[Senate Executive Report 105-10]
[From the U.S. Government Publishing Office]
105th Congress Exec. Rept.
SENATE
1st Session 105-10
_______________________________________________________________________
TAX CONVENTION WITH SWITZERLAND
_______
October 30, 1997.--Ordered to be printed
_______________________________________________________________________
Mr. Helms, from the Committee on Foreign Relations,
submitted the following
R E P O R T
[To accompany Treaty Doc. 105-8]
The Committee on Foreign Relations, to which was referred
the Convention between the United States of America and the
Swiss Confederation for the Avoidance of Double Taxation with
Respect to Taxes on Income, signed at Washington, October 2,
1996, together with a Protocol to the Convention, having
considered the same, reports favorably thereon, with two
declarations and one proviso, and recommends that the Senate
give its advice and consent to ratification thereof, as set
forth in this report and the accompanying resolution of
ratification.
CONTENTS
Page
I. Purpose..........................................................1
II. Background.......................................................2
III. Summary..........................................................2
IV. Entry Into Force and Termination.................................3
V. Committee Action.................................................3
VI. Committee Comments...............................................4
VII. Budget Impact...................................................17
VIII.Explanation of Proposed Treaty and Proposed Protocol............17
IX. Text of the Resolution of Ratification..........................65
X. Appendix........................................................67
I. Purpose
The principal purposes of the proposed income tax treaty
between the United States and the Swiss Confederation
(``Switzerland'') 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 income taxes of the two countries. The proposed treaty is
intended to continue 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. It is intended to enable the two
countries to cooperate in preventing avoidance and evasion of
taxes.
II. Background
The proposed treaty and proposed protocol both were signed
on October 2, 1996. The United States and Switzerland also
exchanged notes with an attached Memorandum of Understanding to
provide clarification with respect to the application of the
proposed treaty. \1\ The proposed treaty would replace the
existing income tax treaty between the two countries that was
signed in 1951.
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\1\ The United States and Switzerland originally exchanged notes
dated October 2, 1996, with an attached Memorandum of Understanding.
The United States and Switzerland subsequently exchanged notes, dated
April 8, 1997, and May 14, 1997. Attached to those subsequent notes was
a revised Memorandum of Understanding (which is included in Treaty Doc.
105-8). (The notes dated April 8, 1997, and May 14, 1997, are
reproduced in the Appendix to this report.)
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The proposed treaty, together with the proposed protocol,
was transmitted to the Senate for advice and consent to its
ratification on June 25, 1997 (see Treaty Doc. 105-8). The
Senate Committee on Foreign Relations held a public hearing on
the proposed treaty and proposed protocol on October 7, 1997.
III. Summary
The proposed treaty (as supplemented by the proposed
protocol) is similar to other recent U.S. income tax treaties,
the 1996 U.S. model income tax treaty (``U.S. model''), \2\ and
the model income tax treaty of the Organization for Economic
Cooperation and Development (``OECD model''). However, the
proposed treaty and proposed protocol contain certain
substantive deviations from those documents.
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\2\ The Treasury Department released the U.S. model on September
20, 1996. A 1981 U.S. model treaty was withdrawn by the Treasury
Department on July 17, 1992.
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As in other U.S. tax treaties, the proposed treaty's
objective of reducing or eliminating double taxation
principally is achieved by each country agreeing 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
neither country generally will 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 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 and certain capital gains derived by a resident of
either country from sources within the other country may be
taxed by both countries (Articles 10 and 13); however, the rate
of tax that the source-country may impose on a resident of the
other country on dividends generally will be limited by the
proposed treaty (Article 10). The proposed treaty also provides
that interest and royalties derived by a resident of either
country generally will be exempt from tax in the other country
(Articles 11, 12 and 21).
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 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'') contained in U.S. tax treaties that each
country retains the right to tax its citizens and residents as
if the treaty had not come into effect (Article 1). In
addition, the proposed treaty contains the standard provision
that it may not be applied to deny any taxpayer any benefits
the taxpayer would be entitled to under the domestic law of a
country or under any other agreement between the two countries
(Article 28).
The proposed treaty also contains a detailed limitation on
benefits provision to prevent the inappropriate use of the
treaty by third-country residents (Article 22).
IV. Entry Into Force and Termination
A. Entry into Force
The proposed treaty is subject to ratification in
accordance with the applicable procedures of each country, and
instruments of ratification are to be exchanged as soon as
possible. In general, the proposed treaty will enter into force
upon the exchange of instruments of ratification. The present
treaty generally ceases to have effect once the provisions of
the proposed treaty take effect.
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 entry into
force. With respect to other taxes, the proposed treaty will be
effective for taxable periods beginning on or after the first
of January following entry into force.
Where greater benefits would be available to a taxpayer
under the present treaty than under the proposed treaty, the
proposed treaty provides that the taxpayer may elect to be
taxed under the present treaty (in its entirety) for the
twelve-month period beginning on the date the proposed treaty
would otherwise have effect.
B. Termination
The proposed treaty will continue in force until terminated
by either country. Either country may terminate the proposed
treaty at any time by giving at least six months prior notice
through diplomatic channels. A termination will be effective
with respect to taxes withheld at source for amounts paid or
credited on or after the first of January following the
expiration of the six-month period. A termination will be
effective with respect to other taxes for taxable periods
beginning on or after the first of January following the
expiration of the six-month period.
V. Committee Action
The Committee on Foreign Relations held a public hearing on
the proposed treaty with Switzerland and the related protocol
(Treaty Doc. 105-8), as well as on other proposed tax treaties
and protocols, on October 7, 1997. The hearing was chaired by
Senator Hagel. The Committee considered these proposed treaties
and protocols on October 8, 1997, and ordered the proposed
treaty with Switzerland and the related protocol favorably
reported by voice vote, with the recommendation that the Senate
give its advice and consent to ratification of the proposed
treaty and proposed protocol, subject to two declarations and a
proviso.
VI. Committee Comments
On balance, the Committee on Foreign Relations believes
that the proposed treaty with Switzerland is in the interest of
the United States and urges that the Senate act promptly to
give advice and consent to ratification. However, the Committee
has taken note of certain issues raised by the proposed treaty
and believes that the following comments may be useful to
Treasury Department officials in providing guidance on these
matters should they arise in the course of future treaty
negotiations.
A. Treatment of REIT Dividends
REITs in general
Real Estate Investment Trusts (``REITs'') essentially are
treated as conduits for U.S. tax purposes. The income of a REIT
generally is not taxed at the entity level but is distributed
and taxed only at the investor level. This single level of tax
on REIT income is in contrast to other corporations, the income
of which is subject to tax at the corporate level and is taxed
again at the shareholder level upon distribution as a dividend.
Hence, a REIT is like a mutual fund that invests in qualified
real estate assets.
An entity that qualifies as a REIT is taxable as a
corporation. However, unlike other corporations, a REIT is
allowed a deduction for dividends paid to its shareholders.
Accordingly, income that is distributed by a REIT to its
shareholders is not subject to corporate tax at the REIT level.
A REIT is subject to corporate tax only on any income that it
does not distribute currently to its shareholders. As discussed
below, a REIT is required to distribute on a current basis the
bulk of its income each year.
In order to qualify as a REIT, an entity must satisfy, on a
year-by-year basis, specific requirements with respect to its
organizational structure, the nature of its assets, the source
of its income, and the distribution of its income. These
requirements are intended to ensure that the benefits of REIT
status are accorded only to pooling of investment arrangements,
the income of which is derived from passive investments in real
estate and is distributed to the investors on a current basis.
In order to satisfy the organizational structure
requirements for REIT status, a REIT must have at least 100
shareholders and not more than 50 percent (by value) of its
shares may be owned by five or fewer individuals. In addition,
shares of a REIT must be transferrable.
In order to satisfy the asset requirements for REIT status,
a REIT must have at least 75 percent of the value of its assets
invested in real estate, cash and cash items, and government
securities. In addition, diversification rules apply to the
REIT's investment in assets other than the foregoing qualifying
assets. Under these rules, not more than 5 percent of the value
of its assets may be invested in securities of a single issuer
and any such securities held may not represent more than 10
percent of the voting securities of the issuer.
In order to satisfy the source of income requirements, at
least 95 percent of the gross income of the REIT generally must
be from certain passive sources (e.g., dividends, interest, and
rents). In addition, at least 75 percent of its gross income
generally must be from certain real estate sources (e.g., real
property rents, mortgage interest, and real property gains).
Finally, in order to satisfy the distribution of income
requirement, the REIT generally is required to distribute to
its shareholders each year at least 95 percent of its taxable
income for the year (excluding net capital gains). A REIT may
retain 5 percent or less of its taxable income and all or part
of its net capital gain.
A REIT is subject to corporate-level tax only on any
taxable income and net capital gains that the REIT retains.
Under an available election, shareholders may be taxed
currently on the undistributed capital gains of a REIT, with
the shareholder entitled to a credit for the tax paid by the
REIT with respect to the undistributed capital gains such that
the gains are subject only to a single level of tax.
Distributions from a REIT of ordinary income are taxable to the
shareholders as a dividend, in the same manner as dividends
from an ordinary corporation. Accordingly, such dividends are
subject to tax at a maximum rate of 39.6 percent in the case of
individuals and 35 percent in the case of corporations. In
addition, capital gains of a REIT distributed as a capital gain
dividend are taxable to the shareholders as capital gain.
Capital gain dividends received by an individual will be
eligible for preferential capital gain tax rates if the
relevant holding period requirements are satisfied.
Foreign investors in REITs
Nonresident alien individuals and foreign corporations
(collectively, foreign persons) are subject to U.S. tax on
income that is effectively connected with the foreign person's
conduct of a trade or business in the United States, in the
same manner and at the same graduated tax rates as U.S.
persons. In addition, foreign persons generally are subject to
U.S. tax at a flat 30-percent rate on certain gross income that
is derived from U.S. sources and that is not effectively
connected with a U.S. trade or business. The 30-percent tax
applies on a gross basis to U.S.-source interest, dividends,
rents, royalties, and other similar types of income. This tax
generally is collected by means of withholding by the person
making the payment of such amounts to a foreign person.
Capital gains of a nonresident alien individual that are
not connected with a U.S. business generally are subject to the
30-percent withholding tax only if the individual is present in
the United States for 183 days or more during the year. The
United States generally does not tax foreign corporations on
capital gains that are not connected with a U.S. trade or
business. However, foreign persons generally are subject to
U.S. tax on any gain from a disposition of an interest in U.S.
real property at the same rates that apply to similar income
received by U.S. persons. Therefore, a foreign person that has
capital gains with respect to U.S. real estate is subject to
U.S. tax on such gains in the same manner as a U.S. person. For
this purpose, a distribution by a REIT to a foreign shareholder
that is attributable to gain from a disposition of U.S. real
property by the REIT is treated as gain recognized by such
shareholder from the disposition of U.S. real property.
U.S. income tax treaties contain provisions limiting the
amount of income tax that may be imposed by one country on
residents of the other country. Many treaties, like the
proposed treaty, generally allow the source-country to impose
not more than a 15-percent withholding tax on dividends paid to
a resident of the other treaty country. In the case of real
estate income, most treaties, like the proposed treaty, specify
that income derived from, and gain from dispositions of, real
property in one country may be taxed by the country in which
the real property is situated without limitation. \3\
Accordingly, U.S. real property rental income derived by a
resident of a treaty partner generally is subject to the U.S.
withholding tax at the full 30-percent rate (unless the net-
basis taxation election is made), and U.S. real property gains
of a treaty partner resident are subject to U.S. tax in the
manner and at the rates applicable to U.S. persons.
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\3\ The proposed treaty, like many treaties, allows the foreign
person to elect to be taxed in the source-country on income derived
from real property on a net basis under the source country's domestic
laws.
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Although REITs are not subject to corporate-level taxation
like other corporations, distributions of a REIT's income to
its shareholders generally are treated as dividends in the same
manner as distributions from other corporations. Accordingly,
in cases where no treaty is applicable, a foreign shareholder
of a REIT is subject to the U.S. 30-percent withholding tax on
ordinary income distributions from the REIT. In addition, such
shareholders are subject to U.S. tax on U.S. real estate
capital gain distributions from a REIT in the same manner as a
U.S. person.
In cases where a treaty is applicable, this U.S. tax on
capital gain distributions from a REIT still applies. However,
absent special rules applicable to REIT dividends, treaty
provisions specifying reduced rates of tax on dividends apply
to ordinary income dividends from REITs as well as to dividends
from taxable corporations. As discussed above, the proposed
treaty, like many U.S. treaties, reduces the U.S. 30-percent
withholding tax to 15 percent in the case of dividends
generally. Prior to 1989, U.S. tax treaties contained no
special rules excluding dividends from REITs from these reduced
rates. Therefore, under pre-1989 treaties such as the present
treaty with Switzerland, REIT dividends are eligible for the
same reductions in the U.S. withholding tax that apply to other
corporate dividends.
Beginning in 1989, U.S. treaty negotiators began including
in treaties provisions excluding REIT dividends from the
reduced rates of withholding tax generally applicable to
dividends. Under treaties with these provisions such as the
proposed treaty, REIT dividends generally are subject to the
full U.S. 30-percent withholding tax. \4\
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\4\ Many treaties, like the proposed treaty, provide a maximum tax
rate of 15 percent in the case of REIT dividends beneficially owned by
an individual who holds a less than 10 percent interest in the REIT.
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Analysis of treaty treatment of REIT dividends
The specific treaty provisions governing REIT dividends
were introduced beginning in 1989 because of concerns that the
reductions in withholding tax generally applicable to dividends
were inappropriate in the case of dividends from REITs. The
reductions in the rates of source-country tax on dividends
reflect the view that the full 30-percent withholding tax rate
may represent an excessive rate of source-country taxation
where the source-country already has imposed a corporate-level
tax on the income prior to its distribution to the shareholders
in the form of a dividend. In the case of dividends from a
REIT, however, the income generally is not subject to
corporate-level taxation.
REITs are required to distribute their income to their
shareholders on a current basis. The assets of a REIT consist
primarily of passive real estate investments and the REIT's
income may consist principally of rentals from such real estate
holdings. U.S. source rental income generally is subject to the
U.S. 30-percent withholding tax. Moreover, the United States's
treaty policy is to preserve its right to tax real property
income derived from the United States. Accordingly, the U.S.
30-percent tax on rental income from U.S. real property is not
reduced in U.S. tax treaties.
If a foreign investor in a REIT were instead to invest in
U.S. real estate directly, the foreign investor would be
subject to the full 30-percent withholding tax on rental income
earned on such property (unless the net-basis taxation election
is made). However, when the investor makes such investment
through a REIT instead of directly, the income earned by the
investor is treated as dividend income. If the reduced rates of
withholding tax for dividends apply to REIT dividends, the
foreign investor in the REIT is accorded a reduction in U.S.
withholding tax that is not available for direct investments in
real estate.
On the other hand, some argue that it is important to
encourage foreign investment in U.S. real estate through REITs.
In this regard, a higher withholding tax on REIT dividends
(i.e., 30 percent instead of 15 percent) may not be fully
creditable in the foreign investor's home country and the cost
of the higher withholding tax therefore may discourage foreign
investment in REITs. For this reason, some oppose the inclusion
in U.S. treaties of the special provisions governing REIT
dividends, arguing that dividends from REITs should be given
the same treatment as dividends from other corporate entities.
Accordingly, under this view, the 15-percent withholding tax
rate generally applicable under treaties to dividends should
apply to REIT dividends as well.
This argument is premised on the view that investment in a
REIT is not equivalent to direct investment in real property.
From this perspective, an investment in a REIT should be viewed
as comparable to other investments in corporate stock. In this
regard, like other corporate shareholders, REIT investors are
investing in the management of the REIT and not just its
underlying assets. Moreover, because the interests in a REIT
are widely held and the REIT itself typically holds a large and
diversified asset portfolio, an investment in a REIT represents
a very small investment in each of a large number of
properties. Thus, the REIT investment provides diversification
and risk reduction that are not easily replicated through
direct investment in real estate.
At the October 7, 1997 hearing on the proposed treaty (as
well as other proposed treaties and protocols), the Treasury
Department announced that it has modified its policy with
respect to the exclusion of REIT dividends from the reduced
withholding tax rates applicable to other dividends under
treaties. The Treasury Department worked extensively with the
staff of the Committee on Foreign Relations, the staff of the
Joint Committee on Taxation, and representatives of the REIT
industry in order to address the concern that the current
treaty policy with respect to REIT dividends may discourage
some foreign investment in REITs while maintaining a treaty
policy that properly preserves the U.S. taxing jurisdiction
over foreign direct investment in U.S. real property. The new
policy is a result of significant cooperation among all parties
to balance these competing considerations.
Under this policy, REIT dividends paid to a resident of a
treaty country will be eligible for the reduced rate of
withholding tax applicable to portfolio dividends (typically,
15 percent) in two cases. First, the reduced withholding tax
rate will apply to REIT dividends if the treaty country
resident beneficially holds an interest of 5 percent or less in
each class of the REIT's stock and such dividends are paid with
respect to a class of the REIT's stock that is publicly traded.
Second, the reduced withholding tax rate will apply to REIT
dividends if the treaty country resident beneficially holds an
interest of 10 percent or less in the REIT and the REIT is
diversified, regardless of whether the REIT's stock is publicly
traded. In addition, the current treaty policy with respect to
the application of the reduced withholding tax rate to REIT
dividends paid to individuals holding less than a specified
interest in the REIT will remain unchanged.
For purposes of these rules, a REIT will be considered
diversified if the value of no single interest in real property
held by the REIT exceeds 10 percent of the value of the REIT's
total interests in real property. An interest in real property
will not include a mortgage, unless the mortgage has
substantial equity components. An interest in real property
also will not include foreclosure property. Accordingly, a REIT
that holds exclusively mortgages will be considered to be
diversified. The diversification rule will be applied by
looking through a partnership interest held by a REIT to the
underlying interests in real property held by the partnership.
