[Senate Executive Report 114-2]
[From the U.S. Government Publishing Office]
114th Congress } { Exec. Rept.
SENATE
2d Session } { 114-2
======================================================================
PROTOCOL AMENDING THE TAX
CONVENTION WITH SPAIN
_______
February 8, 2016.--Ordered to be printed
_______
Mr. Corker, from the Committee on Foreign Relations,
submitted the following
REPORT
[To accompany Treaty Doc. 113-4]
The Committee on Foreign Relations, to which was referred
the Protocol Amending the Convention between the United States
of America and the Kingdom of Spain for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income and its Protocol, signed at Madrid on February
22, 1990, and a related Memorandum of Understanding signed on
January 14, 2013, at Madrid, together with correcting notes
dated July 23, 2013, and January 31, 2014 (together the
``Protocol'') (Treaty Doc. 113-4), having considered the same,
reports favorably thereon with one declaration, 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.................................................3
V. Implementing Legislation.........................................3
VI. Committee Action.................................................3
VII. Committee Comments...............................................4
VIII.Text of Resolution of Advice and Consent to Ratification.........5
IX. Annex 1.--Technical Explanation..................................8
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 Spain. The proposed Protocol
provides an exemption from source-country withholding on
certain direct dividend payments and limits source-country
taxation on all other dividends and branch profits, consistent
with the U.S. Model Tax Treaty. The proposed protocol also
exempts from source-country withholding cross-border payments
of interest, royalties, and capital gains in a manner
consistent with the U.S. Model. The Protocol contains rigorous
protections designed to protect against ``treaty shopping,''
which is the inappropriate use of a tax treaty by third-country
residents, and provisions to ensure the exchange of information
between tax authorities in both countries. While the proposed
Protocol generally follows the 2006 U.S. Model Income Tax
Treaty (the ``U.S. Model''), it deviates from the U.S. Model in
certain respects discussed below.
II. Background
The United States has a tax treaty with Spain that is
currently in force, which was concluded in 1990 (Convention
between the United States of America and the Kingdom of Spain
for the Avoidance of Double Taxation and the Prevention of
Fiscal Evasion with Respect to Taxes on Income and its
Protocol, signed at Madrid on February 22, 1990). The proposed
Protocol was negotiated to bring U.S.-Spain tax treaty
relations into closer conformity with each country's current
tax treaty policies. For example, the proposed Protocol
contains updated provisions designed to address ``treaty-
shopping.'' The proposed Protocol also includes updated
exchange of information articles and a mandatory binding
arbitration provision to resolve disputes between the revenue
authorities of the United States and Spain.
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 June 19, 2014, which is included
at Annex 1 to this report. In addition, the staff of the Joint
Committee on Taxation prepared an analysis of the Protocol,
JCX-67-14 (June 17, 2014), 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.
LIMITATION ON BENEFITS
Consistent with current U.S. tax treaty policy, the
proposed Protocol includes a ``Limitation on Benefits'' (LOB)
provision, which is designed to avoid treaty-shopping by
limiting the indirect use of a treaty's benefits by persons who
were not intended to take advantage of those benefits. The
limitation of benefits provision states that a corporation or
similar entity resident in a contracting state (i.e., the
United States or Spain) is not entitled to the benefits of the
treaty unless that entity meets certain tests, such as carrying
on an active trade or business, or being a publicly-traded
company on certain specified stock exchanges. The provision is
designed to identify entities that have established residency
for tax-abuse purposes.
The Protocol's limitation of benefits provision generally
reflects the anti-treaty-shopping provisions included in the
U.S. Model treaty and more recent U.S. income tax treaties, but
differs in a few respects that may permit some companies to
qualify for treaty benefits under tests not found in the Model.
For instance, the proposed Protocol contains a derivative
benefits test under which a company could qualify for treaty
benefits if at least 95 percent of the aggregate voting power
and value of its shares (and at least 50 percent of any
disproportionate class of shares) are held by seven or fewer
``equivalent beneficiaries.'' The proposed Protocol also
contains a headquarters company test, under which a resident
company would qualify if it meets the criteria to be considered
a headquarters company of a multinational group. The proposed
Protocol would also restrict the discretionary grant of tax
treaty benefits that allows companies that do not pass one of
the LOB tests but demonstrate that they have no treaty shopping
purpose to claim treaty benefits.
EXCHANGE OF INFORMATION
The proposed Protocol provides authority for the two
countries to exchange tax information that is foreseeably
relevant to carrying out the provisions of the existing
Convention. The proposed Protocol allows the United States is
allowed to obtain information (including from financial
institutions) from Spain regardless of whether Spain needs the
information for its own tax purposes.
MANDATORY ARBITRATION
The Protocol incorporates mandatory, binding arbitration
for certain cases where the competent authorities of the United
States and Spain have been unable to resolve after within two
years under the mutual agreement procedure. A mandatory and
binding arbitration procedure is not included in the U.S. Model
treaty, but has recently been included in the U.S. income tax
treaties with Belgium, Canada, Germany, France, and
Switzerland.
MEMORANDUM OF UNDERSTANDING
The Memorandum of Understanding commits the United States
and Spain to initiate discussions within six months after the
proposed Protocol enters into force to extend the benefits of
the Protocol to investments between Puerto Rico and Spain.
IV. Entry Into Force
Article XV states that the proposed Protocol shall enter
into force three months after the United States and Spain have
notified each other that they have completed all required
internal procedures for entry into force. The Memorandum of
Understanding enters into force on the same date as the
proposed Protocol.
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 Convention on
October 29, 2015. Testimony was received from Robert Stack,
Deputy Assistant Secretary (International Tax Affairs) at the
U.S. Department of the Treasury and Thomas Barthold, Chief of
Staff of the Joint Committee on Taxation. A transcript of the
hearing is included in Annex 2 of Executive Report 114-1.
On November 10, 2015, the committee considered the Protocol
and ordered it favorably reported by voice vote, with a quorum
present and without objection.
In the 113th Congress, on April 1, 2014, the committee
considered the Protocol and ordered it favorably reported by
voice vote, with a quorum present and without objection.
VII. Committee Comments
The Committee on Foreign Relations believes that the
Protocol will stimulate increased trade and investment, reduce
treaty shopping incentives, and promote closer co-operation
between the United States and Spain. 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. LIMITATION ON BENEFITS
The committee applauds the Treasury Department's
significant efforts to address treaty shopping both in this
Convention and in other bilateral tax treaties. After careful
examination of this Protocol, as well as testimony and
responses to questions for the record from the Treasury
Department, the committee is of the view that the Convention's
protections against treaty-shopping are robust and will
substantially deny treaty shoppers the benefit of the
Convention. The committee believes that it is critical for the
Treasury Department to closely monitor and keep the committee
informed on the effectiveness of the above-mentioned provisions
in discouraging and eliminating treaty-shopping under the
Convention.
B. INFORMATION EXCHANGE
The Protocol would replace the existing Convention's tax
information exchange provisions with updated rules that are
consistent with current U.S. tax treaty practice. The provision
would allow the tax authorities of each country to exchange
information relevant to carrying out the provisions of the
Convention or the domestic tax laws of either country. It would
also enable the United States to obtain information (including
from financial institutions) from Spain whether or not Spain
needs the information for its own tax purposes.
After careful examination of this Protocol, as well as
witness testimony and responses to questions for the record,
the committee believes that the exchange of information
provisions will substantially aid in the full and fair
enforcement of United States tax laws. According to witness
testimony, the ``foreseeably relevant'' standard used in the
Protocol does not represent a lower threshold than the standard
found in earlier U.S. tax treaties. Witnesses also testified
that the ``foreseeably relevant'' standard has been extensively
defined in internationally agreed guidance to which no country
has expressed a dissenting opinion to date. The committee is
also of the view that the Protocol provides adequate provisions
to ensure that any information exchanged pursuant to the
Convention is treated confidentially. In sum, the committee
believes these provisions on information exchange are important
to the administration of U.S. tax laws and the Protocol
provides adequate protection against the misuse of information
exchanged pursuant to the Convention.
C. DECLARATION ON THE SELF-EXECUTING NATURE OF THE CONVENTION
The committee has included one declaration in the
recommended resolution of advice and consent. The declaration
states that the Convention is self-executing, as is the case
generally with income tax treaties. Prior to the 110th
Congress, the committee generally included such statements in
the committee's report, but in light of the Supreme Court
decision in Medellin v. Texas, 128 S. Ct. 1346 (2008), the
committee 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. Text of 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
The Senate advises and consents to the ratification of the
Protocol Amending the Convention between the United States of
America and the Kingdom of Spain for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion With Respect to
Taxes on Income and its Protocol, signed at Madrid on February
22, 1990, and a related Memorandum of Understanding signed on
January 14, 2013, at Madrid, together with correcting notes
dated July 23, 2013, and January 31, 2014 (the ``Protocol'')
(Treaty Doc. 113-4), subject to the declaration of section 2
and the conditions of section 3.
SECTION 2. DECLARATION
The advice and consent of the Senate under section 1 is
subject to the following declaration:
The Protocol is self-executing.
SECTION 3. CONDITIONS
The advice and consent of the Senate under section 1 is
subject to the following conditions:
(1) Not later than 2 years after the Protocol enters
into force and prior to the first arbitration conducted
pursuant to the binding arbitration mechanism provided
for in the Protocol, the Secretary of the Treasury
shall transmit to the Committees on Finance and Foreign
Relations of the Senate and the Joint Committee on
Taxation the text of the rules of procedure applicable
to arbitration panels, including conflict of interest
rules to be applied to members of the arbitration
panel.
(2)(A) Not later than 60 days after a determination
has been reached by an arbitration panel in the tenth
arbitration proceeding conducted pursuant to the
Protocol or any of the treaties described in
subparagraph (B), the Secretary of the Treasury shall
prepare and submit to the Joint Committee on Taxation
and the Committee on Finance of the Senate, subject to
laws relating to taxpayer confidentiality, a detailed
report regarding the operation and application of the
arbitration mechanism contained in the Protocol and
such treaties. The report shall include the following
information:
(i) For the Protocol and each such treaty,
the aggregate number of cases pending on the
respective dates of entry into force of the
Protocol and each treaty, including the
following information:
(I) The number of such cases by
treaty article or articles at issue.
(II) The number of such cases that
have been resolved by the competent
authorities through a mutual agreement
as of the date of the report.
(III) 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 the Protocol and each such treaty,
including the following information regarding
each case:
(I) The commencement date of the case
for purposes of determining when
arbitration is available.
(II) Whether the adjustment
triggering the case, if any, was made
by the United States or the relevant
treaty partner.
(III) Which treaty the case relates
to.
(IV) The treaty article or articles
at issue in the case.
(V) The date the case was resolved by
the competent authorities through a
mutual agreement, if so resolved.
(VI) The date on which an arbitration
proceeding commenced, if an arbitration
proceeding commenced.
(VII) The date on which a
determination was reached by the
arbitration panel, if a determination
was reached, and an indication as to
whether the panel 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 panel pursuant
to the Protocol or any such treaty, the
following information:
(I) In the case of a dispute
submitted under the Protocol, an
indication as to whether the presenter
of the case to the competent authority
of a Contracting State submitted a
Position Paper for consideration by the
arbitration panel.
(II) An indication as to whether the
determination of the arbitration panel
was accepted by each concerned person.
(III) 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.
(IV) The proposed resolutions
(income, expense, or taxation)
submitted by each competent authority
to the arbitration panel.
(B) The treaties referred to in subparagraph (A)
are--
(i) 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, done at
Berlin June 1, 2006 (Treaty Doc. 109-20) (the
``2006 German Protocol'');
(ii) 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, done at Brussels July 9,
1970 (the ``Belgium Convention'') (Treaty Doc.
110-3);
(iii) the Protocol Amending the Convention
between the United States of America and Canada
with Respect to Taxes on Income and on Capital,
signed at Washington September 26, 1980 (the
``2007 Canada Protocol'') (Treaty Doc. 110-15);
or
(iv) the Protocol Amending the Convention
between the Government of the United States of
America and the Government of the French
Republic for the Avoidance of Double Taxation
and the Prevention of Fiscal Evasion with
Respect to Taxes on Income and Capital, signed
at Paris August 31, 1994 (the ``2009 France
Protocol'') (Treaty Doc. 111-4).
(3) The Secretary of the Treasury shall prepare and
submit the detailed report required under 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 panel, and noted as such in prior
reports may be omitted.
(4) The reporting requirements referred to in
paragraphs (2) and (3) supersede the reporting
requirements contained in paragraphs (2) and (3) of
section 3 of the resolution of advice and consent to
ratification of the 2009 France Protocol, approved by
the Senate on December 3, 2009.
IX. Annex 1.--Technical Explanation
DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE PROTOCOL SIGNED
AT WASHINGTON ON JANUARY 14, 2013 AMENDING THE CONVENTION BETWEEN THE
UNITED STATES OF AMERICA AND THE KINGDOM OF SPAIN FOR THE AVOIDANCE OF
DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO
TAXES ON INCOME AND ITS PROTOCOL, WHICH FORMS AN INTEGRAL PART OF THE
CONVENTION, SIGNED AT MADRID ON FEBRUARY 22, 1990
This is a Technical Explanation of the Protocol signed at
Washington on January 14, 2013, the related Memorandum of
Understanding signed the same day, and a subsequent Exchange of
Notes dated July 23, 2013 (hereinafter the ``Protocol'',
``Memorandum of Understanding'' and ``Exchange of Notes''
respectively), amending the Convention between the United
States of America and the Kingdom of Spain for the avoidance of
double taxation and the prevention of fiscal evasion with
respect to taxes on income, signed at Madrid on February 22,
1990 (hereinafter the ``existing Convention'') and the
Protocol, which forms an integral part of the existing
Convention, signed at Washington on November 6, 2003
(hereinafter the ``Protocol of 1990'').
Negotiations took into account the U.S. Department of the
Treasury'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.
This Technical Explanation is an official guide to the
Protocol, Memorandum of Understanding and Exchange of Notes. It
explains policies behind particular provisions, as well as
understandings reached during the negotiations with respect to
the interpretation and application of the Protocol, Memorandum
of Understanding and the Exchange of Notes.
References 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, Memorandum of Understanding
and Exchange of Notes. The Technical Explanation is not
intended to provide a complete guide to the existing Convention
as amended by the Protocol, Memorandum of Understanding and
Exchange of Notes. To the extent that the existing Convention
and Protocol of 1990 have not been amended by the Protocol,
Memorandum of Understanding and Exchange of Notes, the
technical explanation of the existing Convention and the
Protocol of 1990 remains the official explanation. 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 of 1986, as amended.
References to a ``Treas. Reg.'' are to regulations issued by
the Treasury Department.
ARTICLE I
Article I of the Protocol revises Article 1 (General Scope)
of the existing Convention by deleting references to Article 20
of the existing Convention, by adding new paragraphs 5 and 6.
New Paragraph 5 of Article 1
New paragraph 5 relates to non-discrimination obligations
of the Contracting States under the GATS. The provisions of
paragraph 5 are an exception to the rule provided in paragraph
2 of Article 1 under which the Convention shall not restrict in
any manner any benefit now or hereafter accorded by any other
agreement between the Contracting States.
Subparagraph 5(a) provides that, unless the competent
authorities determine that a taxation measure is not within the
scope of the Convention, the national treatment obligations of
the GATS shall not apply with respect to that measure. Further,
any question arising as to the interpretation or application of
the Convention, including in particular whether a measure is
within the scope of the Convention, shall be considered only by
the competent authorities of the Contracting States, and the
procedures under the Convention exclusively shall apply to the
dispute. Thus, paragraph 3 of Article XXII (Consultation) of
the GATS may not be used to bring a dispute before the World
Trade Organization unless the competent authorities of both
Contracting States have determined that the relevant taxation
measure is not within the scope of Article 25 (Non-
Discrimination) of the Convention.
The term ``measure'' for these purposes is defined broadly
in subparagraph 5(b). It would include a law, regulation, rule,
procedure, decision, administrative action or any other similar
provision or action.
New Paragraph 6 of Article 1
New paragraph 6 addresses special issues presented by the
payment of items of income, profit or gain to entities that are
either wholly or partly fiscally transparent, such as
partnerships, estates and trusts. Because countries may take
different views as to when an entity is wholly or partly
fiscally transparent, the risk of both double taxation and
double non-taxation is relatively high. The provision, and the
corresponding requirements of the substantive rules of the
other Articles of the Convention, should be read with two goals
in mind. The intention of paragraph 6 is to eliminate a number
of technical problems that could prevent investors using such
entities from claiming treaty benefits, even though such
investors would be subject to tax on the income derived through
such entities. Paragraph 1 of the Memorandum of Understanding
sets forth the understanding of the Contracting States that
paragraph 6 applies to identify the person that derives an item
of income, profit or gain paid to a fiscally transparent entity
for purposes of applying the Convention to that first mention
person. The provision also prevents a resident of a Contracting
State from claiming treaty benefits in circumstances where the
resident investing in the entity does not take into account the
item of income paid to the entity because the entity is not
fiscally transparent in its State of residence.
In general, the principles incorporated in this paragraph
reflect the regulations under Treas. Reg. 1.894-1(d). Treas.
Reg. 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 by the
interest holder. Entities falling under this description in the
United States include partnerships, corporations that have made
a valid election to be taxed under Subchapter S of Chapter 1 of
the Code (``S corporations''), common investment trusts under
section 584, simple trusts and grantor trusts. This paragraph
also applies to payments made to other entities, such as U.S.
limited liability companies (``LLCs''), that may be treated as
either partnerships or as disregarded entities for U.S. tax
purposes.
