TESTIMONY OF THE STAFF OF THE JOINT COMMITTEE ON TAXATION 

BEFORE THE SENATE COMMITTEE ON FOREIGN RELATIONS HEARING ON 

THE PROPOSED PROTOCOL TO THE INCOME TAX TREATY WITH CANADA 

AND THE PROPOSED INCOME TAX TREATIES WITH ICELAND AND BULGARIA1

JULY 10, 2008 

My name is Emily S. McMahon. I am Deputy Chief of Staff of the Joint Committee on 

Taxation. It is my pleasure to present today the testimony of the staff of the Joint Committee on 

Taxation concerning the proposed protocol to the income tax treaty with Canada and the 

proposed income tax treaties with Iceland and Bulgaria. 

Overview

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

protocol and treaties. The pamphlets provide detailed descriptions of the proposed protocol and 

treaties, including comparisons with the United States Model Income Tax Convention of 

November 15, 2006 (the “U.S. Model treaty”), prepared by the Treasury Department, and with 

other recent U.S. income tax treaties.2 The pamphlets also provide detailed discussions of 

certain issues raised by the proposed protocol and treaties. We consulted with the Treasury 

Department and with the staff of your committee in analyzing the proposed protocol and treaties 

and in preparing the pamphlets. 

The principal purposes of the protocol and each treaty are to reduce or eliminate double 

taxation of income earned by residents of either the United States or the treaty country from 

 1

 This document may be cited as follows: Joint Committee on Taxation, Testimony of the Staff of 

the Joint Committee on Taxation Before the Senate Committee on Foreign Relations Hearing on the 

Proposed Protocol to the Income Tax Treaty with Canada and the Proposed Income Tax Treaties with 

Iceland and Bulgaria (JCX-60-08), July 10, 2008. This publication can also be found at www.jct.gov. 

2

 Joint Committee on Taxation, Explanation of Proposed Protocol to the Income Tax Treaty 

Between the United States and Canada (JCX-57-08), July 8, 2008; Joint Committee on Taxation, 

Explanation of Proposed Income Tax Treaty Between the United States and Iceland (JCX-58-08), July 8, 

2008; Joint Committee on Taxation, Explanation of Proposed Income Tax Treaty Between the United 

States and Bulgaria (JCX-59-08), July 8, 2008. 

JOINT COMMITTEE ON TAXATION 

July 10, 2008 

JCX-60-08 
2

sources within the other country and to prevent avoidance or evasion of the taxes of the two 

countries. The proposed protocol and each treaty also are intended to promote close economic 

cooperation between the United States and the respective treaty country and to eliminate possible 

barriers to trade and investment caused by the overlapping taxing jurisdictions of the United 

States and the treaty country. As in other U.S. income tax treaties, these objectives principally 

are achieved through each country’s agreement to limit, in certain specified situations, its right to 

tax income derived from its territory by residents of the other country. 

The proposed protocol with Canada would make several modifications to an existing 

income tax treaty that was signed in 1980. The U.S.-Canada income tax treaty has been 

modified by four previous protocols, in 1983, 1984, 1995, and 1997. The proposed income tax 

treaty with Iceland, together with a contemporaneously signed protocol, would replace an 

existing treaty signed in 1975. The proposed income tax treaty with Bulgaria, together with the 

proposed 2007 and 2008 protocols, would be the first income tax treaty between the United 

States and Bulgaria. 

My testimony today will highlight some of the significant features of the proposed 

protocol and treaties and certain issues that they raise. 

U.S. Model treaty

In November 2006, the Treasury Department released the present U.S. Model treaty.3

 As 

a general matter, the U.S. model tax treaties are intended to provide a framework for U.S. tax 

treaty policy and a starting point for negotiations with our treaty partners. These models provide 

helpful information to taxpayers, the Congress, and foreign governments as to U.S. policies on 

tax treaty matters. Periodical updates to reflect new developments and congressional views with 

regard to particular issues of U.S. tax treaty policy ensure that the model treaties remain 

meaningful and relevant. 

The present U.S. Model treaty incorporates the key developments in U.S. income tax 

treaty policy that are reflected in recent U.S. income tax treaties. The proposed protocol and 

treaties that are the subject of this hearing are generally consistent with the provisions found in 

the U.S. Model treaty. However, there are some significant differences from the U.S. Model 

treaty that I will discuss. 

