[JPRT 106-9-99]
[From the U.S. Government Publishing Office]
JCS-9-99
[JOINT COMMITTEE PRINT]
EXPLANATION OF PROPOSED
INCOME TAX TREATY AND
PROPOSED PROTOCOL BETWEEN
THE UNITED STATES AND
THE ITALIAN REPUBLIC
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. Personal Scope............................... 8
Article 2. Taxes Covered................................ 10
Article 3. General Definitions.......................... 11
Article 4. Resident..................................... 13
Article 5. Permanent Establishment...................... 15
Article 6. GIncome from Immovable Property.............. 17
Article 7. Business Profits............................. 18
Article 8. Shipping and Air Transport................... 20
Article 9. Associated Enterprises....................... 21
Article 10. Dividends.................................... 22
Article 11. Interest..................................... 26
Article 12. Royalties.................................... 29
Article 13. Capital Gains................................ 31
Article 14. Independent Personal Services................ 33
Article 15. Dependent Personal Services.................. 33
Article 16. Directors' Fees.............................. 34
Article 17. Artistes and Athletes........................ 34
Article 18. Pensions, Etc................................ 35
Article 19. Government Service........................... 37
Article 20. Professors and Teachers...................... 37
Article 21. Students and Trainees........................ 38
Article 22. Other Income................................. 38
Article 23. Relief from Double Taxation.................. 39
Article 24. Non-Discrimination........................... 41
Article 25. Mutual Agreement Procedure................... 43
Article 26. Exchange of Information...................... 44
Article 27. Diplomatic Agents and Consular
Officials............................................ 45
Article 28. Entry into Force............................. 45
Article 29. Termination.................................. 46
IV. Explanation of Proposed Protocol.................................47
Article 1................................................ 47
Article 2................................................ 47
Article 3................................................ 51
Article 4................................................ 51
Article 5................................................ 51
Article 6................................................ 52
Article 7................................................ 52
Article 8................................................ 52
V. Issues...........................................................54
A. Main Purpose Tests.................................... 54
B. Creditability of Italian IRAP Tax..................... 57
C. Insurance Excise Tax.................................. 59
D. Shipping and Aircraft Income.......................... 60
E. Treaty Shopping....................................... 62
F. Arbitration Under the Mutual Agreement Procedures.... 63
G. Exchange of Information............................... 63
INTRODUCTION
This pamphlet,1 prepared by the staff of the
Joint Committee on Taxation, describes the proposed income tax
treaty, as supplemented by the proposed protocol, between the
United States of America and the Italian Republic (``Italy'').
The proposed treaty and proposed protocol were signed on August
25, 1999.2 The Senate Committee on Foreign Relations
has scheduled a public hearing on the proposed treaty and
proposed protocol 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 and Proposed
Protocol Between the United States and the Italian Republic (JCS-9-99),
October 8, 1999.
\2\ For a copy of the proposed treaty, see Senate Treaty Doc. 106-
11, September 21, 1999.
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Part I of the pamphlet provides a summary with respect to
the proposed treaty and protocol. 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 and certain provisions of the proposed protocol. Part IV
contains an article-by-article explanation of the proposed
protocol. Part V contains a discussion of issues with respect
to the proposed treaty and proposed protocol.
I. SUMMARY
The principal purposes of the proposed income tax treaty
between the United States and Italy 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 23).
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 protocol 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.
The proposed treaty contains certain ``main purpose'' tests
which operate to deny the benefits of the dividends article
(Article 10), the interest article (Article 11), the royalties
article (Article 12) and the other income article (Article 22)
if the main purpose or one of the main purposes of a person is
to take advantage of the benefits of the respective article
through a creation or assignment of shares, debt claims, or
rights that would give rise to income to which the respective
article would apply. The proposed protocol also contains a
detailed limitation on benefits provision to prevent the
inappropriate use of the treaty by third-country residents.
The United States and Italy have an income tax treaty
currently in force (signed in 1984). The proposed treaty is
similar to other recent U.S. income tax treaties, the 1996 U.S.
model income tax treaty (``U.S. model''), and the model income
tax treaty of the Organization for Economic Cooperation and
Development (``OECD 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
necessary 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 Italy, as
supplemented by the proposed protocol, is set forth below. The
United States and Italy also agreed upon a Memorandum of
Understanding to provide clarification with respect to the
application of the proposed treaty. In the explanation below,
the understandings and interpretations reflected in the
Memorandum of Understanding are covered together with the
relevant articles of the proposed treaty and certain aspects of
the proposed protocol. A separate description of the proposed
protocol is contained in Part IV.
Article 1. Personal Scope
Overview
The personal 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 Italy, with specific
modifications to such scope provided in other articles (e.g.,
Article 19 (Government Service), Article 24 (Non-
Discrimination), and Article 26 (Exchange of Information)).
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 protocol provides that the proposed treaty
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 Italy.
Thus, the proposed treaty will not apply to increase the tax
burden of a resident of either the United States or Italy.
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 Italy 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 protocol 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 Italy are parties in determining
whether a measure is within the scope of the proposed treaty.
The proposed protocol also provides that, unless the competent
authorities agree that a taxation measure is outside the scope
of the proposed treaty, only the proposed treaty's non-
discrimination rules, and not the non-discrimination rules of
any other agreement in effect between the United States and
Italy, 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 Italy 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 protocol contains a provision under which the
saving clause (and therefore the U.S. jurisdiction to tax)
applies to a former U.S. citizen or 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; 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 source-country tax for certain
alimony, child support, and pension payments (Article 18,
paragraphs 5 and 6); relief from double taxation through the
provision of a foreign tax credit (Article 23); protection from
discriminatory tax treatment with respect to transactions with
residents of the other country (Article 24); and benefits under
the mutual agreement procedures (Article 25). These exceptions
to the saving clause permit residents or citizens of the United
States or Italy to obtain such benefits of the proposed treaty
with respect to their country of residence or citizenship. In
addition, the proposed protocol provides that the saving clause
does not override the exemption from source country tax of
social security benefits (Article 18) for individuals who are
citizens of the residence country even if they are citizens of
both countries. The proposed protocol also provides that the
saving clause does not override the special rule of Article 4
of the proposed protocol relating to a credit against Italian
taxes for U.S. citizens resident in Italy who are partners of a
U.S. partnership. The exception to the saving clause with
respect to social security benefits means that if the United
States makes a social security payment to a resident of Italy
who is a citizen of both countries, only Italy can tax that
payment.
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, an Italian
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
professors or teachers (Article 20), certain income received by
students or trainees (Article 21), and certain income of
diplomats and consular officials (Article 27).
Article 2. Taxes Covered
The proposed treaty generally applies to the income taxes
of the United States and Italy. However, Article 24 (Non-
Discrimination) is applicable to all taxes imposed at all
levels of government, including State and local taxes.
Moreover, Article 26 (Exchange of Information) 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, but
excludes social security taxes. In addition, like the present
treaty, the proposed treaty applies to the U.S. excise taxes
imposed on insurance premiums paid to foreign insurers and with
respect to private foundations. Unlike the present treaty, but
like the U.S. model, the proposed treaty applies to the
accumulated earnings tax and the personal holding company tax.
The proposed protocol, like the protocol to the present
treaty, provides that the proposed treaty applies to the excise
taxes on insurance premiums paid to foreign insurers only to
the extent that the risks covered by such premiums are not
reinsured with a person that is not entitled to an exemption
from such taxes under the proposed treaty or any other treaty.
Because the insurance excise taxes are covered taxes under the
proposed treaty, Italian insurers generally are not subject to
the U.S. excise taxes on insurance premiums for insuring U.S.
risks. The excise taxes continue to apply, however, when an
Italian insurer reinsures a policy it has written on a U.S.
risk with a foreign insurer that is not entitled to a similar
exemption under this or a different tax treaty.
In the case of Italy, the proposed treaty applies to the
individual income tax (l'imposta sul reddito delle persone
fisiche); the corporation income tax (l'imposta sul reddito
delle persone giuridiche); and the regional tax on productive
activities (l'imposta regionale sulle attivita produttive) (the
so-called ``IRAP'' tax), but only that portion of the IRAP tax
that is considered to be an income tax under Article 23 (Relief
from Double Taxation). The present treaty covers a local tax
rather than this regional tax. Such taxes include those that
are collected by means of withholding.
The proposed treaty also contains a rule generally found in
U.S. income tax treaties (including the present treaty) 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
significant official published materials concerning the
application of the proposed 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 ``person'' includes an individual, a company, an
estate, a trust, a partnership, 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
treaty country and an enterprise carried on by a resident of
the other treaty country. 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 proposed treaty defines ``international traffic'' as
any transport by a ship or aircraft, except when the transport
is solely between places in the other treaty country.
Accordingly, with respect to an Italian 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 Italian ``competent authority'' is the Ministry
of Finance.
The term ``United States'' means the United States of
America (including the States thereof and the District of
Columbia), but does not include Puerto Rico, the Virgin
Islands, Guam, or any other U.S. possession or territory. The
term ``United States'' also includes the territorial sea of the
United States and any area beyond the territorial sea that is
designated as an area within which the United States, in
compliance with its legislation and in conformity with
international law, exercises sovereign rights in respect of the
exploration and exploitation of the natural resources of the
seabed, the subsoil, and the superjacent waters. The Technical
Explanation states that the extension of the term to such areas
applies only if the person, property, or activity to which the
proposed treaty is being applied is connected with such natural
resource exploration or exploitation.
The term ``Italy'' means the Italian Republic and includes
any area beyond the territorial sea that is designated as an
area within which Italy, in compliance with its legislation and
in conformity with international law, exercises sovereign
rights in respect of the exploration and exploitation of the
natural resources of the seabed, the subsoil and the
superjacent waters.
The term ``nationals'' means (1) all individuals possessing
the citizenship of a treaty country; and (2) all legal persons,
partnerships, and associations deriving their status as such
from the laws in force in a treaty country.
The proposed treaty defines the term ``qualified
governmental entity'' as any person or body of persons that
constitutes a governing body of a treaty country, or of a
political or administrative subdivision or local authority of a
treaty country. Also defined as a qualified governmental entity
is a person that is wholly owned (directly or indirectly) by a
treaty country or a political or administrative subdivision or
local authority thereof, provided it is organized under the
laws of a treaty country, its earnings are credited to its own
account with no portion of its income inuring to the benefit of
any private person, and its assets vest in the treaty country,
political or administrative subdivision or local authority upon
dissolution. A qualified governmental entity is also defined to
include a pension trust or fund of a person previously
described in this paragraph that is constituted and operated
exclusively to administer or provide pension benefits described
in Article 19 (Government Service). The definitions described
in the previous two sentences only apply if the entity does not
carry on commercial activities. These definitions are the same
as those in the U.S. model. The proposed protocol provides that
in the case of the United States, a qualified governmental
entity includes the Federal Reserve Banks, the Export-Import
Bank, and the Overseas Private Investment Corporation. In the
case of Italy, the proposed protocol provides that a qualified
governmental entity includes La Banca d'Italia (the Central
Bank), L'Istituto per il Commercio con l'Estero (the Foreign
Trade Institute), and L'Istituto per l'Assicurazione del
Credito all'Esportazione (the Official Insurance Institute for
Export Credits). The proposed protocol also provides that a
qualified governmental entity includes financial institutions,
the capital of which is wholly owned by a treaty country or any
state or political or administrative subdivision or local
authority as may be agreed from time to time between the
competent authorities of both treaty countries.