New paragraph 6 provides that, for purposes of applying the
Convention, an item of income, profit or gain derived through
an entity that is fiscally transparent under the laws of either
Contracting State, and that is formed or organized in either
Contracting State, or in a state that has an agreement in force
containing a provision for the exchange of information on tax
matters with the Contracting State from which the income,
profit or gain is derived, shall be considered to be derived by
a resident of a Contracting State to the extent that the item
is treated for purposes of the taxation law of such Contracting
State as the income, profit or gain of a resident. For example,
if a company that is a resident of Spain pays interest to an
entity that is formed or organized either in the United States
or in a country with which Spain has an agreement in force
containing a provision for the exchange of information on tax
matters, and that entity is treated as fiscally transparent for
U.S. tax purposes, the interest will be considered derived by a
resident of the United States, but only to the extent that the
taxation laws of the United States treat one or more U.S.
residents (whose status as U.S. residents is determined, for
this purpose, under U.S. tax law) as deriving the interest for
U.S. tax purposes. Where the entity is a partnership, the
persons who are, under U.S. tax laws, treated as partners of
the entity would normally be the persons whom the U.S. tax laws
would treat as deriving the interest income through the
partnership. Also, it follows that persons whom the United
States treats as partners but who are not U.S. residents for
U.S. tax purposes may not claim a benefit under the Convention
for the interest paid to the partnership, because such third-
country partners are not residents of the United States for
purposes of claiming this benefit. If, however, the country in
which the third-country partners are treated as residents for
tax purposes, as determined under the laws of that country, has
an income tax convention with the other Contracting State, they
may be entitled to claim a benefit under that convention (these
results would also follow in the case of an entity that is
disregarded as an entity separate from its owner under the laws
of one jurisdiction but not the other, such as a single-owner
entity that is viewed as a branch for U.S. tax purposes and as
a corporation for tax purposes under the laws of the other
Contracting State). In contrast, where the entity is organized
under U.S. laws and is classified as a corporation for U.S. tax
purposes, interest paid by a company that is a resident of
Spain to the U.S. corporation will be considered derived by a
resident of the United States since the U.S. corporation is
treated under U.S. taxation laws as a resident of the United
States and as deriving the income.
The same result would be reached even if the tax laws of
Spain would treat the entity differently (e.g., if the entity
were not treated as fiscally transparent in Spain in the first
example above where the entity is treated as a partnership for
U.S. tax purposes). Similarly, the characterization of the
entity by a third country is also irrelevant, even if the
entity is organized in that third country, although in such
cases, subparagraph 6(b) requires that an agreement containing
a provision for the exchange of information be in force between
the source State and the third country.
These principles also apply to trusts to the extent that
they are wholly or partly fiscally transparent in either
Contracting State. For example, suppose that X, a resident of
Spain, creates a revocable trust in the United States and names
persons resident in a third country as the beneficiaries of the
trust. If, under the laws of Spain, X is treated as taking the
trust's income into account for tax purposes, the trust's
income would be regarded as being derived by a resident of
Spain. In contrast, since the determination of deriving an item
of income, profit or gain is made on an item by item basis, it
is possible that, in the case of a U.S. non-grantor trust, the
trust itself may be able to claim benefits with respect to
certain items of income, such as capital gains, so long as it
is a resident liable to tax on such gains, but not with respect
to other items of income that are treated as income of the
trust's interest holders.
As noted above, paragraph 6 is not an exception to the
saving clause of paragraph 4. Accordingly, paragraph 6 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. LLC with members who are residents of Spain
elects to be taxed as a corporation for U.S. tax purposes, the
United States will tax that LLC on its worldwide income on a
net basis, without regard to whether Spain views the LLC as
fiscally transparent.
Paragraph 1 of the Memorandum of Understanding sets forth
the understanding of the Contracting States regarding the
relationship of paragraph 6 with the other provisions of the
Convention. In order to obtain the benefits of the Convention
with respect to an item of income, the person who according to
paragraph 6 derives an item of income must satisfy all
applicable requirements specified in the Convention, including
other applicable requirements of Article 1, the requirements of
Article 4 (Residence), Article 17 (Limitation on Benefits) and
the concepts of beneficial ownership found in Articles 10
(Dividends), 11 (Interest) and 12 (Royalties).
ARTICLE II
Article II of the Protocol amends Article 3 (General
Definitions) of the existing Convention.
Paragraph 1
Paragraph 1 adds a new subparagraph (j) to paragraph 1 of
Article 3. Subparagraph 1(j) defines the term ``pension fund''.
Clause 1(j)(i) provides that in the case of Spain, the term
means any scheme, fund, mutual benefit institution or other
entity established in Spain that satisfies two criteria. First,
as provided in clause 1(j)(i)(A), the person must be operated
principally to manage the right of its beneficiaries to receive
income or capital upon retirement, survivorship, widowhood,
orphanhood, or disability. Second, contributions to the pension
fund must be deductible from the taxable base of personal
taxes.
Subparagraph 3(a) of the Memorandum of Understanding as
corrected by the Exchange of Notes sets forth a non-exhaustive
descriptive list of those U.S. entities that will be regarded
as pension funds for purposes of the Convention. The list
includes: a trust providing pension or retirement benefits
under an Internal Revenue Code section 401(a) qualified pension
plan (which includes a Code section 401(k) plan), a profit
sharing or stock bonus plan, a Code section 403(a) qualified
annuity plan, a Code section 403(b) plan, a trust that is an
individual retirement account under Code section 408, a Roth
individual retirement account under Code section 408A, a simple
retirement account under Code section 408(p), a trust providing
pension or retirement benefits under a simplified employee
pension plan under Code section 408(k), a trust described in
section 457(g) providing pension or retirement benefits under a
Code section 457(b) plan, and the Thrift Savings Fund (section
7701(j)). A group trust described in Revenue Ruling 81-100, as
amended by Revenue Ruling 2004-67 and Revenue Ruling 2011-1,
shall qualify as a pension fund only if it earns income
principally for the benefit of one or more pension funds that
are themselves entitled to benefits under the Convention as
residents of the United States.
Subparagraph 3(b) of the Memorandum of Understanding sets
forth a non-exhaustive descriptive list of those Spanish
entities that will be regarded as pension funds for purposes of
the Convention. The list includes: 1) any fund regulated under
the Amended Test of the Law on pension funds and pension
schemes (Texto Refundido de la Ley sobre Fondos y Planes de
Pensiones), passed by Legislative Royal Decree 1/2002 of
November 29; 2) any entity defined under Article 64 of the
Amended Text of the Law on the regulation and monitoring of
private insurances (Texto Refundido de la Ley de Ordenacion y
Supervision de los Seguros Privados) passed by Legislative
Royal Decree 6/2004 of October 29, provided that in the case of
mutual funds all participants are employees; promoters and
sponsoring partners are the companies, institutions or
individual entrepreneurs to which the employees are engaged;
and benefits are exclusively derived from the social welfare
agreement between both parties, as well as any other comparable
entity regulated within the scope of the political subdivisions
(Comunidades Autonomas); and 3) insurance companies regulated
under the Amended Text of the Law on the regulation and
monitoring of private insurances passed by Legislative Royal
Decree 6/2004 of October 29 whose activity is the coverage of
the contingencies provided for in the Amended Text of the Law
on pension funds and pension schemes.
Clause 1(j)(ii) of new subparagraph 1(j) of Article 3
provides that in the case of the United States, the term
``pension fund'' means any person established in the United
States that is generally exempt from income taxation in the
United States, and is operated principally either to administer
or provide pension or retirement benefits, or to earn income
principally for the benefit of one or more persons established
in the same Contracting State that are generally exempt from
income taxation in that Contracting State and are operated
principally to administer or provide pension or retirement
benefits.
The definition, as it applies in the case of the United
States, recognizes that pension funds sometimes administer or
provide benefits other than pension or retirement benefits,
such as death benefits. However, in order for the fund to be
considered a pension fund for purposes of the Convention, the
provision of any other such benefits must be merely incidental
to the fund's principal activity of administering or providing
pension or retirement benefits. The definition also ensures
that if a fund is a collective fund that earns income for the
benefit of other funds, then substantially all of the funds
that participate in the collective fund must be residents of
the same Contracting State as the collective fund and must be
entitled to benefits under the Convention in their own right.
Paragraph 2
Paragraph 2 replaces paragraph 2 of Article 3 of the
existing Convention. Terms that are not defined in the existing
Convention are dealt with in paragraph 2.
New paragraph 2 of Article 3 provides that in the
application of the Convention, any term used but not defined in
the Convention will have the meaning that it has under the
domestic law of the Contracting State applying the Convention,
unless the context requires otherwise, and subject to the
provisions of Article 26 (Mutual Agreement Procedure). If the
term is defined under both the tax and non-tax laws of a
Contracting State, the definition in the tax law will take
precedence over the definition in the non-tax laws. Finally,
there also may be cases where the tax laws of a State contain
multiple definitions of the same term. In such a case, the
definition used for purposes of the particular provision at
issue, if any, should be used.
The reference in paragraph 2 to the domestic law of a
Contracting State means the law in effect at the time the
treaty is being applied, not the law as in effect at the time
the treaty was signed. The use of ``ambulatory'' definitions,
however, may lead to results that are at variance with the
intentions of the negotiators and of the Contracting States
when the treaty was negotiated and ratified. The inclusion in
both paragraphs 1 and 2 of an exception to the generally
applicable definitions where the ``context otherwise requires''
is intended to address this circumstance. Where reflecting the
intent of the Contracting States requires the use of a
definition that is different from a definition under paragraph
1 or the law of the Contracting State applying the Convention,
that definition will apply. Thus, flexibility in defining terms
is necessary and permitted.
ARTICLE III
Article III of the Protocol replaces paragraph 3 of Article
5 (Permanent Establishment) of the existing Convention.
Paragraph 3 of Article 5 provides rules to determine whether a
building site or a construction, assembly or installation
project, or an installation or drilling rig or ship used for
the exploration of natural resources constitutes a permanent
establishment for the contractor, driller, etc. Such a site or
activity does not create a permanent establishment unless the
site, project, etc. lasts, or the exploration activity
continues, for more than twelve months. It is only necessary to
refer to ``exploration'' and not ``exploitation'' in this
context because exploitation activities are defined to
constitute a permanent establishment under subparagraph (f) of
paragraph 2 of Article 5. Thus, a drilling rig does not
constitute a permanent establishment if a well is drilled in
less than twelve months. However, the well becomes a permanent
establishment as of the date that production begins.
The twelve-month test applies separately to each site or
project. The twelve-month period begins when work (including
preparatory work carried on by the enterprise) physically
begins in a Contracting State. A series of contracts or
projects by a contractor that are interdependent both
commercially and geographically are to be treated as a single
project for purposes of applying the twelve-month threshold
test. For example, the construction of a housing development
would be considered as a single project even if each house were
constructed for a different purchaser.
In applying this paragraph, time spent by a sub-contractor
on a building site is counted as time spent by the general
contractor at the site for purposes of determining whether the
general contractor has a permanent establishment. However, for
the sub-contractor itself to be treated as having a permanent
establishment, the sub-contractor's activities at the site must
last for more than twelve months. For purposes of applying the
twelve-month rule, time is measured from the first day the sub-
contractor is on the site until the last day. Thus, if a sub-
contractor is on a site intermittently, intervening days that
the sub-contractor is not on the site are counted.
These interpretations of the Article are based on the
Commentary to paragraph 3 of Article 5 of the OECD Model, which
contains language that is substantially the same as that in the
Convention. These interpretations are consistent with the
generally accepted international interpretation of the relevant
language in paragraph 3 of Article 5 of the Convention.
If the twelve-month threshold is exceeded, the site or
project constitutes a permanent establishment from the first
day of activity.
ARTICLE IV
Article IV of the Protocol replaces Article 10 (Dividends)
of the existing Convention. New Article 10 provides rules for
the taxation of dividends paid by a company that is a resident
of one Contracting State to a beneficial owner that is a
resident of the other Contracting State. The Article provides
for full residence-State taxation of such dividends and
limitations on (including, in some cases, a prohibition from)
taxation by the source State. New Article 10 also provides
rules for the imposition of a tax on branch profits by the
State of source. Finally, the Article prohibits a State from
imposing taxes on a company resident in the other Contracting
State, other than a branch profits tax, on undistributed
earnings.
Paragraph 1 of New Article 10
Paragraph 1 of new Article 10 permits a Contracting State
to tax its residents on dividends paid to them by a company
that is a resident of the other Contracting State. For
dividends from any other source paid to a resident, Article 23
(Other Income) of the Convention grants the residence country
exclusive taxing jurisdiction (other than for dividends
attributable to a permanent establishment in the other State).
Paragraph 2 of New Article 10
The State of source also may tax dividends beneficially
owned by a resident of the other State, subject to the
limitations of paragraphs 2, 3 and 4. Paragraph 2 of new
Article 10 generally limits the rate of withholding tax in the
State of source on dividends paid by a company resident in that
State to 15 percent of the gross amount of the dividend. If,
however, the beneficial owner of the dividend is a company
resident in the other State and owns directly shares
representing at least 10 percent of the voting power of the
company paying the dividend, then the rate of withholding tax
in the State of source is limited to 5 percent of the gross
amount of the dividend. For application of this paragraph by
the United States, shares are considered voting stock if they
provide the power to elect, appoint or replace any person
vested with the powers ordinarily exercised by the board of
directors of a U.S. corporation.
The determination of whether the ownership threshold for
subparagraph 2(a) is met for purposes of the 5 percent maximum
rate of withholding tax is made on the date on which
entitlement to the dividend is determined. Thus, in the case of
a dividend from a U.S. company, the determination of whether
the ownership threshold is met generally would be made on the
dividend record date.
Paragraph 2 does not affect the taxation of the profits out
of which the dividends are paid. The taxation by a Contracting
State of the income of its resident companies is governed by
the domestic law of the Contracting State, subject to the
provisions of paragraph 4 of Article 25 (Non-Discrimination).
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, generally defined under the
domestic law of the country imposing tax (i.e., the source
country). The beneficial owner of the dividend for purposes of
Article 10 is the person to which the income is attributable
under the laws of the source State. Thus, if a dividend paid by
a corporation that is a resident of one of the States (as
determined under Article 4 (Residence)) is received by a
nominee or agent that is a resident of the other State on
behalf of a person that is not a resident of that other State,
the dividend is not entitled to the benefits of this Article.
However, a dividend received by a nominee on behalf of a
resident of that other State would be entitled to benefits.
These limitations are supported by paragraphs 12-12.2 of the
Commentary to Article 10 of the OECD Model.
Special rules apply to shares held through fiscally
transparent entities both for purposes of determining whether
the ownership threshold has been met and for purposes of
determining the beneficial owner of the dividend.
A company that is a resident of a Contracting State shall
be considered to own directly the voting stock owned by an
entity that is considered fiscally transparent under the laws
of that State and that is not a resident of the other
Contracting State of which the company paying the dividends is
a resident, in proportion to the company's ownership interest
in that entity. This is consistent with the rules of paragraph
6 of Article 1 (General Scope) as revised by Article I, which
provides that residence State principles shall be used to
determine who derives the dividends, to ensure that the
dividends 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.
For example, assume that FCo, a company that is a resident
of the Spain, owns a 50 percent interest in FP, a partnership
that is organized in Spain. FP owns 100 percent of the sole
class of stock of USCo, a company resident in the United
States. Spain views FP as fiscally transparent under its
domestic law, and taxes FCo currently on its distributive share
of the income of FP and determines the character and source of
the income received through FP in the hands of FCo as if such
income were realized directly by FCo. In this case, FCo is
treated as deriving 50 percent of the dividends paid by USCo
under paragraph 6 of Article 1. Moreover, FCo is treated as
owning 50 percent of the stock of USCo directly. The same
result would be reached even if the tax laws of the United
States would treat FP differently (e.g., if FP were not treated
as fiscally transparent in the United States), or if FP were
organized in a third state, provided that that state has an
agreement in force containing a provision for the exchange of
information on tax matters with Spain, which in this example is
the Contracting State from which the dividend arises, and as
long as FP were still treated as fiscally transparent under the
laws of the United States.
While residence State principles control who is treated as
owning voting stock of the company paying dividends through a
fiscally transparent entity and, consequently, who derives the
dividends, source State principles of beneficial ownership
apply to determine whether the person who derives the
dividends, or another resident of the other Contracting State,
is the beneficial owner of the dividends. If the person who
derives the dividends under paragraph 6 of Article 1 would not
be treated as a nominee, agent, custodian, conduit, etc. under
the source State's principles for determining beneficial
ownership, that person will be treated as the beneficial owner
of the dividends for purposes of the Convention. In the example
above, FCo is required to satisfy the beneficial ownership
principles of the United States with respect to the dividends
it derives. If under the beneficial ownership principles of the
United States, FCo is found not to be the beneficial owner of
the dividends, FCo will not be entitled to the benefits of
Article 10 with respect to such dividends. If FCo is found to
be a nominee, agent, custodian, or conduit for a person who is
a resident of the other Contracting State, that person may be
entitled to benefits with respect to the dividends.
Paragraph 3 of New Article 10
Paragraph 3 of new Article 10 provides exclusive residence-
country taxation (i.e., an elimination of withholding tax) with
respect to certain dividends distributed by a company that is a
resident of one Contracting State to a resident of the other
Contracting State. As described further below, this elimination
of withholding tax is available with respect to certain inter-
company dividends and with respect to certain pension funds.
Subparagraph 3(a) provides for the elimination of
withholding tax on dividends beneficially owned by a company
that has owned, directly or indirectly through one or more
residents of either Contracting State, 80 percent or more of
the voting power of the company paying the dividend for the
twelve-month period ending on the date entitlement to the
dividend is determined. The determination of whether the
beneficial owner of the dividends owns at least 80 percent of
the voting power of the company is made by taking into account
stock owned both directly and indirectly through one or more
residents of either Contracting State.
Eligibility for the elimination of withholding tax provided
by subparagraph 3(a) is subject to additional restrictions
based on, and supplementing, the rules of Article 17
(Limitation on Benefits) as that Article has been modified by
Article IX. Accordingly, a company that meets the holding
requirements described above will qualify for the benefits of
paragraph 3 only if it also: (1) meets the ``publicly traded''
test of subparagraph 2(c) of Article 17, (2) meets the
``ownership-base erosion'' and ``active trade or business''
tests described in subparagraph 2(e) and paragraph 4 of Article
17, (3) meets the ``derivative benefits'' test of paragraph 3
of Article 17, or (4) is granted the benefits of paragraph 3 of
Article 10 at the discretion of the competent authority of the
source State pursuant to paragraph 7 of Article 17.
For example, assume that ThirdCo is a company resident in a
third country that does not have a tax treaty with the United
States providing for the elimination of withholding tax on
inter-company dividends. ThirdCo owns directly 100 percent of
the issued and outstanding voting stock of USCo, a U.S.
company, and of SCo, a Spanish company. SCo is a substantial
company that manufactures widgets. USCo distributes those
widgets in the United States. If ThirdCo contributes to SCo all
the stock of USCo, dividends paid by USCo to SCo would qualify
for treaty benefits under the active trade or business test of
paragraph 4 of Article 30. However, allowing ThirdCo to qualify
for the elimination of withholding tax, which is not available
to it under the third state's treaty with the United States (if
any), would encourage treaty shopping.
