[Senate Executive Report 109-12]
[From the U.S. Government Publishing Office]
109th Congress Exec. Rept.
SENATE
2d Session 109-12
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PROTOCOL AMENDING THE TAX CONVENTION WITH SWEDEN (TREATY DOC. 109-8)
_______
March 27, 2006.--Ordered to be printed
_______
Mr. Lugar, from the Committee on Foreign Relations,
submitted the following
R E P O R T
[To accompany Treaty Doc. 109-8]
The Committee on Foreign Relations, to which was referred
the Protocol Amending the Convention Between the United States
of America and the Government of Sweden for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income, together with an Exchange of Notes,
signed at Washington on September 30, 2005, having considered
the same, reports favorably thereon 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.................................................4
VI. Committee Comments...............................................4
VII. Budget Impact....................................................8
VIII.Explanation of Proposed Protocol.................................9
IX. Text of Resolution of Advice and Consent to Ratification.........9
I. Purpose
The principal purposes of the existing income tax treaty
between the United States and Sweden\1\ and the proposed
protocol amending the existing treaty 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 taxes of the two countries.
The existing treaty and proposed protocol also are intended to
continue to promote close economic cooperation between the two
countries and to eliminate possible barriers to trade and
investment caused by overlapping taxing jurisdictions of the
two countries.
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\1\ All references to the treaty between the United States and
Sweden are to the Convention Between the United States of America and
the Government of Sweden for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income, signed at
Stockholm on September 1, 1994.
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II. Background
The proposed protocol was signed at Washington on September
30, 2005. The United States and Sweden exchanged notes on the
same day to provide clarification with respect to the
application of the proposed protocol. The proposed protocol
would amend the U.S.-Sweden income tax treaty, which was signed
at Stockholm on September 1, 1994.
The proposed protocol was transmitted to the Senate for
advice and consent to its ratification on November 10, 2005
(see Treaty Doc. 109-8). The Committee on Foreign Relations
held a public hearing on the proposed protocol on February 2,
2006.
III. Summary
The proposed protocol modifies several provisions in the
existing treaty to make it similar to more recent U.S. income
tax treaties, the 1996 U.S. model income tax treaty (``U.S.
model''), and the 1992 model income tax treaty of the
Organization for Economic Cooperation and Development, as
updated (``OECD model''). However, the existing treaty, as
amended by the proposed protocol, contains certain substantive
deviations from these treaties and models.
The proposed protocol replaces Article 10 (Dividends) of
the present treaty with a new article that generally allows
full residence-country taxation and limited source-country
taxation of dividends. The proposed protocol would retain both
the generally applicable maximum rate of withholding at source
of 15 percent and the reduced five-percent maximum rate for
dividends received by a company owning at least 10 percent of
the dividend-paying company. However, like several other recent
treaties and protocols, the proposed protocol would provide for
a zero rate of withholding tax on certain dividends received by
a parent company from a subsidiary that is at least 80-percent
owned by the parent. A zero rate also generally would apply to
dividends received by a pension fund. As in the current treaty,
special rules would apply to dividends received from RICs and
REITs, with some new modifications applicable to dividends from
REITs, similar to provisions included in other recent treaties
and protocols.
The proposed protocol replaces Article 17 (Limitation on
Benefits) of the existing treaty with a new article that
reflects the anti-treaty-shopping provisions included in the
U.S. model and more recent U.S. income tax treaties. Unlike the
U.S. model, but like the recent protocol amending the
Netherlands income tax treaty, the proposed protocol includes a
requirement to determine whether a company's public trading or
management constitutes an adequate connection to its residence
in a treaty country to prevent certain companies from
qualifying for treaty benefits.
The proposed protocol amends Article 20 (Government
Service) of the existing treaty to include a special new rule
related to Swedish tax on a U.S. Government pension.