The proposed treaty also contains the standard provision
that, unless the context otherwise requires, all terms not
defined in the treaty have the meaning pursuant to the
respective tax laws of the country that is applying the 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.
Italy
Under Italian law, residents are subject to tax on their
worldwide income, while nonresident individuals are subject to
tax only on income arising in Italy. Individuals are considered
to be residents of Italy if their habitual abode is in Italy,
if the center of their vital interests is in Italy, or if they
are registered for the greater part of the tax period with the
Office of Records of the Resident Population.
Companies that are resident in Italy are subject to
taxation on their worldwide income. A company that for the
greater part of the tax year has its legal seat, place of
effective management, or main business purpose in Italy is
considered to be resident in Italy. Nonresident companies are
subject to corporate income tax on income derived from Italy.
Proposed treaty rules
The proposed treaty specifies rules to determine whether a
person is a resident of the United States or Italy for purposes
of the proposed treaty. The rules generally are consistent with
the rules of the U.S. model.
Like the present treaty, 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 domicile, residence, 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. The
proposed protocol provides that Italy will treat an individual
who is a U.S. citizen or lawful permanent resident of the
United States (i.e., a ``green card'' holder) as a resident of
the United States only if he or she has a substantial presence,
permanent home, or habitual abode in the United States. The
determination of whether a citizen or national is considered a
resident of the United States or Italy is made based on the
principles of the treaty tie-breaker rules described below.
The proposed protocol provides special rules to treat as
residents of a treaty country certain organizations that
generally are exempt from tax in that country. Under these
rules, a resident includes 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 (1) exclusively for a religious, charitable,
educational, scientific, or other similar purpose; or (2) 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.
The proposed protocol also provides that a qualified
governmental entity is a resident of the country where it is
established.
The proposed treaty and proposed protocol contain special
rules for fiscally transparent entities. Under these rules, the
income of a partnership, estate, or trust (or according to the
proposed protocol, a fiscally transparent entity) 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. For example, if a
corporation resident in Italy distributes a dividend to an
entity treated as fiscally transparent for U.S. tax purposes,
the dividend will be considered to be derived by a resident of
the United States only to the extent that U.S. tax laws treat
one or more U.S. residents (whose status as U.S. residents is
determined under U.S. tax laws) as deriving the dividend income
for U.S. tax purposes.
The Technical Explanation states that these rules for
income derived through fiscally transparent entities apply
regardless of where the entity is organized (i.e., in the
United States, Italy, or a third country). The Technical
Explanation also states that these rules apply even if the
entity is viewed differently under the tax laws of the other
country. As an example, the Technical Explanation states that
income from Italian sources received by an entity organized
under the laws of Italy, which is treated for U.S. tax purposes
as a corporation and is owned by a U.S. shareholder who is a
U.S. resident for U.S. tax purposes, is not considered derived
by the shareholder of that corporation, even if under the tax
laws of Italy the entity is treated as fiscally transparent.
Rather, for purposes of the proposed treaty, the income is
treated as derived by the Italian entity.
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.
In the case of any person other than an individual that
would be a resident of both countries, the proposed treaty
requires the competent authorities to endeavor 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 in 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, a quarry, or
other place of extraction of natural resources. It also
includes a building site or construction or assembly project
that continues for more than twelve months. The proposed
protocol provides that it also includes a drilling rig or ship
used for the exploration or development of natural resources
only if it continues for more than twelve months. The present
treaty, on the other hand, treats such drilling rigs and ships
as permanent establishments if the activity continues for more
than 180 days in a twelve month period. The Technical
Explanation states that the twelve-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 twelve-month threshold
is exceeded, the site or project constitutes a permanent
establishment as of the first day that work in the country
began.
Under the proposed treaty, as under the present 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 for the enterprise
solely for the purpose of advertising, for the supply of
information, for scientific research, or for similar activities
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. The
Treasury Explanation states that Italy is unwilling to commit
that all or several of the activities described above may be
undertaken in combination without constituting a permanent
establishment.
Under the proposed treaty, as under the present 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 in such first country, 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 activities
are limited to the purchase of goods or merchandise for the
enterprise.
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. The
Technical Explanation states that whether an enterprise and an
agent are independent is a factual determination, relevant
factors of which include the extent to which the agent bears
business risk and whether the agent has an exclusive or nearly
exclusive relationship with the principal.
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
carries on business in the other country does not of itself
cause either company to be a permanent establishment of the
other.
Article 6. Income from Immovable 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 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 property
includes income from agriculture or forestry.
The term ``immovable property'' (``real property'') has the
meaning which it has under the law of the country in which the
property in question is situated.4 The proposed
treaty specifies that the term in any case includes property
accessory to immovable property; livestock and equipment used
in agriculture and forestry; rights to which the provisions of
general law respecting landed property apply; usufructs of
immovable property; and rights to variable or fixed payments as
consideration for the working of, or the right to work, mineral
deposits, sources, and other natural resources. Ships, boats,
and aircraft are not considered to be immovable property.
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\4\ In the case of the United States, the term is defined in Treas.
Reg. sec. 1.897-1(b).
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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
property. The rules of Article 6, permitting source country
taxation, also apply to the income from immovable property of
an enterprise and to income from immovable property used for
the performance of independent personal services.
Unlike the U.S. model, the proposed treaty does not provide
that residents of a treaty country that are liable for tax in
the other treaty country on income from immovable property
situated in such other treaty country may elect to compute the
tax on such income on a net basis. However, U.S. internal law
provides for such a net basis election in the case of income of
a foreign person from real property (Code secs. 871(d) and
882(d)). The Technical Explanation states that Italian internal
law contains a provision that approximates net basis taxation
for income from real property.
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)).
Italy
Foreign corporations and nonresident individuals generally
are subject to Italian tax only on income derived in Italy.
Business income derived in Italy by a foreign corporation or
nonresident individual generally is taxed in the same manner as
the income of an Italian corporation or resident individual.
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.
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 separate
enterprise engaged in the same or similar activities under the
same or similar conditions and dealing wholly independently
with the enterprise of which it is a permanent establishment
and other associated enterprises. The Technical Explanation
states that this rule permits the use of methods other than
separate accounting to determine 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 of a permanent
establishment, the proposed treaty provides that deductions are
allowed for expenses, wherever incurred, which are attributable
to the activities of the permanent establishment. These
deductions include a reasonable allocation of executive and
general administrative expenses. The Technical Explanation
states that as in the present treaty, but unlike the U.S.
model, the proposed treaty does not explicitly state that the
expenses that may be considered to be incurred for the purposes
of the permanent establishment are expenses for research and
development, interest, and other similar expenses. The
Technical Explanation, however, states that Italy accepts the
principle of a reasonable allocation of expenses (such as in
Treas. Reg. sections 1.861-8 and 1.882-5). The Technical
Explanation states 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.
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.
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 5), capital gains (Article 13, paragraph 2),
independent personal services income (Article 14), and other
income (Article 22, paragraph 2).
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. 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.
Article 8. Shipping and Air Transport
Article 8 of the proposed treaty covers income from the
operation of ships and aircraft 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.
Like the present treaty, the proposed treaty provides that
profits which are derived by an enterprise of one country from
the operation in international traffic of ships or aircraft 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)(d) (General Definitions)
as any transport by a ship or aircraft, except when the
transport is solely between places in the other treaty country.
The proposed protocol provides that profits from the
operation of ships or aircraft in international traffic include
profits derived from the rental of ships or aircraft on a full
(time or voyage) basis (i.e., with crew). Like the present
treaty, it also includes profits from the rental of ships or
aircraft on a bareboat basis (i.e., without crew) if such
rental activities are incidental to the activities from the
operation of ships or aircraft in international traffic.
Although not provided for in the proposed treaty, the Technical
Explanation states that 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 protocol 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 for the transport of
goods or merchandise in international traffic is taxable only
in that country.
As under the U.S. model, the shipping and air transport
provisions of the proposed treaty apply to profits derived 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 income from the
rental of ships, aircraft, or containers which is not exempt
from source country tax under this article is taxable as
royalty income (Article 12) or as business profits if
attributable to a permanent establishment (Article 7). Under
the royalty article, the rental income is considered to have
its source in Italy if the payer is a resident of Italy or if
the rental payment is for the use of the property in Italy. The
Technical Explanation also 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.
The proposed protocol provides, like the present treaty,
that profits which a U.S. national not resident in Italy or
which a U.S. corporation derives from operating ships
documented or aircraft registered under U.S. law will be exempt
from tax in Italy. The Technical Explanation states that this
exception applies regardless of whether the income was derived
from the operation of ships or aircraft in international
traffic.
The proposed protocol provides that if a U.S. state or
local government imposes tax on the profits of Italian
enterprises from the operation of ships or aircraft in
international traffic, Italy may impose its regional tax on
productive activites (l'imposta regionale sulle attivita
produttive) (i.e., the IRAP tax) on the profits of U.S.
enterprises from such activities, notwithstanding the
provisions of Article 2 (Taxes Covered) and 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 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
proposed protocol. Any such adjustment is to be made only in
accordance with the mutual agreement procedures of the proposed
treaty. 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.
The proposed protocol provides that the proposed treaty
does not limit any provisions of either country's internal law
which permit the distribution, apportionment, or allocation of
income, deductions, credits, or allowances between persons
owned or controlled directly or indirectly by the same interest
when necessary in order to prevent evasion of taxes or to
clearly reflect the income of any person. Any such adjustments
are permitted even if they are different from, or go beyond,
those specifically authorized by this article, as long as they
are in accord with general arm's length principles.
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.
Italy
Italy generally imposes a withholding tax on dividend
payments to nonresidents at a rate of 27 percent. However,
nonresident individuals may claim reimbursement of up to two-
thirds of the withholding tax and nonresident companies may
claim reimbursement of up to four-ninths of the withholding
tax, but only if the respective nonresident can show that
residence-country tax was paid on the dividend income. There is
no branch remittance tax.
Proposed treaty limitations on internal law
The present treaty provides that dividends derived from
sources within one country by a resident of the other country
may be taxed by the source country. The rate of source country
tax generally is limited to 15 percent. However, the rate of
tax is limited to 5 percent if the dividend recipient is a
company that has owned more than 50 percent of the voting stock
during the 12-month period ending on the date of dividend
declaration. Furthermore, the rate of tax is limited to 10
percent if the beneficial owner is a company that has owned at
least 10 percent but not more than 50 percent of the voting
stock during the 12-month period ending on the date of dividend
declaration. In order for the 5 or 10 percent rates to apply
under the present treaty, not more than 25 percent of the gross
income of the payor corporation may be derived from interest or
dividends (other than interest or dividends derived in the
conduct of a banking or finance business and interest or
dividends received from subsidiary companies).
