Joint Committee on Taxation

 October 25, 1999

 JCX-76-99

TESTIMONY OF THE 

STAFF OF THE JOINT COMMITTEE ON TAXATION

BEFORE THE 

SENATE COMMITTEE ON FOREIGN RELATIONS

HEARING ON TAX TREATIES AND PROTOCOLS 

WITH EIGHT COUNTRIES

October 27, 1999

My name is Lindy Paull. I am chief of staff of the Joint Committee on Taxation. It is my

pleasure to present testimony of the staff of the Joint Committee on Taxation (“Joint Committee

staff”) today concerning the proposed income tax treaties with Denmark, Estonia, Italy, Latvia,

Lithuania, Slovenia, and Venezuela, and the proposed estate and gift tax protocol with Germany.

Overview

As in the past, the Joint Committee staff has prepared pamphlets covering each of the

proposed treaties and protocols. The pamphlets contain detailed descriptions of the provisions of

the proposed treaties and protocols, including comparisons with the 1996 U.S. model treaty,

which reflects preferred U.S. treaty policy, and with other recent U.S. tax treaties. The pamphlets

also contain detailed discussions of issues raised by the proposed treaties and protocols. We

consulted extensively with the staff of your Committee in analyzing the proposed treaties and

protocols and preparing the pamphlets.

Five of the eight agreements at issue today represent new tax treaty relationships for the

United States. The new agreements are with Estonia, Latvia, Lithuania, Slovenia, and Venezuela. 

The remaining three agreements modify existing treaty relationships. The proposed treaty with

Denmark would replace an existing treaty signed in 1948. The proposed protocol with Germany

would make several modifications to the existing estate, gift, and inheritance tax treaty signed in

1980. The proposed treaty with Italy would replace an existing treaty signed in 1984.

My testimony will highlight some of the key features of these treaties and protocols and

certain issues they raise.
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Baltic Countries (Estonia, Latvia, and Lithuania)

The proposed treaties with the three Baltic countries of Estonia, Latvia, and Lithuania 

represent new tax treaty relationships for the United States. The terms of the three proposed

Baltic treaties are substantially similar to each other.

Under the proposed treaties, each Baltic country agrees to reduce its taxes on the income

that U.S. residents earn from sources in that country and the United States agrees to reciprocal

reductions of its tax on U.S. income of Baltic country residents. The United States and each

Baltic country also agree that their tax administrators will exchange tax information to carry out

the provisions of the proposed treaties and each country’s tax laws, and will cooperate together

to resolve problems in the coordination of the tax rules of the countries that may arise in

individual cases.

The proposed treaties with Estonia, Latvia, and Lithuania follow the U.S. model treaty in

many respects. However, they differ from the U.S. model treaty in certain respects, primarily by

not reducing source-country taxation to the same extent as many U.S. tax treaties. In this regard,

the proposed treaties are similar to other treaties that the United States has entered into with

developing countries.

The proposed treaties allow broader source-country taxation of business activities of

residents of the other country than the U.S. model treaty. They also permit higher maximum

rates of source-country tax on royalties, and permit the imposition of source-country tax on

certain equipment rental income. The maximum rate of source-country tax on royalties generally

is 10 percent. The proposed treaties treat equipment rental income as royalties subject to a

maximum 5-percent source-country tax.

Under the proposed treaties, as under certain other U.S. tax treaties, the reduced rates of

U.S. withholding tax applicable to dividends generally would not apply to dividends from U.S.

Real Estate Investment Trusts (“REITs”). Thus, REIT dividends may be subject to U.S.

withholding tax at the full statutory rate of 30 percent. In 1997, the Treasury Department

modified its policy with respect to the exclusion of REIT dividends from the reduced withholding

tax rates applicable to other dividends under the treaties. 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 certain cases. The proposed treaties do not

incorporate this new policy with respect to the treatment of REIT dividends (i.e., the 30-percent

U.S. withholding tax for REIT dividends generally would not be reduced under the proposed

treaties).

