale or lease of goods or in the provision
of services.)
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Under the proposed treaty, income derived in connection
with a trade or business is eligible for treaty benefits if the
trade or business conducted in the residence country is
substantial in relationship to the income-generating activity
in the other country. Under the U.S. model, the trade or
business in the residence country must also be ``substantial''
in cases where the income derived by the source country is
``incidental'' to the trade or business of the residence
country. The proposed treaty does not apply a substantiality
test to such incidental income.
Whether the trade or business of the income recipient is
substantial generally is determined by reference to its
proportionate share of the trade or business in the source
country, the nature of the activities performed, and the
relative contributions made to the conduct of the trade or
business in both countries. 24 The MOU provides a
safe harbor for this purpose. Under the safe harbor, the trade
or business of the income recipient will be deemed to be
substantial if certain attributes of the residence-country
business exceed a threshold fraction of the corresponding
attributes of the trade or business located in the source
country that produces the source-country income. The attributes
are assets, gross income, and payroll expense. The level of
each such attribute in the active conduct of the trade or
business by the income recipient in the residence country, and
the level of each such attribute in the trade or business
producing the income in the source country, is measured for the
prior year. For each separate attribute, the ratio of the
residence country level to the source country level is
computed.
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\24\ Cf. Treas. Reg. sec. 1.884-5(e)(3). (A foreign corporation
engaged in business in its residence country has a substantial presence
in that country if certain of the attributes of that business,
physically located in its residence country, equal at least a threshold
percentage of its worldwide attributes).
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In general, the safe harbor is satisfied if the average of
the three ratios is greater than 10 percent, and each ratio
separately is greater than 7.5 percent. If any separate ratio
is equal to or less than 7.5 percent for the prior year, the
average of the corresponding ratios in the three prior years
may be substituted. These safe harbor percentages are similar
to those contained in the U.S. model.
Income incidental to a trade or business
According to the MOU, income that is incidental to a trade
or business is defined in the same manner as income that is
derived in connection with a trade or business. Under that
definition, income is incidental to a trade or business if the
income-producing activity in the source country is a line of
business which forms a part of, or is complementary to, the
trade or business conducted in the residence country, or the
income is produced by assets that are part of the income
recipient's business property. One of the examples contained in
the MOU illustrates that income from the short-term investment
of the working capital of the residence-country trade or
business is treated as ``incidental income''. Unlike the
proposed treaty, the U.S. model defines incidental income
separately from income derived in connection with a trade or
business. Under the U.S. model definition, income is incidental
to a trade or business in the residence country if the
production of such income facilitates the conduct of a trade or
business in the other country.
Attribution rules
As set forth in the MOU, the active business test takes
into account the extent to which the person seeking treaty
benefits either is itself engaged in business or is deemed to
be so engaged through the activities of related persons. The
MOU provides that under the proposed treaty, a treaty country
resident is deemed to be engaged in the active conduct of a
trade or business in its residence country (and is considered
to carry on the proportionate share of such trade or business)
if it is a partner in a partnership that is so engaged, or if
it owns, either alone or as a member of a group of five or
fewer persons that are qualified persons or residents of an
``identified state,'' a controlling beneficial interest in a
person that is engaged in the active conduct of a trade or
business in the resident country of such owner. 25
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\25\ An ``identified state'' means any third country, identified by
agreement of the competent authorities, which has effective provisions
for the exchange of information with the residence country of the
person being test under these rules.
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A company resident in a treaty country is also deemed to be
engaged in the active conduct of a trade or business in its
residence country if it is a member of a group of companies
that form or could form a consolidated group for tax purposes
in the residence country and the group is engaged in the active
conduct of a trade or business in that country. 26 A
similar principle applies if a treaty country resident is under
the common control with another person that is so engaged,
provided that the control is held by five or fewer persons that
are qualified persons or residents of an identified state.
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\26\ This rule is applied without regard to the residence of such
companies.
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Finally, the activities of an owner of a treaty country
resident may be attributed to such resident. Attribution to a
treaty country resident applies if a controlling beneficial
interest in the treaty country resident is held by a single
person engaged in the active conduct of a trade or business in
that same country. Attribution also applies if a controlling
beneficial interest in the treaty country resident is held by a
group of five or fewer persons, each of which is engaged in
activity in that country which is a component part of or
directly related to the trade or business in that country.
Grant of treaty benefits by the competent authority
The proposed treaty provides a ``safety-valve'' for a
treaty country resident that has not established that it meets
one of the other more objective tests, but for which the
allowance of treaty benefits would not give rise to abuse or
otherwise be contrary to the purposes of the treaty. Under this
provision, such a person may be granted treaty benefits if the
competent authority of the source country so determines. The
MOU provides that in making this determination, the competent
authority will take into account as its guideline whether the
establishment, acquisition, or maintenance of the person, or
the conduct of its operations, has or had as its principal
purpose the obtaining of benefits under the proposed treaty.
The competent authority of the source country will consult with
the competent authority of the other country before denying the
benefits of the treaty under this rule.
This provision of the proposed treaty is similar to a
portion of the qualified resident definition under the U.S.
branch profits tax rules, under which the Secretary of the
Treasury may, in his sole discretion, treat a foreign
corporation as a qualified resident of a foreign country if the
corporation establishes to the satisfaction of the Secretary
that it meets such requirements as the Secretary may establish
to ensure that individuals who are not residents of the foreign
country do not use the treaty between the foreign country and
the United States in a manner inconsistent with the purposes of
the Code rule (Code sec. 884(d)(4)(D)).
The MOU provides that in determining whether the
establishment, acquisition, or maintenance of a corporation
resident in one of the States has or had as its principal
purpose the obtaining of benefits under the proposed treaty,
the competent authorities may consider the following factors
(among others):
(1) the existence of a clear business purpose for the
structure and location of the income earning entity
in question;
(2) the conduct of an active trade or business (as opposed to
a mere investment activity) by such entity;
(3) a valid business nexus between that entity and the
activity giving rise to the income; and
(4) the extent to which an entity which is a corporation
would be entitled to treaty benefits comparable to
those afforded by the proposed treaty if it had
been incorporated in the country of residence of
the majority of its shareholders.
