[Senate Executive Report 110-15]
[From the U.S. Government Publishing Office]
110th Congress Exec. Rept.
SENATE
2d Session 110-15
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PROTOCOL AMENDING 1980 TAX
CONVENTION WITH CANADA
_______
September 11, 2008.--Ordered to be printed
_______
Mr. Dodd, from the Committee on Foreign Relations,
submitted the following
REPORT
[To accompany Treaty Doc. 110-15]
The Committee on Foreign Relations, to which was referred
the Protocol Amending the Convention between the United States
of America and Canada with Respect to Taxes on Income and on
Capital done at Washington on September 26, 1980, as amended by
the Protocols done on June 14, 1983, March 28, 1984, March 17,
1995, and July 29, 1997, signed on September 21, 2007, at
Chelsea (the ``Protocol'') (Treaty Doc. 110-15), having
considered the same, reports favorably thereon with one
declaration and one condition, as indicated in the resolution
of advice and consent, and recommends that the Senate give its
advice and consent to ratification thereof, as set forth in
this report and the accompanying resolution of advice and
consent.
CONTENTS
Page
I. Purpose..........................................................1
II. Background.......................................................2
III. Major Provisions.................................................2
IV. Entry Into Force.................................................6
V. Implementing Legislation.........................................6
VI. Committee Action.................................................6
VII. Committee Recommendation and Comments............................7
VIII.Resolution of Advice and Consent to Ratification................10
IX. Annex I.--Technical Explanation.................................13
X. Annex II.--Treaty Hearing of July 10, 2008......................89
I. Purpose
The purpose of the Protocol, along with the underlying
treaty, is to promote and facilitate trade and investment
between the United States and Canada. Principally, the Protocol
would amend the existing tax treaty with Canada (the
``Treaty'') in order to eliminate withholding taxes on cross-
border interest payments, coordinate the tax treatment of
contributions to, and other benefits of, pension funds for
cross-border workers, and provide for mandatory arbitration of
certain cases before the competent authorities of both
countries.
II. Background
The United States has a tax treaty with Canada that is
currently in force, which was concluded in 1980. This Protocol
is the fifth protocol to the 1980 Treaty; it has been the
subject of negotiations for approximately ten years.\1\ The
Protocol was negotiated to address specific issues that have
arisen in our tax treaty relations and changes in each
country's domestic law and tax treaty policy.
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\1\The 1980 Canadian Tax Treaty has been amended by protocols done
on June 14, 1983 (Treaty Doc. 98-7), March 28, 1984 (Treaty Doc. 98-
22), March 17, 1995 (Treaty Doc. 104-4), and July 29, 1997 (Treaty Doc.
105-29).
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III. Major Provisions
A detailed article-by-article analysis of the Protocol may
be found in the Technical Explanation published by the
Department of the Treasury on July 10, 2008, which is reprinted
in Annex I. In addition, the staff of the Joint Committee on
Taxation prepared an analysis of the Protocol, Document JCX-57-
08 (July 8, 2008), which was of great assistance to the
committee in reviewing the Protocol. A summary of the key
provisions of the Protocol is set forth below.
1. Arbitration
Among the most important features of this new Protocol with
Canada is a binding arbitration provision that would apply when
the Canadian and U.S. competent authorities are unable to
resolve a case in a timely fashion under the Mutual Agreement
Procedure in the current tax treaty with Canada. See Article
21. This type of provision is a relatively recent innovation
and has only been included in two other U.S. bilateral income
tax treaties, both of which were approved by the Senate last
year: a tax protocol with Germany and a tax treaty with
Belgium.\2\ The arbitration procedure is sometimes referred to
as ``last best offer'' arbitration or ``baseball
arbitration''\3\ because each of the competent authorities
proposes one and only one figure for settlement and the
arbitration board must select one of those figures as the
award. The arbitration decision is binding on both countries if
the decision is accepted by the taxpayer. The taxpayer,\4\
however, has the right to reject the decision and access, for
example, the relevant country's court system. See Article
21(7)(e).
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\2\The arbitration mechanism in the Canada Protocol is most like
the mechanism found in the Germany Tax Treaty, Treaty Doc. 109-20,
which is similarly limited in its application to certain articles of
the treaty.
\3\ Referring to the arbitration method first introduced in the
1970 Collective Bargaining Agreement (CBA) of Major League Baseball and
expanded in the 1973 CBA to include player salaries.
\4\A taxpayer is referred to as a ``concerned person'' in the
treaty.
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2. Interest
The Protocol would eliminate withholding taxes on certain
cross-border interest payments. See Article 6. This provision
comes into effect with respect to interest paid to unrelated
parties on the first day of January of the year in which the
proposed Protocol enters into force. The zero rate for interest
paid to related persons would be phased in over a three-year
period. See Article 27(3)(d).
3. Dual-Resident Corporations
The Protocol would address the issue of so-called ``dual-
resident corporations.'' It provides that if such a company is
created under the laws in force in one treaty country but not
under the laws in force in the other treaty country, the
company is deemed to be a resident only of the first treaty
country. See Article 2(1). If that rule is inapplicable, the
Protocol generally provides that the competent authorities of
the United States and Canada shall endeavor to reach agreement
on the treatment of such companies for purposes of the treaty.
In the absence of such agreement, the company is not considered
to be a resident of either treaty country for purposes of its
claiming any benefits under the treaty.
4. Permanent Establishment
In general, U.S. bilateral tax treaties attempt to ensure
that a person or entity is not subject to undue and overly
burdensome taxation in instances in which the taxpayer has
minimal contacts with the taxing jurisdiction. This is
accomplished in the Treaty through provisions under which the
United States and Canada agree not to tax business income
derived from sources within either country by residents of the
other country unless the business activities in the taxing
country are substantial enough to constitute a permanent
establishment. See Article VII(1) of the Treaty. A permanent
establishment is generally defined as ``a fixed place of
business through which the business of a resident of a
Contracting State is wholly or partly carried on.'' See Article
V(1) of the Canada Tax Treaty. Examples include a place of
management, an office, branch, or factory. See Article V(2).
The Protocol, however, would amend Article V of the
existing treaty with Canada and effectively expand the
definition of a permanent establishment in a way that would
affect enterprises that provide services. See Article 3.
Specifically, an enterprise of one country would be deemed to
have a permanent establishment in the other country if either
(a) services are performed by an individual who is present in
the other country for at least 183 days during any 12-month
period and more than 50 percent of the enterprise's gross
active business revenues during that time is income derived
from those services or (b) the services are provided in the
other country for at least 183 days during any 12-month period
with respect to the same or a connected project for customers
who are residents of that country or who have a permanent
establishment there for which the services are provided. See
Article 3(2). Thus, an enterprise that met either of these
criteria would be deemed to have a permanent establishment in
the treaty partner country, even if it did not have a fixed
place of business in that country, and attributable business
profits would be subject to tax by that country.
As noted in relation to the Bulgaria Convention in
Executive Report 110-16, the United States has included similar
provisions in some of its tax treaties with developing nations,
but this would be the first time that such a provision would be
included in a tax treaty with a developed nation. The provision
addresses an issue that has been the subject of litigation in
Canada, and has the effect of reversing a case that effectively
limited Canada's taxing authority's interpretation of
``permanent establishment.''\5\
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\5\The provision effectively reverses the result of the Canadian
Federal Court of Appeal decision in The Queen v. Dudney, 99 DTC 147
(T.C.C.C.), aff'd, 2000 DTC 6169 (F.C.A.), in which a U.S. independent
contractor was held not to have a Canadian ``fixed base'' (which the
court recognized to have substantially the same meaning as ``permanent
establishment''), even though the contractor spent substantial time at
his customer's premises during the course of two consecutive calendar
years.
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This special rule presents a number of administrative and
compliance challenges. For example, a number of the terms used
in this rule, such as what constitutes ``presence'' or a
``connected project'' are ambiguous and require further
clarification. In addition, when combined with Article XV of
the Treaty, as amended by Article 10(2) of the Protocol,
additional complexities arise. Article XV(1) of the Treaty,
with certain exceptions, sets forth a general rule that if an
employee who is a resident of one treaty country (the
``residence country'') is working in the other treaty country
(the ``employment country''), his or her salaries, wages, and
other remuneration derived from the exercise of employment in
that country may be taxed by that country (the employment
country). Notwithstanding this general rule, Article XV(2) of
the treaty provides that the remuneration derived by the
employee from the exercise of employment in the employment
country shall be taxed only by the residence country (and not
the employment country) if (1) the employee's remuneration does
not exceed $10,000; or (2) the employee is present in the
employment country for 183 days or less in any 12-month period
commencing or ending in the taxable year concerned; the
remuneration is not paid by, or on behalf of, a person who is a
resident of the employment country; and the remuneration is not
``borne'' by a permanent establishment in the employment
country. It is this final requirement (that the remuneration
must not be ``borne'' by a permanent establishment that the
employer has in the employment country), which interacts with
the special rule in Article 3(2) of the Protocol in a way that
is likely to create problems for some taxpayers.
In other words, the salaries, wages, and other remuneration
derived by an employee performing services through a permanent
establishment arising under Article 3(2) of the Protocol would
be subject, under Article XV of the Treaty to being taxed by
the employment country, even if the other requirements of the
exception in Article XV(2) had been met. Thus, the interaction
of these two provisions increases the complexities associated
with the special rule. For example, such a scenario would mean
that an employer and the relevant employees would need to
fulfill several tax-related obligations, including obtaining
tax identification numbers and providing for the withholding of
income taxes and other taxes as appropriate that would cover
the period beginning on the first day such services were
performed by such employee during the affected year, despite
the fact that they may not know whether the enterprise will be
deemed to have a permanent establishment under the treaty until
perhaps 6 months into the relevant 12-month period, and will
therefore be subject to various taxes, including employment
taxes, by the employment country reaching back to the beginning
of the relevant 12-month period.
Another aspect of the rule that would appear to be
difficult to manage is that the 12-month period is not tied to
a fiscal or calendar year. Also, it is necessary to determine
whether customers in the employment country are residents or
have a permanent establishment in that country. Some of the
issues that may arise result from the fact that an enterprise
with a deemed permanent establishment in another country that
is not an actual fixed base is unlikely to have the
infrastructure in that other country to do the things necessary
to comply with the rules of the provision. For example, such an
enterprise is unlikely to keep in the employment country a full
set of financial records, or records tracking employees'
activities there.
The committee asked the Treasury Department a number of
questions regarding this provision in an attempt to gain
greater insight about its operation. These questions and
answers can be found in Annex II.
Fiscally Transparent and Hybrid Entities
Article 2(2) of the Protocol would amend Article IV of the
existing treaty to include a new paragraph 6 and 7, setting
forth specific rules for the treatment of certain income,
profit, or gain derived through or paid by fiscally transparent
entities. The new paragraph 6 would set forth a ``positive''
rule, which identifies scenarios in which ``income, profit or
gain shall be considered to be derived by a person who is a
resident of a Contracting State.'' The new paragraph 7 would
set forth a ``negative'' rule intended to prevent the use of
such entities to claim the benefits where the investors are not
subject to tax on the income in their state of residence. In
particular, paragraph 7 is aimed largely at curtailing the use
of certain legal entity structures that include hybrid fiscally
transparent entities, which, when combined with the selective
use of debt and equity, may facilitate the allowance of either
(1) duplicated interest deductions in the United States and
Canada, or (2) a single, internally generated, interest
deduction in one country without offsetting interest income in
the other country. As noted by the Joint Committee on Taxation
in its explanation of the Protocol, commentators have raised a
question as to whether subparagraph 7(b) is too broad, because
it could prevent legitimate business structures that are not
engaging in potentially abusive transactions from taking
advantage of benefits that would otherwise be available to them
under the treaty.
The Treasury Department, in response to questions from the
committee, noted as follows regarding subparagraph 7(b):
Subparagraph 7(b) essentially denies benefits in cases in
which the residence country treats a payment differently than
the source country and other conditions are met. The rule is
broader than an analogous rule in Treasury regulations issued
pursuant to section 894 of the Internal Revenue Code. The
Treasury Department is aware that the scope of subparagraph
7(b) is potentially overbroad, especially in the case of non-
deductible payments. The Treasury Department has been
discussing, and will continue to discuss with Canada, whether
to address this issue. The Treasury Department does not
contemplate incorporating such a rule in future tax treaties.
Additional questions were asked by the committee of the
Treasury Department regarding this provision. These questions
and answers can be found in Annex II.
Pensions and Annuities
The Protocol would amend Article XVIII of the existing
treaty, mainly to address certain individual retirement
accounts and cross-border pension contributions and benefits
accruals. Many of the new rules are similar to those found in
the U.S. Model Tax Treaty, but several reflect the uniquely
large cross-border flow of personal services between Canada and
the United States, including a large number of cross-border
commuters. These rules are intended to remove barriers to the
flow of personal services between the two countries that could
otherwise result from discontinuities under the laws of each
country regarding the deductibility of pension contributions
and the taxation of a pension plan's earnings and accretions in
value. In addition, the Protocol would add a new provision to
address the source of certain annuity or life insurance
payments made by branches of insurance companies.
Limitation on Benefits
The Protocol would replace the Limitation on Benefits
article in the existing treaty (Article XXIX A) with a new
article that reflects the anti-treaty shopping provisions
included in the U.S. Model treaty and more recent U.S. income
tax treaties. The rules in the existing treaty are not
reciprocal and can only be applied by the United States. The
new rules are stronger and reciprocal.
Exchange of Information
The Protocol would replace Article XXVII of the existing
treaty, which deals with the exchange of tax information, with
an article on the same subject that is similar to what appears
in the 2006 U.S. Model Tax Treaty. The new rules generally
provide that the two competent authorities will exchange such
information as may be relevant in carrying out the provisions
of the domestic laws of the United States and Canada concerning
taxes to which the treaty applies, to the extent the taxation
under those laws is not contrary to the treaty.
IV. Entry Into Force
The United States and Canada shall notify each other in
writing through diplomatic channels when their respective
applicable procedures for the entry into force of this Protocol
have been satisfied. This Protocol shall enter into force on
the date of the later of these notifications. The various
provisions of this Protocol will have effect as described in
paragraphs 2 and 3 of Article 27.
V. Implementing Legislation
As is the case generally with income tax treaties, the
Protocol is self-executing and does not require implementing
legislation for the United States.
VI. Committee Action
The committee held a public hearing on the Protocol on July
10, 2008. Testimony was received from Mr. Michael Mundaca,
Deputy Assistant Secretary (International), Office of Tax
Policy, U.S. Department of the Treasury and Ms. Emily S.
McMahon, Deputy Chief of Staff to the Joint Committee on
Taxation. A transcript of this hearing can be found in Annex
II.
On July 29, 2008, the committee considered the Protocol and
ordered it favorably reported by voice vote, with a quorum
present and without objection.
VII. Committee Recommendation and Comments
The Committee on Foreign Relations believes that the
Protocol will stimulate increased trade and investment,
substantially deny treaty-shoppers the benefits of this tax
treaty, and promote closer co-operation between the United
States and Canada. The committee therefore urges the Senate to
act promptly to give advice and consent to ratification of the
Protocol, as set forth in this report and the accompanying
resolution of advice and consent.
A. SPECIAL PERMANENT ESTABLISHMENT RULE FOR SERVICES
As discussed in Section III, the Protocol includes a
special rule that would effectively expand the standard
definition of a permanent establishment in a way that affects
enterprises that provide services. This provision also appears
in the Tax Convention with Bulgaria that is before the Senate,
and presents a number of serious administrative and compliance
challenges to service enterprises that may be subject to the
rule.
The Treasury Department has made clear in testimony before
the committee that the inclusion of this provision in the
Convention and the Tax Protocol with Canada ``does not reflect
a change in U.S. tax treaty policy, and inclusion of such a
provision in the U.S. Model is not being considered.'' The
committee welcomes this statement and urges the Treasury
Department to avoid including such a provision in future tax
treaties, but particularly in treaties with developed nations
for which there is no articulated rationale for its inclusion.
In addition, the Treasury Department indicated that there
have been ongoing discussions with Canada ``regarding the
interpretation and application of the new rule concerning the
taxation of services'' and that ``additional guidance with
respect to the services rule included in both the proposed
Protocol with Canada and the Convention with Bulgaria is needed
to provide more certainty to taxpayers.'' In the committee's
view, such discussions are crucial, particularly given the
significant cross-border trade with Canada and the impact that
such an unwieldy rule can have on businesses operating in both
countries. The committee urges the Treasury Department to
produce guidance on the rule's application, including ways in
which enterprises might approach their compliance, as soon as
is feasible and to keep the committee posted on its progress.
B. ARBITRATION
Report on Arbitration
The committee recognizes the potential value that the
binding arbitration mechanism contained in the Protocol has
with respect to the effective implementation and enforcement of
the Tax Treaty with Canada and commends the Department's work
in its development. Under the current treaty, disputes between
the competent authorities have gone unresolved for extended
periods of time, burdening taxpayers and encumbering capital
that could be put to more productive use. Delays in resolving
disputes can also have the consequence of slowing payments by
taxpayers, thereby depriving the U.S. Treasury of revenue. The
inclusion of such a provision is, however, a new development in
tax treaties and thus, the committee has included a reporting
requirement in the resolution of advice and consent that is
intended to help the committee determine whether the mechanism
is functioning as anticipated and hoped.
The report required by the Resolution of advice and consent
has two parts. The first part requires the Secretary of the
Treasury to transmit to this committee, the Committee on
Finance, and the Joint Committee on Taxation the texts of the
rules of procedure that are ultimately developed and applicable
to the arbitration boards established pursuant to the Canada,
Germany, and Belgium tax treaties, including conflict of
interest rules to be applied to members of the arbitration
board. The second part requires specific data on the
arbitrations conducted pursuant to the Canada, Germany, and
Belgium tax treaties. This information, which will be provided
by the Secretary of the Treasury on an annual basis for a total
of six years, is designed to help the committee evaluate the
operation of the mandatory arbitration mechanism set forth in
the three tax treaties. Because this data is potentially
subject to U.S. law that provides for the confidentiality of
taxpayer returns and return information, the Resolution
requires the report containing this data to be provided only to
the Committee on Finance and to the Joint Committee on
Taxation. The Resolution is itself intended to constitute a
written request for taxpayer information in accordance with the
requirements of 26 U.S.C. Sec. 6103(f)(1), but as a matter of
practice, the Treasury Department should advise the chairman of
the Committee on Finance and the chairman of the Joint
Committee on Taxation when the reporting requirement is
initially triggered (60 days after a determination has been
reached by an arbitration board in the tenth arbitration
proceeding conducted pursuant to either this Protocol, the 2006
German Protocol, or the Belgium Convention) so that the
chairmen can formalize the request in writing, in order to
comply with taxpayer disclosure law. It is the committee's
expectation that the report will help to inform the Joint
Committee on Taxation's analysis of the operation of the
arbitration mechanism, and that the analysis will then be
shared with this committee in a manner consistent with U.S.
taxpayer confidentiality law.
Should this committee determine that it has a need to view
the data contained in the report itself, it may avail itself of
the statutory mechanism under 26 U.S.C. Sec. 6103(f)(3). It
should also be understood that the committee and the Joint
Committee on Taxation may request further information, beyond
that included in the report, if it is needed to evaluate the
arbitration mechanism.
Comments on Arbitration for the Future
The committee made a number of comments regarding issues
that might be addressed in future arbitration provisions by the
Treasury Department in the committee's Executive Report on the
Protocol Amending the Tax Convention with Germany, which are
equally relevant to the arbitration mechanism in this
Protocol.\6\ In particular, the committee offered specific
comments regarding 1) Taxpayer Input; 2) Treaty Interpretation;
and 3) the Selection of Arbiters.
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\6\ See Exec. Rept. 110-5 at pp. 7-9.
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In response to committee questions regarding why these
comments were not reflected in this Protocol, the Treasury
Department testified that the arbitration provision in the
Protocol with Canada had already been negotiated at the time
the committee provided its comments to the Department and thus,
it was not possible to take them into account in this Protocol.
The Treasury Department further indicated that ``the
committee's concerns have been and will continue to be
considered in any arbitration negotiations the Treasury
Department conducts.'' The committee expects that the next
treaty with a mandatory arbitration mechanism will address the
committee's comments and concerns.
C. FISCALLY TRANSPARENT AND HYBRID ENTITY PROVISIONS
As noted in Section III above, Article 2(2) of the Protocol
would amend Article IV of the existing treaty to include a new
paragraph 6 and 7, setting forth specific rules for the
treatment of certain income, profit, or gain derived through or
paid by fiscally transparent entities. The new paragraph 7 is
intended to prevent the use of fiscally transparent entities to
claim the benefits when the investors are not subject to tax on
the income in their state of residence. As discussed above and
described at length in questions for the record included in
Annex II, the scope of paragraph 7(b) is potentially overbroad,
especially in the case of non-deductible payments, so that in
some circumstances a legitimate business structure that is not
engaging in potentially abusive transactions would be prevented
from taking advantage of benefits that should be available to
them under the treaty. The Treasury Department noted in
testimony before the committee that it ``has been discussing,
and will continue to discuss with Canada, whether to address
this issue. The Treasury Department does not contemplate
incorporating such a rule in future tax treaties.'' The
committee welcomes this statement and urges the Treasury
Department to address this issue with Canada as soon as
possible.
D. DUAL-RESIDENT CORPORATIONS
As noted in Section III above, the Protocol would address
the issue of so-called ``dual-resident corporations'' by
providing that if such a company is created under the laws in
force in one treaty country but not under the laws in force in
the other treaty country, the company is deemed to be a
resident only of the first treaty country. See Article 2(1). If
that rule is inapplicable, the Protocol generally provides that
the competent authorities of the United States and Canada shall
endeavor to reach agreement on the treatment of such companies
for purposes of the treaty. In the absence of such agreement,
the company is not considered to be a resident of either treaty
country for purposes of its claiming any benefits under the
treaty.
The committee recognizes that the new rule is likely to be
helpful in addressing abuse of the existing treaty by certain
companies. Nevertheless, the rule appears to have some
drawbacks. For example, application of the dual-residency rule
in the Protocol would not be equitable with respect to a
corporation that was organized under the laws of the United
States many years ago and has long since ceased to have
significant contacts with the United States, but instead is
managed and controlled in Canada. In response to questions from
the committee on this point, the Treasury Department noted that
it ``[i]t has been a longstanding treaty policy of the United
States to place significant weight on the place of
incorporation when addressing questions of dual corporate
residence. However, we have included in other agreements, for
example in our agreement with the United Kingdom and the
proposed Bulgaria and Iceland agreements, provisions directing
the Competent Authorities to endeavor to determine for treaty
purposes the residence of dual resident corporations.'' The
committee supports the Treasury Department's efforts to cut
down on treaty abuse, but recommends that when including such a
rule in future, the Competent Authorities be afforded the
discretion to override a strict application of the rule when
the result would be inequitable.
E. RESOLUTION
The committee has included in the resolutions of advice and
consent one condition, which is a report on the arbitration
mechanism in the Protocol and in the Belgium and German Tax
treaties, which is discussed above, and one declaration, which
is the same for each treaty and is discussed below.
Declaration
The committee has included a proposed declaration, which
states that the Protocol is self-executing, as is the case
generally with income tax treaties. The committee has in the
past included such a statement in the committee's report, but
in light of the recent Supreme Court decision, Medellin v.
Texas, 128 S. Ct. 1346 (2008), the committee has determined
that a clear statement in the Resolution is warranted. A
further discussion of the committee's views on this matter can
be found in Section VIII of Executive Report 110-12.
VIII. Resolution of Advice and Consent to Ratification
Resolved (two-thirds of the Senators present concurring
therein),
SECTION 1. SENATE ADVICE AND CONSENT SUBJECT TO A DECLARATION AND A
CONDITION
The Senate advises and consents to the ratification of the
Protocol Amending the Convention between the United States of
America and Canada with Respect to Taxes on Income and on
Capital done at Washington on September 26, 1980, as Amended by
the Protocols done on June 14, 1983, March 28, 1984, March 17,
1995, and July 29, 1997, signed on September 21, 2007, at
Chelsea (the ``Protocol'') (Treaty Doc. 110-15), subject to the
declaration of section 2 and the condition of section 3.
SECTION 2. DECLARATION
The advice and consent of the Senate under section 1 is
subject to the following declaration:
This Convention is self-executing.
SECTION 3. CONDITION
The advice and consent of the Senate under section 1 is
subject to the following condition:
Report.
1. Not later than two years from the date on which this
Protocol enters into force and prior to the first arbitration
conducted pursuant to the binding arbitration mechanism
provided for in this Protocol, the Secretary of Treasury shall
transmit the text of the rules of procedure applicable to
arbitration boards, including conflict of interest rules to be
applied to members of the arbitration board, to the committees
on Finance and Foreign Relations of the Senate and the Joint
Committee on Taxation.
The Secretary of Treasury shall also, prior to the first
arbitration conducted pursuant to the binding arbitration
mechanism provided for in the 2006 Protocol Amending the
Convention between the United States of America and the Federal
Republic of Germany for the Avoidance of Double Taxation and
the Prevention of Fiscal Evasion with Respect to Taxes on
Income and Capital and to Certain Other Taxes (the ``2006
German Protocol'') (Treaty Doc. 109-20) and the Convention
between the Government of the United States of America and the
Government of the Kingdom of Belgium for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income, and accompanying protocol (the
``Belgium Convention'') (Treaty Doc. 110-3), transmit the text
of the rules of procedure applicable to the first arbitration
board agreed to under each treaty to the committees on Finance
and Foreign Relations of the Senate and the Joint Committee on
Taxation.
2. 60 days after a determination has been reached by an
arbitration board in the tenth arbitration proceeding conducted
pursuant to either this Protocol, the 2006 German Protocol, or
the Belgium Convention, the Secretary of Treasury shall prepare
and submit a detailed report to the Joint Committee on Taxation
and the Committee on Finance of the Senate, subject to law
relating to taxpayer confidentiality, regarding the operation
and application of the arbitration mechanism contained in the
aforementioned treaties. The report shall include the following
information:
I. The aggregate number, for each treaty, of cases
pending on the respective dates of entry into force of
this Protocol, the 2006 German Protocol, or the Belgium
Convention, along with the following additional
information regarding these cases:
a. The number of such cases by treaty
article(s) at issue;
b. The number of such cases that have been
resolved by the competent authorities through a
mutual agreement as of the date of the report;
and
c. The number of such cases for which
arbitration proceedings have commenced as of
the date of the report.
II. A list of every case presented to the competent
authorities after the entry into force of this
Protocol, the 2006 German Protocol, or the Belgium
Convention, with the following information regarding
each and every case:
a. The commencement date of the case for
purposes of determining when arbitration is
available;
b. Whether the adjustment triggering the
case, if any, was made by the United States or
the relevant treaty partner and which competent
authority initiated the case;
c. Which treaty the case relates to;
d. The treaty article(s) at issue in the
case;
e. The date the case was resolved by the
competent authorities through a mutual
agreement, if so resolved;
f. The date on which an arbitration
proceeding commenced, if an arbitration
proceeding commenced; and
g. The date on which a determination was
reached by the arbitration board, if a
determination was reached, and an indication as
to whether the board found in favor of the
United States or the relevant treaty partner.
III. With respect to each dispute submitted to
arbitration and for which a determination was reached
by the arbitration board pursuant to this Protocol, the
2006 German Protocol, or the Belgium Convention, the
following information shall be included:
a. An indication as to whether the
determination of the arbitration board was
accepted by each concerned person;
b. The amount of income, expense, or taxation
at issue in the case as determined by reference
to the filings that were sufficient to set the
commencement date of the case for purposes of
determining when arbitration is available; and
c. The proposed resolutions (income, expense,
or taxation) submitted by each competent
authority to the arbitration board.
3. The Secretary of Treasury shall, in addition, prepare
and submit the detailed report described in paragraph (2) on
March 1 of the year following the year in which the first
report is submitted to the Joint Committee on Taxation and the
Committee on Finance of the Senate, and on an annual basis
thereafter for a period of five years. In each such report,
disputes that were resolved, either by a mutual agreement
between the relevant competent authorities or by a
determination of an arbitration board, and noted as such in
prior reports may be omitted.
IX. Annex I.--Technical Explanation
TECHNICAL EXPLANATION OF THE PROTOCOL DONE AT CHELSEA ON SEPTEMBER 21,
2007 AMENDING THE CONVENTION BETWEEN THE UNITED STATES OF AMERICA AND
CANADA WITH RESPECT TO TAXES ON INCOME AND ON CAPITAL DONE AT
WASHINGTON ON SEPTEMBER 26, 1980, AS AMENDED BY THE PROTOCOLS DONE ON
JUNE 14, 1983, MARCH 28, 1994, MARCH 17, 1995, AND JULY 29, 1997
INTRODUCTION
This is a Technical Explanation of the Protocol signed at
Chelsea on September 21, 2007 (the ``Protocol''), amending the
Convention between the United States of America and Canada with
Respect to Taxes on Income and on Capital done at Washington on
September 26, 1980, as amended by the Protocols done on June
14, 1983, March 28, 1994, March 17, 1995, and July 29, 1997
(the ``existing Convention''). The existing Convention as
modified by the Protocol shall be referred to as the
``Convention.''
Negotiation of the Protocol took into account the U.S.
Treasury Department's current tax treaty policy and the
Treasury Department's Model Income Tax Convention, published on
November 15, 2006 (the ``U.S. Model''). Negotiations also took
into account the Model Tax Convention on Income and on Capital,
published by the Organisation for Economic Cooperation and
Development (the ``OECD Model''), and recent tax treaties
concluded by both countries.
The Technical Explanation is an official United States
guide to the Protocol. The Government of Canada has reviewed
this document and subscribes to its contents. In the view of
both governments, this document accurately reflects the
policies behind particular Protocol provisions, as well as
understandings reached with respect to the application and
interpretation of the Protocol and the Convention.
References made to the ``existing Convention'' are intended
to put various provisions of the Protocol into context. The
Technical Explanation does not, however, provide a complete
comparison between the provisions of the existing Convention
and the amendments made by the Protocol. The Technical
Explanation is not intended to provide a complete guide to the
existing Convention as amended by the Protocol. To the extent
that the existing Convention has not been amended by the
Protocol, the prior technical explanations of the Convention
remain the official explanations. References in this Technical
Explanation to ``he'' or ``his'' should be read to mean ``he or
she'' or ``his or her.'' References to the ``Code'' are to the
Internal Revenue Code.
On the date of signing of the Protocol, the United States
and Canada exchanged two sets of diplomatic notes. Each of
these notes sets forth provisions and understandings related to
the Protocol and the Convention, and comprises an integral part
of the overall agreement between the United States and Canada.
The first note, the ``Arbitration Note,'' relates to the
implementation of new paragraphs 6 and 7 of Article XXVI
(Mutual Agreement Procedure), which provide for binding
arbitration of certain disputes between the competent
authorities. The second note, the ``General Note,'' relates
more generally to issues of interpretation or application of
various provisions of the Protocol.
ARTICLE 1
Article 1 of the Protocol adds subparagraph 1(k) to Article
III (General Definitions) to address the definition of
``national'' of a Contracting State as used in the Convention.
The Contracting States recognize that Canadian tax law does not
draw distinctions based on nationality as such. Nevertheless,
at the request of the United States, the definition was added
and contains references to both citizenship and nationality.
The definition includes any individual possessing the
citizenship or nationality of a Contracting State and any legal
person, partnership or association whose status is determined
by reference to the laws in force in a Contracting State. The
existing Convention contains one reference to the term
``national'' in paragraph 1 of Article XXVI (Mutual Agreement
Procedure). The Protocol adds another reference in paragraph 1
of Article XXV (Non-Discrimination) to ensure that nationals of
the United States are covered by the non-discrimination
provisions of the Convention. The definition added by the
Protocol is consistent with the definition provided in other
U.S. tax treaties.
The General Note provides that for purposes of paragraph 2
of Article III, as regards the application at any time of the
Convention, any term not defined in the Convention shall,
unless the context otherwise requires or the competent
authorities otherwise agree to a common meaning pursuant to
Article XXVI (Mutual Agreement Procedure), have the meaning
which it has at that time under the law of that State for the
purposes of the taxes to which the Convention apply, any
meaning under the applicable tax laws of that State prevailing
over a meaning given to the term under other laws of that
State.
ARTICLE 2
Article 2 of the Protocol replaces paragraph 3 of Article
IV (Residence) of the existing Convention to address the
treatment of so-called dual resident companies. Article 2 of
the Protocol also adds new paragraphs 6 and 7 to Article IV to
determine whether income is considered to be derived by a
resident of a Contracting State when such income is derived
through a fiscally transparent entity.
Paragraph 3 of Article IV--Dual resident companies
Paragraph 3, which addresses companies that are otherwise
considered resident in each of the Contracting States, is
replaced. The provisions of paragraph 3, and the date upon
which these provisions are effective, are consistent with an
understanding reached between the United States and Canada on
September 18, 2000, to clarify the residence of a company under
the Convention when the company has engaged in a so-called
corporate ``continuance'' transaction. The paragraph applies
only where, by reason of the rules set forth in paragraph 1 of
Article IV (Residence), a company is a resident of both
Contracting States.
Subparagraph 3(a) provides a rule to address the situation
when a company is a resident of both Contracting States but is
created under the laws in force in only one of the Contracting
States. In such a case, the rule provides that the company is a
resident only of the Contracting State under which it is
created. For example, if a company is incorporated in the
United States but the company is also otherwise considered a
resident of Canada because the company is managed in Canada,
subparagraph 3(a) provides that the company shall be considered
a resident only of the United States for purposes of the
Convention. Subparagraph 3(a) is intended to operate in a
manner similar to the first sentence of former paragraph 3.
However, subparagraph 3(a) clarifies that such a company must
be considered created in only one of the Contracting States to
fall within the scope of subparagraph 3(a). In some cases, a
company may engage in a corporate continuance transaction and
retain its charter in the Contracting State from which it
continued, while also being considered as created in the State
to which the company continued. In such cases, the provisions
of subparagraph 3(a) shall not apply because the company would
be considered created in both of the Contracting States.
Subparagraph 3(b) addresses all cases involving a dual
resident company that are not addressed in subparagraph 3(a).
Thus, subparagraph 3(b) applies to continuance transactions
occurring between the Contracting States if, as a result, a
company otherwise would be considered created under the laws of
each Contracting State, e.g., because the corporation retained
its charter in the first State. Subparagraph 3(b) would also
address so-called serial continuance transactions where, for
example, a company continues from one of the Contracting States
to a third country and then continues into the other
Contracting State without having ceased to be treated as
resident in the first Contracting State.
Subparagraph 3(b) provides that if a company is considered
to be a resident of both Contracting States, and the residence
of such company is not resolved by subparagraph 3(a), then the
competent authorities of the Contracting States shall endeavor
to settle the question of residency by a mutual agreement
procedure and determine the mode of application of the
Convention to such company. Subparagraph 3(b) also provides
that in the absence of such agreement, the company shall not be
considered a resident of either Contracting State for purposes
of claiming any benefits under the Convention.
Paragraphs 6 and 7 of Article IV--income, profit, or gain derived
through fiscally transparent entities
New paragraphs 6 and 7 are added to Article IV to provide
specific rules for the treatment of amounts of income, profit
or gain derived through or paid by fiscally transparent
entities such as partnerships and certain trusts. Fiscally
transparent entities, as explained more fully below, are in
general entities the income of which is taxed at the
beneficiary, member, or participant level. Entities that are
subject to tax, but with respect to which tax may be relieved
under an integrated system, are not considered fiscally
transparent entities. Entities that are fiscally transparent
for U.S. tax purposes include partnerships, common investment
trusts under section 584, grantor trusts, and business entities
such as a limited liability company (``LLC'') that is treated
as a partnership or is disregarded as an entity separate from
its owner for U.S. tax purposes. Entities falling within this
description in Canada are (except to the extent the law
provides otherwise) partnerships and what are known as ``bare''
trusts.
United States tax law also considers a corporation that has
made a valid election to be taxed under Subchapter S of Chapter
1 of the Internal Revenue Code (an ``S corporation'') to be
fiscally transparent within the meaning explained below. Thus,
if a U.S. resident derives income from Canada through an S
corporation, the U.S. resident will under new paragraph 6 be
considered for purposes of the Convention as the person who
derived the income. Exceptionally, because Canada will
ordinarily accept that an S corporation is itself resident in
the United States for purposes of the Convention, Canada will
allow benefits under the Convention to the S corporation in its
own right. In a reverse case, however--that is, where the S
corporation is owned by a resident of Canada and has U. S.-
source income, profits or gains--the Canadian resident will not
be considered as deriving the income by virtue of subparagraph
7 (a) as Canada does not see the S corporation as fiscally
transparent.
Under both paragraph 6 and paragraph 7, it is relevant
whether the treatment of an amount of income, profit or gain
derived by a person through an entity under the tax law of the
residence State is ``the same as its treatment would be if that
amount had been derived directly.'' For purposes of paragraphs
6 and 7, whether the treatment of an amount derived by a person
through an entity under the tax law of the residence State is
the same as its treatment would be if that amount had been
derived directly by that person shall be determined in
accordance with the principles set forth in Code section 894
and the regulations under that section concerning whether an
entity will be treated as fiscally transparent with respect to
an item of income received by the entity. Treas. Reg. section
1.894-1(d)(3)(iii) provides that an entity will be fiscally
transparent under the laws of an interest holder's jurisdiction
with respect to an item of income to the extent that the laws
of that jurisdiction require the interest holder resident in
that jurisdiction to separately take into account on a current
basis the interest holder's respective share of the item of
income paid to the entity, whether or not distributed to the
interest holder, and the character and source of the item in
the hands of the interest holder are determined as if such item
were realized directly from the source from which realized by
the entity. Although Canada does not have analogous provisions
in its domestic law, it is anticipated that principles
comparable to those described above will apply.
Paragraph 6
Under paragraph 6, an amount of income, profit or gain is
considered to be derived by a resident of a Contracting State
(residence State) if 1) the amount is derived by that person
through an entity (other than an entity that is a resident of
the other Contracting State (source State), and 2) by reason of
that entity being considered fiscally transparent under the
laws of the residence State, the treatment of the amount under
the tax law of the residence State is the same as its treatment
would be if that amount had been derived directly by that
person. These two requirements are set forth in subparagraphs
6(a) and 6(b), respectively.
For example, if a U.S. resident owns a French entity that
earns Canadian-source dividends and the entity is considered
fiscally transparent under U.S. tax law, the U.S. resident is
considered to derive the Canadian-source dividends for purposes
of Article IV (and thus, the dividends are considered as being
``paid to'' the resident) because the U.S. resident is
considered under the tax law of the United States to have
derived the dividend through the French entity and, because the
entity is treated as fiscally transparent under U.S. tax law,
the treatment of the income under U.S. tax law is the same as
its treatment would be if that amount had been derived directly
by the U.S. resident. This result obtains even if the French
entity is viewed differently under the tax laws of Canada or of
France (i.e., the French entity is treated under Canadian law
or under French tax law as not fiscally transparent).
Similarly, if a Canadian resident derives U. S.-source
income, profit or gain through an entity created under Canadian
law that is considered a partnership for Canadian tax purposes
but a corporation for U.S. tax purposes, U. S.-source income,
profit or gain derived through such entity by the Canadian
resident will be considered to be derived by the Canadian
resident in considering the application of the Convention.
Application of paragraph 6 and related treaty provisions by Canada
In determining the entitlement of a resident of the United
States to the benefits of the Convention, Canada shall apply
the Convention within its own legal framework.
For example, assume that from the perspective of Canadian
law an amount of income is seen as being paid from a source in
Canada to USLLC, an entity that is entirely owned by U.S.
persons and is fiscally transparent for U.S. tax purposes, but
that Canada considers a corporation and, thus, under Canadian
law, a taxpayer in its own right. Since USLLC is not itself
taxable in the United States, it is not considered to be a U.S.
resident under the Convention; but for new paragraph 6 Canada
would not apply the Convention in taxing the income.
If new paragraph 6 applies in respect of an amount of
income, profit or gain, such amount is considered as having
been derived by one or more U.S. resident shareholders of
USLLC, and Canada shall grant benefits of the Convention to the
payment to USLLC and eliminate or reduce Canadian tax as
provided in the Convention. The effect of the rule is to
suppress Canadian taxation of USLLC to give effect to the
benefits available under the Convention to the U.S. residents
in respect of the particular amount of income, profit or gain.
However, for Canadian tax purposes, USLLC remains the only
``visible'' taxpayer in relation to this amount. In other
words, the Canadian tax treatment of this taxpayer (USLLC) is
modified because of the entitlement of its U.S. resident
shareholders to benefits under the Convention, but this does
not alter USLLC's status under Canadian law. Canada does not,
for example, treat USLLC as though it did not exist,
substituting the shareholders for it in the role of taxpayer
under Canada's system.
Some of the implications of this are as follows. First,
Canada will not require the shareholders of USLLC to file
Canadian tax returns in respect of income that benefits from
new paragraph 6. Instead, USLLC itself will file a Canadian tax
return in which it will claim the benefit of the paragraph and
supply any documentation required to support the claim. (The
Canada Revenue Agency will supply additional practical guidance
in this regard, including instructions for seeking to establish
entitlement to Convention benefits in advance of payment.)
Second, as is explained in greater detail below, if the income
in question is business profits, it will be necessary to
determine whether the income was earned through a permanent
establishment in Canada. This determination will be based on
the presence and activities in Canada of USLLC itself, not of
its shareholders acting in their own right.
Determination of the existence of a permanent establishment from the
business activities of a fiscally transparent entity
New paragraph 6 applies not only in respect of amounts of
dividends, interest and royalties, but also profit (business
income), gains and other income. It may thus be relevant in
cases where a resident of one Contracting State carries on
business in the other State through an entity that has a
different characterization in each of the two Contracting
States.
Application of new paragraph 6 and the provisions of
Article V (Permanent Establishment) by CanadaAssume, for
instance, that a resident of the United States is part owner of
a U.S. limited liability company (USLLC) that is treated in the
United States as a fiscally transparent entity, but in Canada
as a corporation. Assume one of the other two shareholders of
USLLC is resident in a country that does not have a tax treaty
with Canada and that the remaining shareholder is resident in a
country with which Canada does have a tax treaty, but that the
treaty does not include a provision analogous to paragraph 6.
Assume further that USLLC carries on business in Canada,
but does not do so through a permanent establishment there.
(Note that from the Canadian perspective, the presence or
absence of a permanent establishment is evaluated with respect
to USLLC only, which Canada sees as a potentially taxable
entity in its own right.) Regarding Canada's application of the
provisions of the Convention, the portion of USLLC's profits
that belongs to the U.S. resident shareholder will not be
taxable in Canada, provided that the U.S. resident meets the
Convention's limitation on benefits provisions. Under paragraph
6, that portion is seen as having been derived by the U.S.
resident shareholder, who is entitled to rely on Article VII
(Business Profits). The balance of USLLC's profits will,
however, remain taxable in Canada. Since USLLC is not itself
resident in the United States for purposes of the Convention,
in respect of that portion of its profits that is not
considered to have been derived by a U.S. resident (or a
resident of another country whose treaty with Canada includes a
rule comparable to paragraph 6) it is not relevant whether or
not it has a permanent establishment in Canada.
Another example would be the situation where a USLLC that
is wholly owned by a resident of the U.S. carries on business
in Canada through a permanent establishment. If the USLLC is
fiscally transparent for U.S. tax purposes (and therefore, the
conditions for the application of paragraph 6 are satisfied)
then the USLLC's profits will be treated as having been derived
by its U.S. resident owner inclusive of all attributes of that
income (e.g., such as having been earned through a permanent
establishment). However, since the USLLC remains the only
``visible'' taxpayer for Canadian tax purposes, it is the
USLLC, and not the U.S. shareholder, that is subject to tax on
the profits that are attributable to the permanent
establishment.
Application of new paragraph 6 and the provisions of Article V
(Permanent Establishment) by the United States
It should be noted that in the situation where a person is
considered to derive income through an entity, the United
States looks in addition to such person's activities in order
to determine whether he has a permanent establishment. Assume
that a Canadian resident and a resident in a country that does
not have a tax treaty with the United States are owners of
CanLP. Assume further that Can LP is an entity that is
considered fiscally transparent for Canadian tax purposes but
is not considered fiscally transparent for U.S. tax purposes,
and that CanLP carries on business in the United States. If
CanLP carries on the business through a permanent
establishment, that permanent establishment may be attributed
to the partners. Moreover, in determining whether there is a
permanent establishment, the activities of both the entity and
its partners will be considered. If CanLP does not carry on the
business through a permanent establishment, the Canadian
resident, who derives income through the partnership, may claim
the benefits of Article VII (Business Profits) of the
Convention with respect to such income, assuming that the
income is not otherwise attributable to a permanent
establishment of the partner. In any case, the third country
partner cannot claim the benefits of Article VII of the
Convention between the United States and Canada.
Paragraph 7
Paragraph 7 addresses situations where an item of income,
profit or gain is considered not to be paid to or derived by a
person who is a resident of a Contracting State. The paragraph
is divided into two subparagraphs.
Under subparagraph 7(a), an amount of income, profit or
gain is considered not to be paid to or derived by a person who
is a resident of a Contracting State (the residence State) if
(1) the other Contracting State (the source State) views the
person as deriving the amount through an entity that is not a
resident of the residence State, and (2) by reason of the
entity not being treated as fiscally transparent under the laws
of the residence State, the treatment of the amount under the
tax law of the residence State is not the same as its treatment
would be if that amount had been derived directly by the
person.
For example, assume USCo, a company resident in the United
States, is a part owner of CanLP, an entity that is considered
fiscally transparent for Canadian tax purposes, but is not
considered fiscally transparent for U.S. tax purposes. CanLP
receives a dividend from a Canadian company in which it owns
stock. Under Canadian tax law USCo is viewed as deriving a
Canadian-source dividend through CanLP. For U.S. tax purposes,
CanLP, and not USCo, is viewed as deriving the dividend.
Because the treatment of the dividend under U.S. tax law in
this case is not the same as the treatment under U.S. law if
USCo derived the dividend directly, subparagraph 7(a) provides
that USCo will not be considered as having derived the
dividend. The result would be the same if CanLP were a third-
country entity that was viewed by the United States as not
fiscally transparent, but was viewed by Canada as fiscally
transparent. Similarly, income from U.S. sources received by an
entity organized under the laws of the United States that is
treated for Canadian tax purposes as a corporation and is owned
by shareholders who are residents of Canada is not considered
derived by the shareholders of that U.S. entity even if, under
U.S. tax law, the entity is treated as fiscally transparent.
Subparagraph 7(b) provides that an amount of income, profit
or gain is not considered to be paid to or derived by a person
who is a resident of a Contracting State (the residence State)
where the person is considered under the tax law of the other
Contracting State (the source State) to have received the
amount from an entity that is a resident of that other State
(the source State), but by reason of the entity being treated
as fiscally transparent under the laws of the Contracting State
of which the person is resident (the residence State), the
treatment of such amount under the tax law of that State (the
residence State) is not the same as the treatment would be if
that entity were not treated as fiscally transparent under the
laws of that State (the residence State).
That is, under subparagraph 7(b), an amount of income,
profit or gain is not considered to be paid to or derived by a
resident of a Contracting State (the residence State) if: (1)
the other Contracting State (the source State) views such
person as receiving the amount from an entity resident in the
source State; (2) the entity is viewed as fiscally transparent
under the laws of the residence State; and (3) by reason of the
entity being treated as fiscally transparent under the laws of
the residence State, the treatment of the amount received by
that person under the tax law of the residence State is not the
same as its treatment would be if the entity were not treated
as fiscally transparent under the laws of the residence State.
For example, assume that USCo, a company resident in the
United States is the sole owner of CanCo, an entity that is
considered under Canadian tax law to be a corporation that is
resident in Canada but is considered under U.S. tax law to be
disregarded as an entity separate from its owner. Assume
further that USCo is considered under Canadian tax law to have
received a dividend from CanCo.
In such a case, Canada, the source State, views USCo as
receiving income (i.e., a dividend) from a corporation that is
a resident of Canada (CanCo), CanCo is viewed as fiscally
transparent under the laws of the United States, the residence
State, and by reason of CanCo being disregarded under U.S. tax
law, the treatment under U.S. tax law of the payment is not the
same as its treatment would be if the entity were regarded as a
corporation under U.S. tax law. That is, the payment is
disregarded for U.S. tax purposes, whereas if U.S. tax law
regarded CanCo as a corporation, the payment would be treated
as a dividend. Therefore, subparagraph 7(b) would apply to
provide that the income is not considered to be paid to or
derived by USCo.
The same result obtains if, in the above example, USCo is
considered under Canadian tax law to have received an interest
or royalty payment (instead of a dividend) from CanCo. Under
U.S. law, because CanCo is disregarded as an entity separate
from its owner, the payment is disregarded, whereas if CanCo
were treated as not fiscally transparent, the payment would be
treated as interest or a royalty, as the case may be.
Therefore, subparagraph 7(b) would apply to provide that such
amount is not considered to be paid to or derived by USCo.
The application of subparagraph 7(b) differs if, in the
above example, USCo (as well as other persons) are owners of
CanCo, a Canadian entity that is considered under Canadian tax
law to be a corporation that is resident in Canada but is
considered under U.S. tax law to be a partnership (as opposed
to being disregarded). Assume that USCo is considered under
Canadian tax law to have received a dividend from CanCo. Such
payment is viewed under Canadian tax law as a dividend, but
under U.S. tax law is viewed as a partnership distribution. In
such a case, Canada views USCo as receiving income (i.e., a
dividend) from an entity that is a resident of Canada (CanCo),
CanCo is viewed as fiscally transparent under the laws of the
United States, the residence State, and by reason of CanCo
being treated as a partnership under U.S. tax law, the
treatment under U.S. tax law of the payment (as a partnership
distribution) is not the same as the treatment would be if
CanCo were not fiscally transparent under U.S. tax law (as a
dividend). As a result, subparagraph 7(b) would apply to
provide that such amount is not considered paid to or derived
by the U.S. resident.
As another example, assume that CanCo, a company resident
in Canada, is the owner of USLP, an entity that is considered
under U.S. tax law (by virtue of an election) to be a
corporation resident in the United States, but that is
considered under Canadian tax law to be a branch of CanCo.
Assume further that CanCo is considered under U.S. tax law to
have received a dividend from USLP. In this case, the United
States views CanCo as receiving income (i.e., a dividend) from
an entity that is resident in the United States (USLP), but by
reason of USLP being a branch under Canadian tax law, the
treatment under Canadian tax law of the payment is not the same
as its treatment would be if USLP were a company under Canadian
tax law. That is, the payment is treated as a branch remittance
for Canadian tax purposes, whereas if Canadian tax law regarded
USLP as a corporation, the payment would be treated as a
dividend. Therefore, subparagraph 7(b) would apply to provide
that the income is not considered to be paid to or derived by
CanCo. The same result would obtain in the case of interest or
royalties paid by USLP to CanCo.
Paragraphs 6 and 7 apply to determine whether an amount is
considered to be derived by (or paid to) a person who is a
resident of Canada or the United States. If, as a result of
paragraph 7, a person is not considered to have derived or
received an amount of income, profit or gain, that person shall
not be entitled to the benefits of the Convention with respect
to such amount. Additionally, for purposes of application of
the Convention by the United States, the treatment of such
payments under Code section 894(c) and the regulations
thereunder would not be relevant.
New paragraphs 6 and 7 are not an exception to the saving
clause of paragraph 2 of Article XXIX (Miscellaneous Rules).
Accordingly, subparagraph 7(b) does not prevent a Contracting
State from taxing an entity that is treated as a resident of
that State under its tax law. For example, if a U.S.
partnership with members who are residents of Canada elects to
be taxed as a corporation for U.S. tax purposes, the United
States will tax that partnership on its worldwide income on a
net basis, even if Canada views the partnership as fiscally
transparent.
Interaction of paragraphs 6 and 7 with the determination of
``beneficial ownership''
With respect to payments of income, profits or gain arising
in a Contracting State and derived directly by a resident of
the other Contracting State (and not through a fiscally
transparent entity), the term ``beneficial owner'' is defined
under the internal law of the country imposing tax (i.e., the
source State). Thus, if the payment arising in a Contracting
State is derived by a resident of the other State who under the
laws of the first-mentioned State is determined to be a nominee
or agent acting on behalf of a person that is not a resident of
that other State, the payment will not be entitled to the
benefits of the Convention. However, payments arising in a
Contracting State and derived by a nominee on behalf of a
resident of that other State would be entitled to benefits.
These limitations are confirmed by paragraph 12 of the
Commentary to Article 10 of the OECD Model.
Special rules apply in the case of income, profits or gains
derived through a fiscally transparent entity, as described in
new paragraph 6 of Article IV. Residence State principles
determine who derives the income, profits or gains, to assure
that the income, profits or gains for which the source State
grants benefits of the Convention will be taken into account
for tax purposes by a resident of the residence State. Source
country principles of beneficial ownership apply to determine
whether the person who derives the income, profits or gains, or
another resident of the other Contracting State, is the
beneficial owner of the income, profits or gains. The source
State may conclude that the person who derives the income,
profits or gains in the residence State is a mere nominee,
agent, conduit, etc., for a third country resident and deny
benefits of the Convention. If the person who derives the
income, profits or gains under paragraph 6 of Article IV would
not be treated under the source State's principles for
determining beneficial ownership as a nominee, agent,
custodian, conduit, etc., that person will be treated as the
beneficial owner of the income, profits or gains for purposes
of the Convention.
Assume, for instance, that interest arising in the United
States is paid to CanLP, an entity established in Canada which
is treated as fiscally transparent for Canadian tax purposes
but is treated as a company for U.S. tax purposes. CanCo, a
company incorporated in Canada, is the sole interest holder in
CanLP. Paragraph 6 of Article IV provides that CanCo derives
the interest. However, if under the laws of the United States
regarding payments to nominees, agents, custodians and
conduits, CanCo is found be a nominee, agent, custodian or
conduit for a person who is not a resident of Canada, CanCo
will not be considered the beneficial owner of the interest and
will not be entitled to the benefits of Article XI with respect
to such interest. The payment may be entitled to benefits,
however, if CanCo is found to be a nominee, agent, custodian or
conduit for a person who is a resident of Canada.
With respect to Canadian-source income, profit or gains,
beneficial ownership is to be determined under Canadian law.
For example, assume that LLC, an entity that is treated as
fiscally transparent for U.S. tax purposes, but as a
corporation for Canadian tax purposes, is owned by USCo, a U.S.
resident company. LLC receives Canadian-source income. The
question of the beneficial ownership of the income received by
LLC is determined under Canadian law. If LLC is considered the
beneficial owner of the income under Canadian law, paragraph 6
shall apply to extend benefits of the Convention to the income
received by LLC to the extent that the Canadian-source income
is derived by U.S. resident members of LLC.
ARTICLE 3
Article 3 of the Protocol amends Article V (Permanent
Establishment) of the Convention. Paragraph 1 of Article 3 of
the Protocol adds a reference in Paragraph 6 of Article IV to
new paragraph 9 of Article V. Paragraph 2 of Article 3 of the
Protocol sets forth new paragraphs 9 and 10 of Article V.
Paragraph 9 of Article V
New paragraph 9 provides a special rule (subject to the
provisions of paragraph 3) for an enterprise of a Contracting
State that provides services in the other Contracting State,
but that does not have a permanent establishment by virtue of
the preceding paragraphs of the Article. If (and only if) such
an enterprise meets either of two tests as provided in
subparagraphs 9(a) and 9(b), the enterprise will be deemed to
provide those services through a permanent establishment in the
other State.
The first test as provided in subparagraph 9(a) has two
parts. First, the services must be performed in the other State
by an individual who is present in that other State for a
period or periods aggregating 183 days or more in any twelve-
month period. Second, during that period or periods, more than
50 percent of the gross active business revenues of the
enterprise (including revenue from active business activities
unrelated to the provision of services) must consist of income
derived from the services performed in that State by that
individual. If the enterprise meets both of these tests, the
enterprise will be deemed to provide the services through a
permanent establishment. This test is employed to determine
whether an enterprise is deemed to have a permanent
establishment by virtue of the presence of a single individual
(i.e., a natural person).