Limitation-on-benefits provisions

One important area in which the proposed protocol and treaties are generally consistent 

with the U.S. Model treaty is the inclusion in all three proposed instruments of a comprehensive 

limitation-on-benefits provision. These limitation-on-benefits provisions generally are intended 

to make it more difficult for residents of countries other than the United States and the treaty 

partner to benefit inappropriately from the treaty. 

 3

 For a comparison of the 2006 U.S. model income tax treaty with its 1996 predecessor, see Joint 

Committee on Taxation, Comparison of the United States Model Income Tax Convention of September 

15, 1996 with the United States Model Income Tax Convention of November 15, 2006 (JCX-27-07), May 

8, 2007. 
3

When a resident of one country derives income from another country, the internal tax 

rules of the two countries may cause that income to be taxed in both countries. One purpose of a 

bilateral income tax treaty is to allocate taxing rights for cross-border income and thereby to 

prevent double taxation of residents of the treaty countries. Although a bilateral income tax 

treaty is intended to apply only to residents of the two treaty countries, residents of third 

countries may attempt to benefit from a treaty by engaging in a practice known as “treaty 

shopping.” Treaty shopping may involve directing an investment in one treaty country through 

an entity organized in the other treaty country or engaging in income-stripping transactions with 

a treaty-country resident. Limitation-on-benefits provisions are intended to deny treaty benefits 

in certain cases of treaty shopping. 

The proposed treaty with Iceland contains a detailed limitation-on-benefits provision 

(Article 21) that reflects the anti-treaty-shopping provisions included in the U.S. Model treaty 

and more recent U.S. income tax treaties. In contrast, the present treaty between the United 

States and Iceland is one of only eight remaining U.S. income tax treaties that do not include any 

limitation-on-benefits rules. Three of those eight treaties, including the treaties with Iceland, 

Hungary, and Poland, provide for a complete exemption from withholding on interest payments 

from one treaty country to the other treaty country. Consequently, those three treaties present 

particularly attractive opportunities for treaty-shopping. In fact, a November 2007 report 

prepared by the Treasury Department at the request of the U.S. Congress suggests that the 

income tax treaties with Hungary and Iceland have increasingly been used for treaty-shopping 

purposes in recent years as the United States adopted modern limitation-on-benefits provisions in 

its other treaties.4

 The proposed treaty with Iceland, including its modern limitation-on-benefits 

rules, would thus eliminate a significant treaty-shopping opportunity. Nevertheless, the 

Committee may wish to inquire of the Treasury Department regarding its plans to address the 

remaining U.S. income tax treaties that do not include limitation-on-benefits provisions, and in 

particular the treaties with Hungary and Poland. 

The proposed protocol with Canada replaces Article XXIX A (Limitation on Benefits) of 

the present treaty with a new article that reflects the anti-treaty-shopping provisions included in 

the U.S. Model treaty and more recent U.S. income tax treaties. Unlike the rules in the present 

treaty (which may be applied only by the United States), the new rules are reciprocal and are 

intended to prevent the indirect use of the treaty by persons who are not entitled to its benefits by 

reason of residence in Canada or the United States. 

The proposed treaty with Bulgaria also contains a detailed limitation-on-benefits 

provision similar to that of the U.S. Model treaty to prevent the inappropriate use of the treaty by 

third-country residents (Article 21). 

 4

 Department of the Treasury, Report to the Congress on Earnings Stripping, Transfer Pricing 

and U.S. Income Tax Treaties (Nov. 28, 2007). The report states that, as of 2004, it does not appear that 

the U.S.-Poland income tax treaty has been extensively exploited by third-country residents. 
4

“Zero-rate” dividend provisions

Another significant similarity between the U.S. Model treaty and the proposed protocol 

and treaties is the lack of a “zero-rate” of withholding tax on certain intercompany dividends. 

Until 2003, no U.S. income tax treaty provided for a complete exemption from dividend 

withholding tax, and the U.S. Model treaty and the 2005 Model Convention on Income and 

Capital of the Organisation for Economic Co-operation and Development (“OECD”) do not 

provide an exemption. By contrast, many bilateral income tax treaties of other countries 

eliminate withholding taxes on direct dividends between treaty countries, and the European 

Union (“EU”) Parent-Subsidiary Directive repeals withholding taxes on intra-EU direct 

dividends (determined by reference to a 15-percent ownership threshold in 2007). 

