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Treas.
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Department of the Treasury
PRESS RELEASES
Number not used HP-l 062.
P-l 06J: lh~der Secretary McConnick .':ltatemcnt <br>on World Bank Approval of Clean Technology F...
Page 1 of I
July 1, 2008
HP-1063
Under Secretary McCormick Statement
on World Bank Approval of Clean Technology Fund
"The United States welcomes the World Bank's decision today to establish a $5$10 billion international clean technology fund that will reduce greenhouse gas
emissions growth in the fastest growing developing countries by promoting lowcarbon development.
"We have been working closely with the Bank's leadership, potential donor and
recipient countries, as well as the environmental and business communities, to
develop a Fund that effectively addresses the dual challenges of poverty and
climate change.
"The President has requested from Congress $2 billion over the next three years for
the Fund to support immediate action to help reduce greenhouse gas emissions in
developing countries where they are growing the fastest through the deployment of
commercially available clean technology."
-30-
http://www.treas.gov/press/releases/hpl063.htm
8/1/2008
P-1064:
Re~rks
by U.S. Treasury Seaetary Henry M. Paulson, Jr. <br>on the U.S., the World Econo... Page 1 of 5
July 2,2008
HP-1064
Remarks by U.S. Treasury Secretary Henry M. Paulson, Jr.
on the U.S., the World Economy and Markets before the Chatham House
London· Thank you, Robin. I am pleased to be in London again. Today I will
provide my perspective on current U.S. and global economic conditions and then
look forward to your questions.
When President Bush visited the United Kingdom last month, Prime Minister Brown
remarked on the similarities between our countries -- that both are "founded upon
liberty, our histories forged through democracy, our shared values expressed by a
commitment to opportunity for all." And indeed our countries are loyal and true
allies, our people are friends and we stand and work together on the world
economic stage.
U,S. Economy
Today, the U.S. economy is going through a rough period. And while we have seen
better growth in Europe over the last few quarters, there are signs of a slowdown in
Europe in general and the UK specifically. However, emerging economies are
expected to continue a period of strong growth, which will support global growth
overall.
Early this year, President Bush and the U.S. Congress enacted an economic
stimulus package that is injecting $150 billion into the U.S. economy now when it's
most needed. To date, almost 95 million payments totaling over $78 billion have
been sent. Consumer spending data in May show these payments are helping
families weather this period of slow growth and higher food and gas prices.
Still, the U.S. economy is facing a trio of headwinds: high energy prices, capital
markets turmoil and a continuing housing correction.
U.S. Housing Market
While we have implemented several public and private initiatives to prevent
avoidable foreclosures, the housing correction continues to pose a significant
downside risk to the U.S. economy. As the market works through past excesses,
U.S. foreclosures will remain elevated and we should not be surprised at continued
reports of falling home prices. Our policy continues to be to work to avoid
preventable foreclosures while not impeding the necessary correction because the
sooner housing prices stabilize and more buyers return to the market the sooner
housing will begin to contribute to economic growth.
U.S. and Global Capital Markets
Today I will focus on our capital markets - where the United States and the United
Kingdom face similar challenges and are pursuing similar approaches. I see our
work in three tranches; first and foremost, our number one priority continues to be
promoting market stability and limiting the impact on the broader economy as we
work through today's institutional and markets stresses. Second, implementing the
appropriate policy responses to recent events to address the deficiencies in our
markets which the current problems have exposed. Third, improving our overall
financial regulatory structure to better prevent and address future turmoil.
Working through the current turmoil will take additional time, as markets and
financial institutions continue to reassess risk, and re-price securities across a
number of asset classes and sectors. I have encouraged financial institutions to delever, recognize and disclose losses and raise capital, so they can continue to play
http://www.treas.govLPress/releases/hpl064.htm
8/1/2008
P-1064: ReTt1arks by U.S. Treasury
S~retary
Henry M. Paulson, Jr. <br>on the U.S., the World Econo... Page 2 of 5
their vital role in supporting economic growth. Even in this difficult environment,
financial institutions worldwide have raised over $338 billion. Institutions in the U.S.
and the U.K. have raised capital equal to 95 and 96 percent of their recognized
losses, respectively. In continental Europe, the gap is wider; there, institutions have
raised only 56 percent of their recognized losses so far. I encourage financial
institutions to continue to strengthen balance sheets by raising capital, deleveraging or reviewing dividend policies.
Today's markets are difficult and this is a tough earnings environment for our
financial institutions as they work through the present market turmoil and adjust to
the underlying challenges in our economy. For example, high oil prices will in all
likelihood prolong our economic slowdown and housing continues to pose a
significant downside risk.
U.S. Response to Policy Issues Arising from Market Turmoil
As the United States and international capital markets work through the immediate
turmoil, policymakers around the world have been focused on addressing the policy
implications.
In the United States, the Treasury Department, the Federal Reserve, the Securities
and Exchange Commission and the Commodities Futures Trading Commission
worked together through the President's Working Group on Financial Markets, the
PWG, to recommend and implement specific near-term policy actions. U.S.
regulators, investors, financial institutions and credit ratings agencies have begun to
implement these and other recommendations, which include stronger mortgage
origination oversight, national licensing standards for mortgage brokers, and actions
to improve market infrastructure, regulatory oversight, risk management practices,
steps to address valuation issues, and policies and practices related to the credit
ratings agencies and the mortgage securitization chain.
International Policy Response to Market Turmoil
From the outset, U.S. and world policymakers knew that the interconnectedness of
U.S. and global markets required an internationally coordinated response.
Throughout this process, we have been in regular contact and worked closely with
our international colleagues, particularly with the UK. At our meeting last October,
the G7 tasked the Financial Stability Forum, the FSF, to analyze the underlying
causes of the turbulence and offer proposals for change. The FSF, which brings
together the supervisors, central banks, and finance ministries of major financial
centers, has done its work quickly and effectively, and recently produced 67
recommendations. These are consistent with and complement efforts in the United
States.
We have already seen progress on the implementation: an updated code of
conduct for credit rating agencies has been issued and is being implemented;
disclosure practices have been published and are being put in place; and the Basel
Committee just issued updated bank liquidity guidance. A large number of other
projects are well underway, and the FSF is closely monitoring progress. The United
Kingdom and European nations are taking a number of other actions that support
and reinforce the FSF recommendations.
There is no easy solution that will immediately relieve current financial market
stress or protect against future problems and market challenges which will
inevitably occur. Together, the United States, the United Kingdom, other nations
and the FSF are addressing current challenges and the underlying weaknesses that
contributed to present economic circumstances.
Vision for a Modern U.S. Financial Regulatory Structure
That said, I believe we in the United States need to go further - to address not only
the specific policy issues that gave rise to recent turmoil, but also the outdated
nature of the U.S. financial regulatory system. Few, if any, defend our current
balkanized system as optimal.
Treasury made our recommendations for an optimal structure when we released
our Blueprint for a Modernized Financial Regulatory Structure last March. We
http://www.treas.gov/press/releases/hpl064.htm
811 12008
P-I064: Rel'!1<lrks by U.S. Treasury Secretary Henry M. Paulson, Jr. <br>on the U.S., the World Econo ... Page 3 of5
recommend a U.S. regulatory model based on objectives that more closely link the
regulatory structure to the reasons why we regulate. Our model proposes three
primary regulators: one focused on market stability across the entire financial
sector, another focused on safety and soundness of institutions supported by a
federal guarantee, and a third focused on protecting consumers and investors.
A major advantage of this structure is its timelessness and its flexibility. Because it
is organized by regulatory objective rather than by financial institution category, it
can more easily respond and adapt to the ever-changing marketplace. These
recommendations eliminate regulatory competition that creates inefficiencies and
can engender a race to the bottom.
We began work on this Blueprint well before our current challenges emerged. Our
goal then, which has only accelerated now, is to modernize the U.S. financial
regulatory structure to better reflect modern financial markets. Of course, regulation
alone cannot fully protect the financial system. Market discipline must also constrain
risk-taking. Finding the right balance between market discipline and market
oversight is critical to maintaining the market stability and innovation necessary to
support vibrant economic growth.
When we released the Blueprint, I was clear that it was a long-term vision that
would take time to consider and implement. That is still the case, but today we have
both a clear need and a unique opportunity to accelerate this process. The Bear
Stearns episode and market turmoil more generally have placed in stark relief the
outdated nature of our financial regulatory system. We are working with the Fed
and the SEC on the immediate issues raised by the Fed's provision of liquidity to
the primary dealers, an extraordinary step taken in the wake of Bear Stearns and
one that was necessary to ensure the stability and orderliness of our financial
system.
The Bear Stearns episode highlighted the need for the Fed and SEC to work
constructively together including an MOU that should be helpful and inform future
decisions as our Congress considers how to modernize and improve our regulatory
structure.
In addition to the MOU, there are three important steps that the United States
should take in the near term, all of which move us further in the direction of the
optimal regulatory structure outlined in the Blueprint.
First, whether it was Long Term Capital Management in 1998 or Bear Stearns this
year, it is clear that Americans have come to expect the Federal Reserve to step in
to avert events that pose unacceptable systemic risk. But, as we noted in our
Blueprint, the Fed has neither the clear statutory authority nor the mandate to
attempt to anticipate and prevent risks across our entire financial system. Therefore
we should consider how most appropriately to give the Federal Reserve the
information and authority necessary to play its expected role of market stability
regulator. The Fed would need the authority to access necessary information from
complex financial institutions -- whether it is a commercial bank, an investment
bank, a hedge fund, or another type of financial institution -- and the tools to
intervene to mitigate systemic risk in advance of a crisis.
This is a tall order. History teaches us that in a dynamic market economy regulation
alone cannot eliminate instability. To be clear, I do not believe that we can
eliminate, by regulation or otherwise, all future bouts of market instability -- they are
difficult to predict and past history may be a poor predictor of the future. However,
just because the overall task is difficult, we should not stop trying to understand and
mitigate instability.
To that end, we should create a system that gives us the best chance of foreseeing
a crisis, including a market stability regulator with the authorities to avert systemic
issues it foresees and providing the information, tools and authorities to deal better
with unexpected events when they inevitably occur.
To complement this regulator's efforts, we must have strong market discipline to
reinforce the stability of our markets. For market discipline to be effective it is
imperative that market participants not have the expectation that lending from the
Fed, or any other government support, is readily available. Otherwise, market
discipline will be compromised severely. I know from first hand experience that
http://www.treas.gov/press/releases/hpl064.htm
8/1/2008
P-1064: Rewarks hy U.S. Treasury Secretary Henry M. Paulson, Jr. <br>on the U.S., the World Econo... Page 4 of 5
normal or even presumed access to a government backstop has the potential to
change behavior within financial institutions and with their creditors. It compromises
market discipline and lowers risk premiums, ultimately putting the system at greater
risk.
So how do we strengthen market discipline? Today's priority is clearly market
stability. However, looking beyond the immediate turmOil, we need to design
carefully and put in place a stronger capacity for resolution and crisis intervention
that reinforces market discipline. In an optimal system, market discipline effectively
constrains risk because the regulatory structure is strong enough that a financial
institution can fail without threatening the overall system. For market discipline to
constrain risk effectively, financial institutions must be allowed to fail. Under optimal
financial regulatory and financial system infrastructures, such a failure would not
threaten the overall system.
However, today two concerns underpin expectations of regulatory intervention to
prevent a failure. They are that an institution may be too interconnected to fail or too
big to fail. We must take steps to reduce the perception that this is so -- and that
requires that we reduce the likelihood that it is so.
Strengthening market infrastructure will reduce the expectation that an institution is
too interconnected to fail. We need to strengthen our practices and financial
infrastructure in the OTC derivatives market and in the tri-party repo system.
Important work is underway in each of these areas, and needs to be completed
quickly.
To address the perception that some institutions are too big to fail, we must improve
the tools at our disposal for facilitating the orderly failure of a large complex
financial institution. As former Federal Reserve Chairman Greenspan often noted,
the real issue is not that an institution is too big or too interconnected to fail, but that
it is too big or interconnected to liquidate quickly.
Today, our tools are limited. We have the Fed's broad lender of last resort powers
which are currently being used to help stabilize our markets. Current law also
allows our President to declare a national economic emergency, and then dictate
the actions of commercial banks. But this tool is both too blunt, in that exercising it
would likely spur greater concern and too narrow, in that commercial banks are only
one group of participants in today's broad financial markets. We also have
specialized resolution provisions that apply solely to insured depository institutions,
but these do not apply to a large group of complex financial companies.
In general, bankruptcy law serves as the resolution regime for non-depository
financial institutions and most corporations. This regime has a long legal history,
and is initiated by private-sector decisions to initiate bankruptcy proceedings, which
then start a process to pay claims. In contrast, under the administrative procedures
for insured depository institutions, regulators determine when and how to start the
proceeding and in many ways regulators largely take the place of the courts in
determining the allocation of claims
These two very different approaches for resolution have advantages and
disadvantages. Bankruptcy imposes market discipline on creditors, but in a time of
crisis could involve undue market disruption. An administrative procedure under the
control of regulators helps to mitigate market disruption, but can reduce market
discipline. For insured depository institutions, this special insolvency regime was
deemed necessary because of the role these institutions play in the overall
financing of economic activity and the presence of a government guarantee.
As I have continually noted, the financial landscape has changed, and non-bank
financial institutions playa significantly greater role. We need to consider broadly
{he resolution regime in light of these changes. It is clear that some institutions, if
they fail, can have a systemic impact, so we must give regulators the authorities to
limit that impact and facilitate an orderly failure. In my view, looking beyond the
immediate market challenges of today, we need to create a resolution process that
ensures the financial system can withstand the failure of a large complex financial
firm. To do this, we will need to give our regulators additional emergency authority
to limit temporary disruptions. These authorities should be flexible and -- to
reinforce market discipline -- the trigger for invoking such authority should be very
high, such as a bankruptcy filing. And as part of this process we should consider
ways to ensure that costs are imposed on creditors and equity holders. Any
http://www.treas.gov/press/releases/hpl064.htm
811 12008
}-1064:
Rem~lrks
by U.S. Treasury
SeC'~etary
Henry M. Paulson, Jr. <br>on the U.S., the World Econo... Page 5 of 5
commitment of government support should be an extraordinary event that requires
the engagement of the Executive Branch. It should be focused on areas with the
greatest potential for market instability and should contain sufficient criteria to
ensure that the cost to the taxpayers is minimized.
In the United Kingdom, you gave recently proposed changes to your regulatory
system as the United States is doing now. While your regulatory system is different
from ours, we both recognize the direction our systems must take to better deal with
market stability issues and today's financial markets. In the U.K., colleagues have
recently proposed modifications to your regulatory structure and authorities similar
to what Treasury envisioned in our Blueprint. Under this new proposal, the Bank of
England would be given specific statutory responsibility for financial stability
regulation. A new Financial Stability Committee, chaired by the Governor of the
Bank of England, would oversee the Bank's functions as they relate to market
stability. The Bank of England would also have new authorities to carry out this
function, including access to firm-specific information related to market stability,
formal oversight of payment systems, as we are recommending for the Federal
Reserve in the U.S., and a lead role in working with the FSA to establish a new
resolution regime.
As U.S. and global regulators respond to recent events, we must recognize that the
stability and vitality of our markets require both robust oversight and market
discipline.
Conclusion
The United States and the United Kingdom share a long history and a bright future.
As we cooperate and work closely with you during this period of economic difficulty
we look forward to emerging, as we always do, to a new day of promise and
prosperity. Thank you.
-30-
http://www.treas.gov/press/releases/hpl064.htm
8/1/2008
-1065: TreasL!ry Identities New Aliases<br>of AI Rashid and AI-Akhtar Trusts<br>Pakistan-Based T... Page 1 of 2
July 2,2008
HP-1065
Treasury Identifies New Aliases
of AI Rashid and AI-Akhtar Trusts
Pakistan-Based Trusts Previously Designated for Supporting al Qaida
Washington - The U.S. Department of the Treasury today added to its list of
Specially Designated Global Terrorists (SDGTs) new aliases under which AI Rashid
Trust and AI-Akhtar Trust International are operating in an apparent effort to
circumvent sanctions imposed by the United States and the United Nations.
"We are very concerned about designated entities reconstituting themselves under
new names in attempts to circumvent sanctions and continue funneling money to
terrorist activities," said Adam J. Szubin, Director of the Office of Foreign Assets
Control (OFAC). "OFAC will continue to put the public on notice when we find that a
designated entity is trying to operate under the cloak of a new alias."
AI Rashid Trust
AKA: AI Amin Welfare Trust
AKA: AI Amin Trust
AKA: AI Ameen Trust
AKA: AI-Ameen Trust
AKA: AI Madina Trust
AKA: AI-Madina Trust
AI Rashid Trust was designated on September 23, 2001, in the Annex to Executive
Order 13224 and was added to the UN 1267 Committee's List of individuals and
entities associated with Usama bin Laden, al Qaida or the Taliban on April 24,
2002. As of mid- 2007, AI Rashid Trust was operating under the name AI Amin
Welfare Trust and the other AKAs listed above.
A1-Akhtar Trust International
AKA: Pakistan Relief Foundation
AKA: Pakistani Relief Foundation
AKA: Azmat-e-Pakistan Trust
AKA: Azmat Pakistan Trust
AI-Akhtar Trust International was designated pursuant to E.O. 13224 on October
14,2003, and was added to the UN 1267 Committee's List on August 17, 2005. As
of July 2007, A 1-Akhtar Trust International was using the alternate name Pakistan
Relief Foundation and the other AKAs listed above. As of May 2007, Pakistan
Relief Foundation had taken over all assets of AI-Akhtar Trust, and AI-Akhtar
Trust's senior leaders had begun working on behalf of Pakistan Relief Foundation.
AI Rashid Trust, AI-Akhtar Trust International, and the AKAs named today are
designated under Executive Order 13224, which targets terrorists, those owned or
controlled by or acting for or on behalf of terrorists, and those providing financial,
technological, or material support to terrorists or acts of terrorism. Assets these
designees hold under U.S. jurisdiction are frozen and U.S. persons are prohibited
from engaging in transactions in property or interests in property blocked under the
order.
For more information on the September 23,2001 designation of AI Rashid Trust,
please visit: http://www,treas.gov/offices/enforcement/keyissues/protecting/cha rities _ execorder_13224-a .shtml#trust.
For more information on the October 14, 2003 designation of AI-Akhtar Trust
International, please visit: http://www.treas.gov/press/releases/js899.htm.
http://www.treas.gov/press/releases/hpl065.htm
8/1/2008
S. Treasury - 0ffice of Terrorism and F1I1ancialintciligence (TFI)
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Complete List of Designations
IE
Additional Background Information on Charities Designated Under Executive Order
13224
81 BI CI DI EI FI GI
Hili
JI KI LI MI NI 01 PI QI RI SI TI UI VI WI XI YI
Z
A
Afghan Support Committee
U.S. Designation Date: January 9, 2002
UN Designation Date: January 11, 2002
Background: The Afghan Support Committee (ASC) is a non-governmental organization
(NGO) established by Usama bin Laden, based in Afghanistan, and affiliated with the
Revival of Islamic Hentage Society (RIHS). Abu Bakr AI-Jazln. the finance chief of ASC,
also served as the head of organized fundralslng for UBL. AI-JaZin collected funds for al
Oaida in Jalalabad through the ASC. He also collected money for al Oalda from local Arab
NGOs by claiming the funds were for orphans and Widows. AI-Jazin then turned the funds
over to al Oaida's finance committee. In 2000. he moved from Jalalabad to Pakistan where
he continued to raise and transfer funds for 031 Oaida.
AKAs: Ahya UI Turas
Jamiat Ayat-Ur-Rhas AI Islamla
Jamiat Ihya UI Turath UI Turath AI Islamia
LaJnat UI Masa Eldatul Afghani
For Additional Information http://www.treas.gov/press/releases/p0910.htm
Aid Organization of the Ulema
U.S. Designation Date: April 19, 2002
UN Designation Date: April 24, 2002
Background: The Aid Organization of the Ulema (AOU) is based In Pakistan and IS a
successor organization to AI Rashid Trust, listed by the UN as a financial faCilitator of
terrorists in September 2001. under UNSCR 1333 AI Rashid Trust was among the first
organizations designated as a terrorist financier and facilitator. AI Rashid Trust changed ItS
name to AOU and remains active. AOU IS headquartered in Pakistan, and continues to
operate offices there. AOU has been raiSing funds for the Taliban since 1999, and officers of
the organization are reported to be representatives and key leaders of al Oalda. ThiS
deSignation captures the re-named office and Identifies additional locatiolls of other brandl
offices in Pakistan.
AKAs: AI Rashid Trust AI Rushed Trust AI-Rushed Trust AI-Rashid Trust
.treas.gov /offices/en forcement/key-issues/protecting/chari ties _exec order_13 224-a. shtml
8/1/2008
S. Treasuty - Office of Terrorisl11 wid Financial Intelligence (TFI)
Page 2 of 10
For Additional Information http://www.treas.gov/press/releases/p03014.htm
AI Akhtar Trust
U.S. Designation Date: October 14, 2003
Background: AI Akhtar Trust is known to have provided support to al Oaida fighters in
Afghanistan AI Akhtar Trust is carrying on the activities of the previously designated AI
Rashid Trust (designated September 23,2001) and is linked to the Tallban and AI Oaida.
An associate of AI Akhtar Trust has attempted to raise funds to finance obligatory Jihad in
Iraq, and it has been reported that a financier of AI Akhtar Trust has been linked to the
kidnapping and murder of the Wall Street Journal's South Asia Bureau Chief. Daniel Pearl
The group leader of the terrorist group Jadish-e-Mohammed, Mastoid Zahra, set up two
organizations registered in Pakistan as humanitarian aid agenCies AI Akhtar Trust alld
Elkhart Trust. Jadlsh-e-Mohammed hoped to give the Impression that the two new
organizations were separate entities and sought to use them as a way to deliver arms allel
ammunition to their members under tile guise of providing humanitarian aid to refugees and
other needy groups. Pakistani newspaper reporting In November 2000 Indicated that AI
Akhtar Trust was establlsrled under tile supervlslofl of prominent rellgloLis scholars for tile
purpose of providing financial assistance for mujahideen, financial support to the Tallban
and food, clothes, and education to orphans of martyrs. The Chairman and Chief Executive
Officer of AI Akhtar Trust is Hakeen Muhammad Akhtar, a Pakistani citizen, who stated that
their services for the Taliban and Mullah Omar were known to the world. AI Akhtar Trust was
providing a wide range of support to AI-Oaida and Pakistani-based sectarran and Jihadl
groups, speCifically Lashkar-e-Tayyiba, Lashkar-I-Jhangvi, and Jaish-e-Mollammed All
three of these organizations have been designated by the U.S. These efforts included
providing financial and logistical support as well as arranging travel for Islamic extremists.
This designation covers operations of AI Akhtar Trust through offices and Individuals
operating outside of Pakistan.
In June 2008, the United States identified new aliases AI Akhtar used to circumvent
sanctions so that it could continue to support al Oaida.
AKAs: AI Akhtar Trust
AI-Akhtar Trust International
Akhtarabad Medical Camp
Akhtar Medical Centre
Pakistan Relief Foundation
Pakistani Relief Foundation
Azmat-e-Pakistan Trust
Azrnat Pakistan Trust
For Additional Information http://www.treas.gov/press/releases/js899.htm
For Additional Information about New Aliases.
http://www.ustreas.gov/press/releases/hp106S.htm
AI Aqsa Foundation
U.S. Designation Date: May 29, 2003
Background: AI Aqsa Foundation (AAF) IS a critical part of the HAMAS terrorist support
Infrastructure. Through its headquarters In Germany and branch offices In the Netherlands.
Denmark, Belgium, Sweden. Pakistan, South Afrrca, Yemen and elsewhere, AAF funnels
money collected for charitable purposes to HAMAS terrorists. Like other HAMAS-affrliated
charities, AAF uses humanitarian relief as cover to provide support to the HAMAS terrorist
organization. Mahmoud Amr, the Director of AAF In Germany, is an active figure in HAM AS.
AAF offices are included in lists of organizations that contributed to the HAMAS-affiliated
Charity Coalition in 2001 and 2002. Pursuant to a July 31, 2002 administrative order.
German authorrties closed AAF In Germany for supporting HAMAS. In April 2003. Dutch
authorrties blocked AAF assets in The NeUlerlands based on information that funds were
provided to organizations supporting terrorism In the Middle East Crrminal charges against
some AAF officials were also filed On January 1, 2003, the Danish government charged
three AAF officials in Denmark for supporting terrorism. Also. the head of the Yemeni
branch of AAF, Shaykh Muhammad Ali Hassan AI-Muayad. was arrested for providing
http://www.treas.gov/offices/enforcement/key-issues/protecting/charities_ execorder_13224-a.shtml
8/112008
S. TreasUlY - Office of Terrorism <l",d Financial Intelligence (TFI)
Page 3 of 10
support to terrorist organizations, including AI-Qaida and HAMAS, in January 2003 by
German authorities. In Scandinavia. the Oslo, Norway-based Islamic League used the AAF
in Sweden to channel furlds from SOme members of the Islamic community In Oslo, Norway
to HAMAS AI-Muayad has also allegedly provided money, arms, recruits and
communication equipment for AI-Qaida At least until AI-Muayad's arrest. Ali Muqbil, the
General Manager of AAF In Yemen and a HAMAS official, transferred funds on AI-Muayads
orders to HAMAS, PIJ or other Palestinian organizations assisting "Palestinian fighters." Tile
disbursements were recorded as contributions for charitable projects. Also. several officials
and active supporters of al Qalda and Asbat AI-Ansar (deSignated under EO 13224 as a
specially designated global terrorist) are leaders of some branches of the AAF.
AKAs: AI-Aqsa International Foundation AI-Aqsa Charitable Foundation Sanabil al-Aqsa
Charitable Foundation AI-Aqsa Sinabil Establisllment AI-Aqsa Charitable Organization
Charitable AI-Aqsa Establishment Mu'assa al-Aqsa al-Khayriyya Mu'assa Sanabll AI-Aqsa
al- Khayriyya Aqssa Society, AI-Aqsa Islamic Charitable Society Islamic Charitable Society
for al-Aqsa Charitable Society to Help the Noble al-Aqsa Nusrat al-Aqsa ai-Sharif
For Additional Information http://www.treas.gov/press/releases/js439.htm
AI Furqan
U.S. Designation Date: May 6, 2004
UN Designation Date: May 11, 2004
Background: Information shows this non-governmental organization was associated with al
Qaida. having close ties and sharing an office with the Global Relief Foundation (GRF), and
was chiefly sponsored by the Bosnian branch of the AI Haramain Islamic Foundation, with
whom It JOintly conducted many activities in Bosnia Individuals working for AI Furqan have
been involved in multiple instances of suspicious activity, including surveillance of the U.S
Embassy and UN buildings in Sarajevo. One former AI Furqan employee also has ties to the
Algerian Armed Islamic Group (GIA). Although AI Furqan ostensibly ceased operations In
2002, two successor organizations, Sirat and Istikamet, continue to act on behalf of AI
Furqan in Bosnia.
AKAs: Dzemilijati Furkan Dzem'ijjetul Furqan Association for Citizens Rights and
Resistance to Lies Dzemijetul Furkan Association of Citizens for the Support of Truth and
Suppression of Lies Sirat Association for Education Culture and Building Society-Sirat
Association for Education Cultural and to Create Society-Slrat Istikamet In Siratel
For Additional Information: http://www.treas.gov/press/releases/js1527.htm
AI-Haramain & AI Masjed AI-Aqsa Charity Foundation
U.S. Designation Date: May 6, 2004
UN Designation Date: June 28, 2004
Background: The AI-Haramain & AI Masjed AI-Aqsa Charity Foundation (AHAMAA) has
Significant financial ties to the Bosnia-based NGO AI Furqan, and al Qaida financier Wa'el
Hamza Julaidan, who was designated by the Treasury Department on September 6, 2002.
Wa'el Hamza Julaidan, a Saudi citizen, is a close associate of Usama bin Laden Julaidan
fought with bin Laden in Afghanistan In the 1980s. Bin Laden himself acknowledged his
close ties to Julaidan during a 1999 interview with al-Jazeera TV. As a member of the Board
of Directors for AHAMAA, Julaidan opened three bank accounts on behalf of the NGO
between 1997 and 2001 and continued to have authorization to handle two of their accounts
as a signatory on two the NGO's Bosnian accounts.
AKAs: AI Haramain AI Masjed AI Aqsa AI Haramayn AI Masjid AI Aqsa AI-Haramayn and AI
Masjid AI Aqsa Charitable Foundation
For Additional Information http://www.treas.gov/press/releases/js1527htm
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AI Haramain Islamic Foundation-related Designations:
•
•
•
•
•
AI Haramain Islamic FoundatiQn (general background information)
AI Haral11ain Islamic Foundation - All Offices
Afghanistan
Albania
6angJade_sh
• 6_Q§ota
•
•
COrnoros Islands
Ethiopia
• ImtQoesla
•
Keoy.a
•
•
•
Pakistan
Somalia
TanzaniCl
Vnlt~LqSt<:l~eS
• TtteJ\tetberlaods
•
General Background: AI-Haramain Islamic Foundation (AHF) represents itself as a private,
charitable, and educational organization dedicated to promoting Islamic teaching throughout
the world. It is one of the principal Islamic non-governmental organizations active throughout
the world. Funding generally comes from grants from other countries, individual Muslim
benefactors, and special campaigns, which selectively target Muslim-owned business
entities around the world as sources of donations.
There is evidence that field offices and representatives operating throughout Africa, Asia
and Europe have provided financial and logistical support to the al Qaida network and other
terrorist organizations designated by the United States, and, in some cases, included on the
UN 1267 Committee's consolidated list of individuals/entities subject to Security Council
Sanctions. Some of these organizations include the Egyptian Islamic Jihad (EIJ), Jemaah
Islamiyah, AI-Ittihad AI-Islamiya (AlAI), Lashkar E-Taibah, and HAMAS - all of which are
designated terrorist organizations and all of which have received funds from AHF, its
branches, or local intermediaries.
AI Haramain • Afghanistan
Saudi/U.S. Designation Date: June 2, 2004
UN Designation Date: June 6, 2004
Background: In Afghanistan, prior to the removal of the Taliban from power, AHF
supported the cause of Jihad and was linked to the UBL financed Makhtab al-Khidemat
(MK), a pre-cursor organization of al Qaida and a Specially Designated Global Terrorist
pursuant to the authorities of E.O. 13224.
Following the September 11,2001 terrorist attacks, AHF activities supporting terrorism in
Afghanistan continued. In 2002, activities included involvement with a group of persons
trained to attack foreigners in Afghanistan. A journalist suspected of meeting with al Qaida
and Taliban members in Afghanistan was reportedly transferring funds on behalf of the al
Qaida-affiliated AHF and forwarding videotapes from al Qaida leaders to an Arabic
language TV network for broadcast.
For Additional Information: http://www.treas.gov/press/releases/js1703.htm
AI Haramain • Albania
Saudi/U.S. Designation Date: June 2, 2004
UN Designation Date: June 6, 2004
The U.S. has information that indicates UBL may have financed the establishment of AHF in
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Albania. which has been used as cover for terrOrist activity In Albania and In Europe In late
2000. a close associate of a UBL operative moved to Albania and was running an unnamed
AHF subsidiary In 1998, the head of Egyptian Islamic Jihad in Albania was reportedly also
a financial official for AHF In Albania This Individual, Ahmed Ibrahim ai-Nagar. was
reportedly extradited from Albania to Egypt irl 1998 At his trial in Egypt, ai-Nager repoliedly
voiced his support fm UBL and al Oaldas August 1998 terrorist attacks against tile U S
embassies in Kenya and Tanzania.
Salih Tivari, a senior official of the moderate Albanian Muslim community, was murdered In
January 2002. Ermlr GJlnishl, who had been supported by AHF, was detained In connectloll
With the murder, but no charges were filed; he was later released by Albanian authorities.
Just prior to being murdered. Tivari informed the AHF-affillated GJinlshi that he Intended to
reduce "foreign IslamiC influence" In the Albanian Muslim community
Pnor to his murder, Tivari controlled finances, personnel decisions, and donations Within the
Albanian Muslim community This provided him significant power, enabling him to survive
several attempts by extremists trained overseas to replace him or usurp hiS power
As of late 2003, AHF was paying for, through a HAMAS member with close ties to AHF In
Albania, security personnel to guard Hle AHF building in Albania, WhlCll had been shut down
earlier in 2003.
For Additional Information http://www.treas.gov/press/.releases/js1703.htm
AI Haramain - Bangladesh
Saudi/U.S. Designation Date: June 2, 2004
UN Designation Date: June 6, 2004
Background: Infonnatlon available to the US shows that a senior AHF offiCial deployed a
Bangladeshi natiollal to conduct surveillance on U.S. consulates In India for potential
terrorist attacks The Bangladeshi national was arrested in early 1999 In India, reportedly
carrying four pounds of explosives and five detonators. The terrmist suspect told police that
he intended to attack US. diplomatic missions in India The suspect reportedly confessed to
training in al Oalda terrorist camps in Afghanistan, where he met personally with Usama bill
Laden In 1994 The suspect first heard of plans for these attacks at the AHF office In
Bangladesh.
For Additional Information http://www.treas.gov/press/releases/js1703.htm
AI Haramain Islamic Foundation (Vazir a/k/a) - Bosnia
Saudi/U.S. Designation Date: March 11, 2002
Amended December 22, 2003
UN Designation Date: March 13, 2002
Amended December 26, 2003
Background: The Bosnia office of AI Haramaln IS linked to AI-Gama'at al-Islamiyya, an
Egyptian terrorist group (deSignated under Executive Order 13224 on October 31. 2001 )
that was a signatory to UBLs February 23, 1998 fatwa against the United States. After the
Bosnia branch of AI Haramain was deSignated In March 2002, AI Haramaln offiCials closed
ItS Bosnian operations. Officials in Bosnia then persuaded senior AI Haramaln offiCials to
reoperl the organization under a different name In Travnik, Bosnia. The new nongovernmental organization. Vazlr, was founded In May 2003 and established Its
headquarters in a business space formerly used by AI Haramaln. The Ministry of Justice
and Administration fm the Central Bosnian canton registered Vazir on June 11. 2003, as an
association for sport, culture, and education. The office opened under the name Vazir In
early August 2003. The original deSignation of the Bosnian branch of AI Haramaln was
amended to add the aka, 'Vazir," resultirlg in the formal deSignation of Vazlr on December
22,2003.
For Additional Informationht1p;ljwww.tre~s_.gQ\l/p[~$::;/relE:}aseS/P91086.htl11
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AI Haramain Islamic Foundation - Comoros Islands
U.S. Designation Date: September 9, 2004
UN Designation Date: September 28, 2004
Background: AI Haramain had operations throughout the Union of the Comoros, and
information shows ttlat associates of AHF Comoros are linked to al Oalda. According to tile
transcript of U S v. Bin Laden, the Union of the Comoros was used as a staging area and
exfiltration route for the perpetrators of the 1998 bombings of the U.S. embassies in Kenya
and Tanzania. The AHF branches in Kenya and Tanzania have been preViously designated
for providing financial and other operational support to these terrorist attacks.
For Additional Information http://www.treas.gov/press/releases/js1895.htm
AI Haramain - Ethiopia
SaUdi/U.S. Designation Date: June 2, 2004
UN Designation Date: June 6, 2004
Background: Information available to the US. shows that AHF In Ethiopia has prOVided
support to AI-Ittihad AI-Islamiya (AlAI). In Ethiopia, AlAI has engaged in attacks against
Ethiopian defense forces AlAI has been designated both by the U.S. Government and by
the UN 1267 Sanctions Committee. Ethiopia IS one of the countries where AHF's website
states that they have operations, but there does not appear to be a formal branch office. As
part of our efforts to designate thiS branch, we have asked that adon be taken to ensure
that individuals cannot use the name of AHF or act under ItS auspices within, or in
connection with services provided in, Ethiopia.
For Additional Information: http://www.treas.gov/press/releases/js1703.htm
AI Haramain Islamic Foundation - Indonesia
U.S. Designation Date: January 22, 2004
UN Designation Date: January 26, 2004
Background: In 2002, money purportedly donated by the AI Haramain Islamic Foundation
(AHF) for humanitarian purposes to non-profit organizations in Indonesia was pOSSibly
diverted for weapons procurement, with the full knowledge of AHF in Indonesia. USing a
variety of means, AHF has provided financial support to al Oaida operatives III IndoneSia
and to the terrorist group Jemaah Islamiyatl (JI). According to Omar al-Faruq, a senior al
Oaida official apprehended in Southeast Asia, AHF was one of the primary sources of
funding for al Oaida network activities In the region The U.S. has designated JI, and the
1267 Committee has included it on its list, because of its ties to al Oaida JI has committed a
series of terrorist attacks, including the bombing of a nightclub in Bali on October 12, 2002
that killed 202 people and wounded over 300 additional people.
AKA: Yayasan AI-Manahil-Indonesia
For Additional Information http://www.treas.gov/press/releases/js1108.htm
AI Haramain Islamic Foundation - Kenya and Tanzania
U.S. Designation Date: January 22, 2004
UN Designation Date: January 26, 2004
Background: AI Haramain Islamic Foundation offices in Kenya and Tanzania prOVide
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support, or act for or on behalf of, AI-Itihaad al-Islamiya (AlAI) and al Qaida. AlAI shares
ideological, financial and training links with al Qaida and financial links with several NGOs
and companies, including AHF, which is used to transfer funds. AlAI also has invested In the
"legitimate" business activities of AHF
As early as 1997, U.S. and other friendly authorities were Informed that the Kenyan branch
of AHF was involved in plotting terrorist attacks against Americans. As a result, a number of
individuals connected to AHF in Kenya were arrested and later deported by Kenyan
authorities. In August 1997, an AHF employee indicated that the planned attack against the
U.S. Embassy in Nairobi would be a suicide bombing carried out by crashing a vehicle Into
the gate at the Embassy. A wealthy AHF official outside East Africa agreed to provide the
necessary funds. Also in 1997, AHF senior leaders in Nairobi decided to alter their (then)
previous plans to bomb the U.S Embassy in Nairobi and instead sought to assassinate US
citizens. During this time period, an AHF official indicated he had obtained five hand
grenades and seven "bazookas' from a source in Somalia. According to Information
available to the US., these weapons were to be used in a possible assassination attempt
against a U.S. official. A former Tanzanian AHF Director was believed to be associated With
UBL and was responsible for making preparations for the advance party that planned the
August 7,1998, bombings of the U.S. EmbaSSies In Dar Es Salaam, Tanzania, and Nairobi,
Kenya. As a result of these attacks, 224 people were killed
Shortly before the dual-Embassy bombing attacks In Kenya and Tanzania, a former AHF
official in Tanzania met with another conspirator to the attacks and cautioned the IndiVidual
against disclosing knowledge of preparations for the attacks. Around the same time, four
individuals led by an AHF official were arrested in Europe. At that time, they admitted
maintaining close ties With two terrorist groups, Egyptian Islamic Jihad (EIJ) and Gamma
Islamiyah. In early 2003, individuals affiliated with AHF In Tanzania discussed the status of
plans for an attack against several hotels in Zanzibar. The scheduled attacks did not take
place due to increased security by local authOrities, but planning for the attacks remained
active.
For Additional Information http://www.treas.gov/press/releases/js1108.htm
AI Haramain - The Netherlands
Saudi/U.S. Designation Date: June 2, 2004
UN DeSignation Date: June 6, 2004
Background: Since 2001, Dutch officials have confirmed that the AI Haramain
Humanitarian Aid Foundation located in Amsterdam is part of the larger AI Haramaln IslamiC
Foundation network and that Aqeel Abdul AZlz AI-Aqil, who has also been designated by the
United States and the UN 1267 Sanctions Committee because of AH F's support for al Qaida
while under his overSight, IS chairman of this foundation's board of directors. As noted
elsewhere in this document, AHF was the founder and leader of AHF and was responsible
for all of its activities, including Its support of terrorism.
AKA: Stichting AI Haramain Humanitarian Aid
For Additional Information http://www.treas.gov/press/releases/js1703.htm
AI Haramain Islamic Foundation - Pakistan
Saudi/U.S. Designation Date: March 11, 2002
UN Designation Date: March 13, 2002
Background: Before the removal of the Tallban from power In Afghanistan, the AI
Haramain Islamic Foundation in Pakistan (AHF-Pakistan) supported the Taliban and other
groups. AHF-Pakistan is also linked to the UBL-financed and designated terrorist
organization, Makhtab al-Khidemat (MK). At least two former AHF-Pakistan employees are
suspected of having al Qaida ties, and another AHF-Paklstan employee is suspected of
financing al Qaida operations. Another former AHF employee In Islamabad was Identified as
an alleged al- Qaida member who reportedly planned to carry out several devastating
terrorist operations in the United States. In January 2001. extremists with ties to individuals
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associated with a fugitive UBL lieutenant were indirectly Involved with AHF-Paklstan. As of
late 2002, a senior member of AHF In Pakistan, who has also been identified as a "bin
Laden facilitator." reportedly operated a human smuggling ring to facilitate travel of al Oalda
members and their families out of Afghanistan to various other countnes. AHF In Pakistan
also supports the designated terrorist organization, Lashkar E-Taibah (LET). Some time In
2000. an AHF representative in Karachi. Pakistan met with Zelinkhan Yandarbiev The US
has designated Yandarbiev, and the UN 1267 Committee has Included him Oil its list
because of his connections to al Oalda. The AHF representative and Yandarbiev reportedly
resolved the issue of delivery to Chechnya of Zenlt missiles. stinCj anti-ailnaft missiles, emu
hand-held anti-tank weapons.
For Additional Information http://www.treasury.gov/press/releases/p01086.htm
AI Haramain Islamic Foundation - Somalia
Saudi/U.S. Designation Date: March 11, 2002
UN Designation Date: March 13,2002
Background: The Saudi-based AI Haramain IslamiC Foundation is a private, charitable and
educational organization dedicated to promoting IslamiC teachings throughout the world
The Somalia office, however is linked to Usama bin Laden's al Oaida network and AI-Itlhaad
al-Islamiyya (AlAI). a Somali terrorist group (designated under Executive Order 13224 on
September 23, 2001). AI Haramain Somalia employed AlAI members and provided them
with salaries through al Barakaat Bank (designated under Executive Order 13224 on
November 7.2001), which was a primary source of terrorist funding. AI Haramaln Somalia
continued to provide material and financial support for AlAI even after the group's
deSignation under E.O. 13224 and UNSCR 1333. Money was funneled to AlAI by disgUISing
funds as if they were intended for orphanage projects or Islamic schools
For Additional Informatlon bttp:llwww.treas.gov/press/releases/po1086.htm
AI Haramain Islamic Foundation - United States
U.S. Designation Date: September 9,2004
UN Designation Date: September 28,2004
The US.-based branch of AHF was formally established in 1997 Documents naming
Sullman AI-Buthe as the organization's attorney and providing him with broad legal authorrty
were signed by Aqeel Abdul Aziz AI-Aqil. the former director of AHF Aqil has been
deSignated by the United States and the UN 1267 Sanctions Committee because of AHF's
support for al Oaida while under hiS oversight, and AI-Buthe has also been deSignated by
the United States and the UN 1267 Sanctions Committee. The assets of tile U.S AHF
branch, which IS headquartered in Oregon, were orrginally blocked pending investigation on
February 19, 2004 An affidavit In support of a search warrant by otller federal agencies also
alleged that the U.S branch of AHF criminally violated tax laws and engaged In other
money laundering offenses. Information showed that individuals associated With the branch
tried to conceal the movement of funds Intended for Chechnya by omitting them from tax
returns and mischaracterrzlng their use, which they claimed was for the purchase of a
prayer house in Springfield, Missouri. The U.S,-based branch of AHF was fully designated
under E.O. 13224 on September 9, 2004, and under UNSCR 1267 on September 28,2004
For Additional Information http://www.treas.gov/presslreleases/js1895.htm
AI Haramain Islamic Foundation - All Offices
U.S. Designation Date: June 19.2008
General Background: Evidence demonstrates that the AHF organization was Involved In
providing financial and logistical support to the al Oalda network alld other terrorrst
organizations deSignated by the United States and the United Nations. Between 2002-2004,
the United States designated thirteen AHF branch offices operating In Afghanistan, Albania,
Bangladesh, Bosnia & Herzegovilla, Comoros Islands, Ethiopia, Indonesia, Kenya,
Netherlands, Pakistan, Somalia, Tanzania. and the United States The Kingdom of Saudi
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Arabia joined the United States In designating several branch offices of AHF and, due to
actions by Saudi authorities, AHF has largely been precluded from operating in Its own
name. Despite these efforts, AHF leadership has attempted to reconstitute the operations of
the organization, and parts of the organization have continued to operate. In 2008, the U S
Government designated the entirety of the AHF organization, including its headquarters In
Saudi Arabia.
For Additional Information: http://www.ustreas.gov/press/releases/hp1043.htm
AI Rashid Trust
U.S. Designation Date: September 23, 2001
UN DeSignation Date: October 6,2001
Background:When President Bush initiated the financial war on terrorism in September
2001, the AI Rashid Trust was among the first organizations named as a financial faCIlitator
of terrorists. This organization had been raising funds for the Taliban since 1999. The AI
Rashid Trust IS a group that funded al Oalda and the Taliban and is also closely linked to
the al Oaida-assoclated Jalsh Mohammed terrorist group AI Rashid has been directly linked
to the January 2002 abduction and subsequent murder of Wall Street Journal reporter
Daniel Pearl in Pakistan. AI Rashid and other fronts and groups have used a British internet
site called the Global Jihad Fund, which openly associates itself with Usama bin Laden, to
publish bank account Information and solicit support to facilitate the growth of various Jihad
movements around the world by supplying them With funds to purchase their weapons. See
also Aid Organization of the Ulema.
In July 2008, the United States identified new aliases AI Rashid used to circumvent
sanctions so that it could continue to support al Oaida.
AKAs: AI Amin Welfare Trust
AI Amin Trust
AI Ameen Trust
AI-Ameen Trust
AI Madina Trust
AI-Madina Trust
For Add itional Information: httpj/www.whitehouse.gov!news!releases/2001 f09/2001 09241.html
For Additional Information about New Aliases:
http://www.ustreas.gov/press/releases/hp1065.htm
AI Salah Society (Palestinian territories)
U.S. Designation Date: August 7, 2007
Background: AI-Salah Society is one of the largest and best-funded Hamas charitable
organizations in the Palestinian territories. AI-Salah Society's director, Ahmad AI-Kurd, was
also designated on this date. The AI-Salah Society supported Hamas-afflliated combatants
during the first Intifada and recruited and indoctrinated youth to support Hamas's activities.
The AI-Salah Society has received substantial funding from Persian Gulf countries, Including
at least hundreds of thousands of dollars from Kuwaiti donors, and it has employed a
number of Hamas military wing members. The AI-Salah Society was included on a list of
suspected Hamas and Palestinian IslamiC Jihad-affiliated NGOs whose accounts were
frozen by the Palestinian Authority as of late August 2003. After freezing the bank
accounts, PA officials confirmed that the AI-Salah Society was a front for Hamas.
AKAs:
AI-Salah Association
AI-Salah Islamic Foundation
AI-Salah
AI-Salah Islamic Society
AI-Salah Islamic Association
AI-Salah Islamic Committee
AI-Salah Organization
Islamic Salah Foundation
Islamic Salah Society
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Islamic Salvation Society
Islamic Righteous Society
Islamic AI-Salah Society
Jamiat AI-Salah Society
Jamiat ai-Salah al-Islamiya
Jaln'at ai-Salah al-Islaml
Jami'a ai-Salah
Jammeat EI-Salah
Salah Islamic Associatioll
Salah Welfare Orgallizatlon
Salah Charitable Association
For Addition information http://www.treas.gov/pressfreleasesfhp531.htm
Last Updated. July 17. 2008
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811 12008
-899: U.S. DESIGNATES AL AKHTAR TRUST Pakistani Based Charity is Suspected
Pagelof3
FROM THE OFFICE OF PUBLIC AFFAIRS
October 14, 2003
JS-899
U.S. DESIGNATES AL AKHTAR TRUST
Pakistani Based Charity is Suspected of
Raising Money for Terrorists in Iraq
WASHINGTON - The U.S Treasury Department today announced that it is
designating AI Akhtar Trust as a terrorist support organlLatlon under Executive
Order 13224 and will be requesting that the United Nations list the organization as a
terrorist support group. Today's designation freezes any assets of AI Akhtar Trust
within the US. and prohibits transactions with U.S. nationals. The UN listing will
require that all UN Member States take similar actions.
"Today's designation strikes at the life blood of terrorists -- the money that funds
them," Secretary of the Treasury John Snow stated. "Shutting down thiS
organization will Grlpple yet another source of support for terrorists and possibly
help undermine the financial backing of terrOrists staging attacks against American
troops and Iraqi civilians in Iraq. The activities of AI Akhtar Trust demonstrate the
dangerous alliance between corrupted charities and terrorists. There is little more
despicable than raising money under the guise of doing good and instead diverting
the resources of often well-intentioned donors to supporting acts of terror."
AI Akhtar Trust IS a Pakistani based charity known to have provided support to alQaida fighters in Afghanistan AI Akhtar is carrying on the activities of the
previously designated AI Rashid Trust. The organization IS also suspected of
raising money for Jihad In Iraq and is connected to an individual with ties to the
kidnapping and murder of Wall Street Journal Reporter Daniel Pearl This
designation builds on ongoing counter-terrorism cooperation with the Pakistani
government and comes on the heels of Secretary Snow's recent visit to Islamabad.
With today's deSignation, the US. and our international partners have designated
321 individuals and organizations as terrorists and terrorist supporters and have
frozen over $136.8 million in terrorist assets and have seized more than $60 million.
A fact sheet providing more details on today's deSignation is attached.
FACT SHEET
AL AKHTAR TRUST INTERNATIONAL
INTRODUCTION
AI Akhtar Trust International is linked to the following persons/entities deSignated by
the U.S under Executive Order 13224 the Taliban and AI Qaida and AI- Rashid
Trust, among others. An associate of AI Akhtar Trust has attempted to raise funds
to finance Obligatory Jihad In Iraq, and it has been reported that a financier of AI
Akhtar Trust has been linked to the kidnapping and murder of the Wall Street
Journal's South Asia Bureau Grlief, Daniel Pearl.
IDENTIFIER INFORMATION
AL AKHTAR TRUST
AL-AKHTAR TRUST INTERNATIONAL
• 3T -1/A, Gulsahn-E-Iqbal, Block 2, Karachi 25300, Pakistan
• AI-Akhtar Medical Centre, Gulistan-E-Jauhar, Block 12, Karachi. Pakistan
• Regional Offices in Pakistan: Bawalnagar, Bahawalpur, Gilgit, Islamabad, Mirpur
Khas, and Tando-Jan-Muhammad
• Akhtarabad Medical Camp, Spin Baldak, Afghanistan
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,-899: U.S. DESIGNATES A I
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BACKGROUND INFORMATION
According to information available to the U.S government, following the house
arrest of the group leader of Jalsh-e-Mohammed, Masoud Azhar, Jaish-eMollammed members set up two organizations registered in Pakistan as
humanitarian aid agencies AL AKHTAR TRUST and Alkhair Trust. Jaish-eMohammed hoped to give the impression that the two new organizations were
separate entities and sought to use them as a way to deliver arms and ammunition
to their members under the guise of providing humanitarian aid to refugees and
other needy groups (Jaish-e-Mohammed was designated by the U.S on October
12,2001 and by the UN 1267 Sanctions Committee on October 17, 2001).
Pakistani newspaper reporting in November 2000 indicated that AL AKHTAR
TRUST INTERNATIONAL was established under the supervision of prominent
religious scholars for the purpose of providing financial assistance for mujahldeen,
financial support to the Taliban and food, clothes, and education to orpllans of
martyrs. (The Taliban has been designated by the US and UN.) At a ceremony in
Islamabad celebrating the establishment of the Trust, the Information Secretary of
Harkatul MUjahideen. Maulana Allah Wasaya Qasim. termed the establishment of
AL AKHTAR TRUST as "commendable" and stated that religious scholars should
have entered the field earlier. (Harkatul MUjahideen was designated by the U.S. on
September 23, 2001 and by the UN 1267 Sanctions Committee on October 6.
2001 ) There was an appeal to the people to support generously the AL AKHTAR
TRUST.
According to Information available to the US. Government, the Chairman and Chief
Executive of AL AKHTAR TRUST is Hakeem Muhammad Akhtar. a Pakistani
Citizen When asked about his services in Afghanistan and his special relations With
Mullah Omar, Supreme Commander of the Tallban, Akhtar stated that their services
for the Taliban and Mullah Omar were known to the world. (Mullah Omar, aka
Mohammed Omar. has been designated by the U.S and the UN 1267 Sanctions
Committee
Operation Enduring Freedom, the military phase of the war against terrorism. began
on October 7. 2001. The U.S. government has information that, as of mldNovember 2001. the AL AKHTAR TRUST was secretly treating wounded AI Qaida
members at the medical centers it was operating in Afghanistan and Pakistan. (AI
Qalda has been deSignated by both the U.S. and UN 1267 Sanctions Committee).
During a custodial Interview in early 2003. a senior AI Qaida detainee related that
AL AKHTAR TRUST and AI-Rashid Trust were the primary relief agencies that AI
Qaida used to move supplies into Qandahar, Afghanistan. This detainee was aware
of one shipment. in 2001. arranged by an AI Qaida operative that included a "room
full" of cartons. The detainee was not aware of the contents of the cartons. but
believed that either AI-Rashid Trust or AL AKHTAR TRUST was used for the
shipment.
In 2002. AI-Rashid Trust and AL AKHTAR TRUST decided to start a drive to collect
donations from the business/industrial circles of Pakistan. Mullah Izatullah. an AI
Qalda offiCial living in Chaman, Pakistan. was associated with both AI-Rashid Trust
and AL AKHTAR TRUST AI-Rashid Trust was designated by the U.S. on
September 23. 2001 and by the UN 1267 Sanctions Committee on October 6,
2001. Information in the possession of the US Government Indicates that. as of
mid-March 2002. AL AKHTAR TRUST was conducting all activities of the former AIRashid Trust.
DUring a custodial Interview In mid-April 2003. a senior AI Qaida detainee stated
that AI-Rashid Trust and AL AKHTAR TRUST provided donations to AI Qaida
While AI Qalda was based In Qandahar. Afghanistan. these organizations provided
donations In ttle form of blankets and clothing to AI Qalda members. When AI Qaida
members fled from Qandahar in late 2001, these organizations provided the
families of AI Qaida members with financial assistance
AL AKHTAR TRUST was providing a wide range of support to AI-Qaida and
Pakistani based sectarian and jlhadl groups, specifically Lashkar-e- Tayyiba.
Lashkar-I-Jhangvi, and Jaish-e-Mohammed. (All three of these organizations have
been designated by the US) These efforts included providing financial and
logistical support as well as arranging travel for Islamic extremists
http://www.treas.gov/press/releases/j5899.htm
8/1/2008
-899: U.S. UESIGNATES AL AKHT.-\R TRUST Pakistani Based Charity is Suspected
Page 3 of3
According to Information available to the U.S. Government from March 2003, an
associate of AL AKHTAR TRUST was attempting to raise funds in order to finance
"obligatory jihad" in Iraq (ie., because fatwas had been issued. Muslims were
obligated to support jihad in Iraq). Donors were told they could contact AL AKHTAR
TRUST via email for additional information
A financier of AL AKHTAR TRUST is also reported to have ties to the kidnapping
and murder of the Wall Street Journal's South Asia Bureau. Chief, Daniel Pearl.
According to an article appearing In the Wall Street Journal, on or about January 31
or February 1,2002, citing Pakistani police, a man named Saud Memon drove Into
the compound where Daniel Pearl was being held, along With three Arabic-speaking
men. The compound was owned by Mr. Memon, a garment manufacturer, and was
located in the northern outskirts of Karachi, Pakistan. Eventually, the three Arabicspeaking men, along with one of Mr. Memon's employees, were left alone with
Daniel Pearl in one room of the compound. One of these men turned on a video
camera, and another asked Mr. Pearl questions about his religious background
After the videotaped statement by Mr. Pearl, he was blindfolded and killed.
Shortly after the murder, Pakistani police sealed Mr. Memon's home In Karachi,
which also contained his garment business. Mr. Memon remains one of the key
figures still at large in the Pearl slaYing Photos of him along With other alleged
conspirators [laVe been published throughout Pakistan, and a reward has been
offered for information leading to their arrest.
According to the article, Mr. Memon IS a known financier for militant groups Irl
association With the AI-Rashid Trust, which is described in the article as having
changed its name to AI AKHTAR TRUST. According to information available to the
U S. government, an Individual by the name of AI-Saud Memon is the individual
primarily responsible for the AL AKHTAR TRUSTs finances and the direction of
financial resources and support for the Trust.
http://www.treas.go v/press/releases/js899.htm
8/1/2008
)-1066:
Weet~
10 Wrap-Up: Treasury Sent 10.025 Million Stimulus Payments This Week
Page 1 of2
10 view or pnnt the /-'Ur content on tnls page, download tne Tree AootJe® Acrooat® Keaaer®.
July 3, 2008
HP-1066
Week 10 Wrap-Up: Treasury Sent 10.025 Million Stimulus Payments This
Week
This week the Treasury Department sent out 10.025 million economic stimulus
payments to American households totaling $7.775 billion. So far, Treasury has sent
out 104.875 million total economic stimulus payments totaling $86.079 billion.
Cumulative Total
Total Number of Payments: 104.875 million
Total Amount of Payments: $86.079 billion
Week Ten (June 30-July 4)
Total Number of Payments: 10.025 million
Total Amount of Payments: $7.775 billion
Week Nine (June 23-27)
Total Number of Payments: 9.674 million
Total Amount of Payments: $7.522 billion
Week Eight (June 16-20)
Total Number of Payments: 9.071 million
Total Amount of Payments: $6.919 billion
Week Seven (June 9-13)
Total Number of Payments: 9.526 million
Total Amount of Payments: $7.032 billion
Week Six (June 2-6)
Total Number of Payments: 9.143 million
Total Amount of Payments: $6.789 billion
Week Five (May 26-30)
Total Number of Payments: 5.757 million
Total Amount of Payments: $4.320 billion
Week Four (May 19-23)
Total Number of Payments: 6.211 million
Total Amount of Payments: $4.927 billion
Week Three (May 12-16)
Total Number of Payments: 15.575 million
Total Amount of Payments: $13.562 billion
http://www.treas.gov/press/releases/hpl066.htm
8/\/2008
)-1066: Weei' 10 Wrap-Up: Treasury Sent 10.025 Million Stimulus Payments This Week
Page 2 of2
Week Two (May 5-9)
Total Number of Payments: 22.180 million
Total Amount of Payments: $20.138 billion
Week One (April 28-May 2)
Total Number of Payments: 7.708 million
Total Amount of Payments: $7.091 billion
The Treasury Department will announce at the end of every week the total number
of payments that have been sent to households, and the total amount of payments
sent. Payments began April 28 and will continue via direct deposit or paper check
through mid-July. For a single filer, the minimum payment is generally $300 and
the maximum payment is $600. For joint filers, the minimum is generally $600 and
the maximum $1,200. There is also an additional $300 payment for each qualifying
child.
For tax returns processed by the Internal Revenue Service by April 15 households
will receive their payments according to the last two digits of the Social Security
number on the tax form. On a joint return, the first number listed will determine
when a stimulus payment will be sent.
A small percent of tax returns will require additional time to process and to compute
a stimulus payment amount. For these returns, stimulus payments may not be
issued in accordance with the schedule above, even if the tax return was processed
by April 15. In these cases, the stimulus payment will be issued approximately 2
weeks after the tax return is ultimately processed.
- 30 -
LINKS
http://www.treas.go v/press/releases/hpl066.htm
8/1/2008
Direct Deposit Payments
!fthe last two digits of your Social Security Your economic stimulus payment deposit
number are:
should be transmitted to your bank account
by:
00-20
21-75
76-99
May 2
May 9
May 16
Paper Check
!fthe last two digits of your Social Security Your check should be in the mail by:
number are:
00-09
10-18
19-25
26-38
39-51
52-63
64-75
76-87
88-99
May 16
May 23
May 30
June 6
June 13
June 20
June 27
July 4
July 11
A small percent of tax retums will require additional time to process and to compute a
stimulus payment amount. For these retums, stimulus payments may not be issued in
accordance with the schedule above, even if the tax retum was processed by April IS. In
these cases, the stimulus payment will be issued approximately 2 weeks after the tax
retum is ultimately processed.
-30-
}-1067: Tn.?a$llry Economic Update 7.3.0X
Page 10f2
July 3,2008
HP-1067
Treasury Economic Update 7.3.08
UPDATE 7.3.08
"Today's employment data reflect the impact of the headwinds we face from
high energy prices, the housing correction, and the credit disruption. The
rebate checks and investment incentives in the stimulus package are helping
to support spending while adjustments continue in housing and financial
markets."
Assistant Secretary Phillip Swagel, July 3, 2008
Employment Fell in June:
Job Growth: Payroll employment fell by 62,000 in June, following a decrease of
62,000 in May. The United States has added about 7.8 million jobs since August
2003. Employment increased in 35 states and the District of Columbia over the
year ending in May. (Last updated: July 3, 2008)
Unemployment: The unemployment rate was 5.5 percent in June, unchanged from
May. (Last updated: July 3, 2008)
Signs of Economic Strength Include Exports and Low Inflation:
Exports: Strong global growth is boosting U.S. exports, which grew by 9.5 percent
over the past 4 quarters. (Last updated: June 26, 2008)
Inflation: Core inflation remains contained. The consumer price index excluding
food and energy rose 2.3 percent over the 12 months ending in May. (Last updated:
June 13, 2008)
The Economic Stimulus Package Will Provide a Temporary Boost to Our
Economy:
The package will help our economy weather the housing correction and other
challenges. The Economic Stimulus Act of 2008, signed into law by President
Bush has two main elements--stimulus payments so that working Americans have
more money to spend and temporary tax incentives for businesses to invest and
grow. Together, the legislation will provide about $150 billion of stimulus for the
economy in 2008, providing a meaningful boost to the U.S. economy in 2008. (Last
updated: February 29, 2008)
Pro-Growth Policies Will Enhance Long-Term U.S. Economic Strength:
We are on track to make significant further progress on the deficit. The FY07
budget deficit was down to 1.2 percent of GOP, from 1.9 percent in FY06. Much of
the improvement in the deficit reflects strong revenue growth, which in turn reflects
strong economic growth. Looking ahead, higher spending on entitlement programs
dominates the future fiscal situation; we must squarely face up to the challenge of
reforming these programs.
www.treas.gov/economic-plan
http://www.treas.gov/press/releases/hp1067.htm
8/1/2008
11ited States - Department of The Tre:~sury - Economy
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The U.S. economy is fundamentally strong, but the housing
correction, credit turmoil, and high oil prices are weighing on growth
this year and short-term risks are to the downside. The Economic
Stimulus Act of 2008, signed into law on February 13, will help
protect the strength of our economy as we weather the housing
downturn and other challenges. This agreement includes short-term
incentives to bolster business investment and consumer spending to
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We_ek 11 Weap-Up: TreasLJrySent7.530MiliionStimulus
PaY!T1f~flts Tbis Week
Treasurer Cabral Remarks on the Economic Stimulus
Package
Paulson Remarks on the Economic Stimulus Package
Fact Sheet: State-by-State Benefit of the Economic Stimulus
Act of 2008 IE
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Package will Benefit Americans
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Paulson Remarks at White House Press Briefing
White House Fact Sheet: Taking Action to Keep Our
Economy Healthy
Transcript: President's Remarks
: "Today's employment data reflect
of the headwinds we face
energy prices, the housing
',...,.,rr",.M,r,n and the credit disruptic
The rebate checks and investmer
I/nf:AnTlW?C; in the stimulus packagE
to support spending while
IAIlI/J,c;lrmf.~nr.c; continue in housing (
cial markets. "
IASSlsrant Secretary Phillip Swage
uly 3,2008
MORE INFORMATION
Economic Report of the Presic
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Budget
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BurSau of Labor Statistics
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Economic Data Tables
RELATED OFFICES
Treasury's Office of Economic
Policy
Treasury Releases Social Security Papers
To build on the discussions that Secretary Paulson has had with
http://www.treas.gov/economic-plan!
8/1/2008
nited States - Department of The TreAsury - Economy
Page 2 of2
members of Congress in both parties, Treasury will release a series
of issue briefs that will discuss Social Security reform, focusing on
the nature of the problem and those aspects of reform that have
broad support.
•
•
•
•
•
•
Paulson Statement on Treasury Social Security Papers on
Common Ground
Issue Brief 1: Social Security Reform: The Nature of the
Problem
Issue Brief 2: Social Security Reform: A Framework for
Analysis
Issue Brief 3: Social Security Reform: Benchmarks for
'Assessing Fairness and Benefit Adequacy
Issue Brief 4: Social Security Reform: Mechanisms for
Achieving True Pre-Funding
Issue Brief 5: Treasury Releases Fifth in a Series of Social
Security Papers
U.S. Economic Strength
Employment FeIJ in June:
Job Growth: Payroll employment fell by 62,000 in June, following a
decrease of 52,000 in May. The United States has added about 7.8
million jobs since August 2003. Employment increased in 33 states
and the District of Columbia over the year ending in June. (Last
updated: July 18, 2008)
Unemployment:The unemployment rate was 5.5 percent in June,
unchanged from May. (Last updated: July 3, 2008)
Signs of Economic Strength Include Exports and Low Inflation:
Exports: Strong global growth is boosting U.S. exports, which grew
by 9.5 percent over the past 4 quarters. (Last updated: June 26,
2008)
Inflation: Core inflation remains contained. The consumer price
index excluding food and energy rose 2.4 percent over the 12
months ending in June. (Last updated: July 16, 2008)
The Economic Stimulus Package Will Provide a Temporary
Boost to Our Economy:
The package will help our economy weather the housing
correction and other chaIJenges.The Economic Stimulus Act of
2008, signed into law by President Bush has two main elementsstimulus payments so that working Americans have more money to
spend and temporary tax incentives for businesses to invest and
grow. Together, the legislation will provide about $150 billion of
stimulus for the economy in 2008, providing a meaningful boost to
the U.S. economy in 2008, (Last updated,' Febru3lY 29, 2008)
Pro-Growth Policies Will Enhance Long-Term U.S. Economic
Strength:
We are on track to make significant further progress on the
deficit.The FY07 budget deficit was down to 1.2 percent of GOP,
from 1.9 percent in FY05. Much of the improvement in the deficit
reflects strong revenue growth, which in turn reflects strong
economic growth. Looking ahead, higher spending on entitlement
programs dominates the future fiscal situation; we must squarely
face up to the challenge of reforming these programs.
Last Updated: July 18, 2008
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http://www .treas.gov /economic-plan!
811 12008
1-1068: Staterncnt by U.S. Treasury Secretary Henry M. Paulson, Jr. On the SEC, Federal Reserve Me...
Page 1 of 1
July 7,2008
hp-1068
Statement by U.S. Treasury Secretary Henry M. Paulson, Jr. On the SEC,
Federal Reserve Memorandum of Understanding
Washington- Treasury Secretary Henry M. Paulson, Jr. made the following
statement today regarding the memorandum of understanding on information
sharing and cooperation between the Securities and Exchange Commission and
the Federal Reserve.
"The MOU finalized between the SEC and the Federal Reserve is consistent with
the long-term vision of Treasury's Blueprint for a Modernized Regulatory Structure
and should help inform future decisions as our Congress considers how to
modernize and improve our regulatory structure."
-30-
http://wwW.treas.gov/press/releases/hpl068.htm
8/1/2008
-1069: Trea511ry Will Consult on Baseiine Survey of Adult Financial Literacy
Page 1 of 1
July 7,2008
hp-1069
Treasury Will Consult on Baseline Survey of Adult Financial Literacy
Washington - The Treasury Department announced a new research initiative
today to examine financial literacy among U.S. adults and how they fare in handling
their finances. The study, conducted with the Financial Industry Regulatory
Authority Investor Education Foundation, is the first of its kind to focus on adult
consumers at both state and national levels.
The President's Advisory Council on Financial Literacy recommended that the
Department consult on the project during the Council's February 2008 meeting.
Preliminary survey data is expected to be released to researchers and the general
public in early 2009.
"The field of financial education in America is in its adolescence. By learning what
Americans know, think and feel about money we can better help them, while
moving our nation's financial education efforts toward maturity," said Dan lannicola,
Jr., Deputy Assistant Secretary for Financial Education and executive director of the
President's AdviSOry Council. "Equipping Americans to make good financial
decisions is always important, but in challenging economic times it matters even
more."
The FINRA Investor Education Foundation - the largest foundation dedicated to
investor education - will design, fund and conduct the survey, with input from
Treasury. Survey working group partners include Dartmouth College Professor
Annamaria Lusardi and a team from Applied Research and Consulting, the
Employee Benefit Research Institute and the American Institute of Certified Public
Accountants.
"We look forward to consulting with Treasury on this inaugural national survey,"
said Mary Schapiro, a member of the President's Advisory Council on Financial
Literacy who is also Chairman of the Financial Industry Regulatory Authority
Foundation and CEO of FINRA. "The survey will be unique in its scale and in its
focus on the combined effect of knowledge, skills and attitudes on the behavior of
adult consumers in the U.S., and will be invaluable in informing a wide range of
financial education efforts now and in the future."
"The Council is pleased that Treasury will be consulted on this important project,"
said Tahira Hira, chair of the President's Advisory Council's Research Committee
and a professor at Iowa State University. ''''There is so much we still don't know
about how Americans handle their money, how they make decisions, how they
learn, how they want to learn, what brings about changes in their financial behavior.
We hope this study will help answer this and many other questions."
For additional information on Council activities, visit
WWw.tre.aS-.gov!fiD~m:;ial~Qt.Jcgti9n. Information on the FINRA Foundation may be
found at www.fin.r~.fQ-'J_lJdC!tLon.Qrg.
-30-
http://www.treas.gov/press/releases/hpl069.htm
8/1/2008
Page 1 of2
S. Treasury. Office of Domestic Finance
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http://www.treas.gov/offices/domestic-finance/financial- instituti on/fin -education/
8/1/2008
)-1070: Remarks by Secretary H~nry M. Paulson, Jr. <br>on U.S. Housing Market before FDIC's Foru ... Page 1 of 5
/~~~\ PRESS ROOM
u.s. OEPARTMENT OF THE TREASURY
--
{IJ!
]"~L~.~~-' .~. ~:-
,.'~,' .
,
July 8,2008
HP-1070
Remarks by Secretary Henry M. Paulson, Jr.
on U.S. Housing Market before FDIC's Forum
on Mortgage Lending to Low and Moderate Income Households
Washington, DC--Good afternoon. Thank you Chairman Bair for convening this
forum, and thanks to all of you for your interest in encouraging responsible lending
to low and moderate income households.
As we all know, this is a timely issue as the housing correction and capital markets
turmoil has reduced the availability of credit for mortgages and other lending. Men
and women who have worked hard and saved in order to own their own home
should know that despite pressures, the mortgage market remains open to them.
As the late Ned Gramlich often observed, subprime and other low and middle
income lending has played a critical role in helping expand homeownership
opportunities for these borrowers. Our responsibility is to work through today's
issues and do so in a way that preserves and protects responsible mortgage
lending to low and middle income families.
U.S. Housing Market
After several years of lax lending standards and rapid home price appreciation, we
are going through an inevitable housing correction. The correction began in 2006,
and most forecasters expect a prolonged period of adjustment with foreclosures
continuing to rise and housing prices continuing to fall. We are working through the
excess new home inventory - the inventory of new single family homes is down 21
percent from its 2006 peak. Another sign that we are well into the adjustment
process is that existing home sales appear to have flattened over the past several
months, indicating that demand may be stabilizing.
Many of the headlines of falling national home prices are alarming. While prices are
undoubtedly declining, the true picture of what homeowners are facing on the
ground is varied and cannot be captured in a single national number.
We need to recognize that there is not a national housing market, but a collection of
regional markets. Although home prices nationwide experienced rapid price
appreciation, price increases were especially pronounced in a few regions. For
example, house prices in California, Florida, Arizona and Nevada more than
doubled between 2000 and 2006. Similarly, the severity of the current correction
varies widely by state and region. These four states, which have 25 percent of all
U.S. mortgages, accounted for 42 percent of foreclosure starts in the first quarter of
this year, and almost 90 percent of the increase in foreclosure starts. When we add
Indiana, Michigan and Ohio, states facing economic challenges, to the
aforementioned four states, these seven states comprise 33 percent of mortgages
and over 50 percent of foreclosure starts in the first quarter. Foreclosure starts in
these states are up 300 percent over the past two years. Of course, that does not
mean the correction isn't being felt everywhere; even in the other 43 states,
foreclosure starts are up about 90 percent since early 2006. OFHEO's home price
data does show, however, that in about one half of the states, home prices actually
rose in the first quarter of this year.
In addition, even within a city, home price patterns can be more complex than a
single number suggests. We know that foreclosure sales are making up a larger
share of total sales than is typical. We also know that foreclosure sales usually
occur at a discount to regular home sales. And reported average home sales price
is a mix of foreclosure prices and more normal sales prices. Consequently, the
prices homeowners realize when selling their home may not be as depressed as
the headlines suggest. For example: data from Radar Logic show that in Los
Angeles, foreclosure sales in March 2008 were 29 percent of total sales, up from 3
http://www.treas.gov/press/releases/hpl070.htm
8/1/2008
)·1070: Remarks by Secretary Henry tvl. Paulson, Jr. <br>on U.S. Housing Market before FDIC's Foru ... Page 2 of 5
percent in March 2007. In fact, data from this source also show that through March
of this year, foreclosure sale prices fell 11 percent in Los Angeles while prices of
other homes sold fell 2 percent. This is not intended to minimize what homeowners
are experiencing; rather, looking behind the statistics gives us a better
understanding of what is really happening.
Beginning last summer, we have implemented a series of public and private
initiatives to help struggling homeowners, while also working to minimize the impact
of the housing correction, without impeding its necessary progress. The sooner we
get through this correction, the sooner we will see home values stabilize, more
buyers will return to the housing market and housing will again contribute to
economic growth.
In the simplest of terms, the housing market is being negatively impacted by excess
inventory and a reduction in the number of homebuyers. These two factors are
working in tandem; we cannot reduce the inventory unless we have committed
homebuyers. And the availability and price of mortgage financing will affect how
many buyers come into the market and when.
There were 1.5 million foreclosures started in all of 2007, and a number of
economists now estimate we will see about 2.5 million foreclosures started this
year. Even with a strong economy and strong housing market, we saw 800,000
foreclosures started in 2004. Although regrettable, this is normal, and attributable to
life events, such as job loss. Public policy cannot be expected to prevent these
foreclosures. Many of today's unusually high number of foreclosures are not
preventable. Due to the lax credit and underwriting standards of the past years,
some people took out mortgages they can't possibly afford and they will lose their
homes. There is little public policymakers can, or should, do to compensate for
untenable financial decisions. And in the midst of rapid price appreciation, some
people bought homes anticipating an immediate profit. Now that their investments
have not turned out as they had hoped, these people may walk away, even though
they can afford their mortgage payment. These borrowers can and should be living
up to their mortgage commitment· government intervention here would be
inappropriate. These two categories of foreclosures· stemming from lax
underwriting standards and increased speculation - will remain elevated in the near
term.
Since last summer, we have been intently focused on avoiding preventable
foreclosures: where homeowners, one, want to keep their homes and two, have the
financial wherewithal to do so. Here, the challenge we encountered - and it was a
big one· was the impending threat of a market failure arising from the complexities
and difficulties of a mortgage market that had been transformed by the wide-scale
securitization of mortgage financing. Simply put, this impending market failure had
the potential to result in many foreclosures that did not make economic sense
because it was in the best interest of both the homeowner and the lender to modify
the terms of the mortgage so the borrower could stay in the home.
This potential market failure arose from the emergence of the complex originate-todistribute securitization model where mortgages had been sliced and diced then
packaged and sold to investors around the world. The magnitude of the impending
correction threatened to overwhelm the normal workout and modification processes
in a way that raised a series of technical, legal and accounting issues that likely
could not be addressed in a timely fashion by individual market partiCipants working
on their own. The result would have been that many borrowers who would
otherwise get a modification or refinance would instead go into foreclosure simply
because no one could respond to them in time. No responsible homeowner who
has been making payments and wants to stay in their home should go into
foreclosure merely because the workout system was too busy to find them a
solution that is in both the lenders' and the homeowners' best interest.
We sought to address this potential market failure, by working with the industry to
facilitate a process that approximates what would be normal behavior between a
bank and a struggling borrower if the borrower were dealing with a bank that had
originated and held the mortgage. And so last summer, we encouraged the creation
of the HOPE NOW Alliance of mortgage lenders, servicers and counselors with the
urgent mission of untying the Gordian knot of complexities surrounding the
mortgage workout process. In many ways, this has been a race against time. While
there have been bumps in the road and there is still work to do, the industry,
through HOPE NOW has made an enormous effort and great progress toward
http://www.treas.gov/press/releases/hpl 070.htrn
811/2008
)-1070: Remorks by Secretary Henry M. Paulson, Jr. <br>on U.S. Housing Market before FDIC's Foru ... Page 3 of 5
meeting these challenges.
HOPE NOW's numerous efforts to help homeowners avoid preventable
foreclosures has been successful. HOPE NOW reports that since last July, the
industry has helped 1.7 million homeowners with loan workouts that allowed them
to stay in their homes. At the current pace, nearly 200,000 additional borrowers are
helped every month. This private sector effort has complemented public efforts to
avoid preventable foreclosures, including through expanded access to Federal
Housing Administration programs, which has enabled more than 250,000 borrowers
to refinance into affordable FHA mortgages since last August.
In particular, there are a number of key areas where HOPE NOW is showing
substantial progress. Improved outreach strategies have dramatically increased the
response rate of troubled borrowers. Industry is more closely coordinating with
mortgage counselors, including paying for counseling. The Alliance members get
together routinely, to continuously improve efficiency and reduce the time it takes to
respond to a borrower who asks for help. Importantly, modifications as a percent of
workouts have climbed from 19 percent to 41 percent for all borrowers. For
subprime borrowers, this trend has been even more pronounced, going from 17 to
50 percent. While HOPE NOW is aimed at helping all borrowers, several programs
are focused specifically at subprime ARMs. In keeping with recent trends, in the first
quarter of 2008 these loans accounted for 6 percent of loans outstanding but 37
percent of foreclosures started - that means that a subprime ARM is four times
more likely to have entered foreclosure than a prime ARM and 22 times more likely
than a prime fixed-rate mortgage.
In December, HOPE NOW announced a new protocol designed to streamline some
subprime ARM borrowers into consideration for a refinancing or modification, so
that resources are available for more difficult situations. The objective is not to
maximize modifications; it is to minimize foreclosures for those subprime ARM
borrowers who could afford the starter rate. From the outset of the HOPE NOW
process, I have measured success by whether a borrower who has made all the
payments at the initial rate, but COUldn't afford the reset and reached out for help
avoids going into foreclosure. And so far, the data on this question show an
unqualified success.
Of course, lower interest rates have significantly reduced the reset problem. Still,
there is no question that because industry has acted to fast-track eligible borrowers,
we are achieving our objective. Of the more than 700,000 subprime mortgage
resets originally scheduled through May of 2008, only 1800 loans that were current
at reset have entered foreclosure. We will continue tracking that number closely to
monitor progress. Entire industries do not adjust easily or quickly, even when
markets are calm. The HOPE NOW Alliance is demonstrating that an industry can,
through coordination, make a difference and do so without forcing American
taxpayers to pay the bill.
And we are always pushing to do more. For example, second liens have proven to
be an impediment to completing loan workouts as negotiations between borrowers,
first lien holders and second lien holders have been complex and time consuming.
To help address this, HOPE NOW recently announced guidelines for automatic resubordination of second liens to enable loan modifications and refinancings to
execute more quickly. The American Securitization Forum (ASF) announced today
that it would extend its streamlined protocol announced in December to more
borrowers than just those experiencing their first rate reset, helping HOPE NOW
reach more families. These and other similar efforts will help ensure that the
industry as a whole moves together.
Homeowners have responsibility as well. We can't help those who aren't willing to
help themselves, and we must continue to urge struggling borrowers that if they
haven't already, they need to reach out for help.
Availability of Mortgage Finance
Essential to ending the correction is a return of homebuyers. In many parts of the
country a starter home had become unaffordable, and the current correction should
bring home prices back within reach for many Americans, so long as financing is
available. Those of you here today will have an enormous impact on their ability to
get the financing to buy a home.
http://www.treas.gov/press/releases/hpl070.htm
8/1/2008
P-I070: Rem~rks by Secretary Henry M. Paulson, Jr. <br>on U.S. Housing Market before FDIC's Foru ... Page 4 of 5
Two institutions in particular - Fannie Mae and Freddie Mac - have an important
role to play. They can be a constructive force in this period of stress in the housing
market. I have been strongly encouraging all financial institutions to raise capital so
they can continue to finance consumer and business activity that supports our
economy. In particular, I am pleased that this spring both GSEs committed to raise
more capital. Fannie Mae has raised $7.4 billion in capital in the last several
months, and Freddie Mac has committed to raise additional capital. Fannie Mae
and Freddie Mac today touch 70 percent of all new mortgages. Fresh capital will
strengthen their balance sheets and allow them to provide additional mortgage
capital, as they balance their responsibilities to their mission and to their
shareholders during this period of housing market adjustment. The availability of
mortgage finance is also supported by the Federal Housing Finance Board's
decision to allow the Federal Home Loan Banks to increase their purchases of
mortgage securities.
Given the very important role being played by the GSEs today, we are particularly
focused on completing work to create a world-class regulator for Fannie Mae,
Freddie Mac and the Federal Home Loan Banks. A strengthened regulator for
Fannie and Freddie will increase investor confidence in these enterprises and will
be a substantial tool to ease the housing downturn and increase the availability of
affordable mortgages for Americans who want to buy a new home or refinance their
current one. Creating a strong independent regulator will help ensure that the GSEs
achieve their mission while operating safely and soundly.
The House and Senate have made good progress on GSE reform. As I have
continually emphasized, completing this legislation is the single most powerful step
Congress can take this year to help our nation get through this housing correction.
That said, working through this correction is made more challenging by the virtual
disappearance of the subprime lending market. In response to excesses, that
market has probably changed unalterably - as it must. Clearly, some who took out
subprime mortgages never should have been approved for a mortgage in the first
place. Practices, such as low or no doc loans, minimal or no down payments and
other lax credit practices, are likely, as they should be, a thing of the past. At the
same time, we cannot lose sight of the fact that subprime lending gave millions of
responsible Americans a chance to borrow, despite a less-than-perfect credit
history. We must not lose the benefits of the subprime market as we eliminate its
flaws. Your discussions today will be instructive as to what products and standards
can reinvigorate this important sector of the market, as we know that subprime
lending is vital to bring the dream and economic good of homeownership to millions
of Americans. The subprime market will evolve as markets always do, to find better
ways to evaluate and manage credit risk.
Today we are also looking more broadly for ways to increase the availability and
lower the cost of mortgage financing to accelerate the return of normal homebuying
activity. We are working with FDIC, the Federal Reserve, the OCC and the OTS to
explore the potential of covered bonds, which is one promising financing vehicle to
do just that. Covered bonds provide funding to an issuer, generally a depository
institution such as a commercial bank or thrift, through a secured debt instrument
collateralized by a pool of residential mortgage loans that remain on the issuer's
balance sheet. Interest is paid to investors from the issuer's cash flow. In the event
of a default, covered bond investors' primary recourse is the pool of mortgage
loans, and secondary recourse is an unsecured claim on the issuer. Covered bonds
have been widely used in Europe to finance residential and commercial real estate,
and municipal bonds. At the end of 2006 the European covered bond market was
over 1.9 trillion Euros.
And, as Treasury seeks to encourage new sources of mortgage funding in the
United States, improve underwriting standards and strengthen financial institutions'
balance sheets, covered bonds have the potential to serve these purposes and
reduce the costs for first-time home buyers, and for existing homeowners to
refinance.
We are also strengthening efforts to improve financial literacy, so that borrowers
better understand sophisticated lending products and the obligations they carry.
Through the President's AdviSOry Council on Financial Literacy, Treasury is
identifying approaches to financial education that will help potential borrowers
evaluate mortgage options and avoid commitments they cannot meet.
http://www.treas.gov/press/releases/hpI070.htm
811/2008
P-I070: Rem.uks by Secretary Henry M. Paulson, Jr. <br>on U.S. Housing Market before FDIC's Foru ... Page 5 of 5
Conclusion
The subprime mortgage turmoil has also revealed broader financial regulatory
issues, and we are working to address these on a number of fronts, including
modernizing the U.S. financial regulatory structure to better match our modern
financial system. Treasury released its recommendations for reform last March, and
we look forward to working with all interested parties - the Congress, regulators
and market participants - to develop and put in place a better regulatory structure
as we work toward an optimal one that hopefully will foster continued progress in
mortgage financing while avoiding some of the problems and excesses of the past.
Thank you.
http://www.treas.gov/press/releases/hpl070.htm
8/1/2008
)-1071: Treasury Designates Iranian Pro! iferatioll Individuals, Entities
"rill, PRESS ROOM
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July 8,2008
hp-1071
Treasury Designates Iranian Proliferation Individuals, Entities
Washington - The U.S. Department of the Treasury today designated four
individuals and four entities for their ties to Iran's nuclear and missile programs.
"Iran's nuclear and missile firms hide behind an array of agents that transact
business on their behalf," said Stuart Levey, Under Secretary for Terrorism and
Financial Intelligence. "As long as Iran continues to engage in such deceptive
practices, companies and banks must exercise extraordinary vigilance to avoid
participating in illicit transactions."
The individuals designated today include Dawood Agha-Jani, Moshen Hojati,
Mehrdada Akhlaghi Ketabachi, and Naser Maleki. The entities designated today
include Shahid Sattari Industries, Seventh of Tir (a/kla 7th of Tir), Ammunition and
Metallurgy Industries Group (AMIG), and Parchin Chemical Industries.
This action was taken pursuant to Executive Order 13382, an authority aimed at
freezing the assets of proliferators of weapons of mass destruction and their
supporters, and at isolating them from the U.S. financial and commercial systems,
Designations under E.O. 13382 are implemented by the Department of the
Treasury's Office of Foreign Assets Control (OFAC) and the State Department, and
they generally prohibit transactions between the designees and U.S. persons, and
freeze assets the designees may have under U.S. jurisdiction.
The Annex to E.O. 13382, issued by President George W. Bush in June 2005,
designated the Atomic Energy Organization of Iran (AEOI), Iran's Aerospace
Industries Organization (AIO), the Shahid Bakeri Industrial Group (SBIG), and the
Shahid Hemmat Industrial Group (SHIG) as entities of proliferation concern.
The AEOI, which reports directly to the Iranian President, is the main Iranian
organization for research and development activities in the field of nuclear
technology, including Iran's centrifuge enrichment program; it also manages Iran's
overall nuclear program. The AEOI is identified in the Annex to United Nations
Security Council Resolution (UNSCR) 1737 for its involvement in Iran's nuclear
program.
Dawood Agha-Jani is being designated because he acts or purports to act for or on
behalf of, directly or indirectly, the AEOI. Agha-Jani was listed in UNSCR 1737 for
his involvement in Iran's nuclear program, and identified as the head of the Pilot
Fuel Enrichment Plant (PFEP) at Natanz. Natanz, which is subordinate to the AEOI,
is Iran's main uranium enrichment facility. The PFEP is a test facility that has the
capacity to hold 1,000 centrifuges.
Moshen Hojati is being designated because he acts or purports to act for or on
behalf of, directly or indirectly, the AIO and the Fajr Industries Group. The AIO, a
subsidiary of the Iranian Ministry of Defense and Armed Forces Logistics, is the
overall manager and coordinator of Iran's missile program. AIO oversees all of
Iran's missile industries. Its subsidiaries, SBIG and SHIG, were both identified in the
Annex to UNSCR 1737.
Hojati has been linked to the AIO since at least 2001, serving in various capacities.
Hojati was listed in UNSCR 1747 for his involvement in Iran's ballistic missile
program, and identified as the head of the Fajr Industries Group, an entity identified
in the Annex to UNSCR1737 and designated by OFAC under E.O. 13382, on June
8,2007, for being owned or controlled by the AIO.
http://www.treas.gov/press/releases/hpl071.htm
8/1/2008
1-1071:
Trea~ury
Designates Iranian Pr0liferation Individuals, Entities
Page 2 of2
Mehrdada Akhlaghi Ketabachi is being designated because be acts or purports to
act for or on behalf of, directly or indirectly, SBIG. As the head of SBIG, Ketabachi
plays a key role in SBIG's day-to-day affairs. Ketabachi is also active in negotiating
the procurement of equipment for SBIG.
Naser Maleki is being designated because he acts or purports to act for or on
behalf of, directly or indirectly, SHIG. Maleki has been identified in UNSCR 1747 as
the head of SHIG and an Iranian Ministry of Defense and Armed Forces Logistics
(MOOAFL) official who oversees work on the Shahab-3 ballistic missile program.
Also designated today is Shahid Sattari Industries, an entity which is owned or
controlled by, and acts or purports to act for or on behalf of, directly or indirectly,
SBIG. Shahid Sattari Industries is involved in the manufacturing and maintenance
of ground support equipment for SBIG.
The other three entities designated today, Seventh of Tir (a/k/a 7th of Tir),
Ammunition and Metallurgy Industries Group (AMIG), and Parchin Chemical
Industries, are owned or controlled by, or act or purport to act for or on behalf of,
directly or indirectly, Iran's Defense Industries Organization (010). The U.S.
Department of State designated 010 under E.O. 13382 on March 28, 2007, for
engaging or attempting to engage in activities or transactions that materially
contributed to or pose a risk of materially contributing to the proliferation of
weapons of mass destruction or their means of delivery. 010 also is identified in the
Annex to UNSCR 1737.
AMIG was listed in UNSCR 1747 for its relationship with Seventh of Tir, which it
controls. Seventh of Tir has been involved in a variety of international transactions
related to weapons procurement. UNSCR 1737 described Seventh of Tir as a
subordinate of 010, widely recognized as being directly involved in Iran's nuclear
program. Seventh of Tir has been connected to Iran's centrifuge development
program.
Parchin Chemical Industries is an element of DIO's chemical industries group and
is identified in the Annex to UNSCR 1747. As a subordinate of 010, Parchin acts on
behalf of 010, importing and exporting chemical goods throughout the world. In
April 2007, Parchin Chemical Industries was identified as the final recipient of
sodium perchlorate monohydrate, a chemical precursor for solid propellant oxidizer,
possibly to be used for ballistic missiles.
-30-
REPORTS
•
Fact Sheet on Iranian Designations
http://www.treas.gov/press/releases/hpl071.htm
8/1/2008
esignation of Iranian Entities and Individuals for Proliferation Activities
Page 1 of 4
Fact Sheet
Office of the Spokesman
Washington, DC
July 8,2008
Designation of Iranian Entities and Individuals for Proliferation Activities
The U.S. Government is taking actions today to further U.S. efforts to counter Iran's pursuit of technology that could enable it
to develop nuclear weapons and the missiles capable of delivering them. Today, the Departments of State and Treasury
designated under Executive Order 13382 six Iranian individuals and five entities of proliferation concern. These actions provide
additional information that will help financial institutions in the United States and worldwide protect themselves from deceptive
financial practices employed by Iranian entities and individuals engaged in or supporting proliferation.
All UN Member States are required to freeze the assets of entities and individuals listed in the Annexes of UN Security Council
resolutions 1737, 1747 and 1803, as well as assets of entities owned or controlled by them, and to prevent funds or economic
resources from being made available to them.
Effect of Today's Actions
As a result of our actions today, all transactions involving any of the designees and any U.S. person will be prohibited and any
assets the designees may have under U.S. jurisdiction will be frozen. Noting the UN Security Council's grave concern over
Iran's nuclear and ballistic missile program activities, the United States also encourages all jurisdictions to take similar actions
to ensure full and effective implementation of UN Security Council Resolutions 1737, 1747, and 1803.
Proliferation Finance - Executive Order 13382 Designations
:.0.13382, signed by the President on June 28, 2005, is an authority aimed at freezing the assets of proliferators of weapons
)f mass destruction and their supporters, and at isolating them from the U.S. financial and commercial systems. Designations
Jnder the Order prohibit all transactions between the designees and any U.S. person, and freeze any assets the designees
nay have under U.S. jurisdiction.
ranian Individuals
Y!9hs~flfakhrizadeh-Mahabadi: Fakhrizadeh was named in that annex of UNSCR 1747; he is a senior scientist at the Ministry
)f Defense and Armed Forces Logistics (MODAFL) and former head of the Physics Research Centre (PHRC). The
nternational Atomic Energy Agency (IAEA) has asked to interview him about the activities of the PHRC over the period he was
lead of the PHRC, but Iran has refused.
(ahya Rahim Safavi: Safavi was named in the annex of UNSCR 1737 as the Commander of the Iranian Revolutionary Guard
:orps (IRGC) and the UNSC listed him as the involved in both Iran's nuclear and ballistic missile programs. On September 1,
~007, Safavi was replaced as IRGC Commander and appointed as advisor and senior aide for armed forces affairs to the
>upreme Leader of the Islamic Republic of Iran Ayatollah Seyyed Ali Khamenei.
