EXPLANATION OF PROPOSED PROTOCOL

TO THE INCOME TAX TREATY BETWEEN

THE UNITED STATES AND THE NETHERLANDS

Scheduled for a Hearing

Before the

COMMITTEE ON FOREIGN RELATIONS

UNITED STATES SENATE

On September 24, 2004

____________

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

September 16, 2004

JCX-54-04
ii

CONTENTS

Page

INTRODUCTION .......................................................................................................................... 1

I. SUMMARY................................................................................................................................. 2

II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL TRADE AND INVESTMENT 

AND U.S. TAX TREATIES........................................................................................................... 4

A. U.S. Tax Rules.................................................................................................................... 4

B. U.S. Tax Treaties................................................................................................................ 6

III. OVERVIEW OF TAXATION IN THE NETHERLANDS ..................................................... 8

A. National Income Taxes....................................................................................................... 8

B. International Aspects of Taxation in the Netherlands....................................................... 10

C. Other Taxes....................................................................................................................... 11

IV. THE UNITED STATES AND THE NETHERLANDS: CROSS-BORDER

INVESTMENT AND TRADE ..................................................................................................... 12

A. Introduction....................................................................................................................... 12

B. Overview of International Transactions Between the United States and the

Netherlands....................................................................................................................... 13

C. Trends in Current Account Income Flows Between the United States and the

Netherlands....................................................................................................................... 15

D. Trends in the Financial Account Between the United States and the Netherlands........... 23

E. Income Taxes and Withholding Taxes on Cross-Border Income Flows.......................... 32

F. Analyzing the Economic Effects of Protocols to Income Tax Treaties............................ 33

V. EXPLANATION OF PROPOSED PROTOCOL.................................................................... 34

Article 1. General Scope ...................................................................................................... 34

Article 2. Resident ............................................................................................................... 34

Article 3. Dividends............................................................................................................. 35

Article 4. Branch Tax........................................................................................................... 40

Article 5. Pension, Annuities, Alimony ............................................................................... 41

Article 6. Basis of Taxation ................................................................................................. 44

Article 7. Limitation on Benefits......................................................................................... 46

Article 8. Exchange of Information and Assistance and Support in Collection .................. 58

Article 9. Outdated References............................................................................................ 60

Article 10. Entry into Force ................................................................................................. 60
Page

iii

VI. ISSUES................................................................................................................................... 62

A. Zero Rate of Withholding Tax on Dividends from 80-Percent-Owned Subsidiaries....... 62

B. Expatriation to Avoid Tax by Former U.S. Citizens and Long-Term Residents.............. 67

C. Treaty Shopping................................................................................................................ 70

D. U.S. Model Income Tax Treaty ........................................................................................ 74
1

INTRODUCTION

This pamphlet,1 prepared by the staff of the Joint Committee on Taxation, describes the 

proposed protocol to the existing income tax treaty between the United States and the 

Netherlands (the “proposed protocol”).2 The proposed protocol was signed on March 8, 2004. 

The Senate Committee on Foreign Relations has scheduled a public hearing on the proposed 

protocol for September 24, 2004.3

Part I of the pamphlet provides a summary of the proposed protocol. Part II provides a 

brief overview of U.S. tax laws relating to international trade and investment and of U.S. income 

tax treaties in general. Part III contains a brief overview of the Netherlands tax laws. Part IV 

provides a discussion of investment and trade flows between the United States and the 

Netherlands. Part V contains an article-by-article explanation of the proposed protocol. Part VI 

contains a discussion of issues relating to the proposed protocol.

 

1

 This pamphlet may be cited as follows: Joint Committee on Taxation, Explanation of 

Proposed Protocol to the Income Tax Treaty Between the United States and the Netherlands 

(JCX-54-04), September 16, 2004. References to “the Code” are to the U.S. Internal Revenue 

Code of 1986, as amended.

2

 The proposed protocol is accompanied by official understandings implemented by an 

exchange of diplomatic notes (the “notes,” collectively).

3

 For a copy of the proposed protocol, see Senate Treaty Doc. 108-25.
2

I. SUMMARY

The principal purposes of the existing treaty between the United States and the 

Netherlands are to reduce or eliminate double taxation of income earned by residents of either 

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

the two countries. The existing treaty also is intended to promote close economic cooperation 

between the two countries and to eliminate possible barriers to trade and investment caused by 

overlapping taxing jurisdictions of the two countries.

The proposed protocol modifies several provisions in the existing treaty (signed in 1992 

and modified by protocol in 1993) to make it similar to more recent U.S. income tax treaties, the 

1996 U.S. model income tax treaty (“U.S. model”), and the 1992 model income tax treaty of the 

Organization for Economic Cooperation and Development, as updated (“OECD model”). 

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

deviations from these treaties and models.

The proposed protocol replaces Article 10 (Dividends) of the existing treaty with a new 

dividends article. This new article eliminates the withholding tax on certain intercompany 

dividends in cases in which an 80-percent ownership threshold is met. The new article preserves 

the maximum withholding tax rate of 15 percent on portfolio dividends, but provides a maximum 

withholding tax rate of five percent on dividends meeting a 10-percent ownership threshold. The 

proposed protocol also modifies Article 11 (Branch Tax) of the existing treaty to eliminate the 

branch profits tax for Dutch companies.

The proposed protocol replaces Article 26 (Limitation on Benefits) of the existing treaty 

with a new article that reflects the anti-treaty-shopping provisions included in the U.S. model and 

more recent U.S. income tax treaties. Unlike the U.S. model and more recent U.S. income tax 

treaties, the proposed protocol includes a new requirement that tests for “substantial presence” in 

the country of residence to prevent certain companies from qualifying for treaty benefits.

The proposed protocol amends Article 19 (Pensions, Annuities, Alimony) of the existing 

treaty to include new rules related to cross-border pension contributions. 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.

The proposed protocol expands the “saving clause” provision in Article 24 (Basis of 

Taxation) of the existing treaty to allow the United States to tax certain former long-term 

residents whose termination of residency has as one of its principal purposes the avoidance of 

tax. This provision generally allows the United States to apply special tax rules under section 

877 of the Code as amended in 1996. The proposed protocol also updates the existing treaty to 

include the rules in the U.S. model related to fiscally transparent entities.

The proposed protocol in effect modifies Article 30 (Exchange of Information) and 

Article 31 (Assistance and Support in Collection) to facilitate information exchange between the 

two countries. 
3

The proposed protocol updates Article 1 (General Scope) and Article 4 (Resident) of the 

existing treaty to bring it into conformity with the U.S. model and more recent U.S. income tax 

treaties.

Article 9 of the proposed protocol modifies outdated references in Article 2 (Taxes 

Covered), and updates Article 18 (Artistes and Athletes) and Article 22 (Students and Trainees) 

of the existing treaty to reflect the movement from the Netherlands guilder to the euro. 

Article 10 of the proposed protocol provides for the entry into force of the modifications 

made by the proposed protocol.
4

II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL TRADE

AND INVESTMENT AND U.S. TAX TREATIES

This overview briefly describes certain U.S. tax rules relating to foreign income and 

foreign persons that apply in the absence of a U.S. tax treaty. This overview also discusses the 

general objectives of U.S. tax treaties and describes some of the modifications to U.S. tax rules 

made by treaties.

A. U.S. Tax Rules

The United States taxes U.S. citizens, residents, and corporations on their worldwide 

income, whether derived in the United States or abroad. The United States generally taxes 

nonresident alien individuals and foreign corporations on all their income that is effectively 

connected with the conduct of a trade or business in the United States (sometimes referred to as 

“effectively connected income”). The United States also taxes nonresident alien individuals and 

foreign corporations on certain U.S.-source income that is not effectively connected with a U.S. 

trade or business.

Income of a nonresident alien individual or foreign corporation that is effectively

connected with the conduct of a trade or business in the United States generally is subject to U.S. 

tax in the same manner and at the same rates as income of a U.S. person. Deductions are allowed 

to the extent that they are related to effectively connected income. A foreign corporation also is 

subject to a flat 30-percent branch profits tax on its “dividend equivalent amount,” which is a 

measure of the effectively connected earnings and profits of the corporation that are removed in 

any year from the conduct of its U.S. trade or business. In addition, a foreign corporation is 

subject to a flat 30-percent branch-level excess interest tax on the excess of the amount of 

interest that is deducted by the foreign corporation in computing its effectively connected income 

over the amount of interest that is paid by its U.S. trade or business.

U.S.-source fixed or determinable annual or periodical income of a nonresident alien 

individual or foreign corporation (including, for example, interest, dividends, rents, royalties, 

salaries, and annuities) that is not effectively connected with the conduct of a U.S. trade or 

business is subject to U.S. tax at a rate of 30 percent of the gross amount paid. Certain insurance 

premiums earned by a nonresident alien individual or foreign corporation are subject to U.S. tax 

at a rate of one or four percent of the premiums. These taxes generally are collected by means of 

withholding.

Specific statutory exemptions from the 30-percent withholding tax are provided. For 

example, certain original issue discount and certain interest on deposits with banks or savings 

institutions are exempt from the 30-percent withholding tax. An exemption also is provided for 

certain interest paid on portfolio debt obligations. In addition, income of a foreign government 

or international organization from investments in U.S. securities is exempt from U.S. tax.

U.S.-source capital gains of a nonresident alien individual or a foreign corporation that 

are not effectively connected with a U.S. trade or business generally are exempt from U.S. tax, 

with two exceptions: (1) gains realized by a nonresident alien individual who is present in the 
5

United States for at least 183 days during the taxable year, and (2) certain gains from the 

disposition of interests in U.S. real property.

Rules are provided for the determination of the source of income. For example, interest 

and dividends paid by a U.S. citizen or resident or by a U.S. corporation generally are considered 

U.S.-source income. Conversely, dividends and interest paid by a foreign corporation generally 

are treated as foreign-source income. Special rules apply to treat as foreign-source income (in 

whole or in part) interest paid by certain U.S. corporations with foreign businesses and to treat as 

U.S.-source income (in whole or in part) dividends paid by certain foreign corporations with U.S. 

businesses. Rents and royalties paid for the use of property in the United States are considered 

U.S.-source income.

Because the United States taxes U.S. citizens, residents, and corporations on their 

worldwide income, double taxation of income can arise when income earned abroad by a U.S. 

person is taxed by the country in which the income is earned and also by the United States. The 

United States seeks to mitigate this double taxation generally by allowing U.S. persons to credit 

foreign income taxes paid against the U.S. tax imposed on their foreign-source income. A 

fundamental premise of the foreign tax credit is that it may not offset the U.S. tax liability on 

U.S.-source income. Therefore, the foreign tax credit provisions contain a limitation that ensures 

that the foreign tax credit offsets only the U.S. tax on foreign-source income. The foreign tax 

credit limitation generally is computed on a worldwide basis (as opposed to a “per-country” 

basis). The limitation is applied separately for certain classifications of income. In addition, a 

special limitation applies to the credit for foreign taxes imposed on foreign oil and gas extraction 

income.

For foreign tax credit purposes, a U.S. corporation that owns 10 percent or more of the 

voting stock of a foreign corporation and receives a dividend from the foreign corporation (or is 

otherwise required to include in its income earnings of the foreign corporation) is deemed to 

have paid a portion of the foreign income taxes paid by the foreign corporation on its 

accumulated earnings. The taxes deemed paid by the U.S. corporation are included in its total 

foreign taxes paid and its foreign tax credit limitation calculations for the year in which the 

dividend is received.
6

B. U.S. Tax Treaties

The traditional objectives of U.S. tax treaties have been the avoidance of international 

double taxation and the prevention of tax avoidance and evasion. Another related objective of 

U.S. tax treaties is the removal of the barriers to trade, capital flows, and commercial travel that 

may be caused by overlapping tax jurisdictions and by the burdens of complying with the tax 

laws of a jurisdiction when a person's contacts with, and income derived from, that jurisdiction 

are minimal. To a large extent, the treaty provisions designed to carry out these objectives 

supplement U.S. tax law provisions having the same objectives; treaty provisions modify the 

generally applicable statutory rules with provisions that take into account the particular tax 

system of the treaty partner.

The objective of limiting double taxation generally is accomplished in treaties through 

the agreement of each country to limit, in specified situations, its right to tax income earned from 

its territory by residents of the other country. For the most part, the various rate reductions and 

exemptions agreed to by the source country in treaties are premised on the assumption that the 

country of residence will tax the income at levels comparable to those imposed by the source 

country on its residents. Treaties also provide for the elimination of double taxation by requiring 

the residence country to allow a credit for taxes that the source country retains the right to 

impose under the treaty. In addition, in the case of certain types of income, treaties may provide 

for exemption by the residence country of income taxed by the source country.

Treaties define the term “resident” so that an individual or corporation generally will not 

be subject to tax as a resident by both of the countries. Treaties generally provide that neither 

country will tax business income derived by residents of the other country unless the business 

activities in the taxing jurisdiction are substantial enough to constitute a permanent establishment 

or fixed base in that jurisdiction. Treaties also contain commercial visitation exemptions under 

which individual residents of one country performing personal services in the other will not be 

required to pay tax in that other country unless their contacts exceed certain specified minimums 

(e.g., presence for a set number of days or earnings in excess of a specified amount). Treaties 

address passive income such as dividends, interest, and royalties from sources within one 

country derived by residents of the other country either by providing that such income is taxed 

only in the recipient's country of residence or by reducing the rate of the source country's 

withholding tax imposed on such income. In this regard, the United States agrees in its tax 

treaties to reduce its 30-percent withholding tax (or, in the case of some income, to eliminate it 

entirely) in return for reciprocal treatment by its treaty partner.

In its treaties, the United States, as a matter of policy, generally retains the right to tax its 

citizens and residents on their worldwide income as if the treaty had not come into effect. The 

United States also provides in its treaties that it will allow a credit against U.S. tax for income 

taxes paid to the treaty partners, subject to the various limitations of U.S. law.

The objective of preventing tax avoidance and evasion generally is accomplished in 

treaties by the agreement of each country to exchange tax-related information. Treaties generally 

provide for the exchange of information between the tax authorities of the two countries when 

such information is necessary for carrying out provisions of the treaty or of their domestic tax 

laws. The obligation to exchange information under the treaties typically does not require either 
7

country to carry out measures contrary to its laws or administrative practices or to supply 

information that is not obtainable under its laws or in the normal course of its administration or 

that would reveal trade secrets or other information the disclosure of which would be contrary to 

public policy. The Internal Revenue Service (the “IRS”), and the treaty partner's tax authorities, 

also can request specific tax information from a treaty partner. This can include information to 

be used in a criminal investigation or prosecution.

Administrative cooperation between countries is enhanced further under treaties by the 

inclusion of a “competent authority” mechanism to resolve double taxation problems arising in 

individual cases and, more generally, to facilitate consultation between tax officials of the two 

governments.

Treaties generally provide that neither country may subject nationals of the other country 

(or permanent establishments of enterprises of the other country) to taxation more burdensome 

than the tax it imposes on its own nationals (or on its own enterprises). Similarly, in general, 

neither treaty country may discriminate against enterprises owned by residents of the other 

country.

At times, residents of countries that do not have income tax treaties with the United 

States attempt to use a treaty between the United States and another country to avoid U.S. tax. 

To prevent third-country residents from obtaining treaty benefits intended for treaty country 

residents only, treaties generally contain an “anti-treaty shopping” provision that is designed to 

limit treaty benefits to bona fide residents of the two countries.
8

III. OVERVIEW OF TAXATION IN THE NETHERLANDS4

A. National Income Taxes

Overview

The Netherlands imposes individual income tax under the Income Tax Act of 2001 and 

corporate tax under the Companies Tax Act of 1969. Netherlands tax law uses a ‘source of 

income’ model. Only income derived from a ‘source’ is subject to taxation. Source income 

arises only in cases where a taxpayer undertakes an economic activity with the intent of deriving 

a benefit that can objectively be expected to materialize. As a result, activities that are unlikely 

to produce any positive amount of income (e.g., hobby farms, inventing) will not be deemed a 

source of income.

Individuals

Individuals resident in the Netherlands are taxed on their worldwide income. The income 

tax takes into account the origin of the income and distinguishes between three categories known 

as “boxes.” The income in each of the boxes is taxed at a different rate. The sum of the tax 

owed in each of the three boxes is the total income tax payable. 

Box 1 includes taxable income from wages, profits, social security benefits, and pensions. 

The individual income tax rates are combined with contributions for social security. Social 

security contributions are due only on income up to €29,543.5 The rate structure is progressive 

and extends from 33.4 percent for taxable income under €16,265 (this rate is comprised of one 

percent tax and 32.4 percent social security contributions) to 52 percent for marginal taxable 

income over €50,652. In addition to the income tax, income from employment is subject to the 

wages tax under the Wages Tax Act of 1964. Amounts withheld as wages tax are credited 

against any income tax due. 

Box 2 includes substantial business interests, the income from which is subject to a flat 

tax of 25 percent. A taxpayer is regarded as having a substantial interest in a company if the 

taxpayer, either alone or together with a fiscal partner,6 holds directly or indirectly, at least five 

percent of the company’s shares. Income from a substantial interest is the aggregate amount of 

dividends received and capital gains. 

 

4

 The information in this section relates to Dutch law and is based on the Joint 

Committee staff’s review of publicly available secondary sources, including in large part a 

publication of the Dutch government. See Dutch Ministry of Finance, Taxation in the 

Netherlands 2004.

5

 As of mid-September 2004, one euro was worth approximately $0.822743.

6

 Fiscal partners are spouses and registered partners.
9

Box 3 includes income from savings and investment and is taxed at a flat rate of 30 

percent. The tax is levied on an assumed yield of four percent, regardless of actual return. 

Investors thus pay 1.2 percent of their capital in taxes each year. Dividends are subject to a 

withholding tax of 25 percent (which is creditable against the income tax liability of residents 

and those of nonresidents where the dividend is attributable to Dutch-source income for which 

they are subject to ordinary taxation).

Corporations

Entities resident in the Netherlands are subject to corporate income tax on their 

worldwide income. All income earned by companies is deemed to be business income. 

Corporate income tax is levied at a rate of 29 percent on the first €22,689 of taxable profits and 

at 34.5 percent on the excess.7 Losses may be carried forward and deducted from profits in a 

subsequent year. Profits distributed to shareholders are not deductible from taxable profits for 

purposes of the corporate income tax. A company distributing dividends is required to withhold 

tax at a rate of 25 percent. The tax withheld is creditable against the dividend recipient’s 

individual income tax liability (usually classified as capital income in Box 3). There is no 

withholding on interest and royalty payments.