Denmark

The proposed treaty with Denmark is a comprehensive update of the 1948 treaty. The

provisions of the proposed treaty generally are consistent with the U.S. model treaty.
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The proposed treaty includes a comprehensive anti-treaty-shopping provision, which

resembles the provisions of the U.S. model treaty and other recent treaties. The proposed treaty

includes a “derivative benefits” provision under which treaty benefits generally would be

available to Danish companies owned by residents of countries that are members of the

European Union or the European Economic Area, or are parties to the North American Free

Trade Agreement.

The proposed treaty provides certainty to U.S. taxpayers that taxes imposed under the

Danish Hydrocarbon Tax Act are creditable income taxes for purposes of the U.S. foreign tax

credit. It is not entirely clear whether such taxes would be creditable under U.S. law. The

proposed treaty subjects each tax imposed under the Danish Hydrocarbon Tax Act to separate

“per-country” limitations. Such limitations do not otherwise exist under U.S. law. A prior

proposed U.S. income tax treaty with Denmark contained a similar provision providing for the

creditability of taxes imposed under the Danish Hydrocarbon Tax Act. This Committee reported

favorably the prior proposed treaty (and its protocol) in 1984 and 1985. During Senate

consideration of the proposed treaty in 1985, objections were raised regarding the creditability

under the treaty of the Danish hydrocarbon tax. The Senate has not given its advice and consent

to ratification of that treaty.

Germany

The proposed protocol with Germany modifies in several respects the estate, gift, and

inheritance tax treaty between the United States and Germany that was signed in 1980.

First, the proposed protocol modifies certain tiebreaker rules in the existing treaty that

determine which country has the right to tax on a worldwide basis when a decedent or donor is

domiciled in both the United States and Germany at the time of death or at the time of making a

gift. In this regard, the proposed protocol extends from five to ten years the period of time during

which a citizen of one country can be domiciled in the other country without being subject to the

primary taxing jurisdiction of the other country.

Second, the proposed protocol modifies certain exemptions granted when property is

transferred between spouses. The existing treaty provides that interspousal transfers of property

are granted a 50-percent exemption. The proposed protocol permits the United States to deny

this exemption if the decedent or donor was a U.S. citizen, or was a former U.S. citizen or longterm resident who lost such status principally to avoid tax.

Third, the proposed protocol provides a pro-rata unified credit to an individual domiciled

in Germany, who is not a U.S. citizen, for purposes of computing the U.S. estate tax. Under this

provision, such an individual domiciled in Germany would be entitled to a credit against U.S.

estate tax with respect to assets of the estate that are located in the United States.
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Fourth, the proposed protocol provides a limited U.S. estate tax marital deduction when

the surviving spouse is not a U.S. citizen.

Finally, the proposed protocol expands the saving clause of the treaty to cover two

additional classes of individuals over which the United States would retain the right to tax under

U.S. law. These are individuals who, at the time of the transfer of property, were either domiciled

in the United States, or were former long-term residents of the United States who lost such status

principally to avoid tax.

Italy

The proposed treaty with Italy would replace the 1984 treaty. The proposed treaty

generally follows the U.S. model treaty. However, the proposed treaty differs from the U.S.

model treaty in certain respects, as described below. 

The proposed treaty contains certain “main purpose” tests that do not appear in any other

U.S. treaties or the U.S. model treaty. The main purpose tests operate to deny the benefits of the

dividends, interest, royalties, and other income articles of the proposed treaty if the main purpose

or one of the main purposes of a person is to take advantage of the benefits of the respective

article through a creation or assignment of shares, debt claims, or rights that would give rise to

income to which the respective article would otherwise apply. In addition, the proposed treaty

provides that the competent authorities of the treaty countries can agree as to when the

conditions of the main purpose tests have been met. While the main purpose tests are intended

to prevent inappropriate benefits under the treaty, such tests inject considerable uncertainty into

the treaty provisions because such tests are subjective and vague. This uncertainty can create

difficulties for legitimate business transactions, and can hinder a taxpayer’s ability to rely on the

treaty.