The MOU contains an example that illustrates the application of
these principles.
The MOU provides that Austria's membership in the EU is a
factor in the determination of eligibility for treaty benefits
of an Austrian company with significant other EU member
ownership or with significant business activities carried on in
EU countries. Similar principles apply with respect to the
special relationship between the United States, Canada, and
Mexico under the North American Free Trade Agreement.
The MOU provides that if the United States and Austria
determine that it is desirable to amend Article 16 of the
proposed treaty to reflect the closer relationship between
Austria and its EU partners, the negotiators will promptly
negotiate a Protocol in this regard.
Triangular cases
Under present laws and treaties that apply to Austrian
residents, it is possible for profits of a permanent
establishment maintained by an Austrian resident in a third
country to be subject to a very low aggregate rate of Austrian
and third-country income tax. The proposed treaty, in turn,
eliminates the U.S. tax on several specified types of income of
an Austrian resident. In a case where the U.S. income is earned
by a third-country permanent establishment of an Austrian
resident (the so-called ``triangular case'') the proposed
treaty could have the potential of helping Austrian residents
to avoid all (or substantially all) taxation, rather than
merely avoiding double taxation.
This article provides for an exception to the general rule
in Articles 11 and 12 of the proposed treaty that eliminate or
reduce the U.S. tax on interest and royalties. If the exception
applies, the United States may tax the interest or royalty in
accordance with its internal law (i.e., the United States
generally may impose a 30-percent withholding tax on payments
made to an Austrian resident).
In order for this U.S. withholding tax to be imposed, two
conditions must be met. First, the interest or royalty must be
derived by an Austrian enterprise and must be attributable to a
permanent establishment of that enterprise in a third
jurisdiction. Second, combined Austrian and third country tax
on the profits of the permanent establishment must be levied at
an effective rate which is less than 60 percent of the general
rate of company tax applicable in Austria.
The special rule generally does not apply to interest
income derived in connection with, or incidental to, an active
trade or business carried on by the permanent establishment in
the third country (other than the business of making or
managing investments, unless these activities are banking or
insurance activities carried on by a bank or insurance
company), royalties that are received as compensation for the
use of, or the right to use, intangible property produced or
developed by the permanent establishment, or if the income is
subject to taxation by the United States under the subpart F
controlled foreign corporation rules.
Article 17. Artistes and Athletes
Like the U.S. and OECD models, the proposed treaty contains
rules that apply to the taxation of income earned by
entertainers (such as theater, motion picture, radio, or
television ``artistes,'' or musicians) and athletes. These
rules apply notwithstanding the other provisions dealing with
the taxation of income from personal services (Articles 14 and
15) and business profits (Article 7), and are intended, in
part, to prevent entertainers and athletes from using the
treaty to avoid paying any tax on their income earned in one of
the countries. However, an artiste or athlete not subject to
host country tax under the provisions of this article may still
be taxable by that country under the rules of Article 14 or 15.
Under this article of the proposed treaty, one country may
tax an entertainer or athlete who is a resident of the other
country on the income from his or her personal services as such
in the first country during any year in which the gross
receipts derived from such activities, including reimbursed
expenses, exceed $20,000 or its Austrian shillings equivalent.
Thus, if an Austrian entertainer maintained no fixed base in
the United States and performed (as an independent contractor)
for one day of a taxable year in the United States for gross
receipts of $2,000, the United States could not tax that
income. If, however, that entertainer's gross receipts were
$30,000, the full $30,000 (less appropriate deductions) would
be subject to U.S. tax. This provision does not bar the country
of residence from also taxing that income (subject to a foreign
tax credit). (See Article 22 (Relief from Double Taxation),
below.) The Technical Explanation clarifies that because it is
not possible to know whether the $20,000 (or the Austrian
shillings equivalent) is exceeded until the end of the year,
the source country may subject all payments to an artiste or
athlete to withholding and then refund any excess amount
withheld.
The Technical Explanation provides that in determining
whether income is governed by this article, the controlling
factor is whether the income in question is predominately
attributable to the performance itself or other activities or
property rights. In the case where an individual functions as a
performer and non-performer, and the role in one of the
capacities is negligible, the predominant character of the
individual's activities should control the characterization of
those activities. If the roles are not negligible, there should
be an apportionment between the performance related
compensation and the other compensation. 27
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\27\ See paragraph 4 of the Commentaries to Article 17 of the OECD
model.
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The proposed treaty provides a standard provision that is
intended to address potential abuses. Under this provision,
where income in respect of activities exercised by an
entertainer or athlete in his or her capacity as such accrues
not to the entertainer or athlete, but to another person, that
income may be taxed by the country in which the activities are
exercised, unless it is established that neither the
entertainer or athlete nor persons related to him or her
participate directly or indirectly in the profits of that other
person in any manner (including the receipt of deferred
remuneration, bonuses, fees, dividends, partnership
distributions, or other distributions). (This provision applies
notwithstanding the business profits, independent personal
service and dependent service articles (Articles 7, 14 and
15).) This provision prevents certain performers and athletes
from avoiding tax in the country in which they perform by, for
example, routing the compensation for their services through a
third entity such as a personal holding company or a trust
located in a country that would not tax the income.
In cases where payments are made to a person other than the
entertainer or athlete who exercised the activities, but that
do not involve routing payments to an entity to avoid source-
country tax as described above, the proposed treaty provides
that such payments may be subject to source-country tax. Upon
request of that person, the withholding tax may be refunded to
the extent the amount exceeds the tax liability of the
entertainer or the athlete. The Technical Explanation indicates
that the refund claims must be accompanied by proper
documentation. An example in the Technical Explanation
illustrates that such a case may arise when a payment is made
to an entertainer through a third-country promotor.