The Companies Income Tax Act provides for a participation exemption, which is 

applicable to both domestic and foreign shareholdings. Corporate tax need not be paid on the 

profits generated by the participation. The exemption allows for the avoidance of double 

taxation when the profits of a subsidiary are distributed to its parent company. A participation 

exists if the taxpayer (1) holds at least five percent of the nominal paid-up capital of a company, 

or (2) holds less than five percent, but ownership of the shares is necessary for the conduct of 

normal business, or the acquisition of the shares serves a general interest. All profits gained 

from shareholdings are exempt from taxation unless shares in a foreign corporation are held as 

an investment or the foreign company in which the shares are held is not subject to tax on its 

profits in the foreign country. A 25 percent withholding tax is imposed on dividends from 

corporations resident in the Netherlands, unless the participation exemption applies. Dividends 

received from a qualifying subsidiary company are exempt from tax in the hands of the parent 

company. Similarly, capital gains realized on the disposition of shares of such a subsidiary 

company are exempt.

Under certain conditions a parent corporation may be taxed as a group together with one 

or more of its subsidiaries. Group taxation allows losses of one company to be set off against 

profits of another company, and fixed assets may be transferred tax-free from one company to 

another. Group taxation is allowed only if all the companies involved are based in the 

Netherlands for tax purposes and the parent company holds at least 95 percent of the shares in 

the subsidiary. 

 

7

 On August 19, 2004, the Netherlands government announced plans to cut the corporate 

tax rate from 34 percent to 31.5 percent. If approved, the plan to cut the corporate tax rate would 

go into effect in 2005. 
10

B. International Aspects of Taxation in the Netherlands

Individuals

As mentioned above, individuals resident in the Netherlands are taxed on their worldwide 

income. Nonresidents are only taxed on income received from the Netherlands. Nonresidents 

are subject to tax on substantial interest income (Box 2) only if the substantial interest is in a 

company resident in the Netherlands. For nonresident taxpayers, a company is deemed to be 

resident in the Netherlands if it meets the traditional test for residency (tests discussed below) or 

if it has been a resident for at least five of the last 10 years. Nonresidents are only taxed on 

savings and investment income (Box 3) generated by savings and investments in the 

Netherlands. The profit base is the value of assets in the Netherlands less the value of debts 

connected with the assets. Assets in the Netherlands include real estate (and rights to real estate) 

in the Netherlands and rights to shares in the profits of a company the management of which is 

established in the Netherlands.

Corporations

Companies established in the Netherlands are residents for tax purposes. Whether a 

company is deemed to be established in the Netherlands is based on factual circumstances. 

Relevant factors include the place of actual management, the head office location, and the place 

where the general shareholder meeting is held. Under the Corporate Income Tax Act, all 

companies incorporated under Dutch law are conclusively regarded as being established in the 

Netherlands. As mentioned above, all Dutch companies are subject to tax on their worldwide 

income. Nonresident companies are subject to Dutch corporate income tax on taxable income 

from an enterprise carrying on business in the Netherlands and on taxable income from a 

substantial interest in a company established in the Netherlands.

In line with the EU Parent-Subsidiary Directive of 1990, the participation exemption was 

extended in 1992 to apply to acquisitions of interests in companies established in other EU 

member states. Qualification for the exemption requires ownership of at least 25 percent of the 

company’s share capital, or in some instances, at least 25 percent of the company’s voting rights.

Relief from Double Taxation

Resident taxpayers (persons and entities) may avoid double taxation on their foreignsource income and profits by operation of a bilateral tax treaty, or if no such treaty exists, under 

the 2001 Unilateral Decree on the Avoidance of Double Taxation. 
11

C. Other Taxes

Inheritance, Gift, and Transfer Taxes

Inheritance tax is levied on assets (less any exemptions) acquired from the estate of an 

individual whose last place of residence was situated in the Netherlands. Tax rates depend upon 

the identity of the heir and the value of the property acquired. Gift tax is levied on the value of 

anything received by way of gift (less exemptions) from an individual resident in the 

Netherlands. A transfer tax is payable when certain domestic assets, such as real estate, pass by 

way of a gift from persons whose last place of residence was outside the Netherlands. There are 

no exemptions for the transfer tax. The rate structure for the gift tax and transfer tax parallels 

that of the inheritance tax. 

Indirect Taxes

The Netherlands imposes a value-added tax, known as BTW in the Netherlands, which is 

a general consumption tax levied on all private spending and included in the price consumers pay 

for goods and services. The general rate is 19 percent, but there are exemptions and special rates 

for certain goods and services. Excise duties are also levied on certain consumer goods, such as 

alcohol, tobacco, and oil. Taxes are also levied on legal transactions, which include the 

acquisition of real estate, the procurement of insurance, and the raising of capital by domestic 

companies. Environmental taxes are levied on water, waste, fuel, and energy.

 
12

IV. THE UNITED STATES AND THE NETHERLANDS:

CROSS-BORDER INVESTMENT AND TRADE

A. Introduction

A principal rationale for negotiating tax treaties is to improve the business climate for 

business persons in one country who might aspire to sell goods and services to customers in the 

other country and to improve the investment climate for investors in one country who might 

aspire to own assets in the other country. Clarifying the application of the two nations’ income 

tax laws makes more certain the tax burden that will arise from different transactions, but may 

also increase or decrease that burden. Where there is, or where there is the potential to be, 

substantial cross-border trade or investment, changes in the tax structure applicable to the income 

from trade and investment has the potential to alter future flows of trade and investment. 

Therefore, in reviewing the proposed protocol it may be beneficial to examine the cross-border 

trade and investment between the United States and the Netherlands.

When measuring by trade in goods or services or when measuring by direct and nondirect cross-border investment, the United States and the Netherlands are important components 

of each country’s current and financial accounts. In 2003, aggregate cross-border investment 

between the United States and the Netherlands totaled $13.2 billion. Substantial cross-border 

investment by persons in both countries over the years has resulted in cross-border income flows 

in excess of $25 billion (real 2003 dollars) annually since 1997. The income from cross-border 

trade and investment generally is subject to income tax in either the United States or the 

Netherlands and in many cases the income is subject to withholding taxes. 
13

B. Overview of International Transactions Between

the United States and the Netherlands

The value of trade between the United States and the Netherlands is large. In 2003, the 

United States exported $28.4 billion of goods and services to the Netherlands and imported $18.1 

billion in goods and services from the Netherlands.8 These figures represent 10.6 percent of all 

exports from the United States and 4.6 percent of all imports into the United States. Similarly, 

the value of cross-border investment, U.S. investments in the Netherlands and Dutch investments 

in the United States is large. In 2003, U.S. investments in the Netherlands increased by $11.0 

billion and Dutch investments in the United States increased by $2.2 billion.9 The increase in 

U.S. investments in the Netherlands represents 7.9 percent of the increase in all U.S. assets 

abroad in 2003. The increase in Dutch-owned U.S. assets represents one percent of the increase 

in all foreign-owned assets in the United States in 2003. Table 1, below, summarizes the 

international transactions between the United States and the Netherlands in 2003.

Table 1 presents the balance of payments accounts between the United States and the 

Netherlands. Two primary components comprise the balance of payments account: the current 

account and the financial account.10 The current account measures flows of receipts from the 

current trade in goods and services between the United States and the Netherlands and the flow 

of income receipts from investments by U.S. persons in the Netherlands and by Dutch persons in 

the United States. The financial account measures the change in U.S. investment in the 

Netherlands and the change in Dutch investment in the United States.

 

8

 Bureau of Economic Analysis, U.S. Department of Commerce, Data Release June 18, 

2004. Reported figures represent the Bureau of Economic Analysis’s preliminary estimates.

9

 Ibid.

10 Prior to 1999, the U.S. Department of Commerce, Bureau of Economic Analysis 

reported and described international transactions by reference to the “current account” and the 

“capital account.” Beginning in June 1999 the Bureau of Economic Analysis adopted a threegroup classification to make U.S. data reporting more closely aligned with international 

guidelines. The three groups are labeled, as in Table 1: current account; capital account; and 

financial account. Under this regrouping, the “financial account” encompasses all transactions 

that used to fall into the old “capital account,” so that the financial account measures U.S. 

investment abroad and foreign investment in the United States. The new (post-1999) system 

redefines the “current account” by removing a small part of the old measure of unilateral 

transfers and including it in the newly defined “capital account.” The newly defined capital 

account consists of capital transfers and the acquisition and disposal of non-produced, nonfinancial assets. For example, the newly defined capital account includes such transactions as 

forgiveness of foreign debt, migrants’ transfers of goods and financial assets when entering or 

leaving the country, transfers to title to fixed assets, and the acquisition and disposal of nonproduced assets such as natural resource rights, patents, copyrights, and leases. In practice, the 

Bureau of Economic Analysis believes the newly defined “capital account” transactions will be 

small in comparison to the current account and financial account.
14

Table 1.–International Transactions Between the United States and the Netherlands, 2003

($ billions, nominal)

Current Account Balance

Exports of Goods and Services from the United States and income receipts 

from the Netherlands

Merchandise

Services

Income receipts from U.S. assets in the Netherlands

Imports of goods and services from the Netherlands and income payments 

to the Netherlands

Merchandise

Services

Payments on Dutch-owned U.S. assets

17.2

48.2

20.5

7.9

19.9

29.8

11.5

6.6

11.7

Unilateral Transfers -1.3

Financial Account Balance

Dutch Investment in the United States

Direct Investment1

Private non-direct investment

Official

U.S. Investment in the Netherlands

Direct Investment

Private non-direct investment1

Increase in government assets

8.8

2.2

-0.6

n.a.2

n.a.2

11.0

15.0

-4.0

0.0

Capital Account Transactions, net 0.0

Statistical Discrepancy 8.4

Notes:

1 A negative number represents net dispositions of such assets.

2

 Foreign private holding and foreign official holdings of assets are combined in the data to avoid disclosure of 

holdings by foreign official agencies. The Bureau of Economic Analysis combines official asset holdings with other 

non-direct investment.

Source: Bureau of Economic Analysis, U.S. Department of Commerce, Data Release June 18, 2004.
15

C. Trends in Current Account Income Flows Between

the United States and the Netherlands

Payments of Royalties

As Table 1 displays, the current account consists of three primary components: trade in 

goods; trade in services; and payment of income on assets invested abroad. Numerous disparate 

activities comprise trade in services. Among the sources of receipts from exported services are 

payments for transportation of goods, travel by persons and passenger fares, payments for 

professional services such as management consulting, architecture, engineering, and legal 

services, financial services, insurance services, computer and information services, and film and 

television tape rentals. Also included in receipts for services are the returns from investments in 

intangible assets in the form of royalties and license fees. In 2003, U.S. persons received 

approximately $1.8 billion in royalty and license fees from the Netherlands. The $1.8 billion 

paid by Dutch persons accounted for 3.7 percent of all royalties and license fees paid to the 

United States in 2003. The Department of Commerce reports that in 2002 the Netherlands 

ranked as the eighth largest payor of royalties and license fees of all U.S. trading partners. More 

than two-thirds of such receipts received were paid to U.S. parents from their affiliates in the 

Netherlands.11 In 2003, Dutch persons received $1.7 billion in royalties and license fees from 

the United States. The $1.7 billion paid to Dutch persons constituted 8.5 percent of all royalties 

and license fees paid abroad by the United States. In 2002, the Netherlands was the fourth 

largest recipient of payments of royalties and license fees from the United States.12 Figure 1 

documents the cross-border payments of royalties and license fees between the United States and 

the Netherlands.13 Even with virtually no growth in such receipts to the United States over the 

past decade, the aggregate amount of such cross-border flows has grown from less than $1.0 

billion in 1986 (measured in real 2003 dollars) to more than $3.0 billion in 2003. 

 

11 Maria Borga and Michael Mann, “U.S. International Services: Cross-Border Trade in 

2002 and Sales Through Affiliates in 2001,” Survey of Current Business, vol. 83, October 2003, 

pp. 58-118, p. 92. The seven countries providing larger total payments of royalties and license 

fees in 2002 were Japan, the United Kingdom, Canada, Germany, Singapore, France, and 

Switzerland.

12

 Ibid, p. 93. Japan, Germany, and Switzerland received more total payments of 

royalties and license fees from the United States in 2002.

13 In Figure 1 through Figure 4 a solid line represents payments to the United States from 

the Netherlands and a heavy broken line represents payments from the United States to the 

Netherlands. Figure 1 and Figure 2 also have a lighter broken line representing the sum of 

payments from the Netherlands and from the United States.
Source: JCT tabulations of data from Bureau of Economic Analysis.

Figure 1.--U.S. and the Netherlands Payments of Royalties and License Fees, 1986-200

[Millions of Real 2003 Dollars]

0

500

1,0001,5002,0002,5003,0003,5004,000

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 

Year

[millions of dollars]

aggregate payments of royalties 

and license fees

U.S. receipts of royalties 

and license fees
17

Income receipts from investments

Overview

Figure 2 shows the growth in cross-border receipts between the United States and the 

Netherlands that has occurred in cross-border payments of income from Dutch assets owned by 

U.S. persons and from U.S. assets owned by Dutch persons. Measured in real dollars, income 

received by U.S. persons from the ownership of assets in the Netherlands has grown more than 

four and one half times since 1986. Over the same period, income received by Dutch persons 

from the ownership of assets in United States has grown almost two and one half times.
Source: JCT tabulations of data from Bureau of Economic Analysis.

Figure 2.--U.S. and the Netherlands Receipts of Income from Investments, 1986-2003

[Millions of Real 2003 Dollars]

0.0

5,000.0

10,000.015,000.020,000.025,000.030,000.035,000.040,000.0

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200

Year

[millions of dollars]

aggregate income payments

income pa

(to the Neth

income receipts

(from the Netherlands)
19

Income from direct investment and income from non-direct investment

Income from foreign assets is categorized as income from “direct investments” and 

income from “non-direct investments.” Direct investment constitutes assets over which the 

owner has direct control. The Department of Commerce defines an investment as direct when a 

single person owns or controls, directly or indirectly, at least 10 percent of the voting securities 

of a corporate enterprise or the equivalent interest in an unincorporated business. Often the 

income that crosses borders from direct investments is in the form of dividends from a subsidiary 

to a parent corporation, although interest on loans between such related corporations is another 

source of income from a direct investment. In non-direct investments the investor generally does 

not have control over the assets that underlie the financial claims. Non-direct investments 

consist mostly of holdings of corporate equities and corporate and government bonds, generally 

referred to as “portfolio investments,” and bank deposits and loans. Hence, the income from 

non-direct investments generally is interest or dividends. Dutch persons have substantial 

holdings of U.S. government bonds. Figure 3 shows the payments by the U.S. government to 

Dutch persons, largely interest on holdings of U.S. government bonds. Holdings of U.S. 

government bonds by Dutch persons have varied since 1986 and, as holdings have varied, 

interest received by Dutch persons has varied. Such payments totaled over $1.1 billion in 

2003.14 

 

14 Comparable data are not available for holdings of governmental bonds of the 

Netherlands by U.S. persons. The interest from U.S. holdings of governmental bonds of the 

Netherlands is included in portfolio income in Figure 4 below.
Source: JCT tabulations of data from Bureau of Economic Analysis.

Figure 3.--Real U.S. Government Payments to Dutch Persons, 1986-2003

[Millions of Real 2003 Dollars]

0

500

1,0001,5002,0002,500

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 

Year

[millions of dollars]
21

While the flow of income to the Netherlands from Dutch holdings of U.S. government 

bonds is significant, Dutch persons earn greater income both from direct investments in the 

United States and from private, portfolio (non-governmental) and other non-direct investments in 

the United States. Income received by Dutch persons from direct investments has exceeded 

income received by Dutch persons from payments by the U.S. Government in every year since 

1990, and over the past five years income from direct investments has averaged approximately 

four times the amount of income from U.S. Government payments. Income received by Dutch 

persons from private, portfolio and other non-direct investments has exceeded income received 

by Dutch persons from payments by the U.S. Government in every year since 1987, and over the 

past five years such income has averaged approximately twice the amount of income from U.S. 

Government payments. 

In 2003, the income received by Dutch persons from direct investments in the United 

States totaled $8.0 billion and the income received by Dutch persons from portfolio (nongovernmental) and other non-direct investments in the United States totaled $2.7 billion. In 

2003, the income of Dutch persons from direct investments in the United States was roughly 50 

percent of the income received by U.S. persons on their direct investments in the Netherlands, 

($8.0 billion compared to $15.8 billion). The income received by U.S. persons on their portfolio 

and other non-direct investments in the Netherlands ($4.1 billion in 2003), was roughly 50 

percent greater than the income received by Dutch persons from portfolio (non-governmental) 

and other non-direct investments in the United States ($2.7 billion in 2003). Figure 4 records the 

cross-border income flows from direct and portfolio and other non-direct investments between 

the United States and the Netherlands. 
Source: JCT tabulations of data from Bureau of Economic Analysis.

Figure 4.--U.S. and the Netherlands Income from Direct and Non-Direct Investments, 1986

[Millions of Real 2003 Dollars]

0

2,0004,0006,0008,000

10,00012,00014,00016,00018,000

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200

Year

[millions of dollars]

Direct investment income from Netherlands to U.S. Direct investment income from U.S. to Other private payments from Netherlands to U.S. Other private payments from U.S. to N
23

D. Trends in the Financial Account Between the United States

and the Netherlands

Overview

As discussed above, the current account of international transactions between the United 

States and the Netherlands records the current-year flow of receipts from current export of goods 

and services and the income flows arising from past investments. The financial account of 

international transactions between the United States and the Netherlands (the bottom portion of 

Table 1) measures the change in U.S ownership of Dutch assets and the change in Dutch 

ownership of U.S. assets. The importance of the financial account, as documented in preceding 

discussion, is that ownership of assets abroad generates future receipts of income. In 2003, 

aggregate cross-border investment between the United States and the Netherlands totaled $13.2 

billion. As Table 1 documented, in 2003 the United States’ financial account balance with the 

Netherlands was a positive $8.8 billion, i.e., in 2003, U.S. persons accumulated $8.8 billion more 

in additional assets in the Netherlands than Dutch persons accumulated in additional assets in the 

Netherlands. In the last half of the 1980s, Dutch persons accumulated U.S. assets at a greater 

rate than U.S. persons accumulated assets in the Netherlands. During the 1990s, U.S. persons 

accumulated assets in the Netherlands at a rate comparable to the rate of Dutch persons’ 

accumulation of assets in the United States. Figure 5, below, shows the annual change in U.S.-

owned Dutch assets and the annual change in Dutch-owned U.S. assets.15

Figure 6, Figure 7, Figure 8, and Figure 9 decompose these annual changes in asset 

ownership into direct investment and components of non-direct investment. 

 

15 In Figure 5 through Figure 9 a solid line indicates the net acquisition (purchase of 

assets, purchase of securities, bank deposit, or extension of credit) by U.S. persons of assets in 

the Netherlands, and a broken line indicates the net acquisition by Dutch persons of U.S. assets. 