For the purposes of subparagraph 9(a), the term ``gross
active business revenues'' shall mean the gross revenues
attributable to active business activities that the enterprise
has charged or should charge for its active business
activities, regardless of when the actual billing will occur or
of domestic law rules concerning when such revenues should be
taken into account for tax purposes. Such active business
activities are not restricted to the activities related to the
provision of services. However, the term does not include
income from passive investment activities.
As an example of the application of subparagraph 9(a),
assume that Mr. X, an individual resident in the United States,
is one of the two shareholders and employees of USCo, a company
resident in the United States that provides engineering
services. During the 12-month period beginning December 20 of
Year 1 and ending December 19 of Year 2, Mr. X is present in
Canada for periods totaling 190 days, and during those periods,
70 percent of all of the gross active business revenues of USCo
attributable to business activities are derived from the
services that Mr. X performs in Canada. Because both of the
criteria of subparagraph 9(a) are satisfied, USCo will be
deemed to have a permanent establishment in Canada by virtue of
that subparagraph.
The second test as provided in subparagraph 9(b) provides
that an enterprise will have a permanent establishment if the
services are provided in the other State for an aggregate of
183 days or more in any twelve-month period with respect to the
same or connected projects for customers who either are
residents of the other State or maintain a permanent
establishment in the other State with respect to which the
services are provided. The various conditions that have to be
satisfied in order for subparagraph 9(b) to have application
are described in detail below.
In addition to meeting the 183-day threshold, the services
must be provided for customers who either are residents of the
other State or maintain a permanent establishment in that
State. The intent of this requirement is to reinforce the
concept that unless there is a customer in the other State,
such enterprise will not be deemed as participating
sufficiently in the economic life of that other State to
warrant being deemed to have a permanent establishment.
Assume for example, that CanCo, a Canadian company, wishes
to acquire USCo, a company in the United States. In preparation
for the acquisition, CanCo hires Canlaw, a Canadian law firm,
to conduct a due diligence evaluation of USCo's legal and
financial standing in the United States. Canlaw sends a staff
attorney to the United States to perform the due diligence
analysis of USCo. That attorney is present and working in the
United States for greater than 183 days. If the remuneration
paid to Canlaw for the attorney's services does not constitute
more than 50 percent of Canlaw's gross active business revenues
for the period during which the attorney is present in the
United States, Canlaw will not be deemed to provide the
services through a permanent establishment in the United States
by virtue of subparagraph 9(a). Additionally, because the
services are being provided for a customer (CanCo) who neither
is a resident of the United States nor maintains a permanent
establishment in the United States to which the services are
provided, Canlaw will also not have a permanent establishment
in the United States by virtue of subparagraph 9(b).
Paragraph 9 applies only to the provision of services, and
only to services provided by an enterprise to third parties.
Thus, the provision does not have the effect of deeming an
enterprise to have a permanent establishment merely because
services are provided to that enterprise. Paragraph 9 only
applies to services that are performed or provided by an
enterprise of a Contracting State within the other Contracting
State. It is therefore not sufficient that the relevant
services be merely furnished to a resident of the other
Contracting State. Where, for example, an enterprise provides
customer support or other services by telephone or computer to
customers located in the other State, those would not be
covered by paragraph 9 because they are not performed or
provided by that enterprise within the other State. Another
example would be that of an architect who is hired to design
blueprints for the construction of a building in the other
State. As part of completing the project, the architect must
make site visits to that other State, and his days of presence
there would be counted for purposes of determining whether the
183-day threshold is satisfied. However, the days that the
architect spends working on the blueprint in his home office
shall not count for purposes of the 183-day threshold, because
the architect is not performing or providing those services
within the other State.
For purposes of determining whether the time threshold has
been met, subparagraph 9(b) permits the aggregation of services
that are provided with respect to connected projects. Paragraph
2 of the General Note provides that for purposes of
subparagraph 9(b), projects shall be considered to be connected
if they constitute a coherent whole, commercially and
geographically. The determination of whether projects are
connected should be determined from the point of view of the
enterprise (not that of the customer), and will depend on the
facts and circumstances of each case. In determining the
existence of commercial coherence, factors that would be
relevant include: 1) whether the projects would, in the absence
of tax planning considerations, have been concluded pursuant to
a single contract; 2) whether the nature of the work involved
under different projects is the same; and 3) whether the same
individuals are providing the services under the different
projects. Whether the work provided is covered by one or
multiple contracts may be relevant, but not determinative, in
finding that projects are commercially coherent.
The aggregation rule addresses, for example, potentially
abusive situations in which work has been artificially divided
into separate components in order to avoid meeting the 183-day
threshold. Assume for example, that a technology consultant has
been hired to install a new computer system for a company in
the other country. The work will take ten months to complete.
However, the consultant purports to divide the work into two
five-month projects with the intention of circumventing the
rule in subparagraph 9(b). In such case, even if the two
projects were considered separate, they will be considered to
be commercially coherent. Accordingly, subject to the
additional requirement of geographic coherence, the two
projects could be considered to be connected, and could
therefore be aggregated for purposes of subparagraph 9(b). In
contrast, assume that the technology consultant is contracted
to install a particular computer system for a company, and is
also hired by that same company, pursuant to a separate
contract, to train its employees on the use of another computer
software that is unrelated to the first system. In this second
case, even though the contracts are both concluded between the
same two parties, there is no commercial coherence to the two
projects, and the time spent fulfilling the two contracts may
not be aggregated for purposes of subparagraph 9(b). Another
example of projects that do not have commercial coherence would
be the case of a law firm which, as one project provides tax
advice to a customer from one portion of its staff, and as
another project provides trade advice from another portion of
its staff, both to the same customer.
Additionally, projects, in order to be considered
connected, must also constitute a geographic whole. An example
of projects that lack geographic coherence would be a case in
which a consultant is hired to execute separate auditing
projects at different branches of a bank located in different
cities pursuant to a single contract. In such an example, while
the consultant's projects are commercially coherent, they are
not geographically coherent and accordingly the services
provided in the various branches shall not be aggregated for
purposes of applying subparagraph 9(b). The services provided
in each branch should be considered separately for purposes of
subparagraph 9(b).
The method of counting days for purposes of subparagraph
9(a) differs slightly from the method for subparagraph 9(b).
Subparagraph 9(a) refers to days in which an individual is
present in the other country. Accordingly, physical presence
during a day is sufficient. In contrast, subparagraph 9(b)
refers to days during which services are provided by the
enterprise in the other country. Accordingly, non-working days
such as weekends or holidays would not count for purposes of
subparagraph 9(b), as long as no services are actually being
provided while in the other country on those days. For the
purposes of both subparagraphs, even if the enterprise sends
many individuals simultaneously to the other country to provide
services, their collective presence during one calendar day
will count for only one day of the enterprise's presence in the
other country. For instance, if an enterprise sends 20
employees to the other country to provide services to a client
in the other country for 10 days, the enterprise will be
considered present in the other country only for 10 days, not
200 days (20 employees x 10 days).
By deeming the enterprise to provide services through a
permanent establishment in the other Contracting State,
paragraph 9 allows the application of Article VII (Business
Profits), and accordingly, the taxation of the services shall
be on a net-basis. Such taxation is also limited to the profits
attributable to the activities carried on in performing the
relevant services. It will be important to ensure that only the
profits properly attributable to the functions performed and
risks assumed by provision of the services will be attributed
to the deemed permanent establishment.
In addition to new paragraph 9, Article 3 of the Protocol
amends paragraph 6 of Article V of the Convention to include a
reference to paragraph 9. Therefore, in no case will paragraph
9 apply to deem services to be provided through a permanent
establishment if the services are limited to those mentioned in
paragraph 6 which, if performed through a fixed place of
business, would not make the fixed place of business a
permanent establishment under the provisions of that paragraph.
The competent authorities are encouraged to consider
adopting rules to reduce the potential for excess withholding
or estimated tax payments with respect to employee wages that
may result from the application of this paragraph. Further,
because paragraph 6 of Article V applies notwithstanding
paragraph 9, days spent on preparatory or auxiliary activities
shall not be taken into account for purposes of applying
subparagraph 9(b).
Paragraph 10 of Article V
Paragraph 2 of Article 3 of the Protocol also sets forth
new paragraph 10 of Article V. The provisions of new paragraph
10 are identical to paragraph 9 of Article V as it existed
prior to the Protocol. New paragraph 10 provides that the
provisions of Article V shall be applied in determining whether
any person has a permanent establishment in any State.
ARTICLE 4
Article 4 of the Protocol replaces paragraph 2 of Article VII (Business
Profits).
New paragraph 2 provides that where a resident of either
Canada or the United States carries on (or has carried on)
business in the other Contracting State through a permanent
establishment in that other State, both Canada and the United
States shall attribute to permanent establishments in their
respective states those business profits which the permanent
establishment might be expected to make if it were a distinct
and separate person engaged in the same or similar activities
under the same or similar conditions and dealing wholly
independently with the resident and with any other person
related to the resident. The term ``related to the resident''
is to be interpreted in accordance with paragraph 2 of Article
IX (Related Persons). The reference to other related persons is
intended to make clear that the test of paragraph 2 is not
restricted to independence between a permanent establishment
and a home office.
New paragraph 2 is substantially similar to paragraph 2 as
it existed before the Protocol. However, in addition to the
reference to a resident of a Contracting State who ``carries
on'' business in the other Contracting State, the Protocol
incorporates into the Convention the rule of Code section
864(c)(6) by adding ``or has carried on'' to address
circumstances where, as a result of timing, income may be
attributable to a permanent establishment that no longer exists
in one of the Contracting States. In such cases, the income is
properly within the scope of Article VII. Conforming changes
are also made in the Protocol to Articles X (Dividends), XI
(Interest), and XII (Royalties) of the Convention where Article
VII would apply. As is explained in paragraph 5 of the General
Note, these revisions to the Convention are only intended to
clarify the application of the existing provisions of the
Convention.
The following example illustrates the application of
paragraph 2. Assume a company that is a resident of Canada and
that maintains a permanent establishment in the United States
winds up the permanent establishment's business and sells the
permanent establishment's inventory and assets to a U.S. buyer
at the end of year 1 in exchange for an installment obligation
payable in full at the end of year 3. Despite the fact that the
company has no permanent establishment in the United States in
year 3, the United States may tax the deferred income payment
recognized by the company in year 3.
The ``attributable to'' concept of paragraph 2 provides an
alternative to the analogous but somewhat different
``effectively connected'' concept in Code section 864(c).
Depending on the circumstances, the amount of income
``attributable to'' a permanent establishment under Article VII
may be greater or less than the amount of income that would be
treated as ``effectively connected'' to a U.S. trade or
business under Code section 864. In particular, in the case of
financial institutions, the use of internal dealings to
allocate income within an enterprise may produce results under
Article VII that are significantly different than the results
under the effectively connected income rules. For example,
income from interbranch notional principal contracts may be
taken into account under Article VII, notwithstanding that such
transactions may be ignored for purposes of U.S. domestic law.
A taxpayer may use the treaty to reduce its taxable income, but
may not use both treaty and Code rules where doing so would
thwart the intent of either set of rules. See Rev. Rul. 84-
17, 1984-1 C.B. 308.
The profits attributable to a permanent establishment may
be from sources within or without a Contracting State. However,
as stated in the General Note, the business profits
attributable to a permanent establishment include only those
profits derived from the assets used, risks assumed, and
activities performed by the permanent establishment.
The language of paragraph 2, when combined with paragraph 3
dealing with the allowance of deductions for expenses incurred
for the purposes of earning the profits, incorporates the arm's
length standard for purposes of determining the profits
attributable to a permanent establishment. The United States
and Canada generally interpret the arm's length standard in a
manner consistent with the OECD Transfer Pricing Guidelines.
Paragraph 9 of the General Note confirms that the arm's
length method of paragraphs 2 and 3 consists of applying the
OECD Transfer Pricing Guidelines, but taking into account the
different economic and legal circumstances of a single legal
entity (as opposed to separate but associated enterprises).
Thus, any of the methods used in the Transfer Pricing
Guidelines, including profits methods, may be used as
appropriate and in accordance with the Transfer Pricing
Guidelines. However, the use of the Transfer Pricing Guidelines
applies only for purposes of attributing profits within the
legal entity. It does not create legal obligations or other tax
consequences that would result from transactions having
independent legal significance. Thus, the Contracting States
agree that the notional payments used to compute the profits
that are attributable to a permanent establishment will not be
taxed as if they were actual payments for purposes of other
taxing provisions of the Convention, for example, for purposes
of taxing a notional royalty under Article XII (Royalties).
One example of the different circumstances of a single
legal entity is that an entity that operates through branches
rather than separate subsidiaries generally will have lower
capital requirements because all of the assets of the entity
are available to support all of the entity's liabilities (with
some exceptions attributable to local regulatory restrictions).
This is the reason that most commercial banks and some
insurance companies operate through branches rather than
subsidiaries. The benefit that comes from such lower capital
costs must be allocated among the branches in an appropriate
manner. This issue does not arise in the case of an enterprise
that operates through separate entities, since each entity will
have to be separately capitalized or will have to compensate
another entity for providing capital (usually through a
guarantee).
Under U.S. domestic regulations, internal ``transactions''
generally are not recognized because they do not have legal
significance. In contrast, the rule provided by the General
Note is that such internal dealings may be used to attribute
income to a permanent establishment in cases where the dealings
accurately reflect the allocation of risk within the
enterprise. One example is that of global trading in
securities. In many cases, banks use internal swap transactions
to transfer risk from one branch to a central location where
traders have the expertise to manage that particular type of
risk. Under paragraph 2 as set forth in the Protocol, such a
bank may also use such swap transactions as a means of
attributing income between the branches, if use of that method
is the ``best method'' within the meaning of regulation section
1.482-1(c). The books of a branch will not be respected,
however, when the results are inconsistent with a functional
analysis. So, for example, income from a transaction that is
booked in a particular branch (or home office) will not be
treated as attributable to that location if the sales and risk
management functions that generate the income are performed in
another location.
The understanding in the General Note also affects the
interpretation of paragraph 3 of Article VII. Paragraph 3
provides that in determining the business profits of a
permanent establishment, deductions shall be allowed for the
expenses incurred for the purposes of the permanent
establishment, ensuring that business profits will be taxed on
a net basis. This rule is not limited to expenses incurred
exclusively for the purposes of the permanent establishment,
but includes expenses incurred for the purposes of the
enterprise as a whole, or that part of the enterprise that
includes the permanent establishment. Deductions are to be
allowed regardless of which accounting unit of the enterprise
books the expenses, so long as they are incurred for the
purposes of the permanent establishment. For example, a portion
of the interest expense recorded on the books of the home
office in one State may be deducted by a permanent
establishment in the other. The amount of the expense that must
be allowed as a deduction is determined by applying the arm's
length principle.
As noted above, paragraph 9 of the General Note provides
that the OECD Transfer Pricing Guidelines apply, by analogy, in
determining the profits attributable to a permanent
establishment. Accordingly, a permanent establishment may
deduct payments made to its head office or another branch in
compensation for services performed for the benefit of the
branch. The method to be used in calculating that amount will
depend on the terms of the arrangements between the branches
and head office. For example, the enterprise could have a
policy, expressed in writing, under which each business unit
could use the services of lawyers employed by the head office.
At the end of each year, the costs of employing the lawyers
would be charged to each business unit according to the amount
of services used by that business unit during the year. Since
this has the characteristics of a cost-sharing arrangement and
the allocation of costs is based on the benefits received by
each business unit, such a cost allocation would be an
acceptable means of determining a permanent establishment's
deduction for legal expenses. Alternatively, the head office
could agree to employ lawyers at its own risk, and to charge an
arm's length price for legal services performed for a
particular business unit. If the lawyers were under-utilized,
and the ``fees'' received from the business units were less
than the cost of employing the lawyers, then the head office
would bear the excess cost. If the ``fees'' exceeded the cost
of employing the lawyers, then the head office would keep the
excess to compensate it for assuming the risk of employing the
lawyers. If the enterprise acted in accordance with this
agreement, this method would be an acceptable alternative
method for calculating a permanent establishment's deduction
for legal expenses.
The General Note also makes clear that a permanent
establishment cannot be funded entirely with debt, but must
have sufficient capital to carry on its activities as if it
were a distinct and separate enterprise. To the extent that the
permanent establishment has not been attributed capital for
profit attribution purposes, a Contracting State may attribute
such capital to the permanent establishment, in accordance with
the arm's length principle, and deny an interest deduction to
the extent necessary to reflect that capital attribution. The
method prescribed by U.S. domestic law for making this
attribution is found in Treas. Reg. section 1.882-5. Both
section 1.882-5 and the method prescribed in the General Note
start from the premise that all of the capital of the
enterprise supports all of the assets and risks of the
enterprise, and therefore the entire capital of the enterprise
must be allocated to its various businesses and offices.
However, section 1.882-5 does not take into account the
fact that some assets create more risk for the enterprise than
do other assets. An independent enterprise would need less
capital to support a perfectly-hedged U.S. Treasury security
than it would need to support an equity security or other asset
with significant market and/or credit risk. Accordingly, in
some cases section 1.882-5 would require a taxpayer to allocate
more capital to the United States, and therefore would reduce
the taxpayer's interest deduction more, than is appropriate. To
address these cases, the General Note allows a taxpayer to
apply a more flexible approach that takes into account the
relative risk of its assets in the various jurisdictions in
which it does business. In particular, in the case of financial
institutions other than insurance companies, the amount of
capital attributable to a permanent establishment is determined
by allocating the institution's total equity between its
various offices on the basis of the proportion of the financial
institution's risk-weighted assets attributable to each of
them. This recognizes the fact that financial institutions are
in many cases required to risk-weight their assets for
regulatory purposes and, in other cases, will do so for
business reasons even if not required to do so by regulators.
However, risk-weighting is more complicated than the method
prescribed by section 1.882-5. Accordingly, to ease this
administrative burden, taxpayers may choose to apply the
principles of Treas. Reg. section 1.882-5(c) to determine the
amount of capital allocable to its U.S. permanent
establishment, in lieu of determining its allocable capital
under the risk-weighted capital allocation method provided by
the General Note, even if it has otherwise chosen the
principles of Article VII rather than the effectively connected
income rules of U.S. domestic law. It is understood that this
election is not binding for purposes of Canadian taxation
unless the result is in accordance with the arm's length
principle.
As noted in the Convention, nothing in paragraph 3 requires
a Contracting State to allow the deduction of any expenditure
which, by reason of its nature, is not generally allowed as a
deduction under the tax laws in that State.
ARTICLE 5
Article 5 makes a number of amendments to Article X
(Dividends) of the existing Convention. As with other benefits
of the Convention, the benefits of Article X are available to a
resident of a Contracting State only if that resident is
entitled to those benefits under the provisions of Article XXIX
A (Limitation on Benefits).
See the Technical Explanation for new paragraphs 6 and 7
of Article IV (Residence) for discussion regarding the
interaction between domestic law concepts of beneficial
ownership and the treaty rules to determine when a person is
considered to derive an item of income for purposes of
obtaining benefits of the Convention such as withholding rate
reductions.
Paragraph 1
Paragraph 1 of Article 5 of the Protocol replaces
subparagraph 2(a) of Article X of the Convention. In general,
paragraph 2 limits the amount of tax that may be imposed on
dividends by the Contracting State in which the company paying
the dividends is resident if the beneficial owner of the
dividends is a resident of the other Contracting State.
Subparagraph 2(a) limits the rate to 5 percent of the gross
amount of the dividends if the beneficial owner is a company
that owns 10 percent or more of the voting stock of the company
paying the dividends.
The Protocol adds a parenthetical to address the
determination of the requisite ownership set forth in
subparagraph 2(a) when the beneficial owner of dividends
receives the dividends through an entity that is considered
fiscally transparent in the beneficial owner's Contracting
State. The added parenthetical stipulates that voting stock in
a company paying the dividends that is indirectly held through
an entity that is considered fiscally transparent in the
beneficial owner's Contracting State is taken into account,
provided the entity is not a resident of the other Contracting
State. The United States views the new parenthetical as merely
a clarification.
For example, assume USCo, a U.S. corporation, directly owns
2 percent of the voting stock of CanCo, a Canadian company that
is considered a corporation in the United States and Canada.
Further, assume that USCo owns 18 percent of the interests in
LLC, an entity that in turn owns 50 percent of the voting stock
of CanCo. CanCo pays a dividend to each of its shareholders.
Provided that LLC is fiscally transparent in the United States
and not considered a resident of Canada, USCo's 9 percent
ownership in CanCo through LLC (50 percent x 18 percent) is
taken into account in determining whether USCo meets the 10
percent ownership threshold set forth in subparagraph 2(a). In
this example, USCo may aggregate its voting stock interests in
CanCo that it owns directly and through LLC to determine if it
satisfies the ownership requirement of subparagraph 2(a).
Accordingly, USCo will be entitled to the 5 percent rate of
withholding on dividends paid with respect to both its voting
stock held through LLC and its voting stock held directly.
Alternatively, if, for example, all of the shareholders of LLC
were natural persons, the 5 percent rate would not apply.
Paragraph 2
Paragraph 2 of Article 5 of the Protocol replaces the
definition of the term ``dividends'' provided in paragraph 3 of
Article X of the Convention. The new definition conforms to the
U.S. Model formulation. Paragraph 3 defines the term dividends
broadly and flexibly. The definition is intended to cover all
arrangements that yield a return on an equity investment in a
corporation as determined under the tax law of the source
State, as well as arrangements that might be developed in the
future.
The term dividends includes income from shares, or other
corporate rights that are not treated as debt under the law of
the source State, that participate in the profits of the
company. The term also includes income that is subjected to the
same tax treatment as income from shares by the law of the
source State. Thus, for example, a constructive dividend that
results from a non-arm's length transaction between a
corporation and a related party is a dividend. In the case of
the United States the term ``dividend'' includes amounts
treated as a dividend under U.S. law upon the sale or
redemption of shares or upon a transfer of shares in a
reorganization. See, e.g., Rev. Rul. 92-85, 1992-2 C.B. 69
(sale of foreign subsidiary's stock to U.S. sister company is a
deemed dividend to extent of the subsidiary's and sister
company's earnings and profits). Further, a distribution from a
U.S. publicly traded limited partnership that is taxed as a
corporation under U.S. law is a dividend for purposes of
Article X. However, a distribution by a limited liability
company is not considered by the United States to be a dividend
for purposes of Article X, provided the limited liability
company is not characterized as an association taxable as a
corporation under U.S. law.
Paragraph 3 of the General Note states that distributions
from Canadian income trusts and royalty trusts that are treated
as dividends as a result of changes to Canada's taxation of
income and royalty trusts enacted in 2007 (S.C. 2007, c. 29)
shall be treated as dividends for the purposes of Article X.
Additionally, a payment denominated as interest that is
made by a thinly capitalized corporation may be treated as a
dividend to the extent that the debt is recharacterized as
equity under the laws of the source State. At the time the
Protocol was signed, interest payments subject to Canada's
thin-capitalization rules were not recharacterized as
dividends.
Paragraph 3
Paragraph 3 of Article 5 of the Protocol replaces paragraph
4 of Article X. New paragraph 4 is substantially similar to
paragraph 4 as it existed prior to the Protocol. New paragraph
4, however, adds clarifying language consistent with the
changes made in Articles 4, 6, and 7 of the Protocol with
respect to income attributable to a permanent establishment
that has ceased to exist. Paragraph 4 provides that the
limitations of paragraph 2 do not apply if the beneficial owner
of the dividends carries on or has carried on business in the
State in which the company paying the dividends is a resident
through a permanent establishment situated there, and the
stockholding in respect of which the dividends are paid is
effectively connected to such permanent establishment. In such
a case, the dividends are taxable pursuant to the provisions of
Article VII (Business Profits). Thus, dividends paid in respect
of holdings forming part of the assets of a permanent
establishment or which are otherwise effectively connected to
such permanent establishment will be taxed on a net basis using
the rates and rules of taxation generally applicable to
residents of the State in which the permanent establishment is
situated.
To conform with Article 9 of the Protocol, which deletes
Article XIV (Independent Personal Services) of the Convention,
paragraph 4 of Article 5 of the Protocol also amends paragraph
5 of Article X by omitting the reference to a ``fixed base.''
Paragraph 4
To conform with Article 9 of the Protocol, which deletes
Article XIV (Independent Personal Services) of the Convention,
paragraph 4 of Article 5 of the Protocol amends paragraph 5 of
Article X by omitting the reference to a ``fixed base.''
Paragraph 5
Paragraph 5 of Article 5 of the Protocol replaces
subparagraph 7(c) of Article X of the existing Convention.
Consistent with current U.S. tax treaty policy, new
subparagraph 7(c) provides rules that expand the application of
subparagraph 2(b) for the treatment of dividends paid by a Real
Estate Investment Trust (REIT). New subparagraph 7(c) maintains
the rule of the existing Convention that dividends paid by a
REIT are not eligible for the 5 percent maximum rate of
withholding tax of subparagraph 2(a), and provides that the 15
percent maximum rate of withholding tax of subparagraph 2(b)
applies to dividends paid by REITs only if one of three
conditions is met.
First, the dividend will qualify for the 15 percent maximum
rate if the beneficial owner of the dividend is an individual
holding an interest of not more than 10 percent in the REIT.
For this purpose, subparagraph 7(c) also provides that where an
estate or testamentary trust acquired its interest in a REIT as
a consequence of the death of an individual, the estate or
trust will be treated as an individual for the five-year period
following the death. Thus, dividends paid to an estate or
testamentary trust in respect of a holding of less than a 10
percent interest in the REIT also will be entitled to the 15
percent rate of withholding, but only for up to five years
after the death.
Second, the dividend will qualify for the 15 percent
maximum rate if it is paid with respect to a class of stock
that is publicly traded and the beneficial owner of the
dividend is a person holding an interest of not more than 5
percent of any class of the REIT's stock.
Third, the dividend will qualify for the 15 percent maximum
rate if the beneficial owner of the dividend holds an interest
in the REIT of 10 percent or less and the REIT is
``diversified.'' A REIT is diversified if the gross value of no
single interest in real property held by the REIT exceeds 10
percent of the gross value of the REIT's total interest in real
property. For purposes of this diversification test,
foreclosure property is not considered an interest in real
property, and a REIT holding a partnership interest is treated
as owning its proportionate share of any interest in real
property held by the partnership.
A resident of Canada directly holding U.S. real property
would pay U.S. tax either at a 30 percent rate of withholding
tax on the gross income or at graduated rates on the net
income. By placing the real property in a REIT, the investor
absent a special rule could transform real estate income into
dividend income, taxable at the rates provided in Article X,
significantly reducing the U.S. tax that otherwise would be
imposed. Subparagraph 7(c) prevents this result and thereby
avoids a disparity between the taxation of direct real estate
investments and real estate investments made through REIT
conduits. In the cases in which subparagraph 7(c) allows a
dividend from a REIT to be eligible for the 15 percent maximum
rate of withholding tax, the holding in the REIT is not
considered the equivalent of a direct holding in the underlying
real property.
Article 6
Article 6 of the Protocol replaces Article XI (Interest) of
the existing Convention. Article XI specifies the taxing
jurisdictions over interest income of the States of source and
residence and defines the terms necessary to apply Article XI.
As with other benefits of the Convention, the benefits of
Article XI are available to a resident of a Contracting State
only if that resident is entitled to those benefits under the
provisions of Article XXIX A (Limitation on Benefits).
Paragraph 1 of Article XI
New paragraph 1 generally grants to the residence State the
exclusive right to tax interest beneficially owned by its
residents and arising in the other Contracting State. See the
Technical Explanation for new paragraphs 6 and 7 of Article IV
(Residence) for discussion regarding the interaction between
domestic law concepts of beneficial ownership and the treaty
rules to determine when a person is considered to derive an
item of income for purposes of obtaining benefits under the
Convention such as withholding rate reductions.
Subparagraph 3(d) of Article 27 of the Protocol provides an
additional rule regarding the application of paragraph 1 during
the first two years that end after the Protocol's entry into
force. This rule is described in detail in the Technical
Explanation to Article 27.
Paragraph 2 of Article XI
Paragraph 2 of new Article XI is substantially identical to
paragraph 4 of Article XI of the existing Convention.
Paragraph 2 defines the term ``interest'' as used in
Article XI to include, inter alia, income from debt claims of
every kind, whether or not secured by a mortgage. Interest that
is paid or accrued subject to a contingency is within the ambit
of Article XI. This includes income from a debt obligation
carrying the right to participate in profits. The term does
not, however, include amounts that are treated as dividends
under Article X (Dividends).
The term ``interest'' also includes amounts subject to the
same tax treatment as income from money lent under the law of
the State in which the income arises. Thus, for purposes of the
Convention, amounts that the United States will treat as
interest include (i) the difference between the issue price and
the stated redemption price at maturity of a debt instrument
(i.e., original issue discount (OID)), which may be wholly or
partially realized on the disposition of a debt instrument
(section 1273), (ii) amounts that are imputed interest on a
deferred sales contract (section 483), (iii) amounts treated as
interest or OID under the stripped bond rules (section 1286),
(iv) amounts treated as original issue discount under the
below-market interest rate rules (section 7872), (v) a
partner's distributive share of a partnership's interest income
(section 702), (vi) the interest portion of periodic payments
made under a ``finance lease'' or similar contractual
arrangement that in substance is a borrowing by the nominal
lessee to finance the acquisition of property, (vii) amounts
included in the income of a holder of a residual interest in a
real estate mortgage investment conduit (REMIC) (section 860E),
because these amounts generally are subject to the same
taxation treatment as interest under U.S. tax law, and (viii)
interest with respect to notional principal contracts that are
re-characterized as loans because of a ``substantial non-
periodic payment.''
Paragraph 3 is in all material respects the same as
paragraph 5 of Article XI of the existing Convention. New
paragraph 3 adds clarifying language consistent with the
changes made in Articles 4, 5, and 7 of the Protocol with
respect to income attributable to a permanent establishment
that has ceased to exist. Also, consistent with the changes
described in Article 9 of the Protocol, discussed below,
paragraph 3 does not contain references to the performance of
independent personal services through a fixed base.
Paragraph 3 provides an exception to the exclusive
residence taxation rule of paragraph 1 in cases where the
beneficial owner of the interest carries on business through a
permanent establishment in the State of source and the interest
is effectively connected to that permanent establishment. In
such cases the provisions of Article VII (Business Profits)
will apply and the source State will retain the right to impose
tax on such interest income.
Paragraph 4 of Article XI
Paragraph 4 is in all material respects the same as
paragraph 6 of Article XI of the existing Convention. The only
difference is that, consistent with the changes described below
with respect to Article 9 of the Protocol, paragraph 4 does not
contain references to a fixed base.
Paragraph 4 establishes the source of interest for purposes
of Article XI. Interest is considered to arise in a Contracting
State if the payer is that State, or a political subdivision,
local authority, or resident of that State. However, in cases
where the person paying the interest, whether a resident of a
Contracting State or of a third State, has in a State other
than that of which he is a resident a permanent establishment
in connection with which the indebtedness on which the interest
was paid was incurred, and such interest is borne by the
permanent establishment, then such interest is deemed to arise
in the State in which the permanent establishment is situated
and not in the State of the payer's residence. Furthermore,
pursuant to paragraphs 1 and 4, and Article XXII (Other
Income), Canadian tax will not be imposed on interest paid to a
U.S. resident by a company resident in Canada if the
indebtedness is incurred in connection with, and the interest
is borne by, a permanent establishment of the company situated
in a third State. For the purposes of this Article, ``borne
by'' means allowable as a deduction in computing taxable
income.
Paragraph 5 of Article XI
Paragraph 5 is identical to paragraph 7 of Article XI of
the existing Convention.
Paragraph 5 provides that in cases involving special
relationships between the payer and the beneficial owner of
interest income or between both of them and some other person,
Article XI applies only to that portion of the total interest
payments that would have been made absent such special
relationships (i.e., an arm's-length interest payment). Any
excess amount of interest paid remains taxable according to the
laws of the United States and Canada, respectively, with due
regard to the other provisions of the Convention.
New paragraph 6 provides anti-abuse exceptions to exclusive
residence State taxation in paragraph 1 for two classes of
interest payments.
The first class of interest, dealt with in subparagraphs
6(a) and 6(b), is so-called ``contingent interest.'' With
respect to interest arising in the United States, subparagraph
6(a) refers to contingent interest of a type that does not
qualify as portfolio interest under U.S. domestic law. The
cross-reference to the U.S. definition of contingent interest,
which is found in Code section 871(h)(4), is intended to ensure
that the exceptions of Code section 871 (h)(4)(C) will apply.
With respect to Canada, such interest is defined in
subparagraph 6(b) as any interest arising in Canada that is
determined by reference to the receipts, sales, income, profits
or other cash flow of the debtor or a related person, to any
change in the value of any property of the debtor or a related
person or to any dividend, partnership distribution or similar
payment made by the debtor or a related person.1 Any such
interest may be taxed in Canada according to the laws of
Canada.
Under subparagraph 6(a) or 6(b), if the beneficial owner is
a resident of the other Contracting State, the gross amount of
the ``contingent interest'' may be taxed at a rate not
exceeding 15 percent.
The second class of interest is dealt with in subparagraph
6(c). This exception is consistent with the policy of Code
sections 860E(e) and 860G(b) that excess inclusions with
respect to a real estate mortgage investment conduit (REMIC)
should bear full U.S. tax in all cases. Without a full tax at
source, foreign purchasers of residual interests would have a
competitive advantage over U.S. purchasers at the time these
interests are initially offered. Also, absent this rule, the
U.S. fisc would suffer a revenue loss with respect to mortgages
held in a REMIC because of opportunities for tax avoidance
created by differences in the timing of taxable and economic
income produced by these interests.
Therefore, subparagraph 6(c) provides a bilateral provision
that interest that is an excess inclusion with respect to a
residual interest in a REMIC may be taxed by each State in
accordance with its domestic law. While the provision is
written reciprocally, at the time the Protocol was signed, the
provision had no application in respect of Canadian-source
interest, as Canada did not have REMICs.
Paragraph 7 of Article XI
Paragraph 7 is in all material respects the same as
paragraph 8 of Article XI of the existing Convention. The only
difference is that, consistent with the changes made in Article
9 of the Protocol, paragraph 7 removes the references to a
fixed base.
Paragraph 7 restricts the right of a Contracting State to
impose tax on interest paid by a resident of the other
Contracting State. The first State may not impose any tax on
such interest except insofar as the interest is paid to a
resident of that State or arises in that State or the debt
claim in respect of which the interest is paid is effectively
connected with a permanent establishment situated in that
State.
1 New subparagraph 6(b) of Article XI erroneously refers to
a ``similar payment made by the debtor to a related person.''
The correct formulation, which the Contracting States agree to
apply, is ``similar payment made by the debtor or a related
person.''
Relationship to other Articles
Notwithstanding the foregoing limitations on source State
taxation of interest, the saving clause of paragraph 2 of
Article XXIX (Miscellaneous Rules) permits the United States to
tax its residents and citizens, subject to the special foreign
tax credit rules of paragraph 5 of Article XXIV (Elimination of
Double Taxation), as if the Convention had not come into force.
ARTICLE 7
Article 7 of the Protocol amends Article XII (Royalties) of
the existing Convention. As with other benefits of the
Convention, the benefits of Article XII are available to a
resident of a Contracting State only if that resident is
entitled to those benefits under the provisions of Article XXIX
A (Limitation on Benefits).
See the Technical Explanation for new paragraphs 6 and 7
of Article IV (Residence) for discussion regarding the
interaction between domestic law concepts of beneficial
ownership and the treaty rules to determine when a person is
considered to derive an item of income for purposes of
obtaining benefits of the Convention such as withholding rate
reductions.
Paragraph 1
Paragraph 1 of Article 7 of the Protocol replaces paragraph
5 of Article XII of the Convention. In all material respects,
new paragraph 5 is the same as paragraph 5 of Article XII of
the existing Convention. However, new paragraph 5 adds
clarifying language consistent with the changes made in
Articles 4, 5, and 6 of the Protocol with respect to income
attributable to a permanent establishment that has ceased to
exist. To conform with Article 9 of the Protocol, which deletes
Article XIV (Independent Personal Services) of the Convention,
paragraph 1 of Article 7 of the Protocol also amends paragraph
5 of Article XII by omitting the reference to a ``fixed base.''
New paragraph 5 provides that the 10 percent limitation on
tax in the source State provided by paragraph 2, and the
exemption in the source State for certain royalties provided by
paragraph 3, do not apply if the beneficial owner of the
royalties carries on or has carried on business in the source
State through a permanent establishment and the right or
property in respect of which the royalties are paid is
attributable to such permanent establishment. In such case, the
royalty income would be taxable by the source State under the
provisions of Article VII (Business Profits).
Paragraph 2
Paragraph 2 of Article 7 of the Protocol sets forth a new
subparagraph 6(a) of Article XII that is in all material
respects the same as subparagraph 6(a) of Article XII of the
existing Convention. The only difference is that, consistent
with the changes made in Article 9 of the Protocol, new
subparagraph 6(a) omits references to a ``fixed base.''
Paragraph 3
Paragraph 3 of Article 7 of Protocol amends paragraph 8 of
Article XII of the Convention to remove references to a ``fixed
base.'' In addition, paragraph 8 of the General Note confirms
the intent of the Contracting States that the reference in
subparagraph 3(c) of Article XII of the Convention to
information provided in connection with a franchise agreement
generally refers only to information that governs or otherwise
deals with the operation (whether by the payer or by another
person) of the franchise, and not to other information
concerning industrial, commercial or scientific experience that
is held for resale or license.
ARTICLE 8
Paragraph 1
Paragraph 1 of Article 8 of the Protocol replaces paragraph
2 of Article XIII (Gains) of the existing Convention.
Consistent with Article 9 of the Protocol, new paragraph 2 does
not contain any reference to property pertaining to a fixed
base or to the performance of independent personal services.
New paragraph 2 of Article XIII provides that the
Contracting State in which a resident of the other Contracting
State has or had a permanent establishment may tax gains from
the alienation of personal property constituting business
property if such gains are attributable to such permanent
establishment. Unlike paragraph 1 of Article VII (Business
Profits), paragraph 2 limits the right of the source State to
tax such gains to a twelve-month period following the
termination of the permanent establishment.
Paragraph 2
Paragraph 2 of Article 8 of the Protocol replaces paragraph
5 of Article XIII of the existing Convention. In general, new
paragraph 5 provides an exception to the general rule stated in
paragraph 4 that gains from the alienation of any property,
other than property referred to in paragraphs 1, 2, and 3,
shall be taxable only in the Contracting State of which the
alienator is a resident. Paragraph 5 provides that a
Contracting State may, according to its domestic law, impose
tax on gains derived by an individual who is a resident of the
other Contracting State if such individual was a resident of
the first-mentioned State for 120 months (whether or not
consecutive) during any period of 20 consecutive years
preceding the alienation of the property, and was a resident of
that State at any time during the 10-year period immediately
preceding the alienation of the property. Further, the property
(or property received in substitution in a tax-free transaction
in the first-mentioned State) must have been owned by the
individual at the time he ceased to be a resident of the first-
mentioned State and must not have been property that the
individual was treated as having alienated by reason of ceasing
to be a resident of the first-mentioned State and becoming a
resident of the other Contracting State.
The provisions of new paragraph 5 are substantially similar
to paragraph 5 of Article XIII of the existing Convention.
However, the Protocol adds a new requirement to paragraph 5
that the property not be ``a property that the individual was
treated as having alienated by reason of ceasing to be a
resident of the first-mentioned State and becoming a resident
of the other Contracting State.'' This new requirement reflects
the fact that the main purpose of paragraph 5--ensuring that
gains that accrue while an individual is resident in a
Contracting State remain taxable for the stated time after the
individual has moved to the other State--is met if that pre-
departure gain is taxed in the first State immediately before
the individual's emigration. This rule applies whether or not
the individual makes the election provided by paragraph 7 of
Article XIII, as amended, which is described below.
Paragraph 3
Paragraph 3 of Article 8 of the Protocol replaces paragraph
7 of Article XIII.
The purpose of paragraph 7, in both its former and revised
form, is to provide a rule to coordinate U.S. and Canadian
taxation of gains in the case of a timing mismatch. Such a
mismatch may occur, for example, where a Canadian resident is
deemed, for Canadian tax purposes, to recognize capital gain
upon emigrating from Canada to the United States, or in the
case of a gift that Canada deems to be an income producing
event for its tax purposes but with respect to which the United
States defers taxation while assigning the donor's basis to the
donee. The former paragraph 7 resolved the timing mismatch of
taxable events by allowing the individual to elect to be liable
to tax in the deferring Contracting State as if he had sold and
repurchased the property for an amount equal to its fair market
value at a time immediately prior to the deemed alienation.
The election under former paragraph 7 was not available to
certain non-U.S. citizens subject to tax in Canada by virtue of
a deemed alienation because such individuals could not elect to
be liable to tax in the United States. To address this problem,
the Protocol replaces the election provided in former paragraph
7, with an election by the taxpayer to be treated by a
Contracting State as having sold and repurchased the property
for its fair market value immediately before the taxable event
in the other Contracting State. The election in new paragraph 7
therefore will be available to any individual who emigrates
from Canada to the United States, without regard to whether the
person is a U.S. citizen immediately before ceasing to be a
resident of Canada. If the individual is not subject to U.S.
tax at that time, the effect of the election will be to give
the individual an adjusted basis for U.S. tax purposes equal to
the fair market value of the property as of the date of the
deemed alienation in Canada, with the result that only post-
emigration gain will be subject to U.S. tax when there is an
actual alienation. If the Canadian resident is also a U.S.
citizen at the time of his emigration from Canada, then the
provisions of new paragraph 7 would allow the U.S. citizen to
accelerate the tax under U.S. tax law and allow tax credits to
be used to avoid double taxation. This would also be the case
if the person, while not a U.S. citizen, would otherwise be
subject to taxation in the United States on a disposition of
the property.
In the case of Canadian taxation of appreciated property
given as a gift, absent paragraph 7, the donor could be subject
to tax in Canada upon making the gift, and the donee may be
subject to tax in the United States upon a later disposition of
the property on all or a portion of the same gain in the
property without the availability of any foreign tax credit for
the tax paid to Canada. Under new paragraph 7, the election
will be available to any individual who pays taxes in Canada on
a gain arising from the individual's gifting of a property,
without regard to whether the person is a U.S. taxpayer at the
time of the gift. The effect of the election in such case will
be to give the donee an adjusted basis for U.S. tax purposes
equal to the fair market value as of the date of the gift. If
the donor is a U.S. taxpayer, the effect of the election will
be the realization of gain or loss for U.S. purposes
immediately before the gift. The acceleration of the U.S. tax
liability by reason of the election in such case enables the
donor to utilize foreign tax credits and avoid double taxation
with respect to the disposition of the property.
Generally, the rule does not apply in the case of death.
Note, however, that Article XXIX B (Taxes Imposed by Reason of
Death) of the Convention provides rules that coordinate the
income tax that Canada imposes by reason of death with the U.S.
estate tax.
If in one Contracting State there are losses and gains from
deemed alienations of different properties, then paragraph 7
must be applied consistently in the other Contracting State
within the taxable period with respect to all such properties.
Paragraph 7 only applies, however, if the deemed alienations of
the properties result in a net gain.
Taxpayers may make the election provided by new paragraph 7
only with respect to property that is subject to a Contracting
State's deemed disposition rules and with respect to which gain
on a deemed alienation is recognized for that Contracting
State's tax purposes in the taxable year of the deemed
alienation. At the time the Protocol was signed, the following
were the main types of property that were excluded from the
deemed disposition rules in the case of individuals (including
trusts) who cease to be residents of Canada: real property
situated in Canada; interests and rights in respect of
pensions; life insurance policies (other than segregated fund
(investment) policies); rights in respect of annuities;
interests in testamentary trusts, unless acquired for
consideration; employee stock options; property used in a
business carried on through a permanent establishment in Canada
(including intangibles and inventory); interests in most
Canadian personal trusts; Canadian resource property; and
timber resource property.
Paragraph 4
Consistent with the provisions of Article 9 of the
Protocol, paragraph 4 of Article 8 of the Protocol amends
subparagraph 9(c) of Article XIII of the existing Convention to
remove the words ``or pertained to a fixed base.''
Relationship to other Articles
The changes to Article XIII set forth in paragraph 3 were
announced in a press release issued by the Treasury Department
on September 18, 2000. Consistent with that press release,
subparagraph 3(e) of Article 27 of the Protocol provides that
the changes, jointly effectuated by paragraphs 2 and 3, will be
generally effective for alienations of property that occur
after September 17, 2000.
ARTICLE 9
To conform with the current U.S. and OECD Model
Conventions, Article 9 of the Protocol deletes Article XIV
(Independent Personal Services) of the Convention. The
subsequent articles of the Convention are not renumbered.
Paragraph 4 of the General Note elaborates that current tax
treaty practice omits separate articles for independent
personal services because a determination of the existence of a
fixed base is qualitatively the same as the determination of
the existence of a permanent establishment. Accordingly, the
taxation of income from independent personal services is
adequately governed by the provisions of Articles V (Permanent
Establishment) and VII (Business Profits).
ARTICLE 10
Article 10 of the Protocol renames Article XV of the
Convention as ``Income from Employment'' to conform with the
current U.S. and OECD Model Conventions, and replaces
paragraphs 1 and 2 of that renamed article consistent with the
OECD Model Convention.
Paragraph 1
New paragraph 1 of Article XV provides that, in general,
salaries, wages, and other remuneration derived by a resident
of a Contracting State in respect of an employment are taxable
only in that State unless the employment is exercised in the
other Contracting State. If the employment is exercised in the
other Contracting State, the entire remuneration derived
therefrom may be taxed in that other State, subject to the
provisions of paragraph 2.
New paragraph 1 of Article XV does not contain a reference
to ``similar'' remuneration. This change was intended to
clarify that Article XV applies to any form of compensation for
employment, including payments in kind. This interpretation is
consistent with paragraph 2.1 of the Commentary to Article 15
(Income from Employment) of the OECD Model and the Technical
Explanation of the 2006 U.S. Model.
Paragraph 2
New paragraph 2 of Article XV provides two limitations on
the right of a source State to tax remuneration for services
rendered in that State. New paragraph 2 is divided into two
subparagraphs that each sets forth a rule which,
notwithstanding any contrary result due to the application of
paragraph 1 of Article XV, prevents the source State from
taxing income from employment in that State.
First, subparagraph 2(a) provides a safe harbor rule that
the remuneration may not be taxed in the source State if such
remuneration is $10,000 or less in the currency of the source
State. This rule is identical to the rule in subparagraph 2(a)
of Article XV of the existing Convention. It is understood
that, consistent with the prior rule, the safe harbor will
apply on a calendar-year basis.
Second, if the remuneration is not exempt from tax in the
source State by virtue of subparagraph 2(a), subparagraph 2(b)
provides an additional rule that the source State may not tax
remuneration for services rendered in that State if the
recipient is present in the source State for a period (or
periods) that does not exceed in the aggregate 183 days in any
twelve-month period commencing or ending in the fiscal year
concerned, and the remuneration is not paid by or on behalf of
a person who is a resident of that other State or borne by a
permanent establishment in that other State. For purposes of
this article, ``borne by'' means allowable as a deduction in
computing taxable income.
Assume, for example, that Mr. X, an individual resident in
Canada, is an employee of the Canadian permanent establishment
of USCo, a U.S. company. Mr. X is sent to the United States to
perform services and is present in the United States for less
than 183 days. Mr. X receives more than $10,000 (U.S.) in the
calendar year(s) in question. The remuneration paid to Mr. X
for such services is not exempt from U.S. tax under paragraph
1, because his employer, USCo, is a resident of the United
States and pays his remuneration. If instead Mr. X received
less than $10,000 (U.S.), such earnings would be exempt from
tax in the United States, because in all cases where an
employee earns less than $10,000 in the currency of the source
State, such earnings are exempt from tax in the source State.
As another example, assume Ms. Y, an individual resident in
the United States is employed by USCo, a U.S. company. Ms. Y is
sent to Canada to provide services in the Canadian permanent
establishment of USCo. Ms. Y is present in Canada for less than
183 days. Ms. Y receives more than $10,000 (Canadian) in the
calendar year(s) in question. USCo charges the Canadian
permanent establishment for Ms. Y's remuneration, which the
permanent establishment takes as a deduction in computing its
taxable income. The remuneration paid to Ms. Y for such
services is not exempt from Canadian tax under paragraph 1,
because her remuneration is borne by the Canadian permanent
establishment.
New subparagraph 2(b) refers to remuneration that is paid
by or on behalf of a ``person'' who is a resident of the other
Contracting State, as opposed to an ``employer.'' This change
is intended only to clarify that both the United States and
Canada understand that in certain abusive cases, substance over
form principles may be applied to recharacterize an employment
relationship, as prescribed in paragraph 8 of the Commentary to
Article 15 (Income from Employment) of the OECD Model.
Subparagraph 2(b) is intended to have the same meaning as the
analogous provisions in the U.S. and OECD Models.
Paragraph 6 of the General Note
Paragraph 6 of the General Note contains special rules
regarding employee stock options. There are no similar rules in
the U.S. Model or the OECD Model, although the issue is
discussed in detail in paragraph 12 of the Commentary to
Article 15 (Income from Employment) of the OECD Model.
The General Note sets forth principles that apply for
purposes of applying Article XV and Article XXIV (Elimination
of Double Taxation) to income of an individual in connection
with the exercise or other disposal (including a deemed
exercise or disposal) of an option that was granted to the
individual as an employee of a corporation or mutual fund trust
to acquire shares or units (``securities'') of the employer in
respect of services rendered or to be rendered by such
individual, or in connection with the disposal (including a
deemed disposal) of a security acquired under such an option.
For this purpose, the term ``employer'' is considered to
include any entity related to the service recipient. The
reference to a disposal (or deemed disposal) reflects the fact
that under Canadian law and under certain provisions of U.S.
law, income or gain attributable to the granting or exercising
of the option may, in some cases, not be recognized until
disposition of the securities.
Subparagraph 6(a) of the General Note provides a specific
rule to address situations where, under the domestic law of the
Contracting States, an employee would be taxable by both
Contracting States in respect of the income in connection with
the exercise or disposal of the option. The rule provides an
allocation of taxing rights where (1) an employee has been
granted a stock option in the course of employment in one of
the Contracting States, and (2) his principal place of
employment has been situated in one or both of the Contracting
States during the period between grant and exercise (or
disposal) of the option. In this situation, each Contracting
State may tax as Contracting State of source only that
proportion of the income that relates to the period or periods
between the grant and the exercise (or disposal) of the option
during which the individual's principal place of employment was
situated in that Contracting State. The proportion attributable
to a Contracting State is determined by multiplying the income
by a fraction, the numerator of which is the number of days
between the grant and exercise (or disposal) of the option
during which the employee's principal place of employment was
situated in that Contracting State and the denominator of which
is the total number of days between grant and exercise (or
disposal) of the option that the employee was employed by the
employer.
If the individual is a resident of one of the Contracting
States at the time he exercises the option, that Contracting
State will have the right, as the State of residence, to tax
all of the income under the first sentence of paragraph 1 of
Article XV. However, to the extent that the employee renders
his employment in the other Contracting State for some period
of time between the date of the grant of the option and the
date of the exercise (or disposal) of the option, the
proportion of the income that is allocated to the other
Contracting State under subparagraph 6(a) of the General Note
will, subject to paragraph 2, be taxable by that other State
under the second sentence of paragraph 1 of Article XV of the
Convention. For this purpose, the tests of paragraph 2 of
Article XV are applied to the year or years in which the
relevant services were performed in the other Contracting State
(and not to the year in which the option is exercised or
disposed). To the extent the same income is subject to taxation
in both Contracting States after application of Article XV,
double taxation will be alleviated under the rules of Article
XXIV (Elimination of Double Taxation).
Subparagraph 6(b) of the General Note provides that
notwithstanding subparagraph 6(a), if the competent authorities
of both Contracting States agree that the terms of the option
were such that the grant of the option is appropriately treated
as transfer of ownership of the securities (e.g., because the
options were in-the-money or not subject to a substantial
vesting period), then they may agree to attribute income
accordingly.
ARTICLE 11
Consistent with Article 9 and paragraph 1 of Article 10 of
the Protocol, paragraphs 1, 2, and 3 of Article 11 of the
Protocol revise paragraphs 1, 2, and 4 of Article XVI (Artistes
and Athletes) of the existing Convention by deleting references
to former Article XIV (Independent Personal Services) of the
Convention and deleting and replacing other language in
acknowledgement of the renaming of Article XV (Income from
Employment).
ARTICLE 12
Article 12 of the Protocol deletes Article XVII
(Withholding of Taxes in Respect of Personal Services) from the
Convention. However, the subsequent Articles are not
renumbered.
ARTICLE 13
Article 13 of the Protocol replaces paragraphs 3, 4, and 7
and adds paragraphs 8 through 17 to Article XVIII (Pensions and
Annuities) of the Convention.
Paragraph 1--Roth IRAs
Paragraph 1 of Article 13 of the Protocol separates the
provisions of paragraph 3 of Article XVIII into two
subparagraphs. Subparagraph 3(a) contains the existing
definition of the term ``pensions,'' while subparagraph 3(b)
adds a new rule to address the treatment of Roth IRAs or
similar plan (as described below).
Subparagraph 3(a) of Article XVIII provides that the term
``pensions'' for purposes of the Convention includes any
payment under a superannuation, pension, or other retirement
arrangement, Armed-Forces retirement pay, war veterans pensions
and allowances, and amounts paid under a sickness, accident, or
disability plan, but does not include payments under an income-
averaging annuity contract (which are subject to Article XXII
(Other Income)) or social security benefits, including social
security benefits in respect of government services (which are
subject to paragraph 5 of Article XVIII). Thus, the term
``pensions'' includes pensions paid by private employers
(including pre-tax and Roth 401(k) arrangements) as well as any
pension paid in respect of government services. Further, the
definition of ``pensions'' includes, for example, payments from
individual retirement accounts (IRAs) in the United States and
from registered retirement savings plans (RRSPs) and registered
retirement income funds (RRIFs) in Canada.
Subparagraph 3(b) of Article XVIII provides that the term
``pensions'' generally includes a Roth IRA, within the meaning
of Code section 408A (or a similar plan described below).
Consequently, under paragraph 1 of Article XVIII, distributions
from a Roth IRA to a resident of Canada generally continue to
be exempt from Canadian tax to the extent they would have been
exempt from U.S. tax if paid to a resident of the United
States. In addition, residents of Canada generally may make an
election under paragraph 7 of Article XVIII to defer any
taxation in Canada with respect to income accrued in a Roth IRA
but not distributed by the Roth IRA, until such time as and to
the extent that a distribution is made from the Roth IRA or any
plan substituted therefore. Because distributions will be
exempt from Canadian tax to the extent they would have been
exempt from U.S. tax if paid to a resident of the United
States, the effect of these rules is that, in most cases, no
portion of the Roth IRA will be subject to taxation in Canada.
However, subparagraph 3(b) also provides that if an
individual who is a resident of Canada makes contributions to
his or her Roth IRA while a resident of Canada, other than
rollover contributions from another Roth IRA (or a similar plan
described below), the Roth IRA will cease to be considered a
pension at that time with respect to contributions and
accretions from such time and accretions from such time will be
subject to tax in Canada in the year of accrual. Thus, the Roth
IRA will in effect be bifurcated into a ``frozen'' pension that
continues to be subject to the rules of Article XVIII and a
savings account that is not subject to the rules of Article
XVIII. It is understood by the Contracting States that,
following a rollover contribution from a Roth 401(k)
arrangement to a Roth IRA, the Roth IRA will continue to be
treated as a pension subject to the rules of Article XVIII.
