[JPRT 106-5-99]
[From the U.S. Government Publishing Office]
JCS-5-99
[JOINT COMMITTEE PRINT]
EXPLANATION OF PROPOSED
INCOME TAX TREATY BETWEEN
THE UNITED STATES AND
THE REPUBLIC OF LITHUANIA
Scheduled for a Hearing
before the
COMMITTEE ON FOREIGN RELATIONS
UNITED STATES SENATE
ON OCTOBER 13, 1999
__________
Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION
[GRAPHIC] [TIFF OMITTED]
OCTOBER 8, 1999
JOINT COMMITTEE ON TAXATION
106th Congress, 1st Session
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HOUSE SENATE
BILL ARCHER, Texas, WILLIAM V. ROTH, Jr., Delaware,
Chairman Vice Chairman
PHILIP M. CRANE, Illinois JOHN H. CHAFEE, Rhode Island
WILLIAM M. THOMAS, California CHARLES GRASSLEY, Iowa
CHARLES B. RANGEL, New York DANIEL PATRICK MOYNIHAN, New York
FORTNEY PETE STARK, California MAX BAUCUS, Montana
Lindy L. Paull, Chief of Staff
Bernard A. Schmitt, Deputy Chief of Staff
Mary M. Schmitt, Deputy Chief of Staff
Richard A. Grafmeyer, Deputy Chief of Staff
C O N T E N T S
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Page
Introduction..................................................... 1
I. Summary...........................................................2
II. Overview of U.S. Taxation of International Trade and Investment and
U.S. Tax Treaties.................................................4
A. U.S. Tax Rules........................................ 4
B. U.S. Tax Treaties..................................... 5
III.Explanation of Proposed Treaty....................................8
Article 1. General Scope................................ 8
Article 2. Taxes Covered................................ 10
Article 3. General Definitions.......................... 11
Article 4. Resident..................................... 12
Article 5. Permanent Establishment...................... 14
Article 6. GIncome From Immovable (Real) Property....... 16
Article 7. Business Profits............................. 17
Article 8. Shipping and Air Transport................... 20
Article 9. Associated Enterprises....................... 21
Article 10. Dividends.................................... 22
Article 11. Interest..................................... 25
Article 12. Royalties.................................... 28
Article 13. Capital Gains................................ 30
Article 14. Independent Personal Services................ 31
Article 15. Dependent Personal Services.................. 32
Article 16. Directors' Fees.............................. 33
Article 17. Artistes and Sportsmen....................... 33
Article 18. Pensions, Social Security, Annuities,
Alimony, and Child Support........................... 34
Article 19. Government Service........................... 34
Article 20. Students, Trainees and Researchers........... 35
Article 21. Offshore Activities.......................... 36
Article 22. Other Income................................. 37
Article 23. Limitation of Benefits....................... 38
Article 24. Relief From Double Taxation.................. 41
Article 25. Nondiscrimination............................ 43
Article 26. Mutual Agreement Procedure................... 44
Article 27. Exchange of Information and Administrative
Assistance........................................... 45
Article 28. Members of Diplomatic Missions and Consular
Posts................................................ 46
Article 29. Entry Into Force............................. 46
Article 30. Termination.................................. 47
IV. Issues...........................................................48
A. Treatment of REIT Dividends........................... 48
B. Developing Country Concessions........................ 52
C. Royalty Source Rules.................................. 55
D. Income from the Rental of Ships and Aircraft.......... 55
E. Treaty Shopping....................................... 56
INTRODUCTION
This pamphlet,\1\ prepared by the staff of the Joint
Committee on Taxation, describes the proposed income tax treaty
between the United States of America and the Republic of
Lithuania (``Lithuania''). The proposed treaty was signed on
January 15, 1998.\2\ The Senate Committee on Foreign Relations
has scheduled a public hearing on the proposed treaty on
October 13, 1999.
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\1\ This pamphlet may be cited as follows: Joint Committee on
Taxation, Explanation of Proposed Income Tax Treaty Between the United
States and the Republic of Lithuania (JCS-5-99), October 8, 1999.
\2\ For a copy of the proposed treaty, see Senate Treaty Doc. 105-
56, June 26, 1998.
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Part I of the pamphlet provides a summary with respect to
the proposed treaty. Part II provides a brief overview of U.S.
tax laws relating to international trade and investment and of
U.S. income tax treaties in general. Part III contains an
article-by-article explanation of the proposed treaty. Part IV
contains a discussion of issues with respect to the proposed
treaty.
I. SUMMARY
The principal purposes of the proposed income tax treaty
between the United States and Lithuania are to reduce or
eliminate double taxation of income earned by residents of
either country from sources within the other country and to
prevent avoidance or evasion of the taxes of the two countries.
The proposed treaty also is intended to promote close economic
cooperation between the two countries and to eliminate possible
barriers to trade and investment caused by overlapping taxing
jurisdictions of the two countries.
As in other U.S. tax treaties, these objectives principally
are achieved through each country's agreement to limit, in
certain specified situations, its right to tax income derived
from its territory by residents of the other country. For
example, the proposed treaty contains provisions under which
each country generally agrees not to tax business income
derived from sources within that country by residents of the
other country unless the business activities in the taxing
country are substantial enough to constitute a permanent
establishment or fixed base (Articles 7 and 14). Similarly, the
proposed treaty contains ``commercial visitor'' exemptions
under which residents of one country performing personal
services in the other country will not be required to pay tax
in the other country unless their contact with the other
country exceeds specified minimums (Articles 14, 15, and 17).
The proposed treaty provides that dividends, interest,
royalties, and certain capital gains derived by a resident of
either country from sources within the other country generally
may be taxed by both countries (Articles 10, 11, 12, and 13);
however, the rate of tax that the source country may impose on
a resident of the other country on dividends, interest, and
royalties generally will be limited by the proposed treaty
(Articles 10, 11, and 12).
In situations where the country of source retains the right
under the proposed treaty to tax income derived by residents of
the other country, the proposed treaty generally provides for
relief from the potential double taxation through the allowance
by the country of residence of a tax credit for certain foreign
taxes paid to the other country (Article 24).
The proposed treaty contains the standard provision (the
``saving clause'') included in U.S. tax treaties pursuant to
which each country retains the right to tax its residents and
citizens as if the treaty had not come into effect (Article 1).
In addition, the proposed treaty contains the standard
provision providing that the treaty may not be applied to deny
any taxpayer any benefits the taxpayer would be entitled to
under the domestic law of a country or under any other
agreement between the two countries (Article 1).
The proposed treaty also contains a detailed limitation on
benefits provision to prevent the inappropriate use of the
treaty by third-country residents (Article 23).
No income tax treaty between the United States and
Lithuania is in force at present. The proposed treaty is
similar to other recent U.S. income tax treaties, the 1996 U.S.
model income tax treaty (``U.S. model''), the model income tax
treaty of the Organization for Economic Cooperation and
Development (``OECD model''), and the United Nations Model
Double Taxation Convention between Developed and Developing
Countries (the ``U.N. model''). However, the proposed treaty
contains certain substantive deviations from those treaties and
models.
II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL TRADE AND INVESTMENT AND
U.S. TAX TREATIES
This overview briefly describes certain U.S. tax rules
relating to foreign income and foreign persons that apply in
the absence of a U.S. tax treaty. This overview also discusses
the general objectives of U.S. tax treaties and describes some
of the modifications to U.S. tax rules made by treaties.
A. U.S. Tax Rules
The United States taxes U.S. citizens, residents, and
corporations on their worldwide income, whether derived in the
United States or abroad. The United States generally taxes
nonresident alien individuals and foreign corporations on all
their income that is effectively connected with the conduct of
a trade or business in the United States (sometimes referred to
as ``effectively connected income''). The United States also
taxes nonresident alien individuals and foreign corporations on
certain U.S.-source income that is not effectively connected
with a U.S. trade or business.
Income of a nonresident alien individual or foreign
corporation that is effectively connected with the conduct of a
trade or business in the United States generally is subject to
U.S. tax in the same manner and at the same rates as income of
a U.S. person. Deductions are allowed to the extent that they
are related to effectively connected income. A foreign
corporation also is subject to a flat 30-percent branch profits
tax on its ``dividend equivalent amount,'' which is a measure
of the effectively connected earnings and profits of the
corporation that are removed in any year from the conduct of
its U.S. trade or business. In addition, a foreign corporation
is subject to a flat 30-percent branch-level excess interest
tax on the excess of the amount of interest that is deducted by
the foreign corporation in computing its effectively connected
income over the amount of interest that is paid by its U.S.
trade or business.
U.S.-source fixed or determinable annual or periodical
income of a nonresident alien individual or foreign corporation
(including, for example, interest, dividends, rents, royalties,
salaries, and annuities) that is not effectively connected with
the conduct of a U.S. trade or business is subject to U.S. tax
at a rate of 30 percent of the gross amount paid. Certain
insurance premiums earned by a nonresident alien individual or
foreign corporation are subject to U.S. tax at a rate of 1 or 4
percent of the premiums. These taxes generally are collected by
means of withholding.
Specific statutory exemptions from the 30-percent
withholding tax are provided. For example, certain original
issue discount and certain interest on deposits with banks or
savings institutions are exempt from the 30-percent withholding
tax. An exemption also is provided for certain interest paid on
portfolio debt obligations. In addition, income of a foreign
government or international organization from investments in
U.S. securities is exempt from U.S. tax.
U.S.-source capital gains of a nonresident alien individual
or a foreign corporation that are not effectively connected
with a U.S. trade or business generally are exempt from U.S.
tax, with two exceptions: (1) gains realized by a nonresident
alien individual who is present in the United States for at
least 183 days during the taxable year, and (2) certain gains
from the disposition of interests in U.S. real property.
Rules are provided for the determination of the source of
income. For example, interest and dividends paid by a U.S.
citizen or resident or by a U.S. corporation generally are
considered U.S.-source income. Conversely, dividends and
interest paid by a foreign corporation generally are treated as
foreign-source income. Special rules apply to treat as foreign-
source income (in whole or in part) interest and dividends paid
by certain U.S. corporations with foreign businesses and to
treat as U.S.-source income (in whole or in part) dividends
paid by certain foreign corporations with U.S. businesses.
Rents and royalties paid for the use of property in the United
States are considered U.S.-source income.
Because the United States taxes U.S. citizens, residents,
and corporations on their worldwide income, double taxation of
income can arise when income earned abroad by a U.S. person is
taxed by the country in which the income is earned and also by
the United States. The United States seeks to mitigate this
double taxation generally by allowing U.S. persons to credit
foreign income taxes paid against the U.S. tax imposed on their
foreign-source income. A fundamental premise of the foreign tax
credit is that it may not offset the U.S. tax liability on
U.S.-source income. Therefore, the foreign tax credit
provisions contain a limitation that ensures that the foreign
tax credit offsets only the U.S. tax on foreign-source income.
The foreign tax credit limitation generally is computed on a
worldwide basis (as opposed to a ``per-country'' basis). The
limitation is applied separately for certain classifications of
income. In addition, a special limitation applies to the credit
for foreign taxes imposed on foreign oil and gas extraction
income.
For foreign tax credit purposes, a U.S. corporation that
owns 10 percent or more of the voting stock of a foreign
corporation and receives a dividend from the foreign
corporation (or is otherwise required to include in its income
earnings of the foreign corporation) is deemed to have paid a
portion of the foreign income taxes paid by the foreign
corporation on its accumulated earnings. The taxes deemed paid
by the U.S. corporation are included in its total foreign taxes
paid and its foreign tax credit limitation calculations for the
year the dividend is received (or an amount is included in
income).
B. U.S. Tax Treaties
The traditional objectives of U.S. tax treaties have been
the avoidance of international double taxation and the
prevention of tax avoidance and evasion. Another related
objective of U.S. tax treaties is the removal of the barriers
to trade, capital flows, and commercial travel that may be
caused by overlapping tax jurisdictions and by the burdens of
complying with the tax laws of a jurisdiction when a person's
contacts with, and income derived from, that jurisdiction are
minimal. To a large extent, the treaty provisions designed to
carry out these objectives supplement U.S. tax law provisions
having the same objectives; treaty provisions modify the
generally applicable statutory rules with provisions that take
into account the particular tax system of the treaty partner.
The objective of limiting double taxation generally is
accomplished in treaties through the agreement of each country
to limit, in specified situations, its right to tax income
earned from its territory by residents of the other country.
For the most part, the various rate reductions and exemptions
agreed to by the source country in treaties are premised on the
assumption that the country of residence will tax the income at
levels comparable to those imposed by the source country on its
residents. Treaties also provide for the elimination of double
taxation by requiring the residence country to allow a credit
for taxes that the source country retains the right to impose
under the treaty. In addition, in the case of certain types of
income, treaties may provide for exemption by the residence
country of income taxed by the source country.
Treaties define the term ``resident'' so that an individual
or corporation generally will not be subject to tax as a
resident by both the countries. Treaties generally provide that
neither country will tax business income derived by residents
of the other country unless the business activities in the
taxing jurisdiction are substantial enough to constitute a
permanent establishment or fixed base in that jurisdiction.
Treaties also contain commercial visitation exemptions under
which individual residents of one country performing personal
services in the other will not be required to pay tax in that
other country unless their contacts exceed certain specified
minimums (e.g., presence for a set number of days or earnings
in excess of a specified amount). Treaties address passive
income such as dividends, interest, and royalties from sources
within one country derived by residents of the other country
either by providing that such income is taxed only in the
recipient's country of residence or by reducing the rate of the
source country's withholding tax imposed on such income. In
this regard, the United States agrees in its tax treaties to
reduce its 30-percent withholding tax (or, in the case of some
income, to eliminate it entirely) in return for reciprocal
treatment by its treaty partner.
In its treaties, the United States, as a matter of policy,
generally retains the right to tax its citizens and residents
on their worldwide income as if the treaty had not come into
effect. The United States also provides in its treaties that it
will allow a credit against U.S. tax for income taxes paid to
the treaty partners, subject to the various limitations of U.S.
law.
The objective of preventing tax avoidance and evasion
generally is accomplished in treaties by the agreement of each
country to exchange tax-related information. Treaties generally
provide for the exchange of information between the tax
authorities of the two countries when such information is
relevant for carrying out provisions of the treaty or of their
domestic tax laws. The obligation to exchange information under
the treaties typically does not require either country to carry
out measures contrary to its laws or administrative practices
or to supply information that is not obtainable under its laws
or in the normal course of its administration or that would
reveal trade secrets or other information the disclosure of
which would be contrary to public policy. The Internal Revenue
Service (the ``IRS''), and the treaty partner's tax
authorities, also can request specific tax information from a
treaty partner. This can include information to be used in a
criminal investigation or prosecution.
Administrative cooperation between countries is enhanced
further under treaties by the inclusion of a ``competent
authority'' mechanism to resolve double taxation problems
arising in individual cases and, more generally, to facilitate
consultation between tax officials of the two governments.
Treaties generally provide that neither country may subject
nationals of the other country (or permanent establishments of
enterprises of the other country) to taxation more burdensome
than that it imposes on its own nationals (or on its own
enterprises). Similarly, in general, neither treaty country may
discriminate against enterprises owned by residents of the
other country.
At times, residents of countries that do not have income
tax treaties with the United States attempt to use a treaty
between the United States and another country to avoid U.S.
tax. To prevent third-country residents from obtaining treaty
benefits intended for treaty country residents only, U.S.
treaties generally contain an ``anti-treaty shopping''
provision that is designed to limit treaty benefits to bona
fide residents of the two countries.
III. EXPLANATION OF PROPOSED TREATY
A detailed, article-by-article explanation of the proposed
income tax treaty between the United States and Lithuania is
set forth below.
Article 1. General Scope
Overview
The general scope article describes the persons who may
claim the benefits of the proposed treaty. It also includes a
``saving clause'' provision similar to provisions found in most
U.S. income tax treaties.
The proposed treaty generally applies to residents of the
United States and to residents of Lithuania, with specific
modifications to such scope provided in other articles (e.g.,
Article 25 (Nondiscrimination) and Article 27 (Exchange of
Information and Administrative Assistance)). This scope is
consistent with the scope of other U.S. income tax treaties,
the U.S. model, and the OECD model. For purposes of the
proposed treaty, residence is determined under Article 4
(Resident).
