49–119

1 All references to the treaty between the United States and Sweden are to the Convention

Between the United States of America and the Government of Sweden for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, signed at

Stockholm on September 1, 1994.

109TH CONGRESS EXEC. REPT.

2d Session " ! SENATE 109–12

PROTOCOL AMENDING THE TAX CONVENTION WITH

SWEDEN (TREATY DOC. 109–8)

MARCH 27, 2006.—Ordered to be printed

Mr. LUGAR, from the Committee on Foreign Relations,

submitted the following

REPORT

[To accompany Treaty Doc. 109–8]

The Committee on Foreign Relations, to which was referred the

Protocol Amending the Convention Between the United States of

America and the Government of Sweden for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to

Taxes on Income, together with an Exchange of Notes, signed at

Washington on September 30, 2005, having considered the same,

reports favorably thereon and recommends that the Senate give its

advice and consent to ratification thereof, as set forth in this report

and the accompanying resolution of ratification.

CONTENTS

Page

I. Purpose ........................................................................................................... 1

II. Background .................................................................................................... 2

III. Summary ........................................................................................................ 2

IV. Entry Into Force and Termination ............................................................... 3

V. Committee Action .......................................................................................... 4

VI. Committee Comments ................................................................................... 4

VII. Budget Impact ................................................................................................ 8

VIII. Explanation of Proposed Protocol ................................................................. 9

IX. Text of Resolution of Advice and Consent to Ratification .......................... 9

I. PURPOSE

The principal purposes of the existing income tax treaty between

the United States and Sweden1 and the proposed protocol amending the existing treaty are to reduce or eliminate double taxation

2

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 and proposed protocol also

are intended to continue to promote close economic cooperation between the two countries and to eliminate possible barriers to trade

and investment caused by overlapping taxing jurisdictions of the

two countries.

II. BACKGROUND

The proposed protocol was signed at Washington on September

30, 2005. The United States and Sweden exchanged notes on the

same day to provide clarification with respect to the application of

the proposed protocol. The proposed protocol would amend the

U.S.-Sweden income tax treaty, which was signed at Stockholm on

September 1, 1994.

The proposed protocol was transmitted to the Senate for advice

and consent to its ratification on November 10, 2005 (see Treaty

Doc. 109–8). The Committee on Foreign Relations held a public

hearing on the proposed protocol on February 2, 2006.

III. SUMMARY

The proposed protocol modifies several provisions in the existing

treaty 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

present treaty with a new article that generally allows full residence-country taxation and limited source-country taxation of dividends. The proposed protocol would retain both the generally applicable maximum rate of withholding at source of 15 percent and the

reduced five-percent maximum rate for dividends received by a

company owning at least 10 percent of the dividend-paying company. However, like several other recent treaties and protocols, the

proposed protocol would provide for a zero rate of withholding tax

on certain dividends received by a parent company from a subsidiary that is at least 80-percent owned by the parent. A zero rate

also generally would apply to dividends received by a pension fund.

As in the current treaty, special rules would apply to dividends received from RICs and REITs, with some new modifications applicable to dividends from REITs, similar to provisions included in other

recent treaties and protocols.

The proposed protocol replaces Article 17 (Limitation on Benefits) of the existing treaty with a new article that reflects the antitreaty-shopping provisions included in the U.S. model and more recent U.S. income tax treaties. Unlike the U.S. model, but like the

recent protocol amending the Netherlands income tax treaty, the

proposed protocol includes a requirement to determine whether a

company’s public trading or management constitutes an adequate

connection to its residence in a treaty country to prevent certain

companies from qualifying for treaty benefits.

3

The proposed protocol amends Article 20 (Government Service) of

the existing treaty to include a special new rule related to Swedish

tax on a U.S. Government pension.

The proposed protocol expands the ‘‘saving clause’’ provision in

Article 1 (Personal Scope) of the existing treaty to allow the United

States to tax certain former citizens and long-term residents regardless of whether their 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 and 2004. The proposed protocol

makes coordinating changes to Article 23 (Relief from Double Taxation) with respect to foreign tax credits allowed in such situations.

The proposed protocol updates Article 1 of the existing treaty to

include the rules in recent U.S. treaties related to fiscally transparent entities, modifies outdated references in Article 2 (Taxes

Covered), and brings Article 4 (Residence) of the existing treaty

into conformity with the U.S. model and more recent U.S. income

tax treaties.

Article VIII of the proposed protocol provides for the entry into

force of the modifications made by the proposed protocol.

IV. ENTRY INTO FORCE AND TERMINATION

A. ENTRY INTO FORCE

In order for the proposed protocol to enter into force, each country must notify the other when it has completed its required ratification procedures, accompanied by an instrument of ratification.

The proposed protocol will enter into force on the thirtieth day

after the later of such notifications. The effective dates of the protocol’s provisions, however, vary.