)aWQ9cl Agha-Jani: Agha-Jani was named in the annex of UNSCR 1737 for his involvement in Iran's nuclear program, and
jentified as the head of the Pilot Fuel Enrichment Plant (PFEP) at Natanz. Natanz, which is subordinate to the Atomic Energy
)rganization of Iran (AEOI), is Iran's main uranium enrichment facility. The PFEP is a test facility that has the capacity to hold
.,000 centrifuges.
ilQhsen Hojati: Hojati was named in the annex of UNSCR 1747 for his involvement in Iran's ballistic missile program. Hojati
las been linked to the Aerospace Industries Organization (AIO) since at least 2001, serving in various capacities. He has also
leen identified as the head of the Fajr Industries Group, an entity designated by OFAC under E.O. 13382 on June 8, 2007, for
leing Owned or controlled by the AIO.
http://www.state.gov/r/paJprs/psI2008/07II06608.htm
8/1/2008
esignation uf Iranian Entities and Individuals for Proliferation Activities
Page 2 of 4
Mehr9~da Akhlaghi Ketabfjchi: Ketabachi was named in the annex of UNSCR 1747. As the head of the Shahid Bakeri
Industrial Group (SBIG), Ketabachi plays a key role in SBIG's day-to-day affairs. Ketabachi is also active in negotiating the
procurement of equipment for SBIG.
Nas~IJv1()leki: Maleki was named in the annex of UNSCR 1747 as the head of the Shahid Hemmat Industrial Group (SHIG)
and an Iranian Ministry of Defense and Armed Forces Logistics (MOOAFL) official who oversees work on the Shahab-3
ballistic missile program. As head of SHIG, Maleki is involved in multiple aspects of SHIG operations.
Iranian Companies
The TAMAS Company: TAMAS was named in the annex of UNSCR 1803 for its involvement in enrichment-related activities.
The LiNSC listed TAMAS as the overarching body, under which four subsidiaries have been established, including one for
uranium extraction to concentration and another in charge of uranium processing, enrichment and waste.
S@IlidSattari Jndustries: Shahid Sattari Industries is involved in the manufacture and maintenance of ground support
equipment for SBIG.
The other three entities designated today, Seventh of Tir (a/k/a 7th of Tir), Ammunition and Metallurgy Industries Group
(AMIG), and Parchin Chemical Industries, are owned or controlled by, or act or purport to act for or on behalf of, directly or
indirectly, Iran's Defense Industries Organization (010). The U.S. Department of State designated 010 under E.G. 13382 on
March 30, 2007, for engaging in activities that materially contributed to the development of Iran's nuclear and missile
programs.
7th of Tir: Seventh of Tir was named in the annex of UNSCR 1737, which described Seventh of Tir as a subordinate of
Defense Industries Organization (010), widely recognized as being directly involved in Iran's nuclear program. Seventh of Tir
has been involved in a variety of international transactions related to weapons procurement. Seventh of Tir has been
connected to Iran's centrifuge development program.
Ammunition amLMetallurgy Industries Group (AMIG): AMIG was named in the annex of UNSCR 1747 for its relationship with
Seventh of Tir, which it controls. AMIG was also designated for its relationship with 010.
Parchin Ch~JTlicaUm:lu~1ries: Parchin was listed in the annex of UNSCR 1747. As a subordinate of 010, Parchin acts on behalf
of 010 and is an element of OIO's chemical industries group, importing and exporting chemical goods throughout the world. In
April 2007, Parchin Chemical Industries was identified as the final recipient of sodium perchlorate monohydrate, a chemical
precursor for solid propellant oxidizer, possibly to be used for ballistic missiles.
Iran Designation Identifier Information Pursuant to E.O. 13382
July 8,2008
1. Individual: Mohsen Fakhrizadeh mahabadi
t..KA: Mohsen Fakhrizadeh
t..KA: Fakhrizadeh
Passport Numbers: A0009228, 4229533
2. iDdividugJ: Yahya Rahim Safavi
~KA: Rahim Safavi
~KA: Yahya Rahim-Safavi
~KA: Sayed Yahya Safavi
~KA: Yahia Rahim Safawi
~KA: Seyyed Yahya Rahim-Safavi
~KA: Yahya Rahim AI-Sifawi
)ate of Birth: March to September 1952-1953
)Iace of Birth: Esfahan, Iran
).Individual: DAWOOD AGHA-JANI
~KA: Davood Aghajani
~KA: Davoud Aghajani
http://www.state.gov/r/pa/prs/ps/2008/07/106608.htm
8/112008
~signation
01 Iranian Entities and Indi\'iduals for Proliferation Activities
Page 3 of4
~KA:
Davud Aghajani
Kalkhoran Davood Aghjani
A.KA: Da'ud Aqajani Khamena
Date of Birth: April 23, 1957
Place of Birth: Ardebil, Iran
Passport Number: 15824769 (Iran)
Nationality: Iran
~KA:
4. Individual: MOHSEN HOJATI
Address: clo Fajr Industries Group, Tehran, Iran
Date of Birth: September 28, 1955
Place of Birth: Najafabad, Iran
Passport Number: G4506013 (Iran)
Nationality: Iran
5. Individual: MEHRDADA AKHLAGHI KETABACHI
Address: clo Shahid Bakeri Industrial Group, Tehran, Iran
Date of Birth: 10 September 1958
Passport Number: A00030940-04
5. Individual: NASER MALEK I
AKA: Nasser Maleki
Address: cia Shahid Hemmat Industrial Group, Tehran, Iran
Date of Birth: circa 1960
Passport Number: A0003039
7. Entity: The TAMAS Company
AKA: TAMAS
AKA: Nuclear Fuel Production Company
Location: No.84, 20th street. Northern Kargar Avenue. Tehran, 10000. Iran.
3. Entity: SHAHID SATTARIINDUSTRIES
AKA: Shahid Sattari Group Equipment Industries
_ocation: Southeast Tehran, Iran
3. Entity: 7TH OF TIR
AKA:
AKA:
AKA:
AKA:
of Tir Complex
of Tir Industrial Complex
7th of Tir Industries
7th of Tir Industries of Isfahan/Esfahan
~KA: MOjtamae Sanate Haftome Tir
AKA: Sanaye Haftome Tir
AKA: Seventh of Tir
-ocation: Mobarakeh Road Km 45, Isfahan, Iran
Alternate Location: P.O. Box 81465-478, Isfahan, Iran
7th
7th
10. Entity: AMMUNITION AND METALLURGY INDUSTRIES GROUP
~KA: AMIG
\KA: Ammunition and Mettalurgy Industry Group
~KA: Ammunition Industries Group
I.KA: Sanaye Mohematsazi
.ocation: P.O. Box 16765-1835, Pasdaran Street, Tehran. Iran
http://www.state.gov/r/palprs/ps/200S/07/10660S.htm
8/1/2008
esignation ot Jranian Entities and IndivIduals for Proliferation Activities
Page 4 of 4
II,lternate Location: Department 145-42, P.O. Box 16765-128, Moghan Avenue, Pasdaran Street, Tehran, Iran
11. Entity: PARCHIN CHEMICAL INDUSTRIES
AKA: Para Chemical Industries
AKA: Parchin Chemical Factories
AKA: Parchin Chemical Industries Group
AKA: peF
AKA: PCI
Location: 2nd Floor Sanam Bldg., 3rd Floor Sanam Bldg., P.O. Box 16765-358, Nobonyad Square, Tehran, Iran
Alternate Location: Khavaran Road Km 35, Tehran, Iran
2008/556
Released on July 8,2008
Iblished by the U.S. Department of State Website at http://www.state.gov maintained by the Bureau of Public Affairs.
http://www.state.gov/r/pa/prs/ps/2008/07/106608.htm
8/1/2008
)-1072: Undt~ Secretary David H. McCurmick<BR>Remarks on Treasury's Changing Role in a Glob...
Page 1 of 5
July 9,2008
HP-1072
Under Secretary David H. McCormick
Remarks on Treasury's Changing Role in a Global Economy
at the Center for International & Strategic Studies
Washington - Today's global economic and financial system is characterized by
increasingly interconnected financial markets and expanding cross-border capital
flows. While bringing enormous benefits and efficiencies to the U.S. and global
economies, this also makes our economy more vulnerable to risks or disruptions
that exist or could arise in far off places around the globe. In today's environment,
we are also uniquely challenged with protecting our national security by countering
new threats from illicit finance and rebuilding fragile security environments which
are of paramount concern.
Moreover, global public goods such as addressing climate change or rises in
commodity prices have taken on important economic implications and growing
urgency. Simply put, the challenges we presently face are more complex, more
diverse, and more interdependent than those of the past. Not surprisingly, to be
effective in this rapidly changing environment, the Treasury Department has had to
make some dramatic changes in how we define our mission and how we are
organized to achieve it. We have also had to develop new capabilities at home and
abroad to address these challenges. Treasury's core mission has typically involved
supporting the integrity and strength of financial markets and promoting U.S. and
global economic growth and stability. In recent months, the traditional role of
responding to crises and supporting global financial stability has been underscored
by the rapid and comprehensive policy response that has been required during the
current financial market turmoil.
But Treasury has also developed and deployed new capabilities in other critical
areas to: (1) combat illicit finance, (2) ensure economic renewal and stability in
post-conflict countries, (3) fight rising protectionism, and (4) support, and where
appropriate, lead multilateral efforts to protect the environment in tandem with
sustainable economic growth.
Today's Treasury is very different from the one that existed seven and a half years
ago, or even two years ago when Secretary Paulson joined the Administration.
While there is certainly much more to be done, we are well prepared to develop and
execute U.S. economic policy in these dynamic times.
Financial Market Turmoil
At the center of Treasury's current efforts is maintaining the health and stability of
the U.S. economy. The U.S. economy is facing significant headwinds - sharp
reductions in the housing sector, turmoil in the capital markets, and rapidly rising
energy prices. Though these challenges are serious, and we expect to be working
through them for some time, the long-term prospects for the U.S. economy - and
the underlying fundamentals on which it is based - remain sound. Policymakers in
the United States and around the world are taking aggressive and targeted actions
to stabilize financial markets, reduce the impact of markets on the U.S. economy,
and protect against the same mistakes being repeated.
Our highest priority has been to address the challenges arising from market turmoil
and the housing downturn, so as to reduce the impact on the rest of the economy.
The Administration and Congress responded with a $150 billion bipartisan stimulus
package when it became clear that the market turmoil posed significant risks to the
U.S. economy. Policymakers also launched a series of housing-market initiatives to
help millions of Americans by preventing avoidable foreclosures.
Enhanced domestic regulatory coordination has been a key part of the response. In
http://www.treas.gov/press/releases/hpl072.htm
8/1/2008
P-I072: Und~r Secretary David H. M('t'ormick<BR>Remarks on Treasury's Changing Role in a Glob...
Page 2 of 5
the United States, the President's Working Group on Financial Markets (PWG),
chaired by Secretary Paulson, reviewed the causes of the recent turmoil and made
recommendations to mitigate systemic risk, restore investor confidence, and
facilitate stable economic growth. These recommendations are presently being
implemented.
International regulatory coordination has also been a priority. Today's global
markets require an international response to guard against uneven national
responses and the risks of regulatory arbitrage. Therefore, we have worked closely
with counterparts in major economies around the world to address the market
instability consistently and comprehensively The Financial Stability Forum (FSF),
which brings together the supervisors, central banks, and finance ministries of
major financial centers, has been critical to this effort. The FSF has released a
number of recommendations that echo and complement efforts underway in the
United States.
Beyond the near-term actions, there is also a need to ensure that all financial
systems periodically reassess their effectiveness. Thus, well before the market
turmoil began last summer, the Treasury began to consider how to modernize our
outdated financial regulatory structure. The recently released Blueprint for a
Modernized Financial Regulatory Structure proposes an objectives-based approach
consisting of three regulators: a market stability regulator, a prudential regulator for
institutions with federal guarantees, and a business conduct regulator with a focus
on consumer protection.
We see this combination of initiatives already beginning to have a positive effect. As
with other periods of market instability, this storm too shall pass. The United States
will work through these challenges and emerge as it has in the past as a driver of
growth and innovation for the global economy.
These efforts, while critical, should be no surprise. It is at the center of Treasury's
long-standing mandate to ensure global financial stability. What some of you may
not know about, however, are the other critical efforts underway over the past year
that are reflective of Treasury's changing role in a globalized world.
Combating Illicit Finance
A relatively new, but important area of Treasury involvement in national security is
in combating illicit financial activity. To manage the threat to the international
financial system, Treasury has built up its capabilities to target state sponsors of
terror and prevent the proliferation of weapons of mass destruction (WMD). We
have also coupled these domestic actions with coordinated multilateral efforts and
actual engagement with the international financial community to increase the
effectiveness of our work.
Within Treasury, the Administration created a new office--the Office of Terrorism
and Financial Intelligence (TFI)--Ied by an Under Secretary and dedicated to
targeting the financial networks supporting illicit actors, including narcotics
traffickers and terrorist groups. This office was the beginning of a transformation
within Treasury to playa more strategic role in combating terrorism. We have also
created an in-house intelligence analysis office to bring the knowledge of the
intelligence community to bear on the threat of illicit finance.
Iran is a case in point. We have seen that a combination of targeted financial
measures can put real pressure on the regime and its continued pursuit of a nuclear
capability and support for terrorist groups. Diplomatic efforts have resulted in three
UN Security Council Resolutions targeting the entities and individuals that support
Iran's attempts to develop WMDs. Treasury is working to implement these
resolutions and prevent illicit conduct through targeted financial measures against
Iranian banks, entities, and individuals engaged in these activities.
Treasury is also coordinating international efforts to alert the financial community to
the threats of money laundering and terrorist financing. In February 2008, the
world's premier standard-setting body on countering the financing of terrorism and
the laundering of money -- the Financial Action Task Force (FATF) -- called on all
governments to issue advisories to their financial institutions, warning them of the
risks of dealing with Iran. All 32 member countries and jurisdictions have responded
by issuing warnings about Iran, and on June 23 the European Union moved to
http://www.treas.gov/press/releases/hpl072.htm
8/1/2008
P-I072: Uno?r Secretary David H. MC'Cormick<I:3R>Remarks on Treasury's Changing Role in a Glob...
Page 3 of 5
designate and freeze the assets of Iran's largest state owned bank, Bank Melli.
The bottom line is that these efforts are making a difference. Earlier this year, Ali
Larijani, who served as Iran's top nuclear negotiator, said, "These sanctions are a
burden on the economy. Rising inflation, an unemployment rate that is not falling,
and the high cost of living are all direct consequences of the sanctions." We have
learned that sanctions, especially targeted ones, will always be more effective when
done on a multilateral basis.
Post-Conflict Rebuilding
Another facet of Treasury's greater role in national security can be seen in our work
supporting the development of economies in difficult security environments.
Through our experiences in war-torn countries in the Balkans, the Middle East, and
Africa, the United States has learned that security and economic stability must go
hand in hand if we are to achieve lasting peace. Treasury's role is to devise and
implement strategies that avert financial crises and to promote policies that
generate sustainable growth and job creation. To do this right, we have to put
people in the field - both financial attaches and technical advisors. In fact, we had
some of the first civilians on the ground in Afghanistan and Iraq - as well as in
places like Kosovo, Bosnia, and Liberia.
These critical personnel assess the situation on the ground and help us respond
with appropriate measures. Treasury has played a major role, for example, in
helping the Government of Iraq create a more stable macroeconomic environment
and build a solid foundation for economic growth. Following the fall of Saddam
Hussein, our advisors alerted us that rampant counterfeiting could lead to a
collapse in the value of currency, feeding inflation and civil unrest. Under the
leadership of one of my predecessors, John Taylor, they then developed a
comprehensive strategy for creating, printing and circulating a new currency to 250
distribution points around the country.
Currently, we are working with the military to help Iraq use its resources more
effectively to ensure that essential services--like electricity--get to the people.
Because these efforts are so important to preserving recent security gains, we are
planning to more than double our existing presence in Iraq. This plan is closely
coordinated with the military command, which will provide logistical and security
support for new advisors. General Petraeus has told me personally that he views
the deployment of these twelve additional Treasury advisors as a top priority.
We have also made similar contributions in Afghanistan, where our advisors helped
the Afghan Ministry of Finance craft the first post-Tali ban budget working with
nothing more than an Excel spreadsheet. And our debt management experts have
helped Afghanistan secure over $10 billion in international debt relief and build
capacity to avoid falling back into unsustainable debt. Without progress in these
areas, Afghanistan has little hope of achieving a lasting and economically viable
peace. We know that by helping these countries govern effectively and achieve
economic success, their citizens will develop a stake in political stability, eliminating
the longer term need for boots on the ground.
Investment Policy
A fourth area posing new challenges and new responsibilities for the Treasury is the
growing risk of protectionism, particularly directed toward foreign investment,
including investment from sovereign wealth funds, here in the United States. In the
aftermath of 9/11, we have seen a backlash against foreign investment on national
security grounds, with some voicing concerns about the potential for foreigners to
gain control over key sectors or critical technologies within our borders.
Foreign control over U.S. businesses may, in some cases, raise genuine national
security concerns. But we also know that foreign direct investment flows into the
United States strengthen the U.S. economy by stimulating growth and creating jobs.
U.S. affiliates of foreign multinationals employ over five million U.S. workers, or 4.5
percent of all private sector employment. Foreign-owned firms in the United States
also pay on average 25 percent more than U.S. firms and help stimulate investment
in research and development in high-technology areas that promote innovation and
competitiveness. Thus, a significant component of our economic policy mission is
safeguarding national security but in a manner that maintains and strengthens the
http://www.treas.gov/press/reJeases/hpl072.htm
8/1/2008
172: Under ~kcrctary D'lyid H. McConnick<BR>Remarks on Treasury's Changing Role in a Glob...
u.s. economy through our longstanding commitment to an open investment policy.
Page 4 of 5
Recent proposals in other countries for additional restraints on foreign investment
raise some concerns in this regard. Investment reviews must be strictly limited to
genuine national security concerns, not broader economic or national interests. In
the United States. the interagency Committee on Foreign Investment (CFIUS),
chaired by Secretary Paulson, reviews certain foreign investments in U.S.
businesses to determine whether they raise any genuine national security
concerns. The preponderance of transactions in the United States do not require a
CFIUS review, and for cases that do, we are taking steps to clarify and streamline
the process.
Foreign government-controlled investment, particularly from sovereign wealth funds
(SWFs), has also garnered a great deal of attention recently. The rapid growth in
number and size of SWFs does raise legitimate financial stability and investment
policy questions that should be addressed through a measured, multilateral
approach that maintains openness. Treasury has taken a number of steps to help
accomplish this objective, including proposing and strongly supporting the IMF
effort to develop voluntary best practices for SWFs and urging the OECD to identify
inward investment policy best practices for countries that receive sovereign wealth
investments. Both initiatives are well underway. The IMF expects to complete best
practices by October 2008 -- covering areas such as fund objectives, institutional
and governance arrangements, risk management and transparency. The OECD will
issue investment policy principles later this year.
Energy and the Environment
Finally, Treasury's work has ventured into energy and environmental policy, an area
largely ignored by finance ministries up until now. This is a part of Treasury's
portfolio where our interactions with the emerging economies are particularly
important. Since 2002, developing countries have been responsible for about twothirds of global GOP growth, and not surprisingly, the environmental implications of
their exploding energy needs are daunting.
While this unprecedented expansion has brought economic opportunities and
higher standards of living to these previously impoverished countries, it has also led
to surging demand for energy in the power, transport, building, and industrial
sectors. The International Energy Agency (lEA) estimates that last year China
surpassed the U.S. as the largest global greenhouse gas emitter and the rate of
emissions growth of developing countries will soon surpass those of developed
countries. The need for sustainable economic growth, in a way that protects our
planet, is one of the most pressing challenges facing our country.
Recognizing this fact, President Bush asked Secretary Paulson in September 2007
to take the lead in establishing a major multilateral initiative to create a new
international clean technology fund to help developing countries harness the power
of clean energy technologies to place themselves on a cleaner emissions growth
trajectory. The Clean Technology Fund (CTF), which is to be housed at the World
Bank, aims to reduce the growth of greenhouse gas emissions in developing
countries by helping to finance the additional costs of deploying clean energy
technologies over cheaper, dirtier alternatives. It will stimulate and leverage private
sector investment in existing clean technologies, and it will promote international
trust and cooperation on climate change, a prerequisite for a future climate change
agreement.
Secretary Paulson has led U.S. efforts to build support for the development of this
fund, in conjunction with the UK and Japan, the other founding partners. Earlier this
month, the G-8 Finance Ministers issued a strong statement endorSing the Fund
and calling on other countries to participate, and this week, G-8 countries
collectively pledged over $5 billion for CTF. This Fund is one important step that the
United States can take along with the other developed countries to demonstrate
leadership and to contribute constructively to broader international efforts to
mitigate the effects of climate change.
Clearly, climate change will have lasting economic effects as will the policies that
are developed to address it. Treasury must playa critical role in policy development
and implementation. As a result, we have created a new senior position, and a
dedicated team, specifically for providing leadership on both international and
domestic economic policy issues related to the environment.
http://www.treas.gov/press/releases/hpl072.htm
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'-1072: Under Secretary David H. Mex.'om1ick<BR>Remarks on Treasury's Changing Role in a Glob...
Page 5 of 5
A Broader Reform Agenda
Today I have focused on the U.S. Treasury's changing role in the global economy
and ways that we have adapted to meet these new challenges. But we are not
alone in needing to reform. There is also a pressing need to evolve among finance
ministries, central banks, regulators, the International Monetary Fund (1M F), and the
Multilateral Development Banks (MOBs) around the world. There are a few areas in
particular deserving a brief mention.
First, coordination and cooperation on international economic policy can no longer
be isolated to the G-7 countries alone. As dynamic emerging economies increase
their share of and integration into the global economy, our existing dialogues such
as the G-7 and G-8, the G-20, the Financial Stability Forum, and others must adapt
to accommodate the increasingly important role played by these countries.
Likewise, the international financial institutions, such as the International Monetary
Fund, must also reform in order to remain relevant. The IMF has taken an important
first step to reform its governance structure to reflect the growing weight of dynamic
emerging markets by reforming the quota and voice representation of its members.
It needs to further evolve by strengthening its multilateral and bilateral surveillance
capabilities, focusing on exercising firm exchange rate surveillance, encouraging
openness to international investment, and supporting global financial market
stability.
For the MOBs, this means considering how to effectively address their core
missions to promote economic development and reduce poverty. They should also
consider how to work more effectively within their comparative advantages vis-a-vis
other donors and how to leverage their unique convening ability to help tackle
global public goods such as climate change, HIV/AIDS, and escalating food prices
in a coordinated way. We see, as an example, the World Bank under Bob Zoellick's
leadership making important strides in this direction.
As the world has transformed around us, Treasury has had to rethink its role in the
global economy and the ways we fulfill our mission. Even as many of our longerterm goals and priorities - such as ensuring stable growth and maintaining global
financial stability - have not changed, the way we do business to achieve them has.
The challenges I discussed today are just a few examples of the many we face.
In these rapidly changing times, economic policymakers around the world must
continuously review and adapt how they are defining and conducting their missions.
While our journey is far from complete, the U.S. Treasury Department has made
important progress on this front.
Thank you for your attention.
-30-
http://www.treas.gov/press/releases/hpl072.htm
8/1/2008
)·1073: Statell1cnt by Treasury Secret~ry Henry M. Paulson, Jr. <br>On Staff Changes in The Office
0...
Pagc 1 of I
10 vIew or pnnt tne pUr content on tnlS page, download tne tree Adobe® Acrobat® Header®.
July 9,2008
HP-1073
Statement by Treasury Secretary Henry M. Paulson, Jr.
On Staff Changes in The Office of Domestic Finance
Washington- Treasury Secretary Henry M. Paulson, Jr. made the following
statement today regarding the resignation of Under Secretary for Domestic Finance
Robert K. Steel and the broader role that Assistant Secretary for Financial Markets
Anthony W. Ryan will take on in the Department.
"Bob Steel has been a friend and colleague to me for more than 30 years. He has
served the President and the public with ingenuity and dedication during
extraordinary times in our financial markets. I know he will excel in his future
endeavors," said Secretary Paulson.
Assistant Secretary for Financial Markets Anthony W. Ryan will take on a broader
role managing Treasury's domestic finance and financial markets agenda. Assistant
Secretary for Financial Institutions David Nason will continue to spearhead
regulatory reform efforts and oversee financial institutions policy, including issues
surrounding the government sponsored enterprises. Steven Shafran, who had 22
years of experience in finance before coming to Treasury, will take on a broader
role in his current capacity as Senior Adviser to the Secretary. Assistant Secretary
Kenneth Carfine will continue to oversee the government's fiscal operations,
including managing federal financing needs and the government's cash flow.
Deputy Assistant Secretary for Financial Institutions Policy Jeremiah Norton will
take on additional financial institutions responsibilities.
"I have great confidence in the abilities of the Domestic Finance team at Treasury
to adjust to this change and not miss a beat," said Secretary Paulson.
IJng§L.Se~[~Jm:y_Sl~~ was sworn in on October 10, 2006. AssLstal1t Secretary Ryan
joined the Treasury first as Senior Adviser to the Secretary in July 2006 and was
sworn into his current position on December 18, 2006. Assistant Secr~tary Nason
was first sworn in as Deputy Assistant Secretary for Financial Institutions Policy in
October 2005; he was promoted to Assistant Secretary and sworn in on June 28,
2007. Assistant Secretary Carfine was sworn in on March 15, 2007 and has served
the federal government for 35 years. Deputy Assistant Secretary Norton was
named to his position on June 12, 2007. Steven Shafran joined the Treasury
Department in February 2008 as a Senior Adviser to the Secretary.
-30REPORTS
•
Steel ResignatioIll...etter (PDF)
http://www.treas.gov/press/releases/hpI073.htm
8/1/2008
S. Treasury - Biography of Rob~rt Stt:"d, Under Secretary for Domestic Finance
Page I of I
Robert Steel
Under Secretary for Domestic Finance
On Tuesday, October 10, 2006, Robert K. Steel was sworn in as the Undel'
Secretary of the Treasury for Domestic Finance In that capacity, he serves as the
principal adviser to the Secretary on matters of domestic finance and leads the
Department's activities with respect to the domestic finanCial system, fiscal policy
and operations, governmental assets and liabilities, and related economic and
financial matters.
Robert K. Steel retired from Goldman Sachs as a vice chairman of the firm on
February 1, 2004. He Joined Goldman Sachs in 1976 and served in the Chicago
office until his transfer to London in 1986. In London he founded the Equity Capital
Markets group for Europe and was extensively involved in privatization and capital
raising efforts for European corporallons and governments. He later assumed the
position as head of Equities for Europe. In 1994 he relocated to New York and
served as head of the Equities Division from 1998-2001 until his appointment as a
vice chairman of the firm. He became a partner In 1988 and joined the
Management Committee in 1999. Upon his retirement from Goldman Sachs, he
assumed the position of adVISory director for the firm and then senior director in
December 2004
From February 2004 to September 2006 Mr. Steel served as a senior fellow at the
Center for Business and Government at the John F. Kennedy School of
Government at Harvard University.
Mr. Steel received his undergraduate degree from Duke University and his MBA
from the University of Chicago. He resides in Connecticut and Washington. D.C.
with his wife and three daughters.
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8/1/2008
S. Treasury - Biography of Anthony Ryan, Assistant Secretary for Financial Markets
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Anthony Ryan
Assistant Secretary for Financial Markets
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Anthony W. Ryan was sworn in as Assistant Secretary of the Treasury for Financial Markets
on December 18. 2006.
As the ASSistant Secretary for Financial Markets, Anthony Ryan serves as senior adViser to
the Secretary. Deputy Secretary, and Under Secretary on broad matters of domeslic finance.
financial markets. Federal. State and local finance including the Federal debt. Federal
Government credit policies. lending and privatization. He oversees issues involving Treasury
financing. public debt management. Federal regulation of financial markets and related
economic matters including regulatory issues in the Government securities markets and the
futures markets.
Mr. Ryan also serves as the senior member of the Treasury Financing Group and
coordinates the inter-agency President's Working Group on FinanCial Markets In addition,
he oversees the Office of Debt Management and the Office of Government Financial POliCY,
as well as the operations of a set of commissions and board staff.
Prior to hiS confirmation as Assistant Secretary. Mr. Ryan served as a Senior AdVisor to US
Treasury Secretary Henry M Paulson. In that capacity he proVided counsel to the Secretary
and the Treasury Chief of Staff on key policy matters. Mr. Ryan also coordinated Issues
within the Department and its bureaus, as well as with the White House and other agencies.
Before Joining the Treasury Department. Mr. Ryan spent 20 years in the financial services
industry. Most recently. he was a partner of Grantham. Mayo. van Otterloo & Co. LLC
(GMO). Prior to GMO. Mr. Ryan was a portfolio manager and business executive for global
institutional asset management firms Including State Street Corporation and The Boston
Company
Mr. Ryan graduated from the University of Rochester In 1985. and received hiS Masters
Degree from the London School of Economics & Political Science In 1986. He and his Wife.
Ann. and four children live In Washington. D.C.
Last Updated Deceillber 20 2006
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S. Treasury - David G. Nason - Assi~tant Secretary for Financial Institutions
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wrqr ].' 3'?'1W;.
David G. Nason
Assistant Secretary for Financial Institutions
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In 2007, David G. Nason was confirmed as Assistant Secretary for Financial Institutions. In
this role he serves as a senior advisor to the Secretary, the Deputy Secretary and the Under
Secretary for Domestic Finance on all matters relating to financial institutions, government
sponsored enterprises, financial education initiatives, the CDFI Fund and ensuring the
resilience of the financial services sector.
Previously, Mr. Nason served as Deputy Assistant Secretary for Financial Institutions. In thiS
position, Mr. Nason oversaw the Office of Financial Institutions Policy which develops,
analyzes, and coordinates the Department's policies on legislative and regulatory issues
affecti ng financial institutions.
Mr. Nason also serves as a key adviser to the Treasury Secretary In his capacity as Chair of
the President's Working Group on Financial Markets. The Presidents Working Group also
consists of the Chairs of the Federal Reserve Board, the Securities and Exchange
Commission, and the Commodity Futures Trading Commission. Nason oversees the
Terrorism Risk Illsurance Program, which is the Treasury office that implements and
manages the program created by the Terrorism Risk Insurance Act of 2002.
Prior to Treasury, Mr. Nason was at the Securities & Exchange Commission where he served
as counsel to Commissioner Paul S. Atkins. In this capacity, he served as a primary adViser
for capital raising and corporate governance issues, Gramm-Leactl-Bliley compliance, and
hedge fund and mutual fund initiatives.
Prior to Joining the SEC, Mr. Nason was an attorney at Covington & Burllllg In Washington,
DC, where he focused Oil securities offerings, mergers and acquisitions, and federal tax
planning. Nason preViously served as law clerk to the Honorable MarVin J Garbis of the US.
District Court for District of Maryland.
A native of Providence, Rhode Island, Mr. Nason received a B.S. in Finance from The
American University, and a J D, summa cum laude, from The Washington College of Law at
The American University. He is married and has two daughters and a son.
Last Updated r",1arch 21,2008
http://www,treas,gov/organization/bios/nason-e.html
8/1/2008
S. Treasury - Biography of Kenneth F. Carfine, Fiscal Assistant Secretary
Page 1 of 1
.
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TREASURY OFFICIALS
Kenneth E. Carfine
Fiscal Assistant Secretary
Ken Carfine was appointed Fiscal Assistant Secretary, a career position, on March
15,2007.
In this position. Mr. Carfine provides policy oversight over the two Fiscal Service
Bureaus -- the Financial Management Service and the Bureau of the Public Debt.
This office also serves as the Treasury's liaison with the Federal Reserve System in
its role as the government's fiscal agent. The scope of his responsibilities includes
managing the government's cash flow, improving government financial
management, executing the government's financing activities and overseeing the
operation of government-wide financial accounting and reporting systems, including
the preparation of the Consolidated Financial Statements of the United States. In
addition, Mr. Carfine is a statutory member of the Government-wide CFO Council,
and represents the Secretary on the Trust Fund Boards for the National Archives
and Library of Congress.
Previously, Mr. Carfine was the Deputy Assistant Secretary for Fiscal Operations
and Policy, a position to which he was appointed in April 2003. In that position, he
advised and assisted the Fiscal Assistant Secretary on a broad range of policy and
operational matters related to the fiscal activities of the Treasury, and oversaw the
development and implementation of policies relating to the government's cash and
investment management, debt financing, trust fund investment and administration,
payments, collections and debt collection. He also worked closely with the
Financial Management Service, the Bureau of the Public Debt, and the Federal
Reserve System in the execution of his duties.
Mr. Carfine began his Treasury career in 1973 with the Financial Management
Service, holding positions of increasing responsibility in areas of banking, cash
management. payments, check claims, and government-wide accounting.
Mr. Carfine graduated from the University of Baltimore with a B.S. degree in
Accounting. He and his wife, Deborah, have two sons and one granddaughter and
live in Maryland.
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8/l/2008
S, Treasury - Biograph)' of Rob Nich(\~s, Deputy Assistant Secretary Office of Public Affairs
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< BACK
Jeremiah Norton
Deputy Assistant Secretary for Financial Institutions Policy
Open Print Version
Jeremiah 0, Norton was named Deputy Assistant Secretary for Financial Instltullons on June
12.2007. In this position, Norton oversees the Office of FinanCial Institutions PoliCY which
develops. analyzes, and coordinates the Department's policies on legislative and regulalory
issues affecting financial institutions. including depository Institutions, insurance companies.
government sponsored enterprises, securities firms, finance companies, mutual funds. and
all other regulated and unregulated financial intermediaries. The Offices principal focus IS on
issues dealing with safety and soundness, market structure, condition, and competitiveness,
and regulatory structure, Norton also oversees the Terrorism Risk Insurance Program, which
is the Treasury office that implements and manages the program created by the Terrorism
Risk Insurance Act of 2002,
Prior to Treasury, Norton served on the legislative staff of Representative Edward R Royce,
a senior Member of the House Committee on Financial SerVices, In this capacity, he served
as the primary adviser on issues such as banking, insurance, SeCUrities, and government
sponsored enterprises. Prior to joining Representative Royce, Norton worked in the Financial
Institutions and Governments investment banking group at J,P, Morgan Securities, Inc
A native of McLean, Virginia, Norton received an A.B in Economics from Duke UniverSity,
and a J.D, from the Georgetown University Law Center,
http://www.treas.gov/organization/bios!norton-e.html
8/1/2008
P-1074: Oral Statement by Senc;;tary Henry M. Paulson, Jr. <br>on Regulatory Reform before House...
Page lof3
July 10, 2008
HP-1074
Oral Statement by Secretary Henry M. Paulson, Jr.
on Regulatory Reform before House Committee on Financial Services
Washington, DC-- Mr. Chairman, Ranking Member Bachus, thank you for holding
this hearing, and for your leadership on these important issues. As you know, our
financial markets have been experiencing turmoil since last August. It will take
additional time to work through challenges. Progress has not come in a straight line
but much has been accomplished. Our financial institutions are repricing risk,
deleveraging, recognizing losses, raising capital and improving their financial
position. Their ability to raise capital even during times of stress is a testament to
our financial institutions and our financial system.
Fannie Mae and Freddie Mac are also working through this challenging period.
They play an important role in our housing markets today and need to continue to
play an important role in the future. Their regulator has made clear that they are
adequately capitalized.
Market practices and discipline on the part of financial institutions and investors are
also improving. Our regulators are shining a light on our challenges. Through the
PWG, we have issued a report analyzing the causes of the turmoil and
recommending a comprehensive policy response, implementation of which is well
underway. Regulators are enhancing guidance, issuing new rules, and
communicating more effectively across agencies - domestically and internationally.
Although our regulatory architecture and authorities are outdated and less than
optimal, we have been working together, while respecting our different authorities
and responsibilities, to ensure the stability of the financial system, because it is in
the interest of the American people that we do so. Today this is by far our most
important priority. And our seamless cooperation to achieve it is made possible by
the leadership and support provided by this committee and other leaders in
Congress.
I have confidence in our regulators and markets. We need to remain focused and
continue to address challenges with your help and support, but we will ultimately
emerge with strong capital markets, which in turn will enable our economy to
continue to grow.
Looking beyond this period of market stress, which will eventually pass as these
situations always do, I have presented my ideas for improving our regulatory
structure and expanding our emergency powers. And I look forward to discussing
these ideas with you today, even as we continue our primary focus on confronting
current challenges and maintaining stable, orderly financial markets.
In March, I laid out a Blueprint for a Modernized Financial Regulatory Structure, in
which we recommended a U.S. regulatory model based on objectives that more
closely link the regulatory structure to the reasons why we regulate. Our model
proposes three primary regulators: one focused on market stability across the entire
financial sector, another focused on safety and soundness of institutions supported
by a federal guarantee, and a third focused on protecting consumers and investors.
A major advantage of this structure is its timelessness and its flexibility and that,
because it is organized by regulatory objective rather than by financial institution
category, it can more easily respond and adapt to the ever-changing marketplace. If
implemented, these recommendations eliminate regulatory competition that creates
inefficiencies and can engender a race to the bottom.
The Blueprint also recommends a number of near-term steps. These include
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formalizing the current informal coordination among U.S. financial regulators by
amending and enhancing the Executive Order which created the President's
Working Group on Financial Markets and, while retaining state-level regulation of
mortgage origination practices, creating a new federal-level commission, the
Mortgage Origination Commission to establish minimum standards for, among other
things, personal conduct and disciplinary history, minimum educational
requirements, testing criteria and procedures, and appropriate licensing revocation
standards.
The Blueprint includes recommendations on a number of intermediate steps as well
- focusing on payment and settlement systems and on areas, such as futures and
securities, where our regulatory structure severely inhibits our competitiveness. We
recommend the creation of an Optional Federal Charter for insurance companies,
similar to the current dual-chartering system for banking, and that the thrift charter
has run its course and should be phased out. We also recommend the creation of a
federal charter for systemically important payment and settlement systems and that
these systems should be overseen by the Federal Reserve, in order to guard the
integrity of this vital part of our nation's economy.
When we released the Blueprint, I said that we were laying out a long-term vision
that would not be implemented soon. Since then, the Bear Stearns episode and
market turmoil more generally have placed in stark relief the outdated nature of our
financial regulatory system, and has convinced me that we must move much more
quickly to update our regulatory structure and improve both market oversight and
market discipline. Over the last several weeks, I have recommended important
steps that the United States should take in the near term, all of which move us
toward the optimal regulatory structure outlined in the Blueprint. I will briefly
summarize these.
First, Americans have come to expect the Federal Reserve to step in to avert
events that pose unacceptable systemic risk. But the Fed does not have the clear
statutory authority nor the mandate to do this; therefore we should consider how to
most appropriately give the Federal Reserve the authority to access necessary
information from complex financial institutions - whether it is a commercial bank, an
investment bank, a hedge fund, or another type of financial institution - and the
tools to intervene to mitigate systemic risk in advance of a crisis.
The MOU recently finalized between the SEC and the Federal Reserve is
consistent with this long-term vision of the Blueprint and should help inform future
decisions as our Congress considers how to modernize and improve our regulatory
structure.
Market discipline is also critical to the health of our financial system, and must be
reinforced, because regulation alone cannot eliminate all future bouts of market
instability. For market discipline to be effective, market participants must not expect
that lending from the Fed, or any other government support, is readily available. I
know from first hand experience that normal or even presumed access to a
government backstop has the potential to change behavior within financial
institutions and with their creditors. It compromises market discipline and lowers risk
premiums, ultimately putting the system at greater risk.
For market discipline to effectively constrain risk, financial institutions must be
allowed to fail.
Today two concerns underpin expectations of regulatory intervention to prevent a
failure. They are that an institution may be too interconnected to fail or too big to
fail. Steps are being taken to improve market infrastructure, especially where our
financial firms are highly intertwined - the OTC derivatives market and the tri-party
repurchase agreement market, which is the marketplace through which our financial
institutions obtain large amounts of secured funding.
It is clear that some institutions, if they fail, can have a systemic impact. Looking
beyond immediate market challenges, last week I laid out my proposals for creating
a resolution process that ensures the financial system can withstand the failure of a
large complex financial firm. To do this, we will need to give our regulators
additional emergency authority to limit temporary disruptions. These authorities
should be flexible, and - to reinforce market discipline - the trigger for invoking
such authority should be very high, such as a bankruptcy filing. Any potential
commitment of government support should be an extraordinary event that requires
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the engagement of the Treasury Department and contains sufficient criteria to
prevent costs to the taxpayer to the greatest extent possible.
This work will not be done easily. It must begin now, and begin in earnest. Thank
you.
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July 10, 2008
HP-1075
Treasury Targets Rami Makhluf's Companies
Washington - The U.S. Department of the Treasury today added Syriatel, Syria's
largest mobile phone operator, and Ramak, a chain of Syrian duty free stores, to its
Specially Designated Nationals and Blocked Persons List. All property and interests
in property of these entities are blocked as a result of the direct or indirect
ownership interest of at least 50 percent by Rami Makhluf in each entity.
"Rami Makhluf uses his access to high-level Syrian Government insiders to enrich
himself at the expense of the Syrian people," said Adam J. Szubin, Director of the
Office of Foreign Assets Control (OFAC). "We will continue to target Makhluf and
his commercial empire as well as others who follow in his footsteps."
Makhluf was designated on February 21, 2008 pursuant to Executive Order 13460,
which targets individuals and entities determined to have contributed to, or to have
benefited from, the public corruption of senior officials of the Syrian regime.
Makhluf, a maternal cousin of Syrian president Bashar al-Asad, has exploited his
relationships with Syrian regime members to amass his commercial empire.
Makhluf has manipulated the Syrian judicial system and has used Syrian
intelligence officials to intimidate business rivals.
Pursuant to E.O. 13460, any assets in Syriatel's or Ramak's names held in the
United States or within the possession or control of U.S. persons are blocked, and
U.S. persons, therefore, are prohibited from engaging in business or transactions
with Syria tel or Ramak.
President George W. Bush issued E.O. 13460 on February 13, 2008 to take
additional measures to address the threat to the national security, foreign policy,
and economy of the United States posed by certain conduct of the Government of
Syria.
This new authority builds on E.O. 13338, which was issued by President Bush in
May 2004, by targeting activities that entrench and enrich the Syrian regime and its
cohorts thereby enabling the regime to continue to engage in threatening behavior,
including actions that undermine efforts to stabilize Iraq. Corruption by the regime
also reinforces efforts that deny the people of
Syria political freedoms and economic prosperity, undercut peace and stability in
the region, fund terrorism and violence, and undermine the sovereignty of Lebanon.
Identifying Information
RAMAK
AKAs:
Ramak Duty Free Shop Ltd
Ramak Duty Free Shops Ltd.
Ramak Duty Free Shops - Syria
Ramak Duty Free
Ramak Firm for Free Trade Zones
Addresses:
Ramak Duty Free Shop Ltd., Free Zone Area, Jamarek, PO Box 932,
Damascus, Syria
Ramak Duty Free Shops - Syria, AI Rawda Street, PO Box 932,
Damascus, Syria
Abu Ramana Street, Rawda, Damascus, Syria
Damascus Duty Free, Damascus International Airport, Damascus, Syria
Dara'a Duty Free, Naseeb Border Center, Dara'a, Syria
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Aleppo Duty Free, Aleppo International Airport, Aleppo, Syria
Jdaideh Duty Free Complex, Jdaideh Yaboos, Damascus, Syria
Ramak Duty Free Shop Ltd., Bab el Hawa Border Center, Aleppo
Ramak Duty Free Shop Ltd., Lattakia Port, Lattakia
Ramak Duty Free Shop Ltd., Tartous Port, Tartous
Telephone:
+963 11 2139222
+963 11 2138990
+963 11 2114666
Email:
dam.d. free@net.sy
Website:
http://www.ramakdutyfree.net
SYRIATEL
AKAs:
Syriatel Mobile Telecom SA
Syriatel Mobile Telecom
Syriatel Mobile
SyriaTel Mobile Telecom
Address:
Doctors Syndicate Building, AI Jalaa Street, Abu Roumaneh Area,
PO Box 2900, Damascus, Syria
-30-
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July 10,2008
hp-1076
Testimony of Treasury Deputy Assistant Secretary for
International Tax Affairs
Michael F. Mundaca
Before the Senate Committee on Foreign Relations
on Pending Income Tax Treaties
Washington, DC -- Mr. Chairman, Ranking Member Lugar, and distinguished
Members of the Committee, I appreciate the opportunity to appear today to
recommend, on behalf of the Administration, favorable action on three tax treaties
pending before this Committee. We appreciate the Committee's interest in these
treaties and in the U.S. tax treaty network overall.
This Administration is committed to eliminating barriers to cross-border trade and
investment, and tax treaties are the primary means for eliminating tax barriers to
such trade and investment. Tax treaties provide greater certainty to taxpayers
regarding their potential liability to tax in foreign jurisdictions; they allocate taxing
rights between the two jurisdictions and include other provisions that reduce the risk
of double taxation, including provisions that reduce gross-basis withholding taxes;
and they ensure that taxpayers are not subject to discriminatory taxation in the
foreign jurisdiction.
This Administration is also committed to preventing tax evasion, and our tax treaties
play an important role in this area as well. A key element of U.S. tax treaties is
exchange of information between tax authorities. Under tax treaties, one country
may request from the other such information as may be relevant for the proper
administration of the first country's tax laws. Because access to information from
other countries is critically important to the full and fair enforcement of U.S. tax
laws, information exchange is a top priority for the United States in its tax treaty
program.
A tax treaty reflects a balance of benefits that is agreed to when the treaty is
negotiated. In some cases, changes in law or policy in one or both of the treaty
partners make the partners more willing to increase the benefits beyond those
provided by the treaty; in these cases, negotiation of a revised treaty may be very
beneficial. In other cases, developments in one or both countries, or international
developments more generally, may make is desirable to revisit a treaty to prevent
exploitation of treaty provisions and eliminate unintended and inappropriate
consequences in the application of the treaty; in these cases, it may be expedient to
modify the agreement. Both in setting our overall negotiation priorities and in
negotiating individual treaties, our focus is on ensuring that our tax treaty network
fulfills its goals of facilitating cross border trade and investment and preventing
fiscal evasion.
The treaties before the Committee today with Canada, Iceland, and Bulgaria serve
to further the goals of our tax treaty network. The treaties with Canada and Iceland
would modify existing tax treaty relationships. The tax treaty with Bulgaria would be
the first between our two countries. We urge the Committee and the Senate to take
prompt and favorable action on all of these agreements.
Before discussing the pending treaties in more detail, I would like to address some
more general tax treaty matters, to provide background for the Committee's and the
Senate's consideration of the pending tax treaties.
Purposes and Benefits of Tax Treaties
Tax treaties set out clear ground rules that govern tax matters relating to trade and
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investment between the two countries.
One of the primary functions of tax treaties is to provide certainty to taxpayers
regarding the threshold question with respect to international taxation: whether a
taxpayer's cross-border activities will subject it to taxation by two or more countries.
Tax treaties answer this question by establishing the minimum level of economic
activity that must be engaged in within a country by a resident of the other before
the first country may tax any resulting business profits. In general terms, tax treaties
provide that if branch operations in a foreign country have sufficient substance and
continuity, the country where those activities occur will have primary (but not
exclusive) jurisdiction to tax. In other cases, where the operations in the foreign
country are relatively minor, the home country retains the sole jurisdiction to tax.
Another primary function is relief of double taxation. Tax treaties protect taxpayers
from potential double taxation primarily through the allocation of taxing rights
between the two countries. This allocation takes several forms. First, the treaty has
a mechanism for resolving the issue of residence in the case of a taxpayer that
otherwise would be considered to be a resident of both countries. Second, with
respect to each category of income, the treaty assigns the primary right to tax to
one country, usually (but not always) the country in which the income arises (the
"source" country), and the residual right to tax to the other country, usually (but not
always) the country of residence of the taxpayer (the "residence" country). Third,
the treaty provides rules for determining which country will be treated as the source
country for each category of income. Finally, the treaty establishes the obligation of
the residence country to eliminate double taxation that otherwise would arise from
the exercise of concurrent taxing jurisdiction by the two countries.
In addition to reducing potential double taxation, tax treaties also reduce potential
"excessive" taxation by reducing withholding taxes that are imposed at source.
Under U.S. law, payments to non-U.S. persons of dividends and royalties as well as
certain payments of interest are subject to withholding tax equal to 30 percent of the
gross amount paid. Most of our trading partners impose Similar levels of withholding
tax on these types of income. This tax is imposed on a gross, rather than net,
amount. Because the withholding tax does not take into account expenses incurred
in generating the income, the taxpayer that bears the burden of withholding tax
frequently will be subject to an effective rate of tax that is significantly higher than
the tax rate that would be applicable to net income in either the source or residence
country. The taxpayer may be viewed, therefore, as suffering excessive taxation.
Tax treaties alleviate this burden by setting maximum levels for the withholding tax
that the treaty partners may impose on these types of income or by providing for
exclusive residence-country taxation of such income through the elimination of
source-country withholding tax. Because of the excessive taxation that withholding
taxes can represent, the United States seeks to include in tax treaties provisions
that substantially reduce or eliminate source-country withholding taxes.
As a complement to these substantive rules regarding allocation of taxing rights, tax
treaties provide a mechanism for dealing with disputes between the countries
regarding the treaties, including questions regarding the proper application of the
treaties that arise after the treaty enters into force. To resolve disputes, designated
tax authorities of the two governments - known as the "competent authorities" in
tax treaty parlance - are to consult and to endeavor to reach agreement. Under
many such agreements, the competent authorities agree to allocate a taxpayer's
income between the two taxing jurisdictions on a consistent basis, thereby
preventing the double taxation that might otherwise result. The U.S. competent
authority under our tax treaties is the Secretary of the Treasury. That function has
been delegated to the Deputy Commissioner (International) of the Large and MidSize Business Division of the Internal Revenue Service.
Tax treaties also include provisions intended to ensure that cross-border investors
do not suffer discrimination in the application of the tax laws of the other country.
This is similar to a basic investor protection provided in other types of agreements,
but the non-discrimination provisions of tax treaties are specifically tailored to tax
matters and, therefore, are the most effective means of addressing potential
discrimination in the tax context. The relevant tax treaty provisions explicitly prohibit
types of discriminatory measures that once were common in some tax systems. At
the same time, tax treaties clarify the manner in which possible discrimination is to
be tested in the tax context.
In addition to these core provisions, tax treaties include provisions dealing with
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more specialized situations, such as rules coordinating the pension rules of the tax
systems of the two countries or addressing the treatment of Social Security benefits
and alimony and child-support payments in the cross-border context. These
provisions are becoming increasingly important as more individuals move between
countries or otherwise are engaged in cross-border activities. While these matters
may not involve substantial tax revenue from the perspective of the two
governments, rules providing clear and appropriate treatment are very important to
the affected taxpayers.
Tax treaties also include provisions related to tax administration. A key element of
U.S. tax treaties is the provision addressing the exchange of information between
the tax authorities. Under tax treaties, the competent authority of one country may
request from the other competent authority such information as may be relevant for
the proper administration of the first country's tax laws; the information provided
pursuant to the request is subject to the strict confidentiality protections that apply
to taxpayer information. Because access to information from other countries is
critically important to the full and fair enforcement of the U.S. tax laws, information
exchange is a priority for the United States in its tax treaty program. If a country has
bank-secrecy rules that would operate to prevent or seriously inhibit the appropriate
exchange of information under a tax treaty, we will not enter into a new tax treaty
relationship with that country. Indeed, the need for appropriate information
exchange provisions is one of the treaty matters that we consider non-negotiable.
Tax Treaty Negotiating Priorities and Process
The United States has a network of 58 income tax treaties covering 66 countries.
This network covers the vast majority of foreign trade and investment of U.S.
businesses and investors. In establishing our negotiating priorities, our primary
objective is the conclusion of tax treaties that will provide the greatest benefit to the
United States and to U.S. taxpayers. We communicate regularly with the U.S.
business community and the Internal Revenue Service, seeking input regarding the
areas in which treaty network expansion and improvement efforts should be
focused and seeking information regarding practical problems encountered under
particular treaties and particular tax regimes.
The primary constraint on the size of our tax treaty network may be the complexity
of the negotiations themselves. Ensuring that the various functions to be performed
by tax treaties are all properly taken into account makes the negotiation process
exacting and time consuming.
Numerous features of a country's particular tax legislation and its interaction with
U.S. domestic tax rules must be considered in negotiating a treaty or protocol.
Examples include whether the country eliminates double taxation through an
exemption system or a credit system, the country's treatment of partnerships and
other transparent entities, and how the country taxes contributions to pension
funds, earnings of the funds, and distributions from the funds.
Moreover, a country's fundamental tax policy choices are reflected not only in its tax
legislation but also in its tax treaty positions. These chOices differ significantly from
country to country, with substantial variation even across countries that seem to
have quite similar economic profiles. A treaty negotiation must take into account all
of these aspects of the particular treaty partner's tax system and treaty policies to
arrive at an agreement that accomplishes the United States' tax treaty objectives.
Obtaining the agreement of our treaty partners on provisions of importance to the
United States sometimes requires concessions on our part. Similarly, the other
country sometimes must make concessions to obtain our agreement on matters
that are critical to it. Each treaty that we present to the Senate represents not only
the best deal that we believe can be achieved with the particular country, but also
qonstitutes an agreement that we believe is in the best interests of the United
States.
In some situations, the right result may be no tax treaty at all. Prospective treaty
partners must evidence a clear understanding of what their obligations would be
under the treaty, especially those with respect to information exchange, and must
demonstrate that they would be able to fulfill those obligations. Sometimes a tax
treaty may not be appropriate because a potential treaty partner is unable to do so.
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In other cases, a tax treaty may be inappropriate because the potential treaty
partner is not willing to agree to particular treaty provisions that are needed to
address real tax problems that have been identified by U.S. businesses operating
there or because the potential treaty partner insists on provisions the United States
will not agree to, such as providing a U.S. tax credit for investment in the foreign
country (so-called "tax sparing"). With other countries there simply may not be the
type of cross-border tax issues that are best resolved by treaty. For example, if a
country does not impose significant income taxes. there is little possibility of double
taxation of cross-border income, and an agreement that is focused on the exchange
of tax information ("tax information exchange agreements" or TIEAs) may be the
most appropriate agreement.
A high priority for improving our overall treaty network is continued focus on
prevention of "treaty shopping." The U.S. commitment to including comprehensive
limitation on benefits provisions is one of the keys to improving our overall treaty
network. Our tax treaties are intended to provide benefits to residents of the United
States and residents of the particular treaty partner on a reciprocal basis. The
reductions in source-country taxes agreed to in a particular treaty mean that U.S.
persons pay less tax to that country on income from their investments there and
residents of that country pay less U.S. tax on income from their investments in the
United States. Those reductions and benefits are not intended to flow to residents
of a third country. If third-country residents are able to exploit one of our tax treaties
to secure reductions in U.S. tax, such as through the use of an entity resident in a
treaty country that merely holds passive U.S. assets, the benefits would flow only in
one direction as third-country residents would enjoy U.S. tax reductions for their
U.S. investments, but U.S. residents would not enjoy reciprocal tax reductions for
their investments in that third country. Moreover, such third-country residents may
be securing benefits that are not appropriate in the context of the interaction
between their home country's tax systems and policies and those of the United
States. This use of tax treaties is not consistent with the balance of the deal
negotiated in the underlying tax treaty. Preventing this exploitation of our tax
treaties is critical to ensuring that the third country will sit down at the table with us
to negotiate on a reciprocal basis, so we can secure for U.S. persons the benefits of
reductions in source-country tax on their investments in that country.
Consideration of Arbitration
Tax treaties cannot facilitate cross-border investment and provide a more stable
investment environment unless the treaty is effectively implemented by the tax
administrations of the two countries. Under our tax treaties, when a U.S. taxpayer
becomes concerned about implementation of the treaty, the taxpayer can bring the
matter to the U.S. competent authority who will seek to resolve the matter with the
competent authority of the treaty partner. The competent authorities will work
cooperatively to resolve genuine disputes as to the appropriate application of the
treaty.
The U.S. competent authority has a good track record in resolving disputes. Even in
the most cooperative bilateral relationships, however, there will be instances in
which the competent authorities will not be able to reach a timely and satisfactory
resolution. Moreover, as the number and complexity of cross-border transactions
increases, so does the number and complexity of cross-border tax disputes.
Accordingly, we have considered ways to equip the U.S. competent authority with
additional tools to resolve disputes promptly, including the possible use of
arbitration in the competent authority mutual agreement process.
The first U.S. tax agreement that contemplated arbitration was the U.S.-Germany
income tax treaty signed in 1989. Tax treaties with several other countries,
including Canada, Mexico, and the Netherlands, incorporate authority for
establishing voluntary binding arbitration procedures based on the provision in the
prior U.S.-Germany treaty. Although we believe that the presence of these
voluntary arbitration provisions may have provided some limited assistance in
reaching mutual agreements, it has become clear that the ability to enter into
voluntary arbitration does not provide sufficient incentive to resolve problem cases
in a timely fashion.
Over the past few years, we have carefully considered and studied various types of
mandatory arbitration procedures that could be used as part of the competent
authority mutual agreement process. In particular, we examined the experience of
countries that adopted mandatory binding arbitration provisions with respect to tax
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matters. Many of them report that the prospect of impending mandatory arbitration
creates a significant incentive to compromise before commencement of the
process. Based on our review of the U.S. experience with arbitration in other areas
of the law, the success of other countries with arbitration in the tax area, and the
overwhelming support of the business community, we concluded that mandatory
binding arbitration as the final step in the competent authority process can be an
effective and appropriate tool to facilitate mutual agreement under U.S. tax treaties.
One of the treaties before the Committee, the Protocol with Canada, includes a type
of mandatory arbitration provision negotiated contemporaneously with, and very
similar to, a provision in our current, recently ratified treaties with Germany and
Belgium, which this Committee and the Senate considered last year.
In the typical competent authority mutual agreement process, a U.S. taxpayer
presents its problem to the U.S. competent authority and participates in formulating
the position the U.S. competent authority will take in discussions with the treaty
partner. Under the arbitration provision proposed in the Canadian protocol, as in the
similar provisions that are now part of our treaties with Germany and Belgium, if the
competent authorities cannot resolve the issue within two years, the competent
authorities must present the issue to an arbitration board for resolution, unless both
competent authorities agree that the case is not suitable for arbitration. The
arbitration board must resolve the issue by choosing the position of one of the
competent authorities. That position is adopted as the agreement of the competent
authorities and is treated like any other mutual agreement (i.e., one that has been
negotiated by the competent authorities) under the treaty.
Because the arbitration board can only choose between the positions of each
competent authority, the expectation is that the differences between the positions of
the competent authorities will tend to narrow as the case moves closer to
arbitration. In fact, if the arbitration provision is successful, difficult issues will be
resolved without resort to arbitration. Thus, it is our expectation that these
arbitration provisions will be rarely utilized, but that their presence will encourage
the competent authorities to take approaches to their negotiations that result in
mutually agreed conclusions in the first instance.
The arbitration process proposed in the agreement with Canada, consistent with the
German and Belgian provisions, is mandatory and binding with respect to the
competent authorities. However, consistent with the negotiation process under the
mutual agreement procedure, the taxpayer can terminate the arbitration at any time
by withdrawing its request for competent authority assistance. Moreover, the
taxpayer retains the right to litigate the matter (in the United States or the treaty
partner) in lieu of accepting the result of the arbitration, just as it would be entitled to
litigate in lieu of accepting the result of a negotiation under the mutual agreement
procedure.
Arbitration is a growing and developing field, and there are many forms of
arbitration from which to choose. We intend to continue to study other arbitration
provisions and to monitor the performance of the provisions in the agreements with
Belgium and Germany, as well as the performance of the provision in the
agreement with Canada, if ratified. We look forward to continuing to work with the
Committee to make arbitration an effective tool in promoting the fair and expeditious
resolution of treaty disputes. The Committee's comments made with respect to the
German and Belgian arbitration provisions have been very helpful and will inform
future negotiations of arbitration provisions.
Discussion of Proposed Treaties
I now would like to discuss in more detail the three treaties that have been
transmitted for the Senate's consideration. We have submitted a Technical
Explanation of each treaty that contains detailed discussions of the provisions of
each treaty. These Technical Explanations serve as an official guide to each treaty.
The Technical Explanation to the Protocol with Canada was reviewed by Canada,
and Canada subscribes to its contents, as will be confirmed by a press release from
the Canadian Ministry of Finance.
Canada
The proposed Protocol with Canada was signed in Chelsea on September 21,
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2007, and is the fifth protocol of amendment to the current Convention negotiated in
1980 and amended by prior protocols in 1983, 1984, 1995, and 1997. The most
significant provisions in this treaty relate to the taxation of cross-border interest, the
treatment of income derived through fiscally transparent entities, the taxation of
certain provisions of services, and the adoption of mandatory arbitration to facilitate
the resolution of disputes between the U.S. and Canadian revenue authorities. The
proposed Protocol also makes a number of changes to reflect changes in U.S. and
Canadian law, and to bring the current Convention into closer conformity with
current U.S. tax treaty policy.
The proposed Protocol eliminates withholding taxes on cross-border interest
payments. The elimination of withholding taxes on all cross-border interest
payments between the United States and Canada has been a top tax treaty priority
for both the business community and the Treasury Department for many years. The
proposed Protocol represents a substantial improvement over the current
Convention, which generally provides for a source-country withholding tax rate of
10 percent. This provision would be effective for interest paid to unrelated parties
on the first day of January of the year in which the proposed Protocol enters into
force, and it would be phased in for interest paid to related persons over a threeyear period. Consistent with U.S. tax treaty policy, the proposed Protocol also
provides exceptions to the elimination of source-country taxation with respect to
contingent interest and payments from a U.S. real estate mortgage investment
conduit.
The proposed Protocol also would provide that a U.S. person is generally eligible to
claim the benefits of the treaty when such person derives income through an entity
that is considered by the United States to be fiscally transparent (e.g., a
partnership) unless the entity is a Canadian entity and is not treated by Canada as
fiscally transparent. The proposed Protocol in addition contains anti-abuse
provisions intended to address certain situations involving the use of these entities
to obtain treaty benefits inappropriately.
The current Convention generally limits the taxation by one country of the business
profits of a resident of the other country. The source country's right to tax such
profits is generally limited to cases in which the profits are attributable to a
permanent establishment located in that country. The proposed Protocol would add
provisions related to the taxation of permanent establishments. Most importantly,
the proposed Protocol includes a special rule allowing source-country taxation of
income from certain provisions of services not otherwise considered to be provided
through a permanent establishment. This rule is broader than the permanent
establishment rule in the U.S. Model tax treaty but was key to achieving an overall
agreement that we believe is in the best interests of the United States and U.S.
taxpayers.
As previously noted, the proposed Protocol provides for mandatory arbitration of
certain cases that have not been resolved by the competent authority within a
specified period, generally two years from the commencement of the case. Under
the proposed Protocol, the arbitration process may be used to reach an agreement
with respect to certain issues relating to residence, permanent establishment,
business profits, related persons, and royalties. The arbitration board must deliver a
determination within six months of the appointment of the chair of the arbitration
board, and the determination must either be the proposed resolution submitted by
the United States or the proposed resolution submitted by Canada. The board's
determination has no precedential value and the board shall not provide a rationale
for its determination.
The proposed Protocol also makes a number of other modifications to the current
Convention to reflect changes to U.S. law and current U.S. tax treaty policy. For
example, the proposed Protocol updates the current Convention's treatment of
pensions for cross-border workers to remove barriers to the flow of personal
services between the United States and Canada that could otherwise result from
discontinuities in the laws of the two countries regarding the tax treatment of
pensions. In addition, the proposed Protocol updates the current Convention's
limitation on benefits provisions so that they apply on a reciprocal basis. The
proposed Protocol also addresses the treatment of companies that engages in
corporate "continuance" transactions and revises the current Convention's rules
regarding the residence of so-called dual resident companies.
The proposed Protocol provides that the United States and Canada shall notify
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each other in writing, through diplomatic channels, when their respective applicable
procedures for ratification have been satisfied. The proposed Protocol will enter into
force upon the date of the later of the required notifications. For taxes withheld at
source, it will generally have effect for amounts paid or credited on or after the first
day of the second month that begins after the date the proposed Protocol enters
into force, although certain provisions with respect to interest may have earlier
effect. With respect to other taxes, the proposed Protocol will generally have effect
for taxable years that begin after the calendar year in which the proposed Protocol
enters into force. Certain provisions will be phased in or have a delayed effective
date. Provisions regarding corporate continuance transactions will apply
retroactively, consistent with prior Treasury Department public statements.
Iceland
The proposed Convention and accompanying Protocol with Iceland was signed in
Washington, D.C., on October 23, 2007. It would replace the current Convention,
concluded in 1975. The most important change from the current Convention is the
addition of a limitation on benefits provision. The proposed Convention also makes
changes to some of the withholding tax rates provided in the current Convention. In
addition, the proposed Convention makes a number of changes to reflect changes
in U.S. and Icelandic law, and to conform to current U.S. tax treaty policy.
As just noted, the proposed Convention contains a comprehensive limitation on
benefits provision, generally following the current U.S. Model income tax treaty. The
current Convention does not contain treaty shopping protections and, as a result,
has been abused by third-country investors in recent years. For this reason,
revising the current Convention has been a top tax treaty priority.
The proposed Convention generally provides for withholding rates on investment
income that are the same as or lower than those in the current Convention. Like the
current Convention, the proposed Convention provides for reduced source-country
taxation of cross-border dividends. In addition, the proposed Convention would
eliminate source-country withholding tax on cross-border dividend payments to
pension funds. As with the current Convention, the proposed Convention generally
would eliminate source-country withholding tax on cross-border interest payments.
However, while the current Convention eliminates source-country withholding taxes
on all cross-border payments of royalties, the proposed Convention would allow the
country in which certain cross-border trademark royalties arise to impose a
withholding tax of up to 5 percent. Inclusion of this provision was key to achieving
an overall agreement that we believe is in the best interests of the United States
and U.S. taxpayers.
In addition, the proposed Convention provides for the exchange between the tax
authorities of each country of information relevant to carrying out the provisions of
the agreement or the domestic tax laws of either country.
The proposed Convention provides that the United States and Iceland shall notify
each other in writing, through diplomatic channels, when their respective applicable
procedures for ratification have been satisfied. The proposed Convention will enter
into force on the date of the later of the required notifications. It will have effect, with
respect to taxes withheld at source, for amounts paid or credited on or after the first
day of January of the calendar year following entry into force, and with respect to
other taxes, for taxable years beginning on or after the first day of January following
the date upon which the proposed Convention enters into force. The current
Convention will, with respect to any tax, cease to have effect as of the date on
which this proposed Convention has effect with respect to such tax. However,
where any person would be entitled to greater benefits under the current
Convention, at the election of the person, the current Convention shall continue to
have effect in its entirety with respect to such person for a period of 12 months from
the date the provisions of the proposed Convention are effective.
Bulgaria
The proposed income tax Convention and accompanying Protocol with Bulgaria
signed in Washington, D.C., on February 23,2007, and the subsequent Protocol
with Bulgaria signed in Sofia, on February 26, 2008, together would represent the
first income tax treaty between the United States and Bulgaria. The proposed
Convention is generally consistent with the current U.S. Model income tax treaty
and with treaties that the United States has with other countries.
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Under the proposed Convention, withholding taxes on cross-border portfolio
dividend payments may be imposed by the source state at a maximum rate of 10
percent. When the beneficial owner of a cross-border dividend is a company that
directly owns at least 10 percent of the stock of the company paying the dividend,
withholding tax may be imposed at a maximum rate of 5 percent. The proposed
Convention also provides for a withholding rate of zero on cross-border dividend
payments to pension funds.
The proposed Convention generally limits withholding taxes on cross-border
interest payments to a maximum rate of 5 percent. No withholding tax on a crossborder interest payment is generally permitted, however, when the interest is
beneficially owned by, or guaranteed by, the government or the central bank of the
other country (or any institution owned by that country), a pension fund resident in
the other country, or a financial institution (including a bank or an insurance
company) resident in the other country.
The proposed Convention provides that withholding taxes on cross-border royalty
payments are limited to a maximum rate of 5 percent.
The proposed Convention also incorporates rules provided in the U.S, Model tax
treaty for certain classes of investment income. For example, dividends paid by
entities such as U.S. regulated investment companies and real estate investment
trusts, are subject to special rules to prevent the use of these entities to transform
what is otherwise higher-taxed income into lower-taxed income.
The proposed Convention limits the taxation by one country of the business profits
of a resident of the other country. The source country's right to tax such profits is
generally limited to cases in which the profits are attributable to a permanent
establishment located in that country. The proposed Convention includes a rule,
similar to a rule in the proposed Protocol with Canada, allowing source-country
taxation of income from certain provisions of services. The proposed Convention
also provides that certain employees or agents that maintain a stock of goods from
which the agent regularly fills orders on behalf of the principal. and conduct
additional activities contributing to the conclusion of sales, may result in a
permanent establishment.
Consistent with current U.S. tax treaty policy, the proposed Convention includes a
comprehensive limitation on benefits article, which is designed to deny treaty
shoppers the benefits of the Convention. The proposed Convention provides for
non-discriminatory treatment by one country to residents and nationals of the other
country. In addition, the proposed Convention provides for the exchange between
the tax authorities of each country of information relevant to carrying out the
provisions of the agreement or the domestic tax laws of either country. This will
facilitate the enforcement of U.S. domestic tax rules.
The proposed Convention provides that the United States and Bulgaria shall notify
each other, through diplomatic channels, when their respective applicable
procedures for ratification have been satisfied. The proposed Convention will enter
into force upon the date of receipt of the later of the required notifications. It will
have effect, with respect to taxes withheld at source, for amounts paid or credited
on or after the first day of January in the year following the date upon which the
proposed Convention enters into force and, with respect to other taxes, for taxable
years beginning on or after the first day of January in the year following the date
upon which the proposed Convention enters into force.
Treaty Program Priorities
A key continuing priority for the Treasury Department is updating the few remaining
U.S. tax treaties that provide for low withholding tax rates but do not include the
limitation on benefits provisions needed to protect against the possibility of treaty
shopping. Accordingly, we currently are in ongoing discussions with both Poland
and Hungary regarding the inclusion of anti-treaty shopping provisions.
In addition, we continue to maintain a very active calendar of tax treaty
negotiations. We recently initialed a new tax treaty with Malta. We also are currently
negotiating with France and New Zealand, and expect to announce soon the
opening of other negotiations.
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We also have undertaken exploratory discussions with several countries in Asia
and South America that we hope will lead to productive negotiations later in 2008 or
in 2009.
Conclusion
Mr. Chairman and Ranking Member Lugar, let me conclude by thanking you for the
opportunity to appear before the Committee to discuss the Administration's efforts
with respect to the three agreements under consideration. We appreciate the
Committee's continuing interest in the tax treaty program, and we thank the
Members and staff for devoting time and attention to the review of these new
agreements. We are also grateful for the assistance and cooperation of the staff of
the Joint Committee on Taxation.
On behalf of the Administration, we urge the Committee to take prompt and
favorable action on the agreements before you today. I would be happy to respond
to any question you may have.
-30REPORTS
•
•
•
Canada Technical Explanation
Iceland Technical Explanation
Bulgaria Technical Explanation
http://www.treas.gov/press/releases/hpI076.htm
8/1/2008
DEPARTMENT OF THE TREASURY
TECHNICAL EXPLANATION OF
THE PROTOCOL DONE AT CHELSEA ON SEPTEMBER 21, 2007
AMENDING THE CONVENTION BETWEEN
THE UNITED STATES OF AMERICA AND CANADA
WITH RESPECT TO TAXES ON INCOME AND ON CAPITAL
DONE AT WASHINGTON ON SEPTEMBER 26 , 1980 ,
AS AMENDED BY THE PROTOCOLS DONE ON
JUNE 14, 1983, MARCH 28, 1994, MARCH 17, 1995, AND JULY 29, 1997
INTRODUCTION
This is a Technical Explanation of the Protocol signed at Chelsea on September
21, 2007 (the "Protocol"), amending the Convention between the United States of
America and Canada with Respect to Taxes on Income and on Capital done at
Washington on September 26, 1980, as amended by the Protocols done on June 14, 1983,
March 28, 1994, March 17, 1995, and July 29, 1997 (the "existing Convention"). The
existing Convention as modified by the Protocol shall be referred to as the "Convention."
Negotiation of the Protocol took into account the U.S. Treasury Department's
current tax treaty policy and the Treasury Department's Model Income Tax Convention,
published on November 15,2006 (the "U.S. Model"). Negotiations also took into
account the Model Tax Convention on Income and on Capital, published by the
Organisation for Economic Cooperation and Development (the "OECD Model"), and
recent tax treaties concluded by both countries.
The Technical Explanation is an official United States guide to the Protocol. The
Government of Canada has reviewed this document and subscribes to its contents. In the
view of both governments, this document accurately reflects the policies behind
particular Protocol provisions, as well as understandings reached with respect to the
application and interpretation of the Protocol and the Convention.
References made to the "existing Convention" are intended to put various
provisions of the Protocol into context. The Technical Explanation does not, however,
provide a complete comparison between the provisions of the existing Convention and
the amendments made by the Protocol. The Technical Explanation is not intended to
provide a complete guide to the existing Convention as amended by the Protocol. To the
extent that the existing Convention has not been amended by the Protocol, the prior
technical explanations of the Convention remain the official explanations. References in
this Technical Explanation to "he'" or "his" should be read to mean "he or she" or "his or
her." References to the "Code" are to the Internal Revenue Code.
On the date of signing of the Protocol, the United States and Canada exchanged
(wo sets of diplomatic notes. Each of these notes sets forth provisions and
understandings related to the Protocol and the Convention, and comprises an integral part
Jf the overall agreement between the United States and Canada. The first note, the
"Arbitration Note:' relates to the implementation of nev-' paragraphs 6 and 7 of Article
XXVI (Mutual Agreement Procedure), which provide for binding arbitration of certain
disputes between the competent authorities. The second note, the "General Note:' relates
more generally to issues of interpretation or application of various provisions of the
Protocol.
Article I
Article 1 of the Protocol adds subparagraph l(k) to Article III (General
Detinitions) to address the definition of"national" ofa Contracting State as used in the
Convention. The Contracting States recognize that Canadian tax law does not draw
distinctions based on nationality as such. Nevertheless, at the request of the United
States, the definition was added and contains references to both citizenship and
nationality. The definition includes any individual possessing the citizenship or
nationality of a Contracting State and any legal person, partnership or association whose
status is determined by reference to the laws in force in a Contracting State. The existing
Convention contains one reference to the term '"national" in paragraph 1 of Article XXVI
(Mutual Agreement Procedure). The Protocol adds another reference in paragraph 1 of
Article XXV (Non-Discrimination) to ensure that nationals of the United States are
covered by the non-discrimination provisions of the Convention. The definition added by
the Protocol is consistent with the definition provided in other U.S. tax treaties.
The General Note provides that for purposes of paragraph 2 of Article II I, as
regards the application at any time of the Convention, any term not defined in the
Convention shall, unless the context otherwise requires or the competent authorities
otherwise agree to a common meaning pursuant to Article XXVI (Mutual Agreement
Procedure), have the meaning which it has at that time under the law of that State for the
purposes of the taxes to which the Convention apply, any meaning under the applicable
tax laws of that State prevailing over a meaning given to the term under other laws of that
State.
Article 2
Article 2 of the Protocol replaces paragraph 3 of Article IV (Residence) of the
existing Convention to address the treatment of so-called dual resident companies.
Article 2 of the Protocol also adds new paragraphs 6 and 7 to Article IV to determine
whether income is considered to be derived by a resident of a Contracting State when
such income is derived through a fiscally transparent entity.
l\.,'agraph 3 ofArticle IV - Dual resident companies
Paragraph 3, which addresses companies that are otherwise considered resident in
each of the Contracting States, is replaced. The provisions of paragraph 3, and the date
upon which these provisions are effective, are consistent with an understanding reached
between the United States and Canada on September 18, 2000, to clarify the residence of
a company under the Convention when the company has engaged in a so-called corporate
"continuance" transaction. The paragraph applies only where, by reason of the rules set
forth in paragraph 1 of Article IV (Residence), a company is a resident of both
Contracting States.
.
Subparagraph 3(a) pr~\'ides a ~le to address the situation when a company is a
reSident of b?th Contractmg States but IS created un~er the laws in force in only one of
the Co~tractmg Stat~s. In such a case, ~he .ru.le proVides that the company is a resident
?nly ot the C?ntractm~ State under which It IS crea~ed. For example, if a company is
mcorporated m the Untted States but the company IS also otherwise considered a resident
2
of Canada because the c0n:tpany is ma.naged in Canada, subparagraph 3(a) provides that
the company shall be considered.a ~esident only of the United States for purposes of the
Convention. Subparagraph 3(a) IS mtended to operate in a manner similar to the first
sentence of former paragraph 3. However, subparagraph 3(a) clarifies that such a
company must be considered created in only one of the Contracting States to fall within
the scope of subparagraph 3(a). In some cases, a company may engage in a corporate
continuance transaction and retain its charter in the Contracting State from which it
continued, while also being considered as created in the State to which the company
continued. In such cases, the provisions of subparagraph 3(a) shall not apply because the
company would be considered created in both of the Contracting States.
Subparagraph 3(b) addresses all cases involving a dual resident company that are
not addressed in subparagraph 3(a). Thus, subparagraph 3(b) applies to continuance
transactions occurring between the Contracting States if, as a result, a company otherwise
would be considered created under the laws of each Contracting State, e.g., because the
corporation retained its charter in the first State. Subparagraph 3(b) would also address
so-called serial continuance transactions where, for example, a company continues from
one of the Contracting States to a third country and then continues into the other
Contracting State without having ceased to be treated as resident in the first Contracting
State.
Subparagraph 3(b) provides that if a company is considered to be a resident of
both Contracting States, and the residence of such company is not resolved by
subparagraph 3(a), then the competent authorities ofthe Contracting States shall
endeavor to settle the question of residency by a mutual agreement procedure and
determine the mode of application of the Convention to such company. Subparagraph
3(b) also provides that in the absence of such agreement, the company shall not be
considered a resident of either Contracting State for purposes of claiming any benefits
under the Convention.
Paragraphs 6 and 7 ofArticle IV - income, profit, or gain derived throughfiscally
transparent entities
New paragraphs 6 and 7 are added to Article IV to provide specific rules for the
treatment of amounts of income, profit or gain derived through or paid by fiscally
transparent entities such as partnerships and certain trusts. Fiscally transparent entities,
as explained more fully below, are in general entities the income of which is taxed at the
beneficiary, member, or participant level. Entities that are subject to tax, but with respect
j 0 which tax may be relieved under an integrated system, are not considered fiscally
transparent entities. Entities that are fiscally transparent for U.S. tax purposes include
partnerships, common investment trusts under section 584, grantor trusts, and business
entities such as a limited liability company ("LLC") that is treated as a partnership or is
disregarded as an entity separate from its owner for U.S. tax purposes .. Entities fal~ing
within this description in Canada are (except to the extent the law prOVIdes otherwIse)
partnerships and what are known as "bare" trusts.
United States tax law also considers a corporation that has made a valid election
to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code (an "S
corporation") to be fiscally transparent within the meaning expla~ned below. Th~s, if a
U.S. resident derives income from Canada through an S corporatIOn, the U.S. reSIdent
will under new paragraph 6 be considered for purposes of the Convention as the person
who derived the income. Exceptionally, because Canada will ordinarily accept that an S
r,orporation is itself resident in the U n~ted States for purpo~es ?f ~he Conv:ention, Canada
will allow benefits under the ConventIOn to the S corporatIOn m Its own nght. In a
3
reverse case, however - that is, where the S corporation is o\\-ned by a resident of Canada
and has U.S.-source income, profits or gains - the Canadian resident will not be
considered as deriving the income by virtue of subparagraph 7 (a) as Canada does not see
the S corporation as fiscally transparent.
Under both paragraph 6 and paragraph 7, it is re levant whether the treatment of an
amount of income, profit or gain derived by a person through an entity under the tax law
of the residence State is "the same as its treatment would be if that amount had been
deri ved directly." For purposes of paragraphs 6 and 7, whether the treatment of an
amount derived by a person through an entity under the tax law of the residence State is
the same as its treatment would be if that amount had been derived directly by that person
shall be determined in accordance with the principles set forth in Code section 894 and
the regulations under that section concerning whether an entity will be treated as fiscally
transparent with respect to an item of income received by the entity. Treas. Reg. section
1.894-1(d)(3)(iii) provides that an entity will be fiscally transparent under the laws of an
interest holder's jurisdiction with respect to an item of income to the extent that the laws
of that jurisdiction require the interest holder resident in that jurisdiction to separately
take into account on a current basis the interest holder's respective share of the item of
income paid to the entity, whether or not distributed to the interest holder, and the
character and source of the item in the hands of the interest holder are determined as if
such item were realized directly from the source from which realized by the entity.
Although Canada does not have analogous provisions in its domestic law, it is anticipated
that principles comparable to those described above will apply.
Paragraph 6
Under paragraph 6, an amount of income, profit or gain is considered to be
derived by a resident of a Contracting State (residence State) if 1) the amount is derived
by that person through an entity (other than an entity that is a resident of the other
Contracting State (source State), and 2) by reason of that entity being considered fiscally
transparent under the laws of the residence State, the treatment of the amount under the
tax law of the residence State is the same as its treatment would be if that amount had
been derived directly by that person. These two requirements are set forth in
subparagraphs 6(a) and 6(b), respectively.
For example, if a U.S. resident O\\-TIS a French entity that earns Canadian-source
dividends and the entity is considered fiscally transparent under U.S. tax law, the U.S.
resident is considered to derive the Canadian-source dividends for purposes of Article IV
(and thus, the dividends are considered as being "paid to" the resident) because the U.S.
resident is considered under the tax law of the United States to have derived the dividend
through the French entity and, because the entity is treated as fiscally transparent under
U.S. tax law, the treatment of the income under U.S. tax law is the same as its treatment
would be if that amount had been derived directly by the U.S. resident. This result
obtains even if the French entity is viewed differently under the tax laws of Canada or of
France (i. e., the French entity is treated under Canadian law or under French tax law as
not fiscally transparent).
Simila~ly, if a Canadian reside~t derives U ..S.-sou~ce income, profit or gain
throug~ an entIty created under Cana~iIan law that IS conSIdered a partnership for
dna~Ian t~ purposes but a cOIl?oratlOn for U,S'.tax pu.rposes, U.S.-source income, profit
r
or gam denved through such entIty by the CanadIan reSIdent will be considered to be
derived by the Canadian resident in considering the application of the Convention.
4
Application ofparagraph 6 and related treaty provisions by Canada
In determining the entitlement of a resident of the United States to the benefits of
the Convention, Canada shall apply the Convention within its own legal framework.
For example, assume that from the perspective of Canadian law an amount of
income is seen as being paid from a source in Canada to USLLC, an entity that is entirely
owned by U.S. persons and is fiscally transparent for U.S. tax purposes, but that Canada
considers a corporation and, thus, under Canadian law, a taxpayer in its own right. Since
USLLC is not itself taxable in the United States, it is not considered to be a U.S. resident
under the Convention; but for new paragraph 6 Canada would not apply the Convention
in taxing the income.
If new paragraph 6 applies in respect of an amount of income, profit or gain, such
amount is considered as having been derived by one or more U.S. resident shareholders
ofUSLLC, and Canada shall grant benefits of the Convention to the payment to USLLC
and eliminate or reduce Canadian tax as provided in the Convention. The effect of the
rule is to suppress Canadian taxation of USLLC to give effect to the benefits available
under the Convention to the U.S. residents in respect of the particular amount of income,
profit or gain.
However, for Canadian tax purposes, USLLC remains the only "visible" taxpayer
in relation to this amount. In other words, the Canadian tax treatment of this taxpayer
(USLLC) is modified because of the entitlement of its U.S. resident shareholders to
benefits under the Convention, but this does not alter USLLC's status under Canadian
law. Canada does not, for example, treat USLLC as though it did not exist, substituting
the shareholders for it in the role of taxpayer under Canada's system.
Some of the implications of this are as follows. First, Canada will not require the
shareholders of USLLC to file Canadian tax returns in respect of income that benefits
from new paragraph 6. Instead, USLLC itselfwill file a Canadian tax return in which it
will claim the benefit of the paragraph and supply any documentation required to support
the claim. (The Canada Revenue Agency will supply additional practical guidance in this
regard, including instructions for seeking to establish entitlement to Convention benefits
in advance of payment.) Second, as is explained in greater detail below, if the income in
question is business profits, it will be necessary to determine whether the income was
earned through a permanent establishment in Canada. This determination will be based
on the presence and activities in Canada of USLLC itself, not of its shareholders acting in
their own right.
Determination of the existence of a permanent establishment from the business activities
of a fiscally transparent entity
New paragraph 6 applies not only in respect of amounts of dividends, interest and
royalties, but also profit (business income), gains and other income. It may thus be
relevant in cases where a resident of one Contracting State carries on business in the
other State through an entity that has a different characterization in each of the two
Contracting States.
Application of new paragraph 6 and the provisions ofArticle V (Permanent
Establishment) by Canada
Assume, for instance, that a resident of the United States is part owner ofa U.S.
limited liability company (USLLC) that is treated in the United States as a fiscally
5
transparent entity, but in Canada as a corporation. Assume one of the other two
shareholders of USLLC is resident in a country that does not have a tax treaty with
Canada and that the remaining shareholder is resident in a country with which Canada
does have a tax treaty, but that the treaty does not include a provision analogous to
paragraph 6.
Assume further that USLLC carries on business in Canada, but does not do so
through a permanent establishment there. (Note that from the Canadian perspective, the
presence or absence of a permanent establishment is evaluated with respect to USLLC
only, which Canada sees as a potentially taxable entity in its own right.) Regarding
Canada's application of the provisions of the Convention, the portion ofUSLLC's profits
that belongs to the U.S. resident shareholder will not be taxable in Canada, provided that
the U.S. resident meets the Convention's limitation on benefits provisions. Under
paragraph 6, that portion is seen as having been derived by the U.S. resident shareholder,
who is entitled to rely on Article VII (Business Profits). The balance ofUSLLC's profits
will, however, remain taxable in Canada. Since USLLC is not itself resident in the
United States for purposes of the Convention, in respect of that portion of its profits that
is not considered to have been derived by a U.S. resident (or a resident of another country
whose treaty with Canada includes a rule comparable to paragraph 6) it is not relevant
whether or not it has a permanent establishment in Canada.
Another example would be the situation where a USLLC that is wholly owned by
a resident of the U.S. carries on business in Canada through a permanent establishment.
If the USLLC is fiscally transparent for U.S. tax purposes (and therefore, the conditions
for the application of paragraph 6 are satisfied) then the USLLC's profits will be treated
as having been derived by its U.S. resident owner inclusive of all attributes of that
income (e.g., such as having been earned through a permanent establishment). However,
since the USLLC remains the only "visible" taxpayer for Canadian tax purposes, it is the
USLLC, and not the U.S. shareholder, that is subject to tax on the profits that are
attributable to the permanent establishment.
Application of new paragraph 6 and the provisions ofArticle V (Permanent
Establishment) by the United States
It should be noted that in the situation where a person is considered to derive
income through an entity, the United States looks in addition to such person's activities in
order to determine whether he has a permanent establishment. Assume that a Canadian
resident and a resident in a country that does not have a tax treaty with the United States
are owners of CanLP. Assume further that Can LP is an entity that is considered fiscally
transparent for Canadian tax purposes but is not considered fiscally transparent for U.S.
tax purposes, and that CanLP carries on business in the United States. If CanLP carries
on the business through a permanent establishment, that permanent establishment may be
attributed to the partners. Moreover, in determining whether there is a permanent
establishment, the activities of both the entity and its partners will be considered. If
CanLP does not carry on the business through a permanent establishment, the Canadian
resident, who derives income through the partnership, may claim the benefits of Article
VII (Business Profits) of the Convention with respect to such income, assuming that the
income is not othenvise attributable to a permanent establishment of the partner. In any
case, the third country partner cannot claim the benefits of Article VII of the Convention
between the United States and Canada.
6
Paragraph 7
Paragraph 7 addresses situations where an item of income, profit or gain is
considered not to be paid to or derived by a person who is a resident of a Contracting
State. The paragraph is divided into two subparagraphs.
Under subparagraph 7(a), an amount of income, profit or gain is considered not to
be paid to or derived by a person who is a resident of a Contracting State (the residence
State) if(1) the other Contracting State (the source State) views the person as deriving the
amount through an entity that is not a resident of the residence State, and (2) by reason of
the entity not being treated as fiscally transparent under the laws of the residence State,
the treatment of the amount under the tax law of the residence State is not the same as its
treatment would be if that amount had been derived directly by the person.
For example, assume USCo, a company resident in the United States, is a part
owner of CanLP, an entity that is considered fiscally transparent for Canadian tax
purposes, but is not considered fiscally transparent for U.S. tax purposes. CanLP
receives a dividend from a Canadian company in which it owns stock. Under Canadian
tax law USCo is viewed as deriving a Canadian-source dividend through CanLP. For
U.S. tax purposes, CanLP, and not USCo, is viewed as deriving the dividend. Because
the treatment of the dividend under U.S. tax law in this case is not the same as the
treatment under U.S. law if USCo derived the dividend directly, subparagraph 7(a)
provides that US Co will not be considered as having derived the dividend. The result
would be the same if CanLP were a third-country entity that was viewed by the United
States as not fiscally transparent, but was viewed by Canada as fiscally transparent.
Similarly, income from U.S. sources received by an entity organized under the laws of
the United States that is treated for Canadian tax purposes as a corporation and is owned
by shareholders who are residents of Canada is not considered derived by the
shareholders of that U.S. entity even if, under U.S. tax law, the entity is treated as fiscally
transparent.
Subparagraph 7(b) provides that an amount of income, profit or gain is not
considered to be paid to or derived by a person who is a resident of a Contracting State
(the residence State) where the person is considered under the tax law of the other
Contracting State (the source State) to have received the amount from an entity that is a
resident of that other State (the source State), but by reason of the entity being treated as
fiscally transparent under the laws of the Contracting State of which the person is resident
(the residence State), the treatment of such amount under the tax law of that State (the
residence State) is not the same as the treatment would be if that entity were not treated
as fiscally transparent under the laws of that State (the residence State).
That is, under subparagraph 7(b), an amount of income, profit or gain is not
considered to be paid to or derived by a resident of a Contracting State (the residence
State) if: (1) the other Contracting State (the source State) views such person as receiving
the amount from an entity resident in the source State; (2) the entity is viewed as fiscally
transparent under the laws of the residence State; and (3) by reason ofthe entity being
treated as fiscally transparent under the laws of the residence State, the treatment of the
amount received by that person under the tax law of the residence State is not the same as
its treatment would be if the entity were not treated as fiscally transparent under the laws
of the residence State.
For example, assume that USCo, a company resident in the United States is the
sole owner of CanCo, an entity that is considered under Canadian tax law to be a
7
corporation that is resident in Canada but is considered under U.S. tax law to be
disregarded as an entity separate from its owner. Assume further that USCo is
considered under Canadian tax law to have received a dividend from CanCo.
In such a case, Canada, the source State, views USCo as receiving income (i. e., a
dividend) from a corporation that is a resident of Canada (CanCo), CanCo is viewed as
fiscally transparent under the laws of the United States, the residence State, and by reason
of Can Co being disregarded under U.S. tax law, the treatment under U.S. tax law of the
payment is not the same as its treatment would be if the entity were regarded as a
corporation under U.S. tax law. That is, the payment is disregarded for U.S. tax
purposes, whereas if U.S. tax law regarded CanCo as a corporation, the payment would
be treated as a dividend. Therefore, subparagraph 7(b) would apply to provide that the
income is not considered to be paid to or derived by USCo.
The same result obtains if, in the above example, USCo is considered under
Canadian tax law to have received an interest or royalty payment (instead of a dividend)
from CanCo. Under U.S. law, because CanCo is disregarded as an entity separate from
its owner, the payment is disregarded, whereas if CanCo were treated as not fiscally
transparent, the payment would be treated as interest or a royalty, as the case may be.
Therefore, subparagraph 7(b) would apply to provide that such amount is not considered
to be paid to or derived by USCo.
The application of subparagraph 7(b) differs if, in the above example, USCo (as
well as other persons) are owners of CanCo, a Canadian entity that is considered under
Canadian tax law to be a corporation that is resident in Canada but is considered under
U.S. tax law to be a partnership (as opposed to being disregarded). Assume that USCo is
considered under Canadian tax law to have received a dividend from CanCo. Such
payment is viewed under Canadian tax law as a dividend, but under U.S. tax law is
viewed as a partnership distribution. In such a case, Canada views USCo as receiving
income (i.e., a dividend) from an entity that is a resident of Canada (CanCo), CanCo is
viewed as fiscally transparent under the laws of the United States, the residence State,
and by reason of CanCo being treated as a partnership under U.S. tax law, the treatment
under U.S. tax law of the payment (as a partnership distribution) is not the same as the
treatment would be if CanCo were not fiscally transparent under U.S. tax law (as a
dividend). As a result, subparagraph 7(b) would apply to provide that such amount is not
considered paid to or derived by the U.S. resident.