Assume, for example, that Mr. X moves to Canada on July 1,
2008. Mr. X has a Roth IRA with a balance of 1,100 on July 1,
2008. Mr. X elects under paragraph 7 of Article XVIII to defer
any taxation in Canada with respect to income accrued in his
Roth IRA while he is a resident of Canada. Mr. X makes no
additional contributions to his Roth IRA until July 1, 2010,
when he makes an after-tax contribution of 100. There are
accretions of 20 during the period July 1, 2008 through June
30, 2010, which are not taxed in Canada by reason of the
election under paragraph 7 of Article XVIII. There are
additional accretions of 50 during the period July 1, 2010
through June 30, 2015, which are subject to tax in Canada in
the year of accrual. On July 1, 2015, while Mr. X is still a
resident of Canada, Mr. X receives a lump-sum distribution of
1,270 from his Roth IRA. The 1,120 that was in the Roth IRA on
June 30, 2010 is treated as a distribution from a pension plan
that, pursuant to paragraph 1 of Article XVIII, is exempt from
tax in Canada provided it would be exempt from tax in the
United States under the Internal Revenue Code if paid to a
resident of the United States. The remaining 150 comprises the
after-tax contribution of 100 in 2010 and accretions of 50 that
were subject to Canadian tax in the year of accrual.
The rules of new subparagraph 3(b) of Article XVIII also
will apply to any plan or arrangement created pursuant to
legislation enacted by either Contracting State after September
21, 2007 (the date of signature of the Protocol) that the
competent authorities agree is similar to a Roth IRA.
Source of payments under life insurance and annuity
contracts
Paragraph 1 of Article 13 also replaces paragraph 4 of
Article XVIII. Subparagraph 4(a) contains the existing
definition of annuity, while subparagraph 4(b) adds a source
rule to address the treatment of certain payments by branches
of insurance companies.
Subparagraph 4(a) provides that, for purposes of the
Convention, the term ``annuity'' means a stated sum paid
periodically at stated times during life or during a specified
number of years, under an obligation to make the payments in
return for adequate and full consideration other than services
rendered. The term does not include a payment that is not
periodic or any annuity the cost of which was deductible for
tax purposes in the Contracting State where the annuity was
acquired. Items excluded from the definition of ``annuity'' and
not dealt with under another Article of the Convention are
subject to the rules of Article XXII (Other Income).
Under the existing Convention, payments under life
insurance and annuity contracts to a resident of Canada by a
Canadian branch of a U.S. insurance company are subject to
either a 15-percent withholding tax under subparagraph 2(b) of
Article XVIII or, unless dealt with under another Article of
the Convention, an unreduced 30-percent withholding tax under
paragraph 1 of Article XXII, depending on whether the payments
constitute annuities within the meaning of paragraph 4 of
Article XVIII.
On July 12, 2004, the Internal Revenue Service issued
Revenue Ruling 2004-75, 2004-2 C.B. 109, which provides in
relevant part that annuity payments under, and withdrawals of
cash value from, life insurance or annuity contracts issued by
a foreign branch of a U.S. life insurance company are U.S.-
source income that, when paid to a nonresident alien
individual, is generally subject to a 30-percent withholding
tax under Code sections 871(a) and 1441. Revenue Ruling 2004-
97, 2004-2 C.B. 516, provided that Revenue Ruling 2004-75 would
not be applied to payments that were made before January 1,
2005, provided that such payments were made pursuant to binding
life insurance or annuity contracts issued on or before July
12, 2004.
Under new subparagraph 4(b) of Article XVIII, an annuity or
other amount paid in respect of a life insurance or annuity
contract (including a withdrawal in respect of the cash value
thereof), will generally be deemed to arise in the Contracting
State where the person paying the annuity or other amount (the
``payer'') is resident. However, if the payer, whether a
resident of a Contracting State or not, has a permanent
establishment in a Contracting State other than a Contracting
State in which the payer is a resident, the payment will be
deemed to arise in the Contracting State in which the permanent
establishment is situated if both of the following requirements
are satisfied: (i) the obligation giving rise to the annuity or
other amount must have been incurred in connection with the
permanent establishment, and (ii) the annuity or other amount
must be borne by the permanent establishment. When these
requirements are satisfied, payments by a Canadian branch of a
U.S. insurance company will be deemed to arise in Canada.
Paragraph 2
Paragraph 2 of Article 13 of the Protocol replaces
paragraph 7 of Article XVIII of the existing Convention.
Paragraph 7 continues to provide a rule with respect to the
taxation of a natural person on income accrued in a pension or
employee benefit plan in the other Contracting State. Thus,
paragraph 7 applies where an individual is a citizen or
resident of a Contracting State and is a beneficiary of a
trust, company, organization, or other arrangement that is a
resident of the other Contracting State, where such trust,
company, organization, or other arrangement is generally exempt
from income taxation in that other State, and is operated
exclusively to provide pension, or employee benefits. In such
cases, the beneficiary may elect to defer taxation in his State
of residence on income accrued in the plan until it is
distributed from the plan (or from another plan in that other
Contracting State to which the income is transferred pursuant
to the domestic law of that other Contracting State).
Paragraph 2 of Article 13 of the Protocol makes two changes
to paragraph 7 of Article XVIII of the existing Convention. The
first change is that the phrase ``pension, retirement or
employee benefits'' is changed to ``pension or employee
benefits'' solely to reflect the fact that in certain cases,
discussed above, Roth IRAs will not be treated as pensions for
purposes of Article XVIII. The second change is that ``under''
is changed to ``subject to'' to make it clear that an election
to defer taxation with respect to undistributed income accrued
in a plan may be made whether or not the competent authority of
the first-mentioned State has prescribed rules for making an
election. For the U.S. rules, see Revenue Procedure 2002-23,
2002-1 C.B. 744. As of the date the Protocol was signed, the
competent authority of Canada had not prescribed rules.
Paragraph 3
Paragraph 3 of Article 13 of the Protocol adds paragraphs 8
through 17 to Article XVIII to deal with cross-border pension
contributions. These paragraphs are intended to remove barriers
to the flow of personal services between the Contracting States
that could otherwise result from discontinuities in the laws of
the Contracting States regarding the deductibility of pension
contributions. Such discontinuities may arise where a country
allows deductions or exclusions to its residents for
contributions, made by them or on their behalf, to resident
pension plans, but does not allow deductions or exclusions for
payments made to plans resident in another country, even if the
structure and legal requirements of such plans in the two
countries are similar.
There is no comparable set of rules in the OECD Model,
although the issue is discussed in detail in the Commentary to
Article 18 (Pensions). The 2006 U.S. Model deals with this
issue in paragraphs 2 through 4 of Article 18 (Pension Funds).
Workers on short-term assignments in the other Contracting State
Paragraphs 8 and 9 of Article XVIII address the case of a
short-term assignment where an individual who is participating
in a ``qualifying retirement plan'' (as defined in paragraph 15
of Article XVIII) in one Contracting State (the ``home State'')
performs services as an employee for a limited period of time
in the other Contracting State (the ``host State''). If certain
requirements are satisfied, contributions made to, or benefits
accrued under, the plan by or on behalf of the individual will
be deductible or excludible in computing the individual's
income in the host State. In addition, contributions made to
the plan by the individual's employer will be allowed as a
deduction in computing the employer's profits in the host
State.
In order for paragraph 8 to apply, the remuneration that
the individual receives with respect to the services performed
in the host State must be taxable in the host State. This
means, for example, that where the United States is the host
State, paragraph 8 would not apply if the remuneration that the
individual receives with respect to the services performed in
the United States is exempt from taxation in the United States
under Code section 893.
The individual also must have been participating in the
plan, or in another similar plan for which the plan was
substituted, immediately before he began performing services in
the host State. The rule regarding a successor plan would apply
if, for example, the employer has been acquired by another
corporation that replaces the existing plan with its own plan,
transferring membership in the old plan over into the new plan.
In addition, the individual must not have been a resident
(as determined under Article IV (Residence)) of the host State
immediately before he began performing services in the host
State. It is irrelevant for purposes of paragraph 8 whether the
individual becomes a resident of the host State while he
performs services there. A citizen of the United States who has
been a resident of Canada may be entitled to benefits under
paragraph 8 if (a) he performs services in the United States
for a limited period of time and (b) he was a resident of
Canada immediately before he began performing such services.
Benefits are available under paragraph 8 only for so long
as the individual has not performed services in the host State
for the same employer (or a related employer) for more than 60
of the 120 months preceding the individual's current taxable
year. The purpose of this rule is to limit the period of time
for which the host State will be required to provide benefits
for contributions to a plan from which it is unlikely to be
able to tax the distributions. If the individual continues to
perform services in the host State beyond this time limit, he
is expected to become a participant in a plan in the host
State. Canada's domestic law provides preferential tax
treatment for employer contributions to foreign pension plans
in respect of services rendered in Canada by short-term
residents, but such treatment ceases once the individual has
been resident in Canada for at least 60 of the preceding 72
months.
The contributions and benefits must be attributable to
services performed by the individual in the host State, and
must be made or accrued during the period in which the
individual performs those services. This rule prevents
individuals who render services in the host State for a very
short period of time from making disproportionately large
contributions to home State plans in order to offset the tax
liability associated with the income earned in the host State.
In the case where the United States is the host State,
contributions will be deemed to have been made on the last day
of the preceding taxable year if the payment is on account of
such taxable year and is treated under U.S. law as a
contribution made on the last day of the preceding taxable
year.
If an individual receives benefits in the host State with
respect to contributions to a plan in the home State, the
services to which the contributions relate may not be taken
into account for purposes of determining the individual's
entitlement to benefits under any trust, company, organization,
or other arrangement that is a resident of the host State,
generally exempt from income taxation in that State and
operated to provide pension or retirement benefits. The purpose
of this rule is to prevent double benefits for contributions to
both a home State plan and a host State plan with respect to
the same services. Thus, for example, an individual who is
working temporarily in the United States and making
contributions to a qualifying retirement plan in Canada with
respect to services performed in the United States may not make
contributions to an individual retirement account (within the
meaning of Code section 40 8(a)) in the United States with
respect to the same services.
Paragraph 8 states that it applies only to the extent that
the contributions or benefits would qualify for tax relief in
the home State if the individual were a resident of and
performed services in that State. Thus, benefits would be
limited in the same fashion as if the individual continued to
be a resident of the home State. However, paragraph 9 provides
that if the host State is the United States and the individual
is a citizen of the United States, the benefits granted to the
individual under paragraph 8 may not exceed the benefits that
would be allowed by the United States to its residents for
contributions to, or benefits otherwise accrued under, a
generally corresponding pension or retirement plan established
in and recognized for tax purposes by the United States. Thus,
the lower of the two limits applies. This rule ensures that
U.S. citizens working temporarily in the United States and
participating in a Canadian plan will not get more favorable
U.S. tax treatment than U.S. citizens participating in a U.S.
plan.
Where the United States is the home State, the amount of
contributions that may be excluded from the employee's income
under paragraph 8 for Canadian purposes is limited to the U.S.
dollar amount specified in Code section 415 or the U.S. dollar
amount specified in Code section 402(g)(1) to the extent
contributions are made from the employee's compensation. For
this purpose, the dollar limit specified in Code section
402(g)(1) means the amount applicable under Code section
402(g)(1) (including the age 50 catch-up amount in Code section
402(g)(1)(C)) or, if applicable, the parallel dollar limit
applicable under Code section 457(e)(15) plus the age 50 catch-
up amount under Code section 414(v)(2)(B)(i) for a Code section
457(g) trust.
Where Canada is the home State, the amount of contributions
that may be excluded from the employee's income under paragraph
8 for U.S. purposes is subject to the limitations specified in
subsections 146(5), 147(8), 147.1(8) and (9) and 147.2(1) and
(4) of the Income Tax Act and paragraph 8503(4)(a) of the
Income Tax Regulations, as applicable. If the employee is a
citizen of the United States, then the amount of contributions
that may be excluded is the lesser of the amounts determined
under the limitations specified in the previous sentence and
the amounts specified in the previous paragraph.
The provisions described above provide benefits to
employees. Paragraph 8 also provides that contributions made to
the home State plan by an individual's employer will be allowed
as a deduction in computing the employer's profits in the host
State, even though such a deduction might not be allowable
under the domestic law of the host State. This rule applies
whether the employer is a resident of the host State or a
permanent establishment that the employer has in the host
State. The rule also applies to contributions by a person
related to the individual's employer, such as contributions by
a parent corporation for its subsidiary, that are treated under
the law of the host State as contributions by the individual's
employer. For example, if an individual who is participating in
a qualifying retirement plan in Canada performs services for a
limited period of time in the United States for a U.S.
subsidiary of a Canadian company, a contribution to the
Canadian plan by the parent company in Canada that is treated
under U.S. law as a contribution by the U.S. subsidiary would
be covered by the rule.
The amount of the allowable deduction is to be determined
under the laws of the home State. Thus, where the United States
is the home State, the amount of the deduction that is
allowable in Canada will be subject to the limitations of Code
section 404 (including the Code section 401(a)(17) and 415
limitations). Where Canada is the home State, the amount of the
deduction that is allowable in the United States is subject to
the limitations specified in subsections 147(8), 147.1(8) and
(9) and 147.2(1) of the Income Tax Act, as applicable.
Cross-border commuters
Paragraphs 10, 11, and 12 of Article XVIII address the case
of a commuter who is a resident of one Contracting State (the
``residence State'') and performs services as an employee in
the other Contracting State (the ``services State'') and is a
member of a ``qualifying retirement plan'' (as defined in
paragraph 15 of Article XVIII) in the services State. If
certain requirements are satisfied, contributions made to, or
benefits accrued under, the qualifying retirement plan by or on
behalf of the individual will be deductible or excludible in
computing the individual's income in the residence State.
In order for paragraph 10 to apply, the individual must
perform services as an employee in the services State the
remuneration from which is taxable in the services State and is
borne by either an employer who is a resident of the services
State or by a permanent establishment that the employer has in
the services State. The contributions and benefits must be
attributable to those services and must be made or accrued
during the period in which the individual performs those
services. In the case where the United States is the residence
State, contributions will be deemed to have been made on the
last day of the preceding taxable year if the payment is on
account of such taxable year and is treated under U.S. law as a
contribution made on the last day of the preceding taxable
year.
Paragraph 10 states that it applies only to the extent that
the contributions or benefits qualify for tax relief in the
services State. Thus, the benefits granted in the residence
State are available only to the extent that the contributions
or benefits accrued qualify for relief in the services State.
Where the United States is the services State, the amount of
contributions that may be excluded under paragraph 10 is the
U.S. dollar amount specified in Code section 415 or the U.S.
dollar amount specified in Code section 402(g)(1) (as defined
above) to the extent contributions are made from the employee's
compensation. Where Canada is the services State, the amount of
contributions that may be excluded from the employee's income
under paragraph 10 is subject to the limitations specified in
subsections 146(5), 147(8), 147.1(8) and (9) and 147.2(1) and
(4) of the Income Tax Act and paragraph 8503(4)(a) of the
Income Tax Regulations, as applicable.
However, paragraphs 11 and 12 further provide that the
benefits granted under paragraph 10 by the residence State may
not exceed certain benefits that would be allowable under the
domestic law of the residence State.
Paragraph 11 provides that where Canada is the residence
State, the amount of contributions otherwise allowable as a
deduction under paragraph 10 may not exceed the individual's
deduction limit for contributions to registered retirement
savings plans (RRSPs) remaining after taking into account the
amount of contributions to RRSPs deducted by the individual
under the law of Canada for the year. The amount deducted by
the individual under paragraph 10 will be taken into account in
computing the individual's deduction limit for subsequent
taxation years for contributions to RRSPs. This rule prevents
double benefits for contributions to both an RRSP and a
qualifying retirement plan in the United States with respect to
the same services.
Paragraph 12 provides that if the United States is the
residence State, the benefits granted to an individual under
paragraph 10 may not exceed the benefits that would be allowed
by the United States to its residents for contributions to, or
benefits otherwise accrued under, a generally corresponding
pension or retirement plan established in and recognized for
tax purposes by the United States. For purposes of determining
an individual's eligibility to participate in and receive tax
benefits with respect to a pension or retirement plan or other
retirement arrangement in the United States, contributions made
to, or benefits accrued under, a qualifying retirement plan in
Canada by or on behalf of the individual are treated as
contributions or benefits under a generally corresponding
pension or retirement plan established in and recognized for
tax purposes by the United States. Thus, for example, the
qualifying retirement plan in Canada would be taken into
account for purposes of determining whether the individual is
an ``active participant'' within the meaning of Code section 21
9(g)(5), with the result that the individual's ability to make
deductible contributions to an individual retirement account in
the United States would be limited.
Paragraph 10 does not address employer deductions because
the employer is located in the services State and is already
eligible for deductions under the domestic law of the services
State.
U.S. citizens resident in Canada
Paragraphs 13 and 14 of Article XVIII address the special
case of a U.S. citizen who is a resident of Canada (as
determined under Article IV (Residence)) and who performs
services as an employee in Canada and participates in a
qualifying retirement plan (as defined in paragraph 15 of
Article XVIII) in Canada. If certain requirements are
satisfied, contributions made to, or benefits accrued under, a
qualifying retirement plan in Canada by or on behalf of the
U.S. citizen will be deductible or excludible in computing his
or her taxable income in the United States. These provisions
are generally consistent with paragraph 4 of Article 18 of the
U.S. Model treaty.
In order for paragraph 13 to apply, the U.S. citizen must
perform services as an employee in Canada the remuneration from
which is taxable in Canada and is borne by an employer who is a
resident of Canada or by a permanent establishment that the
employer has in Canada. The contributions and benefits must be
attributable to those services and must be made or accrued
during the period in which the U.S. citizen performs those
services. Contributions will be deemed to have been made on the
last day of the preceding taxable year if the payment is on
account of such taxable year and is treated under U.S. law as a
contribution made on the last day of the preceding taxable
year.
Paragraph 13 states that it applies only to the extent the
contributions or benefits qualify for tax relief in Canada.
However, paragraph 14 provides that the benefits granted under
paragraph 13 may not exceed the benefits that would be allowed
by the United States to its residents for contributions to, or
benefits otherwise accrued under, a generally corresponding
pension or retirement plan established in and recognized for
tax purposes by the United States. Thus, the lower of the two
limits applies. This rule ensures that a U.S. citizen living
and working in Canada does not receive better U.S. treatment
than a U.S. citizen living and working in the United States.
The amount of contributions that may be excluded from the
employee's income under paragraph 13 is the U.S. dollar amount
specified in Code section 415 or the U.S. dollar amount
specified in Code section 402(g)(1) (as defined above) to the
extent contributions are made from the employee's compensation.
In addition, pursuant to Code section 91 1(d)(6), an individual
may not claim benefits under paragraph 13 with respect to
services the remuneration for which is excluded from the
individual's gross income under Code section 911(a).
For purposes of determining the individual's eligibility to
participate in and receive tax benefits with respect to a
pension or retirement plan or other retirement arrangement
established in and recognized for tax purposes by the United
States, contributions made to, or benefits accrued under, a
qualifying retirement plan in Canada by or on behalf of the
individual are treated as contributions or benefits under a
generally corresponding pension or retirement plan established
in and recognized for tax purposes by the United States. Thus,
for example, the qualifying retirement plan in Canada would be
taken into account for purposes of determining whether the
individual is an ``active participant'' within the meaning of
Code section 21 9(g)(5), with the result that the individual's
ability to make deductible contributions to an individual
retirement account in the United States would be limited.
Paragraph 13 does not address employer deductions because
the employer is located in Canada and is already eligible for
deductions under the domestic law of Canada.
Definition of ``qualifying retirement plan''
Paragraph 15 of Article XVIII provides that for purposes of
paragraphs 8 through 14, a ``qualifying retirement plan'' in a
Contracting State is a trust, company, organization, or other
arrangement that (a) is a resident of that State, generally
exempt from income taxation in that State and operated
primarily to provide pension or retirement benefits; (b) is not
an individual arrangement in respect of which the individual's
employer has no involvement; and (c) the competent authority of
the other Contracting State agrees generally corresponds to a
pension or retirement plan established in and recognized for
tax purposes in that State. Thus, U.S. individual retirement
accounts (IRAs) and Canadian registered retirement savings
plans (RRSPs) are not treated as qualifying retirement plans
unless addressed in paragraph 10 of the General Note (as
discussed below). In addition, a Canadian retirement
compensation arrangement (RCA) is not a qualifying retirement
plan because it is not considered to be generally exempt from
income taxation in Canada.
Paragraph 10 of the General Note provides that the types of
Canadian plans that constitute qualifying retirement plans for
purposes of paragraph 15 include the following and any
identical or substantially similar plan that is established
pursuant to legislation introduced after the date of signature
of the Protocol (September 21, 2007): registered pension plans
under section 147.1 of the Income Tax Act, registered
retirement savings plans under section 146 that are part of a
group arrangement described in subsection 204.2(1.32), deferred
profit sharing plans under section 147, and any registered
retirement savings plan under section 146, or registered
retirement income fund under section 146.3, that is funded
exclusively by rollover contributions from one or more of the
preceding plans.
Paragraph 10 of the General Note also provides that the
types of U.S. plans that constitute qualifying retirement plans
for purposes of paragraph 15 include the following and any
identical or substantially similar plan that is established
pursuant to legislation introduced after the date of signature
of the Protocol (September 21, 2007): qualified plans under
Code section 401(a) (including Code section 401(k)
arrangements), individual retirement plans that are part of a
simplified employee pension plan that satisfies Code section
408(k), Code section 408(p) simple retirement accounts, Code
section 403(a) qualified annuity plans, Code section 403(b)
plans, Code section 457(g) trusts providing benefits under Code
section 457(b) plans, the Thrift Savings Fund (Code section
7701(j)), and any individual retirement account under Code
section 408(a) that is funded exclusively by rollover
contributions from one or more of the preceding plans.
If a particular plan in one Contracting State is of a type
specified in paragraph 10 of the General Note with respect to
paragraph 15 of Article XVIII, it will not be necessary for
taxpayers to obtain a determination from the competent
authority of the other Contracting State that the plan
generally corresponds to a pension or retirement plan
established in and recognized for tax purposes in that State. A
taxpayer who believes a particular plan in one Contracting
State that is not described in paragraph 10 of the General Note
nevertheless satisfies the requirements of paragraph 15 may
request a determination from the competent authority of the
other Contracting State that the plan generally corresponds to
a pension or retirement plan established in and recognized for
tax purposes in that State. In the case of the United States,
such a determination must be requested under Revenue Procedure
2006-54, 2006-49 I.R.B. 655 (or any applicable analogous
provision). In the case of Canada, the current version of
Information Circular 71-17 provides guidance on obtaining
assistance from the Canadian competent authority.
Source rule
Paragraph 16 of Article XVIII provides that a distribution
from a pension or retirement plan that is reasonably
attributable to a contribution or benefit for which a benefit
was allowed pursuant to paragraph 8, 10, or 13 of Article XVIII
will be deemed to arise in the Contracting State in which the
plan is established. This ensures that the Contracting State in
which the plan is established will have the right to tax the
gross amount of the distribution under subparagraph 2(a) of
Article XVIII, even if a portion of the services to which the
distribution relates were not performed in such Contracting
State.
Partnerships
Paragraph 17 of Article XVIII provides that paragraphs 8
through 16 of Article XVIII apply, with such modifications as
the circumstances require, as though the relationship between a
partnership that carries on a business, and an individual who
is a member of the partnership, were that of employer and
employee. This rule is needed because paragraphs 8, 10, and 13,
by their terms, apply only with respect to contributions made
to, or benefits accrued under, qualifying retirement plans by
or on behalf of individuals who perform services as an
employee. Thus, benefits are not available with respect to
retirement plans for self-employed individuals, who may be
deemed under U.S. law to be employees for certain pension
purposes. Paragraph 17 ensures that partners participating in a
plan established by their partnership may be eligible for the
benefits provided by paragraphs 8, 10, and 13.
Relationship to other Articles
Paragraphs 8, 10, and 13 of Article XVIII are not subject
to the saving clause of paragraph 2 of Article XXIX
(Miscellaneous Rules) by reason of the exception in
subparagraph 3(a) of Article XXIX.
ARTICLE 14
Consistent with Articles 9 and 10 of the Protocol, Article
14 of the Protocol amends Article XIX (Government Service) of
the Convention by deleting the reference to ``Article XIV
(Independent Personal Services)'' and replacing such reference
with the reference to ``Article VII (Business Profits)'' and by
reflecting the new name of Article XV (Income from Employment).
ARTICLE 15
Article 15 of the Protocol replaces Article XX (Students)
of the Convention. Article XX provides rules for host-country
taxation of visiting students and business trainees. Persons
who meet the tests of Article XX will be exempt from tax in the
State that they are visiting with respect to designated classes
of income. Several conditions must be satisfied in order for an
individual to be entitled to the benefits of this Article.
First, the visitor must have been, either at the time of
his arrival in the host State or immediately before, a resident
of the other Contracting State.
Second, the purpose of the visit must be the full-time
education or training of the visitor. Thus, if the visitor
comes principally to work in the host State but also is a part-
time student, he would not be entitled to the benefits of this
Article, even with respect to any payments he may receive from
abroad for his maintenance or education, and regardless of
whether or not he is in a degree program. Whether a student is
to be considered full-time will be determined by the rules of
the educational institution at which he is studying.
The host State exemption in Article XX applies to payments
received by the student or business trainee for the purpose of
his maintenance, education or training that arise outside the
host State. A payment will be considered to arise outside the
host State if the payer is located outside the host State.
Thus, if an employer from one of the Contracting States sends
an employee to the other Contracting State for full-time
training, the payments the trainee receives from abroad from
his employer for his maintenance or training while he is
present in the host State will be exempt from tax in the host
State. Where appropriate, substance prevails over form in
determining the identity of the payer. Thus, for example,
payments made directly or indirectly by a U.S. person with whom
the visitor is training, but which have been routed through a
source outside the United States (e.g., a foreign subsidiary),
are not treated as arising outside the United States for this
purpose.
In the case of an apprentice or business trainee, the
benefits of Article XX will extend only for a period of one
year from the time that the individual first arrives in the
host country for the purpose of the individual's training. If,
however, an apprentice or trainee remains in the host country
for a second year, thus losing the benefits of the Arti-cle, he
would not retroactively lose the benefits of the Article for
the first year.
Relationship to other Articles
The saving clause of paragraph 2 of Article XXIX
(Miscellaneous Rules) does not apply to Article XX with respect
to an individual who neither is a citizen of the host State nor
has been admitted for permanent residence there. The saving
clause, however, does apply with respect to citizens and
permanent residents of the host State. Thus, a U.S. citizen who
is a resident of Canada and who visits the United States as a
full-time student at an accredited university will not be
exempt from U.S. tax on remittances from abroad that otherwise
constitute U.S. taxable income. However, an individual who is
not a U.S. citizen, and who visits the United States as a
student and remains long enough to become a resident under U.S.
law, but does not become a permanent resident (i.e., does not
acquire a green card), will be entitled to the full benefits of
the Article.
ARTICLE 16
Article 16 of the Protocol revises Article XXI (Exempt
Organizations) of the existing Convention.
Paragraph 1
Paragraph 1 amends Article XXI by renumbering paragraphs 4,
5, and 6 as 5, 6, and 7, respectively.
Paragraph 2
Paragraph 2 replaces paragraphs 1 through 3 of Article XXI
with four new paragraphs. In general, the provisions of former
paragraphs 1 through 3 have been retained.
New paragraph 1 provides that a religious, scientific,
literary, educational, or charitable organization resident in a
Contracting State shall be exempt from tax on income arising in
the other Contracting State but only to the extent that such
income is exempt from taxation in the Contracting State in
which the organization is resident.
New paragraph 2 retains the provisions of former
subparagraph 2(a), and provides that a trust, company,
organization, or other arrangement that is resident in a
Contracting State and operated exclusively to administer or
provide pension, retirement or employee benefits or benefits
for the self-employed under one or more funds or plans
established to provide pension or retirement benefits or other
employee benefits is exempt from taxation on dividend and
interest income arising in the other Contracting State in a
taxable year, if the income of such organization or other
arrangement is generally exempt from taxation for that year in
the Contracting State in which it is resident.
New paragraph 3 replaces and expands the scope of former
subparagraph 2(b) Former subparagraph 2(b) provided that,
subject to the provisions of paragraph 3 (new paragraph 4), a
trust, company, organization or other arrangement that was a
resident of a Contracting State, generally exempt from income
taxation in that State and operated exclusively to earn income
for the benefit of one or more organizations described in
subparagraph 2(a) (new paragraph 2) was exempt from taxation on
dividend and interest income arising in the other Contracting
State in a taxable year. The Internal Revenue Service concluded
in private letter rulings (PLR 200111027 and PLR 200111037)
that a pooled investment fund that included as investors one or
more organizations described in paragraph 1 could not qualify
for benefits under former subparagraph 2(b). New paragraph 3
now allows organizations described in paragraph 1 to invest in
pooled funds with trusts, companies, organizations, or other
arrangements described in new paragraph 2.
Former subparagraph 2(b) did not exempt income earned by a
trust, company or other arrangement for the benefit of
religious, scientific, literary, educational or charitable
organizations exempt from tax under paragraph 1. Therefore, the
Protocol expands the scope of paragraph 3 to include such
income.
As noted above with respect to Article X (Dividends),
paragraph 3 of the General Note explains that distributions
from Canadian income trusts and royalty trusts that are treated
as dividends as a result of changes to Canada's law regarding
taxation of income and royalty trusts shall be treated as
dividends for the purposes of Article X. Accordingly, such
distributions will also be entitled to the benefits of Article
XXI.
New paragraph 4 replaces paragraph 3 and provides that the
exemptions provided by paragraphs 1, 2, 3 do not apply with
respect to the income of a trust, company, organization or
other arrangement from carrying on a trade or business or from
a related person, other than a person referred to in paragraph
1, 2 or 3. The term ``related person'' is not necessarily
defined by paragraph 2 of Article IX (Related Person).
ARTICLE 17
Article 17 of the Protocol amends Article XXII (Other
Income) of the Convention by adding a new paragraph 4. Article
XXII generally assigns taxing jurisdiction over income not
dealt with in the other articles (Articles VI through XXI) of
the Convention.
New paragraph 4 provides a specific rule for residence
State taxation of compensation derived in respect of a
guarantee of indebtedness. New paragraph 4 provides that
compensation derived by a resident of a Contracting State in
respect of the provision of a guarantee of indebtedness shall
be taxable only in that State, unless the compensation is
business profits attributable to a permanent establishment
situated in the other Contracting State, in which case the
provisions of Article VII (Business Profits) shall apply. The
clarification that Article VII shall apply when the
compensation is considered business profits was included at the
request of the United States. Compensation paid to a financial
services entity to provide a guarantee in the ordinary course
of its business of providing such guarantees to customers
constitutes business profits dealt with under the provisions of
Article VII. However, provision of guarantees with respect to
debt of related parties is ordinarily not an independent
economic undertaking that would generate business profits, and
thus compensation in respect of such related-party guarantees
is, in most cases, covered by Article XXII.
ARTICLE 18
Article 18 of the Protocol amends paragraph 2 of Article
XXIII (Capital) of the Convention by deleting language
contained in that paragraph consistent with the changes made by
Article 9 of the Protocol.
ARTICLE 19
Article 19 of the Protocol deletes subparagraph 2(b) of
Article XXIV (Elimination of Double Taxation) of the Convention
and replaces it with a new subparagraph.
New subparagraph 2(b) allows a Canadian company receiving a
dividend from a U.S. resident company of which it owns at least
10 percent of the voting stock, a credit against Canadian
income tax of the appropriate amount of income tax paid or
accrued to the United States by the dividend paying company
with respect to the profits out of which the dividends are
paid. The third Protocol to the Convention, signed March 17,
1995, had amended subparagraph (b) to allow a Canadian company
to deduct in computing its Canadian taxable income any dividend
received by it out of the exempt surplus of a foreign affiliate
which is a resident of the United States. This change is
consistent with current Canadian tax treaty practice: it does
not indicate any present intention to change Canada's ``exempt
surplus'' rules, and those rules remain in effect.
ARTICLE 20
Article 20 of the Protocol revises Article XXV (Non-
Discrimination) of the existing Convention to bring that
Article into closer conformity to U.S. tax treaty policy.
Paragraphs 1 and 2
Paragraph 1 replaces paragraph 1 of Article XXV of the
existing Convention. New paragraph 1 provides that a national
of one Contracting State may not be subject to taxation or
connected requirements in the other Contracting State that are
more burdensome than the taxes and connected requirements
imposed upon a national of that other State in the same
circumstances. The OECD Model would prohibit taxation that is
``other than or more burdensome'' than that imposed on U.S.
persons. Paragraph 1 omits the words ``other than or'' because
the only relevant question under this provision should be
whether the requirement imposed on a national of the other
Contracting State is more burdensome. A requirement may be
different from the requirements imposed on U.S. nationals
without being more burdensome.
The term ``national'' in relation to a Contracting State is
defined in subparagraph 1(k) of Article III (General
Definitions). The term includes both individuals and juridical
persons. A national of a Contracting State is afforded
protection under this paragraph even if the national is not a
resident of either Contracting State. Thus, a U.S. citizen who
is resident in a third country is entitled, under this
paragraph, to the same treatment in Canada as a national of
Canada in the same or similar circumstances (i.e., one who is
resident in a third State).
Whether or not the two persons are both taxable on
worldwide income is a significant circumstance for this
purpose. For this reason, paragraph 1 specifically refers to
taxation or any requirement connected therewith, particularly
with respect to taxation on worldwide income, as relevant
circumstances. This language means that the United States is
not obliged to apply the same taxing regime to a national of
Canada who is not resident in the United States as it applies
to a U.S. national who is not resident in the United States.
U.S. citizens who are not resident in the United States but who
are, nevertheless, subject to U.S. tax on their worldwide
income are not in the same circumstances with respect to U.S.
taxation as citizens of Canada who are not U.S. residents.
Thus, for example, Article XXV would not entitle a national of
Canada residing in a third country to taxation at graduated
rates on U. S.-source dividends or other investment income that
applies to a U.S. citizen residing in the same third country.
Because of the increased coverage of paragraph 1 with
respect to the treatment of nationals wherever they are
resident, paragraph 2 of this Article no longer has
application, and therefore has been omitted.
Paragraph 3
Paragraph 3 makes changes to renumbered paragraph 3 of
Article XXV in order to conform with Article 10 of the Protocol
by deleting the reference to ``Article XV (Dependent Personal
Services)'' and replacing it with a reference to ``Article XV
(Income from Employment).''
ARTICLE 21
Paragraph 1 of Article 21 of the Protocol replaces
paragraph 6 of Article XXVI (Mutual Agreement Procedure) of the
Convention with new paragraphs 6 and 7. New paragraphs 6 and 7
provide a mandatory binding arbitration proceeding (Arbitration
Proceeding). The Arbitration Note details additional rules and
procedures that apply to a case considered under the
arbitration provisions.
New paragraph 6 provides that a case shall be resolved
through arbitration when the competent authorities have
endeavored but are unable through negotiation to reach a
complete agreement regarding a case and the following three
conditions are satisfied. First, tax returns have been filed
with at least one of the Contracting States with respect to the
taxable years at issue in the case. Second, the case (i)
involves the application of one or more Articles that the
competent authorities have agreed in an exchange of notes shall
be the subject of arbitration and is not a case that the
competent authorities agree before the date on which an
Arbitration Proceeding would otherwise have begun, is not
suitable for determination by arbitration; or (ii) is a case
that the competent authorities agree is suitable for
determination by arbitration. Third, all concerned persons and
their authorized representatives agree, according to the
provisions of subparagraph 7(d), not to disclose to any other
person any information received during the course of the
Arbitration Proceeding from either Contracting State or the
arbitration board, other than the determination of the board
(confidentiality agreement). The confidentiality agreement may
also be executed by any concerned person that has the legal
authority to bind any other concerned person on the matter. For
example, a parent corporation with the legal authority to bind
its subsidiary with respect to confidentiality may execute a
comprehensive confidentiality agreement on its own behalf and
that of its subsidiary.
The United States and Canada have agreed in the Arbitration
Note to submit cases regarding the application of one or more
of the following Articles to mandatory binding arbitration
under the provisions of paragraphs 6 and 7 of Article XXVI: IV
(Residence), but only insofar as it relates to the residence of
a natural person, V (Permanent Establishment), VII (Business
Profits), IX (Related Persons), and XII (Royalties) (but only
(i) insofar as Article XII might apply in transactions
involving related persons to whom Article IX might apply, or
(ii) to an allocation of amounts between royalties that are
taxable under paragraph 2 thereof and royalties that are exempt
under paragraph 3 thereof). The competent authorities may,
however, agree, before the date on which an Arbitration
Proceeding would otherwise have begun, that a particular case
is not suitable for arbitration.
New paragraph 7 provides six subparagraphs that detail the
general rules and definitions to be used in applying the
arbitration provisions.
Subparagraph 7(a) provides that the term ``concerned
person'' means the person that brought the case to competent
authority for consideration under Article XXVI (Mutual
Agreement Procedure) and includes all other persons, if any,
whose tax liability to either Contracting State may be directly
affected by a mutual agreement arising from that consideration.
For example, a concerned person does not only include a U.S.
corporation that brings a transfer pricing case with respect to
a transaction entered into with its Canadian subsidiary for
resolution to the U.S. competent authority, but also the
Canadian subsidiary, which may have a correlative adjustment as
a result of the resolution of the case.
Subparagraph 7(c) provides that an Arbitration Proceeding
begins on the later of two dates: two years from the
``commencement date'' of the case (unless the competent
authorities have previously agreed to a different date), or the
earliest date upon which all concerned persons have entered
into a confidentiality agreement and the agreements have been
received by both competent authorities. The ``commencement
date'' of the case is defined by subparagraph 7(b) as the
earliest date the information necessary to undertake
substantive consideration for a mutual agreement has been
received by both competent authorities.
Paragraph 16 of the Arbitration Note provides that each
competent authority will confirm in writing to the other
competent authority and to the concerned persons the date of
its receipt of the information necessary to undertake
substantive consideration for a mutual agreement. In the case
of the United States, this information is (i) the information
that must be submitted to the U.S. competent authority under
Section 4.05 of Rev. Proc. 2006-54, 2006-49 I.R.B. 1035 (or any
applicable successor publication), and (ii) for cases initially
submitted as a request for an Advance Pricing Agreement, the
information that must be submitted to the Internal Revenue
Service under Rev. Proc. 2006-9, 2006-2 I.R.B. 278 (or any
applicable successor publication). In the case of Canada, this
information is the information required to be submitted to the
Canadian competent authority under Information Circular 7 1-17
(or any applicable successor publication). The information
shall not be considered received until both competent
authorities have received copies of all materials submitted to
either Contracting State by the concerned person(s) in
connection with the mutual agreement procedure. It is
understood that confirmation of the ``information necessary to
undertake substantive consideration for a mutual agreement'' is
envisioned to ordinarily occur within 30 days after the
necessary information is provided to the competent authority.
The Arbitration Note also provides for several procedural
rules once an Arbitration Proceeding under paragraph 6 of
Article XXVI (''Proceeding'') has commenced, but the competent
authorities may modify or supplement these rules as necessary.
In addition, the arbitration board may adopt any procedures
necessary for the conduct of its business, provided the
procedures are not inconsistent with any provision of Article
XXVI of the Convention.
Paragraph 5 of the Arbitration Note provides that each
Contracting State has 60 days from the date on which the
Arbitration Proceeding begins to send a written communication
to the other Contracting State appointing one member of the
arbitration board. Within 60 days of the date the second of
such communications is sent, these two board members will
appoint a third member to serve as the chair of the board. It
is agreed that this third member ordinarily should not be a
citizen of either of the Contracting States.
In the event that any members of the board are not
appointed (including as a result of the failure of the two
members appointed by the Contracting States to agree on a third
member) by the requisite date, the remaining members are
appointed by the highest ranking member of the Secretariat at
the Centre for Tax Policy and Administration of the
Organisation for Economic Co-operation and Development (OECD)
who is not a citizen of either Contracting State, by written
notice to both Contracting States within 60 days of the date of
such failure.
Paragraph 7 of the Arbitration Note establishes deadlines
for submission of materials by the Contracting States to the
arbitration board. Each competent authority has 60 days from
the date of appointment of the chair to submit a Proposed
Resolution describing the proposed disposition of the specific
monetary amounts of income, expense or taxation at issue in the
case, and a supporting Position Paper. Copies of each State's
submissions are to be provided by the board to the other
Contracting State on the date the later of the submissions is
submitted to the board. Each of the Contracting States may
submit a Reply Submission to the board within 120 days of the
appointment of the chair to address points raised in the other
State's Proposed Resolution or Position Paper. If one
Contracting State fails to submit a Proposed Resolution within
the requisite time, the Proposed Resolution of the other
Contracting State is deemed to be the determination of the
arbitration board. Additional information may be supplied to
the arbitration board by a Contracting State only at the
request of the arbitration board. The board will providecopies
of any such requested information, along with the board's
request, to the other Contracting State on the date the request
is made or the response is received.
All communication with the board is to be in writing
between the chair of the board and the designated competent
authorities with the exception of communication regarding
logistical matters.
In making its determination, the arbitration board will
apply the following authorities as necessary: (i) the
provisions of the Convention, (ii) any agreed commentaries or
explanation of the Contracting States concerning the Convention
as amended, (iii) the laws of the Contracting States to the
extent they are not inconsistent with each other, and (iv) any
OECD Commentary, Guidelines or Reports regarding relevant
analogous portions of the OECD Model Tax Convention.
The arbitration board must deliver a determination in
writing to the Contracting States within six months of the
appointment of the chair. The determination must be one of the
two Proposed Resolutions submitted by the Contracting States.
The determination shall provide a determination regarding only
the amount of income, expense or tax reportable to the
Contracting States. The determination has no precedential value
and consequently the rationale behind a board's determination
would not be beneficial and shall not be provided by the board.
Paragraph 11 of the Arbitration Note provides that, unless
any concerned person does not accept the decision of the
arbitration board, the determination of the board constitutes a
resolution by mutual agreement under Article XXVI and,
consequently, is binding on both Contracting States. Each
concerned person must, within 30 days of receiving the
determination from the competent authority to which the case
was first presented, advise that competent authority whether
the person accepts the determination. The failure to advise the
competent authority within the requisite time is considered a
rejection of the determination. If a determination is rejected,
the case cannot be the subject of a subsequent MAP procedure on
the same issue(s) determined by the panel, including a
subsequent Arbitration Proceeding. After the commencement of an
Arbitration Proceeding but before a decision of the board has
been accepted by all concerned persons, the competent
authorities may reach a mutual agreement to resolve the case
and terminate the Proceeding.
For purposes of the Arbitration Proceeding, the members of
the arbitration board and their staffs shall be considered
``persons or authorities'' to whom information may be disclosed
under Article XXVII (Exchange of Information). The Arbitration
Note provides that all materials prepared in the course of, or
relating to, the Arbitration Proceeding are considered
information exchanged between the Contracting States. No
information relating to the Arbitration Proceeding or the
board's determination may be disclosed by members of the
arbitration board or their staffs or by either competent
authority, except as permitted by the Convention and the
domestic laws of the Contracting States. Members of the
arbitration board and their staffs must agree in statements
sent to each of the Contracting States in confirmation of their
appointment to the arbitration board to abide by and be subject
to the confidentiality and nondisclosure provisions of Article
XXVII of the Convention and the applicable domestic laws of the
Contracting States, with the most restrictive of the provisions
applying.
The applicable domestic law of the Contracting States
determines the treatment of any interest or penalties
associated with a competent authority agreement achieved
through arbitration.
In general, fees and expenses are borne equally by the
Contracting States, including the cost of translation services.
However, meeting facilities, related resources, financial
management, other logistical support, and general and
administrative coordination of the Arbitration Proceeding will
be provided, at its own cost, by the Contracting State that
initiated the Mutual Agreement Procedure. The fees and expenses
of members of the board will be set in accordance with the
International Centre for Settlement of Investment Disputes
(ICSID) Schedule of Fees for arbitrators (in effect on the date
on which the arbitration board proceedings begin). All other
costs are to be borne by the Contracting State that incurs
them. Since arbitration of MAP cases is intended to assist
taxpayers in resolving a governmental difference of opinion
regarding the taxation of their income, and is merely an
extension of the competent authority process, no fees will be
chargeable to a taxpayer in connection with arbitration.
ARTICLE 22
Article 22 of the Protocol amends Article XXVI A
(Assistance in Collection) of the existing Convention. Article
XXVI A sets forth provisions under which the United States and
Canada have agreed to assist each other in the collection of
taxes.
Paragraph 1
Paragraph 1 replaces subparagraph 8(a) of Article XXVI A.
In general, new subparagraph 8(a) provides the circumstances
under which no assistance is to be given under the Article for
a claim in respect of an individual taxpayer. New subparagraph
8(a) contains language that is in substance the same as
subparagraph 8(a) of Article XXVI A of the existing Convention.
However, the revised subparagraph also provides that no
assistance in collection is to be given for a revenue claim
from a taxable period that ended before November 9, 1995 in
respect of an individual taxpayer, if the taxpayer became a
citizen of the requested State at any time before November 9,
1995 and is such a citizen at the time the applicant State
applies for collection of the claim.
The additional language is intended to avoid the
potentially discriminating application of former subparagraph
8(a) as applied to persons who were not citizens of the
requested State in the taxable period to which a particular
collection request related, but who became citizens of the
requested State at a time prior to the entry into force of
Article XXVI A as set forth in the third protocol signed March
17, 1995. New subparagraph 8(a) addresses this situation by
treating the citizenship of a person in the requested State at
anytime prior to November 9, 1995 as comparable to citizenship
in the requested State during the period for which the claim
for assistance relates if 1) the person is a citizen of the
requested state at the time of the request for assistance in
collection, and 2) the request relates to a taxable period
ending prior to November 9, 1995. As is provided in
subparagraph 3(g) of Article 27, this change will have effect
for revenue claims finally determined after November 9, 1985,
the effective date of the adoption of collection assistance in
the third protocol signed March 17, 1995.
Paragraph 2
Paragraph 2 replaces paragraph 9 of Article XXVI A of the
Convention. Under paragraph 1 of Article XXVI A, each
Contracting State generally agrees to lend assistance and
support to the other in the collection of revenue claims. The
term ``revenue claim'' is defined in paragraph 1 to include all
taxes referred to in paragraph 9 of the Article, as well as
interest, costs, additions to such taxes, and civil penalties.
New paragraph 9 provides that, notwithstanding the provisions
of Article II (Taxes Covered) of the Convention, Article XXVI A
shall apply to all categories of taxes collected, and to
contributions to social security and employment insurance
premiums levied, by or on behalf of the Government of a
Contracting State. Prior to the Protocol, paragraph 9 did not
contain a specific reference to contributions to social
security and employment insurance premiums. Although the prior
language covered U.S. federal social security and unemployment
taxes, the language did not cover Canada's social security
(e.g., Canada Pension Plan) and employment insurance programs,
contributions to which are not considered taxes under Canadian
law and therefore would not otherwise have come within the
scope of the paragraph.
ARTICLE 23
Article 23 of the Protocol replaces Article XXVII (Exchange
of Information) of the Convention.
Paragraph 1 of Article XXVI
New paragraph 1 of Article XXVII is substantially the same
as paragraph 1 of Article XXVII of the existing Convention.
Paragraph 1 authorizes the competent authorities to exchange
information as may be relevant for carrying out the provisions
of the Convention or the domestic laws of Canada and the United
States concerning taxes covered by the Convention, insofar as
the taxation under those domestic laws is not contrary to the
Convention. New paragraph 1 changes the phrase ``is relevant''
to ``may be relevant'' to clarify that the language
incorporates the standard in Code section 7602 which authorizes
the Internal Revenue Service to examine ``any books, papers,
records, or other data which may be relevant or material.''
(Emphasis added.) In United States v. Arthur Young & Co., 465
U.S. 805, 814 (1984), the Supreme Court stated that ``the
language `may be' reflects Congress's express intention to
allow the Internal Revenue Service to obtain `items of even
potential relevance to an ongoing investigation, without
reference to its admissibility.''' (Emphasis in original.)
However, the language ``may be'' would not support a request in
which a Contracting State simply asked for information
regarding all bank accounts maintained by residents of that
Contracting State in the other Contracting State, or even all
accounts maintained by its residents with respect to a
particular bank.
The authority to exchange information granted by paragraph
1 is not restricted by Article I (Personal Scope), and thus
need not relate solely to persons otherwise covered by the
Convention. Under paragraph 1, information may be exchanged for
use in all phases of the taxation process including assessment,
collection, enforcement or the determination of appeals. Thus,
the competent authorities may request and provide information
for cases under examination or criminal investigation, in
collection, on appeals, or under prosecution.
Any information received by a Contracting State pursuant to
the Convention is to be treated as secret in the same manner as
information obtained under the tax laws of that State. Such
information shall be disclosed only to persons or authorities,
including courts and administrative bodies, involved in the
assessment or collection of, the administration and enforcement
in respect of, or the determination of appeals in relation to,
the taxes covered by the Convention and the information may be
used by such persons only for such purposes. (In accordance
with paragraph 4, for the purposes of this Article the
Convention applies to a broader range of taxes than those
covered specifically by Article II (Taxes Covered)). Although
the information received by persons described in paragraph 1 is
to be treated as secret, it may be disclosed by such persons in
public court proceedings or in judicial decisions.
Paragraph 1 also permits, however, a Contracting State to
provide information received from the other Contracting State
to its states, provinces, or local authorities, if it relates
to a tax imposed by that state, province, or local authority
that is substantially similar to a national-level tax covered
under Article II (Taxes Covered). This provision does not
authorize a Contracting State to request information on behalf
of a state, province, or local authority. Paragraph 1 also
authorizes the competent authorities to release information to
any arbitration panel that may be established under the
provisions of new paragraph 6 of Article XXVI (Mutual Agreement
Procedure). Any information provided to a state, province, or
local authority or to an arbitration panel is subject to the
same use and disclosure provisions as is information received
by the national Governments and used for their purposes.
The provisions of paragraph 1 authorize the U.S. competent
authority to continue to allow legislative bodies, such as the
tax-writing committees of Congress and the Government
Accountability Office to examine tax return information
received from Canada when such bodies or offices are engaged in
overseeing the administration of U.S. tax laws or a study of
the administration of U.S. tax laws pursuant to a directive of
Congress. However, the secrecy requirements of paragraph 1 must
be met.
It is contemplated that Article XXVII will be utilized by
the competent authorities to exchange information upon request,
routinely, and spontaneously.
Paragraph 2 of Article XXVI
New paragraph 2 conforms with the corresponding U.S. and
OECD Model provisions. The substance of the second sentence of
former paragraph 2 is found in new paragraph 6 of the Article,
discussed below.
Paragraph 2 provides that if a Contracting State requests
information in accordance with Article XXVII, the other
Contracting State shall use its information gathering measures
to obtain the requested information. The instruction to the
requested State to ``use its information gathering measures''
to obtain the requested information communicates the same
instruction to the requested State as the language of former
paragraph 2 that stated that the requested State shall obtain
the information ``in the same way as if its own taxation was
involved.'' Paragraph 2 makes clear that the obligation to
provide information is limited by the provisions of paragraph
3, but that such limitations shall not be construed to permit a
Contracting State to decline to obtain and supply information
because it has no domestic tax interest in such information.
In the absence of such a paragraph, some taxpayers have
argued that subparagraph 3(a) prevents a Contracting State from
requesting information from a bank or fiduciary that the
Contracting State does not need for its own tax purposes. This
paragraph clarifies that paragraph 3 does not impose such a
restriction and that a Contracting State is not limited to
providing only the information that it already has in its own
files.
Paragraph 3 of Article XXVI
New paragraph 3 is substantively the same as paragraph 3 of
Article XXVII of the existing Convention. Paragraph 3 provides
that the provisions of paragraphs 1 and 2 do not impose on
Canada or the United States the obligation to carry out
administrative measures at variance with the laws and
administrative practice of either State; to supply information
which is not obtainable under the laws or in the normal course
of the administration of either State; or to supply information
which would disclose any trade, business, industrial,
commercial, or professional secret or trade process, or
information the disclosure of which would be contrary to public
policy.
Thus, a requesting State may be denied information from the
other State if the information would be obtained pursuant to
procedures or measures that are broader than those available in
the requesting State. However, the statute of limitations of
the Contracting State making the request for information should
govern a request for information. Thus, the Contracting State
of which the request is made should attempt to obtain the
information even if its own statute of limitations has passed.
In many cases, relevant information will still exist in the
business records of the taxpayer or a third party, even though
it is no longer required to be kept for domestic tax purposes.
While paragraph 3 states conditions under which a
Contracting State is not obligated to comply with a request
from the other Contracting State for information, the requested
State is not precluded from providing such information, and
may, at its discretion, do so subject to the limitations of its
internal law.
As discussed with respect to paragraph 2, in no case shall
the limitations in paragraph 3 be construed to permit a
Contracting State to decline to obtain information and supply
information because it has no domestic tax interest in such
information.
Paragraph 4 of Article XXVI
The language of new paragraph 4 is substantially similar to
former paragraph 4. New paragraph 4, however, consistent with
new paragraph 1, discussed above, replaces the words ``is
relevant'' with ``may be relevant'' in subparagraph 4(b).
Paragraph 4 provides that, for the purposes of Article
XXVII, the Convention applies to all taxes imposed by a
Contracting State, and to other taxes to which any other
provision of the Convention applies, but only to the extent
that the information may be relevant for the purposes of the
application of that provision.
Article XXVII does not apply to taxes imposed by political
subdivisions or local authorities of the Contracting States.
Paragraph 4 is designed to ensure that information exchange
will extend to taxes of every kind (including, for example,
estate, gift, excise, and value added taxes) at the national
level in the United States and Canada.
Paragraph 5 of Article XXVI
New paragraph 5 conforms with the corresponding U.S. and
OECD Model provisions. Paragraph 5 provides that a Contracting
State may not decline to provide information because that
information is held by a financial institution, nominee or
person acting in an agency or fiduciary capacity. Thus,
paragraph 5 would effectively prevent a Contracting State from
relying on paragraph 3 to argue that its domestic bank secrecy
laws (or similar legislation relating to disclosure of
financial information by financial institutions or
intermediaries) override its obligation to provide information
under paragraph 1. This paragraph also requires the disclosure
of information regarding the beneficial owner of an interest in
a person.
Paragraph 6 of Article XXVI
The substance of new paragraph 6 is similar to the second
sentence of paragraph 2 of Article XXVII of the existing
Convention. New paragraph 6 adopts the language of paragraph 6
of Article 26 (Exchange of Information and Administrative
Assistance) of the U.S. Model. New paragraph 6 provides that
the requesting State may specify the form in which information
is to be provided (e.g., depositions of witnesses and
authenticated copies of original documents). The intention is
to ensure that the information may be introduced as evidence in
the judicial proceedings of the requesting State.
The requested State should, if possible, provide the
information in the form requested to the same extent that it
can obtain information in that form under its own laws and
administrative practices with respect to its own taxes.
Paragraph 7 of Article XXVI
New paragraph 7 is consistent with paragraph 8 of Article
26 (Exchange of Information and Administrative Assistance) of
the U.S. Model. Paragraph 7 provides that the requested State
shall allow representatives of the requesting State to enter
the requested State to interview individuals and examine books
and records with the consent of the persons subject to
examination. Paragraph 7 was intended to reinforce that the
administrations can conduct consensual tax examinations abroad,
and was not intended to limit travel or supersede any
arrangements or procedures the competent authorities may have
previously had in place regarding travel for tax administration
purposes.
Paragraph 13 of General Note
As is explained in paragraph 13 of the General Note, the
United States and Canada understand and agree that the
standards and practices described in Article XXVII of the
Convention are to be in no respect less effective than those
described in the Model Agreement on Exchange of Information on
Tax Matters developed by the OECD Global Forum Working Group on
Effective Exchange of Information.
ARTICLE 24
Article 24 amends Article XXIX (Miscellaneous Rules) of the Convention.