Finally, the reduced withholding tax rate will apply to a REIT
dividend if the REIT's trustees or directors make a good faith
determination that the diversification requirement is satisfied
as of the date the dividend is declared.
The Treasury Department will incorporate this new policy
with respect to the treatment of REIT dividends in the U.S.
model treaty and in future treaty negotiations. In addition,
the Treasury Department has committed to use its best efforts
to negotiate a protocol with Switzerland to amend the proposed
treaty to incorporate this policy.
The Committee believes that the new policy with respect to
the applicability of reduced withholding tax rates to REIT
dividends appropriately reflects economic changes since the
establishment of the current policy. The Committee further
believes that the new policy fairly balances competing
considerations by extending the reduced rate of withholding tax
on dividends generally to dividends paid by REITs that are
relatively widely-held and diversified. The Committee
encourages the Treasury Department to act expeditiously in
meeting its commitment to negotiate a protocol with Switzerland
that incorporates this new policy.
B. Exchange of Information
One of the principal purposes of the proposed income tax
treaty between the United States and Switzerland is to prevent
avoidance or evasion of income taxes of the two countries. The
exchange of information article of the proposed treaty is one
of the primary vehicles used to achieve that purpose.
The exchange of information article contained in the
proposed treaty conforms in some respects to and deviates
significantly in other respects from the corresponding articles
of the U.S. and OECD models. As is true under these model
treaties and the present treaty, under the proposed treaty a
country is not required to carry out administrative measures at
variance with the laws and administrative practices of either
country, to supply information which is not obtainable under
the laws or in the normal course of the administration of
either country, or to supply information which discloses any
trade, business, industrial, commercial, or professional secret
or trade process, or information the disclosure of which is
contrary to public policy.
The proposed treaty deviates significantly from the
corresponding articles of the U.S. and OECD models in the scope
of the information exchange provision. Under the proposed
treaty, information shall be exchanged as is necessary to carry
out the purposes of the proposed treaty or for the prevention
of tax fraud. The proposed treaty does not permit the exchange
of information to carry out the provisions of domestic law of
the parties to the treaty; such a provision is included in the
corresponding articles of both the U.S. and OECD models. The
omission of this provision means that under the proposed
treaty, exchange of information will not be possible for the
purpose of routine enforcement of the tax laws (except as is
necessary to carry out the purposes of the proposed treaty or
for the prevention of tax fraud). Consequently, the information
exchange provision in the proposed treaty is significantly more
restrictive than the corresponding provisions in either the
model treaties or most other tax treaties into which the United
States has entered in recent years.
The proposed treaty does contain several provisions
relating to exchanges of information for the prevention of tax
fraud that are somewhat broader than the corresponding
provision in the present treaty. First, the proposed treaty
provides that the exchange of information is not restricted by
the personal scope provisions of the proposed treaty.
Consequently, information exchanges may occur with respect to
persons otherwise outside the scope of the proposed treaty.
There is no comparable provision in the present treaty. Second,
the proposed treaty explicitly provides that authenticated
copies of unedited original records or documents shall be
provided when requested. The Treasury Department's Technical
Explanation of the proposed treaty (hereinafter referred to as
the ``Technical Explanation'') states that the Swiss Supreme
Court, in interpreting the present treaty, limited the form in
which information could be provided to reports and summaries of
information. Third, the Memorandum of Understanding states that
in cases of tax fraud, Swiss banking secrecy provisions do not
hinder the gathering of documentary evidence from banks or its
being provided to the United States pursuant to the proposed
treaty.
As part of its consideration of the proposed treaty, the
Committee asked if the Treasury Department considers the
exchange of information provisions of the proposed treaty to be
sufficient to carry out the tax-avoidance purposes for which
income tax treaties are entered into by the United States. The
relevant portion of the Treasury Department's October 8, 1997
letter \5\ responding to this inquiry is reproduced below:
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\5\ Letter from Joseph H. Guttentag, International Tax Counsel,
Treasury Department, to Senator Paul Sarbanes, Committee on Foreign
Relations, October 8, 1997 (``October 8, 1997 Treasury Department
letter'').
Although the exchange of information provisions of the
proposed treaty are not as broad as the U.S. Model provisions,
they represent a significant improvement over those in the
present treaty. . . . [T]he new treaty and Protocol contain a
clear, broad definition of ``tax fraud'' that should lead to
improved information exchange. The new treaty also provides
that information will, where possible, be provided in a form
that will make it possible for the information to be used in
court proceedings. While these measures do not go as far as we
would like, the improvement that they will allow in our
exchange of information program with Switzerland should make
the anti-avoidance provisions of the new treaty far more
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effective than under the present treaty.
In addition, the Treasury Department noted both the constraints
imposed by Swiss law on reaching a theoretically more desirable
information exchange provision and the fact that the
information exchange provision of the proposed treaty is more
expansive than those of any other Swiss treaty.
Although broader exchange of information provisions are
desirable, the Committee understands the difficulty in
achieving broader provisions given the constraints of Swiss
law. Additionally, the Committee notes that the exchange of
information provisions of the proposed treaty are somewhat
improved over the comparable provisions of the present treaty.
However, the Committee does not believe that the proposed Swiss
treaty should be construed in any way as a precedent for other
negotiations. The exchange of information provisions in
treaties are central to the purposes for which tax treaties are
entered into, and significant limitations on their effect,
relative to the preferred U.S. tax treaty position, should not
be accepted in negotiations with other countries that seek to
have or to maintain the benefits of a tax treaty relationship
with the United States.
C. Insurance Excise Tax
The proposed treaty, unlike the present treaty, covers the
U.S. excise tax on insurance premiums paid to foreign insurers.
With the waiver of the excise tax on insurance premiums, for
example, a Swiss insurer 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 the excise tax on insurance
premiums. However, the tax is imposed to the extent that the
risk is reinsured by the Swiss insurer with a person not
entitled to the benefits of an income tax 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 a 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 granted by Treasury in its future
treaty negotiations without prior consultations with the
appropriate committees of Congress. \6\ Congress subsequently
enacted legislation to ensure the sunset of the waivers in the
two treaties. The insurance excise tax also is waived in the
treaty with the United Kingdom (without the so-called ``anti-
conduit rule''). The inclusion of such a waiver in that treaty
has been followed by a number of legislative efforts to redress
the perceived competitive imbalance created by the waiver.
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\6\ Limited consultations took place in connection with the
proposed treaty.
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The proposed treaty waives imposition of the excise tax on
insurance and reinsurance premiums paid to residents of
Switzerland. The Committee understands that, unlike Bermuda and
Barbados, Switzerland imposes substantial tax on the income,
including insurance income, of its residents. Moreover, unlike
in the case of the U.K. treaty, the waiver in the proposed
treaty contains the anti-conduit clause.
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department whether the Swiss
income tax imposed on Swiss insurance companies on insurance
premiums results in a burden that is substantial in relation to
the U.S. tax on U.S. insurance companies. The relevant portion
of the October 8, 1997 Treasury Department letter responding to
this inquiry is reproduced below:
[T]he Treasury agrees to cover the federal excise tax on
insurance premiums only when it determines that insurance
companies resident in the treaty partner are subject to a
substantial level of taxation. The Treasury studied Swiss
insurance taxation very thoroughly, including meetings with
outside experts and Swiss tax officials, before making the
initial decision to cover the tax. Consultations were then held
with Senate and House Committee staff members before a final
decision was made. We believe that coverage, and thus, waiver,
of the tax represents appropriate policy.
In light of the inclusion in the proposed treaty of the
anti-conduit clause and based on the assessment provided by the
Treasury Department regarding the relative tax burdens of Swiss
insurers and U.S. insurers, the Committee believes that the
waiver of the excise tax for Swiss insurers is consistent with
the criteria the Committee has articulated for such waivers.
However, the Committee instructs the Treasury Department
promptly to notify the Committee of any changes in laws or
business practices that would have an impact on the tax burden
of Swiss insurers relative to that of U.S. insurers.
D. Income from the Rental of Ships and Aircraft
The proposed treaty includes a provision found in the U.S.
model and many U.S. income tax treaties under which profits
from an enterprise's operation of ships or aircraft in
international traffic are taxable only in the enterprise's
country of residence. In the case of profits derived from the
rental of ships and aircraft, the rule limiting the right to
tax to the country of residence applies to such rental profits
only if the rental profits are incidental to other profits from
the operation of ships and aircraft in international traffic.
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 business profits if such
profits are attributable to a permanent establishment. The U.S.
model and many other treaties provide that profits from the
rental of ships and aircraft operated in international traffic
are taxable only in the country of residence, without requiring
that the rental profits be incidental to income of the
recipient from the operation of ships and aircraft. Under the
proposed treaty, unlike under the U.S. model, an enterprise
that engages only in the rental of ships and aircraft, 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.
In addition, the provisions in the U.S. model and many
other U.S. income tax treaties that allow profits from an
enterprise's operation of ships or aircraft in international
traffic to be taxed only in the enterprise's country of
residence generally apply also to income from the use,
maintenance, or rental of containers used in international
traffic. The provision in the proposed treaty does not cover
income from containers. Accordingly, under the proposed treaty,
income from containers used in international traffic would be
taxable by the source-country as business profits if such
income is attributable to a permanent establishment.
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department about the treatment of
income from rentals of ships, aircraft, and containers under
the proposed treaty. The relevant portion of the October 8,
1997 Treasury Department letter responding to this inquiry is
reproduced below:
The rule in the Swiss treaty follows the OECD Model, rather
than the U.S. Model. This reflects Swiss policy. . . . [I]ncome
from the rental of ships, aircraft and containers that is not
incidental to the operation of ships and aircraft in
international traffic is, under the proposed treaty, treated as
business profits, not as shipping income taxable only in the
residence of the recipient of the income. Because of this
characterization, such income is subject to tax in the source-
country only when the rental income is attributable to a
permanent establishment in the source-country, and, if taxable,
may be taxed only on a net basis. As a general matter, rental
contracts will be structured so that the income will not be
attributable to a permanent establishment. Thus, this rule
differs substantially from the rule in some other treaties,
such as Indonesia, where non-incidental income from the leasing
of containers was treated as royalties and subject to a 10%
gross basis tax. While this rule is not preferred U.S. policy,
as part of a negotiated agreement, it provides a reasonable and
practical solution, taking into account all applicable Swiss
tax rules.
In the past, the Committee has expressed concern about the
anti-competitive effects of a provision, such as the provision
in the U.S.-Indonesia treaty, that treats non-incidental income
from container leasing as royalty income subject to a source-
country withholding tax. The Committee understands that under
the proposed treaty income derived by a resident of one country
from the rental of ships, aircraft, and containers would be
subject to tax in the other country only if such income is
attributable to a permanent establishment maintained by the
resident in the other country. Although the circumstances under
which source-country taxation will apply to income from the
rental of ships, aircraft, and containers are more limited in
the proposed Swiss treaty than in the Indonesian treaty, the
Committee continues to reject the notion that a justifiable
distinction can be made between container leasing income and
income derived from other international transportation
activities. The Committee once again urges the Treasury
Department to include only the U.S. model provision with
respect to such income in all future treaties.
E. Treaty Shopping
The proposed treaty, like many 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 residents of
Switzerland and the United States only, 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 on interest. 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 in the proposed treaty
is similar to anti-treaty-shopping provisions in the Internal
Revenue Code (``Code'') (as interpreted by Treasury
regulations) and in the U.S. model. The provision also is
similar to the anti-treaty-shopping provision in several recent
treaties. In particular, the proposed treaty provision
resembles the anti-treaty-shopping provisions contained in the
1993 U.S. treaty with the Netherlands and the 1995 U.S. treaty
with France. The degree of detail included in this provision is
notable in itself. The proliferation of detail may reflect, in
part, a diminution in the scope afforded the IRS and the courts
to resolve interpretive issues adversely to a person attempting
to claim the benefits of a treaty; this diminution represents a
bilateral commitment, not alterable by developing internal U.S.
tax policies, rules, and procedures, unless enacted as
legislation that would override the treaty. (In contrast, the
IRS generally is not limited under the proposed treaty in its
discretion to allow treaty benefits under the anti-treaty-
shopping rules.) The detail in the proposed treaty does
represent added guidance and certainty for taxpayers that may
be absent under treaties that may have somewhat simpler and
more flexible provisions.
The anti-treaty-shopping provisions in the proposed treaty
differ from those in the Code and other treaties in a number of
respects.
The proposed treaty is similar to other U.S. treaties and
the branch tax rules in affording treaty benefits to certain
publicly traded companies. In comparison with the U.S. branch
tax rules, the proposed treaty is more lenient. The proposed
treaty allows benefits to be afforded to a company that is more
than 50 percent owned, directly or indirectly, by one or more
qualifying publicly traded corporations, while the branch tax
rules allow benefits to be afforded only to a wholly-owned
subsidiary of a publicly traded company.
The proposed treaty also provides mechanical rules under
which so-called ``derivative benefits'' are afforded. \7\ Under
these rules, an entity is afforded certain benefits based in
part on its ultimate ownership of at least 70 percent by
residents of European Union, European Economic Area, or North
American Free Trade Agreement (``NAFTA'') countries who would
be entitled to treaty benefits that are as favorable under an
existing treaty with the third country. In addition, the
Memorandum of Understanding effectively expands this derivative
benefits provision. Under this expansion, an entity generally
is entitled to all benefits of the treaty based in part on its
ultimate ownership of at least 95 percent by seven or fewer
residents of European Union, European Economic Area, or NAFTA
countries who would be entitled to treaty benefits that are as
favorable under an existing treaty with the third country. The
U.S. model does not contain a derivative benefits provision.
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\7\ The U.S. income tax treaties with the Netherlands, Jamaica and
Mexico also provide similar benefits.
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Taken as a whole, some may argue that the derivative
benefits provision of the proposed treaty is more generous to
taxpayers claiming U.S. treaty benefits than the derivative
benefits provisions of any U.S. tax treaties currently in
effect. For example, while most other treaties to which the
United States is a party generally allow derivative benefits
only with respect to certain income (e.g., interest, dividends
or royalties), the proposed treaty allows a taxpayer to claim
derivative benefits with respect to the entire treaty. \8\ In
addition, unlike most existing treaties, the proposed treaty,
as supplemented by the Memorandum of Understanding, does not
require any same-country ownership of a Swiss company claiming
treaty benefits. \9\ In other words, a Swiss entity that is
100-percent owned by certain third-country residents and that
does not otherwise have a nexus with Switzerland (e.g., by
engaging in an active trade or business there), may be entitled
to claim benefits under the proposed treaty.
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\8\ The U.S.-Jamaica tax treaty is the only other existing treaty
that allows a taxpayer to claim derivative benefits with respect to the
entire treaty.
\9\ Article 26(4)(a) of the U.S.-Netherlands treaty, for example,
requires more than 30-percent Dutch ownership of the entity claiming
derivative benefits and more than 70-percent European Union ownership
of such entity. On the other hand, the 1995 U.S.-Canada protocol
permits a company to claim certain treaty benefits under the derivative
benefits provision without any same country ownership; however, the
benefits that may be so obtained are limited to reduced withholding
rates for dividends, interest and royalties.
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The proposed treaty includes a special rule designed to
prevent the proposed treaty from reducing or eliminating U.S.
tax on income of a Swiss resident in a case where no other
substantial tax is imposed on that income (the so-called
``triangular cases''). This is necessary because a Swiss
resident may in some cases be wholly or partially exempt from
Swiss tax on foreign (i.e., non-Swiss) income. The special rule
applies generally if the combined Swiss and third-country
taxation of U.S.-source income derived by a Swiss enterprise
and attributable to a permanent establishment in the third
country is less than 60 percent of the tax that would be
imposed if the Swiss enterprise earned the income in
Switzerland.
Under the special rule, the United States is permitted to
tax dividends, interest, and royalties paid to the third-
country permanent establishment at the rate of 15 percent. In
addition, under the special rule, the United States is
permitted to tax other types of income without regard to the
proposed treaty. The special rule generally does not apply if
the U.S. income is derived in connection with, or is incidental
to, an active trade or business in the third country. The
special rule is similar to a provision of the 1993 protocol to
the U.S.-Netherlands tax treaty and a provision of the U.S.-
France treaty. This special rule for triangular cases is not
included in the U.S. model.
The U.S.-France treaty provides a further exception from
the application of the special rule for the triangular case if
the third-country income is subject to taxation by either the
United States or France under the controlled foreign
corporation rules of either country. \10\ Although the proposed
treaty does not provide an explicit controlled foreign
corporation exception, the Committee expects that the U.S.
competent authority would grant relief under the proposed
treaty in a case where the U.S.-source income subject to the
special rule ultimately is included in a U.S. shareholder's
income under the subpart F rules. The Committee believes that
either an explicit controlled foreign corporation exception
should have been included in the text of the proposed treaty,
as in the French treaty and the proposed treaties with Austria
and South Africa, or the availability of such relief should
have been described in the Technical Explanation of the
proposed treaty, as in the case of the proposed treaty with
Luxembourg.
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\10\ In the case of the United States, these provisions are
contained in sections 951-964 of the Code and are referred to as the
``subpart F'' rules.
---------------------------------------------------------------------------
The practical difference between the proposed treaty tests
and the corresponding tests in other treaties will depend upon
how they are interpreted and applied. Given the relatively
bright line rules provided in the proposed treaty, the range of
interpretation under it may be fairly narrow.
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department about the sufficiency
of the anti-treaty-shopping provision in the proposed treaty.