The proposed treaty provides that it does not restrict in
any manner any exclusion, exemption, deduction, credit, or
other allowance accorded by internal law or by any other
agreement between the United States and Lithuania. Thus, the
proposed treaty will not apply to increase the tax burden of a
resident of either the United States or Lithuania. According to
the Treasury Department's Technical Explanation (hereinafter
referred to as the ``Technical Explanation''), the fact that
the proposed treaty only applies to a taxpayer's benefit does
not mean that a taxpayer may select inconsistently among treaty
and internal law provisions in order to minimize its overall
tax burden. In this regard, the Technical Explanation sets
forth the following example. Assume a resident of Lithuania has
three separate businesses in the United States. One business is
profitable and constitutes a U.S. permanent establishment. The
other two businesses generate effectively connected income as
determined under the Internal Revenue Code (the ``Code''), but
do not constitute permanent establishments as determined under
the proposed treaty; one business is profitable and the other
business generates a net loss. Under the Code, all three
businesses would be subject to U.S. income tax, in which case
the losses from the unprofitable business could offset the
taxable income from the other businesses. On the other hand,
only the income of the business which gives rise to a permanent
establishment is taxable by the United States under the
proposed treaty. The Technical Explanation makes clear that the
taxpayer may not invoke the proposed treaty to exclude the
profits of the profitable business that does not constitute a
permanent establishment and invoke U.S. internal law to claim
the loss of the unprofitable business that does not constitute
a permanent establishment to offset the taxable income of the
permanent establishment.\3\
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\3\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
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The proposed treaty provides that the dispute resolution
procedures under its mutual agreement article take precedence
over the corresponding provisions of any other agreement to
which the United States and Lithuania are parties in
determining whether a measure is within the scope of the
proposed treaty. Unless the competent authorities agree that a
taxation measure is outside the scope of the proposed treaty,
only the proposed treaty's nondiscrimination rules, and not the
nondiscrimination rules of any other agreement in effect
between the United States and Lithuania, generally apply to
that measure. The only exception to this general rule is such
national treatment or most favored nation obligations as may
apply to trade in goods under the General Agreement on Tariffs
and Trade. For purposes of this provision, the term ``measure''
means a law, regulation, rule, procedure, decision,
administrative action, or any similar provision or action.
Saving clause
Like all U.S. income tax treaties, the proposed treaty
includes a ``saving clause.'' Under this clause, with specific
exceptions described below, the proposed treaty does not affect
the taxation by a country of its residents or its citizens. By
reason of this saving clause, unless otherwise specifically
provided in the proposed treaty, the United States may continue
to tax its citizens who are residents of Lithuania as if the
treaty were not in force. For purposes of the proposed treaty
(and, thus, for purposes of the saving clause), the term
``residents,'' which is defined in Article 4 (Resident),
includes corporations and other entities as well as
individuals.
The proposed treaty contains a provision under which the
saving clause (and therefore the U.S. jurisdiction to tax)
applies to a former U.S. citizen or a former long-term resident
(whether or not treated as such under Article 4 (Resident)),
whose loss of citizenship or resident status, respectively, had
as one of its principal purposes the avoidance of tax; such
application is limited to the ten-year period following the
loss of citizenship or resident status. Section 877 of the Code
provides special rules for the imposition of U.S. income tax on
former U.S. citizens and long-term residents for a period of
ten years following the loss of citizenship or resident status;
these special tax rules apply to a former citizen or long-term
resident only if his or her loss of U.S. citizenship or
resident status had as one of its principal purposes the
avoidance of U.S. income, estate, or gift taxes. For purposes
of applying the special tax rules to former citizens and long-
term residents, individuals who meet a specified income tax
liability threshold or a specified net worth threshold
generally are considered to have lost citizenship or resident
status for a principal purpose of U.S. tax avoidance.
Exceptions to the saving clause are provided for the
following benefits conferred by a treaty country: the allowance
of correlative adjustments when the profits of an associated
enterprise are adjusted by the other country (Article 9,
paragraph 2); the exemption from residence country tax for
social security benefits and certain child support payments
(Article 18, paragraphs 2 and 5); relief from double taxation
through the provision of a foreign tax credit (Article 24);
protection from discriminatory tax treatment with respect to
transactions with residents of the other country (Article 25);
and benefits under the mutual agreement procedures (Article
26). These exceptions to the saving clause permit residents or
citizens of the United States or Lithuania to obtain such
benefits of the proposed treaty with respect to their country
of residence or citizenship.
In addition, the saving clause does not apply to the
following benefits conferred by one of the countries upon
individuals who neither are citizens of that country nor have
been admitted for permanent residence in that country. Under
this set of exceptions to the saving clause, the specified
treaty benefits are available to, for example, a Lithuanian
citizen who spends enough time in the United States to be taxed
as a U.S. resident but who has not acquired U.S. permanent
residence status (i.e., does not hold a ``green card''). The
benefits that are covered under this set of exceptions are the
exemptions from host country tax for certain compensation from
government service (Article 19), certain income received by
students, trainees, or researchers (Article 20), and certain
income of diplomats and consular members (Article 28).
Article 2. Taxes Covered
The proposed treaty generally applies to the income taxes
of the United States and Lithuania. However, Article 25
(Nondiscrimination) is applicable to all taxes imposed at all
levels of government, including State and local taxes.
Moreover, Article 27 (Exchange of Information and
Administrative Assistance) generally is applicable to all
national-level taxes, including, for example, estate and gift
taxes.
In the case of the United States, the proposed treaty
applies to the Federal income taxes imposed by the Code and the
excise taxes imposed with respect to investment income of
private foundations, but excludes the accumulated earnings tax,
the personal holding company tax, and social security taxes.
In the case of Lithuania, the proposed treaty applies to
the tax on profits of legal persons (juridiniu asmenu pelno
mokestis) and the tax on income of natural persons (fiziniu
asmenu pajamu mokestis).
The proposed treaty also contains a rule generally found in
U.S. income tax treaties which provides that the proposed
treaty applies to any identical or substantially similar taxes
that may be imposed subsequently in addition to or in place of
the taxes covered. The proposed treaty obligates the competent
authority of each country to notify the competent authority of
the other country of any significant changes in its internal
tax laws or of any official published materials concerning the
application of the treaty, including explanations, regulations,
rulings, or judicial decisions. The Technical Explanation
states that this requirement relates to changes that are
significant to the operation of the proposed treaty.
Article 3. General Definitions
The proposed treaty provides definitions of a number of
terms for purposes of the proposed treaty. Certain of the
standard definitions found in most U.S. income tax treaties are
included in the proposed treaty.
The term ``United States'' means the United States of
America, but does not include Puerto Rico, the Virgin Islands,
Guam, or any other U.S. possession or territory. When used in
the geographical sense, the term ``United States'' also
includes the territorial sea of the United States, and for
certain purposes, the definition is extended to include 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
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 proposed treaty is being applied is
connected with such natural resource exploration or
exploitation. Thus, the Technical Explanation concludes that
the term ``United States'' 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.
The term ``Lithuania'' means the Republic of Lithuania and,
when used in the geographical sense, means the territory of the
Republic of Lithuania and any other area adjacent to the
territorial waters of the Republic of Lithuania within which
under the laws of Lithuania and in accordance with
international law, the rights of Lithuania may be exercised
with respect to the sea bed and its sub-soil and their natural
resources.
The term ``person'' includes an individual, an estate, a
trust, a partnership, a company, and any other body of persons.
A ``company'' under the proposed treaty is any body
corporate or any entity which is treated as a body corporate
for tax purposes.
The terms ``enterprise of a Contracting State'' and
``enterprise of the other Contracting State'' mean,
respectively, an enterprise carried on by a resident of a
Contracting State and an enterprise carried on by a resident of
the other Contracting State. The proposed treaty does not
define the term ``enterprise.'' However, despite the absence of
a clear, generally accepted meaning, the Technical Explanation
states that the term is understood to refer to any activity or
set of activities that constitute a trade or business. The
terms ``a Contracting State'' and ``the other Contracting
State'' mean the United States or Lithuania, according to the
context in which such terms are used.
The proposed treaty defines ``international traffic'' as
any transport by a ship or aircraft operated by an enterprise
of a treaty country, except when the transport is solely
between places in the other treaty country. Accordingly, with
respect to a Lithuanian enterprise, purely domestic transport
within the United States does not constitute ``international
traffic.''
The U.S. ``competent authority'' is the Secretary of the
Treasury or his delegate. The U.S. competent authority function
has been delegated to the Commissioner of Internal Revenue, who
has redelegated the authority to the Assistant Commissioner
(International). On interpretative issues, the latter acts with
the concurrence of the Associate Chief Counsel (International)
of the IRS. The Lithuanian ``competent authority'' is the
Minister of Finance or his authorized representatives.
The term ``national'' means (1) any individual possessing
the nationality of a treaty country; and (2) any legal person,
partnership, association, or, in the case of Lithuania, a
personal enterprise without rights of a legal person deriving
its status as such from the laws in force in a treaty country.
The proposed treaty also contains the standard provision
that, unless the context otherwise requires or the competent
authorities agree to a common meaning, all terms not defined in
the treaty have the meaning pursuant to the respective laws of
the country that is applying the treaty. Where a term is
defined both under a country's tax law and under a non-tax law,
the definition in the tax law is to be used in applying the
proposed treaty.
Article 4. Resident
The assignment of a country of residence is important
because the benefits of the proposed treaty generally are
available only to a resident of one of the treaty countries as
that term is defined in the proposed treaty. Furthermore,
issues arising because of dual residency, including situations
of double taxation, may be avoided by the assignment of one
treaty country as the country of residence when under the
internal laws of the treaty countries a person is a resident of
both countries.
Internal taxation rules
United States
Under U.S. law, the residence of an individual is important
because a resident alien, like a U.S. citizen, is taxed on his
or her worldwide income, while a nonresident alien is taxed
only on certain U.S.-source income and on income that is
effectively connected with a U.S. trade or business. An
individual who spends sufficient time in the United States in
any year or over a three-year period generally is treated as a
U.S. resident. A permanent resident for immigration purposes
(i.e., a ``green card'' holder) also is treated as a U.S.
resident.
Under U.S. law, a company is taxed on its worldwide income
if it is a ``domestic corporation.'' A domestic corporation is
one that is created or organized in the United States or under
the laws of the United States, a State, or the District of
Columbia.
Lithuania
Individuals are considered to be residents of Lithuania if
they stay in Lithuania more than 183 days during the calendar
year or if their permanent place of residence is in Lithuania.
Under Lithuanian law, resident individuals are subject to tax
on their worldwide income, while nonresident individuals are
subject to tax only on income earned in Lithuania.
Lithuanian companies include companies formed in Lithuania
and companies incorporated in foreign countries that are
registered in Lithuania. Lithuanian companies are subject to
tax on their worldwide income. Foreign companies, not
registered in Lithuania, are subject to withholding tax.
All payments made to persons resident in tax havens listed
by the government are subject to withholding tax at a rate of
29 percent.
Proposed treaty rules
The proposed treaty specifies rules to determine whether a
person is a resident of the United States or Lithuania for
purposes of the proposed treaty. The rules generally are
consistent with the rules of the U.S. model.
The proposed treaty generally defines ``resident of a
Contracting State'' to mean any person who, under the laws of
that country, is liable to tax in that country by reason of the
person's residence, domicile, citizenship, place of management,
place of incorporation, or any other criterion of a similar
nature. The term ``resident of a Contracting State'' does not
include any person that is liable to tax in that country only
on income from sources in that country. According to the
Technical Explanation, the reference in the proposed treaty to
persons ``liable to tax'' in a country is interpreted as
referring to those persons subject to the taxation laws of such
country; the reference therefore includes REITs that are
subject to the tax laws of a country (even though such
organizations generally do not pay tax). The determination of
whether a citizen or national is considered a resident of the
United States or Lithuania is made based on the principles of
the treaty tie-breaker rules described below.
The proposed treaty provides that the income of a
partnership, estate, or trust is considered to be the income of
a resident of one of the treaty countries only to the extent
that such income is subject to tax in that country as the
income of a resident, either in its hands or in the hands of
its partners or beneficiaries. Under this provision, for
example, if the U.S. partners' share of the income of a U.S.
partnership is only one-half, the proposed treaty's limitations
on withholding tax rates would apply to only one-half of the
Lithuanian source income paid to the partnership.
The proposed treaty provides that an individual who is a
resident (as defined above) of a treaty country due to his or
her citizenship or permanent residency (i.e., a ``green card''
holder), and is not a resident of the other treaty country,
will be considered a resident of the first treaty country only
if he or she has a substantial presence, permanent home, or
habitual home in such country.
The proposed treaty also considers a resident to include
(1) a treaty country, political subdivision, or a local
authority thereof, and any agency or instrumentality of the
treaty country, subdivision, or local authority; and (2) a
legal person organized under the laws of a treaty country and
that is generally exempt from tax in the treaty country because
it is established and maintained either (i) exclusively for a
religious, charitable, educational, scientific, or other
similar purpose; or (ii) to provide pensions or other similar
benefits to employees pursuant to a plan. The Technical
Explanation states that the term ``similar benefits'' is
intended to encompass employee benefits such as health and
disability benefits.
A set of ``tie-breaker'' rules is provided to determine
residence in the case of an individual who, under the basic
residence definition, would be considered to be a resident of
both countries. Under these rules, an individual is deemed to
be a resident of the country in which he or she has a permanent
home available. If the individual has a permanent home in both
countries, the individual's residence is deemed to be the
country with which his or her personal and economic relations
are closer (i.e., his or her ``center of vital interests''). If
the country in which the individual has his or her center of
vital interests cannot be determined, or if he or she does not
have a permanent home available in either country, he or she is
deemed to be a resident of the country in which he or she has
an habitual abode. If the individual has an habitual abode in
both countries or in neither country, he or she is deemed to be
a resident of the country of which he or she is a national. If
the individual is a national of both countries or neither
country, the competent authorities of the countries will settle
the question of residence by mutual agreement.
If a company would be a resident of both countries under
the basic definition in the proposed treaty, the competent
authorities of the countries will attempt to settle the
question of residence by mutual agreement. If a mutual
agreement cannot be reached, the company will not be considered
to be a resident of either country for purposes of enjoying
benefits under the proposed treaty.
In the case of any person other than an individual or a
company that would be a resident of both countries under the
basic definition in the proposed treaty, the proposed treaty
requires the competent authorities to settle the issue of
residence by mutual agreement and to determine the mode of
application of the proposed treaty to such person.
Article 5. Permanent Establishment
The proposed treaty contains a definition of the term
``permanent establishment'' that generally follows the pattern
of other recent U.S. income tax treaties, the U.S. model, and
the OECD model.
The permanent establishment concept is one of the basic
devices used in income tax treaties to limit the taxing
jurisdiction of the host country and thus to mitigate double
taxation. Generally, an enterprise that is a resident of one
country is not taxable by the other country on its business
profits unless those profits are attributable to a permanent
establishment of the resident in the other country. In
addition, the permanent establishment concept is used to
determine whether the reduced rates of, or exemptions from, tax
provided for dividends, interest, and royalties apply, or
whether those items of income will be taxed as business
profits.
In general, under the proposed treaty, a permanent
establishment is a fixed place of business through which the
business of an enterprise is wholly or partly carried on. A
permanent establishment includes a place of management, a
branch, an office, a factory, a workshop, a mine, an oil or gas
well, a quarry, or any other place of extraction of natural
resources. It also includes a building site or a construction
or installation project, if the site or project continues for
more than six months. The Technical Explanation states that the
six-month test applies separately to each individual site or
project, with a series of contracts or projects that are
interdependent both commercially and geographically treated as
a single project. The Technical Explanation further states that
if the six-month threshold is exceeded, the site or project
constitutes a permanent establishment as of the first day that
work in the country began. The U.S. model contains similar
rules, but the threshold period is twelve months rather than
six months.
Under the proposed treaty, the following activities are
deemed not to constitute a permanent establishment: (1) the use
of facilities solely for storing, displaying, or delivering
goods or merchandise belonging to the enterprise; (2) the
maintenance of a stock of goods or merchandise belonging to the
enterprise solely for storage, display, or delivery or solely
for processing by another enterprise; (3) the maintenance of a
fixed place of business solely for the purchase of goods or
merchandise or for the collection of information for the
enterprise; and (4) the maintenance of a fixed place of
business solely for the purpose of carrying on for the
enterprise any other activity of a preparatory or auxiliary
character.
Under the U.S. model, the maintenance of a fixed place of
business solely for any combination of the above-listed
activities does not constitute a permanent establishment. Under
the proposed treaty (as under the OECD model), a fixed place of
business used solely for any combination of these activities
does not constitute a permanent establishment, provided that
the overall activity of the fixed place of business is of a
preparatory or auxiliary character. In this regard, the
Technical Explanation states that it is assumed that a
combination of preparatory or auxiliary activities generally
will also be of a character that is preparatory or auxiliary.