Moreover, the recent U.S. income tax treaties and protocols with Australia, Japan, 

Mexico, the Netherlands, Sweden, the United Kingdom, Germany, Belgium, Denmark, and 

Finland include zero-rate dividend provisions. Eligibility for this zero rate generally is 

contingent on meeting an 80-percent ownership threshold and certain additional requirements. 

The Senate ratified those treaties and protocols in 2003 (Australia, Mexico, and the United 

Kingdom), 2004 (Japan and the Netherlands), 2006 (Sweden), and 2007 (Germany, Belgium, 

Denmark, and Finland). On the other hand, neither the recent protocol with France nor the 

recent treaties with Bangladesh and Sri Lanka include an exemption from dividend withholding. 

In general, the dividend articles of the proposed protocol and treaties provide a maximum 

source-country withholding tax rate of 15 percent (10 percent under the proposed treaty with 

Bulgaria) and a reduced five-percent maximum rate for dividends received by a company 

owning at least 10 percent of the dividend-paying company. A zero rate of withholding is 

generally available under the proposed protocol and treaties for dividends received by a pension 

fund. The proposed protocol and treaties also include special rules for dividends received from 

U.S. regulated investment companies and real estate investment trusts. These special rules 

generally are similar to provisions included in other recent U.S. treaties and protocols. 

In previous testimony before the Committee, the Treasury Department has indicated that 

zero-rate dividend provisions should be allowed only under treaties that have restrictive 

limitation-on-benefits rules and that provide comprehensive information exchange. Even in 

those treaties, according to previous Treasury Department statements, dividend withholding tax 

should be eliminated only based on an evaluation of the overall balance of benefits under the 

treaty. The Committee may wish to consider what overall balance of considerations prompted 

the Treasury Department not to seek a zero-rate provision in the proposed protocol and treaties, 

all of which have comprehensive limitation-on-benefits and information-exchange provisions. 

Mandatory and binding arbitration provision in proposed protocol with Canada

One important feature of the proposed protocol with Canada is the replacement of the 

voluntary arbitration procedure of Article XXVI (Mutual Agreement Procedure) of the present 

treaty with a mandatory arbitration procedure that is sometimes referred to as “last best offer” 

arbitration. Under this procedure, each of the competent authorities proposes one and only one 

figure for settlement of a dispute, and the arbitrator must select one of those figures as the award. 

The last best offer approach is intended to induce the competent authorities to moderate their 
5

positions, including before arbitration proceedings would commence, and thus to increase the 

possibility of a negotiated settlement. Under the proposed protocol, unless a taxpayer or other 

“concerned person” (in general, a person whose tax liability is affected by the arbitration 

determination) does not accept the arbitration determination, it is binding on the treaty countries 

with respect to the case. 

The U.S. Model treaty does not include a mandatory arbitration procedure. However, the 

use of mandatory and binding arbitration in tax disputes between countries is not a novel 

concept. A provision similar to the provision in the proposed protocol with Canada does appear 

in the protocol with Germany and the treaty with Belgium, both ratified by the Senate in 2007. 

Also in 2007, the OECD Committee on Fiscal Affairs adopted proposed changes to its model 

treaty and commentary that incorporate a mandatory and binding arbitration procedure, some 

elements of which are generally similar to those of the proposed protocol. The OECD has 

announced that it will be adopting those changes in final form shortly. In addition, the EU has 

adopted certain mandatory and binding arbitration procedures that are applicable to transfer 

pricing disputes between members of the EU. 

Judging from the actions taken by the OECD and the EU, unresolved competent authority 

proceedings appear to be a multinational occurrence. As a general matter, it is beneficial to 

resolve tax disputes effectively and efficiently. The new arbitration procedures included in the 

proposed protocol are intended to ensure that the mutual agreement procedures occur pursuant to 

a schedule and that all cases are resolved within a limited time period. 

We understand that there are a significant number of competent authority cases pending 

between the United States and Canada, and that, historically, a substantial number of double 

taxation cases have not been satisfactorily resolved by the U.S. and Canadian competent 

authorities. The Treasury Department does not release statistics that reflect competent authority 

activities by individual treaty partners. While many expect that the proposed mandatory and 

binding arbitration procedures will be successful in resolving recurring issues and will encourage 

the competent authorities to settle cases without resort to arbitration, it will take time to ascertain 

if these procedures are effective or if unexpected problems arise. 