As another example, assume that CanCo, a company resident in Canada, is the
owner of USLP, an entity that is considered under U.S. tax law (by virtue of an election)
to be a corporation resident in the United States, but that is considered under Canadian
tax law to be a branch of CanCo. Assume further that CanCo is considered under U.S.
tax law to have received a dividend from USLP. In this case, the United States views
CanCo as receiving income (i.e., a dividend) from an entity that is resident in the United
States (USLP), but by reason ofUSLP being a branch under Canadian tax law, the
treatment under Canadian tax law of the payment is not the same as its treatment would
be if USLP were a company under Canadian tax law. That is, the payment is treated as a
branch remittance for Canadian tax purposes, whereas if Canadian tax law regarded
USLP as a corporation, the payment would be treated as a dividend. Therefore,
subpa~agraph 7(b) would apply to provide that the .in~ome is not considered to be paid to
or denved by CanCo. The same result would obtam m the case of interest or royalties
paid by CSLP to CanCo.
Paragraphs 6 and 7 apply to detennine whether an amount is considered to be
dcriyed by (or paid to) a person vv·ho is a resident of Canada or the United States. If, as a
8
result of paragraph 7, a person is not considered to have derived or received an amount of
income, profit or gain, that person shall not be entitled to the benefits of the Convention
with respect to such amount. Additionally, for purposes of application of the Convention
by the United States, the treatment of such payments under Code section 894(c) and the
regulations thereunder would not be relevant.
New paragraphs 6 and 7 are not an exception to the saving clause of paragraph 2
of Article XXIX (Miscellaneous Rules). Accordingly, subparagraph 7(b) does not
prevent a Contracting State from taxing an entity that is treated as a resident of that State
under its tax law. For example, if a U.S. partnership with members who are residents of
Canada elects to be taxed as a corporation for U.S. tax purposes, the United States will
tax that partnership on its worldwide income on a net basis, even if Canada views the
partnership as fiscally transparent.
Interaction ofparagraphs 6 and 7 with the determination of" beneficial ownership"
With respect to payments of income, profits or gain arising in a Contracting State
and derived directly by a resident of the other Contracting State (and not through a
fiscally transparent entity), the term "beneficial owner" is defined under the intemallaw
of the country imposing tax (i.e., the source State). Thus, if the payment arising in a
Contracting State is derived by a resident of the other State who under the laws of the
lirst-mentioned State is determined to be a nominee or agent acting on behalf of a person
that is not a resident of that other State, the payment will not be entitled to the benefits of
the Convention. However, payments arising in a Contracting State and derived by a
nominee on behalf of a resident of that other State would be entitled to benefits. These
limitations are confirmed by paragraph 12 of the Commentary to Article 10 of the DECD
Model.
Special rules apply in the case of income, profits or gains derived through a
fiscally transparent entity, as described in new paragraph 6 of Article IV. Residence
State principles determine who derives the income, profits or gains, to assure that the
income, profits or gains for which the source State grants benefits of the Convention will
be taken into account for tax purposes by a resident of the residence State. Source
country principles of beneficial ownership apply to determine whether the person who
derives the income, profits or gains, or another resident of the other Contracting State, is
the beneficial owner of the income, profits or gains. The source State may conclude that
the person who derives the income, profits or gains in the residence State is a mere
nominee, agent, conduit, etc., for a third country resident and deny benefits of the
Convention. If the person who derives the income, profits or gains under paragraph 6 of
Article IV would not be treated under the source State's principles for determining
beneficial ownership as a nominee, agent, custodian, conduit, etc., that person will be
treated as the beneficial owner of the income, profits or gains for purposes of the
Convention.
Assume, for instance, that interest arising in the United States is paid to CanLP,
an entity established in Canada which is treated as fiscally transparent for Canadian tax
purposes but is treated as a company for U.S. tax purposes. CanCo, a company
incorporated in Canada, is the sole interest holder in CanLP. Paragraph 6 of Article IV
provides that CanCo derives the interest. However, if under the laws of the United States
regarding payments to nominees, agents, custodians and conduits, CanCo is found be a
nominee, agent, custodian or conduit for a person who is not a resident of Canada, CanCo
will not be considered the beneficial owner of the interest and will not be entitled to the
benefits of Article XI with respect to such interest. The payment may be entitled to
9
benetits, however. if CanCo is found to be a nominee. agent. custodian or conduit for a
person who is a resident of Canada.
With respect to Canadian-source income. profit or gains, beneficial ownership is
to be determined under Canadian law. For example, assume that LLC, an entity that is
treated as fiscally transparent for U.S. tax purposes, but as a corporation for Canadian tax
purposes, is owned by USCo, a U.S. resident company. LLC receives Canadian-source
income. The question of the beneficial ownership of the income received by LLC is
determined under Canadian law. IfLLC is considered the beneficial owner of the income
under Canadian law, paragraph 6 shall apply to extend benefits of the Convention to the
income received by LLC to the extent that the Canadian-source income is derived by U.S.
resident members ofLLC.
Article 3
Article 3 of the Protocol amends Article V (Permanent Establishment) of the
Convention. Paragraph 1 of Article 3 of the Protocol adds a reference in Paragraph 6 of
Article IV to new paragraph 9 of Article V. Paragraph 2 of Article 3 of the Protocol sets
forth new paragraphs 9 and 10 of Article V.
Paragraph 9 ofArticle V
New paragraph 9 provides a special rule (subject to the provisions of paragraph 3)
for an enterprise of a Contracting State that provides services in the other Contracting
State, but that does not have a permanent establishment by virtue of the preceding
paragraphs of the Article. If (and only if) such an enterprise meets either of two tests as
provided in subparagraphs 9(a) and 9(b), the enterprise will be deemed to provide those
services through a permanent establishment in the other State.
The first test as provided in subparagraph 9(a) has two parts. First, the services
must be performed in the other State by an individual who is present in that other State
for a period or periods aggregating 183 days or more in any twelve-month period.
Second, during that period or periods, more than 50 percent of the gross active business
revenues of the enterprise (including revenue from active business activities unrelated to
the provision of services) must consist of income derived from the services performed in
that State by that individual. If the enterprise meets both of these tests, the enterprise will
be deemed to provide the services through a permanent establishment. This test is
employed to determine whether an enterprise is deemed to have a permanent
establishment by virtue of the presence of a single individual U. e., a natural person).
For the purposes of subparagraph 9(a), the term "gross active business revenues"
shall mean the gross revenues attributable to active business activities that the enterprise
has charged or should charge for its active business activities, regardless of when the
actual billing will occur or of domestic law rules concerning when such revenues should
be taken into account for tax purposes. Such active business activities are not restricted
to the activities related to the provision of services. However, the term does not include
income from passive investment activities.
As an example of the application of subparagraph 9( a), assume that Mr. X, an
Individual resident in ~he U~ited Stat~s, is one of the two. shareholders and employees of
US~o, a company resIde~t m th~ U~lted States that prOVIdes engineering services.
D~r~ng the 12-~~nth peno~ begmnmg DeceI?ber 20 o.fYear 1 and ending December 19
"t "\ ear 2. Mr. X IS present m Canada for penods totalmg 190 days, and during those
10
periods, 70 percent of all of the gross active business revenues of US Co attributable to
business activities are derived from the services that Mr. X performs in Canada. Because
both ofthe criteria of subparagraph 9(a) are satisfied, USCo will be deemed to have a
permanent establishment in Canada by virtue of that subparagraph.
The second test as provided in subparagraph 9(b) provides that an enterprise will
have a permanent establishment if the services are provided in the other State for an
aggregate of 183 days or more in any twelve-month period with respect to the same or
connected projects for customers who either are residents of the other State or maintain a
permanent establishment in the other State with respect to which the services are
provided. The various conditions that have to be satisfied in order for subparagraph 9(b)
to have application are described in detail below.
In addition to meeting the 183-day threshold, the services must be provided for
customers who either are residents of the other State or maintain a permanent
establishment in that State. The intent of this requirement is to reinforce the concept that
unless there is a customer in the other State, such enterprise will not be deemed as
participating sufficiently in the economic life of that other State to warrant being deemed
to have a permanent establishment.
Assume for example, that CanCo, a Canadian company, wishes to acquire USCo,
a company in the United States. In preparation for the acquisition, CanCo hires Canlaw,
a Canadian law firm, to conduct a due diligence evaluation of US Co's legal and financial
standing in the United States. Canlaw sends a staff attorney to the United States to
perform the due diligence analysis of US Co. That attorney is present and working in the
United States for greater than 183 days. If the remuneration paid to Canlaw for the
attorney's services does not constitute more than 50 percent of Canlaw's gross active
business revenues for the period during which the attorney is present in the United States,
Canlaw will not be deemed to provide the services through a permanent establishment in
the United States by virtue of subparagraph 9(a). Additionally, because the services are
being provided for a customer (CanCo) who neither is a resident of the United States nor
maintains a permanent establishment in the United States to which the services are
provided, Canlaw will also not have a permanent establishment in the United States by
virtue of subparagraph 9(b).
Paragraph 9 applies only to the provision of services, and only to services
provided by an enterprise to third parties. Thus, the provision does not have the effect of
deeming an enterprise to have a permanent establishment merely because services are
provided to that enterprise. Paragraph 9 only applies to services that are performed or
provided by an enterprise of a Contracting State within the other Contracting State. It is
therefore not sufficient that the relevant services be merely furnished to a resident of the
other Contracting State. Where, for example, an enterprise provides customer support or
other services by telephone or computer to customers located in the other State, those
would not be covered by paragraph 9 because they are not performed or provided by that
enterprise within the other State. Another example would be that of an architect who is
hired to design blueprints for the construction of a building in the other State. As part of
completing the project, the architect must make site visits to that other State, and his days
of presence there would be counted for purposes of determining whether the 183-day
threshold is satisfied. However, the days that the architect spends working on the
blueprint in his home office shall not count for purposes of the 183-day threshold,
because the architect is not performing or providing those services within the other State.
For purposes of determining whether the time threshold has been met,
subparagraph 9(b) permits the aggregation of services that are provided with respect to
11
connected projects. Paragraph 2 of the General Note provides that for purposes of
subparagraph 9(b). projects shall be considered to be connected if they constitute a
coherent whole. commercially and geographically. The determination of whether
projects are connected should be determined from the point of view of the enterprise (not
that of the customer), and will depend on the facts and circumstances of each case. In
determining the existence of commercial coherence, factors that would be relevant
include: 1) \vhether the projects would, in the absence of tax planning considerations.
have been concluded pursuant to a single contract; 2) whether the nature of the work
involved under different projects is the same; and 3) whether the same individuals are
providing the services under the different projects. Whether the work provided is
covered by one or multiple contracts may be relevant, but not determinative, in finding
that projects are commercially coherent.
The aggregation rule addresses, for example, potentially abusive situations in
which work has been artificially divided into separate components in order to avoid
meeting the 183-day threshold. Assume for example, that a technology consultant has
been hired to install a new computer system for a company in the other country. The
\\ork will take ten months to complete. However, the consultant purports to divide the
work into two five-month projects with the intention of circumventing the rule in
subparagraph 9(b). In such case, even if the two projects were considered separate, they
will be considered to be commercially coherent. Accordingly, subject to the additional
requirement of geographic coherence, the two projects could be considered to be
connected, and could therefore be aggregated for purposes of subparagraph 9(b). In
contrast, assume that the technology consultant is contracted to install a particular
computer system for a company, and is also hired by that same company, pursuant to a
separate contract, to train its employees on the use of another computer software that is
unrelated to the first system. In this second case, even though the contracts are both
concluded between the same two parties, there is no commercial coherence to the two
projects, and the time spent fulfilling the two contracts may not be aggregated for
purposes of subparagraph 9(b). Another example of projects that do not have commercial
coherence would be the case of a law firm which, as one project provides tax advice to a
customer from one portion of its staff, and as another project provides trade advice from
another portion of its staff, both to the same customer.
Additionally, projects, in order to be considered connected, must also constitute a
geographic whole. An example of projects that lack geographic coherence would be a
case in which a consultant is hired to execute separate auditing projects at different
branches of a bank located in different cities pursuant to a single contract. In such an
example. while the consultant's projects are commercially coherent, they are not
geographically coherent and accordingly the services provided in the various branches
shall not be aggregated for purposes of applying subparagraph 9(b). The services
provided in each branch should be considered separately for purposes of subparagraph
9(b).
The method of counting days for purposes of subparagraph 9(a) differs slightly
from the method for subparagraph 9(b). Subparagraph 9(a) refers to days in which an
individual is present in the other country. Accordingly, physical presence during a day is
sutlicient. In contrast. subparagraph 9(b) refers to days during which services are
provided by the enterprise in the other country. Accordingly, non-working days such as
\\eekends or holidays would not count for purposes of subparagraph 9(b), as long as no
services are. actually being provided w~ile in the ot~er country on those days. For the
purposes at both subparagraphs, even If the enterpnse sends many individuals
simultaneously to t~e other c~)Untry to provide services, their collective presence during
l)lle calendar day WIll count tor only one day of the enterprise's presence in the other
12
country. For instance, if an enterprise sends 20 employees to the other country to provide
services to a client in the other country for 10 days, the enterprise will be considered
present in the other country only for 10 days, not 200 days (20 employees x 10 days).
By deeming the enterprise to provide services through a permanent establishment
in the other Contracting State, paragraph 9 allows the application of Article VII (Business
Profits), and accordingly, the taxation of the services shall be on a net-basis. Such
taxation is also limited to the profits attributable to the activities carried on in performing
the relevant services. It will be important to ensure that only the profits properly
attributable to the functions performed and risks assumed by provision of the services
will be attributed to the deemed permanent establishment.
In addition to new paragraph 9, Article 3 of the Protocol amends paragraph 6 of
Article V of the Convention to include a reference to paragraph 9. Therefore, in no case
will paragraph 9 apply to deem services to be provided through a permanent
establishment if the services are limited to those mentioned in paragraph 6 which, if
performed through a fixed place of business, would not make the fixed place of business
a permanent establishment under the provisions of that paragraph.
The competent authorities are encouraged to consider adopting rules to reduce the
potential for excess withholding or estimated tax payments with respect to employee
wages that may result from the application of this paragraph. Further, because paragraph
6 of Article V applies notwithstanding paragraph 9, days spent on preparatory or
auxiliary activities shall not be taken into account for purposes of applying subparagraph
9(b).
Paragraph 10 ofArticle V
Paragraph 2 of Article 3 of the Protocol also sets forth new paragraph 10 of
Article V. The provisions of new paragraph 10 are identical to paragraph 9 of Article V
as it existed prior to the Protocol. New paragraph 10 provides that the provisions of
Article V shall be applied in determining whether any person has a permanent
establishment in any State.
Article 4
Article 4 of the Protocol replaces paragraph 2 of Article VII (Business Profits).
New paragraph 2 provides that where a resident of either Canada or the United
States carries on (or has carried on) business in the other Contracting State through a
permanent establishment in that other State, both Canada and the United States shall
attribute to permanent establishments in their respective states those business profits
which the permanent establishment might be expected to make if it were a distinct and
separate person engaged in the same or similar activities under the same or similar
conditions and dealing wholly independently with the resident and with any other person
related to the resident. The term "related to the resident" is to be interpreted in
accordance with paragraph 2 of Article IX (Related Persons). The reference to other
related persons is intended to make clear that the test of paragraph 2 is not restricted to
independence between a permanent establishment and a home office.
New paragraph 2 is substantially similar to parawaph 2 as it existe~ before the
Protocol. However, in addition to the reference to a reSIdent of a Contractmg State who
"carries on" business in the other Contracting State, the Protocol incorporates into the
Convention the rule of Code section 864(c)( 6) by adding "or has carried on" to address
13
circumstances where. as a result of timing, income may be attributable to a permanent
establishment that no longer exists in one of the Contracting States. In such cases. the
income is properly within the scope of Article VII. Conforming changes are also made in
the Protocol to Articles X (Dividends), XI (Interest), and XII (Royalties) of the
Convention where Article VII would apply. As is explained in paragraph 5 of the
General Note, these revisions to the Convention are only intended to clarify the
application of the existing provisions of the Convention.
The following example illustrates the application of paragraph 2. Assume a
company that is a resident of Canada and that maintains a permanent establishment in the
Urlited States winds up the permanent establishment's business and sells the permanent
establishment's inventory and assets to a U.S. buyer at the end of year 1 in exchange for
an installment obligation payable in full at the end of year 3. Despite the fact that the
company has no permanent establishment in the United States in year 3, the United States
may tax the deferred income payment recognized by the company in year 3.
The "attributable to" concept of paragraph 2 provides an alternative to the
analogous but somewhat different "effectively connected" concept in Code section
864( c). Depending on the circumstances, the amount of income "attributable to" a
permanent establishment under Article VII may be greater or less than the amount of
income that would be treated as "effectively connected" to a U.S. trade or business under
Code section 864. In particular, in the case of financial institutions, the use of internal
dealings to allocate income within an enterprise may produce results under Article VII
that are significantly different than the results under the effectively connected income
rules. For example, income from interbranch notional principal contracts may be taken
into account under Article VII, notwithstanding that such transactions may be ignored for
purposes of U.S. domestic law. A taxpayer may use the treaty to reduce its taxable
income, but may not use both treaty and Code rules where doing so would thwart the
intent of either set of rules. See Rev. Rul. 84-17, 1984-1 C.B. 308.
The profits attributable to a permanent establishment may be from sources within
or without a Contracting State. However, as stated in the General Note, the business
profits attributable to a permanent establishment include only those profits derived from
the assets used, risks assumed, and activities performed by the permanent establishment.
The language of paragraph 2, when combined with paragraph 3 dealing with the
allowance of deductions for expenses incurred for the purposes of earning the profits,
incorporates the arm's length standard for purposes of determining the profits attributable
to a permanent establishment. The United States and Canada generally interpret the
arm's length standard in a manner consistent with the OECD Transfer Pricing Guidelines.
Paragraph 9 of the General Note confirms that the arm's length method of
paragraphs 2 and 3 consists of applying the OECD Transfer Pricing Guidelines, but
taking into account the different ~conomic an~ legal circumstances of a single legal entity
(as opposed to separate but assOCIated enterpnses). Thus, any of the methods used in the
Transfer Pricing Guidelines, including profits methods, may be used as appropriate and in
accordance with the Transfer Pricing Guidelines. However, the use of the Transfer
Pricing Guidelines applies only for purposes of attributing profits within the legal entity.
It does not create legal obligations or other tax consequences that would result from
transaction~ having independent legal significance. Thus, the Contracting States agree
that the notIOnal payments used to compute the profits that are attributable to a permanent
est~blishme.n~ will ~ot be taxed a~ if they were actual payments for purposes of other
taxmg provlSlons ot the ConventIOn, for example, for purposes of taxing a notional
royalty under Article XII (Royalties).
14
One example of the different circumstances of a single legal entity is that an entity
that. operate~ through branches rather than separate subsidiaries generally will have lower
capital.re~U1~e~~n~s bec~use all of the a~sets of ~he entity are available to support all of
the. er:ttlty s habilIties (wIth some exc~ptIons attnbutable to local regulatory restrictions).
ThIs IS the reason that most commerCial banks and some insurance companies operate
through branches rather than subsidiaries. The benefit that comes from such lower
capital costs must be allocated among the branches in an appropriate manner. This issue
does not arise in the case of an enterprise that operates through separate entities, since
each entity will have to be separately capitalized or will have to compensate another
entity for providing capital (usually through a guarantee).
Under U.S. domestic regulations, internal "transactions" generally are not
recognized because they do not have legal significance. In contrast, the rule provided by
the General Note is that such internal dealings may be used to attribute income to a
permanent establishment in cases where the dealings accurately reflect the allocation of
risk within the enterprise. One example is that of global trading in securities. In many
cases, banks use internal swap transactions to transfer risk from one branch to a central
location where traders have the expertise to manage that particular type of risk. Under
paragraph 2 as set forth in the Protocol, such a bank may also use such swap transactions
as a means of attributing income between the branches, if use of that method is the "best
method" within the meaning of regulation section 1.482-1 (c). The books of a branch will
not be respected, however, when the results are inconsistent with a functional analysis.
So, for example, income from a transaction that is booked in a particular branch (or home
office) will not be treated as attributable to that location if the sales and risk management
functions that generate the income are performed in another location.
The understanding in the General Note also affects the interpretation of paragraph
3 of Article VII. Paragraph 3 provides that in determining the business profits of a
permanent establishment, deductions shall be allowed for the expenses incurred for the
purposes of the permanent establishment, ensuring that business profits will be taxed on a
net basis. This rule is not limited to expenses incurred exclusively for the purposes of the
permanent establishment, but includes expenses incurred for the purposes of the
enterprise as a whole, or that part of the enterprise that includes the permanent
establishment. Deductions are to be allowed regardless of which accounting unit of the
enterprise books the expenses, so long as they are incurred for the purposes of the
permanent establishment. For example, a portion of the interest expense recorded on the
books of the home office in one State may be deducted by a permanent establishment in
the other. The amount of the expense that must be allowed as a deduction is determined
by applying the arm's length principle.
As noted above, paragraph 9 of the General Note provides that the OEeD
Transfer Pricing Guidelines apply, by analogy, in determining the profits attributable to a
permanent establishment. Accordingly, a permanent establishment may deduct payments
made to its head office or another branch in compensation for services performed for the
benefit of the branch. The method to be used in calculating that amount will depend on
the terms of the arrangements between the branches and head office. For example, the
enterprise could have a policy, expressed in writing, under which each business unit
could use the services oflawyers employed by the head office. At the end of each year,
the costs of employing the lawyers would be charged to each business unit according to
the amount of services used by that business unit during the year. Since this has the
characteristics of a cost-sharing arrangement and the allocation of costs is based on the
benefits received by each business unit, such a cost allocation would be an acceptable
15
means of determining a permanent establishment's deduction for legal expenses.
Alternatively, the head otlice could agree to employ lawyers at its own risk, and to.
.
charge an arm's length price for legal services performed for a particular business umt. If
the la\\'yers were under-utilized, and the "fees" received from the business units were less
than the cost of employing the lawyers, then the head office would bear the excess cost. If
the "fees" exceeded the cost of employing the lawyers, then the head office would keep
the excess to compensate it for assuming the risk of employing the la\\'yers. If the
enterprise acted in accordance with this agreement, this method would be an acceptable
alternative method for calculating a permanent establishment's deduction for legal
expenses.
The General Note also makes clear that a permanent establishment cannot be
funded entirely with debt, but must have sufficient capital to carry on its activities as if it
were a distinct and separate enterprise. To the extent that the permanent establishment
has not been attributed capital for profit attribution purposes, a Contracting State may
attribute such capital to the permanent establishment, in accordance with the arm's length
principle, and deny an interest deduction to the extent necessary to reflect that capital
attribution. The method prescribed by U.S. domestic law for making this attribution is
found in Treas. Reg. section 1.882-5. Both section 1.882-5 and the method prescribed in
the General Note start from the premise that all of the capital of the enterprise supports all
of the assets and risks of the enterprise, and therefore the entire capital of the enterprise
:: lust be allocated to its various businesses and offices.
However, section 1.882-5 does not take into account the fact that some assets
create more risk for the enterprise than do other assets. An independent enterprise would
need less capital to support a perfectly-hedged U.S. Treasury security than it would need
to support an equity security or other asset with significant market and/or credit risk.
Accordingly, in some cases section 1.882-5 would require a taxpayer to allocate more
capital to the United States, and therefore would reduce the taxpayer's interest deduction
more, than is appropriate. To address these cases, the General Note allows a taxpayer to
apply a more flexible approach that takes into account the relative risk of its assets in the
various jurisdictions in which it does business. In particular, in the case of financial
institutions other than insurance companies, the amount of capital attributable to a
permanent establishment is determined by allocating the institution's total equity between
its various offices on the basis of the proportion of the financial institution's riskweighted assets attributable to each of them. This recognizes the fact that financial
institutions are in many cases required to risk-weight their assets for regulatory purposes
and. in other cases, will do so for business reasons even if not required to do so by
regulators. However, risk-weighting is more complicated than the method prescribed by
section 1.882-5. Accordingly, to ease this administrative burden, taxpayers may choose
to apply the principles of Treas. Reg. section 1.882-5(c) to determine the amount of
capital allocable to its U.S. permanent establishment, in lieu of determining its allocable
capital under the risk-weighted capital allocation method provided by the General Note,
even if it has otherwise chosen the principles of Article VII rather than the effectively
connected income rules of U.S. domestic law. It is understood that this election is not
binding for purposes of Canadian taxation unless the result is in accordance with the
arm's length principle.
As noted.in the Conventio~, nothin~ in paragraph 3 ~equires a Contracting State to
alkm the deductIon of any expendIture whIch, by reason of Its nature, is not generally
allowed as a deduction under the tax laws in that State.
16
Article 5
~icle 5 m~es a number of amendments t~ Article X (Dividends) of the existing
ConventIOn. As wIth other benefits of the ConventIOn, the benefits of Article X are
available to a resident of a Contracting State only if that resident is entitled to those
benefits under the provisions of Article XXIX A (Limitation on Benefits).
See the Technical Explanation for new paragraphs 6 and 7 of Article IV
(Residence) for discussion regarding the interaction between domestic law concepts of
beneficial ownership and the treaty rules to determine when a person is considered to
derive an item of income for purposes of obtaining benefits of the Convention such as
withholding rate reductions.
Paragraph 1
Paragraph 1 of Article 5 of the Protocol replaces subparagraph 2(a) of Article X
of the Convention. In general, paragraph 2 limits the amount of tax that may be imposed
on dividends by the Contracting State in which the company paying the dividends is
resident if the beneficial owner of the dividends is a resident of the other Contracting
State. Subparagraph 2(a) limits the rate to 5 percent of the gross amount of the dividends
if the beneficial owner is a company that owns 10 percent or more of the voting stock of
the company paying the dividends.
The Protocol adds a parenthetical to address the determination ofthe requisite
ownership set forth in subparagraph 2(a) when the beneficial owner of dividends receives
the dividends through an entity that is considered fiscally transparent in the beneficial
owner's Contracting State. The added parenthetical stipulates that voting stock in a
company paying the dividends that is indirectly held through an entity that is considered
fiscally transparent in the beneficial owner's Contracting State is taken into account,
provided the entity is not a resident of the other Contracting State. The United States
views the new parenthetical as merely a clarification.
For example, assume USCo, a U.S. corporation, directly owns 2 percent of the
voting stock of CanCo, a Canadian company that is considered a corporation in the
United States and Canada. Further, assume that USCo owns 18 percent of the interests in
LLC, an entity that in turn owns 50 percent of the voting stock of CanCo. CanCo pays a
dividend to each of its shareholders. Provided that LLC is fiscally transparent in the
United States and not considered a resident of Canada, USCo's 9 percent ownership in
CanCo through LLC (50 percent x 18 percent) is taken into account in determining
whether USCo meets the 10 percent ownership threshold set forth in subparagraph 2(a).
In this example, USCo may aggregate its voting stock interests in CanCo that it owns
directly and through LLC to determine if it satisfies the ownership requirement of
subparagraph 2(a). Accordingly, USCo will be entitled to the 5 percent rate of
withholding on dividends paid with respect to both its voting stock held through LLC and
its voting stock held directly. Alternatively, if, for example, all of the shareholders of
LLC were natural persons, the 5 percent rate would not apply.
Paragraph 2
Paragraph 2 of Article 5 of the Protocol replaces the definition of the term
"dividends" provided in paragraph 3 of Article X of the Convention. The new definition
conforms to the U.S. Model formulation. Paragraph 3 defines the term dividends broadly
and flexibly. The definition is intended to cover all arrangements that yield a return on
17
an equity investment in a corporation as detennined under the tax law of the source State,
as well as arrangements that might be developed in the future.
The tenn dividends includes income from shares, or other corporate rights that are
not treated as debt under the law of the source State, that participate in the profits of the
company. The tenn also includes income that is subjected to the same tax treatment as
income from shares by the law of the source State. Thus, for example, a constructive
dividend that results from a non-ann's length transaction between a corporation and a
related party is a dividend. In the case of the United States the term "dividend" includes
amounts treated as a dividend under U.S. law upon the sale or redemption of shares or
upon a transfer of shares in a reorganization. See, e.g., Rev. Rul. 92-85, 1992-2 C.B. 69
(sale of foreign subsidiary's stock to U.S. sister company is a deemed dividend to extent
of the subsidiary's and sister company's earnings and profits). Further, a distribution from
a U.S. publicly traded limited partnership that is taxed as a corporation under U.S. law is
a dividend for purposes of Article X. However, a distribution by a limited liability
company is not considered by the United States to be a dividend for purposes of Article
X, provided the limited liability company is not characterized as an association taxable as
a rorporation under U.S. law.
Paragraph 3 of the General Note states that distributions from Canadian income
trusts and royalty trusts that are treated as dividends as a result of changes to Canada's
taxation of income and royalty trusts enacted in 2007 (S.c. 2007, c. 29) shall be treated as
dividends for the purposes of Article X.
Additionally, a payment denominated as interest that is made by a thinly
capitalized corporation may be treated as a dividend to the extent that the debt is
recharacterized as equity under the laws of the source State. At the time the Protocol was
signed, interest payments subject to Canada's thin-capitalization rules were not
recharacterized as dividends.
Puragraph 3
Paragraph 3 of Article 5 of the Protocol replaces paragraph 4 of Article X. New
paragraph 4 is substantially similar to paragraph 4 as it existed prior to the Protocol. New
paragraph 4, however, adds clarifying language consistent with the changes made in
Articles 4, 6, and 7 of the Protocol with respect to income attributable to a pennanent
establishment that has ceased to exist. Paragraph 4 provides that the limitations of
paragraph 2 do not apply if the beneficial owner of the dividends carries on or has carried
on business in the State in which the company paying the dividends is a resident through
a pennanent establishment situated there, and the stockholding in respect of which the
dividends are paid is effectively connected to such pennanent establishment. In such a
case, the dividends are taxable pursuant to the provisions of Article VII (Business
Profits). Thus, dividends paid in respect of holdings fonning part of the assets of a
penn~ent estab~ishment or which are o~her~ise effectively connected to such pennanent
esta~hshment w~ll be taxed on a ne~ basI~ usmg the rates and rules of taxation generally
apphcable to reSIdents of the State m WhICh the pennanent establishment is situated.
To confonn with Article 9 of the Protocol, which deletes Article XIV
(1", ·~r'cndent Personal Services) of the Convention, paragraph 4 of Article 5 ofthe
Protocol also amends paragraph 5 of Article X by omitting the reference to a "fixed
base."
18
Paragraph 4
To conform with Article 9 of the Protocol, which deletes Article XIV
(Independent Personal Services) of the Convention, paragraph 4 of Article 5 of the
Protocol amends paragraph 5 of Article X by omitting the reference to a "fixed base."
Paragraph 5
Paragraph 5 of Article 5 of the Protocol replaces subparagraph 7( c) of Article X
of the existing Convention. Consistent with current U.S. tax treaty policy, new
subparagraph 7( c) provides rules that expand the application of subparagraph 2(b) for the
treatment of dividends paid by a Real Estate Investment Trust (REIT). New
subparagraph 7( c) maintains the rule of the existing Convention that dividends paid by a
REIT are not eligible for the 5 percent maximum rate of withholding tax of subparagraph
2(a), and provides that the 15 percent maximum rate of withholding tax of subparagraph
2(b) applies to dividends paid by REITs only if one of three conditions is met.
First, the dividend will qualify for the 15 percent maximum rate if the beneficial
owner of the dividend is an individual holding an interest of not more than 10 percent in
the REIT. For this purpose, subparagraph 7(c) also provides that where an estate or
testamentary trust acquired its interest in a REIT as a consequence of the death of an
individual, the estate or trust will be treated as an individual for the five-year period
following the death. Thus, dividends paid to an estate or testamentary trust in respect of a
holding of less than a 10 percent interest in the REIT also will be entitled to the 15
percent rate of withholding, but only for up to five years after the death.
Second, the dividend will qualify for the 15 percent maximum rate if it is paid
with respect to a class of stock that is publicly traded and the beneficial owner of the
dividend is a person holding an interest of not more than 5 percent of any class of the
REIT's stock.
Third, the dividend will qualify for the 15 percent maximum rate if the beneficial
owner of the dividend holds an interest in the REIT of 10 percent or less and the REIT is
"diversified." A REIT is diversified if the gross value of no single interest in real
property held by the REIT exceeds 10 percent of the gross value ofthe REIT's total
interest in real property. For purposes of this diversification test, foreclosure property is
not considered an interest in real property, and a REIT holding a partnership interest is
treated as owning its proportionate share of any interest in real property held by the
partnership.
A resident of Canada directly holding U.S. real property would pay U.S. tax either
at a 30 percent rate of withholding tax on the gross income or at graduated rates on the
net income. By placing the real property in a REIT, the investor absent a special rule
could transform real estate income into dividend income, taxable at the rates provided in
Article X, significantly reducing the U.S. tax that otherwise would be imposed.
Subparagraph 7( c) prevents this result and thereby avoids a disparity between the taxation
of direct real estate investments and real estate investments made through REIT conduits.
In the cases in which subparagraph 7( c) allows a dividend from a REIT to be eligible for
the 15 percent maximum rate of withholding tax, the holding in the REIT is not
considered the equivalent of a direct holding in the underlying real property.
19
Article 6
Article 6 of the Protocol replaces Article XI (Interest) of the existing Convention.
Article XI specifies the taxing jurisdictions over interest income of the States of source
and residence and defines the terms necessary to apply Article XI. As with other benefits
of the Convention, the benefits of Article XI are available to a resident of a Contracting
State only if that resident is entitled to those benefits under the provisions of Article
XXIX A (Limitation on Benefits).
Paragraph 1 ofArticle XI
New paragraph 1 generally grants to the residence State the exclusive right to tax
interest beneficially owned by its residents and arising in the other Contracting State. See
the Technical Explanation for new paragraphs 6 and 7 of Article IV (Residence) for
discussion regarding the interaction between domestic law concepts of beneficial
ownership and the treaty rules to determine when a person is considered to derive an item
of income for purposes of obtaining benefits under the Convention such as withholding
rate reductions.
Subparagraph 3(d) of Article 27 of the Protocol provides an additional rule
regarding the application of paragraph 1 during the first two years that end after the
Protocol's entry into force. This rule is described in detail in the Technical Explanation
to Article 27.
Paragraph 2 ofArticle XI
Paragraph 2 of new Article XI is substantially identical to paragraph 4 of Article
XI of the existing Convention.
Paragraph 2 defines the term "interest" as used in Article XI to include, inter alia,
income from debt claims of every kind, whether or not secured by a mortgage. Interest
that is paid or accrued subject to a contingency is within the ambit of Article XI. This
includes income from a debt obligation carrying the right to participate in profits. The
term does not, however, include amounts that are treated as dividends under Article X
(Dividends).
The term "interest" also includes amounts subject to the same tax treatment as
income from money lent under the law of the State in which the income arises. Thus, for
purposes of the Convention, amounts that the United States will treat as interest include
(i) the difference between the issue price and the stated redemption price at maturity of a
debt instrument (i.e., original issue discount (010)), which may be wholly or partially
realized on the disposition ofa debt instrument (section 1273), (ii) amounts that are
imputed interest on a deferred sales contract (section 483), (iii) amounts treated as
interest or 010 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 ofa partnership'S interest income (section 702), (vi) the
interest portion of periodic payments made under a "finance lease" or similar contractual
arrangement that in substance is a borrowing by the nominal lessee to finance the
acquisition of property, (vii) amounts included in the income of a holder of a residual
interest in a real estate mortgag~ investment conduit (REMIC) (section 860E), because
these amounts generally are subject to the same taxation treatment as interest under U.S.
tax law. and (viii) interest with respect to notional principal contracts that are recharacterized as loans because of a "substantial non-periodic payment."
20
Paragraph 3 ofArticle XI
Paragraph 3 is in all material respects the same as paragraph 5 of Article XI of the
existing Conveption .. New paragraph 3 adds clarifying language consistent with the
changes made In ArtIcles 4,5, and 7 of the Protocol with respect to income attributable to
a peTI?ane~t est~blishment that has cea~ed to exist. Also, consistent with the changes
descnbed In Artlcle 9 of the Protocol, dIscussed below, paragraph 3 does not contain
references to the performance of independent personal services through a fixed base.
Paragraph 3 provides an exception to the exclusive residence taxation rule of
paragraph 1 in cases where the beneficial owner of the interest carries on business
through a permanent establishment in the State of source and the interest is effectively
connected to that permanent establishment. In such cases the provisions of Article VII
(Business Profits) will apply and the source State will retain the right to impose tax on
such interest income.
Paragraph 4 ofArticle XI
Paragraph 4 is in all material respects the same as paragraph 6 of Article XI of the
existing Convention. The only difference is that, consistent with the changes described
below with respect to Article 9 of the Protocol, paragraph 4 does not contain references to
a fixed base.
Paragraph 4 establishes the source of interest for purposes of Article XI. Interest
is considered to arise in a Contracting State if the payer is that State, or a political
subdivision, local authority, or resident of that State. However, in cases where the person
paying the interest, whether a resident of a Contracting State or of a third State, has in a
State other than that of which he is a resident a permanent establishment in connection
with which the indebtedness on which the interest was paid was incurred, and such
interest is borne by the permanent establishment, then such interest is deemed to arise in
the State in which the permanent establishment is situated and not in the State of the
payer's residence. Furthermore, pursuant to paragraphs 1 and 4, and Article XXII (Other
Income), Canadian tax will not be imposed on interest paid to a U.S. resident by a
company resident in Canada if the indebtedness is incurred in connection with, and the
interest is borne by, a permanent establishment of the company situated in a third State.
For the purposes of this Article, "borne by" means allowable as a deduction in computing
taxable income.
Paragraph 5 ofArticle XI
Paragraph 5 is identical to paragraph 7 of Article XI of the existing Convention.
Paragraph 5 provides that in cases involving special relationships between the
payer and the beneficial owner of interest income or between both of them and some
other person, Article XI applies only to that portion of the total interest payments that
would have been made absent such special relationships (i.e., an arm's-length interest
payment). Any excess amount of interest paid remains taxable according to the laws of
the United States and Canada, respectively, with due regard to the other provisions of the
Convention.
21
Paragraph 6 o(Artic!e XI
New paragraph 6 provides anti-abuse exceptions to exclusive residence State
taxation in paragraph I for two classes of interest payments.
The tirst class of interest dealt with in subparagraphs 6(a) and 6(b), is so-called
"contingent interest." With respect to interest arising in the United States, subparagraph
6(a) refers to contingent interest of a type that does not qualifY as portfolio interest under
U.S. domestic law. The cross-reference to the U.S. definition of contingent interest,
which is found in Code section 871(h)(4), is intended to ensure that the exceptions of
Code section 871(h)(4)(C) will apply. With respect to Canada, such interest is detined in
subparagraph 6(b) as any interest arising in Canada that is determined by reference to the
receipts, sales, income, profits or other cash tlow of the debtor or a related person, to any
change in the value of any property of the debtor or a related person or to any dividend,
l
partnership distribution or similar payment made by the debtor or a related person. Any
such interest may be taxed in Canada according to the laws of Canada.
Under subparagraph 6(a) or 6(b), if the beneficial owner is a resident of the other
Contracting State, the gross amount of the "contingent interest" may be taxed at a rate not
exceeding 15 percent.
The second class of interest is dealt with in subparagraph 6( c). This exception is
consistent with the policy of Code sections 860E( e) and 860G(b) that excess inclusions
with respect to a real estate mortgage investment conduit (REMIC) should bear full U.S.
tax in all cases. Without a full tax at source, foreign purchasers of residual interests
would have a competitive advantage over U.S. purchasers at the time these interests are
initially offered. Also, absent this rule, the U.S. fisc would sutTer a revenue loss with
respect to mortgages held in a REMIC because of opportunities for tax avoidance created
by differences in the timing of taxable and economic income produced by these interests.
Therefore, subparagraph 6(c) provides a bilateral provision that interest that is an
excess inclusion with respect to a residual interest in a REMIC may be taxed by each
State in accordance with its domestic law. While the provision is written reciprocally, at
the time the Protocol was signed, the provision had no application in respect of Canadiansource interest, as Canada did not have REMICs.
Paragraph 7 ofArticle XI
Paragraph 7 is in all material respects the same as paragraph 8 of Article XI of the
existing Convention. The only difference is that, consistent with the changes made in
Article 9 of the Protocol, paragraph 7 removes the references to a fixed base.
Paragraph 7 restricts the right of a Contracting State to impose tax on interest paid
by a resident of the other Contracting State. The first State may not impose any tax on
such interest except insofar as the interest is paid to a resident of that State or arises in
that State or the debt claim in respect of which the interest is paid is effectively connected
with a permanent establishment situated in that State.
I
New subparagraph 6(b) of Article XI erroneously refers to a "similar payment made by the debtor to a
related person." The correct formulation, which the Contracting States agree to apply, is "similar payment
made b) the debtor or a related person."
22
Relationship to other Articles
Notwithstanding the foregoing limitations on source State taxation of interest, the
saving clause of paragraph 2 of Article XXIX (Miscellaneous Rules) permits the United
States to tax its residents and citizens, subject to the special foreign tax credit rules of
paragraph 5 of Article XXIV (Elimination of Double Taxation), as if the Convention had
not come into force.
Article 7
Article 7 of the Protocol amends Article XII (Royalties) of the existing
Convention. As with other benefits of the Convention, the benefits of Article XII are
available to a resident of a Contracting State only if that resident is entitled to those
benefits under the provisions of Article XXIX A (Limitation on Benefits).
See the Technical Explanation for new paragraphs 6 and 7 of Article IV
(Residence) for discussion regarding the interaction between domestic law concepts of
beneficial ownership and the treaty rules to determine when a person is considered to
derive an item of income for purposes of obtaining benefits of the Convention such as
withholding rate reductions.
Paragraph 1
Paragraph 1 of Article 7 of the Protocol replaces paragraph 5 of Article XII of the
Convention. In all material respects, new paragraph 5 is the same as paragraph 5 of
Article XII ofthe existing Convention. However, new paragraph 5 adds clarifying
language consistent with the changes made in Articles 4,5, and 6 of the Protocol with
respect to income attributable to a permanent establishment that has ceased to exist. To
conform with Article 9 of the Protocol, which deletes Article XIV (Independent Personal
Services) of the Convention, paragraph 1 of Article 7 of the Protocol also amends
paragraph 5 of Article XII by omitting the reference to a "fixed base."
New paragraph 5 provides that the 10 percent limitation on tax in the source State
provided by paragraph 2, and the exemption in the source State for certain royalties
provided by paragraph 3, do not apply if the beneficial owner of the royalties carries on
or has carried on business in the source State through a permanent establishment and the
right or property in respect of which the royalties are paid is attributable to such
permanent establishment. In such case, the royalty income would be taxable by the
source State under the provisions of Article VII (Business Profits).
Paragraph 2
Paragraph 2 of Article 7 of the Protocol sets forth a new subparagraph 6(a) of
Article XII that is in all material respects the same as subparagraph 6(a) of Article XII of
the existing Convention. The only difference is that, consistent with the changes made in
Article 9 ofthe Protocol, new subparagraph 6(a) omits references to a "fixed base."
Paragraph 3
Paragraph 3 of Article 7 of Protocol amends paragraph 8 of Article XII of the
Convention to remove references to a "fixed base." In addition, paragraph 8 of the
General Note confirms the intent of the Contracting States that the reference in
"'1bparagraph 3(c) of Article XII of the Convention ~o inf0rn.tation provided in connect~on
with a franchise agreement generally refers only to mformatIon that governs or otherwIse
23
deals with the operation (whether by the payer or by another person) of the franchise. a~d
not to other information concerning industriaL commercial or scientitic experience that IS
held for resale or license.
Article 8
Paragraph 1
Paragraph 1 of Article 8 of the Protocol replaces paragraph 2 of Article XIII
(Gains) of the existing Convention. Consistent with Article 9 of the Protocol, new
paragraph 2 does not contain any reference to property pertaining to a fixed base or to the
performance of independent personal services.
New paragraph 2 of Article XIII provides that the Contracting State in which a
resident of the other Contracting State has or had a permanent establishment may tax
gains from the alienation of personal property constituting business property if such gains
are attributable to such permanent establishment. Unlike paragraph I of Article VII
(Business Profits), paragraph 2 limits the right of the source State to tax such gains to a
twelve-month period following the termination of the permanent establishment.
Paragraph 2
Paragraph 2 of Article 8 of the Protocol replaces paragraph 5 of Article XIII of
the existing Convention. In general, new paragraph 5 provides an exception to the
general rule stated in paragraph 4 that gains from the alienation of any property, other
than property referred to in paragraphs 1,2, and 3, shall be taxable only in the
Contracting State of which the alienator is a resident. Paragraph 5 provides that a
Contracting State may, according to its domestic law, impose tax on gains derived by an
individual who is a resident of the other Contracting State if such individual was a
resident of the tirst-mentioned State for 120 months (whether or not consecutive) during
any period of 20 consecutive years preceding the alienation of the property, and was a
resident of that State at any time during the la-year period immediately preceding the
alienation of the property. Further, the property (or property received in substitution in a
tax-free transaction in the first-mentioned State) must have been owned by the individual
at the time he ceased to be a resident of the first-mentioned State and must not have been
property that the individual was treated as having alienated by reason of ceasing to be a
resident of the first-mentioned State and becoming a resident of the other Contracting
State.
The provisions of new paragraph 5 are substantially similar to paragraph 5 of
Article XIII of the existing Convention. However, the Protocol adds a new requirement
to paragraph 5 that the property not be "a property that the individual was treated as
having alienated by reason of ceasing to be a resident of the first-mentioned State and
becoming a resident of the other Contracting State." This new requirement reflects the
fact that the main purpose of paragraph 5 - ensuring that gains that accrue while an
individual is resident in a Contracting State remain taxable for the stated time after the
individual has moved to the other State - is met if that pre-departure gain is taxed in the
first State immediately before the individual's emigration. This rule applies whether or
not the individual makes the election provided by paragraph 7 of Article XIII as
amended. which is described below.
'
Paragraph 3
Paragraph 3 of Article 8 of the Protocol replaces paragraph 7 of Article XIII.
24
The purpose of paragraph 7, in both its former and revised form, is to provide a
rule to coordinate U.S. and Canadian taxation of gains in the case of a timing mismatch.
Such a mismatch may occur, for example, where a Canadian resident is deemed, for
Canadian tax purposes, to recognize capital gain upon emigrating from Canada to the
United States, or in the case of a gift that Canada deems to be an income producing event
for its tax purposes but with respect to which the United States defers taxation while
assigning the donor's basis to the donee. The former paragraph 7 resolved the timing
mismatch of taxable events by allowing the individual to elect to be liable to tax in the
deferring Contracting State as ifhe had sold and repurchased the property for an amount
equal to its fair market value at a time immediately prior to the deemed alienation.
The election under fonner paragraph 7 was not available to certain non-U.S.
citizens subject to tax in Canada by virtue of a deemed alienation because such
individuals could not elect to be liable to tax in the United States. To address this
problem, the Protocol replaces the election provided in former paragraph 7, with an
election by the taxpayer to be treated by a Contracting State as having sold and
repurchased the property for its fair market value immediately before the taxable event in
the other Contracting State. The election in new paragraph 7 therefore will be available
to any individual who emigrates from Canada to the United States, without regard to
whether the person is a U.S. citizen immediately before ceasing to be a resident of
Canada. If the individual is not subject to U.S. tax at that time, the effect of the election
will be to give the individual an adjusted basis for U.S. tax purposes equal to the fair
market value of the property as of the date of the deemed alienation in Canada, with the
result that only post-emigration gain will be subject to U.S. tax when there is an actual
alienation. If the Canadian resident is also a U.S. citizen at the time of his emigration
from Canada, then the provisions of new paragraph 7 would allow the U.S. citizen to
accelerate the tax under U.S. tax law and allow tax credits to be used to avoid double
taxation. This would also be the case if the person, while not a U.S. citizen, would
otherwise be subject to taxation in the United States on a disposition of the property.
In the case of Canadian taxation of appreciated property given as a gift, absent
paragraph 7, the donor could be subject to tax in Canada upon making the gift, and the
donee may be subject to tax in the United States upon a later disposition of the property
on all or a portion of the same gain in the property without the availability of any foreign
tax credit for the tax paid to Canada. Under new paragraph 7, the election will be
available to any individual who pays taxes in Canada on a gain arising from the
individual's gifting of a property, without regard to whether the person is a U.S. taxpayer
at the time of the gift. The effect of the election in such case will be to give the donee an
adjusted basis for U.S. tax purposes equal to the fair market value as of the date of the
gift. If the donor is a U.S. taxpayer, the effect of the election will be the realization of
gain or loss for U.S. purposes immediately before the gift. The acceleration of the U.S.
tax liability by reason of the election in such case enables the donor to utilize foreign tax
credits and avoid double taxation with respect to the disposition of the property.
Generally, the rule does not apply in the case of death. Note, however, that
Article XXIX B (Taxes Imposed by Reason of Death) of the Convention provides rules
that coordinate the income tax that Canada imposes by reason of death with the U.S.
estate tax.
If in one Contracting State there are losses and gains from deemed alienations of
different properties, then paragraph 7 must be applied consistently in the o~her
Contracting State within the taxable peri~d wi~h respect to all su~h prope~les. Parawaph
7 only applies, however, if the deemed ahenatlOns of the propertIes result m a net gam.
25
Taxpayers may make the election provided by new paragraph 7 only with respect
to property that is subject to a Contracting State's deemed disposition rules and with
respect to which gain on a deemed alienation is recognized for that Contracting State's
tax purposes in the taxable year of the deemed alienation. At the time the Protocol was
signed, the following were the main types of property that were excluded from the
deemed disposition rules in the case of individuals (including trusts) who cease to be
residents of Canada: real property situated in Canada; interests and rights in respect of
pensions; life insurance policies (other than segregated fund (investment) policies); rights
in respect of annuities; interests in testamentary trusts, unless acquired for consideration;
employee stock options; property used in a business carried on through a permanent
establishment in Canada (including intangibles and inventory); interests in most Canadian
personal trusts; Canadian resource property; and timber resource property.
Paragraph 4
Consistent with the provisions of Article 9 of the Protocol, paragraph 4 of Article
8 of the Protocol amends subparagraph 9(c) of Article XIII of the existing Convention to
remove the words "or pertained to a fixed base."
Relationship to other Articles
The changes to Article XIII set forth in paragraph 3 were announced in a press
release issued by the Treasury Department on September 18, 2000. Consistent with that
press release, subparagraph 3( e) of Article 27 of the Protocol provides that the changes,
jointly effectuated by paragraphs 2 and 3, will be generally effective for alienations of
pldperty that occur after September 17,2000.
Article 9
To conform with the current U.S. and OECD Model Conventions, Article 9 of the
Protocol deletes Article XIV (Independent Personal Services) of the Convention. The
subsequent articles of the Convention are not renumbered. Paragraph 4 of the General
Note elaborates that current tax treaty practice omits separate articles for independent
personal services because a determination of the existence of a fixed base is qualitatively
the same as the determination of the existence of a permanent establishment.
Accordingly, the taxation of income from independent personal services is adequately
governed by the provisions of Articles V (Permanent Establishment) and VII (Business
Profits).
Article 10
Article 10 of the Protocol renames Article XV of the Convention as "Income from
Employment" to conform with the current U.S. and OECD Model Conventions, and
replaces paragraphs 1 and 2 of that renamed article consistent with the OECD Model
Convention.
Paragraph 1
New par~graph.l of Article ;<.V provides that, i.n general, salaries, wages, and
other remuneratIon denved b~ a resIdent of a Contractmg State in respect of an
employment are taxable only m that State unless the employment is exercised in the other
Contracting State. If the employment is exercised in the other Contracting State, the
26
entire remuneration derived therefrom may be taxed in that other State, subject to the
provisions of paragraph 2.
New paragraph 1 of Article XV does not contain a reference to "similar"
remunerati?n. This change was. inten~ed to clarify that Article XV applies to any form of
compensatIon for employment, mcludmg payments in kind. This interpretation is
consistent with paragraph 2.1 of the Commentary to Article 15 (Income from
Employment) of the OECD Model and the Technical Explanation of the 2006 U.S.
Model.
Paragraph 2
New paragraph 2 of Article XV provides two limitations on the right of a source
State to tax remuneration for services rendered in that State. New paragraph 2 is divided
into two subparagraphs that each sets forth a rule which, notwithstanding any contrary
result due to the application of paragraph 1 of Article XV, prevents the source State from
taxing income from employment in that State.
First, subparagraph 2(a) provides a safe harbor rule that the remuneration may not
be taxed in the source State if such remuneration is $10,000 or less in the currency of the
source State. This rule is identical to the rule in subparagraph 2(a) of Article XV of the
existing Convention. It is understood that, consistent with the prior rule, the safe harbor
will apply on a calendar-year basis.
Second, if the remuneration is not exempt from tax in the source State by virtue of
subparagraph 2(a), subparagraph 2(b) provides an additional rule that the source State
may not tax remuneration for services rendered in that State if the recipient is present in
the source State for a period (or periods) that does not exceed in the aggregate 183 days
in any twelve-month period commencing or ending in the fiscal year concerned, and the
remuneration is not paid by or on behalf of a person who is a resident of that other State
or borne by a permanent establishment in that other State. For purposes of this article,
"borne by" means allowable as a deduction in computing taxable income.
Assume, for example, that Mr. X, an individual resident in Canada, is an
employee of the Canadian permanent establishment of US Co, a U.S. company. Mr. X is
sent to the United States to perform services and is present in the United States for less
than 183 days. Mr. X receives more than $10,000 (U.S.) in the calendar year(s) in
question. The remuneration paid to Mr. X for such services is not exempt from U.S. tax
under paragraph 1, because his employer, USCo, is a resident of the United States and
pays his remuneration. If instead Mr. X received less than $10,000 (U.S.), such earnings
would be exempt from tax in the United States, because in all cases where an employee
earns less than $10,000 in the currency of the source State, such earnings are exempt
from tax in the source State.
As another example, assume Ms. Y, an individual resident in the United States is
employed by USCo, a U.S. company. Ms. Y is sent to Canada to provide services in the
Canadian permanent establishment of USCo. Ms. Y is present in Canada for less than
183 days. Ms. Y receives more than $10,000 (Canadian) in the calendar year(s) in
question. USCo charges the Canadian permanent establishment for Ms. V's
remuneration, which the permanent establishment takes as a deduction in computing its
taxable income. The remuneration paid to Ms. Y for such services is not exempt from
Canadian tax under paragraph 1, because her remuneration is borne by the Canadian
f'':'rmanent establishment.
27
New subparagraph 2( b) reters to remuneration that is paid by or on behalf of a
"person" v-;ho is a resident of the other Contracting State. as opposed to an "employer."
This change is intended only to clarify that both the United States and Canada understand
that in certain abusive cases. substance over tonn principles may be applied to
recharacterize an employment relationship. as prescribed in paragraph 8 of the
Commentary to Article 15 (Income from Employment) of the OECD Model.
Subparagraph 2(b) is intended to have the same meaning as the analogous provisions in
the U.S. and OECD Models.
Paragraph 6 of the General Note
Paragraph 6 of the General Note contains special rules regarding employee stock
options. There are no similar rules in the U.S. Model or the OECD Model, although the
issue is discussed in detail in paragraph 12 of the Commentary to Article 15 (Income
from Employment) of the OECD Model.
The General Note sets forth principles that apply for purposes of applying Article
XV and Article XXIV (Elimination of Double Taxation) to income of an individual in
connection with the exercise or other disposal (including a deemed exercise or disposal)
of an option that was granted to the individual as an employee of a corporation or mutual
f'lI1d trust to acquire shares or units ("securities") of the employer in respect of services
t't~ndered or to be rendered by such individual, or in connection with the disposal
(including a deemed disposal) of a security acquired under such an option. For this
purpose, the tenn "employer" is considered to include any entity related to the service
recipient. The reference to a disposal (or deemed disposal) reflects the fact that under
Canadian law and under certain provisions of U.S. law, income or gain attributable to the
granting or exercising of the option may, in some cases, not be recognized until
disposition of the securities.
Subparagraph 6(a) of the General Note provides a specific rule to address
situations where, under the domestic law of the Contracting States, an employee would
be taxable by both Contracting States in respect of the income in connection with the
exercise or disposal of the option. The rule provides an allocation of taxing rights where
(1 ) an employee has been granted a stock option in the course of employment in one of
the Contracting States, and (2) his principal place of employment has been situated in one
or both of the Contracting States during the period between grant and exercise (or
disposal) of the option. In this situation, each Contracting State may tax as Contracting
State of source only that proportion of the income that relates to the period or periods
between the grant and the exercise (or disposal) of the option during which the
individual's principal place of employment was situated in that Contracting State. The
proportion attributable to a Contracting State is detennined by multiplying the income by
a fraction. the numerator of which is the number of days between the grant and exercise
(or disposal) of the option during which the employee's principal place of employment
was situated in that Contracting State and the denominator of which is the total number of
days between grant and exercise (or disposal) of the option that the employee was
employed by the employer.
If the individual is a resident of one of the Contracting States at the time he
exercises the option. that Contracting State will have the right, as the State of residence
to tax all of the income under the first sentence of paragraph 1 of Article XV. Howeve;
to the extent that the employee renders his employment in the other Contracting State f~r
some period of time between the date of the grant of the option and the date of the
exercise (or disposal) of the option. the proportion of the income that is allocated to the
otl r Contracting State under subparagraph 6(a) of the General Note will, subject to
28
par~graph 2, be taxable by.that other ~tate under the second sentence of paragraph 1 of
Article XV of the ConventlOn. For this purpose, the tests of paragraph 2 of Article XV
are applied to the year or years in which the relevant services were performed in the other
Contracting State (and not to the year in which the option is exercised or disposed). To
the extent the same income is subject to taxation in both Contracting States after
application of Article XV, double taxation will be alleviated under the rules of Article
XXIV (Elimination of Double Taxation).
Subparagraph 6(b) of the General Note provides that notwithstanding
subparagraph 6(a), if the competent authorities of both Contracting States agree that the
terms of the option were such that the grant of the option is appropriately treated as
transfer of ownership of the securities (e.g., because the options were in-the-money or not
subject to a substantial vesting period), then they may agree to attribute income
accordingly.
Article 11
Consistent with Article 9 and paragraph 1 of Article 10 of the Protocol,
paragraphs 1, 2, and 3 of Article 11 of the Protocol revise paragraphs 1, 2, and 4 of
Article XVI (Artistes and Athletes) of the existing Convention by deleting references to
former Article XIV (Independent Personal Services) of the Convention and deleting and
replacing other language in acknowledgement of the renaming of Article XV (Income
from Employment).
Article 12
Article 12 of the Protocol deletes Article XVII (Withholding of Taxes in Respect
of Personal Services) from the Convention. However, the subsequent Articles are not
renumbered.
Article 13
Article 13 of the Protocol replaces paragraphs 3, 4, and 7 and adds paragraphs 8
through 17 to Article XVIII (Pensions and Annuities) of the Convention.
Paragraph 1
Roth lRAs
Paragraph 1 of Article 13 of the Protocol separates the provisions of paragraph 3
of Article XVIII into two subparagraphs. Subparagraph 3(a) contains the existing
definition of the term "pensions," while subparagraph 3(b) adds a new rule to address the
treatment of Roth IRAs or similar plan (as described below).
Subparagraph 3(a) of Article XVIII provides that the term "pen~ions" fo~
purposes of the Convention includes any payme~t under a superannuatlOn, pen~lOn, or
other retirement arrangement, Armed-Forces retuement pay, war veterans penSlOns and
allowances, and amounts paid under a sickness, accident, or disabil.ity plan, bl:lt does not
include payments under an income-averagin~ annuity co~tract (:vh1Ch ~re subje.ct to
Article XXII (Other Income» or social securIty benefits, mcludmg SOCIal securIty
benefits in respect of government services (which are subject to paragraph 5 of Article
XVIII). Thus, the term "pensions" includes pensions paid by private ~mplore~s
(including pre-tax and Roth 401(k) arrangements) as well as any penslOn paId m respect
29
of gowrnment services. Further. the definition of "pensions" includes. for example.
payments from individual retirement accounts (lRAs) in the United States and from
registered retirement savings plans (RRSPs) and registered retirement income funds
(RRlFs) in Canada.
Subparagraph 3(b) of Article XVIII provides that the term "pensions" generally
includes a Roth IRA. within the meaning of Code section 408A (or a similar plan
described below). Consequently, under paragraph 1 of Article XVIII, distributions from a
Roth IRA to a resident of Canada generally continue to be exempt from Canadian tax to
the extent they would have been exempt from U.S. tax if paid to a resident of the United
States. In addition, residents of Canada generally may make an election under paragraph
7 of Article XVIII to defer any taxation in Canada with respect to income accrued in a
Roth IRA but not distributed by the Roth IRA, until such time as and to the extent that a
distribution is made from the Roth IRA or any plan substituted therefore. Because
distributions will be exempt from Canadian tax to the extent they would have been
exempt from U.S. tax if paid to a resident of the United States, the effect of these rules is
that. in most cases, no portion of the Roth IRA will be subject to taxation in Canada.
However, subparagraph 3(b) also provides that ifan individual who is a resident
of Canada makes contributions to his or her Roth IRA while a resident of Canada, other
than rollover contributions from another Roth IRA (or a similar plan described below),
the Roth IRA will cease to be considered a pension at that time with respect to
contributions and accretions from such time and accretions from such time will be subject
to tax in Canada in the year of accrual. Thus, the Roth IRA will in effect be bifurcated
into a "frozen" pension that continues to be subject to the rules of Article XVIII and a
savings account that is not subject to the rules of Article XVIII. It is understood by the
Contracting States that following a rollover contribution from a Roth 401 (k) arrangement
to a Roth IRA, the Roth IRA will continue to be treated as a pension subject to the rules
of Article XVIII.
Assume. for example. that Mr. X moves to Canada on July 1, 2008. Mr. X has a
Roth IRA with a balance of 1,100 on July 1,2008. Mr. X elects under paragraph 7 of
Article XVIII to defer any taxation in Canada with respect to income accrued in his Roth
IRA while he is a resident of Canada. Mr. X makes no additional contributions to his
Roth IRA until July 1, 2010, when he makes an after-tax contribution of 100. There are
accretions of 20 during the period July 1,2008 through June 30, 2010, which are not
taxed in Canada by reason of the election under paragraph 7 of Article XVIII. There are
additional accretions of 50 during the period July 1,20 I 0 through June 30, 2015, which
are subject to tax in Canada in the year of accrual. On July 1,2015, while Mr. X is still a
resident of Canada, Mr. X receives a lump-sum distribution of 1,270 from his Roth IRA.
The 1.120 that was in the Roth IRA on June 30, 20 lOis treated as a distribution from a
pension plan that. pursuant to paragraph 1 of Article XVIII, is exempt from tax in Canada
provided it would be exempt from tax in the United States under the Internal Revenue
Code if paid to a resident of the United States. The remaining 150 comprises the aftertax contribution of 100 in 2010 and accretions of 50 that were subject to Canadian tax in
the year of accrual.
The rules of new subparagraph .3(b ~ of Article XVII.I also will apply to any plan
or arrangement created pursuant t? legislatIOn enacted by eIther Contracting State after
September 21. 2007 (the date of signature of the Protocol) that the competent authorities
agreE' is similar to a Roth IRA.
30
Source ofpayments under life insurance and annuity contracts
Paragraph 1 of Article 13 also replaces paragraph 4 of Article XVIII.
Subparagraph 4( a) contains the existing definition of annuity, while subparagraph 4(b)
adds a s~urce rule to address the treatment of certain payments by branches of insurance
companIes.
Subparagraph 4(a) provides that, for purposes of the Convention, the term
"annuity" means a stated sum paid periodically at stated times during life or during a
specified number of years, under an obligation to make the payments in return for
adequate and full consideration other than services rendered. The term does not include a
payment that is not periodic or any annuity the cost of which was deductible for tax
purposes in the Contracting State where the annuity was acquired. Items excluded from
the definition of" annuity" and not dealt with under another Article of the Convention are
subject to the rules of Article XXII (Other Income).
Under the existing Convention, payments under life insurance and annuity
contracts to a resident of Canada by a Canadian branch of a U.S. insurance company are
subject to either a I5-percent withholding tax under subparagraph 2(b) of Article XVIII
or, unless dealt with under another Article of the Convention, an unreduced 30-percent
withholding tax under paragraph 1 of Article XXII, depending on whether the payments
constitute annuities within the meaning of paragraph 4 of Article XVIII.
On July 12,2004, the Internal Revenue Service issued Revenue Ruling 2004-75,
2004-2 c.B. 109, which provides in relevant part that annuity payments under, and
withdrawals of cash value from, life insurance or annuity contracts issued by a foreign
branch of a U.S. life insurance company are U.S.-source income that, when paid to a
nonresident alien individual, is generally subject to a 30-percent withholding tax under
Code sections 87I(a) and 1441. Revenue Ruling 2004-97, 2004-2 c.B. 516, provided
that Revenue Ruling 2004-75 would not be applied to payments that were made before
January 1,2005, provided that such payments were made pursuant to binding life
insurance or annuity contracts issued on or before July 12,2004.
Under new subparagraph 4(b) of Article XVIII, an annuity or other amount paid
in respect of a life insurance or annuity contract (including a withdrawal in respect of the
cash value thereof), will generally be deemed to arise in the Contracting State where the
person paying the annuity or other amount (the "payer") is resident. However, if the
payer, whether a resident of a Contracting State or not, has a permanent establishment in
a Contracting State other than a Contracting State in which the payer is a resident, the
payment will be deemed to arise in the Contracting State in which the permanent
establishment is situated if both of the following requirements are satisfied: (i) the
obligation giving rise to the annuity or other amount must have been incurred in
connection with the permanent establishment, and (ii) the annuity or other amount must
be borne by the permanent establishment. When these requirements are satisfied,
payments by a Canadian branch of a U.S. insurance company will be deemed to arise in
Canada.
Paragraph 2
Paragraph 2 of Article 13 of the Protocol replaces paragraph 7 of Article XVIII of
the existing Convention. Paragraph 7 continues to provide a rule with respect to the
taxation of a natural person on income accrued in a pension or employee benefit plan in
the other Contracting State. Thus, paragraph 7 applies where an individual is a citizen or
resident of a Contracting State and is a beneficiary of a trust, company, organization, or
31
other arrangement that is a resident of the other Contracting State, where such trust,
company, organization, or other arrangement is generally exempt from income taxati~m
in that other State, and is operated exclusively to provide pension, or employee benehts.
In such cases, the beneficiary may elect to defer taxation in his State of residence on
income accrued in the plan until it is distributed from the plan (or from another plan in
that other Contracting State to which the income is transferred pursuant to the domestic
law of that other Contracting State).
Paragraph 2 of Article 13 of the Protocol makes two changes to paragraph 7 of
Article XVIII of the existing Convention. The first change is that the phrase "pension,
retirement or employee benefits" is changed to "pension or employee benefits" solely to
reflect the fact that in certain cases, discussed above, Roth IRAs will not be treated as
pensions for purposes of Article XVIII. The second change is that "under" is changed to
"subject to" to make it clear that an election to defer taxation with respect to
undistributed income accrued in a plan may be made whether or not the competent
authority of the first-mentioned State has prescribed rules for making an election. For the
U.S. rules, see Revenue Procedure 2002-23, 2002-1 c.B. 744. As of the date the Protocol
was signed, the competent authority of Canada had not prescribed rules.
Paragraph 3
Paragraph 3 of Article 13 of the Protocol adds paragraphs 8 through 17 to Article
XVIII to deal with cross-border pension contributions. These paragraphs are intended to
remove barriers to the flow of personal services between the Contracting States that could
otherwise result from discontinuities in the laws of the Contracting States regarding the
deductibility of pension contributions. Such discontinuities may arise where a country
allows deductions or exclusions to its residents for contributions, made by them or on
their behalf, to resident pension plans, but does not allow deductions or exclusions for
payments made to plans resident in another country, even if the structure and legal
requirements of such plans in the two countries are similar.
There is no comparable set of rules in the OECD Model, although the issue is
discussed in detail in the Commentary to Article 18 (Pensions). The 2006 U.S. Model
deals with this issue in paragraphs 2 through 4 of Article 18 (Pension Funds).
Workers on short-term assignments in the other Contracting State
Paragraphs 8 and 9 of Article XVIII address the case of a short-term assignment
where an individual who is participating in a "qualifying retirement plan" (as defined in
paragraph 15 of Article XVIII) in one Contracting State (the "home State") performs
services as an employee for a limited period of time in the other Contracting State (the
"host State"). If certain requirements are satisfied, contributions made to, or benefits
accrued under, the plan by or on behalf of the individual will be deductible or excludible
in computing the individual's income in the host State. In addition, contributions made to
the plan by the individual's employer will be allowed as a deduction in computing the
employer's profits in the host State.
In order for paragraph 8 to apply, the remuneration that the individual receives
with respect to the services performed in the host State must be taxable in the host State.
This means, for ~~ample, that w~ere the Uni~ed .S~ates is th~ host State, paragraph 8
would not apply It the remuneratIOn that the mdlvldual receives with respect to the
services performed in the United States is exempt from taxation in the United States
under Code section 893.
32
The individual also must have been participating in the plan, or in another similar
plan. for ~hich the plan was substituted, in:mediately before he began performing
serVIces III the host State. The rule regardmg a successor plan would apply if, for
example, the employer has been acquired by another corporation that replaces the
existing plan with its own plan, transferring membership in the old plan over into the new
plan.
In addition, the individual must not have been a resident (as detennined under
Article IV (Residence» of the host State immediately before he began performing
services in the host State. It is irrelevant for purposes of paragraph 8 whether the
individual becomes a resident of the host State while he performs services there. A
citizen of the United States who has been a resident of Canada may be entitled to benefits
under paragraph 8 if (a) he perfonns services in the United States for a limited period of
time and (b) he was a resident of Canada immediately before he began performing such
services.
Benefits are available under paragraph 8 only for so long as the individual has not
perfonned services in the host State for the same employer (or a related employer) for
more than 60 of the 120 months preceding the individual's current taxable year. The
purpose of this rule is to limit the period of time for which the host State will be required
to provide benefits for contributions to a plan from which it is unlikely to be able to tax
the distributions. If the individual continues to perfonn services in the host State beyond
this time limit, he is expected to become a participant in a plan in the host State.
Canada's domestic law provides preferential tax treatment for employer contributions to
foreign pension plans in respect of services rendered in Canada by short-tenn residents,
but such treatment ceases once the individual has been resident in Canada for at least 60
of the preceding 72 months.
The contributions and benefits must be attributable to services performed by the
individual in the host State, and must be made or accrued during the period in which the
individual performs those services. This rule prevents individuals who render services in
the host State for a very short period of time from making disproportionately large
contributions to home State plans in order to offset the tax liability associated with the
income earned in the host State. In the case where the United States is the host State,
contributions will be deemed to have been made on the last day of the preceding taxable
year if the payment is on account of such taxable year and is treated under U.S. law as a
contribution made on the last day of the preceding taxable year.
If an individual receives benefits in the host State with respect to contributions to
a plan in the home State, the services to which the contributions relate may not be taken
into account for purposes of determining the individual's entitlement to benefits under
any trust, company, organization, or other arrangement that is a resident of the host State,
generally exempt from income taxation in that State and operated to provide pension or
retirement benefits. The purpose of this rule is to prevent double benefits for
contributions to both a home State plan and a host State plan with respect to the same
services. Thus, for example, an individual who is working temporarily in the United
States and making contributions to a qualifying retirement plan in Canada with respect to
services performed in the United States may not make contributions to an individual
retirement account (within the meaning of Code section 408(a» in the United States with
respect to the same services.
Paragraph 8 states that it applies only to the extent that the contributions or
benefits would qualify for tax relief in the home State if the individual were a resident of
and performed services in that State. Thus, benefits would be limited in the same fashion
33
as if the individual continued to be a resident of the home State. However. paragraph 9
provides that if the host State is the United States and the individual is a citizen of the
United States. the benefits granted to the individual under paragraph 8 may not exceed
the benefits that would be allowed by the United States to its residents for contributions
to. or benefits otherwise accrued under. a generally corresponding pension or retirement
plan established in and recognized for tax purposes by the United States. Thus,:h~ lower
of the two limits applies. This rule ensures that U.S. citizens working temporarIly In the
United States and participating in a Canadian plan will not get more favorable U.S. tax
treatment than U.S. citizens participating in a U.S. plan.
Where the United States is the home State. the amount of contributions that may
be excluded from the employee's income under paragraph 8 for Canadian purposes is
limited to the U.S. dollar amount specified in Code section 415 or the U.S. dollar amount
specified in Code section 402(g)( 1) to the extent contributions are made from the
employee's compensation. For this purpose, the dollar limit specified in Code section
402(g)( 1) means the amount applicable under Code section 402(g)(l) (including the age
50 catch-up amount in Code section 402(g)( 1)(C) or, if applicable, the parallel dollar
limit applicable under Code section 457(e)(15) plus the age 50 catch-up amount under
Code section 414(v)(2)(B)(i) for a Code section 457(g) trust.
Where Canada is the home State, the amount of contributions that may be excluded
h\)lll the employee's income under paragraph 8 for U.S. purposes is subject to the
limitations specified in subsections 146(5), 147(8), 147.1(8) and (9) and 147.2(1) and (4)
of the Income Tax Act and paragraph 8503(4)(a) of the Income Tax Regulations, as
applicable. If the employee is a citizen of the United States, then the amount of
contributions that may be excl uded is the lesser of the amounts determined under the
I illlitations specified in the previous sentence and the amounts specified in the previous
paragraph.
The provisions described above provide benefits to employees. Paragraph 8 also
provides that contributions made to the home State plan by an individual's employer will
be allowed as a deduction in computing the employer's profits in the host State, even
though such a deduction might not be allowable under the domestic law of the host State.
This rule applies whether the employer is a resident of the host State or a permanent
establishment that the employer has in the host State. The rule also applies to
contributions by a person related to the individual's employer, such as contributions by a
parent corporation for its subsidiary, that are treated under the law of the host State as
contributions by the individual's employer. For example, if an individual who is
participating in a qualifYing retirement plan in Canada performs services for a limited
period of time in the United States for a U.S. subsidiary of a Canadian company, a
contribution to the Canadian plan by the parent company in Canada that is treated under
U.S. law as a contribution by the U.S. subsidiary would be covered by the rule.
The amount of the allowable deduction is to be determined under the laws of the
home State. Thus. where the United States is the home State, the amount of the
deduction that is allowable in Canada will be subject to the limitations of Code section
404 (including the Code section 401 (a)(17) and 415 limitations). Where Canada is the
home State, the amount of the deduction that is allowable in the United States is subject
to the limitations specified in subsections 147(8), 147.1(8) and (9) and 147.2(1) of the
Income Tax Act, as applicable.
34
Cross-border commuters
Paragraphs 10, 11, and 12 of Article XVIII address the case of a commuter who is
a resident of one Contracting State (the "residence State") and performs services as an
employee in the other Contracting State (the "services State") and is a member of a
"qualifying retirement plan" (as defined in paragraph 15 of Article XVIII) in the services
State. If certain requirements are satisfied, contributions made to, or benefits accrued
under, the qualifying retirement plan by or on behalf of the individual will be deductible
or excludible in computing the individual's income in the residence State.
In order for paragraph 10 to apply, the individual must perform services as an
employee in the services State the remuneration from which is taxable in the services
State and is borne by either an employer who is a resident of the services State or by a
permanent establishment that the employer has in the services State. The contributions
and benefits must be attributable to those services and must be made or accrued during
the period in which the individual performs those services. In the case where the United
States is the residence State, contributions will be deemed to have been made on the last
day of the preceding taxable year if the payment is on account of such taxable year and is
treated under U.S. law as a contribution made on the last day of the preceding taxable
year.
Paragraph 10 states that it applies only to the extent that the contributions or
benefits qualify for tax relief in the services State. Thus, the benefits granted in the
residence State are available only to the extent that the contributions or benefits accrued
qualify for relief in the services State. Where the United States is the services State, the
amount of contributions that may be excluded under paragraph 10 is the U.S. dollar
amount specified in Code section 415 or the U.S. dollar amount specified in Code section
402(g)(1) (as defined above) to the extent contributions are made from the employee's
compensation. Where Canada is the services State, the amount of contributions that may
be excluded from the employee's income under paragraph 10 is subject to the limitations
specified in subsections 146(5), 147(8), 147.1(8) and (9) and 147.2(1) and (4) of the
Income Tax Act and paragraph 8503(4)(a) of the Income Tax Regulations, as applicable.
However, paragraphs 11 and 12 further provide that the benefits granted under
paragraph 10 by the residence State may not exceed certain benefits that would be
allowable under the domestic law of the residence State.
Paragraph 11 provides that where Canada is the residence State, the amount of
contributions otherwise allowable as a deduction under paragraph 10 may not exceed the
individual's deduction limit for contributions to registered retirement savings plans
(RRSPs) remaining after taking into account the amount of contributions to RRSPs
deducted by the individual under the law of Canada for the year. The amount deducted
by the individual under paragraph 10 will be taken into account in computing the
individual's deduction limit for subsequent taxation years for contributions to RRSPs.
This rule prevents double benefits for contributions to both an RRSP and a qualifying
retirement plan in the United States with respect to the same services.
Paragraph 12 provides that if the United States is the residence State, the benefits
granted to an individual under paragraph 10 may not exceed the benefits that would be
allowed by the United States to its residents for contributions to, or benefits otherwise
accrued under, a generally corresponding pension or retirement plan established in and
recognized for tax purposes by the United States. For purposes of determining an
individual's eligibility to participate in and receive tax benefits with respect to a pension
or retirement plan or other retirement arrangement in the United States, contributions
35
made to. or benefits accrued under. a qualifying retirement plan in Canada by or on
behalf of the individual are treated as contributions or benetits under a generally
corresponding pension or retirement plan established in and recognized for tax purposes
by the United States. Thus, for example. the qualifYing retirement plan in Canada would
be taken into account for purposes of determining whether the individual is an "active
participant" within the meaning of Code section 219(g)(5), with the result that the
individual's ability to make deductible contributions to an individual retirement account
in the United States would be limited.
Paragraph 10 does not address employer deductions because the employer is
located in the services State and is already eligible for deductions under the domestic law
of the services State.
u.s. citizens resident in Canada
Paragraphs 13 and 14 of Article XVIII address the special case ofa U.S. citizen
who is a resident of Canada (as determined under Article IV (Residence)) and who
performs services as an employee in Canada and participates in a qualifYing retirement
plan (as defined in paragraph 15 of Article XVIII) in Canada. If certain requirements are
satisfied, contributions made to, or benefits accrued under, a qualifYing retirement plan in
Canada by or on behalf of the U.S. citizen will be deductible or excludible in computing
!I!:; or her taxable income in the United States. These provisions are generally consistent
with paragraph 4 of Article 18 of the U.S. Model treaty.
In order for paragraph 13 to apply, the U.S. citizen must perform services as an
employee in Canada the remuneration from which is taxable in Canada and is borne by
an employer who is a resident of Canada or by a permanent establishment that the
employer has in Canada. The contributions and benefits must be attributable to those
services and must be made or accrued during the period in which the U.S. citizen
performs those services. Contributions will be deemed to have been made on the last day
of the preceding taxable year if the payment is on account of such taxable year and is
treated under U.S. law as a contribution made on the last day of the preceding taxable
year.
Paragraph 13 states that it applies only to the extent the contributions or benefits
qualifY for tax relief in Canada. However, paragraph 14 provides that the benefits
granted under paragraph 13 may not exceed the benefits that would be allowed by the
United States to its residents for contributions to, or benefits otherwise accrued under, a
generally corresponding pension or retirement plan established in and recognized for tax
purposes by the United States. Thus, the lower of the two limits applies. This rule
ensures that a U.S. citizen living and working in Canada does not receive better U.S.
treatment than a U.S. citizen living and working in the United States. The amount of
contributions that may be excluded from the employee's income under paragraph 13 is
the U.S. dollar amount specified in Code section 415 or the U.S. dollar amount specified
in Code section 402(g)(l) (as defined above) to the extent contributions are made from
the employee's compensation. In addition, pursuant to Code section 911(d)(6), an
individual may not claim benefits under paragraph 13 with respect to services the
remuneration for which is excluded from the individual's gross income under Code
section 911(a).
For purposes of determining the individual's eligibility to participate in and
receive tax benefits with respect to a pension or retirement plan or other retirement
arrangement established in and recognized for tax purposes by the United States,
contributions made to. or benefits accrued under, a qualifYing retirement plan in Canada
36
by or on behalf of the individual are treated as contributions or benefits under a generally
corresponding pension or retirement plan established in and recognized for tax purposes
by the United States. Thus, for example, the qualifying retirement plan in Canada would
be taken into account for purposes of determining whether the individual is an "active
participant" within the meaning of Code section 219(g)( 5), with the result that the
individual's ability to make deductible contributions to an individual retirement account
in the United States would be limited.
Paragraph 13 does not address employer deductions because the employer is
located in Canada and is already eligible for deductions under the domestic law of
Canada.
Definition of "qualifying retirement plan"
Paragraph 15 of Article XVIII provides that for purposes of paragraphs 8 through
14, a "qualifying retirement plan" in a Contracting State is a trust, company,
organization, or other arrangement that (a) is a resident of that State, generally exempt
from income taxation in that State and operated primarily to provide pension or
retirement benefits; (b) is not an individual arrangement in respect of which the
individual's employer has no involvement; and (c) the competent authority of the other
Contracting State agrees generally corresponds to a pension or retirement plan
established in and recognized for tax purposes in that State. Thus, U.S. individual
retirement accounts (IRAs) and Canadian registered retirement savings plans (RRSPs) are
not treated as qualifying retirement plans unless addressed in paragraph 10 of the General
Note (as discussed below). In addition, a Canadian retirement compensation arrangement
(RCA) is not a qualifying retirement plan because it is not considered to be generally
exempt from income taxation in Canada.
Paragraph 10 of the General Note provides that the types of Canadian plans that
constitute qualifying retirement plans for purposes of paragraph 15 include the following
and any identical or substantially similar plan that is established pursuant to legislation
introduced after the date of signature of the Protocol (September 21, 2007): registered
pension plans under section 147.1 of the Income Tax Act, registered retirement savings
plans under section 146 that are part of a group arrangement described in subsection
204.2(1.32), deferred profit sharing plans under section 147, and any registered
retirement savings plan under section 146, or registered retirement income fund under
section 146.3, that is funded exclusively by rollover contributions from one or more of
the preceding plans.
Paragraph 10 of the General Note also provides that the types of U.S. plans that
constitute qualifying retirement plans for purposes of paragraph 15 include the following
and any identical or substantially similar plan that is established pursuant to legislation
introduced after the date of signature of the Protocol (September 21, 2007): qualified
plans under Code section 401(a) (including Code section 401(k) arrangements),
individual retirement plans that are part of a simplified employee pension plan that
satisfies Code section 408(k), Code section 408(p) simple retirement accounts, Code
section 403(a) qualified annuity plans, Code section 403(b) plans, Code section 457(g)
trusts providing benefits under Code section 457(b) plans, the Thrift Savings Fund (Code
section 77010», and any individual retirement account under Code section 408(a) that is
funded exclusively by rollover contributions from one or more of the preceding plans.
If a particular plan in one Contracting State is of a type specified in paragraph 10
of the General Note with respect to paragraph 15 of Article XVIII, it will not be
necessary for taxpayers to obtain a determination from the competent authority of the
37
other Contracting State that the plan generally corresponds to a pension or retirement
plan established in and recognized for tax purposes in that State. A taxpayer who
believes a particular plan in one Contracting State that is not described in paragraph 10 of
the General Note nevertheless satisfies the requirements of paragraph 15 may request a
determination from the competent authority of the other Contracting State that the plan
generally corresponds to a pension or retirement plan established in and recognized for
tax purposes in that State. In the case of the United States, such a determination must be
requested under Revenue Procedure 2006-54, 2006-49 I.R.B. 655 (or any applicable
analogous provision). In the case of Canada, the current version of Information Circular
71-17 provides guidance on obtaining assistance from the Canadian competent authority.
Source rule
Paragraph 16 of Article XVIII provides that a distribution from a pension or
retirement plan that is reasonably attributable to a contribution or benefit for which a
benefit was allowed pursuant to paragraph 8,10, or 13 of Article XVIII will be deemed to
arise in the Contracting State in which the plan is established. This ensures that the
Contracting State in which the plan is established will have the right to tax the gross
amount of the distribution under subparagraph 2( a) of Article XVIII, even if a portion of
the services to which the distribution relates were not performed in such Contracting
State.
Partnerships
Paragraph 17 of Article XVIII provides that paragraphs 8 through 16 of Article
XVIII apply, with such modifications as the circumstances require, as though the
relationship between a partnership that carries on a business, and an individual who is a
member of the partnership, were that of employer and employee. This rule is needed
because paragraphs 8, 10, and 13, by their terms, apply only with respect to contributions
made to, or benefits accrued under, qualifYing retirement plans by or on behalf of
individuals who perform services as an employee. Thus, benefits are not available with
respect to retirement plans for self-employed individuals, who may be deemed under U.S.
law to be employees for certain pension purposes. Paragraph 17 ensures that partners
participating in a plan established by their partnership may be eligible for the benefits
provided by paragraphs 8, 10, and 13.
Relationship to other Articles
Paragraphs 8, 10, and 13 of Article XVIII are not subject to the saving clause of
paragraph 2 of Article XXIX (Miscellaneous Rules) by reason of the exception in
subparagraph 3(a) of Article XXIX.
Article 14
Consistent with Articles 9 and 10 of the Protocol, Article 14 of the Protocol
amends Article XIX (Government Service) of the Convention by deleting the reference to
"Article XIV (Independent Personal Services)" and replacing such reference with the
reference to "Article VII (Business Profits)" and by reflecting the new name of Article
XV (Income from Employment).
Article 15
Article 15 of the Protocol replaces Article XX (Students) of the Convention.
Article XX provides rules for host-country taxation of visiting students and business
38
trainees. Persons who meet the tests of Article XX will be exempt from tax in the State
that they are visiting with respect to designated classes of income. Several conditions
must be satisfied in order for an individual to be entitled to the benefits of this Article.
First, the visitor must have been, either at the time of his arrival in the host State
or immediately before, a resident of the other Contracting State.
Second, the purpose of the visit must be the full-time education or training of the
visitor. Thus, ifthe visitor comes principally to work in the host State but also is a parttime student, he would not be entitled to the benefits of this Article, even with respect to
any payments he may receive from abroad for his maintenance or education, and
regardless of whether or not he is in a degree program. Whether a student is to be
considered full-time will be determined by the rules of the educational institution at
which he is studying.
The host State exemption in Article XX applies to payments received by the
student or business trainee for the purpose of his maintenance, education or training that
arise outside the host State. A payment will be considered to arise outside the host State
if the payer is located outside the host State. Thus, if an employer from one of the
Contracting States sends an employee to the other Contracting State for full-time training,
the payments the trainee receives from abroad from his employer for his maintenance or
training while he is present in the host State will be exempt from tax in the host State.
Where appropriate, substance prevails over form in determining the identity of the payer.
Thus, for example, payments made directly or indirectly by a U.S. person with whom the
visitor is training, but which have been routed through a source outside the United States
(e.g., a foreign subsidiary), are not treated as arising outside the United States for this
purpose.
In the case of an apprentice or business trainee, the benefits of Article XX will
extend only for a period of one year from the time that the individual first arrives in the
host country for the purpose of the individual's training. If, however, an apprentice or
trainee remains in the host country for a second year, thus losing the benefits of the Artide, he would not retroactively lose the benefits of the Article for the first year.
Relationship to other Articles
The saving clause of paragraph 2 of Article XXIX (Miscellaneous Rules) does not
apply to Article XX with respect to an individual who neither is a citizen of the host State
nor has been admitted for permanent residence there. The saving clause, however, does
apply with respect to citizens and permanent residents of the host State. Thus, a U.S.
citizen who is a resident of Canada and who visits the United States as a full-time student
at an accredited university will not be exempt from U.S. tax on remittances from abroad
that otherwise constitute U.S. taxable income. However, an individual who is not a U.S.
citizen, and who visits the United States as a student and remains long enough to become
a resident under U.S. law, but does not become a permanent resident (i.e., does not
acquire a green card), will be entitled to the full benefits of the Article.
Article 16
Article 16 of the Protocol revises Article XXI (Exempt Organizations) of the
existing Convention.
39
Paragraph 1
Paragraph 1 amends Article XXI by renumbering paragraphs 4,5, and 6 as 5, 6,
and 7, respectively.
Paragraph 2
Paragraph 2 replaces paragraphs 1 through 3 of Article XXI with four new
paragraphs. In general, the provisions of former paragraphs 1 through 3 have been
retained.
New paragraph 1 provides that a religious, scientific, literary, educational, or
charitable organization resident in a Contracting State shall be exempt from tax on
income arising in the other Contracting State but only to the extent that such income is
exempt from taxation in the Contracting State in which the organization is resident.
New paragraph 2 retains the provisions of former subparagraph 2(a), and provides
that a trust, company, organization, or other arrangement that is resident in a Contracting
State and operated exclusively to administer or provide pension, retirement or employee
benefits or benefits for the self-employed under one or more funds or plans established to
provide pension or retirement benefits or other employee benefits is exempt from taxation
on dividend and interest income arising in the other Contracting State in a taxable year, if
the income of such organization or other arrangement is generally exempt from taxation
for that year in the Contracting State in which it is resident.
New paragraph 3 replaces and expands the scope of former subparagraph 2(b)
Former subparagraph 2(b) provided that, subject to the provisions of paragraph 3 (new
paragraph 4), a trust, company, organization or other arrangement that was a resident of a
Contracting State, generally exempt from income taxation in that State and operated
exclusively to earn income for the benefit of one or more organizations described in
subparagraph 2(a) (new paragraph 2) was exempt from taxation on dividend and interest
income arising in the other Contracting State in a taxable year. The Internal Revenue
Service concluded in private letter rulings (PLR 200111027 and PLR 200111037) that a
pooled investment fund that included as investors one or more organizations described in
paragraph 1 could not qualify for benefits under former subparagraph 2(b). New
paragraph 3 now allows organizations described in paragraph 1 to invest in pooled funds
with trusts, companies, organizations, or other arrangements described in new paragraph
2.
Former subparagraph 2(b) did not exempt income earned by a trust, company or
other arrangement for the benefit of religious, scientific, literary, educational or charitable
organizations exempt from tax under paragraph 1. Therefore, the Protocol expands the
scope of paragraph 3 to include such income.
As noted above with respect to Article X (Dividends), paragraph 3 of the General
Note explains that distributions from Canadian income trusts and royalty trusts that are
treated as di vidends as a result of changes to Canada's law regarding taxation of income
and royalty trusts shall be treated as dividends for the purposes of Article X.
Accordingly, such distributions will also be entitled to the benefits of Article XXI.
New paragraph 4 replaces paragraph 3 and provides that the exemptions provided
by paragraphs 1. 2, 3 do not apply with respect to the income of a trust, company,
organization or other arrangement from carrying on a trade or business or from a related
40
person, other than a person referred to in paragraph 1,2 or 3. The term "related person"
is not necessarily defined by paragraph 2 of Article IX (Related Person).
Article 17
Article 17 of the Protocol amends Article XXII (Other Income) of the Convention
by adding a new paragraph 4. Article XXII generally assigns taxing jurisdiction over
income not dealt with in the other articles (Articles VI through XXI) of the Convention.
New paragraph 4 provides a specific rule for residence State taxation of
compensation derived in respect of a guarantee of indebtedness. New paragraph 4
provides that compensation derived by a resident of a Contracting State in respect of the
provision of a guarantee of indebtedness shall be taxable only in that State, unless the
compensation is business profits attributable to a permanent establishment situated in the
other Contracting State, in which case the provisions of Article VII (Business Profits)
shall apply. The clarification that Article VII shall apply when the compensation is
considered business profits was included at the request of the United States.
Compensation paid to a financial services entity to provide a guarantee in the ordinary
course of its business of providing such guarantees to customers constitutes business
profits dealt with under the provisions of Article VII. However, provision of guarantees
with respect to debt of related parties is ordinarily not an independent economic
undertaking that would generate business profits, and thus compensation in respect of
such related-party guarantees is, in most cases, covered by Article XXII.
Article 18
Article 18 of the Protocol amends paragraph 2 of Article XXIII (Capital) of the
Convention by deleting language contained in that paragraph consistent with the changes
made by Article 9 of the Protocol.
Article 19
Article 19 of the Protocol deletes subparagraph 2(b) of Article XXIV (Elimination
of Double Taxation) of the Convention and replaces it with a new subparagraph.
New subparagraph 2(b) allows a Canadian company receiving a dividend from a
U.S. resident company of which it owns at least 10 percent of the voting stock, a credit
against Canadian income tax of the appropriate amount of income tax paid or accrued to
the United States by the dividend paying company with respect to the profits out of which
the dividends are paid. The third Protocol to the Convention, signed March 17, 1995, had
amended subparagraph (b) to allow a Canadian company to deduct in computing its
Canadian taxable income any dividend received by it out of the exempt surplus of a
foreign affiliate which is a resident of the United States. This change is consistent with
current Canadian tax treaty practice: it does not indicate any present intention to change
Canada's "exempt surplus" rules, and those rules remain in effect.
Article 20
Article 20 of the Protocol revises Article XXV (Non-Discrimination) of the
e:xisting Convention to bring that Article into closer conformity to U.S. tax treaty policy.