In order to prevent this type of treaty shopping, paragraph
3 requires SCo to meet the ownership-base erosion requirements
of subparagraph 2(e) of Article 17 as revised by Article IX in
addition to the active trade or business test of paragraph 4 of
Article 17. Because SCo is wholly owned by a third country
resident, SCo could not qualify for the elimination of
withholding tax on dividends from USCo under the combined
ownership-base erosion and active trade or business tests of
subparagraph 3(b). Consequently, SCo would need to qualify
under another test in paragraph 3 or obtain discretionary
relief from the competent authority under Article 17 paragraph
7. For purpose of subparagraph 3(b), it is not sufficient for a
company to qualify for treaty benefits generally under the
active trade or business test or the ownership-base erosion
test unless it qualifies for treaty benefits under both.
Alternatively, companies that are publicly traded or
subsidiaries of publicly-traded companies will generally
qualify for the elimination of withholding tax. Thus, a company
that is a resident of Spain and that meets the requirements of
subparagraph 2(c) of Article 17 will be entitled to the
elimination of withholding tax, subject to the ownership and
holding period requirements.
In addition, under subparagraph 3(c), a company that is a
resident of a Contracting State may also qualify for the
elimination of withholding tax on dividends if it satisfies the
derivative benefits test of paragraph 3 of Article 17, subject
to the ownership and holding period requirements. Thus, a
Spanish company that has owned all of the stock of a U.S.
corporation for the twelve-month period ending on the date on
which entitlement to the dividend is determined may qualify for
the elimination of withholding tax if it is wholly-owned by a
company that falls within the definition of ``equivalent
beneficiary'' in subparagraph 8(g) of Article 17.
The derivative benefits test may also provide benefits to
U.S. companies receiving dividends from Spanish subsidiaries
because of the effect of the Parent-Subsidiary Directive in the
European Union. Under that directive, inter-company dividends
paid within the European Union are free of withholding tax.
Under subparagraph 8(h) of Article 17 that directive will be
taken into account in determining whether the owner of a U.S.
company receiving dividends from a Spanish company is an
equivalent beneficiary. Thus, a company that is a resident of a
member state of the European Union will, by virtue of the
Parent-Subsidiary Directive, satisfy the requirements of
Article subparagraph 8(g)(i)(B) of Article 17 with respect to
any dividends received by its U.S. subsidiary from a Spanish
company. For example, assume USCo is a wholly-owned subsidiary
of ICo, an Italian publicly-traded company. USCo owns all of
the shares of SCo, a Spanish company. If SCo were to pay
dividends directly to ICo, those dividends would be exempt from
withholding tax in Spain by reason of the Parent-Subsidiary
Directive. If ICo meets the other conditions to be an
equivalent beneficiary under subparagraph 8(g) of Article 17,
it will be treated as an equivalent beneficiary.
A company also may qualify for the elimination of
withholding tax pursuant to subparagraph 3(c) if it is owned by
seven or fewer U.S. or Spanish residents who qualify as an
``equivalent beneficiary'' and meet the other requirements of
the derivative benefits provision. This rule may apply, for
example, to certain Spanish corporate joint venture vehicles
that are closely-held by a few Spanish resident individuals.
Subparagraph 8(g) of Article 17 contains a specific rule of
application intended to ensure that for purposes of applying
paragraph 3, certain joint ventures, not just wholly-owned
subsidiaries, can qualify for benefits. For example, assume
that the United States were to enter into a treaty with Country
X, a member of the European Union, that includes a provision
identical to paragraph 3. USCo is 100 percent owned by SCo, a
Spanish company, which in turn is owned 49 percent by PCo, a
Spanish publicly-traded company, and 51 percent by XCo, a
publicly-traded company that is resident in Country X. In the
absence of a special rule for interpreting the derivative
benefits provision, each of PCo and XCo would be treated as
owning only their proportionate share of the shares held by SCo
in USCo. If that rule were applied in this situation, neither
PCo nor XCo would be an equivalent beneficiary, because neither
would meet the 80 percent ownership test with respect to USCo.
However, since both PCo and XCo are residents of countries that
have treaties with the United States that provide for
elimination of withholding tax on inter-company dividends, it
is appropriate to provide benefits to SCo in this case.
Accordingly, the definition of ``equivalent beneficiary''
includes a rule of application that is intended to ensure that
such joint ventures qualify for the benefits of paragraph 3.
Under that rule, each of the shareholders is treated as owning
shares of USCo with the same percentage of voting power as the
shares held by SCo for purposes of determining whether it would
be entitled to an equivalent rate of withholding tax. This rule
is necessary because of the high ownership threshold for
qualification for the elimination of withholding tax on inter-
company dividends.
If a company does not qualify for the elimination of
withholding tax under any of the foregoing objective tests, it
may request a determination from the relevant competent
authority pursuant to paragraph 7 of Article 17.
Paragraph 4 of New Article 10
Paragraph 4 of new Article 10 provides that dividends
beneficially owned by a pension fund may not be taxed in the
Contracting State of which the company paying the tax is a
resident, unless such dividends are derived from the carrying
on of a business, directly or indirectly, by the pension fund
or through an associated enterprise. For purposes of
application of this paragraph by the United States, the term
``trade or business'' shall be defined in accordance with Code
section 513(c). The term ``pension fund'' is defined in
subparagraph 1(j) of Article 3 (General Definitions) of the
Convention, as amended by Article II of the Protocol.
Paragraph 5 of New Article 10
Paragraph 5 of new Article 10 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 state of
source, as well as arrangements that might be developed in the
future.
The term includes income from shares, ``jouissance'' shares
or ``jouissance'' rights, mining shares, founders' shares or
other 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 State of
source, including amounts treated as dividend equivalents under
Code section 871(m). Thus, 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 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, which is taxed as a corporation under U.S. law, is
a dividend for purposes of Article 10. However, a distribution
by a limited liability company is not taxable by the United
States under Article 10, provided the limited liability company
is not characterized as an association taxable as a corporation
under U.S. law. Paragraph 5 also clarifies that the term
``dividends'' does not include distributions that are treated
as gain under the laws of the State of which the company making
the distribution is a resident. In such case, the provisions of
Article 13 (Gains) shall apply (for example, the United States
shall apply Code Section 897(h) and the regulations
thereunder).
Finally, 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.
Paragraph 6 of New Article 10
Paragraph 6 of new Article 10 provides a rule for taxing
dividends paid with respect to holdings that form part of the
business property of a permanent establishment or fixed base.
In such case, the rules of Article 7 (Business Profits) shall
apply. Accordingly, the dividends 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 or
fixed base is located, as such rules may be modified by the
Convention. An example of dividends paid with respect to the
business property of a permanent establishment would be
dividends derived by a dealer in stock or securities from stock
or securities that the dealer held for sale to customers.
Paragraph 7 of New Article 10
The right of a Contracting State to tax dividends paid by a
company that is a resident of the other Contracting State is
restricted by paragraph 7 of new Article 10 to cases in which
the dividends are paid to a resident of that Contracting State
or are effectively connected to a permanent establishment in
that Contracting State. Thus, a Contracting State may not
impose a ``secondary'' withholding tax on dividends paid by a
nonresident company out of earnings and profits from that
Contracting State.
The paragraph also restricts the right of a Contracting
State to impose corporate level taxes on undistributed profits,
other than a branch profits tax. The paragraph does not
restrict a State's right to tax its resident shareholders on
undistributed earnings of a corporation resident in the other
State. Thus, the authority of the United States to impose taxes
on subpart F income and on earnings deemed invested in U.S.
property, and its tax on income of a passive foreign investment
company that is a qualified electing fund is in no way
restricted by this provision.
Paragraph 8 of New Article 10
Paragraph 8 of new Article 10 permits a Contracting State
to impose a branch profits tax on a company resident in the
other Contracting State. The tax is in addition to other taxes
permitted by the Convention. The term ``company'' is defined in
subparagraph 1(e) of Article 3 (General Definitions) of the
Convention.
A Contracting State may impose a branch profits tax on a
company if the company has income attributable to a permanent
establishment in that Contracting State, derives income from
real property (immovable property) in that Contracting State
that is taxed on a net basis under Article 6 (Income from Real
Property (Immovable Property)), or realizes gains taxable in
that State under paragraph 1 of Article 13 (Capital Gains). In
the case of the United States, the imposition of such tax is
limited, however, to the portion of the aforementioned items of
income that represents the amount of such income that is the
``dividend equivalent amount.'' The dividend equivalent amount
for any year approximates the dividend that a U.S. branch
office would have paid during the year if the branch had been
operated as a separate U.S. subsidiary company. This is
consistent with the relevant rules under the U.S. branch
profits tax, and the term dividend equivalent amount is defined
under U.S. law. Section 884 defines the dividend equivalent
amount as an amount for a particular year that is equivalent to
the income described above that is included in the
corporation's effectively connected earnings and profits for
that year, after payment of the corporate tax under Articles 6,
7 (Business Profits) or 13, reduced for any increase in the
branch's U.S. net equity during the year or increased for any
reduction in its U.S. net equity during the year. U.S. net
equity is U.S. assets less U.S. liabilities. See Treas. Reg.
1.884-1. The amount analogous to the dividend equivalent amount
in the case of Spain is the amount of income (Imposicion
Complementaria) determined under the Spanish Non Residents
Income Tax regulated by the Amended Text of Non Residents
Income Tax Law, passed by Legislative Royal Decree 5/2004 of
5th March, as it may be amended from time to time.
As discussed in the Technical Explanation to paragraph 2 of
Article 1 (General Scope), consistency principles prohibit a
taxpayer from applying provisions of the Code and this
Convention in an inconsistent manner in order to minimize tax.
In the context of the branch profits tax, this consistency
requirement means that if a company resident in Spain uses the
principles of Article 7 to determine its U.S. taxable income,
it must then also use those principles to determine its
dividend equivalent amount. Similarly, if the company instead
uses the Code to determine its U.S. taxable income it must also
use the Code to determine its dividend equivalent amount. As in
the case of Article 7, if a Spanish company, for example, does
not from year to year consistently apply the Code or the
Convention to determine its dividend equivalent amount, then
the company must make appropriate adjustments or recapture
amounts that would otherwise be subject to U.S. branch profits
tax if it had consistently applied the Code or the Convention
to determine its dividend equivalent amount from year to year.
Paragraph 9 of New Article 10
Paragraph 9 of new Article 10 limits the rate of the branch
profits tax that may be imposed under paragraph 8 to 5 percent,
as provided in subparagraph 2(a) of Article 10. Paragraph 9
also provides that the branch profits tax shall not be imposed
on a company in any case if certain requirements are met. In
general, these requirements provide rules for a branch that
parallel the rules for when a dividend paid by a subsidiary
will be subject to exclusive residence-country taxation (i.e.,
the elimination of source-country withholding tax).
Accordingly, the branch profits tax cannot be imposed in the
case of a company that satisfies any of the following
requirements set forth in Article 17 (Limitation on Benefits)
as revised by Article IX: (1) the ``publicly traded'' test of
subparagraph 2(c); (2) both the ``ownership-base erosion'' and
``active trade or business'' tests described in subparagraph
2(e) and paragraph 4; (3) the ``derivative benefits'' test of
paragraph 3; or (4) paragraph 7. If the company did not meet
any of those tests, but otherwise qualified for benefits under
Article 17, then the branch profits tax would apply at a rate
of 5 percent as provided in subparagraph 2(a).
Paragraph 9 applies equally if a taxpayer determines its
taxable income under the laws of a Contracting State or under
the provisions of Article 7 (Business Profits). For example, as
discussed above, consistency principles require a company
resident in Spain that determines its U.S. taxable income under
the Code to also determine its dividend equivalent amount under
the Code. In that case, the withholding rate reduction provided
in subparagraph 2(a) would apply even though the company did
not determine its dividend equivalent amount using the
principles of Article 7.
ARTICLE V
Article V of the Protocol replaces Article 11 (Interest) of
the existing Convention. New Article 11 specifies the taxing
jurisdictions over interest income of the States of source and
residence and defines the terms necessary to apply the Article.
Paragraph 1 of New Article 11
Paragraph 1 of new Article 11 generally grants to the State
of residence the exclusive right to tax interest beneficially
owned by its residents and arising in the other Contracting
State.
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined under the domestic law
of the State of source. The beneficial owner of the interest
for purposes of Article 11 is the person to which the income is
attributable under the laws of the source State. Thus, if
interest arising in a Contracting State is received by a
nominee or agent that is a resident of the other State on
behalf of a person that is not a resident of that other State,
the interest is not entitled to the benefits of Article 11.
However, interest received by a nominee on behalf of a resident
of that other State would be entitled to benefits. These
limitations are confirmed by paragraph 9 of the OECD Commentary
to Article 11.
Special rules apply to interest derived through fiscally
transparent entities for purposes of determining the beneficial
owner of the interest. In such cases, residence State
principles shall be used to determine who derives the interest,
to assure that the interest 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.
For example, assume that FCo, a company that is a resident
of Spain, owns a 50 percent interest in FP, a partnership that
is organized in Spain. FP receives interest arising in the
United States. Spain views FP as fiscally transparent under its
domestic law, and taxes FCo currently on its distributive share
of the income of FP and determines the character and source of
the income received through FP in the hands of FCo as if such
income were realized directly by FCo. In this case, FCo is
treated as deriving 50 percent of the interest received by FP
that arises in the United States under paragraph 6 of Article
1. The same result would be reached even if the tax laws of the
United States would treat FP differently (e.g., if FP were not
treated as fiscally transparent in the United States), or if FP
were organized in a third state, provided such state has an
agreement in force containing a provision for the exchange of
information on tax matters with Spain, which in this example is
the Contracting State from which the interest arises, and as
long as FP were still treated as fiscally transparent under the
laws of the United States.
While residence State principles control who is treated as
deriving the interest, source State principles of beneficial
ownership apply to determine whether the person who derives the
interest, or another resident of the other Contracting State,
is the beneficial owner of the interest. If the person who
derives the interest under paragraph 6 of Article 1 would not
be treated as a nominee, agent, custodian, conduit, etc. under
the source State's principles for determining beneficial
ownership, that person will be treated as the beneficial owner
of the interest for purposes of the Convention. In the example
above, FCo is required to satisfy the beneficial ownership
principles of the United States with respect to the interest it
derives. If under the beneficial ownership principles of the
United States, FCo is found not to be the beneficial owner of
the interest, FCo will not be entitled to the benefits of
Article 11 with respect to such interest. If FCo is found to be
a nominee, agent, custodian, or conduit for a person who is a
resident of the other Contracting State, that person may be
entitled to benefits with respect to the interest.
Paragraph 2 of New Article 11
Paragraph 2 of new Article 11 provides anti-abuse
exceptions to the source-country exemption in paragraph 1 for
two classes of interest payments arising in the United States.
The first class of interest, dealt with in subparagraph
2(a) is so-called ``contingent interest'' that does not qualify
as portfolio interest under U.S. domestic law as defined in
Code section 871(h)(4). The exceptions of section 871(h)(4)(c)
will be applicable. If the beneficial owner of the contingent
interest is a resident of Spain, subparagraph 2(a) provides
that the gross amount of the interest may be taxed at a rate
not exceeding 10 percent.
The second class of interest is dealt with in subparagraph
2(b). 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.
Paragraph 3 of New Article 11
Paragraph 3 of new Article 11 provides a definition of the
term ``interest'' for purposes of the Article that is
essentially identical to that provided in paragraph 4 of
Article 11 of the existing Convention. The term ``interest'' as
used in Article 11 is defined in paragraph 3 to include, inter
alia, income from debt claims of every kind, whether or not
secured by a mortgage and whether or not carrying a right to
participate in the debtor's profits. The term does not,
however, include amounts that are treated as dividends under
Article 10 (Dividends), nor does it include penalty charges for
late payment.
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
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 recharacterized as loans because of a
``substantial non-periodic payment.''
Paragraph 4 of New Article 11
Paragraph 4 of new Article 11 is identical in substance to
paragraph 5 of Article 11 of the existing Convention. Paragraph
4 provides an exception to the exclusive residence taxation
rule of paragraph 1 and the source State gross taxation rule of
paragraph 2 in cases where the beneficial owner of the interest
carries on or has carried on business through a permanent
establishment situated in that State, or performs or has
performed independent personal services through a fixed base
situated in that state, and the debt-claim in respect of which
the interest is paid is effectively connected with such
permanent establishment or fixed base. In such cases the
provisions of Article 7 (Business Profits) or Article 15
(Independent Personal Servicers), as the case may be, will
apply and the State of source will retain the right to impose
tax on such interest income.
In the case of a permanent establishment or fixed base that
once existed in a Contracting State but no longer exists, the
provisions of this paragraph shall apply to interest paid with
respect to a debt-claim that would be effectively connected to
such a permanent establishment or fixed base if it did exist in
the year of payment or accrual. Accordingly, such interest
would remain taxable under the provisions of Article 7 or 15,
as the case may be, and not under this Article.
Paragraph 5 of New Article 11
Paragraph 5 of new Article 11 provides a source rule for
interest that is identical in substance to the interest source
rule of the existing Convention. Interest is considered to
arise in a Contracting State if paid by a resident of that
State. However, interest that is borne by a permanent
establishment or fixed base in one of the Contracting States is
considered to arise in that State. For this purpose, interest
is considered to be borne by a permanent establishment or fixed
base if it is allocable to taxable income of that permanent
establishment or fixed base. If the actual amount of interest
on the books of a U.S. branch of a resident of Spain exceeds
the amount of interest allocated to the branch under Treas.
Reg. 1.882-5, the amount of such excess will not be considered
U.S. source interest for purposes of this Article.
Paragraph 6 of New Article 11
Paragraph 6 of new Article 11 is identical to paragraph 7
of Article 11 of the existing Convention. Paragraph 5 provides
that in cases involving special relationships between the payor
and the beneficial owner of interest income, Article 11 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 the other Contracting State, respectively, with due regard
to the other provisions of the Convention. Thus, if the excess
amount would be treated under the source country's law as a
distribution of profits by a corporation, such amount could be
taxed as a dividend rather than as interest, but the tax would
be subject, if appropriate, to the rate limitations of
paragraph 2 of Article 10 (Dividends).
The term ``special relationship'' is not defined in the
Convention. In applying this paragraph the United States
considers the term to include the relationships described in
Article 9, which in turn corresponds to the definition of
``control'' for purposes of Code section 482.