If any line reports a negative number, there was a net disposition of such assets. 
Source: JCT tabulations of data from Bureau of Economic Analysis.

Figure 5.--U.S. and the Netherlands Financial Account Annual Change in Assets Owned, 198

[Millions of Real 2003 Dollars]

-30,000-20,000-10,000

0

10,00020,00030,00040,00050,00060,000

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200

[millions of dollars]

change in Dutch owned assets 

in the United States

change in U.S.-owned assets 

in the Netherlands
25

Changes in Direct Investment

Figure 6 reports the annual change in U.S. direct investment in the Netherlands and the 

annual change in Dutch direct investment in the United States since 1986. Almost all years since 

1986 have showed an increase in the amount of direct investment in assets of the one country by 

investors in the other country. The changes measured in direct investment occur because of 

increases or decreases in equity investment, changes in intra-company debt, the reinvestment of 

earnings, and currency valuation adjustments.

Total direct investment by U.S. persons in the Netherlands is large. Measured on an 

historical cost basis,16 the value of U.S. direct investment in the Netherlands as of the end of 

2003 was $178.9 billion. This comprised 10 percent of total U.S. direct investment overseas and 

represented the third largest U.S. direct investment position abroad in 2003 after the United 

Kingdom ($272.6 billion) and Canada ($192.4 billion).17 The value of Dutch direct investment 

in the United States is $146.1 billion. This comprised 10.6 percent of total foreign direct 

investment in the United States and represented the fourth largest foreign direct investment 

position in the United States after the United Kingdom ($230.4 billion), Japan ($159.3 billion), 

and Germany ($148.8 billion).18 

 

16 The Bureau of Economic Analysis prepares detailed estimates of direct investment by 

country and industry on an historical cost basis only. Thus, the estimates reported reflect price 

levels of earlier periods. For estimates of aggregate direct investment the Bureau of Economic 

Analysis also produces current-cost and market value estimates.

17 Maria Borga and Daniel R. Yorgason, “Direct Investment Positions for 2003: Country 

and Industry Detail,” Survey of Current Business, vol. 84, July 2004, pp. 40-51.

18

 Ibid.
Source: JCT tabulations of data from Bureau of Ecomomic Analysis.

Figure 6.--Change in U.S. and the Netherlands Direct Investment, 1986-2003

[Millions of Real 2003 Dollars]

-10,000

0

10,00020,00030,00040,00050,000

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200

[millions of dollars]

change in Dutch direct investment

in the U.S.

change in U.S. direct investment

in the Netherlands
27

Changes in Non-Direct Investment

Non-direct investment generally may be thought of as consisting of two components, 

portfolio investment, that is, the purchase of securities, and lending activities. Figure 7 reports 

the annual change in the holdings of Dutch securities (stocks and bonds) by U.S. persons and the 

annual change in the holdings of U.S. securities (other than Treasury securities) by Dutch 

persons. In 2003, U.S. holdings of Dutch stocks and bonds decreased by $1.1 billion to a yearend estimated value of $147.5 billion.19 Of this total, Dutch stocks account for $119.9 billion 

and Dutch bonds account for $27.6 billion.20 Among U.S. holdings of foreign stocks, the value 

of Dutch stock held is fifth after holdings of U.K. equities, Japanese equities, Bermudan equities, 

and French equities by U.S. persons.21 Dutch holdings of U.S. securities (other than Treasury 

securities) decreased by $4.2 billion in 2003, so that at the end of 2003, Dutch persons held 

$118.7 billion of U.S. corporate stocks and $28.7 billion of U.S. corporate bonds and the bonds 

of certain Federal agencies (other than general obligation Treasury bonds). In the case of 

equities, these holdings comprised 7.7 percent of total foreign holdings of U.S. equities and 

represented the fourth largest holdings of stocks, after the United Kingdom, Canada, and Japan. 

In the case of bonds, these holdings comprised 1.5 percent of total foreign holdings of such 

bonds and represented the fifth largest holdings of corporate and agency bonds, after the United 

Kingdom, Japan, Canada, and Germany.22

 

19 Patricia E. Abaroa, “The International Investment Position of the United States at Year 

end 2003,” Survey of Current Business, vol. 84, July 2004, pp. 30-39.

20

 Ibid.

21

 Ibid. Among U.S. holdings of foreign bonds, U.S. holdings of Dutch bonds is seventh 

in size after holdings of Canadian, British, German, French, Cayman Island, and Japanese bonds.

22

 Ibid.
Source: JCT tabulations of data from Bureau of Economic Analysis.

Figure 7.--Change in U.S. and the Netherlands Ownership of Portfolio Securities, 1986-2

[Millions of Real 2003 Dollars]

-10,000

-5,000

0

5,000

10,00015,00020,000

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200

[millions of dollars]

change in Dutch portfolio 

ownership of U.S. securities

change in U.S. portfolio 

ownership of Dutch securities
29

Lending activities, aside from the sale of debt securities, constitute the remaining source 

of non-direct cross-border investment. When a U.S. bank makes a loan to a foreign person 

abroad (including a foreign subsidiary), the U.S. bank is making a foreign investment. Non-bank 

U.S. persons also make foreign investments through lending activities. When a non-bank U.S. 

person makes a deposit in a foreign bank, the non-bank U.S. person is making a foreign 

investment. Likewise if a U.S. business draws on a line of credit from a bank in the Netherlands, 

the Dutch bank is making an investment in the United States. Such deposit and borrowing 

activity can be quite variable and changes in exchange rates and business activity abroad may 

lead to substantial variability in the annual level of such activity. Figure 8 indicates that neither 

deposits by non-banking U.S. persons in Dutch banks nor borrowing by non-banking U.S. 

persons from Dutch persons have displayed a definite trend since 1986. 

Figure 9 reports cross-border investment activity between the United States and the 

Netherlands by U.S. banks, including intra-affiliate loans. The solid line in Figure 9 displays no 

discernible trend since 1986 in lending by U.S. banks to the Netherlands. The broken line in 

Figure 9 includes data on U.S. bank borrowing from Dutch affiliates and deposits accepted from 

Dutch persons. However, in Figure 9, the broken line also includes annual changes in Dutch 

holdings of U.S. Treasury securities. As with U.S. bank lending activity, no discernible trend is 

evident. 
Source: JCT tabulations of data from Bureau of Economic Analysis.

Figure 8.--Change in U.S. and the Netherlands Non-Direct Investment

by Persons Other Than Banks, 1986-2003

[Millions of Real 2003 Dollars]

-15,000-10,000

-5,000

0

5,000

10,00015,000

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200

[millions of dollars]

change in U.S. non-bank 

borrowing from Dutch persons

change in Dutch nonbank 

borrowing from the U.S.
Source: JCT tabulations of data from Bureau of Economic Analysis.

Figure 9.--Change in U.S. and the Netherlands Non-Direct Investment by Banks, 1986-20

[Millions of Real 2003 Dollars]

-25,000-20,000-15,000-10,000

-5,000

0

5,000

10,00015,000

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200

[millions of dollars]

change in liabilities of U.S. 

persons to Dutch banks, and 

other nondirect investment 

in the U.S.

change in U.S. bank claims on 

Dutch persons, and other 

nondirect investments

in the Netherlands
32

E. Income Taxes and Withholding Taxes on Cross-Border Income Flows

The data presented above show that U.S. persons own a substantial amount of direct 

investment in the Netherlands and Dutch persons own a substantial amount of direct investment 

in the United States. Data from tax returns reflect the substantial magnitudes of cross-border 

investment and trade and income flows reported above. In 2000, U.S. corporations with Dutch 

parent companies had $11 billion of income subject to tax and paid $3 billion in U.S. Federal 

income taxes. U.S. corporations, including U.S. parent companies of Dutch controlled foreign 

corporations, reported the receipt of $12 billion of dividends from Dutch corporations in 1999. 

Of the $12 billion in dividends reported, approximately $3 billion reflected the grossed up value 

of net dividends to account for deemed taxes paid to the Netherlands. U.S. corporations 

recognized about $15 billion in taxable income originating in the Netherlands, including the 

dividend amounts just cited. This income was subject to an average Dutch corporate income tax 

rate of approximately 21 percent. 

Data for withholding taxes from the late 1990s show that the Netherlands and the United 

States collected approximately the same amounts of receipts, between $100 million and $200 

million annually, by withholding tax on respective payments to each other.23 The data suggest 

that controlled foreign corporations from each nation repatriated about the same amount, 50 

percent, of current corporate earnings and profits. However, data from withholding taxes may be 

an inaccurate indicator of cross-border investment and income flows. With respect to dividend 

income from direct investments, a taxpayer can often control the amount and timing of tax paid, 

because a taxpayer only pays withholding tax when dividends are repatriated to the home 

country.

 

23 For example, data for 1999 show that the United States collected $155 million from 

withholding tax on all U.S. payments to the Netherlands. Statistics of Income Division, Internal 

Revenue Service, “Foreign Recipients of U.S. Income, 1998 and 1999,” SOI Bulletin, vol. 22, 

Summer 2002, p. 213. Data for 1999 also show that the Netherlands collected $105 million from 

withholding tax on Dutch payments to U.S. corporations filing Form 1118. This latter figure 

understates total Dutch collections because it only relates to payment to certain U.S. corporations 

and not all payments, but this difference is insubstantial. Brian Raub, “Corporate Foreign Tax 

Credit, 1999,” SOI Bulletin, vol. 23, Fall 2003, pp. 269-72.
33

F. Analyzing the Economic Effects of Protocols to Income Tax Treaties

Among other things, tax treaties often change both the amount and timing of income 

taxes and the country (source or residence) that has priority to impose such taxes. If the tax treaty 

changes increase the after-tax return to cross-border trade and investment, or to particular forms 

of trade or investment, in the long run there could be significant tax effects. Generally, to the 

extent a treaty reduces barriers to capital and labor mobility, more efficient use of resources will 

result and economic growth in both countries will be enhanced, although there may be negative 

transitional effects occurring in specific industries or geographic regions. On the other hand, tax 

treaties may also lead to tax base erosion if they create new opportunities for tax arbitrage. Tax 

treaties also often increase and improve information sharing between tax authorities. 

Improvements in information sharing and the limitation of benefits provision should reduce the 

potential for outright evasion of U.S. and Dutch income tax liabilities.

Generally, a treaty-based reduction in withholding rates will reduce directly U.S. tax 

collections in the near term on payments from the United States to the Netherlands, but will 

increase U.S. tax collections on payments from the Netherlands to the United States because of 

the reduction in foreign taxes that are potentially creditable against the U.S. income tax. To the 

extent that the withholding rate reduction encourages more income flows between the treaty 

parties, this initial dampening of collections on payments to the Netherlands and related decrease 

in foreign tax credits will begin to reverse. The protocol’s reductions in dividend withholding 

rates will reduce U.S. withholding tax collections on dividend payments from the United States 

to the Netherlands. At the same time, the reduction in Dutch withholding taxes will create a 

roughly equivalent reduction occurring in Dutch taxes available for crediting against U.S. tax, 

again assuming no change in the amount of such payments. Over the longer term, the 

withholding tax rate changes coupled with other changes in the protocol are likely to cause small 

revenue increases in later years as capital flows increase and from improved allocation of capital.

However, this simple analysis is incomplete. A complete analysis of a withholding 

change, or any other change in a treaty, would account for both tax and non-tax related factors, 

such as portfolio capital needs in the affected countries, and the corresponding relation between 

current and financial accounts. The potential for future growth in each country is an important 

determinant of cross-border investment decisions. In sum, even in the short run, the larger 

macroeconomic outlook, compared to treaty modifications, is likely to be a more important 

determinant of future cross-border income and investment flows and the related tax collections.
34

V. EXPLANATION OF PROPOSED PROTOCOL

Article 1. General Scope

Article 1 of the proposed protocol amends Article 1 (General Scope) of the present treaty 

to take account of mutual agreement procedures and non-discrimination procedures under other 

agreements, in particular, the General Agreement on Trade in Services (“GATS”). The 

provisions added by the proposed protocol constitute an exception to the rule in Article 1 of the 

present treaty that the treaty shall not restrict any exclusion, exemption, deduction, credit, or 

other allowance now accorded by the laws of the United States or the Netherlands or by any 

other agreement between them.

The proposed protocol provides that, notwithstanding any other agreement to which the 

United States and the Netherlands may be parties, a dispute about the interpretation or 

application of the treaty, including whether a taxation measure is within the scope of the treaty, is 

determined exclusively as provided under Article 29 (Mutual Agreement Procedure) of the 

present treaty. 

The proposed protocol further provides specifically that the provisions of Article XVII of 

GATS (relating to national treatment) shall not apply to a taxation measure unless the competent 

authorities agree that the measure is not within the scope of Article 28 (Non-Discrimination) of 

the present treaty. For this purpose, a measure means a law, regulation, rule, procedure, 

decision, administrative action, or any similar provision or action. The Technical Explanation to 

the proposed protocol points out that consequently, no national treatment obligation undertaken 

by the United States or the Netherlands under GATS applies to a taxation measure unless the 

competent authorities agree, and that this result imposes no limitation on the most favored nation 

obligation under GATS because the present treaty and the proposed protocol include no most 

favored nation obligation. The Technical Explanation further notes that this provision of the 

proposed protocol applies specifically to GATS; in the event benefits are available to a United 

States or Netherlands resident under other agreements that are not available under Article 28 

(Non-Discrimination) of the present treaty, the proposed protocol does not limit those benefits. 

Article 2. Resident

The proposed protocol modifies Article 4 (Resident) of the present treaty. The proposed 

protocol eliminates from Article 4 of the present treaty a rule relating to the residence of estates 

and trusts. The treatment of such entities is determined under Article 6 of the proposed protocol 

(Basis of Taxation) as it relates to fiscally transparent entities.24

The proposed protocol does not otherwise alter the residence provisions of the present

treaty. However, the notes accompanying the proposed protocol refer to the treatment of dual 

resident companies under the residence provisions of the present treaty. The notes provide that a 

company that is or would be a resident of either the United States or the Netherlands under that 

 

24

 See the discussion of fiscally transparent entities under Article 6, infra, in this 

pamphlet.
35

country's domestic law is not treated as a resident of the country under the proposed protocol, if 

it is treated as a resident of a third country under a treaty between the third country and the 

United States or the Netherlands. The Technical Explanation gives as an example the case of a 

company organized in the Netherlands and managed and controlled in the United Kingdom. 

Although both the Netherlands and the United Kingdom would treat the company as a resident 

under its domestic law, the treaty between the Netherlands and the United Kingdom treats such a 

company as resident in the United Kingdom (the place of effective management). Thus, the 

company would not be eligible for benefits under the proposed protocol because it is not subject 

to tax as a resident in the Netherlands. The Technical Explanation states that this result confirms 

the result of Rev. Rul. 2004-76.25

Article 3. Dividends

The proposed protocol replaces Article 10 (Dividends) of the present treaty with a new 

dividend article that generally provides for full residence country taxation and limited source 

country taxation of dividends. The proposed protocol would retain the maximum rate of 

withholding at source of 15 percent and would provide for a five percent maximum rate for 

dividends from 10-percent owned corporations. It also would provide for a new zero rate of 

withholding tax on dividends from certain direct investments. Special rules are provided for 

dividends from regulated investment companies, real estate investment trusts, and similar Dutch 

entities.

Internal taxation rules

United States.–The United States generally imposes a 30-percent tax on the gross amount 

of U.S.-source dividends paid to nonresident alien individuals and foreign corporations. The 

30-percent tax does not apply if the foreign recipient is engaged in a trade or business in the 

United States and the dividends are effectively connected with that trade or business. In such a 

case, the foreign recipient is subject to U.S. tax on such dividends on a net basis at graduated 

rates in the same manner that a U.S. person would be taxed.

Under U.S. law, the term dividend generally means any distribution of property made by 

a corporation to its shareholders from current or accumulated earnings and profits. However, 

liquidating distributions generally are treated as payments in exchange for stock and, thus, are 

not subject to the 30-percent withholding tax described above (see discussion of capital gains in 

connection with Article 13 below).

 

25 2004-31 I.R.B. 111. In Rev. Rul. 2004-76, the Internal Revenue Service ruled, “[i]f 

Corporation A is treated as a resident of Country Y and not of Country X for purposes of the XY Convention and, as a result, is not liable to tax in Country X by reason of its residence, it is not 

entitled to claim benefits under the U.S.-X Convention, because it is not a resident of Country X 

under the relevant article of the U.S.-X Convention. However, Corporation A is entitled to claim 

benefits under the U.S.-Y Convention as a resident of Country Y, if it satisfies the requirements 

of the applicable limitation on benefits article, if any, and other applicable requirements in order 

to receive benefits under the U.S.-Y Convention.”
36

Dividends paid by a U.S. corporation generally are U.S.-source income. Also treated as 

U.S.-source dividends for this purpose are portions of certain dividends paid by a foreign 

corporation that conducts a U.S. trade or business. The U.S. 30-percent withholding tax imposed 

on the U.S.-source portion of the dividends paid by a foreign corporation is referred to as the 

“second-level” withholding tax. This second-level withholding tax is imposed only if a treaty 

prevents application of the statutory branch profits tax.

In general, corporations are not entitled under U.S. law to a deduction for dividends paid. 

Thus, the withholding tax on dividends theoretically represents imposition of a second level of 

tax on corporate taxable income. Treaty reductions of this tax reflect the view that where the 

United States already imposes corporate-level tax on the earnings of a U.S. corporation, a 

30-percent withholding rate may represent an excessive level of source-country taxation. 

Moreover, the reduced rate of tax often applied by treaty to dividends paid to direct investors 

reflects the view that the source-country tax on payments of profits to a substantial foreign 

corporate shareholder may properly be reduced further to avoid double corporate-level taxation

and to facilitate international investment.

A real estate investment trust (“REIT”) is a corporation, trust, or association that is 

subject to the regular corporate income tax, but that receives a deduction for dividends paid to its 

shareholders if certain conditions are met. In order to qualify for the deduction for dividends 

paid, a REIT must distribute most of its income. Thus, a REIT is treated, in essence, as a conduit 

for federal income tax purposes. Because a REIT is taxable as a U.S. corporation, a distribution 

of its earnings is treated as a dividend rather than income of the same type as the underlying 

earnings. Such distributions are subject to the U.S. 30-percent withholding tax when paid to 

foreign owners.

A REIT is organized to allow persons to diversify ownership in primarily passive real 

estate investments. As such, the principal income of a REIT often is rentals from real estate 

holdings. Like dividends, U.S.-source rental income of foreign persons generally is subject to 

the 30-percent withholding tax (unless the recipient makes an election to have such rental income 

taxed in the United States on a net basis at the regular graduated rates). Unlike the withholding 

tax on dividends, however, the withholding tax on rental income generally is not reduced in U.S. 

income tax treaties.