The MOU clarifies that entities operating an orchestra
generally are not subject to the provisions of this article. On
the other hand, individual members of an orchestra may be
subject to the provisions of this article if their annual
remuneration received for the performance in the source country
exceeds $20,000. In computing whether an individual satisfies
this threshold, the MOU states that a monthly salary is
allocated to the days spent in the source country; however, the
entire amount of a performance-related global payment (e.g., a
payment consisting of compensation for performance in Austria
and for preparation outside of Austria) is taken into account.
The foregoing provisions are generally similar to
provisions in the U.S. and OECD models dealing with
entertainers and athletes.
Article 18. Pensions
This article contains rules applicable to the tax treatment
of private pensions and annuities, social security benefits,
alimony and child support payments, and cross-border pension
contributions.
Under the proposed treaty, as in the present treaty,
pensions and other similar remuneration beneficially derived by
a resident of either country in consideration of past
employment generally are subject to tax only in the recipient's
country of residence. This rule is subject to the provisions of
Article 19 (Government Service). Thus, it generally does not
apply, for example, in the case of pensions paid to a resident
of one country attributable to services performed for
government entities of the other. The Technical Explanation
provides that this provision covers amounts paid by all private
retirement plans and arrangements in consideration of past
employment, regardless of whether they are considered qualified
plans under the Code.
Social Security payments and other public pensions
28 paid by one country to an individual who is a
resident of the other country or to a U.S. citizen will be
taxable only by the paying country. (This rule also is subject
to the provisions of Article 19 (Government Service).) This
rule, which is not subject to the saving clause, exempts U.S.
citizens and residents from U.S. tax on Austrian social
security payments. Under this rule, only the United States may
tax U.S. social security payments to residents of Austria. The
rule thus safeguards the United States' right under the Social
Security Amendments of 1983 to tax a portion of U.S. social
security benefits received by nonresident individuals, while
protecting any such individuals residing in Austria from double
taxation.
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\28\ According to the MOU, the term ``other public pensions'' is
intended to refer to U.S. tier 1 Railroad Retirement benefits. In
addition, the term ``social security payments'' is not restricted to
old age pensions but also refers to other types of social security
benefits such as payments to compensate work-related diseases or
accidents.
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The proposed treaty provides that annuities may be taxed
only in the country of residence of the person who beneficially
owns them. An annuity is defined as a stated sum payable
periodically at stated times during a specified number of
years, under an obligation to make the payments in return for
adequate and full consideration.
Unlike the present treaty, the proposed treaty provides for
the treatment of alimony and child support payments. The
proposed treaty grants exclusive taxing rights with respect to
alimony to the treaty country of residence of the payor. This
rule is different from the U.S. model, which provides that the
recipient's country of residence has the exclusive taxing
rights with respect to alimony payments. The term ``alimony''
as used in the article of the proposed treaty means periodic
payments made pursuant to a written separation agreement or a
decree of divorce, separate maintenance, or compulsory support.
This rule is not subject to the saving clause; thus, alimony
payments from an Austrian resident to a U.S. resident or
citizen are taxable only in Austria.
Under the proposed treaty, child support payments (made
pursuant to a written separation agreement or a decree of
divorce, separate maintenance, or compulsory support) are
exempt from tax by both countries. This rule is the same as the
rule in the U.S. model.
The proposed treaty deals with the taxation of
contributions borne by an individual who renders dependent
personal services in one country (the host country) to a
pension plan established in, and recognized for tax purposes,
in the other country. In general, under the proposed treaty, in
determining the individual's taxable income, the host country
may be required to treat such contributions in the same way and
subject them to the same conditions and limitations as
contributions made to a pension plan established in the host
country. Such treatment is provided only if the employee was
not a resident of the host country and contributed to the
pension plan immediately before exercising employment in the
host country. In addition, the competent authority of the first
country must agree that the pension plan corresponds to a
pension plan recognized for tax purposes by that country.
Article 19. Government Service
The proposed treaty generally exempts the wages of
employees of one country from tax by the other country. Under
the proposed treaty, remuneration, including pensions,
annuities or similar benefits, paid by a country or one of its
political subdivisions or local authorities to a citizen of
such country for services rendered as an employee of that
country (or subdivision or authority) generally is taxable only
in that country.
The proposed treaty states that the above rule also applies
to remuneration paid to the Austrian Foreign Trade
Representatives of the Austrian Federal Economic Chamber and to
the staff members of the Austrian Foreign Trade Offices who are
Austrian citizens to the extent they are discharging
governmental functions in the United States. The MOU provides
that employees of a government entity (such as an Embassy or
Consulate) engaging in activities such as cleaning or driving
are considered to be discharging governmental functions and,
thus, are covered under this article.
If a country or one of its political subdivisions or local
authorities is carrying on a business (as opposed to functions
of a governmental nature), the provisions of Articles 14
(Independent Personal Services), 15 (Dependent Personal
Services), 17 (Artistes and Athletes), and 18 (Pensions) will
apply to remuneration and pensions for services rendered in
connection with such business.
This article is an exception to the saving clause, pursuant
to Article 1, paragraph 5(b) of the proposed treaty.
Consequently, the saving clause does not apply to benefits
conferred by this article with respect to an individual who is
not a citizen of the country conferring such benefits, and, in
the case where the United States is the conferring country,
such individual is not a green-card holder. Thus, for example,
the United States would not tax the compensation of an Austrian
citizen who is not a U.S. green-card holder but who resides in
the United States to perform services for the Austrian
Government.
Article 20. Students and Trainees
Like Article XII of the present treaty, the proposed treaty
provides host country tax exemptions for a student, apprentice,
or trainee, with respect to certain remittances from abroad for
the purpose of the individual's maintenance, education or
training. The U.S. and OECD models also provide for some host-
country exemptions for students and trainees; the proposed
treaty and the U.S. model differ from the OECD model by
providing a time limit for such exemption.