The relevant portion of the October 8, 1997 Treasury Department
letter responding to this inquiry is reproduced below:
Like our Netherlands treaty, there is considerable detail
in the Swiss limitation on benefits provisions and Memorandum
of Understanding. The Swiss wanted this to be able to provide a
measure of certainty to taxpayers as to whether they would be
entitled to treaty benefits. Many of the aspects of the Swiss
provision, such as derivative benefits, we believed were
necessary to avoid setting up a situation where potential
investors could invest in the United States through some U.S.
treaty partners without violating the limitation on benefits
provisions, but could not do so through Switzerland. A company
that satisfies the derivative benefits provision will be
entitled to all the benefits of the treaty, just as in the
U.S.-France treaty. The Swiss provision contains a ``triangular
case'' rule, not found in the U.S. Model, because this is
necessary for countries that exempt certain third- country
permanent establishment profits. Some of the differences
between the Swiss anti-treaty-shopping provisions and the
standard U.S. Model provisions grew out of the fact that
Switzerland has had its own anti-treaty-shopping rules since
1962, and we sought in negotiating the treaty provisions to
mesh their system with ours. We believe that the Swiss treaty
provision will deal appropriately with potential treaty
shoppers.
The Committee believes that the United States should
maintain its policy of limiting treaty-shopping opportunities
whenever possible. The Committee further believes that, in
exercising any latitude Treasury has with respect to the
operation of a treaty, the treaty rules should be applied to
deter treaty-shopping abuses. On the other hand, the Committee
recognizes that implementation of the detailed tests for treaty
shopping set forth in the proposed treaty may raise factual,
administrative, or other issues that cannot currently be
foreseen. The Committee emphasizes that the provisions in the
proposed treaty must be implemented so as to serve as an
adequate tool for preventing possible treaty-shopping abuses in
the future.
F. Arbitration of Competent Authority Issues
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 those
disputes in the interpretation or application of the proposed
treaty that are within the jurisdiction of the competent
authorities to resolve. The competent authorities could release
to the arbitration board such information as is necessary to
carry out the arbitration procedure. The members of the
arbitration board are subject to the limitations on disclosure
contained in the exchange of information article of the
proposed treaty. This provision would take effect only after an
exchange of diplomatic notes between the United States and
Switzerland.
Generally, the jurisdiction of the competent authorities
under the proposed treaty is as broad as it is under any U.S.
income tax treaties. For example, the competent authorities are
empowered (in this as in other treaties) to agree on the
attribution of income, deductions, credits, or allowances of an
enterprise to a permanent establishment. They may agree on the
allocation of income, deductions, credits, or allowances
between associated enterprises and others under the provisions
of Article 9 (Associated Enterprises), which is the treaty
analogue of Code section 482. They also may agree on the
characterization of particular items of income, on the common
meaning of a term, and on the application of procedural aspects
of internal law. Finally, the competent authorities may agree
on the elimination of double taxation in cases not provided for
in the proposed treaty. According to the Technical Explanation
with respect to this procedure, agreements reached by the
competent authorities need not conform to the internal law
provisions of either treaty country.
As part of its consideration of the proposed treaty, the
Committee asked the Treasury Department about the
appropriateness of the arbitration provision contained in the
proposed treaty. The relevant portion of the October 8, 1997
Treasury Department letter responding to this inquiry is
reproduced below:
Treasury recognizes that there has been little practical
experience with arbitration of tax treaty disputes and this
creates some uncertainty about how well arbitration would work.
For this reason, Treasury does not advocate the inclusion of
arbitration provisions in new treaties. However, if the treaty
partner is strongly interested in an arbitration provision, we
are willing to include such a provision in a new treaty with
the proviso that it cannot be implemented until the treaty
partners have exchanged diplomatic notes to that effect. This
provides the opportunity to wait until more experience has been
gained with arbitration and with the treaty partner before
deciding whether the implementation of such a provision is
desirable.
The Committee continues to believe 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 otherwise may impede efficient administration of
the tax laws. However, the Committee also believes that the
appropriateness of such a clause in a future treaty depends
strongly on the other party to the treaty, and on the
experience that the competent authorities have under the
arbitration provision in the German treaty. The Committee
understands that to date there have been no arbitrations of
competent authority cases under the German treaty, and few tax
arbitrations outside the context of that treaty. The Committee
believes that it is appropriate to have conditioned the
effectiveness of the arbitration provision in the proposed
treaty on subsequent action which should occur only after
review of future developments in this evolving area of
international tax administration.
VII. Budget Impact
The Committee has been informed by the staff of the Joint
Committee on Taxation that the proposed treaty is estimated to
cause a negligible change in fiscal year Federal budget
receipts during the 1998-2007 period.
VIII. Explanation of Proposed Treaty and Proposed Protocol
A detailed, article-by-article explanation of the proposed
treaty between the United States and Switzerland, as
supplemented by the proposed protocol, is presented below. 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.
Article 1. Personal Scope
The personal scope article describes the persons who may
claim the benefits of the proposed treaty. The proposed treaty
generally applies to residents of the United States and
residents of Switzerland. However, other articles of the
proposed treaty provide for specific expansions of this scope
to persons that are residents of neither the United States nor
Switzerland for purposes of such articles (e.g., Article 24
(Non-Discrimination) and Article 26 (Exchange of Information)).
The determination of whether a person is a resident of the
United States or Switzerland is made under the provisions of
Article 4 (Resident).
Like all U.S. income tax treaties, the proposed treaty is
subject to a ``saving clause.'' The saving clause in the
proposed treaty is drafted unilaterally to apply only to the
United States. Under this clause, with specific exceptions
described below, the proposed treaty is not to affect the U.S.
taxation of its residents or its citizens. By reason of this
saving clause, unless otherwise specifically provided in the
proposed treaty, the United States will continue to tax its
citizens who are residents of Switzerland as if the treaty were
not in force. Similarly, the United States will continue to tax
persons that are treated as U.S. residents under U.S. tax law
as if the treaty were not in force, unless such persons are
treated as residents of Switzerland under the treaty tie-
breaker rules governing dual residents provided in Article 4
(Resident). The term ``residents'' includes corporations and
other entities as well as individuals.
The proposed treaty contains a provision under which the
saving clause (and therefore the U.S. jurisdiction to tax)
applies to former U.S. citizens. Under the U.S. model, the
saving clause applies to both former citizens and former long-
term residents. The Code provides special rules for the
imposition of U.S. income tax on former U.S. citizens for a
period of ten years following their loss of U.S. citizenship.
The Health Insurance Portability and Accountability Act of 1996
extended the special income tax rules for former U.S. citizens
to apply also to certain former long-term residents of the
United States. The proposed treaty provision reflects the reach
of the U.S. tax jurisdiction pursuant to these special rules
prior to its extension to former U.S. long-term residents.
Accordingly, the saving clause in the proposed treaty does not
permit the United States to impose tax on former U.S. long-term
residents who otherwise would be subject to the special income
tax rules contained in the Code.
Exceptions to the saving clause are provided for the
following benefits conferred by the United States pursuant to
the proposed treaty: the provision for correlative adjustments
to the profits of an enterprise following an adjustment by
Switzerland of the profits of a related enterprise (Article 9,
paragraph 2); the coordination of the timing of gain
recognition with respect to certain cross-border transactions
(Article 13, paragraphs 6 and 7); the provisions for relief
from double taxation (Article 23); the non-discrimination rules
(Article 24); and the mutual agreement procedures (Article 25).
These exceptions to the saving clause allow the provision of
the enumerated benefits to citizens and residents of the United
States, without regard to U.S. internal law.
In addition, exceptions from the saving clause are provided
for certain benefits conferred by the United States pursuant to
the proposed treaty, but only in the case of an individual who
neither is a U.S. citizen nor has immigrant status in the
United States. Under this rule, the specified benefits under
the proposed treaty are available to an individual who spends
enough time in the United States to be taxed as a U.S. resident
under Code section 7701(b), provided that the individual has
not acquired U.S. immigrant status (i.e., is not a green-card
holder). The following benefits are subject to this rule: the
exemption from U.S. tax on compensation from government service
to Switzerland (Article 19, paragraphs 1 and 2); the exemption
from U.S. tax on certain income received by temporary visitors
who are students or trainees (Article 20); the special rules
applicable to diplomatic agents and consular officers (Article
27); and the exemption from U.S. tax on certain contributions
to a pension or other retirement arrangement (Article 28,
paragraph 4).
Article 2. Taxes Covered
The proposed treaty generally applies to the income taxes
of the United States and Switzerland. As discussed below, the
proposed treaty specifies the particular covered taxes of each
country. However, the non-discrimination rules of Article 24
apply to taxes of all kinds imposed by either country or its
political subdivisions or local authorities.
In the case of Switzerland, the proposed treaty, like the
present treaty, covers the federal, cantonal, and communal
taxes on income. The proposed treaty applies to such income
taxes regardless of whether they are imposed on total income,
earned income, income from property, business profits, or some
other measure of income. The proposed treaty does not cover any
Swiss taxes on capital.
In the case of the United States, the proposed treaty, like
the present treaty, applies to the Federal income taxes imposed
by the Code. The proposed protocol contains a specific
exclusion for U.S. social security taxes (but not for the
income taxes on social security benefits). Like the U.S. model
and the present treaty, but unlike some other U.S. income tax
treaties in force, the proposed treaty applies to the
accumulated earnings tax and the personal holding company tax.
In addition, the proposed treaty applies to the U.S. excise
taxes imposed on insurance premiums paid to foreign insurers
and the U.S. excise tax imposed with respect to private
foundations. The present treaty does not apply to any excise
taxes.
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
either under the proposed treaty or under any other treaty.
Because the insurance excise taxes are covered taxes under the
proposed treaty, Swiss 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 a
Swiss insurer reinsures a policy it has written on a U.S. risk
with a foreign reinsurer that is not entitled to a similar
exemption under this or a different tax treaty. Because the
present treaty does not cover excise taxes, the U.S. insurance
excise taxes may be imposed on Swiss insurers under the present
treaty.
The proposed treaty also contains a provision generally
found in U.S. income tax treaties (including the present
treaty) that applies the treaty to any identical or
substantially similar taxes that either country may
subsequently impose. 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. Unlike the U.S. model, the proposed
treaty does not specifically obligate the competent authorities
to notify each other of significant changes in other laws
affecting their obligations under the proposed treaty or of any
official published material regarding the application of the
proposed treaty.
Article 3. General Definitions
This article provides definitions of terms used in the
proposed treaty that apply for all purposes of the proposed
treaty, unless the context requires otherwise. These
definitions generally are consistent with the definitions
contained in the U.S. model. In addition, certain terms are
defined in the articles in which such terms are used.
The term ``person'' includes an individual, a partnership,
a company, an estate, a trust and any other body of persons. A
``company'' is any body corporate or any entity which is
treated as a body corporate for tax purposes under the laws of
the country in which it is organized.
An ``enterprise of a Contracting State'' is defined as an
enterprise carried on by a resident of that country. Similarly,
an ``enterprise of the other Contracting State'' is defined as
an enterprise carried on by a resident of the other Contracting
State. The proposed treaty does not define the term
``enterprise.'' The Technical Explanation states that it is
understood to mean any activity or set of activities that
constitutes a trade or business.
In the case of the United States, the term ``national''
means U.S. citizens and all legal persons, partnerships, and
associations deriving their status as such from the laws in
force in the United States. In the case of Switzerland, the
term ``national'' means all individuals possessing Swiss
nationality and all legal persons, partnerships, and
associations deriving their status as such from the laws in
force in Switzerland.
The term ``international traffic'' means any transport by a
ship or aircraft, other than transport solely between two
points within the other country. The Technical Explanation
states that transport that constitutes international traffic
includes any portion of the transport that is between two
points within the other country, even if the internal portion
of the transport involves a transfer to a land vehicle or is
handled by an independent contractor (provided that the
original bills of lading include such portion of the
transport).
The Swiss competent authority is the Director of Federal
Tax Administration or his authorized representative. The U.S.
competent authority is the Secretary of the Treasury or his
delegate. In fact, 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) of the IRS. On interpretative issues, the
latter acts with the concurrence of the Associate Chief Counsel
(International) of the IRS.
The term ``Switzerland'' means the Swiss Confederation.
The term ``United States'' means the United States of
America, but does not include Puerto Rico, the Virgin Islands,
Guam or any other U.S. possession or territory.
The proposed treaty also provides that, unless the context
otherwise requires or the competent authorities of the two
countries agree to a common meaning, all terms not defined in
the treaty are to have the meanings which they have under the
tax laws of the country whose tax is being applied. The
Technical Explanation states that a meaning of a term provided
under the tax laws of a country will take precedence over a
meaning of such term under other laws of the country.
Article 4. Resident
The assignment of a country of residence in a treaty is
important because the benefits of the treaty generally are
available only to a resident of one of the treaty countries as
that term is defined in the treaty. Furthermore, double
taxation often is avoided by the assignment of a single treaty
country as the country of residence when, under the internal
laws of the treaty countries, a person is a resident of both.
The present treaty does not include a definition of
``resident.''
Under U.S. law, residence of an individual is important
because a resident alien is taxed on 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 substantial time in the
United States in any year or over a three-year period generally
is treated as a U.S. resident (Code sec. 7701(b)). A permanent
resident for immigration purposes (i.e., a green-card holder)
also is treated as a U.S. resident. Under the Code, a company
is domestic, and therefore taxable on its worldwide income, if
it is organized in the United States or under the laws of the
United States, a State, or the District of Columbia.
The proposed treaty generally defines the term ``resident
of a Contracting State'' to mean any person who, under the laws
of that country, is liable to tax therein by reason of his or
her domicile, residence, nationality, place of management,
place of incorporation, or any other criterion of a similar
nature. Although citizenship is not specified as a criterion of
residence, nationality is so specified and is defined in
Article 3 (General Definitions) to mean citizenship in the case
of the United States.
A U.S. citizen or green-card holder who is not a resident
of Switzerland is treated as a U.S. resident under the proposed
treaty only if the individual has a substantial presence,
permanent home, or habitual abode in the United States. Unlike
under the U.S. model, citizenship alone does not establish
residence. As a result, U.S. citizens residing overseas are not
necessarily entitled to the benefits of the proposed treaty as
U.S. residents. In the case of a U.S. citizen or green-card
holder who is also a resident of Switzerland, such individual's
residence is determined under the treaty tie-breaker rule
described below.
The proposed protocol provides that if a Swiss resident
makes an election to be treated as a U.S. resident in order to
file a joint U.S. income tax return with his or her spouse (who
is a U.S. citizen or resident), such individual will continue
to be treated as a resident of Switzerland, but also will be
subject to tax as a U.S. resident. Accordingly, such an
individual will be treated under the proposed treaty in the
same manner as a U.S. citizen who is a Swiss resident.
The government of a treaty country, a political subdivision
or local authority thereof, or any agency or instrumentality of
such government, subdivision, or authority is considered to be
a resident of that country. The Memorandum of Understanding
provides that it is understood that the term ``government''
includes any body that constitutes a governing authority of a
treaty country or political subdivision, provided that the net
earnings of the governing authority are credited to its own
account or other accounts of the treaty country or political
subdivision and no portion of such net earnings inure to the
benefit of any private person. The Memorandum of Understanding
further provides that the term ``government'' includes a
corporation that is not engaged in commercial activities and
that is wholly owned directly or indirectly by a treaty country
or political subdivision; however, this rule applies only if
the corporation is organized under the laws of the treaty
country or political subdivision, its earnings are credited to
its own account or to an account of the treaty country or
political subdivision, and its assets vest in the treaty
country or political subdivision upon dissolution. Finally, the
Memorandum of Understanding provides that the term
``government'' includes a pension trust of a treaty country or
political subdivision that does not engage in commercial
activities and that is established and operated exclusively to
provide pension benefits to employees or former employees of
the treaty country or political subdivision. This is consistent
with the definition contained in Code section 892.
Special rules apply to treat as residents of a treaty
country certain organizations that generally are exempt from
tax in that country. Under these rules, pension trusts and any
other organizations established in a treaty country and
maintained exclusively to administer or provide pension,
retirement or employee benefits are treated as residents of
such country if they are established or sponsored by a person
resident in such country. Similarly, non-profit organizations
established and maintained in a treaty country for religious,
charitable, educational, scientific, cultural, or other public
purposes are treated as residents of such country.
A special rule also is provided for partnerships, estates
and trusts. A partnership, estate, or trust is treated as a
resident of a treaty country only to the extent that income
derived by such entity is subject to tax, either in the
entity's hands or in the hands of its partners or
beneficiaries, in such country in the same manner as income of
a resident of the country.
The term ``resident of a Contracting State'' does not
include any person who is liable to tax in that country in
respect only of income from sources in that country.
The proposed treaty provides a set of ``tie-breaker'' rules
to determine residence in the case of an individual who, under
the basic residence rules, would be considered to be a resident
of both countries. Such a dual resident 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., the ``center of vital interests''). If the
country in which the individual has his or her center of vital
interests cannot be determined, or if the individual does not
have a permanent home available in either country, such
individual 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, the
individual 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 are to settle the question of residence by mutual
agreement.
In the case of an entity that would be considered to be a
resident of both countries under the basic treaty definition,
the proposed treaty provides that the entity is treated as a
resident of one of the treaty countries only if and to the
extent the competent authorities so agree. If the competent
authorities are unable to reach such an agreement, the entity
generally will be ineligible for benefits under the proposed
treaty. This issue may be submitted for arbitration under the
rules specified in Article 25 (Mutual Agreement Procedure). In
this regard, the proposed treaty is similar to some existing
U.S. treaties, but dissimilar to the U.S. model, which does not
specify that treaty benefits will be denied in cases where the
competent authorities cannot agree.
Under the proposed treaty, an individual who otherwise
would be treated as a Swiss resident will not be so treated for
purposes of the proposed treaty if the individual elects not to
be subject to the generally applicable Swiss income taxes with
respect to all U.S.-source income. This rule applies to alien
residents of Switzerland who elect to be taxed under an
alternative regime available in Switzerland instead of under
the generally-applicable Swiss income tax.
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 amounts are taxed as business profits.