Under the proposed treaty, dividends paid by a resident of
a treaty country and beneficially owned by 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 25 percent of the voting stock of
the payor company for a twelve-month period ending on the date
the dividend is declared. 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 limitations do not affect the taxation of the
company on the profits out of which the dividends are paid.
The proposed treaty defines a ``dividend'' to include
income from shares, ``jouissance'' shares or ``jouissance''
rights, mining shares, founder's 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 tax
treatment as income from shares by the internal laws of the
treaty country of which the company making the distribution is
a resident.
The proposed treaty's reduced rates of source country tax
on dividends do not apply if the dividend recipient carries on
business through a permanent establishment (or fixed base, in
the case of an individual who performs independent personal
services) in the source country and the dividends are
effectively connected to the permanent establishment (or fixed
base). In such a case, such dividends are taxable in the source
country according to its own laws. The proposed protocol
provides that such dividends may be taxed as either business
profits (Article 7) or as income from the performance of
independent services (Article 14), as the case may be. 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.
Where a company that is a resident of one country 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, or undistributed profits earned, by such
resident. Thus, the United States cannot impose its
``secondary'' withholding tax on dividends paid by an Italian
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 effectively connected to a permanent establishment or a
fixed base situated in such other treaty country. This rule
does not prevent a country from imposing a branch profits tax
as provided below. This rule also applies even if the dividends
paid or undistributed profits consist wholly or partly of
profits arising in such other country.
Unlike the present treaty, 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 that 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 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 property income
or capital gains, that represents the ``dividend equivalent
amount'' (in the case of the United States) or an analogous
amount (in the case of Italy). 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 that the amendments are consistent with
the purpose of the branch profits tax.
The proposed treaty provides an exemption from source
country tax for dividends paid by a corporation that is a
resident of one country to a qualified governmental entity (as
defined in Article 3(1)(i)) that is resident in the other
country. This exemption from source country tax only applies if
the governmental entity owns (directly or indirectly) less than
25 percent of the voting stock of the company paying the
dividends. This threshold is different than the corresponding
rule in the U.S. model, which provides that the qualified
governmental entity may not ``control'' the dividend paying
company.
Under the proposed treaty, dividends paid by a U.S. RIC are
eligible only for 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 an individual beneficially owning
the dividends holds no more than a 10-percent interest in the
U.S. REIT; the dividends are paid with respect to a class of
stock that is publicly traded and the beneficial owner of the
dividends owns no more than 5 percent of any class of the
REIT's stock; or the beneficial owner of the dividends owns no
more than 10 percent of the REIT and such REIT is also
diversified. Otherwise, dividends paid by a U.S. REIT are
subject to U.S. taxation at the full 30-percent statutory rate.
The Technical Explanation states that, for these purposes, a
REIT is considered diversified if the value of no single
interest in the REIT's real property exceeds 10 percent of the
REIT's total interest in real property.
The proposed treaty provides a ``main purpose'' test that
is not specifically included in the dividends articles of the
U.S. model or OECD model. Under this rule, the proposed
treaty's reduced rates of tax on dividends do not apply if the
main purpose, or one of the main purposes, for the creation or
assignment of shares or other rights in respect of which
dividends are paid is to take advantage of the dividends
article of the proposed treaty. The Technical Explanation
states that it is intended that the provisions of this article
will be self-executing, but the tax authorities of one of the
treaty countries, on review, may deny the benefits of the
reduced rate of tax on dividends. In addition, the Technical
Explanation states that the competent authorities of both of
the treaty countries may together agree that this standard has
been met in a particular case or with respect to a type of
transaction entered into by a number of taxpayers.
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.
Italy
Italian-source interest payments to nonresidents generally
are subject to withholding tax at a rate of 27 percent.
However, no withholding tax is assessed on interest paid to a
U.S. resident with respect to: (1) public bonds; (2) private
bonds issued by banks and listed companies; and (3) deposits or
current accounts. Interest paid with respect to private bonds
having at least an 18-month maturity that are issued by other
than a bank or listed company is subject to withholding tax at
a rate of 12.5 percent.
Proposed treaty limitations on internal law
The present treaty generally limits source country tax to a
maximum rate of 15 percent on interest derived by a resident of
the other country. The present treaty also provides for a
compete withholding exemption for interest derived by a treaty
country (or a wholly-owned instrumentality thereof), or a
treaty country resident with respect to debt obligations
guaranteed or insured by such country (or instrumentality).
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.
The proposed treaty provides for a complete exemption from
source country withholding tax in the case of interest arising
in a treaty country if the interest is (1) beneficially owned
by a resident of the other country that is a qualified
governmental entity owning (directly or indirectly) less than
25 percent of the capital of the person paying the interest,
(2) paid with respect to debt obligations guaranteed or insured
by a qualified governmental entity of that other country and
beneficially owned by a resident of such other country, (3)
paid or accrued with respect to a sale on credit of goods,
merchandise, or services provided by one enterprise to another
enterprise; or (4) paid or accrued in connection with the sale
on credit of industrial, commercial, or scientific equipment.
The proposed treaty defines the term ``interest'' as income
from government securities, bonds, or debentures, whether or
not secured by a mortgage and whether or not carrying a right
to participate in profits. It also includes debt claims of
every kind as well as all other income subject to the same tax
treatment as income from money lent under the tax law of the
source country. The proposed protocol provides that, in the
case of the United States, an excess inclusion with respect to
a residual interest in a U.S. REMIC may be taxed as interest in
accordance with each country's respective internal laws. 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 (or fixed base, in the
case of an individual who performs independent personal
services) and the debt claim in respect of which the interest
is paid is effectively connected to that permanent
establishment (or fixed base). In such a case, such interest is
taxable in the source country according to its own laws. The
proposed protocol provides that such interest may be taxed as
either business profits (Article 7) or as income from the
performance of independent services (Article 14), as the case
may be. 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 the treaty country
or its political subdivisions or local authorities, or is a
resident of that country. 5 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 Italy and
that French resident incurs indebtedness to a U.S. person, the
interest on which is borne by the Italian permanent
establishment, the interest would be treated as having its
source in Italy.
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\5\ 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).
In the case of the United States, the proposed treaty
permits the imposition of the U.S. branch level interest tax on
an Italian corporation, but limits the rate of such tax to 10
percent. The U.S. tax imposed on the Italian corporation is the
excess, if any, of (1) the interest deductible in computing the
profits of the Italian corporation that either are attributable
to a permanent establishment or subject to tax under Article 6
(Income from Immovable Property) or Article 13 (Capital Gains)
over (2) the interest paid by the permanent establishment or
trade or business.
The proposed treaty also provides a main purpose test
similar to that for dividends (Article 10) under which the
provisions with respect to interest will not apply if the main
purpose, or one of the main purposes, for the creation or
assignment of the debt claim in respect of which interest is
paid is to take advantage of the interest article of the
proposed treaty.
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.
Italy
Royalties paid to nonresidents are subject to a 30 percent
withholding tax, which is generally applied to 75 percent of
the gross royalty payment, resulting in an effective rate of
22.5 percent.
Proposed treaty limitations on internal law
The present treaty provides that royalties derived from
sources within one country by a resident of the other country
may be taxed by the source country. The rate of source country
tax generally is limited to 10 percent. However, the rate of
tax is limited to 5 percent if the royalty is in respect of
payments received as consideration for the use of, or the right
to use, any copyright of literary, artistic, or scientific
work. In addition, the rate of tax is limited to 7 percent if
the royalties are derived with respect to tangible personal
property. Furthermore, the rate of tax is limited to 8 percent
if the royalty is in respect of payments received as
consideration for the use of, or the right to use, motion
pictures and films, tapes or other means of reproduction used
for radio or television broadcasting.
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
8 percent of the gross royalties. This maximum 8-percent rate
is higher than the rate permitted under most U.S. treaties and
the U.S. and OECD models, but is generally lower than the
maximum rate under the present treaty. 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
royalties for the use of (or the right to use) computer
software or industrial, commercial, or scientific equipment.
Like the present treaty, but unlike the U.S. model, such rental
income is considered to be a royalty.
Unlike the present treaty, the proposed treaty provides a
complete exemption from source country tax for royalties
beneficially owned by a resident of the other country for the
use of (or right to use) a copyright of literary, artistic, or
scientific work (excluding royalties for computer software,
motion pictures, films, tapes, or other means of reproduction
used for radio or television broadcasting) if such resident is
the beneficial owner of the royalties.
For purposes of the proposed treaty, the term ``royalties''
means payment of any kind received as consideration for the use
of, or the right to use, copyrights of literary, artistic, or
scientific work (including computer software, motion pictures,
films, tapes, or other means of reproduction used for radio or
television broadcasting), patents, trademarks, designs or
models, plans, secret formulae, processes, or other like rights
or properties. 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 states
that it is understood that payments with respect to transfers
of ``shrink wrap'' computer software will be treated as
business profits and not as royalties. The Technical
Explanation also states that, with respect to the United
States, gains derived from the sale of any right or property
that would give rise to royalties is also considered to be
royalty income, but only to the extent that such gain is
contingent on the productivity, use, or further disposition
thereof.
The reduced rates of source country tax do not apply where
the recipient carries on business through a permanent
establishment (or fixed base in the case of an individual who
performs independent personal services) in the source country,
and the royalties are effectively connected to the permanent
establishment (or fixed base). In such a case, such royalties
are taxable in the source country according to its own laws.
The proposed protocol provides that such royalties may be taxed
as either business profits (Article 7) or as income from the
performance of independent services (Article 14), as the case
may be. 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 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, or is one of the treaty
countries or its political subdivisions or local authorities.
If, however, the royalty expense is borne by a permanent
establishment or fixed base that the payor has in Italy 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 Italy and
that French resident pays a royalty to a U.S. person which is
attributable to the Italian permanent establishment, then the
royalty would be treated as having its source in Italy. The
proposed treaty provides that notwithstanding the foregoing
rules, royalties with respect to the use of, or right to use,
rights or property within a treaty county may be deemed to
arise within that country. Thus, consistent with U.S. internal
law, the United States may treat royalties with respect to the
use of property in the United States as U.S. source income.
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).
As in the case of dividends (Article 10) and interest
(Article 11), the proposed treaty includes a main purpose test
under which the royalty provision will not apply if the main
purpose, or one of the main purposes, for the creation or
assignment of rights in respect of which royalties are paid is
to take advantage of the proposed treaty's royalty article.
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.
Italy
Nonresident companies are subject to the corporate income
tax (37 percent) on capital gains from immovable property, but
only if held for 5 years or less. Capital gains recognized by
nonresident companies from the sale of shares or other
participations in Italian resident companies are generally
subject to a 27 percent tax rate. However, if the amount of
participations sold during a 12-month period does not exceed
either (1) 2 percent of voting power or 5 percent of capital
(in the case of listed companies) or (2) 20 percent of voting
power or 25 percent of capital (in all other cases), then such
gains are subject to a 12.5 percent tax rate.