41
Paragraphs 1 and 2
Paragraph 1 replaces paragraph 1 of Article XXV of the existing Convention.
New paragraph 1 provides that a national of one Contracting State may not be subject to
taxation or connected requirements in the other Contracting State that are more
burdensome than the taxes and connected requirements imposed upon a national of that
other State in the same circumstances. The OECD Model would prohibit taxation that is
"other than or more burdensome" than that imposed on U.S. persons. Paragraph I omits
the words "other than or" because the only relevant question under this provision should
be whether the requirement imposed on a national of the other Contracting State is more
burdensome. A requirement may be different from the requirements imposed on U.S.
nationals without being more burdensome.
The term "national" in relation to a Contracting State is defined in subparagraph
l(k) of Article III (General Definitions). The term includes both individuals and juridical
persons. A national of a Contracting State is afforded protection under this paragraph
even if the national is not a resident of either Contracting State. Thus, a U.S. citizen who
is resident in a third country is entitled, under this paragraph, to the same treatment in
Canada as a national of Canada in the same or similar circumstances (i. e.. one who is
resident in a third State).
Whether or not the two persons are both taxable on worldwide income is a
significant circumstance for this purpose. For this reason, paragraph 1 specifically refers
to taxation or any requirement connected therewith, particularly with respect to taxation
on worldwide income, as relevant circumstances. This language means that the United
States is not obliged to apply the same taxing regime to a national of Canada who is not
resident in the United States as it applies to a U.S. national who is not resident in the
United States. U.S. citizens who are not resident in the United States but who are,
nevertheless, subject to U.S. tax on their worldwide income are not in the same
circumstances with respect to U.S. taxation as citizens of Canada who are not U.S.
reSidents. Thus, for example, Article XXV would not entitle a national of Canada
residing in a third country to taxation at graduated rates on U.S.-source dividends or other
investment income that applies to a U.S. citizen residing in the same third country.
Because of the increased coverage of paragraph 1 with respect to the treatment of
nationals wherever they are resident. paragraph 2 of this Article no longer has
application, and therefore has been omitted.
Paragraph 3
Paragraph 3 makes changes to renumbered paragraph 3 of Article XXV in order
to conform with Article 10 of the Protocol by deleting the reference to "Article XV
(Dependent Personal Services)" and replacing it with a reference to "Article XV (Income
from Employment):'
Article 21
Paragraph 1 of Article 21 of the Protocol replaces paragraph 6 of Article XXVI
(Mutual Agreement Procedure) of the Convention with new paragraphs 6 and 7. New
" ' :graphs 6 and 7 provide a mandatory binding arbitration proceeding (Arbitration
Proceeding). The Arbitration Note details additional rules and procedures that applv to a
case considered under the arbitration provisions.
•
42
New paragraph 6 provides that a case shall be resolved through arbitration when
the competent authorities have endeavored but are unable through negotiation to reach a
complete agreement regarding a case and the following three conditions are satisfied.
First, tax returns have been filed with at least one of the Contracting States with respect
to the taxable years at issue in the case. Second, the case (i) involves the application of
one or more Articles that the competent authorities have agreed in an exchange of notes
shall be the subject of arbitration and is not a case that the competent authorities agree
before the date on which an Arbitration Proceeding would otherwise have begun, is not
suitable for determination by arbitration; or (ii) is a case that the competent authorities
agree is suitable for determination by arbitration. Third, all concerned persons and their
authorized representatives agree, according to the provisions of subparagraph 7( d), not to
disclose to any other person any information received during the course of the Arbitration
Proceeding from either Contracting State or the arbitration board, other than the
determination of the board (confidentiality agreement). The confidentiality agreement
may also be executed by any concerned person that has the legal authority to bind any
other concerned person on the matter. For example, a parent corporation with the legal
authority to bind its subsidiary with respect to confidentiality may execute a
.comprehensive confidentiality agreement on its own behalf and that of its subsidiary.
The United States and Canada have agreed in the Arbitration Note to submit cases
regarding the application of one or more of the following Articles to mandatory binding
arbitration under the provisions of paragraphs 6 and 7 of Article XXVI: IV (Residence),
but only insofar as it relates to the residence of a natural person, V (Permanent
Establishment), VII (Business Profits), IX (Related Persons), and XII (Royalties) (but
only (i) insofar as Article XII might apply in transactions involving related persons to
whom Article IX might apply, or (ii) to an allocation of amounts between royalties that
are taxable under paragraph 2 thereof and royalties that are exempt under paragraph 3
thereof). The competent authorities may, however, agree, before the date on which an
Arbitration Proceeding would otherwise have begun, that a particular case is not suitable
for arbitration.
New paragraph 7 provides six subparagraphs that detail the general rules and
definitions to be used in applying the arbitration provisions.
Subparagraph 7(a) provides that the term "concerned person" means the person
that brought the case to competent authority for consideration under Article XXVI
(Mutual Agreement Procedure) and includes all other persons, if any, whose tax liability
to either Contracting State may be directly affected by a mutual agreement arising from
that consideration. For example, a concerned person does not only include a U.S.
corporation that brings a transfer pricing case with respect to a transaction entered into
with its Canadian subsidiary for resolution to the U.S. competent authority, but also the
Canadian subsidiary, which may have a correlative adjustment as a result of the
resolution of the case.
Subparagraph 7( c) provides that an Arbitration Proceeding begins on the later of
two dates: two years from the "commencement date" of the case (unless the competent
authorities have previously agreed to a different date), or the earliest date upon which all
concerned persons have entered into a confidentiality agreement and the agreements have
been received by both competent authorities. The "commencement date" of the case is
defined by subparagraph 7(b) as the earliest date the informatio~ necessary to undertake
substantive consideration for a mutual agreement has been receIved by both competent
authorities.
43
Paragraph 16 of the Arbitration Note provides that each competent authority will
continn in writing to the other competent authority and to the concerned persons the date
of its recei pt of the infonnation necessary to undertake substantive consideration for a
mutual agreement. In the case of the United States. this infonnation is (i) the infonnation
that must be submitted to the U.S. competent authority under Section 4.05 of Rev. Proc.
2006-54.2006-49 I.R.B. 1035 (or any applicable successor publication). and (ii) for cases
initially submitted as a request for an Advance Pricing Agreement, the infonnation that
must be submitted to the Internal Revenue Service under Rev. Proc. 2006-9. 2006-2
I.R.B. 278 (or any applicable successor publication). In the case of Canada, this
infonnation is the infonnation required to be submitted to the Canadian competent
authority under Infonnation Circular 71-17 (or any applicable successor publication).
The infonnation shall not be considered received until both competent authorities have
received copies of all materials submitted to either Contracting State by the concerned
person(s) in connection with the mutual agreement procedure. It is understood that
confinnation of the "infonnation necessary to undertake substantive consideration for a
mutual agreement" is envisioned to ordinarily occur within 30 days after the necessary
infonnation is provided to the competent authority.
The Arbitration Note also provides for several procedural rules once an
Arbitration Proceeding under paragraph 6 of Article XXVI ('"Proceeding") has
commenced, but the competent authorities may modifY or supplement these rules as
necessary. In addition, the arbitration board may adopt any procedures necessary for the
conduct of its business, provided the procedures are not inconsistent with any provision
of Article XXVI of the Convention.
Paragraph 5 of the Arbitration Note provides that each Contracting State has 60
days from the date on which the Arbitration Proceeding begins to send a written
communication to the other Contracting State appointing one member of the arbitration
board. Within 60 days of the date the second of such communications is sent, these two
board members will appoint a third member to serve as the chair of the board. It is
agreed that this third member ordinarily should not be a citizen of either of the
Contracting States.
In the event that any members of the board are not appointed (including as a result
of the failure of the two members appointed by the Contracting States to agree on a third
member) by the requisite date, the remaining members are appointed by the highest
ranking member of the Secretariat at the Centre for Tax Policy and Administration of the
Organisation for Economic Co-operation and Development (DECO) who is not a citizen
of either Contracting State, by written notice to both Contracting States within 60 days of
the date of such failure.
Paragraph 7 of the Arbitration Note establishes deadlines for submission of
materials by the Contracting States to the arbitration board. Each competent authority
has 60 days from the date of appointment of the chair to submit a Proposed Resolution
describing the proposed disposition of the specific monetary amounts of income, expense
or taxation at issue in the case, and a supporting Position Paper. Copies of each State's
submissions are to be provided by the board to the other Contracting State on the date the
later ?f the submissio~s ~s submitted to the. b~ard. Each of the Contracting States may
submIt a Reply SubmISSIOn to the board withm 120 days of the appointment of the chair
to address points raised in the other State's Proposed Resolution or Position Paper. If one
Contracting State fails to submit a Proposed Resolution within the requisite time, the
Proposed Resolution of the other Contracting State is deemed to be the determination of
the arbitra~ion board. Additional information m~y b~ supplied to the arbitration board by
a Contractmg State only at the request of the arbItratIOn board. The board will provide
44
copies of any such requested information, along with the board's request, to the other
Contracting State on the date the request is made or the response is received.
All communication with the board is to be in writing between the chair of the
board and the designated competent authorities with the exception of communication
regarding logistical matters.
In making its determination, the arbitration board will apply the following
authorities as necessary: (i) the provisions of the Convention, (ii) any agreed
commentaries or explanation of the Contracting States concerning the Convention as
amended, (iii) the laws of the Contracting States to the extent they are not inconsistent
with each other, and (iv) any GECD Commentary, Guidelines or Reports regarding
relevant analogous portions of the GECD Model Tax Convention.
The arbitration board must deliver a determination in writing to the Contracting
States within six months of the appointment of the chair. The determination must be one
of the two Proposed Resolutions submitted by the Contracting States. The determination
shall provide a determination regarding only the amount of income, expense or tax
reportable to the Contracting States. The determination has no precedential value and
consequently the rationale behind a board's determination would not be beneficial and
shall not be provided by the board.
Paragraph 11 of the Arbitration Note provides that, unless any concerned person
does not accept the decision of the arbitration board, the determination of the board
constitutes a resolution by mutual agreement under Article XXVI and, consequently, is
binding on both Contracting States. Each concerned person must, within 30 days of
receiving the determination from the competent authority to which the case was first
presented, advise that competent authority whether the person accepts the determination.
The failure to advise the competent authority within the requisite time is considered a
rejection of the determination. If a determination is rejected, the case cannot be the
subject of a subsequent MAP procedure on the same issue(s) determined by the panel,
including a subsequent Arbitration Proceeding. After the commencement of an
Arbitration Proceeding but before a decision of the board has been accepted by all
concerned persons, the competent authorities may reach a mutual agreement to resolve
the case and terminate the Proceeding.
F or purposes of the Arbitration Proceeding, the members of the arbitration board
and their staffs shall be considered "persons or authorities" to whom information may be
disclosed under Article XXVII (Exchange ofInformation). The Arbitration Note
provides that all materials prepared in the course of, or relating to, the Arbitration
Proceeding are considered information exchanged between the Contracting States. No
information relating to the Arbitration Proceeding or the board's determination may be
disclosed by members of the arbitration board or their staffs or by either competent
authority, except as permitted by the Convention and the domestic laws of the
Contracting States. Members of the arbitration board and their staffs must agree in
statements sent to each of the Contracting States in confirmation of their appointment to
the arbitration board to abide by and be subject to the confidentiality and nondisclosure
provisions of Article XXVII of the Co~v~ntion and the ~~plicable d.omestic laws of the
Contracting States, with the most restnctive of the prOVISIOns applymg.
The applicable domestic law of the Contracting States determines the treatment of
any interest or penalties associated with a competent authority agreement achieved
through arbitration.
45
In general. fees and expenses are borne equally by the Contracting States,
including the cost of translation services. However, meeting facilities, related resources,
financial management. other logistical support, and general and administrative
coordination of the Arbitration Proceeding will be provided, at its own cost, by the
Contracting State that initiated the Mutual Agreement Procedure. The fees and expenses
of members of the board will be set in accordance with the International Centre for
Settlement of Investment Disputes (lCSID) Schedule of Fees for arbitrators (in effect on
the date on which the arbitration board proceedings begin). All other costs are to be
borne by the Contracting State that incurs them. Since arbitration of MAP cases is
intended to assist taxpayers in resolving a governmental difference of opinion regarding
the taxation of their income, and is merely an extension of the competent authority
process, no fees will be chargeable to a taxpayer in connection with arbitration.
Article 22
Article 22 of the Protocol amends Article XXVI A (Assistance in Collection) of
the existing Convention. Article XXVI A sets forth provisions under which the United
Sta 1 es and Canada have agreed to assist each other in the collection of taxes.
Paragraph I
Paragraph 1 replaces subparagraph 8(a) of Article XXVI A. In general, new
subparagraph 8(a) provides the circumstances under which no assistance is to be given
under the Article for a claim in respect of an individual taxpayer. New subparagraph 8(a)
contains language that is in substance the same as subparagraph 8(a) of Article XXVI A
of the existing Convention. However, the revised subparagraph also provides that no
assistance in collection is to be given for a revenue claim from a taxable period that
ended before November 9, 1995 in respect of an individual taxpayer, if the taxpayer
became a citizen of the requested State at any time before November 9, 1995 and is such
a citizen at the time the applicant State applies for collection of the claim.
The additional language is intended to avoid the potentially discriminating
application of former subparagraph 8(a) as applied to persons who were not citizens of
the requested State in the taxable period to which a particular collection request related,
but who became citizens of the requested State at a time prior to the entry into force of
Article XXVI A as set forth in the third protocol signed March 17, 1995. New
subparagraph 8(a) addresses this situation by treating the citizenship of a person in the
requested State at anytime prior to November 9, 1995 as comparable to citizenship in the
requested State during the period for which the claim for assistance relates if 1) the
person is a citizen of the requested state at the time of the request for assistance in
collection, and 2) the request relates to a taxable period ending prior to November 9,
1995. As is provided in subparagraph 3(g) of Article 27, this change will have effect for
revenue claims finally determined after November 9, 1985, the effective date of the
adoption of collection assistance in the third protocol signed March 17, 1995.
Paragraph 2
Paragraph 2 replaces paragraph 9 of Article XXVI A of the Convention. Under
paragraph 1 of Article XXVI A, each Contracting State generally agrees to lend
assistance and support to the other in the collection of revenue claims. The term
"revenue claim" is defined in paragraph 1 to include all taxes referred to in paragraph 9 of
the Article, as well as interest, costs, additions to such taxes, and civil penalties. New
paragraph 9 provides that, notwithstanding the provisions of Article II (Taxes Covered)
of the Convention. Article XXVI A shall apply to all categories of taxes collected, and to
contributions to social security and employment insurance premiums levied, by or on
46
behalf of the Government of a Contracting State. Prior to the Protocol, paragraph 9 did
not contain a specific reference to contributions to social security and employment
insurance premiums. Although the prior language covered U.S. federal social security
and unemployment taxes, the language did not cover Canada's social security (e.g. ,
Canada Pension Plan) and employment insurance programs, contributions to which are
not considered taxes under Canadian law and therefore would not otherwise have come
within the scope of the paragraph.
Article 23
Article 23 of the Protocol replaces Article XXVII (Exchange of Information) of
the Convention.
Paragraph 1 ofArticle XXVII
New paragraph 1 of Article XXVII is substantially the same as paragraph 1 of
Article XXVII of the existing Convention. Paragraph 1 authorizes the competent
authorities to exchange information as may be relevant for carrying out the provisions of
the Convention or the domestic laws of Canada and the United States concerning taxes
covered by the Convention, insofar as the taxation under those domestic laws is not
contrary to the Convention. New paragraph 1 changes the phrase "is relevant" to "may
be relevant" to clarify that the language incorporates the standard in Code section 7602
which authorizes the Internal Revenue Service to examine "any books, papers, records, or
other data which may be relevant or material." (Emphasis added.) In United States v.
Arthur Young & Co., 465 U.S. 805,814 (1984), the Supreme Court stated that "the
language 'may be' reflects Congress's express intention to allow the Internal Revenue
Service to obtain 'items of even potential relevance to an ongoing investigation, without
reference to its admissibility. '" (Emphasis in original.) However, the language "may be"
would not support a request in which a Contracting State simply asked for information
regarding all bank accounts maintained by residents of that Contracting State in the other
Contracting State, or even all accounts maintained by its residents with respect to a
particular bank.
The authority to exchange information granted by paragraph 1 is not restricted by
Article I (Personal Scope), and thus need not relate solely to persons otherwise covered
by the Convention. Under paragraph 1, information may be exchanged for use in all
phases of the taxation process including assessment, collection, enforcement or the
determination of appeals. Thus, the competent authorities may request and provide
information for cases under examination or criminal investigation, in collection, on
appeals, or under prosecution.
Any information received by a Contracting State pursuant to the Convention is to
be treated as secret in the same manner as information obtained under the tax laws of that
State. Such information shall be disclosed only to persons or authorities, including courts
and administrative bodies, involved in the assessment or collection of, the administration
and enforcement in respect of, or the determination of appeals in relation to, the taxes
covered by the Convention and the information may be used by such persons only for
such purposes. (In accordance with paragraph 4, for the purposes of this Article the
Convention applies to a broader range of taxes than those covered specifically by Article
II (Taxes Covered». Although the information received by persons described in
paragraph 1 is to be treated as secret, it may be disclosed by such persons in public court
proceedings or in judicial decisions.
Paragraph 1 also permits, however, a Contracting State to provide information
received from the other Contracting State to its states, provinces, or local authorities, if it
47
relates to a tax imposed by that state. province. or local authority that is substantially
similar to a national-level tax covered under Article II (Taxes Covered). This provision
does not authorize a Contracting State to request information on behalf of a state,
province. or local authority. Paragraph I also authorizes the competent authorities to
release information to any arbitration panel that may be established under the provisions
of new paragraph 6 of Article XXVI (Mutual Agreement Procedure). Any information
provided to a state, province, or local authority or to an arbitration panel is subject to the
same use and disclosure provisions as is information received by the national
Governments and used for their purposes.
The provisions of paragraph 1 authorize the U.S. competent authority to continue
to allow legislative bodies, such as the tax-\\>Titing committees of Congress and the
Government Accountability Office to examine tax return information received from
Canada when such bodies or offices are engaged in overseeing the administration of U.S.
tax laws or a study of the administration of U.S. tax laws pursuant to a directive of
Congress. However, the secrecy requirements of paragraph 1 must be met.
It is contemplated that Article XXVII will be utilized by the competent authorities
to exchange information upon request, routinely, and spontaneously.
Paragraph 2 ofArticle XXVII
New paragraph 2 conforms with the corresponding U.S. and OECD Model
provisions. The substance of the second sentence of former paragraph 2 is found in new
paragraph 6 of the Article, discussed below.
Paragraph 2 provides that if a Contracting State requests information in
accordance with Article XXVII, the other Contracting State shall use its information
gathering measures to obtain the requested information. The instruction to the requested
State to "use its information gathering measures" to obtain the requested information
communicates the same instruction to the requested State as the language of former
paragraph 2 that stated that the requested State shall obtain the information "in the same
way as if its own taxation was involved." Paragraph 2 makes clear that the obligation to
provide information is limited by the provisions of paragraph 3, but that such limitations
shall not be construed to permit a Contracting State to decline to obtain and supply
information because it has no domestic tax interest in such information.
In the absence of such a paragraph, some taxpayers have argued that
subparagraph 3(a) prevents a Contracting State from requesting information from a bank
or fiduciary that the Contracting State does not need for its own tax purposes. This
paragraph clarifies that paragraph 3 does not impose such a restriction and that a
Contracting State is not limited to providing only the information that it already has in its
O\\>TI files.
Paragraph 3 ofArticle XXf;11
New paragraph 3 is substantively the same as paragraph 3 of Article XXVII of the
existing Convention. Paragraph 3 provides that the provisions of paragraphs 1 and 2 do
not impose on Canada or the United States the obligation to carry out administrative
measures at variance with the laws and administrative practice of either State; to supply
information which is not obtainable under the laws or in the normal course of the
administration of either State; or to supply information which would disclose any trade,
business. industrial. commercial, or professional secret or trade process, or information
the disclosure of which would be contrary to public policy.
48
Thus, a requesting State may be denied information from the other State if the
information would be obtained pursuant to procedures or measures that are broader than
those available in the requesting State. However, the statute of limitations of the
Contracting State making the request for information should govern a request for
information. Thus, the Contracting State of which the request is made should attempt to
obtain the information even if its own statute of limitations has passed. In many cases,
relevant information will still exist in the business records of the taxpayer or a third party,
even though it is no longer required to be kept for domestic tax purposes.
While paragraph 3 states conditions under which a Contracting State is not
obligated to comply with a request from the other Contracting State for information, the
requested State is not precluded from providing such information, and may, at its
discretion, do so subject to the limitations of its internal law.
As discussed with respect to paragraph 2, in no case shall the limitations in
paragraph 3 be construed to permit a Contracting State to decline to obtain information
and supply information because it has no domestic tax interest in such information.
Paragraph 4 ofArticle XXVII
The language of new paragraph 4 is substantially similar to former paragraph 4.
New paragraph 4, however, consistent with new paragraph 1, discussed above, replaces
the words "'is relevant" with "'may be relevant" in subparagraph 4(b).
Paragraph 4 provides that, for the purposes of Article XXVII, the Convention
applies to all taxes imposed by a Contracting State, and to other taxes to which any other
provision of the Convention applies, but only to the extent that the information may be
relevant for the purposes of the application of that provision.
Article XXVII does not apply to taxes imposed by political subdivisions or local
authorities of the Contracting States. Paragraph 4 is designed to ensure that information
exchange will extend to taxes of every kind (including, for example, estate, gift, excise,
and value added taxes) at the national level in the United States and Canada.
Paragraph 5 ofArticle XXVII
New paragraph 5 conforms with the corresponding U.S. and OECD Model
provisions. Paragraph 5 provides that a Contracting State may not decline to provide
information because that information is held by a financial institution, nominee or person
acting in an agency or fiduciary capacity. Thus, paragraph 5 would effectively prevent a
Contracting State from relying on paragraph 3 to argue that its domestic bank secrecy
laws (or similar legislation relating to disclosure of financial information by financial
institutions or intermediaries) override its obligation to provide information under
paragraph 1. This paragraph also requires the disclosure of information regarding the
beneficial owner of an interest in a person.
Paragraph 6 ofArticle XXVII
The substance of new paragraph 6 is similar to the second sentence of paragraph 2
of Article XXVII of the existing Convention. New paragraph 6 adopts the language of
paragraph 6 of Article 26 (Exchange of Information and Administrative Assistance) of
lhe U.S. Model. New paragraph 6 provides that the requesting State may specify the
form in which information is to be provided (e.g., depositions of witnesses and
authenticated copies of original documents). The intention is to ensure that the information may be introduced as evidence in the judicial proceedings of the requesting State.
49
The requested State should, if possible, provide the infonnation in the fonn requested to
the same extent that it can obtain infonnation in that form under its O\\TI laws and
administrative practices with respect to its O\\TI taxes.
Paragraph 7 (~f Article X¥V/l
New paragraph 7 is consistent with paragraph 8 of Article 26 (Exchange of
Infonnation and Administrative Assistance) of the U.S. Model. Paragraph 7 provides
that the requested State shall allow representatives of the requesting State to enter the
requested State to interview individuals and examine books and records with the consent
of the persons subject to examination. Paragraph 7 was intended to reinforce that the
administrations can conduct consensual tax examinations abroad, and was not intended to
limit travel or supersede any arrangements or procedures the competent authorities may
have previously had in place regarding travel for tax administration purposes.
Paragraph 13 of General Note
As is explained in paragraph 13 of the General Note, the United States and
Canada understand and agree that the standards and practices described in Article XXVII
of the Convention are to be in no respect less effective than those described in the Model
Agreement on Exchange ofInfonnation on Tax Matters developed by the OECD Global
fomm Working Group on Effective Exchange ofInfonnation.
Article 24
Article 24 amends Article XXIX (Miscellaneous Rules) of the Convention.
Paragraph 1
Paragraph 1 replaces paragraph 2 of Article XXIX of the existing Convention.
i\ew paragraph 2 is divided into two subparagraphs. In general, subparagraph 2(a)
provides a "saving clause" pursuant to which the United States and Canada may each tax
its residents, as detennined under Article IV (Residence), and the United States may tax
its citizens and companies, including those electing to be treated as domestic corporations
(e.g. under Code section 1504(d)), as if there were no convention between the United
States and Canada with respect to taxes on income and capital. Subparagraph 2(a)
contains language that generally corresponds to fonner paragraph 2, but omits certain
language pertaining to fonner citizens, which are addressed in new subparagraph 2(b).
New subparagraph 2(b) generally corresponds to the provisions of fonner
paragraph 2 addressing former citizens of the United States. However, new subparagraph
2(b) also includes a reference to fonner long-tenn residents of the United States. This
addition, as well as other changes in subparagraph 2(b), brings the Convention in
confonnity with the U.S. taxation of fonner citizens and long-tenn residents under Code
section 877.
Similar to subparagraph 2(a), new subparagraph 2(b) operates as a "saving
clause" and provides that notwithstanding the other provisions of the Convention. a
fonner citizen or fonner long-tenn resident of the United States, may, for a period often
,,' "s following the loss of such status, be taxed in accordance with the laws of the United
States with respect to income from sources within the United States (including income
deemed under the domestic law of the United States to arise from such sources).
50
Paragraphs 11 and 12 of the General Note provide definitions based on Code
section 877 that are relevant to the application of paragraph 2 of Article XXIX.
Paragraph 11 of the General Note provides that the term "long-term resident" means any
individual who is a lawful permanent resident of the United States in eight or more
taxable years during the preceding 15 taxable years. In determining whether the eightyear threshold is met, one does not count any year in which the individual is treated as a
resident of Canada under this Convention (or as a resident of any country other than the
United States under the provisions of any other U.S. tax treaty), and the individual does
not waive the benefits of such treaty applicable to residents of the other country. This
understanding is consistent with how this provision is generally interpreted in U.S. tax
treaties.
Paragraph 12 of the General Note provides that the phrase "income deemed under
the domestic law of the United States to arise from such sources" as used in new
subparagraph 2(b) includes gains from the sale or exchange of stock ofa U.S. company
or debt obligations of a U.S. person, the United States, a State, or a political subdivision
thereof, or the District of Columbia, gains from property (other than stock or debt
obligations) located in the United States, and, in certain cases, income or gain derived
from the sale of stock of a non-U.S. company or a disposition of property contributed to
such non-U.S. company where such company would be a controlled foreign corporation
with respect to the individual if such person had continued to be a U.S. person. In
addition, an individual who exchanges property that gives rise or would give rise to U.S.source income for property that gives rise to foreign-source income will be treated as if
he had sold the property that would give rise to U.S.-source income for its fair market
value, and any consequent gain shall be deemed to be income from sources within the
United States.
Paragraph 2
Paragraph 2 replaces subparagraph 3(a) of Article XXIX of the existing
Convention. Paragraph 3 provides that, notwithstanding paragraph 2 of Article XXIX,
the United States and Canada must respect specified provisions of the Convention in
regard to certain persons, including residents and citizens. Therefore, subparagraph 3(a)
lists certain paragraphs and Articles of the Convention that represent exceptions to the
"saving clause" in all situations. New subparagraph 3(a) is substantially similar to former
subparagraph 3(a), but now contains a reference to paragraphs 8, 10, and 13 of Article
XVIII (Pensions and Annuities) to reflect the changes made to that article in paragraph 3
of Article 13 of the Protocol.
Article 25
Article 25 of the Protocol replaces Article XXIX A (Limitation on Benefits) of
the existing Convention, which was added to the Convention by the Protocol done on
March 17, 1995. Article XXIX A addresses the problem of "treaty shopping" by
residents of third States by requiring, in most cases, that the person seeking benefits not
only be a U.S. resident or Canadian resident but also satisfy other tests. For example, a
resident of a third State might establish an entity resident in Canada for the purpose of
deriving income from the United States and claiming U.S. treaty benefits with respect to
that income. Article XXIX A limits the benefits granted by the United States or Canada
under the Convention to those persons whose residence in the other Contracting State is
nut considered to have been motivated by the existence of the Convention. As replaced
by the Protocol, new Article XXIX A is reciprocal, and many of the changes to the
former paragraphs of Article XXIX A are made to effectuate this reciprocal application.
51
Absent Article XXIX A. an entity resident in one of the Contracting States would
be entitled to benetits under the Convention, unless it were denied such benetits as a
result of limitations under domestic law (e.g., business purpose, substance-over-lonn,
step transaction, or conduit principles or other anti-avoidance rules) applicable to a
particular transaction or arrangement. As noted below in the explanation of paragraph 7,
general anti-abuse provisions of this sort apply in conjunction with the Convention in
both the United States and Canada. In the case of the United States, such anti-abuse
provisions complement the explicit anti-treaty-shopping rules of Article XXIX A. While
the anti-treaty-shopping rules detennine whether a person has a sufficient nexus to
Canada to be entitled to benefits under the Convention, the anti-abuse provisions under
U.S. domestic law detennine whether a particular transaction should be recast in
accordance with the substance of the transaction.
Paragraph I of Article XXIX A
New paragraph 1 of Article XXIX A provides that, for the purposes of the
application of the Convention, a "qualifying person" shall be entitled to all of the benefits
of the Convention and, except as provided in paragraphs 3, 4, and 6, a person that is not a
qualifying person shall not be entitled to any benefits of the Convention.
Paragraph 2 ofArticle XXIX A
New paragraph 2 lists a number of characteristics anyone of which will make a
United States or Canadian resident a qualifying person. The "look-through" principles
introduced by the Protocol (e.g. paragraph 6 of Article IV (Residence)) are to be applied
in conjunction with Article XXIX A. Accordingly, the provisions of Article IV shall
determine the person who derives an item of income, and the objective tests of Article
XXIX A shall be applied to that person to detennine whether benefits shall be granted.
The rules are essentially mechanical tests and are discussed below.
Individuals and governmental entities
Under new paragraph 2, the first two categories of qualifying persons are (l)
natural persons resident in the United States or Canada (as listed in subparagraph 2(a)),
and (2) the Contracting States, political subdivisions or local authorities thereof, and any
agency or instrumentality of such Government, political subdivision or local authority (as
listed in subparagraph 2(b)). Persons falling into these two categories are unlikely to be
used, as the beneficial owner of income, to derive benefits under the Convention on
behalf of a third-country person. If such a person receives income as a nominee on
behalf of a third-country resident, benefits will be denied with respect to those items of
income under the articles of the Convention that would otherwise grant the benefit,
because of the requirements in those articles that the beneficial owner of the income be a
resident of a Contracting State.
Publicly traded entities
Under new subparagraph 2( c), a company or trust resident in a Contracting State
is a qualifying person if th~ co~pany's 'principa~ class ?f share~, and any disproportionate
clas~ of shares, or the trust s umts, or dI~proportIOnate mterest In a trust, are primarily and
regUlarly traded on one or more recogmzed stock exchanges. The term "recognized stock
exchange" is defined in subparagraph 5(t) of the Article to mean, in the United States the
l\~SDAQ Sys~~m and any stock exchan~e ~egistere~ as a national securities exchang~
WIth the Secuntles and Exchange CommiSSIOn, and, m Canada, any Canadian stock
52
exchanges that are "prescribed stock exchanges" or "designated stock exchanges" under
the Income Tax Act. These are, at the time of signature of the Protocol, the Montreal
Stock Exchange, the Toronto Stock Exchange, and Tiers 1 and 2 of the TSX Venture
Exchange. Additional exchanges may be added to the list of recognized exchanges by
exchange of notes between the Contracting States or by agreement between the
competent authorities.
If a company has only one class of shares, it is only necessary to consider whether
the shares of that class meet the relevant trading requirements. If the company has more
than one class of shares, it is necessary as an initial matter to determine which class or
classes constitute the "principal class of shares." The term "principal class of shares" is
defined in subparagraph See) of the Article to mean the ordinary or common shares of the
company representing the majority of the aggregate voting power and value of the
company. If the company does not have a class of ordinary or common shares
representing the majority of the aggregate voting power and value of the company, then
the "principal class of shares" is that class or any combination of classes of shares that
represents, in the aggregate, a majority of the voting power and value of the company.
Although in a particular case involving a company with several classes of shares it is
conceivable that more than one group of classes could be identified that account for more
~han 50% of the voting power and value of the shares of the company, it is only necessary
for one such group to satisfy the requirements of this subparagraph in order for the
company to be entitled to benefits. Benefits would not be denied to the company even if
a second, non-qualifying, group of shares with more than half of the company's voting
power and value could be identified.
A company whose principal class of shares is regularly traded on a recognized
stock exchange will nevertheless not qualify for benefits under subparagraph 2( c) if it has
a disproportionate class of shares that is not regularly traded on a recognized stock
exchange. The term "disproportionate class of shares" is defined in subparagraph 5(b) of
the Article. A company has a disproportionate class of shares if it has outstanding a class
of shares which is subject to terms or other arrangements that entitle the holder to a larger
portion of the company's income, profit, or gain in the other Contracting State than that to
which the holder would be entitled in the absence of such terms or arrangements. Thus,
for example, a company has a disproportionate class of shares if it has outstanding a class
of "tracking stock" that pays dividends based upon a formula that approximates the
company's return on its assets employed in the United States. Similar principles apply to
determine whether or not there are disproportionate interests in a trust.
The following example illustrates the application of subparagraph 5(b).
Example. OCo is a corporation resident in Canada. OCo has two classes of
shares: Common and Preferred. The Common shares are listed and regularly traded on a
designated stock exchange in Canada. The Preferred shares have no voting rights and are
entitled to receive dividends equal in amount to interest payments that OCo receives from
unrelated borrowers in the United States. The Preferred shares are owned entirely by a
single investor that is a resident of a country with which the United States does not have a
tax treaty. The Common shares account for more than 50 percent ofthe value of OCo
and for 100 percent of the voting power. Because the owner of the Preferred shares is
entitled to receive payments corresponding to the U.S.-source interest income earned by
OCo, the Preferred shares are a disproportionate class of shares. Because the Preferred
shares are not primarily and regularly traded on a recognized stock exchange, OCo will
not qualify for benefits under subparagraph 2( c).
53
The tenn "regularly traded" is not defined in the Convention. In accordance with
paragraph 2 of Article III (General Definitions) and paragraph 1 of the General Note. this
tenn will be defined by reference to the domestic tax laws of the State from which
benefits of the Convention are sought. generally the source State. In the case of the
United States. this tenn is understood to have the meaning it has under Treas. Reg.
section 1.884-5(d)(4)(i)(8), relating to the branch tax provisions of the Code. as may be
amended from time to time. Under these regulations, a class of shares is considered to be
"regularly traded" if two requirements are met: trades in the class of shares are made in
more than de minimis quantities on at least 60 days during the taxable year, and the
aggregate number of shares in the class traded during the year is at least 10 percent of the
average number of shares outstanding during the year. Sections 1.884-5(d)(4)(i)(A), (ii)
and (iii) will not be taken into account for purposes of defining the tenn "regularly
traded" under the Convention.
The regularly-traded requirement can be met by trading on one or more
recognized stock exchanges. Therefore. trading may be aggregated for purposes ofthis
requirement. Thus, a U.S. company could satisfY the regularly traded requirement
through trading, in whole or in part, on a recognized stock exchange located in Canada.
Authorized but unissued shares are not considered for purposes of this test.
The tenn "primarily traded" is not defined in the Convention. In accordance with
paragraph 2 of Article III (General Definitions) and paragraph 1 of the General Note, this
term will have the meaning it has under the laws of the State concerning the taxes to
which the Convention applies, generally the source State. In the case of the United
States, this tenn is understood to have the meaning it has under Treas. Reg. section
1.884-5(d)(3), as may be amended from time to time, relating to the branch tax provisions
of the Code. Accordingly, stock ofa corporation is "primarily traded" if the number of
shares in the company's principal class of shares that are traded during the taxable year
on all recognized stock exchanges exceeds the number of shares in the company's
principal class of shares that are traded during that year on all other established securities
markets.
Subject to the adoption by Canada of other definitions, the U.S. interpretation of
"regularly traded" and "primarily traded" will be considered to apply, with such
modifications as circumstances require, under the Convention for purposes of Canadian
taxation.
Subsidiaries ofpublicly traded entities
Certain companies owned by publicly traded corporations also may be qualifYing
persons. Under subparagraph 2(d), a company resident in the United States or Canada
will be a qualifying person, even if not publicly traded, if more than 50 percent of the
vote and value of its shares, and more than 50 percent of the vote and value of each
disproportionate class of shares, is owned (directly or indirectly) by five or fewer persons
that are qualifYing persons under subparagraph 2(c). In addition, each company in the
chain of ownership must be a qualifYing person. Thus, for example, a company that is a
resident of Canada, all the shares of which are owned by another company that is a
resident of Canada. would qualifY for benefits of the Convention if the principal class of
shares.(an~ any disproportionate .classes of shares) of the parent company are regularly
and pnmanly traded on a recogmzed stock exchange. However, such a subsidiary would
'.ot qualif): for benefit~ under subparagraph 2( d) if the pu?licly traded parent company
were a restdent of a thtrd state. for example, and not a reSIdent of the United States or
Can~da .. Furthennore. if a parent c.ompany qualifYing for be~efits under subparagraph
.2( c) Indtrectly owned the bottom-tIer company through a chaIn of subsidiaries, each
54
subsidiary in the chain, as an intermediate owner, must be a qualifying person in order for
the bottom-tier subsidiary to meet the test in subparagraph 2( d).
Subparagraph 2(d) provides that a subsidiary can take into account ownership by
as many as five companies, each of which qualifies for benefits under subparagraph 2(c)
to determine if the subsidiary qualifies for benefits under subparagraph 2(d). For
example, a Canadian company that is not publicly traded but that is owned, one-third
each, by three companies, two of which are Canadian resident corporations whose
principal classes of shares are primarily and regularly traded on a recognized stock
exchange, will qualify under subparagraph 2( d).
By applying the principles introduced by the Protocol (e.g. paragraph 6 of Article
IV) in the context of this rule, one "looks through" entities in the chain of ownership that
are viewed as fiscally transparent under the domestic laws of the State of residence (other
than entities that are resident in the State of source).
The 50-percent test under subparagraph 2( d) applies only to shares other than
"debt substitute shares." The term "debt substitute shares" is defined in subparagraph
5(a) to mean shares defined in paragraph (e) of the definition in the Canadian Income Tax
Act of "term preferred shares" (see subsection 248(1) of the Income Tax Act), which
relates to certain shares received in debt-restructuring arrangements undertaken by reason
of financial difficulty or insolvency. Subparagraph 5(a) also provides that the competent
authorities may agree to treat other types of shares as debt substitute shares.
Ownership/base erosion test
Subparagraph 2(e) provides a two-part test under which certain other entities may
be qualifying persons, based on ownership and lack of "base erosion." A company
resident in the United States or Canada will satisfy the first of these tests if 50 percent or
more of the vote and value of its shares and 50 percent or more of the vote and value of
each disproportionate class of shares, in both cases not including debt substitute shares, is
not owned, directly or indirectly, by persons other than qualifying persons. Similarly, a
trust resident in the United States or Canada will satisfy this first test if 50 percent or
more of its beneficial interests, and 50 percent or more of each disproportionate interest,
is not owned, directly or indirectly, by persons other than qualifying persons. The
wording of these tests is intended to make clear that, for example, if a Canadian company
is more than 50 percent owned, either directly or indirectly (including cumulative indirect
ownership through a chain of entities), by a U.S. resident corporation that is, itself,
wholly owned by a third-country resident other than a qualifying person, the Canadian
company would not pass the ownership test. This is because more than 50 percent of its
shares is owned indirectly by a person (the third-country resident) that is not a qualifying
person.
It is understood by the Contracting States that in determining whether a company
satisfies the ownership test described in subparagraph 2(e)(i), a company, 50 percent of
more of the aggregate vote and value of the shares of which and 50 percent or more of the
vote and value of each disproportionate class of shares (in neither case including debt
substitute shares) of which is owned, directly or indirectly, by a company described in
subparagraph 2( c) will satisfy the ownership test of subparagraph 2( e)(i). In such case,
no further analysis of the ownership of the company described in subparagraph 2( c) is
required. Similarly, in determining whether a trust satisfies the ownership test described
in subparagraph 2(e)(ii), a trust, 50 percent or more of the beneficial interest in which and
')0 percent or more of each disproportionate interest in which, is owned, directly or
indirectly, by a trust described in subparagraph (2)(c) will satisfy the ownership test of
55
subparagraph (2)(e)(ii). and no further analysis of the o\\'nership of the trust described in
subparagraph 2( c) is required.
The second test of subparagraph 2( e) is the so-called "base erosion" test. A
company or trust that passes the o\\'TIership test must also pass this test to be a qualifying
person under this subparagraph. This test requires that the amount of expenses that are
paid or payable by the entity in question. directly or indirectly. to persons that are not
qualifying persons. and that are deductible from gross income (with both deductibility
and gross income as determined under the tax laws of the State of residence of the
company or trust). be less than 50 percent of the gross income of the company or trust.
This test is applied for the fiscal period immediately preceding the period for which the
qualifying person test is being applied. If it is the first fiscal period of the person, the test
is applied for the current period.
The o\\'nershipibase erosion test recognizes that the benefits of the Convention
can be enjoyed indirectly not only by equity holders of an entity, but also by that entity's
obligees, such as lenders, licensors. service providers, insurers and reinsurers, and others.
For example, a third-country resident could license technology to a Canadian-o\\'ned
Canadian corporation to be sub-licensed to a U.S. resident. The U.S.-source royalty
income of the Canadian corporation would be exempt from U.S. withholding tax under
Article XII (Royalties) of the Convention. While the Canadian corporation would be
subject to Canadian corporation income tax, its taxable income could be reduced to near
zero as a result of the deductible royalties paid to the third-country resident. If, under a
convention between Canada and the third country, those royalties were either exempt
from Canadian tax or subject to tax at a low rate, the U.S. treaty benefit with respect to
the U.S.-source royalty income would have tlowed to the third-country resident at little or
no tax cost, with no reciprocal benetit to the United States from the third country. The
o\\'TIershiplbase erosion test therefore requires both that qualifying persons substantially
O\\'TI the entity and that the entity's tax base is not substantially eroded by payments
(directly or indirectly) to nonqualifying persons.
For purposes of this subparagraph 2(e) and other provisions of this Article, the
term "shares" includes. in the case of a mutual insurance company, any certificate or
contract entitling the holder to voting power in the corporation. This is consistent with
the interpretation of similar limitation on benefits provisions in other U.S. treaties. In
Canada. the principles that are retlected in subsection 256(8.1) of the Income Tax Act
will be applied, in effect treating memberships, policies or other interests in a corporation
incorporated without share capital as representing an appropriate number of shares.
The look-through principles introduced by the Protocol (e.g. new paragraph 6 of
Article IV) are to be taken into account when applying the o\\'TIership and base erosion
provisions of Article XXIX A. Therefore, one "looks through" an entity that is viewed as
fiscally transparent under the domestic laws of the residence State (other than entities that
are resident in the source State) when applying the ownershipibase erosion test. Assume
for example. that USCo, a company incorporated in the United States, wishes to obtain '
treaty benefits by virtue of the ownership and base erosion rule. USCo is o\\'TIed by
USLLC. an entity that is treated as fiscally transparent in the United States. USLLC in
tum is wholly o\\'ned in equal shares by 10 individuals who are residents of the United
States. Because the United States views USLLC as fiscally transparent, the 10 U.S.
individuals shall be regarded as the o\\'ners of USCo for purposes of the o\\'TIership test.
Accordingly. USCo would satisfy the o\\'nership requirement of the o\\'TIershiplbase
~ro~i?n test. Ho~e~er: i~ USLLC were instead. owned ~n .equal shares by four U.S.
mdlvlduals and SIX mdlvlduals who are not reSIdents ot eIther the United States or
56
Canada, USCo would not satisfy the ownership requirement. Similarly, for purposes of
the base erosion test, deductible payments made to USLLC will be treated as made to
USLLC's owners.
Other qualifYing persons
Under new subparagraph 2(f), an estate resident in the United States or Canada is
a qualifying person entitled to the benefits of the Convention.
New subparagraphs 2(g) and 2(h) specify the circumstances under which certain
types of not-for-profit organizations will be qualifying persons. Subparagraph 2(g)
provides that a not-for-profit organization that is resident in the United States or Canada
is a qualifying person, and thus entitled to benefits, if more than half of the beneficiaries,
members, or participants in the organization are qualifying persons. The term "not-forprofit organization" of a Contracting State is defined in subparagraph 5( d) of the Article
to mean an entity created or established in that State that is generally exempt from
income taxation in that State by reason of its not-for-profit status. The term includes
charities, private foundations, trade unions, trade associations, and similar organizations.
New subparagraph 2(h) specifies that certain trusts, companies, organizations, or
other arrangements described in paragraph 2 of Article XXI (Exempt Organizations) are
qualifying persons. To be a qualifying person, the trust, company, organization or other
arrangement must be established for the purpose of providing pension, retirement, or
employee benefits primarily to individuals who are (or were, within any of the five
preceding years) qualifying persons. A trust, company, organization, or other
arrangement will be considered to be established for the purpose of providing benefits
primarily to such persons if more than 50 percent of its beneficiaries, members, or
participants are such persons. Thus, for example, a Canadian Registered Retirement
Savings Plan ("RRSP") of a former resident of Canada who is working temporarily
outside of Canada would continue to be a qualifying person during the period of the
individual's absence from Canada or for five years, whichever is shorter. A Canadian
pension fund established to provide benefits to persons employed by a company would be
a qualifying person only if most of the beneficiaries of the fund are (or were within the
five preceding years) individual residents of Canada or residents or citizens of the United
States.
New subparagraph 2(i) specifies that certain trusts, companies, organizations, or
other arrangements described in paragraph 3 of Article XXI (Exempt Organizations) are
qualifying persons. To be a qualifying person, the beneficiaries of a trust, company,
organization or other arrangement must be described in subparagraph 2(g) or 2(h).
The provisions of paragraph 2 are self-executing, unlike the provisions of
paragraph 6, discussed below. The tax authorities may, of course, on review, determine
that the taxpayer has improperly interpreted the paragraph and is not entitled to the
benefits claimed.
Paragraph 3 ofArticle XXIX A
Paragraph 3 provides an alternative rule, under which a United States or Canadian
resident that is not a qualifying person under paragraph 2 may claim benefits with respect
to those items of income that are connected with the active conduct of a trade or business
in its State of residence.
57
This is the so-called "active trade or business" test. Unlike the tests of paragraph
2, the active trade or business test looks not solely at the characteristics of the person
deriving the income, but also at the nature of the person's activity and the connection
between the income and that activity. Under the active trade or business test, a resident
of a Contracting State deriving an item of income from the other Contracting State is
entitled to benefits with respect to that income if that person (or a person related to that
person under the principles of Code section 482, or in the case of Canada, section 251 of
the Income Tax Act) is engaged in an active trade or business in the State where it is
resident, the income in question is derived in connection with, or is incidental to, that
trade or business, and the size of the active trade or business in the residence State is
substantial relative to the activity in the other State that gives rise to the income for which
benefits are sought. Further details on the application of the substantiality requirement
are provided below.
Income that is derived in connection with, or is incidental to, the business of
making or managing investments will not qualify for benefits under this provision, unless
those investment ac~ivities are carried on with customers in the ordinary course of the
business of a bank, insurance company, registered securities dealer, or deposit-taking
financial institution.
Income is considered derived "in connection" with an active trade or business if,
for example, the income-generating activity in the State is "upstream," "downstream," or
parallel to that conducted in the other Contracting State. Thus, for example, ifthe U.S.
activity of a Canadian resident company consisted of selling the output of a Canadian
manufacturer or providing inputs to the manufacturing process, or of manufacturing or
selling in the United States the same sorts of products that were being sold by the
Canadian trade or business in Canada, the income generated by that activity would be
treated as earned in connection with the Canadian trade or business. Income is
considered "incidental" to a trade or business if, for example, it arises from the short-term
investment of working capital of the resident in securities issued by persons in the State
of source.
An item of income may be considered to be earned in connection with or to be
incidental to an active trade or business in the United States or Canada even though the
resident claiming the benefits derives the income directly or indirectly through one or
more other persons that are residents of the other Contracting State. Thus, for example, a
Canadian resident could claim benefits with respect to an item of income earned by a
U.S. operating subsidiary but derived by the Canadian resident indirectly through a
wholly-owned U.S. holding company interposed between it and the operating subsidiary.
This language would also permit a resident to derive income from the other Contracting
State through one or more residents of that other State that it does not wholly own. For
example, a Canadian partnership in which three unrelated Canadian companies each hold
a one-third interest could form a wholly-owned U.S. holding company with a U.S.
operating subsidiary. The "directly or indirectly" language would allow otherwise
unavailable treaty benefits to be claimed with respect to income derived by the three
Canadian partners through the U.S. holding company, even if the partners were not
considered to be related to the U.S. holding company under the principles of Code section
482.
As described above, income that is derived in connection with, or is incidental to
,
an a~tive trade or b~iness in a Contracting State, mu~t pass the substantiality
reqUIrement to quahfy for benefits under the ConventlOn. The trade or business must be
substantial in relation to the activity in the other Contracting State that gave rise to the
income in respect of which benefits under the Convention are being claimed. To be
58
considered substantial, it is not necessary that the trade or business be as large as the
income-generating activity. The trade or business cannot, however, in terms of income,
assets, or other similar measures, represent only a very small percentage of the size of the
activity in the other State.
The substantiality requirement is intended to prevent treaty shopping. For
example, a third-country resident may want to acquire a U.S. company that manufactures
television sets for worldwide markets; however, since its country of residence has no tax
treaty with the United States, any dividends generated by the investment would be subject
to a U.S. withholding tax of 30 percent. Absent a substantiality test, the investor could
establish a Canadian corporation that would operate a small outlet in Canada to sell a few
of the television sets manufactured by the U.S. company and earn a very small amount of
income. That Canadian corporation could then acquire the U.S. manufacturer with
capital provided by the third-country resident and produce a very large number of sets for
sale in several countries, generating a much larger amount of income. It might attempt to
argue that the U.S.-source income is generated from business activities in the United
States related to the television sales activity of the Canadian parent and that the dividend
income should be subject to U.S. tax at the 5 percent rate provided by Article X
(Dividends) of the Convention. However, the substantiality test would not be met in this
example, so the dividends would remain subject to withholding in the United States at a
rate of 30 percent.
It is expected that if a person qualifies for benefits under one of the tests of
paragraph 2, no inquiry will be made into qualification for benefits under paragraph 3.
Upon satisfaction of any of the tests of paragraph 2, any income derived by the beneficial
owner from the other Contracting State is entitled to treaty benefits. Under paragraph 3,
however, the test is applied separately to each item of income.
Paragraph 4 ofArticle XXIX A
Paragraph 4 provides a limited "derivative benefits" test that entitles a company
that is a resident of the United States or Canada to the benefits of Articles X (Dividends),
XI (Interest), and XII (Royalties), even ifthe company is not a qualifying person and
does not satisfy the active trade or business test of paragraph 3. In general, a derivative
benefits test entitles the resident of a Contracting State to treaty benefits if the owner of
the resident would have been entitled to the same benefit had the income in question been
earned directly by that owner. To qualify under this paragraph, the company must satisfy
both the ownership test in subparagraph 4(a) and the base erosion test of subparagraph
4(b).
Under subparagraph 4(a), the derivative benefits ownership test requires that the
company's shares representing more than 90 percent of the aggregate vote and value of
all of the shares of the company, and at least 50 percent of the vote and value of any
disproportionate class of shares, in neither case including debt substitute shares, be
owned directly or indirectly by persons each of whom is either (i) a qualifying person or
(ii) another person that satisfies each of three tests. The three tests of subparagraph 4(a)
that must be satisfied by these other persons are as follows:
First, the other person must be a resident of a third State with which the
Contracting State that is granting benefits has a comprehensive income tax convention.
The other person must be entitled to all of the benefits under that convention. Thus, if the
person fails to satisfy the limitation on benefits tests, if any, of that convention, no
benefits would be granted under this paragraph. Qualification for benefits under an
59
active trade or business test does not suffice for these purposes. because that test grants
benetits only for certain items of income. not for all purposes of the convention.
Second. the other person must be a person that would qualify for benefits with
respect to the item of income for which benetits are sought under one or more of the tests
of paragraph 2 or 3 of Article XXIX A, if the person were a resident of the Contracting
State that is not providing benetits for the item of income and, for purposes of paragraph
3. the business were carried on in that State. For example, a person resident in a third
country would be deemed to be a person that would qualify under the publicly-traded test
of paragraph 2 of Article XXIX A if the principal class of its shares were primarily and
regularly traded on a stock exchange recognized either under the Convention between the
United States and Canada or under the treaty between the Contracting State granting
benefits and the third country. Similarly, a company resident in a third country would be
deemed to satisfy the ownership/base erosion test of paragraph 2 under this hypothetical
analysis if, for example, it were wholly owned by an individual resident in that third
country and the company's tax base were not substantially eroded by payments (directly
or indirectly) to nonqualifying persons.
The third requirement is that the rate of tax on the item of income in respect of
which benefits are sought must be at least as low under the convention between the
person's country of residence and the Contracting State granting benefits as it is under the
Convention.
Subparagraph 4(b) sets forth the base erosion test. This test requires that the
amount of expenses that are paid or payable by the company in question, directly or
indirectly, to persons that are not qualifying persons under the Convention, and that are
deductible from gross income (with both deductibility and gross income as determined
under the tax laws of the State of residence of the company), be less than 50 percent of
the gross income of the company. This test is applied for the fiscal period immediately
preceding the period for which the test is being applied. If it is the first fiscal period of
the person, the test is applied for the current period. This test is qualitatively the same as
the base erosion test of subparagraph 2( e).
Paragraph 5 ofArticle XXIX A
Paragraph 5 defines certain terms used in the Article. These terms were identified
and discussed in connection with new paragraph 2, above.
Paragraph 6 ofArticle XXIX A
Paragraph 6 provides that when a resident of a Contracting State derives income
from the other Contracting State and is not entitled to the benefits of the Convention
under other provisions of the Article, benefits may, nevertheless be granted at the
discretion of the competent authority of the other Contracting State. This determination
can. be made "Yith respect t? al~ benefits u~der the Convention or on an item by item
bas1s. In makmg a determmatlOn under thIS paragraph, the competent authority will take
into account all ~elevant facts and circumsta~ces ~elating .to the person requesting the
benefits. In partIcular, the competent authonty wIll conSIder the history, structure
O\v~e.rship (including ultimate ?e~eficial o~'I1ership), and operations of the person~ In
addItlOn. the competent authonty 1S to conSIder (1) whether the creation and existence of
the person did not have as a principal purpose obtaining treaty benefits that would not
ot~erwise be available to. the person, and (2) whether it would not be appropriate, in view
ot the purpose of the ArtIcle, to deny benefits. If the competent authority of the other
60
Contracting State determines that either of these two standards is satisfied, benefits shall
be granted.
For purposes of implementing new paragraph 6, a taxpayer will be permitted to
present his case to the competent authority for an advance determination based on a full
disclosure of all pertinent information. The taxpayer will not be required to wait until it
has been determined that benefits are denied under one of the other provisions of the
Article. It also is expected that, if and when the competent authority determines that
benefits are to be allowed, they will be allowed retroactively to the time of entry into
force of the relevant provision of the Convention or the establishment of the structure in
question, whichever is later (assuming that the taxpayer also qualifies under the relevant
facts for the earlier period).
Paragraph 7 ofArticle XXIX A
New paragraph 7 is in substance similar to paragraph 7 of Article XXIX A of the
existing Convention and clarifies the application of general anti-abuse provisions. New
paragraph 7 provides that paragraphs 1 through 6 of Article XXIX A shall not be
construed as limiting in any manner the right of a Contracting State to deny benefits
,:~r the Convention where it can reasonably be concluded that to do otherwise would
result in an abuse of the provisions of the Convention. This provision permits a
Contracting State to rely on general anti-avoidance rules to counter arrangements
involving treaty shopping through the other Contracting State.
Thus, Canada may apply its domestic law rules to counter abusive arrangements
involving "treaty shopping" through the United States, and the United States may apply
its substance-over-form and anti-conduit rules, for example, in relation to Canadian
residents. This principle is recognized by the OECD in the Commentaries to its Model
Tax Convention on Income and on Capital, and the United States and Canada agree that it
is inherent in the Convention. The statement of this principle explicitly in the Protocol is
not intended to suggest that the principle is not also inherent in other tax conventions
concluded by the United States or Canada.
Article 26
Article 26 of the Protocol replaces paragraphs 1 and 5 of Article XXIX B (Taxes
Imposed by Reason of Death) of the Convention. In addition, paragraph 7 of the General
Note provides certain clarifications for purposes of paragraphs 6 and 7 of Article XXIX
B.
Paragraph 1
Paragraph 1 of Article XXIX B of the existing Convention generally addresses the
situation where a resident of a Contracting State passes property by reason of the
individual's death to an organization referred to in paragraph 1 of Article XXI (Exempt
Organizations) of the Convention. The paragraph provided that the tax consequences in a
Contracting State arising out of the passing of the property shall apply as if the
organization were a resident of that State.
The Protocol replaces paragraph 1, and the changes set forth in new paragraph 1
are intended to specifically address questions that have arisen about the application of
former paragraph 1 where property of an individual who is a resident of Canada passes
by reason of the individual's death to a charitable organization in the United States that is
not a "registered charity" under Canadian law. Under one view, paragraph 1 of Article
61
XXIX B requires Canada to treat the passing of the property as a contribution to a
"registered charity" and thus to allow all of the same deductions for Canadian tax
purposes as if the U.S. charity had been a "registered charity" under Canadian law.
Under another view. paragraph 6 of Article XXI (Exempt Organizations) of the
Convention continues to limit the amount of the income tax charitable deduction in
Canada to the individual's income arising in the United States. The changes set forth in
new paragraph 1 are intended to provide relief from the Canadian tax on gain deemed
recognized by reason of death that would otherwise give rise to Canadian tax when the
individual passes the property to a charitable organization in the United States, but, for
purposes of the separate Canadian income tax, do not eliminate the limitation under
paragraph 6 of Article XXI on the amount of the deduction in Canada for the charitable
donation to the individual's income arising in the United States.
As revised, paragraph 1 is divided into two subparagraphs. New subparagraph
1(a) applies where property of an individual who is a resident of the United States passes
by reason of the individual's death to a qualifying exempt organization that is a resident
of Canada. In such case, the tax consequences in the United States arising from the
passing of such property apply as if the organization were a resident of the United States.
A bequest by a U.S. citizen or U.S. resident (as defined for estate tax purposes under the
Code) to an exempt organization generally is deductible for U.S. federal estate tax
purposes under Code section 2055, without regard to whether the organization is a U.S.
corporation. Thus, generally, the individual's estate will be entitled to a charitable
deduction for Federal estate tax purposes equal to the value of the property transferred to
the organization. Generally, the effect is that no Federal estate tax will be imposed on the
value of the property.
New subparagraph l(b) applies where property of an individual who is a resident
of Canada passes by reason of the individual's death to a qualifying exempt organization
that is a resident of the United States. In such case, for purposes of the Canadian capital
gains tax imposed at death, the tax consequences arising out of the passing of the
property shall apply as if the individual disposed of the property for proceeds equal to an
amount elected on behalf of the individual. For this purpose, the amount elected shall be
no less than the individual's cost of the property as determined for purposes of Canadian
tax, and no greater than the fair market value of the property. The manner in which the
individual's representative shall make this election shall be specified by the competent
authority of Canada. Generally, in the event of a full exercise of the election under new
subparagraph 1(b), no capital gains tax will be imposed in Canada by reason of the death
with regard to that property.
New paragraph 1 does not address the situation in which a resident of one
Contracting State bequeaths property with a situs in the other Contracting State to a
qualifying exempt organization in the Contracting State of the decedent's residence. In
such a situation, the other Contracting State may impose tax by reason of death, for
example, if the property is real property situated in that State.
Paragraph 2
Paragraph 2 of Article 26 of the Protocol replaces paragraph 5 of Article XXIX B
of the existing Convention. The provisions of new paragraph 5 relate to the operation of
f'anadian law. Because Canadian law requires both spouses to have been Canadian
res~dents ,!n order ~~ b~ eligible fOT the rollover, these pro,:,isions are intended to provide
de terral ( rollover ~ of the Can~dIan tax at death for ~ertam transfers to a surviving
spouse and to permIt the CanadIan competent authonty to allow such deferral for certain
tlansfers to a trust. For example, they would enable the competent authority to treat a
62
trust that is a qualified domestic trust for U.S. estate tax purposes as a Canadian spousal
trust as well for purposes of certain provisions of Canadian tax law and of the
Convention. These provisions do not affect U.S. domestic law regarding qualified
domestic trusts. Nor do they affect the status of U.S. resident individuals for any other
purpose.
New paragraph 5 adds a reference to subsection 70(5.2) of the Canadian Income
Tax Act. This change is needed because the rollover in respect of certain kinds of
property is provided in that subsection. Further, new paragraph 5 adds a clause "and with
respect to such property" near the end of the second sentence to make it clear that the
trust is treated as a resident of Canada only with respect to its Canadian property.
For example, assume that a U.S. decedent with a Canadian spouse sets up a
qualified domestic trust holding U.S. and Canadian real property, and that the decedent's
executor elects, for Federal estate tax purposes, to treat the entire trust as qualifying for
the Federal estate tax marital deduction. Under Canadian law, because the decedent is
not a Canadian resident, Canada would impose capital gains tax on the deemed
disposition of the Canadian real property immediately before death. In order to defer the
Canadian tax that might otherwise be imposed by reason of the decedent's death, under
new paragraph 5 of Article XXIX B, the competent authority of Canada shall, at the
request of the trustee, treat the trust as a Canadian spousal trust with respect to the
Canadian real property. The effect of such treatment is to defer the tax on the deemed
distribution of the Canadian real property until an appropriate triggering event such as the
death of the surviving spouse.
Paragraph 7 of the General Note
In addition to the foregoing, paragraph 7 of the General Note provides certain
clarifications for purposes of paragraphs 6 and 7 of Article XXIX B. These clarifications
ensure that tax credits will be available in cases where there are inconsistencies in the
way the two Contracting States view the income and the property.
Subparagraph 7(a) of the General Note applies where an individual who
immediately before death was a resident of Canada held at the time of death a share or
option in respect of a share that constitutes property situated in the United States for the
purposes of Article XXIX B and that Canada views as giving rise to employment income
(for example, a share or option granted by an employer). The United States imposes
estate tax on the share or option in respect of a share, while Canada imposes income tax
on income from employment. Subparagraph 7(a) provides that for purposes of clause
6(a )(ii) of Article XXIX B, any employment income in respect of the share or option
constitutes income from property situated in the United States. This provision ensures
that the estate tax paid on the share or option in the United States will be allowable as a
deduction from the Canadian income tax.
Subparagraph 7(b) ofthe General Note applies where an individual who
immediately before death was a resident of Canada held at the time of death a registered
retirement savings plan (RRSP) or other entity that is a resident of Canada and that is
described in subparagraph 1(b) of Article IV (Residence) and such RRSP or other entity
held property situated in the United States for the purposes of Article XXIX B. The
United States would impose estate tax on the value of the property held by the RRSP or
other entity (to the extent such property is subject to Federal estate tax), while Canada
would impose income tax on a deemed distri~ution of the property in the ~S~ or other
entity. Subparagraph 7(b) provides that any Income out.?f or un~er the entlty t~ respect
of the property is, for the purpose of subparagraph 6(a)(1l) of Arttcle XXIX B, Income
63
from property situated in the United States. This provision ensures that the estate tax
paid on the underlying property in the United States (if any) will be allowable as a
deduction from the Canadian income tax.
Subparagraph 7(c) of the General Note applies where an individual who
immediatelv before death was a resident or citizen of the United States held at the time of
death an RRSP or other entity that is a resident of Canada and that is described in
subparagraph 1(b) of Article IV (Residence). The United States would impose estate tax
on the value of the property held by the RRSP or other entity, while Canada would
impose income tax on a deemed distribution of the property in the RRSP or other entity.
Subparagraph 7( c) provides that for the purpose of paragraph 7 of Article XXIX B, the
tax imposed in Canada is imposed in respect of property situated in Canada. This
provision ensures that the Canadian income tax will be allowable as a credit against the
U.S. estate tax.
Article 27
Article 27 of the Protocol provides the entry into force and effective date of the
provisions of the Protocol.
Paragraph 1
Paragraph 1 provides generally that the Protocol is subject to ratification in
accordance with the applicable procedures in the United States and Canada. Further, the
Contracting States shall notify each other by written notification, through diplomatic
channels, when their respective applicable procedures have been satisfied.
Paragraph 2
The first sentence of paragraph 2 generally provides that the Protocol shall enter
into force on the date of the later of the notifications referred to in paragraph 1, or
January 1, 2008, whichever is later. The relevant date is the date on the second of these
notitication documents, and not the date on which the second notification is provided to
the other Contracting State. The January 1,2008 date is intended to ensure that the
provisions of the Protocol will generally not be effective before that date.
Subparagraph 2(a) provides that the provisions of the Protocol shall have effect in
respect of taxes withheld at source, for amounts paid or credited on or after the first day
of the second month that begins after the date on which the Protocol enters into force.
Further. subparagraph 2(b) provides that the Protocol shall have effect in respect of other
taxes. for taxable years that begin after (or, if the later of the notifications referred to in
paragraph 1 is dated in 2007. taxable years that begin in and after) the calendar year in
which the Protocol enters into force. These provisions are generally consistent with the
formulation in the U.S. Model treaty. with the exception that a parenthetical was added in
subparagraph 2(b) to address the contingency that the \Hitten notifications provided
pursuant to paragraph 1 may occur in the 2007 calendar year. Further, subparagraph 3(d)
of Article 27 of the Protocol contains special provisions with respect to the taxation of
cross-border interest payments that have effect for the first two calendar years that end
after the date the Protocol enters into force. Therefore, during this period, cross-border
interest payments are not subject to the effective date provisions of subparagraph 2(a).
r
'I
:igraph 3
Paragraph 3 sets forth exceptions to the general effective date rules set forth in
paragraph 2 of Article 27 of the Protocol.
64
Dual corporate residence tie-breaker
Subparagraph 3(a) of Article 27 of the Protocol provides that paragraph 1 of
Article 2 of the P!otoc.ol relating to Article IV (Residence) shall have effect with respect
to corporate contmuatlOns effected after September 17, 2000. This date corresponds to a
press release issued on September 18, 2000 in which the United States and Canada
identified certain issues with respect to these transactions and stated their intention to
negotiate a protocol that, if approved, would address the issues effective as of the date of
the press release.
Certain payments through fiscally transparent entities
Subparagraph 3(b) of Article 27 of the Protocol provides that new paragraph 7 of
Article IV (Residence) set forth in paragraph 2 of Article 2 of the Protocol shall have
effect as of the first day of the third calendar year that ends after the Protocol enters into
force.
Permanent establishment from the provision ofservices
Subparagraph 3(c) of Article 27 of the Protocol sets forth the effective date for the
provisions of Article 3 ofthe Protocol, pertaining to Article V (Permanent Establishment)
of the Convention. The provisions pertaining to Article V shall have effect as of the third
taxable year that ends after the Protocol enters into force, but in no event shall it apply to
include, in the determination of whether an enterprise is deemed to provide services
through a permanent establishment under paragraph 9 of Article V of the Convention,
any days of presence, services rendered, or gross active business revenues that occur or
arise prior to January 1, 2010. Therefore, the provision will apply beginning no earlier
than January 1, 2010 and shall not apply with regard to any presence, services or related
revenues that occur or arise prior to that date.
Withholding rates on cross-border interest payments
Subparagraph 3(d) of Article 27 ofthe Protocol sets forth special effective date
rules pertaining to Article 6 of the Protocol relating to Article XI (Interest) ofthe
Convention. Article 6 of the Protocol sets forth a new Article XI of the Convention that
provides for exclusive residence State taxation regardless of the relationship between the
payer and the beneficial owner of the interest. Subparagraph 3(d), however, phases in the
application of paragraph 1 of Article XI during the first two calendar years that end after
the date the Protocol enters into force. During that period, paragraph 1 of Article XI of
the Convention permits source State taxation of interest if the payer and the beneficial
owner are related or deemed to be related by reason of paragraph 2 of Article IX (Related
Persons) of the Convention ("related party interest"), and the interest would not otherwise
be exempt under the provisions of paragraph 3 of Article XI as it read prior to the
Protocol. However, subparagraph 3(d) also provides that the source State taxation on
such related party interest is limited to 7 percent in the first calendar year that ends after
entry into force of the Protocol and 4 percent in the second calendar year that ends after
entry into force of the Protocol.
Subparagraph 3(d) makes clear that the provisions of the Protocol with respect to
exclusive residence based taxation of interest when the payer and the beneficial owner
are not related or deemed related ("unrelated party interest") applies for interest paid or
credited during the first two calendar years that end after entry into force of the Protocol.
65
The \\ ithholding rate reductions for related party interest and exemptions for
unrelated party interest will likely apply retroactively. For example, if the Protocol enters
into force on June 30, 2008, paragraph 1 of Article XI, as it reads under subparagraph
3(d) of Article 27, will have the following dIect during the tirst two calendar years.
First. unrelated party interest that is paid or credited on or after January 1. 2008 will be
exempt from taxation in the source State. Second, related party interest paid or credited
on or after January 1, 2008 and before January 1, 2009, will be subject to source State
taxation but at a rate not to exceed 7 percent of the gross amount of the interest. Third.
related party interest paid or credited on or after January 1, 2009 and before January 1.
2010, will be subject to source State taxation but at a rate not to exceed 4 percent of the
gross amount of the interest. Finally, all interest paid or credited after January 1,2010,
will be subject to the regular rules of Article XI without regard to subparagraph 3(d) of
Article 27.
Further, the provisions of subparagraph 3(d) ensure that even with respect to
circumstances where the payer and the beneficial owner are related or deemed related
under the provisions of paragraph 2 of Article IX, the source State taxation of such crossborder interest shall be no greater than the taxation of such interest prior to the Protocol.
Gains
Subparagraph 3(e) of Article 27 of the Protocol provides the effective date for
paragraphs 2 and 3 of Article 8 of this Protocol, which relate to the changes made to
paragraphs 5 and 7 of Article XIII (Gains) of the Convention. The changes set forth in
those paragraphs shall have effect with respect to alienations of property that occur
(including, for greater certainty, those that are deemed under the law of a Contracting
State to occur) after September 17, 2000. This date corresponds to the press release
issued on September 18, 2000 which announced the intention of the United States and
Canada to negotiate a protocol that, if approved, would incorporate the changes set forth
in these paragraphs to coordinate the tax treatment of an emigrant's gains in the United
States and Canada.
Arbitration
Subparagraph 3(t) of Article 27 of the Protocol pertains to Article 21 of the
Protocol which implements the new arbitration provisions. An arbitration proceeding
will generally begin two years after the date on which the competent authorities of the
Contracting States began consideration of a case. Subparagraph 3(t), however, makes
clear that the arbitration provisions shall apply to cases that are already under
consideration by the competent authorities when the Protocol enters into force, and in
such cases, for purposes of applying the arbitration provisions, the commencement date
shall be the date the Protocol enters into force. Further, the provisions of Article 21 of
the Protocol shall be effective for cases that come into consideration by the competent
authorities after the date that the Protocol enters into force. In order to avoid the potential
for a large number of MAP cases becoming subject to arbitration immediately upon the
expiration of two years from entry into force, the competent authorities are encouraged to
develop and implement procedures for arbitration by January 1,2009, and begin
scheduling arbitration of otherwise unresolvable MAP cases in inventory (and meeting
the agreed criteria) prior to two years from entry into force.
Assistance in collection
Subparagraph 3(g) of Article 27 of the Protocol pertains to the date when the
changes set forth in Article 22 of the Protocol. relating to assistance in collection of taxes,
66
shall have effect. Consistent with the third protocol that entered into force on November
9, 1995, and which had effect for requests for assistance on claims finally determined
after November 9, 1985, the provisions of Article 22 of the Protocol shall have effect for
revenue claims finally determined by an applicant State after November 9, 1985.
67
DEPARTMENT OF THE TREASURY
TECHNICAL EXPLANATION OF
THE CONVENTION BETWEEN
THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND
THE GOVERNMENT OF ICELAND
FOR THE AVOIDANCE OF DOUBLE TAXATION AND
THE PREVENTION OF FISCAL EVASION
WITH RESPECT TO TAXES ON INCOME.
This is a technical explanation of the Convention between the Government of the United
States and the Government of Iceland For the Avoidance Of Double Taxation and the Prevention
of Fiscal Evasion with Respect to Taxes on Income, signed on October 23, 2007 (the
"Convention").
Negotiations took into account the U.S. Treasury Department's current tax treaty policy,
and the Treasury Department's Model Income Tax Convention. Negotiations also took into
account the Model Tax Convention on Income and on Capital, published by the Organisation for
Economic Cooperation and Development (the "'OECD Model"), and recent tax treaties
concluded by both countries.
The Technical Explanation is an official guide to the Convention and an accompanying
Protocol. It reflects the policies behind particular Convention and Protocol provisions, as well as
understandings reached during the negotiations with respect to the application and interpretation
of the Convention and Protocol. References in the Technical Explanation to "'he" or "his" should
be read to mean "he or she" or "his and her."
ARTICLE 1 (GENERAL SCOPE)
Paragraph 1
Paragraph 1 of Article 1 provides that the Convention applies only to residents of the
United States or Iceland except where the terms of the Convention provide otherwise. Under
Article 4 (Resident) a person is generally treated as a resident of a Contracting State if that
person is, under the laws of that State, liable to tax therein by reason of his domicile, citizenship,
residence, or other similar criteria. However, if a person is considered a resident of both
Contracting States, Article 4 provides rules for determining a State of residence (or no State of
residence). This determination governs for all purposes of the Convention.
Certain provisions are applicable to persons who may not be residents of either
Contracting State. For example, paragraph 1 of Article 23 (Non-Discrimination) applies to
nationals of the Contracting States. Under Article 25 (Exchange ofInformation and Administrative Assistance), information may be exchanged with respect to residents of third states.
Paragraph 2
Paragraph 2 states the generally accepted relationship both between the Convention and
domestic law and between the Convention and other agreements between the Contracting States.
That is, no provision in the Convention may restrict any exclusion, exemption. deduction, credit
or other benefit accorded by the tax laws of the Contracting States, or by any other agreement
between the Contracting States. The relationship between the non-discrimination provisions of
the Convention and other agreements is addressed not in paragraph 2 but in paragraph 3.
Under paragraph 2, for example, if a deduction would be allowed under the U.S. Internal
Revenue Code (the "Code") in computing the U.S. taxable income of a resident ofIceland, the
deduction also is allowed to that person in computing taxable income under the Convention.
Paragraph 2 also means that the Convention may not increase the tax burden on a resident of a
Contracting States beyond the burden determined under domestic law. Thus, a right to tax given
by the Convention cannot be exercised unless that right also exists under internal law.
It follows that, under the principle of paragraph 2, a taxpayer's U.S. tax liability need not
be determined under the Convention if the Code would produce a more favorable result. A
taxpayer may not, however, choose among the provisions of the Code and the Convention in an
inconsistent manner in order to minimize tax. Thus, a taxpayer may use the Convention to
reduce its taxable income, but may not use both treaty and Code rules where doing so would
thwart the intent of either set of rules. For example, assume that a resident of Iceland has three
separate businesses in the United States. One is a profitable permanent establishment and the
other two are trades or businesses that would earn taxable income under the Code but that do not
meet the permanent establishment threshold tests of the Convention. One is profitable and the
other incurs a loss. Under the Convention, the income of the permanent establishment is taxable
in the United States, and both the profit and loss of the other two businesses are ignored. Under
the Code, all three would be subject to tax, but the loss would offset the profits of the two
profitable ventures. The taxpayer may not invoke the Convention to exclude the profits of the
profitable trade or business and invoke the Code to claim the loss of the loss trade or business
against the profit of the permanent establishment. (See Rev. Rul. 84-17,1984-1 c.ll. 308.) If,
however, the taxpayer invokes the Code for the taxation of all three ventures, he would not be
precluded from invoking the Convention with respect, for example, to any dividend income he
may receive from the United States that is not effectively connected with any of his business
activities in the United States.
Similarly, nothing in the Convention can be used to deny any benefit granted by any
other agreement between the United States and Iceland. For example, if certain benefits are
provided for military personnel or military contractors under a Status of Forces Agreement
between the United States and Iceland, those benefits or protections will be available to residents
of the Contracting States regardless of any provisions to the contrary (or silence) in the
Convention.
Paragraph 3
Paragraph 3 specifically relates to. ~on-discrimination obligations of the Contracting
States under other agreements. The provlSlons of paragraph 3 are an exception to the rule
provided in paragraph 2 of this Article under which the Convention shall not restrict in any
2
manner any benefit now or hereafter accorded by any other agreement between the Contracting
States.
Subparagraph 3(a) provides that, notwithstanding any other agreement to which the
Contracting States may be parties, a dispute concerning whether a measure is within the scope of
this Convention shall be considered only by the competent authorities of the Contracting States,
and the procedures under this Convention exclusively shall apply to that dispute. Thus,
procedures for dealing with disputes that may be incorporated into trade, investment, or other
agreements between the Contracting States shall not apply for the purposes of determining the
scope of the Convention.
Subparagraph 3(b) provides that, unless the competent authorities determine that a
taxation measure is not within the scope of this Convention, the non-discrimination obligations
of this Convention exclusively shall apply with respect to that measure, except for such national
treatment or most-favored-nation ("MFN") obligations as may apply to trade in goods under the
General Agreement on Tariffs and Trade ("GATT"). No national treatment or MFN obligation
under any other agreement shall apply with respect to that measure. Thus, unless the competent
authorities agree otherwise, any national treatment and MFN obligations undertaken by the
Contracting States under agreements other than the Convention shall not apply to a taxation
measure, with the exception of GATT as applicable to trade in goods.
Paragraph 4
Paragraph 4 contains the traditional saving clause found in all U.S. treaties. The
Contracting States reserve their rights, except as provided in paragraph 5, to tax their residents
and citizens as provided in their internal laws, notwithstanding any provisions of the Convention
to the contrary. For example, if a resident oflceland performs professional services in the
United States and the income from the services is not attributable to a permanent establishment
in the United States, Article 7 (Business Profits) would by its terms prevent the United States
from taxing the income. If, however, the resident oflceland is also a citizen of the United States,
the saving clause permits the United States to include the remuneration in the worldwide income
of the citizen and subject it to tax under the normal Code rules (i.e., without regard to Code
section 894(a». However, subparagraph 5(a) of Article 1 preserves the benefits of special
foreign tax credit rules applicable to the U. S. taxation of certain U. S. income of its citizens
resident in Iceland. See paragraph 4 of Article 22 (Relief from Double Taxation).
For purposes of the saving clause, "residence" is determined under Article 4. Thus, an
individual who is a resident of the United States under the Code (but not a U.S. citizen) but who
is determined to be a resident of Iceland under the tie-breaker rules of Article 4 would be subject
to U.S. tax only to the extent permitted by the Convention. The United States would not be
permitted to apply its statutory rules to that person to the extent the rules are inconsistent with
the Convention.
However, the person would be treated as a U.S. resident for U.S. tax purposes other than
determining the individual's U.S. tax liability. For example, in determining under Code section
957 whether a foreign corporation is a controlled foreign corporation, shares in that corporation
held by the individual would be considered to ~e held by a U.S. resident. As a result, othe~ U.S.
citizens or residents might be deemed to be Umted States shareholders of a controlled foreIgn
corporation subject to current inclusion of Subpart F income recognized by the corporation. See,
Treas. Reg. section 301.7701(b)-7(a)(3).
3
Under paragraph 4. the United States also reserves its right to tax fonner citizens and
former long-term residents for a period of ten years following the loss of such status. Thus,
paragraph 4 allows the United States to tax fonner U.S. citizens and former U.S. long-term
resid~ents in accordance with Section 877 of the Code. Section 877 generally applies to a fonner
citizen or long-tenn resident of the United States who relinquishes citizenship or terminates
long-term residency before June 17,2008 if either of the following criteria exceed established
thresholds: (a) the average annual net income tax of such individual for the period of 5 taxable
years ending before the date of the loss of status, or (b) the net worth of such individual as of the
date of the loss of status.
The United States defines ··long-term resident" as an individual (other than a U.S.
citizen) who is a lawful permanent resident of the United States in at least 8 of the prior 15
taxable years. An individual is not treated as a lawful permanent resident for any taxable year in
which the individual is treated as a resident of Iceland under this Convention, or as a resident of
any country other than the United States under the provisions of any other tax treaty of the
United States, and in either case the individual does not waive the benefits of the relevant
convention.
Paragraph 5
Paragraph 5 sets forth certain exceptions to the saving clause. The referenced provisions
are intended to provide benefits to citizens and residents even if such benefits do not exist under
internal law. Paragraph 5 thus preserves these benefits for citizens and residents of the
Contracting States.
Subparagraph 5(a) lists certain provisions of the Convention that are applicable to all
citizens and residents of a Contracting State, despite the general saving clause rule of paragraph
4:
( 1) Paragraph 2 of Article 9 (Associated Enterprises) grants the right to a correlative
adjustment with respect to income tax due on profits reallocated under Article 9.
(2) Paragraphs 2 and 4 of Article 17 (Pensions, Social Security, and Annuities) provide
exemptions from source or residence State taxation for certain pension distributions
and social security payments.
(3) Article 22 (Relief from Double Taxation) confirms to citizens and residents of one
Contracting State the benefit of a credit for income taxes paid to the other or an
exemption for income earned in the other State.
(4) Article 23 (Non-Discrimination) protects residents and nationals of one Contracting
State against the adoption of certain discriminatory practices in the other Contracting
State.
(5) Article 24 (Mutual Agreement Procedure) confers certain benefits on citizens and
residents of the Contracting States in order to reach and implement solutions to
disputes ~etween the two~ C?~tracting States. F?r example, the competent authorities
are permltted to use a defImtion of a term that dIffers from an internal law definition.
The statute of limitations may be waived for refunds, so that the benefits of an
agreement may be implemented.
4
Subparagraph 5(b) provides a different set of exceptions to the saving clause. The
benefits referr~d to are all mtende~ to be granted to temporary residents of a Contracting State
(~o.r example, m the case of the Umte.d States, holders of non-immigrant visas), but not to
CItIzens or to persons who have acquued permanent residence in that State. If beneficiaries of
these provisions travel from one of the Contracting States to the other, and remain in the other
long enough to become residents under its internal law, but do not acquire permanent residence
status (i.e., in the U.S. context, they do not become "green card" holders) and are not citizens of
that State, the host State will continue to grant these benefits even if they conflict with the
statutory rules. ~he bene.fits preserved by this paragraph are: (l) the host country exemptions for
government servIce salarIes and pensions under Article 18 (Government Service), certain income
of visiting students and trainees under Article 19 (Students and Trainees), and the income of
diplomatic agents and consular officers under Article 26 (Members of Diplomatic Missions and
Consular Posts).
Paragraph 6
Paragraph 6 provides that an item of income derived by a fiscally transparent entity is
considered to be derived by a resident of a Contracting State to the extent that the resident is
11 cated under the taxation laws of the State where he is resident as deriving the item of income.
This paragraph applies to any resident of a Contracting State who is entitled to income derived
through an entity that is treated as fiscally transparent under the laws of either Contracting State.
For example, if a corporation resident in Iceland distributes a dividend to an entity that is treated
as fiscally transparent for U.S. tax purposes, the dividend will be considered derived by a
resident of the United States 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 laws) as deriving the dividend income for U.S. tax purposes. In the case of 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 dividend income
through the partnership. Thus, it also 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 dividend paid to the entity. Although these partners are treated as deriving
the income for U.S. tax purposes, they are not residents of the United States for purposes of the
treaty. If, however, they are treated as residents of a third country under the provisions of an
income tax convention which that country has with Iceland, they may be entitled to claim a
benefit under that convention. In contrast, if an entity is organized under U.S. laws and is
classified as a corporation for U.S. tax purposes, dividends paid by a corporation resident in
Iceland to the U.S. entity 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.
Because the entity classification rules of the State of residence govern, the results in the
examples discussed above would obtain even if the entity were viewed differently under the tax
laws of Iceland (e.g., as not fiscally transparent in the first example above where the entity is
treated as a partnership for U.S. tax purposes or as fiscally transparent in the second example
where the entity is viewed as not fiscally transparent for U.S. tax purposes). Moreover, these
results follow regardless of whether the entity is organized in the United States, Iceland, or in a
third country. For example, income from sources in Iceland received by an entity organized
under the laws of Iceland, which is treated for U.S. tax purposes as a corporation and is o'Wned
by a U.S. shareholder who is a U.S. resident for U.S. tax purposes, is not considered derived by
the shareholder of that corporation even if, under the tax laws of Iceland, the entity is treated as
fiscally transparent. These results also follow regardless of whether the entity is disregarded as a
5
separate entity under the la\vs of one jurisdiction but not the other. such as a single O\vner entity
that is viewed as a branch for U.S. tax purposes and as a corporation for tax purposes of in
Iceland.
Where income is derived through an entity organized in a third state that has owners
resident in one of the Contracting States, the characterization of the entity in that third state is
irrelevant for purposes of determining whether the resident is entitled to treaty benefits with
respect to income derived by the entity.
In general. paragraph 6 relates to entities that are not subject to tax at the entity level, as
distinct from entities that are subject to tax, but with respect to which tax may be relieve under
an integrated system. Entities faIling under this description in the United States include
partnerships, common investment trusts under section 584 and grantor trusts. This paragraph
also applies to U.S. limited liability companies «"LLCs"), including an LLC with only one
member), that are treated as partnerships or as disregarded entities for U.S. tax purposes. The
taxation laws of a Contracting State may treat an item of income as income of a resident of that
State even if the resident is not subject to tax on that particular item of income. For example, if a
Contracting State has a participation exemption for certain foreign-source dividends and capital
gains, such income or gains would be regarded as income or gain of a resident of that State who
otherwise derived the income or gain, despite the fact that the resident could be exempt from tax
in that State on the income or gain.
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 own tax law. For example, if a U.S. LLC with members who are
residents of Iceland 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 Iceland
views the LLC as fiscally transparent.
ARTICLE 2 (TAXES COVERED)
This Article specifies the U.S. taxes and the taxes of Iceland to which the Convention
applies. With two exceptions, the taxes specified in Article 2 are the covered taxes for all
purposes of the Convention. A broader coverage applies for purposes of Articles 23 (NonDiscrimination) and 25 (Exchange of Information and Administrative Assistance). Article 23
applies with respect to all taxes, including those imposed by state and local governments.
Article 25 applies with respect to all taxes imposed at the national level.
Paragraph 1
Paragraph 1 identifies the category of taxes to which the Convention applies. Paragraph
1 is based on the U. S. and DECO Models and defines the scope of application of the
Convention. The Convention applies to taxes on income, including gains, imposed on behalf of
a Contracting State. irrespective of the manner in which they are levied. Except with respect to
Article 23 state and local taxes are not covered by the Convention.
Paragraph 2
Paragraph 2 also is based on the U.S. and DECO Models and provides a definition of
taxes on income. on capital and on capital gains. The Convention covers taxes on total income
on total capitaL or any part of income and includes tax on gains derived from the alienation of '
6
property. The Conv~ntio~ does not ap~ly, however, to social security charges, or any other
charges where there IS a dIrect connectIOn between the levy and individual benefits. Social
security and unemploy~ent taxes (Code sections 1401,3101,3111 and 3301) are excluded from
coverage. The ConventIon also does not apply to property taxes, except with respect to Article
23.
Paragraph 3
Paragraph 3 lists the taxes in force at the time of signature of the Convention to which the
Convention applies.
The existing covered taxes of Iceland are identified in subparagraph 3(a). These taxes
are i) the income taxes to the state and ii) the income taxes to the municipalities.
Subparagraph 3(b) provides that the existing U.S. taxes subject to the rules of the
Convention are the Federal income taxes imposed by the Code, together with the excise taxes
imposed with respect to private foundations (Code sections 4940 through 4948) ..
Paragraph 4
Under paragraph 4, the Convention will apply to any taxes that are identical, or
substantially similar, to those enumerated in paragraph 3, and which are imposed in addition to,
or in place of, the existing taxes after October 23, 2007, the date of signature of the Convention.
The paragraph also provides that the competent authorities of the Contracting States will notify
each other of any significant changes that have been made in their laws, whether tax laws or nontax laws, that affect significantly their obligations under the Convention. Non-tax laws that may
affect a Contracting State's obligations under the Convention may include, for example, laws
affecting bank secrecy.
ARTICLE 3 (GENERAL DEFINITIONS)
Article 3 provides general definitions and rules of interpretation applicable throughout
the Convention. Certain other terms are defined in other articles of the Convention. For
example, the term "resident of a Contracting State" is defined in Article 4 (Resident). The term
"permanent establishment" is defined in Article 5 (Permanent Establishment). These definitions
are used consistently throughout the Convention. Other terms, such as "dividends," "interest"
and "royalties" are defined in specific articles for purposes only of those articles.
Paragraph 1
Paragraph 1 defines a number of basic terms used in the Convention. The introduction to
paragraph 1 makes clear that these definitions apply for all purposes of the Convention, unless
the context requires otherwise. This latter condition allows flexibility in the interpretation of the
treaty in order to avoid results not intended by the treaty's negotiators.
The geographical scope of the Convention with respect Iceland is set out in subparagraph
1(o} It encompasses the territory oficeland, including its territorial sea, and any area beyond
the territorial sea within which Iceland, in accordance with intemationallaw, exercises
7
jurisdiction or so\'crcign rights with respect to the sea bed. its subsoil and its adjacent waters.
and their natural resources.
The geographical scope of the Convention with respect to the United States is set out in
subparagraph 1(b). It encompasses the United States of America, including the states, the
District of Columbia and the territorial sea of the United States. The term does not include
Puerto Rico, the Virgin Islands, Guam or any other U.S. possession or territory. For certain
purposes, the term "United States" includes the sea bed and subsoil of undersea areas adjacent to
the territorial sea of the United States. This extension applies to the extent that the United States
exercises sovereignty in accordance with intemationallaw for the purpose of natural resource
exploration and exploitation of such areas. This extension of the definition applies, however,
only if the person, property or activity to which the Convention is being applied is connected
with such natural resource exploration or exploitation. Thus, it would not include any activity
involving the sea floor of an area over which the United States exercised sovereignty for natural
resource purposes if that activity was unrelated to the exploration and exploitation of natural
resources. This result is consistent with the result that would be obtained under Section 638,
which treats the continental shelf as part of the United States for purposes of natural resource
exploration and exploitation.
Subparagraph 1(c) defines the term "person" to include an individual, a trust, a
partnership, a company and any other body of persons. The definition is significant for a variety
of reasons. For example, under Article 4, only a "person" can be a "resident" and therefore
eligible for most benefits under the treaty. Also, all "persons" are eligible to claim relief under
Article 24 (Mutual Agreement Procedure).
The term "company" is defined in subparagraph led) as a body corporate or an entity
treated as a body corporate for tax purposes in the state where it is organized. The definition
refers to the law of the state in which an entity is organized in order to ensure that an entity that
is treated as fiscally transparent in its country of residence will not get inappropriate benefits,
such as the reduced withholding rate provided by subparagraph 2(b) of Article 10 (Dividends).
It also ensures that the Limitation on Benefits provisions of Article 21 will be applied at the
appropriate level.
Subparagraph I (e) defines the term "enterprise" as any activity or set of activities that
constitutes the carrying on of a business. The term "business" is not defined, but subparagraph
(k) provides that it includes the performance of professional services and other activities of an
independent character. Both subparagraphs are identical to definitions recently added to the
OECD Model in connection with the deletion of Article 14 (Independent Personal Services)
from the OECD Model. The inclusion of the two definitions is intended to clarify that income
from the performance of professional services or other activities of an independent character is
dealt with under Article 7 (Business Profits) and not Article 20 (Other Income).
The terms "enterprise of a Contracting State" and "enterprise of the other Contracting
State" are defined i~ subpa~agraph 1(f) as .an enterprise carried on b~ a resident of a Contracting
State and an enterpnse carned on by a reSIdent of the other Contractmg State. An enterprise of a
Contracting State need not be carried on in that State. It may be carried on in the other
Contracting State or a third state (e.g., a U.S. corporation doing all of its business in the other
Contracting State would still be a U.S. enterprise). Although not explicitly stated in the
CullYelltion. these terms also encompass an enterprise conducted through an entity (such as a
partner.ship) .that is treated as fiscall'y tran~parent in t~e Contra~t~ng State where the entity's
o\\ner IS reSIdent. In accordance WIth ArtIcle 4 (ReSIdent), entItIes that are fiscally transparent in
8
the Contracting State in which their owners are resident are not considered to be residents of that
State (although income derived by such entities may be taxed as the income of a resident, if
taxed in the hands of resident partners or other owners). An enterprise conducted by such an
entity will be treated as carried on by a resident of a Contracting State to the extent its partners or
other owners are residents. This approach is consistent with the Code, which under section 875
attributes a trade or business conducted by a partnership to its partners and a trade or business
conducted by an estate or trust to its beneficiaries.
Subparagraph 1(g) provides that the terms "a Contracting State" and "the other
Contracting State" shall mean Iceland or the United States, as the context requires.