Paragraph 1
Paragraph 1 replaces paragraph 2 of Article XXIX of the
existing Convention. New paragraph 2 is divided into two
subparagraphs. In general, subparagraph 2(a) provides a
``saving clause'' pursuant to which the United States and
Canada may each tax its residents, as determined under Article
IV (Residence), and the United States may tax its citizens and
companies, including those electing to be treated as domestic
corporations (e.g. under Code section 1504(d)), as if there
were no convention between the United States and Canada with
respect to taxes on income and capital. Subparagraph 2(a)
contains language that generally corresponds to former
paragraph 2, but omits certain language pertaining to former
citizens, which are addressed in new subparagraph 2(b).
New subparagraph 2(b) generally corresponds to the
provisions of former paragraph 2 addressing former citizens of
the United States. However, new subparagraph 2(b) also includes
a reference to former long-term residents of the United States.
This addition, as well as other changes in subparagraph 2(b),
brings the Convention in conformity with the U.S. taxation of
former citizens and long-term residents under Code section 877.
Similar to subparagraph 2(a), new subparagraph 2(b)
operates as a ``saving clause'' and provides that
notwithstanding the other provisions of the Convention, a
former citizen or former long-term resident of the United
States, may, for a period of ten years following the loss of
such status, be taxed in accordance with the laws of the United
States with respect to income from sources within the United
States (including income deemed under the domestic law of the
United States to arise from such sources).
Paragraphs 11 and 12 of the General Note provide
definitions based on Code section 877 that are relevant to the
application of paragraph 2 of Article XXIX. Paragraph 11 of the
General Note provides that the term ``long-term resident''
means any individual who is a lawful permanent resident of the
United States in eight or more taxable years during the
preceding 15 taxable years. In determining whether the eight-
year threshold is met, one does not count any year in which the
individual is treated as a resident of Canada under this
Convention (or as a resident of any country other than the
United States under the provisions of any other U.S. tax
treaty), and the individual does not waive the benefits of such
treaty applicable to residents of the other country. This
understanding is consistent with how this provision is
generally interpreted in U.S. tax treaties.
Paragraph 12 of the General Note provides that the phrase
``income deemed under the domestic law of the United States to
arise from such sources'' as used in new subparagraph 2(b)
includes gains from the sale or exchange of stock of a U.S.
company or debt obligations of a U.S. person, the United
States, a State, or a political subdivision thereof, or the
District of Columbia, gains from property (other than stock or
debt obligations) located in the United States, and, in certain
cases, income or gain derived from the sale of stock of a non-
U.S. company or a disposition of property contributed to such
non-U.S. company where such company would be a controlled
foreign corporation with respect to the individual if such
person had continued to be a U.S. person. In addition, an
individual who exchanges property that gives rise or would give
rise to U.S.-source income for property that gives rise to
foreign-source income will be treated as if he had sold the
property that would give rise to U.S.-source income for its
fair market value, and any consequent gain shall be deemed to
be income from sources within the United States.
Paragraph 2
Paragraph 2 replaces subparagraph 3(a) of Article XXIX of
the existing Convention. Paragraph 3 provides that,
notwithstanding paragraph 2 of Article XXIX, the United States
and Canada must respect specified provisions of the Convention
in regard to certain persons, including residents and citizens.
Therefore, subparagraph 3(a) lists certain paragraphs and
Articles of the Convention that represent exceptions to the
``saving clause'' in all situations. New subparagraph 3(a) is
substantially similar to former subparagraph 3(a), but now
contains a reference to paragraphs 8, 10, and 13 of Article
XVIII (Pensions and Annuities) to reflect the changes made to
that article in paragraph 3 of Article 13 of the Protocol.
ARTICLE 25
Article 25 of the Protocol replaces Article XXIX A
(Limitation on Benefits) of the existing Convention, which was
added to the Convention by the Protocol done on March 17, 1995.
Article XXIX A addresses the problem of ``treaty shopping'' by
residents of third States by requiring, in most cases, that the
person seeking benefits not only be a U.S. resident or Canadian
resident but also satisfy other tests. For example, a resident
of a third State might establish an entity resident in Canada
for the purpose of deriving income from the United States and
claiming U.S. treaty benefits with respect to that income.
Article XXIX A limits the benefits granted by the United States
or Canada under the Convention to those persons whose residence
in the other Contracting State is not considered to have been
motivated by the existence of the Convention. As replaced by
the Protocol, new Article XXIX A is reciprocal, and many of the
changes to the former paragraphs of Article XXIX A are made to
effectuate this reciprocal application.
Absent Article XXIX A, an entity resident in one of the
Contracting States would be entitled to benefits under the
Convention, unless it were denied such benefits as a result of
limitations under domestic law (e.g., business purpose,
substance-over-form, step transaction, or conduit principles or
other anti-avoidance rules) applicable to a particular
transaction or arrangement. As noted below in the explanation
of paragraph 7, general anti-abuse provisions of this sort
apply in conjunction with the Convention in both the United
States and Canada. In the case of the United States, such anti-
abuse provisions complement the explicit anti-treaty-shopping
rules of Article XXIX A. While the anti-treaty-shopping rules
determine whether a person has a sufficient nexus to Canada to
be entitled to benefits under the Convention, the anti-abuse
provisions under U.S. domestic law determine whether a
particular transaction should be recast in accordance with the
substance of the transaction.
Paragraph 1 of Article XXIX A
New paragraph 1 of Article XXIX A provides that, for the
purposes of the application of the Convention, a ``qualifying
person'' shall be entitled to all of the benefits of the
Convention and, except as provided in paragraphs 3, 4, and 6, a
person that is not a qualifying person shall not be entitled to
any benefits of the Convention.
Paragraph 2 of Article XXIX A
New paragraph 2 lists a number of characteristics any one
of which will make a United States or Canadian resident a
qualifying person. The ``look-through'' principles introduced
by the Protocol (e.g. paragraph 6 of Article IV (Residence))
are to be applied in conjunction with Article XXIX A.
Accordingly, the provisions of Article IV shall determine the
person who derives an item of income, and the objective tests
of Article XXIX A shall be applied to that person to determine
whether benefits shall be granted. The rules are essentially
mechanical tests and are discussed below.
Individuals and governmental entities
Under new paragraph 2, the first two categories of
qualifying persons are (1) natural persons resident in the
United States or Canada (as listed in subparagraph 2(a)), and
(2) the Contracting States, political subdivisions or local
authorities thereof, and any agency or instrumentality of such
Government, political subdivision or local authority (as listed
in subparagraph 2(b)). Persons falling into these two
categories are unlikely to be used, as the beneficial owner of
income, to derive benefits under the Convention on behalf of a
third-country person. If such a person receives income as a
nominee on behalf of a third-country resident, benefits will be
denied with respect to those items of income under the articles
of the Convention that would otherwise grant the benefit,
because of the requirements in those articles that the
beneficial owner of the income be a resident of a Contracting
State.
Publicly traded entities
Under new subparagraph 2(c), a company or trust resident in
a Contracting State is a qualifying person if the company's
principal class of shares, and any disproportionate class of
shares, or the trust's units, or disproportionate interest in a
trust, are primarily and regularly traded on one or more
recognized stock exchanges. The term ``recognized stock
exchange'' is defined in subparagraph 5(f) of the Article to
mean, in the United States, the NASDAQ System and any stock
exchange registered as a national securities exchange with the
Securities and Exchange Commission, and, in Canada, any
Canadian stock exchanges that are ``prescribed stock
exchanges'' or ``designated stock exchanges'' under the Income
Tax Act. These are, at the time of signature of the Protocol,
the Montreal Stock Exchange, the Toronto Stock Exchange, and
Tiers 1 and 2 of the TSX Venture Exchange. Additional exchanges
may be added to the list of recognized exchanges by exchange of
notes between the Contracting States or by agreement between
the competent authorities.
If a company has only one class of shares, it is only
necessary to consider whether the shares of that class meet the
relevant trading requirements. If the company has more than one
class of shares, it is necessary as an initial matter to
determine which class or classes constitute the ``principal
class of shares.'' The term ``principal class of shares'' is
defined in subparagraph 5(e) of the Article to mean the
ordinary or common shares of the company representing the
majority of the aggregate voting power and value of the
company. If the company does not have a class of ordinary or
common shares representing the majority of the aggregate voting
power and value of the company, then the ``principal class of
shares'' is that class or any combination of classes of shares
that represents, in the aggregate, a majority of the voting
power and value of the company. Although in a particular case
involving a company with several classes of shares it is
conceivable that more than one group of classes could be
identified that account for more than 50% of the voting power
and value of the shares of the company, it is only necessary
for one such group to satisfy the requirements of this
subparagraph in order for the company to be entitled to
benefits. Benefits would not be denied to the company even if a
second, non-qualifying, group of shares with more than half of
the company's voting power and value could be identified.
A company whose principal class of shares is regularly
traded on a recognized stock exchange will nevertheless not
qualify for benefits under subparagraph 2(c) if it has a
disproportionate class of shares that is not regularly traded
on a recognized stock exchange. The term ``disproportionate
class of shares'' is defined in subparagraph 5(b) of the
Article. A company has a disproportionate class of shares if it
has outstanding a class of shares which is subject to terms or
other arrangements that entitle the holder to a larger portion
of the company's income, profit, or gain in the other
Contracting State than that to which the holder would be
entitled in the absence of such terms or arrangements. Thus,
for example, a company has a disproportionate class of shares
if it has outstanding a class of ``tracking stock'' that pays
dividends based upon a formula that approximates the company's
return on its assets employed in the United States. Similar
principles apply to determine whether or not there are
disproportionate interests in a trust.
The following example illustrates the application of
subparagraph 5(b).
Example. OCo is a corporation resident in Canada. OCo has
two classes of shares: Common and Preferred. The Common shares
are listed and regularly traded on a designated stock exchange
in Canada. The Preferred shares have no voting rights and are
entitled to receive dividends equal in amount to interest
payments that OCo receives from unrelated borrowers in the
United States. The Preferred shares are owned entirely by a
single investor that is a resident of a country with which the
United States does not have a tax treaty. The Common shares
account for more than 50 percent of the value of OCo and for
100 percent of the voting power. Because the owner of the
Preferred shares is entitled to receive payments corresponding
to the U.S.-source interest income earned by OCo, the Preferred
shares are a disproportionate class of shares. Because the
Preferred shares are not primarily and regularly traded on a
recognized stock exchange, OCo will not qualify for benefits
under subparagraph 2(c).
The term ``regularly traded'' is not defined in the
Convention. In accordance with paragraph 2 of Article III
(General Definitions) and paragraph 1 of the General Note, this
term will be defined by reference to the domestic tax laws of
the State from which benefits of the Convention are sought,
generally the source State. In the case of the United States,
this term is understood to have the meaning it has under Treas.
Reg. section 1.884-5(d)(4)(i)(B), relating to the branch tax
provisions of the Code, as may be amended from time to time.
Under these regulations, a class of shares is considered to be
``regularly traded'' if two requirements are met: trades in the
class of shares are made in more than de minimis quantities on
at least 60 days during the taxable year, and the aggregate
number of shares in the class traded during the year is at
least 10 percent of the average number of shares outstanding
during the year. Sections 1. 884-5(d)(4)(i)(A), (ii) and (iii)
will not be taken into account for purposes of defining the
term ``regularly traded'' under the Convention.
The regularly-traded requirement can be met by trading on
one or more recognized stock exchanges. Therefore, trading may
be aggregated for purposes of this requirement. Thus, a U.S.
company could satisfy the regularly traded requirement through
trading, in whole or in part, on a recognized stock exchange
located in Canada. Authorized but unissued shares are not
considered for purposes of this test.
The term ``primarily traded'' is not defined in the
Convention. In accordance with paragraph 2 of Article III
(General Definitions) and paragraph 1 of the General Note, this
term will have the meaning it has under the laws of the State
concerning the taxes to which the Convention applies, generally
the source State. In the case of the United States, this term
is understood to have the meaning it has under Treas. Reg.
section 1.884-5(d)(3), as may be amended from time to time,
relating to the branch tax provisions of the Code. Accordingly,
stock of a corporation is ``primarily traded'' if the number of
shares in the company's principal class of shares that are
traded during the taxable year on all recognized stock
exchanges exceeds the number of shares in the company's
principal class of shares that are traded during that year on
all other established securities markets.
Subject to the adoption by Canada of other definitions, the
U.S. interpretation of ``regularly traded'' and ``primarily
traded'' will be considered to apply, with such modifications
as circumstances require, under the Convention for purposes of
Canadian taxation.
Subsidiaries of publicly traded entities
Certain companies owned by publicly traded corporations
also may be qualifying persons. Under subparagraph 2(d), a
company resident in the United States or Canada will be a
qualifying person, even if not publicly traded, if more than 50
percent of the vote and value of its shares, and more than 50
percent of the vote and value of each disproportionate class of
shares, is owned (directly or indirectly) by five or fewer
persons that are qualifying persons under subparagraph 2(c). In
addition, each company in the chain of ownership must be a
qualifying person. Thus, for example, a company that is a
resident of Canada, all the shares of which are owned by
another company that is a resident of Canada, would qualify for
benefits of the Convention if the principal class of shares
(and any disproportionate classes of shares) of the parent
company are regularly and primarily traded on a recognized
stock exchange. However, such a subsidiary would not qualify
for benefits under subparagraph 2(d) if the publicly traded
parent company were a resident of a third state, for example,
and not a resident of the United States or Canada. Furthermore,
if a parent company qualifying for benefits under subparagraph
2(c) indirectly owned the bottom-tier company through a chain
of subsidiaries, each subsidiary in the chain, as an
intermediate owner, must be a qualifying person in order for
the bottom-tier subsidiary to meet the test in subparagraph
2(d).
Subparagraph 2(d) provides that a subsidiary can take into
account ownership by as many as five companies, each of which
qualifies for benefits under subparagraph 2(c) to determine if
the subsidiary qualifies for benefits under subparagraph 2(d).
For example, a Canadian company that is not publicly traded but
that is owned, one-third each, by three companies, two of which
are Canadian resident corporations whose principal classes of
shares are primarily and regularly traded on a recognized stock
exchange, will qualify under subparagraph 2(d).
By applying the principles introduced by the Protocol (e.g.
paragraph 6 of Article IV) in the context of this rule, one
``looks through'' entities in the chain of ownership that are
viewed as fiscally transparent under the domestic laws of the
State of residence (other than entities that are resident in
the State of source).
The 50-percent test under subparagraph 2(d) applies only to
shares other than ``debt substitute shares.'' The term ``debt
substitute shares'' is defined in subparagraph 5(a) to mean
shares defined in paragraph (e) of the definition in the
Canadian Income Tax Act of ``term preferred shares'' (see
subsection 248(1) of the Income Tax Act), which relates to
certain shares received in debt-restructuring arrangements
undertaken by reason of financial difficulty or insolvency.
Subparagraph 5(a) also provides that the competent authorities
may agree to treat other types of shares as debt substitute
shares.
Ownership/base erosion test
Subparagraph 2(e) provides a two-part test under which
certain other entities may be qualifying persons, based on
ownership and lack of ``base erosion.'' A company resident in
the United States or Canada will satisfy the first of these
tests if 50 percent or more of the vote and value of its shares
and 50 percent or more of the vote and value of each
disproportionate class of shares, in both cases not including
debt substitute shares, is not owned, directly or indirectly,
by persons other than qualifying persons. Similarly, a trust
resident in the United States or Canada will satisfy this first
test if 50 percent or more of its beneficial interests, and 50
percent or more of each disproportionate interest, is not
owned, directly or indirectly, by persons other than qualifying
persons. The wording of these tests is intended to make clear
that, for example, if a Canadian company is more than 50
percent owned, either directly or indirectly (including
cumulative indirect ownership through a chain of entities), by
a U.S. resident corporation that is, itself, wholly owned by a
third-country resident other than a qualifying person, the
Canadian company would not pass the ownership test. This is
because more than 50 percent of its shares is owned indirectly
by a person (the third-country resident) that is not a
qualifying person.
It is understood by the Contracting States that in
determining whether a company satisfies the ownership test
described in subparagraph 2(e)(i), a company, 50 percent of
more of the aggregate vote and value of the shares of which and
50 percent or more of the vote and value of each
disproportionate class of shares (in neither case including
debt substitute shares) of which is owned, directly or
indirectly, by a company described in subparagraph 2(c) will
satisfy the ownership test of subparagraph 2(e)(i). In such
case, no further analysis of the ownership of the company
described in subparagraph 2(c) is required. Similarly, in
determining whether a trust satisfies the ownership test
described in subparagraph 2(e)(ii), a trust, 50 percent or more
of the beneficial interest in which and 50 percent or more of
each disproportionate interest in which, is owned, directly or
indirectly, by a trust described in subparagraph (2)(c) will
satisfy the ownership test of subparagraph (2)(e)(ii), and no
further analysis of the ownership of the trust described in
subparagraph 2(c) is required.
The second test of subparagraph 2(e) is the so-called
``base erosion'' test. A company or trust that passes the
ownership test must also pass this test to be a qualifying
person under this subparagraph. This test requires that the
amount of expenses that are paid or payable by the entity in
question, directly or indirectly, to persons that are not
qualifying persons, and that are deductible from gross income
(with both deductibility and gross income as determined under
the tax laws of the State of residence of the company or
trust), be less than 50 percent of the gross income of the
company or trust. This test is applied for the fiscal period
immediately preceding the period for which the qualifying
person test is being applied. If it is the first fiscal period
of the person, the test is applied for the current period.
The ownership/base erosion test recognizes that the
benefits of the Convention can be enjoyed indirectly not only
by equity holders of an entity, but also by that entity's
obligees, such as lenders, licensors, service providers,
insurers and reinsurers, and others. For example, a third-
country resident could license technology to a Canadian-owned
Canadian corporation to be sub-licensed to a U.S. resident. The
U.S.-source royalty income of the Canadian corporation would be
exempt from U.S. withholding tax under Article XII (Royalties)
of the Convention. While the Canadian corporation would be
subject to Canadian corporation income tax, its taxable income
could be reduced to near zero as a result of the deductible
royalties paid to the third-country resident. If, under a
convention between Canada and the third country, those
royalties were either exempt from Canadian tax or subject to
tax at a low rate, the U.S. treaty benefit with respect to the
U.S.-source royalty income would have flowed to the third-
country resident at little or no tax cost, with no reciprocal
benefit to the United States from the third country. The
ownership/base erosion test therefore requires both that
qualifying persons substantially own the entity and that the
entity's tax base is not substantially eroded by payments
(directly or indirectly) to nonqualifying persons.
For purposes of this subparagraph 2(e) and other provisions
of this Article, the term ``shares'' includes, in the case of a
mutual insurance company, any certificate or contract entitling
the holder to voting power in the corporation. This is
consistent with the interpretation of similar limitation on
benefits provisions in other U.S. treaties. In Canada, the
principles that are reflected in subsection 256(8.1) of the
Income Tax Act will be applied, in effect treating memberships,
policies or other interests in a corporation incorporated
without share capital as representing an appropriate number of
shares.
The look-through principles introduced by the Protocol
(e.g. new paragraph 6 of Article IV) are to be taken into
account when applying the ownership and base erosion provisions
of Article XXIX A. Therefore, one ``looks through'' an entity
that is viewed as fiscally transparent under the domestic laws
of the residence State (other than entities that are resident
in the source State) when applying the ownership/base erosion
test. Assume, for example, that USCo, a company incorporated in
the United States, wishes to obtain treaty benefits by virtue
of the ownership and base erosion rule. USCo is owned by USLLC,
an entity that is treated as fiscally transparent in the United
States. USLLC in turn is wholly owned in equal shares by 10
individuals who are residents of the United States. Because the
United States views USLLC as fiscally transparent, the 10 U.S.
individuals shall be regarded as the owners of USCo for
purposes of the ownership test. Accordingly, USCo would satisfy
the ownership requirement of the ownership/base erosion test.
However, if USLLC were instead owned in equal shares by four
U.S. individuals and six individuals who are not residents of
either the United States or Canada, USCo would not satisfy the
ownership requirement. Similarly, for purposes of the base
erosion test, deductible payments made to USLLC will be treated
as made to USLLC's owners.
Other qualifying persons
Under new subparagraph 2(f), an estate resident in the
United States or Canada is a qualifying person entitled to the
benefits of the Convention.
New subparagraphs 2(g) and 2(h) specify the circumstances
under which certain types of not-for-profit organizations will
be qualifying persons. Subparagraph 2(g) provides that a not-
for-profit organization that is resident in the United States
or Canada is a qualifying person, and thus entitled to
benefits, if more than half of the beneficiaries, members, or
participants in the organization are qualifying persons. The
term ``not-for-profit organization'' of a Contracting State is
defined in subparagraph 5(d) of the Article to mean an entity
created or established in that State that is generally exempt
from income taxation in that State by reason of its not-for-
profit status. The term includes charities, private
foundations, trade unions, trade associations, and similar
organizations.
New subparagraph 2(h) specifies that certain trusts,
companies, organizations, or other arrangements described in
paragraph 2 of Article XXI (Exempt Organizations) are
qualifying persons. To be a qualifying person, the trust,
company, organization or other arrangement must be established
for the purpose of providing pension, retirement, or employee
benefits primarily to individuals who are (or were, within any
of the five preceding years) qualifying persons. A trust,
company, organization, or other arrangement will be considered
to be established for the purpose of providing benefits
primarily to such persons if more than 50 percent of its
beneficiaries, members, or participants are such persons. Thus,
for example, a Canadian Registered Retirement Savings Plan
(''RRSP'') of a former resident of Canada who is working
temporarily outside of Canada would continue to be a qualifying
person during the period of the individual's absence from
Canada or for five years, whichever is shorter. A Canadian
pension fund established to provide benefits to persons
employed by a company would be a qualifying person only if most
of the beneficiaries of the fund are (or were within the five
preceding years) individual residents of Canada or residents or
citizens of the United States.
New subparagraph 2(i) specifies that certain trusts,
companies, organizations, or other arrangements described in
paragraph 3 of Article XXI (Exempt Organizations) are
qualifying persons. To be a qualifying person, the
beneficiaries of a trust, company, organization or other
arrangement must be described in subparagraph 2(g) or 2(h).
The provisions of paragraph 2 are self-executing, unlike
the provisions of paragraph 6, discussed below. The tax
authorities may, of course, on review, determine that the
taxpayer has improperly interpreted the paragraph and is not
entitled to the benefits claimed.
Paragraph 3 of Article XXIX A
Paragraph 3 provides an alternative rule, under which a
United States or Canadian resident that is not a qualifying
person under paragraph 2 may claim benefits with respect to
those items of income that are connected with the active
conduct of a trade or business in its State of residence.
This is the so-called ``active trade or business'' test.
Unlike the tests of paragraph 2, the active trade or business
test looks not solely at the characteristics of the person
deriving the income, but also at the nature of the person's
activity and the connection between the income and that
activity. Under the active trade or business test, a resident
of a Contracting State deriving an item of income from the
other Contracting State is entitled to benefits with respect to
that income if that person (or a person related to that person
under the principles of Code section 482, or in the case of
Canada, section 251 of the Income Tax Act) is engaged in an
active trade or business in the State where it is resident, the
income in question is derived in connection with, or is
incidental to, that trade or business, and the size of the
active trade or business in the residence State is substantial
relative to the activity in the other State that gives rise to
the income for which benefits are sought. Further details on
the application of the substantiality requirement are provided
below.
Income that is derived in connection with, or is incidental
to, the business of making or managing investments will not
qualify for benefits under this provision, unless those
investment activities are carried on with customers in the
ordinary course of the business of a bank, insurance company,
registered securities dealer, or deposit-taking financial
institution.
Income is considered derived ``in connection'' with an
active trade or business if, for example, the income-generating
activity in the State is ``upstream,'' ``downstream,'' or
parallel to that conducted in the other Contracting State.
Thus, for example, if the U.S. activity of a Canadian resident
company consisted of selling the output of a Canadian
manufacturer or providing inputs to the manufacturing process,
or of manufacturing or selling in the United States the same
sorts of products that were being sold by the Canadian trade or
business in Canada, the income generated by that activity would
be treated as earned in connection with the Canadian trade or
business. Income is considered ``incidental'' to a trade or
business if, for example, it arises from the short-term
investment of working capital of the resident in securities
issued by persons in the State of source.
An item of income may be considered to be earned in
connection with or to be incidental to an active trade or
business in the United States or Canada even though the
resident claiming the benefits derives the income directly or
indirectly through one or more other persons that are residents
of the other Contracting State. Thus, for example, a Canadian
resident could claim benefits with respect to an item of income
earned by a U.S. operating subsidiary but derived by the
Canadian resident indirectly through a wholly-owned U.S.
holding company interposed between it and the operating
subsidiary. This language would also permit a resident to
derive income from the other Contracting State through one or
more residents of that other State that it does not wholly own.
For example, a Canadian partnership in which three unrelated
Canadian companies each hold a one-third interest could form a
wholly-owned U.S. holding company with a U.S. operating
subsidiary. The ``directly or indirectly'' language would allow
otherwise unavailable treaty benefits to be claimed with
respect to income derived by the three Canadian partners
through the U.S. holding company, even if the partners were not
considered to be related to the U.S. holding company under the
principles of Code section 482.
As described above, income that is derived in connection
with, or is incidental to, an active trade or business in a
Contracting State, must pass the substantiality requirement to
qualify for benefits under the Convention. The trade or
business must be substantial in relation to the activity in the
other Contracting State that gave rise to the income in respect
of which benefits under the Convention are being claimed. To be
considered substantial, it is not necessary that the trade or
business be as large as the income-generating activity. The
trade or business cannot, however, in terms of income, assets,
or other similar measures, represent only a very small
percentage of the size of the activity in the other State.
The substantiality requirement is intended to prevent
treaty shopping. For example, a third-country resident may want
to acquire a U.S. company that manufactures television sets for
worldwide markets; however, since its country of residence has
no tax treaty with the United States, any dividends generated
by the investment would be subject to a U.S. withholding tax of
30 percent. Absent a substantiality test, the investor could
establish a Canadian corporation that would operate a small
outlet in Canada to sell a few of the television sets
manufactured by the U.S. company and earn a very small amount
of income. That Canadian corporation could then acquire the
U.S. manufacturer with capital provided by the third-country
resident and produce a very large number of sets for sale in
several countries, generating a much larger amount of income.
It might attempt to argue that the U.S.-source income is
generated from business activities in the United States related
to the television sales activity of the Canadian parent and
that the dividend income should be subject to U.S. tax at the 5
percent rate provided by Article X (Dividends) of the
Convention. However, the substantiality test would not be met
in this example, so the dividends would remain subject to
withholding in the United States at a rate of 30 percent.
It is expected that if a person qualifies for benefits
under one of the tests of paragraph 2, no inquiry will be made
into qualification for benefits under paragraph 3. Upon
satisfaction of any of the tests of paragraph 2, any income
derived by the beneficial owner from the other Contracting
State is entitled to treaty benefits. Under paragraph 3,
however, the test is applied separately to each item of income.
Paragraph 4 of Article XXIX A
Paragraph 4 provides a limited ``derivative benefits'' test
that entitles a company that is a resident of the United States
or Canada to the benefits of Articles X (Dividends), XI
(Interest), and XII (Royalties), even if the company is not a
qualifying person and does not satisfy the active trade or
business test of paragraph 3. In general, a derivative benefits
test entitles the resident of a Contracting State to treaty
benefits if the owner of the resident would have been entitled
to the same benefit had the income in question been earned
directly by that owner. To qualify under this paragraph, the
company must satisfy both the ownership test in subparagraph
4(a) and the base erosion test of subparagraph 4(b).
Under subparagraph 4(a), the derivative benefits ownership
test requires that the company's shares representing more than
90 percent of the aggregate vote and value of all of the shares
of the company, and at least 50 percent of the vote and value
of any disproportionate class of shares, in neither case
including debt substitute shares, be owned directly or
indirectly by persons each of whom is either (i) a qualifying
person or (ii) another person that satisfies each of three
tests. The three tests of subparagraph 4(a) that must be
satisfied by these other persons are as follows:
First, the other person must be a resident of a third
State with which the Contracting State that is granting
benefits has a comprehensive income tax convention. The
other person must be entitled to all of the benefits
under that convention. Thus, if the person fails to
satisfy the limitation on benefits tests, if any, of
that convention, no benefits would be granted under
this paragraph. Qualification for benefits under an
active trade or business test does not suffice for
these purposes, because that test grants benefits only
for certain items of income, not for all purposes of
the convention.
Second, the other person must be a person that would
qualify for benefits with respect to the item of income
for which benefits are sought under one or more of the
tests of paragraph 2 or 3 of Article XXIX A, if the
person were a resident of the Contracting State that is
not providing benefits for the item of income and, for
purposes of paragraph 3, the business were carried on
in that State. For example, a person resident in a
third country would be deemed to be a person that would
qualify under the publicly-traded test of paragraph 2
of Article XXIX A if the principal class of its shares
were primarily and regularly traded on a stock exchange
recognized either under the Convention between the
United States and Canada or under the treaty between
the Contracting State granting benefits and the third
country. Similarly, a company resident in a third
country would be deemed to satisfy the ownership/base
erosion test of paragraph 2 under this hypothetical
analysis if, for example, it were wholly owned by an
individual resident in that third country and the
company's tax base were not substantially eroded by
payments (directly or indirectly) to nonqualifying
persons.
The third requirement is that the rate of tax on the
item of income in respect of which benefits are sought
must be at least as low under the convention between
the person's country of residence and the Contracting
State granting benefits as it is under the Convention.
Subparagraph 4(b) sets forth the base erosion test. This
test requires that the amount of expenses that are paid or
payable by the company in question, directly or indirectly, to
persons that are not qualifying persons under the Convention,
and that are deductible from gross income (with both
deductibility and gross income as determined under the tax laws
of the State of residence of the company), be less than 50
percent of the gross income of the company. This test is
applied for the fiscal period immediately preceding the period
for which the test is being applied. If it is the first fiscal
period of the person, the test is applied for the current
period. This test is qualitatively the same as the base erosion
test of subparagraph 2(e).
Paragraph 5 of Article XXIX AParagraph 5 defines certain
terms used in the Article. These terms were identified and
discussed in connection with new paragraph 2, above.
Paragraph 6 of Article XXIX A
Paragraph 6 provides that when a resident of a Contracting
State derives income from the other Contracting State and is
not entitled to the benefits of the Convention under other
provisions of the Article, benefits may, nevertheless be
granted at the discretion of the competent authority of the
other Contracting State. This determination can be made with
respect to all benefits under the Convention or on an item by
item basis. In making a determination under this paragraph, the
competent authority will take into account all relevant facts
and circumstances relating to the person requesting the
benefits. In particular, the competent authority will consider
the history, structure, ownership (including ultimate
beneficial ownership), and operations of the person. In
addition, the competent authority is to consider (1) whether
the creation and existence of the person did not have as a
principal purpose obtaining treaty benefits that would not
otherwise be available to the person, and (2) whether it would
not be appropriate, in view of the purpose of the Article, to
deny benefits. If the competent authority of the other
Contracting State determines that either of these two standards
is satisfied, benefits shall be granted.
For purposes of implementing new paragraph 6, a taxpayer
will be permitted to present his case to the competent
authority for an advance determination based on a full
disclosure of all pertinent information. The taxpayer will not
be required to wait until it has been determined that benefits
are denied under one of the other provisions of the Article. It
also is expected that, if and when the competent authority
determines that benefits are to be allowed, they will be
allowed retroactively to the time of entry into force of the
relevant provision of the Convention or the establishment of
the structure in question, whichever is later (assuming that
the taxpayer also qualifies under the relevant facts for the
earlier period).
Paragraph 7 of Article XXIX A
New paragraph 7 is in substance similar to paragraph 7 of
Article XXIX A of the existing Convention and clarifies the
application of general anti-abuse provisions. New paragraph 7
provides that paragraphs 1 through 6 of Article XXIX A shall
not be construed as limiting in any manner the right of a
Contracting State to deny benefits under the Convention where
it can reasonably be concluded that to do otherwise would
result in an abuse of the provisions of the Convention. This
provision permits a Contracting State to rely on general anti-
avoidance rules to counter arrangements involving treaty
shopping through the other Contracting State.
Thus, Canada may apply its domestic law rules to counter
abusive arrangements involving ``treaty shopping'' through the
United States, and the United States may apply its substance-
over-form and anti-conduit rules, for example, in relation to
Canadian residents. This principle is recognized by the OECD in
the Commentaries to its Model Tax Convention on Income and on
Capital, and the United States and Canada agree that it is
inherent in the Convention. The statement of this principle
explicitly in the Protocol is not intended to suggest that the
principle is not also inherent in other tax conventions
concluded by the United States or Canada.
ARTICLE 26
Article 26 of the Protocol replaces paragraphs 1 and 5 of
Article XXIX B (Taxes Imposed by Reason of Death) of the
Convention. In addition, paragraph 7 of the General Note
provides certain clarifications for purposes of paragraphs 6
and 7 of Article XXIX B.
Paragraph 1
Paragraph 1 of Article XXIX B of the existing Convention
generally addresses the situation where a resident of a
Contracting State passes property by reason of the individual's
death to an organization referred to in paragraph 1 of Article
XXI (Exempt Organizations) of the Convention. The paragraph
provided that the tax consequences in a Contracting State
arising out of the passing of the property shall apply as if
the organization were a resident of that State.
The Protocol replaces paragraph 1, and the changes set
forth in new paragraph 1 are intended to specifically address
questions that have arisen about the application of former
paragraph 1 where property of an individual who is a resident
of Canada passes by reason of the individual's death to a
charitable organization in the United States that is not a
``registered charity'' under Canadian law. Under one view,
paragraph 1 of Article XXIX B requires Canada to treat the
passing of the property as a contribution to a ``registered
charity'' and thus to allow all of the same deductions for
Canadian tax purposes as if the U.S. charity had been a
``registered charity'' under Canadian law. Under another view,
paragraph 6 of Article XXI (Exempt Organizations) of the
Convention continues to limit the amount of the income tax
charitable deduction in Canada to the individual's income
arising in the United States. The changes set forth in new
paragraph 1 are intended to provide relief from the Canadian
tax on gain deemed recognized by reason of death that would
otherwise give rise to Canadian tax when the individual passes
the property to a charitable organization in the United States,
but, for purposes of the separate Canadian income tax, do not
eliminate the limitation under paragraph 6 of Article XXI on
the amount of the deduction in Canada for the charitable
donation to the individual's income arising in the United
States.
As revised, paragraph 1 is divided into two subparagraphs.
New subparagraph 1(a) applies where property of an individual
who is a resident of the United States passes by reason of the
individual's death to a qualifying exempt organization that is
a resident of Canada. In such case, the tax consequences in the
United States arising from the passing of such property apply
as if the organization were a resident of the United States. A
bequest by a U.S. citizen or U.S. resident (as defined for
estate tax purposes under the Code) to an exempt organization
generally is deductible for U.S. federal estate tax purposes
under Code section 2055, without regard to whether the
organization is a U.S. corporation. Thus, generally, the
individual's estate will be entitled to a charitable deduction
for Federal estate tax purposes equal to the value of the
property transferred to the organization. Generally, the effect
is that no Federal estate tax will be imposed on the value of
the property.
New subparagraph 1(b) applies where property of an
individual who is a resident of Canada passes by reason of the
individual's death to a qualifying exempt organization that is
a resident of the United States. In such case, for purposes of
the Canadian capital gains tax imposed at death, the tax
consequences arising out of the passing of the property shall
apply as if the individual disposed of the property for
proceeds equal to an amount elected on behalf of the
individual. For this purpose, the amount elected shall be no
less than the individual's cost of the property as determined
for purposes of Canadian tax, and no greater than the fair
market value of the property. The manner in which the
individual's representative shall make this election shall be
specified by the competent authority of Canada. Generally, in
the event of a full exercise of the election under new
subparagraph 1(b), no capital gains tax will be imposed in
Canada by reason of the death with regard to that property.
New paragraph 1 does not address the situation in which a
resident of one Contracting State bequeaths property with a
situs in the other Contracting State to a qualifying exempt
organization in the Contracting State of the decedent's
residence. In such a situation, the other Contracting State may
impose tax by reason of death, for example, if the property is
real property situated in that State.
Paragraph 2
Paragraph 2 of Article 26 of the Protocol replaces
paragraph 5 of Article XXIX B of the existing Convention. The
provisions of new paragraph 5 relate to the operation of
Canadian law. Because Canadian law requires both spouses to
have been Canadian residents in order to be eligible for the
rollover, these provisions are intended to provide deferral
(''rollover'') of the Canadian tax at death for certain
transfers to a surviving spouse and to permit the Canadian
competent authority to allow such deferral for certain
transfers to a trust. For example, they would enable the
competent authority to treat a trust that is a qualified
domestic trust for U.S. estate tax purposes as a Canadian
spousal trust as well for purposes of certain provisions of
Canadian tax law and of the Convention. These provisions do not
affect U.S. domestic law regarding qualified domestic trusts.
Nor do they affect the status of U.S. resident individuals for
any other purpose.
New paragraph 5 adds a reference to subsection 70(5.2) of
the Canadian Income Tax Act. This change is needed because the
rollover in respect of certain kinds of property is provided in
that subsection. Further, new paragraph 5 adds a clause ``and
with respect to such property'' near the end of the second
sentence to make it clear that the trust is treated as a
resident of Canada only with respect to its Canadian property.
For example, assume that a U.S. decedent with a Canadian
spouse sets up a qualified domestic trust holding U.S. and
Canadian real property, and that the decedent's executor
elects, for Federal estate tax purposes, to treat the entire
trust as qualifying for the Federal estate tax marital
deduction. Under Canadian law, because the decedent is not a
Canadian resident, Canada would impose capital gains tax on the
deemed disposition of the Canadian real property immediately
before death. In order to defer the Canadian tax that might
otherwise be imposed by reason of the decedent's death, under
new paragraph 5 of Article XXIX B, the competent authority of
Canada shall, at the request of the trustee, treat the trust as
a Canadian spousal trust with respect to the Canadian real
property. The effect of such treatment is to defer the tax on
the deemed distribution of the Canadian real property until an
appropriate triggering event such as the death of the surviving
spouse.
Paragraph 7 of the General Note
In addition to the foregoing, paragraph 7 of the General
Note provides certain clarifications for purposes of paragraphs
6 and 7 of Article XXIX B. These clarifications ensure that tax
credits will be available in cases where there are
inconsistencies in the way the two Contracting States view the
income and the property.
Subparagraph 7(a) of the General Note applies where an
individual who immediately before death was a resident of
Canada held at the time of death a share or option in respect
of a share that constitutes property situated in the United
States for the purposes of Article XXIX B and that Canada views
as giving rise to employment income (for example, a share or
option granted by an employer). The United States imposes
estate tax on the share or option in respect of a share, while
Canada imposes income tax on income from employment.
Subparagraph 7(a) provides that for purposes of clause 6(a)(ii)
of Article XXIX B, any employment income in respect of the
share or option constitutes income from property situated in
the United States. This provision ensures that the estate tax
paid on the share or option in the United States will be
allowable as a deduction from the Canadian income tax.
Subparagraph 7(b) of the General Note applies where an
individual who immediately before death was a resident of
Canada held at the time of death a registered retirement
savings plan (RRSP) or other entity that is a resident of
Canada and that is described in subparagraph 1(b) of Article IV
(Residence) and such RRSP or other entity held property
situated in the United States for the purposes of Article XXIX
B. The United States would impose estate tax on the value of
the property held by the RRSP or other entity (to the extent
such property is subject to Federal estate tax), while Canada
would impose income tax on a deemed distribution of the
property in the RRSP or other entity. Subparagraph 7(b)
provides that any income out of or under the entity in respect
of the property is, for the purpose of subparagraph 6(a)(ii) of
Article XXIX B, income from property situated in the United
States. This provision ensures that the estate tax paid on the
underlying property in the United States (if any) will be
allowable as a deduction from the Canadian income tax.
Subparagraph 7(c) of the General Note applies where an
individual who immediately before death was a resident or
citizen of the United States held at the time of death an RRSP
or other entity that is a resident of Canada and that is
described in subparagraph 1(b) of Article IV (Residence). The
United States would impose estate tax on the value of the
property held by the RRSP or other entity, while Canada would
impose income tax on a deemed distribution of the property in
the RRSP or other entity. Subparagraph 7(c) provides that for
the purpose of paragraph 7 of Article XXIX B, the tax imposed
in Canada is imposed in respect of property situated in Canada.
This provision ensures that the Canadian income tax will be
allowable as a credit against the U.S. estate tax.
ARTICLE 27
Article 27 of the Protocol provides the entry into force
and effective date of the provisions of the Protocol.
Paragraph 1
Paragraph 1 provides generally that the Protocol is subject
to ratification in accordance with the applicable procedures in
the United States and Canada. Further, the Contracting States
shall notify each other by written notification, through
diplomatic channels, when their respective applicable
procedures have been satisfied.
Paragraph 2
The first sentence of paragraph 2 generally provides that
the Protocol shall enter into force on the date of the later of
the notifications referred to in paragraph 1, or January 1,
2008, whichever is later. The relevant date is the date on the
second of these notification documents, and not the date on
which the second notification is provided to the other
Contracting State. The January 1, 2008 date is intended to
ensure that the provisions of the Protocol will generally not
be effective before that date.
Subparagraph 2(a) provides that the provisions of the
Protocol shall have effect in respect of taxes withheld at
source, for amounts paid or credited on or after the first day
of the second month that begins after the date on which the
Protocol enters into force. Further, subparagraph 2(b) provides
that the Protocol shall have effect in respect of other taxes,
for taxable years that begin after (or, if the later of the
notifications referred to in paragraph 1 is dated in 2007,
taxable years that begin in and after) the calendar year in
which the Protocol enters into force. These provisions are
generally consistent with the formulation in the U.S. Model
treaty, with the exception that a parenthetical was added in
subparagraph 2(b) to address the contingency that the written
notifications provided pursuant to paragraph 1 may occur in the
2007 calendar year. Further, subparagraph 3(d) of Article 27 of
the Protocol contains special provisions with respect to the
taxation of cross-border interest payments that have effect for
the first two calendar years that end after the date the
Protocol enters into force. Therefore, during this period,
cross-border interest payments are not subject to the effective
date provisions of subparagraph 2(a).
Paragraph 3
Paragraph 3 sets forth exceptions to the general effective
date rules set forth in paragraph 2 of Article 27 of the
Protocol.
Dual corporate residence tie-breaker
Subparagraph 3(a) of Article 27 of the Protocol provides
that paragraph 1 of Article 2 of the Protocol relating to
Article IV (Residence) shall have effect with respect to
corporate continuations effected after September 17, 2000. This
date corresponds to a press release issued on September 18,
2000 in which the United States and Canada identified certain
issues with respect to these transactions and stated their
intention to negotiate a protocol that, if approved, would
address the issues effective as of the date of the press
release.
Certain payments through fiscally transparent entities
Subparagraph 3(b) of Article 27 of the Protocol provides
that new paragraph 7 of Article IV (Residence) set forth in
paragraph 2 of Article 2 of the Protocol shall have effect as
of the first day of the third calendar year that ends after the
Protocol enters into force.
Permanent establishment from the provision of services
Subparagraph 3(c) of Article 27 of the Protocol sets forth
the effective date for the provisions of Article 3 of the
Protocol, pertaining to Article V (Permanent Establishment) of
the Convention. The provisions pertaining to Article V shall
have effect as of the third taxable year that ends after the
Protocol enters into force, but in no event shall it apply to
include, in the determination of whether an enterprise is
deemed to provide services through a permanent establishment
under paragraph 9 of Article V of the Convention, any days of
presence, services rendered, or gross active business revenues
that occur or arise prior to January 1, 2010. Therefore, the
provision will apply beginning no earlier than January 1, 2010
and shall not apply with regard to any presence, services or
related revenues that occur or arise prior to that date.
Withholding rates on cross-border interest payments
Subparagraph 3(d) of Article 27 of the Protocol sets forth
special effective date rules pertaining to Article 6 of the
Protocol relating to Article XI (Interest) of the Convention.
Article 6 of the Protocol sets forth a new Article XI of the
Convention that provides for exclusive residence State taxation
regardless of the relationship between the payer and the
beneficial owner of the interest. Subparagraph 3(d), however,
phases in the application of paragraph 1 of Article XI during
the first two calendar years that end after the date the
Protocol enters into force. During that period, paragraph 1 of
Article XI of the Convention permits source State taxation of
interest if the payer and the beneficial owner are related or
deemed to be related by reason of paragraph 2 of Article IX
(Related Persons) of the Convention (''related party
interest''), and the interest would not otherwise be exempt
under the provisions of paragraph 3 of Article XI as it read
prior to the Protocol. However, subparagraph 3(d) also provides
that the source State taxation on such related party interest
is limited to 7 percent in the first calendar year that ends
after entry into force of the Protocol and 4 percent in the
second calendar year that ends after entry into force of the
Protocol.
Subparagraph 3(d) makes clear that the provisions of the
Protocol with respect to exclusive residence based taxation of
interest when the payer and the beneficial owner are not
related or deemed related (''unrelated party interest'')
applies for interest paid or credited during the first two
calendar years that end after entry into force of the Protocol.
The withholding rate reductions for related party interest
and exemptions for unrelated party interest will likely apply
retroactively. For example, if the Protocol enters into force
on June 30, 2008, paragraph 1 of Article XI, as it reads under
subparagraph 3(d) of Article 27, will have the following effect
during the first two calendar years. First, unrelated party
interest that is paid or credited on or after January 1, 2008
will be exempt from taxation in the source State. Second,
related party interest paid or credited on or after January 1,
2008 and before January 1, 2009, will be subject to source
State taxation but at a rate not to exceed 7 percent of the
gross amount of the interest. Third, related party interest
paid or credited on or after January 1, 2009 and before January
1, 2010, will be subject to source State taxation but at a rate
not to exceed 4 percent of the gross amount of the interest.
Finally, all interest paid or credited after January 1, 2010,
will be subject to the regular rules of Article XI without
regard to subparagraph 3(d) of Article 27.
Further, the provisions of subparagraph 3(d) ensure that
even with respect to circumstances where the payer and the
beneficial owner are related or deemed related under the
provisions of paragraph 2 of Article IX, the source State
taxation of such cross-border interest shall be no greater than
the taxation of such interest prior to the Protocol.
Gains
Subparagraph 3(e) of Article 27 of the Protocol provides
the effective date for paragraphs 2 and 3 of Article 8 of this
Protocol, which relate to the changes made to paragraphs 5 and
7 of Article XIII (Gains) of the Convention. The changes set
forth in those paragraphs shall have effect with respect to
alienations of property that occur (including, for greater
certainty, those that are deemed under the law of a Contracting
State to occur) after September 17, 2000. This date corresponds
to the press release issued on September 18, 2000 which
announced the intention of the United States and Canada to
negotiate a protocol that, if approved, would incorporate the
changes set forth in these paragraphs to coordinate the tax
treatment of an emigrant's gains in the United States and
Canada.
Arbitration
Subparagraph 3(f) of Article 27 of the Protocol pertains to
Article 21 of the Protocol which implements the new arbitration
provisions. An arbitration proceeding will generally begin two
years after the date on which the competent authorities of the
Contracting States began consideration of a case. Subparagraph
3(f), however, makes clear that the arbitration provisions
shall apply to cases that are already under consideration by
the competent authorities when the Protocol enters into force,
and in such cases, for purposes of applying the arbitration
provisions, the commencement date shall be the date the
Protocol enters into force. Further, the provisions of Article
21 of the Protocol shall be effective for cases that come into
consideration by the competent authorities after the date that
the Protocol enters into force. In order to avoid the potential
for a large number of MAP cases becoming subject to arbitration
immediately upon the expiration of two years from entry into
force, the competent authorities are encouraged to develop and
implement procedures for arbitration by January 1, 2009, and
begin scheduling arbitration of otherwise unresolvable MAP
cases in inventory (and meeting the agreed criteria) prior to
two years from entry into force.
Assistance in collection
Subparagraph 3(g) of Article 27 of the Protocol pertains to
the date when the changes set forth in Article 22 of the
Protocol, relating to assistance in collection of taxes, shall
have effect. Consistent with the third protocol that entered
into force on November 9, 1995, and which had effect for
requests for assistance on claims finally determined after
November 9, 1985, the provisions of Article 22 of the Protocol
shall have effect for revenue claims finally determined by an
applicant State after November 9, 1985.
X. Annex II.--Treaty Hearing of July 10, 2008
TREATIES
----------
Thursday, July 10, 2008
U.S. Senate
Committee on Foreign Relations
Washington, D.C.
The committee met, pursuant to notice, at 2:45 p.m., in
Room SD-419, Dirksen Senate Office Building, Hon. Robert
Menendez, presiding.
Present: Senators Menendez [presiding] and Lugar.
OPENING STATEMENT OF HON. ROBERT MENENDEZ, U.S. SENATOR FROM
NEW JERSEY
Senator Menendez. This hearing of the Committee on Foreign
Relations will now come to order.
Today, the committee meets to consider 12 treaties, many of
which represent years of work that have culminated in the
international frameworks we will discuss today. The topics vary
widely--tax, the environment, telecommunications--and all are
important issues for which international coordination is
crucial. We have an ambitious agenda today, so I will keep my
statement brief.
Two of the environmental treaties that we are considering
today build on existing treaties to which the United States is
already a party and has benefited from over the years. The
London dumping protocol represents the culmination of a
thorough and intensive effort to update and improve the 1972
London Convention. The land-based sources protocol builds on
the 1983 Convention for the Protection and Development of the
Marine Environment of the Wider Caribbean Region, also known as
the Cartagena Convention.
The third treaty, the anti-fouling convention, stands on
its own, but it was negotiated at and relies on the
International Maritime Organization, to which the United States
is an active member.
The next set of treaties are tax treaties. A basic
objective of our bilateral income tax treaties, as their full
title implies, is to prevent double taxation of income. In many
cases, both the country where a company is headquartered and
the company (sic) where a company earns its income tax a
company's earnings with the result that the same dollars are
taxed twice.
Tax treaties tend to allocate the right to certain income
to the residence country rather than the source country or at
least to limit source country taxation with the ultimate goal
of minimizing the tax burden for the taxpayer. But in many
ways, this is just the tip of the iceberg in terms of what tax
treaties help the United States to accomplish.
Tax treaties can, one, reduce tax barriers to cross-border
trade and investment; two, provide, if well drafted, clarity
and greater certainty to taxpayers who are attempting to assess
their potential liability to tax in foreign jurisdictions in
which they are doing business or working; and, three, ensure
that U.S. taxpayers are not being subject to discriminatory
taxes in foreign jurisdictions.
And last, but not least, tax treaties facilitate U.S.
Government efforts to prevent tax evasion through important,
but often overlooked provisions that provide for the exchange
of information between tax authorities.
The United States is a party to 58 income tax treaties
covering 66 countries. If we ratify the treaty with Bulgaria,
along with the 2008 protocol, we will be adding yet another
country to that impressive record. Today, we are considering
four tax treaties with three different countries--Canada,
Iceland, and Bulgaria. All are important instruments.
It is worth noting that the Canadian protocol we consider
today has been in negotiations for over a decade. We do a
tremendous amount of cross-border trade with Canada, and Canada
is our leading merchandise export destination. It is easy to
understand why this protocol is of such importance.
Perhaps the most important aspect of the Canada protocol is
the binding arbitration mechanism that Treasury has negotiated.
The first U.S. tax agreement to include a binding arbitration
provision was the U.S.-Germany income tax treaty, which the
committee considered and voted to approve last year.
Many U.S. entities have been caught up in unresolved
disputes between the tax authorities of both countries when
interpreting and applying the convention. This arbitration
mechanism will afford those entities some relief through final
decisions made by an arbitration board.
Now, I and other members have raised questions about this
mechanism regarding how it might be improved. But I recognize
this is a valuable addition to the U.S.-Canada tax treaty.
The new treaty with Iceland would replace an older treaty
from 1975. The most important aspect of this treaty is the
addition of a strong limitation on benefits provision, which
will, if ratified, limit abuse of our treaty with Iceland by
nonresidents.
The other two treaties are with Hungary and Poland.
Consequently, these three countries present an attractive
opportunity for treaty shopping, and it is certainly good to
see that Treasury has worked to close this loophole. And I hope
to see new treaties with Hungary and Poland that also include
strong limitation on benefit provisions.
The new treaty with Bulgaria, along with the 2008 protocol,
would be the first income tax treaty between the United States
and Bulgaria. The treaty is designed to reduce tax barriers to
cross-border investment, provide for better exchange of tax
information, and facilitate cross-border tax administration
more generally.
Finally, the last set of treaties are the ITU treaties,
which was founded in 1865, barely 10 years after the first
public message over a telegraph was sent between Washington and
Baltimore. Back then, the organization was called the
International Telegraph Union. Today, some 140 years later, the
fundamental objectives of the organization remain basically
unchanged. It is the leading international organization in the
world for information and communication technologies, based in
Geneva, and its membership includes 191 countries.
Three of these treaties under consideration today amend the
constituent documents that define the ITU and its day-to-day
functioning, its constitution, and its convention. These
amendments have three main objectives--to facilitate private
sector involvement in the organization, to improve the ITU's
working methods and flexibility as an organization in order to
respond to rapidly changing technology and membership needs,
and, three, to promote greater fiscal stability and
transparency.
The remaining two ITU treaties under consideration are
revisions to the radio regulations, which are instruments
negotiated under the auspices of the ITU. These treaties are
technical instruments that address international spectrum
allocations and radio regulations in many different services,
including broadcasting, satellite sound broadcasting, mobile
satellite services, and space services.
We are pleased to have a distinguished panel of witnesses,
who will help us understand the treaties before us. Let me, on
behalf of the committee, welcome Ambassador Balton from the
Department of State, the Deputy Assistant Secretary for Oceans
and Fisheries who will be testifying on the environmental
treaties.
For the tax treaties, we have two witnesses. Let me welcome
Mr. Michael Mundaca from the Department of Treasury, the Deputy
Assistant Secretary in the Office of Tax Policy. And Ms. Emily
McMahon, who is the Deputy Chief of Staff for the Joint
Committee on Taxation.
And finally, let me welcome Mr. Richard Beaird, the Senior
Deputy U.S. Coordinator for International Communications and
Information Policy at the Department of State, who will testify
on the ITU treaties.
With that, let me recognize the distinguished Ranking
Member of the committee, Senator Lugar, for his opening
statement.
STATEMENT OF HON. RICHARD G. LUGAR, U.S. SENATOR FROM INDIANA
Senator Lugar. Well, thank you very much, Mr. Chairman,
and I join you in welcoming our distinguished witnesses, who
will help us examine the diverse group of treaties you have
described.
The Senate has an important role under the Constitution in
the treaty-making process. And this committee's work is central
to the exercise of that role.
The treaties before the committee today address several
issues in which cooperation between the United States and other
governments can advance the interests of all parties. In the
economic realm, the tax treaties with Bulgaria, Canada, and
Iceland will bolster our economic relationships with countries
that are already close trade and investment partners.
As the United States considers how to create jobs and
maintain economic growth, it is important that we try to
eliminate impediments that prevent our companies from fully
accessing international markets. We should work to ensure that
the companies pay their fair share of taxes while not being
unfairly taxed twice on the same revenue.
Tax treaties are intended to prevent double taxation so
that companies are not inhibited from doing business overseas.
Now they also strengthen the United States Government's ability
to enforce existing laws by enhancing our efforts to gather and
compare information in cooperation with foreign governments. As
the United States moves to keep the economy growing and to
increase the United States employment, international tax
policies that promote foreign direct investment in the United
States are critically important.
The three environmental treaties before us provide
frameworks for cooperation to address a variety of threats to
the health of our oceans. These agreements seek to combat
pollution of the oceans from multiple sources, including the
dumping of waste into ocean waters, the leaching of protective
coatings applied to the hulls of ships, and the runoff of
wastewater and agricultural pollutants. Such pollution harms
our ability to make productive use of ocean resources and
threatens public health.
With respect to telecommunications, the agreements before
us are part of the ongoing efforts of the United States to
advance cooperation in the management and use of the radio
spectrum under the auspices of the International
Telecommunications Union. Reliable telecommunications
capabilities play a critical role in economic activity and
growth, and we have an interest in facilitating productive
cooperation in this area.