Meanwhile, the Treasury Department or other trading partners may seek to negotiate 

treaty provisions with current or future treaty partners that are similar, in whole or in part, to the 

arbitration procedures of the proposed treaty and protocol. It is still too early to assess the effect 

of the addition of mandatory arbitration provisions to the Germany and Belgium treaties on the 

competent authority processes with respect to those countries. Therefore, the Committee may 

wish to better understand how the Treasury Department intends to monitor the competent 

authority function, as well as arbitration developments with respect to other countries, to 

determine the overall effects of the new arbitration procedures on the mutual agreement process. 

The Committee may wish to consider what information is needed to measure whether the 

proposed arbitration procedures result in more efficient case resolution, both before and during 

arbitration, and whether they enhance the quality of the outcome of the competent authority 

cases. In addition, the Committee may wish to inquire as to whether and under what 

circumstances the Treasury Department intends to pursue similar provisions in other treaties. 
6

The Committee may also wish to consider certain specific features of the arbitration 

procedures included in the proposed protocol. For example, the mandatory arbitration procedure 

is available under the proposed protocol only with respect to certain articles specified by the 

treaty partners in diplomatic notes accompanying the protocol.5

 The Committee may wish to 

inquire about the basis for selection of those particular articles and the implications of excluding 

the others. Other points that the Committee may wish to clarify include the extent to which 

decisions of the arbitration board will be taken into account in subsequent competent authority 

cases involving the same taxpayer, the same issue and substantially similar facts, and the 

application of the mandatory arbitration procedures to competent authority cases already pending 

on the date on which the proposed protocol enters into force. 

Other provisions of the proposed protocol with Canada

The proposed protocol modifies a number of the provisions in the existing treaty. The 

rules of the proposed protocol generally are similar to rules of recent U.S. income tax treaties, 

the U.S. Model treaty, and the 2005 Model Convention on Income and on Capital of the 

Organisation for Economic Cooperation and Development (the “OECD Model treaty”). 

However, the existing treaty, as amended by the proposed protocol, contains certain substantive 

deviations from these treaties and models. 

The proposed protocol amends Article IV (Residence) of the existing treaty specifically 

to address companies that are residents of both treaty countries. The proposed protocol provides 

that if such a dual-resident company is created under the laws in force in a treaty country but not 

under the laws in force in the other treaty country, the company is deemed to be a resident only 

of the first treaty country. If that rule does not apply (for example, because a company created in 

one country is continued in the other country in accordance with its corporate law), the 

competent authorities of the treaty countries must endeavor to settle the question of residency by 

mutual agreement and determine the mode of application of the treaty to the company. In the 

absence of such an agreement, the company is not considered to be a resident of either treaty 

country for purposes of claiming any benefits under the treaty. 

The proposed protocol also amends Article IV of the existing treaty to provide specific 

rules regarding the circumstances in which amounts of income, profit, or gain are deemed to be 

derived through or paid by fiscally transparent entities. In general, an amount of income, profit, 

or gain is considered to be derived by a resident of a treaty country if (1) that person is 

considered under the taxation law of that country to have derived the amount through an entity, 

other than an entity that is a resident of the other treaty country, and (2) by reason of that entity 

being treated as fiscally transparent under the laws of the first treaty country, the treatment of the 

amount under the taxation law of that country is the same as its treatment would be if that 

amount had been derived directly by that person. Notwithstanding the general rule, an amount of 

income, profit, or gain is considered not to be paid to or derived by a person who is a resident of 

 5

 These articles are: Article IV (Residence), but only to the extent the case relates to the 

residence of natural persons; Article V (Permanent Establishment); Article VII (Business Profits); Article 

IX (Related Persons); and Article XII (Royalties), but only to the extent the case relates (1) to the 

application of Article XII to transactions involving related persons, or (2) to an allocation of amounts 

between taxable and non-taxable royalties. 
7

a treaty country if (1) that person is considered under the taxation law of the other treaty country 

as deriving the amount through an entity that is not a resident of the first treaty country, but (2) 

by reason of the entity not being treated as fiscally transparent under the laws of that treaty 

country, the treatment of the amount under the taxation law of that country is not the same as its 

treatment would be if that amount had been derived directly by the person. These rules are 

consistent with present U.S. tax rules. 