This paragraph does not address cases where, owing to a
special relationship between the payer and the beneficial owner
or between both of them and some other person, the amount of
the interest is less than an arm's-length amount. In those
cases a transaction may be characterized to reflect its
substance and interest may be imputed consistent with the
definition of ``interest'' in paragraph 3. The United States
would apply Code section 482 or 7872 to determine the amount of
imputed interest in those cases.
Relation to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of interest, the saving clause of subparagraph 3 of
Article 1 (General Scope) permits the United States to tax its
residents and citizens, subject to the special foreign tax
credit rules of paragraph 3 of Article 24 (Relief from Double
Taxation), as if the Convention had not come into force.
The benefits of this Article are also subject to the
provisions of Article 17 (Limitation on Benefits). Thus, if a
resident of Spain is the beneficial owner of interest paid by a
U.S. corporation, the resident must qualify for treaty benefits
under at least one of the tests of Article 17 in order to
receive the benefits of this Article.
ARTICLE VI
Article VI of the Protocol replaces Article 12 (Royalties)
of the existing Convention. New Article 12 provides rules for
the taxation of royalties arising in one Contracting State and
paid to a beneficial owner that is a resident of the other
Contracting State.
Paragraph 1 of New Article 12
Paragraph 1 of new Article 12 generally grants to the State
of residence the exclusive right to tax royalties beneficially
owned by its residents and arising in the other Contracting
State.
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined under the domestic law
of the State of source. The beneficial owner of the royalties
for purposes of Article 12 is the person to which the income is
attributable under the laws of the source State. Thus, if
royalties arising in a Contracting State are received by a
nominee or agent that is a resident of the other State on
behalf of a person that is not a resident of that other State,
the royalties are not entitled to the benefits of Article 12.
However, the royalties received by a nominee on behalf of a
resident of that other State would be entitled to benefits.
These limitations are confirmed by paragraph 4 of the OECD
Commentary to Article 12.
Special rules apply to royalties derived through fiscally
transparent entities for purposes of determining the beneficial
owner of the royalties. In such cases, residence State
principles shall be used to determine who derives the
royalties, to assure that the royalties 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.For example, assume that FCo, a company that is a
resident of Spain, owns a 50 percent interest in FP, a
partnership that is organized in Spain. FP receives royalties
arising in the United States. Spain views FP as fiscally
transparent under its domestic law, and taxes FCo currently on
its distributive share of the income of FP and determines the
character and source of the income received through FP in the
hands of FCo as if such income were realized directly by FCo.
In this case, FCo is treated as deriving 50 percent of the
royalties received by FP that arise in the United States under
paragraph 6 of Article 1. The same result would be reached even
if the tax laws of the United States would treat FP differently
(e.g., if FP were not treated as fiscally transparent in the
United States), or if FP were organized in a third state,
provided that that state has an agreement in force containing a
provision for the exchange of information on tax matters with
Spain, which in this example is the the Contracting State from
which the royalty arises, and as long as FP were still treated
as fiscally transparent under the laws of the United States.
While residence State principles control who is treated as
deriving the royalties, source State principles of beneficial
ownership apply to determine whether the person who derives the
royalties, or another resident of Spain, is the beneficial
owner of the royalties. If the person who derives the royalties
under paragraph 6 of Article 1 would not be treated as a
nominee, agent, custodian, conduit, etc. under the source
State's principles for determining beneficial ownership, that
person will be treated as the beneficial owner of the royalties
for purposes of the Convention. In the example above, FCo is
required to satisfy the beneficial ownership principles of the
United States with respect to the royalties it derives. If
under the beneficial ownership principles of the United States,
FCo is found not to be the beneficial owner of the royalties,
FCo will not be entitled to the benefits of Article 12 with
respect to such royalties. If FCo is found to be a nominee,
agent, custodian, or conduit for a person who is a resident of
Spain, that person may be entitled to benefits with respect to
the royalties.
Paragraph 2 of New Article 12
Paragraph 2 of new Article 12 defines the term
``royalties,'' as used in Article 12, to include any
consideration for the use of, or the right to use, any
copyright of literary, artistic scientific or other work
(including cinematographic films, and films and recordings for
radio or television broadcasting), any patent, trademark,
design or model, plan, secret formula or process, or for
information concerning industrial, commercial, or scientific
experience. The term ``royalties'' does not include income from
leasing personal property.
The term royalties is defined in the Convention and
therefore is generally independent of domestic law. Certain
terms used in the definition are not defined in the Convention,
but these may be defined under domestic tax law. For example,
the term ``secret process or formula'' is found in the Code,
and its meaning has been elaborated in the context of sections
351 and 367. See Rev. Rul. 55-17, 1955-1 C.B. 388; Rev. Rul.
64-56, 1964-1 C.B. 133; Rev. Proc. 69- 19, 1969-2 C.B. 301.
Consideration for the use or right to use cinematographic
films, or works on film, tape, or other means of reproduction
in radio or television broadcasting is specifically included in
the definition of royalties. It is intended that, with respect
to any subsequent technological advances in the field of radio
or television broadcasting, consideration received for the use
of such technology will also be included in the definition of
royalties.
If an artist who is resident in one Contracting State
records a performance in the other Contracting State, retains a
copyrighted interest in a recording, and receives payments for
the right to use the recording based on the sale or public
playing of the recording, then the right of such other
Contracting State to tax those payments is governed by Article
12. See Boulez v. Commissioner, 83 T.C. 584 (1984), aff'd, 810
F.2d 209 (D.C. Cir. 1986). By contrast, if the artist earns in
the other Contracting State income covered by Article 19
(Artistes and Athletes), for example, endorsement income from
the artist's attendance at a film screening, and if such income
also is attributable to one of the rights described in Article
12 (e.g., the use of the artist's photograph in promoting the
screening), Article 19 and not Article 12 is applicable to such
income.
Computer software generally is protected by copyright laws
around the world. Under the Convention, consideration received
for the use, or the right to use, computer software is treated
either as royalties or as business profits, depending on the
facts and circumstances of the transaction giving rise to the
payment.
The primary factor in determining whether consideration
received for the use, or the right to use, computer software is
treated as royalties or as business profits is the nature of
the rights transferred. See Treas. Reg. 1.861-18. The fact that
the transaction is characterized as a license for copyright law
purposes is not dispositive. For example, a typical retail sale
of ``shrink wrap'' software generally will not be considered to
give rise to royalty income, even though for copyright law
purposes it may be characterized as a license.
The means by which the computer software is transferred are
not relevant for purposes of the analysis. Consequently, if
software is electronically transferred but the rights obtained
by the transferee are substantially equivalent to rights in a
program copy, the payment will be considered business profits.
The term ``industrial, commercial, or scientific
experience'' (sometimes referred to as ``know-how'') has the
meaning ascribed to it in paragraph 11 et seq. of the
Commentary to Article 12 of the OECD Model. Consistent with
that meaning, the term may include information that is
ancillary to a right otherwise giving rise to royalties, such
as a patent or secret process.
Know-how also may include, in limited cases, technical
information that is conveyed through technical or consultancy
services. It does not include general educational training of
the user's employees, nor does it include information developed
especially for the user, such as a technical plan or design
developed according to the user's specifications. Thus, as
provided in paragraph 11.3 of the Commentary to Article 12 of
the OECD Model, the term ``royalties'' does not include
payments received as consideration for after-sales service, for
services rendered by a seller to a purchaser under a warranty,
or for pure technical assistance.
The term ``royalties'' also does not include payments for
professional services (such as architectural, engineering,
legal, managerial, medical or software development services).
For example, income from the design of a refinery by an
engineer (even if the engineer employed know-how in the process
of rendering the design) or the production of a legal brief by
a lawyer is not income from the transfer of know-how taxable
under Article 12, but is income from services taxable under
either Article 15 (Independent Personal Services) or Article 16
(Dependent Personal Services) as applicable. Professional
services may be embodied in property that gives rise to
royalties, however. Thus, if a professional contracts to
develop patentable property and retains rights in the resulting
property under the development contract, subsequent license
payments made for those rights would be royalties.
Paragraph 3 of New Article 12
This paragraph provides an exception to the rule of
paragraph 1 that gives the State of residence exclusive taxing
jurisdiction in cases where the beneficial owner of the
royalties carries on or has carried on a business through a
permanent establishment or performs or has performed personal
services from a fixed base in the state of source and the right
or property in respect of which the royalties are paid is
effectively connected with that permanent establishment or
fixed base. In such cases the provisions of Article 7 (Business
Profits) or Article 15 (Independent Personal Services) will
apply.
In the case of a permanent establishment that once existed
in a Contracting State but that no longer exists, the
provisions of this paragraph also apply to royalties paid with
respect to rights or property that would be effectively
connected to such permanent establishment if it did exist in
the year of payment or accrual. Accordingly, such royalties
would remain taxable under the provisions of Article 7, and not
under this Article.
Paragraph 4 of New Article 12
Paragraph 4 of new Article 12 provides that in cases
involving special relation-ships between the payor and
beneficial owner of royalties, Article 12 applies only to the
extent the royalties would have been paid absent such special
relationships (i.e., an arm's-length royalty). Any excess
amount of royalties paid remains taxable according to the laws
of the two Contracting States, with due regard to the other
provisions of the Convention. If, for example, the excess
amount is treated as a distribution of corporate profits under
domestic law, such excess amount will be taxed as a dividend
rather than as royalties, but the tax imposed on the dividend
payment will be subject to the rate limitations of paragraph 2
of Article 10 (Dividends).
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of royalties, the saving clause of paragraph 3 of
Article 1 (General Scope) permits the United States to tax its
residents and citizens, subject to the special foreign tax
credit rules of paragraph 3 of Article 24 (Relief from Double
Taxation), as if the Convention had not come into force.
As with other benefits of the Convention, the benefits of
exclusive residence State taxation of royalties under paragraph
1 of Article 12 are available to a resident of the other State
only if that resident is entitled to those benefits under
Article 17 (Limitation on Benefits).
ARTICLE VII
Article VII of the Protocol makes amendments to Article 13
(Capital Gains) of the existing Convention.
Paragraph 1
Paragraph 1 of Article VII replaces paragraph 4 of existing
Article 13. Because of the deletion of paragraph 4 of the
existing Article, gains from the alienation of stock,
participations or other rights in the capital of a company
shall be taxed in accordance with the general rules of the
Article. Revised paragraph 4 reflects Spain's prevailing tax
treaty policy. Under the paragraph, a Contracting State may tax
the gain from the alienation of shares of other rights, which
directly or indirectly entitled the owner of such shares or
rights to the enjoyment of immovable property situated in such
Contracting State.
Paragraph 2
Paragraph 2 replaces paragraphs 6 and 7 of Article 13 of
the existing Convention. New paragraph 6 of revised Article 13
provides that gains from the alienation of any property other
than property referred to in paragraph 1 through 5 will be
taxable only in the state of residence of the person alienating
the property.
ARTICLE VIII
In a conforming change to the restatement of Article 10
(Dividends) of the existing Convention under Article IV of the
Protocol, Article VIII of the Protocol deletes Article 14
(Branch Tax) of the existing Convention.
ARTICLE IX
Article IX of the Protocol replaces Article 17 (Limitation
on Benefits) of the existing Convention. New Article 17
contains anti-treaty-shopping provisions that are intended to
prevent residents of third countries from benefiting from what
is intended to be a reciprocal agreement between two countries.
In general, the provision does not rely on a determination of
purpose or intention but instead sets forth a series of
objective tests. A resident of a Contracting State that
satisfies one of the tests will receive benefits regardless of
its motivations in choosing its particular business structure.
The structure of the revised Article is as follows:
Paragraph 1 states the general rule that residents are entitled
to benefits otherwise accorded to residents only to the extent
provided in the Article. Paragraph 2 lists a series of
attributes of a resident of a Contracting State, the presence
of any one of which will entitle that person to all the
benefits of the Convention. Paragraph 3 provides a derivative
benefits rule. Paragraph 4 provides that, regardless of whether
a person qualifies for benefits under paragraph 2, benefits may
be granted to that person with regard to certain income earned
in the conduct of an active trade or business. Paragraph 5
provides a test for headquarters companies. Paragraph 6
provides a special rule for so-called ``triangular cases''
notwithstanding the other provisions of new Article 17.
Paragraph 7 sets forth rules for the competent authorities of
the Contracting States to apply to determine if a resident
which cannot satisfy any of the tests in paragraphs 2, 3, 4 or
5 should nevertheless be entitled to a benefits provided in the
Convention. Paragraph 8 defines certain terms used in the
Article.
Paragraph 1 of New Article 17
Paragraph 1 of new Article 17 provides that a resident of a
Contracting State will be entitled to the benefits otherwise
accorded to residents of a Contracting State under the
Convention only to the extent provided in the Article. The
benefits otherwise accorded to residents under the Convention
include all limitations on source-based taxation under Articles
6 (Income from Real Property (Immovable Property) through 16
(Dependent Personal Services) and 18 (Director's Fees) through
23 (Other Income), the treaty-based relief from double taxation
provided by Article 24 (Relief from Double Taxation), and the
protection afforded to residents of a Contracting State under
Article 25 (Non-Discrimination). Some provisions do not require
that a person be a resident in order to enjoy the benefits of
those provisions. For example, Article 26 (Mutual Agreement
Procedure) is not limited to residents of the Contracting
States, and Article 28 (Diplomatic Agents and Consular
Officers) applies to diplomatic agents or consular officials
regardless of residence. Article 17 accordingly does not limit
the availability of treaty benefits under these provisions.
Article 17 and the anti-abuse provisions of domestic law
complement each other, as Article 17 effectively determines
whether an entity has a sufficient nexus to the Contracting
State to be treated as a resident for treaty purposes, while
domestic anti-abuse provisions (e.g., business purpose,
substance-over-form, step transaction or conduit principles)
determine whether a particular transaction should be recast in
accordance with its substance. Thus, domestic law principles of
the source Contracting State may be applied to identify the
beneficial owner of an item of income, and Article 17 then will
be applied to the beneficial owner to determine if that person
is entitled to the benefits of the Convention with respect to
such income.
Paragraph 2 of New Article 17
Paragraph 2 of new Article 17 has five subparagraphs, each
of which describes a category of residents that will be
considered qualified persons.
It is intended that the provisions of paragraph 2 will be
self-executing. Unlike the provisions of paragraph 7 of the new
Article, discussed below, claiming benefits under paragraph 2
does not require advance competent authority ruling or
approval. 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.
Individuals--Subparagraph 2(a)
Subparagraph 2(a) provides that individual residents of a
Contracting State will be considered qualified persons. If such
an individual receives income as a nominee on behalf of a third
country resident, benefits may be denied under the applicable
Articles of the Convention by the requirement that the
beneficial owner of the income be a resident of a Contracting
State.
Governments--Subparagraph 2(b)
Subparagraph 2(b) provides that the Contracting States and
any political subdivision or local authority or wholly-owned
instrumentality thereof will be considered qualified persons.
Publicly-Traded Corporations--Subparagraph 2(c)(i)
Subparagraph 2(c) applies to two categories of companies:
publicly traded companies and subsidiaries of publicly traded
companies. A company resident in a Contracting State will be
considered a qualified person under clause (i) of subparagraph
(c) if the principal class of its shares, and any
disproportionate class of shares, is regularly traded on one or
more recognized stock exchanges and the company satisfies at
least one of the following additional requirements. First,
under clause A) in the case of a company resident in Spain, the
company's principal class of shares must be primarily traded on
one or more recognized stock exchanges located either in Spain
or within the European Union, and in the case of a company
resident in the United States, the company's principal class or
shares must be primarily traded on a recognized stock exchange
located either in the United States or in another state that is
a party to the North American Free Trade Agreement. If the
company's principal class of shares does not satisfy the
trading requirement set forth in clause A), clause B) provides
that the regularly-traded company can nevertheless satisfy the
requirements of clause (i) if the company's primary place of
management and control is in its State of residence.
The term ``recognized stock exchange'' is defined in
subparagraph 8(a) of revised Article 17. It includes (i) any
stock exchange registered with the Securities and Exchange
Commission as a national securities exchange for purposes of
the Securities Exchange Act of 1934; (ii) any Spanish stock
exchange controlled by the Comision Nacional del Mercado de
Valores; (iii) the principal stock exchanges of Stuttgart,
Hamburg, Dusseldorf, Frankfurt, Berlin, Hannover, Munich,
London, Amsterdam, Milan, Budapest, Lisbon, Toronto, Mexico
City and Buenos Aires, and (iv) any other stock exchange agreed
upon by the competent authorities of the Contracting States.
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''. Subparagraph 8(e) clarifies that the term
``shares'' includes depository receipts thereof. The term
``principal class of shares'' is defined in subparagraph 8(b)
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
shares, 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 be
considered a qualified person 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 8(c). 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
resident in Spain the other Contracting State 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.
The following example illustrates this result.
Example. OCo is a corporation resident in Spain. OCo has
two classes of shares: Common and Preferred. The Common shares
are listed and regularly traded on a Spanish stock exchange
controlled by the Comision Nacional del Mercado de Valores. 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 regularly traded on a recognized stock exchange, OCo
will not qualify for benefits under subparagraph (c) of
paragraph 2.
The term ``regularly traded'' is not defined in the
Convention. In accordance with paragraph 2 of Article 3
(General Definitions), this term will be defined by reference
to the domestic tax laws of the State from which treaty
benefits 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. 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 regular trading requirement can be met by trading on
any recognized exchange or exchanges located in either State.
Trading on one or more recognized stock exchanges 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 any recognized stock exchange.
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 3
(General Definitions), 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. 1.884-5(d)(3), 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 in the
Contracting State of which the company is a resident exceeds
the number of shares in the company's principal class of shares
that are traded during that year on established securities
markets in any other single foreign country.
A company whose principal class of shares is regularly
traded on a recognized exchange but cannot meet the primarily
traded test may claim treaty benefits if its primary place of
management and control is in its country of residence. This
test is distinct from the ``place of effective management''
test which is used in the OECD Model and by many other
countries to establish residence. In some cases, the place of
effective management test has been interpreted to mean the
place where the board of directors meets. By contrast, the
primary place of management and control test looks to where
day-to-day responsibility for the management of the company
(and its subsidiaries) is exercised. The company's primary
place of management and control will be located in the State in
which the company is a resident only if the executive officers
and senior management employees exercise day-to-day
responsibility for more of the strategic, financial and
operational policy decision making for the company (including
direct and indirect subsidiaries) in that State than in the
other State or any third state, and the staff that support the
management in making those decisions are also based in that
State. Thus, the test looks to the overall activities of the
relevant persons to see where those activities are conducted.