In general, under the proposed treaty, a permanent
establishment is a fixed place of business through which an
enterprise carries on business in whole or in part. A permanent
establishment includes (but is not limited to) a place of
management, a branch, an office, a factory, a workshop, a mine,
an oil or gas well, a quarry, or any other place of extraction
of natural resources. It also includes any building site or
construction or installation project, or an installation or
drilling rig or ship used for the exploration or development of
natural resources, if it lasts for more than 12 months. The
Technical Explanation states that the 12-month test applies
separately to each site or project, but that projects that are
commercially and geographically interdependent are to be
treated as a single project. The Technical Explanation further
states that if the 12-month threshold is exceeded, the site or
project is treated as a permanent establishment from the first
day of activity.
Notwithstanding this general definition of a permanent
establishment, the proposed treaty provides that the following
specified activities do not constitute a permanent
establishment: the use of facilities solely for storing,
displaying, or delivering goods or merchandise belonging to the
enterprise; 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; the
maintenance of a fixed place of business solely for the
purchase of goods or merchandise or the collection of
information for the enterprise; the maintenance of a fixed
place of business solely for the purpose of carrying on, for
the enterprise, advertising, the supply of information,
scientific research, or other activities of a preparatory or
auxiliary character. The proposed treaty provides that the
maintenance of a fixed place of business solely for any
combination of these activities does not constitute a permanent
establishment, provided that the overall activity resulting
from such combination is of a preparatory or auxiliary
character. In contrast, the U.S. model provides that such a
combination of activities does not give rise to a permanent
establishment without regard to whether the combination is of a
preparatory or auxiliary character.
If a person, other than an independent agent, is acting on
behalf of an enterprise and has and habitually exercises in a
country the authority to conclude contracts in the name of an
enterprise, the enterprise generally will be deemed to have a
permanent establishment in that country in respect of any
activities that person undertakes for the enterprise. This rule
does not apply where the activities of such person is limited
to those activities described above, such as storage, display,
or delivery of merchandise, which do not constitute a permanent
establishment.
The proposed treaty further provides that no permanent
establishment is deemed to arise based on an agent's activities
if the agent is a broker, general commission agent, or any
other agent of independent status acting in the ordinary course
of its business. The Technical Explanation states that an
independent agent is one that is both legally and economically
independent of the enterprise. Whether an agent and an
enterprise are independent depends on the facts and
circumstances of the particular case.
The fact that a company that is resident in one country
controls or is controlled by a company that is a resident of
the other country, or that carries on business in that other
country, does not of itself cause either company to be a
permanent establishment of the other.
Article 6. Income from Real Property
This article covers income, but not gains, from real
property. The rules covering gains from the sale of real
property are contained in Article 14 (Gains).
Under the proposed treaty, income derived by a resident of
one country from real property situated in the other country
may be taxed in the country where the real property is
situated. Income from real property includes income from
agriculture or forestry. The country in which the real property
is situated is not, however, granted an exclusive right to tax
the income derived from the real property; such income also may
be taxed in the recipient's country of residence.
The term ``real property'' generally has the meaning that
it has under the law of the country in which the property in
question is situated. In the case of the United States, the
term ``real property'' is defined in Treas. Reg. sec. 1.897-
1(b). However, like the OECD model, the proposed treaty
specifies that the term includes property accessory to real
property, livestock and equipment used in agriculture and
forestry, rights with respect to which the law of landed
property applies, usufruct of real property, and rights to
payment with respect to the working of mineral deposits and
other natural resources. The proposed treaty further specifies
that ships and aircraft do not constitute real property.
The country in which real property is situated may tax
income derived from the direct use, letting, or use in any
other form of such property. The rules of this article allowing
source-country taxation also apply to income from real property
of an enterprise and to income from real property used for the
performance of independent personal services. Accordingly,
income from real property may be taxed by the country in which
it is situated even though such income is not attributable to a
permanent establishment or fixed base in such country.
The proposed treaty provides residents of a country that
are taxable in the other country on income from real property
situated in the other country with an election, subject to the
procedures of the domestic law of the country in which the
property is situated, to be taxed by the other country on such
income on a net basis as if such income were attributable to a
permanent establishment or fixed base. Such election is binding
for taxable years as provided by the domestic law of the
country in which the property is located. U.S. internal law
provides such a net-basis election in the case of income of a
foreign person from U.S. real property (Code secs. 871(d) and
882(d)).
Article 7. Business Profits
U.S. internal law
U.S. law distinguishes between the U.S. business income and
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. 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, and rents) 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.
Foreign-source income generally is treated as 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 in the case of insurance
companies.
Any income or gain of a foreign person for any taxable year
that is attributable to a transaction in another taxable 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 taxable year (Code sec.
864(c)(6)).
Proposed treaty limitations on internal law
Under the proposed treaty, business profits of an
enterprise of one country 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.
The taxation of business profits under the proposed treaty
differs from U.S. rules for taxing business profits primarily
by requiring more than merely being engaged in a trade or
business before a country can tax business profits and by
substituting an ``attributable to'' standard for the Code's
``effectively connected'' standard. Under the Code, all that is
necessary for effectively connected business profits to be
taxed is that a trade or business be carried on in the United
States.
The present treaty provides that if a Swiss enterprise has
a permanent establishment in the United States, the United
States may tax all the U.S.-source income of the permanent
establishment. The proposed treaty eliminates this ``force of
attraction'' rule. On the other hand, unlike the present
treaty, the proposed treaty permits the United States to tax
certain non-U.S.-source income of a permanent establishment of
a Swiss enterprise.
Under the proposed treaty, the business profits of a
permanent establishment are determined on an arm's-length
basis. The proposed treaty provides that the business profits
attributed to a permanent establishment are determined based on
the profits it would make if it were a distinct and independent
enterprise engaged in the same or similar activities under the
same or similar conditions. The proposed treaty further
provides that the business profits to be attributed to the
permanent establishment include only the profits derived from
the assets or activities of the permanent establishment. The
proposed treaty is consistent with the U.S. model and other
existing U.S. treaties in this respect. Amounts may be
attributed to the permanent establishment whether they are from
sources within or without the country in which the permanent
establishment is located.
The Memorandum of Understanding specifically addresses the
attribution of profits to a permanent establishment in the case
of contracts for the survey, supply, installation, or
construction of public works or industrial, commercial, or
scientific equipment or premises. The profits attributable to
the permanent establishment are determined on the basis only of
the portion of such a contract that is effectively carried out
by the permanent establishment and not on the basis of the
total amount of the contract. The profits attributable to the
portion of the contract carried out by the enterprise's head
office are not taxable in the country in which the permanent
establishment is situated.
In computing business profits, the proposed treaty provides
that deductions are allowed for expenses incurred for the
purposes of the permanent establishment. These deductions
include a reasonable allocation of executive and general
administrative expenses, research and development expenses,
interest, and other expenses incurred for the purposes of the
enterprise as a whole (or the part of the enterprise that
includes the permanent establishment). This rule applies
without regard to where such expenses are incurred. According
to the Technical Explanation, it is expected that each country
will use its own expense allocation rules. This rule permits
the United States to use its current expense allocation rules
in determining deductible amounts. Thus, for example, a Swiss
company which has a permanent establishment in the United
States but which has its head office in Switzerland will, in
computing the U.S. tax liability of the permanent
establishment, be entitled to deduct a portion of the executive
and general administrative expenses incurred in Switzerland by
the head office for purposes of operating the U.S. permanent
establishment, allocated and apportioned in accordance with
Treas. Reg. section 1.861-8.
Like the OECD model, the proposed treaty provides that a
country may determine the business profits attributed to a
permanent establishment on the basis of an apportionment of the
total profits of the enterprise. If it is customary in a
country to use a total profits apportionment method, such
method may be used pursuant to the proposed treaty, provided
that the method of apportionment gives results that are
consistent with the arm's-length principle of this article.
This rule is not specified in the U.S. model; however, the
provisions of the U.S. model permit the use of a total profits
apportionment method as a means of determining arm's-length
profits. The Technical Explanation states that methods other
than separate accounting may be used to estimate the arm's-
length profits of a permanent establishment, provided that the
method approximates the results that would be achieved under a
separate accounting approach.
Business profits are not attributed to a permanent
establishment merely by reason of the purchase of goods or
merchandise by a 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 the profit element with respect to its purchasing
activities.
The proposed treaty provides that the amount of profits
attributable to a permanent establishment must be determined by
the same method each year unless there is good and sufficient
reason to change the method.
Where business profits include items of income which are
dealt with separately in other articles of the treaty, those
other articles, and not the business profits article, govern
the treatment of such items of income. Thus, for example,
profits attributable to a U.S. ticket office of a Swiss airline
generally are exempt from U.S. Federal income tax under the
provisions of Article 8 (Shipping and Air Transport). This rule
does not apply, however, where the other article specifically
provides that this article takes precedence (e.g., Article 10
specifically provides that dividends attributable to a
permanent establishment are taxable as business profits).
Unlike the U.S. model, the proposed treaty does not contain
a general definition of ``business profits.'' The Technical
Explanation states that such term should be read to include all
income derived from any trade or business. The proposed treaty
specifies that the term ``business profits'' includes income
derived from the rental of tangible movable property and the
rental or licensing of cinematographic films or works on film,
tape, or other means of reproduction for use in radio or
television broadcasting. Accordingly, such income may be taxed
in the source- country only if the income is attributable to a
permanent establishment. The Technical Explanation states that
the term ``business profits'' is understood to include income
attributable to notional principal contracts and other
financial instruments to the extent such income is related to a
trade or business carried on through the permanent
establishment.
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 sale of ships and aircraft
operated in international traffic are contained in Article 13
(Gains).
Under the proposed treaty, 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'' means any transport by
a ship or aircraft except when such transport is operated
solely between places in a treaty country (Article 3(1)(e)
(General Definitions)). Unlike the exemption provided in the
present treaty, the exemption in the proposed treaty applies
whether or not the ships or aircraft are registered in the
first country.
The Technical Explanation states that income from the
rental of ships or aircraft on a full basis for use in
international traffic constitutes income from the operation of
ships and aircraft in international traffic. Such income
therefore is exempt from tax in the other country. In addition
the proposed treaty provides that income from the operation of
ships or aircraft in international traffic includes profits
derived from the rental of ships or aircraft if such rental
profits are incidental to profits from the operation of ships
or aircraft in international traffic. This rule applies to
leases on a bareboat basis. Unlike under the U.S. model, the
exemption from tax under the proposed treaty does not apply to
a bareboat lessor (such as a financial institution or a leasing
company) that does not operate ships or aircraft in
international traffic, but that leases ships or aircraft for
use in international traffic. In such a case, the rental income
constitutes business profits and is subject to tax in the
source-country if it is attributable to a permanent
establishment. The Technical Explanation states that it is
understood that such rental income will not be considered to be
attributable to a permanent establishment unless the permanent
establishment was involved in negotiating or concluding the
lease agreement.
Unlike the U.S. model, the proposed treaty does not address
the treatment of containers. Under the U.S. model, income
derived by an enterprise of one country from the use,
maintenance, or rental of containers (including trailers,
barges, and related equipment for the transport of containers)
used in international traffic is taxable only in that country.
Under the proposed treaty, such income constitutes business
profits and is taxable under the provisions of Article 7.
As under the U.S. model, the shipping and air transport
provisions of the proposed treaty also apply to profits from
participation in a pool, joint business, or international
operating agency. This rule covers profits derived pursuant to
an arrangement for international cooperation between carriers
in shipping and air transport.
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 determine the profits
taxable by that country in the case of transactions between
related enterprises, if the profits of an enterprise do not
reflect the conditions which would have been made between
independent enterprises.
The redetermination rules of the proposed treaty apply
where an enterprise of one country participates directly or
indirectly in the management, control, or capital of an
enterprise of the other country or the same persons participate
directly or indirectly in the management, control, or capital
of such enterprises. In such cases, if conditions between the
two enterprises in their commercial or financial relations
differ from those which would be made between independent
enterprises, then any profits which would have accrued to one
of the enterprises but for these conditions may be included in
the profits of such enterprise and taxed accordingly. This
provision allows a country to adjust the income or loss of one
or both of the enterprises if they have entered into non-arm's-
length transactions.
The Technical Explanation states that it is understood that
this provision does not limit the rights of the respective
countries to apply their internal intercompany pricing rules
(e.g., Code sec. 482, in the case of the United States),
provided that such rules are in accord with the arm's-length
principle. The Technical Explanation also states that it is
understood that the U.S. ``commensurate with income'' standard
for determining appropriate transfer prices for intangibles was
designed to operate consistently with the arm's-length
standard. Finally, the Technical Explanation states that this
rule permits adjustments to address thin capitalization issues.
Under the proposed treaty, where a country proposes to tax
as profits of an enterprise profits on which an enterprise of
the country has been taxed in such other country, the competent
authorities of the countries may consult pursuant to the mutual
agreement procedure (Article 25). If the competent authorities
agree on adjustments to the profits of each such enterprise
reflecting the conditions which would have been made between
independent enterprises, each country will make the agreed
adjustment to the tax on the profits on each enterprise. To
avoid double taxation, the proposed treaty's saving clause
retaining full taxing U.S. jurisdiction over U.S. citizens and
residents does not apply to prevent such correlative
adjustments.
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 as 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.
Dividends paid by a U.S. corporation generally are U.S.-
source income. Also treated as U.S.-source income 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
further 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 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 particular, in order to qualify as a
REIT, the REIT must distribute the bulk of its income on a
current basis. Thus, a REIT is treated, in essence, as a
conduit for federal income tax purposes: generally no tax is
imposed at the entity level and the shareholders are taxed on a
current basis on the REIT's earnings. Because a REIT in form is
taxable as a U.S. corporation, a distribution of its earnings
is treated as a dividend rather than as 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 real estate 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: generally no tax is imposed at
the entity level and the shareholders are taxed on a current
basis on the RIC's earnings. 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,'' which
is a measure of the accumulated U.S. effectively connected
earnings of the corporation that are removed in any year from
its U.S. trade or business. The dividend equivalent amount is
limited by (among other things) the foreign corporation's
aggregate earnings and profits accumulated in taxable years
beginning after December 31, 1986. The Code provides that no
U.S. treaty shall exempt any foreign corporation from the
branch profits tax (or reduce the amount thereof) unless the
foreign corporation is a ``qualified resident'' of the treaty
country. The definition of a ``qualified resident'' under U.S.
internal law is somewhat similar to the definition of a
corporation eligible for benefits under the proposed treaty
(discussed below in connection with Article 22 (Limitation on
Benefits)).
Switzerland
Switzerland generally imposes a withholding tax on profit
distributions from Swiss corporations at a rate of 35 percent.
For this purpose, profit distributions generally include
dividends, liquidation proceeds, and hidden profits
distributions.
Profits of a branch in Switzerland generally are subject to
Swiss income tax. However, Switzerland does not impose a
withholding tax on branch profits.
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
corporation controlling (directly or indirectly) at least 95
percent of the voting power of the payor and not more than 25
percent of the gross income of the payor is derived from
interest and dividends (other than interest and dividends
received from the payor's subsidiaries). This 5-percent rate
does not apply if the relationship between the dividend-paying
corporation and the dividend-receiving corporation was arranged
or maintained primarily with the intention of qualifying for
such rate.
Under the proposed treaty, dividends beneficially owned by
a resident of one country may be taxed by the residence country
without limitation. In addition, such dividends also may be
taxed in the country in which such dividends arise. However,
source-country taxation is subject to limitations if the
beneficial owner of the dividends is a resident of the other
country. Under these limitations, source-country tax is limited
to 5 percent of the gross amount of the dividends if the
beneficial owner is a company that holds directly at least 10
percent of the voting stock of the payor company. Relative to
the present treaty, the proposed treaty represents a
significant liberalization of the conditions under which the 5-
percent rate applies. Under the proposed treaty, source-country
tax generally is limited to 15 percent of the gross amount of
the dividends 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 provides that the 15-percent limitation
(and not the 5-percent limitation) applies to dividends paid by
a RIC. The proposed treaty provides that the 15-percent
limitation applies to dividends paid by a REIT to an individual
owning a less than 10-percent interest in the REIT. There is no
limitation in the proposed treaty on the tax that may be
imposed by the United States on a REIT dividend, if the
beneficial owner of the dividend is either an individual
holding a 10 percent or greater interest in the REIT or is not
an individual. Thus, such a dividend is taxable at the 30-
percent United States statutory rate. The present treaty does
not include these limitations on the application of the reduced
rates of source-country taxation to dividends from RICs and
REITs.
The proposed treaty provides an exemption from source-
country tax in the case of dividends beneficially owned by a
resident of the other country that is a qualifying pension or
other retirement arrangement and that does not control the
dividend-paying company. This rule applies to a pension or
other retirement arrangement that has been determined by the
competent authority to generally correspond to a pension or
other retirement arrangement recognized for tax purposes by the
source-country. The Technical Explanation states that
individual savings plans (such as individual retirement
accounts) are not pension or other retirement arrangements for
this purpose.
Like the U.S. model, the proposed treaty defines
``dividends'' as income from shares or other rights, not
constituting debt-claims, that participate in profits.
Dividends also include income subjected to the same tax
treatment as income from shares under the law of the country in
which the income arises. The proposed protocol provides that
participation in the profits of the obligor is a factor in
determining whether an instrument characterized as a debt-claim
should be treated as equity for purposes of the proposed
treaty.
The proposed treaty's reduced rates of tax on dividends do
not apply if the beneficial owner of the dividend carries on
business through a permanent establishment (or a fixed base, in
the case of an individual who performs independent personal
services) in the source-country and the dividends are
attributable to the permanent establishment (or fixed base).
Such dividends are taxed as business profits (Article 7) or as
income from the performance of independent personal services
(Article 14). In addition, dividends attributable to a
permanent establishment or fixed base, but received after the
permanent establishment or fixed base is no longer in
existence, are taxable in the country where the permanent
establishment or fixed base existed (Article 28, paragraph 3).