Subparagraph 1(h) defines the term "international traffic." The term means any transport
by a ship or aircraft except when such transport is solely between places within a Contracting
State. This definition is applicable principally in the context of Article 8 (Shipping and Air
Transport). The definition combines with paragraphs 2 and 3 of Article 8 to exempt from tax by
the source State income from the rental of ships or aircraft that is earned both by lessors that are
operators of ships and aircraft and by those lessors that are not (~, a bank or a container
leasing company).
The exclusion from international traffic of transport solely between places within a
Contracting State means, for example, that carriage of goods or passengers solely between New
York and Chicago would not be treated as international traffic, whether carried by a U.S. or a
foreign carrier. The substantive taxing rules of the Convention relating to the taxation of income
from transport, principally Article 8 (Shipping and Air Transport), therefore, would not apply to
income from such carriage. Thus, if the carrier engaged in internal U.S. traffic were a resident of
Iceland (assuming that were possible under U.S. law), the United States would not be required to
exempt the income from that transport under Article 8. The income would, however, be treated
as business profits under Article 7 (Business Profits), and therefore would be taxable in the
United States only if attributable to a U.S. permanent establishment of the foreign carrier, and
then only on a net basis. The gross basis U.S. tax imposed by section 887 would never apply
under the circumstances described. If, however, goods or passengers are carried by a carrier
resident in Iceland from a non-U.S. port to, for example, New York, and some ofthe goods or
passengers continue on to Chicago, the entire transport would be international traffic. This
would be true if the international carrier transferred the goods at the U.S. port of entry from a
ship to a land vehicle, from a ship to a lighter, or even if the overland portion of the trip in the
United States was handled by an independent carrier under contract with the original international carrier, so long as both parts of the trip were reflected in original bills oflading. For this
reason, the Convention, following the U.S. Model, refers in the definition of "international
traffic," to "such transport" being solely between places in the other Contracting State, while the
OECD Model refers to the ship or aircraft being operated solely between such places. The
formulation in the Convention is intended to make clear that, as in the above example, even if the
goods are carried on a different aircraft for the internal portion of the international voyage than is
used for the overseas portion of the trip, the definition applies to that internal portion as well as
the external portion.
Finally, a "cruise to nowhere," i.e., a cruise beginning and ending in a port in the same
Contracting State with no stops in a foreign port, would not constitute international traffic.
Subparagraph 1(i) designates the "competent authorities" for Iceland and the United
States. In the case ofIceland, the competent authority is the Minister of Finance or his
authorized representative. The U.S. competent authority is the Secretary of the Treasury or his
9
delegate. The Secretary of the Treasury has delegated the competent authority function to the
Commissioner of Internal Revenue. who in tum has delegated the authority to the Deputy
Commissioner (International) LMSB. With respect to interpretative issues. the Deputy
Commissioner (International) LMSB acts with the concurrence of the Associate Chief Counsel
(International) of the Internal Revenue Service.
The term "national," as it relates to the United States and to Iceland, is defined in
subparagraph 1(j). This term is relevant for purposes of Articles 18 (Government Service) and
23 (Non-Discrimination). A national of one of the Contracting States is (l) an individual who is
a citizen or national of that State, and (2) any legal person, partnership or association deriving its
status, as such, from the law in force in the State where it is established.
Subparagraph 1(1) defines the term "pension scheme" to include any plan, scheme, fund,
trust or other arrangement established in a Contracting State that is generally exempt from
income taxation in that State and that is operated principally to administer or provide pension or
retirement benefits or to earn income for the benefit of one or more such arrangements.
Subparagraph l(b) of the Protocol provides that in the case of the United States, the term
"pension scheme" includes the following: a trust providing pension or retirement benefits under
a Code section 401(a) qualified pension plan, 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,
or 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 4S7(g) providing pension or retirement benefits under a Code section 4S7(b)
plan, and the Thrift Savings Fund (section 7701U». Section 401(k) plans and group trusts
described in Revenue Ruling 81-100 and meeting the conditions of Revenue Ruling 2004-67
qualify as pension funds to the extent they are Code section 401(a) plans or other pension
schemes. In the case ofIceland, subparagraph l(a) of the Protocol provides that the term
"pension scheme" includes any pension fund or pension plan qualified under the Pension Act or
any identical or substantially similar schemes which are created under any law enacted after
October 23,2007, the date of signature of the Convention.
Paragraph 2
Terms that are not defined in the Convention are dealt with in paragraph 2.
Paragraph 2 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 law of the Contracting
State whose tax is being applied, unless the context requires otherwise, or the competent
authorities have agreed ?n a different meaning pursuant to Article 24 (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.
It~ t,he me~ning of ~ te~ cann?t be readily determined under the law of a Contracting
State. or It there IS a contlict m meanmg under the laws of the two States that creates difficulties
in,the ~pplication of the <;=onvention, the co~pet~nt authorities, as indicated in subparagraph 3(t)
ot ArtIcle 24. may establIsh a common meanmg m order to prevent double taxation or to further
10
any other purpose of the Convention. This common meaning need not conform to the meaning of
the term under the laws of either Contracting State.
The reference in paragraph 2 to the internal 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 reference in both paragraphs 1 and 2 to the "context otherwise
requir[ing]" a definition different from the treaty definition, in paragraph 1, or from the internal
law definition of the Contracting State whose tax is being imposed, under paragraph 2, refers to a
circumstance where the result intended by the Contracting States is different from the result that
would obtain under either the paragraph 1 definition or the statutory definition. Thus, flexibility
in defining terms is necessary and permitted.
ARTICLE 4 (RESIDENT)
This Article sets forth rules for determining whether a person is a resident of a
Contracting State for purposes of the Convention. As a general matter only residents of the
Contracting States may claim the benefits of the Convention. The treaty definition of residence is
to be used only for purposes of the Convention. The fact that a person is determined to be a
resident of a Contracting State under Article 4 does not necessarily entitle that person to the
benefits of the Convention. In addition to being a resident, a person also must qualify for benefits
under Article 21 (Limitation On Benefits) in order to receive benefits conferred on residents of a
Contracting State.
The determination of residence for treaty purposes looks first to a person's liability to tax
as a resident under the respective taxation laws of the Contracting States. As a general matter, a
person who, under those laws, is a resident of one Contracting State and not of the other need
look no further. For purposes ofthe Convention, that person is a resident of the State in which he
is resident under intemallaw. If, however, a person is resident in both Contracting States under
their respective taxation laws, the Article proceeds, where possible, to use tie-breaker rules to
assign a single State of residence to such a person for purposes of the Convention.
Paragraph 1
The term "resident of a Contracting State" is defined in paragraph 1. In general, this
definition incorporates the definitions of residence in U.S. law and that ofIceland by referring to
a resident as a person who, under the laws of a Contracting State, is subject to tax there by
reason of his domicile, residence, citizenship, place of management, place of incorporation or
any other similar criterion. Thus, residents of the United States include aliens who are
considered U. S. residents under Code section 770 1(b). Paragraph 1 also specifically includes the
two Contracting States, and political subdivisions and local authorities of the two States, as
residents for purposes of the Convention.
Certain entities that are nominally subject to tax but that in practice are rarely required to
pay tax also would generally be treated as residents and therefore accorded treaty benefits. For
example, a U.S. Regulated Investment Company (RIC) and a U.S. Real Estate Investment Trust
(REIT) are residents of the United States for purposes of the treaty. Although the income earned
by these entities normally is not subject to U.S. tax in the hands of the entity, they are taxable to
the extent that they do not currently distribute their profits, and therefore may be regarded as
11
"liable to tax." They also must satisfy a number of requirements under the Code in order to be
entitled to special tax treatment.
A person who is liable to tax in a Contracting State only in respect of income from
sources within that State or capital situated therein or of profits attributable to a permanent
establishment in that State will not be treated as a resident of that Contracting State for purposes
of the Convention. Thus. a consular official of Iceland who is posted in the United States. who
may be subject to U.S. tax on U.S. source investment income but is not taxable in the United
States on non-U.S. source income (see Code section 7701(b)(5)(B», would not be considered a
resident of the United States for purposes of the Convention. Similarly, an enterprise of Iceland
with a permanent establishment in the United States is not, by virtue of that permanent
establishment. a resident of the United States. The enterprise generally is subject to U.S. tax
only with respect to its income that is attributable to the U.S. permanent establishment, not with
respect to its worldwide income, as it would be if it were a U.S. resident.
Paragraph 2
Paragraph 2 provides that certain tax-exempt entities such as pension schemes and
charitable organizations will be regarded as residents of a Contracting State regardless of
whether they are generally liable to income tax in the State where they are established. The
inclusion of this provision is intended to clarify the generally accepted practice of treating an
entity that would be liable for tax as a resident under the internal law of a State but for a specific
exemption irom tax (either complete or partial) as a resident of that State for purposes of
paragraph 1.
Subparagraph 2(a) applies to pension schemes, as defined in subparagraph 1(1) of Article
3 (General Definitions). Subparagraph 2(b) applies to any plan, scheme, fund, trust, company or
other arrangement established in a Contracting State that is generally exempt from taxation in
that State because it is operated exclusively to administer or provide employee benefits. The
reference to a general exemption is intended to reflect the fact that under U.S. law, certain
organizations that generally are considered to be tax-exempt entities may be subject to certain
excise taxes or to income tax on their unrelated business income. Subparagraph 2( c) applies to
an organization that is established exclusively for religious, charitable, scientific, artistic,
cultural, or educational purposes and that is a resident of a Contracting State. Thus, a section
501(c) organization organized in the United States (such as a U.S. charity) that is generally
exempt from tax under U.S. law is a resident of the United States for all purposes of the
Convention.
Paragraph 3
If, under the laws of the two Contracting States, and, thus, under paragraph 1, an
individual is deemed to be a resident of both Contracting States, a series of tie-breaker rules are
provided in paragraph 3 to determine a single State of residence for that individual. These tests
are to be applied in the order in which they are stated. The first test is based on where the
individual has a permanent home. If that test is inconclusive because the individual has a
permanent home available to him in both States, he will be considered to be a resident of the
Contracting State where his personal and economic relations are closest (i.e., the location of his
"center o~vital inte~est~"). ,If that test is als? inconclusive, or if~e does not have a permanent
home avaIla~le t? hIm m ~Ither State. he wIll be trea!ed as a resI~ent of the Contracting State
where he maIntaInS a habItual abode. Ifhe has a habItual abode In both States or in neither of
them. he wi \I be treated as a resident of the Contracting State of which he is a national. If he is a
12
national of both States or of neither, the matter will be considered by the competent authorities,
who will assign a single State of residence.
Paragraph 4
Paragraph 4 seeks to settle dual residence issues for persons other than individuals (e.g.,
companies, trusts, or estates). For example, a dual residence may arise in the case of a company
that is dually created in both the United States and Iceland or that is incorporated in the United
States, and therefore treated as a resident of the United States, but that is also considered a
resident of Iceland because it is managed and controlled in Iceland. In such a case, if such a
person is, under the rules of paragraph 1, resident in both Contracting States, the competent
authorities shall seek to determine a single State of residence for that person for purposes of the
Convention. If the competent authorities do not reach an agreement on a single State of
residence, that company may not claim any benefit accorded to residents of a Contracting State
by the Convention, except those provided in Article 23 (Non-Discrimination) and Article 24
(Mutual Agreement Procedure). Thus, for example, a State cannot impose discriminatory tax
measures on a dual resident company.
Dual resident companies may be treated as a resident of a Contracting State for purposes
other than that of obtaining benefits under the Convention. For example, if a dual resident
company pays a dividend to a resident ofIceland, the U.S. paying agent would withhold on that
dividend at the appropriate treaty rate because reduced withholding is a benefit enjoyed by the
resident of Iceland, not by the dual resident company. The dual resident company that paid the
dividend would, for this purpose, be treated as a resident of the United States under the
Convention. In addition, information relating to dual resident companies can be exchanged
under the Convention because, by its terms, Article 26 (Exchange of Information and
Administrative Assistance) is not limited to residents of the Contracting States.
ARTICLE 5 (PERMANENT ESTABLISHMENT)
1his Article defines the term "permanent establishment," a term that is significant for
several articles of the Convention. The existence of a permanent establishment in a Contracting
State is necessary under Article 7 (Business Profits) for the taxation by that State of the business
profits of a resident of the other Contracting State. Articles 10 (Dividends), 11 (Interest) and 12
(Royalties) provide for reduced rates of tax at source on payments of these items of income to a
resident ofthe other State only when the income is not attributable to a permanent establishment
that the recipient has in the source State. The concept is also relevant in determining which
Contracting State may tax certain gains under Article 13 (Capital Gains) and certain "other
income" under Article 20 (Other Income).
Paragraph 1
The basic definition of the term "permanent establishment" is contained in paragraph 1.
As used in the Convention, the term means a fixed place of business through which the business
of an enterprise is wholly or partly carried on. As indicated in the OECD Commentary to Article
5 (see paragraphs 4 through 8), a general principle to be observed in determining whether a
permanent establishment exists is that the place of business must be "fixed" in the sense that a
particular building or physical location is used by the enterprise for the conduct of its business,
13
and that it must be foreseeable that the enterprise's use of this building or other physical location
will be more than temporary.
Paragraph 2
Paragraph 2 lists a number of types of fixed places of business that constitute a
permanent establishment. This list is illustrative and non-exclusive. According to paragraph 2,
the term permanent establishment includes a place of management, a branch, an office, a factory,
a workshop, and a mine, oil or gas well, quarry or other place of extraction of natural resources.
Paragraph 3
This paragraph 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 2(t). Thus, a drilling rig does not
constitute a permanent establishment if a well is drilled in only six months, but if production
begins in the following month the well becomes a permanent establishment as of that date.
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 12 months. If a sub-contractor is on a site intermittently, then, for purposes of applying the
12-month rule, time is measured from the first day the sub-contractor is on the site until the last
day (i. e., 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 tirst day of activity.
Paragraph -I
This paragraph contains exceptions to the general rule of paragraph 1, listing a number of
act i vities that may be carried on through a fixed place of business but which nevertheless do not
create a p~rmanent ~stablishment. T~e use of facilities. solely to store, display or deliver
merchandIse belongIng to an enterpnse does not constItute a permanent establishment of that
14
enterprise. The maintenance of a stock of goods belonging to an enterprise solely for the purpose
of storage, display or delivery, or solely for the purpose of processing by another enterprise does
not give rise to a permanent establishment of the first-mentioned enterprise. The maintenance of
a fixed place of business solely for the purpose of purchasing goods or merchandise, or for
collecting information, for the enterprise, or for other activities that have a preparatory or
auxiliary character for the enterprise, such as advertising, or the supply of information, do not
constitute a permanent establishment of the enterprise. Moreover, subparagraph 4(f) provides
that a combination of the activities described in the other subparagraphs of paragraph 4 will not
give rise to a permanent establishment if the combination results in an overall activity that is of a
preparatory or auxiliary character.
Paragraph 5
Paragraphs 5 and 6 specify when activities carried on by an agent or other person acting
on behalf of an enterprise create a permanent establishment of that enterprise. Under paragraph
5, a person is deemed to create a permanent establishment of the enterprise if that person has and
habitually exercises an authority to conclude contracts in the name of the enterprise. If,
however, for example, his activities are limited to those activities specified in paragraph 4 which
would not constitute a permanent establishment if carried on by the enterprise through a fixed
place of business, the person does not create a permanent establishment of the enterprise.
The Convention adopts the OECD Model language "in the name of the enterprise" rather
than the U.S. Model language "binding on the enterprise." This difference in language is not
intended to be a substantive difference. As indicated in paragraph 32 to the OECD
Commentaries on Article 5, paragraph 5 is intended to encompass persons who have "sufficient
authority to bind the enterprise's participation in the business activity in the State concerned."
The contracts referred to in paragraph 5 are those relating to the essential business
operations of the enterprise, rather than ancillary activities. For example, if the person has no
authority to conclude contracts in the name of the enterprise with its customers for, say, the sale
of the goods produced by the enterprise, but it can enter into service contracts in the name of the
enterprise for the enterprise's business equipment, this contracting authority would not fall within
the scope of the paragraph, even if exercised regularly.
Paragraph 6
Under paragraph 6, an enterprise is not deemed to have a permanent establishment in a
Contracting State merely because it carries on business in that State through an independent
agent, including a broker or general commission agent, if the agent is acting in the ordinary
course of his business as an independent agent. Thus, there are two conditions that must be
satisfied: the agent must be both legally and economically independent of the enterprise, and the
agent must be acting in the ordinary course of its business in carrying out activities on behalf of
the enterprise.
Whether the agent and the enterprise are independent is a factual determination. Among
the questions to be considere.d are the extent to. whic~ the agent .ope~ates on.the basis o!
instructions from the enterpnse. An agent that IS subject to detatled mstructlOns regardmg the
conduct of its operations or comprehensive control by the enterprise is not legally independent.
In determining whether the agent is economically independent, a relevant factor is the
extent to which the agent bears business risk. Business risk refers primarily to risk of loss. An
15
independent agent typically bears risk of loss from its own activities. In the absence of oth~r
factors that would establish dependence, an agent that shares business risk with the enterpnse, or
has its own business risk, is economically independent because its business activities are not
integrated with those of the principal. Conversely, an agent that bears little or no risk from the
activities it perfonns is not economically independent and therefore is not described in paragraph
6.
Another relevant factor in detennining whether an agent is economically independent is
whether the agent acts exclusively or nearly exclusively for the principal. Such a relationship
may indicate that the principal has economic control over the agent. A number of principals
acting in concert also may have economic control over an agent. The limited scope of the agent's
activities and the agent's dependence on a single source of income may indicate that the agent
lacks economic independence. It should be borne in mind, however, that exclusivity is not in
itself a conclusive test; an agent may be economically independent notwithstanding an exclusive
relationship with the principal if it has the capacity to diversity and acquire other clients without
substantial modifications to its current business and without substantial hann to its business
profits. Thus, exclusivity should be viewed merely as a pointer to further investigation of the
relationship between the principal and the agent. Each case must be addressed on the basis of its
own facts and circumstances.
Paragraph 7
This paragraph clarifies that a company that is a resident of a Contracting State is not
deemed to have a pennanent establishment in the other Contracting State merely because it controls, or is controlled by, a company that is a resident of that other Contracting State, or that
carries on business in that other Contracting State. The detennination whether a pennanent
establishment exists is made solely on the basis of the factors described in paragraphs 1 through
6 of the Article. Whether a company is a pennanent establishment of a related company,
therefore, is based solely on those factors and not on the ownership or control relationship
between the companies.
ARTICLE 6 (INCOME FROM IMMOVABLE PROPERTY (REAL PROPERTY»
This Article deals with the taxation of income from immovable property (real property)
situated in a Contracting State (the "situs State"). The Article does not grant an exclusive taxing
right to the situs State; the situs State is merely given the primary right to tax. The Article does
not impose any limitation in tenns of rate or fonn of tax imposed by the situs State.
Paragraph I
The first paragraph of Article 6 states the general rule that income of a resident of a
~ontracting St~te derive? fro~ real property si.tua~ed in the other Contracting State may be taxed
m the Contractmg State m whIch the property IS sItuated. The paragraph specifies that income
from real property includes income from agriculture and forestry.
Paragraph 2
The tenn "real property" is defined in paragraph 2 by reference to the internal law
definitio~ in the situs State. I.n. the case of the United S~~tes, ~he tenn has the meaning given to it
by Reg. § 1.89~-_I(b). In.addlt1?~ to the statutory defimtIOns m the two Contracting States, the
paragraph speCIfIes certam addItIOnal classes of property that, regardless of internal law
16
definitions, are within the scope of the term for purposes of the Convention. This expanded
definition conforms to that in the OECD Model. The definition of "real property" for purposes of
Article 6 is more limited than the expansive definition of "real property" in paragraph 1 of
Article 13 (Capital Gains). The Article 13 term includes not only real property as defined in
Article 6 but certain other interests in real property.
Paragraph 3
Paragraph 3 makes clear that all forms of income derived from the exploitation of real
property are taxable in the Contracting State in which the property is situated. This includes
income from any use of real property, including, but not limited to, income from direct use by
the owner (in which case income may be imputed to the owner for tax purposes) and rental
income from the letting of real property. In the case of a net lease of real property, if any
elections to be taxed on a net basis as may be provided under the laws of the situs State have not
been made, the gross rental payment (before deductible expenses incurred by the lessee) is
treated as income from the property.
Other income closely associated with real property is covered by other Articles of the
Convention, however, and not Article 6. For example, income from the disposition of an interest
in real property is not considered "derived" from real property; taxation of that income is
addressed in Article 13. Interest paid on a mortgage on real property would be covered by
Article 11 (Interest). Distributions by a U.S. Real Estate Investment Trust or certain regulated
investment companies would fall under Article 13 in the case of distributions of U.S. real
property gain or Article 10 (Dividends) in the case of distributions treated as dividends. Finally,
distributions from a United States Real Property Holding Corporation are not considered to be
income from the exploitation of real property; such payments would fall under Article 10 or 13.
Paragraph 4
This paragraph specifies that the basic rule of paragraph 1 (as elaborated in paragraph 3)
applies to income from real property of an enterprise. This clarifies that the situs country may tax
the real property income (including rental income) of a resident of the other Contracting State in
the absence of attribution to a permanent establishment in the situs State. This provision
represents an exception to the general rule under Articles 7 (Business Profits) that income must
be attributable to a permanent establishment in order to be taxable in the situs State.
ARTICLE 7 (BUSINESS PROFITS)
This Article provides rules for the taxation by a Contracting State of the business profits
of an enterprise of the other Contracting State.
Paragraph 1
Paragraph 1 states the general rule that business P!ofits of an enterprise of o~e
.
Contracting State may not be taxed by the other Contractmg State ~nless the enterpnse .caITIe~ on
business in that other Contracting State through a permanent estabhshment (as defined m ArtIcle
5 (Permanent Establishment)) situated there. When that .condition ,is met, the S~ate i~ which the
permanent establishment is situated may tax the enterpnse on the mcome that IS attnbutable to
the permanent establishment.
17
Although the Convention does not include a definition of "business profits:' the term is
intended to cover income derived from any trade or business. In accordance with this broad
definition. the tcrm ""business profits"' includes income attributable to notional principal contracts
and other financial instruments to the extent that the income is attributable to a trade or business
of dealing in such instruments or is otherwise related to a trade or business (as in the case of a
notional principal contract entered into for the purpose of hedging currency risk arising from an
active trade or business). Any other income derived from such instruments is. unless specifically
covered in another article. dealt with under Article 20 (Other Income).
The term "business profits" also includes income derived by an enterprise from the rental
of tangible personal property (unless such tangible personal property consists of aircraft, ships or
containers, income from which is addressed by Article 8 (Shipping and Air Transport)). The
inclusion of income derived by an enterprise from the rental of tangible personal property in
business profits means that such income earned by a resident of a Contracting State can be taxed
by the other Contracting State only if the income is attributable to a permanent establishment
maintained by the resident in that other State, and, if the income is taxable, it can be taxed only
on a net basis. Income from the rental of tangible personal property that is not derived in
connection with a trade or business is dealt with in Article 20.
In addition, as a result of the definitions of "enterprise" and "business" in Article 3
(General Definitions), the term includes income derived from the furnishing of personal services.
Thus, a consulting firm resident in one State whose employees or partners perform services in
the other State through a permanent establishment may be taxed in that other State on a net basis
under Article 7, and not under Article 14 (Income from Employment), which applies only to
income of employees. With respect to the enterprise's employees themselves, however, their
salary remains subject to Article 14.
Because this Article applies to income earned by an enterprise from the furnishing of
personal services, the Article also applies to income derived by a partner resident in a
Contracting State that is attributable to personal services performed in the other Contracting
State through a partnership with a permanent establishment in that other State. Income which
may be taxed under this Article includes all income attributable to the permanent establishment
in respect of the performance of the personal services carried on by the partnership (whether by
the partner himself, other partners in the partnership, or by employees assisting the partners) and
any income from activities ancillary to the performance of those services (e.g., charges for
facsimile services).
The application of Article 7 to a service partnership may be illustrated by the following
example: a partnership has five partners (who agree to split profits equally), four of whom are
resident and perform personal services only in Iceland at Office A, and one of whom performs
personal services at Office B, a permanent establishment in the United States. In this case, the
four partners of the partnership resident in Iceland may be taxed in the United States in respect
of their share of the income attributable to the permanent establishment, Office B. The services
giving rise to income which may be attributed to the permanent establishment would include not
only the scrvices performed by the one resident partner, but also, for example, if one of the four
other partners came to the United States and worked on an Office B matter there, the income in
respect of those services. Income from the services performed by the visiting partner would be
subject to tax in the United States regardless of whether the visiting partner actually visited or
lIsed Office B while performing services in the United States.
18
Paragraph 2
Paragraph 2 provides rules for the attribution of business profits to a permanent
establishment. The Contracting States will attribute to a permanent establishment the profits that
it would have earned had it been a distinct and separate enterprise engaged in the same or similar
activities under the same or similar conditions and dealing wholly independently with the
enterprise of which it is a permanent establishment.
The "attributable to" concept of paragraph 2 provides an alternative to the analogous but
somewhat different "effectively connected" concept in Code section 864(c). Depending on the
circumstances, the amount of income "attributable to" a permanent establishment under Article 7
may be greater or less than the amount of income that would be treated as "effectively
connected" to a U.S. trade or business under Code section 864. In particular, in the case of
financial institutions, the use of internal dealings to allocate income within an enterprise may
produce results under Article 7 that are significantly different than the results under the
effectively connected income rules. For example, income from interbranch notional principal
contracts may be taken into account under Article 7, notwithstanding that such transactions may
be ignored for purposes of U.S. domestic law.
The profits attributable to a permanent establishment may be from sources within or
without a Contracting State. However, the business profits attributable to a permanent
establishment include only those profits derived from the assets used, risks assumed, and
activities performed by the permanent establishment.
Paragraph 2 of the Protocol confirms that the arm's length method of paragraphs 2 and 3
consists of applying the OECD Transfer Pricing Guidelines, but taking into account the different
economic and legal circumstances of a single legal entity (as opposed to separate but associated
enterprises). Thus, any of the methods used in the Transfer Pricing Guidelines, including profits
methods, may be used as appropriate and in accordance with the Transfer Pricing Guidelines.
However, the use of the Transfer Pricing Guidelines applies only for purposes of attributing
profits within the legal entity. It does not create legal obligations or other tax consequences that
would result from transactions having independent legal significance.
One example of the different circumstances of a single legal entity is that an entity that
operates through branches rather than separate subsidiaries generally will have lower capital
requirements because all ofthe assets of the entity are available to support all of the entity's
liabilities (with some exceptions attributable to local regulatory restrictions). This is the reason
that most commercial banks and some insurance companies operate through branches rather than
subsidiaries. The benefit that comes from such lower capital costs must be allocated among the
branches in an appropriate manner. This issue does not arise in the case of an enterprise that
operates through separate entities, since each entity will have to be separately capitalized or will
have to compensate another entity for providing capital (usually through a guarantee).
Under U.S. domestic regulations, internal "transactions" generally are not recognized
because they do not have legal significance. In contrast, the Convention provides that such
internal dealings may be used to attribute income to a permanent establishment in cases where
the dealings accurately reflect the allocation of risk within the enterprise. One example is that of
global trading in securities. In many cases, banks use internal swap transactions to transfer risk
from one branch to a central location where traders have the expertise to manage that particular
type of risk. Under the Convention, such a bank may also use such swap transactions as a means
19
of attributing income between the branches. if use of that method is the "'best method" within the
meaning of regulation section l.482-1 (c). The books of a branch will not be respected, however,
when the results are inconsistent with a functional analysis. So. for example. income from a
transaction that is booked in a particular branch (or home office) will not be treated as
attributable to that location if the sales and risk management functions that generate the income
are performed in another location.
Because the use of profits methods is permissible under paragraph 2, it is not necessary
for the Convention to include a provision corresponding to paragraph 4 of Article 7 of the OECD
Model.
Paragraph 3
Paragraph 3 provides that in determining the business profits of a permanent
establishment. deductions shall be allowed for the expenses incurred for the purposes of the
permanent establishment, ensuring that business profits will be taxed on a net basis. This rule is
not limited to expenses incurred exclusively for the purposes of the permanent establishment, but
includes expenses incurred for the purposes of the enterprise as a whole, or that part of the
enterprise that includes the permanent establishment. Deductions are to be allowed regardless of
which accounting unit of the enterprise books the expenses, so long as they are incurred for the
purposes of the permanent establishment. For example, a portion of the interest expense
recorded on the books of the home office in one State may be deducted by a permanent
establishment in the other. The amount of the expense that must be allowed as a deduction is
determined by applying the arm' s length principle. And, as noted above with respect to
paragraph 2 of Article 1 (General Scope), if a deduction would be allowed under the Code in
computing the U.S. taxable income, the deduction also is allowed in computing taxable income
under the Convention. However, except where the Convention provides for more favorable
treatment, a taxpayer cannot take deductions for expenses in computing taxable income under
the Convention to a greater extent than would be allowed under the Code where doing so would
be inconsistent with the intent of the Code. For example, assume that a Bulgarian taxpayer with
a permanent establishment in the United States borrows $100 to purchase U.S. tax exempt bonds,
and that the $100 of tax-exempt bonds and the $100 of related debt would be treated as assets
and liabilities of the permanent establishment. For purposes of computing the profits attributable
to the permanent establishment under the Convention, both the tax exempt interest from the
bonds and the interest expense from the related debt would be excluded.
As noted above, paragraph the Convention provides that the OECD Transfer Pricing
Guidelines apply, by analogy, in determining the profits attributable to a permanent
establishment. Accordingly, a permanent establishment may deduct payments made to its head
office or another branch in compensation for services performed for the benefit of the branch.
The method to be used in calculating that amount will depend on the terms of the arrangements
between the branches and head office. For example, the enterprise could have a policy,
expressed in writing, under which each business unit could use the services of lawyers employed
by the head office. At the end of each year, the costs of employing the lawyers would be
charged to each business unit according to the amount of services used by that business unit
during the year. Since this appears to be a kind of cost-sharing arrangement and the allocation of
costs is based on the benefits received by each business unit, such a cost allocation would be an
acceptable means of determining a permanent establishment's deduction for legal expenses.
Alt~rnatively. t.he head office c~uld agree to employ lawters at its.own risk, and to charge an
"rm s le~~th prIce for legal s~rvlce.s performed for a'partlcul~r busmess unit. If the lawyers were
under-utilIzed. and the "fees received from the busmess UnIts were less than the cost of
employing the lawyers. then the head office would bear the excess cost. If the "fees" exceeded
20
the cost of employing the lawye~s, then the head office would keep the excess to compensate it
for assuming the risk of employmg the lawyers. If the enterprise acted in accordance with this
agreement, this method would be an acceptable alternative method for calculating a permanent
establishment's deduction for legal expenses.
A permanent establishment cannot be funded entirely with debt, but must have sufficient
capital to carry on its activities as if it were a distinct and separate enterprise. To the extent that
the permanent establishment has not been attributed capital for profit attribution purposes, a
Contracting State may attribute such capital to the permanent establishment, in accordance with
the arm's length principle, and deny an interest deduction to the extent necessary to reflect that
capital attribution. The method prescribed by U.S. domestic law for making this attribution is
found in Treas. Reg. section 1.882-5. Both section 1.882-5 and the method prescribed the
Convention start from the premise that all of the capital of the enterprise supports all of the
assets and risks of the enterprise, and therefore the entire capital of the enterprise must be
allocated to its various businesses and offices.
However, section 1.882-5 does not take into account the fact that some assets create more
risk for the enterprise than do other assets. An independent enterprise would need less capital to
support a perfectly-hedged U.S. Treasury security than it would need to support an equity
security or other asset with significant market and/or credit risk. Accordingly, in some cases
section 1.882-5 would require a taxpayer to allocate more capital to the United States, and
therefore would reduce the taxpayer's interest deduction more, than is appropriate. To address
these cases, the Convention allows a taxpayer to apply a more flexible approach that takes into
account the relative risk of its assets in the various jurisdictions in which it does business. In
particular, in the case of financial institutions other than insurance companies, the amount of
capital attributable to a permanent establishment is determined by allocating the institution's
total equity between its various offices on the basis of the proportion of the financial institution's
risk-weighted assets attributable to each of them. This recognizes the fact that financial
institutions are in many cases required to risk-weight their assets for regulatory purposes and, in
other cases, will do so for business reasons even if not required to do so by regulators. However,
risk-weighting is more complicated than the method prescribed by section 1.882-5.
Accordingly, to ease this administrative burden, taxpayers may choose to apply the principles of
Treas. Reg. section 1.882-5(c) to determine the amount of capital allocable to its U.S. permanent
establishment, in lieu of determining its allocable capital under the risk-weighted capital
allocation method provided by the Convention, even if it has otherwise chosen the principles of
Article 7 rather than the effectively connected income rules of U.S. domestic law.
Paragraph 4
Paragraph 4 provides that no business profits can be attributed to a permanent
establishment merely because it purchases goods or merchandise for the enterprise of which it is
a part. This paragraph is essentially identical to paragraph 5 of Article 7 of the DECO Model.
This rule applies only to an office that performs functions for the enterprise in addition to
purchasing. The income attribution issue does not arise if the sole activity of the office is the
purchase of goods or merchandise because such ~ctivity does not give ri.se t~ a p.ermaf,lent
establishment under Article 5 (Permanent EstablIshment). A common SItuatIOn m whIch
paragraph 4 is relevant is 0!le in whic.h a permanent esta?lishment purchases raw materials for
the enterprise's manufactunng operatlOn conducted outSIde the Untted States and sells the manufactured product. While b~s~n.ess profits may be att!ibutable t~ the. permanent e~tablishmef,lt
with respect to its sales actiVIties, no profits are attnbutable to It WIth respect to Its purchasmg
activities.
21
Paragraph 5
Paragraph 5 provides that profits shall be detennined by the same method each year.
unless there is good reason to change the method used. This rule assures consistent tax treatment
over time for pennanent establishments. It limits the ability of both the Contracting State and the
enterprise to change accounting methods to be applied to the pennanent establishment. It does
not. however. restrict a Contracting State from imposing additional requirements. such as the
rules under Code section 481. to prevent amounts from being duplicated or omitted following a
change in accounting method. Such adjustments may be necessary. for example. if the taxpayer
switches from using the domestic rules under section 864 in one year to using the rules of Article
7 in the next. Also. if the taxpayer switches from Convention-based rules to U.S. domestic rules.
it may need to meet certain deadlines for making elections that are not necessary when applying
the rules of the Convention.
Paragraph 6
Paragraph 6 coordinates the provisions of Article 7 and other provisions of the
Convention. Under this paragraph, when business profits include items of income that are dealt
with separately under other articles of the Convention, the provisions of those articles will,
except when they specifically provide to the contrary. take precedence over the provisions of
Article 7. For example, the taxation of dividends will be detennined by the rules of Article 10
(Dividends), and not by Article 7, except where, as provided in paragraph 6 of Article 10, the
dividend is attributable to a pennanent establishment. In the latter case the provisions of Article
7 apply. Thus. an enterprise of one State deriving dividends from the other State may not rely on
Article 7 to exempt those dividends from tax at source if they are not attributable to a pennanent
establishment of the enterprise in the other State. By the same token, if the dividends are
attributable to a pennanent establishment in the other State, the dividends may be taxed on a net
income basis at the source State full corporate tax rate, rather than on a gross basis under Article
10.
As provided in Article 8 (Shipping and Air Transport), income derived from shipping and
air transport activities in international traffic described in that Article is taxable only in the
country of residence of the enterprise regardless of whether it is attributable to a pennanent
establishment situated in the source State.
Paragraph 7
Paragraph 7 incorporates into the Convention the rule of Code section 864( c)( 6). Like
the Code section on which it is based, paragraph 7 provides that any income or gain attributable
to a pennanent establishment during its existence is taxable in the Contracting State where the
pennanent establishment is situated, even if the payment of that income or gain is deferred until
after the pennanent establishment ceases to exist. This rule applies with respect to paragraphs 1
and 2 of Article 7 (Business Profits), paragraph 6 of Article 10, paragraph 4 of Article 11
(Interest). paragraph 3 of Articles 12 (Royalties) and 13 (Capital Gains) and paragraph 2 of
Article 20 (Other Income).
. The.effect ?fthis rule can be ill~str~ted by the following e.xample. Assume a company
that IS a reSIdent ot Iceland and that mamtams a pennanent estabhshment in the United States
\\'inds up the pennanent establishment's business and sells the pennanent establishment's
inventory and assets to a U.S. buyer at the end of year 1 in exchange for an interest-bearing
installment obligation payable in full at the end of year 3. Despite the fact that Article 13's
_/....'
threshold requirement for U.S. taxation is not met in year 3 because the company has no
permanent establishment in the United States, the United States may tax the deferred income
payment recognized by the company in year 3.
Relationship to Other Articles
This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope) of
the Model. Thus, if a citizen of the United States who is a resident of Iceland under the treaty
derives business profits from the United States that are not attributable to a permanent
establishment in the United States, the United States may, subject to the special foreign tax credit
rules of paragraph 4 of Article 22 (Relief from Double Taxation), tax those profits,
notwithstanding the provision of paragraph 1 of this Article which would exempt the income
from U.S. tax.
The benefits of this Article are also subject to Article 21 (Limitation on Benefits). Thus,
an enterprise ofIceland that derives income effectively connected with a U.S. trade or business
may not claim the benefits of Article 7 unless the resident carrying on the enterprise qualifies for
such benefits under Article 21.
As provided in paragraph 3 ofthe Protocol, Articles 7 and 23 (Non-Discrimination) shall
not prevent Iceland from continuing to tax permanent establishments of United States insurance
companies in accordance with Article 70, paragraph 2, section 3 of the Icelandic Tax Code, nor
shall it prevent the United States from continuing to tax permanent establishments of Icelandic
insurance companies in accordance with section 842 b) of the Code.
ARTICLE 8 (SHIPPING AND AIR TRANSPORT)
This Article governs the taxation of profits from the operation of ships and aircraft in
international traffic. The term "international traffic" is defined in subparagraph 1(h) of Article 3
(General Definitions).
Paragraph 1
Paragraph 1 provides that profits derived by an enterprise of a Contracting State from the
operation in international traffic of ships or aircraft are taxable only in that Contracting State.
Because paragraph 6 of Article 7 (Business Profits) defers to Article 8 with respect to shipping
income, such income derived by a resident of one of the Contracting States may not be taxed in
the other State even if the enterprise has a permanent establishment in that other State. Thus, if a
U.S. airline has a ticket office in Iceland, Iceland may not tax the airline's profits attributable to
that office under Article 7. Since entities engaged in international transportation activities
normally will have many permanent establishments in a number of countries, the rule avoids
difficulties that would be encountered in attributing income to multiple permanent establishments if the income were covered by Article 7.
Paragraph 2
The income from the operation of ships or aircraft in international traffic that is exempt
from tax under paragraph 1 is defined in paragraph 2.
In addition to income derived directly from the operation of ships and aircraft in
international traffic, this definition also includes certain items of rental income. First, income of
23
an enterprise of a Contracting State from the rental of ships or aircraft on a full basis (i.e., with
crew) is income of the lessor from the operation of ships and aircraft in international trat1ic and.
therefore, is exempt from tax in the other Contracting State under paragraph 1. Also, paragraph
2 encompasses income from the lease of ships or aircraft on a bareboat basis (i.e .. without crew),
either when the income is incidental to other income of the lessor from the operation of ships or
aircraft in international traffic. or when the ships or aircraft are operated in international trat1ic
by the lessee. Ifneither of those two conditions apply, income from the bareboat rentals would
constitute business profits. The coverage of Article 8 is therefore broader than that of Article 8
of the OECD Model, which covers bareboat leasing only when it is incidental to other income of
the lessor from the operation of ships of aircraft in international traffic.
Paragraph 2 also clarifies, consistent with the Commentary to Article 8 of the OECD
Model, that income earned by an enterprise from the inland transport of property or passengers
within either Contracting State falls within Article 8 if the transport is undertaken as part of the
international transport of property or passengers by the enterprise. Thus, if a U.S. shipping
company contracts to carry property from Iceland to a U.S. city and, as part of that contract, it
transports the property by truck from its point of origin to an airport in Iceland (or it contracts
with a trucking company to carry the property to the airport) the income earned by the U.S.
shipping company from the overland leg of the journey would be taxable only in the United
States. Similarly, Article 8 also would apply to all of the income derived from a contract for the
lI11ernational transport of goods, even if the goods were transported to the port by a lighter, not
by the vessel that carried the goods in international waters.
Finally, certain non-transport activities that are an integral part of the services performed
by a transport company, or are ancillary to the enterprise's operation of ships or aircraft in
international traffic. are understood to be covered in paragraph 1, though they are not specified
in paragraph 2. These include, for example, the provision of goods and services by engineers,
ground and equipment maintenance and staff, cargo handlers. catering staff and customer
services personnel. Where the enterprise provides such goods to, or performs services for, other
enterprises and such activities are directly connected with or ancillary to the enterprise's
operation of ships or aircraft in international traffic, the profits from the provision of such goods
and services to other enterprises will fall under this paragraph.
For example, enterprises engaged in the operation of ships or aircraft in international
traffic may enter into pooling arrangements for the purposes of reducing the costs of maintaining
facilities needed for the operation of their ships or aircraft in other countries. For instance,
where an airline enterprise agrees (for example, under an International Airlines Technical Pool
agreement) to provide spare parts or maintenance services to other airlines landing at a particular
location (which allows it to benefit from these services at other locations), activities carried on
pursuant to that agreement will be ancillary to the operation of aircraft in international traffic by
the enterprise.
Also, advertising that the enterprise may do for other enterprises in magazines offered
aboard ships or aircraft that it operates in international traffic or at its business locations such as
ticket ?~fices, is a!lc~llaIJ: to its operation of these ships or aircra~. Profits generated by 'such
advertIsmg fall wIthm thIS paragraph. Income earned by concesslOnaires, however is not
covered by Article 8. These interpretations of paragraph 1 also are consistent with'the Commentary to Article 8 of the OECD Model.
24
Paragraph 3
Under this paragraph, profits of an enterprise of a Contracting State from the use,
maintenance or rental of containers (including equipment for their transport) used in
international traffic are exempt from tax in the other Contracting State. This result obtains under
paragraph 3 regardless of whether the recipient of the income is engaged in the operation of
ships or aircraft in international traffic, and regardless of whether the enterprise has a permanent
establishment in the other Contracting State. Only income from the use, maintenance or rental of
containers that is incidental to other income from international traffic is covered by Article 8 of
the OECD Model.
Paragraph 4
This paragraph clarifies that the provisions of paragraphs 1 and 3 also apply to profits
derived by an enterprise of a Contracting State from participation in a pool, joint business or
international operating agency. This refers to various arrangements for international cooperation
by carriers in shipping and air transport. For example, airlines from two countries may agree to
share the transport of passengers between the two countries. They each will fly the same number
of flights per week and share the revenues from that route equally, regardless of the number of
passengers that each airline actually transports. Paragraph 4 makes clear that with respect to
each carrier the income dealt with in the Article is that carrier's share of the total transport, not
the income derived from the passengers actually carried by the airline. This paragraph
corresponds to paragraph 4 of Article 8 of the OECD Model.
Relationship to Other Articles
The taxation of gains from the alienation of ships, aircraft or containers is not dealt with
in this Article but in paragraph 4 of Article 13 (Capital Gains).
As with other benefits of the Convention, the benefit of exclusive residence country
taxation under Article 8 is available to an enterprise only if it is entitled to benefits under Article
21 (Limitation on Benefits).
This Article also is subject to the saving clause of paragraph 4 of Article 1 (General
Scope) of the Model. Thus, if a citizen of the United States who is a resident ofIceland derives
profits from the operation of ships or aircraft in international traffic, notwithstanding the
exclusive residence country taxation in paragraph 1 of Article 8, the United States may, subject
to the special foreign tax credit rules of paragraph 4 of Article 22 (Relief from Double Taxation),
tax those profits as part of the worldwide income of the citizen. (This is an unlikely situation,
however, because non-tax considerations (~, insurance) generally result in shipping activities
being carried on in corporate form.)
ARTICLE 9 (ASSOCIATED ENTERPRISES)
This Article incorporates in the Convention the arm's-length principle reflected in the
U.S. domestic transfer pricing provisions, particularly Code section 482. It provides that when
related enterprises engage in a transaction on terms that ~e not arm's-len~th! !he Contracting
States may make appropriate adjustments to the taxable mco~e and .tax hablhty of such relat~d
enterprises to reflect what the income and tax of these enterpnses WIth respect to the transactlOn
would have been had there been an arm's-length relationship between them.
25
Paragraph 1
This paragraph is essentially the same as its counterpart in the U.S. and DECO Models.
It addresses the situation where an enterprise of a Contracting State is related to an enterprise of
the other Contracting State, and there are arrangements or conditions imposed between the
enterprises in their commercial or financial relations that are different from those that would
have existed in the absence of the relationship. Under these circumstances, the Contracting
States may adjust the income (or loss) of the enterprise to reflect what it would have been in the
absence of such a relationship.
The paragraph identifies the relationships between enterprises that serve as a prerequisite
to application of the Article. As the Commentary to the DECD Model makes clear, the
necessary element in these relationships is effective control, which is also the standard for
purposes of section 482. Thus, the Article applies if an enterprise of one State participates
directly or indirectly in the management, control, or capital of the enterprise of the other State.
Also, the Article applies if any third person or persons participate directly or indirectly in the
management, control, or capital of enterprises of different States. For this purpose, all types of
control are included, i.e., whether or not legally enforceable and however exercised or
exercisable.
The fact that a transaction is entered into between such related enterprises does not, in
and of itself, mean that a Contracting State may adjust the income (or loss) of one or both of the
enterprises under the provisions of this Article. If the conditions of the transaction are consistent
with those that would be made between independent persons, the income arising from that transaction should not be subject to adjustment under this Article.
Similarly, the fact that associated enterprises may have concluded arrangements, such as
cost sharing arrangements or general services agreements, is not in itself an indication that the
two enterprises have entered into a non-arm's-length transaction that should give rise to an
adjustment under paragraph 1. Both related and umelated parties enter into such arrangements
(~, joint venturers may share some development costs). As with any other kind of transaction,
when related parties enter into an arrangement, the specific arrangement must be examined to see
whether or not it meets the arm's-length standard. In the event that it does not, an appropriate
adjustment may be made, which may include modifying the terms of the agreement or recharacterizing the transaction to reflect its substance.
It is understood that the "commensurate with income" standard for determining
appropriate transfer prices for intangibles, added to Code section 482 by the Tax Reform Act of
1986, was designed to operate consistently with the arm's-length standard. The implementation
of this standard in the section 482 regulations is in accordance with the general principles of
paragraph 1 of Article 9 of the Convention, as interpreted by the DECO Transfer Pricing
Guidelines.
This Article also permits tax authorities to deal with thin capitalization issues. They may
in the context of Article 9, scrutinize more than the rate of interest charged on a loan between '
related persons. They also may examine the capital structure of an enterprise, whether a
payment in respect of that loan should be treated as interest, and, if it is treated as interest under
what circumstances. interest deductions should be allowed. to the payor. Paragraph 2 ofthe
Commentary to Article 9 of the OECD Model, together With the U.S. observation set forth in
paragraph 15. sets forth a similar understanding of the scope of Article 9 in the context of thin
capitalization.
26
Paragraph 2
When a Contracting State has made an adjustment that is consistent with the provisions
of paragraph 1, and the other Contracting State agrees that the adjustment was appropriate to
reflect arm's-length conditions, that other Contracting State is obligated to make a correlative
adjustment (sometimes referred to as a "corresponding adjustment") to the tax liability of the
related person in that other Contracting State. Although the GECD Model does not specify that
the other Contracting State must agree with the initial adjustment before it is obligated to make
the correlative adjustment, the Commentary makes clear that the paragraph is to be read that
way.
As explained in the Commentary to Article 9 of the OECD Model, Article 9 leaves the
treatment of "secondary adjustments" to the laws of the Contracting States. When an adjustment
under Article 9 has been made, one of the parties will have in its possession funds that it would
not have had at arm's length. The question arises as to how to treat these funds. In the United
States the general practice is to treat such funds as a dividend or contribution to capital,
depending on the relationship between the parties. Under certain circumstances, the parties may
be permitted to restore the funds to the party that would have the funds had the transactions been
entered into on arm's length terms, and to establish an account payable pending restoration of the
funds. See Rev. Proc. 99-32, 1999-2 c.B. 296.
The Contracting State making a secondary adjustment will take the other provisions of
the Convention, where relevant, into account. For example, if the effect of a secondary
adjustment is to treat a U.S. corporation as having made a distribution of profits to its parent
corporation in the other Contracting State, the provisions of Article 10 (Dividends) will apply,
and the United States may impose a 5 percent withholding tax on the dividend. Also, if under
Article 22 (Relief from Double Taxation) the other State generally gives a credit for taxes paid
with respect to such dividends, it would also be required to do so in this case.
The competent authorities are authorized by paragraph 3 of Article 24 (Mutual
Agreement Procedure) to consult, if necessary, to resolve any differences in the application of
these provisions. For example, there may be a disagreement over whether an adjustment made by
a Contracting State under paragraph 1 was appropriate.
If a correlative adjustment is made under paragraph 2, it is to be implemented, pursuant
to paragraph 2 of Article 24, notwithstanding any time limits or other procedural limitations in
the law of the Contracting State making the adjustment. If a taxpayer has entered a closing
agreement (or other written settlement) with the United States prior to bringing a case to the
competent authorities, the U.S. competent authority will endeavor only to obtain a correlative
adjustment from Iceland. See, Rev. Proc. 2006-54, 2006-49 LR.B.I035, Section 7.05.
Relationship to Other Articles
The saving clause of paragraph 4 of Article 1 (General Scope) does not apply to
paragraph 2 of Article 9 by virtue of an exception to the saving clause in subparagraph 5(a) of
Article 1. Thus, even if the statute of limitations has run, a refund of tax can be made in order to
implement a correlative adjustment. Statutory or proceduralli~itations, h~wever, cannot be
overridden to impose additional tax, because paragraph 2 of ArtIcle 1 proVIdes that the
Convention cannot restrict any statutory benefit.
27
ARTICLE 10 (DIVIDENDS)
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 a limited
source-State right to tax. 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
The right of a shareholder's country of residence to tax dividends arising in the source
country is preserved by paragraph 1, which 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 20 (Other Income) grants the
residence country exclusive taxing jurisdiction (other than for dividends attributable to a
permanent establishment in the other State).
Paragraph 2
The State of source also may tax dividends beneficially owned by a resident ofthe other
State, subject to the limitations of paragraphs 2 and 3. Paragraph 2 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 ov.mer of the dividend is
a company resident in the other State and owns directly shares representing at least 10 percent of
the share capital, as represented as 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. Shares are considered voting shares 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 benefits of paragraph 2 may be granted at the time of payment by means of reduced
rate of withholding tax at source. It also is consistent with the paragraph for tax to be withheld at
the time of payment at full statutory rates, and the treaty benefit to be granted by means of a
subsequent refund so long as such procedures are applied in a reasonable manner.
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
internal law of the Contracting State, subject to the provisions of paragraph 4 of Article 23 (NonDiscrimination) .
The term "beneficial owner" is not defined in the Convention, and is, therefore, defined
as under the internal law of the country imposing tax (t. e., the source country). The beneficial
ovvner of the dividend for purposes of Article lOis the person to which the dividend income is
28
attributable for tax purposes 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 (Resident» 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
enticled to benefits. These limitations are confirmed by paragraph 12 of the Commentary to
Article 10 of the OECD Model.
Special rules, however, apply to shares that are held through fiscally transparent entities.
In that case, the rules of paragraph 6 of Article 1 (General Scope) will apply to determine
whether the dividends should be treated as having been derived by a resident of a Contracting
State. Residence State principles shall be used to determine who derives the dividend, to assure
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. Source State principles of
beneficial ownership shall then apply to determine whether the person who derives the
dividends, or another resident of the other Contracting State, is the beneficial owner of the
dividend. The source State may conclude that the person who derives the dividend in the
residence State is a mere nominee, agent, conduit, etc., for a third country resident and deny
benefits of the Convention. If the person who derives the dividend under paragraph 6 of Article
1 would not be treated under the source State's principles for determining beneficial ownership
as a nominee, agent, custodian, conduit, etc., that person will be treated as the beneficial owner
of the income, profits or gains for purposes of the Convention.
Assume, for instance, that a company resident in Iceland pays a dividend to LLC, an
entity which is treated as fiscally transparent for U. S. tax purposes but is treated as a company
for Icelandic tax purposes. USCo, a company incorporated in the United States, is the sole
interest holder in LLC. Paragraph 6 of Article 1 provides that USCo derives the dividend.
Iceland's principles of beneficial ownership shall then be applied to USCo. If under the laws of
Iceland USCo is found not to be the beneficial owner of the dividend, USCo will not be entitled
to the benefits of Article 10 with respect to such dividend. The payment may be entitled to
benefits, however, ifUSCo is found to be a nominee, agent, custodian or conduit for a person
who is a resident of the United States.
Beyond identifying the person to whom the principles of beneficial ownership shall be
applied, the principles of paragraph 6 of Article 1 will also apply when determining whether
other requirements, such as the ownership threshold of subparagraph 2(a) have been satisfied.
For example, assume that IceCo, a company that is a resident of Iceland, owns all of the
outstanding shares in ThirdDE, an entity that is disregarded for U.S. tax purposes that is resident
in a third country. ThirdDE owns 100% of the stock of US Co. Iceland views ThirdDE as
fiscally transparent under its domestic law, and taxes IceCo currently on the income derived by
ThirdDE. In this case, IceCo is treated as deriving the dividends paid by USCo under paragraph
6 of Article l. Moreover, IceCo is treated as owning the shares of US Co directly. The
Convention does not address what constitutes direct ownership for purposes of Article 10. As a
result, whether ownership is direct is determined under the intemallaw of the country imposing
tax (i.e., the source country) unless the context otherwise requires. Accordingly, a company that
holds stock through such an entity will generally be considered to directly own such stock for
purposes of Article 10.
This result may change, however, if ThirdDE is regarded as non-fiscally transparent
under the laws of Iceland. Assuming that ThirdDE is treated as non-fiscally transparent by
29
Iceland. the income will not be treated as derived by a resident of Iceland for purposes of the
Convention. However. ThirdDE may still be entitled to the benefits of the U.S. tax treaty, ifany,
with its country of residence.
The same principles would apply in determining whether companies holding shares
through fiscally transparent entities such as partnerships, trusts, and estates would qualify for
benetits. As a result, companies holding shares through such entities may be able to claim the
benefits of subparagraph 2(a) under certain circumstances. The lower rate applies when the
company's proportionate share of the shares held by the intermediate entity meets the 10 percent
threshold, and the company meets the requirements of Article 1(6) (i.e., the company's country
of residence treats the intermediate entity as fiscally transparent) with respect to the dividend.
Whether this ownership threshold is satisfied may be difficult to determine and often will require
an analysis of the partnership or trust agreement.
Paragraph 3
Paragraph 3 imposes limitations on the rate reductions provided by paragraphs 2 and 3
in the case of dividends paid by RIC or a REIT.
The first sentence of subparagraph 3(a) provides that dividends paid by a RIC or REIT
are not eligible for the 5 percent rate of withholding tax of subparagraph 2( a).
The second sentence of subparagraph 3(a) provides that the 15 percent maximum rate of
withholding tax of subparagraph 2(b) applies to dividends paid by RICs.
The third sentence of subparagraph 3(a) provides that the 15 percent rate of withholding
tax also applies to dividends paid by a REIT 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." 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. 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.
The restrictions set out above are intended to prevent the use of these entities to gain
inappropriate U.S. tax benefits. For example, a company resident in Iceland that wishes to hold
a diversified portfolio of U.S. corporate shares could hold the portfolio directly and would bear
a U.S. withholding tax of 15 percent on all of the dividends that it receives. Alternatively, it
could hold the same diversified portfolio by purchasing 10 percent or more of the interests in a
RIC. If the RIC is a pure conduit, there may be no U.S. tax cost to interposing the RIC in the
chain of ownership. Absent the special rule in paragraph 3, such use of the RIC could transform
portfolio dividends, taxable in the United States under the Convention at a 15 percent maximum
rate of withholding tax, into direct investment dividends taxable at a 5 percent maximum rate of
withholding tax or eligible for the elimination of source-country withholding tax on dividends
paid to pension funds as provided in paragraph 4.
30
Similarly, a resident of Iceland directly holding U.S. real property would pay U.S. tax
upon the sale of the property either at a 30 percent rate of withholding tax on the gross income or
at graduated rates on the net income. As in the preceding example, by placing the real property
in a REIT, the investor could, absent a special rule, transform income from the sale of real estate
into dividend income from the REIT, taxable at the rates provided in Article 10, significantly
reducing the U.S. tax that otherwise would be imposed. Paragraph 3 prevents this result and
thereby avoids a disparity between the taxation of direct real estate investments and real estate
investments made through REIT conduits. In the cases in which paragraph 3 allows a dividend
from a REIT to be eligible for the 15 percent rate of withholding tax, the holding in the REIT is
not considered the equivalent of a direct holding in the underlying real property.
Paragraph 4
Paragraph 4 provides that dividends beneficially owned by a pension scheme or
employee benefits organization may not be taxed in the Contracting State of which the
company paying the tax is a resident. However, the exemption provided in paragraph 4 shall
not apply if the dividends are derived from the carrying on of a business, directly or indirectly,
by the pension scheme or employee benefits organization. For these purposes, the term
"pension scheme" is defined in subparagraph 1(1) of Article 3 (General Definitions).
The exemption is provided because pension schemes and employee benefits
organizations normally do not pay tax (either through a general exemption or because reserves
for future pension liabilities effectively offset all of the fund's income), and therefore cannot
benefit from a foreign tax credit. Moreover, distributions from a pension fund generally do not
maintain the character of the underlying income, so the beneficiaries of the pension are not in a
position to claim a foreign tax credit when they finally receive the pension, in many cases years
after the withholding tax has been paid. Accordingly, in the absence of this rule, the dividends
would almost certainly be subject to unrelieved double taxation.
Paragraph 5
Paragraph 5 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, or other corporate rights that are not treated as
debt under the law of the source State, that participate in the profits of the company. The term
also includes income that is subjected to the same tax treatment as income from shares by the
law of the State of source. 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.
31
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
Paragraph 6 provides a rule for taxing dividends paid with respect to holdings that fonn
part of the business property of a penn anent establishment. 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 pennanent
establishment is located, as such rules may be modified by the Convention. An example of
dividends paid with respect to the business property of a pennanent 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
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 to cases in which the dividends are paid
to a resident of that Contracting State or are attributable to a pennanent establishment or fixed
base 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
Paragraph 8 pennits 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 pennitted by the
Convention. The term "company" is defined in subparagraph 1(d) of Article 3 (General
Definitions ).
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 in that Contracting State that is taxed on a net basis under Article 6 (Income from
Immovable Property (Real 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." This is consistent with the relevant rules
under the U.S. branch profits tax, and the tenn dividend equivalent amount is defined in
paragraph 4 of the Protocol as that portion of the income mentioned in paragraph 7 of Article 10
that is comparable to the amount that would be distributed as a dividend if such income were
earned by a subsidiary incorporated in the United States. For any year, a foreign corporation's
dividend equivalent amount is equal to the after-tax earnings attributable to the foreign
corporation's (i) income attributable to a permanent establishment in the United States, (ii)
32
income from real property in the United States that is taxed on a net basis under Article 6
(Income from Immovable Property (Real Property», and (iii) gain from a real property interest
taxable by the United States under paragraph 1 of Article 13 (Capital Gains), reduced by any
increase in the foreign corporation's net investment in U.S. assets or increased by any reduction
in the foreign corporation's net investment in U.S. assets.
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. If Iceland also imposes a branch profits tax, the base of its tax must be
limited to an amount that is analogous to the dividend equivalent amount.
As discussed in the Technical Explanations to Articles 1(2) and 7(2), consistency
principles require that a taxpayer may not mix and match the rules of the Code and the
Convention in an inconsistent manner. In the context of the branch profits tax, the consistency
requirement means that an enterprise that uses the principles of Article 7 to determine its net
taxable income also must use the principles in determining the dividend equivalent amount.
Similarly, an enterprise that uses U.S. domestic law to determine its net taxable income must
also use U.S. domestic law in complying with the branch profits tax. As in the case of Article 7,
if an enterprise switches between domestic law and treaty principles from year to year, it will
need to make appropriate adjustments or recapture amounts that otherwise might go untaxed.
Paragraph 9
Paragraph 9 provides that the branch profits tax shall not be imposed at a rate exceeding
the direct investment dividend withholding rate of five percent.
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country taxation of dividends, the
saving clause of paragraph 4 of Article 1 permits the United States to tax dividends received by
its residents and citizens, subject to the special foreign tax credit rules of paragraph 4 of Article
22 (Relief from Double Taxation), as if the Convention had not come into effect.
The benefits of this Article are also subject to the provisions of Article 21 (Limitation on
Benefits). Thus, if a resident of the other Contracting State is the beneficial owner of dividends
paid by a U.S. corporation, the shareholder must qualify for treaty benefits under at least one of
the tests of Article 21 in order to receive the benefits of this Article.
ARTICLE 11 (INTEREST)
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
Paragraph 1 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 internal law of the State of source. The beneficial owner ofthe interest for purposes of
33
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.
Paragraph 2
The term "interest" as used in Article 11 is defined in paragraph 2 to include, inter alia,
income from debt claims of every kind, whether or not secured by a mortgage. Penalty charges
for late payment are excluded from the definition of interest. Interest that is paid or accrued
subject to a contingency is within the ambit of Article 11. This includes income from a debt
obligation carrying the right to participate in profits. The term does not, however, include
amounts that are treated as dividends under Article 10 (Dividends).
The term interest also includes amounts subject to the same tax treatment as income from
money lent under the law of the State in which the income arises. Thus, for purposes of the
Convention, amounts that the United States will treat as interest include (i) the difference
between the issue price and the stated redemption price at maturity of a debt instrument (i.e.,
original issue discount ("010")), 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 OlD 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 re-characterized as loans because of a "substantial non-periodic payment."
Paragraph 3
Paragraph 3 provides an exception to the exclusive residence taxation rule of paragraph 1
and the source-country gross taxation rule of paragraph 5 in cases where the beneficial owner of
the interest carries on business through a permanent establishment in the State of source situated
in that State and the interest is attributable to that permanent establishment. In such cases the
provisions of Article 7 (Business Profits) 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 that once existed in the State but that no longer
exists, the provisions of paragraph 3 also apply, by virtue of paragraph 7 of Article 7, to interest
that would be attributable to such a permanent establishment or fixed base if it did exist in the
year of payment or accrual. See the Technical Explanation of paragraph 7 of Article 7.
Paragraph .J
Paragraph 4 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's34
length interest payment). Any excess amount of interest paid remains taxable according to the
laws of the United States and Iceland, respectively, with due regard to the other provisions of the
Convention. Thus, if the excess amount would he treated under the source country's law as a
distribution of profits by a corporation, such amount could be taxcd 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.
The term "special relationship" is not defined in the Convention. In applying this
paragraph the United States considers thc tcrm to include the relationships described in Article 9,
which in turn corresponds to the definition of "control" for purposes of section 482 of the Code.
This paragraph does not address cases where, owing to a special relationship between the
payer and the beneficial o\\-ner 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 retlect its substance and interest may be imputed consistent with the definition
of interest in paragraph 3. The United States would apply section 482 or 7872 of the Code to
determine the amount of imputed interest in those cases.
Paragraph 5
Paragraph 5 provides anti-abuse exceptions to the source-country exemption in paragraph
1 for two classes of interest payments.
The first class of interest, dealt with in subparagraph 5(a) is so-called "contingent
interest." Under this provision, interest arising in a Contracting State that is determined by
reference to the receipts, sales, income, profits or other cash tlow of the debtor or a related
person, to any change in the value of any property of the debtor or a related person or to any
dividend, partnership distribution or similar payment made by the debtor or a related person, and
paid to a resident of the other State may also be taxed in the Contracting State. Any such interest
may be taxed in that Contracting State according to the laws of that State. However, if the
beneficial owner is a resident of the other Contracting State, the gross amount of the interest may
be taxed at a rate not exceeding 15 percent.
The second class of interest is dealt with in subparagraph 5(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.
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country taxation of interest, the
saving clause of paragraph 4 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 4 of Article 22
(Relief from Double Taxation), as if the Convention had not come into force.
As with other benefits of the Convention, the benefits of Article 11 are available to a
resident of the other State only if that resident is entitled to those benefits under the provisions of
Article 21 (Limitation on Benefits).
35
ARTICLE 12 (ROYALTIES)
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 I
Paragraph 1 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 tenn ""beneficial owner" is not defined in the Convention, and is, therefore, defined
under the internal law of the State of source. The beneficial owner of the royalty for purposes of
Article 12 is the person to which the income is attributable under the laws of the source State.
Thus, if a royalty 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
royalty is not entitled to the benefits of Article 12. However, a royalty received by a nominee on
behalf of a resident of that other State would be entitled to benefits. These limitations are
confinned by paragraph 4 of the OECD Commentary to Article 12.
Paragraph 2
Paragraph 2 provides that notwithstanding the provisions of paragraph I, the following
royalties may be taxed in the Contracting State in which they arise: royalties paid in
consideration for the use of, or the right to use a trademark and any infonnation concerning
industrial, commercial or scientific experience provided in connection with a rental or franchise
agreement that includes rights to use a trademark, and royalties paid in consideration for the use
of or the right to use a motion picture film or work on film or videotape or other means of
reproduction for use in connection with television. If, however, the beneficial owner of the
royalty is a resident of the other Contracting State, the tax may not exceed 5 percent of the gross
amount of the royalties.
Paragraph 3
Paragraph 2 defines the tenn "royalties," as used in Article 12, to include any
consideration for the use of, or the right to use, any copyright ofliterary, artistic, scientific or
other work (such as computer software and cinematographic films), any patent, trademark,
design or model, plan, secret fonnula or process, or for infonnation concerning industrial,
commercial, or scientific experience. The tenn "royalties," however, does not include income
from leasing personal property.
The tenn royalties is defined in the Convention and therefore is generally independent of
domestic law. Certain tenns used in the definition are not defined in the Convention, but these
may be defined under domestic tax law. For example, the tenn "secret process or fonnulas" 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.
Consid~ration for. the .use
0: right to ~s~ cinematogr~phi~ films, or works on film, tape, or
()tha means of reproductIOn m radIO or teleVISIOn broadcastmg IS specifically included in the
definition of royalties. It is intended that, with respect to any subsequent technological advances
36
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), affd, 810 F.2d 209 (D.C. Cir. 1986). By contrast, if the artist
earns in the other Contracting State income covered by Article 16 (Entertainers and Sportsmen),
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 16 and not Article 12 is applicable to such
mcome.
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. section 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, 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 7 (Business Profits) or Article 14 (Income from Employment).
Professional services may be embodied in property that gives rise to royalties, however. Thus, if
37
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 -I
This paragraph provides an exception in cases where the beneficial owner of the royalties
carries on business through a permanent establishment in the state of source and the royalties are
attributable to that permanent establishment. In such cases the provisions of Article 7 will apply.
The provisions of paragraph 7 of Article 7 apply to this paragraph. For example, royalty
income that is attributable to a permanent establishment and that accrues during the existence of
the permanent establishment, but is received after the permanent establishment no longer exists,
remains taxable under the provisions of Article 7, and not under this Article.
Paragraph 5
Paragraph 5 contains the source rule for royalties. Under paragraph 5, royalties are
treated as arising in a Contracting State if paid by a resident of that State. As an exception,
royalties that are attributable to a permanent establishment in a Contracting State and borne by
the permanent establishment are considered to arise in that State. Where, however, the payor of
the royalties is not a resident of either Contracting State, and the royalties are not borne by a
permanent establishment in either Contracting State, but the royalties are for the use of, or the right
to use, in one of the Contracting States, any property or right described in paragraph 3, the royalties
are deemed to arise in that State.
Paragraph 6
Paragraph 6 provides that in cases involving special relationships 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 4 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 4 of Article 22
(Relief from Double Taxation), as if the Convention had not come into force.
As with other benefits of the Convention, the benefits of Article 12 are available to a
resident of the other State only if that resident is entitled to those benefits under Article 21
(Limitation on Benefits).
38
ARTICLE 13 (CAPITAL GAINS)
Article 13 assigns either primary or exclusive taxing jurisdiction over gains from the
alienation of property to the State of residence or the State of source.
Paragraph 1
Paragraph 1 of Article 13 preserves the non-exclusive right of the State of source to tax
from the alienation of immovable property (real property) situated in that State. For purposes of
paragraph 1, in all events the term "immovable property (real property) situated in the other
State" includes a United States real property interest in the United States, as that term is defined
in the Internal Revenue Code on the date of signature of the Convention, and as amended
(without changing the general principles of paragraph I). Thus, the United States preserves its
right to collect the tax imposed by section 897 of the Code on gains derived by foreign persons
from the disposition of United States real property interests, including gains arising from indirect
dispositions described in section 897(h).
Paragraph 2
This paragraph defines the term "immovable property (real property) situated in the other
Contracting State." The term includes real property referred to in Article 6 (i.e., an interest in the
real property itself), rights to assets to be produced by the exploration or exploitation of the
seabed and subsoil of that other State and their natural resources, including rights to interests in
or the benefit of such assets, a "United States real property interest" (when the United States is
the other Contracting State under paragraph 1), and, as specified in subparagraph 2(d), an
equivalent interest in immovable property (real property) situated in Iceland.
Under section 897(c) of the Code the term "United States real property interest" includes
shares in a U.S. corporation that owns sufficient U.S. real property interests to satisfy an assetratio test on certain testing dates. The term also includes certain foreign corporations that have
elected to be treated as U.S. corporations for this purpose. Section 897(i).
Paragraph 3
Paragraph 3 of Article 13 deals with the taxation of certain gains from the alienation of
movable property forming part of the business property of a permanent establishment that an
enterprise of a Contracting State has in the other Contracting State. This also includes gains
from the alienation of such a permanent establishment (alone or with the whole enterprise).
Such gains may be taxed in the State in which the permanent establishment is located.
A resident of Iceland that is a partner in a partnership doing business in the United States
generally will have a permanent establishment in the United States as a result of the activities of
the partnership, assuming that the activities of the partnership rise to the level of a permanent
establishment. Rev. Rul. 91-32,1991-1 C.B. 107. Further, under paragraph 3, the United
States generally may tax a partner's distributive share of income realized by a partnership on the
di "position of movable property forming part of the business property of the partnership in the
United States.
39
The gains subject to paragraph 3 may be taxed in the State in which the permanent
establishment is located. regardless of whether the permanent establishment exists at the time of
the alienation. This rule incorporates the rule of section 864(c)(6) of the Code. Accordingly,
income that is attributable to a permanent establishment, but that is deferred and received after
the permanent establishment no longer exists, may nevertheless be taxed by the State in which
the permanent establishment was located.
Paragraph .J
This paragraph limits the taxing jurisdiction of the State of source with respect to gains
from the alienation of ships, aircraft or containers operated in international traffic by the
enterprise alienating the ship or aircraft and from property (other than real property) pertaining
to the operation or use of such ships, aircraft, or containers.
Under paragraph 4, such income is taxable only in the Contracting State in which the
alienator is resident. Notwithstanding paragraph 3, the rules of this paragraph apply even if the
income is attributable to a permanent establishment maintained by the enterprise in the other
Contracting State. This result is consistent with the allocation of taxing rights under Article 8
(Shipping and Air Transport).
Paragraph 5
Paragraph 5 grants to the State of residence of the alienator the exclusive right to tax
gains from the alienation of property other than property referred to in paragraphs 1 through 4.
For example, gain derived from shares, other than shares described in paragraphs 2 or 3, debt
instruments and various financial instruments, may be taxed only in the State of residence, to the
extent such income is not otherwise characterized as income taxable under another article (~,
Article 10 (Dividends) or Article 11 (Interest)). Similarly gain derived from the alienation of
tangible personal property, other than tangible personal property described in paragraph 3, may
be taxed only in the State of residence of the alienator.
Gains derived by a resident of a Contracting State from real property located in a third
state are not taxable in the other Contracting State, even if the sale is attributable to a permanent
establishment located in the other Contracting State.
Paragraph 6
Paragraph 6 sets forth a rule which permits the imposition of certain expatriation taxes.
This rule provides that notwithstanding paragraph 5 a Contracting State may tax gains from the
alienation of shares or rights in a company, the capital of which is wholly or partly divided into
shares. and that is a resident of that State, if the person alienating the shares or rights is an
individual resident in the other Contracting State, but only if such individual was a resident of
the first-mentioned State at any time during the five-year period preceding the alienation.
Relationship fo Other Articles
Notwithstanding the foregoing limitations on taxation of certain gains by the State of
source, the saving clause of paragraph 4 of Article 1 (General Scope) permits the United States
to tax its citizens and residents as if the Convention had not come into effect. Thus, any
limitation in this Article on the right of the United States to tax gains does not apply to gains of a
U.S. citizen or resident.
40
The benefits of this Article are also subject to the provisions of Article 21 (Limitation on
Benefits). Thus, only a resident of a Contracting State that satisfies one of the conditions in
Article 21 is entitled to the benefits of this Article.
Additionally, the provisions of paragraph 6 shall be applied in conjunction with
subparagraph 2(b) of Article 22 (Relief from Double Taxation).
ARTICLE 14 (INCOME FROM EMPLOYMENT)
Article 14 apportions taxing jurisdiction over remuneration derived by a resident of a
Contracting State as an employee between the States of source and residence.
Paragraph 1
The general rule of Article 14 is contained in paragraph 1. Remuneration derived by a
resident of a Contracting State as an employee may be taxed by the State of residence, and the
remuneration also may be taxed by the other Contracting State to the extent derived from
employment exercised (i.e., services performed) in that other Contracting State. Paragraph 1 also
provides that the more specific rules of Articles 15 (Directors' Fees), 17 (Pensions, Social
Security, and Annuities), and 19 (Government Service) apply in the case of employment income
described in one of those articles. Thus, even though the State of source has a right to tax
employment income under Article 14, it may not have the right to tax that income under the
Convention if the income is described, for example, in Article 17 (Pensions, Social Security, and
Annuities) and is not taxable in the State of source under the provisions of that article.
Article 14 applies to any form of compensation for employment, including payments in
kind. Paragraph 1.1 of the Commentary to Article 16 of the OECD Model now confirms that
interpretation.
Consistent with section 864(c)(6) of the Code, Article 14 also applies regardless of the
timing of actual payment for services. Consequently, a person who receives the right to a future
payment in consideration for services rendered in a Contracting State would be taxable in that
State even if the payment is received at a time when the recipient is a resident of the other
Contracting State. Thus, a bonus paid to a resident of a Contracting State with respect to services
performed in the other Contracting State with respect to a particular taxable year would be
subject to Article 14 for that year even if it was paid after the close of the year. An annuity
received for services performed in a taxable year could be subject to Article 14 despite the fact
that it was paid in subsequent years. In that case, it would be necessary to determine whether the
payment constitutes deferred compensation, taxable under Article 14, or a qualified pension
subject to the rules of Article 17 (Pensions, Social Security, and Annuities). Article 14 also
applies to income derived from the exercise of stock options granted with respect to services
performed in the host State, even if those stock options are exercised after the employee has left
the source country. If Article 14 is found to apply, whether such payments were taxable in the
State where the employment was exercised would depend on whether the tests of paragraph 2
were satisfied in the year in which the services to which the payment relates were performed.
Paragraph 2
Paragraph 2 sets forth an exception to the general rule that employment income may be
taxed in the State where it is exercised. Under paragraph 2, the State where the employment is
41
exercised may not tax the income from the employment if three conditions are satisfied: (a) the
individual is present in the other Contracting State for a period or periods not exceeding 183
days in any 12-month period that begins or ends during the relevant taxable year (i.e., in the
United States, the calendar year in which the services are performed); (b) the remuneration is
paid by. or on behalf of. an employer who is not a resident of that other Contracting State; and
(c) the remuneration is not borne as a deductible expense by a permanent establishment that the
employer has in that other State. In order for the remuneration to be exempt from tax in the
source State, all three conditions must be satisfied. This exception is identical to that set forth in
the OECD Model.
The 183-day period in condition (a) is to be measured using the "days of physical
presence" method. Under this method, the days that are counted include any day in which a part
of the day is spent in the host country. (Rev. Rul. 56-24,1956-1 c.B. 851.) Thus, days that are
counted include the days of arrival and departure; weekends and holidays on which the employee
does not work but is present within the country; vacation days spent in the country before, during
or after the employment period, unless the individual's presence before or after the employment
can be shown to be independent of his presence there for employment purposes; and time during
periods of sickness, training periods, strikes, etc" when the individual is present but not working.
If illness prevented the individual from leaving the country in sufficient time to qualify for the
benefit, those days will not count. Also, any part of a day spent in the host country while in
transit between two points outside the host country is not counted. If the individual is a resident
of the host country for part of the taxable year concerned and a nonresident for the remainder of
the year, the individual's days of presence as a resident do not count for purposes of determining
whether the 183-day period is exceeded.
Conditions (b) and (c) are intended to ensure that a Contracting State will not be required
to allow a deduction to the payor for compensation paid and at the same time to exempt the
employee on the amount received. Accordingly, if a foreign person pays the salary of an
employee who is employed in the host State, but a host State corporation or permanent
establishment reimburses the payor with a payment that can be identified as a reimbursement,
neither condition (b) nor (c), as the case may be, will be considered to have been fulfilled,
The reference to remuneration "borne by" a permanent establishment is understood to
encompass all expenses that economically are incurred and not merely expenses that are
currently deductible for tax purposes. Accordingly, the expenses referred to include expenses
that are capitalizable as well as those that are currently deductible, Further, salaries paid by
residents that are exempt from income taxation may be considered to be borne by a permanent
establishment notwithstanding the fact that the expenses will be neither deductible nor
capitalizable since the payor is exempt from tax.
Paragraph 3
Paragraph 3 contains a special rule applicable to remuneration for services performed by
a resident of a Contracting State as an employee aboard a ship or aircraft operated in
international traffic, Such remuneration may be taxed only in the State of residence of the
e~plo!ee if t~e services are perfo~~d as a member of the regular complement of the ship or
~lrcraft. Th,e regular complement mclu~es the crew. In the case of a cruise ship, for example,
11 may also mclude others, ~uch as enterta,mers, lecturers, etc., employed by the shipping
~o~pany to serve ,on the ShIp throughout ItS ~oyag7' The use of the term "regular complement"
IS mtended to clanfy that a person who exerCIses hIS employment as, for example an insurance
'
salesman while aboard a ship or aircraft is not covered by this paragraph.
42
If a U.S. citizen who is resident in Iceland perfonns services as an employee in the
United States and meets the conditions of paragraph 2 for source country exemption, he
nevertheless is taxable in the United States by virtue of the saving clause of paragraph 4 of
Article 1 (General Scope), subject to the special foreign tax credit rule of paragraph 4 of Article
22 (Relief from Double Taxation).
ARTICLE 15 (DIRECTORS' FEES)
This Article provides that a Contracting State may tax the fees and other compensation
paid by a company that is a resident of that State for services perfonned by a resident of the
other Contracting State in his capacity as a director of the company. This rule is an exception to
the more general rules of Articles 7 (Business Profits) and 14 (Income from Employment).
Thus, for example, in detennining whether a director's fee paid to a non-employee director is
subject to tax in the country of residence of the corporation, it is not relevant to establish whether
the fee is attributable to a permanent establishment in that State.
Under this Article, a resident of one Contracting State who is a director of a corporation
that is resident in the other Contracting State is subject to tax in that other State in respect of his
directors' fees regardless of where the services are perfonned. Under U.S. law, however,
services perfonned by a nonresident may not be taxed unless they are performed in the United
States (unless that nonresident is a U.S. citizen, and therefore subject to the saving clause of
paragraph 4 of Article 1 (General Scope».
ARTICLE 16 (ENTERTAINERS AND SPORTSMEN)
This Article deals with the taxation in a Contracting State of entertainers and sportsmen
resident in the other Contracting State from the perfonnance of their services as such. The
Article applies both to the income of an entertainer or sportsman who perfonns services on his
own behalf and one who perfonns services on behalf of another person, either as an employee of
that person, or pursuant to any other arrangement. The rules of this Article take precedence, in
some circumstances, over those of Articles 7 (Business Profits) and 14 (Income from
Employment).
This Article applies only with respect to the income of entertainers and sportsmen. Others
involved in a perfonnance or athletic event, such as producers, directors, technicians, managers,
coaches, etc., remain subject to the provisions of Articles 7 and 14. In addition, except as
provided in paragraph 2, income earned by juridical persons is not covered by Article 16.
Paragraph 1
Paragraph 1 describes the circumstances in which a Contracting State may tax the
perfonnance income of an entertainer or sportsman who is a resident of the other Contracting
State. Under the paragraph, income derived by an individual resident of a Contracting State from
activities as an entertainer or sportsman exercised in the other Contracting State may be taxed in
that other State if the amount of the gross receipts derived by the perfonner exceeds $20,000 (or
its equivalent in Icelandic kronur) for the taxable year. The $20,000 includes expenses
reimbursed to the individual or borne on his behalf. If the gross receipts exceed $20,000, the full
amount, not just the excess, may be taxed in the State of perfonnance.
The Convention introduces the monetary threshold to distinguish between two groups of
entertainers and athletes -- those who are paid relatively large sums of money for very short
43
periods of service. and who would. therefore. normally be exempt from host country tax under
the standard personal services income rules. and those who earn relatively modest amounts and
~re. therefore. not easily distinguishable from those who earn other types of personal service
Income.
Tax may be imposed under paragraph 1 even if the performer would have been exempt
from tax under Article 7 or 14. On the other hand. if the performer would be exempt from hostcountry tax under Article 16, but would be taxable under either Article 7 or 14, tax may be
imposed under either of those Articles. Thus. for example, if a performer derives remuneration
from his activities in an independent capacity, and the performer does not have a permanent
establishment in the host State, he may be taxed by the host State in accordance with Article 16
ifhis remuneration exceeds $20,000 annually, despite the fact that he generally would be exempt
from host State taxation under Article 7. However, a performer who receives less than the
$20.000 threshold amount and therefore is not taxable under Article 16 nevertheless may be
subject to tax in the host country under Article 7 or 14 if the tests for host-country taxability
under the relevant Article are met. For example, if an entertainer who is an independent
contractor earns $14,000 of income in a State for the calendar year, but the income is attributable
to his permanent establishment in the State of performance, that State may tax his income under
Article 7.
Nothing shall preclude a Contracting State from withholding tax from such payments
according to its domestic laws. However, if according to the provisions of this Article, such
remuneration or income may only be taxed in the other Contracting State, the first-mentioned
Contracting State shall make a refund of the tax so withheld upon a duly filed claim. Such claim
must be filed with the tax authorities that have collected the withholding tax within five years
after the close of the calendar year in which the tax was withheld.
As explained in paragraph 9 of the Commentary to Article 17 of the OECD Model,
Article 16 of the Convention applies to all income connected with a performance by the
entertainer, such as appearance fees, award or prize money, and a share of the gate receipts.
Income derived from a Contracting State by a performer who is a resident of the other
Contracting State from other than actual performance, such as royalties from record sales and
payments for product endorsements, is not covered by this Article, but by other articles of the
Convention, such as Article 12 (Royalties) or Article 7. For example, if an entertainer receives
royalty income from the sale of live recordings, the royalty income would be subject to the
provisions of Article 12, even if the performance was conducted in the source country, although
the entertainer could be taxed in the source country with respect to income from the performance
itself under Article 16 if the dollar threshold is exceeded.
In determining whether income falls under Article 16 or another article, the controlling
factor will be whether the income in question is predominantly attributable to the performance
itself or to other activities or property rights. For instance, a fee paid to a performer for
endorsement of a performance in which the performer will participate would be considered to be
so closely associated with the performance itself that it normally would fall within Article 16.
Similarly. a sponsorship fee paid by a business in return for the right to attach its name to the
performance would be so closely associated with the performance that it would fall under Article
16 as well. As indicated in paragraph 9 of the Commentary to Article 17 of the OEeD Model,
however. a cancellation fee would not be considered to fall within Article 16 but would be dealt
with under Article 7 or 14.
44
As indicated in paragraph 4 of the Commentary to Article 17 of the OECD Model, where
an individual fulfills a dual role as performer and non-performer (such as a player-coach or an
actor-director), but his role in one of the two capacities is negligible, the predominant character
of the individual's activities should control the characterization of those activities. In other cases
there should be an apportionment between the performance-related compensation and other
compensation.
Consistent with Article 14, Article 16 also applies regardless of the timing of actual
payment for services. Thus, a bonus paid to a resident of a Contracting State with respect to a
performance in the other Contracting State during a particular taxable year would be subject to
Article 16 for that year even if it was paid after the close of the year. The determination as to
whether the $20,000 threshold has been exceeded is determined separately with respect to each
year of payment. Accordingly, if an actor who is a resident of one Contracting State receives
residual payments over time with respect to a movie that was filmed in the other Contracting
State, the payments do not have to be aggregated from one year to another to determine whether
the total payments have finally exceeded $20,000. Otherwise, residual payments received many
years later could retroactively subject all earlier payments to tax by the other Contracting State.
Paragraph 2
Paragraph 2 is intended to address the potential for circumvention of the rule in
paragraph I when a performer'S income does not accrue directly to the performer himself, but to
another person. Foreign performers frequently perform in the United States as employees of, or
under contract with, a company or other person.
The relationship may truly be one of employee and employer, with no circumvention of
paragraph I either intended or realized. On the other hand, the "employer" may, for example, be
a company established and owned by the performer, which is merely acting as the nominal
income recipient in respect of the remuneration for the performance (a "star company"). The
performer may act as an "employee," receive a modest salary, and arrange to receive the
remainder of the income from his performance from the company in another form or at a later
time. In such case, absent the provisions of paragraph 2, the income arguably could escape hostcountry tax because the company earns business profits but has no permanent establishment in
that country. The performer may largely or entirely escape host-country tax by receiving only a
small salary, perhaps small enough to place him below the dollar threshold in paragraph 1. The
performer might arrange to receive further payments in a later year, when he is not subject to
host-country tax, perhaps as dividends or liquidating distributions.
Paragraph 2 seeks to prevent this type of abuse while at the same time protecting the
taxpayers' rights to the benefits of the Convention when there is a legitimate employee-employer
relationship between the performer and the person providing his services. Under paragraph 2,
when the income accrues to a person other than the performer, and the performer or related
persons participate, directly or indirectly, in the receipts or profits of that other person, the
income may be taxed in the Contracting State where the performer's services are exercised,
without regard to the provisions of the Convention concerning business profits or income from
employment (Article 14). In cases where paragraph 2 is applicable, the income of the
"employer" may be subject to tax in the host Contracting State even if it has no permanent
establishment in the host country. Taxation under paragraph 2 is on the person providing the
services of the performer. This paragraph does not affect the rules of paragraph I, which apply
to the performer himself. The income taxable by virtue of paragraph 2 is reduced to the extent of
salary payments to the performer, which fall under paragraph 1.
45
For purposes of paragraph 2. income is deemed to accrue to another person (i.e .. the
person providing the services of the performer) if that other person has control over. or the right
to receive. gross income in respect of the services of the performer. Direct or indirect
participation in the profits of a person may include, but is not limited to, the accrual or receipt of
deferred remuneration, bonuses, fees, dividends, partnership income or other income or
distributions.
Paragraph 2 does not apply if it is established that neither the performer nor any persons
related to the performer participate directly or indirectly in the receipts or profits of the person
providing the services of the performer. Assume, for example, that a circus owned by a U.S.
corporation performs in the other Contracting State, and promoters of the performance in the
other State pay the circus, which, in tum, pays salaries to the circus performers. The circus is
determined to have no permanent establishment in that State. Since the circus performers do not
participate in the profits of the circus, but merely receive their salaries out of the circus' gross
receipts, the circus is protected by Article 7 and its income is not subject to host-country tax.
Whether the salaries of the circus performers are subject to host-country tax under this Article
depends on whether they exceed the $20,000 threshold in paragraph 1.
Since pursuant to Article 1 (General Scope) the Convention only applies to persons who
are residents of one of the Contracting States, income of the star company would not be eligible
for benefits of the Convention if the company is not a resident of one of the Contracting States.
Relationship to other Articles
This Article is subject to the provisions of the saving clause of paragraph 4 of Article 1
(General Scope). Thus, if an entertainer or a sportsman who is resident in the other Contracting
State is a citizen of the United States, the United States may tax all of his income from
performances in the United States without regard to the provisions of this Article, subject,
however. to the special foreign tax credit provisions of paragraph 4 of Article 22 (Relief From
Double Taxation). In addition, benefits of this Article are subject to the provisions of Article 21
(Limitation On Benefits).
ARTICLE 17 (PENSIONS, SOCIAL SECURITY, AND ANNUITIES)
This Article deals with the taxation of private (i.e., non-government service) pensions,
social security benefits. and annuities.
Paragraph 1
Paragraph 1 provides that distributions from pensions and other similar remuneration
paid to a resident of a Contracting State in consideration of past employment are taxable only in
the State of residence of the beneficiary. The term "pensions and other similar remuneration"
includes both periodic and single sum payments.
The phrase "pensions and other similar remuneration" is intended to encompass
payments made by qualified ~rivate retirerr.tent plans. In the United States, the plans
encompassed by Paragraph 1 mclude: quahfied plans under section 401(a), individual retirement
plans (i?cluding ~ndividual r~tir~rr.tent pla~s that are part of a simplified employee pension plan
that satIsfies sectIOn 408(k), mdIvIdual retIrement accounts and section 408(p) accounts), section
403(a) qu~lified annuity plans. ~d section 403(b~ pla~s. Distributions from section 457 plans
may also tall under Paragraph I1fthey are not paId WIth respect to government services covered
46
by Article 19. In Iceland, the term pension applies to any pension fund or pension plan qualified
under the Pension Act or any identical or substantially similar schemes which are created under
any law enacted after the signature of the Convention. The competent authorities may agree that
distributions from other plans that generally meet similar criteria to those applicable to the listed
plans also qualify for the benefits of Paragraph 1.
Pensions in respect of government services covered by Article 18 are not covered by this
paragraph. They are covered either by paragraph 2 of this Article, if they are in the form of
social security benefits, or by paragraph 2 of Article 18 (Government Service). Thus, Article 18
generally covers section 457(g), 401(a), 403(a), and 403(b) plans established for government
employees, including the Thrift Savings Plan (section 7701U».
Paragraph 2
The treatment of social security benefits is dealt with in paragraph 2. This paragraph
provides that, notwithstanding the provision of paragraph 1 under which private pensions are
taxable exclusively in the State of residence of the beneficial owner, payments made by one of
the Contracting States under the provisions of its social security or similar legislation to a resident ofIceland or to a citizen of the United States will be taxable only in the Contracting State
making the payment. The reference to U.S. citizens is necessary to ensure that a social security
payment by Iceland to a U.S. citizen who is not resident in the United States will not be taxable
by the United States.
This paragraph applies to social security beneficiaries whether they have contributed to
the system as private sector or Government employees. The phrase "similar legislation" is
intended to refer to United States tier 1 Railroad Retirement benefits.
Paragraph 3
Under paragraph 3, annuities that are derived and beneficially owned by a resident of a
Contracting State are taxable only in that State. An annuity, as the term is used in this
paragraph, means a stated sum paid periodically at stated times during a specified number of
years, under an obligation to make the payment in return for adequate and full consideration
(other than for services rendered). An annuity received in consideration for services rendered
would be treated as either deferred compensation that is taxable in accordance with Article 14
(Income from Employment) or a pension that is subject to the rules of paragraph 1.
Paragraph 4
Paragraph 4 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 aU .S. qualified plan while working in the
United States and then establishes residence in Iceland, paragraph 1 prevents Iceland 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.
47
Relationship to other Articles
Paragraphs I and 3 of Article 17 are subject to the saving clause of paragraph 4 of Article
I (General Scope). Thus. a U.S. citizen who is resident in the other Contracting State, and
receives either a pension, annuity or alimony payment from the United States. may be subject to
U.S. tax on the payment, notwithstanding the rules in those three paragraphs that give the State
of residence of the recipient the exclusive taxing right. Paragraphs 2 and 4 are excepted from the
saving clause by virtue of subparagraph 5(a) of Article 1. Thus, the United States will not tax
U.S. citizens and residents on the income described in those paragraphs even if such amounts
otherwise would be subject to tax under U.S. law.
ARTICLE 18 (GOVERNMENT SERVICE)
Paragraph 1
Subparagraphs 1(a) and l(b) deal with the taxation of government compensation (other
than a pension addressed in paragraph 2). Subparagraph 1(a) provides that remuneration paid
from the public funds of a Contracting State or its political subdivisions or local authorities to
any individual who is rendering services to that State, political subdivision or local authority,
which are in the discharge of governmental functions, is exempt from tax by the other State.
Under subparagraph 1(b), such payments are, however, taxable exclusively in the other State
(i.e., the host State) if the services are rendered in that other State and the individual is a resident
of that State who is either a national of that State or a person who did not become resident of that
State solely for purposes of rendering the services. The paragraph applies to anyone performing
services for a government, whether as a government employee, an independent contractor, or an
employee of an independent contractor.
Paragraph 2
Paragraph 2 deals with the taxation of pensions paid by, or out of funds created by, one of
the States, or a political subdivision or a local authority thereof, to an individual in respect of
services rendered in the discharge of functions of a governmental nature to that State or
subdivision or authority. Subparagraph l(a) provides that such pensions are taxable only in that
State. Subparagraph 1(b) provides an exception under which such pensions are taxable only in
the other State if the individual is a resident of, and a national of, that other State.