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 property
situated in the other country may be taxed in the country where
the property is situated. The proposed protocol provides that
with respect to the United States, the term ``immovable
property'' includes a United States real property interest.
Such property is deemed to be situated in the United States for
purposes of this article. In the case of Italy, immovable
property includes (1) immovable property referred to in Article
6 (Income from Immovable Property), (2) shares (or comparable
interests) in a company (or other body of persons) the assets
of which consist wholly or principally of real property
situated in Italy, and (3) an interest in an estate of a
deceased individual, the assets of which consist wholly or
principally of real property situated in Italy. Such property
is deemed to be situated in Italy for purposes of this article.
The proposed treaty contains a standard provision which
permits a country to tax the gain from the alienation of
movable property that forms a part of the business property of
a permanent establishment located in that country, or that
pertains to a fixed base in that country for the purpose of
performing independent personal services. This rule also
applies to gains from the alienation of such a permanent
establishment (alone or with the whole enterprise) or such a
fixed base. 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.
The proposed treaty provides that gains derived by an
enterprise of one of the treaty countries from the alienation
of ships or aircraft operated in international traffic (or
movable property pertaining to the operation or use of ships,
aircraft, or containers) are taxable only in such country. The
proposed protocol provides that this rule also applies to (1)
gains from the sale of containers (including trailers, barges,
and related equipment for the transport of containers) used for
the transport in international traffic of goods or merchandise;
and (2) gains from the sale of ships or aircraft rented on a
full basis or gains from the sale of ships or aircraft rented
on a bareboat basis if, in the latter case, the rental profits
are incidental to other profits from the operation of ships or
aircraft in international traffic.
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.
Italy
Nonresident individuals are subject to a withholding tax of
30 percent on self-employment income.
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.
Like the present treaty, the proposed treaty provides that
income from the performance of professional services in an
independent capacity by a resident of one 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 the
source country for the purpose of performing the
services.6 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.
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\6\ The Technical Explanation states that it is understood that the
concept of a fixed base is similar to the concept of a permanent
establishment.
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The term ``professional services in an independent
capacity'' includes, but is not limited to, scientific,
literary, artistic, educational, and teaching activities as
well as independent activities of physicians, lawyers,
engineers, architects, dentists, and accountants.
Article 15. Dependent Personal Services
Under the proposed treaty, salaries, wages, and other
similar 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 is present in
the source country for not more than 183 days in the fiscal
year; (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 is not 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 regularly exercised as a member of 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 payments
(Article 18), government service income (Article 19), income of
professors and teachers (Article 20), and income of students
and trainees (Article 21).
Article 16. Directors' Fees
Under the proposed treaty, directors' fees and other
similar payments derived by a resident of one country in his or
her capacity as a member of the board of directors of a company
that is a resident of the other country is taxable in that
other country. Like the U.S. model, the proposed protocol
provides that the country of the company's residence may tax
the remuneration of nonresident directors, but only with
respect to remuneration for services performed in that country.
Article 17. Artistes and Athletes
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 athletes. 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 athlete 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 Italian currency, or such entertainer or
athlete is present in the other country for more than 90 days
during the fiscal year. The $20,000 threshold includes
reimbursed expenses. Under this rule, if an Italian entertainer
or athlete 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 athlete's total compensation
were $30,000 (or if the individual was present in the United
States for more than 90 days), 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 athlete in his or
her capacity as such accrues not to the entertainer or athlete
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 athlete 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 provisions of 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.
Article 18. Pensions, Etc.
Under the proposed treaty, pensions and other similar
remuneration derived and beneficially owned by a resident of
either country in consideration of past employment is subject
to tax only in the recipient's country of residence. The
Technical Explanation states that the provision is intended to
apply to both periodic or lump sum payments. This rule is
subject to the provisions of Article 19 (Government Service)
with respect to pensions. The Technical Explanation indicates
that it is understood that the United States may require a U.S.
resident who receives a distribution from an Italian pension
plan to include the entire distribution in the recipient's
taxable income under the general residence-based rule above
regardless of the fact that Italy may have previously imposed a
tax on the Italian pension plan with respect to earnings and
accretions.
Notwithstanding the general residence-based rule above, if
a resident of one country becomes a resident of the other
country, lump-sum payments or severance payments (indemnities)
that are received after the change in residency are taxable
only in the original country of residency. This exception only
applies to amounts that are paid with respect to employment
exercised in the original country of residence and only while
such person was a resident thereof. The term ``severance
payments (indemnities)'' includes any payment made by reason of
the termination of any office or employment of a person. The
Technical Explanation states that this provision is intended to
prevent potential abuses of the general pension rule described
above. The Technical Explanation states that, for example,
Italian law requires Italian employers to make certain lump-sum
retirement payments to employees upon their retirement. The
Technical Explanation notes that absent this provision, an
employee resident in Italy (or the United States) who
anticipates receiving such a payment might establish residence
in the United States (or in Italy) in order to obtain more
favorable U.S. (Italian) tax treatment under the general rule.
Like the present treaty, 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 are taxable only by the country
of residence. In contrast, the U.S. model provides that social
security payments may be taxed only in the source country. The
Technical Explanation states that the term ``similar
legislation'' is intended to include U.S. tier 1 Railroad
Retirement benefits.
The proposed treaty provides that annuities are taxed only
in the country of residence of the individual who beneficially
derives them. The term ``annuities'' is defined for purposes of
this provision as a stated sum paid periodically at stated
times during life or during a specified number of years, under
an obligation to make the payments in return for adequate and
full consideration in money or money's worth (other than
services rendered).
Under the proposed treaty, alimony and child support
payments paid by a resident of one country to a resident of the
other country will be taxable only in the country of residence
of the recipient. However, if the person making such payments
is not entitled to a deduction for such payments in his or her
country of residence, such payments are not taxable in either
treaty 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. The term ``child
support'' means periodic payments for the support of a minor
child made pursuant to a written separation agreement or a
decree of divorce, separate maintenance, or compulsory support.
The proposed treaty includes special rules addressing the
treatment of cross-border pension contributions. Under the
proposed treaty, if an individual who is a member of a pension
plan established and recognized under the law of one country
performs personal services in the other country, contributions
made by the individual to the plan during the period he or she
performs such personal services are deductible in computing his
or her taxable income in the other country. Similarly, payments
made to the plan by or on behalf of his or her employer during
such period are not treated as part of his or her taxable
income and are allowed as a deduction in computing the
employer's profits in the other country. However, these rules
apply only if (1) contributions were made by or on behalf of
the individual to the plan (or to a similar plan for which this
plan is substituted) immediately before he or she visited the
other country, and (2) the competent authority of the other
country has agreed that the plan generally corresponds to a
pension plan recognized for tax purposes by that country.
Moreover, the benefits provided under these rules will not
exceed the benefits that would be allowed by the other country
to its residents for contributions to a pension plan recognized
for tax purposes by that country. The proposed protocol
provides that in the case of Italy, the term ``pension plan''
means ``fondi pensione.''
Article 19. Government Service
Under the proposed treaty, remuneration, other than a
pension, paid by a treaty country or one of its political or
administrative subdivisions or local authorities to an
individual for services rendered to the payor generally is
taxable only by that country. However, such remuneration is
taxable only in the other country (the country that is not the
payor) 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 only that country or (2) did not become a
resident of that country solely for the purpose of rendering
the services. Like the present treaty, if the spouse or
dependent child of an individual who under this provision is
taxable only in the paying country also performs government
functions in the other country, the proposed treaty provides
that remuneration for those functions is taxable only in the
paying country, provided that the spouse or child is not a
national of the other country.
The proposed treaty provides that any pension paid by a
country (or one of its political subdivisions or local
authorities) to an individual for services rendered to the
payor generally 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 service are
subject to Article 18 (Pensions, Etc.) and not this article.
The proposed protocol provides that it is understood that
the competent authorities of the treaty countries may, by
mutual agreement, apply the rules described above to employees
of organizations that perform functions of a governmental
nature. The Technical Explanation states that it is anticipated
that these rules will apply to, in the case of the United
States, employees of the Federal Reserve Banks, the Export-
Import Bank, and the Overseas Private Investment Corporation
and, in the case of Italy, employees of the Central Bank, the
Foreign Trade Institute, and the Official Insurance Institute
for Export Credits.
If a country or one of its political subdivisions or local
authorities is carrying on a business, the provisions of
Articles 14 (Independent Personal Services), 15 (Dependent
Personal Services), 16 (Directors' Fees), 17 (Artistes and
Athletes), or 18 (Pensions, Etc.) will apply to remuneration
and pensions for services rendered in connection with that
business.
Article 20. Professors and Teachers
The treatment provided to professors and teachers under the
proposed treaty generally corresponds to the treatment provided
under the present treaty.
Under the proposed treaty, a professor or teacher who
visits the other country (the host country) for a period not
expected to exceed two years for the purpose of teaching or
conducting research at a university, college, school, or other
recognized educational institution, or at a medical facility
primarily funded from governmental sources, and who immediately
before that visit is, or was a resident of the other treaty
country, generally is exempt from host country tax on his or
her remuneration from such teaching or research activities.
This treaty benefit applies for a period not exceeding two
years. This exemption does not apply to income from research
undertaken not in the general interest but primarily for the
private benefit of a specific person or persons. The proposed
protocol provides that for purposes of this article, the term
``recognized educational institution'' means, in the case of
the United States, an accredited educational institution. An
educational institution is considered to be accredited if it is
accredited by an authority that generally is responsible for
the accreditation of institutions in the particular field of
study.
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. Students and Trainees
The treatment provided to students and trainees under the
proposed treaty generally corresponds to the treatment provided
under the present treaty.
Under the proposed treaty, a student or business apprentice
(trainee) who visits a country (the host country) for the
purpose of his or her education at a recognized educational
institution or for training, and who immediately before that
visit is, or was a resident of the other treaty country,
generally is exempt from host country tax on payments he or she
receives for the purpose of such maintenance, education, or
training; provided, however, that such payments arise outside
the host country. The proposed protocol provides that for
purposes of this article, the term ``recognized educational
institution'' means, in the case of the United States, an
accredited educational institution. An educational institution
is considered to be accredited if it is accredited by an
authority that generally is responsible for the accreditation
of institutions in the particular field of study. The Technical
Explanation states that a payment generally is considered to
arise outside the host country if the payer is located outside
the host country.
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 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 Italy. As a general rule, items of
income not otherwise dealt with in the proposed treaty which
are derived by residents of one of the countries 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 Italy 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 property as defined in
Article 6) if the person deriving 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 effectively connected to such permanent
establishment or fixed base. In such a case, the income is
taxable in the source country according to its laws. The
proposed protocol states that the provisions of Article 7
(Business Profits) or Article 14 (Independent Personal
Services), as the case may be, may 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.
The proposed treaty contains a main purpose test similar to
that provided with respect to the dividends, interest, and
royalties articles (Articles 10, 11 and 12). The Technical
Explanation states that, like those articles, the other income
article is intended to be self-executing. However, the tax
authorities, on review, may deny the benefits of the article in
cases in which the main purpose, or one of the main purposes,
for the creation or assignment of the rights in respect of
which income is paid is to take advantage of the article.