Today's group of treaties places a number of important
issues on the committee's plate. Several of these agreements
are quite detailed and will require the committee's careful
study and analysis. I appreciate the opportunity to discuss
these treaties and look forward to the testimony of our
witnesses today.
And I thank you, Mr. Chairman, for conducting the hearing.
Senator Menendez. Thank you. Thank you, Senator Lugar.
With that, we will start the testimony of the witnesses. We
ask that you keep your statements to about 5 minutes. Your
entire statement will be included in the record, and this will
give us some time for some questions and answers.
And if you would start, Ambassador Balton, in the order
that I introduced you and move down the line? Thank you.
STATEMENT OF HON. DAVID A. BALTON, DEPUTY ASSISTANT SECRETARY
FOR OCEANS AND FISHERIES, BUREAU OF OCEANS, ENVIRONMENTAL, AND
SCIENTIFIC AFFAIRS, DEPARTMENT OF STATE, WASHINGTON, D.C.
Ambassador Balton. Thank you very much, Mr. Chairman,
members of the committee.
I am pleased to testify in support of the three treaties
designed to protect the oceans. The three treaties address
different aspects of marine pollution. We commend the committee
for taking advantage of this opportunity to consider them
together. Ratification of these treaties will allow the United
States to reinforce its leadership role on oceans at the
international level.
Two of these treaties require implementing legislation. The
administration has, in both cases, forwarded to Congress draft
legislation for this purpose. We believe that Senate advice and
consent to these treaties would spur both houses to enact such
legislation.
Please allow me to highlight a few key elements of each
treaty. First, the convention on anti-fouling systems. This
treaty prohibits the use and application of certain paint-like
coatings on a ship's hull. Some of these coatings, while
effective in preventing the attachment of barnacles and similar
creatures, have significant adverse environmental side effects.
In particular, those coatings that contain organotin
biocides can harm oysters and other valuable marine resources
when those biocides leach into the water. U.S. law already
prohibits use of such anti-foulants on most vessels in the
United States. The United States canceled the last registration
of organotin paint in 19--I am sorry--in 2005.
To implement the convention fully, the administration has
proposed new legislation that would, among other things,
broaden existing requirements to cover all U.S. ships as well
as foreign ships entering U.S. ports and certain other waters.
The anti-fouling coatings industry in the United States
supports the standards in the convention and the proposed
implementing legislation.
This treaty will enter into force this September. Thirty
states representing more than 49 percent of the world's
shipping tonnage have already adhered to it. As a party, the
United States could participate fully in the international
implementation of the convention, especially in the review and
adoption of possible proposals to control other anti-fouling
systems.
The second treaty is a protocol to the Cartagena
Convention, which concerns environmental protection and
sustainable development in the Caribbean region. The United
States ratified the convention in 1984. The protocol before the
Senate today is actually the third protocol to this convention.
The United States is already a party to the other two, which
deal with oil spills and specially protected areas and
wildlife.
This third protocol addresses pollution of the marine
environment from land-based sources and activities. Improving
control over these sources of pollution, which account for an
estimated 70 to 90 percent of all marine pollution, will help
protect coral reefs and other sensitive coastal habitats,
recreation, tourism, and public health.
Among other things, the protocol sets forth specific
effluent limitations for domestic wastewater. The United States
already meets or exceeds these standards in all respects.
The United States signed the protocol in 1999. Four states
have ratified it so far. We believe U.S. ratification would
spur others to follow suit. The protocol will enter into force
when nine nations have adhered to it. Although the protocol
applies only to the wider Caribbean region, it is the first
regional agreement to establish effluent standards of this kind
and may well serve as a model for other regions.
The third treaty is the 1996 London protocol, which
regulates dumping of harmful wastes and other matter into the
sea. The protocol updates the original London convention to
which the United States has been a party since 1975. Although
the convention and the protocol share many features, the
protocol will protect the marine environment more effectively.
Where the convention generally prohibits the dumping of
specifically listed substances, the protocol generally
prohibits the dumping of all substances except those that are
specifically listed. The list of substances that may be
permitted for dumping can be amended in light of new
information and technologies. Indeed, the list was already
amended once to facilitate certain initiatives to sequester
carbon dioxide below the sea floor.
The United States would join the treaty as amended. And as
a party, the United States would best be able to influence
possible further changes to this list as well as fully
participate in all issues arising under the protocol.
The United States signed this protocol in 1998. It entered
into force in 2006. Currently, it has 35 parties. U.S.
ratification would not require significant changes for the
United States. However, the administration has submitted
proposed implementing legislation in the form of several
amendments to the Ocean Dumping Act to bring U.S. law fully
into conformity with the requirements of the protocol.
Thank you very much for this opportunity to convey the
support of the administration for these vital treaties. I would
be happy to answer any questions.
[The prepared statement of Ambassador Balton follows:]
Prepared Statement of Ambassador David A. Balton
Mr. Chairman and members of the committee: I am pleased to testify
today in support of the Senate's provision of advice and consent to
three treaties designed to protect the oceans. The three treaties
address different aspects of marine pollution in distinct and vital
ways. One controls toxic side effects of certain substances used on
hulls to prevent attachment of barnacles and other unwanted organisms.
Another reduces land-based sources of marine pollution in the Wider
Caribbean Region. The third updates and improves an existing treaty on
ocean dumping.
As you know, the administration supported Senate action on each of
these treaties in its February 2007 letter to Chairman Biden setting
out its treaty priorities for the 110th Congress. Although the treaties
are not legally or institutionally connected, we commend the committee
for taking advantage of this opportunity to consider them together in
an effort to send a strong message about the urgent need to protect the
world's oceans.
The three treaties before you are: the International Convention on
the Control of Harmful Anti-Fouling Systems on Ships, or the ``AFS
Convention,'' transmitted to the Senate on January 22, 2008; the
Protocol Concerning Pollution from Land-Based Sources and Activities,
or the ``LBS Protocol'' to the Convention for the Protection and
Development of the Marine Environment of the Wider Caribbean Region, or
the ``Cartagena Convention,'' transmitted to the Senate on February 16,
2007; and the 1996 Protocol to the Convention on the Prevention of
Marine Pollution by Dumping of Wastes and Other Matter, or the ``London
Protocol,'' transmitted to the Senate on September 4, 2007.
Prompt action to facilitate ratification of these treaties will
allow the United States to reinforce and maintain its leadership role
on oceans issues at the international and regional levels. Ratification
would enhance our ability to work with other States to promote
effective implementation of these treaties. As a Party to these
treaties, the United States would be able to participate fully in
meetings of States Parties aimed at implementation of these treaties
and, thereby, more directly affect the implementation and
interpretation of these treaties. Further, after the United States
ratifies a treaty, other nations are more likely to ratify as well,
resulting in greater overall protection of the oceans from marine
pollution.
The United States participated actively in the negotiation of each
of these treaties. Our technical expertise and drafting skills
significantly influenced the final language of each instrument.
Throughout these processes, affected U.S. stakeholders provided
meaningful input. We believe that ratification of all three treaties
enjoys widespread support among these stakeholders and should not be
contentious.
Two of the three treaties--the London Protocol and the AFS
Convention--require implementing legislation prior to ratification. As
discussed in more detail below, the administration has in both cases
developed and forwarded to Congress draft legislation for this purpose.
We believe that early action by the Senate to provide advice and
consent would spur both Houses to enact such legislation.
The transmittal packages for these treaties detail the provisions
under each regime. I would, however, like to highlight a few key
elements in this testimony.
anti-fouling systems convention
I would like to first address the AFS Convention, which was adopted
at the International Maritime Organization (IMO) in London and aims to
protect the marine environment and human health from the negative
effects of certain anti-fouling systems.
Anti-fouling systems are mainly paint-like coatings used on a
ship's hull to prevent attachment of barnacles and other unwanted
organisms that slow down ships. Some anti-fouling systems may adversely
affect the marine environment through leaching of biocides into the
water. In particular, anti-fouling systems containing organotin
biocides can cause adverse reproductive effects and shell deformities
in marine animals, including economically important species of oysters.
A Party to the AFS Convention must prohibit use and application of
organotin-based anti-fouling systems on ships flying its flag or
operating under its authority, as well as ships entering its ports,
shipyards, or offshore terminals. A survey and certification system,
which the Coast Guard would implement domestically for the United
States, serves to verify that a ship is in compliance. Domestic law
would govern violations of the certificate system and resulting
sanctions. The Convention contains standard language on the treatment
of vessels entitled to sovereign immunity.
While the treaty is currently limited to prohibitions on organotin-
based systems, Annex 1 sets forth procedures for evaluating proposals
to add controls on other harmful anti-fouling systems, after the IMO's
Marine Environment Protection Committee has completed a comprehensive
risk and benefits analysis. As described in the proposed declaration
for Article 16 in the administration's transmittal package, a Party may
choose to require its express consent prior to being bound by any
amendment to Annex 1. The administration recommends that the United
States exercise this option.
The Organotin Anti-Fouling Paint Control Act of 1988 (OAPCA), 33
U.S.C.A. Sec. Sec. 2401-2410, restricts the release rate of organotin
from anti-fouling systems and prohibits use of such systems on most
vessels in the United States under 25 meters in length. The last
organotin anti-fouling paint registration was cancelled in December
2005. The proposed implementing legislation forwarded to Congress would
prohibit the use of organotin anti-fouling systems on U.S. ships and
foreign ships entering U.S. ports and certain other waters. This
prohibition would result in greater protection of the marine
environment in near-coastal waters of the United States, and apply the
same standards for anti-fouling systems on U.S. vessels and foreign
vessels entering U.S. ports. The anti-fouling coatings industry has
consistently supported the standards in the AFS Convention and the
proposed implementing legislation. Most international shipping
interests have already switched to alternative anti-fouling systems
that do not contain organotin.
The AFS Convention will enter into force on September 17, 2008.
Thirty States have ratified or otherwise accepted the Convention,
including Panama, Japan, Mexico and Spain, representing more than 49%
of the world's shipping tonnage. It would be highly desirable for the
United States to be a Party to the Convention when it enters into
force, or soon thereafter, so that we can participate fully in the
international implementation of the Convention, especially the review
of proposals to control other anti-fouling systems. Ratification of the
treaty by the United States would more generally demonstrate our
continued environmental leadership in this area and our support for
more environmentally friendly anti-fouling technologies.
land-based sources protocol
The second treaty I would like to address is a Protocol to the
Cartagena Convention, a regional seas agreement negotiated under the
auspices of the United Nations Environment Program. The Cartagena
Convention, which the United States ratified in 1984, is a framework
agreement that sets out general obligations to protect the marine
environment of the Wider Caribbean Region, an area encompassing the
Gulf of Mexico, Straits of Florida, Caribbean Sea, and the immediately
adjacent areas of the Atlantic Ocean within 200-nautical miles of
shore. This region is of particular importance to the United States, as
waste from other nations combined with the circulation patterns in this
area could result in increased pollution in U.S. waters.
The LBS Protocol is in fact one of three subsidiary agreements to
the Cartagena Convention. The United States is already a Party to the
other two agreements: the Protocol Concerning Co-operation in Combating
Oil Spills in the Wider Caribbean Region, and the Protocol Concerning
Specially Protected Areas and Wildlife. Together, these agreements
offer significant protection to marine and coastal resources in this
crucial region.
In negotiating the LBS Protocol, the United States sought to create
requirements for other nations bordering this region that would, in
effect, bring them up to U.S. standards with respect to controlling
land-based sources of marine pollution. As a result of the success of
this strategy, U.S. ratification of this instrument would not require
new implementing legislation.
It is estimated that 70 to 90 percent of pollution entering the
marine environment worldwide emanates from land-based sources and
activities. Land-based sources of pollution endanger public health,
degrade coral reefs and other sensitive coastal habitats, undermine
fisheries resources, and negatively affect regional economies,
recreation, and tourism.
The LBS Protocol elaborates on the obligation set forth in Article
7 of the Cartagena Convention to ``take all appropriate measures to
prevent, reduce and control pollution of the Convention area caused by
coastal disposal or by discharges emanating from rivers, estuaries,
coastal establishments, outfall structures, or any other sources on
their territories.''
Among the principal land-based sources of marine pollution in the
Wider Caribbean Region are domestic wastewater and agricultural non-
point source runoff. Specific effluent limitations for domestic
wastewater and a requirement to develop plans for the prevention,
reduction and control of agricultural non-point sources of pollution
are contained in the legally binding annexes III and IV. Annex I sets
forth a list of additional pollutants for Parties to take into account.
The Protocol envisions that additional annexes will be developed to
address these pollutants, and Annex II sets out factors to be
considered by the Parties in developing such annexes. While these
original four annexes apply to all Protocol Parties, a Party to the
Protocol may choose to require its express consent prior to being bound
by any additional annexes that may be adopted in the future. As
described in the proposed declaration under Article XVII of the
transmittal package, the administration recommends that the United
States exercise this option.
While having significant beneficial impacts in a region of specific
interest to the United States, the Protocol is also expected to have an
impact even beyond the Wider Caribbean Region, as it is the first
regional agreement to establish effluent standards to protect the
marine environment. It therefore serves as a model for other regions
that are also seeking to address this urgent problem.
The United States signed the LBS Protocol in October 1999. It is
not yet in force, as only four of the nine necessary ratifications for
entry into force have been received--from France, Panama, Saint Lucia,
and Trinidad and Tobago.
However, given the strong leadership role played by the United
States in the negotiation of the Protocol, U.S. ratification would
provide strong encouragement to other States to become contracting
parties. Indeed, several States in the region have indicated that they
would be more likely to join following U.S. ratification.
london protocol
The third treaty before you is the 1996 London Protocol, a treaty
designed to protect the world's oceans from the dumping of harmful
wastes and other matter. The Protocol regulates deliberate disposal at
sea of wastes or other matter from vessels, aircraft, platforms, or
man-made structures at sea. The Protocol also bans incineration at sea
of all wastes or other matter. It represents the culmination of a
thorough and intensive effort to update the 1972 London Convention, to
which the United States has been a Party since 1975. The Protocol is a
free-standing treaty that is intended eventually to replace the London
Convention.
Although the Protocol and the London Convention share many
features, the Protocol will protect the marine environment more
effectively. The Protocol moves from a structure of listing substances
that may not be dumped to a ``reverse list'' approach, which generally
prohibits ocean dumping of all wastes or other matter, except for a few
specified wastes in Annex 1. When considering whether to allow the
dumping of a waste or other matter listed in Annex 1, a Party must
follow detailed environmental assessment criteria found in Annex 2,
which provide a complete waste management strategy, including
consideration of alternatives to ocean disposal.
A few types of activities are not considered dumping under the
Protocol. These include placement of matter, such as research devices
or artificial reefs, for a purpose other than mere disposal, provided
that such placement is not contrary to the aims of the Protocol.
Activities related to oil and gas exploration are excluded from the
definition of dumping. Further, there are exceptions for ``force
majeure'' and emergency situations. The Protocol contains standard
language on the sovereign immunity of ships.
The Protocol, like the Convention, requires a Party to use a permit
process to regulate dumping activities within areas subject to national
jurisdiction, on vessels loaded in its territory and on vessels flying
its flag. Permits are issued and violations are addressed domestically.
The list of substances on Annex 1 that currently may be considered
for dumping is meant to be a dynamic list that can be amended when
necessary as new information and technologies develop. For example, an
amendment, which the U.S. supported, was adopted in November 2006 to
add carbon dioxide streams from carbon dioxide capture processes for
sequestration, to allow for the possibility of sequestration in sub-
seabed geological formations. The United States would join the treaty
as amended. As a party, of course, the United States would be able to
have a say in the addition of other substances to this list, thereby
protecting its interests in determining how and when the ocean may be
used for dumping.
The administration's transmittal package proposes one declaration
and one understanding to be deposited along with the instrument of
ratification. The declaration in Article 3 stems from a suggestion of
the United States during the negotiations that at the time of
ratification, a State may declare that its consent is required before
it may be subject to binding arbitration about the interpretation or
application of the general principles in Article 3.1 or 3.2 on
precaution and polluter pays. The administration proposes making such a
declaration for the United States.
With respect to Article 10, the administration proposes an
understanding making clear that disputes regarding the interpretation
or application of the Protocol with respect to sovereign immune vessels
are not subject to Article 16 dispute settlement procedures.
The United States signed the Protocol on March 31, 1998. It entered
into force on March 24, 2006, having met the 26-State requirement. It
currently has 35 Parties. The IMO serves as the Secretariat for both
the Convention and the Protocol.
Now that the London Protocol has entered into force, it is highly
desirable for the United States to join. The United States supported
the updating and improvements of the Convention that the Protocol
reflects. Further, it is important for the United States to maintain
its current leadership role in this area and to ensure our
participation in the development of policies and procedures under the
Protocol.
The administration has transmitted to Congress a legislative
proposal to implement the London Protocol in the form of amendments to
the Ocean Dumping Act. While ratification of the Protocol would not
require significant changes to the U.S. ocean dumping program as it
currently operates, some changes to the Ocean Dumping Act would be
needed. For example, it has long been U.S. practice not to authorize
incineration at sea or dumping of low-level radioactive wastes. The
proposed amendments to the Ocean Dumping Act would explicitly reflect
those prohibitions.
conclusion
United States' ratification of the treaties before you today would
advance our national interest and would promote our leadership on the
prevention of marine pollution. These treaties are widely supported and
not contentious in our view.
Thank you, Mr. Chairman and members of the committee for this
opportunity to convey the support of the administration for this
effort. I urge that the committee give prompt and favorable
consideration to these treaties. I would be happy to answer any
questions.
Senator Menendez. Thank you.
Mr. Mundaca?
STATEMENT OF MICHAEL MUNDACA, DEPUTY ASSISTANT SECRETARY
(INTERNATIONAL), OFFICE OF TAX POLICY, DEPARTMENT OF THE
TREASURY, WASHINGTON, D.C.
Mr. Mundaca. Mr. Chairman, ranking member Lugar, I
appreciate the opportunity to appear today to recommend on
behalf of the administration favorable action on three tax
treaties. We appreciate the committee's interest in these
treaties and in the tax treaty network generally.
One of the primary functions of tax treaties is to provide
certainty to taxpayers regarding whether their cross-border
activities will subject them to tax in another country. Another
primary function is to relieve double taxation, including
through the reduction of withholding tax rates.
Tax treaties also provide a mechanism for dealing with tax
treaty disputes, most often regarding double taxation. To
resolve disputes, designated officials of the two governments,
known as the competent authorities, consult and endeavor to
reach agreement.
In addition, tax treaties include provisions related to tax
administration, including information exchange, which is a
priority for the United States. In fact, the inclusion of
appropriate information exchange provisions is one of the few
tax treaty matters we regard as non-negotiable.
The treaties before the committee today with Canada,
Iceland, and Bulgaria would further the goals of our tax treaty
program, and we urge the committee and the Senate to take
prompt and favorable action on these agreements, which I will
now describe very briefly.
The proposed protocol with Canada is the fifth protocol to
the current convention. The most significant provisions in this
protocol relate to the taxation of cross-border interest, the
treatment of income derived from fiscally transparent entities,
the taxation of services, and mandatory binding arbitration.
More specifically, the proposed protocol eliminates
withholding taxes on cross-border interest, which has been a
priority for the U.S. business community and the U.S. Treasury
Department for a number of years, and represents a substantial
improvement over the current convention, which generally
provides for a 10 percent withholding tax rate.
In addition, the proposed protocol provides for mandatory
binding arbitration of certain cases not able to be resolved by
the competent authorities. The U.S. competent authority has a
good track record in resolving disputes. Even in the most
cooperative bilateral relationships, however, there will be
instances in which the competent authorities will not be able
to reach a timely and satisfactory result.
The mandatory binding arbitration provision included in the
protocol with Canada was negotiated contemporaneously with and
is very similar to a provision in our tax treaties with Germany
and Belgium, which this committee and the Senate considered
last year. We look forward to continuing to work with this
committee to make arbitration an effective tool in promoting
fair and expeditious resolution of tax treaty disputes.
The committee's comments made with respect to the German
and Belgian arbitration provisions have been very helpful and
will inform future negotiations of arbitration provisions.
Finally, the proposed protocol with Canada would allow
taxation of income from certain provisions of services not
subject to source country tax under the current convention.
This rule is broader than the rule in the U.S. model treaty but
was key to achieving an overall agreement that we believe is in
the best interests of the U.S. taxpayers and the United States.
The proposed convention with Iceland would replace the
current convention concluded in 1975. The most important change
from the current convention is the addition of a limitation on
benefits provision. The current convention does not contain
anti-treaty shopping provisions and, as a result, has been
abused by third country investors.
The proposed convention generally provides for withholding
tax rates on investment income that are the same as or lower
than those in the current convention. However, while the
current convention eliminates withholding tax on cross-border
payments of royalties, the proposed convention would allow
withholding tax of 5 percent on certain trademark royalty
payments. Inclusion of this provision was key to achieving an
overall agreement.
The proposed convention with Bulgaria will be the first tax
treaty between our two countries. Under the proposed
convention, withholding taxes on dividend payments can be
imposed at a maximum rate of 10 percent, lowered to 5 percent
in the case of a dividend paid to a company that directly holds
at least 10 percent of the company paying the dividend.
The proposed convention generally limits withholding taxes
on cross-border interest and cross-border royalty payments to 5
percent. And the proposed convention includes a rule, similar
to the rule in the proposed protocol with Canada, allowing
source country taxation of income from services in certain
cases.
Mr. Chairman and ranking member Lugar, let me conclude by
thanking you for the opportunity to appear before the committee
to discuss these three tax agreements. We thank the committee
members and staff for devoting the time and attention to the
review of these new agreements, and we are grateful for the
assistance and cooperation of the staff on the Joint Committee
on Taxation.
On behalf of the administration, we urge the committee and
the Senate to take prompt and favorable action on the
agreements before you, and I would be happy to answer any
questions you might have.
[The prepared statement of Mr. Mundaca follows:]
Prepared Statement of Michael Mandaca
Mr. Chairman, ranking member Lugar, and distinguished members of
the committee, I appreciate the opportunity to appear today to
recommend, on behalf of the administration, favorable action on three
tax treaties pending before this committee. We appreciate the
committee's interest in these treaties and in the U.S. tax treaty
network overall.
This administration is committed to eliminating barriers to cross-
border trade and investment, and tax treaties are the primary means for
eliminating tax barriers to such trade and investment. Tax treaties
provide greater certainty to taxpayers regarding their potential
liability to tax in foreign jurisdictions; they allocate taxing rights
between the two jurisdictions and include other provisions that reduce
the risk of double taxation, including provisions that reduce gross-
basis withholding taxes; and they ensure that taxpayers are not subject
to discriminatory taxation in the foreign jurisdiction.
This administration is also committed to preventing tax evasion,
and our tax treaties play an important role in this area as well. A key
element of U.S. tax treaties is exchange of information between tax
authorities. Under tax treaties, one country may request from the other
such information as may be relevant for the proper administration of
the first country's tax laws. Because access to information from other
countries is critically important to the full and fair enforcement of
U.S. tax laws, information exchange is a top priority for the United
States in its tax treaty program.
A tax treaty reflects a balance of benefits that is agreed to when
the treaty is negotiated. In some cases, changes in law or policy in
one or both of the treaty partners make the partners more willing to
increase the benefits beyond those provided by the treaty; in these
cases, negotiation of a revised treaty may be very beneficial. In other
cases, developments in one or both countries, or international
developments more generally, may make is desirable to revisit a treaty
to prevent exploitation of treaty provisions and eliminate unintended
and inappropriate consequences in the application of the treaty; in
these cases, it may be expedient to modify the agreement. Both in
setting our overall negotiation priorities and in negotiating
individual treaties, our focus is on ensuring that our tax treaty
network fulfills its goals of facilitating cross border trade and
investment and preventing fiscal evasion.
The treaties before the committee today with Canada, Iceland, and
Bulgaria serve to further the goals of our tax treaty network. The
treaties with Canada and Iceland would modify existing tax treaty
relationships. The tax treaty with Bulgaria would be the first between
our two countries. We urge the committee and the Senate to take prompt
and favorable action on all of these agreements.
Before discussing the pending treaties in more detail, I would like
to address some more general tax treaty matters, to provide background
for the committee's and the Senate's consideration of the pending tax
treaties.
purposes and benefits of tax treaties
Tax treaties set out clear ground rules that govern tax matters
relating to trade and investment between the two countries.
One of the primary functions of tax treaties is to provide
certainty to taxpayers regarding the threshold question with respect to
international taxation: whether a taxpayer's cross-border activities
will subject it to taxation by two or more countries. Tax treaties
answer this question by establishing the minimum level of economic
activity that must be engaged in within a country by a resident of the
other before the first country may tax any resulting business profits.
In general terms, tax treaties provide that if branch operations in a
foreign country have sufficient substance and continuity, the country
where those activities occur will have primary (but not exclusive)
jurisdiction to tax. In other cases, where the operations in the
foreign country are relatively minor, the home country retains the sole
jurisdiction to tax.
Another primary function is relief of double taxation. Tax treaties
protect taxpayers from potential double taxation primarily through the
allocation of taxing rights between the two countries. This allocation
takes several forms. First, the treaty has a mechanism for resolving
the issue of residence in the case of a taxpayer that otherwise would
be considered to be a resident of both countries. Second, with respect
to each category of income, the treaty assigns the primary right to tax
to one country, usually (but not always) the country in which the
income arises (the ``source'' country), and the residual right to tax
to the other country, usually (but not always) the country of residence
of the taxpayer (the ``residence'' country). Third, the treaty provides
rules for determining which country will be treated as the source
country for each category of income. Finally, the treaty establishes
the obligation of the residence country to eliminate double taxation
that otherwise would arise from the exercise of concurrent taxing
jurisdiction by the two countries.
In addition to reducing potential double taxation, tax treaties
also reduce potential ``excessive'' taxation by reducing withholding
taxes that are imposed at source. Under U.S. law, payments to non-U.S.
persons of dividends and royalties as well as certain payments of
interest are subject to withholding tax equal to 30 percent of the
gross amount paid. Most of our trading partners impose similar levels
of withholding tax on these types of income. This tax is imposed on a
gross, rather than net, amount. Because the withholding tax does not
take into account expenses incurred in generating the income, the
taxpayer that bears the burden of withholding tax frequently will be
subject to an effective rate of tax that is significantly higher than
the tax rate that would be applicable to net income in either the
source or residence country. The taxpayer may be viewed, therefore, as
suffering excessive taxation. Tax treaties alleviate this burden by
setting maximum levels for the withholding tax that the treaty partners
may impose on these types of income or by providing for exclusive
residence-country taxation of such income through the elimination of
source-country withholding tax. Because of the excessive taxation that
withholding taxes can represent, the United States seeks to include in
tax treaties provisions that substantially reduce or eliminate source-
country withholding taxes.
As a complement to these substantive rules regarding allocation of
taxing rights, tax treaties provide a mechanism for dealing with
disputes between the countries regarding the treaties, including
questions regarding the proper application of the treaties that arise
after the treaty enters into force. To resolve disputes, designated tax
authorities of the two governments--known as the ``competent
authorities'' in tax treaty parlance--are to consult and to endeavor to
reach agreement. Under many such agreements, the competent authorities
agree to allocate a taxpayer's income between the two taxing
jurisdictions on a consistent basis, thereby preventing the double
taxation that might otherwise result. The U.S. competent authority
under our tax treaties is the Secretary of the Treasury. That function
has been delegated to the Deputy Commissioner (International) of the
Large and Mid-Size Business Division of the Internal Revenue Service.
Tax treaties also include provisions intended to ensure that cross-
border investors do not suffer discrimination in the application of the
tax laws of the other country. This is similar to a basic investor
protection provided in other types of agreements, but the non-
discrimination provisions of tax treaties are specifically tailored to
tax matters and, therefore, are the most effective means of addressing
potential discrimination in the tax context. The relevant tax treaty
provisions explicitly prohibit types of discriminatory measures that
once were common in some tax systems. At the same time, tax treaties
clarify the manner in which possible discrimination is to be tested in
the tax context.
In addition to these core provisions, tax treaties include
provisions dealing with more specialized situations, such as rules
coordinating the pension rules of the tax systems of the two countries
or addressing the treatment of Social Security benefits and alimony and
child-support payments in the cross-border context. These provisions
are becoming increasingly important as more individuals move between
countries or otherwise are engaged in cross-border activities. While
these matters may not involve substantial tax revenue from the
perspective of the two governments, rules providing clear and
appropriate treatment are very important to the affected taxpayers.
Tax treaties also include provisions related to tax administration.
A key element of U.S. tax treaties is the provision addressing the
exchange of information between the tax authorities. Under tax
treaties, the competent authority of one country may request from the
other competent authority such information as may be relevant for the
proper administration of the first country's tax laws; the information
provided pursuant to the request is subject to the strict
confidentiality protections that apply to taxpayer information. Because
access to information from other countries is critically important to
the full and fair enforcement of the U.S. tax laws, information
exchange is a priority for the United States in its tax treaty program.
If a country has bank-secrecy rules that would operate to prevent or
seriously inhibit the appropriate exchange of information under a tax
treaty, we will not enter into a new tax treaty relationship with that
country. Indeed, the need for appropriate information exchange
provisions is one of the treaty matters that we consider non-
negotiable.
tax treaty negotiating priorities and process
The United States has a network of 58 income tax treaties covering
66 countries. This network covers the vast majority of foreign trade
and investment of U.S. businesses and investors. In establishing our
negotiating priorities, our primary objective is the conclusion of tax
treaties that will provide the greatest benefit to the United States
and to U.S. taxpayers. We communicate regularly with the U.S. business
community and the Internal Revenue Service, seeking input regarding the
areas in which treaty network expansion and improvement efforts should
be focused and seeking information regarding practical problems
encountered under particular treaties and particular tax regimes.
The primary constraint on the size of our tax treaty network may be
the complexity of the negotiations themselves. Ensuring that the
various functions to be performed by tax treaties are all properly
taken into account makes the negotiation process exacting and time
consuming.
Numerous features of a country's particular tax legislation and its
interaction with U.S. domestic tax rules must be considered in
negotiating a treaty or protocol. Examples include whether the country
eliminates double taxation through an exemption system or a credit
system, the country's treatment of partnerships and other transparent
entities, and how the country taxes contributions to pension funds,
earnings of the funds, and distributions from the funds.
Moreover, a country's fundamental tax policy choices are reflected
not only in its tax legislation but also in its tax treaty positions.
These choices differ significantly from country to country, with
substantial variation even across countries that seem to have quite
similar economic profiles. A treaty negotiation must take into account
all of these aspects of the particular treaty partner's tax system and
treaty policies to arrive at an agreement that accomplishes the United
States' tax treaty objectives.
Obtaining the agreement of our treaty partners on provisions of
importance to the United States sometimes requires concessions on our
part. Similarly, the other country sometimes must make concessions to
obtain our agreement on matters that are critical to it. Each treaty
that we present to the Senate represents not only the best deal that we
believe can be achieved with the particular country, but also
constitutes an agreement that we believe is in the best interests of
the United States.
In some situations, the right result may be no tax treaty at all.
Prospective treaty partners must evidence a clear understanding of what
their obligations would be under the treaty, especially those with
respect to information exchange, and must demonstrate that they would
be able to fulfill those obligations. Sometimes a tax treaty may not be
appropriate because a potential treaty partner is unable to do so.
In other cases, a tax treaty may be inappropriate because the
potential treaty partner is not willing to agree to particular treaty
provisions that are needed to address real tax problems that have been
identified by U.S. businesses operating there or because the potential
treaty partner insists on provisions the United States will not agree
to, such as providing a U.S. tax credit for investment in the foreign
country (so-called ``tax sparing''). With other countries there simply
may not be the type of cross-border tax issues that are best resolved
by treaty. For example, if a country does not impose significant income
taxes, there is little possibility of double taxation of cross-border
income, and an agreement that is focused on the exchange of tax
information (``tax information exchange agreements'' or TIEAs) may be
the most appropriate agreement.
A high priority for improving our overall treaty network is
continued focus on prevention of ``treaty shopping.'' The U.S.
commitment to including comprehensive limitation on benefits provisions
is one of the keys to improving our overall treaty network. Our tax
treaties are intended to provide benefits to residents of the United
States and residents of the particular treaty partner on a reciprocal
basis. The reductions in source-country taxes agreed to in a particular
treaty mean that U.S. persons pay less tax to that country on income
from their investments there and residents of that country pay less
U.S. tax on income from their investments in the United States. Those
reductions and benefits are not intended to flow to residents of a
third country. If third-country residents are able to exploit one of
our tax treaties to secure reductions in U.S. tax, such as through the
use of an entity resident in a treaty country that merely holds passive
U.S. assets, the benefits would flow only in one direction as third-
country residents would enjoy U.S. tax reductions for their U.S.
investments, but U.S. residents would not enjoy reciprocal tax
reductions for their investments in that third country. Moreover, such
third-country residents may be securing benefits that are not
appropriate in the context of the interaction between their home
country's tax systems and policies and those of the United States. This
use of tax treaties is not consistent with the balance of the deal
negotiated in the underlying tax treaty. Preventing this exploitation
of our tax treaties is critical to ensuring that the third country will
sit down at the table with us to negotiate on a reciprocal basis, so we
can secure for U.S. persons the benefits of reductions in source-
country tax on their investments in that country.
consideration of arbitration
Tax treaties cannot facilitate cross-border investment and provide
a more stable investment environment unless the treaty is effectively
implemented by the tax administrations of the two countries. Under our
tax treaties, when a U.S. taxpayer becomes concerned about
implementation of the treaty, the taxpayer can bring the matter to the
U.S. competent authority who will seek to resolve the matter with the
competent authority of the treaty partner. The competent authorities
will work cooperatively to resolve genuine disputes as to the
appropriate application of the treaty.
The U.S. competent authority has a good track record in resolving
disputes. Even in the most cooperative bilateral relationships,
however, there will be instances in which the competent authorities
will not be able to reach a timely and satisfactory resolution.
Moreover, as the number and complexity of cross-border transactions
increases, so does the number and complexity of cross-border tax
disputes. Accordingly, we have considered ways to equip the U.S.
competent authority with additional tools to resolve disputes promptly,
including the possible use of arbitration in the competent authority
mutual agreement process.
The first U.S. tax agreement that contemplated arbitration was the
U.S.-Germany income tax treaty signed in 1989. Tax treaties with
several other countries, including Canada, Mexico, and the Netherlands,
incorporate authority for establishing voluntary binding arbitration
procedures based on the provision in the prior U.S.-Germany treaty.
Although we believe that the presence of these voluntary arbitration
provisions may have provided some limited assistance in reaching mutual
agreements, it has become clear that the ability to enter into
voluntary arbitration does not provide sufficient incentive to resolve
problem cases in a timely fashion.
Over the past few years, we have carefully considered and studied
various types of mandatory arbitration procedures that could be used as
part of the competent authority mutual agreement process. In
particular, we examined the experience of countries that adopted
mandatory binding arbitration provisions with respect to tax matters.
Many of them report that the prospect of impending mandatory
arbitration creates a significant incentive to compromise before
commencement of the process. Based on our review of the U.S. experience
with arbitration in other areas of the law, the success of other
countries with arbitration in the tax area, and the overwhelming
support of the business community, we concluded that mandatory binding
arbitration as the final step in the competent authority process can be
an effective and appropriate tool to facilitate mutual agreement under
U.S. tax treaties.
One of the treaties before the committee, the Protocol with Canada,
includes a type of mandatory arbitration provision negotiated
contemporaneously with, and very similar to, a provision in our
current, recently ratified treaties with Germany and Belgium, which
this committee and the Senate considered last year.
In the typical competent authority mutual agreement process, a U.S.
taxpayer presents its problem to the U.S. competent authority and
participates in formulating the position the U.S. competent authority
will take in discussions with the treaty partner. Under the arbitration
provision proposed in the Canadian protocol, as in the similar
provisions that are now part of our treaties with Germany and Belgium,
if the competent authorities cannot resolve the issue within two years,
the competent authorities must present the issue to an arbitration
board for resolution, unless both competent authorities agree that the
case is not suitable for arbitration. The arbitration board must
resolve the issue by choosing the position of one of the competent
authorities. That position is adopted as the agreement of the competent
authorities and is treated like any other mutual agreement (i.e., one
that has been negotiated by the competent authorities) under the
treaty.
Because the arbitration board can only choose between the positions
of each competent authority, the expectation is that the differences
between the positions of the competent authorities will tend to narrow
as the case moves closer to arbitration. In fact, if the arbitration
provision is successful, difficult issues will be resolved without
resort to arbitration. Thus, it is our expectation that these
arbitration provisions will be rarely utilized, but that their presence
will encourage the competent authorities to take approaches to their
negotiations that result in mutually agreed conclusions in the first
instance.
The arbitration process proposed in the agreement with Canada,
consistent with the German and Belgian provisions, is mandatory and
binding with respect to the competent authorities. However, consistent
with the negotiation process under the mutual agreement procedure, the
taxpayer can terminate the arbitration at any time by withdrawing its
request for competent authority assistance. Moreover, the taxpayer
retains the right to litigate the matter (in the United States or the
treaty partner) in lieu of accepting the result of the arbitration,
just as it would be entitled to litigate in lieu of accepting the
result of a negotiation under the mutual agreement procedure.
Arbitration is a growing and developing field, and there are many
forms of arbitration from which to choose. We intend to continue to
study other arbitration provisions and to monitor the performance of
the provisions in the agreements with Belgium and Germany, as well as
the performance of the provision in the agreement with Canada, if
ratified. We look forward to continuing to work with the committee to
make arbitration an effective tool in promoting the fair and
expeditious resolution of treaty disputes. The committee's comments
made with respect to the German and Belgian arbitration provisions have
been very helpful and will inform future negotiations of arbitration
provisions.
discussion of proposed treaties
I now would like to discuss in more detail the three treaties that
have been transmitted for the Senate's consideration. We have submitted
a Technical Explanation of each treaty that contains detailed
discussions of the provisions of each treaty. These Technical
Explanations serve as an official guide to each treaty. The Technical
Explanation to the Protocol with Canada was reviewed by Canada, and
Canada subscribes to its contents, as will be confirmed by a press
release from the Canadian Ministry of Finance.
Canada
The proposed Protocol with Canada was signed in Chelsea on
September 21, 2007, and is the fifth protocol of amendment to the
current Convention negotiated in 1980 and amended by prior protocols in
1983, 1984, 1995, and 1997. The most significant provisions in this
treaty relate to the taxation of cross-border interest, the treatment
of income derived through fiscally transparent entities, the taxation
of certain provisions of services, and the adoption of mandatory
arbitration to facilitate the resolution of disputes between the U.S.
and Canadian revenue authorities. The proposed Protocol also makes a
number of changes to reflect changes in U.S. and Canadian law, and to
bring the current Convention into closer conformity with current U.S.
tax treaty policy.
The proposed Protocol eliminates withholding taxes on cross-border
interest payments. The elimination of withholding taxes on all cross-
border interest payments between the United States and Canada has been
a top tax treaty priority for both the business community and the
Treasury Department for many years. The proposed Protocol represents a
substantial improvement over the current Convention, which generally
provides for a source-country withholding tax rate of 10 percent. This
provision would be effective for interest paid to unrelated parties on
the first day of January of the year in which the proposed Protocol
enters into force, and it would be phased in for interest paid to
related persons over a three-year period. Consistent with U.S. tax
treaty policy, the proposed Protocol also provides exceptions to the
elimination of source-country taxation with respect to contingent
interest and payments from a U.S. real estate mortgage investment
conduit.
The proposed Protocol also would provide that a U.S. person is
generally eligible to claim the benefits of the treaty when such person
derives income through an entity that is considered by the United
States to be fiscally transparent (e.g., a partnership) unless the
entity is a Canadian entity and is not treated by Canada as fiscally
transparent. The proposed Protocol in addition contains anti-abuse
provisions intended to address certain situations involving the use of
these entities to obtain treaty benefits inappropriately.
The current Convention generally limits the taxation by one country
of the business profits of a resident of the other country. The source
country's right to tax such profits is generally limited to cases in
which the profits are attributable to a permanent establishment located
in that country. The proposed Protocol would add provisions related to
the taxation of permanent establishments. Most importantly, the
proposed Protocol includes a special rule allowing source-country
taxation of income from certain provisions of services not otherwise
considered to be provided through a permanent establishment. This rule
is broader than the permanent establishment rule in the U.S. Model tax
treaty but was key to achieving an overall agreement that we believe is
in the best interests of the United States and U.S. taxpayers.
As previously noted, the proposed Protocol provides for mandatory
arbitration of certain cases that have not been resolved by the
competent authority within a specified period, generally two years from
the commencement of the case. Under the proposed Protocol, the
arbitration process may be used to reach an agreement with respect to
certain issues relating to residence, permanent establishment, business
profits, related persons, and royalties. The arbitration board must
deliver a determination within six months of the appointment of the
chair of the arbitration board, and the determination must either be
the proposed resolution submitted by the United States or the proposed
resolution submitted by Canada. The board's determination has no
precedential value and the board shall not provide a rationale for its
determination.
The proposed Protocol also makes a number of other modifications to
the current Convention to reflect changes to U.S. law and current U.S.
tax treaty policy. For example, the proposed Protocol updates the
current Convention's treatment of pensions for cross-border workers to
remove barriers to the flow of personal services between the United
States and Canada that could otherwise result from discontinuities in
the laws of the two countries regarding the tax treatment of pensions.
In addition, the proposed Protocol updates the current Convention's
limitation on benefits provisions so that they apply on a reciprocal
basis. The proposed Protocol also addresses the treatment of companies
that engages in corporate ``continuance'' transactions and revises the
current Convention's rules regarding the residence of so-called dual
resident companies.
The proposed Protocol provides that the United States and Canada
shall notify each other in writing, through diplomatic channels, when
their respective applicable procedures for ratification have been
satisfied. The proposed Protocol will enter into force upon the date of
the later of the required notifications. For taxes withheld at source,
it will generally have effect for amounts paid or credited on or after
the first day of the second month that begins after the date the
proposed Protocol enters into force, although certain provisions with
respect to interest may have earlier effect. With respect to other
taxes, the proposed Protocol will generally have effect for taxable
years that begin after the calendar year in which the proposed Protocol
enters into force. Certain provisions will be phased in or have a
delayed effective date. Provisions regarding corporate continuance
transactions will apply retroactively, consistent with prior Treasury
Department public statements.
Iceland
The proposed Convention and accompanying Protocol with Iceland was
signed in Washington, D.C., on October 23, 2007. It would replace the
current Convention, concluded in 1975. The most important change from
the current Convention is the addition of a limitation on benefits
provision. The proposed Convention also makes changes to some of the
withholding tax rates provided in the current Convention. In addition,
the proposed Convention makes a number of changes to reflect changes in
U.S. and Icelandic law, and to conform to current U.S. tax treaty
policy.
As just noted, the proposed Convention contains a comprehensive
limitation on benefits provision, generally following the current U.S.
Model income tax treaty. The current Convention does not contain treaty
shopping protections and, as a result, has been abused by third-country
investors in recent years. For this reason, revising the current
Convention has been a top tax treaty priority.
The proposed Convention generally provides for withholding rates on
investment income that are the same as or lower than those in the
current Convention. Like the current Convention, the proposed
Convention provides for reduced source-country taxation of cross-border
dividends. In addition, the proposed Convention would eliminate source-
country withholding tax on cross-border dividend payments to pension
funds. As with the current Convention, the proposed Convention
generally would eliminate source-country withholding tax on cross-
border interest payments. However, while the current Convention
eliminates source-country withholding taxes on all cross-border
payments of royalties, the proposed Convention would allow the country
in which certain cross-border trademark royalties arise to impose a
withholding tax of up to 5 percent. Inclusion of this provision was key
to achieving an overall agreement that we believe is in the best
interests of the United States and U.S. taxpayers.
In addition, the proposed Convention provides for the exchange
between the tax authorities of each country of information relevant to
carrying out the provisions of the agreement or the domestic tax laws
of either country.
The proposed Convention provides that the United States and Iceland
shall notify each other in writing, through diplomatic channels, when
their respective applicable procedures for ratification have been
satisfied. The proposed Convention will enter into force on the date of
the later of the required notifications. It will have effect, with
respect to taxes withheld at source, for amounts paid or credited on or
after the first day of January of the calendar year following entry
into force, and with respect to other taxes, for taxable years
beginning on or after the first day of January following the date upon
which the proposed Convention enters into force. The current Convention
will, with respect to any tax, cease to have effect as of the date on
which this proposed Convention has effect with respect to such tax.
However, where any person would be entitled to greater benefits under
the current Convention, at the election of the person, the current
Convention shall continue to have effect in its entirety with respect
to such person for a period of 12 months from the date the provisions
of the proposed Convention are effective.
Bulgaria
The proposed income tax Convention and accompanying Protocol with
Bulgaria signed in Washington, D.C., on February 23, 2007, and the
subsequent Protocol with Bulgaria signed in Sofia, on February 26,
2008, together would represent the first income tax treaty between the
United States and Bulgaria. The proposed Convention is generally
consistent with the current U.S. Model income tax treaty and with
treaties that the United States has with other countries.
Under the proposed Convention, withholding taxes on cross-border
portfolio dividend payments may be imposed by the source state at a
maximum rate of 10 percent. When the beneficial owner of a cross-border
dividend is a company that directly owns at least 10 percent of the
stock of the company paying the dividend, withholding tax may be
imposed at a maximum rate of 5 percent. The proposed Convention also
provides for a withholding rate of zero on cross-border dividend
payments to pension funds.
The proposed Convention generally limits withholding taxes on
cross-border interest payments to a maximum rate of 5 percent. No
withholding tax on a cross-border interest payment is generally
permitted, however, when the interest is beneficially owned by, or
guaranteed by, the government or the central bank of the other country
(or any institution owned by that country), a pension fund resident in
the other country, or a financial institution (including a bank or an
insurance company) resident in the other country.The proposed
Convention provides that withholding taxes on cross-border royalty
payments are limited to a maximum rate of 5 percent.
The proposed Convention also incorporates rules provided in the
U.S. Model tax treaty for certain classes of investment income. For
example, dividends paid by entities such as U.S. regulated investment
companies and real estate investment trusts, are subject to special
rules to prevent the use of these entities to transform what is
otherwise higher-taxed income into lower-taxed income.
The proposed Convention limits the taxation by one country of the
business profits of a resident of the other country. The source
country's right to tax such profits is generally limited to cases in
which the profits are attributable to a permanent establishment located
in that country. The proposed Convention includes a rule, similar to a
rule in the proposed Protocol with Canada, allowing source-country
taxation of income from certain provisions of services. The proposed
Convention also provides that certain employees or agents that maintain
a stock of goods from which the agent regularly fills orders on behalf
of the principal, and conduct additional activities contributing to the
conclusion of sales, may result in a permanent establishment.
Consistent with current U.S. tax treaty policy, the proposed
Convention includes a comprehensive limitation on benefits article,
which is designed to deny treaty shoppers the benefits of the
Convention. The proposed Convention provides for non-discriminatory
treatment by one country to residents and nationals of the other
country. In addition, the proposed Convention provides for the exchange
between the tax authorities of each country of information relevant to
carrying out the provisions of the agreement or the domestic tax laws
of either country. This will facilitate the enforcement of U.S.
domestic tax rules.
The proposed Convention provides that the United States and
Bulgaria shall notify each other, through diplomatic channels, when
their respective applicable procedures for ratification have been
satisfied.
The proposed Convention will enter into force upon the date of
receipt of the later of the required notifications. It will have
effect, with respect to taxes withheld at source, for amounts paid or
credited on or after the first day of January in the year following the
date upon which the proposed Convention enters into force and, with
respect to other taxes, for taxable years beginning on or after the
first day of January in the year following the date upon which the
proposed Convention enters into force.
treaty program priorities
A key continuing priority for the Treasury Department is updating
the few remaining U.S. tax treaties that provide for low withholding
tax rates but do not include the limitation on benefits provisions
needed to protect against the possibility of treaty shopping.
Accordingly, we currently are in ongoing discussions with both Poland
and Hungary regarding the inclusion of anti-treaty shopping provisions.
In addition, we continue to maintain a very active calendar of tax
treaty negotiations. We recently initialed a new tax treaty with Malta.
We also are currently negotiating with France and New Zealand, and
expect to announce soon the opening of other negotiations.
We also have undertaken exploratory discussions with several
countries in Asia and South America that we hope will lead to
productive negotiations later in 2008 or in 2009.
conclusion
Mr. Chairman and ranking member Lugar, let me conclude by thanking
you for the opportunity to appear before the committee to discuss the
administration's efforts with respect to the three agreements under
consideration. We appreciate the committee's continuing interest in the
tax treaty program, and we thank the members and staff for devoting
time and attention to the review of these new agreements. We are also
grateful for the assistance and cooperation of the staff of the Joint
Committee on Taxation.
On behalf of the administration, we urge the committee to take
prompt and favorable action on the agreements before you today. I would
be happy to respond to any question you may have.
Senator Menendez. Thank you.
Ms. McMahon?
STATEMENT OF EMILY S. MCMAHON, DEPUTY CHIEF OF STAFF, JOINT
COMMITTEE ON TAXATION, UNITED STATES CONGRESS, WASHINGTON, D.C.
Ms. McMahon. Thank you, Mr. Chairman.
I appreciate the opportunity to present the testimony of
the staff of the Joint Committee on Taxation concerning the
proposed protocol with Canada and the proposed treaties with
Iceland and Bulgaria.
As we have in the past, the Joint Committee staff has
prepared pamphlets concerning the proposed protocol and the
treaties. These provide detailed descriptions of their
provisions and comparisons with the U.S. model treaty and with
other recent U.S. income tax treaties. Therefore, in my time
today, I am going to focus just on a few of the more
significant features of the proposed agreements.
First, with respect to Canada, as has been mentioned, the
proposed protocol would modify an existing treaty with Canada
that was signed in 1980. Most of the provisions are intended to
bring the treaty more in line with other recent U.S. treaties,
but there are at least four provisions that merit particular
attention.
The first is that the proposed protocol would reduce the
rate of withholding tax on interest payments from 10 percent
under the existing treaty to zero in most cases. The existing
treaty with Canada is only--is one of only a handful of U.S.
treaties that currently permit withholding on interest
payments. So the proposed protocol would bring the Canadian
treaty in line with most other U.S. treaties and with the
model.
The protocol does not, however, provide for a zero rate of
withholding on dividends paid by a subsidiary to a corporate
parent, and that is a distinction from several of the more
recent--a number of the more recent treaties with major trading
partners.
Second, the proposed protocol, as has been mentioned, would
replace the voluntary arbitration procedures of the present
treaty with a mandatory binding arbitration procedure for
resolving disputes between the competent authorities. The U.S.
model also does not include a mandatory arbitration procedure,
but a similar provision does appear in the recent treaties with
Belgium and Germany.
We understand that there are a significant number of
competent authority cases now pending between the United States
and Canada and that, historically, a substantial number of
these cases simply have not been resolved. The mandatory
arbitration procedure is intended to ensure that tax disputes
between the two countries are resolved effectively and within a
limited time period. In fact, the mere existence of the
procedure is expected to encourage the competent authorities to
settle cases promptly in order to avoid arbitration.
However, it will take time to determine whether the
procedure is effective or whether there may be unexpected
problems. At this point, it is still too early to assess the
effect of the mandatory arbitration provisions in the treaties
with Germany and Belgium, and therefore, the committee may wish
to understand how the Treasury Department intends to monitor
the effectiveness of the arbitration procedures in all three of
these treaties and the extent to which future treaties are
expected to include similar procedures.
Third, the proposed protocol would add some new rules
regarding the circumstances in which income earned through or
paid by fiscally transparent entities will be entitled to
treaty benefits. In many respects, those rules are consistent
with existing U.S. internal tax rules. However, they also
include some more restrictive rules that are designed to
address so-called double-dip financing structures under which
U.S. and Canadian taxpayers have used fiscally transparent
hybrid entities to produce income that effectively escapes tax
in both countries.
And finally, the proposed protocol adds a special rule
under which income from services performed by an enterprise of
one country in the other country can be taxed in the recipient
country even if the service provider does not otherwise have a
permanent establishment in that country. A similar provision
appears in several existing U.S. treaties with developing
countries and in the proposed treaty with Bulgaria, but this is
the first time that such a provision has been proposed with a
developed country.
There are a number of unresolved questions regarding the
administration of this provision, and the committee may wish to
understand whether discussion is going on between the U.S. and
Canada to resolve these questions, especially in light of the
substantial flow of cross-border services between the two
countries.
With respect to Iceland, the proposed treaty would replace
an existing treaty signed in 1975. And in most respects, the
proposed new treaty is consistent with the U.S. model and other
recent U.S. treaties. But as indicated earlier, its most
significant feature is the inclusion of a comprehensive modern
limitation on benefits provision that will prevent the
inappropriate use of the treaty by third country residents, a
practice known as treaty shopping.
The present treaty with Iceland is one of three treaties,
the others being Hungary and Poland, that are especially--
present especially attractive opportunities for treaty
shopping. And the fact that the new treaty with Iceland
includes a comprehensive limitation on benefits provision will
eliminate one of those major opportunities.
And finally, with respect to Bulgaria, the proposed treaty
would be the first treaty with that country, the first income
tax treaty with that country. It is generally consistent with
the provisions of the U.S. model and with other recent treaties
with developing countries.
A somewhat unusual feature is that it does permit a 5
percent withholding rate on interest and dividends, but that is
consistent with an EU directive that Bulgaria is eligible for
for a transitional period in respect to payments to other EU
countries, and Bulgaria has agreed to reconsider that rate in
2014 in connection with the expiration of that transitional
period.
And finally, as mentioned earlier, the Bulgaria treaty does
have the same services provision that appears in the Canadian
treaty. But that is not so unusual in this case, given that
this is a treaty with a developing country.
As I mentioned earlier, all of these provisions and issues
are discussed in more detail in the Joint Committee pamphlets,
and I would be happy to answer any questions that the committee
may have either now or in the future.
Thank you.
[The prepared statement of Ms. McMahon follows:]
Prepared Statement of Emily S. McMahon
My name is Emily S. McMahon. I am Deputy Chief of Staff of the
Joint Committee on Taxation. It is my pleasure to present today the
testimony of the staff of the Joint Committee on Taxation concerning
the proposed protocol to the income tax treaty with Canada and the
proposed income tax treaties with Iceland and Bulgaria.\1\
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\1\This document may be cited as follows: Joint Committee on
Taxation, Testimony of the Staff of the Joint Committee on Taxation
Before the Senate Committee on Foreign Relations Hearing on the
Proposed Protocol to the Income Tax Treaty with Canada and the Proposed
Tax Treaties with Iceland and Bulgaria (JCX-60-08), July 10, 2008. This
publication can also be found at www.jct.gov.
---------------------------------------------------------------------------
overview
As in the past, the Joint Committee staff has prepared pamphlets
covering the proposed protocol and treaties. The pamphlets provide
detailed descriptions of the proposed protocol and treaties, including
comparisons with the United States Model Income Tax Convention of
November 15, 2006 (the ``U.S. Model treaty''), prepared by the Treasury
Department, and with other recent U.S. income tax treaties.\2\ The
pamphlets also provide detailed discussions of certain issues raised by
the proposed protocol and treaties. We consulted with the Treasury
Department and with the staff of your committee in analyzing the
proposed protocol and treaties and in preparing the pamphlets.
---------------------------------------------------------------------------
\2\Joint Committee on Taxation, Explanation of Proposed Protocol to
the Income Tax Treaty Between the United States and Canada (JCX-57-08),
July 8, 2008; Joint Committee on Taxation, Explanation of Proposed
Income Tax Treaty Between the United States and Iceland (JCX-58-08),
July 8, 2008; Joint Committee on Taxation, Explanation of Proposed
Income Tax Treaty Between the United States and Bulgaria (JCX-59-08),
July 8, 2008.
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The principal purposes of the protocol and each treaty are to
reduce or eliminate double taxation of income earned by residents of
either the United States or the treaty country from sources within the
other country and to prevent avoidance or evasion of the taxes of the
two countries. The proposed protocol and each treaty also are intended
to promote close economic cooperation between the United States and the
respective treaty country and to eliminate possible barriers to trade
and investment caused by the overlapping taxing jurisdictions of the
United States and the treaty country. As in other U.S. income tax
treaties, these objectives principally are achieved through each
country's agreement to limit, in certain specified situations, its
right to tax income derived from its territory by residents of the
other country.