With respect to withholding taxes, 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 taxes on income covered

by Article VI of the proposed protocol, relating to the taxation by

Sweden of pensions of certain employees of the U.S. embassy in

Stockholm or the U.S. consulate general in Gothenburg, the proposed protocol will have effect for income derived on or after January 1, 1996. With respect to other taxes, the proposed protocol will

have effect for taxable years beginning on or after the first day of

January next following the date on which the proposed protocol enters into force.

B. TERMINATION

The proposed protocol will remain in force as long as the existing

treaty remains in force. Either country may terminate the treaty,

after the expiration of a period of five years from the date of its

entry into force, by giving six months prior written notice of termination to the other country through diplomatic channels.

V. COMMITTEE ACTION

The Committee on Foreign Relations held a public hearing on the

proposed protocol with Sweden (Treaty Doc. 109–8) on February 2,

4

2The transcript of this hearing (‘‘Tax Treaties,’’ February 2, 2006, S. Hrg. 109–308) has been

printed and is available at http://www.gpoaccess.gov/congress/senate/foreignrelations/index.html.

2006. The hearing was chaired by Senator Lugar.2 The committee

considered the proposed protocol at its business meeting on March

14, 2006, and ordered the proposed protocol with Sweden favorably

reported by voice vote, with a quorum present and without objection.

VI. COMMITTEE COMMENTS

On balance, the Committee on Foreign Relations believes that

the proposed protocol with Sweden is in the interest of the United

States and urges that the Senate act promptly to give advice and

consent to ratification. The committee has taken note of certain

issues raised by the proposed protocol and believes that the following comments may be useful to Treasury Department officials

in providing guidance on these matters should they arise in the

course of future treaty negotiations.

A. 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 dividend—paying corporation

(often referred to as ‘‘direct dividends’’), provided that certain conditions are met. 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 the

United States, but not Sweden, imposes as a matter of internal

law. Thus, the principal immediate effect of this provision would be

to exempt dividends that U.S. subsidiaries pay to Swedish parent

companies from U.S. withholding tax. With respect to dividends

paid by Swedish subsidiaries to U.S. parent companies, the effect

of this provision would be to provide greater certainty as to the

continued availability of a zero rate of Swedish withholding tax, regardless of how Swedish domestic law might change in this regard.

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. Moreover, in

2003 and 2004, the Senate approved U.S. treaties and protocols

containing zero-rate provisions with the United Kingdom, Australia, Mexico, Japan, and the Netherlands. 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 do the other

provisions, among other differences discussed below.

5

3See, e.g., IRC § 904.

Description of Provision

Under the proposed protocol, the withholding tax rate is reduced

to zero on dividends beneficially owned by a company that has

owned shares representing at least 80 percent of the voting power

of the company paying the dividend for the 12-month period ending

on the date on which entitlement to the dividend is determined.

The 80-percent ownership requirement under this provision may be

satisfied by either direct or indirect ownership (through one or

more residents of either contracting state).

Eligibility for the benefits of the zero-rate provision is subject to

a more stringent set of limitation-on-benefits requirements than

normally would apply under the proposed protocol. Specifically, in

order to qualify for the zero rate, the dividend-receiving company

must either: (1) meet the public trading test of the limitation-onbenefits article; (2) meet the ownership and base erosion test and

satisfy the active trade or business conditions of the limitation-onbenefits article with respect to the dividend in question; (3) meet

the derivative benefits test of the limitation-on benefits article; or

(4) receive a favorable determination from the competent authority

with respect to the zero-rate provision.

Issues

Benefits and costs of adopting a zero rate with Sweden

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 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, 3 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 Sweden, 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 (subVerDate 11-MAY-2000 10:09 Mar 28, 2006 Jkt 025358 PO 00000 Frm 00005 Fmt 6659 Sfmt 6602 SWEDEN.TXT SFRELA2 PsN: SFRELA2
6

ject to allowable foreign tax credits or, in the case of Sweden, 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 dividend-receiving corporation as

having a more remote investor-type interest warranting the imposition of a second-level source-country tax.

Because Sweden does not currently impose a withholding tax on

these dividends under its internal law, the zero-rate provision

would principally benefit direct investment in the United States by

Swedish companies, as opposed to direct investment in Sweden by

U.S. companies. In other words, the potential benefits of the provision would accrue mainly in situations in which the United States

is importing capital, as opposed to exporting it.

However, it should be noted that although Swedish internal law

currently does not impose a withholding tax on dividends paid by

Swedish subsidiaries to U.S. parent companies, there is no guarantee that this will always be the case. Thus, the inclusion of a

zero-rate provision under the proposed protocol would give U.S.-

based enterprises somewhat greater certainty as to the applicability of a zero rate in Sweden, which arguably would facilitate

long-range business planning for U.S. companies in their capacities

as capital exporters. Along the same lines, the provision would protect the U.S. fisc against increased foreign tax credit claims in the

event that Sweden were to change its internal law in this regard.