Article 23. 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.
Italy
Italian double tax relief is allowed through a foreign tax
credit. Italian foreign tax credits are limited to the lesser
of the foreign tax paid or the Italian tax that relates (based
on a ratio of foreign income to total income) to such amount of
the income. Unlike the United States, the foreign tax credit
limitation is determined on a per-country basis.
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 Italy 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 Italy. The proposed
treaty also requires the United States to allow a deemed-paid
credit, with respect to Italian income tax, to any U.S. company
that receives dividends from an Italian company if the U.S.
company owns 10 percent or more of the voting stock of such
Italian 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.
In the case of Italy, the proposed treaty provides that the
individual income tax (l'imposta sul reddito delle persone
fisiche); the corporation income tax (l'imposta sul reddito
delle persone giuridiche); and a portion of the regional tax on
productive activities (l'imposta regionale sulle attivita
produttive) (the so-called ``IRAP'' tax) are income taxes
available for credit against U.S. tax liabilities.
The IRAP tax applies to Italian residents as well as
nonresidents of Italy with a permanent establishment in Italy.
The IRAP tax base is calculated without a deduction for labor
costs and, for certain taxpayers, without a deduction for
interest costs. With respect to manufacturing companies, for
example, the IRAP tax base generally equals gross revenues from
sales in Italy, with certain deductions for costs of goods
sold, rent, and depreciation. No deduction is permitted for
interest or labor expenses. With respect to banks and other
financial institutions, the tax base generally equals interest
and other income received, with certain deductions including
interest paid, rent and depreciation (but with no deduction for
labor expenses). The initial IRAP tax rate generally is 4.25
percent (5.4 percent for banks and other financial
institutions). Because the IRAP tax base does not permit
deductions for labor and, in certain cases, interest, it is not
likely to be a creditable tax under U.S. internal law.
The proposed treaty provides that a portion of the taxes
imposed under the IRAP will be considered to be a creditable
income tax under this article. The proposed treaty provides a
formula under which the creditable amount is calculated by
multiplying the ``applicable ratio'' by the total amount of tax
paid or accrued to Italy under the IRAP. The applicable ratio
is a fraction, the numerator of which is the total IRAP tax
base decreased (but not below zero) by labor expense and
interest expense not otherwise taken into account in connection
with the IRAP tax base. The denominator of the fraction is the
actual tax base upon which Italy imposes the IRAP tax. The
result of this calculation is an amount of the IRAP tax that
approximates what the tax would have been had it been imposed
on net income.
The proposed treaty generally provides that in taxing its
residents Italy may include in its tax base income that the
United States may tax under the proposed treaty, but that if
Italy does so, it must credit U.S. taxes paid by the Italian
resident on that income that is taxable in the United States.
This credit is not to exceed the amount of the tax that would
be paid to the United States if the resident were not a U.S.
citizen. That is, in the case of an Italian resident who is
subject to U.S. tax on worldwide income as a U.S. citizen,
Italy will credit only the U.S. tax to which the Italian
resident would have been subject absent U.S. citizenship. Italy
need not credit U.S. taxes if the relevant item of income is
subject in Italy to a final withholding tax by request of the
recipient in accordance with Italian law.
The proposed treaty, like the U.S. model and other U.S.
treaties, contains a special rule designed to provide relief
from double taxation for U.S. citizens who are Italian
residents. Under this rule, Italy will allow a foreign tax
credit to a U.S. citizen who is resident in Italy by taking
into account only the amount of U.S. taxes paid pursuant to the
proposed treaty (other than taxes that may be imposed solely by
reason of citizenship under the saving clause of Article 1
(Personal Scope)) with respect to items of income that are
either exempt from U.S. tax or are subject to a reduced rate of
tax when derived by an Italian resident who is not a U.S.
citizen. The United States will then credit the income tax
actually paid to Italy, determined after application of the
preceding sentence. The proposed treaty recharacterizes the
income that is subject to Italian taxation as foreign source
income for purposes of this computation, but only to the extent
necessary to avoid double taxation of such income.
The proposed treaty provides a resourcing rule for purposes
of the U.S. foreign tax credit in the case of a person who is a
dual national of the United States and Italy, and is taxable by
Italy on income for services rendered to the Italian government
(under Article 19(1)(a)), but is taxable by the United States
under the saving clause. In such cases, the proposed treaty
provides that such income is treated as Italian-source income
for purposes of the U.S. foreign tax credit. The Technical
Explanation states that this resourcing rule is provided in
order to relieve potential double taxation. Thus, the United
States may tax such income but must allow a credit for the
Italian income tax, if any, in accordance with the other
provisions of this article.
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.
Article 24. Non-Discrimination
The proposed treaty contains a comprehensive non-
discrimination article relating to all taxes of every kind
imposed at the national, state, or local level. It is similar
to the non-discrimination article in the U.S. model, the
present treaty, 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. This rule applies (notwithstanding the personal
scope article (Article 1)) whether or not the nationals in
question are residents of the United States or Italy. However,
for purposes of U.S. tax, U.S. citizens subject to tax on a
worldwide basis are not in the same circumstances as Italian
nationals who are not U.S. residents.
Under the proposed treaty, neither country may tax a
permanent establishment of an enterprise 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 7 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 non-discrimination 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.
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 proposed protocol provides that nothing
in the non-discrimination article is to be construed as
preventing either of the countries from imposing a branch
profits tax or a branch-level interest tax.
The saving clause (which allows the country of residence or
citizenship to impose tax notwithstanding certain treaty
provisions) does not apply to the non-discrimination article.
Thus, a U.S. citizen resident in Italy may claim benefits with
respect to the United States under this article.
Article 25. 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 (irrespective of internal law remedies)
present his or her case to the competent authority of the
country in which he or she is a resident, or if the case comes
under the non-discrimination article (Article 24), to the
competent authority of the country in which he or she is a
national. Similar to the OECD model, and unlike the U.S. model,
the proposed treaty provides that the case must be presented
within three years from the first notification of the action
resulting in taxation not in accordance with the provisions of
the treaty. The competent authority will then make 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 are to endeavor
to resolve by mutual agreement any difficulties or doubts
arising as to the interpretation or application 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 protocol makes
clear that the competent authorities can agree that the
conditions for application of the main purpose provisions in
Articles 10 (Dividends), 11 (Interest), 12 (Royalties), or 22
(Other Income) have been met.
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. The
Technical Explanation states that 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. When it seems advisable in order to reach
agreement to have an oral exchange of opinions, such exchange
may take place through a Commission consisting of
representatives of both country's competent authorities.
Under the proposed treaty, if an agreement cannot be
reached by the competent authorities pursuant to the rules
described above, the case may, if agreed to by the taxpayer and
each competent authority, be submitted to arbitration. The
arbitration procedure does not become effective at the same
time as the remainder of the treaty; instead, the arbitration
procedure becomes effective on the date specified in a future
exchange of diplomatic notes. The proposed protocol provides
that within three years after entry into force of the proposed
treaty, the competent authorities will consult to determine
whether it is appropriate to exchange diplomatic notes
implementing the arbitration procedure. The Memorandum of
Understanding elaborates on the circumstances under which an
exchange of diplomatic notes implementing the arbitration
procedure will take place and also sets forth the procedures
that will apply to arbitration proceedings if the provision is
implemented.
If the arbitration procedures become effective, the
following rules apply. The taxpayer must agree in writing to be
bound by the decision of the arbitration board. The competent
authorities are permitted to release to the arbitration board
such information as is necessary for carrying out the
arbitration procedure. Any award of the arbitration board is
binding on the taxpayer as well as each treaty country, with
respect to the case at hand.
Article 26. Exchange of Information
This article provides for the exchange of information
between the two countries. Notwithstanding the provisions of
Article 2 (Taxes Covered), the proposed protocol provides that
the 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 necessary 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), and for the prevention of fraud and tax
evasion. This exchange of information is not restricted by
Article 1 (Personal 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 or collection 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.7 The proposed
protocol provides that information may also be disclosed to
persons or authorities involved in the oversight of such
activities. The Technical Explanation states that persons
involved in the oversight 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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\7\ 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 nontax 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.
Under the proposed protocol, a country may collect on
behalf of the other country such amounts as may be necessary to
ensure that relief granted under the treaty by the other
country does not enure to the benefit of persons not entitled
thereto. 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 27. Diplomatic Agents and Consular Officials
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 agents or
consular officials 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
Italian residents may be protected from Italian tax.
Article 28. Entry into Force
The proposed treaty provides that the treaty is subject to
ratification in accordance with the applicable procedures of
each country, and that instruments of ratification will be
exchanged as soon as possible. The proposed treaty will enter
into force upon the exchange of instruments of ratification.
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 the second month following the date on
which the proposed treaty enters into force. With respect to
other taxes, the proposed treaty will be effective for taxable
periods beginning on or after the first day of January next
following the date on which the proposed treaty enters into
force.
Taxpayers may elect temporarily to continue to claim
benefits under the present treaty with respect to a period
after the proposed treaty takes effect. For such a taxpayer,
the present treaty would continue to have effect in its
entirety for a twelve-month period from the date on which the
provisions of the proposed treaty would otherwise take effect.
The present treaty ceases to have effect once the provisions of
the proposed treaty take effect under the proposed treaty.
Article 29. Termination
The proposed treaty will continue in force until terminated
by either country. Either country may terminate the proposed
treaty at any time after five years from the date of entry into
force, provided that at least six months prior notice of
termination is given 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 January
next following the expiration of the six-month period of
notification. In the case of other taxes, a termination is
effective for taxable periods beginning on or after the first
day of January next following the expiration of the six-month
notification period.
IV. EXPLANATION OF PROPOSED PROTOCOL
A detailed, article-by-article explanation of the proposed
protocol, is set forth below. Certain provisions of the
proposed protocol have been described in Part III. above in
connection with the description of the proposed treaty.
Article 1.
Article 1 of the proposed protocol modifies specific
articles of the proposed treaty. Discussions of such
modifications appear in the discussions of the affected
articles, above.
Article 2.
The proposed protocol 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 Italy. The present treaty
contains a provision that is not as extensive.
The proposed protocol is intended to limit double taxation
caused by the interaction of the tax systems of the United
States and Italy 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 Italy or the United States will be entitled
to the benefits of the proposed treaty only if the resident:
(1) is an individual;
(2) is a qualified governmental entity;
(3) is a company that satisfies a public company
test;
(4) is a company that is owned by certain public
companies;
(5) is a charitable organization or other legal
person established and maintained exclusively for a
religious, charitable, educational, scientific, or
other similar purpose;
(6) is a pension fund that satisfies an ownership
test; or
(7) is an entity that satisfies both an ownership
and base erosion test.
Alternatively, a resident that does not fit into any of the
above categories may claim treaty benefits with respect to
certain items of income under the active business test. In
addition, a person that does not satisfy any of the above
requirements may be entitled to the benefits of the proposed
treaty if the source country's competent authority so
determines.
