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Harrington Speaks On Pending Tax Treaty Issues

by Mike Godfrey, Tax-News.com, Washington

19 July 2007


Speaking on Tuesday before the Senate Committee on Foreign Relations, the US Treasury's International Tax Counsel, John Harrington outlined the Administration's plans for pending income tax agreements.

He told Committee members that:

"I appreciate the opportunity to appear today at this hearing to recommend, on behalf of the Administration, favorable action on four tax agreements that are pending before this Committee. We appreciate the Committee's interest in these agreements and in the US tax treaty network, as demonstrated by the scheduling of this hearing."

"This Administration is dedicated to eliminating unnecessary barriers to cross-border trade and investment. The primary means for eliminating tax barriers to trade and investment are bilateral tax treaties. Tax treaties eliminate barriers by providing greater certainty to taxpayers regarding their potential liability to tax in the foreign jurisdiction; by allocating taxing rights between the two jurisdictions so that the taxpayer is not subject to double taxation; by reducing the risk of excessive taxation that may arise because of high gross-basis withholding taxes; and by ensuring that taxpayers will not be subject to discriminatory taxation in the foreign jurisdiction."

"The international network of over 2,500 bilateral tax treaties has established a stable framework that allows international trade and investment to flourish. The success of this framework is evidenced by the fact that countless cross-border transactions, from an individual's investment in a few shares of a foreign company to a multi-billion dollar purchase of a foreign operating company, take place each year, with only a relatively few disputes regarding the allocation of tax revenues between governments."

"To ensure that our tax treaties cannot be used inappropriately, we continually monitor our existing network of tax treaties to make sure that each treaty continues to serve its intended purposes and is not being exploited for unintended purposes. A tax treaty reflects a balance of benefits that is struck when the treaty is negotiated and that can be affected by future developments. In some cases, changes in law or policy in one or both of the treaty partners may make it possible to increase the benefits provided by the treaty; in these cases, negotiation of a new or revised agreement may be very beneficial."

"In other cases, developments in one or both countries, or international developments more generally, may require a revisiting of the agreement to prevent exploitation and eliminate unintended and inappropriate consequences; in these cases, it may be necessary to modify or even terminate the agreement. Both in setting our overall negotiation priorities and in negotiating individual agreements, 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 agreements before the Committee today with Belgium, Denmark, Finland, and Germany serve to further the goals of our tax treaty network and improve long-standing treaty relationships. We urge the Committee and the Senate to take prompt and favorable action on all of these agreements."

He continued:

"I now would like to discuss the four agreements that have been transmitted for the Senate's consideration. We have submitted a Technical Explanation of each agreement that contains detailed discussions of the provisions of each treaty or protocol. These Technical Explanations serve as an official guide to each agreement."

With regard to the pending protocol to update the treaty with Finland, Mr Harrington explained that:

"The proposed Protocol with Finland was signed in Helsinki on May 31, 2006, and amends the current Convention, which entered into force in 1990. The most significant provisions in this agreement relate to dividends, royalties, anti-abuse provisions, and exchange of information. The Protocol also makes a number of necessary updates to the current Convention and brings the Convention more in line with recent agreements with other Nordic countries. "

"The proposed Protocol makes a number of changes to the dividend article of the current Convention...the proposed Protocol eliminates the source-country withholding tax on many intercompany dividends. In general, a company receiving a dividend must have a substantial interest in the distributing corporation for a 12-month period and meet special limitation on benefits provisions to qualify for the exemption from withholding tax. The proposed Protocol also eliminates the source-country withholding tax on dividends paid to pension funds. This provision is necessary to eliminate the double taxation that occurs when tax is imposed on distributions to pension funds that cannot be credited or used against further tax in the hands of the beneficiaries of the fund. The proposed Protocol also updates the dividend article to incorporate policies reflected in the US Model provision, such as those regarding real estate investment trusts (REITs)."

Once ratified by the Senate, the proposed Protocol will enter into force upon the exchange of instruments of ratification. For taxes withheld at source, the proposed Protocol will generally have effect within two months after entry into force. However, if such instruments are exchanged before December 31, 2007, the countries agreed to eliminate withholding taxes for intercompany dividends and dividends to pension funds for dividends derived on or after January 1, 2007. With respect to other taxes, the Protocol will have effect January first of the year following the year in which the Protocol enters into force.

Commenting on the arrangements shortly to be put in place between the United States and Denmark, the International Tax Counsel explained that:

"The proposed Protocol with Denmark was signed in Copenhagen on May 2, 2006. The proposed Protocol closely follows the recent protocol with Sweden, which entered into force in 2006, and the proposed Protocol with Finland, described above, with respect to dividends and limitation on benefits. "

"As noted above, the proposed Protocol amends the dividend article to eliminate the withholding tax on intercompany dividends when a company meets certain ownership and limitation on benefits requirements. In addition, the proposed Protocol conforms to current US tax treaty policy by eliminating withholding tax on dividends to pension funds. The provisions of the current Convention applicable to regulated investment companies (RICs) and REITs are updated to apply reciprocally, should Denmark and the United States agree that certain Danish companies are similar to US RICs and REITs. In addition, the proposed Protocol includes other updates to the dividend article, including a definition of "diversified" to clarify the application of the REIT provisions adopted in 1999."