Under the proposed treaty, if a person, other than an
independent agent, is acting in a treaty country on behalf of
an enterprise of the other country and has, and habitually
exercises, the authority to conclude contracts in the name of
such enterprise, the enterprise is deemed to have a permanent
establishment in the first country in respect of any activities
undertaken for that enterprise. This rule does not apply where
the contracting authority is limited to the activities listed
above, such as storage, display, or delivery of merchandise,
which are excluded from the definition of a permanent
establishment.
Under the proposed treaty, no permanent establishment is
deemed to arise if the agent is a broker, general commission
agent, or any other agent of independent status, provided that
the agent is acting in the ordinary course of its business.
However, an agent will not be considered as independent if its
activities are devoted wholly or almost wholly on behalf of an
enterprise and the conditions between the agent and the
enterprise differ from those which would be made between
independent persons (i.e., the agent and the enterprise are not
operating at arms length). In such a case, the rules in the
preceding paragraph will apply. The Technical Explanation
states that whether an enterprise and an agent are independent
is a factual determination, a relevant factor of which includes
the extent to which the agent bears business risk.
The proposed treaty provides that the fact that a company
that is a resident of one country controls or is controlled by
a company that is a resident of the other country or that
engages in business in the other country (whether through a
permanent establishment or otherwise) does not of itself cause
either company to be a permanent establishment of the other.
Article 6. Income From Immovable (Real) Property
This article covers income from real property. The rules
covering gains from the sale of real property are in Article 13
(Capital Gains).
Under the proposed treaty, income derived by a resident of
one country from immovable (real) property situated in the
other country may be taxed in the country where the property is
located. This rule is consistent with the rules in the U.S. and
OECD models. For this purpose, income from immovable (real)
property includes income from agriculture or forestry.
The term ``immovable (real) property'' has the meaning
which it has under the law of the country in which the property
in question is situated. In the case of the United States, the
term ``real property'' is defined in Treas. Reg. sec. 1.897-
1(b). The proposed treaty specifies that the term in any case
includes property accessory to immovable (real) property;
livestock and equipment used in agriculture and forestry;
rights to which the provisions of general law respecting landed
property apply; any option or similar right to acquire
immovable (real) property; usufruct of immovable (real)
property; and rights to variable or fixed payments relating to
the production from, or the right to work, mineral deposits,
sources, and other natural resources. Ships, boats, and
aircraft are not considered to be immovable (real) property.
The proposed treaty further provides that immovable (real)
property includes rights to assets to be produced by the
exploration or exploitation of the sea bed and sub-soil and
their natural resources in the treaty country, including rights
to interests in, or to the benefits of, such assets.
The proposed treaty specifies that the country in which the
property is situated also may tax income derived from the
direct use, letting, or use in any other form of immovable
(real) property. The rules of Article 6, permitting source
country taxation, also apply to the income from immovable
(real) property of an enterprise and to income from immovable
(real) property used for the performance of independent
personal services.
Where the ownership of shares or other corporate rights in
a company entitles the owner to the enjoyment of immovable
(real) property held by the company, any income from the direct
use, letting, or use in any other form of this right of
enjoyment may be taxed in the treaty country in which the
immovable (real) property is situated. The Technical
Explanation states that this rule is intended to clarify that
such income is to be treated as income from immovable (real)
property and not as income from movable property, and will
likely apply to a shareholder of an apartment rental
cooperative.
The proposed treaty provides that residents of a treaty
country that are liable for tax in the other treaty country on
income from immovable (real) property situated in such other
treaty country may elect to compute the tax on such income on a
net basis. In the case of the U.S. tax, such an election will
be binding for the taxable year of the election and all
subsequent taxable years unless the competent authority of the
United States agrees to terminate the election. U.S. internal
law provides such a net-basis election in the case of income of
a foreign person from U.S. real property (Code secs. 871(d) and
882(d)).
Article 7. Business Profits
Internal taxation rules
United States
U.S. law distinguishes between the U.S. business income and
the other U.S. income of a nonresident alien or foreign
corporation. A nonresident alien or foreign corporation is
subject to a flat 30-percent rate (or lower treaty rate) of tax
on certain U.S.-source income if that income is not effectively
connected with the conduct of a trade or business within the
United States. The regular individual or corporate rates apply
to income (from any source) which is effectively connected with
the conduct of a trade or business within the United States.
The treatment of income as effectively connected with a
U.S. trade or business depends upon whether the source of the
income is U.S. or foreign. In general, U.S.-source periodic
income (such as interest, dividends, rents, and wages) and
U.S.-source capital gains are effectively connected with the
conduct of a trade or business within the United States if the
asset generating the income is used in (or held for use in) the
conduct of the trade or business or if the activities of the
trade or business were a material factor in the realization of
the income. All other U.S.-source income of a person engaged in
a trade or business in the United States is treated as
effectively connected with the conduct of a trade or business
in the United States (under what is referred to as a ``force of
attraction'' rule).
Foreign-source income generally is effectively connected
income only if the foreign person has an office or other fixed
place of business in the United States and the income is
attributable to that place of business. Only three types of
foreign-source income are considered to be effectively
connected income: rents and royalties for the use of certain
intangible property derived from the active conduct of a U.S.
business; certain dividends and interest either derived in the
active conduct of a banking, financing or similar business in
the United States or received by a corporation the principal
business of which is trading in stocks or securities for its
own account; and certain sales income attributable to a U.S.
sales office. Special rules apply for purposes of determining
the foreign-source income that is effectively connected with a
U.S. business of an insurance company.
Any income or gain of a foreign person for any taxable year
that is attributable to a transaction in another year is
treated as effectively connected with the conduct of a U.S.
trade or business if it would have been so treated had it been
taken into account in that other year (Code sec. 864(c)(6)). In
addition, if any property ceases to be used or held for use in
connection with the conduct of a trade or business within the
United States, the determination of whether any income or gain
attributable to a sale or exchange of that property occurring
within ten years after the cessation of business is effectively
connected with the conduct of a trade or business within the
United States is made as if the sale or exchange occurred
immediately before the cessation of business (Code sec.
864(c)(7)).
Lithuania
Permanent establishments of foreign corporations and
nonresident individuals generally are subject to Lithuanian tax
on income derived in Lithuania. Business income derived in
Lithuania by a foreign corporation or nonresident individual
generally is taxed in the same manner as the income of a
Lithuanian corporation or resident individual, at a rate of 29
percent.
Proposed treaty limitations on internal law
Under the proposed treaty, business profits of an
enterprise of one of the countries are taxable in the other
country only to the extent that they are attributable to a
permanent establishment in the other country through which the
enterprise carries on business. This is one of the basic
limitations on a country's right to tax income of a resident of
the other country. The rule is similar to those contained in
the U.S. and OECD models.
Under certain circumstances, the business profits of an
enterprise of one country may be taxable in the other country
even though the permanent establishment was not involved in the
generation of such profits if two conditions are met. First,
the profits must be derived either from the sale of goods or
merchandise of the same or similar kind as those sold through
the permanent establishment or from other business activities
of the same or similar kind as those effected through the
permanent establishment. Second, it must be established that
the sale or activities were structured in a manner intended to
avoid taxation in the country in which the permanent
establishment is located. Taxation by the source country of
this category of profits represents a limited force of
attraction rule that is similar to, but narrower than, the
rules found in the U.N. model and Code section 864(c)(3). The
intent of the provision is to permit the source country to tax
the income derived from sales or other business activities
within its borders by the home office of the enterprise if such
sales or activities are the same as or similar to sales or
activities conducted there by the permanent establishment. Such
profits may not be taxed by the source country, however, unless
it is established that the transactions were structured to
avoid such tax.
The taxation of business profits under the proposed treaty
differs from U.S. internal law rules for taxing business
profits primarily by requiring more than merely being engaged
in a trade or business before a country can tax business
profits and by substituting an ``attributable to'' standard for
the Code's ``effectively connected'' standard. Under the
proposed treaty, some level of fixed place of business would
have to be present and the business profits generally would
have to be attributable to that fixed place of business (or
subject to the limited force of attraction rule described
above).
The proposed treaty provides that there will be attributed
to a permanent establishment the business profits which it
might be expected to make if it were a distinct and independent
enterprise engaged in the same or similar activities under the
same or similar conditions. The Technical Explanation states
that this rule permits the use of methods other than separate
accounting to estimate the arm's-length profits of a permanent
establishment where it is necessary to do so for practical
reasons, such as when the affairs of the permanent
establishment are so closely bound up with those of the head
office that it would be impossible to disentangle them on any
strict basis of accounts.
In computing taxable business profits, the proposed treaty
provides that deductions are allowed for expenses, wherever
incurred, which are incurred for the purposes of the permanent
establishment. These deductions include a reasonable allocation
of research and development expenses, interest, and other
similar expenses and executive and general administrative
expenses. The Technical Explanation states that this rule
permits (but does not require) each treaty country to apply the
type of expense allocation rules provided by U.S. law (such as
in Treas. Reg. secs 1.861-8 and 1.882-5).
The Technical Explanation clarifies that deductions will
not be allowed for expenses charged to a permanent
establishment by another unit of the enterprise. Thus, a
permanent establishment may not deduct a royalty deemed paid to
the head office.
Unlike the U.S. model or the OECD model, the proposed
treaty allows each treaty country, consistent with its internal
law, to impose limitations on the deductions taken by the
permanent establishment as long as the limitations are
consistent with the concept of net income (e.g., partially
disallowed entertainment expenses).
In cases where the information available to the competent
authority is not adequate to measure accurately the profits of
a permanent establishment, the tax authorities of a treaty
country may apply the provisions of their internal law in
determining the tax liability of such permanent establishment.
This rule applies provided that, on the basis of available
information, the determination of the profits of the permanent
establishment is consistent with the principles of this
article.
Business profits are not attributed to a permanent
establishment merely by reason of the purchase of goods or
merchandise by the permanent establishment for the enterprise.
Thus, where a permanent establishment purchases goods for its
head office, the business profits attributed to the permanent
establishment with respect to its other activities are not
increased by a profit element in its purchasing activities.
The proposed treaty requires the determination of business
profits of a permanent establishment to be made in accordance
with the same method year by year unless a good and sufficient
reason to the contrary exists. For purposes of the proposed
treaty, the term ``business profits'' means profits derived
from any trade or business, including profits from
manufacturing, mercantile, fishing, transportation,
communications, or extractive activities. Also included are
profits from the furnishing of personal services of another
person, including the furnishing by a company of the personal
services of its employees. Business profits, however, do not
include income received by an individual for his performance of
personal services either as an employee or in an independent
capacity.
Where business profits include items of income that are
dealt with separately in other articles of the proposed treaty,
those other articles, and not the business profits article,
govern the treatment of those items of income (except where
such other articles specifically provide to the contrary).
Thus, for example, dividends are taxed under the provisions of
Article 10 (Dividends), and not as business profits, except as
specifically provided in Article 10.
The proposed treaty provides that, for purposes of the
taxation of business profits, income may be attributable to a
permanent establishment (and therefore may be taxable in the
source country) even if the payment of such income is deferred
until after the permanent establishment or fixed base has
ceased to exist. This rule incorporates into the proposed
treaty the rule of Code section 864(c)(6) described above. This
rule applies with respect to business profits (Article 7,
paragraphs 1 and 2), dividends (Article 10, paragraph 4),
interest (Article 11, paragraph 5), royalties (Article 12,
paragraph 4), capital gains (Article 13, paragraph 3),
independent personal services income (Article 14), and other
income (Article 22, paragraph 2).
Article 8. Shipping and Air Transport
Article 8 of the proposed treaty covers income from the
operation or rental of ships, aircraft, and containers in
international traffic. The rules governing income from the
disposition of ships, aircraft, and containers are in Article
13 (Capital Gains).
The United States generally taxes the U.S.-source income of
a foreign person from the operation of ships or aircraft to or
from the United States. An exemption from U.S. tax is provided
if the income is earned by a corporation that is organized in,
or an alien individual who is resident in, a foreign country
that grants an equivalent exemption to U.S. corporations and
residents. The United States has entered into agreements with a
number of countries providing such reciprocal exemptions.
Under the proposed treaty, profits which are derived by an
enterprise of one country from the operation in international
traffic of ships or aircraft (``shipping profits'') are taxable
only in that country, regardless of the existence of a
permanent establishment in the other country. ``International
traffic'' is defined in Article 3(1)(g) (General Definitions)
as any transport by a ship or aircraft operated by an
enterprise of a treaty country, except when the transport is
solely between places in the other treaty country.
For purposes of the proposed treaty, shipping profits
subject to the rule described in the foregoing paragraph
include profits derived from the rental of ships or aircraft on
a full (time or voyage) basis (i.e., with crew). It also
includes profits from the rental of ships or aircraft on a
bareboat basis (i.e., without crew) by an enterprise engaged in
the operation of ships or aircraft in international traffic, if
such rental activities are incidental to the activities from
the operation of ships or aircraft in international traffic.
The Technical Explanation states that such rental profits from
bareboat leasing that are not incidental to the operation of
ships or aircraft in international traffic are treated as
royalties (Article 12) or as business profits (Article 7).
Profits derived by an enterprise from the inland transport of
property or passengers within either treaty country are treated
as profits from the operation of ships or aircraft in
international traffic if such transport is undertaken as part
of international traffic by the enterprise.
The proposed treaty provides that profits of an enterprise
of a country from the use, maintenance, or rental of containers
(including trailers, barges, and related equipment for the
transport of containers) used in international traffic is
exempt from tax in the other country.
The shipping and air transport provisions of the proposed
treaty apply to profits 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.
The Technical Explanation states that certain non-transport
activities that are an integral part of the services performed
by a transport company are understood to be covered by this
article of the proposed treaty.
Article 9. Associated Enterprises
The proposed treaty, like most other U.S. tax treaties,
contains an arm's-length pricing provision. The proposed treaty
recognizes the right of each country to make an allocation of
profits to an enterprise of that country in the case of
transactions between related enterprises, if conditions are
made or imposed between the two enterprises in their commercial
or financial relations which differ from those which would be
made between independent enterprises. In such a case, a country
may allocate to such an enterprise the profits which it would
have accrued but for the conditions so imposed. This treatment
is consistent with the U.S. model.
For purposes of the proposed treaty, an enterprise of one
country is related to an enterprise of the other country if one
of the enterprises participates directly or indirectly in the
management, control, or capital of the other enterprise.
Enterprises are also related if the same persons participate
directly or indirectly in their management, control, or
capital.
Under the proposed treaty, when a redetermination of tax
liability has been made by one country under the provisions of
this article, the other country will (after agreeing that the
adjustment was appropriate) make an appropriate adjustment to
the amount of tax paid in that country on the redetermined
income. In making such adjustment, due regard is to be given to
other provisions of the proposed treaty, and the competent
authorities of the two countries are to consult with each other
if necessary. The proposed treaty's saving clause retaining
full taxing jurisdiction in the country of residence or
citizenship does not apply in the case of such adjustments.
Accordingly, internal statute of limitations provisions do not
prevent the allowance of appropriate correlative adjustments.
This article does not replace the internal law provisions
that permit adjustments between related parties when necessary
in order to prevent evasion of taxes or clearly to reflect the
income. Adjustments are permitted under internal law provisions
even if such adjustments are different from, or go beyond, the
adjustments authorized by this article, provided that such
adjustments are consistent with the general principles of this
article permitting adjustments to reflect arm's-length terms.
Article 10. Dividends
Internal taxation rules
United States
The United States generally imposes a 30-percent tax on the
gross amount of U.S.-source dividends paid to nonresident alien
individuals and foreign corporations. The 30-percent tax does
not apply if the foreign recipient is engaged in a trade or
business in the United States and the dividends are effectively
connected with that trade or business. In such a case, the
foreign recipient is subject to U.S. tax on such dividends on a
net basis at graduated rates in the same manner that a U.S.
person would be taxed.
Under U.S. law, the term dividend generally means any
distribution of property made by a corporation to its
shareholders, either from accumulated earnings and profits or
current earnings and profits. However, liquidating
distributions generally are treated as payments in exchange for
stock and thus are not subject to the 30-percent withholding
tax described above (see discussion of capital gains in
connection with Article 13 below).