The proposed protocol with Canada would make several modifications
to an existing income tax treaty that was signed in 1980. The U.S.-
Canada income tax treaty has been modified by four previous protocols,
in 1983, 1984, 1995, and 1997. The proposed income tax treaty with
Iceland, together with a contemporaneously signed protocol, would
replace an existing treaty signed in 1975. The proposed income tax
treaty with Bulgaria, together with the proposed 2007 and 2008
protocols, would be the first income tax treaty between the United
States and Bulgaria.
My testimony today will highlight some of the significant features
of the proposed protocol and treaties and certain issues that they
raise.
U.S. Model treaty
In November 2006, the Treasury Department released the present U.S.
Model treaty.\3\ As a general matter, the U.S. model tax treaties are
intended to provide a framework for U.S. tax treaty policy and a
starting point for negotiations with our treaty partners. These models
provide helpful information to taxpayers, the Congress, and foreign
governments as to U.S. policies on tax treaty matters. Periodical
updates to reflect new developments and congressional views with regard
to particular issues of U.S. tax treaty policy ensure that the model
treaties remain meaningful and relevant.
---------------------------------------------------------------------------
\3\For a comparison of the 2006 U.S. model income tax treaty with
its 1996 predecessor, see Joint Committee on Taxation, Comparison of
the United States Model Income Tax Convention of September 15, 1996
with the United States Model Income Tax Convention of November 15, 2006
(JCX-27-07), May 8, 2007.
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The present U.S. Model treaty incorporates the key developments in
U.S. income tax treaty policy that are reflected in recent U.S. income
tax treaties. The proposed protocol and treaties that are the subject
of this hearing are generally consistent with the provisions found in
the U.S. Model treaty. However, there are some significant differences
from the U.S. Model treaty that I will discuss.
Limitation-on-benefits provisions
One important area in which the proposed protocol and treaties are
generally consistent with the U.S. Model treaty is the inclusion in all
three proposed instruments of a comprehensive limitation-on-benefits
provision. These limitation-on-benefits provisions generally are
intended to make it more difficult for residents of countries other
than the United States and the treaty partner to benefit
inappropriately from the treaty.
When a resident of one country derives income from another country,
the internal tax rules of the two countries may cause that income to be
taxed in both countries. One purpose of a bilateral income tax treaty
is to allocate taxing rights for cross-border income and thereby to
prevent double taxation of residents of the treaty countries. Although
a bilateral income tax treaty is intended to apply only to residents of
the two treaty countries, residents of third countries may attempt to
benefit from a treaty by engaging in a practice known as ``treaty
shopping.'' Treaty shopping may involve directing an investment in one
treaty country through an entity organized in the other treaty country
or engaging in income-stripping transactions with a treaty-country
resident. Limitation-on-benefits provisions are intended to deny treaty
benefits in certain cases of treaty shopping.
The proposed treaty with Iceland contains a detailed limitation-on-
benefits provision (Article 21) that reflects the anti-treaty-shopping
provisions included in the U.S. Model treaty and more recent U.S.
income tax treaties. In contrast, the present treaty between the United
States and Iceland is one of only eight remaining U.S. income tax
treaties that do not include any limitation-on-benefits rules. Three of
those eight treaties, including the treaties with Iceland, Hungary, and
Poland, provide for a complete exemption from withholding on interest
payments from one treaty country to the other treaty country.
Consequently, those three treaties present particularly attractive
opportunities for treaty-shopping. In fact, a November 2007 report
prepared by the Treasury Department at the request of the U.S. Congress
suggests that the income tax treaties with Hungary and Iceland have
increasingly been used for treaty-shopping purposes in recent years as
the United States adopted modern limitation-on-benefits provisions in
its other treaties.\4\ The proposed treaty with Iceland, including its
modern limitation-on-benefits rules, would thus eliminate a significant
treaty-shopping opportunity. Nevertheless, the Committee may wish to
inquire of the Treasury Department regarding its plans to address the
remaining U.S. income tax treaties that do not include limitation-on-
benefits provisions, and in particular the treaties with Hungary and
Poland.
---------------------------------------------------------------------------
\4\Department of the Treasury, Report to the Congress on Earnings
Stripping, Transfer Pricing and U.S. Income Tax Treaties (Nov. 28,
2007). The report states that, as of 2004, it does not appear that the
U.S.-Poland income tax treaty has been extensively exploited by third-
country residents.
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The proposed protocol with Canada replaces Article XXIX A
(Limitation on Benefits) of the present treaty with a new article that
reflects the anti-treaty-shopping provisions included in the U.S. Model
treaty and more recent U.S. income tax treaties. Unlike the rules in
the present treaty (which may be applied only by the United States),
the new rules are reciprocal and are intended to prevent the indirect
use of the treaty by persons who are not entitled to its benefits by
reason of residence in Canada or the United States.
The proposed treaty with Bulgaria also contains a detailed
limitation-on-benefits provision similar to that of the U.S. Model
treaty to prevent the inappropriate use of the treaty by third-country
residents (Article 21).
``Zero-rate'' dividend provisions
Another significant similarity between the U.S. Model treaty and
the proposed protocol and treaties is the lack of a ``zero-rate'' of
withholding tax on certain intercompany dividends. Until 2003, no U.S.
income tax treaty provided for a complete exemption from dividend
withholding tax, and the U.S. Model treaty and the 2005 Model
Convention on Income and Capital of the Organisation for Economic Co-
operation and Development (``OECD'') do not provide an exemption. By
contrast, many bilateral income tax treaties of other countries
eliminate withholding taxes on direct dividends between treaty
countries, and the European Union (``EU'') Parent-Subsidiary Directive
repeals withholding taxes on intra-EU direct dividends (determined by
reference to a 15-percent ownership threshold in 2007).
Moreover, the recent U.S. income tax treaties and protocols with
Australia, Japan, Mexico, the Netherlands, Sweden, the United Kingdom,
Germany, Belgium, Denmark, and Finland include zero-rate dividend
provisions. Eligibility for this zero rate generally is contingent on
meeting an 80-percent ownership threshold and certain additional
requirements. The Senate ratified those treaties and protocols in 2003
(Australia, Mexico, and the United Kingdom), 2004 (Japan and the
Netherlands), 2006 (Sweden), and 2007 (Germany, Belgium, Denmark, and
Finland). On the other hand, neither the recent protocol with France
nor the recent treaties with Bangladesh and Sri Lanka include an
exemption from dividend withholding.
In general, the dividend articles of the proposed protocol and
treaties provide a maximum source-country withholding tax rate of 15
percent (10 percent under the proposed treaty with Bulgaria) and a
reduced five-percent maximum rate for dividends received by a company
owning at least 10 percent of the dividend-paying company. A zero rate
of withholding is generally available under the proposed protocol and
treaties for dividends received by a pension fund. The proposed
protocol and treaties also include special rules for dividends received
from U.S. regulated investment companies and real estate investment
trusts. These special rules generally are similar to provisions
included in other recent U.S. treaties and protocols.
In previous testimony before the Committee, the Treasury Department
has indicated that zero-rate dividend provisions should be allowed only
under treaties that have restrictive limitation-on-benefits rules and
that provide comprehensive information exchange. Even in those
treaties, according to previous Treasury Department statements,
dividend withholding tax should be eliminated only based on an
evaluation of the overall balance of benefits under the treaty. The
Committee may wish to consider what overall balance of considerations
prompted the Treasury Department not to seek a zero-rate provision in
the proposed protocol and treaties, all of which have comprehensive
limitation-on-benefits and information-exchange provisions.
Mandatory and binding arbitration provision in proposed protocol with
Canada
One important feature of the proposed protocol with Canada is the
replacement of the voluntary arbitration procedure of Article XXVI
(Mutual Agreement Procedure) of the present treaty with a mandatory
arbitration procedure that is sometimes referred to as ``last best
offer'' arbitration. Under this procedure, each of the competent
authorities proposes one and only one figure for settlement of a
dispute, and the arbitrator must select one of those figures as the
award. The last best offer approach is intended to induce the competent
authorities to moderate their positions, including before arbitration
proceedings would commence, and thus to increase the possibility of a
negotiated settlement. Under the proposed protocol, unless a taxpayer
or other ``concerned person'' (in general, a person whose tax liability
is affected by the arbitration determination) does not accept the
arbitration determination, it is binding on the treaty countries with
respect to the case.
The U.S. Model treaty does not include a mandatory arbitration
procedure. However, the use of mandatory and binding arbitration in tax
disputes between countries is not a novel concept. A provision similar
to the provision in the proposed protocol with Canada does appear in
the protocol with Germany and the treaty with Belgium, both ratified by
the Senate in 2007. Also in 2007, the OECD Committee on Fiscal Affairs
adopted proposed changes to its model treaty and commentary that
incorporate a mandatory and binding arbitration procedure, some
elements of which are generally similar to those of the proposed
protocol. The OECD has announced that it will be adopting those changes
in final form shortly. In addition, the EU has adopted certain
mandatory and binding arbitration procedures that are applicable to
transfer pricing disputes between members of the EU.
Judging from the actions taken by the OECD and the EU, unresolved
competent authority proceedings appear to be a multinational
occurrence. As a general matter, it is beneficial to resolve tax
disputes effectively and efficiently. The new arbitration procedures
included in the proposed protocol are intended to ensure that the
mutual agreement procedures occur pursuant to a schedule and that all
cases are resolved within a limited time period.
We understand that there are a significant number of competent
authority cases pending between the United States and Canada, and that,
historically, a substantial number of double taxation cases have not
been satisfactorily resolved by the U.S. and Canadian competent
authorities. The Treasury Department does not release statistics that
reflect competent authority activities by individual treaty partners.
While many expect that the proposed mandatory and binding arbitration
procedures will be successful in resolving recurring issues and will
encourage the competent authorities to settle cases without resort to
arbitration, it will take time to ascertain if these procedures are
effective or if unexpected problems arise.
Meanwhile, the Treasury Department or other trading partners may
seek to negotiate treaty provisions with current or future treaty
partners that are similar, in whole or in part, to the arbitration
procedures of the proposed treaty and protocol. It is still too early
to assess the effect of the addition of mandatory arbitration
provisions to the Germany and Belgium treaties on the competent
authority processes with respect to those countries. Therefore, the
Committee may wish to better understand how the Treasury Department
intends to monitor the competent authority function, as well as
arbitration developments with respect to other countries, to determine
the overall effects of the new arbitration procedures on the mutual
agreement process. The Committee may wish to consider what information
is needed to measure whether the proposed arbitration procedures result
in more efficient case resolution, both before and during arbitration,
and whether they enhance the quality of the outcome of the competent
authority cases. In addition, the Committee may wish to inquire as to
whether and under what circumstances the Treasury Department intends to
pursue similar provisions in other treaties.
The Committee may also wish to consider certain specific features
of the arbitration procedures included in the proposed protocol. For
example, the mandatory arbitration procedure is available under the
proposed protocol only with respect to certain articles specified by
the treaty partners in diplomatic notes accompanying the protocol.\5\
The Committee may wish to inquire about the basis for selection of
those particular articles and the implications of excluding the others.
Other points that the Committee may wish to clarify include the extent
to which decisions of the arbitration board will be taken into account
in subsequent competent authority cases involving the same taxpayer,
the same issue and substantially similar facts, and the application of
the mandatory arbitration procedures to competent authority cases
already pending on the date on which the proposed protocol enters into
force.
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\5\These articles are: Article IV (Residence), but only to the
extent the case relates to the residence of natural persons; Article V
(Permanent Establishment); Article VII (Business Profits); Article IX
(Related Persons); and Article XII (Royalties), but only to the extent
the case relates (1) to the application of Article XII to transactions
involving related persons, or (2) to an allocation of amounts between
taxable and non-taxable royalties.
---------------------------------------------------------------------------
Other provisions of the proposed protocol with Canada
The proposed protocol modifies a number of the provisions in the
existing treaty. The rules of the proposed protocol generally are
similar to rules of recent U.S. income tax treaties, the U.S. Model
treaty, and the 2005 Model Convention on Income and on Capital of the
Organisation for Economic Cooperation and Development (the ``OECD Model
treaty''). However, the existing treaty, as amended by the proposed
protocol, contains certain substantive deviations from these treaties
and models.
The proposed protocol amends Article IV (Residence) of the existing
treaty specifically to address companies that are residents of both
treaty countries. The proposed protocol provides that if such a dual-
resident company is created under the laws in force in a treaty country
but not under the laws in force in the other treaty country, the
company is deemed to be a resident only of the first treaty country. If
that rule does not apply (for example, because a company created in one
country is continued in the other country in accordance with its
corporate law), the competent authorities of the treaty countries must
endeavor to settle the question of residency by mutual agreement and
determine the mode of application of the treaty to the company. In the
absence of such an agreement, the company is not considered to be a
resident of either treaty country for purposes of claiming any benefits
under the treaty.
The proposed protocol also amends Article IV of the existing treaty
to provide specific rules regarding the circumstances in which amounts
of income, profit, or gain are deemed to be derived through or paid by
fiscally transparent entities. In general, an amount of income, profit,
or gain is considered to be derived by a resident of a treaty country
if (1) that person is considered under the taxation law of that country
to have derived the amount through an entity, other than an entity that
is a resident of the other treaty country, and (2) by reason of that
entity being treated as fiscally transparent under the laws of the
first treaty country, the treatment of the amount under the taxation
law of that country is the same as its treatment would be if that
amount had been derived directly by that person. Notwithstanding the
general rule, an amount of income, profit, or gain is considered not to
be paid to or derived by a person who is a resident of a treaty country
if (1) that person is considered under the taxation law of the other
treaty country as deriving the amount through an entity that is not a
resident of the first treaty country, but (2) by reason of the entity
not being treated as fiscally transparent under the laws of that treaty
country, the treatment of the amount under the taxation law of that
country is not the same as its treatment would be if that amount had
been derived directly by the person. These rules are consistent with
present U.S. tax rules.
The proposed protocol provides an additional rule applicable in the
area of fiscally transparent entities that is new to the U.S. tax
treaty network. Under this new rule, an amount of income, profit, or
gain is not considered to be paid to or derived by a person who is a
resident of a treaty country if (1) the person is considered under the
tax law of the other treaty country to have received the amount from an
entity resident in the other treaty country, but (2) by reason of the
entity being treated as fiscally transparent under the laws of the
first treaty country, the treatment of the amount received by that
person under the tax law of that country is not the same as its
treatment would be if the entity were treated as not fiscally
transparent under the laws of that country. Thus, treaty benefits may
not be claimed with respect to such payments. There is some uncertainty
with regard to how this rule applies to deductible payments made by
hybrid partnerships, and the Committee may wish to inquire about this
point.
The proposed protocol amends Article V of the existing treaty to
add a special rule under which services performed by an enterprise of a
treaty country in the other treaty country may give rise to a permanent
establishment in the other country if the enterprise exceeds certain
levels of presence in the other country and if certain other conditions
are met. The special rule applies if the enterprise does not have a
permanent establishment in the other country by virtue of any of the
customary treaty standards. A similar provision appears in several
existing U.S. tax treaties with developing countries (and in the
proposed treaty with Bulgaria), but this is the first time such a
provision has been proposed with a developed country. If certain
additional conditions are met, the provision would subject individual
employees to taxation as well. There are several unresolved questions
regarding the administration of this provision. The Committee may wish
to inquire whether active discussion is occurring between the United
States and Canada on these matters, and whether these questions will be
resolved before the protocol becomes effective.
The proposed protocol applies the treaty partners' interpretation
of the arm's-length standard in a manner consistent with the OECD
Transfer Pricing Guidelines to the attribution of profits to a
permanent establishment under Article VII, taking into account the
different economic and legal circumstances of a single legal entity.
Under the proposed protocol, the business profits to be attributed to a
permanent establishment include only the profits derived from the
assets used, risks assumed, and activities performed by the permanent
establishment. The proposed protocol also amends Article VII of the
existing treaty to clarify that income may be attributable to a
permanent establishment that no longer exists in one of the treaty
countries. In addition, the proposed protocol provides that income
derived from independent personal services (i.e., income from the
performance of professional services and of other activities of an
independent character) is included within the meaning of the term
``business profits.'' Accordingly, the treatment of such income is
governed by Article VII rather than by present treaty Article XIV
(Independent Personal Services), which the proposed protocol deletes.
These new rules are similar to provisions included in other recent U.S.
treaties and protocols, including the U.S Model treaty.
The proposed protocol modifies Article X (Dividends) of the present
treaty to reflect more closely the dividend provisions included in the
U.S. Model treaty and recent U.S. income tax treaties. The
modifications include a revised definition of the term ``dividends''
and an updated special rule that applies to dividends paid by U.S.
REITs.
The proposed protocol replaces Article XI (Interest) of the present
treaty with a new article that generally provides for exclusive
residence-country taxation of interest. Limited exceptions permit
source-country taxation of interest if the beneficial owner of the
interest carries on, or has carried on, business through a permanent
establishment in the source country and the debt-claim in respect of
which the interest is paid is effectively connected with that permanent
establishment. Two anti-abuse provisions relating to contingent
interest payments and residual interests in real estate mortgage
investment conduits also permit source-country taxation of interest.
Special rules apply to cases involving a non-arm's-length interest
charge between a payer and a beneficial owner that have a special
relationship.
The proposed protocol conforms Article XII (Royalties) to the
proposed elimination of Article XIV (Independent Personal Services) and
clarifies the treatment of income attributable to a permanent
establishment that has ceased to exist.
The proposed protocol modifies Article XIII (Gains) of the present
treaty in two principal respects. First, the proposed protocol narrows
the emigration exception to the Article's rule providing for exclusive
residence-country taxation of gains from the alienation of property in
cases other than those specifically enumerated in Article XIII. The
proposed protocol provides that this exception will not apply if the
property was treated as alienated immediately before an individual's
emigration. Second, the proposed protocol provides a revised election
intended to coordinate U.S. and Canadian taxation of gains in the case
of timing mismatches.
The proposed protocol conforms Article XV (Dependent Personal
Services) of the present treaty to the U.S. and OECD Model treaties, as
well as to the proposed elimination of Article XIV (Independent
Personal Services), and broadens the definition of ``remuneration. In
addition, the proposed protocol changes the rules with respect to
calculating the number of days an individual is present in the other
treaty country for purposes of determining if a resident of one treaty
country may be taxed by the other treaty country. The proposed protocol
also contains provisions intended to eliminate potential abuses through
the use of intermediary employers. The diplomatic notes exchanged in
connection with the proposed protocol set forth new rules for
allocating income from the exercise or disposal of an option between
the two treaty countries.
The proposed protocol modifies some of the existing treaty rules of
Article XVIII of the present treaty (Pensions and Annuities), mostly to
address Roth individual retirement accounts, and adds several new
provisions that address cross-border pension contributions and benefits
accruals. Many of the new rules are similar to those found in the U.S.
Model treaty, but several reflect the uniquely large cross-border flow
of personal services between Canada and the United States, including
the large number of cross-border commuters. These rules are intended to
remove barriers to the flow of personal services between the two
countries that could otherwise result from discontinuities under the
laws of each country regarding the deductibility of pension
contributions and the taxation of a pension plan's earnings and
accretions in value. In addition, the proposed protocol adds a new
provision to address the source of certain annuity or life insurance
payments made by branches of insurance companies.
The proposed protocol replaces Article XX (Students) of the present
treaty with a new article that generally corresponds to the treatment
provided under the present treaty. The proposed protocol adds a one-
year limitation on the exemption from income tax in the host country in
the case of apprentices and business trainees.
The proposed protocol modifies Article XXI (Exempt Organizations).
The new rules are intended to permit charitable-type organizations to
invest indirectly and to pool their investments with pension-type
organizations.
The proposed protocol adds a new paragraph to Article XXII (Other
Income) of the treaty for guarantee fees. The new paragraph provides
that compensation derived by a resident of a contracting state in
respect of a guarantee of indebtedness shall be taxable only in that
state, unless the compensation is business profits attributable to a
permanent establishment in the other contracting state, in which case
Article VII (Business Profits) shall apply.
The proposed protocol changes the obligations of Canada under
Article XXIV (Elimination of Double Taxation) of the treaty with
respect to dividends received by a Canadian company from a U.S.
resident company. Under the proposed protocol, a Canadian company
receiving a dividend from a U.S. resident company of which it owns at
least 10 percent of the voting stock, is allowed a credit against
Canadian income tax for the appropriate amount of income tax paid or
accrued to the United States by the dividend paying company with
respect to the profits out of which the dividends are paid.
The proposed protocol revises the general rules of Article XXV
(Non-Discrimination) of the present treaty to bring those rules into
closer conformity with the U.S. Model treaty and recent U.S. income tax
treaties. The proposed protocol generally prohibits a treaty country
from discriminating against nationals of the other treaty country by
imposing on those nationals more burdensome taxation than it imposes or
may impose on its own nationals in the same circumstances.
The proposed protocol modifies Article XXVI A (Assistance in
Collection) of the present treaty to further limit, in a narrow class
of cases, one treaty country's obligation to assist the other treaty
country in collecting taxes. The modifications also explicitly provide
that the assistance-in-collection provisions apply to contributions to
social security and employment insurance premiums levied by or on
behalf of the government of a treaty country.
The proposed protocol replaces Article XXVII (Exchange of
Information) of the present treaty with rules similar to those in the
U.S. model treaty. The proposed rules generally provide that the two
competent authorities will exchange such information as may be relevant
in carrying out the provisions of the domestic laws of the United
States and Canada concerning taxes to which the treaty applies to the
extent the taxation under those laws is not contrary to the treaty.
The proposed protocol amends the saving clause in Article XXIX
(Miscellaneous Rules) to bring the treaty generally in conformity with
the U.S. taxation of former citizens and former long-term residents
under section 877 of the Code. The proposed protocol provides that
notwithstanding the other provisions of the treaty, a former citizen or
former long-term resident of the United States, may, for a period of
ten years following the loss of such status, be taxed in accordance
with the laws of the United States with respect to income from sources
within the United States (including income deemed under the domestic
law of the United States to arise from such sources). Section 877 is
applicable to individuals who relinquish their U.S. citizenship or
cease to be a lawful permanent resident prior to June 17, 2008.
For any individual who relinquishes U.S. citizenship or ceases to
be a lawful permanent resident of the United States on or after June
17, 2008, a new set of rules applies. In general, to the extent those
rules impose U.S. tax on an individual after the individual
expatriates, they require or deem the individual to waive any rights to
claim a reduction in U.S. tax under a U.S. tax treaty and any other
rights under a U.S. tax treaty that would preclude the assessment or
collection of tax imposed by the new rules.
The proposed protocol replaces Article XXIX B (Taxes Imposed by
Reason of Death) of the present treaty with a new article that
generally addresses certain concerns regarding the application of
Canadian tax rules and regarding the availability of tax credits or
deductions when the United States and Canada impose tax on the same
items of income or property.
Article 27 of the proposed protocol provides for the entry into
force of the proposed protocol. The provisions of the proposed protocol
are generally effective on a prospective basis. However, the provisions
with respect to dual-residence tie breakers (Article 2 of the proposed
protocol) and an emigrant's gain (Article 8 of the proposed protocol)
are effective retroactive to September 17, 2000. In certain situations,
the reduction of interest withholding rates is also retroactive, with
the initial phase-in rate applicable for the year in which the proposed
protocol becomes effective. Also, the provisions for assistance in the
collection of taxes are retroactively effective to revenue claims that
have been definitively determined after November 9, 1985.
With respect to certain payments through fiscally transparent
entities and the new provisions regarding permanent establishments, the
proposed protocol is effective as of the first day of the third year
that ends after the proposed protocol enters into force. Special rules
apply for determining when to start counting (1) days present, (2)
services rendered, and (3) gross active business revenues for purposes
of the permanent establishment provision. With respect to the
arbitration provisions, the proposed protocol clarifies that a
competent authority matter currently in progress will be deemed to have
started on the date on which the proposed protocol enters into force.
Iceland
The proposed treaty replaces the existing treaty that was signed in
1975. The rules of the proposed treaty generally are similar to rules
of recent U.S. income tax treaties, the U.S Model treaty, and the OECD
Model treaty. However, the proposed treaty contains certain substantive
deviations from these treaties and models.
The proposed treaty contains provisions under which each country
generally agrees not to 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 (Article 7). Similarly, the proposed treaty
contains certain 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 7, 14, and 16). The
proposed treaty also provides that pensions and other similar
remuneration paid to a resident of one country may be taxed only by
that country, and only at such time and to the extent that a pension
distribution is made (Article 17).
The proposed treaty provides that dividends and certain gains
derived by a resident of either country from sources within the other
country generally 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 may be limited by the
proposed treaty. The proposed treaty provides that, subject to certain
rules and exceptions, interest and most types of royalties derived by a
resident of either country from sources within the other country may be
taxed only by the residence country (Articles 11 and 12).
Notwithstanding this general rule, the source country may impose tax on
certain royalties in an amount not to exceed five percent of such
royalties.
In situations in which the country of source retains the right
under the proposed treaty to tax income derived by residents of the
other country, the proposed treaty generally provides for relief from
the potential double taxation through the allowance by the country of
residence of a tax credit for foreign taxes paid to the other country
(Article 22).
The proposed treaty contains the standard provision (the ``saving
clause'') included in U.S. tax treaties pursuant to which each country
retains the right to tax its residents and citizens as if the treaty
had not come into effect (Article 1). In addition, the proposed treaty
contains the standard provision that the treaty may not be applied to
deny any taxpayer any benefits to which the taxpayer would be entitled
under the domestic law of a country or under any other agreement
between the two countries (Article 1).
The proposed treaty (Article 19) generally provides that students,
business trainees, and researchers visiting the other treaty country
are exempt from host country taxation on certain types of payments
received.
The proposed treaty includes the standard provision (Article 20)
that assigns taxing jurisdiction over income not addressed in the other
articles of the proposed treaty. In general, such income is taxable
solely by the residence country. The proposed treaty provides authority
for the two countries to resolve disputes (Article 24) and exchange
information (Article 25) in order to carry out the provisions of the
proposed treaty.
The provisions of the proposed treaty will have effect generally on
or after the first day of January following the date that the proposed
treaty enters into force. The proposed treaty allows taxpayers to
temporarily continue to claim benefits under the present treaty for up
to an additional year if they would have been entitled to greater
benefits under the present treaty. In addition, a teacher entitled to
benefits under the present treaty at the time the proposed treaty
enters into force will continue to be entitled to the benefits
available under the present treaty for as long as such individual would
have been entitled to the previously existing benefits.
Bulgaria
The United States and Bulgaria do not have an income tax treaty
currently in force. The rules of the proposed treaty and protocols
generally are similar to various rules of recent U.S. income tax
treaties, the U.S. Model treaty, the OECD Model treaty, and the 1980
United Nations Model Double Taxation Convention between Developed and
Developing Countries, as amended January 11, 2001 (``the U.N. Model
treaty''). However, the proposed treaty, as amended by the proposed
2007 and 2008 protocols, also contains certain substantive deviations
from these treaties and models.
The proposed treaty contains provisions under which each country
generally agrees not to 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 (Article 5). The proposed treaty includes a
special rule under which services performed by an enterprise of a
treaty country in the other treaty country may give rise to a permanent
establishment in the other country if the enterprise's activities in
the other country occur for a certain number days and if certain other
conditions are met. The special rule applies if the enterprise does not
have a permanent establishment in the other country by virtue of any of
the customary treaty standards.
The proposed treaty provides that dividends, interest, royalties,
and certain capital gains derived by a resident of either country from
sources within the other country generally may be taxed by both
countries (Articles 10, 11, 12, and 13); however, the rate of tax that
the source country may impose on a resident of the other country on
dividends, interest, and royalties may be limited by the proposed
treaty (Articles 10, 11, and 12). Withholding tax on dividends is
limited to 10 percent in most cases and is limited to five percent for
dividends received by a company owning at least 10 percent of the
dividend-paying company. A zero rate of withholding tax generally
applies to dividends received by pension funds. In general, withholding
tax on interest and royalties is limited to five percent under the
proposed treaty. Under the proposed 2007 protocol, the treaty countries
agree to reconsider source-country taxation of interest and royalties
arising in Bulgaria and beneficially owned by a resident of the United
States, at a time that is consistent with the December 31, 2014
conclusion of the transition period under a European Union Council
Directive applicable to interest and royalties deemed to arise in
Bulgaria and beneficially owned by a resident of the European Union.
In situations in which the country of source retains the right
under the proposed treaty to tax income derived by residents of the
other country, the proposed treaty generally provides for relief from
the potential double taxation, in the case of residents of the United
States, through the allowance of a credit for foreign taxes paid to
Bulgaria, and, in the case of residents of Bulgaria, through a
combination of credits and exemptions (Article 22).
The proposed treaty contains the standard provision (the ``saving
clause'') included in U.S. tax treaties pursuant to which each country
retains the right to tax its residents and citizens as if the treaty
had not come into effect (Article 1). In addition, the proposed treaty
contains the standard provision providing that the treaty may not be
applied to deny any taxpayer any benefits the taxpayer would be
entitled under the domestic law of a country or under any other
agreement between the two countries (Article 1).
The proposed treaty includes the standard provision (Article 20)
that assigns taxing jurisdiction over income not addressed in the other
articles of the proposed treaty. In general, such income is taxable
solely by the residence country. The proposed treaty provides authority
for the two countries to exchange information (Article 25) in order to
carry out the provisions of the proposed treaty. The proposed treaty
also contains a detailed limitation-on-benefits provision to prevent
the inappropriate use of the treaty by third-country residents (Article
21).
ConclusionThese provisions and issues are all discussed in more detail
in the Joint Committee staff pamphlets on the proposed protocol
and treaties. I am happy to answer any questions that the
Committee may have at this time or in the future.
Senator Menendez. Thank you.
Mr. Beaird?
STATEMENT OF RICHARD C. BEAIRD, SENIOR DEPUTY U.S. COORDINATOR
FOR INTERNATIONAL COMMUNICATIONS AND INFORMATION POLICY, BUREAU
FOR ECONOMIC, ENERGY, AND BUSINESS AFFAIRS, DEPARTMENT OF
STATE, WASHINGTON, D.C.
Mr. Beaird. Thank you, Mr. Chairman.
Mr. Chairman, ranking member Lugar, I am pleased to be here
to testify in support of the five telecommunications treaties
before you this afternoon and to urge the Senate's advice and
consent to ratification by the President.
These treaties flow from the work of the International
Telecommunications Union, the United Nations (U.N.) specialized
agency for telecommunication matters. Ratification of these
treaties will advance the interests of U.S. businesses,
consumers, and the United States Government. These treaties
have enabled U.S. businesses to secure valuable radio spectrum
and allowed them to offer innovative products and services to
U.S. and foreign markets.
They have also protected U.S. Government spectrum interests
and ensured that critical Government programs, ranging from the
International Space Station to essential equipment for weather
sensing and forecasting, can operate without interference.
Furthermore, these treaties have ensured that first responders
can more quickly and effectively coordinate their response to
natural disasters and other emergencies.
These treaties have also helped make the ITU a more
transparent, nimble, and accountable international organization
that better serves the interests of its member states. As a
result of these treaties--as a result, these treaties are
strongly supported by U.S. businesses and by the Government,
subject to the declarations and reservations outlined in each
of the treaty packages.
In fact, a broad range of representatives from U.S.
businesses and Government agencies were involved at every step
in establishing and pursuing our negotiating objectives for
these treaties. By becoming a party to these five ITU
instruments, we will convey to the other members of the union
our commitment to these important decisions and our continuing
strong support for the mission of the ITU.
Mr. Chairman, I would like to identify some of the
highlights of the ITU treaties, which fall into two main
categories corresponding to the world radiocommunication
conferences and the plenipotentiary conferences. The first
category involves amendments to the radio regulations, which
are treaties governing the use of the radio frequency spectrum
and the geostationary and non-geostationary satellite orbits.
At the 1992 World Administrative Radio Conference, the
United States was successful in obtaining additional spectrum
for Voice of America, spectrum allocation for low-Earth orbit
satellite systems, frequency allocation for digital audio radio
service, and additional spectrum for NASA projects such as the
lunar and Martian missions.
At the 1995 World Radiocommunication Conference, the United
States achieved new spectrum allocation for mobile satellite
systems and a new allocation for non-geostationary fixed
satellite services for broadband Internet.
The second category of treaties are proposed amendments to
the ITU constitution and convention, which are the result of
ITU plenipotentiary conferences which are the principal
administrative and policy conferences of the ITU.
In 1998, the United States hosted the first plenipotentiary
conference since it hosted the conference in 1947. The United
States achieved several objectives at this conference including
enhanced status of public and private companies participating
in ITU activities, added provisions in the constitution to
convene world radio conferences every 2 to 3 years to meet the
challenges of a dynamic telecom environment, improved ITU's
accountability through changes in the budget process.
At the 2002 Plenipotentiary Conference in Marrakesh,
Morocco, that conference adopted the following. The conference
developed a financial plan to balance the ITU budget and reduce
expenditures by 10 percent. The conference allowed private
companies to become observers at ITU council meetings, and it
changed the structure of the Radio Regulations Board to make it
more effective.
At the 2006 Plenipotentiary Conference held in Antalya,
Turkey, the United States achieved the following results. The
conference enhanced ITU budgetary process requiring ITU carry
out annual review of income and expenditures. It lengthened the
dates between ITU's established conferences so as to hold down
costs. It enhanced member state oversight of ITU financial and
administrative activities. It promoted budgetary transparency,
and it preserved the private sector role within the ITU.
Mr. Chairman, this completes my summary of the treaties.
Telecommunications is growing at an incredible pace, and U.S.
companies are introducing new services here and abroad on a
steady basis. The United States Government stands ready to move
forward as rapidly as possible to bring the benefits of
international telecommunications to our citizens.
It was my pleasure and honor to present this testimony. I
recommend that the Senate act favorably on these treaties. This
concludes my oral statement, and I have submitted a more
comprehensive account in my written statement and ask that it
be entered into the record.
Mr. Chairman, I stand ready to answer any questions that
the committee may have. Thank you.
[The prepared statement of Mr. Beaird follows:]
Prepared Statement of Richard C. Beaird
Chairman Menendez, ranking member Hagel, members of the
subcommittee, I am pleased to be here to testify in support of the five
telecommunications treaties before you this morning, and to urge the
Senate's advice and consent to ratification by the President. These
treaties flow from the work of the International Telecommunication
Union (ITU), the United Nations' (UN) specialized agency for
telecommunication matters. They are contained in the Final Acts of:
The ITU World Administrative Radio Conference--1992
The ITU World Radiocommunication Conference--1995
The ITU Plenipotentiary Conference--1998
The ITU Plenipotentiary Conference--2002
The ITU Plenipotentiary Conference--2006
Ratification of these treaties will advance the interests of U.S.
businesses, consumers and the U.S. Government. These treaties have
enabled U.S. businesses to secure valuable radio spectrum and allowed
them to offer innovative products and services to U.S. and foreign
markets. They also have protected U.S. Government spectrum interests
and ensured that critical government programs ranging from the
International Space Station to essential equipment for weather sensing
and forecasting can operate without interference. Furthermore, these
treaties have ensured that first responders can more quickly and
effectively coordinate their response to natural disasters and other
emergencies. These treaties also have helped make the ITU a more
transparent, nimble and accountable international organization that
better serves the interests of its Member States.
As a result, these treaties are strongly supported by U.S.
businesses and by the U.S. Government, subject to the declarations and
reservations outlined in each of the treaty packages. In fact, a very
broad range of representatives from U.S. businesses, and government
agencies were involved at every step in establishing and pursuing U.S.
negotiating objectives for these treaties. By becoming a party to these
five ITU instruments, we will convey to the other members of the Union
our commitment to these important decisions and our continuing strong
support for the mission of the ITU.
Before I summarize what each of the treaties does, it might be
helpful for me to quickly share with you some background about the ITU
and how the United States organizes its participation in the
negotiations that led to these treaties.
The International Telecommunication Union was formed in 1865 when
European countries saw the need to work together to facilitate
telegraphic communications across their borders. Today, the ITU is
involved in every phase of global telecommunications, working to
maintain international cooperation among its 191 Member States for
management of global spectrum use, and the adoption of international
telecommunication standards, and to foster the expansion of
telecommunication systems and services in developing countries. ITU's
purposes and activities are governed by several international
instruments, including the Constitution, the Convention, and the
Administrative Regulations.
The organization is unusual among UN agencies in that its
membership also includes 715 Sector Members (86 of which are from the
United States) and 164 Associates, representing companies and
organizations with an interest in telecommunications. This feature is
particularly vital to U.S. interests, in view of our reliance on the
private sector for the provision of telecommunications networks and
services on both the national and international levels, and in view of
the dependence of many U.S. companies on effective communications to
support their multinational operations.
As a result of the 1992 Plenipotentiary Conference, the ITU was
reorganized to give it greater flexibility to adapt to today's
increasingly complex, interactive, and competitive environment.
Consequently, the Union is organized into three Sectors, corresponding
to its three main areas of activity: (1) Telecommunication
Standardization (ITU-T); (2) Radiocommunication (ITU-R); and (3)
Telecommunication Development (ITU-D). The reorganization also
introduced a regular cycle of conferences to help the Union rapidly
respond to new technological advances.
The Union's three sectors represent an extremely diverse comm
unity, ranging from regulators to users, manufacturers to service
providers, as well as consumers. In one form or another, international
telecommunications involve every government agency and touch most
aspects of A merican business and the public in general. Hence, the
work of the ITU is of great importance and interest to the United
States.
The Union convenes Plenipotentiary Conferences to set the Union's
general policies, which often are reflected in amendments to the ITU
Constitution and Convention, and World Radiocommunication Conferences
(WRCs) to revise international Radio Regulations. Three of the treaties
before the Committee are the result of the Union's top policy making
body, the Plenipotentiary Conference, and the remaining two treaties
are the result of WRCs.
The Department of State's responsibility is to coordinate U.S.
participation in the activities of the U nion. This includes the
presentation of U.S. proposals to the ITU and its member countries,
development of strategies and positions relating to conference issues,
and assembly of well-qualified delegations from both the public and
private sector to carry out the complex and often technical
negotiations. For these five treaties which amend the ITU Constitution
and Convention, and the Radio Regulations, the Department is assisted
in the detailed preparations for the ITU conferences by the Federal
Communications Commission (FCC) and the National Telecommunications and
Information Administration (NTIA) in the Department of Commerce. The
FCC regulates all non-Federal use of the radio spectrum and all
interstate telecommunications as well as all international
communications that originate or terminate in the United States. The
NTIA manages Federal use of the radio spectrum and is the President's
principal adviser on telecommunications and information policy issues,
representing the Executive Branch in both domestic and international
telecommunications and information policy activities.
One important advantage of this extensive national effort is that
it ensures the United States is well prepared to negotiate at the
conferences. Moreover, private groups and individuals have the
opportunity to express their views at each stage of the process, from
initial conception of ideas to the eventual adoption of the national
regulations.
I will now give a summary of the treaties that fall into two main
categories, corresponding to the W RCs and the Plenipotentiary
Conferences.
The first category involves amendments to the Radio Regulations
which are treaties governing the use of the radio-frequency spectrum
and the geostationary and non-geostationary satellite orbits. At the
1992 World Administrative Radio Conference (WARC), the United States
was successful in obtaining a considerable amount of additional
spectrum to relieve frequency congestion in the existing broadcasting
bands used by Voice of America. Allocation for Low Earth Orbit (LEO)
satellite systems to enable voice-grade telephony and data was one of
the most difficult and complex debates during WARC-92 and one of the
highest U.S. priorities and achievements. The conference essentially
adopted the U.S. allocation proposal. The United States also secured a
Satellite Digital Audio Radio
Service frequency allocation. In support of NASA's communication
needs, the U nited States obtained additional spectrum for such
programs as the International Space Station, lunar and Mars missions,
and NASA's next-generation robotic deep space exploration programs.
At the 1995 World Radiocommunication Conference (W RC), the United
States achieved a new spectrum allocation that would permit global
deployment of new satellite technologies, specifically, Mobile
Satellite Systems. This allocation was critical to the future operation
of LEO satellite systems, which are used for expanding communications
and observation networks. WRC-95 also acted favorably on the U.S.
spectrum proposal for non-geostationary fixed satellites. This new
technology paved the way for U.S. industry to provide satellite based
global broadband Internet to remote regions. All these achievements are
reflected in the proposed amendments to the Radio Regulations for which
we are seeking advice and consent.
The second category of treaties are proposed amendments to the ITU
Constitution and Convention which are the result of ITU Plenipotentiary
Conferences, which are the principal administrative and policy
conferences of the ITU. In 1998, the United States hosted its first
Plenipotentiary Conference since 1947. The United States achieved
several objectives at this Conference, including enhancing the status
of public and private companies that participate in ITU activities,
adding a provision in the Constitution to convene W RCs every two to
three years to meet the challenges of a dynamic telecom environment,
and improving the ITU's accountability through changes in the budget
process. All of these changes improved the function of the ITU and
strengthened the role of the private sector within the ITU.
The 2002 Plenipotentiary Conference in Marrakesh, Morocco, adopted
several amendments supported by the U nited States to improve
management, functioning and finances of the ITU. Because of ITU's
serious budget shortfalls, the United States led in the effort to
develop a financial plan that balanced the ITU budget and reduced 10%
of program expenditures. One of the U.S. proposed amendments allows
private companies to be represented as observers at ITU Council
meetings. A nother broadened the field of potential candidates to the
ITU's Radio Regulation Board (RRB). These and other amendments approved
by the 2002 Plenipotentiary Conference have made it easier for the ITU
to respond to changes in the telecom munications environment.
The 2006 Plenipotentiary Conference held in Antalya, Turkey,
adopted new provisions to enhance the ITU budgetary process by
requiring that the ITU Council carry out an annual review of income and
expenditures and by advancing the deadline for budget contributions.
The Conference also adopted another fiscally responsible measure by
lengthening the dates between ITU's established Conferences and
Assemblies so as to hold down costs. The United States achieved many of
its objectives at this Conference, including enhancing Member State
oversight of ITU financial and administrative activities, promoting
budgetary transparency, and preserving the role of the private sector
in the ITU.
Mr. Chairman, this completes my summary of the treaties.
Telecommunication is growing at an incredible pace and U.S. companies
are introducing new services here and abroad on a steady basis. They
are looking for a quick response from the U.S. Government as they
conduct business in this fast-moving world. The United States
understands that the ITU must encourage rapid progress in
telecommunications; the ITU must be a partner in progress and a
catalyst to technological innovation. The United States Government
stands ready to move forward as rapidly as possible to bring the
benefits of international telecommunications to our citizens.
Mr. Chairman, it was my pleasure and honor to present this
testimony, and to discuss the International Telecommunication Union. In
conclusion, I recommend that the Senate act favorably on these
treaties. I stand ready to answer any questions that the committee may
have.
Senator Menendez. Thank you.
All of your statements will be fully included in the
record, and we will start with 10-minute rounds since I see
there is massive interest here. I think you and I, Senator
Lugar, might cover the waterfront.
So let me start off. I have questions for all of you, but
within my 10 minutes, let us see how far we can go.
Mr. Mundaca, with reference to the Canada protocol, that
includes a provision that would broaden the current definition
of permanent establishment or what is often referred to as the
183-day rule. I read it a couple of times, and maybe you can
help me. The--I am sure businesses would like some help as
well.
If a U.S. service enterprise doesn't have a fixed place of
business in Canada, it may still be deemed to have a permanent
establishment if it meets one of two tests. I won't read them
because I am sure you are fully, intimately familiar with them.
But a great many businesses have raised concerns with us about
this provision, suggesting that particularly in relationship to
Canada, it will be very hard for them to administrate.
Now I understand we have included such a provision in other
treaties with developing nations, and in fact, the Bulgaria
treaty includes such a provision. But as noted in Ms. McMahon's
testimony, this is the first time such a provision has been
included in a tax treaty with a developed nation like Canada.
Can you talk a little bit about this provision, explain why
you think it works, and why was it included in this protocol?
And we will start there, and I have a few other questions in
this regard.
Mr. Mundaca. Thank you, Senator.
We do--I should begin by saying we do understand the
concerns with administering this provision. We have already
begun discussions with Canada in the context of both in coming
to an agreement on the technical explanation of the treaty that
goes into a little bit more detail on what the provision
provides, and we will continue those discussions to try to
provide some further guidance to make this easier to
administer.
As you note, this is not a new provision. It has been in
treaties in the past, but never with a developed country and
never with a country with whom we have such a great cross-
border trade and services. And again, we do understand that we
will need to provide more guidance so that companies know if
they do trip the 183-day rule.
Some of the complexities of this that we know we need to
address are with respect to whether projects are connected,
when you have to count together certain periods of time in
which you are providing services to see if you reach the 183
day. There also are some issues with determining when it is
that you cross this threshold and if you will cross it in a
year, if you haven't planned on doing that.
If, for example, the project takes longer than you might
have thought and you wind up providing services in excess of
183 day, you may not have had the proper withholding
mechanisms, estimated tax payments in place. We do understand
those--those complexities.
As you may know, this is an issue that is not just between
ourselves and Canada. The OECD, the 30 larger economies in the
world have been wrestling with this issue as well. There are
many countries who do feel that this provision is appropriate,
that if someone does provide services in excess of 6 months in
a 12-month period that they should be subject to tax even if
they don't trip the fixed-base rule that is standard in our
treaties.
That is not our view. That is not our treaty policy. We do
not intend to extend this beyond those cases in which another
country has offered a package of benefits with respect to this
provision that we feel makes this in the best interest of the
U.S.
Senator Menendez. Well, you answered my next question,
whether this was a change in policy. And I am glad to hear that
it is not.
But let me go back to the challenge, the test that is
devised here presents a number of challenges. For one thing,
the sheer amount of effort and resources that would presumably
have to be spent on keeping track of one's employees, its
customers, its revenue stream from each country. It is pretty
daunting.
In addition, what is the 12-month period? It is not
necessarily tied to a fiscal year. And so, that a business
would have to keep continuous records in order to determine if
during any consecutive 12-month period--it is like a revolving
12-month period--they had crossed the line.
And Joint Tax, I think, has raised concerns regarding how
this provision interacts with amendments made under the
protocols of Article 15 of the treaty in relation to the
treatment of employees.
So have you thought about these challenges as we move
forward?
Mr. Mundaca. We have, and we have been in discussions with
Canada regarding how best to address them. We also welcome
input from your committee or from the business community about
the best ways to make this administerable for all of us. As you
mentioned, this is a rolling 12-month period. It is not tied to
a fiscal year. It will require record keeping.
One of the issues we think we need to address that could
provide some clarity around these issues is, again, what the
definition is of the connected projects for which you do have
to aggregate periods. So I think a clear definition of that
will provide some relief to taxpayers so they do know when they
can cut off counting days with respect to a particular
provision of services.
I should also note that some other variants of this
provision, one that the OECD is considering is broader than we
have provided here. They do not have the restriction we have in
our provision regarding the geographic coherence. That is, if
you are not providing services in one place, our rule doesn't
apply. THE OECD rule is broader in that extent.
So we have tried to build in some safeguards for
overbreadth, but we do recognize that we do have more work to
do. There is a delayed effective date on this. We will work
this year and next year to provide further guidance on this.
Senator Menendez. One last thing, I will just stick with
you for one more concern. And I hope you take this concern back
to the department seriously because I think the committee had
it in its report. I raised it in the last meeting that I
chaired on the question of some other treaties that we had. I
want to talk about the arbitration mechanism that appears in
the Canada protocol.
In the last hearing where your colleague, Mr. Harrington,
was here, a concern about the fact that the arbitration
mechanism in both the Germany and Belgium treaties did not
provide for direct taxpayer input to the arbitration board
during an arbitration proceeding. Now this--notwithstanding
raising those issues in those treaties, this is not changed in
the Canada protocol. The mechanism still does not provide for
direct taxpayer input to an arbitration board during an
arbitration proceeding.
And I know that the committee report on both of those
previous treaties raised other issues, including concerns
regarding treaty interpretation and the selection of
arbitrators, but, you know, I haven't seen the department be
responsive. And I hope you can address--can we expect to see
some of these concerns that have been raised dealt with in
future track's treaties with similar arbitration mechanisms
because if not, speaking as one Senator, I will have
difficulties in being as supportive as I have been to date.
Mr. Mundaca. We understand, and we appreciate your past
support, and we understand the concerns. They were not taken
onboard with respect to the Canada provision, as you point out.
Not because we didn't regard them as valid or important, but
simply because that had been agreed to before we got the input
with respect to Germany and Belgium. Those provisions, all of
them were negotiated approximately the same time, and we had
locked down that issue with Canada.
But we do take those concerns seriously. They will be
reflected in future arbitration provisions. We will certainly
raise them with treaty partners we talk to about this
provision. Again, it is a negotiation. What their reaction will
be to the issues you raised with respect to taxpayer input,
precedential value of decisions, the authorities for the
arbitration board to consider, and the choice of the arbiters,
please know we will raise all those issues with people we
negotiate with in the future.
Senator Menendez. All right. Ambassador Balton, let me
just take one or two questions with you in the time I have
remaining.
Did the U.S. industry groups that are affected by these
environmental treaties that we are considering before the
committee today participate in the negotiations? And to the
extent that they did, did they support the treaties, and have
they voiced any specific concerns?
Ambassador Balton. Let me take each of the treaties
separately.
Senator Menendez. Yes, if you could put your microphone
on?
Ambassador Balton. Thank you, Senator. Let me take you to
those treaties separately on that question.
With respect to the London protocol, the American
Association of Ports and Harbors was involved in the
negotiations of this, and indeed, this group attends the
meetings of both the London convention and now the London
protocol regularly.
The U.S. industry group that is most affected or would be
most affected by U.S. ratification is actually our dredging
industry. And the U.S. industry association in this field, the
Dredging Contractors of America, have indicated that they are
fully aware of the protocol and support its objectives.
With respect to the anti-foulants convention, here, the
U.S. anti-fouling paint industry favors this convention. Why?
Because it promotes a single regulatory program for all
countries. That will likely increase the use of environmentally
friendly anti-foulants that they, the U.S. industry, have
developed. U.S. shipyards are also interested in the single
international standard because it provides a more level playing
field as between them and shipyards in other countries.
And finally, the U.S. ship owners and operators, what they
most want is an effective set of anti-fouling systems that do
not increase their costs. They have already moved on, away from
the anti-foulants that are prohibited under the convention to
use the environmentally friendly anti-foulants that are
permitted for use, both under the convention and U.S. law. So
they support our moving forward, too.
Finally, with respect to the LBS protocol, the land-based
sources protocol, I should start by saying that our entire
approach to the negotiation of this treaty was to create a set
of environmental standards that the United States was already
meeting or exceeding. The idea was to bring our neighbors in
the Caribbean region, most of whom are developing countries, up
to or at least close to U.S. standards.
And because of this approach, which was successful, U.S.
industry was not directly involved in the negotiations. U.S.
ratification of this treaty will not have a significant bearing
on their activities. We have not heard and are not aware of any
opposition to U.S. ratification from dischargers, agricultural
interests, or other similar U.S. industry stakeholders.
We fully expect that a wide variety of other U.S.
industries who will stand to benefit from stronger
environmental protection of the oceans support ratification of
the protocol. Here, I am thinking of the U.S. fishing industry,
the U.S. tourism industry, among others.
Finally, I would note that U.S. negotiators of this
protocol did consult throughout the negotiations with officials
from the U.S. States and territories that border this region.
Those include Texas, Louisiana, Mississippi, Alabama, Florida,
as well as the Commonwealth of Puerto Rico and the territory of
the Virgin Islands.
Senator Menendez. So all of the industries that did
participate with you, they are, as I hear your answer,
supportive and raise no concerns?
Ambassador Balton. That is a fair summary, sir.
Senator Menendez. Thank you very much.
Senator Lugar?
Senator Lugar. Thank you, Mr. Chairman.
Mr. Beaird, I would like to just query this point about
this particular timing for the ITU treaties. My understanding
is that revisions to the ITU radio regulations were concluded
in 1992 and 1995, respectively. They were submitted to the
Senate for advice and consent in 2002 and 2004.
Now why did nearly a decade elapse before the executive
branch sought Senate advice and consent on these instruments?
And given the significant passage of time and the vast changes
in the telecommunications sector and innovating period, why
does the administration consider important that the Senate act
upon these instruments now?
Mr. Beaird. Thank you very much, Senator Lugar.
We are quite aware of the time lapse that has occurred
between the final acts of the treaty--these final acts of these
conferences and the present submission for advice and consent.
We are reviewing that process within the department. We are
aware that oftentimes priorities within the department do not
elevate telecommunications treaties to the position that, in
some cases, we would prefer in the Economic and Energy Bureau,
but we are talking with colleagues about that to remedy the
situation.
Secondly, Mr. Chairman--Senator Lugar and Mr. Chairman, the
implementation of these final acts do take place within the
Administrative Procedures Act of the FCC and the National
Telecommunications and Information Administration. As such, we
rely upon them to tell us the timing of the implementation of
the final act. So we work closely with those agencies to make
sure that no one is disadvantaged.
However, we also--and thirdly, we also are having
conversations with the staff of your committee to assess how we
can best move forward so that we can shorten the length of time
between the final acts and their submission for advice and
consent.
Senator Lugar. I appreciate that response, and you have
been very candid that sometimes, as you say, the priorities
within the department have not elevated this perhaps in such a
timely way. This is, I suppose, one of the problems with the
treaties, all of them that we are discussing today. These are
of vast significance to American business, to those who are
innovating an American society.
And yet at the same time, they do not have frequently the
currency of warfare or threatened international conflagrations
and so forth, even though the amount of money involved--the
jobs and so forth--are vast and not really recognized. That is
why I pursued this because in telecommunications, as you would
testify and would know more about it than I would, the amount
of innovation, extraordinary changes in this period of time
really would tax the abilities of everyone who was trying to
get their arms around the problem and bring about equity,
fairness, accessibility, all the things that telecommunications
people are interested in.
This leads me to sort of the second question. To what
extent the new treaties lead to more private industry
participation with the ITU? In other words, are you informed in
a timely way by people who are on the frontiers, figuring out
new ways of communicating so that the regulations with which
you are entrusted not only are enforced, but there is some
relevance to what you are enforcing as compared to what is
actually occurring in the world?
Mr. Beaird. Senator Lugar, we made, as a fundamental
purpose of the 1998 Plenipotentiary in Minneapolis, the goal to
enhance the role of the private sector in the ITU, and we think
we have accomplished that in a number of areas.
First of all, we have given an opportunity to participate
in leadership positions in the ITU, to chair committees at
conferences that they--the conferences that have a bearing upon
the future of their businesses and an opportunity for them to
have an input into the innovative process of the ITU to bring
these new services to the marketplace.
Secondly, we have given them a wider opportunity to
participate in actual meetings of the ITU as in the sense that
they are now observers at the council meetings of the ITU, the
governing board of the ITU.
Our assessment is that if you look at the U.N. system as a
whole, we believe that we have achieved a balance between the
intergovernmental organization that the ITU is and the need to
bring to that organization a private sector participation and
leadership. We think we have set the bar very high for the U.N.
system, but we are also continuing to review the situation in
the ITU, to make sure that other opportunities, as appropriate,
can be given to the private sector.
Senator Lugar. Are the companies and the industries
involved supportive of these treaties? If they were sitting at
the table with you, would they be testifying enthusiastically
or strongly, or how would you characterize their feelings?
Mr. Beaird. Well, I am confident, having spent many years
working very closely with them, that they would be very
supportive of these treaties. They would only underscore your
comment as to the need to get them up here quicker than we
have, and we are also consulting with industry on that point.
Senator Lugar. Thank you.
Mr. Mundaca, let me just explore for a moment this term
treaty shopping, which arises whenever we have one of these
treaties, and the fact that the new Iceland treaty closes a
much-exploited loophole. Now, what was the loophole? Describe
why the problems of the Iceland situation were difficult and
why Americans should be concerned about that?