"The proposed Protocol makes changes to the limitation on benefits provision to tighten the publicly traded test, consistent with the policy reflected in the US Model treaty. It also tightens the limitation on benefits provision by adopting a triangular provision similar to the provision adopted in the proposed Protocol with Finland and in many other U.S. tax treaties; the provision would deny full U.S. treaty benefits to Danish enterprises with respect to certain income exempt from tax in Denmark. The Protocol continues the special rules applicable to Danish taxable nonstock corporations. A Danish taxable nonstock corporation is a vehicle used to prevent takeovers of operating companies through control of voting shares, with public shareholders receiving most rights to dividends of the operating company. Because of the constraints applicable to such corporations, the structure is not likely to be subject to treaty shopping abuses."

Following Senate ratification, the proposed Protocol will enter into force upon the receipt of the later of the notifications that the requirements for entry into force have been met in each country. It will have effect within two months of entry into force for taxes withheld at source. With respect to other taxes, the proposed Protocol will have effect January first of the year following the year in which the Protocol enters into force.

With regard to Germany, he announced that:

"The proposed Protocol was signed in Berlin on June 1, 2006, and amends the current Convention, concluded in 1989. The most significant provisions in this agreement relate to taxation of cross-border dividend payments, coordination of pension rules, and adoption of mandatory arbitration as part of the mutual agreement procedure. The proposed Protocol also makes a number of changes to reflect changes in US and German law, and to bring the Convention into closer conformity with current US tax treaty policy."

"The proposed Protocol updates the current Convention's treatment of pensions. It removes barriers to the flow of personal services between the United States and Germany that could otherwise result from discontinuities in the laws of the two countries regarding the deductibility of pension contributions. Like the US Model treaty, an individual employed in one country who participates in a pension plan in the other may, subject to certain conditions, be allowed in his country of employment to deduct contributions to his plan in the other country. Because significant changes in German law will phase in over time to allow Germany to tax distributions of retirement income rather than taxing contributions and accretions to pension funds, the United States has agreed to consult with Germany in the future (but not before January 1, 2013) to provide for limited source-based taxation of certain distributions of retirement income."

He added that:

"The proposed Protocol makes a number of changes to the current Convention to reflect legislative changes since 1989 and current treaty policy. For example, the proposed Protocol provides that former citizens or long-term residents of the United States may for the period of ten years following the loss of such status be taxed in accordance with the laws of the United States, makes technical changes to the article dealing with the elimination of double taxation, significantly strengthens the treaty's limitation on benefits provisions, and adopts the US Model treaty approach to attribution of profits to a permanent establishment."

Once ratified by the Senate, the proposed amendments will enter into force upon the exchange of instruments of ratification. For taxes withheld at source, the proposed Protocol will generally have effect January first of the year in which it enters into force. With respect to other taxes, the Protocol generally will have effect January first of the year following the year in which the Protocol enters into force. Special effective date rules apply to arbitration in the mutual agreement process, taxation of income from government service, and coordination of the treaty's nondiscrimination provisions with those of non-tax agreements. The taxpayer may elect to apply the current Convention, as unmodified by the proposed Protocol, for the year following these effective dates.

Moving on to Belgium, Mr Harrington explained that:

"The proposed income tax Convention and accompanying Protocol (the proposed Treaty) with Belgium was negotiated to replace the current Convention, concluded in 1970 and amended by protocol in 1987 (the existing Convention). The proposed Treaty makes a number of changes to conform to changes in US law and to reflect current US tax treaty policy, particularly with respect to exchange of information."

Following Senate ratification, the proposed Treaty will enter into force upon the exchange of instruments of ratification and notification through diplomatic channels. For taxes withheld at source, the proposed Treaty will generally have effect within two months after entry into force. With respect to other taxes, the proposed Treaty will have effect January first of the year following the year in which the proposed Treaty enters into force. Special effective date rules apply to the limitation on benefits provision relating to headquarters companies, arbitration in the mutual agreement process and exchange of information. In general, the taxpayer may elect to extend the application of the existing Convention (in its entirety) to the 12-month period following the effective dates of this proposed Treaty. However, the election does not affect the effective date of the new exchange of information provisions.

Commenting on current treaty program priorities, the Treasury official told the Committee that:

"We continue to maintain a very active calendar of tax treaty negotiations. We recently signed treaties with Bulgaria and Iceland. We have substantially completed work with Canada and Norway, and we currently are in ongoing negotiations with Chile and Hungary. We also expect to announce soon the onset of other negotiations."

"A key continuing priority is updating the few remaining US 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. We also have undertaken exploratory discussions with several countries in Asia and South America that we hope will lead to productive negotiations later in 2007 or 2008."

He concluded:

"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 four agreements under consideration. We appreciate the Committee's continuing interest in the tax treaty program, and 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 staffs of this Committee and of the Joint Committee on Taxation in the tax treaty process."

"On behalf of the Administration, we urge the Committee to take prompt and favorable action on the agreements before you today."


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