The proposed protocol expands the ``saving clause''
provision in Article 1 (Personal Scope) of the existing treaty
to allow the United States to tax certain former citizens and
long-term residents regardless of whether their termination of
residency has as one of its principal purposes the avoidance of
tax. This provision generally allows the United States to apply
special tax rules under section 877 of the Code as amended in
1996 and 2004. The proposed protocol makes coordinating changes
to Article 23 (Relief from Double Taxation) with respect to
foreign tax credits allowed in such situations.
The proposed protocol updates Article 1 of the existing
treaty to include the rules in recent U.S. treaties related to
fiscally transparent entities, modifies outdated references in
Article 2 (Taxes Covered), and brings Article 4 (Residence) of
the existing treaty into conformity with the U.S. model and
more recent U.S. income tax treaties.
Article VIII of the proposed protocol provides for the
entry into force of the modifications made by the proposed
protocol.
IV. Entry Into Force and Termination
A. ENTRY INTO FORCE
In order for the proposed protocol to enter into force,
each country must notify the other when it has completed its
required ratification procedures, accompanied by an instrument
of ratification. The proposed protocol will enter into force on
the thirtieth day after the later of such notifications. The
effective dates of the protocol's provisions, however, vary.
With respect to withholding taxes, the proposed protocol
will have effect for amounts paid or credited on or after the
first day of the second month next following the date on which
the proposed protocol enters into force. With respect to taxes
on income covered by Article VI of the proposed protocol,
relating to the taxation by Sweden of pensions of certain
employees of the U.S. embassy in Stockholm or the U.S.
consulate general in Gothenburg, the proposed protocol will
have effect for income derived on or after January 1, 1996.
With respect to other taxes, the proposed protocol will have
effect for taxable years beginning on or after the first day of
January next following the date on which the proposed protocol
enters into force.
B. TERMINATION
The proposed protocol will remain in force as long as the
existing treaty remains in force. Either country may terminate
the treaty, after the expiration of a period of five years from
the date of its entry into force, by giving six months prior
written notice of termination to the other country through
diplomatic channels.
V. Committee Action
The Committee on Foreign Relations held a public hearing on
the proposed protocol with Sweden (Treaty Doc. 109-8) on
February 2, 2006. The hearing was chaired by Senator Lugar.\2\
The committee considered the proposed protocol at its business
meeting on March 14, 2006, and ordered the proposed protocol
with Sweden favorably reported by voice vote, with a quorum
present and without objection.
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\2\ The transcript of this hearing (``Tax Treaties,'' February 2,
2006, S. Hrg. 109-308) has been printed and is available at http://
www.gpoaccess.gov/congress/senate/foreignrelations/index.html.
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VI. Committee Comments
On balance, the Committee on Foreign Relations believes
that the proposed protocol with Sweden 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 protocol
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. ZERO RATE OF WITHHOLDING TAX ON DIVIDENDS FROM
80-PERCENT-OWNED SUBSIDIARIES
In General
The proposed protocol would eliminate withholding tax on
dividends paid by one corporation to another corporation that
owns at least 80 percent of the stock of the dividend--paying
corporation (often referred to as ``direct dividends''),
provided that certain conditions are met. The elimination of
withholding tax under these circumstances is intended to reduce
further the tax barriers to direct investment between the two
countries.
Under the present treaty, these dividends may be taxed by
the source country at a maximum rate of five percent, a tax
that the United States, but not Sweden, imposes as a matter of
internal law. Thus, the principal immediate effect of this
provision would be to exempt dividends that U.S. subsidiaries
pay to Swedish parent companies from U.S. withholding tax. With
respect to dividends paid by Swedish subsidiaries to U.S.
parent companies, the effect of this provision would be to
provide greater certainty as to the continued availability of a
zero rate of Swedish withholding tax, regardless of how Swedish
domestic law might change in this regard.