Dividends paid by a U.S. corporation generally are U.S.-
source income. Also treated as U.S.-source dividends for this
purpose are portions of certain dividends paid by a foreign
corporation that conducts a U.S. trade or business. The U.S.
30-percent withholding tax imposed on the U.S.-source portion
of the dividends paid by a foreign corporation is referred to
as the ``second-level'' withholding tax. This second-level
withholding tax is imposed only if a treaty prevents
application of the statutory branch profits tax.
In general, corporations are not entitled under U.S. law to
a deduction for dividends paid. Thus, the withholding tax on
dividends theoretically represents imposition of a second level
of tax on corporate taxable income. Treaty reductions of this
tax reflect the view that where the United States already
imposes corporate-level tax on the earnings of a U.S.
corporation, a 30-percent withholding rate may represent an
excessive level of source country taxation. Moreover, the
reduced rate of tax often applied by treaty to dividends paid
to direct investors reflects the view that the source country
tax on payments of profits to a substantial foreign corporate
shareholder may properly be reduced further to avoid double
corporate-level taxation and to facilitate international
investment.
A real estate investment trust (``REIT'') is a corporation,
trust, or association that is subject to the regular corporate
income tax, but that receives a deduction for dividends paid to
its shareholders if certain conditions are met. In order to
qualify for the deduction for dividends paid, a REIT must
distribute most of its income. Thus, a REIT is treated, in
essence, as a conduit for federal income tax purposes. Because
a REIT is taxable as a U.S. corporation, a distribution of its
earnings is treated as a dividend rather than income of the
same type as the underlying earnings. Such distributions are
subject to the U.S. 30-percent withholding tax when paid to
foreign owners.
A REIT is organized to allow persons to diversify ownership
in primarily passive real estate investments. As such, the
principal income of a REIT often is rentals from real estate
holdings. Like dividends, U.S.-source rental income of foreign
persons generally is subject to the 30-percent withholding tax
(unless the recipient makes an election to have such rental
income taxed in the United States on a net basis at the regular
graduated rates). Unlike the withholding tax on dividends,
however, the withholding tax on rental income generally is not
reduced in U.S. income tax treaties.
U.S. internal law also generally treats a regulated
investment company (``RIC'') as both a corporation and a
conduit for income tax purposes. The purpose of a RIC is to
allow investors to hold a diversified portfolio of securities.
Thus, the holder of stock in a RIC may be characterized as a
portfolio investor in the stock held by the RIC, regardless of
the proportion of the RIC's stock owned by the dividend
recipient.
A foreign corporation engaged in the conduct of a trade or
business in the United States is subject to a flat 30-percent
branch profits tax on its ``dividend equivalent amount.'' The
dividend equivalent amount is the corporation's earnings and
profits which are attributable to its income that is
effectively connected with its U.S. trade or business,
decreased by the amount of such earnings that are reinvested in
business assets located in the United States (or used to reduce
liabilities of the U.S. business), and increased by any such
previously reinvested earnings that are withdrawn from
investment in the U.S. business. The dividend equivalent amount
is limited by (among other things) aggregate earnings and
profits accumulated in taxable years beginning after December
31, 1986.
Lithuania
Lithuania generally imposes a withholding tax on dividend
payments to foreign corporations at a rate of 29 percent.
Dividend payments to nonresident individuals are not subject to
withholding tax. Lithuania does not impose a withholding tax
with respect to earnings of a Lithuanian branch of a
nonresident corporation.
Proposed treaty limitations on internal law
Under the proposed treaty, dividends paid by a resident of
a treaty country to a resident of the other country may be
taxed in such other country. Dividends paid by a resident of a
treaty country and beneficially owned by a resident of the
other country may also be taxed by the country in which the
payor is resident, but the rate of such tax is limited. Under
the proposed treaty, source country taxation (i.e., taxation by
the country in which the payor is resident) generally is
limited to 5 percent of the gross amount of the dividend if the
beneficial owner of the dividend is a company which owns at
least 10 percent of the voting shares of the payor company. The
source country dividend withholding tax generally is limited to
15 percent of the gross amount of the dividends beneficially
owned by residents of the other country in all other cases. The
proposed treaty provides that these rules do not affect the
taxation of the paying company on the profits out of which the
dividends are paid.
Under the proposed treaty, dividends paid by a U.S. RIC are
eligible only for the limitation that applies the 15-percent
rate, regardless of the beneficial owner's percentage ownership
in such entity. Dividends paid by a U.S. REIT are not eligible
for the 5-percent rate. Moreover, such REIT dividends are
eligible for the 15-percent rate only if the dividend is
beneficially owned by an individual who holds less than a 10-
percent interest in the U.S. REIT. Otherwise, dividends paid by
a U.S. REIT are subject to U.S. taxation at the full 30-percent
statutory rate.
The proposed treaty defines a ``dividend'' to include
income from shares or other rights, not being debt-claims,
participating in profits, as well as income from other
corporate rights which is subject to the same taxation
treatment as income from shares by the internal laws of the
treaty country of which the company making the distribution is
a resident. The term further includes income from arrangements,
including debt obligations, carrying the right to participate
in profits, to the extent so characterized under the law of the
treaty country in which the income arises.
The proposed treaty's reduced rates of tax on dividends do
not apply if the beneficial owner of the dividend carries on
business through a permanent establishment in the source
country and the dividends are attributable to the permanent
establishment. Dividends attributable to a permanent
establishment are taxed as business profits (Article 7). The
proposed treaty's reduced rates of tax on dividends also do not
apply if the beneficial owner of the dividend is a nonresident
who performs independent personal services from a fixed base
located in the source country and such dividends are
attributable to the fixed base. In such a case, the dividends
attributable to the fixed base are taxed as income from the
performance of independent personal services (Article 14).
Under the proposed treaty, these rules also apply if the
permanent establishment or fixed base no longer exists when the
dividends are paid but such dividends are attributable to the
former permanent establishment or fixed base.
The proposed treaty permits the imposition of a branch
profits tax, but limits the rate of such tax to 5 percent. The
branch profits tax may be imposed on a company that is a
resident of a treaty country and has a permanent establishment
in the other treaty country or is subject to tax in the other
treaty country on a net basis on its income from immovable
(real) property (Article 6) or capital gains (Article 13). Such
tax may be imposed only on the portion of the business profits
attributable to such permanent establishment, or the portion of
such immovable (real) property income or capital gains, that
represents the ``dividend equivalent amount.'' The Technical
Explanation states that the term ``dividend equivalent amount''
has the same meaning that it has under Code section 884, as
amended from time to time, provided the amendments are
consistent with the purpose of the branch profits tax.
Where a treaty country resident derives profits or income
from the other treaty country, the proposed treaty provides
that such other country cannot impose any tax on the dividends
paid by such resident. Thus, the United States cannot impose
its ``secondary'' withholding tax on dividends paid by a
Lithuanian company out of its earnings and profits from the
United States. An exception to this provision is provided in
cases where the dividends are paid to a resident of the other
treaty country or are attributable to a permanent establishment
or a fixed base situated in such other treaty country (even if
the dividends paid consist wholly or partly of profits arising
in such other country).
Article 11. Interest
Internal taxation rules
United States
Subject to several exceptions (such as those for portfolio
interest, bank deposit interest, and short-term original issue
discount), the United States imposes a 30-percent withholding
tax on U.S.-source interest paid to foreign persons under the
same rules that apply to dividends. U.S.-source interest, for
purposes of the 30-percent tax, generally is interest on the
debt obligations of a U.S. person, other than a U.S. person
that meets specified foreign business requirements. Also
subject to the 30-percent tax is interest paid by the U.S.
trade or business of a foreign corporation. A foreign
corporation is subject to a branch-level excess interest tax
with respect to certain ``excess interest'' of a U.S. trade or
business of such corporation; under this rule, an amount equal
to the excess of the interest deduction allowed with respect to
the U.S. business over the interest paid by such business is
treated as if paid by a U.S. corporation to a foreign parent
and therefore is subject to the 30-percent withholding tax.
Portfolio interest generally is defined as any U.S.-source
interest that is not effectively connected with the conduct of
a trade or business if such interest (1) is paid on an
obligation that satisfies certain registration requirements or
specified exceptions thereto and (2) is not received by a 10-
percent owner of the issuer of the obligation, taking into
account shares owned by attribution. However, the portfolio
interest exemption does not apply to certain contingent
interest income.
If an investor holds an interest in a fixed pool of real
estate mortgages that is a real estate mortgage interest
conduit (``REMIC''), the REMIC generally is treated for U.S.
tax purposes as a pass-through entity and the investor is
subject to U.S. tax on a portion of the REMIC's income (which,
generally is interest income). If the investor holds a so-
called ``residual interest'' in the REMIC, the Code provides
that a portion of the net income of the REMIC that is taxed in
the hands of the investor--referred to as the investor's
``excess inclusion''--may not be offset by any net operating
losses of the investor, must be treated as unrelated business
income if the investor is an organization subject to the
unrelated business income tax, and is not eligible for any
reduction in the 30-percent rate of withholding tax (by treaty
or otherwise) that would apply if the investor were otherwise
eligible for such a rate reduction.
Lithuania
Lithuania generally imposes a withholding tax on interest
payments to foreign corporations at a rate of 15 percent.
Interest payments to nonresident individuals are subject to
withholding tax at a rate of 20 percent. However, bank interest
is not subject to withholding tax. ZA784.001
Proposed treaty limitations on internal law
The proposed treaty provides that interest arising in one
of the countries and beneficially owned by a resident of the
other country generally may be taxed by both countries. This is
contrary to the position of the U.S. model which provides for
an exemption from source country tax for interest beneficially
owned by a resident of the other country.
The proposed treaty limits the rate of source country tax
that may be imposed on interest income. Under the proposed
treaty, if the beneficial owner of interest is a resident of
the other country, the source country tax on such interest
generally may not exceed 10 percent of the gross amount of such
interest. This rate is higher than the U.S. model rate, which
is zero.
The proposed treaty provides for a complete exemption from
source country withholding tax in the case of interest arising
in a treaty country and (1) derived and beneficially owned by
the Government of the other treaty country, including political
subdivisions and local authorities thereof, (2) derived and
beneficially owned by the Central Bank or any financial
institution wholly owned by the Government, or (3) derived on
loans guaranteed or insured by the Government, subdivision,
authority, or institution. The Technical Explanation states
that the second exemption refers to the Central Bank of
Lithuania or any Federal Reserve Bank of the United States and
that the third exemption refers to loans guaranteed or insured
by the U.S. Export-Import Bank and the Overseas Private
Investment Corporation. A further complete exemption from
source country withholding applies to interest beneficially
owned by an enterprise of a treaty country that is paid with
respect to indebtedness arising as a consequence of the sale on
credit by an enterprise of the other treaty country of any
merchandise, or industrial, commercial, or scientific equipment
to an enterprise of the first treaty country, except where the
sale on credit is between related persons.
The proposed treaty provides two anti-abuse exceptions to
the general source-country reduction in tax discussed above.
The first exception relates to ``contingent interest''
payments. If interest is paid by a source-country resident to a
resident of the other country and is determined by reference to
(1) the receipts, sales, income, profits, or the cash flow of
the debtor or a related person, (2) any change in the value of
any property of the debtor or a related person, or (3) to any
dividend, partnership distribution or similar payment made by
the debtor to a related person, such interest may be taxed in
the source country in accordance with its internal laws.
However, if the beneficial owner is a resident of the other
country, such interest may not be taxed at a rate exceeding 15
percent (i.e., the rate prescribed in paragraph 2(b) of Article
10 (Dividends)). The second anti-abuse exception provides that
the reduction in and exemption from source country tax do not
apply to excess inclusions with respect to a residual interest
in a U.S. REMIC. Such income may be taxed in accordance with
U.S. domestic law.
The proposed treaty defines the term ``interest'' as income
from debt claims of every kind, whether or not secured by a
mortgage and whether or not carrying a right to participate in
the debtor's profits. In particular, it includes income from
government securities and from bonds or debentures, including
premiums or prizes attaching to such securities, bonds, or
debentures. The proposed treaty includes in the definition of
interest any other income that is treated as interest by the
domestic law of the country in which the income arises. Penalty
charges for late payment are not regarded as interest for
purposes of this article. The proposed treaty provides that the
term ``interest'' does not include amounts treated as dividends
under Article 10 (Dividends).
The proposed treaty's reductions in source country tax on
interest do not apply if the beneficial owner carries on
business in the source country through a permanent
establishment located in that country and the interest is
attributable to that permanent establishment. In such an event,
the interest is taxed as business profits (Article 7). The
proposed treaty's reduced rates of tax on interest also do not
apply if the beneficial owner is a treaty country resident who
performs independent personal services from a fixed base
located in the other treaty country and such interest is
attributable to the fixed base. In such a case, the interest
attributable to the fixed base is taxed as income from the
performance of independent personal services (Article 14).
These rules also apply if the permanent establishment or fixed
base no longer exists when the interest is paid but such
interest is attributable to the former permanent establishment
or fixed base.
The proposed treaty provides that interest is treated as
arising in a treaty country if the payor is a resident of that
country.\4\ If, however, the interest expense is borne by a
permanent establishment or a fixed base, the interest will have
as its source the country in which the permanent establishment
or fixed base is located, regardless of the residence of the
payor. Thus, for example, if a French resident has a permanent
establishment in Lithuania and that French resident incurs
indebtedness to a U.S. person, the interest on which is borne
by the Lithuanian permanent establishment, the interest would
be treated as having its source in Lithuania.
---------------------------------------------------------------------------
\4\ This is consistent with the source rules of U.S. law, which
provide as a general rule that interest income has as its source the
country in which the payor is resident.
---------------------------------------------------------------------------
The proposed treaty addresses the issue of non-arm's-length
interest charges between related parties (or parties otherwise
having a special relationship) by providing that the amount of
interest for purposes of applying this article is the amount of
interest that would have been agreed upon by the payor and the
beneficial owner in the absence of the special relationship.
Any amount of interest paid in excess of such amount is taxable
according to the laws of each country, taking into account the
other provisions of the proposed treaty. For example, excess
interest paid by a subsidiary corporation to its parent
corporation may be treated as a dividend under local law and
thus be subject to the provisions of Article 10 (Dividends).
The proposed treaty permits the United States to impose its
branch level interest tax on a Lithuanian corporation. The base
of this tax is the excess, if any, of (1) the interest
deductible in computing the profits of the corporation that are
subject to tax and either attributable to a permanent
establishment or subject to tax under Article 6 (Income From
Immovable (Real) Property) or Article 13 (Capital Gains) over
(2) the interest paid by or from the permanent establishment or
trade or business. Such excess interest will be deemed to arise
in the United States and be beneficially owned by the
Lithuanian corporation for purposes of applying the reduced
withholding rates under this article.
Article 12. Royalties
Internal taxation rules
United States
Under the same system that applies to dividends and
interest, the United States imposes a 30-percent withholding
tax on U.S.-source royalties paid to foreign persons. U.S.-
source royalties include royalties for the use of or the right
to use intangible property in the United States.
Lithuania
Lithuania generally imposes a withholding tax on royalties
paid to foreign corporations at a rate of 10 percent. Royalty
payments to nonresident individuals are subject to withholding
tax at a rate of 13 percent.
Proposed treaty limitations on internal law
The proposed treaty provides that royalties arising in a
treaty country and beneficially owned by a resident of the
other country may be taxed by that other country. In addition,
the proposed treaty allows the country where the royalties
arise (the ``source country'') to tax such royalties. However,
if the beneficial owner of the royalties is a resident of the
other country, the source country tax generally may not exceed
10 percent of the gross royalties. This 10-percent rate is
higher than the rate permitted under most U.S. treaties and the
U.S. and OECD models. The U.S. and OECD models generally exempt
royalties from source country taxation. The proposed treaty
further provides that the source country tax on certain amounts
treated as royalties may not exceed 5 percent of the gross
royalties. This 5-percent limitation applies to payments of any
kind in consideration for the use of industrial, commercial, or
scientific equipment.
For purposes of the proposed treaty, the term ``royalties''
means payments of any kind received as consideration for the
use of, the right to use, or the sale (which is contingent on
the productivity, use, or further disposition) of any copyright
of literary, artistic, or scientific work (including computer
software, cinematographic films and films or tapes and other
means of image or sound reproduction for radio or television
broadcasting), patent, trademark, design or model, plan, secret
formula, or process. The term also includes consideration for
the use of, or the right to use, industrial, commercial, or
scientific equipment, or for information concerning industrial,
commercial, or scientific experience. According to the
Technical Explanation, it is understood that whether payments
with respect to computer software are treated as royalties or
as business profits will depend on the facts and circumstances
of the particular transaction. The Technical Explanation also
states that it is understood that payments with respect to
transfers of ``shrink wrap'' computer software will be treated
as business profits.
