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[Senate Executive Report 109-12]
[From the U.S. Government Publishing Office]

109th Congress                                              Exec. Rept.
                                 SENATE
 2d Session                                                      109-12

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  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

                              R E P O R T

                    [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 Sweden\1\ and the proposed 
protocol amending the existing treaty 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 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.
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    \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.
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                             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 anti-treaty-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.
    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, 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.
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    \2\ The 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.
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                         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.

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-on-benefits article; (2) meet 
the ownership and base erosion test and satisfy the active 
trade or business conditions of the limitation-on-benefits 
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.
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    \3\ See, e.g., IRC Sec. 904.
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    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 (subject 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 non-OECD-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 concessions 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.
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    \4\ Testimony 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.
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                    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\
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    \5\ Treasury Department, Technical Explanation of the United States 
Model Income Tax Convention, at 3 (September 20, 1996).

    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 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.
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    \6\ Testimony 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.
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                           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.

                 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).

                                    
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