Under the proposed treaty, an individual temporarily
present in a treaty country for full-time education at a
recognized educational institution, or for full-time training,
and who, immediately before visiting the host country, is a
resident of the other treaty country, is exempt from host
country tax on certain payments he or she receives for a period
of three years from the date the individual first arrives in
the host country for the purpose of his or her training. Where
this rule applies, the host country may not tax remittances
from abroad for the purpose of maintenance, education, or
training. The Technical Explanation provides that an individual
who visits the host country to obtain business training and who
also receives a salary from his or her employer for providing
services would not be considered a trainee and would not be
entitled to the benefits of this article.
The present treaty exempts from host country tax a non-
profit sector grant, allowance, or award paid to a recipient of
the other country. In addition, remuneration paid to a
professor or teacher temporarily visiting the other country is
also exempted from host country taxation. The proposed treaty
does not contain these exemptions.
This article is an exception to the saving clause, pursuant
to Article 1, paragraph 5(b) of the proposed treaty.
Consequently, the saving clause does not apply to benefits
conferred by this article with respect to an individual who is
not a citizen of the country conferring such benefits, and, in
the case where the United States is the conferring country,
such individual is not a green-card holder. Thus, for example,
an Austrian citizen who is not a U.S. green-card holder and who
is residing in the United States for the purpose of full-time
education would be entitled to the benefit of this article.
Article 21. Other Income
This article is a catch-all provision intended to cover
items of income not specifically covered in other articles, and
to assign the right to tax income from third countries to
either the United States or Austria. This article is
substantially identical to the corresponding article in the
U.S. model.
As a general rule, items of income not otherwise dealt with
in the proposed treaty which are derived by residents of either
country will be taxable only in the country of residence. This
rule, for example, gives the United States the sole right under
the proposed treaty to tax income derived from sources in a
third country and paid to a resident of the United States. This
article is subject to the saving clause, so U.S. citizens who
are Austrian residents will continue to be taxable by the
United States on their third-country income, with a foreign tax
credit provided for income taxes paid to Austria (see
discussion in connection with Article 22 (Relief From Double
Taxation), below).
The general rule just stated does not apply to income
(other than income from real property (as defined in Article
6)) if the recipient of the income is a resident of one country
and carries on business in the other country through a
permanent establishment or performs services from a fixed base,
and property with respect to which the income is paid is
effectively connected with the permanent establishment or fixed
base. In such a case, the provisions of Article 7 (Business
Profits) or Article 14 (Independent Personal Services), as the
case may be, will apply. Thus, for example, income arising
outside the United States that is attributable to a permanent
establishment maintained in the United States by a resident of
Austria generally would be taxable by the United States under
Article 7 (Business Profits), even if the income was sourced in
a third country.
The prohibition on taxation by the country other than the
residence country does apply, however, to income from real
property that such country is not given permission to tax under
Article 6. The Technical Explanation provides that even if real
property is part of the property of a permanent establishment
or fixed base in a treaty country, that country may not tax
income from the property if neither the situs of the property
nor the residence of the owner of the property is in that
country. Thus, for example, if an Austrian resident derives
income from real property located outside the United States
that is effectively connected with the resident's permanent
establishment or fixed base in the United States, only Austria
may tax such income.
Article 22. Relief from Double Taxation
U.S. internal law
One of the two principal purposes for entering into an
income tax treaty is to limit double taxation of income earned
by a resident of one of the countries that may be taxed by the
other country. The United States seeks unilaterally to mitigate
double taxation by generally allowing U.S. 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 receives a dividend from 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 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.
Foreign tax credits generally cannot exceed 90 percent of
the pre-foreign tax credit alternative minimum tax (determined
without regard to the net operating loss deduction). However,
no such limitation will be imposed on a corporation if more
than 50 percent of its stock is owned by U.S. persons, all of
its operations are in one foreign country with which the United
States has an income tax treaty with information exchange
provisions, and certain other requirements are met. The 90-
percent alternative minimum tax foreign tax credit limitation,
enacted in 1986, overrode contrary provisions of then-existing
treaties.
Austrian internal law
Austria unilaterally mitigates double taxation in several
ways. First, the general rule of Austrian law that mitigates
double corporate-level taxation--the so-called ``participation
exemption''--generally exempts a taxable Austrian company from
corporate income tax on dividends derived in connection with a
``participation'' in another entity, including in many cases a
foreign company. A participation may be deemed to exist on the
basis of a 25-percent or more shareholding in the entity. Where
the entity is foreign, the entity must be subject to certain
types of foreign tax law in order for the participation
exemption to apply.
Certain other types of foreign income of an Austrian
resident may be unilaterally exempt from Austrian tax on a pro
rata basis. That is, Austrian tax on worldwide income is
reduced in the same proportion that exempt foreign income bears
to worldwide income. This is also referred to as ``exemption
with progression,'' in light of the fact that all worldwide
income is included in the tax base for purposes of determining
the marginal rate of Austrian tax that applies. Finally,
foreign withholding taxes on certain dividends, interest, and
royalties are in some limited cases (generally inapplicable to
U.S.-source items) unilaterally creditable against Austrian
tax.
Proposed treaty rules
Unilateral efforts to limit double taxation are imperfect.
Because of differences in rules as to when a person may be
taxed on business income, a business may be taxed by two
countries as if it is engaged in business in both countries.
Also, a corporation or individual may be treated as a resident
of more than one country and be taxed on a worldwide basis by
both.
Part of the double tax problem is dealt with in other
articles of the proposed treaty that limit the right of a
source country to tax income. This article provides further
relief where both Austria and the United States would otherwise
still tax the same item of income. This article is not subject
to the saving clause, so that the country of citizenship or
residence waives its overriding taxing jurisdiction to the
extent that this article applies.