Individuals
An individual resident of a treaty country is entitled to
the benefits of the proposed treaty.
Qualified governmental entities
Under the proposed protocol, a qualified governmental
entity is entitled to all treaty benefits. Qualified
governmental entities include the two countries, their
political or administrative subdivisions, or their local
authorities. Qualified governmental entities also include
certain wholly-owned entities, the earnings of which are
credited to the entity's own account, and certain pension
trusts or funds providing government service pension benefits.
Public company tests
A company that is a resident of Italy or the United States
is entitled to treaty benefits if more than 50 percent of the
vote and value of all classes of the shares in such company are
regularly traded on a recognized stock exchange. In addition, a
company is entitled to treaty benefits if at least 50 percent
of each class of shares of the company is owned (directly or
indirectly) by five or fewer companies that satisfy the test
previously described, provided that each intermediate owner
used to satisfy the control requirement is a resident of Italy
or the United States. These rules follow the corresponding
rules in the U.S. model.
Under the proposed protocol, 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) any stock exchange constituted and
organized according to Italian laws; and (3) any other stock
exchange agreed upon by the competent authorities of both
countries.
Tax exempt organizations
An entity is entitled to the benefits under the proposed
treaty if it is a legal person organized under the laws of a
treaty country, generally exempt from tax in such country, and
that is established and maintained in such country exclusively
for a religious, charitable, educational, scientific, or other
similar purpose.
Pension funds
A legal person, whether or not exempt from tax, is entitled
to treaty benefits if (1) it is organized under the laws of a
treaty country to provide pension or other similar benefits to
employees pursuant to a plan, and (2) more than 50 percent of
the person's beneficiaries, members, or participants are
individuals resident in either treaty country. This rule is
similar to the rule in the U.S. model.
Ownership and base erosion tests
Under the proposed protocol, an entity that is a resident
of one of the countries is entitled to treaty benefits if it
satisfies an ownership test and a base erosion test. Under the
ownership test, on at least half of the days during the taxable
year at least 50 percent of each class of the beneficial
interests in an entity must be owned (directly or indirectly)
by certain qualified residents described above (i.e., an
individual; a qualified governmental entity; a company that
satisfies one of the public company tests (described in the
discussion of public company tests above); a charitable
organization or other legal person established and maintained
exclusively for a religious, charitable, educational,
scientific, or other similar purpose; or a legal person that
satisfies the test for pension funds (described in the
discussion of pension funds above)). The Technical Explanation
states that trusts may be entitled to treaty benefits if they
are treated as residents of a treaty country and otherwise
satisfy the requirements under these provisions.
The base erosion test is satisfied only if less than 50
percent of the person's gross income for the taxable year is
paid or accrued (directly or indirectly), in the form of
deductible payments, to persons who are not residents of either
treaty country (unless the payment is attributable to a
permanent establishment situated in either treaty country).
This rule is intended to prevent a corporation, for example,
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. This treatment is similar to the corresponding rule in
the U.S. model. The term ``gross income'' is not defined in the
proposed treaty or proposed protocol and therefore will be
defined according to the respective country's laws that is
applying the treaty. The Technical Explanation states that for
purposes of the base erosion test, in the case of the United
States, ``gross income'' is defined as gross receipts less cost
of goods sold.
Active business test
A resident satisfies the active business test if it is
engaged in the active conduct of a trade or business in its
country of residence; the income is connected with or
incidental to that trade or business; and the trade or business
is substantial in relation to the activity in the other country
generating the income. However, the proposed protocol provides
that 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 proposed protocol provides that the determination of
whether a trade or business is substantial is made based on all
facts and circumstances. However, the proposed protocol
provides a safe harbor rule under which a 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. In determining these ratios,
only amounts to the extent of the resident's direct or indirect
ownership interest in the activity in the other treaty country
are taken into account. The Technical Explanation provides that
if neither the resident nor any of its associated enterprises
has an ownership interest in the activity in the other country,
the resident's trade or business in its country of residence is
considered substantial in relation to such activity.
The proposed protocol 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 protocol, income is incidental to a
trade or business if it facilitates the conduct of the trade or
business in the other country.
The term ``trade or business'' is not specifically defined
in the proposed treaty or proposed protocol. 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.
Grant of treaty benefits by the competent authority
The proposed protocol provides a ``safety-valve'' for a
person that has not established that it meets one of the other
more objective tests, but for which the allowance of treaty
benefits would not give rise to abuse or otherwise be contrary
to the purposes of the treaty. Under this provision, such a
person may be granted treaty benefits if the competent
authority of the source country so determines. The
corresponding article in the U.S. model contains a similar
rule. The Technical Explanation states that for this purpose,
factors the competent authorities are to take into account are
whether the establishment, acquisition, and maintenance of the
person, and the conduct of its operations, did not have as one
of its principal purposes the obtaining of treaty benefits.
Article 3.
This article of the proposed protocol contains the standard
rule that the proposed treaty will 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 Italy. Thus, the proposed treaty will not
apply to increase the tax burden of a resident of either the
United States or Italy.
This article also 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 Italy are parties in determining
whether a measure is within the scope of the proposed treaty.
It also provides that, unless the competent authorities agree
that a taxation measure is outside the scope of the proposed
treaty, only the proposed treaty's non-discrimination rules,
and not the non-discrimination rules of any other agreement in
effect between the United States and Italy, 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.
Article 4.
This article provides that a U.S. citizen and Italian
resident who is a partner in a U.S. partnership is entitled to
a refundable credit against his or her Italian individual
income tax (l'imposta sul reddito delle persone fisiche) for
the taxable period that equals the portion of his Italian
corporate tax (l'imposta sul reddito delle persone giuridiche)
that is attributable to his or her share of the partnership
income. In other words, Italy agrees to treat a U.S.
partnership in the way that the United States treats it, as a
flowthrough entity for tax purposes, when the partner whose tax
is at issue is a U.S. citizen who is an Italian resident.
Article 5.
This article provides for one method by which the competent
authority of one of the two countries may allow the reduced
withholding tax rates of the proposed treaty. The article
establishes rules that will apply if either country establishes
a refund system for withholding taxes whose rates the treaty
reduces. In the case of such a refund system, the source
country will withhold taxes at the regular rate, without regard
to treaty reduction of that rate. Thereupon, the taxpayer
receiving the income is to make to the source country a claim
for refund (within the time fixed by law of the source country
for claiming a refund) and to furnish with the claim an
official certificate of his residence country that certifies
the existence of the conditions allowing the reduced treaty
rate to that taxpayer. The proposed treaty does not obligate
the United States or Italy to establish a refund system. The
United States does not presently use such a system, but rather,
allows a payor to reduce withholding taxes at the source based
on residence documentation provided by the beneficial owner of
a U.S.-source payment.
Article 6.
This article provides that each country may collect taxes
for the other country to the extent necessary to insure that
benefits of the treaty are not going to persons not entitled to
those benefits. This treaty obligation does not oblige either
country to use administrative measures that it does not use in
collecting its own taxes or that are contrary to its
sovereignty, security, or public policy.
Article 7.
This article contains two provisions. The first states that
either country may request consultations with the other country
to determine whether amendment to the proposed treaty is
appropriate to respond to changes in the law or policy of
either country. If these consultations determine that the
effect of the proposed treaty or its application have been
changed by domestic legislation of either country resulting in
an alteration to the balance of benefits provided by the
proposed treaty, further consultations shall occur with a view
toward amending the proposed treaty to restore an appropriate
balance of benefits.
The second provision in this article relates to the
implementation of the mutual agreement procedures of the
proposed treaty. This provision states that within three years
of the entry into force of the proposed treaty, the competent
authorities shall consult with respect to the implementation of
the mutual agreement procedures. They shall take into account
experience with respect to the mutual agreement procedures and
shall determine whether modifications to that article of the
proposed treaty would be appropriate. In addition, after taking
into account experience with respect to arbitration of
international tax disputes, they shall also determine whether
it is appropriate to exchange the diplomatic notes that are
prerequisite to the commencement of the arbitration procedures
of the proposed treaty.
The Memorandum of Understanding provides further detail
regarding the arbitration proceedings. First, it states that
the requisite diplomatic notes will be exchanged when the
experience of the two countries with respect to similar
provisions in other specified treaties has proven to be
satisfactory. Second, if this condition is satisfied and the
arbitration procedures become operative, the Memorandum of
Understanding specifies that the results of the arbitration are
to be binding. Third, it provides procedural rules for the
arbitration, such as specifying time limits, appointment
procedures for arbitrators, and rules for costs.
Article 8.
Under this article of the proposed protocol, if a U.S.
state or local government imposes tax on the profits of Italian
enterprises from the operation of ships or aircraft in
international traffic, Italy may impose its regional tax on
productive activities (l'imposta regionale sulle attivita
produttive) on the profits of U.S. enterprises from such
activities, notwithstanding the provisions of Article 2 (Taxes
Covered) and Article 8 (Shipping and Air Transport) of the
proposed treaty.
V. ISSUES
The proposed treaty with Italy presents the following
specific issues.
A. Main Purpose Tests
In general
The proposed treaty includes a series of specific ``main
purpose'' tests that can operate to deny the benefits of the
dividends article (Article 10), the interest article (Article
11), the royalties article (Article 12) and the other income
article (Article 22). This series of main purpose tests is not
found in any other U.S. treaty, and is not included in the U.S.
model or the OECD model.8 The main purpose tests
apparently are modeled after similar main purpose provisions
found in treaties of other countries, such as many of the
modern treaties of the United Kingdom.9
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\8\ Although not included in the OECD model, paragraph 17 of the
commentary to the dividends article of the OECD model suggests that the
treaty partners may find it appropriate to adopt a rule to deny treaty
benefits if the acquisition of stock was ``primarily for the purpose of
taking advantage of this provision.''
\9\ For example, the Convention Between the Government of the
United Kingdom of Great Britain and Northern Ireland and the Government
of the Republic of Korea for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income and
Capital Gains (Dec. 30, 1996) (``U.K.-Korea Treaty''), par. 6 of Art.
10 (Dividends), provides that ``[t]he provisions of this Article
[Article 10 (Dividends)] shall not apply if it was the main purpose or
one of the main purposes of any person concerned with the creation or
assignment of the shares or other rights in respect of which the
dividend is paid to take advantage of this Article by means of that
creation or assignment.'' See also par. 10 of Art. 11 (Interest), par.
7 of Art. 12 (Royalties), and par. 4 of Art. 22 (Other Income) of the
U.K.-Korea Treaty; Convention Between the Government of the United
Kingdom of Great Britain and Northern Ireland and the Government of the
Republic of Venezuela for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income and
Capital Gains, par. 7 of Art. 10 (Dividends), par. 9 of Art. 11
(Interest), par. 7 of Art. 12 (Royalties), par. 5 of Art. 21 (Other
Income) (Dec. 31, 1996); Convention Between the Government of the
United Kingdom of Great Britain and Northern Ireland and the Government
of the Republic of Argentina for the Avoidance of Double Taxation and
the Prevention of Fiscal Evasion with Respect to Taxes on Income and
Capital Gains, par. 9 of Art. 11 (Interest), par. 7 of Art. 12
(Royalties), par. 4 of Art. 21 (Other Income) (Aug. 1, 1997).