The proposed treaty contains a general limitation on the
taxation by one country of dividends paid by companies that are
residents of the other country. Under this provision, a country
may not, except in two cases, impose any taxes on dividends
paid by a company resident in the other country that derives
profits or income from the first country. The first exception
is the case where the dividends are paid to residents of the
first country. The second exception is the case where the
dividends are attributable to a permanent establishment or a
fixed base in the first country.
The proposed treaty allows the United States to impose the
branch profits tax on a Swiss resident corporation that either
has a permanent establishment in the United States or is
subject to tax on a net basis in the United States on income
from real property or gains from the disposition of real
property interests. In cases where a Swiss corporation conducts
a trade or business in the United States, but not through a
permanent establishment, the proposed treaty generally
eliminates the branch profits tax that the Code imposes on such
corporation.
In general, the proposed treaty provides that the branch
profits tax may be imposed by the United States only on the
business profits of the Swiss corporation that are attributable
to its U.S. permanent establishment and the income that is
subject to tax on a net basis as income or gains from real
property. The tax is further limited to such amounts that are
included in the ``dividend equivalent amount,'' as that term is
defined under the Code and as it may be amended from time to
time without changing the general principle thereof. The
proposed protocol specifies that the general principle of the
``dividend equivalent amount'' is to approximate the portion of
the specified income that is comparable to the amount that
would be distributed as a dividend if such income were earned
by a U.S. subsidiary. The foreign corporation's dividend
equivalent amount is equal to the after-tax earnings
attributable to the specified income, reduced by any increase
in the corporation's net investment in U.S. assets or increased
by any reduction in the corporation's net investment in U.S.
assets.
The proposed treaty limits the rate of the U.S. branch
profits tax to the direct investment dividend tax rate of 5
percent.
Article 11. Interest
Internal taxation rules
United States
Subject to numerous exceptions (such as those for portfolio
interest, bank deposit interest, and short-term original issue
discount), the United States imposes a 30-percent 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 to a foreign person 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 a 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 and that (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 is inapplicable 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
in turn 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.
Switzerland
Switzerland generally imposes a withholding tax on interest
derived from deposits with Swiss banks and bonds from Swiss
debtors at a rate of 35 percent. Switzerland generally does not
impose a withholding tax on interest on intercompany loans.
Proposed treaty limitations on internal law
The proposed treaty generally exempts interest derived and
beneficially owned by a resident of one country from tax in the
other country. The present treaty allows source-country tax at
a maximum rate of 5 percent on interest derived by a resident
of the other country.
The treaty defines the term ``interest'' generally as
income from debt claims of every kind, whether or not secured
by mortgage. In particular, it includes income from government
securities and from bonds or debentures, including premiums and
prizes attaching to such securities, bonds, or debentures. The
term `` interest'' includes an excess inclusion with respect to
a residual interest in a REMIC. Interest does not include
income covered in Article 10 (Dividends). Penalty charges for
late payment also are not treated as interest. The proposed
protocol provides that participation in the profits of the
obligor is a factor in determining whether an instrument
characterized as a debt claim should be treated as equity for
purposes of the proposed treaty.
This exemption from source-country tax does not apply if
the beneficial owner of the interest carries on business
through a permanent establishment (or a fixed base, in the case
of an individual who performs independent personal services) in
the source-country and the interest paid is attributable to the
permanent establishment (or fixed base). In that event, the
interest is taxed as business profits (Article 7) or income
from the performance of independent personal services (Article
14). In addition, interest attributable to a permanent
establishment or fixed base, but received after the permanent
establishment or fixed base is no longer in existence, is
taxable in the country where the permanent establishment or
fixed base existed (Article 28, paragraph 3).
The proposed treaty addresses the issue of non-arm's-length
interest charges between related parties (or parties having an
otherwise special relationship) by stating that this article
applies only to the amount of arm's-length interest. Any amount
of interest paid in excess of the arm's-length interest is
taxable according to the laws of each country, taking into
account the other provisions of the proposed treaty. For
example, excess interest paid to a parent corporation may be
treated as a dividend under local law and, thus, entitled to
the benefits of Article 10 (Dividends).
The proposed treaty limits the right of one country to tax
interest paid by a company that is resident in the other
country. The first country may tax interest payments only if
the interest is paid by a permanent establishment in that
country or is paid out of income or gain from real property
that is subject to net-basis taxation in that country. This
rule allows the United States to impose tax on certain interest
payments made by a Swiss company; however, because of the
general rule providing for exclusive residence-country
taxation, this rule does not allow the United States to tax
such interest payments if made to Swiss residents.
Like the U.S. model, the proposed treaty includes two
limitations on the application of the exemption in the case of
United States. First, the exemption does not apply to interest
arising in the United States if the amount of such interest is
determined by reference to receipts, sales, income, profits, or
other cash flow of the debtor or a related person, to any
change in the value of property of the debtor or a related
person, or to any dividend, partnership distribution or similar
payment by the debtor or similar person. However, this rule
applies only to the extent that such interest is excluded from
the definition of portfolio interest under the Code. Second,
the exemption does not apply to an excess exclusion with
respect to a residual interest in a REMIC. Amounts covered by
these two exceptions may be taxed by the United States under
the proposed treaty at the full statutory rate of 30 percent.
Article 12. Royalties
Internal taxation rules
Under the same system that applies to dividends and
interest, the United States imposes a 30-percent tax on U.S.-
source royalties paid to foreign persons and on gains from the
disposition of certain intangible property to the extent that
such gains are from payments contingent on the productivity,
use, or disposition of the intangible property. Royalties are
from U.S. sources if they are for the use of property located
in the United States. U.S.-source royalties include royalties
for the use of, or the right to use, intangible property in the
United States. Switzerland does not impose a withholding tax on
royalties.
Proposed treaty limitations on internal law
The proposed treaty provides that royalties derived and
beneficially owned by a resident of a treaty country may be
taxed only by the residence country. Thus, the proposed treaty
generally continues the rule of the present treaty that exempts
U.S.-source royalties paid to Swiss residents from the 30-
percent U.S. tax. This exemption is similar to that provided in
the U.S. model.
Royalties are defined as payments of any kind received as
consideration for the use of or the right to use any copyright
of literary, artistic, or scientific work; for the use of or
right to use any patent, trademark, design or model, plan,
secret formula or process, or other like right or property; or
for information concerning industrial, commercial or scientific
experience. The term ``royalties'' also includes gains from the
alienation of any property described above which are contingent
on the productivity, use, or disposition of the property.
Unlike the U.S. model, the proposed treaty specifically
excludes from the definition of royalties payments for the
right to use motion pictures or films, tapes, or other means of
reproduction for use in radio or television broadcasting. Under
the proposed treaty, such payments are specifically treated as
business profits (Article 7). Such amounts are taxable by the
source-country on a net basis if such payments are attributable
to a permanent establishment.
Unlike the U.S. model, the proposed treaty does not include
an explicit reference to computer software in the definition of
royalties. The Technical Explanation states that consideration
for the use of software is treated as royalties or business
profits, depending on the facts and circumstances of the
transaction. In this regard, the Technical Explanation further
states that it is understood that payments for transfers of
``shrink-wrap'' computer software constitute business profits
rather than royalties.
The exemption under the proposed treaty does not apply
where the beneficial owner carries on business through a
permanent establishment (or a fixed base, in the case of an
individual who performs independent personal services) in the
source-country and the royalties are attributable to the
permanent establishment (or fixed base). In that event, such
royalties are taxed as business profits (Article 7) or income
from the performance of personal services (Article 14). In
addition, royalties attributable to a permanent establishment
or fixed base, but received after the permanent establishment
or fixed base is no longer in existence, are taxable in the
country where the permanent establishment or fixed base existed
(Article 28, paragraph 3).
The proposed treaty addresses the issue of non-arm's-length
royalties between related parties (or parties having an
otherwise special relationship) by stating that this article
applies only to the amount of arm's-length royalties. Any
amount of royalties paid in excess of the arm's-length royalty
is taxable according to the laws of each country, taking into
account the other provisions of the proposed treaty. For
example, excess royalties paid to a parent corporation by its
subsidiary may be treated as a dividend under local law and,
thus, entitled to the benefits of Article 10 of the proposed
treaty.
Article 13. Gains
Internal taxation rules
United States
Generally, gain realized by a nonresident alien individual
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.
However, a nonresident alien individual 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 other than solely
as a creditor (e.g., stock) in certain corporations that hold
or held U.S. real property, provided that at least 50 percent
of the fair market value of such corporation is (or was)
attributable to U.S. real property interests.
Switzerland
Under Swiss law, gains from the sale of a capital asset by
a foreign corporation may be taxed in the same manner as other
business income. In addition, gains from the sale of Swiss real
estate by a foreign individual may be subject to tax in
Switzerland.
Proposed treaty limitations on internal law
Under the proposed treaty, gains derived by a resident of
one country attributable to the alienation of real property
situated in the other country may be taxed in the other
country. Real property situated in the other country for
purposes of this article includes real property referred to in
Article 6 (Income from Real Property); shares or other
comparable rights in a company resident in the other country,
the assets of which consist wholly or principally of real
property in such other country; and an interest in a
partnership, trust, or estate, to the extent attributable to
real property situated in such other state. The proposed treaty
specifies that real property includes a United States real
property interest, as defined under the Code (as it may be
amended from time to time without changing the general
principles thereof). The Technical Explanation states that
distributions by a REIT that are attributable to gains derived
from a disposition of real property are taxable under this
article (and are not taxable under the dividends article
(Article 10)).
The proposed treaty contains a standard provision which
permits a country to tax the gain from the alienation of
movable property that forms part of the business property of a
permanent establishment located in that country or that
pertains to a fixed base in that country. This rule also
applies to gains from the alienation of such a permanent
establishment or such a fixed base. The proposed treaty
generally does not permit the United States to tax gains from
the disposition of any movable property after such property
ceases to be used in a U.S. trade or business. However, gains
attributable to a permanent establishment or a fixed base, but
received after the permanent establishment or fixed base is no
longer in existence, are taxable in the country where the
permanent establishment or fixed base existed (Article 28,
paragraph 3).
The proposed treaty provides that gains of an enterprise of
one of the treaty countries from the alienation of ships or
aircraft operated in international traffic are taxable only in
that country. This rule applies even if such gain is
attributable to a permanent establishment in the other country.
Unlike under the U.S. model, this exemption under the proposed
treaty does not apply to gain from the alienation of containers
used in international traffic. The proposed treaty further
provides that gains described in the royalties article (Article
12) are taxable only in accordance with that article.
The proposed treaty provides that gains from the alienation
of any property other than that discussed above are taxable
under the proposed treaty only in the country of residence.
The proposed treaty provides authority for the competent
authorities to coordinate the two countries' rules regarding
the nonrecognition of income upon a corporate organization,
reorganization, merger, or similar transaction. Where a
resident of one country alienates property in such a
transaction and does not recognize income on such transaction
for purposes of such country's tax, the competent authority of
the other country, if requested by the acquiror of such
property, may agree to defer recognition of income for purposes
of the other country's tax. Any such deferral would be for such
time and subject to such terms and conditions as may be
stipulated in the agreement. The Technical Explanation states
that whether any deferral is granted by the competent authority
is entirely within the discretion of the competent authority.
The proposed treaty provides an additional rule regarding
the coordination of the timing of income recognition under the
two tax systems. This rule applies if a resident of one country
who is subject to tax in both countries on a disposition of
property is taxable currently on such disposition in one
country but not the other country. In such a case, the resident
may elect to be taxed in the country that would otherwise allow
deferral as if he or she had sold and repurchased the property,
immediately before the disposition, for an amount equal to its
fair market value. Such an election will apply for the taxable
year in which made and any time thereafter.
Article 14. Independent Personal Services
Internal taxation rules
United States
The United States taxes the income of a nonresident alien
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 the conduct of a trade
or business within the United States.
Under the Code, the income of a nonresident alien 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: (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.
Switzerland
Nonresident alien individuals generally are subject to
Swiss tax on income derived from Swiss sources. Nonresidents
may be subject to Swiss withholding tax on employment income
and, in the case of artists and athletes, income earned from
activities performed in Switzerland.
Proposed treaty limitations on internal law
The proposed treaty limits the right of each country to tax
income from the performance of personal services by a resident
of the other country. Under the proposed treaty (unlike the
present treaty), income from the performance of independent
personal services (i.e., services performed as an independent
contractor, not as an employee) is treated separately from
income from the performance of dependent personal services.
Under the proposed treaty, like under the U.S. model,
income from the performance of independent personal services by
a resident of one country is exempt from tax in the other
country unless the individual performing the services has a
fixed base regularly available to him or her in the second
country for the purpose of performing the activities. In that
case, the nonresidence country may tax only that portion of the
individual's income which is attributable to the fixed base in
such country and that is derived in respect of services
performed in such country. In contrast to the rules applicable
to business profits, income from independent personal services
is taxable in the country in which the fixed base is located
only if such income is derived from services performed in such
country.
The proposed treaty provides that amounts attributable to a
fixed base, but received or incurred after the fixed base is no
longer in existence, may nevertheless be taken into account in
the country in which the fixed base was located (Article 28,
paragraph 3).
Under the proposed treaty, in determining taxable
independent personal services income, the principles of Article
7 (Business Profits) are applicable. According to the Technical
Explanation, the taxpayer may deduct all relevant expenses,
wherever incurred, in computing the net income from independent
personal services subject to tax in the country in which the
fixed base is located.
Article 15. Dependent Personal Services
Under the proposed treaty, wages, salaries, 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 in the other country if
three requirements are met: (1) the individual is present in
the source-country for not more than 183 days in any twelve-
month period beginning or ending during the taxable year
concerned; (2) the individual's employer 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
generally are consistent with the U.S. and OECD models.
In this regard, the Memorandum of Understanding provides
that this rule shall not preclude a country from withholding
tax from such payments according to its domestic law. If, under
this rule, the remuneration is taxable only in the residence
country, the source country will make a refund of the withheld
tax upon a duly filed claim. Such claims must be filed within
five years after the close of the year of the withholding. This
procedure is necessary because it may not be possible to know
whether an employee will satisfy the requirements for an
exemption from source-country tax until the close of the year.
The proposed treaty, like the U.S. model, provides that
compensation derived from employment as a member of the regular
complement of a ship or aircraft operated in international
traffic is taxable only in the employee's country of residence.
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
which is a resident of the other country may be taxed in that
other country. Under this rule, the country in which the
company is resident may tax all of the remuneration paid to
non-resident board members, regardless of where the services
are performed. By contrast, under the U.S. model, the country
in which the company is resident may tax only the portion of
the non-resident board member's remuneration that is for
services performed in such country.
Article 17. Artistes and Sportsmen
Like the U.S. and OECD models, the proposed treaty contains
rules that apply to the taxation of income earned by
entertainers (such as theater, motion picture, radio, or
television ``artistes,'' or musicians) and sportsmen. These
rules apply notwithstanding the other provisions dealing with
the taxation of income from personal services (Articles 14 and
15) and business profits (Article 7), and are intended, in
part, to prevent entertainers and sportsmen from using the
proposed treaty to avoid paying any tax on their income earned
in one of the countries.
Under this article of the proposed treaty, one country may
tax an entertainer or sportsman who is a resident of the other
country on the income from his or her personal activities as
such exercised in the first country during any year in which
the gross receipts derived by him or her from such activities,
including reimbursed expenses, exceed $10,000 or its Swiss
franc equivalent. The threshold specified in the U.S. model is
$20,000.
Under the proposed treaty, if a Swiss entertainer
maintained no fixed base in the United States and performed (as
an independent contractor) for one day of a taxable year in the
United States for gross receipts of $2,000, the United States
could not tax that income. If, however, that entertainer's
gross receipts were $30,000, the full $30,000 (less appropriate
deductions) would be subject to U.S. tax. This provision does
not bar the country of residence from also taxing that income
(subject to a foreign tax credit). (See Article 23 (Relief from
Double Taxation.))
The Memorandum of Understanding clarifies that because it
is not possible to know whether the $10,000 (or the Swiss franc
equivalent) is exceeded until the end of the year, the source-
country may subject all payments to an entertainer or sportsman
to withholding and refund any excess amount withheld upon a
duly filed claim. Such claim must be filed within five years.
According to the Technical Explanation, this article
applies to all income directly connected with a performance by
an entertainer or sportsman, such as appearance fees, award or
prize money, and a share of the gate receipts. Income derived
by an entertainer or sportsman from other than actual
performance, such as royalties from record sales and payments
for product endorsements, is not covered by this article;
instead, these amounts are covered by other articles of the
proposed treaty, such as Article 12 (Royalties) or Article 14
(Independent Personal Services). For example, if a Swiss
entertainer receives royalty income from the sale of recordings
of a concert given in the United States, the royalty income
will be exempt from U.S. withholding tax under Article 12, even
if the remuneration from the concert itself may have been
covered by this article.
The proposed treaty provides that where income in respect
of activities exercised by an entertainer or sportsman in his
or her capacity as such accrues not to the entertainer or
sportsman but to another person, that income may be taxed by
the country in which the activities are exercised, unless it is
established that neither the entertainer or sportsman nor
persons related to him or her participate directly or
indirectly in the profits of that other person in any manner,
including the receipt of deferred remuneration, bonuses, fees,
dividends, partnership distributions or other distributions.
(This provision applies notwithstanding the business profits
and independent personal service articles (Articles 7 and 14).)
This provision prevents certain entertainers and sportsmen 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 and Annuities
Under the proposed treaty, pensions and other similar
remuneration beneficially derived by a resident of either
country in consideration of past employment generally are
subject to tax only in the recipient's country of residence.
This rule is subject to the provisions of Article 19
(Government Service and Social Security). Thus, for example, it
generally does not apply to pensions paid to a resident of one
treaty country attributable to services performed for
government entities of the other country. The Technical
Explanation states that it is understood that this provision
will apply to both periodic and lump sum payments. The present
treaty similarly provides for exclusive residence-country tax
with respect to pensions, but defines ``pension'' to include
only periodic payments. The Technical Explanation states that
this provision covers amounts paid by all private retirement
plans and arrangements in consideration of past employment,
regardless of whether they are considered qualified plans under
the Code. The Technical Explanation further states that this
provision covers individual retirement accounts.