U.S. internal law also generally treats a regulated investment company (“RIC”) as both a 

corporation and a conduit for income tax purposes. The purpose of a RIC is to allow investors to 

hold a diversified portfolio of securities. Thus, the holder of stock in a RIC may be characterized 

as a portfolio investor in the stock held by the RIC, regardless of the proportion of the RIC’s 

stock owned by the dividend recipient.

The Netherlands.–The Netherlands generally imposes a 25-percent withholding tax on 

dividend payments to nonresidents. The withholding tax is creditable against the income tax 

liability of nonresidents where the dividend is attributable to Dutch-source income for which 

they are subject to ordinary taxation.
37

Proposed protocol limitations on internal law

In general.–Under the proposed protocol, dividends paid by a company that is a resident 

of a treaty country to a resident of the other country may be taxed in such other country. Such 

dividends also may be taxed by the country in which the payor company is resident, but the rate 

of such tax is limited. Under the proposed protocol, source-country taxation of dividends (i.e., 

taxation by the country in which the dividend-paying company is resident) generally is limited to 

15 percent of the gross amount of the dividends paid to residents of the other treaty country. A 

lower rate of five percent applies if the beneficial owner of the dividend is a company that owns 

at least 10 percent of the voting stock of the dividend-paying company.

The term “beneficial owner” is not defined in the current treaty or proposed protocol and, 

thus, is defined under the internal law of the source country. The Technical Explanation states 

that the beneficial owner of a dividend for purposes of this article is the person to which the 

dividend income is attributable for tax purposes under the laws of the source country. Further, 

companies holding shares through fiscally transparent entities, such as partnerships, are 

considered to hold their proportionate interest in the shares. Consistent with internal U.S. tax 

law,26 the notes provide that a securities lender that receives from the borrower payments in 

amounts that are equivalent to dividend distributions made with respect to the loaned shares is 

treated as the beneficial owner of the dividend paid with respect to such shares for purposes of 

this article.

In addition, the proposed protocol provides a zero rate of withholding tax with respect to 

certain intercompany dividends in cases in which there is a sufficiently high (80-percent) level of 

ownership (often referred to as “direct dividends”). The zero rate also would apply with respect 

to dividends received by a tax-exempt pension fund, provided that such dividends are not derived 

from the carrying on of a business, directly or indirectly, by such fund.

Zero rate for direct dividends.–Under the proposed protocol, the withholding tax rate is 

reduced to zero on dividends beneficially and directly owned by a company that has owned at 

least 80 percent of the voting power of the company paying the dividend for the 12-month period 

ending on the date the dividend is declared (subparagraph 3 of Article 10 (Dividends)). Under 

the current treaty, these dividends may be taxed at a five percent rate.

In certain circumstances, eligibility for the zero rate under the proposed protocol is 

subject to an additional restriction designed to prevent companies from reorganizing for the 

purpose of obtaining the benefits of the provision. Specifically, in cases in which a company 

satisfies the Limitation on Benefits article only under the “ownership/base-erosion,” “active trade 

or business,” “headquarters company,” and/or “shipping/air transport” tests (subparagraph 2(f) 

and paragraphs 4, 5 and 6, respectively, of Article 26 (Limitation on Benefits)), the zero rate will 

apply only if the dividend-receiving company owned (directly or indirectly) at least 80 percent of 

 

26 Treas. Reg. secs. 1.861-2(a)(7), 1.861-3(a)(6), 1.871-7(b)(2), and 1.881-2(b)(2); 

Notice 97-66, 1997-2 C.B. 328.
38

the voting power of the dividend-paying company prior to October 1, 1998.27 In other cases, the 

Limitation on Benefits article itself is considered sufficient to prevent treaty shopping. Thus, 

companies that qualify for treaty benefits under the “public trading,” “derivative benefits,” or 

discretionary tests (subparagraph 2(c) and paragraphs 3 and 7, respectively, of Article 26 

(Limitation on Benefits)) will not need to meet the October 1, 1998 holding requirement in order 

to claim the zero rate.

Dividends paid by U.S. RICs and REITs and similar Dutch entities.–The proposed 

protocol generally denies the five percent and zero rates of withholding tax to dividends paid by 

RICs and REITs in the United States and beleggingsinstellings in the Netherlands.

The 15-percent rate of withholding generally is allowed for dividends paid by a RIC or a 

Dutch beleggingsinstelling (subject to a special rule for beleggingsinstellings that invest 

primarily in real estate). The 15-percent rate of withholding is allowed for dividends paid by a 

REIT or a Dutch beleggingsinstelling that invests in real estate to the same extent as a REIT, 

provided any one of four additional conditions is met: (1) the person beneficially entitled to the 

dividend must be an individual holding an interest of not more than 25 percent in the REIT or 

beleggingsinstelling; (2) the dividend must be paid with respect to a class of stock that is publicly 

traded and the person beneficially entitled to the dividend is a person holding an interest of not 

more than five percent of any class of stock of the REIT or beleggingsinstelling; (3) the person 

beneficially entitled to the dividend must hold an interest in the REIT or beleggingsinstelling of 

not more than 10 percent and the REIT or beleggingsinstelling is “diversified” (i.e., the gross 

value of no single interest in real property held by the REIT or beleggingsinstelling exceeds 10 

percent of the gross value of the total interest of the REIT or beleggingsinstelling in real 

property); or (4) the dividend must be paid by a REIT to a beleggingsinstelling or by a 

beleggingsinstelling to a RIC or a REIT.

The Technical Explanation indicates that the restrictions on availability of the lower rates 

are intended to prevent the use of RICs and REITs in the United States and beleggingsinstellings 

in the Netherlands to gain unjustifiable source-country benefits for certain shareholders resident 

in the other country. For example, a company resident in the Netherlands could directly own a 

diversified portfolio of U.S. corporate shares and pay a U.S. withholding tax of 15 percent on 

dividends on those shares. Absent these restrictions, there is a concern that such a company 

could purchase 10 percent or more of the interests in a RIC, which could even be established as a 

mere conduit, and thus obtain a lower withholding rate by holding a similar portfolio through the 

RIC (transforming portfolio dividends generally taxable at 15 percent into direct investment 

dividends taxable under the treaty at zero or five percent).

Similarly, the Technical Explanation provides an example of a resident of the 

Netherlands directly holding real property and required to pay U.S. tax either at a 30 percent rate 

 

27 It is understood that this is the date on which the Treasury Department announced that 

it was negotiating a zero rate of withholding with the United Kingdom, the first instance in 

which the United States was negotiating a zero rate. A similar restriction referring to this date 

now is contained in the income tax treaty with the United Kingdom, which the Senate ratified in 

2003.
39

on gross income or at graduated rates on the net income. By placing the property in a REIT, the 

investor could transform real estate income into dividend income, taxable at the lower rates 

provided in the proposed protocol. The limitations on REIT dividend benefits are intended to 

protect against this result.

Special rules and limitations.–The proposed protocol’s reduced rates of tax on dividends 

do not apply if the dividend recipient carries on business through a permanent establishment in 

the source country, or performs in the source country independent personal services from a fixed 

base located in that country, and the holding in respect of which the dividends are paid is 

effectively connected with such permanent establishment or fixed base. In such cases, the 

dividends effectively connected to the permanent establishment or the fixed base are taxed as 

business profits (Article 7) or income from independent personal services (Article 15), as the 

case may be. In the case of a permanent establishment that once existed, but that no longer 

exists, the “saving clause” (Article 24 (Basis of Taxation)), as amended by the proposed 

protocol, provides that this rule also applies to dividends that would be attributable to such a 

permanent establishment if it did exist in the year of payment or accrual.

The proposed protocol prevents the United States from imposing a tax on dividends paid 

by a Dutch company unless such dividends are paid to a resident of the United States or are 

attributable to a permanent establishment in the United States. Thus, this provision generally 

overrides the ability of the United States to impose a “second-level” withholding tax on the U.S.-

source portion of dividends paid by a Dutch corporation. The proposed protocol also restricts the 

United States from imposing corporate level taxes on undistributed profits, other than a branch 

profits tax.

The proposed protocol generally defines “dividends” as income from shares (or other 

corporate participation rights that are not treated as debt under the law of the source country), as 

well as other amounts that are subjected to the same tax treatment as income from shares by the 

source country (e.g., constructive dividends). 

Relation to other Articles

The Technical Explanation notes that the saving clause of paragraph 1 of Article 24 

(Basis of Taxation) permits the United States to tax dividends received by its residents and 

citizens, subject to the special foreign tax credit rules of paragraph 6 of Article 25 (Methods of 

Elimination of Double Taxation), as if the proposed protocol had not come into effect.

The benefits of the dividends article are also subject to the provisions of Article 26 

(Limitation on Benefits). Thus, if a resident of the Netherlands is the beneficial owner of 

dividends paid by a U.S. company, the shareholder must qualify for treaty benefits under at least 

one of the tests of Article 26 in order to receive the benefits of this article.
40

Article 4. Branch Tax

Internal taxation rules

United States.–U.S. persons are subject to U.S. tax on their worldwide income. Foreign 

taxes may be credited against U.S. tax on foreign-source income of the taxpayer. For purposes 

of computing the foreign tax credit, the taxpayer’s income from U.S. sources and foreign sources 

must be determined.

Nonresident individuals who are not U.S. citizens and foreign corporations (collectively, 

foreign persons) are subject to U.S. tax on income that is effectively connected with the conduct 

of a U.S. trade or business; the U.S. tax on such income is calculated in the same manner and at 

the same graduated rates as the tax on U.S. persons (secs. 871(b) and 882). Foreign persons also 

are subject to a 30-percent gross basis tax, collected by withholding, on certain U.S.-source 

passive income (e.g., interest and dividends) that is not effectively connected with a U.S. trade or 

business. This 30-percent withholding tax may be reduced or eliminated pursuant to an 

applicable tax treaty. Foreign persons generally are not subject to U.S. tax on foreign-source 

income that is not effectively connected with a U.S. trade or business.

In general, dividends paid by a domestic corporation are treated as being from U.S. 

sources and dividends paid by a foreign corporation are treated as being from foreign sources. 

Thus, dividends paid by foreign corporations to foreign persons generally are not subject to 

withholding tax because such income generally is treated as foreign-source income. 

An exception from this general sourcing rule applies in the case of dividends paid by 

certain foreign corporations. If a foreign corporation derives 25 percent or more of its gross 

income as income effectively connected with a U.S. trade or business for the three-year period 

ending with the close of the taxable year preceding the declaration of a dividend, then a portion 

of any dividend paid by the foreign corporation to its shareholders will be treated as U.S.-source 

income and, in the case of dividends paid to foreign shareholders, will be subject to the 30-

percent withholding tax (sec. 861(a)(2)(B)). This rule is sometimes referred to as the “secondary 

withholding tax.” The portion of the dividend treated as U.S.-source income is equal to the ratio 

of the gross income of the foreign corporation that was effectively connected with its U.S. trade 

or business over the total gross income of the foreign corporation during the three-year period 

ending with the close of the preceding taxable year. The U.S.-source portion of the dividend 

paid by the foreign corporation to its foreign shareholders is subject to the 30-percent 

withholding tax.

Under the branch profits tax provisions, the United States taxes foreign corporations 

engaged in a U.S. trade or business on amounts of U.S. earnings and profits that are shifted out 

of the U.S. branch of the foreign corporation. The branch profits tax is comparable to the 

second-level taxes imposed on dividends paid by a domestic corporation to its foreign 

shareholders. The branch profits tax is 30 percent of the foreign corporation’s “dividend 

equivalent amount,” which generally is the earnings and profits of a U.S. branch of a foreign 

corporation attributable to its income effectively connected with a U.S. trade or business (secs. 

884(a) and (b)). In arriving at the dividend equivalent amount, a branch’s effectively connected 

earnings and profits are adjusted to reflect changes in a branch’s U.S. net equity (i.e., the excess 
41

of the branch’s assets over its liabilities, taking into account only amounts treated as connected 

with its U.S. trade or business) (sec. 884(b)). The first adjustment reduces the dividend 

equivalent amount to the extent the branch’s earnings are reinvested in trade or business assets in 

the United States (or reduce U.S. trade or business liabilities). The second adjustment increases 

the dividend equivalent amount to the extent prior reinvested earnings are considered remitted to 

the home office of the foreign corporation.

If a foreign corporation is subject to the branch profits tax, then no secondary 

withholding tax is imposed on dividends paid by the foreign corporation to its shareholders (sec. 

884(e)(3)(A)). If a foreign corporation is a qualified resident of a tax treaty country and claims 

an exemption from the branch profits tax pursuant to the treaty, the secondary withholding tax 

could apply with respect to dividends it pays to its shareholders. Several tax treaties (including 

treaties that prevent imposition of the branch profits tax), however, exempt dividends paid by the 

foreign corporation from the secondary withholding tax.

Netherlands.–The Netherlands does not impose a branch profits tax.

Proposed treaty limitations on internal law

Article 4 of the proposed protocol provides an exemption from the branch profits tax that 

parallels the provision of the proposed protocol providing a zero rate of withholding on 

dividends.

The United States is allowed under the current treaty to impose the branch profits tax (at 

a rate of five percent) on the business profits of a Dutch corporation that are effectively 

connected (or treated as effectively connected) with the conduct of a trade or business in the 

United States, and are either attributable to a permanent establishment in the United States, or 

subject to tax on a net basis in the United States on income from real property or gains from the 

disposition of interests in real property. The tax is imposed on the “dividend equivalent 

amount,” as described above.

Under the proposed protocol, the branch profits tax will not be imposed by the United 

States in cases in which a zero rate of withholding on dividends would apply if the Dutch 

company had conducted the U.S. branch business through a separate U.S. subsidiary. Thus, the 

branch profits tax will not be imposed in the case of a company that, before October 1, 1998, had 

a permanent establishment in the United States, or in the case of income or gains subject to tax 

on a net basis in the United States from real property or from the disposition of interests in real 

property. In addition, the branch profits tax will not apply to a Dutch company that is considered 

a qualified person by reason of being a publicly-traded company, or that is entitled to benefits 

with respect to the dividend equivalent amount under the derivative benefits or competentauthority discretion rules under Article 26 (Limitation on Benefits).

Article 5. Pension, Annuities, Alimony

The proposed protocol replaces the current rules regarding cross-border pension 

contributions found in paragraph 5 of Article 28 (Non-Discrimination) with new paragraphs 7 

through 11 of Article 19 (Pensions, Annuities, Alimony). The proposed rules are intended to 

remove barriers to the flow of personal services between the two countries that could otherwise 
42

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

contributions. With the exception of the addition of paragraph 11 to Article 19, the rules of the 

proposed protocol are similar to rules in the corresponding article of the United Kingdom treaty.

The proposed protocol provides that neither country may tax a resident on pension 

income earned through an exempt pension trust that is a resident of the other country until such 

income is distributed. When a resident receives a distribution from an exempt pension trust, 

such distribution is subject to taxation in accordance with the provisions of Article 19 currently 

in effect. For example, if a U.S. citizen contributes to a U.S. qualified plan while working in the 

United States and then establishes residence in the Netherlands, the Netherlands is prevented 

from taxing currently the plan’s earnings and accretions with respect to that individual. For 

purposes of this provision, roll-overs to another exempt pension trust in the same country are not 

treated as distributions.

Under the proposed protocol, if an individual who is a member of an exempt pension 

trust established under the law of one country performs personal services in the other country, 

whether or not the individual is resident in that other country, contributions made by or on behalf 

of the individual to the plan during the period he or she performs such personal services are 

deductible in computing his or her taxable income in the other country. Similarly, contributions 

made to the plan by or on behalf of his or her employer during such period, and benefits accrued 

under the plan, are not treated as part of his or her taxable income, and such contributions are 

allowed as a deduction in computing the employer's profits in the other country. For example, if 

a participant in a U.S. qualified plan goes to work in the Netherlands for a period of time, 

contributions made by the participant and his or her employer during that period are not included 

in the participant’s income in the Netherlands, and the employer may deduct its contributions 

from its business profits in the Netherlands.

The rules of the immediately preceding paragraph apply only if: (1) contributions were 

made by or on behalf of the individual, or by or on behalf of the individual’s employer to the 

exempt pension trust (or to a similar exempt pension trust for which the exempt pension trust has 

been substituted) before he or she began to exercise employment or self-employment in the other 

country; and (2) the competent authority of the other country has agreed that the exempt pension 

trust “generally corresponds” to an exempt pension trust recognized for tax purposes by that 

country. Moreover, the relief provided under these rules by the other country will not exceed the 

relief that would be allowed by that country to its residents for contributions to, or benefits 

accrued under, an exempt pension trust established in that country.

The proposed protocol also provides that a U.S. citizen who is resident in the Netherlands 

may exclude or deduct for U.S. tax purposes contributions to an exempt pension trust established 

in the Netherlands, provided such contributions are made during the period the U.S. citizen 

exercises taxable employment in the Netherlands and are attributable to such employment, and 

expenses related to such employment are borne by a Netherlands employer or Netherlands 

permanent establishment. Similarly, employer contributions to, or benefits accrued under, a 

Netherlands exempt pension trust are not treated as part of the employee’s taxable income in the 

United States. 
43

The benefits under the rules of the immediately preceding paragraph do not apply unless 

the U.S. competent authority has agreed that the exempt pension trust generally corresponds to 

an exempt pension trust established in the United States. The U.S. tax benefits under the rules of 

the immediately preceding paragraph are limited to the lesser of: (1) the amount of relief allowed 

for the contributions or benefits in the Netherlands; and (2) the amount of relief that would be 

allowed by the United States for contributions to, and benefits accrued under, a generally 

corresponding exempt pension trust established in the United States. Further, to the extent relief 

is available to the individual under this provision, the contributions made to (and benefits 

accrued under) a Netherlands exempt pension trust are counted when determining the 

individual’s eligibility for benefits and contribution limits under a generally corresponding 

exempt pension trust established in the United States.

In accordance with the notes, the term “exempt pension trust” includes those 

arrangements that are treated as exempt pension trusts for purposes of Article 35 of the present 

treaty (Exempt Pension Trusts). The United States and the Netherlands entered into a competent 

authority agreement regarding the types of plans in each jurisdiction that qualify as exempt 

pension trusts.28

The proposed protocol specifically applies the current practices under paragraph 5(c) of 

Article 28 to the more detailed rules of the proposed protocol. Under longstanding Netherlands 

law, a premature withdrawal or lump-sum distribution from a pension plan is not considered to 

be a pension payment. The Netherlands requires its domestic pension plans to provide surety or 

to otherwise ensure that the participants are not able to avoid the Netherlands claim on such 

payments. Under proposed paragraph 11 of Article 19, the benefits of Article 5 of the proposed 

protocol apply with respect to an exempt pension trust established in the United States only if the 

pension trust undertakes to provide information and surety to the tax authorities of the 

Netherlands in accordance with the Netherlands law regarding foreign pension trusts. Thus, 

under both the current treaty and the proposed protocol, in order to “generally correspond” to a 

Netherlands exempt pension trust, a U.S. exempt pension trust must provide assurances to the 

Netherlands similar to those required of a Netherlands exempt pension trust.