The reduced rates of tax on royalties do not apply where
the beneficial owner is an enterprise that carries on business
through a permanent establishment in the source country, and
the royalties are attributable to the permanent establishment.
In that event, the royalties are taxed as business profits
(Article 7). The proposed treaty's reduced rates of tax on
royalties also do not apply if the beneficial owner is a treaty
country resident who performs independent personal services
from a fixed base located in the other treaty country and such
royalties are attributable to the fixed base. In such a case,
the royalties attributable to the fixed base are taxed as
income from the performance of independent personal services
(Article 14). These rules also apply if the permanent
establishment or fixed base no longer exists when the royalties
are paid but such royalties are attributable to the former
permanent establishment or fixed base.
The proposed treaty addresses the issue of non-arm's-length
royalties between related parties (or parties otherwise having
a special relationship) by providing that the amount of
royalties for purposes of applying this article is the amount
that would have been agreed upon by the payor and the
beneficial owner in the absence of the special relationship.
Any amount of royalties paid in excess of such amount is
taxable according to the laws of each country, taking into
account the other provisions of the proposed treaty. For
example, excess royalties paid by a subsidiary corporation to
its parent corporation may be treated as a dividend under local
law and thus be subject to the provisions of Article 10
(Dividends).
The proposed treaty provides source rules for royalties
which differ, in part, from those provided under U.S. internal
law. Royalties are deemed to arise within a country if the
payor is a resident of that country. If, however, the royalty
expense is borne by a permanent establishment or fixed base
that the payor has in Lithuania or the United States, the
royalty has as its source the country in which the permanent
establishment or fixed base is located, regardless of the
residence of the payor. Thus, for example, if a French resident
has a permanent establishment in Lithuania and that French
resident pays a royalty to a U.S. person which is attributable
to the Lithuanian permanent establishment, then the royalty
would be treated as having its source in Lithuania. In
addition, the proposed treaty provides that where the preceding
rules do not operate to deem royalties as arising in either the
United States or Lithuania, and the royalties relate to the use
of, or the right to use, a right or property in one of those
countries, the royalties are deemed to arise in that country
and not in the country of which the payor is resident.
Finally, notwithstanding the sourcing rules above, payments
received for the use of containers (including trailers, barges,
and related equipment for the transport of containers) used in
the transportation of passengers or property (other than
transportation solely between places in the same treaty
country) and not dealt with in Article 8 (Shipping and Air
Transport) will be deemed to arise in neither treaty country.
Article 13. Capital Gains
Internal taxation rules
United States
Generally, gain realized by a nonresident alien or a
foreign corporation from the sale of a capital asset is not
subject to U.S. tax unless the gain is effectively connected
with the conduct of a U.S. trade or business or, in the case of
a nonresident alien, he or she is physically present in the
United States for at least 183 days in the taxable year. A
nonresident alien or foreign corporation is subject to U.S. tax
on gain from the sale of a U.S. real property interest as if
the gain were effectively connected with a trade or business
conducted in the United States. ``U.S. real property
interests'' include interests in certain corporations if at
least 50 percent of the assets of the corporation consist of
U.S. real property.
Lithuania
Foreign corporations and nonresident individuals are
subject to a 10 percent capital gains tax in Lithuania.
Proposed treaty limitations on internal law
The proposed treaty specifies rules governing when a
country may tax gains from the alienation of property by a
resident of the other country. The rules are generally
consistent with those contained in the U.S. model.
Under the proposed treaty, gains derived by a resident of
one treaty country from the alienation of immovable (real)
property situated in the other country may be taxed in the
country where the property is situated. For the purposes of
this article, immovable (real) property in the other country
includes: (1) immovable (real) property as defined in Article 6
(Income from Immovable (Real) Property) situated in the other
country; (2) shares of stock of a company the property of which
consists at least 50 percent of immovable (real) property
situated in the other country; and (3) an interest in a
partnership, trust, or estate, to the extent that its assets
consist of immovable (real) property situated in the other
country. In the United States, the term includes a ``United
States real property interest.''
Gains from the alienation of movable property that forms a
part of the business property of a permanent establishment
which an enterprise of one country has in the other country,
gains from the alienation of movable property pertaining to a
fixed base which is available to a resident of one country in
the other country for the purpose of performing independent
personal services, and gains from the alienation of such a
permanent establishment (alone or with the whole enterprise) or
such a fixed base, may be taxed in that other country. This
rule also applies if the permanent establishment or fixed base
no longer exists when the gains are recognized but such gains
relate to the former permanent establishment or fixed base.
Gains derived by an enterprise of a treaty country from the
alienation of ships, aircraft, or containers operated in
international traffic (or movable property pertaining to the
operation or use of ships, aircraft, or containers) are taxable
only in such country.
Payments that satisfy the definition of royalties are
taxable under the proposed treaty only in accordance with
Article 12 (Royalties). The Technical Explanation states that
this rule makes clear that this article does not apply to gains
from the sale of any right or property that would give rise to
royalties, to the extent that such gains are contingent on the
productivity, use, or further disposition thereof.
Gains from the alienation of any property other than that
discussed above is taxable under the proposed treaty only in
the country where the person disposing of the property is
resident.
Article 14. Independent Personal Services
Internal taxation rules
United States
The United States taxes the income of a nonresident alien
individual at the regular graduated rates if the income is
effectively connected with the conduct of a trade or business
in the United States by the individual. The performance of
personal services within the United States may constitute a
trade or business within the United States.
Under the Code, the income of a nonresident alien
individual from the performance of personal services in the
United States is excluded from U.S.-source income, and
therefore is not taxed by the United States in the absence of a
U.S. trade or business, if the following criteria are met: (1)
the individual is not in the United States for over 90 days
during the taxable year; (2) the compensation does not exceed
$3,000; and (3) the services are performed as an employee of,
or under a contract with, a foreign person not engaged in a
trade or business in the United States, or are performed for a
foreign office or place of business of a U.S. person.
Lithuania
Payments to nonresidents for personal services are subject
to withholding tax at a rate of 20 percent.
Proposed treaty limitations on internal law
The proposed treaty limits the right of a country to tax
income from the performance of personal services by a resident
of the other country. Under the proposed treaty, income from
the performance of independent personal services (i.e.,
services performed as an independent contractor, not as an
employee) is treated separately from income from the
performance of dependent personal services.
Under the proposed treaty, income in respect of
professional services or other activities of an independent
character performed in one country by a resident of the other
country is exempt from tax in the country where the services
are performed (the source country) unless the individual
performing the services has a fixed base regularly available to
him or her in that country for the purpose of performing the
services.\5\ In that case, the source country is permitted to
tax only that portion of the individual's income which is
attributable to the fixed base. This rule also applies where
the income is received after the fixed base is no longer in
existence. An individual will be deemed to have a fixed base
regularly available in the other country if he or she stays in
the source country for a period or periods exceeding 183 days
within a twelve-month period, commencing or ending in the
taxable year concerned. This latter rule represents a departure
from the U.S. model, which would permit the source country to
tax the income from independent personal services of a resident
of the other country only if the income is attributable to a
fixed base regularly available to the individual in the source
country for the purpose of performing the activities.
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\5\ According to the Technical Explanation, it is understood that
the concept of a fixed base is analogous to the concept of a permanent
establishment.
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Under the proposed treaty, income that is taxable in the
other country pursuant to this article will be determined in
the same way as professional services income (or other income
from activities of an independent character) of a resident of
the other country. However, the proposed treaty does not
require a treaty country to grant to residents of the other
country any personal allowances, reliefs, and reductions for
taxation purposes on account of civil status or family
responsibilities that it grants to its own residents.
The term ``professional services'' includes especially
independent scientific, literary, artistic, educational, or
teaching activities as well as the independent activities of
physicians, lawyers, engineers, architects, dentists, and
accountants.
Article 15. Dependent Personal Services
Under the proposed treaty, wages, salaries, and other
remuneration derived from services performed as an employee in
one country (the source country) by a resident of the other
country are taxable only by the country of residence if three
requirements are met: (1) the individual must be present in the
source country for not more than 183 days in any twelve-month
period; (2) the individual is paid by, or on behalf of, an
employer who is not a resident of the source country; and (3)
the compensation must not be borne by a permanent establishment
or fixed base of the employer in the source country. These
limitations on source country taxation are the same as the
rules of the U.S. model and the OECD model.
The proposed treaty contains a special rule that permits
remuneration derived by a resident of one country in respect of
employment as a member of the regular complement (including the
crew) of a ship or aircraft operated in international traffic
by an enterprise of the other country to be taxed in that other
country. A similar rule is included in the OECD model. U.S.
internal law does not impose tax on such income of a
nonresident alien, even if such person is employed by a U.S.
entity.
This article is subject to the provisions of the separate
articles covering directors' fees (Article 16), pensions,
social security, annuities, alimony, and child support (Article
18), government service income (Article 19), and income of
students, trainees, and researchers (Article 20).
Article 16. Directors' Fees
Under the proposed treaty, directors' fees and other
compensation derived by a resident of one country in his or her
capacity as a member of the board of directors (or any similar
organ) of a company that is a resident of that other country is
taxable in that other country. The provision is similar to the
corresponding rule in the OECD model. Under this rule, the
country in which the company is resident may tax all of the
remuneration paid to nonresident board members, regardless of
where the services are performed. The U.S. model contains a
different rule, which provides that the country of the
company's residence may tax nonresident directors, but only
with respect to remuneration for services performed in that
country.
Article 17. Artistes and Sportsmen
Like the U.S. and OECD models, the proposed treaty contains
a separate set of rules that apply to the taxation of income
earned by entertainers (such as theater, motion picture, radio,
or television ``artistes'' or musicians) and sportsmen. These
rules apply notwithstanding the other provisions dealing with
the taxation of income from personal services (Articles 14 and
15) and are intended, in part, to prevent entertainers and
athletes from using the treaty to avoid paying any tax on their
income earned in one of the countries.
Under the proposed treaty, income derived by an entertainer
or sportsman who is a resident of one country from his or her
personal activities as such in the other country may be taxed
in the other country if the amount of the gross receipts
derived by him or her from such activities exceeds $20,000 or
its equivalent in Lithuanian litas. The $20,000 threshold
includes reimbursed expenses. Under this rule, if a Lithuanian
entertainer or sportsman maintains no fixed base in the United
States and performs (as an independent contractor) for one day
of a taxable year in the United States for total compensation
of $10,000, the United States could not tax that income. If,
however, that entertainer's or sportsman's total compensation
were $30,000, the full amount would be subject to U.S. tax.
The proposed treaty provides that where income in respect
of activities exercised by an entertainer or sportsman in his
or her capacity as such accrues not to the entertainer or
sportsman but to another person, that income is taxable by the
country in which the activities are exercised unless it is
established that neither the entertainer or sportsman nor
persons related to him or her participated directly or
indirectly in the profits of that other person in any manner,
including the receipt of deferred remuneration, bonuses, fees,
dividends, partnership distributions, or other distributions.
This provision applies notwithstanding the business profits and
personal service articles (Articles 7, 14, and 15). This
provision prevents highly-paid entertainers and athletes from
avoiding tax in the country in which they perform by, for
example, routing the compensation for their services through a
third entity such as a personal holding company or a trust
located in a country that would not tax the income.
The proposed treaty provides that these rules do not apply
to income derived from activities performed in a country by
entertainers or sportsmen if such activities are wholly or
mainly supported by public funds of the other country or a
political subdivision or a local authority thereof. In such a
case, the income is taxable only in the country in which the
entertainer or sportsman is a resident.
Article 18. Pensions, Social Security, Annuities, Alimony, and Child
Support
Under the proposed treaty, pensions and other similar
remuneration derived and beneficially owned by a resident of
either country in consideration of past employment, whether
paid periodically or in a lump sum, is subject to tax only in
the recipient's country of residence. However, the amount of
any such pension or remuneration that would be excluded from
taxable income in the other country if the recipient were a
resident thereof will be exempt from taxation in the first-
mentioned country of residence. These rules are subject to the
provisions of Article 19 (Government Service) with respect to
pensions.
The proposed treaty provides that payments made by one of
the countries under the provisions of the social security or
similar legislation of the country to a resident of the other
country or to a U.S. citizen are taxable only by the source
country, and not by the country of residence. The Technical
Explanation states that the term ``similar legislation'' is
intended to include U.S. tier 1 Railroad Retirement benefits.
Consistent with the U.S. model, this rule with respect to
social security payments is an exception to the proposed
treaty's saving clause.
The proposed treaty provides that annuities are taxed only
in the country of residence of the individual who beneficially
owns and derives them. The term ``annuities'' is defined for
purposes of this provision as a stated sum (other than a
pension) paid periodically at stated times during a specified
number of years, under an obligation to make the payments in
return for adequate and full consideration (other than services
rendered).
Under the proposed treaty, alimony paid by a resident of
one country, and deductible therein, to a resident of the other
country will be taxable only in the other country. For this
purpose, the term ``alimony'' means periodic payments made
pursuant to a written separation agreement or a decree of
divorce, separate maintenance, or compulsory support, which
payments are taxable to the recipient under the laws of the
country of residence. However, periodic payments (other than
alimony) for the support of a minor child made pursuant to a
written separation agreement or a decree of divorce, separate
maintenance, or compulsory support, paid by a resident of one
country to a resident of the other country, are not taxable in
the other country.
Article 19. Government Service
Under the proposed treaty, remuneration, other than a
pension, paid by, or out of the public funds of a treaty
country or a political subdivision or local authority thereof
to an individual in respect of dependent personal services
rendered to that country (or subdivision or authority) in the
discharge of functions of a governmental nature generally is
taxable only by that country. Such remuneration is taxable only
in the other country, however, if the services are rendered in
that other country by an individual who is a resident of that
country and who (1) is also a national of that country or (2)
did not become a resident of that country solely for the
purpose of rendering the services. This treatment is similar to
the rules under the U.S. and OECD models.
The proposed treaty further provides that any pension paid
by, or out of the public funds of one of the countries (or a
political subdivision or local authority thereof) to an
individual in respect of services rendered to that country (or
subdivision or authority) in the discharge of functions of a
governmental nature is taxable only by that country. Such a
pension is taxable only by the other country, however, if the
individual is a resident and national of that other country.
Social security benefits in respect of government services are
subject to Article 18 (Pensions, Social Security, Annuities,
Alimony, and Child Support) and not this article. This
treatment is similar to the OECD model, but differs from the
U.S. model, in that it applies only to government employees and
not to independent contractors engaged by governments to
perform services for them.
The Technical Explanation states that the phrase
``functions of a governmental nature'' is generally understood
to encompass functions traditionally carried on by a
government. It generally would not include functions that
commonly are found in the private sector (e.g., education,
health care, utilities). Rather, it is limited to functions
that generally are carried on solely by the government (e.g.,
military, diplomatic service, tax administrators) and
activities that directly support the carrying out of those
functions.
The provisions described in the foregoing paragraphs are
exceptions to the proposed treaty's saving clause for
individuals who are neither citizens nor permanent residents of
the country where the services are performed. Thus, for
example, a resident of Lithuania, who in the course of
performing functions of a governmental nature becomes a
resident of the United States (but not a permanent resident),
would be entitled to the benefits of this article. However, an
individual who receives a pension paid by the Government of
Lithuania in respect of services rendered to that Government is
taxable on that pension only in Lithuania unless the individual
is a U.S. citizen or acquires a U.S. green card.
Article 20. Students, Trainees and Researchers
Under the proposed treaty, a resident of one country who
visits the other country (the host country) for the primary
purpose of studying at a university or other accredited
educational institution, securing training in a professional
specialty, or studying or doing research as the recipient of a
grant from a governmental, religious, charitable, scientific,
literary, or educational organization will be exempt from tax
in the host country with respect to certain items of income for
a period not exceeding five years from the date of arrival in
the host country. The items of income that are eligible for
exemption from host country taxation are: (1) payments from
abroad for maintenance, education, study, research, or
training; (2) grants, allowances, or awards; and (3) income
from personal services performed in the other country to the
extent of $5,000, or its equivalent in Lithuanian litas.