Until 2003, no U.S. treaty provided for a complete
exemption from withholding tax under these circumstances, and
the U.S. and OECD models currently do not provide for such an
exemption. However, many bilateral tax treaties to which the
United States is not a party eliminate withholding taxes under
similar circumstances, and the same result has been achieved
within the European Union under its Parent-Subsidiary
Directive. Moreover, in 2003 and 2004, the Senate approved U.S.
treaties and protocols containing zero-rate provisions with the
United Kingdom, Australia, Mexico, Japan, and the Netherlands.
These provisions are similar to the provision in the proposed
protocol, although the treaty with Japan allows a lower
ownership threshold (i.e., more than 50 percent, as opposed to
at least 80 percent) than do the other provisions, among other
differences discussed below.
Description of Provision
Under the proposed protocol, the withholding tax rate is
reduced to zero on dividends beneficially owned by a company
that has owned shares representing at least 80 percent of the
voting power of the company paying the dividend for the 12-
month period ending on the date on which entitlement to the
dividend is determined. The 80-percent ownership requirement
under this provision may be satisfied by either direct or
indirect ownership (through one or more residents of either
contracting state).
Eligibility for the benefits of the zero-rate provision is
subject to a more stringent set of limitation-on-benefits
requirements than normally would apply under the proposed
protocol. Specifically, in order to qualify for the zero rate,
the dividend-receiving company must either: (1) meet the public
trading test of the limitation-on-benefits article; (2) meet
the ownership and base erosion test and satisfy the active
trade or business conditions of the limitation-on-benefits
article with respect to the dividend in question; (3) meet the
derivative benefits test of the limitation-on benefits article;
or (4) receive a favorable determination from the competent
authority with respect to the zero-rate provision.
Issues
Benefits and costs of adopting a zero rate with Sweden
Tax treaties mitigate double taxation by resolving the
potentially conflicting claims of a residence country and a
source country to tax the same item of income. In the case of
dividends, standard international practice is for the source
country to yield mostly or entirely to the residence country.
Thus, the residence country preserves its right to tax the
dividend income of its residents, and the source country agrees
either to limit its withholding tax to a relatively low rate
(e.g., five percent) or to forgo it entirely.
Treaties that permit a positive rate of dividend
withholding tax allow some degree of double taxation to
persist. To the extent that the residence country allows a
foreign tax credit for the withholding tax, this remaining
double taxation may be mitigated or eliminated, but then the
priority of the residence country's claim to tax the dividend
income of its residents is not fully respected. Moreover, if a
residence country imposes limitations on its foreign tax
credit, \3\ withholding taxes may not be fully creditable as a
practical matter, thus leaving some double taxation in place.
For these reasons, dividend withholding taxes are commonly
viewed as barriers to cross-border investment. The principal
argument in favor of eliminating withholding taxes on certain
direct dividends in the proposed protocol is that it would
remove one such barrier.
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\3\ See, e.g., IRC Sec. 904.
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Direct dividends arguably present a particularly
appropriate case in which to remove the barrier of a
withholding tax, in view of the close economic relationship
between the payor and the payee. Whether in the United States
or in Sweden, the dividend-paying corporation generally faces
full net-basis income taxation in the source country, and the
dividend-receiving corporation generally is taxed in the
residence country on the receipt of the dividend (subject to
allowable foreign tax credits or, in the case of Sweden, the
participation exemption). If the dividend-paying corporation is
at least 80-percent owned by the dividend receiving
corporation, it is arguably appropriate to regard the dividend-
receiving corporation as a direct investor (and taxpayer) in
the source country in this respect, rather than regarding the
dividend-receiving corporation as having a more remote
investor-type interest warranting the imposition of a second-
level source-country tax.
Because Sweden does not currently impose a withholding tax
on these dividends under its internal law, the zero-rate
provision would principally benefit direct investment in the
United States by Swedish companies, as opposed to direct
investment in Sweden by U.S. companies. In other words, the
potential benefits of the provision would accrue mainly in
situations in which the United States is importing capital, as
opposed to exporting it.