In addition, residents of the Netherlands who become nonresidents are required under 

Netherlands domestic law to provide surety against such a premature withdrawal or lump-sum 

distribution from a pension plan. This requirement is not eliminated with respect to U.S. exempt 

pension trusts under either the present treaty or the proposed protocol. However, according to 

the notes, the competent authorities of the United States and the Netherlands agree to consult 

regarding reducing the burden of the multiple undertakings required of exempt pension trusts and 

their members.

 

28

 See Notice 2000-57, 2000-2 C.B. 389. U.S. pension arrangements considered to be 

exempt pension trusts include: (1) qualified retirement plans under section 401(a), including 

qualified cash or deferred arrangements and savings incentive match plans for employees 

(“SIMPLE”) under section 401(k); (2) eligible deferred compensation plans under section 

457(b); (3) tax-sheltered annuities under section 403(b); (4) individual retirement arrangements 

(“IRAs”) under section 408, including Roth IRAs under section 408A; (5) SIMPLE IRAs under 

section 408(p); and (6) simplified employee pensions (“SEPs”) under section 408(k).
44

Article 6. Basis of Taxation

Saving Clause

Like all U.S. income tax treaties and the U.S. model, the present treaty includes a “saving 

clause.” Under this clause, with specific exceptions, the treaty does not affect the taxation by 

either treaty country of its residents or its citizens. Thus, the United States generally may 

continue to tax its citizens who are residents of the Netherlands as if the treaty were not in force. 

The present treaty contains a provision under which the saving clause (and therefore U.S. 

tax jurisdiction) applies for U.S. tax purposes to a former U.S. citizen (other than Netherlands 

nationals) whose loss of citizenship status had as one of its principal purposes the avoidance of 

U.S. income tax. The provision is limited to the 10-year period following the loss of U.S. 

citizenship. 

The proposed protocol expands the saving clause provision in the present treaty also to 

include former long-term residents (other than Netherlands nationals) whose termination of 

residency has as one of its principal purposes the avoidance of U.S. tax. This provision makes 

the treaty largely consistent with amendments to the U.S. tax rules in 1996 related to certain

former citizens and former long-term residents. 

Prior to 1996, the Code provided special rules for the imposition of U.S. income tax on 

former U.S. citizens for a period of 10 years following the loss of citizenship, if his or her loss of 

U.S. citizenship had as one of its principal purposes the avoidance of U.S. income, estate or gift 

taxes. The Health Insurance Portability and Accountability Act of 1996 made several changes to 

these special rules, including making these rules, as amended, applicable to certain former longterm residents of the United States. 

The proposed protocol generally reflects this change to U.S law. The proposed protocol 

also generally follows the standard provision in the U.S. model. However, unlike U.S. law, the 

U.S. model or any other U.S. tax treaty, the provision does not apply to former long-term 

residents who are Netherlands nationals. Consequently, the saving clause does not reflect the 

full reach of the U.S. tax jurisdiction. However, the proposed protocol is consistent with the 

current treaty because the provision in the present treaty dealing with former U.S. citizens also 

does not apply to Netherlands nationals. 

The term “long-term resident” is not defined under the proposed protocol and in accord 

with Article 3 (General Definitions) of the present treaty, the term is defined under the domestic 

laws of the two countries. The United States defines a “long-term resident” as an individual 

(other than a U.S. citizen) who is a lawful permanent resident of the United States in at least 

eight of the prior 15 taxable years. An individual is not treated as a lawful permanent resident 

for any taxable year if such individual is treated as a resident of a foreign country under the 

provisions of a tax treaty between the United States and the foreign country and the individual 

does not waive the benefits of such treaty applicable to residents of the foreign country. 

Exceptions to the saving clause are provided for certain benefits conferred by Article 19 

(Pensions, Annuities, Alimony) of the present treaty, as amended by the proposed protocol.
45

Fiscally transparent entities

The proposed protocol contains special rules for fiscally transparent entities. Under these 

rules, income derived through an entity that is fiscally transparent under the laws of either treaty 

country is considered to be the income of a resident of one of the treaty countries only to the 

extent that the income is subject to tax in that country as the income of a resident. For example, 

if a Dutch company pays interest to an entity that is treated as fiscally transparent for U.S. tax 

purposes, the interest will be considered to be derived by a resident of the United States only to 

the extent that U.S. tax laws treat one or more U.S. residents (whose status as U.S. residents is 

determined under U.S. tax laws) as deriving the interest income for U.S. tax purposes.

The Technical Explanation states that these rules for income derived through fiscally 

transparent entities apply regardless of where the entity is organized (i.e., in the United States, 

the Netherlands, or a third country). The Technical Explanation also states that these rules apply 

even if the entity is viewed differently under the tax laws of the other country. As an example, 

the Technical Explanation states that income from U.S. sources received by an entity organized 

under the laws of the United States, which is treated for Dutch tax purposes as a corporation and 

is owned by a Dutch shareholder who is a Dutch resident for Dutch tax purposes, is not 

considered derived by the shareholder of that corporation even if, under the tax laws of the 

United States, the entity is treated as fiscally transparent. 

The notes state that if an item of income is considered by a treaty country to be derived 

by a person who is a resident of that country by operation of the rules for fiscally transparent 

entities, and the same item is considered by the other country to be derived by a person who is a 

resident of that other country, neither country is prevented from taxing the item as the income of 

the person considered by that treaty country to have derived that item of income. This result is in 

accord with the saving clause (discussed above), because the rules for fiscally transparent entities 

are not an exception to the saving clause. For example, if a Dutch resident (“Z”) wholly owns a 

U.S. limited liability company (“Y”), which elects to be taxed as a corporation for U.S. tax 

purposes, and Y wholly owns a U.S. corporation (“X”), the United States is not prevented from 

exercising full taxing jurisdiction over Y, without regard to whether the Netherlands views Y as 

fiscally transparent. Accordingly, the United States may tax the dividends from X to Y and Y to 

X in accordance with its domestic law. However, with respect to the dividends from Y to Z, 

Article 10 (Dividends), as amended by the proposed protocol, determines the applicable rate of 

U.S. withholding tax, assuming the treaty is otherwise applicable. 

The notes also state that the competent authority of a treaty country may grant the 

benefits of the treaty to a resident of the other treaty country with respect to an item of income, 

even though it is not treated as income of the resident under the laws of the other treaty country, 

in cases where the income would have been exempt from tax if it had been treated as the income 

of that resident. The notes provide the following example. Z is an exempt pension trust within 

the meaning of Article 35 (Exempt Pension Trusts) that is a resident of the Netherlands for 

purposes of the treaty. Z is a member of Y, a U.S. limited liability company that has elected to 

be treated as fiscally transparent for U.S. tax purposes and is treated as non-transparent under 

Netherlands law. Y owns shares in U.S. companies that currently pay dividends. Because the 

dividend income is not treated by the Netherlands as income of Z, Z would not be otherwise 

entitled to treaty benefits. However, the U.S. competent authority may determine that Z is 
46

entitled to benefits because Z would be exempt from tax on the income even if it were treated as 

having derived the income.29

Article 7. Limitation on Benefits

In general

The proposed protocol replaces Article 26 (Limitation on Benefits) of the present treaty 

with an article that reflects the limitation on benefits provisions included in more recent U.S. 

income tax treaties. These provisions are intended to limit the benefits of the treaty to qualified 

residents of the United States and the Netherlands.

The proposed protocol is intended to limit double taxation caused by the interaction of 

the tax systems of the United States and the Netherlands as they apply to residents of the two 

countries. At times, however, residents of third countries attempt to use a treaty. This use is 

known as “treaty shopping,” which refers to the situation where a person who is not a resident of 

either treaty country seeks certain benefits under the income tax treaty between the two 

countries. Under certain circumstances, and without appropriate safeguards, the third-country 

resident may be able to secure these benefits indirectly by establishing a corporation or other 

entity in one of the treaty countries, which entity, as a resident of that country, is entitled to the 

benefits of the treaty. Additionally, it may be possible for the third-country resident to reduce 

the income base of the treaty country resident by having the latter pay out interest, royalties, or 

other amounts under favorable conditions either through relaxed tax provisions in the distributing 

country or by passing the funds through other treaty countries until the funds can be repatriated 

under favorable terms.

The proposed anti-treaty shopping article provides that a treaty country resident is 

entitled to all treaty benefits only if it is in one of several specified categories. Generally, a 

resident of either country qualifies for the benefits accorded by the proposed treaty if such 

resident is within one of the following categories of “qualified persons” (and satisfies any other 

specified conditions for obtaining benefits):

(1) An individual;

(2) One of the two countries or a governmental entity of one of the two countries;

(3) A company that satisfies a public company test and certain subsidiaries of such 

companies;

(4) An exempt pension trust that meets an ownership test;

(5) An organization operated exclusively for religious, charitable, scientific, artistic, 

cultural, or educational purposes; or

 

29 The competent authorities have already reached such an agreement with respect to 

exempt pension funds. Announcement 2003-21, I.R.B. 2003-17. 
47

(6) An entity that satisfies an ownership test and a base erosion test.

Alternatively, a resident that does not fit into any of the above categories may claim 

treaty benefits under the headquarters company test. In addition, a resident may claim treaty 

benefits with respect to certain items of income under the derivative benefits test or the active 

business test. Finally, a person that does not satisfy any of the above requirements may be 

entitled to the benefits of the proposed treaty if the source country’s competent authority so 

determines.

Individuals

Under the proposed protocol, individual residents of the United States and the 

Netherlands are entitled to all treaty benefits. However, if such an individual receives income as 

a nominee on behalf of a third country resident, and thus is not the beneficial owner of such 

income, benefits may be denied.

Governmental entities

The proposed protocol provides that the United States and the Netherlands, any political 

subdivision or local authority of the two countries, or any agency or instrumentality of the two 

countries is entitled to all treaty benefits. 

Publicly traded companies

A company is a resident of the Netherlands or the United States if the principal class of 

its shares, and any disproportionate class of shares, is listed on a recognized U.S. or Netherlands 

stock exchange and is regularly traded on one or more recognized stock exchanges. In addition, 

the proposed protocol includes a new requirement that tests for “substantial presence” in the 

country of residence in order for a company to qualify for treaty benefits under the public 

company and ownership/base erosion tests. The proposed protocol requires that a company 

establish substantial presence by meeting one of the two requirements described below. 

The first requirement determines whether public trading constitutes an adequate 

connection to the residence country. To satisfy the first requirement, each of two tests must be 

met. The first test compares trading in the country of which the company is not a resident to 

trading in the company’s “primary economic zone.” For the United States, the primary 

economic zone includes all NAFTA countries and for the Netherlands, the primary economic 

zone includes the European Economic Area (“EEA”) and the European Union (“EU”). Thus, in 

the case of a Netherlands company, if more trading in its stock takes place on recognized stock 

exchanges in the United States than on recognized stock exchanges in the EEA and the EU, it 

will fail the first requirement. The second trading test compares trading within the company’s 

primary economic zone with worldwide trading. In that case, if the stock of a company is not 

traded in its primary economic zone at all, or if trading in the primary economic zone constitutes 

less than 10 percent of total worldwide trading, the company will fail the first requirement. 

Thus, a Netherlands company that met the regularly traded test primarily through trading on the 

Johannesburg, Sydney, Tokyo or Toronto stock exchanges (i.e., exchanges other than those in 

the EEA and EU) might fail the first requirement. 
48

However, even if a company fails the first requirement of the substantial presence test, it 

can still establish substantial presence if it meets the second requirement. The second 

requirement determines whether the company’s primary place of management and control is in 

the country where it is a resident. The Technical Explanation notes that this test should be 

distinguished from the “place of effective management” test which is used by many countries to 

establish residence and by the OECD Model as a tiebreaker. The place of effective management 

test has been interpreted to mean the place where the board of directors meets. By contrast, 

under the proposed protocol the primary place of management and control test looks to where 

day-to-day responsibility for the management of the company (and its subsidiaries) is exercised. 

According to the Technical Explanation, a company’s primary place of management and control 

will be located in the country in which the company is a resident only if the executive officers 

and senior management employees exercise day-to-day responsibility for more of the strategic, 

financial and operational policy decision making for the company (including direct and indirect 

subsidiaries) in the residence country than in the other country or any third country, and the 

staffs that support the management in making those decisions are also based in the residence 

country.

The notes provide guidance regarding the persons who are to be considered “executive 

officers and senior management employees.” The notes clarify that the relevant persons may be 

employees of subsidiaries if they make the strategic, financial and operational policy decisions. 

The Technical Explanation includes an example that further illustrates this point. If there are 

special voting arrangements that result in certain board members making certain decisions 

without the participation of other board members, that is a factor that would be taken into 

account. 

The notes also include a special rule for dealing with integrated corporate groups, where 

staffs located in two different countries support the management of two publicly traded 

companies. A Netherlands company will be treated as satisfying the requirement of primary 

management and control with respect to the location of its staffs if the staffs conduct more 

management activities in the Netherlands and the other country than in any other country. The 

special rule only applies if the other country in which the staffs are located is in the primary 

economic zone of the Netherlands and has a tax treaty with the United States that would provide 

equivalent benefits to the proposed protocol. Currently, this rule is limited to integrated 

corporate groups consisting of a Netherlands publicly traded company and a U.K. publicly traded 

company and their direct and indirect subsidiaries. 

The term “recognized stock exchange” means the NASDAQ System owned by the 

National Association of Securities Dealers; any stock exchange registered with the U.S. 

Securities and Exchange Commission as a national securities exchange under the U.S. Securities 

Exchange Act of 1934; as well as the Amsterdam Stock Exchange and any other stock exchange 

subject to regulation by the Authority for the Financial Markets (or its successor) in the 

Netherlands. The notes specify that, for these purposes, certain exchanges that are part of 

Euronext will be considered to be subject to regulation by the Authority for the Financial 

Markets. The term also includes the Irish Stock Exchange, the Swiss Stock Exchange and the 

stock exchanges of Brussels, Frankfurt, Hamburg, Johannesburg, London, Madrid, Milan, Paris, 

Stockholm, Sydney, Tokyo, Toronto, and Vienna and any other stock exchange agreed upon by 

the competent authorities of the United States and the Netherlands.
49

The term “principal class of shares” means the ordinary or common shares of the 

company representing the majority of the aggregate voting power and value of the company. If 

the company does not have a single class of ordinary or common shares representing the 

majority of the aggregate voting power and value, then the “principal class of shares” means that 

class or any combination of classes of shares that represents, in the aggregate, a majority of the 

aggregate voting power and value of the company. For these purposes, the term “shares” 

includes depository receipts for shares or trust certificates for shares.

The term “disproportionate class of shares” means an outstanding class of shares which is 

subject to terms or other arrangements that entitle the holder to a larger portion of the company’s 

income, profit, or gain in the country than that to which the holder would be entitled in the 

absence of such terms or arrangements. A company resident in the Netherlands would meet this 

requirement if it has outstanding a class of “tracking stock” that pays dividends based upon a 

formula that approximates the company’s return on its assets employed in the United States.

Shares are considered to be “regularly traded” in a taxable period on one or more 

recognized stock exchanges if the aggregate number of shares of that class traded during the 12 

months ending on the day before the beginning of that taxable period is at least six percent of the 

average number of shares outstanding in that class during that 12-month period. The notes 

provide that if a class of shares was not listed on a recognized stock exchange during this 12-

month period, the class of shares will be treated as regularly traded only if that class meets the 

aggregate trading requirements for the taxable period in which the income arises. The Technical 

Explanation states that this requirement can be met by aggregating trading on one or more of the 

recognized stock exchanges.

In addition, a company that is a resident of the United States or the Netherlands is entitled 

to treaty benefits if at least 50 percent of the aggregate vote and value of the company’s shares is 

owned (directly or indirectly) by five or fewer companies that satisfy the test previously 

described, provided that each intermediate owner used to satisfy the control requirement is a 

resident of the United States or the Netherlands. This rule allows certain subsidiaries of publicly 

traded companies to take advantage of all benefits under the treaty.

Exempt pension trusts

An exempt pension trust is entitled to all the benefits of the proposed protocol if, as of the 

close of the end of the prior taxable year, more than 50 percent of the beneficiaries, members or 

participants of the organization are individuals resident in either the United States or the 

Netherlands or if the organization sponsoring the pension trust is a qualified person. According 

to the Technical Explanation, for purposes of this provision, the term “beneficiaries” should be 

understood to refer to the persons receiving benefits from the organization. 

Tax-exempt and charitable organizations

Under the proposed protocol, an entity is entitled to treaty benefits if it is organized under 

the laws of the United States or the Netherlands and established and maintained exclusively for 

religious, charitable, educational, scientific or similar purposes (notwithstanding that all or part 
50

of its income is tax-exempt). There is no requirement that specified percentages of the 

beneficiaries of these organizations be residents of the United States or the Netherlands. 

Ownership and base erosion tests

An entity that is a resident of one of the countries under the proposed protocol is entitled 

to treaty benefits if it satisfies an ownership test and a base erosion test. However, a company 

that would be a qualified person under the public company test but for the fact that it has no 

substantial presence in its country of residence may not qualify for benefits under the ownership 

and base erosion test.

Under the ownership test, on at least half the days of the taxable period, shares or other 

beneficial interests representing at least 50 percent of the entity’s aggregate voting power and 

value (and 50 percent of any disproportionate class of shares) must be owned (directly or 

indirectly) by certain qualified persons described above (i.e., individuals, governmental entities, 

parent companies that meet the public company test, exempt pension trusts, or an organization 

operated exclusively for religious, charitable, scientific, artistic, cultural, or educational 

purposes).

The base erosion test is satisfied only if less than 50 percent of the person’s gross income 

for the taxable period is paid or accrued, directly or indirectly, in the form of deductible 

payments, to persons who are not residents of either treaty country. The notes provide that for 

this purpose, the term “gross income” means the total revenues derived by a resident of a country 

from its principal operations, less the direct costs of obtaining such revenues. The Technical 

Explanation states that in the case of the United States, the term “gross income” has the same 

meaning as under domestic law (i.e., section 61 of the Code and the regulations thereunder). In 

addition, for purposes of this test, deductible payments do not include arm’s-length payments in 

the ordinary course of business for services or tangible property and payments in respect of 

financial obligations to a bank; provided that, if the bank is not a resident of one of the countries, 

such payment is attributable to a permanent establishment of that bank located in one of the 

countries.