The proposed protocol provides an additional rule applicable in the area of fiscally 

transparent entities that is new to the U.S. tax treaty network. Under this new rule, an amount of 

income, profit, or gain is not considered to be paid to or derived by a person who is a resident of 

a treaty country if (1) the person is considered under the tax law of the other treaty country to 

have received the amount from an entity resident in the other treaty country, but (2) by reason of 

the entity being treated as fiscally transparent under the laws of the first treaty country, the 

treatment of the amount received by that person under the tax law of that country is not the same 

as its treatment would be if the entity were treated as not fiscally transparent under the laws of 

that country. Thus, treaty benefits may not be claimed with respect to such payments. There is 

some uncertainty with regard to how this rule applies to deductible payments made by hybrid 

partnerships, and the Committee may wish to inquire about this point. 

The proposed protocol amends Article V of the existing treaty to add a special rule under 

which services performed by an enterprise of a treaty country in the other treaty country may 

give rise to a permanent establishment in the other country if the enterprise exceeds certain levels 

of presence in the other country and if certain other conditions are met. The special rule applies 

if the enterprise does not have a permanent establishment in the other country by virtue of any of 

the customary treaty standards. A similar provision appears in several existing U.S. tax treaties 

with developing countries (and in the proposed treaty with Bulgaria), but this is the first time 

such a provision has been proposed with a developed country. If certain additional conditions 

are met, the provision would subject individual employees to taxation as well. There are several 

unresolved questions regarding the administration of this provision. The Committee may wish to 

inquire whether active discussion is occurring between the United States and Canada on these 

matters, and whether these questions will be resolved before the protocol becomes effective. 

The proposed protocol applies the treaty partners’ interpretation of the arm’s-length 

standard in a manner consistent with the OECD Transfer Pricing Guidelines to the attribution of 

profits to a permanent establishment under Article VII, taking into account the different 

economic and legal circumstances of a single legal entity. Under the proposed protocol, the 

business profits to be attributed to a permanent establishment include only the profits derived 

from the assets used, risks assumed, and activities performed by the permanent establishment. 

The proposed protocol also amends Article VII of the existing treaty to clarify that income may 

be attributable to a permanent establishment that no longer exists in one of the treaty countries. 

In addition, the proposed protocol provides that income derived from independent personal 

services (i.e., income from the performance of professional services and of other activities of an 

independent character) is included within the meaning of the term “business profits.” 

Accordingly, the treatment of such income is governed by Article VII rather than by present 

treaty Article XIV (Independent Personal Services), which the proposed protocol deletes. These 

new rules are similar to provisions included in other recent U.S. treaties and protocols, including 

the U.S Model treaty. 
8

The proposed protocol modifies Article X (Dividends) of the present treaty to reflect 

more closely the dividend provisions included in the U.S. Model treaty and recent U.S. income 

tax treaties. The modifications include a revised definition of the term “dividends” and an 

updated special rule that applies to dividends paid by U.S. REITs. 

The proposed protocol replaces Article XI (Interest) of the present treaty with a new 

article that generally provides for exclusive residence-country taxation of interest. Limited 

exceptions permit source-country taxation of interest if the beneficial owner of the interest 

carries on, or has carried on, business through a permanent establishment in the source country 

and the debt-claim in respect of which the interest is paid is effectively connected with that 

permanent establishment. Two anti-abuse provisions relating to contingent interest payments 

and residual interests in real estate mortgage investment conduits also permit source-country 

taxation of interest. Special rules apply to cases involving a non-arm’s-length interest charge 

between a payer and a beneficial owner that have a special relationship. 

The proposed protocol conforms Article XII (Royalties) to the proposed elimination of 

Article XIV (Independent Personal Services) and clarifies the treatment of income attributable to 

a permanent establishment that has ceased to exist. 

The proposed protocol modifies Article XIII (Gains) of the present treaty in two principal 

respects. First, the proposed protocol narrows the emigration exception to the Article’s rule 

providing for exclusive residence-country taxation of gains from the alienation of property in 

cases other than those specifically enumerated in Article XIII. The proposed protocol provides 

that this exception will not apply if the property was treated as alienated immediately before an 

individual’s emigration. Second, the proposed protocol provides a revised election intended to 

coordinate U.S. and Canadian taxation of gains in the case of timing mismatches. 