Pensions paid to retired civilian and military employees of a Government of either State
are intended to be covered under paragraph 2. When benefits paid by a State in respect of
services rendered to that State or a subdivision or authority are in the form of social security
benefits, however. those payments are covered by paragraph 2 of Article 17 (Pensions, Social
Security, Annuities. Alimony, and Child Support). As a general matter, the result will be the
same whether Article 17 or 19 applies, since social security benefits are taxable exclusively by
the source country and so are government pensions. The result will differ only when the
payment is made to a citizen and resident of the other Contracting State, who is not also a citizen
of the paying State. In such a case, social security benefits continue to be taxable at source while
government pensions become taxable only in the residence country.
48
Paragraph 3
Paragraph 3 provides that the remuneration described in paragraph 1 will be subject to
the rules of Articles 14 (Income from Employment), 15 (Directors' Fees), 16 (Entertainers and
Sportsmen) or 17 ifthe recipient of the income is employed by a business conducted by a
government.
Relationship to other Articles
Under subparagraph 5(b) of Article 1 (General Scope), the saving clause (paragraph 4 of
Article 1) does not apply to the benefits conferred by one of the States under Article 18 if the
recipient of the benefits is neither a citizen ofthat State, nor a person who has been admitted for
permanent residence there (i.e., in the United States, a "green card" holder). Thus, a resident of a
Contracting State who in the course of performing functions of a governmental nature becomes a
resident of the other State (but not a permanent resident), would be entitled to the benefits of this
Article. Similarly, an individual who receives a pension paid by the Government ofIceland in
respect of services rendered to the Government of Iceland shall be taxable on this pension only
in Iceland unless the individual is a U.S. citizen or acquires a U.S. green card.
ARTICLE 19 (STUDENTS AND TRAINEES)
This Article provides rules for host-country taxation of visiting students and business
trainees. Persons who meet the tests of the Article will be exempt from tax in the State that they
are visiting with respect to designated classes of income. Several conditions must be satisfied in
order for an individual to be entitled to the benefits of this Article.
Paragraph 1
Paragraph 1 provides that an individual who is a resident of one Contracting State at the
time he becomes temporarily present in the other Contracting State and who is temporarily
present therein for the primary purpose of studying at a university or other recognized
educational institution in that other Contracting State, securing training required to qualify him
to practice a profession or professional specialty, or studying or doing research as a recipient of a
grant, allowance, or award from a governmental, religious, charitable, scientific, literary, or
educational organization, will be exempt from tax by that other Contracting State for a period not
exceeding five taxable years from the date of his arrival in that other Contracting State on:
(1) Gifts from abroad for the purpose of his maintenance, education, study, research or
training;
(2) The grant, allowance, or award; and
(3) Income from personal services performed in the other Contracting State not in excess
of $9,000 or its equivalent in Icelandic kronur for any taxable year.
Paragraph 2
Under paragraph 2, an individual who is a resident of one Contracting State at the time he
b!~mmes temporarily present in the other Contracting State and who is temporarily present
therein as an employee of, or under contract with, a resident of the first-mentioned Contracting
State, for the primary purpose of acquiring technical, professional, or business experience from a
49
person other than that resident of the first-mentioned Contracting State or other than a person
related to such resident, or studying at a university or other recognized educational institution in
that other Contracting State, will be exempt from tax by that other Contracting State for a period
of twelve consecutive months on income from personal services not in excess of $9,000 or its
equivalent in Icelandic kronur.
Paragraph 3
Paragraph 3 provides an exemption for residents of one Contracting State who become
temporarily present in the other Contracting State for purposes of training, research or study in a
program sponsored by the other Contracting State. The exemption is available to an individual
who is a resident of one Contracting State at the time he becomes temporarily present in the
other Contracting State and who is temporarily present in that other Contracting State for a
period not exceeding one year, as a participant in a program sponsored by the other Contracting
State, for the primary purpose of training, research, or study. A person meeting these
requirements will be exempt from tax by the other Contracting State with respect to his income
from personal services in respect of such training, research, or study performed in that other
Contracting State in an aggregate amount not in excess of $9,000 or its equivalent in Icelandic
kronur.
Relationship to other Articles
The saving clause of paragraph 4 of Article 1 (General Scope) does not apply to this
Article with respect to an individual who is neither a citizen of the host State nor an individual
who has been admitted for permanent residence there. The saving clause, however, does apply
with respect to citizens and permanent residents of the host State. Thus, a U.S. citizen who is a
resident ofIceland and who visits the United States as a full-time student at an accredited
university will not be exempt from U.S. tax on remittances from abroad that otherwise constitute
U.S. taxable income. An individual, however, who is not a U.S. citizen, and who visits the
United States as a student and remains long enough to become a resident under U.S. law, but
does not become a permanent resident (i.e., does not acquire a green card), will be entitled to the
full benefits of the Article.
ARTICLE 20 (OTHER INCOME)
Article 20 generally assigns taxing jurisdiction over income not dealt with in the other
articles (Articles 6 (Income from Immovable Property (Real Property» through 19 (Students and
Trainees» of the Convention to the State of residence of the beneficial owner of the income. In
order for an item of income to be "dealt with" in another article it must be the type of income
described in the article and, in most cases, it must have its source in a Contracting State. For
example, all royalty income that arises in a Contracting State and that is beneficially owned by a
resident of the other Contracting State is "dealt with" in Article 12 (Royalties). However, profits
derived in the conduct of a business are "dealt with" in Article 7 (Business Profits) whether or
not they have their source in one of the Contracting States.
Examples of items of income covered by Article 20 include income from gambling,
punitive (but not compensatory) damages and covenants not to compete. The article would also
apply to income from a variety of financial transactions, where such income does not arise in the
course of the conduct ~f a ~rade or business .. F?r exa.mple, i~com~ from notional principal
contracts and ot.her denvatl~es ~ould f~ll WIthIn ArtIcle 20 If de~1Ved by persons not engaged in
the trade or bUSIness of dealIng In such Instruments, unless such Instruments were being used to
50
hedge risks arising in a trade or business. It would also apply to securities lending fees derived
by an institutional investor. Further, in most cases guarantee fees paid within an intercompany
group would be covered by Article 20, unless the guarantor were engaged in the business of
providing such guarantees to unrelated parties.
Article 20 also applies to items of income that are not dealt with in the other articles
because of their source or some other characteristic. For example, Article 11 (Interest) addresses
only the taxation of interest arising in a Contracting State. Interest arising in a third State that is
not attributable to a permanent establishment, therefore, is subject to Article 20.
Distributions from partnerships are not generally dealt with under Article 20 because
partnership distributions generally do not constitute income. Under the Code, partners include in
income their distributive share of partnership income annually, and partnership distributions
themselves generally do not give rise to income. This would also be the case under U.S. law with
respect to distributions from trusts. Trust income and distributions that, under the Code, have the
character of the associated distributable net income would generally be covered by another
article of the Convention. See Code section 641 et seq.
Paragraph 1
The general rule of Article 20 is contained in paragraph 1. Items of income not dealt with
in other articles and beneficially owned by a resident of a Contracting State will be taxable only
in the State of residence. This exclusive right of taxation applies whether or not the residence
State exercises its right to tax the income covered by the Article.
The reference in this paragraph to "items of income beneficially owned by a resident of a
Contracting State" rather than simply "items of income of a resident of a Contracting State," as
in the OECD Model, is intended merely to make explicit the implicit understanding in other
treaties that the exclusive residence taxation provided by paragraph 1 applies only when a
resident of a Contracting State is the beneficial owner of the income. Thus, source taxation of
income not dealt with in other articles of the Convention is not limited by paragraph 1 if it is
nominally paid to a resident of the other Contracting State, but is beneficially owned by a
resident of a third State. However, income received by a nominee on behalf of a resident of that
other State would be entitled to benefits.
The term "beneficially owned" is not defined in the Convention, and is, therefore, defined
as under the intemallaw of the country imposing tax (i.e., the source country). The person who
beneficially owns the income for purposes of Article 20 is the person to which the income is
attributable for tax purposes under the laws of the source State.
Paragraph 2
This paragraph provides an exception to the general rule of paragraph 1 for income that is
attributable to a permanent establishment maintained in a Contracting State by a resident of the
other Contracting State. The taxation of such income is governed by the provisions of Article 7
(Business Profits). Therefore, income arising outside the United States that is paid in respect of a
right or property that is effectively connected with a permanent establishment maintained in the
United States by a resident ofIceland generally would be taxable by the United States under the
provisions of Article 7. This would be true even if the income is sourced in a third state.
51
Relationship to Other Articles
This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope).
Thus, the United States may tax the income of a resident of Iceland that is not dealt with
elsewhere in the Convention, if that resident is a citizen of the United States. The Article is also
subject to the provisions of Article 21 (Limitation On Benefits). Thus, if a resident ofIceland
earns income that falls within the scope of paragraph 1 of Article 21, but that is taxable by the
United States under U.S. law, the income would be exempt from U.S. tax under the provisions of
Article 20 only if the resident satisfies one of the tests of Article 21 for entitlement to benetits.
ARTICLE 21 (LIMITATION ON BENEFITS)
Article 21 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 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 anyone of which will entitle that person to all the benefits of the Convention.
Paragraph 3 provides a so-called "derivative benefits" test under which certain categories of
income may qualify for benefits. Paragraph 4 provides that, regardless of whether a person
qualities 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 special
rules for so-called "triangular cases" notwithstanding the other provisions of Article 21.
Paragraph 6 provides special rules for income from so-called "disproportionate shares"
notwithstanding the other provisions of Article 21. Paragraph 7 provides that benefits also may
be granted if the competent authority of the State from which benefits are claimed determines
that it is appropriate to provide benefits in that case. Paragraph 8 defines certain terms used in
the Article.
Paragraph 1
Paragraph 1 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 Immovable
Property (Real Property) through 20 (Other Income), the treaty -based relief from double taxation
provided by Article 22 (Relief from Double Taxation), and the protection afforded to residents of
a Contracting State under Article 23 (Non-Discrimination). Some provisions do not require that
a person be a resident in order to enjoy the benefits of those provisions. Article 24 (Mutual
Agreement Procedure) is not limited to residents of the Contracting States, and Article 26
(Members of Diplomatic Missions and Consular Posts) applies to diplomatic agents or consular
officials regardless of residence. Article 21 accordingly does not limit the availability of treaty
btTcfits under these provisions.
52
Article 21 and the anti-abuse provisions of domestic law complement each other, as
Article 21 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, intemallaw
principles of the source Contracting State may be applied to identify the beneficial owner of an
item of income, and Article 21 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
Paragraph 2 has five subparagraphs, each of which describes a category of residents that
are entitled to all benefits of the Convention.
It is intended that the provisions of paragraph 2 will be self executing. Unlike the
provisions of paragraph 7, 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
entitled to all treaty benefits. If such an individual receives income as a nominee on behalf of a
third country resident, benefits may be denied under the respective 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 thereof will be entitled to all benefits of the Convention.
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 is
entitled to all the benefits of the Convention under clause (i) of subparagraph 2(c) if the principal
class of its shares is regularly traded on one or more recognized stock exchanges and the
company satisfies at least one of the following additional requirements: first, the company's
principal class of shares is primarily traded on one or more recognized stock exchanges located
in the Contracting State of which the company is a resident; or, second, 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(b). It includes (i) the
NASDAQ System and 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) the Icelandic Stock Exchange; (iii) the stock exchanges of Amsterdam, Brussels,
Copenhagen, Frankfurt, Hamburg, Helsinki, London, Oslo, Paris, Stockholm, Sydney, Tokyo,
and Toronto; and (iv) any other stock exchange agreed upon by the competent authorities of the
Contracting States.
53
If a company has only one class of shares. it is only necessary to consider whether the
shares of that class meet the relevant trading requirements. If the company has more than one
class of shares. it is necessary as an initial matter to determine which class or classes constitute
the "principal class of shares". The term "principal class of shares" is defined in subparagraph
8(a) 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.
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 1.8845(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 a recognized stock exchange located
in Iceland. 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, this term will have the meaning it has under the laws of the State
concerning the taxes to which the Convention applies, generally the source State. In the case of
the United States, this term is understood to have the meaning it has under Treas. Reg. section
1.884-5(d)(3). relating to the branch tax provisions of the Code. Accordingly, stock ofa
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 wh.ose ~rincipal class of shar~s is regularly traded on a recognized exchange
but cannot meet the pnm~I!Y ~raded test may c~alm treaty. benefits if its primary place of
manage~e~t an.d control IS In It~. country. of ~eslden~e. ThIS test should be distinguished from the
"I lace.ot effectIve. mana~ement test whIch IS used In the OECD Model and by many other
~ountnes to establIsh reSidence. In some cases, th~ place of effective management test has been
Interpreted to mean the place vv'here the board of dIrectors meets. By contrast, the primary place
54
of management an~ contr~l ~es~ lo~ks to w~ere day-to-day responsibility for the management of
the company (and Its Subsl~lanes) IS exercised. The company's primary place of management
and control will be located m 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 Chief Executive Officer 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 2( c) 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. 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 Iceland, all the shares of which are
owned by another company that is a resident of Iceland, would qualify for benefits under the
Convention if the principal class of shares ofthe parent company are regularly and primarily
traded on a recognized stock exchange in Iceland. 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 Iceland. Furthermore, if a
parent company in Iceland 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 Iceland in order for the subsidiary to meet the test in clause (ii).
Tax Exempt Organizations -- Subparagraph 2(d)
Subparagraph 2( d) provides rules by which the tax exempt organizations described in
paragraph 2 of Article 4 (Resident) will be entitled to all the benefits of the Convention. A
pension scheme described in paragraph 2(a) of Article 4 or an employee benefits plan described
in paragraph 2(b) of Article 4 will qualify for benefits 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. On the other hand, an
organization resident in a Contracting State that is established exclusively for religious,
55
charitable. scientific. artistic. cultural. or educational purposes automatically qualifies for
benefits. without regard to the residence of its beneficiaries or members.
Ownership/Base Erosion -- Subparagraph 2(e)
Subparagraph 2(e) provides an additional method to quality for treaty benefits that
applies to any form of legal entity that is a resident of a Contracting State. The test provided in
subparagraph 2( 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 2(a), 2(b), 2(d) or clause (i) of subparagraph 2(c). 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 and they otherwise satisty 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 subparagraphs 2(a), 2(b), 2( d) or clause (i) of subparagraph 2( c) 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
subparagraphs 2(a), 2(b), 2(d) or clause (i) of subparagraph 2(c) .
The base erosion prong of clause (ii) of subparagraph 2( 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, directly or indirectly, to
persons who are not residents of either Contracting State entitled to benefits under subparagraphs
2(a). 2(b), 2(d) or clause (i) of subparagraph 2(c), 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
tinancial obligations to a bank, provided that where such a bank is not a resident of a Contracting
State. such payment is attributable to a permanent establishment of that bank located in one of
the Contracting States. 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
Paragraph 3 sets fo.rth a d~rivati:ve ~e.nefits. test that. is potentially applicable to all treaty
benefits. although the test IS apphed to mdlvldualltems of mcome. In general, a derivative
benefits test entitles the resident of a Contracting State to treaty benefits ifthe owner of the
resident would have been entitled to the same benefit had the income in question flowed
directly to that owner. To quality under this paragraph, the company must meet an ownership
test and a base erosion test.
56
Clause (i) of subparagraph 3(a) sets forth the ownership test. Under this test, at least 95
percent of the aggregate voting power and value of the shares of the company must be owned by
seven or fewer persons that are residents of Member States of the European Union, or of the
European Economic Area, or parties to the North American Free Trade Agreement or the
European Free Trade Agreement. Ownership may be direct or indirect. To be considered a
resident of Member States of the European Union, or of the European Economic Area, or parties
to the North American Free Trade Agreement or the European Free Trade Agreement for
purposes of paragraph 3, a person must meet the requirements of subparagraph 3(b). These
requirements may be met in two alternative ways.
Under one alternative, a person may be treated as a resident of Member States of the
European Union, or of the European Economic Area, or parties to the North American Free
Trade Agreement or the European Free Trade Agreement because it is entitled to equivalent
benefits under a treaty between the country of source and the country in which the person is a
resident. To satisfy this requirement, the person must be entitled to all the benefits of a
comprehensive income tax convention in force 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(d) and clause (i) of subparagraph 2(c). If the treaty in
question does not have a comprehensive limitation on benefits article, this requirement is met
only ifthe person would be entitled to treaty benefits under the tests in subparagraphs 2(a), 2(b),
2(d) and clause (i) of subparagraph 2(c) of this Article if the person were a resident of one of the
Contracting States.
In order to satisfy this alternative with respect to dividends, interest, royalties or branch
tax, 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: (I) 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 received the income directly from the source
State. For example, USCo is a wholly owned subsidiary of IceCo, a company resident in
IceJand. IceCo is wholly owned by CanCo, a corporation resident in Canada. Assuming IceCo
satisfies the requirements of paragraph 2 of Article 10 (Dividends), IceCo would be eligible
for a dividend withholding tax rate of 5 percent. The dividend withholding tax rate in the
treaty between the United States and Canada is also 5 percent. Thus, if CanCo received the
dividend directly from USCo, CanCo would have been subject to a 5 percent rate of
withholding tax on the dividend. Because CanCo would be entitled to a rate of withholding tax
that is at least as low as the rate that would apply under the Convention to such income,
CanCo is treated as a resident of Member States of the European Union, or of the European
Economic Area, or parties to the North American Free Trade Agreement or the European Free
Trade Agreement with respect to the elimination of withholding tax on dividends.
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 Canadian parent of an Icelandic company is engaged in the
active conduct of a trade or business in Canada and therefore would be entitled to the benefits
of the U.S.-Canada treaty if it received dividends directly from a U.S. subsidiary of the
Icelandic company is not sufficient for purposes of this paragraph. Further, the Canadian
ccmpany 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.-Canada treaty.
57
Ho\vever. it would be possible to look through the Canadian company to its parent company to
determine whether the parent company is an equivalent beneficiary.
The second alternative requirement for treatment as a resident of Member States of the
European Union, or of the European Economic Area, or parties to the North American Free
Trade Agreement or the European Free Trade Agreement is available only to residents of one of
the two Contracting States. U.S. or Icelandic residents who are eligible for treaty benefits by
reason of subparagraphs 2(a), 2(b), 2(d) or clause (i) of subparagraph 2(c) are treated as residents
of Member States of the European Union, or of the European Economic Area, or parties to the
North American Free Trade Agreement or the European Free Trade Agreement under the second
alternative. Thus, an Icelandic individual will qualify 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 any of those subparagraphs or
any other rule of the treaty, and therefore does not qualify under this alternative. Thus, a resident
of a third country will be treated as a resident of Member States of the European Union, or of the
European Economic Area, or parties to the North American Free Trade Agreement or the
European Free Trade Agreement 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 Icelandic company under this
paragraph. Thus, for example, if 90 percent of an Icelandic company is owned by five companies
that are resident in member states of the European Union who satisfy the requirements of clause
(ii), and 10 percent of the Icelandic company is owned by a U.S. or Icelandic individual, then the
Icelandic company still can satisfy the requirements of subparagraph 3(b).
Clause (ii) of subparagraph 3(a) sets forth the base erosion test. A company meets this
base erosion test ifless 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 residents of Member States of the European Union, or of the European
Economic Area, or parties to the North American Free Trade Agreement or the European Free
Trade Agreement in the form of payments deductible for tax purposes in company's State of
residence.
Paragraph .:/
Paragraph 4 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
or 3.
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 ~~siness" is not defin.e~ in the Conventi<?n. Pursuant to paragraph 2
of Article 3 (General DefimtIons), when determmmg whether a resIdent of Iceland 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
58
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 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 constitute 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. 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 3.
An item of income is derived in connection with a trade or business if the incomeproducing 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. US Co is engaged in an
active manufacturing business in the United States. US Co owns 100 percent of the shares of
ICo, a corporation resident in Iceland. ICo distributes USCo products in Iceland. Since the
business activities conducted by the two corporations involve the same products, ICo's
distribution business is considered to form a part of US Co'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 ICo. ICo and other
USCo affiliates then manufacture and market the US Co-designed products in their respective
markets. Since the activities conducted by ICo and US Co 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
ann 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
59
business conducted in the State of residence, it is necessary to identity 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 tirst out of earnings and profits of the treaty-benetited
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 confonns 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. IceSub is a wholly-owned subsidiary of Americair resident in Iceland.
IceSub operates a chain of hotels in Iceland that are located near airports served by Americair
flights. Americair frequently sells tour packages that include air travel to Iceland and lodging at
IceSub 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 IceSub's business does not fonn a part of Americair's business.
However, IceSub'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 IceSub owns an office
building in Iceland instead of a hotel chain. No part of Americair's business is conducted
through the otlice building. IceSub's business is not considered to fonn 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
IceHolding, a corporation resident in Iceland. IceHolding is a holding company that is not
engaged in a trade or business. IceHolding owns all the shares of three corporations that are
resident in Iceland: IceFlower, IceLawn, and IceFish. IceFlower distributes USFlower flowers
under the USFlower trademark in Iceland. IceLawn markets a line of lawn care products in
Iceland under the USFlower trademark. In addition to being sold under the same trademark,
IceLawn and IceFlower products are sold in the same stores and sales of each company's
products tend to generate increased sales of the other's products. IceFish imports fish from the
United States and distributes it to fish wholesalers in Iceland. For purposes of paragraph 3, the
business of IceFlower fonns a part of the business of USFlower, the business of IceLawn is
complementary to the business of US Flower, and the business ofIceFish 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 4(b) st.ates a furthe~ conditi.on to th.e gener~l rule in subparagraph 4(a) in
cases where the trade or busmess generatmg the item of mcome 10 question is carried on either
by the person derivi~g the inc.ome o~ by any associate? enterprises. Subparagraph 4(b) states
that the trade or busmess carrIed on 10 the State of reSidence, under these circumstances must
~e substantial in relation to the activity in the Stat~ of source: The .substantiality require~ent is
mtended to prevent a narrow case oftreaty-shoppmg abuses m which a company attempts to
60
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).
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.
The determination in subparagraph 4(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 3, 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.
Subparagraph 4( c) provides special attribution rules for purposes of applying the
substantive rules of subparagraph 4(a). Thus, these rules apply for purposes of determining
whether a person meets the requirement in subparagraph 4(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. Subparagraph 4( c) attributes to a person activities conducted by a
partnership in which that person is a partner and 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 ifY 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, directly or indirectly, 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 Yare controlled by the same
person or persons.
Paragraph 5
Paragraph 5 deals with the treatment of income in the context of a so-called "triangular
case."
The term "triangular case" refers to the use of the following structure by a resident of
Iceland to earn, in this case, interest income from the United States. The resident ofIceland, who
is assumed to qualify for benefits under one or more of the provisions of Article 16 (Limitation
on Benefits), sets up a permanent establishment in a third jurisdiction that imposes only a low
rate of tax on the income of the permanent establishment. The Icelandic resident lends funds into
the United States through the permanent establishment. The permanent establishment, despite its
third-jurisdiction location, is an integral part of a Icelandic resident. Therefore the income that it
earns on those loans, absent the provisions of paragraph 5, is entitled to exemption from U.S.
withholding tax under the Convention. Under a current Icelandic income tax treaty with the host
jurisdiction of the permanent establishment, the income of the permanent establishment is
exempt from Icelandic tax (alternatively, Iceland may choose to exempt the income of the
permanent establishment from Icelandic income tax). Thus, the interest income is exempt from
61
U.S. tax. is subject to little tax in the host jurisdiction of the pennanent establishment. and is
exempt from lcelandic tax.
Paragraph 5 applies reciprocally. However, the United States does not exempt the profits
of a third-jurisdiction penn anent establishment of a U.S. resident from U.S. tax, either by statute
or by treaty.
Paragraph 5 provides that the tax benefits that would otherwise apply under the
Convention will not apply to any item of income if the combined tax actually paid in the
residence State and the third state is less than 60 percent of the tax that would have been
payable in the residence State if the income were earned in that State by the enterprise and
were not attributable to the pennanent establishment in the third 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 5 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
detennine 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 5 will not apply under certain circumstances. In the case of royalties,
paragraph 5 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 pennanent establishment itself. In
the case of any other income, paragraph 5 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 pennanent
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 banking or
securities activities carried on by a bank or registered securities dealer.
Paragraph 6
Paragraph 6 provides a special rule where a company resident in a Contracting State, or a
company that controls such a company directly or indirectly, has a class of shares that is subject
to tenns or other arrangements that entitle the holder to a larger portion of the company's income
than the portion the holders would receive absent such tenns or arrangements ("the
disproportionate part of the income"). Where 50 percent or more of such a class of shares is
owned by persons who are not entitled to benefits under paragraph 2, the benefits of the
Convention shall not apply with respect to the disproportionate part of the income of the
Company.
The following example illustrates this result.
Example. IceCo is a corporation resident in Iceland. IceCo has two classes of shares:
Common and Preferred. The Common shares are listed and regularly traded on the Icelandic
Stock Exchange. The Preferred shares have no voting rights and are entitled to receive dividends
equal in amount to interest payments that IceCo receives from unrelated borrowers in the United
States. The Preferred shares are owned entirely by a single investor that is a resident of a third
country. The Common shares account for more than 50 percent of the value of IceCo and for 100
percent of the voting power. Because the owner of the Preferred shares is entitled to receive
62
payments corresponding to the U.S. source interest income earned by IceCo, the Preferred shares
are a disproportionate class of shares. Because the Preferred shares are not owned by persons
entitled to benefits under paragraph 2, the benefits of the Convention shall not apply with respect
to IceCo's U.S.-source interest income.
Paragraph 7
Paragraph 7 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 still shall be granted benefits under the
Convention if the competent authority of the State from which benefits are claimed determines
that the establishment, acquisition, or maintenance of the person seeking benefits under the
Convention, or the conduct of such person's operations, has or had as one of its principal
purposes the obtaining of benefits under the Convention. Benefits will not be granted, however,
solely because a company was established prior to the effective date of a treaty or protocol. In
that case a company would still be required to establish, to the satisfaction of the competent
authority, clear non-tax business reasons for its formation in a Contracting State, or that the
allowance of benefits would not otherwise be contrary to the purposes of the treaty. Thus,
persons that establish operations in one of the States with a principal purpose of obtaining the
benefits of the Convention ordinarily will not be granted relief under paragraph 7.
The competent authority's discretion is quite broad. It 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 the re-sourcing rule of subparagraph 2(a) of Article 22, 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
Paragraph 8 defines several key terms for purposes of Article 22. Each of the defined
terms is discussed above in the context in which it is used.
ARTICLE 22 (RELIEF FROM DOUBLE TAXATION)
This Article describes the manner in which each Contracting State undertakes to relieve
d('uble taxation. The United States uses the foreign tax credit method under its internal law, and
by treaty.
63
Paragraph 1
The United States agrees, in paragraph 1, to allow to its citizens and residents a credit
against U.S. tax for income taxes paid or accrued to Iceland. Paragraph 1 also provides that
Iceland's covered taxes are income taxes for U.S. purposes. This provision is based on the
Treasury Department's review ofIceland's laws.
Subparagraph 1(b) provides for a deemed-paid credit, consistent with section 902 of the
Code. to a U.S. corporation in respect of dividends received from a corporation resident in
Iceland of which the U.S. corporation owns at least 10 percent of the voting stock. This credit is
for the tax paid by the corporation to Iceland on the profits out of which the dividends are
considered paid.
The. ~dits allowed under paragraph 1 are allowed in accordance with the provisions and
subject to the limitations of U.S. law, as that law may be amended over time, so long as the
general principle of the Article, that is, the allowance of a credit, is retained. Thus, although the
Convention pr'lvides for a foreign tax credit, the terms of the credit are determined by the
provisio
: time a credit is given, of the U.S. statutory credit.
. ll\!P
.dW (
U
I!,
the U.S. credit under the Convention is subject to the various limitations of
. g., Code sections 901-908). For example, the credit against U.S. tax generally is
tHee'
reley'
.
1
"amount l)fU.S. tax due with respect to net foreign source income within the
;gn tax credit limitation category (see Code section 904(a) and (d», and the dollar
,ilt
redit is determined in accordance with U.S. currency translation rules (see, e.g.,
.I.)fl ')~t)
:hrk
.S. law applies to determine carryover periods for excess credits
• :
, inter-vear ..;...
..1ts .
Paragraph _ ,',
SUl paragraph 2(a) i
u.s. foreign tax crl
r1 ~Jry taxing rigl' ',:> .:-
~rcing rule for gross income covered by paragraph 1.
':ll'Ure that a U.S. resident can obtain an appropriate amount of
~s pai~ to Iceland when the Convention assigns to Iceland
gross Income.
Accordingl~;
Convention allows Iceland to tax an item of gross income (as defined
under U.s. law) d lV~U by aft ident of the United States, the United States will treat that item
of gross income a~ gross income from sources within Iceland for U.S. foreign tax credit
purposes. In the case of '.S.-owned foreign corporation, however, section 904(g)(l0) may
ar
for purposes of delermining the U.S. foreign tax credit with respect to income subject to
this re-sourcing rule. Section 904(g)( 10) generally applies the foreign tax credit limitation
separately to re-sourced income. Furthermore, the subparagraph 2(a) re-sourcing rule applies to
gross income, not net income. Accordingly, U.S. expense allocation and apportionment rules,
see, e.g., Treas. Reg. section 1.861-9, continue to apply to income resourced under subparagraph
2(a).
Subparagraph 2(b) provides that gains derived by an individual who was a resident of the
United States that are taxed by the United States in accordance with the Convention and that
may also be taxed in Iceland solely by reason of Article 13 (Capital Gains), shall b~ deemed to
be gains from sources in the United States. The provisions of subparagraph 2(b) ensure that the
United States does not bear, from a foreign tax credit standpoint, the cost of Iceland's
expatriation tax.
64
Paragraph 3
Specific rules are provided in paragraph 3 under which Iceland, in imposing tax on its
residents, provides relief for U.S. taxes paid by those residents. Subparagraph 3( a) provides that
when a resident of Iceland derives income that, in accordance with the provisions of the
Convention, may be taxed in the United States, Iceland shall allow as a credit against Icelandic
income taxes an amount equal to those taxes paid to the United States.
Subparagraph 3(b) limits the credits against Icelandic taxes to those taxes that are
attributable to the income that has been taxed by the United States.
Subparagraph 3( c) provides that when a resident of Iceland derives income that, in
accordance with the provisions of the Convention, may be taxed by the United States, Iceland
shall allow the credit against Icelandic tax described in subparagraph 3(b). However,
subparagraph 3(c) also permits Iceland to include the income corresponding to the U.S. tax in the
resident's tax base for purposes of determining the Icelandic tax. This rule is a variation ofthe
"exemption with progression rule," adapted to accommodate Iceland's credit system. It is also
similar to U.S. domestic law, which permits credits for foreign taxes paid, while at the same time
taxing residents on worldwide income. Finally, subparagraph 3(c) provides that for purposes of
this Article, the U.S. taxes referred to in subparagraph 3(b) and paragraph 4 of Article 2 (Taxes
Covered) are considered to be income taxes and are allowed as credits against Icelandic tax on
income, subject to all of the provisions and limitations of this paragraph.
Paragraph 4
Paragraph 4 provides special rules for the tax treatment in both States of certain types of
income derived from U.S. sources by U.S. citizens who are residents ofIceland. Since U.S.
citizens, regardless of residence, are subject to United States tax at ordinary progressive rates on
their worldwide income, the U.S. tax on the U.S. source income of a U.S. citizen resident in
Iceland may exceed the U.S. tax that may be imposed under the Convention on an item of U.S.
source income derived by a resident ofIceland who is not a U.S. citizen. The provisions of
paiagraph 4 ensure that Iceland does not bear the cost of U.S. taxation of its citizens who are
residents of Iceland.
Subparagraph 4(a) provides, with respect to items of income from sources within the
United States, special credit rules for Iceland. These rules apply to items of U.S.-source income
that would be either exempt from U.S. tax or subject to reduced rates of U.S. tax under the
provisions of the Convention if they had been received by a resident ofIceland who is not a U.S.
citizen. The tax credit allowed under paragraph 4 with respect to such items need not exceed the
U.S. tax that may be imposed under the Convention, other than tax imposed solely by reason of
the U.S. citizenship of the taxpayer under the provisions of the saving clause of paragraph 4 of
Article 1 (General Scope).
For example, if a U.S. citizen resident in Iceland receives portfolio dividends from
sources within the United States, the foreign tax credit granted by Iceland would be limited to 15
percent of the dividend - the U. S. tax that may be imposed under subparagraph 2(b) of Article 10
(Dividends) - even if the shareholder is subject to U.S. net income tax because of his U.S.
c:i'i?enship. With respect to interest income, Iceland would allow no foreign tax credit, because
its residents are exempt from U.S. tax on interest income under the provisions of Articles 11
(Interest).
65
Subparagraph 4(b) eliminates the potential for double taxation that can arise because
subparagraph 4(a) provides that Iceland need not provide full relief for the U.S. tax imposed on
its citizens resident in Iceland. The subparagraph provides that the United States will credit the
income tax paid or accrued to Iceland, after the application of subparagraph 4(a). It further
provides that in allowing the credit, the United States will not reduce its tax below the amount
that is taken into account in Iceland in applying subparagraph 4(a).
Since the income described in subparagraph 4(a) generally will be U.S. source income,
special rules are required to re-source some of the income to Iceland in order for the United
States to be able to credit the tax paid to Iceland. This re-sourcing is provided for in
subparagraph 4(c), which deems the items of income referred to in subparagraph 4(a) to be from
foreign sources to the extent necessary to avoid double taxation under subparagraph 4(b). Clause
(iii) of subparagraph 3(c) of Article 24 (Mutual Agreement Procedure) provides a mechanism by
which the competent authorities can resolve any disputes regarding whether income is from
sources within the United States.
The following two examples illustrate the application of paragraph 4 in the case of a
U.S.-source portfolio dividend received by a U.S. citizen resident in Iceland. In both examples,
the U.S. rate of tax on residents ofIceland, under subparagraph 2(b) of Article 10 (Dividends) of
the Convention, is 15 percent. In both examples, the U.S. income tax rate on the U.S. citizen is
35 percent. In example 1, the rate of income tax imposed in Iceland on its resident (the U.S.
citizen) is 25 percent (below the U.S. rate), and in example 2, the rate imposed on its resident is
40 percent (above the U.S. rate).
Example 1
Example 2
$100.00
15.00
100.00
25.00
15.00
10.00
$100.00
15.00
100.00
40.00
15.00
25.00
U.S. pre-tax income
$100.00
U.S. pre-credit citizenship tax
35.00
Notional U.S. withholding tax
15.00
U.S. tax eligible to be offset by credit
20.00
Tax paid to Iceland
10.00
Income re-sourced from U.S. to foreign source (see below)
28.57
U.S. pre-credit tax on re-sourced income
10.00
U.S. credit for tax paid to Iceland
10.00
Net post-credit U.S. tax
10.00
Total U.S. tax
25.00
$100.00
35.00
15.00
20.00
25.00
57.14
20.00
20.00
0.00
15.00
Subparagraph (a)
U.S. dividend declared
Notional U.S. withholding tax (Article 10(2)(b))
Taxable income in Iceland
Icelandic tax before credit
Less: tax credit for notional U.S. withholding tax
Net post-credit tax paid to Iceland
Subparagraphs (b) and (c)
In b~th e~ampl.es, in the application of.s~bparagraph 4(a), Iceland credits a 15 percent
,
U. S. tax a,gamst Its r~sldence tax .0r:t the U .S. ~ltlzen. In the first example, the net tax paid to
Iceland atter the foreIgn tax credIt IS $10.00; m the second example, it is $25.00. In the
66
application of subparagraphs 4(b) and 4(c), from the U.S. tax due before credit of$35.00, the
United States subtracts the amount of the U.S. source tax of$15.00, against which no U.S.
foreign tax credit is allowed. This subtraction ensures that the United States collects the tax that
it is due under the Convention as the State of source.
In both examples, given the 35 percent U.S. tax rate, the maximum amount of U.S. tax
against which credit for the tax paid to Iceland may be claimed is $20 ($35 U.S. tax minus $15
U.S. withholding tax). Initially, all of the income in both examples was from sources within the
United States. For a U.S. foreign tax credit to be allowed for the full amount of the tax paid to
Iceland, an appropriate amount of the income must be re-sourced to Iceland under subparagraph
4(c).
The amount that must be re-sourced depends on the amount of tax for which the U.S.
citizen is claiming a U.S. foreign tax credit. In example 1, the tax paid to Iceland was $10. For
this amount to be creditable against U.S. tax, $28.57 ($10 tax divided by 35 percent U.S. tax
rate) must be resourced to Iceland. When the tax is credited against the $10 of U.S. tax on this
resourced income, there is a net U.S. tax of$10 due after credit ($20 U.S. tax eligible to be offset
by credit, minus $10 tax paid to Iceland). Thus, in example 1, there is a total of $25 in U.S. tax
($1.; U.S. withholding tax plus $10 residual U.S. tax).
In example 2, the tax paid to Iceland was $25, but, because the United States subtracts
the U.S. withholding tax of$15 from the total U.S. tax of$35, only $20 of U.S. taxes may be
offset by taxes paid to Iceland. Accordingly, the amount that must be resourced to Iceland is
limited to the amount necessary to ensure a U.S. foreign tax credit for $20 of tax paid to Iceland,
or $57.14 ($20 tax paid to Iceland divided by 35 percent U.S. tax rate). When the tax paid to
Iceland is credited against the U.S. tax on this re-sourced income, there is no residual U.S. tax
($20 U.S. tax minus $25 tax paid to Iceland, subject to the u.s. limit of $20). Thus, in example
2, there is a total of$15 in U.S. tax ($15 U.S. withholding tax plus $0 residual U.S. tax). Because
the tax paid to Iceland was $25 and the U.S. tax eligible to be offset by credit was $20, there is
$5 of excess foreign tax credit available for carryover.
Relationship to other Articles
By virtue of subparagraph 5(a) of Article 1 (General Scope), Article 22 is not subject to
the saving clause of paragraph 4 of Article 1. Thus, the United States will allow a credit to its
citizens and residents in accordance with the Article, even if such credit were to provide a
benefit not available under the Code (such as the re-sourcing provided by paragraph 2 and
subparagraph 4( c».
ARTICLE 23 (NON-DISCRIMINATION)
This Article ensures that nationals of a Contracting State, in the case of paragraph 1, and
residents of a Contracting State, in the case of paragraphs 2 through 4, will not be subject,
directly or indirectly, to discriminatory taxation in the other Contracting State. Not all
differences in tax treatment, either as between nationals of the two States, or between residents
of the two States, are violations of the prohibition against discrimination. Rather, the nondiscrimination obligations of this Article apply only if the nationals or residents of the two States
are comparably situated.
Each of the relevant paragraphs of the Article provides that two persons that are
comparably situated must be treated similarly. Although the actual words differ from paragraph
67
to paragraph (e.g, paragraph 1 refers to two nationals "in the same circumstances," paragraph 2
refers to two enterprises "carrying on the same activities" and paragraph 4 refers to two
enterprises that are "similar"), the common underlying premise is that if the ditlerence in
treatment is directly related to a tax-relevant ditlerence in the situations of the domestic and
foreign persons being compared, that ditference is not to be treated as discriminatory (i.e., if one
person is taxable in a Contracting State on worldwide income and the other is not, or tax may be
collectible from one person at a later stage, but not from the other, distinctions in treatment
\vould be justified under paragraph 1). Other examples of such factors that can lead to nondiscriminatory differences in treatment are noted in the discussions of each paragraph.
The operative paragraphs of the Article also use different language to identify the kinds
of differences in taxation treatment that will be considered discriminatory. For example,
paragraphs 1 and 4 speak of "any taxation or any requirement connected therewith that is more
burdensome," while paragraph 2 specifies that a tax "shall not be less favorably levied."
Regardless of these differences in language, only differences in tax treatment that materially
disadvantage the foreign person relative to the domestic person are properly the subject of the
Article.
Paragraph 1
Paragraph 1 provides that a national of one Contracting State may not be subject to
taxation or connected requirements in the other Contracting State that are different from or more
burdensome than the taxes and connected requirements imposed upon a national of that other
State in the same circumstances.
The term "national" in relation to a Contracting State is defined in subparagraph 1(j) of
Article 3 (General Definitions). The term includes both individuals and juridical persons.
A national of a Contracting State is afforded protection under this paragraph even if the national
is not a resident of either Contracting State. Thus, a U.S. citizen who is resident in a third
country is entitled, under this paragraph, to the same treatment in Iceland as a national of Iceland
who is in similar circumstances (i.e., presumably one who is resident in a third State).
As noted above, whether or not the two persons are both taxable on worldwide income is
a significant circumstance for this purpose. For this reason, paragraph 1 specifically states that
the United States is not obligated to apply the same taxing regime to a national ofIceland who is
not resident in the United States as it applies to a U.S. national who is not resident in the United
States. United States citizens who are not residents of the United States but who are,
nevertheless, subject to United States tax on their worldwide income are not in the same
circumstances with respect to United States taxation as citizens ofIceland who are not United
States residents. Thus, for example, Article 23 would not entitle a national of Iceland resident in
a third country to taxation at graduated rates on U.S. source dividends or other investment
income that applies to a U.S. citizen resident in the same third country.
Paragraph 2
Paragraph 2 of the Article, provides that a Contracting State may not tax a permanent
establishment of an enterprise of the other Contracting State less favorably than an enterprise of
that first-mentioned State that is carrying on the same activities.
The ract that a U:S. pe~anent establishment of an ent~rprise ofIceland is subject to U.S.
tax only on mcome that IS attnbutable to the permanent estabhshment, while a U.S. corporation
68
engaged in the same activities is taxable on its worldwide income is not, in itself, a sufficient
difference to provide different treatment for the permanent establishment. There are cases,
however, where the two enterprises would not be similarly situated and differences in treatment
may be warranted. For instance, it would not be a violation of the non-discrimination protection
of paragraph 2 to require the foreign enterprise to provide information in a reasonable manner
that may be different from the information requirements imposed on a resident enterprise,
because information may not be as readily available to the Internal Revenue Service from a
foreign as from a domestic enterprise. Similarly, it would not be a violation of paragraph 2 to
impose penalties on persons who fail to comply with such a requirement (see, e.g., sections
874(a) and 882(c)(2)). Further, a determination that income and expenses have been attributed or
allocated to a permanent establishment in conformity with the principles of Article 7 (Business
Profits) implies that the attribution or allocation was not discriminatory.
Section 1446 of the Code imposes on any partnership with income that is effectively
connected with a U.S. trade or business the obligation to withhold tax on amounts allocable to a
foreign partner. In the context of the Convention, this obligation applies with respect to a share
of the partnership income of a partner resident in Iceland, and attributable to a U.S. permanent
establishment. There is no similar obligation with respect to the distributive shares of U.S.
resident partners. It is understood, however, that this distinction is not a form of discrimination
within the meaning of paragraph 2 of the Article. No distinction is made between U.S. and nonU.S. partnerships, since the law requires that partnerships of both U.S. and non-U.S. domicile
withhold tax in respect of the partnership shares of non-U.S. partners. Furthermore, in
distinguishing between U.S. and non-U.S. partners, the requirement to withhold on the non-U.S.
but not the U.S. partner's share is not discriminatory taxation, but, like other withholding on
nonresident aliens, is merely a reasonable method for the collection of tax from persons who are
not continually present in the United States, and as to whom it otherwise may be difficult for the
United States to enforce its tax jurisdiction. If tax has been over-withheld, the partner can, as in
other cases of over-withholding, file for a refund.
Paragraph 2 does not obligate a Contracting State to grant to a resident of the other
Contracting State any tax allowances, reliefs, etc., that it grants to its own residents on account
of their civil status or family responsibilities. Thus, if a sole proprietor who is a resident of
Iceland has a permanent establishment in the United States, in assessing income tax on the
profits attributable to the permanent establishment, the United States is not obligated to allow to
the resident of Iceland the personal allowances for himself and his family that he would be
permitted to take if the permanent establishment were a sole proprietorship owned and operated
by a U.S. resident, despite the fact that the individual income tax rates would apply.
Paragraph 3
Paragraph 3 prohibits discrimination in the allowance of deductions. When a resident or
an enterprise of a Contracting State pays interest, royalties or other disbursements to a resident
of the other Contracting State, the first-mentioned Contracting State must allow a deduction for
those payments in computing the taxable profits of the resident or enterprise as if the payment
had been made under the same conditions to a resident of the first-mentioned Contracting State.
Paragraph 3, however, does not require a Contracting State to give nonresidents more favorable
treatment than it gives to its own residents. Consequently, a Contracting State does not have to
allow nonresidents a deduction for items that are not deductible under its domestic law (for
example, expenses of a capital nature).
69
The term "other disbursements" is understood to include a reasonable allocation of
executive and general administrative expenses, research and development expenses and other
expenses incurred for the benefit of a group of related persons that includes the person incurring
the expense.
An exception to the rule of paragraph 3 is provided for cases where the provisions of
paragraph 1 of Article 9 (Associated Enterprises), paragraph 4 of Article 11 (Interest) or paragraph 6 of Article 12 (Royalties) apply. All of these provisions permit the denial of deductions
in certain circumstances in respect of transactions between related persons. Neither State is
forced to apply the non-discrimination principle in such cases. The exception with respect to
paragraph 4 of Article 11 would include the denial or deferral of certain interest deductions
under Code section 163 U).
Paragraph 3 also provides that any debts of an enterprise of a Contracting State to a
resident of the other Contracting State are deductible in the first-mentioned Contracting State for
purposes of computing the capital tax of the enterprise under the same conditions as if the debt
had been contracted to a resident of the first-mentioned Contracting State. Even though, for
general purposes, the Convention covers only income taxes, under paragraph 6 of this Article,
the nondiscrimination provisions apply to all taxes levied in both Contracting States, at all levels
of government.
Paragraph 4
Paragraph 4 requires that a Contracting State not impose more burdensome taxation or
connected requirements on an enterprise of that State that is wholly or partly owned or
controlled, directly or indirectly, by one or more residents of the other Contracting State than the
taxation or connected requirements that it imposes on other similar enterprises of that firstmentioned Contracting State. For this purpose it is understood that "similar" refers to similar
activities or ownership of the enterprise.
This rule, like all non-discrimination provisions, does not prohibit differing treatment of
entities that are in differing circumstances. Rather, a protected enterprise is only required to be
treated in the same manner as other enterprises that, from the point of view of the application of
the tax law, are in substantially similar circumstances both in law and in fact. The taxation of a
distributing corporation under section 367(e) on an applicable distribution to foreign
shareholders does not violate paragraph 4 of the Article because a foreign-owned corporation is
not similar to a domestically-owned corporation that is accorded non-recognition treatment
under sections 337 and 355.
For the reasons given above in connection with the discussion of paragraph 2 of the
Article, it is also understood that the provision in section 1446 of the Code for withholding oftax
on non-U.S. partners does not violate paragraph 5 of the Article.
It is further understood that the ineligibility of a U.S. corporation with nonresident alien
shareholders to make an election to be an "S" corporation does not violate paragraph 4 of the
Article. If a corporation elects to be an S corporation, it is generally not subject to income tax
and the shareholders take into account their pro rata shares of the corporation's items of income,
lo,s.s, ~e~uction or credit. .(The purpose o~the pr?visio.n is to allow an individual or small group
of mdIvIduals the protectIOns of conductmg busmess m corporate form while paying taxes at
i~d!vidual rates as if.the business were conducted directly) A nonresid.ent alien does not pay
U.S. tax on a net baSIS, and, thus, does not generally take mto account Items ofloss, deduction or
70
credit. Thus, the S corporation provisions do not exclude corporations with nonresident alien
shareholders because such shareholders are foreign, but only because they are not net-basis
taxpayers. Similarly, the provisions exclude corporations with other types of shareholders where
the purpose of the provisions cannot be fulfilled or their mechanics implemented. For example,
corporations with corporate shareholders are excluded because the purpose of the provision to
permit individuals to conduct a business in corporate form at individual tax rates would not be
furthered by their inclusion.
Finally, it is understood that paragraph 4 does not require a Contracting State to allow
foreign corporations to join in filing a consolidated return with a domestic corporation or to
allow similar benefits between domestic and foreign enterprises.
Paragraph 5
Paragraph 5 of the Article confirms that no provision of the Article will prevent either
Contracting State from imposing the branch profits tax described in paragraph 8 of Article 10
(Dividends).
Paragraph 6
As noted above, notwithstanding the specification of taxes covered by the Convention in
Article 2 (Taxes Covered) for general purposes, for purposes of providing nondiscrimination
protection this Article applies to taxes of every kind and description imposed by a Contracting
State or a political subdivision or local authority thereof. Customs duties are not considered to
be taxes for this purpose.
Relationship to Other Articles
The saving clause of paragraph 4 of Article 1 (General Scope) does not apply to this
Article by virtue of the exceptions in subparagraph 5(a) of Article 1. Thus, for example, a U.S.
citizen who is a resident of Iceland may claim benefits in the United States under this Article.
Nationals of a Contracting State may claim the benefits of paragraph 1 regardless of
whether they are entitled to benefits under Article 21 (Limitation on Benefits), because that
paragraph applies to nationals and not residents. They may not claim the benefits of the other
paragraphs of this Article with respect to an item of income unless they are generally entitled to
treaty benefits with respect to that income under a provision of Article 21.
ARTICLE 24 (MUTUAL AGREEMENT PROCEDURE)
This Article provides the mechanism for taxpayers to bring to the attention of competent
authorities issues and problems that may arise under the Convention. It also provides the
authority for cooperation between the competent authorities of the Contracting States to resolve
disputes and clarifY issues that may arise under the Convention and to resolve cases of double
taxation not provided for in the Convention. The competent authorities of the two Contracting
States are identified in subparagraph 1(i) of Article 3 (General Definitions).
Paragraph 1
This paragraph provides that where a resident of a Contracting State considers that the
actions of one or both Contracting States will result in taxation that is not in accordance with the
71
Convention. he may present his case to the competent authority of either Contracting State. This
rule is more generous than in most treaties, which generally allow taxpayers to bring competent
authority cases only to the competent authority of their country of residence. or citizenship/nationality. Under this more generous rule, a U.S. permanent establishment of a
corporation resident in Iceland that faces inconsistent treatment in the two countries would be
able to bring its request for assistance to the U.S. competent authority. If the U.S. competent
authority can resolve the issue on its own, then the taxpayer need never involve the Icelandic
competent authority. Thus, the rule provides t1exibility that might result in greater efficiency.
Although the typical cases brought under this paragraph will involve economic double
taxation arising from transfer pricing adjustments, the scope of this paragraph is not limited to
such cases. For example, a taxpayer could request assistance from the competent authority if one
Contracting State determines that the taxpayer has received deferred compensation taxable at
source under Article 14 (Income from Employment), while the taxpayer believes that such
income should be treated as a pension that is taxable only in his country of residence pursuant to
Article 17 (Pensions, Social Security, and Annuities).
It is not necessary for a person requesting assistance first to have exhausted the remedies
provided under the national laws of the Contracting States before presenting a case to the
competent authorities, nor does the fact that the statute of limitations may have passed for
seeking a refund preclude bringing a case to the competent authority. Unlike the OECD Model,
no time limit is provided within which a case must be brought.
Paragraph 2
Paragraph 2 sets out the framework within which the competent authorities will deal with
cases brought by taxpayers under paragraph 1. It provides that, if the competent authority of the
Contracting State to which the case is presented judges the case to have merit, and cannot reach a
unilateral solution, it shall seek an agreement with the competent authority of the other
Contracting State pursuant to which taxation not in accordance with the Convention will be
avoided.
Any agreement is to be implemented even if such implementation otherwise would be
barred by the statute of limitations or by some other procedural limitation, such as a closing
agreement. Paragraph 2, however, does not prevent the application of domestic-law procedural
limitations that give effect to the agreement (e.g, a domestic-law requirement that the taxpayer
tile a return ret1ecting the agreement within one year of the date of the agreement).
Where the taxpayer has entered a closing agreement (or other written settlement) with
the United States before bringing a case to the competent authorities, the U.S. competent
authority will endeavor only to obtain a correlative adjustment from Iceland. See Rev. Proc.
2006-54.2006-49 I.R.B. 1035, § 7.05. Because. as specified in paragraph 2 of Article 1
(General Scope), the Convention cannot operate to increase a taxpayer's liability, temporal or
other procedural limitations can be overridden only for the purpose of making refunds and not to
impose additional tax.
Paragraph 3
Paragraph 3 authorizes the competent authorities to resolve difficulties or doubts that
may arise as to the application or interpretation of the Convention. The paragraph includes a
non- exhaustive list of examples of the kinds of matters about which the competent authorities
72
may reach agreement. This list is purely illustrative; it does not grant any authority that is not
implicitly present as a result of the introductory sentence of paragraph 3.
The competent authorities may, for example, agree to the same allocation of income,
deductions, credits or allowances between an enterprise in one Contracting State and its
permanent establishment in the other or between related persons. These allocations are to be
made in accordance with the arm's length principle underlying Article 7 (Business Profits) and
Article 9 (Associated Enterprises). Agreements reached under these subparagraphs may include
agreement on a methodology for determining an appropriate transfer price, on an acceptable
range of results under that methodology, or on a common treatment of a taxpayer's cost sharing
arrangement.
As indicated in subparagraphs 3(a) through 3(f), the competent authorities also may agree
to settle a variety of conflicting applications of the Convention. They may agree to settle
conflicts regarding the characterization of particular items of income, including the same
characterization of income that is assimilated to income from shares by the taxation law of one
of the Contracting States and that is treated as a different class of income in the other State.
They may also agree to the characterization of persons, the application of source rules to
particular items of income, the meaning of a term, or the timing of an item of income.
The competent authorities also may agree as to the application of the provisions of
domestic law regarding penalties, fines, and interest in a manner consistent with the purposes of
the Convention.
Since the list under paragraph 3 is not exhaustive, the competent authorities may reach
agreement on issues not enumerated in paragraph 3 if necessary to avoid double taxation. For
example, the competent authorities may seek agreement on a uniform set of standards for the use
of exchange rates. Agreements reached by the competent authorities under paragraph 3 need not
conform to the intemallaw provisions of either Contracting State.
Finally, paragraph 3 authorizes the competent authorities to consult for the purpose of
~ljm;nating double taxation in cases not provided for in the Convention and to resolve any
dLLficulties or doubts arising as to the interpretation or application of the Convention. This
provision is intended to permit the competent authorities to implement the treaty in particular
cases in a manner that is consistent with its expressed general purposes. It permits the competent
authorities to deal with cases that are within the spirit of the provisions but that are not
specifically covered. An example of such a case might be double taxation arising from a transfer
pricing adjustment between two permanent establishments of a third-country resident, one in the
United States and one in Iceland. Since no resident of a Contracting State is involved in the
case, the Convention does not apply, but the competent authorities nevertheless may use the
authority of this Article to prevent the double taxation of income.
Paragraph 4
Paragraph 4 provides that the competent authorities may communicate with each other
for the purpose of reaching an agreement. This makes clear that the competent authorities of the
two Contracting States may communicate without going through diplomatic channels. Such
communication may be in various forms, including, where appropriate, through face-to-face
mce1 i ngs of representatives of the competent authorities.
73
Tremy (erminalion in relalion 10 compelent awhority dispute resolution
A case may be raised by a taxpayer after the Convention has been terminated with respect
to a year for which a treaty was in force. In such a case the ability of the competent authorities
to act is limited. They may not exchange confidential information, nor may they reach a solution
that varies from that specified in its law.
Triangular competent authority solutions
International tax cases may involve more than two taxing jurisdictions (e.g., transactions
among a parent corporation resident in country A and its subsidiaries resident in countries Band
C). As long as there is a complete network of treaties among the three countries, it should be
possible, under the full combination of bilateral authorities, for the competent authorities of the
three States to work together on a three-sided solution. Although country A may not be able to
give information received under Article 26 (Exchange of Information and Administrative
Assistance) from country B to the authorities of country C, if the competent authorities of the
three countries are working together, it should not be a problem for them to arrange for the
authorities of country B to give the necessary information directly to the tax authorities of
country C, as well as to those of country A. Each bilateral part of the trilateral solution must, of
course, not exceed the scope of the authority of the competent authorities under the relevant
bilateral treaty.
Relationship 10 Other Articles
This Article is not subject to the saving clause of paragraph 4 of Article 1 (General
Scope) by virtue of the exceptions in subparagraph 5(a) of that Article. Thus, rules, definitions,
procedures, etc. that are agreed upon by the competent authorities under this Article may be
applied by the United States with respect to its citizens and residents even if they differ from the
comparable Code provisions. Similarly, as indicated above, U.S. law may be overridden to
provide refunds of tax to a U.S. citizen or resident under this Article. A person may seek relief
under Article 24 regardless of whether he is generally entitled to benefits under Article 21
(Limitation on Benefits). As in all other cases, the competent authority is vested with the
discretion to decide whether the claim for relief is justified.
ARTICLE 25 (EXCHANGE OF INFORMATION AND ADMINISTRATIVE
ASSIST ANCE)
This Article provides for the exchange of information and administrative assistance
between the competent authorities of the Contracting States.
Paragraph 1
The obligation to obtain and provide information to the other Contracting State is set out
in paragraph 1. The information to be exchanged is that which is relevant for carrying out the
provisions of the Convention or the domestic laws of the United States or of the Iceland
concerning taxes of every kind applied at the national level. 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 Conventi.on. Thus, for ~xample, .inform~tion may be exchanged with
! eS!)ect .to a cover~d t~x. even Ifth~ transactIOn to whIch the mformation relates is a purely
domestIc tra!lsactlOn m the reql!estmg State ~md. th~ref0.re, the exchange is not made to carry out
the ConventIOn. An example ot such a case IS proVIded In the OECD Commentary: a company
74
resident in the United States and a company resident in Iceland 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, the taxes covered by the Convention. Thus, the competent authorities may request
and provide information for cases under examination or criminal investigation, in collection, on
appeals, or under prosecution.
The taxes covered by the Convention for purposes of this Article constitute a broader
category of taxes than those referred to in Article 2 (Taxes Covered). Exchange of information
is authorized with respect to taxes of every kind imposed by a Contracting State at the national
level. Accordingly, information may be exchanged with respect to U.S. estate and gift taxes,
excise taxes or, with respect to Iceland, value added taxes.
Information exchange is not restricted by paragraph 1 of Article 1 (General Scope).
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 Iceland, 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 Iceland, 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
Iceland 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 for most
purposes of the Convention, Section 7651 of the Code authorizes the Internal Revenue Service to
utilize the provisions of the Internal Revenue Code to obtain information from the U.S.
possessions pursuant to a proper request made under Article 25. If necessary to obtain requested
information, the Internal Revenue Service could issue and enforce an administrative summons to
the taxpayer, a tax authority (or a government agency in a U.S. possession), or a third party
located in a U.S. possession.
Paragraph 1 also 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. Information received may be disclosed only to persons, including courts and
administrative bodies, involved in the assessment, collection, or administration of, the
enforcement or prosecution in respect of, or the determination of the of appeals in relation to, the
taxes covered by the Convention. The information must be used by these persons in connection
with the specified functions. Information may also be disclosed to legislative bodies, such as the
tax-writing committees of Congress and the Government Accountability Office, engaged in the
oversight of the preceding activities. Information received by these bodies must be for use in the
pe~formance 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.
75
ParaKraph 2
Paragraph 2 provides that when information is requested by a Contracting State in
accordance \,ith 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 3
Paragraph 3 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 7 of the Protocol provides that the powers of each Contracting State's
competent authority to obtain information include powers to obtain information held by financial
institutions, nominees, or persons acting in an agency or fiduciary capacity (not including
information that would reveal confidential communications between a client and an attorney,
solicitor, or other legal representative, where the client seeks legal advice), and information
re lating t.o the ow~ership of legal per~on~. Paragraph 7 of the Pro~ocol acknowledges that each
Contractmg State s competent authonty IS able to exchange such mformation in accordance with
Article 25. The provisions of paragraph 7 of the Protocol prevent a Contracting State from
rel~ing.on parawaph 3 ?fthe Convention.to ~rgue th~t its domestic bank secrecy laws (or similar
legIslatIOn relatmg to dIsclosure of financIal mformatIon by financial institutions or
intermediaries) override its obligation to provide information under paragraph 1.
Paragraph .f
Paragraph 4 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).
76
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 5
Paragraph 5 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 5, 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
at source granted under the Convention by that other State is not enjoyed by persons not entitled
to those benefits. For example, ifthe 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 5 would obligate the other
Iceland 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 those used in the collection of its own taxes, or that would be contrary to
its sovereignty, security or public policy.
Paragraph 6
Paragraph 6 provides that a Contracting State must notify the competent authority of the
other Contracting State before sending representatives to enter the requested State to interview
individuals and examine books and records with the consent of the persons subject to
examination.
ARTICLE 26 (MEMBERS OF DIPLOMATIC MISSIONS AND CONSULAR POSTS)
This Article confirms that any fiscal privileges to which diplomatic or consular officials
are entitled under general provisions of international law or under special agreements will apply
notwithstanding any provisions to the contrary in the Convention. The agreements referred to
include any bilateral agreements, such as consular conventions, that affect the taxation of
diplomats and consular officials and any multilateral agreements dealing with these issues, such
as the Vienna Convention on Diplomatic Relations and the Vienna Convention on Consular
Relations. The U.S. generally adheres to the latter because its terms are consistent with
customary international law.
The Article does not independently provide any benefits to diplomatic agents and
consular officers. Article 18 (Government Service) does so, as do Code section 893 and a
number of bilateral and multilateral agreements. In the event that there is a conflict between the
Convention and international law or such other treaties, under which the diplomatic agent or
consular official is entitled to greater benefits under the latter, the latter laws or agreements shall
have precedence. Conversely, if the Convention confers a greater benefit than another
agreement, the affected person could claim the benefit ofthe tax treaty.
77
Pursuant to subparagraph 5(b) of Article 1 (General Scope), the saving clause of
paragraph 4 of Article 1 does not apply to override any benefits of this Article available to an
individual who is neither a citizen of the United States nor has immigrant status in the United
States.
ARTICLE 27 (ENTRY INTO FORCE)
This Article contains the rules for bringing the Convention into force and giving effect to
its provisions.
Paragraph 1
Paragraph 1 provides that the Convention is subject to ratification in accordance with the
applicable procedures of the United States and Iceland. Further, the Contracting States shall
notifY each other by written notification, through diplomatic channels, when their respective
applicable procedures have been satisfied.
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
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 Convention will enter into force on the date of the later of
the notifications referred to in paragraph 1. The relevant date is the date on the second of these
notification documents, and not the date on which the second notification is provided to the other
Contracting State. The 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 Convention will have effect with respect to taxes withheld
at source (principally dividends, interest and royalties) for income derived on or after the first
day of January in the first calendar year following the date on which the Convention enters into
force. For all other taxes, subparagraph 2(b) specifies that the Convention will have effect for
taxes chargeable for any tax year beginning on or after January 1 of the year following entry into
force.
Paragraph 3
Paragraph 3 provides an exception to the general rule of paragraph 2. Under paragraph 3,
if the prior income tax convention between the United States and Iceland would have afforded
greater relief from t.ax than this ~onvention, tha~ prior conv:ention shall, at the election of any
person that was entItled to benefIts under the pnor conventIOn, continue to have effect in its
78
entirety for a twelve-month period from the date on which this Convention otherwise would have
had effect with respect to such person.
Thus, a taxpayer may elect to extend the benefits of the prior convention for one year
from the date on which the relevant provision of the new Convention would first take effect.
During the period in which the election is in effect, the provisions of the prior convention will
cOlltinue to apply only insofar as they applied before the entry into force of the Convention. If
the grace period is elected, all of the provisions ofthe prior convention must be applied for that
additional year. The taxpayer may not apply certain, more favorable provisions of the prior
convention and, at the same time, apply other, more favorable provisions of this Convention.
The taxpayer must choose one convention in its entirety or the other.
The prior convention shall terminate on the last date on which it has effect with respect to
any tax in accordance with the provisions of Article 28.
Paragraph 4
Paragraph 4 provides that an individual who was entitled to beneiits under Article 21
(Teachers) of the prior convention at the time of the entry into force of this Convention is
"grandfathered," and will continue to be entitled to the benefits available under the prior
convention until such time as that individual would cease to be entitled to benefits if the prior
convention remained in force.
ARTICLE 28 (TERMINATION)
The Convention is to remain in effect indefinitely, unless terminated by one of the
Contracting States in accordance with the provisions of Article 28. The Convention may be
terminated by giving notice of termination in writing at least six months before the end of any
calendar year. If notice of termination is given, the provisions of the Convention with respect to
withholding at source will cease to have effect on income derived on or after the first day of
January in the first calendar year following the year in which notice is given. For other taxes, the
Convention will cease to have effect for taxes chargeable for any tax year beginning on or after
the iirst day of January in the first calendar year following the year in which notice is given.
Article 28 relates only to unilateral termination of the Convention by a Contracting State.
Nothing in that Article should be construed as preventing the Contracting States from concluding
a new bilateral agreement, subject to ratification, that supersedes, amends or terminates provisions of the Convention without the notification period.
Customary intemationallaw observed by the United States and other countries, as
reflected in the Vienna Convention on Treaties, allows termination by one Contracting State at
any time in the event of a "material breach" of the agreement by the other Contracting State.
79
DEPARTMENT OF THE TREASURY
TECHNICAL EXPLANATION OF
\THE CONVENTION BETWEEN
THE UNITED STATES OF AMERICA AND
THE REPUBLIC OF BULGARIA
FOR THE A VOIDANCE OF DOUBLE TAXATION AND
THE PREVENTION OF FISCAL EVASION
WITH RESPECT TO TAXES ON INCOME,
SIGNED AT WASHINGTON ON FEBRUARY 23, 2007
This is a technical explanation of the Convention between the United States and Bulgaria
for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income, signed on February 23,2007, and the Protocol between the United States and
Bulgaria signed on the same date (the "Protocol"), as amended by the Protocol between the
United States and Bulgaria signed on February 26, 2008 (collectively, the "Convention"). The
Protocol is discussed below in connection with the relevant articles ofthe Convention.
Negotiations took into account the U.S. Treasury Department's current tax treaty policy,
and the Treasury Department's Model Income Tax Convention, updated as of November 15,
2006. Negotiations also took into account the Model Tax Convention on Income and on Capital,
published by the Organisation for Economic Cooperation and Development (the "OECD
Model"), and recent tax treaties concluded by both countries.
The Technical Explanation is an official guide to the Convention. It reflects the policies
behind particular Convention provisions, as well as understandings reached during the
negotiations with respect to the application and interpretation of the Convention. References in
the Technical Explanation to "he" or "his" should be read to mean "he or she" or "his and her."
ARTICLE 1 (GENERAL SCOPE)
Paragraph 1
Paragraph I of Article 1 provides that the Convention applies only to residents of the
United States or Bulgaria except where the terms of the Convention provide otherwise. Under
Article 4 (Resident) a person is generally treated as a resident of a Contracting State if that
person is, under the laws of that State, liable to tax therein by reason of his domicile, citizenship,
residence, or other similar criteria. However, if a person is considered a resident of both
Contracting States, Article 4 provides rules for determining a State of residence (or no State of
residence). This determination governs for all purposes of the Convention.
Certain provisions are applicable to persons who may not be residents of either
Contracting State. For example, paragraph 1 of Article 23 (Non-Discrimination) applies to
nationals of the Contracting States. Under Article 25 (Exchange of Information and Administrative- Assistance), information may be exchanged with respect to residents of third states.
Paragraph 2
Paragraph 2 states the generally accepted relationship both between the Convention and
domestic law and between the Convention and other agreements between the Contracting States.
That is. no provision in the Convention may restrict any exclusion, exemption, deduction, credit
or other benefit accorded by the tax laws of the Contracting States, or by any other agreement
between the Contracting States. The relationship between the non-discrimination provisions of
the Convention and other agreements is addressed not in paragraph 2 but in paragraph 3.
Under paragraph 2, for example, if a deduction would be allowed under the U.S. Internal
Revenue Code (the "Code") in computing the U.S. taxable income of a resident of Bulgaria, the
deduction also is allowed to that person in computing taxable income under the Convention.
Paragraph 2 also means that the Convention may not increase the tax burden on a resident of a
Contracting State beyond the burden determined under domestic law. Thus, a right to tax given
by the Convention cannot be exercised unless that right also exists under internal law.
It follows that, under the principle of paragraph 2, a taxpayer's U.S. tax liability need not
be determined under the Convention if the Code would produce a more favorable result. A
taxpayer may not, however, choose among the provisions of the Code and the Convention in an
inconsistent manner in order to minimize tax. A taxpayer may use the treaty to reduce its taxable
income, but may not use both treaty and Code rules where doing so would thwart the intent of
either set of rules. For example, assume that a resident of Bulgaria has three separate businesses
in the United States. One is a profitable permanent establishment and the other two are trades or
businesses that would earn taxable income under the Code but that do not meet the permanent
establishment threshold tests of the Convention. One is profitable and the other incurs a loss.
Under the Convention, the income of the permanent establishment is taxable in the United
States, and both the profit and loss of the other two businesses are ignored. Under the Code, all
three would be subject to tax, but the loss would offset the profits of the two profitable ventures.
The taxpayer may not invoke the Convention to exclude the profits of the profitable trade or
business and invoke the Code to claim the loss of the loss trade or business against the profit of
the permanent establishment. See Rev. Rul. 84-17, 1984-1 c.B. 308. If, however, the taxpayer
invokes the Code for the taxation of all three ventures, he would not be precluded from invoking
the Convention with respect, for example, to any dividend income he may receive from the
United States that is not effectively connected with any of his business activities in the United
States.
Similarly, nothing in the Convention can be used to deny any benefit granted by any
other agreement between the United States and Bulgaria. For example, if certain benefits are
provided for military personnel or military contractors under a Status of Forces Agreement
between the United States and Bulgaria, those benefits or protections will be available to
residents of the Contracting States regardless of any provisions to the contrary (or silence) in the
Convention.
Paragraph 3
Paragraph 3 specifically relates to non-discrimination obligations of the Contracting
States under the General Agreement on Trade in Services (the "GATS"). The provisions of
paragraph 3 are an exception to the rule provided in paragraph 2 of this Article under which the
Convention shall not restrict in any manner any benefit now or hereafter accorded by any other
dgrf'ement between the Contracting States.
Subparagraph 3(a) provides that, unless the competent authorities determine that a
taxation measure is not with~n 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
2
interpretation of the Convent~on, including in particular whether a measure is within the scope of
the Convention shall be consIdered on.ly 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 23 (NonDiscrimination) of the Convention.
The term "taxation measure" for these purposes is defined broadly in subparagraph 3(b).
It would include, for example, a law, regulation, rule, procedure, decision, administrative action
or guidance, or any other form of measure relating to taxation.
Paragraph 4
Paragraph 4 contains the traditional saving clause found in all U.S. treaties. The
Contracting States reserve their rights, except as provided in paragraph 5, to tax their residents
and citizens as provided in their intemallaws, notwithstanding any provisions of the Convention
to the contrary. For example, if a resident of Bulgaria performs professional services in the
United States and the income from the services is not attributable to a permanent establishment
in the United States, Article 7 (Business Profits) would by its terms prevent the United States
from taxing the income. If, however, the resident of Bulgaria is also a citizen of the United
States, the saving clause permits the United States to include the remuneration in the worldwide
income of the citizen and subject it to tax under the normal Code rules (i.e., without regard to
Code section 894(a)). However, subparagraph 5(a) of Article 1 preserves the benefits of special
foreign tax credit rules applicable to the U.S. taxation of certain U.S. income of its citizens
resident in Bulgaria. See paragraph 4 of Article 22 (Relief from Double Taxation).
For purposes ofthe saving clause, "residence" is determined under Article 4 (Resident).
Thus, an individual who is a resident of the United States under the Code (but not a U.S. citizen)
but who is determined to be a resident of Bulgaria under the tie-breaker rules of Article 4 would
be subject to U.S. tax only to the extent permitted by the Convention. The United States would
not be permitted to apply its statutory rules to that person to the extent the rules are inconsistent
with the treaty.
However, the person would be treated as a U.S. resident for U.S. tax purposes other than
determining the individual's U.S. tax liability. For example, in determining under Code section
957 whether a foreign corporation is a controlled foreign corporation, shares in that corporation
held by the individual would be considered to be held by a U.S. resident. As a result, other U.S.
citizens or residents might be deemed to be United States shareholders of a controlled foreign
corporation subject to current inclusion of Subpart F income recognized by the corporation. See
Treas. Reg. section 301.7701 (b)-7(a)(3).
Under paragraph 4, the United States also reserves its right to tax former citizens and
former long -term residents for a period of ten years following the loss of such status with respect
to income from sources within the United States (including income deemed under the domestic
law of the United States to arise from such sources). Thus, paragraph 4 allows the United States
to tax former U.S. citizens and former U.S. long-term residents in accordance with section 877 of
the Code. Section 877 generally applies to a former citizen or long-term resident of the United
States who relinquishes citizenship or terminates long-term residency before June 17,20.08 if
either of the following criteria exceed established thresholds: (a) the average annual net mcome
tax of such individual for the period of 5 taxable years ending before the date of the loss of
status, or (b) the net worth of such individual as of the date of the loss of status. Paragraph 1 of
the Protocol provides that the term "long-term resident" means any indivi~ual who is a l~wful
permanent resident of the United States in eight or more taxable years dunng the precedmg 15
3
taxable years. In determining whether the eight-year threshold is met. one does n~t count any
year in which the individual is treated as a resident of Bulgaria under the ConventIOn (or as a
resident of any country other than the United States under the provisions of any othe~ U .S. ta~
treatv), and the individual does not waive the benefits of such treaty applicable to resIdents ot the
other country. This understanding is consistent with how this provision is generally interpreted
in U.S. tax treaties ..
Paragraph 5
Paragraph 5 sets forth certain exceptions to the saving clause. The referenced provisions
are intended to provide benefits to citizens and residents even if such benefits do not exist under
internal law. Paragraph 5 thus preserves these benefits for citizens and residents of the
Contracting States.
Subparagraph (a) lists certain provisions of the Convention that are applicable to all
citizens and residents of a Contracting State, despite the general saving clause rule of paragraph
4:
(l) Paragraph 2 of Article 9 (Associated Enterprises) grants the right to a correlative
adjustment with respect to income tax due on profits reallocated under Article 9.
(2) Paragraphs 2 and 5 of Article 17 (Pensions, Social Security Payments, Annuities,
Alimony, and Child Support) provide exemptions from source or residence State
taxation for certain pension distributions and social security payments.
(3) Article 22 (Relief from Double Taxation) confirms to citizens and residents of one
Contracting State the benefit of a credit for income taxes paid to the other or an
exemption for income earned in the other State.
(4) Article 23 (Non-Discrimination) protects residents and nationals of one Contracting
State against the adoption of certain discriminatory practices in the other Contracting
State.
(5) Article 24 (Mutual Agreement Procedure) confers certain benefits on citizens and
residents of the Contracting States in order to reach and implement solutions to
disputes between the two Contracting States. For example, the competent authorities
are permitted to use a definition of a term that differs from an internal law definition.
The statute of limitations may be waived for refunds, so that the benefits of an
agreement may be implemented.
Subparagraph 5(b) provides a different set of exceptions to the saving clause. The
benefits referred to are all intended to be granted to temporary residents of a Contracting State
(for example, in the case of the United States, holders of non-immigrant visas), but not to
citizens or to persons who have acquired permanent residence in that State. If beneficiaries of
these provisions travel from one of the Contracting States to the other, and remain in the other
long enough to become residents under its internal law, but do not acquire permanent residence
status (i.e., in the U.S. context they do not become "green card" holders) and are not citizens of
that State. the host State will continue to grant these benefits even if they conflict with the
statutory rules. ~he bene.fits preserve.d by this parawaph are: (1) the host country exemptions for
gowrnment servIce salanes and pensIOns under ArtIcle 18 (Government Service), certain income
of visiting students, trainees, teachers, and researchers under Article 19 (Students Trainees
Teachers and Researchers), and the income of diplomatic agents and consular officers unde~
Article 26 (Members of Diplomatic Missions and Consular Posts).
4
Paragraph 6
Paragraph 6 addresses special issues presented by fiscally transparent entities such as
p~nerships and certain. est.ates and trusts. Because di~ferent countries frequently take different
VIews as to when an entIty IS fiscally transparent, the risk of both double taxation and double
non-taxation are relatively high. The intention of paragraph 6 is to eliminate a number of
technical problems that arguably would have prevented investors using such entities from
claiming treaty benefits, even though such investors would be subject to tax on the income
derived through such entities. The provision also prevents the use of such entities to claim treaty
benefits in circumstances where the person investing through such an entity is not subject to tax
on the income in its State of residence. The provision, and the corresponding requirements of
the substantive rules of Articles 6 through 20, should be read with those two goals in mind.
In general, paragraph 6 relates to entities that are not subject to tax at the entity level, as
distinct from entities that are subject to tax, but with respect to which tax may be relieved under
an integrated system. This paragraph applies to any resident of a Contracting State who is
entitled to income derived through an entity that is treated as fiscally transparent under the laws
of either Contracting State. Entities falling under this description in the United States include
partnerships, common investment trusts under section 584 and grantor trusts. This paragraph
also applies to U.S. limited liability companies ("LLCs") that are treated as partnerships or as
disregarded entities for U.S. tax purposes.
Under paragraph 6, an item of income derived by such a fiscally transparent entity will be
considered to be derived by a resident of a Contracting State if a resident is treated under the
taxation laws of that State as deriving the item of income. For example, if a company that is a
resident of Bulgaria pays interest to an entity that is treated as fiscally transparent for U.S. tax
purposes, the interest will be considered derived by a resident of the United States only to the
extent that the taxation laws of the United States treats 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. In the case of 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 for the interest paid to the entity under the Convention, because they are not
residents ofthe United States for purposes of claiming this treaty benefit. (If, however, the
country in which they are treated as resident for tax purposes, as determined under the laws of
that country, has an income tax convention with Bulgaria, they may be entitled to claim a benefit
under that convention.) In contrast, if, for example, an 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
Bulgaria to the U.s. entity 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 obtains even if the entity were viewed differently under the tax laws of
Bulgaria (e.g., as not fiscally transparent in the first example above where the entity is treated as
a partnership for U.S. tax purposes). Similarly, the characterization of the entity in a third
country is also irrelevant, even if the entity is organized in that third country. The results follow
regardless of whether the entity is disregarded as a separate entity 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 Uflder the laws of Bulgaria. These results also
obtain regardless of where the entity is organized (i.e., in the United States, in Bulgaria or, as
noted above, in a third country).
5
For example, income from U.S. sources received by an entity organized under the laws of
the United States, which is treated for tax purposes under the laws of Bulgaria as a corporation
and is owned by a shareholder who is a resident of Bulgaria for its tax purposes, is not
considered derived by the shareholder of that corporation even if, under the tax laws of the
United States, the entity is treated as fiscally transparent. Rather, for purposes of the treaty, the
income is treated as derived by the U.S. entity.
These principles also apply to trusts to the extent that they are fiscally transparent in
either Contracting State. For example, if X, a resident of Bulgaria, creates a revocable trust in
the United States and names persons resident in a third country as the beneficiaries of the trust,
the trust's income would be regarded as being derived by a resident of Bulgaria only to the
extent that the laws of Bulgaria treat X as deriving the income for its tax purposes, perhaps
through application of rules similar to the U.S. "grantor trust" rules.
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 Bulgaria 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 Bulgaria
views the LLC as fiscally transparent.
ARTICLE 2 (TAXES COVERED)
This Article specifies the U.S. taxes and the taxes of Bulgaria to which the Convention
applies. With two exceptions, the taxes specified in Article 2 are the covered taxes for all
purposes of the Convention. A broader coverage applies, however, for purposes of Articles 23
(Non-Discrimination) and 25 (Exchange ofInformation and Administrative Assistance). Article
23 (Non-Discrimination) applies with respect to all taxes, including those imposed by state and
local governments. Article 25 (Exchange ofInformation and Administrative Assistance) applies
with respect to all taxes imposed at the national level.
Paragraph 1
Paragraph 1 identifies the category of taxes to which the Convention applies. Paragraph
1 is based on the U.S. and OECD Models and defines the scope of application of the Convention.
The Convention applies to taxes on income, including gains, imposed on behalf of a Contracting
State, irrespective of the manner in which they are levied. Except with respect to Article 23
(Non-Discrimination), state and local taxes are not covered by the Convention.
Paragraph 2
Paragraph 2 also is based on the U.S. and OECD Models and provides a definition of
taxes on income and on capital gains. The Convention covers taxes on total income or any part
of income and includes tax on gains derived from the alienation of property. The Convention
does not apply, however, to social security charges, or any other charges where there is a direct
connection between the levy and individual benefits. Nor does it apply to property taxes except
'
with respect to Article 23 (Non-Discrimination).
Paragraph 3
Paragraph 3 lists the taxes in force at the time of signature of the Convention to which the
Convention applies.
6
·
T~e existing covered taxes of Bylgaria are identified in subparagraph 3(a), as the
personal mcome tax and the corporate mcome tax. Paragraph 2 of the Protocol clarifies that
these taxes include the patent tax, which is a tax imposed on certain small business operations in
lieu of a net basis income tax.
Subparagraph 3(b) provides that the existing U.S. taxes subject to the rules of the
Convention are the Federal income taxes imposed by the Code, together with the excise taxes
imposed with respect to the investment income of foreign private foundations (Code section
4940). Social security and unemployment taxes (Code sections 1401,3101,3111 and 3301) are
excluded from coverage.
Paragraph 4
Under paragraph 4, the Convention will apply to any taxes that are identical, or
substantially similar, to those enumerated in paragraph 3, and which are imposed in addition to,
or in place of, the existing taxes after February 23, 2007, the date of signature of the Convention.
The paragraph also provides that the competent authorities of the Contracting States will notify
each other of any changes that have been made in their laws, whether tax laws or non-tax laws,
that significantly affect their obligations under the Convention. Non-tax laws that may affect a
Contracting State's obligations under the Convention may include, for example, laws affecting
bank secrecy.
ARTICLE 3 (GENERAL DEFINITIONS)
Article 3 provides general definitions and rules of interpretation applicable throughout
the Convention. Certain other terms are defined in other articles of the Convention. For
example, the term "resident of a Contracting State" is defined in Article 4 (Resident). The term
"permanent establishment" is defined in Article 5 (Permanent Establishment). These definitions
are used consistently throughout the Convention. Other terms, such as "dividends," "interest"
and "royalties" are defined in specific articles for purposes only of those articles.
Paragraph 1
Paragraph 1 defines a number of basic terms used in the Convention. The introduction to
paragraph 1 makes clear that these definitions apply for all purposes of the Convention, unless
the context requires otherwise. This latter condition allows flexibility in the interpretation of the
Convention in order to avoid results not intended by the Convention's negotiators.
The geographical scope of the Convention with respect to Bulgaria is set out in
subparagraph lea). The term "Bulgaria" encompasses the Republic of Bulgaria, including the
territory and the territorial sea over which it exercises its State sovereignty, as well as the
continental shelf and the exclusive economic zone over which it exercises sovereign rights and
jurisdiction in conformity with international law.
The geographical scope of the Convention with respect to the United States is set out in
subparagraph l(b). It encompasses the United States of America, including the stat~s, the
District of Columbia and the territorial sea of the United States. The term does not mclude
Puerto Rico, the Virgin Islands, Guam or any other U.S. possessi~n or territory. For ceI"!ain
purposes the term "United States" includes the sea bed and subSOIl of undersea areas adjacent to
the territ~rial sea of the United States. This extension applies to the extent that the United States
exercises sovereignty in accordance with international law for the purpose of natural resource
exploration and exploitation of such areas. This extension of the definition applies, however,
only if the person, property or activity to which the Convention is being applied is connected
with such natural resource exploration or exploitation. Thus, it would not include any activity
7
inYolying the sea tloor of an area over which the United States exercised sovereignty for natural
resource purposes if that activity was unrelated to the exploration and exploitation of natural
resources. This result is consistent with the result that would be obtained under Code section
638. which treats the continental shelfas part of the United States for purposes of natural
resource exploration and exploitation.
Subparagraph 1(c) provides that the terms "a Contracting State" and ..the other
Contracting State" shall mean Bulgaria or the United States, as the context requires.
Subparagraph 1(d) defines the term "person" to include an individual, a company and any
other body of persons. Paragraph 3 of the Protocol clarifies that the term "any other body of
persons" includes partnerships, trusts, and estates. The definition is significant for a variety of
reasons. For example, under Article 4, only a "person" can be a "resident" and therefore eligible
for most benefits under the Convention. Also, all "persons" are eligible to claim relief under
Article 24 (Mutual Agreement Procedure).
The term "company" is defined in subparagraph l(e) as a body corporate or an entity
treated as a body corporate for tax purposes in the state where it is organized. The definition
refers to the law of the state in which an entity is organized in order to ensure that an entity that
is treated as fiscally transparent in its country of residence will not get inappropriate benefits,
such as the reduced withholding rate provided by subparagraph 2(b) of Article 10 (Dividends).
It also ensures that the Limitation on Benefits provisions of Article 21 will be applied at the
appropriate level.
The terms "enterprise ofa Contracting State" and "enterprise of the other Contracting
State" are defined in subparagraph 1(f) as an enterprise carried on by a resident of a Contracting
State and an enterprise carried on by a resident of the other Contracting State. An enterprise of a
Contracting State need not be carried on in that State. It may be carried on in the other
Contracting State or a third state (e.g., a U.S. corporation doing all of its business in Bulgaria
would still be a U.S. enterprise).
These terms also encompass an enterprise conducted through an entity (such as a
partnership) that is treated as fiscally transparent in the Contracting State where the entity's
owner is resident. In accordance with Article 4 (Resident), entities that are fiscally transparent in
the Contracting State in which their owners are resident are not considered to be residents of that
Contracting State (although income derived by such entities may be taxed as the income of a
resident, if taxed in the hands of resident partners or other owners). An enterprise conducted by
such an entity will be treated as carried on by a resident of a Contracting State to the extent its
partners or other owners are residents. This approach is consistent with the Code, which under
section 875 attributes a trade or business conducted by a partnership to its partners and a trade or
business conducted by an estate or trust to its beneficiaries.
Subparagraph (g) defines the term "enterprise" as any activity or set of activities that
constitutes the carrying on of a business. The term "business" is not defined, but subparagraph
(h) provides that it includes the performance of professional services and other activities of an
independent character. Both subparagraphs are identical to definitions recently added to the
OECD Model in connection with the deletion of Article 14 (Independent Personal Services)
from the OECD Model. The inclusion of the two definitions is intended to clarity that income
from the performance of professional services or other activities of an independent character is
(kllt with under Article 7 (Business Profits) and not Article 20 (Other Income). Subparagraph
(i) further clarities. at the request of Bulgaria, that "business profits" also include income from
the performance of professional services and other activities of an independent character.
8
Subparagraph 1U) defines the term "international traffic." The term means any transport
by a ship or aircraft except when such transport is solely between places within a Contracting
State. The exclusion from international traffic of transport solely between places within a
Contracting State means, for example, that carriage of goods or passengers solely between New
York and Chicago would not be treated as international traffic, whether carried by a U.S. or a
foreign carrier. The substantive taxing rules of the Convention relating to the taxation of income
from transport, principally Article 8 (International Traffic), therefore, would not apply to income
from such carriage. Thus, if the carrier engaged in internal U.S. traffic were a resident of
Bulgaria (assuming that were possible under U.S. law), the United States would not be required
to exempt the income from that transport under Article 8. The income would, however, be
treated as business profits under Article 7 (Business Profits), and therefore would be taxable in
the United States only if attributable to a U.S. permanent establishment of the foreign carrier,
and then only on a net basis. The gross basis U.S. tax imposed by section 887 would never apply
under the circumstances described. If, however, goods or passengers are carried by a carrier
resident in Bulgaria from a non-U.S. port to, for example, New York, and some of the goods or
passengers continue on to Chicago, the entire transport would be international traffic. This
would be true if the international carrier transferred the goods at the U.S. port of entry from a
ship to a land vehicle, from a ship to a lighter, or even if the overland portion of the trip in the
United States was handled by an independent carrier under contract with the original international carrier, so long as both parts of the trip were reflected in original bills oflading. For this
reason, the Convention, following the U.S. Model refers, in the definition of "international
traffic," to "such transport" being solely between places in the other Contracting State, while the
OECD Model refers to the ship or aircraft being operated solely between such places. The
formulation in the Convention is intended to make clear that, as in the above example, even if the
goods are carried on a different aircraft for the internal portion of the international voyage than is
used for the overseas portion of the trip, the definition applies to that internal portion as well as
the external portion.
Finally, a "cruise to nowhere," i.e., a cruise beginning and ending in a port in the same
Contracting State with no stops in a foreign port, would not constitute international traffic.
Subparagraph l(k) designates the "competent authorities" for Bulgaria and the United
States. The Bulgarian competent authority is the Minister of Finance or an authorized
representative. The U.S. competent authority is the Secretary of the Treasury or his delegate.
The Secretary of the Treasury has delegated the competent authority function to the
Commissioner of Internal Revenue, who in turn has delegated the authority to the Deputy
Commissioner (International) LMSB. With respect to interpretative issues, the Deputy
Commissioner (International) LMSB acts with the concurrence of the Associate Chief Counsel
(International) of the Internal Revenue Service.
The term "national," as it relates to the United States and to Bulgaria, is defined in
subparagraph I (1). This term is relevant for purposes of Articles 18 (Government Service) and
23 (Non-Discrimination). A national of one of the Contracting States is (1) an individual who is
a citizen of that State, and (2) any legal person, partnership or association deriving its status, as
such, from the law in force in the State where it is established.
Subparagraph l(m) defines the term "pe~sion fund" t~ in~lude any person esta?lished in a
Contracting State that is generally exempt from m~ome taxatIO~ m that State .and that IS operated
principally to administer or provide pension or retlrement benehts or to earn mcome for the
benefit of one or more such arrangements. In the case of the United States, the term "pension
fund" includes the following: a trust providing pension or retirement benefits under a Code
section 401(a) qualified pension plan, profit shar.ing or stock bonus plan, a tr,ust pr:ov~d~ng
pension or retirement benefits under a Code sectIOn 403(b) plan, a trust that IS an mdividual
retirement account under Code section 408, a Roth individual retirement account under Code
9
section 408A. or a simple retirement account under Code section 408(p). a trust providing
pension or retirement benetits 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 77010». Section 401(k) plans and
group trusts described in Rev. Rul. 81-100. 1981-1 C.B. 326. and meeting the conditions of Rev.
Rul. 2004-67. 2204-2 C.B. 28. qualify as pension funds because they are covered by Code
section 401(a).
Paragraph 2
Terms that are not defined in the Convention are dealt with in paragraph 2.
Paragraph 2 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 law of the Contracting
State whose tax is being applied. unless the context requires otherwise, or the competent
authorities have agreed on a different meaning pursuant to Article 24 (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.
If the meaning of a term cannot be readily determined under the law of a Contracting
State, or if there is a conflict in meaning under the laws of the two States that creates difficulties
in the application of the Convention, the competent authorities, as indicated in paragraph 3(t) of
Article 24 (Mutual Agreement Procedure), may establish a common meaning in order to prevent
double taxation or to further any other purpose of the Convention. This common meaning need
not conform to the meaning of the term under the laws of either Contracting State.
The reference in paragraph 2 to the internal law of a Contracting State means the law in
effect at the time the Convention is being applied, not the law as in effect at the time the
Convention 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
Convention was negotiated and ratified. The reference in both paragraphs 1 and 2 to the
"context otherwise requir[ing]" a definition different from the Convention definition, in
paragraph 1, or from the internal law definition of the Contracting State whose tax is being
imposed, under paragraph 2, refers to a circumstance where the result intended by the
Contracting States is different from the result that would obtain under either the paragraph 1
definition or the statutory definition. Thus, flexibility in defining terms is necessary and
permitted.
ARTICLE 4 (RESIDENT)
This Article sets forth rules for determining whether a person is a resident of a
Contracting State for purposes of the Convention. As a general matter only residents of the
Contracting States may claim the benefits of the Convention. The treaty definition of residence
is to be used only for purposes of the Convention. The fact that a person is determined to be a
resident of a Contracting State under Article 4 does not necessarily entitle that person to the
benefits of the Convention. In addition to being a resident, a person also must qualify for
benefits under Article 21 (Limitation on Benefits) in order to receive benefits conferred on
residents of a Contracting State.
The determination of residence for treaty purposes looks first to a person's liability to tax
as a r~sident under the respective taxation laws of the Contracting States. As a general matter, a
10
person who, under those laws, is a resident of one Contracting State and not of the other need
look no further. For purposes of the Convention, that person is a resident of the State in which
he is resident under internal law. If, however, a person is resident in both Contracting States
under their respective taxation laws, the Article proceeds, where possible, to use tie-breaker rules
to assign a single State of residence to such a person for purposes of the Convention.
Paragraph I
The tenn "resident of a Contracting State" is defined in paragraph 1. In general, this
definition incorporates the definitions of residence in U.S. law and that of Bulgaria by referring
to a resident as a person who, under the laws of a Contracting State, is subject to tax there by
reason of his domicile, residence, citizenship, place of management, place of incorporation or
any other similar criterion. Thus, residents of the United States include aliens who are
considered U.S. residents under Code section 770I(b). Paragraph 1 also specifically includes the
two Contracting States, and political subdivisions and local authorities of the two States, as
residents for purposes of the Convention.