In most cases, it will be a necessary, but not a sufficient,
condition that the headquarters of the company (that is, the
place at which the CEO and other top executives normally are
based) be located in the Contracting State of which the company
is a resident.
To apply the test, it will be necessary to determine which
persons are to be considered ``executive officers and senior
management employees''. In most cases, it will not be necessary
to look beyond the executives who are members of the Board of
Directors (the ``inside directors'') in the case of a U.S.
company. That will not always be the case, however; in fact,
the relevant persons may be employees of subsidiaries if those
persons make the strategic, financial and operational policy
decisions. Moreover, it would be necessary to take into account
any special voting arrangements that result in certain board
members making certain decisions without the participation of
other board members.
Subsidiaries of Publicly-Traded Corporations--Subparagraph
2(c)(ii)
A company resident in a Contracting State is entitled to
all the benefits of the Convention under clause (ii) of
subparagraph (c) of paragraph 2 if five or fewer publicly
traded companies described in clause (i) are the direct or
indirect owners of at least 50 percent of the aggregate vote
and value of the company's shares (and at least 50 percent of
any disproportionate class of shares). If the publicly-traded
companies are indirect owners, however, each of the
intermediate companies must be a resident of one of the
Contracting States.
Thus, for example, a company that is a resident of Spain,
all the shares of which are owned by another company that is a
resident of Spain, would qualify for benefits under 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
in Spain (or within the European Union). However, such a
subsidiary would not qualify for benefits under clause (ii) if
the publicly traded parent company were a resident of a third
state, for example, and not a resident of the United States or
Spain. Furthermore, if a parent company in Spain indirectly
owned the bottom-tier company through a chain of subsidiaries,
each such subsidiary in the chain, as an intermediate owner,
must be a resident of the United States or Spain in order for
the subsidiary to meet the test in clause (ii).
Tax Exempt Organizations--Subparagraph 2(d)
Subparagraph 2(d) set forth a limitation on benefits rule
for persons referred to in paragraph 4 of the Memorandum of
Understanding, which provides that the United States and Spain
follow the positions described in paragraph 8.6 of the
Commentary to Article 4 (Resident) of the OECD Model. Under
clause (i) of subparagraph 2(d), a tax-exempt organization
other than a pension fund automatically shall be considered a
qualified person without regard to the residence of its
beneficiaries or members. Entities qualifying under this rule
generally are those that are exempt from tax in their State of
residence and that are organized and operated exclusively to
fulfill religious, charitable, scientific, artistic, cultural,
or educational purposes.
Clause (ii) of paragraph 2(d), sets forth a rule to
determine when pension funds described in subparagraph 1(j) of
Article 3 (General Definitions) will be considered qualified
persons. Clause (A) provides that pension funds described in
clauses (i) and (ii)(A) of subparagraph 1(j) of Article 3 will
be considered qualified persons if more than fifty percent of
the beneficiaries, members or participants of the organization
are individuals resident in either Contracting State. For
purposes of this provision, the term ``beneficiaries'' should
be understood to refer to the persons receiving benefits from
the organization. Pension funds described in clause (ii)(B) of
subparagraph 1(j) will be qualified persons if all of the
persons for which such pension fund earns income satisfy the
requirements of clause (A) of subparagraph 2(d).
Ownership/Base Erosion--Subparagraph 2(e)
Subparagraph 2(e) provides an additional method to qualify
for treaty benefits that applies to any form of legal entity
that is a resident of a Contracting State. The test provided in
subparagraph (e), the so-called ownership and base erosion
test, is a two-part test. Both prongs of the test must be
satisfied for the resident to be entitled to treaty benefits
under subparagraph 2(e).
The ownership prong of the test, under clause (i), requires
that 50 percent or more of each class of shares or other
beneficial interests in the person is owned, directly or
indirectly, on at least half the days of the person's taxable
year by persons who are residents of the Contracting State of
which that person is a resident and that are themselves
entitled to treaty benefits under subparagraphs (a), (b), (d)
or clause (i) of subparagraph (c) of paragraph 2. In the case
of indirect owners, however, each of the intermediate owners
must be a resident of that Contracting State.
Trusts may be entitled to benefits under this provision if
they are treated as residents under Article 4 (Residence) and
they otherwise satisfy the requirements of this subparagraph.
For purposes of this subparagraph, the beneficial interests in
a trust will be considered to be owned by its beneficiaries in
proportion to each beneficiary's actuarial interest in the
trust. The interest of a remainder beneficiary will be equal to
100 percent less the aggregate percentages held by income
beneficiaries. A beneficiary's interest in a trust will not be
considered to be owned by a person entitled to benefits under
the other provisions of paragraph 2 if it is not possible to
determine the beneficiary's actuarial interest. Consequently,
if it is not possible to determine the actuarial interest of
the beneficiaries in a trust, the ownership test under clause
i) cannot be satisfied, unless all possible beneficiaries are
persons entitled to benefits under the other subparagraphs of
paragraph 2.
The base erosion prong of clause (ii) of subparagraph (e)
is satisfied with respect to a person if less than 50 percent
of the person's gross income for the taxable year, as
determined under the tax law in the person's State of
residence, is paid or accrued to persons who are not residents
of either Contracting State entitled to benefits under
subparagraphs (a), (b), (d) or clause (i) of subparagraph (c)
of paragraph 2, in the form of payments deductible for tax
purposes in the payer's State of residence. These amounts do
not include arm's-length payments in the ordinary course of
business for services or tangible property or payments in
respect of financial obligations to a bank that is not related
to the payer. To the extent they are deductible from the
taxable base, trust distributions are deductible payments.
However, depreciation and amortization deductions, which do not
represent payments or accruals to other persons, are
disregarded for this purpose.
Paragraph 3 of New Article 17
Paragraph 3 of new Article 17 sets forth a ``derivative
benefits'' test that is potentially applicable to all treaty
benefits, although the test is applied to individual items of
income. In general, a derivative benefits test entitles certain
companies that are residents of a Contracting State to treaty
benefits if the owner of the company would have been entitled
to the same benefit had the income in question flowed directly
to that owner. To qualify under this paragraph, the company
must meet an ownership test and a base erosion test.
Subparagraph 3(a) sets forth the ownership test. Under this
test, seven or fewer equivalent beneficiaries must own shares
representing at least 95 percent of the aggregate voting power
and value of the company and at least 50 percent of any
disproportionate class of shares. Ownership may be direct or
indirect, although in the case of indirect ownership, each
intermediate owner must be a resident of a member state of the
European Union or any party to the North American Free Trade
Agreement.
The term ``equivalent beneficiary'' is defined in
subparagraph 8(g). This definition may be met in two
alternative ways.
Under the first alternative, a person may be an equivalent
beneficiary because it is entitled to equivalent benefits under
a tax treaty between the country of source and the country in
which the person is a resident. This alternative has two
requirements.
The first requirement as set forth in clause (i) of
subparagraph 8(g) is that the person must be a resident of a
member state of the European Union or of a party to the North
American Free Trade Agreement (collectively, ``qualifying
States''). In addition, the person must be entitled to all the
benefits of a comprehensive tax treaty between the Contracting
State from which benefits of the Convention are claimed and a
qualifying state under provisions that are analogous to the
rules in subparagraphs 2(a), 2(b), 2(c)(i), or 2(d) of this
Article. If the treaty in question does not have a
comprehensive limitation on benefits article, this requirement
is met only if the person would be entitled to treaty benefits
under the tests in subparagraphs 2(a), 2(b), 2(c)(i), or 2(d)
of this Article if the person were a resident of one of the
Contracting States.
Clause (i)(B) of subparagraph 8(g) requires that with
respect to insurance premiums, dividends (including branch
profits), interest, and royalties, the person must be entitled
to a rate of tax that is at least as low as the tax rate that
would apply under the Convention to such income. Thus, the
rates to be compared are: (1) the rate of tax that the source
State would have imposed if a qualified resident of the other
Contracting State was the beneficial owner of the income; and
(2) the rate of tax that the source State would have imposed if
the third state resident had received the income directly from
the source State.
Subparagraph 8(g) provides a special rule to take account
of the fact that withholding taxes on many inter-company
dividends, interest and royalties are exempt within the
European Union by reason of various EU directives, rather than
by tax treaty. If a U.S. company is owned by a company resident
in a member state of the European Union that would have
qualified for an exemption from withholding tax if it had
received the income directly and receives such payments from a
Spanish company, the parent company will be treated as an
equivalent beneficiary. This rule is necessary because many
European Union member countries have not re-negotiated their
tax treaties to reflect the exemptions available under the
directives.
The requirement that a person be entitled to ``all the
benefits'' of a comprehensive tax treaty eliminates those
persons that qualify for benefits with respect to only certain
types of income. Accordingly, the fact that a French parent of
a Spanish company is engaged in the active conduct of a trade
or business in France and therefore would be entitled to the
benefits of the U.S.-France treaty if it received dividends
directly from a U.S. subsidiary of the Spanish company will not
qualify such French company as an equivalent beneficiary.
Further, the French company cannot be an equivalent beneficiary
if it qualifies for benefits only with respect to certain
income as a result of a ``derivative benefits'' provision in
the U.S.-France treaty. However, because such French company is
a resident of a qualifying state, it would be possible to look
through the French company to its parent company to determine
whether the parent company is an equivalent beneficiary.
The second alternative for satisfying the ``equivalent
beneficiary'' test is available only to residents of one of the
two Contracting States. U.S. or Spanish residents who are
eligible for treaty benefits by reason of subparagraphs 2(a),
2(b), 2(c)(i), or 2(d) are equivalent beneficiaries for
purposes of the relevant tests in this Article. Thus, a Spanish
individual will be an equivalent beneficiary without regard to
whether the individual would have been entitled to receive the
same benefits if it received the income directly. A resident of
a third country cannot qualify for treaty benefits under these
provisions by reason of those paragraphs or any other rule of
the treaty, and therefore does not qualify as an equivalent
beneficiary under this alternative. Thus, a resident of a third
country can be an equivalent beneficiary only if it would have
been entitled to equivalent benefits had it received the income
directly.
The second alternative was included in order to clarify
that ownership by certain residents of a Contracting State
would not disqualify a U.S. or Spanish company under this
paragraph. Thus, for example, if 90 percent of a Spanish
company is owned by five companies that are resident in member
states of the European Union who satisfy the requirements of
subparagraph 8(g)(i), and 10 percent of the Spanish company is
owned by a U.S. or Spanish individual, then the Spanish company
still can satisfy the requirements of subparagraph 3(a).
Subparagraph 3(b) sets forth the base erosion test. A
company meets this base erosion test if less than 50 percent of
its gross income (as determined in the company's State of
residence) for the taxable period is paid or accrued, directly
or indirectly, to a person or persons who are not equivalent
beneficiaries in the form of payments deductible for tax
purposes in company's State of residence. These deductible
payments do not include arm's-length payments in the ordinary
course of business for services or tangible property or
payments in respect of financial obligations to a bank that is
not related to the payor. This test is qualitatively the same
as the base erosion test in subparagraph 2(e)(ii), except that
the test in paragraph 3(b) focuses on base-eroding payments to
persons who are not equivalent beneficiaries.
Paragraph 4 of New Article 17
Paragraph 4 of new Article 17 sets forth an alternative
test under which a resident of a Contracting State may receive
treaty benefits with respect to certain items of income that
are connected to an active trade or business conducted in its
State of residence. A resident of a Contracting State may
qualify for benefits under paragraph 4 whether or not it also
qualifies under paragraph 2.
Subparagraph 4(a) sets forth the general rule that a
resident of a Contracting State engaged in the active conduct
of a trade or business in that State may obtain the benefits of
the Convention with respect to an item of income derived in the
other Contracting State. The item of income, however, must be
derived in connection with or incidental to that trade or
business.
The term ``trade or business'' is not defined in the
Convention. Pursuant to paragraph 2 of Article 3 (General
Definitions), when determining whether a resident of Spain is
entitled to the benefits of the Convention under paragraph 3 of
this Article with respect to an item of income derived from
sources within the United States, the United States will
ascribe to this term the meaning that it has under the law of
the United States. Accordingly, the U.S. competent authority
will refer to the regulations issued under Code section 367(a)
for the definition of the term ``trade or business.'' In
general, therefore, a trade or business will be considered to
be a specific unified group of activities that constitutes or
could constitute an independent economic enterprise carried on
for profit. Furthermore, a corporation generally will be
considered to carry on a trade or business only if the officers
and employees of the corporation conduct substantial managerial
and operational activities.
The business of making or managing investments for the
resident's own account will be considered to be a trade or
business only when part of banking, insurance or securities
activities conducted by a bank, an insurance company, or a
registered securities dealer respectively. Such activities
conducted by a person other than a bank, insurance company or
registered securities dealer will not be considered to be the
conduct of an active trade or business, nor would they be
considered to be the conduct of an active trade or business if
conducted by a bank, insurance company or registered securities
dealer but not as part of the company's banking, insurance or
dealer business. Because a headquarters operation is in the
business of managing investments, a company that functions
solely as a headquarters company will not be considered to be
engaged in an active trade or business for purposes of
paragraph 4.
An item of income is derived in connection with a trade or
business if the income-producing activity in the State of
source is a line of business that ``forms a part of'' or is
``complementary'' to the trade or business conducted in the
State of residence by the income recipient.
A business activity generally will be considered to form
part of a business activity conducted in the State of source if
the two activities involve the design, manufacture or sale of
the same products or type of products, or the provision of
similar services. The line of business in the State of
residence may be upstream, downstream, or parallel to the
activity conducted in the State of source. Thus, the line of
business may provide inputs for a manufacturing process that
occurs in the State of source, may sell the output of that
manufacturing process, or simply may sell the same sorts of
products that are being sold by the trade or business carried
on in the State of source.
Example 1. USCo is a corporation resident in the United
States. USCo is engaged in an active manufacturing business in
the United States. USCo owns 100 percent of the shares of FCo,
a corporation resident in Spain. FCo distributes USCo products
in Spain. Since the business activities conducted by the two
corporations involve the same products, FCo's distribution
business is considered to form a part of USCo's manufacturing
business.
Example 2. The facts are the same as in Example 1, except
that USCo does not manufacture. Rather, USCo operates a large
research and development facility in the United States that
licenses intellectual property to affiliates worldwide,
including FCo. FCo and other USCo affiliates then manufacture
and market the USCo-designed products in their respective
markets. Since the activities conducted by FCo and USCo involve
the same product lines, these activities are considered to form
a part of the same trade or business.
For two activities to be considered to be
``complementary,'' the activities need not relate to the same
types of products or services, but they should be part of the
same overall industry and be related in the sense that the
success or failure of one activity will tend to result in
success or failure for the other. Where more than one trade or
business is conducted in the State of source and only one of
the trades or businesses forms a part of or is complementary to
a trade or business conducted in the State of residence, it is
necessary to identify the trade or business to which an item of
income is attributable. Royalties generally will be considered
to be derived in connection with the trade or business to which
the underlying intangible property is attributable. Dividends
will be deemed to be derived first out of earnings and profits
of the treaty-benefited trade or business, and then out of
other earnings and profits. Interest income may be allocated
under any reasonable method consistently applied. A method that
conforms to U.S. principles for expense allocation will be
considered a reasonable method.
Example 3. Americair is a corporation resident in the
United States that operates an international airline. FSub is a
wholly-owned subsidiary of Americair resident in Spain. FSub
operates a chain of hotels in Spain that are located near
airports served by Americair flights. Americair frequently
sells tour packages that include air travel to Spain and
lodging at FSub hotels. Although both companies are engaged in
the active conduct of a trade or business, the businesses of
operating a chain of hotels and operating an airline are
distinct trades or businesses. Therefore FSub's business does
not form a part of Americair's business. However, FSub's
business is considered to be complementary to Americair's
business because they are part of the same overall industry
(travel) and the links between their operations tend to make
them interdependent.
Example 4. The facts are the same as in Example 3, except
that FSub owns an office building in Spain instead of a hotel
chain. No part of Americair's business is conducted through the
office building. FSub's business is not considered to form a
part of or to be complementary to Americair's business. They
are engaged in distinct trades or businesses in separate
industries, and there is no economic dependence between the two
operations.
Example 5. USFlower is a corporation resident in the United
States. USFlower produces and sells flowers in the United
States and other countries. USFlower owns all the shares of
ForHolding, a corporation resident in Spain. ForHolding is a
holding company that is not engaged in a trade or business.
ForHolding owns all the shares of three corporations that are
resident in Spain: ForFlower, ForLawn, and ForFish. ForFlower
distributes USFlower flowers under the USFlower trademark in
Spain. ForLawn markets a line of lawn care products in Spain
under the USFlower trademark. In addition to being sold under
the same trademark, ForLawn and ForFlower products are sold in
the same stores and sales of each company's products tend to
generate increased sales of the other's products. ForFish
imports fish from the United States and distributes it to fish
wholesalers in Spain. For purposes of paragraph 3, the business
of ForFlower forms a part of the business of USFlower, the
business of ForLawn is complementary to the business of
USFlower, and the business of ForFish is neither part of nor
complementary to that of USFlower.
An item of income derived from the State of source is
``incidental to'' the trade or business carried on in the State
of residence if production of the item facilitates the conduct
of the trade or business in the State of residence. An example
of incidental income is the temporary investment of working
capital of a person in the State of residence in securities
issued by persons in the State of source.
Subparagraph (b) of paragraph 4 states a further condition
to the general rule in subparagraph (a) in cases where the
trade or business generating the item of income in question is
carried on either by the person deriving the income or by any
associated enterprises. Subparagraph (b) states that the trade
or business carried on in the State of residence, under these
circumstances, must be substantial in relation to the activity
in the State of source. The substantiality requirement is
intended to prevent a narrow case of treaty-shopping abuses in
which a company attempts to qualify for benefits by engaging in
de minimis connected business activities in the treaty country
in which it is resident (i.e., activities that have little
economic cost or effect with respect to the company business as
a whole). Paragraph 5 of the Memorandum of Understanding sets
forth the understanding of the Contracting States that a person
shall be deemed to be related to another person if either
person participates directly or indirectly in the management,
control or capital of the other, or the same persons
participate directly or indirectly in the management, control
or capital of both.