Mr. Mundaca. Thank you, Senator.
The concern is that when we negotiate treaties, we
negotiate them based on reciprocal benefits provided by, for
example, Iceland to our residents and for us to provide
benefits to Iceland residents. Through treaty shopping, through
various techniques, residents of third countries can access
those benefits.
So, for example, we saw in the case of Iceland, and we are
seeing it with respect to Hungary as well, is that third
country residents set up corporations or other entities in
those jurisdictions. Those entities then derive interest
payments, for example, from the United States. They claim zero
withholding on that, and that income is not subject to tax in
the jurisdiction, either Iceland or Hungary, and the owners are
able to access the U.S. treaty, achieve zero withholding, not
pay tax in the other jurisdiction, and get the benefits of the
treaty when, in fact, they should not.
The inclusion of limitation on benefits provisions prevents
that. We have other mechanisms to go after some of these
structures, some of the anti-concurrent rules that we have, et
cetera. But limitation on benefits provisions are the best way
to prevent the treaties by being accessed by third country
residents.
We saw huge debt flows. We delivered a report to Congress
at the end of 2007 that reported on some of these issues. And
again, although they are not some of our leading trading
partners, both Iceland and Hungary were within the top 10 of
recipients of interest payments out of the U.S. And again, we
think primarily because of these loopholes in the treaties.
Senator Lugar. Well, how, as a practical matter, do you
identify these third countries? For example, is Iceland under
the treaty responsible for saying the people taking advantage
of this treaty are our citizens, they are Icelanders. In other
words, there are no Swedes or Norwegians or what have you?
Mr. Mundaca. Right.
Senator Lugar. Or front companies. In other words, an
Iceland representative, but really behind it is the capital
flow coming in from somewhere else, taking advantage of the
namesake on the door there.
Mr. Mundaca. And that is the issue is under the current
treaty, there is no such obligation to determine who the owners
are of these entities in order to grant that entity benefit. So
the Icelandic entity can be owned by just about anybody in the
world and claim benefits under our treaty. With the inclusion
of the limitation on benefits provision, that would end. And it
would have to be reporting and proving of the owners of the
companies before they could claim benefits.
Senator Lugar. So you are relying on the reporting system
and the integrity of the country that we are dealing with.
Now how does the information sharing business work in this
case? In other words, how deeply can we probe down in the weeds
as to who is doing what in what country? To what extent are
there privacy issues involved in these probes?
Mr. Mundaca. There are privacy issues, and the privacy
issues with respect to confidentiality are dealt with in the
treaty. So there is no chance of the information that is gained
in exchange being used inappropriately or being released. On
the other hand, in the Iceland treaty, there is full exchange
of information. There is no hiding behind bank secrecy laws or
other laws of either the U.S. or Iceland to shield from the
ownership information that is required.
Also, because we do require that information be provided in
order for U.S. withholding agents, for example, to grant the
lower withholding, we don't have to necessarily go out and get
that information. That has to be provided to us in order for
the lower withholding rate to apply.
Senator Lugar. But the U.S. could send auditors to Iceland
and sort of go through the books?
Mr. Mundaca. Yes, that is right. Under the treaty, that
sort of investigation is permitted.
Senator Lugar. Thank you very much.
Thank you, Mr. Chairman.
Senator Menendez. Thank you, Senator Lugar.
I just have another--we will do another round if necessary.
I just have a few more questions that I would like to get on
the record.
Ambassador Balton, with reference to the reverse list
approach taken in the London dumping protocol, which is an
improvement of the 1972 London Convention to which the U.S. is
now a party, why is it that we consider it an improvement?
And secondly, while I understand that it is more
restrictive, are we worried that we may find and identify other
items, like carbon sequestration, as something that we think
should be dumped and then find ourselves engaged in a very
lengthy negotiation to amend the treaty?
Ambassador Balton. Thank you, Senator.
We do agree that the reverse list approach represented by
the protocol is better than the sort of black list approach of
the convention to which we are now bound. It is simpler and
more effective, in our view, and we do not foresee conflicts
between the approach of the protocol and the U.S. pollution
dumping program as it stands.
The list on the protocol, the white list, already includes
a broad range of substances that may be considered for dumping.
And this list reflects more than 35 years of worldwide
experience in determining which substances may cause harm to
the marine environment if dumped.
To the extent that another substance not previously
considered may need to be added in the future, the London
protocol parties have already shown their agility in responding
to new and emerging technologies. They, in fact, amended the
list once already precisely on the topic you raised, Senator.
The list now includes carbon dioxide streams for purposes of
sub seabed geological sequestration.
The U.S., though not a party to the protocol, supported
this amendment very much. The process was quick. It took less
than a year from start to finish.
There are other protections under the protocol as well. I
note that there are a variety of activities that are not
defined as dumping for purposes of the protocol. These include
disposal into the sea of substances derived from normal
operations of vessels and other craft, placement of substances
in the sea for purposes other than mere disposal.
The protocol also does not cover disposal or storage of
substances arising from or related to the exploration,
exploitation, or processing of offshore oil, gas, or other
resources. And finally, the protocol gives parties significant
flexibility to dump substances in emergency or force majeure
situations.
I raise these because for all these reasons, we believe
that the reverse list approach does not constrain the
legitimate needs of the United States or other nations on this
range of issues of ocean disposal and waste management.
Senator Menendez. And one last question on the protocol.
What if we find an emergent situation in which something that
is prohibited needs to be dumped? Is there some mechanism that
deals with that?
Ambassador Balton. Yes, sir. Article 8 of the protocol is
a good example of the sophistication of this treaty in
providing flexibility. There are two different situations it
allows for.
First, it allows a party to issue a permit and thus create
an exception to the protocol's general rules on dumping in
situations of emergencies posing an unacceptable threat to
human health, safety, or the marine environment when there is
no other feasible alternative. This provision, the emergency
permit, is actually broader than the one of the original
convention to which we are now bound.
And then there is the second provision as well, which is
replicated from the original convention. It contains a
provision for situations of force majeure caused by weather or
other immediate threats to human life or the marine environment
where there is no other alternative. In these situations,
dumping or incineration at sea may proceed even without the
permit, although a party should conduct these things in a
manner so as to minimize harm to human or marine life.
So, in light of these provisions, once again we believe the
protocol provides the necessary flexibility we would need as a
party.
Senator Menendez. Thank you.
Mr. Mundaca, one last question. I am going back to the
protocol with London. What sorts of disputes do you think are
most likely to be arbitrated through the mandatory arbitration
mechanism provided for in the protocol? And will that mandatory
arbitration provision be applicable to disputes that have
already arisen? How do you see this working?
Mr. Mundaca. Based on the experience we have of the
pending cases, I would guess--and it is just a guess--is that
transfer pricing disputes would be the ones that will proceed
to arbitration. Those are the ones that we have seen, in our
experience, are the most difficult at this point to come to an
agreement with in a timely manner.
And therefore, I would expect, looking at the types of
cases that are currently pending, that those are the ones that
would likely be the predominant cases that are moving to
arbitration.
Regarding the coverage of current cases, they are covered.
The 2-year trigger for a case moving out of the negotiation
phase of the competent authority process to the arbitration
phase, the trigger date will be the entry into force of the
treaty, and then 2 years after that, pending cases can move
into arbitration.
We are working with Canada on a mechanism for identifying
cases that are currently beyond the 2-year mark that could be
moved into arbitration more quickly. And we hope over the next
months to get that process in place so that the taxpayers don't
have to wait the full 2 years that they have already had a case
in competent authority that has been unable to be resolved.
Senator Menendez. All right. Thank you.
Mr. Beaird, one question for you--two questions. One is one
of our key concerns in negotiating radio regulations is the
ability to obtain the high-frequency bands necessary to
broadcast Voice of America throughout the world. In instances
where the United States has not obtained enough of the spectrum
to meet its needs, it has entered reservations stating that it
will take appropriate actions to maintain broadcasting.
When other countries accuse the United States of causing
harmful interference and attempt to jam our broadcasts, what is
our response, and how does the ITU manage these situations?
Mr. Beaird. Thank you very much, Mr. Chairman.
In instances in which this has occurred, and it has
occurred certainly in the last 30 years and in more than one
instance, the United States complains to the ITU in a filing
indicating the signal's origin and its strength and the extent
of time and time and duration of the interference. That
complaint is then referred to the Radio Regulations Board,
which makes a finding.
We have a situation currently where we have filed a
complaint against a country neighboring to us, and the board
has found that the origin of the signal was, in fact, from that
country and has asked, pursuant to the radio regulations, that
the harmful interference be resolved through the cooperation of
the two countries.
Now that is an approach that is undertaken by the ITU. The
ITU is not an adjudicative body. It can only recommend a
solution or a resolution of the harmful interference. But the
United States always, when it occurs, registers the complaint
to make it known to the ITU that there is such an interference
occurring.
Senator Menendez. So it is not a binding determination?
Mr. Beaird. That is correct.
Senator Menendez. All right. And one last question. The
ITU was not in the best financial shape a few years ago, and I
am wondering have the amendments to the budget process improved
the situation, and what are the current challenges the entity
faces in this area?
Mr. Beaird. Thank you, Mr. Chairman.
We believe we have made great progress at the ITU. In 2002,
at the plenipotentiary in Marrakesh, for the first time we had
a resolution adopted that called for a balanced budget at the
ITU. It resulted in some--and we also indicated we wanted at
least 10 percent cuts in the expenditures of the union.
There were follow-up actions. Staff levels were reduced,
new software introduced, budget transparency brought about. And
in 2007, at the ITU council, which adopts its budget, I am
pleased to report that a balanced budget was adopted at that
council.
We believe we have made great improvements at the ITU, but
it is an ongoing task for us and the other member states and
the sector members--that is, say, the private sector--to
monitor the financial situation of the union. But we believe,
at this time, the union is in far better financial shape than
it was certainly in 2002.
Senator Menendez. Thank you.
Senator Lugar?
Senator Lugar. Mr. Balton, you have touched upon this, but
amplify a bit more about the land-based sources protocol.
Because this protocol, as you pointed out, was concluded in
1999, which is 9 years or so ago. And so, there is a track
record by this time of what kind of pollution may have been
abated in the Caribbean to some extent. But can you give us
sort of a mind's eye map?
How many States are a part of that protocol now, and how
would you characterize the pollution situation? What is under
control and what is not under control due to non-adherents or
non-membership?
Ambassador Balton. Thank you, Senator.
I am sorry to say that as we sit here today only four
nations have ratified the protocol. It is not yet in force. It
requires a minimum of nine to enter into force. The four that
have--
Senator Lugar. This is after 9 years, only 4 states? I
see.
Ambassador Balton. The four that are are France, which
does have territories in--other parts of France in the area,
Panama, St. Lucia, Trinidad and Tobago. My supposition,
Senator, is that a number of other countries of the region are
waiting for the United States.
Senator Lugar. I see.
Ambassador Balton. We were among the driving forces behind
the protocol. We are one of the few developed countries in the
region. We are a leader, and we have not yet ratified.
Some of that is due to other priorities. We are sorry it
took as long as it has to get the protocol to the Senate. We
are, nevertheless, hopeful that the protocol can go through,
and we can become a party and encourage other countries in the
region to become party and to bring their environmental
standards up to those of the United States in this area.
The situation is not good overall. The problems of marine
pollution in the Caribbean region are very real. Effluents of
many sorts--agricultural runoff, domestic wastewater, other
types of pollutants from land-based activities--are causing
real harm. And we believe the protocol, once it is in force,
can serve as a vehicle to find collective solutions to a region
that we, in fact, share with many countries.
So that is our hope, and that is the reason we are seeking
Senate advice and consent.
Senator Lugar. Well, I appreciate your candor, and I
appreciate even more your bringing the treaty to this point
and, likewise, the Chairman holding the hearing. One of the
dilemmas, and we touched upon this a little bit with the ITU
situation, is that these affairs have been rumbling out there
for many, many years. And I think you make a very good point
that the rest of the world, in some cases, waits upon the
United States to offer leadership. Or to the contrary, if we
don't, others say, well, why should we care?
Now, still in the conservation mode that so many Americans,
I would hope a majority, are in with concerns that are
addressed by this, and I think that is shared by other
countries. It is interesting that France would be one of the
four, clearly not a place of residence in the Caribbean,
although interests in the various countries, as you say. But in
terms of the actual citizens of that area, this is really
significant.
But this is not a time to complain why was there no
priority. It is a time to celebrate the fact that we finally
have come to the table, have a session of this variety attended
at least by two members of the committee who are deeply
interested in what is going on here, as well as a good number
of citizens who have come to hear what you had to say today and
to see whether progress was going to occur. So I appreciate
that.
Let me just raise one more question with regard to the tax
treaties. And I will ask you again, Mr. Mundaca, I am just--I
am curious, for instance, why some people in the business
community that I have heard from are very appreciative of the
Canadian treaty in particular. They think this really has very
substantial significance.
Now, in part, I can understand this from a parochial
standpoint. My State of Indiana has--is just seventh, I have
found, in terms of trade between Indiana and Canada. But even
then we are exporting about $10 billion worth of goods and
services from Indiana to Canada. We are importing $6 billion.
So we are producing a balance of trade of $4 billion in one
State with barely 2.5 percent of the population of the country.
So this is a very significant treaty in terms of income for
people in Canada and Indiana, for that matter. So I can
understand why they would be interested in it. But they are
saying beyond that apparently there were the questions that we
were just discussing before of this binding arbitration is
especially significant, maybe because there are so many
elements of trade. Maybe it is so many more deals or
sophisticated questions or entities that come into this.
I am wondering whether that has been the case as you have
found it from testimony around the country, that because really
of our trading relationship with Canada, a sizable amount, that
this is not necessarily overwhelming, but at the same time it
could be. The number of cases stacking up that are unresolved,
justice denied for years. So that then there gets to be a good
bit of indecision about the tax code.
Back here in the Congress, we change the tax code, or we
don't really change it. But meanwhile, all these cases are out
there. What is the caseload, just out of curiosity? And is this
one reason why there is such business support for this
particular treaty?
Mr. Mundaca. I think that is exactly right that the level
of trade we have with Canada, the nearness of Canada and,
therefore, the opportunities for many taxpayers--not just large
multi-nationals, but small businesses and individuals to engage
in cross-border activity with Canada--has led to many more tax
disputes than we see with other countries. And there has
developed a backlog of cases with Canada people are eager to
see resolved on a more timely basis.
And we are very optimistic this mechanism will speed to
resolution through the negotiation process pending cases, and
if they can't be settled in that--in that phase, then moved to
arbitration so the taxpayers get the certainty that they
deserve.
Oftentimes, taxpayers, although they always mind paying
taxes, they really mind paying taxes twice. And what they
really do want is certainty about where their tax needs to go
and have the other country respect that determination, and that
is what we hope that this mechanism will provide in this
context.
There are probably more pending cases between the U.S. and
Canada than we have with any other jurisdiction at this point.
We get complaints about the timeliness of the resolution of
those disputes, and again, we are very optimistic this
mechanism can speed those along.
Senator Lugar. Now from the standpoint outside of the
business community of taxpayers in both countries, what
confidence do taxpayers have generally that these businesses
finally are paying taxes properly, either in Canada or the
United States? Do you note a good bit of evasion through all
this delay or maybe through a lack of definition to begin with?
Mr. Mundaca. Actually, from what we have seen, at least
with respect to Canada, it mostly goes the other way. Is that
companies are concerned that they have a tax liability with
respect to the same income stream to both Canada and the United
States due to the lack of resolution of some of these large
pending cases.
So at least in my experience, I have not seen cases where
the issue is that neither country is seeing the income and,
therefore, it goes untaxed. The issue we see more are cases in
which taxpayers come forward, and there are clear double tax
cases that need to be resolved.
Senator Lugar. Thank you very much.
Thank you, Mr. Chairman.
Senator Menendez. Thank you, Senator Lugar.
Let me thank you all for your testimony and the hard work
you put into treaties over many years. I specifically want to
thank Avril Haines from the committee staff, who has done a
tremendous service preparing the materials for this hearing and
making them understandable to some of us who are not
intricately engaged in this work.
The record will remain open for 1 day so that committee
members may submit additional questions to the witnesses, and
we ask the witnesses to respond expeditiously to these
questions.
And seeing no other member seeking recognition, the hearing
is adjourned.
[Whereupon, at 4:00 p.m., the hearing was adjourned.]
APPENDIX
----------
responses to additional questions for the record submitted to deputy
assistant secretary michael mundaca by senator joseph r. biden, jr.
Question. The President's Letter of Transmittal for the proposed
Iceland Tax Treaty notes that because the existing treaty with Iceland
from 1975 does not contain a Limitation on Benefits (``LOB'')
provision, which is intended to prevent so-called treaty shopping,
there has been ``substantial abuse of the existing Treaty's provisions
by third country investors.'' See Treaty Doc. 110-17 at III. Please
describe the evidence upon which this statement is based.
Answer. A Treasury Department report to Congress, ``Earning
Stripping, Transfer Pricing and U.S. Income Tax Treaties,'' released in
November 2007 (2007 Treasury Report), describes abuses of the U.S. tax
treaty network by third-country investors, particularly through
inappropriate reductions in withholding tax. The 2007 Treasury Report
presented data, gathered from U.S. tax returns, on deductible payments
such as interest made by U.S. companies to related foreign companies
located in treaty jurisdictions. The data suggested that tax treaties
that have no LOB provision and a zero rate of withholding tax on
deductible payments, such as our treaties with Iceland and Hungary, had
begun to be abused by third-country investors. In particular, the 2007
Treasury Report notes that while in 1996 almost no U.S.-source interest
was paid by foreign-controlled U.S. companies to related parties in
Iceland and Hungary, payments of such interest had increased by 2004 to
over $2 billion. In addition, publicly available information indicates
that many of those related parties were ultimately owned by
corporations from third countries. This evidence strongly suggests the
existence of treaty abuse by third-country residents.
Question. Please explain how the LOB provision will be enforced
against third-country investors that attempt to benefit from the
treaty's provisions, should the new treaty be ratified. In addition,
please describe specific enforcement challenges, if any, that the
United States has faced in the past when attempting to enforce LOB
provisions in other tax treaties.
Answer. The Internal Revenue Service has a multi-pronged approach
to enforcing compliance with treaty LOB provisions.
With respect to payments of amounts subject to withholding, such as
interest, royalties, and dividends, U.S. withholding agents (e.g.,
banks, brokers) are obligated to obtain, from each foreign payee,
documentation on which the withholding agents can rely to treat a
payment as made to a foreign person entitled to a reduced rate of
withholding tax under the treaty. Absent such documentation,
withholding at 30 percent is required. More specifically, foreign
taxpayers who derive and beneficially own the payment must complete a
Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for U.S.
Tax Withholding) to claim a reduced rate of withholding tax. Part II of
the W-8BEN is entitled ``Claim of Tax Treaty Benefits.'' On line 9 the
beneficial owner must identify its country of residence and, if the
person is not an individual, represent that it meets the LOB article of
the relevant treaty.
With respect to claiming treaty benefits other than withholding tax
reductions, such as a claim that a taxpayer does not have a permanent
establishment in the United States, the taxpayer must file Form 8833
(Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b))
attached to a Form 1120-F (U.S. Income Tax Return of a Foreign
Corporation) or Form 1040 NR (U.S. Nonresident Alien Income Tax
Return). Line 4 of Form 8833 requires the taxpayer to identify the LOB
provision that the taxpayer relies upon to be eligible to take the
treaty-based return position.
In addition, the Internal Revenue Service audits LOB compliance as
part of its general assessment of whether a foreign taxpayer is
eligible to claim treaty benefits. The Treasury Department understands
that the IRS' audit experience indicates that LOB issues most often
arise in the context of audits of U.S. corporations that makes payments
of interest, dividends, or royalties to related foreign persons.
In the end, however, the simple inclusion of a LOB article in a
treaty may by itself be largely responsible for limiting treaty
shopping. The 2007 Treasury Report provides evidence that the mere
inclusion of a comprehensive LOB provision is a deterrent against
treaty shopping.
Question. As set forth in Article 27(3) of the proposed treaty with
Iceland, an unusual year-long transition period is provided for
investors that are entitled to greater benefits under the 1975 treaty
than the new treaty, during which they can elect to continue to benefit
from the application of the 1975 treaty, rather than have the new
treaty's provisions applied to them. Why was this provision included?
How does this provision benefit the United States? Is this provision
one that might be included in future treaties?
Answer. The transition rule coordinating the entry into force of
the proposed Iceland treaty and the termination of benefits of the 1975
treaty is not an uncommon practice when an existing treaty is being
replaced by a new agreement or is being amended by a new protocol. For
instance, similar provisions were included in the U.S.-Belgium tax
treaty (signed November 27, 2006), the U.S.-Germany protocol (signed
June 1, 2006), the U.S.-U.K. tax treaty (signed July 24, 2001), and the
U.S.-Denmark tax treaty (signed August 19, 1999). In order to reach
agreement in 2007 with Iceland regarding inclusion of a LOB provision,
we agreed to this election.
Question. U.S. income tax treaties with Hungary and Poland provide
an exemption from withholding on cross-border interest payments and, as
in the case of the 1975 tax treaty with Iceland, these treaties do not
include an LOB provision. Is the Treasury Department negotiating
protocols with Hungary and Poland in order to rectify the omission of
an LOB provision? If not, why not? If so, please describe the status of
those negotiations.
Answer. Updating the agreements with Hungary and Poland is a key
part of the Treasury Department's effort to protect the U.S. tax treaty
network from abuse. The Treasury Department has had two rounds of
negotiations with Hungary already in 2008 with the aim of concluding a
new agreement as soon as possible. The next round of negotiations is
scheduled for September 2008, and an additional round is also
scheduled, if necessary, for December 2008.
As shown in the 2007 Treasury Report, it does not appear that the
U.S.-Poland tax treaty has yet been extensively exploited by third-
country residents. Nevertheless, the Treasury Department has had
preliminary discussions with Poland and anticipates continuing those
discussions in 2008 with the goal of commencing negotiations to
conclude a new agreement to update the 1976 agreement. The United
States places a very high priority on bringing the proposed treaty with
Iceland into force and on concluding as soon as possible negotiations
with Hungary and Poland.
Beyond renegotiating the treaties with Hungary and Poland, the
Treasury Department reviews the current U.S. tax-treaty network on a
continuing basis to identify deficiencies in existing agreements and
areas where more beneficial terms for the United States and U.S.
taxpayers could be negotiated. As part of this process, anti-treaty-
shopping provisions are given special scrutiny to ensure that they are
functioning appropriately. Those treaties with LOB provisions that are
out of date or need strengthening are given higher priority in the
Treasury Department's plan for negotiations.
Question. The proposed treaty with Iceland includes special anti-
abuse rules intended to deny benefits in certain circumstances in which
an Icelandic-resident company earns U.S.-source income attributable to
a third-country permanent establishment and is subject to little or no
tax in the third jurisdiction and Iceland. Similar anti-abuse rules are
included in other recent treaties, including the proposed Convention
with Bulgaria. The U.S. Model Tax Treaty, however, does not include
rules addressing so-called ``triangular arrangements.'' Why? Is this a
provision that might be added to the U.S. Model Tax Treaty?
Answer. The Treasury Department's current policy is to incorporate
the so-called ``triangular rule'' into tax treaties in which the treaty
partner exempts from tax certain foreign source income such that a tax
treaty may be used inappropriately in conjunction with certain branch
structures to exempt fully from tax certain U.S.-source payments. The
Treasury Department is considering whether it is appropriate to include
such a rule in the next update of the U.S. Model tax treaty.
Question. The Committee on Taxation of Business Entities of the New
York City Bar has written to the Committee on Foreign Relations in
reference to the so-called ``derivative benefits''' test contained in,
for example, Article 21(3) of the LOB provision in the proposed treaty
with Iceland. In particular, the Bar's Committee on Taxation of
Business Entities has stated that they ``believe that there is a need
for guidance in determining the scope of the dividend payment relief
under such derivative provisions, due to the uncertainties involved in
calculating the relevant stock ownership.'' Has the Office of Tax
Policy considered whether it would be useful to publish guidance on
this topic?
Answer. The New York City Bar Association's Committee on Taxation
of Business Entities, in its May 2008 report (the NYCBA Report),
suggests that there is need for guidance clarifying how ownership is
calculated for purposes of the derivative-benefits rule in our recent
tax treaties. The Office of Tax Policy recognizes the importance of
providing published guidance with respect to income tax treaties
generally, and is currently considering this and other recommendations
made by the NYCBA Report.
Question. Under the U.S. Model Tax Treaty child support payments
paid to a resident of a treaty country is exempt from tax in either
country. The proposed treaty with Iceland, however, makes no mention of
the tax treatment of child support payments. Why is that?
Answer. The absence of a special rule governing the taxation of
child support payments in the proposed Iceland treaty means that the
taxation of such payments would be governed by Article 20 (Other
Income), which assigns the exclusive right to tax to the country of
residence of the recipient. During the course of the negotiations, the
Treasury Department learned that under Iceland's domestic law, most
child support payments are not subject to tax. Accordingly, leaving the
treatment of child support payments to Article 20 (Other Income)
achieves a tax result very similar to the result under the U.S. Model
rule; that is, the residence country will have the exclusive right to
tax child support, but such payments are in most cases exempt from tax
under the domestic laws of both the United States and Iceland.
Question. Why doesn't the proposed treaty with Iceland address the
tax treatment of cross-border pension contributions?
Answer. The proposed treaty with Iceland does not address the tax
treatment of cross-border pension contributions primarily for two
reasons. First, the U.S. Model pension funds provision provides for
deductibility in one State of contributions to a pension fund of the
other State only where the pension fund ``generally corresponds'' to a
pension fund in the first state. The provision is, therefore, only
appropriate if the two countries have pension systems that are similar.
During the course of negotiations, it became clear that Iceland and the
United States have very different pension systems. As a result, the
provision was not appropriate to include in the proposed treaty.
Second, Iceland had limited flexibility in changing by tax treaty its
rules for taxing pensions, because those rules are technically under
Iceland's pension law, not its tax law.
Question. Like the U.S. Model Tax Treaty, the Iceland Treaty
provides that pension distributions owned by a resident of a
contracting country are taxable in the recipient's country of
residence. The U.S. Model Tax treaty, however, contains an exception to
this provision under which a pension beneficiary's country of residence
must exempt from tax a pension amount or other similar remuneration
that would be exempt from tax in the other contracting country where
the pension fund is established, as if the beneficiary had been a
resident of that other country. Why doesn't the proposed treaty with
Iceland contain such an exception?
Answer. Like other departures from the U.S. Model, the omission in
the U.S.-Iceland tax treaty of the exemption from tax for pension
benefits that would be exempt from tax in the source country was the
result of the negotiation process. Moreover, Iceland had limited
flexibility in changing by tax treaty its rules for taxing pensions,
because those rules are technically under Iceland's pension law, not
its tax law.
Question. The U.S. Model Tax Treaty allows recipients of ``income,
gains, or profits'' from an entity that is fiscally transparent under
the tax laws of the recipient's residence to enjoy the same treaty
benefits on that income as they would have if the ``income, gains, or
profits'' had been received by them directly, so long as the income
coming to them through the entity is treated no differently by their
resident country than it would have been had it been received directly
by them. The provision in the Iceland Treaty for fiscally transparent
entities closely parallels the provision in the U.S. Model Tax Treaty.
Yet, rather than referring to such entities as ``fiscally
transparent,'' the Iceland Treaty refers instead to entities that are
either ``a partnership, trust, or estate.'' See Article 1(6).
Treasury's Technical Explanation makes clear that this is intended to
include U.S. limited liability companies (``LLCs'') that are treated as
partnerships or as disregarded entities for U.S. tax purposes,
including LLCs with only one member. Although the meaning appears to be
equivalent, why wasn't the phrase ``fiscally transparent'' used in
Article 1(6)?
Answer. Paragraph 6 of Article 1 of the proposed treaty with
Iceland does not use the U.S. Model's phrase ``fiscally transparent''
because that term does not have meaning under the domestic law of
Iceland. During the course of the negotiations, the Treasury Department
obtained agreement in principle with Iceland over the intent and
application of paragraph 6 of Article 1. Accordingly, the Treasury
Department believes that the rule will be interpreted and applied by
Iceland consistent with the language in the U.S. Model Tax Treaty.
Question. The Convention Between the United States and the Republic
of Bulgaria for the avoidance of Double Taxation and the Prevention of
Fiscal Evasion With Respect to Taxes on Income, with accompanying
Protocol, was signed on February 23, 2007. Before transmitting this
treaty to the Senate, however, a Protocol amending the 2007 treaty was
negotiated with Bulgaria. This Protocol was signed on February 26, 2008
and only after its completion, did the Executive Branch transmit the
original treaty to the Senate for advice and consent. Why was the 2008
Protocol needed? What changed between February 2007 and February 2008
to necessitate amending the 2007 treaty? What is the most important
correction made by the 2008 Protocol to the underlying treaty?
Answer. The 2008 Protocol made certain technical corrections to the
2007 Convention and accompanying Protocol, and addressed features of
the Bulgarian tax system and treaty network that could result in a
Bulgarian tax exemption for U.S. source income attributable to offshore
branches of the Bulgarian company receiving the U.S. source income. To
address the potential ``double exemption'' issue, the proposed 2008
Protocol would add a so-called ``triangular rule'' to the LOB provision
of the proposed treaty, which is the most important addition to be made
by the 2008 Protocol.
Question. Under the Bulgaria Convention, with limited exceptions,
the withholding tax on cross-border royalty and interest payments would
be imposed at a maximum rate of five percent. Under the accompanying
protocol, the United States and Bulgaria are to reconsider source-
taxation of interest and royalties arising in Bulgaria and beneficially
owned by a resident of the United States, at a time that is
``consistent with the conclusion of the transition period'' under a
European Union Council Directive applicable to interest and royalties
deemed to arise in Bulgaria and beneficially owned by a resident of the
European Union. The conclusion of the transition period is due to occur
on December 31, 2014. Please explain the reason for including this
commitment to reconsider source-taxation of interest and royalties
arising in Bulgaria and beneficially owned by a resident of the United
States. Is it fair to say that when you consult, you expect to
negotiate an amendment to the Bulgaria Convention that would further
reduce the maximum rate of withholding that can be imposed on cross-
border interest and royalties arising in Bulgaria and beneficially
owned by a resident of the United States?
Answer. At the conclusion of the transition period under the
European Union Council Directive, Bulgaria is expected to adopt rates
of withholding on cross-border interest and royalties for residents of
European Union member states that are lower than the rate provided for
in the proposed treaty. The provision of the 2007 Protocol is intended
to memorialize the understanding between Bulgaria and the United States
that the United States will have the opportunity at the conclusion of
the transition period to negotiate a further protocol to the proposed
treaty with Bulgaria that could reduce the maximum rate of withholding
that may be imposed on cross-border interest and royalties arising in
Bulgaria.
Question. Both the Bulgaria Convention and the Canada Protocol
include a special rule that broadens the typical definition of a
``Permanent Establishment'' such that a service enterprise may still be
deemed to have a Permanent Establishment in a treaty country, even if
it does not have a fixed place of business in that country (the
``services country''). See Article 5(8) of the Bulgaria Convention and
Article 3(2) of the Canada Protocol.
A number of the terms used in this rule are somewhat ambiguous and
although the Technical Explanations for the Bulgaria Convention and the
Canadian Protocol help to resolve some of that ambiguity, there is
still work to be done. Please describe the steps you are taking with
Canada, Bulgaria, and internally to further clarify the application and
operation of this provision, including the specific terms you are
focused on clarifying. In particular, is work being done to further
clarify what constitutes ``presen[ce]'' in the services country and
what constitutes a ``connected project''? What about the ``provision of
services''? Is this term, for example, intended to include preparatory
work or the collection of data from an office in one country in order
to provide services in the other country?
Question. In preparing the agreed Technical Explanation of the
proposed Protocol with Canada, the Treasury Department had many
discussions with Canada regarding the interpretation and application of
the new rule concerning the taxation of services.
Answer. If the proposed Protocol is approved by the Senate, the
Treasury Department will continue these discussions with Canada. The
Treasury Department's discussions with Canada to date have encompassed
the interpretation of a number of terms, including ``presen[ce]'' in
the services country, what constitutes "connected projects," and the
meaning of ``provision of services.'' For example, the Technical
Explanation to the proposed Protocol clarifies that paragraph 6 of
Article V (Permanent Establishment) of the existing U.S.-Canada treaty
applies notwithstanding the new rule for taxation of services.
Paragraph 6 identifies activities with respect to which a fixed place
of business will not give rise to a permanent establishment, which
includes activities that have a preparatory or auxiliary character.
Accordingly, days spent on preparatory or auxiliary activities shall
not be taken into account for purposes of applying the services rule
described in subparagraph 9(b) of Article V.
The Treasury Department recognizes that additional guidance with
respect to the services rule included in both the proposed Canada
Protocol and the Bulgaria Convention is needed to provide more
certainty to taxpayers, and we welcome further input regarding
application of the rule.
Question. Article 14(1) of the Bulgaria Convention, with certain
exceptions, sets forth a general rule that if an employee who is a
resident of one treaty country (the ``residence country'') is working
in the other treaty country (the ``employment country''), his or her
salaries, wages, and other remuneration derived from the exercise of
employment in that country may be taxed by that country--i.e., the
employment country. Notwithstanding this general rule, Article 14(2) of
the treaty provides that the remuneration derived by the employee from
the exercise of employment in the employment country shall be taxed
only by the residence country (and not the employment country) if 1)
the employee is present in the employment country for 183 days or less
in any 12-month period commencing or ending in the taxable year
concerned; 2) the remuneration is paid by, or on behalf of, an employer
who is not a resident of the employment country; and 3) the
remuneration is not ``borne'' by a permanent establishment that the
employer has in the employment country. The Canada Protocol has a
variation of this provision in Article 10(2), which amends Article XV
of the Canada Tax Treaty. In both treaties, the final requirement
(i.e., that the remuneration is not ``borne'' by a permanent
establishment that the employer has in the employment country),
interacts with the special rule expanding the definition of a permanent
establishment in a potentially problematic way.
For example, in the case of the Bulgaria Convention, it appears
that the salaries, wages, and other remuneration derived by an employee
performing services through a permanent establishment arising under
Article 5(8) of the treaty would be subject under Article 14 to being
taxed by the employment country, even if the other requirements of the
test in Article 14(2) had been met (i.e., the employee had been present
in the employment country for less than 183 days during any 12-month
period commencing or ending in the taxable year concerned and the
employee's remuneration was paid by an employer who is a resident of
the other country). Is this correct? If so, the interaction of these
two provisions would increase the complexities associated with the
special rule contained in Article 5(8). For example, such a scenario
would mean that an employer and the relevant employees would need to
fulfill several tax-related obligations, including obtaining tax
identification numbers and providing for the withholding of income
taxes and other taxes as appropriate that would cover the period
beginning on the first day such services were performed by such
employee during the affected year. Please explain how the Department
intends to address the problems presented by this result for taxpayers
that may not know whether they will be deemed to have a permanent
establishment under the treaty until perhaps 6 months into the relevant
12-month period, and will therefore be subject to various taxes,
including employment taxes, by the services country reaching back to
the beginning of the relevant 12-month period.
Answer. It is correct that a permanent establishment arising under
Article 5(8) of the proposed Bulgaria Convention is a permanent
establishment for purposes of Article 14 of the Convention, and
therefore the salaries, wages, and other remuneration of an employee
borne by a permanent establishment of the employer arising under
Article 5(8) of the treaty would be subject under Article 14 to being
taxed by the source country, even if the other requirements of the test
in Article 14(2) had been met.
The Treasury Department recognizes that the rule for taxation of
services in the proposed Canada Protocol raises compliance and
administrative concerns for companies and their employees. The Treasury
Department and Internal Revenue Service have met with a number of U.S.
taxpayers, including professional services firms, to discuss the
interpretation and application of this rule, focusing on administrative
issues. The Treasury Department has discussed with Canada and, if the
proposed Protocol is approved by the Senate, will continue to discuss
with Canada, possible methods of easing the administrative burden on
businesses associated with complying with this new rule, the effective
date of which is delayed until the third taxable year ending after the
proposed Protocol enters into force. The Technical Explanation to the
proposed Canada Protocol, the contents of which the Government of
Canada has subscribed to, provides that ``[t]he competent authorities
are encouraged to consider adopting rules to reduce the potential for
excess withholding or estimated tax payments with respect to employee
wages that may result from the application of [the services rule].''
Question. A version of this special rule appears in the 2008 OECD
draft update to the OECD Model Tax Convention as an alternative
services permanent establishment provision. There are, however, a few
differences in language between the OECD rule and the one used in the
Bulgaria Convention and the Canada Protocol. In particular, the OECD
language clarifies that services performed by an individual on behalf
of an enterprise may be considered as performed by that enterprise only
if the enterprise supervises, directs, or controls the manner in which
the services are performed by the individual. The language in the text
of the Bulgaria Convention and the Canada Protocol are silent on this
point, apparently leaving open the question of whether, and if so,
under what circumstances, the use of a subcontractor might give rise to
a permanent establishment of a general contractor. Is it Treasury's
view that services performed by an individual on behalf of an
enterprise may be considered as performed by that enterprise only if
the enterprise supervises, directs, or controls the manner in which the
services are performed by the individual? Does Canada share this view?
Does Bulgaria?
Answer. For a number of years, the OECD has debated whether to
include an alternative rule for the taxation of services in the OECD
Model or its Commentary. The 2008 Update to the OECD Model, released on
July 18, 2008, includes a version of the services rule as an
alternative in the Model Commentary. The language of the OECD provision
does not match in all respects the language of provision included in
the proposed Bulgaria Convention and the Canada Protocol. For example,
the language of the Bulgarian and Canadian provision requires that the
services be provided ``for customers who are either residents of that
other State or who maintain a permanent establishment in that other
State.'' That language regarding the provision of services to customers
is not included in the OECD provision, and thus the issue of whether
the use of a subcontractor might give rise to a permanent establishment
is especially important in applying the OECD provision. If the Senate
approves the proposed the Bulgaria Convention and Canada Protocol, the
Treasury Department will continue to discuss with Bulgaria and Canada
the interpretation and application of the version of the rule for
taxation of services included in our agreements.
Question. One aspect of the rule in both the Bulgaria Convention
and the Canada Protocol that would appear to be difficult to manage is
the fact that the 12-month period isn't tied to a fiscal year. Is this
something you considered and rejected during the course of
negotiations? Is this something that might be considered in the future,
should you include this special rule in future treaties?
Answer. The rule for taxation of services in the proposed
agreements with Bulgaria and Canada refers to an aggregate of 183 days
or more in ``any 12-month period'' as opposed to, for example, 183 days
or more in a fiscal or calendar year. The reference to ``any 12-month
period'' addresses potential situations in which, for example, work has
been artificially divided into two separate fiscal years in order to
avoid meeting the 183-day threshold. For instance, a taxpayer could
circumvent a threshold based on 183 days in a fiscal year by providing
services in the other state for the last five months of one fiscal year
and the first five months of the following fiscal year.
The Treasury Department recognizes the administrative and
compliance concerns of companies and their employees regarding the
rule's reference to ``any 12-month period.'' If the proposed agreements
with Bulgaria and Canada are approved by the Senate, the Treasury
Department will continue to discuss the interpretation and application
of this rule with Bulgaria and Canada in the context of exploring ways
to alleviate administrative and compliance burdens.
The inclusion of a rule for taxation of services in the proposed
agreements with Bulgaria and Canada does not reflect a change in U.S.
tax treaty policy, and inclusion of such a provision in the U.S. Model
is not being considered. However, it is a provision that the Treasury
Department will consider in the context of negotiating a particular
agreement in exchange for significant concessions in other areas, and
the inclusion of such a provision in the proposed agreements with
Bulgaria and Canada was a key element to achieving overall agreements
that provide benefits to the United States and to U.S. taxpayers. At
the same time, the Treasury Department recognizes the concerns raised
by the Joint Committee on Taxation's ``Explanation of Proposed Protocol
to the Income Tax Treaty between the United States and Canada'' about
the appropriateness of including a services rule in a tax treaty with a
developed country.
In the context of negotiating a particular agreement in the future,
the Treasury Department may consider referring to an alternative 12-
month period. The Treasury Department welcomes input concerning this
issue.
Question. Mandatory arbitration was included in the Protocol with
Canada, but not in the treaty with Iceland or Bulgaria. Please explain
why. In negotiating future treaties, what are the factors considered by
Treasury when deciding whether or not to include binding arbitration in
a new tax treaty or in an amendment to an existing tax treaty? Are you
currently negotiating mandatory arbitration mechanisms with other
countries? If so, which countries?
Answer. The Treasury Department believes that mandatory binding
arbitration, as an extension of the competent authority process, is an
effective tool to strengthen the Mutual Agreement Procedure in the U.S.
treaty network as a whole. Even in the best competent authority
relationships, there are, on occasion, difficult treaty interpretation
questions and disputes that arise. The Treasury Department believes
that the arbitration mechanism included in the proposed agreement with
Canada will help resolve cases in a timely manner and enhance the
working relationship of the competent authorities.
The Treasury Department has been discussing mandatory binding
arbitration in general terms with our treaty partners, and intends to
continue to raise inclusion of a mandatory binding arbitration
provision with our treaty partners in future negotiations. The Treasury
Department welcomes further input from the committee concerning the
factors that should be taken into account when considering whether to
include an arbitration provision in the context of the negotiation of a
particular agreement, as well as ways that the arbitration provision in
future agreements might be improved or varied.
Question. When considering the mandatory arbitration provisions in
the Belgium and Germany tax treaties, which were approved by the Senate
last year, the committee focused on, among other things, the selection
of fair, objective, and independent arbiters. In answer to a question
for the record regarding your process for selecting arbiters, it was
noted that the Treasury Department ``expect[s] to have further
discussions with our treaty partners concerning the [selection of
arbiters], with a view toward achieving the best balance of the
concerns expressed and providing to taxpayers an efficient and
effective resolution of their double taxation.'' Please describe the
status of such discussions with Belgium and Germany. Does the
Department expect to have discussions with Canada on this topic as
well? Specifically, what work has been done to ensure that the United
States and all three treaty partners will select fair, objective, and
independent arbiters for service on arbitration boards constituted by
the mechanisms provided in these treaties?
Answer. The U.S. competent authority has formally begun discussions
with Belgium and Germany on a number of procedural matters to ensure
the effective implementation of the arbitration provision, including
regarding the qualifications for arbiters, especially those
qualifications required to ensure that arbiters are sufficiently
independent. In those discussions, the U.S. competent authority has
expressed the concerns raised by the committee in its considerations of
the Belgian and German agreements regarding the selection of Government
employees as arbiters. We hope that similar discussions with Canada
begin soon. While we do not yet have formal agreements with any of
these treaty partners, they understand and agree with the need for
fair, objective, and independent arbitration boards.
Question. The Canada Protocol, as in the case of the Belgium and
Germany tax treaties, does not identify the procedural rules that will
be used by arbitration boards constituted in accordance with the
mandatory arbitration provision included in each treaty. In answer to a
question for the record on this topic in relation to the Belgium and
Germany tax treaties, the Treasury Department noted that ``after
studying the details of the [procedural] rules commonly used in
commercial arbitration, we concluded that most of these rules relate to
evidentiary procedures not relevant to the simplified arbitration
format proposed in the agreements with Belgium and Germany, primarily
because the decision of the arbitration board is to be based upon a
record rather than a presentation of evidence.'' Has the Treasury
Department had discussions with Canada, Belgium, and Germany regarding
what procedural rules would be appropriate for the arbitration format
provided for in these treaties? In particular, has there been any
discussion regarding conflict of interest rules that might apply to
arbiters?
Answer. The U.S. competent authority has formally begun discussions
with Belgium and Germany, and informally with Canada, on a number of
procedural matters to ensure the effective implementation of the
arbitration provision. The objective of these discussions is to have
the procedures in place with respect to Belgium and Germany no later
than December 31, 2008. As part of the discussions with Belgium and
Germany, the U.S. competent authority has also begun discussing the
need for conflict-of-interest rules to govern arbiters. For example,
the U.S. competent authority has discussed whether safeguards might be
built into the necessary procurement arrangements between the United
States and the arbiter. While the U.S. competent authority does not yet
have formal agreements with any of these treaty partners, they
understand and agree with the need for fair, objective, and independent
arbitration boards.
Question. The committee Report on the Germany and Belgium treaties
raised certain concerns regarding the mandatory arbitration mechanism,
including concerns regarding treaty interpretation and the selection of
arbiters. Other Members have indicated related concerns regarding these
provisions. None of these are addressed in the Canada Protocol
arbitration provision, but presumably that is because the Canada
Protocol was already negotiated when these concerns were raised. Can
you, however, confirm that these concerns will be considered and
addressed in future tax treaties with similar arbitration mechanisms?
Answer. The arbitration provision in the proposed Protocol with
Canada was already negotiated at the time the Senate considered the
agreements with Germany and Belgium in 2007. It is for this reason that
the concerns expressed by the committee on the agreements with Germany
and Belgium are not reflected in the proposed Canada Protocol.
The Treasury Department greatly appreciates the input received from
the committee on several aspects of the German and Belgian arbitration
provisions, and similarly with the Canadian Protocol. The committee's
concerns have been and will continue to be considered in any
arbitration negotiations the Treasury Department conducts.
Question. The exchange of notes between the United States and
Canada that accompanies the Canada Protocol includes many of the
details that would govern the binding arbitration mechanism to be
included in the treaty. Among other things, the notes make clear that
the arbitration mechanism would only apply to certain articles in the
treaty, which are listed, unless otherwise agreed to by the parties.
How were the articles to which arbitration applies, selected?
Answer. The Treasury Department believes that mandatory binding
arbitration, as an extension of the competent authority process, is an
effective tool to strengthen the Mutual Agreement Procedure in the U.S.
treaty network as a whole. However, the scope of an arbitration
provision in a particular agreement is a matter that must be negotiated
with the treaty partner. Some countries may be willing to cover only
specific articles in the treaty. It should be noted that while the
mandatory binding arbitration provision in the proposed Canada Protocol
is limited to certain articles, other issues are eligible for
arbitration if the competent authorities agree that the particular case
is suitable for arbitration.
Question. Why isn't Article 3 (Definitions) among the articles
included in this list?
Answer. Article III of the existing Canada treaty provides
definitions and general rules of interpretation for the treaty.
Paragraph 1 of Article III defines a number of terms for purposes of
the treaty. Certain other terms are defined in other articles of the
treaty. Paragraph 2 of Article III provides that, in the case of a term
not defined in the treaty, the domestic tax law of the Contracting
State applying the treaty shall control, unless the context in which
the term is used requires a definition independent of domestic tax law
or the competent authorities reach agreement on a meaning.
To the extent that an issue concerning the definition of a term is
part of a case regarding the application of one or more articles
explicitly within the scope of the mandatory arbitration provision,
such definitional issue will be considered during the arbitration
process.
Question. If a dispute focuses on a term that is defined in Article
3 and appears in another Article that is within the scope of the
arbitration mechanism, would such a dispute be subject to arbitration
under the Protocol?
Answer. To the extent that an issue concerning the definition of a
term defined in Article III is part of a case regarding the application
of one or more articles explicitly within the scope of the mandatory
arbitration provision, such definitional issue will be considered
during the arbitration process
Question. Article 2(1) of the proposed Canada Protocol addresses
the issue of so-called ``dual-resident corporations.'' It provides that
if such a company is created under the laws in force in a treaty
country but not under the laws in force in the other treaty country,
the company is deemed to be a resident only of the first treaty
country. Have you considered whether this rule is equitable, for
example, in circumstances in which a corporation was organized under
the laws of the United States many years ago and has long since ceased
to have significant contacts with the United States, but instead is
managed and controlled in Canada? Have you considered whether it might
be appropriate to provide discretion to the Competent Authorities in
such a case to determine, for example, that the company is in fact a
resident of Canada?
Answer. To address abuses of the existing treaty by U.S. companies
continuing into Canada, the proposed Protocol replaces the existing
treaty's rule for resolving dual-residency conflicts for corporations
with an updated rule that is similar to the rule in the U.S. Model. It
has been a longstanding treaty policy of the United States to place
significant weight on the place of incorporation when addressing
questions of dual corporate residence. However, we have included in
other agreements, for example in our agreement with the United Kingdom
and the proposed Bulgaria and Iceland agreements, provisions directing
the Competent Authorities to endeavor to determine for treaty purposes
the residence of dual resident corporations.
Question. Article 2(2) of the Canada Protocol would amend Article
IV of the Canada Tax Treaty to include a new paragraph 6 and 7, setting
forth specific rules for the treatment of certain income, profit, or
gain derived through or paid by fiscally transparent entities. The new
paragraph 6 would set forth a ``positive'' rule, which identifies
scenarios in which ``income, profit or gain shall be considered to be
derived by a person who is a resident of a Contracting State.'' The new
paragraph 7 would set forth a ``negative'' rule intended to prevent the
use of such entities to claim the benefits where the investors are not
subject to tax on the income in their state of residence. In
particular, paragraph 7 is aimed largely at curtailing the use of
certain legal entity structures that include hybrid fiscally
transparent entities, which, when combined with the selective use of
debt and equity, may facilitate the allowance of either 1) duplicated
interest deductions in the United States and Canada, or 2) a single,
internally generated, interest deduction in one country without
offsetting interest income in the other country. As noted by the Joint
Committee on Taxation in its explanation of the Canada Protocol,
commentators have raised a question as to whether subparagraph 7(b) is
too broad, because it could prevent legitimate business structures that
are not engaging in potentially abusive transactions from taking
advantage of benefits that would otherwise be available to them under
the treaty. Please explain whether you agree or disagree with the
assertion that subparagraph 7(b) is overbroad. If so, has there been
any discussion regarding what might be done to improve the situation?
In addition, does the Treasury Department expect to include such a rule
in future tax treaties? If so, has the Treasury Department considered
alternate versions that might provide for a narrower exception from the
rule in paragraph 6?
Answer. Subparagraph 7(b) essentially denies benefits in cases in
which the residence country treats a payment differently than the
source country and other conditions are met. The rule is broader than
an analogous rule in Treasury regulations issued pursuant to section
894 of the Internal Revenue Code. The Treasury Department is aware that
the scope of subparagraph 7(b) is potentially overbroad, especially in
the case of non-deductible payments. The Treasury Department has been
discussing, and will continue to discuss with Canada, whether to
address this issue. The Treasury Department does not contemplate
incorporating such a rule in future tax treaties.
Question. The Treasury Department's Technical Explanation provides
several examples of the application of subparagraph 7(b) to certain
legal entity structures. But, the Technical Explanation does not
provide an example of a payment made by a U.S. domestic reverse hybrid
entity that is treated as a partnership for Canadian tax purposes to
one of its owners. Although the partnership example in the Technical
Explanation should apply reciprocally to a payment treated as a
dividend for U.S. tax purposes and a partnership distribution for
Canadian tax purposes, the Technical Explanation does not state so
explicitly. Can you confirm that this is the case?
In addition, the Technical Explanation does not include examples
relating to a deductible interest (or royalty) payment from a hybrid
partnership entity to one of its owners. In the case of such a payment
from a Canadian hybrid partnership entity, the U.S. recipient of the
payment would generally treat it as a payment of interest (or
royalties) for U.S. tax purposes.\1\ One might expect that subparagraph
7(b) would not apply in this case because the fiscal transparency of
the partnership would generally not be relevant for residence-country
tax purposes, but there is no discussion of this case in the Technical
Explanation. Can you confirm that this is a reasonable reading of
subparagraph 7(b)? Also, please clarify whether subparagraph 7(b)
applies with respect to deductible payments by a domestic reverse
hybrid partnership entity to one of its Canadian owners.
---------------------------------------------------------------------------
\1\Under section 707(a) and Treas. Reg. section 1.707-1(a), if a
partner engages in a transaction with a partnership other than in the
capacity as a member of the partnership, the transaction is, in
general, considered as occurring between the partnership and one who is
not a partner. See Rev. Rul. 73-301, 1973-2 C.B. 215.
Answer. Page 10 of the agreed Technical Explanation provides an
---------------------------------------------------------------------------
example of the application of subparagraph 7(b):
[Assume] in the above example, USCo (as well as other
persons) are owners of CanCo, a Canadian entity that is
considered under Canadian tax law to be a corporation that is
resident in Canada but is considered under U.S. tax law to be a
partnership (as opposed to being disregarded). Assume that USCo
is considered under Canadian tax law to have received a
dividend from CanCo. Such payment is viewed under Canadian tax
law as a dividend, but under U.S. tax law is viewed as a
partnership distribution. In such a case, Canada views USCo as
receiving income (i.e., a dividend) from an entity that is a
resident of Canada (CanCo), CanCo is viewed as fiscally
transparent under the laws of the United States, the residence
State, and by reason of CanCo being treated as a partnership
under U.S. tax law, the treatment under U.S. tax law of the
payment (as a partnership distribution) is not the same as the
treatment would be if CanCo were not fiscally transparent under
U.S. tax law (as a dividend). As a result, subparagraph 7(b)
would apply to provide that such amount is not considered paid
to or derived by the U.S. resident.
The provisions of subparagraph 7(b) apply reciprocally. Assume, for
example, that CanCo (as well as other persons) are owners of USCo, a
U.S entity that is considered under U.S. tax law to be a corporation
resident in the United States, but is considered under Canadian tax law
to be a partnership (a so-called ``domestic reverse hybrid''). Assume
that CanCo is considered under U.S. tax law to have received a dividend
from USCo. Such payment is viewed under U.S. tax law as a dividend, but
under Canadian tax law is viewed as a partnership distribution. In such
a case, the United States views CanCo as receiving income (i.e., a
dividend) from an entity that is a resident of the United States
(USCo), USCo is viewed as fiscally transparent under the laws of
Canada, the residence State, and by reason of USCo being treated as a
partnership under Canadian tax law, the treatment under Canadian tax
law of the payment (as a partnership distribution) is not the same as
the treatment would be if USCo were not fiscally transparent under
Canadian tax law (as a dividend). As a result, subparagraph 7(b) would
apply to provide that such amount is not considered paid to or derived
by the Canadian resident.
As noted in the agreed Technical Explanation: ``Paragraphs 6 and 7
apply to determine whether an amount is considered to be derived by (or
paid to) a person who is a resident of Canada or the United States. If,
as a result of paragraph 7, a person is not considered to have derived
or received an amount of income, profit or gain, that person shall not
be entitled to the benefits of the Convention with respect to such
amount. Additionally, for purposes of application of the Convention by
the United States, the treatment of such payments under Code section
894(c) and the regulations thereunder would not be relevant.'' Thus,
subparagraph 7(b) applies with respect to deductible payments by a
domestic reverse hybrid to its Canadian owners.
Although not specifically addressed in the Technical Explanation,
the Treasury Department and Canada agree that subparagraph 7(b) does
not apply to deny benefits to interest and royalty payments by an
entity that is treated as a partnership by one country and a
corporation by the other if the treatment of such amount by the country
of the person deriving the income would be the same if such amount had
been derived directly by such person (interest or royalties).
Question. Does the Treasury Department intend to formally share its
Technical Explanation regarding the Bulgaria and Iceland Treaties with
each country, as a courtesy?
Answer. As a courtesy, the Treasury Department has sent copies of
its Technical Explanation to each country. Unlike the Technical
Explanation to the proposed Canada Protocol, however, the Technical
Explanations to the proposed Bulgaria and Iceland Conventions have not
been reviewed by or subscribed to by the relevant country.
__________
responses to additional questions for the record submitted to deputy
assistant secretary michael mundaca by senator richard g. lugar
Question. Please give an overview of current cases that have not
been resolved and the anticipated case load that would be addressed by
the Arbitration Provision in the Protocol with Canada, including number
of cases, length of time unresolved, and country of origin breakdowns.
Answer. There are currently 192 active cases with Canada. Of those,
approximately 90 percent are transfer-pricing cases, with the remainder
involving interpretive issues, such as residency and permanent-
establishment determinations. The Canadian tax authorities initiated
the adjustment in 85 percent of the cases caused by a transfer pricing
adjustment.