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 nonOECD-members 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 Parent-Subsidiary Directive. Finally, many countries have eliminated withholding taxes on dividends as a matter

of internal law. 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.

Committee Conclusions

The committee believes that every tax treaty must strike the appropriate balance of benefits in the allocation of taxing rights. The

agreed level of dividend withholding for inter-company dividends is

one of the elements that make up that balance, when considered

in light of the benefits inuring to the United States from other conVerDate 11-MAY-2000 10:09 Mar 28, 2006 Jkt 025358 PO 00000 Frm 00006 Fmt 6659 Sfmt 6602 SWEDEN.TXT SFRELA2 PsN: SFRELA2
7

4Testimony of Patricia Brown, Deputy International Tax Counsel, United States Department

of the Treasury, before the Senate Committee on Foreign Relations on Pending Income Tax

Agreements, February 2, 2006. 5Treasury Department, Technical Explanation of the United States Model Income Tax Convention, at 3 (September 20, 1996).

cessions the treaty partner may make, the benefits of facilitating

stable cross-border investment between the treaty partners, and

each partner’s domestic law with respect to dividend withholding

tax.

In the case of this protocol, considered as a whole, the committee

believes that the elimination of withholding tax on intercompany

dividends appropriately addresses a barrier to cross-border investment. The committee believes that the Treasury Department

should only incorporate similar provisions into future treaty or protocol negotiations on a case-by-case basis. It notes with approval

Treasury’s statement that it does not view the elimination of withholding tax on intercompany dividends as a blanket change in the

United States’ tax treaty practice.

The committee notes with approval that the Treasury Department has set forth basic criteria for determining the circumstances

under which the elimination of withholding tax on intercompany

dividends would be appropriate in future negotiations with other

countries. The zero rate will be agreed to only if the agreement includes limitation on benefits and information exchange provisions

that meet the highest standards, and if the overall balance of the

agreement is appropriate.4 The committee expects the Treasury

Department to consult with the committee regarding the evolution

of these criteria and the consideration of elimination of the withholding tax on intercompany dividends in future treaties.

B. 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. The U.S. policies on income tax treaties are

contained in the U.S. model. Some of the purposes of the U.S.

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.5

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. For purposes of clarity and transparency in

8

6Testimony of Patricia Brown, Deputy International Tax Counsel, United States Department

of the Treasury, before the Senate Committee on Foreign Relations on Pending Income Tax

Agreements, February 2, 2006.

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.

With assistance from the staff of the Joint Committee on Taxation, the Senate Committee on Foreign Relations reviews tax treaties negotiated and signed by the Treasury Department before advice and consent to ratification by the full Senate is considered.

The U.S. model is important as 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.

Committee Conclusions

The committee recognizes 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 U.S.

model (e.g., withholding rates, limitation on benefits, exchange of

information), the technical provisions of recent U.S. tax treaties

have increasingly diverged from the U.S. model. The important

purposes served by the U.S. model tax treaty are undermined if

that model does not accurately reflect current U.S. positions. The

committee notes with approval the intention of the Treasury Department to update the U.S. model treaty 6 and strongly encourages the Treasury Department to complete the update soon. In the

process of revising the U.S. model, the committee expects the

Treasury Department to consult with the committee generally, and

specifically regarding the potential implications for U.S. trade and

revenue of the policies and provisions reflected in the new model.

VII. BUDGET IMPACT

The committee has been informed by the staff of the Joint Committee on Taxation that it has assessed the likely budget impact

of the proposed protocol to the income tax treaty between the

United States and Sweden. The Joint Committee staff estimates

that the withholding tax changes and other provisions of the proposed protocol will cause a negligible change in the federal budget

receipts during the fiscal year 2006–2015 period, based solely on

the amount and type of historical income flows between Sweden

and the United States.

9

VIII. EXPLANATION OF PROPOSED PROTOCOL

A detailed, article-by-article explanation of the proposed protocol

between the United States and Sweden can be found in the pamphlet of the Joint Committee on Taxation entitled Explanation of

Proposed Protocol to the Income Tax Treaty Between the United

States and Sweden (JCX–1–06), January 26, 2006.

IX. TEXT OF RESOLUTION OF ADVICE AND CONSENT TO RATIFICATION

Resolved (two-thirds of the Senators present concurring therein),

That the Senate advise and consent to the ratification of the Protocol Amending the Convention Between the United States of

America and Sweden for the Avoidance of Double Taxation and the

Prevention of Fiscal Evasion with Respect to Taxes on Income of

September 1, 1994, signed at Washington on September 30, 2005

(Treaty Doc. 109–8).

Æ