The proposed protocol conforms Article XV (Dependent Personal Services) of the 

present treaty to the U.S. and OECD Model treaties, as well as to the proposed elimination of 

Article XIV (Independent Personal Services), and broadens the definition of “remuneration.” In 

addition, the proposed protocol changes the rules with respect to calculating the number of days 

an individual is present in the other treaty country for purposes of determining if a resident of 

one treaty country may be taxed by the other treaty country. The proposed protocol also contains 

provisions intended to eliminate potential abuses through the use of intermediary employers. 

The diplomatic notes exchanged in connection with the proposed protocol set forth new rules for 

allocating income from the exercise or disposal of an option between the two treaty countries. 

The proposed protocol modifies some of the existing treaty rules of Article XVIII of the 

present treaty (Pensions and Annuities), mostly to address Roth individual retirement accounts, 

and adds several new provisions that address cross-border pension contributions and benefits 

accruals. Many of the new rules are similar to those found in the U.S. Model treaty, but several 

reflect the uniquely large cross-border flow of personal services between Canada and the United 

States, including the large number of cross-border commuters. These rules are intended to 

remove barriers to the flow of personal services between the two countries that could otherwise 

result from discontinuities under the laws of each country regarding the deductibility of pension 

contributions and the taxation of a pension plan's earnings and accretions in value. In addition, 
9

the proposed protocol adds a new provision to address the source of certain annuity or life 

insurance payments made by branches of insurance companies. 

The proposed protocol replaces Article XX (Students) of the present treaty with a new 

article that generally corresponds to the treatment provided under the present treaty. The 

proposed protocol adds a one-year limitation on the exemption from income tax in the host 

country in the case of apprentices and business trainees. 

The proposed protocol modifies Article XXI (Exempt Organizations). The new rules are 

intended to permit charitable-type organizations to invest indirectly and to pool their investments 

with pension-type organizations. 

The proposed protocol adds a new paragraph to Article XXII (Other Income) of the treaty 

for guarantee fees. The new paragraph provides that compensation derived by a resident of a 

contracting state in respect of a guarantee of indebtedness shall be taxable only in that state, 

unless the compensation is business profits attributable to a permanent establishment in the other 

contracting state, in which case Article VII (Business Profits) shall apply. 

The proposed protocol changes the obligations of Canada under Article XXIV 

(Elimination of Double Taxation) of the treaty with respect to dividends received by a Canadian 

company from a U.S. resident company. Under the proposed protocol, a Canadian company 

receiving a dividend from a U.S. resident company of which it owns at least 10 percent of the 

voting stock, is allowed a credit against Canadian income tax for the appropriate amount of 

income tax paid or accrued to the United States by the dividend paying company with respect to 

the profits out of which the dividends are paid. 

The proposed protocol revises the general rules of Article XXV (Non-Discrimination) of 

the present treaty to bring those rules into closer conformity with the U.S. Model treaty and 

recent U.S. income tax treaties. The proposed protocol generally prohibits a treaty country from 

discriminating against nationals of the other treaty country by imposing on those nationals more 

burdensome taxation than it imposes or may impose on its own nationals in the same 

circumstances. 

The proposed protocol modifies Article XXVI A (Assistance in Collection) of the present 

treaty to further limit, in a narrow class of cases, one treaty country’s obligation to assist the 

other treaty country in collecting taxes. The modifications also explicitly provide that the 

assistance-in-collection provisions apply to contributions to social security and employment 

insurance premiums levied by or on behalf of the government of a treaty country. 

The proposed protocol replaces Article XXVII (Exchange of Information) of the present 

treaty with rules similar to those in the U.S. model treaty. The proposed rules generally provide 

that the two competent authorities will exchange such information as may be relevant in carrying 

out the provisions of the domestic laws of the United States and Canada concerning taxes to 

which the treaty applies to the extent the taxation under those laws is not contrary to the treaty. 

The proposed protocol amends the saving clause in Article XXIX (Miscellaneous Rules) 

to bring the treaty generally in conformity with the U.S. taxation of former citizens and former 

long-term residents under section 877 of the Code. The proposed protocol provides that 
10

notwithstanding the other provisions of the treaty, a former citizen or former long-term resident 

of the United States, may, for a period of ten years following the loss of such status, be taxed in 

accordance with the laws of the United States with respect to income from sources within the 

United States (including income deemed under the domestic law of the United States to arise 

from such sources). Section 877 is applicable to individuals who relinquish their U.S. 

citizenship or cease to be a lawful permanent resident prior to June 17, 2008. 