Certain entities that are nominally subject to tax but that in practice are rarely required to
pay tax also would generally be treated as residents and therefore accorded treaty benefits. For
example, a U.S. Regulated Investment Company (RIC) and a U.S. Real Estate Investment Trust
(REIT) are residents of the United States for purposes of the treaty. Although the income earned
by these entities nonnally is not subject to U.S. tax in the hands ofthe entity, they are taxable to
the extent that they do not currently distribute their profits, and therefore may be regarded as
"liable to tax." They also must satisfy a number ofrequirements under the Code in order to be
entitled to special tax treatment.
Under paragraph 1 of the Convention and paragraph 4 of the Protocol, a person who is
liable to tax in a Contracting State only in respect of income from sources within that State or of
profits attributable to a pennanent establishment in that State will not be treated as a resident of
that Contracting State for purposes of the Convention. Thus, a consular official of Bulgaria who
is posted in the United States, who may be subject to U.S. tax on U.S. source investment income,
but is not taxable in the United States on non-U.S. source income (see Code section
7701 (b)(5)(B)), would not be considered a resident of the United States for purposes of the
Convention. Similarly, an enterprise of Bulgaria with a permanent establishment in the United
States is not, by virtue ofthat pennanent establishment, a resident of the United States. The
enterprise generally is subject to U.S. tax only with respect to its income that is attributable to
the U.S. pennanent establishment, not with respect to its worldwide income, as it would be if it
were a U.S. resident.
Paragraph 4 of the Protocol also clarifies that if a company is a resident of one of the
Contracting States under the domestic law of that State, but is treated as a resident of a third state
under a treaty between that State and the third state, then it will not be treated as a resident of the
Contracting State for purposes of the Convention. For example, if a company that is organized
in Bulgaria is managed and controlled in the United Kingdom, both countries would treat the
company as being a resident under its domestic laws. However, if a treaty between Bulgaria and
the United Kingdom assigned residence in such a case to the country in which the company's
place of effective management is located, and the place of effective management is the United
Kingdom, the company would not qualify for benefits under the U.S.-Bulgaria treaty because it
is not subject to tax in Bulgaria as a resident of Bulgaria. This rule is consistent with the holding
of R('v. Rul. 2004-76, 2004-2 C.B. 111.
11
ParaRraph 2
Paragraph 2 provides that certain tax-exempt entities such as pension funds and
charitable organizations will be regarded as residents of a Contracting State regardless of
whether they are generally liable to income tax in the State where they are established. The
paragraph applies to legal persons organized under the laws of a Contracting State and
established and maintained in that State to provide pensions or other similar benefits pursuant to
a plan. or exclusively for religious, charitable. scientific, artistic, cultural, or educational
purposes. Thus, a section SOl(c) organization organized in the United States (such as a U.S.
charity) that is generally exempt from tax under U.S. law is a resident of the United States for all
purposes of the Convention.
Paragraph 3
If, under the laws of the two Contracting States, and, thus, under paragraph 1, an
individual is deemed to be a resident of both Contracting States, a series of tie-breaker rules are
provided in paragraph 3 to determine a single State of residence for that individual. These tests
are to be applied in the order in which they are stated. The first test is based on where the
individual has a permanent home. If that test is inconclusive because the individual has a
permanent home available to him in both States, he will be considered to be a resident of the
Contracting State where his personal and economic relations are closest (i.e., the location of his
"center of vital interests"). If that test is also inconclusive, or if he does not have a permanent
home available to him in either State, he will be treated as a resident of the Contracting State
where he maintains a habitual abode. If he has a habitual abode in both States or in neither of
them, he will be treated as a resident of the Contracting State of which he is a national. If he is a
national of both States or of neither, the matter will be considered by the competent authorities,
who \\ i II assign a single State of residence.
Paragraph .J
Dual residents other than individuals (such as companies, trusts, or estates) are addressed
by paragraph 4. If such a person is, under the rules of paragraph 1 or 2, resident in both
Contracting States. the competent authorities shall seek to determine a single State of residence
for that person for purposes of the Convention. If the competent authorities do not reach an
agreement on a single State of residence, that dual resident may not claim any benefit accorded
to residents of a Contracting State by the Convention. The dual resident may, however, claim
any benefits that are not limited to residents, such as those provided by paragraph 1 of Article 23
(Non-Discrimination). Thus, for example, a State cannot discriminate against a dual resident
company.
Dual residents also may be treated as a resident of a Contracting State for purposes other
than tha~ o.f obtaining b~nefits under th~ Convention. ~or example, if a dual resident company
pays a dIVIdend to a reSIdent of Bulgana, the U.S. paymg agent would withhold on that dividend
at the appropriate treaty rate because reduced withholding is a benefit enjoyed by the resident of
Bulgaria, not by the dual resident company. The dual resident company that paid the dividend
would, for this purpose, be treated as a resident of the United States under the Convention. In
addition. information relating to dual residents can be exchanged under the Convention because,
by its terms. Article 26 (Exchange of Information and Administrative Assistance) is not limited
to residents of the Contracting States.
ARTICLE 5 (PERMANENT ESTABLISHMENT)
Th~s Artic}e de!ines th~ term "pe~anent est~blishment," a term that is significant for
snera 1 artIcles ot the (onventlon. [he eXIstence of a permanent establishment in a Contracting
12
State is necessary under Article 7 (Business Profits) for the taxation by that State of the business
profits of a resident ofthe other Contracting State. Articles 10, 11 and 12 (dealing with
dividends, interest, and royalties, respectively) provide for reduced rates oftax at source on
payments of these items of income to a resident of the other State only when the income is not
attributable to a permanent establishment that the recipient has in the source State. The concept
is also relevant in determining which Contracting State may tax certain gains under Article 13
(Capital Gains) and certain "other income" under Article 20 (Other Income).
Paragraph 1
The basic definition of the term "permanent establishment" is contained in paragraph 1.
As used in the Convention, the term means a fixed place of business through which the business
of an enterprise is wholly or partly carried on. As indicated in the OECD Commentary to Article
5 (see paragraphs 4 through 8), a general principle to be observed in determining whether a
permanent establishment exists is that the place of business must be "fixed" in the sense that a
particular building or physical location is used by the enterprise for the conduct of its business,
and that it must be foreseeable that the enterprise's use of this building or other physical location
will be more than temporary.
Paragraph 2
Paragraph 2 lists a number of types of fixed places of business that constitute a
permanent establishment. This list is illustrative and non-exclusive. According to paragraph 2,
the term permanent establishment includes a place of management, a branch, an office, a factory,
a workshop, and a mine, oil or gas well, quarry or other place of extraction of natural resources.
Paragraph 3
This paragraph 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 six 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 (t) of paragraph 2. Thus, a drilling rig
does not constitute a permanent establishment if a well is drilled in only three months, but if
production begins in the following month the well becomes a permanent establishment as of that
date.
The six-month test applies separately to each site or project. The six-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 six-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 six months. If a sub-contractor is on a site intermittently, then, for purposes of applying the
six-month rule, time is measured from the first day the sub-cont~actor is on the site until the last
day (i.e., intervening days that the sub-contractor is not on the SIte are counted).
13
These interpretations of the Article are based on the Commentary to paragraph 3 of
Article 5 of the OECD Model. \vhich 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.
Il' the six-month threshold is exceeded, the site or project constitutes a permanent
establishment from the first day of activity.
Paragraph -I
This paragraph contains exceptions to the general rule of paragraph 1, listing a number of
activities that may be carried on through a fixed place of business but which nevertheless do not
create a permanent establishment. The use of facilities solely to store, display or deliver
merchandise belonging to an enterprise does not constitute a permanent establishment of that
enterprise. The maintenance of a stock of goods belonging to an enterprise solely for the
purpose of storage, display or delivery, or solely for the purpose of processing by another
enterprise does not give rise to a permanent establishment of the first-mentioned enterprise. The
maintenance of a fixed place of business solely for the purpose of purchasing goods or
merchandise, or for collecting information, for the enterprise, or for other activities that have a
preparatory or auxiliary character for the enterprise, such as advertising, or the supply of
information, do not constitute a permanent establishment of the enterprise. Moreover,
subparagraph 4(f) provides that a combination of the activities described in the other
subparagraphs of paragraph 4 will not give rise to a permanent establishment if the combination
results in an overall activity that is of a preparatory or auxiliary character.
Paragraph 5
Paragraphs 5 and 6 specify when activities carried on by an agent or other person acting
on behalf of an enterprise create a permanent establishment of that enterprise. For example,
under subparagraph 5(a), a person is deemed to create a permanent establishment of the
enterprise if that person has and habitually exercises an authority to conclude contracts in the
name of that enterprise. If, however, his activities are limited to those activities specified in
paragraph 4 which would not constitute a permanent establishment if carried on by the enterprise
through a fixed place of business, the person does not create a permanent establishment of the
enterprise.
The Convention adopts the OECD Model language "in the name of that enterprise" rather
than the US Model language "binding on the enterprise." This difference in language is not
intended to be a substantive difference. As indicated in paragraph 32 to the OECD
Commentaries on Article 5. paragraph 5 of the Article is intended to encompass persons who
have "sufficient authority to bind the enterprise's participation in the business activity in the
State concerned."
The contracts referred to in paragraph 5 are those relating to the essential business
operations of the enterprise, rather than ancillary activities. For example, if the person has no
a~thority to conclude contracts in the. name o.fthe enterp~ise with its customers for, say, the sale
ot the goods produced by the enterpnse, but 1t can enter mto service contracts in the name of the
enterprise for the enterprise's business equipment, this contracting authority would not fall within
the scope of the paragraph, even if exercised regularly.
Un~er ~ubparagraph 5(b), a perso~ is also deemed to create a permanent establishment of
the e~terpnse 1fthat person has no auth?nty to co~clude contracts, but habitually maintains in
that State ~ stock of goods or mer~ha~d1se belongmg to the enterprise from which the person
ll:gularly hIls orders or makes dehvenes on behalf of the enterprise, and additional activities
14
conducted in that State on behalf of the enterprise have contributed to the conclusion of the sale
of such goods or merchandise.
Paragraph 6
Under paragraph 6, an enterprise is not deemed to have a permanent establishment in a
Contracting State merely because it carries on business in that State through an independent
agent, including a broker or general commission agent, if the agent is acting in the ordinary
course of his business as an independent agent. Thus, there are two conditions that must be
satisfied: the agent must be both legally and economically independent of the enterprise, and the
agent must be acting in the ordinary course of its business in carrying out activities on behalf of
the enterprise.
Whether the agent and the enterprise are independent is a factual determination. Among
the questions to be considered is the extent to which the agent operates on the basis of
instructions from the enterprise. An agent that is subject to detailed instructions regarding the
conduct of its operations or comprehensive control by the enterprise is not legally independent.
In determining whether the agent is economically independent, a relevant factor is the
extent to which the agent bears business risk. Business risk refers primarily to risk of loss. An
independent agent typically bears risk of loss from its own activities. In the absence of other
factors that would establish dependence, an agent that shares business risk with the enterprise, or
has its own business risk, is economically independent because its business activities are not
integrated with those of the principal. Conversely, an agent that bears little or no risk from the
activities it performs is not economically independent and therefore is not described in paragraph
6.
Another relevant factor in determining whether an agent is economically independent is
whether the agent acts exclusively or nearly exclusively for the principal. Such a relationship
may indicate that the principal has economic control over the agent. A number of principals
acting in concert also may have economic control over an agent. The limited scope of the agent's
activities and the agent's dependence on a single source of income may indicate that the agent
lacks economic independence. It should be borne in mind, however, that exclusivity is not in
itself a conclusive test; an agent may be economically independent notwithstanding an exclusive
relationship with the principal if it has the capacity to diversify and acquire other clients without
substantial modifications to its current business and without substantial harm to its business
profits. Thus, exclusivity should be viewed merely as a pointer to further investigation of the
relationship between the principal and the agent. Each case must be addressed on the basis of its
own facts and circumstances.
Paragraph 7
This paragraph clarifies that a company that is a resident of a Contracting State is not
deemed to have a permanent establishment in the other Contracting State merely because it controls, or is controlled by, a company that is a resident of that other Contracting State, or that
carries on business in that other Contracting State. The determination whether a permanent
establishment exists is made solely on the basis of the factors described in paragraphs 1 through
6 of the Article. Whether a company is a permanent establishment of a related company,
therefore, is based solely on those factors and not on the ownership or control relationship
between the companies.
15
Paragraph 8
Paragraph 8 provides a special rule (subject to the provisions of paragraph 4) for an
enterprise of a Contracting State that provides services in the other Contracting State. but that
does not have a permanent establishment by virtue of the preceding paragraphs of the Article. If
(and only it) such an enterprise meets either of two tests as provided in subparagraphs 8(a) and
8(b). the enterprise will be deemed to provide those services through a permanent establishment
in the other State.
The tirst test as provided in subparagraph 8(a) has two parts. First. the services must be
performed in the other State by an individual who is present in that other State for a period or
periods aggregating 183 days or more in any twelve-month period. Second, during that period or
periods, more than 50 percent of the gross active business revenues of the enterprise (including
revenue from active business activities unrelated to the provision of services) must consist of
income derived from the services performed in that State by that individual. If the enterprise
meets both of these tests, the enterprise will be deemed to provide the services through a
permanent establishment. This test in subparagraph 8(a) is employed to determine whether an
enterprise is deemed to have a permanent establishment by virtue of the presence of a single
individual (i.e. a natural person).
For the purposes of subparagraph 8(a), the term "gross active business revenues" shall
mean the gross revenues attributable to active business activities that the enterprise has charged
or should charge for its active business activities, regardless of when the actual billing will occur
or of domestic law rules concerning when such revenues should be taken into account for tax
purposes. Such active business activities are not restricted to the activities related to the
provision of services. However, the term does not include income from passive investment
activities.
The second test as provided in subparagraph 8(b) provides that an enterprise will have a
permanent establishment if the services are provided in the other State for an aggregate of 183
days or more in any twelve-month period with respect to the same or connected projects for
customers who either are residents of the other State or maintain a permanent establishment in
the other State with respect to which the services are provided. The various conditions that have
to be satisfied in order for subparagraph 8(b) to have application are described in detail below.
In addition to meeting the 183-day threshold, the services must be provided for customers
who either are residents of the other State or maintain a permanent establishment in that State.
The intent of this requirement is to reinforce the concept that unless there is a customer in the
other State, such enterprise will not be deemed as participating sufficiently in the economic life
of that other State to warrant being deemed to have a permanent establishment.
Paragraph 8 applies only to the provision of services, and only to services provided by an
enterprise to third parties. Thus. the provision does not have the effect of deeming an enterprise
to have a permanent establishment merely because services are provided to that enterprise.
Further. paragraph 8 only applies to services that are performed or provided by an
enterprise of a Contracting State within the other Contracting State. It is therefore not sufficient
that the ~elevant services be me!ely fu~ished to a resident of the other Contracting State.
\\l1ere, tor example. an enterpnse proVIdes customer support or other services by telephone or
computer to customers located in the ot?er State. those would not be covered by paragraph 8
because they are not performed or proVIded by that enterprise within the other State. Another
example would be that of an architect who is hired to design blueprints for the construction of a
huilding in the other State. As part of completing the project, the architect must make site visits
to that other State. and his days of presence there would be counted for purposes of determining
16
whether the 183-day threshold is satisfied. However, the days that the architect spends working
on the blueprint in his home office shall not count for purposes of the 183-day threshold, because
the architect is not performing or providing those services within the other State.
. For purposes. of determi.ning whether the .time ti?"eshold has been met, subparagraph 8(b)
permits the aggregatlOn of services that are provided with respect to connected projects. For
purposes of this test, projects shall be considered to be connected if they constitute a coherent
whole, commercially and geographically. The determination of whether projects are connected
should be determined froI? the point of view of the enterprise (not that of the customer), and will
depend on the facts and CIrcumstances of each case. In determining the existence of commercial
coherence, factors that would be relevant include: 1) whether the projects would, in the absence
of tax planning considerations, have been concluded pursuant to a single contract; 2) whether the
nature of the work involved under different projects is the same; and 3) whether the same
individuals are providing the services under the different projects. Whether the work provided is
covered by one or multiple contracts may be relevant, but is not determinative, in finding that
projects are commercially coherent.
The aggregation rule addresses, for example, potentially abusive situations in which work
has been artificially divided into separate components in order to avoid meeting the 183-day
threshold. Assume for example, that a technology consultant has been hired to install a new
computer system for a company in the other country. The work will take ten months to
complete. However, the consultant purports to divide the work into two five-month projects
with the intention of circumventing the rule in paragraph 8. In such case, even if the two
projects were considered separate, they will be considered to be commercially coherent.
Accordingly, subject to the additional requirement of geographic coherence, the two projects
could be considered to be connected, and could therefore be aggregated for purposes of
subparagraph 8(b). In contrast, assume that the technology consultant is contracted to install a
particular computer system for a company, and is also hired by that same company, pursuant to a
separate contract, to train its employees on the use of another computer software that is unrelated
to the first system. In this second case, even though the contracts are both concluded between
the same two parties, there is no commercial coherence to the two projects, and the time spent
fulfilling the two contracts may not be aggregated for purposes of subparagraph 8(b). Another
example of projects that do not have commercial coherence would be the case of a law firm
which, as one project provides tax advice to a customer from one portion of its staff, and as
another project provides trade advice from another portion of its staff, both to the same customer.
Additionally, projects, in order to be considered connected, must also constitute a
geographic whole. An example of projects that lack geographic coherence would be a case in
which a consultant is hired to execute separate auditing projects at different branches of a bank
located in different cities pursuant to a single contract. In such an example, while the
consultant's projects are commercially coherent, they are not geographically coherent and
accordingly the services provided in the various branches shall not be aggregated for purposes of
applying subparagraph 8(b). The services provided in each branch should be considered
separately for purposes of subparagraph 8(b).
The method of counting days for purposes of subparagraph 8(a) differs slightly from the
method for subparagraph 8(b). Subparagraph 8(a) refers to days in which an individual is
present in the other country. Accordingly, physical presence during a day is sufficient. In
contrast, subparagraph 8(b) refers to days during which services are provide.d by the enterprise in
the other country. Accordingly, non-working days such as weekends or hohdays would not
count for purposes of subparagraph 8(b), as long as no services are actually being provided while
in the other country on those days. For the purposes of both subparagraphs, e~en ifth.e
.
enterprise sends many individuals simultaneously to the other country to proVide serv~ces, their
collective presence during one calendar day will count for only one day of the enterpnse's
17
presence in the other country. For instance. if an enterprise sends 20 employees to the other
country to provide services to a client in the other country for 10 days. the enterprise will be
considered present in the other country only for 10 days. not 200 days (20 employees x 10 days).
By deeming the enterprise to provide services through a permanent establishment in the
other Contracting State. paragraph 8 allows the application of Article 7 (Business Profits), and
accordingly, the taxation of the services shall be on a net-basis. Such taxation is also limited to
the profits attributable to the activities carried on in performing the relevant services. It will be
important to ensure that only the profits properly attributable to the functions performed and
risks assumed by provision of the services will be attributed to the deemed permanent
establishment.
Paragraph 8 applies subject to the provisions of paragraph 4. In no case will paragraph 8
apply to deem services to be provided through a permanent establishment if the services are
limited to those mentioned in paragraph 4 which, if performed through a fixed place of business,
would not make the fixed place of business a permanent establishment under the provisions of
that paragraph. Further, days spent on preparatory or auxiliary activities shall not be taken into
account for purposes of applying subparagraph 8(b).
ARTICLE 6 (INCOME FROM IMMOVABLE PROPERTY (REAL PROPERTY)
This Article deals with the taxation of income from immovable property (real property)
situated in a Contracting State (the "situs State"). The Article does not grant an exclusive taxing
right to the situs State; the situs State is merely given the primary right to tax. However, until
such time as Bulgaria provides, with respect to income taxable under this Article, for an election
to be subject to tax on a net basis as though such income were business profits attributable to a
permanent establishment, the Bulgarian rate of tax may not exceed 10 percent of the gross
amount of income derived by a u.s. resident from real property situated in Bulgaria.
Paragraph 1
The first paragraph of Article 6 states the general rule that income of a resident of a
Contracting State derived from real property situated in the other Contracting State may be taxed
in the Contracting State in which the property is situated. The paragraph specifies that income
from real property includes income from agriculture and forestry.
Paragraph 2
The term "real property" is defined in paragraph 2 by reference to the internal law
definition in the situs State. In the case of the United States, the term has the meaning given to it
by Treas. Reg. section 1.897-1 (b). In addition to the statutory definitions in the two Contracting
States, the paragraph specifies certain additional classes of property that, regardless of internal
law definitions, are within the scope of the term for purposes of the Convention. This expanded
definition conforms to that in the OECD Model. The definition of "real property" for purposes
of ~rticle 6 is ~ore li~ited than the. expansive d~finition of "real property" in paragraph 1 of
ArtIcle 13 (CapItal Gams). The ArtIcle 13 term mcludes not only real property as defined in
Artic Ie 6 but certain other interests in real property.
Paragraph 3
Paragraph 3 I?akes clear tha~ all form~ of i~come derived from the exploitation of real
property are taxable m the Contractmg State m whIch the property is situated. This includes
jl'(""me from any use ofreal property, including, but not limited to, income from direct use by
18
the owner (in which case income may be imputed to the owner for tax purposes) and rental
income from the letting of real property.
Other income closely associated with real property is covered by other Articles of the
Convention, however, and not Article 6. For example, income from the disposition of an interest
in real property is not considered "derived" from real property; taxation of that income is
addressed in Article 13 (Capital Gains). Interest paid on a mortgage on real property would be
covered by Article 11 (Interest). Distributions by a U.S. Real Estate Investment Trust or certain
regulated investment companies would fall under Article 13 (Capital Gains) in the case
of distributions of U.S. real property gain or Article 10 (Dividends) in the case of distributions
treated as dividends. Finally, distributions from a United States Real Property Holding
Corporation are not considered to be income from the exploitation of real property; such
payments would fall under Article 10 or 13.
Paragraph 4
This paragraph specifies that the basic rule of paragraph 1 (as elaborated in paragraph 3)
applies to income from real property of an enterprise. This clarifies that the situs country may
tax the real property income (including rental income) of a resident of the other Contracting
State in the absence of attribution to a permanent establishment in the situs State. This provision
represents an exception to the general rule under Article 7 (Business Profits) that income must be
attributable to a permanent establishment in order to be taxable in the situs state. However, if a
resident of a Contracting State carries on a business in the other Contracting State through a
permanent establishment situated therein and the real property is effectively connected with such
permanent establishment, the provisions of Article 7 apply to the real property income. This rule
is important in view of the lack of an election to be subject to tax on a net basis with respect to
income taxable under this Article under Bulgarian law and the Convention. Accordingly, if a
U.S. resident has a permanent establishment in Bulgaria through which the real property income
is earned, that income will be taxed on a net basis using the rates and rules of taxation generally
applicable to residents of Bulgaria, as such rules may be modified by the Convention.
Paragraph 5
This paragraph contains a special rule limiting the rate of Bulgarian taxation to 10
percent of the gross amount of income derived by a U.S. resident from real property situated in
Bulgaria. This special rule applies for as long as U.S. residents are not entitled under Bulgarian
law to make an election to compute the tax on income from real property situated in Bulgaria on
a net basis as if such income were business profits attributable to a permanent establishment in
Bulgaria.
ARTICLE 7 (BUSINESS PROFITS)
This Article provides rules for the taxation by a Contracting State of the business profits
of an enterprise of the other Contracting State.
Paragraph 1
Paragraph 1 states the general rule that business profits of an enterprise of one
Contracting State may not be taxed by the other Contracting State unless the enterprise carries on
lJll <,;ness in that other Contracting State through a permanent establishment (as defined in Article
5 (Permanent Establishment)) situated there. When that condition is met, the State in which the
permanent establishment is situated may tax the enterprise on the income that is attributable to
the permanent establishment.
19
Although the Convention does not include a definition of "business profits," the term is
intended to cowr income derived from any trade or business. In accordance with this broad
definition. the term "business profits" includes income attributable to notional principal contracts
and other financial instruments to the extent that the income is attributable to a trade or business
of dealing in such instruments or is otherwise related to a trade or business (as in the case of a
notional principal contract entered into for the purpose of hedging currency risk arising from an
active trade or business). Any other income derived from such instruments is, unless specifically
covered in another article, dealt with under Article 20 (Other Income).
The term "business profits" also includes income derived by an enterprise from the rental
of tangible personal property (unless such tangible personal property consists of aircraft. ships or
containers, income from which is addressed by Article 8 (International Traffic)). The inclusion
of income derived by an enterprise from the rental of tangible personal property in business
profits means that such income earned by a resident of a Contracting State can be taxed by the
other Contracting State only if the income is attributable to a permanent establishment
maintained by the resident in that other State, and, if the income is taxable, it can be taxed only
on a net basis. Income from the rental of tangible personal property that is not derived in
connection with a trade or business is dealt with in Article 20 (Other Income).
In addition, as a result of the definitions of "enterprise" and "business" in Article 3
(General Definitions), the term includes income derived from the furnishing of personal services.
Thus, a consulting firm resident in one State whose employees or partners perform services in
the other State through a permanent establishment may be taxed in that other State on a net basis
under Article 7, and not under Article 14 (Income from Employment), which applies only to
income of employees. With respect to the enterprise's employees themselves, however, their
salary remains subject to Article 14.
Because this Article applies to income earned by an enterprise from the furnishing of
personal services, the Article also applies to income derived by a partner resident in a
Contracting State that is attributable to personal services performed in the other Contracting
State through a partnership with a permanent establishment in that other State. Income that may
be taxed under this Article includes all income attributable to the permanent establishment in
respect of the performance of the personal services carried on by the partnership (whether by the
partner himself, other partners in the partnership, or by employees assisting the partners) and any
income from activities ancillary to the performance of those services (e.g., charges for facsimile
services),
The application of Article 7 to a service partnership may be illustrated by the following
example: a partnership has five partners (who agree to split profits equally), four of whom are
resident and perform personal services only in Bulgaria at Office A, and one of whom performs
personal services at Office B, a permanent establishment in the United States. In this case, the
four partners ofthe partnership resident in Bulgaria may be taxed in the United States in respect
of their share of the income attributable to the permanent establishment, Office B. The services
giving rise to income which may be attributed to the permanent establishment would include not
only the services performed by the one resident partner, but also, for example, if one ofthe four
other partners came to the United States and worked on an Office B matter there, the income in
respect of those services. Income from the services performed by the visiting partner would be
subject to tax in the United States regardless of whether the visiting partner actually visited or
used Office B while performing services in the United States,
Paragraph 2
. Paragraph 2 provides,rules for th~ attrib,ution of business profits to a permanent
estabhshment. The Contractmg States wIll attnbute to a permanent establishment the profits that
20
it would have earned had it been a distinct and separate enterprise engaged in the same or similar
activities under the same or similar conditions and dealing wholly independently with the
enterprise of which it is a permanent establishment.
The "attributable to" concept of paragraph 2 provides an alternative to the analogous but
s?mewhat different "effective~y conn~~ted." concept in Code section 864( c). Depending upon the
CIrcumstances, the amount of mcome attnbutable to" a permanent establishment under Article 7
may be greater or less than the amount of income that would be treated as "effectively
connected" to a U.S. trade or business under Code section 864. In particular, in the case of
financial institutions, the use of internal dealings to allocate income within an enterprise may
produce results under Article 7 that are significantly different than the results under the
effectively connected income rules. For example, income from interbranch notional principal
contracts may be taken into account under Article 7, notwithstanding that such transactions may
be ignored for purposes of U.S. domestic law.
The profits attributable to a permanent establishment may be from sources within or
without a Contracting State. However, as stated in paragraph 5 of the Protocol, the business
profits attributable to a permanent establishment include only those profits derived from the
assets used, risks assumed, and activities performed by, the permanent establishment.
Paragraph 5 of the Protocol confirms that the arm's length method of paragraphs 2 and 3
consists of applying the OECD Transfer Pricing Guidelines, but taking into account the different
economic and legal circumstances of a single legal entity (as opposed to separate but associated
enterprises). Thus, any of the methods used in the Transfer Pricing Guidelines, including profits
methods, may be used as appropriate and in accordance with the Transfer Pricing Guidelines.
However, the use of the Transfer Pricing Guidelines applies only for purposes of attributing
profits within the legal entity. It does not create legal obligations or other tax consequences that
would result from transactions having independent legal significance.
For example, an entity that operates through branches rather than separate subsidiaries
generally will have lower capital requirements because all of the assets of the entity are available
to support all of the entity's liabilities (with some exceptions attributable to local regulatory
restrictions). This is the reason that most commercial banks and some insurance companies
operate through branches rather than subsidiaries. The benefit that comes from such lower
capital costs must be allocated among the branches in an appropriate manner. This issue does
not arise in the case of an enterprise that operates through separate entities, since each entity will
have to be separately capitalized or will have to compensate another entity for providing capital
(usually through a guarantee).
Under U.S. domestic regulations, internal "transactions" generally are not recognized
because they do not have legal significance. In contrast, the rule provided by the Convention is
that such internal dealings may be used to attribute income to a permanent establishment in cases
where the dealings accurately reflect the allocation of risk within the enterprise. One example is
that of global trading in securities. In many cases, banks use internal swap transactions to
transfer risk from one branch to a central location where traders have the expertise to manage
that particular type of risk. Under the Convention, such a bank may also use such swap
transactions as a means of attributing income between the branches, if use of that method is the
"best method" within the meaning of Treas. Reg. section 1.482-1 (c). The books of a branch will
not be respected, however, when the results are inconsistent with a functional analysis. So, for
example, income from a transaction that is booked in a particular branch (or home office) will
not be treated as attributable to that location if the sales and risk management functions that
generate the income are performed in another location.
21
Because the use of profits methods is pennissible under paragraph 2. it is not necessary
for the Convention to include a provision corresponding to paragraph 4 of Article 7 of the OECD
Model.
Paragraph 3
Paragraph 3 provides that in detennining the business profits of a pennanent
establishment, deductions shall be allowed for the expenses incurred for the purposes of the
pennanent establishment, ensuring that business profits will be taxed on a net basis. This rule is
not limited to expenses incurred exclusively for the purposes of the pennanent establishment, but
includes expenses incurred for the purposes of the enterprise as a whole, or that part of the
enterprise that includes the pennanent establishment. Deductions are to be allowed regardless of
which accounting unit of the enterprise books the expenses, so long as they are incurred for the
purposes of the pennanent establishment. For example, a portion of the interest expense
recorded on the books of the home office in one State may be deducted by a pennanent
establishment in the other if properly allocable thereto. The amount of expense that must be
allowed as a deduction is detennined by applying the arm's length principle. As noted above
with respect to paragraph 2 of Article 1 (General Scope), if a deduction would be allowed under
the Code in computing the U.S. taxable income, the deduction also is allowed in computing
taxable income under the Convention. However, except where the Convention provides for
more favorable treatment, a taxpayer cannot take deductions for expenses in computing taxable
income under the Convention to a greater extent than would be allowed under the Code where
doing so would be inconsistent with the intent of the Code. For example, assume that a
Bulgarian taxpayer with a penn anent establishment in the United States borrows $100 to
purchase U.S. tax exempt bonds, and that the $100 of tax-exempt bonds and the $100 of related
debt would be treated as assets and liabilities of the pennanent establishment. For purposes of
computing the profits attributable to the pennanent establishment under the Convention, both the
tax exempt interest from the bonds and the interest expense from the related debt would be
excluded.
As noted above, paragraph 5 of the Protocol provides that the OECD Transfer Pricing
Guidelines apply, by analogy, in detennining the profits attributable to a pennanent
establishment. Accordingly, a pennanent establishment may deduct payments made to its head
office or another branch in compensation for services performed for the benefit of the branch.
The method to be used in calculating that amount will depend on the terms of the arrangements
between the branches and head office. For example, the enterprise could have a policy,
expressed in writing, under which each business unit could use the services of lawyers employed
by the head office. At the end of each year, the costs of employing the lawyers would be
charged to each business unit according to the amount of services used by that business unit
during the year. Since this appears to be a kind of cost-sharing arrangement and the allocation of
costs is based on the benefits received by each business unit, such a cost allocation would be an
acceptable means of detennining a permanent establishment's deduction for legal expenses.
Alternatively, the head office could agree to employ lawyers at its own risk, and to charge an
arm's length price for legal services performed for a particular business unit. If the lawyers were
under-utilized. and the "fees" received from the business units were less than the cost of
employing the lawyers, then the head office would bear the excess cost. If the "fees" exceeded
the cost o~ emplo~ing the la\\>'Ye~s, then the head office would .keep the excess to compensate it
for assummg the nsk of employmg the lawyers. If the enterpnse acted in accordance with this
agreeI?ent, th~s metho~ would be an acceptable alternative method for calculating a permanent
. I ~1hshment s deductIOn for legal expenses.
Paragraph 5 of the Protocol also makes clear that a permanent establishment cannot be
funcied entirely with debt. but must have sufficient capital to carry on its activities as if it were a
distinct and separate enterprise. To the extent that the permanent establishment does not have
22
such capital, a Contracting State may, for profit attribution purposes, attribute such capital to the
permanent establishment in accordance with the arm's length principle and deny an interest
deduction to. the extent nec~ssaIJ: to repec~ th~t capital.attribution. The method prescribed by
U.S. domestIc law for makmg thiS attnbutIOn IS found m Treas. Reg. section 1.882-5. Both
section 1.882-5 and the method prescribed in the Convention start from the premise that all of
the capital of the enterprise supports all of the assets and risks of the enterprise, and therefore the
entire capital of the enterprise must be allocated to its various businesses and offices.
However, section 1.882-5 does not take into account the fact that some assets create
more risk for the enterprise than do other assets. An independent enterprise would need less
capital to support a perfectly-hedged U.S. Treasury security than it would need to support an
equity security or other asset with significant market and/or credit risk. Accordingly, in some
cases section 1.882-5 would require a taxpayer to allocate more capital to the United States, and
therefore would reduce the taxpayer's interest deduction more, than is appropriate. To address
these cases, paragraph 5 of the Protocol allows a taxpayer to apply a more flexible approach that
takes into account the relative risk of its assets in the various jurisdictions in which it does
business. In particular, in the case of financial institutions other than insurance companies, the
amount of capital attributable to a permanent establishment is determined by allocating the
institution's total equity between its various offices on the basis of the proportion of the financial
institution's risk-weighted assets attributable to each of them. This recognizes the fact that
financial institutions are in many cases required to risk-weight their assets for regulatory
purposes and, in other cases, will do so for business reasons even if not required to do so by
regulators. However, risk-weighting is more complicated than the method prescribed by section
1.882-5. Accordingly, to ease this administrative burden, taxpayers may choose to apply the
principles of Treas. Reg. section 1.882-5(c) to determine the amount of capital allocable to its
U.S. permanent establishment, in lieu of determining its allocable capital under the risk-weighted
capital allocation method provided by the Convention, even if it has otherwise chosen the
principles of Article 7 rather than the effectively connected income rules of U.S. domestic law.
Paragraph 4
Paragraph 4 provides that no business profits can be attributed to a permanent
establishment merely because it purchases goods or merchandise for the enterprise of which it is
a part. This paragraph is essentially identical to paragraph 5 of Article 7 of the OECD Model.
This rule applies only to an office that performs functions for the enterprise in addition to
purchasing. The income attribution issue does not arise if the sole activity of the office is the
purchase of goods or merchandise because such activity does not give rise to a permanent
establishment under Article 5 (Permanent Establishment). A common situation in which
paragraph 4 is relevant is one in which a permanent establishment purchases raw materials for
the enterprise's manufacturing operation conducted outside the United States and sells the manufactured product. While business profits may be attributable to the permanent establishment
with respect to its sales activities, no profits are attributable to it with respect to its purchasing
activities.
Paragraph 5
Paragraph 5 provides that profits shall be determined by the same method each year,
unless there is good reason to change the method used. This rule assures consistent tax treatment
over time for permanent establishments. It limits the ability of both the Contracting State and
the enterprise to change accounting methods to be applied to the permanent establishment. It
does not, however, restrict a Contracting State from imposing additional requirements, such as
the rules under Code section 481, to prevent amounts from being duplicated or omitted following
a change in accounting method. Such adjustments may be necessary, for example, if the
taxpayer switches from using the domestic rules under section 864 in one year to using the rules
23
of Article 7 in the next. Also. if the taxpayer switches from Convention-based rules to U.S.
domestic rules, it may need to meet certain deadlines for making elections that are not necessary
when applying the rules of the Convention.
Paragraph 6
Paragraph 6 coordinates the provisions of Article 7 and other provisions of the
Convention. Under this paragraph, when business profits include items of income that are dealt
with separately under other articles of the Convention, the provisions of those articles will,
except when they specifically provide to the contrary, take precedence over the provisions of
Article 7. For example. the taxation of dividends will be determined by the rules of Article 10
(Dividends), and not by Article 7, except where, as provided in paragraph 6 of Article 10, the
dividend is attributable to a permanent establishment. In the latter case the provisions of Article
7 apply. Thus. an enterprise of one State deriving dividends from the other State may not rely on
Article 7 to exempt th(),e dividends from tax at source if they are not attributable to a permanent
estab,hn:,:nt of;
dlerprise in the other State. By the same token, if the dividends are
attributable to a permanent establishment in the other State, the dividends may be taxed on a net
income basis at the source State full corporate tax rate, rather than on a gross basis under Article
10 (Dividends).
As provided in Article 8 (International Traffic), income derived from shipping and air
transport activities in international traffic described in that Article is taxable only in the country
of residence of the enterprise r~gardless of whether it is attributable to a permanent establishment
situated in the source State.
The Convention incorporates the rule of Code section 864(c)(6). Like the Code section
on which it is based, paragraph 5 of the Protocol provides that any income or gain attributable to
a permanent establishment during its existence is taxable in the Contracting State where the
permanent establishment is situated, even if the payment of that income or gain is deferred until
after the permanent establishment ceases to exist. This rule applies with respect to Article 7
(Business Profits), paragraph 4 of Article 6 (Income from Immovable Property (Real Property»,
paragraph 6 of Article 10 (Dividends), paragraph 5 of Article 11 (Interest), paragraph 4 of
Article 12 (Royalties), paragraph 3 of Article 13 (Capital Gains) and paragraph 2 of Article 20
(Other Income).
The effect of this rule can be illustrated by the following example. Assume a company
that is a resident of Bulgaria and that maintains a permanent establishment in the United States
winds up the permanent establishment's business and sells the permanent establishment's
inventory and assets to a U.S. buyer at the end of year 1 in exchange for an interest-bearing
installment obligation payable in full at the end of year 3. Despite the fact that Article l3's
threshold requirement for U.S. taxation is not met in year 3 because the company has no
permanent establishment in the United States, the United States may tax the deferred income
payment recognized by the company in year 3.
Relationship to Other Articles
This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope).
if a citizen of the Unit~d States who is a resident. of Bulgaria under the treaty derives
busmess profits from the Umted States that are not attnbutable to a permanent establishment in
the United States. the United States may, subject to the special foreign tax credit rules of
paragraph 4 of Article 22 (Relief from Double Taxation), tax those profits, notwithstanding
paragraph 1 of this Article. which would exempt the income from U.S. tax.
Th~s,
24
The benefits of this Article are also subject to Article 21 (Limitation on Benefits). Thus,
an enterprise of Bulgaria and that derives income effectively connected with a U.S. trade or
business may not claim the benefits of Article 7 unless the resident carrying on the enterprise
qualifies for such benefits under Article 21.
ARTICLE 8 (INTERNATIONAL TRAFFIC)
This Article governs the taxation of profits from the operation of ships and aircraft in
international traffic. The term "international traffic" is defined in subparagraph 10) of Article 3
(General Definitions).
Paragraph 1
Paragraph 1 provides that profits derived by an enterprise of a Contracting State from the
operation in international traffic of ships or aircraft are taxable only in that Contracting State.
Because paragraph 6 of Article 7 (Business Profits) defers to Article 8 with respect to shipping
income, such income derived by a resident of one of the Contracting States may not be taxed in
the other State even if the enterprise has a permanent establishment in that other State. Thus, if a
U.S. airline has a ticket office in Bulgaria, Bulgaria may not tax the airline's profits attributable
to that office under Article 7. Since entities engaged in international transportation activities
normally will have many permanent establishments in a number of countries, the rule avoids
difficulties that would be encountered in attributing income to multiple permanent establishments if the income were covered by Article 7 (Business Profits).
Paragraph 2
The income from the operation of ships or aircraft in international traffic that is exempt
from tax under paragraph 1 is defined in paragraph 2.
In addition to income derived directly from the operation of ships and aircraft in
international traffic, this definition also includes certain items of rental income. First, income of
an enterprise of a Contracting State from the rental of ships or aircraft on a full basis (i.e., with
crew) is income of the lessor from the operation of ships and aircraft in international traffic and,
therefore, is exempt from tax in the other Contracting State under paragraph 1. Also, paragraph
2 encompasses income from the lease of ships or aircraft on a bareboat basis (i.e., without crew)
when the income is incidental to other income of the lessor from the operation of ships or aircraft
in international traffic. If the income is not incidental to other income of the lessor from the
operation of ships or aircraft in international traffic, income from bareboat rentals would
constitute business profits.
Paragraph 6 of the Protocol clarifies, consistent with the U.S. Model and the Commentary
to Article 8 of the OECD Model, that profits derived by an enterprise from the inland transport
of tangible property or passengers within either Contracting State is treated as profits from the
operation of ships or aircraft in international traffic if such transport is undertaken as part of
international traffic. Thus, if a U.S. shipping company contracts to carry property from Bulgaria
to a U.S. city and, as part of that contract, it transports the property by truck from its point of
origin to an airport in Bulgaria (or it contracts with a trucking company to carry the property to
the airport) the income earned by the U.S. shipping company from the overland leg of the
journey would be taxable only in the United States. Similarly, Article 8 also would apply to all
of the income derived from a contract for the international transport of goods, even if the goods
were transported to the port by a lighter, not by the vessel that carried the goods in international
waters.
25
Finally, certain non-transport activities that are an integral part of the services performed
by a transport company. or are ancillary to the enterprise' s operation of ships or aircraft in
international traffic. are understood to be covered in paragraph 1. though they are not specified
in paragraph 2. These include. for example. the provision of goods and services by engineers,
ground and equipment maintenance and staff: cargo handlers, catering staff and customer
services personnel. Where the enterprise provides such goods to, or performs services for, other
enterprises and such activities are directly connected with or ancillary to the enterprise's
operation of ships or aircraft in international traffic, the profits from the provision of such goods
and services to other enterprises will fall under this paragraph.
For example, enterprises engaged in the operation of ships or aircraft in international
traffic may enter into pooling arrangements for the purposes of reducing the costs of maintaining
facilities needed for the operation oftheir ships or aircraft in other countries. For instance,
where an airline enterprise agrees (for example, under an International Airlines Technical Pool
agreement) to provide spare parts or maintenance services to other airlines landing at a particular
location (which allows it to benefit from these services at other locations), activities carried on
pursuant to that agreement will be ancillary to the operation of aircraft in international traffic by
the enterprise.
Also, advertising that the enterprise may do for other enterprises in magazines offered
aboard ships or aircraft that it operates in international traffic or at its business locations, such as
ticket offices, is ancillary to its operation of these ships or aircraft. Profits generated by such
advertising fall within this paragraph. Income earned by concessionaires, however, is not
covered by Article 8. These interpretations of paragraph 1 also are consistent with the Commentary to Article 8 of the OEeD Model.
Paragraph 3
Under this paragraph, profits of an enterprise of a Contracting State from the use,
maintenance or rental of containers (including equipment for their transport) used for the
transport of goods or merchandise are exempt from tax in the other Contracting State, unless
those containers are used for transport solely in the other Contracting State. This result obtains
under paragraph 3 regardless of whether the recipient of the income is engaged in the operation
of ships or aircraft in international traffic, and regardless of whether the enterprise has a
permanent establishment in the other Contracting State. Only income from the use, maintenance
or rental of containers that is incidental to other income from international traffic is covered by
Article 8 of the OECD Model.
Paragraph .J
This paragraph clarifies that the provisions of paragraphs 1 and 3 also apply to profits
derived by an enterprise of a Contracting State from participation in a pool, joint business or
international operating agency. This refers to various arrangements for international cooperation
by carriers in shipping and air transport. For example, airlines from two countries may agree to
share the transport of passengers between the two countries. They each will fly the same number
of flights per week and share the revenues from that route equally, regardless of the number of
passengers that each airline actually transports. Paragraph 4 makes clear that with respect to
eac~ carrier th~ income dealt with in the Article is th~t carrier's s~<l:re of the total transport, not
the mcome derIved from the passengers actually carned by the aIrlme. This paragraph
Cl:l "t'sponds to paragraph 4 of Article 8 of the OECD Model.
26
Relationship to Other Articles
The taxation of gains from the alienation of ships, aircraft or containers is not dealt with
in this Article but in paragraphs 4 and 5 of Article 13 (Capital Gains).
As with other benefits of the Convention, the benefit of exclusive residence country
taxation under Article 8 is available to an enterprise only if it is entitled to benefits under Article
21 (Limitation on Benefits).
This Article also is subject to the saving clause of paragraph 4 of Article 1 (General
Scope) of the Model. Thus, if a citizen of the United States who is a resident of Bulgaria derives
profits from the operation of ships or aircraft in international traffic, notwithstanding the
exclusive residence country taxation in paragraph 1 of Article 8, the United States may, subject
to the special foreign tax credit rules of paragraph 4 of Article 22 (Relief from Double Taxation),
tax those profits as part of the worldwide income of the citizen. (This is an unlikely situation,
however, because non-tax considerations (~, insurance) generally result in shipping activities
being carried on in corporate form.)
ARTICLE 9 (ASSOCIATED ENTERPRISES)
This Article incorporates in the Convention the arm's-length principle reflected in the
U.S. domestic transfer pricing provisions, particularly Code section 482. It provides that when
related enterprises engage in a transaction on terms that are not arm's-length, the Contracting
States may make appropriate adjustments to the taxable income and tax liability of such related
enterprises to reflect what the income and tax of these enterprises with respect to the transaction
would have been had there been an arm's-length relationship between them.
Paragraph J
This paragraph is essentially the same as its counterpart in the U.S. and OECD Models.
It addresses the situation where an enterprise of a Contracting State is related to an enterprise of
the other Contracting State, and there are arrangements or conditions imposed between the
enterprises in their commercial or financial relations that are different from those that would
have existed in the absence of the relationship. Under these circumstances, the Contracting
States may adjust the income (or loss) of the enterprise to reflect what it would have been in the
absence of such a relationship.
The paragraph identifies the relationships between enterprises that serve as a prerequisite
to application of the Article. As the Commentary to the OECD Model makes clear, the
necessary element in these relationships is effective control, which is also the standard for
purposes of section 482. Thus, the Article applies if an enterprise of one State participates
directly or indirectly in the management, control, or capital of the enterprise of the other State.
Also, the Article applies if any third person or persons participate directly or indirectly in the
management, control, or capital of enterprises of different States. For this purpose, all types of
control are included, i.e., whether or not legally enforceable and however exercised or
exercisable.
The fact that a transaction is entered into between such related enterprises does not, in
and of itself, mean that a Contracting State may adjust the income (or loss) of one or both of the
ent~rprises under the provisions of this Article. If the conditions of the transaction are consistent
with those that would be made between independent persons, the income arising from that transaction should not be subject to adjustment under this Article.
27
Similarly. the fact that associated enterprises may have concluded arrangements. such as
cost sharing arrangements or general services agreements. is not in itself an indication that the
two enterprises have entered into a non-arm's-length transaction that should give rise to an
adjustment under paragraph 1. Both related and unrelated parties enter into such arrangements
(e.g .. joint venturers may share some development costs). As with any other kind of transaction,
when related parties enter into an arrangement, the specific arrangement must be examined to see
whether or not it meets the arm's-length standard. In the event that it does not, an appropriate
adjustment may be made, which may include modifying the terms of the agreement or recharacterizing the transaction to reflect its substance.
It is understood that the "commensurate with income" standard for determining
appropriate transfer prices for intangibles, added to Code section 482 by the Tax Reform Act of
1986, was designed to operate consistently with the arm's-length standard. The implementation
of this standard in the section 482 regulations is in accordance with the general principles of
paragraph 1 of Article 9 of the Convention, as interpreted by the OECD Transfer Pricing
Guidelines.
This Article also permits tax authorities to deal with thin capitalization issues. They may,
in the context of Article 9, scrutinize more than the rate of interest charged on a loan between
related persons. They also may examine the capital structure of an enterprise, whether a
payment in respect of that loan should be treated as interest, and, if it is treated as interest, under
what circumstances interest deductions should be allowed to the payor. Paragraph 3 of the
Commentary to Article 9 of the OECD Model. together with the U.S. observation set forth in
paragraph 15, sets forth a similar understanding of the scope of Article 9 in the context of thin
capitalization.
Paragraph 2
When a Contracting State has made an adjustment that is consistent with the provisions
of paragraph L and the other Contracting State agrees that the adjustment was appr:opriate to
reflect arm's-length conditions, that other Contracting State is obligated to make a correlative
adjustment (sometimes referred to as a "corresponding adjustment") to the tax liability of the
related person in that other Contracting State. Although the OECD Model does not specify that
the other Contracting State must agree with the initial adjustment before it is obligated to make
the correlative adjustment, the Commentary makes clear that the paragraph is to be read that
way.
As explained in the Commentary to Article 9 of the OECD Model, Article 9 leaves the
treatment of "secondary adjustments" to the laws of the Contracting States. When an adjustment
under Article 9 has been made, one of the parties will have in its possession funds that it would
not have had at arm's length. The question arises as to how to treat these funds. In the United
States the general practice is to treat such funds as a dividend or contribution to capital,
depending on the relationship between the parties. Under certain circumstances, the parties may
be permitted to restore the funds to the party that would have the funds had the transactions been
entered into on arm's length terms, and to establish an account payable pending restoration of the
funds. See Rev. Proc. 99-32, 1999-2 c.B. 296.
The Contracting State making a secondary adjustment will take the other provisions of
th~ Conven~ion. where relevant, into .account. ~ or example,. if ~he :ffect of a secondary
adJustm~nt I~ to treat ~ U.S. corp?r.atIon as ha.vmg mad~ ~ distrIbutIOn of profits to its parent
corporatlOn!n Bulgar!a. the prov~slOns ~f ArtIcle 10 (D~v~dends) will apply, and the United
~tates may Impose ~ ) percent .wIthholdmg t~x on the ~IvIdend. Also, if under Article 22 (Relief
trom Double TaxatIOn) Bulgana generally gives a credIt for taxes paid with respect to such
dividends. it would also be required to do so in this case.
28
The competent authorities ~re authorized by paragraph 3 of Article 24 (Mutual
Agreement Procedure) to consult, tf necessary, to resolve any differences in the application of
these provisions. For example, there may be a disagreement over whether an adjustment made
by a Contracting State under paragraph 1 was appropriate.
If a correlativ~ adjustment is made under paragraph 2, it is to be implemented, pursuant
to paragraph 2 of Arttcle 24 (Mutual Agreement Procedure), notwithstanding any time limits or
other procedural limitations in the law of the Contracting State making the adjustment. If a
taxpayer has entered into a closing agreement (or other written settlement) with the United States
prior to bringing a case to the competent authorities, the U.S. competent authority will endeavor
only to obtain a correlative adjustment from Bulgaria. See, Rev. Proc. 2006-54, 2006-2 C.B.
1035, Section 7.05.
Relationship to Other Articles
The saving clause of paragraph 4 of Article 1 (General Scope) does not apply to
paragraph 2 of Article 9 by virtue of an exception to the saving clause in subparagraph 5(a) of
Article 1. Thus, even if the statute of limitations has run, a refund of tax can be made in order to
implement a correlative adjustment. Statutory or procedural limitations, however, cannot be
overridden to impose additional tax, because paragraph 2 of Article 1 provides that the
Convention cannot restrict any statutory benefit.
ARTICLE 10 (DIVIDENDS)
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 country taxation of such dividends and a limited
source-State right to tax. 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
eammgs.
Paragraph 1
The right of a shareholder's country of residence to tax dividends arising in the source
country is preserved by paragraph 1, which 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 20 (Other Income) grants the State of
residence exclusive taxing jurisdiction (other than for dividends attributable to a permanent
establishment in the other State).
Paragraph 2
The State of source also may tax dividends beneficially owned by a resident ofthe other
State, subject to the limitations of paragraphs 2 and 4. Paragraph 2 genera.lly lir:tits the rate of
withholding tax in the State of source on dividends paid by a company restdent m that State to 10
percent ofthe 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 rat~ ?f withholding tax in t~e
State of source is limited to 5 percent of the gross amount of the dtvtdend. Shares are constdered
voting shares if they provide the power to elect, appoint or replace any ~erson vested with the
powers ordinarily exercised by the board of directors of a U.S. corporatlOn.
29
The benetits of paragraph 2 may be granted at the time of payment by means of reduced
rate of withholding tax at source. It also is consistent with the paragraph for tax to be withheld
at the time of payment at full statutory rates, and the treaty beneiit to be granted by means of a
subsequent refund so long as such procedures are applied in a reasonable manner.
The detennination 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 detennined. Thus, in the case of a dividend from a U.S. company,
the detennination 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 proiits out of which the dividends are paid.
The taxation by a Contracting State of the income of its resident companies is governed by the
internal law of the Contracting State, subject to the provisions of paragraph 4 of Article 23 (NonDiscrimination).
The tenn "beneficial owner" is not defined in the Convention, and is, therefore, defined
as under the intemallaw 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 dividend income is
attributable for tax purposes 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 detennined under Article 4 (Resident)) 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 confinned by paragraph 12 of the Commentary to
Article 10 of the OECD Model.
Special rules, however. apply to shares that are held through fiscally transparent entities.
In that case, the rules of paragraph 6 of Article 1 (General Scope) will apply to detennine
whether the dividends should be treated as having been derived by a resident of a Contracting
State. Residence State principles shall be used to detennine who derives the dividend, to assure
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. Source state principles of
beneiicial ownership shall then apply to detennine whether the person who derives the
dividends, or another resident of the other Contracting State, is the beneficial owner of the
dividend. The source State may conclude that the person who derives the dividend in the
residence State is a mere nominee, agent, conduit, etc., for a third country resident and deny
benefits of the Convention. If the person who derives the dividend under paragraph 6 of Article
1 would not be treated under the source State' s principles for detennining beneficial ownership
as a nominee, agent, custodian, conduit, etc., that person will be treated as the beneficial owner
of the income, proiits or gains for purposes of the Convention.
Assume, for instance, that a company resident in Bulgaria pays a dividend to LLC an
entity whi~h is treated as fiscally transparent fo~ U.S. tax purposes but is treated as a company
for BulgarIan tax purposes. USCo, a company Incorporated In the United States, is the sole
interest holder in LLC. Paragraph 6 of Article 1 provides that USCo derives the dividend.
Bulgaria's principles of beneficial ovmership shall then be applied to USCo. If under the laws of
Bulgaria USCo is found not to be the beneficial owner of the dividend, USCo will not be entitled
to the benefits of A!iicle 10 .with respect to such .dividend. The payment may be entitled to
benefits. however, If USCo IS found to be a nomInee, agent, custodian or conduit for a person
who is a resident of the United States.
30
· Beyon~ i~entifYing the person to wh?m the ~rinciples of beneficial ownership shall be
apphed, th.e pnnclples of paragraph 6 of.ArtIcle 1 wIll also apply when determining whether
other reqUlrements, such as the ownershIp threshold of subparagraph 2(a) have been satisfied.
F.or exampl~, ass~e that Bul~o, a co~p~ny that is a resident of Bulgaria, owns all of the
outstandmg shares m ThudDE, an entity that IS dIsregarded for U.S. tax purposes that is resident
in a third country. ThirdDE owns 100% of the stock of US Co. Bulgaria views ThirdDE as
fiscally transparent under its domestic law, and taxes BulCo currently on the income derived by
ThirdDE. In this case, BulCo is treated as deriving the dividends paid by US Co under paragraph
6 of Article 1. Moreover, BulCo is treated as owning the shares of US Co directly. The
Convention does not address what constitutes direct ownership for purposes of Article 10. As a
result, whether ownership is direct is determined under the internal law of the country imposing
tax (Le., the source country) unless the context otherwise requires. Accordingly, a company that
holds stock through such an entity will generally be considered to directly own such stock for
purposes of Article 10.
This result may change, however, ifThirdDE is regarded as non-tiscally transparent
under the laws of Bulgaria. Assuming that ThirdDE is treated as non-fiscally transparent by
Bulgaria, the income will not be treated as derived by a resident of Bulgaria for purposes of the
Convention. However, ThirdDE may still be entitled to the benefits of the U.S. tax treaty, ifany,
with its country of residence.
The same principles would apply in determining whether companies holding shares
through fiscally transparent entities such as partnerships, trusts, and estates would qualify for
benefits. As a result, companies holding shares through such entities may be able to claim the
benefits of subparagraph (a) under certain circumstances. The lower rate applies when the
company's proportionate share of the shares held by the intermediate entity meets the 10 percent
threshold, and the company meets the requirements of Article 1(6) (i.e., the company's country
ofresidence treats the intermediate entity as fiscally transparent) with respect to the dividend.
Whether this ownership threshold is satisfied may be difficult to determine and often will require
an analysis of the partnership or trust agreement.
Paragraph 3
Paragraph 3 imposes limitations on the rate reductions provided by paragraphs 2 and 4
in the case of dividends paid by a RIC or a REIT.
The first sentence of subparagraph 3(a) provides that dividends paid by a RIC or a REIT
are not eligible for the 5 percent rate of withholding tax of subparagraph 2( a).
The second sentence of subparagraph 3(a) provides that the 10 percent maximum rate of
withholding tax of subparagraph 2(b) applies to dividends paid by RI Cs and that the elimination
of source-country withholding tax of paragraph 4 applies to dividends paid by RICs and
beneficially owned by a pension fund.
The third sentence of subparagraph 3(a) provides that the 10 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 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
0wner of the dividend is an individual or a pension fund, in either case holding an interest of not
mor~ than 10 percent in the REIT. Se.cond, the dividen~ ~s paid. with respect to.a class. of stock
that IS publicly traded and the benefiCial owner of the dIVIdend IS a person holdmg an mterest of
not more than 5 percent of any class of the REII'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."
31
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. 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.
Subparagraph (b) provides that the rules of subparagraph (a) shall also apply to dividends
paid by companies resident in Bulgaria that are similar to a RIC or a REIT. Whether companies
that are residents of Bulgaria are similar to RICs or REITs will be determined by mutual
agreement of the competent authorities.
The restrictions set out above are intended to prevent the use of these entities to gain
inappropriate tax benefits. For example, a company resident in Bulgaria that wishes to hold a
diversified portfolio of U.S. corporate shares could hold the portfolio directly and would bear a
U.S. withholding tax of 10 percent on all of the dividends that it receives. Alternatively, it
could hold the same diversified portfolio by purchasing 10 percent or more of the interests in a
RIC. If the RIC is a pure conduit, there may be no U.S. tax cost to interposing the RIC in the
chain of ownership. Absent the special rule in paragraph 3, such use ofthe RIC could transform
portfolio dividends, taxable in the United States under the Convention at a 10 percent maximum
rate of withholding tax, into direct investment dividends taxable at a 5 percent maximum rate of
withholding tax.
Similarly, a resident of Bulgaria directly holding U.S. real property would pay U.S. tax
upon the sale of the property either at a 30 percent rate of withholding tax on the gross income or
at graduated rates on the net income. As in the preceding example, by placing the real property
in a REIT, the investor could, absent a special rule, transform income from the sale of real estate
into dividend income from the REIT, taxable at the rates provided in Article 10, significantly
reducing the U.S. tax that otherwise would be imposed. Paragraph 3 prevents this result and
thereby avoids a disparity between the taxation of direct real estate investments and real estate
investments made through REIT conduits. In the cases in which paragraph 3 allows a dividend
from a REIT to be eligible for the 10 percent rate of withholding tax, the holding in the REIT is
not considered the equivalent of a direct holding in the underlying real property.
Paragraph -I
Paragraph 4 provides that, notwithstanding paragraph 2, the State of source will not tax
dividends beneficially owned by a pension fund resident in the other Contracting State, unless
such dividends are derived from the carrying on of a business by the pension fund or from an
associated enterprise that is not itself a pension fund resident in the other Contracting State. For
these purposes, the term "pension fund" is defined in subparagraph l(m) of Article 3 (General
Definitions ).
The exemption is provided because pension funds normally do not pay tax (either
through a general exemption or because reserves for future pension liabilities effectively offset
all of the fund's income), and therefore cannot benefit from a foreign tax credit. Moreover,
~istributions from a pe!ls~on fund gener~lly do not ~aintai~ !he character of the underlying
mcome. so !he benehc~anes ofthe'pen~IOn are not m a pOSitIOn to claim a foreign tax credit
v.·~en they fm~lly re~elve the penSIOn, I~ many case~ ~ears after the withholding tax has been
paid. Accordmgly, m the absence of thiS rule, the diVidends would almost certainly be subject
[0 unrelieved double taxation.
32
Paragraph 5
Paragraph 5 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, or other corporate rights that are not treated as
debt under the law of the source State, that participate in the profits of the company. The term
also includes income that is subjected to the same tax treatment as income from shares by the
law of the State of source. 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.
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
Paragraph 6 provides a rule for taxing dividends paid with respect to holdings that form
part of the business property of a permanent establishment. 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 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
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 to cases in which the dividends are paid
to a resident of that Contracting State or are attributable 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 lev~l
taxes on undistributed profits, other than a branch profits tax. The paragraph does not restnct 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
?!l earnings deemed invested in U.S. propeI"o/' and it~ t~x on income of a passive .foreig~ .
mvestment company that is a qualified electmg fund IS m no way restncted by thiS proVISIOn.
33
Pww~raph c"?
Paragraph 8 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 ICe) of Article 3 (General
Definitions ).
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 in that Contracting State that is taxed on a net basis under Article 6 (Income from
Immovable Property (Real 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." 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 Article 6,
Article 7, or Article 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. section 1.884-1.
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. If Bulgaria also imposes a branch profits tax, the base of its tax must be
limited to an amount that is analogous to the dividend equivalent amount.
As discussed in the Technical Explanation to paragraph 2 of Article I, consistency
principles require that a taxpayer may not use both treaty and Code rules where doing so would
thwart the intent of either set of rules. In the context of the branch profits tax, the consistency
requirement means that an enterprise that uses the principles of Article 7 to determine its net
taxable income also must use those principles in determining the dividend equivalent amount.
Similarly, an enterprise that uses U.S. domestic law to determine its net taxable income must
also use U.S. domestic law in complying with the branch profits tax. As in the case of Article 7,
if an enterprise switches between domestic law and treaty principles from year to year, it will
need to make appropriate adjustments or recapture amounts that otherwise might go untaxed.
Subparagraph b) provides that the branch profits tax shall not be imposed at a rate
exceeding the direct investment dividend withholding rate of five percent.
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country taxation of dividends, the
saving clause of paragraph 4 of Article 1 permits the United States to tax dividends received by
its resid.e~ts and citizens. subj~ct to th~ special forei~n tax credit rules of paragraph 4 of Article
22 (RelIef from Double TaxatIOn), as If the ConventIOn had not come into effect.
The benefits of this Article are also subject to the provisions of Article 21 (Limitation on
Benefits). Thus. if a resident of the other Contracting State is the beneficial owner of dividends
p8;d 1-''. a U.S. corporation. the shareholder must qualifY for treaty benefits under at least one of
the l~stS of Article 21 in order to receive the benefits of this Article.
34
ARTICLE 11 (INTEREST)
Article 11 specifies the taxing jurisdictions over interest arising in one Contracting State
and paid to a resident of the other Contracting State.
Paragraph 1
Paragraph 1 generally grants to the State of residence the non-exclusive right to tax
interest arising in the other Contracting State and paid to its residents.
Paragraph 2
Paragraph 2 provides that the State of source also may tax the interest, but if the interest
is beneficially owned by a resident of the other Contracting State, the rate of tax will be limited
to 5 percent of the gross amount of the interest.
The tenn "beneficial owner" is not defined in the Convention, and is, therefore, defined
under the intemallaw 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 confinned by
paragraph 9 of the OECD Commentary to Article 11.
Paragraph 3
Paragraph (3) provides for exclusive residence-based taxation in certain cases.
Under subparagraph (a), interest beneficially owned by a Contracting State, a political
subdivision, or a local authority thereof (i.e., in the United States, a State or local government),
the central bank of that Contracting State or any institution wholly owned by that Contracting
State is subject to exclusive residence-based taxation.
Under subparagraph (b), interest beneficially owned by a resident of a Contracting State
with respect to debt-claims guaranteed, insured or indirectly financed by the Contracting State, a
political subdivision or a local authority thereof, the central bank of that Contracting State or any
institution wholly owned by that Contracting State is subject to exclusive residence-based
taxation.
Under subparagraph (c), interest beneficially owned by any financial institution,
including, for example, a bank or an insurance company, is subject to exclusive residence-based
taxation, unless the interest is paid as a part of a back-to-back loan or an arrangement that is
economically similar to and has the effect of a back-to-back loan. Paragraph 8 of the Protocol
clarifies that the term "back-to-back loan" as used in subparagraph c) means a loan structured to
obtain the benefits of subparagraph c) in which the loan is made to a financial institution that in
tum lends the funds directly to the intended borrower. By referencing arrangements that are
economically similar to, and that have the effect of, a back-to-back loan, paragraph (3)(c)
reaches transactions that would not meet the legal requirements of a loan, but would nevertheless
serve that purpose economically. For example, the tenn would encompas~ secu:ities issued at a
di~,ount, or certain swap arrangements intended to operate as the economIC eqUlvalent ofa back-
35
to-hack loan. In addition. nothing in Article 11 is intended to limit the ability of the Contracting
States to enforce their domestic anti-avoidance provisions.
Subparagraph (d) provides for exclusive residence-based taxation of interest beneticially
owned by a pension fund resident in the other Contracting State, provided that the interest is not
derived from the carrying on of a business, directly or indirectly, by the pension fund.
Paragraph -I
The term "interest" as used in Article 11 is defined in paragraph 4 to include, infer alia,
income from debt claims of every kind, whether or not secured by a mortgage. Penalty charges
for late payment are excluded from the definition of interest. Interest that is paid or accrued
subject to a contingency is within the ambit of Article 11. This includes income from a debt
obligation carrying the right to participate in profits. The term does not, however, include
amounts that are treated as dividends under Article 10 (Dividends).
The term interest also includes amounts subject to the same tax treatment as income from
money lent under the law of the State in which the income arises. Thus, for purposes of the
Convention, amounts that the United States will treat as interest include (i) the difference
between the issue price and the stated redemption price at maturity of a debt instrument (i. e.,
original issue discount ("OlD")), 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 OlD 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 re-characterized as loans because of a "substantial non-periodic payment."
Paragraph 5
Paragraph 5 provides an exception to the rules of paragraphs 1, 2 and 3 in cases where
the beneficial owner of the interest carries on business through a permanent establishment in the
State of source and the interest is attributable to that permanent establishment. In such cases the
provisions of Article 7 (Business Profits) will apply and the State of source will retain the right
to impose tax on such interest income.
.
In the c~s~ of a permanent establishment t~at once existed in the State but that no longer
eXIsts. the proVIsIOns of paragraph 5 also apply to Interest that would be attributable to such a
permanent establishment if it did exist in the year of payment or accrual. See the Technical
Explanation to Article 7.
Paragraph 6
Paragraph 6 provides a source rule for determining the source of interest that is identical
in substance to the interest source rule of the OECD Model. Interest is considered to arise in a
Contracting State ifpaid by a resident of that State. As an exception, interest on a debt incurred
in con,nection ~ith a J?ermanent ~sta?lishment in one of!he States and borne by the permanent
establIshment IS conSIdered to anse In that State. For thIS purpose, interest is considered to be
36
borne by a permanent establishment if it is allocable to taxable income of that permanent
establishment.
Paragraph 7
Par~graph 7 pro:rides th~t in cases i~volving sp~cial relationships between the payor and
the benefiCIal owner of mterest mcome, 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'slength interest payment). Any excess amount of interest paid remains taxable according to the
laws of the United States and Bulgaria, 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.
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 section 482 of the Code.
This paragraph does not address cases where, owing to a special relationship between the
payor 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 4. The United States would apply section 482 or 7872 of the Code to
determine the amount of imputed interest in those cases.
Paragraph 8
Paragraph 8 provides anti-abuse exceptions to the rules of paragraphs 2 and 3 for two
classes of interest payments.
The first class of interest, dealt with in subparagraphs (a) and (b) is so-called "contingent
interest." With respect to interest arising in the United States, subparagraph (a) refers to
contingent interest of a type that does not qualify as portfolio interest under U.S. domestic law.
The cross-reference to the U.S. definition of contingent interest, which is found in section
871 (h)(4) of the Code, is intended to ensure that the exceptions of section 871 (h)(4)(c) will be
applicable. With respect to Bulgaria, such interest is defined in subparagraph (b) as any interest
arising in Bulgaria that is determined by reference to the receipts, sales, income, profits or other
cash flow of the debtor or a related person, to any change in the value of any property of the
debtor or a related person or to any dividend, partnership distribution or similar payment made
by the debtor or a related person. Any interest dealt with in subparagraphs (a) and (b) may be
taxed in the source State at a rate not exceeding 10 percent of the gross amount of the interest.
The second class of interest is dealt with in subparagraph 8( c). This exception is
consistent with the policy of Code sections 860E( e) and 860G(b) that excess inclusions with
respect to a real estate mortgage investment conduit (REMIC) should bear full U.S. tax in all
cases. Without a full tax at source foreign purchasers of residual interests would have a
competitive advantage over U.S. purchasers at the time these interests are initially offered. Also,
absent this rule, the U.S. fisc would suffer a revenue loss with respect to mortgages held in a
REMIC because of opportunities for tax avoidance created by differences in the timing of
taxable and economic income produced by these interests.
37
ParlJwaph
I)
Paragraph 9 permits a Contracting State to impose its branch level interest tax on a
corporation resident in the other Contracting State. The base of this tax is the excess, if any, of
the interest deductible in the first-mentioned Contracting State in computing the profits of the
corporation that are subject to tax in the first-mentioned Contracting State and either attributable
to a permanent establishment in the first-mentioned Contracting State or subject to tax in the
first-mentioned Contracting State under Article 6 or Article 13 of the Convention over the
interest paid by the permanent establishment or trade or business in the first-mentioned
Contracting State. Such excess interest may be taxed as if it were interest arising in the firstmentioned Contracting State and beneficially owned by the corporation resident in the other
Contracting State. Thus, such excess interest may be taxed by the Contracting State of source at
a rate not to exceed the 5 percent rate provided for in paragraph 2, and shall be exempt from tax
by the Contracting State of source if the recipient is described in paragraph 3.
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country taxation of interest, the
saving clause of paragraph 4 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 4 of Article 22
(Relief from Double Taxation), as if the Convention had not come into force.
As with other benefits of the Convention, the benefits of this Article are available to a
resident of the other State only if that resident is entitled to those benefits under the provisions of
Article 21 (Limitation on Benefits).
Agreement to Reconsider Withholding Rates
The Convention permits positive rates of taxation on interest and royalties. Paragraph 7
of the Protocol evidences the agreement of the Contracting States to reconsider the provisions of
Article 11 and Article 12 with respect to interest and royalties arising in Bulgaria where the
beneficial owner of the income is a U.S. resident. Such reconsideration is permitted to occur at
an appropriate time, consistent with the December 31, 2014 conclusion of the transition period
applicable to interest and royalties deemed to arise in Bulgaria that are beneficially owned by a
resident of the European Union pursuant to Council Directive 2003/49/EC of 3 June 2003, on a
common system of taxation applicable to interest and royalty payments made between associated
companies of different Member States.
ARTICLE 12 (ROYAL TIES)
Article 12 provides rules for the taxation of royalties arising in one Contracting State and
paid to a resident of the other Contracting State.
Paragraph 1
Paragraph 1 grants the State of residence the non-exclusive right to tax a royalty arising
in the other Contracting State and paid to its residents.
Paragraph 2
Par~graph 2 allows the Stat~ of so~rce to tax royalties arising in that State. If, however,
the benefiCIal o\\ner of the royalty IS a reSIdent of the other Contracting State the tax may not
exceed 5 percent of the gross amount of the royalties.
'
38
The
. term "beneficial owner" is not defined in the Convention ' and is , therefore , defined
under the mternallaw of the State of source. The beneficial owner of the royalty for purposes of
Article 12 is the person to which the income is attributable under the laws of the source State.
Thus, if a royalty 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
royalty is not ~ntit1ed to the benefits of Article 12. However, a royalty 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.
Paragraph 3
The term "royalties" as used in this Article means:
Paragraph 3 defines the term "royalties," as used in Article 12, to include any
consideration for the use of, or the right to use, any copyright ofliterary, artistic, scientific or
other work (including cinematographic films and films, tapes or other means of image or sound
reproduction 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" also includes gain derived from the alienation of any right or
property that would give rise to royalties, to the extent the gain is contingent on the productivity,
use, or further alienation thereof. Gains that are not so contingent are dealt with under Article 13
(Capital Gains). The term "royalties," however, 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 formulas" 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), afCd, 810 F.2d 209 (D.C. Cir. 1986). By contrast, if the
artist earns in the other Contracting State income covered by Article 16 (Entertainers and
Sportsmen), 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 16 and not Article 12 is applicable to
such income.
Computer software generally is protected by co~yright laws around the world .. Under the
Convention consideration received for the use, or the nght 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.
39
The primary factor in determining whether consideration received for the use: or t~e right
to use. computer software is treated as royalties or as business profits is the nature ot the fights
transferred. See Treas. Reg. section 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"s~rink
\\Tap" software generally will not be considered to give rise to royalty income. even though tor
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 el 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 11.4 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, 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 7 (Business Profits) or Article 14 (Income from Employment).
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 ..J
This paragraph provides an exception to the manner of allocating taxing rights specified
in paragraphs 1 and 2 in cases where the beneficial owner of the royalties carries on business
through a permanent establishment in the State of source and the royalties are attributable to that
permanent establishment. In such cases the provisions of Article 7 (Business Profits) will apply.
The provisions of paragraph 5 of the Protocol, regarding Article 7 (Business Profits),
apply.to this paragraph. For example. royalty income that is attributable to a permanent
establIshment and that accrues dunng the eXIstence of the permanent establishment, but is received after the permanent establishment no longer exists, remains taxable under the provisions
of Article 7 (Business Profits), and not under this Article.
Par~graph ~ contains a source ~u.le f?r determinin.g the source of royalties. Under
paragraph ). royaltIes are treated as arISIng In a ContractIng State if paid by a resident of that
40
State. As an exception, royalties that are attributable to a permanent establishment in a
Contracting State and borne by the permanent establishment are considered to arise in that State.
Where, however, the payor of the royalties is not a resident of either Contracting State, and the
royalties are not borne by ~ pennanent.establishment in either Contracting State, but the royalties
relate to the use of, or the nght to use, In one of the Contracting States, any property or right
described in paragraph 3, the royalties are deemed to arise in that State.
Paragraph 6
Paragraph 6 provides that in cases involving special relationships 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 annis-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 4 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 4 of Article 22
(Relief from Double Taxation), as if the Convention had not come into force.
As with other benefits of the Convention, the benefits of Article 12 are available to a
resident of the other State only if that resident is entitled to those benefits under Article 21
(Limitation on Benefits).
Agreement to Reconsider Withholding Rates
The Convention permits positive rates of taxation on interest and royalties. Paragraph 7
of the Protocol evidences the agreement of the Contracting States to reconsider the provisions of
Alticle 11 and Article 12 with respect to interest and royalties arising in Bulgaria where the
beneficial owner of the income is a U.S. resident. Such reconsideration is permitted to occur at
an appropriate time, consistent with the December 31, 2014 conclusion of the transition period
applicable to interest and royalties deemed to arise in Bulgaria that are beneficially owned by a
resident of the European Union pursuant to Council Directive 2003/49/EC of3 June 2003, on a
common system of taxation applicable to interest and royalty payments made between associated
companies of different Member States.
ARTICLE 13 (CAPITAL GAINS)
Article 13 assigns either primary or exclusive taxing jurisdiction over gains from the
alienation of property to the State of residence or the State of source.
Paragraph 1
Paragraph 1 of Article 13 preserves the non-exclusive right of the State of source to tax
gains attributable to the alienation of real property situated in that State. The paragraph therefore
pennits the United States to apply section 897 of the Code to tax gains derived by a resident of
Bulgaria that are attributable to the alienation of real property situated in the United States (as
41
detined in paragraph 2). Gains attributable to the alienation of real property include gains from
any other property that is treated as a real property interest within the meaning of paragraph 2.
Paragraph 1 refers to gains "attributable to the alienation of immovable property (real
property)" rather than the OECD Model phrase "gains from the alienation" to clarify that the
United States will look through distributions made by a REIT and certain RICs. Accordingly,
distributions made by a REIT or certain RICs are taxable under paragraph 1 of Article 13 (not
under Article 10 (Dividends) when they are attributable to gains derived from the alienation of
real property.
Paragraph 2
This paragraph defines the term "immovable property (real property) situated in the other
Contracting State." The term includes real property referred to in Article 6 (i.e., an interest in the
real property itself), a "United States real property interest" (when the United States is the other
Contracting State under paragraph 1), and, as specified in paragraph 2(c), an equivalent interest in
immovable property (real property) situated in Bulgaria.
Under section 897(c) of the Code the term "United States real property interest" includes
shares in a U.S. corporation that owns sufficient U.S. real property interests to satisfy an assetratio test on certain testing dates. The term also includes certain foreign corporations that have
elected to be treated as U.S. corporations for this purpose. Section 897(i).
Section 897( c )(3) provides that, in certain situations stock regularly traded on an
established securities market will not be treated as a U.S. real property interest, even if the stock
derives its value primarily from U.S. real property. With respect to Bulgaria, subparagraph
2(c)(i) of Article 13, provides an analogous carve-out in the case of stock regularly traded on an
established securities market. The term "established securities market" is defined in paragraph 9
of the Protocol to mean a national securities exchange which is officially recognized, sanctioned,
or supervised by a governmental authority as well as an over the counter market. An over the
counter market is any market reflected by the existence of an interdealer quotation system. An
interdealer quotation system is any system of general circulation to brokers and dealers which
regularly disseminates quotations of stocks and securities by identified brokers or dealers, other
than by quotation sheets which are prepared and distributed by a broker or dealer in the regular
course of business and which contain only quotations of such broker or dealer. This definition is
consistent with the regulations under section 897.
Paragraph 3
Paragraph 3 of Article 13 deals with the taxation of certain gains from the alienation of
movable property forming part of the business property of a permanent establishment that an
enterprise of a Contracting State has in the other Contracting State. This also includes gains
trom the alienation of such a permanent establishment (alone or with the whole enterprise).
Such gains may be taxed in the State in which the permanent establishment is located.
A resident of Bulgaria that is a partner in a partnership doing business in the United
States generally will have a permanent establishment in the United States as a result of the
activities of the partnership, assuming that the activities of the partnership rise to the level of a
p~f!11anent establishment. Rev. Rul. 91-3,2, 1.99!-1 ~.B. 107. F~rther, under paragraph 3, the
l) mted ~tates. ~enerally may tax a partner s d.lstnbutIve share Income realized by a partnership
on the dISPOSItIon of movable property formIng part of the bUSIness property of the partnership
in the United States.
or
42
· The ga~ns subject to paragraph 3 may be taxed in the State in which the permanent
estabhshment IS located, regardless of whether the permanent establishment exists at the time of
!he alienatio~. Th.is rule incorporates the rule o~ section 864(c)(6) of the Code. Accordingly,
mcome that IS attrIbutable to a permanent establIshment, but that is deferred and received after
the permanent establishment no longer exists, may nevertheless be taxed by the State in which
the permanent establishment was located.
Paragraph 4
This paragraph limits the taxing jurisdiction of the State of source with respect to gains
fr?m t~e alienati?n of ~hips or aircraft operated in international traffic by the enterprise
ahenatmg the ShIP or aIrcraft and from property (other than real property) pertaining to the
operation or use of such ships or aircraft.
Under paragraph 4, such income is taxable only in the Contracting State in which the
alienator is resident. Notwithstanding paragraph 3, the rules of this paragraph apply even if the
income is attributable to a permanent establishment maintained by the enterprise in the other
Contracting State. This result is consistent with the allocation of taxing rights under Article 8
(International Traffic).
Paragraph 5
Paragraph 5 provides a rule similar to paragraph 4 with respect to gains from the
alienation of containers and related personal property. Such gains derived by an enterprise of a
Contracting State shall be taxable only in that Contracting State unless the containers were used
for the transport of goods or merchandise solely within the other Contracting State. The other
Contracting State may not tax such gain even if it is attributable to a permanent establishment
maintained by the enterprise in that other Contracting State.
Paragraph 6
Paragraph 6 provides that, if certain conditions are met, a Contracting State can tax gains
from the alienation of shares of a resident company that are derived by a resident of the other
Contracting State. This provision permits Bulgaria to continue to impose its tax on the gain
derived by U.S. residents on the alienation of shares in Bulgarian companies in a narrow set of
cases. The first requirement is that the alienation occurs within 12 months of the date that the
shares are acquired. The second requirement is that the recipient of the gain must have owned,
directly or indirectly, at least 25 percent of the capital of the company at some time within the
12-month period preceding the alienation. Finally, the provision provides that a Contracting
State may not in any case tax gains derived by a resident of the other Contracting State from the
alienation of shares of stock of public companies traded on an established securities market.
As described above, the term "established securities market" is a national securities
exchange which is officially recognized, sanctioned, or supervised by a governmental authority
as well as an over the counter market. An over the counter market is any market reflected by the
existence of an interdealer quotation system, and an interdealer quotation system is any system
of general circulation to brokers and dealers which regularly disseminates quotations of stocks
and securities by identified brokers or dealers, other than by quotation sheets which are prepared
and distributed by a broker or dealer in the regular course of business and which contain only
quotations of such broker or dealer.
The United States will treat gain taxed by Bulgaria under this paragraph as of Bulgarian
source to the extent necessary to permit a credit for the Bulgarian tax, subject to the limitations
of u.S. law.
43
Paragraph 6 is reciprocal. If the United States were to introduce such a tax. it could be
imposed in accordance \vith the rules of this paragraph.
Paragraph ..,
Paragraph 7 clarifies the interre lationship between Articles 12 (Royalties) and 13 with
respect to certain gains treated as royalties. Under subparagraph 3(b) of Article 12, the term
royalties includes gain derived from the alienation of property that would give rise to royalties,
to'the extent the gain is contingent on the productivity, use, or further alienation thereof.
Therefore, such royalties are governed by the provisions of Article 12 and not by this Article.
Paragraph 8
Paragraph 8 grants to the State of residence of the alienator the exclusive right to tax
gains from the alienation of property other than property referred to in paragraphs 1 through 7.
For example, gain derived from shares, other than shares described in paragraphs 2, 3, or 6, debt
instruments and various financial instruments, may be taxed only in the State of residence, to the
extent such income is not otherwise characterized as income taxable under another article (U,
Article 10 (Dividends) or Article 11 (Interest)). Similarly gain derived from the alienation of
tangible personal property, other than tangible personal property described in paragraph 3, may
be taxed only in the State of residence of the alienator.
Gains derived by a resident of a Contracting State from real property located in a third
state are not taxable in the other Contracting State, even if the sale is attributable to a permanent
establishment located in the other Contracting State.
Relationship to Other Articles
Notwithstanding the foregoing limitations on taxation of certain gains by the State of
source, the saving clause of paragraph 4 of Article 1 (General Scope) permits the United States
to tax its citizens and residents as if the Convention had not come into effect. Thus, any
limitation in this Article on the right of the United States to tax gains does not apply to gains of a
U.S. citizen or resident.
The benefits of this Article are also subject to the provisions of Article 21 (Limitation on
Benefits). Thus, only a resident ofa Contracting State that satisfies one of the conditions in
Article 21 is entitled to the benefits of this Article.
ARTICLE 14 (INCOME FROM EMPLOYMENT)
Article 14 apportions taxing jurisdiction over remuneration derived by a resident of a
Contracting State as an employee between the States of source and residence.
Paragraph 1
.
The general r~le of Article 14 is contained in paragraph 1. Remuneration derived by a
reSIdent of a ContractIng State as an employee may be taxed by the State of residence and the
remuneration also may be taxed by the other Contracting State to the extent derived f;om
, mi,loym~nt exercised (i.e,. serv.ices perf0rI?ed~ in that ot~er Contracting State. Paragraph 1
also P!ondes that the mo~e. specl~c rules ot Artl~les 15 (DIrectors' Fees), 17 (Pensions, Social
?ecunty Pay~ents. AnnUlt~es. AlImony,. and ~hIld Support), and 18 (Government Service) apply
1!1 the c~se of emploYf!1ent Income descnbed I~ one of those arti.cles. Thus. even though the
State ot source has a nght to tax employment Income under ArtIcle 14, it may not have the right
44
to tax.that inco?le unde~ the Convention if~h.e inco~e is described, for example, in Article 17
(PensIOns, SOCIal SecurIty Payments, AnnUltles, AlImony, and Child Support) and is not taxable
in the State of source under the provisions of that article.
Article 14 applies to any form of compensation for employment, including payments in
kind. Paragraph 1.1 of the Commentary to Article 16 of the 0 ECD Model now confirms that
interpretation.
..
Consistent with section 8~4( c)( 6) of the Code, Article 14 also applies regardless of the
tImmg of actual payment for servIces. Consequently, a person who receives the right to a future
payment in consideration for services rendered in a Contracting State would be taxable in that
State even if the payment is received at a time when the recipient is a resident of the other
Contracting State. Thus, a bonus paid to a resident of a Contracting State with respect to
services performed in the other Contracting State with respect to a particular taxable year would
be subject to Article 14 even if it was paid after the close of the year. An annuity received for
services performed in a taxable year could be subject to Article 14 despite the fact that it was
paid in subsequent years. In that case, it would be necessary to determine whether the payment
constitutes deferred compensation, taxable under Article 14, or a qualified pension subject to the
rules of Article 17 (Pensions, Social Security Payments, Annuities, Alimony, and Child
Support). Article 14 also applies to income derived from the exercise of stock options granted
with respect to services performed in the host State, even if those stock options are exercised
after the employee has left the source country. If Article 14 is found to apply, whether such
payments were taxable in the State where the employment was exercised would depend on
whether the tests of paragraph 2 were satisfied in the year in which the services to which the
payment relates were performed.
Paragraph 2
Paragraph 2 sets forth an exception to the general rule that employment income may be
taxed in the State where it is exercised. Under paragraph 2, the State where the employment is
exercised may not tax the income from the employment if three conditions are satisfied: (a) the
individual is present in the other Contracting State for a period or periods not exceeding 183
days in any 12-month period that begins or ends during the relevant taxable year (i.e., in the
United States, the calendar year in which the services are performed); (b) the remuneration is
paid by, or on behalf of, an employer who is not a resident of that other Contracting State; and
(c) the remuneration is not borne as a deductible expense by a permanent establishment that the
employer has in that other State. In order for the remuneration to be exempt from tax in the
source State, all three conditions must be satisfied. This exception is identical to that set forth in
the OECD Model.
The 183-day period in condition (a) is to be measured using the "days of physical
presence" method. Under this method, the days that are counted include any day in which a part
of the day is spent in the host country. (Rev. Rul. 56-24, 1956-1 C.B. 851.) Thus, days that are
counted include the days of arrival and departure; weekends and holidays on which the employee
does not work but is present within the country; vacation days spent in the country before, during
or after the employment period, unless the individual's presence before or after the employment
can be shown to be independent of his presence there for employment purposes; and time during
periods of sickness, training periods, strikes, etc., when the individual is present but not working.
If illness prevented the individual from leaving the country in sufficient time to qualify for the
benefit, those days will not count. Also, any part of a day spent in the host country while in
transit between two points outside the host country is not counted. If the individual is a resident
of the host country for part of the taxable year concerned and a non-resident for the remain~e: of
the year, the individual's days of presence as a resident do not count for purposes of determmmg
whether the 183-day period is exceeded.
45
Conditions (b) and (c) are intended to ensure that a Contracting State will not be required
to allow a deduction to the payor for compensation paid and at the same time to exempt the
cmployee on the amount received. Accordingly, if a foreign person pays the salary of an
employee who is employed in the host State, but a host State corporation or permanent
establishment reimburses the payor with a payment that can be identified as a reimbursement
neither condition (b) nor (c), as the case may be, will be considered to have been fulfilled.
The reference to remuneration "borne by" a permanent establishment is understood to
encompass all expenses that economically are incurred and not merely expenses that are
currently deductible for tax purposes. Accordingly, the expenses referred to include expenses
that are capitalizable as well as those that are currently deductible. Further, salaries paid by
residents that are exempt from income taxation may be considered to be borne by a permanent
establishment notwithstanding the fact that the expenses will be neither deductible nor
capitalizable since the payor is exempt from tax.
Paragraph 3
Paragraph 3 contains a special rule applicable to remuneration for services performed by
a resident of a Contracting State as an employee aboard a ship or aircraft operated in
international traffic. Such remuneration may be taxed only in the State of residence of the
employee if the services are performed as a member of the crew of the ship or aircraft or as other
personnel regularly employed to serve aboard the ship or aircraft. In the case of a cruise ship, for
example, paragraph 3 applies to the crew and others, such as entertainers, lecturers, etc.,
employed by the shipping company to serve on the ship throughout its voyage. The use of the
phrase "regularly employed to serve" is intended to clarify that a person who exercises his
employment as, for example, an insurance salesman while aboard a ship or aircraft is not covered
by this paragraph.
Relationship to Other Articles
Ifa U.S. citizen who is resident in Bulgaria performs services as.an employee in the
United States and meets the conditions of paragraph 2 for source country exemption, he
nevertheless is taxable in the United States by virtue of the saving clause of paragraph 4 of
Article 1 (General Scope), subject to the special foreign tax credit rule of paragraph 4 of Article
22 (Relief from Double Taxation).
ARTICLE 15 (DIRECTORS' FEES)
.
This Article pro~ides t~at a Contracting State ma~ tax the fees and other compensation
paId by a company that IS a reSIdent of that State for servIces performed by a resident of the
o!h~r Contracting. State ~n his capac~ty as a member of the board of directors or a functionally
SImIlar body. ThIS rule IS an exceptIOn to the more general rules of Articles 7 (Business Profits)
and 14 (Income from Employment). Thus, for example, in determining whether a director's fee
paid to a non-employee. director is subject ~o tax .in the country of residence of the corporation, it
IS not relevant to establIsh whether the fee IS attnbutable to a permanent establishment in that
State.
t~(,t
.
1S
U~der t~is Article, a residen~ of one C.ontra~ting State ,who is a director of a corporation
re~l~ent ill the other Contractmg Sta~e IS subject to tax ill that other State in respect of his
directors fees regardless of where the services are performed. This provision of the Convention
is identical in substance to the analogous provision in the OECD Model.
46
ARTICLE 16 (ENTERTAINERS AND SPORTSMEN)
.
~his Article deals wit~ the taxation in a Contracting State of entertainers and sportsmen
resIdent m the other Contractmg State from the performance of their services as such. The
Article applies both to the income of ~ entertainer or sportsman who performs services on his
own behalf and one who performs serVIces on behalf of another person, either as an employee of
that pe~son, or pursuant to any other ar:rangement. The rules of this Article take precedence, in
some cIrcumstances, over those of ArtIcles 7 (Business Profits) and 14 (Income from
Employment ).
This Article applies only with respect to the income of entertainers and sportsmen.
Others involved in a performance or athletic event, such as producers, directors, technicians,
managers, coaches, etc., remain subject to the provisions of Articles 7 and 14. In addition,
except as provided in paragraph 2, income earned by juridical persons is not covered by Article
16.
Paragraph 1
Paragraph 1 describes the circumstances in which a Contracting State may tax the
performance income of an entertainer or sportsman who is a resident of the other Contracting
State. Under the paragraph, income derived by an individual resident of a Contracting State
from activities as an entertainer or sportsman exercised in the other Contracting State may be
taxed in that other State if the amount of the gross receipts derived by the performer exceeds
$15,000 (or its equivalent in Bulgarian currency) for the taxable year. The $15,000 includes
expenses reimbursed to the individual or borne on his behalf. If the gross receipts exceed
$15,000, the full amount, not just the excess, may be taxed in the State of performance.
This Convention introduces a monetary threshold to distinguish between two groups of
entertainers and athletes -- those who are paid relatively large sums of money for very short
periods of service, and who would, therefore, normally be exempt from host country tax under
the standard personal services income rules, and those who earn relatively modest amounts and
~re, therefore, not easily distinguishable from those who earn other types of personal service
Income.