The Technical Explanation states that trusts may be entitled to the benefits of this 

provision if they are treated as residents of one of the countries and they otherwise satisfy the 

requirements of the provision. 

Derivative benefits rule

The proposed protocol contains a reciprocal derivative benefits rule. This rule effectively 

allows a Netherlands 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 treaty countries will be entitled to the benefits 

of the proposed protocol.

A company resident in one of the countries satisfies this rule if both ownership and baseerosion requirements are met. Under the ownership requirement, shares representing at least 95 
51

percent of the aggregate voting power and value of the company must be owned, directly or 

indirectly, by seven or fewer persons who are “equivalent beneficiaries.” 

For this purpose, an equivalent beneficiary includes European Community states, EAA 

states and NAFTA countries, but only if one of two alternative conditions are satisfied. Under 

the first alternative condition, that resident must be entitled to all the benefits of a comprehensive 

tax treaty under specified clauses between its residence country and the country from which the 

benefits of the proposed treaty are being claimed. However, if such treaty does not contain a 

comprehensive limitation on benefits provision, the person must be a person that would be a 

qualified person under the tests described above (and in the case of trusts, without applying the 

ownership test for equivalent beneficiaries), if such person were a resident of the Netherlands or 

the United States under the proposed protocol. With respect to dividends, interest, and royalties, 

the resident must be entitled under such treaty to a rate of tax that is at least as low as the rate 

applicable to such income under the proposed protocol.

The Technical Explanation sets forth the following example. A U.S. company, USCo, is 

a wholly owned subsidiary of DCo, a company resident in the Netherlands. DCo is wholly 

owned by ICo, a corporation resident in Italy. Assuming DCo satisfies the requirements of 

paragraph 3 of Article 10 (Dividends), DCo would be eligible for a zero rate of withholding tax. 

The dividend withholding rate in the treaty between the United States and Italy is five percent. 

Thus, if ICo received the dividend directly from USCo, ICo would have been subject to a five 

percent rate of withholding tax on the dividend. Because ICo would not be entitled to a rate of 

withholding tax that is at least as low as the rate that would apply under the Convention to such 

income (i.e., zero), ICo is not an equivalent beneficiary.

The proposed protocol provides a special rule to take into account the fact that 

withholding taxes on many intercompany dividends, interest and royalties are exempt within the 

European Union by reason of various EU directives, rather than by tax treaty. If a U.S. company 

receives such payments from a Netherlands company, and that U.S. company is owned by a 

company resident in a member state of the European Union that would have qualified for an 

exemption from withholding tax if it had received the income directly, the parent company will 

be treated as an equivalent beneficiary. The Technical Explanation notes that this rule is 

necessary because many EU member countries have not re-negotiated their tax treaties to reflect 

the rates applicable under the directives. Under the second alternative condition for qualifying as 

an equivalent beneficiary, the person must be a resident of either the United States or the 

Netherlands and be treated as a qualified person under the tests described above.

Under the second requirement to satisfy the derivative benefits rule, the company must 

satisfy the base erosion test similar to that described above, with certain modifications. The base 

erosion test is satisfied only if less than 50 percent of the person’s gross income for the taxable 

period is paid or accrued, directly or indirectly, to persons who are not equivalent beneficiaries 

(as defined above) in the form of deductible payments for tax purposes in the company’s country 

of residence. Thus, deductible payments made to equivalent beneficiaries, rather than amounts 

paid to residents of the United States or Netherlands, are not counted against a company for 

purposes of determining whether the company exceeds the 50 percent limit. The notes provide 

that for this purpose, the term “gross income” means the total revenues derived by a resident of a 

country from its principal operations, less the direct costs of obtaining such revenues. The 
52

Technical Explanation states that in the case of the United States, the term “gross income” has 

the same meaning as under domestic law (i.e., section 61 of the Code and the regulations 

thereunder). In addition, for purposes of this test, deductible payments do not include arm’slength payments in the ordinary course of business for services or tangible property and 

payments in respect of financial obligations to a bank; provided that, if the bank is not a resident 

of one of the countries such payment is attributable to a permanent establishment of that bank 

located in one of the countries.

Under the present treaty, the ownership prong of the derivative benefits provision has 

slightly different requirements. The test requires that some of the shares of the company 

claiming benefits be owned by Netherlands residents, but only 70 percent of the shares have to 

be owned by equivalent beneficiaries. The Technical Explanation notes that it is possible that 

some companies would qualify for benefits under the prior test, but not under the provisions in 

the proposed protocol, and vice versa. The Technical Explanation maintains that since 

satisfaction of the prior test demonstrates a close connection to the Netherlands, it remains a 

valid objective test. Accordingly, the notes provide that a company will be granted the benefits 

of the proposed protocol, pursuant to the competent authority discretion provision, in cases 

where more than 30 percent of vote and value of the company’s shares are owned by qualified 

residents of the United States or the Netherlands and more than 70 percent of the shares (and at 

least 50 percent of any disproportionate class of shares) is owned by seven or fewer equivalent 

beneficiaries, provided that the base erosion test has been met.

Active business test

Under the active business test, residents of one of the countries are entitled to treaty 

benefits with respect to income, profit, or gain derived from the other country if (1) the resident 

is engaged in the active conduct of a trade or business in its residence country, (2) the income is 

derived in connection with, or is incidental to, that trade or business, and (3) the trade or business

is substantial in relation to the trade or business activity in the other country. The proposed 

protocol provides that the business of making or managing investments for the resident’s own 

account does not constitute an active trade or business unless these activities are banking, 

insurance, or securities activities carried on by a bank, insurance company, or registered 

securities dealer. For this purpose, a bank will be considered to be engaged in the active conduct 

of a trade or business only if it regularly accepts deposits from the public and makes loans to the 

public. Furthermore, an insurance company only is engaged in the active conduct of an 

insurance business if its gross income consists primarily of insurance or reinsurance premiums 

and investment income attributable to such premiums. 

Because a headquarters operation is in the business of managing investments, a company 

that functions solely as a headquarters company is not considered to be engaged in an active 

trade or business for purposes of this test. However, it can qualify for benefits if it meets the 

requirements of a headquarters company, described below.

The notes provide that an item of income is derived in connection with a trade or business 

if the income-producing activity in the source-country is a line of business that “forms a part of” 

or is “complementary” to the trade or business conducted in residence-country by the income 

recipient. 
53

According to the Technical Explanation, a business activity generally will be considered 

to form part of a business activity conducted in the country of source 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 line of business in the country of residence may be upstream, downstream, 

or parallel to the activity conducted in the country of source. Thus, the line of business may 

provide inputs for a manufacturing process that occurs in the country of source, may sell the 

output of that manufacturing process, or simply may sell the same sorts of products that are 

being sold by the trade or business carried on in the country of source. 

The Technical Explanation also states that for two activities to be considered to be 

“complementary,” the activities need not relate to the same types of products or services, but 

they should be part of the same overall industry and be related in the sense that the success or 

failure of one activity will tend to result in success or failure for the other. Where more than one 

trade or business is conducted in the country of source and only one of the trades or businesses 

forms a part of or is complementary to a trade or business conducted in the country of residence, 

it is necessary to identify the trade or business to which an item of income is attributable. 

Royalties generally are considered to be derived in connection with the trade or business to 

which the underlying intangible property is attributable. Dividends are deemed to be derived 

first out of earnings and profits of the treaty-benefited trade or business, and then out of other 

earnings and profits. Interest income may be allocated under any reasonable method consistently 

applied. A method that conforms to U.S. principles for expense allocation will be considered a 

reasonable method.

The notes provide that an item of income derived from the country of source is 

“incidental to” the trade or business carried on in the country of residence if production of the 

item facilitates the conduct of the trade or business in the country of residence. An example of 

incidental income is the temporary investment of working capital of a person in the country of 

residence in securities issued by persons in the country of source. 

The notes also elaborate on the purpose and application of the substantiality requirement 

to the general rule. The requirement is intended to prevent a narrow case of treaty-shopping 

abuses in which a company attempts to qualify for benefits by engaging in de minimis connected 

business activities in the treaty country in which it is resident (i.e., activities that have little 

economic cost or effect with respect to the company business as a whole).

The determination of substantiality is made based upon all the facts and circumstances 

and takes into account the comparative sizes of the trades or businesses in each country 

(measured by reference to asset values, income and payroll expenses), the nature of the activities 

performed in each country, and the relative contributions made to that trade or business in each 

country. In any case, making each determination or comparison, due regard will be given to the 

relative sizes of the U.S. and Netherlands economies.

Like the U.S. model and the present treaty, the notes provide a safe harbor under which 

the trade or business of the income recipient may be deemed to be substantial based on three 

ratios that compare the size of the recipient's activities to those conducted in the other country 

with respect to the preceding taxable year, or the average of the preceding three years. The three 

ratios compare: (i) the value of the assets in the recipient's country to the assets used in the other 
54

country; (ii) the gross income derived in the recipient's country to the gross income derived in 

the other country; and (iii) the payroll expense in the recipient's country to the payroll expense in 

the other country. The average of the three ratios must exceed 10 percent, and each individual 

ratio must exceed 7.5 percent. For purposes of this test, if the income recipient owns, directly or 

indirectly, less than 100 percent of the activity conducted in either country, only its proportionate 

share of the activity will be taken into account. 

Headquarters company

Under the proposed protocol, a resident of the United States or the Netherlands is entitled 

to treaty benefits if that person functions as a headquarters company for a multinational corporate 

group. A person is considered a headquarters company for this purpose only if each of several 

criteria is satisfied. 

Overall supervision and administration

The person seeking such treatment must provide a substantial portion of the overall 

supervision and administration of the group. The Technical Explanation provides that a person 

will be considered to engage in supervision and administration if it engages in a number of the 

following activities: group financing, pricing, marketing, internal auditing, internal 

communications, and management. However, such company cannot be principally involved in 

group financing. The above-mentioned functions are not an exhaustive list, but intended to be 

suggestive of the types of activities in which a headquarters company will be expected to engage. 

Furthermore, it is understood that in determining if a substantial portion of the overall 

supervision and administration of the group is provided by the headquarters company, the 

activities it performs as a headquarters company for the group must be substantial in comparison 

to the same activities for the same group performed by other entities within the multinational 

group.

For example, a Japanese corporation establishes a subsidiary in the Netherlands to 

function as a headquarters company for its European and North American operations. The 

Japanese corporation also has two other subsidiaries functioning as headquarter companies; one 

for the African operations and one for the Asian operations. The Dutch headquarters company is 

the parent company for the subsidiaries through which the European and North American 

operations are carried on. The Dutch headquarters company supervises the bulk of the pricing, 

marketing, internal auditing, internal communications and management for its group. Although 

the Japanese overall parent sets the guidelines for all of its subsidiaries in defining the worldwide 

group policies with respect to each of these activities, and assures that these guidelines are 

carried out within each of the regional groups, it is the Dutch headquarters company that 

monitors and controls the way in which these policies are carried out within the group of 

companies that it supervises. The capital and payroll devoted by the Japanese parent to these 

activities relating to the group of companies the Dutch headquarter company supervises is small 

relative to the capital and payroll devoted to these activities by the Dutch headquarters company. 

Moreover, neither the other two headquarter companies, nor any other related company besides 

the Japanese parent company, perform any of the above-mentioned headquarter activities with 

respect to the group of companies that the Dutch headquarters company supervises. In the above 
55

case, the Dutch headquarters company would be considered to provide a substantial portion of 

the overall supervision and administration of the group it supervises.

The proposed protocol does not require that the group that is supervised include persons 

in the other country. However, the Technical Explanation makes clear that it is anticipated that 

in most cases the group will include such persons, due to the requirement that the income derived 

by the headquarters company be derived in connection with or be incidental to an active trade or 

business supervised by the headquarters company (described below).

Active trade or business

Either for the taxable year concerned, or as an average for the preceding four years, the 

activities and gross income of the corporate group that the headquarters company supervises and 

administers must be spread sufficiently among different countries. To satisfy the active trade or 

business requirement, the group must consist of corporations resident in, and engaged in an 

active business in, at least five countries, and the income derived in the treaty country of which 

the headquarter company is not a resident must be derived in connection with, or be incidental to, 

that active business. 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.

Single country limitation

The business activities carried on in any one country other than the country where the 

headquarter company resides cannot generate 50 percent or more of the gross income of the 

group. As mentioned above, the proposed protocol states that if the gross income requirement 

under this clause is not met for a taxable year, the taxpayer may satisfy this requirement by 

averaging the ratios for the four years preceding the taxable year. The Technical Explanation 

provides an example of such application:

Example:–DHQ is a corporation resident in the Netherlands. DHQ functions as a 

headquarters company for a group of companies. DHQ derives dividend income from a U.S. 

subsidiary in the 2004 taxable year. The state of residence of each of these companies, the situs 

of their activities and the amounts of gross income attributable to each for the years 2004 through 

2008 are set forth below:

Company Situs 2008 2007 2006 2005 2004

United States U.S. $100 $100 $95 $90 $85

United States Mexico 10 8 5 0 0

United States Canada 20 18 16 15 12

United Kingdom U.K. 30 32 30 28 27

New Zealand N.Z. 40 42 38 36 35

Japan Japan 35 32 30 30 28

Singapore Singapore 25 25 24 22 20

TOTAL $260 $257 $238 $221 $207

Because the United States’ total gross income of $130 in 2008 is not less than 50 percent 

of the gross income of the group, the provision is not satisfied with respect to dividends derived 
56

in 2008. However, the United States’ average gross income for the preceding four years may be 

used in lieu of the preceding year’s average. The United States’ average gross income for the 

years 2004-2007 is $111.00 ($444/4). The group’s total average gross income for these years is 

$230.75 ($923/4). Because $111.00 represents 48.1 percent of the group’s average gross income 

for the years 2004 through 2007, the United States satisfies such provision.

Other country gross income limitation

No more than 25 percent of the headquarter company's gross income may be derived 

from the treaty country of which it is not a resident. Thus, if the headquarters company’s gross 

income for the taxable year is $100, no more than $25 of this amount may be derived from the 

other country. As with the single country limitation calculation, the proposed protocol provides 

that if the gross income requirement under this clause is not met for the taxable year, the 

taxpayer may satisfy this requirement by averaging the ratios for the four years preceding the 

taxable year.

Independent Discretionary Authority

The headquarters company must have and exercise independent discretionary authority to 

carry out the overall supervision and administration functions mentioned in the overall 

supervision and administration requirement, above. The Technical Explanation states that this 

determination is made separately for each function. Thus, if a headquarters company is 

nominally responsible for group financing, pricing, marketing, and internal auditing functions, 

and another entity is actually directing the headquarters company as to the group financing 

function, the headquarters company would not be deemed to have independent discretionary 

authority for group financing, but it may have such authority for the other functions. 

Income taxation rules

The headquarters company must be subject to the generally applicable income taxation 

rules in its country of residence. The Technical Explanation states that this reference should be 

understood to mean that the company must be subject to the income taxation rules to which a 

company engaged in the active trade or business would be subject. Thus, if one of the countries 

has or introduces special taxation legislation that imposes a lower rate of income tax on 

headquarter companies than is imposed on companies engaged in the active conduct of a trade or 

business, or provides for an artificially low taxable base for such companies, a headquarters 

company subject to these rules is not entitled to the benefits under such provision.

In connection with or incidental to a trade or business

The income derived in the other country must be derived in connection with or be 

incidental to the active business activities referred to in the active trade or business requirement, 

above. For example, if a Netherlands company that satisfied the other requirements of this subsection acted as a headquarters company for a group that included a United States corporation, 

and the group was engaged in the design and manufacture of computer software, but the U.S. 

company was also engaged in the design and manufacture of photocopying machines, the income 

that the Netherlands company derived from the United States would have to be derived in 

connection with or be incidental to the income generated by the computer business in order to be 
57

entitled to treaty benefits under this sub-section. Similarly, interest income received from the 

U.S. company also would be entitled to the benefits of the treaty under this paragraph as long as 

the interest was attributable to a trade or business supervised by the headquarters company. 

Interest income derived from an unrelated party would normally not, however, satisfy the 

requirements of this clause.

Derivative benefits for shipping and air transport income

The proposed protocol provides that shipping or air transport income, as defined in 

Article 8 (Shipping and Air Transport) of the present treaty, that is derived by a resident of one 

treaty country from the other treaty country, and that is not entitled to benefits of the proposed 

protocol under any of the tests mentioned above, is entitled to benefits under the proposed 

protocol if it meets one of two tests. 

First, a resident of one of the countries is entitled to benefits with respect to shipping or 

air transport income if at least 50 percent of the beneficial interest in the person (in the case of a 

company, at least 50 percent of the aggregate vote and value of the stock of the company) is 

owned, directly or indirectly, by qualified persons or individuals who are residents of a third 

country that grants a similar exemption for shipping and air transport income to citizens and 

corporations of the other country. This provision is analogous to the relief provided under Code 

section 883(c)(1).

Alternatively, a resident of one of the two treaty countries is entitled to benefits with 

respect to shipping or air transport income if at least 50 percent of the beneficial interest in the 

person (in the case of a company, at least 50 percent of the aggregate vote and value of the stock 

of the company) is owned, directly or indirectly, by a company or combination of companies the 

stock of which is primarily and regularly traded on an established securities market in a third 

country, provided that the third country grants a similar exemption for shipping and air transport 

income to citizens and corporations of the other country. This provision is analogous to the 

relief provided under Code section 883(c)(3). The term “primarily and regularly traded on an 

established securities market” is not defined in the proposed protocol. The Technical 

Explanation states that in determining whether a resident of the Netherlands is entitled to benefits 

under the proposed protocol, the United States will apply the principles of Code section 

883(c)(3)(A).

A resident of the Netherlands or the United States that derives shipping or air transport 

income from the other country but that does not meet all the requirements under the headquarter 

company test can still qualify for benefits under the proposed protocol if it meets the 

requirements of the publicly-traded test or the active trade or business test. 

Grant of treaty benefits by the competent authority

The proposed protocol provides a “safety-valve” for a person that has not established that 

it meets one of the objective tests, but for which the allowance of treaty benefits would not give 

rise to abuse or otherwise be contrary to the purposes of the treaty. Under this provision, such a 

person may be granted treaty benefits if the competent authority of the source country determines 

that the establishment, acquisition, or maintenance of such resident and the conduct of its 
58

operations did not have as one of its principal purposes the obtaining of benefits under the 

proposed protocol. The Technical Explanation provides that in applying this provision, the 

competent authorities will consider the respective obligations of the Netherlands by virtue of its 

membership in the European Community and by it being a party to the EAA, and the respective 

obligations of the United States by virtue of it being a party to NAFTA. The notes specify that in 

particular, the competent authorities will consider any legal requirements for the facilitation of 

the free movement of capital and persons, the differing internal tax systems, tax incentive 

regimes and existing treaty policies among member states of the European Community or the 

EAA states, or parties to NAFTA.