The determination of substantiality is made based upon all
the facts and circumstances and takes into account the
comparative sizes of the trades or businesses in each
Contracting State the nature of the activities performed in
each Contracting State, and the relative contributions made to
that trade or business in each Contracting State. In any case,
in making each determination or comparison, due regard will be
given to the relative sizes of the economies in the two
Contracting States.
The determination in subparagraph (b) also is made
separately for each item of income derived from the State of
source. It therefore is possible that a person would be
entitled to the benefits of the Convention with respect to one
item of income but not with respect to another. If a resident
of a Contracting State is entitled to treaty benefits with
respect to a particular item of income under paragraph 4, the
resident is entitled to all benefits of the Convention insofar
as they affect the taxation of that item of income in the State
of source.
The application of the substantiality requirement only to
income from related parties focuses only on potential abuse
cases, and does not hamper certain other kinds of non-abusive
activities, even though the income recipient resident in a
Contracting State may be very small in relation to the entity
generating income in the other Contracting State. For example,
if a small U.S. research firm develops a process that it
licenses to a very large, unrelated, pharmaceutical
manufacturer in Spain, the size of the U.S. research firm would
not have to be tested against the size of the manufacturer.
Similarly, a small U.S. bank that makes a loan to a very large
unrelated company operating a business in Spain would not have
to pass a substantiality test to receive treaty benefits under
paragraph 4.
Subparagraph (c) of paragraph 3 provides special
attribution rules for purposes of applying the substantive
rules of subparagraphs (a) and (b). Thus, these rules apply for
purposes of determining whether a person meets the requirement
in subparagraph (a) that it be engaged in the active conduct of
a trade or business and that the item of income is derived in
connection with that active trade or business, and for making
the comparison required by the ``substantiality'' requirement
in subparagraph (b). Subparagraph (c) attributes to a person
activities conducted by persons ``connected'' to such person. A
person (``X'') is connected to another person (``Y'') if X
possesses 50 percent or more of the beneficial interest in Y
(or if Y possesses 50 percent or more of the beneficial
interest in X). For this purpose, X is connected to a company
if X owns shares representing fifty percent or more of the
aggregate voting power and value of the company or fifty
percent or more of the beneficial equity interest in the
company. X also is connected to Y if a third person possesses
fifty percent or more of the beneficial interest in both X and
Y. For this purpose, if X or Y is a company, the threshold
relationship with respect to such company or companies is fifty
percent or more of the aggregate voting power and value or
fifty percent or more of the beneficial equity interest.
Finally, X is connected to Y if, based upon all the facts and
circumstances, X controls Y, Y controls X, or X and Y are
controlled by the same person or persons.
Paragraph 5 of Article 17
Paragraph 5 of new Article 17 provides that a resident of
one of the Contracting States is entitled to all the benefits
of the Convention if that person functions as a recognized
headquarters company for a multinational corporate group. The
provisions of this paragraph are consistent with the other U.S.
tax treaties where this provision has been adopted. For this
purpose, the multinational corporate group includes all
corporations that the headquarters company supervises, and
excludes affiliated corporations not supervised by the
headquarters company. The headquarters company does not have to
own shares in the companies that it supervises. In order to be
considered a headquarters company, the person must meet several
requirements that are enumerated in paragraph 5. These
requirements are discussed below.
Overall Supervision and Administration
Subparagraph 5(a) provides that the person must provide a
substantial portion of the overall supervision and
administration of the group. This activity may include group
financing, but group financing may not be the principal
activity of the person functioning as the headquarters company.
A person only will be considered to engage in supervision and
administration if it engages in a number of the following
activities: group financing, pricing, marketing, internal
auditing, internal communications, and management. Other
activities also could be part of the function of supervision
and administration.
In determining whether a ``substantial portion'' of the
overall supervision and administration of the group is provided
by the headquarters company, its headquarters-related
activities must be substantial in relation to the same
activities for the same group performed by other entities.
Subparagraph 5(a) does not require that the group that is
supervised include persons in the other State. However, it is
anticipated that in most cases the group will include such
persons, due to the requirement in subparagraph 5(g), discussed
below, that the income derived in the other Contracting State
by the headquarters company be derived in connection with or be
incidental to an active trade or business supervised by the
headquarters company.
Active Trade or Business
Subparagraph 5(b) is the first of several requirements
intended to ensure that the relevant group is truly
``multinational.'' This subparagraph provides that the
corporate group supervised by the headquarters company must
consist of corporations resident in, and engaged in active
trades or businesses in, at least five countries. Furthermore,
at least five countries must each contribute substantially to
the income generated by the group, as the rule requires that
the business activities carried on in each of the five
countries (or groupings of countries) generate at least 10
percent of the gross income of the group. For purposes of the
10 percent gross income requirement, the income from multiple
countries may be aggregated into non-overlapping groupings, as
long as there are at least five individual countries or
groupings that each satisfies the 10 percent requirement. If
the gross income requirement under this subparagraph is not met
for a taxable year, the taxpayer may satisfy this requirement
by applying the 10 percent gross income test to the average of
the gross incomes for the four years preceding the taxable
year.
Example. SHQ is a corporation resident in Spain. SHQ
functions as a headquarters company for a group of companies.
These companies are resident in the United States, Canada, New
Zealand, the United Kingdom, Malaysia, the Philippines,
Singapore, and Indonesia. The gross income generated by each of
these companies for 2012 and 2013 is as follows:
------------------------------------------------------------------------
Country 2012 2013
------------------------------------------------------------------------
United States $40 $45
Canada 25 15
New Zealand 10 20
United Kingdom 30 35
Malaysia 10 12
Philippines 7 10
Singapore 10 8
Indonesia 5 10
------------------------------------------------------------------------
Total $137 $155
------------------------------------------------------------------------
For 2012, 10 percent of the gross income of this group is
equal to $13.70. Only the United States, Canada, and the United
Kingdom satisfy this requirement for that year. The other
countries may be aggregated to meet this requirement. Because
New Zealand and Malaysia have a total gross income of $20, and
the Philippines, Singapore, and Indonesia have a total gross
income of $22, these two groupings of countries may be treated
as the fourth and fifth members of the group for purposes of
subparagraph 5(b).
In the following year, 10 percent of the gross income is
$15.50. Only the United States, New Zealand, and the United
Kingdom satisfy this requirement. Because Canada and Malaysia
have a total gross income of $27, and the Philippines,
Singapore, and Indonesia have a total gross income of $28,
these two groupings of countries may be treated as the fourth
and fifth members of the group for purposes of subparagraph
5(b). The fact that Canada replaced New Zealand in a group is
not relevant for this purpose. The composition of the grouping
may change from year to year.
Single Country Limitation
Subparagraph 5(c) provides that the business activities
carried on in any one country other than the headquarters
company's State of residence must generate less than 50 percent
of the gross income of the group. If the gross income
requirement under this subparagraph is not met for a taxable
year, the taxpayer may satisfy this requirement by applying the
50 percent gross income test to the average of the gross
incomes for the four years preceding the taxable year. The
following example illustrates the application of this clause.
Example. SHQ is a corporation resident in Spain. SHQ
functions as a headquarters company for a group of companies.
SHQ derives dividend income from a United States subsidiary in
the 2008 taxable year. The state of residence of each of these
companies, the situs of their activities and the amounts of
gross income attributable to each for the years 2008 through
2012 are set forth below.
----------------------------------------------------------------------------------------------------------------
Country Situs 2012 2011 2010 2009 2008
----------------------------------------------------------------------------------------------------------------
United States U.S. $100 $100 $95 $90 $85
Mexico U.S. 10 8 5 0 0
Canada U.S. 20 18 16 15 12
United Kingdom U.K 30 32 30 28 27
New Zealand N.Z. 35 42 38 36 35
Japan Japan 35 32 30 30 28
Singapore Singapore 30 25 24 22 20
----------------------------------------------------------------------------------------------------------------
Total $260 $257 $238 $221 $207
----------------------------------------------------------------------------------------------------------------
Because the United States' total gross income of $130 in
2012 is not less than 50 percent of the gross income of the
group, subparagraph 5(c) is not satisfied with respect to
dividends derived in 2012. However, the United States' average
gross income for the preceding four years may be used in lieu
of the preceding year's average. The United States' average
gross income for the years 2008-11 is $111.00 ($444/4). The
group's total average gross income for these years is $230.75
($923/4). Because $111 represents 48.1 percent of the group's
average gross income for the years 2008 through 2011, the
requirement under subparagraph 5(c) is satisfied.
Other State Gross Income Limitation
Subparagraph 5(d) provides that no more than 25 percent of
the headquarters company's gross income may be derived from the
other Contracting State. Thus, if the headquarters company's
gross income for the taxable year is $200, no more than $50 of
this amount may be derived from the other Contracting State. If
the gross income requirement under this subparagraph is not met
for a taxable year, the taxpayer may satisfy this requirement
by applying the 25 percent gross income test to the average of
the gross incomes for the four years preceding the taxable
year.
Independent Discretionary Authority
Subparagraph 5(e) requires that the headquarters company
have and exercise independent discretionary authority to carry
out the functions referred to in subparagraph 5(a). Thus, if
the headquarters company was nominally responsible for group
financing, pricing, marketing and other management functions,
but merely implemented instructions received from another
entity, the headquarters company would not be considered to
have and exercise independent discretionary authority with
respect to these functions. This determination is made
individually for each function. For instance, a headquarters
company could be nominally responsible for group financing,
pricing, marketing and internal auditing functions, but another
entity could be actually directing the headquarters company as
to the group financing function. In such a case, the
headquarters company would not be deemed to have independent
discretionary authority for group financing, but it might have
such authority for the other functions. Functions for which the
headquarters company does not have and exercise independent
discretionary authority are considered to be conducted by an
entity other than the headquarters company for purposes of
subparagraph 5(a).
Income Taxation Rules
Subparagraph 2(f) requires that the headquarters company be
subject to the generally applicable income taxation rules in
its country of residence. This reference should be understood
to mean that the company must be subject to the income taxation
rules to which a company engaged in the active conduct of a
trade or business would be subject. Thus, if one of the
Contracting States has or introduces special taxation
legislation that imposes a lower rate of income tax on
headquarters companies than is imposed on companies engaged in
the active conduct of a trade or business, or provides for an
artificially low taxable base for such companies, a
headquarters company subject to these rules is not entitled to
the benefits of the Convention under paragraph 5.
In Connection With or Incidental to Trade or Business
Subparagraph 5(g) requires that the income derived in the
other Contracting State be derived in connection with or be
incidental to the active business activities referred to
subparagraph 5(b). This determination is made under the
principles set forth in paragraph 3. For instance, assume that
a Spanish company satisfies the other requirements in paragraph
5 and acts as a headquarters company for a group that includes
a U.S. corporation. If the group is engaged in the design and
manufacture of computer software, but the U.S. corporation is
also engaged in the design and manufacture of photocopying
machines, the income that the Spanish company derives from the
United States would have to be derived in connection with or be
incidental to the income generated by the computer business in
order to be entitled to the benefits of the Convention under
paragraph 5. Interest income received from the U.S. corporation
also would be entitled to the benefits of the Convention under
this subparagraph as long as the interest was attributable to
the computer business supervised by the headquarters company.
Interest income derived from an unrelated party would normally
not, however, satisfy the requirements of this clause.
Paragraph 6 of Article 17
Paragraph 6 of new Article 17 deals with the treatment of
income in the context of a so-called ``triangular case.'' The
term ``triangular case'' refers to the use of a structure like
the one described in the following paragraph by a resident of
the other Contracting State to earn income from the United
States:
A resident of Spain, who would, absent paragraph 6, qualify
for benefits under one or more of the provisions of this
Article, sets up a permanent establishment in a third state
that imposes a low or zero rate of tax on the income of the
permanent establishment. The resident of Spain lends funds into
the United States through the permanent establishment. The
permanent establishment, despite its third-jurisdiction
location, is an integral part of the resident of Spain.
Therefore, the income that it earns on those loans, absent the
provisions of paragraph 6, is entitled to exemption from U.S.
withholding tax under the Convention. Under a current income
tax treaty between Spain and the host jurisdiction of the
permanent establishment, the income of the permanent
establishment is exempt from tax by Spain (alternatively, Spain
may choose to exempt the income of the permanent establishment
from income tax). Thus, the interest income, absent paragraph
6, would be exempt from U.S. tax, subject to little or no tax
in the host jurisdiction of the permanent establishment, and
exempt from tax in Spain.
Paragraph 6 provides that the tax benefits that would
otherwise apply under the Convention will not apply to any item
of income if the combined aggregate effective tax rate in the
residence State and the third state is less than 60 percent of
the general rate of company tax applicable in the residence
State. In the case of dividends, interest and royalties to
which this paragraph applies, the withholding tax rates under
the Convention are replaced with a 15 percent withholding tax.
Any other income to which the provisions of paragraph 6 apply
is subject to tax under the domestic law of the source State,
notwithstanding any other provisions of the Convention.
In general, the principles employed under Code section
954(b)(4) will be employed to determine whether the profits are
subject to an effective rate of taxation that is above the
specified threshold.
Notwithstanding the level of tax on interest and royalty
income of the permanent establishment, paragraph 6 will not
apply under certain circumstances. In the case of royalties,
paragraph 6 will not apply if the royalties are received as
compensation for the use of, or the right to use, intangible
property produced or developed by the permanent establishment
itself. In the case of any other income, paragraph 6 will not
apply if that income is derived in connection with, or is
incidental to, the active conduct of a trade or business
carried on by the permanent establishment in the third state.
The business of making, managing or simply holding investments
is not considered to be an active trade or business, unless
these are securities activities carried on by a registered
securities dealer.
Paragraph 6 applies reciprocally. However, the United
States does not exempt the profits of a third-jurisdiction
permanent establishment of a U.S. resident from U.S. tax,
either by statute or by treaty.
Paragraph 7 of New Article 17
Paragraph 7 of new Article 17 provides that a resident of
one of the States that is not entitled to the benefits of the
Convention as a result of paragraphs 1 through 5 may be granted
benefits under the Convention at the discretion of the
competent authority of the State from which benefits in certain
circumstances. Such competent authority shall make the
determination of whether the granting of benefits would be
justified based on an evaluation of the extent to which such
resident satisfies the requirements of paragraphs 2, 3, 4 or 5.
Such competent authority shall also consider the opinion, if
any of the competent authority of the other Contracting State
as to whether under the circumstances it would be appropriate
to grant such benefits.
A competent authority may grant all of the benefits of the
Convention to the taxpayer making the request, or it may grant
only certain benefits. For instance, it may grant benefits only
with respect to a particular item of income in a manner similar
to paragraph 3. Further, the competent authority may establish
conditions, such as setting time limits on the duration of any
relief granted.
For purposes of implementing paragraph 7, a taxpayer will
be permitted to present his case to the relevant competent
authority for an advance determination based on the facts. In
these circumstances, it is also expected that, if 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 treaty provision or the establishment of the structure
in question, whichever is later.
Finally, there may be cases in which a resident of a
Contracting State may apply for discretionary relief to the
competent authority of his State of residence. This would
arise, for example, if the benefit it is claiming is provided
by the residence country, and not by the source country. So,
for example, if a company that is a resident of the United
States would like to claim the benefit of treaty-based relief
from double taxation under Article 24 (Relief from Double
Taxation), but it does not meet any of the objective tests of
paragraphs 2 through 5, it may apply to the U.S. competent
authority for discretionary relief.
Paragraph 8 of New Article 17
Paragraph 8 of new Article 17 defines several key terms for
purposes of Article 17. Each of the defined terms is discussed
above in the context in which it is used.
ARTICLE X
Article X of the Protocol amends Article 20 (Pensions,
Annuities, Alimony and Child Support) of the existing
Convention by adding a new paragraph 5.
New Paragraph 5 of Article 20
New paragraph 5 provides that, if a resident of a
Contracting State participates in a pension fund established in
the other Contracting State, the State of residence will not
tax the income of the pension fund with respect to that
resident until a distribution is made from the pension fund.
Thus, for example, if a U.S. citizen contributes to a U.S.
qualified plan while working in the United States and then
establishes residence in Spain, paragraph 5 prevents Spain from
taxing currently the plan's earnings and accretions with
respect to that individual. When the resident receives a
distribution from the pension fund, that distribution may be
subject to tax in the State of residence, subject to paragraph
1 of Article 20.
ARTICLE XI
Article XI of the Protocol replaces paragraph 3 of Article
25 (Non-Discrimination) of the existing Convention in order to
conform to changes made by the deletion of Article 14 and the
changes made to Article 10 dealing with the taxation of branch
profits tax. It clarifies that nothing in Article 25 should be
construed as preventing either Contracting State from imposing
a tax described in paragraph 8 of Article 10 (Dividends) as
revised by Article IV.
ARTICLE XII
Article XII of the Protocol makes amendments to Article 26
(Mutual Agreement Procedure) of the existing Convention, which
deals with the mutual agreement procedure. In particular,
Article XII of the Protocol incorporates into Article 26 rules
that provide for mandatory binding arbitration to resolve
certain cases that the competent authorities of the Contracting
States have been unable to resolve after a reasonable amount of
time.
New Paragraph 5 of Article 26
New paragraph 5 provides that a case shall be resolved
through mandatory binding arbitration when a ``concerned
person'' as defined in subparagraph 6(a) has presented a case
to the competent authority of either Contracting State on the
basis that the actions of one or both of the Contracting States
have resulted for that person in taxation not in accordance
with the provisions of the Convention, and the competent
authorities of the Contracting States have not been able to
reach an agreement to resolve the case, and if the conditions
specified in this paragraph and in paragraph 6 are satisfied.
The mandatory binding arbitration provision is an extension of
(as opposed to an alternative to) the interaction between the
competent authorities as provided in the mutual agreement
procedure. Accordingly, only cases that have first been
negotiated by the competent authorities pursuant to Article 26
shall be eligible for arbitration.
An initial condition set forth in paragraph 5 is that a
concerned person has presented a case to the competent
authority of either Contracting State on the basis that the
actions of one or both of the Contracting States have resulted
for that person in taxation not in accordance with the
provisions of the Convention. Such taxation should be
considered to have resulted from the actions of one or both of
the Contracting States as soon as, for example, tax has been
paid, assessed, or otherwise determined, or even in cases where
the taxpayer is officially notified by the tax authorities that
they intend to tax him on a certain element of income. As
provided in paragraph 18 of the Protocol of 1990 as revised by
Article XIV of the Protocol, in the case of the United States,
such notification would take the form of a notice of proposed
adjustment, and in Spain, such notification would include a
notification of the Administrative Act of Assessment.