Under the present treaty, the United States, subject to the
provisions of sections 901 through 905 of the Code, grants a
foreign tax credit for the Austrian taxes specified in Article
I. Austria likewise grants a credit against its tax for the
amount of United States taxes specified in Article I with
respect to income received from sources within the United
States by its residents or corporations. However, the amount
allowed as a credit is not in any case permitted to exceed the
Austrian tax imposed on the income from sources within the
United States. The proposed treaty modifies this system of the
present treaty. The modifications include amending the rules
applicable to U.S. citizens resident in Austria.
Proposed treaty limitations on U.S. internal law
The proposed treaty generally provides that the United
States will allow a citizen or resident a foreign tax credit
for the income taxes imposed by Austria. The proposed treaty
also requires the United States to allow the deemed-paid
credit, with respect to Austrian income taxes, to any U.S.
corporate shareholder of an Austrian company that receives
dividends from such company if the U.S. company owns 10 percent
or more of the voting stock of the Austrian company.
The credit generally is to be computed in accordance with
the provisions and subject to the limitations of U.S. law (as
those provisions and limitations may change from time to time
without changing the general principles of the treaty
provision). The MOU clarifies that this requirement refers to
the laws in effect as of the date of entry of the proposed
treaty, as they may be subsequently amended. The MOU provides
that it is understood that, the 90-percent alternative minimum
tax foreign tax credit limitation is consistent with the
general U.S. commitment to provide a foreign tax credit. The
MOU illustrates the calculation of the deemed-paid foreign tax
credit and the dividend gross-up under U.S. tax principles.
Austrian taxes covered by the proposed treaty (Article 2
(Taxes Covered)) are to be considered income taxes for purposes
of the U.S. foreign tax credit rules.
The proposed treaty, like other U.S. treaties, contains a
special rule designed to provide relief from double taxation
for U.S. citizens who are Austrian residents. Under the special
rule, a U.S. citizen who is resident in Austria will:
(1) Compute the tentative U.S. income tax and the tentative
Austrian income tax with respect to items of income that, under
the proposed treaty, are subject to Austrian tax and either are
exempt from U.S. tax or are subject to a reduced rate of tax
when derived by an Austrian resident who is not a U.S. citizen.
(2) Reduce the tentative Austrian tax by a hypothetical
foreign tax credit for taxes imposed on his or her U.S.-source
income. The amount of this credit is limited to the U.S.
withholding tax that the citizen would have paid under the
proposed treaty on such income if that person were an Austrian
resident but not a U.S. citizen (e.g., 15 percent in the case
of portfolio dividends).
(3) Reduce the tentative U.S. income tax by a foreign tax
credit for income tax actually paid to Austria as computed in
step (2) (i.e., after Austria allowed the credit for U.S.
taxes). The proposed treaty recharacterizes the income that is
subject to Austrian taxation as foreign source income for
purposes of this computation.
The end result of this three-step formula is that the
ultimate U.S. tax liability of U.S. citizen who is an Austrian
resident with respect to an item of income should not be less
than the tax that would be paid if the individual were not a
U.S. citizen.
The foregoing provisions are similar to those found in many
U.S. income tax treaties.
Proposed treaty limitations on Austrian internal law
In general, the proposed treaty requires Austria to
continue to employ its ``exemption with progression'' method
with respect to most U.S. income, as it does under the present
treaty and internal Austrian law. As explained above, under the
exemption with progression method the income, while exempt from
tax, is taken into the tax base for purposes of determining the
proportion by which Austrian tax is reduced.
In addition, Austria also is required to permit an Austrian
resident to claim a foreign tax credit for taxes paid to the
United States in accordance with the rules of the proposed
treaty. However, the amount of the credit shall not exceed the
Austrian tax attributable to the income that may be taxed by
the United States. For this purpose, the amount of U.S. branch
profits tax (paragraph 6 of Article 10) is deemed to be
attributable to the taxable income derived by the U.S.
permanent establishment of an Austrian enterprise in the year
that the tax is levied.
Article 23. Non-Discrimination
The proposed treaty contains a comprehensive
nondiscrimination article relating to all taxes of every kind
imposed at the national, state, or local level. It is similar
to the nondiscrimination article in the U.S. model and to
provisions that have been embodied in other recent U.S. income
tax treaties. It is broader than the nondiscrimination
provision of the present treaty.
In general, under the proposed treaty, one country cannot
discriminate by imposing other or more burdensome taxes (or
requirements connected with taxes) on nationals of the other
country than it would impose on its nationals in the same
circumstances. This provision applies whether or not the
nationals in question are residents of the United States or
Austria. A U.S. national who is not a resident of the United
States and an Austrian national who is not a resident of the
United States are not deemed to be in the same circumstances
for U.S. tax purposes.
Under the proposed treaty, neither country may tax a
permanent establishment of an enterprise of the other country
less favorably than it taxes its own enterprise carrying on the
same activities. Consistent with the U.S. and OECD models,
however, a country is not obligated to grant residents of the
other country any personal allowances, reliefs, or reductions
for tax purposes granted to its own residents on account of
civil status or family responsibilities. Under internal
Austrian law, an Austrian enterprise may carry forward its
losses for seven years to offset other income of that
enterprise. The MOU extends this loss carryforward provision to
losses incurred by an Austrian permanent establishment of a
U.S. corporation.
In a provision not contained in the present treaty, each
country is required (subject to the arm's-length pricing rules
of Articles 9 (Associated Enterprises), 11 (Interest), and 12
(Royalties)) to allow its residents to deduct interest,
royalties, and other disbursements paid by them to residents of
the other country under the same conditions that it allows
deductions for such amounts paid to residents of the same
country as the payor. The Technical Explanation indicates that
term ``other disbursements'' is understood to include a
reasonable allocation of executive and general administrative
expenses, research and development expenses, and other expenses
incurred for the benefit of a group of related enterprises.