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Description of provisions
Under the proposed treaty, the provisions of the dividends
article (Article 10) will not apply if it was the main purpose
or one of the main purposes of any person concerned with the
creation or assignment of the shares or rights in respect of
which the dividend is paid to take advantage of the dividends
article by means of that creation or assignment. Similarly, the
interest article (Article 11) provides that its provisions will
not apply if it was the main purpose or one of the main
purposes of any person concerned with the creation or
assignment of the debt claim in respect of which the interest
is paid to take advantage of the interest article by means of
that creation or assignment. Substantially similar main purpose
tests apply in the case of the royalties article (Article 12)
and the other income article (Article 22).
The Technical Explanation indicates that the main purpose
tests are to be ``self-executing.'' The Technical Explanation
further states that the tax authorities of one of the treaty
countries may, on review, deny the benefits of the respective
article if the conditions of the main purpose test are
satisfied. In addition, the proposed protocol provides that
under the mutual agreement procedures article (Article 25) the
competent authorities of the treaty countries may agree that
the conditions for application of the main purpose tests are
met. The Technical Explanation states that the competent
authority agreement does not have to relate to a particular
case. Rather, if the competent authorities agree that a type of
transaction entered into by several taxpayers is entered into
with a main purpose of taking advantage of the treaty, treaty
benefits can be denied to all taxpayers who had entered into
such a transaction. The Technical Explanation states that it is
anticipated that the public would be notified of such generic
agreements through the issuance of press releases.
Issues
The new main purpose tests in the proposed treaty present
several issues. The tests are subjective, vague and add
uncertainty to the treaty. It is unclear how the provisions are
to be applied. In addition, the provisions lack conformity with
other U.S. tax treaties. This uncertainty can create planning
difficulties for legitimate business transactions, and can
hinder a taxpayer's ability to rely on the treaty. The
Committee may wish to consider whether the benefits of such
tests outweigh the uncertainty the main purpose tests would
create.
The main purpose standard in the relevant provisions of the
proposed treaty is that the ``main purpose or one of the main
purposes'' is to ``take advantage of'' the particular article
in which the main purpose test appears. This is a subjective
standard, dependent upon the intent of the taxpayer, that is
difficult to evaluate.
U.S. treaty policy has shifted away from subjective tests.
In fact, the limitation on benefits provision (Article 2 of the
proposed protocol), which addresses an abuse of the treaty
whereby residents of third countries try to take advantage of
the treaty provisions through what is known as ``treaty
shopping'' (discussed below), is designed to avoid questions of
taxpayer intent by providing a series of objective tests as to
whether a person should be treated as a resident entitled to
treaty benefits. The Technical Explanation to this article of
the proposed protocol acknowledges in connection with a
principal purpose test that a ``fundamental problem presented
by this approach is that it is based on the taxpayer's motives
in establishing an entity in a particular country, which a tax
administrator is normally ill-equipped to identify.'' Although
this criticism is specific to a principal purpose test with
respect to a treaty shopping provision, the same criticism
applies to subjective tests in general.
It is also unclear how the rule would be administered. The
Technical Explanation indicates that the provision is intended
to be self-executing. In the absence of a taxpayer applying the
rule to itself, the tax authorities of one of the countries
may, on review, deny the treaty benefits. Thus, the Italian tax
authorities apparently could apply Italian law to determine
whether a U.S. company's main purpose, or one of its main
purposes, was to take advantage of the specific article. If the
U.S. company disagreed with the Italian tax authority, it could
turn to the U.S. competent authority. In any event, it may be
difficult for a U.S. company to evaluate whether its
transaction may be subject to Italian main purpose standards.
Again, this lack of clarity as to the application of the main
purpose rule can impede reliance on the treaty.
A fairness question also may be raised insofar as the
proposed treaty provides the competent authorities with the
ability to declare an entire class of transactions as abusive
and, accordingly, deny treaty benefits to that class without
the necessity of evaluating the facts of a specific
transaction. It is unclear what degree of deference would be
accorded to such a competent authority agreement.
Many of the types of abusive transactions in which persons
would be attempting to take advantage of the favorable treaty
treatment with respect to dividends, interest, or royalties,
involve persons who are not otherwise entitled to treaty
benefits. The limitation on benefits provision (Article 2 of
the proposed protocol) is designed to address such concerns. On
the other hand, potentially abusive situations could arise in
which the limitation on benefits provision would not apply. For
example, a bank that is a resident of Italy and that can
satisfy the tests under the limitation on benefits provision
may decide to ``sell'' its treaty qualification to a customer
that does not so qualify because it is a resident of a third
country. The bank would agree to purchase immediately before a
dividend record date shares in a U.S. company held by its
customer. At the same time, the bank would enter into a
``repurchase'' agreement under which it agrees to ``resell''
the shares to the customer on a certain date at a certain
price. The repurchase agreement would be designed to eliminate
the bank's exposure to any market risk in connection with
holding the shares. The bank would collect the dividend and, on
its face, would qualify for the reduced withholding rate under
the treaty. The bank then would resell the shares to the
customer pursuant to the repurchase agreement.10
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\10\ See the Technical Explanation to Article 10 (Dividends).
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The favorable withholding rates provided under the proposed
treaty if certain ownership requirements are satisfied also
could invite potentially abusive activities. For example, the
proposed treaty provides that there will be no source-country
withholding on dividends if the beneficial owner of the
dividends is a resident of the other country and is a qualified
governmental entity that holds, directly or indirectly, less
than 25 percent of the voting stock of the company paying the
dividend. An Italian government pension fund with an ownership
interest of more than 25 percent in a U.S. company, shortly
before the dividends become payable, could enter into a
transaction to decrease temporarily its holding to below the
25-percent ownership threshold primarily for purposes of
securing the exemption from dividend withholding under the
treaty.11 Because the party or parties to this
transaction are residents of a treaty country, the limitation
on benefits provision (Article 2 of the proposed protocol)
would not apply.
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\11\ A similar example is provided in paragraph 17 of the
Commentary to the dividends article of the OECD model.
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Although the limitation on benefits provision may not
address all of the potential transactions in which a person can
improperly take advantage of the treaty benefits, it would
appear that residual abusive situations could be adequately
addressed under U.S. internal law addressing issues such as
beneficial ownership, conduit financing, economic substance,
business purpose, and similar abuses, which should apply
notwithstanding the treaty. Moreover, because this main purpose
test does not appear in other U.S. treaties or with respect to
other articles of this proposed treaty, some may assert that an
issue arises as to whether its inclusion in specific provisions
of this proposed treaty creates a negative inference as to the
United States' ability to raise its internal anti-abuse rules
in connection with other treaties (or provisions) in which such
main purpose tests do not appear. The Technical Explanation
states that no such inference with respect to other treaties is
intended.
B. Creditability of Italian IRAP Tax
Italian IRAP
In addition to the individual income tax and the
corporation income tax, the proposed treaty covers, in part,
the Italian regional tax on productive activities (l'imposta
regionale sulle attivita produttive or ``IRAP'') (paragraph
2(b)(iii) of Article 2 (Taxes Covered)). Effective January 1,
1998, the IRAP replaced Italy's local income tax (l'imposta
locale sul redditi or ``ILOR''), which is covered under the
present U.S.-Italy treaty. Paragraph (3) of Article 2 (Taxes
Covered) of the present treaty provides that any identical or
substantially similar tax that is imposed by one of the treaty
countries after date of enactment of that treaty in addition
to, or in place of, an existing tax is itself a covered tax. It
is the Treasury Department's position that the IRAP is not
identical to or substantially similar to the ILOR, which it
replaced.12
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\12\ See IR-INT-98-6 (March 31, 1998).
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The IRAP applies to Italian residents as well as
nonresidents of Italy with a permanent establishment in Italy.
Unlike the ILOR, the IRAP is calculated without a deduction for
labor costs and, for certain taxpayers, without a deduction for
interest costs. With respect to manufacturing companies, for
example, the IRAP tax base generally equals gross revenues from
sales in Italy, with certain deductions for costs of goods
sold, rent, and depreciation. No deduction is permitted for
interest or labor expenses. With respect to banks and other
financial institutions, the tax base generally equals interest
and other income received, with certain deductions including
interest paid, rent and depreciation (but with no deduction for
labor expenses). In general, the IRAP legislation refers to its
tax base as ``added value produced in the territory of the
region.'' The initial IRAP tax rate generally is 4.25 percent
(5.4 percent for banks and other financial institutions).
The Internal Revenue Service has stated that it does not
consider IRAP to be an income tax or an ``in lieu of'' tax
within the meaning of section 901 or section 903 of the
Code.13 Hence, in order to provide temporary relief
under the present treaty during 1998 while the United States
and Italy negotiated the new proposed treaty, the competent
authorities of the two countries agreed to treat a portion of
the IRAP as an income tax under the present
treaty.14
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\13\ Id.
\14\ See Id.
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Treatment under the proposed treaty
The proposed treaty generally provides in Article 23
(Relief from Double Taxation) that the United States agrees to
allow its citizens and residents a credit against U.S. tax for
income taxes paid to Italy. The amount of the credit is based
on the amount of tax paid to Italy, but is subject to the
limitations of the internal law of the United States, as that
law may be amended over time, for purposes of limiting the
credit to the U.S. tax on income from sources without the
United States.
With respect to taxes paid pursuant to the IRAP, the
proposed treaty provides that only a portion of the taxes paid
will be considered to be a creditable income tax under Article
23. In general terms, the proposed treaty provides a formula
under which the amount of the IRAP that is considered to be a
creditable income tax is determined by multiplying the amount
of the IRAP actually paid or accrued by a fraction. The
numerator of the fraction represents an amount approximating
the taxpayer's business profits that would be subject to the
IRAP if deductions for interest and labor costs were allowed.
The denominator of the fraction equals the actual tax base upon
which Italy imposes the IRAP. Thus, if the IRAP tax base is
twice that which it would have been if it permitted deductions
for interest and labor (and therefore more closely approximated
net income), then only half of the amount paid will be treated
as a creditable income tax under the proposed treaty. That
amount then would be subject to the other limitations on
foreign tax credits under U.S. law.
Issues
U.S. law, subject to certain limitations, allows a credit
for income, war profits or excess profits taxes paid to a
foreign country. A foreign levy is an income tax only if it is
a tax and the predominant character of that tax is that of an
income tax in the U.S. sense.15 Treasury regulations
provide that certain requirements must be satisfied in order
for the predominant character of a tax to be considered an
income tax in the U.S. sense. One such requirement is that the
tax must be likely to reach net gain in the normal
circumstances in which it applies.16 Among other
things, the IRAP's failure to permit a deduction for labor
costs and, in certain circumstances, interest costs calls into
question whether the tax is likely to reach net gain. Hence,
the tax is unlikely to be creditable under U.S. internal law.
No specific determinations have been made administratively or
judicially concerning the creditability of the IRAP under the
Code.17
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\15\ Treas. Reg. sec. 1.901-2(a)(1).