The additional conditions that must be satisfied before a
case may be resolved through arbitration are set forth in
subparagraphs 5(a) through 5(e). Subparagraph 5(a) provides
that tax returns must be filed with at least one of the
Contracting States with respect to the taxable years at issue
in the case. Subparagraph 5(b) provides that the case may not
be a case that the competent authorities have mutually agreed
before the date on which arbitration proceedings would
otherwise have begun, is not suitable for determination by
arbitration. Subparagraph 5(c) provides that an unresolved case
shall not be submitted to arbitration if a decision on such
case has already been rendered by a court or administrative
tribunal of either Contracting State. Subparagraph 5(d)
provides that the case must not involve a determination under
paragraph 3 of Article 4 (Residence) dealing with dual resident
entities. Finally, subparagraph 5(e) provides that the
provisions of subparagraph 6(c), described below, which sets
forth the rule governing the date on which an arbitration
proceeding shall commence, must be satisfied.
New paragraph 6 of Article 26
New paragraph 6 sets forth additional rules and definitions
to be used in applying the arbitration provisions. Subparagraph
6(a) defines the term ``concerned person'' as the person that
brought the case to competent authority for consideration under
Article 26 and 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 would include a U.S. corporation that brings
a transfer pricing case with respect to a transaction entered
into with its subsidiary in Spain for resolution to the U.S.
competent authority, as well as the subsidiary, which may seek
a correlative adjustment as a result of the resolution of the
case.
Subparagraph 6(b) defines the term ``commencement date'' as
the earliest date on which the information necessary to
undertake substantive consideration for a mutual agreement has
been received by the competent authorities of both Contracting
States. The competent authority of the United States will be
considered to have received the information necessary to
undertake substantive consideration for a mutual agreement on
the date that it has received the information that must be
submitted pursuant to Rev Proc. 2006-54, 2006-2 C.B. 1035,'
4.05 (or any similarly applicable or successor procedures). The
competent authority of Spain will be considered to have
received the information necessary to undertake substantive
consideration for a mutual agreement on the date it has
received the information that must be submitted pursuant to
Article 6 of Royal Decree 1794/2008 of November 3 (or any
similarly applicable or successor procedures). 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.
Subparagraph 6(c) provides that an arbitration proceeding
shall begin on the latest of four dates: (i) two years from the
commencement date of that case (unless both competent
authorities have previously agreed to a different date), (ii)
the date upon which the present of the case has submitted a
written request to a competent authority for a resolution of
the case through arbitration, (iii) the earliest date upon
which all concerned persons have entered into a confidentiality
agreement and the agreements have been received by both
competent authorities, or (iv) the date on which all legal
actions or suits pending before the courts of either
Contracting State concerning any issue involved in the care are
suspended or withdrawn (as applicable) under the laws of the
Contracting State in which the legal actions or suits are
pending.
Clause (i) of this subparagraph permits the competent
authorities of the Contracting States to mutually agree to
initiate arbitration proceedings on a date other than two years
after the commencement date. This could be the case, for
instance, if the negotiation of a case between the competent
authorities was nearing completion and could be expected to be
resolved in an additional short period of time, thus avoiding
the need for an arbitration proceeding. As another example, if
under paragraphs 5 and 6 arbitration proceedings would be
initiated on the same date for a large number of cases, clause
(i) would allow the competent authorities of the Contracting
States to agree to establish different dates (including
accelerated dates) to initiate arbitration proceedings for such
cases in order to avoid having multiple arbitration proceedings
take place at the same time. Clause (i) requires that the
competent authorities of the Contracting States notify the
presenter of the case of any such agreements.
Clause (ii) of this subparagraph provides that the
presenter of the case must submit a written request to the
competent authority for a resolution of the case through
arbitration. However, the presenter of the case may not submit
such written request prior to the completion of the two year
period after the commencement date described in clause (i).
Clause (iii) of this subparagraph requires that all
concerned persons and their authorized representatives or
agents agree in writing prior to the beginning of an
arbitration proceeding not to disclose to any other person any
information received during the course of the arbitration
proceeding from either Contracting State or the arbitration
panel, other than the determination of the panel. A
confidentiality agreement may 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.
Clause (iv) of this subparagraph requires that in the event
that any issue involved in the case that is potentially subject
to arbitration is the subject of any legal actions or suits
pending before the courts of either Contracting States, such
legal action must be either suspended or withdrawn as
applicable under the laws of the Contracting State in which
such legal actions or suits are pending.
Subparagraph 6(d) provides that the determination of the
arbitration panel shall constitute a resolution by mutual
agreement under Article 26 and thus shall be binding on the
Contracting States. As is the case with any negotiated
resolution between the competent authorities pursuant to the
mutual agreement procedure, the presenter of the case preserves
the right not to accept the determination of the arbitration
panel.
Subparagraph 6(e) provides that for purposes of an
arbitration proceeding under paragraphs 5 and 6 of Article 26,
the members of the arbitration panel and their staff shall be
considered ``persons or authorities'' to whom information may
be disclosed under Article 27 (Exchange of Information and
Administrative Assistance) of the Convention as revised by
Article XIII.
Subparagraph 6(f) sets forth the confidentiality
obligations of the competent authorities of the Contracting
States as well as the members of the arbitration panel and
their staffs regarding an arbitration proceeding. Subparagraph
6(g) provides that no information relating to an arbitration
proceeding (including the arbitration panel's determination)
may be disclosed by the competent authorities of the
Contracting States, except as permitted by this Convention and
the domestic laws of the Contracting States. In addition, all
material prepared in the course of, or relating to, an
arbitration proceeding shall be considered to be information
exchanged between the Contracting States. Subparagraph 6(f)
requires that all members of the arbitration panel and their
staff make statements in writing not to disclose any
information relating to an arbitration proceeding (including
the arbitration panel's determination), and to abide by and be
subject to the confidentiality and nondisclosure provisions of
Article 27 of this Convention and the applicable domestic laws
of the Contracting States. In the event those provisions
conflict, the most restrictive condition shall apply. These
statements from the members of the arbitration panel shall also
include confirmation of their appointment to the arbitration
panel.
Subparagraph 6(g) sets forth a non-exhaustive list of items
related to the time periods and procedures related to
conducting an arbitration proceeding that the competent
authorities of the Contracting States must agree to in order to
ensure the effective and timely implementation of the
provisions of paragraph 5 and 6 of Article 26. Such agreement
must be consistent with the provisions of paragraphs 5 and 6 of
Article 25 and paragraph 21 of the Protocol of 1990 as amended
by Article XIV, and shall take the form of published guidance
before the date that the first arbitration proceeding
commences. Subparagraph 6(g) lists the following items for
which the competent authorities of the Contracting States shall
agree on time frames and procedures for:
i) notifying the presenter of the case of any
agreements pursuant to either subparagraph 5(b) that
the case is not suitable for resolution through
arbitration, or clause i) of subparagraph 5(c) to
change the date on which an arbitration proceeding
could begin;
ii) obtaining the statements of each concerned
person, authorized representative or agent, and member
of the arbitration panel (including their staff), in
which each such person agrees not to disclose to any
other person any information received during the course
of the arbitration proceeding from the competent
authority of either Contracting State or the
arbitration panel, other than the determination of such
panel;
iii) the appointment of the members of the
arbitration panel;
iv) the submission of proposed resolutions, position
papers, and reply submissions by the competent
authorities of the Contracting States to the
arbitration panel;
v) the submission by the presenter of the case of a
paper setting forth the presenter's views and analysis
of the case for consideration by the arbitration panel;
vi) the delivery by the arbitration panel of its
determination to the competent authorities of the
Contracting States;
vii) the acceptance or rejection by the presenter of
the case of the determination of the arbitration panel;
and
vii) the adoption by the arbitration panel of any
additional procedures necessary for the conduct of its
business.
Paragraph 6 also provides that the competent authorities of
the Contracting States may agree in writing on such other
rules, time periods or procedures as may be necessary for the
effective and timely implementation of the provisions of
paragraphs 5 and 6 of Article 26.
ARTICLE XIII
Article XIII of the Protocol replaces Article 27 (Exchange
of Information and Administrative Assistance) of the existing
Convention. This Article provides for the exchange of
information between the competent authorities of the
Contracting States. While mutual agreement procedures are
addressed in Article 26, exchanges of information for purposes
of the mutual agreement procedures are governed by this
Article.
Paragraph 1 of New Article 27
The obligation to obtain and provide information to the
other Contracting State is set out in paragraph 1 of new
Article 27. The information to be exchanged is that which may
be is foreseeably relevant for carrying out the provisions of
the Convention or the domestic laws of the United States or of
the other Contracting State concerning taxes of every kind
applied at the national level. This language incorporates the
standard of the OECD Model. The Contracting States intend for
the phrase ``is foreseeably relevant'' to be interpreted to
permit the exchange of information that ``may be relevant'' for
purposes of 26 U.S.C. Section 7602 of the Code, which
authorizes the IRS 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 IRS 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. Thus, the language of paragraph 1
is intended to provide for exchange of information in tax
matters to the widest extent possible, while clarifying that
Contracting States are not at liberty to engage in ``fishing
expeditions'' or otherwise to request information that is
unlikely to be relevant to the tax affairs of a given taxpayer.
Consistent with the OECD Model, a request for information
does not constitute a ``fishing expedition'' solely because it
does not provide the name or address (or both) of the taxpayer
under examination or investigation. In cases where the
requesting State does not provide the name or address (or both)
of the taxpayer under examination or investigation, the
requesting State must provide other information sufficient to
identify the taxpayer. Similarly, paragraph 1 does not
necessarily require the request to include the name and/or
address of the person believed to be in possession of the
information.
The standard of ``foreseeable relevance'' can be met in
cases dealing with both one taxpayer (whether identified by
name or otherwise) or several taxpayers (whether identified by
name or otherwise). Where a Contracting State undertakes an
investigation into an ascertainable group or category of
persons in accordance with its laws, any request related to the
investigation will typically serve the objective of carrying
out the domestic tax laws of the requesting State
administration or enforcement of its domestic laws and thus
will comply with the requirements of paragraph 1, provided it
meets the standard of ``foreseeable relevance.'' In such cases,
the requesting State should provide, supported by a clear
factual basis, a detailed description of the group or category
of persons and of the specific facts and circumstances that
have led to the request, as well as an explanation of the
applicable law and why there is reason to believe that the
taxpayers in the group or category of persons for whom
information is requested have been non-compliant with that law
supported by a clear factual basis. The requesting State should
further show that the requested information would assist in
determining compliance by the taxpayers in the group or
category of persons.
Exchange of information with respect to each State's
domestic law is authorized to the extent that taxation under
domestic law is not contrary to the Convention. Thus, for
example, information may be exchanged under this Article, even
if the transaction to which the information relates is a purely
domestic transaction in the requesting State and, therefore,
the exchange is not made to carry out the Convention. An
example of such a case is provided in subparagraph 8(b) of the
OECD Commentary: a company resident in one Contracting State
and a company resident in the other Contracting State transact
business between themselves through a third-country resident
company. Neither Contracting State has a treaty with the third
state. To enforce their internal laws with respect to
transactions of their residents with the third-country company
(since there is no relevant treaty in force), the Contracting
States may exchange information regarding the prices that their
residents paid in their transactions with the third-country
resident.
Paragraph 1 clarifies that information may be exchanged
that relates to the assessment or collection of, the
enforcement or prosecution in respect of, or the determination
of appeals in relation to, taxes of every kind imposed by a
Contracting State at the national level. Accordingly, the
competent authorities may request and provide information for
cases under examination or criminal investigation, in
collection, on appeals, or under prosecution, and information
may be exchanged with respect to U.S. estate and gift taxes. In
contrast, paragraph 7, which relates to collection assistance,
applies only to those taxes covered for general purposes of the
Convention as defined in Article 2 (Taxes Covered).
Information exchange is not restricted by paragraph 1 of
Article 1. Accordingly, information may be requested and
provided under this Article with respect to persons who are not
residents of either Contracting State. For example, if a third-
country resident has a permanent establishment in the other
Contracting State, and that permanent establishment engages in
transactions with a U.S. enterprise, the United States could
request information with respect to that permanent
establishment, even though the third-country resident is not a
resident of either Contracting State. Similarly, if a third-
country resident maintains a bank account in the other
Contracting State, and the Internal Revenue Service has reason
to believe that funds in that account should have been reported
for U.S. tax purposes but have not been so reported,
information can be requested from the other Contracting State
with respect to that person's account, even though that person
is not the taxpayer under examination.
Although the term ``United States'' does not encompass U.S.
possessions or territories for most purposes of the Convention,
section 7651 of the Code authorizes the Internal Revenue
Service to utilize the administrative and enforcement
provisions of the Code in the U.S. possessions or territories,
including to obtain information pursuant to a proper request
made under Article 26. If necessary to obtain requested
information, the Internal Revenue Service could issue and
enforce an administrative summons to the taxpayer, a tax
authority (or other U.S. possession or territory government
agency), or a third party located in a U.S. possession or
territory.
The final sentence of paragraph 1 provides that the
requesting Contracting State may specify the form in which
information is to be provided (e.g., authenticated copies of
original documents (including books, papers, statements,
records, accounts, and writings)). 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 2 of New Article 27
Paragraph 2 provides assurances that any information
exchanged will be treated as secret, subject to the same
disclosure constraints as information obtained under the laws
of the requesting State. The confidentiality rules cover
communications between the competent authorities (including the
letter requesting information) as well as references to
exchanged information that may occur in other documents, such
as advice by government attorneys to their respective competent
authorities. At the same time, it is understood that the
requested State can disclose the minimum information contained
in a competent authority letter (but not the letter itself)
necessary for the requested State to be able to obtain or
provide the requested information to the requesting State,
without frustrating the efforts of the requesting State. If,
however, court proceedings or the like under the domestic laws
of the requested State necessitate the disclosure of the
competent authority letter itself, the competent authority of
the requested State may disclose such a letter unless the
requesting State otherwise specifies.
Information received may be disclosed only to persons or
authorities, including courts and administrative bodies,
involved in the assessment, collection, or administration of,
the enforcement or prosecution in respect of, or the
determination of appeals in relation to, the taxes referred to
in paragraph 1. Under this standard, information may be
communicated to the taxpayer or his proxy. The information must
be used by these persons only for the purposes mentioned in
paragraph 2. Information may also be disclosed to legislative
bodies, such as the tax-writing committees of the U.S. Congress
and the U.S. Government Accountability Office, engaged in the
oversight of the preceding activities. Information received by
these bodies must be for use in the performance of their role
in overseeing the administration of U.S. tax laws. Information
received may be disclosed in public court proceedings or in
judicial decisions.
In situations in which the requested State determines that
the requesting State does not comply with its duties regarding
the confidentiality of the information exchanged under this
Article, the requested State may suspend assistance under this
Article until such time as proper assurance is given by the
requesting State that those duties will indeed be respected. If
necessary, the competent authorities may enter into specific
arrangements or memoranda of understanding regarding the
confidentiality of the information exchanged under this
Article.
Paragraph 2 also provides that the competent authority of
the Contracting State that receives information under this
Article may, with the written consent of the other Contracting
State, make that information available to be used for other
purposes allowed under the provisions of a mutual legal
assistance treaty in force between the Contracting States that
allows for the exchange of tax information.
Paragraph 3 of New Article 27
Paragraph 3 of new Article 27 provides that the obligations
undertaken in paragraphs 1 and 2 to exchange information do not
require a Contracting State to carry out administrative
measures that are at variance with the laws or administrative
practice of either State. Nor is a Contracting State required
to supply information not obtainable under the laws or
administrative practice of either State, or to disclose trade
secrets or other 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.
Paragraph 4 of New Article 27
Paragraph 4 of new Article 27 provides that when
information is requested by a Contracting State in accordance
with this Article, the other Contracting State is obligated to
obtain the requested information as if the tax in question were
the tax of the requested State, even if that State has no
direct tax interest in the case to which the request relates.
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 5 of New Article 27
Paragraph 5 of new Article 27 provides that a Contracting
State may not decline to provide information because that
information is held by banks, other financial institutions,
nominees or persons acting in an agency or fiduciary capacity
or because it relates to ownership interests in a person. 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, such as the identity of a beneficial owner of bearer
shares.
Subparagraphs 3 (a) and (b) do not permit the requested
State to decline a request where paragraph 4 or 5 applies.
Paragraph 5 would apply, for instance, in situations in which
the requested State's inability to obtain the information was
specifically related to the fact that the requested information
was believed to be held by a bank or other financial
institution. Thus, the application of paragraph 5 includes
situations in which the tax authorities' information gathering
powers with respect to information held by banks and other
financial institutions are subject to different requirements
than those that are generally applicable with respect to
information held by persons other than banks or other financial
institutions. This would, for example, be the case where the
tax authorities can only exercise their information gathering
powers with respect to information held by banks and other
financial institutions in instances where specific information
on the taxpayer under examination or investigation is
available. This would also be the case where, for example, the
use of information gathering measures with respect to
information held by banks and other financial institutions
requires a higher probability that the information requested is
held by the person believed to be in possession of the
requested information than the degree of probability required
for the use of information gathering measures with respect to
information believed to be held by persons other than banks or
financial institutions.
Paragraph 6 of New Article 27
Paragraph 6 of new Article 27 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 New Article 27
Paragraph 7 provides for assistance in collection of taxes
to the extent necessary to ensure that treaty benefits are
enjoyed only by persons entitled to those benefits under the
terms of the Convention. Under paragraph 7, a Contracting State
will endeavor to collect on behalf of the other State only
those amounts necessary to ensure that any exemption or reduced
rate of tax granted under the Convention by that other State is
not enjoyed by persons not entitled to those benefits. For
example, if the payer of a U.S.-source portfolio dividend
receives a Form W-8BEN or other appropriate documentation from
the payee, the withholding agent is permitted to withhold at
the portfolio dividend rate of 15 percent. If, however, the
addressee is merely acting as a nominee on behalf of a third-
country resident, paragraph 7 would obligate Spain to withhold
and remit to the United States the additional tax that should
have been collected by the U.S. withholding agent.
This paragraph also makes clear that the Contracting State
asked to collect the tax is not obligated, in the process of
providing collection assistance, to carry out administrative
measures that are different from the laws or administrative
practice of either Contracting State from those used in the
collection of its own taxes, or that would be contrary to its
sovereignty, security, or public policy.