The rule of nondiscrimination also applies under the
proposed treaty to enterprises of one country that are owned in
whole or in part by residents of the other country. Enterprises
resident in one country, the capital of which is wholly or
partly owned or controlled, directly or indirectly, by one or
more residents of the other country, will not be subjected in
the first country to any taxation or any connected requirement
which is other or more burdensome than the taxation and
connected requirements that the first country imposes or may
impose on its similar enterprises. The nondiscrimination
provisions do not prevent the imposition of the U.S. branch
profits tax.
U.S. internal law generally treats a corporation that
distributes property in a complete liquidation as realizing
gain or loss as if the property had been sold to the
distributee. If, however, 80 percent or more of the stock of
the corporation is owned by another corporation, a
nonrecognition rule applies and no gain or loss is recognized
to the liquidating corporation. A special provision makes the
nonrecognition provision inapplicable if the distributee is a
foreign corporation (Code sec. 367(e)(2)). Even where the
distributee is a foreign corporation resident in a treaty
country, such treatment is not considered discriminatory,
because absence of tax to the subsidiary in this case
represents a complete elimination of U.S. tax jurisdiction over
any appreciation, while a similar absence in the case of a
domestic distributee simply shifts the appreciation into the
hands of another U.S. taxpayer. 29 The MOU states
that the application of this rule is consistent with the
nondiscrimination article of the proposed treaty.
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\29\ See Notice 87-66, 1987-2 C.B. 376.
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U.S. internal law permits certain corporations that satisfy
certain conditions to elect to be treated as a pass-through
entity. If this so-called ``S corporation'' election is made,
the corporation would not be subject to federal income tax on
its profits at the entity level; instead, the individual
shareholders of the corporation would be taxed directly on such
profits. The election is only available if all of the
shareholders of the corporation are U.S. citizens or residents.
The MOU confirms that the S corporation provisions, including
the rule that prevents a nonresident alien from being a
shareholder of an S corporation, are not in conflict with the
nondiscrimination provisions of the proposed treaty.
U.S. internal law generally requires a partnership that
engages in a U.S. trade or business to pay a withholding tax
attributable to a foreign partner's share of the effectively-
connected income of the partnership. The withholding tax is not
the final liability of the partner, but is a prepayment of tax
which will be refunded to the extend it exceeds a partner's
final U.S. tax liability. No withholding is required with
respect to a U.S. partner's share of the effectively-connected
income of the partnership. The MOU provides that it is
understood that the withholding tax is a reasonable collection
mechanism, and it is not in conflict with the nondiscrimination
provisions of the proposed treaty.
The saving clause (which allows the country of residence or
citizenship to tax notwithstanding certain treaty provisions)
does not apply to the nondiscrimination article.
Article 24. Mutual Agreement Procedure
The proposed treaty contains the standard mutual agreement
provision, with some variation, which authorizes the competent
authorities of the United States and Austria to consult
together to attempt to alleviate individual cases of double
taxation not in accordance with the proposed treaty. The saving
clause of the proposed treaty does not apply to this article,
so that the application of this article may result in a waiver
of taxing jurisdiction by the country of citizenship or
residence.
Under this article a resident of one country, who considers
that the action of one or both of the countries results, or
will result, in him or her to paying a tax not in accordance
with the proposed treaty, may present the case to the competent
authority of the country of which he or she is a resident or
citizen. The competent authority will then make a determination
as to whether the objection appears justified. If the objection
appears to be justified and if the competent country is not
itself able to arrive at a satisfactory solution, the competent
authority will endeavor to resolve the case by mutual agreement
with the competent authority of the other country, with a view
to the avoidance of taxation which is not in accordance with
the treaty. The provision authorizes a waiver of the statute of
limitations of either country so as to permit the issuance of a
refund or credit notwithstanding the statute of limitations.
The competent authorities of the countries are to endeavor
to resolve by mutual agreement any difficulties or doubts
arising as to the interpretation or application of the treaty.
They may also consult together for the elimination of double
taxation in cases not provided for in the treaty.
The proposed treaty makes express provision for the
competent authorities to mutually agree on the attribution and
allocation of income, deductions, credits, or allowances, the
characterization of particular items of income, the
determination of the country in which an item of income arises,
the common meaning of a term and the elimination of double
taxation in cases not provided for in the treaty. The proposed
treaty does not provide, as does the U.S. model, that the
competent authorities may agree on the same characterization of
persons; advance pricing agreements; and the application of
penalties, fines, and interest under internal law and increases
(where appropriate in light of economic or monetary
developments) in the dollar thresholds in provisions such as
the artistes and athletes article and the students and trainees
provisions.
The proposed treaty authorizes the competent authorities to
communicate with each other directly for purposes of reaching
an agreement in the sense of this mutual agreement article.
This provision makes clear that it is not necessary to go
through diplomatic channels in order to discuss problems
arising in the application of the treaty. It also removes any
doubt as to restrictions that might otherwise arise by reason
of the confidentiality rules of the United States or Austria.
The competent authorities shall consult together with a view to
developing a commonly agreed application of the provisions of
the proposed treaty, including the rules of Article 16
(Limitation on Benefits). The competent authorities are
authorized to prescribe regulations to carry out the purposes
of the proposed treaty.
The MOU clarifies that the mutual agreement procedure is
not intended to create new treaty law but is intended to
provide the possibility for the two countries to find an agreed
position in their interpretation of the provisions of the
proposed treaty.
Article 25. Exchange of Information and Administrative Assistance
Exchange of information
The proposed treaty provides for the exchange of
information necessary to carry out the provisions of the
proposed treaty or of the tax laws of the two countries
provided that taxation under those domestic laws is not
contrary to the treaty. The carrying out of the provisions of
the two countries concerning taxes includes ``penal
investigations'' regarding fiscal offenses relating to taxes.