The notes further provide that where certain changes in circumstances might cause a 

person to cease to qualify as a qualified person (as defined above), such changes need not result 

in the denial of benefits under the treaty. The Technical Explanation states that this rule 

recognizes the legal requirements for the free flow of goods and services within the European 

Communities and within NAFTA. The changes in circumstances contemplated by the notes 

include, all under ordinary business conditions: (1) a change in the country of residence of a 

major participant in the company, (2) the sale of part of the ownership interests in a company to 

a resident of a qualifying country, (3) or an expansion of a company’s activities in another 

qualifying country. The notes provide that if the competent authority is satisfied that these 

changed circumstances are not attributable to tax avoidance motives, then this will be a factor 

weighing in favor of granting benefits in accordance with this provision.

The proposed protocol provides that the competent authority of the source country must 

consult with the competent authority of the residence country before refusing to grant benefits 

under this provision. 

Article 8. Exchange of Information and Assistance and Support in Collection

Article 8 of the proposed protocol amends Article 32 of the present treaty. Article 32 of 

the present treaty sets out limitations on Articles 30 (Exchange of Information and 

Administrative Assistance) and 31 (Assistance and Support in Collection) of the present treaty.30 

In general, Article 8 of the proposed protocol provides further detail on the operation of these 

limitations and makes Article 32 more consistent with the U.S. model. 

Paragraph 1 of Article 32 (as contained in Article 8 of the proposed protocol) is identical 

to Article 32 of the present treaty. It states that neither Articles 30 nor 31 shall be construed to 

impose the obligation to carry out administrative measures at variance with the law or 

administrative practice of either country, to supply information that is not obtainable under the 

 

30 The structure of the present treaty, which is maintained by the proposed protocol, is 

unusual for U.S. tax treaties (and at variance with both the U.S. model and the OECD model) 

insofar as it states some of the limitations on and operating rules for the exchange of information 

and assistance in collection provisions in a separate article (as opposed to putting them in the 

article to which they relate). This unusual structure does not affect the substantive operation of 

these treaty provisions.
59

law or administrative practice of either country, or to disclose trade or other commercial secrets 

the disclosure of which would be contrary to public policy.

Paragraph 2 of Article 32 (as contained in Article 8 of the proposed protocol) is new with 

respect to the present treaty. It is substantially the same as the first sentence of paragraph 3 of 

Article 26 of the U.S. model.31 Paragraph 2 provides that, notwithstanding paragraph 1, the 

competent authorities of both countries have the authority to obtain and provide information held 

by financial institutions, nominees, or persons acting in an agency or fiduciary capacity, as well 

as information about persons holding interests, including bearer shares, in another person, 

regardless of any laws or practices of the country that might otherwise preclude the obtaining of 

such information.

Paragraph 3 of Article 32 (as contained in Article 8 of the proposed protocol) is also new 

with respect to the present treaty. Although it is not contained in Article 26 of the U.S. model, it 

does reflect current U.S. treaty policy. For example, a substantially similar provision was 

contained in the 2004 U.S. tax treaties with Japan32 and Sri Lanka33 and in the 2003 U.S. tax 

treaty with the United Kingdom.34 

Paragraph 3 of the proposed protocol does not impose the obligation to obtain or provide 

information that would reveal confidential communications between a client and an attorney, 

solicitor, or other admitted legal representative where the communications are produced for the 

purposes of seeking or providing legal advice or of use in existing or contemplated legal 

proceedings. The Technical Explanation states that, in the case of the United States, the scope of 

the privilege for such confidential communications is coextensive with the attorney-client 

privilege under U.S. law.

The notes35 require, in specified circumstances, that the United States seek records 

through the exchange of information provisions of the treaty before issuing a summons. This 

paragraph is identical to the parallel paragraph in the 1993 Memorandum of Understanding. It is 

not contained in the U.S. model nor is it contained in any other U.S. tax treaty.36 The Senate 

 

31 The remainder of paragraph 3 of Article 26 of the U.S. model is contained in 

paragraph 2 of Article 30 of the present treaty, which is not amended by the proposed protocol.

32 November 6, 2003, diplomatic note, paragraph 8.

33 September 20, 2002, diplomatic note, page 2. 

34 July 24, 2001, diplomatic note, “With reference to Article 27 (Exchange of 

Information and Administrative Assistance)”.

35 Paragraph XXXII of the proposed Memorandum of Understanding between the United 

States and the Netherlands.

36 Accordingly, it does not appear to represent U.S. tax treaty policy and should not be 

considered a precedent for other treaties. 
60

Foreign Relations Committee Report37 accompanying the 1993 Memorandum of Understanding 

states: “The Committee does not believe that the treaty should be interpreted as depriving the 

IRS of the discretion it retains under the regulation.38 The Committee believes that, by allowing 

the IRS to bypass the treaty exchange of information process in a case where, under all the 

circumstances presented, the records will not be obtainable through that process on a timely and 

efficient basis, the Understanding necessarily reserves to the IRS the discretion that it has under 

the regulation, and thus is consistent with Congressional intent.” This statement would continue 

to be authoritative in administering the proposed protocol.

Article 9. Outdated References

Article 9 of the proposed protocol modifies outdated references in Articles 2 (Taxes 

Covered), 18 (Artistes and Athletes), and 22 (Students and Trainees) of the present treaty. The 

proposed protocol eliminates references in Article 2 of the present treaty to the Mining Act of 

1810 and the Netherlands Continental Shelf Mining Act of 1965, and substitutes a reference to 

the Mining Act. The proposed protocol substitutes references to the euro for references to the 

Netherlands guilder in Articles 18 and 22 of the present treaty.

Article 10. Entry into Force

Article 10 of the proposed protocol relates to the entry into force of the modifications 

provided in the protocol.

The article provides that the proposed protocol will enter into force on the later of the 

dates on which the respective treaty countries have notified each other in writing that the 

formalities constitutionally required in their respective countries have been followed. With 

respect to withholding taxes, the provisions of the proposed protocol will have effect for amounts 

paid or credited on or after the first day of the second month next following the date on which 

the proposed protocol enters into force. With respect to other taxes, the provisions of the 

proposed protocol will have effect for taxable periods beginning on or after the first day of the 

January in the year following the date of entry into force of the proposed protocol. 

Notwithstanding the entry into force of the proposed protocol, taxpayers may elect 

temporarily to continue to claim benefits under the present treaty with respect to a period after 

the proposed protocol takes effect if they would have been entitled to greater benefits under the 

present treaty. 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 

protocol would otherwise take effect. 

The notes state that the two treaty countries will consult each other at regular intervals 

regarding the terms, operation and application of the treaty and proposed protocol to ensure that 

it continues to serve the purposes of avoiding double taxation and preventing fiscal evasion and 

will conclude further protocols to amend the treaty as they consider it appropriate. 

 

37 S. Exec. Rpt. 103-19, November 18, 1993.

38 Treas. Reg. Sec. 1.6038A-6(b).
61

Notwithstanding that either treaty country may at any time request consultation with the other 

country on matters relating to the treaty that require urgent attention, the first such consultation 

will take place no later than the thirty-first day of December of the fifth year following the date 

on which the proposed protocol enters into force. Further consultations will take place thereafter 

at intervals of no more than five years. 
62

VI. ISSUES

A. Zero Rate of Withholding Tax on Dividends

from 80-Percent-Owned Subsidiaries

In general

The proposed protocol would eliminate withholding tax on dividends paid by one 

corporation to another corporation that owns at least 80 percent of the stock of the dividendpaying corporation (often referred to as “direct dividends”), provided that certain conditions are 

met (paragraph 3 of Article 10 (Dividends)). The elimination of withholding tax under these 

circumstances is intended to reduce further the tax barriers to direct investment between the two 

countries.

Under the present treaty, these dividends may be taxed by the source country at a 

maximum rate of five percent, a tax that both the Netherlands and the United States do impose as 

a matter of internal law. The principal immediate effects of the zero-rate provision on U.S. 

taxpayers and the U.S. fisc would be: (1) to relieve U.S. corporations of the burden of Dutch 

withholding taxes in connection with qualifying dividends received from Dutch subsidiaries; (2) 

to relieve the U.S. fisc of the requirement to allow foreign tax credits with respect to these 

dividends; and (3) to eliminate the withholding tax revenues currently collected by the U.S. fisc 

with respect to qualifying dividends received by Dutch corporations from U.S. subsidiaries.39

Until 2003, no U.S. treaty provided for a complete exemption from withholding tax under 

these circumstances, and the U.S. and OECD models currently do not provide for such an 

exemption. However, many bilateral tax treaties to which the United States is not a party 

eliminate withholding taxes under similar circumstances, and the same result has been achieved 

within the European Union under its “Parent-Subsidiary Directive.” In addition, in 2003 and 

2004, the Senate ratified U.S. treaties and protocols with the United Kingdom, Australia, 

Mexico, and Japan that contain zero-rate provisions. These provisions are similar to the 

provision in the proposed protocol, although the treaty with Japan allows a lower ownership 

threshold (i.e., more than 50 percent, as opposed to at least 80 percent) than the UK, Australia,

and Mexico provisions or the provision in the proposed protocol. Thus, the proposed protocol 

would be the fifth U.S. treaty to provide a complete exemption from withholding tax on direct 

dividends.

Description of provision

Under the proposed protocol, the withholding tax rate is reduced to zero on dividends 

beneficially owned by a company that has directly owned at least 80 percent of the voting power 

of the company paying the dividend for the 12-month period ending on the date the dividend is 

declared (paragraph 3 of Article 10 (Dividends)). Under the current treaty, these dividends may 

be taxed at a five percent rate.

 

39

 See Part IV of this pamphlet for an economic analysis of this provision and of the 

proposed protocol in general.
63

In certain circumstances, eligibility for the zero rate under the proposed protocol is 

subject to an additional restriction designed to prevent companies from reorganizing for the 

purpose of obtaining the benefits of the provision. Specifically, in cases in which a company 

satisfies the Limitation on Benefits article only under the “ownership/base-erosion,” “active trade 

or business,” “headquarters company,” and/or “shipping/air transport” tests (subparagraph 2(f) 

and paragraphs 4, 5 and 6, respectively, of Article 26 (Limitation on Benefits)), the zero rate will 

apply only if (1) the dividend-receiving company directly or indirectly owned at least 80 percent 

of the voting power of the dividend-paying company prior to October 1, 1998, or (2) such 

company requests and obtains a discretionary ruling from the competent authority that it 

qualifies for the zero rate. In other cases, the Limitation on Benefits article itself is considered 

sufficient to prevent treaty shopping with respect to direct dividends. Thus, companies that 

qualify for treaty benefits under the “public trading,” “derivative benefits,” or discretionary tests 

(subparagraph 2(c) and paragraphs 3 and 7, respectively, of Article 26 (Limitation on Benefits)) 

will not need to meet the October 1, 1998 holding requirement in order to claim the zero rate.

Issues

In general

In view of the relative novelty of zero-rate dividend provisions in the U.S. treaty network, 

the Committee may wish to devote particular attention to the benefits and costs of taking this 

step. In addition, the Committee may wish to determine whether October 1, 1998 is the 

appropriate 80-percent ownership testing date for the proposed protocol with respect to eligibility 

for the zero rate on dividends received by companies that satisfy the Limitation on Benefits 

article only under the “ownership/base-erosion,” “active trade or business,” “headquarters 

company,” and/or “shipping/air transport” tests.

The Committee also may want to determine whether the inclusion of the zero-rate 

provision in the proposed protocol (as well as in the U.K., Australia, Mexico, and Japan treaties) 

signals a broader shift in U.S. treaty policy, and under what circumstances the United States may 

seek to include similar provisions in other treaties. The Committee posed these questions in its 

tax treaty reports in 2003 and 2004, and it may wish to satisfy itself that these questions have 

been answered.40

Benefits and costs of adopting a zero rate with the Netherlands

Tax treaties mitigate double taxation by resolving the potentially conflicting claims of a 

residence country and a source country to tax the same item of income. In the case of dividends, 

standard international practice is for the source country to yield mostly or entirely to the 

 

40

 See Senate Committee on Foreign Relations, Report, Tax Convention with Japan, S. 

Exec. Rpt. 108-9, March 4, 2004; Senate Committee on Foreign Relations, Report, Tax

Convention with the United Kingdom, S. Exec. Rpt. 108-2, March 13, 2003; Senate Committee 

on Foreign Relations, Report, Protocol Amending the Tax Convention with Australia, S. Exec. 

Rpt. 108-3, March 13, 2003; Senate Committee on Foreign Relations, Report, Protocol 

Amending the Tax Convention with Mexico, S. Exec. Rpt. 108-4, March 13, 2003.
64

residence country. Thus, the residence country preserves its right to tax the dividend income of 

its residents, and the source country agrees either to limit its withholding tax to a relatively low 

rate (e.g., five percent) or to forgo it entirely. 

Treaties that permit a positive rate of dividend withholding tax allow some degree of 

double taxation to persist. To the extent that the residence country allows a foreign tax credit for 

the withholding tax, this remaining double taxation may be mitigated or eliminated, but then the 

priority of the residence country’s claim to tax the dividend income of its residents is not fully 

respected. Moreover, if a residence country imposes limitations on its foreign tax credit,41

withholding taxes may not be fully creditable as a practical matter, thus leaving some double 

taxation in place. For these reasons, dividend withholding taxes are commonly viewed as 

barriers to cross-border investment. The principal argument in favor of eliminating withholding 

taxes on certain direct dividends in the proposed protocol is that it would remove one such 

barrier. 

Direct dividends arguably present a particularly appropriate case in which to remove the 

barrier of a withholding tax, in view of the close economic relationship between the payor and 

the payee. Whether in the United States or in the Netherlands, the dividend-paying corporation 

generally faces full net-basis income taxation in the source country, and the dividend-receiving 

corporation generally is taxed in the residence country on the receipt of the dividend (subject to 

allowable foreign tax credits or, in the case of the Netherlands, the participation exemption). If 

the dividend-paying corporation is at least 80-percent owned by the dividend-receiving 

corporation, it is arguably appropriate to regard the dividend-receiving corporation as a direct 

investor (and taxpayer) in the source country in this respect, rather than regarding the dividendreceiving corporation as having a more remote investor-type interest warranting the imposition 

of a second-level source-country tax.

Both the United States and the Netherlands currently impose withholding tax on some or 

all cross-border direct dividends as a matter of domestic law. Therefore, the zero rate provision 

would provide immediate and direct benefits to the United States as both an importer and an 

exporter of capital. The overall revenue impact of this provision is unclear, as the direct revenue 

loss to the United States as a source country would be offset in whole or in part by a revenue 

gain as a residence country from reduced foreign tax credit claims with respect to Dutch 

withholding taxes.

Although the United States only recently first agreed to bilateral zero rates of withholding 

tax on direct dividends, many other countries have a longer history of including such provisions 

in one or more of their bilateral tax treaties. These countries include OECD members Austria, 

Denmark, France, Finland, Germany, Iceland, Ireland, Japan, Luxembourg, Mexico, the 

Netherlands, Norway, Sweden, Switzerland, and the United Kingdom, as well as non-OECDmembers Belarus, Brazil, Cyprus, Egypt, Estonia, Israel, Latvia, Lithuania, Mauritius, Namibia, 

Pakistan, Singapore, South Africa, Ukraine, and the United Arab Emirates. In addition, a zero 

rate on direct dividends has been achieved within the European Union under its “ParentSubsidiary Directive.” Finally, many countries have eliminated withholding taxes on dividends 

 

41

 See, e.g., Code sec. 904.
65

as a matter of internal law (e.g., the United Kingdom and Mexico). Thus, although the zero-rate 

provision in the proposed protocol is a relatively recent development in U.S. treaty history, there 

is substantial precedent for it in the experience of other countries. It may be argued that this 

experience constitutes an international trend toward eliminating withholding taxes on direct 

dividends, and that the United States would benefit by joining many of its treaty partners in this 

trend and further reducing the tax barriers to cross-border direct investment.

Appropriateness of October 1, 1998 testing date for limitation on zero rate

The October 1, 1998 testing date with respect to eligibility for the zero rate on dividends 

received by companies that satisfy the Limitation on Benefits article only under certain specific 

tests provided in that article apparently is modeled after a similar limitation on the zero rate for 

direct dividends in the U.S.-U.K. treaty. This limitation is intended to supplement the general 

limitation on benefits provisions in order to prevent companies from treaty-shopping by 

becoming eligible for the zero rate through reorganization. With regard to the U.S.-U.K. treaty, 

October 1, 1998 was chosen because it was the date on which the United States and the United 

Kingdom announced that they were negotiating the treaty. Thus, October 1, 1998 was the date 

on which companies presumptively were on notice that the negotiation of the U.S.-U.K. treaty 

could result in a zero rate on direct dividends.

It is appropriate to supplement the Limitation on Benefits article in the proposed protocol 

to prevent companies from treaty-shopping with respect to the zero rate on direct dividends. 

However, it not clear why October 1, 1998 is the appropriate testing date for the limitation with 

respect to companies that satisfy the Limitation on Benefits article only under the 

“ownership/base-erosion,” “active trade or business,” “headquarters company,” and/or 

“shipping/air transport” tests. While the United Kingdom and the Netherlands share a 

particularly close economic relationship as members of the EU, especially in light of the ParentSubsidiary Directive, it is not apparent how the announcement of U.S.-U.K. treaty negotiations 

would have encouraged companies to restructure in order to generate direct dividends between 

the United States and the Netherlands in anticipation of possible future treaty negotiations 

between the United States and the Netherlands that could result in a zero rate on such 

dividends.42 The Committee may wish to inquire further with regard to the rationale for the 

October 1, 1998 testing date in the context of the proposed protocol.

General direction of U.S. tax treaty policy

Looking beyond the treaty relationship between the United States and the Netherlands, 

the Committee may wish to determine whether the inclusion of the zero-rate provision in the 

proposed protocol (as well as in the U.K., Australia, Mexico, and Japan treaties) signals a 

broader shift in U.S. tax treaty policy. Specifically, the Committee may want to know whether 

the Treasury Department: (1) intends to pursue similar provisions in other proposed treaties in 

the future; (2) proposes any particular criteria for determining the circumstances under which a 

 

42 Neither the October 1, 1998 testing date nor any other testing date is included in the 

Australia or Japan treaty zero rate provisions, although the October 1, 1998 testing date is 

included in the Mexico treaty.
66

zero-rate provision may be appropriate or inappropriate; (3) expects to seek terms and conditions 

similar to those of the proposed protocol in connection with any zero-rate provisions that it may 

negotiate in the future; and (4) intends to amend the U.S. model to reflect these developments.43

 

43

 See Part VI. D of this pamphlet for a discussion of the status of the U.S. model.
67

B. Expatriation to Avoid Tax by Former U.S. Citizens

and Long-Term Residents

The saving clause of the present treaty applies to former U.S. citizens, other than 

Netherlands nationals, 44 whose loss of citizenship status had as one of its principal purposes the 

avoidance of U.S. income tax. The provision is limited to the 10-year period following the loss 

of U.S. citizenship. This provision is unlike the U.S. model, any other U.S. income tax treaties, 

and U.S. internal law because it excludes the treaty partner’s nationals. 