Paragraph 8 of New Article 27
Paragraph 8 of new Article 27 states that the competent
authorities of the Contracting States may develop an agreement
concerning the mode of application of the Article. The Article
authorizes the competent authorities to exchange information on
an automatic basis, on request in relation to a specific case,
or spontaneously. It is contemplated that the Contracting
States will utilize this authority to engage in all of these
forms of information exchange, as appropriate.
The competent authorities may also agree on specific
procedures and timetables for the exchange of information. In
particular, the competent authorities may agree on minimum
thresholds regarding tax at stake or take other measures aimed
at ensuring some measure of reciprocity with respect to the
overall exchange of information between the Contracting States.
Effective dates and termination in relation to exchange of
information
Once the Protocol is in force, the competent authority may
seek information under the Protocol with respect to a year
prior to the entry into force of the Protocol. In that case,
the competent authorities have available to them the full range
of information exchange provisions afforded under this Article.
In contrast, if the provisions of new Article 27 were to
terminate in accordance with the provisions of Article 30
(Termination) of the existing Convention, it would cease to
authorize, as of the date of termination, any exchange of
information, even with respect to a year for which the Protocol
was in force. In such case, the tax administrations of the two
countries would only be able to exchange information to the
extent allowed under either domestic law or another
international agreement or arrangement.
ARTICLE XIV
This Article makes a number of amendments to the Protocol
of 1990.
Paragraph 1
Paragraph 1 amends paragraph 5 of the Protocol of 1990 by
deleting subparagraph 5(b) and renaming subparagraph 5(c) as
subparagraph 5(b). Existing subparagraph 5(b) was deleted
because it is no longer necessary, given the inclusion into
Article 1 (General Scope) of the Convention of new paragraph 6,
pursuant to Article 1 of this Protocol.
Paragraph 2
Paragraph 2 replaces paragraph 7 of the Protocol of 1990.
In the case of Spain, new subparagraph 7(a) provides special
rules regarding dividend withholding on dividends paid by
certain Spanish entities. Clause (i) provides that the 5
percent withholding limitation provided in subparagraph 2(a) of
Article 10 (Dividends) shall not apply in the case of dividends
paid by an entity regulated under the law 11/2009 of 26th
October on Sociedades Anonimas Cotizadas de Inversion en el
Mercado Inmobiliario (SOCIMI) or successor statutes. Instead,
the 15 percent withholding limitation provided in subparagraph
2(b) of Article 10, or the exemption from withholding provided
in paragraph 4 of Article 10 for dividends paid to pension
funds, as the case may be, shall apply with respect to such
dividends, but only if the beneficial owner of the dividends
holds, directly or indirectly, capital that represents no more
than 10 percent of all of the capital in the SOCIMI. Clause
(ii) provides that the 5 percent withholding limitation shall
also not apply in the case of dividends paid by a Spanish
investment institution regulated under the law 35/2003 of 4th
November on Instituciones de Inversion Colectiva or successor
statutes. Instead, the 15 percent withholding limitation
provided in subparagraph 2(b) of Article 10, or the exemption
from withholding provided in paragraph 4 of Article 10 for
dividends paid to pension funds, as the case may be, shall
apply with respect to such dividends.
In the case of the United States, new subparagraph 7(b)
imposes limitations on the rate reductions provided by
subparagraph 2(a) of revised Article 10 in the case of
dividends paid by a regulated investment company (RIC) or a
real estate investment trust (REIT). The first sentence of new
subparagraph 7(b) provides that dividends paid by a RIC or REIT
are not eligible for the 5 percent rate of withholding tax of
subparagraph 2(a) of revised Article 10. The second sentence of
new subparagraph 7(b) provides that the 15 percent maximum rate
of withholding tax of subparagraph 2(b) of revised Article 10
applies to dividends paid by RICs and that the elimination of
source-country withholding tax of paragraph 4 of revised
Article 10 applies to dividends paid by RICs and beneficially
owned by a pension fund.
The third sentence of new subparagraph 7(b) provides that
the 15 percent rate of withholding tax also applies to
dividends paid by a REIT and that the elimination of source-
country withholding tax of paragraph 4 of revised Article 10
applies to dividends paid by REITs and beneficially owned by a
pension fund, provided that one of the three following
conditions is met. First, the beneficial owner of the dividend
is an individual or a pension fund, in either case holding an
interest of not more than 10 percent in the REIT. Second, the
dividend is paid with respect to a class of stock that is
publicly traded and the beneficial owner of the dividend is a
person holding an interest of not more than 5 percent of any
class of the REIT's shares. Third, the beneficial owner of the
dividend holds an interest in the REIT of not more than 10
percent and the REIT is ``diversified.''
New subparagraph 7(b) provides a definition of the term
``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. Section 856(e) 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.
Paragraph 3
Paragraph 3 replaces paragraph 8 of the Protocol of 1990.
New paragraph 8 provides a definition of the term ``real estate
mortgage investment conduit (REMIC)'' for purposes of revised
Article 11 (Interest) of the Convention as amended by Article
V. The term means an entity that has in effect an election to
be treated as a REMIC under Code Section 860D.
Paragraph 4
Paragraph 4 deletes subparagraph 10(c) of the Protocol of
1990 as a conforming change to the amendments made to Article
13 (Capital Gains) of the Convention by Article VII.
Paragraph 5
Paragraph 5 deletes paragraph 11 of the Protocol of 1990 as
a conforming change to the deletion of Article 14 (Branch Tax)
of the Convention by Article VIII.
Paragraph 6
Paragraph 6 deletes paragraph 12 of the Protocol of 1990.
Prior paragraph 12 referred to Commentary on Article 14
(Independent Personal Services) of the 1977 Model Convention
for the Avoidance of Double Taxation with Respect to Taxes on
Income and on Capital of the Organisation for Economic
Cooperation and Development, and of any guidelines which, for
the application of such Article, may be developed in the
future. The deletion of prior paragraph 12 ensures that the
Contracting States can interpret Article 14 (Independent
Personal Services) of the Convention in an ambulatory manner
and consistently with the prevailing Commentaries of the OECD
Model.
Paragraph 7
Paragraph 7 amends paragraph 13 of the Protocol of 1990.
Revised paragraph 13 describes in a non-exhaustive fashion
those entities to which clause (ii) of subparagraph 2(d) of
revised Article 17 (Limitation on Benefits) as restated by
Article IX applies. Because under Spain's current domestic law,
a number of the entities described, including pension funds
established in Spain, are not exempt from tax, the words ``tax
exempt'' have been deleted from paragraph 13.
Paragraph 8
Paragraph 8 replaces paragraph 18 of the Protocol of 1990.
New paragraph 8 defines the term ``first notification'' for the
purposes of applying paragraph 1 of Article 26 (Mutual
Agreement Procedure) of the Convention. The term means, in the
case of the United States, the Notice of Proposed Adjustment,
and in the case of Spain, the Notification of the
Administrative Act of Assessment.
With respect to paragraph 5 of Article 26 as amended by
Article XII, paragraph 8 clarifies when taxation not in
accordance with the Convention shall be considered to have
resulted from the actions of one or both of the Contracting
States. The Contracting States understand that an action of
either Contracting State that has resulted in taxation not in
accordance with the provisions of the Convention shall include
a Notice of Proposed Adjustment, a Notification of the
Administrative Act of Assessment or in the case of taxes at
source, a payment or withholding of tax.
Paragraph 9
Paragraph 9 deletes paragraph 19 of the Protocol of 1990.
The deletion of prior paragraph 19 permits the Contracting
States to interpret Article 27 (Exchange of Information and
Administrative Assistance) of the Convention as amended by
Article XIII, in an ambulatory manner and consistently with the
prevailing Commentaries of the OECD Model.
Paragraph 10
Paragraph 10 adds a new paragraph 21 to the Protocol of
1990. New paragraph 21 sets forth a number of principles
related to the implementation of the mandatory binding
arbitration rules provided in new paragraphs 5 and 6 of Article
26 (Mutual Agreement Procedure).
New subparagraph 21(a) of the Protocol to 1990 sets forth
rules that the competent authorities of the Contracting States
shall follow for selecting the members of the arbitration
panel. The arbitration panel shall consist of three individual
members. The members appointed shall not be employees nor have
been employees within the twelve-month period prior to the date
on which the arbitration proceeding begins, of the tax
administration, the Treasury Department or the Ministry of
Finance of the Contracting State which identifies them. Each
competent authority of the Contracting States shall select one
member of the arbitration panel. The two members of the
arbitration panel who have been selected shall select the third
member, who shall serve as Chair of the arbitration panel. If
the two initial members of the arbitration panel fail to select
the third member in the manner and within the time periods
prescribed by the competent authorities of the Contracting
States pursuant to subparagraph 6(g)(iii) of Article 26 of the
Convention, these members shall be dismissed, and each
competent authority of the Contracting States shall select a
new member of the arbitration panel. The Chair shall not be a
national or lawful permanent resident of either Contracting
State.
New subparagraph 21(b) of the Protocol of 1990 provides
that if at any time before the arbitration panel delivers a
determination to the competent authorities certain events
occur, notwithstanding the initiation of an arbitration
proceeding, the arbitration proceeding and the mutual agreement
procedure with respect to a case shall terminate.
Clause (i) provides that the arbitration proceeding and the
mutual agreement procedure with respect to a case shall
terminate if the competent authorities of the Contracting
States reach a mutual agreement to resolve the case. Clause
(ii) provides that the arbitration proceeding and the mutual
agreement procedure with respect to a case shall terminate if
the presenter of the case withdraws the request for
arbitration, as is the case for the mutual agreement procedure
as a general matter. Clause (iii) provides that the arbitration
proceeding and the mutual agreement procedure with respect to a
case shall terminate if any concerned person, or any of their
representatives or agents, willfully violates the written
statement of nondisclosure referred to in clause (iii) of
subparagraph (c) of paragraph 6, and the competent authorities
of both Contracting States agree that such violation should
result in the termination of the arbitration proceeding.
Finally, clause (iv) provides that the arbitration proceeding
and the mutual agreement procedure with respect to a case shall
terminate if any concerned person initiates a legal action or
suit before the courts of either Contracting State concerning
any issue involved in the case, unless such legal action or
suit is suspended according to the applicable laws of the
Contracting State.
New subparagraph 21(c) of the Protocol to 1990 sets forth
the rule governing the submission of proposed resolutions for
consideration by the arbitration panel. The competent authority
of each of the Contracting States shall be permitted to submit
a proposed resolution addressing each adjustment or similar
issue raised in the case. Such proposed resolution shall be a
resolution of the entire case and shall reflect without
modification all matters in the case previously agreed between
the competent authorities of both of the Contracting States.
Such proposed resolution shall be limited to a disposition of
specific monetary amounts (for example, of income, profit, gain
or expense) or, where specified, the maximum rate of tax
charged pursuant to the Convention for each adjustment or
similar issue in the case. The competent authority of each of
the Contracting States shall also be permitted to submit a
supporting position paper for consideration by the arbitration
panel.
New subparagraph 21(d) of the Protocol of 1990 provides a
special rule for proposed resolutions involving an initial
determination of a threshold question (such as the existence of
a permanent establishment). Subparagraph 21(d) provides that
notwithstanding the provisions of subparagraph 21(c), it is
understood that, in the case of an arbitration proceeding
concerning: i) the tax liability of an individual with respect
to whose State of residence the competent authorities have been
unable to reach agreement; ii) the taxation of the business
profits of an enterprise with respect to which the competent
authorities have been unable to reach an agreement on whether a
permanent establishment exists; or iii) such other issues the
determination of which are contingent on resolution of similar
threshold questions, the proposed resolutions and position
papers may include positions regarding the relevant threshold
questions in clause i), ii) or iii) above (for example, the
question of whether a permanent establishment exists), in
addition to proposed resolutions to the contingent
determinations (for example, the determination of the amount of
profit attributable to such permanent establishment). The
determination of the arbitration panel regarding the initial
threshold question may preclude the need for a further
determination regarding contingent determinations.
New subparagraph 21(e) of the Protocol of 1990 provides
that where an arbitration proceeding concerns a case comprising
multiple adjustments or issues each requiring a disposition of
specific monetary amounts of income, profit, gain or expense
or, where specified, the maximum rate of tax charged pursuant
to the Convention, the proposed resolution may propose a
separate disposition for each adjustment or similar issue. This
flexibility permits each adjustment or issue to be resolved
independently through the arbitration proceeding, such that the
determination of the arbitration panel will constitute a mutual
agreement of the entirety of the issues in the case.
New subparagraph 21(f) of the Protocol of 1990 provides
that each of the competent authorities of the Contracting
States shall receive the proposed resolution and position paper
submitted by the other competent authority, and shall be
permitted to submit a reply submission to the arbitration
panel. Each of the competent authorities of the Contracting
States shall also receive the reply submission of the other
competent authority.
New subparagraph 21(g) of the Protocol of 1990 provides
that the presenter of the case shall be permitted to submit for
consideration by the arbitration panel a paper setting forth
the presenter's analysis and views of the case. The submission
by the presenter of the case is not a proposed resolution that
the arbitration panel could select in making its determination.
The submission by the presenter may not include any information
not previously provided to the competent authorities prior to
the initiation of an arbitration proceeding. The competent
authorities should determine an appropriate time frame for
submission of such paper by the presenter in order to ensure
that the competent authorities have sufficient time to consider
the information.
New subparagraph 21(h) of the Protocol of 1990 provides
that the arbitration panel shall deliver a determination in
writing to the competent authorities of the Contracting States.
The determination reached by the arbitration panel in the
arbitration proceeding shall be limited to one of the proposed
resolutions for the case submitted by one of the competent
authorities of the Contracting States for each adjustment or
similar issue and any threshold questions, and shall not
include a rationale or any other explanation of the
determination. The determination of the arbitration panel shall
have no precedential value with respect to the application of
the Convention in any other case.
New subparagraph 21(i) of the Protocol of 1990 provides
that unless the competent authorities of both Contracting
States agree to a longer time period, the presenter of the case
shall have 45 days from receiving the determination of the
arbitration panel to notify, in writing, the competent
authority of the Contracting State to whom the case was
presented, his acceptance of the determination. In the event
the case is pending in litigation, each concerned person who is
a party to the litigation must also advise, within the same
time frame, the relevant court of its acceptance of the
determination of the arbitration panel as the resolution by
mutual agreement and its intention to withdraw from the
consideration of the court the issues resolved through the
proceeding. If any concerned person fails to so advise the
relevant competent authority and relevant court within this
time frame, the determination of the arbitration panel shall be
considered not to have been accepted by the presenter of the
case. Where the determination of the arbitration panel is not
accepted, the case will not be eligible for any subsequent
further consideration by the competent authorities.
New subparagraph 21(j) of the Protocol of 1990 provides
that the fees and expenses of the members of the arbitration
panel, as well as any costs incurred in connection with the
proceeding by the Contracting States, shall be borne equitably
by the competent authorities of Contracting States.
ARTICLE XV
This Article contains rules for bringing the Protocol into
force and giving effect to its provisions.
Paragraph 1
Paragraph 1 obligates the governments of the Contracting
States to notify each other through diplomatic channels when
the internal procedures required by each Contracting State for
the entry into force of the Protocol have been complied with.
In the United States, the process leading to ratification and
entry into force is as follows: Once a treaty has been signed
by authorized representatives of the two Contracting States,
the Department of State sends the treaty to the President who
formally transmits it to the Senate for its advice and consent
to ratification, which requires approval by two-thirds of the
Senators present and voting. Prior to this vote, however, it
generally has been the practice for the Senate Committee on
Foreign Relations to hold hearings on the treaty and make a
recommendation regarding its approval to the full Senate. Both
Government and private sector witnesses may testify at these
hearings. After the Senate gives its advice and consent to
ratification of the protocol or treaty, an instrument of
ratification is drafted for the President's signature. The
President's signature completes the process in the United
States.
Paragraph 2
Paragraph 2 provides that the Protocol will enter into
force three months following the date of the later of the Notes
referred to in paragraph 1. The date on which a treaty enters
into force is not necessarily the date on which its provisions
take effect. Paragraph 2, therefore, also contains rules that
determine when the provisions of the treaty will have effect.
Under subparagraph 2(a), the Protocol will have effect with
respect to taxes withheld at source (principally dividends,
interest and royalties) for amounts paid or credited on or
after the date on which the Protocol enters into force. For
example, if the later of the Notes referred to in paragraph 1
is dated April 25 of a given year, the withholding rates
specified in new Article 11 of the Convention as amended by
Article V of the Protocol would be applicable to any interest
paid or credited on or after July 25 of that year. This rule
allows the benefits of the withholding reductions to be put
into effect without waiting until the following year. The delay
of three months is required to allow sufficient time for
withholding agents to be informed about the change in
withholding rates. If for some reason a withholding agent
withholds at a higher rate than that provided by the Convention
(perhaps because it was not able to re-program its computers
before the payment is made), a beneficial owner of the income
that is a resident of the other Contracting State may make a
claim for refund pursuant to section 1464 of the Code.
Under subparagraph 2(b), the Protocol will have effect with
respect to taxes determined with reference to a taxable period
beginning on or after the date on which the Protocol enters
into force.
For all other taxes, subparagraph 2(c) specifies that the
Protocol will have effect on or after the date on which the
Protocol enters into force.
Paragraph 3
Paragraph 3 sets forth additional rules regarding the
applicability of the mandatory binding arbitration rules
provided in paragraphs 5, 6 of revised Article 26 of the
Convention as amended by Article XII of the Protocol.
Under paragraph 3, paragraphs 5 and 6 of revised Article 26
of the Convention are not effective for cases that are under
consideration by the competent authorities as of the date on
which the Protocol enters into force. For cases that come under
such consideration after the Protocol enters into force, the
provision of paragraphs 5 and 6 of revised Article 26 of the
Convention shall have effect on the date on which the competent
authorities agree in writing on a mode of application pursuant
to subparagraph (g) of paragraph 6 of Article 26. In addition,
the commencement date for cases that are under consideration by
the competent authorities as of the date on or after which the
Convention enters into force, but before such provisions have
effect, is the date on which the competent authorities have
agreed in writing on the mode of application.
OTHER
The various provisions in the Memorandum of Understanding
are explained above in the relevant portions of the Technical
Explanation with the exception of paragraph 2. Paragraph 2
provides that with reference to paragraph 3 of the Protocol of
1990, the Contracting States commit to initiate discussions as
soon as possible, but no later than six months after entry into
force of the Protocol, regarding the conclusion of an
appropriate agreement to avoid double taxation on investments
between Puerto Rico and Spain.
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