The proposed treaty provides certainty to U.S. taxpayers that a portion of taxes imposed

with respect to the Italian regional tax on productive activities (referred to as the “IRAP”) are

creditable income taxes for purposes of the U.S. foreign tax credit. Effective January 1, 1998, the

IRAP replaced Italy’s local income tax (referred to as the “ILOR”), which was a creditable tax

under the present U.S.-Italy treaty. Unlike the ILOR, the IRAP is calculated without a deduction

for labor costs and, for certain taxpayers, without a deduction for interest costs. Absent the

proposed treaty, the IRAP is unlikely to be a creditable tax under U.S. law. The proposed treaty

provides a formula to calculate a portion of the IRAP that is intended to approximate an income

tax under U.S. tax principles. Creditability is provided for only that portion of the IRAP.

The proposed treaty provides an exemption for Italian insurance companies from the U.S.

excise tax on insurance and reinsurance premiums paid to foreign insurers with respect to U.S.

risks. This exemption applies only to the extent that the U.S. risk is not reinsured by the Italian

insurer with a foreign person that is not entitled to the benefits of a U.S. treaty providing a similar

exemption from such tax.
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The proposed treaty includes an arbitration provision that is similar to the provision that

was included in the 1989 U.S.-Germany treaty. However, like the provisions in several other

recent U.S. treaties, such as the treaties with Ireland and Switzerland, the arbitration provision in

the proposed treaty will take effect only upon a future exchange of diplomatic notes. It is

intended that this arbitration approach be evaluated by taking into account experience arbitrating

cases under the U.S.-Germany treaty.

The exchange of information article contained in the proposed treaty conforms in most

respects to the corresponding articles of the U.S. and OECD model treaties. As is true under

these model treaties, the proposed treaty requires the countries to exchange such information as

is necessary for carrying out the provisions of the proposed treaty and the domestic tax laws of

the countries. There is one significant respect in which the exchange of information article does

not conform to the corresponding article of the U.S. model treaty. The proposed treaty omits the

provision in the U.S. model treaty that requires information to be provided to the requesting

country notwithstanding that such disclosure may be precluded under bank secrecy laws or

similar legislation.

Slovenia

The proposed treaty with Slovenia is a new tax treaty relationship for the United States. 

The provisions of the proposed treaty generally comport with the U.S. model treaty. Under the

proposed treaty, Slovenia agrees to reduce its taxes on the income that U.S. residents earn from

sources in Slovenia and the United States agrees to a reciprocal reduction of its tax on U.S.

income of Slovenian residents.

Like the proposed treaty with Italy, the proposed treaty with Slovenia contains certain

“main purpose” tests that do not appear in any other U.S. treaties or the U.S. model treaty. The

main purpose tests operate to deny the benefits of the dividends, interest, royalties, and other

income articles of the proposed treaty if the main purpose or one of the main purposes of a

person is to take advantage of the benefits of the respective article through a creation or

assignment of shares, debt claims, or rights that would give rise to income to which the respective

article would otherwise apply. In addition, the proposed treaty provides that the competent

authorities of the treaty countries can agree as to when the conditions of the main purpose tests

have been met. While the main purpose tests are intended to prevent inappropriate benefits

under the treaty, such tests inject considerable uncertainty into the treaty provisions because such

tests are subjective and vague. This uncertainty can create difficulties for legitimate business

transactions, and can hinder a taxpayer’s ability to rely on the treaty.

The exchange of information article contained in the proposed treaty conforms in most

respects to the corresponding articles of the U.S. and OECD model treaties. As is true under

these model treaties, the proposed treaty requires the countries to exchange such information as

is relevant for carrying out the provisions of the proposed treaty and the domestic tax laws of the

countries. There is one significant respect in which the exchange of information article does not
1

 The draft new tax law also provides for several fundamental changes in Venezuela’s tax

laws beyond the adoption of a worldwide tax system, including the imposition of taxes on

dividends, the adoption of rules on transfer pricing, as well as general anti-abuse rules to allow

the tax authorities to disregard transactions entered into with a principal purpose to evade, avoid,

or otherwise reduce income taxes.

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conform to the corresponding article of the U.S. model treaty. The proposed treaty omits the

provision in the U.S. model treaty that requires information to be provided to the requesting

country notwithstanding that such disclosure may be precluded under bank secrecy laws or

similar legislation.