Fifty-three of the 192 total cases have been unresolved for over
two years. Of those 53 cases, the ``oldest'' case is 2,289 days old and
the ``youngest'' case is 762 days old. Four of the 53 cases involve
interpretive issues, the oldest of which is 1,657 days and the youngest
of which is 1085 days.
We should note that different countries track their outstanding
competent authority cases differently. For example, concepts such as
the definition of a case may vary by country. Thus, we have observed
that where a treaty partner has aggregate information regarding its
case load with the United States the numbers sometimes notably diverge
from the numbers used by the United States.
Question. Traditionally, tax treaties agreements have been seen as
facilitating cross-border trade and investment of multinational
businesses. However, increasing globalization also affects small
businesses. Is the current model for U.S. Tax Treaties clear,
understandable and usable for smaller businesses? Give examples of how
small business can take advantage of these treaties.
Answer. The current U.S. Model Tax Treaty and Technical Explanation
are available on the Treasury Department website. The Treaty and
especially the Technical Explanation are drafted to be as clear and
understandable as possible, but we recognize that technical
international tax rules and issues may appear opaque to many taxpayers.
IRS publications, especially Publication 901 on Tax Treaties, provide
international tax guidance in less technical terms and may be more
accessible to individuals who do not have significant tax experience.
We further recognize that in our increasingly global economy, small
businesses and individuals may, and perhaps must, address cross-border
tax issues. Because our tax treaties provide generally uniform and
clear rules regarding such important issues as withholding tax rates
and tax jurisdictional thresholds, we think they can be especially
useful to small businesses and individuals, who may not have access to
multi-national advisors or foreign tax advice. More specifically, tax
treaties generally allow U.S. businesses to engage in trade in goods
and services of greater value and duration with foreign clients without
incurring foreign taxes than would be the case in the absence of
treaties. Treaties may also facilitate access to foreign skilled
workers and researchers, and to foreign capital via reduced withholding
rates.
We welcome further input from the committee regarding how best to
serve small businesses in this regard.
Question. Please describe the current U.S. position on reciprocal
elimination of withholding taxes on cross-border dividends paid between
a subsidiary and its parent company. Has there been a change in the
U.S. policy position?
Answer. The policy of the Treasury Department continues to be that
the elimination of source-country taxation of dividends should be
considered only on a case-by-case basis. Such a provision is not part
of the U.S. Model because we do not believe that it is appropriate to
include in every treaty. We must consider the interaction of our tax
system with our treaty partner's, as well as the overall balance of the
treaty before deciding whether inclusion is appropriate.
__________
responses to additional questions for the record submitted to senior
deputy u.s. coordinator richard beaird by senator joseph r. biden, jr.
Question. Please provide a list of recent accomplishments of the
International Telecommunications Union (``ITU'') that have had a
significant impact on U.S. interests, with a particular focus on
national security, public diplomacy, and economic interests.
Answer. In terms of National Security, the ITU has been a leader in
the development of Standards for Emergency Telecommunications (and
related standards for Telecommunications for Disaster Relief). This is
important because emerging telecommunications networks are based on
fundamentally different switching technologies from the legacy Public
Switched Telecommunications Networks.
In terms of public diplomacy, the ITU Development (D) Sector has
made one of its primary goals developing a ``cybersecurity best
practices'' report for use by the developing world. The U.S. has a
leadership role in this effort. The draft report on cybersecurity best
practices has been well received by developing nations, and already
constitutes a success story at the ITU for both the U.S. (which
developed the basic materials), and the institution.
In terms of economic interest, the 2007 World Radiocommunication
Conference (WRC-07) addressed some 30 agenda items related to almost
all terrestrial and space radio services and applications. These
included future generations of mobile telephony, aeronautical telemetry
and telecommand systems, satellite services including meteorological
applications, maritime distress and safety signals, digital
broadcasting, and the use of radio in the prediction and detection of
natural disasters.
Question. Please provide a list of current and future priorities of
the ITU that are of importance to the United States.
Answer. The United States supports the ITU's approach of focusing
on the theme of convergence in providing a range of services over a
single network. As legacy telecommunication systems transition to
Internet Protocol-based platforms that support expanded information and
communication technologies (ICTs), the U.S. believes it is necessary to
examine the potential of ICTs to address significant global issues. One
such issue is ICT and its effect on the environment.
The U.S. also supports the ITU's efforts to coordinate the needs of
developing and developed countries to expand Digital Inclusion. The ITU
is also urging Regional Groups to fully collaborate to identify the
necessary spectrum for International Mobile Telecommunications (IMT),
which will allow use of advanced broadband mobile technology on a
global basis. In October 2007, at the World Radiocommunication
Assembly, the ITU added a WiMAX-derived technology to the IMT-2000 set
of global standards. This paves the way for the world-wide deployment
of voice, data and multimedia services to stationary and mobile
devices, at higher speeds and across wider areas.
Question. Many of the amendments made to the ITU Constitution and
the ITU Convention that are now under consideration (Treaty Docs. 108-
5, 109-11, and 110-16), are designed to facilitate private sector
participation in the work of the ITU.
Please describe how the increased private sector participation has
changed the dynamic at the ITU.
Answer. There are a number of trends in ITU participation since the
year 2000 that have changed the landscape in the ITU. Since 2000, the
private sector has shown increased interest in participating in ITU
activities (as ITU Sector Members) and in partnering with the ITU in
order to interface with relevant governmental decision-makers (and
other potential partners) that are involved in addressing the
constantly changing and evolving telecommunication environment. The
increased participation of ITU Sector Members has assisted the ITU in
developing innovative agendas to encourage access to Information and
Communication Technologies (ICTs) in developing countries. It has also
provided Sector Members with new business opportunities.
Question. Does more need to be done to facilitate private sector
participation?
Answer. We continue to look for ways to make the ITU a more
attractive forum for private sector participation. At the last
Plenipotentiary Conference in Antalya, the U.S. was successful in
keeping the Conference from increasing the minimum contribution for
Sector Members. We believe that maintenance of the current levels of
contribution will encourage private sector participation in the ITU. We
are encouraged that major corporations have recently broadened their
participation in the ITU.
Question. At what point does private sector participation become
concerning? What are the challenges that the ITU faces in balancing
Member States' rights with the involvement of the private sector?
Answer. Private sector participation in the ITU's activities is
crucial to the future success of the ITU. More participation per se by
the private sector is never a threat. However, if changes were made in
the ITU's procedural rules that resulted in Sector Members gaining
control over the ITU's processes, such changes would be a concern
because they could prevent Member States from exercising their
appropriate role as guardians of the public interest and national
security. No such changes are currently envisioned.
Question. One of the most important aspects of the 1998 amendments
to the Constitution and the Convention was a clarification of the roles
of Member States of the ITU and private sector participants in the ITU,
which include ``Sector Members'' and ``Associates.''
Answer. Please provide information on the role and importance of
Sector Members within the ITU.
Answer. Sector Members have an important role to play in all three
ITU Sectors, but their participation relative to that of Member States
varies from Sector to Sector. In the ITU-T, since national networks
have been privatized, Member States generally no longer engage in
technical work (with some exceptions where there are national interests
at stake, such as priority of communications in times of national
disasters and emergencies, or identity management). Consequently,
Sector Members are largely responsible for preparing technical
contributions for telecommunications standards. In the ITU-R, both
Sector Members and Member States have major stakes in obtaining and
protecting radio spectrum. In the ITU-D, with some notable exceptions,
the private sector has historically been much less involved. This may
be because the business case for assisting developing countries is much
less obvious than the need to obtain spectrum for a new service (in
ITU-R), or to establish an international standard for
telecommunications equipment (in ITU-T).
Question. Why did the United States decide not to authorize the
direct application procedures that were added to Article 19 of the
Convention in an effort to streamline the application process for
Sector Members?
Answer. The U.S. has chosen to maintain minimal oversight over
which U.S. entities are allowed to apply for ITU membership for a
number of reasons. One is that the U.S., which has more Sector Members
than any other country, wants to be kept informed about what U.S.
entities are participating in the ITU. Another is that the U.S. may
incur some de facto responsibilities as a result of a U.S. company
becoming an ITU member. For example, the ITU turns to the U.S. to
assist in seeking payment from a U.S. entity when that U.S. entity does
not meet its ITU obligations, such as failure to pay its contributory
share.
Question. Please provide information on the role and importance of
Associates, including their role in ITU study groups.
Answer. Associates are entitled to attend and participate in a
specific Study Group or Groups, whereas Sector Members are entitled to
attend and participate in all the Study Groups in a given Sector.
Associates play an important role in the ITU standards development
process. Creation of an Associate category has increased private sector
participation in the ITU and brought into the ITU process entities with
specialized expertise in particular fields of telecommunications. The
private sector has benefited from the Associate category because it has
allowed entities that have expertise in a particular telecommunications
subject to participate in that part of the work of the ITU that is of
interest to them, at a lower rate than they would have to pay to as
Sector Members.
Question. Is there any overlap between Sector Members and
Associates?
Answer. Sector Membership entitles a private sector member to
attend all the Study Groups in a Sector. An Associate can only
participate in the specific Study Group(s) for which it is an
Associate. If an entity is a Sector Member, it would make no sense for
it also to be an Associate in the same sector.
We are aware that several entities have chosen to be a Sector
Member in one Sector but an Associate in another Sector.
Question. How many U.S. Sector Members and U.S. Associates
participate in the ITU's work? Is there a list that is publicly
available?
Answer. Yes.
There is a publicly available list of Sector Members on the ITU's
website at--
www.itu.int/cgi-bin/htsh/mm/scripts/mm.list?_search=sec&_languageid=1
And Associates at--
www.itu.int/cgi-bin/htsh/mm/scripts/
mm.list?_search=associates&_languageid=1
There are currently 568 Sector Members and 153 Associate Members
listed, in addition to 191 Member States.
Question. The 1998 amendments to Article 28 of the Constitution
provide that the Secretary General should notify the Member States of
the provisional values of contributory units before the beginning of
the Plenipotentiary Conference and that Member States, in turn, should
determine their final choice of contributory unit, their allocation
level, before the end of the Conference. The United States
unsuccessfully opposed the change in the time allowed for Member States
to notify the Secretary General of their final allocation level,
arguing that it needed more time for Congressional input. Has this
change in the time-line for contributions created any problems for the
United States?
Answer. The time-line has not created any problems for the U.S.
Question. There has been considerable discussion relating to the
role that the ITU should play in governing the Internet. The Report of
the U. S. Delegation to the Plenipotentiary Conference of the
International Telecommunications Union in Marrakesh (2002) stated that
``while Member States have become significantly more interested in the
issues related to Internet governance, the U.S. successfully worked to
ensure that three ITU resolutions concerning management of the Internet
reaffirmed private sector leadership in this area and limited the ITU
involvement to its core competencies.'' See pg. 2. The Report of the
United States Delegation to the Plenipotentiary Conference of the
International Telecommunication Union in Antalya, Turkey (2006)
indicated that the role of the ITU in internet governance was discussed
and was affirmed insofar as it related to cyber security, consistent
with the existing mandate of the ITU. See pg. 16.
What is the role that the ITU currently plays in Internet
governance? Which ITU bodies are most involved in this work?
Answer. The Administration believes that the term ``Internet
governance'' covers a wide range of public policy-related issues and
serves as a ``catch-all'' for a multitude of topics related to the
Internet including spam, e-commerce, e-literacy, universal
connectivity, management of the domain name and addressing system
(DNS), etc. Given the breadth of topics potentially encompassed under
the rubric of ``Internet governance,'' the Administration believes that
no single venue can appropriately address the subject in its entirety.
As a general matter and consistent with its mandate, the ITU has a role
with respect to the telecommunications infrastructure over which the
Internet operates. All three ITU Sectors (ITU-D, ITU-R, and ITU-T) are
involved in this work.
While the Administration recognizes that the current private-sector
led system for management of the Internet is working, we continue to
encourage an ongoing dialogue with all stakeholders around the world in
the various entities (including the ITU) that are involved in various
aspects of the Internet (pursuant to their expertise, core
competencies, and governing agreements), as a way to facilitate
discussion and to advance our shared interest in the ongoing robustness
and dynamism of the Internet.
Question. Going forward, what role should the ITU play in Internet
governance? Have public statements been made, which reflect the
Administration's position on this question? If so, where?
Answer. The advancement and proliferation of the Internet is
dependent upon the continued interworking of the underlying
telecommunication infrastructure that the ITU has historically
addressed. The Administration supports continuation of this work, as
well as the ITU's technical involvement in Internet Protocol-based
networks through its membership-driven study group process on issues
such as spam, cybersecurity, etc., to the extent such work is
consistent with the historical core competencies of the ITU. We do not
support an expanded scope for the ITU into other issues related to
``Internet governance'' and we have strived to ensure that ITU work
programs are not duplicative of work ongoing in other international and
intergovernmental institutions. This view is routinely conveyed in
written contributions to ITU as well as speeches and testimony of
senior Administration officials.
Question. The Report of the United States Delegation to the
Plenipotentiary Conference of the International Telecommunication Union
in Antalya, Turkey (2006) indicated that ``the ITU Council should
establish a working group to consider the range of issues associated
with the participation of all relevant stakeholders in the activities
of the Union related to [World Summit on the Information Society].''
See pg. 16. The World Summit on the Information Society (WSIS) is
focused on ensuring that the benefits of the Internet are accessible to
everyone. Did the ITU Council establish a working group, as envisioned
in the 2006 Report? If so, what were the recommendations of this group?
Answer. On November 24, 2006 at an extraordinary session, the ITU
Council created the Council Working Group on the Study on the
Participation of All Relevant Stakeholders in ITU Activities Related to
the WSIS (WG-WSIS), as called for in Resolution 141of the
Plenipotentiary Conference in Antalya, Turkey. The group, which will
present a final report to the 2009 session of Council, has met four
times thus far and is scheduled to meet again September 29-30, 2008 in
Geneva. The upcoming meeting will review the results of questionnaires
developed by the Working Group to seek input of ITU Member States as
well as entities that were accredited to the WSIS regarding the
effectiveness of existing mechanisms for participation in the ITU.
Question. Please explain to what extent the Executive Branch
regards the ITU instruments under consideration to be self-executing.
Answer. The ITU instruments under consideration are not of their
own force intended to be judicially enforceable. Implementation by the
United States is authorized by the Communications Act of 1934, 47
U.S.C. Sec. 151, et seq., as amended, and by the National
Telecommunications and Information Administration Organization Act, 47
U.S.C. Sec. 901 et seq., as amended. No new U.S. legislation is needed
to implement these amendments.
Question. The 1998 amendments to the Constitution increased the
number of members of the Radio Regulations Board (RRB) from nine to not
more than 12 or a number corresponding to six percent of the total
number of Member States, whichever is greater. See Article 14 of the
Constitution. Article 9 of the Constitution of the ITU provides that
each Member State may propose only one candidate to the RRB. What is
the current make-up of the RRB? How does this amendment to Article 14
affect, if at all, the United States' chance of having its candidate
elected to the RRB?
Answer. The RRB is currently comprised of representatives from
twelve countries. They are the USA (Chair for 2008), Cameroon, Canada,
France, India, Kyrgyzstan, Lithuania, Malaysia, Morocco, Nigeria,
Pakistan and Poland. The RRB members perform their duties independently
and on a part-time basis, normally meeting up to four times a year in
Geneva, and are elected at the Plenipotentiary Conference. The twelve
candidates receiving the most votes at the Plenipotentiary Conference
are elected to the RRB. Under such rules, the chances of a country
having its candidate elected are increased as the size of the Board
increases.
Question. The 2006 amendments to the Convention included the
deletion of a provision in the Convention that gave the representative
of each Member State of the Council the right to attend, as an
observer, all meetings of the ITU Sectors. See Article 4(7) of the
Convention (SUP 58). Moreover, the Convention was amended to clarify
that Sector Members may attend (and not merely be represented at)
meetings of the Council, its committees, and its working groups,
subject to certain conditions. See Article 4(9ter). Please explain why
each of these amendments were made and whether the United States
supported these amendments.
Answer. A practical difficulty preceding the 2006 amendments was
the status of observer Member States attending ITU Council meetings.
The specific issue was whether such observer Member States could
participate at committees and working groups of Council. This issue
consumed significant energy, particularly in that vocal observer Member
States sought entrance to committee meetings and working groups of the
Council that some Member States already represented on the Council
thought were not authorized. The United States' view was that, subject
to the rules in force, all participants at Council meetings and working
groups should be afforded the opportunity to make their views known. In
the view of the United States, affording participants at lower level
meetings the opportunity to generally voice their views is the best
method of achieving a consensus on the eventual outcomes. Accordingly
the U.S. supported the amendments in question.
__________
responses to additional questions for the record submitted to senior
deputy u.s. coordinator richard beaird by senator richard lugar
Questions Relating to Treaty Docs. 108-5, 109-11, and 110-16 Generally
Question. What is the current status of the amendments to the ITU
Constitution and Convention contained in these documents?
In the case of each set of amendments, how many ITU Member States
have ratified or acceded to the amendments, and how many have not done
so?
Answer. All of the amendments are in force for those ITU Member
States that have deposited their instrument of ratification, acceptance
or approval of the amendments with the ITU.
----------------------------------------------------------------------------------------------------------------
Member States Member States
that have that have not
Treaty Doc Number Total ITU Member ratified, ratified,
States acceded or acceded or
approved approved
----------------------------------------------------------------------------------------------------------------
108-5..................................................... 189 81 108
109-11.................................................... 189 63 126
110-16.................................................... 191 8 183
----------------------------------------------------------------------------------------------------------------
Question. To the extent that the amendments have entered into force
for some ITU Member States, and not for others, what rules govern when
an issue addressed by the amendments arises?
Answer. As the ITU Constitution and Convention and their amending
instruments are silent on this question, customary rules of
international law govern the ITU legal relations between ITU Member
States that are parties to such amendments and those that are not.
Pursuant to those customary rules, as between any two such Member
States, only the amendments to the ITU Constitution and Convention to
which both states are parties apply to their mutual relations. For the
United States, this is the ITU Constitution and Convention, as amended
in 1992 and 1994.
Question. Is the United States currently enjoying rights provided
for in these amendments even though it has not yet ratified them? If
so, please indicate what rights the United States is enjoying and on
what legal basis it is enjoying them?
Answer. In general terms, we believe that the various amendments to
the Constitution and Convention, many of which have been voluntarily
implemented by Member States that have not yet ratified them, have
improved the management, functioning and finances of the ITU so as to
make the ITU a more transparent, nimble and accountable organization
that better serves the interests of its Member States, including the
United States.
Question. Is the United States currently complying with obligations
of ITU Member States provided for in these amendments even though it
has not yet ratified them? If so, please indicate what such obligations
the United States is currently complying with and on what legal basis
it is doing so?
Answer. As indicated in the public testimony and in our response to
General Question 1c above, many of the amendments to the ITU
Constitution and Convention that are pending for Senate advice and
consent to ratification concern the management, functioning and
finances of the ITU. The United States has voluntarily supported
implementation of these amendments, even though it has not yet ratified
them. For example, in 1998 and 2006, the ITU Plenipotentiary
Conferences adopted amendments to the ITU Constitution to require
Member States to announce their class of contribution by particular
deadlines so that the ITU could develop a realistic budget. The United
States has voluntarily sought to adhere to those deadlines in order to
improve the management and finances of the ITU, even though it is not
yet required to do so.
Question. Are U.S. private sector entities currently able to enjoy
rights with respect to participation in the ITU provided for in these
amendments even though the United States has not ratified them? If so,
please indicate on what legal basis such entities are able to enjoy
such rights?
Answer. We believe that the U.S. private sector has gained
significant benefits from these amendments, in terms of its
participation in the ITU. The 1998 ITU Plenipotentiary Conference
adopted amendments to enhance the status of ITU Sector Members,
including recognition that Sector Members may provide chairs and vice
chairs at sector assemblies and meetings and at World Telecommunication
Development Conferences and establishing a new category of ITU
Associate that can participate in the work of a particular ITU Study
Group. The 2002 and 2006 ITU Plenipotentiary Conference adopted
amendments to allow private ITU Sector Members may attend meetings of
the ITU Council, its committees and working groups under certain
conditions. All of these amendments have enhanced the ability of the
private sector to participate in the work of the ITU. The legal basis
for that participation is the various ITU amendments that have entered
into force, even though the United States has not yet ratified those
amendments. Thus, U.S. private sector entities are able to enjoy these
benefits even though the U.S. has not yet ratified the amendments.
Question. Does the Administration believe it is sound policy for
the ITU to amend its governing rules every four years? What impact does
this practice have on the stability of the ITU's activities and the
legal certainty of the rules governing them?
Answer. The ITU reviews its governing rules every four years. The
governing rules are changed only when necessary, on the basis of
consensus. This practice provides for a flexible organization with the
ability to adapt to emergent technologies and yet offers stability to
the multiplicity of ITU Member States and ITU Sector Members. While
various amendments are made to the ITU Constitution and Convention as
part of this process, those amendments do not fundamentally change the
basic structure of the ITU. Hence, the technical changes to the ITU
governing rules do not disrupt the stability of the ITU's activities
and the legal certainty of the rules governing those activities.
Question. The United States made a number of declarations and
reservations to the instruments contained in these documents at the
time it signed the Final Acts of the relevant Plenipotentiary
Conferences, and is seeking advice and consent to those declarations
and reservations. Please indicate whether and when the Executive Branch
consulted with the Senate prior to making these declarations and
reservations?
Answer. While the Executive Branch did not formally consult with
the Senate prior to making these declarations and reservations, the
Executive Branch sought in its declarations and reservations to
preserve the prerogatives of the Senate in providing advice and consent
to ratification of these instruments amending the Constitution and
Convention. In particular, the Executive Branch made clear in each case
that it reserved the right of the United States to make additional
declarations and reservations to each instrument at the time of deposit
of its instrument of ratification of the amendments with the ITU, so as
to preserve the right of the Senate to provide additional declarations
and reservations at the time of advice and consent to ratification.
Also, because certain provisions of the 1992/1994 ITU Constitution
provide for implied consent to be bound by revisions of the
Administrative (Radio) Regulations adopted either before or after
amendments to the ITU Constitution and Convention have been adopted,
the Executive Branch has also included specific declarations in each
instance specifying that the United States has not consented to be
bound by those revisions without specific notification to the ITU of
the United States' consent to be bound. These declarations and
reservations will be found at Treaty Doc. 110-16, at X-XI; Treaty Doc.
109-11, at 8-9; and Treaty Doc. 108-5, at X. Further, the declarations
and reservations in these instruments are consistent with those made in
earlier instruments to which the Senate has previously given its advice
and consent. See Treaty Doc. 104-34, at IX.
Questions Relating to Treaty Doc. 108-5
Question. The transmittal package for Treaty Doc. 108-5 describes
amendments relating to the Rules of Procedure of Conferences and
Meetings of the ITU as follows:
The 1998 Conference adopted amendments to the Convention that
removed the Rules of Procedure of Conferences and Meetings of
the ITU, with the exception of provisions relating to
reservations and the right to vote, from the Convention and
transferred them to a separate legal instrument. (See
Convention, Article 32B, SUP 341-467.) This separate legal
instrument entered into force on January 1, 2000, for those
Member States that, as of that date, had submitted their
instrument of ratification, acceptance, approval or accession
to the 1998 Amendments. It will enter into force for all other
Member States, including the United States, on the date on
which they deposit their instruments of ratification,
acceptance, approval or accession to the 1998 Amendments.
Unless otherwise agreed to by a plenipotentiary conference,
amendments to this separate legal instrument shall enter into
force on the date of signature of the Final Acts of the
plenipotentiary conference at which they are adopted. (See
Rules of Procedure of Conferences and Other Meetings of the
International Telecommunication Union, 25.)
What was the source of the Rules of Procedure that governed
the United States participation in the 2002 and 2006 ITU
Plenipotentiary Conferences?
Answer. Prior to 1998, the Rules of Procedure for ITU Conferences
and other meetings were contained in Article 32 (## 340406, 410-444,
447-467) of the 1992/1994 ITU Convention, which entered into force for
the United States on October 26, 1997. As noted above above, the
relations of an ITU member state that has not ratified, acceded or
approved later amendments (such as the United States) with an ITU
member state that has ratified, acceded or approved the later
amendments is governed by the earlier version of the ITU Constitution
and Convention to which both ITU Member States are parties, without the
amendments. Hence, for the United States, the Rules of Procedure found
in the 1992/1994 version of the ITU Convention governed United States
participation at the 2002 and 2006 ITU Plenipotentiary Conferences.
Question. Was the source of these rules different than that of the
Rules of Procedure that governed the participation of ITU Member States
that ratified the 1998 Amendments prior to January 1, 2000?
Answer. Yes. The ITU Rules of Procedure are now found in a separate
legal instrument entitled ``General Rules of Conferences, Assemblies
and Meetings of the Union.'' Since these rules, however, originated in
Article 32 of the 1992/1994 ITU Convention and were extracted from the
1992/1994 Convention to form the separate legal instrument, the
substance of the rules, in large part, is the same as that found in
Article 32 of the 1992/1994 ITU Convention.
Question. To date, have any changes been made to the Rules of
Procedure contained in the ``separate legal instrument'' provided for
in these amendments?
Answer. Yes, minor amendments.
Question. If so, is United States participation in ITU meetings
currently governed by such changes even though it has not yet ratified
the amendments providing for the ``separate legal instrument''?
Answer. No.
Question. If so, what is the legal basis for the application of
such changes to the United States?
Answer. See answers above.
Question. To the extent that different Rules of Procedure have
applied to different ITU Member States at ITU meetings subsequent to
the entry into force for some states of these amendments, how were
matters addressed in the case of conflicts between the varying sets of
rules?
Answer. To our knowledge, no such conflicts have arisen. If they
did, they should be resolved as indicated in General Question 1b above
and Question 1a immediately above.
Question. Amendments to Article 20 of the ITU Convention provide
for the establishment of Business Study Groups which may adopt certain
questions and recommendations without the formal consultation of ITU
Member States.
Please provide a list of topics on which Business Study Groups have
adopted questions or recommendations without formal consultation with
ITU Member States.
Answer. Article 20 of the Convention provides for the ``Conduct of
Business of Study Groups.'' Pursuant to Article 20 (in particular,
paragraph CV 246-A and 246-D), Member States have established
procedures for both study Questions and Recommendations to be adopted
without formal consultation of the Member States where there is no
doubt that the Questions and Recommendations involved lack policy or
regulatory implications. In the ITU Telecommunication Standardization
Sector, Questions may be adopted at Study Group meetings where there is
consensus (see WTSA Resolution 1, Section 7.2.2). Recommendations may
also be adopted without formal Member State consultation pursuant to
the streamlined process set forth in ITU-T Recommendation A.8.
Twenty-two Questions were adopted during the 2004-2008 period
without formal Member State consultation.
In the ITU Telecommunication Standardization Sector, most
Recommendations are highly technical and do not involve regulatory or
policy issues, and are therefore approved under the streamlined
process, i.e., by the Member States and Sector Members present at the
Study Group meeting without further formal consultation of all Member
States. In the period from 2004-2008, there were 840 ITU-T
Recommendations approved using this process; a list of these can be
provided if requested. It is estimated that this constitutes over 90%
of the ITU-T's recommendations during this period. However, even in
these cases, Member States may call for a formal Member State
consultation process where they believe policy or regulatory issues are
involved.
Question. Please indicate whether there have been any disputes
within the ITU over whether particular questions or recommendations
required formal consultation with ITU Member States under these
amendments and how any such disputes were resolved.
Answer. The process adopted by Member States for approval of
Questions without formal Member State consultation is set forth in WTSA
Resolution 1 at Section 7.2. It permits study groups to approve
Questions if there is consensus of those present (including Member
States) at the meeting (Section 7.2.2). However, if there is no
consensus, a formal Member State consultation process may be initiated
(Section 7.2.3). It has never been necessary to apply this formal
consultation process.
From time to time the issue of whether a given Recommendation
should be approved according to the streamlined approval process or by
formal consultation with Member States has arisen. If there is no
consensus at the study group meeting at which the issue arises, ITU-T
Recommendation A.8, Section 8.1.1 calls for Member States present to
decide the issue by majority vote, but it has never been necessary to
apply this voting procedure.
Question. The transmittal package for Treaty Doc. 108-5 (1998
Plenipotentiary Conference) indicates that the United States
unsuccessfully sought an amendment to Article 33 of the ITU Convention
that would have eliminated the requirement that interest be paid on
arrears to the ITU.
Is the United States currently in arrears to the ITU?
Answer. The U.S. has paid all the assessed contributions except for
the 2008 assessment of Swiss francs (CHF) 9,540,000 ($9,376,321).
Because of a funding shortfall in the Contributions to International
Organizations (CIO) account, U.S. payments to ITU, along with eight
other organizations, became partially deferred in FY 2006. The assessed
contribution to ITU for calendar year 2008 will be paid from two
different fiscal years: thirty percent from FY08 funds and seventy
percent from FY09 funds.
Question. Has the United States been in arrears to the ITU at any
point in the past? Please indicate the amounts and dates of any such
arrears.
Answer. Yes, the 1997 assessment for ITU was short by CHF
1,419,594. ($1,394,932)
Question. Has the ITU sought to invoke Article 33 to collect
interest payments from the United States? If so, please indicate the
amounts and dates of any such efforts.
Answer. Yes, per article 33 outstanding amounts bear interest from
the beginning of the fourth month of the financial year (April 1) at 3%
then at 6% from the beginning of the seventh month (July 1.) As a
result, the U.S. has been invoiced as follows:
------------------------------------------------------------------------
-----------------------------------------------------------------------
1996 CHF 155,158 ($152,480) interest on arrears
1997 CHF 1,483,476 shortfall on 1997
($1,457,585) assessment and interest
on arrears
1998 CHF 88,050 ($86,538) interest on arrears
1999 CHF 92,971 ($91,394) interest on arrears
2000 CHF 98,475 ($96,808) interest on arrears
2001 CHF 104,301 ($102,536) interest on arrears
2002 CHF 100,202 ($98,507) interest on arrears
2003 CHF 37,587 ($36,948) interest on arrears
2004 CHF 310,672 ($305,328) interest on arrears
2005 CHF 173,293 ($170,299) interest on arrears
2006 CHF 456,286 ($448,403) interest on arrears
2007 CHF 321,180 ($315,601) interest on arrears
------------------------------------------------------------------------
The current balance for interest on arrears as of January 2008 is CHF
1,369,380 ($1,345,728).
Question. Has the United States made any payments of interest on
arrears to the ITU? If so, please indicate the dates and amounts of any
such interest payments.
Answer. Yes, CHF 602,837 ($592,402) on November 14, 2002 to
partially pay the accumulated interest on arrears owed.
Question. The transmittal package for Treaty Doc. 108-5 states that
``for domestic policy reasons'' the United States will require U.S.
private Sector Members to continue to apply for ITU Sector Membership
using procedures requiring the direct involvement of the U.S.
Government, rather than through alternative procedures providing for
direct applications through the ITU.
Please explain the domestic policy reasons for this decision.
Answer. The U.S. has chosen to maintain minimal oversight over
which U.S. entities are allowed to apply for ITU membership for a
number of reasons. One is that the U.S., which has more Sector Members
than any other country, wants to be kept informed about what U.S.
entities are participating in the ITU. Another is that the U.S. may
incur some de facto responsibilities as a result of a U.S. company
becoming an ITU member. For example, the ITU turns to the U.S. to
assist in seeking payment from a U.S. entity when that U.S. entity does
not meet its ITU obligations, such as failure to pay its contributory
share.
Please give an assessment of how the direct application procedures
have worked in practice for those states that have utilized them, and
of the impact on the work of the ITU of the participation of Sector
Members admitted through such procedures.
Answer. Although other Member States do not disclose the benefits
of their direct application procedures, for the U.S., the application
process has worked very well. The endorsement process is not
complicated for either the U.S. or for the ITU. This is evident in the
large number of public and private companies that have joined the ITU
(568 Sector Members, of which 86 are from the U.S., and 153 Associate
members).
Questions Related to Treaty Doc. 109-11
Question. Please indicate how much money the ITU is expected to
save on an annual basis as a result of the amendments to Article 4 of
the Convention with regard to the payment of travel expenses of Member
State representatives in connection with meetings of the ITU Council.
Please also indicate how much money the ITU currently spends on such
expenses on an annual basis.
Answer. Using today's conversion rate of U.S. Dollar to Swiss Franc
(CHF) ($1 US = .97 CHF), the expected savings on travel expenses for
the sixteen ITU Member States that are developed countries (at an
average cost of $3,931) equals $62,896 per ITU council meeting. The ITU
Council meets annually. Hence, the expected savings on daily
subsistence allowance expenses for the sixteen ITU Member States that
are developed countries (at $491/day over an average of 10 days),
equals $78,560 per Council session. This results in a total savings of
$141,456.
The ITU's annual travel expenditures between 2002 and 2007 amount
to approximately $2.2 million ($ 3.3 million including fellowships).
Questions Related to Treaty Doc. 110-16
Question. As described in the transmittal package, amendments to
Article 5 of the ITU Convention contained in 110-16 provide for the ITU
Secretary General and other specified ITU officials to participate in
ITU meetings ``in an advisory, vice consultative, capacity.'' Please
explain the distinction between these two capacities and the
significance of this change.
Question. The distinction between the two terms relates to the core
role that is desired of the Secretary General in the ITU. Each sector
of the ITU (ITU-R, ITU-T and ITU-D) has an advisory group whose output
is available for consideration by the Member States. Prior to the
Antalya Plenipotentiary Conference, the term ``consultative,'' as
applied to the Secretary-General's participation, was deemed to give
the Secretary General too strong a role in the conduct of what is
fundamentally an inter-governmental organization. The ITU Member States
did not regard the Secretary-General as properly being on a par with
the Member States. Accordingly, the Antalya Plenipotentiary Conference
made clear that the Secretary-General and other ITU officials provide
advice to the Member States but Member States need not consult them.
Questions Related to Treaty Docs. 107-17 and 108-28
Question. The revisions to the ITU radio regulations contained in
Treaty Docs. 107-17 and 108-28 were concluded in 1992 and 1995,
respectively.
Is the United States already implementing or acting in accordance
with these revisions? If so, please indicate the authorities on which
the Executive Branch has relied in order to do so.
Answer. In the exercise of their statutory and regulatory
authority, the Federal Communications Commission (FCC) and the National
Telecommunications and Information Administration (NTIA) have generally
been able to implement revisions to the Radio Regulations through
notice and comment rulemaking under the Administrative Procedure Act
(APA). Both the FCC and NTIA have broad authority over their respective
spheres of telecommunication regulation, the FCC for non-governmental
telecommunications and the NTIA for governmental telecommunications.
The FCC's basic authority is found in 47 U.S.C. Sec. Sec. 152(a), 301
and 303. The NTIA exercises delegated Presidential authority over all
governmental telecommunications found in 47 U.S.C. 305 under
Reorganization Plan No. 1 of 1977 and E.O.12046, as set forth in 47
U.S.C. 902(b). 47 U.S.C. 303(r) specifically authorizes the FCC to make
rules and regulations, not inconsistent with law, necessary to carry
out the provisions of any international radio or wire communications
treaty or convention to which the United States is or may hereafter
become a party. 47 U.S.C. 902(b)(2)(A) & (K) authorize the NTIA to
assign frequencies and establish policies concerning spectrum use by
radio stations belonging to the U.S. Pursuant to this law, NTIA
implements amendments to the ITU instruments regarding
telecommunications spectrum for governmental stations.
Question. Given the significant changes in telecommunications
sector in the intervening period since the adoption of these revisions,
please explain why these revisions remain relevant and why the
Administration considers their ratification to be important.
Answer. We are making an earnest effort to bring the United States
up-do-date with all ITU instruments because we believe, among other
things, that this would continue to support the United States' strong
presence in the ITU, which hopefully will assist in furthering the
USG's telecommunications goals within that organization. It is
important that the United States not be seen as picking and choosing
ITU Final Acts to ratify since it would send a signal internationally
that the U.S. has moved away from its historical practice of managing
international telecom and spectrum policy. Further, these earlier
revisions provide the foundation for more recent amendments to the
radio regulations, and thus it is important for the United States to
ratify them in a comprehensive fashion.
responses to additional questions for the record submitted to deputy
assistant secretary david a. balton by senator joseph r. biden, jr.
Question. How will joining these three environmental treaties (The
Anti-Fouling Convention, the London Dumping Protocol, and the Land-
Based Sources Protocol) benefit the United States? Why should the
Senate act on them now?
Answer. Prompt action to facilitate ratification of these treaties
will allow the United States to reinforce and maintain its leadership
role on oceans issues at the international and regional levels.
Ratification would enhance our ability to work with other States to
promote effective implementation of these treaties. As a Party to these
treaties, the United States would be able to participate fully in
meetings of States Parties and, thereby, more directly affect the
implementation and interpretation of these treaties. Further, after the
United States ratifies a treaty, other nations are more likely to
ratify as well, resulting in greater overall protection of the oceans
from marine pollution.
With respect to the Anti-Fouling Systems Convention, the United
States has an obvious interest in protecting its marine environment and
ecosystems from the harmful effects of anti-fouling systems,
particularly hazardous leaching of organotin in our ports and other
waters. U.S. ratification and enactment of the proposed implementing
legislation will together require foreign vessels entering U.S. ports
and certain other waters to stop using harmful anti-foulants containing
organotins. Since the United States already has significant existing
prohibitions against organotin use, this will help create a ``level
playing field'' on this issue. Ratification would also allow the United
States to participate in decisions on inclusion of other harmful anti-
fouling systems in the future.
The Caribbean region covered by the Land-Based Sources Protocol is
of crucial importance, as pollution of these waters directly affects
the United States. For this reason, the United States strongly
advocated the development of the Land-Based Sources Protocol.
Ratification by the United States is likely to spur other governments
in the region to also become Party. This would lead to an overall
improvement of the marine environment in this neighboring region,
resulting in improved protection of human health and marine resources,
as well as a stronger regional economy and tourism industry.
The London Protocol is increasingly replacing the London Convention
as the primary international regime for addressing ocean dumping. It is
therefore crucial that the United States be able to fully participate
in this forum to advance and protect key U.S. interests such as
protection of the marine environment and proper regulation of
legitimate uses of the oceans for disposal purposes.
Question. What has been the impact of the Cartagena Convention and
the two Cartagena Protocols that we've joined regarding oil spills and
specially protected areas and wildlife? Do you have any concerns about
their operation thus far? Have these instruments been effectively
implemented?
Answer. The Cartagena Convention (the Convention for the Protection
and Development of the Marine Environment of the Wider Caribbean
Region) serves as an umbrella agreement for addressing marine
environmental protection in the Caribbean Region. Twenty-three nations
in the Caribbean participate in this regime and overall the United
States has been very satisfied with how the Cartagena Convention and
its Protocols have been implemented.
The Protocol Concerning Cooperation in Combating Oils Spills has
been very successful in strengthening oil spill preparedness and
response capacity of the nations and territories of the region, and in
facilitating co-operation and mutual assistance to prevent and control
major oil spill incidents. The United States helps support a regional
oil spill training and response center in Curacao, and has detailed a
U.S. Coast Guard officer to this facility to provide technical
assistance.
The Protocol Concerning Specially Protected Areas and Wildlife--the
SPAW Protocol--has served as an important vehicle for promoting greater
awareness of the threats to marine species in the region. The Protocol
has made significant progress in helping Caribbean nations and
territories better protect marine mammals, and has developed guidelines
to help members evaluate and designate marine protected areas.
Question. The Land-Based Sources Protocol calls for international
cooperation and assistance relating to land-based sources of maritime
pollution. Does the United States already provide such assistance to
nations in the Caribbean region? Would we be expected to provide
additional assistance as a Party to the Protocol?
Answer. The United States already provides substantial assistance
to nations in the Caribbean region for environmental programs,
including for control of land-based sources of marine pollution. Much
of our assistance to the region in this area is through in-kind
services and the provision of technical expertise.
The United States provides technical advice on marine environmental
protection to the Caribbean through USAID, the Department of
Agriculture, NOAA and EPA. In addition, the United States is a
principal contributor to the United Nation's Caribbean Environment
Program (CEP), which supports marine environmental protection
activities in the region. In recent years we have provided
approximately $400,000 in annual support to the CEP's Caribbean Trust
Fund, and an additional $50,000 or so for the CEP's work on land-based
sources of marine pollution.
As a party to the Land-Based Sources Protocol, we would not incur
any new funding obligations. Financing is done on a voluntary basis.
We nevertheless hope that entry into force of the Protocol may spur
international donors to provide greater assistance to nations of the
Caribbean to address these issues.
Question. Do you have any concerns regarding other countries that
could join the Land-Based Sources Protocol, meeting the standards set
forth in the Protocol and particularly Annex III of that Protocol?
Answer. The Land-Based Sources Protocol was negotiated with the aim
of helping other countries in the region improve their domestic
standards. We are aware that some of these countries face challenges in
this regard, and are hopeful that the Land-Based Sources Protocol will
provide a mechanism for them to raise their standards.
Question. Article 15 of the London Dumping Protocol states that
``[i]n accordance with the principles of international law regarding
State responsibility for damage to the environment of other States or
to any other area of the environment, the Contracting Parties undertake
to develop procedures regarding liability arising from the dumping or
incineration at sea of wastes or other matter.'' Have these procedures
been developed since the Protocol entered into force? If so, please
provide a copy for the committee's information. If not, please describe
their status and indicate whether the United States is involved in the
process of their development. Does the United States have any concerns
regarding their development?
Answer. Article 15 liability procedures have not been developed
under the London Protocol. Indeed, the second Meeting of Contracting
Parties held in November 2007 agreed not to embark on the development
of liability procedures under Article 15 at this stage. It is worth
noting that the London Convention contains a similar provision in
Article X regarding the development of liability procedures, but that
no such procedures have ever been developed.
Article 15, like Article X of the London Convention, describes a
process for consideration of this issue rather than mandating a
specific outcome. Were this process to move forward, which it has not
yet done, the United States would participate as fully as possible so
as to advance and protect U.S. interests.
Question. Have there been any proposals to amend Annex I of the
London Dumping Protocol since the addition of carbon dioxide streams
from carbon dioxide capture processes for sequestration? If so, please
provide information on such proposals, including the U.S. position on
any such proposals.
Answer. We are unaware of any current proposals to amend Annex I.
Question. Article 26 of the London Dumping Protocol allows non-
parties to the 1972 London Convention to declare, when ratifying the
Protocol, that they require up to five years to comply with specified
Protocol provisions. Have any such declarations been made thus far?
Answer. No Article 26 declarations have been made.
Question. The Anti-Fouling Convention uses the venue of the
International Maritime Organization's Marine Environmental Protection
Committee to review proposals to amend Annex 1 to the Convention. Does
the United States have a seat on the Marine Environmental Protection
Committee? If so, is it a permanent seat?
Answer. Pursuant to Article 37 of the Convention on the
International Maritime Organization, the Marine Environment Protection
Committee shall consist of all the Members. The United States became a
Member of the International Maritime Organization in 1950 and plays a
strong and active role in this committee.
Question. The Letter of Submittal for the Anti-Fouling Convention
indicates that Article 5 will be implemented through existing
provisions of the Solid Waste Disposal Act and the Clean Water Act.
Please specify which provisions of these two acts will be relied upon
to implement Article 5. See Treaty Doc. 110-13, Letter of Submittal at
VII.
Answer. Article 5 of the Anti-Fouling Systems Convention addresses
collection, handling, treatment and disposal of wastes associated with
the application and removal of anti-fouling systems. Certain wastes
generated during application and removal of anti-fouling paints may be
considered hazardous wastes, due to their solvent and/or active
ingredient content. Hazardous wastes are subject to Solid Waste
Disposal Act (SWDA) requirements, including those addressing
generation, transport, treatment, storage, and disposal (see SWDA
Sec. Sec. 3002, 3003, 3004). In addition Sec. 301(a) of the Clean Water
Act (CWA) regulates the discharge of pollutants into waters of the
United States. Discharges from industrial facilities such as shipyards
and dry-docks may be subject to permitting under CWA Sec. 402, and
those permits would establish technology-based effluent limits for
discharges of pollutants from such facilities, and where necessary, any
more stringent limits needed to achieve applicable water quality
standards adopted by States or EPA under CWA Sec. 303.
Question. Is it correct that the use of TBT as an anti-fouling
coating on ships has already been phased out in the United States? When
was the last FIFRA registration for TBT use on a ship cancelled?
Answer. The cancellation of the last FIFRA registration for a TBT
antifouling coating product for hulls of ships and boats became
effective on December 1, 2005. This is the date after which the
registrant could no longer legally sell or distribute the product
except as permitted in a limited existing stocks provision. The
registrant was allowed until December 31, 2005 to sell any existing
stocks of its product (produced before 12/1/05). Stocks in the hands of
users may be used until exhausted. The functional shelf-life of this
material is also limited, so significant use of the products at this
time seems unlikely.
Section 13 of the proposed implementing legislation does allow
continued use of TBT antifouling product on sonar domes and in
conductivity sensors in oceanographic instruments.
Question. Where in the world are TBT-based anti-fouling systems
still being produced and used?
Answer. It is our understanding that TBT-based systems are still
produced in Asia, particularly Southeast Asia and Korea, although the
extent has not been determined. In the past, there were a small number
of U.S.-based companies that marketed TBT paint for export to the
Caribbean, reportedly for use on pleasure craft. This practice may
continue today on a small scale. A U.S. registration is not a
requirement for export.
The European Union has already implemented restrictions for vessels
bearing TBT on their hulls. The major cruise lines and many shippers
have switched to non-TBT alternatives. Likely consumers of TBT paints
would probably include owner/operators of vessels traveling within Asia
where restrictions do not exist.
Question. Do any of these three environmental treaties (The Anti-
Fouling Convention, the London Dumping Protocol, and the Land-Based
Sources Protocol) provide for mandatory technology transfers?
Answer. No, there are no provisions in these treaties mandating
technology transfer.
Question. Do any of these three environmental treaties (The Anti-
Fouling Convention, the London Dumping Protocol, and the Land-Based
Sources Protocol) provide a private right of action in U.S. courts for
individuals claiming a violation of any of these treaties?
Answer. No.
__________
responses to additional questions for the record submitted to deputy
assistant secretary david a. balton by senator richard g. lugar
Relating to Multiple Treaties
Question. Article 3(2) of the Convention on anti-fouling systems
and Article 10(4) of the marine dumping protocol each exempt from the
respective instruments' application certain categories of state
vessels, but these provisions define differently the categories of
vessels covered by the exemptions. Is there any difference in scope
between the two exemptions? If so, please explain the difference and
the rationale for it.
Answer. The London Protocol Article 10.4 language was taken from
Article VII(4) of the 1972 London Convention. The Anti-Fouling Systems
Convention Article 3.2 language was modeled after Article 3(3) of the
International Convention on the Prevention of Pollution from Ships,
1973, and Article 236 of the United Nations Convention on the Law of
the Sea. The language in these provisions effectively excludes the same
vessels from coverage by the treaties. (It should be noted that the
London Protocol also includes a reference to aircraft, which is
explained by the fact that it covers aircraft within the scope of its
obligations, while the Anti-Fouling Systems Convention does not.)
Relating to Treaty Doc. 110-13 (Anti-Fouling)
Question. Article 11 of the Convention refers to guidelines to be
developed by the International Maritime Organization for the inspection
of ships for the purpose of determining whether they are in compliance
with the Convention.
a. Have such guidelines been developed? If so, please provide
a copy of the guidelines.
b. If such guidelines have not yet been developed, please
describe the status of the process for developing them and
indicate when the guidelines are expected to be finalized.
c. Please indicate whether ship owners and operators have had
or will have the opportunity to participate in the development
of these guidelines, and describe the process allowing for such
participation.
Answer. Article 11 guidelines under the Anti-Fouling Systems
Convention have been developed in the form of MEPC.102(48) (see
Attachment 1), MEPC.104(49) (see Attachment 2) and MEPC.105(49) (see
Attachment 3). Additionally, work continues at the International
Maritime Organization (IMO) to integrate this guidance into the more
general Survey Guidelines under the Harmonized System of Survey and
Certification (A.948(23)) and the Procedures for Port State Control
(A.787(19), as amended), which are presently under consideration for
revision. Enhancements to the existing guidelines are likely to result
from this ongoing work, within the next two to three years.
Ship owner and operator representatives have been, and continue to
be, very active in the development of these guidelines. They
participate at the relevant IMO Committee and Sub-committee meetings,
both as members of national delegations and as members of non-
governmental organization observer delegations such as International
Chamber of Shipping, International Shipping Federation, and INTERTANKO.
Further, they have made, and continue to make, their perspectives known
to the United States delegation. They can do this on an ad hoc basis
and via the Shipping Coordination Committee, in preparation for the
relevant IMO meetings. The Shipping Coordination Committee is a public
forum whose meetings are conducted as recorded proceedings, under the
cognizance of the Department of State.
Question. The transmittal package for the Convention indicates that
the Coast Guard has adequate existing authorities to compensate any
meritorious claims with respect to undue delay or detention of ships
raised pursuant to Article 13.
a. Please identify the authorities on which the Coast Guard
would rely to address such cases.
b. Please indicate what standard would be used to determine
the amount of damages in such cases, and the potential extent
of damages that could arise.
Answer. The Coast Guard has existing authorities, such as the Suits
in Admiralty Act and the Military Claims Act, which provide
compensation mechanisms for meritorious claims of this nature. In the
case where liability is found, the amount of damages would be subject
to proof by the claimant of the type of damages payable in a civil
action in admiralty if a private person had caused the same kind of
injury. Damages might involve fixed costs like crew wages, dockage
fees, and indemnification or contribution for losses to cargo interests
for which the carrier would be responsible.
Relating to Treaty Doc. 110-5 (Marine-Dumping)
Question. Article 8(1) provides a force majeure exception to the
protocol's prohibitions which applies, inter alia, in cases of a ``real
threat to vessels, aircraft, platforms or other man-made structures at
sea.'' What is the meaning of the word ``real'' as used in this
context? Does it have a substantive effect on the scope of the force
majeure exception?
Answer. The force majeure exception under the London Protocol
closely parallels the one found in London Convention Article V(1). It
is intended to cover threats of an immediate nature to the safety of
human life or of vessels, aircraft, platforms, or other man-made
structures at sea. The term ``real,'' which also is used in the London
Convention provision, should be interpreted in the sense of ``actual''
and ``imminent.'' Article 8(1) may be invoked only if dumping appears
to be the only way of averting the threat and if there is every
probability that the damage consequent upon such dumping will be less
than would otherwise occur.
Question. Article 11 specifies that no later than two years after
the protocol's entry into force, the Meeting of Contracting Parties
shall establish procedures and mechanisms to assess and promote
compliance with the protocol.
a. Have such procedures and mechanisms been finalized? If so,
please provide a copy of the procedures and mechanisms. If not,
please indicate the status of efforts to establish them.
b. What rules apply to the adoption of such procedures and
mechanisms by the parties to the protocol? Must such procedures
and mechanisms be adopted by consensus, or may they be adopted
over the objection of one or more parties?
c. What legal effect will these procedures and mechanisms
have for parties to the protocol? Will parties be legally
obligated to comply with them?
Answer. The rules and procedures on compliance mandated by Article
11 of the London Protocol were adopted at the 2nd Meeting of
Contracting Parties in November 2007 (LC 29/17 Annex 7, see Attachment
4). They were adopted by consensus.
The compliance procedures create a facilitative process that will
not lead to binding consequences for Parties.
Question. Article 12 provides for parties to the protocol to engage
in regional efforts consistent with the protocol to reduce and, where
practicable, eliminate pollution caused by dumping or incineration at
sea of wastes or other matter. Are any such efforts currently underway
or anticipated with respect to regions of which the United States is a
part? If so, please indicate the status and objectives of such efforts.
Answer. For more than thirty years, the U.S. has been a leader in
the control of marine pollution from ocean disposal, and our technical
experts are in high demand for advising other nations on managing their
dredging programs and other ocean disposal activities. The United
States has been an active participant in regional cooperation
activities to improve management of ocean dumping, especially within
the Western Hemisphere. In recent years, U.S. technical experts from
EPA and the Army Corps have participated in regional workshops on ocean
disposal in Ecuador, China, and Bahrain. We engaged with countries in
the wider Caribbean to encourage them to join the London Convention and
Protocol through UNEP's Caribbean Environment Programme. We are also an
active member of the South Pacific Regional Environment Programme, and
leader within that organization on preventing marine pollution from
ocean dumping in the Pacific.
U.S. technical experts played a leading role in the London
Convention/Protocol Scientific Group in developing ``Waste Assessment
Guidance'' for evaluating various types of material for ocean disposal.
This year EPA is providing the London Convention/Protocol Secretariat
at the IMO with $80,000 to develop guidance for developing countries on
dredged material management, and to promote training and capacity
building in ocean dumping regulation. Over the next two years, we plan
to contribute additional funds to this effort with a focus on Latin
America and the Caribbean. Should we become Party to the London
Protocol, we would expect to continue our leadership role in promoting
cooperation and providing technical assistance on ocean dumping.
Question. Article 15 provides for parties to the protocol to
develop procedures regarding liability arising from the dumping or
incineration at sea of wastes or other matter.
a. What is the status of efforts to develop such procedures?
b. What rules apply to the adoption of such procedures by the
parties to the protocol? Must such procedures be adopted by
consensus, or may they be adopted over the objection of one or
more parties?
c. What legal effect will such procedures have for parties to
the protocol? Will parties be legally obligated to comply with
them?
Answer. Article 15 liability procedures have not been developed
under the London Protocol. Indeed, the second Meeting of Contracting
Parties held in November 2007 agreed not to embark on the development
of liability procedures under Article 15 at this stage. It is worth
noting that the London Convention contains a similar provision in
Article X regarding the development of liability procedures, but that
no such procedures have ever been developed. The rules of procedure of
the Protocol apply to adoption of all decisions and contain provisions
on voting.
Article 15, like Article X of the London Convention, describes a
process for consideration of this issue rather than mandating a
specific outcome. Were this process to become active and were it to
lead to the development of new legally binding obligations, there is
nothing in the treaty that would authorize the automatic imposition of
such obligations on Parties. A further instrument would be required
and, were the United States to be interested in joining, it would need
to obtain appropriate authority prior to becoming bound by any such
obligations.
Question. Please explain why the Administration believes that the
procedures in Article 16 for the resolution of disputes are appropriate
to this protocol.
Answer. Article 16 and Annex 3 of the London Protocol set forth the
process for settling any disputes that may arise. In the first
instance, Parties are to resolve any such dispute through negotiation,
mediation, conciliation or other peaceful means of their choice. If no
resolution is reached, the dispute shall, at the request of any Party,
be settled by arbitration, using procedures contained in Annex 3,
unless the Parties to the dispute agree on a different mechanism. The
Annex 3 arbitration procedures are identical to a proposed amendment to
the London Convention that the U.S. ratified in the 1980's, but which
never entered into force.
Given our experience under our environmental treaties, compliance
issues are unlikely to be of a bilateral nature such that these kinds
of procedures would be relevant. Rather, compliance issues have tended
to be treated under multilateral, consultative compliance procedures.
Nevertheless, the existence of the procedure may promote compliance by
other Parties, which is an important U.S. objective.
Question. Please indicate what additional costs the International
Maritime Organization is expected to incur in connection with the
performance of Secretariat duties provided for in Article 19. Please
also indicate what portion of any such additional costs will be
assessed to the United States as an IMO member.
Answer. London Convention and London Protocol meetings are held
jointly, and the programs and activities performed by the Secretariat
in support of the London Protocol are effectively the same as those
performed in support of the Convention. In 1996 the IMO Council agreed
that the Secretariat would accept the functions assigned by the
Protocol ``on the understanding that additional functions shall not
result in additional costs to the Organization.'' It is not possible to
separate out the Secretariat's costs for supporting the Protocol from
what it costs to support the Convention, but it would be no more than
any additional costs incurred by additional Parties joining the
Convention. The United States will bear no additional costs than it
would as merely a Convention Party, since our IMO assessment is based
on flag-state member ship tonnage.