For any individual who relinquishes U.S. citizenship or ceases to be a lawful permanent 

resident of the United States on or after June 17, 2008, a new set of rules applies. In general, to 

the extent those rules impose U.S. tax on an individual after the individual expatriates, they 

require or deem the individual to waive any rights to claim a reduction in U.S. tax under a U.S. 

tax treaty and any other rights under a U.S. tax treaty that would preclude the assessment or 

collection of tax imposed by the new rules. 

The proposed protocol replaces Article XXIX B (Taxes Imposed by Reason of Death) of 

the present treaty with a new article that generally addresses certain concerns regarding the 

application of Canadian tax rules and regarding the availability of tax credits or deductions when 

the United States and Canada impose tax on the same items of income or property. 

Article 27 of the proposed protocol provides for the entry into force of the proposed 

protocol. The provisions of the proposed protocol are generally effective on a prospective basis. 

However, the provisions with respect to dual-residence tie breakers (Article 2 of the proposed 

protocol) and an emigrant’s gain (Article 8 of the proposed protocol) are effective retroactive to 

September 17, 2000. In certain situations, the reduction of interest withholding rates is also 

retroactive, with the initial phase-in rate applicable for the year in which the proposed protocol 

becomes effective. Also, the provisions for assistance in the collection of taxes are retroactively 

effective to revenue claims that have been definitively determined after November 9, 1985. 

With respect to certain payments through fiscally transparent entities and the new 

provisions regarding permanent establishments, the proposed protocol is effective as of the first 

day of the third year that ends after the proposed protocol enters into force. Special rules apply 

for determining when to start counting (1) days present, (2) services rendered, and (3) gross 

active business revenues for purposes of the permanent establishment provision. With respect to 

the arbitration provisions, the proposed protocol clarifies that a competent authority matter 

currently in progress will be deemed to have started on the date on which the proposed protocol 

enters into force. 

Iceland

The proposed treaty replaces the existing treaty that was signed in 1975. The rules of the 

proposed treaty generally are similar to rules of recent U.S. income tax treaties, the U.S Model 

treaty, and the OECD Model treaty. However, the proposed treaty contains certain substantive 

deviations from these treaties and models. 

The proposed treaty contains provisions under which each country generally agrees not to 

tax business income derived from sources within that country by residents of the other country 

unless the business activities in the taxing country are substantial enough to constitute a 
11

permanent establishment (Article 7). Similarly, the proposed treaty contains certain 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 7, 14, and 16). The proposed treaty also provides that pensions 

and other similar remuneration paid to a resident of one country may be taxed only by that 

country, and only at such time and to the extent that a pension distribution is made (Article 17). 

The proposed treaty provides that dividends and certain gains derived by a resident of 

either country from sources within the other country generally 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 may be limited by the proposed treaty. The proposed treaty 

provides that, subject to certain rules and exceptions, interest and most types of royalties derived 

by a resident of either country from sources within the other country may be taxed only by the 

residence country (Articles 11 and 12). Notwithstanding this general rule, the source country 

may impose tax on certain royalties in an amount not to exceed five percent of such royalties. 

In situations in which the country of source retains the right under the proposed treaty to 

tax income derived by residents of the other country, the proposed treaty generally provides for 

relief from the potential double taxation through the allowance by the country of residence of a 

tax credit for foreign taxes paid to the other country (Article 22). 

The proposed treaty contains the standard provision (the “saving clause”) included in 

U.S. tax treaties pursuant to which each country retains the right to tax its residents and citizens 

as if the treaty had not come into effect (Article 1). In addition, the proposed treaty contains the 

standard provision that the treaty may not be applied to deny any taxpayer any benefits to which 

the taxpayer would be entitled under the domestic law of a country or under any other agreement 

between the two countries (Article 1). 

The proposed treaty (Article 19) generally provides that students, business trainees, and 

researchers visiting the other treaty country are exempt from host country taxation on certain 

types of payments received. 