Venezuela

The proposed treaty with Venezuela represents a new tax treaty relationship for the

United States.

The proposed treaty raises unique issues because Venezuela currently has a territorial tax

system. Under this system, Venezuela taxes income of residents or nonresidents only with

respect to income from Venezuelan sources; accordingly, foreign-source income is not taxed by

Venezuela. This is unlike the U.S. tax system, which taxes U.S. residents on worldwide income

and generally taxes nonresidents only on certain income from U.S. sources. The inconsistencies

between the two tax systems could result, in certain cases, in Venezuelan residents obtaining a

complete exemption from both U.S. and Venezuelan taxes under the proposed treaty with

respect to certain U.S. source income. In addition, under the proposed treaty, the reduced rates

of U.S. withholding tax on certain payments to Venezuelan persons (such as for dividends,

interest, and royalties) would provide additional relief for such persons from taxation by both

countries.

The Committee should be aware that Venezuela is in the process of moving from a

territorial tax system to a worldwide tax system. On April 26, 1999, an enabling law authorized

the President to take “extraordinary economic and financial measures,” including reforming

Venezuela’s income tax laws. Among other things, the enabling law specifically authorizes the

President to amend Venezuela’s tax laws to adopt a worldwide tax system (in lieu of Venezuela’s

current territorial tax system) with a credit system to provide relief from international double

taxation. The enabling law authorizes the President to publish a decree within six months of the

authorization (i.e., no later than October 26, 1999) which contains these and other changes to

Venezuelan tax laws. In September 1999, the Council of Ministers, with the President presiding,

approved a draft of a new income tax law which includes provisions adopting a worldwide tax

system.1

In general, the new worldwide tax system is similar to the U.S. system. Under the new

worldwide tax system, Venezuelan residents and domiciled entities would be taxable on
2

 In general, laws are enacted in Venezuela by means of publication in Venezuela’s

Official Gazette.

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worldwide income while nonresidents and non-domiciled entities would be taxable only on

certain income from Venezuelan sources. Taxpayers generally would be permitted to claim a

credit against their Venezuelan tax liability for foreign taxes paid on their foreign source income.

The draft new tax law has not yet been published in Venezuela’s Official Gazette.

2

 For

such law to take effect as provided by the enabling law, this action must take place no later than

October 26, 1999. Once officially published, the new tax law generally would take effect for

taxable years beginning after the law is published. However, the new worldwide tax system

would take effect for taxable years beginning on or after January 1, 2001.

The proposed treaty differs from the U.S. model treaty in certain respects. First, the

proposed treaty does not reduce source-country taxation to the same extent as many U.S.

treaties. In this regard, the proposed treaty is similar to other treaties that the United States has

entered into with developing countries.

Second, the proposed treaty would allow broader source-country taxation of business

activities of residents of the other country than the U.S. model treaty. For example, the proposed

treaty expands the definition of a permanent establishment to include cases in which an

enterprise provides services through its employees in a country if the activities continue for more

than 183 days.

Third, the proposed treaty permits higher maximum rates of source-country tax on

royalties, and permits the imposition of source-country tax on certain equipment rental income. 

The maximum rate of source-country tax on royalties generally is 10 percent. The proposed

treaty treats equipment rental income as royalties subject to a maximum 5-percent sourcecountry tax.

Venezuela currently is in a period of constitutional and institutional change. In the past

ten months, the Venezuelan people have elected a new President, Hugo Chavez. In April, a new

National Constituent Assembly was formed to draft a new constitution. Among other things,

conflicts have developed between the new National Constituent Assembly and established

political institutions, such as the Venezuelan Congress. The Committee should consider the

implications of ongoing political changes in Venezuela as they relate to the proposed treaty. For

example, if there are competing claims as to who is authorized to exercise legislative, executive,

or judicial functions, it may be difficult to identify the responsible competent authority with

respect to the proposed treaty. These uncertainties may make it difficult to administer the treaty. 
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Conclusion

These issues are discussed in more detail in the Joint Committee staff pamphlets on the

proposed treaties and protocols. I would be happy to answer any questions the Committee may

have at this time and in the future.