However, it should be noted that although Swedish internal
law currently does not impose a withholding tax on dividends
paid by Swedish subsidiaries to U.S. parent companies, there is
no guarantee that this will always be the case. Thus, the
inclusion of a zero-rate provision under the proposed protocol
would give U.S.-based enterprises somewhat greater certainty as
to the applicability of a zero rate in Sweden, which arguably
would facilitate long-range business planning for U.S.
companies in their capacities as capital exporters. Along the
same lines, the provision would protect the U.S. fisc against
increased foreign tax credit claims in the event that Sweden
were to change its internal law in this regard.
Although the United States only recently first agreed to
bilateral zero rates of withholding tax on direct dividends,
many other countries have a longer history of including such
provisions in one or more of their bilateral tax treaties.
These countries include OECD members Austria, Denmark, France,
Finland, Germany, Iceland, Ireland, Japan, Luxembourg, Mexico,
the Netherlands, Norway, Sweden, Switzerland, and the United
Kingdom, as well as non-OECD-members Belarus, Brazil, Cyprus,
Egypt, Estonia, Israel, Latvia, Lithuania, Mauritius, Namibia,
Pakistan, Singapore, South Africa, Ukraine, and the United Arab
Emirates. In addition, a zero rate on direct dividends has been
achieved within the European Union under its Parent-Subsidiary
Directive. Finally, many countries have eliminated withholding
taxes on dividends as a matter of internal law. Thus, although
the zero-rate provision in the proposed protocol is a
relatively recent development in U.S. treaty history, there is
substantial precedent for it in the experience of other
countries. It may be argued that this experience constitutes an
international trend toward eliminating withholding taxes on
direct dividends, and that the United States would benefit by
joining many of its treaty partners in this trend and further
reducing the tax barriers to cross-border direct investment.
Committee Conclusions
The committee believes that every tax treaty must strike
the appropriate balance of benefits in the allocation of taxing
rights. The agreed level of dividend withholding for inter-
company dividends is one of the elements that make up that
balance, when considered in light of the benefits inuring to
the United States from other concessions the treaty partner may
make, the benefits of facilitating stable cross-border
investment between the treaty partners, and each partner's
domestic law with respect to dividend withholding tax.
In the case of this protocol, considered as a whole, the
committee believes that the elimination of withholding tax on
intercompany dividends appropriately addresses a barrier to
cross-border investment. The committee believes that the
Treasury Department should only incorporate similar provisions
into future treaty or protocol negotiations on a case-by-case
basis. It notes with approval Treasury's statement that it does
not view the elimination of withholding tax on intercompany
dividends as a blanket change in the United States' tax treaty
practice.
The committee notes with approval that the Treasury
Department has set forth basic criteria for determining the
circumstances under which the elimination of withholding tax on
intercompany dividends would be appropriate in future
negotiations with other countries. The zero rate will be agreed
to only if the agreement includes limitation on benefits and
information exchange provisions that meet the highest
standards, and if the overall balance of the agreement is
appropriate.\4\ The committee expects the Treasury Department
to consult with the committee regarding the evolution of these
criteria and the consideration of elimination of the
withholding tax on intercompany dividends in future treaties.
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\4\ Testimony of Patricia Brown, Deputy International Tax Counsel,
United States Department of the Treasury, before the Senate Committee
on Foreign Relations on Pending Income Tax Agreements, February 2,
2006.