The proposed treaty provides that annuities may be taxed
only in the country of residence of the person who derives and
beneficially owns them. An annuity is defined as a stated sum
payable periodically at stated times during a specified number
of years or for life, under an obligation to make the payments
in return for adequate and full consideration (other than
services rendered). The present treaty similarly provides
exclusive residence-country taxation for annuities. The U.S.
model defines ``annuity'' to include only amounts paid during a
specified number of years and not amounts paid for life.
Article 19. Government Service and Social Security
Under the proposed treaty, remuneration, other than a
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 in that country only. 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 and the individual is a resident of that
other country who either is a national of that other country or
did not become a resident of that country solely for the
purpose of rendering the services. Thus, for example,
Switzerland will not tax the compensation of a U.S. citizen and
resident who is in Switzerland to perform services for the U.S.
Government, and the United States will not tax the compensation
of a Swiss citizen and resident who performs services for the
U.S. Government in Switzerland.
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 in
that country. However, such pensions are taxable only in the
other country if the individual is both a resident and a
national of that other country.
These rules regarding government remuneration and pensions
are exceptions to the saving clause, pursuant to Article 1,
paragraph 3(b) of the proposed treaty. Consequently, the saving
clause does not apply to benefits conferred by this article to
an individual who is neither a U.S. citizen nor a U.S. green-
card holder. Thus, for example, the United States would not tax
the compensation of a Swiss citizen who is not a U.S. green-
card holder but who resides in the United States to perform
services for the Swiss Government.
If a country or one of its political subdivisions or local
authorities is carrying on a business (as opposed to functions
of a governmental nature), the provisions of Articles 15
(Dependent Personal Services), 16 (Directors' Fees), and 18
(Pensions and Annuities) will apply to remuneration and
pensions for services rendered in connection with such
business.
Under the proposed treaty, social security payments and
other public pensions paid by one country to an individual
resident in the other country may be taxed in the residence
country. \11\ In addition, such payments may be taxed in the
source-country according to the laws of such country, but such
tax may not exceed 15 percent of the gross amount of the
payment. 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 deviation from the U.S.
model is necessary in this case to mitigate the double taxation
of Swiss residents receiving U.S. social security benefits that
arises under the two countries' tax regimes applicable to such
amounts.
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\11\ The proposed protocol provides that the term ``other public
pensions'' is intended to refer to United States tier 1 Railroad
Retirement benefits.
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Article 20. Students and Trainees
The treatment provided to students and trainees under the
proposed treaty corresponds generally to the treatment provided
under the present treaty.
Under the proposed treaty, a student, apprentice, or
business trainee who visits the other country (the host
country) for the purpose of full-time education or training,
and who immediately before that visit is or was a resident of
the other treaty country, is exempt from tax in the host
country on payments that he or she receives for the purpose of
maintenance, education, or training provided that such payments
arise from sources outside the host country. Under the U.S.
model, the corresponding exemption for students and trainees is
available only for a period of one year from the date the
individual first arrives in the host country for the purpose of
training; the proposed treaty does not contain any time
limitation on the availability of the exemption from host-
country tax.
This article is an exception to the saving clause, pursuant
to Article 1, paragraph 3(b) of the proposed treaty.
Consequently, the saving clause does not apply to benefits
conferred by this article to an individual who is neither a
U.S. citizen nor a U.S. green-card holder. Thus, for example,
the United States would not tax such amounts paid to a Swiss
citizen who is not a U.S. green-card holder but who resides in
the United States as a full-time student.
Article 21. 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 Switzerland. This article is
substantially similar to the corresponding article in the U.S.
model.
As a general rule, items of income of a resident of either
country that are not otherwise dealt with in the proposed
treaty are taxable only in the country of residence. This rule,
for example, gives the United States the sole right under the
treaty to tax income derived from sources in a third country
and paid to a resident of the United States. This article is
subject to the saving clause, so U.S. citizens who are Swiss
residents would continue to be taxable by the United States on
their third-country income, with a foreign tax credit provided
for income taxes paid to Switzerland.
The general rule just stated does not apply to income 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 a fixed base and the right or property in
respect of which the income is paid is effectively connected
with such permanent establishment or fixed base. In such a
case, the provisions of Article 7 (Business Profits) or Article
14 (Independent Personal Services), as the case may be, will
apply. In addition, other income attributable to a permanent
establishment or fixed base, but received after the permanent
establishment or fixed base is no longer in existence, is
taxable in the country where the permanent establishment or
fixed base existed (Article 28, paragraph 7). An exception to
this rule is provided for income from real property. Thus, for
example, if a U.S. resident has a Swiss permanent establishment
and the resident derives income from real property located in a
third country that is effectively connected with the Swiss
permanent establishment, under the proposed treaty, only the
United States may tax such income.
Under the proposed treaty, the rule of exclusive residence-
country tax provided in this article does not apply to income
subject to tax in either country on wagering, gambling, or
lottery winnings. Accordingly, each country may tax such
winnings under its internal law. Under the U.S. model, such
winnings are covered by the rule of exclusive residence-country
tax.
Article 22. Limitation on Benefits
In general
The proposed treaty contains a provision generally intended
to limit indirect use of the treaty by persons who are not
entitled to its benefits by reason of residence in the United
States or Switzerland, or in some cases, in another member
country of the European Union or the European Economic Area, or
in a party to NAFTA.
The proposed treaty is intended to limit double taxation
caused by the interaction of the tax systems of the United
States and Switzerland 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 country seeks certain benefits under
the income tax treaty between the two countries. Under certain
circumstances, and without appropriate safeguards, the
nonresident may be able to secure these benefits indirectly by
establishing a corporation (or other entity) in one of the
countries, which entity, as a resident of that country, is
entitled to the benefits of the treaty. Additionally, it may be
possible for a third-country resident to reduce the income base
of a treaty country resident by having the latter pay out
interest, royalties, or other deductible amounts under
favorable conditions either through relaxed tax provisions in
the distributing country or by passing the funds through other
treaty countries (essentially, continuing to treaty shop),
until the funds can be repatriated under favorable terms.
Summary of proposed treaty provisions
The anti-treaty shopping article in the proposed treaty
provides that a treaty country resident is entitled to treaty
benefits in the other country only if it falls within one of
several specified categories. This provision of the proposed
treaty is in some ways comparable to the U.S. Treasury
regulation under the branch tax definition of a qualified
resident. \12\ However, the proposed treaty provides
opportunities for treaty benefit eligibility which are not
provided under that regulation.
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\12\ Treas. Reg. sec. 1.884-5.
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Generally, a resident of either country qualifies for the
benefits accorded by the proposed treaty if such resident falls
within one of the following categories:
(1) An individual;
(2) A government;
(3) An entity that satisfies an active business test with
respect to a particular item of income;
(4) An entity that satisfies a headquarters company test;
(5) A company that satisfies a public company test;
(6) A company, trust or estate that satisfies a predominant
interest test;
(7) A qualified family foundation; or
(8) A qualified pension trust or non-profit organization.
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 derivative benefits test.
Special rules apply to income derived by a resident of
Switzerland in certain ``triangular'' cases described below.
Finally, a treaty country resident is entitled to treaty
benefits if the resident is otherwise approved by the source-
country's competent authority, in the exercise of the latter's
discretion.
The proposed treaty provides that the competent authorities
are to consult with a view to developing a commonly agreed
application of these provisions. Subject to the limitations in
the information exchange article, the competent authorities may
exchange such information as is necessary for carrying out
these provisions.
Individuals
Under the proposed treaty, individual residents of one of
the countries are entitled to all treaty benefits.
Governments
Under the proposed treaty, the two countries, political
subdivisions and local authorities thereof, and agencies or
instrumentalities of such countries, subdivisions or
authorities are entitled to all treaty benefits. The definition
of the term ``government'' contained in the Memorandum of
Understanding for purposes of determining the country of
residence is broader than this concept. This concept does not
include, for example, pension trusts for current and former
employees of a country or political subdivision.
Entities satisfying active trade or business test
In general
Under the active business test, treaty benefits in the
source-country are available under the proposed treaty to an
entity that is a resident of one treaty country if it is
engaged in the active conduct of a trade or business in the
residence country and the income derived from the source-
country is derived in connection with, or is incidental to,
that trade or business. The proposed protocol adds a further
requirement in the case of payments between related parties:
such a payment is treated as derived in connection with a trade
or business only if the trade or business carried on in the
residence country is substantial in relation to the income-
producing activity carried on in the source-country.
This active business test is applied separately to each
item of income. Accordingly, an entity may be eligible for
treaty benefits with respect to some but not all of the income
derived in the source-country. In contrast, satisfaction of the
requirements for any one of the other specified categories
allows treaty benefits for all income derived from the source-
country.
Trade or business
Under the proposed treaty, the active business test is
applied by disregarding the business of making, managing, or
holding investments for the entity's own account, unless these
activities are banking, insurance or securities activities
carried on by a bank, insurance company, or registered
securities dealer, respectively. The Memorandum of
Understanding clarifies that this rule does not affect the
status of investment advisors or others that actively conduct
the business of managing investments beneficially owned by
others.
The proposed protocol provides that the determination
whether activities constitute an active trade or business must
be made under all the facts and circumstances. However, it
further provides that a trade or business generally comprises
activities that constitute an independent economic enterprise
carried on for profit. In order to constitute a trade or
business, a resident's activities ordinarily must include every
operation that is a part of, or a step in, a process by which
an enterprise may earn income or profit. A resident is
considered to actively conduct a trade or business if it
regularly performs active and substantial management and
operational functions through its own officers or employees.
Although some of such activities may be carried out by
independent contractors under the direct control of the
resident, the activities of such independent contractors are
disregarded in determining whether the resident actively
conducts a trade or business.
The Memorandum of Understanding clarifies that the active
conduct of a trade or business may involve the performance of
services as well as manufacturing or sales activities. The
Memorandum of Understanding further clarifies that the resident
itself may be actively conducting a trade or business or it may
be deemed to be so engaged through the activities of related
persons that are residents of one of the countries.
Income derived in connection with a trade or business
Under the proposed treaty, the income eligible for treaty
benefits under this active business test is the income derived
from the source-country in connection with, or incidental to,
the active conduct of a trade or business in the residence
country. The Memorandum of Understanding clarifies that income
is considered derived in connection with an active trade or
business in a country if the income-producing activity in the
other country is a line of business which is part of or is
complementary to the trade or business conducted in the first
country. The line of business in the first country may be
upstream, downstream or parallel to the income-producing
activity in the other country. The Technical Explanation states
that it is intended that a business activity in the source-
country will be considered to form a part of a business
activity 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 states that two activities will be
considered complementary if they are part of the same overall
industry and the success or failure of the two are
interrelated. According to the Technical Explanation, where
more than one business is conducted in the source-country and
only one of such businesses forms a part of or is complementary
to a business conducted in the residence country, the income
attributable to that particular business must be determined for
purposes of applying this test.
The Memorandum of Understanding clarifies that income is
considered to be incidental to the trade or business carried on
in the other country if the production of such income
facilitates the conduct of such trade or business. For example,
interest income earned from the short-term investment of
working capital would be considered to be incidental income.
Substantiality requirement for related party payments
Under the proposed protocol, a payment between related
parties is treated as derived in connection with a trade or
business only if the trade or business carried on in the
residence country is substantial in relation to the income-
producing activity carried on in the other country. For this
purpose, the income recipient is related to the income payor if
it owns, directly or indirectly, at least 10 percent of the
shares or other comparable rights in the payor.
The proposed protocol further provides that
``substantiality'' will be determined based on all the facts
and circumstances, taking into account the following factors:
the comparative sizes of the businesses in each country
(measured based on asset values, income and payroll expenses),
the nature of the activities in each country, and, in cases
where a business is conducted in both countries, the relative
contributions to such business in each country. In making a
determination or comparison, due regard is to be given to the
relative sizes of the Swiss and U.S. economies.
The Memorandum of Understanding clarifies that this
substantiality requirement is intended to prevent treaty-
shopping abuses involving the attempt to qualify for treaty
benefits by engaging in de minimis business activities in the
source-country that have little economic cost or effect with
respect to the business as a whole.
Headquarters companies
Under the proposed treaty, entities that are recognized
headquarters companies for multinational corporate groups are
eligible for treaty benefits. The Technical Explanation states
that the headquarters company need not own shares in the
companies it supervises. For this purpose, an entity is a
recognized corporate headquarters company if it meets the
following seven requirements.
First, the company must provide in its residence country a
substantial portion of the overall supervision and
administration of a group of companies. Such activities may
include group financing, but such financing cannot be the
principal activity. The group of companies so supervised and
administered may be part of a larger multinational corporate
group. Moreover, the Technical Explanation states that the
supervised group is not required to include companies resident
in the other country.
According to the Technical Explanation, while other
activities could be part of the supervision and administration
function, a company will be considered to engage in supervision
and administration only if it engages in some of the following
activities: group financing, pricing, marketing, internal
auditing, internal communications, and management. The
Technical Explanation further states that a company will
satisfy the requirement that it perform a substantial portion
of the overall supervision and administration of a group only
if its supervision and administration activities are
substantial in relation to such activities performed for the
same group by other entities. However, the standard for
``substantial '' is not specified.
Second, the group of companies must include corporations
resident in and engaged in business in at least five countries
and the business activities carried on in each of the five
countries (or five groupings of countries) must generate at
least 10 percent of the gross income of the group. For purposes
of this rule, income from multiple countries may be aggregated
as long as there are at least five individual countries or
groupings that each satisfy the 10-percent requirement. If this
requirement is not satisfied for a particular year, it will be
deemed to be satisfied if it is met based on an averaging of
the gross income of the preceding four years.
Third, the business activities carried on in any single
country other than the headquarters company's country of
residence must generate less than 50 percent of the group's
gross income. If this requirement is not satisfied for a
particular year, it will be deemed to be satisfied if it is met
based on an averaging of the gross income of the preceding four
years.
Fourth, no more than 25 percent of the company's gross
income may be derived from the other country. If this
requirement is not satisfied for a particular year, it will be
deemed to be satisfied if it is met based on an averaging of
the gross income of the preceding four years.
Fifth, the company must have and exercise independent
discretionary authority to carry out the overall supervision
and administration functions. The Technical Explanation states
that this determination is made separately for each function.
Sixth, the company must be subject to generally applicable
tax rules in its residence country. The Technical Explanation
states that this requirement should be understood to mean that
the company must be subject to the tax rules applicable to a
company engaged in the active conduct of a trade or business.
Accordingly, the Technical Explanation states that if the
company is subject to special tax rules applicable to
headquarters companies, it would not be considered to be a
recognized headquarters company.
Seventh, the income derived in the other country must be
derived in connection with, or must be incidental to, the
business activities conducted in other countries. The Technical
Explanation states that this determination is made under the
principles set forth with respect to the active business test.
Public companies
Under the proposed treaty, a company is entitled to treaty
benefits if sufficient shares in the company are traded
actively enough on a suitable stock exchange. This rule is
similar to the branch profits tax rules in the Code under which
a company is entitled to treaty protection from the branch tax
if it meets such a test or if it is the wholly-owned subsidiary
of certain publicly traded corporations resident in a treaty
country.
Publicly traded companies
A company that is a resident of Switzerland or the United
States is entitled to treaty benefits if the principal class of
its shares is primarily and regularly traded on a recognized
stock exchange. Thus, such a company is entitled to the
benefits of the treaty regardless of where its actual owners
reside.
The term ``recognized stock exchange'' means any Swiss
stock exchange on which regular dealings in shares take place;
any stock exchange registered with the Securities and Exchange
Commission as a national securities exchange for the purposes
of the Securities Exchange Act of 1934; the NASDAQ System owned
by the National Association of Securities Dealers; the stock
exchanges of Amsterdam, Frankfurt, London, Milan, Madrid,
Paris, Tokyo and Vienna; and any other stock exchange agreed
upon by the competent authorities of the two countries.
The term ``principal class of shares'' is not defined in
the proposed treaty. However, the Technical Explanation states
it will be interpreted by the United States to mean the class
of shares that represents the majority of the voting power and
value of the company. If no single class of shares accounts for
more than half of the company's voting power and value, then
this test will be applied with respect to a group of two or
more classes of the company's shares that accounts for more
than half of the company's voting power and value. In this
regard, it is necessary only that one such group be primarily
and regularly traded on a recognized stock exchange.
The term ``regularly traded'' also is not defined in the
proposed treaty. This term therefore is defined by reference to
the domestic laws of the country from which benefits are being
sought. The Technical Explanation states that, in the case of
the United States, the term is understood to have the meaning
it has under U.S. internal law: trades in the class of shares
must be made in more than de minimis quantities on at least 60
days during the taxable year and the average number of shares
traded during the year must be at least 10 percent of the
average number of shares outstanding.
The Technical Explanation further states that this
requirement can be met by trading on any one or more of the
recognized stock exchanges.
Subsidiaries of publicly traded companies
A company that is a resident of Switzerland or the United
States is entitled to treaty benefits if the ultimate
beneficial owners of a predominant interest in such company are
one or more companies, the principal classes of the shares of
which are traded as described above. The Technical Explanation
states that this predominant interest requirement will be
interpreted consistently with the predominant interest test
described below. This generally requires a direct or indirect
interest of more than 50 percent. The Memorandum of
Understanding clarifies that a subsidiary that qualifies under
this rule must be a subsidiary of a resident of one of the
countries.