Like the U.S. model and recently negotiated U.S. income tax treaties, the proposed 

protocol expands the saving clause provision (and therefore U.S. tax jurisdiction) under the 

present treaty to include former long-term U.S. residents whose termination of residency had as 

one of its principal purposes the avoidance of U.S. income tax. Thus, the proposed protocol 

largely reflects the changes to the U.S. tax rules for former citizens and long-term residents as of 

1996. However, unlike the U.S. model, any other U.S. income tax treaty, and U.S. internal law, 

this provision does not apply to the treaty partner’s nationals. 

Prior to 1996, section 877 of the Code provided special rules for the imposition of U.S. 

income tax on former U.S. citizens for a period of 10 years following the loss of citizenship; 

these special tax rules applied to a former citizen only if his or her loss of U.S. citizenship had as 

one of its principal purposes the avoidance of U.S. income, estate or gift taxes. The Health 

Insurance Portability and Accountability Act of 1996 (“HIPA”) made several changes to these 

special rules, including making these rules, as amended, applicable to certain former long-term 

residents of the United States. For purposes of applying the special tax rules to former citizens 

and long-term residents, individuals who meet a specified income tax liability threshold or a 

specified net worth threshold generally are considered to have lost citizenship or resident status 

for a principal purpose of U.S. tax avoidance. Certain categories of individuals, including a very 

limited class of dual residents or citizens, may avoid being deemed to have a tax avoidance 

purpose for relinquishing citizenship or terminating residency by submitting a ruling request to 

the IRS for a determination as to whether the relinquishment of citizenship or termination of 

residency had as one of its principal purposes the avoidance of U.S. income, estate or gift taxes. 

There is a potential conflict between the present treaty and proposed protocol and section 

877 because the saving clause specifically excludes former U.S. citizens and long-time residents 

who are nationals of the Netherlands. 45 The Code provides that neither a treaty nor a statute have 

 

44 In the case of individuals, Article 3 (General Definitions) of the present treaty defines 

a national as all individuals possessing the nationality or citizenship of the one of the treaty 

countries. 

45

 See Letter from the Department of Treasury to Joint Committee on Taxation, 

reproduced in, Joint Committee on Taxation, Review of the Present Law Tax and Immigration 

Treatment of Relinquishment of Citizenship and Termination of Long-Term Residency, (JCS-2-

03), February 2003, Appendix A-22 (“[A] . . . potential conflict exists with the U.S.-Netherlands 

treaty, because that treaty provides that the saving clause does not apply to former U.S. citizens 

who are nationals of the Netherlands.”).
68

preferential status, so that the later-in-time of a statute or a treaty controls (the so-called “later-intime rule”).46 To the extent there is a conflict between section 877, as amended by HIPA, and an 

income tax treaty in force on August 21, 1996 (i.e., HIPA’s date of enactment), the legislative 

history to HIPA states: “[I]t is intended that the purpose of [section 877], as amended, not be 

defeated by any treaty provision.”47 However, any remaining treaty provision that remains in 

force 10 years after August 21, 1996 will take precedence over section 877, as amended by 

HIPA.48 The legislative history to HIPA also discusses the need to renegotiate certain existing 

treaties to reflect the full reach of revised section 877: “The Treasury Department is expected to 

review all outstanding treaties to determine whether the [section 877] provisions, as revised, 

potentially conflict with treaty provisions and to eliminate any such potential conflicts through 

renegotiation of the affected treaties as necessary.”49

As reflected in the legislative history to HIPA, if there is a conflict between the present 

treaty and section 877, as amended by HIPA, section 877 will prevail until August 21, 2006.50 

Thus, the United States may exercise its full tax jurisdiction until August 21, 2006 with respect 

to Netherlands nationals who are former U.S. citizens and whose loss of U.S. citizenship status 

had as one of its principal purposes the avoidance of U.S. income tax, even though the present 

treaty provides otherwise. After that date, the saving clause in the current treaty, with its specific 

exception for former citizens who are Netherlands nationals, will prevail over section 877. 

Because the proposed protocol will enter into force after August 21, 1996, the proposed 

protocol would arguably prevail over section 877 under the later-in-time rule. 51 The saving 

 

46 Section 7852(d).

47 Conf. Rep. No. 104-736, 104th Cong., 2d Sess., 329 (1996). This coordination rule 

applies to those provisions of section 877 that were amended by HIPA as well as those that were 

not amended by HIPA. Rev. Rul. 97-19, 1997-1 C.B. 394. 

48 Conf. Rep. No. 104-736, at 329; Rev. Rul. 97-19.

49 Conf. Rep. No. 104-736, at 329.

50 The present treaty was in force before August 21, 1996. 

51 Section 7852(d); see also Crow v. Commissioner, 85 TC 376 (1985) (holding that an 

individual who relinquished U.S. citizenship for a tax avoidance purpose would not be subject to 

U.S. taxation under the saving clause of the 1942 U.S.-Canada income tax treaty, in part, because 

the legislative history did not allow section 877 to override the treaty; the treaty was silent on the 

right of the U.S. to tax former citizens under section 877); Letter from the Department of 

Treasury to Joint Committee on Taxation, reproduced in, Joint Committee on Taxation, Review 

of the Present Law Tax and Immigration Treatment of Relinquishment of Citizenship and 

Termination of Long-Term Residency, (JCS-2-03), February 2003, Appendix A-22, n. 1 (stating 

that “[b]ecause the treaties with Austria and Ireland entered into force after the enactment of the 

1996 legislation, the 1996 legislation does not override those treaties with respect to former longterm residents”; these two treaties contain saving clauses that explicitly allow U.S. taxation of 

former citizens who loss of citizenship was tax-motivated, but do not explicitly refer to former 
69

clause in the proposed protocol does not permit the United States to impose the special tax rules 

on Netherlands nationals who are former U.S. long-term residents and who terminate U.S. 

residency with a principal purpose of avoiding U.S. income tax. As discussed above, this 

provision is unlike the U.S. model or any other U.S. income tax treaties and does not reflect U.S. 

tax jurisdiction with respect to former long-term residents. 

The Committee may wish to inquire as to why the present treaty was not updated to 

eliminate potential conflicts with section 877, as revised. The Committee may wish to satisfy 

itself that it is appropriate for the United States arguably to cede its tax jurisdiction with respect 

to Netherlands nationals who are former U.S. citizens and long-term residents and whose loss of 

citizenship status or termination of U.S. residency had as one of its principal purposes the 

avoidance of U.S. income tax. In addition, the Committee may want to satisfy itself that it is 

appropriate for the special tax rules for former U.S. citizens and long-term residents to apply 

differently to Netherlands nationals until August 21, 2006 depending on whether they are former 

citizens or former long-term residents, given that section 877 does not draw this distinction.

 

long-term residents). But see Rev. Rul. 79-152 (holding that section 877 applies to an individual 

who terminated U.S. citizenship to avoid U.S. income tax, even though the income tax treaty 

between the U.S. and the foreign country was silent on the right of the U.S. to tax former citizens 

under section 877).
70

C. Treaty Shopping

The proposed protocol, like a number of U.S. income tax treaties, generally limits treaty 

benefits for treaty country residents so that only those residents with a sufficient nexus to a treaty 

country will receive treaty benefits. Although the proposed protocol generally is intended to 

benefit residents of the Netherlands 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 that then makes the loan to the U.S. person and claims the 

treaty reduction for the interest it receives.

The anti-treaty-shopping provision of the proposed protocol is similar to anti-treatyshopping provisions in the Code (as interpreted by Treasury regulations) and in the U.S. model. 

The proposed protocol replaces the anti-treaty shopping provision in the present treaty to update 

it for modifications included in the U.S. model and other more recent U.S. income tax treaties. 

The degree of detail included in these provisions 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 by legislation that would override the treaty. (In 

contrast, the IRS generally is not limited under the proposed protocol in its discretion to allow 

treaty benefits under the anti-treaty-shopping rules.) The detail in the proposed protocol does 

represent added guidance and certainty for taxpayers that may be absent under treaties that have 

somewhat simpler and more flexible provisions.

The provision in the proposed protocol is similar to the anti-treaty-shopping provisions in 

several recent U.S. income tax treaties; however, the anti-treaty-shopping provisions in the 

proposed protocol differ from those in the Code and other treaties in some respects. Most 

notably, the proposed protocol includes a new requirement that tests for “substantial presence” in 

the residence country in order for a public company to qualify for treaty benefits under the public 

company test or ownership/base erosion test. The proposed protocol requires that a company 

establish substantial presence by meeting one of the two requirements described below.

The first requirement determines whether public trading constitutes an adequate 

connection to the residence country. To satisfy the first requirement, each of two tests must be 

met. The first test compares trading in the country of which the company is not a resident to 

trading in the company’s “primary economic zone.” For the United States, the primary 

economic zone includes all NAFTA countries and for the Netherlands, the primary economic 

zone includes the European Economic Area (“EEA”) and the European Union (“EU”). Thus, in 

the case of a Netherlands company, if more trading in its stock takes place on recognized stock 

exchanges in the United States than on recognized stock exchanges in the EEA and the EU, it 

will fail the first requirement. The second trading test compares trading within the company’s 
71

primary economic zone with worldwide trading. In that case, if the stock of a company is not 

traded in its primary economic zone at all, or if trading in the primary economic zone constitutes 

less than 10 percent of total worldwide trading, the company will fail the first requirement. 

Thus, in the case of a Netherlands company that met the regularly traded test primarily through 

trading on the Johannesburg, Sydney, Tokyo or Toronto stock exchanges (i.e., exchanges other 

than those in the EEA and EU) might fail the first requirement. 

However, even if a company fails the first requirement of the substantial presence test, it 

can still establish substantial presence if it meets the second requirement. The second 

requirement determines whether the company’s primary place of management and control is in 

the country where it is a resident. This test should be distinguished from the “place of effective 

management” test that is used by many countries to establish residence and by the OECD model 

as a tiebreaker. The place of effective management test has been interpreted to mean the place 

where the board of directors meets. By contrast, the primary place of management and control 

test under the proposed protocol looks to where day-to-day responsibility for the management of 

the company (and its subsidiaries) is exercised. A company’s primary place of management and 

control will be located in the country in which the company is a resident only if the executive 

officers and senior management employees exercise day-to-day responsibility for more of the 

strategic, financial and operational policy decision making for the company (including direct and 

indirect subsidiaries) in the residence country than in the other country or any third country, and 

the staffs that support the management in making those decisions are also based in the residence 

country.

In determining which individuals are considered “executive officers and senior 

management employees,” the proposed protocol looks generally to the decision-making activities 

of all executive officers and senior management employees that are members of the Executive 

Board or Board of Directors. Under a traditional, centralized management structure, the 

Executive Board or Board of Directors are generally those individuals who report to the 

corporate headquarter offices and make the strategic, financial and operational policy decisions 

for the company. Thus, the rule generally should work well in testing where the strategic policy 

decisions of the business are being carried out. However, given the changing corporate 

landscape, many companies operate under a more decentralized management structure, where 

many strategic policy decisions are delegated down to individuals that are directors of subsidiary 

companies. In this situation, individuals who are not board members may be carrying on the 

day-to-day management of the company; however, the rule in the proposed protocol still would 

look to members of the Executive Board or Board of Directors unless the individuals on the 

Board merely provide formal approval of decisions by others. While the rule provides certainty 

for persons applying this provision, the Committee may wish to satisfy itself that such rule is 

appropriate, given the test is aimed at ascertaining the real location of management and control.

There is a special rule for dealing with integrated corporate groups, where staffs located 

in two different countries support the management of two publicly traded companies. A 

Netherlands company will be treated as satisfying the requirement of primary management and 

control with respect to the location of its staffs if the staffs conduct more management activities 

in the Netherlands and the other country than in any other country. The special rule only applies 

if the other country in which the staffs are located is in the primary economic zone of the 

Netherlands and has a tax treaty with the United States that would provide equivalent benefits to 
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the proposed protocol. Currently, this rule is limited to integrated corporate groups consisting of 

a Netherlands publicly traded company and a U.K. publicly traded company and their direct and 

indirect subsidiaries. 

The new substantial presence test makes the public company test in the proposed protocol 

distinctly different from the U.S. model and more recent U.S. income tax treaties. The rules in 

the proposed protocol test for adequate connection to the residence country while the U.S. model 

and more recent U.S. income tax treaties only require that a public company is listed in one of 

the two treaty countries and regularly traded on a recognized stock exchange, thereby allowing a 

company to qualify for treaty benefits if all the trading takes place in the other country or a third 

country exchange. The new rules tighten the public company test by requiring nexus in the 

residence country and they address situations where a company may simply invert its corporate 

structure to change its residence status without changing the situs from which the business is 

carried on and where it is managed and controlled. In comparing the new rules to other recent 

U.S. income tax treaties, only the recently signed U.S.-Barbados protocol contains similar rules 

and the rules in that protocol are tighter than the anti-treaty shopping provisions in the proposed 

protocol. On the other hand, the recently ratified U.S.-Japan income tax treaty, which was being 

negotiated at the same time as the proposed protocol, does not include the substantial presence 

rules. This raises the question as to what Treasury’s treaty policy is for negotiating tighter 

limitation on benefits provisions.

The proposed protocol also provides mechanical rules under which so-called “derivative 

benefits” are afforded. The U.S. model does not contain a derivative benefits provision.

Under these rules, a company is afforded treaty benefits if, among other things, the 

company is at least 95-percent owned by seven or fewer persons who are equivalent 

beneficiaries, defined generally as residents of EU, EEA or NAFTA countries who meet certain 

other conditions. In addition, the proposed protocol carries forward the rule under the present 

treaty, pursuant to the competent authority discretion provision, that provides that a company 

will be granted benefits in cases where more than 30 percent of vote and value of the company’s 

shares is owned by qualified residents of the United States or the Netherlands and more than 70 

percent of the shares (and at least 50 percent of any disproportionate class of shares) is owned by 

seven or fewer equivalent beneficiaries, provided that the base erosion test has been met. 

The Committee has in the past expressed its belief that the United States should maintain 

its policy of limiting treaty-shopping opportunities whenever possible. The Committee has 

further expressed its belief that, in exercising any latitude Treasury has with respect to the 

operation of the treaty, the treaty rules should be applied to deter treaty-shopping abuses. On the 

other hand, implementation of the tests for treaty shopping set forth in the proposed protocol may 

raise factual, administrative, and other issues. The Committee may wish to satisfy itself that the 

anti-treaty-shopping rules in the proposed protocol are adequate under the circumstances.

Finally, some have speculated that developments in the European Union might call into 

question certain bilateral arrangements between an EU country and a non-EU country, such as 

tax-treaty benefits that are subject to standard limitation-on-benefits clauses. Of course, EU 

bodies do not have the authority to require the United States to grant any treaty benefits that the 

United States has not specifically negotiated. However, in light of the importance of limitation-
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on-benefits provisions to U.S. treaty policy, the Committee may wish to ask the Treasury 

Department for its views as to how the ongoing process of European integration might affect the 

operation and development of the U.S. network of bilateral tax treaties with EU member 

countries.
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D. U.S. Model Income Tax Treaty

It has been longstanding practice for the Treasury Department to maintain, and update as 

necessary, a model income tax treaty that reflects the current policies of the United States 

pertaining to income tax treaties. Some of the purposes of this model are explained by the 

Treasury Department in its Technical Explanation of the U.S. model:

[T]he Model is not intended to represent an ideal United States income tax treaty. 

Rather, a principal function of the Model is to facilitate negotiations by helping 

the negotiators identify differences between income tax policies in the two

countries. In this regard, the Model can be especially valuable with respect to the 

many countries that are conversant with the OECD Model. ... Another purpose of 

the Model and the Technical Explanation is to provide a basic explanation of U.S. 

treaty policy for all interested parties, regardless of whether they are prospective 

treaty partners.52

U.S. model tax treaties provide a framework for U.S. treaty policy. These models 

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

policies on often complicated treaty matters. In order to promote clarity, transparency, and 

meaningful Congressional oversight in this area, the U.S. model tax treaties should reflect the 

most current positions on U.S. treaty policy. Periodically updating the U.S. model tax treaties to 

reflect changes, revisions, developments, and the viewpoints of Congress with regard to U.S. 

treaty policy would ensure that the model treaties remain meaningful and relevant.53 

With assistance from the staff of the Joint Committee on Taxation, the Committee on 

Foreign Relations reviews tax treaties negotiated and signed by the Treasury Department before 

ratification by the full Senate is considered. The U.S. model is an important part of this review 

process, because it helps the Senate determine the Administration’s most recent treaty policy and 

understand the reasons for diverging from the U.S. model in a particular tax treaty. To the extent 

that a particular tax treaty adheres to the U.S. model, transparency of the policies encompassed in 

the tax treaty is increased and the risk of technical flaws and unintended consequences resulting 

from the tax treaty is reduced.

It is recognized that tax treaties often diverge from the U.S. model due to, among other 

things, the unique characteristics of the legal and tax systems of treaty partners, the outcome of 

negotiations with treaty partners, and recent developments in U.S. treaty policy. However, even 

without taking into account the central features of tax treaties that predictably diverge from the 

 

52 Treasury Department, Technical Explanation of the United States Model Income Tax 

Convention, at 3 (September 20, 1996).

53 The staff of the Joint Committee on Taxation has recommended that the Treasury 

Department update and publish U.S. model tax treaties once per Congress. Joint Committee on 

Taxation, Study of the Overall State of the Federal Tax System and Recommendations for 

Simplification, Pursuant to Section 8022(3)(B) of the Internal Revenue Code of 1986 (JCS-3-01), 

April 2001, vol. II, pp. 445-447.
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U.S. model (e.g., withholding rates, limitation on benefits, exchange of information), the 

technical provisions of recent U.S. tax treaties have diverged substantively from the U.S. model 

with increasing frequency. This development suggests that the U.S. model, which has not been 

updated since 1996, is becoming obsolete.

In testimony before the Committee in February 2004, the Treasury Department stated that 

it intended to update the U.S. model, and to work with the staffs of this Committee and the Joint 

Committee on Taxation in this regard.54 The Committee may wish to inquire of the Treasury 

Department as to the current status of this project.

 

54 Testimony of Barbara M. Angus, International Tax Counsel, U.S. Treasury 

Department, Before the Senate Committee on Foreign Relations Hearing on Pending Income Tax 

Agreements, February 25, 2004.