Under the proposed treaty, an individual resident of one
country who visits the other country as an employee of, or
under contract with, a resident of the first country for the
primary purpose of acquiring technical, professional, or
business experience from a person other than his employer or
studying at a university or other accredited educational
institution in the other country is exempt from tax by the
other country for a period of 12 consecutive months on
compensation for personal services in an aggregate amount not
exceeding $8,000 or its equivalent in Lithuanian litas.
Under the proposed treaty, an individual resident of one
country who is temporarily present in the other country for a
period not exceeding one year, as a participant in a program
sponsored by the Government of the other country, for the
primary purpose of training, research, or study is exempt from
tax by the other country on compensation for personal services
performed in the other country in respect of such training,
research, or study, in an aggregate amount not exceeding
$10,000 or its equivalent in Lithuanian litas.
The proposed treaty provides that this article does not
apply to income from research undertaken not in the public
interest, but primarily for the private benefit of a specific
person or persons.
This article of the proposed treaty is an exception from
the saving clause in the case of persons who are neither
citizens nor lawful permanent residents of the host country.
Article 21. Offshore Activities
Under the proposed treaty, a resident of a treaty country
that carries on activities offshore in the other country in
connection with the exploration or exploitation of the sea bed
and sub-soil and their natural resources will be deemed, in
relation to such activities, to be carrying on business in the
other country through a permanent establishment or a fixed base
situated therein. This provision applies, notwithstanding the
provisions of Articles 4 through 20. This provision only
applies when offshore activities are carried on by a resident
(and certain associated persons) in the other country for a
period or periods aggregating more than 30 days in any 12-month
period. For this purpose, if two associated persons are
carrying on substantially the same offshore activities at
different times, each activity of an associated person will be
regarded as being carried on by the other. Persons are
associated if one is controlled (directly or indirectly) by the
other, or both are controlled (directly or indirectly) by a
third person or persons.
The proposed treaty specifically excludes from the
application of this article the following activities: (1) one
or any combination of the activities deemed not to constitute a
permanent establishment (as described in paragraph 4 of Article
5 (Permanent Establishment)); (2) towing or anchor handling by
ships primarily designed for such purpose and any other
activities performed by such ships; or (3) the transport of
supplies or personnel by ships or aircraft in international
traffic.
Under the proposed treaty, wages and similar remuneration
derived by a resident of one country in respect of an
employment connected with the exploration or exploitation of
the sea bed and sub-soil (and their natural resources) situated
in the other country, to the extent performed offshore in the
other country, may be taxed in the other country. However, such
remuneration is taxable only by the first country (i.e., the
employee's country of residence) if the employment is carried
on offshore for an employer who is not a resident of the other
country and for a period or periods not exceeding, in the
aggregate, 30 days in any 12-month period.
The proposed treaty further provides that salaries, wages,
and similar remuneration derived by a resident of one country
in respect of an employment exercised aboard a ship or aircraft
engaged in the transportation of supplies or personnel to a
location, or between locations, where sea bed and sub-soil (and
their natural resources) exploration or exploitation activities
are being carried on in the other country, or in respect of an
employment exercised aboard tugboats or other vessels operated
auxiliary to such activities, may be taxed in the country of
which the employer is a resident.
Article 22. Other Income
This article is a catch-all provision intended to cover
items of income not specifically covered in other articles, and
to assign the right to tax income from third countries to
either the United States or Lithuania. As a general rule, items
of income not otherwise dealt with in the proposed treaty which
are beneficially owned by residents of one of the countries,
wherever arising, are taxable only in the country of residence.
This rule is similar to the rules in the U.S. and OECD models.
This rule, for example, gives the United States the sole
right under the proposed treaty to tax income derived from
sources in a third country and paid to a U.S. resident. This
article is subject to the saving clause, so U.S. citizens who
are residents of Lithuania will continue to be taxable by the
United States on their third-country income.
The general rule just stated does not apply to income
(other than income from immovable (real) property as defined in
Article 6) if the beneficial owner of the income is a resident
of one country and carries on business in the other country
through a permanent establishment, or performs independent
personal services in the other country from a fixed base, and
the income is attributable to such permanent establishment or
fixed base. In such a case, the provisions of Article 7
(Business Profits) or Article 14 (Independent Personal
Services), as the case may be, will apply. Such exception also
applies where the income is received after the permanent
establishment or fixed base is no longer in existence, but the
income is attributable to the former permanent establishment or
fixed base.
Article 23. Limitation of Benefits
In general
The proposed treaty contains a provision generally intended
to limit the indirect use of the proposed treaty by persons who
are not entitled to its benefits by reason of residence in the
United States or Lithuania.
The proposed treaty is intended to limit double taxation
caused by the interaction of the tax systems of the United
States and Lithuania as they apply to residents of the two
countries. At times, however, residents of third countries
attempt to use a treaty. This use is known as ``treaty
shopping,'' which refers to the situation where a person who is
not a resident of either treaty country seeks certain benefits
under the income tax treaty between the two countries. Under
certain circumstances, and without appropriate safeguards, the
third-country resident may be able to secure these benefits
indirectly by establishing a corporation or other entity in one
of the treaty countries, which entity, as a resident of that
country, is entitled to the benefits of the treaty.
Additionally, it may be possible for the third-country resident
to reduce the income base of the treaty country resident by
having the latter pay out interest, royalties, or other amounts
under favorable conditions either through relaxed tax
provisions in the distributing country or by passing the funds
through other treaty countries until the funds can be
repatriated under favorable terms.
The proposed anti-treaty shopping article provides that a
resident of either Lithuania or the United States will be
entitled to the benefits of the proposed treaty only if the
resident is a ``qualified resident.'' A resident is a qualified
resident for a taxable year only if it:
(1) is an individual;
(2) is a treaty country, a political subdivision or
a local authority thereof, or an agency or
instrumentality of such country, subdivision, or
authority;
(3) is a company, trust, or estate that satisfies
both aspects of an ownership and base erosion test;
(4) is a person that satisfies a public company test;
(5) is a person that is owned by certain public
companies;
(6) is a tax-exempt organization or pension fund
that satisfies an ownership test; or
(7) is a United States regulated investment company,
or a similar entity in Lithuania as may be agreed by
the competent authorities of the treaty countries.
Alternatively, a resident that is not a qualified resident
may claim treaty benefits for particular items of income if it
satisfies an active business test. In addition, a resident of
either country that is not a qualified resident may be entitled
to the benefits of the proposed treaty if the competent
authority of the country in which the income in question arises
so determines.
Individuals
An individual resident of a treaty country is entitled to
the benefits of the proposed treaty.
Governments
Under the proposed treaty, the two countries, their
political subdivisions or local authorities, or agencies or
instrumentalities of the countries or their political
subdivisions or local authorities, are entitled to all treaty
benefits.
Ownership and base erosion test
Under the proposed treaty, an entity that is resident in
one of the countries is entitled to treaty benefits if it
satisfies an ownership test and a base erosion test. For this
purpose, an entity includes a company, as well as a trust or an
estate. Under the ownership test, at least 50 percent of the
beneficial interests in an entity (in the case of a company, at
least 50 percent of each class of the company's shares) must be
beneficially owned, directly or indirectly, on at least half
the days of the taxable year by qualified residents (as
described above) or U.S. citizens, provided that each
intermediate owner used to satisfy the control requirement is a
resident of Lithuania or the United States. This rule could,
for example, deny the benefits of the reduced U.S. withholding
tax rates on dividends and royalties paid to a Lithuanian
company that is controlled by individual residents of a third
country.
In addition, the base erosion test is satisfied only if no
more than 50 percent of the gross income of the company (or the
payments in the case of a trust or estate) is paid or accrued
during the taxable year to persons (1) that are neither
qualified residents nor U.S. citizens, and (2) that are
deductible for income tax purposes in the entity's country of
residence (but not including arm's length payments in the
ordinary course of business for services or tangible property).
This rule is intended to prevent an entity from distributing
most of its income, in the form of deductible items such as
interest, royalties, service fees, or other amounts to persons
not entitled to benefits under the proposed treaty.
Public company tests
The public company test is satisfied if at least 50 percent
of the value of each class of the beneficial interests in a
person are substantially and regularly traded on a recognized
stock exchange. Similarly, treaty benefits are available to a
person that is at least 50-percent owned, directly or
indirectly, by a person that satisfies the public company test
previously described, provided that each intermediate owner
used to satisfy the control requirement is a resident of
Lithuania or the United States.
The Technical Explanation states that interests are
considered to be ``substantially and regularly traded'' if two
requirements are met: trades in the class of interests are made
in more than de minimis quantities on at least 60 days during
the taxable year, and the aggregate number of interests in the
class traded during the year is at least 6 percent of the
average number of interests outstanding during the year.
Under the proposed treaty, the term ``recognized stock
exchange'' means: (1) the NASDAQ System owned by the National
Association of Securities Dealers, Inc. and any stock exchange
registered with the U.S. Securities and Exchange Commission as
a national securities exchange under the U.S. Securities
Exchange Act of 1934; (2) the National Stock Exchange of
Lithuania (Nacionaline vertybiniu popieriu birza); and (3) any
other stock exchange agreed upon by the competent authorities
of the countries.
Tax-exempt entities
A legal person organized under the laws of either treaty
country and that is generally exempt from tax in that country
is entitled to the benefits of the proposed treaty if it is
established and maintained in a treaty country either
exclusively for a religious, charitable, educational,
scientific, or other similar purpose; or to provide pensions or
other similar benefits to employees pursuant to a plan. In
addition, more than half of the beneficiaries, members, or
participants, if any, in such person must be qualified
residents.
Regulated investment companies
A United States regulated investment company, or a similar
entity in Lithuania as may be agreed by the competent
authorities of the treaty countries, is entitled to the
benefits of the proposed treaty.
Active business test
Under the active business test, treaty benefits are
available to a resident of a country with respect to an item of
income derived from the other country if: (1) the resident is
engaged in the active conduct of a trade or business in the
country of residence; (2) the income is connected with or
incidental to that trade or business; and (3) the trade or
business is substantial in relation to the activity in the
other country generating the income. However, the business of
making or managing investments does not constitute an active
trade or business (and benefits therefore may be denied),
unless such activity is a banking, insurance, or securities
activity conducted by a bank, insurance company, or registered
securities dealer.
The determination of whether a trade or business is
substantial is determined based on all facts and circumstances.
However, the proposed treaty provides a safe harbor under which
the trade or business of the resident is considered to be
substantial if certain attributes of the residence-country
business exceed a threshold fraction of the corresponding
attributes of the trade or business located in the source
country that produces the source-country income. Under this
safe harbor, the attributes are assets, gross income, and
payroll expense. To satisfy the safe harbor, the level of each
such attribute in the active conduct of the trade or business
by the resident (and any related parties) in the residence
country, and the level of each such attribute in the trade or
business producing the income in the source country, is
measured for the prior year or for the prior three years. For
each separate attribute, the ratio of the residence country
level to the source country level is computed.
In general, the safe harbor is satisfied if, for the prior
year or for the average of the three prior years, the average
of the three ratios exceeds 10 percent, and each ratio
separately is at least 7.5 percent. These rules are similar to
those contained in the U.S. model. The Technical Explanation
states that if a resident owns less than 100 percent of an
activity in either country, the resident will only include its
proportionate interest in such activity for purpose of
computing the safe harbor percentages.
The proposed treaty provides that income is derived in
connection with a trade or business if the activity in the
other country generating the income is a line of business that
forms a part of or is complementary to the trade or business.
The Technical Explanation states that a business activity
generally is considered to ``form a part of'' a business
activity conducted in the other country 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
Technical Explanation further provides that in order 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. Under the proposed treaty, income is incidental to a
trade or business if it facilitates the conduct of the trade or
business in the other country.
The term ``active conduct of a trade or business'' is not
specifically defined in the proposed treaty. However, as
provided in Article 3 (General Definitions), undefined terms
are to have the meaning which they have under the laws of the
country applying the proposed treaty. In this regard, the
Technical Explanation states that the U.S. competent authority
will refer to the regulations issued under Code section 367(a)
to define an active trade or business.
Other matters
Under the proposed treaty, the competent authorities of the
treaty countries will consult together with a view to
developing a commonly agreed application of the provisions of
this article, including the publication of public guidance. The
competent authorities will, in accordance with the provisions
of Article 27 (Exchange of Information and Administrative
Assistance), exchange such information as is necessary for
carrying out the provisions of this article.
Article 24. Relief From Double Taxation
Internal taxation rules
United States
The United States taxes the worldwide income of its
citizens and residents. It attempts unilaterally to mitigate
double taxation generally by allowing taxpayers to credit the
foreign income taxes that they pay against U.S. tax imposed on
their foreign-source income. An indirect or ``deemed-paid''
credit is also provided. Under this rule, a U.S. corporation
that owns 10 percent or more of the voting stock of a foreign
corporation and that receives a dividend from the foreign
corporation (or an inclusion of the foreign corporation's
income) is deemed to have paid a portion of the foreign income
taxes paid (or deemed paid) by the foreign corporation on its
earnings. The taxes deemed paid by the U.S. corporation are
included in its total foreign taxes paid for the year the
dividend is received.
Lithuania
Lithuanian resident individuals and companies are allowed a
credit for taxes paid to foreign countries that would not be in
excess of the Lithuanian tax on such income.
Proposed treaty limitations on internal law
One of the principal purposes for entering into an income
tax treaty is to limit double taxation of income earned by a
resident of one of the countries that may be taxed by the other
country. Unilateral efforts to limit double taxation are
imperfect. Because of differences in rules as to when a person
may be taxed on business income, a business may be taxed by two
countries as if it were engaged in business in both countries.
Also, a corporation or individual may be treated as a resident
of more than one country and be taxed on a worldwide basis by
both.
Part of the double tax problem is dealt with in other
articles of the proposed treaty that limit the right of a
source country to tax income. This article provides further
relief where both Lithuania and the United States otherwise
still tax the same item of income. This article is not subject
to the saving clause, so that the country of citizenship or
residence will waive its overriding taxing jurisdiction to the
extent that this article applies.
The proposed treaty generally provides that the United
States will allow a U.S. citizen or resident a foreign tax
credit for the income taxes imposed by Lithuania. The proposed
treaty also requires the United States to allow a deemed-paid
credit, with respect to Lithuanian income tax, to any U.S.
company that receives dividends from a Lithuanian company if
the U.S. company owns 10 percent or more of the voting stock of
such Lithuanian company. The credit generally is to be computed
in accordance with the provisions and subject to the
limitations of U.S. law (as such law may be amended from time
to time without changing the general principles of the proposed
treaty provisions). This provision is similar to those found in
the U.S. model and many U.S. treaties.
The proposed treaty generally provides that, unless
domestic law grants a more favorable treatment, Lithuania will
allow its residents, who derive income that may be subject to
tax in the United States and Lithuania, a deduction against
Lithuanian income tax for the U.S. incomes taxes paid (other
than any such tax imposed by reason of U.S. citizenship). The
deduction cannot exceed the pre-credit amount of Lithuanian
income tax attributable to the income that may be taxed in the
United States. For purposes of this rule, the amount of tax
available for deduction includes the appropriate portion of the
taxes paid in the United States on the underlying profits of
the company out of which the dividend is paid, but only when
the Lithuanian resident receives the dividend from a U.S.
resident company in which it owns at least 10 percent of the
voting power.
For purposes of allowing relief from double taxation under
this article, the proposed treaty provides a source rule for
determining the country in which an item of income is deemed to
have arisen. Under this rule, income derived by a resident of
one of the countries that may be taxed in the other country in
accordance with the proposed treaty (other than solely by
reason of citizenship) is treated as arising in that other
country. However, the preceding rule does not override the
source rules of the domestic laws of the countries that are
applicable for purposes of limiting the foreign tax credit.
Article 25. Nondiscrimination
The proposed treaty contains a comprehensive
nondiscrimination article relating to all taxes of every kind
imposed at the national, state, or local level. It is similar
to the nondiscrimination article in the U.S. model and to
provisions that have been included in other recent U.S. income
tax treaties.
In general, under the proposed treaty, one country cannot
discriminate by imposing other or more burdensome taxes (or
requirements connected with taxes) on nationals of the other
country than it would impose on its nationals in the same
circumstances, in particular with respect to residence. This
rule applies whether or not the nationals in question are
residents of the United States or Lithuania. However, for
purposes of U.S. tax, U.S. nationals subject to tax on a
worldwide basis are not in the same circumstances as Lithuanian
nationals who are not U.S. residents.
Under the proposed treaty, neither country may tax a
permanent establishment of an enterprise (or a fixed base of a
resident individual) of the other country less favorably than
it taxes its own enterprises carrying on the same activities.