Entities satisfying predominant interest test
Under the proposed treaty, a company, trust, or estate that
is resident in one of the countries is entitled to treaty
benefits unless one or more persons who are not entitled to
benefits are, in the aggregate, the ultimate beneficial owners
of a predominant interest, in the form of a participation or
otherwise, in such entity. The proposed protocol provides that
for this purpose the countries will take into account not only
equity interests that such persons have in the entity but also
other contractual interests such persons have in the entity and
the extent to which such persons receive (or have the right to
receive) directly or indirectly payments from such entity that
reduce the amount of the taxable income of such entity. The
payments referred to include interest and royalties but not
arm's-length payments for services or for the purchase or use
of, or right to use, tangible property in the ordinary course
of business. These payments and interests other than equity
interests are taken into account only to deny benefits to an
entity that would otherwise qualify under this predominant
interest test when equity interests only are taken into
account.
The Technical Explanation states that a predominant
interest is a direct or indirect interest of more than 50
percent. If the persons not entitled to treaty benefits own a
predominant interest in the equity of the entity, the entity is
not entitled to treaty benefits. Only if persons not entitled
to treaty benefits do not own a predominant interest in the
equity of the entity is an inquiry made into the ownership of
payments and interests other than equity.
The Memorandum of Understanding includes a series of
examples illustrating the application of this test.
Swiss family foundations
Under the proposed treaty, a family foundation resident in
Switzerland is entitled to treaty benefits, unless (1) the
founder or the majority of the beneficiaries are not
individuals resident in one of the treaty countries or (2) 50
percent or more of the foundation's income could benefit
persons who are not individuals resident in one of the treaty
countries. The Technical Explanation states that a family
foundation that distributes all its income to U.S. and Swiss
residents would not qualify under this rule if there is no
restriction that would prevent the possibility of a
distribution to other non-qualifying persons.
Tax-exempt organizations
Under the proposed treaty, an entity is entitled to treaty
benefits if it is a pension trust or nonprofit organization
resident in one of the countries provided that more than half
the beneficiaries, members, or participants, if any, in the
organization are persons entitled to benefits under the
proposed treaty (other than under the active business or tax-
exempt organizations tests). This rule applies to organizations
maintained exclusively to administer or provide pensions,
retirement or employee benefits and established by or sponsored
by a resident of such country and to not-for-profit
organizations established and maintained for religious,
charitable, educational, scientific, cultural or other public
purposes, provided that such organization by reason of its
nature as such generally is tax-exempt in its residence
country.
Derivative benefits rule
The proposed treaty contains a reciprocal derivative
benefits rule. This rule effectively allows a Swiss company,
for example, to receive ``derivative benefits'' in the sense
that it derives its entitlement to U.S. tax reductions in part
from the U.S. treaty benefits to which its owners would be
entitled if they earned the income directly. If the
requirements of this rule are satisfied, a company that is
resident in one of the countries will be entitled to the
benefits of the proposed treaty under the dividends, interest,
and royalties articles.
First, the company must satisfy an ownership test. Under
this test, the ultimate beneficial owners of more than 30
percent of the aggregate vote and value of all the company's
shares must be persons that are resident in that country and
that are entitled to benefits under the proposed treaty (other
than under the active business or tax-exempt organizations
tests). The Technical Explanation states that only direct
ownership is taken into account for purposes of this test.
Second, the company must satisfy a derivative benefits
test. Under this test, the ultimate beneficial owners of more
than 70 percent of the aggregate vote and value of all of the
company's shares must be persons that either qualify under the
ownership test or are qualifying persons that are residents of
member states of the European Union or the European Economic
Area or parties to NAFTA. For this purpose, a person is a
qualifying person only if the person (1) is a resident of a
country with which the other country has a comprehensive income
tax treaty and is entitled to all the benefits of such treaty;
(2) would qualify for benefits (other than under the active
business or tax-exempt organizations tests) if the person were
a resident of the first treaty country; and (3) would be
entitled to a rate of tax in the other country under a treaty
between such country and the person's country of residence that
is at least as low as the rate applicable under the proposed
treaty.
Third, the company must satisfy a base reduction test.
Under this test, the deductible expenses paid or payable by the
company for its preceding fiscal period to persons that do not
qualify for treaty benefits must be less than 50 percent of the
company's gross income for the period. If the company's first
fiscal period is at issue, this test is applied based on the
current fiscal period. The term ``gross income'' is not
defined. The Technical Explanation states that, in the case of
the United States, the term will be defined as gross receipts
less cost of goods sold.
Triangular cases
Under present laws and treaties that apply to Swiss
residents, it is possible for profits of a permanent
establishment maintained by a Swiss resident in a third country
to be subject to a very low aggregate rate of Swiss and third-
country income tax. The proposed treaty, in turn, eliminates
the U.S. tax on several specified types of income of a Swiss
resident. In a case where the U.S. income is earned by a third-
country permanent establishment of a Swiss resident (the so-
called ``triangular case'') the proposed treaty could have the
potential of helping Swiss residents to avoid all (or
substantially all) taxation, rather than merely avoiding double
taxation.
The Technical Explanation provides that although the
proposed treaty is drafted reciprocally with respect to this
issue, these rules have no application to the United States
because the United States does not exempt the profits of a U.S.
company attributable to its third-country permanent
establishment.
The proposed treaty includes a special rule designed to
prevent the proposed treaty from reducing or eliminating U.S.
tax on income of a Swiss resident in a case where no other
substantial tax is imposed on that income. Under the special
rule, the United States is permitted to tax dividends,
interest, and royalties paid to the third-country permanent
establishment at the rate of 15 percent. In addition, under the
special rule, the United States is permitted to tax other types
of income without regard to the treaty.
In order for the special rule to apply, three conditions
must be satisfied. First, a Swiss enterprise must derive income
from the United States. Second, such income must be
attributable to a permanent establishment that the Swiss
enterprise has in a third country. Third, the combined Swiss
and third-country taxation of the item of U.S.-source income
earned by the Swiss enterprise with the third-country permanent
establishment must be less than 60 percent of the Swiss tax
that would be imposed if the income were earned by the same
enterprise in Switzerland and were not attributable to the
permanent establishment.
The special rule does not apply to royalties received as
compensation for the use of, or the right to use, intangible
property produced or developed by the third-country permanent
establishment. The special rule also does not apply if the
U.S.-source income is derived in connection with, or is
incidental to, the active conduct of a trade or business
carried on by the permanent establishment in the third country
(other than the business of making, managing or holding
investments for the person's own account unless these
activities are banking, insurance or securities activities
carried on by a bank, insurance company or registered
securities dealer, respectively).
Grant of treaty benefits by the competent authority
Finally, the proposed treaty provides a ``safety-valve''
for a treaty country resident that has not established that it
meets one of the other more objective tests. Under this
provision, such a person may be granted treaty benefits if the
competent authority of the source-country so determines after
consultation with the competent authority of the other country.
The Technical Explanation states that the competent
authority of a country will base its determination on whether
the establishment, acquisition, or maintenance of the person
seeking benefits under the proposed treaty, or the conduct of
such person's operations, has or had as one of its principal
purposes the obtaining of benefits under the treaty. Thus,
persons that establish operations in either the United States
or Switzerland with the principal purposes of obtaining
benefits under the proposed treaty ordinarily will not be
granted such benefits. The Technical Explanation also states
that the competent authorities may determine to grant all, or
partial, benefits of the treaty.
This provision of the proposed treaty is similar to a
portion of the qualified resident definition under the Code
branch tax rules, under which the Secretary of the Treasury
may, in his sole discretion, treat a foreign corporation as a
qualified resident of a foreign country if the corporation
establishes to the satisfaction of the Secretary that it meets
such requirements as the Secretary may establish to ensure that
individuals who are not residents of the foreign country do not
use the treaty between the foreign country and the United
States in a manner inconsistent with the purposes of the Code
rule (sec. 884(d)(4)(D)).
The Memorandum of Understanding sets forth the
understanding that certain companies will be granted treaty
benefits. This understanding applies to a company resident in
one of the countries if two requirements are met. First, the
ultimate beneficial owners of at least 95 percent of the voting
power and value of all its shares must be seven or fewer
persons that are residents of a member state of the European
Union or the European Economic Area or a party to NAFTA that
meet the requirements for the derivative benefits rule. Second,
the company's deductible expenses paid or payable for its
preceding fiscal year to persons that are not residents of a
member state of the European Union or the European Economic
Area or a party to NAFTA that qualify under the derivative
benefits must be less than 50 percent of the company's gross
income for the period.
However, the Memorandum of Understanding further provides
that a company otherwise entitled to benefits pursuant to this
understanding will be denied benefits if the company, or a
company that controls such company, has outstanding a
``disproportionate'' class of shares that is more than 50-
percent (by vote or value) owned by persons that are neither
U.S. citizens nor residents of a member state of the European
Union or the European Economic Area or a party to NAFTA that
qualify under the derivative benefits rule. A disproportionate
class of shares is one with terms or other arrangements that
entitle the holders to a portion of the income derived from the
other country that is greater than the portion such holders
would receive absent such terms or arrangements.
Article 23. Relief from Double Taxation
Internal taxation rules
United States
One of the two 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. The United States seeks unilaterally to mitigate
double taxation by generally allowing U.S. 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 receives a dividend from 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 for the year the
dividend is received.
A fundamental premise of the foreign tax credit is that it
may not offset the U.S. tax on U.S.-source income. Therefore,
the foreign tax credit provisions contain a limitation that
ensures that the foreign tax credit only offsets U.S. tax on
foreign-source income. The foreign tax credit limitation
generally is computed on a worldwide consolidated basis. Hence,
all income taxes paid to all foreign countries are combined to
offset U.S. taxes on all foreign income. The limitation is
computed separately for certain classifications of income
(e.g., passive income and financial services income) in order
to prevent the crediting of foreign taxes on certain high-taxed
foreign-source income against the U.S. tax on certain types of
traditionally low-taxed foreign-source income. Other
limitations may apply in determining the amount of foreign
taxes that may be credited against the U.S. tax liability of a
U.S. taxpayer.
Switzerland
Under Swiss law, relief from double taxation generally is
provided under one of two methods. Under the exemption with
progression method, foreign-source income generally is exempt
from Swiss tax but is taken into account in determining the
Swiss tax rates applicable to other income. Under the deduction
approach, the foreign tax is deducted as an expense and only
the net foreign-source income is subject to Swiss tax. The
deduction method generally applies to dividends, interest and
royalties.
Proposed treaty rules
Overview
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 is engaged in business in both countries.
Also, a corporation or individual may be treated as a resident
of more than one country and may be taxed on a worldwide basis
by both.
The double tax issue is addressed in part 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
Switzerland and the United States would otherwise still tax the
same item of income. This article is not subject to the saving
clause, so that the United States waives its overriding taxing
jurisdiction to the extent that this article applies.
The present treaty provides separate rules for relief from
double taxation for the United States and Switzerland. The
present treaty generally provides for relief from double
taxation of U.S. residents and citizens by requiring the United
States to permit a credit against its tax for taxes paid to
Switzerland. The determination of this credit is made in
accordance with U.S. law. The present treaty generally provides
for relief from double taxation of Swiss residents by requiring
Switzerland to provide, in accordance with Swiss law, an
exclusion for the items of U.S.-source income that are not
exempt from, nor entitled to a reduced rate of, U.S. tax
pursuant to the treaty. In the case of a U.S. citizen resident
in Switzerland, such exclusion applies to all U.S.-source
income. However, Switzerland reserves the right to take income
excluded under these rules into account in determining the rate
of Swiss tax applicable to other income.
Proposed treaty limitations on Swiss internal law
Under the proposed treaty, the relief rules applicable in
the case of Switzerland depend upon the particular type of
income that is subject to U.S. tax. In general, the proposed
treaty requires Switzerland to exempt from its internal tax
income derived by a Swiss resident that is subject to U.S. tax
under the proposed treaty. However, gains from U.S. real
property will be eligible for this exemption only if the Swiss
resident demonstrates that such gains are subject to actual tax
in the United States. Moreover, as under the present treaty,
Switzerland may employ its ``exemption with progression''
method with respect to the income taxed in the United States;
under this method, the exempt income is taken into account for
purposes of determining the rate of Swiss tax applicable to the
remainder of the resident's income.
In the case of dividends that are derived by a Swiss
resident and that are taxable under Article 10 of the proposed
treaty, the proposed treaty provides that Switzerland will
provide relief from its tax upon request. This relief may take
the form of (1) a deduction from the Swiss tax on such
dividends for an amount equal to the U.S. tax imposed in
accordance with Article 10 (Dividends), provided that such
deduction will not exceed the pre-relief portion of the Swiss
tax with respect to the income taxed in the United States, (2)
a lump sum reduction of the Swiss tax, or (3) a partial
exemption from the Swiss tax on such dividends, representing at
least the deduction of the U.S. tax from the gross amount of
the dividends. The applicable relief and procedures are
determined in accordance with Swiss law.
In the case of income derived by a Swiss resident that
represents REIT dividends not eligible for a reduction in U.S.
tax, contingent interest and excess inclusions with respect to
a residual interest in a REMIC not eligible for a reduction in
U.S. tax, and other income taxed in the United States because
it does not qualify for treaty benefits under Article 22
(Limitation on Benefits), Switzerland allows a deduction of the
U.S. tax from the gross amount of such income.
In the case of U.S. social security benefits and other
public pensions derived by a Swiss resident and subject to U.S.
tax, Switzerland will allow a deduction from Swiss taxable
income for an amount equal to the U.S. tax, plus an exemption
from Swiss tax for one-third of the net amount of such payment.
This rule, together with the rules of Article 19 (Government
Service and Social Security), are designed to provide relief
from the double taxation of such U.S. benefits of a Swiss
resident.
Proposed treaty limitations on U.S. internal law
The proposed treaty generally provides that the United
States will allow a U.S. citizen or resident a foreign tax
credit for the taxes imposed by Switzerland. The proposed
treaty also requires the United States to allow a deemed-paid
credit, with respect to Swiss tax, to any U.S. corporate
shareholder of a Swiss company that receives dividends from
such company if the U.S. company owns 10 percent or more of the
voting stock of the Swiss company.
The credit generally is to be computed in accordance with
the provisions and subject to the limitations of U.S. law (as
those provisions and limitations may change from time to time
without changing the general principle of this credit
provision). This provision is similar to those found in the
U.S. model and many other U.S. income tax treaties.
For purposes of applying the U.S. foreign tax credit rules,
Swiss taxes covered by the proposed treaty (Article 2 (Taxes
Covered)) are considered to be income taxes.
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 Swiss residents.
Under this rule, Switzerland will apply the foreign tax credit
relief provisions to a U.S. citizen who is resident in
Switzerland as if the person were not a U.S. citizen (i.e., by
taking into account only the amount of U.S. taxes that would be
paid if he or she were not a U.S. citizen with respect to items
of income that, under the proposed treaty, are either exempt
from U.S. tax or are subject to a reduced rate of tax when
derived by a Swiss resident who is not a U.S. citizen). The
United States will then credit the income tax actually paid to
Switzerland. The proposed treaty recharacterizes the income
that is subject to Swiss taxation as foreign-source income for
purposes of this computation. The result of this computation is
that the ultimate U.S. tax liability of a U.S. citizen who is a
Swiss resident, with respect to an item of income, should not
be less than the tax that would be paid if the individual were
a Swiss resident and not a U.S. citizen.
Article 24. Non-Discrimination
The proposed treaty contains a comprehensive
nondiscrimination article relating to all taxes of every kind
imposed at the national, state, or local level. It is similar
to the nondiscrimination articles in the U.S. model and other
recent U.S. income tax treaties. It is broader than the
nondiscrimination provision of the present treaty.
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 provision applies whether or not the
nationals in question are residents of the United States or
Switzerland. A U.S. national who is not a resident of the
United States and a Swiss national who is not a resident of the
United States are not considered to be in the same
circumstances for U.S. tax purposes.
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 enterprise or resident
carrying on the same activities. However, the proposed treaty
further provides that nothing is this article will be construed
as preventing the United States from imposing a branch profits
tax. Consistent with the U.S. and OECD model treaties, 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
which it grants to its own residents.
Each country is required (subject to the arm's-length
pricing rules of Articles 9 (Associated Enterprises), 11
(Interest), and 12 (Royalties)) to allow enterprises of such
country 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 indicates 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 enterprises. Similarly, any debts of an
enterprise that is a resident of either country to a resident
of the other country must be deductible for the purposes of
determining the taxable capital of the enterprise under the
same conditions as if the debts had been contracted to a
resident of the first country.
The nondiscrimination rule also applies under the proposed
treaty 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 and connected
requirements that the first country imposes or may impose on
its similar enterprises.
U.S. internal law generally treats a corporation that
distributes property to its shareholders as realizing gain or
loss as if the property had been sold. A nonrecognition rule
applies, however, to certain distributions of stock and
securities of a controlled corporation. U.S. internal law also
generally treats a corporation that distributes property in
complete liquidation as realizing gain or loss as if the
property had been sold to the distributee. If, however, 80
percent or more of the stock of the corporation is owned by
another corporation, a nonrecognition rule applies and no gain
or loss is recognized to the liquidating corporation. Special
provisions make these nonrecognition provisions inapplicable if
the distributee is a foreign corporation (Code sec. 367(e)(1)
and (2)). The proposed protocol provides that nothing in this
nondiscrimination article will prevent the United States from
applying Code section 367(e)(1) or (2).
U.S. internal law generally requires a partnership that
engages in a U.S. trade or business to pay a withholding tax
attributable to a foreign partner's share of the effectively-
connected income of the partnership. The withholding tax is not
the final liability of the partner, but is a prepayment of tax
which will be refunded to the extent it exceeds a partner's
final U.S. tax liability. No withholding is required with
respect to a U.S. partner's share of the effectively-connected
income of the partnership. The proposed protocol provides that
nothing in this nondiscrimination article will prevent the
United States from applying section Code 1446.
The saving clause (which allows the United States to tax
its citizens or residents notwithstanding certain treaty
provisions) does not apply to the nondiscrimination article.