According to the MOU, the term ``penal investigations'' applies
to proceedings carried out by either judicial or administrative
bodies, such as the commencement of a criminal investigation by
the Criminal Investigation Division of the IRS. According to
the Technical Explanation, it is understood that a U.S. penal
investigation forms a basis for disclosure under the Austrian
bank secrecy laws and practices.
Any information exchanged is treated as secret in the same
manner as information obtained under the domestic laws of the
country receiving the information. The exchanged information
may be disclosed only to persons or authorities (including
courts and administrative bodies) involved in assessment,
collection, administration, enforcement, prosecution or
determination of appeals with respect to the taxes covered by
this article. The information exchanged may be used only such
purposes. 30 Exchanged information generally may be
disclosed in public court proceedings or in judicial decisions.
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\30\ Code section 6103 provides that otherwise confidential tax
information may be utilized for a number of specifically enumerated
non-tax purposes. Information obtained by the United States pursuant to
this treaty could not be used for these non-tax purposes.
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The MOU provides that the appropriate committees of the
U.S. Congress and the U.S. General Accounting Office shall be
afforded access to information for use in the performance of
their role in overseeing the administration of U.S. tax laws.
31 The MOU also provides that such disclosure is
permitted (with respect to Austria) to the Accounting Court
(Rechnungshof) and the Committees of Parliament as is necessary
to carry out their oversight responsibilities.
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\31\ The MOU clarifies that this rule intends that the Senate
Committee on Finance, the House Committee on Ways and Means and the
Joint Committee on Taxation, as well as the U.S. General Accounting
Office, will have access to all information received under the proposed
treaty under the above-described conditions.
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Under the proposed treaty, information may be exchanged
spontaneously or upon request and the competent authorities may
agree on information which shall be furnished on a regular
basis. The Technical Explanation states that the exchange of
information in connection with simultaneous examinations is
contemplated. In addition, the Technical Explanation permits
the presence of tax examiners within the other country for
purposes of conducting tax examinations, including interviewing
taxpayers (with the consent of such taxpayers). In addition,
the MOU provides that a request for information cannot be
rejected by the requested state merely because the request was
made for the purposes of pending judicial proceedings.
As is true under the present treaty and the U.S. and OECD
models, under the proposed treaty a country is not required to
carry out administrative measures at variance with the laws and
administrative practices of either country, to supply
information which is not obtainable under the laws or in the
normal course of the administration of either country, or to
supply information which discloses any trade, business,
industrial, commercial, or professional secret or trade
process, or information the disclosure of which is contrary to
public policy. The MOU provides, on the basis of paragraph 19
of the OECD Commentary on Article 26 of the OECD model,
provisions on bank secrecy do not constitute a professional,
trade, business, industrial, or commercial secret.
Consequently, according to the Technical Explanation, Austrian
bank account information may be exchanged under this article
upon commencement of a U.S. penal investigation.
Upon an appropriate request for information, the requested
country is to obtain the information to which the request
relates in the same manner and to the same extent as if its tax
were at issue. Where specifically requested by the competent
authority of one country, the competent authority of the other
country shall endeavor to provide the information in the form
requested. Specifically, the competent authority of the other
country will endeavor to provide depositions of witnesses and
authenticated copies of unedited original documents (including
books, papers, statements, accounts, and writings) to the same
extent that they can be obtained by such other competent
authority under the laws and administrative practices of such
other country.
The proposed treaty provides that the tax authorities may
deliver documents to persons in the other country by using
postal services. Each country shall determine in accordance
with its domestic law the legal efficacy or sufficiency of the
documents that are so delivered.
The information exchange provisions of the proposed treaty
apply to assistance carried out under penal investigation
procedures. Accordingly, for an exchange of information in
connection with a U.S. penal proceeding (as interpreted in the
MOU), Austria has agreed to use its penal investigation
procedures. However, the proposed treaty does not cover arrests
of persons.
The exchange of information provisions are not restricted
by Article 1 (Personal Scope). Therefore, third-country
residents are covered. For example, the Technical Explanation
provides that the United States may request information with
respect to an Austrian bank account of a third-country resident
under the proposed treaty. In addition, like the U.S. model,
the exchange of information article (except for the assistance
in collection provision) is not restricted by Article 2 (Taxes
Covered).
Assistance in collection
The proposed treaty generally provides that the countries
are to undertake to assist and support each other in collecting
the taxes enumerated in Article 2 of the proposed treaty to the
extent necessary to ensure that treaty benefits are enjoyed
only by persons entitled to those benefits under the proposed
treaty. The MOU provides that the assistance extends to
interest but not fines or other penalties.
When one country applies to the other for assistance in
enforcing a revenue claim, its application must include a
certification by its competent authorities that the taxes are
finally due and enforceable under its own laws. The Technical
Explanation states that the concept of ``finally due and
enforceable'' is to be applied under the same standard
applicable to the U.S. income tax treaties with the Netherlands
and Canada with respect to determining whether a claim is
``finally determined'' under those treaties. Therefore, a tax
is finally due and enforceable when the applicant country has
the right under its internal law to collect the tax and all
administrative and judicial rights of the taxpayer to restrain
collection in the applicant country have lapsed or been
exhausted.
Under the proposed treaty, the certified document shall be
rendered enforceable under the laws of the requested country.
The proposed treaty provides that where Austria is the country
requesting assistance, such document must be rendered
enforceable by the Regional Finance Directorates
(Finanzlandesdirektionen).
Under the proposed treaty, an accepted request shall be
collected by the accepting country as though the claim were
that country's own revenue claim that has been finally
determined. However, the claim will not have, in the accepting
country, any priority accorded to the revenue claims of that
country (e.g., in the case of a bankruptcy). In the event that
judicial execution is necessary, the proposed treaty provides
that a request from Austria shall be requested by the
Finanzprokuratur or by the finance office delegated to act on
his behalf. The proposed treaty provides that appeals
concerning the existence or the amount of the debt shall lie
only to the competent tribunal of the requesting country.