Consistent with the U.S. model and the OECD model, however, a
country is not obligated to grant residents of the other
country any personal allowances, reliefs, or reductions for tax
purposes on account of civil status or family responsibilities
that are granted to its own residents.
Each country is required (subject to the arm's-length
pricing rules of paragraph 1 of Article 9 (Associated
Enterprises), paragraph 7 of Article 11 (Interest), and
paragraph 5 of Article 12 (Royalties)) to allow its residents
to deduct interest, royalties, and other disbursements paid by
them to residents of the other country under the same
conditions that it allows deductions for such amounts paid to
residents of the same country as the payor. The Technical
Explanation states that 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. The Technical Explanation further
states that the rules of section 163(j) of the Code are not
discriminatory within the meaning of this provision. The
proposed treaty further provides that any debts of a resident
of one country to a resident of the other country are
deductible for purposes of determining the taxable capital of
the debtor under the same conditions as if the debt had been
owed to a resident of the country imposing such tax.
The nondiscrimination rules also apply to enterprises of
one country that are owned in whole or in part by residents of
the other country. Enterprises resident in one country, the
capital of which is wholly or partly owned or controlled,
directly or indirectly, by one or more residents of the other
country, will not be subjected in the first country to any
taxation (or any connected requirement) which is other or more
burdensome than the taxation (or connected requirements) that
the first country imposes or may impose on its similar
enterprises. The Technical Explanation includes examples of
Code provisions that are understood by the two countries not to
violate this provision of the proposed treaty. Those examples
include the rules that impose a withholding tax on non-U.S.
partners of a partnership and the rules that prevent foreign
persons from owning stock in Subchapter S corporations.
The proposed treaty provides that nothing in the
nondiscrimination article is to be construed as preventing
either of the countries from imposing a branch profits tax or a
branch-level interest tax. Notwithstanding the definition of
taxes covered in Article 2, this article applies to taxes of
every kind and description imposed by either country, or a
political subdivision or local authority thereof.
The saving clause (which allows the country of residence or
citizenship to impose tax notwithstanding certain treaty
provisions) does not apply to the nondiscrimination article.
Article 26. Mutual Agreement Procedure
The proposed treaty contains the standard mutual agreement
provision, with some variation, that authorizes the competent
authorities of the two countries to consult together to attempt
to alleviate individual cases of double taxation not in
accordance with the proposed treaty. The saving clause of the
proposed treaty does not apply to this article, so that the
application of this article might result in a waiver (otherwise
mandated by the proposed treaty) of taxing jurisdiction by the
country of citizenship or residence.
Under this article, a resident of one country who considers
that the action of one or both of the countries will cause him
or her to be subject to tax which is not in accordance with the
proposed treaty may present his or her case to the competent
authority of either country. The case must be presented within
3 years from the first notification of the action resulting in
taxation not in accordance with the provisions of the treaty.
The competent authority then makes a determination as to
whether the objection appears justified. If the objection
appears to it to be justified and if it is not itself able to
arrive at a satisfactory solution, that competent authority
must endeavor to resolve the case by mutual agreement with the
competent authority of the other country, with a view to the
avoidance of taxation which is not in accordance with the
proposed treaty. The provision authorizes a waiver of the
statute of limitations of either country.
The competent authorities of the countries must endeavor to
resolve by mutual agreement any difficulties or doubts arising
as to the interpretation or application of the proposed treaty.
In particular, the competent authorities may agree to the
following: (1) the same attribution of income, deductions,
credits, or allowances of an enterprise of one treaty country
to the enterprise's permanent establishment situated in the
other country; (2) the same allocation of income, deductions,
credits, or allowances between persons; (3) the same
characterization of particular items of income; (4) the same
characterization of persons; (5) the same application of source
rules with respect to particular items of income; (6) a common
meaning of a term; (7) increases in any specific dollar amounts
referred to in the proposed treaty to reflect economic or
monetary developments; (8) advance pricing arrangements; and
(9) the application of the provisions of each country's
internal law regarding penalties, fines, and interest in a
manner consistent with the purposes of the proposed treaty. The
competent authorities may also consult together for the
elimination of double taxation regarding cases not provided for
in the proposed treaty. This treatment is similar to the
treatment under the U.S. model.
The proposed treaty authorizes the competent authorities to
communicate with each other directly for purposes of reaching
an agreement in the sense of this mutual agreement article.
This provision makes clear that it is not necessary to go
through diplomatic channels in order to discuss problems
arising in the application of the proposed treaty.
Article 27. Exchange of Information and Administrative Assistance
This article provides for the exchange of information
between the two countries. Notwithstanding the provisions of
Article 2 (Taxes Covered), the proposed treaty's information
exchange provisions apply to all taxes imposed in either
country at the national level.
The proposed treaty provides that the two competent
authorities will exchange such information as is relevant to
carry out the provisions of the proposed treaty or the
provisions of the domestic laws of the two countries concerning
taxes to which the proposed treaty applies (provided that the
taxation under those domestic laws is not contrary to the
proposed treaty). This exchange of information is not
restricted by Article 1 (General Scope). Therefore, information
with respect to third-country residents is covered by these
procedures.
Any information exchanged under the proposed treaty is
treated as secret in the same manner as information obtained
under the domestic laws of the country receiving the
information. The exchanged information may be disclosed only to
persons or authorities (including courts and administrative
bodies) involved in the assessment, collection or
administration of, the enforcement or prosecution in respect
of, or the determination of appeals in relation to, the taxes
to which the proposed treaty applies. Such persons or
authorities must use the information for such purposes only.\6\
The Technical Explanation states that persons involved in the
administration of taxes include legislative bodies with
oversight roles with respect to the administration of the tax
laws, such as, for example, the tax-writing committees of
Congress and the General Accounting Office. Information
received by these bodies must be for use in the performance of
their role in overseeing the administration of U.S. tax laws.
Exchanged information may be disclosed in public court
proceedings or in judicial decisions.
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\6\ Code section 6103 provides that otherwise confidential tax
information may be utilized for a number of specifically enumerated
non-tax purposes. Information obtained by the United States pursuant to
the proposed treaty could not be used for these non-tax purposes.
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As is true under the U.S. model and the OECD model, under
the proposed treaty, a country is not required to carry out
administrative measures at variance with the laws and
administrative practice of either country, to supply
information that is not obtainable under the laws or in the
normal course of the administration of either country, or to
supply information that 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.
Notwithstanding the preceding paragraph, a country has the
authority to obtain and provide information held by financial
institutions, nominees, or persons acting in a fiduciary
capacity. It also has the authority to obtain information
respecting ownership of debt instruments or interests in a
person. Such information must be provided to the requesting
country notwithstanding any laws or practices of the requested
country that would otherwise preclude acquiring or disclosing
such information. Furthermore, if information is requested by a
treaty country pursuant to this article, the other country is
obligated to obtain the requested information as if the tax in
question were the tax of the requested country, even if that
country has no direct tax interest in the case to which the
request relates. If specifically requested, the competent
authority of a country must provide information in the form of
depositions of witnesses and authenticated copies of unedited
original documents (including books, papers, statements,
records, accounts, and writings), to the same extent such
depositions and documents can be obtained under the laws and
administrative practices of the requested country with respect
to its own taxes. Also, the proposed treaty provides that the
competent authority of the requested country must allow
representatives of the requesting country to enter the
requested country to interview individuals and examine books
and records with the consent of the person subject to
examination.
Under the proposed treaty, a country must endeavor to
collect on behalf of the other country only those amounts
necessary to ensure that any exemption or reduced rate of tax
at source granted under the treaty by the other country is not
enjoyed by persons not entitled to such benefits. However,
neither country is obligated, in the process of providing
collection assistance, to carry out administrative measures
that differ from those used in the collection of its own taxes,
or that would be contrary to its sovereignty, security, or
public policy.
Article 28. Members of Diplomatic Missions and Consular Posts
The proposed treaty contains the rule found in the U.S.
model and other U.S. tax treaties that its provisions do not
affect the fiscal privileges of members of diplomatic missions
or consular posts under the general rules of international law
or under the provisions of special agreements. Accordingly, the
proposed treaty will not defeat the exemption from tax which a
host country may grant to the salary of diplomatic officials of
the other country. The saving clause does not apply in the
application of this article to host country residents who are
neither citizens nor lawful permanent residents of that
country. Thus, for example, U.S. diplomats who are considered
Lithuanian residents may be protected from Lithuanian tax.
Article 29. Entry Into Force
The proposed treaty will enter into force on the date on
which the second of the two notifications of the completion of
ratification requirements has been received. Each country must
notify the other through diplomatic channels when its
constitutional requirements for ratification have been
satisfied.
With respect to taxes withheld at source, the proposed
treaty will be effective for amounts paid or credited on or
after the first day of January of the calendar year next
following the year in which the proposed treaty enters into
force.
With respect to other taxes, the proposed treaty will be
effective for taxable years beginning on or after the first day
of January of the calendar year next following the year in
which the proposed treaty enters into force.
The proposed treaty provides that the appropriate
authorities of the treaty countries will consult within 5 years
from the date of the entry into force of the proposed treaty
regarding its application, including the negotiation of a
treaty amendment (by means of a protocol, if appropriate)
regarding income derived from new technologies (such as
payments received for transmission by satellite, cable, optic
fibre, or similar technology).
Article 30. Termination
The proposed treaty will continue in force until terminated
by either country. Either country may terminate the proposed
treaty at any time at least six months before the end of any
calendar year by giving written notice of termination through
diplomatic channels. A termination is effective, with respect
to taxes withheld at source for amounts paid or credited on or
after the first day of the calendar year next following the
expiration of the notification period. In the case of other
taxes, a termination is effective for taxable years beginning
on or after the first day of January next following the
expiration of the notification period.
IV. ISSUES
The proposed treaty with Lithuania presents the following
specific issues.
A. Treatment of REIT Dividends
REITs in general
REITs essentially are treated as conduits for U.S. tax
purposes. The income of a REIT generally is not taxed at the
entity level but is distributed and taxed only at the investor
level. This single level of tax on REIT income is in contrast
to other corporations, the income of which is subject to tax at
the corporate level and is taxed again at the shareholder level
upon distribution as a dividend. Hence, a REIT is like a mutual
fund that invests in qualified real estate assets.
An entity that qualifies as a REIT is taxable as a
corporation. However, unlike other corporations, a REIT is
allowed a deduction for dividends paid to its shareholders.
Accordingly, income that is distributed by a REIT to its
shareholders is not subject to corporate tax at the REIT level.
A REIT is subject to corporate tax only on any income that it
does not distribute currently to its shareholders. As discussed
below, a REIT is required to distribute on a current basis the
bulk of its income each year.
In order to qualify as a REIT, an entity must satisfy, on a
year-by-year basis, specific requirements with respect to its
organizational structure, the nature of its assets, the source
of its income, and the distribution of its income. These
requirements are intended to ensure that the benefits of REIT
status are accorded only to pooling of investment arrangements,
the income of which is derived from passive investments in real
estate and is distributed to the investors on a current basis.
In order to satisfy the organizational structure
requirements for REIT status, a REIT must have at least 100
shareholders and not more than 50 percent (by value) of its
shares may be owned by five or fewer individuals. In addition,
shares of a REIT must be transferrable.
In order to satisfy the asset requirements for REIT status,
a REIT must have at least 75 percent of the value of its assets
invested in real estate, cash and cash items, and government
securities. In addition, diversification rules apply to the
REIT's investment in assets other than the foregoing qualifying
assets. Under these rules, not more than 5 percent of the value
of its assets may be invested in securities of a single issuer
and any such securities held may not represent more than 10
percent of the voting securities of the issuer.
In order to satisfy the source of income requirements, at
least 95 percent of the gross income of the REIT generally must
be from certain passive sources (e.g., dividends, interest, and
rents). In addition, at least 75 percent of its gross income
generally must be from certain real estate sources (e.g., real
property rents, mortgage interest, and real property gains).
Further, in order to satisfy the distribution of income
requirement, the REIT generally is required to distribute to
its shareholders each year at least 95 percent of its taxable
income for the year (excluding net capital gains). A REIT may
retain 5 percent or less of its taxable income and all or part
of its net capital gain.
A REIT is subject to corporate-level tax only on any
taxable income and net capital gains that the REIT retains.
Under an available election, shareholders may be taxed
currently on the undistributed capital gains of a REIT, with
the shareholder entitled to a credit for the tax paid by the
REIT with respect to the undistributed capital gains such that
the gains are subject only to a single level of tax.
Distributions from a REIT of ordinary income are taxable to the
shareholders as a dividend, in the same manner as dividends
from an ordinary corporation. Accordingly, such dividends are
subject to tax at a maximum rate of 39.6 percent in the case of
individuals and 35 percent in the case of corporations. In
addition, capital gains of a REIT distributed as a capital gain
dividend are taxable to the shareholders as capital gain.
Capital gain dividends received by an individual will be
eligible for preferential capital gain tax rates if the
relevant holding period requirements are satisfied.
Foreign investors in REITs
Nonresident alien individuals and foreign corporations
(collectively, foreign persons) are subject to U.S. tax on
income that is effectively connected with the foreign person's
conduct of a trade or business in the United States, in the
same manner and at the same graduated tax rates as U.S.
persons. In addition, foreign persons generally are subject to
U.S. tax at a flat 30-percent rate on certain gross income that
is derived from U.S. sources and that is not effectively
connected with a U.S. trade or business. The 30-percent tax
applies on a gross basis to U.S.-source interest, dividends,
rents, royalties, and other similar types of income. This tax
generally is collected by means of withholding by the person
making the payment of such amounts to a foreign person.
Capital gains of a nonresident alien individual that are
not connected with a U.S. business generally are subject to the
30-percent withholding tax only if the individual is present in
the United States for 183 days or more during the year. The
United States generally does not tax foreign corporations on
capital gains that are not connected with a U.S. trade or
business. However, foreign persons generally are subject to
U.S. tax on any gain from a disposition of an interest in U.S.
real property at the same rates that apply to similar income
received by U.S. persons. Therefore, a foreign person that has
capital gains with respect to U.S. real estate is subject to
U.S. tax on such gains in the same manner as a U.S. person. For
this purpose, a distribution by a REIT to a foreign shareholder
that is attributable to gain from a disposition of U.S. real
property by the REIT is treated as gain recognized by such
shareholder from the disposition of U.S. real property.
U.S. income tax treaties contain provisions limiting the
amount of income tax that may be imposed by one country on
residents of the other country. Many treaties, like the
proposed treaty, generally allow the source country to impose
not more than a 15-percent withholding tax on dividends paid to
a resident of the other treaty country. In the case of real
estate income, most treaties, like the proposed treaty, specify
that income derived from, and gain from dispositions of, real
property in one country may be taxed by the country in which
the real property is situated without limitation.\7\
Accordingly, U.S. real property rental income derived by a
resident of a treaty partner generally is subject to the U.S.
withholding tax at the full 30-percent rate (unless the net-
basis taxation election is made), and U.S. real property gains
of a treaty partner resident are subject to U.S. tax in the
manner and at the rates applicable to U.S. persons.
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\7\ The proposed treaty, like many treaties, allows the foreign
person to elect to be taxed in the source country on income derived
from real property on a net basis under the source country's domestic
laws.
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Although REITs are not subject to corporate-level taxation
like other corporations, distributions of a REIT's income to
its shareholders generally are treated as dividends in the same
manner as distributions from other corporations. Accordingly,
in cases where no treaty is applicable, a foreign shareholder
of a REIT is subject to the U.S. 30-percent withholding tax on
ordinary income distributions from the REIT. In addition, such
shareholders are subject to U.S. tax on U.S. real estate
capital gain distributions from a REIT in the same manner as a
U.S. person.
In cases where a treaty is applicable, this U.S. tax on
capital gain distributions from a REIT still applies. However,
absent special rules applicable to REIT dividends, treaty
provisions specifying reduced rates of tax on dividends apply
to ordinary income dividends from REITs as well as to dividends
from taxable corporations. As discussed above, the proposed
treaty, like many U.S. treaties, reduces the U.S. 30-percent
withholding tax to 15 percent in the case of dividends
generally. Prior to 1989, U.S. tax treaties contained no
special rules excluding dividends from REITs from these reduced
rates. Therefore, under pre-1989 treaties, REIT dividends are
eligible for the same reductions in the U.S. withholding tax
that apply to other corporate dividends.