\16\ Treas. Reg. sec. 1.901-2(a)(3) and -2(b).
\17\ Although there has been no specific determinations, as stated
above, Treasury (through the IRS Assistant Chief Counsel
(International)) has publicly announced that the United States does not
consider the IRAP to be an income tax or an ``in lieu of'' tax within
the meaning of section 901 or section 903. IR-INT-98-6.
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The primary issue, therefore, is the extent to which
treaties should be used to provide a credit for taxes that may
not otherwise be fully creditable. In considering this issue,
it is important for the Committee to be aware that the tax
credits allowed under the proposed treaty for IRAP taxes could
be larger than the credits otherwise allowed under the Code and
Treasury regulations and, therefore, potentially could reduce
the U.S. taxes collected from U.S. companies operating in
Italy.
In the past, it generally has not been considered
consistent with U.S. policy for deductions from the U.S. tax
base of a U.S. person to be granted by a treaty. Nor has it
been considered consistent with U.S. tax policy to guarantee by
treaty the U.S. creditability of what might be an otherwise
noncreditable foreign tax. It may be more appropriate for both
such functions to be accomplished in the normal course of
internal U.S. tax legislation. In essence, in order to claim a
credit for a portion of the IRAP, the proposed treaty requires
a hypothetical calculation of taxes paid to Italy that would
more likely resemble a creditable income tax in the U.S. sense,
while taking the unusual additional step of guaranteeing that
such portion of that tax is eligible for the U.S. foreign tax
credit.18 On the other hand, the formula provided in
the proposed treaty is designed to limit the amount of the
creditable IRAP tax under the proposed treaty to an amount that
could be considered to be creditable under U.S. internal law if
the IRAP were designed (like the ILOR which it replaced) to
reach net gain.
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\18\ Although the modification to Italian internal law in order for
a portion of the IRAP tax to be creditable, and the corresponding
guarantee of creditability under the proposed treaty, may be unusual
and raise certain policy concerns, it is not unprecedented. The U.S.
treaties with Kazakhstan and the pending treaty with the Ukraine (which
was signed in 1994 and approved by the Senate in 1995, but for which
the exchange of instruments of ratification has been delayed pending
the resolution of issues relating to the newly enacted Ukrainian bank
secrecy laws), for example, require Kazakhstan and the Ukraine,
respectively, to modify their internal law to provide for deductions
for interest and labor costs in the case of certain U.S. persons and
U.S. participating entities, and provide for the creditability of such
taxes as modified. The U.S. treaty with the Russian Federation also
requires Russia to provide interest and labor cost deductions in order
to assist U.S. taxpayers seeking eligibility of Russian taxes for use
as credits against U.S. income; however, the Russian treaty does not
guarantee that the Russian tax is creditable for U.S. purposes.
Although these treaties provide some precedent for the proposed
treaty's treatment of the IRAP, it is important to note that the
proposed treaty does not require Italy to modify its internal law;
rather it calculates a hypothetical tax that approximates what would
have been imposed had Italy modified its internal law.
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The Committee may wish to consider (1) whether it is
appropriate to use a treaty to guarantee creditability of a tax
that otherwise is a noncreditable tax under U.S. law, and (2)
whether it is appropriate to use a hypothetical tax calculation
to approximate an income tax in order to achieve that result.
C. Insurance Excise Tax
The proposed protocol, like the protocol to the present
treaty, covers the U.S. excise tax on insurance premiums paid
to foreign insurers. Thus, for example, an Italian insurer or
reinsurer without a permanent establishment in the United
States can collect premiums on policies covering a U.S. risk or
a U.S. person free of this tax. However, the tax is imposed to
the extent that the risk is reinsured by the Italian insurer or
reinsurer with a person not entitled to the benefits of the
proposed treaty or another treaty providing exemption from the
tax. This latter rule is known as the ``anti-conduit'' clause.
Such waivers of the excise tax have raised serious
congressional concerns. For example, concern has been expressed
over the possibility that such waivers may place U.S. insurers
at a competitive disadvantage with respect to foreign
competitors in U.S. markets if a substantial tax is not
otherwise imposed (e.g., by the treaty partner country) on the
insurance income of the foreign insurer (or, if the risk is
reinsured, the reinsurer). Moreover, in such case, a waiver of
the tax does not serve the primary purpose of treaties to
prevent double taxation, but instead has the undesirable effect
of eliminating all tax on such income.
The U.S.-Barbados and U.S.-Bermuda tax treaties each
contained such a waiver as originally signed. In its report on
the Bermuda treaty, the Committee expressed the view that those
waivers should not have been included. The Committee stated
that waivers should not be given by Treasury in its future
treaty negotiations without prior consultations with the
appropriate committees of Congress.19 Congress
subsequently enacted legislation to ensure the sunset of the
waivers in the two treaties. The insurance excise tax is waived
in the treaty with the United Kingdom (without the so-called
``anti-conduit rule''). The inclusion of such a waiver in the
treaty has been followed by a number of legislative efforts to
redress the perceived competitive imbalance created by the
waiver.
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\19\ Limited consultations took place in connection with the
proposed treaty.
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The issue is whether the waiver of the insurance excise tax
in the proposed treaty is consistent with the Committee's view
of sound tax treaty policy. Furthermore, the Committee may wish
to satisfy itself that the Italian income tax imposed on
Italian insurance companies on insurance premiums results in a
burden that is substantial in relation to the U.S. tax on U.S.
insurance companies.
D. Shipping and Aircraft Income
Income from the rental of ships and aircraft
The proposed treaty, like the present 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. Like the present treaty, 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 or 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 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.
Gains from the sale of ships and aircraft
The proposed treaty, like the present treaty, includes a
provision found in the U.S. model and many U.S. income tax
treaties under which gains derived by an enterprise from one of
the treaty countries from the alienation of ships or aircraft
operated in international traffic (or movable property
pertaining to the operation or use of ships, aircraft or
containers) are taxable only in the country of residence,
regardless of the existence of a permanent establishment in the
other country. For this purpose, the proposed protocol provides
that this rule also applies to gains from the sale of
containers used for the transport in international traffic of
goods and merchandise, and gains from the sale of ships or
aircraft rented on a full basis. Like the present treaty, in
the case of gains from the sale of ships or aircraft rented on
a bareboat basis, the rule limiting the right to tax to the
country of residence applies to such gains only if the rental
profits from such bareboat rentals are incidental to other
profits of the lessor from the operation of ships or aircraft
in international traffic. Such gains that are not incidental to
other income from the operation of ships and aircraft generally
would be taxable by the source country as business profits if
such profits are attributable to a permanent establishment. The
U.S. model and many other treaties provide that gains from the
sale of ships and aircraft operated in international traffic
are taxable only in the country of residence, without requiring
that the rental profits from the use of such ships be
incidental to income of the recipient from the operation of
ships or 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 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 gains from
the sale of containers used in international traffic are
taxable only in the country of residence.
Issues
The Committee may wish to consider whether the proposed
treaty's rules with respect to income derived from the rental
of ships and aircraft, and gains from the sale of ships and
aircraft, 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 Italy 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 Italy because third-country
investors may be unwilling to share ownership of such investing
entities on a 50-50 basis with U.S. or Italian 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 an Italian conduit. Finally, Italy
imposes significant taxes of its own; these taxes may deter
third-country investors from seeking to use Italian entities to
make U.S. investments. 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.
F. Arbitration Under the Mutual Agreement Procedures
The proposed treaty would allow for a binding arbitration
procedure, if agreed by both competent authorities and the
taxpayer or taxpayers involved, for the resolution of disputes
regarding individual cases of double taxation not in accordance
with the proposed treaty. Several conditions would have to be
satisfied before this arbitration procedure could be utilized.
First, the two countries would have to exchange diplomatic
notes implementing this arbitration procedure; until that
occurs, the arbitration procedure is not in effect. Second, the
affected taxpayer must present his or her case to the competent
authority. Third, the competent authority must first attempt to
resolve the issue by itself, and if it cannot, then it must
attempt to do so by mutual agreement with the competent
authority of the other country.
The Memorandum of Understanding explicitly states that the
two countries will exchange the requisite diplomatic notes when
the experience of the two countries with respect to a similar
provision in the treaty between the U.S. and Germany has proven
to be satisfactory. In approving ratification of the U.S.-
Germany treaty, the Committee indicated a belief that the tax
system potentially may have much to gain from use of a
procedure, such as arbitration, in which independent experts
can resolve disputes that may otherwise impede efficient
administration of the tax laws. However, the Committee also
believed that the appropriateness of such a clause in a future
treaty depended strongly on the other party to the treaty and
the experience that the competent authorities would have under
the provision in the German treaty.
The Committee may wish to consider whether this provision
allowing for the future implementation of an arbitration
procedure is appropriate.
G. Exchange of Information
One of the principal purposes of the proposed treaty
between the United States and Italy is to prevent avoidance or
evasion of taxes of the two countries. The exchange of
information article of the proposed treaty (Article 26) is one
of the primary vehicles used to achieve that purpose.
The exchange of information article contained in the
proposed treaty generally conforms to the corresponding article
of the OECD model and the U.S. model.20 As is true
under these model treaties, 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 discloses any trade,
business, industrial, commercial, or professional secret or
trade process, or information the disclosure of which is
contrary to public policy.
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\20\ This takes into account Article 1, paragraph 20 of the
proposed protocol (including authorities involved in the oversight of
tax administration within the ambit of persons to whom information may
be disclosed) and the Technical Explanation of Article 26 of the treaty
(stating that ``necessary'' is to be interpreted equivalently to
``relevant'' with respect to the scope of the exchange of information
provision).
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The exchange of information article contained in the
proposed treaty varies significantly from the U.S. model in one
respect: the authority to obtain information from third parties
(commonly referred to as the ``bank secrecy'' provision). This
provision of the U.S. model provides that, notwithstanding the
limitations described in 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. This 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.
One issue is the significance of the omission of this
provision with respect to this proposed treaty. The omission of
this provision from the proposed treaty may not be significant
in that, according to the Treasury Department, Italian law
permits exchanges of the types of information provided for
under the U.S. model provision. On the other hand, if Italian
law is not in conflict with the provision of the U.S. model,
some may question why it was omitted. The Committee may wish to
satisfy itself as to the sufficiency of this provision.
Another issue is the implications of the omission of this
provision from this treaty with respect to future treaty
negotiations. While some treaty partners do not object to this
bank secrecy provision, other treaty partners have resisted its
inclusion in tax treaties. The broader issue of transparency of
transactions involving third parties is a significant issue
internationally, and in many respects the United States has
attempted to advance greater transparency. It is possible that
the omission of the bank secrecy provision from this treaty may
be interpreted by other treaty partners as a weakening of the
U.S. commitment to greater transparency and may make other
treaty negotiations with respect to this issue more difficult.
The Committee may wish to consider whether a statement that the
omission of this provision from this treaty does not lessen the
commitment of the United States to pursue broader exchanges of
information in future treaty negotiations would be beneficial.