Similar to the U.S. model, the collection provision does
not impose on either country the obligation to carry out
administrative measures of a different nature from those used
in the collection of its own taxes, or that is contrary to its
sovereignty, security, public policy or essential interest.
According to the MOU, a country that has been requested to
recover a tax on behalf of the other country may deny the
request by invoking this ``essential interest'' clause and
claim that the tax in question is not levied in accordance with
the provisions of the proposed treaty.
The MOU clarifies that the requested country shall be
obligated to obtain the requested information according to its
procedures at the time of the request (and not its procedures
at the time the treaty enters into force). In addition, the MOU
clarifies that the exchange of information and collection
provisions are not confined to taxes levied, or information
coming into existence, after the proposed treaty becomes
effective.
Article 26. Diplomatic Agents and Consular Officers
The proposed treaty contains the rule found in other U.S.
tax treaties that its provisions are not to affect the
privileges of diplomatic agents or consular officials under the
general rules of international law or the provisions of special
agreements. Accordingly, the proposed treaty will not defeat
the exemption from tax which a host country may grant to the
salary of diplomatic officials of the other country. The saving
clause does not apply in full to this article, so that, for
example, U.S. diplomats who are considered Austrian residents
generally may be protected from Austrian tax.
Article 27. Application of the Convention
As a matter of internal law, the United States generally
implements treaty reductions in taxes subject to withholding by
reducing the amounts of tax withheld at the source. An
alternative that the United States views as permissible under
treaties is the refund of amounts withheld at the statutory
rates. The proposed treaty contains express language confirming
the validity of the latter method under this treaty. It
provides that if a treaty country taxes an item by withholding
at source, then the right to require withholding at the
statutory rate is not affected by the treaty. The proposed
treaty requires that the tax be refunded on application to the
extent of the treaty reduction in accordance with the
applicable procedures of the country under whose laws the
withholding is made.
Article 28. Entry Into Force
The proposed treaty will enter into force on the first day
of the second month following the exchange of instruments of
ratification. The provisions of the proposed treaty generally
take effect for taxable years and periods beginning on or after
the first day of January in the year following the date of
entry into force. In the case of taxes payable at source, the
proposed treaty generally takes effect for payments made on or
after the first day of the second month following the date the
treaty enters into force (i.e., the first day of the fourth
month following the exchange of instrument of ratification).
The MOU clarifies that the provisions of the exchange of
information and administrative assistance article (Article 25)
are not confined to taxes levied, or to information coming into
existence after the date the proposed treaty enters into force.
Taxpayers may elect temporarily to continue to claim
benefits under the present treaty with respect to a period
after the proposed treaty takes effect. For such a taxpayer,
the present treaty continues to have effect in its entirety for
the first assessment period or taxable year from the date on
which the provisions of the proposed treaty would otherwise
take effect. The present treaty ceases to have effect once the
provisions of the proposed treaty take effect under the
proposed treaty.
Article 29. Termination
The proposed treaty will continue in force until terminated
by a treaty country. Either country may terminate it at any
time after five years from the date of its entry into force by
giving at least six months prior written notice through
diplomatic channels. A termination will be effective for
taxable years and periods beginning after the end of the
calendar year in which the notice has been given. With respect
to taxes payable at source, a termination will be effective for
payments made after the end of the calendar year in which the
notice has been given.
IX. Text of the Resolution of Ratification
Resolved, (two-thirds of the Senators present concurring
therein), That the Senate advise and consent to the
ratification of the Convention between the United States of
America and the Republic of Austria for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income, signed at Vienna on May 31, 1996 (Treaty Doc.
104-31), subject to the understanding of subsection (a), the
declarations of subsection (b), and the proviso of subsection
(c).
(a) UNDERSTANDING.--The Senate's advice and consent is
subject to the following understanding, which shall be included
in the instrument of ratification, and shall be binding on the
President:
(1) OECD COMMENTARY.--Provisions of the Convention
that correspond to provisions of the Organization for
Economic Cooperation and Development (OECD) Model Tax
Convention on Income and on Capital generally shall be
expected to have the same meaning as expressed in the
OECD Commentary thereon. The United States understands,
however, that the foregoing will not apply with respect
to any reservations or observations it enters to the
OECD Model or its Commentary and that it may enter such
a reservation or observation at any time.
(b) DECLARATIONS.--The Senate's advice and consent is
subject to the following two declarations, which shall be
binding on the President:
(1) REAL ESTATE INVESTMENT TRUSTS.--The United States
shall use its best efforts to negotiate with the
Republic of Austria a protocol amending the Convention
to provide for the application of subparagraph (b) of
paragraph 2 of Article 10 of the Convention to
dividends paid by a Real Estate Investment Trust in
cases where (i) the beneficial owner of the dividends
beneficially holds an interest of 5 percent or less in
each class of the stock of the Real Estate Investment
Trust and the dividends are paid with respect to a
class of stock of the Real Estate Investment Trust that
is publicly traded or (ii) the beneficial owner of the
dividends beneficially holds an interest of 10 percent
or less in the Real Estate Investment Trust and the
Real Estate Investment Trust is diversified.
(2) TREATY INTERPRETATION.--The Senate affirms the
applicability to all treaties of the constitutionally
based principles of treaty interpretation set forth in
Condition (1) of the resolution of ratification of the
INF Treaty, approved by the Senate on May 27, 1988, and
Condition (8) of the resolution of ratification of the
Document Agreed Among the States Parties to the Treaty
on Conventional Armed Forces in Europe, approved by the
Senate on May 14, 1997.
(c) PROVISO.--The resolution of ratification is subject to
the following proviso, which shall be binding on the President:
(1) SUPREMACY OF THE CONSTITUTION.--Nothing in the
Treaty requires or authorizes legislation or other
action by the United States of America that is
prohibited by the Constitution of the United States as
interpreted by the United States.