Beginning in 1989, U.S. treaty negotiators began including
in treaties provisions excluding REIT dividends from the
reduced rates of withholding tax generally applicable to
dividends. Under treaties with these provisions such as the
proposed treaty, REIT dividends generally are subject to the
full U.S. 30-percent withholding tax.\8\
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\8\ Many treaties, like the proposed treaty, provide a maximum tax
rate of 15 percent in the case of REIT dividends beneficially owned by
an individual who holds a less than 10 percent interest in the REIT.
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Analysis of treaty treatment of REIT dividends
The specific treaty provisions governing REIT dividends
were introduced beginning in 1989 because of concerns that the
reductions in withholding tax generally applicable to dividends
were inappropriate in the case of dividends from REITs. The
reductions in the rates of source country tax on dividends
reflect the view that the full 30-percent withholding tax rate
may represent an excessive rate of source country taxation
where the source country already has imposed a corporate-level
tax on the income prior to its distribution to the shareholders
in the form of a dividend. In the case of dividends from a
REIT, however, the income generally is not subject to
corporate-level taxation.
REITs are required to distribute their income to their
shareholders on a current basis. The assets of a REIT consist
primarily of passive real estate investments and the REIT's
income may consist principally of rentals from such real estate
holdings. U.S. source rental income generally is subject to the
U.S. 30-percent withholding tax. Moreover, the United States's
treaty policy is to preserve its right to tax real property
income derived from the United States. Accordingly, the U.S.
30-percent tax on rental income from U.S. real property is not
reduced in U.S. tax treaties.
If a foreign investor in a REIT were instead to invest in
U.S. real estate directly, the foreign investor would be
subject to the full 30-percent withholding tax on rental income
earned on such property (unless the net-basis taxation election
is made). However, when the investor makes such investment
through a REIT instead of directly, the income earned by the
investor is treated as dividend income. If the reduced rates of
withholding tax for dividends apply to REIT dividends, the
foreign investor in the REIT is accorded a reduction in U.S.
withholding tax that is not available for direct investments in
real estate.
On the other hand, some argue that it is important to
encourage foreign investment in U.S. real estate through REITs.
In this regard, a higher withholding tax on REIT dividends
(i.e., 30 percent instead of 15 percent) may not be fully
creditable in the foreign investor's home country and the cost
of the higher withholding tax therefore may discourage foreign
investment in REITs. For this reason, some oppose the inclusion
in U.S. treaties of the special provisions governing REIT
dividends, arguing that dividends from REITs should be given
the same treatment as dividends from other corporate entities.
Accordingly, under this view, the 15-percent withholding tax
rate generally applicable under treaties to dividends should
apply to REIT dividends as well.
This argument is premised on the view that investment in a
REIT is not equivalent to direct investment in real property.
From this perspective, an investment in a REIT should be viewed
as comparable to other investments in corporate stock. In this
regard, like other corporate shareholders, REIT investors are
investing in the management of the REIT and not just its
underlying assets. Moreover, because the interests in a REIT
are widely held and the REIT itself typically holds a large and
diversified asset portfolio, an investment in a REIT represents
a very small investment in each of a large number of
properties. Thus, the REIT investment provides diversification
and risk reduction that are not easily replicated through
direct investment in real estate.
Modification of policy regarding treaty treatment of REIT dividends
In 1997, the Treasury Department modified its policy with
respect to the exclusion of REIT dividends from the reduced
withholding tax rates applicable to other dividends under the
treaties. The new policy was a result of significant
cooperation among the Treasury Department, the staff of the
Committee on Foreign Relations, the staff of the Joint
Committee on Taxation, and representatives of the REIT
industry. Under this policy, REIT dividends paid to a resident
of a treaty country will be eligible for the reduced rate of
withholding tax applicable to portfolio dividends (typically,
15 percent) in two cases. First, the reduced withholding tax
will apply to REIT dividends if the treaty country resident
beneficially holds an interest of 5 percent or less in each
class of the REIT's stock and such dividends are paid with
respect to a class of the REIT's stock that is publicly traded.
Second, the reduced withholding tax rate will apply to REIT
dividends if the treaty country resident beneficially holds an
interest of 10 percent or less in the REIT and the REIT is
diversified, regardless of whether the REIT's stock is publicly
traded.\9\ In addition, the current treaty policy with respect
to the application of the reduced withholding tax rate to REIT
dividends paid to individuals holding less than a specified
interest in the REIT will remain unchanged.
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\9\ For purposes of the rules, a REIT will be considered to be
diversified if the value of no single interest in real property held by
the REIT exceeds 10 percent of the value of the REIT's total interests
in real property.
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In 1997, the Committee included a reservation to the U.S.-
Luxembourg treaty that was submitted for ratification,
requiring that such treaty incorporate this new policy with
respect to the treatment of REIT dividends generally.\10\ In
addition, the Committee included declarations to the 1997
treaties with Austria, Ireland, and Switzerland, which stated
that the United States will use its best efforts to negotiate a
protocol with Austria, Ireland, and Switzerland to amend such
treaties to incorporate this new policy. The Treasury
Department also will incorporate this new policy with respect
to the treatment of REIT dividends in the U.S. model treaty and
in future treaty negotiations.
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\10\ The reservation to the Luxembourg treaty also provided for a
special rule for dividends on certain existing REIT investments.
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Issue
Under many older U.S. tax treaties, the U.S. withholding
tax on REIT dividends paid to residents of the treaty partner
is limited to a maximum rate of 15 percent. Under the proposed
treaty, as under some U.S. tax treaties, the reduced rates of
U.S. withholding applicable to dividends generally do not apply
to REIT dividends and, thus, REIT dividends paid to residents
of Lithuania may be subject to U.S. withholding tax at the full
statutory rate of 30 percent.
The Committee may wish to consider whether, in light of the
competing considerations discussed above, the treatment of REIT
dividends in the proposed treaty is appropriate.
B. Developing Country Concessions
The proposed treaty contains a number of developing country
concessions, some of which are found in other U.S. income tax
treaties with developing countries. The most significant of
these concessions are described below.
Definition of permanent establishment
The proposed treaty departs from the U.S. and OECD models
by providing for broader source-basis taxation with respect to
business activities. The proposed treaty's permanent
establishment article, for example, permits the country in
which business activities are carried on to tax the activities
in circumstances where it would not be able to do so under
either of the model treaties. Under the proposed treaty, a
building site or construction, assembly or installation project
in a treaty country constitutes a permanent establishment if
the site or project continues in a country for more than six
months; under the U.S. and OECD models, such a site or project
must last for more than one year in order to constitute a
permanent establishment. Thus, for example, under the proposed
treaty, a U.S. enterprise's business profits that are
attributable to a construction project in Lithuania will be
taxable by Lithuania if the project lasts for more than six
months. It should be noted that many tax treaties between the
United States and developing countries similarly provide a
permanent establishment threshold of six months for building
sites and drilling rigs.
In addition, under Article 21 (Offshore Activities) of the
proposed treaty, offshore activities for the exploration or
exploitation of the sea bed and sub-soil and their natural
resources in a country for more than 30 days in any 12-month
period would cause such activities to be treated in a manner
analogous to a permanent establishment. Under the U.S. model,
drilling rigs or ships must be present in a country for more
than one year in order to constitute a permanent establishment.
Taxation of business profits
Under the U.S. model and many other U.S. income tax
treaties, a country may only tax the business profits of a
resident of the other country to the extent those profits are
attributable to a permanent establishment situated within the
first country. The proposed treaty expands the definition of
business profits that are attributable to a permanent
establishment to include profits that are derived from sales of
goods or merchandise of the same or similar kind as those sold
through the permanent establishment and profits derived from
other business activities of the same or similar kind as those
effected through the permanent establishment. However, this
rule applies only if it is proved that the sales or activities
were structured in a manner intended to avoid tax in the
country where the permanent establishment is located. This
expanded definition is narrower than the rule included in other
U.S. tax treaties with developing countries. It should be noted
that although this rule provides for broader source basis
taxation than does the rule contained in the U.S. model, it is
not as broad as the general ``force of attraction'' rule that
is included in the Code.
Taxation of certain equipment leasing
The proposed treaty treats as royalties, payments for the
use of, or the right to use, industrial, commercial, or
scientific equipment. In most other treaties, these payments
are considered rental income; as such, the payments are subject
to the business profits rules, which generally permit the
source country to tax such amounts only if they are
attributable to a permanent establishment located in that
country, and the payments are taxed, if at all, on a net basis.
By contrast, the proposed treaty permits gross-basis source
country taxation of these payments, at a rate not to exceed 5
percent, if the payments are not attributable to a permanent
establishment situated in that country. If the payments are
attributable to such a permanent establishment, the business
profits article of the proposed treaty is applicable.
Other taxation by source country
The proposed treaty includes additional concessions with
respect to source basis taxation of amounts earned by residents
of the other treaty country.
The proposed treaty allows a maximum rate of source country
tax on royalties of 10 percent (5 percent in the case of income
from the use of certain equipment as discussed above). By
contrast, both the U.S. model and the OECD model generally
would not permit source country taxation of royalties.
The proposed treaty permits source country taxation of
income derived by a resident of the other treaty country from
professional or other independent services if the resident is
present in the source country for the purpose of performing
such services for more than 183 days in any 12-month period. By
contrast, the U.S. and OECD models generally would permit
source country taxation of income from independent personal
services only where such income is attributable to a fixed base
or permanent establishment in the source country.
Issue
One purpose of the proposed treaty is to reduce tax
barriers to direct investment by U.S. firms in Lithuania. The
practical effect of these developing country concessions could
be greater Lithuanian taxation of future activities of U.S.
firms in Lithuania than would be the case under rules that were
comparable to those of either the U.S. model or the OECD model.
The issue is whether these developing country concessions
represent appropriate U.S. treaty policy and, if so, whether
Lithuania is an appropriate recipient of these concessions.
There is a risk that the inclusion of these concessions in the
proposed treaty could result in additional pressure on the
United States to include such concessions in future treaties
negotiated with developing countries. However, a number of
existing U.S. income tax treaties with developing countries
already include similar concessions. Such concessions arguably
are necessary in order to enter into treaties with developing
countries. Tax treaties with developing countries can be in the
interest of the United States because they provide reductions
in the taxation by such countries of U.S. investors and a
clearer framework for the taxation of U.S. investors. Such
treaties also provide dispute resolution and nondiscrimination
rules that benefit U.S. investors and exchange of information
procedures that benefit the tax authorities.
C. Royalty Source Rules
Under the proposed treaty, royalties are sourced by
reference to where the payor resides (or where the payor has a
permanent establishment or fixed base, if the royalty was
incurred and borne by the permanent establishment or fixed
base). If this rule does not treat the royalty as sourced in
one of the treaty countries, the royalty is sourced based on
the place of use of the property. This source provision has
been included in some other U.S. treaties (e.g., the 1995 U.S.-
Canada protocol, the U.S.-Thailand treaty, and the U.S.-Turkey
treaty). However, this source provision is different than the
U.S. internal law rule which sources royalties based on the
place of use of the property.
Under the proposed treaty, if a Lithuanian resident that
does not have a permanent establishment or fixed base in the
United States pays a royalty to a U.S. resident for the right
to use property exclusively in the United States, the proposed
treaty would treat such royalty as Lithuanian source (and
therefore potentially taxable in Lithuania). However, U.S.
internal law would treat such a royalty as U.S.-source income.
The staff understands, however, that this situation would arise
in relatively few cases (as opposed to the more common
situation in which a Lithuanian resident using property in the
United States would also have a permanent establishment or
fixed base in the United States).
The Committee may wish to consider whether the treaty
provision that sources royalties in a manner that is
inconsistent with the U.S. internal law rules is appropriate.
D. Income from the Rental of Ships and Aircraft
The proposed treaty includes a provision found in the U.S.
model and many U.S. income tax treaties under which profits
from an enterprise's operation of ships or aircraft in
international traffic are taxable only in the enterprise's
country of residence. For this purpose, the operation of ships
or aircraft in international traffic includes profits derived
from the rental of ships or aircraft on a full (time or voyage)
basis. In the case of profits derived from the rental of ships
and aircraft on a bareboat (without a crew) basis, the rule
limiting the right to tax to the country of residence applies
to such rental profits only if the bareboat rental profits are
incidental to other profits of the lessor from the operation of
ships and aircraft in international traffic. Such bareboat
rental profits that are not incidental to other income from the
international operation of ships and aircraft generally would
be taxable by the source country as royalties at a 5-percent
rate (or as business profits if such profits are attributable
to a permanent establishment). The U.S. model and many other
treaties provide that profits from the rental of ships and
aircraft operated in international traffic are taxable only in
the country of residence, without requiring that the rental
profits be incidental to income of the recipient from the
operation of ships and aircraft. Under the proposed treaty,
unlike under the U.S. model, an enterprise that engages only in
the rental of ships and aircraft on a bareboat basis, but does
not engage in the operation of such ships and aircraft, would
not be eligible for the rule limiting the right to tax income
from operations in international traffic to the enterprise's
country of residence. It should be noted that under the
proposed treaty profits from the use, maintenance, or rental of
containers used in international traffic are taxable only in
the country of residence. The Committee may wish to consider
whether the proposed treaty's rules treating profits from
certain rental of ships and aircraft less favorably than
profits from the operation of ships and aircraft and the rental
of containers are appropriate.
E. Treaty Shopping
The proposed treaty, like a number of U.S. income tax
treaties, generally limits treaty benefits for treaty country
residents so that only those residents with a sufficient nexus
to a treaty country will receive treaty benefits. Although the
proposed treaty generally is intended to benefit only residents
of Lithuania and the United States, residents of third
countries sometimes attempt to use a treaty to obtain treaty
benefits. This is known as treaty shopping. Investors from
countries that do not have tax treaties with the United States,
or from countries that have not agreed in their tax treaties
with the United States to limit source country taxation to the
same extent that it is limited in another treaty may, for
example, attempt to reduce the tax on interest on a loan to a
U.S. person by lending money to the U.S. person indirectly
through a country whose treaty with the United States provides
for a lower rate of withholding tax. The third-country investor
may attempt to do this by establishing in that treaty country a
subsidiary, trust, or other entity which then makes the loan to
the U.S. person and claims the treaty reduction for the
interest it receives.
The anti-treaty shopping provision of the proposed treaty
is similar to anti-treaty shopping provisions in the Code (as
interpreted by Treasury regulations) and in several recent
treaties. Some aspects of the provision, however, differ from
the anti-treaty shopping provision in the U.S. model. The issue
is whether the anti-treaty shopping provision of the proposed
treaty will be effective in forestalling potential treaty
shopping abuses.
One provision of the anti-treaty shopping article differs
from the comparable rule of some earlier U.S. treaties, but the
effect of the change is not clear. The general test applied by
those treaties to allow benefits to an entity that does not
meet the bright-line ownership and base erosion tests is a
broadly subjective one, looking to whether the acquisition,
maintenance, or operation of an entity did not have ``as a
principal purpose obtaining benefits under'' the treaty. By
contrast, the proposed treaty contains a more precise test that
allows denial of benefits only with respect to income not
derived in connection with (or incidental to) the active
conduct of a substantial trade or business. (However, this
active trade or business test does not apply with respect to a
business of making or managing investments carried on by a
person other than a bank, insurance company, or registered
securities dealer; so benefits may be denied with respect to
such a business regardless of how actively it is conducted.) In
addition, the proposed treaty (like all recent treaties) gives
the competent authority of the country in which the income
arises the authority to determine that the benefits of the
treaty will be granted to a person even if the specified tests
are not satisfied.
The Committee has in the past expressed its belief that the
United States should maintain its policy of limiting treaty
shopping opportunities whenever possible. The Committee has
further expressed its belief that in exercising any latitude
the Treasury Department has to adjust the operation of the
proposed treaty, it should satisfy itself that its rules as
applied will adequately deter treaty shopping abuses. The
proposed treaty's ownership test may be effective in preventing
third-country investors from obtaining treaty benefits by
establishing investing entities in Lithuania because third-
country investors may be unwilling to share ownership of such
investing entities on a 50-50 basis with U.S. or Lithuanian
residents or other qualified owners in order to meet the
ownership test of the anti-treaty shopping provision. The base
erosion test contained in the proposed treaty will provide
protection from certain potential abuses of a Lithuanian
conduit. On the other hand, implementation of the tests for
treaty shopping set forth in the treaty may raise factual,
administrative, or other issues that cannot currently be
foreseen. Thus, the Committee may wish to satisfy itself that
the provision as proposed is an adequate tool for preventing
possible treaty-shopping abuses in the future.