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B. U.S. MODEL INCOME TAX TREATY
It has been longstanding practice for the Treasury
Department to maintain, and update as necessary, a model income
tax treaty that reflects the current policies of the United
States pertaining to income tax treaties. The U.S. policies on
income tax treaties are contained in the U.S. model. Some of
the purposes of the U.S. model are explained by the Treasury
Department in its Technical Explanation of the U.S. model:
[T]he Model is not intended to represent an ideal
United States income tax treaty. Rather, a principal
function of the Model is to facilitate negotiations by
helping the negotiators identify differences between
income tax policies in the two countries. In this
regard, the Model can be especially valuable with
respect to the many countries that are conversant with
the OECD Model. . . . Another purpose of the Model and
the Technical Explanation is to provide a basic
explanation of U.S. treaty policy for all interested
parties, regardless of whether they are prospective
treaty partners.\5\
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\5\ Treasury Department, Technical Explanation of the United States
Model Income Tax Convention, at 3 (September 20, 1996).
U.S. model tax treaties provide a framework for U.S. treaty
policy. These models provide helpful information to taxpayers,
the Congress, and foreign governments as to U.S. policies on
often complicated treaty matters. For purposes of clarity and
transparency in this area, the U.S. model tax treaties should
reflect the most current positions on U.S. treaty policy.
Periodically updating the U.S. model tax treaties to reflect
changes, revisions, developments, and the viewpoints of
Congress with regard to U.S. treaty policy would ensure that
the model treaties remain meaningful and relevant.
With assistance from the staff of the Joint Committee on
Taxation, the Senate Committee on Foreign Relations reviews tax
treaties negotiated and signed by the Treasury Department
before advice and consent to ratification by the full Senate is
considered. The U.S. model is important as part of this review
process because it helps the Senate determine the
administration's most recent treaty policy and understand the
reasons for diverging from the U.S. model in a particular tax
treaty. To the extent that a particular tax treaty adheres to
the U.S. model, transparency of the policies encompassed in the
tax treaty is increased and the risk of technical flaws and
unintended consequences resulting from the tax treaty is
reduced.
Committee Conclusions
The committee recognizes that tax treaties often diverge
from the U.S. model due to, among other things, the unique
characteristics of the legal and tax systems of treaty
partners, the outcome of negotiations with treaty partners, and
recent developments in U.S. treaty policy. However, even
without taking into account the central features of tax
treaties that predictably diverge from the U.S. model (e.g.,
withholding rates, limitation on benefits, exchange of
information), the technical provisions of recent U.S. tax
treaties have increasingly diverged from the U.S. model. The
important purposes served by the U.S. model tax treaty are
undermined if that model does not accurately reflect current
U.S. positions. The committee notes with approval the intention
of the Treasury Department to update the U.S. model treaty \6\
and strongly encourages the Treasury Department to complete the
update soon. In the process of revising the U.S. model, the
committee expects the Treasury Department to consult with the
committee generally, and specifically regarding the potential
implications for U.S. trade and revenue of the policies and
provisions reflected in the new model.
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\6\ Testimony of Patricia Brown, Deputy International Tax Counsel,
United States Department of the Treasury, before the Senate Committee
on Foreign Relations on Pending Income Tax Agreements, February 2,
2006.
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VII. Budget Impact
The committee has been informed by the staff of the Joint
Committee on Taxation that it has assessed the likely budget
impact of the proposed protocol to the income tax treaty
between the United States and Sweden. The Joint Committee staff
estimates that the withholding tax changes and other provisions
of the proposed protocol will cause a negligible change in the
federal budget receipts during the fiscal year 2006-2015
period, based solely on the amount and type of historical
income flows between Sweden and the United States.
VIII. Explanation of Proposed Protocol
A detailed, article-by-article explanation of the proposed
protocol between the United States and Sweden can be found in
the pamphlet of the Joint Committee on Taxation entitled
Explanation of Proposed Protocol to the Income Tax Treaty
Between the United States and Sweden (JCX-1-06), January 26,
2006.
IX. Text of Resolution of Advice and Consent to Ratification
Resolved (two-thirds of the Senators present concurring
therein), That the Senate advise and consent to the
ratification of the Protocol Amending the Convention Between
the United States of America and Sweden for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income of September 1, 1994, signed at
Washington on September 30, 2005 (Treaty Doc. 109-8).