Therefore, a U.S. citizen resident in Switzerland 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, which authorizes the competent
authorities of the United States and Switzerland 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 may result in a waiver
(otherwise mandated by the proposed treaty) of U.S. taxing
jurisdiction over its citizens or residents.
Under this article, a resident of one country, who
considers that the actions of one or both of the countries
result, or will result, for him or her in taxation not in
accordance with the proposed treaty, may present the case to
the competent authority of the country of which he or she is a
resident or national. The competent authority will then make a
determination as to whether the objection appears justified. If
the objection appears to be justified and if the competent
authority is not itself able to arrive at a satisfactory
solution, then the competent authority will 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
Technical Explanation states that Swiss law does not permit
competent authority relief if a request for relief is not made
within the 10-year period after the final assessment of Swiss
taxes; the Technical Explanation further states the United
States will use such a 10-year period for accepting competent
authority requests.
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. Like the U.S. model, the proposed treaty makes express
provision for competent authorities to mutually agree on
various issues, including the attribution of income,
deductions, credits, or allowances to a permanent establishment
of an enterprise of a treaty country; the allocation of income,
deductions, credits, or allowances; the characterization of
particular items of income; the characterization of persons;
the application of source rules with respect to particular
items of income; the common meaning of a term; the application
of domestic law with respect to penalties, fines, and interest;
and the elimination of double taxation in cases not provided
for in the treaty. The proposed treaty does not specify, as
does the U.S. model, that the competent authorities may agree
on advance pricing arrangements and increases (where
appropriate in light of economic or monetary developments) in
the dollar thresholds in provisions such as the artistes and
sportsmen article and the students and trainees articles.
The proposed treaty authorizes the competent authorities to
communicate with each other directly for purposes of reaching
an agreement. 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.
Under the proposed treaty, the competent authorities also are
authorized to prescribe procedures to carry out the purposes of
the proposed treaty.
The proposed treaty contains a provision allowing for
arbitration. If any difficulty arising as to the interpretation
or application of the proposed treaty cannot be resolved by the
competent authorities pursuant to the mutual agreement
procedures, the case may be submitted to arbitration. This
procedure applies only if both competent authorities and all
affected taxpayers agree to it and the taxpayers agree in
writing to be bound by the decision of the arbitration board.
The decision of the arbitration board in a particular case will
be binding on both countries with respect to such case. The
proposed treaty provides that the procedures with respect to
arbitration will be established in an exchange of notes between
the two countries. The proposed treaty further provides that
the provisions with respect to arbitration will take effect
only after the two countries have so agreed through an exchange
of notes.
Article 26. Exchange of Information
The proposed treaty provides for the exchange of
information necessary to carry out the provisions of the
proposed treaty or for the prevention of tax fraud or the like
in relation to the taxes covered by the proposed treaty. The
Technical Explanation states that the ``necessary'' standard
requires only that the information be relevant and does not
require that the requesting country demonstrate that it would
be unable to enforce its tax laws without such information.
This ``relevant'' standard is consistent with the parallel
provision in the U.S. model.
Under the proposed treaty, information may be exchanged in
connection with the enforcement of either country's domestic
law only in the case of tax fraud. This means that, except for
exchanges of information to carry out the provisions of the
proposed treaty, information will only be exchanged in the case
of tax fraud. Two special rules apply to exchanges of
information in the case of tax fraud. First, the exchange of
information is not restricted by Article 1 (Personal Scope).
Therefore, third-country residents are covered by these
exchange of information provisions (but only in cases of tax
fraud). Second, where specifically requested by the competent
authority of one country, the competent authority of the other
country shall provide information in the form of authenticated
copies of unedited original documents.
For purposes of this provision, the proposed protocol
provides that ``tax fraud'' means fraudulent conduct that
causes (or is intended to cause) an illegal and substantial
reduction in the amount of tax paid to one of the countries.
Fraudulent conduct will be assumed in cases where, for example,
a taxpayer uses a forged or falsified document or a scheme of
lies to deceive the tax authorities. The proposed protocol
further provides that tax fraud may include acts that, at the
time of a request for information, constitute fraudulent
conduct with respect to which the requested country may obtain
information under its laws or practice. In addition, the
proposed protocol provides that, in determining whether tax
fraud exists in a case involving the conduct of a profession or
business, the requested country will treat the record-keeping
laws of the requesting country as if they were its own
requirements. This means, for example, that if the United
States is contemplating making a request for information from
Switzerland with respect to tax fraud involving a profession or
business, Switzerland would have to apply U.S. recordkeeping
requirements (instead of Swiss recordkeeping requirements) in
determining whether tax fraud existed. The Memorandum of
Understanding states that this definition of tax fraud also is
applicable for purposes of applying other means of mutual
assistance in matters involving tax fraud in order to obtain
assistance, such as the deposition of witnesses.
Any information exchanged is to be 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
assessment, collection, administration, enforcement,
prosecution or determination of appeals with respect to the
taxes covered by the proposed treaty. The information exchanged
may be used only for the purposes stated above. \13\ The
Technical Explanation states that the appropriate committees of
the U.S. Congress and the U.S. General Accounting Office shall
be afforded access to information for use in the performance of
their role in overseeing the administration of U.S. tax laws.
The Memorandum of Understanding clarifies that exchanged
information may be disclosed in public court proceedings or
judicial decisions.
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\13\ 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
this treaty could not be used for these non-tax purposes.
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As is true under the present treaty and the U.S. and OECD
models, under the proposed treaty, a country is not required to
carry out administrative measures at variance with the
regulations and practice of either country or which would be
contrary to its sovereignty, security or public policy, to
supply information which is not obtainable under the laws of
either country, or to supply information which would disclose
any trade, business, industrial, or professional secret or
trade process. The Memorandum of Understanding confirms that
Swiss bank secrecy laws do not hinder the gathering of
documentary evidence from banks or the forwarding of such
evidence under the proposed treaty to the U.S. competent
authority in cases involving tax fraud.
The proposed treaty further provides that the competent
authorities may provide to an arbitration board (established
pursuant to Article 25) such information as is necessary for
the arbitration procedure. However, the limitations on
disclosure contained in this article will apply to the members
of the arbitration board.
The proposed treaty also provides for administrative
cooperation between the two countries in collecting taxes to
the extent necessary to ensure that certain treaty benefits do
not inure to the benefit of persons not entitled to such
benefits. Under the proposed treaty, each country may collect
taxes imposed by the other country as though such taxes were
its own in order to ensure that the exemption or reduced rate
of tax granted by the other state under the dividends,
interest, royalties, and pensions and annuities articles will
not be enjoyed by persons not entitled to such benefits.
Article 27. Members of Diplomatic Missions and Consular Posts
The proposed treaty contains the rule found in other U.S.
tax treaties that its provisions are not to affect the fiscal
privileges of diplomatic agents or consular officials under the
general rules of international law or 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
U.S. residents who are neither U.S. citizens nor green-card
holders. Thus, Swiss diplomats who are considered U.S.
residents generally may be protected from U.S. tax.
The proposed treaty provides that, to the extent that
income is not subject to tax in the receiving country because
of the fiscal privileges granted to diplomatic agents or
consular officers, the right to tax such income is reserved to
the sending country. This provision does not affect the fiscal
privileges provided under international law or special
international agreements but rather modifies the terms
otherwise provided in the proposed treaty in order to prevent
such income from escaping tax in both countries.
The proposed treaty provides a special rule for determining
the country of residence of individuals who are members of a
diplomatic mission, consular post, or permanent mission of one
country located in the other country or in a third country.
Under this rule, for purposes of the proposed treaty, such an
individual will be deemed to be a resident of the sending
country if (1) under international law he or she is not liable
to tax in the receiving country on income from sources outside
that country and (2) he or she is liable in the sending country
to the same obligations with respect to tax on his or her total
income as are residents of that country. Under this rule, a
U.S. diplomat stationed in a third country would be treated as
a U.S. resident for purposes of determining whether he or she
is eligible for reduced rate of, or exemption from, Swiss tax
on Swiss-source income.
The proposed treaty does not apply to international
organizations, organs and officials of such organizations, and
persons who are members of a diplomatic mission, consular post
or permanent mission of a third country present in one of the
treaty countries, if such persons are not treated in either of
the treaty countries as residents for purposes of the country's
income taxes.
Article 28. Miscellaneous
This article contains various rules that apply throughout
the proposed treaty.
The proposed treaty provides that it does not restrict in
any manner any exclusion, exemption, deduction, credit, or
other allowance accorded by internal law or by any other
agreement between the United States and Switzerland. Thus, the
proposed treaty will not apply to increase the tax burden of a
resident of either the United States or Switzerland. According
to 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 Switzerland 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, 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. \14\
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\14\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
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The proposed treaty provides that the dispute resolution
procedures under its mutual agreement article take precedence
over the corresponding provisions of any other agreement to
which the United States and Switzerland are parties in
determining whether a measure is within the scope of the
proposed treaty. Unless the competent authorities agree that a
taxation measure is outside the scope of the proposed treaty,
only the proposed treaty's nondiscrimination rules, and not the
nondiscrimination rules of any other agreement in effect
between the United States and Switzerland, generally apply to
that law or other 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 other form of measure.
The proposed treaty contains a rule providing that any
income, gain, or expense attributable to a permanent
establishment during its existence is taken into account in the
country where such permanent establishment was located even if
the amounts are deferred until after the permanent
establishment has ceased to exist. This rule applies for
purposes of paragraphs 1 and 2 of Article 7 (Business Profits),
paragraph 5 of Article 10 (Dividends), paragraph 3 of Article
11 (Interest), paragraph 3 of Article 12 (Royalties), paragraph
3 of Article 13 (Gains), paragraph 2 of Article 14 (Independent
Personal Services), and paragraph 2 of Article 21 (Other
Income). Under this rule, which is described above in the
discussion of these articles, items that are attributable to a
permanent establishment are taxed under the rules applicable to
business profits and not the rules applicable to specific types
of income such as interest or dividends, even if such items are
deferred until after the termination of the permanent
establishment.
The proposed treaty includes a special rule regarding
cross-border pension contributions. This rule applies where an
individual is resident in and performs personal services in one
of the countries but is not a national of such country.
Contributions paid by or on behalf of such individuals to a
pension or other retirement arrangement that is established,
maintained, and recognized for tax purposes in the other
country will be treated for purposes of taxation in the host
country in the same way as a contribution to a pension or other
retirement arrangement established, maintained, and recognized
for tax purposes in the host country. However, this rule
applies only if two conditions are met. First, the individual
must not have been a resident of the host country, and must
have been contributing to that pension or other retirement
arrangement, immediately before he or she began exercising
employment in that country. Second, the competent authority of
the host country must agree that the pension or other
retirement arrangement in the other country generally
corresponds to an arrangement that is recognized for tax
purposes in the host country. Under the proposed treaty, the
benefits of this rule are applicable only for a period not
exceeding five taxable years beginning with the first year in
which the individual rendered personal services in the host
country. A pension or retirement arrangement is recognized for
tax purposes in a country if the contributions to and the
earnings of such arrangement would qualify for tax relief in
such country. The Technical Explanation states that this rule
applies to an individual retirement account. The Technical
Explanation further states that the benefits to be provided by
the host country under this rule are limited to the benefits
that such country would provide to arrangements recognized
under its law.
The proposed treaty includes a provision with respect to
the effect of changes in the law of either country. The
appropriate authority of either country may request
consultations with the appropriate authority of the other
country to determine whether an amendment to the proposed
treaty is appropriate to address a change in the law or policy
of either country. If, as a result of these consultations, a
determination is made that the effect or application of the
proposed treaty have been changed unilaterally by reason of
domestic legislation enacted by a country such that the balance
of the benefits provided by the proposed treaty have been
altered significantly, such authorities will consult with a
view toward amending the treaty to restore an appropriate
balance. The Technical Explanation notes that any such
amendment would be subject to Senate advice and consent to
ratification.
Article 29. Entry Into Force
The proposed treaty will enter into force on the day of the
exchange of instruments of ratification. The provisions of the
proposed treaty generally take effect for taxable years and
periods beginning on or after the first day of January in the
year following the date of entry into force. In the case of
taxes payable at source, the proposed treaty generally takes
effect for payments made on or after the first day of the
second month following the date of entry 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 30. Termination
The proposed treaty will continue in force until terminated
by a treaty country. Either country may terminate it by giving
at least six months' prior notice through diplomatic channels.
Unlike many U.S. tax treaties, but like the U.S. model, the
proposed treaty does not contain a rule which provides that
either country may terminate the treaty only after it has been
in force for five years. A termination generally will be
effective for taxable years and periods beginning on or after
the first day of January following the expiration of the six-
month period. With respect to taxes payable at source, a
termination will be effective for payments made after the first
day of January following the expiration of the six-month
period.
IX. Text of the Resolution of Ratification
Resolved, (two-thirds of the Senators present concurring
therein), That the Senate advise and consent to the
ratification of the Convention between the United States of
America and the Swiss Confederation for the Avoidance of Double
Taxation with Respect to Taxes on Income, signed at Washington,
October 2, 1996, together with a Protocol to the Convention
(Treaty Doc. 105-8), subject to the declarations of subsection
(a), and the proviso of subsection (b).
(a) DECLARATIONS.--The Senate's advice and consent is
subject to the following two declarations, which shall be
binding on the President:
(1) REAL ESTATE INVESTMENT TRUSTS.--The United States
shall use its best efforts to negotiate with the Swiss
Confederation a protocol amending the Convention to
provide the application of subparagraph (b) of
paragraph 2 of Article 10 of the Convention to
dividends paid by a Real Estate Investment Trust in
cases where (i) the beneficial owner of the dividends
beneficially holds an interest of 5 percent or less in
each class of the stock of the Real Estate Investment
Trust and the dividends are paid with respect to a
class of stock of the Real Estate Investment Trust that
is publicly traded or (ii) the beneficial owner of the
dividends beneficially holds an interest of 10 percent
or less in the Real Estate Investment Trust and the
Real Estate Investment Trust is diversified.
(2) TREATY INTERPRETATION.--The Senate affirms the
applicability to all treaties of the constitutionally
based principles of treaty interpretation set forth in
Condition (1) of the resolution of ratification of the
INF Treaty, approved by the Senate on May 27, 1988, and
Condition (8) of the resolution of ratification of the
Document Agreed Among the States Parties to the Treaty
on Conventional Armed Forces in Europe, approved by the
Senate on May 14, 1997.
(b) PROVISO.--The resolution of ratification is subject to
the following proviso, which shall be binding on the President:
(1) SUPREMACY OF THE CONSTITUTION.--Nothing in the
Treaty requires or authorizes legislation or other
action by the United States of America that is
prohibited by the Constitution of the United States as
interpreted by the United States.
A P P E N D I X
----------
Department of State,
Washington, DC,
April 8, 1997.
His Excellency, Carlo Jagmetti,
Ambassador of Switzerland.
Excellency:
I have the honor to refer to the Convention Between the United
States of America and the Swiss Confederation for the Avoidance of
Double Taxation with Respect to Taxes on Income, with Protocol, signed
at Washington, October 2, 1996, and to diplomatic notes, with an
enclosed Memorandum of Understanding clarifying application of the
Convention in specified cases, which were exchanged on the same date.
The Memorandum of Understanding is a statement of intent setting
forth a common understanding and interpretation of certain provisions
of the Convention reached by the delegations of the United States and
the Swiss Confederation acting on behalf of their respective
governments. These understandings and interpretations are intended to
give guidance both to the taxpayers and the tax authorities of our two
countries in interpreting these provisions. Since the notes were
exchanged, several additional matters regarding the interpretation of
the Convention have been identified. In order to address these matters,
several additions have been made to the Memorandum of Understanding.
The Memorandum of Understanding that reflects these additions is
enclosed herewith.
If the understandings and interpretations in the Memorandum of
Understanding are acceptable, this note and your note reflecting such
acceptance will memorialize the understandings and interpretations that
the parties have reached. I further propose that the Memorandum of
Understanding enclosed with this Note will replace the original
Memorandum of Understanding.
Accept, Excellency, the renewed assurances of my highest
consideration.
For the Secretary of State:
Barbara J. Griffith
Enclosure: As stated
______
The Charge d'affaires a.i. of Switzerland,
Washington, D.C., May 14, 1997.
Dear Madam Secretary:
I have the honor to confirm the receipt of your Note dated April 8,
1997 which reads as follows:
``Excellency:
I have the honor to refer to the Convention Between the
United States of America and the Swiss Confederation for the
Avoidance of Double Taxation with Respect to Taxes on Income,
with Protocol, signed at Washington, October 2, 1996, and to
diplomatic notes, with an enclosed Memorandum of Understanding
clarifying application of the Convention in specified cases,
which were exchanged on the same date.
The Memorandum of Understanding is a statement of intent
setting forth a common understanding and interpretation of
certain provisions of the Convention reached by the delegations
of the United States and the Swiss Confederation acting on
behalf of their respective governments. These understandings
and interpretations are intended to give guidance both to the
taxpayers and the tax authorities of our two countries in
interpreting these provisions. Since the notes were exchanged,
several additional matters regarding the interpretation of the
Convention have been identified. In order to address these
matters, several additions have been made to the Memorandum of
Understanding. The Memorandum of Understanding that reflects
these additions is enclosed herewith.
If the understandings and interpretations in the Memorandum
of Understanding are acceptable, this note and your note
reflecting such acceptance will memorialize the understandings
and interpretations that the parties have reached. I further
propose that the Memorandum of Understanding enclosed with this
Note will replace the original Memorandum of Understanding.
Accept, Excellency, the renewed assurances of my highest
consideration.
For the Secretary of State:
Attachment
The Honorable Madeleine Albright,
Secretary of State
United States Department of State
Washington, D.C.
I have the honor to inform you that the understandings and
interpretations in the Memorandum of Understanding are acceptable.
Accept, Madam Secretary, renewed assurances of my highest
consideration.
The Charge d'Affaires a.i. of Switzerland,
Pierre Combernous.