The proposed treaty includes the standard provision (Article 20) that assigns taxing 

jurisdiction over income not addressed in the other articles of the proposed treaty. In general, 

such income is taxable solely by the residence country. The proposed treaty provides authority 

for the two countries to resolve disputes (Article 24) and exchange information (Article 25) in 

order to carry out the provisions of the proposed treaty. 

The provisions of the proposed treaty will have effect generally on or after the first day of 

January following the date that the proposed treaty enters into force. The proposed treaty allows 

taxpayers to temporarily continue to claim benefits under the present treaty for up to an 

additional year if they would have been entitled to greater benefits under the present treaty. In 

addition, a teacher entitled to benefits under the present treaty at the time the proposed treaty 

enters into force will continue to be entitled to the benefits available under the present treaty for 

as long as such individual would have been entitled to the previously existing benefits. 
12

Bulgaria

The United States and Bulgaria do not have an income tax treaty currently in force. The 

rules of the proposed treaty and protocols generally are similar to various rules of recent U.S. 

income tax treaties, the U.S. Model treaty, the OECD Model treaty, and the 1980 United Nations 

Model Double Taxation Convention between Developed and Developing Countries, as amended 

January 11, 2001 (“the U.N. Model treaty”). However, the proposed treaty, as amended by the 

proposed 2007 and 2008 protocols, also contains certain substantive deviations from these 

treaties and models. 

The proposed treaty contains provisions under which each country generally agrees not to 

tax business income derived from sources within that country by residents of the other country 

unless the business activities in the taxing country are substantial enough to constitute a 

permanent establishment (Article 5). The proposed treaty includes a special rule under which 

services performed by an enterprise of a treaty country in the other treaty country may give rise 

to a permanent establishment in the other country if the enterprise’s activities in the other 

country occur for a certain number days and if certain other conditions are met. The special rule 

applies if the enterprise does not have a permanent establishment in the other country by virtue 

of any of the customary treaty standards. 

The proposed treaty provides that dividends, interest, royalties, and certain capital gains 

derived by a resident of either country from sources within the other country generally may be 

taxed by both countries (Articles 10, 11, 12, and 13); however, the rate of tax that the source 

country may impose on a resident of the other country on dividends, interest, and royalties may 

be limited by the proposed treaty (Articles 10, 11, and 12). Withholding tax on dividends is 

limited to 10 percent in most cases and is limited to five percent for dividends received by a 

company owning at least 10 percent of the dividend-paying company. A zero rate of 

withholding tax generally applies to dividends received by pension funds. In general, 

withholding tax on interest and royalties is limited to five percent under the proposed treaty. 

Under the proposed 2007 protocol, the treaty countries agree to reconsider source-country 

taxation of interest and royalties arising in Bulgaria and beneficially owned by a resident of the 

United States, at a time that is consistent with the December 31, 2014 conclusion of the transition 

period under a European Union Council Directive applicable to interest and royalties deemed to 

arise in Bulgaria and beneficially owned by a resident of the European Union. 

In situations in which the country of source retains the right under the proposed treaty to 

tax income derived by residents of the other country, the proposed treaty generally provides for 

relief from the potential double taxation, in the case of residents of the United States, through the 

allowance of a credit for foreign taxes paid to Bulgaria, and, in the case of residents of Bulgaria, 

through a combination of credits and exemptions (Article 22). 

The proposed treaty contains the standard provision (the “saving clause”) included in 

U.S. tax treaties pursuant to which each country retains the right to tax its residents and citizens 

as if the treaty had not come into effect (Article 1). In addition, the proposed treaty contains the 

standard provision providing that the treaty may not be applied to deny any taxpayer any benefits 

the taxpayer would be entitled under the domestic law of a country or under any other agreement 

between the two countries (Article 1). 
13

The proposed treaty includes the standard provision (Article 20) that assigns taxing 

jurisdiction over income not addressed in the other articles of the proposed treaty. In general, 

such income is taxable solely by the residence country. The proposed treaty provides authority 

for the two countries to exchange information (Article 25) in order to carry out the provisions of 

the proposed treaty. The proposed treaty also contains a detailed limitation-on-benefits provision 

to prevent the inappropriate use of the treaty by third-country residents (Article 21). 

Conclusion

These provisions and issues are all discussed in more detail in the Joint Committee staff 

pamphlets on the proposed protocol and treaties. I am happy to answer any questions that the 

Committee may have at this time or in the future.