Tax may be imposed under paragraph 1 even if the performer would have been exempt
from tax under Article 7 (Business Profits) or 14 (Income from Employment). On the other
hand, if the performer would be exempt from host-country tax under Article 16, but would be
taxable under either Article 7 or 14, tax may be imposed under either of those Articles. Thus, for
example, if a performer derives remuneration from his activities in an independent capacity, and
the performer does not have a permanent establishment in the host State, he may be taxed by the
host State in accordance with Article 16 ifhis remuneration exceeds $15,000 annually, despite
the fact that he generally would be exempt from host State taxation under Article 7. However, a
performer who receives less than the $15,000 threshold amount and therefore is not taxable
under Article 16 nevertheless may be subject to tax in the host country under Article 7 or 14 if
the tests for host-country taxability under the relevant Article are met. For example, if an
entertainer who is an independent contractor earns $14,000 of income in a State for the calendar
year, but the income is attributable to his permanent establishment in the State of performance,
that State may tax his income under Article 7.
Since it frequently is not possible to know until year-end whether the income an
entertainer or sportsman derived from performances in a Contracting State will exceed $15,000,
nothing in the Convention precludes that Contracting State from withholding tax during the year
~r1(:t :efunding it after the close of the year if the taxability threshold has not been met.
47
As explained in paragraph 9 of the Commentary to Article 17 of the OECD ModeL
Article 16 of the Convention applies to all income connected with a performance by the
entertainer. such as appearance fees. award or prize money. and a share of the gate receipts.
Income derived from a Contracting State by a performer \vho is a resident of the other
Contracting State from other than actual performance. such as royalties from record sales and
payments for product endorsements. is not covered by this Article, but by other articles of the
Convention. such as Article 12 (Royalties) or Article 7 (Business Profits). For example. if an
entertainer receives royalty income from the sale of live recordings, the royalty income would be
subject to the provisions of Article 12, even if the performance was conducted in the source
country, although the entertainer could be taxed in the source country with respect to income
trom the performance itself under Article 16 if the dollar threshold is exceeded.
In determining whether income falls under Article 16 or another article, the controlling
factor will be whether the income in question is predominantly attributable to the performance
itself or to other activities or property rights. For instance, a fee paid to a performer for
endorsement of a performance in which the performer will participate would be considered to be
so closely associated with the performance itself that it normally would fall within Article 16.
Similarly, a sponsorship fee paid by a business in return for the right to attach its name to the
performance would be so closely associated with the performance that it would fall under Article
16 as well. As indicated in paragraph 9 of the Commentary to Article 17 of the OECD Model,
however, a cancellation fee would not be considered to fall within Article 16 but would be dealt
with under Article 7 (Business Profits) or 14 (Income from Employment).
As indicated in paragraph 4 of the Commentary to Article 17 of the OECD Model, where
an individual fulfills a dual role as performer and non-performer (such as a player-coach or an
actor-director), but his role in one of the two capacities is negligible, the predominant character
of the individual's activities should control the characterization of those activities. In other cases
there should be an apportionment between the performance-related compensation and other
compensation.
Consistent with Article 14 (Income from Employment), Article 16 also applies regardless
of the timing of actual payment for services. Thus, a bonus paid to a resident of a Contracting
State with respect to a performance in the other Contracting State during a particular taxable year
would be subject to Article 16 even ifit was paid after the close of the year. The determination
as to whether the $15,000 threshold has been exceeded is determined separately with respect to
each year of payment. Accordingly, if an actor who is a resident of one Contracting State
receives residual payments over time with respect to a movie that was filmed in the other
Contracting State. the payments do not have to be aggregated from one year to another to
determine whether the total payments have finally exceeded $15,000. Otherwise, residual
payments received many years later could retroactively subject all earlier payments to tax by the
other Contracting State.
Paragraph 2
Paragraph 2 is intended to address the potential for circumvention of the rule in
paragraph 1 when a p.erform~r's incof!1e does not accrue ?irectly to the performer himself, but to
another person. ForeIgn performers frequently perform In the United States as employees of or
under contract with. a company or other person.
'
The relationship may truly be one of employee and employer, with no circumvention of
paragraph 1 eithe: intended or realized. On the other ha~d, ~he "employer" may, for example, be
~ company .e~tabl~shed and owned by the pe~former, whIch IS merely acting as the nominal
mc~mc reCIpIent In respect of the re~uner~tlOn for the performance (a "star company"). The
performer may act as an "employee. receIve a modest salary. and arrange to receive the
48
remainder of the income from his performance from the company in another form or at a later
time. In such case, absent the provisions of paragraph 2, the income arguably could escape hostcountry tax because the company earns business profits but has no permanent establishment in
that country. The performer may largely or e~tirely escape host-country tax by receiving only a
small salary, perhaps small enough to place hIm below the dollar threshold in paragraph 1. The
performer might arrange to receive further payments in a later year, when he is not subject to
host-country tax, perhaps as dividends or liquidating distributions.
Paragraph 2 seeks to prevent this type of abuse while at the same time protecting the
taxpayers' rights to the benefits of the Convention when there is a legitimate employee-employer
relationship between the performer and the person providing his services. Under paragraph 2,
when the income accrues to a person other than the performer, the income may be taxed in the
Contracting State where the performer's services are exercised, without regard to the provisions
of the Convention concerning business profits (Article 7) or income from employment (Article
14), but only if one of two conditions is met. The first condition is that the contract pursuant to
which the personal activities are performed designates the entertainer or sportsman (by name or
description). The second condition is that the contract allows the other party to the contract (or a
person other than the entertainer, sportsman or the person to whom the income accrues) to
designate the individual who is to perform the personal activities. This rule is consistent with the
U.S. domestic law provision characterizing income from certain personal service contracts as
foreign personal holding company income.
The premise of this rule is that, in a case where a performer is using another person in an
attempt to circumvent the provisions of paragraph 1, the recipient of the services of the
performer would contract with a person other than that performer (i.e., a company employing the
performer) only if the recipient of the services were certain that the performer himself would
perform the services (i.e., the contract mentioned the performer by name or description or else
allowed the recipient of the services to designate who is to perform the services). If instead the
person to whom the income accrues is allowed to designate the individual who is to perform the
services, then likely that person is a service company not formed to circumvent the provisions of
paragraph 1. The following example illustrates the operation of this rule.
Example. Company 0, a resident of Bulgaria, is engaged in the business of operating an
orchestra. Company 0 enters into a contract with Company A pursuant to which Company 0
agrees to carry out two performances in the United States in consideration of which Company A
will pay Company 0 $200,000. The contract designates two individuals, a conductor and a
flutist, that must perform as part of the orchestra, and allows Company 0 to designate the other
members of the orchestra. Because the contract mentions by name the conductor and the Hutist,
the portion of the $200,000 that is attributable to the personal services of the conductor and the
flutist may be taxed by the United States pursuant to paragraph 2. However, because Company
A is not allowed to designate the other performers the remaining portion of the $200,000, is not
subject to tax by the United States pursuant to paragraph 2.
In cases where paragraph 2 is applicable, the income of the "employer" may be subject to
tax in the host Contracting State even if it has no permanent establishment in the host country.
Taxation under paragraph 2 is on the person providing the services of the performer. This
paragraph does not affect the rules of paragraph 1, which apply to the performer himself. The
income taxable by virtue of paragraph 2 is reduced to the extent of salary payments to the
performer, which fall under paragraph 1.
For purposes of paragraph 2, income is deemed to accrue to another person (i.e., the.
person providing the services of the performer) if that other person has control over, or the nght
to receive, gross income in respect of the services of the performer.
49
Pursuant to Article 1 (General Scope) the Convention only applies to persons who are
residents of one of the Contracting States. Thus, income of a star company that is not a resident
of one of the Contracting States would not be eligible for the benefits of the Convention.
Relationship to other Articles
This Article is subject to the provisions of the saving clause of paragraph 4 of Article 1
(General Scope). Thus, if an entertainer or a sportsman who is resident in Bulgaria is a citizen of
the United States, the United States may tax all of his income from performances in the United
States without regard to the provisions of this Article, subject, however, to the special foreign tax
credit provisions of paragraph 4 of Article 22 (Relief from Double Taxation). In addition,
benefits of this Article are subject to the provisions of Article 21 (Limitation on Benefits).
ARTICLE 17 (PENSIONS, SOCIAL SECURITY, ANNUITIES, ALIMONY, AND CHILD
SUPPORT)
This Article deals with the taxation of private (i.e., non-government service) pensions
and annuities, social security benefits, alimony and child support payments.
Paragraph 1
Paragraph 1 provides that distributions from pensions and other similar remuneration
beneficially owned by a resident of a Contracting State in consideration of past employment are
taxable only in the State of residence of the beneficiary. The term "pensions and other similar
remuneration" includes both periodic and single sum payments.
The phrase "pensions and other similar remuneration" is intended to encompass
payments made by qualified private retirement plans. In the United States, the plans
encompassed by paragraph 1 include: qualified plans under section 401(a), individual retirement
plans (including individual retirement plans that are part of a simplified employee pension plan
that satisfies section 408(k), individual retirement accounts and section 408(p) accounts), section
403(a) qualified annuity plans, and section 403(b) plans. Distributions from section 457 plans
may also fall under Paragraph 1 if they are not paid with respect to government services covered
by Article 18.
Pensions in respect of government services covered by Article 18 are not covered by this
paragraph. They are covered either by paragraph 2 of this Article, if they are in the form of
social security benefits, or by paragraph 2 of Article 18 (Government Service). Thus, Article 18
generally covers section 457, 401(a), 403(b) plans established for government employees, and
the Thrift Savings Plan (section 7701(j».
Paragraph 2
. The treatmept of so~ial security .b~nefits is dealt with in paragraph 2. This paragraph
prOVides that, notWithstandIng the prOVISion of paragraph 1 under which private pensions are
taxable excll:lsively in the State of res~d.ence o~the b~neficial ?wner, payments made by one of
the Co~tractIn~ States un~~r the proVISlO?S of Its socI~1 securIty or similar legislation to a resident.of Bulgana or to a cItIzen of the Unjlted ~~tes ~Ill be taxable only in the Contracting State
makIng the payme~t. The refer~n.ce to U.S: citizens .IS ne~essary to ensure that a social security
paYl:lent by Bulgaria to a U.S. cItIzen who IS not reSident In the United States will not be taxable
by the United States.
50
This paragraph applies to social security beneficiaries whether they have contributed to
the system as private sector or Government employees. The phrase "similar legislation" is
intended to refer to United States tier 1 Railroad Retirement benefits.
Paragraph 3
Under paragraph 3, annuities that are derived and beneficially owned by a resident of a
Contracting State are taxable only in that State. An annuity, as the term is used in this
paragraph, means a stated sum paid periodically at stated times during a specified number of
years, under an obligation to make the payment in return for adequate and full consideration
(other than for services rendered). An annuity received in consideration for services rendered
would be treated as either deferred compensation that is taxable in accordance with Article 14
(Income from Employment) or a pension that is subject to the rules of paragraph 1.
Paragraph 4
Paragraph 4 deals with alimony and child support payments. Under paragraph 4, alimony
and child support payments paid by a resident of a Contracting State to a resident of the other
Contracting State are not taxable in the recipient's State of residence. In addition, such
payments are not taxable in the payor's State of residence unless he is entitled to a deduction for
such payments in computing taxable income in his State of residence. The term alimony is
defined as periodic payments made pursuant to a written separation agreement or a decree of
divorce, separate maintenance, or compulsory support.
Paragraph 5
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 Bulgaria, paragraph 5 prevents Bulgaria 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 under paragraph 1.
Relationship to other Articles
Paragraphs 1,3, and 4 of Article 17 are subject to the saving clause of paragraph 4 of
Article 1 (General Scope). Thus, a U.S. citizen who is resident in Bulgaria, and receives a
pension, annuity or alimony payment from the United States, may be subject to U.S. tax on the
payment, notwithstanding the rules in paragraphs 1, 3 and 4. Paragraphs 2 and 5 are excepted
from the saving clause by virtue of subparagraph 5(a) of Article 1. Thus, the United States will
not tax U.S. citizens and residents on the income described in paragraph 2, even if such amounts
otherwise would be subject to tax under U.S. law, and the United States will allow U.S. citizens
and residents the benefits of paragraph 5.
ARTICLE 18 (GOVERNMENT SERVICE)
Paragraph 1
Paragraph 1 deals with the taxation of gov~mment compensat~on (ot.her than ~ p~n~ion
addressed in paragraph 2). Subparagraph (a) proVIdes that remuneratIOn p~Id ~o any mdlvldual
who is rendering services to that State, political subdivision or local authonty IS exempt from tax
by the other State. Under subparagraph (b), such payments are, however, taxable exclusively in
51
the other State (i.e .. the host State) if the services are rendered in that other State and the
indi vidual is a resident of that State who is either a national of that State or a person who did not
become resident of that State solely for purposes of rendering the services. The paragraph
applies to anyone performing services for a government, whether as a government employee. an
independent contractor. or an employee of an independent contractor.
Paragraph 2
Paragraph 2 deals with the taxation of pensions paid by, or out of funds created by, one of
the States. or a political subdivision or a local authority thereof, to an individual in respect of
services rendered to that State or subdivision or authority. Subparagraph (a) provides that such
pensions are taxable only in that State. Subparagraph (b) provides an exception under which
such pensions are taxable only in the other State if the individual is a resident of, and a national
of: that other State.
Pensions paid to retired civilian and military employees of a Government of either State
are intended to be covered under paragraph 2. When benefits paid by a State in respect of
services rendered to that State or a subdivision or authority are in the form of social security
benefits, however, those payments are covered by paragraph 2 of Article 17 (Pensions, Social
Security Payments, Annuities, Alimony, and Child Support). As a general matter, the result will
be the same whether Article 17 or 18 applies, since social security benefits are taxable
exclusively by the source country and so are government pensions. The result will differ only
when the payment is made to a citizen and resident of the other Contracting State, who is not
also a citizen of the paying State. In such a case, social security benefits continue to be taxable
at source while government pensions become taxable only in the residence country.
Paragraph 3
Paragraph 3 provides that the remuneration described in paragraph 1 will be subject to
the rules of Articles 14 (Income from Employment), 15 (Directors' Fees), 16 (Entertainers and
Sportsmen) or 17 (Pensions, Social Security Payments, Annuities, Alimony, and Child Support)
if the recipient of the income is employed by a business conducted by a government.
Relationship to other Articles
Under paragraph 5(b) of Article 1 (General Scope), the saving clause (paragraph 4 of
Article 1) does not apply to the benefits conferred by one of the States under Article 18 if the
recipient of the benefits is neither a citizen of that State, nor a person who has been admitted for
permanent residence there (i.e., in the United States, a "green card" holder). Thus, a resident of a
Contracting State who in the course of performing functions of a governmental nature becomes a
resident of the other State (but not a permanent resident), would be entitled to the benefits of this
Article. An individual who receives a pension paid by the Government of Bulgaria in respect of
services rendered to the Government of Bulgaria shall be taxable on this pension only in
Bulgaria unless the individual is a U.S. citizen or acquires a U.S. green card.
ARTICLE 19 (STUDENTS, TRAINEES, TEACHERS AND RESEARCHERS)
.
This Article provides rules for host-country taxation of visiting students, business
tral~ees. teachers and researc~e:~. Per~ons who meet t~e tests of the Article will be exempt from
tax m the State that they .are vlsItmg WIth respec~ to desI~nated classes of income. Paragraph 1
addresses payments receIved by a student or busmess tramee, while paragraph 2 addresses
teachers and researchers temporarily present in the host country.
52
Paragraph 1
Subparagraph (a) addresses the situation where a student or business trainee that is a
resident of a Contra?t.ing State receiv~s designated clas~es of payments while present in the host
State. Several conditIons must be satIsfied for such an mdividual to be entitled to the benefits of
paragraph 1.
First, the student or business trainee must have been, either at the time of his arrival in
the host State or immediately before, a resident of the other Contracting State.
Second, the purpose of the visit must be the full-time education (at a college, university,
or other recognized educational institution of a similar nature) or full-time training of the visitor.
Thus, if the visitor comes principally to work in the host State but also is a part-time student, he
would not be entitled to the benefits of paragraph 1, even with respect to any payments he may
receive from abroad for his maintenance or education, and regardless of whether or not he is in a
degree program. Whether a student is to be considered full-time will be determined by the rules
of the educational institution at which he is studying.
The host-country exemption in paragraph 1 applies to payments received by the student
or business trainee for the purpose of his maintenance, education or training that arise outside the
host State. A payment will be considered to arise outside the host State if the payor is located
outside the host State. Thus, if an employer from one of the Contracting States sends an
employee to the other Contracting State for training, the payments the trainee receives from
abroad from his employer for his maintenance or training while he is present in the host State
will be exempt from tax in the host State. Where appropriate, substance prevails over form in
determining the identity of the payor. Thus, for example, payments made directly or indirectly
by a U.S. person with whom the visitor is training, but which have been routed through a source
outside the United States (e.g., a foreign subsidiary), are not treated as arising outside the United
States for this purpose.
Paragraph 1 also provides a limited exemption for remuneration from personal services
rendered in the host State with a view to supplementing the resources available to him for such
purposes to the extent of $9,000 United States dollars (or its equivalent in the currency of
Bulgaria) per taxable year. The competent authorities are instructed to adjust this amount every
five years, if appropriate.
In the case of a business trainee, the benefits of paragraph 1 will extend only for a period
of two years from the time that the visitor first arrives in the host country for the purpose of
training. If, however, a trainee remains in the host country for a third year, thus losing the
benefits of paragraph 1, he would not retroactively lose the benefits of the paragraph 1 for the
first two years. The term "business trainee" is defined as a person who is in the country
temporarily either for the purpose of securing training that is necessary to qualify to pursue a
profession or professional specialty, or as an employee of, or under contract with, a resident of
the other Contracting State, for the primary purpose of acquiring technical, professional, or
business experience, from someone who is not his employer or related to his employer. Thus, a
business trainee might include a lawyer employed by a law firm in one Contracting State who
works for one year as a stagiare in an unrelated law firm in the other Contracting State.
However, the term would not include a manager who normally is employed by a parent company
in one Contracting State who is sent to the other Contracting State to run a factory owned by a
subsidiary of the parent company.
53
Para~raph
:2
Paragraph 2 provides a limited exemption from host State taxation for certain teachers
and researchers temporarily present in the host State for the purpose of teaching or carrying on
research at a schooL college, university or other recognized educational or research institution.
The teacher or researcher must be a resident of the other Contracting State at the beginning of his
visit to the host State. The income eligible for exemption is the person' s remuneration received
in consideration of teaching or carrying on research. The host-country exemption will extend to
payments received by a teacher or researcher only for a period of two years from the time that
the visitor first arrives in the host country. A teacher or researcher remaining in the host country
for more than 2 years becomes subject to tax on remuneration with respect to teaching and
researching, but does not retroactively lose the benefits of paragraph 2 for the first two years.
Paragraph 2 does not apply to exempt income in consideration of carrying on research if the
research is primarily for the private benetit of a specitic person or persons rather than in the
public interest.
Relationship to other Articles
The saving clause of paragraph 4 of Article 1 (General Scope) does not apply to this
Article with respect to an individual who is neither a citizen of the host State nor has been
admitted for permanent residence there. The saving clause, however, does apply with respect to
citizens and permanent residents of the host State. Thus, for example, a U.S. citizen who is a
resident of Bulgaria and who visits the United States as a full-time student at an accredited
university will not be exempt from U.S. tax on remittances from abroad that otherwise constitute
U.S. taxable income. A person, however, who is not a U.S. citizen, and who visits the United
States as a student and remains long enough to become a resident under U.S. law, but does not
become a permanent resident (i.e., does not acquire a green card), will be entitled to the full
benefits of the Article.
ARTICLE 20 (OTHER INCOME)
Article 20 generally assigns taxing jurisdiction over income not dealt with in the other
articles (Articles 6 through 19) of the Convention to the State of residence of the beneficial
o\\-ner of the income. In order for an item of income to be "dealt with" in another article it must
be the type of income described in the article and, in most cases, it must have its source in a
Contracting State. For example, all royalty income that arises in a Contracting State and that is
beneficially o\\-TIed by a resident of the other Contracting State is "dealt with" in Article 12
(Royalties). However, profits derived in the conduct of a business are "dealt with" in Article 7
(Business Profits) whether or not they have their source in one of the Contracting States.
Examples of items of income covered by Article 20 include income from gambling,
punitive (but not compensatory) damages and covenants not to compete. The Article would also
apply to income from a variety of financial transactions, where such income does not arise in the
course of the conduct ~f a ~rade or business .. F?r exa.mple, i~com~ from notional principal
contracts and ot.her denvatI~es ~ould f~ll wIth10 ArtIcle 20 If de~1Ved by persons not engaged in
the trad~ or b~s~nes~ of deal10g 10 s~ch 1Ostruments, unless such 10struments were being used to
hedge .ns~s a:Is1Og.1O a trade or bus1O~ss. It would also apply to securities lending fees derived
by an InstItutIOnal 1Ovestor. Fu:ther. In most cases guarantee fees paid within an intercompany
group would be covered by ArtIcle 20, unless the guarantor were engaged in the business of
providing such guarantees to unrelated parties.
Article 20 also applies to items of income that are not dealt with in the other articles
because of their source or some other characteristic. For example, Article 11 (Interest) addresses
54
only the taxation of interest arising in a Contracting State. Interest arising in a third State that is
not attributable to a permanent establishment, therefore, is subject to Article 20.
Distributions from partnerships are not generally dealt with under Article 20 because
partnership distributions generally do not constitute income. Under the Code, partners include in
income their distributive share of partnership income annually, and partnership distributions
themselves generally do not give rise to income. This would also be the case under U.S. law
with respect to distributions from trusts. Trust income and distributions that, under the Code,
have the character of the associated distributable net income would generally be covered by
another article of the Convention. See Code section 641 et seq.
Paragraph 1
The general rule of Article 20 is contained in paragraph 1. Items of income not dealt
with in other articles and beneficially owned by a resident of a Contracting State will be taxable
only in the State of residence. This exclusive right of taxation applies whether or not the
residence State exercises its right to tax the income covered by the Article.
The reference in this paragraph to "items of income beneficially owned by a resident of a
Contracting State" rather than simply "items of income of a resident of a Contracting State," as
in the DECD Model, is intended merely to make explicit the implicit understanding in other
treaties that the exclusive residence taxation provided by paragraph 1 applies only when a
resident of a Contracting State is the beneficial owner of the income. Thus, source taxation of
income not dealt with in other articles of the Convention is not limited by paragraph 1 if it is
nominally paid to a resident of the other Contracting State, but is beneficially owned by a
resident of a third State. However, income received by a nominee on behalf of a resident of that
other State would be entitled to benefits.
The term "beneficially owned" is not defined in the Convention, and is, therefore, defined
as under the internal law of the country imposing tax (i.e., the source country). The person who
beneficially owns the income for purposes of Article 20 is the person to which the income is
attributable for tax purposes under the laws of the source State.
Paragraph 2
This paragraph provides an exception to the general rule of paragraph 1 for income that is
attributable to a permanent establishment maintained in a Contracting State by a resident ofthe
other Contracting State. The taxation of such income is governed by the provisions of Article 7
(Business Profits). Therefore, income arising outside the United States that is attributable to a
permanent establishment maintained in the United States by a resident of Bulgaria generally
would be taxable by the United States under the provisions of Article 7. This would be true even
if the income is sourced in a third State.
Relationship to Other Articles
This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope).
Thus, the United States may tax the income of a resident of Bulgaria that is not dealt with
elsewhere in the Convention if that resident is a citizen ofthe United States. The Article is also
subject to the provisions of Article 21 (Limitation on Benefit~). Thus, if a res~dent of Bulgaria
f.?rns income that falls within the scope of paragraph 1 of ArtIcle 20, but that IS taxable ~y.the
United States under U.S. law, the income would be exempt from U.S. tax under the provislOns of
Article 20 only if the resident satisfies one of the tests of Article 21 for entitlement to benefits.
55
ARTICLE 21 (LIMITATION ON BENEFITS)
Article 21 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 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 anyone of which will entitle that person to all the
benefits of the Convention. Paragraph 3 provides a so-called "derivative benefits" test
under which certain categories of income may qualify for benefits. Paragraph 4 provides
that. regardless of whether a person qualifies for benefits under paragraph 2 or 3, 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 special rules for so-called "triangular
cases" notwithstanding paragraphs 1 through 4 of Article 21. Paragraph 6 provides that
benefits also may be granted if the competent authority of the State from which benefits
are claimed determines that it is appropriate to provide benefits in that case. Paragraph 7
defines certain terms used in the Article.
Paragraph I
Paragraph 1 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 through 20, the treaty-based
relief from double taxation provided by Article 22 (Relief from Double Taxation), and the
protection against discrimination afforded to residents of a Contracting State under Article 23
(Non-Discrimination). Some provisions do not require that a person be a resident in order to
enjoy the benefits of those provisions. Article 24 (Mutual Agreement Procedure) is not limited
to residents of the Contracting States, and Article 26 applies to diplomatic agents or consular
officials regardless of residence. Article 21 accordingly does not limit the availability of treaty
benefits under these provisions.
Article 21 and the anti-abuse provisions of domestic law complement each other, as
Article 21 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, internal law
principles of the source Contracting State may be applied to identify the beneficial owner of an
item of income. and Article 21 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
Paragraph 2 has five subparagraphs, each of which describes a category of residents that
are entitled to all benefits of the Convention .
. . It is intended that th~ provisions of para~r~ph 2 will be self executing. Unlike the
proYISlOnS of paragraph 6. dIscussed below, claImmg benefits under paragraph 2 does not require
56
an ~dvance co~petent authority ruling o.r approval. .The tax authorities may, of course, on
reView, detennme that the taxpayer has Improperly mterpreted the paragraph and is not entitled
to the benefits claimed.
Individuals -- Subparagraph 2(a)
Subparagraph (a) provides that individual residents of a Contracting State will be entitled
to all treaty benefits. If such an individual receives income as a nominee on behalf of a third
co~try resident, benefits m~y be denied un~er the respective articles of the Convention by the
reqUirement that the benefiCial owner of the mcome be a resident of a Contracting State.
Governments -- Subparagraph 2(b)
Subparagraph (b) provides that the Contracting States and any political subdivision or
local authority thereof will be entitled to all benefits of the Convention.
Publicly-Traded Corporations -- Subparagraph 2(c)(i)
Subparagraph (c) applies to two categories of companies: publicly traded companies and
subsidiaries of publicly traded companies. A company resident in a Contracting State is entitled
to all the benefits of the Convention 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, the company's principal class of shares is primarily traded on one or more recognized stock
exchanges located in the Contracting State of which the company is a resident; or, second, the
company's primary place of management and control is in its State of residence.
The tenn "recognized stock exchange" is defined in subparagraph 7(a). It includes (i) the
NASDAQ System and 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) the Bulgarian Stock Exchange - Sofia, and any other stock exchange licensed to trade
securities and financial instruments under the Bulgarian law; and (iii) 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 detennine which class or classes constitute
the "principal class of shares". The term "principal class of shares" is defined in subparagraph
7(b) to mean the ordinary or common shares ofthe 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 ofthe 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 satisty 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-qualitying, 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 r~c?gnized stock
exchange will nevertheless not quality for benefits under subparagraph. 2( c) If It has a
oisproportionate class of shares that is not regularly traded on a recogmzed stock exchange. The
term "disproportionate class of shares" is defined in subparagraph 7( c). A company has a
57
disproportionate class of shares if it has outstanding a class of shares that 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 Bulgaria 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. BulCo is a corporation resident in Bulgaria. BulCo has two classes of shares:
Common and Preferred. The Common shares are listed and regularly traded on the principal
stock exchange of Bulgaria. The Preferred shares have no voting rights and are entitled to
receive dividends equal in amount to interest payments that BulCo 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 BulCo 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 BulCo, the Preferred shares are a disproportionate
class of shares. Because the Preferred shares are not regularly traded on a recognized stock
exchange, BulCo will not qualify for benefits under subparagraph 2(c).
A class of shares will be "regularly traded" on one or more recognized stock exchanges
in a taxable year, under subparagraph 7(g), if the aggregate number of shares of that class traded
on one or more recognized exchanges during the twelve months ending on the day before the
beginning of that taxable year is at least six percent of the average number of shares outstanding
in that class during that twelve-month period. 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 a recognized stock exchange located in Bulgaria.
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. section 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 wh.ose ~rincipal class of shar~s is regularly trad~d. on a recognized exchange
but cannot meet the pnmarIly traded test may claim treaty benefits If Its primary place of
management and control is in its country of residence. This test should be distinguished from
the "pl.ace of effec~ive m~nagement" test which is used in the OECD Model and by many other
countnes to establIsh reSIdence. In some cases, the place of effective management test has been
in~erpreted to mean the place where the board of directors meets. By contrast, the primary place
ot management an? contr~l ~es~ lo~ks to w~ere day-to-day responsibility for the management of
the company \ and Its Subsl~IarIes) IS ex.ercise.d. The company's primary place of management
a~~ control wIll,be located m the State m whIch t~e company is a resident only if the executive
othcer~ an~ sen~or manageme,nt emplo.yees e~e~clse da~-to-day responsibility for more of the
"trategic. fmancIaI and operatIOnal polIcy deCISIOn makmg for the company (including direct and
58
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 necess~y, 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 se!1ior 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)(U)
A company resident in a Contracting State is entitled to all the benefits of the
Convention under clause (ii) of subparagraph 2(c) 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 Bulgaria, all the shares of which are
owned by another company that is a resident of Bulgaria, 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 Bulgaria.
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 Bulgaria. Furthermore, if a parent company in Bulgaria 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 Bulgaria in order for the
subsidiary to meet the test in clause (ii).
Tax Exempt Organizations -- Subparagraph 2(d)
Subparagraph 2( d) provides rules by which the tax exempt organizations des~ribed in
paragraph 2 of Article 4 (Resident) will be entitled to all the benefits of the C~m~entlOn. A
pension fund will qualify for benefits if more than fifty percent of the benefiCiaries, members or
participants of the organization are individuals resident in either Contracting State. For pu~?ses
of this provision, the term "beneficiaries" should be understood to refe: to ~he persons recelvmg
benefits from the organization. On the other hand, a tax-exempt orgamzatlOn other than a
pension fund automatically qualifies for benefits, without regard to the residence of its
beneficiaries or members. Entities qualifying under this rule are those that are generally 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.
59
Ownership Base Erosion -- Suhparagraph 2(e)
Subparagraph 2( e) provides an additional method to qualifY for treaty benefits th~t
.
applies to any form of legal entity that is a resident of a Contracting State. The test provIded m
suhparagraph (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 at least 50 percent of the
aggregate voting power and value (and at least 50 percent of any disproportionate class of
shares) 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 2(a). (b), (c)(i), or (d). In the case of indirect owners, 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 (Resident) 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 bc 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 subparagraphs
2(a), (b), (c)(i), or (d).
The base erosion prong of clause (ii) of subparagraph (e) is satisfied with respect to a
person ifless 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, directly or indirectly, to
persons who are not residents of either Contracting State entitled to benefits under subparagraphs
(~1). (b), (c)( i), or (d), in the form of payments deductible for tax purposes in the payor's State of
residence. These amounts do not include arm 's-length payments in the ordinary course of
business for services or tangible property. To the extent they are deductible from the taxable
base. trust distributions are deductible payments. However, depreciation and amortization
deductions, \vhich do not represent payments or accruals to other persons, are disregarded for
this purpose.
Paragraph 3
_ Paragraph 3 sets f0:th a d~rivati:e ?e.nefits. test that. is potentially applicable to all treaty
benefIts, although the test IS applIed to mdlvldualltems of mcome. In general, a derivative
benefits test entitles the resident of a Contracting State to treaty benefits if the owner of the
resident would have been entitled to the same benefit had the income in question t10wed
directly to that owner. To qualifY under this paragraph, the company must meet an ownership
test and a base erosion test.
_ ~u~paragraph (a) sets forth the o.\\nership test. Under this test, seven or fewer equivalent
benehCl~nes must own shares repr_esentIng at least 95. percent ?f the aggregate voting power and
yalue of t.he compan;-: and at least )0 per~ent of any dIs~rop~r:tlOnate class of shares. Ownership
may be direct or IndIrect. [he term "eqUIvalent benefiCiary IS defined in subparagraph (e) of
60
paragraph 7. This definition may be met in two alternative ways, the first of which has two
requirements.
Under the first alternative, a person may be an equivalent beneficiary because it is
entitled to equivalent benefits under a treaty between the country of source and the country in
which the person is a resident. This alternative has two requirements.
The first requirement is that the person must be a resident of a member state of the
European Union, or of a European Economic Area state, or of a party to the North American
Free Trade Agreement (collectively, "qualifying States").
The second requirement of the definition of "equivalent beneficiary" is that the person
must be entitled to equivalent benefits under an applicable treaty. To satisfy the second
requirement, the person must be entitled to all the benefits of a comprehensive 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 paragraph 2 (a), (b), (c)(i), and (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), (b), (c)(i), and (d) of this Article if the person were a resident of one of the
Contracting States.
In order to satisfy the second requirement necessary to qualify as an "equivalent
beneficiary" under subparagraph 7(e)(i)(B) with respect to dividends, interest, royalties or
branch tax, 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 oftax that the
source State would have imposed if the third State resident received the income directly from
the source State.
Subparagraph 7(t) 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 receives
such payments from a Bulgarian company, and that U.S. company is owned by a company
resident in a member state ofthe European Union that would have qualified for an exemption
from withholding tax ifit had received the income directly, 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 Bulgarian 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 ifit received dividends directly from a U.S. subsidiary of the Bulgarian
company is not sufficient for purposes of this paragraph. Further, the French company cannot
be an equivalent beneficiary if it qualifies for benefits only with respect to ce~in income as a
result of a "derivative benefits" provision in the U.S.-France treaty. However, It would be
possible to look through the French company to its parent company to determine whether the
parent company is an equivalent beneficiary.
61
The second alternative for satisfying the "equivalent beneficiary" test is available only to
residents of one of the two Contracting States. U.S. or Bulgarian residents who are eligible for
treaty benetits by reason of subparagraphs 2(a), (b), (c)(i), or (d) are equivalent beneficiaries for
purposes of the relevant tests in Article 21. Thus, a Bulgarian 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 Bulgarian company under this
paragraph. Thus, for example, if 90 percent of a Bulgarian company is owned by five companies
that are resident in member states of the European Union who satisfy the requirements of
subparagraph7(e)(i), and 10 percent of the Bulgarian company is owned by a U.S. or Bulgarian
individual, then the Bulgarian 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 i fless 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 ofresidence. These amounts do not include arm's-length payments in the
ordinary course of business for services or tangible property. This test is the same as the base
erosion test in subparagraph 2(e)(ii), except that the test in paragraph 3(b) focuses on baseeroding payments to persons who are not equivalent beneficiaries.
Paragraph"
Paragraph 4 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
or 3.
Subparagraph (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 Bulgaria is entitled
to the benefits of the Convention under paragraph 4 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 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 constitute or could constitute an independent
econ?mic enterprise carried on for p:ofit. Furt~ermore, a corporation generally will be
conSidered to carry on a trade or busmess only If the officers and employees of the corporation
conduct substantial managerial and operational activities.
62
The business of making or managing investments for the resident's own account will be
considered to be a trade ~r business only when part of banking, insurance or securities activities
conducted by a bank, an Insurance company, or a registered securities dealer. Such activities
conducted by a person other than a bank, insurance company or registered securities dealer will
not be considered to be th~ conduct of an ~ctive. trade or business, nor would they be considered
to be the condu~t.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 ~ 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 incomeproducing 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. US Co is engaged in an
active manufacturing business in the United States. USCo owns 100 percent of the shares of
BulCo, a corporation resident in Bulgaria. BulCo distributes USCo products in Bulgaria. Since
the business activities conducted by the two corporations involve the same products, BulCo'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, US Co operates a large research and development facility in the United
States that licenses intellectual property to affiliates worldwide, including BuiCo. BulCo and
other USCo affiliates then manufacture and market the USCo-designed products in their
respective markets. Since the activities conducted by BulCo and US Co 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 reside':'!t,in the Unite~ S~ates ~hat o.perates ~
mtE'mational airline. BulSub is a wholly-owned subSidiary of Amencau reSIdent In Bulgana.
BUlSub operates a chain of hotels in Bulgaria that are located near airports served by Americair
63
!lights. Americair frequently sells tour packages that include air travel to Bulgar~a and lodging
at BulSub hotels. Although both companies are engaged in the active conduct ot a trade or
business. the businesses of operating a chain of hotels and operating an airline are distinct trades
or businesses. Therefore BulSub's business does not form a part of Americair's business.
However. BulSub'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 BulSub owns an office
building in Bulgaria instead of a hotel chain. No part of Americair's business is conducted
through the office building. BulSub'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
BulHolding, a corporation resident in Bulgaria. BulHolding is a holding company that is not
engaged in a trade or business. BulHolding owns all the shares of three corporations that are
resident in Bulgaria: BulFlower, BulLavm, and BulFish. BulFlower distributes USFlower
flowers under the USFlower trademark in Bulgaria. BulLawn markets a line of lawn care
products in Bulgaria under the USFlower trademark. In addition to being sold under the same
trademark, BulLawn and BulFlower products are sold in the same stores and sales of each
company's products tend to generate increased sales of the other's products. BulFish imports fish
from the United States and distributes it to fish wholesalers in Bulgaria. For purposes of
paragraph 4, the business of BulFlower forms a part of the business of USFlower, the business of
BulLawn is complementary to the business of US Flower, and the business of BulFish 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 ofresidence 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 4(b) 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).
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.
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
bene~its of t~e Convent~on with r.espe~t to one item of inc5>me ~ut not with respect to another. If
a reSIdent ot a Contractmg State IS entItled to treaty benehts WIth respect to a particular item of
64
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 applicatio~ 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
activ.ities, even th?ugh the i~co~e recip~ent resident in a Co~tracting State may be very small in
relatIon to the entlty generatmg mcome m the other Contractmg State. For example, if a small
U.S. research ~rm deve.lops a ~rocess that it licenses to a very large, unrelated, pharmaceutical
manufacturer m Bulgaria, 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 Bulgaria would not have to pass a substantiality test
to receive treaty benefits under paragraph 4.
Subparagraph 4( c) provides special attribution rules for purposes of applying the
substantive rules of subparagraphs (a) and (b). 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 ifY 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, directly or indirectly, 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 Yare controlled by
the same person or persons.
Paragraph 5
Paragraph 5 deals with the treatment of interest or royalty income in the context of a socalled "triangular case." The paragraph provides special rules applicable to U.S. source interest
or royalties that are attributable to a permanent establishment that a Bulgarian company has in a
third state, and that are otherwise exempt from taxation in Bulgaria.
The term "triangular case" refers to the use of the following structure by a resident of
Bulgaria to earn, in this case, interest income from the United States. The resident of Bulgaria,
who is assumed to qualify for benefits under one or more of the provisions of Article 21
(Limitation on Benefits), sets up a permanent establishment in a third jurisdiction that imposes
only a low rate of tax on the income of the permanent establishment. The Bulgarian resident
lends funds into the United States through the permanent establishment. The permanent
establishment, despite its third-jurisdiction location, is an integral part of a Bulgarian resident.
Therefore, the income earned on those loans, absent the provisions of paragraph 5, may be
entitled to a reduced rate of U.S. withholding tax under the Convention. Under a current
Bulgarian income tax treaty with the host jurisdiction of the permanent establishment, the
income of the permanent establishment is exempt from Bulgarian tax. Alternatively, Bulgaria
may choose to exempt the income of the permanent establishmen~ fron: Bulga~ian inco!lle tax.
Thus, the interest income is subject to a reduced rate of U.S. tax, IS sUbJ.ect to httle tax m the host
jurisdiction of the permanent establishment, and is exempt from BulgarIan tax.
65
Because 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, the paragraph
only applies with respect to U.S. source interest or royalties that are attributable to a thirdjurisdiction permanent establishment of a Bulgarian resident.
Paragraph 5 replaces the otherwise applicable rules in the Convention for interest and
royalties with a 15 percent withholding tax for interest and royalties if the actual tax paid on the
income in the third state is less than 60 percent of the tax that would have been payable in
Bulgaria if the income were earned in Bulgaria by the enterprise and were not attributable to the
permanent establishment in the third state.
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 5 will not apply under certain circumstances. In the case of interest
(as defined in Article 11 (Interest)), paragraph 5 will not apply if the interest 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
banking or securities activities carried on by a bank or registered securities dealer. In the case
of royalties (as defined in Article 12 (Royalties)), paragraph 5 will not apply if the royalties are
received as compensation for the use ot~ or the right to use, intangible property produced or
developed by the permanent establishment itself.
Paragraph 6
Paragraph 6 provides that a resident of one of the States that is not entitled to the benefits
of the Convention as a result of paragraphs 2 through 4 still may be granted benefits under the
Convention at the discretion of the competent authority of the State from which benefits are
claimed. Under paragraph 6, that competent authority will determine whether the establishment,
acquisition, or maintenance of the person seeking benefits under the Convention, or the conduct
of such person's operations, has or had as one of its principal purposes the obtaining of benefits
under the Convention. Benefits will not be granted, however, solely because a company was
established prior to the effective date of a treaty or protocol. In that case a company would still
be required to establish to the satisfaction of the Competent Authority clear non-tax business
reasons for its formation in a Contracting State, or that the allowance of benefits would not
otherwise be contrary to the purposes of the treaty. Thus, persons that establish operations in
one of the States with a principal purpose of obtaining the benefits of the Convention ordinarily
will not be granted relief under paragraph 6.
The competent authority'S discretion is quite broad. It 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 4. Further, the competent authority may establish conditions such as
setting time limits on the duration of any relief granted.
'
For purposes of implementing. paragraph 6, a taxpayer ~ill be permitted to present his
case to the relevant competent authonty for an advance determmation 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.
66
·
. Finally, ~ere may be cases in whic~ a resi~ent of a Cont~acting State may apply for
discretionary rehefto the competent authonty of hIS State of resIdence. This would arise for
example, if the benefit the resident is ~laiming is provided by the residence country, and ~ot by
the source country. So, for example, lfa company that is a resident of the United States would
like to claim the benefit of the re-sourcing rule of paragraph 3 of Article 22 but it does not meet
any of the objective tests of this Article, it may apply to the U.S. competent authority for
discretionary relief.
Paragraph 7
Paragraph 7 defines several key terms for purposes of Article 21. Each of the
defined terms is discussed above in the context in which it is used.
ARTICLE 22 (RELIEF FROM DOUBLE TAXATION)
This Article describes the manner in which each Contracting State undertakes to relieve
double taxation. The United States uses the foreign tax credit method under its internal law, and
by treaty.
Paragraph 1
Paragraph 1 provides that Bulgaria will provide relief from double taxation through a
mixture of the credit and exemption methods.
Subparagraph l(a) states the general rule that Bulgaria will exempt income derived by a
resident if the income may' be taxed in the United States in accordance with the Convention.
Subparagraph l(c), permits Bulgaria to include the income corresponding to the U.S. tax in the
resident's tax base in calculating the Bulgarian tax on the remaining income of the resident. This
rule provides for "exemption with progression." Under subparagraph l(b), Bulgaria provides for
a tax credit rather than an exemption with respect to limited classes of income. If the income
may be taxed by the United States under the provisions of Article 10 (Dividends), Article 11
(Interest), or Article 12 (Royalties), Bulgaria will relieve double taxation by allowing a credit
against Bulgarian tax in an amount equal to the tax paid in the United States on such income, but
!imited to the amount of Bulgarian tax attributable to such dividends, interest, and royalty
Income.
Paragraph 2
The United States agrees, in paragraph 2, to allow to its citizens and residents a credit
against U.S. tax for income taxes paid or accrued to Bulgaria. Paragraph 2 also provides that
Bulgaria'S covered taxes are income taxes for U.S. purposes. This provision is based on the
Treasury Department's review of Bulgaria's laws.
Subparagraph (b) provides for a deemed-paid credit, consistent with section 902 of the
Code, to a U.S. corporation in respect of dividends received from a corporation resident in
Bulgaria of which the U.S. corporation owns at least 10 percent of the voting stock. This credit
is for the tax paid by the corporation to Bulgaria on the profits out of which the dividends are
considered paid.
The credits allowed under paragraph 2 are allowed in accordance with the provisions and
subject to the limitations of U.S. law, as that law may be amended over time, so long as the
general principle of the Article, that is, the allowance of a credit, i~ retained. ~hus, although the
Convention provides for a foreign tax credit, the terms of the cre~lt are determmed by the
provisions, at the time a credit is given, of the U.S. statutory credIt.
67
Therefore. the U.S. credit under the Convention is subject to the various limitations of
U.S. law (see. e.g .. Code sections 901-908). For example. the credit against U.S. tax generally is
limited to the amount of U.S. tax due with respect to net foreign source income within the
relevant foreign tax credit limitation category (see Code section 904(a) and (d». and the dollar
amount of the credit is determined in accordance with U.S. currency translation rules (see. e.g.
Code section 986). Similarly, U.S. law applies to determine carryover periods for excess credits
and other inter-year adjustments.
Paragraph 3
Paragraph 3 provides a re-sourcing rule for gross income covered by paragraph 2.
Paragraph 3 is intended to ensure that a U.S. resident can obtain an appropriate amount of U.S.
foreign tax credit for income taxes paid to Bulgaria when the Convention assigns to Bulgaria
primary taxing rights over an item of gross income.
Accordingly, if the Convention allows Bulgaria to tax an item of gross income (as
defined under U.S. law) derived by a resident of the United States, the United States will treat
that item of gross income as gross income from sources within Bulgaria for U.S. foreign tax
credit purposes. In the case of a U.S.-owned foreign corporation, however, section 904(h)(1O)
may apply for purposes of determining the U.S. foreign tax credit with respect to income subject
to this re-sourcing rule. Section 904(h)( 10) generally applies the foreign tax credit limitation
separately to re-sourced income. Furthermore, the paragraph 3 re-sourcing rule applies to gross
income, not net income. Accordingly, U.S. expense allocation and apportionment rules, see,
e.g, Treas. Reg. section 1.861-9, continue to apply to income resourced under paragraph 3.
Paragraph .f.
Paragraph 4 provides special rules for the tax treatment in both States of certain types of
income derived from U.S. sources by U.S. citizens who are residents of Bulgaria. Since U.S.
citizens, regardless of residence, are subject to United States tax at ordinary progressive rates on
their worldwide income, the U.S. tax on the U.S. source income of a U.S. citizen resident in
Bulgaria may exceed the U.S. tax that may be imposed under the Convention on an item of U.S.
source income derived by a resident of Bulgaria who is not a U.S. citizen. The provisions of
paragraph 4 ensure that Bulgaria does not bear the cost of U.S. taxation of its citizens who are
residents of Bulgaria.
Subparagraph (a) provides, with respect to items of income from sources within the
United States, special credit rules for Bulgaria. These rules apply to items of U.S.-source
income that would be either exempt from U.S. tax or subject to reduced rates of U.S. tax under
the provisions of the Convention if they had been received by a resident of Bulgaria who is not a
U.S. citizen. The tax credit allowed by Bulgaria under paragraph 4 with respect to such items
need not exceed the U.S. tax that may be imposed under the Convention, other than tax imposed
solely by reason of the U.S. citizenship of the taxpayer under the provisions of the saving clause
of paragraph 4 of Article 1 (General Scope).
For example. if a U.S. citizen resident in Bulgaria receives portfolio dividends from
sources within the United States. the foreign tax credit granted by Bulgaria would be limited to
10 percent of the dividend - the U.S. tax that may be imposed under subparagraph 2(b) of Article
10 (Dividends) - even if the shareholder is subject to U.S. net income tax because of his U.S.
citizenship.
Subparagraph 4(b) eliminates the potential for double taxation that can arise because
~ub~a.ragraph ~(a) p:ovides t~at Bulgaria need not provi?e full relief for the U.S. tax imposed on
Its cItIzens reSIdent III Bulgana. The subparagraph prOVIdes that the United States will credit the
68
income tax paid or accrued to Bulgaria, after the application of subparagraph 4(a). It further
provides that in allowing the credit, the United States will not reduce its tax below the amount
that is taken into account in Bulgaria in applying subparagraph 4(a).
Since the income described in paragraph 4(a) generally will be U.S. source income,
special rules are required to re-source some of the income to Bulgaria in order for the United
States to be able to credit the tax paid to Bulgaria. This re-sourcing is provided for in
subparagraph 4(c), which deems the items of income referred to in subparagraph 4(a) to be from
foreign sources to the extent necessary to avoid double taxation under subparagraph 4(b).
Subparagraph 3( e) of Article 24 (Mutual Agreement Procedure) provides a mechanism by which
the competent authorities can resolve any disputes regarding whether income is from sources
within the United States.
The following two examples illustrate the application of paragraph 4 in the case of a
U.S.-source portfolio dividend received by a U.S. citizen resident in Bulgaria. In both examples,
the U.S. rate of tax on residents of Bulgaria, under subparagraph 2(b) of Article 10 (Dividends)
of the Convention, is 10 percent. In both examples, the U.S. income tax rate on the U.S. citizen
is 35 percent. In example 1, the rate of income tax imposed in Bulgaria on its resident (the U.S.
citizen) is 25 percent (below the U.S. rate), and in example 2, the rate imposed on its resident is
40 percent (above the U.S. rate).
Example 1
Example 2
$100.00
10.00
100.00
25.00
10.00
15.00
$100.00
10.00
100.00
40.00
10.00
30.00
$100.00
U.S. pre-tax income
35.00
U.S. pre-credit citizenship tax
10.00
Notional U.S. withholding tax
25.00
U.S. tax eligible to be offset by credit
15.00
Tax paid to Bulgaria
Income re-sourced from U.S. to foreign source (see below) 42.86
15.00
U.S. pre-credit tax on re-sourced income
15.00
U.S. credit for tax paid to Bulgaria
10.00
Net post-credit U.S. tax
20.00
Total U.S. tax
$100.00
35.00
10.00
25.00
30.00
71.43
25.00
25.00
0.00
10.00
Subparagraph Ca)
U.S. dividend declared
Notional U.S. withholding tax (Article 10(2)(b»
Taxable income in Bulgaria
Bulgaria tax before credit
Less: tax credit for notional U.S. withholding tax
Net post-credit tax paid to Bulgaria
Subparagraphs (b) and (c)
In both examples, in the application of subparagraph (a), Bulgaria credits a 10 percent
U.S. tax against its residence tax on the U.S. citizen. In the first example, the net tax paid to
Bulgaria after the foreign tax credit is $15.00; in the second example, it is $30.00. In the
application of subparagraphs (b) and (c), from the U.S. tax due before credit of$35.00, the
United States subtracts the amount of the U.S. source tax of $10.00, against which no U.S.
foreign tax credit is allowed. This subtraction ensures that the United States collects the tax that
it is due under the Convention as the State of source.
In both examples, given the 35 percent U.S. tax rate, the maximum amount of U.S. tax
against which credit for the tax paid to Bulgaria may be claimed is $25 ($35 U.S. tax minus $10
69
U.S. withholding tax). Initially. all of the income in both examples was from sources wit~in the
United States. For a U.S. foreign tax credit to be allowed for the full amount of the tax paid to
Bulgaria. an appropriate amount of the income must be re-sourced to Bulgaria under
subparagraph (c).
The amount that must be re-sourced depends on the amount of tax for which the U.S.
citizen is claiming a U.S. foreign tax credit. In example 1, the tax paid to Bulgaria was $15. For
this amount to be creditable against U.S. tax, $42.86 ($15 tax divided by 35 percent U.S. tax
rate) must be resourced to Bulgaria. There is a net U.S. tax of$10 due after credit ($25 U.S. tax
eligible to be offset by credit, minus $15 tax paid to Bulgaria). Thus, in example 1, there is a
total of$20 in U.S. tax ($10 U.S. withholding tax plus $10 residual U.S. tax).
In example 2, the tax paid to Bulgaria was $30, but, because the United States subtracts
the U.S. withholding tax of$10 from the total U.S. tax of$35, only $25 of U.S. taxes may be
offset by taxes paid to Bulgaria. Accordingly, the amount that must be resourced to Bulgaria is
limited to the amount necessary to ensure a U.S. foreign tax credit for $25 of tax paid to
Bulgaria, or $71.43 ($25 tax paid to Bulgaria divided by 35 percent U.S. tax rate). When the tax
paid to Bulgaria is credited against the U.S. tax on this re-sourced income, there is no residual
U.S. tax ($25 U.S. tax minus $30 tax paid to Bulgaria. subject to the U.S. limit of$25). Thus, in
example 2, there is a total of$lO in U.S. tax ($10 U.S. withholding tax plus $0 residual U.S.
tax). Because the tax paid to Bulgaria was $30 and the U.S. tax eligible to be offset by credit was
$25, there is $5 of excess foreign tax credit available for carryover.
Relationship to other Articles
By virtue of subparagraph 5(a) of Article 1 (General Scope), Article 22 is not subject to
the saving clause of paragraph 4 of Article 1. Thus, the United States will allow a credit to its
citizens and residents in accordance with the Article, even if such credit were to provide a
benefit not available under the Code (such as the re-sourcing provided by paragraph 3 and
subparagraph 4( c)).
ARTICLE 23 (NON-DISCRIMINATION)
This Article ensures that nationals of a Contracting State, in the case of paragraph 1, and
residents of a Contracting State, in the case of paragraphs 2 through 5, will not be subject,
directly or indirectly, to discriminatory taxation in the other Contracting State. Not all
differences in tax treatment, either as between nationals of the two States, or between residents
of the two States, are violations of the prohibition against discrimination. Rather, the nondiscrimination obligations of this Article apply only if the nationals or residents of the two States
are comparably situated.
Each of the relevant paragraphs of the Article provides that two persons that are
comparably situated must be treated similarly. Although the actual words differ from paragraph
to paragraph (e.g., paragraph 1 refers to two nationals "in the same circumstances," paragraph 2
refers to two enterprises "carrying on the same activities" and paragraph 4 refers to two
enterprises that are "similar"), the common underlying premise is that if the difference in
treatment is directly related to a tax-relevant difference in the situations of the domestic and
foreign.persons b~ing compar~d. that difference is !l0t.t0 be treated as discriminatory (i.e., if one
person.Is taxable m a Contractmg State on worldWIde mcome and the other is not, or tax may be
collectIble from one person at a later stage, but not from the other, distinctions in treatment
v.:ould be justified under paragraph 1). Other examples of such factors that can lead to nondiscriminatory differences in treatment are noted in the discussions of each paragraph.
70
The operative paragraphs of the Article also use different language to identify the kinds
of differences in taxation treatment that will be considered discriminatory. For example,
paragraphs 1 and 4 speak of" any taxation or any requirement connected therewith that is more
burdensome," while paragraph 2 specifies that a tax "shall not be less favorably levied."
Regardless of these differences in language, only differences in tax treatment that materially
disadvantage the foreign person relative to the domestic person are properly the subject of the
Article.
Paragraph 1
Paragraph 1 provides that a national of one Contracting State may not be subject to
taxation or connected requirements in the other Contracting State that are more burdensome than
the taxes and connected requirements imposed upon a national of that other State in the same
circumstances. The OECD Model language would prohibit taxation that is "other than or more
burdensome" than that imposed on u.S. persons. This Convention omits the reference to
taxation that is "other than" that imposed on u.S. persons because the only relevant question
under this provision should be whether the requirement imposed on a national of the other
Contracting State is more burdensome. A requirement may be different from the requirements
imposed on u.S. nationals without being more burdensome.
The term "national" in relation to a Contracting State is defined in subparagraph 1(1) of
Article 3 (General Definitions). The term includes both individuals and juridical persons. A
national of a Contracting State is afforded protection under this paragraph even if the national is
not a resident of either Contracting State. Thus, a u.S. citizen who is resident in a third country
is entitled, under this paragraph, to the same treatment in Bulgaria as a national of Bulgaria who
is in similar circumstances (i.e., presumably one who is resident in a third State).
As noted above, whether or not the two persons are both taxable on worldwide income is
a significant circumstance for this purpose. For this reason, paragraph 1 specifically states that
the United States is not obligated to apply the same taxing regime to a national of Bulgaria who
is not resident in the United States as it applies to a U.S. national who is not resident in the
United States. United States citizens who are not residents of the United States but who are,
nevertheless, subject to United States tax on their worldwide income are not in the same
circumstances with respect to United States taxation as citizens of Bulgaria who are not United
States residents. Thus, for example, Article 23 would not entitle a national of Bulgaria resident
in a third country to taxation at graduated rates on U.s. source dividends or other investment
income that applies to a U.S. citizen resident in the same third country.
Paragraph 2
Paragraph 2 of the Article, provides that a Contracting State may not tax a permanent
establishment of an enterprise of the other Contracting State less favorably than an enterprise of
that first-mentioned State that is carrying on the same activities.
The fact that a U.S. permanent establishment of an enterprise of Bulgaria is subject to
U.S. tax only on income that is attri~u~ble.to the perm~ent establ~s~ent, w~ile a ~.S:
corporation engaged in the same actIvltles IS taxable on Its worldWide mcoI?e IS not, m Itself, a
sufficient difference to provide different treatment for the. p~rmane?-t estabhshm.ent. Ther~ are
cases, however, where the two enterprises would not be slmlla:ly s.Ituated and dIff~ren~e~ m.
treatment may be warranted. For instance, i~ would no~ be a vIOla.tIO~ of the n.on-~lscnmmatIOn
protection of paragraph 2 to require the foreign .enterpn~e to pro~lde mformatIOn ~n a reasonable
manner that may be different from the informatIOn reqUlr~ments Imposed on a reSident
.
enterprise, because information may not be as readily avaIlable to the Inte~al R~venue SerVIce
from a foreign as from a domestic enterprise. Similarly, it would not be a VIOlatIOn of paragraph
71
~ to impose penalties on persons who fail to comply with such a requirement (see.
e.g. sections
874(a) and 882(c)(2)). Further. a detem1ination that income and expenses have been attributed
or allocated to a permanent establishment in conformity with the principles of Article 7
(Business Protits) implies that the attribution or allocation was not discriminatory.
Section 1446 of the Code imposes on any partnership with income that is effectively
connected with a U.S. trade or business the obligation to withhold tax on amounts allocable to a
foreign partner. In the context of the Convention. this obligation applies with respect to a share
of the partnership income of a partner resident in Bulgaria, and attributable to aU. S. permanent
establishment. There is no similar obligation with respect to the distributive shares of U.S.
resident partners. It is understood. however, that this distinction is not a form of discrimination
within the meaning of paragraph 2 of the Article. No distinction is made between U.S. and nonU.S. partnerships, since the law requires that partnerships of both U.S. and non-U.S. domicile
withhold tax in respect of the partnership shares of non-U.S. partners. Furthermore, in
distinguishing between U.S. and non-U.S. partners, the requirement to withhold on the non-U.S.
but not the U.S. partner's share is not discriminatory taxation, but, like other withholding on
nonresident aliens, is merely a reasonable method for the collection of tax from persons who are
not continually present in the United States, and as to whom it otherwise may be diflicult for the
United States to enforce its tax jurisdiction. If tax has been over-withheld. the partner can, as in
other cases of over-withholding, file for a refund.
Paragraph 3
Paragraph 3 makes clear that the provisions of paragraphs 1 and 2 do not obligate a
Contracting State to grant to a resident of the other Contracting State any tax allowances, reliefs,
etc .. that it grants to its own residents on account of their civil status or family responsibilities.
rhus. if a sole proprietor who is a resident of Bulgaria has a permanent establishment in the
United States, in assessing income tax on the profits attributable to the permanent establishment,
the United States is not obligated to allow to the resident of Bulgaria the personal allowances for
himself and his family that he would be permitted to take if the permanent establishment were a
sole proprietorship owned and operated by a U.S. resident, despite the fact that the individual
income tax rates would apply.
Paragraph -I
Paragraph 4 prohibits discrimination in the allowance of deductions. When a resident or
an enterprise of a Contracting State pays interest, royalties or other disbursements to a resident
of the other Contracting State, the first-mentioned Contracting State must allow a deduction for
those payments in computing the taxable profits of the resident or enterprise as if the payment
had been made under the same conditions to a resident of the first-mentioned Contracting State.
Paragraph 4, however. does not require a Contracting State to give non-residents more favorable
treatment than it gives to its own residents. Consequently, a Contracting State does not have to
allow non-residents a deduction for items that are not deductible under its domestic law (for
example. expenses of a capital nature).
The term "other disbursements" is understood to include a reasonable allocation of
executive and general administrative expenses, research and development expenses and other
expenses incurred for the benetit of a group of related persons that includes the person incurring
the expense.
An exc,epti?n to the rule. of paragraph. 4 is provided for cases where the provisions of
paragraph lot. ArtIcle 9 (ASS?CIated EnterprIses). paragra'p~ 7 of Arti.cle 11 (Interest) or paragraph 6 of ArtIcle 12 (RoyaltIes) apply. All of these proVISIOns permIt the denial of deductions
in '~ertain circumstances in respect of transactions between related persons. Neither State is
72
forced to apply the non-discrimination principle in such cases. The exception with respect to
paragraph 7 of Article 11 would include the denial or deferral of certain interest deductions
under Code section 163(j).
Paragraph 4 also provides that any debts of an enterprise of a Contracting State to a
resident of the other Contracting State are deductible in the first-mentioned Contracting State for
purposes of computing the capital tax of the enterprise under the same conditions as if the debt
had been contracted to a resid~nt of the first-m.entioned Contracting State. Even though, for
general purposes, the ConventIOn covers only mcome taxes, under paragraph 7 of this Article,
the nondiscrimination provisions apply to all taxes levied in both Contracting States, at all levels
of government. Thus, this provision may be relevant for both States. Bulgaria may have capital
taxes and in the United States such taxes frequently are imposed by local governments.
Paragraph 5
Paragraph 5 requires that a Contracting State not impose more burdensome taxation or
connected requirements on an enterprise of that State that is wholly or partly owned or
controlled, directly or indirectly, by one or more residents of the other Contracting State than the
taxation or connected requirements that it imposes on other similar enterprises of that firstmentioned Contracting State. For this purpose it is understood that "similar" refers to similar
activities or ownership of the enterprise.
This rule, like all non-discrimination provisions, does not prohibit differing treatment of
entities that are in differing circumstances. Rather, a protected enterprise is only required to be
treated in the same manner as other enterprises that, from the point of view of the application of
the tax law, are in substantially similar circumstances both in law and in fact. The taxation of a
distributing corporation under section 367(e) on an applicable distribution to foreign
shareholders does not violate paragraph 5 of the Article because a foreign-owned corporation is
not similar to a domestically-owned corporation that is accorded non-recognition treatment
under sections 337 and 355.
For the reasons given above in connection with the discussion of paragraph 2 of the
Article, it is also understood that the provision in section 1446 of the Code for withholding of tax
on non-U.S. partners does not violate paragraph 5 of the Article.
It is further understood that the ineligibility of a U.S. corporation with nonresident alien
shareholders to make an election to be an "S" corporation does not violate paragraph 5 of the
Article. If a corporation elects to be an S corporation, it is generally not subject to income tax
and the shareholders take into account their pro rata shares of the corporation's items of income,
loss, deduction or credit. (The purpose of the provision is to allow an individual or small group
of individuals the protections of conducting business in corporate form while paying taxes at
individual rates as if the business were conducted directly.) A nonresident alien does not pay
U.S. tax on a net basis, and, thus, does not generally take into account items of loss, deduction or
credit. Thus, the S corporation provisions do not exclude corporations with nonresident alien
shareholders because such shareholders are foreign, but only because they are not net-basis
taxpayers. Similarly, the provisions exclude corporations with other types of shareholders where
the purpose of the provisions cannot be fulfilled or their mechanics implemented. For example,
corporations with corporate shareholders are excluded because the purpose of the provision to
permit individuals to conduct a business in corporate form at individual tax rates would not be
furthered by their inclusion.
Finally, it is understood that paragraph 5 does not require a Contracting State to allow
frwign corporations to join in filing a consolidated return with a domestic corporation or to
aHli,' similar benefits between domestic and foreign enterprises.
73
Pawwaph 6
Paragraph 6 of the Article confinns that no provision of the Article will prevent either
Contracting State from imposing either the branch profits tax described in paragraph 8 of Article
10 (Dividends) or the branch-level interest tax described in paragraph 9 of Article 11 (Interest).
ParaKraph 7
As noted above, notwithstanding the specification of taxes covered by the Convention in
Article 2 (Taxes Covered) for general purposes, for purposes of providing nondiscrimination
protection this Article applies to taxes of every kind and description imposed by a Contracting
State or a political subdivision or local authority thereof. Customs duties are not considered to
be taxes for this purpose.
Relationship to Other Articles
The saving clause of paragraph 4 of Article 1 (General Scope) does not apply to this
Article by virtue of the exceptions in paragraph 5(a) of Article 1. Thus, for example, a U.S.
citizen who is a resident of Bulgaria may claim benefits in the United States under this Article.
Nationals of a Contracting State may claim the benefits of paragraph 1 regardless of
\'.lJether they are entitled to benefits under Article 21 (Limitation on Benefits), because that
paragraph applies to nationals and not residents. They may not claim the benefits of the other
paragraphs of this Article with respect to an item of income unless they are generally entitled to
treaty benefits with respect to that income under a provision of Article 21.
ARTICLE 24 (MUTUAL AGREEMENT PROCEDURE)
This Article provides the mechanism for taxpayers to bring to the attention of competent
authorities issues and problems that may arise under the Convention. It also provides the
authority for cooperation between the competent authorities of the Contracting States to resolve
disputes and clarifY issues that may arise under the Convention and to resolve cases of double
taxation not provided for in the Convention. The competent authorities of the two Contracting
States are identified in paragraph l(k) of Article 3 (General Definitions).
Paragraph 1
This paragraph provides that where a resident of a Contracting State considers that the
actions of one or both Contracting States will result in taxation that is not in accordance with the
Convention he may present his case to the competent authority of either Contracting State. This
rule is more generous than in most treaties, which generally allow taxpayers to bring competent
authority cases only to the competent authority of their country of residence, or citizenship/nationality. Under this more generous rule, a U.S. permanent establishment of a
corporation resident in the treaty partner that faces inconsistent treatment in the two countries
would be able to bring its request for assistance to the U.S. competent authority. If the U.S.
competent authority can resolve the issue on its own, then the taxpayer need never involve the
Bulgarian competent authority. Thus, the rule provides flexibility that might result in greater
efficiency.
Although the typical cases brought under this paragraph will involve economic double
taxation arising from transfer pricing adjustments, the scope of this paragraph is not limited to
such cas~s. For example: a taxpayer could request assi~tance from the competent authority if one
Contractmg State detennmes that the taxpayer has receIved deferred compensation taxable at
source under Article 14 (Income from Employment), while the taxpayer believes that such
74
income should be treated as a pension that is taxable only in his country of residence pursuant to
Article 17 (Pensions, Social Security Payments, Annuities, Alimony, and Child Support).
It is not necessary for a person requesting assistance first to have exhausted the remedies
provided under the national laws of the Contracting States before presenting a case to the
competent authorities, nor does the fact that the statute of limitations may have passed for
seeking a refund preclude bringing a case to the competent authority. Unlike the OECD Model,
no time limit is provided within which a case must be brought.
Paragraph 2
Paragraph 2 sets out the framework within which the competent authorities will deal with
cases brought by taxpayers under paragraph 1. It provides that, if the competent authority of the
Contracting State to which the case is presented judges the case to have merit, and cannot reach a
unilateral solution, it shall seek an agreement with the competent authority of the other
Contracting State pursuant to which taxation not in accordance with the Convention will be
avoided.
Any agreement is to be implemented even if such implementation otherwise would be
barred by the statute of limitations or by some other procedural limitation, such as a closing
agreement. Paragraph 2, however, does not prevent the application of domestic-law procedural
limitations that give effect to the agreement (e.g., a domestic-law requirement that the taxpayer
file a return reflecting the agreement within one year of the date of the agreement). Where the
taxpayer has entered a closing agreement (or other written settlement) with the United States
before bringing a case to the competent authorities, the U.S. competent authority will endeavor
only to obtain a correlative adjustment from Bulgaria. See Rev. Proc. 2006-54, 2006-2 c.B.
1035, Section 7.05.
Because, as specified in paragraph 2 of Article 1 (General Scope), the Convention cannot
operate to increase a taxpayer's liability, temporal or other procedural limitations can be
overridden only for the purpose of making refunds and not to impose additional tax. Under
Bulgarian law, a taxpayer may secure payment of any tax due (for example, using a letter of
credit) and need not pay the entire amount of tax due until the competent authorities resolve the
case, while under U.S. law with respect to U.S. initiated adjustments the United States generally
will postpone further administrative action with respect to the issues under competent authority
consideration. See Rev. Proc. 2006-54, 2006-2 C.B. 1035, Section 7.01.
Paragraph 10 of the Protocol to the Convention sets forth two additional clarifications to
the application of paragraph 2 of Article 24. First, the Protocol notes that an agreement reached
would not affect any court proceedings or any tinal court decisions or final tax assessment acts.
This provision of the paragraph is intended to address certain aspects of the relationship of
mutual agreement procedures and judicial or assessment proceedings in Bulgaria.
Under Bulgarian law, a taxpayer may begin court proceedings either before or after it has
made a request for assistance under this Article. The Protocol confirms that Bulgarian judicial
proceedings involving mutual agreement procedure issues in question will not be inhibited
merely by the initiation of a request for competent authority assistance. Moreover, any final
judicial determination involving mutual agreement procedure issues may be set aside only if the
requirements under Bulgarian law for revision or repeal of final acts are fulfilled. Similarly, if
the Bulgarian revenue authority has finalized its tax assessment, irrespective of any ju~icial
activity, a mutual agreement procedure cannot change that assessment unless the reqUirements
under Bulgarian law for revision or repeal of final acts are fulfilled.
75
Under the Bulgarian law for revision or repeal of tinal acts, an assessment may be
changed based on new information. The Treasury Department understands that Bulgaria will
interpret broadly what constitutes "new information." For example, if an examination in
Bulgaria is completed and closed, the Bulgarian competent authority may nonetheless accept a
request for assistance based on new information, such as an adjustment in the United States.
Second, paragraph 10 of the Protocol notes that if an examination is completed and
closed (and the subject of the mutual agreement procedure request is not a matter pending before
a court or for which a settlement or court decision has been reached) in a Contracting State, that
Contracting State's competent authority may nonetheless accept a request for assistance if an
adjustment causing double taxation is made in the other Contracting State. This provision of the
Protocol confirms that the Bulgarian competent authority can accept a mutual agreement
procedure request based upon a US-initiated adjustment and can subsequently implement any
resulting competent authority agreement, so long as the issue that is the subject of the mutual
agreement procedure request is neither an issue presented to and pending before a Bulgarian
court, nor one for which a Bulgarian judicial decision or litigation settlement has been
concluded.
Paragraph 3
Paragraph 3 authorizes the competent authorities to resolve difficulties or doubts that
may arise as to the application or interpretation of the Convention. The paragraph includes a
non- exhaustive list of examples of the kinds of matters about which the competent authorities
may reach agreement. This list is purely illustrative; it does not grant any authority that is not
implicitly present as a result of the introductory sentence of paragraph 3.
The competent authorities may, for example, agree to the same allocation of income,
deductions, credits or allowances between an enterprise in one Contracting State and its
permanent establishment in the other or between related persons. These allocations are to be
made in accordance with the arm's length principle underlying Article 7 (Business Profits) and
Article 9 (Associated Enterprises). Agreements reached under these subparagraphs may include
agreement on a methodology for determining an appropriate transfer price, on an acceptable
range of results under that methodology, or on a common treatment of a taxpayer's cost sharing
arrangement.
The competent authorities also may agree to settle a variety of conflicting applications of
the Convention. They may agree to settle conflicts regarding the characterization of particular
items of income, the characterization of persons, the application of source rules to particular
items of income, or the meaning of a term. They also may agree as to advance pricing
arrangements.
Since the list under paragraph 3 is not exhaustive, the competent authorities may reach
agreement on issues not enumerated in paragraph 3 if necessary to avoid double taxation. For
example, the competent authorities may seek agreement on a uniform set of standards for the use
of exchange rates. Agreements reached by the competent authorities under paragraph 3 need not
conform to the intemallaw provisions of either Contracting State.
. . ~inally. paragraP.h 3 .authorizes the cO.mpetent .authorities to consult for the purpose of
e~I~Inat~ng double taxa~I?n In cases n?t proVIde? for In the. C0!lvention and to resolve any
dIfficultIes or doubts arIsmg as to the mterpretatIOn or applIcatIOn of the Convention. This
provis,ion is intended t~ permi.t the cO?1p~tent authorities to implement the treaty in particular
cases I!l. a manner th~t IS conSIstent WIt~ It~ expres~e.d general purposes. It permits the competent
authontIcs to deal WIth cases that are wIthm the spmt of the provisions but that are not
sr "'itically covered. An example of such a case might be double taxation arising from a transfer
76
pri~ing adjustment bet~een two. per~anent esta~lishments of a third-country resident, one in the
Umted States and one m Bulgaria. Smce no reSIdent of a Contracting State is involved in the
case, the Convention does not apply, but the competent authorities nevertheless may use the
authority of this Article to prevent the double taxation of income.
Paragraph 4
Paragraph 4 authorizes the competent authorities to increase any dollar amounts referred
to in the Convention to reflect economic and monetary developments. Under the Convention,
this refers only to Article 16 (Entertainers and Sportsmen); Article 19 (Students, Trainees,
Teachers and Researchers) separately instructs the competent authorities to adjust the exemption
amount for students and trainees in accordance with specified guidelines. The rule under
paragraph 4 is intended to operate as follows: if, for example, after the Convention has been in
force for some time, inflation rates have been such as to make the $15,000 exemption threshold
for entertainers unrealistically low in terms of the original objectives intended in setting the
threshold, the competent authorities may agree to a higher threshold without the need for formal
amendment to the treaty and ratification by the Contracting States. This authority can be
exercised, however, only to the extent necessary to restore those original objectives. This
provision can be applied only to the benefit of taxpayers (i.e., only to increase thresholds, not to
reduce them).
Paragraph 5
Paragraph 5 provides that the competent authorities may communicate with each other
for the purpose of reaching an agreement. This makes clear that the competent authorities of the
two Contracting States may communicate without going through diplomatic channels. Such
communication may be in various forms, including, where appropriate, through face-to-face
meetings of representatives of the competent authorities.
Treaty termination in relation to competent authority dispute resolution
A case may be raised by a taxpayer after the Convention has been terminated with respect
to a year for which the Convention was in force. In such a case the ability of the competent
authorities to act is limited. They may not exchange confidential information, nor may they
reach a solution that varies from that specified in its law.
Triangular competent authority solutions
International tax cases may involve more than two taxing jurisdictions (e.g., transactions
among a parent corporation resident in country A and its subsidiaries resident in countries Band
C). As long as there is a complete network of treaties among the three countries, it should be
possible, under the full combination of bilateral authorities, for the competent authorities of the
three States to work together on a three-sided solution. Although country A may not be able to
give information received under Article 25 (Exchange of Information and Administrative
Assistance) from country B to the authorities of country C, if the competent authorities of the
three countries are working together, it should not be a problem for them to arrange for the
authorities of country B to give the necessary information directly to the tax authorities of
country C, as well as to those of country A. Each bilateral part of the. t!ilateral solution must, of
course, not exceed the scope of the authority of the competent authontles under the relevant
bilateral treaty.
77
Relutionship 10 Other Articles
This Article is not subject to the saving clause of paragraph 4 of Article 1 (General
Scope) by virtue of the exceptions in paragraph 5(a) of that Article. Thus, rules, definitions,
procedures, etc. that are agreed upon by the competent authorities under this Article may be
applied by the United States with respect to its citizens and residents even if they differ from the
comparable Code provisions. Similarly, as indicated above, U.S. law may be overridden to
provide refunds of tax to a U.S. citizen or resident under this Article. A person may seek relief
under Article 24 regardless of whether he is generally entitled to benefits under Article 21
(Limitation on Benefits). As in all other cases, the competent authority is vested with the
discretion to decide whether the claim for relief is justified.
ARTICLE 25 (EXCHANGE OF INFORMATION AND ADMINISTRATIVE
ASSIST ANCE)
This Article provides for the exchange of information and administrative assistance
between the competent authorities of the Contracting States.
Paragraph 1
The obligation to obtain and provide information to the other Contracting State is set out
in paragraph 1. The information to be exchanged is that which may be relevant for carrying out
the provisions of the Convention or the domestic laws of the United States or of Bulgaria
concerning taxes of every kind applied at the national level. This language incorporates the
standard in 26 U.S.C. section 7602 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.
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 with respect to a covered tax, 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 the
OECD Commentary: a company resident in the United States and a company resident in
Bulgaria transact business between themselves through a third-country resident company.
Neither Contracting State has a treaty with the third State. To enforce their intemallaws 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
colle.ction of, the enforcement or prosecution. in respect of, or the determination of appeals in
relatIOn t?, t~e taxes ~overed by the ConventI~n. Thus, th: c?mp~tent authorities may request
and proVIde mformatlOn for cases under exammatlOn or cnmmal mvestigation in collection on
appeals, or under prosecution.
'
,
The taxes covered by the Convention for purposes of this Article constitute a broader
category of taxes than those referred to in Article 2 (Taxes Covered). Exchange of information
78
is authorized with respect to taxes of every kind imposed by a Contracting State at the national
level. Accordingly, information may be exchanged with respect to U.S. estate and gift taxes,
excise taxes or, with respect to Bulgaria, value added taxes.
Information exchange is not restricted by paragraph 1 of Article 1 (General Scope).
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 Bulgaria, 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 Bulgaria,
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 Bulgaria 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 for most
purposes of the Convention, section 7651 of the Code authorizes the Internal Revenue Service to
utilize the provisions of the Internal Revenue Code to obtain information from the U.S.
possessions pursuant to a proper request made under Article 25. Ifnecessary to obtain requested
information, the Internal Revenue Service could issue and enforce an administrative summons to
the taxpayer, a tax authority (or a government agency in a U.S. possession), or a third party
located in aU. S. possession.
Paragraph 2
Paragraph 2 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 3
Paragraph 3 also 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. Information received may be disclosed only to persons, 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
covered by the Convention. The information must be used by these persons in connection with
the specified functions. Information may also be disclosed to legislative bodies, such as the taxwriting committees of Congress and the 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.
Paragraph 4
Paragraph 4 provides that the obligation~ undertaken in paragraph~ ~, 2, ~nd 3 to
exchange information do not require a Contractmg State to carry out admlmstratlve 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
79
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 \vould 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 4 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 5
Paragraph 5 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 4(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 4 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 6
Paragraph 6 provides that a Contracting State may not decline to provide information
because that information is held by financial institutions, nominees or persons acting in an
agency or fiduciary capacity. Thus, paragraph 6 would effectively prevent a Contracting State
hom relying on paragraph 4 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 o\Vner of an interest in a person, such as the
identity of a beneficial owner of bearer shares.
Treaty effective dates and termination in relation to exchange of information
Once the Convention is in force, the competent authority may seek information under the
Convention. with respect to a ye~r prior to the .entry,into force oft~e Convention. Even though
no ConventIOn was m effect dunng the years m whIch the transactIOn at issue occurred the
~xch~nge of information provi~ions of the Convention shall h~ve effect from the date of entry
mto force of the ConventIOn WIthout regard to the taxable penod to which the matter relates. In
that case. the competent authorities have available to them the full range of information
exchange provisions afforded und~r this Articl~. Par~graph 11 of the Protocol, regarding Article
27 (Entry mto Force). confirms thIS understandmg With respect to the effective date of the
Article.
\\3S
. ~ tax a.dministration may also see~ information with respect to a year for which a treaty
m force after the treaty has been termmated. In such a case the ability of the other tax
80
administration to act is limited. The treaty no longer provides authority for the tax
administrations to exchange confidential information. They may only exchange information
pursuant to domestic law or other international agreement or arrangement.
ARTICLE 26 (MEMBERS OF DIPLOMATIC MISSIONS AND CONSULAR POSTS)
This Article confirms that any fiscal privileges to which diplomatic or consular officials
are entitled under general provisions of international law or under special agreements will apply
notwithstanding any provisions to the contrary in the Convention. The agreements referred to
include any bilateral agreements, such as consular conventions, that affect the taxation of
diplomats and consular officials and any multilateral agreements dealing with these issues, such
.as the Vienna Convention on Diplomatic Relations and the Vienna Convention on Consular
Relations. The U.S. generally adheres to the latter because its terms are consistent with
customary international law.
The Article does not independently provide any benefits to diplomatic agents and
consular officers. Article 18 (Government Service) does so, as do Code section 893 and a
number of bilateral and multilateral agreements. In the event that there is a conflict between the
Convention and international law or such other treaties, under which the diplomatic agent or
consular official is entitled to greater benefits under the latter, the latter laws or agreements shall
have precedence. Conversely, if the Convention confers a greater benefit than another
agreement, the affected person could claim the benefit of the tax treaty.
Pursuant to subparagraph 5(b) of Article 1, the saving clause of paragraph 4 of Article 1
(General Scope) does not apply to override any benefits of this Article available to an individual
who is neither a citizen of the United States nor has immigrant status in the United States.
ARTICLE 27 (ENTRY INTO FORCE)
This Article contains the rules for bringing the Convention into force and giving effect to
its provisions.
Paragraph 1
Paragraph 1 provides that the Contracting States shall notify each other, through
diplomatic channels, when their respective requirements for the entry into force of the
Convention have been satisfied. The Convention shall enter into force on the date of receipt of
the later of these notifications.
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 an~ make a reco~endatIOn
regarding its approval to the full Senate. B?th ~overnI?ent and prIvate sect?r wl~nesses may
testify at these hearings. After the Senate gIves Its adVIce and consent to ratIficatIOn of the
treaty, an instrument of ratification is drafted for the President's signature. The
President's signature completes the process in the United States.
81
Paragraph :2
The date on \vhich a Convention enters into force is not necessarily the date on which its
provisions take etTect. Paragraph 2 contains rules that detennine when the provisions of the
Convention will have etTect.
Under paragraph 2(a), the Convention will have effect with respect to taxes withheld at
source (principally dividends, interest and royalties) for amounts paid or credited on or after the
tirst day of January in the calendar year following the date on which the Convention enters into
th
force. For example, if instruments ofratification are exchanged on April 25 of year 1, the
withholding rates specified in paragraph 2 of Article 10 (Dividends) would be applicable to any
dividends paid or credited on or after January 1 of year 2.
For all other taxes, paragraph 2(b) specifies that the Convention will have effect for any
taxable period beginning on or after January 1 of the year following entry into force.
As discussed under Article 25 (Exchange of Infonnation), the powers afforded under that
article apply retroactively to taxable periods preceding entry into force.
ARTICLE 28 (TERMINATION)
The Convention is to remain in effect indefinitely, unless tenninated by one of the
Contracting States in accordance with the provisions of Article 28. For example, if written
notice of tennination is given through the diplomatic channel not later than June 30th of calendar
year 1, the provisions of the Convention will cease to have effect with respect to taxes withheld
at source on income paid or credited on or after January 15t of calendar year 2. For other taxes,
the Convention will cease to have effect for any taxable period beginning on or after January 1st
of calendar year 2.
Article 28 relates only to unilateral tennination of the Convention by a Contracting State.
Nothing in that Article should be construed as preventing the Contracting States from concluding
a new bilateral agreement, subject to ratification, that supersedes, amends or tenninates provisions of the Convention without the notification period.
Customary international law observed by the United States and other countries, as
reflected in the Vienna Convention on Treaties, allows tennination by one Contracting State at
any time in the event of a "material breach" of the agreement by the other Contracting State.
)77: WEEK 11 WRAP-UP:<br>rREASURY SENT 7.530 MILLION STIMULUS PAYMENTS Too. Page 1 of2
10 view or prmt tne fJUI- content on tn,s page, C1ownloaC1 tne tree AC1obe® Acrobat® KeaC1er®.
July 11, 2008
HP-1077
WEEK 11 WRAP-UP:
TREASURY SENT 7.530 MILLION STIMULUS PAYMENTS THIS WEEK
This week the Treasury Department sent out 7.530 million economic stimulus
payments to American households totaling $5.755 billion. In total, Treasury has
sent out 112.405 million total economic stimulus payments totaling $91.834 billion.
This week marks the final week of mass disbursements of stimulus payments.
Payments will continue to be sent to households in small batches throughout the
end of the year as returns are filed by the October 15 extension deadline. Those
Americans who do not file by October 15 and still qualify for a payment can obtain
their stimulus payment by filing a 2008 tax return next year.
Cumulative Total
Total Number of Payments: 112.405 million
Total Amount of Payments: $91.834 billion
Week Eleven (July 7-11)
Total Number of Payments: 7.530 million
Total Amount of Payments: $5.755 billion
Week Ten (June 30-July 4)
Total Number of Payments: 10.025 million
Total Amount of Payments: $7.775 billion
Week Nine (June 23-27)
Total Number of Payments: 9.674 million
Total Amount of Payments: $7.522 billion
Week Eight (June 16-20)
Total Number of Payments: 9.071 million
Total Amount of Payments: $6.919 billion
Week Seven (June 9-13)
Total Number of Payments: 9.526 million
Total Amount of Payments: $7.032 billion
Week Six (June 2-6)
Total Number of Payments: 9.143 million
Total Amount of Payments: $6.789 billion
Week Five (May 26-30)
Total Number of Payments: 5.757 million
Total Amount of Payments: $4.320 billion
http://www.treas.gov/press/releaseslhpl077.htm
81112008
·1077: WEEK 11 WRAP-UP:<br>TREASURY SENT 7.530 MILLION STIMULUS PAYMENTS T... Page 2 of 2
Week Four (May 19-23)
Total Number of Payments: 6.211 million
Total Amount of Payments: $4.927 billion
Week Three (May 12-16)
Total Number of Payments: 15.575 million
Total Amount of Payments: $13.562 billion
Week Two (May 5-9)
Total Number of Payments: 22.180 million
Total Amount of Payments: $20.138 billion
Week One (April 28-May 2)
Total Number of Payments: 7.708 million
Total Amount of Payments: $7.091 billion
Payments began April 28 and will continue via direct deposit or paper check
through mid·July. For a single filer, the minimum payment is generally $300 and
the maximum payment is $600. For joint filers. the minimum is generally $600 and
the maximum $1,200. There is also an additional $300 payment for each qualifying
Child.
For tax returns processed by the Internal Revenue Service by April 15 households
will receive their payments according to the last two digits of the Social Security
number on the tax form. On a jOint return, the first number listed will determine
when a stimulus payment will be sent.
REPORTS
•
Pire~t Oel2osit Payments
http://www.treas.gov/press/re\eases/hpl077.htm
8/1/2008
Direct Deposit Payments
If the last two digits of your Social Security
number are:
Your economic stimulus payment deposit
should be transmitted to your bank account
by:
00-20
21-75
76-99
May 2
May 9
May 16
Paper Check
If the last two digits of your Social Security
number are:
00-09
10-18
19-25
26-38
39-51
52-63
64-75
76-87
88-99
Your check should be in the mail by:
May 16
May 23
May 30
June 6
June 13
June 20
June 27
July 4
July 11
A small percent of tax returns will require additional time to process and to compute a
stimulus payment amount. For these returns, stimulus payments may not be issued in
accordance with the schedule above, even if the tax return was processed by April 15. In
these cases, the stimulus payment will be issued approximately 2 weeks after the tax
return is ultimately processed.
-30-
J.1078: Statement by Secretary henry M. Paulson, lr. on Fannie Mae and Freddie Mac
/~'~~, PRESS
ROOM
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Page 1 of 1
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July 11, 2008
HP-1078
Statement by Secretary Henry M. Paulson, Jr. on Fannie Mae and Freddie Mac
Washington, DC--Secretary Henry M. Paulson, Jr. made the following comment
today on news stories about "contingency planning" at Treasury:
"Today our primary focus is supporting Fannie Mae and Freddie Mac in their
current form as they carry out their important mission.
"We appreciate Congress' important efforts to complete legislation that will help
promote confidence in these companies. We are maintaining a dialogue with
regulators and with the companies. OFHEO will continue to work with the
companies as they take the steps necessary to allow them to continue to perform
their important public mission."
-30-
://WWw.treas.gov/press/releases/hpl078.htm
811/2008
P-I079: Paubuli Announccli G::JIi lrutlatives
Page 1 of 1
/£'~~, PRESS ROOM
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July 13, 2008
HP-1079
Paulson Announces GSE Initiatives
Washington, DC-- Treasury Secretary Henry M. Paulson, Jr. issued the following
statement:
Fannie Mae and Freddie Mac playa central role in our housing finance system and
must continue to do so in their current form as shareholder-owned companies.
Their support for the housing market is particularly important as we work through
the current housing correction.
GSE debt is held by financial institutions around the world. Its continued strength is
important to maintaining confidence and stability in our financial system and our
financial markets. Therefore we must take steps to address the current situation as
we move to a stronger regulatory structure.
In recent days, I have consulted with the Federal Reserve, OFHEO, the SEC,
Congressional leaders of both parties and with the two companies to develop a
three-part plan for immediate action. The President has asked me to work with
Congress to act on this plan immediately.
First, as a liquidity backstop, the plan includes a temporary increase in the line of
credit the GSEs have with Treasury. Treasury would determine the terms and
conditions for accessing the line of credit and the amount to be drawn.
Second, to ensure the GSEs have access to sufficient capital to continue to serve
their mission, the plan includes temporary authority for Treasury to purchase equity
in either of the two GSEs if needed.
Use of either the line of credit or the equity investment would carry terms and
conditions necessary to protect the taxpayer.
Third, to protect the financial system from systemic risk going forward, the plan
strengthens the GSE regulatory reform legislation currently moving through
Congress by giving the Federal Reserve a consultative role in the new GSE
regulator's process for setting capital requirements and other prudential standards.
I look forward to working closely with the Congressional leaders to enact this
legislation as soon as possible, as one complete package.
-30-
http://www.treas.gov/press/reJeases/hpl079.htm
8/1/2008
Page 1 of 4
PRESS ROOM
JUlY 1"1', LVVU
2008-7 -14-17 -17 -49-22597
U.S. International Reserve Position
The Treasury Department today released U.S. reserve assets data for the latest week. As indicated in this table, U.S.
reserve assets totaled $74,082 million as of the end of that week, compared to $74, 508 million as of the end of the
prior week.
I. Official reserve assets and other foreign currency assets (approximate market value. In US millions)
I
II
IIJune 13.2008
I
I
A. Official reserve assets (in US millions unless otherwise specified) 1
JIEuro
Ilyen
1(1) Foreign currency reserves (in convertible foreign currencies)
II
I(a) Securities
11 9.797
II
1111.831
lof which issuer headquartered in reporting country but located abroad
II
II
I(b) total currency and deposits with:
II
l(i) other national central banks, BIS and IMF
Iii) banks headquartered
In
11 74 ,082
11 21 ,628
110
II
II
14.579
IITotal
5,842
the reporting country
11 20 .421
110
11 0
lof which located abroad
11 0
11 0
I(iii) banks headquartered outside the reporting country
lof which located in the reporting country
1(2) IMF reserve position 2
11 5,064
1(3) SDRs 2
11 9 ,682
(4) gold (including gold deposits and, If appropriate, gold swapped) 3
11 11 ,041
I--volume in millions of fine troy ounces
11261499
1(5) other reserve assets (specify)
11 6 ,246
I--financial derivatives
II
I--Ioans to nonbank nonresidents
II
--other (foreign currency assets invested through reverse repurchase
agreements)
11 6 ,246
B. Other foreign currency assets (specify)
JI
--securities not included in official reserve assets
JI
--deposits not included in official reserve assets
II
--loans not included in official reserve assets
J
--financial derivatives not included In offiCial reserve assets
J
--gold not included in official reserve assets
I
[ --other
1
II
II
Ii. Predetermined short-term net drains on foreign currency assets (nominal value)
ttp:IIWWW.treas.gov/press/releases/200871417174922597.htm
81112008
Page 2 of 4
[
II
Ilprincipal
I
I--inflows (+)
IIlnterest
IIPrlnclpal
I
IIlnterest
II
II
II
I
More than 3
months and up to
1 year
More than 1and
up to 3 months
CUpto1mooth
[
11. Foreign currency loans, SeCUrities, and deposits
I--outflows (-)
I
II
II
II
II Maturity breakdown (residual maturity)
[
I
II
II
II
I
II
II
II
I
II
I
II
I
2. Aggregate short and long positions in forwards and
futures in foreign currencies vis-a-vis the domestic
currency (includlnQ the forward leq of currency swaps)
(a) Short
~ositions ( _ ) 4
~62,OOO
~62,OOO
I
(b) Long positions (+)
3. Other (specify)
--outflows related to repos
I
(~)
I
--inflows related to reverse repos (+)
--trade credit (-)
--trade cred it (+)
-~other
accounts payable
(~)
--other accounts receivable (+)
III. Contingent short-term net drains on foreign currency assets (nominal value)
II
II
I
IMaturity breakdown (residual maturity, where
applicable)
I
[
11 Contingent liabilities
In
foreign currency
(a) Collateral guarantees on debt falling due within 1
year
I(b) Other contingent liabilities
More than 3
months and up to
1 year
More than 1 and
up to 3 months
CUPto1mooth
II
II
II
I
JI
I
I
I
II
2. Foreign currency securities issued with embedded
options (puttable bonds)
JI
13. Undrawn, unconditional credit lines provided by:
II
(a) other national monetary authorities, BIS, IMF, and
other international organizations
I
I
I--other national monetary authorities (+)
I
II
t- BIS (+)
II
t~IMF (+)
(b) with banks and other financial institutions
headquartered in the reporting country (+)
II
(c) With banks and other financial institutions
headquartered outside the reporting country (+)
I!
Undrawn, unconditional credit lines provided to
J
(a) other national
@FedFRASER